Through the Roof and to the Moon

Warning: Before America ascends into economic superstardom, it may first slip into the "Greater Depression." Doug Casey explores…

There’s an old saying to the effect that a person’s views on the economy tell you more about their mind-set than they do about the direction of the economy. Long-time readers know I’m of two minds on the subject.

For the long term, it’s a near certainty that the longest trend in existence, the Ascent of Man, will not only continue, but also likely accelerate. Over the next century, the poorest regions on Earth will have standards of living better than that of the average American today, just as the average American has a standard of living far superior to the wealthiest royalty of only a couple centuries ago. In fact, that probably understates the case. As nanotechnology becomes a practical reality over the next couple of generations, the nature of life itself will change totally and almost unrecognizably. Things will not only be better than you might imagine, but probably better than you can imagine.

That’s the good news. The bad news is that something called the business cycle still exists, which evidences itself in periodic booms and busts. We’ve had a tremendous boom from 1982 on. Must it result in a serious bust? In a word, yes. Especially in that the latest boom has been accelerated by currency inflation giving false signals to the market. The distortions and misallocations of capital it causes must be liquidated, through bankruptcies and unemployment.

What I expect is a depression: a period of time when most people’s standard of living drops significantly. It will occur for the same reasons as the unpleasantness of the 1930s, but not necessarily in the same way. For one thing, it’s likely to be inflationary, not deflationary, because the government has far more power today than it did in the ’30s. And the amount of debt at all levels of society is much greater, which means there’s political advantage in making it disappear through inflation.

Inflation is an excellent way of getting rid of the liability represented by a couple trillion dollars held offshore by foreigners.

Inflation is also an excellent way for the government to generate revenue for itself, which it will increasingly need to do, with its deficits running $500 billion a year and, I suspect, headed much higher. And that’s not even assuming the various wars the U.S. government is fighting will heat up. As I expect they will. Throw in an unhealthy dose of trade protectionism as political pabulum for the whining masses who complain about outsourcing, and the stage is well set for the next economic episode – an episode I think will someday be called the Greater Depression – of plunging stock prices and dwindling profits.

Invest In Commodities: Low Volatility

But while stocks plummet, commodities will flourish.

Contrary to popular opinion, however, commodities aren’t very volatile. They’re far less volatile than stocks, whose prices can drop to zero or multiply hundreds of times: Either extreme is an impossibility for commodities.

Commodity prices are generally limited on the downside by the production costs of the most efficient producer, and on the upside by substitution from other commodities and new production. Although commodities boom and bust for many reasons, an equilibrium price generally floats around the production cost of the average producer, plus a "businessman’s return" margin.

I don’t comment on commodities as often as I used to simply because, since 20-1 leverage is available in commodities futures, people usually wind up using it. And that tends to turn the commodities pits into gambling casinos, where 95% of the players walk away losers, eaten up by commissions, fees, bid-ask spreads and the vagaries of their own emotions.

The best approach with commodities – as with any market, actually – is to treat them like a ball game with no called strikes. You just wait for the market to get tired and lob a real kiss over the plate. Although the long-term trend (and here, I mean since the beginning of recorded history) for commodities is to head down, I’m generally a bull at the moment.

Invest in Commodities: Buying on Low Margin

Oil (which we’ll have a feature on in the near future) is definitely in a new equilibrium range, over $40, and is probably headed over $100 in the next few years. Natural gas and unleaded gasoline are likely to do even better, relatively. The meat complex is in midrange, therefore uninteresting. Corn at $2, wheat at $3 and beans at $6 are all excellent buys. The real bargains are in the tropicals: Cocoa at $1,600, coffee at 65 cents, OJ at 62 cents and sugar at 8 cents are all below production cost, and have been for years now.

I think someone who buys a bunch of them on very low margin is going to make a killing. Such a person might even do as well as someone who buys the precious metals.

I know many observers, mostly chartists, have said that gold is due for a big reaction, having gone "too far, too fast," accompanied by too much interest on the part of the public. Personally, I don’t have many short-term opinions on the market. In my view, the near term is mostly random fluctuation, and trying to make a bet on where gold is going to be next week or next month makes about as much sense as trying to guess exactly which card will come up next in a blackjack shoe. Anyway, these arguments about gold going down make no sense to me on their face. The metal has, in fact, risen only about in step with the world currency markets; so far, we haven’t really seen a bull market in gold so much as a collapse of the dollar. In fact, gold has been a laggard among the metals. And it’s complete nonsense about the public being involved. The public still doesn’t even know gold exists, and the few that do mostly see it as an outmoded relic of bygone days.

