Hard Assets, Financial Markets, Risk/Reward Ratio: Where to invest?

Lee Quaintance and Paul Brodsky of QB Partners are concerned about runaway monetary inflation and the decline of the U.S.

In this week’s Barron’s Up and Down Wall Street, they address the question "Where to invest when the financial markets seem unduly risky and the risk/reward ratio generally unfavorable?"

"The answer, they believe, is that hard assets will provide more profits and carry less risk than most financial assets. And that since most "hard-asset derivatives (equity) remain unpopular among financial-market investors," they provide intriguing investment potential.

To illustrate, even with oil at record high prices above $80 a barrel, "energy-related public equities continue to be valued on implied assumptions of long-term crude prices of no more than $45 a barrel."

In like vein, they note that the equity-market valuations of certain global agricultural, precious and industrial metals, and mineral concerns are trading at a fraction of their future production/reserve values. Lee and Paul allow as there are valid reasons why such shares sell below their optimum value, but the discounting is typically much too severe.

Basically, their view is that "investors have not begun to allocate to these sectors en masse because we think they have yet to recognize the relationship linking money creation (and fiat currency declines) to the intrinsic value of natural resources."

They go on to explain that "most stocks that derive their value from natural resources are cheap because most investors that could sponsor such plays haven’t done so in 30 years." But the pros will be forced to change that stance when economic fundamentals give them no choice. And, in due course, they’ll be followed by the investment masses, who, as always, will be late to the party."  (emphasis added)

I couldn’t agree more.

One last item of concern: Moral Hazard. Quaintance and Brodsky note that "financial-asset markets are not set up to
anticipate economic downturns, since it seems that Big Brother is always there to
bail them out."

I suspect Ben Bernanke is all too aware of this, and was part of his calculus last month, despite the 50 bp cut. Indeed, it may be part of what’s weighing against a cut in the October  meeting . . .


Rudy in a Burka?
Alan Abelson

Barron’s, October 15, 2007   

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  1. Shrek commented on Oct 14

    What is with the lovefest for tech lately?

  2. Winston Munn commented on Oct 14

    It is odd to me how similar in nature is this point of view to the “crack up boom” that Mises described, which is basically a flight away from currencies and into hard assets.

    Are we investing at this point or simply running for our lives?

  3. dukeb commented on Oct 14

    I know the end is near simply based upon the near doubling in price of orange juice lately. Goodbye Tropicana, hello again Tang of my youth!

  4. theeconomicfractalist commented on Oct 14

    The Great Wilshire Saturation Fractal Pattern

    The current Wilshire fractal pattern of interest starts from the low on 14 March 2007 with a pattern of 13/30/20 days. 11 May 2007 concluded the 30 day second fractal. The Wilshire’s’final x/2.5x/2x (to 2.5x) saturation fractal series” begins with the 20 day third fractal of the preceding growth series. Starting on 11 May this series, as of 13 October, has progressed in a 20/49/41 day fractal pattern with 16 August at the 49 day 2.5x low and 11 October at the 40 day 2x high. On 11 October 2007 the Wilshire gapped in a minutely fashion at the day’s opening above its previous day’s closing high and to a new record high. At its close it was near the low of the trading day and below the preceding day’s close. This exhaustion gap activity for the Great Wilshire occurred on 40th or 2x day of the defined 20/49/40 day saturation fractal series. From the lows on day 40 on 11 October, a perfect 6/14/12 x/2.5x/2x 15-minute unit fractal can be easily observed taking the Wilshire to its close on 12 October 2007. Even with the pricing aberration and fractal caricaturization associated with the largely unanticipated 0.5 per cent Fed Funds rate cut, if the Wilshire’s price-volume-time multiple and area under the curve for July 2007 ultimately exceeds that of its recent October price-volume-time integration, the 11/27/22 monthly Wilshire high will maintain its position as the price-volume-time composite valuation high for the asymptotic area of Wilshire’s saturation curve – proxy for the global macroeconomic system. Will the 20/49 40 day fractal series proceed further …. to 20/49/49-50? Not likely.

