Havana Nights

Dear Reader,

“Have you ever made love to a Cuban woman?” the elegant sixty-something woman sitting across from me inquired matter-of-factly, causing the DNA remaining in me from the Puritans to blush.

“No, I haven’t,” I responded honestly and more than a little sheepishly.

“Oh, but you must! It is something that we are very, very good at.”

The speaker was the wife of a hero of the Cuban revolution, the place a small privado – an underground restaurant operating in a private home – on the outskirts of Havana.

The topic of Cuban love-making had arisen because the woman’s aging husband, the man who drove the revolutionary’s first tank into Havana on the eve of victory, had excused himself between coffee and dessert and had been AWOL for going on 20 minutes.

“I wonder where he could be?” I had asked, somewhat concerned.

“Oh, my Charlie!” She answered with a smile and a dismissive wave. “He’s probably with one of the black women – he just loves them, can’t get enough.”

“I’m sure he wouldn’t be doing that,” my puritanical sensibilities and naïveté answered in chorus.

At which point she smiled and popped the opening question in today’s missive, bringing with it the dawn that I really wasn’t in Kansas anymore.

I was in Cuba as part of a scheme a friend and I had to start a micro-brewery in Havana, establishing a solid Cuban beer brand before the country reopened to Americans. The idea was sound, and even the Cubans liked it. With one not-so-small condition – that in order to proceed, we had to take over a huge defunct and decrepit Soviet-era brewery, clean it up, and re-employ the 750 workers that used to work there.

Oh, and pay them a salary of US$500 per month. Well, not exactly. We were to pay the Cuban government US$500 a month per employee.

In turn, it would pay the 750 workers 500 Cuban pesos a month. If memory serves, at the time the Cuban peso was trading for about 10% of the U.S. dollar. So, the state would get 90% of the wages and the workers 10%.

Given that our business plan called for a maximum of eight employees and included no budget entry for millions of dollars in capital improvements on a derelict three-story brewery, we passed.

Even so, wandering far from the well-beaten tourist path in my quest to become Cuba’s premium brewer made for a fascinating and informative life experience. Along the way I was fortunate to get to know Cubans from all the nation’s socio-economic strata, from the aforementioned hero of the revolution and his charming and tolerant wife, to a young doctor who spent many hours extolling the wonders of the Cuban education system but then, once I had gained her trust over the course of a week, whispered to me in angry words how much she hated the communists and what they had done to her people.

I was able to see the damage first-hand during an evening spent in the company of a family of the desperately poor living in the heart of the broken-down slums just off the Malecόn, Havana’s formerly glamorous waterfront.

Taking what I now see as excessive risk, my girlfriend and I accepted an invitation to enter the slums at night, then dined with the family on beans in an apartment perched on the third floor of a building. The center of the building had literally collapsed, leaving only a crumbly staircase that wound up around the rubble to the precariously perched apartment – one of only two that had managed to stay intact during the collapse.

In a scene out of a black-and-white WWII movie, following dinner the patron of the family climbed into a secret room overhead where he could safely listen to Radio Free America.

My Cuban adventures were informative on many levels, but probably mostly in that they allowed me the intimate experience of seeing the inevitable consequences of a command economy. After all, here was a particularly well-sited and endowed nation, which by every right should have been prosperous to the extreme, but was instead a collectivized ruin. Only faint glimmers of its glamorous former self still showed through – almost exclusively in expensive establishments specifically run for the benefit of the relatively few tourists then wandering the place.

In fact, during my time there, the most noticeable aspect of the economy was that it was nearly impossible to progress on foot more than 20 feet without being beset by men selling boxes of cigars that had fallen off the back of the proverbial truck, or women selling themselves.

So much so that on preparing for my second trip, I devised a plan to allow me to navigate Cuba without being constantly hustled – and I mean constantly – tucking a box of cigars under one arm and having a woman on my other (my girlfriend at the time – now my wife). Of course, many of the men who read this will wonder what the problem is with a steady supply of good cigars and beautiful women – but I’ll just confess to being something of an old-fashioned guy and leave it at that.

