A Gift to My Children Page 5

  DO NOT PANIC; LEARN THE PSYCHOLOGY.

  To be a successful investor, you really need to understand psychology as well as history and philosophy. Very often emotions drive the market up or down. Remember that economies and stock markets are two different things. As Paul Samuelson, the Nobel Prize-winning economist, once put it, “The stock market has anticipated nine of the last five recessions.” China's economy, for example, has been growing rapidly for years now, yet its stock market declined consistently for four years between 2001 and 2005. The public, overreacting to positive or negative news reports, will buy or sell short at the wrong time. Investor psychology can accelerate such trends in the market.

  Anybody can feel panicky. I have panicked a number of times and lost money in the market. After the oil shock of 1978 to 1980, when oil prices doubled, I watched the price of oil continue to rise. My research told me that, with supply exceeding demand, the price would soon fall, and so I ended up selling short. Just then, war broke out between Iran and Iraq, two of the world's largest oil producers. With the world concerned about possible future oil shortages, prices only shot up further.

  I had to admit the error in judgment. Some called it bad luck, but no. I didn't do my homework. I should have seen the conflict between these two foes coming. Someone had to know that war was imminent. Huge military movements had to have occurred. Propaganda machines had to have been activated. Much like a novice trader, I then had to scramble to buy back the position I had sold, and at a higher price than before. The oil price eventually fell, as I predicted it would, but by then, it was too late: I had already closed out my position.

  In hindsight, I should not have panicked. I should have realized that the fundamentals underpinning the oil price weren't sound. I had not quite grasped the effect of the mob mentality at the time, and as a result, I made a costly mistake. Losing your perspective in the midst of market panic is equivalent to losing your money in that market.

  SELLING HYSTERIA.

  For the most part, it is in short-term trades that prices are driven by emotion. Mid-term and long-term investments are usually influenced more by the fundamentals. Ordinarily I do not use charts to trade. Now, some people in the markets use graphs of previous stock or commodity movements in order to predict future price movements. They are called “technicians” or “chartists.” They spend a lot of time poring over the historic price movements and the formations these show on their charts as a way to predict what will happen next. Occasionally, I will turn to them as a way to see what has been happening and to check facts if I sense mob hysteria or panic at work. Charts sometimes reveal a beeline rise, an indication that prices have increased far beyond actual value. It means that people have lost perspective. It shows the level of the hysteria. I know that prices will eventually return to the appropriate level, so I sell short. You need to be careful, though, that you are not selling short simply because prices are high. Never sell short unless prices are astronomically expensive, and you detect negative change coming.

  Recently, pending evidence of hysteria in the charts for certain stocks related to home building, I sold them short. What I want you to remember is that bubbles burst in the wake of hysteria, while plummeting prices usually end in panic. You can see panic in falling prices when you see them collapsing straight down day after day for extended periods. Historically, long periods of selling have ended in “selling climaxes” when everyone finally panics and dumps to get out of the market at any price no matter what the fundamental reality might be. Large price declines across the board should attract your attention. A good rule of thumb is to sell during times of market hysteria and buy during times of panic. Always remember to buy low and sell high. It sounds so simple, but it is extremely difficult. Just keep this dictum in mind always—especially when your emotions are getting the best of you.

  CHAPTER 11

  Recognize Change and Embrace It

  EVERYTHING CHANGES.

  EVERYTHING.

  To understand what is likely to happen in the future, you have to be able to understand current events and the changes presently under way in the world. All social environments transform over time. Some people see such changes as evidence of a society's opening up, others as a reflection of its closing in. Regardless of your perspective, refusing to accept the change is like swimming against the current of a thundering river. Try to resist the force, and you will not last very long.

  NO ONE HAS DEFIED THE PRINCIPLE OF

  SUPPLY AND DEMAND AND SURVIVED.

  In 1991 the world witnessed a significant change: the fall of the Soviet Union. The totalitarian state was unable to sustain its political framework because of the fatal flaw of Communism, an ideology purposely deaf to the fundamental principle that you can find on the first page of any economics textbook: supply and demand.

  It is only logical that Communism would fail. All prices fluctuate according to supply and demand. Therefore sustaining a distorted pricing structure for any length of time is impossible, even if restricted to just one country. No government, no empire, has ever defied the principle of supply and demand and prevailed. In 1990, I traveled by motorcycle through the cities of the Soviet Union. Gloom (and not just the perennially gray Russian skies) permeated everywhere I went. I felt as though I was actually seeing Communism on the brink of collapse. Two years later, the USSR dissolved.

  CHANGE CAN BE A CATALYST.

  When I give advice about investing, I always emphasize the need to recognize change. Successful investors manage to do this—in most cases buying stock, commodities, currencies, bonds, real estate, art, antiques, coins, stamps, collectibles, and so on at phenomenally cheap prices, putting very little money at risk.

