In This Month’s Issue · THE CASEY REPORT 1 Volume III, Issue 8 / August 2010 The latest from Don...
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THE CASEY REPORT 1 Volume III, Issue 8 / August 2010 Dear Reader, While I am clearly biased, I believe we have a very special edition of e Casey Report in store for you this month. First up is Bud Conrad’s revealing analysis of the outlook for China and Japan, “ Asia’s Place in the World.” With so much of the world now looking to Asia to provide the engine for recovery, Bud’s analysis raises important and even troubling questions. It’s no secret that we here at Casey Research believe that the end of this crisis will come in an implosion of the latest global fiat money experiment. In “Back to the Future of Gold,” our own Terry Coxon, one of the world’s most knowledgeable authorities on monetary matters, explains how a return to the gold standard is likely to come about. en, in addition to our usual features – including the Data Farm, How to Invest and Obama Watch, which, this month, examines the Obama administration’s claims about economic gains – we’re especially pleased to present Doug Casey’s comprehensive special report on a recent trip “Into Iraq.” ere’s all that, and more. Mark the Dates Before getting on with the show, however, a quick heads-up on the dates and location for our next Casey Research Summit: October 1 – 3 in Carlsbad, California (just outside of San Diego). e program will have a heavy focus on gold and gold-related investments, and provide updated analysis on the unfolding train wreck in the global economy and how to prepare for what’s next. In is Month’s Issue... Click on the link to jump directly to an article. Introduction David Galland sets the stage for this month’s edition. Asia’s Place in the World Bud Conrad’s outlook for China and Japan. Back to the Future of Gold Terry Coxon on the coming gold standard. How to Invest An update on our recommended investments. e Data Farm A monthly recap of data worth paying attention to. Obama Watch: About at Job Creation… e latest from Don Grove, our man in Washington. Special Report: Into Iraq Doug Casey’s travel journal, with reflections on the Middle East. End Note A closing comment by Doug Casey.
Transcript of In This Month’s Issue · THE CASEY REPORT 1 Volume III, Issue 8 / August 2010 The latest from Don...
THE CASEY REPORT 1
Volume III, Issue 8 / August 2010
Dear Reader,
While I am clearly biased, I believe we have a very special edition of The Casey Report in store for you this month.
First up is Bud Conrad’s revealing analysis of the outlook for China and Japan, “Asia’s Place in the World.” With so much of the world now looking to Asia to provide the engine for recovery, Bud’s analysis raises important and even troubling questions.
It’s no secret that we here at Casey Research believe that the end of this crisis will come in an implosion of the latest global fiat money experiment. In “Back to the Future of Gold,” our own Terry Coxon, one of the world’s most knowledgeable authorities on monetary matters, explains how a return to the gold standard is likely to come about.
Then, in addition to our usual features – including the Data Farm, How to Invest and Obama Watch, which, this month, examines the Obama administration’s claims about economic gains – we’re especially pleased to present Doug Casey’s comprehensive special report on a recent trip “Into Iraq.”
There’s all that, and more.
Mark the DatesBefore getting on with the show, however, a quick heads-up on the dates and location for our next Casey Research Summit: October 1 – 3 in Carlsbad, California (just outside of San Diego). The program will have a heavy focus on gold and gold-related investments, and provide updated analysis on the unfolding train wreck in the global economy and how to prepare for what’s next.
In This Month’s Issue...Click on the link to jump directly to an article.
Introduction David Galland sets the stage for this month’s edition. Asia’s Place in the World Bud Conrad’s outlook for China and Japan. Back to the Future of Gold Terry Coxon on the coming gold standard. How to Invest An update on our recommended investments.
The Data Farm A monthly recap of data worth paying attention to. Obama Watch: About That Job Creation… The latest from Don Grove, our man in Washington. Special Report: Into Iraq Doug Casey’s travel journal, with reflections on the Middle East. End Note A closing comment by Doug Casey.
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In addition to the senior Casey Research team, including Doug, Terry, and Bud – as well as Marin Katusa of our energy division and Louis James, head of our mining research – the faculty already confirmed (and this is just for starters) include: Richard Russell, Dow Theory Letters, Jim Puplava, Financial Sense Online; Eric Sprott, Sprott Asset Management; Robert Prechter, Elliott Wave International; Rick Rule, Global Resource Investments; Neil Howe, co-author of The Fourth Turning; Vitaliy Katsenelson, Investment Management Associates, Inc., Kevin Bambrough, Sprott Resource Corp; Brent Cook, Exploration Insights, and Bob Bishop, independent mining share investor.
You’ll receive more information on the summit in the near future, along with the opportunity to register. If you’re at all interested in participating, please act promptly – as these events are invariably a quick sell-out and you won’t want to miss this one. I look forward to meeting you there.
And now, let’s get to this month’s edition.
David Galland Managing Editor
Back to Table of Contents
Asia’s Place in the World By Bud ConradWith the vortex of continuing troubles in U.S. real estate and the eurozone competing for my attention recently, I’ve been somewhat neglectful in updating my analysis on the important economies of Asia. In this article, I’ll do just that.
The vast majority of coverage done on the topic in recent years has touted the magnificent success of China, detailing how the Western Empire is handing over its leading position to Asia’s rapidly growing economies. I plan on kicking the tires on those contentions and trying to get a reasonably good fix on Asia’s place in the world’s economic structure.
As an executive at Amdahl, the large mainframe computer manufacturer owned 40% by Fujitsu, I was integrally involved in what was at the time called the “miracle” of Japan’s heady economic success. The model worked well: Asia’s abundant and disciplined workforce was exploited to manufacture products for the world, using our technology.
I recall our Japanese partner copying our designs and providing excellent products. They learned the details of our computers, and we gained a short-term benefit of competitive manufacturing to beat IBM at its own game. But short-term gain didn’t bring long-term benefits. Amdahl no longer exists, and by contrast, just now, I am typing this newsletter on that Japanese company’s computer. That is a microcosm of what has happened between the West and Asia over the subsequent decades.
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Of course, since then Japan has ceded its lead as a premier manufacturer to China and other Asian Tigers. That wasn’t all bad news for Japan as its banks provided much of the financing for the growth of Asia. Simply, as rising wages made Japan’s workers uncompetitive, new industrial investment was made where the labor was cheaper – in countries like China.
And so China became the world’s leading manufacturer, and in the process accomplished something unprecedented: moving from a backward nation to the world’s third most powerful economy in only two short decades. It did so by absorbing, stealing, and exploiting technology while putting its low-cost, productive populace to work.
Tackling the changing role of Asia in the global economy, and how that role will affect the fortunes of the U.S. and other Western powers is a daunting task. To bring the analysis down to a more manageable level, I’ll focus on Japan and China as the two most important Asian countries and present an overview of how key components of their economies compare to our own in the U.S.
This is an overview article, so I won’t provide in-depth focus on specific investment opportunities, but there are insights here to provide warnings about where markets may be moving.
I start with a comparison of stock markets, because those offer a reflection of much of what is going on in an economy.
Stock MarketsThe chart shows the huge bubble that Japan experienced into 1990, a bubble so large that even after two decades, the Japanese stock market remains 70% below that peak. As you can see, the United States then experienced its own big bubble up to the year 2000. A swift decline was followed by a surprising recovery triggered by deep Fed rate cuts that stimulated our housing bubble and led to a second stock market top.
Since 2007, the worst financial crisis since the Great Depression put the U.S. economy in low gear. While massive government stimulus in 2009 helped stabilize the stock market, the future holds more question marks than confidence.
Surprisingly to many, the most rapid rise of any of the three stock market bubbles occurred as China’s Shanghai stock market peaked in 2008. Its subsequent fall in percentage terms from the peak was far faster than the other countries’, but if history is an example, the Chinese stock market may take a decade or more before it returns to its previous peak.
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Multiply right scale by 3 for Shanghai
Copyright Bud Conrad Casey Research 2010
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Real EstateThe value of real estate holdings is on a similar level to that of stocks, so in the chart here I show a comparison of housing value normalized by dividing by GDP. It is worth noting that stock market bubbles are usually accompanied by real estate bubbles because optimism and credit expansion drive both.
Japan’s severe bubble and collapse were made worse by their real estate and stock market bubbles happening at the same time. The double peak in the United States reflects the housing bubble that gave a second push to the stock market into 2007. Likewise, there is a new mania in Chinese real estate, fueled by credit expansion, that looks extremely ripe for implosion.
As you can see, relative to the peak in U.S. housing, it is at a much higher level and is now approaching that experienced in Japan.
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Gross Domestic ProductThe big-picture pattern of economic growth is measured by the gross domestic product (GDP). As you can see in the chart here, Japan grew dramatically in the 1980s. While their stock market bubble burst in 1990, their currency continued to appreciate so that, in dollar terms, their GDP continued rising into the mid-1990s. Then their forward progress stalled: for the last 15 years, Japan has not been able to grow, even when denominated in dollars.
Meanwhile, up until the current recession grabbed hold in 2008, the United States GDP had managed steady growth. If Japan is a model, the United States GDP could stagnate for a decade. The Chinese situation is less clear, because although they are overtaking Japan and on a very rapid growth trajectory, they have important weaknesses I’ll discuss momentarily.
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Copyright Bud Conrad Casey Research 2010
$ Billions The U.S. or China Could Stagnate Like Japan
Japan Bubble
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Source: IMF World Economic Outlook
Japan Lost Decades
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Global TradeOf course, all of the major countries are closely intertwined in what can accurately be called a global economy. According to forecasts from the International Monetary Fund, the consensus view for the future of that global economy is that China, as the manufacturing engine of the world, will continue expanding its exports. Conversely, the U.S. is expected to continue its consumption by buying all that output. If the U.S. economy stays moribund from the high unemployment that can at least partly be attributed to the loss of jobs to Asia, there’s a big question of how we can afford to soak up China’s massive output.
In terms of world trade, Japan has been relatively stagnant and is expected to maintain a positive stance but not be an overwhelming or big factor.
A closer look at just the trade balances for Japan and China with the United States shows a similar pattern.
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U.S. Current AccountJapan Current AccountChina Current Account
Copyright Bud Conrad Casey Research 2010
$ Billions U.S. Trade Deficit, Chinese Surplus, May Continue
IMF Projections
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Copyright Bud Conrad Casey Research 2010
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CurrenciesEven though the U.S. and other Western governments are actively encouraging China to increase the value of its currency, the long-term history does not show the Chinese yuan as a strong currency. Japan’s yen has been much stronger, with the big rise into the mid-1990s that made Japanese economic strength in dollar terms appear to extend beyond 1990 to 1995 in the earlier GDP chart .
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Copyright Bud Conrad Casey Research 2010
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The weakness of the yuan in the late 1980s and mid-1990s is also reflected in spikes of CPI price inflation. Political problems affected China in a negative way in those periods. The current recession has put a damper on inflation on a worldwide basis into 2009, with a big drop in energy prices being an important factor.
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China's Higher Inflation in the 1980s and 1990 Caused the Yuan to Weaken
Copyright Bud Conrad Casey Research 2010
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Comparative money supply growth gives China the dubious title of biggest money printer. I’ll have more on Chinese money growth later.
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International ReservesChina’s emergence as the clear winner in world exports gives rise to the other side of that equation – that country’s accumulation of a massive reserve of foreign currency denominated assets. This gives China a lot of international leverage, especially in dealing with the U.S. Indirectly, China is funding our government spending, from tax cuts to wars, and our government very much needs that funding to continue.
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SDR Billions International Reserves Grew from Trade Surplus
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EnergyOil usage reflects economic growth. In fact, I claim that most economic growth comes from exploitation of energy to build the things that eventually become our wealth.
The correlation between income per capita and energy use per capita confirms that energy is necessary for economic success. The problem for our planet is that we can’t expect to indefinitely continue burning over 80 million barrels a day of fossil fuels laid down over 100 million years without eventually reaching supply limitations. The United States built much of its wealth on extracting energy from Texas. Japan has almost no oil, and China’s growth has now far outstripped its ability to supply its own needs.
The chart below shows the dramatic growth in petroleum demands in China to produce its world output and improve its own lifestyles. This chart also provides a perspective on the relative directions of the underlying economies: the U.S. is the biggest, but in decline. Japan is stagnant. And China is moving up.
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Copyright Bud Conrad Casey Research 2010
M bbl/dayConsumption of Petroleum Products
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China gobbling oil with growth
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China – Facing the Limits to GrowthChina has enjoyed a truly remarkable economic growth of around 10% per year for the last two decades. The most recent quarter ending in June 2010 saw a 10.3% increase in GDP. No other country has produced these kinds of numbers. Whereas at the beginning of their rise, China might have been overlooked as relatively unimportant in the overall scheme of things, today, by any world economic measure, China has to be part of the equation. The model of being the manufacturer to the world has worked. Despite our Western dogma that free markets provide the incentives and creativity for economic growth, China, with its massive central government, has produced a miracle that absolutely no one could have anticipated.
But there are cracks in China’s seemingly well-planned system, a system that, while still under the command of a small cadre of communist functionaries, has allowed private businesses and ventures to grow rapidly. It’s hard to believe that the Shanghai stock exchange only reopened in 1990, after decades of communist rule that actively suppressed capitalism. Yet, economic miracles usually are discovered to be mirages – that’s certainly the case with China’s extreme stock market rise to 6,000 in 2007. As was shown in the first chart, since the peak, that market has already taken a big hit down to 2,500.
Earlier I mentioned the correlation between stock markets and real estate. The same forces that move both up in tandem can work in reverse: Japan’s stock market crash was followed by a real estate crash within the year. So the question is, how vulnerable is the booming Chinese real estate market today?
