By The Gold Report, on October 10th, 2011
   When the currency system as we know it dies, some people will become very wealthy. In this special report from the Casey Research/Sprott Inc. Summit “When Money Dies,” The Gold Report cornered Global Resource Investments Founder and Chairman Rick Rule, Casey Research Senior Editor Louis James and Casey Energy Opportunities Senior Editor Marin Katusa for a roundtable discussion on the best strategies for thriving during the coming economic transition.
The Gold Report: Since we are at a conference called “When Money Dies,” please explain who killed money and how, after all these years of governments around the world trying everything from quantitative easing to bank bailouts, we are still in the midst of the weakest global economy in this generation’s history?
Rick Rule: The answer is in an old Pogo Cartoon that reads: “I have seen the enemy and he is us.” Collectively in the West, we have lived beyond our means for a substantial amount of time. We rely on a government that we have paid to steal from our neighbors. Money is how we deal with transfers. Dealing with transfers dishonestly by making more of the medium that isn’t backed by any value is the process by which money dies.
Louis James: The problem is that you are asking the guardian who has stolen the goods to recover them. Government has been in charge of money for hundreds of years. When it is debased, you have to ask: “Who was watching the hens in the hen house?” When you discover who the fox is, you don’t want to put him back in charge.
TGR: We are looking at quantitative easing 3 (QE3) in the U.S. Europe is considering the same thing. Even China is doing its version. Will money actually die or will it all inflate together?
Marin Katusa: I am going to take the contrarian view. With all this quantitative easing, there is actually asset deflation occurring right now if you look at the valuations from an equity standpoint. Trillions will be printed, but look at the deflation in the assets. He who has cash will be king because he can afford to buy these discounted stocks. If you do your homework and be sharp, you will make a fortune in the next three years.
TGR: But money is an asset; cash is an asset. If you are holding your wealth in money wouldn’t it all deflate?
MK: It’s all about purchasing power. Look at Canada’s largest oil company. It is just as good of a company as it was three months ago, but it has lost half its market cap, which means your dollar will buy more of a great company. It isn’t inflationary all across the board. It’s an asset deflationary market. That is a current example of equity asset deflation in the market right now.
TGR: So cash will deflate less rapidly than physical equities?
MK: Yes, right now.
RR: It is likely that the purchasing power of Western currencies will lose 5%–7% compounded for a long while, maybe until they go extinct. But in the interim, when you are experiencing incredible volatility, that is demonstrably better than losing 30% per anum in assets that are illiquid. Despite the fact that money is going to die, perversely you have to have lots of it to take advantage of the liquidity crisis.
LJ: You see, inflation figures are averages. Asset price destruction in a certain area doesn’t negate monetary inflation, nor its impact on other prices. Tremendous money creation is going on. This has economic consequences. The guy at the supermarket can see it even if his house is worth less. It is the worst of all possible models. Necessities cost more, but once trusted assets—the store of wealth in real estate and pensions—are depreciating. This has investment and economic consequences. The government is creating all this money and blowing it out the window. You have to figure out where to stand with a net.
TGR: How do you know what way the wind is blowing so you know where to place your net?
LJ: It’s all about stuff. Stuff people need is, in general, good when paper or theoretical money is bad. In certain asset classes, including real stuff, there will be price destruction. Real estate, for instance, still has a speculative side to it and has not yet bottomed. But fundamentally, real stuff that has value can’t just blow away. The world will go forward. People will need food and raw materials. Gold is another vehicle with intrinsic value. These things can’t be inflated out of existence. When prices on valuable stuff goes down ridiculously, that should be seen as a godsend. People will still need copper, steel and timber. Buy when that stuff is priced low and wait for it to go high, then sell.
TGR: Oil is priced in dollars. Is there a dollar price above which demand stops?
MK: Yes, that is why you have to put the price into perspective when considering an investment. Are you valuing a company at $60, $70 or $80/barrel (bbl.) oil? If a company isn’t making money at $60/bbl. oil, you don’t want to own that stock.
TGR: The market in the last six months has been volatile, but it seems to be like a roller coaster coming back to where it started. Is there a bigger trend moving daily prices?
RR: Dramatic volatility will lead to higher highs and lower lows. Despite the fact that it may look like a mean on a chart, people who experience it don’t experience a mean. They experience extraordinary discomfort. The fact that a $10 stock becomes a $7 stock in a few days causes people to speculate less frequently. It tames the animal spirits. The volatility will act as a depressant on the market.
That is why it is important to understand the causes of these fluctuations. QE is a polite way of saying counterfeiting. If you debase the denominator, the numerator doesn’t seem to matter much. You are actively debasing the currency by making it less rare. In the process, the government has declared a war on savers, reducing the utility they could get through traditional savings, forcing them to make more speculative investments.
The problem is even deeper than that, however. At the same time you have plentiful money, you have restrictive credit. People assume prices get set across the whole spectrum, but they get set on the margin and dramatically on the margin based on the psychology of the participants. It makes no sense. Look at the downdrafts in commodities. Nothing about the utility of copper caused it to fall. But interdraft lending dried up and when credit goes away, fabricators, traders and shippers can buy. Economic dislocations like this cause the market to be really volatile for substantial periods of time, which will unnerve many market participants.
I am actually fairly excited about it. I believe if it is going to happen anyway, find a way to enjoy it.
TGR: Marin, you are skilled at mathematics. Your models help assess equities. In a market driven by psychology and government policies, how relevant are your models and have you changed the factors you use to value companies?
MK: Since so many people are investing on emotion in the resource sector, you have to take your profits in a bull market and have lots of cash on hand to take advantage of deals in a bear market. In the program I created, there are literally thousands of variables you can analyze and interpret, but one of my favorite metrics for the junior exploration sector is the Casey Cash Box Indicator. One year ago, three companies were trading for less than cash on hand. Now I know of a little over 30. But, we are no where near the low of March 2009 when over one-third of all the companies on the TSX and TSX-V were trading less than cash. The Cash Box Indicator is what I use to give me a “feel” of the psychological sentiment in the market. When there are lots of companies trading under cash, people are fearful, and that is good if you’re looking for value.
For the junior exploration companies that do not have any tangible assets, the models I use for producing projects with cash flow are not as relevant.
TGR: Louis, you are out there visiting companies all over the world. In this market, how important is management?
LJ: It is and it isn’t. Having competent people to run the show is imperative. The alternative is non-competent people. Who wants that? Incompetence shows up quickly in performance. But just because a company has good people and a good project doesn’t mean it will do well; nature may not cooperate with exploration, or it could run out of money. When fear is in the driver’s seat, people are less willing to take chances, even on good people.
