Gold and Silver Backings Fallacy, Fool.com

Is Your Safe Haven a House of Cards?

By Christopher Barker
April 5, 2010 | Comments (16)

If automatically dismissing allegations about the suppression of gold and silver prices as tinfoil-hat madness helps you to sleep better at night, then I wish you sweet dreams.

If you prefer to consider the evidence on the merits; and draw your own conclusions, then you will want to read on.

A recent extraordinary hearing held by the Commodity Futures Trading Commission (CFTC) to discuss the need for position limits in metals futures morphed unexpectedly into what I will argue was the grandest expose of potential fraud in modern financial history.

A little background
There is not an investor among us who has not been deeply disappointed by revelations of shady dealings in the financial sector over recent years. The list of prior assumptions about the economic landscape that people have been forced to begrudgingly shed stretches out like a list of Bernie Madoff's unsuspecting victims. We've witnessed the forensic discovery of Lehman's pre-collapse book-cooking, and now Goldman Sachs (NYSE: GS) has admitted (and defended) its role in disguising some of Greece's sovereign debt woes.

Given a financial industry so awash in systemic impropriety, perhaps the notion of a scheme to manipulate and suppress the prices of gold and silver isn't so loony after all.

I have been tracking this topic for several years, and we would need to sit down over a gigantic cup of coffee to pore over all the verifiable evidence amassed by researchers like GATA (Gold Antitrust Action Committee), John Embry of Sprott Asset Management, silver analyst Ted Butler, and many others.

Fools may recall GATA from a full-page ad that appeared in the Wall Street Journal in 2008 calling for an independent audit of the United States' gold reserves. GATA also "seeks to disclose and publicize the huge speculative short positions in gold taken by financial institutions and bullion banks" and has spent more than a decade compiling evidence of gold price suppression.

One year ago, GATA board member Adrian Douglas issued a seminal report entitled Pirates of the COMEX, in which he deduced by comparing two sets of government-supplied data that JPMorgan Chase (NYSE: JPM) and HSBC (NYSE: HBC) were the principle holders of derivatives in precious metals. When only two entities control 85%-100% of a futures market segment, as Douglas alleged, they can effectively control the price of the underlying commodity. Fools eager to dig further into the reams of evidence pointing to price suppression in gold and silver are encouraged to visit my CAPS blog post here for a collection of relevant links.

They finally have a whistleblower
Whereas this research has come from the outside looking in, during the CFTC hearings the world was finally offered a glimpse from inside the alleged manipulation process. Andrew Maguire, a professional metals trader in London, has claimed colleagues from JPMorgan Chase bragged of their ability to knock down the price of silver at will.

On February 3, 2010, in an email message posted here on GATA's website, he reportedly informed the CFTC's enforcement division of a manipulation event that would occur two days later when U.S. non-farm payroll data was released. He apparently then followed up with detailed insight into the process while it was occurring.

Ultimately dissatisfied with the CFTC's response to his communications, Mr. Maguire alerted GATA of his allegations ... which were then made public by GATA Chairman Bill Murphy during the recent hearings.

But wait ... the story gets bigger still.

Is your "physical" gold or silver leveraged at 100:1?
A critical exchange occurred after GATA's Adrian Douglas chimed into a conversation with his assertion that the leveraged market for physical metal is essentially a game of "paper backing paper." The underlying argument here is that the volume of gold traded daily at the London OTC metals exchange (LBMA) is so large (at about 20 million ounces of gold per day), that in fact the over-the-counter market for "physical" metal can not possibly be backed on a 1:1 basis by actual physical supply. As Mr. Douglas asserts: "it's fractional-reserve accounting, and you can't trade that much gold -- it doesn't exist in the world."

