The Room 4/7/08

Dear Readers,

This week finds me writing from Room 2218 of the infamous Jekyll Island Club. The hotel's adjective comes from a secret meeting held here in 1910 involving some of America's most powerful men. Here's an official history of that seminal event...

Soon after the 1907 panic, Congress formed the National Monetary Commission to review banking policies in the United States. The committee, chaired by Senator Nelson W. Aldrich of Rhode Island, toured Europe and collected data on the various banking methods being incorporated. Using this information as a base, in November of 1910 Senator Aldrich invited several bankers and economic scholars to attend a conference on Jekyll Island. While meeting under the ruse of a duck-shooting excursion, the financial experts were in reality hunting for a way to restructure America's banking system and eliminate the possibility of future economic panics.

The 1910 "duck hunt" on Jekyll Island included Senator Nelson Aldrich, his personal secretary Arthur Shelton, former Harvard University professor of economics Dr. A. Piatt Andrew, J.P. Morgan & Co. partner Henry P. Davison, National City Bank president Frank A. Vanderlip and Kuhn, Loeb, and Co. partner Paul M. Warburg. From the start the group proceeded covertly. They began by shunning the use of their last names and met quietly at Aldrich's private railway car in New Jersey. In 1916, B. C. Forbes discussed the Jekyll conference in his book Men Who Are Making America and illuminates, "To this day these financiers are Frank and Harry and Paul [and Piatt] to one another and the late Senator remained 'Nelson' to them until his death. Later [following the Jekyll conference], Benjamin Strong, Jr., was called into frequent consultation and he joined the 'First-Name Club' as 'Ben.'"

And so it was that the Fed, that blight upon the U.S. dollar and instrument of unlimited government power, was born. Some of you, learning in last week's missive that Doug and I were heading to this place, wrote strong words condemning the place as if it had a life of its own. Like, perhaps, the set piece of one of those classic horror films.

But writing from the perspective of an instant expert (as I have only been here three days now), the hotel is grandiose and very pleasant in a Southern manor sort of way. The food is excellent, the amenities are plentiful and the weather far more agreeable than that gripping my hometown in the Northeast. I would, however, caution you to avoid the place in summer; in addition to high heat, the bugs are reputed to be both fierce and relentless. Even now, in early spring, the truth of that reputation is confirmed by the occasional no-see-um enjoying a snack at my personal expense.

Apparently, the old club had fallen into disrepair after World War II, when the money men that founded the place, including J.P. Morgan himself, stopped coming here in favor of the more refined holiday resorts of Europe. Such disrepair, in fact, that it was closed for four decades before eventually limping back into existence as a 4H camp and, some have said, even a flop house. Thanks to a substantial infusion of cash from the state of Georgia, or, more correctly, the taxpayers of Georgia, the club and its grounds have been restored to their former state of glory and are now very much up to code.

But why are Doug and I here? As much as I wish it was pure holidaying, or even plotting to replace the Fed system and returning to one that is actually based on something more tangible than political whim, we are here at the invitation from a friendly competitor, Porter Stansberry, to attend his annual editors conference.

It has been an interesting experience because Stansberry tends to focus on investment areas we tend to avoid. That said, there is a solid contrarian streak that flows through the organization, such as the one that has some editors talking about homebuilders being a good buy just now.

Homebuilders? Surely you jest, I thought to myself as I listened to the presentation. But then, Steve Sjuggerud, editor of the highly popular and widely read Daily Wealth, discussed how, in a typical housing collapse, the shares in the homebuilders will go down by as much as 75% to 90%, a level that would make it seem hard to get hurt. But the more important thing is that when they rebound from those depressed levels, they can go up by as much as 300% to 500%.

Consulting the ever-reliable stock research tool on the website, I find that Steve has a point. Centrix (CTX), which is shown in the chart below and will be mentioned later, is off by about 68%.


And the following chart is from another of the nation's largest builders, Toll Brothers (TOL), which is off from about $57 to $24... a loss of about 58%.


