June 23, 2010
Oxford, England

Yesterday in the UK, something happened that has significant implications for us all.

Old western economies are clearly losing their dominance. Particularly in Europe, the costs of broken pension plans and entitlement programs are bankrupting entire economies.

Yet, national governments continue to perversely borrow and consume; politicians have been acting like degenerate gamblers, borrowing money from anyone they could, blowing it all on terrible bets, borrowing more money to make even worse bets, and actually expecting different results.

Something needs to change… and it appears that Britain is the first major western government to face the music. As such, British Chancellor of the Exchequer George Osborne unveiled yesterday what has been touted as ‘emergency’ budget austerity.

Osborne’s budget cuts deep. It hits the elderly, it hits low income workers, it hits single mothers, it hits business owners and investors… it even hits the Queen, who will see her multimillion pound salary frozen for several years.

To give credit where credit is due, Osborne should be commended for looking his nation in the face, speaking about a very grim reality, and being candid about the tough sacrifices that everyone will have to make.

But here’s the scary part, and what we need to learn from:

While there was significant talk in Osborne’s speech about spending cuts, most line items have yet to be fully determined. What they are absolutely clear about, though, are the tax changes.

Britain’s VAT, for example, will increase from 17.5% to 20%.  Many personal income tax rates will rise as well, particularly for high income earners.  These changes will be phased in gradually… except for one.

Osborne announced that Britain’s capital gains tax will increase from 18% to 28% for higher income earners. Yet unlike the other changes which are phased in over time, capital gains tax change occurs IMMEDIATELY.

There is a serious lesson here: governments have the power and willingness to make major changes overnight. With the stroke of a pen, they can impose capital controls, higher taxes, gold forfeiture, confiscation of retirement savings, or anything else they can dream up.

Britain’s emergency budget underscores this point even more, and reminds those of us who aren’t in the UK that we need to prepare NOW.  Why? Because other countries won’t be far behind, including the United States.

At a certain point, President Obama will be forced by circumstance to look the American people in the eye and ask them to sacrifice… and pay higher taxes effective immediately.

Also, it’s likely that the US government will get its hands on private retirement savings some day soon… there’s about $5 trillion out there, and at some point that they’ll mandate a portion of all managed retirement accounts to be held in the ‘safety’ of US Treasuries.

I can’t stress this enough– proper financial planning should be an integral part of your multiple flag strategy.

To protect yourself from overnight tax hikes, this means using existing, legitimate tax shelters.  US tax code, for example, provides a means for people to set aside tax-deferred savings for retirement through an IRA or 401(k).

Most of these entities, though, are unfortunately engineered to generate profits for the financial institution who manages the account, rather than the individual who is busting his butt every day to save for retirement.

The best solution that protects your savings from rising tax rates and government confiscation is to hold your investments in an Open Opportunity IRA structure.

Similar to a regular IRA, an Open Opportunity IRA allows you to generate tax-deferred (or tax-free) returns on your savings. Unlike a regular IRA, this structure gives you complete control and flexibility to do what you want with your retirement savings– like planting multiple flags overseas.

With an Open Opportunity IRA structure, you can buy foreign property, store gold overseas, establish an offshore bank account… as well as invest in all the other instruments that you might already be investing in right now with your retirements savings.

The big difference? It’s nearly impossible for the government to get their hands on it.  And if you start investing through this tax deferred structure, you won’t wake up one morning to higher tax rates that will pummel your investment returns… which is exactly what happened in the UK this morning.

This is one of the biggest no-brainers for US taxpayers… even if you’re just starting out, establishing one of these structures provides a long-term solution to generate tax-deferred or tax-free savings as you make contributions over time.

Terry Coxon is a leading expert in this industry; he’s authored numerous books on tax and personal finance issues, and his latest e-book is one that you should absolutely own.

In Unleash Your IRA, Terry explains the real magic behind these structures– how to set one up, how to protect yourself and your assets, and all the amazing things you can do while still following the tax rules.

Click here to get this book now.

I strongly urge you to take action now… continuing to kick the can down the road is a very dangerous course of action given all the warning signs around us.

May 21, 2010
Quad Cities, IA, USA

It’s been a lovely few days here in America’s heartland… I’ve been able to catch up with some of my friends, but to be honest with you, I’m aching to get back on a plane and get out here.

I’ve decided to wait it out for another 2-weeks; there is an Atlas 400 gathering in New York City on June 4th, and a lot of my friends have committed to attending. One member is traveling from as far as the Philippines to attend, so I’d really like to be there.

Immediately after the Atlas event, though, I’m going to hop on a plane with my business partner and a few other members for Panama, then Brazil, then Europe.

I’ll tell you more about what I have planned for that trip later. For now, let’s move on to this week’s questions.

Leading off, Kyle writes, “Simon- I would first like to thank you for your letter; it is a very good way to start my day. Question: I am a 20 year old male who is soon joining the US military. Given my small budget, what do you recommend I do to protect my assets?”

I get this question a lot, and it’s great that you’re thinking in the right direction. However, with limited assets, you really don’t have any assets to protect. Instead, if I were in your soon to be well-polished boots, I would focus on four things:

First, the military has a way of taking young people at an impressionable age and teaching them how to excel within a bureaucracy… not to mention the military can also inculcate groupthink. I’m speaking from experience.

This may be good for unit discipline, but it’s terrible for the mind of a free man. I would strongly encourage you, during your service, to focus on keeping your mind free and creative– read as much as possible, ask questions, and understand that the military microcosm is not the real world.

Second, as you will not have much time or availability to build financial assets during your time in service, you should focus on building up your most important asset– yourself.

This means developing skills. Learn as much as possible– a foreign language or two, a technical trade, medical training, etc. These are subjects which are easy to pursue in the military. On the side, I would also be reading about sales and marketing– generating revenue is always a valuable skill.

Third, I would focus on cultivating an international mindset. Try to get stationed overseas, and immerse yourself in the culture. If you unfortunately end up deployed to the Middle East, make the most of it by interacting with the locals as much as allowed and learning the language.

Fourth, be smart with your money. The military makes it easy to save– they provide a roof over your head and food on the table, so save as much of your salary as you can so that you have a sizeable pool of capital by the time you are finished.

Next, Rick asks, “Simon, I get your Notes from the Field every day. Do you have any premium services available that I can subscribe to?”

I enjoy writing a free, daily publication… but I recognize that there is a lot more information that I can provide that goes beyond the scope of this short blog.

Not to mention, there is a lot of information that I would like to provide that I am simply unwilling to publish in this forum. My trusted contacts around the world don’t want their contact info posted online, and I don’t want the most sensitive information to be indexed and archived by Google.

Matt and I have come to the conclusion that the best way to provide the most comprehensive and sensitive information to subscribers is to launch an additional premium service. I’ll give you more details at a later date when I can dedicate more space to the topic. I need to move on for now.

Peter writes, “Hi Simon, earlier this week you said that you are closing out almost all of your speculative positions. Does that mean you are holding on to your non-speculative positions? What type of investments are those?”

For me, my nonspeculative positions are anything where I simply don’t care about the investment return. Physical gold is one such example– it doesn’t matter to me whether the price of gold rises or falls, the value of my coins remains the same to me.

Another example is private stakes in non-public companies, of which I own a few; I made these investments to generate long term profits and enterprise value, not to speculate on the immediate appreciation of share price.

Real property that I hold for its yield, or because it has personal benefit (an escape pad) is also a nonspeculative position.

When I say ‘speculative position,’ I’m referring to instruments in the public markets (stocks, currency, etc.) that I purchase or sell short because I’m speculating on a rise or fall in the asset price.

These are the positions that I’ve closed– there is way too much government intervention in the marketplace right now, and whenever that happens, there are always gross misallocations of private capital that wreck havoc on asset prices.

To be clear, this includes the long gold/short euro position that we closed on Tuesday at 1,003 euro, booking a 35% gain.

May 19, 2010
Quad Cities, IA, USA

I wanted to send you a short note today from America’s heartland to tell you what I’m doing with my investment capital, and why.

I’m closing out almost all of my speculative positions and going to sit on the sidelines for a bit because I’m concerned that the markets are entering another major deleveraging period.

Here are the facts which concern me-

1) Interbank lending in Europe is on the decline. Banks are now hesitant to lend to each other for fear and skepticism of what may be on others’ balance sheets; sovereign debt default has everyone worried, and lenders are mistrustful of anyone who may have exposure to the PIIGS.

The consequence is that European banks are now sitting on their cash and not extending credit to businesses, consumers, and investors. As the modern financial system depends entirely on the availability of credit, a major reduction in credit curtails output and demand, reducing asset prices.

We saw how a credit crunch affected asset prices in 2008, and what’s happening with European banks right now is similar.

2) Markets have been incredibly volatile lately, and this trend is likely to persist in the near term. Extreme volatility can often cause capital flight from risky markets, either due to margin calls or risk aversion.

When capital flees markets, prices fall. We also saw this in the autumn of 2008.

3) Government intervention is on the rise. Yesterday, Germany dropped an 800 pound gorilla on the markets by announcing a series of bans on certain short trades. Among the consequences is that credit markets now have reduced capability to hedge their exposure to risky sovereign debt.

In Switzerland, the central bank (SNB) has dramatically intervened in the currency market, boosting the euro by over 225 pips against the franc for a roughly 1.4% gain overnight. This is a huge move for a major currency.

History shows us that government interventions do not stabilize the markets. At best, intervention discourages private capital from participating in the markets; at worst, intervention encourages gross misallocations of private capital by trying to second-guess future interventionist moves.

Either way, the effect is negative for markets and asset prices.

4) Substantial risks still exist which could cause another leg down in the markets and create more capital losses for banks. These risks include sovereign debt erosion (which is happening), continued rise in foreclosures (which is happening), and a major currency crisis (which is unfolding).

In each of these cases, the net result will be reduced lending and credit availability as banks have to focus on rebuilding their balance sheets and increasing loss reserves.

Again, we saw the effects of these risk factors in 2008. Banks have been on the sidelines ever since, and the consequent lack of credit availability created major cash shortages in the broader economy.

The result is a fire sale of all assets, which causes steep price declines.

To be clear, I think this will affect the gold market as well, mostly because of the reciprocal effect of ETF instruments. The SPDR Gold ETF, better known as GLD, is allegedly the largest private holder of gold in the world.

In the event of a market meltdown, significant sales of ETF shares trigger a sale of gold holdings, which would in turn cause a further decline in the ETF shares, triggering more sales of gold holdings.

It’s a cycle of momentum. Just as we saw oil prices quickly rise to $147 in 2008, the inverse of this cycle is a rapid unwinding. Gold could get caught up in this because there is so much ETF exposure. Consider this if you are holding gold for speculative purposes.

Silver, however, would likely fall even more… and that’s why a bet on a rising gold/silver ratio is one of the few speculations that does make sense to me right now. I could see it rising from 63 to 75 or 80 in the near future.

In full disclosure, none of these assessments is a foregone conclusion in my book, but I see enough risk in the marketplace to take my speculative cash off the table… and that’s really what I wanted to tell you today.

I don’t have a high risk tolerance with my money, and when I see one ‘investment professional’ after another on CNBC telling me why I should jump into the markets because everything is rosy, I get really nervous.

The truth is that until there is some finality with the challenges in the eurozone (which will take quite some time), I don’t see how the markets can do any better than trading sideways.

May 17, 2010
Undisclosed location

You’ve probably seen some clips on the news about the political current unrest in Thailand, and some headlines like “CHAOS IN THAILAND!”

These headlines are inaccurate. Thailand, the country, is not in chaos. The political unrest is taking place in a small section of Bangkok, and this is where the chaos is… actually, it’s more like a war zone.

In the rest of the country, though, it’s business as usual.

I’ve been talking to a lot of my friends and business partners fairly regularly who live in Thailand. Most of them have noticed no changes at all– they’re still sitting on the beach in Koh Samui or drinking beer with the bar girls in Pattaya.

Even some friends who live in Bangkok are going on about their normal lives.

One close friend of mine, though, is living quite literally in the middle of the kill zone. He tells me about how he can hear gunfire and explosions from his living room window… and as a young, brand new father, he’s nervous.

Rightfully so, I’d say.

He went on to describe the ‘business as usual’ attitude in Thailand– “hey look, this is the Land of Smiles. They treat conflict with passivity… just ignore it with a smile and hope that it goes away. That may be beneficial for small conflicts, but in this case, it’s gotten out of hand.”

To be clear, political tension is normal for Thailand– coups are frequent, corruption is pervasive, and demonstrations are commonplace. You can see this in the market as investors have shrugged off the turmoil; the Thai baht and stock exchange are both largely unchanged over the last 3 months.

This latest conflict, however, seems to be something entirely different. Local Thais are now starting to take notice and say “this is unlike anything we’ve seen before,” and their anxity level is starting to rise.

The seeds of revolution were planted in September 2006 when “democratically elected” Prime Minister Thaksin Shinawatra was ousted, in absentia, by a military coup. It appears now that a civil war has been brewing ever since.

Thai protestors are demanding that the current, ‘illegitimate’ government step down and hold new elections. They don’t seem to be going anywhere until they get their way.

The government has rolled out the military to contain the protests… but as it turns out, the protesters are well armed and equally willing to shoot, and kill.

Jean-Jacques Rousseau once wrote in his treatise The Social Contract, “as long as a people is compelled to obey and does so, it does so well; as soon as it is able to throw off its yoke and does so, it does so even better…”

True believers are skilled at insurrection, and for this reason, the conflict could go either way. The protestors could be overpowered by government forces, or the government could finally be compelled (with support from the international community) to hold new elections.

Here’s what really scares me, though…

The King of Thailand is old. He’ll be 83 this year and has reigned for nearly 64 years. This longevity has created an overwhelming sense of respect and adoration for him among all Thais– the monks, the military, and the people.

In this conflict, he wields power over both sides… and while he has a history of staying out of political maneuvering in Thailand, the few times he has used his authority to step in has immediately ended the conflict.

If things truly get out of hand in Thailand in the coming weeks and months, the King could put a stop to it all by wagging his little finger.

But if something should happen to the king during this conflict, I’m concerned that the country could descend into major turmoil. At best, Thailand would have another military governorship. At worst, the present quagmire could persist for years.

In the long run, Thailand will pull through just fine, as it always does. It will remain an international hedonist’s and retiree’s paradise, full of cheap living, wild nightlife, and accommodating locals.

But Thailand could be in for a rough couple of months… especially if something does happen to the king.

In that case, I would expect that the price of rice (of which Thailand is a major supplier) would go through the roof, and both the Thai baht and stock exchange would take a major beating.

You can invest in rice futures (either going long in expectation of conflict, or shorting at the peak) with any commodities broker, or an Interactive Brokers account. You can take a position in the Thai baht and stock market through a brokerage like Boom Securities, based in Hong Kong.

May 14, 2010
Undisclosed location

I want to start off today by once again thanking you for all the well-wishing emails after my operation this week. I read through a large backlog of email last night, and I was truly humbled by all the positive energy and goodwill out there. Thank you.

With that, I’d like to jump in to this week’s questions:

Phil says, “Simon, I sincerely appreciate the info contained in your letter. I’d like to take your advice: get second citizenship, buy property overseas, store assets outside the US, etc. I’m wondering if you can recommend a ‘how to’ guide with specific instructions for these issues?”

At the moment, there really isn’t one out there that covers the specific ‘how to’ details of getting started with multiple flags. I try to cover these issues on a daily basis, but as our conversations cover so many different topics an abbreviated space, I know we could go much deeper.

Right now, I’m working with a very capable partner to draft a multiple flags instructional overview. I suspect it will be exactly what you’re looking for. We should be finished in a few weeks, so stay tuned for more information.

Maldek asks, “Simon, how do you think the Euro/dollar exchange rate will change if Germany leaves the eurozone and introduces its Deutschmark (DM) again?”

Rumors are already flying that both France and Germany have separately threatened to bail out of the eurozone. It will happen eventually– the single currency is absolutely doomed, just as I believe the integrity of the United States are doomed in the long run.

A German factory worker would no sooner pay for a Greek hairdresser’s early retirement than an overtaxed California entrepreneur would pay for a Rhode Island school teacher’s pension.

Yet these are the kinds of mandates that politicians are forcing on people. Voters may act like sheep when their civil liberties come under attack… but put your hand in their wallets and they get militant.

The real irony is that breaking apart the eurozone is a popular idea in Europe, so you can be sure that the dissolution is inevitable.

If the relatively healthier economies in Europe actually did break away– Germany, Luxembourg, Slovakia (yes I’m serious), Netherlands, Austria, Belgium– the resulting economic union would certainly be among the healthiest, most balanced in the western world.

In other words, today’s euro would become worthless, but the future euro would be quite valuable and respected by investors. The major issue is whether the new currency would be large enough to challenge the dollar’s dominance. We won’t know the answer until they piece the deal together.

William writes, “Simon, I bought Terry Coxon’s book “Unleash your IRA,” and it’s probably the best thing I’ve bought this year. I’m amazed at everything I can do with my retirement funds, including buying gold bullion and foreign property, tax free. Is this a good way to plant another flag offshore?”

Absolutely. Terry is one of the most knowledgeable people I have ever known about all matters related to money, and the Open Opportunity IRA structure he talks about in his book is one of the biggest no-brainers I see out there right now.

Why? A couple of reasons.

First, the US government has its targets set very squarely on retirement funds. There are trillions of dollars of savings that politicians could easily regulate.

For example, do-gooders in the Congress could whip up a new law tomorrow requiring that a percentage of managed retirement funds be invested in US Treasuries… you know, because they’re so secure.

Through Open Opportunity IRA structure that Terry describes in his book, you ensure that no one can confiscate your hard earned savings.

More importantly, though, you can take ordinary returns and make them extraordinary by planting a retirement savings flag overseas.

Imagine that you buy an undervalued property in Colombia. The property is selling for $100,000 and yields about $1,500 per month in net rental income.

Over the years, as Colombia’s economy continues to perform strongly, the property appreciates substantially in value. The Colombian peso outperforms the US dollar. And the rental income rings the register month after month with the reliability of a Swiss train. Not a bad deal, right?

Now let’s assume that you bought the property with your retirement funds through an Open Opportunity IRA. Not only do you receive the rental income, the property appreciation, and the currency appreciation, but you get to take it all tax-free because your IRA owns the property.

I could cite you a million more examples, but frankly Terry’s book does a better job. Bottom line, this is one of the best ways to plant and overseas return and make lot more money at the same time.

Finally, Libero asks, “Simon- you mentioned that Italy has a reciprocity agreement with Panama. I just spent about 2 hours searching and can’t find anything. Can you provide more information?”

Sure. I’m not surprised. Google is the Black Hole of accurate information, and most of the people who write about this sort of thing are just armchair expats who parrot others’ work without putting boots on the ground.

I can tell you with 100% certainty that Panama has a bilateral agreement signed with Italy that provides instant residency for nationals of either country to live in the other. In other words, Panamanians can acquire Italian residency, and Italians can acquire Panamanian residency.

How do you do this? If you’re an Italian citizen, head to Panama and talk to a local **reliable** immigration lawyer. If you need a referral, drop us a line and my assistant will get you in touch with someone. I don’t like to publish these things for Google to index.

May 12, 2010
Undisclosed Location

First of all, I really want to thank all the well-wishers who were kind enough to write me and wish me luck on my operation yesterday. Everything went off without a hitch, and I’m already feeling much better.

I will unfortunately need to stay in place for a few weeks while I recover and have a few follow-up visits, but I expect to get airborne again quite soon.

To be honest with you, the place I’d love to be the most right now is Greece. I think history is unfolding right in front of us, and I really want to see it with my boots on the ground.

I thought it was absolutely amazing when European leaders came to the table this week with almost $1 trillion to defend the euro against the market’s siege. Yet, by the end of the day after the initial euphoria had worn off, Europe’s support didn’t register so much as blip in the euro’s strength.

Specifically, after the announcement of the trillion dollar support package, the euro finally closed Monday afternoon at $1.27. Prior to the announcement before the weekend, the euro closed Friday at… $1.27. Not exactly much of a difference.

In other words, the market essentially laughed off the government’s trillion dollar pledge of support. Why? A few reasons-

First, no one really believes the European support truly exists, especially not in that magnitude;

Second, even if it did, investors now finally realize that these politicians are simply playing with their own worthless monopoly money;

Third, and most importantly, anyone with two brain cells to rub together recognizes that Europe’s economic woes cannot be contained with more paper money… and now the problem just became $1 trillion worse.

Battling back from an economic crisis requires hard work, savings, and minimal disruption from the government. There’s no magic pill, entitlement program, or paper money bomb that will suddenly make things better.

Instead, governments should be curtailing social benefits that encourage people to be lazy, while simultaneously stripping taxes to the bare bones in order to give entrepreneurs and investors the proper motivation to work hard, take risks, and hire employees.

These things are not happening, nor will they ever happen in the foreseeable future. And so, backed by Europe’s trillion dollar pledge, Greece will likely go back to business as usual… spending money that it doesn’t have, and making its problems exponentially worse.

Last summer, when I was in Europe, I wrote a short piece about the euro. At the time, I explained why it was overvalued (at around $1.43 back then) and that its fair market value should be in the range of $1.18 to $1.25 to achieve similar parity as the US dollar.

In the past, investors were desperate to dump their dollars, and the euro seemed like the most viable alternative. Investors paid a premium for the euro, bidding the price well beyond its fair market value to as much as $1.60.

Today, the euro is once again trading near its fair market value range that I estimated at $1.18 to $1.25. This is because the market no longer views the euro as a viable alternative to the dollar, hence it is not worth paying a substantial premium to fair market value.

Remember, due to the size of their respective bond markets and relative lack of capital controls, there are only three currencies in the world that have the capacity to absorb large institutional capital flows– the dollar, the yen, and the euro.

If you’re a small investor with a few million dollars, you can park that cash just about anywhere without affecting the exchange rate.

But if you’re a large institution with billions of dollars, only the dollar, yen, and euro can consistently absorb huge inflows/outflows of capital without drastically affecting the exchange rate.

For now, those capital flows are moving out of the euro and into the dollar. The reasons behind the ‘europremium’ are gone, so the purchasing power of the two currencies should be roughly the same.

As such, I would be uncomfortable having a short euro/long dollar position in this range unless there were a very clear signal that the euro’s collapse is imminent.

Since the PIGS have a trillion pieces of paper to burn through for the time being, I expect this won’t happen for some time.

Additionally, for the time being, I’m happy to maintain my short euro/long gold position (XAUEUR) as I continue to believe that institutional funds are starting to shun government bonds in favor of gold. This position has returned us 30% since I first mentioned it a few months ago.

May 6, 2010
Undisclosed Location

If you’ll kindly indulge me, I will jump right into this week’s questions.

First, Jeff writes, “Simon- you really called the gold/euro short (XAUEUR), I’m up 25% since you mentioned it. Where do you see it going now?”

The European-induced panic is causing a rush to ‘quality’ once again. The dollar has surged, Treasuries rallied, and just about everything else fallen, including oil, silver, and that third-world peso we call the euro.