  5. sanjosie commented on Oct 14

    I couldnt agree more. As I read the column, I’m goin’ I gotta blog this. You did. So I’m relieved.

    We’re still early in the game for hard assets. I remember Louis Rukeyser furrowing his brow when a guest recommended asset allocation of 20% mining stocks, 20% gold, etc. Then it was late in the last cycle. When everyone starts agreeing with your current view, Barry, then it is done. As the QB Partners state, it is still early.

  6. Aaron commented on Oct 14

    The agricultural and basic material areas all have some very nice economic growth right now, but I have to wonder at what point has the market valued all of that growth in.

  7. MikeinMT commented on Oct 14

    Aaron –

    The point I took was that it’s not so much the growth prospects that are mis-perceived as it is the currency being overvalued. This is an inflation call in the truest sense of the word.

  8. jake commented on Oct 14

    dont worry about anything…..cut interest rates and lie about inflation…it’s a wonderful thing

  9. Bob commented on Oct 14

    Resolution Trust Corp V2007:

    “The tentative name for the fund is Master-Liquidity Enhancement Conduit, or M-LEC.”

  10. Bob Dobalina commented on Oct 14

    Umm, Barry, even with $800 gold in the models, most (all?) large-cap gold miners are trading at P/NAVs of 1.5-4x.

    Know any exceptions?

  11. m3 commented on Oct 14

    One last item of concern: Moral Hazard… Indeed, it may be part of what’s weighing against a cut in the October meeting . . .

    i disagree.

    mishkin recently wrote a paper that addressed their thoughts on moral hazards; basically, they don’t care. I pulled some quotes below. It’s a complete JOKE:


    One objection to an easing of monetary policy following the collapse of an asset bubble is that it might lead market participants to believe that the central bank will always act to prop up asset prices, a belief that can make a bubble more likely. The central bank can mitigate such an interpretation, however, if it publicly emphasizes that its monetary policy is not directed at stabilizing any particular asset price but is rather
    focused on achieving price stability and maximum sustainable employment.

    LOLOLOL, so they are going to talk hedge funds out of making stupid bets?! LOLOLOLOLOLOLOLOLOLOLOLOLOLOLOLOLOLOLLOLOLOLOL

    If…excessive risk-taking on the part of financial institutions, the central bank, along with other supervisory agencies, can encourage financial institutions to have appropriate risk-management practices in place.

    Given the uncertainty about the effect of interest rates on bubbles, raising rates to deflate a bubble may do more harm than good.

    The problem in Japan was not so much the bursting of the bubble
    as it was the subsequent policies.
    The imbalances in Japan’s banking sector were not resolved, so they continued to get worse well after the bubble had burst. In addition, as pointed out in Ahearne and others (2002), the Bank of Japan did not ease monetary policy sufficiently or rapidly enough in the aftermath of the crisis.
    The lesson that should be drawn from Japan’s experience is that the task for a
    central bank confronting a bubble is not to stop it but rather to respond quickly after it has burst.

    the moral hazard issue is apparently moot.

    they are implicitly saying they don’t care if they make another bubble or not. they’ll just cut rates after it blows up…

    straight from the horse’s mouth.

  12. stormrunner commented on Oct 14

    Somehow I have trouble thinking this is the contrarian view, you know, the one that takes 90% of market participants in the direction that allows the other 10% to clean house. Looks like a bait and switch. Recent monetary expansions include Repo’s, which are expiring as fast as new issuances, as well as expansion of M3 credit creation which will create additional debt, with virtually no expansion in M1, i.e. no way to service the debt. Where are the wage increases comming from, employers -borrowing- money to pay their employees? No one on this board has yet to impune the assertions of the likes of Mish and North who seem to insist that real money creation has yet to show its face.


    Chart updated here,

    Is this position bunk, if so why, I would think that at some level more debt can not come to the recue without a ficility to pay it back and if goverment expansion is being aligned to this end, why are we not seeing changes in the “adjusted monetary base”.

