Scenarios

Dear Reader,

Last week I spent a few days in the nation's capital for a series of meetings, including a delightful dinner with Casey Research partners Doug Casey and Olivier Garret.

One thing you can say about Washington, DC is that the denizens of that particular swamp have a firm appreciation for fine dining. In fact, I suspect there are more upscale beaneries (as Doug likes to call them) in the zip codes immediately around Washington, DC than any other city in the world. Your tax dollars at work?

While I could drop names of some of the people we met with, the one meeting I want to focus on today was with someone you've never heard of and likely never will. That's because he is very highly placed in the national-security apparatus. Nosebleed levels, actually.

So much so that, other than leading me to my theme for today's musings, I don't plan on revealing anything about him or much of anything about what we discussed.

I will say that the individual is a higher-up in an organization charged with analyzing strategic options for the Department of Defense. In short, they scan the world for threats and recommend military strategies to counteract those threats.

Over breakfast, I received just the barest of insights into the thinking of those in the organization and, frankly, didn't want to hear any more. The phrase "You can't handle the truth" from the Jack Nicholson movie, A Few Good Men, ran through my mind as we spoke.

Speaking of which, it is very much worth your time to re-watch that scene, because Nicholson's character so clearly expresses the exact sentiments held by the people involved in the national-security apparatus. It certainly provides food for thought… and while it can be tempting to nod in agreement with much of what he says, there are very dark and dangerous implications of accepting his arguments at face value that I hope to make clear as today's missive continues. Here's a link.

The field of strategic planning – which in the context of today's musings I'll define as identifying possible futures and developing plans to deal with them – is large and complex. Businesses need to engage in scenario planning, as do governments on any number of levels.

Consider, for example, that years ago some number cruncher in the government projected that Social Security would be sustainable pretty much forever. But then, as time passed, the projections were proven to be wildly optimistic. In fact, the Social Security trust fund set up to pay disability benefits will be out of funds in 2016, followed by the big show – the trust fund set up to pay retirement benefits – being broke by 2033.

Scenario planners must now go back to the drawing board and envision the various ways to avert the defaults (and Medicare is in even worse shape) or deal with the consequences of a large segment of the population finding that the money they were counting on won't be there just when they need it most.

I could go on and on with examples of the importance of – and difficulties associated with – scenario planning within the context of government, but as the topic is so large, I'll focus instead on the process as it relates to national defense.

As it might be helpful in setting the context, I will touch upon something a former CIA officer told me some time back about the defense briefings the president of the United States begins receiving just before taking office, and then on a regular basis thereafter.

In essence, to prepare the president-elect for his role as commander in chief, an individual designated to represent the various defense agencies regularly sits down with the president and reviews top-secret threat assessments and analysis on things that are currently being monitored by the various agencies around the world.

For several reasons – including facts on the ground or competitive political posturing to protect agency budgets – the information revealed is eye-opening and in many cases downright frightening. So many threats, from so many quarters… perhaps a possible leak in nuclear technology coming out of Pakistan, or insider info on Iranian attempts to build bombs, or a new line of stealth weapons being developed by Russia, or a perceived domestic terrorist threat posed by disgruntled Iraq veterans, etc. It doesn't take much of an imagination to imagine that the list is long.

It should be no surprise, therefore, that the current president, a self-described champion of peace with a Nobel Peace Prize to prove it, hardly missed a beat before unleashing a blitzkrieg of drone attacks in the Middle East.

The simple reality, especially given the dispersed nature of real and perceived threats these days (i.e., from small cells of determined individuals and not standing armies), strategic planners have to take an almost infinite number of thin facts in the present and use them to weave a credible tapestry for an unknowable future. In fact, what they end up with are multiple unknowable futures that then need to be prioritized and plans created and set into motion to either mitigate or avoid the possible worst-case scenarios.

And in many cases, we're talking big plans involving thousands of people, large amounts of money, hardware, software, political pandering, and mass manipulations. Plans that might include everything from ordering the construction of new, smaller aircraft carriers costing into the billions, or specialized drones, or creeping degradations of the Constitution.

Viewed in this context, the recent revelation that the US government has been tracking pretty much all of your communications should come as no surprise.

But the simple truth of this scenario planning is that no one can actually tell the future. Which reduces the entire effort to guesswork. And, in many cases, guesswork with dangerous consequences.

