Financial Sense Archive | About | Newshour | Metals | Storm Watch | Authors | Resources

Big Picture Banner

Financial Sense Newshour

The BIG Picture Transcription

March 18, 2006

real player icon RealPlayer winamp icon WinAmp windows media player icon Windows Media mp3 icon MP3 charts icon Charts

Fundamentals of the Commodity Bull

JOHN: Well Jim, here we are, going through some of the newspapers looking at headlines– particularly the economic papers: “Sell off could mean end of bull market for commodities” that’s from the Financial Times; Resource Investor – “Gold Watch, a bear camp lurking.” CNBC: “record inventories could mean lower energy prices.” The Economic Times: “gold moves further South.” CNBC chimed in as well: “gold in an evident downtrend.”

My gosh Jim, we’ve been preaching the wrong thing here on the program. Why don’t you give us your chill Friday take on this, I’m wondering what these people are smoking?

JIM: Well, you know, just the facts, as Joe Friday had to say. In any bull market, you’re not going to have a constant rise in prices, you’ll see a big upswing in prices that may last for a rather lengthy period of time, and then you get these pullbacks. What these people are missing I think is that any time that commodities pull back we get into wishful thinking. But here are some simple facts – and I’m going from the year 2001 which was the bottom for most commodities markets (probably with the exception of oil which you would probably have to go back to 1998) –just from 2001, the CRB index bottomed in October of 2001 right after the events of 9/11 at 183 ¼ , today it’s at 327, so it’s up 144 points, or roughly 79%. You’ve seen uranium prices go from $8, to $39.50, up 394%; copper has gone from 70 cents to $2.36, up 237%; nickel prices have gone from 2 ¼ to 6.60 a pound, up 193%; gold has gone from 255 to 554, up 117%, which is remarkable when you consider all the intervention from central banks to keep that price down. Silver has gone from a little over $4 to $10.35, up 155%; oil has gone from a low of $17.45 to $63.50, up 264%; natural gas has gone from a little over let’s say $1.80 to 7.15, up 291%. Now, I ask you, John, does that sound like a bear market? [2:47]

JOHN: Uh, the old trick questions aside, no.

But Jim, you know, look at all these headlines I just read why do you believe as opposed to what they’re saying, why is Wall Street missing and underestimating what’s really an explosive bull market?

JIM: I think you have to look at that the world has changed over especially in the last decade. And I think what happened on Wall Street, and especially with mainstream economists, is they relied on the old paradigm models that looked at basically the OECD countries which are mainly the western industrialized economies of the world – Europe, the United states, and throw in Japan. What I think they missed completely was the impact of China, India and the growth in Latin America. In other words, the tremendous growth that’s taking place in these emerging markets.

And so what you have is unlike the past over the last let’s say during the 80s, and the 90s, any time we would get a temporary oil spike, oil prices would come back down again – or for that matter a spike in gold, for example, between 1985 and 1987, gold prices spiked, as the dollar was coming down we were in a dollar crisis, but then eventually gold prices came right back down again. We had a spike in 1991 during the first Gulf war, then they came down; we had a spike in the mid 90s, oil prices came back down. We had a spike in gold between 1993 and 1994, then central banks slammed the gold market, it came back down. We had a run up prior to 98, then we had a big fall off, oil prices dropped to $10 a barrel; same thing with gold. So, if you look back at historical records and over the last couple of decades, any time commodity prices would rise, maybe you would get a one or two year rise, but then it would be over, it would be back to another downtrend.

And if you looked at the charts whether you were looking at gold oil, natural gas, copper, lead, zinc, nickel – it didn’t matter what you were looking at the price was in a long term downtrend. And so they were looking back at these models, and not really factoring into their forecasts the impacts of an industrializing China. I can remember I think it was 2002, that I interviewed Jim Rogers on my program and he had just come back from his 3 year tour around the world, setting another record for the Guinness Book of Records, and he’d written his new book. I remember a comment he said on the program: he said we’ll never see $25 oil again. And that really struck me, because I was researching peak oil at that time and that really resonated with me. So by the end of 2002 when we were approaching $30 a barrel, the analysts were talking about oil going back in the 20s; then oil got into the mid 30s and then it got into the 40s. By the time oil prices were in the upper 30s and 40s, they were talking about oil prices going back to the 30s. Then we hit oil prices in the 50s; then when we hit the 50s analysts were saying, no it’s going back into the 40s.

