August 29, 2012; Bill King: Trader’s Perspective – A Crucial Conversation

Weekly Commentary • Aug 31 2012
August 29, 2012; Bill King: Trader’s Perspective – A Crucial Conversation
David McAlvany Posted on August 31, 2012

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

Kevin: David, again, our guest is Bill King. When a person has heart surgery, one of the key questions that he wants to ask the surgeon is, “How many have you done before mine?” That is just within a hospital setting. Think about the doctors who are actually working in the field all the time.

David: I think of a military field doctor, whatever kind of surgery it is. There will be multiple surgeries that they do every day, every hour, just because.

Kevin: That’s just pure practicality.

David: It is. It is the rate at which things are done in the midst of war. I think that kind of experience gives one a certain instinct and a certain sort of, literally, battle hardened quality.

Kevin: And where we are going is that Bill King is that kind of guy in the financial markets. I can’t help but smile when we are talking to Bill, because he is just coming out, and he is giving you his experience, and he is just raw with the information.

David: Bill, it’s good to have you back. Looking at market dynamics, where is the economic growth going to come from, by what is implied in current prices? In our family, I’m the optimist, and I’m not seeing it. I think the market has it terribly wrong, it is woefully complacent. We have had somewhat disappointing earnings, and yet we find ourselves above 13,000 on the Dow. If you take out the financials, we are at all-time highs in the S&P 500. What am I not seeing here, Bill? Does the market know something that I don’t, or is the market just dead wrong?

Bill King: It’s not a question of the market being dead wrong. The market is reality. That’s what the prices are. But what is different is that the stock market no longer reflects economic activity. It is not a gauge. For centuries, it was a gauge, a barometer, of the economy. That all fell apart over the last decade or so because we had a huge divergence. It’s a game, it’s a casino parlor game, and it is largely because of the easy money. That is what has perverted the stock market.

That is what is vexing the Fed. If you remember, when Bernanke was taken to task by Congress about what QE-II did, the first words out of his mouth were, “It got the stock market up.” It had nothing to do with the economy, and in fact, it hurt the economy by getting inflation roaring in 2011. That is why we haven’t had any more QE, because they are scared that they are going to not do anything for the economy, but that they are going to boost inflation.

To get back to your point. The stock market is a separate game from the economy now. It is trader-driven. It is computer trading, high-frequency, it is proprietary trading desks, because by and large, over this whole post-crisis recovery, the average investor has been taking money out. They keep taking money out, and there might be some judgment there on the economic prospects and what is going to happen next, and the bigger issue is that people are liquidating to keep solvent, or to maintain living standards, or just to prevent their living standards from falling further, and this is what happens in a very difficult economic environment.

People use up their resources, and that is the major issue that we are facing right now, is that this recovery has been so bad that the people that were savers, or were able to hang on, are exhausting their resources. It is one thing to use resources to build for future growth, it is another thing to use resources to survive. This isn’t a supposition or a guess. Anybody who has talked to accountants, especially accountants that do a lot of business with small business people, this is what we have heard for over a year.

The people that were smart enough, or lucky enough, to survive the crisis, have just been holding on, holding on, holding on, and they are exhausting their resources, in both maintaining their businesses, and in maintaining their household standard of living. And if we don’t start getting this economy cooking really well, we are going to have really big trouble in 2013.

David: We have a rally at present, and as you say, that has nothing to do with the economy, but we have had a rally through the summer months on fairly light volume. Any thoughts? We have two things butting up against each other, the seasonality of the classic September/October nightmare months, plus volume has been awful (laughter).

Bill: That’s why you get these real ugly falls. Falls aren’t always very ugly. The typical time when you get problems is April/May, and again in the fall, and the reason is because Wall Street gets euphoric in the first quarter, all the hype, everything’s going to be great. Companies like to issue a lot of debt early in the year so they can give the rosiest projections. It’s psychological. That first quarter, the big pop, everybody gets excited.

Then you get hit in the fall, especially if you have a bad economy or global problems. That is why 2012 is trading exactly like 2011. All the big hype and hope there in the first quarter, Europe blows up, everything goes to hell, then we cobble together some BS bailouts, and stop the decline, and then summer shows up, real activity drops to almost nothing because people understand there is a big rig on, but the traders take over the market. When the traders take over the market, because it is thin, they just jam it up, jam it up, jam it up.

