The Room : Health Care

The Room – 06/12/2009

David Galland — Fri, 12 Jun 2009 21:08:00 GMT

The Room Special Alert:

Casey Research Summit, this one dedicated to Energy and Special Situations

September 18 – 20 at the Westin Tabor Center in Denver

David

Dear Readers,

Again this week, I was admonished by one of your fellow dear readers, who recommended that I keep my political comments to myself. And furthermore that I, and the entire Casey team, should focus solely on finding the next great investment.

While I can’t and won’t argue with the latter part of his advice -- that is, after all, our overarching mandate, and a mandate we take seriously – I suspect the real issue is that the political views we occasionally express run contrary to those of the author of this rebuke.

Even so, if you give the matter any thought at all, you will almost have to conclude that the business of America is now hugely dependent on the business of government.

As a refresher, the following – compliments of the Encyclopedia of Business – describes the two major foundations economies have typically been built on in modern times: central planning and capitalism.

centrally planned economy

capitalism,

Now, I may be naïve about certain things, for example the autoeroticism of the sort apparently favored by the late David Carradine, but I’m not naïve enough to think that there is such a thing as a "pure" economy that fits either of those two descriptions to a T.

Therefore, the important thing is to understand where your particular economy – in my case, that of the United States – falls on the scale between the two systems.

I usually refuse to jump into the same rumpled bed as the hard right wing of the U.S. political spectrum, but they are probably waving their arms about the same economic concerns we comment on here and in our other publications from time to time.

What makes me different from the Limbaughs et al., and maybe it is a fading difference, is that I really would like the current administration to succeed. As I don't really like either party, either party will do – as long as that party makes intelligent choices about the role government should play in our daily lives.

President Obama appears to be a reasonable, intelligent, and certainly articulate human being. Therefore, I hold out hope that he will eventually come around to making the only logical decision that can be made about the path forward. If for no other reason than that choosing the wrong path will inevitably lead to election defeat.

To prove that simple point, it is hard to miss the rising tide of fiscally conservative attitudes evidenced in the polling booths during the recent European elections. Europe, which is not exactly known for its free-market policies, rose up as one and soundly defeated the hard left socialist candidates on the ballot.

Unfortunately, at this point, Obama and his many government operatives and sycophants appear to be speeding down the wrong road – the road that leads to a continued shift in the direction of a centrally planned economy.

For example, this week the House of Representatives passed a bill that meddles with the choices that Americans make regarding the cars they drive. The idea is to give a marketing boost to the new U.S.-owned auto companies. enticing consumers to buy new cars by taking up to $4,500 out of taxpayers’ pockets and giving the money to others. Those, in turn, give it to automakers that provide cars that drive at least two miles further per gallon in the tank.

Here’s a quick take on the bill from politico.com…

There has always been a problem with a centrally planned economy. When you remove the free market from the supply and demand equation or tamper with the free market, you cause unnatural dislocations and all manner of unintended consequences.

Of course, Mr. Obama enjoys strong union support, and we as taxpayers now own large shares in the American auto manufacturers. Therefore, the good intention of the central planners in Congress is that this "cash for clunkers" law will unleash a new wave of naked consumerism, returning the economy to the happy days we all wish for.

There are, however, more than a few flies in the ointment. Starting with the fact that for the last six years, the top-selling cars in these United States have all been produced by Japanese companies. While many of those cars are now built in the United States, they are not built in Detroit, and they are not built by GM or Chrysler.

It is also worth pointing out that all of the top sellers will easily qualify for the largess being offered by we the U.S. taxpayer. Perhaps the legislators hope that GM's new hybrid, the "Volt,” will ride to the rescue. But Toyota’s well-selling Prius hybrid – which has recently been redesigned, is a huge hit in Japan, and is expected to fare equally well in the U.S. – could throw a wrench in GM’s poorly laid-out plan. Especially because the Prius sells for about half of what the Volt is expected to debut at. With either car, you get the $4,500 rebate, so the choice comes down to this: do you want to pony up an extra $20,000 for a GM-made experiment or get a proven high-quality winner from Toyota for a lot less?

According to a study by researchers at Carnegie Mellon, the premium sought by GM can’t be rationalized:

plug-in hybrids

The problem is the added weight – and the cost of the batteries. The lifespan of the batteries is also a big question mark. According to an article on Mixed Power…

K.G. Duleep, managing director of consulting firm Energy & Environmental Analysis Inc. in Arlington, Virginia, and a researcher on a U.S. study on plug-ins and other advanced autos, said he is very skeptical about the lifespan of the batteries. “I’m very skeptical about the prospects for near-term durability of the batteries. Even in the lab, they aren’t lasting more than seven years,” said Duleep.
So, into the dogfight for what few automobiles will be sold in the crunch years ahead, the new and supposedly improved Government Motors (GM) will send an expensive, so far unproven entrant... which, according to the central planners, will be snapped up in such quantities as to knock off the reigning champs, all Japanese. My take: GM is a dead duck, and the Japanese will be the primary beneficiaries of this latest bit of central planning.

GM was delisted from the NASDAQ this week, and investors looking to buy it must turn to the disgraceful OTC Pink Sheets for their shares.

And this is what the central planners have deemed worthy of dropping $25 billion in taxpayer funds on.

Health Care, Everyone?

The central planners are also hard at work on putting the final bullet into the head of American healthcare. The first shot, Medicare, only severely wounded it.

Speaking of Medicare, the following data points may prove useful as you hear more and more about the greater efficiency supposedly gained by having the government expand its health options to cover everyone.

(FYI: Medicare Part A, passed into law in 1965, covers hospital visits for those over the age of 65 or with certain types of medical conditions; Part B, passed later, covers doctor’s visits and certain outpatient services; Part C allowed private insurers to provide the Medicare benefits; and Part D, passed in 2003, provided prescription drug benefits.)

So, how has that whole Medicare efficiency thing been working out?

The following is from "Medicare for All" Universal Health Care Would Not Solve the Problem of Rising Health Care Costs by David Hogberg, Ph.D.

The fiscal future of Medicare itself is bleak. The Medicare Trustees report notes that, by 2018, revenues for Part A will only be sufficient to cover 80 percent of its costs. By 2080, revenues will only cover 29 percent of costs. “Closing deficits of this magnitude,” the report warns, “will require very substantial increases in tax revenues and/or reductions in expenditures.” The prospects for Part B and Part D are not much better, with the report stating that revenues for those parts will “have to increase rapidly to match expected expenditure growth under current law.” From 2005-2080, the report predicts, Medicare’s share of GDP will rise from 2.7 percent to 11 percent.
There are numerous fiscal problems associated with any government-provided program, especially one that ignores pre-existing conditions, as is the case with the current legislation now being proposed. One is that greater accessibility at a lower cost – or for many, at no cost at all – and providing credits toward government payments to households with revenues of up to $110,000 will make people flock to the docs in large and steady numbers. And that, of course, will drive the cost of healthcare even higher. Call it an unintended consequence if you will, but I will call it a completely natural and to-be-expected consequence.

Thus, though the Obama administration projects that the nation will have to spend another trillion dollars it doesn't have providing medical care for all -- that number is certainly far off the actual tally required.

Again, according to Dr. Hogberg…

Why anyone would want to put every American in a program that is already nearing fiscal collapse is perplexing, to say the least.
As for dislocations, in the current legislation, private insurers will not be able to deny a person coverage for pre-existing conditions or charge them a higher premium. This bit of central planning means simply that everyone will have to pay a higher premium. Furthermore, companies in the healthcare industry will almost certainly have to compete with a government-run insurance program whose mandate will be to ensure that everyone can afford insurance.

Shareholders in private U.S. health insurance companies are already burdened by their share of the costs that those companies have to incur in order to comply with an estimated 130,000 pages of Medicare-related regulations. Now they will not only see the sheer quantity of those regulations ratchet up exponentially, but they’ll have to pay even higher taxes to support direct competition to their companies by the government.

All of which is to say that private insurers are going to have a very hard time competing against their own government, leading to the very real potential down the road for a sole U.S. healthcare insurance provider – “Mama Sam.”

And corporations that already provide insurance, or don't, will be forced to pay even more to the government in order to cover the cost of bringing all the uninsured under the umbrella.

Again quoting politico.com...

R. Bruce Josten, a lobbyist for the U.S. Chamber of Commerce, said: “We are disappointed, clearly.” He participated in weekly meetings with Kennedy’s committee, and the bill that resulted suggests “the only person who has skin in the game is the employers,” Josten said.
Josten is, of course, talking his own book. That's because employers – i.e., corporations – don't actually pay taxes. Consumers do when they purchase the products of those companies, whose costs are calibrated to cover expenses such as taxes. And so, American industry will have to raise the cost of its products, making them less competitive on the global stage.

This reduced competitiveness will result in American corporations going out of business, and more and more people will be added to the unemployment rolls, moving them out of the category of "net contributors" to the new healthcare system and into the category of "net recipients," sending costs ever higher.

Of course, one way that the government, having laid this bed of nails, might decide to respond is by adding entry barriers for foreign-made goods. Which, when you think about it, may be the solution to the automobile conundrum as well?

I'm not sure where one goes to school to learn the fine art of central planning, or even if such a school exists, but I'm fairly sure that even the best of such a school can adequately train its graduates in the effective, long-term, micromanagement of a complex system such as the U.S. economy – or any economy, for that matter.

Is there a potential bright spot for investors in all of this? I think passing of this healthcare legislation, which is a near certainty given the Democrats’ majority, will shake out the weaker insurance companies already buried under mountains of bad investments that are about to get a lot badder. And I have to believe that unless and until Mama Sam passes legislation prohibiting private insurance altogether, there will be a niche for an insurance company that charges very high premiums but promises quick care of the highest quality in return.

Faced with the alternatives of doing business with the upscale private provider or the far less expensive government option (or one of the private companies that try to compete on price with that entity), the bulk of individuals with pre-existing conditions or generally poor health will choose the less expensive option.