While I personally am of the belief that the real estate that underlies these companies has a long way to go before touching bottom... a topic we'll return to momentarily, it is hard to argue with Steve's basic premise that, at some point, the home builders sell at such a steep discount that there is pretty much only one way they can move: up.

It is a classic contrarian play and one to watch for. When the blood-letting has these stocks down by 80% or more, which I think we'll see, you can assume that pretty much anyone who is going to sell will have sold... which, for the speculative minded, is the time to buy. Then sit back and wait for the next upswing. It may take quite awhile for the payoff, but provided the companies have the financial ability to avoid bankruptcy - a matter for further and serious investigation - in time the upswing will come and provide a big payday.

The Trillion-Dollar Sure Thing

After falling as low as $887 earlier in the week, gold has come quickly back to $907 as I write in the wee hours of Friday morning. Why the fall? Sometimes it is hard to divine the minds of humankind, so I'm not really sure. Misplaced optimism? Profit taking?

Even so, gold showed its spine, returning quickly to the $900 level, a level which, as we have recently discussed in this missive, may be the new base for the yellow metal... a level below which people intuit that gold is "cheap." Which it is.

Why? Because it is the U.S. dollar that most people use when assessing the value of gold. And the U.S. dollar is being increasingly put at risk by the growing list of bailouts that are hastily engineered by the government and all its various apparatchiks. During a phone call the other day, our own Bud Conrad started tallying up all the money that the government has applied or committed to the unfolding crisis so far. The sum is now closing in on one trillion dollars.

Does that number concern you? Does it surprise you? Does it make you, mouth agape, stumble toward the nearest barkeep, your hand waving in a frantic attempt to capture his attention so that he might provide a restorative?

I suspect not.

Thanks to our being inoculated with a steady dose of large numbers, a number as huge as a trillion probably only softly touches your individual consciousness. The way, perhaps, that an acquaintance in this gentle clime might helpfully brush a fallen magnolia blossom from the shoulder of your white linen suit.

The impact should, however, register more like a solid slap across your ruddy jowls delivered by a southern belle after an imprudent remark encouraged by one too many mint juleps.

But a trillion-dollar bailout, just like a three-trillion-dollar war - or more correctly, in addition to a three-trillion-dollar war -- carries with it consequences. As an old and wise friend of mine now in his twilight repose in Portugal likes to ungrammatically say, "There ain't no such thing as a free lunch." And he's right, mostly.

A basic tenet of economics has it correctly that if you flood the market with a large supply of anything, the value of each successive unit must fall. Money is no different, and monetary inflation will, as sure as day precedes night, result in price inflation. And you don't need me to tell you that the cost of pretty much everything at this point is going up.

While the sort of price inflation that eventually stirs the masses to action is still ahead of us, there is little question at this point that it is inevitable. Therefore, betting that interest rates will rise as lenders demand compensation for the anticipated erosion in the value of their money between the time it is lent and the time it is returned to them, is as close to a sure thing - even a free lunch -- as you can imagine.

In the past I have mentioned those fairly rare occasions where Doug Casey, our illustrious chairman and resident guru here at Casey Research, gets a certain look in his eye and speaks with a certain tone in his voice that indicates that he is issuing forth, oracle-like, a forecast that invariably comes true. His view on the inevitability of interest rates rising strongly over the next few years is delivered with that same force of conviction. In fact, he is on the record, as recently as yesterday morning, saying it is the single most powerful trend he sees just now.

Personally, I have placed my bets on that particular outcome and you might want to consider doing so as well.

One of the best ways to do so is with properly organized EuroDollar puts. If you are a subscriber of the International Speculator and want to re-read our write-up on that investment strategy, simply access the March 2008 issue from the archives, or by clicking here.

If you are not yet a subscriber to the International Speculator, sign up today with our 3-month, 100% satisfaction money-back guarantee. Click here to learn more and sign up now.

(There is a reason that this publication is now in its 28th year, but me telling you and seeing for yourself - without risk - are two different things.)

China on the Brink?

