Steady tailwinds benefited the stock market for most of 2010, but Stansberry & Associates Investment Research Founder Porter Stansberry is bracing himself and his clients for a bumpy ride for equities in the new year, as well as unprecedented instability in muni bonds and Treasuries. In this exclusive interview with The Gold Report, Porter, who's been predicting the dire consequences of unbridled borrowing and continued quantitative easing for some time, recommends utmost caution and conservatism for investors in 2011.
The Gold Report: Much has happened since our last discussion in September. The election, with the Republicans taking the House and the super majority in the Senate. QE2 (quantitative easing) not only discussed but actually released. The U.S. assisting in the financing in Europe. The benefactors of the 2008 bailout money finally published. And then the hottest topic in Washington for a while, extending the Bush tax credits along with an Obama unemployment tax credit. Have any of these developments changed or firmed your opinion of the U.S. economy or the international monetary crisis?
Porter Stansberry: I'm fascinated by the way the crisis is unfolding. The U.S. government is still willing to add enormous amounts of new debt. And it is willing to underwrite not only quantitative easing in the U.S. but also fund it in Europe as well. These are symptoms of a much bigger ongoing problem-the enormous sovereign debt crisis in the Western democracies.
I think we're going to see a lot more quantitative easing. We're going to have to see a lot more fiscal deficit growth going forward, especially with a union between the Republican House that wants to cut taxes and the Obama administration that wants to extend benefits. You let us cut taxes and we'll agree to extend benefits. Of course, that's the worst of both worlds in terms of our fiscal position because it will result in vastly bigger spending and less tax revenue. There's no other government that will even attempt adding vast new debts at this stage in the game. Americans still have no idea of the risks our government is taking with our currency.
TGR: The international quantitative easing you mentioned was in Europe. Is it only the Western countries that concern you and not Asia?
PS: There's been a dichotomy in the world financial markets over the last 30 years between the developed markets and the developing markets. Brazil, for example, always had to pay a lot more in interest to borrow money than governments in developed nations. We're seeing a whole new kind of order in the markets. Think of countries that simply run sound fiscal policies-such as Canada, Switzerland, Singapore and Hong Kong. You can probably throw a couple more in there now, such as Brazil.
In places with current account balances or surpluses, the currencies continue to strengthen versus the U.S. dollar. Bond yields continue to decline versus the U.S. dollar. Meanwhile, places that used to be considered safe, such as France, the U.K. and the U.S., are seeing bond yields go higher and currencies go lower. This is a new bifurcation in the world markets that's completely related to the ongoing policy decisions of these major Western countries, where governments have always had easy access to credit markets. There is a belief, at least on the part of the American people, that they can borrow money forever without consequence. I'm sure you'll recall the famous Dick Cheney remark that deficits don't matter.
I believe we are at the end of the line of those policies. And that's why we've had to begin to fund our fiscal deficits with just printing paper. That's what quantitative easing is. I think we're at a real crisis point, where for the first time ever America's creditors are beginning to abandon the dollar. You see that in two ways. Number one, for the first time since the early 1970s, central banks are now net buyers of gold again. Number two is the huge move down in the bond market that you've seen just really recently since the last round of quantitative easing began in the U.S. This is a really big change.
TGR: And an important one.
PS: It certainly is, and right now we have a situation where the muni bond market in the U.S. is crashing. Muni bonds are falling 2% or 3% every week. These bonds shouldn't decline at all. People have long thought of the muni bond market as the safest place in the bond market for retirees' money. Well, now it's in freefall. Normally, if you took money out of the muni bond market, you'd put it in the Treasury bond market. That's the only thing that's even safer. But both markets now are in decline. People are selling both muni bonds and Treasury bonds at the same time. That's a sign of a major problem in the fixed income markets. And, because the U.S. bond markets are the largest securities markets in the world, that means we're in the midst of a major, major financial crisis. I don't really think people realize it yet.
TGR: Are you referring to the general population?
PS: When I talk to people, when I talk to news commentators, when I do interviews, when I talk to investors, when I go to investment conferences, when I talk to very well-known hedge fund managers. . .all of these people have some idea that things are going wrong. Lots of them say they're worried about being on the verge of a big crisis. I think we're in one. So, I ask them, rhetorically, what do they have to see in the markets before they realize the crisis is underway?
