Bill Gross’ $8.1 Billion Bet

By Dr. Steve Sjuggerud Wednesday, September 22, 2010
“Bill Gross’s PIMCO made an $8.1 billion wager,” Bloomberg news reported last week.

Bill’s bet is simple: He’s betting inflation will return to the U.S. in the next 10 years. And he’s willing to risk billions on the idea.

Bill Gross is known as the Bond King. He’s probably the most famous and successful bond-fund manager in history. He manages the PIMCO Total Return Fund the world’s biggest bond fund, with a quarter-trillion dollars in assets. It makes sense to pay attention to Bill’s bets…

Bill is betting on inflation. Actually, more specifically, Bill is betting that DEFLATION won’t happen.

Today, I’ll show you why Bill’s bet is a smart one. And I’ll show how to make your own bet on this idea. But first, let me explain what exactly Bill is up to…

The mechanics of Bill’s bet are a bit complicated. In short, he took the other side of a bet on deflation.

Bill received $70.5 million now… If deflation occurs over the next 10 years (if the consumer price index is lower in 2020 than it is today), Bill is on the hook for up to $8.1 billion. If deflation does NOT occur, he simply gets to keep the upfront $70.5 million.

“We think the possibility that the U.S. goes 10 years with stagnant or falling prices is remote,” a PIMCO portfolio manager told Bloomberg news.

Fears of deflation have increased dramatically this year. We’ve seen a huge shift in the mindset of the U.S. consumer. We’ve gone from a “conspicuous consumption nation” to a nation of savers. Deflation is simply defined as “falling prices” and the U.S. consumer has surely seen that… Exhibit “A” is the price of their home.

But Bill has an ace in the hole for PIMCO’s anti-deflation bet… Ben Bernanke.

Bernanke is the chairman of the U.S. Federal Reserve. He is a student of the Great Depression. And he is determined to prevent the destructive deflation we saw in the 1930s from happening again today.

In a now-infamous 2002 speech, he said:

…The U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost… Under a paper-money system, a determined government can always generate higher spending and hence positive inflation…

…Prevention of deflation remains preferable to having to cure it. If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.

Bill Gross has made a career out of taking calculated risks. A bet on inflation, when Ben Bernanke is at the helm of the Fed, seems like a smart one. While the fears of deflation are high, the chances of sustained deflation are slim in a paper-money society.

If the Fed does “crank up the printing press,” the simple investment you want to hold is gold. The Fed can print dollars, but it can’t print gold.

Gold is particularly attractive today… Since the Fed has cut interest rates essentially to zero, gold is more attractive than money in the bank… You earn zero percent on your cash in the bank, and earn zero percent on your gold. You don’t give up any “opportunity cost” you don’t give up any interest on your cash by holding gold today.

If you believe Bernanke is telling the truth and the U.S. government will print money as needed to prevent deflation you should hold at least some of your savings in gold instead of paper money. You’ll be on the same side of the bet as the Bond King.

Good investing,

Steve

ANOTHER “CHINA PLAY” IS SOARING

More on the “China confounds the skeptics” story…

As I mentioned in yesterday’s column, plenty of investors believe China’s economy and real estate market is a bubble ready to burst. They think the Chinese government has directed huge amounts of money into wasteful real estate and infrastructure projects.

But as we highlighted yesterday, the market is warming back up to high-profile China stocks like New Oriental Education… and sending them to new 52-week highs. Add Home Inns and Hotels (HMIN) to this list…

HMIN is one of the largest hotel operators in China. Its market cap is nearly $4 billion. HMIN is a play on China’s growing wealth and propensity to travel… so it booms and busts according to investor sentiment toward the country.

As you can see from today’s chart, you can mark HMIN in “boom mode.” After briefly struggling early this year, the stock has gained 40% and sits near its all-time high. The “China story” is still intact.