The Daily Reckoning December 17th

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Joe Altman — Concentrated Value Investing.

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Brad Farquhar — Bringing Capital Markets to the Farm Gate

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Brad Farquhar — Bringing Capital Markets to the Farm Gate appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

Promises Will be Broken

When wealth was easy to identify and easy to control — that is, when it was mostly land — a few insiders could do a fairly good job of keeping it for themselves. The feudal hierarchy gave everybody a place in the system, with the insiders at the top of the heap.

But come the industrial revolution and suddenly wealth was accumulating outside the feudal structure. Populations were growing too…and growing restless. The old regime tried to tax this new money, but the new ‘bourgeoisie’ resisted.

“No taxation without representation,” was a popular slogan of the time. The outsiders wanted in. And there were advantages to opening the doors.

Rather than a small clique of insiders, the governments of the modern world count on the energy of the entire population. This was the real breakthrough of the French Revolution and its successors. They harnessed the energy of millions of citizens, who were ready to be taxed and to die, if necessary, for the mother country. This was Napoleon’s secret weapon — big battalions, formed of citizen soldiers. These enthusiastic warriors gave him an edge in battle. But they also ushered him to his very own Waterloo.

Napoleon Bonaparte himself was an outsider. He was not French, but Corsican. He didn’t even speak French when he arrived in Toulon as a boy. But there never is one fixed group of people who are always insiders. Instead, the insider group has a porous membrane separating it from the rest of the population. Some people enter. Some are expelled. The group swells. And shrinks. Potential rivals are brought in and bought off. Weak members are pushed out. Sometimes, a military defeat brings a whole new group of insiders into power. Elections, too, can change the make-up of the core group.

The genius of modern representative government is that it allows the masses to believe that they are insiders too. They are encouraged to vote…and to believe that their vote really matters. Of course, it matters not at all. Generally, the voters have no idea what or whom they are voting for. Often, they get the opposite of what they thought they had voted for anyway.

The common man likes the idea that he is running things. And he pays dearly for it. After the insiders brought him into the voting booth, his taxes soared. In America, taxation with representation proved far more costly than without it. Before the War of Independence, government spending was as little as 3% of GDP. Now, according to the figures above, US government expenditures tote to 38.9% of GDP. And if you live in a high-tax jurisdiction, such as Baltimore or New York, you will find your state, local and federal tax bill will run to nearly 45% of your income.

In short, the insiders pulled a fast one. They allowed the rube to feel that he had a solemn responsibility to set the course of government. And while the fellow was dazzled by his own power…they picked his pocket!

It didn’t stop there. Under the kings and emperors, a soldier was a paid fighter. If he was lucky, his side would win and he’d get to loot and rape in a captured town for three days. Relatively few people were soldiers, however, because sensible people despised them and societies were not rich enough to afford large, standing armies.

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The industrial revolution changed that too. By the 20th century, developed countries could afford the cost of maintaining an expensive level of military preparedness, even when there was not really very much to be prepared for. But the common man was skinned again. Not only was he expected to pay for it, still under the delusion that he was in charge, he also was made to believe that he had a patriotic duty to defend the homeland insiders! That is the real reason that the modern democratic system has spread all over the world. It allows the insiders to mobilize more of the resources and energy of the country on their behalf. Nothing can compete with it.

You may wonder, though, why the real insiders would devote so much of national output to programs that benefit people other than themselves. The answer is obvious; because that is how they retain power. They must buy it. And since every vote is equal to every other one, they bid for votes on the basis of price, not quality. Everyone really knows his vote is not worth very much. That is why so many are cast on the basis of what seem to be cultural or symbolic issues of little material consequence — such as gay marriage or abortion. But other voters use their votes to get the material benefits that they want. Naturally, the elites want to buy them at the cheapest prices, so they begin the bidding in poor neighborhoods. Trouble there is that poor people tend not to vote at all…so they have to aim a little higher and pay a little more, which ends up in the middle and lower-middle classes…where health and retirement benefits are key election issues. In order to win an election, all major political parties solemnly swear to do what none can do honestly…or reliably — to keep the money flowing to these voters. The party that wins is the one that makes its promises most convincing…the one that seems most able to deliver.

But now the insiders are in trouble. The typical citizen is beginning to realize that he’s been had. As long as the insiders could plausibly promise him more and more benefits, he was willing to go along. But now, growth has stalled. With more and more people retiring, social costs are rising faster than revenues. Public finances can’t keep up. Democracies can’t deliver. And since the recipients of social spending are also the deciders, the faux-insiders who vote for the candidates of their choice, the government can’t adapt. It can’t avoid its own suicide. It will continue spending, diverting energy from the people who produce to the people who consume, until the system collapses. The ‘complexity’ of the system now strangles it.

