Financial Sense Newshour
The BIG Picture Transcription
February 11, 2006
- Gold Market: Past, Present & Future
- Ignore the Noise, Clear the Mechanism & Focus On What Works
- Emails and Q-Calls
- Other Voices: Ross Hansen, Northwest Territorial Mint
- Other Voices: Kelley Wright, Investment Quality Trends
Gold Market: Past, Present & Future
Hi, Jim and John, this is Jay calling from Hawaii, on the island of Oahu. First of all let me say thank you for sharing your knowledge and making it available for free on your website. This has been a great boon to many of us like me who have only a small portfolio and can’t afford to pay for big time, big expensive advice. My question concerns your February 4th interview with Michael Bolser of the Golden Sextant: you stated that you agree with Michael that a Fed attack on the gold market is coming; anyone long gold right now is vulnerable. What’s the deal? For a month now you’ve been encouraging folks to buy both stocks and physical gold, what are you recommending? Should we now get out of our long gold positions. Thank you.
Hi there Jim, first off I’d like to introduce myself I’m your former forum administrator for Financial Sense online, and my ID there is Crow. Anyway, I’d like to give two thumbs up to yourself, Mary, your staff, and contributors and of course your wonderful guests who make Financial Sense such an amazing organization and contribution to investors. On your January 28th Newshour program you raised the eyebrows of a few of the listeners when you announced being bullish on some tech stocks; and needless to say I think a few of us spilled our morning coffee on our keyboards when we heard that one. So we were wondering are you starting to see a broader change in the high caps, especially with the NASDAQ approaching a 5-year high. My understanding is bubbles very rarely repeat themselves very soon after they’ve burst, so I was surprised to hear those words, especially with many of us being in the precious metal and commodities camp. Just wondering if you still feel we are in phase II of the gold bull market. And whether your comments just mentioned the point of a few opportunities. Anyway, and thanks in advance for your comments. [1:52]
JOHN: Well, Jim, those two calls into what we’re calling the Q-line here on Financial Sense Newshour very adequately introduced the topics we’d like to discuss today. First of all, the gold market itself – its past, present and future. And then very tightly related to that, since the issue of tech stocks came up in dealing with investing, it is not necessarily a matter of religious or philosophical orthodoxy, it is a matter of pragmatism: focus on what works and do it.
JIM: Well, we’ve been focusing quite a bit of attention on oil recently, because there are two things from a macro picture and I think this is all going to start to fit into place when we paint this picture for you. The two most significant events that are going to happen probably in our lifetime, and especially for those of us living in the United States, is the coming great inflation and also peak oil. And as I mentioned last week, after I wrote my Perfect Financial Storm, I had three possible outcomes: then we got the recession of 2001, we got the events of 9/11, and then subsequently the events that happened afterward, where we saw the greatest reinflation of money and credit that I have ever seen in this country’s history. And by the Summer of 2004 I had come to the conclusion that where we were going was the route of what happened in Germany and Argentina. It was going to take a longer time than what happened in Argentina and Germany because the dollar is the world’s reserve currency.
The second thing that I’m focusing my attention on right now is peak oil, and that is going to impact a lot of things in the market, the economy, and globally. And we’re going to head down this road, and what I have tried to do is say: OK, given this scenario what is going to work? And in order to do that we’re going to get into the gold market, and we’re going to get into what I see unfolding for the rest of the year.
So, John, I want to start out with the gold market today and just take a look at what’s happened. The first thing, If we take a look at last year, 2005 was the fifth straight year of price gains in the gold market. The gold market was up: gold prices were up 23% in the year 2002; they were up 22% in the year 2003; they were up 5% in 2004; and they were up 20% in 2005. What was even more significant last year is there were a lot of people in the gold camp saying it was only a dollar phenomenon. I can think of some very well known people that are followed on the internet – in fact I interviewed some of them in the 2003 Gold Show – and they said, “no, this is just strictly a dollar phenomenon.” Well, that didn’t hold true because last year you saw gold break out against all major currencies: it was up 31% against the South African Rand; it was up 26% against the Australian dollar; up 14% against the Canadian dollar; up 36% against the euro; 35% against the yen; 22% against the Indian rupee; and up 32% against the British pound. So, clearly, gold was breaking out in all of the world's major currencies, and that I think is rather significant. [5:30]
JOHN: OK, if we look back just over that record that you just mentioned – 5 years worth of gains – what has been driving this rise, which by the way, most of the commentators on the mainline have chosen to ignore?
JIM: You’ll hear things like jewelry demand. I think there are a number of things behind the gold market. You’ve got macroeconomic factors right now, which we’ll get into in just a minute. You have investment sentiment that is turning favorable. You have inflation expectations and of course currency movements. And looking at the global money: from the US money supply up over 9% in the 4th quarter; you’ve got the money supply in Europe over 10%; you’ve got money supply growing at almost 17% in China; Japan’s money supply. So, the macroeconomic factors are favorable to gold because people know that central banks are inflating, meaning the currencies are depreciating one against each other but more importantly depreciating against the real money in the world which is gold. So you’ve got that and the sort of a macro factor background.
The other thing is you know with 5 year's worth of gains, with depreciation of currency, with inflation running up, it’s very hard to tell people that there is no inflation. I think that’s pretty much accepted; the guy in the street is seeing his grocery bills going up, housing prices going up, service costs going up; companies are reporting their labor costs are going up; their raw material costs are going up. So investment sentiment is shifting positively towards gold and that reflects 5 years worth of gains, inflation expectations, and then of course what’s going on in the currency.
And the other side of the coin, if we look at the demand side, last year fabrication demand for gold was up 7%. The hoarding of gold was up 17%, in other words, investment demand. If you look at the COMEX gold position the long’s position in gold has been long – net long – since 2002. You’ve got investment demand coming into the gold market with new products like the gold exchange traded funds – and now we’re even looking at that for silver. Don’t be surprised if you see it for other raw materials as well. You’ve got currency depreciation, you’ve got global money supply running rampant – it’s the fastest that we’ve seen in more than a decade. So the result is if we take a look at last year the HUI, the Amex gold index was up 28.6%, and then you had the Philadelphia gold and silver index up 28.9%. And part of that was a reflection that you had this pull back in gold equities in 2004, because remember in 2004 gold prices in the US dollar were only up 5% - it was not a good year for gold stocks in 2004. Remember also, the first half of 2005 until we called the bottom in gold in May, gold stocks got hammered pretty hard. So what happened is anybody that was buying into the gold equity market went into the major gold stocks: the Newmonts, the Agnico-Eagles, the Meridians, the Goldcorps, the Glamis’, the companies that were most liquid because any time there would be a correction these were large cap big liquid stocks, and you could get out of your position. And as a result of everybody piling in to the big cap gold stocks we were seeing was extreme overvaluation in gold equities. It was one reason I was looking at getting out of our large cap and intermediate gold positions towards the end of last year, because they simply had become overvalued. [9:30]
JOHN: Well, You know, Jim, I know you’ve looked at the fundamentals of this before but in any kind of investment, in any sector for that matter things are going to go in cycles, and they run to extremes at a certain point. And when they do you should be prepared to take a profit out of that. It’s not that you’ve abandoned the investment in that it’s just moving in and out of that market as the time is appropriate, right?
