Dear Reader,

Last week, I wrote an article on furloughs that upset some of our readers from the government sector. Essentially, I pointed out that furloughs are a benefit of government employment. In the private sector, workers don’t get furloughed in a budget crisis; they get fired. And I openly noted that I don’t have much pity for the furlough complaints. It’s better than losing a job. Furthermore, the furloughs likely wouldn’t last long. In this case, they never even started. However, my tone was perhaps a bit harsh, and I do apologize for that.

Hence, a few readers wrote angry emails accusing me of being insensitive. According to the emails, government employees are just plain folks trying to pay their mortgages. They didn’t create the system. The government’s runaway spending isn’t their fault. Why be insensitive to them? While there’s truth to this, I’ve never been a fan of the “I’m just following orders” excuse. This isn’t Libya where we actually could blame a small group of families for ruining everything. (Please no conspiracy theory emails for that sentence.)

In some ways, we’re all partially responsible for the way this country has turned out – some more than others. Consider that 40% of government workers are members of public unions. They directly pay union dues used to lobby for more inefficiency, higher wages, and more spending. Maybe, these 40% didn’t personally introduce the most recent bill to Congress, but they certainly can’t claim zero responsibility. And the other 60%? While not everyone who works for the government supports it, I doubt many government employees are writing their congressman with requests to reduce funding for their departments. People rarely bite the hand that feeds them.

Furthermore, after some additional thinking, I realized that my original statements were partially wrong. Private-sector employees are furloughed. In fact, they’re furloughed every year. Can’t remember any furlough days? Have I jumped off the deep end? Not at all. Every time inflation eats away at your earnings and taxes get higher, you get furloughed. You’re working the same amount for less. In fact, it’s actually worse than a furlough. The worker doesn’t stay home, but must work more days to gain the same purchasing power.

So, here’s the problem. If my statements were insensitive to public-sector workers, aren’t the emails sent to me insensitive to other taxpayers? The money paid to government employees comes from somewhere. It either comes from other folks trying to pay a mortgage today, or it can be borrowed and repaid in the future by folks trying to pay a mortgage then. Every time someone in the public sector picks up a paycheck, someone picks up a smaller one in the private sector – now or in the future. It’s a zero-sum game. 

One could say, “Hey, you’re right, but why go after the government employees. They’re just regular Joes. Let’s cut spending on the war or the bailouts.” Sure, makes sense, but don’t think the mortgage argument isn’t circular here as well. Someone puts those armored Hummers together, someone builds those bombers, and someone checks mortgage papers at Citigroup. These are all regular Joes paying a mortgage too. They didn’t create the system, and most are doing even less than a public-sector union member to perpetuate it.   

In fact, it would be hard to cut any spending without a regular Joe getting hurt.

So, am I mean and insensitive? Maybe in some ways. But if I’m sensitive to the plight of the government worker, I’m simultaneously being insensitive to other taxpayers. And, to admit my own bias, I feel worse for the private-sector employee. He doesn’t have the safety net of government employment (the whole point of my previous piece). When the going gets tough in a recession, the private-sector mortgage payer is the first one to default.

The entire system is mean and insensitive. It’s based on taxing some people to pay others – whether they are government employees, financial services employees, or workers in the military-industrial complex. Taxpayers are charged arbitrary bills for services many don’t want and in some cases even despise. It’s a nasty, nasty process that pits different groups in society against each other. 

I’m sorry if I’ve hurt anyone’s feelings; I’m just trying to call it like I see it. I’m not a politician trying to get your vote here. We’ve gotten to our present mess exactly by trying to please everyone and not hurt anyone’s feelings. We don’t want to offend any firefighters, teachers, military personnel and other government employees. At the same time, we don’t want to raise taxes and hurt the private sector.

So what happens instead? The U.S. government borrows money like crazy and sets us all on a trajectory towards disaster. That’s simply not a solution. There’s no way to cut expenditures without hurting some decent person who wasn’t at all responsible. The only way out of this is getting tough… yes, getting a little insensitive. If not, we’ll all be comrades in the soup line together.

First, Alex Daley will cover some ways to insure your portfolio against a market crash. Then, Kevin Brekke will discuss new plans to prevent delinquent taxpayers from getting a passport. Finally, I’ll add some more notes on forex trading.

Is Your Portfolio Insured?

By Alex Daley

Let’s be blunt: stocks are looking expensive right now.

Sure, maybe on a relative valuation to estimated forward earnings, things aren’t that expensive. Or using a historical index of price to sales and tangible book value across the S&P 500, it doesn’t look awful. But the simple fact is, the S&P and Dow are both up more than 50% in two years’ time, and many specific sectors like gold miners or junior explorers are up even more. 

Many investors who took advantage of the big discounts the 2008 panic provided are stuck between a rock and a hard place: sitting on large gains and not wanting to miss out on any further growth, yet worrying about a systemic hiccup that could wipe out large portions of their portfolio, just like last time. 

While market bullishness is now at an all-time high, according to surveys by Investors Intelligence and the American Association of Individual Investors, investors seem at least anecdotally nervous about their own portfolios. More and more often these days, I hear the question, “Should I be getting out of this market?” 

