The Triumph of Contrarian Investing

My father was the ultimate contrarian. He rarely trusted Wall Street. He never followed the crowd. And he was repeatedly among the few that uncovered some of the most unique investment opportunities of the 20th Century. So to kick off the New Year, I recommend you do two things today: First, try to guess how I’m going to invest my money this year and hopefully win a 46″ hi-definition flat-screen TV or other great prizes. (Click here for all the details.) Second, make sure you learn all the lessons you can from Dad’s own account of his investing successes … — Martin

I first went to work on Wall Street as a typist in 1924 when I was only 16 years old.

I made $25 a week, which was good money. I knew very little about the stock market. But I found it so exciting that I went back four years later as a trader.

I traded some stocks for myself and a few clients. When the ’29 crash hit, I was as surprised as everyone else by the utter fury of the decline. But my portfolio was clean. Neither I nor any of my clients had one share of stock.

My good fortune was due to a combination of skepticism, naiveté and just plain poverty.

I saw that real estate prices were plunging. I saw commodities falling. Yet, all around me, investors were going wild over stocks.

If people bought stocks with their own money, it might have been OK. But they were doing it on margin, with broker loans.

These loans, which normally totaled around a half a billion or a billion dollars, surged to a total of $8 billion. That was huge in those days! The entire Gross National Product (GNP) was only a bit over $100 billion.

The rest of the country was sinking. Why should Wall Street be any different? I couldn’t understand the discrepancy. I wasn’t about to risk my meager savings on something as uncertain as a surging stock market in the midst of sick economy.

Looking back, I can see that escaping the Crash of ’29 was a critical event in my life. Had I been caught with some shares, no matter how few, I might have left the business in disgust. Instead I stuck around.

I met George Kato, a Japanese analyst who was in the States for a few years and was in close touch with the most astute speculators of the day. Kato was like a big brother. He spent months teaching me his technical trading methods, about how to sell short, how much and when.

Kato showed me that selling short isn’t difficult or complex. Instead of buying low and then selling high, you just reverse the transaction. You borrow the stock and sell it. Then, you wait for it to go down and buy it back at lower prices. The more it goes down, the more money you make.

For example, one astute trader went to his broker and borrowed 100 shares of Radio Corporation. Then he sold the borrowed stock for $100 per share, giving him a credit in his account of $10,000. The stock plunged to about $40, he bought it back for $4,000, and returned the 100 shares to his broker.

His profit: $6,000. Since he only put up a deposit of $1,000 for the borrowed stock, he multiplied his money by 6 times. While nearly everyone else on Wall Street lost their shirts, this trader made a fortune.

This fascinated me. I wanted to learn more. So George Kato introduced me to the trading strategies of other great traders — men like Jesse Livermore, who built up a fortune trading the market.

I didn’t have the money to actually test the market. But I could usually tell, from the volume and the price action, when it was running into support or resistance.

I shared this new knowledge with my older brother, Al, who helped me throughout my career. We learned everything we could about selling short. So when the market rallied from November 1929 into early 1930, we were ready.

With this rally, almost everyone on Wall Street thought we were in “a new bull market.” But I was skeptical. The volume just wasn’t there. Deflation was spreading from commodities and real estate to other assets. The situation at the banks was getting worse by the day. The economy was sinking. When I saw nearly everyone turning bullish again, I just shook my head.

President Hoover was the biggest bull of them all. In order to reassure the country that this was “just a temporary situation,” he called in executives of the big companies for a special meeting. He urged them not to lay people off, to keep the economy strong.

A lot of people took it to heart and that helped to rally the market still further. But when the executives went home, guess what they did! They did exactly the opposite of what Hoover told them to do. They laid off workers left and right.

Still, no one on Wall Street was paying much attention. They said the crash was a “temporary lapse.” They believed Hoover. I didn’t. I borrowed $500 from my mother and started to go short the stock market — 100 shares, 200, 300, building it up slowly at first.

To me, $500 was a lot of money in those days. I grew up in a poor and tough immigrant neighborhood in Manhattan. I worked two jobs to help support my parents and family ever since I was a teenager. I didn’t have much money. But I was confident because of my indicators.

