CHISWICK, WEST LONDON – Greetings from my childhood home…
It’s time for our Friday mailbag edition, where I answer the latest questions you’ve sent in.
This week, we talk about my “Hero Trade” to bet against zombie companies… whether I consider real estate a good inflation-proof investment… and why I like holding more gold than silver.
All this and more below, so let’s dive in…
Reader question: I loved your July 7 postcard about zombie companies just waiting to go bankrupt and I love the idea of betting against them. Using options fits my investing budget well, but I am not sure if I can get a put option with more than a year left until expiration. I hope you can clarify your “betting against zombie companies” strategy?
Let me preface this by saying I’m not sure this is a good idea. Betting against the U.S. stock market and corporate America has been a money loser for a long time.
That said, it feels like we are in the final act of a super-bubble, and my ego wants me to be the hero that makes a fortune by shorting it like Jesse Livermore – a pioneer of day trading – did in 1929. So I have not made up my mind yet if this is something I am going to do.
Also, options aren’t the ideal way to express this as I don’t know how long we will have to wait. Short positions are the ideal trade to express this, but I can’t sell short in my retirement accounts so buying put options is the only way I have.
Anyway, my idea is to target the most leveraged companies in America… the ones with gargantuan debt loads resting on thin slivers of equity who aren’t profitable and can only meet their interest payments by borrowing more.
Essentially, these companies are only surviving because of the credit bubble and Federal Reserve stimulus and how easy it is to borrow at almost 0% interest rates. (When you include inflation, interest rates are now below zero.) The moment the good conditions change, these companies are going to melt down and their equity is going to quickly fall to zero.
These companies are the walking dead. And there are dozens of them operating in public markets.
Finding them is easy. Simply find the holdings of the iShares iBoxx $ High Yield Corporate Bond ETF (HYG), the $19 billion junk-bond exchange-traded fund (ETF). Then, look for companies that have these three things:
Long-term debt loads greater than 10 times the shareholders’ equity…
Whose stocks have rallied 200% or more over the last 15 months…
And whose interest expense eats up a significant chunk of their operating profits (or even better, there are no operating profits).
It requires some sifting work. And like I said, I’m still thinking about whether this is worth doing today. Once I make up my mind, I’ll provide specific recommendations to my Tom’s Portfolio subscribers.
Reader comment: About losing sleep over the Hero Trade, perhaps my father’s advice from a lifetime of betting on the ponies would be helpful: Bet a little to win a lot.
I call these types of bets “asymmetric” bets. They’re trades where the potential reward is far greater than the capital at risk. And I agree. This is the only way I ever speculate or invest.
Gold has asymmetric risk/return. Deep value shipping stocks have asymmetric risk/return. And bonds have asymmetric risk/return…
Except in the case of bonds, it is inverted. The potential losses are huge and the potential returns are tiny, which is why I want to short zombie companies.
But as with backing “underdogs“ at the racetrack, just making asymmetric risk/return trades in the stock market isn’t enough to win. You have to pick the right ones, at the right time. This is especially true when shorting the market.
And I am just not convinced that the credit bubble is ready to burst yet. I’m scared of getting run over. That’s what keeps me up at night.
Reader comment: I’d like to help you with your Hero Trade worries. The No. 1 rule of trading is: “If you’re trading too big, reduce your position size until you don’t care.”
I call this the “Sleep Rule.” If an investment keeps me up at night, it’s too big. The problem is conviction levels. I have great conviction in gold, so I can hold a huge position and sleep well.
I don’t have great conviction in the Hero Trade yet, so even a small position would keep me up at night. I need to ponder this more and find more conviction before I can place this trade…
Reader comment: You wrote, “The best thing to do is simply hold gold and silver and other hard currencies and wait on the sidelines until the dust has settled.” In March, I bought gold and silver bars and coins from the Perth Mint. But the depository account costs $1,200 per year in fees. Gold and silver haven’t risen in value, so I’m losing money. This makes a term deposit at the bank with zero interest look good.
I’d give the Perth Mint a call and ask them what you can do about those fees. I don’t know what $1,200 is as a percent of your gold and silver investment, but it sounds high. And personally, I’m allergic to fees.
Reader question: My bullion advisor tells me silver is going to rise faster than gold, starting now. Silver is not only a precious metal, but it is also useful in electric vehicles, photovoltaic cells, and 5G, which will all increase demand. Do you agree?
Your bullion advisor is expressing a commonly held opinion, and he or she may be right. We own silver, too, but I like gold better.
I expect major economic turbulence ahead. And, as I’ve written before in these Postcards, it will likely result in a rewiring of the global financial system without the paper dollar at its center.
This will likely benefit gold much more than silver. So I like holding about four parts gold, one part silver.
Reader question: You are predicting a continuing and severe depreciation of the dollar, a.k.a. inflation. You look to gold and, to a lesser extent, steel, to protect your purchasing power.
What about real estate? That would certainly hold value during inflationary times. It is also very functional for providing shelter and gives a measure of emotional security. As a rental property, it could also provide income with a low fixed cost of financing.
