What Can You Do To Protect Your Investments?

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There’s nothing like a war in the Middle East to fire up the oil price. News that Saudi Arabia launched air strikes across the Yemeni border sent the oil price up nearly 4.5% overnight.

Gold had a strong reaction as well, rallying to nearly US$1,220 an ounce in London trade before retreating during the US session. Aussie dollar gold had a good session too, closing at $1,540 an ounce after falling to a low of $1,475 just a week earlier.

As I’ve been saying, the US dollar gold price that you hear quoted everyday is still lacklustre. But the Aussie dollar gold price — the price that matters for you if you’re investing in Aussie listed gold stocks — looks much more constructive.

If you want to know how to take advantage of this emerging new trend, click here.

The conflict in Yemen is another proxy war between Iran and Saudi Arabia, following on from the tragic debacle that is Syria. Yemen has been a failed state for some time now and has provided the impetus for the Iranian backed Houthis to gain a foothold of power.

The Saudi’s aren’t happy about it, hence the launch of airstrikes and a large troop build on the border. Whether this escalates or dies down from here is anyone’s guess.

Regardless, under the surface there is a slow change in the balance of power in the Middle East. Iran’s influence is rising. The Saudi’s are under pressure. The proxy war between the two in Syria has been going for years. This is probably the start of a similar situation in Yemen.

As an investor, is this anything you should worry about? Not immediately. But there is no doubt the troubles in the region will continue to have a greater impact in the West.

The Syrian conflict gave rise to ISIS. Another war will just create another generation of young men without hope, fuelling radical ideologies and violence. Great.

Is there anything you can do about it? Not really. You can be tolerant and understanding, non-judgemental and compassionate in your daily life. Good and decent behaviour does have a flow on effect, even if you don’t see where it flows.

But wait! The Daily Reckoning’s beat is money, not morality or virtue. So let’s get selfish and focus on what you can control in the world of money and materialism.

You can control your investment decisions and where you get your ideas, which is why you’re reading this non-mainstream publication. You’ve obviously decided to take greater control over your money by becoming more informed and perhaps investing yourself.

On that front, I have something that might be of interest to you. Tomorrow, we’re launching a new service focussed on income investments called Total Income. You’ve heard from editor Matt Hibbard throughout the week in these pages, but if you’re like me, you probably have a few more questions about what the service will be about.

With that in mind, I sat down with Matt yesterday to ask a few probing questions about Total Income. We chatted for about 30 minutes. I’m a pretty erratic interviewer, so the below Q&A is an edited version.

I started by asking a question based on an important point that Matt raised in his first Daily Reckoning essay on Monday…

You mentioned in your first essay this week that allowing for risk [Editor’s note: making sure you don’t overpay for a stock simply to get the yield] is the most important thing income investors should do. But how do they do this in a world of central bank manipulation that deliberately mis-prices risk.

What I meant by that comment was that you have to distinguish between the different types of dividend paying companies. It’s about putting a risk premium on cash flows — smaller, less established dividend payers would probably be a riskier investment than a larger company with an established record of paying out dividends. In other words, it isn’t just a linear process of going through the cash balance, EPS (earnings per share) and dividend growth, and making a recommendation without taking into consideration the risk attached to the cash flows.

In relation to your question about central banks manipulating the risk premium, it’s true and something that all income investors need to be aware of. But no one knows how long this state of affairs will continue. It could be like this for years to come.

My strategy to deal with it is to focus on asset allocation, diversification, and low levels of leverage. People need to be totally aware of the risks that central banks have created with their low rates and money printing, even if the market isn’t adequately pricing in those risks.

The other thing to keep an eye on is inflation…

Well that brings me to another question I had. Normally, higher inflation is good for income investors as it often leads to higher interest rates and dividends. But in today’s world, persistent concerns over deflation have kept interest rates low and asset prices high. To what extent are you concerned that rising inflation might cause a big fall in asset prices, negating the benefits of receiving an income yield?

Like many people, I find it hard to believe that years of money printing won’t lead to a rise in inflation in the future. But we haven’t seen it yet and we may not see it for years to come. We’re in uncharted territory. No one knows what lies ahead. It could be years of more of the same or something completely different. All investors can do is deal with the conditions as they are.

One thing I plan to do is keep a close eye on a number of inflation statistics and present these in the newsletter in an ‘income dashboard’, so members can monitor these things regularly and get a sense of how the market is reacting to the prospects of inflation.

Going back to your earlier comment on asset allocation and diversification, what does this mean in terms of what stocks and sectors you’ll be looking at?

The primary aim of the newsletter is to go beyond the obvious ‘dividend payers’ like the banks or Telstra. There are hundreds of dividend payers in the market and my job is to uncover the quality companies that can sustain a dividend through the economic cycle. So I’ll be focussing on an ‘overlooked’ area of the market for sustainable dividend payers, if you want to put it that way.

The other thing to keep in mind is that the dividend payers I’ll be recommending are long term holdings. I recognise people need an income from stocks for the long term and are less concerned about short term market fluctuations. So I’m not going to try and time entry into and out of stocks. If the fundamentals are strong and the divvy is sustainable, I’m happy to buy and hold.

What does that mean for mining stocks as income payers? Will they feature in Total Income at all?

Yes and no. A lot of the miners don’t pay a dividend anyway. And some only do at cycle highs, which doesn’t satisfy my demand for sustainable dividends through the cycle.

One thing I will look at is a ‘special situation’ pick where I might look at a BHP, RIO…or a Woodside or Santos. It might be where it’s close to a cycle bottom for their particular or dominant commodity and they are paying out a sustainable dividend that should increase as commodity prices recover. It will be on a case by case basis, but they won’t feature heavily.

Thanks Matt and best of luck with Total Income!

You can read on below for another one of Matt’s essays. And keep your eye out for your invitation to join Total Income tomorrow.

Until next week…

Greg Canavan,
for The Daily Reckoning Australia

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Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.

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