iHub Mining Sector Entrance Lobby

[Old Frank P]

Yeah ... I hope this thread takes off... I'm so-so when it comes to FA on mining stocks - but not so bad when it comes to the oilpatch.

Black Gold?
Yellow Crude?

Here's an article that was written a while back, and it reads out like a mission statement for a commodities investor like myself.

Best,
Frank P.

Crossroads: Will Deflation Destroy The Commodities Market?

Do darkening clouds of deflation mean tough times for commodities...or will a tidal wave of new money push real asset prices through the roof?
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John Myers

CALGARY - Make no mistake - the United States is in the midst of an economic rollover. But what kind of rollover? A recession. A massive recession, in fact. And where the United States goes, the world usually follows.

For over a year now the U.S. economy has been under siege. First came the tech-wreck. Then it was corporate earnings grinding to a halt. A typical recession, or so everyone thought. That was until Sept. 11. And now with U.S. soldiers in a far-off desert fighting a war against terrorism, it seems nothing could be worse.

But as we attempt to get back to our everyday lives, we now face the threat of another type of terrorism - this time bio-terrorism skulking inside the venerated U.S. mail service. Each time we've thought things couldn't possibly get worse, they have. So now we are on constant alert, wondering what will happen next. The uncertainty isn't doing anything to help the sluggish economy.

There are impressive opportunities arising from this growing morass. And make no mistake, there are fortunes waiting to be made. But there are also incredible risks. And as much as I might like to ignore them, it would be irresponsible for me to do that.

I won't pretend that I can predict the future. But what I would like to do is lay all the cards on the table for you: The evidence that points towards 1930s-style deflation and the counter-argument of inflation wrought by Uncle Sam's liquidity machine.

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Facing Another Type of War

There is an economic war being fought in the markets week-by-week, day-by-day. At stake is nothing less than our economic future.

The outcome of this conflict and whether or not we play it correctly will determine our financial fortunes for years to come. Because not during the 30 years I've been investing have the stakes been so high.

Are we falling into a 1930s depression, replete with the massive destruction of wealth? Or are we on course towards a 1970s economy, where cascades of fresh money pushed commodity prices to record highs?

Forget the economic analysis, the Ivy League analysis and all the rest. We are in a crisis. The question is, does the government have the wherewithal to pump enough money into the system to arrest this economic slowdown, and in the process, reverse the commodity price meltdown? If so, the Fed's pump-priming could translate into a bonanza for real asset investors.

The Early Evidence Points to Deflation

Deflation is just a gentler word for depression. The last time America was afflicted with it was during the 1930s.

Of course we've had periods of rolling deflation since then - notably the early 1980s. Yet this period was unique in that deflation moved from one sector to another the way a cold might move from one person to another. First hit was agriculture. Hundreds of thousands of farm families were driven off their land, ruined by crushing debts and collapsing prices. The seeds for it were planted in the late 1970s when farmers bought into the idea that they would feed the world with escalating grain prices.

Then came the meltdown in mining, followed by the collapse of Third World debt. That in turn sickened many of America's big banks. It was a horrendous period of retreating wealth, but it didn't hit everywhere at once. In fact, during the 1980s the stock market was steadily rising, as was GDP.

But what we are facing now is a different breed of cat, an animal destroying wealth across the board.

According to Morgan Stanley economist Stephen Roach, "History tells us that recessions trigger deflationary forces. For the world as a whole, I would judge the risk of deflation to be higher than at any point in 70 years. Therein lies the risk: financial markets seem largely unprepared for such a possibility."

Certainly the commodity markets have been taking it on the chin. At this writing oil prices have broken below $20 a barrel with other commodities falling as well. And there are more telltale signs of deflation. Just consider:

* Office vacancies are at a five-year high. Meanwhile new construction and home sales are rife with weakness.
* Layoffs continue to mount in almost every sector as corporate America hunkers down.
* Consumer confidence continues to decline, pushing spending levels down.
* Copper prices - an excellent barometer of future economic activity - have fallen to new lows, bumping against 60 cents. That puts copper at its lowest level in 14 years. The Commodity Research Bureau's index of raw industrial prices peaked in 1995 and stands at a 15-year low, off 16% this year -  down 40% from its high in the 1980s.
* The U.S. economy shrank in the third quarter of 2001. The government also reported a
decline of 0.4% (annual rate) in prices for personal consumption expenditures. That was the first quarterly decline in 47 years.
* Four trillion dollars in stock market wealth have been erased since the stock market peaked in early 2000.

Learning from History

The question is, where are we headed? The worst-case scenario is spreading deflation turning into a depression. A quick review from the historical record sheds light on why the government will do anything - and I mean anything - to prevent this.

America's national income plummeted from $99 billion in 1929 to just $40 billion in 1933. During the same period, output of American factories declined by 50%. By 1933 U.S. auto manufacturers were making just one-fifth the cars they were building in 1929. Also in 1933 American steel mills were operating at just 12% of capacity, and production of pig iron stood at its lowest point since 1896.

