Reader’s Corner: Four of Your Questions Answered by Jim Rickards

All week you’ve heard from Jim.

To finish this week, we thought we shake things up a bit.

Here, we have four reader questions that Jim has answered.

What does your personal portfolio look like? What percentage of your money is in physical gold and/or silver, and do you own any stocks?

Tom M.

My personal portfolio is a blend of cash, fine art, gold, silver, land and private equity. I do not own any publicly traded stocks or bonds, partly due to restrictions under various regulatory requirements applicable to my role as a portfolio strategist and newsletter writer.

The mix in my portfolio changes from time to time based on valuations of the particular asset classes. My recommended mix is 10% precious metals, 10% fine art, 30% cash, 20% land and 30% alternatives such as hedge funds, private equity and venture capital.

Currently, my personal allocation is overweight land, fine art and private equity and underweight cash and precious metals. However, this will change, because the fine art fund is currently making profit distributions, which are being reallocated to gold, at what I consider to be a good entry point, and to cash.

All investors should be able to purchase precious metals and land and hold cash without difficulty. Alternatives such as hedge funds, private equity and venture capital are not open to all investors, because they are frequently traded as private funds limited to accredited investors with high minimum subscription amounts.

There are also publicly traded equities such as high-quality bond funds and companies holding hard assets in energy, transportation, natural resources and agriculture.

Fracking technology has been around for decades. Was the shale revolution a bubble fuelled by low interest rates? Some say it will save our country, but I fear it may do the opposite.

David C.

The American energy boom on the whole is a triumph of American technology and entrepreneurship and will be good for long-term growth. But as with many disruptive technologies in the past, there will be excesses and losses and unintended consequences in the early stages of this technological revolution.

America benefited greatly from the railroad boom of the late 19th century, but railroads were overbuilt or poorly managed in some cases and many investors suffered losses on railroad stocks and bonds. Something similar is now happening in the energy sector, despite the clear advantages of the technology.

The benefits of fracking are obvious, which include plentiful low-cost energy and lots of high-paying jobs in the oil and natural gas fields. The problems are less obvious. For one thing, this low-cost energy is deflationary at a time when the Federal Reserve desperately wants to increase inflation.

If the deflationary impact of fracking causes the Fed to push monetary ease to the point where confidence in the dollar is destroyed, then the costs of this revolution will be very high. Of course, this will not be the fault of the frackers, but rather the fault of the Fed. Yet the dangers are there, nonetheless.

The other problem is that much of the euphoria in the fracking fields was financed with low-grade corporate debt. This debt was issued on the assumption that oil prices would remain above $80 per barrel or higher. With oil in the $45 per barrel area and likely to remain below $60 per barrel, much of this investment will have to be written off.

The amount is in the trillions of dollars, larger than the subprime mortgage crisis, and much of the debt is stashed away in bond funds buried in retail 401(k)s. As I mentioned earlier, you should check your 401(k) to see if there are any corporate bond funds, and if so, call your broker or adviser to find out if there are any fracking-related junk bonds tucked inside.

I read in the introduction of Currency Wars about the possibility of an 80-90-98% “windfall profits tax” on gold (if and when it goes up to US$5,000-plus per ounce). If that’s true, wouldn’t that mitigate the benefits of holding gold?

Gordon L. 

My reference to a future windfall profits tax on gold in the introduction to my book Currency Wars was intended to form a contrast to the confiscation of gold in 1933. The point simply is that the government sometimes works to suppress the price of gold, but when gold goes up anyway, the government finds a way to steal the profits from private investors. A windfall profits tax is one way to do this, but not the only way. I mentioned it as an illustration of what could happen, not as a hard-and-fast prediction.

The possibility of such a tax is not a reason to avoid holding gold today. The surge in the dollar price of gold that I expect has barely begun. If the price does move up sharply, there should be time to sell the gold at a high level and reinvest in another asset class, such as land or fine art, which is less likely to be targeted for confiscatory taxation by the government.

Of course, deciding when the profits on gold are large enough to justify the pivot into other hard assets will not be an easy call, but that’s one of the things we will be thinking about and pointing out to you as a Strategic Intelligence reader in the months and years ahead.

Why do you think that there is a corporate debt problem? Aren’t US companies sitting on hordes of cash?

Rich C.

Debt comes in many forms, including high-quality US Treasury debt, high-grade corporate debt and junk bonds. Debt is also issued by both US companies and foreign companies. Some of the foreign corporate debt is issued in local currencies and some in dollars. In discussing debt defaults, it’s necessary to keep all of these distinctions in mind.

The US companies sitting on hoards of cash, such as Apple, IBM and Google, are not the ones I’m concerned about; they will be fine. The defaults will be coming from three other sources.

The first wave of defaults will be from junk bonds issued by energy exploration and drilling companies, especially frackers. These bonds were issued with expectations of continued high energy prices. With oil prices at $60 per barrel or below, many of these bonds will default.

The second wave will be from structured products and special purpose vehicles used to finance auto loans. We are already seeing an increase in subprime auto loan defaults. That will get worse.

The third wave will come from foreign companies that issued US dollar debt but cannot get easy access to US dollars from their central banks or cannot afford the interest costs now that the US dollar is much stronger than when the debt was issued.

The combined total of all three waves — energy junk bonds, auto loans and foreign corporations — is in excess of $10 trillion, more than 10 times larger than the subprime mortgages outstanding before the last crisis, in 2007.

Not all of these loans will default, but even a 10% default rate would result in over $1 trillion of losses for investors, not counting any derivative side bets on the same debt. This debt will not default right away and not all at once, but look for a tsunami of bad debts beginning in late 2015 and into early 2016.


Jim Rickards

Strategist, Strategic Intelligence

Ed note: The above article is an edited extract from the US Strategic Intelligence. It was first published in January 2015.

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James G. Rickards is an American lawyer, economist, and investment banker with 35 years of experience working in capital markets on Wall Street. He was the principal negotiator of the rescue of Long-Term Capital Management L.P. (LTCM) by the U.S Federal Reserve in 1998. mist for West Shore Group.

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