At our recent Scottsdale Crisis & Opportunity Summit, I had an exchange with one of our many interesting subscribers. In the interest of his privacy, and because of where he calls home, I will call him only CG. He is an international entrepreneur whose latest venture has led him to take up residence in China for some time now.

In Scottsdale he told me that he had translated some recent observations I had made in this weekly column on the topic of China for his Chinese wife. His wife, as he relayed it, said something to the effect of, "He is exactly right. How does he know this?"

While it is always flattering to have one's opinion thought worthy by those in the know, what I found most interesting, and why I share this story here, is that my comments were about the potential for civil unrest in China. Not to be repetitious, but I think the topic important enough to repeat the paragraphs which CG's wife found so revealing... here they are:

After all, while many of the world's economic observers fawn over China's remarkable progress, the facts are simple. (a) The U.S. already has the infrastructure in place that China is now trying to build; (b) China is run by a cadre of corrupt communist comrades, not exactly a model ripe for emulation by a thinking person; (c) they have over a billion mouths to feed. Which is to say, any setbacks that cause the aspirations of its large public to be disappointed could result in social unrest and worse. (The rocketing cost of rice, up almost 100% over the last year, may be a catalyst for such unrest.)

Adding to the discomfort about the potential consequences of social unrest, one only needs to glance casually into the cupboard to find tightly packed examples of the culture's apparent disdain for steadily beating hearts.

Reaching into said cupboard, we pick up Barbara Tuchman's excellent Stillwell and the American Experience in China to read her accounts of General "Vinegar Joe" Stillwell's arrival in that country in the support of Chiang Kai-Shek, as despicable a two-legged creature ever to have wandered onto the human stage. In between other duties, Joe had to restrain himself, and his men, from opening fire on officers of Mr. Kai-Shek's nationalist army that would routinely punish the loss of even so much as a single lice-ridden blanket by a foot soldier with summary execution.

But as degraded as Chiang and his fellows were, they were nothing compared to the big guy himself. Based on readings on the topic, confirmed with an airplane seat consultation with an academic who had made the study of such things his life's work, Chairman Mao was reliably responsible for the unnatural deaths of over 50,000,000 of his fellow countrymen.

To disabuse you of the notion that China has reached a level of permanent stability, I would like to share with you a YouTube video that our own Louis James brought to my attention. While I have only watched part 1 of the 8 parts available (I plan on ordering the full documentary), it's enough to give you a better sense of the place than you'll get from the mainstream media.

The documentary is called The Tank Man and it is quite moving. View it here...

One of the consequences of a sense of unsettledness in that populous nation will almost certainly be a move to stash away more gold, something they can do more easily these days, thanks to a liberalization of gold ownership that began in 2005.

How You Trade: The Casey Broker Survey...

Recently we conducted a fairly comprehensive survey of how you, our highly valued and much appreciated subscribers, traded the resource stocks. Do you favor online brokers or the full-service variety? Do those of you domiciled in the U.S. buy on Canadian markets or over-the-counter? Who are your favorite brokers? What are the best ways to save on commissions? All these questions and more were addressed in the survey, the results of which you can read by clicking here.

We would also like to thank those of you who took the time to take the survey... it offers a valuable look at an important topic.

My Mother's House - Continued

Jim Turk of likes to view the economy and markets, using as his lens grams of gold, as opposed to the U.S. dollar, a fiction at this point. Apparently a regular reader of these weekly ramblings, he weighed in on the recent discussion of the current value of my mother's childhood home, a photo of which she sent along since my first posting on the topic. Here are Jim's comments...


Here's another way of looking at the price of your mother's childhood home in Mont Clair, New Jersey, which you note was purchased in 1929 for $45,000, sold below that price almost 20 years later, and now valued by at $1.24 million. Your comment that "the actual current value of the property is likely closer to twice that value" because it was subdivided into a number of lots is a pretty good estimate when viewed in terms of real money.

