Raymond “Scott” Stone
Partner/ Investment Manager
Stone House Investment Management, LLC
For our current clients and those of you who are considering using our services, I want to give you a quick guide for whether you should be choosing an active or passive investment management strategy. I want to keep it brief and easy to understand, so I won’t be able to go through all of the details, but my hope is that it will give you enough information to make an educated decision.
We have designed Stone House so that it offers our clients the best chances of achieving their financial goals. One of the ways that we have done this is by offering several very different investment management strategies that can be used in tandem with one another to create a “Super Portfolio”. The strategies we offer function very differently and can consequently have very different outcomes year to year. I would like to pretend that I know which one will be the best over any given time, but I have invested money for people long enough to know that the best we can do is make smart decisions to protect and grow our clients assets and then adjust as the world changes (And boy, does it change). I want to talk about three of our portfolios management styles and how their performance has differed over the years to illustrate this point.
First, is our “Flagship” portfolio strategy that we call Keystone. Keystone is a strategy that we built in-house that is very different from almost any other portfolio in which you may currently invest. Keystone allows us to evaluate the market daily, then determine if we feel there is a strong reason to stay invested based on historical behavior of the stock market. It has done extremely well for our investors in some years, but more recently the performance of this strategy has been lackluster. That isn’t to say that it has been bad, but it hasn’t kept up with some investment benchmarks like the S&P 500. The investment decisions we make inside of Keystone are well educated preparations for an uncertain future. Because the future is uncertain, no amount of intelligence can guarantee that any decision today will pan out to be correct in the future. In a “normal” year, the markets may be…. 60% to 70% predictable and 30% to 40% unpredictable. The past few years have been unusual to say the least. The unprecedented actions taken by governments around the world have manipulated the functioning of most equity, commodity and fixed income markets. As there is no precedent to rely on to understand how certain actions will effect our clients’ investments, it dramatically raises the unpredictability of the markets leaving investment managers in a very difficult position. Seemingly, the more we try to protect and grow our clients’ portfolios, the more Congress, or the President, or the Federal Reserve Chairman, or some foreign central banker want to ruin our plans.
Additionally, because of the uncertainty in the United States, we thought it prudent to diversify internationally in case our government made choices that did not favor our stock market. Europe was a mess with its own issues, so we ended up weighting our less conservative Keystone portfolios to Emerging Markets. Unfortunately, the actions taken by our government to prop up our stock market have had a negative impact on Emerging Market countries causing many of their markets to fall precipitously even as our stock market has moved higher. This has added to the disparity of globally diversified investments verses the S&P 500 over the past few years. Again, in our attempt to protect our investors, we missed out on some gains.
As an alternative, you could choose a more buy-and-hold management strategy like that of our Essential and Diversidex Investment management strategies. These portfolios each invest expecting the stock market to go up over time, but are less concerned with the day to day movements in the market. These strategies have worked great over the past few years. No matter how dark the economic skies got, no matter how dysfunctional our government is, no matter how high our national debt goes or how low the US dollar goes, our stock market keeps going up! Being fueled by the “money printing” of the Federal Reserve, our Stock Market has either blissfully ignored the dangers, or quickly recovered from any downturns due to these accumulating economic risks. So that’s the answer, right? Just buy and hold? Not so fast!
The reason that this strategy has worked is because the governments of the world (particularly our own) have taken a series of deliberate actions to favor the short-term performance of the stock market at the cost of addressing our long-term sustainability. That is not to say that this is not a “smart” economic policy, only time can tell us that, but it is important to remember that every 3 months or so, an organization within some nations’ government has chosen to take unpopular actions to bolster their financial markets. Had they chosen a different path, buy-and-hold portfolios would likely look very different. For example, in the latest debt ceiling debate, there was talk by certain members of Congress of letting the government default on its debt. Even if they had chosen to do this for a very short time, it would have been disastrous to our economy and a buy-and-hold portfolio. A catastrophic mistake like this would have had you wishing that your advisor put your money on the sidelines leading up to the decision. Such events have happened in the recent stock market crashes of 2000-2002 and 2008-2009. However, because in recent years the governments of the world have taken extraordinary actions time and time again to prop up the stock market, the market rose significantly and had you been sitting on the sidelines, you would have fallen behind the averages.
So which is better? Trying to protect your portfolio at the risk of potentially missing out on some return, or to blindly hope that the boogieman never comes out of the closet and that your buy-and-hold stock portfolio doesn’t get eaten? There is no right answer to this question. It largely comes down to your attitude as an investor. However, Stone House offers the option to take part in both of these categories of investment strategy. We encourage our clients to choose to divide their investments into multiple strategies to give them the best chance of success. Additionally, we offer our Cornerstone portfolios which have elements of active and passive investment management.
When you partner with Stone House, we do our best to help you prepare for an uncertain future. Through helping clients invest using multiple investment philosophies, we promote more stable portfolios and hopefully a return that allows our clients to achieve their financial goals. Over the past few years, buy-and-hold management has beaten out more actively managed portfolios, but as asset values inflate, the potential for return decreases and the risk of a correction or bear market goes up. Only time will tell how long buy-and-hold strategies will hold out. One thing is for sure, in a buy-and-hold strategy, you will make a lot of money when things do well and lose a lot of money when things are bad. Markets move in cycles and the longer this bull market runs, the more likely we are to see a bear. Active management strategies may help protect you from the next inevitable market downturn, but may not return as much while the Bull market rages on. It might be a good time to try some of each in your portfolio.
