Dear Reader,

Welcome to the weekend edition of Casey Daily Dispatch, a compilation of our favorite stories from the week for the time-stressed readers.

Of course, if you want to read all of the Daily Dispatches from the week, you may do so in the archives at CaseyResearch.com.

Bernanke’s Speech

By Vedran Vuk

In his Jackson Hole speech, Bernanke claimed that the economy’s long-term growth fundamentals have been unchanged in the past four years. In some ways, he’s correct: The US is still developing incredible technologies; and the majority of regulations are identical to those of the pre-crisis era. This isn’t FDR’s recession, where every industry saw a major push for regulation.

However, no changes whatsoever? That’s going a bit far. There are certainly permanent and serious long-term changes. Let’s go through a few of them.

1. An embedded bailout mentality. For all the talk of temporary bailouts, no one believes the rhetoric. Would anyone accept a bet that no major financial institution will receive a bailout in the next 20 years? It’s almost a certainty that bailouts will continue for some time.

Furthermore, the Fed has come to the rescue of falling equity prices every time. In 2008 they first jumped strongly into the market. Then, with the economy slowing, they pushed it with QE2. As soon as the market began dropping recently, Bernanke promised two years of near-zero rates. Bailouts are the new norm, and moral hazard is a very real problem for US markets.

2. The financial sector is a complete mess. Each year the rules get tighter and tighter. Whether it’s credit-card regulations or debit-card fee limits, the banks are becoming overregulated on multiple fronts. Let’s not even get into the implementation of Dodd-Frank coming down the pipeline. Furthermore, there could be still more punishment ahead. It’s not over yet.

The government’s logic regarding this sector is absolutely perverse. First, the government encouraged the financials to jump into the deep end. When they started to drown, the government threw them a life preserver. Then, as soon as they were dragged back on deck, the crew bludgeoned them with baseball bats. The government spent billions to bail out the banks… only to regulate them to death. Unfortunately for us, the financials are an important part of the economy. A drag here will slow things down everywhere.

3. The national debt. During the crisis, US debt swelled to historic proportions, and it’s not going down anytime soon. Even by Keynesian standards, the money spent was a waste, as the stimulus barely produced any growth or jobs. We haven’t paid the piper on the debt yet, but that time is growing increasingly close. The decisions of Congress have placed a permanent scar on our fiscal situation.

Yes, some of our problems are transitory – though perhaps not immediately short term. Unemployment can go back down and growth can speed up, but the items above are here to stay. How can the bailout mentality be reversed? I just don’t see that scenario happening, unless the government allows a couple of Lehman Brothers to fail the next time around. The banking regulations aren’t going anywhere either. Consider that something like the Glass-Steagall Act took over 60 years to repeal. Though deregulation is the favorite bogeyman of the left, it almost never happens. The past hundred years of American history have been a march toward more regulation and bigger government – not deregulation.

The other problem is of course the Fed’s and the government’s short-term actions. Though the long-term fundamentals are mostly intact, that won’t matter much if the Fed continues operating in emergency mode, and the federal government creates a business environment of uncertainty at the same time.

Tracking Gold

By Doug Hornig

Recently, we’ve received a number of emails from readers asking why the primary gold ETF, SPDR Gold Trust (NYSE: GLD), doesn’t more closely track the price of gold, and other related questions. For those readers who aren’t already familiar with the workings of this innovative way to “own gold,” it’s worth going over a few of the details, because there are some common misunderstandings regarding the ETF.

The creators of GLD were as savvy as it gets. They saw a market crying for something like this and turned that need into one of the most successful new financial products ever introduced. The ETF burst upon the scene in November of 2004 and was immediately latched onto as a means of riding the gold bull market without the inconvenience of having to transport and securely store actual bullion. In the past seven years, its rise has been meteoric. It has steadily ascended the list of the world’s leading gold repositories, until today it has the sixth-largest global stash of the metal, at more than 1,230 tons, or 39.57 million ounces, worth over $70.7 billion.