JIM: Yeah, we were getting ready towards the end of 2005 to rotate our position in the gold market where we had to go into the majors and intermediates because the juniors were being ignored they were getting hammered. You had to go where liquidity was, and where the movement of the market was, so we went into the majors. But towards the end of last year we started to see a lot of the majors and the intermediate companies get so overpriced, and I’m just going to give you an example. You take a look at Goldcorp. Goldcorp’s gold in the ground was being valued at close to $400/oz; you had Meridian’s gold in the ground being valued at almost $1300 an oz; you had Agnico-Eagle being valued at $310 an oz; Centerra 414; Claude 484; Dundee 596; Freeport Copper and Gold 296; Glamis 382; Iam Gold 340 in the ground. And then you had to take a look on top of that production costs were going up: you had Agnico-Eagle’s costs go up to 270; Centerra 294.
And not only was the gold in the ground being valued at a high price, but production costs were going up – if you take a look at the two it didn’t make sense. You had tremendous premiums going for the gold majors and the intermediate stocks, whereas you were seeing the opposite with the juniors which were being thrown away. You were paying 30% to 40% premiums for the majors and intermediates, while the juniors were being discounted anywhere from 30 to 40%. So, from a rotation point of view it seemed to us it was time that a rotation should be made to get back into the juniors. So, we were going to raise cash for that position only.
The other thing that we also saw which we’ll get into in the next segment is we knew a hit was coming to the gold market, and we’ll explain that in the second segment. But, on top of that, what we did see last year is the majors were not replacing their reserves, what you’re seeing in the gold sector is similar to what you’re seeing in the oil sector: the Exxons, the Chevrons, the BPs, the major oil companies are not replacing their reserves – their daily oil production is going down. The same thing is happening with the gold majors. The majors aren’t replicating their reserves. What’s going out their front door is not coming in the back door. If you take a look at some of the big mergers that were put together, Newmont at its peak was producing 7.6 million ounces a year, they’re down to about 6 million ounces. You’re going to see Barrick and Placer become the new big gold company, but you’re going to see their production levels go down. So what it was happening even though exploration spending was increasing the project pipeline was not filling up, and so the growth strategy that became the alternative to finding new ounces was to go out and buy another company. So last year we saw a string of takeovers, which by the way I think will accelerate this year: we saw Barrick take over Placer; Goldcorp bid up junior development company Virginia Gold; El Dorado take Afghan mining; Oxiana take over Minotaur; High River merged with Jilbey; Gold Fields buying Bolivar Gold; and Yamana buying RNC. And so, given that this trend that the majors aren’t replacing their reserves the alternative growth strategy is going to be they’re going to go out and look for it. And where are the opportunities? The opportunities are going to be in the juniors. [13:49]
JOHN: Well, Jim if we look at demand fundamentals say for example for oil things have never been better, but with oil there is a supply issue that despite the demand the supply is not going to be able to meet that. And don’t we have a similar type of a situation with gold?
JIM: Sure, because the gold market went through a multiple-decade bear market. A lot of money was not spent on exploration, and only until recently the last two or three years has exploration stepped up, but a lot of the major gold fields in the world have been discovered. And similarly to the energy sector, you’re not hearing about major elephant gold discoveries each year, it’s not happening. And furthermore, last year, the largest producer of gold in the world, South Africa, their gold production was down 12.8% last year. In the 4th quarter alone gold production in South Africa was down 8.8%; in the month of December alone gold production was down 3.8%. So, similar to the energy situation you have now growing demand: for gold from fabrication; from bar hoarding; to the new products that are coming online, like the ETFs. So demand is going up at the same time supply cannot keep up with demand. And gold prices today would be somewhere in the neighborhood of 750 to 850 if wasn’t for the huge gold derivative position, and the selling of gold by western central banks. And unfortunately, it is creating a disparity in the gold market where you have production costs - you know, yes, the price of gold was up 20% last year, but look what’s happening to production costs – Newmont’s production costs have gone from $200 to $275 in the last 3 years; Cambior has seen its production costs go from 250 to almost 300; Centerra 190 to 294; Durban has gone from 340 to 400; IAM Gold from 225 to 280; Yamana from a little over 200 to 267. So production costs are going up, they’re not finding the big deposits, so supply is shrinking. We’re running about a 1500 tonne deficit each year that’s being supplied by central bank leasing – by central bank selling – otherwise, John, you and I would be talking about 750-850 gold today. They’re trying to keep the price of gold down in a way of disguising that things are OK on the inflation front, and that paper money is actually worth something. [16:41]
JOHN: Right, because when you hide things like the M3 money supply and everything related to that you’re left with one indicator, aren’t you, that has traditionally been the price of gold? So here we have to jimmy the meter to not give the accurate result.
JIM: Yeah, and so you’ve got this supply issue, and that’s why I think when you’re looking at this gold market it’s time we’re going to go through a severe correction in our opinion, and that’s one of the things that we called for in December – we were a little bit early, we don’t think we’re wrong in the intermediate term but we were wrong in the short term. But also more importantly we thought it was time to rotate your gold investments, and get back into the junior producers, and the junior development sector because we think that’s the way to play this next leg up.
And more importantly, I think you’re going to have to look at areas that are going to be politically stable because the world is increasingly becoming unstable, especially when it comes to natural resources. I also think a key play going forward in the gold market is going to be key energy sources. You’re going to have to look at areas that have access to energy, and so that is going to be a key factor. And the price of gold is going to have to increase substantially in order to bring that supply deficit back in line, and I’m talking about a substantial increase in the price of gold – and I’m talking about north of $1000 an ounce. And ultimately we’re going to see it go north of over $2000 an ounce. [18:14]
JOHN: Given what you’re seeing so far then, if you’ve got to make some moves how are you going to play this market?
JIM: Well, as I mentioned before towards the end of December we were getting ready to rotate out of the gold sector despite the fact that we were seeing a correction coming, because we thought it was time to get out of the majors and the intermediates which were just selling for la-la prices that didn’t no longer make sense to us and when at the same time the junior producers and the junior developers were literally being trashed and given away. In the first of the year, we took a position in a company where we were getting a late stage gold development play and buying gold in the ground at $6. That to us made a lot more sense than paying $600 for gold in the ground or 3 or $400 for gold in the ground, given the fact that between the cost of production and the cost of the gold in the ground it was higher than the current prevailing gold price.
So I would be looking at junior producers and junior development companies and one of the criteria we’re looking at is – we call it 3 plus 2 – companies that have the potential to accumulate or amass 3 million ounces worth of potential reserves therefore when they go into production you’re going to see 200,000 ounces of gold production a year – I think that’s a reasonable target and that’s more likely what you’re going to find in the world today versus these large elephants that nobody seems to be finding. It also made sense to look at buying gold in the ground at $10 to $20 versus trying to buy gold in the ground at $600.