The main indicator I watched was the Federal Reserve’s figures on the broker loans of the large New York banks that issued their data weekly. I noticed that, instead of broker loans going up, as they normally would in a recovery, they were going down.

This tipped me off that the banks were liquidating stocks. The banks represented the smart money in those days. So I followed them. They didn’t have any faith in stocks, so neither did I. As long as they sold, I sold. When they stopped selling, I stopped selling.

My other benchmark was foreign currencies, especially the British pound. Britain was still the financial capital of the world. So when the pound fell, it had a direct impact. We charted the pound daily, and as soon as it broke a key low, we sold short stocks that were closely tied to the pound’s fate.

I decided to target short sale companies that I thought could get hurt by the falling pound. One was Electric Bond and Share, which was a holding company of public utilities, especially in Latin America. Their main subsidiary was called American and Foreign Power. I sold them short in ever bigger amounts. This turned out to be extremely profitable and other trades worked out even better.

By the time the crash was nearing bottom, I had transformed my mother’s $500 into six figures. She was overjoyed and so was I.

But not every trade was a success. At one point, just when I thought the market was going down still further, there was a terrific rally. I lost half my profits. What a sobering lesson that was!

There was one great benefit to this experience, though. It stirred me to learn as much as I could about other key areas — especially interest rates.

The Interest Rate Explosion of the Early 1930s —
Why It Took Me Completely By Surprise

The going theory about interest rates was that it was tied to inflation. When we had more inflation, interest rates would go up. When we had less inflation or actual deflation, interest rates would fall.

Nobody looked at interest rates as being separate from inflation, and neither did I. Boy, was I in for a big surprise! In fact, just as I began to watch interest rates more carefully, every single thing I had read about interest rates went by the wayside.

Interest rates had fallen sharply during the stock market crash, which was to be expected. Then something absolutely astounding happened. Although we were still experiencing deflation, although the economy was still sinking, interest rates began to surge dramatically. The immediate reason: Bond markets collapsed.

To understand why, consider this example: In 1929, an investor puts $1,000 in a General Motors bond paying 3 percent per year, or $30 interest.

But after the crash, fearing that GM might go broke, he sells the bonds for $500. Since it’s still paying 3 percent a year, the new buyer now is making $30 per year on a $500 investment, or 6 percent! So as the bond price fell in half, the current yield doubled!

But when I saw interest rates surging, I didn’t understand the cause. Was it inflation coming back? Did I read the textbooks upside down? That’s when I began to look at interest rates as a powerful fundamental force in their own right.

The yields on low-grade corporate bonds were the first to surge as their prices plunged. It was like an aftershock from the stock market crash, but with a lag. This made sense because they were being downgraded left and right. They were issued by companies which were on the verge of defaulting on their payments.

A lot of the companies simply ceased to exist. So it was natural that their bonds should become worthless. The yields went to 15 percent, 20 percent, 30 percent. But what good was it if you lost your principal?

Then high-grade corporate bonds also got hit hard. Investors feared that any company — regardless of rating — could go belly up, and they were right! At some companies, finances deteriorated so quickly that, by the time the rating agencies got around to downgrading them, it was too late.

Amazingly, high-grade corporate bond yields surged past their pre-crash highs as their prices crashed. Someone was selling the hell out of them. But who?

You’d think that at least Treasury bonds would be protected from this selling panic. They weren’t. Investors sold them aggressively, driving their prices to new lows, just like the corporate bonds. Yields surged.

Where was all the selling coming from? What drove interest rates up when every textbook in existence said they should be going down?

It wasn’t until many years later that my brother Al and I began to put it all together. To understand what was going on, we had to throw all the traditional theories about interest rates into the trash can. We had to forget about inflation, deflation, money supply and the Federal Reserve.

Instead, we looked at bonds like any other kind of investment — no different from stocks or commodities. When investors sold them, they went down in price. When investors bought them, they went up.

These investors didn’t give a hoot about textbooks. All they cared about was the fact that they needed cash. The banks needed cash to meet huge demands for withdrawals. Businesses needed cash to pay bills. Insurance companies needed cash to pay claims. So they went to their financial VPs to dig up something they could sell off for cash.

“What’s this?” they asked.

“They’re bonds, sir,” came the answer.” They’re solid investments — not like stocks.”

“Can you sell ’em?”

