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The Daily Reckoning | Tuesday, July 13, 2010 The dubious origins of America's Social Security scheme, White noise in the markets and an explosive element for your portfolio, Plus, Bill Bonner on disappearing debt and shrinking the Dow by half... ------------------------------------------------------- Dear Daily Reckoning Reader... For seven years, we've been conspiring to put together a research advisory service that covers the nexus between money and politics, between Wall Street and Washington. We wanted to cut through the clutter you see from corrupt and polluted research departments at the biggest investment banks on Wall Street to deliver you useful ideas on how to protect and grow your wealth. Now after seven years, countless hours spent and miles traveled, conferences attended and books written, we're finally ready test the idea of Apogee's high vantage point research again...and we need your help. Details Here... Nomadic Stocks In Search of Recovery Where the markets are headed, and the round about way they’re taking to get there Joel Bowman From Beijing, China... The markets produced little more than white noise yesterday. Major indexes in the US closed within a fraction of a percent from where they began. Stocks have been lollygagging for most of this year, wandering hither and thither like a donkey in the desert, without so much as a map or a compass to guide them. On the one hand, they have the interventionalists - whose very careers depend on a faux recovery magically morphing into something tangible, something buyable - pulling them in one direction. Then, on the other hand, they have the unrelenting natural forces of the market, pushing down on prices and squeezing the bejeezus out of growth potential. One gets the feeling that, if something doesn't give way soon, this ass is going to die of thirst. So what gives? Where is the recovery we were hearing so very much about until just a few weeks ago? The papers tell us that investors are simply sitting on their hands, calmly awaiting the results of earnings season. Some outfits will miss forecasts by a penny and dive into the red. Others, craftier in the art of mainstream press prestidigitation, will beat expectations by the thinnest of margins and rocket into the evening news. In the grand scheme of things, however, even those numbers may still be considered noise. Companies can fiddle the digits to make them appear as they wish. Cut a few thousand employees and all of a sudden profits look a lot more impressive. Move a few other expenses off balance sheet...hire a crack PR team to put a positive spin on a dismal outlook...conveniently forget to foreclose on a bunch of bad loans...extend and pretend, as they say. Unless you're really looking at the fine print, and unless you have a reliable source giving you the real scoop, it's almost impossible to pick a winner on this racetrack. And even if you do, who's to say some Wall Street heavy hitter won't be forced to unwind a sizable position on short notice, sending a good stock straight off to the glue factory? But there are larger trends afoot, fellow reckoner. Real estate in the US, for instance, is still trying to find a market-clearing price. Inventories are swelling, including the ominous-sounding "shadow inventory" - properties that would-be sellers are holding back from the market in the hope they'll fetch a better price down the road. And now we learn that the aftershocks of the subprime quake are beginning to ripple through the millionaire's market. You might have seen this quote in yesterday's issue, from The New York Times: More than one in seven homeowners with loans in excess of a million dollars are seriously delinquent, according to data compiled for The New York Times by the real estate analytics firm CoreLogic... Though it is hard to prove, the CoreLogic data suggest that many of the well-to-do are purposely dumping their financially draining properties, just as they would any sour investment. Another report tells us there are around 7,000 unsold condos in downtown Miami, all just waiting for that special buyer. This, from Bloomberg: ...banks that financed the condo projects agreed to let developers slash sales prices by as much as 40 percent, said Peter Zalewski, a principal with consulting firm Condo Vultures LLC in Miami. That spurred demand from foreign buyers and all-cash investors, many of whom are renting out their units until prices rebound, he said. The question, of course, is when will prices rebound? The truth is, nobody knows. Investors with short memories hope for a swift return to a property landscape in which people with no jobs and no visible income - "no-doc" loaners - moved into houses with Infinity Pools and granite countertops. When will we see that again? Maybe not for a long, long time. Maybe never. Moreover, we'd bet that, on a national scale, there are a lot more unsold condos and empty villas than there are all-cash investors. That, too, will continue to keep a lip on prices. Maybe the foreigners will buy them up on the cheap, then? Well, them foreigners 'ave got problems of their own, sir... We can probably count the Europeans out of the game for a little while, at least. Ratings agency Moody's finally downgraded Portugal's sovereign debt rating today, sparking fresh concerns about "contagion" of the continent's ongoing crisis. The agency (which must fairly be in contention for the Christopher Columbus Award for discovering something a long time after a large number of people already knew about it) cited worsening public finances and weak growth outlook as the reason behind their