Now, I know this whole thing about universal healthcare will strike a negative chord with many of you, including many of our neighbors to the north. And, please don’t think of me as hard hearted. But this gets back to the idea of positive vs. negative rights. If you believe that we the people have the inalienable right to healthcare, then you might as well believe that we also have the right to three square meals a day, a respectable roof over the head, dental care, a top-quality education, a decent wardrobe, transportation to get to our jobs, day care for the kids, and so on and so forth.

The problem is, and always will be, how can you pay for all of this without coercively taking the money out of one family’s pocket in order to shift it into another’s? And by coercively, I mean the direct threat of imprisonment if you don’t hand over the cash. That violates the morally correct right that we should be free from threats of personal harm, extortion, and outright theft.

In fact, the very idea that some faceless government functionary can walk into my house, or my office, at any time and on any pretense and require me to spend my time and resources assisting him in going over my books so that he may demand more money from me – money that will then flow through the machine to be used to purposes I find personally abhorrent -- is a truly warped and disturbing concept.

At least with a consumption tax, you can make a voluntary decision as to which products you buy, with full knowledge of the taxes you’ll also pay. That is very much not the case with income taxes, property taxes, estate taxes, etc., ad nauseam.

Don’t get me started…

No More Big Bucks for You!

For today’s catalogue of evidence that we’re heading toward a centrally planned economy, I provide the following from Bloomberg this week…

Now, far be it from me to champion the insane pay levels of public company officers. But to actually get into the trenches and try to engineer those pay levels to something considered more politically correct strikes me as a serious step in the wrong direction. Shareholders of companies, which these days are mostly mutual funds and other institutions, need to pay a lot more attention to compensation practices than they obviously have been. And if they are too lazy to do so, then they deserve what they get, should they fail to get a level of corporate performance reflecting said pay.

Fortunately, We Have the Law

I wish I could stop there, but I can't. That's because this week, the faint glimmer of hope evaporated that I had felt when the Supreme Court put a halt to the Chrysler bankruptcy so that it might study the legality of the structure the government had imposed on the company’s stakeholders.

The claims of the secured bondholders in that company were – by tradition and legal rights that extend literally back to the beginning of America and to English law before that – superior to the unsecured claims of the union pension operators. Nevertheless, they were ignored and their legitimate claims set aside "for the public good."

Again, my sympathy goes out to pensioners who dedicated their working lives to a company whose executives may have been better qualified as washroom attendants. But to let one's emotions (or political ambitions) willy-nilly trump well-established law seems the height of insanity.

How, now that the precedent has been re-set, are bond investors – or, for that matter, any stakeholder in a company – supposed to evaluate the investments being offered to them? When commercial obligations can be tossed out the window for political expediency, what does that do to the legal certainty that is supposed to be such a big competitive advantage for America?

Commenting on the transaction, an official of the Treasury, which strong-armed the deal into existence, had this to say…

“This morning’s closing represents a proud moment in Chrysler’s storied history. The Chrysler-Fiat alliance has now exited the bankruptcy process and is poised to emerge as a competitive, viable automaker.”
Since we are relying on dictionaries today, let’s look up the word “proud” just to be sure we are understanding this member of officialdom clearly.

Relying on Webster this time,

prūd,

prod, prud, prou

prode

“Advantageous?” Sure, for the unions and, by extension, the political fortunes of Mr. Obama.

“Just?” Hardly. How is it that the unions put up nothing and get 55% of the company?

“Wise?” Politically, maybe. But turning commercial law on its head to try and bail out a twice bankrupt company? And handing the “new” company another $6 billion of money the government very much doesn’t have as an “exit” gift hardly seems intelligent, at least to me.

“Bold?” In my book, that is not the word I would use to describe the government’s bullying tactics, including publicly vilifying legitimate bond holders.

No, proud is not a word I would associate with this takeover. Expedient, reckless, capricious… all of those words seem far more appropriate.

This is one of those seminal events that has the potential to be with us for a very long time – in future bankruptcy proceedings, which I expect we'll see a lot of – and in the very structure of capital markets.

Capital Gains… What Capital Gains?

David M., the coordinator of our SoCal Phyle, sent along an interesting essay written by Chriss Street, the treasurer/tax collector of Orange County, California. He argues against states spending beyond their means, and also against a bailout of the states by the federal government. The essay is worth reading, and you can do so here.

I thought the following excerpt from Street’s essay is especially noteworthy, given the coming increase in capital gains taxes…

All of which raises the question, where is California going to get the money it needs to dig itself out of its current hole… now expected to ring in at about $25 billion for the year?

Why, Mama Sam, of course.

The Road Less Traveled

While we don’t talk about it much, I feel compelled to give a tip of the hat to our senior researchers who think nothing of hopping on planes to far corners of the world, literally risking the worst in their quest for opportunities ahead of the crowd.

What compels me this week was a trip to Colombia Louis James of our International Speculator just returned from. Accompanied by heavy security, he walked the ground on a new discovery with the credible potential to host five million high-grade ounces of gold, and maybe more.

While the armed escort is still advisable in those parts, it is increasingly becoming less so and is mostly just a holdover from the bad old days of the 1990s at this point. Back then, the area Louis visited was bristling with guerillas and out-of-control paramilitary groups who, some say, were even worse. Today it’s peaceful, and the locals couldn’t be happier to see a new gold rush. Colombia has a truly fabled history in gold mining, and it is now politically stable and pro-business – perhaps the most pro-business country in South America. This has led to big profits for investors in successful junior gold explorers (the company Louis visited saw its share price shoot up 104.5% in two days).

Louis will report on the opportunities he found on his trip to Colombia in the next issue of the International Speculator. You can learn more by clicking here.

There is much opportunity, even in challenging markets… but sometimes nothing but putting your boots on the ground will do. And for being ever willing to do that, my hats off to the tireless team!

21 Economic Models Explained

(Thanks to our regular correspondent and longtime friend, “the General,” for sending this along. Sorry if this gores anyone’s ox… or, cow, such as the case may be.)

SOCIALISM
You have 2 cows.
You give one to your neighbor.

COMMUNISM
You have 2 cows.
The State takes both and gives you some milk.

FASCISM
You have 2 cows.
The State takes both and sells you some milk.

NAZISM
You have 2 cows.
The State takes both and shoots you.

BUREAUCRATISM
You have 2 cows.
The State takes both, shoots one, milks the other, and then throws the milk
away.

TRADITIONAL CAPITALISM
You have two cows.
You sell one and buy a bull.
Your herd multiplies, and the economy grows.
You sell them and retire on the income.

SURREALISM
You have two giraffes.
The government requires you to take harmonica lessons.

AN AMERICAN CORPORATION
You have two cows.
You sell one and force the other to produce the milk of four cows.
Later, you hire a consultant to analyze why the cow has dropped dead.

ROYAL BANK OF SCOTLAND VENTURE CAPITALISM
You have two cows.
You sell three of them to your publicly listed company, using letters of credit opened by your brother-in-law at the bank, then execute a debt/equity swap with an associated general offer so that you get all four cows back, with a tax exemption for five cows.
The milk rights of the six cows are transferred via an intermediary to a Cayman Island company secretly owned by the majority shareholder, who sells the rights to all seven cows back to your listed company.
The annual report says the company owns eight cows, with an option on one more. You sell one cow to buy a new president of the United States, leaving you with nine cows.
No balance sheet provided with the release.
The public then buys your bull.

A FRENCH CORPORATION
You have two cows.
You go on strike, organize a riot, and block the roads, because you want three cows.

A JAPANESE CORPORATION
You have two cows.
You redesign them so they are one-tenth the size of an ordinary cow and produce twenty times the milk.
You then create a clever cow cartoon image called “Cowkimon” and market it worldwide.

A GERMAN CORPORATION
You have two cows.
You reengineer them so they live for 100 years, eat once a month, and milk themselves.

AN ITALIAN CORPORATION
You have two cows, but you don’t know where they are.
You decide to have lunch.

A RUSSIAN CORPORATION
You have two cows.
You count them and learn you have five cows.
You count them again and learn you have 42 cows. You count them again and learn you have 2 cows.
You stop counting cows and open another bottle of vodka.

A SWISS CORPORATION
You have 5,000 cows. None of them belong to you.
You charge the owners for storing them.

A CHINESE CORPORATION
You have two cows.
You have 300 people milking them.
You claim that you have full employment and high bovine productivity.
You arrest the newsman who reported the real situation.

AN INDIAN CORPORATION
You have two cows.
You worship them.

A BRITISH CORPORATION
You have two cows.
Both are mad.

AN IRAQI CORPORATION
Everyone thinks you have lots of cows.
You tell them that you have none.
No one believes you, so they bomb the crap out of you and invade your country.
You still have no cows, but at least you are now a democracy.

AN AUSTRALIAN CORPORATION
You have two cows.
Business seems pretty good.
You close the office and go for a few beers to celebrate.

A NEW ZEALAND CORPORATION
You have two cows.
The one on the left looks very attractive.

Promoting Free Market Economics…

By Louis James

As you may recall, Doug Casey joined me in my yearly teaching sabbatical in Eastern Europe last summer (click here for last August’s report on how it went). It was a smashing success, and the students had such a good time learning about free enterprise and entrepreneurship, most of them are returning this year and bringing friends. The result is a record group of students – about 90 – who will come to learn more about rational economics, creating businesses, investing, and more, at what we now are proud to be able to call the first Casey Youth Conference on Liberty and Entrepreneurship (CYCLE), to be held from June 29 to July 5, in beautiful Trakai, Lithuania.

This year, they’ll have to write a complete business plan to complete the course – we’re excited. The students are as well and are building a web site for CYCLE. It’s still in beta-testing as we go to press, but you can try it here: CYCLE.

Doug sees CYCLE as one of the most cost-effective ways to teach young people about free-market economics, and better yet, to enable them to join the producers and creators in the world who make progress possible. Eastern Europeans have living memory of soul-crushing communism, and they are hungry for this sort of learning – it’s a great environment. In fact, if you have college-age children who would like to join in, drop us a line at feedback@caseyresearch.com, and we may be able to squeeze in a few who can pay their own way.

