Casey Files:
This week in 'The Room'
Doug Casey
International Speculator
written Feb 22, 2008
posted Feb 25, 2008
Welcome to "The Room"
The subscribers-only home page of Casey Research.
February 22, 2008
Dear Readers...
Much to talk about this week.
Too much, I fear.
I shall, therefore, endeavor
to be succinct, a trait, unfortunately, that I seemed to have
misplaced in my formative years.
Even so, as I like to believe
that humankind possesses an innate ability to better themselves,
I shall buckle down post haste and give it the old school try.
Hey, How ‘Bout That Gold?
While it’s nice to see
things going along so swimmingly for our favorite form of money,
even I am a little breathless after gold’s surge to yet
another record this week. And its kissing cousin, silver, has
been no slouch either.
But I am not surprised, given
that the precious metals are doing what they are supposed to
do. Namely, reacting to the rising tide of inflation now beginning
to make itself known here in the U.S. and around the world. This
past week, we learned that even the Comedic Politicized Inflation
index (CPI) is beginning to slip the leash. As you can see in
the chart below from Shadow Government Statistics (shadowstats.com), which
tracks inflation the good old-fashioned way -- i.e., the way
it was done before all the jiggering - the actual rate of inflation
is in a steady upward trend. It is only going to get worse from
here.
On that front, we have been
surveying global inflation and finding that, with only few exceptions,
the trend I brought to your attention last week holds true…
the inflation the U.S. is experiencing is, indeed, worldwide.
That is not to say that there
are no deflationary pressures, there clearly are. Much of which
is related to the declining net worth of homeowners whose inflated
real estate values are headed in the wrong direction.
The result, we believe, will
be akin to one of those television commercials where you have,
say, a truck carrying chocolates colliding with another carrying
peanuts… followed by a smiling bystander, covered in the
accidental mix, licking his lips and finding the formula entirely
to his liking.
Except that the stagflationary
sludge which is coming next – faltering economies concurrent
with higher prices -- will be to almost nobody’s liking.
Unless, of course, you are smart enough to take the necessary
precautions and position yourself to profit. That you are reading
this is highly suggestive that you belong in that category.
Here Comes the Gold Stocks
While there are a number of
reasonable explanations as to why gold stocks have been lagging,
I have come to believe that the single most important reason
has to do with the fact that the price of gold was still under
$280 as recently as January 28, 2002.
Against that number was a cash
cost of around $250 per ounce, which was about as low as it could
go, on the average, indicating an industry doing everything it
could just to survive. Put another way, as a result of the 20-year
bear market up to that point, the industry had been beaten down
about as far as possible. Therefore, as gold began its upward
move, it did so against the backdrop of an industry in mothballs,
running on a skeleton staff and highly optimized operations.
This is important on a number of fronts.
- Having been trained in the
acid bath of razor-thin margins, gold company management teams
were intensely skeptical about gold’s rising price. They
assumed it would be just another bear market trap, ready to punish
unwary optimists who went out on a limb by spending money to
ramp up production.
- I used the phrase above “highly
optimized operations.” By that I mean the mines were focusing
only on the easy-to-mine, higher-grade material that would allow
them to produce a return... maybe. It also meant they were extremely
frugal, reluctant to buy new equipment, or hire the bare minimum
of employees.
- Another survival technique
was the selling of future production at a set price, a perfectly
rational exercise in a bear market, because it at least assured
a price that would cover the known costs.
When you add all that together,
especially the inherent skepticism of management, it becomes
easier to understand why it was that the industry was slow to
act even as the gold price started moving up. In fact, it was
only in February 2003, with gold trending over $350, that Barrick
Gold Corp., the world’s largest, began the expensive process
of unwinding its hedges. And it wasn’t until November of
that year that the company announced it was foregoing forward
sales altogether and would work to bring its hedge book back
to zero.
