SPRINTING DOWN THE ROAD TO RUIN

By James R. Cook

Early January 2009

Mention the gold standard in Washington or New York and you’re written off as the David Duke of finance. However, when Roosevelt abolished gold money, he opened Pandora’s box. Under the gold standard the money supply grew at the rate that gold was mined (about 3% a year). Under the paper standard all such discipline was removed and discarded. This enabled politicians to introduce a vast array of social schemes that could now be paid for by inflating. It greased the skids for big government and the U.S. brand of socialism known as the mixed economy.

The fate of a nation’s currency mirrors that country’s financial health, prestige and influence. The big picture unfolding over the past hundred years and projecting a century into the future leaves little room for optimism. What grew the country was high savings, low taxes, capital accumulation, limited government and entrepreneurial freedom (laissez faire). Going forward we have low savings, high taxes, capital consumption, cancerous big government and regulatory zeal (interventionism). Instead of expanding what works, we embraced what never works.

Twin Towers – Economic

and Social Collapse

As we careen from one economic crisis to another, our society will begin to unravel. The heavy footprint of government will grow more burdensome. Now laws and regulations will curb our freedoms. Rude civil servants will be even more obnoxious and unresponsive. Tax collectors will more aggressively seek out our wealth and new taxes will be spawned by a government desperate for funds to pay a growing army of the subsidized. Hatred of the affluent will be stoked by populist politicians. In the latter half of this century, the rich will be harassed like the Jews in 1930s Germany.

The government’s reliance on inflating money and credit makes price inflation inevitable. Today’s leftists, radicals and liberals will never see that the social programs they created are the cause of inflation and economic retrogression. Although their vaunted socialistic schemes can never be paid for, they will still demand more. With the help of the media they will elect officials who resort to draconian measures of expropriation. In Argentina the government recently took over the banks and nationalized private retirement plans. A desperate government will do more harm than ever. The U.S. has embraced the monetary policies of a banana republic. Radical socialism is sure to follow.

As the economy collapses civil unrest will become unbearable. Demonstrations, riots, crime, strikes and social hatred will skyrocket as living standards plummet. The productive and the affluent will retreat into enclaves that promise security. Entrepreneurs will move offshore and immigrants return to their origins. Big government, the source of the nation’s agony, will fail in its only important mission, to keep the citizenry safe. Eventually, Washington will become a cesspool of corruption, and New York a decrepit hulk of broken infrastructure populated by subsidized creatures howling for sustenance from the state.

The culture will coarsen further. As the subsidized underclass broadens, their morality and values will infect the media and corrupt our entertainment. Social injustice, poverty and inequality of incomes will dominate the news. Talking heads on TV will overwhelmingly stump for bigger government, higher taxes and more subsidies. Spokespersons for liberal social sympathy and compassionate conservatism will spew our nauseating prescriptions for helping a huge and growing class of ethically-challenged moochers. Rugged individualism and self- sufficiency will be replaced with weak-kneed shirkers who resonate helplessness.

The America we once knew will vanish under the onslaught of economic backwardness, social welfare, stifling bureaucracy, wealth transfer and chaotic behavior. If you think I’m exaggerating, guess again. The current rush into government bailouts and statist economic schemes sounds the alarm bell for this once great civilization. All such government programs and subsidies are socialistic. We have been adopting socialism for 75 years. There is no compromise between free market capitalism and socialism. Instead of trusting the market system, we have piecemeal adopted a left wing agenda. Unfortunately, there’s no middle road. You have capitalism or you have the government fiasco we have today.

Socialism is killing our prosperity. Government rules and regulations have choked off Silicon Valley as the world’s foremost hatchery of innovation. All the governments in the world, working in unison, could not create an Apple, a Google, an E-bay, a Cisco or a Hewlett-Packard. It’s the entrepreneurs and free markets that make wealth and progress, not the politicians ladling out pork at the government trough.

Socialism doesn’t work, can’t work and never will work. Inevitably, it must lead into a new dark ages. That’s where we’re going in America - towards misery, mediocrity and perhaps extinction. Either we roll back socialism or we perish. So it was written by the great economists, so it shall be.

