BEFORE YOU JUMP INTO TODAY’S ISSUE:

‘The stars are well-aligned for today’s Gold Strike 2024 re-open’, writes Brian Chu…

‘US GDP numbers disappoint, pushing markets to risk-off behaviour.

‘The New York HUI Gold Index jumped 4% overnight.

‘Oil edging down, giving a boost to gold mining industry margins.

‘And our free trade, full buying instructions revealed in this presentation, has broken out of its tight trading range over the last six months.

‘Operating results for March quarter have improved, bringing back buying to the ASX Gold Index, and investors will look at explorers from here.

‘Four of our five priority trades are up since February, four of them have announced capital raising, corporate takeovers and development progress.’

It’s a very exciting time for the gold sector.

Watch Gold Strike ’24 for a limited time here.

***

Dear Reader,

Over the next few weeks, I’m going to focus on THE most important thing to understand when it comes to investing. It’s more important than valuation, company analysis, or mastering the ‘technicals’.

It’s understanding investor psychology, and how your brain plays tricks on you.

Charlie Munger was famous for his multidisciplinary approach to investing. He put understanding psychology up there as one of the most important disciplines for an investor to master.

He was so impressed with the book Persuasion, that he gifted the author, psychologist Robert Cialdini, a share of Berkshire Hathaway.

What I want to do over the next few weeks is give you an understanding of just why your brains works in the way it does in certain circumstances. If you understand the mechanics of the brain when it comes to dealing with investment markets, you might be better able to control its impulses.

Buffett and Munger have long said that they are not particularly intelligent. Rather, they just practice the right temperament for investing.

I would argue that they are very intelligent. But this isn’t their edge. Many intelligent people fail in investing. Their edge is their temperament. They have mastered their emotions.

I’m not saying you can do it too. It’s obviously hard. But understanding how your ‘software’ system works is a good start on the road to being able to program it better.

The simple fact is that the brain has not evolved to deal with investment markets. That’s why so many investors lose when they first start out. Not because they picked the wrong stocks, but because they succumbed to emotional pressures. These pressures are the result of our innate software program that runs in the background.

What is this program?

At a very basic level, I guess you’d call it a survival program. By that I mean social survival. We can’t survive on our own. We need to cooperate to ensure we have adequate shelter, food and water, and clothing. We are, therefore, social creatures. And evolution has ensured we are rewarded for social behaviour.

How?

Our brain releases neurochemicals to reward behaviour that promotes survival. It also releases other neurochemicals to discourage behaviour that threatens our survival (physical or social).

In her book, I, Mammal, Dr Loretta Breuning writes:

‘Humans have a big cortex and a big capacity to learn from experience. But we cannot short circuit our mammalian limbic system. Our cortex gives our limbic system information to make better decisions, but our limbic system still controls the neurochemicals that link mind and body. Our actions ultimately come from our neurochemical selves.’

Fear and greed chemicals

What are these neurochemicals? Let’s call them:

1. Fear (or stress) chemicals, and

2. Greed (or happy) chemicals.

From an investment perspective, these are the chemicals your brain releases (via the limbic system) at extreme highs or lows in individual stocks, or the stock market as a whole. These chemicals override your rational brain and make you do things you later regret.

They make you buy at the top and sell at the bottom. Which is really annoying.

Knowing what these chemicals are, how they work and why, will give your rational brain — your cortex — the best opportunity to override the evolutionary survival impulses fired off by these neurochemicals.

Given that we’ve been in a ‘greed’ phase for the past few months, let’s take a look at how these chemicals work to influence our behaviour. Next week, we’ll examine the effect of fear chemicals.

The greed chemicals are:

• Dopamine
• Serotonin
• Oxytocin

Dopamine: The offer of a big reward

Dopamine is the big one here. Previously, researchers believed that the brain produced dopamine in response to obtaining a reward. Now, it’s thought that dopamine comes from the expectation of a reward. It’s a motivating chemical.

Consider how Dr Loretta Breuning puts it in her book, Habits of a Happy Brain:

‘Our ancestors didn’t know where their next meal was coming from. They constantly scanned their surroundings for something that looked good, and then invested energy in pursuit. Dopamine is at the core of this process. In today’s world, you don’t need to forage for food. But dopamine makes you feel good when you scan your world, find evidence of something that felt good before, and go for it. You are constantly deciding what is worth your effort and when it’s better to conserve your effort. Your dopamine circuits guide that decision.’

Translated to the game of investing, this is what happens in a bull market when you’re planning to buy a stock. You might have already made some gains on a particular stock. If you see a similar situation unfolding in another stock, its potential excites you. That’s the dopamine flowing. It provides the motivation for you to take the risk and place the trade. Motivation = decision = action.

Dopamine especially flows when the reward you get exceeds your expectation. Say you buy a stock expecting steady price appreciation. But a takeover announcement sees it soar 50% instead. At that point, you get a surge of dopamine as a reward and motivation to do it again.

Unfortunately, unexpected rewards are hard to replicate. That’s why they’re unexpected. The craving for dopamine leads you to take increased risks to try and obtain your past investment high. Such a pursuit generally leads to trouble.

I think this is partially why winning streaks typically end in tears. In your attempt to replicate past successes, you often take on riskier bets and replace sound judgement with hope. That never works well.

Dopamine has us constantly searching for the next big winner. That’s why people love punting on tiny resource stocks, cryptocurrencies, or tech stocks. The offer of a big reward gives us a dopamine high.

While this is fine if it’s controlled, keep in mind that dangerous habits can form, especially if you’re ‘unlucky’ enough to stumble on some early winners.

Early (and unexpected) winners give you the dopamine rush that you continue to seek out. It can turn into a form of addiction. Consider the following, from Jason Zweig’s, Your Money and Your Brain:

‘At Harvard Medical School, neuroscientist Hans Breiter has compared activity in the brains of cocaine addicts who are expecting to get a fix and people who are expecting to make a profitable financial gamble. The similarity isn’t just striking; it’s chilling. Lay an MRI brain scan of a cocaine addict next to one of somebody who thinks he’s about to make money, and the patterns of neurons firing in the two images are “virtually right on top of each other”, says Breiter.’

That’s why making easy money when you first start out is dangerous. Through the release of brain chemicals, you’re conditioned to think this is the norm. So you continue to chase the feeling by taking bigger and riskier punts.

Serotonin: A swarm of locusts

Serotonin explains why we get sucked into investment fads. It’s another survival-promoting chemical found present in every living thing.

In the animal world, serotonin is released when access to food is secure.

Animals also enjoy a serotonin release when they rank higher in social status. This provides a clue as to how it works with humans and investing.

Dr Loretta Breuning gives a few examples in her book, I, Mammal:

‘In an experiment with an alpha male vervet monkey and his subordinates, researchers placed a one-way mirror between them. The alpha male could see his troop, but they couldn’t see him. During his displays of dominance, the troop didn’t react with its usual deference. After several days of this, the alpha male’s serotonin levels dropped, and his anxiety levels increased.’

Doing better than others in the investment game? Enjoy that sweet flow of serotonin…

And then there is this interesting finding between serotonin and locusts.

‘Serotonin has been found to play a curious role in the behaviour of locusts. A locust generally avoids other locusts, but serotonin transforms them into swarm creatures. Locusts produce serotonin when they get jostled and stimulated by fellow locusts due to overcrowding. Once their serotonin is triggered, they seek each other out, creating a pestilent swarm in pursuit of food. Serotonin makes them sociable when solitary food seeking cannot satisfy their needs.’

It is easy to see the similarities here between swarming locusts and investors (or speculators) swarming around the latest investment fad. Being part of a crowd searching for food (or big returns) makes people feel good. Serotonin is the feel-good chemical.

Because we have evolved to crave this chemical, being part of a crowd feels good. And when you’re invested in a stock or asset class that is doing well, you feel good when you tell others about it. It elevates your social status, if only in your eyes, and if only for a brief time.

