In the spring of 1969, the Dow Jones industrial average stood at 969. By 1982, the Dow hit 1,071. That’s thirteen years of going nowhere. (We’ve had 10 years or so of going nowhere, though the ride between the poles has been anything but boring).

The problem is inflation makes that performance look better than it really was, like when a crooked judge makes a fight look close with a split decision even when the one fighter can barely walk to his corner and everybody in the building knows it was a rout.

Adjusted for inflation, or the weak dollar, the Dow was really more like 400. That makes it one of the worst stretches for the market since the 1930s.

The consumer price index, that flawed measure of inflation, doubled from 1960 to 1982. This is why a generation of people grew to believe that the best way to buy a house was to borrow all you could afford. And for a time, that looked brilliant. As Robert Sobel relates in a history of the period, a modest suburban home going for $30,000 in 1969 sold for $300,000 13 years later. With a lot of debt, your returns were much greater.

Of course, that kind of thinking eventually got us into a heap of trouble, as we now know.

But that period of time also had an effect on Corporate America’s balance sheets. When a company buys an asset, say a factory, it records its cost on its books. It will then depreciate this asset over time. So the value of the factory on its books will decline over time.

In a period of high inflation, its book value will be understated. The cost of a similar factory will be a lot higher in dollar terms, though the company will still show the old figure.

In other words, during periods of inflation, book values understate the true value of corporate assets. This happened in the 1960-82 period. Combine that with the stagnant market and you get many stocks trading for super cheap by 1982, when the great bull market began.

In fact, in July 1984, S&P reported that 30% of the stocks on the NYSE traded below net tangible book value. The old value mavens like Ben Graham would have had a field day.

What happened next, though, is what interests us especially. The low stock prices kicked off a takeover boom. The 1980s takeover mania was the busiest since the “age of Morgan at the turn of the century,” Sobel reports in his The Age of Giant Corporations. The 1980s was the age of the LBO, Barbarians at the Gate, Michael Milken and the corporate raider.

The oil industry also had its takeover boom. In fact, the outlines of the 1980s oil and gas industry look similar to today’s. In 1970s, there was a drilling boom as people thought that oil and gas prices would rise indefinitely. That collapsed and then you had oil and gas companies sitting on huge reserves they built up during the boom.

So in a time when it cost $15 a barrel to get oil out the ground, many oil companies traded for $5 a barrel in proven reserves. Getty Oil traded for $72 per share, with assets of $250 per share. Marathon’s stock went for $68, though each share had $210 in assets backing it up. And on and on it went.

Enter T. Boone Pickens. An Oklahoma-born geologist, Pickens was well aware of the value of these companies. He started going after them and making millions of dollars as bidding wars ensued. He lost several of these, but still cleared millions in profits.

There was a roll call of takeovers in the industry during this time — Shell bought Belridge Oil for $3.6 billion, DuPont bought Conoco for $7.4 billion and U.S. Steel took out Marathon for $6.5 billion. (Yes, U.S. Steel thought it would be smart to diversify). These were some of the bigger deals.

I won’t go too much into the history of this period, and perhaps I’ve already gone into too much detail. But I think something similar may be unfolding in today’s market.

We have the potential for high inflation thanks to the government’s monetary and fiscal stimulus. We also have a weak economy. In oil and gas, we have many companies trading cheaply in the wake of a drilling boom gone bust. What we need now is a T. Boone Pickens to shake things up.

Sincerely,
Chris Mayer

September 3, 2009

A New Age of Corporate Takeovers Could Soon Emerge was originally featured in the Penny Sleuth.

The interview was notable for two reasons – first, because interviews with the Chairman of the Fed were until now almost unheard of, and second, because Bernanke told 25 million viewers that we could see the recession end this year.

“We’ll see the recession coming to an end probably this year. We’ll see recovery beginning next year. And it will pick up steam over time,” he told Pelley.

But Bernanke was quick to qualify his projections: “We won’t be back to full employment. But we will see, I hope, the end of these declines that have been so strong in a last couple of quarters.”

Those are strong words for anyone who sits in Washington’s inner circle, but it’s important to remember that Bernanke hasn’t been a Washingtonian for long. And despite allegations that he’s been too generous with the financial industry, Wall Street is equally as foreign to him.

Bernanke spent the majority of his professional career as an academic, first as a professor at Stanford, NYU and MIT, then as the Chair of Princeton’s Economics Department.

During the interview, 60 Minutes stressed Bernanke’s small-town upbringing. They reminded America that Dr. Ben Bernanke, PhD grew up in the middle class in Dillion, South Carolina. And with no shortage of made-for-TV irony, the cameras met with Bernanke at his childhood home in Dillon, a rancher that’s in foreclosure because the current owners couldn’t make the payments.

But frills aside, what Bernanke said last Sunday night was important for investors to remember.

He pointed out that we’re not going to see any sort of an economic recovery until the financial system gets itself in order. While that doesn’t mean that the stock market has to make sense again, it does mean that our nation’s banks have to get their acts together before things get straightened out.

