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Table of Contents

The Idea of AmericA

| Bill Bonner

The Decay of Paper Currency real heroes

| Bill Bonner

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| Chris Mayer

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Alphas, Betas, Scamps and Scalawags Standby Commodities

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| Kevin Kerr

Alas, The Demise of the Dollar

| Bill Bonner

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17

| Addison Wiggin

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23 Strengthening a Weak Economic Link | Dan Amoss 26 Depleting Resources, Leaping Population | Byron W. King 29 Can the Real Bull Market Please Stand Up? | Ed Bugos 31 An Economic and Social Epidemic

| Christopher Hancock

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THE IDEA OF AMERICA By Bill Bonner ––––––––––––––––––––––––––––––––––––––––––––– February 21, 2002

“Elizabeth,” I asked this morning, as my wife climbed out of the pool. “How would you describe that sea turtle we saw on the beach?” Pausing for a moment, she replied: “Rotating its slow and majestic flippers, it ground its way slowly and inexorably towards China...” The sea turtle was headed east. Whether China was its destination or not, I don’t know. I only know that it was about to leave the Latin America isthmus, from the west coast of Nicaragua, and put out to sea when a muscular, brown young man picked it up and carried it back up on the beach. He and his friends had dug a big hole in the sand where the turtle was placed. At night we often see the dim light of flashlights along the beach. “It’s the locals looking for turtle eggs,” Manuel explained. “It’s illegal to take them, but...” Manuel shrugged his shoulders. Sea turtles are protected by international convention. But here in the wilds of Nicaragua they still end up in the soup from time to time. This is America too...but it is not the same America. It is the New World...but not as new as the world north of the Rio Grande. Here, the Old World has not yet been snuffed out. It survives in a semitropical paradise. But the object of our attention in today’s Daily Reckoning is neither the Old World nor the New one – but the ever-changing, never-fully-explored idea of America. “Proud to be an American” says one bumper sticker. “One nation – indivisible,” says another. America was, of course, founded on the opposite principle...the idea that people were free to separate themselves from a parent government whenever they felt they had come of age. But no fraud, no matter how stupendous, is so obvious as to be detected by the average American. That is America’s great strength...or its most serious weakness. After September 11, so many people bought flags that the shops ran short. Old Glory festooned nearly every porch and bridge. Patriotism swelled every heart. Europeans, coming back to the Old Country, reported that they had never seen anything like it. A Frenchman takes his country for granted. He is born into it, just as he is born into his religion. He may be proud of La Belle France the way he is proud of his cheese. But he is not fool enough to claim credit for either one. He just feels lucky to have them for his own. America, by contrast, is a nation of people who chose to become Americans. Even the oldest family tree in the New World has immigrants at its root. And where did its government, its courts, its businesses and saloons come from? They were all invented by us. Having chosen the country...and made it what it is...Americans feel more responsibility for what it has become than the citizens of most other nations. And they take more pride in it too.

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But what is it? What has it become? What makes America different from any other nation? Why should we care more about it than about, say, Lithuania or Chad? Pressed for an answer, most Americans would reply, “Because America is a free country.” What else can be said of the place? Its land mass is as varied as the earth itself. Inhabiting the sands of Tucson as well as the steppes of Alaska, Americans could as well be called a desert race as an arctic one. Its religions are equally diverse – from moss-backed Episcopalians of the Virginia tidewater to the holy rollers of East Texas to the Muslims of East Harlem. Nor does blood itself give the country any mark of distinction. The individual American has more in common genetically with the people his people come from than with his fellow Americans. In a DNA test, your correspondent is more likely to be mistaken for an IRA hitman than a Baltimore drug dealer. America never was a nation in the usual sense of the word. Though there are plenty of exceptions – especially among the made-up nations of former European colonies – nations are usually composed of groups of people who share common blood, culture, and language. Americans mostly speak English. But they might just as well speak Spanish. And at the debut of the republic, the founding fathers narrowly avoided declaring German the official language...at least, that is the legend. A Frenchman has to speak French. A German has to speak the language of the Vaterland. But an American could speak anything. And often does. Nor is there even a common history. The average immigrant didn’t arrive until the early 20th century. By then, America’s history was already 3 centuries old. The average citizen missed the whole thing. Neither blood, history, religion, language – what else is left? Only an idea: that you could come to America and be whatever you wanted to be. You might have been a bog-trotter in Ireland or a baron in Silesia; in America you were free to become whatever you could make of yourself. “Give me liberty or give me death,” said Patrick Henry, raising the rhetorical stakes and praying no one would call him on it. Yet, the average man at the time lived in near perfect freedom. There were few books and few laws on them. And fewer people to enforce them. Henry, if he wanted to do so, could have merely crossed the Blue Ridge west of Charlottesville and never seen another government agent again. Thomas Jefferson complained, in the Declaration of Independence, that Britain had “erected a multitude of New Offices, and set hither swarms of Officers to harass our people, and eat out their substance.” Yet the swarms of officers sent by George III would have barely filled a mid-sized regional office of the IRS or city zoning department today. Likewise, the Founding Fathers kvetched about taxation without representation. But history has shown that representation only makes taxation worse. Kings, emperors and tyrants must keep tax rates low... otherwise, the people rise in rebellion. It is democrats that really eat out the substance of the people: the illusion of self-government lets them get away with it. Tax rates were only an average of 3% under the tyranny of King George III. One of the blessings of democracy is average tax rates that are ten times as high. “Americans today,” wrote Rose Wilder Lane in 1936, after the Lincoln administration had annihilated the principle of self-government...but before the Roosevelt team had finished its work, “are the most reckless and lawless of peoples...we are also the most imaginative, the most temperamental, the most infinitely varied.”

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But by the end of the 20th century, Americans were required to wear seat belts and ate low-fat yogurt without a gun to their heads. The recklessness seems to have been bred out of them. And the variety too. North, south, east and west, people all wear the same clothes and cherish the same decrepit ideas as if they were religious relics. And why not? It’s a free country. Bill Bonner\

The Daily Reckoning

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THE DECAY OF PAPER CURRENCY by Chris Mayer ––––––––––––––––––––––––––––––––––––––––––––– March 24, 2005

Inflation, as it is commonly known, has not always been the normal state of affairs. As James Grant, editor of Grant’s Interest Rate Observer, has pointed out, “From George Washington to the A-bomb, prices alternately rose and fell...As Alan Greenspan himself has pointed out, the American price level registered little net change between 1800 and 1929.” The basic nature of our money assures it will lose value over time. It can be created nearly at will and it is left in the hands of government officials, who routinely spend more than they have. In such a state, a nation’s paper money has a shelf life like a fresh egg or a jar of mayonnaise. It doesn’t last forever. Unlike these foodstuffs, paper money has no printed expiration date. According to economist Felix Somary, who experienced firsthand the devastating monetary inflations that destroyed the German mark in the 1920s, it took Rome four centuries to destroy its currency. Germany and Austria reached that point in just nine years, ending in the famous hyperinflations of the 1920s, and before that, Russia managed it in only five years. Everyone’s experience is different, but our collective experiments in paper money have not created a currency that increases in value over time. The life and value of a monetary unit has less to do with the wealth of a country than with the simple facts of supply and demand. As the great Austrian economist Ludwig von Mises noted, “Even the richest country can have a bad currency and the poorest country a good one.” The Fall of the Dollar: The Pound

For some interesting insights into the flight of the dollar, I want to share some thoughts I recently read from Justin Mamis, author of several investment books and a longtime market adviser. Mamis was born during one of the great turning moments in stock market history – 929. Mamis talks about the experience of the dollar’s immediate predecessor as cock of the walk, the old British pound. The pound, the currency of choice for a long stretch of time before the American dollar, was the product of the British Empire. Imperial ambition and sound money, though, never mix, and the pound probably peaked somewhere before World War I. After World War II, Mamis notes, “The Empire peeled off like an onion into a grab bag of different independent countries...the Bretton Woods Agreement of July 1944 signaled the end of the British pound as the world’s reserve currency.” The British pound continued to weaken against the dollar over the ensuing years. Mamis notes: “Weakness, in a long-term sense, begets weakness, like the flaws in an incestuous genetic pool.” The dollar has been the world’s reserve currency, or currency of choice, since at least Bretton Woods. From this short collection of historical vignettes, we can make one safe assumption. As Mamis puts it, the status of being a “reserve currency is not a permanent appointment.” To pinpoint when the dollar’s status as the world’s currency of choice will end is an impossible task. These things tend to unfold over many years, and there does not appear to be any immediate contender

