The Cupboard is Bare

Doug Casey has been speculating in gold and other commodities since the early 1970s. He has seen it ALL before: from bell-bottom pants to twenty-year bear markets. Then we landed in 2004…

The bear market rally of the U.S. dollar has the talking heads employed by Wall Street declaring that the two-year bull market in commodities is a dead man walking. All the talk in the world is not going to make the slightest bit of difference, as these pundits-for-hire are proven wrong once again. The U.S. dollar is in a secular downtrend. Typically, currency trends, once in motion, tend to stay in motion for a decade or more – and as the dollar falls, commodities rise.

But, as you’ll read in this article, there’s much more to the current rally in commodities than just a weakening dollar, and it increasingly reminds me of the 1970s. For those of you whose only memory of the 1970s is bell-bottom pants, it was also a time of spiraling interest rates, out-of-control inflation and a powerful bull market in commodities, driven by monetary factors and supply and demand.

I remember the time with great fondness because I made a lot of money on mining stocks, ultimately selling them to the masses who, as usual, came late to the party. No doubt encouraged by testosterone and the arrogance of youth, my decision to be a steady buyer of gold and silver stocks (after reading Harry Browne’s "You Can Profit from the Coming Devaluation in 1971") made the decade very, very good for me, even though I had very limited capital to start with.

Commodity Bull Market: The Twenty-Year Bear Market

All the commodities peaked, more or less together, in 1980, and remained in a secular bear market until about 2001 – notwithstanding several wild cyclical rallies (82-83, 85-87, and 93-96). During the twenty-year bear market, and especially the last five years, large segments of the mining industry have been mothballed. Gold and silver became laughing stock investments among brokers. Oil exploration ground to a halt. So what? The copper, steel, aluminum, and nickel industries are on their back. Who cares?

Well, soon the great masses will care, a lot.

Crude oil futures are now in the same neighborhood as the highs last seen in the aftermath of Saddam’s torching of the Kuwait oil fields back in August 1990. Sure, the dollars are worth a lot less, but a new equilibrium level has been reached.

In February, hot-rolled steel rose to $360 a ton. That’s up about 30% year-over-year…but even that doesn’t tell the story, because supply is so tight that distributors are starting to add premiums. A recent survey of the distributors by Longbow Research forecasts that the stuff will be selling for $600 a ton by June. Further indication of just how tight things are getting is provided by the number of countries that are now limiting exports of scrap steel – most of which is headed for China for reprocessing before coming back to the market in the form of new goods.

Back in the 1970s, commodities boomed partially as a reaction to the go-go stock market days of the 1960s when they were largely ignored. Inflation simultaneously drove people out of stocks and bonds and into commodities.

Commodity Bull Market: Persistent Raw Material Supply Shortage

Now older and, if not wiser, at least more cynical, I try not to be quite so dogmatic about these things. But when I look even a little way over the horizon, I still find myself tempted to use phrases like "sure thing" and "can’t miss" when it comes to forecasting a persistent raw material supply shortage caused by three things: 1) under-investment in the commodity businesses, 2) the booming demand coming out of places like China and India, and 3) a monetary environment that’s likely to be worse than that of the 70s.

From a speculator’s (as opposed to a consumer’s) perspective, the good news is that this is not a problem that will be resolved in the short term, even if prices go much higher. Any inventory and capacity overhang from the nineties has been worked off, and the cupboard is bare. Yet the demand from the fast-growing Chinese and Indian economies is, in historic terms, just getting started. Shortages are already affecting copper, lead, zinc and tin production.

I say these things within the context of one who, for the long run, is super-bearish on the commodities. Remember that commodity prices have been going down, in real terms, for as far back as we have records. Which is to say for at least 4,000 years. The trend accelerated with the productivity breakthroughs of the industrial revolution. With the rise of nano-technology (among other things), the long-term collapse of commodity prices is going to re-accelerate. I discuss all this in detail in my last book, Crisis Investing in the 90s. But that, as they say, was then, and this is now. And for quite some time you should expect – cyclically – much higher prices across the board.

And we shouldn’t have to wait long. Once the market catches on to how tenacious the growing shortages in metals are, prices can move quickly. Case in point, within a few weeks of publishing "The Coming Copper Crunch" in our February 5, 2004 edition of the Casey Investment Alert, copper rose by about 50%.

For those of you wise enough to jump on the commodity train early, the desire to take profits now must be building, but remember the best time to sell during a bull market is in the mania stage…not a sell-off. The bubble top is, in my view, probably still several years away. If you haven’t yet taken your positions, then now is the time to climb on board. Stay in touch with these markets and the quality players, and you have a real shot at leveraging your investments into a very comfortable nest egg.