At the point that the industry
realized that the bull market in gold was for real, it started
to scramble to play catch up. Which, in a choo-choo industry
like mining, means hiring and training lots of people, buying
and refurbishing the equipment needed to reestablish production
on more marginal deposits, upgrading facilities, building expensive
new mills, etc., etc. And, of course, dealing with the cost of
unwinding hundreds of millions of forward hedge contracts.
The rebuilding of the gold
mining industry, in short, really only began in earnest over
the past few years. As would be expected, the costs associated
with this rebuilding required big hits to the financial metrics
that institutional investors look at before making an investment
decision.
The metrics were not helped
by the shift away from high-grade ore (the lower the grade, the
more the material you have to process)or generally rising inflation
and a falling dollar. The end result was that the cash cost of
production rose by as much as twice what it had been during the
mothball years, keeping the margins tight and the miners unattractive
as investments.
By contrast, the base metals
companies bottomed much earlier, in late 1998 and the first quarter
of 1999, thanks to increasing demand out of China and elsewhere.
As a result, they were well on the road to recovery when the
big price increases for base metals began in 2004, positioning
them to make free cash flow hand over fist. Thus, while the gold
miners have been largely shunned in recent years, the base metals
sector has been enjoying salad days, reflected in multi-billion
mergers and acquisitions and, of course, sharply higher share
prices.
Here at Casey Research, we
are of the firm opinion that now that the worst financial aspects
of restarting their industry are behind them, the big gold companies
are poised to take off. Proof of this point should come in rapidly
improving margins which, lo and behold, we have begun to see
in the quarterly reports now being released. Just this week we
have learned that Goldcorp’s profits almost quadrupled last
quarter, Barrick’s net profit rose by 28% last year and
is expected to build rapidly from here and Kinross has just posted
a record quarter, with profits up almost three-fold over the
same quarter a year before.
The exception to the pack was
an announcement that Newmont lost $933 million in the last quarter.
But even there we find confirmation, because the loss was mainly
associated with a one-time write-down of costs associated with
acquiring new reserves and closing down an unprofitable merchant
banking operation. In sum, Newmont took the write down because
they could afford to, and because the high price of gold would
help mute any investor disappointment. In essence, they have
effectively cleaned up the books in order to join the profit
party.
We will not long be alone in
noting the pending improvements to the bottom line of the big
gold companies… the investment herd is coming and, we expect,
coming soon.
Now, I am going to dig down
one more layer to make a couple of points you may consider blatantly
commercial. Be that as it may, I’m not going to shy away
from making these points simply because Casey Research will benefit
if you take the action I’m going to recommend.
The first point I want to make
is that if you don’t already have a subscription to BIG
GOLD, now is the time to take one. Our number-one pick, Kinross
Gold, has already bucked the trend by moving up over 68% in the
last 9 months, but the show is just beginning. The underperforming
big gold companies and the new producers we are following, are
going to catch up in a big way and soon. If you haven’t
yet subscribed, do yourself a favor and do so today. You can
subscribe today for just $79 a year, and your subscription comes
with a 3-month, 100% money-back guarantee, so you have less than
zero to lose.
Click here to learn more about
BIG
GOLD and to subscribe.
The second point I need to
make has to do with the junior exploration companies.
History has proven that, other
than discovery stories, the big gold stocks need to get in gear
before the investor sentiment reaches the critical mass needed
to spill over into the junior sector. History also shows that,
as profitable as the big gold companies are in a bull market,
the returns offered by the juniors can blow those away. Exponentially.
This upside, of course, comes with a greater degree of risk.
As the existing subscribers
to the International Speculator will attest, these stocks
can move down just as fast as they can move up… but if you
have the tolerance for volatility and invest only with money
you can afford to take a 50% (or more) haircut on, then you absolutely
have to take a subscription today, while the bargains are still
available. Again, we offer a discounted new subscriber rate and
a 3-month guarantee… meaning you lose nothing by giving
it a try.
Click here to learn more and
to sign up for a subscription to the International
Speculator now.
If you have the means, you
really should have both.
While that may be the most
blatant pitch I have ever made in this missive, I hope you can
appreciate that I believe every word.
