Reflections of a Contrarian Investor
PHILIP: It is not every day that I have the pleasure of speaking with someone of the caliber of Mr. Adam Hamilton. For sometime I have been reading Adam’s weekly articles published on various leading websites. Adam’s perspective is always refreshing, his research and historical outlook, second to none. His articles always leave the reader with a better understanding of the days in which we are living. The front page of his excellent website www.zealllc.com says it all “seeking truth in an age of deception”.
PHILIP: I’m privileged today to be speaking to with Mr Adam Hamilton, a private investor and contrarian analyst. Mr Hamilton publishes Zeal Intelligence Newsletter, an in depth monthly Strategical and Technical analysis of markets, geo-politics, economics, finance and investing delivered from an explicitly pro free market and lasse fare perspective.
Adam, you’ve called yourself a contrarian investor, what do you mean by that?
ADAM: Well a contrarian investor is someone who doesn’t follow the normal general perceptions of markets. A contrarian tends to think that the majority of investors are usually wrong. For instance a contrarian thinks that by the time a sector of the market is really hot like the NASDAQ in March 2000 it is already overvalued and it is time to sell. A contrarian thinks that when a market is really low and everybody hates it like the gold market for instance right now it is time to buy.
A contrarian is one of those goofy black sheep, I guess, who likes to buy straw hats in winter and sell them in the summer when everybody wants them. They buck the trend, I guess, which is the best way to explain it from an investment standpoint.
PHILIP: That’s a good explanation. Sometimes it requires a lot of patience.
ADAM: Yes it does, it is really hard. One of the biggest things for a contrarian is first of all, all your friends, all your investments friends, all you associates think you’re crazy because they’ve seen the markets and seen what’s happening. Everybody gets caught up in the hype, even contrarians get caught up in the hype.
You know there are times when contrarians doubt, I doubt my trades and positions. You know, sometimes there are times when you think you are way too early, it’s never going to happen, there’re times when you wonder why you put in all this effort and try to understand it all when you could just trade in the momentum sectors, like they are doing on the financial television programs in the States. So it is definitely challenging at times without a doubt.
PHILIP: Well Adam for quite some time you’ve been writing about the markets being in a bubble phase and due for a major correction. What are some of the signs of a typical market top?
ADAM: Oh great question. One of my favorite hobbies in the market is reading about 1929, and also about the manias before that like London and France in the 1720’s and Holland in the 1630’s, the famous Tulip mania. I think the most important hallmark of a bubble fundamentally is measured by valuations. As you know every stock spins off a certain cash flow stream either through earning or dividends, or else the probability of future earnings of dividends, and in an extreme mania, those valuations really get to ludicrous levels. For instance, people might buy stocks that will take a thousand years for them to make back their original investment at current prices. Also, there is a really important psychological dimension and I think that it’s important to realize that when everybody in the world thinks something is a great investment, and they are just going to throw unlimited money at it, like the internet dot coms around the world last year, then that it is probably time to sell, because there is probably a bubble brewing
PHILIP: In the last 12 months we’ve seen probably the worst stock market performance in twenty years and then now in April of 2001 many are saying we are seeing a bottom, particular in the technology stocks. Do you feel the bottom is in place or could it just be called a dead cat bounce?
ADAM: How true, it should be a dead cat bounce. I’m about 95% certain that we haven’t seen anywhere near a bottom of tech stocks around the world Philip. The primary reasons are in historical bare markets after a super cycle bubble; by super cycle I mean every sixty years or so there is a giant mass speculative mania when you know everybody from shoe-shine boys to CEO’s are just investing all their money in the markets. After one of these bubbles, historically, you usually see lows go to ten or fifteen years back, ten or fifteen years of gains of the full market erased in a bear market. Currently the April 2000 lows of the NASDAQ in the US for instance, they were still well above the 1998 lows.
