Building Wealth

SCIENTIFIC APPROACH

Building wealth is a process, more like erecting a building. It builds gradually. If we take a scientific approach, we should take out the strokes of luck and chances, though they have some role in building one's fortune. Instead, take it as a systematic process.

The hardcore trait of creating wealth is: Wealth Builders are Aggressive Savers. Rain or shine, a professional wealth builder (who manages and builds his wealth professionally!) must put aside some of his money into savings. THIS IS THE REAL CATCH! 

The best way to save is regular savings, like monthly PAC (pre-authorized chequing), where a pre-set amount of money is taken out of your bank account, and put into any type of investment. In this way, we make sure that we keep on saving!

FUNCTION OF TIME

An intelligent person knows that, any growth is function of time, be it money or skill or knowledge. The more time is spent on something, the more growth opportunity is created.

WEALTH = f (TIME)

EXAMPLE:

I give you a stupid simple example. Let's say, you put your money in a bank savings account, which gives you 12% interest per year. Now, you put $100 of your money into this savings account.

• If you put your money in January 1 and withdraw it in December 31: 
• total earning: $100 * 12% = $12
• Instead, if you put your money in December 1 and shortly withdraw it in December 31: 
• total earning: $100 * 12%* 1/12 = $1

This simple example illustrates that, the more time your money is invested, the more growth is there, other things kept constant (like alternative growth opportunity, risk, inflation, tax).

VISION OF RICH

The serious wealth builder has a vision. He sees himself RICH! The more specific and determined that vision is, the more power there is. Instead of focusing on spending, he focuses more on saving and creating assets. As wealth is function of time, over long run, this systematic effort reaps the harvest of wealth. 

Age of the Clouds

NEXT INTERNET BOOM

Within the next four years, size of the internet is expected to quadruple in size.

The last time web traffic volume was expanding this fast, Microsoft shares went up from $3.7 to $58.4, establishing a gain of 1500% in five years. Same time frame, CISCO Systems saw gains as high as 3900%.

So, what’s the catch?

By 2016, annual IP traffic is predicted to reach 1.3 zettabytes [just consider: there are one trillion (yes trillion) gigabytes in one zettabyte].

There are several reasons for this surge:

More Devices: Mobile phones, tablets and other gadgets will continue to penetrate into people’s hands. By 2016, there will be 2.5 connections for every person on earth.

More Wi-Fi: More than 50% of Internet Traffic is expected to be connected through Wi-Fi during the time.

Faster Speeds: Faster travel means higher rates of traffic. Average broadband speeds will more than triple within next four years.

Increased Video: Video obviously uses more data. By 2016, two years worth of video will move through the Internet every second.

CLOUD COMPUTING

As Internet traffic and acceptance of cloud security increase, so will the cloud industry as a whole. Gartner, a leading technology research company predicts the cloud market to grow by 19% to $131 billion in 2013. The market will see major gains within this sector.

Analytics Company Comscore found that before adopting cloud services, 45% of small to medium-sized companies express security concerns. However, after adopting the cloud, 94% actually feel more secure.

So, what is cloud computing?

It refers to online service that provides applications and document storage remotely, instead of on the user’s hard drive. In general, hosting computers (servers) and subscribers (clients) are the main components of cloud computing- just as they are in a traditional client-server network.

So, what distinguishes cloud computing from a traditional client/server network? There are three major differences:

In cloud computing, the delivery of the services from the provider to a subscriber must be over the internet.

The services provided over the cloud by a provider are scalable; they can be increased or decreased as the need s of an individual subscriber or company change. Services are typically offered and billed by the minute or hours.

The services provided are managed completely by the cloud provider, the owner or manager of the host. The client or subscriber of the service does not have to worry about having a specific computer or operating system, or a certain processor or amount of RAM, and does not need to purchase software upgrades or download service patches. The subscribed services are not on the individual’s computer or system. They are on the provider’s hosts and are maintained by that provider and simply accessed by the subscriber.

COMPUTER POWER!

As per Moore’s Law (co-founder of Intel), computer power doubles in every 18 months! As a consequence, as internet  is becoming more and stronger with dizzying speed, the new revolution in internet-based computer usage is coming to the fore. The pioneers in cloud computing like Cisco (NASDAQ:CSCO) or Palo Alto (NYSE:PANW), are set to shoot in their value.