Commodity Bull Market: Cyclical Downturn

What are the risks? My biggest concern is a collapse of what’s become a financial bubble in fast-growing economies such as China and India – accompanied by a rapid drop in commodity usage and relatively lower prices. But that would still be just a cyclical downturn in a demand-driven, secular bull market. And the other factors behind the bull would remain intact.

What investors should realize is that the markets for all base metals are in a tightening mode. In some cases, there is still excess capacity that, at the right price, could come back onto the market – but at the current rate of demand, we are looking at shortages pretty much across the board.

Oil provides a useful comparison. Until very recently, it was generally expected that global production capacity would continue to outstrip demand until about 2050. However, recent data shows that the "tipping point" has moved to 2010 – a full 40 years earlier than expected. The reason: China and, increasingly, India, which I’ve recently seen referred to as the "English speaking China," will require lakes of oil to carry momentum into the future.

Of course, there is every chance that the Chinese or Indian turbo economies will hit a wall somewhere down the road…but for now, there are few likely scenarios to precipitate a crisis in the short or even mid term. Despite my inherently optimistic nature, I’m looking for the storm clouds and will report back if and when I can find something to worry about. But that is another story, for another day.

In the meantime, the shortage in base metals is a trend we want to make our friend.


Doug Casey
for The Daily Reckoning
May 27, 2004

Editor’s Note: Doug Casey, author of bestsellers Crisis Investing and Crisis Investing for the Rest of the 90’s, has been seeking and finding incredible opportunities around the world for over 25 years. He has lived in seven countries and visited over one hundred more, actively – and successfully – speculating in international stock, bond, commodity and real estate markets. A version of this essay was first published in the May edition of Doug’s investment letter, International Speculator.

"The main difference between Europe and the United States," said an French analyst yesterday, "is that the U.S. is much more dynamic.

"Americans believe in taking action. They are taking action in Afghanistan and Iraq…while Europeans hang back. Their central bankers are taking action, too – Greenspan has cut rates aggressively, to one quarter of the key rate in Europe…while the European central bank is reluctant to cut rates at all.

"It’s true of consumers, too. And entrepreneurs. Americans buy things readily. They don’t mind borrowing money to live well…because they believe that there is an infinite abundance they can take advantage of.

"The European counts his money carefully and doesn’t buy – especially not on credit – until he is sure things will work out. He is careful. He distrusts the future. He distrusts his government. He distrusts everybody and everything.

"Of course, that’s the big difference, isn’t it? You Americans saw the threat of terrorism and decided to do something about it; you went to war…didn’t you? Europeans saw the threat and decided there was not much they could do about it…at least not much that was worth the expense and risk.

"But then, Americans have never actually suffered much from war. There have never been any sieges, for example. In 1870, the Prussians besieged Paris. We ate almost every animal in the zoo. We went hungry again in the 1940s…when the Germans occupied the country. America has never been occupied. Never been bombed (except a couple of terrorist bombings). We had whole cities leveled, with tens of thousands of victims. We had famines. Millions of people died. Our industries were destroyed. War did not pay for Europe.

"The same attitude is visible in the economy. Faced with the threat of a downturn, Greenspan took action. But we Europeans are much more conservative. We’re afraid of inflation. We distrust our own money.

"But you Americans have never lived through anything like the inflation in Germany in the ’20s…or the devaluations…or the replacement of one money for another. Even in my lifetime, we had the ‘old franc’ replaced by ‘new francs.’ You go out to the country and some old people will still quote you the price of bread…they’ll tell you a loaf of bread is 1,400 francs. The currency has changed twice since then…to the new francs…and then to the euro. We Europeans know that currencies come and go. But you Americans seem to think the dollar is eternal…"

American investors are more dynamic, too, he might have pointed out. They buy, even when there is not much worth buying. Like Europeans, they’ve had their derrières kicked on more than one occasion. But it’s been so long, they can’t remember.

There is a time for action and a time for reflection, we believe. Typically, people are in the mood for action before they take losses…and in the mood for reflection after.

But here, we check in with our ace reporter, Eric Fry…with an update on the mood on Wall Street:


Eric Fry, from the World’s Financial Center…

– Yesterday’s "spinning top" trading action produced little change in any of the major financial markets. Treasury bonds and the dollar both inched ahead slightly, while gold dipped 10 cents to $388.30 an ounce. Over in the stock market, the Dow Jones Industrial Average fell eight points to 10,110, while the Nasdaq added half a percent to 1,976.

