Cash? What kind?...

Cash? What kind?... Grantham says the most fateful words in finance: It's different this time... Monetizing debts 101... In the mailbag: A real scam…

*** Usually, it's my job to kick the hornet's nest on Friday, writing about some of the unpleasant truths of finance. Yesterday, though, Dan did it for me. His growing preference for "cash" as opposed to securities or commodities confused many of our subscribers… and enraged more than a few. These folks immediately accused us of talking out of both sides of our mouths. Dan speaks for himself in today's mailbag… But the ruckus was meaningful for me, too...

*** Let me help Dan clear up the confusion and set our views on the matter slightly apart. As longtime readers have heard me say before, I don't spend a fortune on my editorial staff to dictate what they write. Instead, I pay them well to say what they believe – and then I hold them accountable. If Dan believes the greenback (the U.S. dollar) is undervalued, he may well want to hold more of it. His view is actually a bit more nuanced than this. And in any case, I agree with him in some respects.

However, I part ways with Dan in one important way. Dan says the U.S. dollar is what people own when they don't want to own investments. When you sell stocks, you end up with U.S. dollars in your account, by default. That's because the U.S. dollar is the world's reserve currency. When most people talk about moving to "cash," they're talking about U.S. dollars – even if they live in another country. But that's changing...

*** In late 2009, renowned hedge-fund manager John Paulson said, "Once the Fed began directly buying Treasurys and mortgages, I lost faith in the dollar as a reserve currency for my assets..." Using derivates, he created a gold-backed interest in his fund and moved his entire personal holdings into these new gold-backed shares. Doing so made him around $15 billion in 2009. Imagine if you had been able to do the same with your income and investments…

*** Moves like Paulson's – which will certainly be mimicked by other funds and high net worth investors – prove that people won't necessarily want dollars when they sell securities during the next big bear market. For the first time in many decades, Americans are beginning to prefer holding the currencies of other countries. For example, Bill Gross – who runs the largest bond fund in America – has sold short the U.S. Treasury market and is buying Brazilian debt for the first time in as long as I can remember. Of course, many Americans – some for the first time in their lives – are buying alternative currencies… such as gold and silver.

*** Some people view these events as a "bubble" in precious metals or emerging markets. But this isn't a bubble. It's not driven by credit. It's driven by the real and large structural imbalances in the world economy – factors unlikely to be resolved easily.

This fundamental restructuring of the world's monetary system is long overdue – as the size of America's deficits should make clear to any observer. For investors who are cautious and knowledgeable about the inevitable devaluation of the U.S. dollar, these changes will create opportunities. But for most Americans who don't understand the first thing about monetary affairs, this will be a true disaster.

One of the reasons we frequently show you charts of things like oil and equity prices denominated in gold instead of U.S. dollars is because we want you to understand what's happening in the world through the lens of a sound currency. These charts would look similar if viewed through the currencies of Canada, Australia, Singapore, Switzerland, and China, too.

*** So when we write about allocating to "cash" because we see little value (broadly speaking) in the public markets for stocks and bonds, we're going to have to be more specific. What kind of cash? Just remember this acronym: CASSH. Again, that's Canada, Australia, Singapore, Switzerland, and Hong Kong (China).

Yes, yes... I know the Hong Kong dollar is tied to the U.S. dollar. And yes, I know exactly what that means. But corporate debt issued in Hong Kong is now frequently denominated in Chinese yuan. And as yuan-denominated accounts are now widely available in Hong Kong, it is only a matter of time until the world's most capitalistic society abandons the U.S. dollar completely. I'm sure you'd agree that's not a good sign for our country or currency.

*** How can you use this advice? Probably the easiest way is to simply open an account with Everbank, which offers CDs guaranteed by the FDIC, but denominated in any one of 22 currencies. Getting out of the dollar is as easy as picking up the phone and telling the Everbank teller to put your savings in Swiss francs.

*** If you're a high net worth account (with more than $1 million in deposits), Everbank is launching a new, private bank that will give you the services of a private banker – but waives almost all the fees most other banks will charge you. Call Everbank and ask about its new Elite program.