knuckle-rap. Portugal's government finances will continue to deteriorate for "at least another two to three years," Moody's team of clairvoyants announced. Even without this entirely predictable wrinkle, European leaders appear committed to a path of austerity. Between national belt-tightening and the social unrest this balance sheet restoration will surely bring, we can't foresee too many Spaniards or Greeks opting to relieve American developers of their obligations anytime soon. So how about all those cashed-up Asian buyers? Your editor is in Beijing this week, on his second visit to China's capital city. As you might expect, it's pretty hard to get a grasp on what's really going on here. Early this morning we took a taxicab to what we thought was going to be an old "Hutong" - traditionally some of the poorer areas of the city with narrow, snaking alleyways and, in recent years, very low cost housing for migrant workers from the provinces. After a 15-minute drive from our hotel, the taxi driver stopped in front of a shiny new shopping mall. "New China" was all he said before handing us the receipt. We did manage to meet up with a Mandarin-speaking fellow reckoner in the afternoon, however, who was kind enough to gave us a quick tour around a bit of the "other" China. We'll have more on that this weekend, when we're safely beyond the bounds of the Great Firewall. Besides, we've got a double-header of essays for you in today's issue: one from value maven Chris Mayer, who takes another look at investing in uranium, and one from Lifetime Income Report editor, Jim Nelson, who gives us his perspective on the dubious origins of the Social Security scheme. Please enjoy... An Anonymous Office in Houston Just Increased Your Potential Return It's a modest office at 700 Louisiana Street, Houston. And while it opened for business on October 1st, it's already changed the way you and all investors could make money in the next year. Indeed, thanks to the business being done at this 25-person outpost of Gazprom, the Russian natural gas giant, you could quadruple your money. Here's what's happening... The Daily Reckoning Presents A Glowing Recommendation Chris Mayer One of the best investments we can make right now is to buy into supplies of relatively secure, low-cost uranium - the feedstock for nuclear reactors. The simple story is that the uranium supply trails far behind demand. The added wrinkle is that supply cannot easily increase. "In the world of commodities, demand is rarely the compelling reason to get long," observes Robert Mitchell, a general partner at Portal Capital, "Instead, you want to own a commodity where supply is incapable of responding to even a small bump in bids." In other words, you want to buy the commodities where it is very difficult to increase supply. Though hardly a new insight, it's one that investors sometimes forget. One commodity that aces this simple test is uranium. Just looking at the raw numbers, the annual mined supply of uranium provides little more than half the annual demand. Most of the balance comes from decommissioned warheads. Furthermore, uranium production is constrained, both geologically and politically. A few years ago, Cameco's enormous Cigar Lake project went "offline" due to massive flooding. This property will not come back online until 2013! A large, offline mine is a very big deal in the uranium world, as nearly 60% of the world's mined uranium comes from only ten mines. Cameco's MacArthur River mine alone provides 15% of the world's production. For comparison, the top ten mines in the gold sector produce only 19% of the world's supply. Politically, uranium production is also problematic. Let's take a look at just a pair of snapshots from around the world. Consider them postcards from the frontier of the uranium market. (Even if you don't care about uranium, this is an issue that affects many commodities, including oil.) First up, the blue men of the desert... The Tuaregs have been roaming the deserts of North Africa since at least the seventh century. For hundreds of years, they prospered from the lucrative trans-Sahara caravan trade. Tuaregs trafficked in gold, salt, ivory and slaves across the bazaars of North Africa and its trading hubs, such as Timbuktu. Because the indigo dyes they use in their veils and turbans rub off on their skin, people call them the "blue men of the desert." The rise of maritime trade in the 16th century led to the decline of the great overland trade routes of Africa, as it also contributed to the demise of the old Silk Roads across Asia. Today, the Tuaregs live in poverty - even though Tuareg lands in Niger and Mali sit on the third largest reserves of uranium on the planet. Mining interests have tried to push the Tuaregs off these lands. In response, Tuareg fighters have clashed with Niger troops and ambushed mining personnel. The Niger government, by the way, is not exactly a hallmark of stability, either. Niger just had another coup d'état. The mining contracts signed so far are about as good as Confederate money. Risks abound. So even though Niger has handed out over 130 prospecting licenses, mostly for uranium, only 10% are active, because of the Tuareg revolt and political uncertainty. Niger may hold some of the world's richest uranium reserves, but they aren't worth a pile of eggshells if you can't get them out of the ground. Another postcard comes from Kazakhstan - a great, big, empty country in Central Asia. It's the ninth largest country in the world by area, bigger than Western Europe. Yet it has only 16 million people - that's about 15 people per square mile. Kazakhstan, though, is one of the world's largest uranium