Weekend Edition

Dear Reader,

Welcome to the weekend edition of Casey's Daily Dispatch, a compilation of our favorite stories from the week for the time-stressed readers.

Of course, if you want to read all of the Daily Dispatches from the week, you may do so in the archives at CaseyResearch.com.

Get a Degree in Energy Investing

For the first time ever, we are making the audio from one of our Casey Research Summits available in a complete CD set. This is particularly timely, because the recordings of our recent Energy and Special Situations Summit contain timeless insights on virtually everything you need to know about the entire energy sector.

The CD set includes 20 hours of detail on the specific opportunities – and risks – in oil, solar, geothermal, wind, lithium, uranium, natural gas, and more. Plus, learn how to profit from “special situations” in potash, real estate, and rare earth elements.

While the specific energy stocks discussed at length in the CDs will make you back the cost of buying the set many times over, even more valuable are the priceless insights and information on what’s really important to understand about the various energy sectors moving forward.

Without any exaggeration, it’s like buying an advanced education in energy investing, but at a fraction of the cost… and a fraction of the time it would take to get this education anywhere else. Here’s the link to learn more.

A Chinese Take on the East German Question

A couple of weeks ago, I kicked off an exchange with readers by running an article on the mindset of the East Germans right after the fall of the Berlin Wall.

The latest entry, from a dear reader that was raised in China but now lives in Canada, I found to be interesting and worth reprinting.

Hi, David,

I'd like to add my 2 cents to the East Germany vs. West Germany topic that you've been discussing for the past two days in Daily Dispatch.

What has not been said is actual example(s) of how fast a former communist society can change with respect to people's attitude toward work. I've never been to Germany, but I've witnessed the change of China as I grew up in Beijing. There are many examples I can think of, but let me just pick the city bus system in Beijing.

In the 1980's and earlier, the buses in Beijing were run by the government, where the employees had guaranteed lifelong employment. It was horrible for passengers. The buses were old, dirty, crowded, slow, and the drivers and ticket collectors were rude and lazy. The same sort of work ethic as described about East Germans.

Then, the government turned some of those same employees into what essentially are commissioned salesmen. They'd get a basic salary, but the bonus money depended on the profitability of the route. The government also loosened up on the structure of bus routes. New types of vehicles were added, overlapping with existing routes. Those new types of buses have fewer stops, air conditioners, guaranteed seating for every passenger, etc. You'd pay a higher fare for those. Gradually, a variety of competitive elements were created in the bus system.

The bus employees first complained about losing the "iron rice bowl." Not all employees were switched to the new system. But among those who did, their attitudes toward passengers changed. Suddenly, I find myself being wooed at the bus stops to get on their new, more expensive type of bus. As a consumer in a communist country, I had never been treated like a king before, until then.

So, I can relate to what has been said about East German people. But I think that's just a static snapshot at that moment. Give them free-market economy, not handouts, and I'd bet you'll see how fast people's attitude toward work changes.

Fast forward 20 years to the present, and change the location to Toronto, Canada, where I now live and take the bus to work every day. The bus system in Toronto is run by the government, where the employees have guaranteed lifelong employment in the form of labor union. It is horrible for passengers. The buses and subways are old, dirty, crowded, slow, and the drivers and ticket collectors are rude and lazy. You see a pattern here? I'm told that the public transit in Toronto is one of the best in North America. If that's so, public transit authorities in North America should really learn market economy from communist China.

On an unrelated topic... in your Nov 6 Daily Dispatch, you said you were "being told as a child to clean my plate because there were millions of people starving in China." I must protest. As a child in China, I vividly remember that my father used to tell me to eat up everything in my rice bowl because there were millions of people starving in *Africa*! Apparently, parents around the world could not think of any other ideas to encourage their children to eat.

David again. On the topic of buses, when we used to live in Santiago, Chile, the buses were privatized – with some 2,000 companies competing for business on the city streets. The result was, literally, bus races, as each tried to beat the competition to the next bus stop. The good news was that you didn’t have to wait long for a bus. The bad news was that getting on and off a bus in Santiago was a dangerous proposition, given the drivers made every attempt to minimize the amount of time they remained stationary.