End of a City

The Scenario

The City of Detroit in Michigan has declared Chapter 9 bankruptcy on 18 July this year (Chapter 9, Title 11 of the United States Code is a chapter of the United States Bankruptcy Code, available exclusively to municipalities that assists them in the restructuring of debts). America’s 18^th largest city- Motor City, Mocity has gone flat broke. It is now the largest American city to ever file for bankruptcy protection.

Gripped by $17 billion of piled up debt, the city can no longer sustain itself. Detroit’s population has declined from a peak of 1.8 million in 1950, and recently the New York Times called the city as “home to 700,000 people, as well as to tens of thousands of abandoned buildings, vacant lots and unlit streets.”

 

The Crisis

“Can we help Detroit? We don’t know.”

--- U.S. Vice President Joe Biden

Apart from the piling debt burden, the city owes $9 billion in unfunded retiree benefits.

The city’s lawyer is seeking to have the judge invalidate its pension contracts- so they can deny the pensions they promised to tens of thousands of workers.

As part of the bankruptcy petition, the city may be legally permitted to default on the promised pensions from those unlucky retirees in a futile attempt to “revive” the city. If those retires are lucky, they may get ten cents on the dollar. Even if the judge says it’s illegal for the city to confiscate the promised pensions- who has the better clouts?

For 60 years, Detroit has survived by the skin in the midst of serious mismanagement while spending non-existing money (i.e. paper borrowing on trust) in all the wrong places.

Now it can bear no more. Bailing out Chrysler and GM with taxpayer money (during 2008 recessionary bailouts) was apparently a politically attractive move. Bailing out the city is a different story. Which was echoed by the U.S. Vice President’s statement.

More Detroits to come

The problem is not quite unique to Detroit.  Listen to what is said by Michigan State Economist Eric Scorsone:

“ …Detroit is not unique. It’s the same in Chicago and New York and San Diego and San Jose. It’s a lot major cities in this country. They may not be as extreme as Detroit, but a lot of them face  the same problems.”

The credit based economy, with unlimited paper and debt creation power, is wobbling on its own hills. The same scenario is emerging everywhere. From Detroit to Greece.

Chaos at the Glacial Pace

The problems are fomenting slowly. Like a glacier which is moving slowly without making any sign of great fall, problems are piling. Even the Pope- is saying the path we’re on isn’t sustainable. His visit to Brazil came at a time when thousands of people were rioting because of the government’s failure to provide basic necessities while spending billions to host the World Cup. Taking the side of the protesters, Pope Francis notes that globally “we risk having a generation that hasn’t held a job. Personal dignity comes from working, from earning your bread.”

This may look extraneous that the city government of Detroit is seeking to deny its pension obligations, but is it really? If the trust is broken from the top level, what might happen next? The recent drama that is going on in Washington D.C. over possible U.S. debt default and government shut-down, who knows what happens.

Alternative Exposure to Real Estate

NEW IDEA IN REAL ESTATE

The new idea in Real Estate investment is the REIT, which stands for Real Estate Investment Trust. It is basically indirect exposure to the Real Estate sector.

Major features are:

• Its an Investment Fund, just like a mutual fund, legally set up as a trust.
• The fund builds, buys and repossess properties and manage them.
• Income comes from rental income, capital gain and other investments.
• By law, REITs must distribute100% of its taxable income for a taxation year so that it does not incur tax.

Owning a REIT gives  the benefits of being a landlord without having to face the hassle of actively managing the property.

REITs are governed by many regulations, the most important being that they must distribute all/most of their taxable income to unitholders/shareholders each year as distributions. That’s why they’re so popular with investors seeking steady income.

Other important regulations include:

Asset requirements: at least 75% of assets must be real estate, cash, and government securities.

Income requirements: at least 75% of gross income must come from rents, interest from mortgages, or other real estate investments.

Stock ownership requirements: shares in the REIT must be held by a minimum of 100 shareholders.

REITs specialize by property type. They invest in most major property types with nearly two-thirds of investment being in offices, apartments, shopping centers, regional malls, industrial facilities, and even fast-food chains.

