We are believed to be on the verge of another deflationary downwave, similar to or more severe than the one which drove the dollar spike – and commodity slump – between July of last year and March, and caused by an intensification of the debt crisis, with increasing capital flight out of Europe and into dollar assets as the EU crumbles. More QE will not save the situation, as it is already discredited and will have no more effect than trying to inflate a tire or rubber boat that has a big hole in it. 

It is understood that in this modern age many readers have a very limited attention span, due to time constraints and the tendency to multi-task. For this reason this update is being kept short and to the point. It is intended to make plain in the clearest possible manner the scenario that is expected to unfold in the coming months. So let’s get to it.

The only way to purge debt is to retrench – curb spending and balance the books. Modern governments have sought to avoid this responsibility for years now, by cheating and printing money out of nothing, because they are not subject to the discipline of a gold standard. The result of this is a towering debt and derivatives mountain that is set to bury them, despite their meddling in the markets to keep interest rates at zero to stop the debt compounding. Debt to GDP levels have risen to unsustainable levels in many countries around the world. This is why economies are weakening and standards of living are dropping, and the problem has now caught up with China. We are now caught in a downward deflationary spiral and it won’t stop until the debt is purged or written off. The astronomic magnitude of the debt means that the situation could quickly get out of control leading to a global economic calamity. Few investments will be spared as the liquidation intensifies, and the dollar will be the prime beneficiary of this especially as a torrent of funds will flee Europe as it backslides into chaos.

That’s enough of an introduction, now let’s look at the charts starting with the dollar.

The dollar index chart looks very positive, with it now breaking out upside from a Triangular consolidation that allowed its earlier heavily overbought condition to unwind. Note the strongly bullish alignment of its moving averages. It is now in position to take off and this upleg is likely to be as big as the one that ran from last July to March – or bigger – meaning that it could advance towards 120.

Of course, a big reason for the dollar’s strength is the malaise of the dying euro (the dollar index is made up 57% of the euro), with the bungling incompetent actions of the EU’s leaders in respect to Greece making plain to the world that they are unfit for office, and that the European Union will probably eventually unravel. Having seen what was done to Greece, we can be in no doubt that the leaders of Italy, Portugal, Spain will be considering their options. The euro look set to drop hard as shown on its 2-year chart below.

Of course a strongly rising dollar will wreak havoc on commodity prices, as it did when it rose strongly the last time, from July of last year through March. The commodity index shown below should plunge as shown by the red arrow.

Copper appears to have been marking out a massive top pattern on its long-term charts, and it looks set to plunge to strong support at its 2008 crash lows in the $1.25 area, and perhaps lower. Its COTs are currently quite bullish, so we may see a relief rally at some point. However, its key support has already failed some time ago and it is now very vulnerable.

The oil chart has some similarities with copper, which is because they are both dropping due to deflation. Oil looks set to be particularly hard hit and may drop into the mid-$20’s.

Gold, which has been struggling to find a footing for 2 years now, is expected to be forced into another downleg by another strong dollar upleg, and should drop to the $850 – $100 area, probably nearer to $850.

Silver will crash support and drop towards the lower boundary of its long-term downtrend channel, which means it may drop to below $10.

The scenario set out here is a grim prospect, it is true, because of its implications for many aspects of life, but it will considerably easier if you are on the right side of the trade – and we plan to be.

End of update.

Posted at 10.20 am EDT on 17th June 15.

Last Sunday, we arrived in Greece. We have interviewed since then more than 25 people across the country. We have selected ordinary people, with different jobs, from all ages, both in cities and rural areas. So our research is representative for the whole population. What people told us is staggering, and it becomes worse we compare this with the acts of the government. This is a live report about the government debt crisis.

In general, people describe the current economic situation as hopeless; there is no outlook for growth whatsoever. Everyone agrees that this crisis will go on for many years before the country can see any economic improvement.

