The Second Crash – On the Way and Unstoppable
By Doug Hornig, Editor, BIG GOLD

Tuesday, October 9, 2007 started as a nice day in New York City. A lovely early fall day, with the temperature still a balmy 80° at 2:00 in the morning. By evening, though, the temperature had dropped twenty degrees, the clouds had rolled in, there was thunder and rain.

As with the weather, there were some hints of trouble here and there on Wall Street. But all in all, things could not have seemed better. Little did we know, the stormy end of 10/9/07 signaled a very large bubble that had just popped.

That was the day when the Dow Jones Industrial Average hit its historic peak. From there, it was all downhill -- slowly but steadily at first, and then violently after last August -- until the Dow bottomed (for now) on March 9 of this year. Over that span, the index lost 54% of its value.

It’s been a crushing blow to just about everyone. But it’s already being referred to as the crash. As if the unpleasantness were now all behind us. More likely, in the future it will be seen as, simply, the first crash.

Don’t believe it? In a moment you will, when you see the scariest graph of the year.

But let’s quickly recall what’s already happened. During the late, great housing boom, interest rates were at microscopic levels, while bankers were encouraged to grant home loans on little more than a wink and a nudge. In order to inflate their balance sheets, those bankers resorted to all sorts of gimmicky, adjustable rate mortgages (ARMs), whose common feature was an interest rate that would eventually reset. That is, it would balloon somewhere down the road. And those most likely to come quickly to grief were the riskiest borrowers, who held loans known as “subprime.”

“But not to worry,” borrowers were told. “Betting on ever-rising home prices is the safest wager in the whole wide world. If you have problems with cash flow when the ARM resets, your house will be worth a lot more, so you can simply sell it and walk away with a nice chunk of change in your pocket.” Uh-huh.

The bankers themselves were a little more concerned about the deterioration of their portfolios. They took out insurance in the form of credit default swaps (CDSs). These were a brand-new invention in world financial history, allowing mortgages to be sold and resold until they were leveraged 20 times over. They became the shakiest part of a huge global derivatives market, with a nominal value in the tens of trillions of dollars.

For a while, this Ponzi scheme even worked. But then, as they had to, the ARMs began resetting, and there were defaults. Then more of them. Because at the same time, the housing market was cooling off and the economy was stalling out. More and more people were trapped in a situation where they owed more on their home than they could sell it for. Many simply mailed their keys to the bank and moved on.

All of this wreaked havoc in the derivatives market. Sellers of these exotic packages could no longer establish what they were worth. Buyers couldn’t determine a fair price and so stopped buying. As the ripples spread through the world financial system, trust disappeared and liquidity dried up.

Now consider that the base cause for all that dislocation was the subprime sector. And how big is that? Not very. Subprime mortgages account for only about 15% of all home loans. Their influence has been way out of proportion to their numbers, because of derivatives. Here’s the good news: the subprime meltdown has about run its course. These loans were resetting en masse in 2007 and the first eight months of ’08. Now they’re pretty much done.

And the bad news? No one in the mainstream media seems to be asking what should be a pretty obvious question: What about loans other than subprime? Truth is, the banks didn’t just trick up their subprime loans. ARMs were the order of the day – across the board.

Now, here’s that frightening graph we referred to earlier.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Take a good, long look. You can see that from the beginning of 2007 through September of 2008, subprime loans (the gray bars above) were resetting like crazy. Those are the ones people were walking away from, sending a shockwave from defaults and foreclosures smack into the middle of the economy. Now they’re gone.

The ARM market got very quiet between December 2008 and March 2009, hitting a low that won’t be seen again until November of 2011. Small wonder a few “green shoots” have poked their heads above ground. But in April, resets began to increase and will reach an intermediate peak in June. After that, they tail off a little, going basically flat for the next ten months.

It’s not until May of 2010 that the next wave really hits. From there to October of 2011, the resets will be coming fast and furious. That’s 18 months of further turmoil in the housing market, and the beginning is still nearly a year away! (Although the months in between are likely to be no picnic, either.)

While it isn’t subprime ARMs that are resetting this time, neither are they prime loans. Those eligible for prime loans wisely tended to stay away from ARMs in the first place, as indicated by the relatively small space they take up on each bar.

No, the next to go are Alt-A’s (the white bars), Option ARMs (green) and Unsecuritized ARMs (blue). Alt-A’s are loans to the folks who are a small step up from subprime. Unsecuritized loans are a 50-50 proposition; either the borrowers were good enough that they weren’t thrown into the CDS pool, or they were so risky no one would insure them.

