Liberty Maven

While watching Neil Cavuto rip apart Bill O’Reilly on The O’Reilly Factor, my blood pressure rose a few points when I heard Bill O’Reilly call for the government to “watch over” banks and businesses to make sure they’re not preying on unsuspecting innocent people. He ranted that “it was wrong for those banks to lend to people who can’t pay it back” and my my blood pressure shot through the roof. While in chat with a friend, I ranted:  (slightly edited to remove cursing)

(12:32:26 AM) LibertarianMikeM: I get so (bleep)ing pissed off when liberals (and apparently also neocons like Bill O’Reilly) say that “it was wrong for those banks to lend to people who can’t pay it back” when in fact it was Clinton Administration (thanks to the Community Redevelopment Act in the late 60′s) who FORCED the banks to give out loans to “underprivileged” buyers. So the banks did what they were told even though it was a bad idea, and then when things went wrong, they blame the banks.  WTF?
(12:32:45 AM) LibertarianMikeM: Here in Baltimore, the exact thing is happening.  Wells Fargo was coerced (by threat of being called racists) to make loans available to many people who didn’t have the means to pay back to the loans.  Then the housing bubble burst, and people started defaulting on their loans causing this huge mess, and now the city is suing Wells Fargo for being “greedy” and handing out these loans.
(12:32:58 AM) LibertarianMikeM: What a (bleeped) up situation!

While I’m sure there were some cases of overly-zealous loan officers taking advantage of the “good times” at the height of the bubble, it cannot be denied that many banks were coerced into handing out questionable loans against their will.  They were forced by legislators to go against their own policies in the name of “social progress”.  Then when all the foreclosures came, nobody seemed to remember it was the government’s intervention that cause the problem in the first place.  It’s oh so convenient to blame the “greedy” bankers.

Investor’s Business Daily discussed the same thing:

But it was the Clinton administration, obsessed with multiculturalism, that dictated where mortgage lenders could lend, and originally helped create the market for the high-risk subprime loans now infecting like a retrovirus the balance sheets of many of Wall Street’s most revered institutions.

Tough new regulations forced lenders into high-risk areas where they had no choice but to lower lending standards to make the loans that sound business practices had previously guarded against making. It was either that or face stiff government penalties.

The untold story in this whole national crisis is that President Clinton put on steroids the Community Redevelopment Act, a well-intended Carter-era law designed to encourage minority homeownership. And in so doing, he helped create the market for the risky subprime loans that he and Democrats now decry as not only greedy but “predatory.”

Yes, the market was fueled by greed and overleveraging in the secondary market for subprimes, vis-a-vis mortgaged-backed securities traded on Wall Street. But the seed was planted in the ’90s by Clinton and his social engineers. They were the political catalyst behind this slow-motion financial train wreck.

Nevertheless, the media constantly repeats the lies and the drooling masses suck it all up.  Then all these unconstitutional bailouts, and we’re way over our heads in debt.  There’s no doubt in my mind that the only possible end result of all of this is economic collapse.

Ron Paul gives his thoughts to Neil Cavuto on FOX yesterday regarding the AIG bailout or so called “loan”.

Bill O’Reilly managed to somewhat improve the quality of his programming last night. Instead of focusing his efforts on vilifying Chevy Chase for not “believing in” the Great Sarah Palin, he instead decided to address the hypocrisy of the leaders in Washington, who always show up at the Bottom of the 9^th Inning during a legitimate crisis, as opposed to proactively informing the public when red flags start to appear.

While I do agree with his statements that our leaders should bite the bullet and make the tough call of delivering bad news (as opposed to McCain, blowing smoke our way the other day, claiming that our current economy has a strong foundation) and also that “both parties are to blame” for this current economic and bailout crisis, I do, however, find it quite humorous that he asserts “there was no Paul Revere in public office to alert us”. Bill, perhaps there was no Paul Revere, but there was and is a Ron Paul in office to alert us. He has been warning the country for almost 2 decades of an impending crisis, such as the one we are currently facing.

The headlines of today are the former “alarmist” predictions of “that kook, fringe candidate, Ron Paul”. It’s unfortunate that O’Reilly, most of the Fox News Network, and the Mainstream Media, in general, have spent many years ignoring the warnings of an honest and economically literate public official. O’Reilly cries out for a leader with the spine to be a leader, yet, at the same time, O’Reilly does his best to ignore a Ron Paul and sweep him under the rug. Fortunately, shrewd journalists such as Glenn Beck and Neil Cavuto regularly march the Ron Pauls and the Peter Schiffs of the world onto their shows in an attempt to inform the public of the very financial corruption thriving in D.C., as well as the dangers of government intervention.

This brings me to the second, and most positive aspect of O’Reilly’s show last night: his discussion with Neil Cavuto. Unlike O’Reilly, Neil Cavuto “gets it”, and then some. However, regardless of your financial or political viewpoint, anyone can thoroughly enjoy this heated back-and-forth between Cavuto and O’Reilly. In the space of just a few short minutes, Neil Cavuto easily and effortlessly exposes Bill O’Reilly for the pro-government interventionist socialist that he is.

