Tuesday, May 06, 2008

Article from Casey Research.

Welcome to "The Room"

The subscribers-only home page of Casey Research



Written: May 2, 2008

Dear Readers,

Some years back, I was a founding partner of a mutual fund group. We started with a single fund and over 9 years, built up the group to 13 funds before selling the whole kit and caboodle to a bank.

While I learned much as a result of my involvement as an investment dealer, the one lesson that sticks with me above all others is that the great mass of investors invariably invest in the wrong investments at pretty much exactly the wrong time and for all the wrong reasons.

The parentage of this phenomenon likely goes back, in my view, to the way people think, a topic I elaborated on recently in these weekly musings (archived edition here.)

Specifically, the shuffling of the greater investment herd towards the next precipice has to do with the reliance of most people on heuristics when it comes to thinking. When casting about for investments, they look at the sector returns from the previous quarter, spot the ones that glowed most brightly, and get it into their skulls that they would like returns such as those presented.

This thinking is then cemented into place via interviews on CNBC and similar outlets, with money managers feted for having outshined their peers over the reporting period.

The problem, of course, is that yesterday’s Kentucky Derby winner is a rare repeat.

This phenomenon was in evidence this week in a report on mutual fund asset flows from Financial Research Corp.

According to that report, the investment herd showed some sense by bailing out, wholesale, from mutual funds over the first quarter of the year; out of the top 25 U.S. mutual funds, all but one showed steep outflows.

But it was the single exception to the exodus that makes my point: the Pimco Total Return Fund, a bond fund, picked up $9 billion in new assets.

Lest the point eludes you, what the report unequivocally shows is that people are pouring into a bond fund at a time when real U.S. interest rates are near record lows.

To even a casual observer, it would seem obvious that this is exactly the time to steer clear of the sector, not pile in. Not only does the combination of low interest rates and high real inflation mean you are actually losing money from the get-go… but as interest rates rise, logically the far more likely direction given said inflation, your bonds will get slaughtered.

You would literally be better off keeping your money under your mattress.

We have much on that topic, including how to play rising interest rates for maximum profits in the just released May edition of the International Speculator. (If you are not a subscriber, this one issue has the potential to pay for your subscription into the next generation. Best of all, you can, as always, try it risk-free for three months. Check it out.)


Gold & Interest Rates

On the topic of interest rates and gold, Bud Conrad, chief economist and head wonk here at Casey Research, shot me an email yesterday you should find of interest.

    If the Fed is keeping the short-term rate below the inflation rate, the real interest is negative. That is a time when money held in T-bills is losing value, encouraging people to look to gold as a better protection of their assets.

    To examine that premise, inverted real interest rates should tend to go with rising gold. Digging in, I prepared the following chart that shows the relationship with the real interest rate inverted and compared to the change in the price of gold. Note that this uses the CPI. If you use a more accurate measure of inflation, the argument only gets more compelling.
    The caveats are that there is usually a delayed reaction to Fed actions, and that there are plenty of other things that affect markets, like oil being affected by strikes in Africa. So the relationship is not exact. Even so, this fits with the fundamental of buying gold for the long term, though the summer “Shopping Season” could keep the price under pressure until August.
David again. While we’re on the topic of interest rates and bonds, yesterday there was this out of Bloomberg… interestingly, they didn’t label it as “Humor”…

    Financial market turmoil has caused the fixed rate on the newest issue of Series I inflation-indexed savings bonds to fall to zero for the first time, according to the U.S. Treasury's Bureau of Public Debt. Investors still get a return on the investment as long as consumer prices rise, because the government pays additional interest in lockstep with inflation.

    The fixed rate's decline to zero reflects the decline in returns in money markets in the aftermath of the credit collapse, said Kim Treat, a spokesman for the bureau in Washington. The government promotes the savings bonds as ”low-risk” investments for individuals that protect them against inflation.
So, there’s a concept. An investment that pays… zero. Where do I sign up?

And it’s worse than that, because you and I both know that the CPI as currently fabricated -- a topic I’ll have more on momentarily -- is a pale reflection of the real rate of inflation. And so anyone looking for a “low-risk” investment who actually buys one of these inflation-indexed savings bonds is buying into a guaranteed loss.

If you consider that low risk, you might want to consider picking up a McMansion in a California suburb.

Speaking of California housing, the following chart on foreclosures in that beautiful but overbuilt state should provide a not so gentle reminder that the worst is not over…


Faced with the accelerating credit crisis, the government is left with but one politically acceptable option, the only sort of option the pandering politicos even consider: pump up the money supply.


