Category: simonblack

It’s one of the best sectors in the world for explosive gains…

Deeply cyclical industries such as shipping, oil & gas, mining, and the service industries that supply them are one of the few areas of the market where you can actually make 5 to 10 times your money… and you can make those kinds of returns on large, well-known companies.

Anyone who tells you those types of gains are only achievable by taking wild speculations (bitcoin comes to mind today) is wrong.

Cyclical stocks can fall 80 or 90% during a downturn. But when the market turns, these beaten-down stocks are coiled springs.

And here’s the best part…

Because you’re buying solid companies at rock-bottom prices, you’re able to achieve these enormous returns without huge amounts of risk.

Take shipping company Frontline (FRO) for example. It’s the largest oil tanker company in the world. Frontline owns a fleet of 59 tankers that it uses to move oil and oil products from where they are produced around the world to where they are consumed.

It’s a simple business. But it’s one of the most cyclical in existence.

When oil prices soar, demand for tankers is extremely high and shipping companies such as Frontline charge very high “day rates” to rent their vessels.

As day rates increase, companies redeploy any idle ships to capture those profits. And they order new ships (which can cost around $100 million and take years to build).

At the same time, the underlying oil market is seeing similar activity…

As oil prices increase, producers rush to bring more oil online. We see an oil glut and price crash.

Drillers idle their rigs. Shipping companies are stuck with extra capacity.

Day rates for shipping plummet. And highly indebted shipping companies struggle to even service their debt (and hold on to their ships).

Lots of shipping companies go out of business in the downturn, which reduces the tanker supply.  The companies that survive are forced to idle their excess ships.

Soon after, there’s a shortage of tanker capacity. And day rates start creeping back up.

The companies that survived the cyclical downturn are in prime position to make windfall profits as the next bull market gets under way.

Back to Frontline…

The stock hit a low of $19.95 on September 1, 2001. But shares soared to over $300 by November 2004. That’s a 1,400% gain – enough to turn every $10,000 invested into $150,000 in just three years.

But shares fell back down to $164 by January 2007. Then another bull market sent them soaring to new highs of $348 by June 2008.

You get the idea. Cyclical companies like Frontline are volatile.

If you bought at the bottom of the cycle in 2001 and held until the June 2008 peak, you made a life-changing 1,644% gain.

At Frontline’s 2008 peak, crude oil was over $140 a barrel. Today, it’s trading for less than $52.

And shares of Frontline have fallen 98% to just over $6 a share.

But Frontline is still one of the largest tanker companies in the world with a $1 billion market cap. It’s survived previous downturns. And I’d bet it will survive this one, too.

So anyone buying shares of Frontline today could potentially make hundreds, even thousands of percent profits.

It sounds easy enough.

Wait for cyclical stocks to fall 90%, buy at the depths of the market, then wait for the cycle to turn around.

But two things typically conspire against investors achieving success in deep cyclical stocks:

1. Human nature. Most people can’t act against the crowd and buy when assets are hated and prices are depressed. It’s scary to do. And it’s easy to fall into the trap of believing “this time it’s different,” and that the gloom and despair are going to last forever. But it never does.
2. Debt. Whether the cyclical company in question has too much debt to survive the deepest down-turn is always a key consideration. And it pays to err on the side of caution. Hence, I am only interested in largely debt-free cyclical businesses. And there are not a lot of them.

Here’s a 70-year chart of crude oil prices that shows you just how big the swings can be. Be honest with yourself… Could you withstand these wild price swings?

I’m currently recommending a cyclical oil exploration company in The 4^th Pillar… And it fits perfectly into my strategy of buying high-quality companies at less than their net cash.

At the top of the last oil boom, the company’s shares were north of A$12. They’d run up from the initial listing price of 20c. In other words, $10,000 invested at the IPO would have grown to $600,000 at the top of the boom — a gain of over 5,900%.

Right now the company has a market value of under A$300 million. But it’s got around A$400 million in cash and no debt.

Plus, the company owns 100% of an oilfield I think can throw of US$409 million a year in revenue (remember, the entire company is under A$300 million today) … And oil majors Chevron and Statoil are exploring near its other major asset. If either of these companies has success, this small company will soar in value.

4^th Pillar subscribers can access this recommendation in my September issue.

For everyone else, if you’d like to learn more about The 4^th Pillar and immediately access this recommendation, click here…

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US stock markets hit another all-time high on Friday.

The S&P 500 is nearing 2,600 and the Dow is over 23,300.

In fact, US stocks have only been more expensive two times since 1881.

According to Yale economist Robert Shiller’s Cyclically Adjusted Price to Earnings (CAPE) ratio – which is the market price divided by ten years’ average earnings – the S&P 500 is above 31. The last two times the market reached such a high valuation were just before the Great Depression in 1929 and the tech bubble in 1999-2000.

