Investing

One of the most interesting figures in ancient Greek mythology is the Trojan woman Cassandra.  According to legend, she had been granted the gift of prophecy by the Greek god Apollo.  But when she later displeased the god, he cursed her to never be believed in spite of her prophetic gift.  This twisted curse later figured prominently in one of the best known tales of ancient Greek mythology – the destruction of the walled city of Troy.

In ancient accounts of the fall of Troy, Cassandra is one of the few people to recognize the danger that the besieging Greeks pose.  In fact, she attempts to intervene several times on behalf of the Trojan people to avert the disaster, only to be thwarted in every instance.  The Trojans ridiculed Cassandra, believing her prophecies to be insane.  The naive Trojans are eventually tricked into accepting the gift of the Trojan horse.  The Greek soldiers hiding inside the hollow horse spill out at night to pillage and burn the doomed city while Cassandra is forced to helplessly sit by and watch.

I feel, in many ways, that I am a modern-day parallel to the Cassandra of ancient Greek myth.  I have watched in horror over the past 20 years as a relatively stable, prosperous U.S. economy has been gradually deformed and hollowed-out by serial bubbles blown by the malicious Federal Reserve.  And yet I have been powerless to do anything about it.  I am a present-day financial Cassandra.

My life as a financial Cassandra started back in late 1999.  The first internet bubble was in full swing at the time.  I was a freshly-minted college graduate who had just landed his first job at a Boston-based mutual fund company.  I was learning everything I could about the financial markets, but a couple things puzzled me endlessly.

First, I couldn’t understand why everyone was in love with “new economy” technology stocks.  They seemed hopelessly overvalued to me.  But the investors buying them – including my company’s fund managers – could see a future of endless growth that was invisible to me.

Instead, I salivated at the prospect of buying the old-fashioned tobacco company Philip Morris which sported a shockingly-high dividend yield of 10% at the time.  Ironically, I had no money to invest myself and couldn’t convince anyone else of the value of the company.  Being a financial Cassandra has rarely been so frustrating.

In retrospect, Philip Morris has been a phenomenally good investment since 2000.  If you bought Philip Morris back then and held to today without selling, you would have received massive dividends over the years.  In addition, you would also be the proud owner of shares in four valuable Philip Morris successor companies: Altria Group, Philip Morris International, Kraft Foods Inc. and Mondelez.

The next memorable period during my career as a financial Cassandra occurred in the spring of 2007.  I could foresee that a financial crisis of some form was going to hit the economy, although I didn’t know exactly when.  Everyone else thought I was crazy.  My co-workers were talking about a permanent economic expansion driven by the ever upward spiraling housing and stock markets.  Predictably, I could convince no one of my views.  My co-workers and I eventually agreed to amicably disagree on investment strategy.

So I went searching for the most secure future cash flows I could find – U.S. Treasury bonds.   However, I also wanted the longest duration Treasury securities I could get as well.  This would enhance my profits if my forecast of an economic crash came to pass.  After much research, I eventually opted for zero-coupon, 30-year U.S. treasury strips.  Zero coupon bonds make no periodic interest payments, but instead issue one large final payment at maturity.

Buying long-dated U.S. treasury strips was so unorthodox at the time that the bond broker I spoke to when I placed the trade actually tried to talk me out of it.  I politely declined his free “advice”.  The global financial crisis unfolded about a year later.  I closed my U.S. treasury strip position for an 80% gain in only 18 months.  Being a financial Cassandra can be very profitable, if you can be patient and ignore the ridicule that comes with it.

And now, in 2017, I am staring at the third major bubble period of my life as a financial Cassandra.  This bubble is absolutely huge and the accompanying stock market insanity is breathtaking.  We are clearly headed for another economic disaster.

As an example of the absurdity of current stock valuations, media streaming company Netflix currently trades at more than 200 times earnings.  This is even though the technology darling has nearly saturated the domestic U.S. market, greatly diminishing its prospects for future growth.  In addition, the company’s profitability will always be constrained by content owners who will seek to arbitrage away any excessive revenue Netflix derives from an increasing subscriber base or rising subscription prices.

Another bubble stock, Tesla, looks like a raging Ponzi scheme with a staggering $61 billion market capitalization, which is larger than either Ford’s or General Motors’.  Its CEO, Elon Musk, could have reined in the company’s expansion when it was still a niche, luxury electric car manufacturer.  Tesla would have been a much smaller company under those circumstances, but it also would have had a reasonable shot at being profitable.

Instead, Musk chose to let it turn into a cancerous monster, growing without any limit using cheap capital market financing.  Unfortunately, the company is far too large and unwieldy to salvage now, particularly after its ill-advised Solar City acquisition.  Absent an unlikely buyout, it is only a matter of time until a financial crisis closes the capital markets and forces Tesla into bankruptcy.

Not all investments are doomed in the next financial bust, though.  Tangible asset like precious metals, investment grade antiques and fine art have been largely overlooked during our latest bout of bubble insanity.  These enticing investments have track records hundreds of years long proving they are sound investments.  And it takes far less money to get started buying art and antiques than you might think.

Of course, I can convince very few people of these opinions.  Such is the curse of a financial Cassandra.  But I implore you; please learn from my past.  Paper assets are grossly overvalued right now while fine art and antiques are perhaps the world’s most under-owned asset class.

