10/20/13: Real Asset Investing – Using Hard Assets to Hedge Against a Falling Dollar

The dollar has been on a steady decline since Nixon took it off the gold standard in 1971.  Since then, the dollar has lost a staggering 80% of its purchasing power.  Ouch.

The flip side of a falling dollar is that it takes more of them to buy anything that’s real.  That’s why that gallon of gas you could buy for 35 cents in 1970 now costs ten times as much.  And amazingly, gas is a product which has actually become cheaper to produce!  It’s also why gold, which was $35 an ounce in 1971 is now $1300 an ounce.  Or why that 3 bedroom house you could buy for $30,000 is now worth $300,000.

In other words, equity happens to those who own real assets when a currency declines, which is the topic of this episode.

In the studio for another powerful parade of playful pontification:

  • A man whose hard asset is his real talent for talking, your host Robert Helms
  • His inflated co-host whose value continues to fall, Russell Gray

Last episode, we talked about the government shutdown and the “threat” of a U.S. government debt default.  You know, like in “Put down that healthcare or we’re going to blow up the economy.” 

We’re not making light of it (well, maybe a little), but did anyone seriously think they were going to default?  No.  All the financial markets just yawned and munched popcorn while they watched the same movie play that we all watched in 2011.  Only this time, we didn’t even get sequestration.  All the theater’s fun, but we have work to do.

Now that it’s clear to all (as if it wasn’t before) that Uncle Sam has neither will nor the skill to curtail spending and Uncle Ben is handing the printing press keys to Janet Yellen-for-more QE, our focus is (as it was before) on how to position ourselves for the perpetual flood of currency.  Because we know that just standing here watching the waves come in is a good way to get washed away with the rest of the debris.

And all of this is happening against the backdrop of a disastrous roll out of the latest mega-entitlement program (Obamacare), as if the other two (Social Security and Medicare) weren’t already putting enough pressure on Uncle Sam’s budget.  Oh wait.  What were we thinking?  Uncle Sam doesn’t HAVE a budget!  No worries, because now he doesn’t have a credit limit either.  Problem solved!

Not really.  More like “Problem exacerbated”.  But that’s just what Uncle Sam is doing to HIMSELF.  Remember, now China’s making noise about Uncle Sam’s shenanigans.

China holds a LOT of U.S. debt.  And they’re smart enough to know that getting paid back in cheaper dollars is a rip off.  They aren’t happy.  The Chinese Premier was publicly taking the U.S. to task back in 2010 for out of control spending and printing.  Did we listen?  Noooooo…..

So the Chinese went and cut a deal with Russia to settle their trade without going through the dollar.  “Don’t worry.  This isn’t a repudiation of the dollar standard,” they said.  No. More like a warning shot across the bow, but Uncle Sam closed his eyes.

Now China is making a lot more noise about removing the dollar as the world’s reserve currency.  And not only are they making noise, but they’re busy cutting  many more deals to settle their international trade without using the dollar.  So what?

All that trade requires countries to buy dollars.  That’s DEMAND.  When they don’t use the dollar, demand goes down.  Combine that with QE (printing), which INCREASES the supply of dollars.  What happens when you decrease demand and increase supply?  Prices drop.  So hence, ergo, therefore my Dear Watson, etc., etc., the dollar’s future is murky.

Yes, we know it’s nearly Halloween and this all seems like a nightmare.  BUT….there’s actually a LOT of OPPORTUNITY in all of this.  So don’t go hide under your bed sheets just yet.

To thrive in all of this, you simply have to keep it real.  As in, REAL ASSETS.

Long time listeners know that after the Great Recession of 2008, we’ve spent a lot of time looking at the macro factors affecting real estate… because it makes no sense to build your real estate empire on the beach when there’s a tsunami coming.  The last tsunami caught us myopically counting doors, which we were buying everywhere and anywhere.  Today, we’re working hard to be a lot smarter.

In other words, market selection, price point, product type and financing structure have become VERY important for the long term buy and hold income property investor.

We learned the hard way that even through a rising tide (of easy credit) lifted all boats (asset values), when the tide recedes, only those investments with solid fundamentals weathered the storm.

Now, here we are in a jobless recovery and it isn’t credit (yet) that’s pumping up asset values.  In fact, interest rates are rising.  The FHA (the post 2008 supplier of “sub-prime” funding) needs a bailout.  And fewer people have good paying jobs.  And everyone is being squeezed by rising real world costs of living (forget the bogus CPI number).  So if higher incomes and looser lending isn’t pushing up values (yet), who is?

Investors.  Some call them speculators, but we’re not so sure.  We think it makes sense to buy real estate when you can get it below replacement costs, use relatively cheap long term financing when you can get it, and pick up tax breaks;  knowing that over the long haul, that debt will be easier to pay off with cheaper dollars.

