Editor’s Note: This is the second part of Mike’s long post. See the first part here.

Mike Price sends: Now, I did not just sell without reason or cause, I had been developing a whole new philosophy towards investing, one which I will explain here, I will start with my new influences, move onto the investment themes I’ve drawn from them and finally into my current investments.

Influences
Peter Schiff

As I mentioned before, Schiff was the catalyst in my renewed interest in investing, especially as economics applies to it, I read Crash Proof and listened to Bull Moves in Bear Markets, here I’ll quickly go through his thesis from Crash Proof, then show how I’ve applied it.

Schiff sees America’s shift from production to consumerism combined with the Fed’s control of the currency to be a possibly killing blow to the dollar and recommends investing elsewhere to avoid the coming (and actually current) inflation.

Schiff starts the book by showing how America’s shift from producing things to outsourcing the production then borrowing money to buy the produced goods has created a mass of debt in the country, this debt is, for the most part, held by China. The consequence of this shift into consumerism over production has created a huge trade deficit.

The trade deficit can be a good thing because it shows the division of labor is high, but in America’s case we are not importing things using saved money, but rather from borrowed money, which is the root of the problem.

Schiff then moves on to inflation and the fall in value of the dollar. Historically, fiat currencies have never worked - the dollar has fallen 95% since the creation of the Federal Reserve in 1913 (that is one dollar of purchasing power in 1913 is worth 5 cents today, or to flip it around if you bought a candy bar for 5 cents in 1913 it would cost one dollar today, and these stats are probably off as we’ve had a lot of inflation since the book was written in 2006).

Schiff follows the declining currency chapter to show how inflation screws up the market by creating artificial demand and changing the structure of production, then he shows why government’s need inflation (for their pet policies) and how they keep it ‘silent,’ that is fudge the numbers to make it look smaller than the reality.

Schiff then dedicates a chapter to refuting popular Wall St. notions (bonds are safe investments or using mutual funds is a good idea) and going ‘back to basics,’ to show how to value companies in which to invest. I’d like to point out that Schiff is a value investor, though he may not focus on it often. I listened to a podcast that was hosted by the lead analyst for his Brokerage Firm, and the analyst talked about how they evaluate individual companies by forecasting their cash flows out and buying them for only less than their true value.

After predicting the bursting of the housing bubble (which is where he gained fame) and once again touching on the consumer debt problem Schiff starts the second part of his book on how to invest in an inflationary depression.

Schiff has three parts to it: Buying Foreign Stocks, Buying Gold (and Silver) and Staying Liquid. Recently there was a lot of hoopla over people claiming he had not been right all along because a couple of his clients were way down in 2008, it seems those who criticized him had not read his book. The third part, staying liquid, mentions the fact that price of his recommended investments may fall even lower than they already are and one should keep some cash to average down, this is in fact what did happen.

So first, investing in foreign stocks: Schiff’s thesis here is that the US stock market will probably rise in the future, but the gains will most likely come from inflation, not from actual rises in production. He says that by investing in foreign stocks not only do you miss the loss in purchasing power in the US, but when you convert your shares back to the dollar you will profit from the fall in the dollar relative to the currency of the country where your company is. As an added bonus foreign stocks usually have a lot higher dividends than US stocks and Schiff speculates that investors should be able to find a conservative foreign portfolio with an 8% dividend yield.

Second, gold investment: Gold (GLD) has already moved up to $930 per ounce from $250 in 2000, further increases in demand, combined with inflation will push the price even further. Currently, gold is not used as money in any country in the world, Schiff believes this will change as seven decades of Keynesianism all over the world has produced solely economic destruction is noticed. He believes that even if most countries stall in changing to a gold standard, individuals will start doing it on their own and smaller more fragile economics will switch (Schiff mentions Russia here, which has, in fact, mentioned going back on the gold standard) as well. Add this to the protection investors will seek in gold, from inflation, and you get a huge surge in gold demand. This compared to the historic yearly increase in supply of only 2% per year will cause huge increases in the price of gold.

Schiff also shows how historically the Dow to Gold ratio moves in cycles and is currently in the middle of a down cycle for the Dow, but up cycle for Gold and the usual Gold:Silver ratio is way off implying big returns in silver as well.

In the end Schiff has contributed strongly to the outline of how I will invest, looking first at the impact of inflation and then allowing my other themes to follow that.

Jim Rogers

I’ve known about Rogers for a number of years, but never took the time to read any of his books because they all deviated from the 100% ‘buy value stocks,’ philosophy I held. This was until I read an interview that Peter Schiff did with him on the EuroPac site.

After that I read Hot Commodities, A Gift to My Children and parts of A Bull in China. I’ve also read a number of articles and interviews with him as well as the chapter in Money Masters of Our Time.