Invest in Commodities: Precious Metals

This letter concentrates on the precious metals simply because, right now and for the foreseeable future, they’re both the safest and the highest potential place to be. Although it’s not quite right to lump the precious metals together: Silver is primarily an industrial metal from the demand side, and a byproduct of other metal ores from the supply side. And although it has often served as money – like copper – it’s secondary to gold. On the other hand, because its "market cap" is so small, and because the aboveground inventories are trivial relative to those of gold, it’s potentially much more volatile. Other differences are that silver proponents tend to treat it as a religious icon, and most investment professionals hold it in disdain.

The real action will be in gold. The reason for this is quite simple: It’s the only financial asset that is not simultaneously someone else’s liability. It’s also anonymous, liquid, universally accepted, and not politically controlled. In a world beset by huge instabilities in every area, it’s going to become the asset of choice. The price of gold is not just going through the roof; it’s going to the moon.

The timing of this occurrence is, of course, problematical. As is the case for all the other investments discussed here. Sticking my neck out, it seems to me the situation is very much an amplified replay of what happened about 35 years ag a massive dollar crisis stemming from huge fiscal and trade deficits, overpriced stock and bond markets, social euphoria and a nasty foreign war.

I think we’ll see gold prices surpass $3,000 before this decade is over and, by comparison with some other things that seem likely, that price won’t be at all remarkable. I know that price point is hard to imagine, but history is littered with sweeping economic dislocations of far greater magnitude.

Economies can, and historically do, change dramatically and almost overnight.


Doug Casey
for The Daily Reckoning
September 30, 2004

"Something very odd appears to be happening on Wall Street this month," writes James Ferguson in tomorrow’s MoneyWeek magazine.

Yes, dear reader, many financial services claim to be able to provide you with tomorrow’s headlines today, but only we here at The Daily Reckoning can do so. (We peeked at James’ article before it went to press!)

What is odd, says James, is the U.S. bond market. Everyone knew bonds peaked out last summer. And everyone knew yields would rise from here to eternity. But recently, that is, maybe until yesterday, bond yields went down and bond prices went up – the very opposite of what they were supposed to do.

What could it mean?

Well, it could be nothing more than "a giant fake-out," as Christopher Wood puts it, caused entirely by Asian and Chinese buying.

Then again, as tomorrow’s headline suggests, it could be a sign that "something evil this way comes."

"The jobless recovery is still largely jobless," James points out.

"If the economy can’t generate enough jobs, consumption will falter and the recovery will stall."

"This is the first time since 1939," adds Christopher Wood, "that employment has still not yet fully recovered 41 months after the previous business cycle peaked."

Yesterday, the government came out with a new figure for GDP growth in the second quarter of this year – 3.3%, a half of a percentage point greater than estimated.

Don’t get too excited. The number is half fraud and half humbug. The fraud part jiggles the figures. The humbug part misunderstands them.

Bill Gross addresses the fraud: "I am not a believer in central bank intervention as a market mover past a short period…yes, they can move the markets in the short run, but eventually, if the market participants want to keep pushing, the central bank will lose."

How the bills get settled is the story behind the headlines, not just for tomorrow, but for many years ahead. James is nice enough to give us credit for worrying about a "soft depression" a la Japan. "If the United States follows [Japan’s example]," he concludes, "there could be a very nasty decade ahead."

More news, from Eric…then, more views…


Eric Fry, on the beat in New York…

– "There’s a bubble in crude oil!" wails a chorus of Wall Street analysts…

– "A sudden and violent crash in crude oil prices cannot be dismissed," warns Thorsten Fischer, senior economist for Meanwhile, Bear Stearns analyst Frederick Leuffer staunchly maintains his forecast that oil prices will average about $25 a barrel in 2005.

– Yesterday’s oil inventory report – and subsequent sell-off in crude oil – lent some temporary support to the bears’ argument. Crude supplies jumped 3.4 million barrels in the week ended Sept. 24, according to the Energy Department. The surprising increase in stockpiles triggered the very first drop in crude oil prices in 10 days.

– Investors took flight from almost every corner of the energy markets. Crude for November delivery slumped 39 cents, to $49.51, while gasoline and heating oil both dipped a bit. Oil shares also suffered the blunt trauma of rapid-fire sell orders, as the XOI Index of oil stocks retreated 1% from its all-time high, reached Tuesday.