So, even today – and this will sort of give you some mainline thinking – Value Line, which is a very impartial research organization, they don’t do underwriting, they don’t take advertising, they sell their research, their estimates for oil are that oil prices will average $60 a barrel this year. Then next year, oil prices will drop down to $55 a barrel in 2007. Then in 2008, oil prices will drop in the 40s, and between 2009, and 2011, we’ll be looking at $40 oil. The reasoning is, “gosh, higher oil prices are going to bring on all this supply.” And they’re going by these old paradigm models, so therefore you know with these high prices, eventually this will fall back down just like it’s always done for the last two decades. [6:59]

JOHN: Yeah, if you look at this there’s a cycle in how these forecasts work. A few people that seem to know what’s going on are saying it’s going to 20, 30, 40. The general market responds, and says “never happen”, and when it hits that plateau the response is not to worry, it’s going back down, which it never does, and we’ve repeated this cycle over and over. So, what’s wrong with these forecasts? Why can’t they hit them?

JIM: Well, they’ll always throw this caveat. We think we’re headed for lower oil prices outside a Middle East war, so that seems to be the caveat out there. What they’re looking at is based on the oil discoveries of the late 90s, and the early 20th Century. You’ve got about 14-16 million barrels of new production coming online by the balance of this decade: Saudi Arabia said they’re gong to increase their oil production by 5 million barrels; then you’ve got countries like Kuwait, Iraq, Nigeria, the IEA forecasts increases of half a million barrels a day coming from each one of those countries; Russia is supposed to increase its production by 2 million barrels; and Venezuela is supposed to increased its production by 1 million barrels.

Now, assuming – and that’s a big word – assuming, that Saudi Arabia, Kuwait, Iraq, Russia and Venezuela, can all increase their production, the big thing these forecasts are missing is a word called depletion. Ghawar, the world’s largest oil field, is in decline. Cantarell, Mexico’s newest oil field, is in decline – and I know there’s news they’ve discovered a new major oil discovery but notice they don’t mention any particulars. Burgan, Kuwait’s largest oil field in decline. The North Sea and Alaska, the 2 biggest discoveries in the last 40 years, all in major decline. Two-thirds of the world’s producers have already passed peak.

And getting back to the assumptions, can Saudi Arabia go from 10 million barrels a day of production to 15 million barrels? That’s a big if. Same thing with Kuwait. We already know Iraqi oil production is going down, nobody’s going to explore for new oil in Iraq when they’re blowing up everything. Nigeria, you’ve got a state of almost civil war going on there with the rebels – another 100,000 barrels a day just went offline in Nigeria. So, 550,000 barrels of oil have gone offline, instead of adding an additional half a million. Russia, with Putin’s control over the country now, basically Russian production could be going into decline, because there’s no real new technology and investment that’s really being made in Russia, because Russia’s basically closed its doors to Western oil companies. Take a look at Venezuela. With the way Chavez is running the country oil production has dropped precipitously in Venezuela. So, even these so-called 14-16 million barrels of new production that are supposed to be coming on line according to the IEA, that is questionable as we can see in recent events in Nigeria, recent events in Kuwait, recent events in Iraq – it doesn’t matter where you’re looking at, those forecasts are somewhat questionable.

And the other thing is as you take a look at these large oil fields, such as Ghawar, Cantarell, the Burgan, North Sea, Alaska, a lot of the declining output in the world today is coming from these super giant oil fields that were discovered 50 and 60 years ago. In fact, light oil production globally has nearly peaked, and what none of these forecasts really do is differentiate the difference between light and heavy crude. One of the key things that has people worried today about Nigeria is Nigeria produces light sweet crude, that’s the best kind of oil for an oil refinery, and what most oil refineries are geared to process. And so with 550,000 barrels taken off line, and maybe even more, you’re going to see some tightness.

And in a nutshell, John, these production forecasts don’t take into consideration depletion. And if I was going to give you an example in terms of inventory, picture a warehouse where all you saw coming in the front door of the warehouse was all this new oil that was being brought in through the front door. Unless you subtract what is going out the back door, in this case the back door representing depletion, you really don’t get a real accurate picture. So, everybody can throw out these numbers, we’ve got all this new production coming on line, but they’re forgetting a very important, fundamental aspect of that new production is how much of this new production will have to go to replace the increase in declining oil production as a result of depletion. [12:00]

JOHN: When we hear announcement like the country of “umbarreh” has announced it’s going to be putting another 5 billion barrels a month out there or something, who audits this to even know this information is even correct?