While the brewery didn’t work out – couldn’t, really, given the nature of the Cuban bureaucracy and my American passport – the idea of getting established in Cuba with the right products prior to its reopening to the U.S. is a sound one.

Which brings me to why I chose to wander down this particular memory lane: there are currently several bills in Congress that, if passed, will essentially do away with the ridiculous and counterproductive 47-year-old prohibition against Americans traveling to Cuba. In reality, all the embargo has done is give the Castros cover for the bungle they have made of things – a contention supported by the fact that the citizens of virtually every other country in the world have always been pretty much free to come and go as they please.

One straw in the wind that the travel restrictions will soon be lifted can be found in the planning now underway for a sailing regatta between Sarasota and Havana to be held in the spring of next year. Over 135 boats have already signed on.

More importantly, key members of Florida’s politically influential Cuban expat community – the only reason the embargo has persisted so long – are now supportive of a new and more open approach to resolving the troubled relations between neighbors.

There are a number of implications of a shift in policy. While many of the “early mover” opportunities have already been grabbed by non-U.S. citizens and corporations – including Canadians, Spaniards, Mexicans, and others for whom no restrictions apply – the sheer financial weight of even a small percentage of 310 million Americans making the short trip to Cuba for a look-see, and then making such trips habitual as they were pre-Castro, can’t be overestimated.

Paradoxically, however, along with the opportunities from a reopening, there will be risks and financial pain.

For example, there will be an increase in financial frauds (or near-frauds) associated with Cuba. Everything from the promise of buying land that someone else owns, to stock issuances by public companies that pretend to be well positioned to capitalize from the opening by building hotels or whatever but actually aren’t. The loosening of travel restrictions won’t make the Cuban bureaucracy any more efficient, and the transition will be a particularly challenging time.

Another substantial blow will be felt by Florida’s already struggling hotels and real estate. Why settle for plastic fantastic Florida, when you can be sipping a made-from-scratch Mojito on the (rejuvenated) Malecόn?

The real hit, however, will come to the outer islands of the Caribbean. Prior to Cuba’s closing, the beaches on most of those islands were nearly unmarked by the footprints of tourists. It was only after Cuba went offline for Americans that the big boom in out-island tourism began. Today, as most people who have spent time in places like St. Thomas, St. Croix, Jamaica, Barbados, etc. will testify, the locals have learned to view the tourists through a derisory lens, as nothing more than walking wallets to be snatched at.

Once Cuba reopens, those out islands will again find themselves devoid of tourists, followed by desperate economic times that will drive previously pricey real estate down even further.

That’s not to say the Cubans won’t also quickly develop bad habits. But for the next decade or so, they’ll be operating off the cultural memory of America as the land of the free and be overjoyed at actually having food on the table. Consequently, I suspect they’ll bend over backwards to be accommodating.

Regardless, the novelty of returning to Cuba – supercharged by the whole Hemingway mystique – will bring about a sea change in Cuba and the Caribbean. It could also offer the American public just the sort of circus it needs right now to keep its mind off the dismal domestic conditions.

Not sure how much is actionable in all of this, unless you are sitting on an expensive condo in St. Thomas, in which case you might want to hit the bid, but I do think having a big new playground opening up in America’s backyard will have consequences well beyond those discussed above.

Since we’re on the topic of embargos with consequences, here’s one that could lead to something more important than making it hard to get a good cigar – another war in the Middle East.

Bud’s Got a Book!

In yesterday’s missive, I mentioned in passing that our own Bud Conrad has just had a book published. It’s titled Profiting From the World’s Economic Crisis – Finding Investment Opportunities by Tracking Global Market Trends.

Having worked closely with Bud for many years now, I know how hard he works to get to the facts and hard data, as opposed to just parroting other people’s opinions.

His book couldn’t be more timely – coming as it is just as the world is heading to the far wall of the eye of the storm.

I asked Bud to provide a “Cliff Notes” of the book to share with you, and that follows. But if you want to get the entire story, including Bud’s updated collection of uniquely valuable charts, you’ll need to buy the book, which you can do at Amazon (here’s a link.)

Here’s Bud’s overview of what’s in the book…

The global financial collapse will affect all your investments, and you need protection.