If anything, people are extremely frustrated. That remains underexposed in the media. The frustration comes from the fact that the masses believe they are disadvantaged with the ongoing reforms. People understand they have to contribute (by paying taxes for instance) to fight the crisis, but it has to happen equally: the ones who benefited most during the years of excesses should contribute proportionately more. And that is not happening. Even with this extreme left government led by Syriza, it is simply not happening.

With the recent bank holiday (started July 5th) it became clear that the economic and political problem is not a far-flung event, a view which was shared by most people up until that point. The bank holiday has exhausted people financially, and the restriction of retrieving 60 EUR / day is extremely frustrating. Many ATM’s are not working, there is not always one nearby, so people often have a cost of 5 to 15 EUR simply to get to money out of an ATM.

Greek people were already in a very bad shape financially, but the bank holiday and ATM restriction is exhausting them. And everyone we interviewed was convinced that capital controls will be there to stay for many months, not a very healthy outlook.

Next to financial exhaustion, people are increasingly becoming psychologically exhausted. On the one hand, leaders proceed from one crisis meeting to another. Every meeting is announced as being a critical one. On the other hand, all local media are broadcasting all sorts of opinions and viewpoints, almost 24/7. People are at a point where they are confused, and don’t understand what is truly good or bad for them.

Everyone we interviewed said they desperately want “ a ” solution. The solution itself, whether it is in line with their view or not, has become of secondary importance. People simply want a direction, a path forward; they want to work towards a goal.

In that respect, most of the people we talked to had a lot of criticism about the referendum of July 5th as it has created even more confusion among people. First and foremost, because the people’s voice has been abused during political negotiations. People admit that they were not able to assess the documents that were proposed by the insitutions, which were technical in nature, long, and hence incomprehensive. The “OXI” votes were merely nationalistic. Second, the results have been misinterpreted. It remained quite underexposed that 39% of the citizens did NOT vote, so the majority vote was blank. Given that figure, the 61% “OXI” vote was in reality 36% in total, and so the remaining 25% voted “yes.” That’s a different story than the one propagated by the government and in the media. Third, all Greeks we interviewed agreed that the referendum left too much room for (mis)interpration. People admit that everyone has another interpretation, which adds to the confusion.

If anything, Greek people want justice. One of the big problems of the past was mismanagement of government money (think of subsidies, pensions, etc). The abuse was staggering, and the money has been distributed in an asymmetric way (in other words, a small group of people has benefited in a disproportionate way). Greek people want those issues to be solved. They want justice.

Case in point: one of the people we interviewed is running a cafeteria. The taxes for playing music were approx. 400 EUR per year. With a recent law, the tax increased to 1000 EUR. Apparently, that was the result of a ‘new’ law. However, only a few people have paid that tax in the past. The problem now is that those who did not pay it previously, are exempt because of the fact it is an ‘outdated’ law (replaced by  ’new’ one). That is extremely frustrating for those who are paying taxes correctly.

That brings up the point of fraud and overpaid civil servants. In recent years, there were a lot of reports about “shadow pensions”, for instance pensions to people who were not alive. Similarly, a lot of pension plans included premiums as high as 100k EUR, unreasonably high. Also, we heard a lot of cases in which subsidies were greatly abused, maximizing the unproductiveness of the country. “That is the reason we are in such a bad shape today”, is the view of almost all people we interviewed.

Contrary to what some others report, we got a very clear picture about how Greece got into this situation. Greek people understand that structural reforms are an absolute must. The number of civil servants has to come down, the government has to crack down on fraud and corruption. What remains unclear, however, is how economic growth can be stimulated. Let’s consider that the biggest challenge of the government.

And that is where we see a big problem. The current government has promised an even bigger state, not a smaller one. They have promised hard measures against the ones who benefited most in the past, but haven’t executed any so far. They have promised economic improvements, but the country is an economic catastrophe since Syriza took over in January.

Here is the biggest mistery of them all. Although the government has promised to fight any bailout plan, Mr. Tsipras came up with Greece’s 3d big bailout plan this week. How do Greek people react on that?