Some of the blame for high valuation goes to the so-called “FANG” stocks (Facebook, Amazon, Netflix and Google), whose average P/E is now around 130.

But there’s something different about today’s bull market…

Simply put, everything is going up at once.

Leading up to the tech bubble bursting, investors would dump defensive stocks (thereby pushing down their valuations) to buy high-flying tech stocks like Intel and Cisco – the result was a valuation dispersion.

The S&P cap-weighted index (which was influenced by the high valuations of the S&P’s most expensive tech stocks) traded at 30.6 times earnings. The equal-weighted S&P index (which, as the name implies, weights each constituent stock equally, regardless of size) traded at 20.7 times.

Today, despite sky-high FANG valuations, the S&P market-cap weighted and equal-weighted indexes both trade at around 22 times earnings.

Thanks to the trillions of dollars printed by the Federal Reserve (and the popularity of passive investing, which we’ll discuss in a moment), investors are buying everything.

In a recent report, investment bank Morgan Stanley wrote:

We say this not as hyperbole, but based on a quantitative perspective… Dispersions in valuations and growth rates are among the lowest in the last 40 years; stocks are at their most idiosyncratic since 2001.

So, ask yourself… With stocks trading at some of the highest levels in history, is now the time to be adding more equity risk?

Or, as billionaire hedge fund manager Seth Klarman notes… “When securities prices are high, as they are today, the perception of risk is muted, but the risks to investors are quite elevated.”

Volatility – as measured by the Volatility Index (VIX) – remains below 10 (close to its lowest levels in history). For comparison, the VIX hit 89.53 in October 2008, as the market plunged.

We haven’t seen a 3% down day since the election. And if that holds through the end of the year, it will be the longest streak in history.

And this false sense of security comes just as the main driver of this bull market – the trillions of dollars global central banks printed after the GFC – is coming to an end.

Markets saw around $500 billion of accommodation in 2016. And “quantitative tightening” should suck about $1 trillion out of the markets in 2018… That’s a $1.5 trillion swing in two years. And it’s a major headwind for today’s already overvalued markets.

But that’s just one issue. Remember, we also have…

Slowing global growth, record-high debt, potential nuclear war with North Korea, a rising world power in China, and cyber terrorism (just to name a few of the potential pitfalls) …

Still, investors continue to put money to work without a care in the world.

And more and more of that money is being invested with ZERO consideration of market valuation – thanks to the rise of passive investing.

Through July 2017, exchange-traded funds (ETFs) took in a record $391 billion – surpassing 2016’s record inflow of $390 billion.

According to Bank of America, 37% of the S&P 500 stocks are now managed passively.

Investors in these passive index funds and ETFs pay super-low fees in return for an automated investment process. For example, any money invested in a passively-managed S&P 500 ETF is equally distributed (based on market cap weighting) across the 500 S&P companies… So, companies like Apple, Google, Facebook and Amazon get the biggest share of that money.

The result… as this dumb money rushes in, the biggest stocks get even bigger – despite their already ludicrous valuations.

And the biggest players in this field are amassing a tremendous amount of power.

Vanguard, which introduced the world’s first passive index fund for individuals in 1976, has $4.7 trillion in assets (around $3 trillion of that is passive).

BlackRock, the world’s largest asset manager and owner of the iShares ETF franchise, is approaching $6 trillion in assets. And only 28% of BlackRock’s assets are actively managed.

Passive funds owned by these two firms are taking in $3.5 billion a day.

Bank of America estimates Vanguard owns 6.8% of the S&P 500 (and stakes of more than 10% in over 80 S&P 500 stocks).

And as long as the money keeps flowing into passive funds, the bubble keeps expanding.

At a time of exceptional market risk, more and more money is being managed without any notion of risk.

But what happens when these uninformed and value-agnostic investors have to sell?

Humans are emotional creatures. And when we do finally see that 3% (or even larger) down day, investors will rush for the exits.

And the computers will pile on the selling (every model based on historically low volatility will completely break when volatility spikes).

But when the wave of selling comes, who will be there to buy?

As these passive funds dump the largest stocks in the world, we’ll see an air pocket… nobody will be there to hit the bid.

And when the drop comes, it will come faster than anyone expects.

So, while most investors are ignoring risk, I’d advise you to use this record-high stock market to your advantage…

Sell some expensive stocks to raise cash. Own some gold. And allocate capital to sectors of the market that haven’t been blown out of proportion thanks to the popularity of passive investing. That means looking at smaller stocks and stocks outside the US.

Even if stocks go up for another year, which they may, it’s simply not worth the risk to chase them higher… Because the downturn will be devastating.

