Crisis and Opportunity: An Interview with Casey Research Chief Economist Bud Conrad
Source: The Gold Report (2/26/08)
The Gold Report recently caught up with Casey Research Chief Economist Bud Conrad, who will be a featured speaker at Casey's Crisis & Opportunity Summit in March. Conrad recommends investing in precious metals, energy, food commodities,and shorting financials. He also says that the underreported "Peak Food" issue is sure to become a major problem in the decade ahead.
CONRAD: I’ve been predicting recession for over a year, and we are in recession. Analysts and stockbrokers who want to sell stocks look for the bright side, saying that the glass is half full. But when you see employment numbers going negative — from a government that knows how to make the numbers look good —when you see ISM numbers for the service industry below the 50 level, that says that the service industry is actually declining. And that is supposed to be our growth area. Add in all kinds of disasters in the housing area and in the financial community, particularly the guys at the end of that whipsaw who were insuring bonds, like MBIA that we recommended shorting in the September issue of International Speculator, and you’ve got a pretty negative picture. Recession is here!
We use the word, bubble, but I say the financial markets are typically always moving back and forth in cyclic fashion, always swinging like a pendulum, and the traditional equilibrium that people talk about is when the pendulum is straight up and down. When a pendulum is swinging, that's when it’s moving fastest. The point is that looking for an equilibrium is not as good an economic system as noticing that things go beyond an equilibrium. George Soros recognized this and he coined the term "reflexivity" for what he observed. These swings in the market and the credit market are big, and we haven’t yet seen how bad this cycle can become.
This isn’t a typical four-year investment cycle. This is the end of maybe a 40-year swing, at least since the 1980 peak of higher interest rates and fear, really down to a bottom of interest rates that is now headed the other way for a good decade. That includes a loss of confidence in money, which will mean higher interest rates. I think one of the great plays of the next decade will be betting against the bond paper, including government bonds, not just the non-government bonds.
TGR: Tell us what you think this means for precious metals – the actual bullion itself, or ETFs, and the large basket of varying types of mining companies.
CONRAD: Let me back up a little about this landscape we’re in. The usual economist will tell you that during recession, demand slacks off and therefore price pressure drops and then typically there could be deflation. Are we headed into deflation? That is a logical, normal expectation. I say, however, the downturn is probably worse than most people realize, and will be counteracted by a bigger-than-usual response from all the powers-that-be who want to bail this mess out.
Bernanke said that any time the government wants to stop a deflation, it can do so by creating more money: It can just drop money from helicopters. We laugh about it, but that is what the Fed is starting to do.
Take a slowing economy, which generally means slowing revenues to the government, and a continuing war, and you’ve got a big budget deficit growing to easily $400 billion or maybe even $500 billion this year. So you have a recession stimulus from the federal government handing out $600 to everybody, at the same time as deep Fed cuts, to overcome the recession. I expect dollar purchasing power to drop. I’m more concerned about the dollar dropping against oil and commodities, than against other currencies. It’s not clear that other currencies are of any better quality than tissue paper.
The trade deficit is actually bigger than the budget deficit, but they both have the same origins—paper money. You can print money to give people anything they want and live happily to the next election.
All of this is supportive for commodity prices despite the deflationary arguments. So, that’s my second point. We’ve got recession, but it’s an inflationary recession that’s setting the stage.
The third point I would make is about commodities. T. Boone Pickens predicted last summer that oil would rise to $100 a barrel, and we just hit it. Look at the big picture: The world supply of crude oil was stored up over a 100 million years, and now half has been used up in the last 100 years. If you believe, as I do, that the world economies and expansion of population from 1 billion people to 6 billion are based on energy, you get pretty concerned. People in China and India want to get off a bicycle and get on a motorcycle, and so you realize that the demand for energy is still growing to support the life style we all want. If China were to move to a life style of per capita usage that matched Mexico, we would need as much more oil production as we now use in the US. It just isn’t there.
