When Bert Dohmen talks, smart investors listen.
In 2007 when most investment analysts and economists were downplaying the developing credit market troubles, Bert warned investors that the probability was very high that the troubles would escalate into full-blown crisis and would produce a crash of historic proportions. He chronicled the developing credit crisis in the pages of his newsletter and also published a book in early 2008, Prelude to Meltdown, which provided his insightful views on the emerging crisis in depth. The book will surely go down as a landmark written by a financial visionary who was several steps ahead of his peers.
Dohmen writes the widely read Wellington Letter investment advisory, which has provided top-notch forecast and analysis of U.S. and global financial and economic trends since January 1977. His newsletter has received many #1 ratings by the top ratings services and has forecasted every bear market using sophisticated technical analysis. Bert also frequently appears as a guest on financial television, including CNN's Moneyline, CNBC and FOX News. Over the last 30 years he has been a favorite speaker at the largest investment conferences.
On August 27, I spoke with Bert concerning his forecast of the credit crisis, the likelihood of another financial crisis, the bond market "bubble" and the outlook for gold. His answers were as always refreshing and full of insight. Following is a transcript of that interview.
Q: Could you tell us what first attracted you to the financial markets and how you got your start in it?
Dohmen: I started trading when I was in graduate school and I was quite interested in the financial markets. Technical analysis wasn't widely in use at the time. I started with $400 and using advice from a major brokerage firm that quickly imploded. They got me into a stock with a 10 percent yield - I though the broker was a genius to find me such a stock. But the problem was they had only one copper mine and it was later nationalized. So that's when I decided that if I was going to be successful in the markets I would have to do it myself. So I spent a lot of time reading and studying and decided for myself that fundamental analysis wasn't in accordance with my philosophy because it only shows you what happened in the past. And I wanted to know what the big money was doing now. And the big money means the well informed money and that you can only find out with price and volume analysis and the charts.
Q: What prompted you to write the book, Prelude to Meltdown?
Dohmen: I wrote in the book in 2007 and it was published in early 2008 and it predicted the global near meltdown. I wanted to get it out because I said that people in 50 years will still be talking about it and wondering why no one forecast it.
Q: You were one of the very few analysts who correctly foresaw the approaching danger of the credit storm and you wrote extensively about it in Prelude to Meltdown.
Dohmen: It wasn't all that difficult throughout 2007 to figure out what was coming. At the end of the book I stated that the only question is whether the central bankers would be able to stop the meltdown altogether or if would be five minutes before twelve before they do. And now we know even in the words of the top guys at the Federal Reserve and the Treasury that we did get up to five minutes till twelve.
Q: Do you find it amazing that so few financial experts were focusing on the problems that were building up in the early stages of the credit crisis?
Dohmen: For me it was really very strange that so few people were looking at that. It really wasn't that difficult. Throughout 2007 in our Wellington Letter I had been writing about all the proverbial canaries. I had a section in the newsletter describing "more canaries in the mine." The April 2007 issue was headlined, "The perfect financial storm," and it listed all the reasons why. The thing is that sub-prime mortgages were starting to go sour. I knew that the sub-prime mortgages had been packaged up by Wall Street firms as CDOs and then sold around the world. And through basically buying the ratings of the major bond ratings agencies they were able to take this junk and take tranches of that and get AAA ratings from the agencies, which was just amazing when you consider that there are only four U.S. corporations which are strong enough to get a AAA rating on their bond in the United States. It was just absolutely amazing. Then I found out that the models that these ratings agencies were using were mathematical models that justified the AAA ratings and they had no provision in that mathematical formula for a decline in housing prices. This was an absolute shock and surprise to me as to how they could look at the huge absolute speculative frenzy in the real estate market and not think we were going to have a crisis. And at the time I was saying that real estate prices would go back down to the 2002 levels. In other words the entire speculative bubble created by excess credit would be wiped out and we'd be going back to basics.
For example, here in Nevada you had 32 percent gains in housing prices and the next year it was a 33 percent gain. And people started believing that it was normal and sustainable. Well it's not. Over the years you're happy if housing goes up 5 percent a year if even that.
Q: It indeed appeared that the monetary authorities waited until the proverbial last minute before acting. Is there anything the Fed and the Treasury could have done to mitigate the credit crisis in 2007 and 2008?
