Paul Dietrich's Global Investing Trends Report

Protecting The Buying Power Of Your Portfolio In The New Investment Environment

Posted December 10, 2010 · 4 Comments

Greetings from Hong Kong!

For almost a month I have been on a lecture tour and meeting with some of the world’s top investment analysts on commodities and Asia and emerging markets.  The trip has taken me to London, Paris, Tokyo, Beijing and Hong Kong.


Over the next month or so I will be writing a series of Global Outlooks telling you what I have learned during this trip and how some of these global economic and investing trends could affect investments for at least the next five years.


Protecting The Buying Power Of Your Investments!

 This Global Outlook newsletter may be the most important one I have ever written.  We are making an historic shift into a new investment environment over the next five years and every investor needs to prepare for these changes. 


This Global Outlook will discuss issues that are extremely important to your financial future.  I am going to discuss how investors can protect the “buying power” of their investment portfolios when we start seeing significant inflation over the next few years because of the government’s printing of trillions of new dollars (backed by nothing) to fund our government’s bailouts, stimulus packages and continuing deficit spending.


Unfortunately, I go into a few complicated calculations and charts to explain what is happening and I know a lot of reader’s eyes glaze over when they see a chart, but this Global Outlook may be crucial to you having enough money to retire.  I urge you to read it through to the very end.


First, How Are The Recent Elections Going To Affect The Economy?

I believe the stock market will continue to move unevenly upward through the end of this year and probably through  March or April of 2011.  I believe we should see good overall gains during this period.


There will be a temporary extension of the Bush tax cuts for which we can thank the Republicans, but after that, by the early spring of next year, many Americans will realize that the new Republican congress can’t actually accomplish any of the things they promised to do during the elections, like repeal Obamacare or his consumer and financial regulatory reforms.  The reason they won’t be able to do any of these things is because President Obama has a veto pen.


All of us will have to get use to gridlock in Washington for the next two years.  And if that means the government can’t do anything bad to us—that may not be such a bad thing.


After March or April of next year, I believe the stock market will largely track the underlying U.S. economy and there will be some growth but it will be mediocre at best.  Next year should produce nice, but modest gains from the U.S. stock market.  Asia and emerging markets and hard asset commodities should perform much better than the U.S. stock market next year.


Earlier I mentioned I thought the stock market would go up unevenly through the early spring of 2011.  It will go up unevenly partially because of the current European debt crisis.  So far, Greece and Ireland have had to be bailed out and there are at least three other countries that will need major bailouts over the next few months.


Each time a new European country must be bailed out, the U.S. stock market will react negatively for a week or two until Germany finally agrees to bail them out.


The good news is that almost all of this bad debt is held by European banks and it will hurt Europe but will have very little long term effect on the U.S. stock market.  U.S. banks only hold about $140 billion in Euro bonds.


The Federal Reserve Decisions Will Have A Far Greater Impact On The Economy

 Recently the Federal Reserve decided to print another $600 billion dollars as a new economic stimulus effort they call Quantitative Easing 2 (QE2).  The Fed, at the same time, announced it was also printing another $300 billion to bail out bad mortgages once again at Fannie Mae and Freddy Mac.  That’s a total of $900 billion in newly printed U.S. dollars. 


According to the Fed, the goal of printing all this new money is to “create inflation,” because they are worried that we will technically fall into deflation if they don’t stimulate the economy.


A second goal in creating more inflation is to persuade investors who are holding cash or short-term bonds to move them into the stock market or other investments so that cash can be used to indirectly stimulate the economy.


In the short-term, this is good for the stock market and should move a significant amount of cash out of banks and into productive investments.  This will help the stock market in the short-term.


In the long-term, printing all of this new money may produce serious inflation.


Is Deflation Really A Problem?

 When most of us hear the word “deflation,” we think of the Great Depression, when the price of everything just kept going down.  No one would buy anything in advance, because they knew it would be cheaper next week.


But the technical deflation America may experience in the next year has everything to do with the real estate bubble.  Other than real estate, prices for everything else you buy are going up.


Housing Prices Should Continue To Fall

 According to almost all the experts, because there is such an enormous over-supply of houses versus demand, housing prices are projected to fall until 2014.  After that, the projections indicate they will only increase by about 1% or 2% a year for the next ten years thereafter.  That is not enough to keep up with inflation.


