Dear Reader,

After yesterday’s comments on baby boomers selling their stock, one of our readers made a good point about the future of equities. Perhaps equities won’t decrease in value due to a major selloff, but rather due to lower expenditure by the baby boomers in retirement. If future cash flows are lower, then the price of the stock today should be lower too. The theory makes perfect sense. Now, the big question is whether boomer expenditures will dramatically decrease.

Of course, people will spend less in retirement, but the conundrum is, how much less? In my opinion, future consumer spending isn’t only a story of one generation but a story of three generations. First of all, how were our expectations of retirement formed? The folks deep in retirement now weren’t smoking joints at Woodstock; they were smoking Germans out of foxholes or just exiting the Great Depression in their youth.

Their experience has framed our expectations of a retiring generation. However, I don’t think that this generation can tell us much about the future. They were a unique group faced with innumerable hardships that forever shaped their views on money – sometimes to the point of irrationality. My grandparents are a good example of this generation. They spend money as if they’ll live for another 50 years. This isn’t an attitude that has begun in their old age; it’s followed them ever since the Great Depression.

Personally, I don’t think the baby boomers’ spending habits will magically transform into the thrift of the “Greatest Generation” overnight. Furthermore, the boomers will benefit from the thriftiness of the past. For example, this article notes that the boomer generation will inherit $11.6 trillion.

It’s not just their parents’ wealth that will keep the boomers spending. Their attitude toward the next generation will help as well. According to a Bank of America survey of wealthy retiring boomers, only 49% say that it’s important to leave an inheritance for the next generation. The article notes, “Instead, many people plan to use their savings for travel and to focus on personal relationships…” So the boomers will inherit piles of money but plan to leave little for those coming after them. Ain’t that just swell.

There will be a slowdown in spending, but don’t expect the baby boomers to behave exactly like the Greatest Generation. As the saying goes, 60 is the new 40. For some, that will be true with regards to spending habits.

However, there could be a spending slowdown in unexpected places. I’m starting to see younger adults in their twenties and thirties exhibiting some characteristics of the Great Depression generation. Months and months of unemployment will permanently change your view on savings.

Take, for example, a close friend of mine. During the recession, he must have been unemployed for eight or nine months, only to find a job in debt collections. This guy is as smart as a whip with a law degree, and hard-working too, with his résumé stretching uninterrupted until then back to the age of 14. After working at the debt collection agency for nearly a year, he finally found a really well-paying job. I visited him recently and noticed nothing new in his tiny apartment. I asked, “Man, I thought they were paying you well; are you paying off your student loan or something?” He said, “Nope, I’ve got six months of living expenses saved in cash. I’m not going through that same BS again.”

I don’t have any statistics on this, but I’ve seen this attitude more and more among younger adults. If this recession lasts a couple more years, you can bet that this sentiment will spread. Consumer spending is definitely going to evolve, but I don’t think that it will be as simple to figure out as it seems at first blush.

First, in today’s issue, Dan Steinhart will discuss hedging against inflation. How much gold would you have to hold to maintain the same purchasing power throughout the decade? The answer is surprising. Then, Chris Wood will give us the big-picture reasons for investing in water.

A Little Gold Goes a Long Way

By Dan Steinhart, Junior Analyst

Casey readers of any duration already know how to avoid silent robbery by inflation: own gold.

Since the beginning of 2002, according to the CPI (which famously understates inflation), the dollar has lost over 20% of its purchasing power, a precipitous decline in less than 10 years. During this period, gold owners have not only protected themselves, they’ve most likely profited in both nominal and real terms. But for all of the non-gold bugs just now awakening to the doomed reality of the dollar, how much gold is actually needed to protect yourself from inflation?

Probably less than you think. The graph below charts the purchasing power of a hypothetical portfolio; each line represents a different allocation between dollars and gold, from 100% dollars to 100% gold and everything in between:

(Click on image to enlarge)

Let’s start from the bottom with the dismal dollar: unsurprisingly, if you held no gold, your purchasing power would have dropped in conjunction with the dashed gray line, down to about 78% of its 2002 level.

But the next data point may surprise you. The dashed red line line represents a cash/gold allocation that would have maintained purchasing power at 2002 levels. How much gold would you have needed to hit this breakeven point? Only 5.75% of your portfolio! Even a gold skeptic could handle that tiny allocation: for every $30,000 in your portfolio, keep one gold eagle coin, and you’re covered against inflation.