The dollar in 1929 was defined as 23.222 grains of gold, which meant that one ounce could be exchanged for $20.67. So that 1929 price was really 2,177.1 ounces. Gold today is trading around $930, which means the adjusted purchase price of your mother's house, allowing for inflation and other debasement of the dollar, is $2,024,703. It's not quite double the estimate, but that could be because gold is still relatively undervalued notwithstanding its rise in price the past several years.

In any case, this example explains why gold is money -- gold communicates value very effectively over long periods of time, making it the ideal money for economic calculation.

Jim Turk

While on the topic of real estate, I'd like to share another email from one of our subscribers, Frank, on a topic that I think you'll find of interest. As you'll see, he touches on some recent transactions made by Centrix, the homebuilder mentioned earlier.

I am a subscriber to Big Gold and International Speculator.

I am a real estate developer based in Sacramento, CA and doing business throughout Northern California. If you use this information, please do not use my last name.

In the Sacramento and surrounding area MLS, 51% of all listings are REO or short sale. 61% of all actual transactions are REO or short sale. With a bulge of ARM resets through July, the existing resale market should be soft for the next fifteen months anyway.

The real blood bath is bulk residential lots, both paper lots and finished lots. The privately held builders are mostly headed to bankruptcy. Of the big residential, privately held developers in my area, literally perhaps two survive and all the rest go down. When I meet with a residential developer who wants to "fire-sale" lots, there is no possibility for a transaction because in most cases the debt exceeds the land value. Which brings up the lenders. The lenders are not foreclosing yet. Why? Are they not being leaned on by the regulators yet? The attitude from the lenders so far is denial that they have problems. Other banks have problems but not them.

Some of the public builders are starting to dump lots. 30 days ago, Centex sold approximately 880 paper lots that they had paid $60,000,000 for three years ago and had spent an additional $10,000,000 in entitlements for a total of $70,000,000. They sold these for $8,000,000. $70,000,000 to $8,000,000 in three years! Centex sold 97 finished lots on Friday, March 28, for $27,000 per lot. The cost to finish these lots was approximately $40.000 per lot, therefore the residual land value is less than zero. 12 months ago, Centex had over $900,000,000 in unrestricted cash. Today they have just over $65,000,000. Do you see a trend? I think the residential market starts to come back in California in 2-3 years. The public builders run out of lots over the next 18-24 months and California keeps growing and there is continual if diminished housing formation.

Additional bad news is that the retail and office markets are starting to roll over now. These foreclosures have not started but will soon and will lag residential by 12 months or so. Office vacancies are rising and the big box retailers and grocers have all pulled out of the market.

In a follow-up email, I asked the author of that email, "How are you going to manage?" To which Frank responded...

Thanks for asking about me. I have no bad projects, one that is underperforming has NO DEBT! That is how you survive as a developer. Plus, having turned $250,000 into $1,500,000 over the last eight years, thanks to your investment publications plus Richard Russell's Dow Theory Letters, I know I will survive just fine.

I would keep one thing in mind, just about everybody is bearish on the real estate market and that is when it will eventually turn. I say the bottom is in 2009, not 5-10 years out, and then we will start a slow process of recovery but from a much lower base.

I've said it before, and I'll say it again. We have the best subscribers in the world. If you have comments you'd like to share, drop me a note at [email protected]

Energy Chart of the Week

Natural gas markets used to be regional and disconnected. Not so long ago, the gas price in Europe bore little relation to the gas price in the United States and vice versa.

Pipelines, even just fifteen years ago, were the only way that natural gas, on a mass scale, was transported. But not anymore...

The rapid growth of the liquefied natural gas (LNG) business has transformed natural gas into a global commodity. Nations like Japan now rely on LNG supertankers for the fuel to meet a significant chunk of their energy needs.

LNG is linking together natural gas markets from around the world. It's allowed the tiny Middle Eastern nation of Qatar, which has the world's third largest natural gas reserves (after Russia and Iran), to become an energy superpower.

Generally, the higher associated costs of LNG (liquefaction, transportation, regasification) have meant that the LNG price has been higher than the U.S. domestic price. This trend flipped between 2003 and 2006 due to a sudden uptick in LNG supply followed by Hurricanes Rita and Katrina, which wiped out production in the Gulf of Mexico and drove up domestic prices.

