Why Tech Is A Bad Bet

This is the title of an interesting article (on page 131)in the current edition of Fortune magazine. It tells how it is now five years since the NASDAQ began its free fall and that the case for jumping back into tech stocks appears to be more than a little convincing. However, while the Dow has regained much of the ground that it lost when the bubble burst, it still remains 60% below its March, 2000 peak. Also, after a relatively robust showing in 2004, it's down by 10% so far this year.

The tech sector happens to be the place that large mutual funds like Fidelity's Magellan and Vanguard's Capital Opportunity Fund are putting 17% and 31% respectively of their portfolios at this time. Plus, virtually every one of the 250 growth funds that Lipper tracks has tech as its largest sector holding with an average weighting of about 25%.

Well, we're here to tell you that tech is an absolutely disastrous place to invest right now. Why? Because the large and small players in telecom, software, the Internet, and chips are still trading at valuations that can't be supported by reasonable math. Their earnings are still puny compared with their stock prices. And given their modest prospects for growth, it's virtually impossible for them to expand profits fast enough to reward investors.

For the purposes of this argument, we'll use the NASDAQ 100 (NYSE: QQQQ) as a proxy for the entire technology sector. The NASDAQ 100 encompasses most of the big tech names such as Intel, Microsoft, Yahoo and eBay. To simplify, we'll treat the NASDAQ 100 as if it were one big company and see whether you'd want to buy its stock.

Currently the NASDAQ 100 companies are earning $55 billion a year, based on their cumulative profits over the past 12 months. Their combined market cap is $1.82 trillion. So the price/earnings ratio is 33, and that's already a frightening number. Add to that the fact that companies don't have to subtract stock-option expense from earnings, even though it's a real cost to shareholders.

For the NASDAQ 100, the hidden cost of options is staggering. In the most recent fiscal year, it hit 17% of reported earnings at Intel; 28% at Cisco; and 27% at Dell. All told, option costs not included in official net earnings reached $12 billion for the most recent fiscal year. That reduces earnings for the NASDAQ 100 from $55 billion to $43 billion. Hence, the real P/E ratio, the one that matters to investors, isn't 33 but 43!

Taking out the huge run-ups before the 1987 crash and the start of the late 1990's bubble, the P/E of the NASDAQ 100 has averaged around 23. The best bet is that it falls back to around that number or even lower. That implies that the NASDAQ as a whole must fall to around 1000, or by 50%, before investors should get back in.

So ignore the happy talk and hoard your cash until the inevitable, wrenching correction makes tech a good buy again. It's bound to happen. The math says so!

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Near-Sighted Investing

It is not a crime to be nervous about the market because nobody likes to see his or her portfolio shrink. And goodness knows there are plenty of reasons to be concerned when we hear about things like bogus accounting, crooked CEOs, and events worldwide that have an impact on the market's performance.

Yet it's wrong to ever allow short-term market developments drive long-term investment decisions, and that is exactly what many investors do!

Whenever you find yourself becoming too myopic about your investments, try to sober your thinking by remembering these few key points:

1. The three main engines that drive stock prices over time are inflation, interest rates, and corporate profits. While it is certainly true that many things can affect stock prices in the short term, what affects investment returns over the long term however are, and I repeat, inflation, interest rates, and corporate profits.

2. Successful investors invest on a regular basis, regardless of short-term market movements. Now it isn't easy to be putting new money into the market on a consistent basis - especially in a period of time when stocks are declining - but how well your portfolio does five years from now will depend to a large extent on what you do in the near-term. And if history holds true then I'd be willing to bet that anyone who invests today will be glad they did five years from now!

3. Market corrections within bull markets are supposed to scare investors . That is the purpose of corrections - to jolt investors and restore value to the market. As we discussed previously, ever since March of 2000, we have been in a secular bear market. And ever since February of 2003, we have been experiencing a cyclical bull within the secular bear. This type of market condition has a history of lasting anywhere from eight to eighteen years in length. And the only time that you can make money is to remain alert and try to profit during periods of cyclical bull market action.