In fact, I have never been
more bullish on the gold stocks in my life. That doesn’t
mean I’m right, but you can rest assured that I am completely,
entirely sincere. We have a great team here, all of whom work
very, very hard to get things right. Which, generally speaking,
we do. Right now, the single best recommendation I can give you
is to get very serious about your gold stock portfolio. Know
why you own each stock you do, and don’t bet the family
farm, but be bold and the payoff should be truly extraordinary.
I don’t think we are going
to have long to wait for the show to really get on the road.
Spy vs. I
An outraged instant message
from Fitzroy MacLean of Without Borders, our international
investment and lifestyle letter, popped up on my screen earlier
this week. Now, given that Fitzroy used to earn his porridge
by engaging in covert and overt operations where a failure in
risk management could lead to a bullet in the head (he is former
CIA and an Army Ranger), he is not easily flapped, so his strident
message caught my attention.
He was writing me from Germany
where the news had just broken that German intelligence officers
had paid on the order of US$5.9 million to a Liechtenstein bank
employee to steal a disk containing the names of all the German
account holders of the bank (and, I suspect, everyone else…
giving the German government a very nice trading card). The purpose,
of course, was to crack down on anyone who had been trying to
avoid taxes by stashing funds in that tax haven.
Now, unlike Fitz who was appalled
that the country’s intelligence services were being put
to work spying for the tax department, some of you may think
that it is good and proper that the tax cheats are being rounded
up and hauled off to the cells. If so, then you’ll have
much to cheer you in the months and years just ahead.
The fact is that governments
in all their many permutations are themselves starting to feel
the pinch from their overspending and overcommitting to spend
more. The pinch will turn to a vice grip as the flaws of the
fiat monetary systems they uniformly deploy begin to collapse
as they futilely try to keep the dyke from bursting.
In the United Kingdom, for
example, the government has made the decision to nationalize
the failed Northern Rock bank at a cost of almost US$7,000 per
citizen. And in Germany, you have a bailout now approaching US$2
billion underway for the 1KB bank.
But this is only so much kinder-play
when compared to the U.S., where the banks have been lining up
around the block to take advantage of the Fed’s Term Auction
Facility (TAF). Which is to say, the banks are handing the Fed
a bunch of toxic waste as collateral and receiving, in return,
tens of billions of freshly minted dollars at a very agreeable
interest rate.
And even that doesn’t
begin to measure up against the $170 billion of handouts contained
in the stimulus package.
Which pales in comparison to
the larger 2008 budget deficit, now estimated to be over $400
billion.
But all of that is only a splash
on the rim of the bucket against the tens of trillions of bills
now coming due for the benefits due the retiring baby boomers,
a number sure to go higher when President Obama rolls up his
well-pressed sleeves to implement universal healthcare…
and… and…
The pressure is beginning to
be felt all the way down the chain. In California, Governor Schwarzenegger
attracted a lot of unhappy attention by suggesting the state
start letting criminals out of jail, cutting welfare and closing
down public parks and other facilities because that once golden
state could no longer afford the bills. Here in Vermont, the
governor has proposed selling the state’s lottery to raise
some pocket cash.
Make no mistake, we are still
in the early, more friendly phase of this process. Once the state
really starts to come under pressure, it will do whatever it
takes to keep afloat.
A relevant comparison, sadly,
comes from ancient Rome. During his unhappy term in office, Roman
Emperor Caligula first spent the treasury dry, then, after it
was depleted, turned to doing whatever it took to keep the state
afloat. Which, at that time, involved – among other activities
– accusing the wealthier citizens with treason followed
by a speedy trial (“Hail Gaius! You’re guilty, off
to the lions with you. Have a nice day!”) and the confiscation
of all their property. As things slipped further down the slope,
he passed into law incentives whereby friends, relatives and
fellow countrymen of said property owners could rat them out,
for which they would receive a cut of everything confiscated.
And, one would imagine, as a bonus get a front-row box seat to
watch the lions eat.