I traveled to China in 2008 before the Olympics and was absolutely amazed by the miles and miles of high-rise buildings surrrounding Beijing. Similarly, across the river from Shanghai, the skyline of Pudong reveals gleaming buildings beside the famous floating balls of the futuristic Oriental Pearl TV tower. In its penchant for large real estate projects, China’s economic might is very visible.
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Of course, China’s leadership has much to lose should a slowing economy put restless citizens on the street. Which helps explain why, in the downturn of 2008, China aggressively applied stimulus. In fact, when measured on comparative size of the economies, China’s stimulus greatly exceeded even the seemingly excessive programs unleashed by the U.S. government. As a consequence, they were able to essentially buy continued growth in their economy. And that stimulus bubbled over into yet more real estate growth in a collective private and government-fueled development of all kinds of buildings.
It’s important to note that China measures its growth by what is produced, not by what is sold and utilized. So a vacant shopping center counts for its full production cost in accumulating its output. This provides an incentive to local bureaucrats trying to meet government goals for growth.
Of course, such an approach reveals the potential for serious cracks in this apparent growth miracle. China’s central government is able to edict that new spending and loans be provided by its banking system. That provides funding for people buying condominiums that they never intend to occupy. They are jumping on this bandwagon of price increases. Sound familiar?
Here is the smoking gun: in opening its floodgate of massive loans to fight recession, China has stimulated a real estate bubble. China’s housing price index softened in the 2008 recession but exploded since, with the infusion of new lending under the government’s $587 billion stimulus programs.
The second chart of this article speaks volumes by showing the Chinese real estate bubble approaching the level of Japan’s peak.
Other measures of Chinese real estate – for example, by comparing rental rates to purchase price and prices to income – all confirm the extreme nature of the bubble. One amazing measure is that the price of private land in Beijing has increased nine times over in the last decade. Most land is held by the government and leased for 75 years, so the escalation of traditional measures reflects that of the structure more heavily. Some smaller amounts of land are privately held, and this price escalation demonstrates the more extreme perception of rise.
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From Wu, Gyourko and Deng
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That this real estate bubble became so extreme can be attributed to an interlocking, self-supporting group of forces. While down payments for housing are supposed to be 30%, often the minimum down payment requirements are circumvented through borrowing outside the banking system, perhaps from groups of families who pool their assets for investment. Local government leaders get involved with supporting developers who make their money up front as units are sold before they are completed. Banks provide loans with support from the government to get the construction projects started. And decisions to build projects can be based on keeping workers busy and expanding the economy, as much as they are on market demands.
We are already seeing the first signs of weakness in this bubble. There are now 65 million vacant housing units. That is not a typo. Price growth actually went negative in the last month measured. And most dangerously, the visible signs of whole cities being built to support export markets that are in decline have left behind ghostly, empty shopping malls and underutilized facilities.
The government role in creating these excesses comes from its active encouragement of lending to the developers and, lately, direct stimulus spending. You can see that stimulus in the following chart showing the amazing increase in money supply as the government undertook energetic efforts to avoid economic slowing. Over a 20-month period, Chinese M2 grew 47%, reflecting the impetus for spending and development.
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Copyright Bud Conrad Casey Research 2010
100 M Yuan China Money Jumped $3.5 T in Crisis
Jumped $3.5 Trillion (47%) 11/'08 to 6/'10
Source: Peoples Bank of China Data to June 2010
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Money growth is so big that it should limit the much discussed appreciation in the yuan. Why would anyone want to own a currency that is being expanded by the government so fast? An alternative is to invest in tangible things like real estate, and locals have jumped in with both feet.
Of course, the wild expansion of real estate lending has put the Chinese banking system in the precarious position of holding a lot of loans that might be difficult to service if the real estate bubble begins to deflate. There are stories of people on modest salaries owning five condominiums, hoping to pay their mortgages based on the rise in purchase value. Again, sound familiar?
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And the problems don’t just stop with residential and commercial development. Bloomberg reported that a review of Chinese banks found they may struggle to recoup about 23 percent of the 7.7 trillion yuan ($1.1 trillion) they’ve lent to finance local government infrastructure projects. Local governments get involved with banks to fund projects such as highways and airports, because they are not allowed to directly borrow money. That sets up a complex web of promoters, government, and lenders all pushing for new building projects.
Even though Beijing has tried to slow the bubble, the evidence of empty buildings in faraway cities that were supposed to develop products for export seems like a disaster that has already happened but that has not yet been acknowledged.
Japan – over the Demographic HillJapan’s bubble burst much earlier, in 1990, so their government has been trying to stimulate Japanese economy longer. The result is gross government debt equaling 250% of GDP. The much maligned gross debt of the U.S. government is “only” approaching 100% of GDP – a level that, while dangerous, is, compared to Japan, much less extreme.
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Copyright Bud Conrad Casey Research 2010
Debt % GDP Japanese Government Debt Is Worse Than U.S.
IMF Projections
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One important difference between the U.S. and Japan is that most of Japan’s debt is owned by its own citizens, who can be more easily “managed” than foreigners. By contrast, as a result of our long-standing trade deficits that have accumulated mostly as Treasuries, over 40% of U.S. government debt is owned by foreigners.
One of the more interesting changes in the Japanese position is that it previously depended on the U.S. for 70% of its export volume. As you can see in the next chart, that has changed, with China now buying more from Japan than does the United States.
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Copyright Bud Conrad Casey Research 2010
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China Replaced U.S. as Largest Buyer of Japanese Exports
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2010 estimated from first 5 months annualized
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Similarly, Japan’s purchases from the U.S. have declined precipitously while its purchases from China have increased. Japan has no oil; so as the price of oil increased, their imports from the Middle East grew. In both exports and imports, China has become the more important partner for Japan.
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Source: Ministry of Financehttp://www.stat.go.jp/english/data/getujidb/index.htm#f
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Japan’s government was the first to attempt to stimulate its economy when, 15 years ago, it dropped its central bank interest rate close to zero. The effectiveness of this stimulus is not clear, for the simple reason that we can’t know how much worse its economy might have been without this gift to banks – a gift that helped them cover their loan losses and recapitalize.
Regardless, the pattern is being repeated in the U.S., with interest rates manipulated to the lowest level in half a century. While there was, briefly, some talk about the Fed exiting the stimulus and encouraging rates to rise, with the economy suffering persistent weakness and the dollar strengthening against the euro, such talk has largely dissipated.
Of course, these managed low rates – both in the U.S. and Japan – appear way out of line, considering the profligate government borrowing and spending. The next chart provides a useful context to where we now are.
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As has been previously discussed in this service, and elsewhere, Japan is sitting on a ticking time bomb: an aging population that will be a very big burden in the next few decades. Not only is their population expected to drop from 127 million people to 95 million by the year 2050, the percentage of the population over 65 is on track to grow from 20% to 40%. With 50% of the population in the working age bracket of 15 to 64 years, the burden of subsidizing the retirees will be a drag on the economy for decades.
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Japan’s Aging and Declining Population Population Age composition (%) 1,000 Year 0-14 15 - 64 65 +As of Oct. 1 of each year years years years1872 34,806 … … …1900 43,847 33.9 60.7 5.41910 49,184 36.0 58.8 5.21920 55,963 36.5 58.3 5.31930 64,450 36.6 58.7 4.81940 71,933 36.7 58.5 4.81950 84,115 35.4 59.6 4.91955 90,077 33.4 61.2 5.31960 94,302 30.1 64.1 5.71965 99,209 25.7 68.0 6.31970 104,665 24.0 68.9 7.11975 111,940 24.3 67.7 7.91980 117,060 23.5 67.3 9.11985 121,049 21.5 68.2 10.31990 123,611 18.1 69.5 12.01995 125,570 15.9 69.4 14.52000 126,926 14.6 67.9 17.32004 127,787 13.9 66.6 19.52005 127,768 13.7 65.8 20.12006 127,770 13.6 65.5 20.82007 127,771 13.5 65.0 21.52008 127,692 13.5 64.5 22.1Projection2010 127,176 13.0 63.9 23.12020 122,735 10.8 60.0 29.22030 115,224 9.7 58.5 31.82040 105,695 9.3 54.2 36.52050 95,152 8.6 51.8 39.6Source: Statistics Bureau, MIC; Ministry of health, Labor and Welfare.
Commentators give lots of reasons why Japan lost decades to stagnant growth: ineffective government programs, a busted real estate bubble, bad banking loans, and various conflicting political factions. But one simple reason is that, as a result of its economic “miracle” of the 1980s, labor wage rates rose to the point where Japan’s exports became less competitive in global markets. As a result, Japan changed from being the low-cost producer to becoming the banker of Asia, investing in many other countries where labor rates were more attractive than at home.
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Japan is now gaining returns on those investments that, at least partially, make up for its much smaller trade surpluses. While Japan is very successful in developing technology in its own right with many patents and creative engineers, it is no longer the competitive manufacturing powerhouse that helped fuel economic success in the 1980s.
The U.S. Is Dependent on Asian CapitalWhile the players within the Asian export community have changed in relative importance, mostly in China’s favor, the effects of that region’s manufacturing ascendancy on the U.S. are obvious.
Manufacturing as a percentage of the U.S. workforce has been declining for decades, resulting in a structural shift where U.S. manufacturing has been hollowed out – weakening the underpinnings of our large middle class. While the ownership class and CEOs may have profited greatly from the massive offshoring of production, the effect of using cheaper labor over there has fundamentally changed the nature of our economy.
Sure, profits were maintained and bonuses were big. And our success with financial manipulation created many millionaires in the investment banking sector. But at the core, the demand for U.S. labor to put things together has been shipped overseas. Making matters worse for the middle class, the bust in U.S. housing has led to huge losses in construction jobs too. Depending on which statistics you believe, U.S. unemployment numbers are somewhere between 10% and 20% of the workforce. This isn’t going to change anytime soon, because the jobs are gone and aren’t coming back.
An important slice that I watch closely – because of its potential to wreak havoc in our financial markets – is the symbiotic relationship between foreigners selling us their goods and their countries lending us the money to buy their goods. In essence, as we buy their products, foreigners gain claims on our assets. If foreigners were to stop buying government debt, the U.S. government would be unable to continue borrowing so easily, at low interest rates.
The total of foreign investment in the United States has reached the staggering level of $11 trillion. In essence, at $37,000 per U.S. citizen, foreigners have supplied investments approaching the size of our stock market. If that level of investment slows and goes into decline, the consequences would be severe – most notably in the need for the U.S. government to raise interest rates and/or monetize further deficit spending.
In the next chart, we can see that since 2008, there has been a marked slowing in the total of foreign investments in U.S. assets. Federal government debt purchases did not slow, but private investment such as in corporate bonds and equities did. This is not surprising as world trade declined, decreasing the funds available for foreigners to invest.
The question is, what would happen if foreigners changed their pattern?
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A more detailed slice through the various sectors, showing the most recent 12-month totals, points to the more dramatic shift that foreigners have taken in their flight to safety by investing in Treasury securities rather than the other forms of U.S. assets. This steep decline in those other investments was engendered by the fears about the severe recession. You can see some small recovery in those measures at the right-hand side of their curves.
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The confidence of foreigners in our financial system took a big hit when it was revealed that much of their U.S. holdings were toxic, even though many were rated AAA. China’s response has been to create its own rating agency for sovereign debt. It recently published its rankings, giving the U.S. a much lower rating than Standard and Poor’s and Moody’s did. I take this as another straw in the wind of foreign governments asserting independence, and possibly looking for other investment approaches than mindlessly continuing to buy and hold U.S. Treasuries.
That said, foreigners do not have easy alternatives for investing the dollars we give them in exchange for their goods. The result is a close relationship between the size of our deficit and their reinvestment in our country.
As you can see in the chart below, long-term foreign investment in the U.S. dropped dramatically in the middle of our recession, coinciding with a similarly sharp decline in the trade deficit due to lower-cost oil imports and from slowing economic activity. Clearly, these indicators move together.
While we have seen a modest recovery in trade, along with a corresponding modest recovery in foreign reinvestment, the fear is that a replay of foreign unwillingness to participate in funding our government debt could bring a return of the recession. And worse, an increase in interest rates and the monetization of U.S. sovereign debt.
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On that last point, a closer look at the size of foreign central bank investment in U.S. government and agency debt as accumulated in custody accounts by our Federal Reserve can also provide useful insights. When foreigners buy our Treasuries, they help keep interest rates low.
As you can see in the chart here, growth in custody holdings by foreigners has slowed. Also shown, in the overlay on the chart, this slowing has the potential to put upwards pressure on the benchmark 10-year U.S. Treasury rate: as indicated by the dotted arrow, the 10-year rate could rise above 4% to meet the level of foreign buying consistent with history.
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Investment ImplicationsAsia has serious problems. While I have been closely watching many problems in the U.S. and other Western economies, the problems in Asia appear every bit as acute, and on a number of accounts, even more so. The obvious housing bubble and weak banking system in China, and the very serious demographic problem in Japan provide reasons to be cautious about the economic future of Asia.
Looking at China’s housing bubble and predicting that they are now at a peak is pretty convincing. We’ve traveled down this road before. When banking regulators are willing to look the other way, government lowers interest rates, and risks are backed up by government support, a housing bubble is predictable.
Thinking through the scenario of what might come next, the obvious policy decisions are likely to be repeated: defaults, long workouts, a further propping up of financial institutions by government, more government stimulus programs – all culminating in lackluster economic growth.
The Japanese story is illuminating for the kinds of things that are likely to happen. China’s overinvestment in real estate and new factory cities will have to be unwound, with the public picking up the damage, in what we call “socializing malinvestment.” This leads to much lower projections for China’s economic growth than in the past.