That’s what happened in 1987. Back then it was programmed trading in the index arbitrage, and it was the rumor-trage, all the takeover rumors that were going around in 1987. They did that in the summer on light volume, nobody cared, and then when people show up in the fall, it gets ugly. It happened in 1989, 1987, and 1979, but 1979 was a little different because Volcker was raising rates in October of 1978. But 1907, 1929, almost any of these real disaster years, especially when you have a slumping economy, when you get this summer rally on light volume and the public not participating, it tends to be ugly in the fall when people get back and the rally shows up.

Of course, the other little difference we have this year is this November election, and that is another reason why people aren’t playing. We have unprecedented central planning and government intervention in the economy in the marketplace, whether it is GM stuffing cars into dealers, and government… GM car sales were up 76% in June to government, and they didn’t lay off, and one reason we are getting some better economic data in industrial production and jobless claims in July is that normally every year in July automotive workers get laid off because you do your retooling for the new models.

They did not do that this year. It is strictly political, to make the unemployment and the industrial production look better for the election, because we know car sales stunk, inventories are building up everywhere, globally, so this is largely a political move. Again, once the election passes, this will all disappear and we are going to have to pay a price. We see the Treasury telling Fannie and Freddie they are going to have to liquidate their portfolios 50% more next year. Right now they are told that they could have to liquidate 10% a year, next year it is going to 15%.

Why is this important? Because Fannie and Freddie own repossessed properties. They kept them off the market to make housing look better, to not suppress prices, to not create a problem. There are a lot of things that have gone on to make the economy look good for the election.

It’s not just this president. It goes on every election year. That is why we tend to get these kind of plays in election years, but then after the election, in the ensuing year, everything falls off. This year, everybody understands this financial cliff thing. It is going to hit in 2013, the tax hikes and the budget cuts, unless something is changed. People see that, but a lot of people aren’t paying attention to all the gimmicks that are done to dress up economic data, to make things look better, all these little games that are being played because it is an election year.

Also, there is a lot of spending that is done in an election year, state and local government, hiring people for campaigns, hiring people wherever they can, for the same reasons, for political reasons. There are a lot of workers, a lot of campaign expenses going on, that will boost employment, will boost spending, all this money that is raised in the campaigns, all this campaigning will disappear shortly. You see how bad the economy is, but this should be a great year because it is an election year, but it’s not. We have to worry about what is going to happen in the next year.

The stock market, again, is divorced. It is a trader’s game. The same thing happened in the summer of 2008. We had the Dow-Jones transportation average, which is supposed to be the most sensitive economic barometer, make it to an all-time high in July. The U.S. was at least two quarters into recession, if not more. How could that happen? It’s not supposed to happen. The stock market is supposed to lead. Well, it was a trader’s game then, and it is even more of a trader’s game now.

David: Bill, I think it was the summer of 2008 when we had a conversation when you were on the program. We were talking about the changes in the credit markets, and the commercial paper. Some strange things were happening, and you were talking about just paying off the house and making sure you had a few ounces in the safety deposit box. There was probably more palpable concern from me to you, you to me, than I have ever seen, at least in your writings. Are we in a similar place? When you reference 1987 or the summer of 2008, and lump that in with 1907 and 1929, that is kind of like 2012 (laughter). Frankly, I don’t know if I want to be the politician inheriting 2013, but that is another issue. Where are you in terms of your own fear factor?

Bill: The biggest difference now, as you know, because we talk often, is that in 2008 we had a huge, huge crisis. But now it has become apparent to anybody who is thinking, that debt is not the crisis. The crisis is still in front of us. In 2008 it was that the financial systems in the world were collapsing from years of abuse, over-leverage, lax regulation, fraud, you name it. That has gone on for decades, because that was the new economy. That was producing money, whether it was producing tax revenue or producing graft and donations to Congress, they allowed this to go on. So when it blew up, they could not allow this to blow up and take everything down, because the culpability would be put directly on Washington, D.C. and New York, the financial area. They were working together.

What we know has happened, here, in Europe, and elsewhere, is that sovereign governments bailed out the financial systems to prevent political revolution, if not some harder revolution. In so doing, they have bankrupted themselves. That is the moral of the story in Europe. The big banks have bankrupted themselves. Because of that, everybody is going all in. They can’t stop this game, because we will get political revolution. The whole system is coming apart.

For most people that are alive today, the big hook that Wall Street held over everybody’s head, and it was actually two-fold, was “Yeah, things could get bad, but the Fed is always here to save you. They will always be able to print money and save you.” The second is the government. The government can always save somebody. They may choose not to. That is the consideration. Do we let Lockheed go under? Do we let certain industries go under? Or do we save them?