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Last time, we touched on the basics of commodity spreads and went over the basic example of soybeans (S) and soybean meal (SM), or the “crush spread.” We noted that by tracking their ratio (S/SM), we could identify times when the relationship between these two contracts is out of alignment with the historical relationship, and take advantage by buying the undervalued contract and simultaneously selling the overvalued.

An important question is: how much do we buy and sell? The obvious (and easiest) answer is to buy one contract of the undervalued commodity, and sell one contract of the overvalued. However, each commodity gives the owner power over a certain number of the commodity – one soybean contract controls 5,000 bushels, for example – and the values of these contracts might be different.

To give an example, let’s look at the soybean / soybean meal spread that we were looking at before. As the chart showed, the ratio of 3.631 looks lower than usual, meaning that soybeans are undervalued and soy meal is overvalued. A $1 move in the contract price of soybeans is a move of $50 in actual value; a $1 move in the contract price of soybean meal is a move of $100 in actual value. These can be calculated from the screen captures above – on the left is the “tick” size for soybeans, and on the right is the “tick” size for soy meal. As the ratio suggests, the two typically trade at a ratio of (roughly) 4 to 1 – that is, the price of the soybean contract will move 4 times as much as that of the soy meal contract. Let’s assume that tomorrow, the soybean contract moves up $4, and the soy meal contract moves up $1, in accordance with this ratio.

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[Editor's Note: Liberty Maven welcomes Matt Malkus to The Free Investor contributor team. We look forward to learning more about investing in general and "liberty style" investing in particular from Matt.]

Note: This will be part one in a continuing series of articles related to commodity spreads, offering advantages and disadvantages, potential mistakes, and detailed examples.

The world of commodities is a fast-paced, highly-leveraged world where gains and losses per day can be in the thousands, even in the smallest of trades. This offers unique advantages and disadvantages over equities, where one share is just one share, and its face value is what you pay. For example, the “face value” price of a soybean contract is currently at $1357.75 (and this is what you will pay to obtain it), this is the price of 100 bushels of soybeans. However, one contract controls 5,000 bushels of soybeans, making a change of $1 in the contract price a change of $50 in actual value in your position. A “limit” movement (maximum allowed) of $50 in the contract price means gaining or losing up to $2,500 in a single trading day on a single contract!

As such, if you can’t afford to lose a few thousand dollars on a trade, it is not advisable to purchase a contract outright without employing a strategy that greatly minimizes this risk (while, of course, also limiting the upside potential). One of the major upsides to dealing with commodities over equities in developing a strategy is the relationships present between multiple markets. In equities, for example, shares of technology companies may all move loosely together – but if Apple comes out with an earnings report, announces a new product, or hires a new CEO, it may not follow the broader sector.

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What a ride it has been the past few weeks on the market!  Freddie and Fannie have now cajoled the government into providing a bailout; meanwhile, Bennigan’s, Steve and Barry’s, and other companies began closing their doors.  In such a volatile time, how do we remain confident that we’ve made the proper investment choices?  Remember, diversification.

Hedging against inflation

I am a strong advocate of, in a high inflation environment, holding 5-15% of one’s portfolio’s NAV (net asset value) in gold, silver, platinum, or palladium.  Such metals are a strong ‘hedge’ against inflation, meaning they almost always go up in value as a currency decreases.  There are a few methods of purchasing these metals, but I’d warn against purchasing an ETF linked to precious metal; true ownership is the best scenario in case of a market crash.  Both home ownership and overseas holding are the best two options, although the government has seized gold before.  If one is looking into purchasing gold/silver, bars are almost always better than numismatic purchases, as one does not pay the collector’s overhead on the coins.  That being said, there is also a good market in junk silver, where a large discount is to be had.  Be creative, and one can often purchase many ounces of silver at a significant discount to melt price.

Beyond gold and silver, one can also store some of their money in more well-managed currencies, such as the Swiss Franc.  This is a more complex investment strategy, but is easily accomplished through such online brokers as Interactive Brokers, who can put one’s cash deposit in any currency  within their Forex database.  Alternatively, one could hold the currency itself, but may find convertibility to be an issue.

Positions written about in the Free Investor are purely the opinions of Alexander Drummond and the Free Investor staff.  Tomorrow and Sunday, this series will be continued with a segment on Overseas Investment, as well as possible U.S. stocks that can survive economic recession.  Following that, the Free Investor will be on a 3 week vacation, after which we will transfer to a twice-weekly program with posts on Tuesdays and Fridays.

Ron Paul, following his interview on Glenn Beck’s radio show the other day, appeared on Beck’s TV show tonight. Many similar topics were covered, but it is so refreshing to see Ron Paul being treated with respect in the main stream media. While I think his interview on the radio was better, this TV interview was fantastic as well. When Ron Paul speaks about economics, inflation, the value of the dollar, and sweet liberty people should listen. Watch it below in 2 parts.