One of the lone standouts, though, has been gold. Once again, I find the market’s rush into Treasuries coupled with the simultaneous rise in gold prices to be an incredibly bullish sign for gold.

I’m far from a gold bug, but I cannot ignore facts and simple analysis. In good times, investors frequently use the bond market to park large swaths of cash. These days, though, institutions are increasingly skeptical about lending money to corrupt, fiscally irresponsible politicians, especially at low interest rates.

One of the most obvious alternatives for institutional investors is gold… so instead of gold falling during the panicked sell-off, many investors are rushing into gold faster than US Treasuries.

Not only has this been excellent for our gold/euro trade, it suggests that investors are now starting to view gold as a ‘less risky’ asset than government securities. In the longer-term, this will be tremendously bullish for gold as more investors shun sovereign debt for the metal.

In the medium-term, I think the next move will be a rise in the gold/silver ratio; it tends to rise during times of tension and high risk perception. I also think that the Swiss National Bank is finally going to intervene in the euro/franc cross, but I’ll save that for another time.

Next, Dieter writes, “Simon- you mentioned that in the event of a dollar crash, Panama would be OK in the long run. I disagree; Panama does not produce anything, and the income from the Canal is not enough to sustain itself. Comments?”

Correct. Panama does not produce anything to speak of. Neither does Hong Kong.

Yet, the two are able to attract significant foreign investment because of relatively business-friendly environments, as well as large pools of capital from neighboring countries that fund robust financial sectors.

(Chinese money goes to Hong Kong, Colombian/Venezuelan money to Panama)

The pools of capital and foreign investment have built diversified economies in both locations, including strong domestic consumption markets. Coupled with Panama’s Canal revenue, I believe that the country will be much better positioned than most of its neighbors in the event of a dollar crisis. I’ll discuss this more next week.

Next, Don from Thailand cautions us all: “Simon, I brought my gold to Thailand with me and it was forcibly confiscated upon entry. They said that I should have declared it at Customs and paid a VAT fee of several thousand dollars.”

Ouch. I’m not sure how much gold Don had on him, but these days, it’s just not a good idea to be carrying more money in your briefcase than the annual salary of the guy inspecting it.

In most countries, gold is not considered money, at least officially. All across Asia, though, gold has significant cultural importance. In many poor countries, if officials spot your gold and can take advantage of you, then they absolutely will. After all, they’re the ones wearing the guns.

The thing is, no one should be thinking about storing gold in poor, underdeveloped countries anyhow– stick to Austria, Switzerland, Hong Kong, etc. These are countries of negligible corruption risk and a well-defined rule of law. And make sure you check customs rules before you go.

For large amounts, use a secure transportation service like Viamat; they’ll ensure the integrity of your shipment from door-to-door, and even store it for you if necessary.

Next, Paul writes, “Simon, great article about Greece. Although the US is not dealing with a 900% debt to GDP ratio, we are heading down a road that sure feels the same. Increased taxes, VAT, and massive entitlements will surely bring us to a critical tipping point soon. Ecuador keeps looking better all the time.”

Agreed. Look, these problems aren’t going away. There is no chance that Greece can possibly be bailed out, and there is no chance that Spain, Portugal, and Italy won’t follow. Then Japan. Then the UK. Then finally the United States.

These countries absolutely have to implode. As Bill Bonner astutely remarked last weekend in Las Vegas, “when things get out of whack, they tend to get back into whack.”

Well… 900% of GDP worth of government debt and obligations is out of whack. Trillions upon trillions of dollars in unfunded and growing entitlement programs is out of whack. Borrowing and spending your way out of debt is out of whack.

Getting back into whack requires a system reset.

Here’s the good news: this is nothing to be afraid of. We can all see this coming from miles away despite the governments’ lies and the blinders on the mainstream media.

We can prepare, today, by planting multiple flags to safeguard ourselves, our families, and our assets… and then focus on thriving from all the opportunity being created.

Remember– the sky is not falling. Now is the time to be calm, confident, and measured. Panic is for the unprepared, and fear is for the uninformed.

May 5, 2010
Undisclosed location

The last few days have been great for the shorts. I’m one of them. Global markets have been in an absolute panic over what’s happening in Europe, and many major indices have erased their 2010 gains.

Clearly, the most concerning issue of the day is the ongoing trouble in Greece. The government has been borrowing and spending far beyond its means, and far beyond its growth potential for years. Hell, for decades.

Now the country is going with hat in hand to the European Union and International Monetary Fund (what essentially amounts to the United States) for a bailout. Make no mistake, this absolutely has the potential to break apart the euro zone.

At a minimum, bailing out Greece will require substantial cash infusions in order to get the government running again… quite literally, the Greek government is bankrupt, and it will need a lot of money just to limp along from paycheck to paycheck.

More importantly, however, the EU and IMF will have to step up and guarantee large portions of Greece’s $400+ billion public debt. If they don’t, private investors will be simply unwilling to buy all of the new debt that Greece so desperately needs to issue in order to finance its government for the next several years.

Naturally, if the EU (read: Germany) guarantees Greek debt, it will put 100% of the risk (with 0% upside) squarely on the shoulders of German workers.

Now… let’s go back and reconsider the history of Europe. This is a continent that has been at war with itself, or threatening to go to war with itself, for millennia. If we ignore the Balkan conflicts in the 90s, Europe only has a 20-year experiment of patching things up and playing nice.

I’m not advocating that the continent will once again plunge into destructive warfare… but rather trying to illustrate that the average German worker, who already struggles to give half of his paycheck to the government, doesn’t give a damn about ensuring Greece’s generous entitlement programs.

To give you an example of what I’m talking about, a hairdresser in Greece has the right to retire with full benefits at age 50 because the occupation is one of 580 job categories considered ‘hazardous’.

According to the New York Times, which published a list of these hazardous Greek occupations in March, radio announcers and reed instrument musicians are right up there with coal miners and bomb disposal workers. They all get to retire at 50 or 55.

Needless to say, these entitlement programs suggest that Greece’s financial problems extend far beyond its debt. Total government obligations, including its ridiculous pension program, tally nearly 900% of GDP.

It will be impossible to borrow this amount from private markets, and it is absurd to think that Germany would ever consider guaranteeing such a sum.

This means that Greece will have to make massive, massive cuts to its social welfare programs… and this, after all, is one of the prime conditions of its bailout. Greece is to cut government spending to the bones while simultaneously raising taxes to plug its budget shortfall.

Naturally, this is another stupid idea. Anyone with even most cursory understanding of street-level economics knows that raising taxes provides a disincentive for everyone.

If you raise sales taxes (VAT), you provide a disincentive for consumers to spend… in which case, congratulations, you won’t be able to rely on consumer spending to drive economic growth.

If you raise income tax rates, you leave consumers and businesses with less disposable income to allocate towards investments and purchases which will drive economic growth.

If you raise capital gains taxes, you provide a disincentive for entrepreneurs and investors to take risks that will create jobs and build wealth.

If you raise payroll taxes, you provide a disincentive for employers to hire workers.

You get the idea. Raising taxes is the exact opposite of what Greece should be doing right now… and yet, its politicians are surrounded bureaucratic vultures insisting that the only way out of the crisis is higher taxes.

Now– the other side of the equation, massive cuts to government spending, is laudable. But here’s the problem: Greeks have been paying exorbitant taxes for years. They have been misled for decades that their pension programs would be waiting for them upon retirement.

Now that many Greeks have reached retirement age, suddenly the money that they have been paying into the system for their entire lives is no longer there. And the government is telling the Greek people that they are the ones who need to make sacrifices.

If I had paid hundreds of thousands of euro into a system that had effectively robbed me and left me with nothing, I would be angry too. I would take to the streets too.

That’s exactly what the Greeks are doing now.

If Greece were a private company, the officers and directors would be locked up forever. Politicians, on the other hand, control paramilitary forces which quell the rebellion and shoot a few of their own countrymen.

It’s a disgustingly perverse system, and it deserves to go down in flames.

As I’ve stated before, one of the best ways to play this is to short the euro against gold and silver. I recommended this a few months ago at 760, and gold keeps hitting new, historic highs above 910.

For contrarians, taking a small, speculative bet on Greece right now may be a decent, short-term gamble in the event of a temporary pullback– I know some people who are buying National Bank of Greece (NYSE: NBG), for example.

In the longer-term, though, Greece’s financial problems are clearly unable to be contained, even with EU/IMF support. Afterwards, the continent will have to deal with Spain, Portugal, and Italy… and their problems substantially outweigh those of Greece.

What do you think– would you take to the streets too? I’m curious.

May 3, 2010
35,000 feet over the Sonora desert

You’ll have to forgive me for taking the day off yesterday. This past weekend’s Casey Research Summit was simultaneously exhilarating and exhausting… but after standing on my feet all weekend taking rapid-fire questions from hundreds of subscribers, I really needed some time to myself.

As I’m presently en route to see my family for a few days (Wi-Fi on airplanes is a convenient curse), I now have the opportunity to digest everything that happened this weekend and share my observations.

First, I learned that we absolutely need to have our own SovereignMan conference dedicated to internationalization solutions.

The demand for information from this past weekend’s conference attendees was frankly a bit overwhelming, and I recognize now that we need to put together a high quality, comprehensive offshore conference.

This is not a question of “if”, but rather “when”. These things take time to plan and organize, so I’m thinking about sometime this autumn. I don’t commit to anything unless I can make it the absolute BEST, and I promise that our own conference will set the standard for the offshore industry.

In the coming weeks and months, I will have much more to discuss with you about our conference, so stay tuned for that.

I also got a lot of great investment insights from this weekend’s speakers that I’d like to share.

Andy Miller, one of the country’s premier institutional real estate investors, gave a very sobering assessment of commercial property.

In his very informed and experienced opinion, it’s only a matter of time before commercial real estate crashes. The entire industry is using pie-in-the-sky valuations for properties, yet rents and occupancy rates are all falling.

Meanwhile, delinquency rates on commercial property mortgages are rising, and Andy expects this to start having a major impact on the financial sector later this year.

Bill Bonner, the founder and chairman of Agora publishing, also gave some rather interesting remarks. In Bonner’s own words, “things that are very out-of-whack tend to get back into whack,” which means that, in the longer-term, today’s bubbles will have to revert to the mean.

There’s no good reason, for example, why US Treasuries have been rising since 1983. The rest of the world is now loaning money to the world’s biggest debtor at very low interest rates. This is out of whack and needs to be corrected.

Bonner recommended shorting US and Japanese Treasuries (the Japanese bond market is even more out of whack) and going long Japanese small cap companies, which have been in decline since 1989.

You can read excerpts from his speech here.

Finally, Bud Conrad gave what I thought was the best speech of the weekend. Bud has a best-selling book out right now, and his speeches are always full of very interesting data and analysis.

According to Bud, right now the economy is caught in the eye of a hurricane. The first wave of the storm already passed us by from late 2008 through mid 2009. It was devastating, but it blew through.

Now the eye of the storm is upon us. It’s calm, and people think that the storm is over. The second wave, however, is charging towards us, and it could have an equally devastating effect.

As you’re undoubtedly aware, world government are trying to paper over the issue by borrowing and printing enormous amounts of money to drop into their respective economies. This is an absolutely terrible idea, and if you look at the numbers you can see why.

In the United States, for example, the federal government has ‘stimulated’ its economy with $385 billion that it never had to begin with. This doesn’t count the trillions in additional deficit spending, or other entitlements / bailouts / guarantees.

You’d think that if the government invests $385 billion in the economy, there should be at least $385 billion in economic growth… and hopefully more.

Not the case. We’ve recently seen a mere $116.8 billion in US economic growth. This means that the federal government has managed to lose nearly $270 billion in money that it had to borrow from the Chinese.

Not only can politicians not generate a positive ROI, but they manage to lose 70% of their investors’ capital. If Uncle Sam were an institutional money manager, he would be charged with criminal negligence and hauled off to jail.

Bud believes that buying gold is one of the best ways to preserve wealth and mitigate looming economic disaster. As for speculative recommendations, Bud also has some really fantastic picks.

His past track record is stellar, including a 93% gain on shorting MBIA on 10-months, and a quick double on wheat futures. In fact, his recommendations have personally put a lot of money in my pocket… so if you want to follow Bud and his monthly insights, I definitely recommend giving his Casey Report a try.

As for my own predictions… well, I’m much more optimistic than most of the other speakers were. I think that there are clearly major challenges that the world has to deal with, or is at least forcing itself to deal with– climate change, resource shortages, overpopulation, economics, etc.

When you think about it, though, these challenges are nothing new. History has never seen a time when there haven’t been wars, genocide, government failures, and general calamity. And yet, humanity manages to limp along just fine despite the consistent corruption and incompetence of its political leadership.

For the sharp, patient, and well-prepared, these challenges provide substantial opportunities to make a lot of money… so rather than be fearful and gloomy, I suggest adopting a more upbeat perspective.

And if you’re not prepared, i.e. your livelihood depends on the very fragile system that is in danger of breaking again, I strongly urge you to focus on making preparations– planting multiple flags; safeguarding yourself, your family, and your assets; and seeking alternate forms of income.

April 28, 2010
St. Michaels, MD, USA

Since I arrived from Santo Domingo on Monday evening, I’ve been enjoying some peace and quiet in this quaint, quiet, wealthy little town on the Maryland shoreline.

St. Michaels is where Porter Stansberry is holding his annual ‘idea conference,’ which he sponsors each year around this time. The goal? He brings together successful people from a variety of backgrounds to discuss their best ideas– investments, business concepts, or anything else of intellectual value.

These events always generate a lot of promising ideas from which everyone can profit; Porter himself tells stories about how a single idea from a past conference generated millions of dollars for his business. I know that I personally will benefit substantially from many of the investment ideas I’ve heard.

While I’m not at liberty to write about everyone else’s ideas in this forum, I can at least tell you what I’m talking about– gold.

As an investment or inflation hedge, gold is nothing new… and to be clear, I am far from a die hard gold bug. But a few months ago, I wrote the following about gold vs. the dollar:

—

“Naturally, the chief reason that Treasuries are considered safe is because they are backed by the full power of the US government’s printing press. Investors are wise to this trick, and smart money will not be fooled into longer term bonds unless there is another financial cataclysm.

As I survey the situation, I’m convinced that gold is nowhere near peaking exactly for this reason. In a flight to safety, institutional money still flows into the dollar. Gold will not truly break out until there is a bifurcation in investors’ mentality regarding safety.

To put it more clearly, when worried investors start piling into gold instead of the US dollar to protect their assets, this is the sign that we are charging towards the top.”

—

Yesterday, we started seeing the first signs of this bifurcation. World markets tanked. The Dow shed over 200 points, silver and copper dropped, oil fell, etc. It was a pretty bad day for bulls.

The dollar, on the other hand, strengthened considerably, especially against it’s ugly European sisters. Accordingly, US Treasuries rallied as worried investors piled into the perceived safety and security of bonds.

Ordinarily when these types of events occur, gold falls right alongside everything else… especially since many gold investors are sitting on large gains, and they’d rather take profits than assume the risk of holding gold during so much uncertainty.

And uncertainty there this… Credit expansion is showing symptoms of a bubble in China. Thailand is having major political challenges. The Eurozone is under intense pressure. Dubai still can’t pay its debts. The British pound is looking like a third-world peso. etc.

Curiously, though, gold rose handily yesterday against the dollar, which itself had risen against nearly every other currency, index, and commodity. This is highly unusual, and I’m considering it a possible sign that the market’s perception of risk may be starting to change.

Specifically, we may have hit the bifurcation point where investors consider gold to be less risky than loaning money to sovereign governments. We’re already seeing this with many corporate bonds that have much higher ratings and lower yields than some first-world sovereign debt.

One of the best ways to play this bifurcation trend for now is to buy gold and short non-dollar currencies. In December, I recommended buying gold at 760 euro. We nailed that one– since then, gold has risen and the euro has tanked… and gold hit a high of 890 euro yesterday. I expect this trend to continue over the medium term.

Will gold go up in a straight line? Absolutely not.

Remember, the value of all the gold ever mined currently amounts to about $5 trillion, only a fraction of world financial market values. Thus, in a cataclysmic financial event when institutional money leaves risky assets for quality, it simply won’t be possible for everyone to pile into gold.

In the longer term, this means that gold will likely have some breakaway runs to higher and higher levels in US dollar terms, similar to how the oil market was behaving in 2007-2008. I think that yesterday’s market reaction foretells this trend.

I would suggest keeping a close eye on the gold/dollar relationship over the next weeks and months as the Greek debacle plays out, and investors start looking at other sick economies like Japan. If the trend holds, it is an extraordinarily bullish sign for gold.

April 12, 2010
Medellin, Colombia

As tectonic plates slowly drift over millions of years, an occasional fissure opens up in the earth’s surface.  We call them volcanoes, and they provide a means for the earth to release some of the intense pressure that builds up over time.

Volcanic eruptions are typically harmless… the earth blows off some steam and everything settles quickly. In rare instances, though, when significant pressure builds up near highly populated areas, an unmitigated disaster can occur.

Over the last few days, several geopolitical hotspots have simultaneously erupted around the world– the violence in Thailand, the coup in Kyrgyzstan, the plane crash in Poland which killed its President, etc.

Kyrgyzstan and Poland are the harmless eruptions that generally blow over… nothing to worry about. Kyrgyzstan is only significant to US interests as a supply base for the pointless Afghanistan conflict, it’s only significant to Russia for ego, and it’s not really significant to the Chinese at all, even though they share a border.

Similarly, Poland has a strong economy and will continue to shine despite the untimely demise of its political leadership.  While the plane crash was truly unfortunate, it may likely highlight how much an economy can succeed when it is unconstrained by bureaucrats.

Thailand, on the other hand, has some potential to be one of the disastrous eruptions.

When I was living there over the last few months, I watched the “Red Shirt” opposition group really step up its anti-government protests– their ultimate goal has been to force new, open national elections.

The Red Shirts have been vigilant in maintaining constant pressure on the current government, even employing creative tactics to garner attention like dumping blood in front of the Prime Minister’s house.

Most of their demonstrations, though, have been largely ignored… until now.

This weekend, the Red Shirts staged another protest in Bangkok that coincided with a major Thai holiday. As protestors stood eyeball to eyeball with Thai military and police forces, it seemed like just another day in Thailand– political demonstrations are incredibly commonplace in the kingdom, so nobody pays much attention.

At some point during the evening, however, gunfire rang out and all hell broke loose.  Over 20 people were killed on both sides with hundreds wounded, and no one seems to know exactly where the gunfire came from or what started the violence.

If you want to see a first hand account of what happened, check out this video from blogger Tony Joh. He gives an incredibly balanced (and colorful) report with his boots planted very firmly on the ground in the thick of it.

(note: If you get squeamish easily, stop watching at exactly 7 minutes into the video.)

It’s funny how death can really get the ball rolling on political issues. A bill might be tied up in Congress for years, but the moment a 12-year old boy dies, suddenly it becomes important.

In Thailand, the protestors haven’t been able to make a dent in their goals despite months of their best efforts. The government has remained in control with the full support of the military, one of Thailand’s most powerful institutions.

Today, however, after so much loss of life, Thailand’s Army chief called for new elections. This is the clearest sign that things may actually be changing in Thailand, and it’s also fueling speculation that the initial gunshots over the weekend may have actually been staged by the Red Shirts.

To be clear, political instability in Thailand is nothing new.  If it’s not political demonstrations, then there are rumors about the King’s health. If it’s not the King, then there’s a new dispute with neighboring Cambodia… it’s always something.

Most of the time, instability in Thailand is totally peaceful, and markets shrug off these events. Despite ongoing tensions, the Thai Baht has steadily appreciated for months against the dollar, and this provides an interesting indication of the market’s perception of risk: blood in the streets is a better bet than 30-year Treasuries.

Today, though, markets woke up to the realization that Thailand may be entering an extended period of instability; it could take months to sort out the consequent election issues resulting from this weekend’s bloodshed– and if something happens to their 82-year old king during that period, the country will be in real trouble.

The Thai stock index dropped 5% today, undoubtedly due to a rush of foreign capital being pulled out of the country. In the near-term, there may be significant buying opportunities in the market as solid companies become undervalued by capital flight.

I’m watching a handful of Thai stock like Bangkok Bank, Bumrungrad Hospital, and Krung Thai Bank, all of which have strong businesses, decent dividend yields, and US pink sheet listings.

April 8, 2010
Panama City, Panama

Do you remember that really awkward phase we all went through as adolescents?

Growth spurts, voice changes, menstruation, and yes, pimples– in the end, while we all came out of it more mature and grown up, there was a difficult and sometimes painful transition period in which we had to learn how to deal with new realities.

Developing countries go through the same sort of transition, and it can be just as awkward and painful.

Typically, they try to transition from fledgling banana republics with corrupt governments and byzantine regulatory systems to stable democracies with a growing middle class and reformed tax code.

Most countries have a very difficult time with this.

For example, I expect China to undergo significant pain as their economy continues to inflate. One day the Chinese will find that their rising currency and wages are no longer cheap, and they’ll have to seek competitive advantage in something other than manufacturing knick-knacks.

In other words, a country of a billion people cannot go from making socks to being the world’s investment bankers overnight, or without any fuss.

These sorts of transitions are very difficult because they affect the entire social landscape– employees are laid off and have to retrain to new skills, businesses go bust and reinvent themselves, etc.  Of course, politicians always get in the way by passing laws which only prolong the pain.

Overall, the transition cycle is not easy, and few countries pull it off well.  In my assessment, Panama is one of the countries succeeding.

20-years ago, with its puppet dictator, open drug trade, and banana exports, Panama was nothing but a bad punch line.  Over the last decade, though, the country has been able to successfully develop a service-oriented economy with robust tourism, banking, and transportation sectors.

Today, while the country is definitely no Shangri-La, Panama is thriving and on a very clear upward trend.

Remember, this is ultimately the most critical point to consider when planting a flag overseas– is the country or jurisdiction on an upward trend? Will it be a better place 10-years from now?

When you survey the political landscape in developed countries, the headlines generally tend to get worse and worse.  Certainly, not all news is bad, but the subversion of civil liberties, erosion of financial privacy, and rapid growth of big government seem to be at least weekly occurrences.

Meanwhile, in developing Latin economies like Panama, Chile, and Peru, things are consistently improving– they are going through the awkward growth phase as smoothly as possible.

As an example, the Martinelli administration in Panama recently passed comprehensive tax code reform.  While increasing the sales (consumption) tax by 2%, it cuts corporate and some personal tax rates, reduces some property tax rates by half, and completely eliminates over 30 types of tax.

This new, simplified tax code is a major step in the right direction, and it will be excellent for business.

The government here clearly understands that successful businesses hire employees and generate wealth in the economy.  This model has done wonders for Singapore and Hong Kong, and Panama is following suit.

Yes, there are still elements of poverty, corruption, drug trafficking, etc. in Panama.  The trend, however, is undeniably one of consistent improvement and greater economic freedom.  Ultimately, this is exactly what helps countries successfully transition through those difficult growth phases.

As I’ve said before, until these economies become large or popular enough, local capital markets tend to be off-limits for armchair investors.  I don’t see TD Ameritrade offering access to the Peruvian stock market anytime soon.