In the end, volatility is your best friend because you know that a market that’s down will go up again. When your favorite wine or something you value goes on sale, you don’t complain. You celebrate and buy two. We have that opportunity now. Wall Street hates volatility, Howe Street loves volatility—or it should, even on the downside, because that is a sign that it’s shopping season.
TGR: In the 1970s, we saw a bullish precious metals market, followed by a big upside. This time we had a big upside and now extreme volatility. Have we already experienced the extent of the bull side?
RR: You have to acknowledge the fact that despite volatility’s unpleasantness, it can be an opportunity. Gold and silver still have a long way to go although it may not be straight up. Even if it were to go to $2,500/ounce (oz.) eventually, it could test $1,000/oz. first. You have to have an understanding of history in order to understand what you might face. Keep cash on hand to take advantage of the volatility. Prepare yourself to have the courage to take advantage of the dips. A lot of people have been responsible investors and studied everything about the market except themselves. They haven’t prepared themselves. You need the cash and courage to use volatility.
Be careful, however. Don’t get your information from the market. The market is a mob. It is a facility to buy fractional ownership of businesses. But you have to get a sense of the value of the business to make good decisions. Take advantage of the idiocy of the other players. Other players only drive value of the stock in the short term. In the long term, the company fundamentals will determine the value of the business. What the three people in this room have become good at is buying companies that will be taken over by the industry at higher prices later. Playing foolishness is fun, but that is less important than the fundamentals associated with the valuations of the companies. The safest and most consistent money is made when you find discrepancies in the valuation of a company and the market valuation and play the arbitrage.
TGR: How can you value gold in a volatile market like this where the price of gold can vary between $1,000/oz. and $1,900/oz. Do those lows wipe out some companies?
LJ: The average cost of production for most companies is $600/oz. Even at $1,000/oz. gold, a 40% margin in any industry is considered pretty good. A lot of mining companies are making lots of money right now, which means they are fundamentally strong. In the face of that, when the market fluctuates, it’s a good thing; it brings opportunity. I have stocks in my portfolio that we have been able to take profits on when they were high and buy again when they were stupid cheap. We have been able to make doubles this way multiple times—on the same stock.
But not all gold stocks are production stories. How do you value an exploration play where there is no particular asset? That is difficult. You can use peers, or speculate about what the company might have in the ground if it is successful and try to estimate a value. Whatever path you choose, you should have some kind of metric, a sense of what is reasonable.
A great example of how volatility can create opportunity and profits is Extorre Gold Mines Ltd. (XG:TSX; XG:NYSE.A; E1R:Fkft), the spin out from Exeter Resource Corp. (XRC:TSX; XRA:NYSE.A; EXB:Fkft), operating mostly in Santa Cruz, Argentina. I have been there and looked at the main asset. I have no doubt the flagship Cerro Moro project is going to be a highly profitable mine, unless the government goes completely insane. Extorre had good exploration success there and has started getting very positive results from a second project. Based on this work, Extorre went from CAD$2 to CAD$14, so naturally we took profits along the way. I love Extorre, but at CAD$12, its market cap was greater than some profitable producers with cash flow and it was still just exploring. Now, with no bad news from the company, the market correction has the stock down to CAD$7. We know more about its assets now than we did when the shares were higher, but it’s selling cheaper, so it’s a better value now. We don’t know when things will go up and down, we just know they will. We know when they are cheap it is a good time to buy; when they are expensive, it’s a good time to take profits.
TGR: It seems like investors have to be more active now, going in and out of stocks. They can’t just buy and sit on them.
MK: You have to be careful in this volatile market. An investor needs to understand what type of investor he/she is. If you are a day trader, this is your type of market, because the volatility and big swings are present. I don’t believe relative valuation. I think it is important to distinguish between intrinsic valuation and relative valuation. But the answer to your question really depends on what type of investor you are and why you bought the specific stock. In my experience, my biggest gains have been buying big positions in companies where I believed in management and the projects, and bought more when the stock was down, and held the stock for more than a few years.
LJ: There is a distinction between resource investing and mainstream investing. Tried and true Graham-Dodd analysis was never applicable to our industry because the underlying commodities change too quickly, making even the biggest companies too fickle for that sort of securities analysis. However, I would posit that Wall Street is becoming more like Howe Street in a post-Lehman Brothers world. Everyone is taking more risk. There is no safe place anywhere in the world where you can buy a stock and forget about it.
RR: The two central tenets of Ben Graham’s book The Intelligent Investor deal with evaluating the margin of safety and management. You have to speculate in companies that have the financial wherewithal to weather the most immediate risks. In today’s volatile market, you are competing against manic-depressive traders who show up one day wanting to pay more than what you have is worth and the next day willing to sell for less than their assets are worth. In a devotion to net-nets, one of the best indicators of when you ought to be all-in is when it is full of people so disgusted in the market they are selling for less than they are worth. It’s a great time to be an investor.
TGR: If a lot of these companies are worthless, how does the average investor know which companies can go the distance?
LJ: You have to make your own decisions based on your risk tolerance. Your mileage will vary. Read the financial statements, talk to management. At some point you have to act, but you can and should wait until you are fully confident in your investment decision, so your confidence won’t be easily shaken by market volatility. It’s not like baseball; you can wait for the perfect ball, so don’t swing until you’re sure you’re buying low.
MK: Great tools are available. Watch the legends and insiders to see what they are buying and selling.
TGR: My last question is how does a new investor start in this industry?
RR: Go for a walk. Have a conversation with yourself. Do a personality audit. How hard are you willing to work and what is your risk tolerance? If you aren’t willing to work and don’t like volatility, try owning physical trusts, ETFs or seniors. If you have a longer-term perspective and stomach for volatility, you can take advantage of the opportunities in the junior space. But you need to have a plan.
MK: You can’t succeed unless you are passionate in whatever you do. If you don’t really like the sector, then you won’t go as deep as you need to have success and you won’t make the best decisions. Make sure you have a passion for mining. And have fun. Life is short.
You also have to be willing to make lonely trades. When everyone else says you are wrong, that is when investing becomes very interesting.
RR: Just because everyone else’s money dies, that doesn’t mean your money has to die. You are responsible for your future.
Founder and CEO of Global Resource Investments and President of Sprott Asset Management USA, Rick Rule began his career in the securities business in 1974 and has been principally involved in natural resource security investments ever since. He is a leading American retail broker and asset manager specializing in mining, energy, water utilities, forest products and agriculture. Rule’s company has built a sterling reputation for its specialist expertise in taking advantage of global opportunities in the resources industries. In 2011, Rule closed a landmark deal with Eric Sprott, Founder of Sprott Inc., another famous powerhouse in the arena. Sprott Inc. offers resource-oriented investors opportunities in segregated managed accounts, mutual funds, hedge funds and private partnerships. The collective organization offers unparalleled expertise and access to investment opportunities in all resource sectors. Sprott Inc. manages a portfolio of small-cap resource investments worth more than $8 billion and boasts a workforce of more than 130 professionals in Canada and the U.S.