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In today’s podcast, Sovereign Man’s Chief Investment Strategist Tim Staermose joins me to talk about the risks in today’s market…

We cover the rise of passive investing, and why we think it could cause chaos when the market turns – with some of the biggest and most popular stocks (like Apple and Amazon) falling 10% or 20% in a day.

We also discuss the massive amount of debt in the system today and how capitalism has turned upside down.

Tim also explains his value-investing strategy that has led to a 97% success rate in his advisory service, The 4th Pillar… And he shares a couple of his favorite opportunities today.

You can listen to the full discussion here.

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In 1982, a man named Jim Tisch bought seven supertankers for $42 million. He found them by cold calling companies he found in the Yellow Pages.

Yes, $42 million is a lot of money… but these tankers were each four football fields long. That’s a lot of steel. And they could carry between 2-3 million barrels of oil.

And these ships were built just eight years earlier at a cost of $50 million apiece.

Jim Tisch is the son of the legendary Laurence “Larry” Tisch, the late billionaire founder of Loews. Corp – a conglomerate that has owned hotels, movie theaters, insurance, cigarettes, oil and watches over the years.

And like his Dad, Jim had a nose for value…

Low oil prices in the early 1970’s (around $3 a barrel) caused demand to soar. To keep up with the growing demand, everyone rushed to build supertankers (which can take years to complete).

Then the Arab oil embargo in 1973 sent oil prices soaring to $12 a barrel by 1975.

The Iranian Revolution (and ousting of the Shah) followed in 1979… And Iran drastically slashed its output. Oil jumped to over $37 a barrel.

Now there was much less oil coming out of Iran (and a year later, Iraq), but the tankers were still floating in the water.

Tisch started sniffing around for tankers in the early 80s, when, according to Tisch, only 30% of the global fleet was necessary to meet demand.

That’s why he was able to buy at an almost 90% discount. As he said at a 2006 speech at Columbia University:

[S]hips were trading at scrap value. That’s right. Perfectly good seven-year-old ships were selling like hamburger meat – dollars per pound of steel on the ship. Or, to put it another way, one was able to buy fabricated steel for the price of scrap steel. We had confidence that with continued scrapping of ships and increased oil demand, one day the remaining ships would be worth far more than their value as scrap.

By 1990, the market for tankers was turning around… too many ships were scrapped and the volume of oil coming from the Persian Gulf was increasing.

Noting the strength, Tisch sold a 50% interest in his ships for 10 times his initial investment.

He still maintained half ownership… and collected enormous cashflows from operating those ships.

When he first stepped foot on a supertanker, Tisch said he formulated the “Jim Tisch $5 million test.” From the same speech at Columbia:

And what is the Jim Tisch $5 Million Test, you may ask? While on the ship you look to the front and then you look to the rear – then take a look to the right and then to the left –then you scratch your head and say to yourself – “Gee! You mean you get all this for $5 million?!”

In other words, sometimes a good investment is obvious…

But where do you find obvious value today?

The US stock market is at all-time highs… And companies like Netflix (that lose billions each quarter) march higher and higher.

Bond yields are still scraping the bottom…

And cryptocurrencies have soared so high many are calling it a speculative bubble. Even if you’re a believer in crypto, it’s still not prudent to allocate a large portion of your wealth to the sector at this point.

Likewise, you can’t put everything you have into cash or gold.

But if you do the work, you can find certain securities that are just as safe as cash…

That’s the entire premise behind The 4th Pillar – the value-investing service written by our Chief Investment Strategist, Tim Staermose.

Tim screens thousands of stocks across every global market to find something that – according to efficient-market theorists – shouldn’t exist… “a free lunch.”

What if I offered to sell you a $100 bill for $60… would you take that deal?

Of course you would. It’s literally free money.

But that same opportunity exists in the market today. You just have to know where to look.

That’s why Tim spends all day screening literally ever global stock market until he finds what he’s looking for…excellent companies trading for less than the net cash on the books.

Some of these companies are trading so cheaply because of a short-term problem. Others are just ignored or misunderstood by the market.

But when you’re able to buy an entire operating company for less than the amount of cash it has in the bank… Well, let’s just say that passes Jim’s $5 million test.

After all… How much risk is there if you could take a company private for way less than the amount of cash it has in the bank, cease operations and pay out the cash as a dividend?

Not much…

Remember, there’s still value in the market today… it’s just getting harder and harder to find.

You can start by screening global stock markets for companies trading for less than their net cash… Or you can see how Tim does it.

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With the nearly daily moves to record highs among the hundreds of cryptocurrencies that currently exist, talking about ‘regular’ currencies seems about as out-of-fashion as that hideous shoulder pad trend from the 1980s.

[Millennial readers: see here if you’re confused.]

But there are actually a few currencies out there worth talking about right now.

And top among them, especially for anyone holding US dollars, is the Hong Kong dollar.

