Welcome to “The Room”

Written: December 19, 2008


Dear Readers,

On Wednesday of this week, I closed out my bullish futures position on gold, at $872, for a tidy profit of $4,500 per contract.

A sudden change of heart on our favorite metal?

Hardly, as I still retain a considerable core position in gold and gold stocks, which I have no intention of selling at anywhere near current prices.

In fact, this week I raised my hand to participate in a private placement for a deeply undervalued junior gold exploration/development company. That’s the first time I’ve done that in several months.

So, my view on the outlook for gold over the next couple of years remains fully intact. Rather, closing my futures position reflects the following strategic considerations:

1. Play the trading range. While the market is decidedly warming up to gold, the trading herd is still playing a range that seems set between about $750 and $900. While an increasing number of individuals and even institutions are beginning to grasp the import of the Fed’s move toward quantitative easing, the focus of the herd is still mostly on the deflationary pressures now controlling the economy. Thus, the just mentioned trading range will likely remain intact for awhile longer before ultimately being taken out decisively. So, buying near the bottom of the range and selling near the top, with the corner of your portfolio dedicated to trading, makes a lot of sense.
   
2. See a profit, take a profit. In markets such as these, one should not hesitate to take a profit when one is available. That is a strategy we have been using in The Casey Report, and it has paid off handsomely. A recent example is provided by our short position in Emcor (EME), a heavy construction company, which was initially recommended on 8/1/08 when it was trading at $30.34.
   In our December 1 edition, with EME trading down to $15.83, we recommended closing the position for a quick four-month gain of 92%.
   The reason for closing the position was no more complex than the fact that the government’s massive and increasingly activist involvement in today’s economy, coupled with historic levels of volatility, make the short-term price action of almost any investment extremely unpredictable.
   Thus, see a profit, take a profit… especially when it is in the high double digits over a short period of time. The rest of the story, you see, is that today, as I write, EME has rebounded all the way back to $20 per share, based on a wide impression that Obama’s plan to launch a massive public works program will benefit the construction companies. (It will only help a relatively few, but the sector has a whole has risen nonetheless.)

Gold will have its day – and when that day comes, it will cut through the top end of the range and keep on going. While no one can say with any certainty, I don’t think we’ll have to wait overly long for the next leg up. But in the interim, trading the range with money you can afford to lose if things move sharply against you can be good sport (few things are more exhilarating than a big investment win).

If you need a reminder that holding a core position in gold can play an essential role in surviving the unfolding carnage, it is worth remembering that, on this very same day a year ago, gold was trading at $795. As I write, it is at $837. While that annualized return is nothing to write home about under normal circumstances, it sure beats the S&P 500. On this day last year, it was trading at about 1450 – a glance at the screen shows me it has fallen all the way to 890, a loss of 39%.

During breakfast last Sunday with a friend who sits near the top of the feeding chain in the world of high finance, he commented, “We are beginning to get interested in gold.”

“We,” in this case, is one of the largest and most influential banks in the country.

Hang in there; when the big institutions start moving into gold, it will be breathtaking…

Refi Your House

I know, because I interact with so many of you, that readers of our various Casey Research publications are far deeper thinkers than the general population. Thus, I probably don’t need to tell you that there is more than one way to take advantage of the scenario we are forecasting – lightly summed up as a deflationary period of fairly modest duration, giving way to a serious inflation or, more likely, serious stagflation.

One move you can make today to take advantage of the Fed’s new zero interest rate policy is to refinance your mortgage at today’s give away prices. To get the latest, I just spoke with my former partner, Frank Trotter, president of EverBank Direct. EverBank, which continues to be very profitable, has stayed well out of trouble thanks to a long-standing conservative lending posture.

In our call, Frank told me that last Wednesday was the biggest “lock day” in the company’s history. The term refers to people who have applied for a mortgage deciding to move ahead, signaled by locking in the rate by paying a modest fee.

Confirming the obvious, Frank said that hardly anyone is looking to refinance a new house these days, or is interested in a flexible-rate loan, but rather are refinancing an existing mortgage with a 15- or 30-year fixed-rate term.