Louis James is chief metals and mining investment strategist at Casey Research, where he is also the senior editor of Casey’s International Speculator, Casey Investment Alert and Conversations with Casey. When not in meetings with mining company executives in Vancouver, B.C., James regularly travels the world evaluating highly prospective geological targets and visiting explorers and producers getting to know their management teams. For more than 25 years, Casey Research, headed by investor and best-selling author Doug Casey, has been helping self-directed investors to earn returns through innovative investment research designed to take advantage of market dislocations.
Investment Analyst Marin Katusa is the senior editor of Casey’s Energy Report, Casey’s Energy Opportunities and Casey’s Energy Confidential. He left a successful teaching career to pursue what has proven an equally successful—and far more lucrative—career analyzing and investing in junior resource companies. With a stock pick record of 19 winners in a row—a 100% success rate last year—Katusa’s insightful research has made his subscribers a great deal of money. Using his advanced mathematical skills, he created a diagnostic resource market tool that analyzes and compares hundreds of investment variables. Through his own investments and his work with the Casey team, Katusa has established a network of relationships with many of the key players in the junior resource sector in Vancouver. In addition, he is a member of the Vancouver Angel Forum, where he and his colleagues evaluate early seed investment opportunities. Katusa also manages a portfolio of international real estate projects.
By Christopher Briem, on October 10th, 2011
Some have asked whether I agree with the story earlier in the week on the size of the energy industry in the region. I have not read it in detail, but without getting into any specific numbers sure I do. Energy has long been a huge part of the regional economy. One can argue energy is what we really always were good at. Without the coal, there would have been no steel and so forth and so on. But it goes far beyond that if you connect the dots as I wrote years ago in Energy Burgh.
The funny thing is that when I wrote that I really had folks Downtown laugh at me. It was the past was the message, not the future. For much a decade, other than some interest in ‘clean coal’, energy was not a focus of development. It was all talk of ‘high tech’ (pick your definition), biotech in particular, ‘advanced’ manufacturing (I’m not sure there is anything other than ‘advanced’ manufacturing still surviving these days) and until the bankruptcies of USAirways, air transportation. Remember when air transportation was going to ‘replace steel’ which was as stilly a concept then as it is now. Talk of energy was ‘quaint’ as literally put to me. That general apathy was the main reason I felt compelled to write that piece.
The irony is that if you go back and look at the date of the oped.. 2005. That must have been awfully close to the time some meeting somewhere was going on starting with “you know, we can get natural gas out of the shale in Pennsylvania”. Funny how disruptive things work. Just wait until the ‘greater’ Pittsburgh geothermal industry kicks in which will likely all center on fracking as well and found with Google’s help. Nothing happens on it’s own. It’s all interconnected.
One thing I mentioned in that article which didn’t plan out was the whole fuel cell project that did not pan out. At the time it was the biggest thing on the horizon. The fuel cells Siemens was working on were to be powered by natural gas for the most part. Even in failure, the fuel cell story is a lot more important than it may ever seem. Pittsburgh beat out intense competition for the fuel cell investment from locations in Florida, but more intense competition from Ross Perot who was pushing for the site to go to Texas and clearly put more money on the table at the time. Yet sheer money didn’t win in that decision which says a lot. In the end the market could not quite support what they were trying to do and they could not quite get their manufacturing costs low enough to make the product, mostly intermediate sized stationary fuel cells, viable. In some counterfactual world, if the decline in natural gas prices had come a bit earlier, maybe we could have added a growing fuel cell industry to the region as well. Think what the regional ‘energy story’ would have been. Alas.
The site that was to be the fuel cell manufacuting operation? Taken over by US Steel for research. Again, the more things change……
So is the local energy industry all or even mostly shale gas. Clearly no. Is the increase in jobs or output reported in the story all shale related. Probably not either. Check out the story on the gubenatorial election in WV decided this week. In it is this quote:
But the rising price of coal has boosted the state’s economy, giving it a lower unemployment rate than the nation at large and allowing Mr. Tomblin to boast of a state budget surplus in contrast to the fiscal straits of some of its neighbors.
So when you really push out beyond the MSA, and certainly into the 32 counties some focus on these days, coal is still the presence defining the economy, especially when you are talking sheer number of jobs.
By Bron Suchecki, on October 10th, 2011
I missed this piece dated 6 September 140 Year of Silver Volatility where Fekete picks up on Bob Moriarty’s Facts on Silver from 25 April with this cutting comment: “Beware of the fund manager, crying from his rooftop that the paper silver market is a joke, while down there under the roof he is selling paper silver at a 25% mark-up.”
Also worth reading Bob’s article with these five facts on silver:
1. When charts go parabolic, it ends badly.
2. The actual ratio of silver to gold in the earth’s crust is not 16 to 1.
3. There is no shortage of silver. There never has been a shortage of silver. Until the laws of supply and demand are repealed, there never will be a shortage of silver.
4. The most illogical thinking and worst use of “facts” is common among the silver uberbulls and the parrots that follow them.
5. There cannot be a run on Comex. The rules do not allow the chance for a run.
By the way, Bob is certainly in the “Repeat of 1980″ category with comments like “You can’t profit if you don’t sell and all the permabulls are screaming “Buy, buy, buy.” As they will at every top.”
PS I missed the Schoon and Morairty posts because those sites don’t run RSS feeds, which I think are essential. I’ve got around 100 feeds giving approx 250 posts a day to get through, just not possible to include manual site visits in that. 
By Simon Grey, on October 7th, 2011
I believe that a person who is 65 years old and has been forced into Social Security is owed something. But the question is, Who owes it to him? Congress has spent every penny of his Social Security “contribution.” Young workers have no obligation to be fleeced in order to make up for the dishonesty and dereliction of Congress. The tragedy is that most seniors just want their money and couldn’t care less about whom Congress takes it from.
Here’s what might be a temporary fix: The federal government owns huge quantities of wasting assets – assets that are not producing anything – 650 million acres of land, almost 30 percent of the land area of the United States. In exchange for those who choose to opt out of Social Security and forsake any future claim, why not pay them off with 40 or so acres of land? Doing so would give us breathing room to develop a free choice method to finance retirement.
This seems like a very good way to handle the current mess known as Social Security because it’s rather fair to both those who have already paid in and those who are currently paying. Best of all, it takes power away from the federal government, which is reason enough in my book to go forward with this plan.