Foreign investing seems to be all the rage these days.  I am continually bombarded by articles on finance websites emphasizing the necessity of international diversification.   And here’s the thing.  I don’t disagree with these assessments.

International diversification is an important element in any well-balanced investment portfolio.  This can easily be accomplished by purchasing ADRs (American Depositary Receipts) or foreign-focused ETFs (Exchange Traded Funds) and mutual funds.  These securities give exposure to well-established foreign corporations that are operated according to international best practices.

But this isn’t the kind of foreign investing that worries me.  Instead, I want to talk about offshore gold storage.  Precious metal pundits and skeptical financial commentators often advise people to buy and store gold overseas.  Their argument generally goes something like this:

The world’s financial system is incredibly over-levered and unstable.  This will inevitably lead to a currency crisis in the dollar, euro, pound or yen (or even all of them simultaneously).  The financial authorities will invariably respond to this financial panic by instituting capital controls, requiring the purchase of overvalued government bonds in retirement accounts or even seizing financial assets outright.

Notice that the foreign ADRs, ETFs and mutual funds I mentioned above, while claims on foreign cash flows, don’t provide any protection against this scenario.  These paper assets in your brokerage account are easily accessible to desperate governments, should the need arise.  That is why many tangible asset proponents recommend that people protect themselves via offshore gold storage.

However, while I am sympathetic to many of these arguments, the devil is in the details.  The timing, magnitude and propagation of any global financial crisis will have a dramatic impact on its outcome.  Believing yourself to be completely inoculated against financial adversity because of your overseas gold holdings is an investing conceit that most people can ill afford.  Offshore gold storage is not the panacea it purports to be.

Overseas gold storage is usually couched in terms of “escaping” from your home country’s financial system.  Pundits will often recommend that individuals acquire foreign citizenship and passports at the same time, in order to “internationalize” themselves.  Sometimes they will go so far as to advise people make direct investments in foreign real estate or private businesses.

In any case, I am not a fan of being an “international” man.  For one, you must have an incredibly large net worth to make it remotely viable, probably on the order of $10 million or more.  It also presupposes that you can easily blend in with the population of whatever country you’ve chosen as your safe haven.  But the locals will always be able to spot the outsider among themselves.  And, if this immigration occurs in the context of a global financial crisis, those outsiders will not be well received.

But it is the idea of offshore gold storage that I dislike the most.  First, the storage fees for offshore gold storage in a secure vault are often exorbitant, generally ranging from 0.25% to over 1% per annum.  That might not seem like a lot, but it is a recurring annual fee that insidiously eats into your principal.  100 ounces of gold subject to a 1% storage fee will be whittled down to a mere 78 ounces after 25 years.  That is not the kind of return most people are looking for on their tangible investments.

Next, chances are good that you will never actually physically see your gold if it is stored overseas.  In other words, you will pay your money, but your gold may or may not be there.  Obviously, choosing a reputable (and by extension more expensive) custodian for your offshore gold storage will give you a greater assurance that your gold actually resides in the vault you think it does.  But remember this – fancy corporate letterhead and official-looking audits are relatively easy to forge with today’s technology.  Many, many people have been defrauded by bullion storage schemes in the past and I suspect that many more will be over the coming years.

It is also relatively common for precious metal dealers and banks to warehouse gold in what is called “unallocated” or “unsegregated” storage.  This is when a financial institution promises to give you your gold on demand.  But there might not actually be much, or any, gold in their vaults most of the time.  Holders of unallocated gold deposits are, in effect, unsecured creditors of a financial institution in the event of default or insolvency.

“Allocated” or “segregated” offshore gold storage, where specific gold bars with individually recorded serial numbers are stored in a vault, while safer, is still not without its risks.  Fraud and inside jobs are omnipresent dangers in such situations.  Even staid central banks have been accused of surreptitiously loaning out their nations’ gold reserves to achieve shady policy goals!  The bottom line is that if you can’t physically hold your gold, you don’t own it.

Finally, if there is ever a global financial crisis of epic proportions, the ostensibly politically stable countries with large amounts of offshore gold storage – Switzerland, Singapore, Hong Kong, Australia and the U.K. – will be sorely tempted to nationalize all that treasure.  This temptation will be even more acute if the country in question is suffering from a severe currency crisis.  All those precious gold bars neatly stacked in secure vaults would go a long way to quelling a country’s financial panic and restoring prosperity.  Yes, there would presumably be international diplomatic repercussions, but it just may be worth it, depending on the severity of the financial crisis.  This may not be a likely scenario, but I think it is one that can’t be discounted entirely, either.

Now, I don’t believe offshore gold storage is completely useless.  If you have a net worth of tens or hundreds of millions of dollars, there might be some value in keeping a million or two of gold bars in a Swiss vault deep underground.  But for the average investor, or even most well-heeled investors, offshore gold storage is just too expensive and carries too many risks.

This is why I advocate keeping your tangible investments local.  As the old adage goes, possession is 9/10ths of the law.  And while precious metals are great investments, other tangible assets, like art and antiques are also great diversifiers.  There is nothing quite like holding a sparkling old mine cut diamond or an ultra-rare French piedfort coin in your hand to remind you what true wealth is.