If your credit is good and your loan is conforming, which generally means below $625,500 thanks to recent loosening by the government, you can lock in a rate at around 5%. A non-conforming jumbo loan – for which the secondary market has been greatly reduced – will cost you about 7%.

When I last refinanced, a few years back, at about 6.25%, I never anticipated having to refinance again… but with a 5% rate, how can I resist? And so I won’t.

If it is helpful to you, call EverBank for a quote at 1-877-436-4381 (or go to EverBank.com), then use that quote to try to get an even better rate from a local lender. If they can’t beat it, then EverBank may be your best option. I have done my last two mortgages through them and they have been very efficient.

In the interest of full disclosure, I still own some shares in the privately held EverBank and so would, in a greatly diluted way, benefit if you did your mortgage through them. Maybe enough for a cup of coffee and a bagel. So, consider this really just an introduction of mutual acquaintances.

Whatever you do, don’t miss this opportunity to lock in money for next to nothing…

Skepticism Rewarded

In last week’s edition of these musings, I wrote…

When asked, over the past couple of weeks, whether I thought the automakers would get their bailout, my steady answer has been along the lines of, “Absolutely, no question. All the so-called debate is nothing more than political theater.”

You might assume, therefore, that I am chagrined by reading the news this morning and learning that the Senate rejected the hastily cobbled-together auto bailout bill. Your assumption would be wrong.

And…

Considering the numbers involved, the $15 billion the car makers are looking for are nothing more than table scraps. They’ll get their bailout.

This morning, while driving the kids to school, I heard a news report on the public radio that Bush and Paulson were considering letting the automobile zombies go into an “orderly bankruptcy.” The same story held the top position on the online news pages.

I still wasn’t buying it.

I didn’t have to wait long for my continued skepticism to be rewarded. As I sat down to begin writing today, the following flashed across the screens, from Bloomberg…

General Motors Corp. and Chrysler LLC will get $13.4 billion in initial government loans to keep operating in exchange for a restructuring under a rescue plan announced by President George W. Bush.

A bankruptcy is unlikely to work for the automakers at this time and can’t be allowed, Bush said at the White House.
“These are not ordinary circumstances,” Bush said. “In the midst of a financial crisis and a recession, allowing the U.S. auto industry to collapse is not a responsible course of action.”
The money will be drawn from the Troubled Asset Relief Program and the automakers will get an additional $4 billion from the fund in February for a total of $17.4 billion in assistance, according to a statement from the Bush administration. The funds would allow GM and Chrysler to keep operating until March.

My aforementioned skepticism was not the result of any “insider” insights, but rather a basic understanding of government as regular folks who will do whatever it takes to get reelected. They are no different from any other group of individuals who daily make calculations that they think will likely help them enhance their income or, as in this case, keep their jobs.

Once you clearly understand that the bureaucrats are not some sort of elevated class of humanoid, then predicting their actions in any given situation is falling-off-a-log simple.

In fact, the last thing I can remember the U.S. government doing that actually surprised me was all the way back in 1981, when President Reagan fired the air traffic controllers.

Our long-standing forecast that the government would engage in a massive inflation to try and counteract the current crisis comes from that same understanding. And, again, it hasn’t disappointed; based on figures released by the Fed this week, the monetary base has grown 101% over the last 12 months alone.

And they’ll keep at it until they are sure the economy is out of the woods… at which point, they’ll then have to switch into damage control. When that time comes, you can take it to the bank that the Fed will apply a Volcker-like solution – raising interest rates sharply -- because Volcker’s much-hailed bravado at the time offers a rare example of something the Fed has done that actually worked.

(Of course, as the prices of things begin spiraling out of control, we’ll be looking to sell our greatly appreciated inflation hedges to the inrushing crowd.)

It is hard to stress how important it is to pretty much ignore the constant chatter that assaults the mind these days, and pay attention only to inputs that help you answer the question, “What are the political calculations now being made to assure a leg up over the competition in the next election?”

Answer that, and you’ll have a very good idea of how things will shake out.