How high does the price of gold have to go? How far do Treasury bonds and muni bonds have to fall? How far does the dollar have to decline on a trade-weighted basis? How high does unemployment have to go? How big do the fiscal deficits have to grow? They don't have any answers to those questions because all of the thresholds have been violated already. Two years ago, no one would've thought it possible for the muni bond market and the Treasury bond market to both fall as much as they have fallen in the last six weeks at the same time. That just didn't happen ever before.
TGR: So if we've passed all those thresholds, why doesn't the general media say we're in a crisis?
PS: Even though the currency markets and the bond markets are vastly larger, the stock market hasn't cracked open yet, and for whatever reason, the major media focus is almost entirely on the stock market. Until stocks fall 20% or so, the media won't panic. But God help you if you're still long on stocks when the nightly news begins to feature the core financial problems we face.
TGR: You've been advising people to get into so-called real asset classes such as agriculture, gold, silver, various forms of energy. But won't all stocks be worthless in an economic catastrophe and global hyperinflation?
PS: Stocks actually can be a very good hedge against inflation, and short of hyperinflation, stocks will have the ability to increase their dividends to match the rise in prices. Now I say short of hyperinflation; if we get to real hyperinflation all that's off the table and you're exactly right.
So what we're doing now is buying what we think are the best hedges against inflation-energy, agriculture and hard money-silver and gold bullion. We're also selling short lots of stocks that are overly in debt or are obsolete, such as newspapers or hard drive companies. Earlier this year, I told people that if they aren't willing to short stocks to hedge their portfolios they should only be in cash and gold, and they shouldn't own any stocks.
TGR: You said investors who aren't willing to short stocks should stay in cash and gold. But cash value is getting inflated away with quantitative easing. Why put anything in cash if it won't appreciate? Why not put it all in gold?
PS: When you're dealing with a bankrupt sovereign- like the U.S. government-you're dealing with a very powerful wounded bear. You have to be very careful because you can't know what the beast is going to do. You have to balance against both the risks of the ongoing inflation and the risks of a government reaction to the falling value of the dollar. If you put 50% of your portfolio in very short-term Treasury bonds, like one-year Treasury bonds, and the other 50% in gold, you've really set up a perfectly hedged position. You've gone to a very liquid position where you could hold on to what you've got safely. If the dollar falls, you're protected. If the government acts to reduce the price of gold, you're hedged. No matter what happens, you'll have liquidity and there's very little chance of losing purchasing power.
TGR: But if it's perfectly hedged, doesn't one offset the other and you have not then increased wealth?
PS: True, you're just treading water. But in periods of a crisis just treading water is actually a very good return. It's easy to say, Oh, I'll just go all to gold. But the government can't allow gold prices to continue to escalate without losing credibility for their paper, so what if the government decides to shake up the gold market? What if they do something to influence the price of gold negatively in a very severe way? I'm not saying they would confiscate all the gold, although they could. They could change margin requirements or launch an investigation of the gold ETF. They could do all kinds of things to undermine the gold market that could send gold prices down 20% or 30% in the short term. If that happened and you had all of your savings in gold it would be extremely uncomfortable. In the meantime, if you were long 50% dollars and 50% gold you still would have made more than 10% this year. So you're actually doing just fine. You're just doing so in a way that recognizes we're in a very dangerous and unstable period of time.
TGR: In our last conversation, you recommended-at least for 2010-buying the highest-quality blue-chip companies in America that had good global businesses that are really cheap. You gave a couple of examples, Wal-Mart Stores Inc. (NYSE:WMT), Johnson & Johnson (NYSE:JNJ), Intel Corporation (NASDAQ:INTC) and Microsoft Corporation (NASDAQ:MSFT). You pointed out they were paying increasing dividends, in fact, at a higher rate than clipping the coupons for these particular companies. Will that continue to be a good strategy through 2011?
PS: Yes. I strongly endorse that strategy. High-quality blue-chip international businesses are very cheap right now. Their global earnings offer a lot of protection against a dollar decline. Intel makes something like 75% of its sales outside the U.S. dollar. That's global protection via a very high-quality business that has a fantastic protective moat, has very high margins and has a shareholder-friendly board and a business model.
But while you can use equities to hedge against the risk of inflation, unfortunately you can't use them to hedge against the risk of a hyperinflation. That's why I've also been urging people to buy silver and gold bullion and to be willing to hedge their long exposure by shorting some very low-quality stocks.