First misconception: Contrary to popular opinion, the SPDR Gold Trust does not buy and sell gold. It creates and redeems paper shares in the company. These are passed through a group of market makers, who trade them on the NYSE, then deposit into or withdraw from the HSBC vault in London the corresponding amount of physical bullion, in the form of 400 oz. London Good Delivery bars.

And even that description is somewhat misleading. GLD deals only in “baskets” of 100,000 shares, with the goal being for the share price to track gold’s market value as closely as possible. Since each share represents slightly less than a tenth of an ounce of gold, that means each basket must trade close to 10,000 ounces of gold. That’d be impractical if the buying and selling had to be done on the open market.

So how do they pull it off? Well, the company is not exactly forthcoming about its inner workings, but after extensive conversations with officials, I was able to determine that what actually happens is that the gold is moved either into or out of the GLD-allocated section of HSBC’s vault, to or from another section of that same vault. When I found that out, I envisioned a guy on a yellow forklift, driving pallets laden with thousands of ounces of gold back and forth across the vault floor. Such a job.

Beyond the basics, we don’t know much. You will not be allowed to see the vault, whether or not you are a GLD shareholder and no matter how many shares you own. In fact, a high Trust official in New York told me that even he isn’t allowed inside there.

For the most part, GLD does a pretty good job of following the spot price of gold. A share will never be priced exactly at the value of a tenth of an ounce of metal, simply because the Trust deducts transaction fees and other expenses. But it’s close. During August of 2011, for example, the net asset value (NAV) of a share of GLD varied from 97.3635-97.3867% of the gold price, as fixed each day at 10:30 a.m. New York time.

However, if you are an investor in GLD, or are considering becoming one, there are a few things to keep in mind. First of all, it can’t be stressed enough that this is a paper asset. It is not a way to buy gold and have someone else store your holdings for you. That can be done in other ways. There are depositories that specialize in this service, both domestically and in foreign jurisdictions like Switzerland. But that isn’t what GLD is about.

Now theoretically, it is true that you can convert your GLD shares to physical gold and take delivery of it. But practically, you can’t. For one thing, you have to be approved to do so (generally meaning, you’re either a broker or a market maker), and then you have to redeem a minimum of 100,000 shares. And even if you meet those qualifications, buried in the firm’s prospectus – a very tough read, by the way, but you can get a copy at their website if you want to try your luck – is a provision stating that they have the option of redeeming such shares in cash equivalent rather than bullion.

This is to say: If there is a sudden run on physical gold, GLD is not contractually obligated to provide actual metal, in exchange for however many shares, to anyone.

Thus our position has always been: Hold as much gold in coins and bullion as you comfortably can. Use the ETFs to generate profits if you like, but make sure you realize that all of those profits will be of the paper variety.

Furthermore, there is the little matter of taxation. You may well understand that GLD shares are not a substitute for precious metals, and you may be in it only as a way to make money from a rising gold price by simply placing an order with your regular stock broker. If so, well and good. But what you may not know is that GLD shares, although they trade like stock, are not stocks in the same sense as Apple shares. Not when the taxman cometh.

If you buy shares of Apple, and hold them long term, for more than a year, then sell them, you are taxed at the prevailing capital gains rate, currently 15%. Gold, however, is considered a “collectible.” If you buy gold coins, for example, and hold them long term, then sell them, your tax liability is at the rate for collectibles, presently 28%. If you sell them for a short-term profit, you’re liable for taxes at the same rate as for ordinary income, which is determined by whatever bracket you’re in.

Of course, GLD shares are not gold, as I’ve just taken some pains to point out. Ah, but here’s the rub. GLD is structured as a grantor trust, not a mutual fund. A grantor trust is ignored for tax purposes so that the investor is treated as owning a pro-rata share of the underlying holdings, not the entity as it exists on paper. That is to say, if GLD were a mutual fund, shares would be taxed at the normal capital gains rate, but because it is a grantor trust, its long-term gains are taxed at the applicable rate for the gold it holds… which is 28%.

This situation leads to some rather odd tax peculiarities. Say your ordinary income is in the 25% tax bracket. You’re actually better off selling GLD shares short term than you would be if you held them long term and got pushed into a 28% liability.