  13. will rahal commented on Oct 14

    Last week I posted a graph of Employment of Financial Services relative to Mining and Natural Resources. The graph shows how in the 70’s, as now, the Financial sector was under performing. The 70’s was a period where tangible assets performed well and P/E contraction for the overall Stock Market took place. See “Relative Employment: the bad and the Ugly”

  14. Norman commented on Oct 14

    Short Oil and Buy XOM, CVX etc.

    BR says, “I couldn’t agree more.”

    Well BR cannot only agree but he and we all have a great market move at our disposal. With oil companies priced at $45/bbl and the price at $80/bbl you can hardly ever find a better arbitrage: Short oil and buy XOM,CVX etc.

    Anyone running out to do that? How about the writers of the article?


    BR: If you want to make a hedged trade, thats the way to go — but most of the funds I deal with are looking for directional trades that are not fully hedged . . .

  15. Estragon commented on Oct 14

    stormrunner – “I would think that at some level more debt can not come to the recue”

    Why not? How big is big? Digits can be added to a debt ad infinitum, and due dates can be pushed out past the end of the universe. The only limitation is the willingness of the borrower and lender to do so. As long as both perceive it to be in their interest (no pun intended) to do so, they will.

    As for money creation, give it some time. Creation requires not only supply, but also demand. All else equal, demand will respond to the lower price in due course. Recall also that the effective fed funds rate dropped well under the target rate in early August, and back up closer to the target rate before the September target rate cut.

  16. stormrunner commented on Oct 14

    >>The only limitation is the willingness of the borrower and lender to do so.

    Exactly, this defines a “credit crunch” this issue has not gone away. Sales of housing and other big ticket items are in decline, I would have to think that partially, lack of available financing is at the heart of this. Recent retail sales increases seem to be largely a result of inflation more than a gain in productivity. Lenders should be adverse to lending in an evironment where borrowers are facing higher consumption costs relative to wages. Where’s the money to service this new debt extended??

    This would seem to almost be a circular argument by definition. No wonder a serious condensation appears to be adhering to the inside surface of my crystal ball.

  17. Estragon commented on Oct 14


    Your crystal ball may stay foggy for a while yet. The fed could have called, but they chose to raise. Unless and until someone calls we can’t see all the cards, so the outcome of the hand is unknown. In the end there’s also the possibility the house will just issue new chips to the losing hands so everybody wins ;-)

  18. stormrunner commented on Oct 14

    In other words are not all these businesses that fund their operations from the sale of ABCP in a box similiar to that confining the sub prime borrower. They need to turn over the paper, no one wants it, any more than banks want to hold title to real estate and lieu of a promise to pay at current RE valuations. Cramer’s full point at the discount window repaired all this??

    Are we done now or is another credit “seizure” necessary to solicit “Global” support for futher rate cuts. The previous round seemed confined abroad -the US somehow escaped this phenomenon??

  19. Winston Munn commented on Oct 14


    Let me chime on on this subject with information that is as valuable as the price paid for it….which isn’t much, so grains of salt additives are advised.

    Obviously, the question of monetary inflation is difficult to quantify else there would not be so many opposing viewpoints. Myself, I like to simplify the complex as much as possible.

    Here is how I reason this. Loaner Bank of Mistrust holds X amount of reserves, which under normal circumstances limits its ability to expand debt because of fractional reserve limitations. Buyer Dumhas comes in for a new home loan. To cut it short, LB&M loans $250,000, which in effect creates $250,000 in new money, which goes to the seller. LB&M packages up a bunch of these loan and sells them, releasing their reserves to do it all over again – in essence, removing the reserve limitations. This is simply unlimited monetary expansion. And this is the reason it is wrong to look at banking reserves as a measure of monetary growth and why the same amount of reserves could exponentially serve this growth.

    We have been doing this as a nation for what…6 years now? In essence, we have already adopted a form of hyperinflation. Why aren’t we in the same mess as Zimbabwe, then?

    Most likely this is because this new hyperinflation was sector specific, and therefore did not spill over as greatly into the broad economy – the vast amount of these proceeds were captured by a narrow section of the economy which plowed most of these profits back into the same sector.