Today, no major government in the developed world can make good on its promises. The US, for example, has committed itself to pay $86 trillion in debt as well unfunded health and retirement benefits. In 2012, the feds added another $7 trillion to this figure. GDP, meanwhile, grew by about $320 billion. Financial obligations are now growing 21 times faster than the economy that will have to pay them.

Growth rates have trended down over the last half a century. It doesn’t seem to matter who was in the White House, or what was the price of oil, or whether interest rates were high or low, or whether the government ran deficits or surpluses. The same thing happened in France as in the US. From GDP growth around 5% in the 1960s and 1970s, growth rates in the developed world have been cut in half.

Nor is the current financial crisis to blame. Growth rates began to decline at least 40 years ago. Today’s rates are not extraordinarily low. And nobody really knows why this is happening. A steadily declining GDP growth rate seems to defy our assumptions about the way the world works.

The world now has more scientists, more accumulated knowledge, more money spent on research and development. These things should mean accelerated growth rates. They should allow people to get richer and richer at a faster and faster pace. Why has growth stagnated?

We don’t know. But we don’t have to know. The question is: where’s the downside? The US used a lot more energy in the period 1920-1980. Its GDP grew fast too. Now, energy use and GDP growth have both leveled out. So what?

This discussion might be merely inconsequential; instead, the future of the United States of America, Europe, Japan and the entire world economy hangs on it.

Growth — more GDP…more jobs…more revenue…more people — is also what every government in the developed world desperately needs. Without it, their deficit spending (all are running in the red) leads to growing debt and eventual disaster.

Growth over the last hundred years — in population, GDP, wages, prices — made it possible to expand government spending greatly, anticipating larger, richer generations that would support their smaller, poorer parents.

“Without growth,” we observed last week, “this system of public financing is doomed to spectacular failure. More spending will not be better; it will be calamitous.”

Western governments have bet heavily on high rates of growth. But those bets are starting to look like losing wagers. And it was not only government that bet heavily on high rates of growth. Private households bought bigger houses than they could really afford — counting on growth to raise housing prices. They also went deeply into debt, expecting wage growth (and perhaps inflation) to bail them out.

Investors, too, were “long growth.” That is, they bought stocks in anticipation that growth would make their holdings more valuable. They took it for granted. Over the long run, they said to themselves, stocks always go up. Why? Because the economy always grows.

In a stagnant economy, stocks are only worth whatever their stream of dividend payments deserve. One company might become more valuable than others, thanks to luck or better management. But if the economy itself is not growing, a company can only grow by taking market share away from another company. Overall, investors will be even. But that’s little comfort.

When you’re headed for The Downside, you don’t want to speed up.

If Napoleon had lost at Austerlitz, he never would have invaded Russia. If Hitler had run out of fuel at the Dnieper he never would have made it to Volga. And if it hadn’t been so easy to make his first $1 million, Bernie Madoff might never have lost $65 billion.

Regards,

Bill Bonner
for The Daily Reckoning

Promises Will be Broken appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

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John Towers — Fishing in the Niche Market Alternatives Barrel

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John Towers — Fishing in the Niche Market Alternatives Barrel appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

Chris Mayer — Optimism, Pessimism and the Coffee Cup Project

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Chris Mayer — Optimism, Pessimism and the Coffee Cup Project appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

Government, the New Debtors’ Prison

An old banking buddy of mine has been out of work for a full year. I met up with him yesterday, and he told me the good news that he has finally found work. It’s not enjoyable. But it pays better than sitting at home.

His time of unemployment had been doubly tough because his son was also out of work at the same time. The proud father seemed happier that his son had also found a job.

“And since he works for a nonprofit, they will pay his student loan,” he said.

“What?” I said, not sure that I was hearing right.

“If you go to work for the government or a nonprofit, they will pay your student loan.”

I told my friend that I’m thrilled for him and his son, but that I’m stunned that these sorts of incentives are in place to drive debt-laden college graduates to government and nonprofit jobs.

After all, this means taxpayers are footing the bill for these loans, on top of paying for government salaries that are, of course, a dead weight on private enterprise.

Well, it didn’t take much digging to find the Public Service Loan Forgiveness Program (PSLF) that was passed by Congress in 2007. According to Forbes, “The program promises to absolve remaining balances on the federal student loans of qualifying borrowers who make 120 monthly loan payments under eligible plans.”