With our government insisting that the Chinese should let their currency rise to decrease our trade surplus, I had the impression that the yuan would be ready to rise as soon as the Chinese government eased its managed peg to the dollar. That could be the case because things are still cheap from China when measured in U.S. dollars. But the extreme creation of money by the Chinese government to keep its juggernaut rolling along and employing as many workers as possible gives me a feeling that the yuan is like all currencies of the world: just another paper tiger.
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Of course, while the banking system of China is in trouble, so are the banks of the U.S., the European Union, and the UK. I don’t believe the European stress test any more than that Bernanke has my best interests in mind when doubling his balance sheet. We all have feet of clay.
In looking at Japan, the main thing that looks attractive is that they’ve already had their bubbles burst, so prices are low. The stock market is still down 70% from its peak 20 years ago. With the size of the Japanese government debt being twice our own on a relative basis, it’s amazing that the yen has continued to increase in relation to our dollar. That seems like a trend ready to turn around. If so, a declining yen could be advantageous to Japanese exporters, and therefore Japanese stocks could be a reasonable investment.
Yet, a downturn in the yen would likely trigger a sharp upward move in Japanese interest rates from their current level of close to zero. When I add the long-term view of Japanese population decline and aging, I see massive difficulties for handling the large debt; and when interest rates rise, managing such a huge government debt feeds back on itself so that confidence in that currency will decline even more, driving rates even higher.
Put another way, like most of the world’s largest economies, Japan is also stuck between a rock and a hard place.
This is a spring that is tightly wound. Once it starts to unwind, there will be investment opportunities in playing rising Japanese rates, and this could happen soon.
With all the uncertainties, especially about timing, it’s hard to come to a convincing recommendation. The stories of all three countries have similar lessons for each other: Stock market bubbles burst. Real estate bubbles burst. And eventually fiat paper currency issuance only delays the problems until the confidence game is revealed for what it is.
The timing of these big-picture cycles is different, but the processes are surprisingly similar. I think we can look to the next big shift coming from China’s real estate implosion. Population demographics and world energy limitations will affect all markets. There will be investment opportunities for shifts in these Asian markets, as the imbalances unwind. Interest rates are too low, perhaps Japan’s stock market could rise, and there may be some downside as China’s real estate bubble breaks. Even so, with so many moving parts, I am not confident enough to turn any of these observations into specific investment recommendations, but they provide sign posts for what to look for in the future.
In this kind of environment, physical assets like gold, energy, and low-priced agricultural, productive land still seem like the safest investments. Back to Table of Contents
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Back to the Future of Gold By Terry CoxonFast forward a few years, to somewhere near 2014 or 2015. Most people have been through a rough time and are still in it.
In 2011, recovery from the worldwide recession that had begun in 2008 gave way to a second dip. Later that year, the defaults by Greece and Spain that had been put off by the 2010 really-big-rescue-package-but-not-big-enough became impossible to forestall. Bonds issued by the Greek and Spanish governments were “restructured” to promise (not give, but promise) the holder 40 cents on the euro. This, plus the immediate price drops in the government bonds of Portugal, Italy, and Ireland pushed most European banks into unacknowledged but hardly unnoticed insolvency.
It was a replay of the fall of 2008, with fear of chain-reaction bankruptcies bringing down too-big-to-fail financial institutions in one country after another. But events moved more rapidly. Interbank lending and then nearly all commercial lending quickly dried up. It became clear that what the economy had eluded just two years earlier had turned and was swimming toward it again.
Even the architects of the mess – the politicians, central bankers, and big-government economists – saw that running another round of giant deficits to pay for more “stimulus” spending wasn’t an option. The sovereign defaults had closed that door. They had just one card left to play: In every country that was in trouble, they restarted the rapid growth in the money supply that had begun in the fall of 2008 and then been put on hold before the end of the following year. And this time, no half measures.
In the U.S., that meant the Federal Reserve spending billions daily to buy up U.S. Treasury securities. Few doubted that this was inviting runaway price inflation, but the economy was shriveling, and at an alarming rate. Price inflation seemed like the much lesser evil. And it would come with a welcome consolation: It would erode the real value of the U.S. Treasury’s debt, thereby reducing the risk that the U.S. would join the sovereign defaulters.
It worked. Not for everyone, but the world financial system as a whole became flush with cash. Distress selling ended. On net, people were trying to spend more than they were taking in, to work off the excess cash. Initially, most of the new money went to the investment markets. Prices of most investments recovered, and many boomed. It was a quick repair job for personal and business balance sheets around the world, and that led to a revival of consumer and then business spending.
It worked, but it worked the way downing five cans of Red Bull works. Quick, spectacular results. And then trouble.
Inflation KnocksBy the end of 2012, the desperate fear of deflationary collapse had been replaced by mild concern about price inflation. And compared with what the economy had just dodged, a little inflation, or even a lot of inflation, seemed like a tolerable problem. A little bee at a very nice garden party.
But the buzzing got louder, and then the bee began to sting. The managers of thriving businesses were complaining that delivery times for parts and materials were getting longer, and no supplier was discounting anything. Employees (almost everyone who wanted a job had one) were complaining that things were starting to cost more, even at Walmart.
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The year-over-year price inflation rate was only 2%, but all of the price increases had happened in just four months. Financial writers were delighted. After so many years of deflationary menace, something fresh to talk about. If inflation is running at 2% now, what will it be doing six months from now? Or a year from now?
Almost every investment writer and financial talking head entered the inflation prediction derby by looking back at the experience of the 1970s and prognosticating accordingly. Almost every one of them guessed far on the low side of what actually came.
It took just three months for the inflation rate to go from 2% to 5%, and only another six months to reach 10%. It wasn’t just the cash that the Federal Reserve had created in the recent year that was fueling the process, it was all the billions the Fed had created in 2008 and 2009 – hundreds of billions in liquidity that was no longer being hoarded for protection against deflation.
A second, impossible-to-control process was at work to make inflation run faster than it had in the 1970s. That earlier bout of price inflation had been driven almost entirely by growth in the supply of money. But this time around, runaway growth in the supply of cash was being joined by a drop in the demand for cash.
The 40 years that followed the 1970s had given businesses and individuals practical ways to operate with little in the way of actual cash – alternatives such as the acceptability of credit cards for the smallest purchases and computer-administered lines of credit for ATM cards and checking accounts. Given those ready alternatives, as holding cash became increasingly expensive (the continuous loss of purchasing power), most people were inclined to pare down their holdings of the stuff.
Some individuals and businesses did so by speeding up purchases. Others did it by switching from cash to money market funds or T-bills to capture the now high yields. Of course, the money that one person unloaded became excess money for whoever received it, so it sent the recipient looking for ways to get rid of it. Thus the drop in the demand for cash operated like an after-burner on the urge to spend that had been lit by the increase in the supply of cash.
And the Fed Steps In… Alarmed by price inflation numbers approaching 15%, the Federal Reserve throttled back on growth in money supply. But not for long. The Fed did persevere through the spike in short-term interest rates and the stock market crash that its tight money policy brought on, giving a firm “No” to calls for it to return to its inflationary ways. But when the economy showed unmistakable indications that recession was returning, and returning with a vengeance, they turned the printing presses back on and released a new river of dollars.
Having slowed briefly, the inflation rate began rising again. As it kept moving higher, the Fed repeated its exercise in tight money three times, each time with less persistence. Inflation hit 40%. Talk of a Zimbabwe experience went mainstream. The minutes of Federal Reserve meetings revealed complete bewilderment and demoralization.
Then a certain congressman who was trying to make the public forget about his scandal from the year before launched a proposal that he insisted was his own, original idea. Return the U.S. dollar to the gold standard. Fix a price at which the Treasury will buy as much gold as the public cares to deliver and at which it will redeem as many dollars as the public cares to tender.
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During the 48 hours that followed, no Washington player spoke a word against the proposal, as the pros sniffed for signs of political danger. When nothing grave was detected, the owners of hundreds of political wet fingers hurried to endorse the program. It seemed like an easy way for demonstrated fools to start looking wise, or at least competent. By the time another 48 hours had passed, 423 of the 535 members of Congress had noisily adopted the proposal as their own, including a majority of the 17 members holding a graduate degree in economics from Harvard, Princeton, or MIT.
The New Gold StandardBut it was still only an idea. Just what the new gold standard would look like and how the U.S. would get from here to there wasn’t at all clear. And there were competing “visions,” as the politicians took to calling their plans.
The idea of returning to the gold standard spread to other countries, but nowhere did anyone offer a definite, well-defined program of action. Most countries were waiting for the U.S., or perhaps Russia or China, to go first.
But none of them did. The first to go was... Greece. Yes, Greece, the ancient cradle of European civilization and more recently the cradle of European sovereign default. The Greek government didn’t rely on its huge gold reserves to move to a gold-backed currency. It didn’t have huge gold reserves. In fact, it didn’t have any gold at all.
Instead, it used arithmetic. On the day Greece acted, the price of gold was US$7,800 per ounce. The drachma (with which Greece had replaced the much-hated euro) was trading for US$0.20. That worked out to a price of 39,000 drachma for an ounce of gold. So Greece set its official price for gold at 50,000 drachma per ounce.
That made little Greece the world’s high-bidder for gold. Metal flowed into the Greek Treasury at millions of ounces per day. The flood didn’t last for long. By the end of Week Two, it was down to a trickle. What stopped it was that the flood of gold into the Greek Treasury meant a flood of drachma onto foreign exchange markets. The price of the drachma dropped against other currencies until 50,000 drachma was no longer a high bid for an ounce of gold.
And that brought the drachma and the Greek Treasury to a resting place. When the gold stopped flowing in, the Greek Treasury stopped printing more drachma to buy it. The currency stabilized on foreign exchange markets, and Greece’s official gold holdings settled near 12 million ounces.
Greece, the beggar country, had gotten to the gold standard first. Its success added pressure on politicians in other countries to do something. The mechanics, as the Greeks had demonstrated, were simple. A government merely needed to decide on an official gold price that was high enough. But still, most governments stalled.
The sticking point came from the strict and inescapable link between official gold prices and currency exchange rates. Suppose, for example, that the U.S. acted on its own and set its official price of gold at $8,000 per ounce. If China then wanted to fix the dollar price of the yuan at US$0.10 (for the competitive advantage of its export industries), it would be free to do so simply by setting its official price of gold at 80,000 yuan per ounce.
Politicians in all major countries wanted to return to the gold standard. But none wanted to go first. So they would all have to go together.
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For nearly half a year, as public pressure mounted, diplomatic officials more practiced in matters of borders and bombs argued about what everyone’s official gold price should be. The process ended when enough government officials realized that a bad deal was preferable to a bad election and came to agreement.
The U.S., Canada, United Kingdom, Germany, Russia, China, India, Japan, South Korea, Brazil, and Saudi Arabia agreed upon a set of official gold prices (implying a set of fixed exchange rates), and all but Germany immediately resumed a gold standard. Germany joined the following day, after reinstating the Deutsche Mark.
France had participated in the negotiations but withdrew in a huff at the last minute. Two weeks later, France became the last to leave the euro and announced an official gold price that had been established with scientific precision by a committee of experts from L’Académie Française. Greece hadn’t been invited and didn’t participate at all, because its tiny economy didn’t really matter to the rest of the world.
So ended the worldwide experiment in fiat money that had begun in 1971 when Richard Nixon slammed shut the U.S. Treasury’s gold window, supposedly to bruise the fingers of “international money speculators.” The experiment brought a disaster far worse than anything the speculators had ever been accused of hatching. The disaster ended only when monetary arrangements returned to what they had been in 1914.
Gold convertibility restored enough confidence in paper money to allow the economy to recover. But it did not restore confidence absolutely. Roughly three-quarters of all privately held gold flowed into national treasuries, in exchange for paper currency. The other 25% was kept by individuals who remembered how unthinkable a return to the gold standard had seemed just a few years earlier and who wanted to be ready for the next unthinkable.
Back to Table of Contents
How to Invest In this month’s edition, we have two new investment ideas to share with you – one is a bet on the rebound of oil, and the other a strategy you can use to speculate on, or insure against, a “Black Swan” crash.
Before getting to those ideas, as well as our other portfolio updates, we would like to stress the importance of viewing all of our recommendations in the context of our broader advice that roughly one-third of your portfolio should be in gold, one-third in cash, and one-third in “other.” The new recommendations, and many of the others we are now tracking, fit in that “other” category.
Continuing with such a conservative allocation approach is, we believe, warranted. Despite a concentrated effort by the U.S. administration and its political allies to paint a rosy picture in the months leading up to the November elections, rarely has the global economy been more precariously perched. It’s no exaggeration to say that the monetary system underpinning all of the world’s largest economies is now at risk.
All you have to do to appreciate the scale of the risk is to project the turmoil caused by the troubles of the unimportant economy of Greece onto a global canvas.
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While timing the end of the world’s deeply flawed and dysfunctional fiat monetary regime is impossible, we can say with near certainty that we have already seen the beginning of the end. We can’t yet anticipate whether it will be Japan, China, the U.S., or another member of the eurozone that triggers the next and perhaps final phase of the crisis – but all are equally good candidates for that dubious honor.
We can, however, anticipate that the last chapter in this crisis will be written only once the extreme dislocations caused by decades of unchecked government spending are wrung out of the system through outright defaults or the de facto defaults of massive inflation. Between now and then, special caution is called for.
As a result, we are comfortable with a high allocation in cash, especially in our recommended resource currencies of the Canadian dollar and Norwegian krone. That offers us the significant advantage of lowering our overall portfolio risk while retaining the flexibility to act quickly should a special undervalued opportunity knock.
With that context, following are some ideas on How to Invest in this challenging time.
