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2014/08/01

The Great Gold Swindle

When something looks too good to be true, it is! Follow us on Twitter Like us on Facebook
Friday, August 1, 2014 | Issue #87
Eric Fry, musing about the stocks that aren't going up...

Early last week, when your editor took the podium of The Oxford Club's Private Wealth Seminar in Quebec, he did not step into the midst of a sympathetic audience.

The attendees were very pleasant, as usual; that wasn't the issue. The issue was rather that these pleasant attendees seemed to have very little appetite for an unpleasant topic: the possibility that the U.S. housing market may not be as robust as advertised.

Before launching into the topic at hand, I asked the attendees to raise their hands if they believed home prices would be higher in one year. An ocean of hands filled the room. Then I asked for a show of hands from those who believed home prices would be "flatish" in a year. A few contrarian hands rose timidly into the air.

Finally, I asked if anyone in the room believed home price would be lower in a year. Only two hands went up - a like-minded couple in the front of the room.

After mentioning to the attendees that I sympathized with this courageous couple, I braced myself for the thankless task of delivering a message that no one really wanted to hear. To be clear, I did not predict that home prices would be lower in a year - I'm not in the prediction business - I merely observed that the housing recovery sits atop a feeble foundation.

"While it's true that home prices have bounced from their 2010 lows and that sales volumes have picked up somewhat," I admitted, "there's a problem. The housing market's traditional core buyers are scarce. These 'core buyers' are the young couples and young families who use mortgages to purchase homes."

After running through a battery of charts, I concluded, "The U.S. housing market is probably not a strong as most folks believe." (I reiterated that sentiment here in The Daily Grind last Friday: "The Housing Bust of 2015.")

In the days following this July 22 presentation, the housing sector delivered a barrage of disappointing press releases and data points...

On July 24, the Census Bureau reported that new home sales tumbled a whopping 8.1% from May to June and 11.5% year-over-year. Then, on July 28, the National Association of Realtors (NAR) reported that pending home sales fell 1.1% from May to June and 4.5% year-over-year. The following day, the Census Bureau came out with another bummer: "The U.S. homeownership rate in the second quarter of 2014 dropped to a 19-year low."

These announcements proved to be a toxic brew for homebuilding stocks. The Bloomberg American Homebuilders Stock Index has slumped 8% since my presentation, while many individual homebuilding stocks have fallen twice as much. In other words, investors have become much more enthusiastic about selling homebuilding stocks than about buying them.

But the news is not all bad. Confidence among U.S. homebuilders rose in July to a new six-month high. So at least the housing market has builder confidence on its side... or does it?

It turns out that some of these confident homebuilders are declining to put their money where their "confidence" is.

Each of the CEOs of the nation's five biggest homebuilders has sold his company's stock in the open market during the last five months. By contrast, not one of them has purchased his company's stock in the open market during the last three years. Two of them have never purchased a single share in the open market.

This one-sided trading activity does not necessary mean anything. In the modern era of executive compensation, CEOs are so loaded up with stock and stock options that they rarely wish to purchase even more company stock in the open market. But they often sell stock - usually for "personal financial planning purposes."

Therefore, in order to get a real feel for how a CEO feels about his company's prospects, you need to examine the change in his stock holdings. Are they increasing or decreasing?

Based on this simple examination, homebuilding CEOs seem more bearish than bullish.

Four of the five CEOs of the largest homebuilding companies have reduced their holdings of company stock during the last two years. The CEOs of both Lennar (NYSE: LEN) and D.R. Horton (NYSE: DHI) have slashed their personal holdings by half.

To be sure, this insider selling may not contain a single grain of insight or predictive value. On the other hand, optimistic shareholders rarely cash out half their investment.


In the same way, one month of disappointing housing data does not make a trend. Next month's data could reverse all of this month's bad data. That said, the housing market seems to be anything but robust, which means that the homebuilding stocks bear watching... And the best view may be from the sidelines.

Moving from one cautionary tale to another, Sean Brodrick, editor of Oxford Resource Explorer, has a few words to say about how to gain confidence in your investments. Read on...

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The Great Gold Swindle

By Sean Brodrick


Greetings from Maine! Right now, I'm writing from within foghorn distance of the sea. And this gives me an opportunity to tell you a down east tale that should serve as a warning to every investor: Maine's Great Gold Swindle.

I'm not talking about central banks, or manipulation of today's markets. I'm talking about something from Maine's history that proves the old lesson, "When something looks too good to be true, it is!"

Every enormous dollop of humbug is wrapped around a kernel of truth. And the fact is, there is gold in Maine. Gold is found in Maine's bedrock, in sediments that were eroded by glaciers and in stream deposits. Significant gold discoveries were made in the towns of Acton and Madrid. And there were smaller finds around the state.

But in 1898, two men showed up in Lubec, Maine: Rev. Prescott F. Jernegan and his boyhood friend, Charles E. Fisher. They claimed an astounding way to find gold in Maine: They would harvest the yellow metal from seawater.