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ready to ascend to the throne. But that should not deter the investor from making the basic assumption that the dollar of a decade hence will buy less than a dollar of today. I’ll include one last quote from Mamis, who advises us not to expect long-term trends to always be immediately apparent or obvious. “We must warn not to turn the next century’s global changes into something that has to be evident in its entirety all at once – or else denied. Nor will our concerns be proven instantly ‘wrong’ because the dollar finally has its oversold rebound.” Well said. The Fall of the Dollar: The Need For Sound Investing

This situation – the whittling away of the dollar – creates the need for sound investing. Basically, investors look to survive the ravages of inflation (and taxes – of which inflation is a most insidious type). Like the biting winds of nature that sculpt rock and carve stone, inflation and taxes will grind the greatest piles of fortune to dust over time. Preserving it, making it grow – essentially investing well – is the investor’s difficult art. So should you put your money in euros, perhaps, or some other foreign currency? The euro may strengthen against the dollar, but I think the dollar and the euro share the same fate, like the passenger pigeon and the Carolina parakeet. The road to extinction may be of indeterminable length, but the final destination of that road is not in doubt. The same can be said of all our paper currencies, be they yen or pounds, pesos or ringgit. All of them are on the same slide. But there are other ways to beat the decaying paper currencies that make up so much of our financial wealth. The idea of tangible asset investing, investing in stuff that has survived and prospered in a variety of conditions, should meet the challenge in the years ahead. Often, I’ve looked at some great fortunes and drawn insights and lessons from those experiences. Recently, I came across an old book, originally published in 1907 and written by Gustavus Myers, called History of the Great American Fortunes. It is a mammoth study of American wealth over the previous 200 years and deals with fortunes in shipping, land, fisheries, railroads, trusts, banks and other industries. I’ve only read a couple of the opening chapters, which happen to cover the shipping and land fortunes. But some of Myers’ observations got me thinking about the durability of some forms of investment over others. Shipping and land offer interesting contrasts. Myers writes about the great fortunes of the shippers. “Enormous as were the profits of the shipping business, they were immediate only. In the contest for wealth, it was inevitable that the shipper should fall behind. Their business was one of peculiar uncertainties. The hazards of the sea, the fluctuations and vicissitudes of trade, the severe competition of the times exposed their traffic to many mutations.” In other words, shippers’ fortunes came and went, like the late-1990s boom in tech stocks, the 1960s conglomerate boom or any number of investment crazes of years gone by. Many shippers were aware of the vicissitudes of their business and often invested some piece of their fortunes in land, banks, factories, turnpikes, insurance companies and railroads. Those that didn’t didn’t last. Contrast this with Myers’ observations on those fortunes built on land, primarily in commercial cities of importance:

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The Fall of the Dollar: Fortunes Built On Land

Fortunes built on land in the cities were indued with a mathematical certainty and perpetuity. A lot of the tendencies and currents of the times favored the building up of an aristocracy based on the ownership of city property. With the progressing growth of commerce and population, with immigration continuing ...every year witnessing a keener pressure for occupation of land, the value of this latter was certain to increase. An investment in land was an investment in something that was real and often increased in value despite what its owners did with it. It could be titled and its ownership made certain – unable to be copied by a competitor. One more quote from Myers, who draws this interesting conclusion: A more formidable system for the foundation and amplification of lasting fortunes has not existed...And that it is pre-eminently so is seen in the fact that the large shipping fortunes of a century ago are now generally completely forgotten, as the methods then used are obsolete. But the land has remained land; and the fortunes then incubated have grown into mighty powers of great national, and some of considerable international, importance. Now, I’m not concluding that land is a new surefire investment bound to make us all rich in time. But the best characteristics of land provide insight into what makes a resilient investment, able to hold its value in a variety of market conditions. Land has some characteristics, such as its durability, relatively fixed supply and timeless qualities that have often made wonderful investments and formed the keystone to later fortunes. To survive and prosper in the years ahead while the dollar crumbles, look for real assets that share these qualities. Regards, Chris Mayer

Capital & Crisis

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REAL HEROES by Bill Bonner ––––––––––––––––––––––––––––––––––––––––––––– January 5, 2007

And one was a soldier, and one was a priest, And one was slain by a fierce wild beast... they were all of them saints of God; and I mean, God help me to be one too. - A hymn we used to sing in church Life is not like school. In real life you never know when the tests will come...or what form they will take. They come upon you unannounced and unlabeled. You don’t even know when you are being tested. We watched a scene in an immigration line recently. From near the end of the line, we saw a very pregnant woman – she looked as though she might have been from the Middle East – with two small children, one in a stroller, the other tugging at her hand. The poor woman was having a time of it. The line advanced very slowly. The children were tired. She had more than she could handle. We hoped an agent would step forward and take her to the head of the line. But none came. Nor did anyone in the line help. It wasn’t clear how they could help. DO NOT USE CELL PHONES, said the posters. DO NOT TAKE PHOTOS. Could the woman leave the line? People were timid, a bit embarrassed. Most merely looked away. Finally, a young man with a bright smile and blond dreadlocks, near the front, signaled to her to come ahead and take his place. Another time on the subway in Paris a plump woman of about sixty years of age came into the car. A man has to be careful about giving up his seat to a woman. He never knows whether she is old enough to appreciate the gesture. Unless the old girl is ready to fall down, she is likely to be insulted at being taken for an older woman. Besides, people don’t want to give up their seats. So they tend to keep their heads down, pretending not to notice. After only a moment of hesitation a young man got up and offered her a seat, which she gratefully accepted. Neither of these small acts of kindness will make the history books. We call attention to them today not for their grandeur, but for the grace of them. Today, we do not pause in sorrow and silence over the depths of darkness in man; no, we rejoice in his rare moments of dignity and courage. If life were like school, George W. Bush would have known that Iraq would test him and his administration. He might have done a little study before getting involved in the area. He could have begun, we would suggest, by reading our own book – The Essential Classics - from Les Belles Lettres available from Amazon.com. There, he could have begun his research with the life of one of the world’s most successful men of action – Alexander the Great. Alexander conquered the entire ‘known’ world. But even Alexander couldn’t survive Iraq. He died in Babylon in 323 AD.

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Or maybe he could have boned up on the history of the greatest empire ever – Rome. He could have read about Emperor Septimius Severus’s attack on Ctesiphon, near present day Bagdad. At least, Severus had a plan. He captured 100,000 prisoners – whom he sold into slavery. Back then empire was not only a source of glory...but of profits. But glory is our subject today, not profits. We wonder who gets it and who deserves it. Generally, we note, they are not the same people. In retrospect, George W. Bush might have spent a few hours studying more recent conflicts between Christendom and the Muslim world. Just as Lyndon Johnson could have taken a little insight from France’s war in Indo-China (later known as Vietnam)...America’s current president surely could have learned something from reading a little about France’s war in Algeria. The French are always ahead of us; no military campaign or political project is so stupid that the French haven’t already tried it. It was after World War II that an independent movement in Algeria took hold. France sent its brave young men to put down the uprising, but after fighting for a few years, the French had had enough. They could win the battles, but they could never win ‘hearts and minds’ by killing Algerians. Only when the French had withdrawn, did the real killing begin and the real heroes appear. Hundreds of thousands of local Algerian soldiers had fought next to the French. These ‘Harkis’ had been loyal to the French for many years. But when the time came for the French to leave, the Harkis were to be left behind. What awaited them was vengeance. An article in Le Point from February 2002 noted that were 200,000 Muslim Harkis who had fought with the French. And after the French left, approximately 50,000 of them – including many entire families as well as civilian authorities that had cooperated with the French – were murdered. Whether the French saw it coming or not, we don’t know. But a few officers realized that their men – if they were left behind – would be massacred. The killing was often barbaric. Victims were crucified. Their limbs were torn off. They were butchered, mutilated...tortured in ways that plumb the darkness of the human spirit. A mayor was buried up to his neck; honey was smeared on his head. He suffered hours of agony, being eaten by flies and ants, before finally passing out and dying. Some of the French military officers were outraged that they had been ordered to abandon their men under these circumstances. Brave men follow orders. But braver ones have the courage to disobey. We recall our neighbor, Francois, who fought in Algeria telling us: “One colonel didn’t want to abandon his men. He marched them up to Oran where the ships were taking the French back to France. He went up to the ship’s captain and demanded that he load on his troops – who were not French, but local Harkis...you know, Arabs. The captain of the ship said he was not authorized to take the Harkis. The colonel pulled out his pistol and put it up to the captain’s head. ‘Take them all, or I’ll blow your brains out,’ he said. He got them back to France. But I think the colonel was arrested. And the Harkis were sent back.” Still a few officers – such as Daniel Abolivier – were able to organize an underground railway to get the Harkis to France. A few survived. The others were lucky if their throats were cut. George W. Bush likes to be thought of as a man of action. But there is a time for thought...and a time for action. A married man who has fallen in love with his secretary, for example, has already gone too far.