New Recommendations Occidental Petroleum Corporation (OXY)
Our recent Casey Report recommendation, Vanguard’s Energy ETF (VDE), focused on oil producers wrongly dragged down with BP. As we see it, these companies should instead be bouncing upward. With a major competitor facing gargantuan liabilities, the rest of the industry has an opportunity to steal BP’s worldwide market share. VDE provides good diversified coverage of the oil industry without BP. But one particular company in its portfolio stands out, the Occidental Petroleum Corporation (OXY).
What’s so special about OXY? First of all, their U.S. operations do not involve the Gulf. While other producers are sweating over the Gulf ’s future, Occidental keeps drilling away with no such worries. The bulk of the company’s oil production comes from the Permian Basin (Texas and New Mexico) and the Elk Hills area in California. These two locations – neither of which involves ocean drilling – comprise 56% of OXY’s proved oil reserves and 35% of its proved natural gas reserves.
The Permian Basin accounts for approximately 19% of the U.S.’s total crude oil production. In the basin, OXY is the largest oil producer with a 16% share of the production. OXY’s Permian Basin operations account for 3% of domestically produced oil. In total, the company has proved oil reserves of 2.37 billion barrels (1.6 billion in the U.S.) and 5.16 trillion cubic feet of natural gas reserves (2.8 trillion in the U.S.).
Along with Texas, New Mexico, and California, Occidental also has operations in Kansas, Oklahoma, Utah, and Colorado. Beyond domestic production, OXY is well diversified globally in Argentina, Bahrain, Bolivia, Columbia, Libya, Oman, Qatar, the United Arab Emirates, and Yemen. In a sense, the company dodges many industry bullets. OXY avoids the Gulf of Mexico, and its primary Middle East production is far from the most volatile countries.
The financials look appealing as well. Occidental is quickly rebounding from a bad year. In 2009, the company’s net income was only $2.915 billion. So far with only Q2 and Q1 earnings reported, net income is $2.127 billion. Within half a year, OXY has earned nearly as much income as in all of 2009. This is an impressive comeback, and we expect the company to continue surging forward.
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We’ve set Occidental’s target price at $105. While this may not be the double that some other picks may achieve, it’s certainly a nice return worth the risk. To put a cherry on top of the deal, the company pays an annual dividend of 1.76%. With the dividend recently increased by 5 cents to 38 cents per share, the projected dividend yield approaches 2%.
OXY Metrics
Current Stock Price (close 7/30/10) $77.9352-Week High (05/03/10) $90.9952-Week Low (08/17/09) $67.18Basic EPS (12 months ending 7/27/10) $4.91Diluted EPS (12 months ending 7/27/10) $4.91P/E Ratio (Price/Diluted EPS) 15.88Earnings Yield 6.3%Price to Book Value 2.09Return on Equity (12 months ending 7/27/10) 13.3%Net Profit Margin (12 months ending 7/27/10) 25.1%Cash Flow Margin (12 months ending 7/27/10) 49.8%Total Liabilities to Total Assets 0.34Total Liabilities to Equity 0.52Long-Term Debt to Equity 0.08Current Ratio 1.41Cash Ratio 0.29Dividend Yield 1.76%
Gold & SilverWith the recent gold correction, many investors are getting anxious. But should you be worried? We don’t think so. The financial media is overly excited on nothing more than “sticker shock.” A $50 drop makes many gasp, but in percentage terms, this isn’t a significant retreat at all. We compared the recent price movement with two similar corrections:
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Time Period 1
In time period 1, gold started at $562 and peaked at $725, a 29% increase. From the peak, it fell back down to $570, a 21% decrease. From there, gold moved steadily upward.
Time Period 2
In time period 2, gold moved from $1,052 to $1,218, a 16% increase. From there, it collapsed back to $1,082, an 11% decline followed by our most recent jump.
So where are we now? The price first went upward from around $1,117. Then it spiked to $1,259, a 12.5% jump. From there, it corrected down to $1,166, a 7% decrease. Thus, while numerous articles are using the correction as a jumping point to proclaim the downfall of gold, the gains and losses in percentage terms don’t show a particularly significant event. In fact, there were more reasons to be concerned in previous corrections than now. Take this opportunity to stock up.
Market Vectors Gold Miners ETF (GDX)
For several months, we’ve set a low GDX ideal price in anticipation of a correction. It appears that such an opportunity may be just around the corner. With the modest gold correction, GDX has retreated even more so. We’re still waiting for our ideal price, but for those who just can’t wait any longer, a nibble at current prices wouldn’t be too hazardous either.
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Cash & Cash AlternativesOur two currency picks continue to outperform the dollar. As the euro strengthens, the Norwegian krone has benefited as well. The krone is a great way to diversify cash holdings to Europe without holding the euro. The European Central Bank has some very serious theoretical and on-the-ground problems. Perhaps this crisis won’t tear the euro asunder, but sooner or later, it will happen. A single fiat money supply for several countries with different fiscal policies will not work in the long run. One can expect Greek-style panics to occur over and over again. The NOK doesn’t face the euro’s central bank problems. Hence, we predict a much brighter future for the currency.
Despite gold’s correction, the Canadian dollar maintains a gain over the dollar since our first recommendation. We continue to recommend the CAD as well.
APYs 3 months 6 months 9 months 12 monthsNorwegian Krone (NOK) 0.5% 0.6% 0.63% 1.0%Canadian Dollar (CAD) 0.1% 0.1% 0.1% 0.1%
To invest in these currencies, we’re utilizing EverBank’s WorldCurrency Certificates of Deposit. These FDIC-insured CDs operate like any other CD, except the money is deposited in another currency. Upon withdrawal, EverBank charges a less than 1% conversion fee. The yields are the same as last month.
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The interest rate mutual funds have made gains from last month. The 10-year Treasuries (followed by RTPIX) hit a low 2.9% yield on July 21. The 30-year bond yields (followed by RRPIX and RYJUX) slid down to 3.89%. Any analyst is skeptical of picking bottoms, but from the chart above, something closing in on a bottom appears to have occurred in July. Of course, another sudden shock to the global financial system could send rates lower again – but at this point the downside seems very limited.
Just to be safe, we’re setting our ideal prices at the July lows. Though interest rates can’t go down much further, volatility can still cause these funds to lose value. For more on this subject, check out the May edition of The Casey Report.
With the bottom perhaps behind us, we’re approaching a very interesting time for interest rates… and, by extension, the debt-laden U.S. economy. Until the turn is confirmed, there’s no hurry to chase the rising interest rate plays – so being patient and waiting for our target entry prices to be hit makes sense.
Invest in AgribusinessIn general, there’s less risk in the market now than just a few months ago. For this reason, we’re raising the buy ranges for the agriculture ETFs. However, these investments are still more prone to suffering from a market drop – hence subscribers should be more cautious with them. On the other hand, these ETFS will likely surge forward more quickly than some of our other investments in calmer waters.
Energy Value PlaysVanguard Energy ETF (VDE)
Due to our conservative buy range, we missed the boat on VDE last month. We were correct in predicting an oil price correction at the time, but the slide didn’t go as deep as predicted. Now we’re seeing another correction on the horizon. This time we hope to catch a rebound; hence, we’re raising the ideal buy price.
Since last month, the top 10 holdings in the fund have changed. Here’s an updated list for the quarter: Current Company Rankings Holdings at 6/30/20101. Exxon Mobil Corp. (XOM) 24.1% 2. Chevron Corp. (CVX) 11.3%3. ConocoPhillips (COP) 5.5%4. Schlumberger Ltd. (SLB) 5.2%5. Occidental Petroleum Company (OXY) 4.7%6. Apache Corp.(APA) 2.5%7. Devon Energy Group (DVN) 2.2%8. EOG Resources (EOG) 2.2%9. Halliburton Co. (HAL) 1.9%10. Marathon Oil Corp. (MRO) 1.9%
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The top 3 companies have boosted their percentages – especially Exxon Mobil with a 1.5% increase. The former 9th position, Anadarko Petroleum (APC), and the 10th position, XTO Energy Inc. (XTO), acquired by Exxon Mobil, have dropped out of the top 10. We’re very happy to see Anadarko Petroleum exit the top holdings. Our play is on BP’s competitors and the general industry. Unfortunately, Anadarko had been dragged to the depths along with BP. This company was a smudge in the top 10, and now it thankfully has been wiped away.
*Note: Among the top 10 VDE companies, the Occidental Petroleum Corporation, our new recommendation, makes up 4.7% of the ETF. If you’re not willing to make the dive into OXY alone, VDE offers a more diversified choice. Either way, you’ll be buying a slice of a great company.
PowerShares DB Oil (DBO)In the previous issue, we highlighted the PowerShares Deutsche Bank Oil fund‘s superior tracking performance compared to other oil ETFs. When choosing a commodity ETF, a primary concern should be the ETF’s ability to actually track the commodity. When oil prices rose after the 2008 crash, the majority of oil ETFs failed to follow crude prices upward. Some funds even began moving in the opposite direction of oil! There’s nothing worse than accurately predicting a price movement only to have your investment vehicle stall at a crucial moment. According to our analysis comparing leading oil ETFs, DBO had the highest correlation to WTI crude prices during the post-crash oil rebound. Nonetheless, it, too, had difficulties.
How does DBO outperform everyone else? To explain this, we first have to understand contango and backwardation. When future prices are greater than the current spot price, the futures market is said to be in contango. If the spot price remains the same, future contracts will decrease in value upon approaching maturity. If an oil ETF purchased future contracts in contango, it could lose money even though the spot price remains unchanged.
Backwardation is the opposite of contango. Here, future prices are lower than the spot price. As contracts approach maturity, their prices increase to the higher spot price. Hence, investors make a profit on the shape of the futures curve.
Most oil ETFs do nothing to combat contango. The majority pick arbitrary months to renew futures contracts. For example, let’s say that a contract is about to mature. The ETF sells the contract and purchases another within an arbitrary number of months to maturity. In general, the various ETFs differentiate themselves by purchasing at different future periods. Some funds may always buy 3-month contracts while others may always choose 6-month contracts. Either way, they follow rigid contract purchase rules, and per above, sometimes those rules can force them to lock in an unnecessary loss.
DBO works in a much smarter way. It does not simply roll over to a specific month. Instead, the fund calculates the implied yield from investing in any contract within 13 months of the current one. The fund chooses the contract with the lowest negative yield in contango and highest implied yield in backwardation. DBO intelligently looks for the best deal on the futures curve instead of choosing an arbitrary month.
E.V. Energy Partners (EVEP)EVEP, our oil and natural gas producer, continues to inch higher and higher. The subscribers who bought below our $27 price in May should be in the black by approximately 33%. Further, the company just paid a $0.757 dividend, giving EVEP an 8.3% dividend yield. After reassessing the risk on EVEP, we’ve decided to remove the ideal price. Subscribers are now advised to purchase the stock at market prices. The high dividend yield should create a nice cushion for this stock. However, we don’t see much turbulence ahead as the stock price has been rising with controlled volatility.
THE CASEY REPORT 31
Mirant (MIR)
Mirant is continuing its volatile trading pattern between the $11 and $14 range. As pointed out last month, Mirant’s stock price is driven by two factors, the future demand for electricity and the price of natural gas. The demand for electricity naturally depends on the general economy’s strength. In June and most of July, natural gas prices were higher, but unfortunately the market was moving down at the same time. This month, natural gas prices have remained higher, and the market has increased too.
And voila! Mirant was up nearly 10% earlier this month. With a sustained stronger market and higher natural gas prices, Mirant has doubling potential. But remember, it is also the riskiest pick in our portfolio.
In the last issue, we suggested trading the $11 to $14 range back and forth. Buy below $11 and then sell on a gain. Watch the stock retreat back to $11 and repeat. Some Casey Research team members have made nearly 25% returns trading this way. If you’re a more active investor, give it a try the next time Mirant touches below $11 and sell anytime it approaches $12, or sooner to be a bit more conservative. We believe that Mirant will continue to bounce back and forth in this range for some time before it really takes off. However, we will leave this trade as an informal recommendation as it risks missing the big picture on the company.
Speculator’s CornerBlack Swan Protector
In economic terminology, a Black Swan is a highly unlikely event. In this edition of the Speculator’s Corner, we will discuss a way to risk a little in the hopes of making a lot, should a Black Swan land.
The idea behind an asymmetric payoff is that you invest a very small sum of money with the hopes of a massive payoff. If the investment fails within the time frame, the loss is minuscule and you apply the strategy again. Small losses accrue until the main event occurs. If you are positioned properly, a massive payoff will easily dwarf the losses.
We would like to highlight a high-risk, high-reward transaction that would pay off significantly in a severe rapid market downturn or crash caused by whatever next Black Swan lands. When that crash occurs, volatility would expand significantly, thus being “long” call options on volatility would be a great way to capitalize: if a major break occurs, the returns could be substantial from a modest capital outlay.
If the market collapsed, the VIX index, a measure of volatility, would expand; in a hard crash scenario, a spike to 90 could occur. At the time of this writing ( July 29th 2010), the VIX index is at 24.13. To play the crash – either as pure speculation or as insurance to offset possible loses in other portfolio investments – go long on far-out-of-the-money calls on the VIX index. Thus, at the time of this writing, you can buy 10 November 60 VIX calls @ .50 for an outlay of $500.
If the VIX index moves to 30, the position would be profitable by roughly $600.
If it moves to 40, the position would be profitable by roughly $3,000.
At 50, the position would be profitable by roughly $7,000.
At 60, the position would be profitable by roughly $12,400.
THE CASEY REPORT 32
At 70, the position would be profitable by roughly $19,000.