Oxytocin: The comfort of crowds

Oxytocin performs a similar, if slightly different, role. It’s the chemical release we get from the comfort of crowds. For example, when a sheep can’t see another member of the flock, it panics and its brain releases cortisol. But when it joins the flock again, the brain produces oxytocin.

Humans (and most types of mammal species) are stronger in groups or herds. That’s why we’ve evolved to live in ever larger groups — it promotes survival. Oxytocin is the neurochemical that provides the feel-good factor to promote this survival.

When you’re invested in an asset class that is flying, you get a buzz about being involved in a ‘community’ of like-minded investors. They’re like you and you’re like them.

You feel good when others agree with you, and you feel good when you read things that you already agree with. It’s why confirmation bias (filtering for information that confirms your existing beliefs) is so pervasive in investment markets. It’s the oxytocin!

Stock exchanges form, bubbles follow

There is evidence that trading in financial instruments took place in the early Italian republics of Florence, Venice and Genoa from the 1300s. However, this didn’t result in the establishment of formal stock exchanges.

The Dutch East India Company formed the first modern stock exchange in Amsterdam in 1602. The aim was to create a place where shares in the company could be traded in a secure and organised manner.

Perhaps not coincidentally, one of the first recorded speculative bubbles took place in the Netherlands, or the United Provinces as it was called at the time, soon after the Amsterdam exchange started operating.

The tulip bubble, or tulip mania as it came to be known, gripped the Dutch population in 1636-37. There were clearly a lot of happy chemicals floating around at the time.

Less than a century later, the South Sea Bubble of 1720 inflated in London. Thousands of speculators joined in, but it was a short-lived party. The bubble soon burst, ruining thousands.

This bubble episode is the source of the well-known quote from Sir Isaac Newton: ‘I can calculate the movement of the stars, but not the madness of men.’

It is not definitively known whether Newton lost money in the bubble or not. He was Master of the Royal Mint at the time and was influential in money matters.

So the quote may be a personal lament, or a response to a question of how far prices can rise.

Whatever the case, the point I’m making is that soon after large-scale trading of financial instruments began, people started succumbing to their emotions.

These emotions evolved over millions of years. They are designed to promote survival in a very different environment to the one that exists in the modern investment world.

In fact, survival in the investment world rewards behaviours that go against our evolutionary instincts!

If you want to be a better investor, then, you have to think and act differently from the investment herd. But being with the herd generates feel-good neurochemicals. That’s why it’s not easy to break away. When you do, you feel vulnerable and threatened. The stress hormones adrenaline and cortisol rise in response to ‘being alone’.

It’s why being bearish in the midst of a bull market or bullish in the depths of a bear market is often described as a ‘lonely’ place to be. It doesn’t feel good.

Even though the rational part of your brain knows that it’s the right place to be, your mammal brain makes it exceedingly difficult for you to occupy this space. It simply goes against your evolutionary wiring.

Next week, I’ll look at how the fear chemicals work their magic on you and make you sell at the low…but only if you let them.

***

As always, send any comments or feedback to letters@fattail.com.au

Regards,

Greg Canavan,
Editorial Director, The Insider

Dear Reader,

Gold has made major gains in these recent weeks, and I believe it’s about to get wild.

Have a look at this below:

After trading in a tight range in 2023, it started 2024 poised to break out of its all-time highs of US$2,130 an ounce.

However, rather than follow the momentum from last October, it spent almost three months trading in a tight range, refusing to budge.

Things only changed in mid-March with the Federal Reserve Open Market Committee announcing that it was expecting three rate cuts this year.

Then gold took off.

Add to that the stoush between Israel and Iran two weeks ago that left the world pondering if there’d be a new military conflict.

Gold made a new record last Friday at around US$2,430 an ounce (more than AU$3,700) for two hours as Israeli missiles landed in Iran. Rumours swirled that they were targeting Iranian nuclear facilities.

The world held its breath.

Fortunately, the Iranian government came out to declare that there was little or no damage to key Iranian targets. And the government stated it won’t respond to the attack.

The world breathed a collective sigh of relief.

Gold did the same.

In the last two days, gold sold down as much as US$120 to US$2,300 as you can see below:

As gold threatened to fall below US$2,300, it looked as if the bullish narrative for gold was falling apart.

Focus on de-dollarisation, all else is a supporting act

Most of you are aware that I focus on the long-term when I evaluate the market and make my investment decisions.

That doesn’t mean I ignore the daily price movements. It can affect my emotions, as I’m human.

However, I try not to lose sight of the big picture.

In yesterday’s Fat Tail Daily article, I wrote about how it’s important to focus on what drives the price of gold in the long-term.

It’s the US long-term real yield, which reflects the strength of the US dollar. The dollar pays interest to its holder, with inflation acting as a counter by diminishing its purchasing power.

Most people believe wars and major disasters drive gold’s rally. But the bulk of gold’s gains in the last 25 years came during times of relative stability.

Gold made steady gains as the central banks lent copious amounts of currencies to governments racking up deficits and stoking inflation.

Wars came and went. Some conflicts lingered on. However, the biggest driver for gold’s gains is the growing debt pile that threatens to discount global currencies into oblivion.

And until there’s a cure for society weaning off its reliance on government to solve its problems by creating more of it, you’ll see this cycle continue.

Gold stocks — Neglected, undervalued and poised for a major boom

In the past gold bull markets, gold stocks either led or followed gold closely.

Have a look at the relative performance of gold, established gold producers (reflected by the ASX Gold Index [ASX:XGD]) and gold explorers (reflected by my in-house Speculative Gold Stocks Index) in 2009–11, 2015–16 and 2019–20:

In the 2009–11 boom, gold explorers jumped out of the gates and gold producers followed gold to make record highs.

The 2015–16 boom saw the reverse. Gold producers made astronomical gains while gold explorers staged an underwhelming rally.

The 2019–20 boom delivered strong gains for producers in 2019, only to have the gold explorers dwarf these gains when it staged a phenomenal rally in six months from March to September 2020.

The last three years haven’t been the same.

And you’d expect that since the past doesn’t repeat. It does rhyme, however.

This is the state of play right now:

Gold rose steadily during the last three years, experiencing a lull in 2022 before trending higher into 2023.

It’s gone parabolic in the past month.

Meanwhile, gold producers and explorers have had a rough ride.

Even now, both are significantly undervalued compared to gold. Historically, they would be trading 50–150% higher.

And these are only the indices.

Individual companies should mint millionaires already, and I’m not exaggerating!

Take your positions now for a golden opportunity

The good news is that some companies are poised to turn thousands of dollars into much more.

Of course, there are no guarantees here that this will continue, but…

…to be specific, I’ve seen a few recover over 1,000% from their recent lows. It’s only been a few months since they bottomed too.

You’re not going to see it looking at these charts alone.

And I don’t encourage you to pick out companies trading at a few cents, or even less than 1 cent either.

There’re reasons why some companies trade at such low prices. They don’t have a story to attract the buyers and keep them.

Companies that can turn your life around must have quality projects, a sound plan, the right talents in the management team and a healthy cash balance.

Finding these companies take time. And you have to rely on some element of luck as there’s a lot of uncertainty in this space.

Not only that, you need to adopt the right strategy and mindset. Gold explorers are risky and highly volatile investments, and they can shake the undiscerning and impatient investor.

Success comes to those who can endure the challenge and ride through the thick and thin.

Members of my premium speculative newsletter, Gold Stock Pro, have endured a wild ride these three years. They’ve done the hard yards building their portfolio and holding on.

We’re ready to harvest our gains in the coming bull run.

Gold explorers are poised now to make a major run, as things are now falling into place for them.

Later this week, we’re re-launching Gold Strike 2024, allowing you a chance to build up a portfolio of gold explorers and early-stage developers to benefit from this gold bull run.

Why not consider joining us now for the potential to find life-changing opportunities?