The two main things I’ve learned the most from Rogers are:

1. Rogers puts a huge influence on doing your own work and think differently from others. He also repeatedly talks about learning history and how to think, this is how he made so much money in commodities in the 70’s and how he’s done so well investing internationally in the past.
2. Hot Commodities is a little dated now, five years after it was first published, but one can still learn valuable lessons in how to analyze situations from how Rogers does with each commodity in the book.

Rogers also shares Schiff’s view about dreariness of the future of the US economy and stock market; he moved his family to Singapore and advocates only investing in Chinese companies or commodities.

Chris Mayer

Last summer I developed a fascination with Private Equity vulture type investors and bought Mayer’s book Invest Like a Dealmaker, after seeing it in a Barnes & Noble.

Mayer’s book focuses on two markets for stocks the public stock market and the private values for each stock. After reading parts of his book I subscribed to his newsletter, Capital & Crisis.

I only read a few issues, but was not very interested in it, Mayer focuses on different Macro Economic trends (like shortages of water or increasing demand from China) and then turns on his value discipline to find undervalued, but great companies where he can invest. At the time this did not interest me a whole lot I was strictly a ‘bottom-up,’ investor and preferred DCF to the more asset based valuations Mayer does.

However, in January I noticed the newest newsletter Mayer had written was a ‘Depression Guide,’ which fit right in with my new developing investment philosophy. So I read that issues and later in the year I believe I may have run the computer lab at my school out of paper as I printed every special report he’s written and the issues where he recommended each of the stocks currently in the portfolio. I also recently re-read ‘Invest Like a Dealmaker.’

Like Rogers, Mayer reads widely, a typical newsletter from him will include two or three macro trends and either they work for his current investments or a new investment that is or will profit from them, Mayer also includes nuggets of investment wisdom from every sort of investor and says that he has a weakness for old investing books.

With the current Depression forecasting cash flows is becoming harder and harder so I’ve drawn a lot from Mayer’s focus on assets for valuation (He’s talked about all three of Marty Whitman’s books, I had before thought they may be literally impossible to read).

Themes

Top-Down – Inflation in the US Dollar

I’ve mentioned this in passing a few times, but I’ll go over it more here. I believe the future for the US is not bright, not only has the Fed killed the economy, but the same measures which have literally never worked are again trotted out and proclaimed as what the economy ‘needs.’ The economy didn’t need the New Deal to prolong the Depression by 16 years, it didn’t need the Great Society to create the stagflation of the 70’s and it sure as hell doesn’t need any artificial stimulus to give us a forgotten decade akin to the Japanese.

I cannot logically invest in any US retail companies because of this, which is why I sold out of everything previously in my portfolio. The only company I owned which I believe may do well is Netflix (NFLX), but they traded for 35x earnings, at a time when the best companies and brands in the world trade for less than 10x.

So my new approach will be to take a more top-down approach in attempting to find sectors that will do very well in the future (as a result of certain macro trends like US inflation, Chinese Growth etc.) and then searching these sectors for good investments.

Foreign Investments

The next thing I’m doing is actively searching for foreign companies, right before finals I did a screen looking for foreign companies with huge dividends, but unfortunately finals took over my time and by the time I started looking again many of the companies had doubled or tripled.

My dad’s portfolio has been moved to EuroPac and the majority of his portfolio is currently invested in foreign companies. I own some currently through Leucadia (LUK), but have yet to pull the trigger on any pure foreign companies.

Commodities

Like my three influences above I believe commodities will fair very well in the coming decade, not only because of inflation, but also because of the rise of China and India and the successive rise in demand for many commodities.

I don’t have an account where I can buy futures so my main option here will be to look for companies that focus on commodities, mainly oil, gold and silver, but also those used in farming.

Other Jockeys

I’ve found that one of my favorite things to do is work; this means that I will work the max hours at work – that I am scheduled. Even during finals I worked between 35-45 hours each week, this does not allow much time keep track of a lot of different companies.

So far all the factors I’ve discussed lean towards long-term trends in which I should be able to invest and basically forget about. I keep track of the news enough to know if something big is changed and if something that I’m counting on is changing.

My next theme follows this, I will look for great managers that will allow me to check-up just once a quarter if that’s what’s necessary.

Investments

Gold, Gold Miners and Silver

The investment prospects for these three were laid out in the Schiff section: basically inflation is the future for the US and not only will gold and silver naturally rise in response to the inflation, but the demand will also skyrocket as people and countries attempt to take refuge in real money.

Also, Gold Miners are leveraged to the price of gold, so if gold rises, gold miners will correspondingly rise more (If their cost is $400 per ounce they make $500 on $900 gold, if gold rises to $1,400 per ounce their profit doubles, as the gold price rose only 55%), but there are also more factors with gold miners (like the price of oil and other things they need for production) so I currently have less invested in Gold Miners than gold.