At 80, the position would be profitable by roughly $26,500.
And if the VIX index moved to 90, your position would be profitable by roughly $34,700.
As you can see from the probability table here, the odds of VIX hitting 90 in the time period are very low – the definition of a Black Swan event.
Probabilities AUG 10 SEP 10 OCT4 10 NOV 10 DEC4 10 Jan 11Above 90 0.00% 0.00% 0.06% 0.20% 0.50% 0.80%80-90 0.00% 0.01% 0.09% 0.21% 0.39% 0.52%70-80 0.00% 0.03% 0.23% 0.46% 0.74% 0.91%60-70 0.00% 0.14% 0.65% 1.06% 1.45% 1.66%50-60 0.02% 0.71% 1.87% 2.49% 2.95% 3.15%40-50 0.63% 3.60% 5.46% 6.00% 6.18% 6.15%30-40 12.18% 16.00% 15.29% 14.29% 13.12% 12.31%24.13-30 32.86% 23.02% 17.84% 15.46% 13.44% 12.26%Below 24.12 54.21% 56.50% 58.52% 59.83% 61.24% 62.24%
Should the trade becomes profitable, you could eliminate further risk by selling enough of the position to cover your original cost, thereafter enjoying a free ride.
Of course, to execute this trade, you’ll have to have an options account with your broker, and you should do the homework necessary to fully understand options trading. But if you have some cash set aside for speculations, one that can turn $500 into a profit of over $34,000 – or some lesser but still attractive number if the crash isn’t quite so acute – might be worth the effort.
Sweet Dreams.
The Casey Report Portfolio
THE CASEY REPORT PORTFOLIO1
INVESTMENT Ref. Date2 Symbol Price Price 7/30/10
Current Recommendation Price Target Description Notes
INTEREST RATESProFunds Rising Rates Opp 10 Inv
7/1/2008 RTPIX $22.06 Ideal Buy Range: Below $22.02 $43
Tracks inverse of 10-year Treasury daily price movement
Add to/build positions on falling
Treasury rates
ProFunds Rising Rates Opp Inv 7/1/2008 RRPIX $12.13 Ideal Buy Range
Below $11.89 $49 Tracks 125% inverse of 30-year T-Bond
daily price movement
Add to/build positions on falling
Treasury ratesRydex Inverse Gov Long Bond Strategy Inv
7/1/2008 RYJUX $12.61 Ideal Buy Range Below $12.40 $41
Tracks inverse of 30-year T-Bond daily price movement
Add to/build positions on falling
Treasury rates
THE CASEY REPORT 33
THE CASEY REPORT PORTFOLIO1 continued
INVESTMENT Ref. Date2 Symbol Price Price 7/30/10
Current Recommendation Price Target Description Notes
GOLD & SILVER
Buy Gold - $1,169.00 Buy - Gold bullion and bars Accumulate physical gold
Buy Silver - $17.66 Buy - Silver bullion and bars
Accumulate physical silver
Market Vectors Gold Miners ETF
11/1/2008 GDX $48.22 Ideal Buy Range: Below $45.00 $75
Tracks range of precious metals
companies
Maintain position for higher precious
metal prices
Central Fund of Canada 10/5/2009
CEF $14.49 Buy -
Closed-end fund holding physical gold
and silver
Look to enter when premium is
below 10% T.CEF.A C$14.89
ENERGY VALUE PLAYS
Mirant Corp 8/5/2009 MIR $10.97 Ideal Buy Range: Below $11.00
$42.00 12- to 24- month
horizon
Independent power producer
Rising natural gas prices could fuel the stock price
E.V. Energy Partners L.P. 9/3/2009 EVEP $37.17 Buy
$57.50 12- to 24- month
horizonOil & gas producer Attractive 8.3%
dividend yield
Vanguard Energy ETF 7/6/2010 VDE $78.69 Ideal Buy Range:
Below $70.82
Tracks an index of oil companies and
services
Look for an oil correction
Powershares DB Oil 7/6/2010 DBO $25.01 Ideal Buy Range:
Below $22.51 - Tracks WTI Crude Oil
May not precisely track crude oil at
all timesOccidental Petroleum Corporation
Current Issue OXY $77.93 Ideal Buy Range
Below $70.14 $105 Oil & gas producerCompetitive oil
and gas producer w/o Gulf exposure
DIVERSIFY CASH
Norwegian Krone 6/3/2010 NOK
0.1636 NOK/USD
Buy - Sound monetary policy/ oil exporter
Protect against decline of U.S.
dollar
Canadian Dollar 6/3/2010 CAD0.9666 CAD/USD
Buy - Strong commodities link
Protect against decline of U.S.
dollarAGRICULTUREMarket Vectors Agribusiness ETF
1/6/2009 MOO $41.53 Ideal Buy Range: Below $35.30 $75
Tracks broad range of agribusiness
companies
Use stink bids to buy under the
market
Claymore Global Agriculture ETF 1/6/2009 T.COW C$17.88 Ideal Buy Range:
Below C$15.20 $32 Tracks broad range
of agribusiness companies
Use stink bids to buy under the
market1This sheet represents our current portfolio recommendations and is not a comprehensive track record.2 Reference date is the release date of the publication when the recommendation was originally made in The Casey Report.
*The combination of the “ideal buy range” and “price target” are intended to provide what we believe to be the ideal risk/reward ratio for the investment. Rather than a strict Buy, Sell, Hold approach to the recommendations, we feel this approach will help you make a more informed decision about the timing of your purchases and sales, depending on your personal risk tolerance. However, the ideal buying range is not meant as a limit price for a stink bid or strike price for an option, instead, it is meant, together with the target price, to give a clear understanding of what your gains should look like when entering the position at any price.
*Portfolio Page Updates: Get the latest on your companies by regularly visiting the portfolio page on our website, or click here. Back to Table of Contents
THE CASEY REPORT 34
Casey’s Data Farm A monthly recap of data worth paying attention to.
After two strong months of support for bonds, foreign purchases declined sharply in May. Net foreign purchases of longer-dated U.S. Treasury debt dropped to $12.5 billion in May – the smallest inflow in 12 months.
The monthly Consumer Confidence Survey derives from a questionnaire mailed to 5,000 households nationwide. Respondents rate their attitudes and expectations for business conditions, employment conditions, and family income. The index has fallen for three straight months to 50.4 – its lowest level since February – indicating consumers are becoming more timid about the recovery.
50,000
100,000
150,000
200,000
($ M
illio
ns)
Foreign LT Debt Purchases at 12-Month Low
Net foreign LT Treasury debt purchases through May:2008 - $344 billion; 2009 - $9 billion; 2010 - $297 billion
(100,000)
(50,000)
-
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Initial subprime shock ©Copyright CaseyResearch.com 2010Source: U.S. Dept of Treasury
0
20
40
60
80
100
120
140
160
Cons
umer
Con
fiden
ce In
dex
(198
5=10
0)
Consumer Confidence Hitting Summer Slump
©Copyright CaseyResearch 2010 Source:Consumer Conference Board, www.polingreport.com
.COM
THE CASEY REPORT 35
The Department of Labor’s weekly unemployment insurance (UI) claims report is heavily monitored by analysts, commonly interpreted as a signal for the direction of the economy. The four-week moving average of UI claims has been hovering near 450,000 all year. Bulls are looking for claims to break consistently below 450,000, while bears see claims edging above 500,000 as a double-dip signal.
The household debt service ratio (blue columns) compares the required payments on mortgage and other consumer debt with disposable income. The financial obligation ratio (red columns) reflects those same elements and also auto lease payments, apartment rentals, home insurance, and property taxes. The obligation ratio is now comparable to where it stood in the late 1990s. Household debt levels continued to drop in the first quarter, now at levels not seen since 2000.
Back to Table of Contents
0
100,000
200,000
300,000
400,000
500,000
600,000
700,000
800,000
Wee
kly
Une
mpl
oym
ent I
nsur
ance
Cla
ims
Initial Claims RangeboundRecessions Initial Claims (4-Week Moving Average)
©Copyright Casey Research 2010 Source: U.S. Dept of Labor
.COM
©Copyright CaseyResearch 2010
10.6%11.9% 12.0%11.9%
12.9%14.1% 13.9% 13.9%
13.5% 13.6% 13.6% 13.5% 13.9%12.9% 12.6% 12.5%
15.4%
17.1% 17.4%17.5%18.3% 19.1% 18.8% 18.9% 18.3% 18.5% 18.6% 18.4% 18.0% 17.9% 17.5% 17.4%
0%
5%
10%
15%
20%
25%
Deb
t Pay
men
ts a
s %
of D
ispo
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e In
com
e
Households Are Reducing Debt ObligationsHousehold Debt Service Ratio Financial Obligation Ratio
After decades of debt accumulation...
...debt obligations are now declining.
.COM
THE CASEY REPORT 36
Obama Watch About That Job Creation… By Donald Grove, Casey Research Washington Correspondent
During his confirmation hearings, Fed Chairman Ben Bernanke told senators, “Jobs are the issue right now. It really is the biggest challenge, the most difficult problem that we face.”
Barack Obama took office in January 2009, with the nation’s unemployment rate at 7.6%. Well over 3 million Americans have lost their jobs since then. Today, according to the Bureau of Labor Statistics, unemployment stands at about 9.5%, but that figure grossly understates the reality of joblessness. The BLS tweaks the numbers. For example, it does not count as jobless those who have stopped looking for work. Those discouraged workers are not treated as part of the labor force.
A more realistic unemployment figure is the 22% shown on John Williams’ Shadow Government Statistics (SGS) website – that’s nearly as high as the jobless rate during the Great Depression.
A quick look at the SGS unemployment chart reveals that, whether you refer to the BLS figures or Williams’ more realistic and sobering figures, the unemployment rate started rising steeply early in 2008 during the Bush administration. Unemployment was a growing problem before Obama took office. The jobless rate continued to climb steeply to 10.2% during Obama’s first 10 months in office and has only recently appeared to more or less reach an irregular plateau. Even if that plateau holds, however, it does not mean the underlying problem with jobs has been solved.
The rise in unemployment since Obama took office has occurred despite an $862 billion stimulus bill – the American Recovery and Reinvestment Act (ARRA) – that promised to “save or create 3 to 4 million jobs” and to cap unemployment at 8%. It occurred despite the Hiring Incentives to Restore Employment (HIRE) Act, despite “Cash for Clunkers” and a weatherization program called “Cash for Caulkers,” and a string of other such legislative measures from an out-of-touch Congress that absurdly counts “job creation” as one of its key mandates.
Chuck Schumer (D-NY) warned that “If we don’t create jobs, the economy will not move forward.” Jobs? Yes. Created by the government? Absolutely not.
Vice President Joe Biden recently appeared with Christina Romer, chief of the White House Council of Economic Advisers, to report that the ARRA stimulus program has saved or created 2.5 to 3.6 million jobs. Unfortunately, that figure is roughly the same as the number of jobs the BLS shows have been lost during the Obama presidency, but we’re still not breaking even… there’s still that pesky rising unemployment rate. A CBS poll found that only 23% of those surveyed believe that the ARRA has improved the economy.
Obama says things would be much worse if the government had not stepped in. It’s a great line. Who can say whether and to what extent the White House is prevaricating? At a town hall meeting in Racine, Wisconsin, on June 30, 2010, Obama said that “every economist who has looked at it has said that the recovery did its job. It put a brake on the collapse of the economy. We avoided a Great Depression. We are now growing again. . . things would have been a lot worse. . . unemployment is still at 9.6. Yes, but it’s not 12 or 13, or 15.”
THE CASEY REPORT 37
Despite these assurances, polls show that unemployment is high on the list of issues that Americans are worried about. Understandably so. We are seeing the highest official unemployment rates in 26 years. The real unemployment rate is much higher. Almost 16 million Americans are out of work, a record for the 60 years the Labor Department has been keeping track.
Congress has had to repeatedly extend unemployment benefits. Unemployment benefits used to run out after 26 weeks. The latest extension, just signed by the president on July 22, 2010, extends unemployment benefits to almost two years. Yet the president is claiming this is “the Summer of Recovery.”
[Why wait for 2012?]
House Speaker Nancy Pelosi (who once served on the House Intelligence Committee) has assured us that unemployment benefits not only do not encourage the unemployed to stay unemployed, they are actually a way of creating jobs. She claims that economists agree “it creates jobs faster than almost any other initiative you can name” because the unemployed spend their unemployment checks right away.
Pelosi’s remarks embody the essence of why Americans are losing their jobs. This president and his Congress suffer from the delusion that FDR’s New Deal saved us from the Great Depression. To them, the whole challenge is getting stimulus funds into the economy, whether through unemployment checks or public works projects.
“Public servant” is a misnomer. It is the public who are servants to a growing percentage of the work force who feed at the public trough. We can’t all ride in the wagon. Someone has to pull it.
The underlying question is not how the government “creates” jobs, it is how individuals, for selfish reasons, create new wealth. The answer is for the government to get out of the way – a complete reversal of policy. As the National Review recently observed, “When you’re already moving backward, the only way to go forward is to turn around.”
Last December, Obama invited business executives to the White House for a jobs summit, officially dubbed the Jobs and Economic Growth Forum. He told them, “While I believe the government has a critical role in creating the conditions for economic growth, ultimately true economic recovery is only going to come from the private sector.” He asked them, “What’s holding back business investment, and how can we increase confidence and spur hiring? How do we get businesses to start hiring again?” He said, “If there are things that we’re doing here in Washington that are inhibiting you, then we want to know about it.”
THE CASEY REPORT 38
Lawrence Lindsey, who was an economic adviser to the Bush administration was at the jobs summit and said, “I don’t think there is a moment to lose. I think we have to move aggressively toward policies that actually promote jobs, and so far what’s been tried hasn’t worked very well.”