The carnage in the economy was also taking place in the stock market. The New York Stock Exchange hit rock bottom on July 8, 1932, when just 720,000 shares traded. At the end of the day, the Dow Industrials that had peaked at 452 in September 1929 slid all the way to 58. U.S. Steel fell from $262 to $22 a share. General Motors went from $73 to $8, while Montgomery Ward collapsed from $138 to just $4 a share.

Wall Street represented what was happening to the economy. Between 1929 and 1932 factory wages fell from $12 billion to $7 billion, and the average weekly wage dropped from $25 to less than $17. But this is the real kicker - unemployment reached a staggering 25% in the spring of 1933, with almost 13 million workers unemployed. Certain areas of the country were crushed by layoffs. One million people were out of work in New York, while 80% were unemployed in Toledo. Detroit, home of the new automobile industry, had 50% unemployment.

No More Depressions

Deflation spreads like wildfire upon old August timber. It is basic economics. As the economy slows, companies and consumers slash spending. This exacerbates consumer fears, resulting in further spending cuts.

During the Depression, the federal government didn't understand the way the economy was melting down and, in fact, actually cut spending. That was the last time Washington made that mistake.

More than any other event, the Great Depression was the defining experience of the 20th century. That is why every recession since then has been met with massive federal expenditures and slashes to interest rates.

True to form, the government and Fed are doing it again. In early November the Fed cut interest rates by one-half percentage point, the 10th reduction this year.

This put rates at their lowest level in more than 40 years and is the third dose of rate relief since the Sept. 11 terrorist strikes.

Recently Alan Greenspan and his Fed cohorts warned of "unusual forces." No kidding. Included in the massive cost of fighting terrorism is the gargantuan task of restoring confidence. Little wonder they are hinting of further rate cuts.

"Heightened uncertainty and concerns about a deterioration in business conditions both here and abroad are damping economic activity," said a Fed spokesman.

Most economists are more blunt. Their opinion - the United States and much of the world is sinking into an economic morass that could drag well into next year.

Then there is the Fed, throwing out the understatement of the year: "The risks are weighted mainly toward conditions that may generate economic weakness."

Translation: the Fed will cut rates further.

Several market watchers expect the Federal Reserve's key rate to bottom out at 1.5% in the current downturn, or another half a percentage point beneath its current level.

The last time the Fed cut rates 10 times in one year was in 1991, in the middle of the recession. And the last time the federal funds rate was at 2% was in 1961.

For the first time in years, the central bank's short-term interest rates have actually fallen below the rate of inflation. Consumer prices are rising at a rate of 2.6% compared with the 2% Fed rate.

"Negative real short rates mean that monetary policy is deep in easy territory," said Vincent Lépine, senior economist at National Bank Financial in Canada.

It is not just a case of cheaper money, but also more money. Across the board the money supply is rising at a faster pace than any time since the swinging '70s. And there is more. The idea of bigger government is gaining ground. Remember fat ties and Billy Beer? If you do, you probably remember a monolithic government intent on spending America into prosperity. Two decades after the Reagan Revolution, Americans are again embracing Big - and I mean Big - Brother.

According to Business Week, "September 11 suddenly shook America out of its complacency about terrorism - and also reversed two decades of bipartisan contempt for government. Now, with a gathering economic storm, government again has an enlarged economic role as well as a military one."

More government means more government spending, and that means - effective or not - more money in the system.

What we have then is a triad of new money - cheap money, soaring money supply and government spending. All of which means more money buying fewer goods and services. Bottom line: the onset of inflation.

Ahh, Yes... the Printing Press

The deflationists are quick to point to the decade-long deflation that has ripped Japan. But the United States is not Japan. Why? Because the U.S. dollar is the world's reserve currency. That means that the United States is free to inject as many dollars into the economic system as it wants. With the ever-vigilant bond market watching over it, this is not something Washington takes lightly.

But given the choice between watching bond yields climb or watching the economy slip into a coma, policymakers have a pretty simple choice.

In the words of Richard Russell, it is a case of "inflate or die." Certainly the United States will take a 1970s economy over a 1930s cataclysm hands down.

So you may ask, why isn't inflation showing up on the radar screen? The answer is easy: so far money is being destroyed faster than Washington and the Fed can create it. But at some point - and I suspect it will be sooner rather than later - the tide will turn. When it does, there will be an exodus moving out of U.S. dollars and into hard assets. Until that happens, we will have to buckle down and be patient with our holdings.

But our wait shouldn't be too long. There are several factors at work, most notably growing world uncertainty and a hair trigger in the Middle East. Together that is creating a massive upside for precious metals and crude oil.


Surprisingly Easy Profits From Wall Street's Forgotten Market

John Myers - son of the great goldbug C.V. Myers - has been helping readers earn suprisingly lucrative returns in stocks largely unkown to Wall Street's wunderkind since his early 20s. Our man on the scene in Calgary, John has his fingers on the pulse of oil and gas industry profits. To begin making money using John's profitable insights please subscribe to Outstanding Investments.
http://www.dailyreckoning.com/