Jay O'Keefe's Investment Letters

Letter 19  
March 13, 2008

Uneasy About Jumping on the "Oil, Gold and Commodity Bandwagon?"

One of the lessons I have learned is that I am most vulnerable when things are going well. That¡¯s when my need and dependence on God can fade into the background, and greed can easily take over. And that¡¯s when God usually introduces pain or opposition into my life, not as punishment, but as discipline, or, child-training to motivate me to repentance (see Hebrews 12: 5-11).

One of the ways He disciplines is to take away material wealth which He has given. If you are familiar with the Old Testament, you know that he used this form of discipline several times with Israel (see Deuteronomy 8:17-20). You are familiar with the statement found early in the book of Job, ¡°The Lord gave and the Lord has taken away. May the name of the Lord be praised.¡±  (Job 1:21)  God is to be praised as much for His ¡°takeaways¡± as for His ¡°givings.¡±  Everything He does is in my best interest.

These are some of the thoughts I have had during the past few days. I sense the possibility suggested by this brief Bible study, and I also sense that we may be approaching some kind of critical point in the secular commodity bull market. This has motivated me to rethink what I have learned from the experts I have confidence in.

As I have shared with you, I believe God led me to three men in answer to my prayer, Richard Maybury, Richard Russell and Jim Rogers. I listen intently to every available word they speak or write. There is an almost unbelievable amount of other investment advice out there, in the media, on TV and on the internet. Although I read a little material from 8 or 10 other people, I pass over most of it, because it confuses me. I¡¯d like to discuss some of the key points I have picked up from my three experts. Please bear with me. This will take a while, but I believe it is very important, especially at this point in time.

I have been reading Richard Maybury for 25 years, which is years longer than the other two. If you really want to learn to invest, go to www.chaostan.com and subscribe to his Early Warning Report. I think it is currently $159 per year, and worth many, many times that in my opinion. Those who have followed his counsel over these years are swimming in profits. Unfortunately, I did not start seriously following him until about ten years ago. His counsel has played a major role in our success since then.

As I was thinking about his advice, I asked myself what key points stand out, and the first thing that came to mind is that every few months he repeats his advice for investors to invest money they cannot afford to lose, or subject to high risk, in the Permanent Portfolio Fund (PRPFX). This fund follows the strategy developed by Harry Browne beginning in the 1970s, and described in his short easy-to-read book, Fail-Safe Investing. I have recommended this book in these letters (see Letter 3). Two years ago, Maybury said something I had not heard him say before. He disclosed that the majority of his own money was invested in the Permanent Portfolio strategy (PPF). I don¡¯t know exactly what that meant, but technically it must mean more than half.

When I discussed the PPF beginning in Letter 2, I struggled with how to integrate it with my allocation strategy. What I came up with was complex and confusing. I have since come to the conclusion that the PPF should be considered completely separate from any other investments, and contain money you cannot subject to high risk. I have sought to clarify this in Letter 7, which suggests four plans for managing your investments.

Another key forecast which Maybury made beginning ten years ago which came to my mind was his forecast of the coming destruction of the purchasing power of the US dollar. His letter was the first place I read this forecast in clear, definitive terms, backed by logic and extensive research. More than five years ago he forecast $100-$130 oil, $2,000-$5,000 gold, $50-$100 silver, and many others. The performance of his non-dollar asset recommendations has been stunning.

I have been reading Richard Russell for over 15 years. He writes the longest running newsletter in history, Dow Theory Letters, not missing a single issue since 1958. He is approaching age 84 as this is written, and still of value to me. He has steadfastly recommended gold and silver as an investment since gold was $350 and silver $4. He uses Dow Theory (see www.dowtheoryletters.com) to develop buy and sell signals for the stock market. He published a sell signal in November, 2007, and has been out of the market entirely since then. He admits he doesn¡¯t know how long the bear market will last or how far down it will go, but says he will not own stocks (possible implied exception is a small position in gold and silver mining shares) until he gets the next Dow Theory buy signal.