But now we are at the point where government can’t save. They have to save themselves. For everybody alive today, that is the big issue, and that’s why we saw the surge in gold over the last four years – actually three years. It’s been flat for a year and there is a good reason why it’s flat. But in the aftermath of 2008, every very important person that I talk to, including heads of Big Five brokerage firms, CEOs of Fortune 500 companies, these types of people, all were buying gold in 2008 and thereafter. That was their haven, because they understood what was going on.

Why hasn’t gold gone anywhere over the last year, even though the banks are pumping? My main thought is, there are two reasons. One is that it goes back to the concept of using up your resources to stay alive. A lot of people, especially the wealthy people, have gotten all that they needed, there was a panic in, and now the gold market is digesting all of that. The other issue is that the Fed, for all the talk about doing QE, and we’re going to pump money and save everybody, they’re balance sheet is flat on the year. Their asset level is actually down 17 or 20 billion from a year ago. That is the reason gold has lost its mojo, and silver is even worse, because silver is more of an inflationary play. For all the talk, and all the nonsense going on, the Fed is pretty much unchanged here.

That begs a really huge question. Why is Wall Street so excited? You see what the Fed is doing. They sent out the doves to say, “We’re going to give you QE if things get worse.” They’ve been saying this for over a year. We have the same idiots out there saying, “Oh, you’re going to get QE next week.”

For a year, major brokerage firms, ex-officials of central banks, and especially this one guy from the Bank of England is running around town who has been saying that they are going to give us QE for over a year, and it has not happened. One thing they have been able to do is not even do the QE, threaten to do QE, that’s what this whole summer rally is. It is the threat of doing QE.

Remember how they were saying you had to get it, you had to be in here, because they were going to give it to you in June. Oh, that didn’t happen, they were going to give it to you in August. Oh, that didn’t happen, they are going to give it to you September 12. We’ll see, I doubt they are going to do that. They don’t have to do it, and that is, I think one of the things that is going on. Because it is only traders – it is a thin market – they can give you the threat of easy money, and they are keeping the game going, but they are not giving you the QE.

David: One of the interesting things is that you have a similar correlation of assets, like we had in 2008 and 2009, and it is more to do with Fed dependence. The new element increasing correlation of assets is Fed dependence. To print or not to print, that’s the question.

Bill: You are absolutely right. And the point is, it is not that they are not printing. It is that they are not increasing the printing. This is what presents a problem. When people talk about the exit strategy, or getting out. I think we talked about this before. When people say, “Gee, Paul Volcker and Ronald Reagan broke the back of inflation and government spending in the 1980s and they gave us two decades.”

Volcker never really tightened reserves. He let rates go up. He said, “I don’t care where rates go, I’m going to take the punchbowl away.” People assumed that he took away reserves out of the banking system. He never did. He slowed the growth to a very low rate. Ronald Reagan did the same thing in government. He didn’t cut, he slowed the growth rate, and look what that produced. When we talk about cutting the budget, actually making a real cut, or if the Fed really has to disgorge its balance sheet, oh my … if that’s what you get.

Goldman-Sachs and a few of the other big firms have made this point over the last year. That’s why they were screaming for QE. They were saying that it is no longer a question of how big the Fed’s balance sheet is, it is how much they are doing each month. In other words, are they constantly increasing the amount of liquidity? And what is so stupid about that is that it is like if you have a barrel of beer left over at a fraternity party, and you are making the assumption that maybe we should give them three barrels and they will drink more, and they still don’t, well let’s give them six. The point is, there is too much there, it doesn’t matter.

Wall Street is saying, it is not that there are two or three barrels, it is that you have to keep giving them another barrel to make them drink. They are missing the point. But that is the new rationale over the past six months or so. It’s not that the Fed balance sheet is 2.8 trillion, it is that they have to keep putting increasing reserves out every month, and they haven’t, and that is one of the main reasons, as far as I am concerned, that gold has just been flat on the year.

For all the talk about gold being … the type of market, and the barbarous metal, one of the major differences between gold and stocks is that when the big informed money people are playing in gold, it is a very, very sophisticated market. You are talking the smartest, most connected people in the world, where stocks are, a lot of yahoos, a lot of day traders, a lot of people that listen to what some clown on a financial TV show tells them and goes out and does it.

That is not how gold acts. You might have retail people jump in when they see an ad on TV and then they buy gold. But the real movements in gold are so powerful because it is the big, informed money moving, the major political figures, the oligarchs in Russia, the royal families in the Middle East, the big bankers and the big industrialists in Europe and North America. When they move, they know why they are moving. That’s why gold has gone nowhere the last few months and gold has been telling us, “No QE.” It has been clear. When everybody says the Bank of England is going to this, they are going to do that – no, no, no, and gold is telling you that.

