Yesterday I noticed a very telling paragraph in the November issue of Don Coxe’s excellent Basic Points.  He describes beautifully the way Europe’s leaders have kept voters from expressing their opinions for such a long time.

‘What really upset Sarkozy, Merkel at al. was the idea of putting terms of a eurodeal to the voters.  The euro was a confection of the elites and they have been congratulating each other for years on its wondrous qualities.  It was only put to the electorate of a few members – not including the Germans – and barely survived.  The members of the Eurozone ruling class tend to be more comfortable with each other – despite personal rivalries – than their voters.  They graduate from the best universities and are virtually unanimous that the route to repealing Europe’s bloody past is with supranational institutions that, through one-time constitution-style agreements, are placed permanently above and beyond the direct control of voters.’

Now to the present.  It was made clear during recent negotiations that there was a distinct possibility that Greece could leave the Euro and try to make its own way to economic recovery.  It has also become obvious that it is a near certainty that Greece will default on its debts.

Everyone knows that the European banks are loaded to the eyebrows with the sovereign debt of Greece, Ireland, Portugal, Spain and Italy.  With their very high banking leverage this means that almost all of them will soon be broke if they are not already.

These three simple and obvious conclusions lead me to wonder what kind of corporate treasurers and finance directors looking for homes for their company’s money would invest in any periphery sovereign debt and/or deposit funds with a European bank.  If they lost the company’s money how would they explain their thinking?  Would they lamely say (remember Iceland!) that they were trying to obtain a slightly better yield?  What possible excuse could they make?

I believe that the market will in its usual predatory way continue to pick off the weaklings and it will not be long before France joins the club and is also in danger.  It will become increasingly difficult to raise funds in periphery sovereign debt issues.  Yields will rise higher and higher to a level that will in the long run bankrupt the weaker economies.  Hopefully it will only take a few weeks of this kind of torture before politicians realise that printing more money (with all of its problems) is an alluring alternative.

Jim Slater

The figures shown in ‘The US Problem Explained!’ reduced to a pretend household size, are alarming.  The conversion is of course arbitrary and very broad-brush.  Nevertheless the scaled-down figures give a much more understandable idea of the problems facing the US.

The US Problem Explained!

Here is why S&P downgraded the US credit rating.

• US Tax revenue: $2,170,000,000,000
• Fed budget: $3,820,000,000,000
• New debt: $1,650,000,000,000
• National debt: $14,271,000,000,000
• Recent budget cut: $38,500,000,000

Now let’s remove 8 zeros and pretend it’s a household budget

• Annual family income: $21,700
• Money the family spent: $38,200
• New debt on the credit card: $16,500
• Outstanding balance on the credit card: $142,710
• Total budget cuts: $385

Now that you see these figures, I am sure you will understand why I prefer gold to US dollars.  If you feel you have missed the boat on the ten year bull market in gold, you should read ‘A Golden Mulligan‘ which I have just added under Articles.

Jim Slater

As a key analyst for Standard & Poors, Tortoriello had access to the excellent S&P extensive database which enabled him to research over a long period the effectiveness of selected investment criteria.  This wonderful book is out of print and very hard to get hold of – I had to pay just over £100 for a copy (secondhand copies can be found online at Amazon and other retailers).  It is however, available on Amazon’s Kindle for £38.10.  For any serious investor the book is a must.  It is 460 pages long so I will try to give you a quick insight into some of the points that interested me particularly:-

1. Like O’Shaughnessy, the author found that relative strength was a very powerful single price driver.  O’Shaughnessy usually works on relative strength in the previous year and so do I.  However, Tortoriello found that relative strength in the previous seven months gave the best returns.
2. Earnings growth is the primary driver of stockmarket returns.  Sales growth is a secondary factor.
3. Earnings growth is not predictive of future returns because the market is very efficient at pricing in changes in the rate of earnings growth.
4. Free cash flow (ie: cash flow after capex) is another significant factor in driving share prices upwards but not as strong as earnings growth.  Interestingly free cash flow is predictive.
5. A low forward price earnings ratio works well quantatively.
6. Return of Equity is a simple profitability strategy that works well.
7. There are a number of red flags that are warning signals.  For example, companies with high annual capital expenditure do not usually perform well.
8. Positive momentum works very well in tandem with low valuations.  For example, good relative strength and strong free cash flow produce excellent returns.

