 The Casey Files
The Meltdown
Doug Casey
Editor, The International
Speculator
Aug 29, 2007
Doug Casey is a best-selling
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Over the last few weeks we've
experienced extreme volatility, and fear, in the financial markets.
The event itself wasn't unexpected around here. After all, we're
on record as expecting to see the Greater Depression materialize
in the years to come. Maybe even starting now.
But just because something
is inevitable doesn't mean it's imminent. Some of you may be
asking "OK, Casey, but what makes you think that a depression
is inevitable - forget about imminent?" A proper answer
to that would take a couple of chapters, and this isn't the forum
for that. Besides, I've done that in my book Crisis Investing
for the Rest of the 90's. Unfortunately, the book has been
off the shelves for some years. If you have a copy, go over it,
and see if the reasoning seems sound.
In essence, however, an economic
depression is a period of time when most people's standard of
living drops significantly. More exactly, it's a period of time
when distortions and misallocations of capital - caused by government
intervention in the economy, particularly by currency inflation
- are liquidated. Inflation sends false signals to both businessmen
and consumers; it makes consumers think they're richer than they
really are, so they spend more. Businessmen gear up to meet this
artificially created demand, by hiring more workers and building
more facilities. Currency inflation, in its early stages, gives
the appearance of prosperity. It also tends to lower interest
rates simply because interest is the price of money, and when
you expand the supply of anything, its price tends to fall; so
everybody tends to save less and borrow more. Later, however,
rates rise, because people won't lend without compensation for
the currency's depreciation. The process causes a phenomenon
called the business cycle. A phony boom can cause a very real
depression.
The long boom we've had since
the bottom of the last cycle in 1982 - a time that was characterized
by high unemployment, lots of bankruptcies, high interest rates,
and a low stock market - has lasted 25 years. It could have ended
badly a number of times along the way, such as 1987, 1993, or
2000. Each time the government propped the house of cards up
higher by injecting more currency into the system. It's analogous
to someone driving a high-performance car on a mountain road
with a stuck throttle. The driver can mash on the brakes, slowing
it from 50 to 30. The car charges to 80, but this time the fading
brakes can only bring it down to 60. After a couple of cycles,
it's going 140. And Ben Bernanke is no Michael Schumacher. Perhaps
he can navigate the road. But the chances are better, at this
point, that the economy will go off a cliff.
So, if we're going to have
a depression, what should you do about it? Our advice here has
always emphasized owning a lot of gold. That's because it's the
only financial asset that's not somebody else's liability. That's
important whether the depression is deflationary or inflationary
in nature. Deflationary depressions are characterized by lots
of bankruptcies and defaults; the only assets you can count on
are those in your own possession, like cash or gold. Currency
becomes more valuable because so much is wiped out in defaults.
But gold is the ultimate form of cash. Inflationary depressions,
however, wipe out the currency itself, which loses value rapidly,
because the government creates so much more. Gold profits from
this process.
Is this the start of something
big and nasty? It's impossible to say. But the slap the markets
have administered upside the back of everyone's head should alert
them to the possibility. You want lots of gold. Limited debt.
International diversification. And some situations - like our
recommended gold stocks - that present some real speculative
upside.
The ultimate cause of all the
problems we're facing is government, with its taxes, regulations,
inflation. And wars, pogroms, confiscations, persecutions, and
myriad other stupidities. But most people are more concerned
today about the proximate cause of the recent unpleasantness.
The Proximate Cause
The genesis of the current
crisis is subprime mortgages. For well over a decade, lenders
have been making mortgage loans available to literally anybody
with a pulse who wanted to own a house. Several times, in the
mid-'90s, I expressed astonishment at the fact lenders were loaning
over 100% of the appraised value of a house. Even back then,
it seemed that was the top of the housing bubble. But what do
you know? It hadn't even turned on the turbos... just going to
show how hard it is sometimes to pick an actual top.
This leads to one of the more
interesting distortions arising from a really big credit-driven
boom. You know the old saying: If you owe a banker a little money
and can't pay, you're in trouble. But if you owe a lot of money,
he's in trouble. That's exactly what's happened here. All those
new homeowners are already having trouble paying their mortgages.
As rates go up, their ranks will swell since they're almost all
on floating-rate mortgages. Higher rates and more distress sales
will take housing prices lower. Which, in turn, will encourage
more people to leave their keys in the mailbox and walk away.
