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December 10, 2005

Boom vs. Doom: The Catalyst That Bridges the Two
Major Premium vs. Major Discount: Correction Ahead
Emails

Boom vs. Doom: The Catalyst That Bridges the Two

JOHN LOEFFLER: You know, Jim, There's an old expression that prayer changes things, and there was a little boy who wanted $100 very, very badly so he prayed for weeks but nothing happened. So he decided maybe God wasn't listening and so he would write him a letter. So he sent him a letter requesting $100, and just like letters to Santa Claus the Postal Service got the letter [addressed to] “God, c/o USA.” They decided to send it to the White House, to the President who actually had the letter forwarded to him. He was so amused he instructed his secretary to send the little boy a $5 bill. The President thought this would appear to be a lot of money to the little boy, and he was delighted when he got the bill, and he sat down to write a thank you note to God, which went as follows.

“Dear God, thank you very much for sending the money, however I notice for some reason you sent it through Washington, DC, and those jerks withheld $95 in taxes.”

See, if we can teach them young what this is all about We'd be OK, right?

You know, you have been going against my advice recently, and been reading these horror books before you go to bed, which is why you're not sleeping. And the debate’s on now: are we going into great boom or great doom?

JIM PUPLAVA: Well, you know there are 3 books right now I've just finished 2 of them, I'm on my third and I think they reflect a great debate That's out there right now: are we headed for great times in the market a booming economy as some on Wall Street and in Washington are projecting, or are we just about ready to turn the corner on great cataclysms: something that is just going to be awful?

we're starting out by interviewing 2 of the authors of these 3 books. This week’s author Louis Vincent Gave has written a new book, along with his brother and partner at GaveKal Research, called Our Brave New World. He sets out the sort-of boom argument. And I think he does an excellent job of explaining why we haven’t seen the doom be more pronounced, or why we haven’t had the great doom yet. And the best example is if you look at the trade deficit figures, and he gave the example in the interview which is in Chapter 9 of his book of the $700 Dell computer on which he wrote the book. This $700 computer gets imported into the US at around a cost of $470. But of the $700 in terms of the selling price of that computer $300 went to a Taiwanese flat screen manufacturer who received a $30 profit margin. The box itself was made in China for $100 with a margin of $5 to the Chinese manufacturer. The Intel chip, which was made by TSMC in Taiwan, cost $70 but with a margin of $35 going to Intel, and $5 going to TSMC. Microsoft gets $200 for the software for a margin of 90% or $180. And then Dell tacks on a $30 profit for selling the PC.

So, if you look at the profits of that $700 computer $35 to Intel; $180 to Microsoft; $30 to Dell for $245 dollars versus the people who actually manufactured the box, the Taiwanese flat screen manufacturer got $30, the box maker in China got $5 and the chip maker in Taiwan got $5 for a total profit of $40 versus a profit that US companies made of $245. Now, if you look at how this gets entered in the trade balance, the cost of importing the computer minus the software and Dell’s market is $470. So, $470 gets registered on the trade deficit but on the other hand US corporations pick up $245 in terms of profits towards GDP. So the net difference the $245 profit that US companies made versus the $470 on the trade imbalance is not as bad as it seems. But if you go with some of those figures [there is some distortion] because, John, a lot of the imports into the US are imports from US companies from their subsidiaries. [4:56]

JOHN: If you remember, going back to the 90s, Jim, we had all those books like “Bankruptcy, 1995”. I remember them all flooding the market between 93 and 95, but obviously the book that you're talking about here goes into the background of why that never materialized.

JIM: Yes, because they never talked about how trade deficits get recycled [and how] the trade deficit isn’t as bad as the picture painted. And in fairness to the US our budget deficit is, yes, big by size, if you think of the number close to $400 billion, but if you think of it as a percentage of GDP it is actually much lower than most European countries and for example Asian countries.

So, I think the GaveKal people make a good argument as to why we haven’t seen a lot of the doom.

JOHN: OK, but we're going to be interviewing a gentleman next week who makes a very strong case, as a matter of fact, for the doom side of things. So, why don't you elaborate on that?

JIM: Next week we're going to interview Addison Wiggin who has co-authored a book Empire of Debt: The Rise of an Epic Financial Crisis, co-authored with Bill Bonner and remember they wrote Financial Reckoning Day a couple of years ago which was also a bestseller. And the book has received a lot high commendations from people like Nassim Taleb, author of Fooled by Randomness, Jim Rogers who said, “now perhaps someone will finally listen,” Llewellyn Rockwell, Doug Casey, Eric Fry. So, a lot of people are recommending the book. And they make out a very strong case in terms of why we're going to eventually have this great financial crisis that is going to be upon us, but I do think they miss some of the points that the GaveKal people have made. In other words, yes, the trade deficit looks bad on the surface. However, when you examine it from the perspective of GaveKal, and you see how much of the trade deficit is US companies exporting goods from their subsidiaries, you can't ignore the fact that maybe the manufacturer of the iPod has a 5% profit margin, yet the bulk of the profits made from selling the IPod occur to Apple which has a 40% profit margin.

So, we're entering this information age that Alvin Toffler talked about, and GaveKal talked about in their book a Our Brave New World. we're going to see a lot of displacement. we're going to see some displacement in manufacturing much like we saw a lot of displacement in agriculture [and in] the buggy whip business as we enter into a high tech society. In this society a lot of the 3 things a company does design a product, manufacture it, and sell the product the two most profitable sides of that equation is the design and selling which US companies are accelerating, and also doing very well at. On the other hand There's the manufacturing side where it is more difficult to make money and that is the more volatile side of the economic equation. I think we have a lot of economic theories that have not accounted for this quite yet, although I think in the end the Bonner people will be proven right in that you can't keeping going into debt indefinitely, eventually you will sell all your assets.