One way to get an idea of where the market is heading is to look at a chart of the market's Intermediate Potential Risk. This chart looks at the percentage of stocks on the New York Stock Exchange that are trading above their 200-day moving average. To understand what this chart is telling you, whenever 70% or more of the stocks on the NYSE are trading above their 200-day moving average, the market is considered to be in "higher risk" territory; below 40%, the market is in "lower risk" territory. When it is between 40% and 70%, the market is considered to be in "neutral" risk territory.

The Intermediate Potential Risk chart is the single best indicator for assessing stock market risk on a 3 to 6 month basis.

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Several Items of Interest

From time to time at our meetings I have mentioned a very worthwhile radio program, "The Noon Business Hour" - that you can hear everyday, Monday through Friday, immediately following the network news at 12:00 Noon on the All-News radio station WBBM at 780 on your AM radio dial.

On the program today they were talking about the fact that investors currently seem to be avoiding making any further investments in bonds and instead are building a cash position, which would indicate that there is confidence in the stock market for the near future and investors want to be poised so as to be able to pounce upon any attractive situations that may present themselves over the next six to twelve months.
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Member Erik Berg points out another web site on the Internet where you can listen in to discussions on various financial topics. This site is Financial Sense Newshour and you can find it among our list of "Links."
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There Is A Number That The Best Money Managers Care Very Much About

If you placed $10,000 in a savings account and left it there for the next ten years, at today's interest rate level, you'd probably have $10,500 at the end of those ten years . . . so it's hardly worth doing!

But if you gave that same $10,000 to someone like Warren Buffett who has averaged 22.2% per year since 1965 on his investments, the least return you would have after ten years would be about $42,000 more than if you simply left that original $10,000 in the bank.

Now wouldn't it be nice to know exactly how Warren Buffett does what he does? After all, investing should be like everything else in life. Could there actually be a secret to it that makes the entire process a whole lot easier to understand?

Well I'm not suggesting that it's easy to earn big investment returns because that simply is not the case. However, the basic method that Warren Buffett uses to earn great returns is very simple to understand. He is merely using his own variation of a time-tested method of investing. What Buffett does is to focus on one aspect of any business in which he invests: the business's ability to generate free cash flow.

There are several definitions for the term free cash flow, but it all ends up the same thing: Free cash flow is money that comes from doing business. It doesn't come from selling off assets or from selling more shares of its stock. And it's called "free" because it is the cash that is left over after the company reinvests in the business to keep it running. In short, free cash flow is the money that the management is free to do with as it pleases after it has paid all the bills.

The basic method of calculating free cash flow is very easy to do. You take a company's net income, and then you add back certain non-cash charges like depreciation and amortization. Then you subtract how much capital spending the company needs to do to stay in business. And the resulting number is free cash flow.

Value investors like Warren Buffett earn huge returns because they buy companies that trade at discounts to the company's value as a cash generator.

Knowing one year's worth of free cash flow is merely the beginning of the process that value investors go through. In order to do what Warren Buffett does, you'd have to make an estimate of free cash flow for each of the next seven to ten years. Then you would have to account for the fact that a dollar ten years from now isn't worth as much as a dollar two years from now.

The entire process is simple to understand, but doing it can be quite complicated, and is best left to those who thrive on coping with such mathematical complexities!

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Great News For Investors In Vanguard Mutual Funds!

Vanguard has just announced plans to reduce the account balance requirements in more than 60 of its mutual funds that offer Admiral shares, and this will become effective on May 10th.

Vanguard began offering Admiral shares in year 2000 to reflect economies of scale at its larger and long-standing accounts. As an example of what this change meant to shareholders in the Vanguard S&P 500 Index Fund, the Admiral Share class has an expense ratio of 0.09%, while the Investor Shares class levies an expense ratio of 0.18%.

Under the new requirements, investors with a fund account balance of at least $100,000 will be eligible for the cheaper Admiral share class. Previously, the minimum was $250,000, or $150,000 for accounts at least three years old.

Since 2000, accounts of $50,000 that have been in existence for 10 years also qualify for the Admiral shares.

Vanguard said it will automatically convert accounts of $100,000 or more to the lower cost Admiral share class starting in July, although shareholders can make the switch before then.