As you  know, for growth stocks, I recommend using a low PEG (ie: strong EPS growth coupled with a low forward multiple), strong cahs flow in excess of EPS, above average relative strength in the previous year and no substantial directors selling.  As a result of reading Tortoriello’s book, I am going to pay more attention in future to relative strength in the previous six months (available in Company REFS) and calculate and use free cash flow (easily done with Company REFS) as another key criterion.

You may find it more user-friendly when reading this book to understand first Tortoriello’s method of research by reading the first few chapters very carefully.  After that skip the very detailed research and read the extensive and excellent summaries of his conclusions in subsequent chapters.

This book is a must for serious investors.

Jim Slater

The most frequent criticism is that gold has no instrinsic value.  The dictionary definition of instrinsic is ‘belonging naturally’ or ‘essential’.  It is clear that gold is not essential but neither are many other very attractive investments.

I remember in the mid 1960s when I purchased 50 paintings by L S Lowry for £50,000 from his ex-chauffeur.  At times Lowry had been hard up for cash and had paid his chauffeur with his paintings.  About a month after the purchase I sold the 50 paintings to a leading gallery for £100,000.  I was very pleased with the deal – bear in mind that you would need to add another zero to both figures to convert them to today’s money.

I did not like Lowry paintings then and I do not like them today.  Since I sold the paintings they have appreciated in value about 100 times so it is very clear that many other people do admire his work and are prepared to pay handsomely for it.

Not everyone has to agree on the value of alternative investments provided that there is a growing band of supporters to make a market.  It is indisputable that during the last 50 years Lowry paintings have been an excellent investment and it is also indisputable that they are very far removed from being essential.

There are many other similar assets that have been fantastic investments and are also inessential.  Bronzes, sculptures, diamonds and other precious stones and memorabilia come to mind.

An important feature of gold is that it is not only what it is but what it is not.  Gold is not the depreciating US dollar and dangerous Greek debt and it is not cash in one of the many doubtful and depreciating currencies.  Gold is an alternative currency and is well suited for this purpose as it has seven key characteristics – divisibility, indestructibility, stability, homogeneity, cognizability, utility and portability.  (I remember these by the mnemonic DISH and CUP from the days when I was studying Economics!)

Gold is also in relatively short supply.  All of the gold ever mined would fit into two Olympic-sized swimming pools.  There are very few easy high-grade mines left to produce gold and it is staggering to think that a low-grade deposit might be viable with a grade as low as 0.6 grammes per tonne.  Bear in mind that a gramme is just over 1/28th of an ounce and that to bring a mine into production might require a capital cost of $500m.  This makes it clear why gold is such an expensive, rare and precious metal.

John Kaiser, the producer of the excellent Kaiser Bottom-Fish Report newsletter explained the special nature of gold in a recent interview on Mineweb.  He said: 

‘I regard gold as a special asset class, whose specialness is derived from the fact that gold is very rare, hard to bring above ground and generally useless due to its high cost, unlike silver, which is more abundant than cheap and gets fabricated into all sorts of industrial applications.  Gold would be a wonderful conductor for electronics, too, but it’s just too expensive.  We have just over five billion ounces scattered around the world in safes, vaults and jewellery boxes not doing much at all.