– Once again, investors face the daunting question: Is the oil bull market over or just beginning?

– We freely admit that one man’s bull market is another man’s bubble, but any commodity market that features constrained supply and robust demand would seem more bull than bubble. Despite the vociferous objections of oil bears like Fischer and Leuffer, oil keeps chugging higher.

– Maybe it’s true that a bubble is developing in the oil market, just as Fischer and Leuffer imply. But we submit that the bubble in denial is far more advanced…and dangerous.

– "Denial," broadly defined, is the psychological tendency, either conscious or unconscious, to repudiate all or a portion of the total available meaning of a phenomenon in order to allay anxiety and to minimize distress.

– "Denial, like an umbrella, includes many defenses, such as distortion, forgetfulness, rationalization, humor, suppression and so on," explains Dr. Simon Wein of the Department of Psychiatry at Memorial Sloan-Kettering Cancer Center, "Implied in this definition is the belief that denial is not always bad or maladaptive."

– Unfortunately, denial applied to financial markets is almost always "bad and maladaptive" – also known as "costly." Wall Street’s obstinate, yet errant, forecasts for falling oil prices are but one of many examples of the massive bubble in denial billowing before our eyes.

– Denial is pandemic. Consider the evidence…the lumpeninvestoriat holds the following "truths" to be self-evident:

– Oil is overpriced, U.S. stocks are underpriced, real estate always appreciates and a falling dollar is good for the economy. Unfortunately, the lumps believed oil to be overpriced somewhere around $25 a barrel and believed stocks to be underpriced with the Nasdaq at 5,000. (So far, their abiding faith in appreciating real estate and depreciating currency is serving them well.)

– The energy markets have been hosting widespread denial for some time. One recently glimpsed chart tells the tale of strikingly divergent price trends between the price of crude oil and the price of oil stocks, as represented by the XOI Index.

– On New Year’s Eve 2001, crude oil changed hands for less than $20 a barrel. One year later, the oil price fetched more then $30 a barrel. Mysteriously, the XOI Index of leading oil exploration and production companies FELL 10% during that time frame. Just two months later, the oil price kissed $40 a barrel, and the XOI Index was still languishing more than 15% BELOW its year-end 2001 level. Even today, as the price of crude oil flirts with $50 a barrel – or about 150% above the $20 price as of New Year’s 2001 – the XOI Index has advanced less than 40%.

– Evidently, more than a few investors doubt the durability of the crude oil bull market…even though it has endured for nearly three years.

– Typically, during a lengthy bull run, resource stocks will perform far better than the underlying commodities they represent. For example, when the gold price jumped 50% between year-end 2001 and year-end 2003, the XAU Index of gold stocks doubled, while the HUI Index of "unhedged" gold stocks more than tripled.

– No such confidence is evident among oil stock investors…they’re all about denial.

– Underpinning their evident skepticism evidenced is the idea that a "fear premium" is causing oil to sell about $15-20 above what simple supply and demand would dictate. This notion is as seductive as it is misguided. Because the threat of supply disruption is real and omnipresent, the crude oil market deserves a "permanent premium."

– "In a perfect world," says oil analyst Bruce Lanni of A.G. Edwards & Sons, "you’d take the premium out, and you’re looking at an oil price in the lower- to mid-30s. But it is not a perfect world."

– There’s a fact no one can deny.


Bill Bonner, back in London…

*** "We think, they sweat," writes colleague Steve Sjuggerud. Steve doesn’t believe that we are "just nasty gluttonous Americans." Instead, he seems to believe that we earn our way in life, despite the evidence of the trade deficit, by thinking!

We will gladly take the other side of this trade! We’ve seen thousands and thousands of Americans…over many, many years…but rarely have we seen one actually THINKING! Americans are people who prefer action. That’s why George W. Bush is president; he doesn’t even pretend to think. It’s why people buy stocks for many times what they are worth…why they believe that they can spend money their grandchildren haven’t even earned yet…and why, following a curious attack by mostly Saudi nationals based in Pakistan or Afghanistan, Americans went to war with Iraq!

We have great respect for Steve’s investment savvy…but no one can be right about everything. As far as we can tell, Steve thinks the trade deficit has no information content; it is mute. Apparently, it tells him nothing. But to us here at The Daily Reckoning, the trade deficit speaks louder than actions. It tells us that America is spending more than it earns…and that every day that this continues, America grows poorer.