God bless,

Brian Chu,
For The Insider

Dear Reader,

Last week saw the long awaited correction in tech stocks. Nvidia fell 13.6%, Netflix 11%, Apple 6.5%, Amazon 6.2%, Meta 6%, Microsoft 5.4%, while Alphabet was down just 2.2%.

Given how far this sector has rallied since the October lows, this is not at all surprising, and I wouldn’t read too much into it.

Any opinion on last week’s tech stock performance will simply tell you more about the bias of the person giving it than anything else.

One move that did catch my eye was the Semiconductor index (the SOX) down 9% for the week.

The catalyst was some cautious commentary last week from the largest chipmaker in the world, The Taiwan Semiconductor Manufacturing Company (TSMC).

Although you wouldn’t know it from this Bloomberg article that the Australian Financial Review ran with last Thursday. The author, Jane Lanhee Lee, wrote:

‘Taiwan Semiconductor Manufacturing Co. expects revenue to rise as much as about 30 per cent this quarter, reflecting a boom in AI development that’s boosting demand for the advanced chips it makes for the likes of Nvidia Corp.

‘The better-than-projected outlook follows its first profit rise in a year, after strong AI demand revived growth at the world’s biggest contract chipmaker.’

But Jane must have seen the share price reaction and re-wrote the article. The Fin Review didn’t get the updated memo. Here’s how the new and improved version looked in Bloomberg news:

‘Taiwan Semiconductor Manufacturing Co scaled back its outlook for a chip market expansion, cautioning that the smartphone and personal-computing markets remain weak.

‘The world’s largest maker of advanced chips cut its expectations for 2024 semiconductor market growth — excluding memory chips — to about 10%, from above that figure. Chief Executive Officer C. C. Wei also trimmed his growth forecast for the foundry sector, which TSMC leads. Meanwhile, the company maintained its estimates for spending at anywhere between $28 billion and $32 billion amid capacity expansion and upgrades this year.’

Always remember, markets make opinions.

While I wouldn’t rely on the mainstream business media to tell you what’s going on, I do take note of investor sentiment. And it’s pleasing to see the CNN Fear and Greed index has fallen into a fear reading for the first time since October last year. In fact, it’s not too far off an extreme fear reading.

I say ‘pleasing’ because when the market is fearful prices tend to be more attractive. At the very least it means a bounce may not be far off. (You’ve seen that play out today.)

One thing I’m not seeing though is a lot of ‘value’ coming back into the market. Which makes sense, the ASX200 for example, is only down 4.4% from the peak. It’s hardly anything for value investors to get excited about.

I for one am hoping this correction will continue to unfold for the next few months and reveal some good value opportunities.

Veteran fund manager on what comes next

Callum Newman, who heads up the Australian Small-Cap Investigator and Small-Cap Systems services, had a chat with veteran fund manager Matthew Kidman last week.

As he wrote to his members:

‘I chatted with fund manager Matthew Kidman last week. We’ll have that full video up for your soon. 

‘I mention it because Matthew flagged a possible sell down about now. Believe it or not, he said it would be “good” for the market.

‘It’s been a big run up in the market since November. Now we’re due a bit of a retrace. There’s nothing abnormal about it. Shares are volatile. Get used to it.

‘The main thing is to keep your eye on the big picture.

‘Bull markets don’t go up in a straight line.’

That interview is now up on Youtube. I highly recommend giving it a watch.

The relationship between oil and the market

I sent the excerpt below to members two weeks ago. I think it is something to think about in the months ahead. Not many people realise the liquidity sapping effects of a sharp rise in oil prices…

‘Brent crude is up 10% over the past month, and 25% since its December low. Like gold, oil looks due for a short-term pullback, but it looks to be building momentum for a move above US$100/bbl.

‘If that happens, the broad market rally you’ve seen over the past six months is at risk.

‘Why?

‘A rising oil price soaks up market liquidity. Oil is one of the largest markets in the world. A price rise of 25% means the oil market absorbs 25% more dollars.

‘The more the oil price rises, the more liquidity it soaks up. It’s got to come from somewhere, and that somewhere is ‘the market’.

‘The last major oil price spike occurred from March-June 2022. That wasn’t a good time for equity markets.

‘Back in July 2008, the oil price spiked to over US$140/bbl. A few months later, all hell broke loose. Oil wasn’t the cause of the GFC. But the rising price soaked up whatever liquidity was left.

‘Probably the most extreme example of this occurred back in the early 1970s with the Arab oil embargo quadrupling the oil price. The result was one of the most severe bear markets in history, the 1973/74 bear market.

‘I’m not suggesting that is on the cards here. I’m just pointing out that an oil price spike is not good for markets.

‘And it’s certainly not good for a market that has spent the past six months rallying on the belief that the Fed is about to pivot and cut rates. If oil continues its rally, which looks likely in the months ahead, rate cuts are off the table.

‘The US 10-year bond yield is already trading at 4.43%, up 34 basis points over the past month. The last time yields were at this level was back in November, on the way down. Back then, the S&P500 was about 15% lower.

‘Now, yields are on their way back up (along with oil) yet the market is completely ignoring it.

‘I don’t think you should.’

Well, last week the market decided to take notice of the jump in yields. A correction is now underway. How far will it go? Who knows. But I think the oil price will have a lot to do with the answer.

***

As always, send any comments or feedback to letters@fattail.com.au

Regards,

Greg Canavan,
Editorial Director, The Insider

Another Tailwind for Gold After Israel Attack

By Murray Dawes

In this Issue:

Markets have entered classic risk-off territory after news came out about the Israeli attack on Iran.

I write this on Friday afternoon so you will know more than me about what is going on by the time you read this.

Early reports are pointing to an attack on the Iranian nuclear program as well as an attack on a meeting in Iraq between various Iranian backed groups and the IRGC (Islamic Revolutionary Guard Corps).

This increases the risk that things could spiral out of control, so it is no wonder Mr market is running for cover.

Oil, bonds and gold are rallying, and stocks are falling.

Making predictions about the future path of geopolitical events like this is a fool’s errand.

The highest probability is that things will settle down again after a period of volatility.

The technical situation in US stocks was ripe for a correction so this news could be a catalyst that sets off some stop losses and leads to a sharp fall.

In today’s Closing Bell video I show you the target where I think the S&P 500 is heading to in the short-term.

I then give you a few different scenarios to consider.

Gold is flying higher on the news and should remain well supported while the situation remains volatile, but after such a strong run we should be prepared for a sharp correction if things settle down.

The oil price will let us know how seriously the world takes the current tit-for-tat going on between Israel and Iran. As I have been saying, if Brent crude oil heads above US$96 a barrel I have a target above US$110. This would cause some problems for stocks as they become worried about sticky inflation.

Click on the picture above to check out my latest Closing Bell video where I analyse the S&P 500, US bonds, gold, and the ASX 200 now that the correction is gathering steam.

Regards,

Murray Dawes,
Editor, Retirement Trader and Fat Tail Microcaps

Dear Reader,

Before we get started, just a reminder that you have until midnight tonight to watch Ryan Dinse’s 4th Halving Gameplan presentation.

Tomorrow marks the 4th halving, after which, according to Ryan, the next crypto cycle begins.

The previous three cycles saw Bitcoin and many other cryptocurrencies reach all-time highs in the months following.

This time, we have institutional buying power coming into the market via the newly created ETFs. Bitcoin has already hit a new all-time high this year, a sign that Ryan says makes this halving event more bullish than ever.

We’ll see how it plays out, but for exactly HOW to play it – in the right way and in the right crypto projects – there’s no one better to help you than Ryan.

If you want in, you have to do so now – click here!

Now, let’s get stuck in…

***

In this week’s edition of Uncommon Sense Investing, I’m going to talk about the ‘equity risk premium’ (ERP) and what it means for you as an investor.

It sounds fancy, but it simply refers to the additional return equity investors seek above the risk-free rate to compensate them for investing in a company’s equity.