The Hong Kong dollar is different because it is ‘pegged’ to the US dollar at a pre-determined rate.

Unlike the euro, pound, yen, etc. whose exchange rates fluctuate on a daily basis (and occasionally have major, violent price swings) the Hong Kong dollar is set at 7.80 HKD per US dollar, plus or minus a very narrow band.

The Hong Kong dollar has effectively traded between 7.75 and 7.85 for the past three decades– a variation of about 0.64%. This barely registers as a rounding error.

Now, there are a handful of other currencies which are also pegged to the US dollar.

Venezuela’s government fixes its bolivar currency to the US dollar at an official rate of roughly 10:1. (Though when I was in the country a few weeks ago the Black Market rate was 30,000:1.)

In Africa, the government of Eritrea pegs its currency (the Nakfa) to the US dollar at a rate of 13.5:1.

Even Cuba’s government pegs its “convertible peso” to the US dollar at 1:1 (less some absurd exchange fee).

But none of these currencies is a viable alternative to the US dollar. The US government’s finances may be in shambles, but Eritrea’s, Cuba’s, and Venezuela’s are in much worse condition.

Hong Kong is a rare exception in the world.

The Hong Kong Monetary Authority, the country’s central bank, is among the best capitalized on the planet.

Plus the government is awash with cash and routinely runs substantial budget surpluses.

Hong Kong has virtually zero debt, and nearly $1 trillion Hong Kong dollars ($126 billion) in net foreign reserves.

That’s a public savings account worth roughly 40% of the country’s GDP.

Hong Kong’s Net International Investment Position, which is essentially a reflection of the government’s ‘net worth’ is about $1.25 TRILLION, or 380% of GDP.

This is nearly unparalleled. By comparison, the US government’s net worth is NEGATIVE $65 trillion– roughly NEGATIVE 350% of GDP, versus Hong Kong’s POSITIVE 380% of GDP.

One country is broke. The other is a financial fortress.

And while the US government’s liabilities keep mounting, Hong Kong’s foreign reserves keep increasing.

Between the two, it’s pretty obvious that Hong Kong is in vastly superior financial condition. And that’s what makes the Hong Kong dollar so compelling.

By holding Hong Kong dollars, you essentially get all the US dollar benefit without having to take the US dollar risk.

If the US dollar remains strong, the Hong Kong dollar remains strong. The two are virtually interchangeable.

But unlike holding US dollars (where your savings is linked to a bankrupt country), Hong Kong dollars are backed by one of the most solvent, fiscally responsible governments in the world.

So if there were ever a US-dollar crisis, Hong Kong could simply de-peg its currency… meaning anyone holding Hong Kong dollars would be insulated from the consequences of the US government’s pitiful finances.

It’s like having a free insurance policy… which is what an effective Plan B is all about.

Right now is a good time to think about moving some savings into Hong Kong dollars.

The Hong Kong dollar spent the last several years at the extreme ‘strong’ end of its trading range (7.75 HKD per US dollar).

It’s now back to 7.80, right in the middle of normal trading range, so it’s a slightly better entry point.

If you find that the Hong Kong dollar is not for you, in general it still makes sense to diversify at least a portion of your assets away from your home country’s currency…

… especially if your currency happens to be overvalued.

The US dollar has been artificially strong over the past few years. IT began a multi-year surge back in 2014 for no apparent reason.

GDP growth was tame, US debt kept piling… there was no fundamental, logical reason for the US dollar’s sudden strength.

I took advantage of this anomaly by trading overvalued US dollars for high quality assets (businesses, shares, real estate) in countries with undervalued currencies– like Australia, Chile, Colombia, Georgia, UK, Russia, Canada, etc.

This strategy decreased my risk and increased the odds that the investments will perform well.

As an example, I bought some assets denominated in British pounds (GBP) immediately after the Brexit vote when the pound sank below $1.20. The pound is now around $1.32, about 10% higher.

So even without factoring in the share price appreciation or dividends, those GBP investments have already made 10% in US dollar terms.

In Australia, I acquired a private business at a time when the Australian dollar was at a multi-year low. Similarly, the Aussie dollar is up 10% since then, so there’s already a built-in gain.

The US dollar has definitely lost some ground this year and isn’t as strong as it was in 2015 and 2016.

But the US dollar index is still at a higher level than its long-term, trade-weighted average, so there’s more room for the dollar to weaken.

This means it’s still a good idea for US dollar holders to consider some high quality foreign assets… and at a minimum, think about that free Hong Kong dollar ‘insurance policy’.

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In 1906, American entrepreneur William T. Grant opened his very first “W.T. Grant Co 25 cent store” in a small town outside of Boston.

The store became popular and fairly profitable. So Grant opened another. And another.