One of the things that I saw this week – I don’t know what the guy’s smoking but Ian Cockerill, Chief Executive Gold Fields said on Tuesday in a press conference the company is looking at larger assets going forward rather than those targeted by the previously. There’s a rule in the acquisition category which the majors call the ‘2 plus 2’ – looking at 2 million ounce deposits with 200,000 ounces of potential production. Cockerill said he’s changing that to basically 5 million ounces of deposit with a production of 500,000. I don’t know where he’s going to find that. We’re not discovering Ghawars in the gold business, you’re just not seeing that. And if you take the production profile the majors, which collectively are produce almost 50% of the world’s gold production, you know, they are not finding 25 to 40 million ounces of gold each year, that is simply not happening. So, it just once again builds the case for why we think this year the way to play – after what we see this next coming gold correction – is play the juniors. [21:02]
JOHN: So summing it up Jim basically you’re still positive on gold. We’ve known there was a correction coming in the market, you said you maximized these extremes and turns and we’ll talk more about that coming up in the next section, but basically we’re still positive on the long run prognosis for gold – there’s no change.
JIM: Yeah, absolutely, I mean, people thought that we got out of gold completely – No. We got out of our major positions, we got out of 50% of our gold – we still held 50% – but we’re getting ready to rotate because what we see is the time of suppressing gold is running out for central banks. Roughly, more than 50% of their stockpiles are gone, they no longer exist, although they don’t account for them they show their gold loans or receivables, along with what they have in inventory, as one line item. You can’t account for that in a publicly traded company, you couldn’t say lump your inventory and receivables together, so central banks – western central bank – gold reserves are being drawn down. On the other hand, you’ve got a trend of large central banks that are buying gold: Russia’s buying gold, China, India, OPEC, Argentina. So that is countering it. So the time for controlling the gold market with derivatives is going to be limited because you’ve got a counterforce of buying now coming from investors, and you’ve got a counterforce of buying coming from large central banks, especially in Asia. And you’ve seen the gold break out against major currencies. So, gold once again is becoming a global currency, at the same time that investment demand is kicking in as a result of that.
So what I would wait for is the opportunity to buy juniors. I would still accumulate physical as the price comes down, and I would be looking at companies that can grow their production and grow their reserves and what we see is almost a 75-25 ratio between gold and silver, and this year we’re going to be taking a position where we’re going to be going 60% juniors versus 40% for majors and intermediates. So, we’re getting ready to increase our junior position substantially, we’re just waiting for the right buying opportunity, that’s how to play the market. [23:18]
Ignore the Noise, Clear the Mechanism & Focus On What Works
JOHN: I know Jim from your experience sailing, mine is flying, there’s certain analogies we can bring over into what we’re doing right here as far as investing. One of the things that you always have to deal with is weather and there may be waves or wind or turbulence or whatever it happens to be but you always have to remember what your goal was to go from Point A to point B – in other words, ignore the noise that comes in the middle – and that’s true with investing as well. And the basic bottom line of investing is it’s not so much of sticking to one formula or another it’s a matter of figuring out and understanding what is happening, and then taking what actions are appropriate to the situation.
JIM: Absolutely. Anybody that’s a sailor knows that if you head out and you’re going from point A to point B and the wind shifts direction well, you’ve got to change your tack, or you’ve got to change how you’re positioning the boat to keep the boat going forward, and you have to do this in the investment markets.
One of the analogies that I like to point out – a number of years ago we lived in a neighborhood where we had a lot of local sports figures from the Padres and the Chargers as neighbors, and a couple of them were Padre pitchers. And I remember the movie – and maybe those listening have probably seen this movie – it was called For Love of the Game with Kevin Costner as this kind of aging pitcher. And part of the time when he was on the mound he had this little phrase he would repeat to himself, and he said, “clear the mechanism.” And you know, you’ve got people in the stands booing at you, you’ve got a lot of noise, and I used to be part of this breakfast club that – there were a couple of Padre pitchers that were part of that club and we’d get together and when this movie came out, I said, “you guys really do that when you’re on the mound, I mean clear the mechanism.” They said absolutely, because a lot of times maybe you’re pitches aren’t going well, you’re trying to think of strategy of the batter, you’ve got all the noise in the crowd, and you’ve just got to just clear that noise, focus and concentrate. So, what you’ve got to do is get rid of the noise, and I can’t think of a more appropriate analogy for today’s investment market.
For example, every Wednesday we get the oil inventory numbers which are basically made up to some extent: they’re made up with economic models. The same thing occurs with the natural gas inventory levels. And if you’re looking at the bigger picture what do you care what the inventory levels are on Wednesday and Thursday, versus what they’re going to be couple of months from now, or a year from now? There was a significant article that came out this week about Mexico’s oil output, last year for example we found out that in March Mexico announced that their Cantarell field peaked, in November Kuwait announced that their oil field peaked. So Cantarell being the second largest oil field in the world, reaching peak production, and Burgan, the largest field in Kuwait meeting peak production, you’ve got some real problems.
There was an article in the Wall Street Journal this week on Thursday saying that because of water and gas injections encroaching on more of the in the Mexico’s largest field you could see a precipitous decline in the Cantarell’s production over the next couple of years. Once Cantarell’s production went into decline, now this story is talking about instead of 2 million barrels a day production, that one scenario calls for output could decline to 875,000 barrels by the end of 2007, 520,000 by the end of 2008. Now officials, just like those in OPEC, “oh, no, we can go out and find a whole bunch of it.” But it is highly unlikely that is going to happen. And that’s significant because we get a lot of our imports from Mexico as a key supplier to the United States. So, you know, these weekly inventory numbers are meaningless, I mean, if you take a look at, for example, December, the Cantarell field their output was down 6% for the year, and it was down significantly in the month of December alone. And you get these inventory numbers almost weekly and everybody moves on it but you’ve got to look at what the long term trend is for energy. You’ve got rising demand where’s the supply going to come from, where’re the big oil discoveries that everybody’s talking about? If everybody says we’re not reaching peak oil then we’ve had 5 years of rising energy prices, where are all the big discoveries.
The same thing that is happening in energy is happening in gold. You’ve had 5 years of price increases in gold, 5 years of price increases in energy, and no major discoveries to speak of, and so that’s why these numbers come out on a weekly basis are nothing more than noise and I don’t care if it’s a GDP figure, it’s a CPI number, it’s a trade deficit figure, all these numbers get manipulated, we know for example that GDP is manipulated by hedonics, by the CPI, we know that the unemployment numbers are manipulated, we know that the inflation numbers are manipulated so why people get all lathered up on a number like this that comes out on a monthly basis.
You’ve got to look around you, what are you seeing? The price of energy is not going down to $50, or $40 a barrel, or like they said going back down to $30. You keep seeing these numbers, “it’s going down to $40” – good luck, if we ever see 40 again. Jim Rogers said on this show once that you’ll never see $25 oil, I doubt if you’re ever going to see $40 oil. And so you’ve got to look at what the big picture is telling you, number one, you want to look at investing in areas where demand is strong, where supply is short, where the companies that are producing the goods have pricing power, and then look at things that people have to have. So, gold and energy should be in everybody’s long term portfolio. [30:03]
JOHN: The real point that you have to make is that even though you sort of move where you were in gold your long term position is still pretty much the same.
