Freedom Lawyers of America

Asset models require radical surgery
Most investors ignore cash, gold, commodities, silver

By Thom Calandra, CBS.MarketWatch.com
Last Update: 10:45 AM ET Oct 7, 2002
SAN FRANCISCO (CBS.MW) -- Investors, consumers and November voters are holding more influence over the U.S. economy than at any time since the 1991 recession.

The president of the United States is courting voters and legislators with a Monday night speech about Iraq. The Federal Reserve is keeping fingers crossed on the mood of shoppers. Mortgage investors are wondering when the home refinancing boom will stop reducing the take from their monthly income.

Individuals, for the first time in my recent memory, are beginning to ask if the stock market's demise is something more than a passing trend. At the shopping mall and alongside their kids' soccer matches, Americans are making earnest queries about the erosion of paper wealth in America.

Their concern comes after three years of what stoic investor behavior in the face of the equity storm. Some are even wondering whether it's prudent to be taking refi-cash out of their homes and spending it on home improvements or new cars when their next paycheck may evaporate with a J.P. Morgan Chase-style layoff. See the J.P. Morgan report on 4,000 possible layoffs.

Here in this corner, the view is the same as it's always been: The stinking stock market is not done stinking up the joint, nor will the contraction of stocks, corporate bonds and U.S. dollar be over anytime soon. See: Dow destined for 1,000-point drops.

"We are either going to inflate out or deflation will (persist)," says Michael A. Berry, a former professor of quantitative analysis who favors radical shifts in asset allocation for ordinary investors. "The U.S. equity market is, by historic standards, still significantly overvalued even with the declines in the spring and summer of 2002. It is still replete with the psychology of hope each time a bear rally occurs."

The psychology of hope centers on those one-day, 300-point Dow rallies we see each week. While ordinary folks are praying the rallies signal a return to good times, professionals and prudent investors are using the one-day inflations to sell their holdings and shift into cash.

Berry, who holds a doctorate in finance, recently presented a paper at the San Francisco Money Show. In it, he refers to Gustav Le Bon's 1895 book, "The Crowd: A Study of the Popular Mind." Le Bon explains, "When by various processes an idea has ended by penetrating into the minds of crowds, it possesses an irresistible power and brings about a series of effects, opposition to which is bootless."

In real life October 2002, this means most Americans, snow-stormed by a decades-long rush into stocks, have "forgotten to diversify, forgotten asset allocation, forgotten that markets always revert to their mean value," says Berry.

Wall Street doesn't make life any easier. The big banks and brokerages routinely ignore gold, silver and agricultural commodities in their asset allocation models. The Wall Street and London banks pay lip service to cash, an investment that is not even on the radar screen for ordinary folks seeking their cruise-ship retirements in 10 or 20 years.

The few Americans out there who restyled their portfolios two years ago, or even two months ago, almost certainly weren't considering cash as a powerful investment alternative. Forget about gold and commodities in general -- even though these two classes are up about 18 percent since Jan. 2.

"Gold has been such an under-performing asset class for so long (last 20 years) that it has been forgotten," says Kevin Lane at Technimentals Research in New York. "Not to mention not too many gold and silver companies pay banking fees." In these days of double-dealing Wall Street banks, there is no business reason for a J.P. Morgan or a Goldman Sachs to advertise gold in their portfolio models.

"Investing," says Berry, "is terribly difficult because we are human," Berry tells me, "Our brains are wired to sell at the bottom and buy at the top. We are, without question, creatures of hope and fear at market extremes."

Berry says some 40 percent or more of Americans' portfolios require surgery. His top choice for a quick fix is a little silver. At the just-finished Denver gold show, Pan American Silver (PAAS) CEO Ross J. Beaty took a half-hour to tell me about the new, growing uses for the precious metal group's little brother. See: Gold crowd is growth crowd.

These uses include silver as a possible replacement for the bacteria-battling agent chlorine. Medical uses as disinfectants and anti-bacterials are also growing, says Beaty, who serves as president of the Silver Institute this year.

Berry also points to anti-microbial silver compounds that combat pathogens, such as Legionnaires Disease, salmonella and e-coli bacteria. Silver solutions that could prolong the life of lettuce and other produce are also in the works, he says.

"Warren Buffett purchased 129.7 million ounces of silver in 1998. He must believe in its worth because there is a significant cost of carry to the metal," says Berry. "George Soros and his Quantum Fund own 32 percent of Apex Silver Mines (SIL), which has a 500-million ounce proven deposit in Bolivia. Bill Gates owns at least 10 percent of Pan American Silver."

Even with demand for silver increasing about 4 percent a year, ordinary investors are ignoring the metal, Berry explains.

And then, there is the short angle. Large gold producers that mine silver as a by-product, chief among them Barrick Gold (ABX), have short-sale, deferred-price and other hedged and leasing positions that effectively cap the metal's price by adding to the paper-trading of silver.

The annual production of silver (less than 1 billion ounces a year) amounts to 2 percent of this short position, Berry says. "While I am not predicting a short squeeze, consider the outcome should there be a short squeeze," the former professor says.

Spot silver (82799W01) Monday was selling for about $4.50 an ounce, or about the same level as it was a year ago.