When we wrote about this last summer, several subscribers wrote to ask how they could help. One simple way to do this is to make a tax-deductible contribution to the same non-profit we are working with to run our CYCLE program. That’s the International Society for Individual Liberty (ISIL), a 501(c)(3) tax-exempt organization. Doug generally believes most charities aren’t worth the dynamite it would take to blow them up, but CYCLE is an educational investment with potentially near- to mid-term returns. And if you’re going to pay for something, it’s nice to be able to take half that money out of the government’s pockets in order to do so. To pitch in, click here for ISIL’s secure donation page or call ISIL directly at 707-746-8796 and tell them you’d like to support CYCLE.

The programs is very cost effective – about $150 per student (they pay part of the cost) – but there are a lot of students this year, so CYCLE could use your help. Thanks!

Miscellany

More Casey Phyles Starting Up. If you are interested in meeting up and sharing notes with other Casey subscribers, this week we received indications of interest from individuals in the following locales. South Africa, New York (Manhattan), Massachusetts, South Carolina, France and Chicago. If you are in any of those places and want to be connected, drop us a note at phyles@CaseyResearch.com.
Poker, Anyone? Our own Doug Casey, who is known to enjoy a game or two of cards now and again, forwarded me an article from the Wall Street Journal about a grab by the Feds of 27,000 bank accounts totaling $34 million. The sole rationale for the grab was that the miscreants apparently had the gall to enjoy playing poker online. What’s next? Users of online adult sites pop to mind. Then what? The slippery slope gets more slippery by the day. You can read the full article here.
IMF Gold Sales. This just in from our Washington correspondent, Don Grove, who is keeping a sharp eye on the proposed vote to allow the IMF to sell on the order of 13,000,000 ounces of gold (to the Chinese).
The Daily Room Thing… Thanks to all of you who weighed in on the idea of converting this letter from a weekly to a daily room. The vote came in slightly in favor of keeping this a weekly. Even so, I think we’ll try going daily for awhile (but not until a couple of weeks from now.) For one thing, there is so much that I could, and even should, be addressing that trying to cram it into one issue at the end of the week is impossible.

Currently, I think that we would segment the daily room (name still not decided), by major topic areas. For instance, commodities, energy, equities, the economy and, of course, politics (with some miscellaneous scattered throughout). We would then focus on those major sectors on the same day each week. Thus, if energy was not of interest to you, you could just skip Tuesday, for instance. In this way, we could focus our research a bit more on what’s important in each of these key areas, while keeping the segments shorter. For fans of the weekly version, at the end of the week, we could do a round-up edition.

Hate the idea? Like it? All input always welcomed at david@caseyresearch.com (though I apologize profusely for being a poor correspondent of late. While I have read all of your emails, I just haven’t had the time to respond.)

Speaking of The Room… this week is my wife’s much-deserved annual road trip, a wonderful week during which I play full-time father and relearn to appreciate what it’s like to manage a household 24/7. If history is any guide, the week will start out with a fair amount of chaos but eventually settle into something resembling order. In any event, Casey Research CEO Olivier Garret has gallantly offered to step in and write The Room next week, while I concentrate on the simple things – like not burning down the house with that new wood-burning tool I bought the kids.

As I sign off, I see that the stock market is just barely keeping its lips above the water line. I continue to believe that a big wave is about to change things, and fairly soon. There are now so many new and existing negatives looming over the market that it can’t be overly long before Mr. Market runs for cover. Among the things to watch for is a surge in commercial mortgage defaults, which are anticipated to almost double from recent months, to some 4.1% of the total outstanding.

(In The Casey Report, we are currently shorting two especially ripe commercial real estate companies… you can, too… details here.)

Then there is the pending wave of Option ARM resets, which will hit later this summer and then soar into next year.

And there is the soon-to-be-widely-reported-on smack up the side of the head to mortgage originations, caused by the recent 75 to 100 basis point jump in mortgage rates.. a jump that occurred over the period of a week and a half. Speaking with insiders in the banking business who shall be unnamed, I learned that the rate increase caused mortgage originations to hit the proverbial wall. Full stop. While the punditry has begun to comment on the likely impact of the jump in rates, when the full extent of the impact becomes apparent in the weeks ahead, it will send a signal that Mr. Market will surely not appreciate.

Rates are going up, and we are positioning ourselves to take full advantage in The Casey Report.

Meanwhile, U.S. exports continue to fall, Treasuries continue to come under pressure as Russia and other countries announce they are going to invest in IMF paper vs. that of the U.S.

And one more thing, especially interesting, that came my way via Steve H. It is about a meeting on June 16 by senior officials of the BRIC nations, in a remote mountain resort in Russia. The concern is that they are working on plans to replace the U.S. dollar as the world’s reserve currency.

Start by watching this somewhat odd video linked here…

The presenter comes across as something of an odd duck, and so I asked Steve (who is a very successful money manager and a very solid guy) if the guy was credible. Here’s his response:

www.comdig.com

www.deanlebaron.com

www.leadership.gather.com

So, I did a bit of looking around and found this reference on the pending meeting, from the Beijing Review.

Now, it is a bit of a leap to think that this meeting will indeed amount to a Bretton Woods II, but without the U.S. in the room… you can bet the dollar will be on the agenda.

Interesting times, indeed.

And with that, I must run… I think I smell smoke.

Until the week after next, thank you for reading and for being a subscriber to a Casey Research service.

David Galland
Managing Director
Casey Research, LLC.

The Room 3/31/08

David Galland — Mon, 31 Mar 2008 20:08:36 GMT

Dear Reader,

I am writing to you in the pre-dawn from a soft chair in a Starbucks in Scottsdale, a vast improvement over the small desk in the cluttered toy room that I usually write you from on Fridays. 16 inches from my left hand is a "vente" (in the Starbucks' nomenclature, that means super sized) Americano (four shots of espresso with a dash of water to hold them all together) that I will be consulting with throughout this correspondence. I do so in an attempt to sterilize the effects of a glass of wine or two too many following the close of what I felt was another excellent Crisis & Opportunity Summit.

For those of you unfamiliar with the concept of sterilization, at least as the word is used in the discussion of modern economics, a topic that occasionally slips into these paragraphs, I will elaborate. Sterilization refers to the notion that a central bank can, upon spotting a storm cloud gathering on the horizon, unleash a flood of loose money - the amount is almost irrelevant, as long as it is enough, in their studied opinion, to re-juice the economy and keep the consumers consuming. Then, once the danger is passed, the same central bankers simply cut the supply of money, thereby "sterilizing" the prior injection of cash before the ill and otherwise inevitable effect of price inflation kicks in.

It all seems so logical, this fundamental underpinning of fiat economics. Sense a threat - unleash money. Threat passed - tighten up.

Yet, as you may have noticed, it apparently doesn't work. At least if you use the value of the dollar as the metrics of success, the staunch defense of which is supposed to be job #1 of the Fed. If you are looking for further proof of that contention, your contemplations need extend only far enough to notice that the greenback has lost some 80% of its purchasing power since its link to gold was broken in 1971. There is another side effect of the flawed foundation of the fiat system, at least as it is pursued in the U.S., namely that American consumers, encouraged by the loose money to make a hefty dose of spending a part of their daily activities, are now up to their nostrils in debt and many are underwater.

Over the last day and a half here at the Summit we have heard much about these and other consequences of the government's failed jiggering of the economy and, in particular, the depth and breath of the current crisis. Regrettably, I don't have time to go into great detail in this week's edition, as attempting to do so would result in my missing the plane back home.

To move things right along, I'm going to take the short cut of inviting others to join me on the page. Starting with John, a subscriber who earns his daily soup by serving as a professional real estate appraiser in Northern California. John kindly agreed to candidly answer a series of questions we sent him in our attempt to get a clearer picture of what's going on behind the scenes and under the hood in the all important real estate market.

Real Estate, the Insider's Perspective

Before we get to John's interview, I'd like to share some observations on just one of the many great presentations held at this Summit, that delivered by Andy Miller, one of the most substantial real estate investors in these 50 states (for Andy, a typical day's labor might involve the buying or selling a hundred million dollars worth of real estate or loans connected with same). Andy accepted our invitation to Scottsdale to share his perspective on the outlook for real estate going forward. While Andy used far more sophisticated language than I, I will summarize his outlook as thus:

RUN FOR COVER!

To be more specific, his view on real estate - and remember, Andy is as "inside" as inside gets - is that we are nowhere near the bottom and that some segments, commercial and condos especially, are going to fall off a cliff.

While there is little in the way of specific actions you can take to invest for a short-term profit from this unfolding situation - mainly because the stocks of almost all the publicly-traded real estate firms have already been crushed - Andy does believe that as this crash occurs it will create the opportunity of a lifetime. If nothing else, in six months or a year down the road you should be able to pick up that dream condo on your favorite beach for an off-key song. As to when the market might bottom, Andy's take is that it all depends on the actions of the government. If it stands aside and lets the market take its righteous toll on the overextended mortgagees and those who hold those mortgages, then the worst of the damage could be over in a couple of years (at least that was my sense of the timing Andy suggested). However, if the government, as it is prone to do, rolls up its sleeves and sets about fixing the many dislocations in the real estate market, then, like the Japanese before us, the real estate fiasco and attendant damage could stretch out for a decade or more. Hot tip: watch the politicians carefully (always good advice, in my opinion, especially if you find yourself in a tightly packed elevator with one).

Another of Andy's many insightful comments was that you should not trust appraisals. That's because, as the bubble inflated, loan officers, looking to make as many loans as possible, and the bigger the better, naturally gravitated toward the most liberal appraisers. By contrast, the more cautious appraisers soon found themselves in an un-enviable position portrayed so convincingly by the MayTag Repairman: sitting at an uncluttered desk, staring forlornly at the silent phone.

As is human nature, a great many, if not most, of the appraisers swallowed their ethics, put away the textbooks they studied when learning their trade, and as a basis of their appraisals began to use the amount of money they felt would evoke a smile on the thin lips of the loan officers.