To provide a sense of the challenges the US government faces in attempting to protect the population from unhappy outcomes, consider just a few of the limitless questions officialdom might ask about the future, and then try to imagine how the intelligence or military community might consider mobilizing in response.

• Who will America's primary enemy be a decade from now? Many people would say China, which may be what has set into motion the government's recently announced "shift towards Asia." So, exactly how do you "contain" a nation as large and as ambitious as China? And are the risks under consideration largely military or economic as well? In the case of the latter, will the Chinese try to undermine the US dollar? Are they working to develop computer bugs with the potential to destroy the US economy and render the US military command and control structure helpless?
  
  So what would you do, Mr. Strategic Planner? Plant the seeds today for widespread ethnic chaos within the borders of China five years down the road? Massively fund an operation of computer hackers to beat them at the game, in effect engaging in a computerized arms race?
  
  Others might look past the obvious and see the US government's public pronouncement of a shift to Asia as a head fake designed to throw the real threat, Russia, off guard. After all, when it comes to natural resources, Russia is an 800-pound gorilla, and at the rate that things are going, with the continuing rise of the Watermelons within the governing classes (green on the outside, red on the inside) the battles for natural resources are only likely to heat up. So, how do we try to contain Russia's influence? What if we began planning now to start a war between Russia and China down the road?
  
  But what happens if, instead of increasing enmity, China and Russia move closer together and begin to act in concert against the US? How do we move our chess pieces to counter that possibility, or to deal with it should it come to pass despite our best efforts?
   
• Where will terrorists strike next? When dealing with a highly motivated and highly mobile enemy, willing to exchange their lives for havoc, the challenges of anticipating the time and location of the next attack, or what form that attack might take, is the Gordian Knot of intelligence challenges. And so it is that, as with the original Gordian Knot, the solution is to pull out the sword of state and just hack away… unleashing killer drones, engaging in widespread data collection, condoning torture, and so forth.
  
  During my meeting with the aforementioned individual who will remain unnamed, I asked him what would happen if a nuclear backpack weapon, or the equivalent, went off in the hold of a ship parked in any harbor in the world – a scenario posited by Neal Howe, coauthor of The Fourth Turning. Without missing a beat, he responded, "Well, I guess that would put an end to the whole free-trade thing, right?"
  
  So, what exactly would a world look like where thousands of ships carrying essential supplies were stuck at sea with no ports to land in? How would, for example, the US replace the 7.4 million barrels of oil in net imports that it consumes every day? (And the US is in far better shape than most countries in this regard.)
  
  If the goal of the jihadists is to cause the US government to overreact, which it has reliably done following even relatively minor incidents, then there is no shortage of targets.

• What happens if the world's fiat monetary system collapses? Which is to say, what happens when the collective wealth of the world is wiped out in much the same way the wealth of the Germans in the Weimar Republic was wiped out? I know this meme has been around for some time, about the collapse of the dollar and all that, but just because it hasn't happened yet doesn't mean it won't. Deep in the bowels of some government agency, I suspect there are reams of research and analysis on how to sustain a global monetary system that is inherently unsustainable. When might the whole thing come unglued? When the tide of interest rates begins to rise uncontrollably? How will the public react when the train leaves the track?

One could go on forever about this stuff – big and small. The point of these musings is to try to communicate what should be obvious, but to many is not. And that is that big governments are, in and of themselves, big problems.

That's because all of the problems listed above, and virtually all of the big stuff, are rooted in governments being allowed to grow beyond the simplest of mandates. Having grown too big and being tasked with too much, the government planners feel compelled – and are pushed to it by the mindless masses – to try and discern the future and react to it. An impossible task.

In case I am not being clear, let's quickly tick back through the three security challenges listed above.

• Who will America's biggest enemy be a decade from now? Why should the country have an enemy? There were long periods where the US had no real enemies. Sure, there were economic competitors to companies within our borders, but that's a good thing as it keeps everyone on their toes and ensures the steady evolution of new business practices and technology. Of course, not every country is as fortunate as the US, which enjoys virtually unassailable borders (especially with our nuclear-missile capabilities). In addition, the US has the potential to be entirely self-sufficient in energy and food. So, where's the problem?
  