Currently, I’m investing in Gold through the ETF GLD; I have 14% of my portfolio in it and am down 2%. In Silver I’m using the ETF SLV; I have 8% of the portfolio in it and it’s down 1%. Finally, I’m using the Index GDX for the Gold Miners, have 6% in it and it’s back at the purchase price.

In the future I may look into different Gold Mining companies in which to invest, either in addition to or instead of the index.

Oil

Jim Rogers allocates 21% to crude oil and 14% to brent oil in his commodity index. Oil’s price will rise in the future not only because of the supply/demand imbalance, but also because of inflation.

Also, I see no real risk from any alternative energies, if only because government aren’t letting the market work in its natural way and are probably stalling how investment in alternative energies would naturally work.

I’m using the USO ETF to invest, and currently have 11% of the portfolio in it after a 34% rise since I bought it on March 9th.

Leucadia (LUK)

I’d heard of these guys before, but had never really looked into them until recently when I read about them in Mayer’s book, and then saw Mohnish Pabrai, Prem Watsa, Marty Whitman, Bruce Berkowitz, Jean-Marie Eveillard and, incredibly, others all hold it.

Not only are the managers, Ian Cumming and Joseph Steinberg, amazing capital allocators, as evidenced by the 28% stock price, but they also have made some investment lately which will profit from the general inflation and rise in commodities, plus they’re not afraid to invest internationally.

Atlas Pipelines (APL)

My dad owned this company in his IRA for about a year-and-a-half from 2006-08, his returns were negligible for the unit price, but he made 10-12% in dividends.

He sold to make room for other investments a while ago and I stopped paying attention to it. Until I saw it had a 50% dividend yield (they’re actually called distributions, but I’ll call them dividends to keep it simple) and decided to look into it further.

The company is essentially a natural gas pipeline operator, it is a MLP which means if it pays out enough of its income in distributions to unit holders it does not pay taxes on them. It had fallen on hard times due to a huge debt load and the falling natural gas price. It had fallen to less than $3 per unit, even though it still had over a dollar and a half per share of distributable cash flow. I picked up about $430 at $3.43 per share (at the time a little less than 5% of the portfolio), it’s currently at $7.36 and has been as high as $9.30 in the past few weeks – the current allocation is 14%.

Management is slashing the debt, by selling the rights on some pipelines and suspending the dividend , they should be able to make it more manageable. When the price of natural gas sky rockets in the future this company will be comparable to a stub stock after a recapitalization.

Cash

I’m in the process of filling out my portfolio and currently have 37% of the portfolio still in cash, here are some of my ideas:

China

Due to Jim Rogers I have a strong interest in China for potential investments; I remember reading about Tweedy Browne investing in Japanese companies all at 2x earnings a couple years ago, I may try something like that, but I’m also looking for an index of companies in China.

Commodities, Farming

I want to own some companies that will strongly benefit from the rise in commodity prices, I believe Capital & Crisis (Mayer’s newsletter) will be the best starting point for this.

Special Situations

I’ve always liked Special Situations and believe right now is one of the best times to use them. I’m re-reading Greenblatt’s book and have created Google Alerts for all the keywords. I also hope to start using options and have Options as a Strategic Investment, which seems to be the best known book on the subject.

Other Thoughts

Reading/History

Pretty much all the smart people I’ve read about recommend two things to learn: 1. Read nonstop and 2. Read History. I am currently applying this and am reading an Entrepreneurial History of the US and am doing a comprehensive Austrian Economics Course. I am going to continue focusing on history and economics (among other subjects) as opposed to only reading investment books as I had before.

Summer Job

I’m doing an internship this summer with a corrugated sheet supplier, this may seem strange for a finance major, but I will be able to learn manufacturing, as I will spend time in the factory and with executives learning the business while I’m working.

I Still Do the Micro Things

I sent this to a group of people before posting it and the main reply I got, was that I can’t abandon the bottoms-up part of stock picking, I agree with this and here are my thoughts:

“I actually agree with you that looking at Macro can be useless, however it is my opinion that either top-down or bottom-up is basically useless, you need both to prosper the most.
If you only look bottom-up you can easily miss a huge downturn similar to what we have now or some other radical change tat will affect every company, but, also if you make a macro forecast it’s hard to be right and then still manage to predict how to profit form that forecast.

There is a lot of research that points to sector and industry gain as having huge impacts (my finance professor says 95%) in a stock price’s movement, but then there’s a history of having a margin of safety that gives the best consistent returns.

I think one is best off to not only look into economics, and history to try to find a way to identify macro trends, but to also strictly focus on well managed, undervalued, great businesses - this way he can best hedge his returns if one or the other fails, and if they both turn out right, he gets the best possible return.”

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