Opponents of Syriza obviously are critizing Mr. Tsipras for that. They point out that the current government has brought false hopes, based on unrealistic promises. On the other hand, proponents of Syriza are still defending Mr. Tsipras, saying that he was “cornered”, and that the bailout plan was the only viable solution. They believe that he had a “plan B” but was somehow “prohibited” to implement it. They still believe Mr. Tsipras is a great politician as he is the only one who can bring justice and reforms.

Let us pause for a minute here, and add our own observation. Taking everything together, it is clear to us that today’s economic and monetary crisis is a politically induced one. Politicians can facilitate the way out. And that is where it potentially can go wrong. The country needs drastic measures which are, in nature, politically unpopular. Moreover, politicians have a track record of creating confusion to people, and bringing false hopes (as discussed earlier). The only way out, in our view, is one of increased pressure by European leaders.

That leads us to the European aspect. The current government has stimulated an anti-Europe preference. However, by far most of the people we interviewed have a pro-European viewpoint. Almost everyone believes it is a better thing for Greece to stay in the Eurozone, as it is a much stronger currency than a Greek currency. Hence, the economic outlook, in the very long term, would be better being part of Europe. Moreover, people admit that European leaders have the potential to force discipline, order and justice, something Greek governments will probably not realize themselves.

It is not a strange idea that Europe can help Greece, and it is clear that European leaders are aware of it as well. When we analyzed the bailout plan which was agreed last weekend, we see in the agreement 9 measures related to structural reforms, one of which being the following:

“To modernise and significantly strengthen the Greek administration, and to put in place a programme, under the auspices of the European Commission, for capacity-building and de-politicizing the Greek administration.”

At the end of the day, that is exactly what Greek people are asking for. So Europe can really help Greece in its need to reform structurally. And, obviously, European leaders know very well that is the weakest point of Greece.

The anti-Europeans we interviewed, although a minority, brought up the fact that Europe (read: Germany) is suppressing Greece. That idea is originated from the feeling that Greece is not a sovereign state anymore, which is fed by the current government.

Our conclusion is that Greece is a textbook “boom and bust” case. The country is today paying the price of two decades of excesses, based on unsound economic expansion (i.e., uncontrolled government spending). Contrary to what some report, we clearly see that Greek people realize this, and they desperately want to change this. Whether politicians will be able to bring change or not, is the trillion dollar question in our view. In any case, politicans hold the key to change, especially when it comes to legislation and taxes, corruption and fraud, productive economic stimulus.

It is really sad to see how the Greek people fell victim of an unfair economic system, created by previous governments, cheap money, and a big state. But it is exactly at this point where some Greeks hope that this crisis has the potential to bring real change. Greek people are so exhausted that they are willing to accept change. Politicians, however, have to do the right thing, which means focus on the interest of their country, not their personal votes.

We are preparing a report on “crisis investing in Greece.” Stay tuned by subscribing to our newsletter at SecularInvestor.com.

Plus KeyStone’s Latest Reports Section below:

Rule 1: Invest for Value (Buy Profitable Businesses at Reasonable Prices)

Value is perhaps the most important concept to understand as an investor (next to risk). Most people intuitively understand this in their everyday lives. Unfortunately, it is less understood in the arena of stock investing. What is value? Value, in this sense, is when you get a great deal on buying an asset. In the case of investing, it is when you are able to buy $1 worth of assets for $0.80 or less. When you are making the purchase of an item, like a house, or a car, or a television, and you put extra effort into finding an item of equal or greater quality, but for a lower price, you have made a value purchase. It is the same in the stock market. When you purchase a share of a company, you are buying an ownership interest in an underlying business – an asset. Almost any stock will have a story describing how the managers will try to make money, but if it’s a real business, it will have more than just that. It will have real products, real sales, real profits, and real business models. A successful business will generate cash flow and it will reinvest this cash flow for growth or it will pay this cash flow to back to its shareholders in the form of dividends. When we find those unique opportunities to purchase successful businesses at prices well below their real or intrinsic value, we have made a value investment.