I did some research for a recent essay I wrote for the internet, and if you go back to 1990, of the United States NASDAQ, the low for that year was October 16th and it was 325, by the way that’s not 1,325, just 325 on the index. I think we have a long long way to go on the NASDAQ, we’re not even close to the bottom yet.
PHILIP: A moment ago you touched on valuations and even at this sort of sold level of the NASDAQ now we’ve still got things like Cisco I think I saw yesterday at 166 times earnings, so we have still got extreme valuations, haven’t we.
ADAM: Absolutely, it’s just incredible. Valuations are one of the primary indicators my company uses for trading our own accounts, my partners and I every month accumulate all the data from all the stocks traded in the United States from the major industries like the S&P500 and the NASDAQ 100, and we do what we call a market capitalization weighted average.
With a big company like Cisco, we take its’ weighted average and we compare it to rest of the market. Cisco has a higher market capitalization, which is it’s shares outstanding times the share price, than smaller companies like Juniper Network. But we find that the NASDAQ 100, the 100 biggest stocks in the NASDAQ, still have a market capitalisation weighted average P/E of over 50, and that was before the latest downward earning revisions. So by historical standards we are looking for a level of maybe 8 to 15 for a bottom on the NASDAQ, but with it still above 50, probably above 75 or 100 now on the aggregate with the negative earnings surprises, we have a long way down to go from the fundamental valuation perspective.
PHILIP: Adam, a moment ago you also touched a little bit on market psychology, I guess the psychology of the masses as an indication of a market top. We have obviously got a lot of mass investor almost hysteria still in the market, people are fundamentally still bullish, so that you would see also as an indication that we are no where near bottom.
ADAM: Absolutely, I just read a statistic this morning that 68% of the professional investor advisers in the United States are bullish right now, it is the highest level ever in the history of the markets. A bottom is something you can never have when everyone is looking for it.
As we saw when Alan Greenspan and the US Fed did the surprise rate cut on April 18th in the United States, money poured in like crazy, hot money from all over the United States and probably all over the world jumped into the NASDAQ, the tech stocks again. So it is really obvious, like you said, that psychology is still boiling. There is still a lot of mania type stuff here and until we get to the point where the average investor just hates the market, can’t even stand thinking about an index quote, we are not going to get anywhere near a bottom from a historical hysteria perspective.
PHILIP: Sure, you’ve just mentioned interest rates as well. We’ve seen an amazing growth in M3 and also MZM in the past four to five months, really hitting record levels. It appears the Fed is attempting to flood the economy with money. Why would that be?
ADAM: Oh, that’s a fantastic question and it was answered in your excellent Millennium Money documentary. Basically I think the problem is that in the United States we have a fractional reserve banking system which, as you explain in your video, has the attribute that where every one dollar that is put in the bank is inflated maybe 50 times. So every one-dollar in real currency represents $50 in credit. What happens when the economy slows, when banks quit lending out their money and the credit system stops expanding, things start deflating. Deflation is a really slippery slope, when credits start to get rained in and when banks stop loaning money and people stop wanting to borrow money, the credit system starts to implode faster and faster and faster. So I think the unprecedented growth rates and the money supply measure that is in the United States is the result of the Federal Reserve’s efforts to stave off a deflationary collapse like we had in the 1930’s in America.
PHILIP: Right at this time this is happening, America and the west generally, is carrying the maximum amount of debt it ever has in all history, whether that be consumer debt, corporate debt, you reach a point, as we’ve seen in Japan, where you simply can not take on any more debt regardless of what the interest rate. Even in Japan, where the interest rate has been moved down to zero, you simply can not monetize any more money through debt.
