FSO Editorials

A Letter to My Grandchildren
by Robert B. Gordon, Sc. D.
November 12, 2003

intro graphicThis letter has been forming in my mind for quite some time as I strive to pass on what I have learned about the economy and investing. I think often about Scott in our far West who is waiting anxiously for his wife Anna to return from her grueling job as a language specialist in IRAQ. I am very pleased that Andrea and William in the East are starting work in their new jobs. I also hope that this letter reaches many other young men and women either directly or with the help of other readers.

As I think back to my own grandparents, I never received any memorable verbal or written communication offering guidance for my future life. My father's parents predeceased my birth and my mother's parents, who lived in our same household until I was 20, had little else than occasional verbal suggestions. But the educational advantages that I and many others enjoyed in my generation have filled my mind for many years with information I am urged, actually compelled, to pass on. So far, my efforts along this line have been spasmodic and probably have had very little effect on my young adult grandchildren.

In the past century, each of our generations has passed on its advancing skills and knowledge in areas like health and technology, while at the same time failing to prevent the age old problem of recurring stock manias and the depressions that always followed. In addition to this very serious failure in information transfer is the associated one of not teaching new generations the special skills needed to build and preserve wealth. The result of older generation failures is that our youth must now combat the perils of the world's greatest economic depression, now in its initial stages.

My current days are filled in reading numerous expert views on national and global events that are readily available on the Internet. My mind is filled with a huge amount of information I am willing to pass on to anyone willing to listen. But of course, my young adult grandchildren are completely occupied with their own problems of jobs, families, leisure activities and additional education. I was in this same position 65 years ago, but without any counsel from my elders. Hence, I never really had a saving plan which was a severe handicap.

Although my generation and that of my children have probably created more wealth than any others in world history, the final story is not in because much of this wealth may disappear in the grueling bear market now in its fourth year. The current world economic situation, bad as it is, might actually look better than other crises in nuclear proliferation, terrorism and demography. So, even with their youthful enthusiasm, my grandchildren and others in their age group will be greatly challenged in many areas of their life including health, wealth, war and peace.

In trying to help our grandchildren get a better start on what we hope will be a long and successful journey, we are going to provide some quotations from others in areas where they seem appropriate. Finally in the area of the economy and investing we will give what we have learned in the past 63 years and hope that it helps puts our grandchildren and others in their generation on the road to a happy and prosperous life.

INTRODUCTION

Our world is not a particularly happy place as we write this letter. It is easy to spell out a long list of current and threatening problems, both national and international. Our grandchildren, just starting out in life, are confronted with problems of continuing education, professional development, marriage and family planning along with many other competing interests.

In this letter, we intend to concentrate on four areas, some long range and others immediate, that need to be considered now in order to be recognized in the current thinking and planning of young adults. They are world-wide demographic changes, health concerns both present and future, global economic problems and the critically important job of life-long wealth building and preservation, with emphasis on preservation.

GLOBAL DEMOGRAPHIC CHANGES

We quote a few facts from John Mauldin's unpublished book with written permission of Mr. Mauldin.

demogNovember 01, 2003, Demography is Destiny:

"Now, let's look away from the US, and focus our eyes on the rest of the world. If we think the retirement problems facing the US are severe, then the facts suggest the rest of the developed world is facing a major crisis. Over the next few decades, we are going to see a shift in economic and political power that is simply staggering in its implications. Let's look at facts first, and then draw conclusions.

The population of the "developed countries" will drop rapidly over the next 50 years, while those of undeveloped countries, especially Islamic countries, will rise dramatically. Germany will experience no population growth and will remain at 80 million people, while Yemen grows from 18 million to over 84 million.

Russia will drop from 145 million to slightly over 100 million. Iran grows from 66 million to 105 million. Japan drops to 109 million, while Iraq and Saudi Arabia grow to 110 million. Italy declines from 57 million to 45 million, while Afghanistan grows from 21 to 70 million.

This underscores the 100-page CIA report released in July 2001, entitled Long-Term Global Demographic Trends: Reshaping the Geopolitical Landscape. The following are some quotes from that report:"

"Dramatic population declines have created power vacuums that new ethnic groups exploit. Differential population growth rates between neighbors have historically altered conventional balances of power....Our allies in the industrialized world will face an unprecedented challenge of aging. Both Europe and Japan stand to lose global power and influence... The failure to adequately integrate large youth populations in the Middle East and Sub-Saharan Africa is likely to perpetuate the cycle of political instability, ethnic wars, revolutions and anti-regime activities that already affect many of these countries. Unemployed youth provide exceptional fodder for radical movements and terrorist organizations, particularly in the Middle East."

The welfare state will be under threat. It will be difficult to maintain the current level of public sector services and transfer payments as fiscal strains rise. It is almost inevitable that the retirement age will rise in most advanced economies and real benefits may be cut. Meanwhile, aging populations will put immense pressure on state-funded health care facilities. New medical technologies could even exacerbate the problems by creating expensive new treatments and boosting life expectancy rates.

