Dubai Default... Crisis Part II Or Overreaction

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)


While the U.S. enjoyed the big Thanksgiving feast and the Cowboys put a licking on the Raiders, the rest of the world was dealing with the latest shoe to drop in the financial crisis. It should come as no surprise that Dubai World is having problems servicing their massive debt. I remember reading an article in late 2006 that 75% of the entire world's construction cranes were on the ground in Dubai: 75%!!!

I would partially accept it if it was Japan after WWII and it was being rebuilt. Or a country the size of Russia embarking on major urban renewal and expansion. But this is a tiny little state. I shook my head when I read about building the world’s tallest skyscraper, something that hasn’t panned out for other countries attempting the same thing. And the indoor ski mountain. But I was in utter disbelief when I saw the palm tree fingers real estate project being developed from the sea. And the thousands of those million-dollar properties waiting to be sold.

Talk about a bubble that was easy to spot and was almost guaranteed to implode. In my "Shockers of 2008" piece, I forecasted the end of the great Dubai experiment. It wasn't too difficult, especially after a good friend said he was hopping on the bandwagon and opening an office there since it was becoming the financial capital of the earth. That was one of my better calls in '08 to balance against two horrendous ones, where I forecasted a new bull market beginning. I also forecasted extreme dollar strength, which worked out well, along with a collapse in commodities. But forecasting Japan to lead the developed markets wasn’t so good. I am just starting to work on some shockers for 2010, which should be out next month.

Anyway, I do not believe the Dubai news is the beginning of a new chapter in the crisis, just the same old story regurgitated in a different part of the world. It has the feel of a remnant or outlier more than anything else. And if it was so terrible to threaten their financial system or economy, I believe the powers that be in Abu Dhabi would use part of their $500B war chest to do an AIG rescue.

Below is my first attempt to post charts in the blog. It’s a 60 minute chart of the S&P 500 trading around the clock. That means that each bar, red or green, represents 60 minutes. Although the U.S. markets were officially closed for Thanksgiving, the S&P 500 futures market continued to trade as you can see by looking at 11/26 on the bottom. In fairly short order, the market fell from 1111 to 1068 (-3.8%) and then rallied back to 1111.

Sometimes, it's better to be lucky than good. Last Wednesday morning before the Dubai news broke, I did CNBC's International Exchange as I do on a monthly basis. (See Clip Here ) Part of my comments focused on a stock market pullback after Thanksgiving. I just didn't think it would literally start with a Thanksgiving Day collapse around the globe and end early Friday morning! Thank you to the folks at CNBC for making that segment into a story on their website.

Since Friday morning, stocks have been in strong rally mode that, frankly, has me torn. With such powerfully poor internals on the holiday shortened trading day, there should be more weakness to follow. But this week has shown very positive seasonal tendencies to make it more interesting. While there “should” be another pullback next week, it’s likely to be shallow and followed by higher prices into year-end.

There's been lots of concern lately that the small cap Russell 2000 and mid cap S&P 400 have severely lagged the large cap Dow Jones and S&P 500. While true, that kind of divergence (all indices not confirming each other's move) can exist for weeks, months and even quarters before it ends up mattering. And I am not worried about it yet. It's just sending a message that liquidity is not as strong as it once was and should be monitored.

In short, the Dubai "revelation" is old news and should not impact the markets much longer than a week or so, if at all. The potential debt default in Greece would be a different story. Too much bullish market sentiment still bothers me, but time is running out in 2009 for the bears to do much damage.

As always, please feel free to email me with any questions or comments at Paul@InvestForTomorrow.com.

Until next time…

Paul Schatz

The Rush to Buy GOLD, GOLD, GOLD!

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)

Now that gold has exceeded its all-time high set in March 2008, it’s become headline news. The media is just fascinated with the yellow metal. Gold bugs, whose answer to every investment question is “gold”, are screaming the virtues of owning gold from the rooftops, with prices north of $1000 an ounce. But let’s remember that as of today, the price is only up 17% year-to-date, roughly the same as the stock market.

So why all the fuss with gold? Why are investors so hypnotized by it? Does it belong in everyone’s portfolio?

First, let’s discuss how to own gold. For decades, investors were limited to the futures market to speculate on its direction. If people wanted to take possession of the metal, they typically bought coins from private dealers. While both methods are still used today, the explosion of exchange traded funds (ETFs) has allowed individual investors to act more like institutions by purchasing instruments that trade on the New York Stock Exchange with the State Street Global Advisors Gold Trust, GLD, being by far the most popular. It essentially represents 1/10 of the price of gold and trades like a stock on the exchange.

But there are inherent problems with each of the instruments listed above. Futures require a margin account and often trade at a premium to the spot price. That premium is based on the cost to carry the metal, i.e. interest rates and storage fees. Gold coins purchased through dealers also can trade far above the intrinsic or “real” value. When demand is high, like it’s been, some dealers will mark up prices 10-30% above what they are really worth. That’s their commission. And the GLD supposedly holds actual gold bars in safes, but there’s been speculation that it may not be 100% accurate - a topic for a different discussion.

Gold, like other hard assets such as copper, real estate, and oil does not pay interest or dividends. And as history has shown, owning these assets long-term has been a terrible investment. But tactically or more short-term, they have provided some outstanding opportunities.