producers. It has one-sixth of global reserves. Kazatomprom, the state uranium company, is the largest producer of uranium in the world. Kazakhstan is also a relatively risky place to do business. Recently, Kazakhstan arrested the head of Kazatomprom and seven other executives. The sale of some uranium assets is under scrutiny. Among these assets are Uranium One's mines. There is a possibility, though insiders say it is highly unlikely, that Kazakhstan nationalizes these assets. That would make Uranium One, a publicly traded stock, essentially a zero overnight. (Oil companies have also had issues in Kazakhstan.) In any event, the world is depending on Kazakh's plentiful uranium. It will not come cheaply. Current production is profitable under $50/lb. But the low-hanging fruit is always picked first. Getting Kazakhstan's other vast uranium resources on stream will require uranium prices north of $80/lb. to maintain similar profitability. Current spot prices - meaning for immediate delivery - are only about $42/lb. The long-term price is around $65/lb. Most uranium is sold at the long-term price under contracts. (The uranium spot price peaked in the summer of 2007 at $136/lb.) Kazakhstan and Niger are just two examples of why it's not going to be easy or cheap to increase uranium production. Yet we'll need lots more uranium. The demand for uranium is building in intensity like a heap of hot coals. The market has been in deficit for years, as it burns off Cold War stockpiles, which are finite and dwindling. Another way to look at it: Uranium demand is on its way to hitting 226 million pounds per year. Yet last year, the top dogs - which make up 90% of the market - produced only about 110 million pounds of uranium. There are already 436 reactors up and running today. And there is a surge in demand coming in the next decade from the hundred or so new reactors expected to come online. Yet the industry is about 400 million pounds short of meeting that demand. Jerry Grandey, president and CEO of the second largest uranium miner, says the challenge before the industry "will not be easy." New production has been hard to come by. Miners have generally been unable to keep up with production targets. As evidence, he cites the fact that world uranium production is up only 24% since 2003, even though the price of uranium is up more than fourfold over that timeframe. I've been canvassing people in the uranium business to get a sense for what it looks like on the ground. I had an interesting conversation with Chuck Melbye, who has been in the mining business for five decades. His resume is impressive and too extensive to recount here. (Mining also seems to run in the family. His son is president of Cameco Inc., the marketing arm of the big uranium producer.) Anyway, we talked about all things uranium. We talked about projects in the pipeline. We talked about uranium deals signed by China, Japan and Abu Dhabi and one in the works for India. We talked about the slow process to bring on new mines and how expensive and uncertain it all is. We talked about the diminishing stockpiles of uranium. In the end, Melbye's view echoed much of what I've been hearing. "The uranium price is depressed," he says. "It shouldn't be. It's going to take off one of these days. There is going to be a uranium shortage in three to four years." So let's see... strong demand, plus constrained supply, equals investment opportunity! Tune in tomorrow for a specific investment idea... Regards, Chris Mayer for The Daily Reckoning Chris Mayer's Special Situations Reveals... "The Biggest Resource Breakthrough Since the 'Beaumont Miracle' of 1901" 64 publicly traded companies are already deeply invested... insiders are already raking in as much as $205,421 per day on the shares... But only one of these cutting-edge companies offers you the "secret wealth advantage" I reveal right here...   The Day FDR Tore Up The Constitution Jim Nelson With the Supreme Court nomination hearings for Elena Kagan last week, it's time once again to open up our "Pocket Constitutions." Kagan has already faced questions on the constitutionality of "Don't Ask, Don't Tell" and the classic "Right to Bear Arms." But the major question that nominees always face during these events is whether the Constitution should be open to interpretation or if it is a literal document. And that got us thinking... What if some of our current policies weren't so constitutional after all? After just a little research, we found that one of our most entrenched national institutions barely passed constitutional muster. In part of FDR's New Deal, Social Security was dreamed up to protect people against financial devastation in their most dependent times. The concept of Social Security was straightforward; the constitutionality of it was not. In concept, the Social Security system would collect a special tax to fund a special account that provides financial support to the nation's elderly, disadvantaged and dispossessed. But in constitutional terms, the Social Security program would collect taxes from the many to distribute funds to the few. Thus, the Social Security Act of 1935 was a truly groundbreaking piece of legislation...and maybe even unconstitutional. Prior to the New Deal, legal precedent on the Supreme Court had established that any practice the Constitution did not explicitly permit was, by definition, unconstitutional. Under the 10th Amendment, federal powers are restricted to what the Constitution says. Nevertheless, politicians and jurists throughout history have debated whether the letter or the spirit of the Constitution ought to be the deciding factor in any Supreme Court