JIM: Yeah. It’s just going to rotate from the majors and the intermediates. We’re going to go more to the junior producers and the junior development because that’s where I think the big growth story is. We are also seeing a shift in energy, we’re expecting a price swing to the upside that will be brief, then we’re going to see a downturn in energy. And one of the reasons that you have to understand what is coming, this correction in gold, not only in gold but the correction that you’re seeing in the CRB, the correction in energy, is you have to understand that central banks are inflating globally. The Fed is ready to start the next reflation, but in order to get to the next reflation the Fed needs a cover, they can’t go neutral and say, “OK, we’ve conquered inflation, we’re now neutral, and things are OK.” They can’t do that with gold at $600 an ounce. They can’t do that with oil at $70 a barrel. So we saw with a big correction coming they would have to knock down the commodities complex, get gold prices back down $50 or $75, get the price of oil back down into the $50s, get the commodity CRB index whacked pretty hard, and get the commodity complex down. Then they could say, “OK, we’ve got inflation under control,” and create somewhat of a deflationary scare, similar to what we saw in 2003, where the central banks and Wall Street was running around, “Oh my God, deflation, deflation,” and in the meantime while everybody was worried about deflation, the money supply was getting cranked up and super inflated. I mean, we increased the money supply by almost $1.6 trillion. So, the Fed needs another asset bubble to replace the one is deflating. They’re going to let real estate deflate which has been the objective in this price move, and while they’re going to let the real estate bubble deflate, they’re going to resurrect the equity bubble. Because remember, the United States is a financial economy, it’s a bubble economy.
One of the problems that the Fed has is the US economy is too leveraged, and they can’t push this too far. I think they go to about 5% and that’s it, because if they push rate hikes too far, what you’re going to have happen is you’re going to kill the real estate market, and then you could have a full blown financial crisis because real estate is connected directly to the banking and financial sector. A real estate bubble is different than a financial bubble in stocks because when you take a look at the real estate sector what’s directly linked to it is the nation’s banking system. So if real estate gets in trouble people start defaulting on their loans, and all of a sudden you’ve got bank equity being wiped out, you’ve got foreclosures now you’ve got the banking system in serious trouble. So what they needed to do was cool the real estate sector. In the meantime what they’re going to need to do is reinflate the equities sector, because the minute that the Fed goes neutral and then towards the end of the year [as] they’re cutting interest rates, the first thing that’s going to happen is the equity markets are going to take off because people know that there’s going to be a lot of money coming into the market.
I think what they do is steepen the yield curve, so you can bring the carry trade back into play, and then you reinflate the equity market which can create a sort of a floor underneath the real estate market, because if you’re making a lot of dollars in the equity bubble then you can use that maybe to buy a new house or keep the real estate bubble inflated. The other thing too is there’s a lot of people that are saying this whole thing’s going to come crashing down. The world is not ready for the dollar to collapse. Europe doesn’t want to see the dollar collapse, Asia doesn’t want to see the dollar collapse, because if that happens it’s a full scale global depression, and a world war. And they don’t want to go that route. So, the Euro is not ready to replace the dollar, the yen is not ready to replace the dollar, the yuan is not ready to replace the dollar. And so what they want is to extend this out and keep this thing going for a while longer.
And that’s why I think the next thing you’re going to see is the equities market inflate very similar as this reminds me of what happened in Germany right after the war, beginning about the year 1920. You really saw the inflationary money really come into the German economy, and what happened is in nominal terms you were seeing huge gains in the German stock market, rampant inflation in assets as well as what you were seeing also at the street level in commodities. And this went on for almost a three year period. I think they can keep this thing going for another couple of years. We may have a financial accident along the way, but look how quickly they can mop it up, look what they did with Refco is a good example. So they need to take some of the air out, but they are going to err on the side of inflation. At some point they’re going to go neutral, they’re going to inflate the equity bubble which will replace the real estate bubble. They’re going to create a massive amount of liquidity within the financial system which is the reason they’re getting rid of M3 next month. Just take a look at what M3 looks like today. They’re going to reinflate massively and the reason they want to hit the commodity markets hard now, it gives them the cover to start the next reinflation.
JOHN: OK, as we said before given this scenario, we must ask the question what works?
JIM: Well, if you take a look at 2005 what did well: energy was up over 30%; the metals were up 28%; you had basic materials up 17%; you had technology up 15%. What I think is going to work in this market, energy is going to be a good sector to be in this year; gold is going to be a good sector to be in but we’re going to take a hit first; select technology is going be a good sector to be in. I mean, we’ve been in technology stocks and large cap stocks and that is working out. Telecom is going to be another area. I mean if you look at some of the things that are working right now John, if you look at the Dow, Caterpillar heavy equipment up 19%, General Motors up 12% for the year, AT&T which is telecom up 12%, Disney up 11%, Verizon – telecom – up 10%, Pfizer up 10%, Hewlett-Packard – technology – up 10%; Merck – drugs – up 8%; MacDonald’s and Honeywell. So what I think you’re going to see work this year the strongest areas are going to be energy, gold, technology, telecom and healthcare, followed by industrial.
What would be on the weaker side this year is going to be consumer cyclicals, financials, some of the basic materials and utilities. And a number of weeks ago, we talked about some of the large cap growth stocks, how many of these companies have been forming big bases in their chart patterns, many of these companies have seen their stocks drop by almost two thirds, over the last 6 to 8 years. In the meantime their earnings have doubled, tripled, quadrupled; their PEG ratios (PE times the growth ratio) are much lower today; PE ratios are lower; dividend yields are higher; price to sales ratios are lower. And so I think you’re going to see a rotation into this sector because they’re getting ready to reinflate the markets again. The US cannot afford to have simultaneously collapsing asset bubbles, whether it’s in real estate or it’s in the financial markets such as the stock market. So, they’re getting ready to reinflate and what they need is that cover which is why they’re hitting the oil markets now. There’s huge, huge derivative short position in the energy sector. Look what they did to the natural gas sector in the month of December, one of the coldest Decembers on record, and you’ve got the US government they’ve stopped reporting on the amount of Gulf oil and gas production that’s come online, or refinery production that’s come online. It’s not going to be like it was prior to Katrina and Rita. And I’m looking at projections this year, we’re going to have to import more oil in this country; we’re going to have to import more natural gas; we’re going to have to import more gasoline; we’re going to have to import more jet fuel; we’re going to have to import more diesel fuel.
If you look at all these factors, you can see why they’re going to have to reinflate. But once again, the big picture is going to be they need a cover before they do this, and then once they knock this sector down then you’ll see the next up leg that will begin. And where you’re going to want to position yourself is you’re going to want to buy the large cap growth stocks with low PEG ratios; you’re going to want to buy the dividend stocks; in the energy sector you’re going to want to look at companies that are going to be able to grow their reserves. In the gold sector you’re going to want to look at companies that can grow their production. Or you’re going to want to look at development juniors that can develop and grow their reserves to the point where they become attractive, either to go into production – in other words they have critical mass 3 million oz or more; or they have a critical mass large enough where they become attractive candidate for some of the intermediate and larger companies. [40:21]
Emails and Q-Calls
JOHN: Well, here we go both with emails and v-mails – I guess, voice mails, - Tom is in Houston, Texas:
After listening to last week’s broadcast with Zapata George, I thought a major point regarding oil supplies was missing from the discussion. You mentioned a couple of the majors’ production numbers and how they bolster peak oil as record profits are made but production had decreased. While production numbers are an indicator, short term stats can be affected by a number of things. Perhaps a more valuable indicator, and one I know is closely watched by the majors is the year over year success of reserve replacement from exploration and production activities. This statistic is probably most indicative of future growth and production potential. Reserve replacement does not come only from finding new oil but also from technology improvements to extract more oil from existing reservoirs. I was browsing Exxon-Mobil’s website this morning and found a new publication posted entitled Tomorrow’s Energy Report, it’s fairly lengthy but a detailed summary of the company’s current thirty year outlook. If you haven’t seen it yet it’s a good read. They seem to provide an argument that seems to dispute peak oil.