Three decades later, Grant’s retail empire was generating $100 million in sales (an enormous sum back then). And by the time of Grant’s death in 1972, there were over 1,000 stores bearing his name.

Investors loved W.T. Grant Company stock for its reliable profits and high dividends.

Many of our subscribers may remember W.T. Grant. The chain was among the largest in the US at its peak.

And then something completely unexpected happened…

In 1976, W.T. Grant Company declared bankruptcy.

At the time, it was the second biggest bankruptcy in US history. And, like the downfall of Lehman Brothers and other big Wall Street institutions at the onset of the 2008 financial crisis, it was a shock to the world.

How could a company as big and profitable as W.T. Grant Co. go bust?

In the autopsy that followed the bankruptcy, accountants found that while the company was generating substantial PROFIT, it was not generating any CASH FLOW.

These two terms sound the same, but they’re dramatically different.

Profit, or more specifically net income, includes all sorts of bizarre accounting rules that don’t actually make sense in the real world.

Due to these rules, companies are often required to adjust revenue and expenses for things like “depreciation”, or “foreign exchange gains and losses”.

These are all merely accounting terms that don’t directly and immediately affect cash balances. But they can dramatically impact “profitability.”

Here’s one example from my own experience: a few years ago, the large agriculture company that I founded here in Chile purchased a farm.

We bought it for far below the property’s market value.

It was a great deal for the business. BUT… accounting rules required that our company record a PROFIT based on the difference between what we paid for the property and what it was worth.

This idiotic rule made it seem like we achieved a profit simply for buying a property.

This makes no sense. In the real world, we would only earn a profit by SELLING the property for a higher amount than we paid. You can’t profit before you sell something.

It’s rules like this that make profit an unreliable metric.

CASH FLOW is much more accurate.

Specifically, OPERATING CASH FLOW tells us how much money a company makes from its business.

It strips out all the silly rules and focuses purely on how much cash a business generates from its operations.

Then there’s FREE CASH FLOW, which is the amount of money left over for investors AFTER a company makes all of the necessary investments it requires for future growth.

Cash flow is what counts. If a company has negative cash flow, it will eventually go under.

Profit can be misleading. And that’s what happened to W.T Grant Co. It was profitable but had negative cash flow.

Today there’s another famous business in similar circumstances– our old friend Netflix.

Quarter after quarter, Netflix reports a profit. Just yesterday afternoon the company had its quarterly earnings call, posting a profit of $553 million. Not bad.

Yet when anyone dives just a little bit deeper into the numbers, Netflix’s cashflow is absolutely gruesome.

The company’s Operating cashflow is negative. In other words, after stripping out all the unrealistic accounting nonsense, Netflix’s core business LOSES MONEY.

In fact Netflix’s operating cash flow has been negative FOR YEARS. And the amount of money they’re losing is increasing.

Netflix’s business has lost $1.3 billion so far through the first nine months of 2017. That’s 52% worse than the $916 million operating cashflow deficit they suffered in the first nine months of 2016, and nearly three times worse than the $504 million operating cashflow deficit during the first nine months of 2015.

Throughout this period, the number of Netflix subscribers has steadily grown, now well in excess of 100 million.

And every time Netflix reports a big surge in subscribers, the stock price soars.

This is truly bizarre. Just look at the cash flow numbers: as the number of Netflix subscribers has grown over the years, the company losses have grown even more.

It reminds me of that old saying from the 1990s dot-com bubble– “We lose money on every sale, but make up for it in volume.”

But it gets worse.

The company’s negative Operating Cash Flow doesn’t include the billions of dollars that it spends on content.

And on its quarterly earnings call yesterday, executives announced they will spend a whopping $8 billion on original content next year.

That’s $8 billion that they don’t have. And don’t forget the $1.4 billion operating cash flow deficit.

Where are they possibly going to find this money? Simple. Debt. Netflix will pile on more and more debt despite racking up enormous cashflow deficits.

Now, to be fair, it’s not unusual for a business to lose money for a period of time as part of a longer-term plan to generate strong cashflow.

But just look at this industry: it seems like EVERYONE is diving in to this original content game.

Apple. Facebook. Amazon. CBS. Disney. Google. Sony. Time Warner. Hulu. Each of these organizations has developed a streaming service with original content.

And some of them (especially Google and Facebook) have an endless war chest thanks to their cash-gushing core businesses.

Google’s parent company (Alphabet) reported free cash flow of $11.6 billion in the second quarter alone. So they could easily outspend Netflix and still have billions of dollars left over.

All of this competition is going to be great for consumers; these companies are collectively spending tens of billions of dollars to entertain us. And they’re going to lose money doing it.

But for investors this is sheer madness. Don’t be the sucker paying for other people’s entertainment.

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Something pretty miraculous happened recently.