By The Energy Report, on October 7th, 2011
 Despite the risks and unfavorable public opinion associated with offshore drilling, the truth remains that the keys to unlock the planet’s vast remaining oil resources lie beneath ocean floors, in places like the Gulf of Mexico, Brazil and even the Arctic. In this exclusive interview with The Energy Report, noted commodities expert Amine Bouchentouf tells us why he likes the prospects for oil explorers and producers and how the potash business is fueling food production for a growing world.
The Energy Report: Thank you for joining us this afternoon Amine. You wrote Commodities for Dummies and are a partner in Commodities Investors LLC, an advisory firm. What prompted you to reach out to a non-expert audience?
Amine Bouchentouf: I started investing in commodities around the year 2000, and in 2005 we saw an explosion of products for retail and institutional investors covering the commodities markets. In conjunction with that, I also noticed a lack of information for investors about commodities. That’s how Commodities for Dummies was born; it’s a one-stop guide for investors looking to get exposure to commodities. Why the “For Dummies” series? I felt it’s the Walt Disney of guide books: helpful, easy-to-understand and trusted by everyone. Since I wanted to provide investors with insightful, unbiased and trustworthy advice on different commodities, it made a lot of sense to partner with the series. Oil, natural gas, coal and fertilizers are all part of the commodities that I cover in-depth in my book.
The first edition came out in 2007 and a second edition this year. The book has done extremely well and is really a testament to the growing demand for our industry and for hard assets in general.
TER: Concerns about global population growth and demand for higher-quality food in developing economies have made the fertilizer market a hot topic. What should the average retail investor know about this sector?
AB: The fertilizer space is extremely interesting. If you want to get the broadest exposure to agribusiness then you have got to look at the fertilizer space, which gives you exposure to everything from coffee and orange juice to cattle and corn. The United Nations is predicting a population explosion between now and 2050. With that comes a natural rise in food demand. As we’re increasing available acreage to produce grains and livestock, we need fertilizers to increase yields and make larger-scale agriculture possible in hard-to-farm climates. The fertilizer market was relatively weak 10 years ago, but we’ve since seen prices start to go sky-high in response to increased demand.
If you want a long-term play in hard assets, the fertilizer market is a great way to get exposure to the commodity and agribusiness story. I’ve been looking at the space for a long time and I first recommended Potash Corp. (POT:TSX; POT:NYSE) when it was $12 a share. Had you followed my recommendation you would be sitting on returns of 420%. Now I’m in the process of looking for the next Potash Corp. Which company is going to provide me with that kind of explosive growth? There are certainly a few candidates out there. Allana Potash Corp. (AAA:TSX; ALLRF:OTCQX) is very interesting. The company has operations in Ethiopia, which gives you a unique access point to Africa, the Middle East and Southeast Asia—some of the world’s fastest growing economic blocks. You’d be surprised to know that the infrastructure in Ethiopia is world-class, with modern port, railway and road infrastructure. In addition, the mining laws are very friendly. Finally, the operating costs are low since the potash deposits in Ethiopia are near the surface, only about 100 meters (m) from the surface.
Another company worth a look is Karnalyte Resources Inc. (KRN:TSX). This is an exploration and development company that has potential to build a 2 Mt./year potash facility. It has very strong industry fundamentals and an experienced management team. It can provide you with a good solid exposure to this space.
TER: Where are they located?
AB: They’re up in Saskatchewan with over 85,000 acres of property. Their Wynard Carnallite project is an exploration and early stage pre-development property with a main zone of carnallite and sylvinite, which are minerals containing potassium. The attractive thing about this project is that they will be using what is called “solution mining,” which involves pumping a fluid into the mineral deposit through a drilled well. The carnallite mineral containing the potassium dissolves in this fluid to form a brine solution, which is pumped back to the surface. The potassium and magnesium minerals are then recovered from the solution and processed. Compared to conventional mining methods, this mining process has lower capital costs, shorter time to production, and lower environmental impact.
TER: Have any other companies in that field caught your eye?
AB: One of the best places for agribusiness in the world is Brazil. Brazil is essentially the “Saudi Arabia” of food since it has tremendous water resources and fertile land. I’ve been spending quite a lot of time in Brazil and it’s really a spectacular country to invest in. Brazil is currently the world’s second-largest importer of nitrogen, phosphates and potassium, the three principal chemicals used as fertilizers. The internal demand market is there and the deposits are there, so it makes sense for companies to exploit the potash resources inside the country.
There are a couple of companies in the Brazilian fertilizer space that are worth looking at. Verde Potash (NPK:TSX.V) is an interesting play. Verde has both conventional potash and thermo-potash projects in the state of Minas Gerais, the greenbelt of Brazil’s fertilizer market. They also have developed a new technology in association with Cambridge University in the U.K. to combine potassium with a mixture of salts to create water-soluble potash. If the technology is proven to be economically viable it could create a lot of upside for investors.
Another interesting company is Potassio do Brasil, which is still in pre-IPO mode. It has large reserves in the Amazon region, which shares similar potash characteristics to the world-renowned Saskatchewan basin of Canada. It has mineral rights along 400km in the Amazon basin, close to the 1.1 billion ton (Bt.) Petrobras property, and it also has an active drilling and exploration program. This is a company I’m keeping an eye on.
TER: Oil has been bouncing around in the $80-$100/barrel range for the past year. Where do you think oil is headed, and what opportunities do you see in this space?
AB: Oil is one of my favorite commodities because it is such a global business and it is such a challenging business. Right now I want to see how the situation in Europe develops. At the same time, it’s important to look at the demand side. If Europe blows up, what happens to demand from Europe and what are the spillover effects in the United States and China? The demand picture is still robust in emerging markets. China has become one of the big drivers of oil demand growth along with India and the United States. The United States is still the largest consumer of oil in the world. That’s an important fact to keep in mind. Supply-side disruption, whether in Nigeria or Libya or wherever else, can really send prices forward. On a macro level, I do think OPEC has done a terrific job of managing expectations and has been able to meet demand in a steady and consistent manner.
As far as specific plays, I’m always looking in the energy/equity space for oil companies that can provide good exposure. The offshore exploration companies offer interesting opportunities. Brazil, for example, announced major discoveries by Petrobras (PBR:NYSE) in its pre-salt basins. This has the potential to catapult Brazil into the top-three holders of oil reserves in the world. The exploration upside can be tremendous. Companies such as Transocean Ltd. (RIG:NYSE; RIGN:SIX), Noble Energy, Inc. (NBL:NYSE), Diamond Offshore Drilling Inc. (DO:NYSE) and Hercules Offshore Inc. (HERO:NASDAQ) can provide significant upside. Noble, for example, is already growing and its day rates are increasing. If you want to get more regional exposure, you can always look at Hercules Offshore, which provides Gulf of Mexico exposure. After the BP Plc. (BP:NYSE; BP:LSE) oil spill, we saw permitting essentially grind to a halt. The federal government had a public relations and environmental nightmare on its hands. So it was not going to move forward with permitting drilling activity in the Gulf of Mexico at that time. Now we’re seeing permitting come back to normal levels. It’s not quite to pre-BP oil spill levels but it’s getting close. A company such as Hercules Offshore, which had made some solid acquisitions in that region, gives you exposure as regulations relax.