The task of over-inflating the values became increasingly easier as the "comparables" available to appraisers began to reflect the new reality. To wit, if the shack down the street actually sold for $650,000, then who could dispute that the lovely fixer-up, lacking only in a little TLC (read: "new plumbing") was worth $1,000,000?

Which brings us, finally, to our guest interview with John, a residential real estate appraiser in California. As he described himself in the correspondence leading up to our interview... "I've been appraising in California for 18 years, and deal with the gamut of lenders, borrowers and developers, and see every story, scheme, and scenario possible. I have lots of anecdotal stories and evidence, as well as research and conclusions, from the extremely overbuilt new tracts, where builders are still building—because they're committed—and competing against first generation foreclosures in their earlier phases, and losing money on every sale, to small projects dead in the water or upside down, to the very rural, to the very upscale still paying cash."

With that introduction, here is our interview...

1. Have you ever seen things in the real estate market this bad?

In terms of the all-around uncertainty and worry being felt by borrowers, lenders, buyers and sellers, nothing this bad.

I was in southern California in the mid-1990s downcycle. Things had gotten overheated there especially, but the decline was much more orderly, over maybe 3-5 years, than this one has been in just two or so. In retrospect it was a fairly normal and not surprising correction. People and borrowers got hurt and became wary, but there wasn't the pervasive worry about the bottom falling out. And it wasn't as widespread. That is, while most everyone lost value in their homes in the mid-1990's downturn, fewer people were as directly impacted or in such a critical situation. There wasn't nearly the breadth and depth of indebtedness then. Today there is a much higher percentage of borrowers with a much higher level of debt because, in this run up, so many people continually ran up debt and sucked out their equity.

The frenzy of borrowing and lending up until a year or so ago was far greater than that which led to the escalating prices, and subsequent correction, in the early to mid-1990s. I see instance after instance of someone with say a $300,000 loan taking out a second mortgage or an equity line for $50,000 a year later, followed by an all new mortgage that consolidates the previous two plus tacks on another $50,000. So now they've got a $400,000 loan. Ten months later they get another $60,000. And, in 2004 through 2006 especially, there was a lot of 100% financing, usually a first and a second mortgage, often with the same lender.

The downtrend is not as steady as the mid-90s. It goes in real fits and starts. In cases of some very overbuilt communities I've seen the bar lowered by $30,000 in a single month in a $300,000 to $400,000 neighborhood. It's usually caused by sellers -- often banks -- unloading after a period of waiting or stagnating sales. All of a sudden what was thought of as a competitive asking price is now overpriced by $30,000 or more.

[Ed Note: Andy Miller said the best time to buy properties, when the time is right, of course, is at the end of quarters when the institutional holders dump properties in an attempt to clean up their books.]

2. Are appraisers under any pressure to give rosy valuations?

Not as much at this time, because the lenders are more deeply affected and truly reigning in. Mortgage brokers, who don't fund their own loans, will still try to put some pressure on, but the lenders—the ones actually putting out the money—are saying "tell us what's really happening in the market." They want to know because they've got lots of exposure and want to know the real story. In fact, where before, in the 1990s downturn, FNMA and most lenders encouraged appraisers to call the market "stable" versus "declining" even if everyone knew they weren't stable, this time around they expect to see the declining box checked, unless you make a very convincing case that values are in fact stable (not too common here in California). So, at this point lenders are really tightening. So even the magic cure of lowering interest rates won't help much when lenders are increasingly risk averse.

3. When a property doesn't sell in two or three times the normal time span, why doesn't the seller face facts and slash the price?

I've seen some slashing, and some sellers chasing the price down, but always a step behind. What they'd settle for now, but can't quite get, they could've gotten last year when they were asking $60,000 more. Reductions are more frequent and often sizeable. It used to be that you'd see a token $5,000 reduction, more just to get your listing visible again. Now large reductions are common. This is especially true in the high-end and custom spec homes. Every contractor and contractor's brother was building a spec home, getting bolder in how big and fancy they'd build them. After all if you can make $60,000 on a 2,000 square foot $400,000-value home, why not build a 4,000 square foot home with all the bells and whistles...it'll cost more and take a little longer but the market's just going up anyway. I watched one 6500 sq ft very high quality spec home go from a $2.5M asking price a few months prior to completion in 2005, slowly down to $1.9M, then $1.6M and so on, eventually to $1,200,000. In the end it sold for around $1,150,000. The guy must have lost money because I'm sure that quality cost him close to $200/sf just to build, not to mention the land (probably $200,000+) and the enormous holding costs for 2-3 years.

The other sellers are, of course, banks, whose motivations vary greatly. I've seen a few put money and effort into a home and try to hold out for reasonably close to market value, but most often they want to get them off their books as quickly as possible. Sometimes they're competitive and sometimes they blow them out. I had one agent who handles REOs (Real Estate Owned) for several lenders tell me sometimes they'll get word to get two sold in the next two weeks. He said that a decision was made, for example, to clear 100 properties nationally off their books in the next 30 days, so that meant orders were going to Region A to unload 12, Region B to unload 15, etc.

He said it was sometimes the case of regulators requiring them to reduce their REO units. In one case, the agent reduced a small home on 5 acres with a 3600 sq ft barn with additional 2BR apartment from $569,000 to $400,000, overnight. It was contracted in three days, and closed a few weeks later for $392,000. Someone had paid $710,000 for it in 2005 with 90% or maybe 100% financing. In another case a lender was asking $325,000 and accepted a cash offer of $175,000. The house was dumpy but sound and livable, and reportedly not a major fixer. It was just not worth $325,000 and the bank was tired of looking at it, and took the offer. Until then nothing in a 3BR/2BA in that neighborhood went below $275,000 or $250,000. Of course these are exceptional cases, but the downward pressure is very real, and very intense still. There are many properties for sale, and buyers are wary, or waiting. Some sellers, those fortunate enough not to have to sell, pull out of the market. Those that have to sell usually have to reduce their expectations.

4. Are there sellers who have been in denial for months about what their property is worth but who are about to come out of denial and make a big cut in the price? Are there many of them?

See #3 above. Again, there are always those that must sell. And, there's another category that falls in between the regular homeowner and the bank. It's the owner/borrower who's in trouble and must sell, or lose the house. This is the "short sale" situation, where the borrower owes more than the property is worth, and is engaging the bank in the selling process to have them accept less than the outstanding loan balance. The bank is involved in negotiations and must approve the final sales price. They're fairly agreeable, because the alternative is going through the entire default process, sinking more time and money into it, and likely losing more. And here we're just speaking about the first mortgage (trust deed in California) holder. Often a second mortgage holder will lose their entire loan amount; after all why would they step in and pay off a first mortgage that alone is more than the value of the collateral?

5. How is the market for buildable lots? More depressed than for houses? How much more difficult has it become to get financing for a buildable lot?

The market for lots has completely dried up. In this area (semi-rural northern California) land was on fire for several years, as contractors bought up nice lots and not so nice lots to build homes on. For a while everything turned to gold. People were selling land held in the family for a long time (just like silverware in the late 70s!). Developers, many inexperienced, were getting in to subdivide land to make 4 parcels, 12 parcels, or whatever zoning allowed. But it is a long and expensive process.

The craze and demand peaked probably in 2005-2006, and I still see some of these projects just coming to market. People have spent two years, and more money than they expected, to get their golden little subdivision, all finalized and ready to go to market...and the market is not there. The demand is so low for unimproved land now, but I haven't yet seen the capitulation I expect. I've seen small and medium sized subdivision projects, which are completely upside down. A friend of mine owns a commercial appraisal firm and specializes in large subdivisions. He's been the bearer of bad news too. In the frenzy, national builders were buying farm land in the middle of nowhere, some two plus hours from metro areas, to create new subdivisions and planned communities. Many of the tracts and phases that never got built now have a residual value of less than zero! That is, taking the estimated value of a proposed completed house (times 20 or 200 or 2,000 depending on how big your plans were!) and backing out the cost to build the house and all your infrastructure, bond obligations, etc., the land is worth less than zero. Of course, it is worth something, but only to speculators willing to sit on it for a long time. There's a reason it was farm land in the middle of nowhere to begin with. Some can't even go back to farming because of zoning and general plan changes and new houses now adjacent. [A whole other topic is farmers selling water rights to new developments and municipalities, resulting in what is an increasing amount of fallow land that's apparently not farmable now. Lots of unintended consequences, and unfolding opportunities?] It's going to be very interesting to watch the market unfold.

6. Based on what you are observing, how much further do you think prices are going down?

My answer would have to be anywhere from "some" more, say 15-20%, should well grounded optimism magically set in before year-end, to a lot more, possibly 30-40%, should news and conditions (and perceptions) worsen and snowball, or there be some unexpected large macro event that shakes things up on top of the underlying situation.

This, of course, is the unknown and unexpected, but these things happen. It could be a natural disaster, a military showdown, somebody doing something big and stupid in the Middle East, political correctness of "Olympic" proportions (what if the Tibet situation goes south, Richard Gere and fans get half the world to boycott China this summer and cause them to lose face in an epic way, and they decide in turn to boycott our dollar...), or simply some confluence of events, in the US or elsewhere, that ratchets up fears and concerns here.

In other words, if the stars line up, and lots of things go well, or appear to go well, throughout 2008, things may stabilize with maybe only a 15% haircut, from here, in general real estate values in the US. To predict less than this just calls for too much precision with all the variables and uncertainty, unless you really believe the downturn is about over, which I don't see. Under current conditions 5-10% can potentially whiz by in a month or a quarter, and is really just noise, between commissions, negotiating skills, fear and uncertainty, and the varied motivations of both buyers and sellers.

On the other hand, if things continue along with the same pressures as I see now, we'll likely see drops of 15% to 20%. If conditions fail to improve in the next 6-18 months, or are exacerbated in some way, then I think we could see larger drops in value, and a more prolonged decline.

Of course, there are many markets and sub-markets throughout the country, and some are more volatile and some more insulated than others. There will be some exceptions and some extremes. In general, though, I believe we're in for some more decline.