The experts are also predicting a huge increase in foreclosures through 2014.  The reason for this is that some of the most abusive mortgages written in 2005 to early 2007 were given to many people who would not qualify for a mortgage today.  Mortgage brokers used “teaser rates” to sell these mortgages with extremely low initial interest and principal payments.  Many of those mortgages balloon up in early 2011 and it usually takes 9 months after the rates ratchet up before we will start seeing a dramatic increase in foreclosures that will not end anytime soon.


What Is The Real Rate Of Inflation?

 Inflation is calculated every month by the U.S. Bureau of Labor Statistics (BLS).  Each month the BLS calculates the Consumer Price Index (CPI) which is how the government measures inflation.


Right now, over 32% of that calculation is basic housing prices.  Since almost a third of the CPI calculation is made up of housing values that almost all experts agree is going to dramatically drop over the next four years.  That one calculation has a major influence on the CPI.


The problem with this is that even though experts say housing prices will continue to drop through 2014, this 32% CPI calculation for housing makes it looks like there is no inflation in America.  But that is not true!


Anyone who has gone to a grocery store lately knows that food prices are going up or that packages of food are getting smaller and they are charging the same price.  Gasoline at the pump has hit a new 2010 high this month.  And anyone who runs a business knows the costs of their raw materials are all going up.  How can the government say there is no inflation?


The answer is in how they calculate the index.  With a third of the calculation of the index in housing values it looks like there is no inflation and if housing continues to drop significantly in 2011, as expected, the CPI could technically show deflation.


But if you are not selling a house, EVERYTHING else looks like there is inflation!


To add insult to injury, the U.S. Government changed the way it calculated the CPI in 1980, after the hyper-inflation during the Carter Administration.


From the CPI, the government then publishes the “Core Inflation Index” that specifically excludes both food and energy.  Food makes up almost 15% of the CPI calculation and Energy 8.5%.  Now how many people do you know that don’t eat or use gasoline in a normal month?


I know it sounds crazy to exclude food and gasoline from the Core Inflation Index, but it does help the U.S. government.  The Core Inflation Index is what the government uses to determine cost of living increases, known as COLA’s, for people receiving social security and it is tied to many pensions and other benefits.  This allows the government to make smaller COLA payments to retirees that are below the true level of inflation.  Ungenerous people might call it a government ponzi scheme.


The Core Inflation Index is also used to calculate the inflation rate for increases in “inflation adjusted” U.S. government bonds, better known as TIPs bonds.  Because the Core Inflation Index is skewed based on deflating housing prices, plus the elimination of food and energy, TIPS bonds will never adequately protect investors from the true rate of inflation.


The government used the same calculation for the CPI from 1913 to 1980.  In 1980, after four years of hyper-inflation starting in the late 1970’s, the government changed the calculation and dropped food and energy from the Core Inflation Index.  The chart on the next page shows how much inflation we really have today based on the pre-1980 government inflation calculation.






The Real November 2010 Inflation Rate was 8.5%!


While the U.S. government repeatedly states that we currently have about 1% inflation, by using the older pre-1980 government calculation of inflation the “Alternate CPI” calculation reveals that as of November 2010 the true inflation rate was 8.5%.


Why Is The Price Of Gold Going Up If There Is No Inflation?


If you believe the Federal Reserve when it says the U.S. has effectively no inflation and we may be on the verge (remember declining housing prices) of deflation, why are so many investors buying gold and why is it hitting new price highs?


The answer to that question is because a large number of investment managers and very sophisticated investors know that the government’s inflation calculation is designed to under-report the real inflation rate.  They know that 8.5% inflation is significant and that is why so many sophisticated investors are moving larger percentages of their investment portfolios to gold and other hard asset commodities.


What Causes Inflation?


Historically, serious inflation is the result of a government printing money and expanding its money supply with nothing backing the newly printed money.


In 2009, the U.S. government printed $3 trillion in bailout money, stimulus money and deficit spending.  In 2010, the Fed printed $600 billion for a new economic stimulus program, $300 billion for more bailouts of mortgages and they printed $1.7 billion in deficit spending.  Deficit spending will continue at that rate for the foreseeable future according to the Congressional Budget Office.


