What's Gonna Happen Next?
By Dr. Steve Sjuggerud
October 24, 2008
"So Steve, what's gonna happen next? What do I do now?"
My friend B. called me yesterday and asked me this. Like you, his concerns are very real.
He has some money in real estate, and he started up a business two years ago. His real estate investments and his business were absolutely soaring... until just a few months ago. Now, who knows what his real estate is worth? And just as he's ramping up production in his business, sales are slowing.
Since his situation might be similar to yours, I thought I'd answer his questions right here... So today's DailyWealth isn't about the stock market... or a money-making opportunity. I hope you're OK with that. To me, it's about something even more important – it's about what's gonna happen next, and what to do about it.
Dear B.,
I can't know the future of course. But here's what I think right now. I hope it helps...
B., for the first time in my adult life, people have lost faith in the near future.
Where they were once willing to pull out a credit card, now they're not. Instead of irrationally spending beyond their means because the future was perpetually bright, people are now irrationally hoarding cash believing in a perpetually gloomy future. Neither view is right.
Swings in confidence like this are normal. Typically, the bust period rivals the preceding boom in intensity. It has to, to bring us back to Earth. The boom we just came out of was incredible. It lasted longer than anyone imagined it could. So the following bust could be just as incredible... Unfortunately, it could last longer than you can imagine, as well.
The boom was significantly built on personal debt, and people "pyramiding" their assets into more debt. Right now, we're experiencing the opposite. Whether they're being forced to or because they're scared, people are unwinding their investments on a massive scale. That's not good. When it's over, the pendulum will have swung too far. People will have silly amounts of cash savings instead of silly amounts of debt.
In the meantime, asset prices will fall. The ones that will fall the hardest are the ones that are "owned" with debt (like speculative real estate).
So let's get to the right ways to handle things now...
First off, if you have real estate (beyond your existing home) that you "own" with debt, get out of it now. Chances are, that real estate is not going up in price for a long time. Remember, it is a different time right now. People will be increasing their savings and getting out of debt. Far fewer people will take on debt to buy a real estate project in the coming years.
It's better to get out now and take the loss. Your neighbor is holding and hoping (which is no plan at all). By selling now, you'll beat him to the punch.
In short... speculative real estate is dead money. Don't pay interest, property taxes, maintenance, etc. on dead money. It's painful to get out now. But it's the right thing to do.
Second, about business slowing down...
Now is a time to "err" on the side of being prudent.
You can only take what the market is giving you... At some moments, you can make a fortune, and it feels easy. At other moments, it's time to protect what you have to survive. Now is survival time. And if you make the moves quicker than your competitor, you have a better chance of survival.
In some businesses, of course, it's almost inevitable you'll borrow money for some short-term needs. You can still be prudent about that... by making sure you already have the profits "in the bank" when you borrow. (For example, don't order a shipment unless you've already sold the goods.)
Do the same things at home as you would in business and real estate.
Scale back. Play defense. Make sure you'll be solvent, no matter what. That way, you'll be financially sound enough to take over the world when the time is right.
For me personally, my business income is down this year. For most entrepreneurs, it will be. And I was planning to build a home on the ocean this year. But I'd have to borrow money to build, and I don't want to do that. A year ago, I would have. But not today. My current home is paid for... I have money in the bank to start building someday.
I'm not trying to be a pessimist here. The sun will shine again some day. Money will be easy to make again. All I'm saying is, that day is not here yet. These things go in cycles. We're coming off a huge period of overconfidence. The pendulum is swinging to no confidence.
Position yourself accordingly... Opt for prudence over growth, opt for cash over debt, and you'll be just fine.
All the best,
Steve
Editor's note: Steve Sjuggerud is a regular contributor to DailyWealth, a free investment newsletter focused on the world's best contrarian opportunities. We write with a simple belief in mind: You don't have to take big risks to make big money with your investments.
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LINE IN THE SAND? WE CAN'T EVEN SEE IT ANYMORE!
Our "line in the sand" is becoming a distant memory...
For the past few months, we've been checking the health of the global economy with the price of copper. Copper is in everything around you... from transmission lines and plumbing to cars and refrigerators. This "used in everything" quality makes the metal highly sensitive to economic activity.
In early October, we marked the January 2007 low of $2.40 per pound as a "line in the sand" for the global economy. We said a break below this level would be a sign of severe economic weakness... a sign manufacturing activity is seized up.
As you can see from today's chart, copper didn't just cross our line in the sand, it hurdled over it and landed on its face. Copper is down an unbelievable 50% from its July high. The headlines don't say "recession" yet, but they don't speak nearly as well as copper.
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Gold futures hit a historic high above $1,000 an ounce a few days after Bear Stearns was taken over by J.P. Morgan Chase & Co. on March 14.
But in the recent round of crises triggered by the collapse of Lehman Brothers Holdings Inc., gold has fallen to below $700 for the first time in 13 months. The metal has so far lost more than $180 in October.
The reason, according to analysts at the World Gold Council, is that the latest bout of the credit crisis has been deeper and more far reaching. Funds were forced to sell desired assets such as gold to meet margin calls, while weakness in European economies lifted the U.S. dollar, which then pushed dollar-denominated gold prices lower.
"The fact that gold did not head higher during the current leg of the crisis seems to reflect a combination of the rise in the dollar, deleveraging of commodity positions, sales to meet margin calls, and the unwinding of the long gold, short dollar trade," wrote Natalie Dempster, an analyst at the WGC, in a research report released Thursday.
"The current crisis has seen much more pressure on gold as an 'asset of last resort,' where it has been sold to meet margin calls when there have simply been so few other viable options available," Dempster said.
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The problem for commodities producers, as usual, is that there comes a point where producing is pointless. And it comes sooner for some compared to others.
For instance, Saudi Arabia, the world's biggest [oil] exporter, budgets for $40 and breaks even at under $30 a barrel. But neighboring United Arab Emirates needs oil at $40 to $45 to break even, and Qatar must have $55, according to Merrill Lynch estimates.
From there, things steadily get worse for OPEC members. The International Monetary Fund figures Russia needs $95 oil to make it work. Venezuela says it needs $60 oil, but privately analysts say $120 is the break point, thanks to President Hugo Chavez's out-of-control social spending.
Oil producers can't eat the oil they drill and export, so they'll keep selling and they'll keep drilling. Meanwhile, OPEC has to talk about production cuts, or why have a cartel? But there is little they can do short-term to stop the horrendous slide.
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