None of this is to disparage GLD. For ordinary investors, the ETF represents a way to (indirectly) participate in gold “ownership” without the hassle of actually taking physical delivery and finding a suitable place to vault your metal. Plus, there are no storage fees, bid/ask spreads, threats of theft, or dealer markups to worry about. And finally, for those who like to really play the market, shares are amenable to all the tricks of the securities trade. They can be optioned, shorted, hedged, bundled, margined, whatever. Little wonder GLD is so wildly popular.

So use GLD if you are of a mind to. Just be certain you understand what it is you are dealing with.

[Other ways of indirectly investing in gold exist; some offer even more upside potential than the metal itself. Learn what they are and how to make use of them with a subscription to BIG GOLD. It’s risk-free for three months.]

Falling Oil Prices: A Worrying Trend That May Be a Saving Grace

By the Casey Research Energy Team

When oil prices start to decline, investors and economists get worried. Oil prices in large part reflect global sentiment towards our economic future – prosperous, growing economies need more oil while slumping, shrinking economies need less, and so the price of crude indicates whether the majority believes we are headed for good times or bad. That explains the worry – those worried investors and economists are using oil prices as an indicator, and falling prices indicate bad times ahead.

But oil prices have to correct when economies slow down, or else high energy costs drag things down even further. And the current relationship between oil prices and global economic output is not pretty. In fact, every time the cost of oil relative to global production has hit current levels – and that’s after the sharp corrections earlier this month – an economic slump, if not a recession, has followed, according to a Reuters article.

The “warning signal” that is currently flashing red is the Oil Expense Indicator, which is the share of oil expenses as a proportion of worldwide gross domestic product (specifically, it is oil price times oil consumption divided by world GDP). Since 1965, this indicator has averaged roughly 3% of GDP and has only exceeded 4.5% during three periods: in 1974; between 1979 and 1985; and in 2008. Each period saw severe global recessions.

In 1973/‘74, the Arab oil embargo sent oil prices rocketing skywards in the world’s first “oil shock.” In 1979, a revolution in Iran knocked out much of that country’s oil output and catalyzed the world’s second oil shock. And, of course, in 2008 the housing bubble collided with speculative buying of new debt instruments and a commodities boom to propel oil prices to a record high of US$147 a barrel, which helped to trigger the global financial crisis and the worst slump since World War II.

So where are we right now? Well, Brent crude prices would have to fall to the low US$90s per barrel for the Oil Expense Indicator to drop below 4.5%. Instead of that, Brent prices have been above US$100 per barrel for more than six months (aside from an intraday low of US$98.97 on August 9) and are still hovering between US$105 and US$110.

Oil prices play a major role in global economic growth because oil is crucial to every part of the economy. It powers manufacturing as well as food and commodities production, it fuels transportation, and it is a building block for industries like plastics and electronics. When oil prices stay too high for too long, they choke out economic growth.

Merrill Lynch analysts agree, writing in a recent note: “The last two times that energy as a share of global GDP neared … the current level, the world economy experienced severe crises: the double dip recession of the 1980s and the Great Recession of 2008.”

So we face two options: oil prices come down sharply, or we enter a recession, which will drag oil prices down. Either way, crude has to get cheaper.

That being said, remember that there are many forces at play in the oil markets, not the least of which is supply. At present the world’s most important supplier, Saudi Arabia, is pumping out more oil than it has for 30 years. In July the country produced 9.8 million barrels per day (bpd), lifting total OPEC production to 30.05 million bpd.

If they want, the Saudis can exert considerable influence over prices by reducing supply. And they may want to do just that. Oil analysts generally agree the Saudis want to see oil prices remain above US$85; lower oil prices would impair the country’s ability to meet its spending obligations. Iran, Kuwait, and other OPEC countries similarly want to see oil prices remain strong, to meet their spending requirements. Current OPEC governor Mohammad Ali Khatibi, of Iran, recently said that the cartel’s members have not set a desired price level but some think US$80 to US$90 is appropriate, while others want prices to remain above US$100 a barrel.

