You will certainly recall our many warnings about the coming inflation. As I explained in this month's issue of PSIA:
Every great inflation has two things in common: paper money and a big economic contraction or a war that precedes it. The printing presses get out of control when the monetary authorities get scared. They can be scared by guns and blood or by deflation. What we saw last fall was nothing less than a monetary panic. And it's going to have big consequences. There's no avoiding it.
Reacting to the growing risks of U.S. dollar inflation, the long-dated U.S. Treasury bond has been hammered since the end of last year. TLT, the iShares fund that tracks the 20-year Treasury bill, has fallen from $106 to under $95 in only the last two months. It's down from $120 since the beginning of this year.
In the chart below, you'll find the price of gold (the red line) compared to the price of U.S. long bonds (the blue line). What you see are the unmistakable early warning signs of inflation. Despite a weak economy, gold continues to rise while the vale of the government's debt continues to fall.
In my monthly newsletter, I told my readers to buy gold (via an index of gold mining stocks) in December and to short Treasury bonds in January. "I truly believe the decision to short U.S. Treasury bonds in January 2009 will end up being one of the greatest investment decisions of my entire career. We shorted the market at the very top: U.S. Treasury bonds will not trade at those prices again during my entire life."
The combined profit (long gold, short government bonds) is now over 60%. And there is a long way to go on this trade. Long gold, short bonds is a winning strategy for at least the next five years. Look to establish your position (if you haven't yet) during the inevitable pullbacks from this dominant trend.
U.S. bonds have been in a bull market since the early 1980s – and essentially haven't deviated from the trend at all. (See the chart of Treasury bond yields below. Lower yields indicate higher bond prices.)
In the context of the long-term trend of lower interest rates (and higher bond prices), you can see the significance of the big spike at the end of last year and the reversal since. Things will really heat up if (or when) the yield on long bonds goes solidly above 5%. It will be the first notable reversal of the trend since 1981.
What could trigger such a move in the bond market? How about a downgrade of the credit rating of the United States? Think it won't happen? Bill Gross – the world's largest bond-fund manager – thinks it will.
Gross told Bloomberg the U.S. will eventually lose its triple-A rating. Gross notes that the U.K. was downgraded last night, and the U.K. and U.S. "are similar in debt levels and debt trends." Both countries have prospective deficits of 10% annually, "as far as the eye can see," and those debts may approach 100% of GDP, "a level at which country downgrades tend to occur."
Gross is putting PIMCO's money into "hard currency countries," like Germany, and other countries that aren't piling on debt. He also likes Japan, European countries, and Canada, none of which have monetary-easing policies like the U.S. and U.K.
The other trigger I'm watching is the continued manipulation of long-term interest rates by the Federal Reserve. Since authorizing direct purchases of mortgages last fall, the Fed has bought some $79 billion of mortgage debt – in an effort to keep rates low. (That's about 80% of all new mortgages.)
But mortgage rates are fundamentally tied to the long bond market. If rates on U.S. bonds keep going up, mortgage rates have to follow. That means if the Fed wants to keep mortgage rates down, it will soon have to spend a lot more money buying U.S. long bonds. And that's what really leads to massive inflation, because the Fed is simply printing money to pay off creditors. If it begins to do that on a large scale, look out below.
Assuming you know what's going on behind the scenes, it's relatively easy to make a fortune during a period of inflation. You don't have to be afraid of it, if you know what to do. The most obvious ways to profit from inflation are: buying precious metals, shorting long-dated government bonds, buying high-quality assets (especially if they're leveraged with fixed-rate debt), and owning critical infrastructure – like agriculture, transportation networks, and power producers.
Speaking of agriculture... On Wednesday night, the group I was hosting on the Eastern Shore (my editors, copywriters, and a handful of my best industry contacts) went for a cruise on the Chesapeake Bay. It was a perfect evening: temperatures in the low '70s, a nice dry breeze coming out of the west, and a clear sky without a single cloud. We were sailing on one of the only three remaining oyster-dredging sailboats, or skipjacks, in the country.
The discussion on the boat ranged from our kids' baseball teams (Jeff Clark son's team is undefeated!) to how to safely get assets offshore without breaking the law or alerting the federales. Huge farms dot the coast, up and down the Chesapeake Bay. Looking at the farms, I asked Jeff Clark where he thinks fortunes will be made in the coming years. Immediately, he said farmland – an interesting response coming from an options trader... "If you produce your own food, you'll come out on top... and labor's cheap during a depression."
Jim Rogers agrees. He's been buying farmland in Brazil and Canada. His reasoning... "We're still going to eat, probably." He also noted that farmers can't get loans for fertilizers and supplies are constrained. And now may be the perfect entry price for farmland. According to the Chicago Federal Reserve, land prices in the U.S. farm belt have fallen 6% since January 1 – the largest quarterly decline in 24 years. Lower farmland prices will only constrain supply further, because farmers use their land as collateral against loans.
One of my most experienced analysts is way ahead of the rest of us on the farmland idea – Dan Ferris. He has already recommended three farmland stocks in Extreme Value. He presented on these stocks at last week's conference. Says Ferris:
My top recommendation intends to become one of the largest farming operations in the world. It'll get 15,000 acres into production this year, with the potential for as many as 1 million acres over the next few years.
My second best idea owns 36,000 acres of sugar on Maui and 3,000 acres of coffee on Kauai. The whole company trades for less than 10 times operating earnings – which come from its fleet of shipping container boats. At the current price, you get the land for free.Finally... if you're not afraid of the political risk, you can buy my third idea, which owns 6,750 acres of grapes, almonds, pistachios and walnuts in California. You can buy all 270,000 acres of the company's land today for just $1,600 per acre.