A Golden Week

As you may know, we have been looking forward to the release of the first-quarter 2008 financials by the gold producers. Our anticipation is fueled by what seems to be a near-certainty: that the results are going to break all the right records.

That has, so far, been the case. Last week we reported on Newmont’s record results. This week Centerra released their financials. To quote Reuters:

    OTTAWA, May 1 (Reuters) - Centerra Gold (CG.TO: Quote, Profile, Research) said on Thursday that its first-quarter profit soared as results were lifted by higher gold prices and sales volumes, despite a dip in production.

    The Canadian-based mid-tier gold producer said it earned $19.3 million, or 9 cents per share, in the quarter. This was up from a profit of $5.9 million, or 3 cents a share, in the year-earlier period.
So, a tripling of earnings, not too shabby. This, of course, reflects the fact that the realized price per gold ounce sold for the quarter would have rung in at well over $900, versus about $780 for the prior quarter, the fourth quarter of 2007, also a record.

But, with gold in a correction mode, what about next quarter? Well, unless it falls off a cliff, the average realized price of gold should still be well over the price realized in the fourth quarter of 2007. In other words, millions of dollars in free cash flow, free-flowing champagne and first-class tickets all around.

(On that “falling off a cliff” thing, I just did a quick calculation and even at $850 gold, the current correction has gold off only about 15%... well short of the largest correction so far in this secular gold bull market, 27.7%. I’m not worried.)

But there is something strange going on, uncovered this week by Jake Weber, the Casey researcher tasked with watching the release of financials. In his words…

    My calendar is filling up with companies announcing that they’ll release their Q108 results next week, which is strange because quarterly results from the big ten gold companies have typically trickled out over a couple weeks. Here’s the list of what’s scheduled for next week alone (week of May 5): Mon. -- Endeavor, Goldcorp
    Tue -- Barrick, Kinross, AngloGold
    Wed -- Yamana
    Thu -- Agnico
    Fri -- GFI

    So there will be a lot of news flooding the market next week – potentially all of it of the record-breaking sort.
David again. It would be pure conjecture to think that maybe the big guys got together and decided to put on a show. But if they did, I’d say that was good thinking on their part. Regardless, I suspect you’ll be hearing a lot more about the gold producers over the course of the next week.

Will it be enough to register in the minds of the investment masses? Probably not. But that’s okay, it just gives us more time to buy more and to upgrade our portfolios.


Unlimited Power

I have pondered in past musings here what actions government, with its unlimited powers, might dream up as it desperately tries to keep things afloat.

One example arrived at the doorstep this week when the Bank of England declared that all details on future efforts to bail out banks will henceforth be verboten and anyone from that institution releasing that information will be brought up on charges.

We have also heard from a subscriber relating a conversation with a friend of his in high position within the Bush Administration. His friend told him that, apparently unhappy at the negative press engendered by the bailout of Bear Stearns, the administration has also shifted to a stealth strategy, which will greatly reduce the amount of information released to the public on further bailouts.

Secrecy in public policy matters is almost never a good idea, because it allows a small group of individuals to act unilaterally without fear of public scrutiny. What if they are wrong? Or, even worse, what if they are even a little bit right? At that point, they will pat themselves on the back and figure if it worked in one situation, it will work in others, too.

Next thing you know, the transparency that is the lifeblood of a free-market system, and of freedom itself, is gone.


Big Lies

The “big lie” theory has it that if you tell a big enough lie, and tell it often enough, in time people will begin to believe it.

On that topic, there is an article by Kevin Phillips in Harpers (www.harpers.org) this week on how the government is now massively manipulating the economic statistics the average person relies on when setting their personal financial course.

I found a website with the article on it -- read it here.

You will know much of what you read, because our readership tends to be the exception to the norm… but you could do your friends and business associates a favor by forwarding them the link.

Of course, Big Lies are not limited to matters of economics alone. One of the early uses of the phrase was found, according to a Wikipedia entry… “in a report prepared during the war by the United States Office of Strategic Services in describing Hitler's psychological profile:

    “His primary rules were: never allow the public to cool off; never admit a fault or wrong; never concede that there may be some good in your enemy; never leave room for alternatives; never accept blame; concentrate on one enemy at a time and blame him for everything that goes wrong; people will believe a big lie sooner than a little one; and if you repeat it frequently enough people will sooner or later believe it.”
I find that description of Hitler’s basic approach worth keeping in the back of one’s mind when being exposed to the constant babble emanating from politicians during this election year (or any year, for that matter). It was certainly an idea well understood by George Orwell in his classic 1984.

