Welcome to the December 2009 issue of Condor Monthly!

Please continue below to view the "From the Portfolio Manager" and "Financial Planning Corner" segments in this month's issue.

From the Portfolio Manager

Recently we have received a number of inquiries as to whether we believe gold deserves a place in one's investment portfolio. While we generally do not recommend gold - see reasons in the articles below - we may determine that it is prudent to buy gold at any time depending on the situation. Below are two articles that back-up Condor's current rationale on gold.

Gold Can't Beat Checking Accounts 30 Years After Peak

Gold's best year in three decades has yet to match the returns of an interest-bearing checking account for anyone who bought the most malleable of metals coveted for at least 5,000 years during the last peak in January, 1980. Investors who paid $850 an ounce back then earned 44 percent as gold reached a record $1,226.56 on Dec. 3 in London. The Standard & Poor's 500 stock index produced a 22-fold return with dividends reinvested, Treasuries rose 11-fold and cash in the average U.S. checking account rose at least 92 percent. On an inflation-adjusted basis, gold investors are still 79 percent away from getting their money back.

"You give up a lot of return for the privilege of sleeping well at night," said James Paulsen, who oversees about $375 billion as chief investment strategist at Wells Capital Management in Minneapolis. "If the world falls into an abyss, gold could be a store of value. There is some merit in that, but you can end up holding too much gold waiting for the world to end. From my experience, the world has not ended yet."

While gold's nine-year bull market is attracting hedge-fund managers John Paulson, Paul Tudor Jones and David Einhorn, strategists and fund managers at Barclays Plc, HSBC Holdings Plc, SCM Advisors LLC and Brinker Capital Inc. say buy-and-hold investors shouldn't always own bullion. The accumulation of gold is part of a record $60 billion Barclays estimates will flow into commodities this year.

Hoarding Bullion

The SPDR Gold Trust, the biggest exchange-traded fund backed by bullion, has amassed more metal than Switzerland's central bank, spurred by a plunging dollar and concern that the at least $12 trillion of government spending to lift economies out of the worst global recession since World War II will spur inflation. The collapse of U.S. real estate in 2007 froze credit markets and left the world's biggest financial companies with $1.72 trillion of losses and writedowns, data compiled by Bloomberg show.

The U.S. Mint suspended production last month of some American Eagle coins made from precious metals because of depleted inventories. The U.K.'s Royal Mint more than quadrupled production of gold coins in the third quarter. Harrods Ltd., the London department store, began selling gold bars and coins for the first time in October. Those sales contributed to a 30 percent rally in gold this year, beating the 25 percent gain in the S&P 500, with dividends reinvested, and a 2.4 percent drop in Treasuries. Investors bought gold as the U.S. economy, the world's biggest, shrank 3.8 percent in the 12 months ended in June, the worst performance in seven decades. Gross domestic product expanded at a 2.8 percent annual rate in the third quarter.

Longest Winning Streak

A weakening dollar also contributed to bullion's longest winning streak since at least 1948. The U.S. Dollar Index, a measure against six counterparts, dropped in six of the last eight years, including a 6.6 percent decline in 2009, bolstering demand for a hedge. Gold fell 1.6 percent to $1,143 an ounce by 11:08 a.m. in London. Before today, the metal had risen 32 percent this year, the most since 1979.

Buy-and-hold investors may not have done so well. One dollar put into a U.S. checking account in 1983 would be worth at least $1.92 today, based on annual average interest rates from Bankrate.com. The Federal Reserve target rate from 1980 to 1982 was 8.5 percent to 20 percent. Banks were paying 5 percent on the accounts in January 1981, according to a report in the New York Times.

Dividends Reinvested

The S&P 500 returned 2,182 percent from the beginning of 1980 through the end of the third quarter this year, according to data compiled by Bloomberg. The calculation assumes dividends reinvested on a gross basis. Treasuries returned 1,089 percent through the beginning of this month, according to Merrill Lynch's Treasury Master Index.

"Gold is a useless asset to hold long term," said Charles Morris, who manages more than $2 billion at HSBC Global Asset Management's Absolute Return fund in London. "I'm not a gold bug who believes that you want to own this thing in your portfolio at all times. We should own it when the going is good, and the going right now is great."