So, There's a good argument on why this has been delayed. So, one of the things I'd highly recommend if you're listening to this program is that you order on Amazon and pick up a copy of Bill Bonner’s book Empire of Debt, and also the book Our Brave New World, by GaveKal Research. They're going to give you both sides of the debate and you can see why things have been extended, why the great doom has not come as quickly upon us, and explains also some of the mitigating circumstances why we've seen asset bubbles but not as much inflation occurring on Main Street. we're starting to see that occur now, but for a long period of time, despite the increase in M3 the monetary aggregates since Greenspan took over the Fed, the reason why we haven’t seen a greater inflation rate has been a result of increased global productivity in manufacturing. you've seen the prices of some of these manufactured goods come down while today I think you're seeing the increase in commodity-type prices go up. And That's starting to bite into the economy. [9:34]

JOHN: I should mention by the way if you look at something this complex people have different viewpoints but they can trend in the same direction, if that makes any sense. When you think about it, are there any catalytic events or things that are going to start pulling some of these things together?

JIM: Yes, There's a third book that I want people to get, and It's called Oil Crisis by C. J. Campbell. This book was written the first half of this year, and It's on the market now. C.J. Campbell is one of the foremost geologists in the world, he's part of the peak oil theory, and as he points out in his book, 54 of the 65 major oil producers have reached peak production. If you take a look at North Sea oil production there peaked in 1998, and has fallen off a cliff since then, It's down 25%. Since Colin Campbell wrote his book another country, Kuwait you know John this was buried in the back pages of the newspaper when it was announced, and I was surprised nobody picked up on this just announced their oil production has peaked. So now we have 55 out of the world's 65 top producing countries that have reached peak oil production.

Campbell in his book also completely disputes this abiotic oil theory which none of the oil geologists buy: that somehow deep in the center of the Earth [oil is being replenished], and he lays out scientifically as Matt Simmons does why this can't take place. And they tried this by the way in Norway and Sweden, digging deep down in to the Earth just to see if it would be proved correct and they hit a dead hole, and it didn’t take place. Campbell talks about in his book and I haven’t quite completed it but in one of the chapters he said:

As we progressively use up the concentrated energy of the past provided by fossil fuels things will have to slow down and become more sustainable. This represents a daunting change of direction which will likely be accompanied by great tension.

In other words, he is asking once we reach the peak and production begins to decline how do you ration to an energy starved world? How do you go to China for example which is ramping up its manufacturing base, ramping up their highways, ramping up cars and say, “you know what, you're only going to get a certain allocation.” How do you go to the United States which has 5% of the world's population and consumes 25% of the world's energy and say, “you know what, you're going to have to tell your people you're going to have to go to rationing.”

In the end, if the crisis is correct, and I believe the peak oil people are correct, It's just a matter of timing whether It's this year 2006, or 2007,08, or 2010, it is coming. When that hits us, I think the world is not prepared, politicians aren't prepared, we're doing nothing to mitigate this problem even with higher energy costs. And even, John, what surprises me with the tragedy with the hurricanes this Summer with Katrina and Rita, where you had a whole US city wiped out in one of the most important ports in the United States and one of the most important areas of the United States with regard to energy production, which is still down a lot of that energy production as Joe Duarte just reported in his Energy Report, a lot of that hasn’t come online yet and yet with those tragedies our politicians continue to dawdle in Washington. They nixed a plan to build refineries because we're going to need refineries to handle different forms of oil as we hit peak oil, whether It's shale oil, or Canadian tar sands, or heavy sulfur oil we need different kinds of refineries. So, a lot of people say, “if we're hitting peak oil why build a refinery.” Number one, you're going to have to have it, you don't want all of your refineries located in the path of a hurricane as we saw what happened. But secondarily we don't have enough refineries that are capable of handling what we call unconventional oil like shale oil, tar sand oil, or heavy sulfur oil. So, you need it for that. But anyway our Congress voted that down. we've voted down opening up lands on the Pacific coast and other areas where we do know we have oil deposits, because John, we're going to have to have a bridge to get us to the point where we can find an alternative to replace fossil fuels, and we're doing nothing about it.

And so, we've got 3 books right now that are out there. One, which is talking about a boom Our Brave New World and How It's Changed, That's by GaveKal Research, and I highly recommend it. It's about 136 pages, it'll make excellent reading and it'll open your mind somewhat if you're a doomster. On the other hand, There's Bill Bonner and Addison Wiggin’s book, Empire of Debt, that tells us ultimately, longer term, we've got a crisis ahead of us. Whether the crisis is this year, the end of next year, the year after, whenever it comes, it'll tell you what it is going to look like, and what makes up this crisis. And then There's the third book which is called Oil Crisis by CJ Campbell. If you don't believe we're at peak oil you need to read this book because it has some insights from not only the major companies, but the major geologists that work for those companies, why those major companies have shut down their exploration departments: because the world is mapped. This book is going to open your eyes so that when the crisis comes you will not be surprised. Three books that I highly recommend you pick up because one is about why we've had the boom, the other is why doom is ahead, and the third which is what I think will be the catalyst between these two primary thought processes. And I think it will give you some great insight in terms of where we're going, and perhaps the crises we could face in the years ahead.

