The Daily Reckoning January 29th


Financial Drones

A few hundred words from now, I’ll examine the “liquidity pyramid” that argues for loading up on gold. But between here and there, I’ll amble past a recent news story, convert that story into a metaphor and then…eventually…get to my main point.

First, the news story…About two weeks ago Wired Magazine reported that a US drone strike in Pakistan had killed eight people. It was the sixth US drone strike in Pakistan in the preceding eight days, with at least 35 deaths reported.


(By the way, you should be aware that the number of civilian casualties from drone strikes is almost certainly higher than reported. Under the ‘signature strike’ definition created by the Obama administration, any adult male in the vicinity of a known [or suspected] terrorist or militant is fair game. After all, if you’re within 20 meters of a terrorist, you probably are a terrorist. Therefore your death is not recorded as a civilian casualty).

Obama Judge

Not everyone opposes the use of drones, of course. “Terrorists” don’t deserve civil liberties. But the precedents the Obama administration are now establishing will have long-term ramifications for how other nations use drones down the road. And Americans may not be too thrilled to see hostile nations utilize “American-style” drone tactics.

Using Predator drones to exterminate presumed terrorist thousands of miles away is an ‘extra judicial’ process, which means a handful of people are deciding whose life to end with death from above. Obama greatly expanded George Bush’s use of drones since coming to office in 2008. There have been over 300 US drone strikes since 2008, with an estimated 2,500 casualties.

You don’t hear much about the drone war because it enjoys bipartisan support in America. Perhaps that’s because the popular narrative about drones is so deliciously high-tech and antiseptic. The narrative goes something like this: Drones fly invisibly high in the heavens, from where they conduct precise “targeted killings” of bad guys. Best of all, the drones conduct all their precise, strategically essential, kills without having to put ‘boots on the ground.’

To be sure, there are plenty of principled objections to the use of drones in making war. But there is also at least one very logical practical objection: the US advantage in drone technology is only temporary, whereas the precedent of sending drones across borders to rain death on whomever you choose is permanent.

It won’t be long before everyone is using drones…to kill whomever they’d like. However, it occurs to us that there’s an even larger issue at stake: the ever-increasing automation and mechanization of everyday life. Drones are just one example.

What is a trading algorithm other than a kind of financial drone? High-frequency traders conduct drone strikes in the market all the time. True, no one dies when a stealth algorithm strikes the stock market. But there are plenty of collateral victims. Some investors lose money for reasons that have nothing to do with value or with long-term investing. They are simply in the wrong place at the wrong time.

And more importantly, the prices of securities are no longer determined by what thinking people decide the values are. Prices are, instead, determined by machines.

We suppose what we’re worried about is the general surrender of active thought in so many spheres of life. It’s like people are giving up on critical thinking. Or they are too busy staring at screens all day (computers, televisions, mobile devices) to spare any thought to tougher issues, like whether algorithms should be holding a “free market” hostage, or whether State security agencies should be using machines to kill people without any thought about unintended long-term consequences.

But then, as this article in Scientific American shows, big brains are metabolically expensive! It’s not just that we don’t have time to think about serious things. We probably don’t have the energy for it either! The study shows that the larger brain size in humans comes at the cost of a smaller digestive system (compared to other animals). So I guess it comes down to a choice between thinking and inhaling a tube of Pringles…and thinking does not seem to be winning the choice very often.

Energy is the key to everything, isn’t? Even capital is a kind of stored energy, to the extent that spending it propels resources into the real world. If the world remains in a credit depression, or enters a full-blown sovereign debt depression, “capital energy” will become even more important.

All of this brings me back to the subject of the deflationary ‘prophecy’ by former Fed Vice-President, John Exter. His “liquidity pyramid” both explained and predicted how money would move in the financial system during a financial crisis. He believed investors would move out of less liquid assets that were based on debt and into more liquid, real assets. You can see what it looks like below.


Exter's Pyramix

Based on the pyramid, you shouldn’t be surprised to learn that Exter put all of his money into gold…back in the late 1960s. He foresaw the day when the US dollar would no longer be exchangeable for gold. He knew US deficits would rise and the dollar would be devalued over time.

Yet, the fact of the matter is that there is really only one documented case of outright price deflation in the US in the last 100 years. Bank failures in the 1930s led to a contraction of the money supply and falling prices. In theory, this can’t happen again as long as the Federal Reserve utilizes its capacity to print an unlimited amount of money.

So was Exter wrong to assert that a deflationary crisis would be the automatic end game of currency manipulation? It’s too soon to say. The main difference between now and when he first made his prediction is that the whole world now uses money not backed by gold. This change has allowed for a huge expansion in credit, and even larger bubbles in asset prices (and derivatives).