  But a cheap price alone is not sufficient reason to invest. If something is forever cheap, then it has no recognized value, and its stock may very well remain a worthless piece of paper. For a bargain to soar in price, there has to be a catalyst, and from an investment perspective, that catalyst is change. Whatever the change may be, it must have a significant impact within a country or an industry, and it must also be recognized as significant externally within a few years. If the change is real, others will notice the improvement, and prices will rise to reflect the new circumstances. New investors will catch on and prices can rise considerably for years.

  DEALING WITH CHANGE.

  So how do you deal with change? I am referring not to superficial changes, but to fundamental transformations that happen maybe once in the course of decades.

  When I was a child, immediately after World War II, America was the richest, most powerful country in the world. Now we are the largest debtor nation in history and are terribly overextended in many ways. When my grandfather returned home in 1918 after having served as a fighter pilot in World War I, the United Kingdom was still widely regarded as the richest, most powerful nation on earth, yet few saw the changes taking place beneath the surface. Within just one generation, it lost its empire and became a financial mess.

  Will you adapt to the changes happening around you, or will you resist the changes and lament the passing of “better days” long gone? I hope the former! Those who cannot adjust to change will be swept aside by it. Those who recognize change and react accordingly will benefit.

  CHAPTER 12

  Look to the Future!

  EVERYONE WOULD BE A MILLIONAIRE IF HE COULD

  READ A NEWSPAPER FROM THE FUTURE.

  When I was in my late twenties, working at Neuberger & Berman, a supervisor said to me while reading his morning paper, “When the market opens, Jim, there should be one hundred thousand shares of X Company to be sold at price Y, so I want you to buy those stocks.” True enough, when the market opened, there was a sell order for that exact number of shares and at almost the exact price that he had stipulated. He was able to figure out what was about to happen just by reading the newspaper and sensing the mood of the market. To this day, I remain impressed.

  People who can observe events as they un
fold will certainly acquire wealth. After touring the world from 1990 to 1992, I wrote my first book, Investment Biker. Recently a reporter remarked to me how many of the predictions I made in that book had come true, such as the rise of nationalism and militant Islam. How was I able to foresee the future? he wanted to know. I simply did what an experienced investor did: I read the news.

  My motorcycle journey coincided with the end of the Cold War, the struggle between Communism and capitalism. As I traveled through the Communist bloc, I could see that the national boundaries the USSR had forced upon divergent ethnic groups were unraveling. It seemed logical that without the political and ideological framework of Soviet Communism, these different groups would eventually insist on their own identity, founded upon ethnicity or religion or language. I reached this conclusion by way of my longstanding interest in history and philosophy. Only in this case, instead of reading the newspaper, I relied on my firsthand observation of the developments in these regions as they actually happened.

  MANY COUNTRIES WILL COME APART.

  A hundred years from now, there will probably be anywhere between three hundred and four hundred sovereign nations on this earth, almost twice as many as there are now.

  Today people the world over drive Toyotas, dance to the music of the pop star du jour, and dine on McDonald's and Chinese food, but such changes have had a wearying effect on certain groups of people. Such people are seeking alternatives, looking to have more control over their lives. No longer restricted by the ideological framework forced upon them by a totalitarian government, many are looking to religious, tribal, ethnic, and linguistic affiliations through which to express their identities. This will eventually result in subsequent redrawings of national borders, and a more fragmented, complex world. The empires and large nation-states that have built up over the past few decades often do not work and will come undone. This could be done peacefully, however, and does not necessarily insure war. For example, in 1993 Czechoslovakia split into the Czech Republic and Slovakia without bloodshed. Let us hope for the best going forward, since smaller, more responsive governments would be better for us all. Unfortunately, history shows that politicians usually bungle things.

  Predictions: Iraq will ultimately divide according to religious sects into three or four countries. Canada, Russia, India, Brazil, and the Democratic Republic of the Congo may also split up. An understanding of history and an astute reading of the current course of events suggest that such developments are inevitable—and natural. Not one country in existence today has had the same borders and government for as long as two hundred years. The world will continue changing.

  DO NOT PLACE YOUR BET ON

  THAT WHICH IS DYING OUT.

  Keep your eye on the future. Do not cling to anything that will eventually cease to exist. No matter how much time or energy or money you invest in it, once something is gone, it is gone forever.

  Several hundred years from now, there may be only thirty languages spoken in the world. Many languages will fall out of effective use in your lifetime. Those likely to be spoken for another several hundred years include English, Chinese, and Spanish. If you really want to succeed in the world, gamble on what you know will survive.

  THE WOMEN'S ERA IS APPROACHING!