We’re using up what we’ve already found, and are well past peak discovery. We now use about three times as much oil as we find each year. If you understand the difference between peak discovery and peak production, it’s pretty clear that we’re pretty close to peak oil, which is disastrous for economies, but bullish for people investing in energy.
TGR: What about alternative energies?
CONRAD: Alternative energies had a wonderful screaming run this fall. Most people haven’t noticed it, and it’s sort of under the radar screen. It’s all kind of bets on the future. There is no question that the peaking of oil production will occur in the time of a generation. Nobody, not even the big oil companies, are saying it’s a 50-year-away problem. But it takes a generation to come up with some new energy source.
There are other energy sources. The obvious ones are coal and nuclear, both of which have come through some pretty major changes—nuclear up until last spring; coal right now is spiking higher. In South Africa they don’t have enough energy to keep the mines going. In China, snow and rain have messed their coal up so they can’t generate power and people are in real trouble. Blackouts and shortages and resource wars are all part of a picture of a growing population of six billion people on a limited planet; I say the bull market in commodities has just gotten started.
There is the double whammy for all the precious metals: supply and demand considerations — an increasing desire for it by a population that's growing and improving economically, and a mistrust of what I call "tissue paper." Paper money is the greatest financial con game ever perpetrated; it’s absolutely amazing to me that people still think paper money has any value at all.
The natural direction of governments that can print money and make themselves rich with no reasonable limitation, is that they will. Therefore, all the precious metals are on the top of my list of commodities.
But let’s pick up a new topic that hasn’t been talked about as much, “Peak Food.” People haven’t been talking about it and aren’t aware that we have a problem. A year and a half ago I wrote a commentary saying all the grains are in a worldwide shortage. Corn went from $2.50 to $5 a bushel largely on export demand and requirements for ethanol. Malaysian palm oil hit a new record. Last May in Chicago I predicted that wheat would be the “Next Biggest Thing.” In fact, it’s gone from around $5 last spring to $ 10 now. The worldwide supplies of all grains added together and compared to usage is at the lowest level ever. This is an amazingly dangerous situation. The world shortage in food is big, and it will filter through to the prices of steak and grains and milk at your grocery store. When you add them all up, we’ve got inflation, not deflation.
TGR: What is causing grains to be peak? Unlike oil, you can create more of it.
CONRAD: First of all, there isn’t more land. There are rocks and fields, and you can graze cows on some of it, but the reality is that good agricultural land is not increasing. In a few places they’re chopping down rainforests to make some more, and there’s certainly been productivity increases, where the yield per acre has gone up due to (a) mechanization, (b) hybrid seed, and (c) energy—fertilizer and pesticides come from oil. Tractors and the freezing compartments in the trucks to move it all use energy. The amount of energy in food is actually quite high, so when you start running out of energy, you start running out of food.
On the demand side, the amount of grain needed to produce beef is 20 times per calorie intake as it is for bread. People in China say, “I’d rather have an egg than another rice bowl.” In the increasing wealth patterns of the world, they want more of what are basically inefficient sources of food. Combine all this together and compare, say, the 50-year price appreciation of oil to corn. Corn has gone up 8 times, but oil has gone up 44 times. My point is corn could go up five times from here to just catch up to the 44 times that energy has risen. You’ve got to eat. You will cut back on some of the things you do with your SUV, but starvation is the last thing you want to have happen. I don’t know where this peak food crisis can go to, but I say prices haven’t caught up yet. Few people are playing food as an investment because they don’t know there is a problem, and because they don’t know how to invest it.
TGR: So, how does an investor play this — by buying futures in the commodity markets?
CONRAD: Well, I am biased. I am a futures trader, so you can see why I would say, “Oh, just go and buy a futures contract.” But the average person should not. I certainly don’t recommend playing the futures market because the leverage is ridiculous—20 times or so. But new vehicles are being invented, like ETFs, Exchange Traded Funds. They are kind of an envelope that takes your money and reinvests it in things like a grain futures or other indexes to give you the same return you would get in an unleveraged investment at maybe two times, not 20 times investment.