I want to key on his recent recommendation to investors. It has some interesting insight that I missed at first. For months he has repeated the phrase, ¡°gold and cash, cash and gold.¡± That¡¯s the way he says it, and he explains that by cash he means government T-bills. And every week or so he mentions that he owns silver, stating that it could even have a better potential than gold. A few days ago, he disclosed (for the first time that I¡¯m aware of) that his cash was 60% of his total portfolio.

For months I have been thinking about this, asking myself why only two investments, and why so much cash, since, like Maybury, he has been forecasting the downfall of the dollar. My interest was further peaked when he quoted his 60% cash position. Based on my reflections, and all I have read from him over the years, here¡¯s my conclusion. He believes his gold and silver will protect his wealth against any loss of purchasing power in the dollar, and he believes his cash will protect him against a severe deflation caused by a financial crisis and widespread debt defaults. History strongly supports this thesis. 

In effect this is an ultra-simple form of the permanent portfolio strategy. Interestingly, Harry Browne¡¯s initial allocation included 25% cash and 25% long treasury bonds. Since long term interest rates are currently so low, while inflation is high (a condition which I believe must soon change), there is little room for the long bond to appreciate further in value, thus a 50% cash allocation would serve now just about as well as the usual permanent portfolio allocation. I suspect this is in Russell¡¯s mind. Rest assured, I am carefully thinking about what I have learned from Russell, and next to certain it will soon affect my portfolio allocation. More in the conclusions below.

Now we come to Jim Rogers. He has had the greatest influence on my strategy the last 8 years. In 1999 he said that a long term secular bull market in commodities was beginning. He expects it to last 15 to 20 years, possibly longer. He documented all his research and conclusions in his book, Hot Commodities (Random House, New York, December 2004). I highly recommend the book. Not only does he make the case for buying commodities and holding them through the entire bull market, but he makes it very clear that there will be several major downward corrections during the course of the bull market, that you must be prepared to hold through these, and you must not attempt to trade or time these fluctuations.

Rogers gives speeches at investment conferences around the world, and is interviewed by various media outlets almost every week. I try to find them on the internet, transcribe them and put them in my Rogers three-ring binder. I have almost everything he has said publicly since 2002. By re-reading this material, I get a feel for his wisdom and strategy for investing. A pattern emerges.

He repeatedly says he is the world¡¯s worst trader and the world¡¯s worst market timer, his way of recommending that you not attempt to trade any asset class. His primary investment class is obviously commodities. When a particular commodity goes way up, for example, oil, he will say, ¡°I wouldn¡¯t buy it now, but I¡¯m not selling it. I don¡¯t plan to sell it until 2020. If it goes down far enough, I¡¯ll buy more. With regard to any specific commodities which are down 50% or more from their all-time highs, he will suggest buying them. He has named 6 or 7 since 2006, and they have been very profitable.

Regarding stocks, he sometimes buys stocks he considers undervalued (mostly commodity related), but when he does, he simultaneously sells short equal amounts of stocks he considers overvalued. In other words, he is market neutral (hedged) as far as stocks are concerned. This has been a winning strategy whether the market is going up or down. It doesn¡¯t matter to him which way the market is going.

There is one other key piece of information which can be found in my Rogers binder, but I completely overlooked it until I began preparing to write this letter. Though I cannot quantify this in exact terms, I know that he has a large cash reserve. He owns at least three currencies other than the US dollar, which has been profitable for him. I knew this, but had overlooked the point that he is holding a lot of cash, even though he is aware that all paper currencies are losing their purchasing power through inflation, but they serve as a hedge against a financial crisis resulting in deflation, and buying power when any other asset class falls to a bargain price.

Before I come to my final conclusions and recommendations, I want to mention one other expert I have read for many years, but never mentioned. I like reading his material because he has one of the best world financial data bases, and publishes great charts which are helpful in making investment decisions. I don¡¯t include him in my top three experts, but it was a brief article in his letter that came yesterday that brought a wave of conviction over me and triggered the writing of this letter.