On a somewhat related topic, Doug Casey sent me a link to an interesting review from LewRockwell.com on a book by Nicholson Baker that looks worth picking up. The book is titled “A New Look at How World War II Happened.”

According to the reviewer, the author has tracked down a multitude of citations that put the personalities of the day under close scrutiny and finds that the impression most people have about who they actually were differs significantly from the historical record. For example, FDR really did know about the pending attack on Pearl Harbor. In fact, he encouraged it! You can read the review here.

Now, this is yet another one of those cases where I dearly wish I owned a Kindle book-reading device, so I could do a quick download of the book. A friend of mine recently gave me a hands-on demonstration of his Kindle and it was very impressive. Within about two minutes of agreeing on a book to buy, it had been purchased and finished downloading... and at less than half the price of the printed version.

But I am stubbornly holding out for the inevitable Kindle V.2., though I must admit my resolve is beginning to weaken. (If you or anyone you know works for Amazon and can update us on the status of a Kindle V.2., drop me a note at David@caseyresearch.com. Thanks!)


Bio-Fool Subsidies – the Worm Begins to Turn

A couple of weeks ago in this column, I commented that the ending of biofuel subsidies was inevitable in the face of soaring food prices, riots and possible starvation.

I didn’t have to wait long for that prognosis to be proved right; this week Congress appears to have agreed on key terms of yet another Farm Bill, one term being the reduction of a key ethanol tax credit from 51 cents per gallon to 45.

Given how uneconomic most biofuel operations have been, even with the current level of subsidization, this could serve to torpedo the struggling remnants of the industry under the water line. At the least, it’s a close warning shot that things are going to change.

Piling on, the European Union is now discussing a change in regulations that would essentially block any U.S. biofuels from being sold on European shores.

Some day in the not too distant future the whole idea of biofuels will be looked upon with derision, with the gullibles that spoke so loudly and persistently in its favor in the first place conveniently developing amnesia on the topic.


Governmentium

While I had seen this before, I hadn’t seen it in a while and so, when an acquaintance emailed it to me this week, I wanted to enter it into the record…

    Research has led to the discovery of the heaviest element yet known to science. The new element, Governmentium (Gv), has one neutron, 25 assistant neutrons, 88 deputy neutrons, and 198 assistant deputy neutrons, giving it an atomic mass of 312.

    These 312 particles are held together by forces called morons, which are surrounded by vast quantities of lepton-like particles called peons. Since Governmentium has no electrons, it is inert; however, it can be detected because it impedes every reaction with which it comes into contact. A minute amount of Governmentium can cause a reaction that would normally take less than a second to take from four days to four years to complete.

    Governmentium has a normal half-life of 2- 6 years; it does not decay, but instead undergoes a reorganization in which a portion of the assistant neutrons and deputy neutrons exchange places. In fact, Governmentium's mass will actually increase over time, since each reorganization will cause more morons to become neutrons, forming isodopes. This characteristic of moron promotion leads some scientists to believe that Governmentium is formed whenever morons reach a critical concentration. This hypothetical quantity is referred to as critical morass.

    When catalyzed with money, Governmentium becomes Administratium, an element that radiates just as much energy as Governmentium since it has half as many peons but twice as many morons.

    --Anonymous

Correspondence from China

A few weeks back, I discussed the topic of China’s Olympic Torchture (see April 11 edition in the archives, reachable via the link at the bottom of this page.)

At the time I asked the opinion of one of our China-based correspondents, whom I will henceforth call the Dragon, on the topic of the Olympics and how the Chinese are currently viewing the international condemnation it has received thanks to Tibet and other real and imagined transgressions by the Chinese government. The Dragon, whom I have quoted here in the past, is a successful businessman of French origin who lives outside of Beijing with his Chinese wife.

As I think one of the biggest challenges people face these days is getting news that doesn’t pass through the filter of news organizations beholding to, or afraid of, powerful interests, I thought you’d enjoy this unedited exchange with someone on the ground in China.

    I apologize for the late reply. Leading the many reasons for the delay is the time required to reflect on how to answer your kind email in a quiet environment, and a Sunday afternoon is a good time. It is just so easy to write complete nonsense about anything, and the subject of China seems to lend itself particularly well to this.

    So I will try to be fact oriented and provide you with the contents of my discussions with Chinese people I got to talk to, such as business owners, university deans, scientific research institute professors, bank tellers, taxi drivers, policemen, doctors or restaurant waiters and cooks. Here is what I have heard and seen.