That, in a nutshell, is what this book is about. This book will help you understand the forces behind the global financial collapse, how our government leaders helped create this new reality, and how you can make better investment decisions.

This book explains the big-picture forces that will drive paper currencies to ruin. The train is already on the track, steaming toward a bridge that is out, and the U.S. dollar – which has been the bedrock of the world’s currencies – is the train that will crash into the canyon of no confidence in our lifetime.

My goal in this book is to explain how this catastrophe will unfold, as it destroys wealth around the world for those who believe their governments when they say that the situation is “at a bottom” or “showing green shoots of recovery.” Believing such comforting lies will lead to destruction of your personal wealth.

In contrast, understanding and protecting yourself with reasonable measures will lead you to financial survival. Being ahead of the curve, and armed with the insights of this book, can lead to big personal profits. Here’s why you need to read this book:

• To understand why inflation is coming. • To identify the best investment sectors – and why this is more important than simply picking individual stocks.
• To understand how we got here, to see where we are going – and to invest wisely.
• To see how a system model, that emphasizes the cycles caused by feedback, gives better predictions than steady-state equilibrium models used by economists.
• To review charts and find data for predicting the big trends and making investments.
• To interpret how the historical experiences of the Great Depression, Japan after 1990, and Germany confirm the parallels and differences to today’s crisis.
• To get my reasons for today’s investment recommendations: gold, oil, higher interest rates, energy, food.

As Chief Economist for Casey Research with both an MBA from Harvard and a degree in electrical engineering from Yale, I’ve compiled my interpretation of the global situation using a systems view. The interpretation of markets guided my 25 years of futures trading.

I emphasize data to confirm the realities, and I am specific about what to look for, so you can accurately measure what is driving our economy. There are 262 figures and tables to help explain what is next. I’ve used my investment experience to develop models to predict specific measures to make successful investments. Because I have such a different approach, I was able to predict the current crisis back in 2006. And at the beginning of 2009 I predicted that gold would go to $1,150; that crude oil, then trading at $45 would go to $80, and that the 10 year Treasury would go from 2.2% to 4% – all of which happened – along with a number of other economic measures like the budget and trade deficit.

The key to the future is really quite simple: Paper money is a CONfidence game that will end with your cash being worth only the paper it is printed on. This is the book’s fundamental thesis: that the paper dollar will collapse in my lifetime, eventually requiring the issuance of a new currency. The financial collapse we are now experiencing is far from over. It will become the largest financial crisis the U.S. has ever faced. Because the U.S. is at the center of the world economy, this crisis is affecting all nations. The imbalances are so big that there is no way to return to stability through normal means.

The paper money systems of the world are not based on any promise of convertibility to any tangible commodity, like gold. Yet they have been used to define the value of everything we buy and sell. Without the limitation of redemption (in gold), governments can create wealth for themselves by paying new money to their special-interest supporters. When they do, they decrease the wealth of others. Printing money does not change the value of the planet and the things in it. But the claims on those things change, and those who control the bigger share of those resources do change.

Even casual observers know that something is terribly wrong. They know they aren’t getting anything from the bailouts of big banks by government, and they wonder who is benefiting. My analysis shows how large the deficits that fund these bailouts have become and how this will affect all of us in the years ahead. I anticipated the huge government spending because I understood that the recession from overleveraged mortgages would be very damaging, and I could see how politicians would be predisposed to spend billions to temporarily delay the recognition of problems until after the next election, bailing out friends on Wall Street.

However, this book doesn’t focus only on the simple direction of complete paper money collapse. I provide both the big-picture of what’s happening to our economy, and I drill down to the details of what is important and how to analyze particular sectors. Most people think of “investments” only in terms of stocks and bonds – but this is short-sighted: you also need to consider the benefits of investing in commodities, real estate, currencies, and interest rates. Obviously, there are a lot of relationships, but when you see how the big forces of government spending, dollar collapse and inflation all interconnect, then the collection of investment recommendations becomes a clear picture that is simple to understand.