-Raymond “Scott” Stone
Robert J. Brown, CFP®
Stone House Investment Management, LLC
210 Maple Street, Montrose, Pa 18801
We are often asked if there are ways to contribute royalty income to IRA’s or retirement plans. The answer is no, but there is a work around you may want to consider. Think about increasing your contributions to a retirement plan at work.
Who does this work for? Anyone receiving royalties AND who is employed somewhere that offers a retirement plan or is self-employed.
What you need to do? Dial up your contribution amounts from your paycheck and into your retirement plan. It’s that simple.
Why does it work? It works because you are only allowed to contribute EARNED income to a retirement plan/account. Royalties do not qualify, but you can spend your royalties for your daily expenses and instead contribute your earned income from work to your retirement plan or IRA.
Here’s an example: Let’s say you’re making $60,000/yr at your current job. You were putting 3% ($1,800/yr) into your retirement plan at XYZ Company because the company would match it. However, NOW you’re seeing royalty checks of $2,000/month! You can spend that $2000/month of royalties on living expenses such as groceries, your mortgage payment, your car payment, etc (after you set aside enough for taxes). Then you can instruct your employer to hold out much more from your paycheck to put into your retirement account at work. How much you can contribute depends on your company’s plan. Some plans allow for more than $20,000 per year!
What if you’re self-employed and don’t currently have a retirement plan in place? Now might be the perfect time to set one up. There are many types of plans to choose from depending on the size of your business and what type of contributions you want to make to your own retirement and the retirement of your employees.
For many people, this will give you a great chance to save more for the future and pay less in taxes today. That’s a win-win in most investors’ minds!
Robert J. Brown
Certified Financial PlannerTM
Stone House Investment Management, LLC
Why Bother Checking My Royalties?
As more and more of our residents fall into the category of “royalty owners”, we are beginning to see a trend.
Upon opening the first check, you face sticker shock! Even though you estimated different amounts AND you knew that the first check is often a buildup of several months; once it’s in your hands, the moment is a bit alarming. You glance through the whole statement but it’s all a blur compared to that amount on the final check.
After several of these months go by, you begin to feel more emboldened and knowledgeable about these payments. Now some of the things that your friends and neighbors talked about, like decimal interest and gross vs. net, are starting to make sense.
In many cases, the total amounts begin to wane. Your curiosity turns to skepticism as you sort through the details of the pay stubs in hopes of trying to find out for yourself if things are “adding up”. After your eyes turn bloodshot and you’ve pulled enough of your hair out, you throw your hands up and officially declare it unsolvable!
As time goes by, you wrestle with the internal dilemma that plagues so many royalty owners:
Happy – “I don’t want to seem greedy. I’m thankful for what I’m getting. This is more than I ever thought I’d see.”
Unhappy – “What if I’m NOT getting paid correctly? How can I even determine that? These statements are seemingly impossible to read. If mistakes were found, what would I even do about it?”
Keep It Simple… PLEASE!
Let’s discuss a few simple terms as defined according to Wikipedia.org:
A lease is a contractual arrangement calling for the lessee (user) to pay the lessor (owner) for use of an asset.
A partnership is an arrangement where parties agree to cooperate to advance their mutual interests.
The gas leases that the majority of landowners have signed have formed partnerships between themselves, as owners of the asset and the gas companies as the producers/developers of the asset. In the simplest of terms, that’s pretty much it.
Yet, as this begins to play out, we’re sometimes seeing a substantial communication breakdown between the two parties which can lead to the royalty owner feeling frustrated and less trusting. Does it need to be so complicated? The root of the problem stems from a lack of understanding by most royalty owners on the topic combined with broad assumptions by the gas companies that simply by putting numbers on a check stub, we (the royalty owners) should be able to figure it all out.
In defense of the gas companies, they’ve been very proactive of late in posting tutorials on their websites and inserts of how-to-read-your-royalty-check in their mailings. In cases where you have just ONE company producing the gas and that same ONE company paying your royalties, that type of learning material is helpful. What happens though when your checks begin coming from more than one company? Simply put… it gets complicated.
Look At It From This Angle
Joint Ventures (more than one company) can create complexity based on accountability. Let’s say you lease your 100 acres to a farmer who decides to plant corn and give you 15% of the profits. He comes at the end of the season, harvests the corn and leaves. 3 months later, he sends you a check with a statement. The statement is a bit confusing but you eventually make sense of the calculations. What doesn’t make sense to you is the total amount of corn he took from your property. You thought it would be much more than that. You are confused?
A few weeks later you hear from a few of your neighbors that the farmer who leased from you is working closely with some other farmers (whom you’ve never heard of) and it looks like they’ve formed some sort of Joint Venture to work your field and others around you. You feel a bit odd that you weren’t told this directly and certainly still feel in the dark about the details.
A month after that initial check, you are surprised to get a check from 2 different farmers, paying you for the corn that was taken by the farmer you knew. Each of these farmers use different calculations that look similar but a lot of the details and terms they use are different. You try to add them to what the original farmer sent last month but it doesn’t really add up. Now what?
What often happens at this point is that you start to make assumptions. The mind is a powerful tool and it begins to reach for all kinds of conclusions. In this hypothetical, the farmer and anyone else affiliated with him seem to be out for themselves. When you call any of them they seem to give you answers but not exactly what you’re looking for… or what you wanted to hear. You wanted to hear them tell you that it got confusing but we’ll make it less confusing and pay you more. Instead you got some vague answers. Why? Maybe that’s because you asked them vague questions?