7. How long do you think it will be before we see prices come back to the levels they were before the crash? Are we talking months, years or decades at this point? We know this is pure conjecture, but what is your gut feeling based on many year's experience?

That's a long way to go back up, especially since we're still going down at this point. I'd have to estimate as much as a generation, at least for the areas that are being most impacted. It got so overheated with lenders, buyers and borrowers making mutually terrible decisions. Everyone is going to be wary for a long time, especially because this became such a speculation-driven run up.

Besides lots of average homeowners forgetting common sense (and forgetting that even attractive loans still require repayment) and assuming (speculating) that values would keep going up, there sprang up a whole class of everyday people that became speculators, and actually went out and bought second and third homes to turn over. These were people who otherwise don't do real estate deals, because the market doesn't normally afford that kind of opportunity. There was a huge disconnect from what typically drives a real estate market. Most people probably won't go near real estate speculation again, will be careful in their future borrowing, and will be wary of buying more houses than they need and can afford. So, until they're no longer the primary buyers and owners of real estate, and their kids and grandkids stop taking their advice, we probably won't again have conditions that will lead to a rapid increase in values.

Of course, natural growth and demand do cause values to rise, but it could take 10-20 years of typical appreciation (1-3% per year in traditionally less volatile areas, to maybe 3-6% in more active markets like California, the East Coast and Florida) to cover the ground of 4-8 years of frenzy. And that will be after the current downturn stabilizes, meaning oversupplies are absorbed, foreclosure and defaults have run their course, indebtedness is at normal levels, and healthy market conditions are back in place. That in itself will probably be another year or two at best. It doesn't seem likely that the down cycle will last only 2-3 years, considering the last one lasted 3-6 years when the underlying problems were not as bad. To summarize, to get back to where we were at the peak, at least in the areas hit the hardest, we'll need the time it takes to stabilize, at least a year or two, and then, depending on where things do stabilize, likely a decade or two of healthy and typical appreciation.

David again... my sincere appreciation to John for taking the time to work with us on this interview. Correlating his remarks with those of Andy Miller, and taking into account the sheer magnitude and importance of the real estate markets to the U.S. economy, I think the picture painted is fairly bleak.

That said, per Andy, when this wildfire eventually runs its course, it will create the opportunity of a lifetime for investors who have avoided the worst of the losses and have their capital intact.

As an aside, if you are, like John, an insider in a business with experiences that you think other subscribers would like to hear about, drop me a line at david@caseyresearch.com.

Democracy Versus Republic

As you may have noticed, I am no big fan of the idea of democracy because, in time, democracy inevitably devolves into a fight - with votes - at the public trough. Today, over 51% of the populace of the U.S. are net recipients of money from the U.S. government (read: their fellow citizens).

But if not democracy, what? In my view, it is a republic... a form of government whereby the government is limited to specific functions and no more, and where rights are inviolate and not subject to tampering by whichever gang of powerseekers have captured the flag.

On this topic, one of the participants at the Summit wandered over to me to share the following illustration of the difference between the two forms of government:

In a democracy, two wolves and a sheep get together to decide who they are going to eat for lunch.

In a republic, eating the sheep would be outlawed.

Universal Health Care Anyone?

At this point, given the high cost of health care, the high levels of indebtness which makes those costs unbearable to so many Americans, and because changing the system is as easy as voting in the Democrats, it is my opinion that universal healthcare is a sure thing for the U.S.

Given my time constraints, a more detailed discussion of the wisdom of adopting this large-scale giveaway will have to wait. But I would like to share a couple of anecdotes that will give you a hint as to my general views on the topic.

The first came out of a newspaper I picked up on a recent trip to Canada. The first paragraph, about patients in Ontario, pulls back the peel on the rest of the story, and reads as follows:

"More than 400 Canadians in the full throes of a heart attack or other cardiac emergency have been sent to the United States because no hospital can provide the lifesaving care they require here."

In the same newspaper (the Globe & Mail if I recollect correctly), I also noticed large ads paid for by the Canadian government, couched in a pleading language, for doctors. Given the sheer volume of red tape and effective income restrictions doctors in that country are saddled with, it is no wonder so many of their best and brightest now practice their professions here in the U.S., and there are shortages up north.

My second anecdote comes from a fun service I subscribe to called "This is True" (thisistrue.net). Here it is...

"PLEASE HOLD: More than 43,000 patients had to wait outside in ambulances for at least an hour last year before they could be seen in Britain's National Health Service emergency rooms. Standards require that patients must been seen within four hours when they arrive at an emergency room, so when busy, patients must wait outside so the clock doesn't start ticking."

Who knows, maybe the government in the U.S. will learn its lessons from the various universal health care systems being employed around the world, and won't let politics or demands from constituents drive the creation of a system that destroys the few remaining positive aspects of the U.S. medical system... or beggars the country any more than it already is... but that is a long-shot hope at best.

Inflation? What Inflation?

Last week I shared the story of my mother's childhood residence, in Mont Clair, New Jersey, purchased in 1929 for $45,000, and sold below that price almost 20 years later.

My friend of long standing, Ian McAvity, the editor of Deliberations, an excellent service for those of you who lean toward technical analysis, dropped me an email with the following message.

David,

You might be amused that Zillow.com estimates the value of 10 Sutherland Road, Mont Clair, NJ at $1.24 million currently.

Ian

So, $45,000 to $1.24 million in about 63 years. But it is worse than that, because the former family homestead was, according to my mother, subdivided into a number of lots, so the actual current value of the property is likely closer to twice that value.

I said to my wife the other day, following an expensive meal, that I need to recalibrate how I think about money. Simply, $20 is no longer the $20 I remember from my youth, but is actually more like $2.00, or even $1.00.

Thus, a dinner bill of $200 for a family of four at a decent restaurant should not evoke a reaction such as "$200! This is ridiculous! How does anyone manage to survive these days, let alone save any money!".

Rather, recalibrating my sense of value to the brave new world whose air we now breathe, my reaction should, going forward, be nothing more than, "Nice dinner, and look, it was only $20."

A self-delusion, or the new reality? You decide.

Bearish Questions

Ed Steer, the hardworking contributing editor to our Daily Resource Plus, sent along an article from Reuters on the Bear Stearns buyout, which I thought you would find of interest. I certainly did. Here's an excerpt...

NEW YORK -- Stunned Bear Stearns shareholders who saw investments virtually wiped out overnight when a takeover deal with JPMorgan Chase was unveiled are demanding to know how it was put together in the first place.

For instance, they -- and Washington lawmakers -- want answers on how the deal was arranged, and gained government approval and financing, all in a few hours, and seemingly without alternative bidders being canvassed.

They also have a host of questions about the role of the Federal Reserve and the Treasury Department in engineering the emergency deal.

So far some crucial details remain murky.

"Under the circumstances, shareholders should be entitled to know just about everything," said James Melican, chairman of shareholder advisory firm Proxy Governance Inc., which is expected to make a recommendation to investors on whether the deal should be approved.

"There needs to be full disclosure of exactly what happened over the weekend," he said. Investors have "an absolute right to know whether there is any other alternative mechanism that could either keep Bear Stearns in business or at least have them get a more appropriate price for their shares."

Billions of dollars in shareholder value have been wiped away in the last week. Based on current market prices, the takeover is valued at $2.41 a share, a shockingly low offer compared with Bear's $159 stock price last April.

Another highly unusual aspect of the deal is the way JPMorgan Chase & Co. has been allowed into the Bear Stearns Cos. Inc. to provide "management oversight of its operations."

If shareholders were to reject the JPMorgan offer, JPMorgan still would have been in a position to understand everything about Bear's trading strategies, staff quality and assets.

JPMorgan even has an option to buy the Bear Stearns' building if the deal collapses.

Congress also wants answers, particularly on the involvement of the Federal Reserve in pushing the deal, which came as Bear Stearns faced a sudden cash crunch and possible collapse. In an unusual move, the Fed agreed to lend $30 billion to fund illiquid Bear Stearns assets to help seal the takeover.

Among the unanswered questions are:

-- Were other parties asked to bid on Bear Stearns, or did the government solely approach JPMorgan about the takeover?

-- Were any overseas banks or private equity firms asked to consider a bid, or did the buyer have to be a large U.S. bank?

-- How did the Federal Reserve arrive at the $30 billion figure and did it discuss with Bear whether it was preferable to arrive at a quick sale or explore a bankruptcy filing?

-- How could due diligence be done and the deal approved in the space of a few frantic hours on Sunday?

-- And how can a party taking over another be allowed to run the target before the deal has gone through?

With so many unknowns, the Senate Finance Committee is reviewing the sale and particularly what implications it may have for taxpayers. On Thursday afternoon the committee's top Republican, Iowa Sen. Chuck Grassley, said he wanted details of the Fed's financial support of the deal, as well as how Bear insiders were being treated under the buyout.

In the House of Representatives, the chairman of the House Oversight and Government Reform Committee also wants to know more. The committee is conducting a "preliminary review" of the deal, an aide to Democratic Rep. Henry Waxman of California, who chairs the panel, said on Thursday.

A decision on whether to launch a more formal investigation or to hold committee hearings could take several weeks, said the aide, who declined to be identified. The aide added that the Bear Stearns developments dovetailed with separate hearings that Waxman's committee has conducted on compensation packages for top executives at troubled firms.

Here's a link to the full article.

And That Is It For This Week...

As usual, I have so much more I would like to discuss. But unusually, I have almost no time to dive in further.

I will leave off, however, by saying that I was pleasantly surprised while idly looking through a discarded copy of USA Today, while waiting for yet another jolt of caffeine to be delivered, to find the front page article of the Life Section of that publication dedicated to a glowing discussion of the town of Cafayate and the surrounding wine country, where my own favorite partner of all times is building out his own version of Galt's Gulch. (You can view more at www.cafayateliving.com).

Doug has always had a spectacular eye for moving into the right real estate markets at the right time, and it looks like he's done it again.

In any event, it is time to wrap these weekly musings and rush madly for the airport. Next week I will be writing from the forebodingly named Jekyll Island, Georgia, where Doug and I will be spending a few days in good company further pondering the world as we know it.