It appears that Jamie Dimon, CEO of JP Morgan Chase, went nearly TWO WEEKS without bashing Bitcoin.

This must be a record for Mr. Dimon, who seems to have barely been able to last an hour without calling out Bitcoin as a “fraud”, or a refuge for criminals and North Koreans.

Mr. Dimon finally broke his Zen-like meditative silence late last week, once again returning to the familiar assaults we’ve come to expect from the world’s most powerful banker.

On Thursday, Dimon downplayed the importance of Bitcoin during a teleconference with journalists, and then said he wouldn’t talk about cryptocurrency anymore.

One day later, Dimon was talking about cryptocurrency again, this time at the annual meeting of the Institute for International Finance.

Dimon’s rant was in top form, and he went back to his core material– governments won’t allow Bitcoin to exist, it’s only useful for criminals, etc.

He was later joined by his sidekick Larry Fink, Chairman and CEO of Blackrock (the largest investment management firm in the world with over $5.7 trillion under management).

Fink stated succinctly that Bitoin is “an index for how much demand for money laundering there is in the world.”

Now, these are clearly not dumb guys. Dimon and Fink are princes of Wall Street. They know finance.

But it’s pretty obvious they haven’t done their homework on cryptocurrency… since there’s really no objective evidence to support their assertions.

Dimon’s idea that Bitcoin is a “great product” for criminals is simply WRONG. Bitcoin is terrible for criminals.

Why? Easy. Bitcoin is not fully anonymous. Every single Bitcoin that has ever been mined… and every single transaction in Bitcoin that has ever been made… is recorded in the Blockchain.

In other words, it’s all public information.

That’s not to say that people’s names and addresses are recorded in the Blockchain; instead, a typical transaction record includes information about Bitcoin Wallet IDs, block numbers, etc.

[Visually, it looks something like this: http://ift.tt/2gK89rN]

But for people with enough resources (i.e. governments), the transactions can be traced back to the source.

Here’s an easy example.

Let’s say Alvin the Arms Dealer signs up for a new account at Coinbase– the most popular exchange in the world.

Alvin links his Coinbase account to his bank account at, say, hmmm… JP Morgan Chase, and puts in an order to buy 100 Bitcoin.

The money transfers from JP Morgan to Coinbase, and Alvin’s Coinbase wallet is credited with 100 Bitcoin.

Alvin now sends those 100 Bitcoin to his friend Marvin the Money Launder.

Marvin sells the Bitcoin at another exchange, and deposits the US dollars into his own bank account.

EVERY SINGLE ONE OF THESE TRANSACTIONS has been posted to the blockchain.

And if the FBI or INTERPOL really looks into it, they’ll be able to trace Marvin’s bank deposit back to Alvin’s initial purchase of Bitcoin at Coinbase. Boom. Smoking gun.

In other words, if you’re the FBI, you should HOPE that criminals use Bitcoin. They’ll be easier to catch.

But any criminal with half a brain [oxymoron, I know] is already aware of these issues. So they’ll probably stick to Amazon.com giftcards… which is a MUCH easier way to launder money.

The other laughable point that Dimon makes is that ‘governments won’t allow Bitcoin to exist’.

He believes that governments want to remain in control of money, so at some point they’ll merely outlaw Bitcoin. And poof… demand will vanish.

This is a completely naive view.

Marijuana been illegal under US federal law for DECADES. And yet demand only grows.

Pirating movies is also illegal. And those rules have been aggressively enforced since the passage of the Digital Millennium Copyright Act nearly 20-years ago.

But illegal downloads of movies, music, software, etc. still constitute roughly 25% of all Internet traffic, according to a study commissioned by NBC Universal.

Bitcoin would be even harder to control. You don’t even need to be connected to the Internet in order to receive or store Bitcoin. So fat chance they’ll be able to enforce a ban.

Any attempt to get rid of Bitcoin would be about as successful as preventing people from smoking weed or pirating the latest Game of Thrones episode.

But… Uncle Sam does have one weapon… one way they could potentially disrupt Bitcoin.

Some day the US government and Federal Reserve might actually wake up and realize that crypto is the future.

And when that day comes, the obvious tactic would be to create their own version of the Blockchain that uses “crypto-dollars”.

Cryptodollars would be equivalent to US dollars. So $1 in physical cash = $1 in your bank account = 1 cryptodollar.

Cryptodollars would be legal tender and accepted everywhere in the country– Wal Mart, Amazon, etc., but without any of the wild gyrations and fluctuations that we see in the Bitcoin price.

The introduction of cryptodollars would clearly have an impact on the demand for Bitcoin.

Hardcore users would certainly still hold Bitcoin, so it wouldn’t go to zero.

But casual users might very well abandon Bitcoin in favor of cryptodollars due to the convenience of being able to spend them anywhere.