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He should have thought about it earlier. And when George W. Bush decided to invade Iraq, too, a crucial opportunity for reflection, for study and for preparation was missed. Now, he has to wonder what will happen to his own Harkis when he leaves. In the Vietnam War, Johnson and McNamara sent hundreds of thousands of brave young men on a fool’s errand. More than 58,000 of them didn’t make it back alive. They all got medals and were all called ‘heroes’ by their families and by the politicians. But the rest of the nation didn’t quite believe it. Those who served in Vietnam were certainly brave...a man has to be brave to face death. John Kerry certainly wanted voters to see him as a war hero when he showed off his medals. But the medals sagged a bit when they were hung around John Kerry’s neck. Dying is easy for brave men. It is living that is hard...living with dignity and courage. It doesn’t take a lot of courage to give up a seat on the subway...but there are times when the tests are more important and the stakes are much higher. When asked to serve his country in Vietnam, Muhammed Ali famously said “No”. The media branded him a coward. But Ali faced no threat in going into the army in 1967. It had already offered him a cushy job teaching boxing and acting as a PR man for the Pentagon. The war in Vietnam was already very unpopular. Ali could have served his time in relative safety and luxury...making appearances for the cameras and the clowns...talking up the war effort. On the other hand, if he didn’t go...the punishment would be severe. He would be stripped of his boxing title. He wouldn’t be able to box; he would have a hard time earning a living, let alone paying the legal fees that would be needed to keep him out of jail. Plus, he would be called a traitor. But Ali still said “No”. It was against his Black Muslim religion. And he added: “I ain’t got nothin’ against them Viet Cong...” and “No Viet-Cong ever called me a nigger.” No medals were pinned on Muhammed Ali. They give you medals for helping the politicians with their public spectacles. They don’t give you medals for standing in their way. Sophie Scholl and her brother stood up to Adolph Hitler. They were among the few in Germany to protest the Nazi’s campaign of conquest and extermination. They were hanged for it. Most brave Germans did their duty and won their medals. In his book Ordinary Men, Christopher Browning tells the story of the Hamburg Policemen who were sent to Poland to round up and murder Jews. At first, the men were reluctant to carry out their mission. Some were sickened by it. And at least one man refused – Lieutenant Heinz Buchmann. He announced that “in no case would he participate in such action, in which defenseless women and children are shot.” The others considered him ‘too weak’ to do the work that had been given them. They saw him as a shirker...and a coward. We don’t know what happened to Lieutenant Buchmann. The record says only that he was ‘re-assigned.’ We only regret that there weren’t more like him. Of course, not all heroes are in the military. On January 13, 1982 at 3:59 in the afternoon, Air Florida Flight 90 took off in heavy snow from Washington’s National airport, now known as Reagan National Airport. The pilots were not accustomed to snow. One had failed a flight simulator test earlier in the year. The plane’s wings had been de-iced. But there was a long line waiting to take off from the airport that day. The wings should have been de-iced again, but the pilots decided not to spend the time. Instead, they took off. Heavily. A few minutes later,

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the black box recorded this brief conversation in the cockpit: “Stalling...we’re falling...” “Larry, we’re going down Larry.” “I know it.” Silence. Where they were going down was right onto Washington’s busiest highway, U.S. 395, and just at the 14th Street Bridge. The plane smashed into the bridge and bounced into the Potomac River. Most of the crew and passengers were killed immediately, but seven survived and were thrown into the river...then, icy cold. They couldn’t last long – a fact that must have been obvious to Roger Olian, who jumped from his truck, into the water to try to save them. Unfortunately, Olian wouldn’t last very long either. He had almost stopped breathing and turned blue by the time a helicopter came to his rescue. It was a bad day in Washington. The snowstorm had caused a train wreck too. And traffic was gridlocked. Emergency services had a very hard time getting to the scene. Helicopters, trying to operate in the heavy snow, were having a rough time too. People on the bridge saw the plane go down. They saw the survivors in the water. But what could they do? They fashioned a line out of scarves and belts and tried to get it to those in the water...but it didn’t work. Olian jumped in. But that didn’t work either. Finally, a helicopter arrived...and began to pluck the passengers out of the water. But by that time, the survivors were barely alert. Then, one of them took the lifeline, wrapped it around himself, and was pulled to safety. Coming back for other passengers, the line came to Arland D. Williams, Jr. Arland had not expected a test that day. But he passed with glory. Instead of taking the line himself, he gave it to flight attendant Kelly Duncan. Then, on the next trip, he passed it to Joe Stiley, who was severely injured...and to Priscilla Tirada and Patricia Felch. Ms. Tirada’s husband and baby had just been killed in the crash. She was so hysterical she fell back into the water...too weak to hold onto the line. And here, another hero appeared. Lenny Skutnik took off his coat and boots and swam out to help her. The two were rescued. That left the sixth passenger, Arland D. Williams Jr., still in the river. The helicopter rushed back to get him. But he had been in the freezing water too long. When the helicopter got there...he had slipped into the river’s icy embrace forever. Skutnik, Olian, and Williams (posthumously) were given the Coast Guard’s Gold Lifesaving medal. Bill Bonner

The Daily Reckoning

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ALPHAS, BETAS, SCAMPS AND SCALAWAGS by Bill Bonner ––––––––––––––––––––––––––––––––––––––––––––– March 9, 2007

Probably the greatest disappointment to a modern man over the age of 50 comes when he looks in the mirror. We say that not as a man who has just had his vacation in a bathing suit, but as one who has spent the last couple of days reading the financial press. The two are alike in that every time you look, the picture seems to get worse. A brief summary of the subprime industry’s business model: There is a market, lenders noticed, of people who cannot afford houses and do not qualify for the credit necessary to buy them. On the surface of it, lending money to these people does not seem like a business you would want to take up. But ‘subprime’ borrowers could be decent fish, the sharks reasoned, as long as they could make the mortgage payments. The quants did the math. The strategists looked ahead. Even if the occasional client couldn’t pay up, they had the rising housing market to lift the value of their collateral. And so, a new ‘go-go’ financial industry got going...and pretty soon, its hustlers and entrepreneurs – like the whiz kids of the dotcoms who preceded them – were driving Ferraris and drinking Chateau Petrus. The Orange County (California) Register:

“For Kal Elsayed, a former executive at New Century Financial, a large lender based in Irvine, driving a red convertible Ferrari to work at a company that provided home loans to people with low incomes and weak credit might have appeared ostentatious, he now acknowledges. But, he says, that was nothing compared with the private jets that executives at other companies had. “‘You just lost touch with reality after a while because that’s just how people were living,’ said Mr. Elsayed, 42, who spent nine years at New Century before leaving to start his own mortgage firm in 2005. ‘We made so much money you couldn’t believe it. And you didn’t have to do anything. You just had to show up.’” It was this last line that caught our attention and triggered our disappointment. It reminded us how each generation of geniuses are later unmasked as frauds and fools. It reminded us too of what weak-minded simpletons we humans are; we are always falling for our own line of guff. Modern Homo Sapiens Economicus believes in capitalism. He believes in it as he once believed in the Holy Trinity or the Virgin birth – as dogma. And so, he takes up its tenets and excesses without question or arriere pensees. And, he makes as big a mess of it as his ancestors did of the Crusades. This is as true of the lumpen as it is of the masters of the universe. Recall Henry Paulson’s soothing words: “Credit issues are there, but they are contained,” the U.S. Treasury Secretary said to reporters in Tokyo during a four-day tour of Asia. The U.S. financial sector is healthy and most institutions won’t feel “a big impact.”

