(Vedran Vuk filling in for David Galland)

Dear Reader,

Welcome to the weekend edition of Casey’s 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.

Insider Trading Comes to Congress

According to the Wall Street Journal, 72 aides traded in companies overseen by their bosses. These trades were unethical but legal. Though this seems like groundbreaking news, it’s really just business as usual. The 72 aides barely scratch the surface of insider trading in Washington. This cohort comprises only the dumbest and most blatant of the bunch. Although congressional aides must file their trades, friends and family members are still below the radar. One can only imagine the many uncles, cousins, and college roommates that have been enriched by congressional inside information.

A Politico article points out that the aides didn’t make a killing – only a few thousand dollars in some cases. But once again, this is just the visible money. Suppose a friend in the hedge fund industry got the tip as well. Now we’re talking profit in the millions. But surely congressional aides don’t know anyone in the financial industry, right? Regarding the money earned from insider trading, this report only reveals the tip of the iceberg.

Furthermore, the investigation only considers a direct link between their boss’s legislation and a traded company. But there’s more insider trading below the surface here too. D.C. is practically an ocean of freely floating insider information. When I worked in the District, I, too, heard tidbits of tradable information. I didn’t even seek the information or ask. People would outright reveal classified information in casual conversations about work.

You see… D.C. has a general problem with keeping its lips sealed. That’s one reason that you always hear about “leaks from the White House.” The whole city is a giant gossip mill. Here’s my explanation why. Washington D.C. primarily draws egotistical characters. In no other city can someone feel so important –especially so early in their career. The private sector offers few opportunities to work on world-changing events and to stroll the halls of power. These divas can’t handle the cubicles and the “unimportance” of regular work. Hence, they come to D.C. to bath in the limelight.

So, what do egotistical individuals love to do? Talk about themselves, of course. And they love to reveal all the privileged information that they know and you don’t. It gives them a feeling of self-importance and superiority. In fact, you literally can’t help but hear insider information in D.C. Go for some drinks with your friends on Capitol Hill, and you’ll hear something or another not in the mainstream press… yet. One could likely make a good living simply by buying drinks for congressional staffers and listening.

And this takes us back to those 72 aides. They are just the most obvious culprits. There are innumerable trades where one hill staffer hears something from another hill staffer and then trades on that information. The vast majority of trades will come from this pool, and they won’t be picked up as a conflict of interest.

So, what should be done about this? I say keep it legal but make the information more public. Yes, these congressional bums will enrich themselves through questionable means, but that will happen regardless of insider trading laws. If it’s not insider trading, it will be soul-selling on K-Street.

Instead of filing trades once a year, aides should be required to post them almost immediately. This would give the rest of the market additional information about the inner workings of Congress. Observing congressional trades would provide an early warning sign much like trades of top executives in the private sector.

However, I doubt this law would ever pass. After all, the benefit of the law would come from admitted insider trading by congressional aides. Politicians never want to reveal the whole charade and would never allow such a law to pass. The theft must always be hidden and indirect. Think of the propaganda that public-sector unions always push. Or aides themselves who complain about low pay though they are guaranteed high-paid K-Street jobs after their tenures on the Hill. “Get rich, but don’t make it obvious” has always been the motto for government workers. Hence, Congress will likely pass an insider trading laws instead of just increasing transparency.

The Silver Sleuth

Jeff Clark, Senior Editor, BIG GOLD

Longtime readers will recall we had an ongoing series in BIG GOLD called, “1001 Reasons to Own Gold.” The idea was that there were so many valid reasons to own the metal that I wanted to track and report on them. If you’ve been invested in the precious metals arena, you know there have been a myriad of bullish indicators for silver this year as well.

Here’s a couple new reasons to own silver that a lot of mainstream investors probably aren’t aware of…

Due to increased demand from industry and investors, silver exports from China are expected to drop about 40% this year. And that’s actually an improvement; customs data show exports plunged almost 60% through the first eight months. China exported about 3,500 metric tons of silver in 2009, but has exported only 970 tons through August of this year.

What a lot of Westerners don’t know is that China ended export “rebates” two years ago to stem the shipment of natural resources leaving the country. As a result of the regulation, silver exports decreased in 2009 but are nothing like what they’re experiencing this year. In other words, the large drop in exports is a direct result of a huge increase in demand within China itself. According to one Chinese banker, the spike in demand is coming from all areas – jewelry, investment, and industrial. In his words, it’s led to a “physical market shortage in the Far East.”

How important is this? China is the world’s third largest producer of silver (after Peru and Mexico), so the amount of silver coming to the global marketplace this year will drop by more than 74 million ounces. This represents roughly 8.3% of total annual global supply from 2009. If worldwide demand continues at its current pace, where is the extra metal going to come from? This alone tells us the price of silver will move higher.

The next item I sleuthed out was that the U.S. Mint is expected to release a new five-ounce silver bullion coin this year, the first ever. The coin will be three inches in diameter and have a composition of .999 fine silver.

I’ve read the five-ounce bullion coins will be near-exact replicas of the America the Beautiful quarters. There will reportedly be five different designs, and the mint plans to produce 100,000 of each. I can’t wait to see them.