Those who bought gold when it reached a two-decade low of $251.95 in August 1999 have seen a 387 percent return, more than four times the 82 percent gain in Treasuries. An investment in the S&P 500 lost 0.4 percent through the end of last month. Interest on checking accounts shrank to 0.14 percent this year from 0.89 percent in 1999. Since the S&P 500 peaked in October 2007, investors in the index lost 25 percent, holders of Treasuries made 16 percent and gold buyers are up 64 percent.

'Very Conservative Investments'

"There are people that just stayed in very conservative investments in cash and government bonds," said Larry Hatheway, global head of asset allocation at UBS AG in London, who recommends investors hold about 1 percent of their assets in bullion. "Surely they would have been a lot better off being in gold."

Buying bullion at $35 when U.S. President Richard Nixon abandoned the gold standard in 1971 would have given a 35-fold return, about the same performance as the S&P 500.

Gold will average $1,070 next year, according to the median in a Bloomberg survey of 19 analysts. The metal may jump to $2,000 in the next five years, said HSBC's Morris. Ian Henderson, manager of $5 billion at JPMorgan Chase & Co., said he's adding to his gold-related holdings because of "the momentum behind it." Jim Rogers, the investor who predicted the start of the commodities rally in 1999, has said bullion will surge to at least $2,000 over the next decade.

Touradji Capital

"Our sense is that this bubble is more at the beginning stages than on the brink of collapse," said Thomas Wilson, head of the institutional and private client group at Brinker Capital in Berwyn, Pennsylvania, which manages about $8.5 billion. Touradji Capital Management LP, the New York hedge fund founded by Paul Touradji, bought 2.23 million shares of Barrick Gold Corp., the world's biggest producer, during the third quarter, according to a Nov. 13 filing with regulators. The stake, Touradji's biggest equity holding, is worth $95 million. Paulson & Co., the hedge-fund firm run by billionaire Paulson, will start a gold fund on Jan. 1 investing in mining companies and bullion-related derivatives, according to a person familiar with the plan. Einhorn, who runs New York-based Greenlight Capital Inc., told a presentation in New York in October that he's buying gold to bet against the dollar. Paul Tudor Jones, in an Oct. 15 letter to clients of his Tudor Investment Corp., said gold is "just an asset that, like everything else in life, has its time and place. And now is that time."

Net Gold Buyers

Central banks will become net buyers of gold this year for the first time since 1988, according to New York-based researcher CPM Group. India, China, Russia, Sri Lanka and Mauritius have all added to their reserves. Gold should be held when governments cease to function and currencies are worthless, or when inflation is surging, said Brian Nick, a New York-based investment strategist at Barclays Wealth, which manages $221 billion. He doesn't recommend increasing gold holdings, which are a "very small" part of commodity allocations. Inflation has yet to accelerate. U.S. consumer prices will rise 2 percent next year, the smallest expansion since 2002, according to the median estimate of 63 economists surveyed by Bloomberg. Prices will shrink 0.4 percent this year.

'Knee-Jerk Reaction'

"People have this knee-jerk reaction and say that you want gold as a hedge against inflation," said Maxwell Bublitz, who helps oversee $3.5 billion as the chief strategist at San Francisco-based SCM Advisors LLC and recommends investors hold no more than 5 percent of their assets in the metal. "But the history of gold in regard to inflation shows that it's not a great hedge." Investors seeking to protect themselves against inflation should buy commodities, which are cheaper than gold, said Wells Capital's Paulsen. Copper, after more than doubling this year, is still 28 percent away from the record $8,940 a metric ton reached in July 2008. "Theoretically, it does have a spot in portfolios, a small one," Bublitz said. "You're probably going to get entry points that are a lot better than where gold is now."

5 Reasons to Avoid Gold Rush

September 2009

By Vitaliy Katsenelson

Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.
- Warren Buffett

The reasons why one should sell the cat, pawn the mother-in-law, and use the proceeds to buy gold are well known: the Fed is printing money faster than you can read this, which will result in inflation; the government is borrowing like a drunken monkey, so the dollar will be devalued; this will debase all currencies, so the only thing that will save you is the shiny metal.

However, here are some arguments why one should think twice before jumping in bed with gold bugs, or at least remain sober while determining gold's weight in the portfolio.

