Tuesday, January 31, 2012

The Calm Before The Storm

For the last month or two the world has been on pause. The Greek crisis is still there, Portugal is closing in on BK, and there is a solution being worked out. Deadlines come and go and still no real solution.

FHA, which is about to join Fannie and Freddie in bankruptcy, is still offering great home deals; a friend of ours is buying a 555K home with a 3 ½ percent down payment out here in California. A coworker yesterday showed me a 343K REO home that he was bidding on. It was offered by the bank and since there are 5 other bidders, he’s bidding 383K on it. If it was me, I would have bid 300K and if I didn’t get it, I’d bid on the next one. The only trouble is, very few Realtors want that sort of a client. You’ll be considered a waste of time.

The housing market in California is in the dumpster and everyone is oblivious to it. Prices have dropped enough that buyers think they are getting the deal of a lifetime. There is no panic, just a lot of unexplained burnt lawns and lock boxes hanging on front doors. Interest rates are at an all-time low. All the consumer is interested in is; can I afford the monthly payment? No fear yet, we have yet to hit the lows where panic selling begins.

The real thing to look at is the cost of money. When interest rates are low, the banks are flush with cash and no one to loan it to (or the buyer can’t qualify for a loan). When this happens, commodities take off like a rocket. Futures in gold, oil, wheat and etc. are determined by interest rates. The price of a commodity on the spot market determines the price in the futures market. So if gold is at $1600 an ounce spot, a 100 oz. future 1 year out would be spot plus interest on the value of the spot price for one year on 100ozs. So if the interest rate was 5%, 100 oz. for a year, the premium would be at least $8,000 for the contract. So with very low interest rates, it becomes very profitable to dabble in commodities that are in an upward trend.

Banks are paying zip for interest right now. And the odd thing, there is a very small spread between AAA and DDD bonds. In normal times you could see a spread of 12%. Well with the Federal Reserve guaranteeing everything, there is no risk so Triple D only raises eyebrows when it’s a bra size. The silver foxes are trying to maximize their retirement interest income with high risk investments that have very poor returns for the risk taken. We have speculators playing the commodities and stock markets. All because of very low interest rates.

With the calm before the storm, there are only two real games in town, the stock market and the futures market. As long as we have very low interest rates, look for the markets to go up. Many investors will realize that dollars in the bank are returning nothing and this will be the new sand box to play in. In the end, it plays out like the river boat in India where two star crossed lovers decided to commit suicide rather than be separated. Everyone rushed to one side of the boat to view the event and the boat capsized killing hundreds.

The mess we are facing has a high user confidence level, “I can avoid catastrophe, I know what I am doing.” It’s a little like being the driver facing a head on collision with another driver. You’re confident you can avoid the crash. You both try to turn out of the other cars path. The funny thing is, you both turn in the same direction— away from danger, to where the other car isn't, but will soon be.


Sackerson said...

Good point, Jim. Just as we tried to outsmart each other in the bull phase, the bears are trying to do it now. It is really hard to know what to do for the best. It's like a high-stakes and suspiciously run poker game that you didn't ask to join, but somehow were forced to.

AIM said...

Keynes, a socialist and Dexter White, a communist were the ones who put our new monetary system together via Bretton Woods.

And now all of our economists and politicians and central bank people are Keynesians. It is in their DNA.

They will never see that a corrupt central banking system and a fiat money (not backed by commodities or production) is a formula for doom. They won't stop with their interventions and solutions until the whole system is busted up and destroyed, they are all long gone and a new system has to be put in place. And the American Empire is dead. (High technology and communications allows for a fast demise that only takes a century... unlike Rome which took 3.5 centuries to crash and burn.)


Anonymous said...

They'll continue to falsify a recovery so that Obama gets his 2nd term. He's trashed our Constitution and Bill of Rights, doubled the national debt, supported the largest wealth transfer (robbery)from the middle class to the power elite (bankers and big corps), and foisted the nightmare of ObamaCare upon us in his first term. He should be able to totally destroy whatever is left of our country in his next term.