Gold is manipulated down and up and whatever way. But the point is, gold is a very important market, not every day, but when the big moves are going and important things are occurring, that is the reason why gold moves the way it does.

David: What we have seen in periods of consolidation over the last ten years is that following a period of price consolidation, down, sideways, what have you, it can last anywhere from nine months to 18 months, and we have seen 50-60% moves following that, which you were just mentioning. This last major move higher in gold broke all the past records, at least of this decade, moved up 109%, and the volume was very intriguing, and there was a broader interest, and it was bigger money.

The issue in terms of the election and I think bringing the point back around to some time sensitivity in the marketplace today, we have an outcome that no one knows. Is it going to be the Dems, is it going to be the Republicans? Post election market concerns: If you said okay, Obama returns to the oval office, under that scenario, what are your post election market concerns? Or vice versa?

Bill: It doesn’t matter who wins? We are going to have a really tough 2013 and beyond. We know 2013 will be tough, because all the election rig is falling apart, all of this stuff is going to hit the fan. What we don’t know is the policies that will be implemented. That is what is going to determine the depth and duration of whatever ugliness appears in 2013 economically. We don’t know. We don’t know if the Senate goes Republican. We just don’t know how this thing comes out.

My best guess for investment is that, in the short term, if Obama wins I think we will see gold take off. I think we will see that kind of dynamic because they are going to think he will try to inflate or confiscate. People don’t quite understand gold. It is partially an inflation hedge, but it doesn’t really do as good a job as other assets do against inflation.

David: Not priced in real time. No, it doesn’t track on a day-to-day basis, by any means.

Bill: No, but gold really is a bet against government, and that is why the big government people hate gold, because it has always been an encumbrance, throughout history, back to the Greeks and Romans. It encumbers big government and wanton spending, and it is a hedge against politics, it is the biggest hedge. So if Romney wins, gold is going to have a tough go for a while. Again, it depends on what policies show up.

I don’t think we have seen the long-term peak in gold because we have too much in the world that has to be resolved, such as the U.S. debt problem. Let’s face it. And the reason why the big money, no matter who wins, is going to keep some portion of the gold is because we don’t know how the debt problem is going to be ultimately resolved.

There are three ways to get out of it. One is totally improbable at this point, and that is to grow the economy. The debt is so large now that studies show it actually is an economic encumbrance now. You just can’t get it going. Just as in business, if you can have a good business, you take on debt to expand, and you can grow your way out. But if you take on so much debt that there is no way you can pay that payment, then you have to cannibalize your business. That is what is happening now to sovereign governments all over the world.

So now you are left with two solutions, and we have talked about this before, you either can inflate or you can default, and every government tries to inflate. We have been doing this for decades. Eventually, you hit the point where you either jump to hyperinflation, or you just default, which is what Russia did in 1998, which a lot of state municipalities are going to have to do because they cannot print money, but that is what nobody knows.

Nobody has an idea what this end game is going to look like, so you have to have a good hedge portfolio right now, and flexibility to move once policies start appearing, and once things start happening. That is what is going to make this even more problematic. You don’t know from country to country what their policies are going to be or how their legislatures are going to vote and what policies are coming this way. But we do know there is a major debt problem in Japan which nobody is talking about, which is even a bigger debt problem than Germany, and there are a lot things there that have to be resolved.

That being the point, we all know the basis of financial assets are government bonds, and if you start questioning the value of government bonds and the ability to pay it back, that’s where the real crisis will be, as you see in Greece, Italy, on and on. If that starts spreading to France, then to Germany, then to the U.K., Japan, and the U.S., that’s the game-changer.

Now, the big money, over big periods of time, and the big private money plays it masterfully because they don’t care about what their performance looks like month-to-month, quarter-to-quarter, even year-to-year, they just want the big trend right. The big money is made moving from real assets to paper assets. In the 1980s, that was the game. If you go back to the 1970s and look at the wealthiest people in the world, people like Daniel Ludwig, and it was oil, gas, shipping, real estate. Names like Kluge, Howard Hughes and his real estate, and Hughes Tool and these industries. Marvin Davis. Worldwide. The Ellsbergs, the Bronfmans in Canada. It was resources and real estate.

David: But they had to make the transition.

Bill: Right. By the 1990s you had the Gates and the Buffets, the tech guys, and Larry Ellison, but it was a paper profit. Who played it right? The Bass Brothers did.