TGR: And when you’re saying you’re buying gold, are you buying ETFs, gold coins, gold stocks or the commodity itself?
CONRAD: All of that. We do recommend the large mines in our investment newsletter, Big Gold, and for several years have been focusing in International Speculator on junior mines, many of which are in Canada but have operations throughout South America, throughout the world, although not too many in Africa, but still an international view.
Gold stocks are more volatile than gold. In fact, in a down market they are a little worse; in an up market, they are also a lot better. And I think this is an up market, so I am bullish on gold and gold stocks. Gold stocks have not done as excitingly well last year, but I think that’s just a delay, and not a real problem.
TGR: Do you see any decoupling of the dollar and gold? Historically if the dollar is going down, gold is going up. The dollar has had a pretty substantial break over the last six months to a year. Could we have the dollar going up and gold going up as well?
CONRAD: In the long-term picture, no. What will the dollar buy? Grains and oil and other commodities are probably almost better definers of dollar value than the trading value against the Asian currencies or the Euro. Going forward, I have more confidence in the Asian economies and their abilities to keep their currencies more valuable than the European currencies. But behind that I don’t think we should look at exchange rates as much as we should look at inflation rates in defining the value of the dollar. Commodities going up means the dollar is going down, sort of by definition, rather than by comparison.
So, my view is that we’re in pretty good shape to expect that gold will be up this year, even if the dollar doesn’t go down against other currencies. It just means confidence is lost in all the currencies, not just the dollar. If you look at gold in real terms, not just corrected for the CPI but corrected for a more realistic view of what the inflation has been, it says that in order to meet its peak of 1980, gold should be not just $2,000 but $6,000.
TGR: As you pointed out, the Fed has been cutting interest rates, and another cut is anticipated. What trend do you see in interest rates?
CONRAD: I have a chart that shows what the futures market thinks the interest rates will be for the three months for the dollar going out to 2012. It isn’t necessarily true that futures traders really know what future interest rates will be, but this chart shows interest rates dropping throughout 2008 to a low of about 2.5% and then rising steadily thereafter. So by 2009, we will start to see rates going back up. Dropping rates in 2008 is part of recessionary pressure and the Fed pushing rates down.
What Futures Markets are Saying about Interest Rates and the Economy
The problem is—and this is the issue I think most people miss—that the bailing out by the Fed and others is actually ensuring that inflation is more likely to come back and they’re then going to run into the dollar collapsing.
The rock and the hard place for the Fed is if they cut too much, the dollar collapses; if they don’t cut enough, the economy collapses. The overlapping set is unhappiness for somebody, maybe both; there may not be any happy middle ground that Greenspan was able to ride down for the last two decades.
Now, this isn’t my prediction. This is other people’s actual market bets, and that is why I like it as an indicator. Actually, I am more pessimistic on the far out end of it where interest rates could go.
I interpret this chart to reflect a slowing in the economy through 2008, but that then inflation will pick up, and investors will require higher rates to cover that inflation. It is part of recognizing that the Fed cuts rates by providing more liquidity (aka “printing” money). The result is that in the short run rates drop, but in the longer run inflation returns and rates have to rise to cover that inflation.
Recession, inflation, and weaker dollar lead to recommending investing in precious metals, energy, food commodities, and shorting financials. I look for bigger financial disasters than most people do, and look for the underreported peak food issue to become an important problem in the decade ahead.
Casey's Crisis & Opportunity Summit – Part II, Scottsdale Plaza Resort, AZ, March 25-27, 2008 – We are finally beginning to see the full extent of the credit crisis triggered by the subprime mortgage meltdown, and its repercussions in the broader economy. But, as Doug Casey likes to say, crisis means danger plus opportunity – and the opportunities for contrarian investors have never been better than today… if you know what to look for. One man's crisis is another man's opportunity…