On top of that, no one is yet predicting a reduction in global oil demand. The International Energy Agency (IEA) reduced its forecast for demand growth, but still expects the world to consume 1.2 million more barrels of oil each day next year than this year. Similarly, OPEC reduced its demand growth estimate, but still foresees oil demand rising by more than 1 million barrels of oil a day over the next 12 months.

So, oil prices will come down when the economy falls too, but if oil goes on a tailspin à la 2008, expect to see OPEC step up to the plate, tighten the market, and support prices, so that its members can continue to pay their bills.

[What kind of rollercoaster ride might oil prices go on in the next year? That’s a tough question for even a savvy investor to answer. Marin Katusa and the Casey Research energy team constantly ask such questions, and share the results of their expertise and research in Casey Energy Report. Put them to work for you: a trial subscription is risk-free for ninety days.]

QE or Not QE, Asian Markets Are Driving Gold

by Alena Mikhan and Andrey Dashkov

We’ve seen some real gold volatility in action… up to nominal records then down in a quick retreat. So, what’s next?

Much will depend on whether the US Federal Reserve will embark on another round of quantitative easing (QE3). If QE3 goes live, anticipation of future inflation will persuade many investors to down the trusted path of securing their capital in gold.

But the reality is that even without QE3, gold can go up – one is tempted to say it must go up. As discussed many times and in many ways, the economic problems already on deck are not being solved, and any one of them can make gold soar.

Gold is in the unique investment class of “ultimate safe haven.” Demand will be much higher once push comes to shove and fiat currencies lose what little credibility they still have. This is developing, with or without another round of quantitative easing.

And demand for gold has been accelerating recently. The focus is now on Asia. China, India, and a range of smaller countries showed impressive demand for gold in Q211. The second-quarter update of Gold Investment Digest, published by the World Gold Council, reports on physical bar and coin demand:

Turkey and India were the two strongest markets, chalking up growth rates of 90% and 78% respectively. China (+44% year-on-year) also accounted for a significant portion of the growth in global demand.

It will be quite interesting to see third-quarter statistics, but anecdotal evidence already shows that higher prices don’t scare Asian gold buyers, instead prompting them to purchase more on the dips.

“The surge in prices has sparked another gold-buying craze. The 50 gram and 100 gram gold bars were selling like hot cakes,” said Ms. Liu, a store manager at Shanghai’s major jeweler Lao Feng Xiang Co Ltd, who said gold sales this month were up at least 30 percent from a year ago.

This summer was an interesting one, not quite the tranquil Shopping Season we had hoped it to be. Gold closed at $1,536.50 per ounce on May 31; it closed on August 31 at $1,813.50, an 18% increase.

Fall shall be an interesting season, too. The current price action is already hot, but traditional Indian and Chinese festive seasons are approaching, and those often boost gold prices. This may be one of the reasons why sales in Asia are flourishing at the moment – buyers expect the gold price to continue its ascent and want to use the opportunity to buy cheaper.

So do we. Casey International Speculator tracks the best companies in the precious metals sector and provides investors with advice on how to profit from the current gold trends.

Stupid Monkeys

By David Galland

The human ape has any number of qualities not often found in other species of mammalia, including opposable thumbs and the ability to fashion and use tools.

Continuing the list, I would add a tendency to form all manner of mental constructs and to then act in accordance with those constructs, even when those constructs have little or no connection to reality.

Thus, for instance, I stride confidently onto the golf course with the firmly held conviction that I am a solid striker when, in fact, on most days I am a wild-hitting duffer of the lowest order.

But an over-elevated opinion of one’s golf game is harmless compared to some of the delusions humans are capable of. For instance, the teenager who becomes convinced that by blowing himself up in a crowd of innocents, he is serving some sort of higher purpose… or that his reward will be an eternity highlighted by bedding virgins.

A more widespread delusion is a tendency to believe in the status quo. Simply, that tomorrow will be roughly on par with today, a construct that extends out as far as the mind’s eye can see.

This particular construct is entirely understandable – it’s this expectation that things will be more or less constant that allows us to make plans and take the steps necessary to execute those plans. In other words, it is a lynchpin to human progress.