Since we’re on the topic of actions by the government, here’s the latest from what’s going on down at the Fed, just in from our own Bud Conrad…

The Excess of Excess Reserves

By Bud Conrad

The following chart is yet one more chart showing how the Fed is pumping out money. The measure is one of the most basic measures called Monetary Base. This one shows the components to see inside as to what is going on. It is updated with the data provided December 17. The monetary base is still screaming higher. It is composed of the currency that we know as paper dollars in our pockets, plus the deposits at the Fed owned by commercial banks. Traditionally only a modest amount of required reserves are on deposit. This required amount is a small fraction of banks’ deposits. The growing item is reserves that exceed the requirement.

Usually banks draw the excess down from the Fed to make loans to their customers. We can see that these reserves are not being drawn down. This is at the center of congressmen and others who complain that despite the bailouts, banks are not lending as fast as they could. In fairness, banks are in fact increasing loans, but not at the rate they could if they used these excess reserves. This is the famous limitation of the Fed of “Pushing on a string.”





So you know, the excess reserves and monetary base grew about $185 billion in two weeks.

Planet Moron

For this next section, I am borrowing the name of a very funny website, PlanetMoron.com, because it just seems so appropriate. While I could write a page or two on each of these items, in the interest of time and space, I’ll summarize.

• Where Was the SEC As the Swindler Made Off with $50 Billion? You don’t need me to relate the story of Bernard Madoff, the New York money manager who made off with $50 billion of client money. I will, however, comment that while I feel sorry for the swindled clients, I also see a silver lining in this ugly affair. It is that the next time someone says, “We need more regulation,” I can now answer, “Well, what about that Bernard Madoff thing? You know, where the SEC audited his business in 2005 and 2007 and, despite a number of tangible warnings, missed the fraud?”
  
  In my admittedly lonely view, the Madoff affair makes the case for less, not more, regulation.
  That’s because regulation or, more accurately, the false comfort that comes from same, creates faith in a government bureaucracy where, at best, the practitioners are indifferent to real-world concerns such as earning money by providing a valuable good or service.
  Without the SEC, a private organization whose very survival would depend on doing sound due diligence would exist. In addition, a serious investor would likely demand a second opinion before shelling over $10 billion. As it was, everyone from individual investors to managers of managers simply assumed that Madoff was on the level, because his firm was regulated. As we now know, that has turned out to be a very expensive assumption.
  
• Government: As Good for Your Health As It Is for Your Wealth. During the housing bubble, state governments predictably began basing forward-looking spending commitments on the quaint notion best expressed as “Good times are here to stay!” Or maybe, “And they lived happily ever after…”
  This week, faced with a resulting $400 million budget deficit, New York Governor David Patterson announced a wide range of higher fees as well as a draconian new sales tax on sugary soft drinks, exempting diet soft drinks. That latter action caused one bright, Nicholas D. Kristof, to opine in the New York Times…
  
  “Mr. Paterson suggested the tax — an 18 percent sales tax on soft drinks and other nondiet sugary beverages — to help raise $400 million a year to plug a hole in the state budget. But it’s also a landmark effort that, if other states follow, could help make us healthier.”
  
  While I could wax sarcastically about Mr. Kristof’s apparent need for the government to monitor his activities to assure he acts in a healthful fashion, I will instead let our own Shannara Johnson weigh in on the merits of diet soda, excerpting an article titled “Killer Sweets” she wrote for our now defunct but fondly remembered publication “What We Now Know”…
  
  As to the weight-controlling aspect: phenylalanine and aspartic acid, components of aspartame, stimulate the release of insulin in the body. “Rapid, strong spikes in insulin remove all glucose from the blood-stream and store it as fat. This can result in hypoglycemia and sugar cravings,” writes Christine Lydon, MD, in her ’99 article in Oxygen Magazine. “Additionally, it has been demonstrated to inhibit carbohydrate-induced synthesis of the neurotransmitter serotonin, which signals that the body is satiated.” Notably, aspartame and similar artificial sweeteners are customarily used as feed additives in the commercial swine industry. The purpose? To ensure the pigs stay perpetually hungry.
  