You should know, I helped them develop this program purely out of frustration with Bank of America's pitiful service, but I've declined to participate in the official marketing. (Stansberry & Associates Investment Research does not accept any kind of referral fees from brokers or banks – ever.)

If you're a slightly more experienced or high net worth investor, you may also want to open an account with a brokerage firm that specializes in foreign stocks and bonds, like International Assets. Talk to Jeff Winn (800–432-4402), who's been helping our subscribers buy hard-to-find foreign stocks and bonds for almost two decades. He can, for example, help you follow Chris Weber's legendary Max Yield currency strategy by investing directly in foreign sovereign bonds. Or he can put you in high-yielding Turkish lira.

*** Now, is there a chance that Dan is right? Is the dollar's fall mostly over? And if the stock market corrects, will the U.S. dollar rally? Is it possible doubts about the dollar's future role in the world economy are merely the kind of pessimism that's rampant at a market bottom? Absolutely. In fact, I'm seeing more and more signs that market sentiment on the U.S. dollar is at a pessimistic extreme.

The success of our End of America advertising campaign is a great example. The broad interest of the general public in these kinds of monetary topics is very unusual. That's the kind of thing that typically heralds a market turning point.

Another sign of a bottom in the greenback: Longtime and well-respected dollar bulls are throwing in the towel. Having feared a "deflation" that would have seen the dollar's purchasing power grow, many analysts now realize the next crisis will be inflationary – meaning a collapse in the dollar's purchasing power.

And finally... perhaps most ominously... one of the world's greatest investors, Jeremy Grantham, the head of GMO, recently published a long document explaining why "this time is different" and the value of the dollar will not revert back towards the mean. The world, he says, is facing a Malthusian crisis – "peak everything."

*** It makes me uncomfortable to be on the same side of the market as a modern-day Malthus or anyone claiming "it's different this time." Mean reversion – the tendency of financial assets to fluctuate around average prices – is probably the most permanent and powerful law of finance... or perhaps of nature itself. Furthermore, ideas similar to Grantham's latest research – which says we're running out of everything because of rapid population growth – tend to always pop up in the midst of a currency crisis.

The famous 1969 book Population Bomb is probably the most popular modern exposition of Malthus' ideas. But it didn't presage mass starvation around the world, as it claimed. Instead, it simply marked the beginning of a decade long devaluation of the dollar. Don't worry. The laws of nature haven't been repealed. As Malthus himself admitted before he died, we're not going to run out of everything. It's not different this time. It's just a currency crisis. But unfortunately, it's a long way from being over… a long, long way.

*** Here's the number I keep thinking about: $700,000. Right now, Americans owe almost $700,000 per family. That's all government debt, all private debt, and all corporate debt currently outstanding. That's not future obligations. That's what we owe today. Taking the Producer Price Index rate of inflation (5.5%) and adding a reasonable risk premium to it (say 2.5%), financing this debt legitimately would cost us something around 8% in interest annually. That's $56,000 in interest annually per family, which is also about the amount of total (average) household income.

Think about that for a minute. Just to finance our debts legitimately would consume all our national income: We're broke.

That's why I'm certain the Fed will continue to print money and monetize our government and mortgage debt. Unless we want to default and reorganize our obligations, printing vast quantities of new money is the only option.

*** So far, the Fed has printed up nearly $2.5 trillion of new money and used it to buy Treasury bonds and mortgages, keeping interest rates far lower than the real market rate. Doing so has essentially erased about 4.5% of our total debt. But doing so also caused the Fed's balance sheet to nearly triple, resulting in a massive inflation.

Since the beginning of the Fed's second round of "quantitative easing" (aka money-printing), the value of our currency has fallen by roughly 50% against other sound currencies. It won't be long before these changes send consumer prices skyrocketing. Gas prices have already doubled since the start of the Fed's campaign. Just imagine what gas prices will be by the time the Fed has monetized 50% of our debt – an amount I believe is the minimum necessary to return us to solvency.

That's why I expect the dollar still has a long way to fall. And why I believe it will lose its reserve currency status – a status it has already lost in the eyes of most knowledgeable investors.