JIM: And especially with a lot of the OPEC countries, if you’re familiar with the story of abiotic oil, you almost believe the OPEC countries have discovered abiotic oil, because every year they produce more oil but their reserves never go down. Their reserves have been static since 1988, when everybody increased their reserves because OPEC went on a quota system. It’s the only region of the world where one can make the assumption – if you accept the numbers that are widely published – is that every year Saudi Arabia pumps out 10 million barrels a day, they’re finding 10 million barrels a day. Or if Iran is publishing or producing 2 ½ million barrels a day, they’re finding 2 ½ million barrels. And I really have to question that.

One of the beefs that people in the oil industry – and this is the point that Matt Simmons has made constantly – is there really isn’t any transparency when it comes to the oil business, which is phenomenal when you consider it’s one of the world’s largest industries. And yet we just take whatever’s given – if Saudi Arabia says, “we’re going to increase our production by 5 million barrels.” Everybody says, “OK. They’re producing 10 a day, they’re going to increase it 5,so now they’re going to be producing 15 million barrels.” We never question this.

We’re going to be interviewing Matt Simmons again next month, and that’s one of the questions I’m going to be bringing up. You and I, John, were talking before we went on the air, and CNN has published a major piece on their website ,and it’s called We Were Warned:Tomorrow’s Oil Crisis, and I’ve often remarked on this show that one of these days when we wake up, and you see on the cover of Time magazine and CNN, peak oil, that’s when the panic begins. Well, you just got the first warning sign from CNN on Friday, and if you go to our energy resource page on the front page where it says energy, click on that, it’s the top story, it has video as well as stories talking about tomorrow’s oil crisis. And it’s remarkable if you take a look at some of the topics they’re covering: Poll – most Americans fear vulnerability of oil supply, behind the scenes powering the planet; living on an illusion, the long war of the 21st Century; how much are you spending on gas - alternative fuel. The topics that we’ve been talking on and writing about on Financial Sense or the FSN Newshour for the last 5 years are now starting to make it into the headlines.


3/18 CNN Presents:
We Were Warned: Tomorrow's Oil Crisis

Matt Simmons: Middle East oil is fading as the primary source of oil that can always increase. We have been living on an illusion for half a century.
CNN: An illusion?
Matt Simmons: Yeah.
CNN: What’s the illusion?
Matt Simmons: that the Middle East had unlimited amounts of oil.
CNN: What’s the reality?
Matt Simmons: The reality is that there is twilight in the unlimited amounts of oil.

That was the voice of Matt Simmons appearing on this weekend’s CNN special, about the approaching oil crisis.

JOHN:But if we look at the way these predictions are being made, they’re being made on economic models more like computer images than reality.

JIM: You’re exactly right and I remember when I interviewed Matt Simmons last year, and when he did his first major study of all the world’s major oil wells and nobody had done that up and till the time that Matt did it, and that was phenomenal in itself. And he’d been called into the CIA where they had got 10 of the world’s top oil experts, and these guys were all sitting around the table and they were talking: “Ok, where are we going in oil production?” and these guys had their laptops, and one guy was saying, “well, China’s producing 3 million barrels a day, and by the year 2005 or 2010 they’re going to be producing 4 million barrels.” And all these guys are spouting out all these increases, and then Matt said, “how do you know that?” “Well, that’s what my computer says.”

And the idea behind that is typically if we were applying this to widgets or anything else in the economy, higher oil prices would mean more producers would get in the business, so you’d get an increase in production. And eventually enough producers would come online where you were producing enough widgets so that the price would come down. So, for example when it applies to oil, higher prices mean more exploration, more discoveries, and eventually more oil and with more oil you get lower prices. But the problem with this assumption or economic model, we haven’t replaced our oil consumption each year for the past two decades. Discoveries are in decline, they peaked in the 1960s. Those discoveries that have come since that time have been fewer in number, and smaller in size. If you look at for example, large oil companies, their long life reserves are declining, they’re now anywhere from between 13 and 19 years, and they’re down 7 years in a row.

CNN: How tenuous, how precarious is this situation now?
Matt Simmons: Well, more precarious than it’s ever been, because this is the first time that the world has ever run out of all forms of spare capacity. Saudi Arabia is the only country, they’re the only supplier that we – the world – always assumed the more we’d use the more they’d bring on. And if they failed to deliver that there isn’t anybody in the wings.

JOHN: Once again, Matt Simmons from the CNN special this weekend. Well, everybody’s talking about this oil are there any legitimate sources, is there real new oil out there, and if so where is it coming from?