The above chart indicates exactly why many investors, smartly, look for stocks that pay dividends.  Dividends are simply a method for companies to deliver a portion of their profits to shareholders; however, the consistency and strength of a given dividend often reflects the strengths of the companies.  Investors often view dividend-paying stocks with greater confidence, as many investors see dividends as a constant measure for a given company’s accountability.

Perhaps one of the most powerful attributes of dividend-paying stocks is the ability to reinvest the received dividends back into shares of that company.  Many companies offer a dividend reinvestment program, commonly referred to as a DRIP, that purchases more shares of the company using every dividend.  Often, these programs also allow the purchasing of fractional shares using dividends, further extending the purchasing power of the dividends.

Such dividend reinvestment programs are often offered only directly from the company itself.  However, many full-service and discount brokers offer dividend reinvestment for all stocks, usually for free or at a marginal cost.  As reflected in the chart above, dividend reinvestment has the capacity to increase gains far beyond the growth of the share price alone.

That concludes this week’s Free Investor, as this is a holiday weekend.  Next week we will discuss some of the drawbacks of dividends, as well as some dividend-paying stocks that could have a bright future.

The IMF has informed Ben Bernanke that “the board has ruled that a so-called Financial Sector Assessment Program is to be carried out in the US.” This brings up an interesting dilemma for Ron Paul supporters who monitor the Fed and liken it to an unconstitutional cabal. We are against the IMF and federal style regulation over markets at all levels, yet we painfully yearn for more transparency from the Federal Reserve. If we aren’t yearning for more transparency from the Fed we are advocating abolishing it outright.

So the question is then, do we support the IMF investigating the hated Federal Reserve because it conveniently supports our anti-Fed sentiments? Or are we truly and purely against the IMF and it’s authority to perform such investigations?

In the opinion of David Hirst in Australian’s “The Age”, such IMF interventions are long overdue for America. After all many other IMF countries have had to go through the same investigations. Hirst calls it a “blow to American exceptionism.”

[The] IMF intervention (my expression) is a humiliation for the US, the real significance may be that this is another blow to American exceptionism.

While the examination is far reaching, and deeply intrusive, Canada, Britain, Italy, indeed two-thirds of IMF members, have participated in the program. The new President will soon discover the age of US exceptionism is over.

Meanwhile the US markets have entered bear territory, the economy has done likewise and we are at the beginning of a long and tortuous process before rebuilding can even commence.

The entire article by Hirst is well worth reading although his argument seems to be for demanding fairness from the IMF rather than whether performing such “investigations” should be done in the first place.

Yesterday, the Dow Jones Industrial fell over 3 percentage points, a drop of well over 300 points. Sadly, these kinds of swings hurt small investors far more than they do institutional investors; many individuals see the large drop and immediately sell. On the surface, such a move makes sense. Rather than face further losses, one should leave the market and cut one’s losses.

Why doesn’t this logic hold up? Long-term growth and broker fees.

Over the long-run, these volatile swings in the market tend to be corrected by general economic growth. Timing the market can work; however, many small investors are not quick enough to catch these trends in time to maximize earning potentials. Moreover, many investors fail to rationalize their reasoning for their purchase. Often enough, purchases have as much to do with an investor’s whims and emotions rather than a thorough analysis of fundamentals. As Benjamin Graham, the famed value investor, once said: “The individual investor should act consistently as an investor and not as a speculator. This means.. that he should be able to justify every purchase he makes and each price he pays by impersonal, objective reasoning that satisfies him that he is getting more than his money’s worth for his purchase.”

What can an investor do to avoid dangerous sell-offs like many made yesterday? Detach one’s self from the market. Purchase securities for their long-term growth potential. Better yet, purchase an index fund or ETF. SPDR (SPY) track the S&P 500, whereas Vanguard Total Stock Market (VTI) tracks the entire market itself. Either should provide, over the long-term, growth rates higher than that of the average investor. Since 1950, the S&P 500 has returned 8.66% per annum. Such a rate would mean that one dollar invested in the S&P 500 in the year 1950 would be worth $65.27 today.

Furthermore, make sure that your broker fits your need. With a long-term growth strategy, it makes little sense to have a full-service broker. Many full-service brokers, as well as some discount brokers, charge inactivity fees. These fees can range from $40 to $400 per year. Such a cut can be a significant portion of a client’s portfolio, and is removed regardless of performance.

As you are a long-term investor, stock transaction fees should not matter an incredible amount. However, it would still be advisable to find transaction prices below $15 a trade. Some online brokers, such as Zecco, now offer $0 trades to their investors. Another worthwhile feature of online brokers is automated dividend reinvestment; every dividend received is invested back into stocks as you indicate, compounding your growth further.

Next week, we’ll analyze high-dividend stocks, and why they’re often overlooked. Make sure that this week, which will perhaps bring further drops in the market, does not necessarily create a poor situation for us common investors. Rather, look at it as an opportunity for us to get into the market at a low-point. That does not mean we are entering a bull-market, as it is best to remain highly cautious during these severe dips. However, it is best to take a non-emotional approach to our investing, and remember the long-term outlook.

Alexander Drummond owns none of the stocks mentioned in this article.