The Paper Age

John Myers, of Outstanding Investments fame, with a rather simple formula for investment profits in the natural resource sector. Simple…in our view…should not be ignored.

In my 17th year I spent the summer working with our neighbor Mr. Lynch. Our project: to encircle a quarter section of land with rail fences.

Lionel Lynch had the best stories. He was a World War II Veteran and a self-made millionaire. He was also an old- time farmer who drove a beat-up Ford truck. Riding along in the truck he used to tell me about the landing at Normandy beach, the push through France and a German sniper’s bullet that missed his heart by inches. I remember asking and then being allowed to see the scar.

One windless day in August, the sun was grueling. Mr. Lynch drove the claws of his hammer into a post and said, "Time for a break." He went to the back of his pick-up and threw-off the gunny-sack that was covering a gallon of Mrs. Lynch’s homemade iced tea. We sat on the hood of the truck and old Lionel surveyed the rolling tide of ripening wheat fields that stretched to the foothills.

He dug into his greasy coveralls and reached for his zigzag papers and a pouch of tobacco. Within seconds he had fashioned a cigarette, snapped a match to life from his boot and inhaled a big drag.

"This is a wonderful land we live in," said Mr. Lynch. "And they ain’t making anymore of it."

It may not have seemed that way during the 1980s when the rolling recession plowed a deep gouge into farmland prices. In Alberta a section of land that would grab $1,000 in 1980 would fetch only half of that a few years later. It was the same throughout North America where not only land, but hard assets across the board fell into steep retreat.

Metals – base, precious and strategic – dropped precipitously in the 1980s, as did grains, cotton and almost everything else from hogs to coffee. The CRB Index of commodities fell by almost a third between 1980 and 1985.

The age of paper had arrived and it seemed not only profitless, but downright stupid, to hold anything else.

Beginning with a broad rebound in the Blue Chips in the 1980s and continuing with the NASDAQ in the 1990s, the stock market was the only game in town. At silver’s high in 1980, nine ounces of the white metal would buy you a single share of the Dow Industrials. By 1999 you needed a wheelbarrow to carry 2000 ounces of silver to buy one share in the Dow.

Yet, something very strange has been happening over the past couple of years. The stock market has staggered, while hard assets have been moving up slowly but surely.

So what exactly is happening? I think I have the answer, and it relates back to that summer’s day with Mr. Lynch.

A few years later, economics professors in big auditoriums using fancy charts and complex names would teach it to me. But it was the same lesson, one of supply and demand. As the supply of anything grows, from apples to atom-busters, the price of it falls. Now this is where it gets interesting.

The only thing that has been really growing by gangbusters over the past 10 years is paper…money, US dollars.

In 1992 M3, a broad-based measure of dollars, stood at $4.2 trillion. Currently M3 totals about $8.1 trillion dollars, or almost double what it was a decade ago. If we take the much smaller measure of currency in circulation we see that during the same period it has grown from $267 billion to a shade under $600 billion. That’s correct, there are more than twice as many greenbacks circulating in the world today as there were 10 years ago.

Now let’s compare that to the amount of gold in the world. Each year miners deliver about 50 million new ounces of gold from the ground. That adds about one-half of one percent to the world’s total reserve of gold. Roughly speaking, the amount of above-ground gold has grown from 9.5 billion ounces to 10 billion ounces over the last ten years. That means while the number of dollars has doubled in a decade the amount of gold has risen by only 5%!

To give you an idea of how much gold is produced each year: the entire annual harvest could be put into an 18- square-foot cube. The cold hard truth is that gold supplies are growing at less than 1/10th the rate of the U.S. money supply.

It is the same for almost every commodity. Water is in critically short supply, as is arable land. That means that repeating the Green Revolution of the 1950s and ’60s is all but impossible. World grain farmland increased until 1980. It has been on a steady decline since. The reason? Take your pick – soil erosion, waterlogging and salting of irrigated land, air pollution and water shortages.

Less water, less food, and, it seems, fewer mineral deposits.

Paul van Eeden, a stockbroker at Global Resource Investments, understands the growing scarcity of hard assets. "Let’s look at an example of depletion and discovery. Worldwide copper consumption is about 33 billion pounds per year," writes Paul. "To put that in perspective, the biggest copper mines in the world contain on the order of 20 to 30 billion pounds of copper, which means that our annual consumption depletes the equivalent of one major copper deposit a year."

The drawdown in global mineral reserves has resulted in mineral companies slashing their exploration budgets. According to the Metals Economics Group, total worldwide nonferrous exploration was $5.2 billion in 1997.