“Sure we can. But bonds are good for bad times. You shouldn’t be selling them now because …”

“I don’t give a damn if they’re good, bad or in-between. Sell ’em. Get cash!”

Thus, tremendous amounts of bonds were dumped on the market. High-grade bonds. Low-grade bonds. Muni bonds. Treasury bonds. It didn’t matter what color or denomination. Everywhere, financial institutions and businesses were getting rid of their bonds.

If they were low grade or on the verge of default, they got no more than pennies on the dollar. And even with higher grade bonds, many investors were simply throwing the baby out with the bath water, driving prices to new lows.

I asked some of my business clients why they wanted to sell bonds. They talked about “inflation coming back,” about the danger of “reflation,” as they called it. But later, I realized that inflation was just an excuse. The real reason they sold the bonds was because they needed the cash.

Everyone was scared of bonds, including myself. I hadn’t yet figured out why it was happening, so I just stayed away. How unfortunate, because after they plunged in price, that turned out to be one of the best possible times to buy the highest quality bonds.

Buying the Bottom

Another reason I missed the bottom in bonds was because all my attention was focused on picking the bottom in stocks.

In the early 1930s, I worked with my brother at the midtown branch of a small brokerage firm. The stock market had been battered to unheard-of lows, but the big spotlight was on banks. People were lining up for their money. Failures were beginning to spread.

In an attempt to quell rumors of a bank holiday, Governor Lehman of New York pledged that he would never close the banks. In state after state, other officials made similar vows.

Then, just a few months later, they turned around and did exactly what they said they would never do: One by one, they closed down the banks in their state. Confidence was shaken still further.

We decided to track the banking crisis more closely. We figured the money must be going somewhere. But where?

Soon we discovered the obvious: If people are taking their money out of the banks, it must show up in the “currency in circulation.” That was one of the statistics tracked weekly by the Federal Reserve. And it was readily available for the asking.

Currency in circulation is the cash you carry in your pockets. But back then, most of it wasn’t circulating at all. People were taking their money out of the banks and burying it in their back yards or stashing it under the mattress. It was dead money.

So “currency in circulation” became our number one indicator of the banking crisis. Every Friday morning, we got the figures from the newspaper and plotted them on a graph.

In late 1930, it was climbing at a pretty steady clip. Then, the bank withdrawals accelerated and the line on our chart began to rise more rapidly. We sensed that the banking crisis was approaching a climax.

President-elect Roosevelt was to be inaugurated in a few weeks. He would have to do something dramatic to stop the cash hemorrhaging from the banks. As inauguration day approached, my brother and I began to speculate that Roosevelt might declare a bank holiday. But we needed solid confirmation.

So on Thursday afternoon, March 2, 1933, two days before FDR was to be inaugurated, we decided not to wait for the morning paper to get the latest from the Fed. Instead, we took the downtown express to the New York Fed’s offices on Liberty Street to get the number in person, as soon as it was released.

The only people waiting in line at the Fed were a few messengers from the newspapers and some banks. Virtually no one else was interested in the currency in circulation. When we saw the number, we were shocked!

It had surged far beyond anything we had imagined. That was Thursday night. Roosevelt’s inauguration was going to be Saturday morning. We went home, plotted it on the chart and planned our strategy.

Al said: “This is it! This is the end of the whole decline! Roosevelt is going to have to do something about this.” I agreed.

Most people might think that a bank holiday — easily the worst financial crisis in modern history — would be the harbinger of a further stock market decline and a signal to sell.

We felt it was exactly the opposite. We believed that it was the climax of the whole deflation since 1929. The new President would have no choice but to close the banks, inflate the economy and pump up the stock market. Besides, at these low prices, major blue chips had great value. We had no intention of selling short. Our sole purpose was to buy.

The next morning, we went straight to our firm’s main offices downtown. We didn’t stop at the midtown branch. We wanted to get our orders in to the man who talked directly to the floor traders.

We bought everything we could lay our hands on. We bought GM, AT&T, GE and Sears for pennies on the dollar. The tape barely moved, it was so dead. No more than 350-400 thousand shares of stock were traded. That’s less than trades in just one large transaction today. But that didn’t stop us. We just kept right on buying.

