The Room 3/3/08

Dear Readers,

It's getting to the point where even the most determined optimist is having a hard time finding a good reason to roll out of bed.

Among just the smattering of news that crossed the lens this week...

  • Producer prices rose 7.4 percent in January from a year ago, coming on the heels of the news last week that the Comedic Politicized Inflation (CPI) index has risen over the last 12 months at the highest year-over-year rate in decades.

  • The National Association of Purchasing Management's business barometer has fallen to the lowest level since 2001, beginning to reflect a knock-on slowdown in consumer spending.

  • And, according to the U.S. Commerce Department today, what modest growth in spending there is, is now coming from inflation and not from confident consumers mobbing local electronics shops to load up on the latest and greatest.

  • On that latter point, consumer confidence in the U.S. is reliably reported to have grabbed its chest and slumped to the ground, or at least to levels last seen only in 1992.

And no wonder, given that housing prices, the single most important component of the net worth of so many people, are crashing; in December they fell by the most on record, off 9.1% from the year before.

(During a cross-country ski slog over the weekend, a friend who is a housing contractor by trade told me he has not seen a slowdown like this in his 20 years in the business. He knows of only one new house on the flight path to be built in these parts. The property holder has six different contractors scraping it out in a bidding war to get the job, assuring that the victor ultimately receives as a reward a dry and meatless bone at best.)

If the housing sector slowdown with its rising foreclosures and defaults isn't enough to keep our optimist abed, he would have to do no more than flick on the morning news to learn of soaring food prices, a crashing dollar and a tumbling stock market.

No sooner had a trembling hand secured a double dose of Advil, topped off with a cold compress, then he would hear a report of hundreds of millions and maybe even billions of dollars worth of new and unexpected losses being suffered by municipalities, banks, and sundry financial institutions on purportedly "safe" instruments concocted in earlier, more positive times. This week, for instance, we hear that the supposedly invincible Goldman Sachs may take it in the chops for as much as $11 billion due to "variable interest entities," a form of conduit, our faltering optimist learns as he falls back on his pillow in a fatalistic swoon, that holds close to $800 billion in assets, some significant percentage of which are now considered suspect.

At this point, the only folks able to view the unfolding carnage with any casualness are the super-rich for whom almost any conceivable loss would still leave them the requisite funds to live like the royalty of old... and the relatively small handful of investors who've been smart enough to have moved assets out of harm's way and into gold and other commodities early on (a group that I continue to hope includes you, with the help of our various services).

Interestingly, this week it was revealed that the California Public Employees' Retirement System can be counted among the few that have been seeing the nature of the unfolding crisis in the right light, and has at least begun to act appropriately. Calpers, according to Bloomberg...

...the largest U.S. pension fund, may increase its commodities investments 16-fold to $7.2 billion through 2010 as raw materials prices surge to records.

Calpers, which has about $240 billion in assets, agreed at a Feb. 19 board meeting to hold between 0.5 percent and 3 percent of its assets in commodities, spokesman Clark McKinley said. The Sacramento, California-based fund last year put $450 million into commodities, its first such investment.

The agreement is the fruit of Chief Investment Officer Russell Read's efforts since joining in 2006 to boost returns by shifting funds into raw materials and markets such as China and India. Oil has soared above $100 a barrel, wheat breached $13 a bushel for the first time, and gold and platinum climbed to the highest ever since Calpers began investing in commodities.

"We plan on ramping up the program by hiring additional staff," McKinley said by phone yesterday. "We are excited about commodities, which have performed exceptionally well for us."

To which we say, welcome aboard! Better late than never, so hats off to the obviously competent Mr. Read.

Of course, as the pension funds, like the hedge funds, mutual funds and institutional funds in general tend to run in packs, this news can only help solidify the base under our current favorite investments.

Listen and you can almost hear the chat around the polished-wood-encased water coolers strategically positioned around finely appointed pension managers' offices worldwide.

"Did you hear, Calpers got into commodities last year?"

"Yeah, smart buggers. And here we are with our bonuses slashed -- slashed, I say! -- to only $2 million, just because we invested in AAA bonds!"

"Well, if commodities are good enough for Calpers, who are we to argue, eh?"

"Race you to the trading desk!"