JIM: Well, you’ve got to look at the oil markets today which are much different. 50 years ago, the Seven Sisters – o r the seven major oil companies – really controlled about 50% of the world’s oil production. Today, their production is down to about 5 or 6%. So, you’ve got to look at NOCs (national oil companies ) versus IOCs, or international oil companies, like the Exxons, the Chevrons and the BPs.

And the second thing you have to look at is much of where the oil is located today is untouchable: for example, Russia is now controlled by Putin, and his KGB, off limit to Western oil companies. So, Exxon, Chevron, BP, are not just going to walk into Russia and say, “hey, you’ve got some reserves there, you haven’t spent the money to develop them, why don’t you invite us in.” No way. The Middle East is off limits to western oil companies, and if you look at the Middle East today, it’s engulfed in probably ethnic, tribal, and religious wars – just pick up the newspaper, or turn on your nightly television, I’m not going to tell you anything new there. Just take Venezuela, Hugo Chavez is turning Venezuela into a Marxist dictatorship. Latin America is going Marxist.

In summary, total reserves are shrinking, and more importantly and this is something that is very important for investors to grasp, politically secure areas of the world are also disappearing even faster. How secure would you feel as an oil company, or a gold mining company taking a look at reserves in Venezuela, or for example the Middle East or even Russia? Even if Asian demand was to moderate, let’s say the economic growth rates of China, went from 9 ½ down to 3% or 4%, it’s difficult to imagine where this new oil is going to be produced to offset the declines in Ghawar, the world’s largest oil field, the North Sea, or Alaska. [20:14]

JOHN: It’s really important to point out too when we’re talking about replacing we haven’t made the gains, the world demand on oil is going up, all we’ve managed to do is bring ourselves back to par again.

JIM: Yes, and the thing is everybody says, “well, because of economic slowdown,” this is another thing that some of the economists are plugging into their economic models. Therefore if the US GDP declines – let’s say we go from a 4% growth rate to a 2% growth rate that’s less energy consumption, therefore less energy consumption, less demand for oil, so the price of oil goes down. It’s not going down, it’s going up. I would venture to say that oil’s going to be much higher towards the end of the year than it was at the beginning of the year. Outside of this recent discovery that Mexico has announced, and as you’ll see here in an interview with Zapata George, we’re looking into this, there’s no details, it’s kind of like somebody making an announcement, “hey, we’ve found a whole bunch of oil, but we can’t tell you about it.” [21:10]

JOHN: Now, here on the program, we’ve had hints come up over the last few weeks about peak gold. Are there any analogies between the oil market, and the metals markets? Let’s draw that one.

JIM: Well, you’ve been hearing from me, for over the last couple of years, there’s a lot of parallels between big oil and big gold. The same thing that is happening to the big oil companies are happening to the big gold producing companies. Just like the bear market of the 90s, when you had big difficulties surviving, what you saw was consolidation in the industry because the oil companies weren’t making that much money, oil prices had declined. Heck, by 1998 they had gotten down to $10 a barrel, gold prices had gone from $800 in 1980 all the way down in to the mid 200s, and so the industry consolidated it got bigger, a lot of mines went out of production, a lot of companies went out of production. So the same analogy in the metals market is similar to what’s going on in the oil market. The major gold producers aren’t replacing their reserves. [22:24]

JOHN: OK. So, let’s look at the supply-side then. You’ve been talking about decline in production for oil, what do we see in production of the metals, from the mines?

JIM: The first thing you have to understand is that today the old benchmark for the mining industry used to be that it was about 5 years from the time you poked a hole in the ground and you discovered gold to when that was turned into a mine, and brought into production. Today that time period has doubled. It’s 10 plus years today from the time of discovery to the time you get actual production of gold or silver. So the time from discovery to production has doubled to 10 years, that’s a very important concept to grasp here.

The other thing if we look at some of the bare facts, gold production is in decline: South African gold production last year declined by double digits. The other thing that happened in the 90s as the price of gold fell, a lot of mines high graded their ore – they used their richest deposits to mines because that was the only way they could keep mining economical.

At the same time you’ve got rising demand globally from the developing world. And if you look at not just gold, silver – I’m talking about any kind of base metals, if you look at the emerging markets today – a China, India, even Latin America - they are metals intensive economies. What are they doing in their economies? They’re building infrastructure, they’re building roads, bridges, dams, airports, train stations; they’re building factories, they’re building communications networks, they’re building homes – all of these require a tremendous amount of raw materials. So when their GDP grows it has a much greater impact on the raw materials market than let’s say a service-based economy like the US, and many of the Western economies, that have basically downsized their manufacturing base.