Another area that is off the radar screen of investors is the Arctic, which can provide tremendous upside. The U.S. Geological Survey estimates that there may be up to 450 bbl. of oil equivalent in the Arctic, which is like discovering two Saudi Arabias of oil! We saw in September Exxon Mobil Corp. (XOM:NYSE) and Rosneft Oil (ROSNS:RTS), one of Russia’s biggest oil companies and one of the top majors in the world, sign an exploration agreement to go up to the Arctic and start a $2.2B exploration campaign. They’re expecting to find very, very large reserves up in the Arctic, close to 50 billion barrels (bbl.) of crude, which is just a gigantic number—that’s the equivalent of bringing another Libya into the market. Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE) has been present in the Arctic for three decades and has some interesting activities there; in fact Shell is set to begin an extensive drilling program in the Alaskan Arctic that could yield some large discoveries.
Another company I like that can give you pure Arctic exposure is Cairn Energy Plc. (CNE.L:LSE). Cairn is a Scottish company that has been active in Southeast Asia for a long time and has had tremendous success there. They’ve discovered offshore wells near Bangladesh and India and have a proven track record of creating shareholder value. Cairn has now shifted its focus towards the Arctic. This is another exploration and production company that can get that upside Arctic exposure you’re looking for.
TER: Are there any other spaces in the market you’re watching?
AB: I think the MLP (master limited partnership) space is very interesting. It’s not a space that a lot of people understand. As an investor, I like MLPs because they provide you with two things: physical commodity exposure and high yields. An MLP will distribute all of its cash back to its shareholders. It’s not uncommon to see MLPs that have yields of 8%, 10% and in some unusual cases as high as 18%. I believe a company such as Enbridge Energy Partners, L.P. (EEP/EEQ:NYSE) is a good way to get MLP exposure. They’re in crude oil and natural gas as well as transportation and storage, with really great exposure to the energy basin of North America. I think the company is going to deploy a lot of capital to grow a lot of different projects, especially in the Bakken Shale, which is an area that you have to be in as an investor. I highly recommend investors take a look at Enbridge as an MLP with some solid yields.
Another area I like is the LNG space. I think Teekay LNG Partners, L.P. (TGP:NYSE) is a world-class LNG company. We saw them provide a large cash distribution in the second quarter. Their yield right now is at about 7½%. In addition, it’s acquiring four more LNG carriers between now and 2012. I think these capital expenditure investments are going to generate a lot of cash-flow for the company going forward. Teekay and Enbridge are both solid companies.
TER: What final thoughts do you have that our readers can take away as far as the whole commodity sector and energy in particular?
AB: The energy space is wide and vast. You have to be very selective as to which type of assets you want to be in. You can find some tremendous upside in the mid-cap space as well as in the small caps and the offshore drillers. But, you have to be very, very selective. That said, my forecast for energy, particularly oil, is upward. The supply situation remains very tight and the demand from Asia and emerging markets is rising. If you want to benefit, you have to invest in specific companies.
TER: Thanks for your time, Amine, and the valuable insights you’re provided for our readers.
AB: Thanks for having me.
Amine Bouchentouf is a best-selling author and globally recognized expert in the commodities markets. He is the author of the best-seller Commodities for Dummies, (Wiley), which provides factual insight and analysis on energy, metals and agribusiness. Amine’s market reports and recommendations are read by over 42,000 investors each month. He is also a founder of Commodities Investors LLC, an advisory firm that advises investors on investment allocations into natural resources. He is fluent in English, French, Arabic and Portuguese and graduated from Middlebury College with a degree in economics. You can follow him on www.commodities-investors.com, www.hardassetsinvestor.com/the-commodity-investor and www.twitter.com/commodityinvst. Please feel free to email him with any inquiries at: amine@commodities-investors.com.
By Ajay Shah, on October 7th, 2011
The discussion about State Bank of India (SBI) has treated one proposition as a given: that it is the job of the Ministry of Finance to continually inject capital into SBI so as to enable the growth of the SBI balance sheet; that SBI has a legitimate claim upon fiscal resources at all times.
I’m not sure this is a good way to think about the business of banking. The first task of a bank should be to produce adequate retained earnings so as to support the desired growth. If a bank cannot produce retained earnings enough to grow, there is reason for thinking that it should not grow.
Let’s compare the performance of the best private bank (HDFC Bank) and a good PSU bank (Bank of Baroda) from this perspective.
Growth of the balance sheet and leverage
Let’s look at how the two banks have fared, from 1999-2000 onwards, on the core issues of balance sheet growth and leverage:
|
1999-2000 |
2010-11 |
| Bank of Baroda |
|
|
| Total assets |
58,623 |
358,397 |
| Leverage |
18.12 |
17.07 |
| HDFC Bank |
|
|
| Total assets |
11,731 |
277,429 |
| Leverage |
15.33 |
10.93 |
From 1999-2000 to 2010-11, there has been a sharply superior performance by HDFC Bank. At the start, it was a small bank – with a
balance sheet of just Rs.11,731 crore while BOB was roughly 5x bigger. By the end, HDFC Bank was at a balance sheet size of Rs.277,429 crore while BOB was at Rs.358,397 crore.
What is more, HDFC Bank did this while being more prudent: they deleveraged in this period: They went from a leverage ratio of 15.33 to a leverage ratio of 10.93. In contrast, BOB stayed at a much higher leverage (18.12 at the start and 17.07 at the end).
The bottom line: BOB grew net worth by 6.5 times and the balance sheet by 6.11 times. HDFC Bank grew net worth by 33.17 times
and the balance sheet by 23.65 times.
So how did the net worth grow?
In the naive intuition that’s being bandied about in the discussion about SBI, there would be an expectation that the expansion of net
worth would be obtained by asking shareholders (new or existing) for money. What happened in HDFC Bank and BOB was a bit different.
The hallmark of a healthy bank is the production of retained earnings which can be ploughed back into the business. HDFC Bank did
that: over this period, it brought 13.23% of total assets (summing across the 12 years) back into the business, so as to grow net worth. BOB did not do as well: it brought only 7.86% of total assets back into the business.
