The Dog Bone Portfolio: A Personal Odyssey into the First Kondratieff Winter of the Twenty-First Century

THE

DOG BONE

PORTFOLIO

The decisive crisis will . . . not be in Britain, now merely a weak province of a decaying currency system, but at the centre in the United States. It may not come until the next cycle of recession and boom. Until the centre fails, the extremities may well be supported, but when the centre fails, the extremities will fail also. Politicians seldom move ahead of events, and the attempt to do so can be broken for want of public support, but events will in due course destroy the floating paper system . . . When the paper system collapses, the survivors will dig in the rubble and they will find gold.

–WILLIAM REES-MOGG, 1974

It is the role of the entrepreneur qua businessman or financial advisor – a key figure in Austrian economics – to try to predict future events. But he must be a loner, a contrarian, to do so.

–MARK SKOUSEN, 2009

THE

DOG BONE

PORTFOLIO

A Personal Odyssey into the First Kondratieff Winter

of the Twenty-First Century

Margret Kopala with John Budden

Copyright © 2015 by Margret Kopala and John Budden

All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or any information storage and retrieval system, without permission in writing from the publisher.

Published in 2015 by

BPS Books

Toronto & New York

www.bpsbooks.com

A division of Bastian Publishing Services Ltd.

ISBN 9781772360141 (paperback)

ISBN 9781772360158 (ePDF)

ISBN 9781772360165 (ePUB)

Cataloguing-in-Publication Data available from Library

and Archives Canada.

Cover, text design, and typesetting: Daniel Crack, Kinetics Design, kdbooks.ca Index: Isabel Steurer

Photograph of N. D. Kondratieff, page 14, used by permission of Uchitel Publishing House for the Russian Academy of Sciences, Institute of Economics, International N. D.Kondratieff Foundation.

Note to Readers:

The material contained in this publication is for informational purposes only. No warranty is given as to its accuracy or completeness. Investment, accounting, legal, or other services should be obtained only from a qualified professional or, preferably, several qualified professionals. All participants in the publication of this material disclaim any responsibility for loss, liability, or risk arising from its use.

To the memory of

The Right Honourable Lord William Rees-Mogg

(1928–2012)

Contents

Authors’ Preface

Acknowledgments

Introduction

Authors’ Preface

A Note from Margret Kopala

This book discusses key aspects of the post-2008 economy and offers investment strategies to help navigate its difficult financial markets. With the help of John Budden and the other fine analysts introduced in this book, it is what I, a novice investor, have learned since the market crash of 2008. As such, it is a hybrid work in which Kondratieff long-wave scholarship and related market analysis provide signposts for a personal odyssey that, in 2015, remains ongoing. Its most important lesson is the need to understand the big economic picture.

In part 1, I introduce the life and work of a post-revolutionary Russian economist named Nikolai Kondratieff. His defining macroeconomic perspective reveals that to all things, including capitalist economies, there is a season and that, in 2014–15, we remain in the trough, or Winter season, of the long-wave cycle he identified. Along with the multiplicity of productive, monetary, political, and other factors intrinsic to the long wave’s behaviour, part 1 also demonstrates how Kondratieff laid the groundwork for understanding our economies as a function of these many synergies, including those created by technological innovation and energy. It further explains how and why our central banks and governments may delay, but not necessarily prevent, the depressionary tide that washes over and diffuses an Old Economy in order for a New Economy to grow.

Because this Kondratieff Winter could last well into the second decade of the twenty-first century, parts 2 and 3 consider longer-term economic and investment prospects and conclude that, without the growth successful economic transitions bring, achieving personal financial security, much less real investment returns, will be a challenge. Part 4 then considers how the next New Economy might unfold. The appendices conclude The Dog Bone Portfolio by focusing more closely on events and issues that must be addressed before global economic and investor success – that is, a Kondratieff Spring – is fully possible. In the meantime, and no matter the geographic region or asset class in which we are invested, the reader will learn how events on the global stage are affecting the value of what we own and why, like adventure capitalist Dean LeBaron’s neighbourhood dog, Fido, which buries a number of bones in different hiding places, we had better be certain about what comprises our bones – that is, the asset classes in which we invest, and where we bury them.

A Note from John Budden

I have been involved in the investment business since the mid-1960s. I worked in Canada, Europe, London, and, for ten years, in Boston. In 2002 I returned to my hometown, Ottawa, the capital of Canada and one of the best-kept secrets in this surreal world. One of the macroeconomic factors that lured me back was the dirt-cheap Canadian dollar, which was trading at $.63 to the greenback. The world had not figured out that Canada was on the way to cleaning-up its economic act and that it was sitting on a treasure trove of natural resources. My travels had opened my eyes and made me passionately Canadian.

By early 2003, the commodities bull market was coming out of the gate. Oil was trading at under $20 (U.S.) a barrel, gold was selling at give-or-take $300 (U.S.) and silver at $4.50 (U.S.) an ounce, copper at $.71.5 (U.S.) a pound, potash $155 (U.S.) per metric tonne (U.S.), and corn at about $2.20 (U.S.) a bushel. Global acquisitors were already preparing to pounce on our great Canadian resource companies.

At the time, I was seconded by CFRA, a popular Ottawa news/talk radio station, now owned by Bell Media, as their markets commentator. We all know that commenting on the antics of markets is a mug’s game, analogous to long-term weather forecasting. So, in my search for the Holy Grail, I decided to interview a number of my old friends who had survived and prospered through bull and bear markets, financial chicanery, and central bank and government manipulation.

Through these initial interviews, I discovered a clear pattern in the convergence of knowledge and opinion among these informed investment thinkers who excelled by identifying long-term money-making trends – a skill augmented for me by sentiments expressed by Old Turkey in Edwin Lefèvre’s classic Reminiscences of a Stock Operator. If I sold that stock now I’d lose my position, he explained to urgings that he unload a stock, and then where would I be?¹

A common thread among these savvy investors was a reverence for the long-wave theories of Nikolai Kondratieff – the now legendary Russian economist who was executed by firing squad in 1938 at the behest of Joseph Stalin. I had already developed a fascination with Kondratieff, but now, by aggregating and assimilating their opinions, I was able to hone in on the evolving long-wave economic trends. So when Margret Kopala asked me to contribute to this book, I knew exactly what to do and whom to call.

