HELPING PHYSICIANS ATTAIN FINANCIAL SECURITY
By Robert M. Doroghazi, M.D., F.A.C.C.
In the last letter, I gave reasons why I believe we have inflation that far outstrips the government’s official estimates, and why it may worsen in the future. I noted your strategy during times of inflation should be to trade paper money, which you believe will be worth less in the future, for hard (real) assets, which will retain value. Your goal is to maintain purchasing power.
In the last issue I discussed why fixed-income/bonds are hurt by inflation. I failed to mention the possibility of using TIPS (Treasury Inflation Protected Securities). Note that the inflation premium on these has already started to rise. Also note returns are based on the government-generated figures.
The best way to invest in commodities is directly via futures. In my opinion, futures have an undeservedly bad name. Eighty percent of people lose money with futures, mostly because they are seduced and cannot manage the tremendous leverage.
(Talked with a very smart guy (his brother was a Rhodes Scholar) about this the other day. He was a hog farmer and twice used pork belly futures as a hedge. He said one of the worst experiences of his life was when he was awakened at 6 AM by a margin call. He lamented “Why do they allow so much leverage with futures”?
RMD comment: I thought about that. My conclusion is that this is just one more way the sharpies can clip the 80% of non-sharpies).
For example, the gold contract represents 100 oz of gold. At $1,350 per ounce, one contract controls $135,000 worth of gold. The current margin requirement is about $10K to open one contract. If you put up just the minimum, you have 13.5 to 1 leverage ($10K controls $135K of gold). If gold goes up $100 per ounce, just 7%, you have doubled your money to $20K. You pat yourself on the back for your investment genius. BUT, if gold drops just 7%, you are wiped out, a 100% loss. Remember that general point about leverage (borrowed money, debt): On the way up; it is really cool. On the way down, it gets ugly really fast.
I suggest you read Jim Rogers book Hot Commodities: How Anyone Can Invest Profitably in the World’s Best Market (Random House, 2004). I have mentioned this book many times before. Rogers was as early as anyone in spotting the bull market in commodities. I have also quoted data from this book which shows to my satisfaction that bull markets in financial assets and hard assets alternate leadership in periods lasting 15-18 years. Since the commodity bull market began in 1999 and the bear market in stocks began in 2000, it suggests both still have years to run.
Rogers recommends you be un-leveraged. In the above example, to open one gold contract, deposit the entire amount ($135,000) of the contract with your broker.
Futures have multiple advantages as compared to investing in commodities through various vehicles in the stock market.
1) The money on deposit with the broker can be invested in T-bills, thus generating interest income.
2) Fees are the cost of a trade. In general, it is best to trade the near-month contract (because it is the most liquid) and roll this over continually as it expires. This does generate trading costs. This compares to ETFs, such as GLD and SLV, which have administrative expenses of about ½ % per year.
3) Some ETFs have not tracked their underlying assets very effectively.
4) It will be difficult to create efficient ETFs for bulky commodities. Storing the precious metals is fairly easy and does not require much space. There are significant expenses to store tonnes of a base metal or hundreds of thousands of bushels of grain.
5) If you are in a business that uses a large amount of a commodity, such as a lumber yard, or have a fleet of cars that burn a lot of fuel, you can use futures to “hedge” (fix) your costs. Ex: you go “long” (buy) the gasoline contract at $3.00 per gallon. If gasoline goes to $3.50, the profits from your futures contract will cover your increased fuel costs. If gas goes down to $2.70, your futures contract shows a loss, BUT, this is offset because you are paying less at the pump. You have “hedged” your expenses.
(The trick here is to have the capital to afford the futures contract. Several years ago, when oil briefly went to $140 per barrel, Southwest Airlines (LUV) remained profitable because they had much of their fuel costs hedged. The other airlines, basically broke at the time, had to buy all of their fuel at the spot (current) price, and were crushed. Just one more example of why people in debt can’t compete with those with cash).
6) This is very important. Futures have favorable tax treatment. Sixty percent of the gains are taxed at the capital gains rate, 40% as regular income. This compares to GLD, which the IRS considers a “collectable” and taxes the gains at a 28% rate, no matter how long you hold the investment (You must confirm these facts with your accountant). One conclusion is that the government is trying to discourage you from investing in gold.