The coins will be classified as bullion, meaning they should be available to the same dealers already authorized by the mint. So our recommended dealers in BIG GOLD should have them (see our October issue for the list). This will likely create excitement in the silver market, especially when you consider its affordability. At $23 silver, the five-ounce bullion coin will cost $115, plus premium. One ounce of gold runs $1,340 as I write, while five ounces will cost you $6,700 plus commission.

Perhaps most bullish is the fact that silver is vastly underpriced when compared to gold. Look at it this way: gold is currently priced 57% above its 1980 nominal high of $850; silver would have to more than double to reach its 1980 nominal high of $48.70. And that’s excluding any inflation-adjusted calculation. Yes, silver’s spike was partly a direct result of hoarding by the Hunt Brothers, but my question to the skeptics is this: what’s keeping us from seeing similar stockpiling today? What if there are several Hunt Brothers out there?

It’s true that central banks don’t buy and store physical silver, so one source of demand that’s common for gold isn’t present for silver. But let’s keep things in perspective: demand for all forms of silver is rising, and we see no reason the trend won’t continue. And with indicators like decreasing supply from China and increased attention from a new bullion coin, I say the big picture on the silver price is extremely bullish.

This silver sleuth says, buy some silver on the next dip. There’s lots of reasons you won’t regret it.

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The Anachronistic Economy

By Kevin Brekke, Editor Casey Research Switzerland

Another one of those puzzling headlines caught my attention recently. A report released by the Bureau of Labor Statistics (BLS) announced that there were 3.2 million job openings in the public and private sectors in August, the most recent data. The report goes by the snappy acronym JOLTS (Job Openings and Labor Turnover Survey), a coincidentally appropriate description as the news was certainly a jolting read when juxtaposed against today’s chronically high U.S. unemployment. The news definitely looked counterintuitive and out of sync with reality.

An “anachronism” is anything that is judged as out of place in time or sequence. Derived from the Greek ana (against) + chronos (time), the word is one of my personal favorites, and its appearance can be glimpsed all around us, everyday, if you look hard enough. This is self-evident when you consider that time relegates all things to the anachronistic dustbin, sentient beings included.

And the economic dustbin is starting to fill with artifacts of an anachronistic American workforce. There are several factors that contribute to the discord of high unemployment concurrent with high job availability. One of them is a workforce discovering that it is educated, trained, and experienced for an economy in transition – time is plying its trade, and many job-seekers are skilled in a trade or position that brought home the bacon in the ‘90s but is today no longer in demand.

A segue into an anachronistic economy is well underway.

A greatly simplified explanation of “an economy” might look like this: labor + capital = economy. (I know this is woefully inadequate. So please don’t send emails with Greek-letter-laden calculus. This is KISS analysis.) This mega-macro view underscores the importance of a correctly prepared workforce. Without it, a shortage of qualified labor will impair economic growth and strain public finances with outsized demands made on the welfare state while falling tax revenue threatens to paralyze the state itself (although, short of downsizing or extinction, this is the next best thing).

An ill-prepared workforce is part of the fallout from several decades of misallocated capital into paper assets and bubble economics. The first half of the twentieth century saw the U.S. economy transition from agrarian-based to manufacturing; the second half is touted as a transition from manufacturing-based to an information economy – the “we think, they sweat” paradigm, or so the myth is told.

And this transition could have succeeded if the information-age had been used to actually produce things that other people, and nations, wanted to buy. Instead, we outsourced our manufacturing base offshore and began selling each other financial products and services, insurance, and real estate; the FIRE economy. What we got were some great stock markets and real estate crashes. And a workforce burgeoning with Realtors®, retail sales associates, car salesmen, human resource assistants, welfare caseworkers, struggling artists, and unemployed MBAs.

Sifting through the ashes of the ‘00s, what’s left is a nation that can’t afford or qualify for homeownership, is too broke to shop, and already has three new cars, downsized or bankrupt companies with fewer employees to manage, broke welfare states shrinking their payrolls, Internet videos rather than theater tickets, and the person bagging your double cheeseburger has a higher IQ than you.

And fixing what ails the economy can’t be achieved by simply overlaying a just-in-time inventory management scheme atop a conference room whiteboard presentation that’s been grease-penciled to within an inch of its life. The solution is obvious, but implementing it will not be quick or painless. The task will not be completed as easily as adjusting next season’s fashions.

The recipe for remedy requires but two things: allow the free market to allocate capital and time. As for the first, what’s needed is not a desperate attempt to maintain the old myths by adopting “Change you can believe in” as your own personal mantra. Government interference must cease. Markets must be allowed to clear, and that includes personal and corporate bankruptcies and other assorted unpleasantness.

As to the second, time, this is where the madness of crowds, stealing a phrase coined by Charles Mackay, enters as the wildcard. Working through a multi-trillion-dollar maladjustment such as the U.S. economy will be slow. And so will the ability of a great number of American workers to adapt to it. Whether unemployed John Doe will hunker down, retrain himself, and begin anew in a second career, or take to the streets demanding that government do more (with the nationwide civil disobedience in France brought to him live via cable TV, feeding his frustration) is hard to determine.

The good news is that as a contrarian (if you can read the Daily Dispatch without cursing at your screen, then you are one, too), I consider myself a HiDef Anachronist; one who is out of step with the status quo but sees clearly where we are today and where we are likely headed, and am prepared and preparing for it. That’s what we do here at Casey Research.

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.

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