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But a big impact is just what institutions feel – after they have flapped their wings and taken to the air. Typically, they come down with a thud. The geniuses packaged, bought and sold subprime debt right until they heard the crashing noises. They believed the credits were good as long as homeowners could make their payments. And they saw no reason why homeowners wouldn’t be able to make their payments as long as they had jobs. That was their line of guff; and they believed it. In a world of full employment, there was no reason for the mortgages to go bad – in theory. But theories arise as needed when there is a sale to be made. The theory was that low interest rates were giving a whole new group of borrowers access to credit. The reality was that, what made credit available to un-creditworthy borrowers, was the kind of corruption that wishful thinking hides, but that mirrors...and history...reveal. “What drove the housing-led cycle was not as much the cost of credit,” notes Merrill Lynch’s David Rosenberg, “but rather the widespread availability of credit – irrespective of your FICO score [a measure of your ability to repay]...only a third of the parabolic run-up in the home price-to-rent ratio was due to low interest rates. The other two-thirds reflected other non-price influences, such as lax credit guidelines by the banks and mortgage brokers.” Now, despite 4.6% unemployment and 4.7% yield on 10-year Treasury notes...the subprime lending business is crashing and burning. From Orange County comes news that the aforementioned New Century Financial is trading below $5 a share...a precipitous fall from its high of $66 in December of 2004. At today’s price, in theory, the Golden State lender must be the bargain of a century, with a dividend yield of 167%. But, again, the reality is different: The news report also tells us that the company may be forced into bankruptcy. While the subprime lenders are being pulled from the wreckage, the superprime borrowers are still flying high. In theory, hedge funds charge extraordinary fees for extraordinary performance – 2% of capital and 20% of performance. For what? To return to the Greek alphabet, for helping investors get ‘alpha’ – a rate of return above and beyond ‘beta,’ which is what the general market produces. Warren Buffett, probably the greatest investor who ever lived, says the whole idea is “grotesque.” In last week’s letter to shareholders, he explains that you could invest in his “hedge fund,” otherwise known as Berkshire Hathaway, and pay no management fees at all. The compounded average annual gain of Berkshire Hathaway from 1965 to 2006 is 21.4%. What does the average hedge fund get? In 2006, hedge funds produced a 14% return, almost doubling the 7.6% of 2005 and better than the 10% they did in 2004. Over the longer run, hedge funds show an annual return of about 7%. Mark Gilbert, summing up for Bloomberg News, concludes that hedge funds, “levy outsized fees on the pretense of generating tons of clever alpha, when they are really just seizing the beta available to anyone.” In other words, in practice, the hedge fund managers, like the dotcom entrepreneurs and the subprime lenders, are not really geniuses at all. They make their money just by showing up...just like everyone else. And they get the same rate of return. Or worse. Many funds and hedge funds jumped into Japan after that market went up 40% in 2005. The following year, 2006, was disappointing. The Nikkei Dow rose barely 4%. How did the hedge funds do? As Merryn Somerset Webb reported last week, “far from proving their ability to make absolute returns in any market

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conditions, [hedge funds] did particularly badly; they all fell between 5% and 20% over the year.” Subprime lenders did not hedge the risk inherent in lending to weak borrowers. Instead, they sought it out and leveraged it up. Hedge funds seem to have done the same thing – reaching out a little too far in order to grab a few extra points of yield. Now, we wonder who owns the $23 billion of New Century Financial debt...and who owns the rest of the debt in the subprime area? We wonder too, who owned the $2.5 trillion worth of equity value that disappeared last week? Surely, there’s some more ‘big impact’ lurking out there...still waiting to hit someone. We look in the mirror and hope it isn’t us. Regards, Bill Bonner

The Daily Reckoning

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STANDBY COMMODITIES by Kevin Kerr ––––––––––––––––––––––––––––––––––––––––––––– April 19, 2007

A year ago, the average choice grading steer fetched around $85.50 per cwt to the meat packer. (The abbreviation “cwt” stands for hundredweight. Hundredweight simply means “per 100 pounds specified weight.” It is always qualified as the type of weight used for cattle.) Two weeks ago, the average was $94.44 cwt, an increase of $3.32 over the previous week. Translation: Prices for cattle in the cash market are climbing fast and they will most likely continue to do so. Demand is the driver. As more countries reopen their markets to U.S. beef, demand will increase. Meat packer margins are hovering at break-even levels. Right now, tight cattle supplies and plentiful inexpensive feed will likely result in a firming up of the cattle price. This holds true especially for cattle producers and feedlot operators. Then, of course, there’s avian flu. If one case of bird flu migrates to the United States and infects one person, people will swear off poultry and head right to the meat aisle in the supermarket. In reality bird flu is not actually spread by eating poultry, but often in trading perception is reality and just the threat of bird flu is enough to get the general public to shun poultry. Even though eating it isn’t the cause of the illness, the general public won’t differentiate. And who would want to bite into a chicken of death when they could opt for a nice juicy steak? What mad cow? Typically, market participants have a short memory, so it’s important to act on fear while it’s still in full swing. The cattle and meat markets in general are the butt of many jokes in the investment world – Hillary Clinton’s infamous cattle trade comes to mind, as does the aforementioned question about pork bellies. Truth be told, the meats are a good agricultural market with solid fundamentals and can be a great learning market for the novice trader – just make sure no one knows you’re a novice. In 2006 I carried October live cattle positions and made some very good profits on the 86 call options, and later on the 88 call options. The cattle market is a volatile one and relatively illiquid, so it can be a difficult market if you’re just starting out. You may want to avoid it until you get some experience. The coffee, sugar, and cocoa markets are near and dear to my heart. These three commodities are also known as the tropicals, because most grow in the tropics, or softs, I guess because they’re all soft in texture. But whatever you want to call them, these are some of the best performing and least understood or talked about markets. I spent much of my early career running between the pits of the coffee, cocoa, OJ, and sugar markets, and let me tell you, these are markets that trade like no others. Gold and oil may get the lion’s share of the sound bites and headlines, but if excitement is what you’re looking for, these markets have it. Sugar, for example, is one of my favorites. It is growing exponentially in demand as a result of ethanol production and being widely used in foodstuffs; meanwhile the supply is shrinking due to factors such as European subsidies being curtailed. Sugar is likely to double in a couple of years, in my opinion, and the writing is already on the wall. Much the same can be said for markets like cocoa and coffee. Worldwide demand is sucking up supplies faster then these commodities can be harvested. I know the

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coffee market well – very well, in fact. It’s one of the first markets I traded when I started out in commodities 18 years ago. It’s also one of the fastest-moving and most volatile markets, which means it’s loaded with opportunity for you to make a lot of money. This is a good example for talking about one of the best features of trading commodities: the ability to short a market just as easily as going long. That’s correct – unlike equities, you can short commodities futures just as easily as going long. A market like coffee is particularly important because of its volatility but also because a new Starbucks pops up on every corner from Maine to China and every farmer who could possibly grow coffee beans is doing so, resulting in a glut of beans on the market. Even Juan Valdez, from the TV commercials, hung up his sombrero in 2006. Coffee is thus one of those markets you can play from both directions to get maximum profits – something futures allow you to do, with astounding results. Cotton gave this maniac trader his start. My first full seat was on the New York Cotton Exchange (now the New York Board of Trade). My badge was 8015 QUEST, as in Jonny Quest. (I was young and had blonde hair and a dog named Bandit; when the guys on the floor found out I had done cartoon voiceovers as a kid, the name just stuck. Everyone gets a nickname down there, and it usually isn’t something you’d choose for yourself.) In any case, cotton is an “old boy” market, much like cattle or the grains – not old as in stale, but old in that it has been around a very long time and the people who trade it have been doing it a very, very long time. Cotton is a great market to trade, but you must understand the fundamentals at work and the differences between old crop and new crop. This simply means that two different cotton crops are produced each year in cotton, and you must make sure you know which crop you’re looking at and then make your decisions based on that. Cotton is one market that’s crucial not to underestimate and, much like the ocean, never turn your back on. Trust me, I worked in there for a number of years. Right next door is another very active market, especially in the winter and during hurricane season: orange juice. Orange juice is a perfect market for learning about fundamentals the hard way. Many of you have seen the movie Trading Places, with Eddie Murphy and Dan Aykroyd. If you haven’t seen it, do – it will give you a good laugh. The movie was filmed on the old World Trade Center trading floor and was about trading OJ, but the reality stops there (or does it?). Actually, with tongue in cheek, I can say that it’s probably a fair depiction of the old trading pits. Today, however, the OJ market is tightly controlled by supply and demand and is certainly ruled by weather factors – not just winter hard freezes, either. It may surprise you to know that hurricanes in Florida are the biggest factor influencing this market, not only before the hurricane hits but after, too. The main concern is citrus canker; after the winds and rain die down, this fungus can develop on the crop. Fundamental information like this is important to know and take into consideration when initiating a position. Every market is different, so you must study the fundamentals for all of them. For example, you must understand what soybean meal is used for as opposed to soybean oil. Soybeans are used for biofuel, among many other things, so nowadays soybean prices more closely parallel those of crude oil and heating oil than those of the regular crop reports. Keep in mind that these markets move on the basis of supply and demand. Right now, the demand for soybeans is picking up in a big way due to biofuel consumption, which in turn relates to how high heating oil prices are. It’s not hard to connect the dots to identify what affects a specific commodity, but sometimes you’ve got to do a little research first. Biofuel is used primarily for home heating, and as ethanol is derived

