FSO Editorials: Going Back to Some Investment Basics by Robert B. Gordon 07/28/2004

Going Back to Some Investing Basics
What Really Counts is Holding the Right Assets
by Robert B. Gordon, Sc. D.
July 28, 2004

It is true that several of our stable funds have stopped growing, but that in itself does not lead to a disaster. What matters is the status of an entire portfolio. If the stable assets are holding their own values they are available in rebalancing to increase the size of other more volatile assets that may be in a position to help the portfolio grow. That is why it helps to have more than 3 or 4 different asset classes in a portfolio. Carefully chosen diversity is one of the best features for making a successful portfolio. I am talking here about real diversity and will give some examples later.

For nearly a year from March 2003 to early 2004, we have been in a strong bear market rally. This led many investors to forget that the real bear market is still with us. In a major bear market such as we have, very few securities resist going down in price. The two outstanding exceptions are the hedged Hussman funds which are managed to be stable and the short funds. I have been recommending the short funds for almost two years and now is the time to suggest very strongly that they are almost the only sure way to create gains in an otherwise stable portfolio.

The seriousness of this bear market is emphasized by Bill Bonner’s comment in a recent Daily Reckoning issue:

"The U.S. economy is still working its way into a Japan-style slump, is our guess. If we're right, stocks will fall for the next 10 years. Real estate should start dropping too... just as it did in Japan, about 4 years after the first stock market break."

Are you prepared mentally for this bear market lasting another ten years? Right now, the oil and energy funds and the short funds are about the only sectors that are going up. Gold stocks and funds are going down after doing well the past few years. The current market situation requires a return to investment basics which dictates a "do not lose policy". We will provide some examples for you to consider.

		Annualized Gain 9/20/2002 - 7/23/2004	Weighted Percent Gain
30%	Hussman Growth Fund	11.0%	3.3%
20%	Hussman Income Fund	6.8%	1.4%
10%	Short Foreign Gov't Bond Fund	15.3%	1.5%
60%	Stable Asset Total		6.2%

10%	Broad Energy Fund	20.2%	2.0%
5%	Large Timber REIT Stock	21.2%	1.1%
5%	Small Natural Gas Stock	49.9%	2.5%
20%	Natural Resource Total		5.6%

20%	Fully Managed Short Fund	-12.1%	-2.4%

100%	Grand Total	NA	9.4%

With its 20% short position equal to the natural resource total, this portfolio should be quite stable in its total assets but that is not a good goal. We should plan to take sizable profits that will be available by rebalancing at market tops and bottoms. In our last essay we told exactly how an investor can pick the bottom valleys and the top peaks to the very day. It is very easy to get this valuable information from price charts available freely on the internet. Usually the market tops and bottoms are clearly and sharply visible on the charts. The current market top was an exception in that is was a narrow trading range which lasted for over 5 months before the stock market started down.

This portfolio will almost surely show the price of the short fund to be at a sharp price peak when the market hits a big bottom and it will hit a sharp price valley at a market top. These are very apparent from available price charts. In the bottom rebalancing, assets are transferred from the short fund to the other funds. In the top rebalancing, assets are transferred from the stable assets to the short fund. This will increase the short profits on the next leg down.

I hope that many of our readers will adopt the necessity of having short fund assets if they are to make their retirement goal. This bear market will probably go on for decades, not years. It will be extremely hard to build assets with long positions only. It will also be unreasonable to count on gold as a permanent asset builder as it will be very volatile. It will be essential to take gold profits several times in the next thirty or more years.

		Annualized Gain 9/20/2002 - 7/23/2004	Weighted Percent Gain
20%	Hussman Growth Fund	11.0%	2.2%
20%	Hussman Income Fund	6.8%	1.4%
10%	Short Foreign Gov't Bond Fund	15.3%	1.5%
50%	Stable Asset Total		5.1%

5%	Broad Energy Fund	20.1%	1.0%
5%	Large Timber REIT Stock	21.2%	1.1%
5%	Small Natural Gas Stock	49.9%	2.5%
20%	Natural Resource Total		5.4%

20%	Fully Managed Short Fund	-12.1%	-3.6%

100%	Grand Total	NA	6.9%

Please know that, in the first leg down in 2001 in the bear market, the fully managed BEARX gained 255%, so in the current leg down it will have ample capability to build a nice overall profit in either of the two portfolios shown above. The fact is, that in a bear market there is no substitute for the profitability of a short fund. In the case of an unmanaged 200% short fund (RYVNX) in the same time period, the gain was 246%. So I urge serious investors to move carefully but surely to learn how to use short funds for a big assist thru this long and difficult bear market. They are bought and sold just like all other funds. They differ only in their great and sure ability to gain in down markets. Ideally, they should not be carried in a portfolio during a major up trend, but this shift can be omitted with timely rebalancing.