TIGHTENING PRODUCTION

By Theodore Butler

(This essay was written by silver analyst Theodore Butler, an independent consultant. Investment Rarities does not necessarily endorse these views, which may or may not prove to be correct.)

There is no question that the financial scene has turned ominous in the past two months. I’d like to follow-up on an article I wrote two months ago, "A Shock To The System?"

http://www.investmentrarities.com/weeklycommentary10-27-08.html

In that article, I wrote how the unprecedented collapse in the price of base metals, to levels below the cost of production, would bring about a significant reduction in mine production. The decline in base metal production would then result in a major decline in silver mine production. Almost 70% of silver production derives as a byproduct from the mining of other metals. A falloff in zinc mining means less silver produced. I wrote how this was the first time that this development had occurred, and how it could be the perfect storm for the price of silver.

In the past two months, the data concerning inventories and price seems to confirm that the storm is firmly in place. In spite of cutbacks in base metal mining, there has been a large increase in base metal inventories and a further fall in price. That should accelerate additional base metal mine closings. For example, London Metal Exchange (LME) inventories, measured from the low points of the past six months, have increased in copper by 165%, in zinc by 65%, nickel 70%, and aluminum by 100%. These are important economic indicators of industrial demand. In addition, COMEX copper inventories have also tripled in the past few months. LME lead inventories are still down for the year, but have grown in the past month by 10%.

Low prices have already resulted in a reduction in base metal production. However, if base metal inventories are growing significantly, this is proof of a continuing surplus. It means the world is still producing too much of these metals and must further reduce production. Industrial demand is falling faster than production is falling, causing the increase in inventories.

The prices of base metals have continued to decline sharply in the past two months. Copper has fallen in price by an additional 37%, lead by 45%, nickel by 25%, and aluminum by 33%. These are the price declines from only the end of October. Zinc prices have remained flat in this time span, but are still far below the cost of production for most miners. The new down leg in price over the past two months, coupled with generally sharply higher inventories dictates almost certain additional production cuts ahead. These base metal mine reductions mean less silver production.

How has silver fared in terms of inventory and price over the past few months compared to the base metals? That’s the point of this article - silver has moved in the opposite direction for both inventory and price. COMEX silver warehouse stocks, the accepted commercial inventory depository, have declined to the lowest level of the year, down around 10%. ETF inventories have grown slightly, but that’s due to investor demand, not because of surplus metal. Likewise, the price of silver has not declined since the end of October, and is up 10% or so.

I’m not suggesting that there has been a big inventory decline in silver, nor a big price increase. What is evident, however, is that the inventory and price patterns in silver are in stark contrast to what has occurred in the base metals over the past two months. Will this pattern continue? No one knows. But clearly, while base metal inventories climbed and prices fell, it was just the opposite with silver. What does this mean?

It means that we are not seeing a surplus develop in silver like base metals despite the world economic slowdown impacting each. Either silver industrial consumption is not falling as fast as consumption for base metals, or silver mine and refining production is falling faster than base metal production. It’s possible that silver’s wide range of use in varied applications is keeping its overall consumption stronger than base metals. On the production side, mine closings could already be causing a decline in silver production. It’s also possible that scrap silver production has declined sharply in response to the low prices.

Whatever the reasons behind the sharp contrast in the inventory and price patterns between the base metals and silver, the important issue is whether the contrast is a temporary fluke or a clear signal of a solid trend. Time will tell, but if this trend continues, the impact on the price of silver will be profound. Should commercial silver inventories continue to stagnate or decline, as base metals inventories grow, the price of silver will explode at some point in the near future.

The law of supply and demand is the constant process of balancing consumption and production by price. The invisible hand of the market works to eliminate any surplus or deficit. The continuing build up of base metals inventories and declining prices indicates a clear current surplus of those metals. In time, the law of supply and demand, through the price mechanism, will reduce production and increase consumption so that the base metals surplus is eliminated. Because consumption is under pressure due to reasons unrelated to price (credit contraction and broad world financial concerns), it will take further production cutbacks to balance the base metals supply/demand equation. It’s just a question of how long this will take. But what about silver?

