The Experts' Strategy Made Simple

As I have often told you, I finally figured out that my only hope for attaining some measure of success was to follow those with the best track records. I asked God to reveal them to me if it was His will. My faith (assurance) that He did so is strong.  (See Letter 3 - Whom to Listen To and Letter 19 - Uneasy About Jumping on the "Oil, Gold and Commodity Bandwagon?" for more details.  Letter 3 identifies and briefly describes my experts, and Letter 19 summarizes their wisdom and mentions how I followed their lead to reduce my allocations in stocks and increase my allocation in cash so as to get ready for a major correction downward and have cash for the real bargains.)

What follows is an attempt to simplify the strategy of one of those experts, Mr. Jim Rogers. Let me emphasize, I am dealing with his strategy alone, and by so doing I am not saying or implying that other successful strategies don’t exist. I am saying that I have come to prefer his above all others, and I am moving ever closer to following it exclusively. I consider Rogers one of the most successful investors in history. 

If you study, memorize, meditate on and follow what is explained below, you will be acting contrary to your emotions, your instincts, and what your mind tells you is logical. That’s the reason it works, because you are acting opposite to the vast majority of your fellow investors (“the crowd”). Is it difficult? Common sense tells us it has to be. The crowd cannot win. I tried for years and failed, and even now I practice it imperfectly.

I want this to be simple (brief and clear), so I am breaking it down into a few pieces, which you can study and re-study, practice and re-practice, and from these we will derive a few cardinal investment rules.

1 - The Hated Asset Strategy

As we consider this first piece, I want to state Rogers’ whole investment strategy in one sentence. Buy “hated assets,” which everyone else is selling or has sold, and hold them until they rise to “bubble” levels, when everyone else is buying them or has bought them, then sell. This yields the first rule.

RULE 1 – BUY WEAKNESS AND SELL STRENGTH. I have heard Jim Sinclair say this so many times it has made me blue in the face listening to or reading it.

Usually there are several years between the buy and the sell. What’s going to happen in the next few weeks or months is almost always already reflected in the price of the asset.

RULE 1A – NEVER BUY FOR WHAT’S GOING TO HAPPEN IN THE NEXT FEW WEEKS OR MONTHS. BUY FOR WHAT’S GOING TO HAPPEN IN SEVERAL YEARS.

So how do we find “hated assets” which are being thrown away, but have a great future? I assure you I can’t do it. Rogers (or some other expert) must identify them and tell us when he is buying them, and so far that’s what he has done. Example: He bought more than thirty different commodities in 1998, mentioning it almost every day on CNBC. In his 2004 book, Hot Commodities, he explains why commodities were “hated assets” selling at rock bottom prices, with great intrinsic value and strong fundamentals. He also explained why he expected to hold them for 17 to 20 years. He is still holding them today. That phrase “hold them” highlighted twice in this section suggests a second rule. 

RULE 2 – DON’T ATTEMPT TO TRADE IN AND OUT – HOLD UNTIL ROGERS IDENTIFIES THE BUBBLE STAGE AS EXPLAINED BELOW.

Question: What about trend channels, moving averages, stop-losses, chart patterns, technical indicators, etc.? I have never – ever - heard him even mention any of these. Rogers declares himself to be the world’s worst short-term trader, so he doesn’t do it. I gave up on short-term trading long ago. I gave up on using stops long ago. Selling by using stops violates Rule 1 (You’re selling on weakness). I realize I have discussed some of these techniques in past letters and have used them myself. I am not criticizing those who use them, nor am I qualified to judge them. Use them if you wish, but the longer I follow Rogers, the further I am moving away from them, which has greatly simplified my life. You don’t need them using Rogers’ strategy. 

Question: What if your investment starts going down? Rogers holds through any and all corrections until he perceives the bull market is over. All secular bull markets have minor and major corrections…you know, the bucking bull I have talked about before. We’re in a major one in commodities now. Rogers has sold none of his commodities. But he has just recently begun to add to some commodities, suggesting a variation (but not exception to) Rule 2.