The tricky part is determining what the stock is actually worth. This is by no means an exact science (not even close) and there are many different techniques that people use for varying degrees of success. The reality is that two different people can be given the exact same information on a company and arrive at two different conclusions of what the company is actually worth, and neither one of them is necessarily right or wrong. So rather than trying to determine the exact intrinsic value of the company (stock) you are purchasing, focus more on fundamental principles. If a company is not profitable or is not breaking into profitability, then it is not an investment, it is a speculation. If the company is trading at a premium price, risk increases. If that company is trading at a discounted price, risk decreases. The more solid companies you buy that are making money, at attractive prices, the better your portfolio will perform over time. The more you buy speculative ventures, which are innately impossible to value, the worse your portfolio will do over time. You may need to utilize the services of a qualified and competent advisor, but that is no substitute for maintaining your own opinions and investment strategy. 

Rule 2: Be Patient and Allow Your Investments to Grow

As human beings, most of us possess a desire for immediate gratification. This is in large part why online ‘trader’ programs and strategies have been met with such popularity as of late. The term ‘day trader’ is appealing because it essentially suggests that profits can be attained on a ‘daily’ basis. All of the worthwhile things in our lives however, were not developed on a short-term basis, but instead they required years to grow and develop and eventually begin to yield rewards. This is true with relationships with friends; it is true with building a family, a career, and skills we wish to develop. With each of these assets, as with the act of growing a tree, at one point, we took the initial step of planting a seed and over time, with effort and care, the assets developed strong roots and began to grow. Most rationale people would never expect instant gratification with any of the most important assets in their lives and nor should they from their investments.

When we invest, we do not just buy ideas, we do not buy hype, and we do not buy promises. When we invest, we buy a piece of an operating business for the most attractive price possible. When the business grows, we expect the value of our investment to grow with it. Anyone who has ever built a business knows that success does not come overnight. The business must be given time to grow and so must the investment. 

Rule 3: Invest with Your Mind, Not Your Emotions

Warren Buffet, who is the undisputed greatest investor in the world and often referred to as ‘the smartest man in the room,’ provided a very interesting take on the key ingredient to successful investing. He said, “Success in investing doesn’t correlate with I.Q. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.” This should hopefully come as welcome advice from those that once thought investment success required brilliance. Indeed, more often than not, we are our own worst enemies when it comes to investing. Emotion is the single biggest detriment to long-term investment success in the stock market. When stock market prices are climbing, meaning the underlying businesses are becoming more expensive, emotion encourages most people to become greedy. The opposite is true in a declining market, when prices are falling, and in many cases, some of the underlying businesses are selling for discounted prices, most people become more fearful and consider leaving the markets. Ironically, this is the period where the best mid to long-term investments can be discovered.

The lesson to be learned here is – control the emotions of fear and greed. Understand that the market moves up and down and don’t become too excited or too depressed in either event. Let us remember the Crash of 2008. By mid-2008, stock market activity was at a climax. On the financial news, we were inundated with references to legendary levels of liquidity, M&A activity, and opportunity. The result was irrational exuberance, where like in the tech boom, people thought that the rules had changed and they became willing to pay any price for overvalued assets. Then the crash came and over the second half of the year, sentiment took a 180 degree shift with the overall market losing about 40% in the matter of months. It was at the trough of the market that many of our clients were asking us if they should liquidate their portfolios and stay away from the markets until certainty returned. The problem is that liquidating out of fear, and at the trough of the market, forces you to lock in your losses. The intention is always to re-enter the market during better times. Unfortunately, this timing never works the way it is intended. When we fast forward to the market recovery, the vast majority of the gains were made between March and May, with the market largely moving sideways since. Investors that had elected to lock in their profits during the market’s lowest point, in October of 2008, would not likely have gotten back into the market in time to benefit from the recovery. A quote I am quite fond of is that “success in the market is derived from time in the market and not timing the market.” Another from Warren Buffet is “if you cannot stomach your investments suffering a temporary decline of 50% or more, you have no business investing in the stock market.”