The interviews that resulted appear in this book (chapter eight). They are a compendium of sage and eclectic macroeconomic observations and the market perspectives from some of the best and brightest minds I have come across over the years. I hope they will help you win the battle for investment survival through the latter part of what we call Kondratieff Winter, a period that could last into the 2020s with social and economic upheaval that could materially affect our quality of life and financial well-being. So, as we say in radio . . . Listen up.

Acknowledgments

AS with much else in The Dog Bone Portfolio, this acknowledgments page borrows from the work of investment experts James Dale Davidson and the late Lord William Rees-Mogg, who point to the collaborative nature of all books. But unlike Davidson and Rees-Mogg, or the distinguished human geographer and University of Texas professor Brian J. L. Berry, whose Kondratieff scholarship forms the basis of my approach to the long-wave cycle, I, as a non-expert, have relied intensively on the work of others. Written as a primer, The Dog Bone Portfolio is no substitute for reading the key works of these and other economic and financial analysts who are referenced throughout and whose writings may inform not just Canadian citizens, investors, and policy-makers, but their global counterparts everywhere. These analysts are among the larger-than-life characters now appearing on a digitized global stage where, it is no exaggeration to say, an economic drama, with a denouement yet to make itself known, has reached Shakespearian proportions. Villains are being exposed, dei ex machina are routinely introduced and discarded, and heroes and history are being made.

Among the heroes are those who have stood by the theories of an obscure, controversial Russian economist named Nikolai Kondratieff. Uncompromising and courageous in the face of so much economic uncertainty while divining the longer-term investment perspective demanded by long-wave analysis, Dean LeBaron, J. Anthony Boeckh, Ian Gordon, Larry Jeddeloh, Don Lindsey, the late Lord William Rees-Mogg, Jim Rogers, Eric Sprott, and Ronald-Peter Stöferle not only offer investment advice but speak truth to power as only those who must responsibly manage money can. For both John Budden and me, it is a privilege beyond expression to appear in their company in these pages.

I also gratefully acknowledge my personal heroes whose support, encouragement, and practical advice, made this book possible. First, award-winning Canadian newspaper columnist Roy MacGregor who, upon observing my concerned involvement as an ordinary Canadian during Canada’s constitutional crisis in 1990, addressed me in a private communication as Commissioner Thirteen – a reference to the national panel of twelve citizens convened by the Canadian government to study the crisis. At the time, Ottawa economist Gail Stewart also encouraged my fledgling efforts at citizen responsibility, particularly where my writing and political activities were concerned. Marjorie Bowker, the late family court judge, wrote books on the issues of her day, which, though controversial, laid the foundation for a national conversation and created a model for this book. Susan Riley, Peter Robb, John Godfrey, Sheila Brady, Graham Greene, and David Watson gave me space in the newspaper sections they edited. Having bestowed this mantle upon me, one I continue to wear with a great sense of humility and unease, all set me on a public policy track I have since pursued in a variety of ways. Back then, I never imagined it would lead to work in investment and finance, but the market crash of 2008 left me no choice. I was compelled to find out why I lost money and what to do about it.

In this latter respect, I owe a deep debt of gratitude to my guide, mentor, and co-author, John Budden. His commentary and his interviews with some of the world’s finest investment minds opened up a new world of investment possibility for me and form the backbone of this book. It goes without saying that his personal encouragement and market insights proved indispensable to the book’s progress and completion.

While all errors are my responsibility, The Dog Bone Portfolio would not have been possible without the prepublication feedback essential to determining its accuracy and how to go about publishing it; in particular: Donald George, former dean of the Carleton Faculty of Engineering; David van Praagh, author and professor emeritus of journalism at Carleton University; Susan Howell, retired Foreign Affairs civil servant; Denise Goulimis, former London-based financial services adviser; Louis DeSerres, Montreal-based financial services adviser; Dean LeBaron, adventure capitalist (who suggested the title of the book); Marilyn Pitchford, former CFO of Batterymarch Financial (who suggested its subtitle); George Matheson, retired psychologist; and Arthur Cordell, adjunct professor of economics at Carleton University. Salim Mansur introduced me to Linda McKnight, who set the book on a path to publication; Donald G. Bastian brought it home.

Nida Ali, Anne Johnstone, Bohdan Yankowsky, and Iris Bradley made retreats available to me for productive writing sessions. Martin Collacott, James Bissett, Harry Weldon, and other colleagues at both the Centre for Immigration Policy Reform and the Ottawa thinking tank POGG (the acronym for Canada’s founding principle of peace, order, and good government) were patient with my absences above and beyond the dictates of professional respect. The nudgings, exhortations, and general encouragement of my sister, Dr. Lili Kopala, and friends Margaret Mooney, Robin Jackson, Iris Bradley, Dr. Gail Ivanoff, and Manko Rongongo, plus everyone at Ottawa’s Ukrainian Orthodox Cathedral, simply kept me going. Giannoula Delis Letwin photographed me an amazing number of times in order to produce a portrait that was just right for this book. The unflinching support and literary acumen of my husband, author, journalist, and political theorist Dr. Robert Sibley, and our son, psychologist Dr. Daniel Kopala-Sibley, not only inspired me but also held my writing to a higher standard.

My heartfelt thanks to all.

Margret Kopala, Ottawa

Figure 1 Copyright Longwave Group and reprinted with permission http://www.longwavegroup.com/market/charts/_pdf/Kondratieff_Cycle_Chart.pdf

Figure 2 Copyright © 2015 Margret Kopala

These charts are key to understanding the cyclical factors affecting the big economic picture in which the global economy finds itself; in a sense, this book is an extrapolation of the financial and economic movements delineated herein. For ease of reference, they are placed at the beginning of this book.