Because gold has limited utility, its price is irrelevant to ongoing economic activity.  As a comparison, if oil shoots to $500 a barrel that means that your paycheck would allow you to drive just one-fifth the distance it allows you to drive now.  Such a move in oil would have drastic implications for the global economy.  But if gold shoots to $5,000 an ounce, what happens?  Well, the gold stays in my teeth.  Jewellery demand goes down even more, but nobody makes any decisions to substitute out of gold because it really isn’t being used for much.  In other words, it really should not affect the economy.

People buy gold because it’s a very exchangeable asset class and one that can’t be forged, counterfeited or multiplied like paper of digital assets.  Gold is an asset you want to own because the world is changing in terms of its geopolitical and economic centre of gravity; it’s moving from West to East and that shift will be turbulent.  The East, to some degree, is still communist.  We really do not know how financial and other assets and currencies will play out over the next 20 years.’

In sharp contrast to the rarity of gold, the supply of the US dollars in which gold is priced is rising rapidly as more and more are printed by the Fed.  This week’s QE2 is quite likely to be followed by QE3 and QE4.

Gold has been a currency for over 2,500 years and has a unique place in the human psyche.  Gold is the hallmark of excellence with, for example, gold medals in the Olympics being the ultimate prize in world sport.

Some investors worry about how gold would act in a depression.  The point they are overlooking is that gold is at its best in times of fiscal uncertainty.  It is also helped by today’s very low interest rates which keep the carrying cost low.

There are many critics of the idea of investing in gold but to my mind they are outweighed by the very high calibre of gold’s supporters including, for example, John Paulsen, who was one of the very few investors to forsee the credit cruch and made a multi-billion dollar profit out of it.  Also the Chinese, who know a thing or two, are encouraging their population to buy gold and India has added to its gold reserves during the last twelve months.

It may surprise you to know that I do not own any gold myself and I am not a constant gold bug.  However, I believe that gold is in a strong upward trend and now is its time.  To take advantage of this powerful market move I prefer to invest in junior mining stocks, which satisfy my demanding criteria.  They have been performing well, but, in my view, they still have a long way to go.  As Richard Russell of Dow Theory Letters is fond of saying ‘there is no fever like gold fever!’

Jim Slater

Click on the following link to read more.  Jim Slater Sticks to Gold

On one subsequent occasion following a violent sneeze, I had to go to hospital for about ten days to have treatment including hydrotherapy.  When I was released I was recommended to see a cranial osteopath, Gez Lamb, who helped me to get back to some kind of normality.  However, there were still frequent twinges which were very painful indeed.  I always say they were like labour contractions but my wife tells me that I under-estimate the pain of giving birth.

After continuing to suffer for a few years my doctor recommended me to see Keith Bush, a leading specialist in Harley Street.  He examined me thoroughly and arranged for me to have an MRI which showed that I have a slightly ruptured disc.  He did not recommend an operation so I asked him what he would do if he were me.  ‘There is a man I have recommended to a few of my patients who had a similar problem and I have never heard from them since’ he replied.  That was good enough for me so I arranged to see Warrick McNeill of Physioworks.  He examined me very thoroughly before teaching me how to do some personalised core-stability exercises.  In total there are about 20 of them and I now do these for about a quarter of an hour both morning and evening.  I also swim every day and walk about two miles with the dogs.

I continue to see Jonathan Daniells, who is a cranial osteopath who works closely with Gez Lamb.  Jonathan gives me a regular check-up to pre-empt any problems that might arise.  I also see Warrick every six months or so to audit my exercises and make sure that I am not going astray.  I was going to say that my back has given hardly any trouble for the last few years but I do not want to jinx it, so instead I will say that it has become manageable.

One final thought is that I use a Backfriend which is a portable support seat.  I find it very helpful when playing bridge, watching television, going on a long journey or sitting for any length of time.

If you have an ongoing back problem, and live in the South East, I recommend you to see Jonathan Daniells who is very good at diagnosis.  Then follow this up by seeing Warrick McNeill for the Pilates exercises which help to build the muscles for a more permanent solution.