Rule 4: Diversify Your Investments

Diversification is a tool that every investor has been touted. Although the benefits have undoubtedly been explained to you at some point, it is important enough that I will explain it again. Capital has to be spread around amongst different investments types, amongst different industries, and amongst different individual companies (stocks). How a portfolio is diversified depends a lot on the individual and relatively the importance of their investment portfolio. You can afford to take more risks (and diversify less) if you are young and without dependents. When you are older and become more dependent on your investments, your risk tolerance declines and your need for diversification increases. From experienced investors to novices, just about everybody in this day and age understands that stock market analysis is anything but an exact science. Even the greatest analyst on the planet cannot know unequivocally what will happen to a single stock or the stock market in the future. Even in the case that the analysis of a single stock is flawless, the analysis cannot predict with absolute certainty whether or not an individual company will succeed or fail. 

True diversification should start at the asset class level (stocks, bonds, cash, real estate, etc). Unfortunately diversifying outside of stocks, while necessary for most, is beyond the scope of this commentary. Our focus here will be the discussion of how many individual companies, or stocks, should be in your active portfolio. At KeyStone, we focus on two areas of the market where we believe investors can generate superior returns – high-growth small-cap stocks and dividend growth stocks. For our clients, we typically suggest holding eight to ten individual companies in each of these portfolios. Holding less exposes you to excess risk of poor performance from an individual stock. Holding more makes your active portfolio too difficult to manage. Let’s take a sample portfolio of eight stocks with the following one year returns: A(-40%); B(-20%); C(0%); D(0%); E(20%); F(25%); G(50%); and H(85%). These example returns are being used purely for illustrative purpose, but they do represent a somewhat realistic return spectrum. If you were to diversify equally into all eight of these stocks, you would have made an average return of 15% for the year. On the other hand, if you were to select just one of these stocks (not knowing which would outperform), you would have a 50% chance of either making nothing at all or even losing money. If you were to select just three of the stocks, there is a reasonable chance that you would have selected A, B, and C, which would have yielding an average return of -20%. Of course, by selecting three stocks you could have been lucky and picked F, G, and H, yielding you an average return of 53%. The problem with concentrating into one to three stocks is that you are now depending on luck to guide your returns. “Hindsight is 20/20, but foresight is legally blind.” You don’t know at the beginning of the year which companies will be the losers and which will be the winners, so in order to give yourself the best chance of generating a reasonable return, you have to diversify your holdings. Anything less brings us from the realm of investment to the realm of speculation.  

Rule 5: Maintain Reasonable and Achievable Expectations

Many people buy and sell stocks with an expectation of becoming wealthy within a short time span. Unfortunately, this is more of a pipe dream than a reasonable expectation. By now, you should be familiar with Warren Buffet and his reputation as “the world’s greatest investor.” He has amassed a fortune of $50 billion over a 40 year career as a buyer and seller of businesses. Yet all of his success has been generated with an average annual return of only about 22% per year. To the truly experienced investor, this return is phenomenal. To the average speculator, this return might actually appear meager. Yet no money manager on record can boast of a higher average investment return over a long-term (over ten years) time horizon. The truth is that those that might tend to scoff at the return and consider it unimpressive have not even come close to consistently generating anything comparable. 

A big problem with maintaining overly high expectations is that most people tend to gravitate to high-risk investments in order to achieve them. In the Canadian investment market, this typically means overly high allocations to the very cyclical resource sectors of Mining and Oil & Gas. While these sectors have their place in a well diversified portfolio, overly high allocations almost always result in disaster. In the search for unrealistic returns, many investors go a step further and over allocate towards junior resource and junior high-tech. With only a few exceptions, these types of companies typically do not make any money and are pure speculations. As with the temptation of gambling, many so called investors are attracted to the prospect of the infamous “10 bagger” (a stock that multiplies in value 10 times), but as with gambling, nearly every participate that allows greed to dictate decision ends up nearly penniless. Lest we remember the lessons from the tech boom of the 1990s – long standing wisdom that insisted real companies should actually make money was thrown to the wayside as the investment community became absolutely enamoured with the prospects of generating nearly unlimited returns. Lest we also remember how quickly it took for those paper profits to disappear and how quickly those ambitions for unrealistic returns morphed into hatred for stock market investing. We have seen this again more recently with the stock market crash of 2008. Between 2002 and 2007, many speculative junior mining issues enjoyed excellent returns in the absence of actually generating any real economic value. During this period, many of those who bought and sold stock in junior mining companies undoubtedly saw a few years of triple digit returns. In the end however, after the bell sounded, these individuals were quickly left in the exact same position as those that were once seduced by the tech boom – with stock that in some cases had declined by up to 95% or more. While the speculative sectors, along with the rest of the market, have since seen somewhat of resurgence, they are still almost all trading at depressed prices relative to the pre-2008 levels and almost all of those that participated in that market remain in the red over the course of this market cycle. 

