Clear and Present Financial Danger

Today, we again alter our regularly scheduled program, foregoing our usual Guest Essay in favor of a few more notes from our friend and colleague Dan Denning…

*** A 211 in progress…resources stage biggest rally in 33 years…

*** Lehman left at the altar…bring out your dead…and more!

What a difference a day makes. Or does it? Commodities are on the verge of their biggest one-week rally in 33 years, according to Bloomberg. Gold was up US$25 yesterday (2.7%). Oil rallied five bucks. The Reuters/Jeffries CRB Index tacked on 3.7% yesterday alone. If it can keep itself together today, the index will be looking at a one-week gain of 6.7%.

So is this the second coming of the commodity bull market? Or is it just a bear market rally in what is now a bear market in resources? The answer matters. If the ‘short-dollar’ trade is fully liquidated, then the dollar’s surprising rally may be over and the decks clear for commodities to resume their long-term ascent.

Let’s not forget that the resource bull began in 2003. That puts the recent price action in an altogether different light – a correction in the middle of a long-term rally. But let’s not get into an argument over where the market is headed. Only it knows. And it well tell us soon enough.

Instead, perhaps we should keep an eye on what started the whole resource rally in 2003, namely, a lack of investment in supply and brand new growth in demand. That’s how resource- and China-bull Jim Rogers sees it. “Until either a lot of supply comes on stream or the economy collapses, the bull market will continue,” Rogers told Bloomberg.

*** Some controversy from yesterday’s Daily Reckoning, in which we quoted Detective Harry Callahan. “I thought the Punk did reach for it and got his head blown clean off,” a reader writes in.

Incorrect.

If you go watch the whole scene that inspired yesterday’s Daily Reckoning, you can confirm it yourself. The punk doesn’t go for the gun. He does say to Harry, “I gots to know!” Harry pulls the trigger on his revolver…and nothing happens. He fired six shots.

By the way, if you do watch the whole scene, you’ll find it helpful in describing today’s high financial crimes and monetary misdemeanors. Harry tells his buddy at the diner to call the cops and report “A 211 in progress.” A 211 is California police code for a robbery.

We don’t recommend it, given how humorless bureaucrats are today, but it would be fun to call your Congressman and report a 211 in Washington, D.C., where taxpayers have been getting robbed at gunpoint for years. When you and I commit that kind of crime, it’s called armed robbery. When Congress does it, it’s tax legislation.

Here are some other useful cop codes to know: 470 is a forgery (I’d like to report a 470 at 20th and Constitution Avenue in Washington, D.C). A 484 is theft (you could call that in from anywhere in D.C.). Or, if you’re on Capitol Hill, call in a 594. That’s the code for Malicious Mischief.

*** It’s been over a year since Jim Cramer’s famous meltdown on CNBC. We watched it at the Old Hat Factory today for grins. But seriously, the ‘short-financial trade’ is tired, but clearly not dead yet. Stocks that have fallen 85% from their all-time highs can still fall 100% from their current high. It’s the kind of fall all financial Humpty Dumptys want to avoid.

For example, today’s Financial Times reports that Lehman Brother’s is trying to sell pieces of itself to foreign investors before having to report another $3 billion loss in early September. Lehman has already reported nearly $12 billion in losses since the onset of the credit nightmare. Its stock has fallen by 85%. And the FT reports that talks to sell 50% of itself to the Korea Development Bank and China’s Citic Securities fell through because both bidders said Lehman’s asking price was far too high, given the distressed state of its assets.

You get the feeling Lehman is like a man so desperate for cash that he’ll sell certain vital bodily organs for cash. The commercial real estate portfolio is valued at $40 billion. The wealth asset management group, $10 billion.

The trouble is that there aren’t many organs a man can really do without. You can part with a kidney, your appendix, a gall bladder, and maybe some bone marrow, or other bodily fluids. But try to donate your brain, your heart, or your lungs and you’ll soon be a corpse, where the sum of the parts are worth more than the whole. Once people realize that, Wall Street is going to look a lot like this.

During pandemics and plagues (so we’ve read), you dig graves to bury the bodies (or leave them lying in the street if it gets really bad). While a bull market in gravediggers is good for gravediggers, we think investors should prefer a different kind of digging…for world-class mineral deposits.

That, by the way, is why your guest editor jumped ship from London to move to Australia in 2005. Having sussed out the big picture (sell paper, buy stuff), we wanted to find good ‘stuff’ to buy. We’re not alone. Canadian mining legend Robert Friedland was in town a few weeks ago, talking up the copper prospects of Ivanhoe Australia Limited.

Friedland’s business strategy is simple. Buy a distressed asset. Front up the money to drill it like nobody’s business. Demonstrate that it’s worth a lot more than you paid for it. Then find a JV partner to front up the rest of the capital to make it a producer.

