"It's the End of the World As We Know It"

The Daily Reckoning PRESENTS: Anyone paying even a little attention right now can’t help but notice the stunning array of problems that are menacing the global economy and threatening traditional investments. Doug Casey explains how you can profit from the unfolding crisis…


…”And I feel fine.”

That’s not just the title of an R.E.M. song. It’s how today’s gold and silver investors feel every time they get a reminder from a newspaper or news program.

They see what you see, and anyone paying even a little attention can’t help but notice the stunning array of problems that are menacing the global economy and threatening traditional investments. In fact, I can’t say I’ve experienced the like of it before. And that’s saying something, considering I’ve made crisis (and how to profit from it) the focus of my life’s work.

This time around, the unfolding crisis carries several especially dangerous features – and a locked-in profit opportunity available to anyone even moderately fleet of foot.

First, the intractability of the situation. That’s the word Paul Volcker, former Chairman of the Fed, used to describe things, and it’s a perfectly good word meaning, simply, that the underlying problems can’t be fixed.

In the Middle East, for example, even if we pull all our troops out today, the situation won’t settle down for years… or maybe even decades. And each day of turmoil will cost the U.S. more tens of millions in direct and indirect costs – and keep the global economy in a state of chronic worry over energy supplies. Then there’s the collapsing housing bubble. For years a galloping real estate market was the primary driver of our economy. Now real estate is hobbling on three legs and has become the primary driver of personal and corporate bankruptcies.

Even more serious is the 6 trillion or so U.S. dollars in increasingly twitchy foreign hands. Hardly a day goes by without some government or another announcing plans to diversify out of the dollar. And no wonder, given the record levels of personal and government debt in the U.S.

And even more debt is baked in the cake. We have a freshly-elected slate of Democrat law makers looking to “do something”… from universal health care, to global warming, to confronting the “unfair” trade practices of China and Japan (the very people who own much of the above mentioned $6 trillion). Those projects are just for starters, of course. Congress’s “must-do” list goes on and on, and for politicians, “do something” never means “do something cheaply.”

So far, so bad.

But it gets worse. Much worse. Over 20% of the U.S. population – the baby boomers – are now beginning to retire, and most of them have nowhere near enough savings to enjoy their senior years. So they’ll be absolutely dependent on the Social Security and Medicare promises they’ve been hearing all their lives. Politically, those promises are impossible to renege on. Financially, they’re impossible to pay. And along with the government’s other unfunded entitlement programs, they add up to $50 trillion of off-the-books debt.

Mr.Volker spoke well. Intractable is the word.

There’s more, but that’s enough. We’re in a box canyon with a floor of quicksand, and the only exit is blocked by a landslide. Investors who take a business-as-usual attitude are not going to have a nice day.

In case that litany of problems isn’t enough to get the sweat beading on your forehead, ponder derivatives. While these hybrids have been around for decades, the rocket-shot rise of hedge funds and the advances in financial modeling techniques have spawned something of a competition among the so-called best and brightest to find ever-more-complex ways of skimming pennies from very large piles of money.

The collective result is that our financial system has been wired up to $370 trillion dollars of privately negotiated investment contracts. They’re usually written to shift risk from one bank, pension fund, insurance company or brokerage firm to another. And many are linked together in long chains, with each contract providing collateral for the next.

It’s all very clever, but layering the enormous size- $370 trillion dollars, far more than the net worth of all the financial institutions in the world – on top of all that complexity is downright scary. In simpler times, a home loan going bad would affect only the particular lender. Enough defaults would put the lender out of business. And that would be the end of it. But today a wave of defaults can send a shock through the portfolios of financial institutions around the globe, including hedge funds, banks and pension funds far removed from the troubled borrowers.

Imagine an electrical circuit with thousands of connections. No one designed it. No one tested it. No one has a diagram for it. It just grew. Now, because of its size and power and pervasiveness, everything depends upon it. So what happens when one of those thousands of connections burns out? No one really knows, but I say it’s a circuit you should disconnect from before the world learns the answer.

If you are relying on traditional investments to pad your nest for the future, the problems stalking the world economy should be a matter of serious concern.

Especially given that as bad as we think things are about to get, there remains the potential for things to spin entirely and un-recoverably out of control. That’s because so many wildcards are now in play. A war in Iran? New York hit by a freelance nuke? A worldwide panic exodus out of the dollar? Traditional investments would be the first casualty.

The $2 trillion or so loss in stock market valuations during the recent correction is a precursor of what’s to come… in a best case. The worse case is… much, much worse.

Working apart from the investment multitudes, a very small minority of investors over the past few years have been building portfolios of precious metals and Canadian precious metals stocks. It’s a minority I’m happy to be a part of, as it allows me peace of mind and the considerable advantage of viewing these crises somewhat dispassionately.

That doesn’t mean I’ll enjoy standing on the sidelines and watching the impact of a monetary crisis on the lives of the unprepared. Of course not. Yet I would be a fool, having recognized a crisis shaping up, not to take the fairly obvious steps to profit.