My approach is different from traditional theoretical economic models because I explain why markets go to such cyclic extremes. Traders already understand that markets are dynamic, follow trends, form bubbles and collapse. The point is that markets are normally continually moving through cycles just like a pendulum, and are not in equilibrium, which is the basis of most economic models. Economists allow for shocks as if they were some surprise, but miss the point that the economic pendulum is normally swinging back and forth and is not static. This difference is at the heart of understanding how the system works. I’ve used my electrical engineering training to look at the relationships and include the feedback of self-reinforcing systems that move in vicious and virtuous cycles.

Making the big decisions is what this book is about. The bigger returns are made from being in the right market at the right time. I like being specific, so the figure shows just how wildly successful an investor could have been making the right decisions only once for each of the past four decades:

• Suppose you had invested in one ounce of gold, costing only $35, in 1970. • Then, suppose you had used your profits to buy Japanese stocks during the 1980s.
• Then, suppose you had invested those proceeds in the NASDAQ during the 1990s.
• Finally, suppose you had used those proceeds to invest again in gold.

How to Turn $35 into $166,000+, from 1970 to 2009

As you can see, if you had made the above decisions during the last four decades, that single initial investment of $35 would have grown to more than $166,000. That was with no leverage and only four trades. Certainly, no one actually met that goal, because the graph was developed in hindsight. For comparison, if you had invested the $35 in the S&P 500, you would only have $457. You would have done a little better hanging on to gold which is now over $1000. The point is to emphasize the value of knowing the right sectors for focus for the times presented. And that is my goal for this book: to help you understand these big-picture cycles, so you can capture those profits.

As the value of paper currencies decrease over time, your investments need to get in front of that inevitability, by avoiding long-term holdings denominated in currencies, like bonds or annuities. Instead, I recommend that you hold physical assets like agricultural products, energy or gold. (Alternatively, for example, you can profit by being in debt in dollars that you pay back after they have lost purchasing power.) Why, when, and how are the subjects of the rest of this book.

David, again. Here, again, is the link to order Bud’s book. We’ll also have copies of Bud’s book at our Crisis & Opportunity Summit this weekend, and I am sure Bud will be happy to autograph a copy if you are interested.

Krugman’s Snake Skin Oil – On Sale Now

By Vedran Vuk

When Rachel Maddow or Keith Olbermann makes an economically ignorant statement, I don’t get upset. At the end of the day, they are entertainers – idiocy is practically a part of the job description. But with New York Times columnist, Paul Krugman, it’s different. With a PhD in economics from MIT, Krugman should know better than many of his diatribes.

This isn’t a left versus right or Keynesian versus Austrian economics issue. Krugman’s claims lack sense regardless the school of thought. His recent article on financial reform follows this pattern. Krugman writes:

What’s the matter with finance? Start with the fact that the modern financial industry generates huge profits and paychecks, yet delivers few tangible benefits….

…These profits were justified, we were told, because the industry was doing great things for the economy. It was channeling capital to productive uses; it was spreading risk; it was enhancing financial stability. None of those were true. Capital was channeled not to job-creating innovators, but into an unsustainable housing bubble; risk was concentrated, not spread; and when the housing bubble burst, the supposedly stable financial system imploded, with the worst global slump since the Great Depression as collateral damage.

The “Wall Street created the crisis” thesis isn’t the really troubling part – that’s open to rational debate. His idea that financial firms fail to allocate capital effectively is more problematic. Krugman elaborates in his final paragraph,

But the fact is that we’ve been devoting far too large a share of our wealth, far too much of the nation’s talent, to the business of devising and peddling complex financial schemes – schemes that have a tendency to blow up the economy. Ending this state of affairs will hurt the financial industry. So?

According to Krugman, I should stop wasting my talents in the financial sector and devote my skills to a productive sector of the economy. But if Krugman is right, where would I find socially beneficial employment? At first, this might seem like an easy question, but it’s not.

If capital is misallocated, then society’s resources will flow toward worthless industries and boom/bust projects. Most recently, resources were overinvested in housing. The astronomical housing prices signaled workers to enter the industry whether as construction workers, materials suppliers, or real estate agents. Hundreds of thousands were drawn-in by the misallocated capital which pushed prices upward and funded construction. This brings Krugman’s idea full circle. If funding flows to wasteful industries, workers will follow the money. The ultimate result is both misallocated capital and labor. If his statements about capital misallocation are correct, every job in society would be a misallocation of talent and skills – not just the financial sector.