Vanguard will also add Admiral Shares to the $8.6 billion Vanguard Inflation-Protected Securities fund in June.

These changes by Vanguard are, no doubt, their reaction to the marketing ploy by Fidelity Investments this past March when it reduced expenses on some of its own index funds. So we can see that a bit of rivalry amongst mutual fund competitors can and does bode well for the average investor!

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If you were absent from our meeting last evening then you missed a very informative session about Options, as provided by Mr. Jim Bittman, from the Options Industry Council in Chicago. In fact it was so interesting that we hope to have another meeting in the Fall of this year on Covered Calls.

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The Language of Investing

It never ceases to amaze me when, from time to time at our meetings, I will bring up this topic and discover that many investors simply don't understand the correct definition for certain investment terms that are used most frequently. Take for example, the meanings of money and wealth.

Most of the blame for this in my opinion rests with our educators. If you were given a definition for money when you were in school, it probably went something like this: "Money is a generally accepted medium of exchange of goods and services,for measuring value, or for making payments." Now that definition tells us what money does, however, it fails to tell us what money actually is!... To an investor, money can mean only one thing... power!... A given amount of money provides an investor with the power to do whatever that amount of money will allow him/her to do with it...period!

Now for the other term, wealth. Many investors believe that money is wealth and that cannot be because we have already learned the true definition of money. And I'm certain that they never discussed wealth in school because any teacher who does understand its meaning would likely not be in the teaching profession. So here now is the best definition of wealth that I have ever been able to find: "Wealth is anything that produces an income stream." Again, a clear and simple definition. So from that, we can see that money can lead the way toward wealth, but of and by itself, money is not wealth!

There are two other terms that tend to have investors confused at times and in fact, we got into a serious discussion at one of our meetings when I brought up the terms,
asset and liability. If you look up the standard definition for an asset, you will be given something to this effect: "An asset is something of monetary value that is owned by a firm or an individual." Now that definition in my opinion is simply plain accountantese. It really does not serve the needs of an investor because it doesn't tell us exactly what an asset really is. So in easy-to-understand English, an asset is anything that puts money in your pocket, while a liability is anything that takes money out of your pocket. And when you can understand these definitions of asset and liability, you then can understand why it is that your home is really not an asset. Oh, if you have a mortgage, then your home IS an asset to whatever lending source holds the mortgage on your home, but for as long as you own that home, it is continually taking money out of your pocket and it cannot truly be considered to be an asset until the day that you sell that home and you can show on paper that your selling price, minus all the expenses that you incurred while you owned that home, has resulted in a net profit.

Any comments?

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Should You Mess With A Winning Recipe?

It's only a modest exaggeration to say that you can now use an index fund to act on just about any hunch you may have on the direction of the stock market. The only problem is, that's the last thing index funds were created to do!

The idea behind indexing is that playing hunches, in the long run, is a loser's game. No investor can outsmart the market forever, and even the saviest pro's performance will eventually converge with that of some mediocre money manager.

Such an investing style may not make for very stimulating conversation following your next golf outing, but the results have been compelling. During the past decade, 82 percent of actively managed large-cap funds failed to beat the S&P 500 as tracked by the Vanguard 500 Index Fund.

This bothers mutual fund companies - not just because of what it implies about the typical fund stockpicker's skill, but also because of what it does to the funds' profit margins. So some fund companies have come out with "new" type index funds that are based on very dubious logic and are selling them not because they're useful, but because they'll sell.

Some of today's index funds can give you sticker shock, costing you as much as 1.7 percent of your investment annually, which is almost 10 times the 0.18 percent that you would pay to own the Vanguard 500 Index Fund.

And there's another reason to stop short before buying an index fund, and that's to consider an ETF. Unlike investors in conventional index funds, long-term holders of ETFs don't pay for capital gains incurred by other holders who sell their shares. Thus, ETFs run up less of a tax bill than index funds if you leave the money untouched for about five years.

Yet the ETF approach to indexing really only works if you're putting away money all at once. That's because the downside to ETFs stocklike qualities is that you have to pay a broker's commision each time you buy in (or sell). But if you dollar-cost average, then you're better off investing in a regular no-load index fund.