David: The Bass brothers made the transition.

Bill: The Bass brothers were a Texas family of oil/gas/real estate. They had the insight to see that something was happening with Volcker and they brought in Richard Rainwater from Goldman, and they brought in a convertible arbitrage team from Kitter and they played it masterfully. They made so much money in the 1980s, they effectively dropped out of sight in the 1990s. They did a little bit of RTC buying and they just disappeared.

The point is, you have to move your money from hard assets, whether it is real estate, oil, gas, gold, or whatever, to paper, and then you have to make that transition. In the last decade, gold and commodities took off, and outperformed stocks, by far. Here is the problem if you go to the ’80s. You have to be liquid in transition periods. In other words, the Basses couldn’t just go and buy stocks like crazy in 1979 and 1980, they would have gotten killed. They transitioned, they got out of their oil and gas, got liquid, did some nibbling around the periphery, and then when the move appeared in earnest, they could go. When the Hunts went bankrupt, and other people similarly went bankrupt, they were ready to go.

That is why I cannot emphasize enough not to get too doctrinaire, don’t make too big of a commitment either way right now. Have a nice, balanced portfolio so that if something happens very quickly, you are in a position where you aren’t going to get killed, but also you have a position to play through this transition, because we aren’t anywhere near the end game yet. We are getting closer, no doubt, and that is going to be very tough to navigate.

David: We have suggested for clients, in general, and this is a very broad scope, and of course it can be refined, but a third in cash, a third in gold, a third in equities, where you have some balance, and you aren’t making a commitment one way or the other, default or inflation, because either one could be an outcome, and you have a growth thematic, a call, if you will, on recovery in your equities, but you are more than covered in terms of an insurance policy. If you do see a collapse in the derivatives market, or something that really impairs your personal balance sheet, gold is there to put it back on, usually as a multiplier, seeing decent growth in that environment. It is tough to say you are going to be 100% right, because you don’t know the future and how it is exactly going to play, you can’t put all your chips on one particular number, so to say.

Bill: Absolutely. Right. Nobody alive has lived through what we are going through right now, in which central banks and sovereign government solvency is in question. And we can pretend it’s not, because if you stop pretending, then the whole game is over. So right now, you get to pretend that the bank of England, the ECB, and the Fed can protect everybody, and people realize you can’t, and we see that the governments can’t bail out everybody anymore. People understand that. But you just keep playing the game.

When you see these periods of history, where you have financial crisis and then they cobble together something, there is a bailout, you have to ask yourself who is the patsy, who is getting bailed out, and what are those people doing? If the bailout was good, and after a year or two the insiders thought everything would be great, we would see private equity people buying up companies like we did in the 1980s. It would be worse.

In the 1980s there were only a couple or three big … KKR, and you had Teddy Forstmann, and just a couple of other guys who were takeover players. Now, there are a gazillion guys, there are trillions of dollars out there. How come they are not buying up companies if they are such a good deal? Because of what you just said. You don’t know. You don’t know what the policies are going to be. You don’t know what is coming down the line. So you are freezing people. You are just freezing people to sit here and watch and wait.

You are right, you can’t get out there and make these big empirical decisions right now because you don’t have the necessary information to make them. The question, again, is the government, the solvency of the government, because once that comes into question, then the solvency of the central bank comes into question, and now you are blowing up the mental paradigm and the street paradigm and decades of financial paradigms. So, yes, I agree with you, it’s going to be a challenging game and you just have to make sure you are in a position to play it.

David: What we have tried to do well in advance of this with our wealth management program we started in 2008, looking at a major transition, we placed billions of dollars into the metals markets to see that duly rewarded, but also, in a timely fashion. I think one of the critical things that you just hit on is an exit strategy, a reduction strategy from hard assets, you may have to move to a liquid position for some period of time. You mentioned the Bass brothers, they sat in cash largely for two years. And as you said, they nibbled, but they didn’t go in whole hog.

Frankly, the whole period, right now, tomorrow, the next ten years, it’s just going to be uncomfortable, as an investor. You aren’t going to have certainty, and if that is what helps you sleep at night, it’s not possible.

Bill: Right. It’s different. One thing we know is that what we have now is unsustainable, and if it is unsustainable, it means that something different will emerge. You can get a good indication in the election where the American people want to go, and how you want to go forward, and we will start knowing more. If you get Romney, then stocks will go up, and it will be just like Reagan. You will get an end of the year rally, you will get a first quarter rally. Then you are going to get the medicine.