In the case of royalties, you can’t expect real thorough explanations when you call up and say “I feel like you took more gas than what I got paid for” or “My gas check seems lower than it should be”. If I’m on the other side of that phone call, my response might be, “Uh… well it’s all on your statements”.
Does the squeaky wheel always get attention? Not if you’re making noise just for the sake of making noise. Unless you provide the specific details that evidence your concern, then it sounds like you’re just saying “I wish I had more”.
Are Mistakes Being Made?
Yes. In our experience with our client base, we’ve identified a fair number of issues; some have been corrected while others remain in question. Often these fall into two categories.
Industry Side – Frequently, during normal reconciliation done by the gas company, “adjustments” will need to be made to previous months’ payments often related to a change in unitization, incorrect calculation assumptions, realized gas price, etc… Joint Venture agreements are a factor in how payments flow to the royalty owners and inconsistencies in how these are paid and reported sometimes contribute to errors to your bottom line.
As basic as the math is, we’ve still seen simple mistakes made with things like the Decimal Interest being off, acreage included in the unit not being the same as what’s on the lease, and other clerical type mistakes. By and large, the gas companies seem very willing to examine and correct these when brought to their attention.
Royalty Owner Side – Occasionally, things are happening behind the scenes of ownership that the gas companies are not privy to or may have misunderstood. The probability of these types of errors increases with each degree of complexity; family LLCs, joint ownership, transferred interest, etc…
For example, a family owns substantial acreage broken up into multiple parcels. Several years ago, during the planning process, even though some of these parcels were owned by various combinations of family members, it was mutually decided to transfer the royalties associated with each of them into the new Family LLC.
For more than a year now, money has been flowing into the LLC as the majority of these parcels are included within three side-by-side units. The issue that has now come to light is that royalties on one sizable parcel are not being paid to the LLC. Instead, those monies are going directly to one daughter. Why was this not noticed much earlier?
When everything was being transferred a few years back, it was mutually decided that this daughter would maintain her roughly 10 acre lot that was nearby since it was never considered to be part of the “family farm”. She and her husband remained owners of both the surface and sub-surface. However, the larger parcel which she had ownership in DID have its royalty rights transferred into the LLC. (or so everyone thought)
Eventually, the daughter and her husband began receiving royalties from the XYZ Unit and were pleased with the amounts. What they did not realize was that their checks were based on not just their 10 acres… but also the much larger parcel that was supposed to be going to the LLC. None of this was apparent to them because the check statements were confusing to them and they got lost in the details.
Quite a mess! Now this couple is faced with finding a way to make the Family LLC whole. In addition to the money, this took place over two calendar years, which means the couple paid tax on the extra money they received and now need to pay back. Yikes!
We are only one financial planning firm in NEPA but our office alone has seen errors like this take place. Fortunately, we’ve built quite a sophisticated system to help identify irregularities in royalties but due to the complexity of such matters, we currently only offer it to our clients who also have us managing other investments for them. We view their land as another asset that, especially at this time, needs to be monitored.
Recently, we had the pleasure of meeting with our local State Senator and two State Representatives on this topic and were very pleased to see how attentive they were to these details and aware of how many people were affected by these complex statements. At their request, we submitted a proposal to enhance the transparency of royalty reporting to benefit the land owner and gas company. It is our hope that with their help and the cooperation of the gas industry, some standardization will be in our future so royalties become easier to decipher. Someday Mom and Dad should be able to sit at their kitchen table and sort out their own details; confident that they are receiving a fair share of the partnership they signed up for years ago.
Robert J. Brown, CFP®
Stone House Investment
Raymond “Scott” Stone
Stone House Investment Management, LLC
“Should I buy gold?” This is a question that is frequently presented to us. In this article, I’ll go over some of the more common and controversial claims of gold marketing firms, then wrap up with our position on gold’s place in a good investment strategy.
Over the years, we have heard sales pitches, analyst reports, and political punditry describing a variety of scenarios that typically end in “so you have to buy gold now”. Is there any credibility to these claims? Let’s take a look at some of the more common scenarios pitched by gold bugs:
1) The U.S. dollar being replaced as reserve currency:
This one is actually a possibility. In fact, given enough time, it is highly likely that the US dollar will not serve as the sole reserve currency. Likely it will be replaced by either a “basket” of currencies or a newly created world currency that is completely independent of the debt of any nation. If a basket of currencies is chosen, gold may be part of that basket which could cause the price of gold to rise.
2) Rampant price inflation:
In an environment where inflation rages out of control due to excess monetary supply, gold would likely appreciate significantly in price. This is not a very meaningful statement, though, as virtually all things would appreciate significantly in price. Commodities would likely benefit as money would rush off “the sidelines” (A.K.A. Cash) and seek investments whose prices would keep pace with or exceed inflation. Additionally, there may be an additional fear-premium bump to gold prices as some people think of it as the asset of last resort.