I am expecting financial turbulence and a drop in the overall level of prosperity in America.
I suspect this will be presaged by some inflation, some deflation, some stagnation, and some volatility.
I also think the U.S. government will have to face the fact it’s bankrupt and reorganize its finances. Many corporations will have to do the same.
Gold is the perfect hedge against this type of chaos. Real estate might do okay in some scenarios… especially in places like small-town Heartland America, where it hasn’t been pumped up by the same forces that have pumped up stocks and bonds, and you can still buy a house for less than replacement cost.
But as you say, if you love where you live, you can get a lot of intangible value from a real estate investment. And that probably makes it a good investment regardless of what the price does.
Personally, I don’t enjoy homeownership, so that intangible value isn’t as easy to find for us. We are a hobo family, after all.
Reader question: I am newly retired. I have a financial friend who keeps pushing me to put my money into bonds (corporate floating ETFs). I want gold bullion or gold coins. Keep the rest in cash until after the crash. What do you think about bonds and are value stocks better than bonds?
I cannot give you personal advice, so I’ll just tell you what we’re doing.
I think bonds are now “certificates of confiscation,” which means you’re going to lose anywhere from 3% to 10% a year, after adjusting for inflation.
A decade of returns like that will devastate your capital. (I’m talking inflation-adjusted losses greater than 50%).
Inflation is the culprit. It steals value from bondholders (a.k.a savers) and gives it to borrowers.
Now, as I’ve written before in these Postcards, the Fed is going to have to let inflation run above interest rates for a while. Economists call this a negative real interest rate.
It’s the only way for the U.S. government to meet its vast debt obligations… and to prevent corporate America (also a big borrower) from facing a margin call on its debt. (A margin call is when your bank/broker demands you put up more money as collateral for your loans.)
I expect inflation will be higher than interest rates for years to come. We are therefore financial refuseniks.
We refuse to participate in or support the economy with our savings. We’ve turned everything into gold, silver and some deep-value shipping stocks that pay dividends and hedge against inflation.
Reader question: Since the Chinese tend to undervalue their money versus the U.S. dollar, why not buy the Chinese yuan with our inflated currency?
See my response above. We don’t want to participate in the global economy in any way. As I’ve written before in these Postcards, all the major central banks are participating in the same monetary experiment as the Fed – including China’s central bank.
Additionally, I wouldn’t give the Chinese Communist Party our capital even if they offered free money to investors. (I read that Chinese bonds are becoming more popular with big American money managers. We won’t be following their lead.)
Reader question: Is your father still alive and is he involved in your life? I suspect from the lack of mentions in Postcards, combined with your ponderings on fatherhood, that maybe there is some pain or wounds from your childhood in this regard…
My father lives in New York and I’m very close to him. We all are. The only reason I haven’t mentioned him much in these Postcards is because we haven’t seen him since COVID-19 arrived, and my mother’s death has been occupying my thoughts.
Reader question: Can we get an update on Kate’s parents? You’ve mentioned your parents but no details on hers…
Kate’s parents live in Wellington, Florida. They recently celebrated 55 years of marriage, and they’re both healthy. We’d like to be a lot closer to them, too. But due to my father’s poor health at the moment, we should make spending time with him our first priority.
Reader question: What I find myself as a mother wondering every time I read your posts is how you manage to keep your kids from screens when you have so much dead time, traveling, driving, waiting, being in the middle of nowhere, et cetera, in this day and age. Please enlighten me.
I am so sick of saying “no.” I just wish there was a way to engage my son in stuff, like reading, that he isn’t riveted with, despite being a really smart, thoughtful, analytical kid. This is something we (and other parents) struggle with on a daily basis.
Our kids love their devices, too. They like computer games like Minecraft and Roblox.
We do limit the time they spend on their screens, though, to about an hour a day. And we don’t let them use any form of messaging communication or social media. That seems to work quite well.
We also keep lots of other activities at the ready, including board games, books, and family TV shows to take the pressure from them always wanting to use their screens.
Also, we talk to them about screen addiction and we hope one day they will make good choices for themselves in this regard.
We worry that if we restrict it too much, it’ll only create a scarcity mentality and as soon as they have their freedom, they will go crazy.
Reader question: There is a start-up company called Kinesis backed by ABX [Allocated Bullion Exchange], working on putting gold on the blockchain. I wonder what your thoughts are regarding this start-up.
I love the idea of holding gold in digital form on the blockchain.
I’m not familiar with the particular project you mention so I can’t comment on that. However, I will be watching this space closely.
Once it has a track record of good performance and it has built up a good reputation, I will be excited to invest in digital gold. Until then, I see no reason to rush in now.
And that’s all for this week! As always, please keep your questions and comments coming at [email protected].
I read every note you send us, and I’ll respond to as many as I can in future Friday mailbag editions. (I’ll never reveal your name or potentially identifying details if I decide to republish your note.)
– Tom Dyson