The order clerk looked at us as if we were from another world. “How come you guys are buying?” he asked. “You’re the only ones!”

We smiled and shrugged. It was none of his business. By the time the day was out, we had bought thousands of shares of stock for ourselves and for our clients, at bargain basement prices. As a matter of fact, they were just about the lowest they had fallen in the entire century.

The next day, Roosevelt was inaugurated. Immediately, he announced that he was closing not only the banks, but also the financial markets. All the stock exchanges shut down. There was no trading. Everything was frozen. So if you owned stock, it was impossible to sell. If you didn’t own stock, it was impossible to buy.

Investors wondered: “Is this the end?” … “Will the markets ever re-open again?” … “Is there going to be another crash?” Even at such low levels, people were afraid the market could fall a lot further.

But as we approached the end of the banking holiday, sentiment began to change. Confidence in the banking system recovered. Well-heeled investors made plans to start buying some stocks.

When the stock market finally reopened, prices jumped up. There was a big gap between the closing prices before the holiday and the opening prices after the holiday. So it was too late to get in at the best prices.

However, since we got in ahead of time, we were in great shape. And because we had bought the stocks on margin, our profits were huge.

The Bottom in Utility Stocks

That was just one of the major bottoms of that era.

The best example came in the early 1940s. Yes, most stock sectors hit their lows in 1932 and 1933. But there was one group that failed to recover significantly and then hit a new, lower bottom in 1942: Utility stocks.

The main reason: Wall Street was afraid FDR was going to nationalize all utilities. I went to my brother Al, and said: “He’s already fighting a war overseas. His hands are full. He’s not going to fight another one at home. Let’s get a study up on utilities because they’re way down.”

So we got our staff together and spent a whole year researching the utilities. And we came to the conclusion that it was time to buy.

We bought bonds that were going at 25 cents on the dollar, like Standard Gas and Electric and a host of the other utilities.

We bought stocks in Commonwealth and Southern which were going across the tape, on the Big Board, at 10, 15, 16 cents a share.

It was another great buying opportunity: Tremendous value. Extremely low prices. Virtually no buyers around except ourselves.

The big speculators, the ones who had encouraged earlier price run-ups, were all gone. The more aggressive managers were also gone.

The only ones operating the utilities were engineers and solid, down-to-earth people.

The Original Gold Bugs

I’ve heard some advisers claim that they are the “original gold bugs.” But it’s not true. The first gold bugs of the twentieth century were friends of mine — men like Bernard Baruch, William Baxter, Thomas Bragg and Ben Smith.

Bernard Baruch was an adviser to several presidents and is famous for having made a fortune during the crash. William Baxter was the founder of the International Economic Research Bureau. Tom Bragg and Ben Smith were floor traders specializing in gold stocks. I was working for a Wall Street firm at the time, while writing freelance reports on inflation and gold for Baxter.

The five of us — Bill Baxter, Bernard Baruch, Tom Bragg, Ben Smith and I — had been accumulating gold coins in a small way. In those days, very few people were buying the gold pieces. They were being used mostly for gifts and weren’t circulating. But we bought thousands of them.

For over a hundred years, the price of gold was steady at around $20. So no one viewed it as an investment, as something that might go up or down in value. At the same time, most people still believed in banks. It was assumed that if your money was in a bank, especially a large, well-known bank, it was safe no matter what.

So we had a hard time convincing people to get out of the banks, even close friends.

Mrs. Wallman, my best friend’s mother, was a case in point. In 1932, she asked me what she should do with her money. She had it in the Bank of the United States, which, according to my analysis at the time, was very weak. So I told her to take it out and put it in $20 gold coins.

The next day, she went to the bank to withdraw her money. But the teller called over the vice-president, who then proceeded to talk her out of it:

“Look,” he said, pointing to the others in the bank lobby. “Do you see any of these people taking their money out? You’re the only one!” She put every dime back in.

Several weeks later, FDR declared a national bank holiday. The Bank of the U.S. never reopened. Mrs. Wallman’s life savings was frozen for years, with no interest. She never did buy the gold coins.

But we were able to buy gold coins for ourselves and some other clients. We’d walk up to the bank tellers and ask for $20 gold pieces. They’d give us as many as we wanted, no questions asked. It was just like asking for $20 bills.