RULE 2A – ON A MAJOR CORRECTION WITHIN A SECULAR BULL, WHEN THE FUNDAMENTALS REMAIN STRONG, AND YOU HAVE ADDITIONAL CAPITAL NEEDING TO BE INVESTED, ADD TO YOUR INVESTMENT.

Rogers is following Rule 2A, having recently begun adding to his agricultural commodities. I have found a vehicle for doing this. It’s an investment in actual physical agricultural commodities, not stocks of companies that produce them. I believe the risk in this product is acceptable. I plan to make an initial investment but haven’t pulled the trigger yet. I will disclose it when I do.

Question: But doesn’t Rogers ever make a bad investment that would become a total loss if held indefinitely? Of course. Every expert does. That’s the reason you diversify among several investments within the hated asset class, and put strict limits on every one. That’s what allocation is all about.

Most investments made under the Hated Asset Strategy are made when others are being forced to sell due to debt, margin calls, fear, etc., especially in panics. This suggests Rule 3.

RULE 3: KEEP YOURSELF ALWAYS IN A POSITION OF NOT NEEDING THE MARKET. (I heard this stated by Richard Russell, “The great investors do not need the market.”). IN OTHER WORDS ALWAYS INVEST ON YOUR TERMS, NOT THE MARKET’S TERMS.

In part, Rule 3 means never use borrowed money to invest and always have a cash reserve.

Question: What if I miss an investment because it never trades down to my target fire-sale price? Re-read Rule 3. You don’t have to have any given investment. Hold your cash and wait for the next hated asset opportunity. Once I went down the stairs of the subway station in New York City. I ran toward the train, but the doors closed just before I could get on. Someone nearby said to me, “Don’t worry, there will be another one along in 90 seconds.”

RULE 3A – SUPPRESS THE NOTION THAT YOU HAVE TO ALWAYS BE DOING SOMETHING. PATIENCE IS PROBABLY THE SINGLE MOST IMPORTANT CHARACTERISTIC OF GREAT INVESTORS – PATIENCE TO WAIT FOR THE NEXT GREAT BARGAIN.

2 – The Bubble Strategy

Rogers uses the Hated Asset Strategy to buy as described above. He uses the Bubble Strategy to sell. A bubble occurs after a long rise in the price of an asset class, attracting an ever increasing crowd of new investors. The size of the crowd of buyers seems to peak near the top of the bull market, which makes sense because at some point almost everyone who wants to buy that asset class will have bought, and there will be few buyers left. 

So who are the sellers to these late buyers? Those following the Hated Asset Strategy, of course. This is called “distribution.” During distribution the asset in question moves from strong to weak hands. This is usually a deceptive affair, with the long secular bull market ending by forming a rounded top which is drawn out for months. Want to see what this looks like? Click here to see the 20-year chart of the S&P 500.

Both tops took almost a year to form. The strong hands are smart. They don’t just dump their whole load on the market all at once. When the market drops a few percent, they ease back on their selling and let the last few investors waiting to get in do so, then they sell more. That’s why it’s called “distribution.” Makes sense, doesn’t it? Once the distribution process is complete, then the market begins to accelerate to the downside, and sadly, most investors ride it part or all the way down.

Here is an interesting angle on the Bubble Strategy. Not only does Rogers use it to sell the assets he bought when they were hated. If he identifies a bubble, but doesn’t own any assets in that bubble, he will sell it anyway. That is called shorting, or short-selling. A good example is the housing bubble. Rogers identified it four years ago, and began shorting both the homebuilding stocks and the investment bank stocks. Recently he has covered (bought back) most of his shorts, making huge profits.

So, how do we identify a bubble? I won’t do it. Rogers (or some other expert) will identify it and let us know he is selling. In a recent interview he stated that there is only one bubble left in the investment world today, and that is the long-term US Treasury Bond. (Click here for a chart.)  He has just begun shorting it. That makes things really simple. We only have to worry about one bubble at the present time. Which means we only have to worry about selling one asset class. We don’t need to be thinking about selling any other investments right now (with the possible exception of correcting a past investment mistake, and even then it might be best to do nothing – a subject for another letter).

