Lessons in human nature...

In today's Friday Digest…. a simple lesson in human nature. I'd like to tell you something that's sure to happen across the country over the next several years… and give you a serious warning about what it will mean for our country. I'm talking about the inevitability of huge tax increases. And I'm going to show you a way to realistically double your money on this trend before the end of the year.

The financial media is agog at the "fiscal cliff" – the risk that deadlock in Washington D.C. will result in huge tax increases and spending cuts, a combination that could cut the gross domestic product (GDP) by three percentage points in 2013. Between you and me, I believe there's zero chance this will occur. Politicians never cut spending. Cutting spending is the exact same thing as reducing the government's power. And politicians will never do it. No matter what. That means they'll reach some deal to raise taxes. You can bet your life on it.

Now... let's talk about the human nature part. A substantial percentage of Americans are greedy, stupid, and venal. If you doubt that's true, spend a few days at any Department of Motor Vehicles in any major city in the country. I bet you'd (willingly) hire less than 10% of the people in those buildings to do anything for your family or business.

That probably sounds mean-spirited... but it's a simple fact. Show me a truly random sample of my fellow Americans, and I'll show you a group of people you'd never allow on your property, not even if your house was on fire and they had buckets of water. Keep in mind... these are the same people who vote and whose votes decide most elections.

For decades... almost a hundred years now... these folks have been fed a lie. They've been told by politician after politician that their neighbors owe them... that as Americans, they're entitled to things… like a good-paying job… like health care… like a pension, etc.

Whether or not you believe these things ought to be true doesn't matter. The fact is, nobody owes you anything in life. Not even your parents. God gave you life. Our founding fathers gave you liberty. That's all you get. Everything else has to be earned. It should be obvious that the government can't give you anything it hasn't already taken from another taxpayer.

The core problem in our country is that several generations of Americans don't understand these harsh realities. Instead, they believe whole-heartedly in the nonsense of the Big Political Lie – the idea that you can live at the expense of your neighbor. Sooner or later, your neighbor will get tired of being plundered and will take actions to protect himself. And that's what's about to happen, all across our country.

Take California. In the last election, the "lumpentoriat" (Agora founder Bill Bonner's term for America's growing class of freeloaders) were asked if they'd like to massively raise taxes on the 150,000 highest earners in the state. Shocker alert... you'll never guess what happened. Most of the state's voters thought soaking the rich to benefit "education" sounded like a great idea.

So California is going to attempt to raise $5 billion from those 150,000 people by substantially increasing their income taxes. The top rate will now be 13.3%. That's the highest state income tax in the U.S. by a wide margin.

Assuming OBAMA! is able to push through his big tax hike on the rich (and I think that's a safe bet), residents in California paying the highest taxes will face income tax rates of well over 50% – the highest income tax rates Americans have ever faced. (You'll see lots of pundits claim that taxes were much higher in the past, but that's baloney because of the various loopholes that existed until the tax reforms of 1986. The truth is, Americans have never faced actual income tax rates above the mid-30% range.)

Now... what do you think is going to happen? Back in 2008, Maryland Governor Martin O'Malley said he was going to raise $2 billion a year for the state by taxing "the rich" – those earning more than $1 million per year. What happened? More than 30,000 millionaires left the state, taking a lot of their spending and all of their income taxes with them. The state's income tax revenues actually fell.

Currently, total government spending (federal, state, local) exceeds $6.3 trillion. Our economy's annual GDP is roughly $15 trillion. Thus, government now makes up 42% of our economy. We pay for this largesse through progressive taxes, where roughly 10% of the population pays for 75% of the expense.

On a per-household basis, we're spending $55,000 for our country's governance. But the average household in America only earns $50,000 per year. The combination of our huge government debts (more than 100% of GDP), narrow tax base, and high level of government spending will push us into a massive crisis. It is already beginning.