3) All currencies failing and the world returning to using physical gold as currency:
Put this one on your list of things that are not going to happen… Ever. There are very real reasons that we abandoned gold as a currency. To be completely accurate, gold was never actually a currency. At best, it was a co-currency. Gold has always been thought of as valuable and desirable due to its physical properties and relative scarcity, but it is quite impractical as a currency. It is difficult to denominate because it requires you to actually divide gold the into pieces (hard to make change for a dollar with a piece of gold). It is also difficult to distribute. Currently, very few people have substantial amounts of gold. For it to be adopted as a currency, the gold would have to be removed from vaults, jewelers, and personal jewery collections then melted down, standardized for purity and weight, and then redistributed across the billions of people across the earth. Once distributed (assuming it is even possible) each individual would be responsible for valuing their gold pieces, verifying the purity of the gold being exchanged, and transporting and storing their wealth in heavy metal. Add to this the small detail that there is not enough physical gold to serve sufficiently as a currency even if every ounce available was secured for the purpose of currency. For gold to represent all the value that the currencies of the world represent, it would have to appreciate in price to a ludicrous degree. The reality is that gold as a currency is likely impossible even if it were the only option, but it’s not. It is the worst of a nearly endless variety of options. What are these options?
Human beings have a nasty habit of stealing ideas from nature. One of those ideas is the order of the physical world. The entire universe adheres to a set of laws that presumably something or someone created. Our financial system is based on this idea of rule based order. However, we create the rules, which is very handy because it means we can change the rules as needed. Examples of these rule changes were seen during the various financial crises of 2008 to 2012. The bank bailouts, the auto bailouts, the sovereign debt bailouts, the extension of unemployment benefits, the flood of liquidity from central banks around the world, the unprecedented government purchases of toxic assets, and the extension of special swap agreements between countries are just a few of the examples of how we changed the rules of our financial system to create a new financial reality. Rule changes can be made as long as the majority of market participants are not willing to accept the end result the current rules would bring to bear. Changing these rules typically require some creative thinking, consensus building and the swoop of a pen across a piece of paper. The option to modify the rules to create a new reality that benefits the majority of market participants is so vastly superior to the intense, severe disruption and damage that would be caused by abandoning the financial system in favor of a completely impractical gold currency system that it is virtually impossible to envision using gold as currency. We wouldn’t move everyone to the moon because we dislike natural disasters on earth. It just wouldn’t make sense. Our financial system is imperfect, but using gold as a currency is not a realistic substitute.
4) Returning to the gold standard
As mentioned earlier, I think it is definitely possible that we could create a new standard based on a basket of currencies including gold. I don’t see it as realistic for a currency to be tied solely to the value of a single commodity as that commodity can be effected by supply and demand shocks independent of its value as a currency. It was a bad idea originally and it is still a bad idea. In previous times, it was the best of a lot of bad options, but now we have evolved beyond the need for it largely due to technology. Gold would likely, at best, be included as part of a basket of currencies that becomes the new reserve currency standard. In such case, you may see an appreciation in gold to reflect increased demand for this purpose.
As you can see, the issues regarding currencies are complex and not nearly as black and white as some would like to think. Now let’s look at some common misconceptions about gold investing:
1) If you have physical gold, you don’t have to worry about price fluctuations because you will always have the actual gold in your safe.
This is blatantly false. It is roughly equivalent to saying that if you buy a house it will always be worth as much as you paid for it because you live in it. The value of your house can go down. As many in this country have seen recently, your home value can go down a lot, quickly. When the price of your investments (including gold) goes down, your equity declines which can affect your ability to get credit, your net worth declines, taxation and equalization plans of your estate could be effected and your buying power and retirement income generation potential declines . If you make the assumption that you are buying gold today and that you are going to die owning the same gold and that it doesn’t matter what the effect is on your heirs, then it is true; you don’t need to pay attention to price fluctuations. The same applies to all investments, however. If you have the luxury of not caring what your investments are worth, it doesn’t matter what they are worth. This is as true of any investment as it is of gold. If you do care, however, then physical gold may not be right for you because it REALLY DOES FLUCTUATE IN VALUE (even if it is stored in your personal safe).
2) Gold investing is “safe”
Define Safe? Gold will likely always be worth something. Unlike a share of stock, there will not be a time in the future as we know it where gold might be worthless. Gold can, however, decline substantially in price in a short period of time. It can also stay at these low prices for a considerable amount of time. Over decades most investments, including gold, will trend upward (all else being equal), but you may have to wait years, even decades to get your money back especially if you consider inflation. Gold pays no interest rate or dividend. There is no reward for owning gold other than price appreciation. If you own gold for 10 years and the price does not go up, you have actually lost quite a bit of buying power due to inflation. As Gold is very volatile, and pays no interest or dividends, and has little risk of ever being worthless, it is most similar to a growth stock mutual fund from an investment risk perspective.
3) The value of gold is “more real” than the value of stocks.
The idea that gold has “real value” because it is the only “true currency” is not correct. If you want to get technical, the only “true currencies” are goods and services. If gold ceased to exist, we would be just fine. In fact, most people throughout history have gone through life owning very little gold. Good has always been something that tends to end up in the vaults and showrooms of the rich. So what did the rest of the population do to survive? They worked. They made things, and grew things, and did things and traded these goods and services for the things they needed. Barter is the true system of exchange that our current global economy is based on. We call them “Markets” now.