Pile on in, we shout enthusiastically, daydreaming about selling our appreciated resource stocks to the stampeding herd a ways down the road.

But that, fellow travelers, is about the only golden lining to be found in the chaos now gripping the world. And while a good investment brings a warmth not unlike a crackling fire and a hot toddy on a cold day, the toddy loses much of its flavor when one considers the impact that the unfolding crisis will have on our less well-prepared friends, family and fellow countrymen (and women, as the case may be).

Commenting on the news in an email exchange from New Zealand this morning, Doug Casey had this to say...

"My own feeling is that by the time this cycle is over, people are going to be shocked by how high gold goes. But it will be a sideshow compared to the circus the Greater Depression will put on."

Unfortunately, however, the news for the unprepared gets much, much worse. There are two areas that I would like to comment on in a bit more depth, starting with Bernanke's testimony.

Bernanke Pushes the Button

Yesterday, while engaged in my periodic physical exertions, or more specifically, while I was clinging to the handles of a medieval masochistic device sternly labeled the "Stair Master" down at the local facility for such things, I managed to snake out a finger to the television monitor to tune into Chairman Ben's testimony in front the House Financial Services Committee.

It was, I noticed when the camera pulled back from Bernanke's oddly detached countenance, a sparsely attended affair. In fact, it seemed to my sweat-filled eyes as if there were no more than five or so members of elected officialdom in the gilded chamber.

(But, hey, why should members of Congress be interested in anything to do with the economy? It's not like there's anything going on these days. Whether or not Roger Clemens is doping - now THAT is worth packing the chambers for!)

In all seriousness, however, Bernanke's testimony yesterday was far more important than most people understand, least of all those now doing "service" in government. Far be it from me to be critical of the pandering class, but I was appalled at how unbelievably, well, stupid the questions were that were pushed toward Bernanke by the handful of Congressmorons who bothered skipping the brunch put on by the American Lawyers Association down the hall in order to be present.

Bernanke's testimony was important because in it he made it abundantly clear that the Fed - and by extension the U.S. government - was coming down firmly on the side of inflation.

Those of you who have been with us for any length of time know that we have been calling for things to arrive at a location loosely identified as "between a rock and a hard place." It has been our consistent belief that the Fed would inevitably be forced to make a decision between letting the economy collapse under the weight of its many debts and obligations, or letting the dollar collapse by shifting into default mode. Which is to say, trying to inflate the country out of trouble.

The specific quote from Bernanke's testimony you want to pay attention to was this...

"The Federal Open Market Committee will be carefully evaluating incoming information bearing on the economic outlook and will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks."

Note the lack of reference to run-away-inflation that is already making itself known here, there and everywhere.

The news that the Fed is again opting for inflation, while coming as no surprise to us, caught the gold bears flat-footed by sending gold sharply higher, to over $970 as I write.

Speaking from an entirely personal basis, I am, of course, cheered by the rise in gold, thanks to a long-held position in a gold ETF and a portfolio stuffed to the gills with the higher-quality gold exploration and energy stocks of the sort followed in our International Speculator and Casey Energy Speculator services. But there is a real risk arising... a true tipping point... that I am not so sure I'll be happy to see.

While there are many factors that might push the economy over the edge, the one to watch closely now are the foreign holders of the U.S. dollar. As we have mentioned more than once, the amount of U.S. dollars in the hands of foreign holders is at historic levels. In fact, the level of holdings, estimated at as much as $16 trillion, is unprecedented by an order of magnitude.

At this point in the game, we would expect to see wealthy foreign individuals cashing in their dollars for all manner of alternatives, including other currencies, tangible property and, of course, gold and other tangible assets. Given the price of tangibles at this point, that trend is likely well underway.

Diversification out of the dollar by institutional holders is likely also underway. But after that, if pushed to it, will come the big kahunas: the foreign governments and their many trillions.

Up until this point, that they have been reluctant sellers can be understood in much the same way you can understand the concept of Mutually Assured Destruction when discussing the pros and cons of launching nuclear strikes against your similarly armed adversaries. At what point, however, do the foreign governments come to the conclusion that the other side has already "pushed the button"?