Lubec is the easternmost town in the U.S., way up near the Canadian border. Jernegan explained to credulous investors that Lubec was the perfect site for what he described as a "Klondike factory" because its position on the Passamaquoddy Bay gave it exposure to the huge rise and fall of the tides.

Hook, Line and Seawater

The official name of the company was the Electrolytic Marine Salts Company, or EMS. Jernegan and Fisher sold their "secret formula" to their new company in exchange for 45% of sales of company stock. According to Jernegan, the formula was the end result of over 200 experiments using electricity and chemistry.

Both Jernegan and Fisher came from respected Martha's Vineyard families.

Jernegan was a Baptist minister. His workmen were required to participate in regular Sunday prayer services.

EMS poured money into the project, installing the town's first telephone and electric systems. The company even paid for half the cost of a new steel bridge. The bridge would be used for hauling away the tons of gold EMS would harvest.

Jernegan was also a born salesman, with impressive communication skills. As the old timers in Maine say, "He could sell a werewolf a flea collar."

Still, why did people believe him? Well, there IS gold in seawater. It is in very low concentrations - about one to two parts per 10 billion. Jernegan and Fisher said their revolutionary process could get around that.

Curious would-be investors came to Lubec. Jernegan led them down some stairs and into a room beneath a wharf. There they saw 250 boxes, each containing a battery, some mercury, and a secret recipe of chemicals that would make Colonel Sanders green with envy.

These boxes, called "accumulators," were then lowered deep, deep into the tide-churned salt water. Visitors saw the boxes go down. And they saw other boxes brought up after a 24-hour accumulation period. Cracked open like clams, the boxes revealed their treasure - small but valuable deposits of gold and silver.

A Secret Skill

Jernegan was doing all the hard work of selling, right? So what did Fischer have to do with the scheme? Fischer had a special skill of his own... one that very few knew about. He was a trained deep-sea diver!

In other words, Fisher could descend through the inky depths of the nighttime sea and put gold in the accumulator boxes!

As one local folklorist recalls, "The next day when it was low tide, they'd take these accumulators out and low and behold, there was gold!"

On May 11, 1898, a local newspaper reported: "Nine shipments have been made from the works of the Electrolytic Marine Salts Mining Co. of East Lubec to date. They are said to have averaged about $1,000 apiece in value."

Of course, Jernegan and Fisher were seeding the press stories just like they were seeding the accumulator boxes. But investors fell for it hook, line and sinker, especially because they heard that Plant Number Two would have 5,000 more magic accumulator boxes.

By the end of May, the locals - many of whom now had jobs at EMS - were won over. The Lubec Herald gave Jernegan and Fisher a ringing endorsement, saying, "We believe that time will prove these gentlemen of the EMS Co. to be staunch friends and people who will take a warm interest in the town."

Locals pressed their hard-earned cash on Jernegan and Fisher, eager to get in on the initial offering of EMS shares. But that local Lubec money was small potatoes for the EMS boys. They aimed to hook the big-money speculators.

And man, did they land some whales!

EMS stock was offered at $1 per share. The first offering of 350,000 shares sold out in three days. By July, 2.4 million shares had been sold to investors all over the East Coast, as 800 workers raced to put the finishing touches on Plant Number One.

In July, Fisher left on business. A few days later, locals noticed that Jernegan was also missing. Concerned, some workers went to his home, where they found the entire family had vanished, taking their furniture with them. Mysteriously, all of the company books and ledgers had disappeared as well.

Overnight, the EMS gold-from-seawater venture quickly turned into a major debacle. The July 29 Hartford Courant ran a banner headline: "The Bubble Burst." And EMS stock imploded.

Warrants for Jernegan and Fisher were quickly issued, but both men had fled the country, their bags stuffed with cash. One Lubec local described the affair as "the biggest swindling scheme we ever had in Maine."

The Sea's Real Fortune

Fisher was never seen again, but most reports suggest he died in Australia. Jernegan was discovered living in France.

Upon discovery, Jernegan insisted he was trying to locate Fisher, "the real culprit." The paperwork for Jernegan's arrest warrant didn't come through in time for French authorities to arrest him, and he slipped away, reportedly to the Philippines.

The defunct EMS Plant Number One was later converted into a sardine factory. And guess what? The sardine harvest brought more wealth to Lubec than the gold scheme ever promised to!

Important Lessons From the Great Gold Swindle

I think we can take three important lessons from this story...

  1. Always do your homework. That's why I crunch the numbers on companies I recommend, and fly hither and yon to check out the promising ones in person.
  1. Don't get caught up in hype. Conventional wisdom is no path to real wealth. In fact, it can often work to your advantage to sell when others are buying.
  1. Watch what the insiders are doing. Are they buying or selling? Are they experts in their field or just salesmen with slick haircuts and a song-and-dance? Putting your money to work with people who really know what they are doing is one way to stay ahead of the crowd.
All the best from the road in Maine,

Sean Brodrick
for Free Market Café

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