Daily Dispatch: The Cure for High Prices

September 24, 2010 | www.CaseyResearch.com The Cure for High Prices

Dear Reader,

With gold poking its fair-haired head over the top of $1,300 today, a new record, many dear readers are wondering if this rally is sustainable. Reader and correspondent Mike B. sent along the following chart, which offers a useful road map to any secular bull market.
Of course, those of you who have been subscribers to our services for any period of time will happily note yourselves as belonging to the “smart money” crowd.

As to where we are on this map today, it’s our contention that the public is still almost completely uninvolved in gold at this point. Increasingly, however, the institutions are. David Rosenberg, who has a large following among the institutions, wrote today that he thinks the Mania stage is still well off, and that gold won’t really gain steam until it hits $3,000. This, despite his being a staunch deflationist.

Of course, we can’t know what the purchasing power of a debased U.S. dollar will be a few years down the road and it could be worth nothing which means the price of gold could be literally anything, maybe even one million dollars per ounce.

But Rosenberg is directionally correct that the Mania phase is still ahead of us. Sure we are starting to see increasing media attention to gold, a benchmark on the chart above, but it’s still nowhere the level of coverage the yellow metal used to receive during the latter stage of the 1970s bull market. Back then, the CBS Evening News in fact, all the major news broadcasts would, as a matter of policy, display the price of gold right next to that of the stock indices.

At this point, using any corrections to build positions ahead of the Mania phase still makes a world of sense to us.

Quick Comment on the Stock Market

As I write, a modest (and passing) pick-up in consumer durables has sent the S&P 500 to 1,147, blasting through the 1,130 top of the range we discussed last week. Given that such a high percentage of trades are now computer driven, this could be the move needed to trigger short covering, in which case the market could move higher still.

I have no doubt that this is a bear market trap, but timing when the trap will close is a near impossibility. One bit of useful input came today in the form of a chart in David Rosenberg’s letter showing the tight correlation (75%) between the two-year Treasury note and the S&P 500. His take is that either yields have to rise or the S&P has to fall.
In my view, the two-year rate will rise, causing the S&P to fall. It’s just a question of time.

While we risk being stripped of our speculator credentials, we hold to our contention that in the face of such uncertainty you shouldn’t be afraid to take a profit when a profit is to be taken, and to favor larger allocations to cash and to gold during this transitory period. In other words, be careful.

Still on the bigger picture, I ran an interview yesterday featuring the co-founder of Home Depot speaking with great eloquence on just how challenged American businesses are in this environment. Continuing that theme, the good folks at ZeroHedge tipped us to a Bloomberg story in which William Simon, the CEO of Walmart, is quoted as saying the company is trying “to figure out how to deal with what is an ever-increasing amount of transactions being paid for with government assistance.”

He then goes on to say…
You need not go farther than one of our stores on midnight at the end of the month. And it’s real interesting to watch, about 11 p.m. customers start to come in and shop, fill their grocery basket with basic items baby formula, milk, bread, eggs and continue to shop and mill about the store until midnight when government electronic benefits cards get activated, and then the checkout starts and occurs.
Full story here.

Congressional Hearings on Gold

Congressional hearings have begun on matters related to gold. Reading MineWeb’s story on the hearings, it’s hard not to conclude that the government is looking for an excuse to drop a heavy new layer of regulation onto the gold sellers, a prerequisite to ultimately limiting public access to the soundest form of money.

I have no illusions about the shady nature of many coin dealers, but remain firm in my opinion that more regulation fixes nothing. In fact, it makes things worse because it lulls buyers into a false sense of security. Thanks to the Internet, there are a near endless number of resources now readily available to potential buyers trying to understand the dos and don’ts of coin buying, and to sort the honest dealers from the bad.

In any event, because it’s important to keep an eye on Congress, much in the same way you might watch a drunk boxer sitting next to you at the bar, here are a few relevant quotes and a link to the full story.
Charles Bell, programs director for the Consumers Union, the publisher of Consumer Reports, told the subcommittee, “Many of the problems that have come to public light are related to high-pressure sales tactics that entice consumers to purchase coins that have high mark-ups, that turn out to have much less resale value than the customer initially expected.”
Bell said consumers are also at risk because sellers of gold coins and bullion may not be licensed or regulated either by the SEC or the Commodities Futures Trading Commission. “And sales representatives may not be licensed as investment advisors, even though they present their products as an ‘investment.'”
“Coin and bullion sellers are subject to relatively limited public oversight, and state consumer protection authorities may only be able to offer limited help for consumers who feel they have been defrauded,” Bell explained.
… ” Lois Greisman, associate director in the Bureau of Consumer Protection at the FTC, said, “Scam artists also are putting a new twist on an old scamfalsely touting coins and precious metals as low-risk, high-yield investments to hedge against the economic downturn and fears of a declining U.S. dollar.”
“Often these marketers also fail to disclose hidden fees, mark-ups, and premiums added onto the purchase place of the coin or precious metal investment,” she explained. “By failing to disclose this key information to consumers, the marketers divert consumers from purchasing investment opportunities from legitimate dealers, and leave the consumers drowning in underwater investment.”
…The FTC supports the Coin and Precious Metals Disclose Act, which would require coin and precious metals dealers to fully disclose not only the purchase price, but also all other fees associated with the sale of coins and precious metals, and the melt value and reasonable resale value for coin and precious metals. The legislation would require dealers to make disclosures clearly and conspicuously prior to completing the sale.
That last part sounds reasonable, doesn’t it? Based on the history of these things, though, it’s likely a Trojan Horse. Once they get through the gates, amending and expanding the regulations becomes a snap.