The added benefit to the US government is that a crypto-dollar blockchain would solidify the dollar’s status as the international reserve currency.

So they definitely have compelling reasons to do this.

Now, it might never happen. Or it could take years.

But the possibility exists. So keep that in mind before going ‘all in’ on crypto.

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Today’s Notes is a bit different…

I recorded a conversation I had with my colleague Sean Goldsmith about my recent travels to Venezuela. I explain how I exchanged my US dollars on the black market for Bolivar (with a taxi driver I’d never met before)… and how the situation in Venezuela will get worse before it gets better. Plus, I share observations and stories of things I saw on the ground in one of the world’s poorest and most dangerous countries.

Then we discuss the tragedy in Puerto Rico… and why I think Puerto Rico is still one of the greatest opportunities in the world today. They’ve run the numbers, and their tax incentives like Act 20 and Act 22 are helping the island. I expect the amazing incentives will stay in place. And, although the hurricane was devastating, the financial aid that comes along with the storm is a catalyst to get Puerto Rico back on its feet.

You can listen to our conversation below.

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The Great Financial Crisis happened because Wall Street was financing homes for people who couldn’t afford them.

Leading up to the GFC, there was a voracious appetite from investors for “AAA”-rated mortgage debt. So lenders would make lots of loans to subprime borrowers and sell them to Wall Street. Wall Street would pool them together and one of the major ratings agencies (like Moody’s or Standard & Poor’s) would stamp the steaming pile of garbage with AAA.

AAA by Moody’s definition means the investment “should survive the equivalent of the U.S. Great Depression.” In other words, it’s rock solid.

The reasoning was that one subprime mortgage was risky. But if you bundled thousands together, you get AAA… Because they couldn’t all go bad at once. And, hey, you can’t lose money in real estate.

The rating agencies weren’t as dumb as they appeared, though… Investigations following the crisis showed lots of incriminating emails, like this one from a Standard & Poor’s exec:

“Lord help our fucking scam . . . this has to be the stupidest place I have worked at.”

Like everyone else, they played along because they wanted to make money.

To generate enough mortgages to meet demand, lenders would do anything…

– Sell a house for no money down

– Offer a teaser rate (which temporarily reduces monthly payments, then jumps to market rates)

– And even offer to pay part of your mortgage for a couple months (most small lenders could sell a loan to Wall Street in a month or two, erasing their liability. If the origination payment was more than cash out of pocket, they still came out ahead).

They called the worst of the subprime loans “NINJAs” as in “No income, No job, No assets.”

When they couldn’t actually write enough mortgages to meet demand, Wall Street got creative. They started bundling together bundles of mortgages, something called a CDO-Squared. Then they created synthetic CDOs, which were just derivatives of subprime mortgages and even other CDOs (essentially a
way for people to gamble on the mortgage market without actual mortgages).

As we all know, it ended in disaster… because the people who took out the mortgages they couldn’t afford to buy overpriced homes stopped paying. And the CDOs, CDOs-squared and synthetic CDOs (which had been spread around the world) went bust.

Remember, it all started with selling people homes they couldn’t afford. Which brings me to today…

There’s a record high $1.4 trillion of student debt in the US. And millennials are struggling to pay off those balances.

The National Association of Realtors polled 2,000 millennials between the ages of 22-35 about student debt and homeownership… Only 20% of those surveyed owned a home… Of the 8 in 10 that didn’t own, 83% of them said student debt was the reason. And 84% said they’d have to delay a home purchase for years (seven years being the median response).

And that’s all bad for the home-selling business. Once again, the lenders are getting creative…

Miami-based homebuilder, Lennar Homes, recently announced it would pay a big chunk of a student loan for any borrower buying a home from them.

Through its subsidiary Eagle Home Mortgage, the company will make a payment to a buyer’s student loans of as much as 3% of the purchase price, up to $13,000.

Debt has become such a keystone of our society, that the only way we can afford something is to swap one type of debt they can’t afford with another type of debt.

A recent study by the Pew Charitable Trust showed 41% of US households have less than $2,000 in savings – a full one-third have zero savings (including 1 in 10 families with over $100,000 in income). Another study showed 70% of Americans have less than $1,000 in savings.

The point is, America is broke… A single, surprise expense like a flat tire or a doctor’s visit would wipe most people out.

And it’s only getting worse.

Back in August, I calculated the average household account at Bank of America (which has $592 billion in consumer deposits from 46 million households)… It’s only $12,870 per household… And that includes savings, investments, retirement… EVERYTHING.

Also keep in mind, that’s the average… So accountholders with huge balances skew the numbers higher.

It’s no wonder Americans have $1.021 trillion in credit card debt – the most in history.

Auto loans are also at a record high $1.2 trillion.