My answer inevitably perplexes most who ask, when I respond with the simple question, “Well, do you have insurance?” If you were worried about your home getting wiped out in a flood or fire, you’d probably purchase insurance on it. Same with your car, your boat, even the key employees at your business. With most assets in life, we take the pragmatic approach and keep them insured against catastrophic loss. There’s a cost, sure. But one we usually happily pay to have peace of mind.

But if the crash of 2008 showed us anything, it’s that most investors, even the so-called professionals, are woefully unprotected against the risks of a big market crash. They simply ignore the volatility of the markets and trudge forward with the idea that “in the long run, stocks only go up.” For many of us, our equity portfolios are the largest single asset we have by a long shot, and yet the majority of investors sit completely exposed.

Of course, you cannot go to an Allstate agent and purchase portfolio insurance. Instead, your options are limited mostly to the hedges available on the financial markets (or some more exotic choices if your means are sufficient, but that is beyond the scope of this article).

If you, like many investors, keep the majority of your holdings in relatively liquid stocks on the U.S. exchanges, one of the first places to look is options. Say you are one of the investors who has been along for the ride on Netflix, and your position is up 700% in five years, with the stock trading at about $230/share. Maybe you are willing to live with a 10% haircut, but no more. In that case, you could purchase puts to cover your holdings on the stock out to September, with a strike price of $205. The current premium on such puts is about $20, or less than 10% of the share price. 

That might sound like a lot to pay for insurance. But the nice thing about options is, you can always let someone else pay for your policy. Calls for Netflix at $250 with the same expiration are also trading right around $20. Sell an equal number of covered calls, and your insurance is basically free. If the stock rises, you’ll still get the strike price, sharing in some of the gains (albeit now capped). And if it crashes, you’ll be able to dump your shares onto someone else at the prearranged price.

Options are a great tool for insuring a portfolio of widely traded stocks, but for some investors, the stocks that make up large portions of their portfolios include thinly traded companies, or non-U.S. equities, with little or no options volume to support direct hedges. In the case of these types of investments, you have basically two options:  find an inversely correlated asset or instrument (your asset goes down, this one goes up), or buy insurance against the market as a whole. 

The former is often a difficult thing to find, as in extreme conditions all things tend to correlate (another lesson of 2008). If you can find it, snap it up. Interest rate hedges for bonds, for instance. Or even gold to the U.S. dollar. The latter, however, is much more easily found these days. Funds and options exist to play the long and short side of almost every major index or asset class. One of the favorites of pros, though, is the VIX, an index that tracks the volatility of the S&P 500. The wilder the market, up or down or all around, the higher the VIX index goes. 

The index is currently near a two-year low as the market has had slumping volume and relatively little drama lately. If things take a major swing in the near future, having some options on the VIX could offset a good percentage of losses elsewhere in your portfolio. There are a lot of vehicles from direct options to ETFs and ETNs with differing time horizons and leverage levels.

The insurance principal doesn’t just extend to equities either. Investors with large gold or silver holdings, following these historic run-ups in the commodities’ prices, might consider grabbing some options in the futures markets, like buying puts on silver in the 30s now that it is trading at historic highs. These can be had cheaply and provide huge peace of mind toward protecting some of the newly accumulated wealth.

None of this is as simple as buying car insurance. But it’s possible for almost any portfolio, and given the current market, it’s probably a smart move. Any good financial advisor should be able to help you figure out a strong mix of insurance options for your specific portfolio. And you can turn to the pages of The Casey Report for some market level recommendations that will help you survive and thrive during the next leg down. 15 minutes could save you 15% during the next market downturn.

[Here’s another form of portfolio insurance: foreseeing where the current events lead us and being well prepared when most investors are asleep at the wheel. The Casey Report team – our in-house guru Doug Casey, economists Bud Conrad and Terry Coxon, and investment pro David Galland ­– provide in-depth trend analysis, economic and market research, and the instinct of bloodhounds to help subscribers make the trend their friend. Read more here.]

Forget Currency Controls – Travel Controls Are a Bigger Threat

By Kevin Brekke

The use and expansion of multi-agency linkage for the purpose of cross checking data is set to add another layer of surveillance over the American public. The GAO issued a report this week that suggests consideration of a program whereby citizens who are delinquent in filing or paying their taxes should be denied a passport.

Here is the recommendation in the GAO’s own words,

If Congress is interested in pursuing a policy of linking federal tax debt collection to passport issuance, it may consider taking steps to enable [the] State [Dept.] to screen and prevent individuals who owe federal taxes from receiving passports.

The report was not the product of some make-work assignment intended to keep a bureau of pocket-protector-clad wonks busy. The investigation was conducted by the Forensic Audits and Investigative Service division of the GAO at the behest of certain unnamed congressional requesters.

Look for a bill to begin making its way through subcommittees and on its way to becoming law soon. The financial dire straits of the U.S. pretty much assure this will happen.