The good news is that there is no overt discussion, yet, of confiscating gold, but retaining the freedom to buy and own gold will require constant vigilance.

The Cure for High Prices

Commodity traders have a saying that goes, “The cure for high prices is high prices… and the cure for low prices is low prices.”

The wisdom of that homily can be best understood by considering the impact of price movements on a commodity such as wheat.

Should the price of wheat rise well above the norm, the natural response of farmers will be to plant more. At a high enough price, farmers who traditionally plant other crops will also shift to wheat to take advantage of the profit opportunity. And, in the absence of trade restrictions, producers in other parts of the world will increase their wheat shipments to markets where they can get a better rate for their crops. In almost no time at all, a glut of wheat will assure that the price of wheat will fall. Ergo, “The cure for high prices is high prices.”

Of course, the situation works in reverse as well. Should prices fall to the point where there’s no money to be made in wheat, producers will plant something else or go out of business. Either way, in a relatively short period of time, wheat supplies will come under pressure, and the price will rise.
Despite the obvious truth of the scenarios just described, it’s remarkable how often governments feel compelled to meddle in the market mechanism. Which is why it was so refreshing to recently read the following out of Russia…
Russia Won’t Intervene To Curb Soaring Food Prices Minister
MOSCOW (AFP)–The Russian government won’t intervene to curb prices for basic food stuffs as inflation soars after the country’s worst ever drought, Economic Development Minister Elvira Nabiullina said Tuesday.
“I think it does not make sense to impose [price] limits,” Nabiullina was quoted by Russian news agencies as saying.
“We are of course monitoring what is happening to prices. In August, the average weekly rate of inflation sped up. This is primarily due to the drought.”
Under Russian law, the government can impose caps on the prices of flour, millet, buckwheat and salt if they jump by more than 30% over a 30-day period.
Forty-five Russian regions saw prices for certain foods grow by more than 30% in the 30-day period up to Aug. 23, Vedomosti business daily reported Tuesday, citing a report by the economic development ministry.
While Russia still has many imperfections, it is refreshing to see that after its long communist experiment, Russians have developed an understanding of the importance of letting markets sort themselves out. We can only hope the trend continues to gain momentum.

Since we’re on this general topic, I might as well quickly comment on some other commodities and how high or low prices affect them. Oil and gas, for instance.
Periods of higher prices for oil and gas will typically cause an escalation in exploration, and in the development and production of known reservoirs that have been left undeveloped due to the poor economics. Going after a deepwater target, or investing in a new heavy oil deposit, won’t happen at $40/bbl oil, but if the producers think oil is going to stay over $70, it may. And in relatively short order, escalating production will begin to weigh on the price.

But as the price begins to go down, the production may not fall off nearly so rapidly as might be the case for wheat or other crops. That’s because shutting in a well and eventually restarting production is costly. Further, as long as you are making money, the temptation will be to produce. Thus, if, taking into account all lifting costs, you are producing oil at, say, $25 per bbl and oil is selling for $70 per barrel, you will produce all you can. But what happens if oil drops to $40 a barrel? As long as you are making money, you’ll keep right on producing.

Thus, the time lag between overproduction and lower prices and a reduction in the supply to the point where prices start moving upwards can be protracted. Case in point, at $3.90 natural gas is now selling at close to the cost of production, yet the price has remained stubbornly low.

As per above, lower prices will curtail further exploration and development, and so in time supply and demand will swing in the opposite direction, and you can make a lot of money by positioning yourself ahead of those swings.

Another commodity for which the general rule of thumb doesn’t hold up is gold. As you can see in the chart just below, which we have published previously, despite a stunning rise in price over the past decade, mine production has fallen from previous highs, though the amount of scrap coming to market has certainly increased. This is a clear picture of a commodity with structural limitations to new supply.

Should demand continue to escalate as we believe it must then the mostly static supply profile has to result in higher prices. It would be the equivalent of the world’s dirt becoming so depleted that only so much wheat could be grown and no more. At that point, if you wanted a nice loaf of bread, you’d pay a lot more for it just as you will for an ounce of gold.

Viewed in this context, by the time Jill Q. Public decides to jump on the gold bandwagon, she’ll almost certainly find available supplies limited or at least not available at anything close to today’s prices.

