Agora Financial’s Rude Awakening

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Ouzilly, France

• Delving into the investor’s skull – a neurological look at investing,
• Cashing in on the dollar’s long decline, gold’s long sleep,
• The age old battle of heart vs. mind and plenty more…

From the United Arab Emirates, Joel Bowman reports…

There’s no accounting for human emotions. One needs look no further than any
fool in love for examples of the fervent abandonment of any and all forms of
logic and reason. Otherwise sane men and women forgo the better judgment of
the brain to follow the whimsical caprices of the heart. The example is
magnified if the poor fool finds himself in lust. The further down his or her
body they derive their judgment, the worse the outcome tends to be.

Such is the confusion between the synapses of the brain and the impulses of
the heart that men of sound and reliable judgment have begun using the word
“belief” as an adequate synonym for “knowledge.” We confuse the notion of a
man’s right with his need. Not only do we interchange these vastly different
concepts, we’ve come to favor need over right. Anyone who’s had their right
to their own property infringed upon to pay for another’s need can tell you
that.

But the abandonment of logic is not restricted to the love of one and other.
We’re equally illogical when dealing with our love of money.

So infatuated have we become with the sultry lure of material riches we
delude ourselves into thinking they can, and should, be attained through
nothing more than a disciplined lack of industry. We believe, despite what we
know to the contrary, that something can be manufactured out of
nothing…that a dollar borrowed is equal to a penny earned…that loaning
from Peter to take Paul out for dinner is a sustainable way to manage our
budget.

The American man has become so infatuated with the concept of need, he has
forgotten the means by which his need must be logically met. Rather than earn
his money, he simply borrows it.

This is hardly surprising when one considers the behavior of the government
under which our illogical American operates. He is taught that borrowing from
the bondholders in one country to finance a war in another is the acceptable
modus operandi. And when it comes time to repay the debt incurred for her
exploits abroad, the government cranks up the monopoly printer and injects a
few more funny money bills into the economy. Voilà, problem solved!

The only things more spurious than a promissory note with a dead president on
it are the promises made by whatever goofball occupies the White House when
the survey is taken. The national debt provides about 9 trillion examples of
these broken promises. 

While we pine in vain for the return of the age of reason, we’ll turn over to
Dan Denning, the mastermind behind the Australian Daily Reckoning, for a dose
of logic…

With paper values in such an exaggerated state of flux, gold-boring, yellow
and shiny-looks like a rock of sensibility and stability.

Gold also looks like it could go a lot higher, at least according to an
inflation-adjusted chart of the gold price. Gold’s nominal high is US$850,
set in late January of 1980. But US$850 just doesn’t go as far as it used to.
In today’s dollars, gold’s 1980 high was over US$2,271.59.

Does this mean gold is going to US$2,271 and beyond? Not exactly. It could
happen. But as one listener at the Melbourne Investment Expo pointed out to
us, gold isn’t a sure thing.

“If you bought gold in 1980 and held it, you would have lost money for twenty
years, not only in nominal terms but adjusted for inflation, especially if
you weren’t earning any interest on your gold. It’s a dangerous thing. Bear
markets can last many years.”

He’s right. Entire asset classes can go into 20-year bear markets. Gold and
resources endured one such bear-market, only bottoming in 2000 and beginning
a rally that swept up resource stocks (including Aussie stocks) in 2003. It’s
been full speed ahead since then.

Our view here is that resources weren’t just in a 20-year bear market in
2000. They were in a 200-year bear market. During the first two industrial
revolutions-in Great Britain and the United States-the supply of commodities
grew faster than the populations of the industrialised world.

The urbanisation of the globe, along with the Green revolution in
agriculture, have led to a population explosion…which has created greater
demand for commodities than ever before. And now we have the third industrial
revolution in China-only a much greater, much more resource intensive scale.

As people move from the farm to the city, they need a place to stay, a place
to eat, a place to work, a place to shop, a place to sin, a place to get
sick, a place to heal, and a place six feet underground when it’s all over.
You need a lot of places filled with a lot of stuff for 6 billion people.

Life itself has become more resource intensive. And there are 6 billion
buzzing, teeming, eager, anxious, hungry and ambitious lives on the planet.

Still, markets are driven by human beings and human beings are driven by
emotion as much as logic. They over-reach, over-promise, and over- react to
bad news and good. It’s worth remembering that asset prices don’t go up
forever. And when they go down, it can be for a very long time.

In the column below, Bill Bonner takes a closer look at human emotion and the
various outcomes of those that use their heart, rather than their head, to
invest…

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A Kiss is Still a Kiss
By Bill Bonner

One researcher says emotions are an investor’s number one foe. Another says
emotions improve investment returns.

In a landmark study announced two years ago, it was revealed that investors
got better returns after being knocked in the head.