Obviously, token incentives like exempting companies that hire those unemployed for at least 60 days from the 6.2% Social Security payroll tax through December and giving them an additional $1,000 credit if the new employee stays on the job a full year are virtually meaningless. Such incentives do not offset the liability that comes with hiring a new employee in this highly regulated environment. These incentives, part of the jobs bill enacted on March 18, 2010, PL 111-147, mostly accrue to companies that would have hired those unemployed workers anyway.
In a survey of the nation’s business economists conducted by the National Association for Business Economics during March/April 2010, 73% “reported the fiscal stimulus enacted in February 2009 has had no impact on employment to date.” 68% of the economists thought the so-called “jobs bill” had no impact on unemployment.
Republicans held their own jobs forum where Douglas Holtz-Eakin, a former head of the Congressional Budget Office, said Obama should “reverse course on a dangerous agenda of debt-financed spending, crippling regulation, expensive mandates, and intrusive government expansion.”
Just for starters, here’s a short list of reforms that would truly stimulate the economy and put millions of Americans back to work:
Repeal the 1931 Davis-Bacon Act.
Under this New Deal albatross, all workers on federal construction projects must be paid the local prevailing wage, which typically means union wage. The ARRA expanded Davis-Bacon to include all “projects funded directly by or assisted in whole or in part by and through the Federal Government.” The nation’s economy is penalized by the ARRA-enhanced Davis-Bacon Act as it is by other Obama paybacks to unions.
Reduce the corporate tax rate.
Ours is the second highest in the world at 39.1%.
Scrap Cap-and-Trade.
A carbon tax is one more disincentive to create new wealth.
Repeal Obamacare.
This monster bill and the mind-boggling tsunami of regulations that will implement it constitutes a huge disincentive to hire workers, retain workers, or even stay in business.
Don’t let the Bush tax cuts expire.
These capital-building tax cuts sunset at the end of the year, after the midterm elections. Income tax rates will rise substantially for everyone who pays taxes. The lowest rate jumps from 10% to 15%, the highest rate from 35% to 39.6%. The favorable treatment of capital gains and dividends will end. Favoring investors’ capital gains and dividend income helps build capital, an essential ingredient needed by risk takers to create new wealth and create jobs in the process. Government redistribution of the financial rewards earned and well deserved by risk takers is not new wealth creation.
THE CASEY REPORT 39
In Ayn Rand’s The Fountainhead, Howard Roark said, “Men have been taught that the highest virtue is not to achieve, but to give. Yet one cannot give that which has not been created. Creation comes before distribution – or there will be nothing to distribute.”
Don Grove is our Washington, D.C. correspondent. Don casts a jaundiced eye upon the activities of Congress, the White House, and the courts from his front row seat in the nation’s capital where he is an attorney in federal practice and a managing partner in his law firm. Don entered the practice of law from a background in engineering and heavy industry, including the manufacture of trucks for municipal fleets and the design and prototype field testing of rough-terrain tractors in Australia, as well as researching and drafting patent applications and lobbying Parliament. He graduated summa cum laude with a BS in International Business from the University of Maryland and cum laude from American University’s Washington College of Law where he served on the editorial board of the Administrative Law Review and represented clients before the IRS as a student attorney. He clerked for the Reporter of Decisions at the United States Tax Court in Washington, D.C. and worked on Capitol Hill for Senator Bill Frist and for Congressman Bob Clement. He served on the board of directors of U.S. China Educational Ventures and as a language instructor for that organization in China’s interior. He served as a law clerk for the chief judge of the United States Court of Federal Claims, where plaintiffs bring high-dollar lawsuits against the United States, such as the savings and loan and spent-nuclear-fuel cases. He is admitted to practice in Maryland, Washington, D.C., and Tennessee and is admitted to the bar of the U.S. Court of Federal Claims, the U.S. Court of Appeals for the Federal Circuit, the U.S. District Court for the District of Columbia, and the U.S. Supreme Court. Don is a champion of limited government in the belly of the beast.
Back to Table of Contents
Special Report Into Iraq By Doug Casey
Even though I’ve spent time in more than 170 countries, until a few weeks ago, Iraq wasn’t one of them. So I was eager to get my “boots on the ground,” as they say, and see what I could make of the place.
I spent three days there at the end of June, accompanied by my friend and associate Marin Katusa, head of our Energy Division, visiting the cities of Erbil and Sulaimaniya, and driving about 800 km through Kurdistan close to the Iranian border, looking at the properties of ShaMaran Petroleum.
ShaMaran is under the wing of Lukas Lundin, son of resource industry legend Adolf Lundin and himself a member of our Explorers’ League. Like his father, Lukas is predisposed to investing in obscure, troubled, and unstable countries: Russia, Syria, Egypt, Tanzania, and the Congo are just a few that come to mind. He was an early and highly successful entrant to Argentina when it opened up for mining in the early ‘90s.
I enthusiastically endorse his approach, because although the risks are certainly higher in these places, the prospect of finding an elephant-sized resource is disproportionately higher, simply because such places are underexplored. And costs are much lower, because there’s relatively little competition for mineral rights.
What’s more, no place remains wild and crazy forever; they almost always improve. As a well-known religious philosopher once said: “The first shall be last, and the last shall be first.” That was probably going a bit far, but at least everything tends to revert to the mean. It’s why Nathan Rothschild famously advised, “Buy when blood is running in the streets.”
Lukas, like his father before him, has made billions of dollars for himself and his shareholders by following that approach. I can’t think of a better group to take on Iraq than the one Lukas has put together, but the big game it’s hunting is definitely dangerous.
THE CASEY REPORT 40
Before this trip, I just knew the basics – Iraq is about the most prospective place on the planet for petroleum. It’s also a place where security considerations are paramount; its government is as corrupt and rapacious as they come; and its economy is completely unbalanced.
Since then, I’ve had time to ponder what we think we know about the place and to crystallize my thoughts.
WHAT WE DON’T KNOW ABOUT IRAQIt was a great trip, I learned a lot, and I’m glad I went – although not for the reasons you might think. I say that, for one thing, because it gave me a reality check on the kind of junket that politicians and most members of the press do in Iraq.
It’s an important credential for them to show up “in country,” because these worthies want to say they’ve “been there.” That gives them standing to pontificate about the local situation when they return home. It gives their opinions more weight, because they appear to have learned things “first hand.” It makes them seem authoritative. But accepting that impression is delusionary, nonsensical, and dangerous.
When you go to a real war zone, if you’re a politician or a member of the press, you are going to be closely managed and monitored. That’s partly because if you go wandering off to the wrong place, you might get kidnapped, or robbed, or shot, or diced by a landmine. If your host is at all responsible, he doesn’t want that to happen to you. So it means you’re going to be traveling in a high-security bubble, totally sealed off from the real world around you. You might as well watch a National Geographic video of the place.
This is especially true if you’re the guest of a government in a war zone. They will not only make sure you’re insulated from real information, they will make sure you are immersed in disinformation. The type that suits them. I don’t believe I got any of the latter, since my outing wasn’t a government undertaking.
I bring this up because I don’t believe that the information North Americans and Europeans get from Iraq is generally to be trusted. It’s very much as Will Rogers observed: The problem isn’t what we know; it’s what we think we know that just ain’t so. Why do I say that? Because almost all tours to Iraq are at least indirectly sponsored by a government.
And the people who are invited to tour Iraq are screened to the greatest degree feasible, to be sure they already buy the party line – or are at least not hostile to it. Why bring along a potential troublemaker? Promoting the party line on Iraq isn’t hard, because the place is in fact hazardous, which makes stories easy to come by as to why a visitor must see only what he “should” see and no more.
Newspapers and networks don’t want to spend big bucks to provide security for reporters. And reporters are, partly as a result, reluctant to go. So there are few real independent reports. That’s apart from the fact that Iraq is no garden spot. The food is mediocre, if only because most of it is imported. You can forget about meeting women; those who aren’t wearing burqas at least sport headscarves. You can forget about alcohol and recreational drugs. You can forget about recreation, period.
Iraq and Afghanistan are fundamentally unattractive places – very much unlike Vietnam, even when it was a war zone. Furthermore, the few journalists that stay “in country” for more than a couple of days are usually “embedded” with soldiers. It’s an innovation that ensures journalists don’t go out on their own.
THE CASEY REPORT 41
How about soldiers as observers? Well, you can’t say they are sheltered, but most have a relatively limited range of experience, resting in the barracks in a secure camp and then riding in an MRAP to a scary destination and back. There’s not much opportunity for socializing with the locals and hearing their side of the story. Unless it’s being told under duress, possibly with the aid of a rubber hose and electric shocks. But, that said, there have been some great stories told by recent veterans, which have the ring of truth. I particularly recommend that you see The Hurt Locker, now on DVD.
My guess is that most of the stories you hear about Iraq, however, including all of the tales from politicians and other government employees, are propaganda or secondhand at best. Those from reporters are mostly scuttlebutt picked up hanging around the Green Zone in Baghdad, romanced to sound like the guy is actually earning his keep.
I think the whole reporting process is corrupt and compromised. In 1991, for instance, the tale was told of over 300 babies that the Iraqis ripped out of their incubators in Kuwaiti hospitals and left to die, so that the Iraqis could ship the incubators back to Baghdad.
The story was retailed by one Nayirah, a 15-year-old “nurse” who, it turned out later, was the daughter of the Kuwaiti ambassador to the U.S. Nayirah had been tutored and rehearsed by Hill & Knowlton, a PR agency with a $14 million contract from the U.S. government to keep the public “informed.”
That her story was proved to be a fabrication was bad enough. But I remember remarking, when I first heard it, that the tale was nearly identical to the one made up about German soldiers in Belgium during World War I, who were accused of bayoneting babies for sport. You’d think for that kind of money, the fools could at least have been original – although maybe they were just guilty of a mischievous sense of humor. But the public tends to remember only the original outrageous story; if the retraction ever appears, it’s weeks later, buried on page six below a hemorrhoid ad.
People believed the lies the government told, and the press slavishly repeated, about a totally non-existent relationship between Saddam, al-Qaida, and the events of 9/11. And the non-existent imminent threat presented by chemical, biological, and nuclear weapons from the country that had been the U.S. government’s ally only a few years before. And Boobus americanus still thinks the media is to be trusted. In fact, it’s far less trustworthy than it’s ever been.
So, with that prologue, let me give you the facts as I see them, in particular about the oil business in Iraq and the prospects for successful speculation there.
Let’s start with the big picture.
IRAQ: A NON-COUNTRYIt’s rather strange the way most people seem to think that the countries of the world are a permanent part of the cosmic firmament when, in fact, most of them are recent and totally arbitrary constructs. Almost every country in Africa, the Middle East, and Asia was colonized and had its boundaries drawn in European boardrooms, with absolutely no regard to the natives’ ethnicity, language, religion, or prevailing politics and economics. That has caused, and will continue to cause, literally a world of trouble – but that’s a subject for another time. Let’s just look at Iraq, which is typical.
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Allow me to stuff 6,000 years into a couple of paragraphs. As every school kid at least used to know, the land between the Tigris and Euphrates is the cradle of civilization, featuring the first cities, the invention of writing, large-scale agriculture, ceramics, brewing, weaving, metallurgy, and most other basic crafts. The area featured in almost every important civilization of the ancient world, including those of the Sumerians, the Babylonians, the Assyrians, the Persians, the Greeks, the Romans, and the Mongols.
But the most lasting imprint was made by the Arabs in the 7th century, who brought Islam with them. That influence is likely to persist for some time, while the political map will continue to be redrawn.
During the late Middle Ages, this whole part of the world became part of the Ottoman Empire. What is now called Iraq was essentially three provinces of the empire – Baghdad, Basra, and Mosul – with concentrations of Sunni Arabs, Shia Arabs, and Sunni Kurds, respectively. These three provinces together made up the region the empire called Mesopotamia.
The Ottomans, scions of a Turkic people from Central Asia, were generally benign rulers, which is why their empire lasted roughly 500 years. The Middle East had been a racial melting pot for millennia. With the final collapse of the Byzantine Empire at the end of the 15th century, Islam provided a new unifying framework (although other religions were generously tolerated). People were generally left to that most innocent of activities, trading and making money. Taxes weren’t exorbitant, and citizens were aided in evading them by a notoriously corrupt bureaucracy. There was little conflict within the empire, until World War I, when the British and the French broke it up and nationalism took over.
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Idiotically, the British and French decided the three provinces of Mesopotamia should be one country, under a king. That kingdom lasted until 1958, when the monarchy was overthrown by a military coup. Saddam emerged as president in 1979 and started a war with Iran in 1980, claiming (probably correctly) that the Ayatollah, who had just taken over, was fomenting the majority Shia to overthrow his regime.
Needless to say, the Americans saw him as a tool for punishing their new Iranian enemies. Saddam remained the U.S. government’s BFF in the region until he invaded Kuwait (for which he thought he had U.S. approval) in 1990. It was purely a matter of economics for him; stealing that extra oil production would help with his war debts.
But here’s the point. Iraq was cobbled together by the British after World War I for no reason other than their own convenience. It has no reason of its own for being a nation-state. It’s hanging together as an entity only because it has borders with other (mostly hostile) nation-states. At a minimum it should be three countries, and perhaps as many as 10 to accommodate various other groups.
I hate saying that, in that I believe the nation-state itself is on its way out; but it would be a step in the right direction, if only because it would help the security situation. Providing security is a government’s first duty. And here, as in absolutely everything else, the post-invasion Iraqi government is an abysmal failure.