The only way out of this crisis is for everyone to realize there's no free lunch. But today, roughly half of the country doesn't pay income taxes at all. And only 63% of the working-age, civilian population in the U.S. even has a job – an all-time low. Given these trends, I don't believe any effort to actually broaden the tax base is politically possible.

So what will happen? Taxes will be increased where they can be… on corporations and wealthy individuals. These are the groups that can be outvoted. Will that work to close the fiscal gap? No chance.

If you study the history of revenue and taxes in the U.S., you'll find tax revenue has never exceeded 20% of GDP in our country's history. It doesn't matter how high marginal rates were set. You can study the numbers all the way back to 1913, when the income tax was introduced. Even during the 1930s… when the highest marginal rates were set at 90%... the government never collected more than 20% of GDP in tax revenue. Why? Because the higher taxes get, the more things people will do to avoid them.

The core of the problem is that the average voter has been told to expect a government that spends 40% of GDP. But the government will never collect more than 20% of GDP. Never.

That's the impasse. It's massive. It can't be solved. And these debts are adding to the largest pile of debt in the history of mankind. There's going to be a crisis... and it's going to be far worse than anything anyone has ever imagined. It's all because people were told a lie... that they could live at the expense of their neighbor.

In the political thrashing that's sure to occur as the extent of our problems becomes more and more clear to more and more people, you can be sure taxes will be raised by huge amounts on two groups:

1. The rich (who can't win elections because they vote in small numbers), and

2. The corporations (which don't vote at all).

Here's where your chance to make a lot of money comes in. Corporations are about to do a bunch of things to avoid paying higher taxes. And lots of these changes will happen before the end of this year.

Look what just happened today, for example… Penn National Gaming (PENN), a $3 billion casino operator, announced it will split itself into two firms. New Company A will manage the hotels and casinos that Penn National owns now. It will pay rent to New Company B, which will be incorporated as a real estate investment trust (a "REIT"). Companies with this corporate structure don't pay any corporate income tax. Instead, they distribute all (or almost all) of their earnings to shareholders, who then pay taxes on the distributions.

Making this change will eliminate the double taxation investors normally face. Regular corporations must pay income taxes that average around 35%. Then, they issue dividends. Under Obama's new tax plan, those distributions will be taxed again as ordinary income. That means someone in the highest bracket who owns a corporation would have to pay a combined tax rate of 74%.

But... if these assets were held inside a REIT… these earnings would be taxed only at the highest marginal rate of the individual owner.

What did this mean for the owners of Penn Gaming? The stock is up 29% today. I'd pay close attention to similar hotel/casino companies over the next few weeks. Normally when one company converts to a REIT, the other companies in that sector soon follow suit. And these conversions almost always lead to much higher share prices.

Look at what happened in the timber sector, for example, when several big producers converted to the REIT structure. The charts below show shares of three major timber companies: Weyerhaeuser, Plum Creek, and Rayonier. We've noted the point when each converted to a REIT…

Plum Creek converted to a REIT in July 1999, when shares traded for a bit less than $30… by mid-2008, the stock hit more than $52 a share. The stock suffered a sharp correction since then, but is today at more than $40 a share.

Rayonier went next… converting to a REIT in January 2004 when shares were in the mid-teens… Today, you have to pay almost $50 a share.

Finally, after trading sideways for about a decade, Weyerhaeuser opted to become a REIT in January 2010 when shares were in the teens… Today, the stock goes for more than $25 a share.

The same thing will happen across the gaming sector... and probably before the end of this year.

Our friend John Doody thinks the debt crisis and looming tax increases will also lead to a weaker dollar (via the inevitable money printing) and much higher gold prices. John is the best gold-stock analyst we know... And his newsletter, appropriately named Gold Stock Analyst, generates huge returns for investors... Using his proprietary method, John made 1,032% for his readers between 2001 and 2011 – an average of over 40% a year.

He's personally made a $10 million-plus fortune using this strategy. And today, he's using this same strategy to "go all in." John is personally putting a huge stake of his fortune in gold stocks today... And he's urging anyone who will listen to do the same. He hasn't made such a bold call on gold stocks since 1994.