It is possible, however, for intrepid active investors to open local brokerage accounts and capitalize on the rising tide… though the most passive investment opportunities generally tend to be foreign bank accounts (which provide liquidity and exposure to the currency) or property (which is non-reportable and an excellent inflation hedge).

More on these topics in future letters.

March 29, 2010
Mexico City, Mexico

I was reading some US government propaganda disguised as educational literature the other day, something from the Treasury Department and Federal Reserve… it’s the sort of corrupt dogma is typically used to instill blind and unquestioning faith in a defunct money system.

Laughably, I noted the following passage from the Philadelphia Fed’s “Money in Motion,” intended for children aged 11-14:

“For money to be useful it must function as a unit of account, store of value, and a medium of exchange.  To be a good medium of exchange, money must also be portable, divisible, durable, scarce, acceptable, and stable in value.”

In my imagination I see Comrade Bernanke leading a group of America’s youth on a guided tour of the Federal Reserve, reading aloud from this text as he explains the natural of the Federal Reserve System.

“Yes, that’s right. Scarce. As in, cannot be conjured out of thin air. Now please excuse me, children, I need to go buy $30 billion worth of Treasury securities.”

It is for this reason that I really have a difficult time getting behind bonds, particularly US Treasury securities.

In fact, there is a fundamental question that any serious investor must ask: given the government’s massive deficit spending and printing spree, does it possibly make sense to loan this bureaucracy money for 30-years at 4.75%?

Before dismissing the concept altogether on instinct alone, the idea is at least worth exploring.  Consider that there are essentially two ways to make money, i.e. generate a positive inflation-adjusted return on a 30-year bond investment:

First, the investment would be reasonably sound if the US government does not default on its payment obligations, and if the rate of inflation stays below the 4.75% yield for the duration of the bond’s term.

Unless a massive fiscal restructuring occurs soon, it certainly seems doubtful that the federal government would be able to make good on all of its payments for 30-years.

On its current path, the US will eventually be obliged to spend the preponderance of its cash on interest payments, all before buying a single cruise missile or bridge to nowhere.

Given the political no-brainer of having to choose between paying the ‘Chinese,’ or providing for America’s common defense, America’s politicians will clearly choose to default… at least to foreigners that will be branded the new axis of economic evil.

Additionally, the prospect of inflation not spiking beyond 4.75% for the next 30-years also seems quite dismal.  Based on the fiscal hole that will need to be plugged, there are few realistic options beyond inflating the currency and higher taxes.

Higher taxes are like steroids for prices– they experience massive growth, practically overnight. And it absolutely will happen… when people like Bill Gates, Sr. say things like “society has a just claim on these fortunes,” in regards to estate taxes, you can bet on higher taxes.

So, effectively, an investment in 30-year bonds does not appear to be sound since there is significant likelihood of the government defaulting and/or inflation spiking beyond 4.75%.

The other way to make money on bonds is if the value of the bond increases; this would typically happen if future interest rates will be lower than today.

Needless to say, as interest rates are at historic lows, the likelihood that future rates will be even lower is negligible.

The best scenario one could hope for is that interest rates will stay at current levels for the long-term… though the prospect of sustained historic lows for three full decades certainly seems unlikely.

What seems more likely is that rates will eventually move higher, in line with their historical averages. Since 1980, the 30-year has yielded 7.80% on average.  If this occurs again, the market value of today’s 30-year bonds will fall substantially.

Overall, given the prospect of inflation, default, and declining value, US long-term bonds are clearly financial folly, especially when one considers the risk-adjusted, inflation-adjusted return.  There’s less risk in stuffing it under your mattress.

Finally, it’s worth noting that, since December, the 30-year yield has been quite volatile. Just in the last week, the yield has risen 20 basis points, which is not insignificant.

Former Fed Chairman Alan Greenspan recently called this a ‘canary in the coalmine,’ suggesting that the rapid rise in yields indicates the market’s intense concern for the growing federal debt.

Clearly, Greenspan has an agenda. He’s doing his best to shape a historical legacy that doesn’t blame him for the current economic mess… which is completely laughable. Regardless, though, he’s probably right on the money about the treasury yields.

It’s possible (and likely) that another panic will send investors rushing back into the perceived ‘safety’ of bonds, pushing yields down and bond prices up.  This would be a short-term anomaly, though, and mostly affect the 12-month and 2-year notes much more than the 30-year bond.

Overall, I’m short 30-year debt, and I think this is long-term low-hanging fruit. There are a variety of ways to play this, which I can discuss in future letters if you’d like.

March 10, 2010
Pattaya, Thailand

Yesterday I apparently declared a premature end to major combat operations against the virus that has invaded my body.  Maybe it was just the celebratory Mexican food I ate last night to commemorate the end of my 4-day sickness, but I now seem to be experiencing my own W-shaped recovery.

Always the optimist, though, I’m actually grateful for a few things; namely, I’ve been too consumed with the rugby match being played inside my cranium to pay much attention to the most recent socialist musings of European leaders– something that would ordinarily have me spitting fire at the magnitude of their arrogance.

Most glaringly, Greek Prime Minister George Papandreou has been on a bicontinental tour seeking political support to eliminate some forms of derivatives trading… all with the goal of preventing “unprincipled speculators” from making money by betting on a Greek default.

Rather than misdirecting his criticism at speculators, though, Papandreou should look no further than the nearest mirror to levy criticism.  As a legendary Greek political family, three different Papandreous have spent a combined 10-years as Prime Minister, so there has been ample opportunity to get spending under control.

To lay blame at “unprincipled speculators” as a chief cause of the Greek crisis is thus completely ignorant and hypocritical.  Not to mention, Papandreou should be courting speculators to buy his country’s debt, not vilifying them.

His biggest ally in Europe right now is German Chancellor Angela Merkel. As head of the continent’s largest economy, she is completely on board with the idea of banning credit default swaps (CDS) for the sake of speculation.

A CDS contract for sovereign debt is a bit like an insurance policy designed to protect the downside risk of a bondholder in case the country defaults. As you could imagine, the price of the CDS contract rises and falls based on the creditworthiness of the bond issuer.

As an example, an investor who owns a lot of Greek debt may want to enter into a CDS contract so that he will receive a payout if Greece defaults. As part of the deal he makes payments (like an insurance premium) to the CDS counterparty… who is… guess what? A speculator!

Without speculation, there would be no counterparty on the other end of the deal, and without these credit default swap insurance policies, no one would be willing to buy Greek debt because the risk would be too high.

Meanwhile, in the opposite corner of Europe, UK Prime Minister Gordon Brown gave a rather frantic speech today as he struggles to stay relevant in the upcoming election.

For the duration of his remarks, Brown defended his response to the financial crisis, indicating that the borrowing and printing of unprecedented volumes of money were the only sensible things to do given the situation, and insisting that he is the right man to lead his country through the recovery.

When you look at the data, though, despite all the money he has been borrowing, printing, and spending, it doesn’t seem to be doing the UK economy much good.

Ah, nevermind those “conflicting statistics,” Brown said. And as for the UK’s AAA credit rating, which is under serious scrutiny due to the country’s significant debt and deficit, Brown insists that his country will not be downgraded.

How does he know? Apparently his gut told him. Or maybe his cat. Because he sure as hell didn’t ask Fitch, one of the groups responsible for the UK’s ratings.

Ironically, Fitch’s head of sovereign ratings recently said: “Britain had seen the most rapid rise in the ratio of public debt to gross domestic product (GDP) of any AAA-rated country. . . Why the UK thinks it has more time than other countries [before being downgraded], we’re not sure.”

Like most career politicians, Brown is completely clueless, yet concerned only about being reelected.  This is truly sickening, but unfortunately all too common.

So what are the investment implications of Gordon Brown continuing to ravage his economy, and Merkel handicapping European market liquidity?

For starters, I believe this will result in capital flight.  Of the major currencies in the world that can actually absorb huge capital flows, the dollar is, believe it or not, the least ugly one at the moment, so there will likely be some continued dollar strength against the pound and euro.

Not to mention, a stronger dollar would be most welcome by Europe’s exporters.

As the dollar is, however, fundamentally weak, I would expect the European currencies to post an even larger decline against the strongest Asia-Pacific currencies, as well as precious metals (a position I first recommended in December).

Lastly, I don’t think that any of this news is good news for European equities, and I personally plan on taking a large short position in those markets with some protective options.

To be clear, I will make a lot of money on these investments if Europe continues down this path of destruction… and I suppose that makes me an “unprincipled speculator” too.

March 4, 2010
Pattaya, Thailand

It wasn’t too long ago that there was a concrete dividing line down the center of Europe with large scale nukes pointed at both ends. It wasn’t long before that when two sides were battling it out in Normandy, or in the trenches before that.

Throughout the last thousand or so years, in fact, there are few and short-lived periods of peace among European countries. Just in the last 200 years, over 60 wars and armed conflicts were fought between at least two European powers.

This is why the whole idea of Europeans patching up their differences and playing nice under the auspices of a central bank-controlled fiat currency makes absolutely no sense at all.

I’m not trying to predict another armed conflict here… but these are sovereign nations who have a rich cultural history of going to war against each other to expand their sovereignty. For the past 10-years they’ve given up their sovereignty to the European Central Bank… and for what?

It worked for the better part of a decade because times were good. Now times are tough, and the alliance is frayed once again.

My friend Porter Stansberry (whom I believe to have one of the best common-sense investment approaches in the business) recently wrote, “next to corn-based ethanol, the euro might be the worst large-scale political/economic experiment I can think of…”

Agreed. Now, I discussed this all last week and don’t want to belabor the issue… but I would like to raise two important points:

1) As a rule of thumb, never base your economic analysis on anything that any government tells you.  Yes, Greece is sounding the ‘all clear’ bell because it’s raising taxes to plug the budget gaps. But anyone who understands basic economics should be running away, despite the ECB’s encouragement.

2) Don’t be a contrarian for contrarian’s sake. Some people are constantly looking for an angle, and that angle is to do the exact opposite of what everyone else is doing.

That line of reasoning works if the fundamentals make sense. But occasionally, even the irrational market knows what it’s doing… just ask the people who bought Lehman stock as it was collapsing, thinking that the market had it all wrong.

There’s being a contrarian, and there’s bringing a toaster with you into the bathtub.

I’m telling you this because I recently read a contrarian blogger’s essay on the coming financial tsunami… originating not from European economic challenges, but from an imminent -Singapore- debt crisis.

Singapore?

The blogger described how the debt problems in Greece are nothing compared to the debt problems in Singapore, indicating that Singapore’s debt to GDP ratio is a ‘whopping 99.2 per cent.’

Let me pause for a moment and explain something about this number.

Debt to GDP ratio is one important measure of a country’s economic health– in a way, it’s sort of like a nation’s body fat percentage.  You could be a skinny-mini with a really high body fat percentage (Seychelles), or you could be a 250 pound pro-athlete with a really low body fat percentage (China).

Decreasing a nation’s body fat percentage and thus promoting economic health requires going on a diet (paying down debt by cutting spending) and/or adding muscle mass (real GDP growth).

Greece is having its current problems because its body fat is too high, it doesn’t have the discipline to go on a diet, and it’s too old and broken to hit the gym anymore.

In fact, Greece has hit the tipping point where it has to borrow money just to pay the interest on the money that it’s already borrowed… these are nearly irreversible challenges despite any cheerleading you hear from the government (see point #1 above).

Regarding Singapore, the debt-to-GDP ratio of 99% is completely and totally overstated. Singapore’s actual debt is a small fraction of that– the government routinely runs a budget surplus and doesn’t have the terminal debt addiction that other developed nations are afflicted with.

The reason Singapore’s debt ratio is so overstated is because of the way that the IMF conducts its accounting:

With just a thousand dollars or a million dollars, people with spare cash simply hold it in a bank account. Large institutions with hundreds of billions of dollars, however, need safe, highly liquid debt markets to hold cash for the short-term.

Thus, in order to attract institutional capital flows, Singapore runs a high volume, robust sovereign debt market. It has to, otherwise institutional investors wouldn’t take it seriously as a global financial center.

Unlike US treasuries which are consumed and reissued in a dangerous and unsustainable ponzi scheme, Singapore’s bonds are investment securities that facilitate liquidity in the secondary market.

Because of IMF accounting rules, however, these bonds count ‘against’ Singapore and are included in the country’s debt.

The global economic crisis has certainly hit Singapore squarely on the chin, but to say that the next financial Tsunami will result from a Singapore debt crisis is just being a [misinformed] contrarian for contrarian’s sake.

March 1, 2010
Pattaya, Thailand

There’s something not right with the world.

Yes, I’m dismayed by this weekend’s earthquake in Chile (I really adore the country), and am quite disgusted by the US government’s extension of the PATRIOT Act. Fortunately, I know the Chileans will pull through just fine, and the US government will eventually collapse under its own weight.

What’s really grabbing my attention right now is what’s happening in the markets.

A few weeks ago I wrote about “Lessons from the Intelligence Business,” in which I discussed the Gold/Silver ratio as an indicator of economic expectations. The higher the ratio (the more silver it takes to ‘buy’ gold), the greater the indication of uncertain expectations in the marketplace.

Similarly, and perhaps more importantly, I pay very close attention to the “TED Spread,” which is essentially the rate difference between three-month Treasuries and LIBOR. In other words, the TED spread (Treasury/EuroDollar) is the difference between what banks pay each other for 3-month loans, and what the US government pays.

Naturally, since the US government is erroneously deemed “risk-free”, the banks’ rate is higher… usually averaging about 0.3% to 0.5%, or 30 to 50 basis points higher than the Treasury rate. When times are tough and banks are going out of business, the TED spread rises– it peaked at 460 basis points in October 2008 when banks were terrified to lend to each other.

Now, the opposite is happening.

For the last several weeks, the TED spread has dropped on an almost daily basis, well below its normal range and moving averages. In fact, its current value of 13.71 basis points hasn’t been seen since… well, hardly ever.

Even during the rip-roaring good times of 2003-2006, when banks would throw money at everything and “risk” was just a punchline at happy hour, the spread was still within its normal range.

The TED spread is dropping for two reasons– first, the yield on 3-month treasuries has been inching up lately as investors are starting to demand more for their loans to Uncle Sam.

Second, the three-month LIBOR rate (at which many non-US banks lend to each other) is less than half of the rate from 6-months ago. This suggests that banks are now much more comfortable with their balance sheets and willing to lend to each other.

Both of these factors occurring simultaneously in such a dramatic fashion portends a significant correction.

Some may suggest that the low TED spread is simply an indication that the global economy is recovering. Possibly. If you read this letter each day you know that I have a relatively upbeat view of things given what I see on the ground.

But the TED spread being much lower than its levels during the bonanza times is simply insane.

There is much greater risk and the need for caution in finance… and banks know this. The more likely scenario is that investors are starting to become skeptical of sovereign debt– and rightfully so, considering Dubai, PIIGS, and the US treasury ponzi scheme.

Two months ago, after spending a great deal of time in China and listening to their anti-treasury saber-rattling, I wrote about investor skepticism towards sovereign debt:

–
“Naturally, the chief reason that Treasuries are considered safe is because they are backed by the full power of the US government’s printing press. Investors are wise to this trick, and smart money will not be fooled into longer term bonds unless there is another financial cataclysm.

As I survey the situation, I’m convinced that gold is nowhere near peaking exactly for this reason. In a flight to safety, institutional money still flows into the dollar. Gold will not truly break out until there is a bifurcation in investors’ mentality regarding safety.

To put it more clearly, when worried investors start piling into gold instead of the US dollar to protect their assets, this is the sign that we are charging towards the top.”
–

What we’re seeing right now could be evidence of this shift in risk perception– that gold is starting to be considered ‘safer’ than Treasuries. The low TED spread suggests an aversion away from sovereign debt, and the high gold/silver ratio indicates that investors are putting a lot of faith in gold as a protective measure against uncertainty.

Because nothing moves up and down in a straight line, though, and as the TED spread is at historic lows, I would expect a correction, at least back to the range of 20-30 basis points.

I absolutely consider this low-hanging fruit at the moment, and I’d encourage you to consider investments that bet on the spread between the Treasury rate and LIBOR widening beyond its current level.

February 26, 2010
Bangkok, Thailand

It’s “Judgment Day” in Thailand. I wrote about this on Monday– a Thai high court will rule today on the disposition of ousted former PM Thaksin Shinawatra’s frozen assets valued at several billion dollars.

According to the mainstream media, the entire country is supposed to erupt in chaotic and violent protests today. Even BloombergTV, which I normally respect, has been running sensationalized stock footage of fires, vandalism, and Thai soldiers shooting semi-automatic weapons in the street.

Without doubt, there will certainly be renewed political turmoil in time… this happens in Thailand about every other Thursday, and they present great buying opportunities. But the reality of the situation on the ground here is anything but chaos. Thais are going on about their everyday business, and today is like any other day.

It just goes to show how unreliable a lot of information out there can be.

On to the questions for this week–

Axel and Daniela ask: “Simon, what do you know of the Uruguayan economy and financial system– how much is the peso pegged to the dollar/dependent on it? Are there any problems owning/buying/selling gold?”

Uruguay has a small economy that is highly dependent on foreign trade for most consumer and industrial goods. The country has some level of agricultural independence, but generally has to import just about everything else, from hair spray to televisions to refined fossil fuels.

Its largest trading partner by far is Brazil, and in the long run, the Uruguayan peso’s performance will more closely match that of the Brazilian real, not the US dollar.

There are a couple of unfortunate things about Uruguay, though– first, they tax the hell out of anything deemed a ‘luxury good,’ which is usually most imports that are not everyday items. Cars, consumer electronics, shoes, etc. cost two to three times as much as you would pay in North America.

Second, they stupidly imposed an income tax recently that essentially eliminated the country as a reasonable financial center.

Third, the Uruguayan government does force you to declare gold upon entering the country, and any sizeable amount will be taxed.

Jein asks: “Simon, I’ve been considering the Swiss National Bank’s move to sell Swiss francs recently against the dollar and yen. Is this a hedging technique to get ahead of the markets, or do the Swiss see the slowing of US M2 money supply endangering equity markets and causing a carry unwind?”

Switzerland has repeatedly demonstrated that it will intervene in the currency markets to prevent a rapid appreciation of the franc vs. the euro; given the euro’s recent fall against the dollar and yen, I think the SNB is selling francs as a hedge to offset the rapidly declining euro.

I’ve recently gone long the euro against the franc because I expect the SNB will continue to intervene and offset the franc’s rise against the euro. This should cause a further decline in the value of the franc against the dollar.

Ellen asks: “Simon, if one is eligible for a Polish passport, which is an EU country, doesn’t that mean the person is automatically eligible for another EU passport, i.e. s/he would automatically be eligible for French or Italian citizenship?”

No. Citizenship does not transfer across the EU, only residency. In other words, as long as the EU/Schengen area continues to exist, a Polish citizen has the right to live and work anywhere in the European Union… but as a Polish citizen.

A Polish citizen could realistically establish permanent residence in another European country like France or Italy, and eventually become eligible for citizenship there after 7-10 years.

Frankly, I think that if you’re eligible for Polish citizenship, you should not even think about ‘old Europe.’ Poland is one of the strongest economies in Europe by far, and I think it will stay that way for quite some time. Poland is the future. Italy is the past.

Dee asks: “Greetings, Simon. What are your thoughts on purchasing natural colored diamonds as a means of wealth protection, asset accumulation and privacy?”

I don’t like diamonds for wealth preservation. Technology already exists that can create a chemical replication, which completely eliminates the stone’s scarcity in my book. All that remains is the sex appeal from clever marketing.

I also find diamonds to be too politically contentious with all the chanting about African slave mines. It’s just not worth it. Gold and silver are much more reliable stores of value. No one is going to spray paint your fur coat for owning some Krugerrands.

Mike asks: “Simon, I understand that Moody’s is set to raise Panama’s country rating to investment grade within the next 3 months. What effect do you believe this will have on the local economy and will it give real estate prices a ramp up?”

Honestly, not much. Moody’s is a relic of the old financial system, and the only people who still pay them any attention are institutional investors that still believe in the Tooth Fairy. A Moody’s upgrade will make it easier for Panama to raise cheap capital through a sovereign debt issue, that’s about it.

At this time, the country doesn’t have plans to raise any additional debt, though it may capitalize on cheaper money to refinance existing, higher interest debt, which would save a few bucks for its budget.

Panama’s economy has many opportunities for small to medium sized investors, but with only a $19 billion GDP, it’s simply too small to absorb capital flows from large institutions. Consequently, there really won’t be much of an economic effect from a Moody’s upgrade.

That’s all for this week. We’ll talk again on Monday.

February 16, 2010
Bangkok, Thailand

The popular press has been bandying a lot of cute acronyms for the ‘sick’ European countries. I have seen PIIGS, STUPIDs, and DUHs… and while the individual circumstances of each country are different, they all have one thing in common–

Their obligations far exceed their assets, and they have to borrow money just to pay interest on the money that they’ve already borrowed.

We don’t need a new acronym because there’s already a word for it: junkie. Before too long, the entire euro zone may be heading in this direction… in fact, while the final nail may be a long way off, markets are clearly starting to build a coffin for the euro.

To give credit where credit is due, I believe that Doug Casey and Jim Rogers were among the first well-known figures to declare the euro ‘doomed’ from its inception.

Their idea, long dismissed as a delusional paranoia for the better part of a decade, is now cascading through financial markets as a distinct possibility.

I came to my own conclusions a few years ago when I was traveling through Europe looking for cheap property; I didn’t find any. European costs are much higher than most of the world, and one of the chief reasons is that the governments tax everyone and everything to death.

Yet, despite the high taxes, most European governments were still run budget deficits to pay for legions of useless, omnipresent government workers and social welfare program.

I remember the day very clearly when I came to this realization– I was sitting on a train bound for Giulianova on the Adriatic coast with a gorgeous Italian girl, and the newspaper headline she was reading said “Italy’s budget deficit to exceed the EU limit of 3% of GDP”

That was in 2004 when times were good. I remember thinking to myself, ‘How are these people going to make it during a down cycle when they can’t get their act together during the up cycle?’

More importantly, since European tax rates are among the highest in the world, and the individual governments of the eurozone cannot simply print more money at will, the only way out of a fiscal pinch is to borrow.

It seems so strange that Italy, which collects 43.4% of GDP in tax revenue, can’t figure out a way to make ends meet… and because it cannot realistically squeeze out too much more tax revenue, the government must borrow compulsively.

Italy’s debt level is now well-over 100% of GDP, and investors are rightfully worried.  Given the even more dire situation in Greece, markets are now finally starting to question the legitimacy of the common currency euro zone.

Like all fiat currencies, the euro is fundamentally toxic. It is in a unique situation, though. Unlike the US, European governments don’t have room to raise taxes because their taxes are already so high. What’s more, they have many more social welfare programs and lack the political will to cut them.

That makes Europe first in line for judgment day.

The junkie countries like Greece and Italy will be the catalyst– they refuse to cut their budgets with any serious meaning, and are thus unable to raise any more debt capital from the markets.