Introduction

The Grey-Green Room

IT was November 13, 2008, and the small, grey-green room with sloping ceilings and velvet curtains felt particularly womb-like. A third-floor refuge in our Victorian-era Ottawa home, its serenity was breached only by the occasional thrum of nearby traffic or the monotonous noise of a small, old-fashioned television set tucked among the books lining one wall and now tuned, constantly, to the financial news network. Following several nerve-wracking days of watching the markets, I was hoping to catch a nap, but at around 2:00 p.m. EST, in addition to the usual display of stock market quotes, the small screen revealed the then President of the United States, George W. Bush, approaching a podium.

Thank you very much. Please be seated, he said to a standing ovation.

New York City’s Manhattan Institute, a think tank founded in 1978 by William Casey, who later became President Ronald Reagan’s CIA director, was providing the platform for a much-needed presidential statement.

I appreciate you giving me a chance to come and for me to outline the steps that America and our partners are taking and are going to take to overcome this financial crisis, Bush continued.

From record-breaking highs that saw the Dow Jones Industrial Average break 14,000 in October 2007 and the Toronto Stock Exchange exceed 15,000 in June 2008, by November 13, both had cascaded to lows of 8,500 and 9,300 respectively. With them, incalculable amounts of paper wealth – including a sizeable portion of mine – disappeared. Major banking institutions in the U.S. and Europe were dropping like flies. Already, mortgage finance giants Fannie Mae and Freddie Mac had been bailed out, as well as Wall Street giants AIG and Merrill Lynch. And, with distraught clients having withdrawn $17 billion in two days, Bear Stearns, a major global investment bank and one of the nation’s largest underwriters of U.S. mortgage bonds, had been snapped up by JP Morgan Chase & Co. for less than the value of its real estate. Only Lehman Brothers was left to twist in the wind, leaving many wondering who would be next. Four months after the fact, Congressman Paul Kanjorski would reveal that an electronic run on the money markets had been narrowly averted. Later, on March 9, 2009, on PBS’s Charlie Rose show – with the Dow at 6547 and the TSX at 7566 – Wall Street legend Barton Biggs, manager of Traxis Partners and Morgan Stanley’s chief global strategist, would lay 50 percent odds that the current depression would have a happy outcome; 30 percent odds that, like Japan, the stock market would be lousy with permanent wealth destruction and a standard of living for Americans that would be flat for ten years; and 20 percent odds that there would be a real economic disaster.

President Bush had some explaining to do.

As a novice investor, with important decisions to make about my investments, I watched, riveted, hoping for a sign.

Over the past decade, the world experienced a period of strong economic growth, the outgoing President said, his voice sounding particularly small in New York’s historic, but cavernous, Federal Hall National Memorial. Then, in an oblique reference to the massive number of U.S. Treasuries purchased by China and Japan, he continued:

Nations accumulated huge amounts of savings, and looked for safe places to invest them. Because of our attractive political, legal, and entrepreneurial climates, the United States and other developed nations received a large share of that money.

The massive inflow of foreign capital, combined with low interest rates, produced a period of easy credit. And that easy credit especially affected the housing market. Flush with cash, many lenders issued mortgages and many borrowers could not afford them. Financial institutions then purchased these loans, packaged them together, and converted them into complex securities designed to yield large returns. These securities were then purchased by investors and financial institutions in the United States and Europe and elsewhere – often with little analysis of their true underlying value.

The financial crisis was ignited when booming housing markets began to decline. As home values dropped, many borrowers defaulted on their mortgages, and institutions holding securities backed by those mortgages suffered serious losses. Because of outdated regulatory structures and poor risk management practices, many financial institutions in Europe and America were too highly leveraged. When capital ran short, many faced severe financial jeopardy. This led to high-profile failures of financial institutions in America and Europe, contractions and widespread anxiety – all of which contributed to sharp declines in the equity markets.

These developments have placed a heavy burden on hard-working people around the world. Stock market drops have eroded the value of retirement accounts and pension funds. The tightening of credit has made it harder for families to borrow money for cars or home improvements or education of their children. Businesses have found it harder to get loans to expand their operations and create jobs. Many nations have suffered job losses, and have serious concerns about the worsening economy. Developing nations have been hit hard as nervous investors have withdrawn their capital.

We are faced with the prospect of a global meltdown.

Following this potted history of the subprime mortgage crisis, with its emphasis on Asian savings overinvested in U.S. housing that resulted in such widespread financial devastation, Bush reassured his audience that governments around the globe were taking unprecedented steps to recapitalize financial institutions. In addition, he said, they must make the financial markets more transparent and better regulated. Credit default swaps (financial products that insure against potential losses, he helpfully explained) must be processed through centralized clearinghouses instead of through unregulated over-the-counter markets. The integrity of the markets must ensure against market manipulation and fraud while co-operation between the world’s financial authorities had to be strengthened. Then, after extolling the virtues of the free-market capitalist system, he conceded the catastrophic nature of the situation with all its implications for U.S. global supremacy and invoked the obligatory all-American battle cry:

We’re facing this challenge together and we’re going to get through it together. The United States is determined to show the way back to economic growth and prosperity. I know some may question whether America’s leadership in the global economy will continue. The world can be confident that it will, because our markets are flexible and we can rebound from setbacks. We saw the resilience in the 1940s, when America pulled itself out of Depression, marshaled a powerful army, and helped save the world from tyranny. We saw that resilience in the 1980s when Americans overcame gas lines, turned stagflation into strong economic growth, and won the Cold War. We saw that resilience after September the 11, 2001, when our nation recovered from a brutal attack, revitalized our shaken economy, and rallied the forces of freedom in the great ideological struggle of the 21st century.

The world will see the resilience of America once again. We will work with our partners to correct the problems in the global financial system. We will rebuild our economic strength. And we will continue to lead the world toward prosperity and peace.

