HELPING PHYSICIANS ATTAIN FINANCIAL SECURITY
By Robert M. Doroghazi, M.D., F.A.C.C.
Arbitrage
This is one of those newsletters that will provide you with advice on how to best invest your money and accumulate wealth and educate you on an important topic.
Webster’s defines arbitrage as “simultaneous purchase and sale of the same or equivalent security in order to profit from price discrepancies”. You have probably heard of arbitrage in relation to a hedge fund, bank or brokerage, but in a simple sense you do it every day. Ex: The price of gas at the Shell station is $3.25 a gallon while right down the street at the Exxon station it is $3.19. You are not really arbitraging because you are not buying and selling, but you are profiting from the difference (discrepancy) in price.
About 25 years ago, not long after I entered practice here in Columbia, I was at a baseball card show in St. Louis. I needed a particular set of cards. A man I often dealt with was asking $90. He said “This is hot right now; I can sell all I have”.
I thought that was a little steep, so I walked around and found a dealer who had the same cards for $60. I bought 2 sets. One was for me. With the other set, I walked back to the first dealer and said “Will you give me $70 for this”? “Sure”.
That made my day. By just by walking around the room, I got the set I wanted for $30 less and made ten bucks on the sale of the other set. I did an arbitrage with baseball cards; I profited from the discrepancy in price when I bought and sold the same security.
What makes me write on this now is that I am Chmn. of the Finance Committee of the Boone Hospital Center (Columbia, MO) Foundation. At our meeting last week, Central Trust, the managers of the assets, had added a mutual fund that’s basic strategy is arbitrage. When I asked about it, they noted that because the return on stocks and bonds is so paltry, they were looking for anywhere to make some money. They noted that the return for arbitrage is usually low, on the order of 3-5%, but 1) it is as good or better than what you can get from even the long-dated Treasuries, and 2) it is low-risk.
Examples of arbitrage include:
1) Say that an ETF (Exchange Traded Fund) holds 10 securities. At some point, there is a discrepancy between the price of the ETF and the price of the underlying 10 securities. You can buy or sell one or the other to profit from this difference.
2) Merger arbitrage occurs when Company A wants to acquire Company B. The price of A usually falls because they are paying out cash and/or diluting their stock to make the purchase. The price of B usually rises because the price paid is typically a premium to the last share price. Arbitrageurs will sell short Company A and buy Company B.
3) Say the currency exchange rate in Tokyo is Yen 1000=British Pounds 2=US $12. The exchange rate in NYC is Yen 1000=British Pounds 2=US $10. With your $10 in NYC, buy 2 British Pounds. Take the 2 British Pounds to Tokyo and exchange them for Yen 1000 and then for US $12. In the age of instantaneous communication, this no longer occurs, but in times past was very common.
Points to be taken home:
1) Arbitrage has the useful function of causing the price difference between markets to converge, for the price discrepancies to disappear.
2) There is nothing mystical about arbitrage. In a sense, you do it every day. Keep your eyes open; sometimes you can make an easy profit.
3) In the current low-return environment, consider arbitrage as a legitimate strategy to supplement the return from traditional stock and bond investments.
RMD
The stock market: Going back many years; including October, 1929 and October, 1987, there is often a Thursday-Monday scenario. In a setting where the market has been weakening for some time; there is a terrible Thursday. Friday is choppy or down. People get nervous over the weekend, resulting in a capitulation sell on Monday; which may extend into Tuesday morning.
RMD comment: If this scenario repeats, it would suggest the low today (Monday) or tomorrow (Tuesday). If not, then Thursday may have been the low. We’ll see.
In was a tough week for the precious metals. Silver was annihilated, down almost 15% on Friday alone. Gold fell from about $1,820 on Wednesday to an intraday low of about $1,640 on Friday.
RMD comment: In the press this was attributed to margin calls and people selling what they could to raise cash. As I will discuss in next week’s letter, I think this suggest that the economy is very weak and the possibility of deflation is still a concern.