Throughout history, gold has served as the best material to represent a standardized unit of exchange due to its scarcity, physical properties and somewhat standardized nature. In reality, it is just as fiat as currencies because gold, when used as a method of exchange of value does not reflect the intrinsic value of gold. When gold is used as a currency it is representing the value of the goods and services being purchased or sold. This value can fluctuate from day to day, product to product and community to community. This is the same as any other currency. On Tuesday in Philadelphia, your broken gold jewelry may be worth $500/oz. On Wednesday in London, gold bullion may be worth $1700/oz. The value of gold is contingent upon time, market and condition of exchange, just like fiat currencies.
Like many things, the Information Age has rendered gold obsolete as a unit of exchange. It is likely that in 100 years, we won’t even use cash. So how does this relate to stocks? Stocks represent ownership in a company. The reason you would want ownership in a company is its ability to generate value through providing desirable goods and services to the world. Companies do business using many types of currencies depending upon the country in which they are operating. The collapse of any given currency or even all currencies does not require that we also abandon corporations. In the preposterous scenario that we go back to using physical gold as a currency, we will likely rely on corporate institutions like banks even more to standardize, certify, value and regulate the good order exchange of gold. If you envision a “Mad Max” like apocalypse of society where all of our institutions fail, you will likely be waiting an awfully long time. When faced with global economic implosion or compromising on changes that allow the system to continue (A.K.A. “changing the rules”) modern civilizations will choose to change the rules. Short of nuclear winter, alien invasion, or zombie apocalypse, I am not concerned that our institutions will cease to exist. Consequently, I don’t see a reasonable possibility of a diversified portfolio of stocks ever being worthless. Obviously, the stock of any single company has a certain risk of total collapse, but for the value of a well-diversified portfolio of stocks to go to zero is extremely unlikely.
On the flip side, human understanding of the universe is advancing at an unprecedented pace. According to some scientists, it may be only a matter of years before we can literally change lead into gold. Image what an unlimited gold supply would do to the price of gold! If there were enough supply, it could become virtually worthless.
4) Currencies are a Ponzi Scheme. Gold has real value.
A “Ponzi Scheme” is an illegal investment structure where the money of new investors is used to pay back existing investors. There are LEGAL versions of this structure that are quite prevalent in everyday finance. The reality is that gold is like any other investment that can appreciate in value. Think of it this way; if you buy a piece of gold for $50 how do you get a return on that investment? You get a return by convincing a new investor to give you more than $50. The money that allows existing investors to get their money back and generate a return on their investment comes from new investors. New investors can then only get their money back by convincing even newer investors to buy the gold that they just bought from the last guy and so on and so on. If one day, there were no new investors for gold, the entire market would collapse. All investments, including gold, are only as valuable as what the next guy is willing to pay for them. It is the credibility of an investment that keeps the market from blowing up. An example of a legal structure like this that blew up was the collapse of mortgage backed securities in 2008. As soon as they lost credibility, there were no buyers and the entire market collapsed. Once the government restored confidence to the MBS market, buyers returned and the value of MBS securities rose. Gold is susceptible to this same effect. There are times when a lot of people want gold and times when only a few people want gold. As a consequence, the price of gold rises and falls substantially as people gain and lose confidence in its value.
Relating this to a previous point, the collapse of the mortgage derivative market should have led to the collapse of the entire global financial system, but it didn’t. Why not? Because we changed the rules of how our fiat financial system works. We changed laws, made deals, broke promises, made new promises, bailed out companies, bailed out the unemployed, bailed out homeowners, dropped interest rates, injected stimulus, shuffled balance sheets, etc., until the global financial system regained credibility. We (the human race) changed the rules to create the best outcome for the majority of market participants (human beings) and we will do it again in the next crisis.
5) Gold demand is inelastic.
There is an idea out there that gold can continue to rise in an unlimited fashion like stocks. The problem is that most of the real demand for gold is for the use in making jewelry. Gold is a commodity and it is constrained by supply and demand. As the price of gold rises, it eliminates buyers who either can’t or won’t pay that much for a gold bracelet or wedding ring. In economics, this is called demand destruction. The price elasticity of a good or service refers to how quickly or slowly demand destruction occurs. As demand for gold as a currency or insurance policy against apocalypse rises, so does the price. As price rises, the demand for gold jewelry is harmed. At some price point, the demand for gold jewelry will cease all together. As gold jewelry and other luxury products make up about 70% gold demand, you would have to see a huge increase in demand for gold as a currency/investment to overcome the effect of the demand destruction the price rise in gold would cause.
As you enter a financial crisis, like the one we just came through, you get an increase in demand for gold as a currency/investment. The price rises and the demand for gold jewelry declines. Supply actually increases as people melt down their “Junk Gold” like old jewelry. In the short-term, equilibrium is found at this inflated price as the fear factor keeps the demand for gold as an investment elevated. It is my guess that as the threat of financial crisis subsides, so will the demand for gold as investment. Unfortunately, at the current prices of gold and considering the excess supply from melted scrap gold, prices will likely be above equilibrium of the gold jewelry market requiring that gold fall in price substantially to a point that demand for gold jewelry rebounds. As the price falls, disenchanted gold investors will likely become net sellers, thereby increasing supply and decreasing demand even further driving prices down more quickly. This, however is just a prediction and is subject to assumptions that may not come true.
There are many factors that could drive the price of gold up. There are many factors that could drive the price of gold down. This is true of most investments. Diversifying some of your portfolio to gold may make sense, but on its own, it is an “Aggressive Investment” so only allocate money to it knowing that it could decline in price substantially for extended periods of time and it pays no interest or dividend. Using gold ETF’s is an easier way to add gold to your portfolio, but some investors feel safer with physical gold as an insurance policy against the collapse of the global financial system. One has to question which is more likely; the collapse of the global financial system, or his/her personal gold stash being stolen. As theft occurs every day and we have yet to see the collapse of the modern global financial system, I would have to side with the safety of the global financial system if I had to choose.