It may be difficult to keep the euro area intact. Europe's grim fiscal outlook raises a big question mark about the sustainability of the euro zone. The Stability and Growth pact will eventually have to be scrapped, and different fiscal positions across countries will create enormous strains, given a common monetary policy and currency. Meanwhile, expanding the European Union eastwards will not alleviate Europe's demographic problems as all the new prospective members (Turkey excepted) have even weaker population dynamics than existing EU members.

China will face many of the same problems as the West. The Chinese economy currently is booming, but it too faces demographic challenges down the road. The fertility rate is below replacement level and the working-age population is projected to peak in around 2025. This will make it easier to employ those workers flowing from rural areas to cities, but, as in other countries, the aging population will create a large fiscal problem, albeit later than in the West. Other important issues discussed in the CIA report include the implications of increased urbanization in a number of unstable countries, the global spread of infectious diseases, and the adverse environmental consequence of rapid population growth in the developing world.

The long-run picture for Europe and Japan looks bleak in that a deteriorating fiscal picture will be bearish for bonds while weak aggregate demand is bearish for stocks. Those two trends would be consistent if the eventual outcome is a stagflationary environment, which could occur in the context of labor shortages and attempts to inflate out of a government debt trap.

RBG comment: These demographic changes may be worse abroad, but the United States is in such terrible financial shape, it would be foolish to count on any retirement income other than one produced by a maxed-out individual savings plan. That is the main purpose of this essay - to encourage all young readers of the urgent need to start saving wisely right now.

HEALTH CONCERNS

Most young adult grandchildren spend each day in work or play with little concern for a serious health problem or accidents. Yet young men and women are crippled or die in accidents every day. Despite great advances in medical science, weak medical care in undeveloped nations and scary incidents like the SARS epidemic continue as threats. Right now, one of the biggest problems faced by young Americans is wide spread obesity caused by prosperity and unhealthy eating habits. Whether this disease will moderate in a severe bear market economy remains to be seen.

docWhen moving into a new geographic area, it is wise to get help in selecting the best available personal physician. Large libraries will have an up to date register of physicians working in each major geographic area. It will list age, education and specialties and is a good place to start. Large hospitals may have a doctor referral service that can be helpful. There is a wide range in the experience and abilities of individual doctors. Make a diligent search and change your personal physician until you have one that is right for you.

Our grandchildren's generation will see great advances in health care combined with complex ethical problems in areas like cloning. Costs of health care will soar in major nations and create problems in delivery to retirees and the poor. This problem will be magnified by the increases in the retired age group forecast by demographic studies in developed countries.

Life insurance is no doubt very low on the priorities of most young singles and couples. But a huge term life policy can be obtained for either sex in their twenties at a very low premium cost. Although the probability of death of a young wage earner or a wife and mother is very low, the payoff can be a great blessing in the rare case where it is received. You may have a life insurance policy from your employer but it should be supplemented if not adequate. Take advantage of the very low rates for term insurance at your age and, in view of the probability of failure of many insurance companies in the coming depression, we urge you to go to www.weissratings.com and pay $7.95 each to get a financial rating. Do not buy a term policy from a low rated insurance company as weak companies will almost surely fail in the coming depression.

THE GLOBAL ECONOMY

The huge growth in international trade in recent decades now has the economies of all the major developed nations so closely linked that they are all about to join Japan in a great world wide depression. In the 1980s, Japan's economy was booming and U. S. businessmen were traveling there to discover their secrets. But their stock market bubble crashed in December 1989 and several years later their real estate bubble crashed and now we know they were merely the first major country to enter what will become the first ever global depression.

global crashI want to interject a very personal note at this place because my outlook on the global economy and stock markets was drastically changed in 1995 by discovering Robert Prechter's precedent shattering book titled At the Crest of the Tidal Wave. It changed my understanding of stock market crashes and their ensuing depressions. It put my thinking of stock market waves in a completely new direction. From this great book, I had first learned about the Elliott Wave Principle, a brilliant discovery by Ralph Elliott in the 1930s that a fixed set of natural laws determined the formation of stock waves in every geographic market and in every time scale from minutes to centuries. Please read my essays, listed later, that deal with Elliott Waves. It is a very difficult subject, but imperative to a real understanding of investing.

The other great revelation that came to me in 1995 was the understanding from Prechter's book that the stock market waves precede and, in fact, predict the great economic booms and busts that occur about once in each century. The present prediction from Elliott Wave theory is that the great stock mania that topped in 2000 will bring on a severe world-wide depression that will be deeper and last longer than the one following the 1929 crash. Having lived thru the earlier depression, I agree that this one will be far worse. I say this only to help prepare my young readers for what may lie ahead. It is far better to be prepared than surprised.

One of the great tragedies of our nation's educational system is that the thousands of Ph.D. level economists in colleges, government and Wall Street do not know about Ralph Elliott's great work. The record shows that they have failed miserably in forecasting recessions and depressions. In fact they have only done half as well as flipping a coin. To my knowledge, just one paper on Elliott waves has been written by a college economics professor. Located at the Catholic University in Chile, he did me the honor of translating one of my papers into Spanish and making it required reading in his course on Business Cycles. Read my paper titled Wall Street's Greatest Crime. It will inform, educate and surprise you.