On that point, a straw in the wind flew by yesterday when the following announcement arrived out of the blue on the fax machines of coin dealers across the nation.

Gold get it while you can.

Friday Funnies

I’m running late, and I haven’t come across anything really worthy, so I’m light on the Friday Funnies this week. If you come across a great joke or have any comments on this service, please send them my way at David@CaseyResearch.com.


Hello, and thank you for calling the State Psychiatric Hospital. Please select from the following options menu:

If you are obsessive-compulsive, press 1 repeatedly.

If you are co-dependent, please ask someone to press 2 for you.

If you have multiple personalities, press 3, 4, 5 and 6.

If you are paranoid, we know who you are and what you want; stay on the line so we can trace your call.

If you are delusional, press 7 and your call will be forwarded to the Mother Ship.

If you are schizophrenic, listen carefully and a little voice will tell you which number to press.

If you are manic-depressive, it doesn’t matter which number you press, nothing will make you happy anyway.

If you are dyslexic, press 9696969696969696.

If you are bipolar, please leave a message after the beep or before the beep or after the beep. Please wait for the beep.

If you have short-term memory loss, press 9. If you have short-term memory loss, press 9. If you have short-term memory loss, press 9.

If you have low self-esteem, please hang up; our operators are too busy to talk with you.

If you are menopausal, put the gun down, hang up, turn on the fan, lie down, and cry.
You won’t be crazy forever.

For the Record

As President Obama paves the way for the newest round of peace talks between the Israelis and Palestinians, he has been speaking optimistically about the outlook for the talks. A smattering of quotes…
“The Israelis and Palestinians have waited a long time for this vision to be realized, and I call upon all those gathering to redouble their efforts to turn dreams of peace into reality.”
“I remain personally committed to implementing my vision of two democratic states, Israel and Palestine, living side by side in peace and security.” (1)
*** “The hardest issues now at last are on the table.” He added: “I hope the parties will seize this opportunity and not retreat from the clear moment to capture the momentum of peace.” (2)
*** “We want to be an honest broker, and I think the parties see us in that role, and that’s the role we will continue to play at this point.” (3)
*** “We’ve made significant progress toward peace. We have initiated a dialogue from which we should not consider turning back.”
“Much work remains to be done and the road ahead is tough, but it’s the right road and I remain optimistic that direct negotiations for a just resolution of the Palestinian problem in the context of a real and enduring peace is within our reach.” (4)
*** “We are going to settle things on the West Bank. We are friends. There will be peace in the Middle East.”
“I think there will be peace in the Middle East thanks to these brave men who have had the courage to face difficult problems.” (5)
No, wait it wasn’t Obama who said all that!
It was, in order… (1) George W. Bush; (2) Bill Clinton; (3) George H. W. Bush; (4) Ronald Reagan; (5) Jimmy Carter.
What Obama said was
“We have to summon the will to break the deadlock that has trapped generations of Israelis and Palestinians in an endless cycle of conflict and suffering.”
“This moment of opportunity may not soon come again,” Obama said in the Rose Garden Wednesday afternoon. “The [two sides] cannot afford to let it slip away.”
As regular correspondent Dennis Miller recently wrote, the only way for there ever to be peace in this sort of conflict is if one side or the other loses the will to fight. As they’ve now been at it for half a century and neither side shows signs of throwing in the towel, maybe it’s time that the U.S. stop wasting its time and resources trying to get the two parties together and instead encourage them to drop the gloves and engage in a winner-takes-all Battle Royale?
Or we could let some other country take over the charade of brokering peace. Maybe the leaders of Denmark have some spare time on their hands?


Scottsdale, Arizona, Phyle Meeting. If you live in the Scottsdale area and would like to connect with other Casey readers, the next Casey Phyle meeting is being held at 6pm on Monday, September 27, at the Paradise Bakery on Raintree. The agenda for discussion now includes:
The apparent aversion of a stock market crash, at least for now
The strange dichotomy of a falling dollar with rising bonds
Are agricultural commodities for real?
Why does oil languish while most commodities, including Dr. Copper, are doing well?

If you’re interested in attending, drop us a note at Phyles@CaseyResearch.com, or just show up.

Errata Right Bubble, Wrong Year. In yesterday’s missive, I noted in passing the top of the Japanese real estate bubble as having occurred in 1981. That, of course, was a typo as the actual top occurred in 1989.

New Orleans Investment Conference. As usual, the annual New Orleans Conference is pulling out all the stops to present a star-studded cast of speakers, with headliners that should appeal to those of you dear readers who skew toward the more conservative side of the political spectrum, specifically Newt Gingrich and Con. Dick Armey. While Doug Casey won’t be able to make it this year to balance things out with his more libertarian perspective, our own Marin Katusa will be there to talk about some of his favorite resource plays. More on the event here.

And with that, dear reader, I wish you a nice weekend thank you for reading and for being a Casey Research subscriber!

David Galland
Managing Director
Casey Research