1. For investors (not speculators) it is very hard to own gold, because you cannot attach a logical value to it. Unlike stocks or bonds, gold has no cash flow and has a negative cost of carry - it costs you money to hold it. It is only worth what people perceive it to be worth right now. The argument I commonly hear is, "What about all those Enrons, Lehmans, Citigroups, etc. that either went bankrupt or got near it? What was the value of those?" If the lesson learned is not to own stocks but to own gold, it is the wrong lesson. The lesson should be: own companies you can analyze (the aforementioned companies were unanalyzable) and diversify - don't put your all net worth into one stock.
2. The gold ETF SPDR Gold Shares (GLD) is the seventh largest holder of physical gold in the world. If its holders decide to sell (or are forced to sell; think of hedge-fund liquidations), who will they sell it to? This is extremely important, as the presence of GLD changes the dynamics of the gold price, both to the upside and downside. If gold keeps climbing, the ease of buying will drive gold prices higher than in GLD's absence. In the event of a significant sell-off, there are not enough natural buyers of physical gold. It is a bit like a roach motel - easy to get in, hard to get out.
3. In the past, gold had a monopoly on the inflation and fear trade. Not anymore. Now you have competition from Treasury Inflation-Protected Securities (TIPS), currency ETFs, short US Treasury ETFs, government guaranteed/insured FDIC checking accounts, etc. TIPS suffer from the flaw of the CPI being measured and reported by the US government, which has an inherent bias to understate inflation; returns of commodity ETFs are skewed by price differentials between financial derivatives and spot prices of underlying commodities; returns of leveraged ETFs diverge significantly over the intermediate and long run from the underlying index; FDIC reserves are being depleted with the every-Friday-night bank bailout (but believe you me, the US government will not let FDIC go bankrupt, even if it means it has to raise taxes and impose draconian fees on the banking sector).
   The bottom line here is this: none of these investment vehicles are perfect, in fact many have significant flaws; but despite their flaws they attract money away from gold, thus undermining gold's monopoly on the fear/inflation/currency debasement trade. (I've discussed it in greater detail in my book).
4. If, because of points 2 or 3 above, gold fails to perform as expected, the perception of what gold is worth may change dramatically.
5. Inflation is a possible but not a guaranteed outcome of what is taking place in the economy today. Deflation or a muddle-through economy with very low nominal growth are possible and probable outcomes. We are seeing signs that point away from inflation: the money supply declined at a 12% annualized rate over the past four weeks, according to David Rosenberg of Gluskin Sheff.

Though gold bugs argue that gold will perform well in either an inflationary or deflationary scenario, history doesn't support that conclusion. Gold has done well in inflationary environments but not during deflation or low nominal economic growth. In the 1970s, when inflation in the US was raging, gold performed better than any other asset class (though remember, at the time gold had no competition in the inflation trade, no TIPS, or ETFs that long other commodities, short US Treasuries etc..). However, one had to know exactly when to get on and off the gold bus. If gold was bought after considerable appreciation, that investment/speculation resulted in losses. Gold has more than doubled in price since 2005, but has it already priced in future inflation? I have no idea; you cannot value it.

Though gold bugs make it sound as such, gold is not the only and not the best alternative if the worst fears come to pass. The best way to deal with the risks of dollar devaluation and high inflation - with a much lower cost to being wrong - is, instead, to own stocks of companies that have pricing power of their product. When inflation hits, they will be able to raise prices and thus maintain their profitability. Also, companies that generate a large portion of their sales from outside the US will benefit from the declining dollar.

Gold bugs look at gold as a currency, but it is not one and unlikely to be one in our lifetime. Here is why: there is not enough of it around, so even if world government were to adopt a fractional system (currency in circulation as a multiple of gold reserves), they will never go for it, because central banks and governments will never give up their monetary tools - inflation is a very addictive tool to fight growing monetary obligations.

There is a wild card in the price of gold, though: China (John Burbank made that argument at the Value Investor Congress in Pasadena). If it decides to switch partially from owning US Treasuries to owning gold, the price of gold will skyrocket.

From the Financial Planning Corner

Roth Conversions

Roth IRAs have become popular retirement savings vehicles since their introduction in 1998. However, high-income taxpayers have not been able to participate in the Roth revolution due to income limits. Now, financial professionals across the country are buzzing about a big change to Roth IRA conversion rules. Several years ago, President Bush signed the Tax Increase Prevention and Reconciliation Act (TIPRA) into law. TIPRA repeals the income limit for conversions beginning in 2010. Therefore, all taxpayers regardless of their income can consider converting all or a portion of a traditional IRA to a Roth IRA. Previously, only people with income less than $100,000 could convert. A recent article in the Journal of Financial Planning suggested that more than 13 million taxpayers will become eligible for Roth conversions for the first time.