Jeffrey Christian, founder of commodity consultancy firm CPM Group and "one of the world's foremost authorities on the markets for precious metals," brazenly confirmed Douglas' characterization of the metals market:

The previous fellow was talking about hedges of paper on paper and that is exactly right. Precious metals are financial assets like currencies, T-bills, and T-bonds; they trade in the multiples of a hundred times the underlying physical and so people buying them are voting and giving an economic view of the world or a view of the economic world.

In case you're thinking that Mr. Christian surely must have miscommunicated his intended point, he clarified most pointedly:

People say, and you heard it today, there is not that much physical metal out there, and there isn't. But in the "physical market," as the market uses that term, there is much more metal than that. There is a hundred times what there is.

I repeat: "There is a hundred times what there is." Did he learn from Bill Clinton what the definition of is is? I sure hope that kind of leverage never comes toppling down the way lesser leverage did in the mortgage securitization industry. Not to fear, assures Mr. Christian while commenting earlier on the short segment of the market, "there are any number of mechanisms allowing for cash settlements." It appears that he actually perceives no structural problem inherent in a metals market that would seek to deliver cash in lieu of physical bullion to investors who may be inclined to call this paper bluff. In some circles, one could call that for what it would be: default.

Fools may recall a couple of instances in 2008 when physical supplies of bullion were very tight even as spot prices were mired in weakness. I believe that kind of anomaly results from an enormous disconnect between a leveraged market for paper gold and a much smaller market for actual, hold-it-in-your-hands physical bullion.

Taking it all in
If you have never considered the topics of price suppression or leverage in silver and gold before, this is a lot of material to process all at once. I believe that these revelations place this entire leveraged house of cards at risk. Conceivably, all it would take would be a few deep-pocketed investors overseas to call the market's bluff by demanding physical delivery of bullion, and the world's major futures exchanges could break down before our very eyes. Adrian Douglas points out that the LBMA exchange in London alone trades some $5.4 trillion per year in "gold" on a net basis. If the leverage of paper instruments to bullion stands anywhere near 100:1, then the implications are sufficient to make the Enron debacle look like child's play. Without mincing words, if the supposed quantities of gold and silver bullion simply are not there, then we may witness the greatest incidence of fraud in financial history.

Investors with exposure to the popular gold and silver "bullion" proxies have some very critical assessments to make. Fools are encouraged to note that HSBC is the custodian for the holdings of the wildly popular SPDR Gold Trust (NYSE: GLD). On the silver side, we have JPMorgan Chase serving as custodian for the holdings of the iShares Silver Trust (NYSE: SLV). Both trusts indicate that underlying metal holdings are held on an allocated basis for the trusts, although the silver vehicle permits some 1,100 ounces of unallocated silver per trading day. This allocated nature of the holdings is enough to reassure many investors, but I still have my concerns.

For my part, I have consistently stated my preference for Central Fund of Canada (AMEX: CEF), which has been around since 1961, and offers the magic words that discerning precious metal investors pine for. The fund holds "allocated, segregated and unencumbered gold and silver bullion and does not speculate in gold and silver prices". Another compelling alternative, the Sprott Physical Gold Trust ETV (NYSE: PHYS), was launched recently by the very firm that has been a vocal advocate for terminating the manipulation of the gold price for many years running.

Pitney Bowes Option Sell April 2010; Gurufocus.com

Pitney Bowes – Making Money in a No-Growth Business
Apr. 07, 2010
Author:

Dr.Paul Price

Pitney Bowes [NYSE:PBI - $24.70] is the worldwide market leader in postage meters and mailing equipment. The U.S. and Europe contribute about 68% of revenues and 84% of profits. Their ‘Services’ segment provides mail room, marketing and document management to account for the other 32% of revenues and 16% of earnings.

The rise of the internet has put a permanent damper on overall mail volume and PBI is no longer a growth story. Earnings from continuing operations came in at $2.28 /share in 2009 versus $2.32 in 1999 although EPS did peak at $2.69 - $2.76 in the period from 2005 – 2008.