Thanks for coming and God bless.¹

Manhattan Institute patrons dutifully applauded what was presidential gobbledygook to me. I had taken Economics 101 at university, but what little I remembered did nothing to help me understand references to capital flows and over-the-counter markets. Yet somebody on that 13th day of November 2008 understood or, at least, believed. George W. Bush may not have walked on water, but for a few moments, according to the television screen in the grey-green room, he certainly raised the markets. The Dow Jones Industrial Average closed up 553 points, at 8835.25.

It was a lesson in White House messaging I, too soon, would forget. On Friday, November 21, 2008, President-elect Barack Obama used the same trick, and the markets responded accordingly, and this time, at least until March 2009, more convincingly. The Dow Jones Industrial Average had hit a new low early on November 21, only to explode upwards after the announcement of Timothy Geithner’s appointment as Treasury secretary, closing at 8046.42, up 494.37. But, reeling from the magnitude of the losses I was sustaining, I had given my broker my sell order that same morning. Like the millions of investors who simultaneously lose their nerve, then the contents of their stomach, and thus create market bottoms, I was out of the markets.

Selling at the Bottom

Selling at the bottom was not the first, nor would it be the last, of the mistakes I would make in the turbulent and uncertain markets of 2008 and 2009. I was then approaching my mid-sixties and, like many women of my generation making their way as players in the world’s markets, had some modest savings, in my case from a life in freelance media work – first for the BBC in the U.K., then in independent films, and then writing. I came late to motherhood, and then, foregoing an income, my middle years were given to home life blended with community and political activism. A family inheritance and property proceeds, combined with my husband’s Registered Retirement Savings Plan (RRSP) and pension, meant we could look forward to a viable retirement.

My first foray into the markets took place at the end of 2001. The dot-com bubble had burst and dispersed, but, like most people who had no expectation of ever being in the stock market, I paid little attention. When, unexpectedly, money arrived that needed more management skill than I could provide, I turned to a professional and applied the necessary due diligence in selecting him. Not only did I follow up on all references, but I also had some experience of brokerage firms from my days in the Canadian feature film industry when Initial Public Offerings (IPOs) were a popular financing vehicle. All those I interviewed were investment dealers retained by major chartered banks. In Canada, this meant Scotia McLeod, TD Securities, RBC Dominion Securities, CIBC Wood Gundy, and BMO Nesbitt Securities.

Most offered proprietary packages with formulaic asset allocations, leaving me wondering if, once invested, anyone would ever look at my portfolio again. I finally chose the broker who offered a custom package and who specialized in conservative portfolios for seniors. I also liked him; there seemed to be a healthy chemistry between us.

Mostly, though, the markets were doing fine. My broker navigated the 2002 dip after which any asset allocation would have worked. By 2005, the stock market was fully off and running. A 20 percent annual return was de rigueur.

The first intrusions on my feelings of competence and complacency arrived in February 2008 when an acquaintance, now a good friend, offered cautionary advice. The markets, Montreal-based financial planner Louis DeSerres warned me, were very dangerous because of America’s subprime mortgage crisis. As a newspaper columnist, I had written about this crisis: Canada’s softwood lumber industry, in particular, was hurting because American housing construction had slowed; in addition, taxpayers in Europe were already on the line for propping up banks exposed to toxic subprime mortgages. Though appropriately outraged on behalf of taxpayers, I never made the leap to the implications for my investments. These finally hit home in mid summer when a precipitous decline in the markets also hit. My large institutional brokerage firm, in numerous mailings on the subject, exhorted clients to stay the course. This, it explained, would be another 1987-style decline, a correction, with the concomitant bounce back, stronger than ever. In any case, I wondered, clutching at straws, would I not just lock in my losses if I sold now? What was a 1987 correction?

By November, feelings of mounting dread and high anxiety could barely be contained. My mutual funds were the first to go. Briefly, I flirted with the idea of buying some gold and General Electric, which was scraping unheard-of low levels, but I lacked the knowledge and confidence to act. Warren Buffett was buying, but perhaps he was just being patriotic. Instead, I sold fixed income instruments that were associated with banks abroad. By the end of November, I was out of equities and, for a day or two, felt relieved. Then, the markets started to rise out of their depths. Was the vaunted Santa Claus rally under way, or was this just a dead cat bounce? Would the incoming president, Barack Obama, bring his presidential honeymoon to the markets as well?

Now glued to the financial news networks, I never felt more alone. Never mind feeling alone. I was alone. Friends looked away or giggled nervously at the mention of the stock market. Were they in denial? It is true what they say about money. People are more willing to discuss their sex lives.

In the following months, I read voraciously and spent hours online and watching television commentary. Fundamental analysis. Technical analysis. Seasonal analysis. Analysis paralysis! I signed up for VectorVest, an online service that provides stock analysis and buy, sell, and hold advice. I bought books. I also got a grip and nibbled back into the markets, this time with a safety device I had just discovered called a stop-loss – a mechanism that allows the investor to automatically sell a stock when it drops to a certain specified level. I was as positive and upbeat as possible under the circumstances. My broker humoured me, but, when the market plummeted again in early March and I thought we should be buying, he decided I did not have the risk tolerance to be in. It was bad enough that I had lost a lot of money, but now my broker was zigging while I was zagging.

To be sure, our relationship had altered radically. Like a couple losing a child, each would feel personally responsible but also blame the other for the loss. In my case, the loss was doubly difficult to endure. The family inheritance consisted of assets built up by my mother and father. They were children, respectively, of Ukrainian and Polish immigrants who, at the turn of the twentieth century, acquired their citizenship by sweat equity: picking rocks and clearing bush to turn western Canada into one of the world’s great agricultural regions. They did well on a farm property near Fort Saskatchewan – a small town situated south of Canada’s oil sands operations where major oil refineries were building their facilities. Now I was losing not only my money but theirs as well. When in March the markets veered upward, I bought in, judiciously following my self-styled Pac-Man strategy based on those corporations strong enough to survive the market devastation. But twice burned, twice shy. Would the markets plummet again? It was hard to follow through with conviction and particularly with the cash necessary to make serious returns.