In addition, HDFC Bank raised 13.66% of total assets by bringing in fresh capital. BOB, in contrast, brought in only 2.11% of total assets into the business. You could criticise the Ministry of Finance for being niggardly in giving BOB equity capital.
A thought experiment: Strangle HDFC Bank of access to fresh equity
Suppose we replay these 12 years while allowing HDFC Bank to only grow through retained earnings. We cut off all growth of net worth through issuing fresh equity capital. Suppose we force it to deleverage as it has: from 15.33x in 1999-2000 to 10.93x in
2010-11. Where does this leave us?
The answer: In 2010-11, HDFC Bank would have had total assets of Rs.146,742 crore if this policy had been followed. It would still have obtained growth of 12.5x through this period.
This thought experiment, then, serves as a nice demonstration of what a healthy bank should be: it should make money, pay dividends, and plough back adequate retained earnings to support growth of the balance sheet.
Summary
A well run bank must put retained earnings back to work. If a bank is unable to fund its own growth by increasing net worth through
retained earnings, there is reason to be concerned about the health of the core business.
A steady flow of new capital from shareholders, in order to enable growth, is not that different from recapitalisation in response to bad assets.
Public money is precious. The Ministry of Finance would do well to be very, very stingy in doling out public money to PSUs. Each Rs.5000 crore that goes into a PSU comes at an opportunity cost of 1000 kilometres of NHAI highways which could have been built using that money.
If a PSU cannot grow its balance sheet, odds are the problem lies within: it needs to become a better run business and thus grow the
balance sheet using retained earnings. Such PSUs are precisely the ones who are the least deserving to gain fresh capital. If anything,
fresh capital should be directed into banks like HDFC Bank (as the private capital markets have), who are doing a great job of producing retained earnings.
By B.P.T., on October 7th, 2011
The Monster Employment Index for September was released today, and the index moved up 1 point from last month to a value of 148, which is 7% higher than last September’s value.
At 8:30 AM EDT, the Employment Situation report for September will be announced, and the consensus for non-farm payrolls is an increase of 65,000 jobs compared to no change in the previous month, the consensus for the unemployment rate is that it will increase 0.1% to 9.2%, the consensus average hourly earnings rate is expected to increase 0.2%, and the consensus for the average workweek is 34.2 hours.
At 10:00 AM EDT, the Wholesale Trade report will be released for August, showing inventory levels for wholesalers in the United States. The consensus is that wholesale inventories increased 0.6% in August.
At 3:00 PM EDT, the Consumer Credit report for August will be released. The consensus estimate is that there will be an increase of $8.0 billion in the consumer credit available in August, after an increase of $12 billion in the previous month.
By Ajay Shah, on October 6th, 2011
I was at a money changer in London and saw a tariff card, for purchase and sale of a few currencies (all to the GBP). (This was a while ago: It was on 12 May 2011).
This makes you think: What countries land up in this display, and how bad are the spreads?
Let’s start with the tightest spreads: USD and EUR. The spread — 19.98% for the Euro and 20.87% for the USD — is a pretty huge one
compared with the transaction efficiencies that we’re used to seeing on NSE and BSE. (Don’t miss the GBP 3 charge that’s also tacked onto transactions). The bid/offer spread on the wholesale market for the USD/GBP and the EUR/GBP are roughly zero. The inventory risk carried by the money changing firm must also be quite low given that many customers are likely to come by with such orders. Hence, the values of the spread seen there represent the pure cost of the retail front-end: paying rent, paying salaries, the cost of capital etc.
It’s hence interesting to subtract out the lowest value (19.98% for the Euro) and sort the remainder:
| Euro |
0 |
| USD |
0.892 |
| Japan |
2.141 |
| Australia |
2.479 |
| Saudi Arabia |
4.372 |
| UAE |
4.705 |
| Russia |
6.181 |
| Malaysia |
6.911 |
| Thailand |
7.695 |
| China |
8.860 |
| Kenya |
9.823 |
| Sri Lanka |
13.788 |
| India |
16.853 |
Japan and Australia are floating rates with full convertibility. There is no illegality involved. But the inventory risk is greater given that these are smaller countries; there would be fewer buyers/sellers of their currencies to the GBP. The vol is much like GBP/USD or GBP/EUR, so the enhanced spread reflects purely the greater inventory risk.
Saudi Arabia and UAE have credible hard pegs to the USD. Their vol to the GBP is exactly the vol of the USD to the GBP. (And, they are as convertible as the US). But their spreads are much bigger than that seen for the USD. It must reflect a small number of
transactions and hence inventory risk. They are small countries and even fewer transactions would be taking place. Many of their
nationals would probably hold the bulk of their liquid wealth in USD so the question of transacting through the local currency might not even arise.
Russia has full capital account convertibility, so there is no illegality. But it’s a highly volatile currency and the transaction flow is small. So we get the next step up in the spread, to 6.18%.
China has near-zero volatility to the USD, which means they are a high volatility rate to the GBP. It is a big country so there must
be quite a bit of traffic; there would be low inventory risk. The real issue is the illegality. The enhanced spread is the price paid
by people undertaking these transactions, for the capital controls of China.
And then we have India, the fattest spread in this group of countries, where I reckon it’s a combination of illegality (akin to
China), low volume of transactions (since India is a much smaller economy than China) and currency volatility (since India floats
while China does not).
I wasn’t able to make any sense of the list of countries that showed up in the list. Why Kenya and Sri Lanka, and why not Nigeria
or Indonesia?
By The Gold Report, on October 6th, 2011
Despite the recent pullback in metals prices, Amine Bouchentouf still believes that precious metals and mining stocks offer investors the best way to profit from the unfolding global economic mess. In this exclusive interview with The Gold Report, he talks about a range of mining stocks that can offer investors the type of diversification and upside potential needed in today’s rocky market environment and highlights several favorites.
The Gold Report: Thank you for joining us today. You wrote “Commodities for Dummies” and are a partner in Commodities Investors LLC, an advisory firm. What is your reaction to the spectacular run-up in metals’ prices and recent pullback in the last few weeks? Where are we headed from here?
Amine Bouchentouf: We have to put things in perspective. Let’s not forget that gold has been one of the top performing commodities over the last five years, and even over the last year. I recommended gold in 2006 at about $500/ounce (oz.). Between 2006 and today, gold is up about 175%, even considering last week’s downturn. Take it one step further; even this year gold is up approximately 15% while the S&P is down 7%. So, if you were in gold over the last five years or just the last year, you have outperformed the broad market by a wide margin. The long-term uptrend remains intact but these kinds of pullbacks are normal and provide buying opportunities.
TGR: So, with that mind, what are you thinking about performance in the next several months, and where are we going from here?