KeyStone’s Latest Reports Section

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6/5/2015
ROYALTY POOLS – DIVERSIFIED INDUSTRIES COMPANY GROWS ROYALTY PORTFOLIO 40% SINCE START OF THE YEAR AND PROGRESSES – INVESTMENT POTENTIAL ON 1 TO 3 YEAR TIME HORIZON LOOKS SOLID AS COMPANY PROGRESSES TO NEXT STAGE OF DEVELOPMENT

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5/29/2015
UNDERVALUED SPECIALTY PHARMA MAKES SOLID PRODUCT ACQUISITIONS, MORE-TO-FOLLOW? – MAINTAIN BUY

Habit #3 – Set Clear Strategy

“Strategy is about making choices, trade-offs; It’s about deliberately choosing to be different.”

Michael Porter
 
 Successful business owners know the importance of setting clear goals and how to achieve them, aka strategy!  They set clear strategy because they are agile, close to the customer, bold and not afraid to accentuate what makes them different. 
 
The understand that the essence of good strategy is to leverage whatever resource they have in front of them now, while aligning everyone in the company behind the strategy.  Dodging and weaving as they go, they don’t wait for a perfect 50 page document, rather they get their ideas into the market as quickly as possible for validation or rejection.  When they get a hit, they run with it and plow resources into the greatest opportunity. 
 
Successful business owners set strategies to dominate their sector, not just compete.  It becomes a mindset, an approach, not a boring corporate document.
 
Successful business owners have developed the habit of being strategic thinkers, without over thinking, while being great on execution, without being hasty.  They know good strategy leverages the existing strengths of the business, makes them different in the market place, creates values and is simple.
 
Leveraging Strength:  Even the smallest business has some strength that can be leveraged in a unique way; its location, a unique product or service, the way it connects with a customer, customer experience or some unique talent in its staff. Don’t reinvent the wheel, work with what you have.
 
Be Different: Successful business owners know to avoid the commodity trap or competitive pricing and low margins.  If customers cannot tell the difference between you and the competitor, they will not pay a difference and you will trade at commodity levels.  While low cost can be a good strategy, be prepared with great execution, exceptional systems and the ability to scale. Accentuate what makes you unique, or even peculiar.  Stick out, get attention, and fight through the noise so people remember you.
 
Create Value:  Good strategy creates value, and successful business owners know that value creation is the essence of business.  This starts with a decision on how to make the customer experience better and how to do it at the lowest price and highest quality.  In other words, starting with value creation for the customer and then figuring out how to deliver, not the other way around.
 
Simple:  Successful business owners know that good strategy is usually simple, and can normally be explained to a new employee in one sentence.  For instance, it can be response time, value added services, freemium business model, logistics or product delivery, customization, or anything else that is easy to execute around.
 
Building strategy can be as simple or as complex as you like.  At its most basic level, I normally recommend companies at least have the following four elements in a strategic plan: precisely and clear known, well documented, communicated to key stakeholders, and supported by culture and actions of the organization.  For larger companies, particularly in the technical space, I recommend a more comprehensive 10 step process which you can read HERE.
 
For most companies, a simple planning exercise, will help put together a great approach to understanding the market sector, creating significant value and leveraging their hard-earned strengths to win and dominate the sector.  

By Eamonn Percy