TGR: To summarize where we've been-we're looking at having bullion, blue chips and a short portfolio. Earlier in our conversation we were talking about such investment hedges as agriculture and energy. Where do those fit into what we've just discussed?
PS: When it comes to energy stocks, we like very high-quality integrated blue chips. We like stocks that are involved in the Eagle Ford discovery in south Texas. And we like what are essentially royalty companies, companies that get paid to extract the hydrocarbons from their property, like San Juan Basin Royalty Trust (NYSE:SJT).
When it comes to agricultural stocks, we've written a lot about Monsanto (NYSE:MON), which I know is a controversial business but I think is a very good long-term bet. Having talked to global food company CEOs recently, I'm convinced that Monsanto's seeds are the only way to significantly increase agricultural production globally. That has to happen to keep pace with rising populations. You can also look at a company such as Cresud Inc. (NASDAQ:CRESY), which is managed by one of our friends, Eduardo Elsztain, and is a very good business in South America that owns huge soybean farms. There are all kind of different ways to get exposed to agriculture but those are some of the ideas that I think would be good for investors to consider.
TGR: You've mentioned that agriculture is one of the most important inflation hedges primarily because we all need to eat food.
PS: Hard money is the most important inflation hedge, something like gold and silver, for the simple reason that if you own plenty of gold and silver you can buy any other commodities you need because you own real money. Then energy comes in behind agriculture because you have to eat before you drive your car anywhere.
In terms of increasing productivity, the big problem for agriculture has been the rise of various political movements that oppose expanding farmland. Other political problems go to various subsidies and regulations. For example, in Europe not only are farmers prohibited from using Monsanto genetically modified organism (GMO) seeds, which makes it very difficult to increase crop yield, but the governments continue to pay farmers not to plant. The United States government also pays farmers not to plant certain crops. All kinds of political incentives against increasing production don't make much sense but they exist.
Some food CEOs are very concerned that as global inflation accelerates, there's a big risk of a trade war and a currency war. They're really afraid that some of the people in the poorer countries will begin to starve.
TGR: When we last spoke you said that you were still trying to survive 2010 and weren't prepared to talk about your expectations of 2011 because we weren't there yet. Well, we're almost there now. How well did you survive 2010? And can you make any predictions for 2011?
PS: I don't have the final tally on all of our results but I know we've done very well. Through early December the average profit on the nine stocks we recommended buying during 2010 was 7.5%, led by a 42% gain in San Juan Basin Royalty Trust. Don't forget these recommendations were all super-safe, blue-chip stocks. Our single-digit average return was very much on purpose. We didn't feel comfortable on the long side of the market in 2010. Meanwhile, the average profit on our six recommended short sells was 17.5%, led by a 51% gain shorting Seagate, a hard drive maker we think is going to zero.
Two things to remember about these results. First, they're just plain averages. Lots of newsletter editors will annualize their results to account for the fact that the model portfolio isn't fully invested all year, as recommendations go out monthly. We don't do that because you can't eat annualized results. Second, these results don't include any of our hard money recommendations. Buying gold and silver would have added significantly to your gains this year-as we predicted. Gold is up 27% this year. Silver is up 75%.
As you know, it's one thing to pick stocks and it's another thing to actually make money in the markets. Our primary goal is to help real people make real money. Our portfolio is designed to make double-digit annual returns, no matter what happens in the markets. Including our bullion allocation, I'd estimate that a reader would have earned more than 15% last year on their whole portfolio, even though the portfolio would have been completely hedged the entire year, and would have had a very large cash position for the first six months. Those are world-class risk-adjusted returns and I'm very proud of how we've done.
Unfortunately, I believe it's going to be tougher to make money 2011. I expect the government to strike back. I don't think they're going to let commodity prices continue to soar. I'm very concerned about the repercussions of that on investors. So if I was very conservative in 2010 I've become downright scared in 2011. I don't yet know how we're going to hide, but I can tell you it's going to be a very large combination of hedges. We're going to have to continue to be very, very conservative in our allocations and make sure that we're prepared for any potential eventuality.
I really do think we'll have a huge correction, particularly in the silver market. I'm a major silver bull, and I believe silver is inherently worth $120 an ounce already and it's going higher. But markets just don't go straight up the way silver has in the last couple of months. So I'm concerned that my subscribers may think that we can buy agriculture and energy with impunity and that we can buy as much silver and leverage it as much as we want without getting destroyed by the market volatility, just because we're in the middle of an inflationary crisis. I think we're going to see some of that volatility next year. I don't have a crystal ball, but it seems as if there needs to be a shakeout in the market because the investors have gotten so bullish on these ideas about sound money and energy and agriculture.