Until then, thank you for reading and for subscribing. And a special tip of the hat to all of you who attended our Summit. I have said it before, and I'll say it again, our subscribers are a remarkably philosophically sound and interesting lot. It is always a pleasure to spend time with you, and the Scottsdale Summit was no exception.

Very sincerely,

David Galland
Managing Director
Casey Research, LLC.

The Room 2/11/08

David Galland — Mon, 11 Feb 2008 21:00:00 GMT

Dear Readers,

Good morning! And welcome to this edition of The Room!

If that salutation suggests a certain snap in my step, well, you'd be right.

After all, one can't let one's attitude be overly colored by the gloom and pessimism now stalking the land.

No, this is America... or, at least that is the turf upon which my own chair is currently parked. And no matter how bad things may be, they are, on the whole, no better or worse than those of most other places.

In fact, America has some significant commercial advantages over many countries, especially those which aspire to provide their citizenry a nest of perfect comfort in all the important ways, including semi-permanent employment. "You hire them, you retire them" is a phrase you might hear down at town hall in much of the world.

Not in the ol' U.S. of A. No siree. In those cases where management makes a major flub or reaches too far for the annual bonus and, in so doing, accidentally flips on the Equity Value Death Laser Model 2000-X, you need hardly wait for the minute hand to travel a single rotation before the guillotines are dragged out of storage.

Since July 2007, for instance, Countrywide has held going-away parties (however muted) for 11,000 employees. Morgan Stanley and JP Morgan have both bid farewell to 1,000 of their former stalwarts, with announcements that more will follow once they can afford to buy the requisite pink paper on which to print the traditional "so long and thanks for all the memories" notes.

Meanwhile, Lehman Brothers escorted 3,750 of its less close family members to the door, and Citigroup has begun trimming its rolls, a process by which its alumni will, it is reported, increase by 20,000.

The list goes on and on. In fact, according to the bean counters down at the Department of Labor Statistics, at least 1,408,852 people lost their jobs in 2007 (through November), due to mass layoffs... a 6% increase from 2006. Of that total, many were formerly involved with the building trades which, alone, have lost 284,000 workers since employment in that feast-or-famine sector peaked in September of 2006.

And, I need not remind you that the neck-chopping is just getting started.

While it is, of course, unpleasant to be one of those looking down into the basket while the hooded man finishes his preparations, it is this ability - and willingness - to view the common laborer as something of a disposable item that allows America to bounce back so quickly after periods of economic adversity.

Friend of long standing, Bill Bonner, wrote an excellent piece in his always worthwhile Daily Reckoning (dailyreckoning.com) earlier this week in which he commented:

Americans misunderstood the nature of capitalism itself. It is not an "economic system" that makes people automatically richer. It is a moral system... a system that rewards virtue and punishes error. You don't get richer because of Free Enterprise. Indeed, as the economic history of the last quarter-century shows, you can get poorer. The market system merely provides the setting in which you get what you deserve. You could get rich - if you were to do the right thing: work hard, save your money, innovate, take chances, forgo consumption. But do the wrong thing... and you will pay for it.

Bill is, in my view, right on the money.

Now, please, make no mistake. I would race even a humanitarian on the scale of Al Gore to be the first to pull the lever on any magic machine that reliably delivered on the promise of effortless wealth, health and happiness to all humankind. Sadly, such a machine does not exist.

(And, yes, that is a photo of Al Gore, taken at the recent Davos gala... if you ask me, he has been personally sequestering too many carbon units of late.)

And so we are left with only one economic model that has been proven to actually provide the most benefit to the most people over any period of time: capitalism.

In fact, if you think about it, pure capitalism is really just a continuum of the world's first discernable economic model; "survival of the fittest."

While previously success was gained through skill with the club or at throwing rocks accurately, in the modern-day iteration, the successful are those who understand how to effectively run a business, or know how to make themselves particularly valuable to their employer.

(There is another class of individuals which one has to begrudgingly credit as successful these days; the bureaucrats and other parasitic professions. They understand how to tap into the communal lifeblood and, once entrenched, sink barbs into the body politic to assure they cannot be ejected until they leave of their own free will, a lifelong pension in hand. Their long-term survival, however, is questionable... because they propagate so quickly that, over time, they risk killing the host, or being chased out of their jobs by workers brandishing torches and pitchforks.)

The data continues to confirm that we are headed into a deepening crisis here, which means that unemployment, the first whiffs of which we have now smelled, will only grow worse. In some countries, the economic pain will be deep and dragged out by well-meaning but misguided policies.

In the U.S., however, the odds are relatively good that after the brush fire burns through, the businesses will remain standing, albeit with much lighter attendance at the Friday morning pep talk, ready to pick up the pieces and get smartly back to work.

But it is time to prepare for the brush fire.

How bad could it get? In my view, and the view of most of us here at Casey Research, while the risk is certainly there, the odds remain long against widespread soup lines. If for no other reason than that if you overlay the economic happenings of the last 300 years with the number of months where soup line-level economic havoc has been the order of the day, it quickly becomes clear that massive meltdowns are statistically very rare in the more established economies.

Yet, though rare, the historical record is equally clear that they do happen.

Given the degree of uncertainty just now, it is not unreasonable to take a little time to examine your current circumstances. Do you own some gold bullion to provide protection against a serious crisis? Have you taken steps to offset losses in other areas - and hopefully pull down nest-padding profits - by building a portfolio of quality gold stocks? Are you able to raise a bit more cash "just in case"?

As importantly, are you trying a bit harder to look after your health? Cutting back on the snacks, a little more exercise? Having a health crisis in the middle of a financial crisis would be the very definition of unfortunate.

As well, if you are still in the work force, it is worth taking steps to improve your personal value as an entrepreneur or an employee. On that topic, longer-term readers know that while in my late teens I discovered, with full credit to Earl Nightingale for the revelation, the fountain of wealth: studying a topic you care about one hour a day, just like a college student studies their books.

If you work for a company, how much do you think you could learn about your company and its competition by studying just one hour a day, even after only a few months? Think your new-found knowledge would impress the boss? Darn right it would.

Or, if you are in a dead-end job, or suspect you may be one of those soon to be led to the guillotines, now is a good time to begin studying something that might help you in your next career. The secret is that it must be a subject you are passionate about. Follow your heart, and the money and your life satisfaction will follow.

As a personal aside, in recent weeks, I have turned my daily studies to electronic marketing media - an area that has the advantage of being helpful to almost any business, or anyone with entrepreneurial aspirations. (If you think you might benefit from that same course of studies, there are many good websites where useful, and free, information on the topic is available. One of the best I have come across is marketingexperiments.com.)

Oh, and since we're on that topic, I'd like to mention that we are looking for an experienced marketing director to help us spread the word about Casey Research... just drop me a résumé at David@caseyresearch.com.

But, back on topic, while it is my style and temperament to comment on the world with a lighter tone, make no mistake that I feel very strongly for those whose life's travails have left them unsatisfied, financially or emotionally. You can let it get you down, or you can set your jaw against the challenge and get down to work.

There are, per Bill's comments above, no guarantees built into a capitalist system... other than, one would hope, a guarantee that you get to play on a more or less level playing field. Regretfully, in modern-day America, the system has been substantially degraded by a legislative system that is willing and able to meddle in literally any aspect of life, or bestow almost any grant, opening the door for businesses and their lobbying organizations to influence legislation in much the same way I can get my old dog General to beg by holding up a piece of ham.

In the final analysis, each of us has to look after ourselves and our loved ones. If you look to the government, which is bankrupt beyond all possible repair at this point, to provide you with your retirement, or to assure that the safety net remains intact, you will be setting yourself up for steady disappointment and a life that fails to provide anything more than the barest of necessities, if that.

What Futures Markets Are Saying About Interest Rates and the Economy

By Bud Conrad

The combined effect of a slowing economy and the Fed cutting its rate to stimulate has caused the expectation for 3-month dollar-denominated investments called Eurodollars to drop in 2008 to below 2.5%, but then to rise into the future. (Despite the name, this has nothing to do with the euro currency).

[click to enlarge]

I interpret this to reflect a slowing in the economy through 2008, but that then the inflation will pick up, and investors will require higher rates to cover that inflation. It is part of recognizing that the Fed cuts rates by providing more liquidity. The result is that in the short run rates drop, but in the longer run inflation returns and rates have to rise to cover that inflation.

Making Money in a Crisis

In the current edition of the International Speculator, we provide a list of ETFs you can use to play the current financial crisis.

But, as Bud Conrad points out, it is really not that hard to find successful investments if you open your eyes and use logic. And, I would add, if you understand the various instruments available to you to act on these opportunities.

For example, it's no secret to anyone that the housing construction industry is in a slump.

So, what material is widely used in the building of most houses? The answer, lumber, is obvious.

As you might expect, therefore, and as is demonstrated in the chart just below, lumber prices have fallen along with the activity in the building sector.

[click to enlarge]

According to Bud, who is well versed in the futures markets...

"If you were to play the futures markets, you could have bought a contract for 110,000 board feet of 2"x4" priced at $217/1,000 ft. The contract is worth $23,000. The $90 price drop shown in the chart represents a profit of 900 points, which you multiply by $11 per board feet = almost $10,000. As the initial margin is $1,650, your returns could have been roughly 700% over a six-month period."

Of course, futures markets can swing both ways, and steeply so, and so should only be approached after a great deal of hard research and paper trading. Options trading, while also risky, offers the advantage of high leverage, but with identifiable and limited risk. Taking the time to learn more about options can also pay off, but again, be careful only to invest with money you can afford to lose.

Ed. Note: At the risk of being perceived as cementing a reputation for being crassly commercial, I am compelled to mention that, in addition to giving other profit-making ideas, options specialist Robert Meier of the RMB Group will be presenting a workshop on the right - and wrong - ways to use options at our upcoming Crisis & Opportunity Summit in beautiful Scottsdale, AZ on March 25, 26 & 27. If you are planning to attend, you'll need to register within the next seven days because there are only about 20 seats remaining. The secure link to learn more and register is just below:

http://www.caseyresearch.com/crpmkt/crpSolo.php?id=106

People Say the Funniest Things...