I have recommended members of my family and many friends to see both Jonathan and Warrick with consistently good results.

Gez Lamb and Jonathan Daniells can be contacted at 1 Oldbury Place, London W1U 5PA  Tel: 0207  486 2875 and Jonathan also practices at Neals House, Church Road, Chelsfield, Orpington BR6 7RE  Tel: 01689 877500.

Jim Slater

Many people believe that if we leave the EU we would be worse off because they argue we would lose a lot of our trade. This is absolute nonsense. The UK has a substantial trade deficit in goods and services with the EU. For example, in July 2009 it was £2.6bn and in August 2009 it was £2.3bn (source: Office of National Statistics). If we left the EU, the member countries would do everything possible to preserve trading arrangements with their biggest customer.

Our net contribution for being a member of the EU has been about £3bn per annum. This is due to rise this year to over £6bn as the special arrangement negotiated by Margaret Thatcher comes to an end. I cannot see what we get in exchange for this massive sum by being a member of the EU other than interference in our domestic affairs, our law and our way of life.

The Tories and Liberal Democrats seem to be in favour of staying in the EU arguing that David Cameron will stand up for our interests to help change Europe. He is no Margaret Thatcher and I believe he will be hopelessly outgunned by Angela Merkel and Nicolas Sarkozy.

Jim Slater

When Brown took over from Kenneth Clarke, Britain’s finances were in very good shape.  His first major error was to sell half of Britain’s gold reserves in 17 auctions from 1999-2002 at an average price of only $276.70 an ounce.  The sales realised £2.2 billion compared with about £9 billion that would be realised today.

In 1997, Brown created a tripartite regulatory system that was both ill-conceived and badly executed.  It was put in place with little consultation and against the advice of the then Governor of the Bank of England.  As a result, the Bank of England, the Treasury and the FSA can all deny responsibility and blame each other for the lack of supervision that has led to the financial crisis.

Brown had the benefit of substantial income from North Sea oil but unlike the Norwegians he did not put away anything for a rainy day.  Instead in each of his last five budgets there were very substantial deficits to finance further excessive government spending.  This approach was in stark contrast to the 1997 Labour Party Manifesto which under the rules of government borrowing said ‘We will enforce the ‘golden rule’ of public spending – over the economic cycle, we will only borrow to invest and not to fund current expenditure.  We will ensure that – over the economic cycle – public debt as a proportion of national income is at a stable and prudent level.’

In 1997, Brown’s infamous pension stealth tax removed the tax credits on the dividends received by pension schemes.  Independent actuarial research in October 2006 showed that this tax had cost pension schemes over £100 billion – more than twice the deficits in the economy’s top 350 companies at the time. 

The cumulative result of Brown’s period of stewardship left Britain very vulnerable and unprepared for the financial crisis leading to the current deficit.  Even financial experts find it almost impossible to grasp the enormity of the numbers.  The current oulook is now very bleak.  Total government debt is set to rise to £1,180 billion by the end of 2010.  For the next few years this will continue to rise by £150-200 billion each year.  Add the £150 billion of off-balance sheet Enron-style accounting of PFI contracts and you get to about £1,700 billion.  Then there is the problem of the unfunded liabilities of £1,200 billion for public service pensions increasing the total to about £3 trillion.  Brown’s legacy is a debt of an astonishing £200,000 for each and every family in Britain.  A frightening inheritance for our children and grandchildren.  Some Chancellor!

Jim Slater

To read the extract from Basic Points click on the following link:

Don Coxe on Gold – Basic Points, February 2010

Jim Slater

Digital Look also offers a wealth of other information with updated statistics on all of my shares together with definitive details of all dealings on a trade-by-trade basis.  In addition, any announcements including vitally important directors’ dealings are highlighted promptly.

For a closer and more detailed check on financial statistics, I find online Company REFS invaluable.

Click on the following link for Digital Look.

Jim Slater