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July 1999

Dennis C. Butler, President
Centre Street Cambridge Corporation
Private Investment Counsel


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    of all guest columns written by Dennis C. Butler, CFA

SpacerIn a decision remarkable for its lack of both market savvy and insight into potential consequences, the central bank of one of the major Western industrial nations announced in early May that it would sell more than half of its gold reserves. Since this particular bank was known for its "expertise" in the commodity, the report had an immediate and demoralizing impact on the commodity markets, knocking twelve dollars off the price of an ounce of the metal within a couple of days and eventually sending it to new twenty-year lows under $260 per ounce. This was no isolated lapse of judgement, however: in recent years many central banks (and other entities such as the International Monetary Fund) have sought to unload this "unproductive" asset, preferring instead to place their reserves in more profitable government bonds. But, consider the following: at times during the past year, it has been possible to indirectly purchase an ounce of gold reserves in the stock market for around $100, or about the cash cost of the most productive mines, and well below the industry's average cash cost of production of approximately $250 an ounce. This situation is indicative of a very depressed market. While it is true that proceeds from gold sales could be invested in government bonds for a better rate of return, the yields on those securities are now at relatively low levels historically. We question the wisdom of selling national treasure at fire sale prices only to invest in securities with relatively low yields. Where were the bankers when gold sold for $600-800 per ounce and U.S. treasury securities could be had at rates of 10% and above?

SpacerProposed sales by the International Monetary Fund have come under attack for different reasons. The IMF wants to liquidate part of its gold reserves to fund debt relief for poor nations. This laudatory aim has but one problem: a majority of the nations that would benefit also mine and sell gold. Hence, the benefits are to some extent offset by the pricing pressures caused by the sales. None of this makes much sense to us. However, we have no idea what will happen in the market for precious metals and are not suggesting that readers go out and buy gold stocks. It is a cheap asset, but it could remain so for a long time.

SpacerMeanwhile, other markets have not been so depressed. Asia continued to recover from the financial crisis that began two years ago -- Singapore stocks even reached record highs. Some hard-hit commodities also showed signs of life, partly in anticipation of renewed economic activity in Asia. A few markets in Eastern Europe did exceptionally well: Polish stocks, for example, have risen over 30% since the beginning of the year. Here at home, individual Internet issues may have tumbled as much as 50% from their highs (although, on average, they are still up 40-50% this year), but interest in the stock market broadened away from the technology and large-capitalization issues that have dominated the markets in recent years, and the more inclusive market gauges rose moderately for the quarter. At 19.5% and 22.5% (not including dividends) respectively, the Dow Jones Industrials and the NASDAQ averages are showing year-to-date returns well above the long-term annual norm. Weakness in May and June reflected rising market interest rates and anticipation of Federal Reserve Board action to ward off inflationary pressures.

Signs of the Times

SpacerThe long period of positive experiences with stocks that our society has enjoyed has an important impact on the Zeitgeist which may go unremarked by those who lack the perspective of experience or study. We thought the following observations of "signs of the times" would provide readers with food for thought.

SpacerThe Business of America is Business: Everybody wants to own stock in America: stock holdings as a percentage of U.S. household assets is at record high -- 25%, versus only 8% in 1984 and a previous peak of 24% in 1968. A booming Wall Street is a popular destination for college and business school grads. Ubiquitous news outlets devoted to business affairs and the markets, easy access to stock quotes, computerized trading, the popularity of market Gurus and investment clubs, etc., all reflect a public fascinated with business affairs and financial markets. Unfortunately, owning a share of stock is not necessarily the same as being an investor. When inexperienced people come to view the stock market as a better way to "earn money" than their jobs and trade technology stocks from their places of work, whether they be garage service pits or offices, you know things have gotten out of hand.

SpacerSocial Security and the Stock Market: In 1982 few politicians advocated investing social security funds in stocks. After all, Business Week had proclaimed the "death of equities" and few expected the sea change in market expectations that was about to begin. Now, after sixteen years of remarkable gains, the markets are viewed as a solution to the system's problems (or a way out of making difficult political decisions). Not addressed is the question of what would happen if extended declines in stocks eroded the value of Social Security Trust funds to the point where recovery seemed as remote as it did in the early 1980s.