THE U.S. ECONOMY

The Line In The Sand
November 3, 2003
Bob Wood ChFC, CLU, RIA is President of Kaizen Managed Assets, Inc., an independent money manager in Clearwater, Florida, Email

"Alright, now you've gone too far! Boy, if I had a dollar for every time someone said that to me I'd be living large by now.

Every time someone has said that to me I'd sit and wonder why there was no warning that maybe I was going too far but still had time to turn back and save myself. I mean, going too far holds negative connotations, does it not?

But sometimes I guess its inevitable that we all go too far, or too fast, or both. But without clear lines drawn as to limits, we are at the mercy of guesswork. Its funny though that while there is seldom any sign that we are approaching limits, it is much clearer when we have indeed exceeded them. In retrospect, the lines are always so clearly defined.

In terms of matters of financial and investing interest, let's corral this concept of going too far as it relates to the economy and the stock markets.

And we may have gone too far this time in a big way. The problem is that there are no signs or lines in the sand that alert us to where the outer edge of safety lies. One problem is that we are part of the world's largest economy.

No one has ever been responsible with the oversight of an $11 trillion economy before. We can't just look back in time at how others managed something this big through good and bad times. That book, and all the lessons contained therein are being written now.

The successes and failures will be known after the limits have been realized. But we may soon see signs that we have gone too far in some very big ways. One such limit-buster may well be in valuations for domestic stocks.

Remember when the NASDAQ got hammered over a 2 year time span and lost almost 80% of its value during the recent bear market? In hindsight many investors might see now how the NASDAQ, sitting at just under 2000 is very close to where that index was about 5 years ago.

lineMaybe that's when we crossed the line and accepted too much long term risk. With the NASDAQ lower now than at any time since early 1999, the line was evidently crossed early that year.

So with the S&P 500 according to my new Barron's now selling at about 30x 'reported earnings', or the new code words for GAAP earnings, we may have crossed the proper valuation line a long time ago.

And be careful when anyone quotes the index in a multiple of 'operating earnings'. That's the new code words for 'pro-forma', which no one wants to mutter now.

The bigger risk now I think is to the overall economy. Greenspan has been taking the battle to his fight against deflation. When asked how he would deal with that menace when confronted, he basically said that he didn't know. We have never had to deal with deflation before, he explained.

But before it becomes an issue, he would do whatever it took to prevent deflation from becoming our main concern. He would do everything necessary to reinflate the economy by classic Keynesian methods, which for the most part are accepted as the right thing to do.

But as much stimulus as Greenspan has furnished into the economy, there is still reason to think that the lasting effects have been, and will be minimal. So he adds more new money to the system and the government continues to spend more than they take in from taxes.

The problem is that all that inflationary spending, borrowing and printing seems not to be doing the trick in ways that Greenspan and his pals envisioned. Which might make us wonder if it was the wrong cure for the ailment in the first place. Maybe like a doctor telling you to take an Advil for a broken foot.

In the face of what is evidently becoming clear, that what had worked in the past may not be working now, Greenspan and the federal government nevertheless continue on the path of minimal effect.

But at what point do you realize that maybe all that stimulus and spending is not what was needed, and now we will have to cope with an incredible debt load, larger than ever confronted in history.

But this also represents a confrontation with the unknown. But what is known now is what happened in the past. And the promoters are using the past to justify their claim that investing now is perfectly sensible. This in spite of the world's greatest investor telling us recently that he sees little worth buying.

But the bulls remind us that in the past, the economy's down times were inevitably followed by up times. Or that how lower interest rates stimulated the economy out of recessions or that buying cyclical stocks when their P/E's were high was smart since when the economy rebounds, so will earnings and the multiples will compress.

The main problem with these claims is that for the most part, they are dead wrong. The bulls are throwing out more meaningless information now than can be believed. But its all they have so they use it, meaningless or not.

The problem with drawing parallels to the past is that the variables change. Inasmuch as past recessions have given way to new rounds of spending, production and tax receipts, there has never been a recovery that featured massive job losses.

And I repeat for the annoyingly multitudinous time, we have never had a meaningful bull market that began when rates were low and stock valuations were high. Never, never, never.

The bulls cite long term returns for stocks at about 10% per year. But that is looking back over maybe the past 100 years or so. The biggest difference there is that long ago, we were an emerging market economy, more likely to show strong, sustained growth.

Extrapolating those results into what has become the largest economy in history is taking huge liberty with annoying things like cause and effect.

Just as how the largest companies encounter difficulty in maintaining their historic growth rates, large economies labor under the same constraints, having to generate huge incremental rises in sales and profits to keep growth high.

But given the amount of borrowing and spending seen over the past couple of years, the economy will need to grow at rates more typical of smaller, more vibrant economies.

Trying to force that kind of growth leads policy makers to inject historic amounts of stimulus. That stimulus will have to be offset by equally massive responses in economic activity to be justified and managed.