For some reason, the memory comes to me of the time when, putting in service as the best man at a wedding, I greeted Eleanor Mondale, the ex-vice president's beautiful daughter, in the receiving line. I was single at the time, and so the sight of Ms. Mondale, a model back then, was particularly well received. For some reason, however, the words that tumbled out of my mouth on making her acquaintance - and I still don't know where they came from - didn't appear to make exactly the right impression.

"Nice shoes," I said, looking at her feet. "I bet they must hurt." (In my weak defense, her shoes had very high heels and with very narrow tips.)

A quizzical expression passed over her attractive countenance (shown in the photo) before she replied, "Ah, no. They are just fine, thank you," before she hurried away, glancing back as she moved, I suspect, to be sure I wasn't following her.

John McCain had such a moment when, in a randy mood last year, he burst into song (poorly, it must be added) with the theme that the U.S. government, ideally under his leadership, should engage in the mass annihilation of the unfortunates who, by accident of birth, live under the Iranian theocracy.

(I refer, of course, to his rendition of "Bomb, Bomb, Bomb Iran"... posted for all posterity here... http://www.youtube.com/watch?v=hAzBxFaio1I)

Now, because we serve a broad audience, I suspect that there are any number of you who might agree with Senator McCain's musical sentiment, responding to any critics of same with a roll of the eyes and a comment along the lines of, "C'mon, really! Has everyone lost their sense of humor? Jeez!"

While I admit that the idea of unleashing waves of missiles against another country and the thought of "collateral damage" is a knee-slapper, I do wonder if a majority of the U.S. electorate will share the joke come election time.

I suspect not.

As a result, I strongly suspect that Sen. McCain's long-held aspirations to the highest office may likewise be scuttled.

Especially because, in addition to the somewhat concerning psychology revealed by his impromptu outburst of nihilistic verse, the perma-Senator is firmly on record as being in concert with the idea that America should occupy Iraq for 100 years, a sentiment that is not in step, if you believe the polls, with the majority.

And as a result, Obama or Hillary will be elected. (Sorry, Ron Paul fans, he may have raised a lot of money, but he's been effectively marginalized by the media and his fellow Republicans.)

And this points to the sticky wicket in democratic politics. You see, I am personally quite sure that I would prefer the economic policies of Sen. McCain over those of Sen. Clinton or Sen. Obama... but I'm equally certain that I would prefer either of those candidates' less martial backgrounds and leanings over those of Sen. McCain.

It is a classic no-win proposition. And so I prepare instead to cope the best I can with the damage that I see coming. Given that it is likely the Democrats will soon be ruling the roost, that means preparing for an acceleration of the feel-good policies that have laid such a solid foundation for escalating inflation - and higher gold prices.

My old associate from EverBank (Everbank.com), Chuck Butler, recently shared a Warren Buffett quote with the readers of his Daily Pfennig e-letter. Longer-term readers know that there are issues on which Mr. Buffett and I fail to see eye to eye, but in these remarks, I am in agreement. And I quote....

If something is unsustainable, it's going to have consequences; so far the consequences have been a general decline in the dollar against major currencies. If we continue the same policies, we're going to get the same results in the next five or 10 years.

He also had this to say about inflation... "Inflation has been in remission and is likely to be more prevalent in the next 10 years."

There are many things that cause dislocations in the marketplace, but few are as predictably disruptive - and, if you know how to play things, profitable - as government. The writing is on the wall. Now you just need to take the steps to prepare yourself to profit.

Quick Takes on Politics

At this point in the election cycle, it is probably appropriate for us to share, once again, the world's shortest political quiz, a reliable tool to tell you where you really belong on the political scale.

You can take it here: http://www.theadvocates.org/quiz.html

And, to assist you in contemplating the human frailties that argue so convincingly in favor of restricting the power afforded to any government, there is the following video featuring the antics of one of the anointed of America's political class. While you may have seen one of these videos in the past, this one is particularly well executed. Follow the link just below...

http://www.youtube.com/watch?v=BqLvBUSJucg

The Housing Market - Watch Out Below

One of the more interesting aspects of the current soaring default rate on home mortgages -- the very same defaults that are now bedeviling financial institutions around the globe -- is that the sophisticated models that were created to predict the behavior of the borrowers failed so badly.

This week, in an article in the Financial Times (ft.com), they discussed these failures at some length. Following are some excerpts I thought you would find of interest...

"There has been a failure in some of the key assumptions which supported our analysis and modeling," Mr. McDaniel admits. "The information quality deteriorated in a way that was not appreciated by Moody's or others." Mortgage borrowers, in other words, did not behave as expected.

The issue at stake revolves around so-called delinquency rates, the proportion of people who fall behind on their debt repayments. When American households have faced hard times in previous decades, they tended to default on unsecured loans such as credit cards and car loans first -- and stopped paying their mortgage only as a last resort. However, in the last couple of years households have become delinquent on their mortgages much faster than trends in the wider economy might suggest. That is particularly true of the less creditworthy subprime borrowers. More-over, consumers have stopped paying mortgages before they halt payments on their credit cards or automotive loans -- turning the traditional delinquency pattern on its head. As a result, mortgage lenders have started to face losses at a much earlier stage than in the past.

"In the past, if a household in America experienced financial problems it tended to go delinquent on its credit cards, but kept on paying its mortgage," says Malcolm Knight, head of the Bank for International Settlements, the central banks' bank. "Now what seems to be happening is that people who have outstanding mortgages that are greater than the value of their home, or have negative amortization mortgages, keep paying off their credit card balances but hand in the keys to their house . . . these reactions to financial stress are not taken into account in the credit scoring models that are used to value residential mortgage-backed securities."

And this...

In recent months, Washington politicians have devoted a great deal of attention to the problem of "resets". This refers to the fact that many subprime borrowers took out loans in recent years at initial, ultra-low "teaser" rates, which typically rise (or "reset") after a couple of years. Around 1m of these subprime loans are due to reset this year, which means that many households could suddenly face sharply higher repayments. That in turn has sparked fears of a looming further rise in delinquencies by increasingly cash-strapped households.

To offset this risk, the administration of President George W. Bush recently brokered a plan to freeze the resets. Yet in private, Treasury officials admit that while the scheme might help at the margins, it is unlikely to be a "silver bullet". This is because one dirty secret of recent mortgage data is that, thus far, there has been a surprisingly weak correlation between rate resets and delinquencies. That suggests that the reset freeze may have only a limited effect on foreclosures this year.

And....

Some economists suspect that if house price declines continue but the US jobs market holds up, the pattern of high mortgage defaults relative to other forms of consumer credit could continue. However, if the US slips into recession or even a protracted period of rising unemployment, delinquencies might rise on a wide range of consumer credits, implying a return to a more traditional pattern. Indeed, some banks are starting to brace themselves for this latter shift. "The problems in the credit markets are spreading to the consumer sector - the next area of concern is auto loans and credit cards," says John Thain, chief executive of Merrill Lynch.

I am reminded of a website that Doug Casey (who was first among others) brought to my attention this week. It is www.youwalkaway.com.

Should you click that link, you will find an enterprising e-biz that makes its money by providing homeowners, tired of the burden of paying their mortgages, with a kit that shows them the ins and outs of walking away with no further liabilities. And, even better, it explains how said mortgagees can live payment-free for the typical 8-month period it takes before the lenders are able to escort you from the premises.

Unfortunately for the economy and for those holding the "AAA" rated paper built out of these corrosive loans, www.youwalkaway.com is likely to become an increasingly popular site. Which brings me to...

Neutron Loans

Yesterday I had a pleasant lunch with a financial planner friend of mine. As he tends to deal with a more upscale clientele, he was unfamiliar with a category of mortgages sometimes called "payment optional."

If you thought "Ninja" mortgages were about as bad as it got -- you know, No income, No job, No Assets - then that is only because you haven't come across the payment optional feature offered to many of those same mortgagees.

In a nutshell, payment optional allows borrowers to elect to pay only a portion of their mortgage payment in any given month, rolling the balance-due but unpaid amount back into the original loan. This option was offered under the guise of allowing borrowers to deal with an emergency cash need. You know, the car breaks down and so, for a month, you pay less on your mortgage in order to have available the funds required to repair the car.

The problem, of course, is that many consumers, swept up in the giddy housing boom and romanced by the mortgage originators, borrowed more than they should have. And, when finding themselves unable to make the required payments, they began to fall back on the payment optional feature in order to get them through to the next payday.

With the magic of compounding interest now working against them, the situation was, and is, clearly untenable, assuring a steady supply of fresh customers for youwalkaway.com.

Bloomberg had a good article on the topic. For those of you short of time, here's a quick excerpt...

Feb. 7 (Bloomberg) -- Joe Ripplinger took out a $184,000 mortgage in 2006 and makes his payments every month.

Now he owes $192,000.

The 66-year-old Minneapolis house painter has a payment-option adjustable-rate mortgage. It allows him to write a check for $565 a month even though he owes $1,300. The difference is added to the mortgage, and when his total debt reaches $212,000, or after five years have passed, his monthly minimum will jump to about $2,800, which he can't afford.

"We're barely making it right now," Ripplinger said.

The estimated 1 million homeowners with $500 billion of option ARMs are beyond the help of interest-rate cuts by Federal Reserve Chairman Ben S. Bernanke. While subprime borrowers face an average increase of 8 percent or less when their adjustable- rate mortgages reset, option ARM homeowners may see their monthly payments double after their adjustments kick in.

"We call them neutron loans because they're like a neutron bomb," said Brock Davis, a broker with U.S. Express Mortgage Corp. in Las Vegas. "Three years later the house is still there and the people are gone."