TGR: You expect it to be tougher to make money 2011 because the government will strike back. What tools do they have to strike back at investors?
PS: They have all the tools in the world. They could do all kinds of things. They could pass huge new withholding taxes on any kind of investment in bullion, for example. They could change the rules on the commodity exchanges. They could make rules about prices and windfall profit taxes. There's any number of things they can do to distort the markets and punish speculators, and there's no doubt in my mind that they will do some of them. There's no doubt in my mind that at some point next year Obama is going to come out, point the finger at the camera and say, An international group of speculators is destroying our bond markets. We're going to stop them.
I'm expecting some big volatility next year. You have to be willing to be careful with the size of the positions that you're putting on and with your expectations about volatility. Things are going to get really volatile.
TGR: Does that mean investors need to be more fluid in and out of the market? Not day trading, but more actively trading in and out?
PS: My recommendation is just to be more conservative. Hold larger cash positions than you otherwise might. When you do go to buy a security or take a position in a commodity, make sure the price seems relatively good. It's very difficult to do that when it comes to commodities because it's impossible to determine a real true intrinsic value. I mean, what's gold really worth? It's an impossible question.
But I would just use common sense. Silver, for example, has gone from let's say $15 an ounce to almost $30 an ounce just in the last six months. Buying a commodity after it's doubled in six months is probably not such a good idea. The same goes for buying a stock such as Tesla Motors, Inc. (NASDAQ:TSLA). This electric sports car company has borrowed a tremendous amount of money and can't possibly make a profit, so it's probably not a good idea for next year-unless you're shorting it.
As interest rates go up, as the U.S. bond market begins to look a little more attractive to investors, the long bond might break through the 6% barrier next year. That would have a huge impact on equity valuation because if you have theoretically a risk-free rate of 6%, oh man, equities are going to be worth a lot less than people think they are.
TGR: Theoretical is the operative word there.
PS: Of course. It's not at all risk-free. In fact, it's a guaranteed way to lose money because the inflation rate is certain to exceed 6% next year, but my point is, if yields on government bonds keep backing up, then at some point it's going to impact equity valuations, which are already far too high. And that means, at some point in 2011 we're going to see a big correction in stock prices.
TGR: Porter, in closing, are there any other insights you'd like to provide to our readers?
PS: Just the same thing that I've been saying for a long time. We're in the midst of a crisis and this is a time to be unbelievably conservative with your investments. You can't assume that anything is safe anymore. People have been hiding their savings in muni bonds. They're going to get wiped out next year. People who have been hiding their savings in Treasury bonds are getting wiped out right now. People have been thinking that they can put an unlimited amount of money long in gold and silver and that they're only going to make money. That's not going to happen next year. There's going to be some volatility. So I would urge people to take some profits early, to keep some money in cash and to just simply be very conservative. If you have two investment choices, one of which is speculative and one of which is conservative, go with the conservative one. It's going to be a tough year in the markets.
Want to learn more about Stansberry & Associates Investment Research? Watch this. The first American editor of the Fleet Street Letter, the oldest English-language financial newsletter, Porter Stansberry put out his shingle at Stansberry & Associates Investment Research, a private publishing company, 11 years ago. S&A now has subscribers in more than 130 countries. S&A's 60-plus research analysts, investment experts and assistants, working at company headquarters in Baltimore, Maryland, as well as satellite offices in Florida, Oregon and California, came to S&A from positions as stockbrokers, professional traders, mutual fund executives, hedge fund managers and equity analysts at some of the most influential money-management and financial firms in the world. Porter and his team cover the gamut from value investing to insider trading to short selling, all based on exhaustive amounts of real world, independent research. Porter Stansberry's Investment Advisory, Porter's monthly newsletter, deals with safe value investments poised to give subscribers years of exceptional returns, while Porter Stansberry's Put Strategy Report, his weekly trading service, shows readers the smartest ways to book big gains during the ongoing financial crisis.
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1) Karen Roche of The Gold Report conducted this interview. She personally and/or her family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: None.
3) Porter Stansberry: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None. (Stansberry Research does not permit its analysts to own any of the securities that they personally recommend to its subscribers.)
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