  The problem is that somewhere along the road (Teddy Roosevelt's presidency is a ripe candidate) the US decided it needed to project its power around the globe. Since then, turning a blind eye to George Washington's warning against foreign entanglements, politicians have deliberately interjected the country into untold conflicts, in the case of World War Two even siding with "Uncle Joe," one of history's biggest mass murderers, in the process.
  
  But that discussion is best left for a pleasant evening's debate over a bottle of wine. The point is that there is no reason for the political construct that is the United States to have enemies… all it takes is to get a lot better at minding our own business. And when it comes to a streamlined government, that business should pretty much be confined to providing for defense against an attack on US turf. That does not require troops in over 100 countries around the world, or invading countries in the Middle East, or, or, or…
  
  In other words, in my view at least, the notion of a threat from another nation-state is preposterous, or would be if the US government would stop its activist meddling.
  
  There is, of course, nuance in all of this. For example, there are new potential threats from sources such as hackers who might try to crash the national power grid in the middle of winter just for the hell of it. But heading off that particular threat is a science project that the free market would be very effective at dealing with if left to it.

• Where will the terrorists strike next? In this case, the current most pressing source of terrorism is clear… the US government's meddling in the Middle East and the blowback from that meddling from the jihadists and, inevitably, from the US soldiers returning from the wars there with bad attitudes and broken moral compasses. To be clear, I don't like religious extremists of any stripe. Personally, I wouldn't invite one into my home and I wouldn't accept an invitation to enter theirs… but I sure as hell wouldn't make it policy to send soldiers to the other side of the world to kick in their doors or set killer drones on them. We are only viewed as the Great Satan because we have acted that way in the region, starting by propping up violent dictators despite decades of proof that they use violence against large segments of their population, sending in our military, and, of late, raining death from the sky with drones.
  
  Not being able to see the future, which makes my guess as good as anyone's, to stop terrorism from the Middle East, I would propose my own plan: have the US government ignore the place entirely. If individual enterprises want to try to make a profit there despite the risks, then so be it and good luck.
   
• What happens if the world's monetary system fails? Stuck like a rabbit to a tar baby, we find the US government balled up to its collective ears in trying to use monetary policy to manage the complex system of a very large economy. It's not just futile and doomed to failure, it is as counterproductive as can be. That's because having a central bank, let alone one armed with a blank check, invariably leads to excesses… in government spending, in government debt, and in massive misallocations of capital that, in turn, extend like cracks in lake ice throughout the entire economy.
  
  Moreover, the infrastructure and bureaucracy and businesses that have grown around central bank meddling literally extend around the globe, presenting a clear and present danger to pretty much everyone. While things have gone way too far for anything other than a painful reboot, being an optimist I think that if we were to wake up tomorrow to the news that the Fed was being shuttered and that henceforth the dollar was to be backed by gold (at whatever price that required), the world would quickly adjust and move forward – because that's what we humans do best.

I know I'm being simplistic, but even so, I think I made the basic point – that to expect that big governments with fingers in every pie will be able to correctly anticipate the future and take measures to protect against every rainy day is a form of mass delusion. And a mass delusion with extremely serious consequences, because the only real way to secure the nation against every possible future threat would require locking everyone in the equivalent of a jail cell. Sure you'd be safe, but you certainly wouldn't be free.

Viewing the degradation in individual liberties in the United States over the last decade or so, if you aren't concerned, you aren't paying attention.

There must be a better path, one that stops the pretense that the federal government holds the solution to every problem, and instead demotes it to nothing more than the equivalent of a night watchman.

Personal Scenario Planning

Some years ago, a friend of mine who works in Washington, DC grew concerned that some unforeseen event could trigger class warfare and social chaos, and set about doing his own scenario planning. In his case, it involved buying a motorcycle and a bulletproof jean jacket. The idea being that at the first sight of trouble, he'd don his jacket, fire up his motorcycle, and make like Steve McQueen in his iconic scene from The Great Escape.

I fear his plan would have come to a similar end – it's not very hard to impede someone riding a motorcycle, any brick will do – but at least one has to give him credit for making a plan.

Likewise, in the current economic and political setting, one owes it to oneself, and to one's family, to ponder the future even though it is unknowable, and try to envision how you might be affected.

From there, your personal scenario planning might revolve around mitigating risks or even maximizing rewards.