Which brings me to the opportunity that the crisis is carrying on its back.

For any number of reasons, but first and foremost its use as money in all the world’s cultures, throughout all recorded history, gold has begun to find renewed favor with in-the-know investors as the currency of last resort.

Make no mistake, despite gold’s rise from its $255 low in April of 2001 to over $650 as I write, so far, only the thinnest of trickles, a minor fraction of global capital, has made it into gold. When the flight to safety really heats up, the real fun will begin, and the price of gold won’t just add dollars, it will add digits.

If that sounds like hyperbole, remember that, unlike the U.S. dollar, which can be created at the speed of light, the available supply of gold is finite and is painfully slow to change.

You can’t print gold the way you print paper money. And you can’t just build a gold mine the same way you might build a Starbucks almost anywhere and on short notice. Instead, you first have to find a promising ore body – which is, without exaggeration, like finding a needle in a haystack… a haystack buried “somewhere” in the earth’s crust.

Then you need to go through the immensely complex and expensive exercise of confirming that the ore body is economically viable. Then, years after you started exploring, you can start the even more time consuming and expensive process of actually building your mine. That entails finding a labor force, bringing in power, roads, mills, etc., etc… with every step hindered by environmentalists waving court injunctions.

The long and short is that there are hardly any gold mines of size scheduled to come on stream… and we are not talking about just over the next year or two, but ever. Most people in the know see annual gold production falling from here on.

For proof, there was news recently out of South Africa, the most world’s prolific gold producer. Despite the loud incentive of higher gold prices, South African gold production in 2006 dropped to the lowest level since 1922.

And, above ground, there just isn’t much gold to go around either. The U.S. government, for example, possesses the world’s largest gold reserves…and those reserves amount to only about $170 billion at today’s prices…not even a rounding error on the trillions of dollars in debt the government has guaranteed.

Put simply, the amount of gold available to investors and central banks is like the number of beachfront home sites at Malibu – it’s not going to change much. As a result, when the rush for the lifeboats begins in earnest, the upward pressure on gold will be unimaginable. As will be the profits for anyone who acts now, ahead of the crowd.

If you haven’t yet started accumulating precious metals, you still have time. Start by picking up some bullion coins from a reputable dealer (silver should do as well as gold).

Then build a portfolio of the better small companies exploring for new deposits – the ones with the best management teams, working on the best projects, in the best geology. These stocks are the true profit gems – in part because of an accident of recent history.

During the long bear market that ended in 2001, the large mining companies all but eliminated their exploration departments. Now they urgently need new deposits to restock their declining ore reserves. But rather then scouring the world themselves, the majors let the more agile and entrepreneurial junior explorers – often Canadian firms, due to the resource orientation of that country’s economy – invest the capital and sweat needed to find a new deposit. Then, when a junior company’s project seems ripe, the majors compete to buy the deposit or to acquire the junior explorer itself – and they pay up in a most serious way.

Pick your companies right, and you can pay pennies today for shares in a junior exploration company that history has shown again and again will sell, with a little success, for $10, $20 or more when the market gets rocking and investors at large rush into all things gold.

While there’s no such thing as a sure thing, there are times – like now – when the deck is heavily, massively, stacked in your favor.

You are, therefore, left with a relatively simple choice. Do nothing and hope that all the world’s troubles just drift away-and risk personal financial disaster if they don’t. Or take action, if even with a modest share of your portfolio, and position yourself for extreme profits.


Doug Casey
for The Daily Reckoning
March 28, 2007

[Editor’s note: Doug Casey is the author of the New York Times Best-Seller, Crisis Investing, and Chairman of Casey Research, LLC., publisher of the highly respected International Speculator newsletter, now in its 27th year. International Speculator is the most profitable source of unbiased research on investments with the real potential to double or better in the coming year, with a focus on the best managed junior gold and silver exploration companies.

Now, we turn to the news for more details on the fabulous offer by the Blackstone Group. We say ‘fabulous’ because it is the stuff of fable…a morality tale telling itself.

The facts: The Blackstone Group is the largest private equity firm in the world. According to the report in the Financial Times, Blackstone’s assets have grown from $14 billion to $78 billion in less than six years. That is, it has multiplied its assets under management more than five times in six years.

Even more remarkable has been the incredible profitability of the firm. Its annual rate of return is better than Warren Buffett’s. Since 1987 it has averaged 23% a year, while Buffett’s rate of return has been 22% – though over a much longer time. Blackstone’s real estate holdings have done even better – up 29% per year since 1991.

How does it make so much money? We turned to our colleague Eric Fry, who was sitting next to us, for an explanation:

“Private equity can mean a number of things. But what a company like Blackstone does, typically, is to buy a company from the public, reorganize it and sell it back to the public. Or, sometimes it will buy a private company and sell it to the public. The paper almost always ends up with the public.”

We have commented on private equity before. It is the hottest thing on Wall Street. Here’s why:

Profits in 2006 reached $2.27 billion, more than double that of the previous year.