One University study said it takes anywhere from 2 years to 3 years from the time the government spends newly printed money to the time it starts showing up as real inflation in the economy.  So that means we should start seeing significant inflation in 2012.


Here is a graph that shows the level of government debt as a percent of GDP for all advanced countries.  As you can see, only a few countries, including Greece and Ireland have a higher debt to GDP ratio than the U.S.  Greece and Ireland have effectively declared bankruptcy and the European Union and the IMF are currently bailing them out.




Source: Citywire, December 6, 2010 



The Congressional Budget Office has reported that in 2012, the U.S. government debt to Gross Domestic Product (GDP) ratio will be higher than it was in the late 1970’s during the Carter Administration.


Inflation Destroys The Buying Power Of All Your Stock & Bond Investments

 In 1978, 1979, 1980 and 1981 the United States saw four years of an average 17% compounded rate of inflation.


Do you know what that does to the buying power of your savings and investments?


17% compounded over four years wiped out over 60% of the buying power of every dollar an investor had in cash, bonds and stock investments.


Even worse, during 1980 and 1981 there was a bear market/recession where the stock market dropped 37% over those two years.  So investors lost 37% in the stock market plus the inflation rate went up 17% in 1980 and another 17% in 1981.  Many investors never recovered from those four years.


Although every administration says it supports a strong dollar, the facts are that over the past 76 years, the purchasing power of the U.S. dollar has declined by 94%.  $1.00 in 1913 is only worth about $0.03 in current dollars due to the effects of inflation.


How Do You Hedge Your Investments Against Inflation?

 One of the reasons the stock market dropped 37% in 1980 and 1981 was investors sold their bonds and stocks as quickly as they could because of inflation and they invested that money in alternative investments that would provide a hedge against inflation.


Real estate was a very good hedge against inflation at that time.  Unfortunately, because of the recent real estate bubble and the huge current over-supply versus demand of both commercial and residential real estate, no one believes that either commercial or residential real estate will be a good hedge against inflation this time.


Gold was also a very good investment.  Gold hit its record price during that time.  If you adjust for inflation, gold hit a high of $2300 an ounce in the early 1980’s. 


Oil was at a record high and because of President Carter’s price controls there were long lines at all gas stations.  Almost all other commodities did well and they all were a good hedge against inflation.


Many people also transferred their cash into the Deutsche Mark.  The Germans never allowed their currency to be devalued by inflation.  Unfortunately, the Deutsche Mark doesn’t exist anymore; it has been replaced by the Euro.  The European Central Bank is degrading the Euro right now worse than the U.S. government is devaluing the dollar in order for Europe to pay for the bailouts of Ireland, Greece and others to come.


TIPs or inflation protected bonds may not be a good hedge against inflation in the future for all the reasons I gave earlier.  TIPs bonds are tied to the government’s Core Inflation Index that is designed to under-calculate real inflation.


In fact, the worst investments anyone can have in a highly inflationary environment are cash and U.S. government bonds.  I know so many people who took money out of the stock market in early 2009 and then invested in 5-year to 7-year bank CD’s paying only a few percent a year in interest.  Even with the current real 8.5% inflation, those CD’s and short-term U.S. Government bonds are losing investments and they will become worse if inflation continues to rise.


What Will Be The Best Hedge Against Inflation This Time?

 After studying the various methods investors used to successfully protect the buying power of their investments from 1978 to 1981, I believe the only way that investors will be able to protect the buying power of their portfolios this time will be with a broad basket of actual commodities, like gold and silver and also by investing in commodity producers like oil and mining companies.


Investors Expect Their Investment Managers To Be Thinking Ahead

 I do not know a single economist who does not believe that the U.S. government’s printing of new money will eventually result in significant inflation.  Some economists, especially at the Federal Reserve, believe we may see deflation in the short-term because of the 32% housing price calculation in the CPI discussed before, but even the Fed agrees that inflation is coming eventually.


The big question is how much inflation will all of the recent money expansion create?  This is where economists disagree.  Many believe we will have some inflation over the next five years, but most think there is a strong possibility of the hyper-inflation we saw from 1978 to 1981.