JOHN: I've been watching a lot of the stuff going on Capitol Hill. I was watching hearings about what FEMA did as far as Katrina goes etc., listening to media liberal and conservative and you can't help but get the impression that They're fiddling while Rome burns. If you understand What's happening out there, if you understand the crises that are about to wash on to our shores, the things they are all dickering about going on Capitol Hill have nothing to do with dealing with these crises. And They're all trying to look in their rear view mirrors, saying, “who’s responsible and why did all this happen and what went wrong in New Orleans yesterday?” But in reality the next storm is already washing on to our shores. It's really frustrating, and like you say, you lose sleep over it at times.

JIM: It's amazing. This year I've been studying the Great Depression and World War I and World War II and along with it the decline and fall of the Roman Empire. And in the latter days of the Empire, the politicians just didn’t see a lot of the problems that the Western Empire was facing it. There was corruption [too]. You know, here in California corruption is rampant, with government officials with pensions and you see all of these parallels.

And you're right John, instead of dealing with the real issues, They're completely ignoring these trends. OK, if you don't like fossil fuels then, darn it, get to work on trying to find something whether It's wind or solar or nuclear power because there is no silver bullet when it comes to energy. There's nothing out there that says, Aha! this is what replaces oil and natural gas just as oil and natural gas replaced coal in the 19^th Century.

They're also ignoring some of the trends, even if the GaveKal people prove to be right far longer than we expect, or many people expect. You better retrain your population if this is the brave new world we're heading into, because It's going to take a different breed of education, you're going to have to be more flexible. you're going to have to be more advanced if you want to have good paying jobs in this brave new world they talk about. [18:13]

JOHN: In all fairness, C-Span did carry a conference that was held looking at alternatives. So, it was phrased like, “in the light of global warming what else do we need to be doing?” So, ironically amidst over all the controversy over global warming, if you notice from Montreal, nothing is happening, just like we said it would be on this program.

They're at least beginning to look in that direction. But It's too little too late. And every one is trying to look at it through the old paradigmatical filters and say We'll do it through taxation, We'll do it through this and that. And That's got to go.

JIM: No, It's not going to work. Charles Adams wrote a book called For Good and Evil, it was a history of taxation throughout world history. And sometimes taxes can provide a useful function but at other times, heavy taxation has meant the decline of a country or an empire, and it leads to economic poverty long term. And you can look at this, as Adams brilliantly lays out in his book For Good and Evil, and you know, here in California we are driving businesses out like crazy. This year California raised income taxes another 1%, so the top rate is now 10.3%. And when we were up in San Francisco for the gold show I was in some of the stores and noticed the absence of a very important ingredient during the Christmas season, which is the customer. And the guy said, “we're just doing so many nutty things, we're driving businesses out.” And businesses are leaving California left and right. High taxation does not breed economic prosperity. [20:00]

JOHN: Also, it seems, if you look since the fall of the “Governators” reform proposals last election, that this green light has been given to the Assembly, especially, in Sacramento to plunge ahead with all of these programs. And they were cheering because they managed to theoretically salvage the pension plan and I turned to my wife and said, “and what they don't understand is they can vote themselves anything they want, There's just not going to be anything there to pay it.”

JIM: We're already running and projecting a big deficit for next year, and the legislatures’ now proposing raising taxes even further. You know, we might as well put up a sign: “you want to do business in California, please leave!”

JOHN: Which is happening. Both the businesses are leaving and the wealthy money is leaving. Even movie production is moving a lot of movies are being done in Canada by the way. And also the retired money is leaving, That's the other important segment.

JIM: It's absolutely amazing.

Major Premium vs. Major Discount: Correction Ahead

JOHN: I'm sorry I just can't stop thinking about it. I think California is a State in the process of committing economic suicide. It really is. The levies are beating the crud out of the golden goose to try to get it to pay, at the same time the geese are leaving, and raising all of these social programs and everything else makes it an impossible situation.

Well, let's do a scene change right here.

Major premium vs. major discount: what kind of a correction do we have ahead, if that is indeed in the cards?

JIM: We've covered sort of what we think is a correction coming to the gold market in the first segment with Frank Barbera and Dave Morgan. I just want to give people a bit of a perspective on what we see developing within the gold market, especially in the last 2 years. If we take a look at the gold price and gold shares especially as it relates to junior producers and the juniors themselves we had this big surge in the price of gold shares, and the price of gold bullion that began in the Summer of 2001. That's when the price of gold bottomed around $255, and it began its upwards surge to where it is today. So, the price of gold has doubled on this first pass, but the gold shares went up from the Summer of 2001 all the way at least the majors and intermediates to January 2004, and that was the first peak that we saw. We saw some intermediate corrections along the way, but from January of 2004 the majors and intermediates began to weaken.

However the juniors continued on an upward surge. A lot of money was moving into the junior market because exploration for gold and silver had fallen by the wayside because of the 20 year bear market in gold, especially in the late 90s when technology was hot. And then secondarily, especially after the Bre-X fiasco in 1998 that just literally killed gold exploration, exploration would not revive until about 2001, three years later. In March and April of 2004 we had the first major correction in the gold market, and it was a significant one. The fact that China was going to slow down its economy therefore there would be less demand for commodities was the excuse given at the time for the sentiment. And what you had, John, was a major, big sell off into May of 2004.