Another major factor that you didn’t have maybe 30 years ago is the environmental movement globally is creating massive shortages. You want to build a mine, explore for energy, build a refinery, setup a wind farm a solar farm, build a nuclear power plant, I guarantee one thing you’re going to be hit with is an environmental lawsuit. And it’s not just the US, it’s globally. Many mine companies – Newmont was sued by the Indonesian government; you’ve got Barrick – one of its main replacement mines in Argentina – Pascua-Lama – is being challenged on environmental reasons. You don’t just walk into a neighborhood today and set a mine.

In the United States, if you want to explore for any natural resource – I don’t care if it’s natural gas, oil, uranium, gold, silver, lead, zinc, it doesn’t matter what it is, you’re immediately going to get hit with an environmental lawsuit. Try to build a refinery today, they’ve been trying to do it in Arizona for over 10 years. They’ve been stopped with environmental lawsuits. They’re trying to stop building wind energy off Cape Cod in Hyannis Port – thank you, Ted Kennedy. Try to erect a large solar array somewhere, and they’re going to be worried about you’re going to harm an insect or you’re going to harm a plant or something. We haven’t built a nuclear power plant even though the rest of the world is building them. And so one of the best friends the natural resource investor has are the environmentalists. They are going to make natural resources one of the best performing asset classes, they are creating shortages.

And the thing to understand, and when I go back to that number, it takes 10 years now to bring a mine in production. So, let’s say we discovered a major new gold discovery, and you announce that to the world, it may be 10 years before that actual discovery is brought into production, and when you start seeing the output of that to help satisfy the demand for metals – whether it’s copper, whether it’s alumina, whether it’s silver, doesn’t matter what it is, or even uranium. It just takes a long, incredible amount of time. [26:43]

JOHN: So if we have to summarize all of this as we move forward, what are we going to see? How will it play out?

JIM: We are going to see higher prices plain and simple. You’re not going back to the economists’ models for oil, they’re not going to work for base metals as well. And I want to just throw something in here, though , that’ll give you perspective. Let’s say you are the CEO of a major mining company, it could be a gold mining company, it could be copper, it could be alumina, it could be lead, nickel, zinc, whatever it is – you have to make decisions on how you’re going to spend your cash flow, the investments you’re going to make. And as a CEO today, why would you expend a whole bunch of money developing long range assets that you may not see the benefit of for 10 years.

And the first thing that’s going to happen is your capital expenditures go up, your costs are going up that’s going to reduce profits, that’s not good for shareholders ,and it’s probably one of the quickest ways to lose your job. So what you’re seeing instead of major capital expenditure expansions by not only energy companies but also mining companies – you aren’t seeing them – instead what the CEOs are doing is start taking the immediate road to self gratification, and what they’re doing is simply buying other companies.

Why spend a whole bunch of money cash to go develop, I mean let’s talk about developing a mine. First of all, you’re going to have to find it, so you’re going to have to send your geologist, that’s going to cost you some money, you’re going to have to stake the claim, you’re maybe going to have to pay some royalties a lot of upfront costs. Then you’re gong to have to spend the next 2 or 3 years drilling - that’s going to cost you a fortune. Most drilling crews are going to cost you about ¼ million dollars a month, and then you’re going to have to go through all the environmental permits and hurdles, and then you’re going to have to do a feasibility study, and then you’re going to have to get further permits, and renegotiations in terms of royalties and remember many of the countries you operate in today you can negotiate a deal on Monday, and discover a major discovery and then all of a sudden the government wants to change the deal on Tuesday. Why would you do that when instead of using corporate cash you could use an inflated stock price, go buy another smaller company that’s already done all the hard work, and what you get are short term profits, and short term shareholder value instead of making a long term, long range decision? So that’s what’s driving the economics of this market, it’s one of the reasons why we have been so heavily oriented towards juniors.

We made a mistake [and] got out of our majors, and intermediates, maybe a month too early, towards the end of the year, but we kept our major producers. So we underperformed the market for a month, but now we’re killing the indexes because of our junior position. That in summary, John is what is happening to the oil markets, the same thing is happening to the metals market, precious metals, and base metals. Demand continues to grow because of emerging economies, but supply increases will lag, and that’s going to translate into higher prices. [30:17]

JOHN: Alright, given all of that, we always come down to this bottom line question. For investors, what should your strategy be?