JIM: Well, if you get back to production replacement reserves outside of acquisition Exxon has failed to replace its reserves in 2004. Their reserves were down 18%. In 2002 they only replaced 86% of their production; in 2001 they only replaced 98% of their production. Similar in many of the other large companies too. The only way that they’re replacing their reserves is to go out and buy another company. If they had all this money and they could go out and find all these big reserves to replace their production they would certainly be doing so. Why wouldn’t you as an oil company want to produce as much as you could? If you take a look at where 80% of the world’s reserves are located, basically they don’t have access to them: it’s in the Middle East or the Caspian. So there’s very few places that they can go today, and that’s why I think you’re seeing the acquisitions that you do – whether it’s Conoco-Phillips buying Burlington Resources. I expect to see more of that because certainly Exxon is not replacing reserves. [42:50]
Hi, my name is Chris I’m from Calgary, Canada. My question is I was wondering if Jim might be able to comment on the amount of outstanding derivatives over-the-counter derivatives – that are outstanding and what sort of a threat that poses to the stock market, and what a person can do to shield themselves from that if there was a banking collapse like the LTCM. And also if we take delivery of shares of good, non-indebted gold and silver companies if that is probably a good choice. Again, I just want to say you folks do a tremendous job. Keep up the great work we really need your good work you’ve been doing, and we really appreciate it and I listen to them religiously every weekend, and he’s helping to keep freedom alive, and you know, in the free world, and that’s very important especially with so much misinformation going on out there. We really appreciate and I can’t overemphasize how valuable and important his commentary is, and keep it up. I’m from Canada and have a democracy there, it’s important to be able to listen to his programs. So, thanks, God Bless. Bye.
Well, let’s talk about derivatives, the derivatives position keeps increasing each year but there’s also a lot of counterparty risk which is the real risk in the derivatives market. So far, they’ve been able to mop this stuff up, I mean, look what they did with Refco; and how quickly they cleared up Long Term Capital Management. Eventually this thing is going to blow up, but I think we’re a ways away from that. Any minor accidents, and who knows what goes on behind closed doors on the number of accidents we don’t even see, but that is something longer term that blows up but I think we’ve got a ways to go yet. In terms of taking delivery of shares – No, not a bad idea but really isn’t necessary. I would look more at the strength of your brokerage firm. One of the reasons we went with our clearing firm is they weren’t leveraged. Most people don’t realize a lot of the investment houses on Wall Street are leveraged 30 to 1. [45:00]
JOHN: In Texas, Fort Worth, Brett says:
Dear Mr. Puplava, like many Americans I recognize the need to do something to plan for our energy future, yet I’m generally skeptical that the government can find answers to our difficult problems. Which approach to America’s long term energy question do you think is best? 1. A government sponsored Manhattan project., 2. Incentives for the private sector and alternative technologies, recognizing that such incentives might distort the markets a bit. Or, 3. Just leave the free market alone.
JIM: Well, my ultimate choice would be the free market. As the price of energy goes up what happens? It forces people to change behavior: if you’re driving an SUV that only gets 9 miles per gallon, the price of a gallon of gasoline goes to $3 or $4, eventually to $5, you know, maybe what you do is you get an economy car. As the price of energy goes up it creates an incentive for companies that have been in a bear market for a long time to reinvest that capital. There’s always a risk for companies that – I mean look what they want to do with oil companies, instead of encouraging them to reinvest they want to slap windfall profits tax on them. The energy sector is one of the most capital intensive businesses in the world. Huge amounts of money have to be invested to get a barrel of oil out of the ground. It’s something not one Congressman understands. However, I do think that government can provide a useful role in terms of providing incentives for research, a lot of good research came out of a lot of the government labs, especially in the defense business. So, we’re going to have to do something, and I think government can take the lead through R&D but keep its hands off the marketplace, and let the market work its magic. I mean when the price of gasoline goes up that’s what will encourage people to conserve; that’s what’s going to encourage them to turn the lights off; or maybe turn the thermostat down – not by going bashing the company trying to put in some kind of price controls or the typical solutions, you commonly hear from the average idiot in Congress.
Hi, my name is Diane, I live in Stewart, Florida, and my question involves money markets. I’m wondering how safe they are to keep money in them, probably half of it is in there right now, it’s making about 4%. I don’t have very many choices with my 457 deferred comp? The only thing possible to go into is a large cap fund or an international fund. The rest of it is something I wouldn’t want to invest in. The other problem is even with Vanguard there are no foreign bonds to protect the money to be safe to you know hold value if the dollar goes down. So, my question basically is how safe do you think leaving money in the money market is, when the value of the dollar goes down? Thanks.
Well, what you’re doing by leaving your money in the money market with the value of the dollar going down, you’re just suffering a slow death by inflation. In terms of safety I would look at a government money market fund which would be Treasury Bills versus let’s say your traditional money market fund which is CDs, banker’s acceptances, you know, short-term corporate paper. So, I’d look at T-Bills. If you don’t have a foreign bond fund I think wait for this correction to play through, wait for the Fed to go soft, and when you see the Fed go soft then what you’re going to see is they’re going to reinflate the equity markets, and I would be in large cap stocks. It’s too bad you don’t have let’s say a natural resource fund alternative and maybe a gold fund because those would be ideal hedges if you can shelter part of your money from what’s coming. [48:43]
JOHN: You know we have an interesting email from JC, he says:
Tech stocks? Is Jim sporting a pony tail again?
JIM: I actually have sandals on, a pony tail, and sunglasses on. No…
JOHN: Peace brother.
JIM: Amen. No, you know, listen to the Big Picture and go back and listen to the segment I did today on the show I did with Frank Barbera, and you’ll understand.
JOHN: OK. Steve is in what I affectionately call San Josie – San Jose, California. And he says:
I’d like to know just a little bit about this great huge oil reserve “they say” is located just next door in Canada that seems like a lot of oil up there to me. I realize it takes fuel to get it out of the ground but again “they say” it is cost effective at today’s prices, actually costs less and there’s way much more of it. You guys never mention the oil sands when you’re talking about energy, I wish you’d comment.
Actually, we’ve talked about that quite a bit here on the show.