While you can't be sure which future will emerge, that doesn't mean you can't use your own powers of observation – and those of people you trust – to help you identify the most likely of personal concerns. For example, worrying about terrorism is a complete non-starter. I came across Center for Disease Control data that showed that in all the years since 9/11, there have been about two dozen US citizens killed worldwide by acts of terrorism… versus over 400,000 in automobile accidents.

You might worry, however, about getting killed by a policeman, because in the US you are eight times more likely to be shot by a policeman than killed by a terrorist. Your contingency plan, therefore, may be to be very, very calm and perhaps even practice a little groveling if you are pulled over for even a routine traffic stop.

Oh, and don't forget to practice putting your hands in the air – in addition to being pretty much standard practice when flying, it will come in handy if you are caught in a situation involving first responders.

On matters not quite so life threatening but concerning nonetheless, it doesn't take a Nostradamus to understand that the heavily indebted US government can't allow interest rates to continue rising, but yet can only do so much to prevent that from happening. Yet, there is much talk these days about the Fed "tapering" its purchases of Treasuries. Is not one plausible scenario, then, that should such tapering occur, the market – largely being propped up by the Fed's steady infusion of $85 billion a month – might fall? Or, more to the point, that the recent increase in interest rates might accelerate? As the Fed's public ponderings are quite focused on the tapering, and an inflection point appears on the horizon, might one reasonable action you take be to exit your open-ended bond funds in the not-too-distant future?

Continuing to ponder this matter of interest rates, might the following scenario then unfold?

• The Fed dips its Gucci-clad toes into the water of tapering. Say, by reducing its Treasury purchases from $85 billion a month to a scant $65 billion.
• The stock market (which for most people represents "the economy") falls.
• Interest rates continue to rise, causing a panic in bond markets and pushing yields higher, faster.
• The Fed takes its toe out of the water of tapering and ramps its Treasury purchases back up to $85 billion a month, or maybe more (probably wrapped in the guise of a freshly created program with a different name but the same outcome).
• The idea of the Fed being able to execute a smooth exit from being the Treasury buyer of last resort is revealed as a farce.
• With the clear implication being that Fed purchases will continue apace, Mr. Market concludes (finally!) that the future of the fiat dollar is bleak, investors begin demanding higher interest rates, and money begins shifting into things more tangible than political promises.

Again, this is only one of many possible futures, albeit one that can be rather easily mitigated with a bit of forethought. For example, by stepping out of bond funds for the next little while until the air clears, and buying some insurance in the form of gold.

As a related aside, it is interesting that gold these days does poorly on the release of what appears to be good news, because the trading herd thinks that this could encourage the Fed to begin its tapering. Yet, if the economy truly were recovering, then the trillions of dollars now locked away in banks and corporate coffers would begin flooding back into the economy, sparking the inflation we believe is inevitable and sending gold soaring. So, from my perspective – technical indicators to the contrary – the gold market seems to be set up for a win, no matter how things break as this troubled economic era enters the endgame.

Another entirely plausible scenario might be that some corner of the derivatives market is exposed as having no clothes and there is a sharp and widespread crash that takes down financial institutions around the globe. This is the sort of thing that David Webb will be addressing during the Three Days with Casey Research Summit being held in Tucson, October 4-6 (all-star faculty and early-bird registration information available here).

Might happen, might not. But that doesn't mean you can't move things around a bit to lower your personal risk.

Another scenario, one that is supported by a number of technical analysts at the moment, is that the trend of the rising stock market now in motion will stay in motion. Especially given the potential that the recent carnage in bonds will chase money out of that market and into stocks. Could happen. So, you may not want to abandon the stock market entirely, but you may want to pay a little extra attention to the stocks you own and make sure that they haven't already run up to precarious valuations.

As far as the US government's over-the-top actions in trying to anticipate and avoid every future threat, I fear we are still early on in that trend and that by the time that all is said and done, the US (and other countries that tend to follow its lead) will be greatly changed, and not for the better. I don't think things are anywhere near the point of having to hop on your motorcycle and try to jump the border, but I do think they are reaching the point where finding a place on the other side of that border where you can be comfortable is a pretty good idea.