*** New 52-week highs (as of 4/28/11): Cambria Global (GTAA), PowerShares Dynamic Biotech (PBE), DirecTV (DTV), CARBO Ceramics (CRR), Royal Gold (RGLD), Molina Healthcare (MOH), iShares Silver (SLV), EV Energy Partners (EVEP), Philip Morris International (PM).

*** You may recall the letter we received from James Diffley in last week's Digest. James is a new subscriber. He accused us of "bait and switch" and being a "scam." We took offense to his words. We work hard to deliver you our best investment ideas... ideas that are 100% unbiased. And our marketing, not fees from managing money or facilitating deals, allows us to do this.

In today's mailbag, we're republishing a letter Porter personally wrote to James after receiving an apology. We hope you enjoy it. And if you're a new subscriber, we hope it will help you understand our business better. As always, send your feedback to feedback@stansberryresearch.com.

*** "If the dollar is headed down while inflation is inexorably driving prices up, why should anyone convert assets likely to ride the inflationary tide into dollars that lose value day by day?

"The dollars you're holding now will be the same dollars you have when the market crashes, as you predict, and those dollars will have dwindled in value.

"Why does a weakening dollar herald a collapse of the equities market" – Paid-up subscriber Rod Phelan

Ferris comment: I knew I'd get a lot of questions about my recommendation to hold cash. Before I answer your specific points, I must tell you I view the strong negative response as more evidence this could be a better time to hold cash than most stocks or bonds. The more everybody hates cash, the more I like it.

You mention "assets likely to ride the inflationary tide." I'm not sure which assets you have in mind, but you can't possibly be talking about stocks. Most stocks will not ride the inflationary tide well at all. Stocks are pieces of businesses, and inflation is horrible for all businesses – including mining companies and oil & gas companies. Equity valuations during the inflationary 1970s were in the toilet, below 10 times earnings on average. Inflation did that.

I disagree with you about a market crash's effect on the dollar. A stock market crash is a dollar-buying mania. When people sell stocks and/or bonds, what do they receive? Gold bars? Silver ingots? Gold ETF shares? No. They get cash. Cash is where you go when you sell.

I understand the confusion, though. I'll try to clarify. You hold cash to reduce the risk of holding equities, most of which are overvalued. You hold gold and silver to preserve the value of your savings and hedge the wanton printing of paper dollars.

It's a difficult time to be an investor right now. The Fed and government have interfered with things so much, it's hard to keep everything straight. Just look at the contradiction I've been espousing: Hold cash and precious metals. It seems contradictory. But when I say "hold cash," I mean sell and/or avoid buying overvalued stocks. When I say "hold gold," I mean keep a portion of your assets in precious metals to preserve the value of your savings. Think of them as separate operations affecting the level of risk in separate parts of your portfolio.

*** "First let me apologize for using the word 'scam.' I wrote that I felt like it was a scam. I did not say that it was one. The worst that I could ever think is that you are a hard sell organization. And to me, 'hard sell' usually means there is something wrong with a product or it would sell itself. Also I did not mention the word 'Fraud.'

"I am sorry to get off on the wrong foot with you because I really enjoyed the information that your free video shared with me and also with my family. And I am looking forward to learning more in the future with my subscription. I wrote that my position might change as time passes and I see more of your work. And your response assures me that that I will change over time." – Paid-up subscriber James Diffley

Porter comment: James… Perhaps you don't know the meaning of the word "scam." The dictionary defines "scam" as: "A confidence game or other fraudulent scheme, especially for making a quick profit; swindle."

Using this word to describe my business is particularly cruel, as over the 15 years I've spent building my career and this company, I have always adhered to two very simple rules…

First, I always give my customers the advice and information I'd expect were our roles reversed. Second, we never publish anything I wouldn't be proud and happy for my father to read and implement. (See this recent Digest for more about why that might mean even more to me than most people...)