What, quantitatively, is the equity risk premium?

No one really knows. Academics and market players have been debating it for decades and no one is any the wiser.

The reality is that when sentiment is bullish and prices are high, the ERP is low. That is, you’re not getting adequately compensated for risk. And when sentiment is depressed and prices are low, the ERP is higher.

This is just another way of saying that risk is actually low when it feels high, and it’s high when it feels low. This is how the market works.

That’s why using an ‘adequate’ ERP is useful. It helps you recognise when actual risk is high or low via the opportunities that present themselves (or don’t) in these environments.

What is an ‘adequate’ ERP then?

I usually start with a discount rate (or required rate of return) of 8% for large, established companies. That represents a current equity risk premium of 3.65%. Whether that is adequate or not, I don’t really know. But I have found it to be a good starting point.

Before continuing, let me just go back to Part VII in this series. In it, I wrote about the crucial relationship between the price-to-book (P/B) multiple and return on equity (ROE).

Book value and shareholder equity are the same thing. So, the return you get on that equity will determine the price someone is willing to pay for it.

The higher the return, the higher the price.

Or, the higher the ROE, the higher the P/B.

If you only look at the P/B as a way to assess value, you’ll be led astray. You have to look at it in relation to ROE.

At the end of the last essay, I wrote the following:

‘You can test this out this relationship between ROE and P/B on any company you’re interested in. Just divide the ROE by the Aussie 10-year bond yield and the result will probably be in the vicinity of the current P/B.’

I apologise. I gave you a bit of a bum steer.

To be more accurate, you need to add the ERP to the 10-year bond yield. This is where I get the 8% from.

In the investment world, not many do this to be honest. They employ all sorts of wild strategies that seek to get a short-term edge. Remember when high-frequency trading was all the rage? That was 10 years ago. You don’t hear about it anymore.

Sticking to basic principles will work in the long term. And making sure you’re adequately compensated for investing in the stock market is a pretty basic principle. It’s so basic, that most people have forgotten about it or never learnt it in the first place!

And because it only works in the long term, most people give up on it and revert to speculating.

But even if you don’t employ it in a valuation tool, understanding the concept is useful.

How do you use it then?

Well, in terms of what we’ve been discussing, it’s very simple.

Say you like a company that you think has a sustainable ROE of 15%. What would be a reasonable price to pay for it?

Well, assuming it pays all its earnings out as a dividend, the equation is very simple. You divide the ROE by the discount rate.

In this case, it’s 15/8 = 1.875.

That is, to get your 8% required return on a company that generates 15% ROE, you would pay no more than 1.875 book value.

However, most companies retain some percentage of their earnings, so there is a compounding effect you need to take into account when estimating value.

This is something I do for my members when recommending stocks. In general, it means the higher the percentage of retained earnings, the higher the valuation.

In reality, all companies need to reinvest some of their earnings to maintain competitiveness and their asset base. If you pay everything out as a dividend and never reinvest, you’ll eventually go out of business.

But some infrastructure-type companies do pay out all their free cash flow as a dividend. Transurban [ASX:TCL], APA Group [ASX:APA] and Spark New Zealand [ASX:SPK] are examples of this.

So, let’s look at what they’re yielding and work backwards. Are investors getting adequate compensation investing at these prices?

TCL trades on a prospective FY25 dividend yield of 5.05%.

APA’s is 6.9%.

And SPK’s is 6%.

That’s not adequate compensation for the risk of investing in a company’s equity if your required rate of return is 8%.

Why is the market pricing them like this then?

There are a few things to consider…

One is that not all investors in the market have the same required return as you. Insurance companies or super funds might have lower return hurdles to meet long-term obligations.

This means they are willing to pay higher prices for stocks, especially for reliable, monopoly type, income producing infrastructure assets like those mentioned above.

Do you really want to compete with investors like this, with deep pockets and very long-time horizons?

For me, these infrastructure companies are too expensive (relative to the current risk-free rate). But for others, their monopoly assets are attractive and worth buying, even though the equity risk premium is thin.

The thinking is that they might be a safer bet than government bonds in an inflationary environment, as they can increase prices and therefore increase dividends.

Better than bonds, maybe. But they have still performed poorly in the post-COVID inflationary environment.

Since 1 July 2020, APA’s share price is down nearly 25%, TCL’s is down about 10%, while SPK has increased around 2%.

Given the ASX200 is up around 30% over the same period, you can see these companies have underperformed significantly. They are clearly trading like bond proxies.

In a rising rate environment, they will struggle. In a falling rate environment, they will do well.

The fact of the matter is that in bullish markets like we’re in now, there are not many companies that offer adequate compensation over and above the risk-free rate.

There are definitely opportunities, they are just few and far between.

By way of explanation, have a look at the S&P500. It trades on a forward P/E multiple of 20.9 times. That translates into an earnings yield of 4.8%.

Compared to a 10-year bond yield of around 4.6%, that’s a skinny ERP.

But here’s a spanner in the works to consider. This is why the market is endlessly fascinating. Companies get the benefit of compounding via reinvested earnings, while bonds do not.

The US tax system does not advantage dividend payments like ours does with franking credits. So companies retain earnings in the US far more than they do here.

I would therefore argue that the US ERP should be skinnier than ours due to this compounding effect.

How much skinnier I don’t know.

But I do know (or at least think) that right now it seems a little too thin. Consider that the last time the US 10-year bond yield was at current levels was back in early November 2023.

At that time, the S&P500 was 13% lower. Yes, it seemed more risky back then. But as I said, that’s how markets work.

***

As always, send any comments or feedback to letters@fattail.com.au

Regards,

Greg Canavan,
Editorial Director, The Insider

Dear Reader,

Rumours abounded yesterday that Hong Kong is on the verge of approving new spot Bitcoin ETFs.

If true, it opens up Bitcoin [BTC] to Chinese institutions (and individuals) for the first time since it was banned in 2019.

This is just one of many catalysts set to hit Bitcoin and the wider crypto market over the next few months.

I’ve just released a special presentation on EVERYTHING you need to know.

If I’m right, you’ve a limited window of opportunity to claim your stake in this fast-evolving space before it’s too late.

And when I say limited…I mean just three days from now.

That’s when the ‘Bitcoin Halving’ is due to take place; an event that’s hardwired into the bitcoin algorithm and which halves the new supply of newly mined BTC.

Now nobody knows what could happen this time around, but historically, new all-time highs in Bitcoin along with many other altcoins have ensued in the following 18 months.

And while of course I believe crypto is an investment for way beyond the Halving event…it is a dead-set, guaranteed occurrence that gives anyone interested a clear and renewed sense of urgency.

The time to get interested is now. And that’s what my new presentation is all about.

You can access that presentation here for a limited time right here.

But for today’s piece, I want to give you a brief taste of the big picture behind these imminent changes.

It’ll help explain China’s about turn on crypto, as well as why some major banks are now buyers too.

Let me explain…

An old Russian warning

I once read a story about an old Russian worker.

His son — who fled Russia in the ‘90s to find opportunity in the west — recalled how his father worked his whole life in Soviet Russia, surviving various upheavals and hardships.

The careful father diligently put aside a bit of money every week to save for a modest retirement.

Unfortunately for him, just as he was about to retire, the Soviet Union spectacularly fell apart.

In 1992, Russian inflation hit 2,500% and continued at high levels for the next three years.

The old man saw a lifetime of savings wiped out in the blink of an eye.

And, as his son dryly noted, he ended up just buying a ‘good pair of shoes’ with his entire retirement fund!

This is an extreme example of how currencies can collapse in an instant.

But the truth is, all currencies slowly devalue over time and all currency regimes come to an end.

Right now, on that front, things are getting very interesting…

Central Banks are getting
out of US dollars

Consider this chart:

Throughout history, the global reserve currency has changed with the fortunes of the various empires that held power.

Right now, the US dollar holds this reserve status.

