The investments we told you would benefit from inflation are soaring, and the investments we said would get hurt are either falling or about to turn down.
This demonstrates, in the real world and in real time, the true power of inflation.
Inflation knows no space boundaries and no time limits. It will spread to every country and penetrate every sector. It can continue for years and drive prices to astronomical heights.
It can also demolish the value of money, the price of bonds, and a vast range of other paper assets that follow along with them.
Among the hundreds of investments that exemplify this phenomenon today, here are four that come to mind:
1. Gold, the world’s most reliable barometer of inflation and inflation fears, is going through the roof, zooming toward the $540 level. This week, the nearest futures contract surpassed $510 — up $50 since October and up $90 since July.
And yesterday, most gold mining shares catapulted higher, with gold stock indexes such as the XAU ready to bust out to brand new highs.
What to do now:
If you’re on board, great. If not, it’s not too late to buy. But there’s no time to waste. Among our favorite vehicles for profiting from rising gold markets are Royal Gold (RGLD), streetTRACKS Gold Trust (GLD), and select mining shares. They’re going through the roof right now. And the sky’s the limit.
For specific trading instructions and a complete recommended portfolio, refer to my just-published December Safe Money Report.
And for red-hot small-cap mining companies, check out Sean’s service (800-871-2374).
2. Treasury prices, among the first and most prominent victims of inflation, are sinking again.
Last month, the price of 5-year Treasury notes (depicted in the graph) rallied, while their yields declined a bit. Wall Street thought the Fed’s campaign to raise rates was coming to an end.
But they thought wrong.
Now, Wall Street has largely abandoned any lingering hopes for Fed leniency … notes and bonds have resumed their slide … and yields are marching higher again.
That means all borrowers — governments, corporations, home buyers, credit card holders — will have to pay higher interest rates virtually across the board. And it also means that all those companies who have been depending on low rates (to boost their sales, finance their operations, or just stay alive) are going to get hurt.
What to do now:
If you own medium- or long-term bonds, don’t wait any longer. Sell now — whether at a profit or a loss. Yesterday, they rallied a bit. So this could be your exit window.
Then switch your keep-safe money to 3-month Treasury bills or equivalent. With Treasury bills, not only is your principal protected from bond price declines but your yield goes up in tandem with market interest rates.
The most liquid and convenient vehicle for buying them is a money market mutual fund dedicated to Treasury bills. Examples:
- American Century Capital Preservation Fund (CPFXX; 800-345-2021)
- Dreyfus 100% U.S. Treasury Fund (DUSXX; 800-645-6561)
- Fidelity Spartan U.S. Treasury Fund (FDLXX; 800-544-8888)
- USGI U.S. Treasury Securities Cash Fund (USTXX; 800-873-8637)
- Vanguard Treasury MMF (VMPXX; 800-662-7447)
- Weiss Treasury Only Money Market Fund (WEOXX; 800-430-9617)
3. Oil service stocks, such as those in the Oil Service HOLDRs (OIH), have just made new, all-time highs. These include Baker Hughes (BHI), Schlumberger (SLB), Halliburton (HAL), BJ Services (BJS), GlobalSantaFe (GSF) and others, including one of our favorites, Weatherford International (WFT).
Every single one has erased most or all of its post-Katrina losses. The overwhelming majority are at their highest levels in history. And they’ve been able to do this despite the fact that the energy markets were still down.
Now, however, the energy markets themselves are turning back up. Natural gas is challenging its post-Katrina peaks. Crude oil has touched bottom and recovered to $60-plus. Heating oil has perked up, turning decisively higher.
Result: The stocks that service the industry should surge even higher.
What to do now:
You have several investment choices.
- You can buy the stocks individually.
- You can buy OIH, the exchange-traded fund that holds a basket of these stocks, or similar ETFs.
- You can buy call options on the stocks, multiplying your potential profits by many times the price appreciation of the stocks themselves.
As with any investment, buy in moderation. And if the market is surging when you buy, don’t chase it. Wait for at least an intermediate one- or two-day decline.
4. Enerplus (ERF), one of the more conservative vehicles for taking advantage of rising energy, has just blasted off, also to new highs.
Helping it along: A recent decision by the Canadian government to back off from feared tax law changes that might have threatened some of the tax advantages offered by royalty trusts such as Enerplus.
What to do now:
If you already hold Enerplus, stick with it. If not, it’s not too late to buy, despite the higher price.
You can buy it on the New York Stock Exchange. Its trading volume is large. And on top of the strong potential for more appreciation, it’s paying a very high dividend yield of 8.78%.
Yesterday, it sold off a bit — a good buying opportunity.
Caveat Emptor
As you can see, with the wind of inflation in your sails, you have virtually unlimited profit opportunities before you.
But always remember two things:
First, except for the Treasury bills, none of the above investments are risk free. You CAN lose money. So don’t go overboard.
Second, inflation is not a big happy party. Don’t forget the fallout that inevitably follows in its wake, which is already under way in the most vulnerable sector of our economy today.