Following these rules, I've made several important decisions that set my firm apart from this industry, which is admittedly riddled with questionable operators. For example, I am one of the few (perhaps only) newsletter publishers who has never accepted a penny from stock promoters in any form, shape, or fashion. I won't even accept referral fees from Everbank or other financial service providers (like coin dealers) – despite the fact that some of our analysts do endorse their products – simply because it would create the appearance of a conflict.

I have never, ever purchased a single e-mail address or engaged in "spam" marketing. I have always, since Day 1, provided a reasonable guarantee and lived up to that guarantee to the tune of millions of dollars. I lived up to it even when it was perfectly obvious the "subscriber" had no true intention to pay. And I lived up to it even during times, such as late 2008, when the demands for refunds came despite the correct advice we'd offered. Our subscribers didn't follow the trailing stops we recommended. They didn't short stocks as we urged, and they had not heeded our warnings that a collapse was underway. Then, when the collapse played out almost exactly as we'd predicted, they demanded a refund. We paid all claims, no questions asked – and it almost bankrupted us.

I am still the only newsletter publisher who provides a thorough, objective, and critical review of all his products (and editors) each year, providing an honest and open evaluation of his entire business – a review that always results in hundreds of refunds. I write the Friday Digests, which often intentionally disarms our own marketing by explaining the difficult realities all investors face. Again, doing so frequently results in refund demands.

And while other publishers may share a similarly ethical bent... I haven't seen many others cancel profitable publications simply because the publisher didn't have confidence in the strategies or the editors in question. I have done so about a dozen times – sometimes losing close friends over the tough decisions I felt compelled to make for the good of my subscribers.

I've had the freedom to stick to these principles because of the very thing you're really complaining about: our effective marketing. We encourage our advertising writers to find new and creative ways to sell our products. The success of this advertising allows me to profitably and ethically serve the people who are willing to subscribe to our products. For everyone else, they're free not to buy. Or if they believe we've promised more than we could deliver, we refund their money. What could possibly be more fair or ethical?

And yet... it seems that many subscribers simply resent the fact our business has been successful… or that we advertise at all. Quite frankly, that's never made any sense to me.

Would you rather take investment advice from a firm that can barely keep the lights on? Would you rather we stop selling newsletters and begin cutting our staff... or hiring less qualified analysts? Would you rather we drastically increase our subscription prices and serve only institutional clients who, believe me, would be happy to pay $100,000 or more for exclusive access to a single good investment idea. Or perhaps we should give up trying to serve the public and simply organize yet another hedge fund to pillage the markets for a handful of extremely wealthy investors.

Our advertising is your best friend. It – and nothing else – enables us to serve you so honestly and so well. Without it, these products and the ideas they communicate would have never found their way to your door.

Instead of realizing this obvious and logical truth, you, like so many other people in America, complain the world isn't exactly as you'd wish because every opportunity comes with a price. And so, you trash the reputations of the people who serve you honestly and loyally.

Perhaps I shouldn't judge your comments so harshly. Few people in America remember that to do good you first have to do well. Our success has emboldened and encouraged our principled stance against conflicts of interest, against accepting third-party advertising from the financial industry. It has given us the confidence to always follow the facts as we find them.

As you must know by now... we speak our mind and disregard the consequences. In my humble opinion, that's the single greatest attribute of any adviser. We write what we believe, even when it harms our financial results. We can afford to do this because we have confidence in the ability of our marketing to attract new subscribers who will appreciate the unique value we offer.

The principles by which we have always run this company (and which will guide us for as long as my name remains on the door) stand in stunning contrast to America's financial industry. All of Wall Street's largest brokerage firms were fined hundreds of millions of dollars for intentionally lying to their customers in order to win banking business in the early 2000s. And yet... these firms continue to operate according to the same essential model: Selling stocks and bonds to suckers. Everywhere I travel in finance, professionals say to me consistently: I wish I had the freedom you offer your analysts, to speak the truth regardless of the consequences.

If they had our marketing, they could. Otherwise, they have to toe the line. They have to say things they know are absurd lies. That's the real scam.

Regards,

Porter Stansberry, Sean Goldsmith, and Dan Ferris

Miami Beach, Florida and Medford, Oregon

April 29, 2011