Dollar-cost averaging into a fund that prospers by being average. It's a simple tactic that historically has worked extremely well... So why complicate things?

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A TAXing Matter!

Since this is the time of the year when most of us are faced with the task of doing our taxes, it is therefore appropriate to remind you of things you ought to be aware of if you use some form of tax-deferred retirement account in your investment activities.

You need to give serious thought to which investments belong in your tax-deferred account and which belong in your taxable account. For instance, tax-exempt bonds can be held in a taxable account, whereas most of your stocks would be better served by being held in your tax-deferred retirement plan. However, a retirement plan might be wasted on stocks and stock funds if you are a buy-and-hold type investor because at today's low-dividend rates, a non-traded stock portfolio won't generate much in the way of income tax each year. And, you'll also lose the generous 15% rate on long-term gains by holding stocks in a tax-deferred account.

Another important point to remember is that by holding your stocks in a taxable account, this will allow you to take tax losses, when available, and eventually cash in your winners at long-term capital gains rates.
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You may not be aware of the fact that due to recent legislation passed by our Congress, you are now able to get once each year, a copy of your credit report from the three main credit rating agencies, and this is FREE to you, but only once each year. I have added the "Link" for this web site and you can access it by going to "Annual Credit Report" in our Links section.
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Identity Theft is a national problem and it seems to be on the rise. I have personally been on the receiving end of some rascal's "Phishing Expedition" - and this has happened any number of times - but fortunately I was alert and therefore did not succumb to the ruse each time it was received.

And in an effort to help you to sharpen your own wits and be more alert to any requests for personal information, I have also added a new web site called "ID SAFETY" which you will find among our "Links."

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A New Link

Today I added a new site called "Investars" to our list of Links. This site allows investors to research and compare the ratings and performance of stocks, and the analysts who follow them.

This site can be searched in three ways: by stock, by sector, or by porfolio. To search by stock, enter a ticker symbol, choose the time period, the benchmark, and specific firms following the stock. A graph with the average daily gain or loss on a $10,000 investment is produced along with a detailed table displaying analyst information. Each firm that follows the stock is listed together with a link to more information about the firm and its analysts. The table displays the total number of ratings given to the stock by each firm, and breaks it down as to how many were positive, negative, and neutral. Searching by sector or by portfolio is done in the same manner. And access to the basic information is free.

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Wisdom Of The Ages

Good judgment comes from experience, and experience comes from bad judgment!

-Barry LePatner

The Trailing Stop Strategy

Warren Buffett advises us that the most important Rule of Lasting Wealth is this: Don't lose money! And the second most important Rule is to: Never forget Rule #1!

One of the most difficult decisions facing any investor is knowing when to sell. When buying stocks, you must have and use an exit strategy. But your exit strategy - to be effective - must make you cut your losses while allowing your winners to continue growing. If you follow this pattern then you will have the best chance of outperforming the markets over time.

The trailing stop exit strategy I speak of is simple. It allows you to stay the course with your stock investments for as long as possible, but when you see that a particular stock shows signs of performing poorly, your trailing stop exit strategy is then in place to protect you from serious damage in case that certain stock should go into free fall.

Of course you could find many reasons for selling a stock, but just in case you fail to recognize a major problem before a stock should crash, having a trailing stop strategy in place will serve as a last ditch effort to spare you from serious loss of your hard-earned investment dollars.

You have to decide at the very outset when buying a stock issue as to your comfort level in case the price should fall below what you paid for the shares initially. I prefer to set my trailing stops at 20%. This would mean that if I buy a stock and pay $40 per share, I would not hesitate to sell immediately if the price of the shares dropped to $32 per share. However, there have been certain volatile shares in the past where I set my trailing stop down as low as 7%, and that was because the nature of the stocks in question could move quickly.

Trailing stops also help you protect any gains. If the $40 dollar stock noted above had risen to a price of $55 per share, I would then reset my trailing stop for that particluar stock to a new 20% trailing stop of $44 per share in which case, should the stock decline down to my preset stop, I would therefore have protected a $4 per share gain on my investment in those shares.

