Wednesday, January 7, 2015

Cash Flow is King

Continuing from part 1, Why the Paper-Price of Gold and Silver Matters, as promised, we’ll start with a chart of the dollar and discuss the various heights to which this dirtiest of all shirts can elevate itself. 

Since basing at 78.91 back in May of 2014, the fed-injected steroids really kicked in. The dollar value has surged more than 16% in nine months - and is now trading north of the 90-handle.

We have not seen these levels in the dollar since late 2005, early 2006. So how high can this illusionary fiat darling of the elite go? What would you say if I told you that the dollar could rally another 16%-18% from current levels toward the 108 handle, No way?

Yes way, the 108 target is very plausible in the months and years ahead. The only way to wipe this upside price target off the map is if the dollar was to first collapse below its all time print low of 70.70, and that’s just the way it is.

Ah, the reality of illusion is often a most difficult concept to envision.

Grasp it we must however, for if we choose otherwise, the denial of such can prove rather costly. Before we move on to the conclusion of why dollar-based paper-prices matter, we will leave you with a couple of additional upside price levels for the dollar, one of which has already captured its target.

Annotated by our customary “BAM!” tag, the market has recently captured a long standing upside price target of 90.70. The next target on path toward the 108 level is 96.88. The 96.88 target shall remain viable unless the dollar first collapses back beneath the 72.70 level. Now back to the story.

The dollar is a firmly entrenched cultural anchor that (short of Armageddon) is not going away anytime soon.

3 Reasons why paper prices matter to gold & silver investors

  • Right or wrong, whether we like it or not, gold and silver are valued in dollars per ounce.  
  • For all of the reasons outlined in part 1, short of an Armageddon-like world-changing catastrophe of existential proportion, gold and silver are likely to remain valued in dollars per ounce.   
  • Real or contrived via manipulation, the dollar price per ounce is the only reason anyone is interested in acquiring monetary metals for hedging against inflation or monetary collapse of one sort or another.
The primary reason for investing in and maintaining possession of physical gold and silver is to insure, hedge and protect oneself from the ravages of inflation, or from a severe monetary crisis occurring within the global fiat empire.

Short of Armageddon, in order to effect a suitable claim on such a policy at a future time of pressing need, one will likely need to cash-in/exchange the stable value of their metals, and put the proceeds to work in a readily acceptable currency so as to meet ones varied needs in the prevailing environment of numerous financial stresses.

Think about it this way. You’re in a corrupt system that may (or may not) implode in your lifetime, and you seek to hedge and protect yourself against this, so you invest a measured portion of your worth in physical gold and silver bullion.

That’s great but you can't stop there. Just as you are so inclined to hedge against the plausible disaster, you must also set aside ample resources and the means to hedge your hedge. Meaning that if the dollar doesn’t collapse and instead - the paper-prices of gold and silver collapse further – and you still wish maintain conviction in wanting to hold this insurance without going broke, you have to protect and defend the value of your chosen insurance vehicle.

The only way to do this is through the system – by shorting the paper price of gold and silver via various trading instruments during prolonged bear markets such as the one we've witnessed since the bull market peaked in 2011.

If you want to keep buying on the way down – that’s fine – so long as you have the resources to do so while maintaining the appropriate hedging resources to deploy against past, present, and future bets. At the end of the day, all we’re saying is please don’t delude yourself and over-insure to the point of looking foolish at best, or going broke at worst.

A time and place for everything, and everything in its place in time

As promised, without getting too bat-shit crazy, we will attempt to summarize the time, place, reasons, ways, and prudent means in which one may consider insuring themselves against the real prospect of a monetary catastrophe. 

Naturally, we need to consider some very basic individual circumstances when formulating some general guidelines and suggestions. Hence, based on your individual circumstance, there is a time and place for everything.

If one is currently earning a regular and stable income sufficient to support their intentional lifestyle – accumulating enough income producing reserves on hand to provide for themselves into the their prospective retirement years, the paper-price of gold and silver still matters a lot, but not nearly as much as it does for those without sufficient cash flows.

What we’re saying here is that you don’t want to go all-in trying hedge and protect yourself from a dollar collapse that may or may not happen in your lifetime - without a rational plan. Using good judgment, balance, and measuring your risk against both your projected income relative to your time constraints – and factoring in the variable costs you'll incur as the situation plays out over the long haul are essential to such rationale. At some point, unless you are loaded with conventional system-generated cash flows, you will need an exit strategy.

Cash Flow is King 

No matter what one believes about the future of the dollar, accurately projecting cash flows and sustainable reserves earmarked to facilitate one’s vital comforts and necessities into the future shall remain essential factors that one must address to be successful.

Net Profit is the Measure 

If we agree that cash flow vs. expenditures are indeed king, then we can conclude that the sum of this simple but elegant equation is “net-profit.”