    1. The Olympic Games are politicized in China as much as they are in the West. With few exceptions, the Chinese who live here that I met with express tremendous pride in seeing the event taking place in Beijing and feel the world is putting the Chinese to the test. Most of them strongly feel part of a great collective thing called the nation of China, and here face (MianZi in Chinese) is something to be kept collectively as much as it is to be kept individually. Whether things go right or wrong, most of them will take it almost personally. Whether in the West or out here, what is happening in people's minds when they come across the topic of the Olympic Games reflects a widespread pathology: blind belief in government propaganda and the need for government action.

    If it were not politicized, the first thing that would pop to people's minds should be nothing more than a mere show of spirit-driven and will-powered bodily performance, which individual athletes only should be proud of.

    2. On the subject of Tibet (XiZang in Chinese), most Chinese confirm they entirely agree with what their government is doing there and, when they express how they feel about it, express deep discontent about foreigners' attitudes.

    3. The Chinese government has already retaliated against the French by suppressing long-term visas. The only visas other than work permits the French can now apply for are one-month visas. Prior to March 26, 2008, it was still possible for a European passport holder to apply for a one-year multiple entry visa. Thanks to the Sarko-moron of the Elysee, head of the Soviet Socialist Republic of France, and his mirror image in Germany, people like me have to go through additional unnecessary paperwork incurring additional delays and costs. Sorry, I said facts only, but this one had to come out.

    4. Large amounts of factories in WenZhou (ZheJiang Province), GuangZhou and DongGuan (GuangDong Province) have already shut down and laid off their workers. The newspapers refer to 30% of all factories manufacturing clothes and shoes and 90% of all companies making lighters (where do they make them now if not in China -- Bangladesh?).

    5. Two Chinese authors write and publish in Chinese views independent from the Chinese government, which could be of great interest to Casey Research: they are Mr.LANG Xian Ping and Mr. XIE Guo Zhong (Andy XIE).

    As a conclusion, let me give you the opinion of a Chinese business owner who happens to be one of our distributors in China and whom I had dinner with on Friday evening. He is a Buddhist, has low-level connections within the government and is a reasonably wealthy man by Western standards -- a few million dollars in net worth. On the subject of the Olympics, here is what he told me:

    "I feel nobody is right -- the Chinese government is not right and foreigners are not right. Foreigners are not right because the Chinese do not interfere in foreigners' affairs when the streets of Parisian suburbs are on fire and the French government is not able to bring back order on his territory. Or when French separatist groups blow cars in the Pays Basque.

    “And the Chinese government is not right because we have even bigger problems to deal with than the Olympics. Our U.S. dollar reserves are shrinking in value at a scary pace and I think our government is far too soft. We should dump all our dollars and U.S. bonds onto Westerners' heads and never listen again to what their governments are saying."

    How long before this kind of speech translates into action?

    Anyway, it is midnight here and I am hopping on a flight to the city of Xian tomorrow at 7, so I will stop here. My wife sends her greetings as well and says she is delighted that the David Galland she has heard so much good of gives such credit to her words and says it expresses only her opinion: her family owned large strips of land and factories in the ‘30s, which were all confiscated by the ancestors of the current junta and her own grandfather escaped execution by a miracle intervention by one of his employees who testified that employees were treated well under his leadership. This just to say that she is a natural-born government skeptic and wants me to tell you that her words are to be taken with a grain of salt.

    With kind regards.
To which I then asked if he was concerned about the authorities screening his email and, unhappy with something he has written, knocking on the door. His reply…

    I am fully aware that all emails in and out of China transit through a series of servers in Beijing where the Carnivore system filters everything. I am also aware that there are only two ways to bypass it: a satellite connection (which does not exist yet, it seems) or encrypt emails through PGP software, the use of which would require that you install the PGP decryption software on your machine and input a decryption key to read my missives. The password would be sent by fax (using an anonymous http://www.j2.com/ subscription, for instance) or through Skype or phone. A PGP encryption provides 1,024 bits privacy, not only against the CNG but the USG or the FRG as well and has been outlawed by all of them. I clean up my mail boxes, but still need to change the provider of that service.

    When I do not use PGP as for my previous emails to you, I try to be cautious with my words (unlike in my previous emails). The risk seems currently minimal as long as words are not published for a large audience to read. But these things can change in the blink of an eye and, like wars, they "come out of the blue" as Jim Rogers would say.