And while I’m not saying that’ll change overnight — though I’ll bet the citizens of Soviet Russia didn’t see their collapse coming so swiftly either — there are signs this current regime is in its death throes.

For example, check out this chart:

This chart shows the buying of US Treasuries (US government debt) by foreign central banks.

As you can clearly see, they’ve been reducing their holdings of US government debt continuously since the 2008 GFC.

Though, I should point out that foreign private banks and individuals have filled in some of this gap.

Still, it’s an interesting fact to note.

At the same time, central banks are loading up on their gold purchases.

As Mining.com reported this week:

‘Demand from global central banks for gold has been elevated for two years, and they are on track to remain active buyers in 2024, Gopaul said. Turkey, India, Kazakhstan, and some eastern European countries have been buying gold this year along with China.

‘The People’s Bank of China (PBOC) was the largest official sector buyer of gold in 2023 with net purchases of 7.23 million ounces, or 224.9 metric tonnes. It was the country’s highest single year of reported additions since at least 1977, according to the WGC.’

The gold price has finally reacted to this buying in recent months and now sits at record highs.

Why is all this important for you to know?

Well, you need to understand that central banks’ primary role is to ensure the stability of their currencies.

Without that, nothing else matters.

And to do that they need to be backed by ‘something’ that other countries have some confidence in.

A currency needs to be perceived as being able to store its value in some way.

That can by backing it with an actual asset, like gold. It could be a function of free trade. Or it could even just be ‘trust’ in the legal and economic system — as the US has enjoyed for decades.

Without that confidence, you risk a currency collapse (as we saw in the Soviet Union in the ‘90s, as well as in many other countries before and since).

It’s pretty evident most central banks see the US dollar as less reliable in fulfilling this role in the years to come. So they want less of it on their books.

Furthermore…

The confiscation of Russia’s US financial assets in the wake of the Ukrainian invasion was a strong signal to many countries — both friendly and unfriendly — that the US will weaponise its currency too.

The US dollar is no longer as trusted as it once was.

And if the global reserve currency is on shaky ground, it also applies to our Australian dollar (and every other fiat currency) too.

Trust in the currency system is diminishing worldwide.

The tell?

Inflation!

In turn, that means the value of every asset you hold — stocks, shares, property —could be going down, even if it’s going up in nominal terms.

In short, your wealth is already melting…

Protect your future

Whether it’s a sudden Soviet-style collapse or a 1970s-esque decade of inflation, the value of your money will continue to fall.

That is about as guaranteed as day turns to night.

It’s simply a question of how fast.

Your weekly grocery or quarterly power bill shows you it’s happening.

How can you escape this future?

The only option is to hold an asset that exists outside the current system.

To a degree, physical gold does this.

But in my mind, the better, more modern option is Bitcoin. It’s the world’s first conception of digital scarcity, tailor-made for our digital age.

I’m not alone in thinking this anymore either.

Consider this recent headline:

As I pointed out in Monday’s Fat Tail Daily, despite their rhetoric against it for years, even US banks and financial institutions have started buying it.

The Chief Investment Officer of the US$5 billion Houston Firefighters Retirement Fund said this week that:

‘10 years from now I’d be surprised if any pension fund doesn’t have an allocation to Bitcoin.’

Now, here’s the important point to come back to…

As I said above, in just three days, it’s set to become scarcer than gold.

And as Unchained Capital just wrote in a new 37-page report to institutional investors (emphasis added):

‘Its credibly fixed supply, coupled with its other superior monetary properties, positions it as a solution to the innovation trap humanity faces today, and the very fact that we’ve discovered the trap means we’re close to the economic singularity, where most wealth ends up in bitcoin.

‘Bitcoin may be the only asset that can stop the free market from inevitably “melting” your wealth.’

Look, I don’t pound the table often.

But this is something I truly believe in…and something I’m not just doing myself with my own family’s wealth…but something I’m urging everyone nearest and dearest to me to, at the very least, learn about.

You can watch my special presentation here now on why now could be your last chance to claim your stake in this new future before it’s too late.

Good investing,

Ryan Dinse,
For The Insider

Dear Reader,

It’s been a pretty ordinary weekend for human behaviour. In this melancholy mood it made me think of a great quote from that amazing movie, The Thin Red Line:

‘This great evil, where’s it come from? How’d it steal into the world? What seed, what root did it grow from? Who’s doing this? Who’s killing us, robbing us of life and light, mocking us with the sight of what we might’ve known? Does our ruin benefit the earth, does it help the grass to grow, the sun to shine? Is this darkness in you, too? Have you passed through this night?’

Alas, our beat here is money and markets, not philosophy. I have no answers about the madness of men.

Nor can I tell you what this potential new conflict in the Middle East means for markets, apart from the obvious. That is, oil up, gold up, stocks down.

But betting on the obvious never pays longer term, so it would be foolish to do so.

As a long-term investor, I’m happy to ignore all this noise and stick with the strategy of buying companies at an attractive price relative to their prospects.

I will say one thing on gold though. Last week I mentioned that it had barely made the news. Well that changed towards the end of last week. I even received a text from a friend on Friday night (who I don’t hear from all that often) mentioning the gold price.

That had me thinking a correction was imminent. And of course that happened on Friday evening. Gold peaked at around US$2,430 an ounce in US trade, before falling nearly US$100 an ounce by the end of the session.

But that was before Iran started raining bombs on Israel…

At the time of writing, the gold and oil markets haven’t resumed trading.

One asset class that did trade through the news though was crypto. In a sign of what might be in store for gold, Bitcoin actually traded lower this weekend, but in crypto terms, it was a mere flesh wound.

Our crypto expert Ryan Dinse no doubt thinks this is a buying opportunity ahead of the next halving. That’s why he’s getting on camera today for a very special and timely event called ‘The 4th Halving Gameplan’.

Now, if you ask a barber if you need a haircut, you know what the answer will be.

Ryan is the barber here and Bitcoin is the ‘service’.

But let’s not be too cynical. Bitcoin is a wealth generating asset, haircuts are a service. We received an email from a member last week saying he bought $3,500 of crypto on the team’s advice years ago, only to forget about it.

Upon remembering and checking his account, he found it had swelled to $113,000. Ignorance really is bliss!

But it also points to the long-term benefits of holding this asset class. Those who think it’s a quick-win, speculative vehicle, miss out. Those who hold long-term, through benign neglect or nerves of steel, usually win.

The problem is most people don’t forget about their holdings and most don’t have nerves of steel. Which is why you need a mentor to keep you on track.

For me, this is the benefit of Ryan’s Crypto Capital service. If you’re running solo in this market, the inherent volatility plays on your emotions. It’s very difficult to manage on your own. Which is why having a mentor is absolutely necessary if you want to invest in this space.

For example, here’s what Ryan wrote nearly two months ago, when Bitcoin suffered its first decent correction in this new bull market.

***

As I wrote two weeks ago in an update called ‘Surviving the Bull Market’.

‘Although I’ve no doubt we’ll see some big pullbacks in price as the trend plays out –30% drawdowns are fairly common even in Bitcoin bull runs — the signs are we’re still very early in this part of the cycle.’

Well, it looks like we finally got our first big pullback.

The kind of sharp price fall that’s so vicious even the Bitcoin uber bulls on my Twitter feed quickly turn into shivering wrecks.

This change in sentiment is good news!

Pullbacks in price are necessary to make any rise more sustainable.

It shakes out the low-conviction folk and short-term traders. And it allows longer term investors to get in at better price points.

But in the moment, I know it never feels great.

The current pullback has some interesting reasons behind it, but we’ll get to that soon, as well as some key price points.

But first, check this out…

Still Early Days

This chart shows the price trajectory of Bitcoin through different cycles:

The y-axis is on a log scale, so you’re looking at massive moves in price.

As you can see, we’re still very early in this current cycle (the black line). And the price is actually higher than it was at this point in the previous two cycles (blue and green lines).

So a pullback of sorts was probably overdue (though that’s always easier to see in hindsight!).

But more importantly, look how far along we are in this cycle.

The fun has barely started yet!

Now here’s the thing…

In previous cycles, the regret for many was jumping on too late and not selling any at the top.

In this cycle, I think the regret for many people will be selling too early.

As we’re seeing play out right now, Bitcoin’s infamous volatility remains, so it’ll be a challenge for many people to stick with it through such troughs.

It’s always been this way.

But in my opinion, the difference this time is that we do break out to much higher highs as the digital economy finally takes over the creaking edifice that is the current financial system.

***

That creaking edifice no doubt has some life in it. It’s been creaking along since the 2008 crisis. But massive fiscal deficits have become the norm since COVID. It’s not monetary excess, its fiscal excess. This could be the straw that eventually breaks the camel’s back.

If adding crypto exposure to hedge against this risk interests you, I urge you to watch Ryan’s presentation today.

***

Lastly, thanks for your feedback following my request in Friday’s Insider. If you missed that issue and want to contribute your two cents, go here. And send any comments/feedback to letters@fattail.com.au.

Regards,

Greg Canavan,
Editorial Director, The Insider

Inflation Spooks
but Gold Can’t be Stopped

By Murray Dawes

In this Issue:

A couple of weeks ago I discussed two underperforming gold stocks that I thought were on the cusp of playing catch-up.

Both stocks are up over 11% since then, so I hope you managed to jump on.

I personally don’t like it when analysts just trumpet their good calls and ignore everything else, so I will add that I still like Talga Group [ASX:TLG] which I spoke about recently.

While it has come off the boil, the chart still looks positive to me.

But graphite stocks aren’t firing yet, so I don’t expect Talga to rocket in the immediate future.

Gold stocks on the other hand are catching a strong bid as the US Dollar gold price continues to defy gravity.

Not only are we seeing a massive break-out from a three-year range, but geopolitical risks are rising as Iran and Israel face-off against each other.

I have been saying that there is one final resistance level at US$2,320 that could cause some problems, but gold sliced through it like butter.

As I show you in the Closing Bell video above, if gold hits US$2,470 it is confirmation for me that the range of the past three years is completely dead and buried.

Where gold heads above there is anyone’s guess.

All of this is happening as US bonds get hammered after another miss on inflation numbers during the week. Rising interest rates usually have a dampening effect on the gold price.

The fact that gold continues to go vertical despite the weakness in bonds is a bullish signal in my book. When a market continues to rally despite bad news, it hints that the price could go much higher still.

I pointed out recently that US 10-year bond yields above 4.40% would give targets to 4.70–4.90% which could cause selling pressure in stocks.

The bad inflation numbers during the week spooked the market, with core inflation accelerating higher again. That was enough to kick 10-year yields above 4.40% and they currently sit at 4.56%.

If bonds remain weak this month (yields rising) it will confirm a monthly sell signal in bonds within a long-term downtrend. If that occurs you should think long and hard about remaining long interest rate sensitive sectors.

Stocks, commodities and bonds are moving again after a long time in the wilderness. It’s time to prick your ears up and listen to what the market is saying so you can prepare yourself.

Click on the picture above to watch the latest instalment of Closing Bell and don’t forget to like the video on YouTube and comment if you jumped on those gold stocks!

Regards,

Murray Dawes,
Editor, Retirement Trader and Fat Tail Microcaps

Dear Reader,

Thanks for all your feedback on the ‘Uncommon Sense Investing’ series. It sounds like it’s something you’re enjoying and get a lot out of.

And there is so much more ground to cover. Using common sense to invest really is uncommon. And I think being able to do so consistently can lead to market beating returns over the long term.

So I’m looking forward to continuing the series. But today, I’ll take a break. There has been a lot going on lately and I wanted to get your thoughts on it.

Here’s just a few of the developments…

• Bitcoin and gold surging to new all-time highs…despite relatively high interest rates in the US and Australia. Is this speculation or a sign of fiat currency debasement?
• The government is ‘printing people’…immigration levels are off the charts, creating housing and rental crises. As a result, the young are increasingly disenfranchised. Is it the same for every generation or is this time different? How do you feel about your kids’ (or grandkids’) future?
• Is the energy system breaking down? The government wants us to become a solar panel manufacturer, despite having no competitive advantage. Fiddling while Rome burns? We’re looking at gas shortages and increasing pressure on the grid this winter.
• Related to this, governments around the world are spending trillions on the ‘energy transition’. Is this money well spent or going into the pockets of special interests and just making inflation worse (lots of spending for not much increase in output)?
• Stocks at all-time highs. A sign of a strong economy or weak currency?
• The rise of ETFs. Is this a new way of investing or a new way for ‘Wall Street’ to make money from ‘passive investors?
• Interest rates at long-term highs. Are you content with ‘money in the bank’ over the ‘risks’ of the market.
• And whatever else is on your mind!

There’s a lot to ponder there. I know how I’m thinking about it, but I’d be interested in getting your take, too. When you’ve got your money on the line, these are real concerns and require deep thought about how best to navigate them.

Perhaps as a community we can share ideas that might be beneficial. Of course, not everyone is in the same boat. Some are trying to build wealth; while some are trying to preserve it for retirement, or to pass onto their kids to give them a leg up in this monetary experiment we are living in.

So let me know what you’re thinking. You can do so at letters@fattail.com.au.

Speaking of monetary experiments, the biggest beneficiary of the breakdown of the old system is the world’s newest monetary experiment – Bitcoin.

So I’ll leave you today with a chat between Woody and our Crypto expert, Ryan Dinse recording earlier this morning. As Ryan points out, the big banks are moving into Bitcoin via the recently established ETFs. And China, of all countries, looks like it’s about to launch its own ETF.

And all this is happening before the next halving…just one week away now.

So, enjoy the conversation, and please let me know how you’re thinking about the challenges I laid out above.

And if ‘The 4th Halving Gameplan’ event Ryan is hosting on Monday has you intrigued, get your name down here.

Have a good weekend…

Regards,

Greg Canavan,
Editorial Director, The Insider

Dear Reader,

The clocks went back here in Melbourne on Saturday night.

It meant an extra hour in bed on Sunday morning…or it might’ve if it wasn’t for my three boys (aged 8, 4 and 2).

For them, it meant getting up (and me) at 5.30 am instead of 6.30 am!

The American founding father Benjamin Franklin is credited as being the first person to push the idea of daylight saving.

Apparently, he suggested it on one of his many trips to France after realising he was wasting his Parisian mornings by staying in bed!

So he proposed the French fire cannons at sunrise to wake people up and reduce candle consumption at night.

Over the next 100 years, the Industrial Revolution drove political interest in maximising ‘working hours’.

And the time was set according to the sun in every town and city — often resulting in different times between even close major cities.

Today things are more uniform and organised thanks in part to the advent of the railroads.

After all, you couldn’t have a functioning railway service nationwide if every town and city operated on a different clock!

So, countries started to standardise their national time zones.

Anyway, for those that have it (not you guys in WA, NT, or Queensland!) daylight saving is now a familiar feature of our yearly calendar.

Forwards in Spring, backwards in Autumn.

As regular as clockwork.

Not coincidentally, we turned on our heater for the first time this year in the Dinse household a few days later.

My point is…

10 Days to Go

Our life is driven by cycles.

The earth’s daily rotation. It’s yearly voyage around the sun.

The phases of the moon bringing the shifting tides.

Periods of rain, periods of drought.

These cycles — even of birth and death — define our lives…as well as our veggie patches!

These are all familiar patterns…some long, some short, but all repeatable and to an extent, predictable.

In investing, there are cycles, too.

Business cycles, adoption cycles, product cycles, economic cycles, cycles of fear and greed, and political cycles.

They all have some bearing on your investing decisions.

But the cycle I’m most focussed on right now is the Bitcoin cycle.