Overall, if you wish to invest in commodities, futures are the way to go.
I devote an entire chapter in the second edition of my book to art and collectibles. The prices at the high end of the art market are going bonkers; and the big buyers are—the Chinese (and to a lesser extent, the Russians). My conclusions: 1) People with the really big bucks are trading their paper money for real assets. 2) Art is portable wealth, a very real issue for people with first-hand experience of political instability.
There is no area of investing where intimate knowledge of the subject is more important than collecting. Quality is paramount; buy the best you can afford. One work of $10K is worth at least twice as much as 10 items worth $1K each.
While talking about portable wealth; don’t forget jewelry. Should the government call in gold bullion (as in 1933), they won’t call in jewelry. A lot of people seem to be thinking about this: there are multiple advertisements for expensive watches in every issue of the Wall Street Journal. Barron’s, 2/7/11: Fur coats and fur accessories are making a comeback, esp. in Russia and China.
Buy staple goods. To illustrate: right now, a one-year CD at the bank doesn’t even pay 1% interest. You invest $1,000, and make $8. After taxes, you have $6. If you buy something that will rise 5% in price over the next year, you saved $50 (that is tax-free).
This applies to anything with a long, or indefinite, shelf life. The most obvious example is food, such as canned-goods. This also includes paper products, such as TP, facial tissue and paper towels, supplies for around the house, items of clothing such as underwear, socks, jeans, bed and bath linens. Wine and hard liquor have an indefinite shelf-life, as does ammo.
Real estate tends to track inflation fairly well. The only real estate that has retained value over the last 10 years has been productive agricultural land. Because of the bust in residential, commercial and recreational real estate, I would wait for the turn to be obvious before jumping in. Your purchase must be financed with a fixed-rate note.
Inflation is so destructive; it destroys the purchasing power of savings and pushes everyone into a higher tax bracket. The poor, who have little to start with, are hit because all of their money goes to the things that go up the fastest, such as food and energy. The wealthy, who can buy gold and do other things to protect themselves, are hurt the least. It is the middle class that is hurt the most.
RMD
There is an article in the 2/14/11 issue of Forbes with the subtitle “Here’s how to stop looking at your mortgage as your greatest liability and turn it into a valuable asset”.
It says things such as “the mortgage is still one of the greatest wealth-building tools available” and notes the advantages of the tax-deductibility of the interest. It advises you to “opt for an adjustable rate (mortgage)” and “profit from the equity” by taking out a home equity loan.
RMD comment: This article so disappointed me, because it puts a good spin on all of the things that I believe contributed to the housing mess and financial meltdown. I remind you again: 1) Your home is not an investment, it is a place to live; it is a depreciating asset. 2) A mortgage is compound interest in reverse, working against you. 3) You spend $1.00 on interest to save 35 cents on your taxes. That’s a 65% loss. I don’t consider that particularly astute investing. 4) Your goal should be to pay your mortgage off as quickly as possible, not to use your home as a piggy bank. 5) An adjustable-rate note is gambling. Interest rates are already on the rise. If they keep going up, you will be crushed.
CNNMoney.com, yesterday. “30% of mortgages are underwater. The foreclosure crisis is about to heat up again as more homeowners fall underwater on loans”.
RMD comment: see above.
I recently received a subscription from a medical student, who asked if there were other medical students who subscribed. I said “I have found it frustratingly difficult to get any support from the medical schools. Many students and physicians-in-training don’t think about money, a real shame, as they then do dumb things. It’s depressing to hear docs in their 40s, 50s, 60s and 70s say “I wish I had heard and taken your advice sooner”. Why don’t you do your fellow students a favor and tell them about my newsletter and my book (The Physician’s Guide to Investing: A Practical Approach to Building Wealth)”.
He replied “I tried to offer the leader of the business concentration in my med school to add your book to the personal finance and investing part of the curriculum, but had no luck. (I sense he is having problems hitting his retirement goals). I also tried showing your book to classmates”.
RMD comment: My greatest frustration is the naïve, and I believe hypocritical, position of the academic medical establishment when it comes to teaching physicians how to wisely invest the hard-earned fruits of their labor. It breaks my heart to see hard-working, honest physicians do stupid things with their money, resulting in a life of financial instability, forcing them to work when their skills are no longer adequate, just to make ends meet.
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