Now, after that, beginning in the Summer, gold stocks took off from let's say May to November of last year. But mainly it was the majors and intermediate producers you know, the Agnico-Eagles, the Goldcorps, the Glamis, those kind of stocks. Money went back into the gold market, gold stocks led the advance, but it was basically a lot of people saying: “You know what, I don't trust this.” In case I want to get out I want to be in something liquid in case I had to head for the exit gates.” And that was what happened during the first phase. Then we got what to we call this second phase with the juniors, which basically ran from November of last year till May of this year. It was a brutal down drop for gold stocks. Not only the majors, but the intermediates, and also the juniors continued to get hammered. And we wrote a piece at the beginning of the year and sent it to our clients, in January 2005 telling them not to expect anything to happen until probably mid-year when it looks like we're getting closer to the end of the Fed rate hikes. Also, the dollar was going up and so what happened the dollar became stronger in the first half of the year. Each time the Fed met they were raising interest rates, that created a lot of strength in the dollar. So, we had a strong trend from the Fall of 2004 until the present in the US dollar. However by May when Frank wrote his piece Da Bottom the gold market began to advance again. This time gold was advancing against the dollar. [25:24]

JOHN: You know we had an interesting switch around here. It reminds me of a weather pattern. because starting around 2001 you could see that as the dollar was declining or falling then gold was advancing. But starting in the Summer they both started to advance simultaneously so there was a switch in the pattern.

JIM: Yeah, and also at the same time gold began to break out in other major currencies. And what is really occurring globally is a great reflation by central banks. They may be raising, but, for example, if we take the last 3 months and measure M3 It's growing at an annual rate of 10%. If you look at the money supply in Europe It's growing at 13%. If you look at the money supply in China It's growing around 17%. So, even though central banks, like the US, and more recently the European central bank start to raise interest rates in the case of the Federal Reserve they continued to raise interest rates the money was being goosed at the same time. This was something I discovered when I wrote The Day After Tomorrow, the last piece. When I went around to the developers I expected them to say, “well, we're getting a little tighter, and want more down payment because the lenders are getting tougher.” But I didn’t find any of that, there was plenty of money around and you could buy homes with almost no money down, with all kinds of loans from adjustable rate mortgages etc.. So the money supply was advancing.

Now, getting back to the gold market, what happened this Summer was the majors and the intermediates began to take off, and the juniors began to lag in performance. And this was rather significant and so once again people were getting on the gold bandwagon, but they were getting on the major band wagon. And as a result of that you've had this big disparity. There's a chart that we've put up on the website, I call a “major disconnect”, which shows the price of gold and the net asset value of ounces in the ground of juniors. In other words, a junior doesn't produce, they go out and define a deposit and then they come up with a resource. And up and till about May of this year the price of gold and the net asset value of ounces in the ground were pretty much tracking each other. But from May of this year going forward, the price of gold advanced substantially while the price for ounces in the ground for juniors remained virtually flat. In fact, There's a wide gap, and this is the first time we've seen this divergence since this gold bull market began. So, I think that is rather significant, and as a result you've seen some underperformance of juniors. Some of our juniors have underperformed and despite this they are adding ounces, they are increasing their reserves some are going forward to pre-feasibility. In fact one of the best money managers in the business, Sprott Asset Management, their performance for their gold fund is only up about 9% year to date. Year over year They're down about 4% because Sprott believes, as I do, that the growth of this bull market is going to be with the juniors, and They're more heavily oriented towards the juniors.

But what we've got John is a major gap between what is happening and the price of gold and you've got now, as a result, is people jumping in on the majors and intermediates. They’ve bid up the price of the major and intermediate gold producers where They're selling at 40% premiums above net asset value. And I know a lot of gold bugs will say, “who cares, gold is going up,” but hey, you know what, They're pricing the value of the majors and intermediates right now almost like $575 gold. It has gotten way out of whack and That's why I think fundamentally you could see a potential hard fall here. [29:20]

JOHN: So what we've got here and to see if I'm understanding it, we've got a major disconnect, we've got people overpaying for the large cap stocks, at the same time They're pitching the small cap stocks.

JIM: Exactly. And there are a couple of things happening fundamentally, and I think you're going to see this play out, in the next three to six months. There was a major exploration funding that took place between 2001 and 2004 because remember up to 2001, nobody was going out trying to find a deposit or explore. At least none of the majors and none of the intermediate companies were. It was mainly done with blood, sweat and tears by a lot of these guys that had held on to projects or started companies, and the junior exploration companies, and development companies. So, there was a lot of major funding that took place. There's been some great success that we've seen, some of the juniors are now entering pre-feasibility, or getting ready for full development of their property.

And now as a result of exploration and drilling we're involved with 4 or 5 juniors now that are getting close to prefeasibility. Also there have been some major discoveries. One company I'm involved with has got 2 major discoveries that They're going to work out. So, the thing is, the juniors this year have been coming back into the market getting financing, and They're going through a major refinance. And one of the things about refinancing the minute a mining company starts talking to their investment bankers, the investment bankers hammer the stock before the financing is done. It's what I call the “dump before the pump”. In fact, John, at the San Francisco Gold Show we went around and surveyed at random 30 juniors and we were trying to find 2 things. We were trying to find: 1) did they have a resource or was it just bluff or were they just trying to find something; 2) how well were they doing, what was going on with their stock, and what was going on with the company? And of the 30 companies that we surveyed and talked to 15 had resources, some had major resources and were close to feasibility, as a couple of the companies I'm involved with [are]. Of the 15 that had resources one half was seeking financing because they wanted to get more drills on the property. One company I'm working with want to go to 4 drills on the property because we had 2 major sizeable gold discoveries. Every one of these juniors that we talked to that had resources were having trouble with their stock. The number one complaint I heard at the San Francisco Gold Show from many of the juniors is, “gawd, we start talking to our investment bankers and our stock takes a tumble.”