If silver is not in an industrial surplus, while copper, zinc and other base metals are in a current surplus, additional production cutbacks will impact each differently. Future production cutbacks will eliminate the current surplus in base metals. Any further loss of byproduct supply from base metal production cuts will push silver into a clear shortage. If and when that silver shortage hits in full and prices explode, don’t look to the base metal miners to quickly respond with increased production. Even though they account for the majority of silver mine supply, copper and zinc and lead producers will not increase, or even maintain silver production at an operational loss.

This is the heart of the matter. For decades, silver mine production has grown, largely as a result of the increase in byproduct supply coming from increased base metal production. Silver prices were low (because of a manipulation) during this time, but silver mine production increased anyway, due to growing copper and lead and zinc production. Silver mine production increased automatically, regardless of the price of silver. The base metals producers even came to consider their silver byproduct output as an afterthought in their marketing and accounting calculations. Some even sold their future silver production in advance.

There are two sides to the silver byproduct sword. In and of itself, a byproduct profile is neither bullish nor bearish. That depends on the price of the primary metals produced. Just as silver mine production increased for decades with no regard to the low price of silver, the byproduct profile can easily result in silver mine production decreasing even if silver prices are high. Copper and lead and zinc prices matter more to the ultimate level of byproduct silver output than does the price of silver. For many years, the byproduct nature of silver mining was a bearish influence because base metal production grew. Now, for the first time ever, we are suddenly confronted with the flip side of the byproduct profile causing reduced silver mine production at a time of silver shortage and potentially high silver prices. None of us have ever witnessed that and few are prepared for such an outcome.

This creates the potential for a double or triple bullish whammy for the price of silver. It means reduced mine supply precisely as total demand, led by investment demand, surges. The worse economic conditions become, the more industrial consumption for base metals deteriorates, necessitating additional base metal production cuts and with it, less silver mine production. The bad economic conditions push more investors to buy flight to quality type assets, like gold and silver. This creates a powerfully bullish self-reinforcing circle for silver.

While this bullish phenomenon doesn’t need any additional accelerator, it has one anyway. That’s the long-term silver manipulation. Artificial price schemes can’t last forever. All manipulations must end suddenly, not gradually. All manipulations are resolved with a big move opposite the direction of the manipulation. Since the silver manipulation of the past two decades has been to the downside, it must be resolved with a sudden and dramatic move to the upside.

I understand that many can’t accept that a long-term manipulation exists in silver. On the other hand, many more have come to understand that silver is manipulated. This is a one-way conversion process. In other words, once someone has come to understand the silver manipulation, there is no going back to believing that no manipulation exists. You either come to see it, or you don’t. I don’t know if it’s a curse or a moment of supreme enlightenment, but once you get it, it’s with you forever. Looking at silver through that perspective makes everything understandable. It won’t enable you to predict short-term movements, but it will explain them. It gives you comfort and assurance on silver as a long-term holding. It makes it close to a sure thing.

I raise the issue of manipulation again because I believe it will soon come to a head. We are now witnessing the third investigation by the CFTC, into allegations of a silver manipulation. While I don’t have much faith that the CFTC will do the right thing and bring an end to the manipulation, their action isn’t necessary to break the manipulation. The physical market will resolve it. The fact that they have been forced to reconsider the issue over and over is enough. They haven’t had to do that with any other commodity. The investigations have come from a grass-roots effort, not from an industry insider request, as is usually the case. The investigations have only occurred because of credible public allegations. The investigations have and will generate more conversions, regardless of any denials by the CFTC. Any denial will dance around the real questions and won’t convince anyone. That’s why the Commission is delaying. But delay will only postpone the sudden demise of the silver manipulation and ensures it will end even more dramatically to the upside.

This decline in base metals and silver byproduct output, as well as the deteriorating world economic conditions have afforded you the opportunity to take advantage of a truly exceptional situation. The circumstances have converged to make silver a better buy than ever before, thanks to the sharp sell-off since summer. It’s one thing to say silver is a better buy than ever before, and another to back that statement up. Here’s the backup - It’s in tighter supply than ever and that supply threatens to get tighter. It’s the cheapest it has been in years. World economic conditions favor it more than ever. It has more one-way converts and strong long-term holders daily. The manipulation is closer to ending than ever before. The only thing you must avoid is waiting too long to buy it.