You see, in just ten days’ time we enter a new cycle — the fourth halving.

This is the fourth time in fifteen years that the supply of new Bitcoin has been cut in half.

It’s a pre-programmed part of Bitcoin’s monetary schedule as predictable as the clocks changing.

Check it out:

Under a Bitcoin standard, you don’t need to guess what Jerome Powell or Michele Bullock are thinking.

There are no insiders that can front-run you.

Everyone knows as much as anyone else. It’s a financial level playing field.

You merely need to look at the source code run by a decentralised global network of miners (validators) and nodes.

Here is what that looks like:

These few lines of code mean that every 210,000 blocks (roughly four years), the supply of new Bitcoin paid out to Bitcoin miners is cut in half.

Now, remember there will only ever be 21 million Bitcoin.

And, as of 20 April 2024, 93.75% of all Bitcoin to ever exist will be out ‘in the wild.’

By the time we reach the 5th halving in 2028, almost 97% of all Bitcoin will have been mined.

It’ll take another 112 years to release the last 3.12%.

As you’ve probably realised, Bitcoin is about to become super scarce.

In fact, it’ll be scarcer than gold in just 10 days.

Next Saturday, Bitcoin’s annual supply growth drops from 1.7% to 0.85%.

This beats gold’s number of 1.6% per annum growth (the supply of gold doubles roughly every 44 years).

If every millionaire in the world tried to buy one whole Bitcoin each, there simply wouldn’t be enough to go around.

But here’s the more important thing…

What Happens Next?

This predictable halving cycle has some very interesting consequences on the price of Bitcoin.

Check out what happened over the last three halving cycles:

As you can see, the price of Bitcoin was much higher one year after each halving date.

And the similarities between each cycle are even clearer to see on this chart:

Or how about this one?

OK, I think I’ve made my point…

As you can see for yourself, each halving is a pivotal moment in time for the price of Bitcoin.

And so far, the cycle has been repeated every single time.

In fact, within 100 days, we usually see new all-time highs and the start of a euphoric rush of interest.

Why?

Simply put I think that moment helps define the dominant feature of Bitcoin in people’s minds.

Namely, a decentralised store of value asset, the world’s first conception of digital scarcity.

I mean, consider the guaranteed scarcity value of Bitcoin versus the current global reserve asset:

This is the growing debt pile of the US — new debt is really just the creation of new dollars out of thin air.

This is predicted to grow to over US$54 trillion over the decade.

The consequences of this never-ending supply of new money are apparent to us even today.

We’re seeing the price of everything go up as more dollars chase fewer goods and services.

And if interest rates ever fall, we’ll see bubbles in stocks and property start up again like we did in 2020 as cheap debt pumps asset prices ever higher.

The monetary system has distorted the concept of free markets to such an extent that true price discovery is almost meaningless.

Instead, everyone just ‘watches the Fed.’

In short, this old system of money is in an ongoing death spiral.

If it fails, what will replace it?

In my opinion, this is why we’re seeing the price of Bitcoin (and gold) start to surge.

They represent two store of value assets that can’t be ‘printed at will.’

But Bitcoin has more than just that going for it…

It’s also the foundation of a new digital financial layer.

A new system of ‘blockchain’ rails that’ll replace the crumbling edifices of the old money networks.

Ironically enough, the person pushing for this future hardest right now is a certain Mr Larry Fink.

As you probably know, Fink is the CEO of the humungous Blackrock group. A company that is the epitome of the old money system.

Given that, ask yourself this — why does Fink give two jots about Bitcoin or crypto?

And yet he does — a lot!

Here he is on prime-time TV talking not just about Bitcoin, but also about using crypto to tokenise the entire financial system!

Anyway, there are many layers to this fast-unfolding story.

And in a delicious twist of fate, it all hinges around Bitcoin’s halving date of 20 April.

Just 10 days away!

That’s why I’m rushing to put together a new special presentation on everything — and believe me, there’s a lot! — that’s happening right now.

More importantly, you will learn how to invest smartly through this exciting period of the crypto cycle.

To reserve your spot for that, click here.

Good investing,

Ryan Dinse,
For The Insider

Dear Reader,

Gold futures jumped another 1.6% in US trade on Friday to trade at nearly US$2,350 an ounce.

You know the best thing about this?

It’s not making headlines. At least not in a way that would make a contrarian investor nervous.

Nothing recent in the Financial Review or the business section of The Australian. That’s despite gold surging to an all-time high of nearly $3,560 an ounce in Aussie dollars on Friday.

Instead, the Oz is running with the green dream in its commodities section this morning…

‘Fortescue will open Australia’s largest electrolyser manufacturing facility at Gladstone on Monday as part of plans by the Andrew Forrest-backed mining giant to become a major force in hydrogen and renewable energy.’

Keep an eye on the Fortescue [ASX:FMG] share price. It’s taking the cashflows from its highly profitable iron ore operations and putting them into dubious renewables and hydrogen projects.

Good luck with that.

But back to gold…

The Financial Times did run with a ‘Gold or gilts: which is best for inflation protection?’ headline last week. Not exactly uber bullish though, is it?

And there was this interesting headline from The Wall Street Journal over the weekend:

‘The Costco Shoppers Putting $2,000 Gold Bars in Their Carts’

‘Craig Beauregard and Julia Edwards were at Costco shopping for groceries in December when they spotted a deal that was too good to pass up: a one-ounce bar of gold.

‘Beauregard, 33 years old, checked his phone and saw the bar’s retail price of $2,069 was $3 below its on-the-spot price in financial markets. They threw it in their shopping cart next to a seven-pound bag of frozen chicken and a carton of Kirkland eggs.

‘Americans can’t get enough gold. Costco, which started offering gold bars last year online and in a few stores, has been selling out within hours. Consumers rated gold as a better investment than stocks and mutual funds in 2023 for the first time in a decade, according to a Gallup poll. The price has been hitting record highs.

‘Beauregard and Edwards said inflation has eroded their trust in the U.S. dollar. They increased their investment in physical silver and gold to diversify their portfolio, which also includes 401(k)s, stocks and crypto.’

The thing that the ‘average person’ gets — and this is something that Wall Street types and finance editors often don’t — is that the value of money is eroding much faster than official inflation figures would have you believe.

If you’ve got a set budget each week (not an unlimited amount of fiat currency in your account) you are acutely sensitive to monetary debasement.

And it’s happening big time. Which is why you’re seeing gold and bitcoin hit all-time highs. Or, put more correctly, the value of the world’s reserve currency is at all-time lows relative to these monetary hedges.

Over the past few decades, we’ve been conditioned to blame the Fed for this monetary debasement. But the Fed funds rate is as high as it’s been since early 2001.

And US 10-year real yields (nominal yields minus inflation expectations) are around 2%. They haven’t been consistently this high since before the financial crisis.

So where is this debasement coming from?

Look no further than the US government. The US ran a deficit of 6.3% of GDP in FY23 (the year to September), after a 5.3% deficit in FY22, and 15% and 12% deficits in FY20 and FY21.

The Congressional Budget Office’s latest forecasts don’t paint a pretty picture for the future either. In fact, it’s scary:

FY24: 5.6%
FY25: 6.1%
FY26: 5.3%
FY27: 5.8%
FY28: 7%
FY29: 8.5%

Are you kidding me?!!

The US isn’t in recession, and this is its fiscal outlook?

If you think career politicians who get re-elected by handing out money are going to rein this in, you’re kidding yourself.

No wonder ordinary people are trying to protect themselves. Saving in fiat is a mug’s game.

While gold is at risk of a short-term pullback (as Gold Stock Pro editor Brian Chu writes below) the recent breakout to new all-time highs is significant. In my view, this is the start of a long-term move.

Here’s Brian’s recent commentary. Note his speculative gold stocks index is back above the 200-day moving average…

‘While gold’s recent rally is substantial, the technical signs suggest the price action may be a little overheated.