Of course, just because that worked for the last 10 years, it doesn’t guarantee it will be enough for the next 10. Inflation will likely ramp up at some point in the near future, and when it does, you’ll want more gold. But the point remains: holding just a little bit of gold does wonders to combat inflationary erosion of your cash.

Now that we know how to break even, let’s step it up a notch. We here at Casey Research recommend a 33% allocation to gold. Under such an allocation, your purchasing power would not only have been preserved, it would have more than doubled in less than 10 years. Not too shabby.

For comparison’s sake, we also included how you would’ve done with allocations of gold all the way up to 100%. While we certainly don’t recommend such extreme positions, any outliers who held the majority of their portfolios in gold can now buy over 400% more “stuff” than in 2002.

The moral of the story? If you don’t own gold, get some. Paper dollars are shrinking before our eyes, so offset (or outpace) your losses with concurrent growth in the value of gold.

Water Investing 101

By Chris Wood

Some call it “blue gold.” And many recognize it as “the world’s most precious commodity.” Still, we don’t often think of water as an investment opportunity because most of us have access to as much of it as we want on the cheap, due to government regulations that keep prices artificially low. Nevertheless, there are factors at play that could make water one of the best investment opportunities of the next 20 to 50 years. Let’s discuss…

Water is essential for life. There is no substitute. And while more than 70% of the Earth’s surface is covered by water, 97.5% of it is undrinkable sea water. Most of the remaining 2.5% is inaccessible, leaving just 0.1% of global water readily available for human use and consumption, according to the World Water Council.

Demand for water is on the rise due to general population growth, average per-capita usage growth as the world continues to develop (more-developed countries have much higher usage rates), uses for agriculture to support increased meat consumption (particularly throughout Asia), and uses for energy production.

Some demand specifics:

  • The more people there are, the more water is needed to support that population. And while the annual population growth rate has slowed from 2.2% in 1963 to 1.1% in 2009, even if we assume a mere 1% annual growth going forward, the world will have another 1 billion people to support by 2025.
  • More developed countries have much higher water usage rates. For example, current estimates peg per-capita usage in the US and Europe at 200 to 600 liters per day, while the worldwide average is 50 liters per day and emerging markets average 20 liters per day. As the Asian middle class expands and shifts to a more meat-centric diet, its per-capita water usage will skyrocket since it takes significantly more water to produce meat compared to a similar amount of grain. (It takes anywhere from 7 to 13 lbs. of grain to finish and produce 1 lb. of beef and 3 to 6 lbs. of grain to produce 1 lb. of pork.)
  • The World Bank now estimates that water demand doubles every 21 years and that the pace will accelerate as development progresses across the emerging world.

Meanwhile, the supply situation is tenuous. Depleting aquifers, droughts, crumbling infrastructure, pollution and low water recycle rates are just some of the problems we face.

Some supply specifics:

  • The UN reports that at least 80 countries are already experiencing water shortages. It estimates that 67% of the world population will be “water stressed” by 2025. We may seem far removed from such problems, but even the US is experiencing supply problems due to crippling droughts and depleting aquifers.

In early 2010, the California Department of Water Resources reported that drought in the state’s central valley was so severe that farmers had to bulldoze orchards and crop fields for lack of water. Meanwhile, the Ogallala aquifer, which provides irrigation water for 27% of the US’s farmland and drinking water to 80% of the people that live within its boundaries, is in decline. The USDA Ogallala Research Service reckons the aquifer could be depleted in 20 to 30 years.

  • Pollution poses a huge threat to global water supplies, but the problem is particularly bad in places like India and China. Consider that in 2006, 28% of the rivers and 48% of major lakes and reservoirs in China monitored for water quality failed to meet the lowest standards (unsafe for any use).
  • Aging water infrastructure adds to the supply concerns. Water infrastructure refers to water treatment plants, sewer lines, water distribution lines and water storage facilities. Much of the water infrastructure in the US dates to pre-1960, and often all the way back to the Great Depression.

According to a survey conducted by the EPA, approximately 30% of the pipes in the systems that serve more than 100,000 people are between 40 and 80 years old, and about 10% of the pipes are more than 80 years old. The EPA has projected that over the next 10 years, $150 billion will need to be spent on drinking water infrastructure and another $180 billion over the next 15 years for clean water infrastructure in the US alone. Outside the US, infrastructure needs across the developed and developing economies are also substantial.