Friedland is also a big fan of “polymetallic mineralization,” a kind of selling Peter’s copper to pay for Paul’s gold production. When you have a world-class polymetallic deposit, you can use the cash flow generated from one metal to sustain, or at least offset the production costs, in another.

Friedland thinks he’s got a world-class project going at Mount Isa in Queensland. “The Mount Isa mining district is one of the top five mineralized districts on planet earth,” he told the local paper. “It doesn’t have to apologies to anyone. There’s the Witwatersrand in South Africa, there’s Norilsk in Russia, there’s the Cadillac district fault in Canada, there’s the main structure in Chile. This is one of the great mining regions in the world.”

Friedland is clearly on to something. He points out that these great new ore bodies of the mining world will replace many tired, old, bed-ridden mines that are nearing the end of their productive life. “Our view, and we talk to Rio Tinto about this a lot, is around the year 2012 or 2013 we are going to have a crisis in copper because a lot of the great copper mines are like little old ladies lying in bed waiting to die.”

Younger mines will have plenty of cost blowouts (see BHP’s Ravensthorpe nickel project). They will have to endure volatility in underlying commodity prices. But they have one thing the older mines don’t: a lot of ore in the ground. That’s worth something, especially at today’s resource share prices.

How are we playing it here at the Daily Reckoning’s Australian outpost?

While Frieldand looks for copper at Cloncurry, we’ve been targeting our investments to black coal and coal-seam-methane in Queensland, new uranium mines in South Australia (the only State which is permitting new mines right now), and, most importantly iron ore, vanadium, molybdenum and rare earth juniors in the vast expanse that is Western Australia (especially in the Pilbara region where we’re headed next week. A full report will follow).

Regards,

Dan Denning
The Daily Reckoning

August 22, 2008

Dan Denning is the editor of The Daily Reckoning Australia and The Australia Resource and Mining Report.. He’s also the author of 2005’s best-selling The Bull Hunter (John Wiley & Sons), and spent five years as editor of Strategic Investment, one of the most respected “big-picture” investment newsletters on the market. A former specialist in small-cap stocks, Dan draws on his network of global contacts from his new base in Melbourne, Australia.

We are about to witness a huge drama – one that will, ultimately, determine the fate of the United States of America…and the whole human race.

Before us is a clear and present danger. There is no doubt about it. Anyone who cares to look can see it. If something is not done to protect ourselves against it, the results will be either disastrous or fatal…we’re not sure which.

This week, Addison’s movie I.O.U.S.A. opens in 358 theatres across the nation. It is not merely a documentary film…it is also an expression of hope for our species. The question at hand – the real theme of this monumental drama – is whether a group of people can change the course of history.

You see, dear reader, the U.S. is in a fix. Nothing unusual about it – nations turn into empires (when they are unlucky)…then, they overstretch…they overspend…they overdo it. According to former U.S. comptroller – and the star of I.O.U.S.A. – David Walker, the U.S. government was in over its head by more than $50 trillion in 2007. Unless action is taken, the country will go broke.

Everybody knows that is true. But so far nothing has been done to correct the situation. Too many people in too many positions of power – including the lumpen voter himself – have too many reasons to want the system to continue unchanged. These people are getting something for nothing – and hoping to put the costs onto the next generation. But if the expenses continue to build up…the whole mountain of debt will come tumbling down.

Your editor is proud to have contributed to the movie. It was based, originally, on a book he wrote, with Addison, Empire of Debt. And he has a small speaking role in the film itself.

“I like what you say in the movie,” says a friend who saw the preview. “But you look terrible. You look like a pervert.”

In the film, we point out that empires always overstretch…and always collapse. Looking at history, we see that this story usually plays out as a tragedy – usually accompanied by defeat on the battlefield and national bankruptcy. Nevertheless, the Peterson Foundation is spending a billion dollars, according to press reports, to try to give our own “Made in the U.S.A.” version of this old tale a happy ending. If people can be made to understand the problem, they will do the right thing…or so they believe.

And there is the question: can right-minded, well-meaning people really change the course of history? Is that the way it works…?

We will see, dear reader…we will see.

*** Meanwhile, in Lindau, Germany, a group of 14 Nobel Laureate economists have gathered to discuss the world’s problems. Myron Scholes, who won his Nobel for his work on derivative pricing, said the financial crisis was “not over and I’m not exactly sure when it’s going to be over.” There will be “lots of business failures,” he went on.

Joseph Stiglitz described the cause of the problem as a “massive failure of the brains of the economy.”

Nobody was impolite enough to mention that many of the biggest brains were in the room…and that they had created many of the bubble’s biggest delusions.

*** Our party ended last night about 3 AM.

“This whole place is like a giant pile of tinder…and everyone in the room has a match…” said Elizabeth. More to come…

Enjoy your weekend,

Bill Bonner
The Daily Reckoning