SpacerStocks Always Win: There is a notion abroad these days -- especially in academic circles -- that since equities have produced superior results over sufficiently long periods of time, they are actually less risky than treasury bills. This idea is seductive during periods of strong markets such as we are in now because, statistically speaking, at those times it appears to be correct. Note also that the statistical record on which the claim is based reflects the experience of the United States in this century. We doubt if a long-term study of, say, the German or Russian markets would support a similar conclusion. The last time this sort of idea made the rounds was in 1929 when John J. Raskob said that "everybody ought to be rich," and could be, just by buying stocks every month. The next twenty years proved to be one of those periods when the claim was not correct. The lesson: never assume stocks are low risk and that they can be safely purchased at any price. Yes, you can now place wagers on the stock market -- on-line and with credit. Brought to you by the same crowd that promotes on-line day-trading of Internet stocks, this new service allows you to lose all of your money instantaneously, rather than most of it by the slow torture method (in other words, in a day or two) of actually buying shares. We suspect that these are the same people who, five years from now, will tell you that "stocks are nothing but a gamble," just like many in the generation of the 1930s came to believe.

SpacerOstentatious Wealth: The riches of this country are astounding when you think about it -- a few points on the S&P 500 Index probably represents enough wealth to rebuild Kosovo, if not the entire Balkan region. While the market reflects the strength of the underlying economy, it also works to boost that strength by enhancing shareholder wealth. In addition, rising securities prices tend to create a climate where wealth, so "easily" acquired, is flaunted. With the almost exponential rise in the stock prices in the last four to five years has come a corresponding increase in the construction of "stately mansions," according to The New York Times. Interestingly, mansions are proliferating throughout the land at a rate unmatched since the 1920s, another period that gave rise many new stock market fortunes.

SpacerStock Frauds: Fraudulent activity, though always present, feeds on robust stock markets as the influx of newcomers means easy money to con artists. Recently, for example, the SEC arrested dozens of suspects involved in various schemes. This time around, the Internet means virgin territory for unscrupulous players since it provides a degree of anonymity which the manipulative stock pools of yore could only envy.

SpacerFinally, the mantra of our times repeats the claim that relentless competition will continue to increase the efficiency of our economy. The Internet, in particular, will drive down costs as consumers side-step the middleman and force only the lean and mean to survive. However, as James Grant points out in a recent Interest Rate Observer, the Internet bids down prices during deflationary times. The workings of crowd psychology suggest that the Internet could just as easily bid prices up during an inflationary period. It would be best to remember that each day begins a "new era," and it may not necessarily be like the one that preceded it.


Dennis C. Butler, CFA, is president of Centre Street Cambridge Corporation, investment counsel. He has been a practitioner in the investment field for over 23 years and has been published in Barron's. He holds an MBA from Wharton and a BA in History from Brown University. His quarterly newsletter can be found at

"Current low valuations reward the long-term view", an article by Dennis Butler, appears in the May 7, 2009 issue of the Financial Times (page 28).   "Intelligent Individual Investor", an article by Dennis Butler, appears in the December 2, 2008 issue of NYSSA News, a magazine published by the New Yorks Society of Security Analsysts, Inc. "Benjamin Graham in Perspective", an article by Dennis Butler, appears in the Summer 2006 issue of Financial History, a magazine published by the Museum of American Finance in New York City. To correspond with him directly and /or to obtain a reprint of his featured articles, "Gold Coffin?" in Barron's (March 23, 1998, Volume LXXVIII, No. 12, page 62) or "What Speculation?" in Barron's (September 15, 1997, Volume LXXVII, No. 37, page 58), he may be contacted at:

Dennis C. Butler
Centre Street Cambridge Corporation
Post Office Box 390085
Cambridge, Massachusetts 02139

Telephone: 617.441.9695


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Revised: July 16, 1999 TAF

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