decision. Alexander Hamilton and James Madison debated this very idea in the early years of the republic. Hamilton argued the federal government could levy new taxes for the general welfare of the country in a broad sense. But Madison countered that the federal government could only levy new taxes specifically granted by the Constitution. Central to the New Deal decision was whether or not the Social Security tax "provided for the general welfare" of the country. Creating a brand-new agency to collect and distribute a special tax was unheard of and there were no real precedents to fall back on. Ultimately, the court settled this debate by declaring, "The powers of Congress to authorize expenditure of public moneys for public purposes is not limited by the direct grants of legislative power found in the Constitution." This may have been the most expensive sentence ever issued by the Supreme Court. This one little phrase not only blessed the Social Security concept of taxation and redistribution, but it also created the first legal precedent for levying new taxes to fund specific programs. The rest is history...and it's not a very pretty one. The Social Security system is functionally bankrupt...and growing more insolvent by the day. Far from spending "public moneys for public purposes," the Social Security system borrows foreign money for unsustainable entitlement benefits. Today, roughly 18 million new or reissued Social Security cards are sent out each year. And more than $600 billion in payments are given to some 50.9 million beneficiaries of the Old-Age and Survivors Insurance and the Disabilities Trust Funds. For years, we've heard that someday the Trust would begin to run deficits - handing out more payments than it receives through taxes. This date has always been in the distant future. But because of the economic meltdown of 2008-09, that day has unexpectedly arrived this year. For the first time since Social Security was just a twinkle in FDR's eye, the Trust will lose money. The Congressional Budget Office predicts Social Security outlays to reach $708 billion in FY2010, up from $665 billion last year. Meanwhile, revenues are expected to fall flat near $670 billion. Without significant changes to the system right now, this arguably unconstitutional program could disappear. Jim Nelson, for The Daily Reckoning Jim Nelson's Lifetime Income Report Announces A Way You Can... Legally Collect Thousands of Dollars Each Year... From the Other Government-Backed Retirement Program Starting September 30 this year, America's Social Security "safety net" will officially shrink... So why not let this other government-backed "pension program" pay you thousands of dollars each year instead? Details Here. Bill Bonner How to Cure an Economic Depression Bill Bonner Reckoning from Paris, France... "As recently as two years ago, anyone predicting the current state of affairs (not only is unemployment disastrously high, but most forecasts say that it will stay very high for years) would have been dismissed as a crazy alarmist." That was Paul Krugman in today's newspaper. Thomas Friedman is fixing problems in the Middle East, so we'll have to make do with Krugman to entertain us on economic matters. It is amazing that anyone takes Krugman seriously. It is obvious now that he - and his fellow interventionists - had no idea what was going on two years ago. Now, at least he sees the drift of events more clearly; we are headed towards a Japan-style deflationary slump. "It's a good bet that by some measures we'll be seeing deflation by sometime next year," he writes. "Mr. Bernanke has thought long and hard about how to avoid a Japanese- style economic trap, and the Fed's researchers have been obsessed for years with the same question. But here we are, visibly sliding toward deflation..." So you see, dear reader, even a Nobel Prize-winning dog can learn a new trick. Now, he sees through a glass darkly... Soon, he will be face to face with deflation. Of course, the poor man still completely misunderstands what is really going on. But what do you expect? His career depends on not understanding it. Krugman would have to turn his back on his neo- Keynesian creed if he ever caught on to the plot. He would have to look for a new job if he were ever to tell his readers about it. Almost everyone wants the feds to "do something" to avoid the Japanese "trap." Imagine what would happen if The NY Times' leading economist were to say: "Forget it. The feds have already done too much. Following my advice, they were a major cause of the present crisis. Following my advice, they have made it worse. I was wrong. Now the best thing they can do is to withdraw as gracefully as possible." That's not what Times readers want to hear. It's not what anyone wants to hear, except us "crazy alarmists" here at The Daily Reckoning. We've been talking about the Japan trap for years. Economist Richard Koo calls it a "balance sheet recession." He's right about that. The private sector destroys excess capacity and excess debt. When it's over, the private sector balance sheet looks a lot better. Of course, it could happen faster. In Japan, it may still be going on. Why? Because the Japanese feds worked so hard to stop it. Monetary stimulus. Fiscal stimulus. Quantitative easing. They tried everything. And kept at it for nearly 20 years. But what they were really doing was preventing the one fix that really fixes. It is as if they were letting the air out of the market economy's tires...and then were amazed that it didn't roll. You know what cures a depression, dear reader? We'll tell you. A depression. A depression destroys excessive debt. Businesses