7) Liquidity and transaction safety
I heard someone make the case that physical gold is more liquid than stocks because stocks require T+3 settlement. This means that when you sell a stock, you have to wait 3 days to use the cash proceeds due to settlement (paperwork) procedures at the clearing firm. He then went on to say, “Just call me, we will strike a deal, then I’ll send you a box overnight, you put your gold in and ship it back to me overnight, then I will put the money in your account the next morning.” I was dumbfounded by this argument as he perfectly described the gold sales process as “T+3″. He also failed to mention the substantial costs of overnighting gold and how that could greatly eat into your return. Gold is absolutely NOT more liquid than stocks. When you sell a stock, you do it through an exchange that searches for the best price across millions of market participants and transacts your order in seconds. The exchanges and brokers are large, insured, corporations that are heavily regulated. The physical gold market, however, is very lightly regulated and as a consequence, has a higher transactional risk. Calling around to various gold guys to see who has the best price then shipping them your gold based on the promise that they will send you a specified amount of money in a few days is not my idea of great liquidity or transaction safety.
In summary, gold should be considered as part of a diversified portfolio. You should not blindly jump in thinking it is a “Safe” investment, but you should consider it as part of your asset mix. It is volatile and it can and will lose value and it may or may not grow as fast as other investment options. The truth is that none of us really know with certainty what is going to happen in the future. We do our best to understand the economy and various markets and we invest based on probabilities of future events occurring, but no one really knows the future. Strictly from a diversification standpoint, it is reasonable to include gold as an allocation, however, you may consider expanding it out to an allocation to commodities in general instead of solely to gold or other precious metals. There are many food commodities that benefit from inflation, population growth and political instability. You can also consider fossil fuels like oil and natural gas. Each of these has its own risk/return profile and will rise and fall in price independently (to some degree) from one another. Some of these markets are tricky and require advanced knowledge and continuous diligence. If you are not up to the task, there are various options including mutual funds and ETF’s that will do the heavy lifting for you.
For answers to questions about gold investing or any other financial or investment related topics, call Stone House today.
Robert J. Brown
Certified Financial PlannerTM
Stone House Investment Management, LLC
There have been many articles in the past several months lamenting about the price of natural gas. In fact, we have written a few. How about we move on now to topics that will allow us to go to that next stage of our lives without weeping over what could have been. Instead let’s focusing on how much our financial picture has changed; and where it may go from here.
Some things never change. Never. Why is it that our parents shared so much wisdom with us, yet we refused to listen to them? How painful is it to see our own children go through their own set of growing pains? Oh how we wish we could just make them understand that we’re only trying to help keep them from making mistakes and provide them with a better experience. Then they would surely listen, right? Probably not. Why would they? We didn’t and we think we’re pretty smart! When it comes right down to it, some things you just have to experience for yourself.
Marcellus Shale has created a repeat of this scenario for many local residents in which legal, tax and financial professionals have been advising landowners to proceed with caution and purpose. Even landowners from other parts of the country have forecasted that there would be times that interest in our area would ebb and flow. Yet, some of us revert back to our teenage years when we justified our actions with no actual proof but, instead, the defiant statement of “that won’t happen to me, I’m the exception”.
Strictly from a financial perspective, I’ve seen huge disparity in the spectrum of wealth that natural gas has produced for some over the past four to five years now. I have been talking with clients in various stages of development; preaching about managing expectations and reigning in overzealous budgeting. Now we can begin to see why some of that caution was so engrained in my thoughts. This is one heck of a volatile industry and as a landowner who has leased his/her property, you have signed on for that ride, so rather than getting upset or unnerved when things go in a different direction, take the necessary steps to move forward.
Don’t Dwell on Things… Keep Moving
Is the deflated price of natural gas getting you down and lowering your monthly check? Has the energy company you leased with dramatically reduced its local development efforts? Is there still no completed pipeline to carry your gas to markets? Don’t spend your time worrying about these things… you have no control over these macro, or company-specific issues. Move on to the issues with which you do have some level of input, such as responding in a timely manner to correspondence from the energy company… or simply understanding your lease and its terms which will give you the confidence to watch closely what goes on with your property. If something looks to be inconsistent with what you signed up for, inquire about it. These are excellent reasons why you should have a strong relationship with an attorney whom you have confidence in and who can partner with you to navigate various legal matters.
Moment of Zen
Now let’s talk about what you can control; that moment of Zen when you open your mailbox to find your first royalty check. Once that check is cashed and in your account, only then are you in total control. At that point, you can feel the shift of control as all the hype suddenly transforms into reality. Now you can call the shots and all of the decisions are yours to make. No need to call the energy company or ask permission from anyone. You are the Chief Financial Officer. So… what do you do with it?
Listen to Advice
Many of us wish for another shot at our youth. We long for a chance to go back to the days when we first started working and maybe this time make better decisions with our money and our focus. For some of us, this is that second chance. An opportunity to listen to those who might have valuable insight in matters of estates, legal rights and taxation where you might not have as much experience. There’s a reason that any prudent financial planner or accountant will suggest some common, boring things like paying down bad debts, building up an emergency reserve, funding your retirement accounts to the maximum, etc… It’s because they usually make sense! They lower your taxable income, secure your retirement and eliminate wastefulness. It’s because these are the actions you can take which will result in what’s best for you.