David: Wasn’t that about a three-month period, though, following Carter? But then 18 months of pain.

Bill: Oh, you’re right, it was ugly pain, down to July of 1982. It was very tough. Very, very tough medicine. But it set up the big boom period. They bought us 20 years, and then everything started going back down again, because we blew it. We had a series of pretty bad Presidents and Congresses that blew it, squandered what they were given. They had a toga party instead of doing what they should have done, reforming the entitlement programs and getting a flat tax on business and individuals. There are a lot of things that could have been done that weren’t done. They just perpetuated the game.

David: As an overview, we have covered a lot of ground today. Interested, not interested, and maybe two seconds of why – your thoughts on munies, Treasuries, real estate, U.S. equities, gold, silver. There’s a lot more that can be said, but we are coming down to sort of game time, and where people are going to take a reappraisal of risk. What does that mean, a reappraisal of risk? What is the impact to munies, Treasuries, real estate, and what have you?

Bill: Let’s start with the munies. You have to be in munies that are solid municipalities. There are plenty out there, especially in the farm belt, and in the mountain states, that are solid. You want to avoid the big welfare centers – New York, California, Los Angeles. Everybody knows where the financial problems in this country are. I am living in one here in Chicago, Illinois. Where you have the big cities, you have the problems.

You do see the ones going bankrupt, the Scrantons, so you have to be careful, but there are plenty of good munies out there. The problem for people is, they buy funds or EPFs and in some cases, you are buying a blind pool. It’s incumbent upon people to do the work. You don’t just trust blindly. The economic data is garbage right now, it is manipulated. The earnings are garbage. So whatever you own, you had better know. And it is not, well, I just have xyz mutual fund, or xyz bond fund. You had better know what is in that. You had better do the work, get on line and look and see what they are holding in there.

David: Or we are going to be answering the question, “Who’s the patsy?” (laughter)

Bill: Yeah, you’re going to have another 2008. “Oh, well, it’s triple A rated.” Oh, you mean like all those subprime structured vehicles that blew up, that were nothing but garbage? Are you going to rely on rating agencies or brokerage firms? Ask people how much people they lost doing that. You have to get out there and do your work.

David: With Treasuries, one issue is that we can certainly see the ten-year go to 1, or 1¼, with a major squeeze in Europe and panic-buying, so it’s not as if Treasuries are going to hit a wall tomorrow, but on the other hand, we are talking about that being the looming threat.

Bill: The threat of a lifetime is when the bond market blows up, if you are a trader, and everybody knows it. The problem is, it is a question of timing. These rates are not going to last. It is unbelievable. It is going to be just like Greece. Once the rates back up they are just going to go geometrically. But in the meantime, most sophisticated people understand the U.S. bond market is a safe haven right now. It is not your home, it’s a Motel 6. You’re in there because you’re hiding out for a while, and you had better be able to move out of that when you need to.

Talking about real estate, again, it is very selective. Coastal properties are doing well. Metropolitan areas, the big centers, where there is a lot of government dependency, are struggling, because they have incredible deficits and they are going to come after you. They need the funding. One of two things is going to happen. They have to cut services, which will create problems, or they have to raise taxes, and when they raise taxes, they are going to go for the people that have money.

One of the reasons why you are going to have difficulty in real estate rebound is that you don’t want to pay the taxes on these properties. You just can’t, a lot of people can’t. So you have to be careful where you have your real estate. Farmland has been great. It is overvalued now because of the drought and the way the prices ran up and the foreign buying.

But I think real estate is going to be a better investment over the next decade or so than stocks, because it is a real asset. If you do your work and find good properties, good situations, yes, I think that is a nice hedge against whatever might be coming down the road. But I would be very careful with condominiums in major metropolitan areas where there is financial difficulty. You have to avoid the areas where there is financial difficulty, because you are going to get sucked in, and you are not going to be able to flip those things, not until the crisis really hits.

You want to buy Detroit properties? They might not be bad now, I don’t know how low they can go, but you didn’t want to buy them five years ago, ten years ago, or 15-20 years ago. That’s what you have to be careful of. I think the properties you have to look for are where the baby boomers are going to retire to, and from the demographic pattern that is going to low property tax states, but also states where there are not the huge social service burdens, whether it is Arkansas, Tennessee, Utah, the mountain states. Again, probably, the same areas where you have very good rated municipal bonds is probably where you want to look for real estate investments.