ADAM: One of the really interesting things about that is on the Financial media, CNBC is the major financial media in the United States, the most influential financial network. Everybody watches it even the contrarians, even if they won’t admit it; even I watch it. But one of the main arguments of CNBC for the fantasized second half recovery in the United States, is that consumers are going to start spending again, and as you said, consumer debt in the United States, corporate debt, government debt is at its’ highest levels ever and my company doesn’t think that consumers will have the money to spend their way out of this current recession we’re in or likely to be in. So, just as in Japan, zero percent interest rates don’t really matter after a bubble if people don’t want to spend, and in Japan the nation is net savers; they are just zealous savers. In the United States we’re not that urgent, our saving rate is negative. So the situation would likely be far worse in the United States than even in Japan.
PHILIP: In the last four to five months the Fed has been in an interest rate lowering mode meanwhile the EU Central Bank hasn’t moved accordingly to lower interest rates. What do you think the long-term impact on this could be on the US dollar?
ADAM: Oh, very negative. Obviously there’s trillion of dollars of hot money splashing around the globe every day and it’s seeking the highest short term return. The dollar becomes less competitive the lower the interest rate goes. The lower the interest rate goes generally it pushes down yields on the United States Treasury debt. When ECB is holding steady the yield on Euro denominated debt is higher relative to the US dollar because the European interest rate is relatively higher than the US interest rates and I think this ultimately leads to a fire sale of the US dollar, we can see mass selling of the US dollar anytime actually. It could drop 10, 20, 30 maybe even 40% over a few months if people decide to chase higher yields in the European super state rather than in the United States. I wouldn’t blame them with all the problems we have in the United States. I mean Europe is not a financial nirvana, but it certainly is better than the United States right now and it seems like, with all the problems we have with speculative excesses are over here.
PHILIP: The Euro zone is in current account surplus of course. There is a reported gold reserve against the Euro, so I think it could eventually become a major force to be reckoned with.
ADAM: Absolutely, the information coming out now indicates that the US government maybe propping up the US dollar through illicit gold sales. If those rumors are true and the evidence is true, then it means the US has known for a long time that the dollar is overvalued fundamentally based on inflation rates in the United States and our economy. The ultimate effect on the dollar could be just profound.
PHILIP: People studying the precious metals market, particularly from a contrarian point of view, have been saying in recent years that the market has been very clearly artificially suppressed lower, meanwhile others within the gold community scoff at these manipulation claims. Why would that be?
ADAM: Well, conspiracy is a word no one likes. No one likes to admit a conspiracy or thinking about a conspiracy and actually pretty much everybody, myself included, the conspiracy is the last theory. You go through all these theories on why markets are moving and at the very end of it you get to the conspiracy theory. Nothing else can explain a market movements based on supply and demand fundamentals. You know, who’s buying, who’s selling, how many new tons of precious metals are being mined here, how many tons have been demanded around the world, especially in Asia. You get to this point after a while where a conspiracy is the only option to explain the prices. The people who believe in the conspiracy theory is still relatively small, it is more the professional analyst community. There is a lot grassroots support for notion that gold has been artificially suppressed because of the work of Bill Murphy and Reginald Howard of the North American GATA organization (Gold Anti-Trust Action committee). But so far, in the professional community, as you point out, most people scoff at the conspiracy theory. Gradually more and more people are coming to believe in it, because that seems to be the only plausible explanation for the gold markets activity, in the last few years for sure maybe the last six on the onside.
PHILIP: Something I’ve spoken about a lot and you’ve certainly written a lot about it, is the way in which this manipulation has been able to come into play through central bank leasing of physical bullion into the market. In very broad, brush terms can you let us know how much gold is still available from central banks vaults either through direct markets sale or through this leasing bullion carry trade.
ADAM: Absolutely, to be honest there is a lot of debate in this, the people who don’t buy the conspiracy theory tend to believe that, well first of all lets start with a figure. There is about 33,000 metric tons of gold that central banks around the world report as assets in their vaults.