The basic business remains a predictable cash-cow, however, and capital needs are not high. The company has gradually increased their dividend rate to $0.365 quarterly making for a juicy 5.9% current yield. In today’s close-to-zero interest rate environment, the dividend alone makes PBI shares a reasonable choice for income oriented investors.

Zacks, Value Line and Standard & Poors all expect $2.40 /share in 2010 earnings with a 2011 projected range running from a low of $2.47 (Zacks) to $2.60 (S&P). That puts PBI at about 10.3x this year’s and 10x the 2011 estimates versus their 10-year median P/E of 16x.

I don’t expect to see a sixteen multiple again but it doesn’t seem unreasonable to think PBI can trade at 11x – 12x normalized earnings over the next year or two. That leads me to a minimum 12-month target of $27.60 or about 11.7% above today’s quote. If it takes a year to get there you’ll have a total return of > 17% on a stodgy, low volatility [Beta = 0.9] company.

Is that rational? Standard and Poors carries a $27 one-year goal and rates PBI at 4-Stars (out of 5). Value Line sees a 3 – 5 year P/E of 12x in figuring their long-term price target and notes Pitney Bowes ‘earnings predictability’ falls in the top 1% of all companies from their 1700 stock universe. They also note PBI’s 90th percentile ranking for ‘stock price stability’.

PBI peaked at $27.50 in the disastrous 2008 market and traded at $40 and higher during each calendar year in the entire decade prior to that year. With slightly improved EPS likely and the yield support I see low risk and a high likelihood that my $27.60 goal can be achieved.

These are not ‘home-run’ shares. They can provide conservative investors with a total return many times greater than fixed income without a huge risk factor.

***********************************************************************************
Another way to play with PBI would be to buy shares while writing October puts and calls at the $25 strike price. Here’s how that would look if you set that up right now:
--------------------------------------------Cash Outlay----Cash Inflow
Buy 1000 PBI @ $24.70 /share -------------- $24,700
Sell 10 PBI Oct. $25 Calls @ $1.05 /share -------------------- $1,050
Sell 10 PBI Oct. $25 Puts @ $1.90 /share ----------------- $1,900
Net Cash Out-of-Pocket ---------------------- $21,750


If PBI shares rise by at least 1.3% to $25 or higher by Oct. 16, 2010:
· The $25 calls will be exercised.
· You will sell your shares for $25,000.
· The $25 puts will expire worthless (a good thing for you as a seller).
· You will likely have collected two $0.365 dividends x 1000 shares for $730.
· You will have no further option obligations.
· You will end up with no shares and $25,730 in cash.

That best-case scenario profit would be $25,730 - $21,750 = $3,980.

$3,980/$21,750 = 18.29% cash-on-cash achieved in less than 7 months on shares that only needed to rise by 1.3% or better.

What’s the risk?
If PBI remain below $25 on the October 16, 2010 expiration date:
· The $25 calls will expire worthless.
· The $25 puts will be exercised.
· You will be forced to buy another 1000 shares of PBI.
· You will need to lay out an additional $25,000 in cash.
· You will likely have collected $730 in dividends.
· You will have no further option obligations.
· You will end up with 2000 PBI shares and $730 in cash.

What’s the break-even on the whole trade?

On the original 1000 shares it’s their $24.70 purchase price less the $1.05 /share call premium = $23.65 /share.

On the ‘put’ shares it’s the $25 strike price less the $1.90 /share put premium = $23.10 /share.

Overall your break-even would be $23.38 /share (ignoring dividends) or $23.02 /share if you include the expected yield.

PBI could fall as low as $23.02 or (-6.8%) from the trade inception price without causing a loss on this trade.

Dr. Paul Price - www.BeatingBuffett.com

Disclosure: Author is long PBI shares and short PBI options.

Fool.com How to Stay Invested in Any Market

How to Stay Invested Through Any Market

By Chuck Saletta
March 30, 2010 | Comments (2)

If you were 100% invested in the S&P 500 when that index hit its low point last March and you simply held on, you would have seen an incredible return of around 65% in just about a year. That's an astonishing return for doing nothing more than nothing.