The bottom line is that no one can predict the future – the world is too complex, and a big part of that complexity comes from the human species in which all traits, good and bad, are present. (Is there such a thing as an armadillo with bad character, a bunny rabbit?) When people with bad character, or even good character but suffering from delusions, backed by the full power of the state make it their business to protect you against an unforeseeable future, and approach their task with the idea that individual rights should play a distant second fiddle to the greater good, it's time to be cautious.

And now, as Monty Python liked to quip, it's time for something entirely different… an article just in from our own Bud Conrad on the surprising drop in gold held in the inventories of JPM.

Gold prices are quoted from the futures exchange throughout our trading day and are important for watching the direction of the market. As I described in the May issue of The Casey Report, JPMorgan has come to dominate the supply of gold that is actually delivered on the exchange. JPMorgan manages accounts for itself (house) as well as for customers, and I've combined the amounts in the table below. Participants "issue" delivery notices as an intention to provide gold against their short positions, and "stop" when they are to accept delivery for a long position. The process runs over several days of squaring up the longs and shorts to make that actual delivery final.

JPMorgan continues to dominate the COMEX futures market, issuing 6,432 contracts out of 8,046 so far in June, or 80% of the total. JPM is taking delivery of 213 contracts, so its position will be to deliver 6,219 contracts. The table below shows the monthly issues and totals since December.

[The source of the above numbers is the COMEX year-to-date delivery report, which is updated here. Surprisingly, on June 3, 2013, the COMEX added a disclosure that its numbers may not be reliable.]

The contracts are 100 ounces each, so JPMorgan's issuance for delivery is 621,900 oz.

The following chart shows the dramatic drop in the number of ounces of gold that are stored in JPMorgan's warehouse.

The problem is that JPM doesn't have as much gold in its warehouse as the promised deliveries. Its registered stocks are 413,526. (Registered means it is approved for delivery.) It has a further 136,381 oz. that are not officially available for delivery, but theoretically might be converted to registered. Even the combined total of 549,907 oz. is below the promised delivery by JPM. It may be that JPM customers have stored their gold at other warehouses, but the situation looks like JPM is getting close to not having enough gold to meet deliveries.

The obvious point is that JPMorgan has such big positions that its actions directly affect the markets. The depletion of gold stored in JPMorgan's vault parallels many anecdotal stories of shortages and slow deliveries of physical metal.

While this might look like an immediate crisis, it is likely that other sources will be found. I don't know what fraction of JPMorgan's customers have stored their gold in the JPMorgan warehouse. It would seem logical that their customers would be using their vault, but obviously this can't be the case because there aren't enough ounces in JPMorgan's warehouse for delivery notices that are already provided to the market. It could also happen that some of those who are stopping contracts could change their mind about taking delivery and redeliver their positions, thus canceling out some of the demand for the physical metal. The market price has not moved, so there is no immediate panic about the situation.

I'd like to take a little license in interpreting what these numbers may be leading to:

My personal interpretation is that JPMorgan's very large deliveries allow the bank to contain the price of gold. They are supplying enough gold to drive its price lower. I think at some time there may be a problem with making physical deliveries. So watching these kinds of numbers will be an important guide for predicting where the market will move. I think we are closer to seeing some kind of event that will move gold rapidly upward.

Summer Recommendations

In keeping with a tradition this time of year for people to proffer summer reads and so forth, I'd like to share a few pieces of media that have caught my eye (and ear) of late.

Music: Other songs by The Black Keys have fallen into my favorite genre of dramatic music, but none quite as much as their song Little Black Submarine. Here's the link.

Movie: A not-so-oldie but really goodie is Red starring Helen Mirren, John Malkovich, Marie Louise-Parker, Morgan Freeman, and Bruce Willis. It is fast-paced, very well written and acted. Two thumbs up.

Books: The Name of the Wind is the first in the Kingkiller Chronicles trilogy by Patrick Rothfuss. The equally good second book is The Wise Man's Fear, with the third book now in the works. If you are an aficionado of fantasy, these will definitely float your boat.

The (Medical) Results Are In

Immediately prior to leaving for Argentina, I had a comprehensive medical examination done, including a blood test in order to set a baseline to compare against upon my return. Now that I have returned from my seven months in the wilderness, I redid the examination and this week received the results.

