(Vedran Vuk filling in for David Galland)

Dear Reader,

Let me first update you on David Galland’s and Chris Wood’s status. Chris should be back on Monday, and he’ll take over writing the Daily Dispatch for most of the week. David should be back stateside from Argentina next Thursday. However, I’m not positive if he’ll put pen to paper immediately that day.

First up, Doug Hornig will share some thoughts on Geithner’s “strong dollar” proclamation. Personally, I’m really concerned for Geithner and Bernanke lately. Someone needs to get them to a shrink, and soon – because these two seem to be suffering from delusional schizophrenia. One moment Geithner wants stronger exports and the next he wants a stronger dollar. The Fed engages in Money Printing II while Geithner promises to avoid dollar devaluation. I really think that they might be sick in the head.

After that, I’ve got a small piece explaining the significance of the VIX index. If it has been a long Friday, I’ll understand if you skip this one. It’s a bit technical – so you may want to go straight for the Friday Funnies instead. And last, we’ll hear from Louis James as he gives us some thoughts on Colombia.

The Almighty Dollar

By Doug Hornig, Senior Editor, Casey Research

In a recent edition of Conversations with Casey, Doug made the case for keeping a currency strong, even though there may be some short-term benefits from allowing it to weaken.

Thus, Doug must have been heartened by words from our esteemed Treasury secretary on Monday, right?

Geithner was speaking ahead of this weekend’s meeting of G-20 finance leaders in South Korea, at which currency issues are, well, likely to be discussed. Addressing the Commonwealth Club of California in Silicon Valley, the government’s money man did not mince his words, no sir.

“It is very important for people to understand that the United States of America and no country around the world can devalue its way to prosperity, to (be) competitive,” Geithner solemnly swore.

And he added, “It is not a viable, feasible strategy and we will not engage in it.” [Ok, italics ours.]

This was a pretty big step for Tiny Tim to take. He has (perhaps understandably) been reluctant to sound the alarm for the strong dollar in public, and has not done so since February. However, what else could he do, given last week’s performance by the greenback? On Friday, the dollar index hit a 10-month low against a basket of major currencies, while it has been wallowing around in 15-year-low territory vs. the Japanese yen.

That’s led many countries to complain that Fed money creation is weakening the dollar, causing more funds to flow into their markets, and pushing up the local medium of exchange. No one, it appears, wants a strong currency at the moment.

Oh, except us. Washington to the rescue. The U.S., Geithner swore, will “work hard to preserve confidence in the strong dollar.”

Just as Doug Casey would advise. Hallelujah. You can bet Doug’s rejoicing now, eh?

Mmmmm… which side of that bet do you want to take…?

Why You Should Be Checking the VIX Daily

By Vedran Vuk

Most regular market-watchers peek at the Dow Jones Industrial Average and the S&P 500 daily, but there’s another important index to follow regularly, the VIX (which is the ticker symbol for the Chicago Board Options Exchange Market Volatility Index). Often in the news, the VIX is described as an index of volatility or an “index of fear,” but it’s really so much more than that. To call the VIX an index of volatility is only the most simplified description.

So, today, I’ll give you a slightly advanced explanation. This might not be the smoothest or most entertaining article in the history of Casey’s Daily Dispatch, but I hope you find it useful. 

The VIX index is the direct result of the Black-Scholes options pricing model. Black and Scholes were two professors who made one of the most significant discoveries in finance ever. They found a clear mathematical way to calculate the price of put and call options. As a result, their discovery revolutionized the options market. So if anyone asks, “What do economics and finance academics do for us besides make armchair predictions?” – this is it.

We really have to give them a pat on the back. Their pricing model isn’t the easiest equation. Don’t even try to solve this thing, but for those that simply want a look at the monstrosity tormenting finance students across the globe, here it is:

The price of a call option = S0N(d1) – Ke-rtN(d2)

The price of a put option= Ke-rtN(-d2) – S0N(-d1)

d1= (ln(S0/K) +(r+σ2/2)T)/ σ√T

d2= d1 – σ√T

Glad you didn’t major in finance now? Actually, despite the formula’s complex appearance, all the numbers necessary to calculate it are publicly available – such as the time to maturity, strike price, interest rate, spot price, etc. However, one variable will always be missing: implied volatility (σ). And hence you must solve for it. But guess what? You don’t have to be a math whiz to do it; thankfully the VIX index does it for you.

The VIX shows the implied volatility in 30-day S&P 500 options as computed by this equation. With just a click of the mouse to the VIX, you can see the result without all the math.

But you may be thinking, “Wait, but that’s just volatility, why the long explanation?” Not quite. Yes, I could find the historical volatility with some basic statistics and historical S&P price data. However, this is backward-looking volatility and yesterday’s news. 