To be eligible, you must make these payments while working for the government or a 501(c)(3) nonprofit. The way to maximize the government forgiveness is to sign up for the Income-Based Repayment (IBR) Plan or the Income-Contingent Repayment (ICR) Plan.

So say a theoretical student graduates from law school (to use an example provided by Forbes) with $120,000 in debt and takes a job as a public defender making $45,000 a year with a 3% annual raise.

According to Isaac Bowers, senior program manager for educational debt relief and outreach at Equal Justice Works, a Washington, D.C., nonprofit, that person would be eligible for roughly $151,000 in forgiveness if the young lawyer enrolled in the government’s Income-Based Repayment Plan and repaid about $48,570 in 120 payments.

There is a complete alphabet soup of debt forgiveness programs for those working on the government payroll. Various states have their own programs, as do cities, universities, and so on. Of course, these programs are all subject to funding, so hooking up with a federal government job offering a debt forgiveness program is the safest way to go.

Mark Kantrowitz tells Forbes that loan forgiveness options at the federal level are the most reliable. “Even if they get canceled, existing borrowers are likely to get grandfathered in,” he said. “And they’re not in danger of being canceled. There would be too much of an uproar if they were.”

Meanwhile, MBA graduates gainfully employed in the private sector whipping up lattes and the like are struggling to make payments. This past quarter, 11% of student loans were 90-plus days delinquent, which “for the first time exceeds the ‘serious delinquency’ rate for credit card debt,” William Bennett writes for CNN.com.

Students are graduating with mountains of debt and moving back in with their parents when they can’t find a job, or at least one that provides enough to pay rent and student loan payments. This isn’t some isolated circumstance. One in five families is shouldering student loans debt, according to Pew Research Center. But for households headed by someone younger than 35, the percentage is a whopping 40%. Back in 1989, that number was less than 20%.

Over a quarter of households headed by someone aged 35-44 has student debt, more than double the 11% for this age group in 1989. The average amount of student debt per household has nearly tripled (in adjusted dollars) in the same time frame, rising from $9,634 in 1989 to $26,682 in 2010. The result?

Mr. Bennett makes the very salient point that student loans are risky, and the government, which makes 93% of student loans, is an irrational lender. Someone pursuing a degree in anthropology can borrow just as much and at the same rate as a student earning a marketable degree like say, nursing.

But the government keeps on shoveling out the money. After all, Obama once told Congress,

“Tonight, I ask every American to commit to at least one year or more of higher education or career training. This can be community college or a four-year school; vocational training or an apprenticeship. But whatever the training may be, every American will need to get more than a high school diploma.”

To that end, the Department of Education handed out $133 billion in 2010 and another $157 billion in 2011. And still students are borrowing like never before. But for what? The Associated Press reported earlier this year,

“About 1.5 million, or 53.6%, of bachelor’s degree holders under the age of 25 last year were jobless or underemployed, the highest share in at least 11 years. In 2000, the share was at a low of 41%, before the dot-com bust erased job gains for college graduates in the telecommunications and IT fields.”

My friend went on to tell me that his daughter is nearly done with graduate school. I asked if he had been shouldering the burden of her education costs.

“No. Student loans.”

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I asked if she had racked up a six-figure loan balance.

“Yeah, probably.”

I let out a groan. He quickly added, “but she’ll probably work for the government.”

The mortgage debt crisis has been replaced in the public view by the student loan debt crisis. Total student debt outstanding is approaching $1 trillion. And while students are graduating with fancy degrees, jobs that pay enough to service the debt are few and far between.

The taxpayer just can’t escape funding the higher education racket. Your state taxes provide direct support. Your federal taxes are funding direct aid and student loans. And now graduates have a compelling reason to find a place on the government payroll with you footing the bill. After all, student loan balances can’t be discharged through bankruptcy, but they can be through government employment.

Sincerely,
Douglas French

Original article posted on Laissez-Faire Today 

Government, the New Debtors’ Prison appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

Joel Bowman — The State is Failing…and Other Reasons to be Optimistic

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Joel Bowman — The State is Failing…and Other Reasons to be Optimistic appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

How Gold Miners Can Leverage the Price of Gold

Gazing into their crystal balls in recent days, Wall Street firms interpreted differing futures for gold next year. Morgan Stanley awarded gold the “best commodity for 2013” while Goldman Sachs called the end of the metal’s hot streak.

