The corruption of capitalism… Don't "cut" our taxes anymore… What Seabridge is worth… "Communist" billionaires… More on inflation…

When you read the news, it sounds ordinary – even banal. A Monaco-based hedge fund bought a stake in a failing U.K. mortgage lender, Northern Rock. The stock, which was rumored to be heading for bankruptcy (down 75% this year), turned sharply, rallying 43%.

We wondered about what the newspapers didn't think to ask. How could the hedge-fund managers be certain the bank will survive? How did Bank of America know it was safe to buy a large stake in Countrywide Financial, the U.S. equivalent of Northern Rock?

We have very talented financial analysts on our staff. They've looked at the SEC filings of these companies – they're black boxes. Given that the ratings on big mortgage securities continue to be downgraded, it should be incredibly difficult to know whether or not these firms have enough assets to survive the leveraged losses they're sure to take on the mortgages they own. In fact, many of the CFOs of these mortgage companies were buying their own shares this spring, before the big declines. The folks who know the most about the asset quality of these mortgage companies didn't see what was coming. So, how do these big money players know it's safe to buy?

We don't have the answers, dear readers. But there are times when the questions are more important than the answers…

Six years ago, at a conference in Squaw Valley, California, we had the chance to ask Steve Forbes one of these critical questions. Watching tech stocks – Juniper Networks and Maxim Integrated, in particular – fleece investors through absurdly large option grants (which were later discovered to be fraudulently priced as well), we were concerned with what might happen once investors learned they'd been so abused. Was Forbes worried, we naively wanted to know. We might have asked the fox if the hens were safe. (Two of today's leading presidential candidates were private-equity principals.)

The options scandal, which we thought would become big news and a serious threat to capitalism, occurred... but didn't really put a dent in the reputation of capitalism.

We wonder, why?

Perhaps the public never really understood options. Or, maybe any story with the word "accounting" in the headline doesn't resonate in Peoria. We don't know. But we think capitalists got lucky. And we wonder if they'll get as lucky when it comes to the credit bubble/credit bust.

In the seven years from 1999 to 2006, more household debt was created in the United States than in all of the years before 1999 combined. Powerful institutional investors – foreign governments, hedge funds, pension funds – facilitated this huge surge in lending and borrowing. The world's central banks encouraged the lending, the spending, and the packaging of all of these debts by keeping interest rates low during the recession of 2002. They kept rates low for a long time, allowing the boom to continue for years. There were plenty of signs of excess. Commodities of every stripe boomed. The price of oil tripled. The price of gold doubled… and lending standards collapsed. By 2004, about 20% of all U.S. mortgages were subprime. It's a good bet that at least 25% of all the subprime loans made in 2005 and 2006 will end up in default.

By the looks of things, the central banks are sending signals that they will turn the money presses back on to bail out these borrowers before they spoil the whole "barrel" of mortgage lending. But how much money will need to be created to bail out the borrowing binge of 1999-2006? More than has ever been created before. We wonder how the powerful institutions that have invested in those debts will react. And how will they feel about favored institutions, like certain banks and hedge funds, that seem to have special roles – profitable roles – to play in the bailout process?

These are my kinds of communists: The number of billionaires in China jumped to 108, up from 15 last year. "Communist" China now has more billionaires than any country other than the U.S.

Don't "cut" my taxes anymore. I can't afford it. According to the IRS, Americans coughed up a record $2.568 trillion in taxes in 2007, or 6.7% more than in 2006. The Wall Street Journal places this figure in historical perspective: Federal receipts have climbed by $785 billion since the 2003 investment tax cuts, the largest four-year revenue increase in U.S. history.

S&A Gold Report pick Newmont Mining (NEM) acquired Miramar Mining yesterday for $1.53 billion. The deal will expand Newmont's reserves and give it access to Canada's remote Nunavut Territory. Shares gained close to 3% on the news.

Our geologist Matt Badiali just added Newmont to his S&A Gold Report model portfolio last month. Matt writes this morning: "This shows that majors are willing to buy remote and logistically challenged projects that have practically NO RESERVES (aka Seabridge). Newmont bought Meridian Mining for its Hope Bay Project. It's located up near the Arctic Circle in Nunavut. The project has a tiny probable reserve of 385,000 ounces. But it has indicated resource of 5.2 million ounces and a total resource (indicated and inferred) of 10.7 million ounces. Newmont bought the company for $1.53 billion, which works out to $143 per resource ounce. That's very comparable to Agnico-Eagle's purchase of Cumberland Resources. It means Newmont thinks that resource will grow larger. And that means there is a market for giant gold resources. If someone buys Seabridge for that price, shares would be worth more than $58."

S&A Penny Letter pick International Coal Group (ICO) gained close to 10% after a Stifel Nicolaus analyst upgraded shares of Massey Coal, suggesting production volume and pricing will improve over the next few quarters. A Bank of America analyst also initiated coverage on ICO with a "neutral" rating. Analysts believe metallurgic coal will have a high demand due to the current steel boom.

Extreme Value pick Posco (PKX), the world's fourth-largest steel producer, says it is interested in a U.S. or European merger. CEO Lee Ku-taek wants to expand the company's global reach. "Posco cannot be said to be globalised while we have no more than 5 per cent of our steel being consumed outside Asia," said Lee Ku-taek to the Financial Times. Lee has not given any indication which company piques his interest, but speculators believe it could be ThyssenKrupp of Germany or U.S. Steel, the U.S.'s biggest steelmaker.

In addition to being one of the best performing stocks in the Extreme Value portfolio, up 286% since April 2005, Posco is also a favorite of value legend Marty Whitman. Graham Summers outlines the reasons for Whitman's extraordinary success in today's Growth Stock Wire.

Both the Dow Jones and the S&P 500 closed at record highs yesterday… 14,164.53 and 1,565.15, respectively.

New highs: Advisory Board Company (ABCO), Alnylam (ALNY), Google (GOOG), Gen-Probe (GPRO), Janus (JNS), McDonald's (MCD), Occidental Petroleum (OXY), Petrobras (PBR), SK Telecom (SKM), Verizon (VZ).

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"Where did I just read that inflation makes debt cheaper? With all the money the US owes, don't you want hyperinflation?" – Anonymous

Porter comment: Ignoring for the moment the morality of what you suggest (using inflation to steal from creditors and reward debtors), what all of the fans of central banking (i.e. inflation) forget is that while inflation devalues debts, it also devalues assets at the same rate. Take the subprime crisis. We guess investors could hold $250 billion worth of bad subprime debt. Assuming 50% of the amount is recovered through foreclosure, the industry could suffer a $125 billion loss. According to Bill Bonner's latest book, Mobs, Messiahs, and Markets, Americans hold $46 trillion worth of financial assets denominated in dollars. Assuming a slightly increased rate of inflation to help solve the subprime crisis – by 2 percentage points – you'll see a $920 billion loss of purchasing power. Why would you destroy close to $1 trillion in purchasing power to bail out a $125 billion problem? Because you don't have to raise taxes to do so and because most people have no idea what inflation means or what it costs.

Regards,

Porter Stansberry
Baltimore, Maryland
October 10, 2007

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