News: Dr. Krause appeared yesterday on Milwaukee CBS TV news and talked about the impact of the government shutdown

Dr. Krause appeared yesterday on Milwaukee CBS TV news and talked about the govt shutdown – link to story and video coverage:

krause cbs 58

Dr. Krause on government shutdown


Local impact of a possible Government shutdown

MILWAUKEE – Some Federal workers here are bracing for the worst on Monday night as the clock ticks down to a possible government shut down. Chue Yang works in the Milwaukee office of the U.S. Department of Labor. He says a lot of people in his office are nervous about losing their paychecks for awhile.

Sherrie Tussler, Executive Director of the Hunger Task Force says poor women who rely on nutritional vouchers and accounts will begin getting cut off within a week of a government shutdown. Tussler says within two weeks, The Hunger Task Force will lose 220-thousand pounds of government commodity food. That food is used for the Stock Box program that feeds about 10-thousand local seniors every month.

Marquette Professor of Finance David Krause believes a shutdown would likely be short term. Something like when a blizzard hits D.C. and the government shuts down for a day or two. He believes the much bigger concern comes in a few weeks if the U.S. defaults on it’s debts by not raising the debt ceiling. Professor Krause says would negatively impact the financial markets and raise interest rates.

Dr. Krause talks about debt ceiling

Dr. Krause talks about debt ceiling

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News: Dr. Krause was quoted in an article about investing in precious metals

Investing in Precious Metals: Fool’s Gold or Hidden Gem? Link to article

by John Kiernan on October 1, 2013

gold-barsAll investors hope to strike gold at some point.  But while the cliché applies figuratively to most people’s investment strategies – hitting it big on a speculative play or IPO, for example – others are literally seeking to make money off of gold and other precious metals.

Perhaps their interest in commodities investing stems from some sort of innate patriotism, harkening back to the California Gold Rush of the mid-1800s, or maybe we’ve simply gotten too engrossed in popular reality television programs like Discovery’s “Gold Rush” and A&E’s “Storage Wars.”  But regardless of the underlying rationale, it’s fair to wonder if the shimmering appeal of the commodities markets belies reliable profit potential for the average investor or is merely a fool’s errand?

We sought advice from a number of leading investing experts, and it seems the value of commodities investing varies based on the exact nature and purpose of your investment as well as your market expertise and what else is in your portfolio.

Understanding the Role of Gold & Silver

Adjusting Your Perspective:

The first thing investors must understand about gold and other precious metals is that they’re more akin to insurance than a traditional return-seeking investment.  More specifically, such commodities are used as a hedge, or protection, for other assets (like cash) and investments (like stocks and bonds) whose real value would decline during periods of runaway inflation.  When the dollar carries less purchasing power, cash reserves don’t go as far and equity positions aren’t worth as much, but commodities will likely retain or increase in value as demand for non-paper wealth rises, offsetting losses in other areas of one’s portfolio.

Gold and silver are not investments per se for the average person.  They’re insurance, chaos insurance,” says Mark Waldman, executive in residence for the Department of Finance & Real Estate at American University and co-owner of Waldman Financial Advisors.  “So, to the extent that you think it’s possible that there will be some major, major financial crisis way beyond 2008, owning gold is insurance against the inflation of traditional currencies.”

Vijay Singal, J. Gray Ferguson Professor of Finance in Virginia Tech’s Pamplin College of Business, offers a similar assessment. “Precious metals make sense only when an inflationary environment is expected, which would result in degradation of dollar’s value,” he told CardHub.  “When the Fed embarked on pumping money into the economy four years ago, I started buying silver and gold. My thinking was that inflation will skyrocket in the near future (2-3 years). I was wrong and the Fed was right in maintaining that inflation will not increase.”

If inflation had skyrocketed, the price of gold would likely have done the same, reflecting increased demand for the precious metal as more and more people sought to safeguard their nest eggs.

Nevertheless, there is some disagreement among industry experts as to whether the gains attainable through commodities investments make them a natural hedge against inflation or a highly-speculative way to time the market and profit off of others’ fears.  That’s largely because the correlation between inflation and the price of gold hasn’t always remained constant – gold averaged $619/oz. in 1980, $279/oz. in 2000, and $1,224/oz. in 2010, for example.