with too much debt go broke. Bonds that can't be paid go into default. Households that have spent more than they could afford go broke. Problem solved. Debt disappears. Then, the economy can grow again. So what does Krugman suggest? You guessed it: stop the process of debt destruction at all costs! Do what the Japanese did, in other words, only do more of it. And more thoughts... What's really going on? No one knows. The world is much too complex a place to ever really know what is going on. At best, we can have a vague idea...and maybe see a couple broad trends developing. Our guess is that the broad trend developing leads towards more debt destruction...deflation...and a Japan-style on-again, off-again slump. US stocks still trade at 17-times earnings. Most likely, earnings are going down. P/E multiples are going down too. So, the Dow can be expected to shrink to half or less of today's level. It's harder to see the trend in the bond market. Bill Gross says the two-decade bull market in bonds is over. We're not so sure. The 10-year yield - at 3.05% - is just above the record low from November '09. The 30-year is at 4.04%. Both seem to be sinking toward record lows (meaning higher bond prices). Meanwhile, world trade appears to be slowing. The key shipping index has been down every day for a month. And the two biggest emerging markets both announced warning signs. China said yesterday that its property prices were declining. India said its rate of industrial production growth "sharply" declined to 11.5%. If this is so, expect higher bond prices...and perhaps lower gold prices...over the next few years. *** Does that mean you should sell your gold? Well, if we were speculators, we might consider selling. But here at The Daily Reckoning, we're not gamblers. We hold gold because it represents real wealth, not because we think it will go up in price. We don't really know what direction it is going. But that's why we hold it. We don't know what direction anything is going. The nice thing about gold is that it doesn't matter. Gold doesn't go anywhere. It just sits there. If you buy a bond, for example, you have to worry about the credit quality of the issuer. If things get bad enough, he won't be able to pay up. Your bond could be worthless. Same for stocks. A stock is a share of a company. If the company goes out of business, your stock certificates (assuming you have them) are only good for decorations. Real estate is more reliable. But there are taxes and upkeep to pay. Gold is a better way to store wealth. You don't pay property taxes on it. And the roof never leaks. Besides, gold is especially valuable when other forms of money lose their appeal. The trend of debt destruction will probably not end soon. And the feds will probably sooner or later follow Paul Krugman's advice to "raise [the Fed's] long-term inflation target to help convince the private sector that borrowing is a good idea and hoarding cash is a mistake." In the meantime, gold may go down in dollar terms. Which will make a good time to buy it. *** "Boy, those days were very different. It was before the war." An uncle, 93, was reminiscing. "I was so lucky. I had just gotten out of Polytechnic in Baltimore...which was what you'd call a high school...but I think it was much better than high schools today. And I had a girlfriend at the time whose father had bought her a little roadster. We'd drive around town and have a great time. "I'd pull into a gas station. In those days, someone would come right out and start washing your windshield. "I'd say 'fill 'er up' like I was a big shot. Gasoline was only 15 cents a gallon. But I only had 30 cents. Of course, no one had any money. And everybody knew that no one had any money. So I would say 'fill 'er up' to impress my girlfriend, but then I'd put my arm out the window and hold two fingers down so he knew I really only wanted two gallons. "Ha ha...what a ball we had back then... And then I was lucky again. I got a job at the Bethlehem steel plant. I made $18 a week. That was a lot of money back then...I was on top of the world. "Then, of course, along came the war. And we all knew what we had to do. So, we all went down to the armory and signed up. "We'd had such good training in math and geometry at Poly that they put us in the artillery. And they sent me to officer training... "And then, they sent me to the Pacific. And I was lucky again. I guess I've always been lucky. If I weren't so lucky I probably wouldn't still be here. They sent me to one of the islands. I was leading a platoon. My mission was to clean the enemy out of valley. We went in...and didn't encounter any resistance. And then we realized that it was a trap. We were surrounded. And they were shooting at us from every side. We radioed for help but there wasn't any help around. "The men were looking at me... And I was just a young lieutenant... Good God, I thought we were all finished. "I didn't know what to do. We were stuck. And if we stayed there, we were all going to be killed. So, I ran up a white flag. And when they stopped shooting, I got up and took a couple of men with me...and we advanced to where most of the shooting was coming from. Of course, we thought we were going to be gunned down at any minute. But they allowed us to come up to them... "And I still didn't know exactly what I was doing...but it was too late to think...I went right up to the fellow who was in command and asked him to surrender! "And he did! Ha...ha...I couldn't believe it. "Boy, you can't imagine what that felt like... I was so lucky. He thought he was surrounded...and he was short of supplies." Regards, Bill Bonner, for The Daily Reckoning