The bulls cite the past conveniently. But conditions of the past were different than what we face now. Secular, longer term trends in our ability compete with lower cost manufacturing locales takes a lot of wind from the sails of economic vibrancy.

We are the high cost provider of just about everything. I don't see much of anything done here in terms of manufacturing that can't be done much cheaper anywhere else. There are suddenly a lot of white collar jobs leaving too. That can't be seen as a cause of future economic strength.

We are an older society, and older societies will grow more slowly and are less productive. Too many people not working to be helped along by those who are working.

Another grinding irritant to the economy is deflation in the price of things we produce, offset by inflation in things we use. Manufacturing prices keep dropping while service prices increase.

Simplistically put, imagine the things that provide most of our incomes as losing pricing power and the things we spend money on like energy, health care, insurance and education are rising. Incomes down, expenses up. Not good.

But the Fed and President Bush continue to advocate printing, borrowing and spending. The recent spike in GDP to a reported 7.2% for the most recent quarter was fuelled by tax rebates. That loss of income to our mutual financial statement will have to be replaced, if not by stellar new growth then by higher taxes.

But we don't know for sure since there is no clear line in the sand telling us if we have already gone too far in trying to make an old, slow growing economy act like a smaller, younger more vibrant one.

We are writing history here. But the potential that we have gone way too far looks likely now. Politically, its too hard for our leaders to do what the Brazilian government has done. They cut spending and reined in their balance sheets, not typically popular.

Firing people because you can't justify paying them doesn't play here, not so close to an election. So they stimulate to historic proportions, close their eyes and hope it works out.

But the variables are different now and we may have crossed the line of fiscal irresponsibility long ago. Those deficits and the National Debt are looking as though we will never be able to correct them without taking draconian measures.

We may very well have crossed a very big line. We just won't know until someone tells us very clearly that we've gone too far this time. And the bulls arguments that the past will be repeated ignores what look to be very obvious signs that its different this time.

We may have maxed out our last credit card. What happens now could set new standards for going too far. End".

RBG note: This article is reproduced with written permission of the author.

PRECIOUS METALS WILL ZOOM

coinsAs we will discuss later, we give gold and silver an important role in a life-long wealth building plan. There are many web sites featuring information on precious metals, so we will let you keep up to date by visiting these sources of information. However, we thought the views of James Grant as described in a Tim Wood article were very pertinent to our subject matter. There is no doubt at all in my mind that gold and silver will play a very large role in your wealth building program. You will need to take special care because of the enormous price volatility these metals have displayed in the past and will no doubt continue to do so in the future.

Our first purchases made in the early 1970s cost $39/oz for gold and $1.25/oz for silver. Subsequently, we saw gold shoot to $800 and silver to $50. Gold is now below $400 and silver is below $5. Please read and re-read the following article giving pertinent comments by James Grant, a noted American fiscal authority.

"Go long silver, short Fed arrogance" - Grant
By: Tim Wood, Posted: 2003/11/06 Thu 22:00 EST | © Mineweb 1997-2003

"Nevertheless, he urges a longer-term perspective and returns to silver as a hedge against a monetary misfortune of epic proportion.

Silver should be in a bull market. . . Why isn't it? Perhaps it is lacking a monetary bid in the sense that currencies produced by central banks and governments are not the stores of value they are presented to be and the world has not yet begun to turn to an alternative. It has begun to turn in the gold market and silver can't be all that far behind," Grant suggested.

He says the "slow turn" is a consequence of the United States' global role and the function of its dollar as numeraire. "The dollar is an even greater achievement [than Sterling]. Whereas Sterling was convertible or exchangeable [into gold], the dollar is purely faith based. . . Currencies are IOU nothings."

Grant says the singular problem facing the world is the overextension of American finances. "If Britain was the world's workshop, the US is the world's mouth," he quipped. "We consume more than we produce and the money winds up in the vaults of countries that consume less than they produce."

As a result, dollars are piling up abroad with $1 trillion (a thousand billion dollars) recorded on foreign central bank balance sheets. China and other Asian countries have been accumulating dollars faster than anyone in an effort to prevent the dollar from depreciating to rapidly, so threatening their export led economies.

It is worth noting that Ms Hong Liang, a China economist at Goldman Sachs, says the People's Bank has been forced to accumulate dollars to offset private sector speculation about revaluation of the yuan/renminbi. Indeed, she makes a persuasive case that there has been a swap trade: "Contrary to the common belief in China that hot money is mainly brought in by foreign-currency speculators, it is Chinese residents who are quietly shifting their assets out of dollars and into yuan. The growth in dollar deposits in onshore banks -- held by residents as well as enterprises -- has slowed notably since early 2001, initially in response to interest-rate differentials, but increasingly due to rising expectations that the yuan will appreciate.

"This has led to a steep decline in dollar deposits relative to yuan deposits. If one takes the difference between official reserve accumulation and the sum of the trade surplus and total foreign direct investment inflows in the first half of this year, the inflow of hot money roughly equals $25 billion. During the same period, the share of total bank deposits held in dollars declined by 0.01 percentage points, which is about $24 billion."