But this expansion has arguably made the inevitable bust bigger and more destructive. You could further argue that everything central banks have done since 2008 has been designed to prevent this deflationary bust and prevent the flight of capital ‘down the pyramid’ and into gold.

But it remains to be seen if investors can and will move from intangible assets and derivatives to more real assets as the end-game develops. It’s really a proposition about how things will work. But let’s assume the proposition is correct. Other than gold, are there any other ‘real assets’ worth investing in or owning?

I’ve always thought oil was just as compelling as precious metals, when it comes to real, tangible assets. There are obvious differences, though, when it comes to ‘investability.’ You can carry around gold and silver in your pocket. To buy oil, you either have to use the futures market or the stock market. And of course in the stock market, you’re not really buying the commodity, you’re buying a business that either explores for, or produces, oil or gas.

As a shareholder, you have a claim on a company’s future earnings. That is not the same thing as, say, owning five kilos of silver bullion that you can also use as a door stop. Nevertheless, in the big picture, energy is just as important an input as credit or capital in an economy. That’s why I’m convinced that oil and energy shares will do well, even if John Exter is right.

Time will tell, of course. But the advantage of considering these arguments now is that you can make your decisions calmly and reasonably. That’s the time to make them, before you find yourself reaching for the panic button in the midst of a big sell-off.


Dan Denning,
for The Daily Reckoning

Financial Drones appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

Smart People Share

For young people facing terrible job prospects and a generally bad economic environment going forward, starting a business sounds very appealing. It has advantages over embedding yourself in a big institution, taking your wages in forms of benefits, and hoping (against hope) to climb the ladder.

It’s never been easier to strike out on your own, except for one thing: Commerce is always harder than it appears. Success means overcoming challenges that seem insurmountable and that you never expected.

People write me all the time with business ideas, asking my opinion and some guidance going forward. Such guidance is almost impossible to provide. Also, giving advice is always dangerous. If the person takes it and flops, you are to blame. If they don’t take your advice, you will probably still be blamed.
And there’s another substantial reason that it is dangerous to offer entrepreneurial advice. Decision-making in commerce depends on too many variables of time and place, and it is impossible for an outsider to know them all well enough to provide consulting.

Still, I’m going to venture some broad advice that doesn’t depend on any particulars. It is this: Originality is overrated. Instead of trying something completely new, you are far better off copying someone else’s successful idea and customizing and improving it to suit the needs of a niche that you know best. Emulation is a better path to success. In fact, it is the only proven path.

This advice grows out of a lesson from the history of invention: The idea of the sole creator, the great innovator who came up with something entirely new that shattered an old paradigm, is a romantic idea, but is actually a complete myth. In the real world, innovation takes place over the course of tiny steps through the trials and errors of many people working in the field.

One reason we believe the myth is the menace of patent records. They have names attached to particular inventions and list no credits to those who came before, those who were working simultaneously on the same invention, and those who came after and improved it to make it actually serviceable and usable. These patents records are a major reason why we believe the myth of the sole creator.

The Wright Brothers myth is the favorite American story. It’s not entirely a myth that they were the first to accomplish a manned, controlled, powered, heavier-than-air flight over a substantial distance. But engineers the world over had been making progress in this direction for the better part of a century.



In fact, the most famous photograph of the first Wright Brothers flight could have been taken in many countries over the previous 50 years. For this reason, the newspapers refused to even report the now famous event because it seemed like no big deal.

The innovation of the Wright Brothers was actually quite marginal: a method for steering that allowed the maintenance of aircraft equilibrium. That’s significant, and it made a huge difference, but the patent alone would seem to imply that they depended not at all on the hundreds of others who had been making advances in manned flight.

Their patent did terrible damage to innovations in American flight after, as the litigious brothers hampered American engineers in their ability to improve the airplane, while engineers and entrepreneurs in European countries made much more rapid progress over the next 10 years. That’s the secret legacy of the Wright invention: It dramatically slowed down progress in flight technology.

The myth encourages would-be entrepreneurs to think about innovation in an entirely incorrect way. Another example of Godlike innovation that I’ve always heard is the case of Albert Einstein, whose equation E=mc2 caused the entire world of physics and philosophy to be revolutionized. Until now, I’ve never really questioned it. Maybe Einstein was, indeed, the great outlier in history, a rare case in which a single individual brought about a quantum leap.

Well, an article in The European Physical Journal says otherwise. It turns out that Einstein, too, must share credit with others. Stephen Boughn of Haverford College and Tony Rothman of Princeton University say that Friedrich Hasenohrl of Vienna deserves as much credit, given that he came stunningly close to discerning the same insight. Further, it was Max von Laue of Germany who gave the theory its legs by showing the equation was true not only for electromagnetic radiation, but for all forms of energy.