JIM: Oh, yeah, we’ve talked about quite a bit about oil sands. The problem is energy return for energy input. Right now the amount of energy going in to produce a barrel of oil out of the Canadian oil sands is pretty high. And what they’re talking about instead of heating the Bitumen with natural gas eventually building a nuclear power plant. One of the largest sources of future oil supply is going to come from the Canadian oil sands, it’s also going to come from oil shale, especially in the United States where we have a large supply of oil shale. It’s an expensive process. I think they need $30 to $40 oil to be profitable from oil shale and certainly right now oil sands’ oil is profitable. So, those are the two biggest sources of future oil. It’s going to be unconventional oil, in fact, I think conventional oil peaked from what I can gather in 2004, any difference now in terms of making up increased production has a lot to do with unconventional oil which is off what I call the outer shelf oil, deep sea water oil, the Canadian oil sands, shale oil, coal gasification – all of those methods are what’s enabling us to keep up our present pace of production. But under my estimation by 2008 that’s the crossover point, and that’s when everything peaks, and speaking of which we’ll be discussing that on next weeks show. [51:10]
JOHN: Well, Jim, now we’re moving on to the Other Voices segment which is becoming more and more fascinating by the week. We’ve got two guests again today.
Other Voices: Ross Hansen, Northwest Territorial Mint
JIM: You know we get a lot of emails here on the Financial Sense Newshour about: how can I get involved in precious metals, I don’t have a lot of money, how can I get started, where do I go, do I go to a coin ship? Joining me on the program is Ross Hansen, he’s President of Northwest Territorial Mint. And Ross, let’s start out, let’s say that I don’t have a lot of money I want to get involved in accumulating precious metals, what’s the best way to go about that?
ROSS HANSEN: Well, Jim, we recommend that you get involved in precious metals at any level of financial commitment. Many people like to come to their local coin shop, precious metals dealer, or even contact us – they can buy through us as few as 15 oz of silver and your local coin shop can sell you 1 oz of silver at a time. With silver selling at approximately $10 an oz there’s no reason not to be accumulating silver or gold at this time.
JIM: I see a lot of advertisements on television, I get a lot of junk mail about accumulation, let’s talk about buying – whether it’s silver or it’s gold – let’s say I want to buy silver, and talk about the different forms that you can accumulate. I know there’s silver rounds, we’ve got the Silver Eagle, there’s silver bars, explain the difference between them.
ROSS: Our philosophy here at Northwest Territorial Mint is to buy the metal and not the premium. There’s a number of different products that a wide variety of manufacturers offer, for example, the United States Mint produces the Silver American Eagle, the Royal Canadian Mint produces the Silver Maple Leaf, and all these products are good solid products that are widely recognized. Unfortunately, some products have a very high premium. For example, the American Eagle, which is very popular, has a premium right now of about $1.60 over the current market price, and at $10 an oz silver, that’s about 16%. We believe you’re better off putting your money into the silver and not the premium; that premium will evaporate as silver goes up, and when you turn your silver back you’ll lose a lot of that premium. So our philosophy is buy silver as close to the actual market price as you can. And what I like is I like are the one ounce rounds of silver which are an exact ounce of silver produced from COMEX deliverable metal, or a 1 oz bar, or a 5 or 10 oz bar.
If you’re going to be buying silver buy the smallest denomination you can with the lowest premium. I believe – and a lot of others do – that some day we might have to use these for money. And if we have to use these for money walking into your local store with a 100 oz bar of silver, or a 1000 oz bar of silver will be like walking into 7-11 with a $100 bill. They might not be able to make change. So if you can buy the silver at close to the market price of silver in the smallest denomination, that’s your best bet. [54:32]
JIM: That’s what I have done. I buy my silver rounds from you, but one thing I like about the silver rounds, let’s say today where you have silver close at $9.75 I can call you, lock in the price today, lock in the price at $9.75, and get close to an ounce, or get an ounce of silver. If I was buying, let’s say, a silver Eagle, Ross, what would that cost me?
ROSS: Well, right now, you’re looking at in large quantities a box of 500 Eagles, you’re about a $1.60 over spot. If you’re buying less than 500 you’re at 2 dollars over the spot which of course spot is the current market price. And that premium to me is just very high. You’re much better off to buy a 1 oz silver round at say anywhere from 50 cents to 70 cents over the current market price. Remember, buy the metal, don’t buy the premium. [55:26]
JIM: OK, now, the difference between the silver rounds which are one ounce and then there’s what? 5 oz bars, 10 oz bars. Why would someone want the 5 or 10 for example, is it just that they’re larger amount of ounces?
ROSS: Well, here at Northwest Territorial Mint we actually produce a 1 oz round which is you know very popular product. It is probably our most popular product. It has the look and feel of a silver American dollar. We also produce a 1 oz bar, a 5 oz bar, and a 10 oz bar. Some people prefer bars, it’s just a personal preference. The bars stack a little bit easier, and they’re a little bit more cost effective when it comes to storage. I still believe though, and most people, do your best option is the 1 oz rounds. And those come in tubes of 20 at a time. So it’s just like a roll of silver dollars. [56:17]
JIM: Most people think on our program we talk about a lot in the Morgan Report about the futures market, and of course everybody thinks that’s big money, so if I wanted to buy silver, your firm will sell what? The minimum is 50 ounces of silver?
ROSS: Our minimum is 50 ounces of silver, and if you’re in our local area we have no minimum if you actually come into the mint itself. But to get free delivery, and all of our products are quoted free delivery, 50 ounces is the minimum. [56:44]
JIM: Now, let’s turn our attention to gold for example, what are the options available when you’re talking about gold?
ROSS: Just about every country produces some gold coin. The American Eagle is the most common form of gold coin sold in this country – produced by the US Mint at their West Point mint. Another popular form is the Royal Canadian Mint’s Maple Leaf. Those are the two most popular forms of modern gold coins. There is also the South African Krugerrand. And all three of these products come in fractional sizes. You can buy a tenth oz, a quarter oz, a half oz, or a full oz. Now, the smaller the piece the higher premium that you’re going to pay. So, when you get a quote on an ounce of gold, recognize that 10 one-tenth ounce pieces is going to cost you more than just one one-ounce piece. And all of these are good products, they have legal tender status, and are transportable without any duties or taxes anywhere in the country – anywhere in the world. [57:45]
JIM: Do they have such things as gold rounds?
ROSS: Well, the gold rounds are coins. And the reason that they’ve made these coins legal tender coins is that way they can go across international borders without any duties and taxes. Most countries have reciprocal agreements that coins are not taxed nor is there duty placed on them. So it’s important that you keep a legal tender coin.
There are small gold bars that some manufacturers make. They’ll make them in gram size, 5 gram, 10 gram, or 1 full ounce. But if you’re going to be paying the same amount of premium for a bar you’re better off to buy a coin because it does have that legal tender status, and you’re guaranteed of the weight and period of the coin. [58:33]
JIM: You know it’s interesting but the US gives their pilots gold British Sovereigns so if they’re ever shot down, and they need to go anywhere they have gold coins with them. So, what does that tell you about money?
ROSS: Well, Jim, as a former pilot myself in our bail out pack we did have both little coins and little bars of money. And I tell everybody put a little gold and silver in your bail out pack. [58:57]
JIM: Not a bad idea. Ross, in terms of businesses like yourself which are larger scale versus a coin shop, what’s the advantage for somebody getting started between a mint versus let’s say a local coin guy?