AB: I think we are going to see a volatile fourth quarter. Gold, throughout the year, has been acting as an independent asset. We saw it last week get caught up in the global asset deflationary cycle where, for the first time, every asset class went down with the exception of Treasuries. Equities went down and gold went down with them. That was, quite frankly, slightly unexpected by a lot of market participants. The fundamentals tell me that gold prices should go up.
Only 174,000 tons of gold exist in the world above ground. Looking at the supply side, that asset is growing at 2% a year. Last year gold production came in at approximately 2,500 tons. Throw in the physical demand from Asia and the Central Banks—for the first time we are seeing central banks become net purchasers of bullion. This is a new trend that I believe is going to put a floor on gold prices going forward. I’ve analyzed the holdings of central banks very closely and I think they are going to act as major drivers of physical gold purchases going forward, especially the emerging market central banks.
Let me be specific. The United States holds 75% of its foreign exchange reserves in gold. China currently holds 2% of its foreign exchange reserves in gold. Now we are seeing the Chinese Central Bank, the Brazilian Central Bank, the Russian Central Bank and the South Korean Central Bank all start to acquire gold very aggressively. Kazakhstan this year announced a very important decision. The Kazakhstan Central Bank now has a first option on all of the gold produced in Kazakhstan. And, Kazakhstan is a Top 10 producer with almost 40 tons of gold coming out every year—in a tight market, that kind of move can have a large impact, especially when other central banks start doing the same thing. We’re now seeing a major move by the central banks into the physical market and that’s going to provide a broad support for prices going forward.
TGR: Given that demand, if no one is a seller and every one is a buyer, then what happens?
AB: Right now what we are seeing is an increase in investor demand. We are seeing exchange-traded funds (ETFs) and more participants in the futures markets. We are seeing more hedge funds. We are seeing more mutual funds start to get physical. These have added some volatility to the prices, which is what we saw last week. We saw people deleverage. We saw margin calls and we saw the financial markets dictating the physical price. That has added a lot of volatility. Investors should be very careful of that kind of volatility. Going forward, we may be seeing larger spikes in gold than we regularly see in the silver markets, with new participants starting to flood into the gold markets.
TGR: So, the general trend is up with a lot of erratic activity in between.
AB: Yes.
TGR: In your writing, you have taken the position that junior gold mining companies are more attractive than the ETFs. Tell us why you think that’s the case.
AB: Well, I would like to first say that the ETFs have helped in the democratization of owning all sorts of commodities. I’m not anti-ETFs by any means. I think ETFs provide an important tool and access point to the market that investors otherwise would not get. I would say that the junior mining companies offer a lot more upside because you have the exploration advantage and the potential for new discoveries through knowledgeable management teams that are out there trying to add value.
Let’s just take a quick example. New Gold Inc. (NGD:TSX; NGD:NYSE.A) is a stock that has outperformed gold prices and gold ETFs by a wide margin. That’s because the company has a really solid management team in place and it has been able to grow reserves and add value while keeping cash costs very low. The junior mining space is a great way to get that kind of exposure. If you want to get exposure to gold with additional upside, then I believe the mining equities in general—and the junior miners in particular—offer you a very, very good way to do that.
Also, when you are buying into a junior miner you are getting physical gold at a deep discount. For example, the extraction costs of some of these companies are $350–$450/oz. Even at $600/oz., which is the case of some miners, you are still getting your physical gold at a deep discount when you are buying into a mining equity. In an ideal situation, you would like to own both. You would like to have some physical exposure, but also get the junior mining exposure because the growth in value can be really explosive.
TGR: So, basically ETFs provide a sort of mutual fund approach to investing whereas the individual stocks provide bigger upside with potential pops, if a company comes up with something really spectacular.
AB: Exactly right. ETFs are similar to a tanker ship, which provides you with slow, steady exposure. Whereas the junior miners and the mining companies are more of a speedboat, which can give you a lot faster upside than a tanker would.
TGR: Pure commodities trading offers futures and options and that sort of thing. That’s a whole different game for people who are interested more in gambling. Is that a good way to describe it?
AB: I wouldn’t necessarily characterize it as gambling. I would say that the futures/options space is for experienced market players. If you don’t have experience trading options or futures, don’t do it because the losses can be dramatic. And, you can actually lose much more than your principal. One of the red flags of futures and options is that you can trade them on margin, often with low margin requirements. So, I think if you want to get commodity exposure, ETFs, equities and slight hedging positions, if you are experienced, are really the best way to go.
TGR: When you look at these junior companies, how do you categorize them? What criteria do you use?
AB: You have the three categories: explorers, intermediate producers and senior producers. Depending on which playing field you are in, you are going to get a different risk profile. If you want higher risk with potentially extremely high reward, then I would recommend looking into the explorers. We have recently seen companies make big discoveries and their stock price going through the roof. That’s not just in the mining space, but in oil and other commodities as well. For the more high-risk/high-reward play, I would recommend looking at explorers.
The intermediates offer a steady base from which to build an investment portfolio. The reward might not be as high, but it establishes a floor because the company already has production. Any upside it can generate will flow down to the shareholder, and that’s where you can benefit.
Seniors like Barrick Gold Corp. (ABX:TSX; ABX:NYSE) and Newmont Mining Corp. (NEM:NYSE) are companies that are already producing and have very substantial reserves. The upside will come from acquisitions or ramping up existing production or issuing dividends to existing investors. So, as an investor going to the mining equity space you really have a wonderful universe of companies to choose from that fits every investment profile.
TGR: Do you want to tell us about some names that you think are particularly attractive at this point?
AB: I like several different companies in the space. As far as companies that are already producing, New Gold is an interesting company. It has some great assets and it is growing them. It has a good exposure base. The company is in mining-friendly jurisdictions in Canada, the United States, Australia and Mexico. I’m also not afraid to look into emerging markets like Africa and Latin America for growth. I think a company like Avion Gold Corp. (AVR:TSX; AVGCF:OTCQX), for example, which is in Mali in West Africa, can provide some terrific upside. The company is already producing about 90 thousand ounces (Koz.) a year and has plans to increase that to 200 Koz. by 2012; it also has some great potential upside in exploration with a target-rich area of 600 square kilometers. It’s also in Burkina Faso, which can give you even more exposure to a growing mining jurisdiction. A company like Banro Corp. (BAA:NYSE; BAA:TSX), which is based in Central Africa, for example, can offer additional exposure with an existing base of 7 million ounces of gold plus an exploration package of 210 square kilometers. That’s a spectacularly well-managed company and it can offer tremendous upside.