America: the land of welfare and zombies. Another super power that descended into an effete 3rd world nation.

Long live China and India.

frakrak said...

Hi Jim, thanks for your blog! Always enjoy reading it:) And your bloggers contributions.
If you go by the adage that there is nothing new under the sun, then a retrospective look at how people preserved wealth in the last great crash may be of interest?
I am sure that some entities did come thru this with a large portion of their wealth intact!
As you point out we are all in the boat but the person that takes the 50% haircut will be eminently better off than the person that is forced into the 99%. There will be something ....
It may not be stocks, bonds, cash, gold ...
It could be rare earth metals, diamonds, stocks in particular companies, (who knows? I don't) but my point is there will be something that will preserve or nearly preserve the wealth of the few!
Read quite a few articles of a looming global bank holiday, where banks will be closed around the globe and depositors get a negative 40% interest rate hair cut?? Did this happen with FDR?

Anonymous said...

Back before, in and around the Great Depression everyone got whacked. First the commodity guys got it... then real estate (Florida, etc.)... then the stock guys (1929)... then the bond guys... and finally the gold guys (FDR confiscated and repriced gold).

Things will be worse this time. The diseases created by false economic principles and corruption has spread deep into every aspect of our financial lives.

This time will be worse... nowhere to run. Everyone is gonna get whacked.

The only true wealth appears to be health, food, water and energy. Maybe the only real security and stability and wealth is...

a little free and clear farm with a well, solar and wind power, and animals and crops for food and barter. will need to be a viable operation in order to pay the property taxes which will be sky high.

Anonymous said...

Hi Jim. I'm doing a survey. I respect your logic and opinion.

What would you do if some of your assets ran their course, had to be liquidated and 500k in capital came back to you? In this economy and where we are headed, what would you do right now with $500,000?

I'd appreciate feedback from any other readers as well.

Jim in San Marcos said...

Hi Sack

Welcome to the fray. What is going to eventually happen to GB and the Euro???

I kind of get the feeling that if Great Britain supports the Euro, it's kind of like stepping into a blender--everything is there, its just not the way you thought it would be.

Anonymous said...

Who was able to preserve their wealth in the 30s is a very good question. But I don't think it was anyone.

The commodity guys got killed;;; then the real estate guys;;; then the stock guys;;; then the bond guys;;; and finally the gold guys. Who is left?

Jim in San Marcos said...


If I put you in charge of toasting bread, would you toast it too light or too dark?

There is a lot going on, I think you need to look at the big picture. If you know where you are going, you can sell tickets. If your not sure, you're buying tickets.

I think in 4 years, we will have the answers, and THEN we can write the questions. And that kinda sucks---

Jim in San Marcos said...

Hi Frakrak

There were withdrawal restriction from accounts in the early 1930's. It didn't fix the problem, it only made it worse. The bank holidays didn't fix much.

If you look at the depositor in the 1930's, they had a 90% haircut on savings.

Of course in todays world, we had the same haircut, but the government printed the dollars to make up the deficit. Kind of makes you wonder "How can you print what you can't make?"

SurvivalAndProsperity.com said...

Hey Jim. Totally agree with you that it is "the calm before the storm." Since last week's job numbers, it even feels like we're being led (forced?) to believe the notion that the U.S. economy has now turned around. Which is a hoot, since all that's been done since the financial crisis reared its ugly head in 2008 has been to kick the can down the road. Alas, good looks are only skin deep in our case.

Jim in San Marcos said...

Hi Anon 9:24

If I had 500K, I'd put 100K in real estate,100k in gold, 100k in silver, 100k in cash and 100k in aircraft. Of course, if a mahogany sail boat came up for sale I might cut the aircraft allotment to 50 k.

Anonymous said...