JIM: If you were looking at mining companies, I don’t care if it’s gold, base metals, even the energy sector, look for companies with long life reserves. If you really want to get the better returns you’re going to be better off in late stage development companies – juniors in the gold industry – you’re going to be better off in what I call energy companies that have long life producing assets – in other words their reserves are going to be around for a long period of time. They’re in very stable areas of the world today, especially with so much geopolitical uncertainty. And the result is by sticking where the growth is going to come from in this bull market, this is not going to be like the 70s bull market, where you could throw the dart at the wall, and if you picked a resource company you made money. You’re going to make money if you own Exxon, Chevron, or if you own Newmont or Barrick in this bull market, but that’s not where the big growth story is going to be. The 10, 20,30, 40 baggers are going to be with the energy industry companies that can increase their production, replace their reserves, or increase their reserves. In the mining industry, in the gold industry, late stage development plays, 2 or 3 million oz deposits in very politically safe regions of the world. That’s where this bull market is going to be so much different, and that’s where the returns are going to be. [31:51]

Emails and Q-Calls

JOHN: Tim writes in and says:

I was hoping you could address this on your show, I listen every week and love your Big Picture outlook. I did goof however as I’m still holding my natural resource stocks, waiting for that spike to new highs that probably isn’t going to come this cycle. Given how far some of the oils, uranium, alternative energy, and mining stocks have come down already, could you address holding for the long term as opposed to getting into cash, and buying lower later in the year?
I am not a professional and I have gotten whipsawed a lot recently, making too many short term decisions after reading articles on the Financial Sense site. Not blaming you for my bad decisions, but it seems like trying to time things like you guys did, being nimble in 2006, isn’t working for me. I know you can’t answer specific investment questions, so if you could address it generically but with as much detail as possible. Marc Faber said to get in cash for the next six months, Sinclair says don’t sell a thing, there’s almost too much information out there.

JIM: I would say at this point I would keep what you have, but once again bear in mind what I just said, about long life assets, companies that can increase their production, and increase their reserves; and I would also be looking at alternatives. So if you’ve got good companies hold on to them, and look at any weakness to expand your portfolio in natural resources: base metals, gold, silver, energy, oil, natural gas, coal, uranium, any kind of means of natural resources are going to do very well.

I would use pullbacks – we got out of our majors – if you own major companies, a Barrick, a Newmont, or any stock like that, those I tend to advocate trading because they’re not a growth story: Newmont’s production has dropped from 7.6 million ounces, they’re heading down to 6; even though Barrick bought Placer, and will become the world’s largest gold producer at over 8 million ounces, their production will decline every year. So, I would trade the majors, but if you’ve got good, smaller cap companies, mid tiered producers that have the ability to grow production and reserves, those you keep and add to on any pullback in the markets.

Steve, from Rochester, New York, I’m wondering how you can reconcile higher oil prices going into the Summer, with a higher stock market as well. I mean it’s happened year to date in terms of higher oil, or in the past year I should say, higher oil and higher stock prices, but when we get over 70, and even 80 and beyond, I don’t know how you can possibly see either being bullish like you are on the stock market. Thank you.

Steve, very easy, it’s called money creation. If you take a look at the stock market from, let’s say from March of 2003, and take a look side by side, a chart of the oil market, oil prices have gone from a low of roughly about 17 ½ dollars in October of 2001, to today’s price of roughly over $63 a barrel, at the same time the S&P has gone from [800] to over 1300 – the basic reason: liquidity. Every central bank in the globe is inflating their currency, and for the first time in history today there’s no currency in the world that is backed by gold or silver, or any precious metal commodity. Central banks can print money out of thin air, at will, and that is happening simultaneously by most of the world’s central banks. [35:37]

JOHN: Dr. Garnett writes from Punto Escondido, Oaxaca, Mexico, and she says:

Thank you so much for your fresh and very important information. Alternative energy: I’m wondering if biodiesel shouldn’t be getting at least as much attention as ethanol. It seems to me – a layman – that it has less problems and could be in place rapidly. It might be good for utilities, as well as vehicles. Are there problems that make it less doable? I wonder what you and your experts say, and why we aren’t hearing an emphasis on it?