But mineral exploration expenditures declined by 29% in 1998, 24% in 1999 and another 7% in 2000. That brings the total exploration expenditure at the beginning of the millennium to only $2.6 billion, 50% of what it was only three years prior. Mineral exploration is not keeping up with the historical norm.

Demand for hard assets is soaring. The Developing World is bent on creating its own Industrial Revolution. That means massive amounts of raw materials are needed.

For example, if China were to pursue "an automotive economy" similar to the US as they proposed in 1994, there would be a resource boom like no other we’ve see in history. "If the Chinese were to drive as many per capita passenger miles as Americans currently do each year," Benjamin R. Barber in the book Jihad vs. McWorld "it would take only five years to use up all the earth’s known energy reserves."

In my book, a soaring demand for natural resources of every variety in the face of dwindling supplies coupled with an avalanche of paper dollars makes up a very simple equation. And if Mr. Lynch were still around today, I believe he would come to a similar commonsense conclusion – the value of hard assets is set to soar against a sorry U.S. dollar.

Yours for opportunity,

John Myers,
for The Daily Reckoning
June 06, 2002

P.S. It’s a fairly simple formula…a dwindling supply of resources plus a skyrocketing demand for them coupled with an ever-increasing volume of dollars equals rising prices. Simple as it is, it makes for some fairly impressive investment choices.

For example, in my private trading service, The Resource Trader Alert, we’ve already seen 77% profits on silver in just 3 months…82% profits with gold calls, also in about 3 months…and 99% on unleaded gas (of all things) in only 5 weeks.

Not to mention the 276% we pulled down last year on Range Petroleum… and 668% profits with Ballard Power. Across the board, natural resources are providing far superior returns to anything you might find on Wall Street.

John Myers is son of the late great goldbug C.V. Myers. Accordingly, he’s been helping readers earn lucrative returns in stocks largely ignored by Wall Street since his early 20s. Our man-on-the-scene in Calgary, John has his fingers on the pulse of the natural resource industry – including oil, gas, energy and gold.

"Logic suggests," writes Newsweek’s Wall Street reporter Allan Sloan, "that for the next decade or so, stock prices won’t increase much faster than corporate earnings, which typically rise about 7 percent a year. Throw in an additional 1.5 percent or so for dividends, and you end up with a return – dividends plus stock price increases – in the high single digits. And getting that return depends on price-to-earnings multiples staying at their current high levels…"

"Welcome to reality," says Sloan. But Sloan’s reality is not necessarily Mr. Market’s reality. The 20% per year gains of the late ’90s are gone, he says. Instead, it’s back to "normalcy," in which investors only get what they’ve gotten for the last 56 years – about 9% per year, including dividends.

Mom and Pop Investor are probably just now coming to terms with this ‘reality.’ They liked the big gains of the ’90s…but they’re not greedy. Stocks always go up in the long run, they still believe; it’s just too bad they only go up at 9% per year. But, hey, 9% ain’t so bad. Wouldn’t it be a darned shame, dear reader, if Mr. Market pulled one of his perverse tricks…and stocks lost 9% this year? Or 19%? Or 49%? Or 69%?

Even Mr. Sloan notes that getting 9% in the coming years "depends on price-to-earnings multiples staying at their current high level, which is no sure thing." The reality is that P/E ratios are currently about 3 times the normal level – depending on how you calculate them.

Over the sweep of history, the vernacular wisdom of generations of investors was that stocks should trade for only about 15 times earnings. Why should they be worth more today?

But let’s turn to our own eyes and ears on Wall Street, Mr. Eric Fry, for an up-to-date report:


Eric, adroitly reporting from New York…

– As anticipated in yesterday’s Daily Reckoning, the "obvious trades" stopped working…for one day, anyway.

– The stock market and the dollar stopped falling and gold stocks stopped going up. Although stocks and the dollar both dropped early in the day, they reversed course in the afternoon. Conversely, gold stocks climbed early before falling in the afternoon.

– By mid-morning yesterday, the Dow had dropped more than 100 points. But the blue chips recovered to finish the day with a slim 21-point loss at 9,687. The Nasdaq fared even better than the Dow. Despite falling about 1% in the morning, the Nasdaq ended the day with a 1% gain to 1,578. Interestingly, at its nadir, the Dow traded below its September 10, 2001 closing level of 9,605, thereby joining both the Nasdaq and the S&P 500 in erasing – temporarily – all of the "Patriot Rally."