IRA Basics
Whether you use a traditional or Roth IRA, the accounts grow on a tax-deferred basis. Most contributions into a traditional IRA are deductible and distributions are taxed as ordinary income in the year of withdrawal. By contrast, Roth IRA contributions are not tax-deductible and distributions are generally tax-free. A traditional IRA owner must also take mandatory withdrawals called required minimum distributions (RMDs) after age 70½, while Roth IRAs are not subject to RMDs. From a tax perspective, traditional IRAs let you save on taxes now and pay taxes later, presumably at a lower tax rate after retirement. Roth IRAs require you to pay taxes now, but earnings are essentially tax-free (not just tax-deferred) as distributions are not taxable.

"THE" Conversion Analysis - Taxes, Hedging, and Estate Planning
You can convert a traditional IRA to a Roth IRA, but must pay taxes on the conversion amount. As such, converting might be a boon, a mixed bag, or a mistake depending on your circumstances. Investors should use "THE" Conversion Analysis to determine whether or not it makes sense for to you convert.

Taxes - Converting a traditional IRA to a Roth IRA means you pay taxes now to avoid taxes later when you begin IRA distributions. Thus, the main variables to consider are your future income and your future tax rates. You can take a guess at your future income, but you cannot know for sure. Although the general expectation is that tax rates will increase, it is impossible to know what Congress will do to the tax code. Taxpayers whose future tax bracket will be higher than their current tax bracket can benefit the most by converting. The benefit for taxpayers whose tax bracket will stay at about the same level will see a modest benefit, while those whose tax bracket will decrease over time should probably not convert. Taxpayers with large IRAs, where future RMDs can result in a significant increase in taxable income, are one group that should consider converting. Additionally, since time allows for more compounding of tax-free growth, younger taxpayers should also consider converting.

Hedging - Tax rates are known today, but unknown in the future. A Roth IRA can act as a tax hedge by enhancing flexibility to control your taxable income in later years. With a mixture of taxable (individual, joint, trust), tax-deferred (traditional IRA, 401k), and/or non-taxable accounts (Roth IRA) from which you draw your retirement income, you should be able to better optimize tax brackets at the time of the distribution. However, as with all hedged bets, you may win or you may lose.

Estate Planning - A Roth IRA can also be a very efficient wealth transfer tool. Since the required minimum distributions rules do not apply to the owner of a Roth IRA, the Roth IRA offers greater growth potential for your beneficiaries. This is especially true if you do not need to tap the Roth IRA for income in retirement and if the beneficiary is young (i.e. grandchild). A Roth IRA conversion should also be considered if the account owner is in poor health and will owe estate taxes, since income tax rates are lower than estate tax rates. Keep in mind that there are no federal estate taxes in 2010, but the estate tax is scheduled to return in 2011 unless Congress takes action to change the estate tax laws.

Additional Items
Using cash from your original IRA to pay the taxes on a conversion may not be a good idea because it decreases the Roth IRA balance and cancels out part of conversion benefits. Moreover, this could result in a 10% early withdrawal penalty for investors under age 59½. Thus, it is important to make sure you have enough non-IRA resources to cover the tax liability due to the conversion. Additionally, you want to carefully consider whether it pays to convert an amount that will push you into a higher tax bracket. Partial conversions are a good way to address these issues. You can convert your IRA in stages over multiple years to keep the tax impact in any given year relatively low. You also have the option of taking advantage of the IRS rule for 2010 that lets you spread the income tax from converting over the 2011 and 2012 tax years. Note that if non-deductible contributions represent a significant portion of your traditional IRA, the tax impact of converting will be lower. Finally, recharacterization provides the ability to "undo" a Roth conversion without penalties up to the year's tax filing deadline (including extensions) if you determine later that converting was a mistake. This safety net seems especially relevant in the situation where the Roth IRA experiences sharp investment losses from the conversion date through your tax deadline. While recharacterization does not reduce investment losses, at least you can avoid paying taxes on the higher value.

Conclusion
Though Roth IRA conversions are interesting, they may not be appropriate for all investors. Nonetheless, thanks to the new IRS tax rules, the use of Roth IRAs can now at least be considered by all investors. We strongly advise that anyone considering a Roth conversion consult their investment advisor or tax professional before proceeding. Of course, feel free to contact our office if you have any questions on Roth conversions.