“That means,” says the FT, “each of its 770 workers produced an average of $2.95 million in net income. By comparison, employees at Goldman Sachs Group Inc. – the largest U.S. investment bank – each averaged about $360,000 for the company in 2006.”

And now cometh these über money shufflers with an offer to shuffle some money to the public.

Or from it?

Blackstone, this fabulously successful firm of private equity investors, will now offer 10% of its shares to the public for $4 billion. Earlier in the week, we asked, “Why?!”

Today, we just stop to marvel at the chutzpah of it.

The Associated Press describes the deal:

“Consider this: Blackstone is a great firm. Going public will bring even greater riches to those at the top. That said, great riches have already been captured by those up and down the management hierarchy. This is not the case of a go-go high-technology firm that generates little free cash flow and requires an IPO or a sale to [crystallize] value for its shareholders. Blackstone has been, and will continue to be, a cash machine that can distribute substantial sums to its minions every year. Therefore, either an IPO or a leveraging of the balance sheet is simply a means of extracting even more cash from the business. Given the friendly nature of today’s equity markets, going public offers the best risk/reward decision for Blackstone’s existing shareholders. This is an opportunistic step driven by the state of today’s equity markets and other considerations such as the state of the private equity market.”

Yes, but what does it mean?

The Financial Times comments:

“These self-motivated, intelligent individuals are trying to tell us something important. The question is: Do we have the ability to look beyond their words and actions and intuit motivation? Greed, uncertainty and fear. What are the implications? That the equity markets are in trouble? That the credit markets are on the verge of a sharp sell-off? That we are at the dangerous stage of a private equity bubble?”

There is no magic to the Blackstone Group or other private equity firms. The genius of private equity prime capital is no different from the genius of subprime credit. When liquidity rises…both ride high.

But money and credit are no different from bananas or lovers: The more you have, the more will go bad on you. This is what economists call the Law of Marginal Utility. Each additional increment, of whatever it is, is less valuable than the one that came before.

We find in the Fed statistics that the total credit market debt has been increasing five times as fast as GDP for the entire 21st century, or what we have seen of it so far. Subprime lenders had so much money to lend that they gave it away to people who couldn’t possibly pay it back. There are only so many good borrowers. And there are only so many good private equity deals. And a credit bubble lasts only so long.

AP again:

“What will happen when the debt markets grow less friendly and additional equity is required to get deals done? Returns will fall. What will happen to those who have invested in private equity funds? They will not be happy. And those who have invested in common shares of the private equity management company? Unhappier still.”

More news:


Chris Gaffney, reporting from the EverBank world currency trading desk in St. Louis…

“Yes, the pull back in consumer spending would be a short term negative for the U.S. economy, but the borrow and spend tradition of our consumers has landed us into the predicament that we now face: An economy with way too much debt…”

For the rest of this story, and for more market insights, see today’s issue of The Daily Pfennig


And more views…

*** From our resident Maniac Trader, Kevin Kerr:

“Freemasons would be considered a fairly open society compared to floor traders. While there are no secret handshakes or strange passwords, the world of the exchanges is one unto itself. Maybe not as much today as 20 or 30 years ago, but the veil of secrecy still exists. No, I don’t mean shady dealings or crooked schemes; I mean the secrets of how much money can be made trading commodities and how easy it can be to do it.

“So you may be asking, “Why would they want to keep it a secret?” Obviously, the fewer people that figure out what a good place the markets are to make money the more there is for fewer players. By keeping secrets they exclude the masses from the riches to be made. In the past, the floor traders rarely hired “outsiders”; normally they would hire family and friends to work in their floor operations.

“Back when I started, the only way you could get a job down there was if you had a father, an uncle, a brother, a cousin, or a very best friend who considered you a brother (this may sound sexist, but there it is); that’s how I started. Today the attitude on the trading floor is much more open and in fact, nowadays even CNBC cameras are on the trading floor occasionally! We see a younger generation of floor traders, past and present (yours truly included), opening up and actually welcoming investors to understand and use these markets.

“The commodities markets are continually evolving, and have stripped away much of the old secrecy from days gone by that, in my opinion, kept many investors at arm’s length, which was not a positive thing for the markets long-term.”

More from Kevin tomorrow…

*** Well, the fire alarm works.

We were sleeping soundly last night…at about 3AM. All of a sudden, we became a victim of modern technology. A fire alarm interrupted our dreams. Was the place on fire? It didn’t seem likely. But we couldn’t sleep with the screeching alarm going off…so we dressed and went downstairs.

It is one thing to turn on an alarm. It is another to turn it off.

Pierre was already at the control panel when we got downstairs. He was pushing buttons. But the noise continued for another 10 minutes – until everyone was wide-awake. What could we do, but open another bottle of wine?

*** Well, we don’t have any more views… We’re attending a conference today. We need to pay attention; maybe we’ll learn something.

We know we left you on the edge of your chair with our theory of modern politics. Why has collectivism triumphed everywhere? More tomorrow, dear reader…

The Daily Reckoning