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from corn, biofuel is derived from soy. The bottom line is that you must know, inside and out, the basics about whatever commodity you choose to trade, whether it’s rough rice or natural gas. More importantly, you need to know new factors that may affect a particular market – and these can change. Regards, Kevin Kerr

Outstanding Investments

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ALAS, THE DEMISE OF THE DOLLAR by Addison Wiggin ––––––––––––––––––––––––––––––––––––––––––––– May 5, 2007

The global economy is changing, and the U.S. dollar is on the front lines of change. When we take a look at history, we see how past events have affected everything. The Black Death created a devastating labor shortage throughout Europe for decades. Christopher Columbus’ voyages turned trade upside down for hundreds of years. The Industrial Revolution moved economic power in ways that continue to affect economic balances to this day. And now we face another great shift, away from the U.S. dominance of world markets and toward new leaders – China and India. The economic reality – a type of geography – is changing. As a consequence, real estate speculation in New York, Chicago, and Los Angeles may be replaced with more global interest in the new real estate markets – in Beijing, Shanghai, and Bombay. Who knows? We can only anticipate how changes will occur based on what we observe today. Does this mean the age of America is ending? No, it simply means that economic muscle will be flexed by someone else in the future. This is a trend. And like all trends, they are more easily viewed in historical perspective but harder to judge from their midst. When we look at trends in dollar values, we can observe that incomes have not declined. That’s great. But we also see that prices have risen faster than incomes. So with decreased buying power (caused by this disparity) we have seen a decline in income in terms of what really counts. It takes more dollars to buy the same thing (in other words, prices are higher) but incomes have not risen to meet that price inflation. That’s what happens when the value of the dollar declines. Economic history is a history of bubbles – and of bursts. The great disservice being done to Americans by the financial media is that they are not being offered the opportunity to learn from what is going on. They are losing buying power, but apart from a few painful spikes at the gas pumps, it’s invisible. In the Great Dollar Standard Era, the problem is global. While there is, of course, more to it than just the value of the U.S. dollar, here is how it works: 1. The dollar’s value falls due to Fed policy, liberal credit, and artificially low interest rates. 2. Eventually, we cannot afford to buy as many foreign goods. 3. Foreign manufacturers, unable to sell at previous levels, have excess inventory, which causes an inflationary outcome. 4. Foreign governments, in an effort to counteract this inflation, blame the fallen dollar for the problem and begin moving out of U.S. instruments. 5. As debt returns to the United States, our system is unable to absorb it. This creates more severe recession at home. The whole thing is connected. This is similar to what happened worldwide at the end of the 1920s.The worldwide depression had numerous aspects, but most notable among them were two things: a huge

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transfer of funds from World War I reparations, and far too much credit that went beyond the borrowers’ ability to repay. All of that credit – essentially, funny money – also creates a fake demand. We see the effects of this policy in housing as severely as anywhere. The whole mess is traced back to the origin – a Fed policy encouraging debt spending as a means to artificially create the appearance of productivity. This Fed policy has included four aspects: 1. The Fed has lent money below inflation. Fed lending rates have been far below inflation (even as measured by the consumer price index, not to mention any real inflationary measurements). In a very real sense, the Fed has lost money on these loans. When inflation is higher than the lending rate, it is a loss. Just as a business cannot stay open when it sells goods below cost, the Fed cannot continue to hold the view that it isn’t real money. The point is, the money lent out at bargain rates is real credit, and that is corrupted when it is given away cheaply. 2. The low interest rates have created the mortgage bubble without any corresponding investment. It is basic: if you borrow money to invest in productivity (new plants and equipment, for example) it is a profitable use of money. But those low interest rates have gone, instead, into cheap long-term mortgages. Current homeowners have refinanced, and many first-time buyers have gotten into the market because low rates make housing affordable. 3. The mortgage bubble has inflated the housing market in an exaggerated fashion, creating the illusion of equity. All of that cheap money has created two troubling changes in housing. First is higher demand for owner-occupied housing based on the low cost of borrowed money rather than on any real market forces. Second is the resulting equity buildup from rapid expansion of market value in residential property. But it is as fake as the low interest rates. Like all pyramid schemes, the whole thing will eventually crumble under its own weight. We do not have an endless supply of new home ownership demand; quite the contrary. The baby boomers mostly own homes already, and a smaller population of people coming into home ownership age will ultimately result in an oversupply of housing stock. Once the mortgage bubble bursts, we can expect to see several consequences: Defaults on existing loans. As rates on variable mortgages begin to rise right up to their cap rates, we’ll see many of those marginal loans go into default. Many Americans are barely able to afford the mortgage payments they are making based on low interest qualification. But as the Fed finally faces reality and allows interest rates to rise, those variable increases will kick in as well. Many existing loans will be defaulted as a result. Reduced market value from oversupply of housing. The oversupply in building will become obvious, but suddenly. At some point, when the bubble bursts, everyone will realize that too many homes were built too quickly, and the anticipated demand simply isn’t there. The result: those skyrocketing market values will disappear. Abandonment of no-equity properties. The reduced market value in homes is not going to be limited to a simple supply and demand cyclical change. For investors, reduced demand and flat or falling prices may be viewed as a cyclical and natural effect. But when the supplyand-demand cycle has been manipulated through interest rate policy, we have to expect a more wrenching effect. For those who enter into the housing market when prices are inflated, the day arrives when they realize that real equity is below zero. There remains no incentive to continue making payments, notably when lenders are raising rates and when the dollar’s buying power is tumbling. In such a severe condition, marginal

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buyers are going to simply walk away from their properties. Why stay when there is no equity – or worse, minus equity? Secondary market fallout from these changes. Where does all of that mortgage debt end up? It isn’t held by your local bank or savings and loan. It all gets sold to Ginnie Mae, Freddie Mac, and other mortgage pools, who then package it up and sell it on to investors, many of them from Europe and Asia. Imagine how those pools will perform when the foreclosure rate rises and when – at the same time – market values fall.A high rate of foreclosures in an overbuilt market spells disaster in the housing sector. While a normal supply and demand cycle may last three to five years on average, this downturn could be severe, going much longer into the future.The actual length of the housing recession would depend on how decisively the Fed will be willing to act and to fix the problem. 4. The lack of investment and a flat manufacturing trend are damaging the U.S. competitive position in the world market. Imagine an economic situation in which enterprising homeowners refinanced their homes when rates fell, invested the money in small business expansion, and created an internationally competitive economic climate. Well, this is the rosy picture the Fed hopes will eventually emerge from its monetary policies. By artificially lowering interest rates and enabling homeowners to get at their equity, the idea is that on a broad range of economic trends (housing, business investment, savings, etc.) there will be a strong growth spurt, an economic recovery that will return the United States to its leading position. But the lack of investment is doing great damage. The whole thing is credit-based, starting with the Fed losing on below-inflation loans and ending up with credit based spending but no real productivity. It appears that Fed policy has been premised on the idea that lower interest rates bring down inflation. Yet there is no evidence of that in economic history. It has always been an effective policy to raise rates to slow down inflation, just as lead rods are moved into the radioactive core of a reactor to cool down the chain reaction. Higher rates put a damper on spending. This has been recognized widely, so the Fed policy – based on the idea that lower rates are “good for the economy” – is baseless. In fact, it is damaging. The housing market and its mortgage bubble are most likely to be the first victims of this policy, and the most visible. Regards, Addison Wiggin