Liang also notes that capital flight from China has also reversed for the first time in many years as hot dollars flood in to speculate on revaluation. This is also fuelling credit expansion, a fact Grant illustrates brilliantly.

"China, in order to absorb dollars, must create renminbi. So there is an immense expansion of worldwide credit. . . these dollars still flow west. These central banks turn around and invest these same dollars in US traded securities and the securities of Fannie Mae and Freddie Mac. It's as if [the dollars] never left this country. The renminbi, the yen and the Singapore dollar stay and finance credit expansions in the global and Asian economies.

"The point is that the US current account deficit is a great driver of worldwide credit expansion, especially in Asia."

Grant speculates that at some point the accumulation of dollars would end when one of the Asian banks decides that the whopping stockpile of American paper is sufficient. "Would you not consider an alternative to this monetary asset that comprises the bulk of global reserves?"

The obvious alternatives are gold and silver, especially because the Federal Reserve is willfully depreciating the dollar according to Grant. "The latent power of a move away from the dollar is almost impossible to imagine. Some $6 trillion is held today at interest rates a little higher or lower than zero. . . Japan has several trillion more. So call it $8-10 trillion that is held in dollars earning no return. What might cause these dollar holders to seek a hedge? Do we have a critical mass of dollar holders who have lost confidence in the currency and want to switch to an alternative?"

Grant self deprecates about the continued postponement of his forecast for the Fed to finally overplay its hand, but he has a point that we are currently witnessing one of the great monetary dramas of all time and he makes a very persuasive case for being long precious metals.

What's more, he likens the present infrastructure for selling metal securities to the equity market in 1947. Few people owned stocks, now few don't. Similarly, an elaborate infrastructure and complex instruments developed to sell gold rather than to buy it – he's betting on a spectacular turnaround on that front.

Grant is especially bullish on silver because it has more favorable supply-demand characteristics."

RBG note: © Mineweb, a division of Moneyweb Holdings Limited, 1997-2003. This article is reproduced by written permission of Tim Wood and Mineweb

HOW DID WE GET INTO THIS MESS?

I have deliberately painted a dire picture of our global and domestic economies and stock markets because it is extremely important that any twenty-something woman or man understand what they will be dealing with for many years, even decades - a stubbornly difficult economy that will defy conventional solutions. If anyone wants to cry out "why did it have to happen to me," the answer is very simple. The "experts" in the last 3 generations have completely misunderstood the underlying causes and cures that might have led to a better environment. The economists, politicians and others responsible have completely misread the causes of our 1929 Crash and Great Depression and have failed utterly to make needed changes that might have ameliorated the situation this time. Their words and actions have almost exactly repeated the errors made in the previous tragedy. Unless the lessons are finally learned this time, more boom and bust cycles will surely occur when this one fades into memory.

wave At the present time, virtually every one of our leaders in Washington or New York and nearly all of the general public believe that the "recession" ended two years ago. But our leaders are wrong, dead wrong. They know nothing about Ralph Elliott's great work or the experts that have followed in his footsteps. Robert Prechter's great Tidal Wave book in 1995 predicted the Crash and a Great Depression to follow it. Because of the Grand SuperCycle scale of this market decline, the resultant economic depression is predicted to be harsher, of world scale and lasting perhaps for decades.

Please believe, dear reader, that I do not give this information to scare or worry you, but to help prepare you for some hard times ahead. With the right information and expectations you will be far better able than others to weather whatever transpires. No one can predict the details or timing of what lies ahead. You will be a witness to a major event and will be able perhaps to help your grandchildren live thru another difficult period. I was 14 in 1929 and experienced every single aspect of the Great Depression. Our country today is much, much weaker than in the 1930s and has to endure an even larger debacle. Please take me seriously in this warning message.

I have been expecting the 2000 Crash and ensuing depression for much of the past 8 years and with my understanding of the Elliott Wave Principle have felt that this sequence of events was inevitable. However the EW theory is all about wave forms and not about time. The progress so far strikes me as being slower than I had anticipated. Whether it also means that global stock bear markets will eventually be deeper and longer cannot be known at this time. It is very possible that I will not be alive when our U.S. markets reach an initial low point. However, be warned that this bear market may be a much larger version of the 1966-1982 bear market where the Dow cycled several times between 500 and 1000 in what was known as a "trading range" market. But, be aware this time the range might be between 1000 and 10,000! It would all be one huge bear market, but thought to be a series of large bull and bear cycles - understandable by an Elliott expert but frightening to everyone else.

Due to the chaotic financial conditions right now in this country and other major nations, it is impossible to know what lies ahead. Expert web pages carry a wide spectrum of predictions from collapse of the dollar and meteoric rise in the price of gold to a great new bull market. With our knowledge of Elliott Wave predictions, held by a tiny fraction of the population, we are of course very pessimistic. But, allow me to share another piece of historic data.