Now one of the things that is pretty wild about leasing is, from an accounting perspective, when a central bank leases out the gold it still stays as an asset on their books, because technically the central bank still has title to that gold even though someone else has borrowed it and sold it on the open market and re-invested the proceeds elsewhere. So no one really knows, out of this 33,000 tons of gold, how much has been leased. But the conventional estimate of London based gold organisations is around 5,000 tons. In conspiracy theory, advocates believe, out of that 33,000 tons of central bank gold, the numbers are closer to 10,000 to 15,000 tons of gold that has been leased and sold into the market.
PHILIP: That’s a very big difference.
ADAM: Oh it is huge, it is a vast difference. One of the things that is important to realize is that, out of all of this gold released in the market, most of it would be very difficult or impossible to get back again at current prices. Physical demand has been super heavy in the Asian nations, specifically India, it’s probably the leading example, Turkey and the Middle East. Lots of these people that haven’t lived under the relative stability that we have enjoyed in the western democracy, know that currencies are really fleeting and temporal, paper currencies. It just grabs at their hearts that they know gold as their only alternative financial refuge in times of trouble. So that heavy, heavy Asian buying and a lot of the western gold has been leased from the banks, I believe that its moved east into Asia and is around peoples necks in India and Turkey and it will be really hard to get back unless gold prices go naturally higher.
PHILIP: I’ve always thought and said that it’s really shows a shift of nations power ultimately doesn’t it? Not in the short term but in the longer term the more gold a nation amasses, or a block of nations amass, to themselves, ultimately the greater power they will have, that is at least what we have seen through history.
ADAM: Yes, that’s the biblical definition but the kind of popularized definition of the golden rule is “he has the gold makes the rules” is so true for people and nations, and as you point out in the Millennium Money documentary, civilizations who have had a good strong gold based currency have lasted as long as the currency is not debased. But as soon as the gold moves to somewhere else that civilization falters and I think the same thing is happening in the west. We have heavily, heavily indebted fiat currency, debt based welfare states United States, most of Europe, Australia and we are getting to the point where these states can not support themselves any more. They debase the currency so much they’ve just done away with all financial prudence and the new rulers of the world from a gold perspective, from a true financial perspective, are going to be those Asian countries which are amassing these hoards of gold.
PHILIP: Yes sure, and of course the Middle East too.
ADAM: It’s frightening. Being a westerner, it is kind of frightening to realize that we’ve sold our own future away just by the things we’ve done to our currencies, the debt levels, it is really sad.
PHILIP: Adam on your website www.zealllc.com you’ve got a couple of reports about the Delta Hedging trap which I think our listeners would do well to read those. Can you explain in very simple terms the danger in the incorrectly structured Delta Hedging positions of some of the large financial and bullion banking institutions.
ADAM: Well first of all it is important to have a basic understanding of Delta Hedging. Delta Hedging is an option hedging model based on mathematical formulas developed in the 1970’s. Basically what it says is that you can write an option to this, you can have a short position in gold, in other words you can owe people gold you don’t have, you can borrow gold and sell it, or you can sell gold options that allows someone else to buy gold from you if the gold rises to a certain price.
But the option pricing model has this thing called a Delta Hedge and what Delta Hedge says is that for every one dollar rise in the price of gold you have to buy such a percentage of your total short position back on the open market in physical terms. Basically the Delta Hedge is a mathematically derived level of physical protection that you have for your short position. Say you had a thousand tons of gold that you owe somebody, if the price rose ten dollars an ounce you might have to buy 100 tons of physical gold in the open market.
These Delta Hedge formulas are really complex and probabilistic. But the basic thing that people should realize is that if the price of gold rises, the large bank holding the short position in gold, is forced by prudent money management practice to buy physical gold in the open market to maintain the correct Delta Hedge levels for the total short position.
PHILIP: But we’ve been observing is that this may not have been the case, where bullion banks have in fact, rather than buying in a market rally, they’ve actually come into that market and sold physical gold, which I guess would indicate that they have actually being doing the opposite to what they should have been from a prudence point of view.