After seeing 11 consecutive years of positive performance from gold, one needs to be wary of research analysts’ price forecasts, as they have consistently underestimated the shifting dynamics driving the precious metal higher.

Take a look at analysts’ annual predictions of gold prices, which is “a telling picture,” CEO Nick Holland of Gold Fields told the crowd at a mining conference last summer. From 2006 through 2011, Bloomberg’s contributing analysts have forecasted that future gold prices would be lower. “The analysts who keep telling us the gold price is going down have been wrong seven years out of seven. That’s a remarkable track record!” says Holland.

It is worth keeping gold’s DNA of volatility in mind as the day-to-day price of gold naturally fluctuates, of course. This is the case for both gold and gold equities.

The upside to gold stocks is that investors historically have received a 2-to-1 leverage by owning gold equities instead of the commodity. U.S. Global’s Portfolio Manager Brian Hicks reminded The Gold Report readers of this fact during an extensive conversation that he and Portfolio Manager Ralph Aldis had with Brian Sylvester.

We believe that effective management can help miners gain more leverage over the metal for their shareholders. Picture the gold price as a pulley with gold company executives applying force on one side of a rope. The more disciplined and successful the management, the bigger the potential boost in gold equity returns.

The muscle that gold miners can use to increase their “multiplier effect” for shareholders is three-fold: grow production volume, expand margins or optimize capital, explained Holland. “You want to keep showing that you can increase the return on the mine and that you can increase the cash flow available for shareholders at a particular gold price.”

In recent years, gold mining companies have been facing the dilemma of trying to grow their production profile while also depleting their current resource base. As I explained to Mineweb in a recent podcast, no miner wants to show investors that their production profile is in decline, so there has been a huge push to grow gold production.

However, this “growth for growth’s sake” mind frame has resulted in a congested intersection of projects in the pipeline. Take a look at the chart that National Bank Financial (NBF) put together showing an “unprecedented wave” of projects that mining companies are planning over the next decade.

Each dot represents either a gold and precious metals project or a base metals and iron ore project. The bigger the dot, the larger the estimated cost of the project.

The 2006 through 2010 construction history benchmarks the engineering and construction industry’s capacity to build new mines. Relative to the size and number of new projects in the pipeline, the current pool of expertise to build these projects is quite limited.

NBF’s mining analysts indicate that about 30 projects can be completed in a two-year time frame.
The critical shortage of technically skilled people has been driving up the cost of projects and resources. “Mines that used to cost $2 billion only a few years ago, now cost $5 billion,” and the beneficiaries of these projects have not been shareholders, but contractors, employees, consultants, governments and equipment suppliers, says Stifel Nicolaus’ George Topping, a well-respected analyst with years of experience in capital markets.

In his research, “Don’t Build It And They Will Come,” he analyzed the projects that four senior miners, Barrick, Goldcorp, Kinross and Newmont, have in the pipeline, looking at the capital expenditures, cash costs and internal rates of return to determine whether he thought the projects should be continued or deferred.

Of the 14 he looked at, only five projects were worth pursuing, in his view. Instead of spending the money on these projects, “senior producers would be able to pay higher dividends, say yielding 5 percent at current prices,” according to Stifel. A monthly or quarterly dividend program shows that gold miners have a pulse and are taking disciplined action in paying back some of their capital.

The Fairytale Land of Cash Costs

The other factor that has been hurting gold miners is the outdated use of a cash costs measure which doesn’t reflect the true costs of mining. In the Mineweb podcast, Ralph and I discussed these “cash cost fairytales,” with Ralph pointing out that only governments believe gold miners have seen a windfall profit from the rising price of gold. He says,

“You’ve got to thank your cash cost marketing for basically taxing 50 percent of your gains away in the form of taxes when the government has risked no capital on the project and not borne any of the risks during the construction of the project.”

Research indicates that an “all-in cost” is much more indicative of the true cost of mining, as it takes into consideration operating costs, sustaining capital, construction capital discovery costs, and overhead tax along with acceptable profit. For example, CIBC’s research calculates that a sustainable number for mining an ounce of gold would be $1,700.

These factors highlight the importance of active management, as gold companies that are successful at executing what they’ve articulated to the public should be more effective at leveraging the price of gold.

Frank Holmes

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Original article posted on Daily Resource Hunter 

How Gold Miners Can Leverage the Price of Gold appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

Eric Fry — The First Shall Be the Last…Or At Least Not First

For the complete audio recordings of Rancho Santanta, and all future conference recordings click here.

Eric Fry — The First Shall Be the Last…Or At Least Not First appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

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