As far as some of the other names, I do like some of the royalty companies as well. I think the royalty companies offer a unique entry point into the market. Companies like Royal Gold Inc. (RGL:TSX; RGLD:NASDAQ), for example, have done very well. Franco-Nevada Corp. (FNV:TSX) is also one that investors should be keeping an eye on. These are very interesting plays because you are getting that kind of industry exposure without the operating expenditures. For me, as an investor, that’s an attractive proposition. If I am looking at a Franco-Nevada, this is a company that gives me the gold exposure without the burden of operating and capital expenditures. As an investor, I find that attractive.
TGR: Any others you like?
AB: I think Golden Predator Corp. (GPD:TSX) is a really interesting company. It has a year-long drilling program in the mining-friendly Yukon with no risk of having your assets seized by the government. Its exploration area package is bigger than the state of Delaware so the upside can be significant. Another company is Silver Predator Corp. (SPD:TSX), which is similar to Golden Predator since it also operates in the Yukon, except that it’s focusing on silver assets. It also has assets in Nevada, which is another mining-friendly jurisdiction; it’s thinly traded at the moment but it’s a company I’m keeping on my radar screen.
TGR: That’s a good broad range of coverage for the industry. What do you think metals and mining investors should be concerned about in the coming months as we are going through all this turmoil?
AB: I am watching the European sovereign debt situation and any potential spillovers it may have. If Greece defaults, that may trigger a cascade of defaults across Europe that could dwarf the effects after the 2008 Lehman collapse. So, in this case, I think hard assets do provide you with good exposure. Gold, in particular, provides safety in inflationary times. In addition, if we see large inflationary trends, which we have already seen through Quantitative Easing (QE) 1 and QE2, that’s another reason to be in gold. There is a direct correlation between increase of money supply and the increase in the gold price. I’ve studied this very carefully and determined that for each 1% increase in total money supply in the United States, we see a 0.97% increase in the price of gold.
So, if you are going to see the Federal Reserve and Bernanke print more money, that is a bullish sign for gold, not for dollars. As an investor looking out in the marketplace right now, I want to be in physical assets like gold and silver. Let’s not forget that gold and silver have been currencies for centuries. Let’s say that 100 years ago I showed up with a bar of gold in one hand and some green paper in the other, which do you think would get me what I want? The gold, because gold has that monetary aspect to it and it is a store of value. So, in this time of turmoil and market volatility, you want to be in gold.
TGR: Are you saying that the prospects for gold are good regardless of the intermediate little panics where people play games? Ultimately the metals should outweigh the paper?
AB: Absolutely. The hard assets are a store of value and a great place to be. Going forward, we should see a big increase in gold prices. Silver is a little bit trickier; silver is a schizophrenic commodity because it is 50% industrial and 50% investment oriented. These two undercurrents are always at play in the silver markets. That is why we see such violent swings in silver. If we see a collapse or if we see inflation in Europe and in the United States combined with robust industrial demand from Asia, these are two market drivers that will be bullish for silver. Again, I would like to point out that it is very important for investors to be careful when investing in silver because it can move violently, especially if you are trading the futures or options.
TGR: Is there anything else you would like to leave with our readers?
AB: Right now, valuations are very attractive in the mining equity space. Gold is still an institutionally under-owned asset. We’re seeing strong physical demand from the central banks and from investors. We are seeing strong physical demand for jewelry. So, I believe the future for gold is bright. And, in a period of tremendous market dislocation, you want to be in an asset such as gold.
TGR: Those are good words of advice for our readers and they can make their decisions accordingly. We will just have to stay tuned and see what happens.
AB: Exactly.
TGR: Thanks for joining us today. We’ll look forward to speaking with you again to see what develops.
Amine Bouchentouf is a best-selling author and globally recognized expert in the commodities markets. He is the author of the best-seller “Commodities For Dummies” (Wiley), which provides factual insight and analysis on energy, metals and agribusiness. Bouchentouf’s market reports and recommendations are read by over 42,000 investors each month. He is also a founder of Commodities Investors LLC, an advisory firm that advises investors on investment allocations into natural resources. He graduated from Middlebury College with a degree in economics. You can follow him on www.commodities-investors.com, www.hardassetsinvestor.com/the-commodity-investor and www.twitter.com/commodityinvst. Please feel free to email him with any inquiries at: amine@commodities-investors.com.
By Simon Grey, on October 6th, 2011
Scott Adams has an interesting post called “ Capitulation Stimulation” wherein he theorizes that inflation will kill investing, sparking consumption: Real estate is starting to look as if it will be a bad investment for a generation. Municipal bonds appear riskier than ever. It’s scary to hold cash if your bank has been misbehaving and you have more money in your account than the government insures. How about investing overseas? No thank you. Meanwhile, serious people are predicting that the government will allow inflation to increase as a way of eroding the value of the national debt.
So what does a rational, employed person with some extra money do? I think consumer spending is on the verge of spiking as high-income people decide they’d rather buy some nice things than lose money in sketchy investments. In other words, the horribleness of the economy is the very thing that will make it self-correcting. I could summarize the idea as “Screw the stock market. I might as well buy something.”
There’s a “capitulation stimulation” coming soon. In this context, capitulation means investors give up on investing, or at least love it less, and decide to spend more money on new cars, furniture, phones, and that sort of thing. If you buy a new TV, you have something you can enjoy. If you invest, all you end up with is less money. When being an investor starts to look irrational, overspending becomes the new rational.
I’m inclined to agree with Adams on this, though with the understanding that the rate of inflation will have to be generally high. Theoretically, the rate of inflation would, at the least, have to be higher than the expected rate of return of all investment types, ceteris parabis. Even then, however, it is impossible to say in advance how high the rate of inflation will be, and it is also impossible to know in advance what sort of return one will have on one’s investments. Furthermore, people who are inclined to invest in the first place are more conservative when it comes to money, so the disparity between the rate of inflation and the rate of return on investments would have to be quite noticeable and prolonged in order to expect those currently investing to switch from investing to spending.
This scenario would thus require either hyperinflation (or really high inflation) or investment return rates that are either zero or negative. Hyperinflation, of course, is economically deadly since there will be no incentive to engage in long-term capital accumulation. I’m not sure if low investment returns are a bad thing, in and of themselves, but I can’t imagine that this encourages long-term capital accumulation either.
At any rate, Adams is correct in noting that inflation, if high enough, has a very strong tendency to pull demand forward. And he is also correct in noting that this will stimulate the economy. Unfortunately, like all rounds of inflation Quantitative Easing before it, the results will be disastrous since inflation will disincentivize long-term planning. And once people only concern themselves with the short-term, the words of Keynes will ring far truer than he imagined: “in the long run, we are all dead.” And it will be because we did not plan for the long run. Indeed, we would have no incentive to do so.
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