With the Congressional Budget Office predicting a U.S. debt to GDP ratio greater than what we experienced after the Viet Nam War in the late 1970’s, there are a significant number of economists who believe we could eventually see 15% to 20% inflation over a multi-year period.


What Do We Do If We Have 15% to 20% Inflation?

 At Foxhall Capital, we don’t have a crystal ball to be able to accurately foresee future inflation rates, but when you look at the U.S. debt to GDP ratio, the severity of the last recession, the high unemployment rates, the worldwide financial crisis, trillions of newly printed dollars, the funding of two wars in Iraq and Afghanistan and the inability of Congress to live within its means, you don’t need to be a psychic to imagine that it is very possible we could see 15% to 20% inflation over the next 5 years.


No one expects investment managers to be perfect.  But clients do expect them to be thoughtful, and more importantly, thinking and planning ahead.


Over the past 110 years, there has only been one period of hyper-inflation starting in the late 1970’s.  There are very few, if any, investment managers who were managing any significant amounts of money during that period of time.  Anyone who was managing large accounts at that time is probably now in their late 70’s.


I was not an investment manager until 1986.  Before that I was an international attorney.


In the 1980’s I had a very well known and rich billionaire client who claimed that he had been able to completely keep the “buying power” of his stock investment portfolio during 1978 to 1981 by using a unique investment ratio.


The Leverage Of Commodity Producers

He believed there was a leverage in buying commodity producers.  He knew that gold, oil and other physical commodities would be good investments during a period of inflation and they did very well. 


But he believed one could leverage his investment portfolio by buying the stock of “commodity producers” like oil companies and mining companies.  His theory was that buying oil in the ground through Exxon stock was cheaper than buying a barrel of oil at then current prices.  He believed that buying gold in the ground through a gold mining stock was cheaper than buying an ounce of physical gold.  He believed there was a natural leverage in these stocks.


He was right.  Physical commodity prices went way up during that period.  But in many cases, commodity producer stocks went up even higher and faster than physical commodities did once inflation started to soar.


The Secret Inflation Formula

 He said he used a formula of purchasing commodity producers at 1.5 times the inflation rate.  That means that if inflation is 10%, your portfolio should be invested 15% in commodity producers.  If inflation is 20%, your portfolio should be invested 30% in commodity producers.


He said that if you did this, whatever gains the rest of your portfolio made, those gains would be “real after-inflation gains” and that is how he maintained the buying power of his billion dollar investment portfolio.


He never told me the exact commodity producer stocks he was investing in at the time, but I have tried to back-test his strategy using the stock prices of commodity producers stocks during that 1978 to 1981 period.


My own initial backtest showed that if you invested in a broad basket of commodity producers, an investor would need to invest at least an amount double the inflation rate in order to leverage your investment portfolio to maintain the buying power you lose through inflation.


A Few Last Thoughts….

Whether we like it or not, we are very likely to see significant inflation over the next 5 years.  If it is even near the inflation we saw during 1978 to 1981, it could devastate every investor’s investment portfolio.  At the end of the next five years, you could have the same amount of money in your portfolio, but those dollars will buy much less.


This is something serious that every investor, financial planner and investment manager needs to be talking about.


As I mentioned earlier, very few financial planners or investment managers were in this business in 1978.  Those who were are most likely retired.  Very few financial planners or investment managers have any real-life experience in dealing with investment portfolios during a period of significant inflation.


Since 1982, we have experienced very little inflation.  Most people used a buy and hold investment strategy during that time.  That worked until 2000.


But now we are entering into a new investment environment where cash and fixed return U.S. government bonds have traditionally been terrible investments and will not keep up with inflation.


Investors need to start planning today a new investment strategy for their portfolios that they will implement if inflation starts to take off. 


This is the most important issue facing investors today, because even with what I believe is a real inflation rate of 8.5%, I think investors need to start adjusting their total investment portfolio to begin hedging against this inflation and loss of buying power.


At Foxhall Capital we are thinking through all of these issues to make sure our Foxhall clients don’t lose any significant amount of their buying power in their portfolios due to future inflation.


What Can An Investor Do Right Now?

Currently, every Foxhall Capital equity ETF portfolio has at least 10% of the portfolio invested in commodities or commodity producers.