In other words, it seems that the price of gold doesn’t necessarily increase because of inflation, but perhaps because people think it should increase during periods of high inflation, which creates more of a market for the metal and ultimately drives its price up.

Deciding How to Invest:

Most experts recommend allocating no more than 5% or so of your net worth in precious metals.  But regardless of how much you plan to invest in these commodities, it’s important to understand the variousways in which you can play the silver and gold markets.

Your basic options are to purchase the physical commodities themselves (i.e. buy gold/silver bars, bullion, or coins), to invest in either an Exchange Traded Fund (ETF) that tracks the prices of commodities or one of the companies involved in the procurement and sale of precious metals, or to play the futures and options markets (i.e. try to predict future price changes).  Each, as you might expect, has its own share of relative advantages and disadvantages.

“If you’re buying precious metals as an investment, this characteristic (known as liquidity) is an important consideration,” says Dr. Stephen Henry, assistant professor in the Department of Economics & Finance at the State University of New York (SUNY) College at Plattsburgh.  “The most liquid precious metal investments are probably the various ETFs that are designed to track commodity prices.  If you’re committed to owning the physical material, look for forms that can be bought for a price as close as possible to the melt value – bullion coins or bars.  The problem here is that fees and shipping costs can really eat into your profits, especially for smaller investors.  Be careful with futures or option contracts; they are very liquid, but almost always involve tremendous amounts of leverage, which magnifies the risk of losing your initial investment (and potentially more).”

Don’t Rationalize Jewelry as an Investment:

People often talk themselves into making big-ticket purchases by calling them investments.  This is perhaps most common with jewelry.  However, in most cases, it’s simply too hard to both find a piece will retain or even gain value over time AND ultimately get someone to buy it at a price that will provide a decent return.

“I’m sure it’s possible to find jewelry bargains occasionally at yard sales and storage auctions, but jewelry sold in a retail setting is almost never going to make a worthwhile investment,” Henry says.  “While a piece of jewelry may have a certain intrinsic value due to its precious metal content, the retail price of that jewelry will far exceed both its resale value and its melt value.  Buy jewelry that you like and enjoy wearing, and appreciate it for that… as an investment, it will probably disappoint.”

Different Rules for Different Commodities

Gold and silver aren’t the only commodities in which consumers can invest in some way, shape, or form.  In fact, most people tend to divide commodities into five main categories:  1) Grains; 2) Energy; 3) Livestock; 4) Softs – a miscellaneous category that typically includes foods and fibers; and 5) Metals – gold, silver, copper, steel, and perhaps even jewelry and rare coins.  For the uber-wealthy, physical assets like vintage cars can even make a potentially rewarding investment.

While each different type of commodity serves its own unique purpose – from providing a hedge against economic or political unrest to enabling one to make bets about the future of agriculture or clean energy – there is one important commonality that consumers must understand:  A certain underlying subject matter expertise is needed to navigate the market profitably.  You have to realize that there are people who devote their whole lives to commodities investing, and even they don’t always make the right calls.  You’re also effectively competing with them, so it pays to know what you’re talking about.

At the end of the day, the more specific you get with your investment – buying a particular metal rather than investing in a precious metals ETF, for example – the more important it is to be an expert in the area.


Constructing a Diversified Portfolio

We’ve all heard about the importance of diversification to successful investing, and for good reason.  As Jim Cramer, the host of the popular investing show Mad Money and a former hedge fund manager, likes to say, there’s always a bull market somewhere.  In other words, there will always be certain sectors of the economy that are performing well and others that are doing badly.  And since it’s too hard to predict which ones will be strong or weak with any degree of certainty, it’s best to spread your investments across asset classes in order to protect yourself from wild swings in any one sector.  Sure, your potential gains won’t be as big in certain situations, but your losses won’t wipe you out either.

“What’s the best way to diversify?  Diversify across multiple asset classes — bonds, stock, estate, commodities (including metals and agricultural commodities), and cash and cash equivalents,” says Richard Curtis, senior lecturer of finance in the Johnson School of Management at Cornell University.  “Within each class one might also diversify — for example, within stocks one might hold small and midcaps in addition to large caps, value stocks in addition to growth stocks, U.S. stocks in addition to foreign stocks (including emerging market stocks), etc.”