As anyone who has ever met him knows, Dan has an incredible eye for value – which is why his picks dominate our Top 10 best-performing open position list and have since we began keeping score. To learn more about Extreme Value, click here.
The global market for oil will be another interesting thing to watch as inflation heats up and as green energy fantasies fail. (Anyone who thinks we can all plug our cars into the wall socket while at the same time limiting the amount of electricity we produce from coal is an ignorant fool. Remember what happened to the price of corn when we tried to power our cars with agriculture?)
I bet global demand for oil rebounds far more rapidly than production increases – especially for the two closest large suppliers for the U.S., Mexico, and Venezuela. Says our oil analyst, Matt Badiali:
Mexico's status as a world oil power is fading fast. It's once legendary oil field, Cantarell, isn't even the largest producer in Mexico anymore. In 2004, Cantarell produced 2 million barrels per day. Today, it struggles to put out 700,000 barrels per day. Mexico's new production leader, the Ku Maloob Zaap field, is on the decline as well.
Mexico is the world's sixth-largest oil producer and supplies the U.S. with 10% of our oil imports. That supply is waning fast thanks to a poorly run national oil company and fiscal mismanagement...
The same problems exist in Venezuela, but to an even larger extent. Matt says the declines in those two countries will lead to the emergence of a new dominant player in the region – which will soon pass Mexico to become the third-largest oil producer in the world. See his Oil Report for more details.
"Any mall that's sitting on life support is probably going to get its plug pulled," said Michael Glimcher, chairman and CEO of Glimcher Realty Trust, which owns 23 U.S. properties. In the fiscal year ended March 31, tenants in U.S. malls collectively posted a 6.5% decline in same-store sales... Simon Property Group, the country's largest mall owner, led with an average 7.3% sales drop.
Some analysts estimate we will have 100 "dead malls" by the end of this year. Any mall generating sales of $250 or less per square foot – the U.S. average is $381 – is a "dead mall" and may fail. By that measure, there are 84 dead malls in a 1,032-mall database compiled by real estate firm Green Street.
If you pay attention, it should become pretty obvious over the next few months which REITs can raise new capital and which can't. Buy the former. Sell the latter.
New high: Seabridge Gold (SA).
In the mailbag... Apparently we did something right, for once. Or perhaps one of our dear subscribers was simply drinking too much this week. Good or bad, praise or rage, send your notes. We read them all: feedback@stansberryresearch.com.
"I want to thank all of you at Stansberry for educating me on investing. I became a S&A Alliance member when you were pushing your put strategy report. While I haven't followed all of your recommendations, I have made many times my alliance membership costs using this strategy. My stock account is exactly double today from where it was the first week in March. I doubt I will ever double my money in two months again, but you make it fun." – Paid-up Alliance member "Jim"
"I would appreciate it if someone could discuss the use of stop-losses when one's funds are not in USD. I purchased Wal-Mart as part of the S&A16 and just got an alert that it had declined by 25%. However, this is not so much a decline in Wal-Mart's price, rather the USD has declined relative to the Canadian dollar in which my shares were purchased. I am dithering as to sell or not – on one hand, Wal-Mart is still an attractive company, on the other hand my account is down 25% on these shares. Your thoughts on this matter would be appreciated." – Paid-up subscriber Carol Garagan
Porter comment: I expect this will continue to be a big problem for any foreign investors buying U.S. stocks. I'd recommend hedging your exposure to the dollar on any U.S. stock you buy.
"I purchases 500 shares of USO last year and held it for less than 2 weeks. I made a little over $2,000. In March this year I was informed in a K-10, I think it was, that I was also liable for over $3,000 in gains that I did not realized. I called the company and was told that they do not pay taxes themselves but profits or losses are passed on to the investors. So I paid personal income tax on a gain of over $5,000 and 60% was on income I did not receive. I'm glad I didn't trade more than 500 shares. If I would have traded enough shares I could have been a millionaire of unrealized gain. I know USO is widely recommended but I will never trade it again. Have you heard of this before?" – Paid-up subscriber Rick Mitchell
Porter comment: Sounds like you need to talk to a good accountant...
"Porter, Being a very long term gold bug, I would say that you have been saying, along with Casey, that gold is going to hit $2000 next year, for a number of years. So here is my prediction. Some day you will be right." – Paid-up subscriber Peter Stephens
Porter comment: Actually, Peter, that's just not true. While I have always believed gold is the only reliable form of money, I was very bearish on gold during the 1990s for the simple reason that the real yield on U.S. bonds was very high. I did an extensive study on the price of gold in 1996 as part of a larger debate inside the research group where I worked and discovered through regression analysis that the price of gold is extremely correlated to the real yield on U.S. Treasury bonds.
If you tell me what the real yield on T-bonds is today, I can tell you (within one standard deviation) where the price of gold will be in nine months. When the real yield on Treasury bonds became steeply negative for the first time in 20 years in the early 2000s, I became extremely bullish on gold. I've been mostly bullish ever since, as you note. And while we've published countless essays over the last five years on why you should buy gold, if you were reading my work in the 1990s, you would have thought I was permanently bearish on gold.
In point of fact, I had never offered a $2,000 price target on gold until this week. My target is based on my analysis of the current real negative yield on U.S. Treasury bonds. And I'm willing to bet a lot of money that I'll be exactly right.
Regards,
Porter Stansberry
Baltimore, Maryland
May 22, 2009