Watching Ben Bernanke, there is a reasonable chance, were I a foreign holder, that I might come to the conclusion that he has done the equivalent of just that.

Regardless, the pressure is growing daily on the economies of the Middle East and Asia, which have to date helpfully reinvested the money they have received in exchange for their goods into U.S. Treasury securities. And, by doing so, effectively imported our inflation back home. Even if they wish to continue avoiding the nuclear option, they will at some point be forced to it by the U.S. pursuing a monetary policy one could correctly term "Everyone for themselves!"

Make no mistake that once the tipping point is reached -- and if the Fed makes yet another steep cut at its next meeting on March 18, that could do it -- then things have the potential to shift from crisis to catastrophe almost overnight.

What impact would a true collapse in the dollar have on the global economy? It is a topic we'll continue to poke at here and in our various publications. But for now, keep your eyes wide open and your head down.

I'll touch on the second serious development this week, but the lunch bell has just rung, so I'm going to pass the baton over to Bud Conrad, who has sent over a couple of items he thought you'd find of interest...

Bud on Bernanke

In alarming testimony to the House Financial Services Committee, this week Fed Chairman Ben Bernanke declared: "We have a problem ... the spreads between the Treasury rates and lending rates are widening, and our policy is essentially, in some cases, just offsetting the widening of the spreads, which are associated with signs of illiquidity."

I said at the Denver Summit, and since in articles, to watch out when the Fed cuts and long-term rates don't drop.

It means that the rate-cutting process of printing money to buy Treasuries in an attempt to provide liquidity to lower rates is failing. The confidence in the ability of Bernanke, or anyone else, to stop the collapse is lost when people become aware that printing money makes it worth less. The Fed action becomes the fear, rather than the solution. At this point further cuts won't help the economy, because long-term and riskier rates will reflect that loss of confidence.

(Ed. Note: Bud Conrad recently gave a wide-ranging interview for the Gold Report on where the economy, gold, energy, food and interest rates may be headed. You can view it by clicking here.)

A Trip Down Memory Lane

Our own Terry Coxon sent along a link to a video of Richard Nixon announcing the end of gold convertibility, pointing out that I would especially enjoy the reference to "international speculators."

You can see Nixon make the announcement by clicking here.

The canceling of convertibility was, of course, a seminal event as it left the world with a pure fiat monetary system, an experiment which has subsequently resulted in the steady deterioration of all paper currencies, among other ill effects (including unchecked growth in government, thanks to the removal of any real obstacles to spending).

Will the whole house of cards implodes some day, forcing a return to a gold standard or some other system that forces fiscal restraint? If I was a betting man, I would place large sums that the answer is "yes"... it is inevitable.

In fact, the collapse may have already begun.

Energy Chart of the Week

By Chris Gilpin, Contributing Editor, Casey Energy Speculator

[click to enlarge]

Gasoline prices are comprised of several costs: transportation of oil (usual from some distant corner of the globe), refining costs and profits, more transportation of gasoline (to get it from the refinery to the gas station), taxes from every level of government, and the cost of buying the crude it all started from. This last cost has mounted, and now oil prices hold a greater and greater influence over gasoline prices.

In 2004, oil prices rose 50% from $30 to $45 roughly, and this created a corresponding 26% rise in gasoline prices. In other words, gasoline prices increased half as fast as oil prices did.

As oil prices have risen, the oil cost of gasoline has begun to dwarf all other components. Now when oil prices go up, it will cause a much steeper rise in gas prices. If oil were to make another 50% jump from $100 to $150 - which we think is quite possible in the next year or two - gasoline prices would rise at a rate closer to 35%. The U.S. average for regular-grade gasoline hovers around 310 cents per gallon right now with oil near $100; a 35% increase would lift it to 419 cents per gallon.

The rogue factor in all these calculations is refining capacity. Last spring, a spree of unplanned refinery outages pushed gasoline prices higher when oil had retreated to $60. By the time refining capacity came back online, oil was marching to $100. By having one major cost replace the other, gasoline prices have stayed between 280 and 310 cents per gallon since April 2007.