How, exactly, can the average person gain exposure to each of these asset classes without sacrificing boatloads of time?  The easiest way, according to Curtis, is to “utilize mutual funds and exchange-traded funds for most of these assets classes, and REITS for real estate investments.  Mutual funds, ETFs, and REITs afford diversification, and if one chooses carefully, low expenses,” Curtis says.  “Note that no one has to make all of these investments, but investing in a single asset class leaves one vulnerable to big drops in value.  If one knew what was going to appreciate in value, one wouldn’t have to diversify.  But since none of us can predict the future, it’s prudent not to put all one’s eggs in a single basket.  Diversify!  Diversify!  Diversify!”

Bottom Line

At the end of the day, whether you decide to invest in commodities like precious metals or not, the role they theoretically play in one’s investment portfolio should open your eyes to the importance of hedging your bets and setting yourself up for steady long-term gains, irrespective of the political or economic climate.

“Alternatives investments, such as commodities, real estate and collectibles, can offer decent returns,” says Dr. David S. Krause, director of the Applied Investment Management Program at Marquette University.  “However, their advantage is that they tend to track across the business cycle differently than financial assets. These tend to do well during inflationary periods when financial assets tend to do poorly.”

Having a position in areas that do well while the rest of your portfolio flounders is extremely important given that the name of the investing game is diversification and risk management.  With those safeguards at the heart of your investing philosophy, you’ll be much more likely to strike proverbial gold.  Without them, you may very well end up looking like a fool.

“Without a doubt, the best way to accumulate wealth and to control risk is through the use of a well-diversified portfolio,” Krause says.  “I also advise against the tendency to try to time the market.”


Dr. Krause with Mike Muratore

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Marquette Tribune Article on Dr. Krause and the Intro to Applied Investing MOOC

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The Boy Genius of Ulan Bator – Discovered Taking a M.I.T. MOOC

From the New York Times (Sunday, September 15, 2013)

Battushig Myanganbayar, a 16 year old boy from Ulan Bator, Mongolia, is not your typical teenager. He became one of 340 students out of 150,000 to earn a perfect score in Circuits and Electronics, a sophomore-level class at M.I.T. in a Massive Open Online Course (or MOOC). These are college courses that are videoed and broadcast free or nearly free to anyone with an Internet connection. The professor of the class, who had taught similar classes at M.I.T. said, “If Battushig were a student at M.I.T., he would be one of the top students — if not the top.”

Great story about the power of MOOCs to reach around the globe. To view the story, enter this URL into your browser:

Maybe someone taking the Applied Investing MOOC could be the next Warren Buffett – who knows?

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Module 4: Advanced Topics | Blog 4-3: Real Estate Investment Trusts (REITs) by David S. Krause

In Lesson 4-3 we discussed different ways to invest in real estate – and we talked about real estate investment trusts (REITs). Rather than buying individual REITs, an option is to buy a REIT ETF or mutual fund. We’ll look at each investment option here.

real estate

Real Estate

First, let’s review: A real estate investment trust (REIT) is an entity that acts as an investment agent specializing in real estate and real estate mortgages. Public REITs are usually listed on public stock exchanges and they can be classified as equity, mortgage, or a hybrid (combination of the two).

REITs were created in the U.S. back in the 1950s in order to give individuals the opportunity to invest in large-scale, portfolios of income-producing real estate properties in the same way they were able to access other asset classes – it also helped pool monies for the real estate industry. Since then, the REIT concept has spread around the globe.

Over the past couple of years, a number of ETFs focusing on REITs have been created (see a list below). Each of these has a slightly different approach to the asset class – as they are based on different indexes. The table includes the June 30, 2013, dividend yield, assets under management (AUM), and expense ratio. This is an easy way to own a widely diversified portfolio of REITs at a low cost.

Mod 4 blog 4.3 chartWith an ETF, you generally invest in all REITs – the good, bad, and ugly. Conversely, mutual funds seek, through careful investment analysis and diligent research, to own only the good REITs. And while there is a long list of firms that offer REIT mutual funds – let’s open up the hood on one – the Uniplan REIT (

The graphic below shows information about the fund as of mid-year 2013. You can see the sector allocations, regional mix, and top 10 holdings. This information is available for all mutual fund REITs. Individual research can be done on the various mutual funds (recall Lesson 2-4 and 2-5 on Sources of Information). This analysis allows the individual investor an opportunity to compare the funds, read about the managers’ philosophies, examines their historical track records, and select the fund that most closely aligns with their long-term portfolio goals.

Mod 4 Blog 4.3

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Module 4: Advanced Topics | Blog 4-4: Hedge Funds

In Lesson 4-4 we discussed hedge funds and private equity – two of the major alternative investments. We’ll focus in this entry on hedge funds which have the reputation of being the ‘rock stars’ of the investment world. The conventional wisdom is that the smartest people work for hedge funds and that they generate the best long-run performance.

For the 19 years from 1990 to 2008, hedge fund returns beat or tied the S&P 500 15 times – according to Hedge Fund Research (HFR), which analyzes the performance of the hedge fund industry. Unfortunately, 2013 could be the fifth year in a row that hedge funds, on average, underperform the Standard & Poor’s 500 stock index.

Not only has hedge fund performance been spotty since the 2008 financial crisis, but the industry has a bruised image. In this 2009, Raj Rajaratnam, the billionaire founder of the Galleon Group, a New York based hedge fund, was convicted of trading on inside information and is presently serving an 11-year prison sentence. Additionally, Steven Cohen’s SAC Capital Advisors is the latest hedge fund to be accused of insider trading and making hundreds of millions of dollars illegally. Additionally, Phil Falcone is accused by the Securities & Exchange Commission of using funds from Harbinger Capital to pay his taxes.

Investment masterminds, like John Paulson of Paulson & Co. and Ken Griffin of Citadel, have suffered significant losses the past several years. And in the first half of 2013, hedge funds returned an average of nearly 4%, compared with almost 13% for the S&P 500, according to HFR.

Interestingly, assets under management by hedge funds are at a record level and  performance could turn around. However, there is now some pricing pressure on the 2/20 fees that hedge funds charge. (Most hedge funds have an annual management fee equal to 2% of the assets under management, plus 20% of any profits). Because of the management fee, hedge funds make money even when its investors lose. It will be interesting to see if sub-par performance continues, how long before hedge funds are required to lower their fee structure.


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Module 4: Advanced Topics | Blog 4-2: Alternatives Investments by David S. Krause

In Lesson 4-2 we talked about the different types of alternative investments and we only made brief passing references to investing in natural resources. This entry talks about how to invest in natural resources and gives some possible reasons why.

Oil Well

Oil Well

Ways to investment in natural resources:

  • Direct investing: It is possible to buy some natural resources directly (like gold and silver); however, it is impractical with regards to oil, natural gas, timber, and other resources that require large storage facilities with associated costs.
  • Futures: These instruments have been in existence for 150 years and are accessible to individual investors. They allow the investor to gain exposure (via leverage) to the price exposure of natural resources. Options on the futures are also ways to obtain exposure.  These are fine investments for experienced traders, but should not be used by the novice investor.
  • Natural resource mutual funds and ETFs: These allow an investor to gain broad exposure to all or a few natural resource investments. There are many natural resource mutual funds and ETFs offered, so there are likely be several that meets an investor’s needs.
  • Common stock: While mutual funds and ETFs consist of stocks, direct investment in specific companies is another option. These can include stocks in the following type of companies:  oil and gas exploration, mining, forestry and others. Some firms are ‘pure plays’ meaning that their fortunes are highly tied to the underlying commodity and there are diversified plays (that do everything from extraction to processing to end market).


Some reasons to invest in natural resources:

  • Increasing population means increased demand for resources. The United Nations estimates the world’s population to grow by 47% from 2000 to 2050, to around 9 billion.
  • Rising incomes and a growing middle class in emerging market countries creates additional demand for consumer goods and higher protein food.
  • Future demand is likely to drive prices higher as the world has a limited, finite supply of easily accessible metals, minerals, oil and gas.
  • Political instability can stress existing and near term access to the supply of natural resources.
  • Future exploration activities are likely to be more expensive as these are located in countries with less stable political environments and poor or non-existent infrastructure.


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Module 4: Advance Topics | Blog 4-1: Fundamental Stock Analysis by David S. Krause

In Lesson 4-1: Fundamental Stock Analysis, we paid homage to Warren Buffett; however, we failed to talk about his trusted sidekick, Charlie Munger. He’s been in the background, but he has been instrumental (along with Buffett) in growing Berkshire Hathaway into the colossal firm it is today.