So, why not just check the present state of the market? Sure, checking the price of the Dow and S&P is always useful. But the VIX does something more amazing. It does not derive past volatility or current volatility, but instead it’s a predictor of future volatility.

Since call and put option prices have built-in expectations of the future, finding volatility through them reveals those expectations. Every other index shows you the past – what happened a year ago, a month ago, five minutes ago. Only the VIX shows you what the market thinks will happen to volatility next. Naturally, this makes it far more useful than historical data. 

So, as you can see, the VIX is much more valuable than the financial news ever explains. It’s not just a measure of volatility or fear. It is a moving prediction of the future. That’s why stock analysts get very afraid of a rising VIX. It’s a warning signal of things to come. For example, in the chart below, notice the giant spike in the VIX around the Greek crisis. Though the actual market didn’t move that wildly, the VIX certainly did, giving an early warning sign of a possible catastrophe.

A Note on Today’s VIX

Lately, the VIX has been in a downward trend, but that could change suddenly. Look at the pattern across the year. The market panics about future volatility, and then slowly everyone starts to calm down. And then as soon as they’re too calm, the VIX jumps up again. This pattern has repeated itself three times within a year.

Looking at the chart, the VIX again looks too calm. Could that mean another spike just around the corner? Maybe…

Greetings from La Maroma

By Louis James

I’ve just stopped to rest for the night at Doug’s ranch in Salta, Argentina, called La Maroma. I caught up on some much-needed sleep after a quick, multi-project due diligence tour to Colombia, and we had a chance to work on the next edition of Conversations With Casey. It’s Colombia I wanted to comment on.

Three days ago, I was somewhere in the mountains north of Medellin, taking a shower in the rain. That’s not because I’d been captured by guerillas, but because I was staying at a beautiful new house, built by a Colombian friend of one of the exploration company executives I was traveling with. Among other cool features, the architect of this house designed the bathrooms with showers open to the sky, so I was taking a warm shower in the cold rain. The edge-less pool reflected a beautiful valley as the clouds played with the mountains.

The point?

I saw lots of new and renovated houses like this going up all over the countryside. It’s amazing how much wealth starts bubbling to the surface when 50 years of violence subside and it’s no longer dangerous to show signs of wealth. Colombia is one of my favorite mining jurisdictions in the world; it has a growing no-nonsense, pro-business atmosphere that few places on earth can match. And because of the many decades of violence, it’s greatly underexplored, even compared to other places along the same basic geological trends that had their own violent periods in the 20th century, like Peru. This is a winning combination I like a lot.

There are still dangers, of course. There are still FARC guerillas who can escape the Colombian military by slipping over the borders into Ecuador and Venezuela. Just one Canadian geologist who disregards the warnings and goes for a hike in one of the still-dangerous places and gets himself kidnapped could put a damper on all Colombia plays, even those operating in safer places.

But Colombia is still a fantastic place to explore and an improving place to do business. Opportunities here deserve careful consideration, and that’s exactly what I intend to keep doing.

[Ed. Note: And no one does it better than Louis. It is no coincidence that every single junior mining stock he recommended in 2009 was a winner… and 2010 is shaping up to be an even greater success. Right now Louis is closely watching several companies in the mineral-rich Yukon territory – find out in the current edition of Casey’s International Speculator which ones to keep an eye on. More here.]

Friday Funnies

A cowboy, who is visiting Wyoming from Montana, walks into a bar and orders three mugs of Bud. He sits in the back of the room, drinking a sip out of each one in turn. When he finishes them, he comes back to the bar and orders three more.

The bartender approaches and tells the cowboy, “You know, a mug goes flat after I draw it. It would taste better if you bought one at a time.”

The cowboy replies, “Well, you see, I have two brothers. One is in Arizona, the other is in Colorado. When we all left our home in Montana, we promised that we’d drink this way to remember the days when we drank together. So I’m drinking one beer for each of my brothers and one for myself.”

The bartender admits that this is a nice custom and leaves it there. The cowboy becomes a regular in the bar and always drinks the same way. He orders three mugs and drinks them in turn.

One day, he comes in and only orders two mugs. All the regulars take notice and fall silent. When he comes back to the bar for the second round, the bartender says, “I don’t want to intrude on your grief, but I wanted to offer my condolences on your loss.”

The cowboy looks quite puzzled for a moment, then a light dawns in his eyes and he laughs.

“Oh, no, everybody’s just fine,” he explains, “it’s just that my wife and I joined the Baptist Church and I had to quit drinking. Hasn’t affected my brothers, though.”

And that’s it for today. But since October, the scariest month for investors according to some, is nearly over, I’ll leave you with a funny but true quote:

“October: This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February.” –Mark Twain

Thank you for reading and subscribing to Casey’s Daily Dispatch.

Vedran Vuk