Expect to see more and more
of the sort of covert activity engaged in by the Germans spread
around the globe. We are at the beginning of the trend, not the
end.
Watch yourself.
And Now for Something Entirely Different
As you know, at this point
we are avoiding traditional equities (except to short some),
and have no interest in fixed income. But we are birds of a different
color than most investors, being determined contrarians with
a solid speculative bent.
For those of you who skew a
bit more toward the traditional, you might appreciate reading
some of the material put out by Fidelity Independent Advisors.
Olivier Garret, our CEO, and I met Fidelity’s Don Dion at
a conference last year and were impressed. While I personally
wouldn’t rush into some of the sectors they follow, you
might be more inclined in that direction. If so, check out their
free Hotline e-letter by clicking
here…
Energy Chart of the Week
By Chris Gilpin
Contributing Editor, Casey
Energy Speculator
For the past three years, there’s
been an unusual divergence between the prices of oil and natural
gas. Historically, the price per unit of energy between the two
fuels is roughly equal. It might swing apart during cold winters
when natural gas prices sometimes spike, or during times when
political tensions in the Middle East put a “terror premium”
on crude prices, but all things considered, they usually fall
back into alignment.
That’s because several
large industries, and some power plants, have the capacity to
switch back and forth between the two fuels. With crude costing
twice as much per million British thermal units (MMBtu) as natural
gas, you can rest assured that no one is burning petroleum products
to power their operations or feed the electricity grid, not if
they can possibly help it.
This widening price gap poses
a pressing question: is oil overvalued, or natural gas undervalued?
Both, is the most likely answer.
What’s most fascinating
is that this graph also clearly shows that the price of energy
per unit – no matter what the fuel source – is rising
sharply, proof that the global energy boom is in full swing.
(Ed. Note: If you are
looking to get in on the energy boom, that is a sector we follow.
You can learn more about the Casey Energy Speculator by
clicking
here.)
The Mailbag
I had any number of interesting
reader emails this week. Here are excerpts from a few I thought
you’d find of interest…
“You recommend highly
speculative stocks. Given the respect you carry in the industry
and the size of your readership, I am concerned about the timing
of when you believe it is time to get out of the precious metals.
I wouldn't think your exit would have much of an effect on gold
or silver, per se, but I would like your honest and transparent
belief over how much your "sell signal" will affect
those small and highly speculative precious metal mining companies.
I think it will be substantial, and frankly, I believe this precious
metals bull market may last a lot longer than you seem to think
from your writings. I don't want to be caught holding the bag,
waiting for a small company to come back from carnage that could
ensue when you guys recommend getting out.
Bottom line: How big of an
effect do you think your sell signal will have on those stocks?
An excellent question and a
welcome sign of a heads-up investor paying close attention to
their personal knitting.
The answer, generally speaking,
is that we expect the serious Mania phase in the gold stocks
to last at least a year. At some point in the run up, likely
six months or so into it, we are going to come to the conclusion
that the Mania is headed toward its apex and recommend our subscribers
begin looking to lock in profits by selling into volume.
Remember, this is pure conjecture,
because it is impossible to say with any certainty what market
conditions will be like at the time that we begin to feel the
Mania is reaching full stride.
However, as the subscriber
just quoted so aptly points out, inherent in the discussion above
is the fact that, yes, we are likely to put out the sell signal
well before the bull market run is over. That should, we would
hope, allow for an orderly exit, over a leisurely period of time.
Will our recommendation to take profits at that point cause the
stocks we follow to take a big hit?
Impossible to say – as
much will depend on whether you, the subscribers, decide to rush
to the exits, and what the level of the volume is coming into
the stocks at that time. I don’t think there is much chance
of a mass exodus, however, because it is human nature to hang
on longer than is prudent. With markets being in full bloom at
that point, the odds are that most of you will want to hang around
in the hopes of yet another double.
The best way, as always, of
viewing our services are as a source of unbiased, deeply considered
research on investments to potentially include in your portfolio.