Gold and silver I think is in a holding pattern. I do think if you don’t own physical gold or silver, you should have some. It is like life insurance. People need life insurance. In fact, if you are wealthy enough you don’t need life insurance, but the more money you have, the more you will need gold, because you need that kind of insurance. People always talk about it being insurance, but to me it is almost a little inversely of importance than normal life insurance, because again, if you have a lot of money you don’t need life insurance, except for estate planning, to avoid taxes, but the more wealth you have, the more you need some kind of hedge.

The other thing that people don’t want to talk about too often is that in the system there is custodial risk, and we saw this in 2008 that major firms are going to go down, you lose your stock, you lose your customer count, and of course, it hasn’t been solved because we see what has happened with MF Global and Peregrine. This is another reason why the big, private money is into physical gold and silver, because you don’t have custodial risk. You’ve got it. It depends on where you want to store it, or how you want to store it, or if you want to take it in coins or bullion, but you take that custodial risk out, and it is very, very important right now. I do. I have both physical gold and silver, in a locked box, and it is comforting that it is there.

Stocks are the toughest, because we know it is so divorced from economic reality, and it is so much of a central bank gimmick right now. It is very tough. I think if you are going to hold a percentage of stocks, diversity is always something people throw out, but I think it is incumbent now because we don’t know what is going to play. But I think if you are looking longer term, where you can see some of the smarter money going, there have been a lot of moves into defensive plays over the last year because of this economy. Anybody paying attention to this economy knows it stinks. But where we see people moving is to health care, biotechnology, and this is a big function of the baby boomers all getting older.

Also, I think you keep an eye on natural gas. Natural gas prices have gone up. They are probably going to get ready to roll over, because part of that rally is a lot of traders buying. There is a lot of buying because of the anticipation of QE, and people are buying baskets of commodities, but in the long-term, we are going to see more and more implementation of natural gas. There is an article we had in a letter today that showed up yesterday about CO2 emissions in the U.S. being at a 20-year low. The main reason they cite is that there is more natural gas being used for power plants and less coal. Right now there are a lot of people out there trying to figure out how to start getting more natural gas use, not just in the factories, but also into railroads, heavy industrial users.

It is hard in the retail market. People talk about getting cars to run on that, obviously that is a very hard logistical question. It is much easier for railroads and a big private industry that has terminals or controls – enormous use – as opposed to trying to get tens of millions of people to make the switch. This is something that I think in the future, if you are looking for certain areas to go in, you have to think long term. You have to think of something that you are comfortable holding for over 4-5 years, and that you can see something is going to happening. You see everybody running to Apple and other companies. It is very, very difficult to project what that company is going to look like in 4-5 years, let alone 10 years, because it changes so rapidly, and competitors jump up so quickly. Very difficult.

I think those are some areas. I think you want to avoid some of the home builders because people have been buying them like crazy. They are ridiculously priced now relative to economic reality, and I do think you have to be careful with the Consumer Discretionary. One of the reasons the Consumer Discretionary has held up, and it has done well, is because of all the entitlement programs and welfare and aid programs that have been going on over the last four years. There has been money that has kept pouring in for consumers to spend at Wal-Mart or McDonalds, but we are seeing Wal-Mart and McDonalds now having difficulty in the last quarter or two.

That is a really interesting sign, because in 2008 everybody said, you have to buy Wal-Mart, you have to buy Dollar General, you have to buy McDonalds because people are going to move their consumption down, but the base consumption will be maintained. And it was, largely through entitlement spending and increased unemployment benefits and disability claims jumping and food stamps increasing. But now we are getting to the point where that is even rolling over. That’s an area to be careful in because you are going to see the government cutting back after the election in all these different types of programs. That’s been a hot area. If you look at the trend, you can see the smart money already starting to walk a little bit away from that.

David: Back to the big picture, when we look at the Chinese slowdown, we look at the euro crisis, which is anything but resolved yet, 6, 12, 18 months from now, have we scuttled a couple of the members? Spain gone? Is Greece gone? What is your best guess in terms of the eurozone?

Bill: Greece is effectively gone now. Everybody is just pretending. We have had three bailouts in Greece, and what is absolutely ludicrous, I think it was a week or two ago, we had the people actually there in Greece saying that they are going to look and see if they are meeting the conditions to give them the second bailout, and oh, by the way, let’s give them a quick six billion dollars because they can’t make their payments. How ludicrous is that? You are talking about whether you are going to give them a second bailout, and you are giving them a short-term bailout because they can’t make ends meet. So who are you fooling? The only people you are fooling are the people who are intractable, who are going to be bullish no matter what, and I mean, it’s over.