    Of course, there was some splashing into the broader economy as all the businesses associated with residential construction boomed, and everyone from laborers to real estate lenders were making great sums of money. Some of this monetary expansion is still in the economy.

    In my opinion, the only reason we aren’t seeing much greater inflation figures is because of the blowup in housing – we have inflationary pressures from previously created money but at the same time have deflation in residential construction and its associated businesses.

  20. stormrunner commented on Oct 14


    At the macro level this is that “disintermediation” concept that has been discussed previously, correct.
    I would again have to believe this game is seeing its last leggs hobbled. Is not offloading to CDO, CLO, SIV’s in a coma. No one wants to invest in these Credit Instruments. Debt is being reconstituted at the Fire economy level, but the supporting collateral in the Production/Consumption economy are in decline. Eventually boots on the ground have to be able to carry the weight of the mission. Of course there is no way to determine when “eventually is, but I thought a lot of this ABCP paper was expiring in the comming week or weeks. If the Discount Window full point did not create enough spread to absorb imminent seizure, these weeks before the next FOMC meeting should be the oppertune timing to Media Ramp the event, and provide further acceptance for dollar debasement.

  21. David commented on Oct 14

    Ben Bernanke, will not and can not, lower rates with the stock market making all time highs. However, something is happening, we can see it, a new cold war with Russia Rising.

    “Good now, sit down and tell me, he that knows, Why this same strict and most observant watch So nightly toils the subject of the land, And why such daily cast of brazen cannon And foreign mart for implements of war, Why such impress of shipwrights, whose sore task Does not divide the Sunday from the week. What might be toward, that this sweaty haste Doth make the night joint laborer with the day?
    Who is ‘t that can inform me?”
    William Shakespeare

  22. rickrude commented on Oct 14

    this is the best thread of the year.
    Congrats to Barry, us bears have to make money by buying resource companies that will benefit
    from the USD inflation.

    I have been fully invested in hard assets
    this past year. No way am I going to hold any type of $$ whether USD or foreign.

  23. stormrunner commented on Oct 14

    >>Ben Bernanke, will not and can not, lower rates with the stock market making all time highs.

    Maybe not, but the easy fix, one word from Hank and the boys, GS and Co. becomes the New Version PPT —AKA Plunge Promotion Team, smacking the Sell Sell Sell button over there at the CNBC studio giving the FED all the room it needs to take the currency to what ever level they so desire.

    Yep it’s cynical, but pre market opening discount easements, pre FOMC statements of Moral Hazard, followed by more rate cuts.

  24. million dollar watch commented on Oct 14

    Mr. Ritholtz,

    Many thanks for this timely post. I’m not kidding.

    Very often I’ve found some of your blog posts are CRUCIAL CONTRARY INDICATORS – that is, when you post in FAVOR of some asset category, that asset does POORLY over the next several months.

    I need to reopen my shorts on commodities.

    Thanks again!


    BR: No, thank YOU, Chuck!

    Crude up $1.20 to over $85, while Gold is up another $10 to 767. (Nicely done!)

    Why don’t you post some of your ideas and trades in real time, instead of merely sniping?

    You, my friend, are the true money making fade . . .


    UPDATE: 10/16/07 6:05 am

    Crude Oil hits $88 per barrel — up $5 since this comment was 1st posted. (Speaking of contrary indicators)

  25. Winston Munn commented on Oct 14


    Currently, the Fed shows $917B in nominal ABCP – who knows what the real value may be – but on 8/8/07 the total was $1.17T.

    The outflow is telling, I think. From 8/8-9/19, ABCP total outstanding fell by $144B; however, in the last 4 weeks, that total has only reduced by $6B. To me, this means that there are few if any buyers left for the remaining $917B, meaning forced rollovers – but how can you borrow short term against assets valued at zero?

    This would appear to be the motive of the super conduit – a source of short term commercial paper for those desperately needing to rollover loans. This may keep the bubble poised at the tip of the needle for a bit longer, but it does not solve the underlying problem of bad debt.

    What it will do, though, is cancel the effects of ABCP cashouts propping up other vehicles – without this cashout expect bond prices to continue to rise and equities in the S&P to stall and begin to roll over – in my views, anyway.