And this is so characteristic of the financing cycle with juniors, It's the dump before the pump. So what happens is, you may have a stock at a dollar and you talk to your investment banker and you want to do a financing, the bankers come in and hammer your stock down 55 cents, and then they do the financing at a lower price. Then of course, once the financing is in they drive [up] the price of the stock, because They're going to want to unload their brokers’ shares or their warrants. So, this is one thing that has created some of the disconnect that you're seeing in this market. But the result of this is while you have majors selling for 40% premiums in the market, you've got some of these juniors that are in an advanced stage that are selling at 30-40% discounts. It's almost like night and day between the assets and the prices of the major development juniors versus what I call the major gold stocks. [33:21]

JOHN: It seems to flip back to something you and Frank and Dave Morgan were talking about with Goldcorp’s purchase of Virginia Gold this week. Why don't you zoom in on that because it is probably an illustrative example?

JIM: Well, what you've seen is what you with have companies the size of Newmont at the end of their merger with Normandy and Franco-Nevada they were producing 7.6 million oz, almost close to 8 million oz, if you annualize the 4^th Quarter of 2003 Newmont’s production has dropped from 7.6 to 6.6. you've had Barrick and some of the others drop in production all across the board. And the problem is, as I wrote in one of my gold pieces a couple of years ago, The Gold and Silver Train Wreck, there just aren't that many elephant sized gold deposits out there. I mean, we've been at this spending money on exploration for 3 or 4 years now, and you don't have 5 or 6 elephant-type gold deposits that are being found each year. And I think we're entered a situation John that is very similar to what the major oil companies are facing. What you've got up at the very top is the Barricks going after Placer, the Newmonts buying companies, and all the consolidation, as the majors can't find large deposits to replace their reserves, so They're having to go out and buy it.

But what I think is rather significant is what Goldcorp did this week, because anybody who listens to my interview with Ian Telfer, remembers in 2003 he started buying properties when nobody was paying up for them because he saw a higher gold price. What I'm looking at around the globe, and I've got a sheet in front of me but I just can't release it because It's proprietary. It's got all the world's gold deposits in development stage or production stage and of this page of the world's gold deposits are 2 million and 3 million under in terms of size. In fact, half of the page is 2 million and under.

Telfer is saying, “we're a 2 million oz producer now, and we're going to get bigger.” And up until this time Goldcorp has been mainly buying producers, building up their producing book, and it turns out to be one of the most profitable gold producers on a per oz basis in the world right now. And what he's saying with the purchase of Virginia gold and I think this is a turning point in the gold market is there are not many good gold properties out there.

I know through talking to some of the majors because we're in very close contact with some of the juniors, and for some of the juniors to whom some of the majors are talking to it used to be, well They're looking for 5 million oz, now They’ve lowered the bar and It's 3 million oz, then they lowered the bar again and the talk is “2 plus 2”. That's 2 million ounces of reserves, or possible ounces, and 200,000 oz of production each year. And I think you're going to see that lower again.

I'm working on a project with another geologist right now That's going to take a look at this, and I think what you're going to see in this next leg, and I don't think you're going to see it until next year, is all of a sudden the intermediate companies and the majors start waking up more to the fact of “where in the heck are we going to replace the reserves that we're producing each year?” And I think the major gold producers are in the same, exact situation that the major oil companies are in right now. They're not replacing their reserves, They're not finding those reserves, and as they scope the world and look at major gold deposits there just aren't a lot of elephants out there. And I think you're going to see the majors start to resize themselves, and I think the next major play as the world wakes up to this, and as investors wake up to this, is going to be the junior development companies: the companies that have 1 to 3 million oz. deposits. They're going to start getting gobbled up because I think Telfer has led the way this week with Virginia Gold, and I think that is a key turning point in what is going to unfold here in the next 6 months. [37:45]

JOHN: Jim, you know, speaking of the juniors I know you're involved with them, you're on the board of one particular company. As a board member, does that give a different perspective than if you were an outsider looking in?

JIM: I have certainly changed [my perspective] and it has broadened my perspective in terms of what I look for when I look at a junior today. And we're reshaping our junior portfolio because one of the great learning experiences, you know, if you're in the financial business as I am managing a portfolio, you look at juniors or you look at stock from one perspective, but one of the things that you get from working closely with a company, in this case being a director of a company, you get to look at things the way a mining company looks at things. You get to see things from a miner’s perspective. Why are they doing something in a certain way, or why are these steps being taken, and it gives you a different perspective that you don't get from being on the outside. So you look at things that are going to be successful, you look at why things are being done, and then you also learn about what happens if things aren't done in a certain way.

On some of the mistakes we've seen on some of the juniors that have had major blow ups in some of their stocks, because they haven’t followed through. There was one junior that was a favorite of everybody's, they had huge resources but when they went to their pre-feasibility studies their silver-gold conversion ratio was way too low. They weren’t getting that kind of recovery of their silver. So when they went to pre-feasibility they had to write-off a lot of their silver reserves because it wasn't recoverable, and because they weren’t taking certain steps in engineering. These are the things you sort of learn when you work with engineers, and you work with a geologist because they give you perspective. And looking it at that way you gain a perspective on companies in terms of what you look for or things to monitor in a junior development company that you might not have thought of before. So, yeah, it has given a lot of insight, and certainly changed in a certain direction more of what I like to see now when I look at these companies. [40:00]

JOHN: It's interesting when you mention that Jim because as a sidebar to that if shows that being in a company lends experience and as pensions have been going South, one of the things that companies have been doing is trying to get rid of people prior to having to pay pensions. Theoretically saving the company some money. In reality a lot of wisdom goes out the door with it.