What a failure! An otherwise competent woman was now losing her shirt in the stock market!

Emotional? You bet I was! No, I was not about to leap from some tall building, but it was clear I needed help.

The Die Was Cast

John Budden and I first spoke when I interviewed him for a column I was writing for the Ottawa Citizen about TransAlta, Canada’s largest investor-owned utility company.

In July 2008, the Alberta-based power generator received a non-binding $7.8 billion (CAD) takeover bid from LS Power Equity Partners. Related to hedge fund Luminus Management LLC and Global Infrastructure Partners, LS Power was a joint venture of Credit Suisse and General Electric Company and it knew the value of a good utility. No strangers to successful takeovers, the multinational giants would nonetheless meet opposition on this attempt.

A venerable Canadian utility, TransAlta was founded in 1911² as Calgary Power by W. Max Aitken’s Royal Securities. Aitken, later Lord Beaverbrook, had been a protégé and close friend of Budden’s grandfather, John Fitzwilliam Stairs, founder of Royal Securities, from whom Aitken would ultimately assume control. John Fitzwilliam, in turn, was a member of the old and illustrious Stairs family – Merchant Princes,³ as one biographer characterizes them – who would gain distinction in finance, ships, and steel, not to mention politics, at a time when Halifax, Nova Scotia, was still a crucial centre of Canadian commerce and trade. They were Builders, Budden would later say, quietly implying the capital B. In 1958, John’s uncle Geoffrey Abbot Gaherty would help him get his first summer job working as a lineman at Calgary Power. Gaherty was a brilliant engineer and a visionary who, as the power company’s president for thirty-two years, oversaw an era of unprecedented growth.

Thus imbued with the lore of Calgary Power, Budden knew that the bid of the carpetbaggers for TransAlta bore no relation to its underlying value. Ultimately, the bid failed, and all the private equity players retired from the fray but, for Budden, no garden-variety economic nationalist and already a vociferous crusader against the hollowing out of corporate Canada, the proposed TransAlta transaction was personal, passionate, and authentic.

Budden’s summer job at Calgary Power in 1958 was the beginning of a circuitous route into the investment business. In 1964, after a sojourn in Europe with stints at the Salzburger Hotelfachschule and the University of Grenoble, plus a lot of skiing along the way, Budden would be assisted by another uncle – Bill Budden, co-founder in 1947 of the renowned investment counselling firm McLean Budden – who opened the door to a Sales Trainee position in the London, England, offices of Dominion Securities Corporation. In those days, John said, if you were a male, had a recognizable family name, and were genetically unsound, you automatically got a job in the investment business. No amount of humility or humour, however, could disguise the fact that, from the moment he was born, the die, for John Budden, was cast.

Needless to say, in late 2008 and early 2009, as I listened to his daily market commentary on a local talk radio station, the last thing on my mind was this man’s pedigree. Prior to that time, he’d been part of the kitchen background noise as I prepared dinner. Perhaps if I had paid closer attention I would have caught his warnings on the state of the markets – but now, better late than never, I was all eyes and ears to anything relevant to my investment situation.

At that time some sixty-plus years of age and with more than forty-five years of diverse international investment experience, Budden was known in Ottawa for his dressed-down manner and habit of holding court, iPhone or iPad ever ready, at an out-of-the-way coffee emporium. With the right hat and glasses, he might have resembled Elvis Costello. Instead, ever the perfect contrarian, he sported a preppy haircut and, in concession to the heat and humidity of a typical Ottawa summer, short pants. I quickly learned, too, that in addition to a Damon Runyon–like talent for quips, he also had excellent listening skills. Later, having learned that he had a mild form of dyslexia, I wondered if these were a form of compensation. Whatever the reason, now that he was no longer linked to institutional brokerages or establishment media, he was able to deliver the straightest goods possible in the plainest language possible about what was going on in the markets.

Eventually I would find that a more complete picture of the man was available at his website <www.JohnBudden.com>. Here visitors were greeted by the motto of Canada’s legendary hockey star Wayne Gretzky, Skate where the puck is going to be, not where it has been, and introduced to Budden’s many good friends and great legends. These distinguished Renaissance men are money managers, investment dealers, analysts, economists, and entrepreneurs who are as comfortable discussing Friedrich Nietzsche and avant-garde movies as they are stock market analysis, commodity market capers, and the latest conspiracy and manipulation theories. More importantly, unlike most in the media, academe, or even institutional brokers who work for a salary and commissions, they make financial decisions every day while navigating the worst that governments and markets can deliver – often with copious amounts of their own skin in the game and, as John describes it, all the investment scar tissue that goes with it. On December 18, 2008, I bit the bullet and sent him an e-mail:

Hi John.

I am writing on a personal basis and as an unsophisticated investor.

But firstly, many thanks for your excellent CFRA commentary and www.johnbudden.com, both now indispensable.

I wonder if you could devote some commentary to bonds. There was a short spate of commentary recently referring to the bond bubble. What does this mean and what does it mean for bondholders? I see your (portfolio recommendations contain) no bonds yet Jarislowsky⁴ in yesterday’s Globe and Mail is recommending cash and corporate bonds with good spreads for these deflationary times.

Margret Kopala

And so began my friendship with John Budden. Acting on the premise that it was wiser to ask a stupid question than to make a stupid mistake, I also provided him with a yardstick of unsophisticated investment awareness that he could use for his radio show, all the while educating myself, with his help, about the challenges facing global economies and our portfolios. Ultimately, John and I would decide to write The Dog Bone Portfolio – a book that, under his guidance, details my growing awareness of what it means to be an investor in today’s globalized world.

Writing in 2014, with the stock market approaching new highs, the investment climate remains vulnerable. Though in November 2008 George W. Bush drew attention to how the failures of financial institutions had led to sharp declines in the equity markets, over the intervening years we have witnessed a plethora of high-profile, near failures of nation states. Defaults by Greece, Ireland, and Portugal on their national debts were narrowly, and perhaps only temporarily, averted, while the outlook for Spain and Italy, not to mention several American states, worsened. The future of the European Union may be in jeopardy not only because of the potential for default or outright withdrawals but also because of a social and political backlash.