On the other side of the trade
are all the funds and institutions that bought the paper. They'll
eventually recover some percentage of their money, after the
houses in question have gone into foreclosure and are taken over
by new owners. The ones who will really be hurt are the hedge
funds, which have become so popular in recent years. Hedge funds
are investment pools, available only to sophisticated investors,
which are essentially unregulated and can invest in anything,
long or short.
And, most important, in any
amount of debt. In fact, what many appear to have been doing
in recent years is borrowing money cheaply (perhaps paying 1%
in yen), and then using the proceeds to buy high-yielding paper
(like subprime mortgages yielding perhaps 8%). A million dollars
of capital invested at 8% would impress nobody; a million dollars,
plus another 9 million borrowed at 1%, however, would yield 64%.
This was essentially what Long Term Capital Management was doing
when it blew up in 1998. What's happening today is a repetition
of that misadventure, except on a much larger scale: it is said
that some large percentage of the estimated 9,000 hedge funds
in existence now control over a trillion dollars in debt. The
future of those funds is very much in doubt.
The government will probably
come up with some moronic and counterproductive scheme to keep
people who can't afford their houses - and should be renting,
which is a much better bargain today - in them. That will also
serve to save the investors' bacon. What it will also do is add
to already massive burden on taxpayers. And it will acutely accelerate
the destruction of the currency. As an aside, it will also give
the SEC an entrée to regulate hedge funds, which will
serve no useful purpose.
What you're really asking yourself,
however, in view of the specialty of our flagship publication,
the International
Speculator, is: "What about our mining stocks?"
Mining Stocks
These, as you well know, are
probably the most volatile securities on the planet. And you've
just had a demonstration of how volatility can go both ways.
Many have gone up by a factor of 10, or more, since the current
bull market started in 2000. But on August 16th alone, the average
stock went down about 10%. I'd say most stocks are off 40% from
their previous highs. Many are asking themselves if the bull
market is over. I'd say, almost certainly not. This is for several
reasons:
1. We're still in the Wall
of Worry stage of the market. The Stealth stage ended in 2003,
and the Mania stage hasn't yet begun. The bulls and the bears
are still fighting. Retrenchments like this happen. Bull markets
naturally try to take as few investors along as possible; it
simply wouldn't do if everybody could make a living in the market.
Who'd do the real work? But the market will continue to climb
the Wall of Worry in my view. And we will have a Mania.
2. The public is still out
of the gold market. I promise you that every market top I've
witnessed in my life was accompanied by cocktail party chatter
about the asset class in question. I have yet to have any indication
the public has a clue that gold and other resources even exist.
If this is a market top, it's unique.
3. Extraneous factors, not
fundamentals, caused the sell-off. In other words, gold went
down simply because there was a bid for it, and sellers needed
dollars to meet their obligations. All the other metals were
in the same position. Hedge funds appear to have owned a lot
of metals, simply because they offer a lot of leverage. And the
stocks, which are always illiquid, were showing their usual leverage.
4. Governments all over the
world are pumping hundreds of billions into the system. They're
doing that to ward off a credit collapse, and will almost certainly
succeed. But all that extra purchasing media means higher inflation
and brings us closer to the day that the foreign holders of $6
trillion will step up to the cashier and ask for their money
back. The attention of the markets will soon shift to gold.
My guess, therefore, is that
the ugliness for the mining stocks won't last long. I don't have
any prediction about exactly when the golds will come back. But
I think that by year-end, they'll be heading strongly back towards
new highs. I will say this: you want gold stocks, not copper,
nickel, lead, zinc, or even silver. Gold is the cheapest asset
out there. Uranium remains my second favorite.
We saw the meltdown of the
subprime market coming. And correctly anticipated the government's
response. But we didn't, I think, adequately clock how ugly it
would be for the juniors. Why not? The fact is that once you
sell, you tend not to buy back in. And trading is a sucker's
game; the odds are greatly tilted against you by the bid/ask
spreads, commissions and, most importantly, your own emotions.
So we only like to sell when we think a particular company is
going in the wrong direction.
Recall the recent tech boom.
There were numerous brutal sell-offs on the way to the ultimate
top in March 2000. We'll have other sell-offs in this market
as well on the way to the top.
Rest assured, we're anxious
to give an all-out sell on all these resource stocks. At that
point, we hope to have found a market sector that's as cheap
as they were back in 2000. But that's not yet, and probably not
for a couple of years.
Hang tough. Buy more of the
best of the best.
[Note: The current edition
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Doug Casey
321gold Ltd
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