That only leaves the prospect of a bailout from Europe’s stronger nations… except that even Germany and France cannot withstand the brunt of multiple bailouts. Obviously, if Greece is bailed out, Spain, Italy, etc. will line up with hat in hand as well.

And while the Greeks may be holding mass demonstrations to protest budget cuts, what will happen when the French start rioting in the streets to protest Greek bailouts?

European financial solidarity cannot stand, and there is no long-term solution except for a breakup of the eurozone. For now, the politically expedient answer is the current dog and pony show– bureaucrats gripping hands in a charade that is long on theatrics, short on substance.

Eventually, though, and it will have to be soon, something has to give. Greece is going to run out of money in a few weeks… so it’s either bailout or default. Neither will be pretty for the euro in the medium term.

The euro may rise briefly if Germany and the ECB signal a bailout, but the long-term implications of the moral hazard will be detrimental for the single currency.

One way to invest is to short the euro against gold and silver (XAUEUR and XAGEUR); I recommended this trade two months ago, and each has returned about 8% so far. I expect precious metals to keep rising against the euro, and to hold their value even if the world resuffers another deflationary cycle.

Another implication to consider is the effect on the Swiss franc; the Swiss do not want their currency to appreciate too much against the euro, and the government there has a history of intervening when necessary, so it may be worth opening a short position on the franc in the next few weeks.

Lastly, the implications for the US dollar and yen are significant. Until the global financial system agrees on another safe haven that can absorb massive capital inflows, the dollar and yen should see continued appreciation against the euro until the market’s anti-euro fever has bottomed out.

More on this in future letters. Happy investing.

February 11, 2010
Bangkok, Thailand

Years ago, when I was a bright-eyed lieutenant anxious to defend the world against evil and tyranny, the government decided to ship me off to become an intelligence officer.

I remember a lot of the classroom training, learning about the enemy’s order of battle and maneuver capabilities. Ironically, we were still studying Soviet tactics at the time, even though the Berlin Wall had become a tourist attraction over a decade prior.

During my field training, we focused on collection efforts and intelligence gathering. My instructors would continually hammer into us the importance of ‘indicators,’ signs or symptoms that strongly imply a future action or trend.

According to our threat doctrine, for example, a small isolated scout platoon would be an indicator for a heavily armed vanguard only a few kilometers behind. Ground commanders would rely on these indicators to make tactical decisions, e.g. reinforcing defensive positions in expectation of the vanguard’s attack within the hour.

In his book Art of War, Sun Tzu wrote, “Intelligence is the most important work, because the entire force relies on it for every move… It is the essence of strategy.” Outside of war, the same holds true in finance. Savvy investors rely on market and economic indicators to provide intelligence on future trends.

Part of the trick is differentiating the valuable indicators from the worthless ones… and too many people pay attention to worthless indicators.  Government-manufactured statistics like inflation and unemployment rates, for example, are merely comical charades masquerading as economic indicators.

To get an indication of where the economy is headed, you have to listen to the economy. To get an indication of where the market is headed, you have to listen to the market.

I’ll give you a few examples:

In a weak economy, voluntary employee turnover is very low–  workers tend to stay put because they won’t be able to find a job elsewhere.  In a strong economy, however, businesses generally experience higher employee turnover because workers are confident they can find better pay somewhere else.

This is exactly what is happening in Panama; I saw it with my own eyes a few weeks ago– workers who would voluntarily quit because they had total confidence in being able to find a better paying job elsewhere.

This is a far more insightful indicator than any official statistic in determining an economy’s prospects.

Moreover, when the intelligence becomes too extreme or out of line from the norm, it’s usually a great indication of a top or bottom. Case in point– I pay close attention to the gold/silver ratio, which is the number of ounces of silver required to buy one ounce of gold.

When gold was actually money during the time of Alexander the Great and the Roman Empire, the ratio was fixed around 12.  Over time, the fixed ratio increased to 15, which stood firm until the beginning of the 20th century.

Once worthless paper money took over, metals started floating more freely against each other, hitting a high of 100 and a low of 17, with an average range of 50-60 over the past few decades.

In general, the higher the gold/silver ratio, the higher the ‘fear factor’ in the marketplace. This is because the market for gold is much more capitalized than the silver market.  Thus, institutional investment capital can flow into gold much more easily than into silver, which pushes up the ratio.

Naturally, this only happens when institutions are looking for safe havens for large amounts of capital.  Consequently, when expectations are poor and risk tolerance is very low, the gold/silver ratio increases. When risk tolerance is high and expectations are strong, the gold/silver ratio decreases.

Right now the ratio is about 71… higher than the norm of 50-60. I think this is an indication that markets are becoming risk averse.  It certainly mirrors what has happened with world equity and currency markets lately.

Given the level of uncertainty in the world right now, I think it is too early to make a trade on the gold/silver ratio… but I am continuing to watch it; if it rises beyond 75, I will likely respond by shorting long-dated gold futures and buying long-dated silver futures.

When this trade is properly structured, it doesn’t matter if the metals prices rise or fall– the trade will make money when the gold/silver ratio declines back into the normal range.

This will happen once market and economic tensions ease… and I’m watching what is happening in Europe very closely to help make that determination. It is, after all, an indicator.

February 9, 2010
Bangkok, Thailand

Money is just a tool… nothing more. It’s not the only tool, but it’s certainly a useful one that can be leveraged to acquire more freedom; we can trade money for time, money for health, money for experience, and money for assets that safeguard ourselves and our families.

As such, it certainly behooves any free individual to have some means to generate capital– this can often be through a business or entrepreneurial venture.

Once wealth has been accumulated, though, it is equally important to be able to maintain and grow the account through sensible, well-grounded investments.

Before allocating any investment capital for the long-term, though, investors need to address a fundamental question: will the world’s pent-up economic deficiencies ultimately result in inflation or deflation?

This is an absolutely critical issue to resolve because the investment implications of either case are drastically different. In a deflationary scenario, prices fall. This means that that cash and reliable cash equivalents gain in value while stocks and commodities are losers.

In an inflationary scenario, the general price level rises. This erodes the value of cash against goods and services while the value of stocks and commodities rise.

A completely objective analysis shows very compelling evidence for both sides.  Record high deficits, soaring national debts, and unprecedented expansion of central banks’ balance sheets, particularly in the western world, absolutely portend future price inflation.

Each of these influences effectively creates more paper currency without a similar increase in the aggregate amount of products and services available in the economy.

In addition, consider the effects of population growth, demographic shifts in the developing world, resource scarcity (water, arable land, oil), climate change regulation, and of course, rising taxes in bankrupt western economies.

The combination of these elements certainly seems to make an obvious case for substantial price inflation.  The evidence for deflation, however, is equally compelling.

The accumulated and potential destruction of wealth from toxic assets far surpasses the amount of money that governments are printing, while anemic unemployment and GDP growth rates are pushing down aggregate demand and price levels.  The emergence of new technology also has an effect on reducing price levels.

Moreover, much of the new liquidity created by central banks is not making its way into the financial system.  Risk-averse commercial banks have become a bottleneck to new money creation, and a further meltdown in commercial real estate, sovereign debt, etc. will reduce banks’ willingness to lend.

This credit contraction will reduce the amount of money circulating in the economy, putting downward pressure on price levels.

For someone to invest blindly and unhedged for the long-term without objective consideration for both sides of the argument is frankly irresponsible.

With due regard for both inflationary and deflationary contentions, I think one of the most sensible investments to make right now are high quality companies that trade at a discount to their tangible book value.

In other words, I’m talking about strong companies in growth industries that are woefully undervalued by the market relative to their net assets… small town newspaper chain sitting on a mountain of debt– bad; profitable energy company with enormous cash reserves– good.

This way, if the world undergoes a deflationary cycle, your investment will have essentially bought you cash at a discount, likely one of the best investments you could make.

Otherwise, if the inflation gorilla wins out and prices soar, the company’s earnings and stock price should keep pace, maintaining the value of your capital.

These types of companies are absolute gems, and not to mention quite difficult to find. And you can forget about scoring one in most emerging markets; stocks in China, for example, trade at dizzying multiples of their earnings and book value– think Amazon.com in 1998.

Conversely, the Tokyo Stock Exchange has several undervalued companies right now; Japanese stocks are trading at much lower valuations than most other markets because local investors there have fled low-yielding, yen-denominated assets.

Instead, Japanese capital has been parked in places like China, Thailand, and Australia, where even a simply term deposit account can yield 8%. The exodus of capital has left the Japanese stock market with miniscule valuations, and many companies are trading at less than their book value and at a single digit multiple to their earnings.

Overall, I’m negative on Japan… but even a long-term stagnant economy has solid companies that will continue to be profitable year after year.

If you want to find out more, I’d encourage you to take a look at The Casey Report, which is without doubt one of the best macro-level investment advisories out there.

The most recent issue has some really brilliant commentary on the Japanese market, and the research team routinely uncovers some of these deeply-discounted companies that I’m talking about.

In fact, I’m about to put a BUY order in for their most recent recommendation, a marine transportation company that specializes in the upstream oil and gas industry. It’s trading at a mouth-watering discount to its tangible assets, and is loaded with cash… a very safe bet, in my opinion.

You can read more about it here.

January 12, 2010
Estepona, Spain

There is really a great deal of information out there about offshore corporate structures… frankly it’s mind numbing. Do a search for “offshore corporation” and you will undoubtedly return over a million websites promising you fast incorporation in Panama or the BVI, as well as a host of ‘benefits’ for that particular jurisdiction.

Are these benefits real? Does it make sense to structure a business overseas?

Yes. Planting a flag overseas provides asset protection benefits, and in many cases, significant tax benefits… even if you are a US citizen. It is possible, for example, to generate corporate profits free of tax liability, and to defer personal income tax liability indefinitely.

Let me first back up for a moment and explain some of the lovely US regulations that govern foreign corporations for US taxpayers. (as an aside, you should realize that I am not a tax attorney, nor does this constitute tax advice)

The first is section 957 of the Internal Revenue Code pertaining to “Controlled Foreign Corporations (CFC)”. A CFC is any foreign registered company with more than 50% direct or indirect ownership by a US person.

If a company is deemed to be a CFC, the IRS essentially views it as a domestic US company and expects the foreign company to file a tax return every year.

That’s where places like Panama come in. Some people try to get slick and form a Panamanian company, hiding behind their lawyers as nominee directors. If their name is withheld from a public registry, the US government will never know about their ownership interest… right?

Guess again. Basing your tax strategy around another human being keeping your secrets in just plain absurd. Your lawyer may be a good guy, but when push comes to shove and the US government comes knocking, he’ll sing like a canary.

Let me underscore this point again even more clearly– do NOT expect to hide profits through an offshore company without the government finding out. They will find out. Privacy and secrecy are gone, at least for now.

Fortunately, there’s a big fat silver lining. Most people do not realize that there are perfectly legitimate ways to structure your business interests overseas and realize significant benefit.

Big businesses do this all the time; large multinationals have subsidiaries and affiliate offices all over the world. Consider Boston Scientific, which manufactures products in Ireland and then ‘sells’ them around the world. The company only pays a 12.5% tax to Ireland on its profits from those sales, rather than 30% to the IRS.

You might be thinking to yourself right now– “Great… except I don’t plan on opening a multi-million dollar medical device manufacturing facility in Ireland.” Believe it or not, in many ways it’s even easier for some small businesses to capitalize on this concept, especially if you have an online presence. Here’s why:

A foreign corporation is subject to US income tax, depending on the situation, if any of the following are true–

First, if the foreign company has a permanent establishment in the United States; ‘permanent establishment’ is ordinarily defined by specific tax treaties, but usually includes things like an office, factory, or workshop.

Second, if the foreign company is engaged in a “US trade or business” or has US-source income; income source rules are defined by Internal Revenue Code section 862.

For example, if a business produces inventory, the source of income is where the inventory is produced; if a business performs personal service, the source is where the services were performed. For businesses that sell inventory, the source of income is where the products are sold.

As you can see, these rules clearly favor many types of enterprises, including e-commerce businesses, some service providers, overseas manufacturers, and businesses owned by expatriates.

Foreign corporations that fit these circumstances are not subject to paying US taxes. The company may be subject to tax in its own jurisdiction, but many (BVI, Cayman Islands, Labuan, Singapore, etc.) do not tax corporations on income earned outside of their borders.

In this manner, the corporate entity is free of tax liability. However, when the corporation makes dividend distributions to its owners (US taxpayers), the US citizen will pay tax on those distributions.

Presently, the dividend tax rate is quite low, but you can be sure that the Obama administration will raise the dividend tax in the future. If the corporation does not distribute profits to the owners, however, the individual has no immediate tax payment due and effectively defers his tax liability indefinitely.

Here’s an example– you are a US citizen and own an e-commerce company based in BVI. You have no permanent establishment in the US and have no US-source income by the IRS rules. The company does not pay tax to the US, nor does it pay tax to BVI.

Assume your company nets $1 million annually. You do NOT distribute this income, and rather invest all of your profits with a 20% annual return. At the end of 10-years, your business has accumulated $25.958 million.

Now assume the same business is structured in the US paying 30% to the government. At the end of 10-years, the business will have accumulated $13.536 million.

The compounding power of tax-deferred profits is extraordinary– you make an extra $12,422,575.54 with a properly structured foreign company.

This week I’m going to be interviewing one of the country’s premier international tax attorneys who specializes in offshore business structures. As a personal favor to me, he has agreed to walk you through the regulations and explain how you might be able to realize these benefits.

January 6, 2010

Reporting from: Estepona, Spain

I’m sitting now in lovely Estepona, Spain– a coastal town on the Mediterranean that experienced a massive property boom over the last decade.

The community I’m in is anchored by a five-star Ritz Carlton golf resort, and surrounded on all sides by the mountains or the ocean.  Ancient military tacticians marveled at the defensibility of such a position and likely did not envision it being turned into a holiday hot-spot.

As the coastal region here is generally dry, warm, and nestled in the mountains, it’s ideally suited for me. I prefer clean places that are reasonably priced with great weather, access to major transportation, vibrant culture, and yes, a single’s scene.  Coastal Spain is all of these… but to buy now I would be overpaying. Here’s why:

When the credit bubble got underway earlier in this century, coastal Spain was overrun with foreign property buyers, and their easy credit inflated home prices.   Like other parts of the world, property values in Spain are now upside down in equity– the home is worth less than the mortgage balance.

This is bad news for banks, bad news for owners, but great news for cash buyers… as long as there is legitimate value.

Appraisers generally use three ways to value a property.

The first is the ‘replacement cost’ method, in which the appraiser estimates what it would cost to construct the unit from scratch.  Between 2003-2006, the industry was booming… most contractors were booked solid, and demand for materials and labor pushed up construction costs.

Today is a different story altogether; most contractors haven’t seen a payday in months, and material prices have plummeted alongside housing demand. You could now build one of these spacious 2-bedroom villas for around 100,000 euros, not including the land cost.

The second method is the market approach, in which a property is appraised at a similar price point to where comparable properties are selling. If a 2-bedroom villa with an ocean view recently closed at 400,000 euro, then your 2-bedroom villa with ocean view can likely sell for around the same… in theory.

The problem with the market valuation is that it is highly susceptible to the irrational exuberance of the market’s participants.  Remember, at the end of the day, markets are simply comprised of emotionally charged individuals… they experience fear, euphoria, anxiety, and impatience, and these emotions skew market valuations.

Throughout history, markets have historically proven that they are terrible indicators of value: loss-making tech stocks traded at infinite valuations, small shacks in California sold for millions of dollars, and debt-free mining companies were valued at less than the cash they had in the bank.

None of these passed the common sense test.

Furthermore, here in Spain, the property market has essentially dried up.  Most of the owners have adopted a ‘wait and see’ approach, foolishly believing that if they wait around long enough, price will eventually return to their highs.

This idea is totally absurd. Japanese equity investors are still waiting for the Nikkei to return to its 1989 high of 39,000. Today the Nikkei is still shy of 11,000… so I guess those investors will just have to keep waiting.

Home prices here in Spain won’t start appreciating until the prices are cheap enough to entice buyers.  There is no magical timeframe that will suddenly turn around home prices; if sellers refuse to sell, and buyers refuse to buy, then the market can theoretically remain in a stalemate forever… which leads me to…

The third valuation approach is the income method. For an investor, this is the only thing that counts: What is the investment return I can achieve with this property, and is that investment return adequate for the level of risk that I am taking?

As an example, when I was in Southern Italy over the holiday, I went scrounging around my local family’s neighborhood looking at property.  I found that the going rate for a modest 2-bedroom home was 220,000 euros.

Then I found out that the same home can be rented for about 450 euro per month.

Some quick, back-of-the-envelope math suggests that, after deducting reasonable amounts for vacancy, maintenance, insurance, and utilities (Berlusconi eliminated property taxes), the net operating income would be around 4,200 euro per year.

If the home is bought with cash, that amounts to a whopping 1.9% yield, roughly the same as a much lower risk Certificate of Deposit.  The risk adjusted return on these properties is clearly unreasonable.

I’m seeing the same thing in Spain right now– villas rent for a pittance, but property owners are stubbornly sitting on their asking price, not budging.

Eventually, external pressures will force sellers to capitulate– most won’t be able to continue making their mortgage payments, and others will be so desperate to raise cash they will finally slash prices.

When this happens, prices will drop and yields will rise. I think the time to jump in is when yields comfortably reach double digits and outpace less risky asset classes by a wide margin.

Buying foreign property makes a lot of sense; maybe Spain is for you, maybe it’s not… but you should strongly consider planting an overseas flag, and I recommend using this valuation method to determine your entry point.

I receive a lot of subscriber questions, and while I cannot answer them all, I wanted to specifically address three of them that key in on recurring themes in this community– second citizenship, investing, international opportunities, corporate structures, banking, and gold/silver storage.

1) Paul asks– “I was wondering what your 1st choice would be in setting up an online business offshore.  Which country would be best for business structure, hosting, and merchant accounts?”

There are a lot of great reasons to have an online business– portability, scalability, maneuverability. You can go from zero to profit very quickly, and the Internet allows people to live and work anywhere on the globe.

Most importantly, though, online enterprises provide a great opportunity to easily plant multiple flags in a cost efficient way; you can live in one country, have citizenship in another, have your business structured in another, process credit cards in another, and have your servers based in another.

This prevents significant influence from any single government over your business. As to the right jurisdiction? This is a tough call because it really depends on your country of citizenship and your country of residence.

The United States, for example, is one of a handful of countries that tax its residents on their worldwide income. Some people with online businesses think they are smart because they structure their business in some Panamanian IBC and/or process credit card transactions offshore.

Then they don’t report the income and hold everything offshore.

Not only is this a completely bonehead move, it’s largely illegal. The IRS has clear rules for what it calls ‘check the box’ entities, as well as how to determine the source of income.

I’m going to be talking about this much more in the future, but for now, the bottom line is simple: with a well-structured plan, it is possible to set up an online business to maximize your personal tax advantage while minimizing sovereign risk.

There is great danger, however, in establishing an overseas structure without performing substantial research into the tax implications of your home country.

I’m going to help you solve this problem in a few weeks– early next year, I will bring you some really valuable information from some top North American tax advisers who specialize in offshore structures; they’ll teach you what you need to watch out for.

For instance, you may want to consider structuring your business in a country that has a comprehensive tax treaty with your home country. Switzerland is a great example that has treaties with both the US and Canada. Zero-tax jurisdictions like Panama or BVI do not have tax treaties.

More to follow on this in a few weeks, it’s an incredibly important topic that merits more than a short-answer.

2) Peter asks: “What do you think about Israel? In spite of all the political unrest in the news, Israel has a growing GDP and has a decreasing trade deficit.”

This is a great question.  My take on Israel is that it’s a great place for second (fairly valuable) citizenship.  If you’re willing to convert to Judaism and live in Israel for a bit, you can obtain an Israeli passport fairly easily.

Other than that, I’m not keen on investing in the country; it’s too closely tied with the United States, and there is no ‘blood in the streets’ discount that you would expect of a nation perpetually at war.

If you compare Israel to a place like Sri Lanka, there is no contest when it comes to value.

3) Stefan asks: “I have an account at DBS (Singapore) but they do not give any information about bankruptcy protection. Do you know anything about this? Do you prefer other Singapore banks? Any idea for a safe deposit box in Singapore?”

I can’t comment specifically on DBS, but you should always, ALWAYS, feel comfortable with the balance sheet of your financial institution. Banks in the US are backed by the FDIC, and this gives some people confidence in their account value.

I am not one of them. I bank overseas because I trust in the financial solvency of overseas institutions, but it means I have to do my homework.

Even the most cursory analysis can say a lot about a bank– what is their ratio of liquid assets to deposits? Does the loan portfolio consist of ticking time bombs? How well are they provisioned against loss?

This is why I wrote about Islamic banking a few weeks ago; based on requirements of their religious law, Islamic banks tend to have higher capital adequacy ratios, providing a greater cushion against insolvency in the event of a financial cataclysm.

There are several Islamic banking institutions in Singapore, though overall I’m quite confident in the country’s financial infrastructure. I rely on it myself.

As for gold storage in Singapore, look at Cisco-Certis. Their facilities have fantastic security, and the boxes are reasonably priced.

Somewhere after paying over $100 for a tank of gas, $35 for a haircut, and $15 for a fast food sandwich, it dawned on me last week.  The euro is terribly overpriced against the dollar.

I wrote about this extensively last week, arguing that, because of a litany of taxes and fees, and due to overselling of the dollar, the euro zone is excessively expensive in dollar terms. Clearly there needs to be an adjustment.

Taxes are simply another form of inflation, and one that has been felt acutely in Europe; politicians impose new taxes, and ‘stuff’ becomes more expensive. Employees demand higher wages to maintain some semblance of their living standards, and in the end, all prices have gone up without any real value having been created.

If the current administration gets its way, the same thing will be happening soon in the US.  A national sales tax will likely be introduced, along with a host of other income and luxury taxes, pushing up the prices of everything, from gasoline to haircuts to fast food.

Gold is generally regarded as a proxy on both safety and inflation; when price levels of ‘stuff’ go up, the price of gold rises accordingly… often outpacing the rise of inflation due to increased concerns about safety.

Gold’s rise this year has been more about safety than inflation; price levels generally show stable or declining prices around the world, but institutional money has voiced significant concern regarding investments that were once considered safe.

Dubai, Greece, Latvia, Ireland, Spain, UK, etc. all give investors a lot of reason to worry. Ironically, when things get really bad in the rest of the world, investors rush into the US dollar as the ultimate flight to safety.

I know I don’t have to tell you that this line of reasoning is utter nonsense. Institutional money managers realize it too– the prospect of loaning money to the largest debtor in the history of the world for 30-years at less than 5% is certifiable lunacy.

That’s why so much sovereign and institutional money flows into shorter-term treasuries– they want to sit on the sidelines for a short period of time, and they’re willing to lose on the yield in order to guarantee the safety of their funds.

Naturally, the chief reason that Treasuries are considered safe is because they are backed by the full power of the US government’s printing press. Investors are wise to this trick, and smart money will not be fooled into longer term bonds unless there is another financial cataclysm.