This may have created a false sense of security among motorists, who saw oil move up twenty or thirty dollars without much of a corresponding rise in gasoline prices. This spring refineries have scheduled their normal outages to switch from winter to summer-grade gasoline, but how many unplanned outages will occur? The U.S. oil-refining infrastructure is outdated and badly in need of replacement, but permitting a new refinery in the Lower 48 has proven to be a near impossible task. It's reasonable to expect a growing number of unplanned outages at refineries in the years ahead, and if any of these correspond with another jump in oil prices, then prices at the pump would roar to new heights.

As a motorist, it's all very annoying. The best tactic is to hedge your rising fuel costs with energy stocks that will benefit from higher oil prices - or trade in your car for one of those Flintstone vehicles. But I hear they can be rather hard on the feet.

[Ed. Note: If you are looking to profit from energy, you owe it to yourself to check out the Casey Energy Speculator. And it couldn't be easier, given that subscriptions come with a 3-month, no-questions-asked, 100% money-back guarantee. Check out the current profit-packed edition by clicking here now.)

The Other Important News of the Week

Last week I pointed to the breaking news Fitzroy MacLean of our Without Borders publication tipped me to, about German intelligence officers paying a Liechtenstein bank employee US$5.9 million to steal a disk containing the names of all the German account holders.

In writing this news up, I posited that the Germans likely also got the account names of non-Germans, " the German government a very nice trading card."

It didn't take long for my intuition to be proved right, as it was announced this week that the Germans were now cooperating with friendly governments around the world so they, too, could corner tax miscreants.

Confirming the point, one of our subscribers sent along a news item from New Zealand about how that country's Internal Revenue Department is offering anyone with an offshore account, especially of the Liechtenstein variety to, in essence, come out with your hands up or else. If you are a New Zealander with assets in the pilfered bank, I have no doubt you are sweating bullets.

Here in the U.S. of A., the Internal Revenue Service is also working hand in glove with the Germans to hunt down the tax cheats.

This is a trend firmly in motion, with serious implications.

First, now that executives and even lower-level employees of banks in tax havens with the right levels of access have seen the going market price for client names, and that rather than being brought up on criminal charges for breaking confidentiality agreements, they will be saluted by officialdom around the world, there will be a rush to capitalize. All that the person needs to do is to grab the list, download the file, or whatever, and make it past the front door to collect on the waiting riches.

In addition to the considerable personal problems this will cause the account holders, it effectively spells an end to the idea of financial privacy.

And that is an important battle to be lost by anyone who values individual freedom. Look at it this way, until recently countries knew that if they squeezed too hard, money would begin slipping across the borders to undeclared safety. With that escape route closed, they can now squeeze ever harder.

Even so, human nature being what it is, you can expect the same people - at least those not in jail following the global witch hunt that will soon extend to the Caymans, Andorra, or any other jurisdictions where the bankers have been accommodative to privacy seekers - to look for other ways of hiding wealth.

Of course, gold, diamonds and other readily portable and fungible assets will find favor. Setting the stage for the battle in the war of the state against the individual: a new round of government confiscations of gold and other such assets, "in the public interest."

I can't see this happening imminently, and we should be able to see it coming, but the threat that it could happen in the next decade, along with foreign exchange controls and similar acts of desperation by the tax farmers, is real.

Now let me be clear. I am not in favor of tax cheating. Per the fresh example from Liechtenstein, the risks are too high and, in my view, always have been. But that doesn't mean that I can't lament the fact that the system is moving closer and closer to the point where you won't be able to enjoy any level of privacy in relation to your financial affairs.

Visa's $19 Billion IPO a Scam?

During the course of dinner with a highly positioned financial services executive the other night, he told me that Visa and MasterCard had lost a major lawsuit related to hidden charges, and that it will cost them a lot of money and force them to change their business in a number of detrimental ways.

Almost immediately thereafter I read that Visa was planning a $19 billion IPO. Coincidence, I wondered?

Curious, I decided to dig a bit. I hadn't gotten very far when I came across a very coherent analysis on the situation by Mish Shedlock. You can read it by clicking here.

Could the broader investment community catch on to the true intent of the IPO, dooming it and by doing so, maybe, lead to yet another giant stumbling? While that remains an outside possibility, it is by no means out of the question given the impact of the lost lawsuit, and that the credit card companies are almost certain to be next to feel the pain of consumer belt tightening.