JIM: This is one of the things that happened in the mining industry with the bear market. A lot of companies got rid of their exploration department, or if they didn’t get rid of it they downsized it. At the same time we're facing a situation today where I can think of one company whose mine production went down because they couldn't get enough tires because of oil, John, for their big earth-moving equipment. And who in their right mind in the 90s wanted to go out and become a geologist or work for an oil company or work for a mining company. And There's one company we're involved with on the drilling side which provides drilling and equipment for mining companies and whenever this guy goes to a gold show mining companies are just following him like the Pied Piper because “hey, when can you get us a drill.” Because one of the things you don't want to do now if you're a junior is let go of your drills because, boy!, if you let go of your drills you may not be able to get [another] one, because the drills that you need are in short supply. The geologists that you need are in short supply, mining executives are in short supply, and That's one of the things I admired about Ian Telfer that he's doing at Goldcorp. Each year he's picking somebody from the NBA program as an apprentice to follow him around because we need a lot of people with experience because a lot of people that went into mining or went into the oil business in the late 60s and 70s have grey hair and are getting ready to cash out and go into retirement. And we don't have a large crop of geologists and experienced mining people that are ready to step into their shoes.

And so this thing is a long time in coming and is the result of a bear market. In bear markets, companies consolidate, companies go out of business, supply contracts and nobody spends money on exploration, equipment is allowed to fall into disrepair, mines are allowed to fall into disrepair. And I think that in the mining industry, the majors today are running in parallel to the large oil companies. It is just plain as day to see these two tracks. And one of the things we’re working on now, I'm working with another geologist, is tracking these discoveries. we’ve spent a ton of money on exploration in the last 3 or 4 years, but what have we found? So, we're working on a study on that and It’s just confirming to me that the majors at this point are eventually going to become sort of dinosaurs, They're going to be downsizing. And the real upside potential in the second, big phase of this market is still going to be in the juniors. And I think a lot of people are disappointed with juniors because the majors and intermediates have been where all of the action has been, and That's been the result I think of the liquidity in the market, and a lot of people saying, “gosh I got burned” when the juniors took a big down fall in 2004. Some of them are up this year, some of them have been bought out. Take a look at what [Ian Telfer at] Goldcorp is doing because he's at trailblazer and he's very prophetic in terms of seeing ahead and what he's doing and I think that purchase of Virginia Gold was very telling for Goldcorp because they didn’t want to wait until they had their reserves proved out. It was like, boy, that could be a 3 million oz deposit, there aren't very many of those around, grab it while you can. And That's one of the things we're inching for, we've got our eyes on about 5-10 companies that we think are going to be take-over candidates: some we own, some we're waiting to increase, and some we're waiting to buy in the next corrective phase that we see, because I think it could be the opportunity of a lifetime as the industry itself wakes up to this fact: that the elephants are gone, that most of them have been discovered, and now It's going to be a fight for What's left on the table. [44:28]

Emails

JOHN: And down into the electronic grab bag here, operating at 150,000 volts so be careful.

Kevin’s in Birmingham, England and he says:

“Hi, Tim and Jim. In a recent program you asked Tim about manipulation in the markets. If this is deemed to be a normal phenomenon over an extended period would not this negate one of the tenets of Dow Theory which states to paraphrase Richard Russell - the primary and secondary movements are not susceptible to manipulation. It is conceded possible for a group to alter the price of a single stock or even the minor or daily movement of the market. Hamilton often repeated however that the Federal Reserve, together with the bank of England did not have enough money to manipulate the primary, or secondary trend. Given the Fed’s action to manipulate the currency is it still the case, thus does the theory still stand?”

JIM: I think overall, over a longer period of time I think that theory stands but one of the things that you have today that may alter the Dow Theory and that is when central banks have no limits in terms of the amount of money that they can print, or monetize in essence. And when you have central bankers interfering in all aspects of the market whether It's in the commodities market, whether It's in the bond market or stock market, I think you can alter some of these trends. A lot of the movements in the market that are somewhat suspicious are when you hear stories such as the market was tanking but then there was a large buyer in the futures pit that came in at the end of the day and basically shouted we will buy at any price. I think that alters that today. And one way to alter the market would be intervention that gets a trend going that brings in other money, I think, [this works] as long as they can keep these markets from undergoing a severe drawdown. There was a book written a couple of years ago, by Didier Sornette and it was about markets and some of the experiences central bankers learned from the crash of 1987. And one of the things that they found is you never go through large drawdowns. In other words, in the October crash of 1987 when the stock market lost 23% in a single day, preceding that were 3 days of big drawdowns in the stock market. The Friday before the Monday crash the stock market was down 10%. And It's widely known the Japanese government intervenes in their stock market, and so to think it is not done here is completely naive. [47:13]

JOHN: Plus, I think if you analyze it mathematically, you have what you would call the laws of random probability that operate in the market certain trends even though some of them are driven by trends when things tend to violate those laws you have to say to yourself that something is going on here. Right, That's the only logical conclusion?

JIM: Yeah, when you have something in the last 15 minutes of the day, you're down 175 points, and out of no news somebody shows up in the futures pit and drives the market into positive territory, you have to ask where's that coming from and why. [47:43]

JOHN: Yes, [you have to ask] what is going on there.

West is in Eureka, Illinois, he writes:

A few articles on your site have referred to the discontinuance of M3 money supply. Both refer to repurchase agreements as a tool the Fed could use to move the equities market, I posted McHugh’s article to a chat board, and the response was that repos could not be used to move the equities market because they are private transactions away from the floor of the exchange, and also that they are used not for equities but for government securities. Are these points correct or incorrect? And specifically, how could repos be used to move the market?