Steps to enable a variety of state and federal agencies to talk to one another and exchange data has been underway for decades and is not something new. In the ‘80s, the U.S. states linked their motor vehicle licensing departments. This ended the practice of scofflaw drivers skipping out on a trail of parking tickets and moving violations in state A by simply applying for a license in state B.

The GAO report, however, is far more ominous.

The report is based on data from 2008. That year, 16 million passports were issued, and over 224,000 of these individuals collectively owed the IRS $5.8 billion. The report, as you would expect, focuses on the 25 most egregious cases from which it draws its conclusions.

All 25 of the cases cited involve persons owing millions of dollars in back taxes, years of failure to file a tax return, and, in some cases, felony convictions for fraud and ongoing investigations concerning money laundering. Not exactly the profile that comes to mind of a typical Citizen Joe behind on his taxes.

And therein lies the danger. Like all government programs, once implemented, they tend to expand as the mission is redefined. And nothing redefines a mission more than one that generates fast revenue. It is not stretching the imagination too far to envision a program that initially denies passports to morph into a compliance regime that detains and restricts travelers for any tax infraction.

If you are part of the millions of U.S. taxpayers that must make quarterly estimated tax payments, you could find yourself detained when traveling internationally if the IRS decides that you are “behind” on taxes owed or if you are a little late on making your latest payment. Far-fetched? Think again.

I read an article recently, on an otherwise respectable blog, where the author suggested that the way to take away the authority of the U.S. government is to laugh at them. And he meant it literally and figuratively.

This is nothing to laugh at, I assure you. Use the “laughing strategy” during a Customs and Border Protection questioning, and you could find yourself a guest at one of the new Fusion Center bed and breakfasts.

Can’t happen here? It already is. Individuals detained until the requested information or “bail” is handed over are a routine occurrence. A high-profile example was the UBS executive held in custody by U.S. tax authorities until “his status was resolved.” He was prevented from leaving the country, and it was never revealed what “changed hands” to secure his release.

As has been said before, when the state criminalizes the daily activities of life or minor transgressions of the law, you live in a criminal state.

We regularly remind our subscribers of the importance of diversifying your wealth beyond the reach of a single sovereign. But having resources abroad is pointless if you can’t leave your country. It has never been more important to follow the law to the letter, particularly the laws regarding banking and taxes. For many, this is no longer a DIY project. Find the right people that can keep you within the law and maintain your freedom of movement.

Forex Trading and Efficient Markets

By Vedran Vuk

I just received an interesting email from a reader and copied some parts of it below:

I, too, have heard that most people who engage in FOREX trading lose money. While I am twenty years old and have only been trading live since March 28 of this year ( I also did demos for five months in 2010), I have found that if a trader understands what his chosen indicators indicate and has studied technical analysis at least a little, then FOREX is not gambling. . . .

What I see in FOREX is recognizable and predictable trends, and so I plan my investments knowing that if I have an average day for every ten positions I enter, I will have to close two at a loss, three at break-even and five at profit, and I do exactly that. To me, gambling is entering a position without the faintest idea of what will come, and to me, speculative investing without fundamental or technical analysis to support the trend is the same as gambling. I don’t gamble, and so I wonder why you draw that connection?

Before entering any trade, the most important final question to ask yourself is, “What do I know that the rest of the market doesn’t?” This is a big reason that our publications very rarely recommend big blue-chip companies. The market prices these stocks with a high degree of accuracy. This market is too efficient for us to participate with an edge. Now, consider that currency markets are the most efficient in the world.

Everyone has their eyes peeled to them. As soon as the slightest abnormality emerges, hedge funds, banks, major companies, etc. jump at the opportunity. They place their bets on the market and almost immediately remove the inefficiency. Your letter notes, “What I see in FOREX is recognizable and predictable trends.” The more important question is, “Does everybody else see them?” If they do see them, the opportunity is already gone. If trends were so easily predictable, we’d all be rich. What advantage do you have that the others don’t?

Furthermore, think about your competition. The market isn’t filled with young kids like you and me. You’re in a competition against doctorates of mathematics with 30 years of forex experience. Do you really think that you’re observing trends that they’re missing? Furthermore, consider that their tools are much more powerful. They aren’t drawing lines on a screen to get their data. The numbers are getting crunched in real-time through dozens of complex models. Any info about a currency is at their fingertips. Plus, the speed of algorithmic traders alone will make a million trades before I even have a chance to click the mouse.

I’m not saying that it’s impossible to beat the market, but these are the odds. And once the odds are put in perspective, one has to ask, “Am I really a genius, or have I just gotten lucky thus far?” Even with fundamental analysis, the small investor is at a disadvantage. For arbitrage and trends, the small investor is at an extreme disadvantage. 

Additional Links and Reads

Analyst: Default has upside (Politico)

Americans Back Budget Deal but Declare No Winner (Gallup)

Bernanke Urges Republicans to ‘Deal With’ Debt, Lawmaker Says (Bloomberg)

That’s it for today. Thanks for reading and subscribing to Casey’s Daily Dispatch.

Vedran Vuk
Casey’s Daily Dispatch Editor