– Although most stocks languished yesterday, financial stocks continued their resplendent rebound; the S&P Banks Index, which jumped 1% yesterday, has added more than 7% over the last two weeks. Why the sudden passion for financial stocks? Is Mr. Market "telling" us that interest rates will soon fall? Or is he merely suffering one of his period bouts of dementia?

– We suspect the latter, but most investors seem to believe the man. Interest-rate sensitive stocks have been rebounding for days. But some folks on Main Street are taking the other side of that trade. [Ed. Note: The "rebound" has uncovered some exciting opportunities for value investors…if you’re feeling intrepid, take a look at Porter Stansberry’s Rebound Report before the current profit window closes:

The Rebound Report

– "Interest-Rate Fears Spur Home Sales," declared a front-page headline in the "Personal Journal" section of yesterday’s Wall Street Journal. A few pages away, a headline emblazoned across the top of the Journal’s "Heard on the Street" column read: "Buying into Housing Stocks: Value Investors See Bargains Among Rate-Battered Shares; Betting Things Will Be Different."

– The former story explains that folks like Danene and Greg Hanemann are accelerating their home-buying plans because they’ve "grown nervous that rising interest rates would make monthly payments unaffordable." But the latter Journal story asserts that housing stocks are cheap…as long as nothing bad happens to the housing market.

– We agree…as long as nothing bad happens to the housing market.

– We do not know if home prices will rise or fall, nor do we know if home-building stocks will rise or fall. But we do know that a few bad things are happening in the housing market. Thirty-year mortgage rates have jumped one full point, from 5% to 6%, in two months. A thirty-year mortgage at 6% is not a catastrophe, but the trend is troubling and it is beginning to affect the behavior of buyers and sellers.

– The Hanemanns, who had been planning to begin shopping for a home in October, instead plunked down a deposit for a new home last March. "We weren’t going to dicker with the house," says the Missus, "if our payments went up by even $100, we would have had to seriously think about backing away from buying a home."

– We wonder how many more "Hanemanns" are accelerating their purchase plans – snapping up a home now while they can still barely afford it. How many more "last chance" homebuyers are boosting demand – temporarily – because they fear rising rates will force them to abandon or downsize their home-buying dreams? And what does this "front-loading" of demand portend for homebuilders? Are today’s sales stealing from tomorrow’s sales?

– Furthermore, what if Danene and Greg are correct, and rates continue rising?

– "Bulls on housing stocks are making the risky bet that things will be different this time around," the Journal relates. "During the past 11 periods of rising interest rates, home-construction stocks fell, albeit a slim 2%, according to RiskMetrics Group."

– To be sure, things might be different this time – like a "Granny Smith" apple is different from a "McIntosh." But today’s housing market is still the same old apple it’s always been – when interest rates rise, it turns rotten.

– Indeed, some parts of the housing market are turning rotten already. Rising rates have squeezed the life out of the refinance market like a python around a piglet. The Mortgage Bankers Association’s Refinance Index, which slipped nearly 17% last week, has plummeted 78% year over year. "Currently, only about 20% of mortgage holders have economic incentive to refinance," observes Friedman, Billings, Ramsey & Co, "so we expect mortgage activity to continue to slow, and we believe the index will continue its downward march."

– So far, however, the demand for purchase mortgages is holding up well, thanks in part to "panic buying" by folks like the Hanemanns. And thanks also to the mortgage lenders for devising ever more exotic ways for individuals to buy more house than prudence would allow. A dazzling array of interest only, zero percent down and adjustable-rate mortgages creates a kind of hangman’s boutique – ropes of every sort with which to hang oneself.

– Presumably, homebuyers will begin to feel the squeeze of rising rates eventually…and so will the buyers of homebuilding stocks.


Bill Bonner, back in Paris…

*** News reports tell us that Mr. Greenspan is spending more and more time, cozily nuzzling up to politicians. A Wharton School professor has analyzed the appointment logs and notes that the Fed Chairman meets with the Bush team almost twice as often as he met with Clinton’s crew. The Fed is supposed to be independent of politics. But so is the Fed meant to protect the dollar.

*** Mr. Bush believes the Fed was responsible for his father’s loss to Bill Clinton in 1992. He is determined not to repeat the error. For his part, Mr. Greenspan is nearing the end of his career. There is no sense in changing course now. He has pumped up the entire world on U.S. dollar credit…now, he has to hope things hold together at least long enough for him to scoot offstage so the inevitable blow up can be blamed on someone else.