The Daily Reckoning

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An Economic and Social Epidemic by Christopher Hancock ––––––––––––––––––––––––––––––––––––––––––––– January 3, 2008

On Aug. 1, 2007, every child’s worst nightmare came true. At 6:05 p.m., a school bus transporting 60 children from the Waite House Neighborhood Center day camp clung precariously to a mangled steel guardrail on the I-35W Mississippi River bridge. Thankfully, the children and driver were spared. Many others, however, were not. When the bridge collapsed, dozens of cars, tons of concrete and twisted steel beams plummeted 60 feet to the riverbed below. Thirteen died. Approximately 100 more were injured. “This is a catastrophe of historic proportions,” said Minnesota Gov. Tim Pawlenty. Prior to the collapse, every year as far back as 1990, federal inspectors had assigned a “structurally deficient” rating to the I-35W bridge. Yet for 17 years, the structure stayed open. Currently, 73,518 of America’s 594,709 bridges – roughly 12% – share this “structurally deficient” classification. But like the I-35W bridge, they too stay open. This tragic disaster represents an economic and social epidemic quickly spreading throughout the United States today. American infrastructure keeps crumbling. Collapsing bridges, exploding steam pipes and Louisiana levees... And we fear these failures simply epitomize the tip of the proverbial iceberg. Poorly degraded U.S. roads, highways and interstates cost American taxpayers $67 billion per year, $5.6 billion per month, $186 million per day, $7.8 million per hour or $130,000 every minute – not for reconstruction, mind you – but for patchwork and cosmetic touch-ups. The economic outlook gets worse. We’ve mentioned these stats before. But they bear repeating. The American Society of Civil Engineers issued a grave warning. The United States has fallen so far behind in maintaining public infrastructure – roads, bridges, schools, dams – that it would take more than $1.5 trillion over five years just to bring it back up to standards. The Iraq and Afghanistan wars have cost the United States $474 billion to date. In other words, public infrastructure maintenance alone will cost roughly three times as much as six years of war. Going forward, I believe America needs an even greater commitment to nation-building. Except this time, America needs to rebuild itself. My interest in infrastructure started at an early age, a deeply ingrained, natural byproduct of my upbringing. You see, my father, the former mayor of a small West Virginia town, worked to rebuild our own community’s infrastructure. For better or worse, he constantly dragged me along. My friends worked on farms. I spent my afternoons and Saturday mornings searching for water leaks. They rode John Deere tractors. I rode Caterpillar end loaders.

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Anyhow, around 1982, a rather substantial water leak on the south side of town brought out the picks and shovels. These calls were never routine. Municipal water leaks are tricky business. You see, water leaks rarely surface in close proximity to the broken pipe itself. More often than not, concrete roads and sidewalks force water to trickle way down the line in search of more porous escape routes. Some leaks, in fact, never surface. Meaning, you just don’t dig a big hole beneath a percolating puddle. Maintenance crews check various meters and pressure gauges, trying to pinpoint their proverbial ground zero. It serves to reason. Digging up roads isn’t cheap. Cities (and especially small towns) certainly don’t cut into roads unless they’re pretty confident they’ve located a problem. Well, on that crisp spring afternoon, my dad and his crew felt confident they found their leak. And sure enough, 4 feet later, they were right. The broken pipe was no surprise. The fact that hollowed-out logs served as pipe certainly turned some heads, though. Hollowed-out tree trunks acted as the earliest means for either water or sewage conveyance. Eventually, wood construction gave way to a more durable material. In fact, logs gave way to lead. According to Marc Edwards, a civil engineering professor at Virginia Tech, the U.S. has over 5 million lead pipes in its water infrastructure today. Edwards said: “Lead is a good-quality plumbing material, from the perspective that it lasts a long time and it does not break. Unfortunately, the little that can leach from those pipes into the water is sufficient to pose a serious health concern. More recently, the issue we’ve been discovering is pieces of lead from these pipes, and from lead solder, sometimes detach and, essentially, fall off into the water in pieces. This is very disconcerting, because in some cases, you can take a single glass of water, and if you’re unlucky and it has that piece of lead in it, you can get a very high dose of lead, similar to that which you could obtain by eating lead paint chips.” Edwards estimates it would cost $1 trillion to completely correct this problem. For a quick perspective, consider this: Mattel, the maker of Barney, Barbie and Dora the Explorer toys, recalled more than 9 million toys because its products were coated with lead paint. Mothers and fathers were outraged. China was vilified. Every news outlet in the country ran with the story. Zhang Shuhong, owner of Lee Der Industrial, a company that made toys for Mattel, hanged himself in a company warehouse over the incident. Lead poisoning in young children can lead to neurological problems. But as Edwards points out, “There are no laws requiring lead testing or replacement of plumbing...Only 10% of schools have tested their drinking water in recent years.” Meanwhile, our faucets continue to run. Here in Baltimore, the public school system took action. It turned to bottled water. According to a report by Sara Neufeld in the Baltimore Sun, the city Health Department discovered that 10 fountains that had passed previous tests still contained unacceptably high levels of lead. After 15 years of efforts to remove the lead in its water fountains, Charm City capitulated. So you ask, what will it take to replace these pipes?

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Actually, it will take a great deal. The reason? Partial replacement helps address the aging pipe epidemic. However, partial replacement can actually aggrandize the lead content spewing from our taps. We turn once again to Mr. Edwards: “In terms of the pipe replacement, it is true that for utilities exceeding the lead action limit, a certain percentage of their lead pipes must be ‘replaced’ every year. Or to be more precise, we actually only ‘partly replace’ the lead pipe, because in most cases, we leave the customer’s portion of the lead pipe right where it is. Recent monitoring data have shown that in many cases these ‘partial replacements’ actually cause worse lead problems than if we had done nothing at all, perhaps because of disturbance of the lead scale (e.g., lead rust) and galvanic corrosion of the lead pipe. The worsened lead leaching is known to persist for months and months in some of these cases, and no convincing data exist that the situation completely corrects itself. Replacing part of a lead service pipe is not defensible from either an economic or public health perspective. In fact, in light of what we know about this problem, I challenge someone to put forth a rational argument that speaks in favor of ‘partial replacements.’” Meaning from the way we read things, eliminating the lead risk associated with the current infrastructure system currently in place, it’s an all-or-none case scenario. Regardless of composition, these pipes are old...They’re too old. “Most of the water pipes and treatment plants in our country are over 40 years old right now. And they’re nearing the end of their useful life,” our resident expert Mr. Edwards points out. For investors, infrastructure stocks seem promising. Interminable military obligations, rising prices, a declining dollar and a credit crisis with no end in sight can’t thwart our fundamental need to fix this problem. So the question is...Will Uncle Sam start applying the Band-Aids before the next bridge begins to collapse? Regards, Christopher Hancock

Free Market Investor

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STRENGTHENING A WEAK ECONOMIC LINK by Dan Amoss ––––––––––––––––––––––––––––––––––––––––––––– January 10, 2008