  26. s0mebody commented on Oct 14

    “Buyer Dumhas comes in for a new home loan. To cut it short, LB&M loans $250,000, which in effect creates $250,000 in new money, which goes to the seller. LB&M packages up a bunch of these loan and sells them, releasing their reserves to do it all over again” –Winston

    The bank selling the loans means that someone gave them money for the loan, so the bank should be square again. The loss should then fall to the purchaser of the loan, and stormrunner’s point remains that someone still loses the money.

    Now, the impression I get is that a lot of the conduits and SIVs were the buyers of the debt the banks were packaging, but the conduits and SIVs are basically the Nick Leeson error accounts of each bank, and these error accounts are leveraged up (I think I read one of Citigroups SIVs was “only” leveraged up 15x). And now this new M-LEC proposal sounds like one big error account where all the crap on Wall Street will get stuffed and never has to be repaid, and the hope is that all will be fine.

    But the SIVs and conduits are large and I don’t think the big banks have the money on hand to cover the losses, hence the bailout proposal. So it seems like an insolvency problem and not infinite money expansion. I could be wrong, but I don’t think so.

  27. Winston Munn commented on Oct 14


    Thanks for the response.

    I never intended to imply that the new super SIV would cause infinite monetary expansion. That has occured already due to securitization.

    What I thought I’d said was that the securitization process has effectively eliminated the loan cap created by reserves – it is the securitization process that has caused the virtually unlimited monetary expansion.

    Say you as a bank have reserves of $100, and thus can lend $1000. You do, and you are capped, unable to lend more. But suppose you sell this $1000 loan for $25. Now, you have made a profit of $25 and because no loans are on your books your reserves are free and now you can lend another $1000. You can do this over and over an unlimited amount of times as long as there is a buyer for each loan.
    The reserve requirement basically doesn’t matter. This is in essence a zero reserve banking system.

    I believe this new super conduit will be used to provide short term loans on MBS, creating a method of rolling over loans on paper that is of dubious value, thus allowing a graduated disposal rather than a forced fire sale.

    The effect is not to eliminate the disaster, but to spread it over time so its impact is mitigated.

  28. Tom a taxpayer commented on Oct 14

    Does anyone think it is a coincidence that Paulson, Citigroup, and the other banks are trying to announce the creation of the “super conduit” $100 billion scheme on Monday October 15 the same day that Citigroup is to report its earnings? …and the same week that other banks report earnings?

    This “super-conduit”, in which SIVs are supposedly backed by the banks, is an attempt to add $100 billion to the Ponzi scheme…an effort to bailout Citigroup and other banks so they can continue their sleight-of-hand tricks. Banks like Citigroup have suffered great losses, so how can they bail themselves out? What kind of shell game are the big banks and the Federal Reserve playing? Something is rotten in Washington and Wall Street.

    Hankey Pankey Paulson of the Federal Reserve is saying one thing but doing another. A few weeks ago he said the markets are going thru a repricing of risks…a healthy, needed correction. Yet here he is conniving with his big banker buddies on a Ponzi “super condiut” to prevent the repricing of risk. The US Treasury and Britain’s Financial Services Authority are both encouraging banks to sign up to the deal.

    The bottom line is that Hankey Pankey Paulson, Uncle Ben, the federal home loan administrators, and the Wall Street establishment are doing all they can to prevent a repricing of risk, even if that means destruction of U.S. currency and run-away inflation.

    Pity poor Axel Weber whose call to fight inflation shook the stock market on Thursday:
    “Stocks fell after Axel Weber, a governing council member of the European Central Bank, said the bank might need to raise interest rates to control inflation.” (FT: Chris Bryant, October 12 2007)

    Axel’s rage against inflation reminded me of a Dylan Thomas poem, revised as follows:

    Do not go gentle into that good night,
    Old central bankers should burn and rave at the inflation of the the day:
    Rage, rage against the dying of the currency.

  29. Winston Munn commented on Oct 15

    Tom a taxpayer,

    There is more to this story. Most of these banks have SIVs which have invested in MBS, and done so by borrowing short term.