  The message is clear: Don’t use aspartame as part of a weight-loss diet. A recent study showed that a control group of people switching to an aspartame-free diet experienced an average weight loss of 19 pounds.
  However, weight gain is one of the more harmless side effects of aspartame, which many scientists consider a dangerous neurotoxin. Independent researchers found 92 physical manifestations believed to be caused by regular intake of aspartame. In February 1994, the U.S. Department of Health and Human Services released an extensive list of aspartame-induced reactions, encompassing everything from headaches, dizziness, seizures and convulsions, memory loss, slurring of speech, blurred vision, to chronic fatigue syndrome, infertility, and death. “Aspartame Disease” is also known to mimic syndromes like fibromyalgia, Parkinson’s, Alzheimer’s, Multiple Sclerosis, etc. --with symptoms diminishing or even disappearing after use of the sweetener has been stopped.
  
  To read Shannara’s full article for more on the science of why aspartame is bad for you, click here. In the meantime, I suspect that the non-diet soda business just across the border in New Jersey is about to see a brisk pickup in sales.
  
• Kill the Credit Card Companies! One of the more interesting aspects of the current downturn has been that people have been more willing to walk away from their home mortgages than to stop paying on their credit cards. That is a 180-degree shift from prior recessions. Even so, as the economic straits grow more dire, credit card companies are following mortgage lenders in experiencing a rising wave of defaults that threaten their very survival.
  Surviving will soon become even more difficult thanks to a sizable new body of regulations just passed that significantly overhauls how credit card companies do business. As you can imagine, the well-intentioned regulatory changes all accredit to the long-suffering consumers, and none to the credit-offering companies.
  Now, I am no fan of many of the practices of today’s credit card companies, but this is – again -- a case of “buyer beware.” Anyone who takes a credit card knows that they are entering into an agreement whereby they can buy things on credit but must pay a certain amount on the balance by a certain day each month. And you would have to live under a rock to not know that missing a payment date has dire financial consequences.
  While there are no knuckles involved, credit card borrowing is somewhat akin to borrowing from a loan shark. It is nothing akin to borrowing $20 from Mom to get you to the next payday.
  But, given the billions now revolving in credit card accounts, these companies clearly provide a service that people find useful. Layering on yet more regulation because some people get themselves in real trouble with debt (perhaps, taking their lead from the government?) threatens to administer a coup de grace to the struggling credit card companies. Not exactly what the economy needs just now.
  Of course, as they start to fold, the government will likely be called to provide yet another bailout. As such, by the time the dust settles, it wouldn’t surprise me to see taxpayers adding the role of “credit card lenders of last resort” to their collective resume, just as it is already the case in regards to the nation’s mortgage business.
  
• Just When You Thought You Had Heard It All. While I try to avoid the sort of sensationalist news stories that serve the same basic function as did the gladiatorial arena in Rome’s bloody era, a story caught my eye this week that I thought was worth sharing. It is the almost unfathomable tale of a 12-year-old girl violently arrested by mistake and then arrested again, on purpose, and for nothing more than spite. It’s worth a read, just as a reminder that constant vigilance against tyranny is required. Read it here.

Since we are on the topic of government and vigilance, this just in from Donald Grove, our Washington correspondent…

Pushing on a String

By Don Grove

I am reminded that Japan went for a long time essentially offering money rent free without inspiring their gun-shy consumers to partake. What’s a central bank to do if it lowers rates but still no one borrows? We have seen one example with stimulus checks – that is, just give money away without requiring that consumers borrow at all. In reviewing my notes from the days before Bernanke replaced Greenspan, I found a discussion of ways the Fed can circumvent the constraints of the Federal Reserve Act, essentially making federal agencies the consumer when the average citizen refuses to play ball.

Before serving as chairman of President Bush’s Council of Economic Advisors, Ben Bernanke served on the Federal Reserve’s Board of Governors. As a Fed governor, addressing the National Economists Club in Washington, DC, on November 21, 2002, Bernanke made his often-cited “helicopter” reference, delivered in the context of combating deflation. He said that “the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.” He explained that “[b]y increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services.” See www.federalreserve.gov/boarddocs/spe... .