ADAM: That is really important information from a shareholders standpoint. There’s lots of shareholders around the world who own shares in these large gold short bullion banks and the shareholders have no idea that the managers of these banks are not following time tested option and short management principles in Delta Hedging their portfolios properly. I think there is going to be just a whirlwind of litigation when people realize what has been happening.
The second point I’d like to make, which is one of the key tenets of the conspiracy theory, and that is, why does everybody sell into a rally all the time, when prudence dictates that if they are short, they should buy? As you point out, when there is 4,000 metric tons of gold demanded annually and only 2,500 tons produced, why does the gold price go down year after year after year, no matter what the bullish news is, and so the behavior of these large bullion banks selling into rallies, instead of adding to their Delta Hedges as they should be, this is a definite big clue that something might not be right in the gold market.
PHILIP: I know it is hard to look into the future, but can you suggest what may be a likely outcome of Reg Howe’s action in the Boston Court against Bank of International Settlement, the Fed and the US Treasury?
ADAM: Oh that’s a great question. I honestly don’t know what the judge will do, the judge in the United States is hearing the case in Boston. He has the legal right, he can just throw out the case if he wanted to. I’ve read the documents and I am involved in the legal proceedings on Reg Howe’s discovery team. We all think on the team that there is a lot of merit to the case and there is no way a reasonable person could throw it out once they read all the documents and understand what is happened, so I would say it is a 50/50 percent probability whether the judge admits it or whether he throws it out.
Now if the judge admits it we will probably see a lot of fire works in the gold market because once a judge admits it, it gets really serious. That means that Reg Howe can take his defendants to discovery stage, meaning he can demand private gold trading records from these big bullion banks who allegedly short gold. Once we pour over those records we’ll have a lot better grasp of what has happened in the last five or six years.
I think the gold price will rise dramatically if the judge accepted the case to move forward. Now if the judge rejects it, then we will probably see a sell off on gold, there is a lot gold holders who are really betting on the case, really excited about Reg Howe’s efforts, and they will probably be disappointed if it is thrown out. But I think we’ve got pretty much have even odds right now. The best lawyers in America say that no matter what the merits of your case you usually have a 50/50 chance of winning or losing because of the way the legal system works.
ADAM: That’s why I’m excited about it right now, I certainly hope it goes forward.
PHILIP: Certainly I think we all would. What are the time-frames?
ADAM: Well Reg has told us that the judge could take as long as he wants to rule on the case, it is an extremely complex case, I mean there are hundreds of pages of documents and it is really difficult to grasp, especially if one doesn’t have the financial training, and so the judge can honestly take as long as he wants to go over the case. He could make a ruling tomorrow or it could be two or three months from now, we really don’t know how long it is going to take for him to make a ruling about whether we go to the discovery phase or whether it is thrown out and dismissed as the defendants all want.
PHILIP: Adam, can you give us a little background about what your organization is all about?
ADAM: Well, Zealllc is a company I founded with some partners. The basic mission of Zealllc is to provide world class information and provide those information services with honesty and integrity. It is a Christian organization, we are all traders, we are all contrarians investors, we believe that through biblical principles we can manage money and increase the assets God entrusted us with. I myself write weekly essays that I publish on the internet at our site www.zealllc.com those are published once a week and they are on various financial topics and they can be anything sometimes they are about gold, sometimes they are about tech stocks, sometimes they are about interest rates, just anything financial or economic that I happen to find interesting at the time. Those tend to be pretty strategic. But we also publish a newsletter Zeal Intelligence which is published every month and that is much more tactical and specific and in that we give our best advise or recommendation of what is going to happen and what specific stock or options to buy for the chance of profiting. So that is more of a geo-political intelligence briefing trading type journal than just a strategic view like the weekly essays are.
PHILIP: Well Adam thank you very much for your time today.
ADAM: Well thank you Philip, it was a blessing to talk to you, and I wish you and your company nothing but the best in your future endeavors. God bless your listeners as well.
by Philip Judge