    So what happens when you cannot get a new short term loan to replace an existing short term loan that is due? You have to sell. What is the going rate for MBS in the market?

    This super conduit will be used to fund this demand for short term loans – the purpose is to avoid forced sales of MBS.
    As long as forced sales don’t occur, everyone can pretend that nothing is vastly wrong.

    I strongly suspect the risk is much, much deeper than a few large banks taking losses – this they could do as a 1-time charge, shrug it off, and go on.

    This appears to be a systemic crisis over which the Federal Reserve has no control. No matter how much money the Fed pumps into the market, the Fed cannot force anyone to buy ABCP.

    The problem with ABCP has a duality to it – not only are the basic quality of the loans themselves in question, but also the value of the assets these MBS were based on is declining. Who is silly enough to buy a MBS based on $20M in home value that may turn out to be $16M of collateral?

    The other problem that has not as yet surfaced is credit card debt, which is also packaged in ABCP – how shaky is this debt which has zero collateral backing?

    Presently, there is $917B in outstanding ABCP in the U.S. Is this the extent of the problem or is there much more hidden in derivatives of which we are unaware?

  30. stormrunner commented on Oct 15

    >>Say you as a bank have reserves of $100, and thus can lend $1000. You do, and you are capped, unable to lend more. But suppose you sell this $1000 loan for $25. Now, you have made a profit of $25 and because no loans are on your books your reserves are free and now you can lend another $1000. -Winston

    Can they actually do this?? I have no ties to the banking industry but “common sense” banking would seem to dictate that even in a fractional reserve enviro that they should need to sell the loans @ $1025 to turn a profit of $25 and untie their reserves. I thought the incentive for the purchase of the paper was tied to the interest and servicing fees of the original loans which could then be further portioned to a servicing company who gets just the servicing fees while the issuer of the security profits from the interest. If they could just sell the loans without any constraint with the exception of a $25 paper trade fee, then there is -no problem- what so ever at the major banks with enormous potential for Weimer style inflation. Surely this can not be the case.

    This would be the principle reason for my concern, I believe that in order for additional lending to commense someone has to be willing to put up at least the priciple or some proportion there-of to move an equivilent amount off the banks books for the rights to the interest and servicing fees, if this is not the case and banks can just extend credit then sell the credit for a pitance and still turn a profit, our dollar is toast.

    If your example is correct lending is a no risk proposition and will continue unabated, if my contention is correct who will by this paper to move it from the banks books to free their reserves given the risk of return of principle.

    Please clear this up for me, not to mention that I’d come to believe that money creation had some rules.

  31. Winston Munn commented on Oct 15


    Quite right – perhaps I should have clearly stated the $25 fee is in lieu of continued interest payments, or profit on the loan. Obviously, it requires a purchase of the loan + the fee.

    Still, if the loan can be sold to a third party, excess reserves are freed to repeat the process.

    I’m sure this is an oversimplification, as there are fast default risks built in that would put the bank at risk again, but the essence of recycling reserves is the point.

    How else could we have had such an incredible housing boom yet have total reserves not keep pace?

    Maybe I am dead wrong – if so, perhaps someone else can clarify.

  32. stormrunner commented on Oct 15

    Thanks Winston for the timely reply, this gets me back to my primary premise, if one can not ascertain the street value of the loans extended in an environment of depreciating asset prices who will step in to purchase these securities and free the banks reserves to lend further. And with this doubt and the knowledge that the banks themselves may have to return to holding new loans on their own books, the “good old days”, does this not suggest that unless the spreads get phenomenal, overall lending contract issuances should recede dramatically even if defaults on previous loans were being kept to a minimum, which they are not. In other word the conduit is broken. Offloading to investors, this jig is up??

  33. Winston Munn commented on Oct 15


    It would certainly appear the jig is up, and it is about confindence as well as declining asset prices.

    It has been estimated that 40% of home loans in 2006 were subprime, and now the subprime buyer has been frozen out of the market. With the banks having to hold their own notes, isn’t is odd how mortgage lending standards have tightened?

Read this next.

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