JIM: How the repos could be used to move the market is by putting liquidity into the banking system, and from the banking system That's where orders are directed into the stock market. That's the primary intervention tool that the Fed uses with the banking system are repos so this guy doesn't know what he's talking about.

JOHN: Alright, next question. Michael is in Laurel, Maryland:

I have read about M3 money supply, reporting that those at the Fed obviously plan on monetizing increasing quantities of securities in the future, and they don't want the public especially currency traders to see exactly how much largesse will be involved. Given that the Fed is a fraudulently instituted institution I would think finally more anti-Fed voices in an uproar would be heard, but not so. Why is the silence deafening?

Also, I earned a finance degree in 1988 and but so far my only sales experience is my most recent experience working 3 years in residential real estate. What are your thoughts, pro and con, on obtaining a Series 3 license and becoming a commodities broker given that the future of commodities looks so bright? Perhaps this is the best move but I don't know what to expect.

JIM: OK, you've got 2 questions there. One of the reasons the Fed doesn't want M3 showing up is definitely that, They're going to be doing a lot more monetizing, especially if we look at recent trends over the last 3 months with M3 up 10% year-over-year and having seen the prices of basic living expenses going up.

Why Wall Street doesn't say too much? Wall Street wants the party to continue, they don't want to see a bear market in equities and bonds. They don't want to go back to the 70s, where the only thing place you were making money was in commodities. Most Wall Street firms have shut down their commodity trading departments. They're not set up for a bull market in commodities. So I think That's one reason they go along. And another reason is that so many people on Wall Street have been educated to Keynesian economics that they don't understand the implications of increasing money supply, and how it manifests itself in asset bubbles and the other asset bubbles that we've seen repeatedly, whether it was real estate in the late 80s, and then it was stocks in the 90s, then real estate mortgages again. And so, [There's] an answer to that.

And your second question as a commodity broker I think you'll have a great future. We see this trend lasting at least for the next 10-12 years, so it might not be a bad idea. [50:53]

JOHN: Something you said That's really very important there about Keynesian economics, and that is a person’s worldview, say in a philosophical bent, or here their economic worldview they have, actually affects how they filter the information. So you can take a Von Mises type economist and a Keynesian economist and give them the same facts, they will come to different conclusions, don't you think?

JIM: Oh absolutely. I come from more of the Austrian perspective but That's why we have on this program others who lean more towards the Keynesian perspective. So, you get a little bit of balance between the two. Paul Nolte is more from the Keynesian monetarist point of view, and he adds a nice balance to my own views and we appreciate having Paul on the program. But, you know, depending on what kind of background you come from you see things differently. [51:55]

JOHN: From British Columbia in the city of Vancouver

What do you guys think about what is going on with the UAW and the automakers. Do you think if we lose the UAW we will all be in trouble. Do you think all wages will fall, will we be on our way to the bottom?

In reality, I think, Jim, labor unions coming in the near future are going to be put in a very horrible squeeze, because as things deteriorate people will be glad just to have jobs, they won't be able to strike.

JIM: I think labor unions are more of an anachronism, and if you look at heavily unionized industries they tend to be inefficient. You know, some guy’s trained to work on a bumper and that day They're not running bumpers on the assembly line he gets paid anyway. How are you going to compete with other companies that aren't unionized, that move the guys from bumpers to doors or something like that. So, unions filled a very important role at a time when bosses had the upper hand with their employees but today with all kinds of government regulations from OSHA to all other kinds of things I'm not sure what function they play. [52:58]

JOHN: Andrew is listening in Perth, Australia and he says:

Thanks, Jim, for an excellent read

He's talking about The Day After Tomorrow, your most recent post there.

I'm sure Puplava Securities is well positioned for this type of event but if this type of an event happens don't they start arresting people for fraudulent activities like Enron or Arthur Andersen, and as the gold price rises how much of a gap will gold get as the mining hedge book destroys 4 of the 6 top gold miners who have 34 million ounces out of 50 million oz forward sold at $300-360, US dollars per oz. Your work has confirmed my thoughts on what financial insurance to take out for my immediate family to see us through some tough times ahead of us.

JIM:“Some of your biggest hedgers” I'm sure you're probably referring to Barrick. They’ve got access to unlimited amounts of capital, it seems. Also since they do have the production there they can run a negative hedge book, and still do well. Does that mean if gold went to $1000 overnight in a crisis or something like that and stayed up there for a period of time it wouldn't get in trouble, that would be another thing. But that kind of scenario other than a quick spike and that quick spike staying up there I think this can go on for a much longer time. [54:17]

JOHN: If you remember earlier, Jim, you were talking about California. If the Western economy is the Titanic, then California is the bow so to speak. And as things get a little rough governments do get rapacious in thrashing around looking for sources of revenue and then demonizing those who don't want to go along. I think that was a part of what he was asking. Right?

M: Yeah, exactly, And you're going to see that too, because here in California we're already getting desperate. we've been running year after year large budget deficits, we've had to tap the bond market, and unlike the Federal government the State of California can't print money, and There's been no behavior change here in California by politicians. They want to spend more money than ever, they want more social programs than ever. And they say, “well you know what, We'll just keep extracting, raising taxes, keep raising regulations, we don't want any changes in our perks or benefits.” In the end They're becoming rapacious. we're seeing the beginning of that we've got an income tax increase in California this year where the top rate went from 9.3 to 10.3, and by the way, in California everybody is in a 9.3% tax bracket, because you reach that level at around $40,000 worth of income. Our dear legislature is working on more tax increases as is our city government. [55:37]

JOHN: You also heard that on Capitol Hill a couple of weeks ago when they were saying: “Well, I don't think the CPI is really indicative of inflation. We really need to reindex the income tax” - meaning to raise that up. So What's happening, as the value of the dollar deflates more and more people are getting shoved in those formerly rich man’s bracket. So when people say soak the rich you better find out what it is people really mean before you get soaked.