Charlie Munger and Warren Buffett

Charlie Munger and Warren Buffett

Like Buffett, Charlie Munger is from Omaha, Nebraska. He’s an accomplished business mogul, lawyer, investor, and philanthropist. As Vice-Chairman of Berkshire Hathaway, he serves as Buffett’s partner – and close friend. His accomplishments are many, including chairman of Wesco Financial and the Daily Journal – he’s also a director of Costco Wholesale Corporation. He served as inspiration for Rolf Dobelli‘s book, The Art of Thinking Clearly.

Interestingly, Munger has been quietly creating a mini Berkshire Hathaway in the Daily Journal Corporation, a publisher of newspapers in California and Arizona. Since 2009, he has been investing the company’s excess cash in the stock market. Of note, the Daily Journal’s (ticker: DJCO  market value has tripled since Munger began his investing (see following stock chart).

Stock Chart for Daily Journal

Stock Chart for Daily Journal

The firm is relatively tiny compared to Berkshire – its stock market value is less than $200 million, or about 1,000 times smaller – and trading is thin. The Daily Journal’s holdings (which do not have to be disclosed) include common stock in three large companies (including Wells Fargo) and a pair of smaller foreign manufacturing firms.

A detailed and flattering Bloomberg report was recently published on the Daily Journal and Munger, who is 89 years of age and has an estimated net worth in excess of $1 billion. The Omaha native dropped out of the University of Michigan to serve as a meteorologist in the U.S. Army – and he also attended Harvard Law School. The pragmatic fundamental-based investor first met his friend and business partner, Warren Buffett, at a dinner party in 1959.


Charlie Munger

So don’t ever think that age is a limitation – Munger started investing the Daily Journal’s cash when he was in his mid-80’s. He employed the classic fundamental analysis technique employed by Buffett of buying wonderful companies at low prices. The transformation of a sleepy newspaper publisher into a profitable diversified holding company shows how Charlie Munger applied the same principles we discussed in Lesson 4-1 and produced tremendous gains by buying quality companies when others were fearful.


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Module 2: Investment Basics | Blog 2-3: Investor Protection by David S. Krause

In Lesson 2-3, you learned about the regulation of the U.S. financial markets – and about the misdeeds of Bernie Madoff and other characters that broke various securities laws. The crimes of The Galleon Group, previously one of the largest hedge funds in the world, were also briefly presented. This firm closed in October 2009 amid a well-publicized 2009 insider trading scandal.

steven Cohen source abc news 2.3

Steven Cohen (source: ABC News)

There is another insider trading scandal that involves SAC Capital Advisors – a $14 billion New York based hedge fund founded by Steven A. Cohen, one of the 50 richest persons in the world. In 2010, the Securities and Exchange Commission (SEC) opened an investigation into questionable trading at SAC and in 2013 the firm was indicted for insider trading. In 2014, former employees of SAC pleaded guilty and will begin serving prison terms for insider trading violations.

Several key employees were charged with using inside information to make millions of dollars in profits for SAC Capital. In what officials are calling the largest-ever settlement of an insider trading action, SAC agreed to pay securities regulators over $600 million to resolve a civil lawsuit related to improper trading at the fund.

Cohen used to woo potential high-wealth and institutional investors to his hedge fund by stating in SAC’s internal marketing materials that they gave investors an “edge.” That four-letter word, used 14 times in the insider-trading indictment of his hedge fund, came back to haunt him and others within the firm. In the indictment filed in 2013, U.S. government prosecutors alleged that Cohen and his top SAC managers sought to hire traders and analysts who had the ability to deliver any kind of “edge” over the market.

perp_walk source clevelandleader 2.3

Prep Walk (source: Cleveland Leader)

Employees at SAC were accused of using tips from a doctor who had access to information on key, non-public drug trials to recommend SAC sell their stake in two drug companies, helping the hedge fund make a profit of $276 million. It’s the biggest insider trading case in U.S. history.

Does the relentless pursuit of an information ‘edge’ by hedge funds foster a business culture that pushes the boundaries of legitimate research into the area of the misuse of inside information? How far should government go to ensure there is a ‘level playing field’ in the area of securities research? These are questions that need to be addressed; however, it does appear that the current leadership at the SEC is committed to rooting out illegal trading activity within the hedge fund industry.


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