Combined, these factors make water a compelling investment opportunity in the years ahead.

But how do we play it? It’s not like we can go out and buy water futures on the NYMEX. Truth be told, it is tough to find more than a couple good pure-play opportunities (one of which we recommended in our most recent issue of The Casey Report), but there are other ways to profit from the trend.

The easiest way to think about the situation is that at its core, just like with other resources, the water issue is one of scarcity, and just as importantly, relative scarcity in some areas of the world compared to others. So you look for companies poised to benefit from that scarcity, i.e., companies that can help facilitate an ongoing supply of clean water by:

  • Making more of it;
  • Moving it from one place to another; and
  • Developing new technologies to conserve it, treat it, or use it more efficiently.

In the “making more of it” category, desalination companies come to mind. Unfortunately, the first major opportunity in desalination companies has come and gone. Between 2000 and 2005, most of the pure plays in the industry were scooped up by global conglomerates. There are still some opportunities here, including Consolidated Water Co. (CWCO) and several companies overseas, but it might take some digging to uncover them.

When it comes to moving clean water from one place to another, companies that produce the necessary pipeline systems and those that build the required pumps and valves top the list. One opportunity in this area is Northwest Pipe Co (NWPX), but there are no doubt numerous others you could uncover with targeted research.

The last area of developing new technologies to conserve, treat and use water more efficiently seems to have the most potential, in my view, though a number of the solutions that will make for big investment opportunities in the future are still in the early stages of development or tied up in private companies. For example, APTwater has developed novel technologies that make wastewater and other polluted water drinkable. And NanOasis Technologies is developing membranes that significantly reduce the amount of energy used in desalination and other water treatment. Both of these companies are private.

So, each area of water investment has its opportunities and its challenges, but the companies involved with allowing for the continuous supply of clean water to those who need it should experience robust growth going forward. And they make for some exciting investment opportunities in the years ahead.

Additional Links and Reads

Kazakh Central Bank Gets “Priority Right” to Buy Gold (Bloomberg)

As noted earlier in the week by Alena Mikhan and Andrey Dashkov, resource nationalism is on the rise. The central bank of Kazakhstan is reserving the right to purchase gold from domestic producers first. While this isn’t on the same level as Chavez’s suggested nationalization, it’s a good indicator of the mood out there. I wouldn’t be surprised to see more of the same showing up soon.

The Class the Loans Fell On (Poets & Quants)

This article discusses the first MBA class in the country to hold debt of over $100 million. So is a business degree at a prestigious school such as Wharton worth the money? In my opinion, it depends. The cautionary tale in the article about a Wharton student who wanted to do something in the entertainment industry is a perfect example of my point. He didn’t clearly understand his goals.

After acquiring the degree, he was offered a high-paying consultancy job, which would have covered his loans, but he turned it down. And now he’s complaining. Exactly how is this Wharton’s fault? Education is human capital, and just like any sort of capital, one must have a plan for it. Imagine similarly starting a business with $100K, buying cameras, signing a long-term commercial lease, and hiring an employee. Just one small problem: you don’t have an actual idea for the business other than general “entertainment.” How do you think this business would end up? Probably very badly. First, get an idea or goal. Then find the steps necessary to execute it.

The student in the article expected the degree to do the work for him. But most degrees these days don’t work that way. And there’s a good argument to be made that business degrees have never worked that way. If one wants to be an investment banker at Goldman Sachs, a Wharton degree is probably a good idea. If one is just drifting in the ocean with no direction, an expensive degree won’t act as a compass. In fact, the debt might just sink your ship.

Degrees don’t open all doors in life, only some. Find out if the degree opens your door prior to putting down $100,000.

Biggest Gold Drop Since December 2008 Sends Metal to… Week-Ago Levels (Zero Hedge)

Zero Hedge sums up the drop in gold prices well. It’s the biggest drop since December 2008, taking us back one week. Sure, we’d like to see gold go higher, but even at Casey Research, we were growing a bit suspicious at gold’s upward acceleration. The reasons for our gold investments haven’t changed since last week. Hence, we’re staying the course.

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

Vedran Vuk
Casey Daily Dispatch Editor