BENEFITS OF REITS

High Yields. For many investors, the main attraction of REITs is their dividend yield. The average long-term (15-year) dividend yield for REITs is about 8% — well more than the yield of the S&P 500 Index. Also, REIT dividends are secured by stable rents from long-term leases, and many REIT managers employ conservative leverage on the balance sheet.

Simple Tax Treatment. Unlike most partnerships, tax issues for REIT investors are fairly straightforward. Each year, REITs send Form T3 to their shareholders (in case of non-registered accounts), containing a breakdown of the dividend distributions. For tax purposes, dividends are allocated to ordinary income, capital gains, and return of capital. As REITs do not pay taxes at the corporate level, investors are taxed at their individual tax rate for the ordinary income portion of the dividend.

The portion of the dividend taxed as capital gains arises if the REIT sells assets. Return of capital — or net distributions in excess of the REIT's earnings and profits — are not taxed as ordinary income, but instead applied to reduce the shareholder's cost basis in the stock. When the shares are eventually sold, the difference between the share price and reduced tax basis is taxed as a capital gain.

Liquidity of REIT Shares. One can buy and sell REIT shares easily bought on a stock exchange. By contrast, buying and selling property directly involves higher expenses and requires a great deal of effort.

Diversification.Studies have shown that adding REITs to a diversified investment portfolio increases returns and reduces risk since REITs have little correlation with the S&P 500. 

PERFORMANCE

The S&P/TSX Capped REIT Index is up 19 per cent on a cumulative basis over the past three years, roughly three times more than the broader market.

The S&P/TSX Capped REIT Index is a subset of the broad-based S&P/TSX Income Trust Index.  It is a sector-based index comprised of Real Estate Income Trusts which are classified in the Financials sector of the Global Industry Classification Standard (GICS®).  Individual constituent REITs’ relative weights are capped at 25%. The Toronto Stock Exchange (TSX) serves as the distributor of both real-time and historical data for this index.

Performance Data

 

INDEX NAME	PERFORMANCE (AS ON 30-SEP-2022) *
	3 YEAR	Inception                    (Oct 17-2002)
S & P/TSX CAPPED REIT INDEX	4.27%	8.77%

·         Source: Blackrock.com

 

A FURTHER LOOK AT THE FEATURES

REITs have been largely immune from market chatter, which is appropriate because they’re positioned to thrive in today’s low-rate, low-growth world.

REITs hold portfolios of malls, industrial properties, offices, apartments, hotels or retirement homes.

• They typically pay out quarterly income to investors, with a significant portion coming from a return of capital.
• Income received as a return of capital isn’t taxed in the year it’s received, but it does reduce the adjusted cost base for an investment. This, in turn, may give the investor a larger capital gain when he sells.
• REITs as being somewhere between average and peak valuation levels, which means the opportunity for serious price appreciation has passed.
• Even after a small recent pullback, the REIT index has gained 16 per cent in the past 12 months.
• What’s left is an opportunity to generate income yielding about 5 per cent and additional share price gains of 4 to 6 per cent based on strong fundamentals for commercial real estate.
• There are key differences between that segment and residential real estate, which appears to have peaked in Canada.
• Residential Real Estate market has uncertain growth prospects.
• By comparison, commercial real estate is in good shape. Even with the economy growing slowly, REITs have been able to consistently increase their cash flow.
• Acquisitions, new developments and redevelopments of existing properties have helped boost cash flow, as have rising occupancy rates and rents.
• Shopping mall REITs are benefiting from the arrival of U.S. retailers such as Target and Nordstrom.
• Industrial REITs are recovering from a hit to their tenants caused by the rising Canadian dollar (which makes our exports less competitive).
• Office REITs are doing well because of a limited supply of office space.

 

FINAL COUNT 

• REITs are consistent cash flow earners.
• Commercial REITs are front runners.
• With arrivals of giant retailers like Wal-mart, Targets and Nordstrom in Canada and also through expanding consumer base, commercial REITs create a solid cash flow machine
• On average 5 percent dividends are earned, on top of that, 4 to 6 percent capital gain can be earned.

The Silver Boom

The world is dangerously running out of silver.

 

Silver is there in most of our useful devices than any other commodity besides petroleum. Over HALF of silver is used in industrial applications. It is used in just any of the electronic devices made-from TVs to computers to electric cameras to iPads. It is also essential for batteries, disinfectants, solar energy, CDs, solar energy and water purification.