Foxhall Capital also manages a pure hard asset commodity strategy called the Foxhall Global Hard Asset strategy.  This investment strategy is completely invested in physical commodity ETFs and commodity producer ETFs.


I believe it is now time for every financial planner and investor to look at an investor’s “total investments,” whether they are cash, bonds, real estate, etc. and after calculating the total value of all these investments, they then should think about adjusting the value of their total portfolio and consider investing 1.5 times to 2 times the real inflation rate (8.5% right now) in hard asset commodities, like the Foxhall Global Hard Asset strategy in order to start protecting the inflation-reduced buying power that is starting to happen right now.


That means if the current real inflation rate is 8.5%, which is based on the government’s pre-1980 method of calculating the CPI, then every investor should have about 13% to 17% of their total investments in a commodity strategy like the Foxhall Global Hard Asset strategy.


Most investors have a significant percentage of their total investments in U.S. government bonds or money market funds or bank CDs.  In an inflationary environment these investments have historically lagged behind inflation. 


Investors should begin to reallocate some of these cash and cash equivalent investments to a broad basket of commodities and commodity producers.


Every quarter or so, I will be reporting the current real inflation rate using the government’s pre-1980 calculation that includes food and energy prices.  As the inflation rate rises, I will give my advice as to what percentage of an investor’s total portfolio needs to be invested in commodities to keep up with any increase in inflation.


Every economist knows that inflation changes all the normal rules of investing.  We are now entering into a new investment climate.


Many investors, financial planners and investment managers are going to completely miss this newly changing investment environment.  They will say, look at the government figures, we have no inflation—even though you KNOW THERE IS INFLATION every time you go to the grocery store or buy clothes or fill up your car with gas.  You intuitively know the government is under-reporting inflation!


My advice to you is to talk to your financial planner today and give him a copy of this Global Outlook and ask him or her what their strategy is for protecting your investments against the loss of buying power from inflation.

Until then!


—Paul Dietrich




Disclosure: The opinions and portfolio information provided in the Foxhall Global Outlook are subject to change at any time, and are not to be construed as advice for any individual nor as an offer or solicitation of an offer for purchase or sale of any security. Client accounts may differ from model allocations due to many reasons. All investment strategies offer the potential for loss as well as gain. Individuals should consult with their financial professional to determine an investment strategy appropriate for their objectives, risk level, and time horizon prior to investing.  Past performance is not a guarantee of future performance.



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1. Myself, I believe that the true definition of "purchasing power" is literal. That is, your portfolio's "purchasing power" is not its net market value, but its ability to send you cash with which you can actually BUY SOMETHING!

If an asset must be sold before you can use it to pay your rent or buy groceries, its purchasing power is reduced by necessity to pay capital gains taxes.

2. Prices went up from 1973 on forward, not just 78-81, though that was the worst period. Be careful how you correlate commodity prices. Meat and sugar prices exploded just after the 1973 energy crisis, which was political, as was the one of 1979.

Gold went over $800, but fully half of that price rise happened in just a few months, and just as rapidly vanished.

Silver went up to $50 per ounce, but only as a result of the Hunt Brothers attempting to corner the entire market, not due to fundamentals.

4. From 78-81, while Paul Volcker was jacking up interest rates to fight inflation, bond investors could have locked in high returns that continued long after inflation began to go down. Only commodity investors who knew exactly when to buy and when to sell could have done better. Money market accounts were paying double digit rates of interest. The stock market was considered inconsequential.

3. The more I think on it, the more I'm convinced that "true" wealth is neither gold nor fiat money, it's energy.

The key to preserving "purchasing power" is invest in energy companies, utilities and (in the U.S.) master limited partnerships. They pay dividends, and they will profit so long as civilization needs energy.

current money market interest rates

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Posted by Stock Market | May 17, 2011 10:37pm
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Posted by share tips | July 6, 2011 9:26am
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Posted by Gold Silver Tips | October 15, 2011 2:56am

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About Paul Dietrich
Paul Dietrich is the Chairman, CEO and Co-Chief Investment Officer of Foxhall Capital Management, Inc. (Foxhall).  Foxhall currently manages investments for individuals, mutual funds and private institutions throughout the United States. Paul Dietrich is also a portfolio manager to a publicly traded mutual fund, the Foxhall Global Trends Fund.
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