He includes in his article a 55-year chart of the CRB Spot Commodity Price Index, and three 37 year charts of oil, gold and the US dollar. These charts give perspective that you rarely see in other public charts. Although he has had a number of commodity related stocks in his model portfolio the past few years, he is beginning to feel uneasy about jumping on the ¡°oil, gold and commodity bandwagon¡± because it is starting to get overcrowded. He points out that history shows that all commodity prices are cyclical. They go through up-cycles and down-cycles. The charts verify this. And while arguments for these assets are logical and compelling, they always are at the time the cycle changes. He ends by recommending that investors ¡°reduce holdings in oil, gold and commodity related stocks to ¡®core positions¡¯ that you intend to hold for the next 5 or 10 years, regardless of a sizable correction.¡±

Notice how perfectly this dove tails with Rogers¡¯ statements above, that he plans to sell his commodities in 2020, and not before. But there is one more key bit of information in this expert¡¯s letter, and that is that his model portfolio is currently 47% in cash!!

There are two things that all four of the experts discussed above have in common. They all four have a cash reserve in the 50% range. I had not realized that until yesterday. In effect, they all four have a simplified form of the Permanent Portfolio strategy, their cash serving the equivalent function of Harry Browne¡¯s 50% in cash and bonds.  By contrast, my portfolio is currently 18% in cash. 

The other thing they have in common is the presumption that stocks are either in a bear market, or have a lower potential than other asset classes. Their stocks are either hedged, or they have a lower than normal allocation to stocks.

They all four tend to be long term holders of their favorite non-dollar assets in the half of their portfolio which is not in cash. And they do not attempt to trade in and out as a practice. But they all re-allocate their portfolios from time to time, and sometimes replace overpriced assets with under priced assets.

I will almost certainly begin to bring my own allocation closer to theirs, which simply means to bring my cash allocation up to somewhere between 40% and 50%. I won¡¯t do it in a panic, but in slow steps, selling either stocks or physical commodities which have gone up substantially, until my cash reaches the new allocation. (To keep my diversification strategy in tact, most of the sales will probably be partial positions). This not a trading strategy, but a re-allocation strategy.

It has not been my intention to make specific recommendations, but rather to simply disclose what I am doing. This letter will be an exception. Here are the two things motivating me to do this. According to the experts¡¯ opinions, we are probably near half way through the long term commodity bull market. It has gone up very strongly since 2004. Just in the last few months I¡¯ve started hearing reports that individual investors, traders and hedge funds are pouring money into commodities. It¡¯s reported that several hundred new products are being created each month to invest in commodities, i.e. ETFs and mutual funds. This is scary. My concern for those who have been in this market the last eight years, and gotten good gains, is that we preserve most of our gains. My greater concern is for those who are just now beginning to invest in commodities. They very well could be entering the commodity market just as it is about to have a major correction downward (25% to 50% is very possible at some point).

No, I do not believe the commodity bull is over. I believe it could last another 10 to 15 years (Rogers¡¯ opinion). But a major correction could come at any time without notice. Greed can easily turn to fear resulting in panic selling at a loss. Here are my specific recommendations.

  • To those for whom I have managed these last few years, re-consider what portion of your portfolio you are not willing to subject to high risk speculation. If it is greater than your present allocation to the Permanent Portfolio Fund (PRPFX), consider moving the excess out of harm¡¯s way. See Letter 7 for specifics.

  • For those starting new portfolios, see Letter 7 for specifics.

Think about it. If I am wrong and commodities keep going up, we can praise God for the gains we are earning on the non-cash part of our portfolios. If the big correction comes, we will have plenty of cash for the real bargains.

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"Well done, good and faithful servant; you were faithful over a few things,
I will make you ruler over many things.  Enter into the joy of your lord"
(Mt. 25:21 NKJV)

If you have not been faithful in the unrighteous mammon, who will commit to your trust to true riches?" (Lk. 16:11 NKJV)

The Apostle Paul wrote, "Now godliness with contentment is great gain. We brought nothing into the world and it is certain that neither can we take anything out. So having food and clothing we will be content with that. But those who want to get rich fall into temptation and a snare and into many foolish and harmful desires, that plunge people into ruin and loss; because the love of money is a root of all kinds of evil; in their greediness some have been led away from the faith and have impaled themselves on many distresses." (1 Tim. 6:6-10 NKJV)

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The information in these letters is the responsibility of Mr. E. Jay O'Keefe, but all your decisions are your own responsibility.

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