The last time he saw a similar setup, in late 2008, John's gold stocks surged 1,070% in just two years. Today's opportunity could produce even larger returns.

From a technical perspective, S&A Short Report editor Jeff Clark is also bullish on gold stocks... He thinks they will lead the market out of its current slump. So today is a great time to establish your positions.

To learn more about John Doody and his proprietary method, click here...

New 52-week highs (as of 11/15/12): None.

In the mailbag... Harry Dent's comments on deflation... and many subscribers are finding a reason to ignore their trailing stop losses. (Don't do it!)

Send all of your letters to feedback@stansberryresearch.com. Believe it or not, I still read them all.

"Yesterday I received an email from Erika Nolan of the Sovereign Society entitled 'Forget Retirement Until You've Read This.' In that article was included an essay by Harry Dent. To summarize, Dent is predicting a crushing deflationary period with the DOW down to a possible 3,300. He is recommending getting rid of gold and silver and many other assets and accumulating cash. Ferris, in today's article, to the contrary, is recommending gold and silver and other quality stocks forecasting a highly inflationary period. I find these prognostications very confusing. Can you expound on these differing points of view?" – Paid up subscriber Andrew Z.

Porter comment: I had a long conversation with Harry Dent on my radio show about these issues. I'd encourage anyone who's interested in understanding the risks of inflation versus deflation to listen to it.

You'll be surprised to learn that we don't disagree much with Harry... It's really just a matter of timing. Harry believes the fiscal crisis we face will cause a deflationary collapse before there's a tremendous inflation. We simply disagree with him... and we note that never before during any paper-currency collapse has the exchange value of that paper greatly increased. Gold, on the other hand, has always appreciated during periods of uncertainty under fiat currency regimes.

"I thought I was taking the conservative approach and have set stops on the 10%-15% side. I've positioned my portfolio based on suggestions during the last 2 months and have stopped out of just about everything. Since I've been tracking the stops myself I haven't actually sold all the positions. The current letters tend to ignore the fact that most everything has taken a major dive and all I see is 'it's a good time to buy' – thanks but I bought a month ago.

"Since this is a major market correction should we hold positions or just stop out – and do what? I'm sure other investors who follow your lead are wondering the same thing – feel free to re-word as you like but give us some feedback based on what really going on out there, not just the same jargon about but big picture." – Paid-up subscriber Mark T.

Porter comment: Market corrections and taking small losses thanks to trailing stops are facts of life. Good traders don't worry about these things. They know stops won't optimize the results for any given investment. They simply protect your portfolio from the possibility of suffering a "wipeout" loss. It's difficult to recover from losses of 50% or 75%. Stops also help to make sure that if this small correction turns into a major crisis, you'll have plenty of capital to buy back in at even lower prices.

In the fall of 2008, S&A Resource Report editor Matt Badiali stopped out of every single stock in his portfolio (gold and oil stocks). At the time, readers thought it was a catastrophe. They'd lost money (small amounts) in roughly half of his recommendations.

But look at what happened to gold and oil stocks from mid-September through the end of November – after Matt had closed out those positions... It was a wipeout. Taking a 10% or 20% loss in September felt bad to lots of folks... but it ended up saving them. And it allowed them to have cash at the bottom... where they could buy many of these same stocks, which by then were down another 50% or more.

We don't pretend to know where the market is headed. It could certainly come down more. And the more it falls, the more values will appear to us. We'll tell you about them as we see them.

We don't think there's anything unusual about this pattern... stocks generally have to fall a bit before they represent good value.

Regards,

Porter Stansberry

Baltimore, Maryland

November 16, 2012

Lessons in human nature... How to make 50%-100% in the next month on big changes to corporate taxes... The real size of the fiscal gap... In the mailbag: Readers talk themselves out of following their trailing stops (bad idea)...