		Annualized Gain 1/23/2004 - 7/23/2004	Weighted Percent Gain
15%	Hussman Growth Fund	-1.0%	-0.1%
15%	Hussman Income Fund	-0.7%	0.1%
10%	Short Foreign Gov't Bond Fund	-3.5%	-0.3%
40%	Stable Asset Total		-0.5%

5%	FPACX Mod. Alloc. Fund	17.5%	0.9%
5%	Permanent Portfolio Fund	14.4%	0.7%
10%	Long Term Stable Total		1.6%

5%	Broad Energy Fund	20.1%	1.0%
5%	Large Timber REIT Stock	21.2%	1.1%
5%	Small Natural Gas Stock	49.9%	2.5%
5%	Largest Water Co. Stock	15.4%	0.8%
20%	Natural Resource Total		5.4%

20%	Fully Managed Short Fund	-8.2%	-1.6%
10%	200% Reverse NASDAQ Fund	30.6%	3.1%
30%	Total Short Funds		1.5%

100%	Grand Total	NA	8.0%

Please note that we have changed the time scale on the data above to just the last 6 months, during which time most securities were in a long and narrow price range. Quite obviously this period was not a good time to own the stable asset classes. Note the performance of BEARX whose losses probably came from their gold position. In strong contrast, the unmanaged, leveraged short fund was quite a big gainer. That is why this portfolio uses more than one security in each asset class - a wise example to follow. Even more important, it needs an experienced manager who knows when to own ‘em and when to fold ‘em in each volatile asset class.

In the eleven fund portfolio above, I consider that the 4 securities in the natural resource category and the 2 short funds are decidedly volatile compared to the other 5. Also please note that we have exactly 50% of our assets in the non volatile classes and 50% in the volatile classes. I do not think it would be wise to exceed this highly desirable position.

		Annualized Gain 4/23/2004 - 7/23/2004	Weighted Percent Gain
15%	Hussman Growth Fund	-10.5%	-1.6%
15%	Hussman Income Fund	4.0%	0.6%
10%	Short Foreign Gov't Bond Fund	5.9%	0.6%
40%	Stable Asset Total		-0.4%

5%	FPACX Mod. Alloc. Fund	-4.0%	-0.2%
5%	Permanent Portfolio Fund	-0.3%	-0.0%
10%	Long Term Stable Total		-0.2%

5%	Broad Energy Fund	17.5%	0.9%
5%	Large Timber REIT Stock	19.5%	1.0%
5%	Small Natural Gas Stock	79.0%	3.9%
5%	Largest Water Co. Stock	-25.8%	-1.3%
20%	Natural Resource Total		4.5%

20%	Fully Managed Short Fund	-1.4%	-0.3%
10%	200% Reverse NASDAQ Fund	81.1%	8.1%
30%	Total Short Funds		4.5%

100%	Grand Total	NA	11.7%

Please note the large percentage increase of the 3 month period over the 6 month period. The 6 month period represented the transition period plus the start of the real bear market. The change in the recent 3 month period is due almost entirely to increased gains in the natural resource and short categories. Now, there will always be temporary bear rallies that will last for a few days and gladden all the bullish majority. But the facts are that we are now in a severe bear market and the only way to preserve your capital is to acquire the right assets. Please do it now before more damage is done from inappropriate asset classes.

Richard Russell, whom I have not had the pleasure of meeting, recently celebrated his 80th birthday and many, many years of writing on the stock market. In contrast, I started writing these essays at 86 and on my next birthday will be 90, God willing. Fortunately, my eyes and fingers are still working pretty good and I hope to continue writing as long as I can. But it is perfectly obvious that my future is rather short so I want to urge all my readers, whatever their age and location, to develop their ability to select the very best mutual funds and stocks for their future portfolios. This is 90% of achieving a successful, profitable portfolio. The other 10% is the job of managing it well in stormy markets.

My current recommendations may be good for another 5 or 10 years, but one can never be sure. The problem with mutual funds of the very best caliber is that they grow too big or their manager changes etc. The problem with stocks is that the company may merge with another and lose it’s character, The most permanent securities at present are some of the very successful closed end funds like ASA, CEF, and PEO. These three and many others will probably be here for a very long time. There is voluminous data available on hundreds of closed end funds on the internet. They offer the very best securities for the very long run.

Regardless of your current age and experience level, I urge all readers to develop the ability to use a vast storehouse of data on thousands of securities. To my present knowledge, no one is currently rating the short funds but Morningstar does rate both stocks and funds, usually classifying them by what they own rather than how they perform, which I would greatly prefer. So I exhaust all the useful data on Morningstar and then look at the best looking stocks and funds on my FastTrack tm screen which can display more than 6000 funds and 5000 stocks, This great service which includes unlimited free technical support costs about a dollar per day. The software is free and you pay for the huge amount of daily data.

I have no crystal ball to view the future but, with the incredible debt loads at every level of our personal, business and government activity, one cannot be very optimistic about the economy or the U.S. dollar. Nearly all the gold and silver bulls have been very vocal in their calls for higher prices in the immediate future, but Robert Prechter has been predicting lower prices. We may get some further idea on whether the prices will, indeed, be going down in the next few weeks.

I see no reason why anyone in the process of accumulating the precious metals should not continue. I certainly plan to start buying at somewhat lower prices. Gold and silver stocks and funds have been dropping in price as well. If Prechter is right, prices will continue to drop. If he is wrong, they will start to recover.

The questions and information in your e-mails tells me whether I am doing a good or poor job. So please keep them coming. When sending me a long e-mail, it is very helpful if you will number the questions so I do not miss any. I especially like to hear from young investors and from ladies of all ages. And with respect to the ladies, I do not expect anyone to state their age directly but a hint would be helpful.