In one case I remember, the bus driver didn’t want to stop to let just one person off, because it would take him out of the race to a big bus stop down the road. The rider whose stop was now fading into the distance was, understandably, unhappy and was letting the driver know it in no uncertain terms. So the driver slowed down just a little as he went around a corner, then adroitly flipped the door open behind the disgruntled man and gave him the gentlest of nudges, sending him flying out of the door and into an array of garbage cans.

Of course, if the drivers had exercised even a modicum of common sense, or followed even the sketchiest of traffic laws, the situation could have been much improved. The long and short of it is that the local government stepped back into the market and culled the herd of competing companies to just 10, with strict threats to pull the license if their drivers drove recklessly. And, just to be sure, insisted that new buses be mechanically limited to go no more than 60 km/h and are unable to move until the doors are completely closed.

Humans are nothing if not predictable (even in our unpredictability!). Given the right incentive – for example, an extra payout at the end of the day based on the number of passengers carried – and in the absence of sufficient disincentives for losing passengers out open doors on corners, the Santiago bus races were foreseeable.

On a day less hectic than this, I might ponder the example provided by the Santiago bus races – specifically as it relates to the constrained versus unconstrained view of humanity. But for now, I’ll leave it as food for thought.

The Forgotten Yellow Metal

By Joe Hung, Casey Energy Division

As gold pushes US$1,170 and potentially even higher over the next few months, many investors have turned their attention towards the metal. At the energy department, however, we are more focused on the other yellow metal, the one that has been forgotten by the mainstream media and languishing since its bull market of 2007/2008. Currently, companies looking for this metal are still trading at lows and the sector has never really recovered since the drop in late 2008.

I’m talking about uranium – the metal used to power nuclear reactors across the world. From the period of 2005 to mid-2007, the price of uranium went from US$20 to a high of almost US$140 per pound, a shocking 700% increase. We believe that the current price of US$44.00 will not be around for long, and that in a few years we could see another dramatic rise in price. Even with the weak uranium market, however, selective opportunities in uranium stocks have treated us very well. The chart below is of a uranium company we invested in, in November 2008, for a whopping one-year gain of as much as 1,200%:

Though returns like this definitely don’t come about with any great frequency, a double or better is possible with the new recommendation in uranium that we have just made in the Casey Energy Report -- the first junior company to find a real deposit in the Athabasca Basin, the most prolific uranium-producing basin in the world. Within our portfolio, we also have three companies with all the right elements to be the next company to find such a deposit. If they do, their stock prices will become overnight sensations and will bring investors enough returns to laugh off the previous recession.

(Sorry, it would be unfair to paying subscribers to give you the names of these companies here, but I can do the next best thing by pointing you to our no-risk 3-month trial offer. Click here for more.)

So, why do we like uranium? Several reasons:

1. The world must go nuclear – Nuclear has been an unpopular option for the world ever since the Three Mile Island incident in 1979 and Chernobyl in 1986. However, as the world looks to cut back carbon emissions, even former opponents of nuclear are beginning to embrace it as a lesser evil. Consider the words from the co-founder of Greenpeace, Patrick Moore: “Nuclear energy is a key technology for the future and [there] should be a resurgence of this technology happening now.”
   
2. The ending of the HEU Agreement between the U.S. and Russia in 2013 – The HEU Agreement between the U.S. and Russia, also dubbed the Megatons-to-Megawatts program, converted Russian nuclear warheads to useable fuel for American nuclear reactors. This has supplied a large percentage of the American uranium needs for the past decade. The program is ending in 2013, and the uranium to replace this source will need to come from somewhere else.
   
3. The China factor – China currently generates about 3% of its energy from nuclear. If it reaches the regional average of 25%, it will need 8 times more reactors than it has now, putting further pressure on global uranium stocks.

Central Banks Banking on Gold

That’s the title of a just released report by Raymond James, which is far more commodity savvy than many of its competitors. Following are some excerpts you might find of interest…

The major paradigm shift we have seen evolve recently is the transition of central banks from net sellers of gold to net buyers. Given the inelasticity of mine supply, this shift has significant implications for gold’s supply/demand equation over the medium term. Furthermore, the symbolic implications of central banks buying gold (i.e., indicating a lack of confidence in the U.S. dollar) should underpin healthy retail investment demand as well. We believe this lack of confidence may not be restored for several years given the extent money supply has increased in the U.S. and the extravagant levels of U.S. public debt that will be further encumbered by the building burden of an aging population and health care inflation.