‘Gold could pull back to US$2,100 to form a base in the coming weeks. That’d be a healthy thing as it sets up for a major run towards US$2,500.

‘I know that we’ve been through so many false starts that we’re starting to wonder if this space will ever get off the ground.

‘But take heart, things are turning around.

‘Why do I have such conviction?

‘Take a look at the speculative gold stocks index below:

‘Having bounced since the start of March from the selloff, it has traded at a tight range until now. It’s looking to break upwards once more.

‘If you look at the individual companies that form the index, some of them have risen double-digit percentages in the last few days, and have held these gains.

‘Our recommendations have seen that too.’

As I said, it’s not just gold and gold stocks starting to move. ‘Digital gold’ (Bitcoin) and all things crypto are benefiting nicely from this fiscal insanity.

You’ll hear more about this from Ryan Dinse in Wednesday’s Insider.

Stay tuned for that…

We closed down our special Gold Stock Pro offer last week. But a few stragglers have enquired about it, so we’ve decided to open it up one last time for the next 24 hours.

If you want to see which junior gold stocks Brian is recommending right now, go here. Just keep in mind his warning that in the short-term, the price looks stretched. We want you with us for a long time, not a short time, so go into this sector with your eyes wide open.

***

As always, send any comments or feedback to letters@fattail.com.au

Regards,

Greg Canavan,
Editorial Director, The Insider

Oil Price Rally to End the Market’s Bull Run?

By Murray Dawes

In this Issue:

Oil prices are marching higher as geopolitical risks rise.

Spikes in the price of oil and gold on the back of geopolitical risks are usually reversed within weeks when nothing much happens.

That may be the case this time around, but the technical situation in oil prices is explosive.

I make the case in today’s Closing Bell video that brent crude oil prices could spike towards US$107 if resistance at US$96 gives way (current price is US$91).

That could feed into heightened inflation expectations down the track, which could hurt bond and stock prices.

US stocks remain in a strong uptrend so it will take plenty of downside volatility to threaten the positive momentum. But as the rally continues heading higher there are resistance zones that investors should be aware of, which I point out in the video above.

As long as US 10-year bond yields remain below 4.40% there is reason to remain bullish on bonds, but above there we could see a spike in yields towards 4.70–4.90% which would place some pressure on stock prices.

Regards,

Murray Dawes,
Editor, Retirement Trader and Fat Tail Microcaps

Dear Reader,

‘It is extraordinary to me that the idea of buying dollar bills for 40 cents takes immediately with people or it doesn’t take at all. It’s like an inoculation. If it doesn’t grab a person right away, I find that you can talk to him for years and show him records, and it doesn’t make any difference.

‘I’ve never seen anyone who became a gradual convert over a ten-year period to this approach. It doesn’t seem to be a matter of IQ or academic training. It’s instant recognition, or it is nothing.’

Warren Buffett — The Superinvestors of Graham-and Doddsville

I reference Buffett, Charlie Munger and Ben Graham a lot in this Uncommon Sense Investing series, and I will continue to do so.

Buffett learned his principles from Graham. Munger evolved these principles to make Berkshire into the behemoth it is today.

Buffett wrote in his recent annual letter that Charlie was the ‘architect of Berkshire Hathaway’. It was in tribute to Charlie, who passed away in November. Apparently, Charlie told him back in 1965:

“Warren, forget about ever buying another company like Berkshire. But now that you control Berkshire, add to it wonderful businesses purchased at fair prices and give up buying fair businesses at wonderful prices. In other words, abandon everything you learned from your hero, Ben Graham. It works but only when practiced at small scale.”

Buffett and Munger (and Graham) have laid down a blueprint for successful investing. You don’t need to be a maths or trading whizz. You don’t need exceptional intelligence. You just need a few basic principles and the discipline and patience to stick with them.

Unfortunately most investors lack discipline and patience. They want quick wins…action…results. They want the market (prices) to confirm their views. They are a part of Graham’s voting machine. And they want to vote on what’s popular.

Such speculation is fine if you keep it within limits. But it is not investing. Buffett and Munger have shown us the long-term benefits of having a sound investment framework.

What other investment vehicle from the 1960s is still going strong? If that’s not a model to follow and try to emulate, I don’t know what is. The trick is to remind yourself of this framework constantly so you can maintain the discipline to follow it.

That’s what this series is about.

Buying dollars bills for 40 cents

Which brings me back to the first quote. Buffett talks A LOT about ‘buying dollar bills for 40 cents’. But what does he mean by that?

In the early days, it meant being able to buy a company for 40 cents when its net tangible assets were $1. This is straight from the Graham school of investing.

But in the early days, there were plenty of opportunities like this. As time went on…not so much.

With Munger’s help, Buffett realised that he could buy companies well above net tangible assets…even well above net assets (which includes intangibles) and still get a bargain.

This is where the ‘magic formula’ comes into it. All throughout Buffett’s letters, he makes reference to things like ‘book value’, ‘return on incremental capital’, and ‘retained earnings’.

He writes cryptic things like this:

‘We feel noble intentions should be checked periodically against results. We test the wisdom of retaining earnings by assessing whether retention, over time, delivers shareholders at least $1 of market value for each $1 retained.’

What does it all mean?

What Buffett is saying is that there is a crucial relationship between book value and the return on that book (equity) value. The higher the sustainable return on equity (ROE) a company has, the higher the premium to book, or equity value it will trade at on the stock market.

Forget the P/E…look at the P/B!

That premium (or otherwise) is represented by the price-to-book multiple, or P/B multiple.

No one really talks about it. Rather, it is the price-to-earnings (P/E) multiple that gets all the airplay.

Buffett doesn’t care for the P/E multiple. His focus is on the P/B multiple. And you can only assess the P/B multiple correctly if you know the sustainable ROE a company can generate (or at least make a good guess of it).

For example, if a company trades on a P/B multiple of 2, it means the market value (as set by investors on the stock market) is twice the value of the equity on the balance sheet. Balance sheet equity is just another name for book value.

Therefore, if this company retains $1 of earnings from its profit (instead of paying it out as a dividend) it will turn that $1 into $2 of market value.

But what makes a company trade at a P/B of 2? Here’s a simple way to think about it. Say this company generates a sustainable return on equity of 10%. And say the risk-free rate is 5%.

Ignoring the need for a risk premium to invest in stocks (which, by the way, the US market is doing now) you just divide 10 by 5, and voila.

If the company’s sustainable returns drop to, say, 7%, the P/B multiple would decline to 1.4. So $1 of retained earnings turns into $1.40 of market value.

The quote from Buffett above comes from the 1983 shareholder letter. Back then, interest rates were much higher, probably around 12%. What he was saying was that Berkshire should at least be generating returns of 12% on equity capital to maintain a P/B of 1.

That’s something to keep in mind if inflation becomes embedded. It will structurally lower intrinsic values across the board.

A bargain stock might be one where you buy a company for 1.5 times book value, but it’s actually worth 2.5 times book value. There are mispricings like this all the time. Especially in a world of passive ETF investing where no one cares about valuation.

It works the other way too. Companies with low returns on equity trade at discounts to their book value. That’s why you need to be careful investing in them. Some are cheap. But some are not.

And if they’re reinvesting profits, they’re turning $1 of retained earnings into less than a dollar of market value. Not good!

You can test this out this relationship between ROE and P/B on any company you’re interested in. Just divide the ROE by the Aussie 10-year bond yield and the result will probably be in the vicinity of the current P/B.

So there you go. P/B and ROE are joined at the hip. You can’t understand one without the other.

Before I wrap it up, one crucial caveat…

You can’t value/evaluate all companies like this. It works best on more mature companies, or smaller companies operating in mature, or easy to understand industries.

But the more you experiment, the more you learn…

***

As always, send any comments or feedback to letters@fattail.com.au

Regards,

Greg Canavan,
Editorial Director, The Insider