In other words, Uncle Sam is a big borrower and he’s rigging the system to favor the borrower.  So we want to be borrower’s too.  And income producing real estate provides arguably the best vehicle for shorting the dollar through long term debt.

So if you’re not betting on short term price increases (it’s happening now, but could end tomorrow), then what you’re really doing is betting on LONG term inflation and controlling the asset with the cash flow and tax breaks generated by the property.  In that regard, the game isn’t much different than it’s always been.  In fact, it’s gotten better because the debt is cheaper and the prospects for long term inflation are high.

BUT, the weak economy created by QE creates some real budget challenges for the working middle-class, which means they have a hard time handling rent increases.  In fact, they may need to move to a cheaper property – maybe even a cheaper market.  That’s why picking the right market and price point is important.  We think there will be more demand for cheaper places in big markets with nice amenities.  So proper price point and market selection can be a hedge against a falling dollar.

Obviously, if the deal made cash flow sense when you bought it and you locked in long term financing, you have a much better chance of riding an asset valuation bubble up and down.  And as much as we like to reposition equity (the free duplex story in Equity Happens), there’s no guarantee the financing to do it will be there when the equity is.  If you can do it, great.  But if not, don’t get too attached to that equity and be prepared to ride the wave for the long haul.

So right now, we think the risk of rising interest rates justifies a slight premium to lock in long term financing.  After all, a falling dollar means any lender who loans for profit (as opposed to the Federal Reserve, who loans for political reasons), will want higher interest to compensate for the weak dollar.  So, borrowing long at fixed rates is another hedge against a falling dollar.

But any time you borrow, you put the collateral (the property) at risk if you suffer disruptions in cash flow.  And as asset prices rise faster than rental incomes, cap rates are pushed down, which makes it harder to have a comfortable cushion to weather weakness in rental incomes. (Cap rate is like the interest rate on the investment).

Since wages are slow to respond to “stimulus”, especially since the U.S. has shipped many of its blue collar jobs overseas in the name of “free trade”, how can a U.S. landlord (an any landlord for that matter) hedge against fragile rents?

Good question!  And it’s one we talked about a few episodes back when we looked at cash flowing oil and gas investments as a tool to supplement cash flow.  We won’t bore you with the details now, but you can learn all about it in our special report, Using Oil to Lubricate Your Real Estate Portfolio.  The bottom line is oil, like other commodities, is useful for hedging against a falling dollar.

And speaking of commodities….

Our friend Robert Kiyosaki says, “Savers are losers”.  He doesn’t mean that people should consume more than they produce.  Far from it.  He’s saying that it makes little sense to hoard anything that is decaying.  You wouldn’t buy a 10 year supply of fresh fish, right?  After all, over time the value decays along with the fish.  It’s a losing deal.

It’s the same with the dollar.  If the dollar’s value continues to decay overtime, why would you stock up on them?  Sure, we know that ALL currencies are fiat (unbacked by anything other than the trust of the seller and the taxing power of the issuer), but that just makes the dollar (at best), the least rotten fish in the market.

We also acknowledge that the world still does business (for now) in the dollar, so you have to enough dollars on hand to handle your daily transactions.  But why hold more than necessary?  And what’s the alternative if you want to remain reasonably liquid?

Since real estate investors, like many businesses, tend to have quite a bit of float sitting in their bank accounts, some are taking a chunk of those dollars and converting them to gold and silver bullion.

We know.  It’s a “barbarous relic”.  And it’s dropped in dollar value 30% in the last year (after 12 years of spectacular gains).  But we’re not talking about short term speculation in metals or using metals as a vehicle to accumulate more dollars.  Nor are we suggesting abandoning the fiat dollar and adopting a gold standard (though that’s not a half-bad idea!).

We’re simply saying, in the context of hedging against a falling dollar (or falling currencies of all types), that time-tested hedges are gold and silver.  So if you’re concerned about the long term value of the dollar, it might make sense to take 30-50% of your “always there” bank balance and put it in bullion.  You can easily convert it back to dollars if needed, but the plan is to just let it sit there (and grow), as a component of your liquid reserves  that is something other than dollars.  It’s not only a hedge against a falling dollar, but against counter-party risk (like a Cypress-style bail in).

Does your brain hurt yet?  Our hands our tired of typing.  Plus, it gets crowded when two guys are working on the same keyboard.

So we’ll close by letting you know we’re also looking into farmland investments as a hedge against a falling dollar.  It’s the same concept as combining traditional rental property with an incoming producing commodity investment like oil, except the tenants are trees and the commodity is food, not energy.  All under the banner of Real Asset Investing.  Because we think there’s a lot of air in the paper asset market right now, and it the stock market farts, not only will it stink, but people’s portfolios will get messy.  Not pretty.

So sit back, put your feet up (you’ve earned it, if you’ve read this far!) and enjoy the discussion of Real Asset Investing!

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