Are you ahead each month, breaking even, or losing ground? Before reflexively tapping resources to hedge yourself with hordes of silver and gold regardless of its paper-price, you should first run your current numbers, and project those numbers out into the future as situational dynamics shift.

Naturally, your projected numbers should be adaptive to current conditions, then adjusted and rebalanced accordingly at regular intervals of six-months to a year, or whatever interval is suitable to your personal situation and preferences.

Building Your Basic Numbers 

If you know Excel, you can build a basic spreadsheet to get a general handle on your numbers. If you don’t, you may want to learn Excel, or find someone who can build a custom spreadsheet for you.

Some of what you’ll need to identify, evaluate, and budget for:

  • Net Worth 
  • Net Income 
  • Net Expenses 
  • Liquid Assets 
  • Cash on Hand 
  • Primary Hedging Operation resources 
  • Resources to Hedge Primary Hedging Operation

A common ratio of gold and silver investments relative to net worth is 10% meaning that if you have a net worth of 1-million in current dollars, it would be prudent insurance to hold 100k worth of gold and silver. 

Know that if you plan on using futures contracts to hedge your 100k of gold at some future time, that each full size futures contract controls 100-troy ounces of gold. Click here for more information on the various contract sizes available for gold and silver. 

Advantages of Futures Contracts
The following is from Investopedia. Because they trade at centralized exchanges, trading futures contracts offers more financial leverage, flexibility and financial integrity than trading the commodities themselves. 
Financial leverage is the ability to trade and manage a high market value product with a fraction of the total value. Trading futures contracts is done with performance margin.
It requires considerably less capital than the physical market. The leverage provides speculators a higher risk/higher return investment. 
For example, one futures contract for gold controls 100 troy ounces, or one brick of gold. The dollar value of this contract is 100 times the market price for one ounce of gold. 
If the market is trading at $600 per ounce, the value of the contract is $60,000 ($600 x 100 ounces). Based on exchange margin rules, the margin required to control one contract is only $4,050. So, for $4,050, one can control $60,000 worth of gold. As an investor, this gives you the ability to leverage $1 to control roughly $15. 
In the futures markets, it is just as easy to initiate a short position as a long position, giving participants a great amount of flexibility. 
This flexibility provides hedgers with an ability to protect their physical positions and for speculators to take positions based on market expectations. 

Obviously, based on numerous inputs, your net worth will fluctuate from year to year, and as such, one can revisit their physical holdings relative to their net worth on a yearly basis, and readjust their allocations/hedges accordingly. 

For example, say you bought years ago, and purchased gold at an average price of $800 per ounce. Then after peaking in 2011, the long-term trend in gold turned downward, and price began to decline back down toward your average cost – but you still wished to maintain possession of all that you had originally acquired for long-term insurance. What could you have done?

The only thing you could have done short of selling some or ALL of what you had is to have sold the paper-price short within the firmly entrenched systems financial markets.

Rather than forfeiting your insurance altogether or seeing its value decline by more than 50%, this is what you could have done instead. 

When the long-term trend turned down, upon calculating the worth of your holdings in present dollars, you could then have used appropriately sized futures contracts or inverse ETF's to protect a proportionate and specific value of your holdings against further dollar-based declines.

As such, with that hedge protecting the value of your insurance policy in place,at some point in the future, when the long-term trend reverts to the upside, you could then lift your short positions in the paper markets. It’s that simple.

As an aside, if you seek assistance in timing the long-term trends for this purpose, you can subscribe to the Long-Term Trend Monitor, which sports a rather impressive record of accomplishment in identifying major turns in Gold, Silver, and the S&P 500 index.

Once you have a realistic handle on your current and projected financial condition, you can then begin to formulate a rational plan that includes several contingencies i.e. the accumulation of physical gold and silver for instance.

Quite some time ago, we prepared a tangible asset spreadsheet for our companion site, Prudent Measures. We designed the spreadsheet to help people with allocating their funds for building a Tangible Asset Assurance Portfolio, or (TAAP) as we’ve named it.

It is rather rough in form, and includes such things as accounting inputs for reclaiming retirement funds, but nonetheless, we believe it is suitable for modification, and a good starting point from which to begin building your numbers in the aforementioned realm.

Below we have provided a static screen shot of a generic example showing what the Tangible Asset Assurance worksheet looks like. Click here to download and save the excel file to begin working out your own customized spreadsheet.

In creating and executing your plans, just remind yourself on occasion of how critical paper-prices are to all of your efforts, for at the end of the day, this pricing metric – or one very similar, is likely to remain the means of accounting that you will use to measure your success or failure. 

Until Next Time,

Trade Better / Invest Smarter

The Chart Cast Pilot and Elliott Wave Technology’s Guardian Revere Long-Term Trend Monitor are the proud sponsors of this communication.