Will the government soon collapse under its debts? Will Inflation take off? What events might affect our investments in the near future? How should we react to these risks?
Rick Rule, Chairman and Founder of Sprott Global Resource Investments Ltd., says that most market participants unwittingly consign themselves to failure, because they fail to critically analyze their own investment decision processes.
Rick explains, “Most market decisions are made with an expectation in mind of something to come in the future, but things may turn out differently from what we expect. Too many investors fall victim to wishful thinking. Properly evaluating outcomes and their probabilities will help you become a better investor and improve your performance.”
“Speculating on the events that are certain or almost certain to occur is almost always more profitable than gambling on a long-shot, unlikely occurrence,” he says. “Make investments based on unlikely scenarios only when the potential risks and rewards are disproportionately in your own favor and you can afford the loss that you may incur.”
So what scenarios are Rick and his team preparing for? What are his investment expectations? He outlined specific scenarios that he foresees.
The debasement of the US dollar, says Rick, is a near-certainty. “It appears very unlikely that our society can sustain its level of consumption with its current level of disinvestment. The U.S. federal debt exceeds 16 trillion dollars and off-balance sheet liabilities exceed 60 trillion dollars, while our annual on-balance sheet budget deficit exceeds 1.5 trillion dollars, half of which we borrow and the other half of which we counterfeit by printing. So the government is attempting to service 76 trillion dollars in debt with just 2.5 trillion in revenue, while spending 3.6 trillion annually.”
In order to avoid a default, says Rick, the Fed will likely continue to debase the currency so that the government can repay its debts at lower cost.
This leads Rick to conclude a second scenario. Because Rick projects that currencies will progress on this path of devaluation, he continues to view real assets as one of few ways to play defensively.
“Look at the escalation in commodities prices, even in the face of a very soft economy. The pricing numerator is less important, when the denominator – the U.S. dollar – is falling.”
Rick reminded me that prices are cyclical in the natural resource market. “Resource and commodity markets are cyclical, capital intensive and volatile,” he explains. “These characteristics are often inconvenient and frequently unnerving, but outcomes are often broadly predictable, though not necessarily the timing.”
He continues: “In natural resources, markets tend to work, and periods of low prices give way to periods of high prices, and vice versa. Low prices — as, for instance, uranium and natural gas are experiencing now — stimulate demand and constrain supply. Demand goes up because the utility of the commodity to users increases, and conservation and substitution go down. Low prices encourage fabrication methods to adapt by substituting the cheaper energy sources to a greater extent. Rick says that natural gas is so low-priced now relative to other energy sources that supply will come under pressure: “At today’s prices, producers of natural gas in the U.S. and Canada are often neither earning their cost of capital nor covering their operating costs. These producers are therefore unlikely to spend billions of dollars developing new supplies, and may shutter their projects entirely.”
The turnaround may occur gradually, he explains: “This process takes time, because producers will continue to extract gas even at low prices in an attempt to recover the capital already invested in productive capacity, producing down to or below their costs of production.”
Once you outline your expectations, and then deduce the probability of their occurrence and the reward you would expect to receive, you can guide your investment decisions with much less emotion and with much more success.
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