Three pages later he explained that, “a money-financed tax cut [a tax cut backed by open market purchases by the Fed] is essentially equivalent to Milton Friedman’s famous helicopter drop of money.” He also stated that “prevention of deflation remains preferable to having to cure it. If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.” You can’t push on a string, however.

The government itself will have to become the consumer after American citizens, whose consumption the world has so long relied on, decide like the Japanese to become savers. This concept was discussed six months after the “printing press speech” by Evan Koenig & Jim Dolmas, economists at the Federal Reserve Bank of Dallas, in the July/August 2003 issue of Southwest Economy. See http://www.dallasfed.org/research/sw... . In their article, Monetary Policy in a Zero-interest-rate Economy, Koenig and Dolmas elaborated, explaining that the Fed could implement what is “essentially the classic textbook policy of dropping freshly printed money from a helicopter” by buying goods and services through other government agencies to avoid violation of the Federal Reserve Act.

At some point, the U.S. government will have as much trouble getting anyone to accept payment for even such surreptitious consumption as did the Continental Congress during the Revolutionary War. Oddly, Benjamin Franklin seemed to recognize monetary inflation as theft at the time but was not disturbed and, instead, seemed to revel in the convenience of the technique. In April 1779, he observed: “This currency, as we manage it, is a wonderful machine. It performs its office when we issue it; it pays and clothes troops, and provides victuals and ammunition; and when we are obliged to issue a quantity excessive, it pays itself off by depreciation.”

Constant vigilance.

Just for Fun

Those of you who were indignant at the sight of the president of these United States dodging leather in Baghdad this past week won’t want to click the link here to try a new online game based on that event that has taken the world by storm.

For the rest of you, see if you can beat my first game score of two.

In all seriousness, I actually thought the president handled himself very well during and after the incident. Not just in his physical ability to duck shoes, but also in that he quickly assessed the situation and immediately signaled to the unbelievably-slow-to-act secret service to chill out.

So, there’s that.

And That’s It for This Year

And that, dear readers, is that for this week – and for the year, as The Room goes on hiatus for the next two holiday weeks.

It has been one heck of a year, and 2009 promises to be yet another one for the record books. Together, we will hopefully keep our wits, our sense of humor, and our finances all in good order.

As I finish up, gold seems to be stuck hard at $839 and the stock market is flat, failing to maintain a short-lived rally triggered by news of the automobile bailout.

I continue to wonder if we’re going to see a rally materialize following Obama’s inauguration, despite the obvious signs that the downturn is now moving deeper into the real economy (as opposed to just stock markets). On the one hand, a few weeks ago people seemed deluded to the point of thinking that Obama was some sort of superior human being. But today, I find myself questioning whether such a rally will materialize or the early days of the Obama administration will see a steep resumption of the stock market battering.

The reason for my questioning is that, if you credit his rhetoric, or more importantly, his cabinet selections, Obama is signaling that the big CHANGE! he ran his campaign on is, in the bright light of reality, of the weak-tea variety. In fact, it seems to me that he is determined to reconstitute the Clinton administration. In this age of high expectations and fast-moving news, the patina traditionally enjoyed by new presidents could wear off by the time Obama raises his hand on the Bible in January.

In which case, the stock market could resume its decline to the point where it is genuinely oversold… around 6,500, by my calculation.

We’ll have more on how to play things in The Casey Report and in all of our publications, throughout the new year. We may not always get everything right… in fact, you can rest assured we won’t. But likewise, you can count on us to give you the very best of our research, unfettered by bias and with eyes wide open.

Speaking of The Casey Report, the next edition, a year-end special featuring Doug Casey’s Greater Depression – Part II and a comparison by Bud Conrad of the current economic downturn to the depression of the 1930s as well as Japan’s Lost Decade, will be published Wednesday, January 7, 2009.

And so, for the last time this year, I would like to sincerely thank you for reading and for being a subscriber to a Casey Research publication!

Happy Holidays!





David Galland
Managing Director
Casey Research, LLC.