JIM: Oh, you’re going to hear more emphasis on it. We’re planning a series of programs of authors and guests on alternative energy and I agree with you on biodiesel. In fact I’m talking to the marine industry, and I’m working with a boat company on the design of a motor-sailer and one of the things we’re talking about is conversion to biodiesel, because diesel fuel now – it used to be diesel fuel was cheaper, but because of all the EPA changes it’s making diesel fuel more expensive. And one of the things in the marine industry is most boats run on diesel, at least the larger ones, and they’re talking about converting to biodiesel. You’ll be hearing more about it, but you’re definitely on the right track there. [36:38]

Hi guys, this is John calling from Brunswick, Maine. Listen, I’m really concerned you’re getting it wrong on the political front here, you’re mentioning that Richard Nixon’s second term was one of the only terms where the market headed down, and you cited his impeachment, and you cited the various geopolitical events happening at that time. Well, it’s been kept a very great secret in the mainstream media, but there is a growing impeachment movement now regarding President Bush and Dick Cheney. And I believe this is going to catch fire. And I’m really concerned you might be getting things wrong in terms of the way the gold market might be going short term, and where the market’s going to be going long term – well, at least later in the year. So, I’d like to hear you address that, and I encourage you to do a little research on the impeachment movement before next week’s show. Thanks.

I’ve been watching that, it’s all being done for political purposes. I’m trying to think of – who’s the Congressman, he’s I think from Minnesota, he’s behind this, and he’s also going to be running for president in 2008, and basically what he’s trying to do is to his Democratic constituency prove that he’s further left than Hilary Clinton. Impeachment, in terms of bringing it up, it’s more designed for political purposes to regain the White House and regain Congress. John, I think what you’re seeing here like for example Russ Feingold from Wisconsin, he’s already announced he wants to run for President in 2008, and he’s appealing in order to get the nomination to the Democratic Party, where the bulk of it has now gone way to the left, and all of this is being done for political purposes.

For example, let me give you Newt Gingrich, what happened is there was an effort made to get rid of Gingrich, they threw a whole bunch of accusations at him, there were 300, and you notice he had to resign. He was fined, but 2 years later the government exonerated him of any guilt. You never heard about that, it didn’t matter, the damage was done.

And one of the topics I had taken in political science, and also on propaganda, one of the things that you can do very effectively is come up with allegations, and this is done in the political world all the time. And the reason I’m familiar with this is I ran two political campaigns out of college, and more recently one of my good friends, who is now running for Congress – and I think he’s going to get elected – but when he was a State Assemblyman, after his first term (his second term there was not a lot of effort to get him) they came up with ads on the local radio here showing him equivalent to a Nazi leader, Hitler. All these untruths were put out in the media, and I asked him and I said, how can they get away with this? Why can’t you sue them for libel? And he said you can’t do that in the political process, anything flies.

Whereas in the private sector if I was to go for example after one of my competitors in the business here locally and call him names, or call any of my competitors names, and just throw a whole bunch of stuff to try and tarnish the reputation, I would be taken to court. But in the political process you can say anything you want. It doesn’t matter if it’s true or not, you just throw it out there. So, yeah, the media is after the president, they can’t stand him, but I think you’ve got to look behind the statistics, I just don’t think there’s going to be an impeachment process. [40:21]

JOHN: One of the things to be aware of from a media standpoint is beware the 11th hour scandal. In other words, 4 days before the election, or 7 days before an election, boom, a scandal breaks over the horizon, and there’s much flurry about it, and you’re right, in other words, the election’s going to happen in just 7 days, by the time the scandal dies down it’ll be 3 months, and it’ll all be shown to be groundless, in a lot of cases. These are thrown out, the timing is very specific, and that is to scuttle the election, that’s what they’re trying to do with a particular candidate.

Hi, this isn’t a question, it’s a request. My name is Nancy, I live in San Gabriel California, and I’d just like very much for Mr. Puplava to have Zapata George on again.

Other Voices: Zapata George

zapataJIM: Well, Zapata George, I can think of a number of things that you and I can talk about but one of them I want to get to right away which I think portends or tells a lot about the future and that’s the US Treasury tapping into the Civil Service pension fund. We all know there is no Social Security trust fund, they’ve been raiding that since its beginning, there never was a trust fund it was pay as you go, but now it seems like the government is running out of cash, and they’re looking at anywhere to get money, and the newest venture is to find or raid the Civil Service pension fund.

ZAPATA GEORGE: See, and here I thought we were talking about something new.

Well, I’m afraid that you’re right Jim, and see this is what you’re talking about is a symptom of the overall disease, and unfortunately I don’t see a cure for that overall disease.

JIM: You know George, I’ve got this nagging fear in the back of my mind that you know maybe in this next depression and times get a little bit tough, and maybe the stock market goes down, we have a major bear market, and the government passes some kind of law like the “Retirement Security Act” and they come in and force private pension funds to buy worthless zero-coupon bonds in the name of protecting the pensioners, but I think that is something that we could be looking forward to in the not to distant future especially when our budget deficits get so big foreigners – I mean, there is no amount of money that can finance us.