Then we started on the gold shares — this time, investing in bigger amounts. The shares were grossly undervalued and consistently snubbed by most traders. In fact, back in the early ’30s, my boss used to laugh at me for buying gold shares. Every morning, he’d rib me about it.

Gold and gold shares had a bad reputation. Earlier in the century, a bunch of shady characters used to roam the countryside peddling the shares in mining ventures which went belly up.

So by the 1930s, investors gave mining companies a wide berth. But we didn’t give a darn about what other people thought or said. We figured we couldn’t go wrong if we concentrated on the biggest companies like Homestake plus a couple of big Canadian companies. We knew we were on the right track because our gold stocks started to move up nicely.

We soon had very respectable paper profits. So some of the boys were itching to get out. With the ’29 stock market crash still fresh in their memories, you couldn’t blame them for being nervous.

I called a meeting at Bill Baxter’s office. Bernard Baruch was there, and so were Ben Smith and Tom Bragg. One of them alluded to the possibility of “some big selling which could hit at almost any time.” Baruch said he was hanging on. He knew something we didn’t know. But we didn’t find that out until later.

Our immediate question was: “Who’s going to do the selling and how much?”

I suggested we get the facts with a survey. I got a hold of the stockholder lists of some of the big mining companies and had our staff call about 400 people at random, asking a simple series of questions — “When did you buy your gold shares?” … “How much do you own?” … “What do you plan to do with them?”

Boy, were we surprised when we saw the results! We never got past the second question! About half the stockholders in mining companies didn’t even know they owned the shares. The rest said they had the shares stashed away — in their attic or in a vault somewhere. None of the people had plans to sell the shares.

So I called another meeting and told the boys: “The only big source of selling would have to be from someone right here in this room.” They all breathed a sigh of relief. We held on to our shares and doubled our profits.

This story drives home the basic principle that information about the market is one of the most valuable resources you can get, especially if it’s from an original source. And this concept leads me to the real reason Bernard Baruch wasn’t selling his gold shares.

The Hidden Reason Baruch Was Buying Gold

We gathered from Baruch that FDR might have a plan up his sleeve to stop gold from leaving the country. But we never imagined he’d confiscate the metal.

The banks were shipping gold out to London by the boatload and Baruch was doing the same. He was advising FDR at the time and so he was privy to some information.

He couldn’t tell us what it was, and we tried to anticipate what it might be, but none of us had any way of knowing the details. However, based on our own logic and the bits and pieces Baruch did talk about, we surmised that the President was going to restrict gold investments in some way.

We bought as much as we could, while we still could — gold coins, shares, bullion, you name it.

Then, on April 5, 1933, FDR signed Executive Order 6102, “forbidding the hoarding of gold coin, gold bullion and gold certificates within the continental United States.” The order effectively made it a crime for investors or companies to own gold bullion. It was one of the most blatant cases of asset confiscation in modern U.S. history.

We were ready. But we were also stunned. We had no idea FDR was going to be that tough.

Shares in gold mining companies, however, were still legal to own. And most investors have no idea how huge the profits were in gold shares during that period.

Homestake, for instance, went from a bottom of $65 per share after the crash to $130 and change in 1931. From there, it doubled again to more than $350 a share by 1933.

By the time it peaked in 1936, it had climbed to $540 a share — an astronomical gain of more than $470 per share. That was a 7-fold increase.

In the meantime, the dividends also doubled, redoubled and doubled again — reaching $56 per share in 1935. Think about it. The dividends earned in one year alone almost paid back the entire purchase price of the stock.

Homestake was not an isolated example. Dome, another great gold producer, did even better. You could have bought Dome for as little as $6 a share after the crash. But in the next 7 years, it paid $16.60 in dividends. The dividends alone were equal to more than 2 1/2 times the cost of the stock.

Meanwhile, the price of Dome rose to $61 a share. A person who put $10,000 into Dome could have walked away with more than $100,000 — while nearly everything else remained depressed.

Tom Bragg reaped the biggest benefit. He was the largest holder of Newmont Mining. Then he left Wall Street to become a major executive in the company and stayed with gold for the big rise in subsequent years.

The others made big profits also. I’m not sure how big, because these guys were very private individuals. And unlike so many advisers you meet at today’s investment conferences, they never boasted about how much they were making — especially when they were making a big killing.