But how you manage your portfolio has to remain an entirely personal
activity. When you get a 3- or 4-to-1 shot, we would suggest
you do yourself a huge favor and, no matter how exciting the
party, don’t wait for us to tell you to scrape your original
investment and a handsome profit off the table.
This is, of course, a topic
we will continue to address over time. For now, however, we are
still very much in the portfolio-building phase.
Hi David,
I wanted to share a story with
you that I found quite shocking and relevant to many of the topics
surrounding the current financial predicament this country now
finds itself in.
Since I travel just about every
week all over the country, visiting and working with our various
customers, I try to get a gauge on how the current financial
situation is affecting average working Americans. As part of
the general IT strategy work we do, we typically do a great deal
of process re-engineering work as well. As I have been recently
working with a client in a very rural area, we have focused a
lot of our efforts trying to eliminate many HR-related inefficiencies
in their organization.
As a result of some of the
preliminary workshops we ran the first week, I was shocked to
find out that at the current client, their 401(k) plan has witnessed
a dramatic drop in the number of participants in the plan over
the past 3 years, from a high around 59% participation back in
1998. At present they have about 28% of their employees who opt
in to the plan. However, only 23% of the employees contribute
the full 100% tax-deductible contribution which the company matches
at an average rate. On top of this, their HR department has recently
added money management classes due to the number of their employees
that now find themselves in an ever-increasing pile of credit
card-related debt and in a few cases, bankruptcies.
This is just one example of
the plight of Americans and the current negative savings rate
which we are witnessing now. Given that this is the second-largest
employer here in the area, in my mind this is probably a fairly
good representation of the overall community at large. Oddly
enough, the local Super Wal-Mart was jam packed with local shoppers
purchasing everything from flat screen TVs, to groceries and
iPods.
So as much as I would like
to think that most of these folks who choose not to participate
in their companies' 401(k) plan was out of sheer financial hardship
and necessity, I am driven to conclude that there are a lot of
people out there who simply do not know how to manage their money
properly and just make stupid decisions? It would be interesting
to see what these averages look like on a national basis?
Just thought I would share
that with you.
Human psychology is very complex.
You would think, given that their employers were willing to match
funds, and that the money saved has tax advantages, people would
happily contribute to their 401(k) plans. It is, however, a well-documented
fact that people make financial decisions that don’t make
any sense.
I also believe that decades
of intonations by politicians that the citizenry will be looked
after has, in my opinion, led people to an unrealistic view of
their future, and a naïve belief in the ability of the government’s
safety net to hold up when they are ready to plop into it. In
fact, I think the biggest problem this country will ever face
will be the problem of the indigent elderly… 20 or 30 years
down the road.
Regardless, there is a new
book out on behavioral economics – i.e., what people actually
do with their money, rather than what the economists think
they should do. It’s entitled Predictably Irrational
by MIT professor Dan Ariel. While I haven’t yet read it,
I heard Ariel interviewed yesterday and found his experiments
about how people make financial decisions very interesting. He
used as an example the decision making that goes into deciding
how much to pay for a piece of chocolate. You put the chocolate
in your mouth and it melts, creating an enjoyable taste sensation.
But what process determines how much you are willing to pay for
that sensation? I plan on reading the book.
A unique site. When you click
on the website link below, a world map comes up showing what
strange & dangerous things are happening right now in every
country in the entire world & is updated every few minutes.
You can move the map around, zero in on any area & actually
upload the story of what is going on. This “map” updates
every 300 seconds... constantly 24/7.
http://www.globalincidentmap.com/home.php
Click on any icon on the map
for text update information. It's not just about terrorism -
it's about everything happening every minute some place in the
world of terrorism threats, explosions, airline incidents, etc.