Dohmen: The regulators were in collusion with Wall Street. This wasn't a failure of capitalism, this was a failure of regulatory agencies and in my opinion some of it was criminal. The Wall Street firms, the big ones, were limited to 12-to-1 margin based on their capital until 2004. Then the head of the SEC, who was a former founder of a very large Wall Street firm, and he had been able to field these Wall Street guys and after that they decided to increase the permitted leverage I believe to 34-to-1. That was absolutely incredible. I remember whey that happened I said, "If these firms only have a 3 percent decline in their speculative investment it wipes out all of the equity." I wondered how could this be allowed. These guys were just asking for failure. The reason it was allowed because the higher the leverage the higher the potential profits. And I guess the theory was if something goes wrong the taxpayer would pay the losses. They get the profits, the taxpayer gets the losses. And that's exactly what happened.
We had other things like that in other areas of the housing market. Fannie Mae and Freddie Mac were basically coerced into giving mortgages who had no jobs, no income and no net worth. Yet they got mortgages because the Congressmen said that's what we have to do. You know the names of these Congressmen. So it was really excess of government, excess of speculation and there was no rationale behind it. Even right now when you consider that the FHA is making mortgage loans with only 3 percent down - 3 percent down! Nothing has been learned in this last episode. And that's why this crisis is not over. We are just in the middle of it. There's another 50 percent to go.
Q: What were some of the signs you saw as being potentially ominous in the months leading up to the 2008 bear market?
Dohmen: For one thing, the 5-year bull market top was in October 2007. When it became clear that mark-to-market [accounting rules] was going to come in early November 2007, all the big boys got out in October '07. So the bear market started with the mark-to-market rule. The bear market ended in March of 2009. The mark-to-market rule was changed in April of that year but in March 2009 the U.S. Congress told the FASB, which makes the rules, "You'd better change that rule or we're going to do it for you." That was known in March [2009] and that produced the bottom of the bear market at that time. Wall Street is really a game and if you know how to play it you can make some money on it, just as they do.
Q: Do you think the abolition of the uptick rule in July 2007 played a part in the stock market crash of 2008?
Dohmen: Yes, I really do. In fact when that was done I said something is being prepared to enable some of the very big trading operations to sell short without having to wait for an uptick. I don't think anything happens in the financial markets by coincidence, so I really think that was part of it. Why would they suddenly eliminate the uptick rule which had been in effect since 1933 and did a good job?
Q: The SEC never did reinstitute the uptick rule, did they?
Dohmen: No, they never have reinstituted it and that is why we're going to have another crash.
Q: If worse comes to worst, can the government afford another bank bailout?
Dohmen: Oh sure, the government can always create money and they don't even have to print it now like they used to. Back in 1980, Congressman Ron Paul gave us a tour of the Bureau of Printing and Engraving and they were so proud because they had the latest printing presses, Heidelberg presses from Germany. Of course we all laughed because Germany had lots of experience printing money during the hyperinflation of the 1920s. But it's created electronically today. Now all they have to do is add a few zeroes to make billions turn into trillions.
Q: One thing I've always admired about your work is your ability to predict the direction of the economy much better than most professional economists. What are the main indicators you look at to analyze the U.S. economy?
Dohmen: Credit availability is the main thing I look at to forecast the economy. Money supply M3 was going down at an 8% annual rate. You only see that in depressions. Money velocity is also declining. You don't see such things in a good economy. It all ends up with credit. It's also important to look at commercial and industrial loans, credit card credit and consumer loans. This is extremely important.
Q: What are some other indicators investors should be watching?
Dohmen: When analyzing the economy they should also look at things like credit growth. I consider credit growth, or the lack thereof, to be the most important indicator. Everything else merely follows. Job growth is also an important economic factor dependent on credit growth. If there is no credit growth then there won't be any real job growth. Consumer spending is the third most important thing to analyze for stock investors. If there is no job growth then spending will depend on consumers who have jobs feeling more optimistic and spending more. We have seen this over the past 16 months. Consumer spending is a coincident indicator and it helped us identify the 2007 market top. When spending starts declining, so will the stock market.
In terms of the stock market, technical analysis is also very important. You have to look at things like price and volume and their relationship to each other to get the big picture in the stock market. Fundamental analysis is of no value in today's market. If you try to use fundamental analysis to predict the stock market you will come out on the losing end.
Q: Let's talk about China for a minute. If the U.S. enters another financial crisis, do you believe China is self-sufficient enough to withstand the lack of demand for its products from the U.S. or will China's economy suffer?
