Just as important as finding overlooked stocks is shying away from untimely investments. The time not to buy oil stocks is when the price of oil is at all time highs; the time not to buy cyclical stocks is at the end of an economic expansion; and the time not to buy bonds is when interest rates are at 40-year lows.
I have a slightly younger brother who is fondly known within the family as Uncle Stephen. He is going bald and has been employed as a computer geek long before it is was fashionable. Uncle Stephen dropped by yesterday for dinner. My bride and I hadn’t seen him for a few weeks and wanted to keep in touch. As usually, while the brandy was being poured, the topic of conversation turned to finances.
Raising his snifter to his nose for a good, long whiff, Uncle Stephen made an interesting announcement. "I just sold my interest in the rear-view mirror company to a huge conglomerate. They gave me a pile of cash and I am thinking about buying some bonds for both income and safety. I keep reading about the advantages of having some international exposure and how the Pan-Asian economies will continue to grow. North Korea is in the process of issuing state bonds for the first time and I’m giving it serious consideration."
Uncle Stephen continued, "The bonds, called "People’s Life Bonds" are being issued in denominations of 500 North Korean won (their currency), 1,000 North Korean won, and 5,000 North Korean won. On the black market, one U.S. dollar is exchanged for around 200 won, so I could buy $2.50, $5.00 or $25.00 worth of North Korean bonds. Pretty cheap, right? In addition, I know they will go up in value once the North and South unite and a unified Korea becomes an economic powerhouse. Although I can’t find a U.S. broker to buy these for me, I have found one guy on the Internet from Hong Kong and another from Nigeria, who will sell the bonds to me."
I almost spilled my brandy as I could not believe what I was hearing.
"Uncle Stephen, I think it’s great you sold out of the rear-view mirror business, but you should rethink your People’s Life Bonds. Bonds carry enough risk right now without investing in one of the rogue nations targeted by the current U.S. administration. Keep in mind that North Korea has lost most of its communist trading partners and resorts to exporting missiles to the Middle East to earn much needed cash. According to the U.S. State Department, between one and two million people have died from hunger since the mid-1990s, but the government still maintains the world’s fifth largest army."
"I think your People’s Life Bonds belong with your paper currency collection, squeezed between the Libyan note with the engraving of Moammar Gadhafi and the US$10 Military Payment Certificate issued in the Philippines after WWII."
There are risks to buying bonds today. As bond prices move inversely to trends in interest rates, any future interest rate increases will create a loss of capital from current bond prices. I bought U.S. 30-year government bonds in 1999 for $95 per $100 face amount (principal due at maturity). These same bonds are now selling for around $115 per $100 face amount. The bonds pay a 6.25% coupon, or $625 annual interest per $10,000 bond. Back in 1999, interest rates were rising and then current 30-year interest rates were around 6.5%. Today’s long bonds yield is 5.0% and investors are willing to pay me more for my 6.25% interest coupon. If current rates rise above my coupon rate, the market price will be less than the face value at maturity.
Interest rates will rise along with an economic recovery. Even though there may be talk about another rate cut by the feds, my bet is that 3 years from now, rates will be back to the 5.5% to 6.0% range. In addition, not many items, not even interest rates remain at 40-year lows for very long. A $10,000 30-year bond bought today with an interest payment of $500 (5.0%) could be worth $9,090 if rates cross 5.5% and $8,333 if rates cross 6.0%.
The consolation is that investors actually owning U.S. government bonds, rather than bond funds, will be repaid their principal at maturity. As funds have no set maturity date, bond fund investors have no guarantee of repayment. Add this market risk to Uncle Stephen’s idea of investing in North Korea and you can begin to get a picture of my concern for him.
By the way, Uncle Stephen’s People’s Life Bonds are non-interest paying 10-year notes, backed by the "good faith" of the North Korean government. They will be redeemed by using a lottery system! Bond holders get the opportunity to buy a lottery ticket with a number. If their number is called, they can redeem their bonds and receive a portion of the receipts from the lottery sales as their repayment of bond principal. If you choose not to buy the chance to redeem your bonds or if your paying ticket is a loser, you can wait until next year. According to the official press release from the Korean Central News Agency, the North Korean government plans on offering an annual lottery each year for the next ten years. It has been reported that People’s Life Bonds will be distributed in place of cash as part of employee wages and other payments.
George Fisher, author of The StreetSmart Guide to Overlooked Stocks (McGraw Hill, 2002) and All About DRIPs and DSPs (McGraw Hill, 2001), Sagamore Beach, MA [email protected]
© Canadian MoneySaver, PO Box 370, Bath, ON K0H 1G0 613-352-7448 - Published May 2003
Copyright North Shore Associates 2003