  Traditionally, women in Asia have been treated differently from men. In many countries, a girl's family had to pay a dowry when she married as a further inducement to find her a husband. Like women everywhere, Asian women have long suffered a lack of equal opportunity in society; they have been treated unfairly in pay and promotion in the workplace. But this is all going to change. In China, Korea, India, and other Asian countries, where the priority has been placed on the birth of boys, girls are now in short supply. Soon the typical Asian man will experience great difficulty in finding a wife. For instance, in South Korea, there are 120 twenty-year-old boys for every 100 twenty-year-old girls, while in China, the birthrate is 119 boys for every 100 girls. As all these girls become women, they'll be able to demand more freedom. The ramifications from this will be enormous: Professions, education, politics, everything will change. I am so pleased to have two daughters!

  PAY ATTENTION TO WHAT

  EVERYBODY ELSE NEGLECTS.

  Most investors look only to strong markets. By 1998 my research indicated that a commodities era was approaching. At the time, very few people noticed that the long downturn in the commodities market had severely limited supply. A reporter asked me what I thought was the best option for private investors. I pushed the sugar on the table toward her, smiled, and said, “This is the best investment. Take it home.” The price of sugar at the time was 5.5 cents per pound. The reporter had looked at me skeptically; I smiled back at her. Sometimes, the more ridiculous an investment sounds to other people, the better the chances that it will yield a profit.

  If you are looking for success, be quick to start something new, something that no one else has tried. And if you want to invest, look for the bear market. Many have frequently profited by investing where no one else saw potential—putting money into commodities in 1998, for example. You can be rich if you have the courage to buy something while it is still under the radar of conventional wisdom.

  Incidentally, the price of sugar eventually tripled. But I'll bet that nice reporter missed her opportunity to make some serious money.

  THE MORE CERTAIN SOMETHING IS,

  THE LESS LIKELY IT IS TO BE PROFITABLE.

  A lot of people who attend my lectures ask me if one investment or another will “definitely” be profitable, or when exactly they should buy and sell. Whenever anyone asks me whether something is a sure bet, I tell them honestly that I simply do not know. Nothing in this world is absolutely certain, except my love for you, my daughters. When many people are absolutely sure of something, you should be suspicious.

  DO NOT THINK IN TERMS OF WHAT YOU WISH.

  Never act upon wishful thinking. Act without checking the facts, and chances are that you will be swept away along with the mob. Whenever you see people acting in the same way, it is time to investigate supply and demand objectively.

  Let me give you an example: In 1980 everybody wanted to own gold. The price had skyrocketed to over $850 per troy ounce. But one could see that gold was being overproduced; after all, a supplier is bound to increase production for anything that rises in price. A lot of people bought gold at this inflated price, insisting that it was somehow different from other commodities. Boy, were they wrong.

  More gold started to be mined, and, at the same time, the demand for the precious metal scaled back. In fact, many folks who owned gold jewelry sold it to refiners for melting, which further increased the supply. By the year 2000, the price of gold had sunk to about $250 an ounce. History shows that most bubbles take years for recovery, so there is rarely any reason to rush in after a period of mania. The exact same change in supply and demand happened with silver, which tumbled from $50 in 1980 during its mania to under $4 a couple of decades later.

  When you see so many people being unrealistic, stop and make an objective assessment of the supply-and-demand equation. Bearing in mind this basic principle will bring you that much closer to success.

  KNOW WHEN NOT TO DO ANYTHING.

  Anytime that you think you've become a financial genius—when, in fact, you simply have had the good luck to turn a profit—it is time to sit back and do nothing for a while. If you stumble upon success in a bull market and decide that you are gifted, stop right there. Investing at that point is dangerous, because you are starting to think like everybody else. Wait until the mob psychology that is influencing you subsides.

  CHAPTER 13

  Lady Luck Smiles on Those Who

  Continue in Their Efforts

  DO YOUR HOMEWORK, OR YOU WILL

  END UP WITH A GLASS BEAD.

  Once you take that first step toward your dream, put your full effort into it. Do your homework. If you want to succeed, you must never neglect it. My most successful investments wer
e those in which I invested the most time and hard work, collecting all available information and researching every detail. If you don't understand something—I mean truly understand it—you will never be successful. Likewise, if you merely dabble in an area, you are gambling, not investing.

  When your mother and I were circumnavigating the globe, I bought her a diamond from some smugglers in Namibia, Africa. They told me that the diamond was worth $70,000. I bargained the price down to a mere $500 because I thought the sellers were desperate. Immediately upon seeing it, your mother pronounced that I had been taken. Later, in Tanzania, I showed my purchase to a diamond trader. He laughed, because it was not a diamond but a glass bead. Of course, I knew the value of diamonds, but their value is all I knew. I was such an amateur that I could not tell the difference between a real diamond and a fake! All this time I had been advising people to invest only in what they know, and here I'd made a complete fool of myself over diamonds.

  You have to know what you are dealing with if you want to be successful. If you do not know how to tell if a diamond is genuine, you are going to end up as I did: with a glass bead. Looking back on it, I am glad that it was not the real thing. It was a relatively inexpensive reminder for me to avoid investing in anything that I do not completely understand!