The picture in the U.S. is hardly better. Having set a limit (the debt ceiling) of $16.4 trillion on borrowing in order to avert a first-ever government default in 2011, only to reach that limit by December 31 in 2012, the U.S. government repeated the exercise at crisis pitch in October 2013. Still unresolved, the debt ceiling remained suspended until January 15, 2014. Sadly, as Budden puts it, the U.S. government has evolved into a giant manipulating hedge fund while its presidents, now including Barack Obama, are much better in the telling than the doing when it comes to matters of financial management. Many worry that a default on its debt, along with the loss of its world leadership role, is inevitable.

Most ominous is the threat of a horrible economic crisis, as fund manager, author, and investment economist Marc Faber, based in Hong Kong and Chiang Mai, Thailand, sees it. It may be tomorrow, or it may be in ten years. As more and more money is printed, each dollar in our pocket or in the bank loses some of its ability to buy things. And if the economies of countries like China and India slow down, commodities could drop, Faber warns, causing a deflationary collapse.⁵ In other words, the enormous debt of the U.S. government, among a growing number of other offenders, is a major concern. The greater the deficit and debt, the greater the devaluation of the currency, and the greater the likelihood of collapse.

Deflation? Devaluation? Collapse? What does all this mean? Having been wooed into the markets expecting my money would grow, only to be knocked down by significant portfolio losses in 2008, am I, like other investors, helplessly stuck in the midst of all this? Even today – as 2015 is well under way and markets have seemingly recovered – a sense of ominous gloom prevails. How can stock market gains possibly endure given the global economy’s systemic problems? Is there any way not to lose our shirts?

My journey to financial literacy would be accompanied by another journey, too: call it citizen responsibility, if you will. After an extended period of high consumption, Western governments are exhorting their citizens to increase their savings and nail down their retirement plans, as if these were the sole components of financial literacy. Nowhere are they asking us to learn about the role of central banks, about how our banking system works, or about monetary policy. Yet when a presenter at a seminar I attended asked how many of the one hundred and fifty attendees had this knowledge, only five people raised their hands. As the reader will learn, however, these other economic elements play a profound role in the economies of their countries and, therefore, a profound role in our personal financial lives.

Mostly, though, The Dog Bone Portfolio is designed to help investors weather the market challenges that lie ahead. And because it is innovators, entrepreneurs, and investors who will lead the current economy out of its wintry trough into its spring phase, policy-makers, and academics, too, may find it useful. In this respect, John Budden has enlisted some of the finest market practitioners from around the world to contribute to The Dog Bone Portfolio. Before his death in December 2012, author, columnist, and former editor of The Times Lord William Rees-Mogg kindly granted a brief interview. For an institutional perspective, John spoke with Donald W. Lindsey, CFA, Chief Investment Officer, American Institutes for Research. A native of Demopolis, Alabama, and now resident in Singapore, Jim Rogers is renowned for his commodities trading. Dean LeBaron is an adventure capitalist and founder of Batterymarch Financial Management. Larry Jeddeloh is editor of The Market Intelligence Report and managing director and chief investment officer of TIS Group in Minneapolis. Author of The Great Reflation, J. Anthony Boeckh is an economist and lecturer; having built the renowned independent investment research firm The Bank Credit Analyst from 1968 to 2001, he is also President of Boeckh Investments Inc., a family office and private investment firm, and Chair of the Graham Boeckh Foundation. A world leader in precious metals investment and analysis, Eric Sprott founded the Canadian investment firm Sprott Asset Management, while Ian Gordon has studied, charted, and advanced investment strategies based on Kondratieff’s long-wave cycle. Ronald-Peter Stöferle of Incrementum AG based in Liechtenstein is lead author of the renowned In Gold We Trust, an annual publication that provides rigorous and comprehensive analysis of the gold market. All suggest investment approaches and asset classes to help stabilize and secure portfolios as various crises unfold. We will also look at the history of the role played by gold and why that role is becoming more pronounced, even as our banking and monetary systems undergo greater scrutiny and comprehensive reforms.

With the help of the long-wave perspective and the skills of seasoned investment strategists, our goal is to provide insight into today’s economic uncertainties and offer some equipment to help investors successfully weather the ongoing storms of this first Kondratieff Winter of the twenty-first century.

PART 1

Understanding the First Kondratieff Winter of the Twenty-First Century

Nikolai Kondratieff

1892 ~ 1938

ONE

An Economic Hero: Nikolai Kondratieff’s Life and Work

If we judge by the passion it has aroused, the long wave is something of an economic historian’s Holy Grail.

–ANDREW TYLECOTE¹

Through 2009, the markets moved up, but my portfolio remained in the dumps. I was preserving capital, but none of my strategies for making money were working. I signed on to an online advisory service that promised clear buy, sell, and hold signals and learned about stop-losses. These allowed me to set a price at which I could sell a stock before incurring unbearable losses, usually when it dropped 5 or 10 percent in value. True to the promise, these stops were preventing losses, but they also prevented gains if the stock then turned upward. This was particularly true when I was whipsawed out of a stock – a phenomenon that occurred regularly when investors with short positions on the stock sold, thus depressing the price to a point where it triggered my sell but, at the same time, someone else’s buy order. Up the price would go, leaving me wondering if I should buy back in at the higher price. Additionally, after a certain number of such trades, fees became applicable. It was getting expensive just to pick up the phone to my broker. To regain losses from the 2008 crash, I was advised, it was necessary to be fully invested – that is, all my money had to be in the market, not sitting in cash – but the risk seemed to me to be untenable. Another option, my broker explained to me, was to buy puts. A form of insurance against market losses, these would make money for me if the market dropped again; but this was far too exotic and potentially nerve-wracking for someone of my now extremely tender investment sensibilities. Now I would be betting not only on whether the market would go up but also whether it would go down. What a choice! Also, it was expensive.