The drop was certainly very scary, BUT, this is not the end of the bull market in the precious metals. I don’t know if Friday was the low or how much longer the correction will last, but the panic selling is giving you a chance to get back into or add to your positions at a significantly lower price than just a week or two ago.
The other day at Rotary, a man involved in the real estate industry asked if I was still bullish on gold.
“Yes Sir”.
“Have you considered real estate”?
Lead article in the Wall Street Journal (9/21/11): “Economists, builders and mortgage analysts are predicting the weakened US economy will depress housing prices for years (through 2015), restraining consumer spending, pushing more homeowners into foreclosure and clouding prospects for a sustained recovery”.
RMD comment: Ouch!! Four more years of dead money, or even losses, in housing. I would only invest in residential real estate if it were very compelling. There is nothing wrong with renting.
Also at Rotary, someone asked my opinion. Two resident physicians at the University had married and were having a disagreement over which of their homes to sell. Before I could respond, someone said “Considering that they are carrying two mortgages, and how weak the current real estate market is, they should put them both on the market at very competitive prices, and move into the one that doesn’t sell”.
RMD comment: Perfect advice.
I consider James Turk of the Free Gold Money Report to be about the savviest gold analyst around. At a post on 9/19/11, he wrote “So last week the Swiss National Bank succumbed to these (bad monetary policy) pressures and pegged the Swiss franc to the euro…the world’s last safe-haven national currency has finally disappeared, making the ownership of physical gold and silver all the more important”.
Turk then shows a graph of the Swiss franc vs. gold, and notes it is similar to that of the euro, US dollar, and British pound. This “may surprise some people. The obvious conclusion is that the Swiss franc has not been a safe haven for at least a decade. All currencies are being debased against the world’s time-tested and trustworthy numeraire—gold”.
RMD comment: Buy some physical gold (and maybe silver, see below).
From Morgan: American Financier (Strouse, Random House, 1999).
“To international bankers and traders, a gold dollar was far more than a medium of exchange. Gold stood as the ultimate guarantor of value; a universally sanctioned measure that provided people making economic decisions with reliable information about what things were worth. In an era of wild financial instability (during and after our Civil War), it was “the rule of law applied to money”—a disciplinary force that could regulate currency markets, forestall inflation, keep purchasing power relatively constant, and assure America’s trading partners that their financial commitments would hold steady over time; the government would repay all its debts in full. The gold standard also promised to keep control over the US economy in the hands of men who had these concerns in mind”.
RMD comment: Just as true today as it was 150 years ago. I believe we will eventually return to a gold/commodity-based currency. Buy some physical gold.
The disadvantages of physical silver vs. physical gold:
1) Silver is so much bulkier.
2) No central banks hold silver, and after many years of selling gold, are again buying.
3) Gold is the traditional storehouse of wealth, especially in Asia.
4) If you can’t afford 1 oz. gold coins, it is probably better to put your money in the fractional gold coins rather than silver.
Treasury Secretary Geithner said the proposed $447B stimulus package could create a million new jobs.
RMD comment: That’s 445K per job. Those must be awesome jobs, making almost twice what the average physician makes. Maybe I will apply for one. Or another way to look at it is that it is the typical government waste of money, which will be just as effective in (not) creating jobs as the previous stimulus attempts.
I recently bought a new printer, which happened to have WiFi capabilities. Because I recognize I do not have the computer skills (or the patience) to synch the printer with my WiFi, I paid to have the tech support at Office Depot do it.
It ran great for 3 weeks until we had a brief power outage=the printer had to be re-synched to the WiFi. The chance of me getting this done, even with help over the phone, is zero, and I will not pay to have this done every time the power goes out. My plan is to just walk to the next room and hook my computer directly to the printer, just as I had before.
I have three points:
1) Relating to this particular situation: A printer with WiFi capabilities is neat, but if it goes out, you will have to spend your valuable time, or pay someone, to fix it.
2) Whenever you are considering high-end options on anything, ask yourself A) Is it really worth the added expense? B) As compared to the standard product, how much more will it cost to repair?
3) My general rule: I like to buy things at the top end of the medium range; they tend
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