The election is only 5 months away. We have no way of knowing what will be in the headlines in the weeks ahead, but we are almost certain that readers will find none that say "Fed Tightens!" or words to that effect. Au contraire, if there is any slack left in the credit markets, we are likely to see it played out sometime soon. Stocks may rise. Gold should rise, too. Houses might sprout wings.

The Bush/Greenspan duo is perfectly matched for fame and calamity. One is clueless. The other, ruthless. One has made the biggest military blunder in American history…at least since Woodrow Wilson took the nation into WWI. The other has made the biggest financial blunder in American history – at least since Benjamin Strong decided to administer a "little coup de whiskey" in the 1920s.

*** Our guess is that Bush and Greenspan are leading the nation to disgrace. Not that they are doing anything other than what nature intends for them to do. Every epoch needs the leaders suitable to it; America is headed for a kind of ruin…it has found ruinous leaders to take it where it needs to go. (More on this tomorrow…)

*** Meanwhile, China and India are headed for disasters of their own…and glory too. Our man-on-the-scene…Dan Denning…sends these notes from his blog ( ):

"Yesterday, I went to a conference sponsored by some Western investment banks and financial firms. These firms (Halter Financial, for one) are educating mid-cap Chinese firms on using reverse mergers to get listed in the United States.

"The Chinese investment brokers I talked to said mid-level
Chinese firms (even ones throwing off huge cash) want access to the U.S. capital markets to expand domestic business. Why not access Chinese capital markets, I asked? After all, with a savings rate of 36%, there’s got to be some available savings locked up in the banks, right?

"Of course the problem is that debt financing has already led to an enormous bad loan problem for Chinese banks, all of which are state owned. Chinese firms want equity, not debt. And frankly, though getting started, the listing process for Chinese exchanges is rather…cumbersome. And there’s a liquidity issue.

"For example, yesterday, I visited the Shanghai gold exchange. I was able to walk on the floor and watch the trading operations. It’s a watershed event…that the government has opened up the trading of gold to the free market. But at this point, it’s a relatively small operation. The LME or the Merc does more volume in one hour than the Shanghai exchange does all day. So the concept is right and the structure is right…but the volume isn’t there yet. The same is true across Chinese equity markets, hence the idea of merging with a U.S. shell, escaping rapacious underwriting and IPO fees, and landing on the ground in the world’s largest equity market with a freely trading stock.

"In fact, two of China’s four largest state-owned banks -the Commerical and Industrial Bank and the China Construction Bank, would like very much, I’m told, to go public in the U.S. In order to do that, however, and meet capital requirements for an international bank, they need to clean up their balance sheets.

"That’s leading to a fire sale on high-end commercial real estate that the banks have been carrying at book value, but which is going to be marked to market and sold for whatever they can get. I guess when you’re the ‘people’s bank’ and not a shareholder-owned bank, you can afford to take a large loss on bad loans and not worry about it.

"But again, the idea is important here…the government is withdrawing from the credit business a little…turning over ownership and development of commercial real estate to private developers…and looking to tap into the U.S. equity markets. It makes a lot more sense to finance Chinese growth by racking up a huge earnings multiple on the backs of U.S. investors than it does to take on debt, if you ask me.

"At some point, China is going to have to develop its own capital markets and fund its own growth through savings…but for now…this lull in the appeal of Chinese stocks might be a good time to look around.

"All the low-hanging fruit has been picked here. But there are many, many square miles of orchards…if you have the time to look."

*** It is spring. We are getting a rash of wedding invitations.

Our favorite began as follows: The Viscount and Viscountess de la Rouchebaillarde invite you to take part in the marriage of their daughter, Anne-Céline, etc. etc. at the Château de la Rouchebaillarde on the etc. etc.

People do not use noble titles in France…except in wedding invitations and obituaries. On these occasions, if there is a dog around, they put it on. One invitation even includes the father-of-the-bride’s war record. "Croix de Guerre, 1944," it tells us.

After reading the invitation, your editor turned to his son Henry, 13, with the following suggestion:

"Oh Henry. See if you can find someone from a good family to marry. It would be so much fun to send invitations like this to our relatives in America."

"Dad, I’ve got news for you. Many of these titles are just made up. "

"Well, they still sound good…."

"You’ve come a long way from hoeing tobacco with your father," noted your editor’s mother. "But I haven’t noticed that your friends are really much different. There are some who seem very nice…and others…. "

"And Henry," she went on, "of course you won’t take your father’s advice seriously."

"Nah…I never do."

The Daily Reckoning