I’m talking about the bust now emerging in real estate and mortgage lending, especially among high-risk borrowers.
To give you the details this morning, I’ve invited Weiss Research’s Managing Editor, Michael Larson.
Mike has deeper insight and broader vision into the housing and mortgage sector than any analyst I know. He knows the big picture and is continually on top of it day to day. His report …
Mortgage Loans
Going Bad at an
Accelerating Pace!
Here Are the Likely
Consequences …
by Michael Larson
Mortgage lenders have been dishing out money to anyone with a pulse. They have made loans to homebuyers …
• Without looking at their documents (“no-doc loansâ€) …
• Without proof of their income (“stated-income loansâ€) …
• Without monthly payback of principal (“interest-only loansâ€) …
• And with a program that drives them even deeper into debt with every passing month (“negative amortization loansâ€).
You probably know about this.
You’ve been hearing warnings from us for over a year. And if you’ve been reading the news, you’ve been hearing similar warnings from the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency (OCC), the Office of Thrift Supervision (OTS), and every regulator with a podium.
What you may not yet know, however, is this:
The end game is fast approaching as many of these risky loans go bad at an astonishing rate.
Consider, for example, the subprime adjustable-rate mortgages recently highlighted in the Wall Street Journal. These are loans made to borrowers with bad credit and little or no down payments.
The facts: Of all the loans originated through September, a whopping 6.2% were already delinquent. In the same nine-month period of 2004, only 3.7% were going bad. That’s a 40% jump in the default rate from just one year to the next.
What Bothers Me the Most Is That
This Bust Is Not Going to Be Limited
To the Borrowers with Bad Credit!
For example, also at risk are the so-called “neg am†or “pay option†loans that were handed out like candy. These loans give you a choice of payments: You can pay principal and interest each month, only the interest, or a payment that doesn’t even cover all the interest.
Paying the bare minimum may keep your payments low at first. And so do the incredibly low teaser rates on these loans.
But those rates are adjustable.
They start marching higher almost immediately. And if you don’t pay all the interest (an option most people choose), it gets tacked onto your principal.
Result: your loan balance “negatively amortizes†— or, in plain English, you owe more money instead of less.
Then, a few years later, the real bomb explodes: The sweet spot of the deal expires and you get no more easy breaks. Your monthly payment skyrockets even if interest rates stay flat. If rates go up, your payment can jump by as much as double.
We’re not alone in warning about this. Last Thursday, for example, the OCC’s John Dugan warned about banks taking on way too much risk in this field. In his own words:
“Is this an appropriate product to mass market to customers who may be looking at the less than fully amortizing minimum payment as the only way to afford a larger mortgage — at least for the five years before the onset of payment shock?”
“And are lenders really prepared to deal with the consequences — including litigation risk — of providing such products in markets where real estate prices soften or decline, or where interest rates substantially increase?â€
Good point.
But the horse is out of the barn. And even the new, stronger loan “guidance†on risky loans that’s due out from regulators a few weeks from now won’t bring it back in to the corral.
Nothing they can do now will stop loan losses from ballooning — at mortgage lenders, and big mortgage companies like Fannie Mae or Freddie Mac.
Most Investors Don’t Get It.
But Some Are Starting to See
The Light. And They’re Selling!
Wall Street still underestimates the magnitude of this phenomenon. Many grew up with booming real estate and easy money. So they accept it as the norm.
They think non-prime loans (the ones known to be risky) are the only ones in danger. They figure even if the “extreme fringe†of the industry goes sour, the rest of the industry will be fine.
So most bank stocks have been relatively strong recently. Even U.S. banks with a high exposure to real estate and mortgages have rallied.
Here’s what Wall Street is missing:
Virtually the entire housing and home mortgage industry is the equivalent of what “non-prime†used to be years ago.
In the stock market, it doesn’t take a majority of investors to drive stock prices lower. All it takes is a small minority, and that’s what’s been happening.
New Century Financial (NEW), for example, a leader in non-prime lending, is plunging anew, headed for new lows.
Last month, the stock tried to rally with the other bank stocks. But it failed to make it back up even to last year’s lows.
And now that rally is failing.
This is the canary in the coal mine for much of the U.S. banking industry. It foretells of a similar decline not only for New Century but also for lenders like Countrywide and Washington Mutual. Further down the road, even large diversified banks like Citigroup and Bank of America could see major credit losses.
Bottom line: Easy mortgage money is drying up. Now get ready for the consequences: Rising defaults and foreclosures … a further slowdown in the housing market … and more investor pain.
If you’re a borrower, pay down as much of your mortgage as quickly as you can. And if you own mortgages or mortgage-backed securities, get out now, while you still can at relatively decent prices.
Best wishes,
Michael Larson
About MONEY AND MARKETS
MONEY AND MARKETS (MAM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Larry Edelson, Tony Sagami and other contributors. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MAM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MAM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Contributors include Marie Albin, John Burke, Beth Cain, Amber Dakar, Michael Larson, Monica Lewman-Garcia, Julie Trudeau and others.
© 2005 by Weiss Research, Inc. All rights reserved.
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