The point is not to take away from Einstein’s achievement or brilliance, but simply to observe that progress in knowledge is dependent on learning from others and hardly ever (maybe never!) takes place in gigantic leaps.

It’s the same with business. The software industry grew and improved through small increments of change. It was the same with the telephone, steel, electricity, steam power, telegraphy, printing, and every other invention. The patent trail is highly deceptive, chronicling only those who raced to the government office and filled out the right paperwork. It is not a record of those who deserve credit for the progress of humankind.

Innovation is dependent on emulation. Emulation is dependent on learning. Learning is dependent on access. And this is precisely why there is great reason to be wildly optimistic about the prospects for innovation now and in the future. Despite government regulations and ever more attempts by the powers that be to freeze the world in place and even roll back progress, progress will not be stopped.

The reason is the explosive advance in online learning and the sharing of information. This has always been the precondition for social advance. The Internet has completely revolutionized our capacity to learn from each other, which I regard as the most bullish sign for the state of humanity that I can imagine.

Consider just one learning platform: This platform allows anyone in the course to enroll in the world’s greatest college courses for free. If you take a minute to look through what it offers, one wonders why anyone pays for college at all, unless they absolutely have to. The education is right there, which is why in its short life, the website has already enrolled 2.4 million students who have taken 214 courses from 33 universities.

The knowledge capital of civilization is taking flight as never before.

What does this have to do with starting a business? Commerce is all about serving others. The making money part comes only after the service part is in place. To do that requires absorbing and processing information from wherever you can find it, copying those who have already done this successfully, and then making a tiny improvement that puts the enterprise over the top.

Oh, one more thing: In a world of universal knowledge distribution, you can never stop improving. Your competition is always watching and copying you. This is the life of business: total dedication to making unrelenting progress in the service of the wants and needs of others.

Contrary to what you might have heard, that’s what capitalism is all about.

Jeffrey Tucker

Original article posted on Laissez-Faire Today 

Smart People Share appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

Are You Confident in this Housing Market?

Since 2009, real estate hasn’t mattered.

Housing was bust. Board ’em up and call in the squatters. The evening news teams were there, shoving cameras in the faces of sobbing families in front of the endless rows of foreclosure signs.

We watched these stories unfold for the past five years. We saw how the housing bubble fueled the market’s rise from 2003-2007. As home prices rapidly appreciated, stocks followed suit. Housing’s top was then the bellwether for the 2008 collapse.

That’s when stocks and housing took separate paths.

Stocks vs. Case Shiller

Since 2009, equities had to blaze their own trail toward higher prices.

But that’s all changing now…

In just few short minutes, S&P/Case-Shiller releases updated home price data. The consumer confidence number will immediately follow. Two headliners in a week packed full of important data…

It’s fitting that confidence and home prices will share this morning’s financial headlines. Any way you look at it, price is all about confidence — in this case, the confidence that your house will retain its value and not bankrupt you. As this confidence grows, it will continue to spread to equities.

It’s impossible to deny the transformation in the housing market over the past 12 months. Rising prices, tight supply, building permits, housing starts — all pointing toward recovery.

And as much as we’ve tried to separate homes and stocks since the bottom four years ago, this stock market needs a healthy housing market. Investors need it, too. They need their net worth to remain safe, giving them the confidence to take on risk again.


It’s happening right in front of us. The numbers will continue to improve. A newly-stable housing market will help fuel stocks this year as they approach important milestones. It’s only a matter of time…

Greg Guenthner
for The Daily Reckoning

Are You Confident in this Housing Market? appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

The Race For California’s Shale Is On

It’s America’s final frontier for shale. And the payout will be huge.

Get this…

If you add up the recoverable resource estimate for the oft-mentioned Bakken formation in North Dakota, as well as the Eagle Ford in South Texas…then DOUBLE it, you’ll get close to the number of recoverable barrels of oil that remain trapped in the heart of this untapped “mega” shale deposit.

Put another way, according to the U.S. Energy Information Administration, this one massive shale play represents 64% of the total recoverable shale oil resource base in the country.

It’s the big kahuna, and today we’ll take a look at how the profit opportunities are stacking up for this behemoth…

But first, let’s tackle what I’d consider the most important question when it comes to any resource investment: why now?

Sure, we’ve always known California has oil. Starting early in the 20th century, black gold was flowing up and down the West Coast – propelling business and riches alike.

Of course, like most of the other conventional deposits in the U.S., output has slowly but surely declined.

Today, though, the shale revolution is turning those declining deposits around. From Texas to North Dakota and even towards the East Coast, shale oil and gas are changing America’s energy future. Natural gas is plentiful and oil is coming to the surface, more each day.

That is, except for one untapped shale deposit — what I call the big kahuna — California’s Monterey shale.