By now, John Budden and I were in regular contact and lessons about how to navigate today’s investment climate were under way. One, the most important, would take a very curious turn. Understand the Big Picture, Budden urged. That way your investments will make more sense." Then, literally breathing life into the lesson, John hit the books and started practising a Russian accent. Why? His good friend Dean LeBaron, the founder of Batterymarch Financial Management, an emerging markets investment pioneer, had invited him to portray the Russian economist Nikolai Kondratieff at the annual Contrary Opinion Forum in Vermont. The November 2008 crash was now history and viewed as yet another watershed period in the global economy though, even as the meltdowns were under way, the patrician New Englander and veteran market contrarian, LeBaron, was gamely attempting to divine the future.

I, too, was hitting the books, online commentary, and newspaper articles. One such article, entitled The Twelve Steps to Financial Disaster,² made a huge impression. It had been written in February 2008, well before the November crash, by Nouriel Roubini, a handsome, yet dour looking, economist whose thickly accented, rapid-fire pronouncements had earned him the title of Dr. Doom. As a specialist in credit crises, he had studied financial disasters as they occurred in Third World countries. Now, similar problems were infecting Western economies. In this meltdown scenario, US and global financial markets will experience their most severe crisis in the last quarter of a century . . . We should be pessimistic about the ability of policy and financial authorities to manage and contain a crisis of this magnitude; thus, one should be prepared for the worst, i.e. a systemic financial crisis.³ Unlike Roubini and a small handful of others, most economists and historians had spectacularly failed to anticipate the market fiasco. On the other hand, market practitioners like Lord William Rees-Mogg and James Dale Davidson had been predicting the arrival of a depression since the publication of The Great Reckoning in 1993. Already a fan of Rees-Mogg’s columns in The Times, I also tracked down his 1974 book The Reigning Error, which would inform The Dog Bone Portfolio’s central theme and supply its opening quote. Others, too, like Robert Prechter in Conquer the Crash and Jim Rogers, who co-founded Quantum Fund, provided fair warning. Then, entirely by accident, I would find yet more impressive work. An online excerpt of a book about long-wave rhythms set me on a search for what appeared to be Ottawa’s only copy of Brian J. L. Berry’s Long-Wave Rhythms in Economic Development and Political Behavior – a comprehensive and scholarly overview of Kondratieff’s long-wave theory written in 1991 by a distinguished British-American human geographer, now Lloyd Viel Berkner regental professor at the University of Texas at Dallas. Back in 1991, Berry’s treatment of long-wave theory made it obvious a depressionary event was inevitable.

While divergent in analysis and opinion, all were familiar with the cyclical nature of Western capitalist economies. And so, too, in the U.S., in November 2008, were Dean LeBaron; Walter Deemer, a renowned technical analyst; and Mark Ungewitter, Vice President and Gilded Portfolio manager at Charter Trust Co. Prominent in their paper, A Way Forward,⁴ were references to Kondratieff, a victim of Stalin’s purges, who laid foundations so important to cyclical economic thought that they found their way not only to Professor Berry at the University of Texas and William Rees-Mogg at The Times (and ultimately to the publishing house he chaired, Pickering & Chatto, which published Kondratieff’s collected works in English) but also, much earlier, to Joseph Schumpeter at Harvard, Jay Forrester at MIT, and, later, in 2005, to a NATO-sponsored workshop on asymmetric warfare.

As a devoted father of four children, three of them daughters, Budden was intrigued and jumped at the chance to learn more about this man who cherished his own daughter from the confines of a prison. While many of Kondratieff’s adherents believed he belonged in the economic lexicon alongside Adam Smith, Karl Marx, John Maynard Keynes, Ludwig von Mises, Friedrich Hayek, and Milton Friedman, for John Budden, once again, the issue was personal and passionate.

For me, learning about the life and work of Nikolai Kondratieff would provide insight into fundamental aspects of the global economy and the perspective I needed to understand the erratic nature of today’s markets. In order to do this, however, I would first have to immerse myself in the sweep of Russian revolutionary history, where flesh and blood events commingled with the dry scholarship and intellectual passion of a true economic hero.

Kondratieff’s Life

The great man is always representative either of existing forces or of forces which he helps to create by way of challenge to existing authority.

–E. H. CARR⁵

On August 31, 1938, Nikolai Dmitriyevich Kondratieff sent the following letter to his daughter Elena from the fourteenth-century Spaso-Yefimeyev Monastery in Suzdal, Russia, where he had been imprisoned since February 1932.⁶

My sweet darling Alyonushka:

Probably your holidays are over now and you are back at school. How did you spend the summer? Did you get stronger, put on weight, get tanned? I very much want to know. And I would like, very, very much to see you and kiss you many, many times. I still do not feel well, I am still ill. My sweet, Alyonushka, I want you not to get sick this winter. I also want you to study hard, as you did before. Read good books. Be a clever and a good little girl. Listen to your mother and never disappoint her. I would also be happy if you managed not to forget about me, your papa, altogether. Well, be healthy! Be happy! I kiss you without end.

Your papa.

In the modest circumstances, relatively speaking, of a twenty-first-century credit crisis, a parent’s love of a child is profound enough. Against the sweep of the Russian Revolution when you are your country’s leading pro-market economist languishing in an isolation prison camp without having seen your child for some time, that love must have had a searing poignancy.

Given the times, such poignancy could not have been unusual. The history of the Russian Revolution, raised to contemporary consciousness by the pen of some of history’s greatest writers, reveals how families were separated by the circumstances of World War I and the Revolution. Under Stalin, relatives were banished into exile. Millions were never seen again, brutally executed, or simply murdered. Russian history runs red with blood of other peoples, but among the first to pay the price of the revolution which destroyed the Tsarist autocracy, led to Civil War in 1918, and, eventually, to Stalin’s Great Purge, were the Russian people themselves.