Those two are bad enough. But Option ARMs are the real black sheep, loans with choices on how large a payment the borrower will make. The options include interest-only or, worse, a minimum payment that is less than interest-only, leading to “negative amortization”—a loan balance that continually gets bigger, not smaller. Imagine what happens with those when the piper calls.

Once the carnage begins, will it be as bad as the subprime crisis? That’s the $64K question. Perhaps not. For one thing, subprime loans were a much larger chunk of the market when they started going south. For another, there’s been a lot of refinancing as interest rates dropped; that should help ease the default rate. And the government has massively intervened, with measures designed to prop up those who would otherwise lose their homes.

On the other hand, we’re in a severe recession, which wasn’t the case when the subprime crisis started. More people will be unable to meet payments. And the housing market has continued to decline, pressuring both marginal homeowners and banks that can’t sell foreclosed properties.

Is the stock market’s next 10/9/07 on the way? Yes. Which day will it be? That’s unknowable. It could be in a week, or not for another year.

But make no mistake about it, the second crash is coming. It can’t be prevented, no matter what desperate measures Obama and his hapless financial advisors come up with. All we can hope for is that, with a little luck, it won’t be as severe as the first one. But it will last longer. We aren’t even in the middle of the woods yet, much less on the way out.

The order of the day is to be very defensive. There will be few safe havens, but they do exist. Read our report on “48 Karat Gold,” a gold-related, conservative investment that has continued going up even while the common stock market bombed. It’s not too late to profit… click here to learn more. __________________________________________________________________

The Price of Oil -  How did it get here, and where is it going? By Marin Katusa, Senior Editor, Casey Energy Opportunities

What a difference a year makes.

While March lions and April showers were at work in 2008, so were these factors in the U.S. and global economies:

• The Dow Jones Industrial Average remained steady above 12,000.

• The leading indicator of existing home sales was down over 21% from the previous year, and the official unemployment rate was just beginning its upward creep by crossing the 5% mark.

• The first official admissions of the “R” word. In early April 2008, the International Monetary Fund (IMF) declared a 25% chance of a global recession, and Federal Reserve Chairman Ben Bernanke told Congress that gross domestic product “could even contract slightly.”

• The novelty of bailouts began. Bernanke also assured Congress that the Fed's emergency authorization of a loan against $29 billion of Bear Stearns assets wasn't putting taxpayer money at risk: “I feel reasonably confident that we'll be able to recover all the principal and indeed some interest, and there is some chance of even upside beyond that.”

• The dollar's six-year slide against the euro, hitting its lowest ever at $1.60 in late April. It also fell below the 7-yuan mark in China for the first time.

• And oil, comfortably above $100/barrel, was heading for its summer crest of $147.

A scant 12 months later, the Dow is trying to stagger back from a plunge to 6,500. Home sales are hinting a possible turnaround, unemployment (even the official, conservative figures) is expected to reach double digits before long, “recession” and “bailout” are household words (often accompanied by four-letter ones), the dollar is recovering... and a barrel of oil is worth half that hundred dollars. Hardly worth pulling out of the ground.

What happened? And even more important for us as investors, what's going to happen?

The Casey Energy Opportunities team pulled together the pieces of the oil sector picture that other sources tend to scatter or ignore. We’ll give you a broader understanding of the drivers within the oil industry, the markets in which they operate, and how you can use that knowledge to push your profits upward.

The Oil Industry Now: A Rock, a Hard Place, and a Supply Glut That Isn't

Everyone who drives a car or heats a home with petroleum has welcomed the fall in oil prices from their high in the summer of 2008.

While it's hard to argue that filling your tank at $2 per gallon is a lot easier on the wallet than $4 or $5 per gallon, the broader economic effects of such low oil prices are troubling.

Leading the concerns is the drop in oil exploration and drilling that accompany a drop in price. Below the $50/barrel mark – and for many companies the bar is closer to $65 even for conventional fields – oil producers typically spend more money getting oil out of the ground than they can recoup by selling it. At the same time, turbulent financial markets have tightened credit. These two factors have pressured producers to allocate exploration budgets away from drilling projects and toward meeting debt obligations and day-to-day operating costs instead.

The plunge in prices has consumed the cash buffers of even the major oil companies. ConocoPhillips, for example, announced in January that along with eliminating 1,300 jobs and writing down $34 billion in assets, it was also planning to cut its 2009 investment budget by 18%. Exploration projects are part of both writedowns and spending cuts. The results of curtailed exploration are two-fold. First, some oil companies will be simply unable to survive the economic crisis. Second, supply in the longer term is being sacrificed to stay afloat now.