[click to enlarge]

In the last two years, we've seen LNG prices rise higher than Henry Hub prices once again. Indonesia's state-owned Pertamina just negotiated a deal with Japanese gas companies to sell LNG at over US$10/MMBtu until 2011. The Japanese are competing with Taiwan, South Korea, and a fast-growing Chinese market, all of which are clamoring for more LNG. When a minor earthquake took a Japanese nuclear power plant offline, Japan had to scramble to pick LNG for its natural gas-generated electricity, paying over US$20/MMBtu for some cargos, proof that its deal with Pertamina is no stretch and might actually look like a steal in a few years.

Another factor that few investors realize is that LNG prices in Asia are tied to the Japan Crude Cocktail, a benchmark for crude oil markets in the region. As the dynamics of Peak Oil make themselves felt, LNG prices will rise in tandem with oil prices.

Combine this with a growing need for cleaner fuels, like natural gas, and it's clear that the LNG market, and consequently LNG prices, are headed higher for a long time to come.

[Ed. Note: Jeffrey Brown, one of the faculty members at our Scottsdale Summit, is a petroleum geologist. He gave a very compelling presentation on the concept of the Export Land Model, which shows how declining production combined with rising consumption can result in oil & gas export countries rapidly reaching the point where they can no longer export.

Among many interesting points he made during his presentation, the most interesting was that, based on current trends, Mexico will ship its last barrel of oil to the U.S. in or around 2014... just 6 years from now.

This has, in my opinion, huge implications. For one, Mexico is currently the second largest source of oil for the U.S., so we will have to fight it out with our international competitors to replace that oil. Secondly, Mexico gets something like 65% of its GDP from its oil exports... which means we could see some real trouble south of the border.

You can read some articles by Jeffrey on the Export Land Model on, but for ways to invest in this trend, there is no better source than the Casey Energy Speculator or, for the more active traders among you, the Casey Energy Confidential. The trend of higher oil prices is a trend in motion that will stay in motion for years to come... so getting positioned in the right plays now should pay off in spades going forward.]


  • LAX Phyle. We have yet another brave individual willing to help coordinate a get-together with other members of the Casey "phyle" (yet-to-be-named)... this time in Los Angeles. If you live in that area and would like to meet up for a cup of coffee down at the corner store (or whatever passes for same in a city of 3.8 million), drop Kristen a note at [email protected] and she'll help get you organized.

  • Just for laughs. Back in the day, I periodically used to have to suit up in coat and tie and wander through the canyons of Wall Street and other haunts of Corporate America where I would sit in endless meetings listening to oh-so smart people wax forth on things like strategic planning and "best practices." It did not take me long, even though I am a college drop-out, to ascertain that underneath the suits were just human beings. Conversant in the latest nomenclature and buzz words, yes, but human beings nonetheless. Someone kindly forwarded me the following video, which is funny - especially to those of you in the Southwest... but on one level, it is a bit close to the truth. Click here to view.

  • Favorite headline of the week: "Some homes worth less than their copper pipes"

And That, Dear Readers, Is That for This Week

I am now going to take advantage of the weather and the good company to wander the local golf links. I am fairly new to the sport, but enjoy learning it.

I usually close with a quick check of the markets, but I started so early this morning in order to rendezvous for the just mentioned game of golf, that the stock markets won't be open for another hour and a half.

Speaking of the stock market, you may have wondered why I made no mention of the new "Paulson Plan," but when you think of it, why bother? The final form of same will only really arrive after many months and endless political re-jiggering. In the end, the odds are good that the plan, if there even is one, will bear little resemblance to the current version being floated. Pay attention to the big trend, and the rest of this stuff is just noise.

And with that, I take my leave for a rare day of doing not much of anything at all.

Thank you for reading.


David Galland
Managing Director
Casey Research, LLC.

Posted 04-07-2008 11:03 AM by David Galland