I guess I should've been more specific. Doing what you suggest would be ok for someone who has a job (if I recall correctly, you do have some sort of government based job). But what about if you don't have a job and you are on your own as an investor/entrepreneur such as myself?
Your suggestion wouldn't work for me because that money wouldn't be working very hard for me, ie. giving me much passive income.
I 500k is my whole nestegg, all I've got, it must be preserved and grown so it is a survival point for my wife and I. We want to grow it as fast as we can, and have passive income from it to cover our living expenses so that we are free to work on other money making activities and businesses, etc. And we'd also like a hedge for the coming inflation and currency destruction.
What would you suggest if you were in our position?
Anon 9:24

Jim in San Marcos said...

Hi Anon 9:24

You confuse me. My wife and I both work, and between the two of us have 500K in IRA's, savings and a rental. We are getting a return of about 16K on our investments and that is about a 3 percent. Inflation is unofficially around 7 to 10 percent. I'm not about to retire on that even at age 65.

If interest rates were 10 percent, there might be some real investment opportunities out there.

Gold and silver are way overpriced, real estate for rental income has a potential in some areas but they are rather limited, bonds are at absurd levels, and of course, the stock market is the last game in town. Are you feeling lucky???

In today's market, you need 1 and 1/2 million dollars for a nest egg to have enough passive income that will not eat into your principle as you desire. Managed rest home care is 75K a year in case you need it.

The only thing I can seriously suggest that might satisfy your requirements is illegal--growing Pot in Northern California.

We point to gold and silver as methods of preserving your buying power, but they are not investments, they pay no return. Real estate is a hedge against inflation and the banks will lend 80% of the purchase price. That's 5 to 1 leverage. You have to be able to shop for value.

Reality is the rule of 72. Divide the interest rate you receive into 72 and that gives you the number of years for your nest egg to double. Three into 72 means Obama deserves a kick in the crotch.

Anonymous said...

I need to work that money hard with active investments and activities that will double it and double it again and then as we hit older age we should be able to live off of it. Our formula is earn as much money as we can each year and after frugal living expenses and taxes throw the remainder into the investment portfolio. It is the only way to make it happen. Forget saving 10% per year. We plan to live cheaply and save 60-70% of our income each year!

One idea is private lending. I've met people making 20%+ doing that (doubles your money every 3.6 years per Rule of 72). Need outside the box investments/activities to make this happen.

Anon 9:24

Jim in San Marcos said...

Hi Anon 9:24

I don't even think a con game would offer more than 10% right now. You might be able to do a second trust deed at 12 percent, for a relative that you hated intensely that was down on his luck and desperate.

I can see a pawn broker getting a 20 percent return, but not you and me on an individual basis.

Rental real estate use to return 20%, but you'd be lucky to get 10% in this market.

If you are getting 20% on any investment currently, be prepared for some very serious competition offered at a lot lower interest rate.

Anonymous said...

We're getting close enough to retirement to worry about how to create income via capital. Private pension after 30 years at a leading high tech company is $700/month.

I've been looking at rental real estate - only low-to-middle income. I keep a running tally of what average social security beneficiaries earn, and what Section 8 covers - I try to find properties that can pay the mortgage with rents at 25% of social welfare incomes. But cap rates are in the 6-8% range, which seems awfully low for me to believe the sellers' inflated income claims, understated expenses, and put my good name on the line. Low interest rates drive down cap rates, too.

Once in a while, I see truly low-income housing at 10% cap rates - I try to figure out if the numbers are total BS or if the seller is sick of dealing with deadbeats. Several years of low rates are pushing a lot of investors into any investment they can get - no respect for risk, because inflation is eating us alive today. But if rates rise faster than incomes - seems like they will - investors with new capital will be looking for higher cap rates, and sellers will have to short sell to get out at higher cap rates. As far as I can tell, the only way to survive the current economy is to take a 20+ year view.

Anonymous said...

Hey AIM - it only took England a couple World Wars to lose top billing among super powers. They lost out to America - the country with low debt, hard workers, low overhead, lots of natural resources, few worker protections, and a strong entrepreneurial ethic. Sound like any countries out there today?

Europe was saddled with massive debt and rebuilding costs from the war. Kind of like America today - massive debt, and we've been neglecting infrastructure maintenance. We're still a land of freedom and political stability, but China's got a lot of the advantages we enjoyed from the 40's through the 60's.