– The dollar also reversed course mid-day. After sinking to a 28-month low against the Swiss franc, the U.S. currency pared its loss to nearly unchanged. Gold stocks reversed in the opposite direction – up 2.7% in the morning, down 1.4% by the closing bell.

– Judge not Dennis Kozlowski, the newly indicted former CEO of Tyco International. The man deserves our sympathy, not our scorn. He is clearly suffering from Acute Avarice Syndrome (AAS). He might like to be magnanimous, but his disease prevents it.

– "During his rise to become one of the nation’s chief executives, Mr. Kozlowski persuaded his board to give him hundreds of millions of dollars of cash, stock and [perks]," the New York Times reports. "He took home tens of millions of dollars of pay that supposedly reflected his improvement of the company’s performance. Yet, Tyco still lent him millions of dollars…Incongruously, Mr. Kozlowski also looked for ways to save amounts of money that represented a pittance of his wealth. Rather than waiving the fee to sit on his own board, as most executives do, he received $75,000 last year."

– We healthy people cannot possibly imagine the pain that Kozlowski endures as an AAS sufferer. Tyco shareholders, however, might have some inkling what the pain feels like. Tyco shares have collapsed more than 70% in 2002 alone.

– The "Kozlowski Affair" is but one of the most egregious examples of shareholder abuse. During the late bubble years, corporate chieftains and Wall Street’s investment bankers would take turns wiping their feet on the millions of investors they were purporting to serve. Maybe that’s why the reputational race to the bottom of the sea between corporate America and Wall Street is a dead heat.

– Maybe that’s also why fewer and fewer investors wish to avail themselves of Wall Street’s conflicted research. "With Wall Street’s big research houses swimming in scandals, investigations and litigation, investors are hankering for…unbiased stock research," Crain’s observes. "Independent research houses all over New York are on a roll…Perceived as paragons of disciplined, trustworthy research, they are taking advantage of the myriad messes weighing on their big rivals’ reputations."

– As a contributor to Apogee Research, I have definitely noticed an uptick in demand for independent research. And Apogee is not merely independent, it has also been very right – both on the long side and on the short side of the market. Call it skill or call it luck – or call it a little bit of both – all 13 of Apogee’s current recommendations – 6 shorts and 7 longs – are in the black.

– Even when the stock market falls, consumers are remaining confident. One measure of their steadfast confidence is their growing contribution to GDP. Financial commentators often remark that consumer spending equals about two thirds of GDP. But David Tice calculates that consumer spending is currently contributing a spectacular 88% of GDP. Now that’s confidence! In other words, they are spending more and more, even as corporations are spending less and less.

– Consumers aren’t the only ones who are feeling confidant these days. So are mortgage lenders. Many lenders seem to be so sure that things are getting better that they are refusing to foreclose on folks who don’t pay them. "While the number of mortgage delinquencies has increased in the last five years or so," the New York Times reports, "the proportion of homes that end up being sold through foreclosure has been declining. That’s because many lenders are stepping up their efforts to work out arrangements with delinquent borrowers that let them avoid foreclosure and stay in their homes whenever possible."

– Like the tree that falls in the woods, if a mortgage becomes delinquent and the lender does not foreclose, is it really delinquent?


Slouching back to Paris…

*** Which has done better over the last 30 years – the Nasdaq or the S&P Utilities Index? Utilities, notes Richard Bernstein. Why? Because dividends really do add up…while capital gains have a way of disappearing. Too bad most U.S. stocks pay so little in dividends.

*** "After long U.S. spree," reports the International Herald Tribune, "investors broaden portfolios…" Specifically, investors are buying more European stocks than U.S. stocks. Foreign purchases of U.S. stocks totaled $100 billion in the 12 months ending on May 1, 2002. During the same period foreigners purchased $200 billion of European stocks.

*** Bob Bauman of the Sovereign Society sends this note of warning: "Yesterday came news that leading US financial services firms and banks have formed a private database company to compile information about criminals, terrorists and other ‘suspicious’ and ‘bad people’… A prime measure of suspicion will be possible ‘money laundering,’ that all-purpose, elastic criminal charge that is stretched to cover anything connected to cash, money or finance…The new snitch system reportedly has the government’s OK.

"Well, why not? Private enterprise can now make a profit doing police work and at the same time get rid of unwanted customers and clients with ease. Himmler’s Gestapo and Castro’s block informants are historical pikers compared to the ability of a complicit US banking system reporting to the FBI on a real time basis."

*** This is a big day for Jules. The teenager – whose grades have been marginal – learns today whether or not he will be booted out of his school. The poor boy suffers in anticipation…like a guilty man waiting for a jury verdict.

The Daily Reckoning