David: This is, I think, a decent test case, if you look at Greece, or Spain, for that matter. If they pull out, obviously, they are going back to their own currency. Buying the Greek equity market today, buying the IBEX, if you want to go to Spain, don’t you have the same issue? You can have currency devaluation and even though things have dropped 80-90%, you can still lose 50% of your value in the currency exchange.

Bill: What you are bringing up now is a very, very important investment issue that sophisticated people are starting to think about. I mentioned before that I want to buy the euro when everything blows up. Once you start pulling these people out, it is just as if you have a company that is hemorrhaging red ink, and all of a sudden you just shut down, you just throw out all the worst divisions. That stock gets better, because you aren’t hemorrhaging.

David: Exactly, exactly.

Bill: And if that’s the case, if all of a sudden this stuff starts happening, people are going to just dump stuff in Europe. But, anybody with half a brain understands that the U.S. has been a safe haven. One of the reasons why the U.S. bonds and stocks have rallied here is because money in Europe is coming here. It’s usually North American money, and in the last year it has been heavy European money coming in to buy the coastal properties, because if you are a wealthy person in Europe, and you have a bank account, and you look at it and it is denominated in euros, what is it going to be worth six months from now, a year from now? I don’t know. So they have to get rid of these. I don’t know what it’s going to look like. So you buy real things.

David: But your corporate analogy is great, because you are really just talking about the areas within your business that are non-core, or that are bleeding off the center, and as soon as you scuttle them, you are going back to core competencies, core business, core productivity, core cash flow. It’s great. So you don’t own the euro now, but you own it on the other side of Spain getting spun off, or Greece getting spun off?

Bill: Right. And one thing we know is that because of this uncertainty, euro-denominated assets are going to be suppressed in price, so what I think everybody should be looking at very carefully are good, solid, legitimate European companies that are domiciled in a country that is not going to go socialist crazy, like France, where they are going to put all these ridiculous rates on you. Those prices of these companies are going to be suppressed, especially when this stuff hits the fan.

That being the point, there is where you are going to find the best equity values. It is going to be in European companies, when it is hitting the fan. Again, you have to make sure it is a legitimate company, solid balance sheet, solid products, and they are also going to be domiciled in a country that isn’t going to confiscate a big chunk of the assets, or encumber them with policies that crimp their growth. That is one of the things you would be looking for.

It would be the strong currencies, because the currency guys are the smartest guys, they are the informed guys. You would be talking Northern Europe, you would be talking Finland, Norway, and they are socialist to a degree, but they are small populations with big resources – Norway with the oil, maybe Germany to a degree to see how that plays out. You have to let the U.K. blow up a lot more before those industries are going to be there. That is the point here. The people on Wall Street and on financial TV say buy/sell – no, no, no. That’s not how this game works. This game works by looking for opportunities and waiting.

David: Patience, patience, patience.

Bill: Patience, and it is not just that they get cheap, because things can get a lot cheaper, and if you have enough resources, you can nibble, and that’s what the big guys do – when they get ridiculously cheap, you nibble. You might have to nibble for a couple of years before something turns, but once the catalyst appears, and it is usually pretty clear, like Reagan, Volcker, these types of things, when it starts going. You will see the money surge, so when you see the private equity guys start pouring into Europe, and you see U.S. companies starting to buy up European countries, you had better get involved.

Right now, the reason you can’t do it is because you don’t know the game. You know it is over for Greece, and a number of the other countries, but you don’t know what comes next. “Oh, yeah, this looks great, I’ll go in there and buy Greece.” And then it goes to some military junta or some very leftist country with some 80-90% tax. Who knows? You don’t know. But you do your work and you have your buy list and your buy companies, and when the events start telling you that things are going to go the right way, then you start going in. That’s what people have to do.

You have to be patient. You are right, you are absolutely right. And right now, you shouldn’t be doing anything, because there is nothing to do. One thing I learned as a trader is that smart traders understand that you are paid to watch. People come in every day and they have this urge to play. Either they are desperate because they have to pay their bills and they are trying to generate income, or they are inveterate gamblers, and if you are going to be a gambler, you had better be gambling from the inside, which Wall Street does, to a large degree, but if you are not gambling from the inside, you had better wait for a fat, fat hand to play.

David: Listen, always great to have you in the conversation, and your letter is one of the most invaluable things we have access to on a regular basis – The King Report. It should be required reading for anyone on Wall Street. Great to have you on the program again, and look forward to continuing our conversation.

Bill: Thank you, it’s always a pleasure.

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