The list of products that need silver is enormous and constantly growing- including the two biggest areas of all:

·         Photovoltaic cells used in smartphones (1.2 billion cellphones were sold last year i.e. 2012!)

·         Its recent leading role as antibacterial agent being used by hospitals and health care facilities around the world.

 A report from Thompson Reuters shows, industrial demand for silver could hit a record 511 million ounces by 2014.

On the other hand, the SUPPLY of silver is in downward of historic magnitude. Silver inventories have fallen 92% since the start of 20^th century. Just think about it…..90% of the gold ever mined has been saved, but 90% of all the silver ever mined has been used up for industrial purposes.

 

As we mentioned in our previous discussion on silver, silver is severely underpriced. Wheres the availability of silver in relation to gold is only 3X, the price of gold in relation to silver is 55X (historically, gold silver price has been 16X). So, no doubt silver is set to skyrocket. Simply, there is no other alternative. If we look at the price trend of gold and silver, we find that:

In last ten years, silver has returned 609%, while gold has returned 439%.

 

But still, it is underpriced. And as the data above shows, it has no way but to rise sharply. It has to more than TRIPLE in price (from current ratio of 1:55 to historical ratio of 1:16).

The critical part is this- As people learn of the growing silver shortage, demand rises even more sharply. John Embry, Chief Investment Strategist of Sprott Asset Management of Toronto, says: “When silver  breaks free, I think many people are going to be shocked by how fast and far it goes.”

Multimillionaire and Investments guru Jim Rogers says: “If you put a gun on my head and said you had to buy one, I would buy silver rather than gold.”

So, folks, prepare to take roller coaster ride on silver!

The Magic of Money Creation!

MODERN MONETARY SYSTEM

The money supply is made up of two components: cash and credit.  But the amount of credit is much larger than the amount of cash.

This is the real magic of money creation! This is where the modern (and also magical!) monetary system comes into play.

The Central Bank controls-either directly or indirectly-total supply of money in the economy. The money that the Central Bank prints is only a small portion of total money circulating in the economy at any point in time. The bulk of the money supply consists of deposits that the public holds at financial instituions-i.e in their bank accounts.

Bank deposits are LIBILITIES for the bank. Banks act as FINANCIAL INTERMEDIARIES, by making these surplus funds from savers/suppliers available to users/demanders of fund. By law, banks are allowed to loan out a major part of these deposits to creditors. This process is known as CREDIT CREATION.

It is this credit creation process that constitutes bulk of the money supply.

CREDIT CREATION: USE OF FRACTIONAL RESERVE BANKING

The process of credit creation is done by FRACTIONAL RESERVE BANKING. What it means simply is that, banks can create credit or loan against the amount deposited in their bank, by keeping a fraction of the deposit as RESERVE with the Central Bank, and lending out the remaining amount.  The additional amount that is created through loans, then becomes part of money supply (reserve amount with central bank is NOT part of money supply). This amount lent then become additional loanable fund (after keeping a part of it as reserve) and so on. So, initial money supply keeps growing through the process of CREDIT CREATION and multiplying the money supply in the economy.

This is the root of expansion of money supply by multiple times from the initial money created and circulated by the Central Bank, which is done through the mechanism called the fractional reserve banking.

A SIMPLE EXAMPLE

 Let’s assume Bank A has received a deposit of $100. By the use of Fractional Reserve Banking, it can create credit by keeping 10% of its deposit, i.e. $10 as Reserve with the Central Bank, and lending out the remaining $90 to others.

Individual Bank	Amount deposited ($)	Reserves	Lent Out
A	100	10	90
B	90	9	81
C	81	8.1	72.9

The amount of $90 lent to individuals is then deposited in Bank B. It lends out $81, after keeping fractional reserve of $9. This amount becomes circulated and available in the economy. Eventually this amount then is deposited in Bank C, which again creates credit of $72.9.

 

This money creation process goes on, although initially it was only $100 that was created. But there is a limit of how much money can grow in the economy from the initial cash money. This is calculated by using the MONEY MULTIPLIER.

 

MONEY MULTIPLIER:

 Money Multiplier is calculated by using the reserve requirement. It stipulates how many times a certain amount of money can grow within the economy.