Expert followers of Ralph Elliott's work have traced the history of the Grand SuperCycle Wave III, which topped in early 2000, back to its start in London in 1784. The preceding Wave II was a 62-year bear market that started in 1722 when the huge South Sea Bubble collapsed. This enormous stock crash wiped out nearly every company on the London stock exchange. The New York and other major world exchanges are now in the start of Wave IV, a great bear market that could equal or surpass the six-decade long Wave II. When it ends, it will be followed by a Wave V final bull market that will extend into the next century.

FIVE RECOMMENDATIONS ON WEALTH BUILDING

Every word in this essay up to now was included in preparation for this final section. I do have some expertise in investing that came from 63 years in the "school of hard knocks." Believe me when I say that I have made every possible mistake except losing all my money. I have owned many, many mutual funds over the past 50 years and with the help of computer software can now do a graphic performance comparison of about 6000 funds of all types.

vault 3In writing and publishing nearly 100 essays on the web over the past two years, I have gained a huge amount of new knowledge about selecting various asset classes and combining them into portfolios that can survive bull and bear markets. I know, from my own cocksure attitude in starting out in 1940, that young investors will be anxious to experiment on their own rather than follow my suggestions. I understand this pressure to do your own thing, but hope it will be in parallel and not in place of my rigorous suggestions. I do not need to follow this advice. It is much too late for your parents and is intended only for young people starting their career at this very unfortunate time. I am not going to discuss an investment program, but a rigorous, all-out savings program to be given top priority for your full working life...

Please try and believe that 80% of the investment knowledge I am using right now was learned between age 86 and 88. It resulted from my full time study, aided by the huge amount of information now available and the power of a computer. Think of the great advances you will be able to make if you keep your health and do not go bankrupt. However, you will learn that the human brain will continue to be the weak link in making investment decisions and in determining how well you sleep at night.

I give you this personal information for several reasons. Separate your personal savings and investing as two very different activities with a big wall between them. Your savings money should be placed as I have suggested in assets with a very high potential for success. This should have your top priority. With other funds, considered separately, you can try every idea you get from any other source - a hot tip, an IPO or a sure winner. Believe me when I say this advice comes from a grandfather with the benefit of 63 years of market experience.

Before presenting my ideas on building wealth in stormy times ahead, I want to refer you to the very best article I have ever read on this subject. I have not yet received approval to quote the entire article, but will give you the link to the original.

1. Saving Fundamentals
The Two Essential Elements of Wealth Accumulation
How to make them work for you
By John P. Hussman, Ph.D.

"Wealth is not acquired through addition. It is acquired through multiplication. Very few fortunes have been made by adding up paychecks and overtime. Nor are they made through a huge one-time killing in the markets. Unfortunately, this is the path that many investors try to follow in achieving financial security. While a high annual income is certainly helpful in achieving great wealth, it is not the primary determinant. And while a major move in the market can certainly have an impact, any single move is rarely an important determinant of sizeable fortunes (unless that major move is responsible for wiping an investor out and terminating the ability to continue investing in subsequent years).

According to statistical studies, two factors are most important in achieving wealth:

The number of years that an individual has been consistently saving and investing.
The proportion of funds, on average, allocated to higher return investments such as stocks.

This does not mean that stocks should always be held regardless of price and risk levels. The historical evidence is clear that both the future return on stocks and their probable riskiness depends on the level of market valuation and the "uniformity" of market action (favorable trends across a wide range of indices). However, it is a fact that over time, very wealthy individuals have an average allocation to stocks which is above the norm. Most have achieved their fortunes by compounding a moderate but consistent rate of return over a long period of time. There is a simple mathematical explanation for why these two factors are most important in building wealth:

Future Wealth = Current Wealth x (1+k)T

Where k is the annual rate of return earned on current wealth and T is the number of years that wealth is allowed to compound in value. Wealth accumulation is exponential. At a 10% annual rate of return, $100 compounds to $259 over 10 years and to $673 over 20 years. At a 15% annual rate of return, $100 compounds to $405 over 10 years and to $1,637 over 20 years. So both the rate of return and the length of compounding have enormous leverage in creating future wealth.

Simply stated, if your goal is to accumulate a significant amount of wealth during your lifetime, you must first save something and then exercise some amount of control over one of two factors: your long-term rate of return or the time horizon T over which you compound your wealth."

RBG note: I recommend that everyone go to http://www.hussmanfunds.com/html/wealth.htm and print out a copy of this valuable article on saving. The middle section of this article is not included here due to my inability to receive the author's permission.

"Some advice about saving. The key rule of saving is this. Don't let your savings adjust to your spending needs. Let your spending adjust to your savings needs. It will help tremendously if you budget a certain amount of saving monthly and make your investments first, as if you were paying a telephone bill. If you wait until all the bills are paid and all the spending is done, the result may be that you have nothing meaningful left to invest.

The bottom line: Financial security does not require extraordinary income or investment "home runs." It requires, first and foremost, that you start saving and investing early and add to your investments consistently. As for investment strategy, financial security requires avoiding large losses, particularly in environments that have been historically hostile to stocks. And it requires the willingness to take larger amounts of market risk in environments that have been historically friendly to stocks. The Hussman Strategic Growth Fund incorporates such investment shifts as part of its disciplined strategy, without requiring effort from our shareholders.