Dohmen: I think there's a good chance the next crisis will start in China. Everyone right now is saying, "Look at the gains made by China's housing and financial markets over the last few years. You have to look at what is happening in the last 2-3 months, though, not just the year-to-year trend. An incredible $1 trillion in loans were issued to Chinese borrowers last year. Also earlier last year, China's regulatory officials tightened lending standards in an attempt at curbing speculation but it's just another case of governments believing they can solve problems in the financial markets when it has never been proven that they can. They've seen a tremendous decline in home sales. Home sales are up 8% for the year so far but what the media isn't telling you is that home sales were up an 60% percent or so before the real estate crisis hit. The Chinese economy is coming to a screeching halt.
Q: Do you still consider U.S. Treasuries to be safe long-term investments? Is there a chance the government may someday default on its debt obligations?
Dohmen: Define "someday."
Q: Say in the next 3-5 years.
Dohmen: No, the government won't default on its debt in the next 3-5 years. I've always believed that when it comes to the financial markets, what everyone knows is not worth knowing. Applying that now, everyone knows that bonds are in a bubble and that the stock market will offer a much better return than bonds, and that you should not buy bonds as a result. I take that as a signal that bond prices may go much higher as long-term interest rates decline. If a 4 percent yield declines to 2 percent, then the price of the bond may double.
Another reason why Treasury bonds are being purchased right now by investors all over the world is that Treasuries are a safe haven. I believe the rally in the bond price reflects a global flight to safety. Gold is the only real money, as it can't be produced at will with the printing press or the computer. Therefore, it's a store of value. U.S. Treasuries are also a safe haven for the big money. Not only is there no default risk, but as the globe goes into a decade-long period of deflation, yields will drop and bond prices will rise.
I think the real question is whether the bubble is in the bond market or in the fact that everyone is calling it a bubble. The consensus that bonds are in a bubble seems to be the real bubble.
Q: You correctly predicted the top of the last major gold bull market back in 1980 as well as the bottom in 2001. Do you still see gold as a worthwhile investment for the long term?
Dohmen: In 1981 we had ridden that entire gold bull market in the '70s and then gave a sell signal when gold broke $694/oz. on the downside. We sold and then we sold short and rode it all the way down to $400, which was really a nice trade. At that time my work showed that gold would then go into a 20 year down market based on cycles. But the after that we forecast a 30 year bull market. Now look at what happened. Twenty years after 1981 was 2001, which was the start of the latest gold market. Cycles don't always work out that accurately; as you know they can sometimes bottom a few years to the right or left. But this cycle worked out perfectly. If the second part of that prediction comes true gold should be in a 30 year bull market.
At that time back in 1981 we wondered what could possibly cause a 30 year bull market in gold. Well now we know the answer. Unprecedented deficits are the rationale behind the 30-year gold bull market. And there really isn't enough gold in the world, especially when you consider how much paper money there is.
To answer your question about investing in gold for the long term, if you have great trust in the government then you can buy gold coins or the gold ETFs. You'll ignore the fact that in 1933 the government confiscated all gold owned by U.S. citizens. You'll also ignore the fact that the exchanges and regulators will change the rules in midstream when there is a crisis, such as a parabolic rise in the gold price. In other words, you'll have to have blind faith in very corrupt people not being corrupt.
Gold coins stored abroad seem to be a good alternative. Mining stocks will eventually do well but will suffer greatly when fears of deflation soar.
Q: Is economic collapse inevitable in your view or is there anything that can be done to forestall it or avoid it altogether?
Dohmen: Only if there's a regime change in Washington. Short of this I don't see how it can be averted. People just have to get involved. Unfortunately, history tells us they probably won't.
Q: What steps can an individual investor take to protect himself from financial and economic calamities in the future?
Dohmen: People have to read, read, read. I can't emphasize this enough. There are some excellent independent news outlets out there today that weren't an option many years ago before the Internet. I advise investors to read all that they can about the markets and technical analysis through books and other publications. You can go to Amazon.com and see all the reader reviews of the books that tell you whether or not the books available might be for you. There are just so many opportunities for investors to educate themselves and everyone should be taking advantage of them. You have to take it upon yourself to be informed. You can't be informed of what's really happening out there by just watching the mainstream news on TV.
For ordering information on Bert Dohmen's book, Prelude to Meltdown, visit his web site at www.DohmenCapital.com