In Krugman’s world, we would be in a constant state of boom and bust. One year, the number of fast food restaurants would triple and then nearly all would fail. Another year, five shoe factories may open in your town at once – just to close months later. The next year, it could be pharmaceuticals, agriculture, or any number of ventures.

If capital is consistently misallocated, booms and busts would not happen every decade or so but would instead be monthly events. Capital can be misallocated to certain sectors but to claim that Wall Street is worthless ignores reality. In the real world, bubbles are rare occurrences and mostly occur because of government meddlings with the market, and money does go to funding new technologies, profitable businesses, and sustainable enterprise.

In the short-term, trends can deviate from the big picture, but eventually markets will move toward an efficient allocation of capital. Just because the market is crazy for a moment doesn’t invalidate the entire system. Bubbles popping themselves prove the point. Excess can persist for some time, but the efficiency of markets slams these investors back down to earth in the long-run. On the other side of the coin, investors who foresee bubbles and allocate capital accordingly are rewarded.

If Wall Street can’t allocate capital, then who can? Krugman? Obama? With the Soviet Union, we already learned how central planning manages capital. Krugman is a very well educated economist, and long-term capital market efficiency is no radical theory in his field. He knows better. While the Olbermanns, Maddows, and other propagandists may have an outer circle of hell waiting for them, I’m sure that the darkest corners of Dante’s imagination are reserved for folks like Krugman who spread deceit while being fully aware of the truth.

Housing on the Mend!

By Kevin Brekke

Following yesterday’s release of the Case-Shiller Index that tracks U.S. home prices across 20 cities, the Internet was sprinkled with headlines like the following:

MarketWatch - Houses in 20 major U.S. cities were worth more in February 2010 than in February 2009, the first time in more than three years that values had increased year-to-year, according to the Case-Shiller home price index released Tuesday by Standard & Poor's.

Some observers were hopeful that the year-on-year rise in the index signaled home prices were stabilizing and would now resume an upward trend, albeit a modest one. Being somewhat skeptical of indexes, I reviewed the data behind the index and came up with a more accurate headline:

CaseyResearch.com – Houses in 11 of 20 major U.S. cities were worth less in February 2010 than in February 2009, continuing the more than three-year trend of falling house prices, according to the Case-Shiller home price index released Tuesday by Standard & Poor’s.

Let’s have a look at the 20 cities, broken down into groups of five for clarity, and see how each fared:

Group One: Los Angeles, San Diego, New York City, Washington DC, Boston

In that first group, only one, San Diego, is actually on a clear rising trend, with the uptrend that had been apparent in Los Angeles now looking a bit shaky. The other three are in distinct downtrends.

Group Two: San Francisco, Portland (OR), Miami, Tampa, Seattle

Although the city by the bay has had a good run, all five cities are in clear down trends.

Group Three: Denver, Minneapolis, Charlotte, Chicago, Dallas.

Five more cities in multi-month declines.

Group Four: Detroit, Atlanta, Phoenix, Las Vegas, Cleveland

Phoenix had an extended yet moderate rise but has rolled over and joined the others in a downward slope.

And lastly the 10-city and 20-city indexes:

Both indexes might be higher than they were a year ago, but both have been in a downtrend for the last five consecutive months. In fact, 15 of the 20 cities tracked have seen their index fall for between three and seven consecutive months. Although not conclusive, the evidence seems quite compelling that home prices have yet to stabilize and that the intermediate trend points to further price weakness.

Trading Opportunities

You may or may not be aware that most of the “investment” recommendations we provide in our letters aren’t really investments per se but speculations. As Doug Casey defines it, an investor is one who puts capital into a business in anticipation of making a profit. But a speculator is someone who allocates capital in order to profit from distortions in the market caused by government intervention.

The method our analysts use to pick resource stocks was created by Doug and is described in this free report on our website called The Eight Ps of Resource Stock Evaluation. Outside of the resource sector, we do employ value investing strategies à la Graham & Dodd, or Buffett, but there’s always an underlying trend that we see coming at the root. And that trend is the result of government-caused distortions in the market.