Is there anything magical about trailing stops?... The answer is, no not really. But what is important is the discipline that you develop in handling your stocks because of using a trailing stop strategy. Also, you never want to be in the position of having to recover from where your stock has fallen by 50% or more because this means that your stock would then have to rise by 100% or more just to get you back to where it was when you bought it originally. And by using the trailing stop strategy consistently, chances are that you will never be faced with a serious loss in your portfolio!

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Value vs. Growth Investing

The best indicator of a stock's value is its price. The price is the market's way of assessing risk, which determines a stock's expected rate of return. In other words, the prices people pay for stocks are the prices that will produce the expected returns they require in order to hold the stocks.

The terms "growth" and "value" are often used without completely understanding what these terms really mean or how these types of stocks influence the overall risk and return of a portfolio. News affects the prices of all companies including firms in sound financial condition with stable earnings, as well as firms suffering from some type of distress. Whatever the nature of the company, the price invariably reflects the market's perception of its financial health which is often described by the terms "growth" or "value." Whether you should invest in a growth or value stock depends on your own risk tolerance, investment time horizon and circumstances.

Typically, a growth stock represents a company which has a history of increasing its revenues more quickly than other companies. Growth stocks are usually expensive and have lower rates of return than value stocks. Value stocks are priced inexpensively because they have poorer prospects than growth stocks. Historically, these distressed stocks have, as an asset class, provided higher rates of return than have growth stocks.

The stock market requires distressed companies to discount their stock price to a level that provides an acceptable return to compensate investors who choose to take on more risk. Risk determines return, so the investor's goal is to maximize the return on an investment for any given level of assumed risk. Investing in a portfolio of extremely distressed companies may be an excellent investment for an individual who can bear the risk.

A portfolio of stocks designed to simply capture the returns of the overall stock market is easy to purchase (via index funds) and provides significant advantages. Common stocks provide protection against price inflation, as well as the potential to provide growth in real terms. Stocks contribute to overall portfolio stability because they are not strongly correlated to the returns of other asset classes such as cash, short-term bonds, income generating assets, and gold related assets.

In 1992, stock market researchers Eugene Fama and Kenneth French demonstrated that investors can improve upon a simple portfolio designed to replicate the entire U.S. stock market. They concluded that the growth and value effect existed across both U.S. large and small cap stocks, as well as foreign stocks. Thus an investor can consider several categories of stocks as potential building blocks with which they can construct a portfolio suited to his or her own taste. An aggressive investor could thus "weight" his portfolio more heavily toward small cap value stocks, even extending to foreign stocks, in order to accept more market risk in exchange for higher potential returns.

From this perspective it might seem unusual that an investor would allocate any funds to growth stocks, which have lower expected returns. However, many investors have lower tolerance for the risk that at any point in time their returns might not be in line with those of the overall stock market. Despite strong evidence that value stocks provide higher expected returns over time, there have clearly been periods over the short-term when growth stocks have outperformed value stocks, such as in the late 1990s.

What is the best way to buy stocks?... The next time you are tempted to look over your shoulder at a hot stock pick, ask yourself this question: "Does this stock fit my investment profile?"... This question should remind you to make your investment decisions in the proper context of your risk tolerance and goals. "Value" and "growth" are both appealing labels that suggest an opportunity or a bargain, but in reality they only describe levels of risk. Promises of easy money are tempting but the market in fact offers no free lunches!

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Member Erik Berg sends news of a web site where you can listen in to discussions about various investment topics and here it is for your further interest.

http://www.soundinvesting.com/listen.html

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NEXT MEETING: Thursday, April 21, 2005

Be sure to join us on the evening of Thursday, April 21st when we welcome as our guest speaker Mr. Jim Bittman, of the Options Institute in Chicago. This will be more or less an introduction into options, and while it will serve as a way for those who lack experience in using options to get their feet wet, it can also act as a refresher for anyone who is no stranger to trading options.

We meet from 7:00 to 9:00 PM at DePaul University located in Naperville, Illinois. The address is 150 West Warrenville Road (at the intersection of Herrick and Warrenville Roads). The room number for this meeting will be posted on the easel which stands near the reception desk in the main lobby.