JIM:Yeah, you better hold on to your wallet as you're about to get ready to be soaked too. And That's what They're doing because each year because the inflation index is represented by CPI has gone up over the last year and a half what is happening is They're indexing the brackets so They're losing a little revenue as a result of inflation. Bracket creep was supposed to prevent the pushing of people into higher brackets with inflation. Now they want to scale that back as they need more money. [56:33]

JOHN: Yeah, That's basically it so you won't see What's happening.

Vern is in Chippewa Falls, Wisconsin and we're talking about The Day After Tomorrow again. He enjoyed the story.

JIM: Chippewa Falls, it reminds me of the movie, Titanic.

JOHN: Really?

JIM:Yeah, Leonardo di Caprio, do you remember he was from Chippewa Falls?

JOHN: I've forgotten that, anytime I hear that all I can think of is Rocky and Bullwinkle as in Frostbite Falls.

Anyway, Vern’s got some questions on The Day After Tomorrow.

Is there some reason that total collapse into hyperinflation and economic chaos i.e. Germany in the 1920s is not possible? Who will report M3 or a reasonable facsimile thereof when Helicopter Ben takes over next March?

JIM: Can we get into a type 1920s Germany again? we've seen it erupt all around the globe, we just haven’t seen it happen in the United States. There's no way we can correct the imbalances longer term, and That's what you're going to get reading Empire of Debt, although I think they can delay that for much longer than most people anticipate. I think it will be a gradual grinding process before it eventually hits us. And the second part of his question, I think John Williams of Shadow Government is coming up with the inflation indexes that he tracks the old way before they started manipulating it. So I'm sure he’ll be tracking M3 the way we used to report it, so it'll be out there and We'll try to get it to you.

JOHN: But I don't expect we would see that reported on CNN, would we?

JIM: No, they won't be saying the money supply is growing at 10-20%. No That's just something you won't see.

JOHN: Thomas says:

“The Day After Tomorrow - another job well done. When is the TV mini-series coming out. You have to work in a love story into that, and a few other things. You know you have the possibility for a screenplay there.”

JIM: Actually It's funny because I've gotten a lot of requests to continue this. I'm thinking of a new scenario. I might keep one of the characters but I'm thinking of What's going to happen in the next 3 to 5 years, and especially with oil, energy and geopolitics, as well as the economy. And I've got two or three characters in the back of my mind that I'm developing so: working on my next project.

JOHN: David, is in Los Angeles California. And he said on another topic:

I find it hard to believe the Bush Administration will leave office in 3 years without doing something to take the Chinese noose off our necks. I think it would be a very interesting roundtable with William Engdahl, and John Perkins. I would like to hear their speculations about what options this administration could do.

He was also suggesting someone like Dr. Marc Faber as well would be good at a roundtable on that.

JIM: Well, we hope to have Marc Faber back at the beginning of the year and maybe We'll look at that and as far as what can happen in geopolitics, I'm going to avoid that right now. [59:46]

JOHN: Kurt is in Medina, Ohio.

I was talking to a friend from Australia today who lives here in the States, his brother back in Australia recently received a phone call and was offered a comeback to work as a consultant with his previous employer which is an electric utility in Queensland. Apparently, some years ago, parts of an older grid system were shutdown after being partially replaced with newer equipment. It was never economically feasible to remove so it was basically mothballed. The utility is desperate to find people to train current staff on the old system as They're planning to turn it back on, primarily to service the state’s mining industry that is apparently coming alive again, and with a huge appetite for the energy which the current system is unprepared to supply. So, I think you're right on, we're only at the beginning. These fools paraded out on CNBS daily to announce the commodity cycle is over are clueless and basically traders with no concept of these secular economic trends.

Not only that It's interesting to see sometime you have to bring back the old timers to tell you how to do it.

JIM: Absolutely amazing. I keep saying this. If you're looking for a career in the future, want to be compensated and have good job security, I've got to tell you go into geology, go into the petroleum industry and the mining industry. There is just a lack. Talk to the energy people and I mean the Exxons, all the way down. You talk about the geology in the mining industry from the Newmonts all the way down there is a shortage of geologists and people trained in this industry. It's a great profession. you've got oil companies offering sign up bonuses on college campuses, you'll be seeing them in the mining industry as well. Boy, I’ll tell you, you're dead on.

JOHN: Well, we're stacked with more emails Jim but not enough time unfortunately. This is really one of my favorite parts of the program. I really like getting the feedback from people. It's kind of interesting to hear everybody's perspective, especially globally.

JIM: Well, It's kind of interesting to hear everybody's perspective, especially globally.

Well, coming up next week my special guest is going to be Addison Wiggin, and we're going to talk about the second side of the debate, that you're hearing the first side of this week as we did with Louis Gave. Next week Addison will be hear to talk about the Empire of Debt: the Rise of an Epic Financial Crisis, you don't want to miss probably one of the more important debates we have done this year besides peak oil. And That's coming up next week.

JOHN: I like those emails that talk about filling our mouths up with cement, They're my favorite by the way.

JIM: Alright, well we've run out of time. On behalf of John Loeffler and myself we would like to thank you for joining us here on the Financial Sense Newshour until we talk again have your self a pleasant weekend