There’s little doubt that buying a dream car or building a dream house is a lot more exciting than building an emergency reserve account; but what happens if/when the “music stops”? We’ve seen it stop, or at least dramatically soften in some scenarios around here. Will you be prepared to move on and will you be in a position to still have capitalized on what did come through your door and into your wallet? Even at current gas prices, this is still life-changing money to most of us and certainly worth sitting up straight and paying attention.
It’s in the Details
There is a steady stream of people each month who stride (or run) out to their mailbox for the dramatic experience of opening up the envelope to see what amount it will be; if it will be higher or lower. By the time they’ve reached their own doorstep they’ve already thought of several reasons why it is what it is. And with that, they’ll cash that check into their checking account; not thinking about whether or not they might be over the $250,000 FDIC limit per registration at their bank.
They’ll sit down later that night in front of the TV with the stub report and look at the confusing piles of information printed on it, understanding some of it but not all of it; hoping and trusting that the gas company has it all correct and then filing it away somewhere in the bottom of a cabinet. What if those numbers are off? What if there was a simple, honest mistake when a lease was transferred or units were combined or data was entered and your royalty rate was changed from 15% to 12.5% or your acreage slipped from 87.5 to 85. Add those up over a decade and you could be missing out on a huge amount of royalties.
During tax time, like we’re in now, will your accountant say that you owe more than you thought you’d owe? Will you think back to that conversation with your financial planner who suggested that you may want to max out your retirement contributions at work in order to lower your taxes this year AND build a stronger retirement? Even though it’s too late for 2011, will you make those adjustments in 2012?
Find the Right Resources
Look around and find professionals in the legal, financial and accounting areas with whom you can have confidence. Friends, family and neighbors are wonderful to have and can help provide a sense of comfort and unity by leading you down a similar path that they took; but they may not have taken the path that’s right for you. Doing what everyone else does will not ensure success. There are many foreclosures in our great nation right now as evidence to those who fell victim to doing what everyone else around them was doing.
Ultimately, this is a second chance for all of us to prove that we’ve learned some things from our childhood past. This is truly a great financial opportunity for many and I wish each of you the best in seeing it through.
Robert J. Brown, CFP®
Stone House Investment Management, LLC
Raymond “Scott” Stone
Stone House Investment Management, LLC
Virtually every fast growing industry has growing pains and the shale gas industry is no different. From political hurdles to ecological concerns to underutilization of natural gas, the shale gas industry has had its fair share of bumps along the road. In this article, we will look primarily at the issue of demand for natural gas and how it will affect the growth of the industry in the short and long term. It has been hard not to notice the precipitous decline of natural gas prices over the past couple of years. The price of natural gas has declined more the 80% from its peak! This price decline occurred while oil prices have climbed to nearly $100/barrel. Why is natural gas falling in price while oil is climbing? Since they are both sources of energy and can replace one another for certain purposes, it would be reasonable to think that they would rise and fall in price together.
The difference in price is largely due to infrastructure, or lack thereof. Oil has been our national addiction of choice for many decades. There are gas stations in every town, home heating oil delivery companies serving every community and plenty of refineries, pipelines and transportation systems to get the oil and oil by-products from the suppliers to the people who want to use them.
This is not true of natural gas. The facilities and distribution systems needed to get all of this new natural gas supply to the places that want to use it are not in place. Consequently, we have more natural gas available than we currently need. When you have more of something than you need, the price falls and in the case of natural gas, prices dropped like a rock. Prices dropped by so much, in fact, that it may no longer be economical to drill for gas in some areas. Some companies are even scaling back development plans for natural gas in our area.
So what is the outlook for natural gas prices and the natural gas industry in our area? The lower prices go, the less incentive to bring new production online. When you think about it, the reason gas prices are going down is because there is too much natural gas on the market. Making more natural gas is just going to make things worse in the short-run. This will likely lead to slower development of leased properties, less natural gas being shipped to market from developed properties and may be bad news for unleased areas like those in NY State.
The ramifications may be seen in local job growth as companies reduce the amount of drilling rigs in the Marcellus and as mid-stream infrastructure projects get put on hold due to the decreased capacity growth expectations. It may be seen in reduced royalties to land owners as fewer wells will be produced and the wells that are produced may not be produced at full capacity. It may cause more wells to be shut-in and more acreage to be held by production as gas companies try to lock in their leaseholds. It may cause much lower lease bonuses and less favorable lease terms for acreage that is not currently leased or that may be up for a new lease. It makes lease extensions of acreage outside of core development areas less attractive and it may lead some companies to not extend some existing leases into a secondary term. It may also cause the value of mineral appraisals to decline as natural gas price is one of the main determinants of value.
That being said, the volume of production in the Marcellus is so significant that it may be enough to offset the fall in gas prices and mitigate some of the these effects. Additionally, each company has its own set of priorities and needs and each will weigh its long-term success with how it handles this short-term utilization issue. Ultimately, the growth rate of our local economy will be much smaller than if gas prices were still in the double digits.