We meet on the third Thursday of each and every month, and these meetings are always open to anyone who shares our interest in learning more about investments and investing. You need not be a member of AAII in order to attend our meetings, however, we do have a yearly membership fee of $15.00 to help defray the expenses of the group, and non-members may attend any meeting for a $5.00 donation.

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If you are interested in Exchange Traded Funds (ETFs) then you should pick-up a copy of the April 4, 2005 issue of Barron's, which has a fascinating article - beginning on page F5 - "Playing the ETF Card." This article also carries the Quarterly ETF Scorecard which is a performance review of ETFs for the 1st Qtr., 1 year, and 3 years.

Also for those of you who may be interested in mutual funds, next week in the April 11, 2005 edition of Barron's, they will publish the Lipper Mutual Fund Quarterly, which is about as comprehensive a list of mutual funds that you will find anywhere!
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For those of you who follow Bob Brinker on Saturdays and Sundays, you may be aware that the local ABC radio station (WLS) that carries the Bob Brinker program has been pre-empting the show for other things. They have done this several times over the past two months. So let me suggest that you can tune in to Bob Brinker on the Internet by going to www.kgo.com which is the Internet address for KGO Radio in San Francisco. By the way, you will also hear far fewer commercials on KGO!
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If you have any questions, please e-mail me at rwm123@hotmail.com

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Where Your Money Is Going

Nation by nation, the public is dependent on the wisdom of a group of highly-paid experts called central bankers. These people work for private organizations that have been granted sovereign power by their national governments. No other group of profit-seeking private entrepreneurs in the world enjoys an equal measure of autonomy (self-law) - autonomy from both the government that granted them their monopoly over the money supply and also from consumers in the free market. They impose sanctions, both positive and negative, however, no sanctions are ever imposed on them by the likes of us.

The public has been taught by the media that this profit-seeking monopoly is run for the benefit of the people. That public-spirited monopolists over the money supply really have the nation's best interests at heart. Because these men, unlike all other monopolists, are simultaneously self-sacrificing yet self-serving, thus the politicians have granted them independence from the government. They also possess independence from the free market's negative sanction - bankruptcy. In fact, the central bank is charged with the task of forestalling widespread bankruptcies, beginning with those institutions that legally own the central bank - private commercial banks.

A central bank, unlike any other organization, is praised because no one in civil government controls it. Textbook writers in economics, as well as financial columnists for major newspapers, praise the central bank for its anti-democratic legal status. The nation's professional opinion-makers assure the literate public that the great benefit of a central bank is that it is independent from politics. Congress cannot tell it what to do. Neither can the President. This is presented as an enormous advantage to the public.

There is no monopoly more profitable or with more power to ignore the government than a central bank. It has power over the only common link among all participants in the economy - the money supply. The world's national governments have self-consciously transferred power over the central economic institution - money - to a group of unelected, profit-seeking, self-screened representatives of the commercial banking system, a system based on fraud.

Commercial banks promise to pay depositors interest on the money that can be withdrawn by the depositors at any time, yet the banks lend this same money long-term to borrowers, who do not have to repay it until a specific date. The system therefore is "borrowed short" and "lent long." Bankers earn a good living, and a few get rich, from contracts that are based on a lie. This promise is believable most of the time because only a handful of depositors can actually withdraw their money at the same time. Whenever a lot of them try to withdraw money at the same time, we call these events panics or bank runs.

These events used to produce bankruptcy. But then central banks came along, beginning in 1694 in England. They are invested by the State with what has traditionally been explained as the State's sovereign authority - the authority to create money. This ability to create money reduces the threat of bank runs, but it also guarantees the creation of depreciating money.

Every national currency is depreciating. Compared to the price of goods that the currency would buy 30 years ago - especially real estate - consumers around the world are suffering from currencies of declining value. This makes them seekers of long-term debt, especially for real estate. This quest for money to borrow increases demand for the asset leased by banks, namely money. In other words, the central banks' slow destruction of money creates public demand for the services of commercial banks. This is a classic vicious circle. It is the product of a government-granted monopoly. Banking is not a free-market phenomenon.