Unlike other shale turn-around stories California’s energy output has continued on a downward path. Once a 1.1 million barrel per day (Mbpd) state, California is now producing just half of that – around 500,000 bpd. But when operators in that area finally crack the code, you can bet production will rocket higher.

The best analogy is what we saw recently in Texas.

Once the code was cracked and companies found a way to produce oil and make money, total production for the state skyrocketed. Today, Texas is well on its way to eclipsing the mid-80’s production level above 2.4 Mbpd. Take a look:

Put in perspective, California’s Monterey is truly a sleeping dragon.

The sheer size of this deposit is staggering. In shale terms, the Monterey formation could hold as many as 400 billion barrels of oil. Of that 400 billion, over 15 billion barrels are considered recoverable with today’s technology. That trumps the recoverable estimates from the Bakken and Eagle Ford.

Getting back to the eye-popping statistics above, that represents a whopping 64% of America’s recoverable oil shale reserves. And the way I see it, it’s only a matter of time before this behemoth is spitting out profit opportunities.

That brings us to the other bit of timeliness to this story.

If we were talking about any state other than California (or maybe New York) this energy turnaround story would already be under way. Indeed, the Monterey would be a “household” shale player – with hundreds of rigs spinning as we speak.

But alas, this is California. The political and environmental red tape in the state have brought energy development to a virtual halt.

Of course, if that were the end of the story I wouldn’t’ be writing to you today.

Instead, the way I see it, there’s big change on the horizon. Soon, I believe California’s shale will be open for business…

A Confluence Of Events, The Tipping Point…

What’s the one thing that shale producing states have in common?

Well for starters, governments like Texas, North Dakota and Pennsylvania have enjoyed a boost to tax revenues via shale production. Along with that, unemployment rates are lower than the U.S. average and energy prices are affordable.

Currently California finds itself on the opposite end of this spectrum — a huge budget deficit, high unemployment and expensive energy. As the days pass and deficits increase, pressure mounts to tap this hidden revenue stream.

Another factor at play here is time. Each passing day with, safe, reliable, affordable, U.S. shale production ramping up, there’s more reason for California lawmakers and politicians to look towards shale production as a potential savior for out of control government budgets.

One recent example of this is New York State. New York was the first state to quickly ban shale development. But recently legislation is gaining steam to allow shale production. Indeed, if New York goes the way of shale, the road may be paved for California.

I believe today we’re at the tipping point. As you know I’ve devoted my professional career to “keep my boots muddy” in the resource space. That said, for the past few years I’ve stayed abreast of any worthwhile profit opportunities in America’s shale patch.

Up until now, I haven’t heard a peep out of California. But recently that’s changed. Frankly, I’m not smart enough to know “why” it has changed – whether the debt situation has gotten that bad or the deposit has gotten that good – but it has.

I’m seeing more talk from a political side about permitting and regulation – two things that wouldn’t be hitting my resource desk unless there was a change a’brewin.


In fact, as recently as December, California Governor Jerry Brown released draft regulations that could speed up shale development in the state. Along with that, also in December, the U.S. Bureau of Land Management auctioned off a handful of leases in the state.

The writing is on the wall for a ramp-up of California’s Monterey shale.

Here’s What To Look For…

There are two key factors to keep an eye on here – permits and production.

First, we’ll want to keep an eye on the permit process out west. If sweeping changes open up the permit process – allowing for a massive increase in permit approvals – it’s only a matter of time before the major players skyrocket (California’s usual cast of characters include: Chevron, Shell, Exxon, Occidental and Venoco.)

A change in tone from the political side could fuel this permit turnaround, and the impending shale boom. Is the incumbent Gov. Jerry Brown the pioneer for the job? We’ll see.

However, there is one other force that could boost permitting.

In a similar way that more permits can lead to more production, production can lead to permits. What I’m looking for here is a “code crack” for the Monterey shale. For instance, if an operator in the area can “crack” the Monterey code, and start drastically increasing the production per well, we could see a turnaround for the whole state.

This is similar to what happened in North Dakota, Texas and Pennsylvania. Quietly, but quickly, the shale-code was cracked and production per well started jumping off the charts. The immediate effect was a drastic increase in tax revenue for the state. In the case of ND, TX and PA the states welcomed the bump in tax revenue with open arms and accommodating regulation – meaning plentiful permits.

If permits and production perk up, watch out. The shale boom on the West Coast could come fast. Keep your ear to the ground on this one.

Keep your boots muddy,

Matt Insley

Original article posted on Daily Resource Hunter 

The Race For California’s Shale Is On appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

avatarThe Daily Reckoning - The Daily Reckoning posted Tuesday, January 29th, 2013.

Post a Comment

* Copy This Password *

* Type Or Paste Password Here *