As I survey the situation, I’m convinced that gold is nowhere near peaking exactly for this reason. In a flight to safety, institutional money still flows into the dollar. Gold will not truly break out until there is a bifurcation in investors’ mentality regarding safety.

To put it more clearly, when worried investors start piling into gold instead of the US dollar to protect their assets, this is the sign that we are charging towards the top.

For now, it’s not happening yet, and that’s why I recommended going long gold against the euro– the euro has been overpriced against the dollar, and while gold has dropped roughly 5% against the dollar since I recommended this trade last week, it has risen 3% against the euro.

Despite its historic nominal highs, gold still has a long way to go before achieving this bifurcation. The idea that US treasury securities are safe must be eradicated from the investment community before it’s safe to say we have reached a top.

I know you have heard this before, but gold is way off its inflation adjusted highs. Most of the time people talk gold’s inflation-adjusted high in 1980. But if you want to get a better sense of gold’s potential, you need to go back even further. 

The best apples-to-apples comparison of gold prices is in British pounds sterling (GBP); Britain is a much older country and historic gold prices exist in pounds for nearly 1,000 years. 

Gold’s highest price was recorded in the late 1400s at an inflation-adjusted price of roughly GBP 1200 during what was called the ‘great bullion famine.’ The 1980 peak in sterling terms was about 30% lower than this.  Today gold sells for less than GBP 700 per troy ounce.

The length of the present dollar rally, which technically started several weeks ago, is unknown. From the beginning of the meltdown in 2008 to the dollar’s peak earlier this year was about six-months. This one may be shorter, or if there is a great cataclysm, much longer.

One thing is inevitable, though, and that is the investment community’s eventual abandonment of the dollar as a safe haven. As such, from a fundamental perspective I have great difficulty playing this rally by buying dollars and dollar assets.

I’m sticking with the long gold/short euro position; gold may fall in dollar terms, but I expect it to stay stable and gain against the euro. I also intend on bargain shopping for long-term silver options; as a speculation, I prefer silver to gold as the ‘cheaper’ metal is still over 50% off its nominal high. Gold is less than 10% off its nominal high.

You can do this with long-term options on any of the silver ETFs, or if you have a futures account, you can buy call options for long-dated silver futures contracts like December 2011.

I spent a couple of days this week in a fast BMW with Matt, my friend and business partner. We had a meeting in southern Spain yesterday with a key figure in the world of second passports, and we raced at speeds up to 250 km/h so that we could make the meeting and bring you some tremendously valuable information.

It came at a price– six speeding tickets in total, mostly across the south of France and Monte Carlo. What can I say, I have a heavy foot…

The meeting was great, and it gave me quite a bit to digest.  Our host was one of the most knowledgeable people I have ever known regarding second passport opportunities.  Shortly, once I am able to work through some of the information and go through the process myself, I plan on discussing these very interesting solutions with you.

But first, though, I thought I would answer some of your questions from the last few weeks before I enjoy a nice weekend in Frankfurt with a new inductee to the Atlas 400 club.

First off– yesterday I discussed my observations on the ground here in Europe; the European tax situation makes most goods and services extraordinarily overpriced, and these prices are passed on to the consumer. Eventually, the cycle of higher wages and higher prices becomes simply another form of inflation… as higher taxes are coming to the US, similar price inflation will follow.

Based on a tax-free pricing model, however, the euro still appears overvalued against the dollar, and the dollar is undervalued against ‘stuff’, that is goods and services that consumers buy. I argued that one way to play this is to short the euro against gold and silver, thus profiting from the euro’s correction as well as a rise in inflation.

How to do it? Well, Denmark-based Saxo Bank, which has no nationality restrictions for new customers, trades spot metal prices against a variety of currencies, including US dollar, euro, Hong Kong dollar, yen, etc. In other words, you can take a long position on gold or silver, and a short position against a major currency.

To take a long gold/short euro trade on Saxo, the ticker is XAUEUR, and XAGEUR for silver. I tend to look further out, though, so I’m planning an investment that is a combination of long-term currency put options combined with gold/silver call options in 2011.  I can discuss this in further detail if you are interested.

* Questions from subscribers *

1) Stan asks “Simon, regarding international brokerages- what would you suggest for European citizens who don’t want to hide their wealth, but move money out of the US and Europe? Are HK or Singapore better?”

In a word, yes. US and European officials are getting increasingly desperate for cash, and they will look in every dark corner they can find for a few pennies.  In a single day on this Europe trip, I was stopped twice in France by customs thugs wondering how much currency I was transporting in the car.

Bottom line, they need money, and they’ll find it. After all, only ‘rich’ people invest in the markets.

Asian jurisdictions are safer for western investors simply because it makes more sense to have your money in a place where you do not live– this is central to the multiple flags approach. Furthermore, while financial privacy has gone away, they are less likely to submit to western governments– especially Hong Kong which is backed by mainland China.

Try Boom Securities, based out of Hong Kong, at home.book.com.hk

2) Andrew asks: “I hear a lot of recommendations for exotic locations, but the majority of very wealthy Americans I know have half a foot in New Zealand. What do you think about New Zealand?”

New Zealand is beautiful, peaceful, slow-paced, reasonably-priced, and devoid of anything particularly interesting. The taxes are cumbersome for residents, but as a location to obtain a second passport for non-residents, New Zealand is spectacular.

3) Chris asks: “What Islamic banks, if any, allow Americans to open bank accounts online?”

Worldwide “Know Your Customer” rules require new branch banking customers to show up at least once, unless an intermediary has a very personal relationship with the banker… either way, the account is not generally opened over the internet.

4) Taylor asks “Simon, regarding foreign bank accounts, can’t US citizens side step institutions who won’t accept US clients by opening a Panamanian corporation?”

Sure, in some instances… many banks won’t work with US citizens directly as a customer, but they will work with a corporation or trust whose beneficiary is a US citizen. There is nothing illegal about this as long as the bank is made aware of the arrangement.

Lastly, as an administrative note, I want to tell you that I am planning on making the site much more interactive in the early part of 2010. I think you’ll really like what we’re doing, so stay tuned.

It took three speeding tickets in the south of France on the way from Monaco to Barcelona, but we made it to Spain late yesterday evening.  I had forgotten how expensive it is to drive in France. Fuel is among the most expensive in Europe thanks to a series of extraordinarily high taxes.

Gasoline, as people often forget, is a fungible commodity… in its pure form it should cost the same everywhere because it is priced by the market and traded on futures exchanges.

Aside from some variations in distribution costs, the major reason why fuel is priced differently around the world is government meddling– some governments subsidize fuel so that it’s artificially cheap (Venezuela, Dubai); others tax it to death (France, California).

It’s no secret that western European governments enforce an incredibly high tax burden on their citizens in order to pay for the ‘greater good’ of all members of society.  Taxes, as we are all aware, eventually lead to higher prices.  In this case, I’ve been actually shocked… even offended, at the prices of what I have seen in Europe.

After a series of tax increases over the last 2-years to pay for the effects of the economic slowdown, Europe has become much more expensive than I remember even six-months ago. I spend a few months on the continent each year and have a good feel for pricing; it seems to me that things are starting to get out of control.

$82.50 for two burgers and three beers; $13.50 for a fast food sandwich; $7 for a cup of coffee; $4 for a small pack of gum at a gas station. You get the idea.

Part of this pricing scheme is clearly based on recent dollar weakness. Much of the world’s institutional capital has lost confidence in the dollar simply due to the prospect of an extended period of ultra-low interest rates.

Last Friday’s jobs report gave the market a brief period of confidence in the dollar– investors believed that the US economy had reached a turning point, meaning that interest rates would rise earlier than expected.  Interest rate futures soared, and investors ran back into the dollar.

This only lasted briefly, for as soon as Comrade Bernanke opened his mouth on Monday, he assured markets that he would continue to keep interest rates artificially low. And just as quickly as they piled in to the dollar, investors went looking for the exit once again.

There are only three currencies in the world that have the ability to absorb enormous capital flows like this– the dollar, the euro, and the yen.  When investors flee the dollar and are looking to park their capital, it goes to the yen first, and then the euro. As such, there has been a steady rise in both of these currencies this year.

The price disparity that has developed between Europe and the United States, though, is enormous… and the exchange rate only tells part of the story.

In economics, the “law of one price” suggests that, everything else being equal, identical goods should be priced the same everywhere in the world– an iPod in Paris should cost the same as an iPod in New York. 

But everything else is not equal.

In Europe, merchants are plagued by higher taxes across the board– sales (VAT) taxes, payroll taxes, income taxes, excise fees, and a variety of others. All of these taxes are eventually baked into a higher price for products, and the consumer is the one who ultimately pays.

This is simply another form of inflation. Taxes push up the price of goods, employees demand commensurate wage increases, and the price of everything increases… yet there has been no real wealth created.

It is for this reason that I see two things happening;

First, the euro is due for a fall against the dollar. Yes, investors view the dollar as risky, but as the worthless ratings agencies are circling over Greece for a downgrade, investors also view the euro as risky. This reduces demand for the euro, and as there are few options available to absorb large currency flows, the dollar stands to gain.

Besides, in the long run, prices need to be similar, and that means a currency correction… leading me to point #2:

It’s not that the euro is terribly overpriced; it’s that the dollar is significantly underpriced, relative to ‘stuff’.  iPods and apple pie should all cost more in the United States, and they will.  The next round of new taxes to pay for carbon, health care, etc. will cause European-style price inflation as US merchants have to increase the price of ‘stuff’ to keep up with taxes.

End result? The euro falls against the dollar, and the dollar falls against ‘stuff’.  You can play a euro/dollar short, but I think it would be an even better trade to short the euro against gold and silver.

More on this later.

I’m spending a few days in the Baltics to review how things have changed since I was last here over the summer.  This region was among the hardest hit in the world, and as I have stated numerous times, I’m convinced it will end with a devaluation in Latvia.

The big news of the day here is that Lithuania’s main nuclear reactor, which supplies the preponderance of this small country’s electrical needs, is being forcibly decommissioned. 

As part of their agreement to enter the United States of Europe (EU), Lithuania had to agree to destroy the plant, effectively ending the only sliver of energy independence it had.

Now the country must rely on power from Poland, Sweden, and those all-too-reliable Russians.  Problem is, most of the infrastructure that will carry the load hasn’t been built yet, and even when it does, it’s unclear if there will be enough excess capacity for Lithuania to import.

My friend Gianni Kovacevic , a successful investor whom I have discussed before in this letter, recently sent me an email along the same lines.  Gianni is an incredibly sharp mover and shaker in the Vancouver resource scene, and he’s also quite bullish on copper.

He sees a coming surge in demand for electricity and thinks that most of the world is now scrambling to keep up with demand: 

Simon,

Like you, I travel all over the world… and based on what I am seeing around the world, I wanted to write you a quick letter to address some major trends that I am seeing as they relate to copper.

It’s a scientific fact that electrical energy requires copper for conduction and transmission. Anything electric has copper, and the more ‘major’ an electrical appliance, the more copper it contains.  A window air conditioning unit, for example, contains about 15-20 pounds (7-9 kg) of copper, including the tubing, wiring, motors, etc. 

Now think about Russia.  It wasn’t even 7 or 8 years ago that there were hardly any air conditioning units in an average Moscow apartment building. This has now changed entirely; as you can see in the picture I’ve attached, virtually every window has a split A/C unit.

Obviously, this creates significant demand for copper… and even if copper climbs to $8 per pound and the entire unit cost $100 more, would that prevent anyone from purchasing comfort in the summer heat? Probably not.  

More importantly, though, consider what could take place in city after city due to the lack of an advanced electrical grid.  All of these new electrical appliances– air conditioning units, refrigerators, freezers, space heaters, computers– are power hogs.

Moscow, with a three-month summer, had every other citizen buying, installing, and living with air conditioning, albeit for only 3 months each year.  This creates a major problem for utility companies in developing countries that have been deficient in generating capacity. 

With just one heat wave each year, many nations’ electrical systems will face catastrophic failure as we saw a few years ago on the Eastern seaboard, and just a few weeks ago in Brazil. 

In response to this energy threat, Russia and Ukraine now have two of the largest planned nuclear power expansions in the world.  Other countries are also building multiple megawatt projects at an unprecedented rate. 

The US will be expanding its own electrical infrastructure as well, installing a new “smart” grid for all the new green, clean electrical plants.  As many other countries never even installed the first generation electrical systems, though, they are now efficiently leapfrogging to the most modern power balancing systems.

Sure, it’s true that items are becoming more energy efficient. But consider that in 1980, the average US home had 3 electronic gizmos.  Today it has 25!  Many of these items are not regulated to be energy efficient, thus certain items like plasma televisions are still power hogs.

Homes all over the world are now starting to resemble the average western household, plasma screens and all. For whatever reason there are a few naysayers who ‘don’t believe’ this trend, but I wouldn’t listen to stories on this subject from anyone that doesn’t have stamps in their passport.

Facts are facts and the reality is that just about every place on the planet is using more electricity today than 20 years ago, 10 years ago and even a few years ago.  As the developing world plays catch-up, their power needs are really outpacing the west.

All of this– from the appliances to the electrical generation to the grid expansion– requires copper.  Global appetite for the red metal has grown annually by 4% on average for the last century. Sure there may be corrections, but long-term demand is clear.
 
The Chinese are now all over the globe in a silent economic war, securing and trading their dollar reserves for long-term supplies of commodities they need. No oil, no steel, no copper, no growth, and that simple truth is exacerbated by the never-ending ascent of man.

All of these facts are paving the way for a long-term bull market for all commodities.  While prices won’t move straight up or down without correction, higher average commodity prices will continue to baffle and confuse pessimistic permabears who have little first hand knowledge of basic electricity and way too much Sino-phobia. 

Simon again. I agree with Gianni, and while there may be a short-term technical correction soon, our on-the-ground observations suggest that the long-term outlook for resources is very bright. 

Aside from resource stocks that Gianni personally recommends to me, I’m considering long-term futures contracts and options on futures (similar to my July silver trade that is up over 300%).

It was a rare, cool evening in Bangkok, so we decided to take a tuk-tuk back to the hotel.  You’ve probably seen them– they’re like open-air rickshaws attached to a lawn mower engine, and the drivers will take you anywhere in town for a buck or two.

I was riding with my friend Gianni Kovacevic who had just flown in from Zurich on his way back to Canada; at 35, Gianni is one of Vancouver’s great up and coming dealmakers, and I consider him to be among the finest investment minds I know.

To put it even more clearly, I have always made money on his recommendations, and that is a pretty winning track record in my book.

When he’s not traveling, he spends his time analyzing the markets, keeping up with his network of fund managers and Swiss bankers, and performing some very selective consulting services, which he conducts by invitation-only.  Needless to say, he’s plugged in.

As the tuk-tuk driver sped a long, weaving in and out of Bangkok’s notorious evening traffic, Gianni and I talked about normal guy things– women, sports, and cars. We share a penchant for fast cars and made plans to ship my Stingray to his place in Croatia when the garage is finished.

By the time we pulled in to the Four Seasons Hotel, though, the conversation had shifted to economics.  There was much to discuss. 

We rejoined our other friends for dinner, and our party became quite a cast of characters, setting the stage for an interesting discussion.

Jess, an American, is a full-time investor, entrepreneur, and adventure traveler.  Vran, a Slovenian who formerly owned a high-end liquor distribution business, is also a successful investor.  Agron, a savvy European entrepreneur, secured the exclusive rights to distribute BMWs in Kosovo when he was only 22 years old at the time.  Agron and Vran had just arrived from Burma.

Including Gianni and myself, it was a lively and insightful meal.

As we are all heavily travelers, we see much of the world with our own eyes and form assessments based on empirical evidence.  One thing we all agreed on– the world has not come to an end.

Yes, the economic situation has gotten worse in recent years, and in all likelihood, certain aspects will likely get worse from here. The dollar is strained, as is the anemic US labor market.  Commercial real estate carnage is just a few stops away, and the residential market is a long way from a real recovery.  Major resources like fresh water and oil could see future shortages.

Most governments are doing all the wrong things, trying to prop up weakness instead of letting recessionary forces cleanse the excess out of the marketplaceca. Taxes will rise and civil liberties have been eroding, especially in the west.

Surprisingly, though, we’re quite upbeat and optimistic.

In our collective travels, we have seen some amazing recovery stories; companies and local economies have reinvented themselves to adapt to new conditions. Businesses are more productive, people are saving and investing carefully and deep discounts are starting to draw consumers back to the market.

Asia is showing the world that it can eat its own cooking as domestic consumption from China to Thailand picks up steam.  Gray market employment is at an all-time high in many countries, and even some real estate markets are showing signs of improvement.  The “poor” countries of yesterday now have emerging middle classes that are becoming eager consumers.

More importantly, nonfinancial factors are routinely ignored.  Technological and medical innovations continue to exceed expectations.  Peace and stability are becoming the norm in places like Sri Lanka that were at war for decades.  Countries that were formerly closed off like China, North Korea, and Burma are showing signs of opening up.

Clearly, we are not seeing a wide-open lane full of green lights… there are major hazards ahead as there would be in any situation, including life itself.  Things happen; people get cancer, get hit by a car, slip in the shower, get mugged, etc.

The same sorts of things happen to society and the world economy. And from our perspective, humanity has started to pick itself up and dust itself off instead of just lay there in the fetal position.

Despite the hazards, smart people are figuring out ways to adapt, survive, and prosper. 

Focusing solely on the doom, though, while ignoring boots on the ground reality is close-minded and likely unproductive.  And so, from our take, we are largely optimistic.

Jess described what I think is a brilliant new business idea; Vran and Agron were wheeling and dealing in Burma; Gianni travels the world lecturing about a boom in copper; and me… you know what I do.

Amazingly enough, Hugo Chavez is giving us a gift.  Allow me to explain.

World leaders are gathered today in Berlin, celebrating the 20th anniversary of the fall of the Iron Curtain.  What would have been the greatest armed conflict in the history of the world was successfully avoided… peace prevailed.

Meanwhile, thousands of miles away, Hugo Chavez is stoking the flames of war in his region.

Notwithstanding the collapse of European communism, Hugo steers a rather unwieldly ship of socialism in Venezuela.  Hugo calls his brand “Bolivarian Socialism,” named after the famous Andean political leader Simon Bolivar who had served as President in Colombia, Venezuela, Bolivia, and Peru. 

Ironically, despite the moniker bestowed by Chavez, Bolivar was an avowed proponent of the free market who admired Thomas Jefferson and traveled with Adam Smith’s Wealth of Nations.  Hugo’s policies are a far cry from Bolivar… but then again, the US government does not exactly promote the ideals of the Constitution either.

Now Chavez and the United States find themselves pitted against each other once again, this time through Colombia as an intermediary.  Colombia and the US recently signed a military agreement that allows the US to do what it does best– station American military troops in a foreign land.

In this case, the agreement calls for US troop deployments to seven military bases across Colombia.  Their mission will focus on counter narcotic operations and fighting the paramilitary insurgency. 

Realistically, though, the US is clutching on to its presence in the region.  American forces have already been kicked out of Ecuador, and since the withdrawal from Panama in 2000, the closest military installation with US troops is Soto Cano Air Base in Honduras… and as you are undoubtedly aware, Honduras isn’t exactly a beacon of stability these days.

Furthermore, to say that the US military is stretched thin is definitely the understatement of the day.  Sending even more troops overseas to fight yet another noun (this time it’s the war on ‘drugs’) may end up being the straw that broke the camel’s back.

Fortunately, we have little to fear from Hugo Chavez, at least in terms of conventional warfare.  Over the weekend, while Sarkozy and Merkel glad handed with former resistance leaders like Lech Walesa in Berlin, Chavez was addressing his troops.

“Let’s not waste a day on our main aim: to prepare for war and to help the people prepare for war, because it is everyone’s responsibility,” he said.  A few days before, he sent 15,000 troops to the  border with Colombia, citing fears that the US would use its new presence in the region to attack Venezuela.

The fact remains, however, the Venezuela unequivocally does not want to start an armed conflict.

Colombian forces are battle hardened veterans; they have fought for years against guerilla and paramilitary groups, and their combat experience is among the most extensive in the region.

Not to mention, the Colombian military is well-funded thanks to its alliance with the United States… and military funding means top of the line weaponry.

Venezuela forces, by comparison, are poorly trained, dreadfully equipped, and inexperienced.

Sure, a similar matchup took place in the 1980s between Iraq (funded and equipped by the United States), and Iran.  The Iranians had very little equipment or training– their chief combat tactic was to hurl waves of warm bodies at oncoming Iraqi tanks… and Iran had  a lot of bodies at the time.

The tactic worked.  Millions died, and the long battle of attrition between Iraq and Iran ended in a stalemate. 

Venezuelans, however, do not have the Iranian’s overzealous religious resolve, nor do they particularly care for Chavez and his brand of socialism.

Consequently, if Chavez initiated an attack, it would look like amateur night on the Colombian border. 

Chavez knows this, so all of his rhetoric is simply bombastic statement that won’t be backed up with action– unless something truly catastrophic and unexpected happens, like a clear act of war from the Colombians or the United States. This is highly unlikely.

In the meantime, Chavez will continue his peacock strutting and scare the world into thinking that war is imminent.  I think he’s actually giving us a gift, though.

In 2006, Israel and Lebanon held a brief war… a few people came. Markets got jittery, and both the Israeli shekel and Lebanese pound had a brief plunge.  They returned to normal levels quite literally within days.

In the last few weeks since the Colombia/Venezuela saga began, I’ve watched the Colombian peso sink by 8% against the US dollar.  Part of this has been a dollar rally, but most of the swing has been because markets are scared of war with Venezuela.

I’m convinced the fears are unfounded.

Chavez is shrewd and at least reasonably intelligent to have gotten this far. Venezuela is beset by major problems– crumbling oil infrastructure, water scarcity, frequent power outages, etc. War is a great way to distract and unify the masses, but walking in to an absolutely certain military defeat is a fool’s bet.

As such, I think that if the Colombian peso continues to fall, especially past 2,050, it should make a reasonable short-term investment.

I’m actually reporting tonight from bed-side in my hotel room; I managed to crash my $3/day motorcycle rental this afternoon, and between the cracked rib and other pleasantries, I’ve decided to call it an early evening.

Fortunately for me, Thailand has some of the best healthcare in the world, at least if you’re an expat and go to the several renowned and accredited private hospitals… but more on that in future letters.  Tonight I thought I would sit down and specifically address some of your questions, which is something I have not done in some time:

Keith from Ontario recently asked, “Simon– where is your money when World War III starts?”

Good question. The emergency fund is in physical gold and silver, plus a lot of currency from about 40 different countries. I travel with quite a bit of it and keep the rest stashed away in some strategic locations around the world– you can read about these places in our free Gold Report.

I don’t believe that the world is going back to a barter or gold system anytime soon.  Governments like having an inflatable fiat currency, and people have become too institutionalized on worthless paper money.

If there is a future cataclysmic event that causes a worldwide currency and financial meltdown, governments and financial markets will likely engineer a substitute quite quickly. In this case, gold and silver will have been fantastic investments, but likely not needed as a hard currency for the long-term.