So, how do we take advantage of this bubble? Until recently, the only way you could short the long bond is by using the futures market. Fortunately, the investment world has created ETFs and ETNs which trade just like stocks on the major exchanges. They handle the shorting for you. You can buy them in your stock brokerage account just as easily as you buy a stock. I have identified an ETF which shorts the long bond, and I am ready to take an initial position in it. I’ll let you know when I do.

3- Are there any other hated asset opportunities?

Clearly, Rogers’ principal investment class is commodities, as explained above. My guess is that his second largest asset class is Chinese stocks. This is also a guess on my part, but I think he began buying these as a hated asset class sometime between 2000 and 2003. His reasons for buying them are explained in his latest book, A Bull in China published in 2007. After he purchased them, they went up by 300% or more. Then in late 2007, the Chinese market topped out and began falling. To date, it has fallen almost 70%. He has not sold his Chinese stocks, but consistent with Rule 2A above, he mentioned a few weeks ago that he has been adding to his Chinese stocks. He also began buying some Taiwan stocks a few months ago. He said it was the first time he had bought them. I’ll let you know if I decide to buy either.

Another hated asset class Rogers began buying more than a year ago is airline stocks. He is not buying any US airlines but named several foreign airlines he was buying (see article). He also mentioned he was buying Chinese airlines, but didn’t give specific names. Both China Eastern Airlines (CEA) and China Southern Airlines (ZNH) trade on the New York Stock Exchange, so I thought it logical they would be among the ones he owns, so I bought them along with the other foreign airlines he mentioned. Look at the charts of CEA and ZNH, and tell me if you think they look like hated assets.

The airlines have fallen in this bear stock market. Rogers has not sold any, and mentioned just a few days ago that he was adding to his investment. I have a moderate position in Rogers’ package of airlines. My investment has fallen about 25% since I bought it. Based on Rule 2A, I will probably add to it soon. I’ll let you know if I do.

Question: What about gold and silver? Does Rogers treat them as a hated asset class? That’s a good question. When he bought all his commodities in 1998, gold and silver were included, so the answer is yes so far as his commodities are concerned. Furthermore, at the moment silver has fallen to a point that it qualifies as a buy under Rule 2A, and Rogers has specifically mentioned adding to his silver recently. But gold and silver are also a form of cash, and throughout history, over time, have been a better store of wealth than all paper currencies. Rogers has made statements recently which confirm his agreement with this. So while silver qualifies as a buy under Rule 2A, and gold does not, it’s clear to me that Rogers considers both as a part of the diversification of his cash out of dollars. A few days ago he said, “Even if gold goes up, I will probably buy more.”

I know of no other hated asset classes that Rogers has identified to date. 

4 – Summary

5 – What about the Permanent Portfolio Fund?

This discussion is unrelated to the Permanent Portfolio Fund (PPF). As I have said many times, for money you want to be low risk with maximum safety, use the PPF. It’s the “sleep-at-night” fund. Decide what part of your assets you want in the PPF. Then you can use Rogers’ strategy outlined in this letter for money you are willing to subject to higher risk. Or you can use Richard Maybury’s Variable Portfolio suggestions mentioned in past letters.

6 – A closing devotional word

It is my conviction that the Bible teaches that God decides how much of this world’s assets I will have during this life. I have no control over that no matter how well I manage my financial affairs nor how diligently I follow some investment strategy. But I do have complete control over how much wealth (treasure, reward) I will accumulate in eternity. That will be based on how well I steward His assets here…how well I fulfill His mandate to spread the gospel, help feed the poor, minister to others, etc. (for more details see Chapter 4 and Chapter 15 of the Biblical Economics book on this site).

God’s best to each of you……………………….Jay