I suspect most people wouldn't be unhappy if the credit card companies took it in the neck.

On that theme, years ago I interviewed a senior credit card company executive and over the course of our meeting, I mentioned to him that I had recently caught a charge for "lost credit card insurance" on my bill. It was for something like $46 a year - for nothing, as far as I could tell. Indignant, because I hadn't approved the charge, I called the service center and no sooner were the words of complaint out of my mouth than the representative said, "No problem, sir. That charge will be removed." In other words, no questions or pushback at all.

"Oh, that!" my new acquaintance, the credit card executive, commented, a smirk on his face. "That was the idea of the guy in the office next to me. We were running behind on the quarterly numbers and he came up with the idea to bump the revenue."

"You mean," I asked, a somewhat stunned look on my face, "that you simply hit all the credit cards with a $46 charge?" (And we're talking about hundreds of thousands of accounts.)

"Yep. It was a big winner, because most people don't look very hard at their bills."

"But that must be illegal," I said dismayed.

"Probably," he said with a dismissive shrug.

He didn't get the job.

Of course, the flip side of Visa running into trouble will be yet another form of credit that gets tighter... and more costly.


  • Lines of Lawyers. As predicted, lawyers armed with thick briefcases and high-digit display calculators are increasingly jostling each other in the long lines that are starting to form at the doorsteps of the wounded financial service industry behemoths.

    This week, HSH Nordbank, a German sector public bank (translation, they have clout), announced it was going after UBS bank for "hundreds of millions" in subprime losses. As the piling on grows, we'll start to see the major bank failures that our own Bud Conrad has been forecasting these past months. Followed, natch, by the helicopters' worth of bailouts, courtesy of taxpayers.

  • High-Stakes Shell Game. In a classic shell game, the banks are trying to prop up the AAA ratings of the insurers standing behind the hundreds of billions of dollars of toxic waste now eating away at their portfolios. While cost effective -- $3 to $5 billion is a lot cheaper than the carnage that will follow a downgrade -- the odds are high that they'll invest the money, the insurers will get downgraded anyway, costing them their investments and the value of their portfolios. Unless, of course, the same helicopters show up with yet more taxpayer largess to keep the insurers intact. It would not surprise me in the slightest to see, even, the de facto nationalization of a failing rating agency.

  • In the "Remember, We're All Only Human" Department ... I came across another anecdote about another of the esteemed members of the judiciary, one Robert Somma, a federal bankruptcy judge appointed by President Bush in 2004. It appears he has stepped down from the bench after police found that he had crashed his Mercedes into another car while drunk and wearing a dress, fishnet stockings and heels, and carrying a purse. "He's a highly respected member of the bar," said a fellow judge, "and remains so." I don't care about his dress code, live and let live, I say... but next time, take a cab.

  • Look Before You Leap. There was news out this week that Norilsk, the Russian mining giant, was ordering a fleet of super icebreakers to take advantage of the melting of Arctic ice, opening up new routes across the top of the world. Someone might want to tell them not to place their deposit yet, because the Arctic ice hasn't just re-formed, it's thicker than ever. Here's the reference.

That's It for This Week

Major developments are afoot, with the term "We live in interesting times" barely covering it.

While we expect things to continue in a similar vein, and to likely grow steadily worse for some months and maybe even years to come, the best approach at this point is to assure that you and your family come out okay.

It's like the warnings that the flight attendants give during their briefings on the topic of what one should do should yellow oxygen masks start falling on your head while in flight. If you don't first take care of yourself, before turning your attention to the less well positioned, you could find yourself wiped out and of no use to anyone.

As I close my weekly musings, I see that gold is solidly planted at $971, oil is parked over $101 and the long-suffering DJIA is off yet another 295 points.

Wall Street types like to look down their nose at people who invest in gold, silver and other commodities... but they may have to revisit their prejudice, given that the broader U.S. stock markets have been essentially flat over the last 5 years... which means, adjusted for inflation, their favorite sector has been a loser for half a decade now. Decidedly not the case for the precious metals, energy and other commodities.

Until next week, thanks for reading and for subscribing...


David Galland
Managing Director
Casey Research, LLC

Posted 03-03-2008 11:52 AM by David Galland