Archives

It’s a Mad, Mad World… and Getting Madder

By Bill Bonner on June 6, 2014

First, we want to invite you to attend a very special financial conference in Vancouver this summer. It’s hosted by our old friend Rick Rule. What we like about Rick is that he focuses on companies that produce real resources. There are times to invest in natural resources… and times to stay away. Rick believes the time to invest has come. You can find full details here.

Meanwhile, we are here in Normandy with a group of family office investors. These are people who invest for a long time and tend to care less about making money than about not losing it.

We gave them a speech this morning, the gist of which was that we live in a world so crazy that only a crazy person can understand it… and only a half-wit would trust it.

Yesterday, the half-wits boosted US stocks by another 98 Dow points. Gold rose too, uncharacteristically, by $9.

Europe Goes Negative

Yesterday, too, the Europeans made a mad, mad world a little madder; they moved from ZIRP to NIRP. That is, real interest rates are falling from zero to less than zero, under a NEGATIVE interest rate policy.

The US is still operating a ZIRP system… officially. But, unofficially, major borrowers get their money at rates that are substantially lower than consumer price inflation.

Take IBM, for example. Its bonds, maturing in 2017, yield 1.78%. Officially, the CPI is about 2%. But when MIT measured inflation, without using adjustments and fudges, it came up with a rate of 3.91%. This makes IBM a NIRP borrower, actually earning more than 2% on every dollar it borrows.

IBM is also a big buyer of its own shares. In fact, it may be the biggest. For every dollar it spends on genuine capital investment – in new machinery and facilities – it spends $8 buying its own shares.

This gives us an idea. Want to make beaucoup money? Start a company. Borrow money. Buy your own shares.

Everybody does that, right?

The Magic of ZIRP and NIRP

But our innovation is this: Buy your own products too!

Follow the lead of the Internet companies. Invent some social media so new and so revolutionary that nobody has ever heard of it. Raise $1 billion by selling bonds to the public. You have no credit and no credibility? No worries. The companies that have done best lately are those with the worst credit, according to Bloomberg. These “balance sheet bombs” have benefited most from ZIRP, NIRP, and collapsing spreads.

Everybody wants high yield. And nobody believes the Fed will allow debtors to fail. It follows then that a new company with no track record, no real product, no profits, no sales, and no business plan should have the very worst credit rating possible… and should therefore be a cinch to get plenty of credit.

So, say you have to borrow at twice the rate of IBM – let’s say 4%. With a real inflation rate of 3.91%, you’re getting money for essentially nothing.
But you still have to make debt payments…

You borrow $1 billion. You have to pay $40 million in annual interest. But you take the $1 billion and use it to buy your products (whatever they are). Your company shows sales of $1 billion. You bring about 40% of that to the bottom line… giving you debt cover of 10 times. This makes you one of the best credit risks on the market. Then, if your shares sell for 20 times earnings (modest for a tech company), the capital value of your company will soar by 20 x $400,000,000 = $8 billion!

You see? You started with nothing. Through the magic of ZIRP and NIRP… along with some accounting chicanery… you now have a company worth $8 billion.
Sound crazy? Yes. And that is almost exactly what the Fed is trying to encourage.

Companies borrow. They use the money to buy their shares. Stocks go up. This “wealth effect” is supposed to trickle down to the public, who are meant to buy the corporations’ products. Rising sales will produce higher profits. Stocks will go up. Everyone will be richer.

The risk to the short-term investor may be that he misses out on this gay insanity. Asset prices go up; he wants to be a part of it.

The risk to the long-term investor arrives when the economy comes to its senses.

Regards,

Bill

P.S. When the economy finally does come to its senses it’s not going to be pretty. That’s why Bonner & Partners senior analyst Braden Copeland prepared a special report for investors who want to be ready for the coming crash. Braden has identified six stocks you’ll want to own in the next downturn. Find out what they are here.

0 Comments

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>

©  Bonner & Partners, 455 NE 5th Ave Suite D384, Delray Beach, FL 33483, USA. All rights reserved. Any reproduction, copying, or redistribution, in whole or in part, is prohibited without written permission from the publisher.

Information contained herein is obtained from sources believed to be reliable, but its accuracy cannot be guaranteed. It is not designed to meet your personal financial situation – we are not investment advisors nor do we give personalized investment advice. The opinions expressed herein are those of the publisher and are subject to change without notice. It may become outdated and there is no obligation to update any such information.

Investments recommended in our publications should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company in question. You shouldn't make any financial decision based solely on what you read here. 

Bonner & Partners writers and publications do not take compensation in any form for covering those securities or commodities.

Bonner & Partners expressly forbids its writers from owning or having a financial interest in any security that they recommend to their readers. Furthermore, all other employees and agents of Bonner & Partners and its affiliate companies must wait 24 hours before following an initial recommendation published on the Internet, or 72 hours after a printed publication is mailed.