And let’s not forget the US government, which is in the hole more than $20 trillion. The US’ debt is now 104% of GDP… And total debt has grown 48% since 2010.

The liability side of the balance sheet keeps expanding. Meanwhile assets and productivity aren’t keeping up.

But people continue buying homes, cars, TVs and college educations by taking on more and more debt… And now, by swapping one type of debt for another.

Wealth is built on savings and production. Not on playing tricks with paper and going deeper into debt.

I can’t tell when this house of cards falls. But rest assured, it will come tumbling down.

Will you be ready when it does?

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In the late 1500s, an Englishman named William Lee invented a revolutionary knitting machine that could efficiently do the work of dozens of men.

Given how important the garment industry was at the time in English, Lee’s invention was truly disruptive.

But Queen Elizabeth wasn’t so excited.

When Lee came to visit her to demonstrate the power of his new technology, the Queen grimaced, lamenting that the machine would put too many people out of work… and she refused his request for a patent.

So Lee went to France, where King Henry IV was highly supportive of the technology and issued a royal patent.

I was thinking about this story recently when I read about the government of Vanuatu announcing that they will begin accepting Bitcoin in exchange for citizenship.

If that sounds strange, let me explain–

Vanuatu is one of several nations that offers citizenship to foreigners in exchange for making an ‘investment’ in the country.

Malta. Cyprus. Saint Kitts & Nevis. Etc. These countries all offer what are known as ‘citizenship by investment’ programs.

(And dozens of countries, including the United States, offer ‘residency by investment’ programs, where foreigners receive legal residency in exchange for an investment.)

As I’ve written before, however, sometimes these programs would be more accurately described as ‘citizenship-by-donation’.

Because, in many cases, you’re not really making an investment. You’re just writing a big check to the government.

Malta’s Individual Investor Programme requires foreigners to donate 650,000 euros to the government. And that’s only one of the qualifications. In Cyprus it’s more than 2 million euros.

Vanuatu has had a number of similar programs over the years. It’s MUCH cheaper, though you’ll still end up spending north of $200,000 between the fees and investment.

Dominica’s program is probably the best value for the money, with a donation of just $100,000 (not including fees).

And Saint Kitts is offering a bit of a ‘special’ right now through March 2018, providing citizenship in exchange for a $150,000 donation to their hurricane relief fund (that’s down from the normal $250,000 investment in their Sugar Industry Diversification Fund).

Vanuatu is the first country to accept Bitcoin in exchange for citizenship… which I find pretty shrewd.

There are countless ‘Bitcoin Millionaires’ out there who bought a boatload of the cryptocurrency years ago and are now sitting on hefty gains with limited options to spend it.

So Vanuatu’s economic citizenship program will likely end up being a popular outlet for Bitcoin’s early adopters, causing a surge in applications (and much-needed revenue).

The irony is that this will put Vanuatu in the cross-hairs of illicit hackers.

Even governments in more advanced countries lack in-house crypto expertise who truly understand Bitcoin cold storage and proper handling of private keys.

It’s doubtful that tiny Vanuatu has those resources either.

Consequently, I imagine we may soon hear about the Vanatu government’s Bitcoin wallet being hacked. The potential treasure trove is simply too big for hackers to ignore.

The good news, though, is that this will likely spur other governments to start doing the same thing (once they nail down their cryptosecurity strategies). And that’s a big deal.

Vanuatu’s decision to accept Bitcoin payments shows that there will always be competition among governments.

Some governments have already decided to impose bans of cryptocurrencies or their exchanges.

Just this morning, for example, the Russian central bank said it will block Bitcoin exchange websites.

Other government may also move in that direction.

But there will always be other governments– often in economically underdeveloped countries– which embrace what others ban.

Online gambling is a great example. The US started banning Internet gambling websites more than 15 years ago and chased away a thriving industry.

Malta capitalized on the opportunity and developed favorable legislation to become a safe haven for online gambling companies.

Today the industry accounts for more than 10% of Malta’s economic activity. It was a big loss for the US and a huge gain for Malta.

Taxes are another great example; while some countries stupidly raise taxes and hang a “Closed for Business” sign at the border, other countries welcome business with open arms, slashing their taxes and providing generous investment incentives.

Bitcoin will be no different. Some governments will idiotically chase away the wealth, investment, and opportunity that comes from blockchain and cryptofinance.

Others will embrace it. They’ll become safe havens.

And the great thing about cryptocurrency is that it’s so easily transportable. We’re talking about something that exists online.

It’s not like some Bitcoin exchange website has to pick up and move a factory. Shifting operations from one country to another is much simpler for cryptocurrency businesses than for most traditional industries.

And as long as this type of inter-governmental competition exists between countries, as it has for centuries, they won’t be able to make a dent in the industry with their regulations.

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