Because the Hussman Strategic Growth Fund varies its market exposure as the expected return/risk of the market changes, we believe that new investments in the Fund do not need to be "timed." Since regular investment and compounding is the key to wealth accumulation, we encourage our shareholders to make regular additions to their accounts. In part, our job is to make that decision an easy and attractive one.

For more information about investing in the Hussman Funds, please call us at
1-800-HUSSMAN (1-800-487-7626)"

RBG note: I am acquainted with thousands of funds, but have never found anything like the unique strategy of the two Hussman Funds. I own both of them and understand why they have such excellent performance for their life to date. I urge all readers to read the many informative articles available on their web site.

2. Saving Versus Investment

My early years were lived in a different world where our government had a fairly sound Social Security plan and most large employers offered pension plans fully paid by the company. I am still receiving these benefits, but do not know how long they will continue. In all of my investing up to age 65, I never considered it as being part of my retirement funds. In the future, with the number of retirees rising and the number of employed dropping, concerned employees must consider saving for retirement as mandatory, not optional. So, in making suggestions for a three-phase savings program, I am thinking Safety First at every step and will make it a primary objective from start to finish. We will discuss some possible losses and how to avoid them.

There may be less incentive to start a serious savings program until the storm clouds are overhead, but it is never too early to do some serious planning. The latest Elliott Wave information indicates that the next leg of the bear market will be starting very soon and the dark clouds will be very visible by the end of the year. Some time in the Spring of 2004, the TV and public press will be talking about a very sick economy and stock market. By that time, all of our readers from young to old will understand the serious message we are sending right now. Once rising bond prices end the real estate bubble, the collapse of all sectors of the economy will be in full force. The need for a serious savings plan will be quite obvious by that time. However, for those who elect to make an early start, I have a few carefully considered suggestions.

First of all, I suggest making major use of Dr. John Hussman's two funds which he proudly states are the only two funds you will ever need. And, so far, he has been very right. Please go to the 800 number given earlier and order prospectuses for his Strategic Growth and Total Return Funds which have grown by about 18% and 7% per year since they were started during the bear market years. This is an outstanding performance made possible during a bear market because of Hussman's brilliant management strategy which uses hedging protection in down markets.

In keeping with my previous practice in writing for the web, I have refrained from naming specific mutual funds since there is normally a long list of funds in every single category. However, after a deep study, I am convinced that the two Hussman funds are quite unique. Their strong performance so far in the bear market to date offers all my readers the chance to put their savings to work without the worry of serious losses. In both funds, an effective hedging strategy is used to prevent price declines. I see no reason why this fine record will not continue so long as the present management is in control. Since Hussman put his name on both funds. I am sure he has no plans to leave.

All of the suggestions put forth in this essay are based on my studies of the expected future environment and views of experts I respect. I do not have a crystal ball, but am certain that the next 50 years will bring numerous surprises, some of them unpleasant. So our examples of typical savings plans are intended to give you a start based on current knowledge. If our domestic or global economic conditions undergo major changes either for better or worse, we suggest all young investors seek the best advice available and modify their program.

The tremendous advantage of starting to save very early in life is due to the great power of compound interest. The compounded value at age 65 of the dollars you save in your twenties is much greater than the dollars you save in your fifties. Never forget this important fact. So, our advice is to start now and let the magic of compound interest begin in your life.

3. Saving the First $5,000

Saving the first modest sum for your retirement may be tough in some respects, but is quite easy in deciding what to do with the money, since we have maximum current visibility on which asset classes to buy.

SAVING THE FIRST $5,000
Strategic Growth Fund $2,000
Total Return Fund $1,000
U.S. Gold Eagle Coins $1,000
Circulated Silver Coins $1,000
Total $5,000

The fund shares should be purchased from the fund. The minimum purchase is $1,000 or $500 for a tax-free account. There will be no problems with market timers in these funds since they impose a 1.5% redemption fee on shares held for less than 6 months. We feel it essential that the first purchases should include the gold and silver coins, since these metals are sure to play a large role in your lifetime. The $2,000 suggested will buy two and a fraction Gold Eagles and a heavy sack of silver at current prices. Most every town has at least one coin dealer where these can be bought and they are very easily purchased on the Internet.

4. Saving The First $15,000

SAVING THE FIRST $15,000
Strategic Growth Fund $9,000
Total Return Fund $2,000
U.S. Gold Eagle Coins $3,000
Circulated Silver Coins $1,000
Total $15,000

This table includes the assets purchased in the first table above. It is based on the assumption that the Strategic Growth Fund continues to gain more than the Total Return Fund. At this writing we have no reason to expect the relative performance of the fund will change. We recommend that the gold and silver coins be held permanently for use in a future crisis.