It did not start out that way. For a bright young Russian peasant testing his intellectual mettle, the first years of the twentieth century meant extraordinary opportunity.

The eldest of a family of ten, Nikolai Kondratieff was born in 1892 to a peasant family in a village in the Kineshma district north of Moscow. From prison, many years later, he would remember his rural upbringing as being difficult, because of the struggle to get ahead, but nevertheless sunny and carefree. How inexpressibly wonderful my student years were, he recalled. There was a kind of intoxication with life, a constant moving ahead, continual success, an almost pantheistic attitude.⁷

By the time of Kondratieff’s birth in 1892, socialism was already a gathering force in Tsarist Russia. One of history’s most influential and controversial thinkers, the German philosopher and revolutionary socialist Karl Marx had published his Communist Manifesto in 1848 and, by 1894, all three volumes of Das Kapital. In 1887, Lenin’s brother had been hanged for plotting the murder of Czar Alexander. In 1895, three years after Kondratieff was born, Lenin himself would be placed in solitary confinement and exiled to Siberia for three years. By the time of the 1905 Russian Revolution – ignited by Bloody Sunday and later quelled by Czar Nicolas II’s October Manifesto promising civil liberties and an elected parliament – revolutionary forces had split into two camps. Among other distinguishing programs, the Socialist Revolutionary Party (SRP) favoured land socialization with tenant farmers working the land, while the Russian Social-Democratic Labour Party (itself split into Bolsheviks and the minority Mensheviks) believed the land should be nationalized. Thus attracted by the ideas of the moderate SRP and its peasant sympathies, the precocious fourteen-year-old Kondratieff was elected, in 1906, to a district committee. He then studied agriculture and horticulture at a local college before travelling to St. Petersburg where, having no money to pay tuition, his only hope of gaining entry to university was to pass exams without having attended the relevant lectures – a feat he readily accomplished with characteristic determination and brilliance. Following his admission, there was no looking back for the young soon-to-be professor. Tutors such as Maksim Maksimovitch Kovalevsky, a philosopher-positivist and Nobel peace prize nominee, economist Mikhail Ivanovich Tugan-Baranovsky, and sociologist-ethnographer Alexander Sergeevich Lappo-Danilevsky exposed Kondratieff to the finest scientific, economic, and sociological thinking of the time. In 1915, at the age of twenty-three, he published his first major paper – 446 pages in length – about the economic development of the Russian district where he was raised: The Development of Kineshma zemstvo of Kostroma Juberniya: an Essay on Socio-economics and Finances.

By the time of the February Revolution in 1917, he was a keen activist within the SRP whose short-lived Provisional Government under Alexander Kerensky appointed the twenty-five-year-old Kondratieff deputy minister of food supplies. Later, he would play an influential role in the development of Lenin’s New Economic Policy. In his home province, where the SRP was popular, he became a member of Russia’s first Constituent Assembly. But, too late, the Constituent Assembly and the Provisional Government were routed by Lenin’s Bolsheviks who assumed power in October 1917. By 1918, the one-time deputy food supply minister had split with the SRP and abandoned political questions to concentrate on abstract economic questions as a reader at Moscow Shanyavsky University.⁸ Later, he joined the Petrovsky Institute for Agricultural Economy where he focused on how shifts in government policy affected agricultural markets. More importantly, he laid the foundation for his own institute – one that would make a slow but an indelible mark on the development of world economic thought.

By October 1920, with Russia exhausted by both World War I and a civil war, Kondratieff created the Conjuncture Institute. Its five staff members would eventually number over fifty, and the work of the Institute would become part of an international phenomenon studying conjunctural and cyclical analysis – a pioneering discipline established to determine how market fluctuations and conditions can be predicted by studying the patterns created when significant events intersected or combined and so created conjunctures. In the 1920s and 1930s other pioneers would include, in the U.S., Wesley Mitchell’s National Bureau of Economic Research (NBER), which studied business cycles, as well as the Cambridge School of John Maynard Keynes and Dennis Robertson, the Austrian school of Ludwig von Mises and Friedrich Hayek, the Swedish school of Gunmar Myrdal and Erik Robert Lindahl, British economists Ralph George Hawtrey and Arthur Cecil Pigou, and the American economist Irving Fisher.⁹ Kondratieff was now twenty-eight years old.

The upheavals of World War I had led, by the 1920s, to a sense of anticipation and capacity for achievement. Nowhere was this more evident than in the world of scientific and socio-economic endeavour. From Freud, to Marx, to Darwin, the intellectual world was alight with macro thinking. Who would discover the next Big Idea – the next overarching thesis that would explain it all? In Russia, the Revolution intensified the pressure to find and implement solutions. The Roaring Twenties were under way in the U.S., and the Western world was rapidly industrializing, yet Russia remained an economic backwater. The prospects and possibilities for creating a completely new economic order were exhilarating. Heroically, yet ultimately tragically for Russia and Nikolai Kondratieff, the battle for the ascendance of ideas was on.

Kondratieff’s analytical skills would now move to a new theatre, this time with a global audience. As a prominent Russian economist heading up a major institute, he travelled with his new wife, Yevgenia, looking for all the world like an early Russian version of John F. Kennedy. In Britain, the U.S., and throughout Europe, he met economists of international repute, including John Maynard Keynes, Irving Fischer, and Wesley Mitchell whose Russian-American protégé (and, later, Nobel laureate), Simon Kuznets, would be among the first to translate some of Kondratieff’s work into English. They exchanged newsletters and joined one another’s associations and societies. But where other institutes focused on one aspect or another of the business cycle, Kondratieff’s Conjuncture Institute analysed economic conditions and price fluctuations in the U.S.S.R. and capitalist countries in order to solve issues of economic policy in the fledgling Communist system.

It was a tall assignment and one the Bolsheviks embraced, particularly if those cycles could reveal the flaws inherent in capitalism that would secure its demise. But in this, as in so much of Kondratieff’s star-crossed political-academic life, the very issue that would secure his place in world economic thought would also lead to his ruin in Russia.

Kondratieff