RELEVANT QUOTES

By James R. Cook

Here are interesting quotes from newsletters, analysts and editors pertaining to the financial crisis, with my comments following.

"With its decision to cut official U.S. interest rates to effectively ZERO on December 16, the Fed has all but guaranteed the demise of the U.S. Dollar as the world’s ‘reserve currency’. And if the Fed does what it is now contemplating – tries to issue its own debt paper and/or starts to monetise Treasury debt by buying it directly with Federal Reserve NOTES (aka U.S. Dollars) – it will put the future existence of the U.S. Dollar as a viable medium of exchange into grave doubt." - Bill Buckler

It would be horrible for Americans if the dollar were to lose its role as the world’s reserve currency. Mr. Buckler goes further and suggests that the way the Federal Reserve is reacting, the dollar could become worthless.

"The policies that are signed off on in the coming months will very likely create the greatest inflation anyone living today will ever remember. Let’s not forget: government-sponsored inflation taxes, destroys and robs any wealth held in financial assets such as cash, stocks or bonds. This destruction of wealth will absolutely dwarf the Bernie Madoff hedge fund calamity, and the stock market decline of the last few months." - Richard Benson

In other words, the loss of the dollar’s purchasing power will subtract trillions from paychecks and savings.

"There are growing numbers of farsighted investors who can plainly see that the federal government is starting to launch the greatest worldwide inflation ever seen to fight today’s debt deflation. As more investors around the world sense massive inflation coming, the wise ones will become gold and silver buyers." - Richard Benson

It’s starting to happen. Here’s hoping we can continue to find it.

"The only thing separating most governments today and their central bankers from being declared institutional versions of Mr. Madoff’s alleged ponzi scheme is their exclusive legal ability to print up more ‘funny money.’ What the creation of this new ‘money’ and ‘credit’ does, of course, is makes existing ‘money’ worth less. It’s similar to a farmer watering down his milk supply to make it appear he has more milk." - William Hinsted

This is the basic economic lesson to remember for the next few years.

"There is no way the entire productivity and asset base of the United States now and for decades to come, could ever justify the trillions upon trillions of dollars… the massive Ponzi scheme that is the United States has put into circulation." - James West

Nobody knows the exact impact on the value of our currency or economy. Suffice to say it won’t be like anything we’ve experienced before.

"Perhaps the most sobering thing we have learned during 2008, or rather since the subprime crisis broke in the middle of 2007, is the benefit of transparency in business dealings. Time after time, when a fiasco has occurred, it has been due to a lack of transparency in a transaction or series of transactions." - Martin Hutchinson

If that’s true, the commodity markets will be the next to blow up.

"Great bear markets have tended to end when the dividend yield on the Dow reaches around 6%. At today’s 3.6%, the Dow is currently far away from 6%. Assuming that current dividends hold (which they won’t), the Dow would have to descend into the 5000’s to produce a dividend yield of 6%." - Richard Russell

If you don’t prepare for the worst, you can be wiped out. You must prepare for the worst, just in case.

"For many investors, this has been a glimpse into the abyss. They have been told that if you save regularly for retirement and buy and hold, you will be fine. Now, people see a possibility that this will not be the case." - Terrance Odean

If the dollar rolls over and inflation explodes, this will be more than a possibility.

"This will be worse than your ‘Grandfather’s Depression’. It will end with the destruction of the U.S. dollar as the world’s reserve currency and return us to a gold-backed world currency regime." - Kurt Kasun

If that were to happen, gold and silver would become dear.

"The great Austrian School Economist, Ludwig von Mises wrote, ‘There is no means of avoiding the final collapse of a boom brought about by credit expansion. The question is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.’ There has never been any attempt to abandon the credit expansion. Indeed any crisis was simply an excuse to open the monetary spigots. This, then, is the beginning of the total catastrophe of the American dollar, indeed the entire world monetary and financial structure." - Ian Gordon

How can you not own metals when such arguments are heard?

"What we have done is guaranteed hyperinflation in the United States… The U.S. government is going to default. Treasuries, Fannie Mae, Freddy Mac, the whole lot." – Bob Moriarity