5. Saving The First $25,000

SAVING THE FIRST $25,000
Strategic Growth Fund $15,000 60%
Total Return Fund $3,000 12%
Selected Precious Metals Fund $3,000 12%
U.S. Gold Eagle Coins $3,000 12%
Circulated Silver Coins $1,000 4%
Total $25,000 100%

It is impossible to tell at this date what the best asset allocation will be years from now. However, if any reader wanted to start a $25,000 portfolio right now, this distribution seems reasonable. The percentage of precious metals should be adjusted for any holdings in the Strategic Growth and Total Return funds, both of which may hold gold. The problem in finding a good gold fund is that the best ones now are quite large in size with the result that they cannot buy enough small mining companies to have a large effect on their performance.

We suggest that you use data on the Internet and pick the smallest no-load fund (in $assets) in the top 15% of fund performance over the last 2 or 3 years.

MUTUAL FUND PROBLEMS

We expect that good performing funds, who are not found to be stealing client money in the current scandal, will survive the turbulent economy and stock market we see ahead. We believe that the Hussman Funds will prosper from continued fine performance in the new environment where many honest funds with losing portfolios may disappear.

The only uncertainty in my mind relates to the U.S. and Global economies and stock markets. I have never liked funds with a sales load and think their number will decrease, while the better no-loads will outperform. As the Hussman funds continue to hold the top places in performance ranking, I suspect that copy-cat funds will appear. But by that time, the pioneering Hussman Funds should have perfected their techniques and be unbeatable.

DISCUSSION

I sincerely hope that every young person reading this message will feel the need and urgency of saving before spending and enjoy a happy and successful life. For the full duration of your savings program, follow Warren Buffett's two rules:

1. Don't lose. 2. Don't forget rule 1.

The two Hussman Funds have a well-planned hedging strategy that has given positive returns for their life to date. I see no reason why they will not continue to do so. However, there is no question the precious metals will be very volatile. Fortunately for individual investor nerves, both Hussman Funds may own gold. So, keeping track of the fund's gold holdings will be of some help with respect to making other changes in your savings portfolio. This is readily done since Dr. Hussman puts his latest market thoughts on the web page every Monday before the market opens. I urge all serious saver-investors to read his wise market views.

I feel very good about the asset classes used in the above saving examples. We consider that the holding of precious metals is very important. To help manage their volatility, the best suggestion I can make at this date is to use a periodic rebalancing program once a substantial amount of money is involved. Readers can go to my 8 recent essays which cover all aspects of rebalancing. It is an easy and effective way to prevent the precious metals from increasing their percentage dramatically and then dropping in price with huge losses to the portfolio. The best time to rebalance is when the gold or silver price is at a peak and shows the first signs of a decline. This process will force the transfer of assets from volatile to less volatile assets!

When one of these retirement plans is just starting out, they require little or no management attention, but later on they should be reviewed once a month to check the performance of each asset and to review the balance of the entire portfolio. We wish our grandchildren and all others in their age group a very happy life and hope that this letter will lead to a successful retirement savings program for many of our readers. We will be happy to receive your e-mail questions and will do our very best to answer them.

There are huge uncertainties in the economies of our country and the rest of the developed world. We predict a bad future for a great number of uninformed investors who typically lose most of their assets by selling near bottoms and vowing never to invest again. But we feel good about those who adopt a serious save-first approach and place their confidence in the few asset classes we have selected.

Young investors who pursue a really serious savings plan, like 20% of their income, will have the great pleasure of watching their portfolio grow, perhaps beyond the dreams of avarice, if gold and silver take off to spectacular new highs. I have been involved in the previous price peaks in gold and silver and know the thrill. If this were to happen, Hussman Funds would, no doubt, be holding important amounts of gold as permitted by their prospectuses and they would have the responsibility of getting in and out with profits. Presumably their timing skills would be better than yours.

It should be noted that if any of the suggested savings plans had been in effect over the past life of the Hussman funds, the results would have been very good since all of the asset classes have been in a period of rising prices. However there is no assurance that gold and silver will not undergo a price dip of some magnitude. This would be a positive factor if it did occur since buying during dips is a big help in any long term savings plan.

SUGGESTED READING

I hope that all my readers will read and study the following essays in my FSO archive:

  1. 11/03/03 - A Portfolio for Steady Gains in Turbulent Markets - portfolio rebalancing
  2. 9/11/03 - Profiting from the Elliott Wave Principle
  3. 12/05/02 - Elliott Wave for the Masses
  4. 11/18/02 - A Foggy Day in Uncharted Waters - an Elliott Wave tutorial
  5. 11/02/02 - Wall Street's Greatest Crime - histories of previous market manias

We close this labor of love with the hope it proves of lasting benefit to the far-flung Gordon clan and to our widespread reader group, both young and old.

↑ Top

© 2004 Robert B. Gordon, Sc. D.

Contact Information

Dr. Robert B. Gordon
c/o Roger Gordon
1488 Cynthia Lane
El Cajon, CA 92019

Contact Us | Copyright | Terms of Use | Privacy Policy | Site Map | Financial Sense Site

© 1997-2011 Financial Sense® All Rights Reserved.

The opinions of the contributors to Financial Sense® do not necessarily reflect those of Financial Sense, its staff, or its parent company.