There is a silver lining in the longer term. The cheaper natural gas is compared to oil, the more incentive there is for end users to switch to natural gas. There is also a tremendous potential to sell our natural gas to foreign countries. All we need in place is the infrastructure necessary to utilize the amazing resource right under our feet. Putting it in place, however, will take a degree of political will and for corporations to get behind projects focused on broadening the market for shale gas locally, domestically, and internationally. Over the coming decade, great advancements will be made in natural gas infrastructure with many projects already being planned. As the utilization of natural gas increases, so likely will the price. Until then, though the industry will continue to grow, create good paying jobs and producing significant wealth for leaseholders, it will be at a slower pace than if there were much greater demand for natural gas.
-Raymond “Scott” Stone
Robert J. Brown
Certified Financial PlannerTM
Investment Management, LLC
This month’s edition was intended to be on tax issues and your chances of being audited, but I’ll table that for a future topic. My reason for changing direction abruptly comes as I am writing this and watching natural gas having its worst trading day in 9 months and at its lowest price in 2 years. At this moment in time, it has dropped about 6% just today but even more eye-opening, it has been literally cut in half over the last 7 months!
Can this continue? The funny thing about trends is that while you’re seeing one, it seems improbable that things could ever tip the other way. As a very pertinent example, I’ll offer up this excerpt which was published in 2006 by the US Government Accountability Office1:
In early December 2005, wholesale natural gas prices topped $15 per million BTUs, more than double the prices seen last summer and seven times the prices common during the 1990s. For the 2005-2006 heating season, the U.S. Energy Information Administration predicts that residences heating with gas will pay 35 percent more, on average, than they paid last winter.
Wow, how things have changed. I can remember, just a few years ago, back in 2008, when that unit price of gas was up over $11… now it lingers, beaten up under $3. Why is that? What happened? What does that mean for you? That last one may be the most important question for you to ask. Let’s start with the ‘why’.
Supply vs. Demand
It almost always comes down to this model, doesn’t it? That GAO study, done about six years ago, summarizes that during that time our country was seeing an increasing demand for natural gas but a limited supply of it. It goes further to suggest that this can be solved by enhancing our country’s very underdeveloped infrastructure and finding new gas fields, as the current ones (at that time) were old and depleting quickly. Well… mission accomplished… it only took several years to see that happen.
Drilling is all around us now. In 2008, I was driving to various corners of NEPA to see the first drilling rigs (as if spotting a rig was equal to spotting Big Foot) and talk to the crews & foremen. Now, as I drive back and forth to work, I glance at the rigs, casually, like I would a deer standing out in a field. It goes without saying that the gas companies have positioned themselves for the long haul by dropping wells, not only in NEPA, but all across this country. And not just for gas, but for oil and other forms of energy. Technology has changed the game and now this drilling is far more productive than was ever imagined 10 years ago.
Infrastructure has been booming in its development as we see new pipelines in NEPA cropping up each week; linking all of these new wells to their respective distribution hubs. There have been several recent news releases announcing the completion of several major connections which will dramatically increase companies’ abilities to get this gas out to market.
Better or Worse?
In our office, we’ve seen many landowners with a wide variety of experiences. Initial checks are very large and impressive, but the following months drop off in value; sometimes dramatically. Others have had a steady gain in their royalties each month, despite the recent drops in gas prices. Yet still, others have been placed in a production unit but are only seeing a small amount of revenue. Each story is different but the common consensus among them is that once the pipelines are connected, it’s off to the races. Is it? Let’s not count our chickens before they’re hatched.
The missing ingredient to finding price stability and even price appreciation is not in the completion of stronger distribution channels.
Increased Demand is the Key
The much more obvious method of alleviating this inequity is to balance out the scale on the demand side. How do you do that? Can you make the winter colder? That would be a start, but aside from being impossible to do, it would only help the pricing in the very short term. What about the longer term solutions?
Natural Gas is gobbled up in various ways; such as generation of electricity, residential/commercial heating and cooling, and transportation. Each of these has many factors that feed into the ultimate usage of gas but one thing is certain; to date, the increase in demand, although trending toward growth, is just not keeping pace with the massive increases in supply. Simply seeing a drop in temperatures (heating) or a scorcher of a summer (cooling) will not move the dial on pricing too much over time. Long term pricing trends are often more likely affected by changes in the mindset of the consumers, (a willingness to switch fuel sources) in the policies set by our politicians and in the technological advances which provide opportunities to use the gas. (CNG powered vehicles and distribution stations) Until we see such advancements, we may need to get used to the price of natural gas floating near the bottom of its longer term range.
To the Point
It’s important to recognize YOUR role in all of this. You can pick up the flag and push for the causes that you believe in, but you don’t need me to tell you that. I’m talking more along the lines of your relationship with the energy company you have partnered with when you leased your acreage.
It’s important to recognize that each company is different; different how they treat the landowners, different how they deal with their subcontractors, the regulators and the community. As a large company, they are focused not only on 2012, but many years to follow. They have unique financial and economic issues they are facing and thus each landowner will have a unique experience. Their interests may not align with yours. For example, they may prefer to keep the gas contained and very limited in what they bring to the market due to the pricing pressures currently… you may need the cash flow today.
If you take one thing away from this article, please understand that it is virtually impossible for you to predict what your royalties will be in the future. Focus on what IS real… and that’s what is in your check each month. Once it’s in your hand, YOU have full control. Make wise, informed decisions.
Robert J. Brown, CFP®
Direct Link: http://www.gao.gov/new.items/d06420t.pdf