We continue to believe the equities are roughly 30% undervalued versus the gold price, and as a result we recommend investors add to their precious metal equities positions. We also suggest, based on historic valuation metrics, that the Junior/Mid‐tier producers offer better upside at current levels.

And…

EXPECT GOLD & SILVER PRICES TO REMAIN STRONG

Since the end of the third quarter gold and silver prices are up 16% and 9%, respectively. In absolute terms gold is up $163/oz, an impressive result; however, we would argue this is just the beginning of a longer‐term period of strong precious metal prices based on:

1. Investment demand continues to be extraordinarily strong (and we see no reason for this to change) given the loss of confidence in both the financial system and policy makers and as investors prioritize capital preservation over capital appreciation, increasing portfolio allocation to more creditworthy or “safe haven” investments, i.e., precious metals. Regaining this loss of confidence in the financial system and policy makers, in our view, will take a considerable amount of time, earning precious metals a permanent place in any prudent portfolio and underpinning prices over the longer term.

2. The specter of future inflation is building. Recall it is the fear of inflation that tends to drive the metal prices higher.

3. Declining supply – central banks have moved from net sellers to net buyers. This is a significant structural change in the gold market as central banks have been net sellers for two decades. Central banks looking to diversify their reserves in light of the rampant currency debasement have very few options available, and we would argue gold is the most attractive. It is also important to note new mine supply has essentially just been replacing aging mines. Given the long lead time between finding a deposit and actually moving it through to production is on average around 10 years, new mine supply remains largely inelastic. Adding further pressure on the supply side of the equation is the dearth of new discoveries and the increasingly challenging mine development environment.

4. All‐in costs remain high – aging mines are experiencing declining grades, and new projects tend to be of lower quality, requiring higher and higher metal prices in economic studies, which are still returning IRRs in the mid to high teens.

5. Very low/negative real rates – lowers the opportunity cost of holding hard assets. Most major countries (including the U.S.) continue to support a low interest rate environment; we suspect this will be the case for some time to come as increasing rates may derail recoveries.

On point #3, Doug Casey points out in his article The Greater Depression Is Here in this month’s edition of The Casey Report (more here), since peaking in 2001 at 83.7 million ounces, annual gold production steadily fell throughout most of the period and has only recently shown an upswing. When you take out the impact of dehedging, gold from new mine supply in the third quarter came in at about 73 million ounces on an annualized basis.

That is not to say that the world is running out of gold, but anyone in the industry will tell you that it’s not an easy business to be in under the best of circumstances.

Now more than ever, finding a new deposit of any potential size, then raising the capital to evaluate its potential as a mine, then raising the additional capital to turn it into a mine – all the while fighting a rear guard battle against NGOs, environmentalists, greedy politicians, and, depending on where you operate, armed rebels – requires a Herculean effort. There’s an old adage in the business that only one in a hundred discoveries becomes a mine, and I suspect that the success rate could be even lower than that.

Simply, building a mine is very much not like building a new box store or fast food outlet on a conveniently accessible corner.

Meanwhile, against new supply, the demand for gold is currently running at an annualized pace of over 100 million ounces.

Of course, as demand increases, so, typically, does the number of people willing to ship their treasured family heirlooms off to the nearest smelter. That makes up a lot of the shortfall between new mine supply and demand: recycled gold is the second largest source of supply after new mine production.

Interestingly, even with gold’s more or less steady rise in price, the supply of recycled gold has been steeply falling throughout 2009 – from 18.2 million ounces in the first quarter, down to just 9.02 million ounces in the third quarter.

Even more eye opening is the shift in supplies to the market from central bank selling, which has gone from 1.9 million ounces being sold into the market in the first quarter of 2009, to a net purchase of almost half a million ounces in the third, reflecting a year-on-year fall of 83%.

So, what’s important in all of this?

I would contend that, no matter what else comes out of the current crisis, the true nature of the fiat currencies has been revealed for all to see. And gold has been once again found to be the only reliable form of money.