THE “SECURITY” SITUATIONSecurity is the reason there’s no conventional tourism in Iraq and won’t be for many years to come. Like most Muslim countries, it’s an uptight place – much worse even than Utah. But it’s also dangerous. So ShaMaran Petroleum, our host, provided security.
I was fortunate, on my first day, to have an ex-French Foreign Legionnaire as my bodyguard. I’ve long been a fan of legionnaires, who tend to be cut from the same cloth as Navy SEALs and Army Special Forces – unconventional, roguish thrill-seekers, often with an intellectual bent.
He was a Scot, early 40s, I’d say, and was atypical only for having logged a full 13 years in the Legion. He was a font of great stories about barroom brawls, sniping and counter-sniping during the Bosnian war, conspiracies to rob banks – the usual legionnaire fare. No need to think in those terms now, though, in that good contractors earn a tax-free $150,000-200,000. Plus, back in Iraq’s halcyon Wild West days, up to about 2006, anything that wasn’t nailed down could often be treated as a bonus.
One comment he made, seconded by a couple other team members I chatted with, was that Blackwater was a truly screwy outfit. Their operators tended to be hicks, pumped up with both steroids and a religious outlook that made them righteously trigger-happy when surrounded by the Mohammedan infidel. Their sorry reputation is deserved.
I was impressed with our team’s professionalism, and I gave it more notice than most would because I was long ago a graduate, and am still a shareholding director, of Bob Duggan’s Executive Security International (www.esi-lifeforce.com), a leading executive protection school. Whenever we stopped to view an oil seep (there are thousands in Iraq) or to tap a kidney, the security team fanned out into a perimeter so quickly you didn’t realize it. Out in the boonies, each operator used his choice of a rifle (AKs are ubiquitous) or a machine pistol (H&K MP5s tended to be favorites). In town, everyone had a loose-fitting shirt that covered a primary pistol (Glock 9mms favored), and most carried a small backup.
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As we drove, we encountered numerous roadblocks. Some were manned by KRG (Kurdistan Regional Government) troops, some by the federal government. It seemed like a Chinese fire drill. And a week after we left, there was a firefight between these two forces in a Kurd town; several participants were wounded. There’s lots of recurring and easily available evidence that Kurds and the Arabs don’t work and play well together.
DOING BUSINESS? One question I kept asking myself as we drove around was: What do these people do for a living? A check of the published statistics shows that oil production constitutes over 95% of the total GNP. The only other production in evidence is subsistence farming. Everybody in the countryside appears to have some goats, some sheep, maybe a cow, some fruit trees, and a vegetable garden. Kurdistan reminds me of eastern Colorado, with broad, dry plains and mountains in the distance. Wheat can be seen growing on some of those plains. There are desert regions – most of Iraq is a big desert – but there are also large lakes and small rivers.
But other than the farmers, what do the country’s 29 million people do? Over 30% of them are on the government payroll. The only obvious ones are the ubiquitous police and security. I’m sure many of the others don’t even show up for work, but do collect a check. That’s probably just as well, considering most government employees just shuffle paper that makes legitimate business harder and more expensive. But there are lots of new cars; a trickle-down from the oil business.
Let’s see, official unemployment is 30% to 50%, and 30% are employed by the government – basically nobody is working. And the unemployment is concentrated among the youth, which is a ticking bomb. More on that below.
Of course, Iraq was no picnic in the days of Saddam; the place was clearly a police state, run by a paranoid gangster and his crew. But, to be entirely realistic, things were no worse than in perhaps 25 other countries today. And things were better in some ways under Saddam. You only had to deal with one group of thugs, and the ground rules were fairly clear. Today, what passes for a government will definitely shake you down, but so will any number of other competing political/criminal groups. I simply can’t fathom trying to run a business here, but people obviously do.
Proof of that is offered by the Iraq Stock Exchange, which lists 81 companies, though typically only a third of them trade on a given day. With the Iraqi dinar going for about 1,170 to the dollar, most are penny stocks. I regret to say I was just unable to find any fundamental data on the companies – even basics like market cap, assets, earnings, and discussion of the business. Although, everything else being equal, the lack of information piques my interest. A market where there are lots of broker’s reports tends to be fully priced; a market that discourages buyers may be a real bargain.
In any event, there are eight banks, seven hotel companies, a brewery, a soft drink bottler, a paint company, a furniture company, and a clothing manufacturer among them. You get the picture – basic stuff. The government owns all the oil, the refineries, the pipelines, the utilities, the ports, the roads – anything of real value. Nothing has really changed since the days of Saddam, who actually started the stock market.
One area I looked into was the electrical power situation. Everyone has heard stories of outages running from six to 20 hours a day. That has to be a nightmare in cities, where people live in concrete boxes. Temperatures hit 120F in the summer, and you may have to walk up 10 flights. We didn’t experience any outages, but only because we were, as I said, living in a bubble, staying in secure hotels, with diesel generators that kick in when the grid goes down.
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Before the first Gulf War, a lot of electricity was generated by hydro, on both the Tigris (which rises in Syria) and the Euphrates (from Turkey). But these days a huge amount of water is being diverted upstream for various reasons. Fresh water in populated areas is a problem the world over and absolutely in Mesopotamia. So hydropower, which used to be about a gigawatt, is off about 80%. The country generates another seven gig on the grid from oil and gas. But demand is estimated at 12 gig and is growing at 15% to 20% per year.
One reason is that power is almost free, another foolish legacy from the Saddam days, so no one has a motive not to waste. Another reason is that the Americans have brought about a cultural change, where air conditioning, refrigerators, and flat-screen TVs are now de rigueur. The gap between supply and demand is made up by scores of thousands of private generators, a high-cost and inefficient alternative running on diesel fuel – which is also subsidized.
Most of the generating plant (what survived the wars) is decades old and poorly maintained. The government has a monopoly on the grid, of course, and is promising 40 new natural gas-fired power plants. But that’s a pipe dream; they’ll never set aside the money to build them, and Iraq is a net gas importer. Nobody wants to drill the country’s huge gas reserves, partly because the tax regime is so onerous, but also because there’s no pipeline infrastructure to distribute the gas. But even if the plants and pipelines were built, infrastructure for distributing the electricity is inadequate and decrepit.
After two devastating wars and 10 years of an embargo that was responsible for the deaths of 500,000 infants (a lot of them because of bad water, in that purification plants were unable to operate for lack of chlorine, which is a component of some chemical weapons), not much works in this country. But, as Madeleine Albright famously said in 1996, “We think the price was worth it.”
It’s questionable, at this point, whether the U.S. will be able to afford to fix the electrical infrastructure they destroyed; it would amount to putting in plants, pipeline, and grid for 30 million people. But even if they do, it won’t last long with the perverse counterincentives offered by state ownership, subsidies, and price controls. The U.S. had a chance, early on, to overturn Iraqi socialism and privatize everything. Idiotically, they instead concentrated solely on political elections.
The chance of the Iraqis making changes in a country that’s rife with corruption on all levels is nil.
WAR WITH IRANThe U.S. and the Iranian governments have been hooting and panting at each other for about 30 years now, since the mullahs deposed the Shah.
There have been quite a few times when the constant war of words might have turned violent, such as in 1988, at the end of the Iran-Iraq War, when the USS Vincennes shot down Iran Air 655 with 290 passengers. The Airbus 300 was on a scheduled, 30-minute flight from Tehran to Dubai, still climbing and seven miles away, when the ship fired two missiles. This isn’t the place to discuss the incident, but I suggest you research it.
It’s pretty clear to me that the U.S. was completely and unambiguously at fault, although no apology was ever issued, nor was the commander of the ship even court-martialed. I question what the U.S. response might have been if an Iranian cruiser operating in U.S. waters had shot down an American airliner. Most Americans don’t recall the shameful incident, but I suspect most Iranians do.
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That’s simply background. The current problem is that it appears the Iranians are well along in the process of enriching uranium, which is to say separating readily fissionable U235 from U238. The U.S. really doesn’t have a dog in this fight, at least any more than it might have had when the Chinese, the Indians, the Israelis, the Pakistanis, or the North Koreans built bombs. But the Israelis are on record that they won’t tolerate a nearby enemy state having nuclear weapons. This is why they destroyed Iraq’s Osirak reactor in 1981 and are suspected to have destroyed Syria’s secret al-Kibar reactor in 2007.
Iran would appear to be next on the dance card. But the problem is not going to go away for the Israelis. If they were able to construct nuclear weapons as early as the 1960s and even the North Koreans are able to build them today, then the manufacture of nuclear weapons is within the reach of almost anybody, including a wealthy individual. Although it would be much easier and cheaper to simply buy some, maybe from a Pakistani general, or even an enterprising Russian sergeant major.
The latest news claims that the Iranians are going to stand down, in order to forestall a punishing embargo. But things can change quickly. And everybody now knows that the U.S. wouldn’t have dared invade Iraq if it had possessed even a small nuclear arsenal. So that alone is an excellent reason to be prepared. Especially with continuing advances in technology, nuclear weapons are not only a “must have” but increasingly a “can have” item for anyone.
We’d better hope that the same folks who brought you the Forever War in Iraq and Afghanistan don’t extend it to Iran. In the first place, it’s unnecessary. I suspect they’re near collapse. Their economy is unreformed, centrally planned, tightly regulated, and highly distorted. For instance, gasoline retails for US$0.15 a gallon, even though they have to import almost all of it. The oil industry provides 80% of the government’s revenues but is going into decline for bad management. The youth must hate both the economic situation and the social repression.
But if the U.S. attacks, they’ll “patriotically” line up in back of their leaders. The U.S. fleet in the Gulf will serve mostly as a dive site for people in the 22nd century. And the War against Islam could go into hyperdrive.
Iran is a key factor in what happens to Iraq. The prognosis is not particularly good, and not just because of U.S. meddling.
KURDISTANIt would be bad enough if Kurdistan were just a part of Iraq (where Kurds number 6 million, or 20% of the population) that needed to secede. But there are substantial Kurd populations in Syria (1.6 million, or 8%), Iran (7 million, or 7%), and Turkey (20 million, or 20%). These are guesstimates, on one hand because the Kurds migrate across the borders, and on the other hand because the governments like to officially underestimate their numbers, importance, and, in the case of Turkey, their actual existence. The smartest Kurds are undoubtedly the 1.3 million who live in Western Europe, and especially the 150,000 in North America.
Iraqi Kurdistan is an autonomous region; when we flew into Erbil, the capital, visas were granted by the KRG (Kurdistan Regional Government), not Baghdad. The Kurds are mostly Sunni Muslims but speak an Iranian-group language, with two main dialects and several minor ones that are, I’m given to understand, mutually almost unintelligible. But they share a common culture, and they don’t at all care for their nation being divided among four states, where they’re dominated by Arabs, Persians, and Turks.
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Now, considering that since the devolution of the Ottoman Empire something like 300,000 Kurds have been killed battling the four states in which they live, and that in the last Iraqi elections, in 2005, something like 95% of the Kurds voted for the total independence of Kurdistan, and that they’ve existed as a cultural group for over a thousand years, there’s no reason to believe the Kurds will stop fighting for an independent state.
The Iraqi Kurds are closest to that goal; they already have an autonomous region with its own military and foreign consulates. But will it become independent? Not if the Turkish, Iranian, or Syrian governments can stop it, because then the Kurds would have a truly solid base from which to mount a war of liberation in those countries.
In addition to the KRG military, the Kurds have two main guerrilla movements: the PJAK, with about 3,000 fighters, against the Iranians; and the PKK, with about 5,000, against the Turks. As if to underline the old truism “I’m a freedom fighter, you’re a rebel, he’s a terrorist,” the U.S. and the Europeans have designated both groups as terrorists.
While we were there, the Iranians were shelling Kurdish villages in Iraq and actually occupied some disputed land on the border. And the Turks were bombing areas along their border and sending in commando teams to kill whomever. We didn’t see or hear any of it, but it was widely reported. Nothing has changed for almost 100 years, and I don’t expect any real changes until these nation-states collapse.
Will it really solve any problems if the Kurds get their wish and a Greater Kurdistan emerges? Not really. The 40 million, or however many, Kurds will just wind up fighting each other for control of the new state. And then fighting a formal war against one or more neighboring states. That’s been the drill here for about the last 6,000 years.
In the meantime, nonetheless, Kurdistan impresses me as the best place to be in Iraq. It appears much safer and far more business friendly than the rest of the country.
THE U.S. IN IRAQIt’s still a mystery to me why the U.S. went to Iraq in the first place, and even more so why it’s still there. Was it because Iraq was involved in 9/11? No, that’s been proven a lie. Was it because Saddam wanted nasty weapons? I think not, since most governments want them and will get them – and in any case, if they’re a problem, they are a problem for the neighbors. Was it because of the oil? It’s not working out that way, because not only is production down, American oil companies are the last to benefit from what there is. Was it to promote democracy? Trying to impose mob rule, especially in this part of the world, is tragically laughable. Was it just because the Baby Bush was naïve or megalomaniacal or angry Saddam tried to kill his daddy? As good an answer as any, actually.
But the “why” is water under the bridge. The trillion dollars that’s already been squandered here, with zero return, is a problem for future U.S. taxpayers, or maybe Chinese creditors, to confront. A more relevant and entertaining question is: What now?
The U.S. is apparently going to be down to 50,000 troops in the country by the end of September and fully withdrawn by the end of 2011. I can’t, however, discover exactly what that means. It’s said the U.S. is planning on an “enduring presence” here, presumably in the five existing super bases – complete with Burger Kings and bowling alleys – they’ve constructed in isolated areas around the country.
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It’s said the troops will just hang out and forgo search and destroy missions against insurgents. The day-to-day fighting will be left to the Iraqi army, which by all accounts is incompetent, composed mostly of men desperate for a paycheck, and thoroughly infiltrated with insurgent sympathizers.