You can read the article in its entirety by following the link here.

http://www.bloomberg.com/apps/news?pid=20601109&sid=akYNTEygRJH8&refer=exclusive

The Honorable Richard L. Armitage

Our own Bud Conrad attended a talk at Stanford last night by Richard Armitage, called Diplomacy: Humanitarianism in Action. Here's Bud's report:

Armitage was the second-in-command at the State Department, serving from 2001 to 2005 during Colin Powell's tenure. He had a front-row seat of the decision to go to war on Iraq. He served in Vietnam, was implicated in the outing of Valerie Plame, is on the board of directors of Conoco Phillips and is now working for John McCain's presidential campaign.

He strode on the stage and spoke without notes, evoking the image of a weak impersonation of General Patton. He wore a rumpled suit and was the only person with a tie. The speech was lightly attended, with an audience of only 60 or so. I guess students are more interested in basketball than a conservative who is now slipping off the political stage.

While the speech was of no particulate import, befitting the empty suit he has become, at the reception afterward I gained this most important insight: I asked him what the reason was for going to war in Iraq, and specifically if it was about oil.

He demurred, saying that he was part of the decision and the focus was on WMD (Weapons of Mass Destruction) and on bringing the light of democracy to the region. I pursued to ask how long we would be in Iraq. His answer was "a decade," although with decreasing forces. We didn't discuss the costs, as he still supports the original decision, but from the view of an economist, I have my interpretation. Namely, that we will be spending $100 to $200 billion per year we are there, so, if his assessment is correct, we can expect to add another $1+ trillion to the tab of what we've spent so far.

This ensures continued U.S. deficits and lower productivity, which confirms my basic thesis that the dollar will continue to come under pressure.

(On the topic of wars with Iraq, Doug Hornig, editor of our Daily Resource Plus, sent along the following YouTube video, featuring a rather interesting 1994 interview with *** Cheney. http://www.youtube.com/watch?v=S9YuD9kYK9I)

Get Well Soon

Living in a ski resort as I do, it is not unusual to hear a debate around the dining table on the topic of what is more dangerous, skiing or snowboarding.

Each side of the debate has their opinion, but our own Dave Johnsen, the programmer who assures our websites work each day, decided to wade in decisively on the topic, crashing his snowboard into a tree and breaking his fibula, as well as tearing his ACL, MCL, LCL, and meniscus.

Confined to bed after eight hours of surgery yesterday, he will have abundant time to jot down his further thoughts on the skiing vs. snowboarding debate. In the meantime, all of the Casey team would like to wish him a speedy recovery. (Oh, and if the website starts to get all wiggly, you can now appropriately assign the blame... to snowboarding.)

1984

It is, at this point, a tired literary device to reference George Orwell's seminal work, 1984, when commenting on the recent erosion of personal liberties.

Yet, the notion of an all-powerful entity snooping into your everyday affairs, ala Mr. Orwell's Big Brother, is sufficiently disturbing that observers of these things can't help but to drag it out, much in the same way others commenting on another genre might recall Frankenstein, or Dracula.

Unfortunately, while monsters made from reconstructed men or eternally living blood suckers are pure fiction, Orwell's monster is increasingly real.

Earlier this week, one of our researchers related a conversation between himself and his tax accountant. While requiring him to fill out a rash of new government forms, she commented that, in her role as a professional tax preparer, she no longer worked for him but for the government.

But it gets much worse. You see, our elected officials are now fast-tracking legislation to institutionalize warrantless eavesdropping on your every communication.

Don't believe me? Click the link below...

http://blog.wired.com/27bstroke6/2008/02/sen-rockefeller.html

The Quiet Revolution in Natural Gas

By Chris Gilpin, contributing editor, Casey Energy Speculator

While natural gas production has hummed along, slowly increasing in the U.S. over the past ten years, it would be a big mistake to think that everything is business as usual. There is a major shift underway in the natural gas industry. Conventional gas production is going the way of the dodo bird, while unconventional production - from sources like coal bed methane, tight gas and gas shales - has stepped up and made itself known as the future of natural gas.

The Lower 48 has been pumping more natural gas from unconventional sources than conventional ones since 2000 - the trend is accelerating. Conventional gas could soon account for less than a third of overall production.

The transition from conventional gas to unconventional has been remarkably smooth. It turned out to be much less of a challenge to exploit unconventional sources of natural gas than to exploit unconventional sources of oil, such as oil shale and tar sands (both of which have been nightmares from an engineering perspective).

A conventional gas operation is rather discreet, with a single well working every 640 acres or so, while a Coal Bed Methane (CBM) project dots the landscape with wells everywhere, as many as one per 80 acres. There's a lot of needless hand wringing over the aesthetics of such operations, but what interests us is how this infrastructure build has affected the landscape of supply and demand. For instance, the average production per well has been dropping precipitously.

[click to enlarge]

Despite its growing popularity, unconventional gas is no one's first choice. CBM projects require a huge amount of infrastructure to duplicate the same amount of production as one conventional well. Your average conventional gas well in the U.S. produces about 600 Mcf/d, while your average CBM gas well often pumps out less than 100 Mcf/d.

To make up the difference, the industry has been forced to drill, fracture, dewater, and maintain a lot more wells - all of which costs money. Gas producers have no choice but to pass these expenses along to the broader market, which has been a major factor in the rise of natural gas prices from $2/Mcf in 1998 to over $6/Mcf today.

The same story holds true in western Canada where CBM has just begun catching on in the last few years. The average initial productivity of a gas well drilled in the Western Canadian Sedimentary Basin has dropped from 1,000 to 300 thousand cubic feet per day over the last five years, a combination of ailing conventional gas resources and the rise of unconventional ones.

Without unconventional gas, the U.S. would be left trying to outbid the rest of the world for cargoes of LNG (liquefied natural gas), an unappealing scenario.

Many of the most intriguing investment possibilities now lie in parts of the world outside of the U.S. where unconventional technology is breaking virgin ground. Alberta is just starting to ramp up CBM production. Southeast Asia has huge reserves of unconventional gas that have never been properly explored. Using the American experience as a template, natural gas-producing regions all over the world are learning that it pays to think unconventional.

[Ed. Note: Dr. Marc Bustin, a senior researcher for the Casey energy division, is one of the leading unconventional gas experts in the world. The team is watching for opportunities in gas to open up in the spring and summer, after prices ease up due to seasonal considerations.

In the meantime, the energy division just updated a Special Report, North America's Top 5 Uranium Explorers... featuring the 5 best junior uranium stocks.

This is of particular interest now, because the uranium juniors as a sector have swung from massively overbought to deeply oversold. As determined contrarians, the time is fast approaching to begin reloading in the sector, and these are the companies you'll want to own.

As a subscriber to the Casey Energy Speculator, you'll find the report in the Special Reports section of this website... for everyone else, you can receive the report free of charge if you subscribe today.

Remember, your subscription comes with a no-questions-asked, 3-month money-back guarantee. Click here to get "North America's Top 5 Uranium Explorers" today.]

Affordable Health Care for All

Not so long ago, I was chatting with a cab driver while riding from JFK into Manhattan, when the conversation turned to what constituted a living wage. "I can't even afford health care," he said grumpily, weaving his cab with the grace of a ballet dancer between gaps in rumbling semi-trucks. With a snort he commented, "I'm not much of a Hillary fan, but the time has come for universal health care."

"That may be so," I chimed in from the back seat, "but I once lived in Canada and while there, watched someone I cared for deeply enter the nationalized health care system. After many months of bureaucracy and red tape, he ended up dead because they didn't run the tests that would have discovered his cancer, until it was too late."

"Yeah, but..." he started, his thoughts cut off by the need to concentrate on cutting off the competitor's cab trying to squeeze onto the expressway beside him.

"Here's a question," I continued. "If you didn't have to pay so much of your money in taxes... income taxes, property taxes, taxes on gasoline and all the things you buy... how much money do you think you'd save every year?"

"A lot!" he replied, a happier note in his voice as his mind contemplated the idea.

"So, if you didn't have to pay all those taxes, but instead maybe just a 10% flat tax, do you think you might be able to afford health insurance then?" I asked, rhetorically.

"Hadn't thought of that," he said, shaking his head with some confidence. "But, yes, I could. No problem."

So, what do you think? Could my "Unified Theory on Solving the U.S. Health Care Dilemma" qualify me for a Nobel prize? Who knows, I might actually have a chance, given that the bar on that prize seems to have been precipitously lowered in recent years.

Miscellany

A number of you have sent in the article from the NY Times discussing how merchants there are starting to post signs announcing "Euros Accepted." A sign of the times, to be sure, but I'm watching for the day that they start posting signs "Gold Accepted."
Ernst & Young made headlines this week by saying that most metals analysts' predictions of metal prices "have consistently and significantly lagged behind the actual spot market," and that mining and metals equities have been undervalued. To which I reply, "Welcome to our world."

Here's just one of a number of memorable points they made in their report:

"It is our view that current metal prices are actually a return to sustainable price levels following an extended period of artificially depressed prices, rather than the conventional wisdom that the industry is near the top of a cycle."
I asked one of our researchers to do an analysis of what price level gold needs to reach before we would, based on historical precedence, start seeing serious movement in the gold stocks. For data points, we looked back at two prior gold bull markets, then adjusted the price of gold back then to reflect the current purchasing price of the dollar. While we are still working on the data, a quick look suggests that, if history is a guide, gold has to break over $1,000 decisively to get the masses involved in the stocks. But when they do come, the returns are spectacular. We'll have more on the topic here, and in our other publications, in the near future.

A quick glance at the screen before signing off shows me that Wall Street is again painted red... and that gold, silver, many of the base metals, oil & gas are all higher.

It is especially gratifying to see gold come back so strongly from the whupping it took earlier this week, especially considering all the trash talk about our favorite metal of late. Including, most notably, Dennis Gartman who is calling for it to correct down to $810, though he nuances his comments by stating that even at that level, it would still be in a bull market and poised to surge again.

While we cannot predict the future, nor pretend to, neither can we yet see a scenario that does not favor gold reaching Bud Conrad's forecast of gold over $1,200 this year.

And that, fellow planetary travelers, is that for this week. As always, thank you for spending time with me today.

Next week I am going to endeavor to write an entire edition without mentioning the word "government" once. Until then...

Sincerely,

David Galland
Managing Director
Casey Research, LLC.