How To Predict The Price Of Goods

While everyone is focused on stagflation and the possibility of recession, I’m looking past that and toward an eventual recovery. In order to avert the possibility of a systemic economic collapse, the Fed is currently printing money at an alarming rate. The increase in the money supply means more dollars competing for the same goods.

I caught the below chart from ZealLLC.com that clearly shows the dramatic increase in money supply from the Fed.

The chart above illustrates MZM, or money of zero maturity. MZM is essentially all of the money available for spending not in time deposits or money market funds. The chart is also linked to an interesting article discussing the subject of money inflation.

Taken from the article:

Then in early January 2008, the global stock markets sold off aggressively. Fears of an impending US recession drove heavy selling overseas. This worldwide selloff was so extraordinary that we are unlikely to see anything resembling it again for decades. But instead of reining in monetary growth, the Fed accelerated it. Absolute annual MZM growth peaked at a staggering 16.7% in March 2008!

You read that right. There were 16.7% more US dollars available for spending this March than last! This is incredible, especially during challenging times when the US economy was barely chugging along around 2.2% growth for all of 2007. Sooner or later all this excess money will eventually bid up prices. Some of this inflation will be perceived as good, primarily the part that flows into stocks. But the part bidding up scarce food and energy is not going to make Americans very happy.

If we look at the past effect of increasing money supply, we can see that it lead to the recovery of the recession lead by the .com crash. Without the ability to earn a rate of return exceeding the actual rate of inflation, we are losing money each year. How we can combat the effect of a growing money supply and inflation, is to own the goods that are in competition for our money. While overall prices will rise, earning a greater rate of return means second guessing whether you think the price of oil, agricultural goods like rice, stocks, or a fixed asset like property will rise the most. It may seem counterintuitive, but my primary guess on which asset will rise the most as we emerge from a recession is property.

Looking back at the money supply chart we can see MZM reaching 21.8% at the end of 2001. In the period between 2001 and 2005, we saw property prices double and sometimes triple in certain locations. During this period, the Fed also steadily increased interest rates to the point where deposit rates were over 5%. By the time deposit rates were so high, it was too late for property investors to jump in the market. I made a dear mistake at this time, purchasing an investment property nearly at the markets high.

Pessimism will undoubtedly keep property from being a favored asset class in the short-term. I believe the second half of 2007, marked the beginning of opportunity for property investors holding on to cash. This opportunity stems from the combination of cheap money from falling interest rates and money supply growing at over 16% so far this year. I’ve taken the Fed’s interest rate cuts to nearly 2% as the key indicator to being looking for new opportunities.

Here is another quote from the ZealLLC article:

But all this excess cash had to go somewhere too. Eventually all money the Fed creates will bid on something. Greenspan’s massive monetary growth in 2001 directly led to the housing bubble that he brazenly tries to accept no responsibility whatsoever for today. The torrents of excess money, which the Fed refused to take back out of the system after 9/11, flooded into real estate. And then that bubble started crashing in late 2006.

See the pattern here? The Fed gets scared because some speculators might actually lose on their bad bets so it floods the system with money to help them. But all of the money created in these huge surges eventually has to find a home somewhere, so another bubble is born. And then that bubble pops, scaring the Fed more. So it ramps money growth again, birthing a new bubble. It is a nasty vicious circle.

As a value investor, I’ve learned to disregard my emotional response to market gyrations. I see pessimism as opportunity. I see broad-based sell offs as the easiest time to profit. I’ve learned from my own previous mistakes that it’s much easier to profit by buying and holding onto oversold conditions, than to try and catch an investment opportunity when it may have reached a top. We are currently in a strong buyers market and value investors should consider purchases when no one else wants too.

I have confidence that the housing market will recover as we emerge from a recession. Having a chance to purchase highly desirable properties, such as a park view apartment or ocean front property in a buyers market may be a one of a kind opportunity.

Kudos to ZealLLC.com author Adam Hamilton for writing such a clear article on money inflation.

Gold and Silver Investing and Using Financial Stocks as a Hedge

The USD Index looks like it may breach the 75 level, if this level is reached, I expect gold to trade under $800. A move by the USD Index nearing 80 levels would signal a major breakthrough for the USD. If we near 80 levels, I expect gold to trade between $600-$750.

A move by gold under $800 would likely mean seeing Yamana Gold [[AUY]] shares under $10. Yamana is the primary gold stock I am watching at the moment. With the heavy volatility in gold equities, I’m going to set a limit order to purchase AUY at $10 good for the entire month of May. If the order executes, I plan to set additional orders at $1 increments with major purchasing happening if AUY drops to the $6-$7 range.

Readers of Raw Greed know that I favor heavy volatility for companies with strong earnings and fundamental prospects. I’ve been able to purchase Yamana Gold for the past two years at prices under $10 simply by standing on the sidelines and setting limit orders at large discounts. I simply wait for the weak longs to liquidate as they enter other sectors.

With gold at $800, I expect to see silver at low $15 levels. If gold were to trade in the $600-$750 range, I expect to see silver between $10-$12 levels. My top three silver picks are:

-Coeur d’Alene [[CDE]] with a staring entry price of $2.50 and heavy buying at any price under $1.75
-Silver Wheaton [[SLW]] with a starting entry price of $10 and heavy buying at $7
-Hecla Mining [[HL]] with a starting entry price at $7 and heavy buying at $5

As a hedge against falling gold, I would invest in a basket of financial stocks. Companies like Citigroup Inc. [[C]], UBS AG [[UBS]] and Washington Mutual [[WM]] are at the top of my list. All three of the stocks are still off over 50% from their 52-week highs. Gold is dropping due to a dollar rally and the prospects of a stabilizing economy. Financial stocks should move in the opposite direction to gold stocks in the short-term, this is a stark contrast to the period simply a year ago with high prices for both financial and precious metal stocks.

I would pick up shares of C and WM at current prices. If the dollar rally lasts until the third quarter of 2008 and we see no major news of new writedowns, I expect to see C rally in the 20-25% range and WM to rally 100% or more. Washington Mutual has a large amount in bonds coming due in September. The bonds traded as much as 30-40 dollars under par when I last looked about two months ago, this denoted a lack of investor confidence in Washington Mutual. Spreads on the bonds have dramatically narrowed showing a partial return of investor confidence in the bank. WM shares are lagging in comparison to the positive performance of the banks bond issues. Bonds are considered the more conservative investment in comparison to stocks, so I expect WM shares to recover quickly as bond principals are paid.

By separating yourself evenly between precious metals and financial stocks I believe you will safely lock in tremendous gains from one or the other by the end of the year. People cycle in and out of sectors with blazing speed, primarily due to greed and oversold conditions. I suspect if my limit orders execute for the above precious metals stocks I would be buying into extremely oversold conditions and at a severe discount to recent 52-week highs. Any bounce in gold or silver prices would then have the momentum to cause any of the above picks to jump 10% or more in a matter of days.

My earliest purchase of Yamana Gold for instance was in 2006. I posted the article Selling Yamana Gold in which I earned 46.52% in roughly 30 days. Since then I’ve recommended to buy in and out of Yamana on the heavy volatility surrounding the stock. In 2007 I purchased shares of Hecla Mining and Silver Wheaton at close to my target prices above. I don’t believe this time will be any different. I am by no means a day trader and I simply sit on the sidelines waiting for opportunity to present itself. At the moment I am concentrating on companies I consider a fundamentally good value in sectors that have been oversold. When everything gets sold down, plenty of opportunities will present themselves. When sectors get oversold there is also a higher probability a rally will occur on any positive news.

*Disclaimer: The author does not hold a position in any of the stocks mentioned above.