That came as welcome news to us. There were plenty of investors we wanted to
hit on the head. Besides, we always suspected that you had to be a little mad
in order to invest in the first place. Why? Because of the Law of Declining
Marginal Utility. Broadly stated, the more you have of something, the less
each additional bit of it is worth to you.

The first dollar you earn is like your first real kiss; what an impression it
makes! But after a few girlfriends, you can barely remember their names. And
since you can’t tell the difference between your first dollar and your last
one, the effect of earning an extra buck is to raise your wealth overall, but
to diminish the value of every single dollar you ever earned.

Logically, if an investment only has 50/50 odds of success, you wouldn’t
bother; for every extra dollar you’d earn, you’d lose a more precious one.
Investors are instinctively aware of this. So, there is a gentle bias towards
caution.

Cometh Princeton Professor Daniel Kahneman, who won a Nobel Prize for his
work in the emerging field of neuron-economics. We are well aware that we owe
to science all the modern wonders we enjoy. Without their inquiries into the
nature of things, we wouldn’t have prime-time TV or subprime CDOs. Still, it
is hard to believe that man is such a simpleton as science makes him out to
be.

Professor Kahneman teamed up with brain neuroscientists and began peeking
into investors’ skulls. What they found was that the same areas that flare up
under the influence of drugs, also get a buzz going when there is money on
the table. So, they got together a group of people who had been hit on the
head or whose brains had been damaged in other ways; these people functioned
normally otherwise, but experienced much less emotional fizz than normal
people.

Then, they played a little game. Starting with $20, each one flipped a coin
and called it: heads or tails. If the participant called it correctly, he won
$2.50. If he called it incorrectly, he would lose only $1. If he was feeling
unlucky, he could pass.

Obviously, the player who wanted to maximize his returns would never pass.
The odds of winning were tilted in his favor. But the players demurred
anyway. And those who passed least often were those with damaged brains.
Naturally, they made the most money; after 20 coin tosses, they had an
average of $25.70 versus those with “normal” brains, who had only $22.80.

What does science make of this? That the best investors are mental
defectives? No, the conclusion was that emotions get in the way of successful
investing. Emotions caused participants to react in ‘illogical’
ways…refusing to bet, even when the odds were clearly in their favor. The
un-emotional players, by contrast, did the “rational” thing more often and
won more money.

Now, along comes yet another study with the opposite conclusion:

“Adding emotions to the decision-making process can enhance creativity,
engagement and decision efficiency,” wrote Myeong-Gu Seo of the University of
Maryland and Lisa Feldman Barrett of Boston College in a study released in
August.

“Contrary to the popular belief that the cooler head prevails, people with
hot heads – those who experienced their feelings with greater intensity… –
achieved higher decision-making performance,” they wrote, after following 101
stock market investors in a simulated trading exercise over a four-week
period.

What these studies show is that the people who study investors are
knuckleheads. If the investor does not do as they think he should, they take
him for an idiot.

A “rational” investor will always seek to maximize returns, they say.
Anything else is a “mistake.” But what is so irrational about wanting
something other than maximum returns? Is that all that matters in life? Some
investors would rather be right than rich. Others enjoy playing the
game…teasing themselves with hunches, theories and techniques… even
though they know most will fail. Some don’t want to appear too greedy – even
to themselves.

Any moron, confronted with the coin toss game and favorable odds of 1.5/1,
knows just what to do. There is no skill involved; no fun either. If he is
allowed to ‘play’ infinitely, he’ll win an infinite amount of money. On the
twenty tosses, mathematically, he could expect to walk away with $35. No
more, no less. Maximizing efficiency, he might say, “just give me $34 now and
we’ll be finished.”

But efficiency isn’t everything. What cat doesn’t spend a little idle time
playing with its mouse before killing it…even though, occasionally, one
will get away? What lover longs for the scientist who has perfected the
efficient kiss?

Joel’s Note: Bill Bonner is the founder and editor of The Daily Reckoning. He
is also the author, with Addison Wiggin, of the national best sellers
Financial Reckoning Day: Surviving the Soft Depression of the 21st Century
and Empire of Debt: The Rise of an Epic Financial Crisis.

Bill’s latest book, Mobs, Messiahs and Markets: Surviving the Public
Spectacle in Finance and Politics is available now by clicking here.

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Rude Endnote: The markets are closed here in the Middle East today on account
of Eid al Fitr celebrations - festivities commemorating the end of the
Islamic holy month of Ramadan.

So, while we rejoice in being allowed to eat and drink in public again, we’ll
hand you over to our compadres in Baltimore. Addison and Ian will be along
with your 5-Minute Forecast shortly.

Cheers,

Joel Bowman
Rude Awakening