ROSS: If you have a local coin shop that you’re comfortable with and you know their products are sound, by all means cater to them, but if you’re looking for new product with guaranteed purities and you want the lowest premium you need to come to a company like ours.
JIM: What I like about accumulating silver is I can call you up on a day that I think that silver’s a good price, lock in the price of silver, not have to pay the big premium as you mentioned on Silver Eagles where you can pay anywhere from a $1.60 (buck sixty) to $2 a premium, and then just have them shipped, and you know, I’ve got the same amount of silver. You know, it may not have a pretty eagle on it, but it’s still silver in my mind.
ROSS: Well, Jim, one of the advantages of dealing with our company is we recently formed a partnership with Pan American Silver Corporation, and Pan American wanted to make available to the general public physical silver. And we’ve worked with them closely developing a line of 1 oz rounds, 1 oz bar, a 5 oz bar, and 10 oz bar. And these are available to the public at very low premiums because Pan American is subsidizing the price of that metal, you know, in a small way. These products are recognized all over the world, they have an international hallmark on them and you can call us up without an account, we will quote you a price based on the current market price of silver, we’ll lock you into however many ounces that you want, send us a check we’ll clear your funds, we’ll send you your metal. [1:00:45]
JIM: Well, that’s what I found very convenient for the way I’m accumulating silver. Ross, if somebody wanted to find out more about let’s say coins and things like that, talk about for just a brief minute, because a lot of times you see these articles about you know Silver Morgans, Gold Eagles, the $20 Gold Piece, when you start getting into numismatics that’s a whole ‘nother way, you’ve really got to become more knowledgeable in my opinion to get into that market.
ROSS: That’s correct, Jim. One of the concerns that I have, and I’ve seen over the years is there is a lot of what I would call boiler operations selling numismatic coins. And the reason that they want to sell numismatic coins is the mark up is much higher on a numismatic coin. And many times with the numismatic coin, the grade of the coin, which is all important, is subject to question. I would recommend to the average investor who is just looking to put aside some of his wealth into a hard asset: stay away from numismatic coins. Some of the boiler operations will tell you buy numismatic coins because the threat of confiscation of these coins is less. In 1933, the US government called in all of the bullion coins in the country, and people at that time were naive enough to turn them in thinking that they were doing something good for the country. I think that threat is very minimized. I don’t think we really have to worry about that. And I just believe that you’re better off to take your money and buy metal at as close to the market as you can; take physical delivery of it so that you have it available in times of trouble. [1:02:34]
JIM: You know, that’s the nice thing too, if you’re buying whether it’s silver rounds or you’re buying Gold Eagle you can find a safe place to store it. Ross, what about holding metal outside the country?
ROSS: Subject to which country you’re talking about, some people again are concerned about confiscation issues, or if things in this country become untenable they might want to leave the country. Again, gold and silver are both very portable. Unless you have confidence in the foreign bank or a foreign storage depositary I still recommend keeping the metal as close as you can to your person. And it might sound funny, Jim, but a lot of people have the traditional method of burying their precious metals, or hiding it somewhere in the house, and precious metals gives off no odors or scents, so if they came in with a dog they’re not going to be able to find it, and it’s so compact it’s easy to hide. I also recommend keeping it in a safe, or a safe deposit box. [1:03:36]
JIM: OK, and, Ross, in addition to silver and gold can you do the same with like for example platinum or other precious metals?
ROSS: Well, the four major precious metals of course are gold, silver, platinum and palladium. And recently the US government has come out with a platinum Eagle, and the Royal Canadian Mint has come out with a palladium Maple Leaf. Those are popular form, you know, to own platinum group metals. I’m personally very optimistic on the further continued gains that palladium has.
JIM: Well, Ross, if somebody wanted to find out more about your company and contact you why don’t you give out either your website or phone number.
ROSS: I’ll do both, Jim. You can reach us at 800-344-6468, or you can visit our website at nwtmint.com. [1:04:29]
JIM: Alright. Well, Ross, thanks for joining us on this and Other Voices and look forward to talking to you in the future.
ROSS: Thank you, Jim. [1:04:45]
Other Voices: Kelley Wright, Investment Quality Trends
JIM: You know in an age of accounting scandals, some unpredictability in the market, a lot of people are looking for a strategy that works, time in and time out, and one of those is investing in dividends. Joining me on the program is Kelley Wright, he’s managing editor of IQ Trends, originally established by Geraldine Weiss in…by the way Kelley, it looks like coming up this April your 40th anniversary.
KELLEY WRIGHT: That’s right, Jim, April 1, 1966 was our inaugural issue.
JIM: Well, I know Geraldine Weiss published two books, Dividends Don’t Lie, and The Dividend Connection, and one of the great things that I found about her books and also the philosophy at IQ Trends, is it focuses on dividends, and especially blue chip stocks. And according to Mark Hulbert, who watches over investment newsletters, they’ve named your newsletter IQ Trends the number one performing newsletter on a risk adjusted basis. Why don’t we start getting into dividends – one of the things I like about dividends is if you’re a company you have to earn the money, otherwise you don’t pay a dividend. So you don’t have – or you tend not to have – as many accounting scandals with dividend companies.
KELLEY: Well, that’s true, Jim. We found over the course of our history that the companies which meet our criteria and there’s six individual criterion, and none of them are particularly complex but when taken together as a whole they’re very nice filters that we pour the domestic universe of about 13,000 tradable stocks through, and we end up with about 350 stocks that meet this criteria. What we found is that they all share some characteristics, and one of those characteristics is that over the course of many business cycles which are specific to their business and macroeconomic cycles, which are specific to the economy at large, these companies tend to understand who their customers are, what products need to be manufactured or sold or services provided, that attract customers to the companies, and they know how to hire and groom management so that they have consistency from cycle to cycle to cycle.
One of our criterion, Jim, is that they have to pay an uninterrupted dividend for 25 consecutive years. Any company that can maintain that type of consistency certainly knows who their customers are, they understand their markets, and they have their arms around the products. So it’s not a big stretch to know that they know how to run their companies and produce a growing stream of profits from which to pay those consistent dividends time over time over time. [1:07:33]
JIM: You know the other thing too is you focus on blue chips, and it’s usually a blue chip that is well established, that’s going to feel comfortable paying a dividend. They tend to be more mature companies, but you know the other thing that also strikes me about the dividend philosophy, Kelley, I’ve seen everything Triumph of the Optimists to Jeremy Siegel’s new book The Future for Investors, and any time you look at compounding wealth over a long period of time, 10 year period, multiple decades, the total return in the stock market, most people don’t realize a good portion of that return comes from dividends, and I think that’s something investors forgot about in the 90s, much to their regret.
KELLEY: I agree 100%, Jim. It’s interesting the thing about capital gains is that on a certain level they’re very attractive because you know it appeals to that investor sentiment of not wanting to wait. The thing about a total return approach to investing is that it does entail some patience – I don’t know that you can use our approach and your psychological make up be such that you’re hoping to make it all over night because those are competing ideas. You can’t consistently build wealth on a total return basis by compounding dividends with a get rich quick mentality. The two – they’re like oil and water – they just simply don’t mix. [1:09:02]
JIM: Now you have six criteria that you have found works very well for the companies that you choose. You mentioned one of them which is the company has had to pay a dividend for 25 consecutive years. Would you briefly just mention some of the other criteria?