Storage facilities are bulging. The chart below shows the contents of the Cushing, OK, storage facility — where NYMEX deliveries take place — have recently doubled from their average 2008 volume. Along with a host of other facilities around the world, it got this way because of an unusually dramatic contango at the beginning of 2009. (A contango is a kind of market inversion, when the current [spot] price dips lower than the future price.)

In January, the spot price of oil plummeted as low as $37/barrel, while futures for July delivery were trading for $52. That meant if an oil company could buy and store product for seven months, it could lay out $37/barrel and be guaranteed a profit of $15 – or 40%, minus costs – in July. And indeed the buying frenzy took off, reinforcing the decision to turn off the drills.

So for the moment, we are artificially flush with oil, and demand has dropped as the global economy will likely shrink for the first time since World War II. It’s no surprise that oil prices have been staying down.

Many analysts say we won't feel the effects of declining exploration for a few years. But the numbers are emerging already. According to the U.S. Energy Information Administration (EIA), non-OPEC countries demonstrated an average annual growth in supply of 570,000 barrels/day from 2000 through 2007. In contrast, they recorded a drop last year of some 300,000 barrels/day.

At the same time, OPEC appears to be conforming to its production cuts of 4.2 million barrels/day, begun in September 2008. The oil cartel is known to announce cuts that its members don't actually follow; it's in their economic best interest, if only in the short term, to sell all they can. But this time, oil has plunged far below levels to sustain their economies. Even Saudi Arabia expects to run a budget deficit this year.

OPEC, which produces about 40% of the world's oil, would like to see prices around $75/barrel, at least. But the fragile global economy would have a difficult time absorbing such a price at the moment, and the cartel decided against further production cuts when it met in March. In fact, some three weeks later, Saudi Arabia actually announced a price cut on all its grades of crude to European, North American, and Mediterranean markets – a dramatic attempt to spur demand amidst high inventories.

So, entwined as it is with the economy, the oil industry is currently in a conundrum. The fix it requires – higher prices for its product – will choke the framework in which it operates.

At the same time, we've got supply problems ahead.

How Did We Get Here Anyway?

Like many aspects of the markets, movements in price are driven partly by real factors and partly by perception. Rags-to-riches-to-rags-to-riches Texas oilwoman Sue Sanders summed it up when she noted wryly in her 1940 autobiography that “nothing succeeds like reports of success.”

Last year's run-up of oil was no exception: part real, part report. Some of the real factors:

• The weak U.S. dollar. The United States is not the only country that buys oil in U.S. dollars. The price per barrel is pegged to it, in fact. When the dollar is weak, the cost of U.S. exports drops; and indeed by December 2008, the U.S. trade deficit had fallen to its lowest in nearly six years ($39.9 billion, according to U.S. Commerce Department data). However, a weak dollar means it takes more dollars to buy a barrel of oil. Global concerns over the strength of the U.S. economy, including America's ever-rising level of debt, had undermined the dollar to the point that OPEC members began to murmur about dumping it for the euro or a basket of currencies.

• Geopolitical turbulence in oil-producing countries. The Iraq war, oil-related militancy in Nigeria, and Iran-Israel-U.S. posturing over nuclear issues were hotspots in the first half of 2008. The average nightly news covered casualties in Iraq, but industry watchers tracked attacks on pipelines and oil facilities. Likewise, in Nigeria, sabotage and oil worker kidnappings by militant groups such as the Movement for the Emancipation of the Niger Delta (MEND) regularly shut down facilities to repair, negotiate, or improve security. And as spring warmed up, so did the war of words between Iran and Israel. By early July, Iran had gone so far to indicate it would move against shipping in the Persian Gulf if attacked. The United States would have moved next, of course... thus driving up the price of oil in the jittery oil markets, which depend on Persian Gulf shipping lanes.

• Unusually low crude and gasoline supplies entering the 2008 summer driving season. In early April, the EIA reported significant drops in supply – gasoline declined by 4.53 million barrels and crude oil by 3.2 million barrels, a one-two blow that surprised and worried industry watchers. Behind the gasoline slump were lower refinery margins, called crack spreads. In mid-March, when refineries would normally be coming off their maintenance schedules to churn out gasoline for summer driving, the margin for turning a barrel of crude into gasoline was negative for the first time in three years. Refineries sought profits in other oil products, and the markets responded to the expected imbalance in supply and demand.

• High demand. China is a stand-out here, and for more than its usual energy appetite. China has a penchant for aiming to break records – from its goals in five-year plans and building projects to its haul of Olympic medals – and in the first half of 2008, it was visited by some dramatic examples: a great earthquake and major snowstorms, events that disrupted the country’s energy industry. Combine that with the fact that China was also preparing for the Beijing Olympics in August, and it’s easy to understand why it was buying oil very heavily until mid-summer.

On the perception side of price drivers, it's hard to overlook the fact that the market push stayed strong in the face of increasingly gloomy economic data. Casey Research was earlier than most in predicting the economic crash (we published reports such as “The Coming Currency Crisis” in June 2006), but by spring 2008, even officialdom was dancing around the word recession.

Normally, news of burgeoning foreclosures, plummeting home sales, spiking personal and business bankruptcies, rising unemployment, and other economic indicators would tend to exert a bearish influence. After all, consumers generate 70% of U.S. economic activity, and if they stop or cut back on driving to work or the shopping mall, telephone relatives or business partners instead of flying out to see them, reduce purchases of items containing plastics, turn down the thermostat, and other weather-the-storm measures, oil consumption should decline.

It took months for all these drivers to realign – but as we all know, they did, and then some. The chicken-and-egg debate, whether oil's sky shot triggered or portended the economic debacle in the closing months of 2008, will require more distance and data to resolve. But it's true that the dollar had started its comeback by mid-summer, supply had caught up, geopolitics had settled a bit, China backed off on its buying, no major hurricanes hit – but economic realities did.

Meanwhile, Congress jumped up and down and cried “Speculators!” “OPEC!” “Oil producers!” in tidy sound bites.  

The Next Big Plays: Where You Need to Be

Oil companies are influenced by the range of market drivers and economic conditions according to size. The junior oil producers, those with market capitalizations of $250 million or less, have the small-business advantage of flexibility when times are good. These times aren't good, of course, and even well-managed juniors with good projects are in trouble. Their vulnerability is in the credit market. You’ve likely heard of credit lines being revoked and refinancings denied to people with impeccable credit. Now imagine pitching a drill project without a wallet full of assets ready to lay on the table.

Mid-tier producers, with market caps between $250 million to $2 billion, will look to mergers and acquisitions to survive. The majors ($2-20 billion market cap) and Big Oil (over $20 billion) will also be shopping. With low oil prices shutting down exploration, development, and even production, these companies will be looking to replace their reserves instead by purchasing smaller, solid companies with proven production. It's simply cheaper.

We see two ways to profit from this trend.

First, we buy shares in undervalued, producing companies that are profitable even below $40/barrel, are best of peer, and own large reserves. These are the companies that Big Oil will be looking to acquire. One such company, an oil sands producer, is currently a part of the Casey Energy Opportunities portfolio.

Second, we believe that owning a potential consolidator is the best position. As debt load and low commodity prices overtake them, junior producers will be forced to consolidate their projects. We currently own one such candidate, and are scouting for others with such muscle. Consolidators will be purchasing projects from the bank at 25 to 30 cents on the dollar.

Our tactics have already paid off handsomely in the last six months: all our recent recommendations have been on fire. A few tripled their value, and one generated a return of 540%.

As we’ve seen, supply problems are looming, no matter what timetable of Peak Oil you may believe in. With increased demand inevitably come higher prices. Our approach at Casey Energy Opportunities positions us to take advantage of the trend in both the short and longer term. And we guide our subscribers not only when to buy or sell, but also when to take profits and a “Casey Free Ride” to eliminate risk.

We’d like to offer you the opportunity to kick the tires of Casey Energy Opportunities RISK-FREE for 90 days, with 100% money-back guarantee. Click here to give it a try._________________________________________________________________

Gold Stocks – the Best Strategy for Portfolio Building
by Jeff Clark, Editor of BIG GOLD

October 27, 2008 was the gold mining sector’s Black Monday, the day nearly every stock hit rock bottom. Hindsight makes it plain they got caught in the violent deleveraging that sucked down every equities market in the world.

The broader markets were of course making year-to-date lows at the same time, and unlike gold stocks, they continued falling after a short intermission. In fact, the Dow fell 2,000 points after Obama was elected. In sharp contrast, the mining stocks went on a tear. Between November ’08 and January ’09, many of our BIG GOLD picks made substantial gains, rising anywhere from 45% to 149%.

This good news isn’t the whole story, of course; many mining stocks saw percentage losses greater than the broader market averages during the Big Selloff. But given the fact that gold stocks started rebounding while the broader markets continued lower, the BIG GOLD portfolio ended the year down 24% while the S&P lost 38%. We were also glad to see our portfolio responded better than the HUI; the broad-based mining index lost 32% on the year. Meanwhile, the demand for physical gold and silver was surging, likely attributed to investors who’d been spooked by the broad meltdown.

We held on to our shares throughout the selloff and advised our readers to do the same – and subsequently watched our stocks rebound mightily. And we fully expect these kinds of surges to repeat as gold pushes higher. Keep in mind that the real mania is yet to come. Once inflation responds to the Federal Reserve’s ongoing monetary foolishness, gold will need a space suit and our miners oxygen masks.

A key point to remember going forward is that gold mining shares constitute a minute fraction of the global equities market, and a small shift in investor interest toward our sector can move gold stocks sharply higher in a big hurry. The market cap of the fifteen largest gold producers in the world -- combined -- is a paltry $125 billion. That’s barely more than a single company such as General Electric, at $116B; much less than Microsoft ($175B); and waaay less than Exxon Mobil at $400B.

Miners have also had a temporary respite from high energy costs due to the collapse in the price of crude oil. Energy is one of the biggest expenses a miner has to carry. As energy prices came down, the cost of producing gold also declined, fattening the bottom line. Oil is likely to get back to and then beyond $143 per barrel at some point, but not for a while. We doubt it will top $75 this year, which is enormously helpful for our companies.

Recently, gold stocks have outperformed bullion, a trend we’re keeping an eye on and one we’re confident will continue in the future, especially when we see the certain emergence of serious inflation and the dollar resumes its downtrend.

So… what to do now?

What we hope you’ve been doing all along. Our general rules: If you’re already fully committed to this sector, stay the course; you will be well rewarded.

For those with money still to invest, accumulate well-run, sound companies on weakness. Volatility will continue; we expect days and weeks marked by retracement in the prices of even the best companies. The dips will be your buying opportunities. Place below-market bids and let the price come to you. Take positions with half or so of the funds you’ve allotted for this sector, then fill out your portfolio with whatever bargains come your way.

Whether you’re already full-up with gold stocks or are just getting started, you should be well positioned before the all-out mania for gold stocks hits.


The Quandary of Timing

It may surprise some to hear that we are not “all-in” yet with our portfolio. Why? Because our attitude is one of caution, and because we know that our big gains since October could get clawed back, partly or wholly, by another reversal – which would lead to another buying opportunity we wouldn’t want to miss.

But caution can be expensive when the market runs away from you. What if the train has already left the station? In that case, those waiting on a pullback will be disappointed. Just as all below-market bids placed on October 28 of last year went unfilled, so could today’s, or tomorrow’s.

Looking as little as a year out, our money is confidently on our stocks going higher – much higher. We expect the government’s assorted “stimulus” packages to fail to deliver as advertised, and usher in high inflation. This will push gold and gold stocks much higher. 

But the question is, if the broader markets head lower, will gold stocks follow them down or ride on gold’s coattails?

That question leaves you in a quandary only if you’re looking at the short term. Or if you get emotional about this stuff. Those with no stomach left after the gut-wrenching selloff into last October probably shouldn’t deviate from the cautious strategy outlined above. If you’re one of those who see the big picture and ignore the gyrations along the way – which is what Doug Casey does – then you’re drawn to the idea of placing a bet when you judge that the odds are in your favor. It’s when you see the price of something is far less than its value that you can have the confidence to load up, whether that’s today or perhaps later this summer. 

Whether you buy today or wait in hopes of a pullback, we believe you’ll be looking at profits a year from now. In the big picture, our stocks are still deeply undervalued, even after so many of them have doubled off their lows. But could they retreat again? In a general market pullback, definitely. Could they tread water for a while? Certainly. And could they leave present levels in the dust and double again from here? Absolutely.

There are times when one must put away the crystal ball and simply prepare for more than one scenario. This is one of them. Whether you respond more conservatively or more aggressively, keep your eye on the endgame. We think you’ll be glad you did.

Prudent precious metals strategies for conservative investors – that’s what BIG GOLD is all about. And now that the gold price is going up again, you shouldn’t wait to jump on the bandwagon. Read in our latest report why super-low interest rates mean we could see $1,500/oz gold this year – click here to learn more.