What will the Americans do if the Iraqi government, which is correctly viewed as a bunch of swindlers and collaborators, is overthrown, possibly by the Iraqi army? What will they do if the insurgency heats up again?
Those are likely scenarios. But no less likely, I suspect, than the landing of a real Black Swan, like someone driving a truck with a nuclear device reasonably close to one of the big U.S. bases. With nuclear weapons, to a much greater degree than either horseshoes or hand grenades, close is good enough.
But this kind of conjecture is probably academic, if only because the financial straits of the U.S. government are so dire, they’ll likely be forced to close their “Enduring Presence” bases in the next few years.
The media has reported that a substantial percentage of al-Qaida’s leadership has recently been killed, some by drones, some in “kill or capture” attacks that didn’t get past the first word. This has led some to conclude that the guerrilla war in Iraq is over; mission, finally, more-or-less accomplished. And, indeed, the number of bombings in the country is down considerably. But I see several flaws in this view.
In the first place, al-Qaida isn’t itself the problem; it’s simply the oldest and best promoted anti-Crusader franchise. The USG and its flacks like to talk only about al-Qaida because it makes the problem look specific, containable, and simple. In point of fact, the war of Islam against the U.S. is “open source”; there are no real leaders giving orders from the top. Killing a few dozen elders in Iraq is not only pointless but probably even counterproductive.
It’s not just something called al-Qaida; there are scores of organizations, roughly aligned in worldview but separate and completely independent. They watch each other’s successes and failures, and learn the way computer hackers learn from each other. It’s not like the war in Vietnam, which was directed from Hanoi. This is a hydra-headed monster.
Killing the old radicals serves no purpose but to leave the younger ones – who tend to be bolder, more vigorous, more radical, and more innovative – in the fore. The U.S. is forgetting that in Iraq, Afghanistan, and the rest of the Muslim world, something like 50% of the population is under 25. And they’re mostly unemployed. The most dangerous creature to have ever walked the earth, including T-Rex, is the young, unmarried, unemployed human male.
Some say that killing people is only part of the grand strategy; most important is “winning hearts and minds.” It impresses me as the height of arrogance and foolishness to think you can send teenage soldiers into a country on the other side of the globe, with an alien religion, language, and culture, and believe you can “win hearts and minds.” The average Iraqi likes seeing U.S. troops patrolling his streets about as much as the average American would like seeing a Muslim army patrolling Main Street USA.
The bottom line is that the U.S. adventure in Iraq is going to end very badly. And not just for the U.S., which gets all the costs and none of the benefits – including no oil.
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OILOil is a good thing to have in a society – if that society is based on sound law, a minimal state, strict property rights, and a free market. It’s disaster everywhere else, for the simple reason that oil is almost unique among commodities in having extremely high unit value, often being found in extremely large deposits with extremely low costs of production, and having a broad and deep market. Oil is an immeasurably better business than mining (which is generally a lousy business, however much fun the stocks are to play with).
Unfortunately, those characteristics make oil a natural political football. If a society has oil on its land, it’s exactly like finding a mountain of $100 bills. They no longer have to work or even think. All they have to do is grab the treasure and then naturally allow their worst instincts and basest vices to bubble to the top. If Hong Kong, Japan, South Korea, or Singapore had the oil reserves of Saudi Arabia, Kuwait, Iran, or Venezuela, they too would be shameful and degraded disasters.
One thing that always happens in oil-rich countries is that the government takes control of the resource. The more oil that’s produced, the less need there is to produce anything else. The more power that accrues to the state, the more corrupt the society becomes. People’s attention becomes focused not on how to grow rich through production, but how get on the gravy train – or better, steal the gravy train.
That’s exactly the case in Iraq. An oil explorer has to put up 100% of the expertise, 100% of the money, and take 100% of the risk. But royalties and taxes give the government over 90% of the oil in most scenarios, even in Kurdistan, which is relatively liberal. In the rest of Iraq, they don’t even share in the benefit when the oil price goes up; they get only a fee per barrel pumped. That’s not counting “facilitation fees” of one type or another, which will almost certainly be required by numerous layers of officials. And I see no prospect for improvement.
But just because there’s chaos doesn’t mean you can’t make money. Au contraire.
It’s a certainty that there’s much, much more oil to be pumped from Iraq. Its official reserves are 115 billion barrels, but that’s a doubly meaningless figure. For one thing, it’s an old number, pulled out of thin air back in the days when everybody in OPEC was inflating their reserve numbers to increase their production quotas. For another, the place is grossly underexplored, with no serious work done for about 30 years. Even now, only 15 of 73 known fields are being produced.
To give you a comparison, only 2,000 wells have ever been drilled in Iraq, versus a million in Texas alone. But then Texas doesn’t have possibly millions of people who are at least sympathetic, if not proactive, in blowing up pipelines and otherwise inconveniencing the Crusaders who’ve made themselves at home in their country. In fact, although there are thousands of attacks on the pipelines every year, it’s far more popular, and more profitable, to tap into them and steal the oil. And it’s fairly safe, since the local army and police will likely be in on the deal. At a minimum, you’ll at least have a confederate there to warn you if they come to investigate.
A sidebar. Especially during one stage of the Iran-Iraq War, both countries were sinking each other’s oil tankers (including the largest one ever constructed) and destroying each other’s storage facilities on the Persian Gulf. It’s estimated about 10 times the amount of oil that was recently spilled in the Gulf of Mexico at the BP well went into the Persian Gulf, a much smaller body of water. There have apparently been almost no lasting effects.
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SHAMARAN PETROLEUMSo this has been a very long preamble to bring me to the cause of my visit to Iraq: ShaMaran Petroleum (V.SNM, C$0.40, www.shamaranpetroleum.com). With 504 million shares out, SNM has a market cap of C$201.6 million. The stock is down from a high of C$0.77 in September 2009, but it’s not cheap.
That’s partly due to the Lundin premium (usually justified), partly due to the company’s treasury of C$35 million, partly due to scale of its three concessions – over 2,000 square kilometers, constituting the 4th largest land package in Kurdistan – and that those concessions are located in elephant country and contain significant historical barrels. A final positive is that I think oil is going much higher in the years to come.
The negatives are the brutal tax regime, the lack of infrastructure for doing anything (including getting the stuff out if they hit), the very risky security situation, and the high likelihood of World War III starting in the neighborhood.
My take? The company will likely need to raise funds next year – therefore the best bet is to stay on the sidelines and either wait for a larger company to earn into it, or buy once the current downtrend seems to have bottomed and starts turning up based on successful drill results.
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But no urgency at the moment. I agree with Marin. I say this as someone who’s handed a considerable amount of my own money to Marin to manage. He has not only great technical expertise and probably the best resource database in the business but loads of street smarts. In the past, I’ve always had an emphasis on mining stocks in my portfolio, but I’m adding lots of well-selected energy issues for reasons I’ve touched on above. I urge you to take a close look at Casey’s Energy Report. In particular, see Marin’s take on Iraq and ShaMaran in the current issue.
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In any event, I suspect the way Lukas will play this is to sell the company to a major if they have drilling success. He may well make another billion dollars for everybody.
Back to Table of Contents
End Note A closing comment by Doug Casey
This month’s end quote is a reprint of that from the Feb 2007 edition of International Speculator. I don’t like to repeat myself, but since Iraq was featured this month…
SADDY, WE HARDLY KNEW YE…On December 30, 2006, Saddam Hussein, ex-president of Iraq, was executed. It was “an important milestone on Iraq’s course to democracy,” said Bush. It was really more of an additional tombstone in the shameful, pointless, and criminally expensive American adventure in Iraq. I’m not going to do an obit on Saddam; from one point of view, he’s just another dead scumbag, and good riddance. Instead, I’d like to briefly examine the circumstances of his death, which are far more significant than any events in his sorry life.
ON KILLING IN GENERAL Don’t get me wrong. I’m no pacifist. Some people definitely need killing. That’s a statement very few people will disagree with (even though vanishing few would be willing to say so in as many words). Maybe that’s one reason why politics and religion aren’t considered topics for polite conversation. As for politics, wars are just extreme politics, all about killing, and they’ve always been a popular activity. As for religion, the Bible and the Koran, to name two popular religious texts, seem to advocate lots of killing – as long as the victims are adversaries of Yahweh, Allah, or whoever the authors’ favorite deity is. But this letter doesn’t limit itself to polite conversation. So let’s talk about some of the aspects of ritualized killing. Its ethics, its aesthetics, and its economics.
First, the ethics of the matter. Long-term readers know that I believe most, if not all, matters of right and wrong can be dealt with through the application of the Two Great Laws:
1] Do all that you say you’ll do.
2] Don’t aggress against another person or his property.
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Killing, in itself, would seem to be allowed under Law Two, as long as the killing is defensive in nature. Needless to say, there’s plenty of room for Talmudic, Thomistic, or Koranic interpretation, but at least the principle is clear enough. Actually, in the manner of physicists who are trying to sum up all the truth of the physical universe into one great law, I would sum up my Two Great Laws of ethics into just one. It’s aesthetically appealing to me because it has a rather open-ended Taoist flavor. It is this:
The whole of the law shall be: “Do as Thou Wilt… But Be Prepared to Accept the Consequences.”
I fear, however, the first part of the One Great Law is too scary for most people. That’s because if they follow the first part, they intuit they might be too stupid, or thoughtless, or badly disciplined, to remember the second part. But no matter. The consequences of what you do will pursue you like the Furies of classical mythology.
Second, the aesthetics of the matter. I’m not sure there’s an elegant way to die. But hanging at the end of a rope, attended by the kind of degraded beings that would be willing to do something like that just because they’re told to, is unappealing. I have some sympathy for the victim of a ritual execution, but none for those who carry it out. And even less for those who order it done. It seems to me that if you want somebody killed, you ought to do it yourself. It’s always seemed both cowardly and shameful that people would have to dress themselves up in robes and utter what amount to magical incantations from law books, in order to have some lowlives perform an execution. If Bush or his cronies, or their quislings in Iraq, wanted to kill Saddam, then they should have done it face-to-face. The dishonesty of the whole charade is disgusting.
Third, the economics of the matter. Executing someone doesn’t undo the harm they’ve done. But it does degrade everyone involved in the process. So what should be done with someone who’s done extremely bad things? Should you kill them? If you believe in justice, which can be defined as the process of ensuring people get what they deserve, then it’s most important to look at the victim, or victims. If someone steals a loaf of bread, what good does it do to put him in jail? None. The baker not only doesn’t get his bread back, but his taxes must pay for the offender’s capture, prosecution, and incarceration. This is true of crimes all the way up to murder, in which case the survivors of the victim get no recompense. In a free-market society, an arbitrator would assign damages for the crime and the costs surrounding it. The perpetrator would be obligated to make good to the greatest degree possible. Even if that might involve selling off his body parts.
Fourth, the consequences of the matter. In this case, it’s to unleash yet another Fury to pursue the tattered Spirit of America.
ON KILLING SADDAM IN PARTICULAR As bad as executions are in general, there are reasons why the execution of Saddam was an especially bad idea.
First, he was tried by a kangaroo court. What went on in Baghdad had no resemblance to the Nuremburg trials. It was about as legitimate as the show trial of Noriega, another ex-ally, in 1992, after the U.S. government expended many hundreds of millions, and killed several thousand Panamanians, in order to kidnap him. It puts American justice (because the Iraqi court was just a puppet of the Bushies) on a level with that of the Soviets, who specialized in show trials.
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Second, he died with lots of information. This is the real reason, I suspect, why Saddam had to die. Who knows how much he could have revealed about the part the U.S. played in his war with Iran (besides supplying him with loads of intelligence, weapons, and encouragement)? Who knows what he might have said of his conversations with his ex-friend Donald Rumsfeld, who visited with him 15 months after he was known to have used gas on Iraqi Kurds – as well as Iranian troops? Who knows how many murderers, thieves, torturers, betrayers, and other assorted rats he would have fingered if given half a chance? You can bet they’re all glad he, and his closest associates, have been killed.
Third, his death will apotheosize him to many. I’ve got to say that Saddam died like a man. He didn’t cry or snivel or beg for mercy; he died with dignity. He was a sociopath, like most people involved in statecraft, but at the end, he was also a stand-up guy, unlike most involved in statecraft. The fact he went to his death undaunted, even though he was apparently surrounded by a gang of undisciplined jackals who were almost having a party, makes him seem even more like a lion. Not only can’t Bush and his minions run a war right, even though it’s killed hundreds of thousands, they can’t even execute one man right.
Again, don’t get me wrong: Saddam needed killing. But that should have occurred while he was in power, when he could still do damage, not when he was a helpless prisoner. Idiotically, however, the U.S. has a law against killing foreign politicians while they’re still in power. Alternatively, it would have been nice to have seen him strung up from a lamp post, in a fit of rage, by his own subjects, like Mussolini.
But, done the way it was, he’s likely to become the icon of a cult. He could well become a hero for Iraqis who don’t like Islamists any more than they like the American invaders, or the collaborators now running the Iraqi government. The morons have created a martyr. You say this can’t be possible? Stalin, possibly the worst criminal of the 20th century, is still treated with reverence in Russia, if only because he fought the Nazis. Saddam will become a hero all over the Arab world for being the man who stood up against the Crusaders. Like Stalin, his faults will be minimized. They’ll remember just two things: He stood up against the invaders, and he died bravely.
So, while a lot of people in both Washington and Baghdad might think they’re burying testimony to their crimes with Saddam, they’ve also poured more gasoline on the fires in Iraq. Good going, Baby Bush.
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