The long-term consequences of these revelations (which are not revelations at all to most of you, dear readers) are that anyone who’s been paying attention – individual and institutional investors – will never again dismiss gold as having no role to play in modern finance.

Further, the idea that central banks should divest themselves of their only tangible asset – gold – has been relegated to the trash heap of history. It is thus that we are now hearing influential voices in China calling for an increase in its reserves of another 159 million troy ounces of gold, roughly twice annual global gold production. At $1,200 gold, that means they’d have to spend $190.8 billion, which, while a lot, is really not all that much compared to the size of their reserves of U.S. dollars.

Of course, were they to try and aggressively meet those sorts of targets – competing as they are with other central banks that have now seen the golden light – the price of gold would head much, much higher. That argues for them trying to do off-market transactions – buying whatever gold the IMF wants to sell before it hits the market, for example. And it argues for them rebuilding their gold reserves at a more measured pace.

But most of all, it says that there is a new and very solid floor under the price of gold. Can it correct 5 or 10% in the event of a broader market sell-off? Sure. But more than that? I doubt it.

(One of the best ways to stay closely in touch with the gold and silver markets is with a subscription to Casey’s Gold & Resource Report, which, at $39 a year and with a 3-month trial offer is practically a gift… a gift you can learn more about and sign up for by clicking here.)

The CFTC Prepares to Strike

A Special Casey’s Daily Dispatch Report by Doug Hornig

As David has often said, in order to understand markets these days, you have first to look to Washington. And what emerges next from that shining city is apt to have a profound effect on commodities markets for a long time to come.

The Commodities Futures Trading Commission (CFTC) is currently preparing an overhaul of the way commodities are traded, supposedly in order to make the markets more supply/demand-driven and less susceptible to “manipulation” by speculators.

This notion has a lot of traction in DC, as speculators have been blamed any time markets get out of whack, as during last year’s run-up in oil prices. President Obama is committed to “making sure it doesn’t happen again,” and he’s apt to have strong support among average citizens who believe they’re routinely ripped off by greedy traders who care nothing for Main Street. New regulations are due by the end of the year.

Yes, reformers have come and gone before, and the expectation is always that there will be a lot of huffing and puffing, after which things will essentially stay the same. This time, though, just might be different.

Obama’s appointee to chair the CFTC, Gary Gensler, has consistently maintained that he wants some very specific changes, most importantly the imposition of strict position limits on those trading commodity futures contracts, including energy and the precious metals. He may get them.

And then what? Well, commissioners have already admitted that position limits could have a negative effect on ETFs (oil, gas) that depend on trading large numbers of contracts – United States Natural Gas Fund (UNG), for instance, had to put a moratorium on the issuance of new shares. But we’re assured that the CFTC doesn’t want to destroy ETFs, which give small investors the opportunity to benefit from commodity trends without having to dabble in futures. As one commissioner put it, “If UNG becomes more limited, an alternative ETF will pop up alongside it.” Problem solved. Maybe.

The most potentially explosive developments, though, could come with gold and silver. Long futures contracts in the metals have generally been spread among a large number of market participants. The corresponding short contracts, however (and there must be a short for every long), have been highly concentrated. Just two U.S. banks are presently short more than 123,000 gold contracts (better than 12.3 million ounces).

What if the CFTC declared that henceforth traders would be limited to a few thousand contracts in any given month? (3,000 is the putative Comex limit, though it is not really enforced.) All those tens of thousands of short contracts would have to be unwound.

The net result would depend on the time frame involved, as well as other factors such as which, if any, banks would get exemptions. Nevertheless, a forced unwinding of any market position tends to result in a spike in the price of the underlying asset. That could easily happen, and it could be dramatic. And what of the future, after position limits are firmly in place? Will the number of those traders willing to take the short side expand to take up the slack? If it doesn’t, then the longs will have to bid up the price until they find a level at which there are enough takers to satisfy demand.

Higher gold and silver prices are pretty much baked in the cake if the CFTC does what it says it’s going to do. Over the past two months, gold and silver have been on a tear. Has the market already begun to price in the “CFTC effect?” Stay tuned.

And that, dear reader, is that for this week. See you on Monday!

David Galland
Managing Director