Conversely, when the controlling force of the economy that sustains us in our businesses and lifestyles is ever changeable – and these days that controlling force is the government – sensible humans become wary and start squirreling away nuts in preparation for an uncertain future. This is, of course, not conducive to a vibrant economy.

What will Team Obama dream up next in their flailing attempts at reinvigorating an economy that more than anything needs certainty? It is literally anyone’s guess. Are we going all in on the whole carbon credit thing, or is that now a passing fad? Will the Dodd-Frank Act, with its 400+ new rules for financial institutions and everyday businesses, such as automobile dealers who offer financing, help or hurt? Will the government, having bailed out the big banks, now turn around and sue them out of existence… or just until they squeal?

Is it any wonder that the banks now have upwards of $1.6 trillion in reserves sitting on the Fed’s balance sheet? Sure, they are earning a whopping 0.25% interest rate while taking no risk, as they would do if they put the money out as loans to the public. But the real implication – at least to me – is that they are keeping their capital on hand against the uncertainty of future government action and to deal with the hundreds of billions in toxic loans still on their balance sheets.

Another large subset of the human herd has become brainwashed to the point of delusion by a combination of state education, misinformed college professors, mainstream media, religious leaders and high-talking politicos into believing that they as individuals are little more than pawns, knee-benders, set on this planet to follow a path proscribed by the power elite.

As a consequence, when social trials arise on that path, they look first to the government for solutions. And they cling stubbornly to false beliefs, such as the myth of anthropogenic global warming, even though the truth of the situation would be readily apparent if they trusted in their instincts and did some actual research.

And so it is that while the world is dominated by the human ape, the species is greatly hindered in its progress by stupid monkeys. Let anywhere near the levers of power, it is a certainty these stupid monkeys will start pulling madly, and keep pulling even as the machine begins to shudder and smoke.

Making the point, I would like to share with you – a more sensible species of simian, I am sure – a few examples of stupid monkeys at their dumb deeds; deeds that can only make one shake one’s head in dismay.

For example….

The stupid monkeys at the Justice Department decided to block a merger between AT&T and T-Mobile because it would “harm competition.”

“Gawd’s blood!” I cry out loud to no one. The whole idea of such a business combination is, of course, to “harm the competition” by enhancing profitability with a combination of larger market share and reduced redundancies. Maybe the Justice Department should require AT&T to shut down, because the very act of staying in business is clearly damaging to the competition. And while they are at it, the feds should also clamp down on the burgeoning Internet telephony companies that are now slashing into the market share of all the big telecoms.

A sub-species of particularly stupid and destructive capuchins in the California legislature appear poised to pass a bill that will effectively put an end to hiring an adult babysitter or anyone seeking casual employment doing odd jobs.

Here’s the state’s own legislative summary of the bill’s intent:

Existing law requires employers to secure the payment of workers compensation for injuries incurred by their employees that arise out of and in the course of employment. The failure to secure workers compensation as required by the workers’ compensation law is a misdemeanor. Under existing law, employers of persons who engage in specified types of household domestic service and who work less than a specified number of hours are excluded from that definition of employer and are therefore excluded from the requirement to secure the payment of workers’ compensation, as specified.

This bill would remove that exclusion and require all domestic work employers, as defined, to secure the payment of workers compensation and would make conforming changes. By expanding the definition of a crime, this bill would impose a state-mandated local program.

In lay terms, the bill – which already overwhelmingly passed in the Democrat-controlled assembly and just passed unanimously through the California State Assembly Committee on Appropriations, precedent to passage by the Senate and therefore into law – will require you as a parent (or otherwise casual employer) to follow formal employee reporting protocols and, among other disincentives to employ, provide your babysitter with worker’s compensation benefits, regularly scheduled rest and meal breaks and even paid vacation time.

Failing to do so will open you up to lawsuits from disgruntled help and being dragged into court by the nanny’s nanny (state).

Now, a monkey with even average intelligence might conclude that passing this law in the grips of an unemployment crisis – and California’s unemployment rate is over 12%, versus the nationwide average of 9.1% – would curb enthusiasm for hiring and so should be avoided. But not the stupid California capuchins.