In 1980, during the last bout of inflation, gold soared very quickly to $900. It then spent the next 28 years collapsing to $250 and rallying to $1000. So holding the metal all that time yielded you basically nothing in absolute terms. If you adjust for inflation of the past 28 years, gold needs to hit $2300 before it breaks even from 1980!

Many textbooks teach that gold is a great hedge against inflation. While it may have worked during a period in the 1970s, that is certainly no longer the case. If you are skilled in math or engineering, feel free to run the correlation between gold and the Consumer Price Index (CPI). You will be surprised to see the failure. Gold has also been viewed as a safe haven in times of crisis. The problem is that too many people never actually researched that theory to see how the metal actually performed. In 2008, a year in which no one on earth can argue we didn’t have a crisis, gold was a safe haven but still lost 5.8% in value.

So the $64 million question then is: Why is gold going up now? Seeking answers from the gold bugs is pointless since they always have reasons to own gold, even as it collapsed from $900 to $250. To begin with, gold does tend to perform well when there is lots of liquidity in the financial system. Liquidity is basically the amount of money available for investment. The more liquidity, the better the investing climate. With so much liquidity, the secondary instruments, like gold, silver, platinum, lumber, etc. end up receiving more dollars than normal. And because those aren’t usually large markets, it doesn’t take a sea of money to move price, like it does in treasury bonds or blue chip stocks.

Since early 2008, the U.S. Federal Reserve rammed short-term interest rates to essentially 0%, making money “free” to banks to borrow. As the crisis worsened they began running the printing presses 24/7 to flood the system with money, along with constructing some of the most creative and cutting edge programs in history to unclog the bowels of the financial system. The U.S. Treasury, not wanting to feel left out, also chimed in with a bevy of programs of their own.

This all led to a tsunami of liquidity in the global markets, which helped establish the market low in March. With the rising tide lifting all ships, gold certainly saw its share of the money. Additionally, many investors, myself not included, saw the torrent of free money in the system as very inflationary. I laughed when I heard people comparing our economy to that of Weimar Republic in Germany post World War I or Zimbabwe where hyperinflation was the order of the day with citizens using wheelbarrows of money to simply go grocery shopping.

I am on record on CNBC, WTNH and in my weekly newsletter that Ben Bernanke and his band of merry men would light up his best cigar, open a bottle of his favorite wine and do a celebratory dance if the Fed could somehow engineer some inflation, which my 6 year old daughter could fix. Bernanke & Co. is terrified of deflation, not inflation and that’s a topic for a different day.

What we’re seeing now is a wave of liquidity, not real, threatening inflation. For me to worry, we would need to see wages growing, not falling as they’ve been for some time. The average hourly workweek is down to roughly 33 hours per week and has been falling for years. That would need to be on the steady to worry about inflation. Global capacity utilization is only at 70%, not even at neutral levels let alone inflationary ones. And unemployment has more than doubled and is about to hit 10%, even by the government’s questionable calculation methods.

There is no real threat of inflation now or in the near future. Those who are buying gold to hedge against it will be disappointed. As I’ve said, gold is rallying along with most other instruments because there is so much money in the system. It’s also been strong because of the weak U.S. dollar. Gold is priced in dollars so currency weakness acts as a tailwind to global commodities priced in dollars, like the metals, energy and agriculture products.

History has shown that the best times to buy gold are when no one wants to own it, usually after a significant decline, like we saw in late 2008. That also coincides with market sentiment showing very few traders positive on the metal. For the past month, the sentiment surveys have consistently shown more than 90% bulls, not usually the time to initiate a position as the end tends to come sooner than later.

Ten Tips for Renters

Leases are rental agreements that outline the rights and responsibilities of both the property owner and the tenant. A lease can cover an apartment or a house.

If you are searching for a rental unit, be sure to read the lease carefully and ask questions about any clauses that you do not understand.

Make sure the landlord gives you a signed copy for your records and store it someplace you will remember, that way you can refer to it whenever necessary.

There are both federal and state laws that protect tenants’ interests. The use of security deposits is regulated at the state level. Here in Connecticut, landlords can not require a security deposit any greater than two months’ rent, which can be in addition to rent for the month of move in.

When it comes to tenants age 62 or older, landlords may not demand more than one months’ rent, which can be in addition to rent for the month of move in, under Connecticut law.

Connecticut landlord/tenant law can be found on the Judicial Branch's Web site.

For a state-by-state directory of landlord/tenant law visit the U.S. Department of Housing and Urban Development (HUD).

Here are 10 Tips for Renters, courtesy of the Federal Citizen Information Center:

1. Be prepared to provide a prospective landlord with written references from previous landlords, employers, friends and colleagues; and have a current copy of your credit report with you.

2. Carefully review all the important conditions of the tenancy before you sign a lease.

3. To avoid disputes or misunderstandings with the landlord, get terms and conditions in writing.

4. Ask about your privacy rights before you sign the lease.

5. Know your rights to live in a habitable rental unit – and don’t give them up.

6. Keep communication open with your landlord.

7. Purchase renters’ insurance to cover your valuables.

8. Make sure the security deposit refund procedures are spelled out in your lease or rental agreement.

9. Learn whether your building and neighborhood are safe and what you can expect your landlord to do about it if they aren't.

10. Know when to fight an eviction notice and know when to move. Unless you have the law and provable facts on your side, fighting an eviction notice is usually shortsighted.