But there’s one more type of “investment” recommendation that we occasionally provide in Casey’s Extraordinary Technology. That type of “investment” is really a trade. Trading opportunities are different from investment opportunities and speculation opportunities, because they’re often based on one particular piece of news that may or may not occur (although even when we trade, we make sure the underlying fundamentals are sound and that the company has an extraordinary technology worth investing in). This sounds risky, and it is. But if you know what you’re looking for, you can mitigate that risk to some degree and increase your chances of booking a big gain in very short order.

While there are any number of instances that might make a good trading opportunity, like if a biotech company has a new drug that’s about to (hopefully) clear Phase III trials or have its NDA (new drug application) accepted, one way that shows particular promise in our eyes and seems less risky than others is identifying companies that are ripe targets for being uplisted to the NASDAQ in the near future.

An uplisting is the process of moving a stock to trade on a higher exchange. In this case, we’re concerned with companies currently trading over-the-counter (OTC) that may soon get uplisted to the NASDAQ. We’re concerned with such companies because prior to uplisting they will generally take some very recognizable steps to meet exchange criteria, and once they are uplisted, their stock price often jumps considerably and quickly.

So first let’s look at the steps companies take prior to uplisting, and then we’ll show some recent examples of gains that could have been made with this strategy and examine why it is that stocks often pop following an uplisting.

The exchange criteria issuers need to satisfy that is most visible to outsiders like us are stock-price thresholds and corporate governance requirements.

The NASDAQ requires a minimum share price of $4, so OTC companies trying to uplist will often undergo a reverse split in order to meet the minimum stock price level. When it comes to corporate governance requirements, two obvious tip-offs are restructuring the board of directors to have a majority of independent directors and creating the necessary board committees required by the exchange. Thus, the three main steps to look for that indicate a company may be positioning itself for an uplisting are:

1. Undergoing a reverse split to meet the minimum share price criteria of the exchange ($4 for NASDAQ).
2. Restructuring the board of directors such that a majority of directors are independent.
3. Creating the required board committees (audit, compensation, and nominations committee).

Now that we know the steps to search for, let’s look at some recent examples of the gains that could have been booked with this strategy.

• RINO International (RINO) uplisted to the NASDAQ in July 2009 and initially saw its price jump 12% from $9.10 to over $10.19 the day the uplisting was announced. Since uplisting, the stock closed as high as $34.25 in November 2009 – more than 275% above its pre-NASDAQ price.
  
• Deer Consumer Products (DEER) saw its stock trade up over 50% in one week following the announcement it was approved for listing on the NASDAQ. And it’s currently trading about 70% above its split adjusted pre-NASDAQ price.
  
• China Bio Energy (CBEH) was trading at $5 in July 2009 and then jumped 10% on the day of its NASDAQ approval. It now trades at $11.37 – more than 125% above its pre-NASDAQ price.
  
• L&L Energy (LLEN) is up 75% since it was uplisted to the NASDAQ in February, while the NASDAQ overall is only up 15% over the same period.
  

As you can see by these examples, tracking potential uplisting candidates appears to be well worth the effort. But why? The answer lies in the inflow of new investor demand that often comes with a company being uplisted to a major exchange.

Most institutional investors simply can’t (by charter) or won’t invest in OTC stocks. And since this is the case, research analysts are reluctant to initiate coverage on stocks prior being listed on a major exchange, contributing to the lack of demand for the stock. But as soon as an uplisting occurs, institutional money flows in and drives up price and volume.

It just so happens that in one of our recent alerts for Casey’s Extraordinary Technology, we recommended a stock that is primed for uplisting to the NASDAQ sometime during 2010. But this stock has the added benefit (as all our portfolio picks do) of having an underlying extraordinary technology worth investing in and being fundamentally sound. If you’d like to find out more about this stock and all our portfolio picks, then give Casey’s Extraordinary Technology a risk-free trial. Details here.

That’s It for This Week

It is getting late, dear reader, and I must run. But before I do, I would like to thank you, as always, for reading and for subscribing to a Casey Research service. See you on Monday!

Cheers,

Chris Wood
Casey Research, LLC