If, on the other hand, a major catastrophe turns the world into Mad Max, I think everyone will be wishing s/he had invested in bullets and crop land instead of precious metals.  You might want to check out a great book called Emergency by Neil Strauss for an interesting read about a potential breakdown of our social and financial system… I highly recommend it.

On the same subject, Judy asks “Do you know if Panama has right to carry in place? If you currently have RTC, is it legal to ship your gun to Panama and conceal carry it there as well?”

You can obtain a weapons permit in Panama and even import your own firearms if you have established residency.  The system is fairly convoluted, though– the permit documentation is tied directly to the firearm, not necessarily the individual, so when you buy a weapon, you have to ensure that you buy a permitted firearm.

It’s best to navigate this process with a lawyer, at least the first time you do it. Any of the attorneys I mentioned in my Panama Black Paper will be able to help you with this issue.

Amanda recently asked a question about Australia– “Simon, I’d like to know your opinion on the land down under…”

I think Australia has fantastic prospects.  I generally dislike all governments, but by comparison, the Aussies run a sound economy that normally maintains a trade surplus based on raw materials, as well as a balanced budget.

The Australian dollar has room to appreciate– unlike other countries like Japan and South Korea which depend on a weaker currency to make their exports appear cheap, Australian commodities exporters sell at world market prices, irrespective of the Australian dollar’s value.

Naturally, the country is not perfect and there are a few speed bumps with household debt and immigration policy… but overall, I think the economy is sound and the Australian dollar is a good place to be relative to other fiat currencies, especially considering the higher interest rates.

Howard writes about Thailand– “For investors and businessmen, Thailand is a culture based on deceit and power; a major business expense here is corruption payments… and nothing here is clear, honest, or straight-ahead.”

I agree entirely. Doing business in most places overseas, particularly in developing nations, is fraught with challenges (read: corruption), and Thailand is no different. More specific stories and solutions on this in future letters.

My old friend Nuckolls writes, “According to the mainstream press, California is either a failed state or a gold mine waiting to be rediscovered.  I’m banking on the gold mine future…getting in at busted prices and waiting perhaps five years for the eventual regrowth. Do you have any premonitions about how long I could be waiting for that?”

California has a couple of things going for it that are positive economic drivers– first, it is home to some key industries like entertainment and technology that are still in tremendous demand around the world. Warner Brothers and Apple set the gold standard for everyone else to follow, and this isn’t changing anytime soon.

Second, people still really want to live in California, especially people with money.  This, along with its poor credit rating, will likely force the tough political choices that are necessary for the state to get back on its feet.

Third, California property tax is low, and this is protected by the state constitution. Other things equal, this makes California one of the more attractive US property markets for long-term growth. 

Between the recession, the wild fires, the massive foreclosures, and the fault lines, there are probably some great deals on property. As for how long you will be waiting? Unfortunately we have to look at these things in terms of election cycles given how interfering governments have become in the economy.

I wouldn’t expect anything until after the 2014 election, though given how bad the federal government is mismanaging the economy, an inflation-adjusted turnaround could be well beyond that.

As a final note, if you recently wrote or commented about your interest in official diplomatic programs, you will be hearing from me personally on the subject in the near future. Stay tuned.

I arrived into Thailand at 3am this morning from Shenzhen, and instantly I felt a bit happier. China is undoubtedly a booming colossus full of opportunity, but culturally it can be a bit grating after a while.  After a month on the mainland,  I needed a break, and Thailand was the perfect choice.

Aside from being one of my favorite countries in the world, I wanted to spend some time scouting Thai investment opportunities.  I think the country is ripe for growth, but there are signs of a short-term correction.  I want to be ready when that happens because there will be a lot of buying opportunities.

Additionally, some friends from Europe have met me here, and we’re putting in for visas to Burma. Thailand is the best place to apply for a Burmese visa, and if approved, I will be hopping over there for a few days to get a feel for the place and its opportunities.

Meanwhile, I’m spending the next few days hiding out in Pattaya, a great little Thai beach town that ranks among the cheapest civilized places in the world.

Aside from a few marquee western brands, it’s practically impossible to spend more than $100/night in accommodations here, and everything from drinks to taxi rides to motorcycle rentals is so cheap the prices are almost cute.

There are a lot of westerners here, mostly older men who troll around the city looking to pick up younger Thai women.  You see it everywhere– the proverbial ‘age mismatch’ between a pasty white gentleman in his 60s with a beautiful young thing in her 20s.  The Thais don’t seem to mind, and neither do their male companions.

As such, the place is fabulous for hedonists and retirees… you can live on the cheap and have a great deal of fun in Pattaya, regardless of what you are into– outdoor sports, firearms, aquatics, food, nightlife, spa pampering, exotic animals, etc.

I would say that it’s probably the only place in the world where you can get a massage, play with a tiger, shoot an assault rifle, ride an elephant, and bungee jump– all within about 3 hours and $50.

More importantly, though, Thailand is one of the easiest places in the world to relax. The culture of service here is one of the most deferential in the world– Thais will wait on their patrons hand and foot and cater to their every possible whim.

For example, Thai bathroom attendants give backrubs to grown men who are in the middle of using a urinal, and everyone from elevator operators to hotel porters will snap their heels together and render a formal military salute to patrons who pass by.

To say that the Thai people make you feel welcome is a massive understatement… sometimes it can even make you a bit uncomfortable, especially when you consider the price (or lack of) that you are paying.

In the long term, I don’t see any direction for Thailand but up… it’s hard to imagine things becoming much cheaper here, but more importantly, the country controls vast quantities of two resources that will be absolutely critical in the future– productive agricultural land, and fresh water.

Given the extreme pricing imbalance in Thailand as well as the country’s natural resource wealth, I believe there is strong support for long-term investment here, despite any short-term fluctuations that occasionally arise due to geopolitical instability.

I will be discussing this more in future letters, but as I mentioned last week, an easy way to take a position in the country is through its currency, the baht.  You can buy baht through an online FOREX platform like GFT Forex (www.gftforex.com) or at major banks.

What if they held a bond auction and nobody came?

This is exactly what happened in Latvia a few weeks ago, as the country failed to receive a single bid for $16 million of debt, maturing in April 2010. In other words, investors were not willing to loan what amounts to international finance pocket change to a sovereign government for a measly 6-months.

Why? Because everyone expects that Latvia will devalue its currency; consequently, no one wants to be holding on to local assets there because the value of those assets will drop like rock once the Latvian government finally faces the music and devalues.

I talked about this in July “You Can profit from this countrys Devaluation ” after spending a great deal of time in the Baltics.  Latvia’s currency, the lat, is pegged to the euro at very high rate– the agreement was made in 2004 when Latvia’s economy was growing very rapidly. At the time, the peg seemed reasonable.

Today, Latvia’s economy is collapsing 17% per year, and the central bank is running out of funds to intercede in the market. In order to maintain the peg, Latvia’s central bank has to buy lats and sell euro, essentially creating artificial demand for the lat.  It can only do this for so long before it runs out of euro.

For months, it has been getting euro loans from rich European countries and supranational central banks. Each of these loans has been burned through as Latvia desperately tries to keep the peg alive.  For the euro lenders, this is akin to buying bonds in GM… it’s a lost cause, and any new money you throw at it will surely be lost.

European governments have sternly warned politicians in Latvia that severe austerity measures had better be implemented if they want more loan money. Realistically, though, Latvia would have to eliminate entire divisions of its government and economy in order to meet the EU’s budget demands.

This is not likely to happen.  Consequently, devaluation is looking more and more like the only remaining option.

The greatest fear of devaluation in Latvia is that locals who took out mortgages denominated in foreign currencies (because the interest rates were lower) would suddenly owe a hell of a lot more on the balance after devaluation.

For example, suppose someone took out a mortage of 100,000 at .7 lat = 1 euro.  Latvians think, earn, and spend in lat, so the borrower would consider his mortgage to be 70,000 lat. If Latvia devalues to 1 euro = 1 lat, his mortgage balance in euro would stay the same (100,000 euro), but the equivalent would now be 100,000 lat.

Well… that would certainly make for a bad day.  Imagine waking up one morning and owing another 40% on your mortgage when you already had negative equity to begin with!

Apparently, though, Latvia’s government has already thought this through this issue.

According to the Financial Times, Latvia’s legislature is taking steps to protect locals from the negative effects of a devaluation.  Any overnight increase in mortgage principal as the result of devaluation, for example, will have to be assumed by the bank, not the Latvian borrower.

With such a populist, consumer-protection policy designed to cushion the blow of a devaluation already in the works, there is little remaining for Latvia’s government to do but devalue. It is not a question of if, but when… unless something truly miraculous happens, like Latvia wins the sovereign equivalent of the lottery.

Investment banks like Barclays and RBC are betting that Latvia will devalue 15% by the end of 2010. Sweden’s largest banks (which are the also the largest lenders in Latvia) are  preparing for a devaluation scenario as well. They have to– devaluation in Latvia will hammer their balance sheets.

Swedbank, for example, has about 16% of its loan book in Latvia. When Latvia devalues, Swedbank’s equity will be hit hard and the stock price will suffer. In preparation, the bank conducted a $2.2 billion rights offering this month in order to cushion its balance sheet.

I still think shorting the banks is the best way to play this opportunity, but through carefully selected PUT options that limit risk exposure. If you directly short the stock, be prepared for a volatile run.

I think the market will also punish Sweden’s currency when devaluation occurs, so it would make sense to short the krona against the dollar, euro, and yen.

Let me know what you think about this strategy and if you have other ideas for how to profit.

It had to happen eventually.

Nothing moves in a straight line in either direction, up or down… and when it does, there’s clearly room for a correction. 

In this case, I’m talking about the dollar, which has surged in the last week. 

What a roller coaster ride– we watched it continually slide for years against major currencies while the credit bubble fueled capital flows into foreign currencies and commodities.  When the bubble finally burst last year, capital came flooding back to the dollar as fast as a cracking whip.  Within months, though, the dollar’s slide started again.

Since its recent peak in March, the dollar index has slid 16%, including a nasty spill of 6% in May, and another 5% drop since the beginning of September.  Frankly, the dollar index would be looking much worse if it weren’t for the even more terrible economies of Sweden and the UK, whose currencies comprise part of the index along with the yen, euro, Canadian dollar, and franc.

Sure, the dollar’s fundamentals are exceptionally weak, but such a rapid slide is unsustainable without a brief recovery period.  A dollar rally has nothing to do with renewed confidence in the dollar; rather, it is simply a matter of investors taking advantage of the dollar’s ‘cheapness’ to buy US assets.

Additionally, when investors start feeling a bit skittish again about world economic prospects, they tend to rush back into the dollar to buy the ‘safety’ of US Treasury securities.  This is happening now, to a degree– investors may be realizing that the extreme stock market rallies we have seen recently are clearly overdone, and that the world economy is not yet on solid footing.

Overall, these are indications of strength for the dollar, and explain why the dollar index shot up 1.5% in the past week.  Like I said, it had to happen eventually.

To be clear, the dollar’s fundamentals are not improving in the slightest; they’re getting much worse– more paper, more printing, more debt, more obligations, more stimulus programs, more political pandering.

As to how long the rally will last, though, is anyone’s guess… it could be days, weeks, or months, or possibly longer.  For example, another major financial crash could create a stampede for US Treasuries again, just like we saw last year, and the dollar will surge.  Whatever lift the dollar gets, though, will only be temporary.

Unfortunately the timing on these things is impossible to predict; that’s why I’m looking longer-term. I don’t know what’s going to be happening in the markets tomorrow or 3-months for now, but I’m pretty confident I know the general direction over the next few years– consequently, I’m buying gold and silver futures from 2011-2013. 

For example, July 2012 silver contracts are selling for about $16.94/ounce.  Based on the dollar’s fundamentals, I can easily see silver in the $25 to $30 range by then.  I don’t have to be right by tomorrow or next month– I have two and a half years for the market to reflect the reality of an overly inflated currency.

If I’m right, I stand to make a lot of money. If I’m wrong, I will be happy to take delivery of 5,000 ounces of physical silver.

I need to start off today’s missive with an important update. Last month I wrote a few articles about something that I believe is an absolute no-brainer if you have retirement savings– setting up a self-directed IRA.

Most retirement savings plans are locked in to a handful of investment options– employees are forced to make a selection among four or five choices, most of which are poorly managed funds run by the same institutions that clearly demonstrated their incompetence last autumn.

A self-directed IRA provides a mechanism for an individual to allocate his retirement savings in whatever way he chooses– whether his own portfolio of equities, physical gold, foreign real estate, overseas bank accounts, private placements, etc.

With a self-directed IRA you can take control of your retirement savings to ensure that some bumbling moron at a bankrupt financial institution doesn’t lose it all investing in Fannie Mae. More importantly, you can ship your savings offshore in a perfectly transparent, legitimate way.

I believe in this approach so much that I went through the trouble of negotiating a subscriber discount with Checkbook IRA, the same service providers that set me up with my self-directed IRA structure a few years ago. These guys are an honest, efficient, highly competent family operation, and I was grateful that they extended a $500 discount to subscribers.

I am writing about this again today for two reasons. First, I’ve exchanged a few emails with Jordan Sheppard at Checkbook IRA, and due to the amount of volume they are receiving and limited capacity within the shop, the discount will be discontinued effective next Friday, October 16th.

Second, and perhaps more importantly, I’m concerned about the direction that the market is going to take. There are a lot of people whose retirement savings are literally trapped in some blue chip index fund.

These are the same people who probably had a bad feeling last August that things were about to get really bad. They watched with horror as their positions took a 70% nosedive.

Fortunately, the last six months has been a period of irrational exuberance, and markets have recovered 50% from their lows. As markets tend to be forward-looking, though, can we realistically say that near-term prospects for the US economy are rosy?

Not by a long-shot. The Dow hovering near 10,000 makes about as much sense as lipstick on a pig.

Top line corporate revenue growth is weak at best, and there are numerous long-term factors which hamper earnings growth, namely: baby boomer retirees pulling their capital out of the market; costly health care regulation; increased corporate taxes; capital flows to emerging markets; etc.

Each of these factors has a negative bearing on long-term equity valuations. It is difficult to predict what will happen over the next few months, but given the carnage that we all experienced last year, it is probably more sensible to make low risk investments that mirror our economic outlooks.

To me, this means companies that are trading a steep discount to net asset value, precious metals and certain commodities, Asian currencies, foreign real estate, and carefully selected private placements.

This is why it is so important to unlock your retirement savings– with a self-directed IRA, your money will be protected from idiotic fund managers if the market takes another leg down.

If you currently have a retirement account that boxes you in to limited investment options, or keeps all of your savings within the United States, I’d highly encourage you to find someone that can set you up with a self-directed structure.

I’m comfortable recommending Checkbook IRA since I have worked with them in the past, and they understand unique needs like using a retirement account to buy physical gold and store it overseas.

If you give them a call, make sure you mention the Sovereign Man discount, which is good until October 16th.

While I was en route to China, somewhere over the Sea of Japan, gold hit a record high on ‘concerns’ about the long-term value of the dollar.

Frankly, 1974 was probably the time to be ‘concerned’ about the long-term value of the dollar.  The remaining institutional investors who are only now finding reasons to be concerned about the dollar are probably the same ones that thought Ford and Fannie Mae were bargains last year.

The dollar is likely having such a volatile day thanks to this article from the UK’s Independent. The article asserts that Russia, China, and the Gulf Arab states have been holding secret meetings to plan a transition away from dollar-priced oil.

According to the article, which cites ‘Arab and Chinese banking sources in Hong Kong,’ the plan’s deadline for complete transition is 2018.  This date makes sense considering that the longest-dated oil futures contracts expire in December of that year… but are the claims legitimate or simply rumor?

Who knows. Saudi and Russian authorities have already denied the newspaper’s allegations, but this is to be expected.

While gold may be getting a friendly bump thanks to the Independent’s article regardless of whether the claims are true, it is unquestionable that the dollar’s long-term value is heading south.

On the plane ride to China, I was reading a rather interesting “Trade and Development Report” published recently by the United Nations.  The report provides concrete data for how governments around the world have reacted to the financial crisis.

One of the things that caught my interest in the report was a table on page 66 tallying fiscal stimulus programs and government bank guarantees as a percentage of GDP.

The United States, for example, has backed its banking sector with a whopping 81.1% of GDP.  The United Kingdom, Sweden, Netherlands, and even Japan ring in at 81.7%, 70.2%, 46.5% and 22.3% respectively.

“Developing” nations like Brazil, Chile, Taiwan, Philippines, and Thailand? 0.0%. China came to the table with 0.5%.

The data certainly begs the question– which of these groups should actually be considered ‘developed’?

Ironically, most western ‘developed’ governments, led by the United States, have only been able to make these multi-trillion dollar bank guarantees because of the generosity and savings provided by ‘developing’ countries through US Treasury purchases.

‘Developing’ countries are weary of this model– Chinese and Taiwanese no longer live for the pleasure of exporting their products to the West in the hopes of being paid in US dollar IOUs.  Consequently, the concept of a new reserve currency is one that has legs and will in all likelihood become a reality.

If, under influence from western governments, the IMF decides to not go along with a new reserve currency scheme, the strongest developing nations will likely conspire to create their own internal mechanism.  The US and Europe will be forced to go along with it as a matter of necessity.

This is why gold and silver have such tremendous long-term potential– they will anchor the new reserve currency. Sure, there is the inflation/hyper-inflation argument that will send gold sky-high (though I would suggest that there is ample evidence of deflation as well).

Predominantly, though, precious metals will rise as a function of capital inflows– foreign governments are sitting on trillions of US dollar reserves that they are trying to get rid of.  Gold is where they are going to park most of it.

Three months ago I wrote about some silver investments that I was making– I sold $10 December 2011 put options and bought $15 December 2011 call options. In each of these investments I was betting that the future value of silver would rise.

In 3-months these investments have more than doubled, and I am now analyzing the futures markets to find the best ways to invest directly in gold and silver.

In part, this is what I am doing back in Shanghai.  My longtime friend and colleague Christine Verone is the first foreigner ever to be certified by a Chinese exchange, and I plan on taking new gold and silver positions based on her insight of the Asian markets.

More on this in future letters. In the meantime, look after your savings if you’re dollar-based.  If your savings is sitting in the bank collecting dust, either get it out of the dollar, or put it to work generating a real return.

It’s not time to be on the sidelines anymore.

Apparently I’ve been traveling too much, because I was recently caught out of the loop.

On Wednesday I published an article about Panama’s Resolution 52; the law effectively makes it illegal for landlords to rent property in Panama for less than 1-year.

I predicted in the letter that, based on the past track record of Panama’s National Assembly, the law would be repealed shortly due to significant pressure from the real estate industry and expat community in Panama.

Well, it turns out that I was simultaneously entirely right, and entirely wrong.  By the time my letter was published, Resolution 52 had already been repealed.  Crisis averted.

I found out about it thanks to Augusto, my very dedicated Panamanian attorney.  Even though he was somewhere shy of the 14th green at the time, Augusto somehow managed to read my letter and instantly correct my mistake with the following email:

“Your article is completely wrong. Resolution 52 was already revoked by Resolution 79.”

Did I mention he’s blunt too?

Frankly I couldn’t ask for a better attorney; I have burned through dozens of lawyers in Panama over the years, and Augusto is truly among the best in the business. He has literally saved me tens of thousands of dollars by steering me away from the wrong deals and connecting me with the right people to profit with.

Augusto’s example underscores and incredibly important point: a key element to success in many ventures lies in who you know.  The ability to leverage contacts to make things happen often makes the difference between a home run and a strike out.

I believe in this principle so much that I try to make it a core theme of this letter.

Last month, for example, I published my Panama Black Paper.  It was essentially my personal rolodex of high-level contacts in Panama– lawyers, bankers, real estate agents, gold dealers, etc. whom I trust and have dealt with in the past.

The idea behind the Black Paper was to provide people who are serious about living, investing, or doing business in Panama with a well-connected network of influential individuals who are trustworthy and highly competent.

All of my most profitable deals, most important relationships, and the best experiences have all come to me because of who I knew– my network.  I know it’s cliché, but it’s the truth.  “It’s not what you know, it’s who you know”.

It’s also true that you can dramatically expand your opportunities and experiences if you know how to grow your network; there’s an art to doing it, and it’s something that I’ve been successful with in the past.

For example, when I was working in the intelligence business, infiltrating networks was part of the job description.  Now I use the same tactics to walk in to a foreign country and make a big splash with the upper ranks in a short period of time.

There’s no mystery to doing this, it’s a question of process and persistence… and sometimes even paying to be in the room.

Do you want better investment returns? Become friends with the people who have it mastered. Do you want to make a lot of money? Get networked with talented entrepreneurs and deal makers.  Do you want to meet beautiful models? Get close to photographers and fashion designers.

Once you understand the strategy and tactics involved in building a new network, you’ll be able to immediately change the scope of opportunities in your life, solve problems, and create deep, rich relationships with the kind of people you want to associate with.

I’m thinking of writing a free report about how to generate goodwill, build contacts, and penetrate any network.   This isn’t for everyone, but if you’re looking to take your available opportunities and experiences to the next level, “who you know” can make all the difference.

If you’re interested in this information let me know in the comments below.   The more requests I receive, the higher priority this free report will be.

UPDATE: The report is done. If you are interested in receiving it, sign up for our free daily e-letter, Notes from the Field, and you’ll receive a copy.  (Scroll back to the top of the page and enter your info in the box.)

Years ago, in my early 20s, I had my first taste of investment success.  I wish I could dazzle you with a great story about a goldmine in the jungle or negotiating land rights with warlords… Unfortunately, no. All that would come later.

Rather, my first deal was a set of very plain brick apartments on the wrong side of the railroad tracks.  They weren’t very sexy, but I was able to pick them up for pennies on the dollar… and it was a hell of a learning experience.

Over the next several months and years, my property investments grew, until eventually I became a ‘known player’ in my local real estate market.  Bankers and developers even started calling me to ask advice or offer deals.

My success was based on developing and sticking to a system for valuing real estate transactions based on three methods– comparative market value, “replacement cost,” and income.

I actually use these same three approaches today to value companies as I run around the world in search of exciting business and investment opportunities.

Of the three approaches, the most important one to me was the income valuation… to me, an investment property was literally worthless if it didn’t cash flow enough to cover the debt service– I would have been better off stashing my money under the mattress.

Consider the residential investment property market.  The formula is quite simple: landlord owns property, landlord leases property to tenant, tenant pays landlord, landlord covers all expenses from the rent and pockets the rest.

A landlord’s key operating expenses are property management service, maintenance, taxes/dues, insurance, and any utilities paid.  On top of this the landlord must service any mortgage debt.

If the rental income exceeds the operating and interest expenses, the property is cash flow positive, and the landlord is happy.

If the expenses exceed the rent, however, then the landlord has a problem and must feed the property. Naturally, a landlord can only afford to do this for so long before s/he runs out of money.

This is a similar situation to many start-up businesses that are unprofitable for the first several years of operation; obviously the owners expect the business to eventually turn a profit so that they can recoup their initial investment.