"Andy Kessler offers a more optimistic take on this conventional wisdom in his latest book, Running Money, Steve writes. "Quite frankly, I’ve never bought the conventional argument about trade deficits being a bad thing. So Andy Kessler’s idea is a breath of fresh air."

What is Kessler’s breezy insight?

"A problem is not a problem until it’s a problem," Steve tells us.


A man jumps off a high building. He has no problem, according to Kessler, as he passes the 25th floor. Still no problem going by the 14th…or the 10th…the 7th…and so on. He still has no problem as he goes by the windowsills of the first floor…or even just before he reaches the dust on the pavement. In fact, up until that nanosecond in which his flesh is compressed against the concrete and his hard head is flattened…he is just fine!

"It’s not the fall…that hurts at all…it’s that sudden stop," sings Percy Sledge in "Sudden Stop."

This is thinking? This is the thinking that earns America’s keep?

"We are not a bunch of gluttonous consumers who are mortgaging away our future by overindulging and running huge deficits in foreign goods," writes Kessler. "Instead, the United States turns out high-margin intellectual property that the rest of the world uses to build finished products. We may run trade deficits, but we have more margin than they do."


Ooh la la…let’s say you sell a hit song. High margin, right? So you sell $1,000,000 worth to foreigners and you bring back $500,000 in profit.


The foreigners are not nearly so smart. They don’t think. They sweat…and turn out a million gizmos…which they sell for $10 each and make only $1 each. Low margin, right?

Who’s better off? The foreigners, of course! The trade deficit tells us that more money is going out than coming in. The low margin products provide jobs, profits, new factories, infrastructure and everything else that raises standards of living. Margins may be higher in the United States, but so what? The foreigners are selling more and making more than we are. And they are taking the surplus and buying up U.S. assets.

Is this good?

Is Kessler really thinking…is he offering fresh air or hot air?

*** Addison Wiggin is taking a group of readers to China, where, under the guidance of local experts, they will get to see who’s really sweating and who’s really thinking. There’s one caveat: The Miss World Pageant is being held at the same hotel in Shanghai during Addison’s visit. Focus on trade dynamics may suffer.

*** A Daily Reckoning reader writes:

"I day-trade index options with the help of astrology. The moon is useful; it moves by far the quickest and yields fairly reliable results. Primarily, it’s a mood indicator. However, what one looks for are longer-term configurations of the slower, financially significant planets, taking place over the period of at least a week, up to a month. This increases the odds in one’s favor. Bearing in mind that it is only a matter of discerning increased odds and needs to be coordinated with the trading pattern, sentiment and political winds. There is a fair amount that has been written on the subject, but primarily on longer-term trends. Keeping it on a day trade-type basis simplifies."

*** And another:

"The reality is that we Americans as a whole are in no position to control their government. If we fell pray to a world demanding our debt be paid, our leaders would do so, exclaiming, ‘It was the best thing to do.’ And we all would just sit around doing nothing to stop it and have no say in the transaction. Believe me when I say this will be the end result of the United States as we know it. The world is jealous of us and will do anything to even the playing surface by lowering our standard of living.

"We are now in the final years of this turnover of America. We now are a slave country and can do nothing to reverse the course, short of civil war to change the current dictatorship!

"Not even guns and gold can save us. Move to another country with running water and no McDonald’s or Wal-Mart and you may have half a chance!"

"I blame Wal-Mart for part of this. They have taught our leaders how to make slaves cheap and crushed the manufacturers here by buying abroad by underselling good, decent, hardworking, tax-paying small-business owners, calling it competition and driving them out of business. If you want to try to save this country, STOP buying at WAL-MART and start buying everywhere else, from the few mom and pop stores left, and not from the other types – you know, the ones that come from other countries. I am not saying they’re bad, but why take a chance of giving your money to someone that may or may not be sending it somewhere else in the world?"

*** Bringing the "gift of democracy" to the desert tribes of Mesopotamia seems increasingly thankless. The Iraqis seem almost ungrateful. The International Herald Tribune reports that there were 2,300 attacks against the gift-bearers last month.

An excerpt from The Washington Times:

"Laborer Mohammad Jassem, however, defended the right of Iraqis to kill and terrify Americans and those who work with them. ‘Who told them to come here and sell our fortunes?’ he asked. ‘I would not only kill an American, I would slaughter him and drink his blood. We’ll never forget what the Americans have done to us…every honorable Iraqi approves of killing Americans and beheading them. They should get out of our country.’

The Daily Reckoning