High diesel prices promote investment in alternatives. It makes sense to replace diesel engines with natural gas engines in many applications. So several companies and cities are remaking their truck and bus fleets to run on natural gas. Waste Management operates a fleet of nearly 500 gas-powered trash trucks. Several cities are shifting their bus fleets to gas; 20% of all new transit buses on order have natural gas engines. This is a viable, rapidly growing industry and a few companies will benefit. Clean Energy Fuels (NASDAQ:CLNE) is one of these companies. It’s leading the charge to promote natural gas as a transportation fuel. It builds the infrastructure necessary to store and dispense natural gas at fueling stations. It’s also backed by billionaire investor T. Boone Pickens. Pickens is a great energy investor. He made his fortune investing in oil and gas. He’s often been right about the big picture in energy, spotting trends long before the crowd. Today, he expects a future in which oil and diesel prices remain very high and consumers will use natural gas to fuel many more types of vehicles. He controls 60% of Clean Energy’s stock, a stake worth $400 million. That’s a big bet, even for a billionaire. But there’s one big hurdle to his vision. Pickens knows the U.S. natural gas market as well as anyone, and he says he expects it will remain tight. Domestic gas drillers are working as fast as possible to meet demand from power plants, chemical plants, and homes. A growing fleet of natural gas-powered vehicles would propel natural gas demand to another level, spurring huge investments in liquefied natural gas (LNG). Most of the world’s natural gas reserves are located far from major population centers. When gas is too expensive to transport by pipeline, it’s called “stranded” natural gas. The only way to get stranded gas to market is to cool it until it reaches a liquid state and transport it on ships designed to carry LNG. Pickens’ vision of the future, along with continued global growth in gas demand for industrial uses, sets the stage for a massive boom in LNG infrastructure. Douglas-Westwood, a leading industry authority, forecasts investment in the LNG supply chain to grow dramatically over the next four years and beyond. The importance of natural gas extends well beyond its role as an emerging transportation fuel. It’s a vital feedstock in electricity and chemical production. Synthetic nitrogen fertilizers, which use natural gas as a feedstock, greatly enhance agricultural productivity. Other chemical compounds created from gas are the building blocks for electronics and plastics. Gas is also becoming a popular fuel for home heating. Natural gas furnaces are much more efficient than oil or electric heat furnaces. Without natural gas, many businesses would simply have to close their doors. Reliance on natural gas is a weak link in the global economy. Because of its importance, governments and industrial companies will keep favoring policies that secure reliable natural gas supplies. Since the industrialized world no longer includes just North America and Europe, many more countries have entered the competition to lock up the most promising stranded gas reserves.

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For decades, LNG has not been cost competitive with oil and coal. But continually rising oil prices are heightening the sense of urgency to develop a tradable LNG market. Also, climate change activists will keep pushing to tax, regulate, and eventually banish coal. This benefits LNG because natural gas electric power plants can replace coal plants. The financial and political incentive to develop the world’s stranded gas reserves is strong and growing. Energy companies are responding. Even Exxon Mobil (NYSE:XOM) – a consistent optimist about plentiful future oil supplies - doesn’t assume the United States has enough domestic natural gas to meet growing demand. “Energy independence [within 20 years] is just impractical, and we will have to rely on additional imports of natural gas,” says Ron Billings, Exxon’s vice president of Global LNG. The Wall Street Journal recently reported on Exxon’s plans to build a huge LNG re-gasification terminal 20 miles off the coast of New Jersey: “Exxon said it expects demand for gas to rise in North America, outstripping the ability of gas drillers and producers to keep up. Globally, it said, LNG demand could more than triple, to 500 million metric tons a year, in 2030, from 150 million metric tons a year today. About 20% of gas consumed in North America could be imported by then, up from 3% today.” Like the U.S., China produces almost enough natural gas to meet its needs. Both countries rely on LNG to satisfy the extra 2-3% of domestic demand not met by local production. China’s use of LNG is small, but it can grow dramatically. China is an underserved market. It’s consuming as much gas as its limited pipeline and LNG capacity will allow. Supply constraints and high costs force many Chinese provincial markets to use coal for electricity when they’d rather use gas. Residents of Beijing and Shanghai would certainly prefer gas-fired power plants to the coal-fired plants currently ruining air and water quality. Until now, China has constructed coal-fired plants at a maddening pace simply because they were cheap. But the health costs resulting from coal-based pollution are growing to a critical level. As Chinese wealth grows, the country will look to secure a leading position as a consumer of LNG – much in the same fashion as Japan. It may be more expensive, but China will weigh the extra cost of gas over coal against the benefit of lower health care costs and better social stability. Chinese land drillers are pushing very hard, yet still cannot satisfy demand. China’s onshore oil and gas basins are fairly mature. State-controlled oil companies have been scouring the country for decades. Offshore drilling may eventually bring more gas supplies online. A few promising underexplored basins exist in northwestern China. But the pipelines necessary to deliver this gas to coastal cities will take years and tens of billions of dollars to build. Chinese leaders have signed long-term gas supply agreements with the leaders of Turkmenistan and Kazakhstan, two Central Asian countries endowed with plenty of untapped reserves. But Gazprom, the Russian gas monopoly, also wants access to these reserves. The pipelines required to transport this gas would be very expensive and risky from a geopolitical perspective. The Chinese would probably find it easier to safeguard LNG supplies sourced from emerging exporters like Qatar, Malaysia and Australia. I expect China will increasingly turn to LNG to satisfy growing natural gas demand. But it must compete with the rest of Asia, the U.S., and Europe to invest in the most promising LNG projects. Many European countries are looking to diversify away from politically risky Russian gas supplies. They’re investing in LNG projects that strengthen connections to longtime suppliers like Algeria. Since natural gas provides the building material for so many modern products, its consumption grows as

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living standards improve. According to the BP Statistical Review, the entire Asia-Pacific region consumed just 3% of global natural gas in 1975. This figure expanded fivefold, to 15%, by 2006, and this trend should continue on its current course. Japan was the first Asian country to invest heavily in LNG facilities. After suffering through the oil market disruptions of the 1970s, Japanese leaders decided it was wise to diversify supply of hydrocarbons. South Korean gas demand accelerated from a low base as its industrial machine matured in the 1990s. There’s an interesting aspect about the natural gas market in these two economic powerhouses: Neither of them has a viable domestic gas resource. They both rely on imports. Japan relies on LNG for 97% of its gas and South Korea relies on it for 100%. Japan consumed 39% of the world’s LNG supply in 2006. South Korea came in second, at 16%. Both countries have a huge stake in LNG, so they will keep expanding their LNG re-gasification and storage infrastructure. LNG equipment companies have the opportunity to meet this demand over the long term. Recent events have caused Japanese LNG demand to accelerate. Japan suffered a powerful earthquake in July 2007. It reignited fears of radiation leakage from nuclear power plants, forcing the shutdown of a major nuclear reactor. Ever since the shutdown, Japan has had to make up for the lost electricity with gasfired power. Utilities have been importing as much LNG as storage facilities will allow, paying premiums of about 50% over benchmark U.S. natural gas prices. After this scare, it appears that the Japanese government is rethinking its commitment to new nuclear reactors. In a recent research note, Bernstein Research described this important policy shift, which remains below the investment community’s radar screen: “As a result of new [Japanese government] guidelines, nuclear plant operators will now have to analyze seismic events over a 130,000-year period, in stark contrast to the current mandated 50,000-year period. Geological faults screened to be active...would nullify greenfield site proposals, and could lead to closures of operating nuclear capacity...” Nuclear power supplies 30% of Japan’s electricity. Regulators may delay or cancel some of the 10 gigawatts in new nuclear capacity slated to come online by 2015. If this happens, Japan’s LNG and gas-fired power facilities must expand. Regards, Dan Amoss, CFA

Strategic Investment

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DEPLETING RESOURCES, LEAPING POPULATION by Byron W. King ––––––––––––––––––––––––––––––––––––––––––––– February 12, 2008

A story in USA Today reports that “The U.S. population will soar to 438 million by 2050.” Most of the population growth will be driven by immigration and live births to immigrants. How depressing. And it ought to make you mad, so that you want to “do something” about it...like build a wall or something. Really, why is it that the so-called “immigration debate” in the United States is often tied up with terms of race and seldom tied into the discussion of depleting resources and declining infrastructure? If the immigration debate was framed in the latter terms of resource depletion and infrastructure, people would focus on the point that the nation is “full.” The irrefutable fact is that the U.S. resource base is fastdepleting and the infrastructure system is overloaded. There is no more room at this inn. It’s time to hang out the equivalent of the “No Vacancy” sign for very some practical reasons. The United States is already a net food-importer, yet the nation will now – according to the Pew Research study – grow its population from 300 million to 438 million within the next 43 years? In what soil will the food grow? How much food will be imported, and from where, and how will the nation pay for it? With the national credit card, that is now broken? And while we are discussing eating, let’s wash it down. Water is in critical shortage in many regions of the United States, so what will all of these “new” people drink? For that matter, what will the existing population drink? At the other end of the alimentary canal, the U.S. infrastructure of sewers and pollution control systems has long been inadequate. Water and sewer system construction has traditionally lagged population growth even in the best of times. It is both expensive and politically difficult to gain approvals even for replacement sewage systems, let alone new build construction. Really, who wants a sewage treatment plant in their back yard? C’mon...raise your hand. Let’s think about energy. The United States is already the world’s largest oil-using nation (21 million barrels per day) and the largest oil importer (13 million barrels), so again...how much more oil will these new immigrants consume? While we are at it, the electricity system is strained to its limits in several regions. Each year, the system requires more and more juggling and wheeling of power just to remain up and running. (For example, within the U.S. power companies move electricity from Montana to California; from North Dakota to Illinois; from Tennessee to South Florida.) From where, and from what power plants (few are being built), will the nation obtain its electricity? As things stand, the world is at the cusp of long-term oil depletion and output decline (and the high grade coal reserves have been dug and burned as well). Thus the existing U.S. population base will have its work cut out just to maintain some semblance of an energy-based lifestyle for the current numbers. That is, the United States should expect the volumes of oil available on world markets to shrink. There will be less and less oil available to import, and at higher and higher prices. Ditto with coal. And as for “alternative” energy sources? Hey, these are great present investments. But they are lousy overall solutions to the future energy problems of 300 million people, let alone 438 million. Something is going to have to give.