“The lesson of history is that you do not get a sustained economic recovery as long as the financial system is in crisis. We’ve seen some progress in the financial markets, absolutely. But until we get that stabilized and working normally, we’re not gonna see recovery. But we do have a plan,” he said.

One of the biggest elements of that plan is the “Bernanke Doctrine,” which Chairman Bernanke laid out right after he was sworn in as Fed Chairman back in 2002. In his seven-tiered plan, Bernanke emphasizes a systematic approach to avoiding deflation – one of the biggest concerns that we could face in a recession.

At present, the Bernanke Doctrine is in full effect, and as a result, we’re actually seeing modest inflation right now – up 0.4% in February according to Department of Labor numbers released today. Among other things, that small amount of inflation means that consumers aren’t being pressured by a lack of liquidity in the money supply.

If Bernanke has been this sharp so far on deflation, maybe his seemingly optimistic predictions aren’t so off-the-wall. After all, who has a better pulse on the economy than our nation’s chief economist?

As economic fundamentals begin to show themselves in the coming months, we’ll see if Ben’s hypothesis holds up.

Cheers,
Jonas Elmerraji

March 18, 2009

Berknanke’s Big Bet was originally featured in the Penny Sleuth.

That’s why the greatest inflation fighter in the world is under stress. Of course, we’re talking about gold. Gold is– and always has been– the safest place to put your cash. It has been traded as currency, stockpiled to backup paper money (think Fort Knox), and hedge spend-happy governments. Today, its hedging attribute is important.

Over the past few months, it’s become more and more difficult to buy physical gold. Even if you do locate it, what you actually pay is quite a bit more than its spot price.

In many cases, these buyers were willing to spend up to 25% more for gold than its value. That’s like your broker taking a quarter for every $1 share you buy.

So, if gold is too expensive, where can investors turn? Well, there’s always gold’s little brother…

Silver is not commonly thought of as an inflationary hedging tool. That is, until times get tough. And I don’t think you can find too many times tougher than right now.

Silver is often referred to as “the poor man’s gold”. We call it opportunity. You see, during the 1978-1980 precious metals rally, silver showed up late. Almost all of the large gains in silver came in the last few months.

We see the same events unfolding this time around. As we pointed out in the past, gold has always traded for about 16 times as much as silver, until the past few decades. Currently, the ratio sits around 71. When this number falls, silver booms.

Macroeconomics and ratios aside, there is one final reason we expect an enormous silver rally…

About 3 out of every 5 ounces of silver come from base metal mines. Roughly 28% of all silver comes from copper mines and another 32% comes from lead/zinc mines. Both of these sources are decreasing — and in some cases, completely shutting down — production due to the overall commodity market.

Only 10% of all silver comes from gold mines, which leaves just 30% of the total market to pure silver plays like Coeur d’Alene Mines Corp., Hecla Mining, and Pan American Silver. These serious cuts in production, gives us pure silver investors the inside track to cornering the silver market.

We are seeing a perfect storm brewing in the silver market. If you get in now, you might just beat the rush…

Sincerely,
Jim Nelson

March 17, 2009

How You Can Win with Silver was originally featured in the Penny Sleuth.

I explained it very simply. He likes to play this card game in which the players get different creatures and each of them has certain abilities. I explained to him how he valued certain cards highly because they are rare and hard to get. If the cards were easy to get and common, then they would be less valuable. This he understood.

So I told him that dollars work the same way. As the government prints more of them, they become less special. They buy less. We call this inflation.

Today, the Federal Reserve is laying the groundwork for massive inflation. “Over the past year,” Grant’s Interest Rate Observer notes, “the central bank’s balance sheet has grown by 133%. It was only yesterday when annual growth of 13% seemed aggressive, if not reckless, and certainly inflationary. Ten times that aggressive-if-not-reckless-and-certainly-inflationary rate of expansion is a fact that takes some getting used to.”

Over the last three months, Federal Reserve Bank credit is up 1,560%, reports Grant’s. It was only in September that the Fed’s balance sheet crossed $1 trillion for the first time. On Nov. 5, it scooted past $2 trillion. By year-end, says the president of the Federal Reserve Bank of Dallas, it could slide right on past $3 trillion. Our Federal Reserve seems hellbent on making Argentina look like Switzerland in terms of monetary restraint.

Why is this ballooning balance sheet inflationary? The Federal Reserve increases its assets by buying stuff — financial assets of banks and others. The Federal Reserve pays for these assets by creating money that did not exist before. That’s it. Simple as pie.

Of course, our government is not acting alone. Central banks across the globe are doing the same thing, if with somewhat lesser vigor, at the moment.

In any event, it means paper money will buy less. We may see nominal prices — for oil and gold and metals — continue to fall in the short term, but long term, I think we’re set up for some huge reflation in 2009.

Best Regards,
Chris Mayer
November 20, 2008

The Federal Reserve’s Reflation Infatuation was originally featured in the Penny Sleuth.