Despite a diet consisting largely of (well salted) meat and vegetables, washed down with a glass or three of fine Argentine wines, the results of my metabolic panel didn't get worse in any category. My glucose level, for instance, was 95 in October, near the top of the range, but today is down to 88.

It gets interesting when looking at the cholesterol data. For example, during my October test I had a triglyceride value of 111. Today, it is 68. My overall cholesterol reading in October was 230; today it is 162 – a 30% improvement. More importantly, while my "good" cholesterol reading was down only modestly from 53 to 49 (the acceptable range is 40 to 60, so right in the middle), my LDL (bad) cholesterol reading plummeted from 154 in October to 99 today, a 35% improvement.

When I left, my blood pressure was in the pre-hypertension range of 135/90 with periodic spikes up from there. At my recent checkup, it was 120/70.

Meanwhile, my weight has fallen from 191 pounds in October to 180 today (I suspect I have packed on a few pounds since moving back).

So, why the improvement? If I had to nominate a single change as leading the charge to better numbers, it would be a tip from fellow La Estancia owner, D. Brooks, to greatly reduce my intake of carbs. Thus, most of the time I take a pass when it comes to eating bread and only eat pasta infrequently. Another member of the Casey team follows the same diet, and has for years, revolving around eating meat – as fatty as he wants – plus vegetables and whatever, the key thing being to minimize carbs (you get plenty from meat, vegetables, and fruit) and is as fit as can be.

Next up would be the nature of the food in Cafayate, farm fresh and very high quality. Processed foods are almost never eaten… at least not by us.

Then there is the weather. While this is a bit of a stretch because I haven't looked at the scientific data on such things, living in the Northeast of the United States – an area of low light and, since we have returned for our summer visit, cold rain – just doesn't feel very healthful. By contrast, living in the high desert of Cafayate where the sun shines in excess of 320 days a year lifts the spirits and encourages one to lead a more active lifestyle.

Speaking of which, the level of activity in and around La Estancia is hugely supportive of a more vigorous life. Hiking, horseback riding, the wonderful golf course, polo, tennis, volleyball, bocce, and regular workouts in what may be the most upscale and best outfitted Athletic Club and Spa in Argentina (and maybe the entire Southern Cone).

On the exercise front, again my friend and fellow owner Mr. Brooks turned me on to the high-intensity, slow-motion workout advocated by Dr. Doug McGuff in his book Body by Science, supplemented with a couple of "sprint" workouts… eight hard, fast repetitions (I use boxing and swimming for my sprints). One big advantage is that, in total, you can reduce your workout time to less than 40 minutes a week.

In any event, I wanted to share those updated numbers with you, because I said I would… and now I have.

A Couple of Reminders

• Three Days with Casey Research. I'm convinced that our only Summit of 2013 is going to be the best ever. In addition to a truly stellar faculty, including Dr. Ron Paul, we are going all out to make it as informative and actionable as possible – about everything you need to successfully navigate today's markets.
  
  To give you just one example, we are currently lining up short briefings, 10 to 15 minutes each, on specific ways to invest in the big trends. For example, a specific options strategy to use to insure your gold portfolio at minimal cost, or the single most undervalued collectible you can buy today. These briefings will be provided in the interludes between the big-stage speeches and panels, with the presenters then available throughout the event to personally answer any follow-up questions you may have.
  
  I am really excited about this event and from the response to the program so far, it appears it will once again be a complete sell-out. If you are interested in spending three incredibly interesting and useful days with the Casey Research team and a spectacular faculty, then don't wait overly long to register. Here's more.

• VIP Visits to La Estancia de Cafayate. Instead of doing a single big event, La Estancia de Cafayate, in conjunction with the five-star Grace Hotel opening soon on the property, has arranged a series of one-week VIP visits this November so that a limited number of participants can experience what life is like living on the property. As I will be back in residence over the period, I've volunteered to help host the events and am very much looking forward to showing like-minded people around the place. For more information and to reserve a space, drop an email to VIPConnect@LaEst.com today. Attendance for each of the one-week visits is strictly limited to no more than 10 people, so if you'd like to participate, drop La Estancia an email right away.

And with that, I will sign off for the week by thanking you for reading and for being a Casey Research subscriber. We may not be able to predict the future, but together we'll manage throughout whatever may come.

Until next time…

David Galland
Managing Director
Casey Research