KELLEY: Sure. We don’t have a cap bias whether a company’s large, mid or small cap, but one of our criterion is we do look for liquidity. We need to know that there’s at least 5 million shares outstanding. We don’t want to be invested in a company where you need to make an appointment to trade it, so we find that liquidity is very important, much more important than cap size. What’s also very important to us is that Standard & Poor’s has what they call an earnings and dividend quality rating. Now, this is separate from their debt rating. This is just specifically speaks to their earnings and dividends quality. And for us our stocks have to have an A or better by Standard & Poor’s. We like to have institutional participation in our stocks. The way that our system works, Jim, is that our companies are very, very high quality but for them to get to an area where we’re interested in them meaning that their price is low and their yield is high, there’s generally been some type of negative news that’s precipitated that decline. So, when we buy them typically folks don’t like them. What we count on, and what’s been our experience is that eventually the value shines through – the market recognizes it. That’s when you need institutional investors to be able to step in and lift the stock up off from its undervalued area into what we call the rising trend. And we also look for earnings improvement in 7 of the last 12 years, and we look for dividend increases at least 5 times in the last 12 years, and that pretty much rounds it out. [1:11:01]
JIM: And a lot of this isn’t very complicated. You know there’s a lot of strategies out there today, you know, whether it’s trading, or it gets sort of complex and sometimes intimidating for investors but a lot of the things you guys focus on are very straightforward, they’re easy to understand, this isn’t rocket science.
KELLEY: Absolutely. If you look at who Geraldine’s primary influences were that was 2 people: Charles Henry Dow, and Benjamin Graham. And you know, most folks recognize the name Dow because obviously the Dow indexes and Dow theory. What doesn’t get a lot of recognition is that Dow wrote an awful lot about value – identifying and understanding value in the markets – and that it’s imperative for the investor to establish what value is. And that’s our approach that, you know, we don’t like to lose principal. So we needed a mechanism whereby we could identify value in the market and that qualitative screen I discussed with you draws heavily from the work of Graham in being able to devise a system that gives you a separation from the rest of the markets. So, what we look for is a mechanism and for us it’s the dividend. The dividend represents to us that, number one, here is a company that is profitable because they can pay part of the profits to the shareholders; dividends also establish for us channels of value for undervalue and overvalue – that’s why we know when to buy; and then lastly we look for total return capital appreciation but that’s the third item on our list of what we’re trying to achieve. So we want to protect our principal, get an immediate return, and then capture total return through capital gains. [1:13:00]
JIM: Now, something that you’ve started over the last couple of years is something called your lucky 13. Why don’t you tell us a little bit about that.
KELLEY: The way the lucky 13 works, and the genesis of it is this that for many, many years the greater part of our subscribers were professionals. They just basically wanted our research, they really didn’t need portfolio recommendations from us. But as Geraldine became more widely known and the newsletter became more widely read she would make appearances on Wall Street Week with Louis Rukeyser where we attracted more and more of the individual or do-it-yourself type of investor. Their needs were much different than our professional subscriber needs in that they asked us for portfolio recommendations. So, what we decided is back in 2000 that at the 1st of the year in our first January issue we would come to our subscribers with a core group of stocks and in this case it was 13 stocks for them to begin to build a portfolio around, and that was the genesis of the lucky 13. And we just used some really simple, I would say, tools would be the best way to say it Jim, in that we would go to our undervalued category, we would find stocks that were A-rated or better, that had a PE of 15 or less, book value of 2 times or less, where their pay out percentage was say 50% of trailing 12 month’s earnings or less, and a debt to equity of 50% or less, and we would use that as our filter and we would find 13 stocks in diversified industries that we felt would outperform the market for the coming 52 weeks. And it’s been a tremendous success considering that 52 weeks is not our time frame – we think in terms of 5, 10 and 15 years – but the portfolio has averaged nonetheless about 18.11% a year since 2000. [1:15:00]
JIM: Well, I know you’ve got a lot more individual subscribers today, but your subscriber list also reads like a who’s who on Wall Street. Kelley, as we close, why don’t you tell people about your website, and if they wanted to find out information about your newsletter how could they do so.
KELLEY: Jim, thanks a lot, if you just go to IQTrends.com, and that’s our website and click on the prospective subscribers button and that’ll take you to an area where you can download a free sample, you can look at our introduction which explains our methodology, the genesis for it, how we apply it and how best to use the newsletter. And that’ll give your listeners a real good introduction to IQ Trends and what we do. [1:15:46
JIM: I know when Geraldine first wrote her book, Dividends Don’t Lie, she was I think when I started out in radio in 1987, she was my second guest after Mrs. Fields. Is there any chance Dividends Don’t Lie, which is currently out of publication that you would bring that back.
KELLEY: What we’re doing Jim is actually we’re working on the follow up to it, and it has the real ingenious title of Dividends Still Don’t Lie, which is basically an update of the original and it covers a lot of material since the original was written in 1987, and if the creek doesn’t rise we’re going to try and get that out by the 3rd quarter of this year. [1:16:29]
JIM: Well, I can tell you the minute that that book comes out you’re welcome back on this show and I’d love to have you back to talk about it.
KELLEY: I appreciate it and love to be on any time you want us.
JIM: Alright. Well, Kelley, thanks for joining us.
KELLEY: It’s my pleasure Jim, take care.
JIM: Once again the name of the website is IQTrends.com
JOHN: Well, Jim, you can’t say it was not an interesting program today as always we give our guests and listeners a preview of what’s coming up in future weeks and the list is not uninteresting.
JIM: Well, John, coming up next week we’re going to try to clear the mechanism, give you a bigger view of the big picture, especially on oil – we’re going to have an energy roundtable, joining me on the program will be James Kunstler, Richard Heinberg, and Dr. Ken Deffeyes, and so we’re going to take a look at some of the issues. Boy. There are so many tell-tale signs, I’m seeing them almost every single week about a global peak in oil production. People just don’t realize how close that is. We’re going to be discussing that next week, we’re also going to look at some of the claims of abiotic oil, about technology, and some of these other issues to just give you a sort of big picture look at all of this. And then further down the road we’re also going to have a gold roundtable, it’s going to a different kind of gold roundtable than past guests so we’re working on putting that together. So, all of you gold bugs, no, I haven’t abandoned the gold camp. So, no for all you gold bugs we’ve got a gold roundtable coming up, we’ll announce it when we’ve arranged everybody – like I said it’ll be a little different from previous roundtables. And when we think the air is clear of danger we’ll also be talking about when it’s going to be safe to get back in. I can tell you right now we’ve got a huge, huge shopping list and quite honestly I’m getting excited, it’s…some people like to go shopping in malls, I like to go shopping in the markets. And the days of bargains are just around the corner.
Well, in the meantime, on behalf of John Loeffler and myself as always we like to thank you for joining us here on the Financial Sense Newshour until we talk again, we hope you have a pleasant weekend.