Cash was king back then. This was the Great Depression. Prices of everything were extraordinarily cheap. You just needed a modest portion of that to build real wealth. It didn’t pay to get greedy.

Silver Was Also a Great Way to Build Wealth

I’ll never forget the day I first got interested in silver in 1936.

My boss, Bill Baxter, and I were riding the subway home one evening. I had to raise my voice over the deafening clatter of the uptown express to get my point across. I shouted, “Silver is undervalued. I’m writing a special report on it.” It took me a few times to be heard over the noise, and all he said back was “OK!”

Back then, silver was selling for a meager 17 cents per ounce. I knew that industrial demand was about to take off. When I finished the report a couple of months later, Baxter decided the arguments were so strong that we should release the report to our best clients and subscribers before making it available to the general public.

The very first person we called was Joe Kennedy, the father of JFK. Kennedy really liked the idea, but later, he decided to beg off because his advisers told him it was too much of a “long shot.”

The man was wealthy enough as it was, but this wound up costing him another fortune.

I bought silver at around 17 cents, but I didn’t ride it up to $50. I wish I had. I got out of silver in the 1950s, having multiplied my money several times over.

I thought I was smart to take a profit like that. If I had stashed away a few dozen bars in a trunk and thrown away the key, I’d have made more money than I did with all my other silver trades — large and small — put together.

I calculated that, at 17 cents an ounce, if you invested $4,000, you could have purchased about twenty-two 1,000-ounce silver bars. Each one of them would have been worth $50,000 at the peak, or over one $1 million for the lot.

But back then, if you told me silver would go to $50 an ounce, I would have said you were nuts. It just goes to prove, again, that no one can possibly predict ahead of time the ultimate peak — or the ultimate bottom — be it in a commodity, a stock or interest rates.

Some Important Lessons

All of these experiences helped guide my investment strategies for the rest of my life, and I think you can learn from them too.

First, I learned that the best time to buy anything — stocks, bonds, real estate — is when no one else wants it.

Wait until people’s emotions are so powerful they forget the original reasons they started selling in the first place. Wait until people are selling just for the sake of selling. Don’t trust the public mood. When everything looks the blackest, it could be the time for a real recovery.

Second, gold can play a very special role in crises — especially monetary crises. Its behavior reflects more than just ordinary supply and demand forces, or even crowd behavior. It’s also a mirror of the madness of government.

Third, I learned that it’s a mistake to fly by the seat of your pants. Use a benchmark — an indicator you can rely on. Back then, we used the currency in circulation. Today, the world is more complex and you may need an advisor you can trust and follow. Just make sure he’s a contrarian and does not follow the crowd!

Fourth, the big pay-off from a crash is not just betting on the decline. It’s having the cash — and the courage — to buy the shares when they’ve reached a bottom and no one else wants to buy. It’s by having the stamina and patience to wait for the right time to buy real values. Let the other guy chase the market up. You can afford to wait for a better price.

Fifth, don’t be fooled by old, supposedly “foolproof theories,” such as the theory that interest rates only go up with inflation. A lot of other things can cause interest rates to soar, such as bond ratings downgrades and the fear of defaults. Another theory — that the Great Depression was a one-time event that can never be repeated — is also flawed. And
several other theories about government intervention, such as those developed by Keynes and other modern economists, are also full of holes.

Sixth, Joe Kennedy’s missed opportunity to buy silver — at a dime and some pennies per ounce — is also something you should never forget. He himself wanted to buy silver. He was convinced. But it was too much to convince his advisers, and he missed a great opportunity.

To protect your wealth or to make real money, you have to be your own man. You have to be willing to ignore what everyone else is saying. Listen to their facts and opinions. Then draw your own conclusions — and once you’ve done that, don’t look back.

The more you know, the better. But the more you rely on others to agree with you, the more likely it is you’re going to miss your best shots, because those always come when just about everyone else thinks it’s “a long shot.”

If you ever find yourself in a majority, watch out. The market is too small for a crowd.

Editor’s note: Now, try to guess how Martin Weiss is going to invest his own money this year to maximize your chance of winning a 46″ hi-definition flat-screen TV or other great prizes. (Click here for all the details.)