The money multiplier, m, is the inverse of the reserve requirement, R

             m =  1

                        R

Example

For example, with the reserve ratio of 10 percent, this reserve ratio, R, can also be expressed as a fraction:

R = 1/10

So then the money multiplier, m, will be calculated as:

m =   _1_   

                        1/10    

               = 10

 So, the initial money supply can grow by 10 times, that is, upto $1,000.

It is clear then, that most of the money supply in the economy occurs through the creation of credit.

WHAT’S THE BIG DEAL ABOUT FRACTIONAL RESERVE BANKING?

Fractional Reserve Banking is by definition expansionary, i.e. it is bound to produce inflation in the economy. Since this money creation is not backed by any tangible resource/asset, but by the dictum of the central bank, it can keep expanding indefinitely. By simply tweaking the reserve requirement (i.e percentage of R in the above example), the central bank can determine how much money it can grow. It breed a highly rich moneyed class of people, those who have control and access to this money! So traditionally, the bankers by default control the money, and in reality, they have the real power in the society. The savers, get only a fraction of return from this money circulation cycle (through a tiny percentage of interest income), whereas the users/borrowers take out this money, grows it in business/venture  (through return on investment) and exploit the  real power of money! So, this is the borrowers who make money from other peoples’ money! Those who understand this magic, they get rich.

What is in Gold-Silver Ratio?

There are interesting digressions going on in silver and gold plays, which reveal a sizzling opportunity as far as investing is concerned. Historically, price of gold and silver has been 16:1, based on the assumption that the availability of silver on earth is 16 times more than gold, or availability of gold is 1/16th times  that of silver. So, theoretically the price of gold to silver should not rise beyond 16:1.

 

The Ground Reality

 

1. Annual mining of gold is 80 million ounce, versus 750 million ounce for silver. Annual recycled amount is 50 million oz. and 250 mill. oz. for gold and silver. So, in total, market availability is 130 million oz. for gold and 1,000 million oz. for silver. This gives us current availability ratio of 8:1 for silver and gold.

 

2. Not all gold and silver are available for investment purposes, due to their various use in industrial applications. For investments (jewellery, bars and coins), the annual availability of gold and silver is roughly 120 million oz. versus 350 million oz. So, real availability ratio of silver and gold is 3:1.

2. In reality, investors are allocating their investments between gold and silver in totally different way. Actual Sales of silver in 2012 was 33,742 million oz., versus 744 million oz. for gold. This gives us a sales ratio of 45:1 for silver to gold.

3. Whereas, availability ratio for silver to gold is 3:1, sales ratio is 45:1 in physical value and 55:1 in dollar value. So, investors choose to buy silver at a ratio that is well above what is available.

	GOLD	SILVER	RATIO
Annual Mining (mill. oz)	80	750
Recycled (mill. oz.)	50	250
Total Availability per year (mill. oz.)	130	1,000	8X
Available for Investing (mill. oz.)	120	350	3X
U.S. Mint Actual Sales in 2012 (mill. oz.), partial data	744	33,742	45X
Investments Value (Billion $)	9,000	150	60X
Market Price (in USD) on Dec.28,2012	$1,656.30	$30.00	55X

 Source: World Gold Council (http://www.gold.org/) , U.S. Geological Survey (http://www.usgs.gov/) and Silver Institute (http://www.silverinstitute.org). Market Prices taken from (http://www.cmi-gold-silver.com/gold-silver-daily-spot-prices/).

How Prices are determined?

The silver price is essentially set in the paper market where the daily average trade on the Comex is approximately 300 million ounces. This is against the daily average mine production of about 2 million ounces!  So, no surprise that the price of silver is such severely manipulated!

The investment market for silver is smaller. While the dollar value of gold in the world approaches $9 trillion, the value of investable silver is estimated at around $150 billion. This is a ratio of 60:1 in dollar terms.

Where is the Market Moving Ahead?

Like we said, historically price ratio of gold and silver is 16:1, Today this ratio is 55:1. So, what are these numbers telling us? In all likelihood this price level cannot be sustainable, silver being such severely underpriced. Those who are smart investors and follow the market, they will be rewarded. Expect a super bull market for silver ahead.