    "One better not be in the wrong place at the wrong time" -- Doug Casey's advice is to be remembered clearly -- so with this advice and being the paranoid that I am, I try to make sure that my wife and I can always take off anytime at a moment's notice for another less dangerous spot of the matrix without having to leave anything behind ourselves.
Then, this follow-up, in response to the French government’s condemnation of China over its Tibet policy…

    Hi David,

    Just a brief piece of news you might be interested in: effective today and until further notice, Chinese authorities do not issue any new visas of any type to any French passport holders -- that is, including diplomatic passports (good for them -- it would do the French ambassador great good to be forced out of the country manu militari).

    The main reason? French officials, being the geniuses they are, have granted the Dalai Lama the status of France's Citizen of Honor. Now maybe that moronic reader of yours who adores Marx and thinks he is a great man can explain to me what such a status is or what it is about? All I can say is that it is real funny how yesterday's very good buddy nations -- France and China -- are now sending provocations at each other's face and it is fine as long as it remains only funny. Because such things have the very real potential to send a spark over an ocean of ethanol in no time.

    Every single day that passes, wherever I get to go in the world, reinforces my conviction that the ideas you, Mr. Casey and the rest of the Casey Research gang promote are the soundest there are. One day the editions of The Room will be viewed as those of prophets, and until then the new socialists of this world will continue pretending the world is flat while Galileo is out there rationally claiming that it is round and proving it scientifically.

    On a very practical level, what all this means is that if I want to get back here in the immediate future and before the ban is lifted, I will have to do so on a St. Kitt & Nevis, Panama or Swiss passport. Though I am not quite sure this is what I want anymore. In any event, I will let you know.
While I blush at our correspondent’s kind words about the home team and wish to thank him for those words, I most of all want to thank him for being brave enough to write with his candid views. While the Chinese have accomplished near miracles with their economy, it is always worth remembering that it is still a communist dictatorship where the expression of thought that is perceived as contrary to the state’s interest can end you up in a dark cell. So, I don’t take my correspondence with the Dragon lightly.


More Correspondence, from Pork Chop Acres

Last week I discussed a report from a hog farming acquaintance of ours that he and his colleagues were starting to kill newly born male hogs rather than suffer the expense of feeding them. One of our subscribers sent me an email on that topic.

    I forwarded kin of mine who have a hog farm in eastern Iowa your comments in the current "Room," Food and Politics section. It may be worse than your comments suggest. Here's what they wrote when I forwarded your April 25 comments and asked for their take on it. They replied:

      "There are a lot of farm problems coming! Here on Pork Chop Acres, we aren't buying baby pigs for the empty hog houses, as corn prices are too high to feed the hogs at this time. Ethanol takes a lot of corn, so the price of corn is high. It is going to be very expensive to put in crops this year with fuel prices, fertilizer, and seed all way up.

      "However, some of the farmers are still building new hog houses costing $150,000 to $200,000, so who knows. Mike still has some hogs he is feeding out and will ’play it by ear.’ If it ever quits raining, field work should be starting. Here's another angle -- what if Iowa doesn't have a good crop season this year and there is only half a corn crop?

      "Guess any business is a gamble, so we are used to it. We have survived all these years and done OK with our conservative planning. We only bought land we could pay for at the time, so never had debt problems. If things get too bad, our grandson has quite a herd of goats that are holding their own, with goat milk and goat meat becoming more popular."
I’ve asked our new correspondent to forward further dispatches from Pork Chop Acres (I love that name!) to help keep us in the know on how the farming sector is doing.


And Finally…

As I closed my weekly musings last week, I challenged the readership to guess the high for gold for the week just ended. My forecast was a wide miss at $927, but Donald S., a regular correspondent with a more than passing knowledge of economics, got it right with his call for the top to ring in at $895. Congratulations, Donald! A free one-year subscription to BIG GOLD is yours.

That’s it for this week. As I sign off, the Dow is up modestly at +17 points and gold has struggled back to $856, though based on the news that just came across the wire, it should be trading far, far higher than that.

Specifically, the Fed just announced that it was boosting its Term Auction Facility for banks to $75 billion every two weeks, a 50% increase. Also, they are further loosening the criteria for the collateral they will accept for these handout loans. Per my earlier comments, the spigots are wide open.

The masses clearly do not yet recognize what’s going on… which is why they are piling into bonds. Yet, it is our contention that this remains one of those rare opportunities when you can look over the horizon and see what’s coming… higher interest rates and higher gold prices. (And, yes, the two do tend to move together… another story in this month’s International Speculator.)

Until next week, thank you for reading and for subscribing.






David Galland
Managing Director
Casey Research, LLC.

No comments: