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The Daily Reckoning | Sunday, April 14, 2013 Of “real money” and “fringy cyper-crypto currencies”... A reader writes in with a query about conflicting viewpoints... Plus, all this week’s reckonings archived for your Sunday afternoon enjoyment... --------------------------------------------------------------- The Embarrassing FACT We Found on Page 210 of the White House Budget... On Page 210 of Obama’s latest budget, we found a fact that should embarrass... or enrage... every single American. It doesn’t matter if you’re a Republican or a Democrat. What exactly did we find? Click here to find out. Joel Bowman, checking in today from Buenos Aires, Argentina... Whoa! Did you see that? The wonder currency of bitbugs and anarchist types crashed big time this week...all the way back to a (roughly) 400% gain YTD! Woe to those ne’er-do-wells and techno-geeks. ¡Pobrecitos! As you might recall from our scribbles last weekend, the price of a single unit of the digital currency had risen meteorically in recent times...from a “paltry” $12 back in January to a vertiginous high of $260+ this week...before plummeting back to the upper double-digits (as we write). What to make of it all? The question is deeper than a mere price chart reading...it demands actual thinking. More on that in a second... Meanwhile, back in the world of “real” monies... Stocks were up 300 points this week...at least as they are priced in the government’s rapidly increasing supply of dead president- emblazoned paper notes. Hmm... Gold tumbled through the psychological $1,500 mark on Friday. Last we checked, an ounce of the Honest Metal was trading for around $1,480. A buying opportunity? Maybe... Meanwhile, the Fed, the BoE and the ECB are providing a “jolt” of freshly inked currencies to their respective economies, hoping to prop up optimistic asset prices. The rate of expansion is, says Bill Bonner, “unprecedented in world history.” How will this all end? “We don’t know,” asserts Bill, with characteristically emphatic uncertainty. “We simply note most of the world’s major central bankers are putting their money on the same color... and as the wheel spins... we urge dear readers to leave the casino. “Neither in yen, euros, pounds nor in dollars should we be. For when the dust finally settles on this wild riot of radical gambles by central bankers, gold will be the ‘last man standing.’” Which brings us back to the notion of money...and of man’s inextricable relationship to it. First there was commodity-backed money: gold/silver/bimetal-pegged coins and the like. Then came politically-backed money: Think of the post-’71 U.S. notes, backed by the “full faith and credit” of the United States...and the formidable military industrial complex standing behind them. And now...what? A mathematically-based currency? That’s what the “bitbugs” would have us believe. But are they to be trusted? Will 2+2 always = 4? In the hands of the politicos, no. But in the safekeeping of non-Procrustean “rulers”...i.e., the market? As we see it, the bitcoin concept can be roughly divided into three main “tiers.” 1. The Bitcoin protocol; the code upon which the bitcoin network, a decentralized ledger of transaction records, is secured. An open- source code, this has been wide open for would-be hackers to “crack” for four or five years now...maybe longer. It’s the “holy grail” of the “hacktiverse.” You’d think some basement-dwelling nerd would have cracked it by now. Of course, just because it hasn’t happened yet, doesn’t mean it can’t happen. And if it does, game over...at least for this iteration of the decentralized, digital currency experiment... 2. The peripheral service providers currently populating and building out the network’s infrastructure. These are the exchange portals, wallets, various apps and associated support software. This “downstream” market is extremely nascent and, as we’ve seen, highly prone to fracture under pressure...for now. And finally... 3. The price of bitcoin itself, largely -- at this stage -- driven by speculators and “get-rich-quickers.” (Again, for now...) As we’ve seen in recent months, the network infrastructure is far from robust. But is it, to hijack a Talebian term, “antifragile”? Does it, in other words, become stronger, more resilient, under the increasing strain of speculator-driven stressors? The last crash, in which the currency increased some 30-fold in a matter of weeks...only to collapse 16-fold in a matter of hours, would seem to suggest so. Why? Because the underlying, first tier code remained strong, allowing the second tier participants to resume building out a stronger, more resilient infrastructure on its solid foundation. Antifragility. The bitcoin economy of 2011 could never have supported a participation increase that drove the price of the currency to even $50, much less $100...or more. It fell from $30 per coin to less than $2. The message to downstream engineers was clear: you’ve got all your work ahead of you. After some post-shock frustration, they got back to work. If you build it, goes the old adage, they will come. And come they did. In droves. This time, the network infrastructure cracked in spectacular fashion...though at a much higher pressure point. Moreover, the price fell far less this time around, in percentage terms, than in the last episode. If and where it stabilizes is, of course, anyone’s guess...but the real question remains one concerning first tier integrity. Will the foundation upon which the concept is built remain strong? Additionally, will the second tier infrastructure participants continue to respond to corrections creatively, organically, building new and better services? Markets that are “allowed” to crash, sometimes violently, are usually quick to adapt and evolve, something akin to Schumpeter’s “creative destruction.” They are dynamic, responsive, adaptive. In sharp contrast, markets that receive government/taxpayer-sponsored bailouts are “fragilized”...rendered deaf to the market’s timely lessons...and mute in response to the new demands and expectations of market participants. This is a complex subject, Fellow Reckoner, one deserved of more head scratching in the future. In the meantime, frequent DR contributor, Chris Mayer, the new group of metals that Rick Rule -- perennial favorite at our annual Investment Symposium in Vancouver – says should skyrocket in the very near future. (Hint it’s not gold or silver.) Please enjoy Mr. Mayer’s own reckoning, below... [NB. This column originally appeared in The Daily Reckoning on Tuesday, April 9, 2013.] The Daily Reckoning Presents: “Gold and silver come from many countries and many geologies and as a byproduct with other metals,” Rick says by way of analogy. “But about 90% of platinum and palladium supplies come from South Africa, Zimbabwe and Russia. And they are enormously constrained.” How constrained? Well, South Africa is by far the most important producer. Let’s start there. Read on... Rick Rule’s Favorite New Thesis By Chris Mayer I was chatting with Rick Rule last Friday. Rick is now part of Sprott Asset Management, one of the most respected natural resource investors around. Rick also had a ridiculously good long-term track record in managing money before joining Sprott. Anyway, Rick has a new thesis he is hot on: platinum and palladium, or, more broadly the platinum group metals (PGMs). I’ve learned when Rick gets hot on an idea, it is worth listening to him. Last time I heard him this passionate about an idea was in 2010, and the subject was uranium. (Readers of Mayer’s Special Situations newsletter will recall we picked up Kalahari Minerals in February 2010 and bagged a 70% gain in about a year.) The thesis is simple, as most good ones tend to be. “What we discovered in about four weeks’ work,” Rick told me, “is that the platinum and palladium mining industry as a whole does not earn its cost of capital. What that means is that either the prices of platinum and palladium go up or there is less and less of it going forward.” Another way to say it is that the platinum and palladium business, as is, doesn’t pay investors enough for the risks they take compared with alternatives. So it means people will not invest new dollars in the sector. No new investment in mining means depletion of existing mines with no new sources of supply. Eventually, the price has to go up as rising demand (or flat demand) presses on a diminished supply. What’s unique here is that platinum and palladium face particularly challenging supply constraints. “Gold and silver come from many countries and many geologies and as a byproduct with other metals,” Rick says by way of analogy. “But about 90% of platinum and palladium supplies come from South Africa, Zimbabwe and Russia. And they are enormously constrained.” How constrained? Well, South Africa is by far the most important producer. Let’s start there. “First, it doesn’t earn its cost of capital,” Rick says. “And that has manifested itself in a few ways, but the most important is that the industry by its own estimate has deferred between $6-8 billion in capital investment.” No surprise, then, that production has fallen 19% in six years. “We’re not talking about a set of circumstances that is going to affect production at some future date. We’re talking about a set of circumstances that is already driving higher production costs and lower production.” Rick took me through the situation in South Africa in some detail. The mining industry there is labor-intensive for reasons both historical and geological. Workers are poorly paid. Labor conditions are truly awful. “Workers are crawling across broken rock on their hands and knees, often carrying 125-150 pounds of hand-operated drills with them,” Rick says. “Worker mortality was always disgusting in South Africa, but it’s becoming frightful now.” Workers have almost certainly seen a co-worker killed, if not maimed. “The point of all this,” Rule says, “is that workers’ wages have to go up. But because the industry can’t earn its cost of capital, wages can’t go up.” It’s a hard spot to be in -- but it seems clear that something has to give. Once again, the price of the metals has to go up or production will continue to dwindle as rising costs put these miners out of business. Mining is, of course, energy intensive. And the power industry has a political mandate to provide cheap power for people who can’t afford it. So the mining industry pays more for power but is also the first one to be interrupted. There have been no capacity upgrades in 12 years, Rick says. Meanwhile, demand keeps rising. Antiquated power plants struggle to keep up with demand. Not a promising picture for the most important supplier of mine production of platinum and palladium in the world. Then there is Zimbabwe. “Which I can dismiss very quickly,” Rick said. “Zimbabwe had a viable platinum and palladium industry 10 years ago. Robert Mugabe took care of that.” The industry “de-capitalized itself,” as Rick put. “It can’t be turned around in any reasonable amount of time with any reasonable amount of money.” Moreover, when Mugabe dies, the struggle to succeed him could well paralyze the country for years. “I don’t see Zim affecting platinum or palladium supplies for at least a decade,” Rick sums up. The final alternative is Russia. “I believe it is getting better,” Rick said, “but it is getting better from a low starting point. The problem there isn’t political, it’s geological. The ore bodies of Norilsk, which are the biggest PGM ore bodies in the world, are 80 years old. They are long in the tooth, started by Stalin. And as you get deeper and deeper, the concentration of palladium declines.” Potentially, there is another deposit, but it is about 400 miles from Norilsk, which itself is in western Siberia and is fairly remote. Rick speculates that it will happen in 10 years and take billions of dollars. Short story: It’s not going to happen anytime soon. As Rick says, this is not a resource story that’s going to take place in two-three years. It’s a story that’s already taken place over the last five-six years. I asked about recycling. Rick told me that recycling makes up about 30% of supply. “It is the only source of supply that has been growing,” he says. “It has increased as a percentage of total supply by 50% in the last 10 years.” What about substitution? “Substitution doesn’t make sense at anything less than a 100% increase in price,” he guesses. And the demand scenario? Compelling. “Platinum and palladium go out a tailpipe, go up a smokestack or get turned into jewelry -- that’s what happens to it,” Rick says. They are incredibly useful metals. “The social trade-off is really platinum versus smog,” Rick says. “I mean that’s really what it’s about. The air quality we enjoy today in Western Europe and North America and Japan is a function of catalytic conversion. It takes only about $200 of PGMs at today’s prices to afford the air quality we all enjoy. And that’s $200 against a median sticker price of $27,400 for a new car in the U.S. If the price doubled, the demand implication would be de minimis.” The emerging markets are a big potential source of demand. China eclipsed the U.S. as the largest auto market last year. But its use of platinum and palladium remains a small fraction of North American consumption. “The price has to go up, and can go up,” is the pithy summation Rick offers up. “It’s a thesis that is really, really difficult to poke holes in.” Unless the Western world goes off an economic cliff and vehicle sales get cut in half, it is hard to imagine anything less than a 50-100% increase in price. As you can see, this is a thesis worth investigating further. Regards, Chris Mayer for The Daily Reckoning Ed. Note: Finding ways to profit from the developing PGM story can be tricky. But with that 50-100% price increase on the horizon, now is certainly the best time to take full advantage of this market. That’s where our friends at the Hard Assets Alliance come in. Simply put, HAA provides customers with one of the best ways we’ve ever seen to buy, sell, store or take delivery of your precious metals -- all with just a few simple clicks of your mouse. And given the supply/demand dynamic we’re seeing in the PGM sector right now, this is definitely one of the best ways to gain exposure before prices skyrocket. Opening an account is completely free, so at the very least, we recommend you check it out and see if it’s right for you. Click here now to see for yourself. Note: Because we have a business relationship with the Hard Assets Alliance, we may be compensated if you open and fund your account. But we wouldn’t mention them unless we were fans of the platform. Government Mandate Creates Potential Investor Jackpot... One obscure firm has found favor with government. It’s developed a foolproof way to detect counterfeit goods...and has been rewarded with a virtual monopoly. The Pentagon has released documents explicitly stating that certain contractors must do business with this firm... making this a potential profit-gusher. Few have caught on but they soon will. Get all of the details, here -- before it’s too late. ALSO THIS WEEK in The Daily Reckoning... Thievery in Cyprus Means Pain in Spain By Dan Amoss Ignore the latest Justin Bieber antics! Pay no attention to the continuous CNBC cheerleading for the S&P 500. Wake up and smell the coffee brewing in Cyprus! You’ll be ahead of the investing public, currently tranquilized by the belief that risky assets will never fall again with Ben Bernanke in charge. This brewing Cyprus issue is far bigger than the market believes... FDR’s Gold Confiscation, 80 Years On By Ben Traynor EXECUTIVE ORDER 6102, issued by US president Franklin Delano Roosevelt 80 years ago, on April 5th 1933, banned private gold ownership in the United States, forcing gold owners to take their bullion to a bank and exchange it for Dollars at the prevailing rate. The Fed's Attack on the Elderly By Dennis Miller The Federal Reserve is, of course, a bank. So after it has a meeting, it issues a statement outlining the discussion -- a “bank statement.” Hmm... Now that I think about it, that must be where the acronym “BS” comes from. I pride myself on explaining complex financial situations in everyday language. However, when it comes to the Federal Reserve, I readily admit that I am sometimes befuddled. I used to watch Alan Greenspan testify before Congress when he was Chairman of the Fed, and I often ended up asking myself, “What did he just say?” The Fed’s code and doublespeak is Greek to me, as it is to most folks. Financial Refuge From Mutually Assured Destruction By Dan Denning There hasn’t been a real military crisis to take financial markets to the boiling point in some time. In fact, since the collapse of the American real estate bubble in 2007, stock markets have been driven more by monetary policy than anything else. The “Arab Spring” was big news. But markets largely ignored it. Will they ignore the possibility of a war on the Korean peninsula? Ronald Reagan’s Little-Known “Loophole” In October 1986, Ronald Reagan created one “off-the-radar” investment loophole. By refusing to force companies and the government to pay for what you see below, Reagan opened up the floodgates for investors... Savvy individual investors have been quietly earning “gasoline payback” checks every month -- for decades. What’s more, Big Oil has been footing the bill... Click here to learn how you could enroll in this energy-backed “income plan” today... The Weekly Endnote... This week, Stan G. wrote in to ask about a couple of conflicting reports we recently featured in the Daily Reckoning... Both about hyperinflation... On Wednesday Dan talked about inflation and said: “Phase 3” Inflation! By Dan Amoss If the Fed chooses the disastrous path of loose policy in Phase 3, we’ll see folks trying to get rid of cash as fast as they receive it. Rothbard describes the phenomenon: “A frantic rush ensues to get rid of money at all costs and to buy anything else. In [Weimar Germany circa 1923], this was called a ‘flight into real values.’ The demand for money falls precipitously almost to zero, and prices skyrocket upward virtually to infinity.” Hyperinflation is the ultimate endgame of an addiction to easy money policies. Fed governors may say they can reverse policy anytime they wish. But that’s just theory. In reality, reversing course will be politically impossible here in the U.S. No elected official or Federal Reserve chairman will advocate the true austerity that would be necessary to halt runaway inflation. So easy money is here to stay -- at least until we are well into Phase 2. Last week you sent me: Nothing “Hyper” About US Inflation By Steve Hanke While inflation seems to be on everyone’s mind these days, misconceptions abound. Indeed, few concepts in economics are as misunderstood as inflation. This month I take a look at some common questions about inflation, and a few that I wish more people were asking. Is hyperinflation coming to the U.S.? No. Hyperinflation arises only under the most extreme conditions, such as war, political mismanagement, or the transition from a command economy to a market-based economy. If you compare the U.S. to countries that have experienced hyperinflation — think Iran, North Korea, Zimbabwe, and the former Yugoslavia, for example — the U.S. doesn’t even come close. Hyperinflation begins when a country experiences an inflation rate of greater than 50% percent per month — which comes out to about 13,000% per year. Although it experienced elevated inflation around the time of the Revolution and the Civil War, the United States has never passed this magic mark. At present, the U.S. inflation rate, measured by the consumer price index (CPI), is less than 2% per year. So, to say that the U.S. is on its way to hyperinflation is just nonsense. Who’s right? Or what am I missing? Maybe I am confused because the only thing good that Eric has ever said about the Fed was: The only thing the Fed has accomplished in 100 years is to turn a 5? Coke into a $1 Coke. Why did you send me Steve Hanke? Sincerely, Stan Guss DR: We can understand the confusion. One of these two authors says hyperinflation is likely; the other says it’s not. The truth is, we don’t know who’s right. And we’ll save you the suspense, neither does Dan or Steve. Dan says that hyperinflation is “the ultimate endgame of an addiction to easy money policies.” But his prediction comes with a caveat. That is, “If the Fed chooses the disastrous path of loose policy in Phase 3 [inflation].” Mr. Hanke seems to think there’s no way the U.S. experiences hyperinflation, as it doesn’t possess the “extreme conditions” necessary to facilitate a transition into hyperinflation. If you agree on this point, perhaps a hyperinflationary scenario in the U.S. is unlikely. Whatever the case, they’re both just speculating. Pondering the facts as they see them, and explaining what they think is the most logical result. We’ll leave it up to you to decide who’s right. In the meantime, we’ll continue to do our best to bring you thought- provoking viewpoints on the entropic worlds of both money and politics, hopefully fanning the fires of debate along the way. We’re happy you’ve decided to join us. It’s going to be a fun ride. --- Feel free to email us any thoughts, ideas or comments you may have, and... ..enjoy the rest of your weekend. Cheers, Joel Bowman Editor at Large The Daily Reckoning ---------------------------------------------------------------- Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please send them here: dr@dailyreckoning.com Additional articles and commentary from The Daily Reckoning on: Twitter Facebook DR iPhone APP The Daily Reckoning is committed to protecting and respecting your privacy. We do not rent or share your email address. 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