Vermonters want to block the shipment of oil from the tar sands through the state.

This next example is particularly ripe, providing evidence of just how badly the US educational system has failed its pupils.

Quoting a supportive article in Vermont’s Burlington Free Press

A tar sands oil developer might be planning to pipe its product to Montreal – and then across Vermont’s Northeast Kingdom in an existing pipeline to Portland, Maine, according to Canadian and American environmental groups.

That threatens the region’s air, water and wildlife habitat, the environmentalists say.

Egad, a reader might decide, the region’s environment is at risk. Break out the placards, fuel up the lawyers!

We are all aware, of course, of the principle of NIMBY – as in Not in My Back Yard. But even the most simple of simians might want to rethink the notion that Ft. McMurray, Alberta – the hub of the Canadian tar sands and source of the hateful oil – is in Vermont’s backyard. Unless one also considers, say, Phoenix, Arizona to be similarly a part of the neighborhood: Ft. McMurray is about 2,750 miles from Vermont, and Phoenix just 2,600.

And how is it that feeding processed oil into an existing pipeline constitutes such a dire threat?

Oh, what folly these enviro-monkeys are capable of. It it’s positively laughable, but only if you like laughing in the dark.

Then there’s this, from the Stupid-Monkey-In-Chief (SMIC)

This week, our own President Obama, the SMIC, has confirmed his intention to tune up his vocal chords in order to create the jobs that have so far gone missing in this crisis, and which, according to today’s again dismal unemployment data, remain nowhere in sight.

Said the SMIC:

“It is my intention to lay out a series of bipartisan proposals that the Congress can take immediately to continue to rebuild the American economy by strengthening small businesses, helping Americans get back to work, and putting more money in the paychecks of the middle class and working Americans, while still reducing our deficit and getting our fiscal house in order,” Obama said.

“We’re saved!” shout the staunch few that still believe the SMIC is cut from superior cloth. But even the stupidest of the stupid monkeys might be tempted, after so many disappointments, to raise their hands and ask, “What’s the plan, chief?”

In answer to which I provide the following preview of “the plan,” courtesy of Bloomberg

Obama’s plans include more infrastructure spending, tax incentives to spur hiring, a reduction in the employer portion of the payroll tax credit and changes to unemployment insurance to subsidize worker retraining.

Did you just get an overwhelming sense of déjà vu? If so, it’s probably because the SMIC’s latest plan is pretty much the same as the previous plan, and the one before that. Sure, there are a few tax breaks here and there – but companies don’t hire people based on tax breaks. They do so because there is work to be done and people are needed to do it. And in the real world, a $5,000 tax credit for hiring someone – the amount being bandied about in the new plan – will be burned through in a couple of months of (now mandatory) health insurance payments.

Still in the real world, if the country is to pull itself out of the muck, the government needs to stop spending itself into a deeper and deeper fiscal hole. And it needs to undergo radical reforms in regulatory and tax regimes (to attract businesses and capital here, versus over there). And it needs to remake the monetary system on a foundation of something more tangible than political promises.

But first of all, the government has got to acknowledge the simple reality that it cannot meet its obligations and begin, in earnest, the restructuring of those obligations.

Of course, only a stupid monkey would look at the state of our degraded democracy – where half of the monkeys pay no taxes while complaining about the half who do – and believe that the government will willingly make any significant reforms, versus just handing out more bananas.

Therefore, smarter-than-average monkeys are actively taking steps to protect themselves from the coming currency debasement – the only way the government knows to reduce its debt in a politically acceptable way.

Back in 2001, Doug Casey and very few others were waving their arms and hooting about the need to buy gold – had you acted then, you would have outperformed even the legendary Warren Buffett. And as the chart here shows – thanks, Dominick! – you would have outperformed them, decisively so.

(Click on image to enlarge)

And that, dear reader, is that for this week. Until next week, thank you for reading and for subscribing to a Casey Research service!

Vedran Vuk
Casey Daily Dispatch Editor