Pretty cool, if accurate. For
instance, you would have thought we would have heard something
in the main street media (or “lame street media,” as
some like to call it) about the Indians being arrested while
smuggling uranium. I just googled it, and sure enough, there
it is. In fact, if media reports are right, this is the second
such incident in India in recent years. As if Pakistan doesn’t
have enough trouble…
MISCELLANY
Think Your Laptop is Small? In a recent edition of these ramblings,
I shared my general optimism about the future of humanity, thanks
to steady technological progress. That is, of course, a theme
often referenced by Doug Casey, the chairman of this organization
and my favorite partner of all times. Doug is looking forward,
especially, to the era of nanotech, when all things will be possible.
While waiting, we can entertain ourselves with a steady stream
of cool new stuff. Here
is a link to one of the coolest I have seen of late…
Speaking of Laptops… if you are traveling internationally,
you may want to give consideration to the idea that the local
border clerks – you know, the ones with the warm smiles
and hand guns – may take an unhealthy interest in your laptop
and decide they should have a poke around, or just confiscate
it outright. Some
words to the wise here…
The Stella Awards for 2007
are out (www.stellaawards.com).
These are the prizes awarded for the most frivolous lawsuits,
named after the woman who sued after burning herself on a cup
of MacDonald’s coffee. Here’s the 2007 winner…
Roy L. Pearson Jr. The 57-year-old
Administrative Law Judge from Washington DC claims that a dry
cleaner lost a pair of his pants, so he sued the mom-and-pop
business for $65,462,500. That's right: more than $65 million
for one pair of pants. Representing himself, Judge Pearson cried
in court over the loss of his pants, whining that there certainly
isn't a more compelling case in the District archives. But the
Superior Court judge wasn't moved: he called the case "vexatious
litigation," scolded Judge Pearson for his "bad faith,"
and awarded damages to the dry cleaners. But Pearson didn't take
no for an answer: he's appealing the decision. And he has plenty
of time on his hands, since he was dismissed from his job. Last
we heard, Pearson's appeal is still pending.
This is not a new story, but
it is instructive, nonetheless… I knew a judge once who
was crazy as a rabid rabbit. Eventually, he too was dismissed
after getting caught climbing into the window of his ex-wife’s
house, gun in hand.
About that Ethanol Stuff. We have made derisive noises about
the etha-not boondoggle that is costing you a lot of tax dollars
and helping to drive up the global cost of food (33% of all the
corn grown in the U.S. is expected to be used for the stuff over
the next decade). Well, recent news has it that the demand for
ethanol not only pushed up the price of food by 4.9% last year,
but that it will double the level of greenhouse gases produced
over the next 30 years. Okay, now let’s see how long it
takes before the politicians pass a law which, in principle,
explains, “Oh, about that ethanol stuff… well, hmm,
never mind.” I’m betting it will take a decade, at
least.
Protectionism Watch.The last thing the world needs right
now is a trade war. But, as I have commented on previously, it
may soon get one. The latest sign comes from the Australian government,
which is looking to pass legislation that requires that sovereign
wealth funds are “independent from the relevant foreign
governments.” I wonder what part of the term “sovereign”
our friends down under don’t understand? Meanwhile, Beijing
is none too happy following a decision by a U.S. government panel
to disallow a Chinese state company, in conjunction with Bain
Capital Partners, to buy 3Com Corp. This sort of thing is happening
fairly frequently now, and the pace should only accelerate as
people get more nationalistic, urged along by politicians looking
to assign blame for economic woes anywhere but where it actually
belongs.
That’s It For This Week!
There is much, much more one
could comment on… the failure of auction debt markets (yesterday
395 out of 641 auctions failed. To get a sense of what that means,
consider that since the auction debt market was established in
1984, there had been a total of just 44 failures); the shooting
down of errant satellites; the burning of embassies; the invasion
of our friends the Kurds by our friends the Turks… but there
is only so much time in the day, and other responsibilities call.
A quick check of the screens
show that gold is holding strong at $944, oil is $96 and the
U.S. stock market is, again, down almost 100 points. Business
as usual, I’d say.
Until next week, thank you
for reading!
David Galland
Managing Director
Casey Research, LLC.
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Doug Casey
Casey Archives
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