Today, an American commercial bank can borrow money in the federal funds overnight money market at 2.75%, and then this same commercial bank can turn right around and lend that same money to credit card users for up to 24%. Which means for every $275 dollars paid out, a bank pulls in $2,400 - not too shabby a deal!

The public has trusted politicians and central bankers. Voters assume that the promises and the assurances of these experts are reliable. And thus we have allowed them to indebt our children and our grandchildren. Then, when our children and grandchildren begin to vote, they are assured by these same experts that everything is just fine, and besides, these debts will be paid by their children and grandchildren.

Promises that rest on lies eventually are broken. Everyone can't get his money out of the bank at the same time. Everyone who has been promised a comfortable retirement by the government won't enjoy one. Every old person who gets sick won't get well at government expense. A few will perhaps, but most will not.

So, whom should you trust? Politicians that make promises that statistically cannot be fulfilled? Commercial bankers who make promises - "withdraw your money at any time" - that cannot be fulfilled without a digital printing press to make the promises technically valid? Or should you trust gold, which rises in price whenever political promises are fulfilled with fiat money instead of tax revenues?

The public regards Alan Greenspan as part magician and part guru. This faithful assembly of millions includes some very sophisticated investors. But there is a major problem with investing anyone with guru status as well as a monopoly over our money supply. He is an old man. And Alan Greenspan, like Warren Buffett, will not live forever.

The public always seeks out representatives to trust in. They really do not put much trust in bureaucracies. They put their trust in specific individuals. Voters invest these representatives with the aura of infallibility whenever they do not understand what these representatives actually do. This is rational. Voters need to hold someone responsible. It is far easier to hold an individual responsible than a committee. In good times, the recipients of the public's trust rejoice. In bad times, they point the finger of blame elsewhere. Or they retire.

Alan Greenspan is due to step-down as Fed chairman early in 2006. And when the fateful day of Greenspan's retirement finally arrives, something tells me that you just might not want to be in the stock market!

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Why Invest In Gold?

New gold investment instruments now make it easier than ever for individual investors to own gold. But you may be asking yourself this question: Why should I own gold?

So let us revisit the rationale behind gold investing and examine into why it is that devoting a small portion of your portfolio to an investment in gold may prove to be a very wise decision indeed!

Individual investors benefit from owning gold for many of the same reasons that nations benefit. Gold is real money!... It is a unique asset class because it is no one else's liability.

Gold has intrinsic value that is less dependant on human enterprise, or the economic and political agendas of nations, than are stocks or bonds or other paper investments.

While the rationale for owning gold is often couched in visions of Armageddon, the practicality of holding gold as a form of insurance is questionable. Just try using Kruggerrands on your next shopping trip.

However, the insurance argument is bolstered by strong empirical evidence. Since gold has very low correlation with other asset classes, it can potentially reduce overall portfolio volatility, without significantly reducing returns.

Between January 1968 and December 2003, gold provided a total annual return of 7.1 percent. During the same period Treasury bills provided exactly the same return. But gold was far riskier; its standard deviation, which measures volatility, was over ten times that of Treasury bills. Thus at first glance, gold does not appear attractive at all. However, upon examining the results of a hypothetical, passively managed portfolio composed of large-cap growth stocks, large-cap value stocks, and small-cap value stocks, in equal amounts, and rebalanced annually for the same 36-year period (1968 to 2003), here's what they found:

The addition of 10 percent gold reduced the total portfolio return by 0.07 percent, but also reduced the standard deviation by 2.31 percent.The addition of 10 percent Treasury bills reduced the total return by 0.49 percent but reduced the standard deviation by only 1.82 percent. Thus, even though gold in absolute terms is far more volatile than Treasury bills, it does have the potential to reduce the magnitude of the swings in your portfolio.

Detractors claim that gold is essentially just another commodity. And indeed, gold itself has no positive expected return. Bonds and stocks on the other hand are capital assets that represent a stake in economic growth. Investors who hold a well-diversified portfolio of stocks or bonds thus can expect to benefit to the extent of general economic growth.

In the final analysis, gold is a viable form of portfolio insurance with a long track record. And for most investors, devoting a small portion of a portfolio to gold-related assets would be a prudent move to make!

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