Businesses, however, often have exponential revenue growth potential that can make up for early losses. Investment properties do not; a landlord can only increase rents at a low, linear rate.

Thus, an investment property must have some mechanism for the owners to turn a profit, especially if the property is cash flow negative.  Most landlords expect that the appreciation in the property’s value will bridge this cash flow gap.

For example, if a property fetches $20,000 in rent annually, yet costs $35,000 in annual expenses and interest, an investor would have to be crazy to buy this property… unless, of course, s/he believed that the property would appreciate by at least $15,000 annually.

This price appreciation, in theory, would cover the cash flow shortfall.  But it is based entirely on expectation.

When property markets are in a bubble, the cash flow gap of investment property is enormous, i.e. rents are miniscule compared to the cost of maintaining the property and servicing the debt. This is because buyers have an expectation that properties will increase in value, and the increase will more than make up for the negative cash flow.

You’ve seen it happen– real estate agents, TV infomercials, etc. all urge buyers to run out and make their real estate millions.  People begin to make irrational financial decisions based solely on the expectation that property values would increase, and increase big.

Even the banks believed it– they wrote trillions of dollars of no-doc, zero-down loans based solely on the premise that the US real estate would increase substantially in value, cash flow be damned.  We all know what happened next.

In the long-run, the natural, steady state of a real estate market should be cash flow neutral; cash flow positive properties will be bid up by investors, and prices of cash flow negative properties will fall from lack of demand.

This is exactly what is happening in the United States, as well as many other world property markets right now.  Eventually, once the negative cash flow gap had become too wide, the bubble burst.

NCREIF chart of property returns

The formula starts with RENT– annual rent must cover debt service and operating expenses in order for a property to break even; and in order to find a tenant who is able to pay, rents must be affordable. Affordability, as we know, is directly proportional to the health of the economy.

This is one of the key metrics that I use to evaluate property markets around the world. In the United States, I still see many local markets where rental yields do not support property prices.  Consequently, I believe that US housing prices still have room to fall.

With this is in mind, I will start reporting on rental yields of local property markets as I travel to give you a better idea of which countries present the best real estate investment opportunities.

Roughly $100 billion.

Even in today’s world where politicians throw out the word ‘trillion’ as if it were a casual dinner garnish, $100 billion is still a lot of money… especially when you’re desperate to sustain glimmers of economic growth and trying to plug a budget shortfall that amounts to 13% of GDP.

And yet, roughly $100 billion is exactly what got sucked out of the United States in July by foreigners: “Net capital outflows” increased to $97.5 billion for the month of July, according to recent data released by the Treasury department. Meanwhile, net long-term capital inflows fell to a paltry $15.3 billion in July, an 80% decline from June’s $90.2 billion capital inflow.

What do these numbers mean?

Foreigners are continuing to lose confidence in the US economy at a record pace and are finding better places for their money. This would certainly support the US Dollar Index’s dramatic 3.5% decline in July– though the dollar index only tells a partial story. “DXY” as it is known, though, only tells part of the story.

The dollar index measures the value of the dollar only relative to a small basket of currencies– euro, pound, Canadian dollar, Swedish koruna, yen, and Swiss franc. Powerful Asian nations like the Gulf, China, Singapore, etc. are conspicuously missing. And yet, DXY still dropped 3.5% in July.

Conclusion? If these ‘relatively harmless’ countries that comprise the US Dollar Index are losing confidence in the greenback, you can be sure that China and the Middle East are knocking over women and children on their way to the emergency exit.

Telling you that the dollar will be continually worth less until it is ultimately worthless is nothing new. So if you would indulge me a moment, I’d like to prognosticate on the greater implications.

As the pace of these outflows picks up steam, you can be sure that a group of out-of-touch politicians are monitoring the data and thinking to themselves, “we need to regulate this before it gets out of hand!” And this sentiment is exactly what spawns capital controls.

Capital controls by design are intended to regulate the flow of capital in and out of a currency; in times of uncertainty, shaken politicians always pull this oldie-but-goody out of the playbook… it happened in Iceland, and it’s been discussed around the world recently– Russia, India, Brazil, the Baltics, Poland, Czech Republic, Kazakhstan, etc.

Not to mention, a world largely free of capital controls is a relatively new phenomenon. We can look to history for a recent example of a world superpower turning to capital controls for ‘stability’:

In the mid 1970s after the collapse of the Bretton-Woods system, the British economy was in serious trouble. GDP was contracting, unemployment rising, investment falling, and the government was drowning in red ink, all while social obligations were climbing.

Financial markets responded by turning their backs on Britain’s Pound Sterling, and the currency was crushed. The Wall Street Journal advised investors to ditch the British pound, running headlines “Good-bye Great Britain.” And the government came under intense pressure to ‘do something.’

The first thing the UK did was go to the international community with hat in hand to prop up the currency with loans and bonds. This is already happening in the United States as Tim Geithner attempts to woo China and Middle East into buying US Treasuries.

Subsequently, the British government imposed a slate of capital controls that essentially penalized investors for moving capital out of the country and requiring that all investment transactions go through ‘authorized dealers’ who were charged with enforcing this policy.

The penalty ranged from a 10% to 30% premium on the dollar/Pound spot rate at the time– essentially the same tactic that the Cuban government is employing today.

Frankly I can see the same thing happening in the United States, perhaps starting off with a penalty in the Treasury markets where there is the biggest sucking sound… imposing a sort of ‘restocking fee’ for foreign investors who don’t roll over to new issuances upon maturity.

Eventually, though, you can be sure that the government will impose controls at the consumer level as well– requiring a certain allocation of bank deposits to be held in US Treasuries, restricting foreign remittances, and mandating scrutinous approval for overseas wire transfers above a certain amount.

Naturally, US politicians would never call such measures ‘capital controls,’ because the world’s reserve currency must be freely convertible. They will likely wrap up these policies in the ‘anti-terrorism,’ ‘money-laundering,’ or ‘tax evasion’ blankets, and simultaneously wage a PR war against evil gold and currency speculators.

So what can you do? As I’ve mentioned before, buying foreign real estate is the single best way to move money overseas where it cannot be forcibly repatriated. Physical gold stored overseas is an excellent option as well– there are no reporting requirements for either.

I’ve also strongly suggested buying up such assets with tax-deferred retirement savings. In my opinion, there’s no better way to stay within the letter of the law than to buy foreign investment property and physical gold through a self-directed IRA… I am such a strong believer in this tactic that I negotiated a special discount with a trusted service provider who can set this up for you.

As I conclude this missive today, I see that the “world’s leaders” are gathered in Pittsburgh to listen to the sound of their own voices. Nothing will be accomplished, and they will emerge from their summit with nothing but sound-bytes, empty promises, and a continued fervor to exact tighter control over the markets.

Each of us has the ability to either plan for it, or dismiss reality and do nothing.

Updated 9/23/2009 (thanks JES)

People ask me this question a lot– what’s the best way to diversify US dollar holdings into other currencies?

Well, ‘best’ is certainly relative… I prefer commodities and precious metals as a way to protect my savings, but I can’t exactly pay my American Express bill with the bullion that I have locked away in South America.

Living in the 21st century among our modern conveniences nearly requires that we at least keep part of our wealth within the financial system– this means converting US dollars into another currency, and tucking that currency away at a bank or brokerage that is still plugged in.

So what’s the best way to do it?

Naturally, I think everyone should have at least one foreign bank account, preferably in a strong banking jurisdiction.  This has nothing to do with privacy or secrecy; rather, having a foreign account is an insurance policy against stupidity risk from the stooges who run most governments.

The day they decide to implement exchange controls, take an unsolicited dip in people’s bank accounts, force people to buy their debt, or a variety of other destructive measures, your money will be safely fenced off in foreign lands.  Additionally, in most cases you will be diversified out of the dollar, safeguarding the purchasing power of your savings.

In the past, I’ve discussed opening foreign bank accounts in places like Austria, Panama, and Asia… though I have to admit that I’m a bit of WC Fields when it comes to foreign bank accounts.  For most people, though, a single well-placed foreign account is an excellent hedge, as long as you select a bank, jurisdiction, and currency that you feel comfortable with.

But what if you want the ability to move your savings in and out of different currencies– you think the Australian dollar will do well, and then months later decide that the Swiss Franc’s fundamentals look attractive.  It would certainly be inconvenient and costly to transfer savings among multiple bank accounts.

In this case I would point you towards three specific brokerages that provide an elegant solution to this problem.

Interactive Brokers (US-based), Saxo Bank (European based), and Boom Securities (Hong Kong based) all allow users to log on and change their account’s “base currency” with the click of a button.  US citizens can open accounts at any of these brokerages.

For example, suppose you fund your Interactive Brokers account today with $500,000 US dollars.  Immediately, you decide that you would rather have your money in Swiss francs (CHF)… no problem. Log on to your account administration, select CHF under ‘base currency,’ and at the end of the day, the brokerage will convert your capital into francs at the spot rate.

The next time you log on to your account, the value will be CHF 510,000 (reflecting a spot rate of $1 = CHF 1.02).  Afterwards, regardless of how much the dollar falls against the franc, your account value will always be CHF 510,000.

You can do this as many times as you like, as frequently as you like.

Interactive Brokers denominates accounts in US dollars, euro, British pounds, Canadian dollars, Hong Kong dollars, Indian rupees, Japanese yen, Mexican pesos, Swedish koruna, Swiss francs, and Australian dollars.  IB is US-based, so there is no disclosure paperwork to be filed with Uncle Sam. Update: IB charges a fee ($10) for inactivity, so check with them before you open an account.

Boom Securities denominates accounts in Hong Kong dollars, Singapore dollars, Australian dollars, US dollars, and Japanese yen; furthermore, Boom accounts pay interest on deposits. Update: Boom charges an annual fee of about $25.

Saxo Bank denominates accounts in Hong Kong dollars, British pounds, euro, Swiss Francs, Canadian dollars, Hungarian forint, Czech koruna, Norwegian koruna, New Zealand dollars, Singapore dollars, Turkish lira, Israeli shekels, South African rand, UAE dirhams, and Japanese yen; plus they can take credit card deposits from Visa and Mastercard.

Each of these brokerages is plugged in to the global financial system, so you can move funds to and from your brokerage account as easily as you can with your existing bank account.  Furthermore, even though these brokerages are set up for trading, you can hold your capital in a variety of currencies without ever placing a single trade. Fees may apply.

“Dear Simon- Jeff Clark from Growth Stock Wire recently wrote that ‘China is a fraud’ and that ‘If Americans aren’t buying big-screen TVs or $100 sneakers, Chinese stocks are ultimately headed for trouble.’  I would like your opinion on his view.”

Great question. I like Jeff Clark and generally agree with his analysis… but like I said in Monday’s essay, I am puzzled that a few notable figures in the financial community are bearish on China.

Jeff’s analysis underscores the fact that the American consumer has dropped off the face of the earth. This is absolutely true, and it was a foregone conclusion that had to happen sooner or later. A society cannot persist on a negative savings rate without serious consequences.

That being said, China (and Asia in general) is now developing a robust domestic consumer economy that is picking up the slack.

I cannot emphasize this point enough.  In the 1950s, Asia’s economies were undeveloped, squalid backwaters whose only aspiration was to sell products to ‘rich’ America, the world’s beacon of freedom and prosperity.

That was the past. Today is a different story.

After years of working hard, producing far more than they consumed, and accumulating a substantial pool of savings, Asia is now entering the same position that the United States was in following World War II.

During the war, the US economy was in a state of full production.  Women entered the work force for the first time ever while the men were overseas fighting the war.  As a result, the average American family effectively had two salaries, and because nearly all manufactured goods went towards the war effort, there was nothing to spend money on.

Families built up substantial savings during this period, and by the end of the war, Americans had built up a large pool of capital that financed economic growth for the next several decades.

Asia is in this position now.  China, Singapore, South Korea, etc. are not frauds, but rather emerging consumers sitting on a huge pile of savings.  The growth is real, the macroeconomic fundamentals are solid.

On the other hand, would I invest in the Chinese stock market? No chance– I’d rather play craps in Macau… and Jeff correctly raises this point.

Last week when I was staying in Shanghai, I walked across the street from my hotel and saw what looks like an off-track betting operation: hundreds of Chinese people crammed into a small room staring at a giant data screen. Every few minutes when something would flash across the screen they would rush to the other side of the room to ‘place their bets.

My friend Christine Verone told me later that this is where Chinese daytraders gather, betting on momentum as blindly as lemmings following each other off a cliff.  This is not the market for me.  To be clear, I have little confidence in Chinese accounting standards, market transparency, or accuracy in official economic indicators…

… but I have every confidence that a bright, talented, hard-working entrepreneur can still make a fortune in Asia, and especially in China. The market is wide open in most cases, and the growth fundamentals are completely legitimate.

So if I’m not buying Chinese stocks, what am I investing in these days? Let me caveat this answer by saying that my risk tolerance is quite low. I generate income through various worldwide entrepreneurial ventures, and I multiply that income with what I consider to be ‘no brainer’ investment opportunities.

In my opinion, the best things to invest in these days are strong companies that are anomalously trading for less than their cash value– for example, a profitable company with $50 million in the bank whose market capitalization is only $40 million.

You get the company’s profits for free, plus $10 million in cash– the risk is incredibly low and the upside is huge.

It sounds unreasonable that such anomalies would ever exist… and you’re right, it is unreasonable. But it happens from time to time. Why? Because despite the drivel that they teach at most business schools, markets are NOT EFFICIENT– they are comprised of highly emotional participants, manipulative players, and authoritarian governments.

Consequently, great BUY opportunities emerge from time to time when the market becomes scared or otherwise irrational.

My friend Dr. George Huang has made a career out of finding these opportunities, mostly in the biotech sector.  I invest in his recommendations because he frequently brings me profitable companies that are trading for less than their cash value.

The last few picks have generated returns of roughly 50%, 100%, and 100% in less than 3-months each. Why? Because the market eventually realizes that a solid company trading for less than its cash is… completely absurd. And eventually, usually within a short period of time, the market bids the stock price back up to a reasonable level.

I mention Dr. Huang’s letter from time to time because I think it’s some of the most valuable investment insight out there.  If you haven’t listened to this interview we conducted with him a few weeks ago, it’s definitely a great use of your time.

Otherwise if you want more information about his letter and money-back guarantee, click here for more info.

I’m flipping through channels at 1am here in Seoul, and do you know what I see? Math problems– nutty professors, Korean-style, working out complex partial differential equations and geometric progressions with the intensity and flair of a concert pianist.

In fact, it’s not just one channel… it’s five, roughly 20% of the entire late night channel line-up.

When you think about it, this makes perfect sense. South Korea, once dismissed as an Asian backwater where American GIs defended the frontiers of freedom, has developed itself into a formidable economy on the back of an incredibly hard-working, educated, entrepreneurial culture.

GDP per-capita is now about $28,000 per person, making South Korea’s economy roughly equivalent to Italy, Israel, and New Zealand.

It shows. The landscape is well-developed with wide, clean highways, soaring skyscrapers (at very high occupancy), extensive port facilities, and a highly advanced digital infrastructure.

The great unspoken fear of South Korea is that all of this beautiful infrastructure would be wiped off the face of the earth on the day that North Korea’s Kim Jong-Il threw a nuclear temper tantrum.

It won’t happen. South Koreans do not live in fear of North Korea– it simply doesn’t register on their radar. The North Korea invasion fear, which have kept a US military presence in the south for roughly 60-years, is one of the biggest scams in geopolitical history.

Today, the North Koreans are as much of a military threat to South Korea as the Russians are to Germany (which begs the question– why are US troops still in Europe preparing to defend the Fulda Gap against Soviet Hordes?)

If US troops pulled out of South Korea, the economy would take a short-term hit and present a major buying opportunity. But within 3-years, the private sector will have reallocated the economic resources formerly tied to US military bases– it happened in Panama between 2000 and 2003 after US troops left, and I would venture to say that Panamanians are not half as good businessmen as the South Koreans.

The export-centric Korean economy took quite a hit at the start of the crisis because of the slowdown in global trade. Korea’s large conglomerates like Samsung, LG, Hyundai, POSCO, etc. all suffered in the early days as demand cratered and economists pontificated about whether Asia’s economies could decouple from the west.

Exploring this ‘decoupling’ issue was one of my primary missions in going to Asia… I wanted to put boots on the ground and see for my own eyes whether or not these economies are still dependent on the west.

My conclusion? The slowdown in U.S. consumers activity will continue to be a weight on the shoulders of the Asian exporters. But, while western consumers are dying, Asia’s massive pool of consumers are just beginning to bloom.

I saw it in China, where the level of Chinese consumer activity can only be described as ‘overwhelming.’ I saw it in the Philippines where remittances from overseas workers support domestic spending. I saw it in Singapore where the slowdown seems to have had minimal impact; and I can see it here in South Korea.

Asia is exporting to itself, building up vibrant domestic economies while governments spend their increasingly worthless dollar reserves on stimulus projects. To me, this is a clear indication that Asian currencies will continue their rise against the dollar (as well as the euro) since ‘cheap’ currencies relative to the west are no longer a priority.

But which ones to buy?

The Japanese yen is not a good option in my opinion– Japan is an aging economy that still depends heavily on the United States, and my expectations is that the government will not allow the yen to appreciate much beyond 85 yen to the dollar.

The Chinese renminbi is also not a good option for now– China plays too many games with its currency, and exchange controls are a capitalist’s nightmare.

I do like the Thai baht and think that Thailand has a great future in general, though I would definitely wait to invest until its 81-year old King passes away, leaving the country in temporary turmoil.

The Taiwanese dollar (TWD) and South Korean won (KRW) are good bets for now as proxies on thriving Asian tiger economies; I also really like the Australian dollar (AUD), which has great fundamentals, as an extension of Asia’s growth.

Maximizing the flexibility of your retirement account is an enormous untapped area of Low Hanging Fruit for US investors.

In fact, this might be the single easiest thing you can do right now to grow your retirement assets while shielding them from the lost decade yet to come.

With a properly structured, self directed IRA, you can gain complete control over your retirement funds, and, according to IRS rules, invest in anything other than collectibles and life insurance so long as there is no self-dealing involved.

You can invest in:

- Gold that you store in your home
- Foreign real estate
- Gold stored securely overseas
- FOREX, hard money loans, Options, Stocks & Bonds

And of course much more…

The structure is simple.  You invest your IRA funds in a special LLC.   You’re appointed the Manager of the LLC and direct the activities of the LLC whether that be buying farmland in Argentina, a condo in Panama City, a Perth Mint certificate, or a big pile of gold coins to be stored in an Austrian vault.

There are rules, of course.   Everything needs to be set up properly, so don’t proceed without consulting an expert.

The good news is that setting up this structure isn’t rocket science and once you do it you’ll be glad you did.

=====

Update: Spring 2010 — Friend of Sovereign Man and noted Economist, Terry Coxon, just released an e-book called Unleash Your IRA. In our opinion, structuring your IRA properly is something you should do right now and Terry’s guide explains how to do everything step by step.

It normally takes me less than five minutes to pack, even for a three week trip.  In this case, though, I’m having a tough time– too many climate zones in Asia, too many events. I need to cram SCUBA gear, beach clothes, professional attire, and formal wear all into one little suitcase…

… plus leave plenty of room for all the custom suits I’m going to have tailored.

I haven’t been watching the markets much today, and frankly I’m sick to death (no pun intended) of the obsequious eulogizing of the late Senator from Massachusetts, so I’ll refrain from comment.

But in the spirit of my forthcoming Asia sojourn tomorrow, I’d like to pass along a recent email from Christine Verone who sent along her thoughts on an emerging mega-trend in China:

—-
Simon-

I’m excited for you to come; I have an ambitious agenda lined up for when you arrive in Shanghai, so don’t show up here with any jet lag… CEOs, brokers, and government officials are waiting, plus I know you will want to meet with your sovereign fund guys.

By the way, from our earlier conversation I need to clarify something (and please make this change to your website).  From the ‘Gold in China’ article a few weeks ago, it says that Chinese people were not allowed to own physical gold or silver until 2009.

This is not accurate and I think you misunderstood me when you edited the email.  Gold was attainable by Chinese via Panda coins (China’s version of Eagles) or jewelry since the 1980s.  Walking into a bank and buying coins/bars however is a recent phenomenon.

The critical point to understand is that the government has never before pushed gold and silver as an investment vehicle. It has gone from being illegal to being the hottest assets on the market simply because of the government’s marketing efforts.

I’m convinced that this will create significant upside, especially for silver. You should see how people stand in line at banks to buy silver bars now.

The other thing I wanted to discuss is an emerging megatrend on the mainland.  The Chinese are aware they need to decrease their dependence on exports, especially now that American spending power has evaporated.

Consequently, the government has prioritized building up infrastructure and domestic consumption (two things that foreign analysts on Wall Street won’t be able to see). This included Chinese tourism.

The government supports the tourism industry and encourages domestic travel far more than international travel… just watch 20 minutes of the daily CCTV news in China and you’ll begin to understand what I’m talking about– I can just about guarantee that you will see travel/tourism commercials promoting the importance of the ‘travel experience’ in some far off city with cultural flair.

Overall, domestic Chinese tourism is going to be one of the biggest China growth stories over the next decade.  You have hundreds of millions of people now that have enough money to leave their little town, their province for the first time ever.

Plus, culturally, Chinese travel in groups… we’re talking big parties on guided tours. Think Japanese tourists in the US in the 1990s and you’ll have the right idea. Naturally this creates a whole cottage industry with enormous growth potential.

A few months ago, as a play on Chinese domestic tourism, I bought a local company called Airmedia (NASDAQ: AMCN). At just a quick glance, most analysts would simply label it an innocuous ‘digital media provider.’

But if you put boots on the ground here, you’d see that Airmedia dominates Chinese airports and airplanes, particularly related to air travel advertising sector. And by ‘dominate’ I mean they are the exclusive advertising provider for some of the highest traffic airports in all of China.

Also, they’re expanding heavily into gas station advertising– on average, China is adding roughly 3000 miles of highways each year (this is expected to triple)— and its predicted they’ll soon surpass the US, taking the #1 position in terms of constructed expressways.

With so much highway construction connecting rural towns to urban mega centers (thanks to the Chinese stimulus package), there will be a lot of new gas stations sprouting up across the country… and Airmedia recently signed a deal to become the exclusive digital media provider at the state owned gas stations (Sinopec), essentially giving them the lock on road traffic as well as air traffic.

(Ironically, Mcdonalds is also capitalizing on this trend– they have signed with Sinopec to build over 30,000 drive-thru’s at highway gas stations.)

I bought at $3.91 and the stock now fluctuates between $6.90 and $7.20.  Would I buy it now? No. But if it drops below $5, I’ll consider buying more assuming the fundamentals haven’t changed… so keep this one on your radar– the company stands to profit as millions of China’s new middle class take their first family vacations this year.

By the way, when you’re picking up your luggage at the baggage claim in Shanghai, look at the massive flat screen above your head… all the mini TVs, even wall adverts– this is all Airmedia.