Of course, doing nothing is often easier said than done. At the market's low point, the panic was palpable. We were dealing with a collapsing housing market, crushed investment banks and other financial institutions, and a recession that was already well on its way to being the longest one since the Great Depression.

Staying invested in an environment like that took more than just a little gumption -- it took significant confidence in the companies you were holding.

What it took to persevere
To not pull out what was left of your capital during the market's panicky lows, you had to be certain that the companies you owned would at least survive. The typical questions around how fast they would grow or how much they would earn often took a back seat to that far more primal concern.

And with the debt market in shambles, that survival became a question of balance sheet strength and cash flow. If a company needed to borrow money to make ends meet or even to refinance existing maturing debt, it either couldn't at all or couldn't at anything approaching reasonable rates. That meant that only the most exceptionally strong businesses were able to survive relatively unscathed.

Things may have stabilized a bit since then, but the lessons from that era still remain valid. Indeed, the very characteristics that let the strongest companies survive the downturn are the same ones that will let them thrive as the economy recovers.

And if by some unfortunate event, the recovery never does get to Main Street, those same characteristics that helped them survive the latest crash will help them through the next one, as well.

What corporate strength looks like
Companies set up to survive a mess like the one we've been living through are ones that have -- and had -- their financial houses in order. Key signals of strength include:

* A debt-to-equity ratio below 200%, which indicates the company is not overleveraging itself to try to juice financial returns on minimal business,
* A cash and equivalents-to-current liabilities ratio above 50%, which indicates the company has enough money to cover at least a half-year's worth of its balance-sheet obligations, and
* A free cash flow-to-net income ratio above 90%, which indicates the company is legitimately generating the sort of cash implied by the net income it reports.

When you put that all together, you find companies like these:

Company

1) Debt to Equity (<200%, not slave to debt)
2) Cash and Equivalents to Current Liabilities (>50%, 6 mos reserve)
3) Free Cash Flow to Net Income (>90%, legitimate earnings)

Coca-Cola (NYSE: KO)
1) 47.8%
2) 51.2%
3) 90.8%

Abbott Laboratories (NYSE: ABT)
1) 73.3%
2) 67.5%
3) 107.7%

Oracle (Nasdaq: ORCL)
1) 53.6%
2) 174.8%
3) 145.2%

Intel (Nasdaq: INTC)
1) 5.7%
2) 52.5%
3) 152.3%

Reynolds American (NYSE: RAI)
1) 68.3%
2) 62.7%
3) 136.5%

Fluor (NYSE: FLR)
1) 3.9%
2) 51.1%
3) 97.3%

MasterCard (NYSE: MA)
1) 2.1%
2) 64.9%
3) 90.4%

As you can tell from that eclectic list of names, financial strength can be found in a wide variety of industries. What ties these businesses together, though, is that they've all demonstrated mastery of the cash management side of running a business.

In ordinary times, that's important because it assures they remain disciplined in the expansion opportunities they pursue. Companies with looser cash controls risk grasping at every growth chance they can get, no matter how long the time before the expected payout. Such an undisciplined approach often leads to cases where a business is so expansion-happy that it becomes dependent on being able to roll over its debt at low rates to just survive.

In times of constraints on capital -- our recent experience -- or in times of rising rates -- what we're going into now -- a lack of solid cash management controls can be devastating.

Stay invested in the best
The companies designed and financed with cold, hard cash management in mind are built with the flexibility and strength to survive just about anything the economy can throw at them. By owning companies that are built to survive, you can help yourself maintain the confidence you need to stay invested, no matter how the market performs.

At Motley Fool Inside Value, our unyielding focus on the underlying strength of the companies we've selected enabled us to stay invested, even as the market and the economy tanked. As a result, we've managed to both earn a positive return and stay ahead of the S&P 500 since our launch in 2004.