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Let’s think of some other resource constraints in the United States as well. Have you tried to find a parking space? The major cities are full-up, surrounded by sprawling suburbs and built-out exurbs. Roads are packed and traffic congestion is chronic. Yet few new roads are being built anywhere – for lack of space, let alone the NIMBY-ism that permeates the culture. The nation is having trouble maintaining its existing road and bridge infrastructure. Yet won’t “another” 138 million people need a few more paved roads, bridges, tunnels and exit ramps within the next 40 years or so? Who will build those structures, and how will the nation pay for them? Where would these roads go in any case? You can already get to most places that you want to go, using a highway or road – in some state or repair or another. But when you arrive at your destination you typically find that much of the formerly rural landscape has been transformed into development and track housing, all of which uses energy and water in wasteful ways that will be untenable in years going forward due to scarcity and high costs. While we are at it, for some strange reason, most of the U.S. population wants to live within 200 miles of a coastline. So let’s add the majority of those 138 million new bodies to the existing coastal bands. Tell me when you feel crowded. How else can people move about? Not on trains. The U.S. rail system is essentially maxed out with trains hauling freight shipments, hence there is no room in or near any urban area to acquire new railway rights of way. So rail and light rail – which very few Americans currently use in any case – will not grow in any big sense in future years. Other U.S. public infrastructure – such as the hospital and public health system, court system, public schools and higher education system – are similarly maxed out. The United States can barely serve the population base of 300 million with the existing sets of buildings and personnel. In many jurisdictions, the fact is that the public IS NOT being served in any adequate sense. And in many locales, people are being treated, served and/or allegedly “educated” in trailers, for lack of space in the “real” buildings. Many of the “real” public buildings in the United States are aged and long-past replacement. (In Pittsburgh, for example, no new public high school has been constructed since 1923.) This does not even address the profound national issues of “borders, language and culture” that will be affected by new waves of mass immigration. 438 million? That number is just too many to allow any sort of society to function on half a continent, mostly near the coastlines. But one could also focus on the “depletion” of the traditional American concepts of national boundaries, or the decline of the nation’s common English language and some semblance of an “American” culture based on a shared history. No, if you focus on that kind of thing, people will think that you are talking about immigration in terms of race. So better just to focus on the fact that an increased U.S. population - from whatever source – will lead to massive shortages of food, water and energy. And the public infrastructure will simply break down. Vast swaths of the country will become unrecognizable slums filled with broken-down housing, bad transportation, and hungry and thirsty people living on the squalid edge of human survival. Now, let’s talk about building that wall... Byron King

Outstanding Investments

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CAN THE REAL BULL MARKET PLEASE STAND UP? by Ed Bugos ––––––––––––––––––––––––––––––––––––––––––––– March 13, 2008

Remember that old Wall Street maxim, “Don’t fight the trend”? Now remember another one, “Don’t fight the Fed”? Well, what happens when the Fed fights the trend, as it has been recently? Which axiom to believe? Historically, the Fed loses that fight until the trend is ready to turn back around. Admittedly, the central bank’s inflationary policies will likely help this occur at a higher nominal dollar value than otherwise. Nevertheless, the historical odds favor the trend over the Fed when these two maxims collide. But putting aside my autistic wisdom for a moment, let’s consider what the Federal Reserve is doing for the trend in gold prices – a trend, I am loathe to inform you, which it is not fighting. Let me sum it up: the trajectory of this bull trend shifted north when Bernanke took the helm of the Federal Reserve System, and that the policies pursued by the Bernanke Fed have confirmed the investment thesis driving the bull market in gold. As one pundit recently noted during a Bloomberg interview, “You gotta go with the inflation theme...it’s the only thing still working.” After upping the size of its new term auction facility from $60 to $100 billion this weekend, the Fed revealed another innovative tool that might help it manage liquidity in the banking system. The new facility, the Term Securities Lending Facility (TSLF), will offer up to $200 billion in Treasury Securities to primary dealers in exchange for a wide variety of collateral the Fed has never before accepted, including private label mortgage securities. It also eased swaps with other central banks. The controversy is that although the Fed has been allowed to accept mortgage backed securities as collateral since 1980, it has never outright bought them, and only recently enacted legislation that allows it to actually monetize them – which means to buy them without having to sell other assets. Gold bugs have followed the Fed’s legislative changes with interest. This move should not surprise any of them, but it does hold a special significance in its long-term implications, and for gold prices. And even though the Fed hasn’t expanded bank reserves or the monetary base much since August, it is helping the banking system postpone an increase in reserve demands triggered by criteria built into the Basel II framework, a generally accepted model for capital adequacy standards. By boosting the quality of bank reserves, even if temporarily, the Fed hopefully won’t need to increase the quantity of bank reserves, which have been sufficient to fuel an $800 billion expansion in the broad US credit aggregate, MZM, since August. That is 11%, or 15% year over year. The highest rate since 2002. That is a bullish recipe for the precious metals. There is nothing more bullish for gold than a situation where the central bank refuses to acknowledge that it is pouring gasoline on a raging fire.

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Forget the dollar, and oil. Those were just interim preoccupations. The real bull market is about to stand up. If gold prices are going to continue to drive through $1000, they are going to do it because the central banks are all inflating madly at the worst time. This means that a good old-fashioned bear market on Wall Street is sufficient to keep central bankers’ collective petal to the medal, and sustain the gold bull. So far, the precious metals stocks have bucked the general stock market trend since August. This is as it should be, and it is impressive because by most counts gold stocks are quite expensive relative to today’s gold price. But, investors are complaining about the underperformance of those stocks relative to gold, and also about the lackluster performance of their junior mining assets, which haven’t participated in the precious sector rally at all since August – when the current leg started. There are a few explanations for this. Perhaps John Embry said it best, at a gold conference in Vancouver recently, when he remarked that gold shares sometimes act like a bet on gold, but sometimes they just act like plain old shares. We should leave it at that...however, that is not like me. Historically, I have found that gold shares are susceptible to market declines, except occasionally during a major bull market advance in gold, when they tend toward counter-cyclicality – the more so as the bull market progresses. They will still fall during stock market panics, as all shares do, but they are likely to come back harder and hold their trends better. Still, since 2004, I’ve held the position that, as an asset class, gold shares would not outperform gold prices for the remainder of the primary leg. I continue to think that, with the qualification that we are talking about the average gold stock. Junior markets are wired differently. They do not correlate that well with the underlying commodity trend in the first place. In my experience, they correlate better with market attitudes toward risk. Junior and small cap markets have never fared well in a general market meltdown because they are typically risky assets, and in a selling panic the crowd is averting risk. The larger capitalization precious metal producers are different. The reasons for this are sound. But as a rule, speculative assets do well when the gambling environment is friendly. However, within the small cap resource sector there will invariably be exceptions. It remains to be seen if the junior gold miners will be able to buck the general market trend, but there is a good chance they will. Many of them are cheap now, and the supply fundamentals for gold are tightening. Production from many gold producing regions of the world is currently constrained by power shortages; and rapidly inflating development costs are causing the postponement of several otherwise promising development projects around the world. Meanwhile, gold producers need reserves! The large cap producers are on the hunt for sound mining assets. And they aren’t going to be discouraged by a 20-30 percent drop in gold, or stock prices. Regards, Ed Bugos

Gold & Options Trader

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