– Christine

She works the graveyard shift at a Florida motel off Interstate 75… but she doesn’t seem to mind much.  A rather buxom blond with more curves than hard angles, Stephanie would definitely be considered a “people’s person” and enjoys meeting so many out-of-towners.

Friendly and outgoing, she’s also incredibly smart… which is probably why she was such a great commercial real estate (CRE) agent.

Stephanie’s story is typical of the industry. She quit her job in 2002 and decided to cash in on the coming real estate boom. She studied hard, obtained her residential license, and immediately set out for a glamour photo and sexy business cards to pass out to potential clients.

According to Steph, the market became so saturated with agents by 2005 that “every bored housewife’s grandmother” was selling property. Steph took another exam and graduated to commercial real estate– what insiders consider to be the ‘cream’ of the industry.

Being on the commercial side of real estate (to them) is like being an investment banker. There’s a lot of pomp and pride associated with this more complex aspect of the business.  Now you’re dealing with big businesses and huge numbers instead of kitchen cabinets and local school systems– it takes a different kind of professional.

Commercial real estate is also unique in that it is on a completely different cycle than residential real estate; when residential properties started to collapse in 2006, Stephanie thought she was brilliant for making the move to the commercial side, which in her words was ‘immune’ to a residential downturn.

Three years later, most of the news about real estate has focused on the woes in the residential market… probably because it affects so many Americans, and reporters don’t understand commercial real estate– they think a cap rate is the price for baseball hats, and a triple net lease is only used by circus trapeze artists.

Behind the scenes, however, commercial real estate is dying a slow and painful death…. hence Stephanie’s new job at the roadside motel.  This has significant consequences for the US economy and its fairy tale recovery (CRE, not Steph).

Similar to how residential mortgages were packaged up into what eventually became toxic assets, commercial mortgages were also collateralized into large bonds and sold off in the secondary market.  In fact, securitization of commercial mortgages grew from $14 billion in 1995 to $230 billion in 2007, all while mortgage underwriting standards declined.

We all know the stories of the California bus driver who ‘qualified’ for a $600,000 home loan.  Banks were smoking the same thing when they approved risky commercial loans as well.

Commercial real estate valuations are highly dependent on the state of the economy.  If businesses are cutting back on costs and unemployment is high, demand for office property, retail property, etc. will fall dramatically.  If banks no longer have the capacity to make large commercial loans, the lack of capital will further erode prices.

Furthermore, if businesses are short of cash they will be unable to meet their debt service obligations on commercial loans.

This is exactly the environment we are in today.

Property values are cratering and office vacancy rates are soaring with the unemployment rate.  The downturn has also caused a spike in delinquent payments on commercial real estate loans.

Just last week, Maguire Properties Inc., one of California’s biggest owners of office property, handed over 7 buildings to its creditors, accounting for roughly $1 billion in debt. Unfortunately for the banks, the buildings are worth far less than the $1 billion they are owed.

Similar stories will unfold in the coming months and years, and they will create substantial balance sheet carnage for banks who are already in a fragile state… and this is why Ben Bernanke is extending his bailout TALF program through next year to account for the losses in commercial real estate.

Translation? Even the pinheads at the fed know that CRE is going to tank.   Naturally, I’m looking for an opportunity to profit from this.

To me, shorting the banks is risky– the markets are looking for any reason to buy the banks, and considering all the banks are going to be de facto government-owned before long, I’m not interested in betting against the government’s totalitarian authority.

That leaves a lot of other options, including commercial property trusts, and my favorite, commercial mortgage trusts.  These are publicly traded stocks that invest solely in commercial real estate mortgages and mezzanine debt that is often in a subordinated position.

This means that if the value of the property falls (which it will) and the mortgagee cannot pay (which they won’t), the mortgage trust company will effectively get wiped out.

Ironically, despite the looming cloud hanging over commercial real estate, many of these commercial mortgage trust stocks have had spectacular run-ups over the last few months… this screams of a low-hanging fruit short opportunity to me.

I’m in the process of researching a few of these that I will publish later on, but would love to hear from you if you have other ideas for how to capitalize on this opportunity.

I’ll admit, even I was surprised.

When I think about Asia growth and investment opportunities, places like Singapore, Thailand, Vietnam, and even the Philippines come to mind.  But lately, in my regular discussions with key Asia contacts– brokers, sovereign wealth fund analysts, etc., one place keeps coming up again and again.

Mongolia.

Mongolia is one of the largest, most resource rich countries in the world with a population smaller than Panama– that’s a lower population density than Wyoming.  And with such a low population to support with its abundant resources, the country has the good fortune of being sandwiched in between resource-hungry China and Russia.

Many of my friends and colleagues who are based in Asia make routine trips to Mongolia and describe it as the Wild West– young, fast-paced, and full of opportunities with neither the benefits nor restrictions of established structure.

My old friend Christine Verone, who has an uncanny 6th sense about Asian markets, recently sent me this in an email:

———–

I’m not buying in China right now because I’m not seeing the right indications from the government yet. I will let you know when things change and we can start making money in Shanghai again. In the meantime I am buying in Mongolia as fast as possible.

The stock exchange there is among the smallest in the world; it had a 68% run-up but has since rebalanced to 50% below that level, and there are some fantastic buys. Aside from the broad “metals and mining” sector which is all most people know about Mongolia, there are many plays to found in uranium, cashmere, agriculture… and even new changes in toll roads and water.

It can be seen as another way to play China seeing as nearly 80% of their exports are to the mainland, and an absolute tidal wave of Chinese money is being invested in Mongolia– new infrastructure, luxury hotels, telecom deals, real estate developments, etc.

Everyone from American Express to Ericsson to ZTE is establishing themselves in Mongolia– even Blackberry is launching service in the country… all because a flood of investment dollars and joint venture projects to tap natural resource wealth is creating legitimate, overwhelming demand for services.

I am also looking at clues in demographics– population trends are good predictors for change, and Mongolia is a country that is dominated by young people: 70% of the population is under the age of 35.  This means that they move extraordinarily quickly and are hungry to get deals done.

The stock exchange was started in the 1990s by a 26-year old entrepreneur– this culture is full of people who want to make things happen.

In contrast to my time working in Switzerland in private wealth management, the Mongols move at light speed.  If I were you, I would get this out to your community to see if there’s any interest… and I would suggest two things:

1) The Mongolian Stock Exchange is sitting on multi-year lows; the entire market capitalization is less than $250 million, and daily turnover is often less than $1 million… so institutional capital tends to move prices in a big way.

It’s fairly transparent for foreign investors to get in to this market– which is exactly what I am doing right now. My guess is that there will be a Mongolia ETF very soon once the market has tripled and you start hearing about it on CNBC.

Too late in my book.

2) I know you have a lot of expats who read your letter and are looking for a place to go… I would highly suggest Mongolia– if you have the means and are looking for adventure, Mongolia is a land of opportunity.

Mongolian entrepreneurs are itching to do JV deals with subject matter experts to bring new services to the country… and there’s no such thing as ‘paying your dues’ in Mongolia. You show up, and if you’re smart, you move to the top of the food chain immediately.”

———-

Simon again. What Christine says rings absolutely true… to me, the biggest benefit of living the expatriate lifestyle isn’t the cultural adventure or cheap cost of living– it’s being able to immediately plug in to the movers and shakers who can get deals done and make things happen.

In New York City, San Francisco, LA, etc., it can take years to clutch and claw your way up the ladder and get noticed. Around the world, though, in places like Colombia, Mongolia, Palau, and Panama, it’s possible to become a player very quickly.

Before moving anywhere, though, it’s always a good idea to see the country first hand and scout the opportunities for yourself on the ground. If you’re interested in Mongolia, consider checking out the annual Mongol Rally which takes place in September each year… there is no more unique way to see a country in my opinion.

Let me know if you want to hear more about investing in or moving to Mongolia, and I will do my best to answer your questions.

One of the keys to living free is being able to make money… enough to support the lifestyle that you want as well as provide peace of mind for the future.

To me, there are two clear ways to do this; one is by starting a business and generating cash flow through sales.  The other is by generating investment income.

I try to talk about both in this missive; I am happy to share my own ideas, as well as different products and services out there that I invest in to make money (or keep more of the money that I earn).  Again, these topics are cornerstones to living free.

As I’ve discussed before, I don’t like to take big risks… I take calculated risks to carefully control my downside, and love investing in what I call ‘low hanging fruit.’

We’ve talked about some low hanging fruit already, and one of my favorites is buying cash at a discount… strong, growing companies that are trading for less than the amount of cash they have in the bank.

I recently picked up another one of these stocks, a highly undervalued pharma company, courtesy of Dr. George Huang.  Huang is a master at finding these solid pharma companies that are trading at less than cash value, and he writes about them in his FDA Report.

I’ve mentioned this to you in the past because I know Dr. Huang and believe wholeheartedly in both his ethics and his trading strategy.  I personally think it’s pretty ingenious.

While other biotech letters (and fund managers for that matter) go broke trying to find the next Genentech or Amgen, Huang capitalizes on predictable market patterns based on the FDA’s drug approval, and covers his downside so the risk is limited.

So how’s his track record?

Huang’s average pick returns 30% in just 14-weeks, and he has never had a significant loss.

This is why I wanted to mention Huang’s letter to you again today… making money is critical to living free, and George’s track record, methodology, and good character stand out among the best.

I asked my friend and partner Matt to once again track down Dr. Huang and conduct an interview with him for the benefit of the group… Matt grilled him for about a half hour on his background, his strategy, and his track record, and you can listen to the interview here in MP3 format or below if you have flash (just click on the green area):

I would encourage you to listen to the interview and decide if Huang’s simple strategy is right for you. It works very well for me, but I might have different circumstances.

As a note, the audio quality is not the greatest, but I’d rather get the content out to you than worry about ‘pretty’.  For more information about Dr. Huang’s letter (and don’t mind the marketing copy), click here.

Remember that Croatian commando-turned-entrepreneur from dinner last night?

Well it turns out he’s an aerobatic stunt pilot too… he’s got an old Soviet-made aircraft that is only designed to do one thing– be as unstable as possible. It does the trick.

This morning around 11am Central European Time, we met at a private airfield outside of Zagreb. He strapped me in to the cockpit, took me up to about 2,500 feet, and proceeded to test my manhood.

Let’s just say I’m glad I skipped breakfast.

I have never had to withstand five times the force of gravity before, nor had I much of a clue what that even meant. And yet, over 12-hours later, I am getting queasy all over again just telling you about it.

Fortunately we had the video cameras rolling, and I will be posting footage to the site in a few days for your enjoyment… but first, a little taste of where I happen to be right now in the lovely Italian Alps-

Now… since this is Friday, I wanted to take a moment to review a few topics from this week:

NATIONAL HEALTHCARE

I am deeply appreciative of the intensely personal anecdotes that were provided on the health insurance piece, particularly those accounts with specific prices and treatments.

Several stand out in my mind, including Mike’s “Chile saved her life,” and Jai’s “About a decade’s-worth of care in Asia spent in one morning.” These are powerful testimonials to overseas healthcare solutions that do not rely on insurance companies or government bureaucrats.

A few readers took umbrage with my characterization of national health plans. Fair enough. For every negative example highlighting the failures of the system (VA, Cannuck, NHS), there are certainly a plethora of examples of patients who have been healed due to the quality of care received.

My intention is not to take anything away from the medical professionals who serve under these systems, but rather to demonstrate that bureaucrats fail miserably at everything, especially healthcare.

I simply don’t think the same government that took the better part of a week to deliver water to New Orleans should be running a national healthcare program. Not to mention the idea of nationalized healthcare makes a mockery of the Constitution.

To reiterate, my solution is to build my own network of doctors in places where care is inexpensive– Panama, India, Brazil, Thailand, etc. And if you find it crazy to jump on a plane to seek quality, cost effective, potentially life saving medical care in a foreign country, then you are probably reading the wrong missive.

EURO SHORT

As always, very bright comments from everyone… and Gernot, I am on the way to Germany this weekend to verify what you said. I agree that the euro may likely show signs of stability and even strength in the short-term on the backs of the Germans and BENELUX.

My assessment of a eurozone collapse, however, is a long-term view. And betting in favor of the dollar to take a short position in the euro does not make sense to me in the long-term.

Currency markets are all about capital flows; when risk tolerance is high, institutional wealth pours into emerging market currencies and away from the dollar. When risk tolerance is low, the dollar strengthens and bond yields fall.

When investors begin to lose confidence in the euro, capital will flow away from the eurozone and have to find a home somewhere. At that point, it probably won’t be the dollar. But where?

There are only a handful of instruments in the world that can absorb hundreds of billions of euro in capital flows– and the Japanese Yen is one of them, and my sense is that the Renminbi may be one as well someday.

Long-term contracts for the future values of the Euro/Yen and Euro/Renminbi cross rate are tradable in Chicago, and a variety of overseas exchanges as well.

Furthermore, many online FOREX brokers provide the capability to short the euro against gold and silver (buy XAUEUR and XAGEUR), both of which I expect to perform even better against the euro than the dollar in the longer term.

In the meantime, selling the euro in favor of the dollar in the short-run is too risky for my taste, and I wouldn’t advise it.

Burgers make better economic indicators than official statistics ever could.

As I travel, I typically perform an informal price study of my own basket of consumer goods– a loaf of bread, a pack of cigarettes, a liter of petrol, and a handful of… non-family friendly wares.

This is the type of information that is most valuable for me because, everything else equal, goods of similar quality should cost the same around the world.

Unfortunately, Heisenberg was correct when he postulated that I am not capable of being in multiple places at exactly the same time… which is why I get excited whenever the Economist releases a new iteration of its Big Mac Index.

The Big Mac Index compares worldwide prices, converted into dollars, of the McDonald’s signature sandwich.  It is an excellent, though certainly not conclusive, indicator of whether a nation’s currency is undervalued or overvalued.

The most recent release from July 16th confirms absolutely what I am seeing on the ground here in Europe: the Eurozone is seriously overvalued…by roughly 30% according to the index.

In other words, the burger will set you back $4.62 based on the current euro/dollar exchange rate, 30% more than the $3.57 paid in the US.

This would suggest, in theory, that the euro should fall from $1.42 to $1.08 in order to achieve parity with the dollar’s purchasing power.

Admittedly, there are some flaws in the index.

Europe is, and always has been, more expensive than the United States– taxes, regulation, and employer contributions are out of control… though I suspect the United States will catch up shortly.  These obligations drive up natural price equilibrium and pollute purchasing power parity.

My own experiences suggest that government influence adds 10% to prices in Europe, meaning that the euro’s range should be between $1.18 to $1.25.  At its present valuation, the euro is terribly overpriced.

More on this later.

Right now I am in Budapest, one of my favorite cities in the world… Budapest has an amazing mix of culture, beauty, and elegance, with just a hint of sordidness so that it’s not too stuffy. Not to mention it’s every bit as nice as Paris at a significant discount.

I was last here in December when the Hungarian forint was trading at 230 per US dollar.  At the time, Budapest was the cheapest ‘nice’ city in the world… this was based on an artificially low, panic-induced exchange rate that I knew couldn’t last.

It didn’t.

Despite being on the brink of economic collapse, Hungary’s forint has gained to 195 per US dollar, an 18% increase; that, plus a small dose of inflation, has reduced Budapest’s price appeal for dollar consumers and investors.  Prices are still reasonable, but certainly not ‘cheap’.

In fact, I would say that in terms of cost of living competitiveness, the ship has sailed for the entire European Union, at least for now.  There are certainly a few exceptions– parts of Poland, Bulgaria, and Lithuania to a degree.

Fortunately, I expect this to change in the future. The entire continent is anchored on the euro, and that currency is dead man walking… for all of the problems in the United States absolutely pale in comparison to old Europe’s economic and fiscal woes.

Italy, Greece, and Spain in particular are in such financial turmoil, their only solution is the oldie but goodie political tactic of inflating the currency by printing more of it. Barrack Obama is giving a clinic as we speak.

In order for these countries to have full monetary flexibility, they would have to break apart from the Eurozone. The resulting loss of confidence would send the currency spiraling into a historical footnote.

Even monetary disruptions in countries that have pegged their currencies, but not yet fully adopted the euro (… Latvia, for example) have the power to shake confidence in the unified currency.

The likelihood of just one of these events occurring (Italy or Greece dropping the euro, Latvia devaluing, etc.) is effectively 100%– and this is low hanging fruit in my book.

I have an idea to safely profit from the euro’s demise, but I would like to hear from you first, as always… especially if you have an alternative assessment on the euro’s future.

In the meantime, I believe that Asia and Latin America currently present the best cost of living value, and I will be focusing on these regions in future missives.

All- there were a lot of great comments and questions this week, I will review several here:

LATVIA

Excellent insights on Latvia and the way to trade the devaluation. Johan from Sweden asks if we are too late shorting Sweden’s banks. I think not, and here’s why:

Swedbank, one of the largest Swedish banks in Latvia, posted a 2 billion kronor ($250 million) second quarter loss just hours ago, compared to the average estimate of 1.27 billion kronor. Loan losses soared to 6.67 billion kronor ($850 million), a 1500% increase over last year’s loan losses.

This tells the story of what has happened to the bank’s loan portfolio *before* Latvia devalues. The post-devaluation carnage will be even worse.

Given the bad news, what happened to Swedbanks’s stock today? It rose 11.6%… simply because management expressed ‘confidence.’ I think this is absolutely insane.
Sweden’s banks have certainly taken a hit in the last 12 months, but the good-news story that management is spreading is just a charade to mask weak fundamentals. They will falter, they will fail.

Another important follow-up item about Latvia: Some of you asked me if Latvia has an ancestry citizenship program like Lithuania.

According to my sources, Latvia does NOT have anything similar to Lithuania.  Sorry.  But never fear, there are plenty of cost effective (and even free) passport programs out there.

One of the many things I’m working on is what will probably the most comprehensive second-passport guide out there; I’m partnering with a few other citizenship experts and plan on marketing this in the coming weeks.

BREAKING POINT

I want to thank everyone who contributed some very personal insights… so let me level with you about a few things.

Giving up US citizenship does not mean being barred from the country forever. I know several people who have done it, and they come and go regularly… while entry to the United States for a former citizen is not guaranteed, it is not guaranteed for current citizens either. Renouncing citizenship is more of a psychological exercise than anything else, especially for an expat.

That being said, I am still a US citizen, and I don’t plan on giving it up anytime soon. I think the US still has a future, but it will go through some serious pain first… so I’m willing to hold on to the passport for now until my assessment changes.

Sure, I have to pay stiff taxes in the meantime, but my expat lifestyle means I pay less. More importantly, my assets are safeguarded overseas, my businesses (except for one) are offshore, and I am enjoying bountiful opportunities around the world, both personal and financial.

As I hope you will find out soon when you hit your own breaking point, the expat leap is not all that scary… as ‘Tropical Freedom’ commented, jump in– the water’s just fine.

Taking baby steps is important for beginners… get a passport. Travel. Find places you love that meet your needs. Buy and store gold. Move cash. Buy property. Seek income and investment opportunities. Obtain a second passport.

It doesn’t have to happen at once, and it needn’t cost an arm and a leg. Many expats live an amazing lifestyle at a fraction of the price in their home country… they have children. medical needs. elderly parents. financial constraints. Every excuse for not trying has already been overcome…

Except for the will to act.

MISCELLANY

If I do end up coming to August 6th Atlanta entrepreneur event I mentioned on Wednesday, I will definitely make an announcement ahead of time to have a get together for anyone in the area.

I also received several questions about business opportunities and how to get started… as an investor and entrepreneur, I can say that this covers a lot of ground– so stay tuned and I will dedicate part of this missive to specific overseas opportunities that I see.

Also, for our readers who are already out there living an independent, expat life, please drop me a line… I would like to interview several of you for a regular series as I think it would be beneficial to the phyle at large.

If you’re interested, please contact us from the ‘Contact‘ link on our website.

A final note on Latvia today before I put the Baltics to bed for now–

Yesterday I argued that Latvia is definitely headed for devaluation, and that European governments are practically bending over backwards to make sure we know about it.

In comments yesterday, the astute Mr. Marriott pointed out that the grey economy is now flourishing in Latvia; this is undeniably true, and we see evidence of dark economies around the world in times of crisis. Argentina and Cuba are great examples.

But I would submit that the grey economy is even more reason for the devaluation– tax revenues become even lighter as dark economies grow, while the government’s fiscal burden remains heavy.

So how specifically do we profit from this?

One thing’s for sure, I am NOT going to short the Lat… Rado correctly pointed out yesterday that we will get eaten alive by the interest rate: the Latvian Central Bank is quoting the 3-month Lat rate at 35%, and that is not a type-o.

Hey, we might be right about the devaluation, but we could get killed waiting around for it to happen at 35%.

I agree with Dean and ‘Me’ that the safer tactic is to short Sweden.

Sweden’s banks dominate the Baltic banking scene; two in particular, SEB and Swedbank, are like cockroaches in Riga– they have branches everywhere and are about to get squashed.

In total, Swedish banks have roughly $75 billion of exposure to Latvia’s economy, roughly 25% of Sweden’s GDP. Devaluation of the Lat will have multiple effects on these banks’ balance sheets:

First, the banks will take an immediate hit to their equity as the book value of their Latvian holdings will become worth far less in Swedish kronor terms. Roughly 30% of Swedbank’s equity, for example, is based in the Baltics, and this will see an instant drop.

Second, the loan default rate in Lativa is going to skyrocket. Most loans are denominated in euro or Swedish kronor because the interest rates were lower; when Latvia devalues, borrowers will no longer be able to afford the foreign currency payment.

This will result in another hit to the banks’ equity as their loan assets evaporate and are replaced by a portfolio of worthless foreclosures and bankrupt companies.

Third, with such an intense reduction in Baltic economic activity, the banks will suffer another earnings decline. Baltic banking comprised 30% of Swedbank’s operating profit last year, and that profit will now certainly swing negative.

Fourth, after suffering a huge drop in equity and profitability, Sweden’s banks will likely be under pressure to raise cash, either from the government or in capital markets. These types of rights offerings, like the one SEB recently completed, will be highly dilutive to shareholders.

In short (ha), shorting Sweden’s banks with heavy Baltic exposure, either directly or through PUT options, is one way of profiting from Latvia’s devaluation.

One more thing I’d like to mention, completely off-topic.

A couple of you have asked about entrepreneurial ventures and Internet business opportunities. As an investor/entrepreneur myself, I believe wholeheartedly that the Internet provides a wealth of opportunity to earn money and live anywhere.

I’ve been fortunate to meet with and be educated by some of the industry’s sharpest entrepreneurs, mostly at small, private conferences held by insiders.

My friend and partner Matt, one of the industry’s more brilliant minds, knows the participants well and has been able to talk me in several times.

One such conference is coming up in Atlanta on August 6th… it’s short notice, but I’m going to try like hell to make it, and Matt will definitely be there– along with some top internet entrepreneurs. It should be a great networking and educational event, but the big draw for me will be racing.

The organizer is putting everyone through the Skip Barber Auto Racing school, and as a car lover, I really enjoy that sort of thing. There’s only 15 spots left– take a look if you’re interested.

Also, if you decide to go, make sure you drop me a line to let me know, I will try to organize an informal get together.