GEORGE: The government can force anything upon you. If you don’t believe it all you have to do is go back to the last time they got into real trouble and they –quote – took away gold. Well, what you’re describing is no more onerous than what has already happened at one stage with our government. [43:07]

JIM: And of course if we look at when they did that in the 30s, and you look at the conditions of the country now at least in the 30s we were a creditor nation – we had surpluses of just about everything, commodities, industrial capacity. Just look at us today, we’re the world’s largest [creditor] nation, we’re not the same country.

GEORGE: No, and you know the government believe it or not does not have to pay interest on your money, and let’s go back to the 30s, and there was a time, in that old book I wrote years ago, I show the negative interest rates of the 30s. You would deposit $10,000, you would leave it there for 90 days, they would return $9,985 to you. They would charge you $15 for keeping your money 90 days. The government has actually had negative Treasury instruments. So, anything is possible my friend.

JIM: And in one of the Fed papers about fighting a coming deflation, one of the issues they talked about was doing that very same thing. In other words, the government believes that the problem with the economy is consumers aren’t spending enough money because they’re bone chill scared or something, they could go back and do that very same thing. In other words, the longer you keep that money in the bank, you would start to lose it if you didn’t spend it. Use it or lose it.

GEORGE: Or think about this, suppose they initiated consumer bonds that you got US government bonds for having bought something, see it doesn’t make any difference how silly the scheme you and I can dream up they can think of something stupider.

JIM: I want to talk about another topic, you and I have been talking about peak energy, and a recent report, by the US Army of all things, talks about this peak energy being not too far off in the future. The Army issued a report and this report talked about peak oil and the Army’s future which was [not] surprising because here is a military force structure that moves on food and energy, and without energy you don’t have much of an army.

GEORGE: I think George Patton pointed that out to us about 50 or 60 years ago.

JIM: You know it was surprising because they take a look at – the people that did this study for the Army – which was the US Engineer and Research Center of the US Army. They cite the studies done by ASPO – the Association for the Study of Peak Oil – and one of the things they called into question is its own government’s analysis that there’s a bountiful supply of energy. In fact, they mention that if you believe the government it would imply that there’s going to be a fivefold increase in discovery rates and reserves, and they cited in their own research there is no evidence to back these facts.

GEORGE: Well, see, the USGS is the origin of that document that you’re speaking of, and I happen to know for a fact that there was substantial portions of white lightning in that room when they drew that document up.

JIM: One of the things that I think that causes people to be hesitant or somewhat skeptical of peak oil you’ve had a couple of announcements recently, one was a giant oil discovery by Chevron, and then last week or the beginning of this week, a giant oil discovery by Mexico, supposedly a field so large, if it is as large as they say, this has been the first real elephant sized discovery since the late 60s when we discovered the North Slopes and the North Sea.

GEORGE: You use the words in there and there are only 2 letters in it, and I think you said ‘if’, didn’t you say that a couple of times? I’m afraid you have hit upon the problem, but if I could return for just a moment to the Army report, in that report towards the end of it they say, “our best options for meeting future energy requirements are energy efficiency and renewable sources.” Well, you and I have talked about the efficiency thing before, didn’t make any difference, what renewable sources do they speak of – can you name other than the liquid ethanol, can you name a solid, renewable energy source?

JIM: Not a solid one. I mean I can think of wind and solar, but not a solid one.

GEORGE: Yeah, But they’re talking about renewable, OK, the sun and the wind are renewable, but can you think of a solid, renewable resource other than corn cobs.

JIM: No.

GEORGE: No, I can’t either. See, there you go. I don’t think we’re going to be running these power stations on corn cobs. Do you? And here’s what’s happening, just in literally the last few days both Minnesota and Wisconsin have passed requirements that the people who generate electricity within the confines of their states will be required to use a certain percentile renewable energy source. These things burn coal presently. What are they going to get? They’re passing laws…I’ll tell you what they’re doing, they’re setting up a fine system, if you don’t do this, they’re going to fine you. See. [48:47]

JIM: Yeah, but you and I know where are you going to get all the corn cobs to do all this.

GEORGE: See, you can’t therefore it’s an impossibility. So therefore all they’re doing is setting up a system of collecting fines. Well, I don’t think that’s solving the problem is it?

JIM: No, it’s not solving the problem.

GEORGE: I have pointed out on your show, and a number of other shows that there are considerable technological innovations that are not being applied. We need to get off our dead ‘you know what’ and do something about it.

JIM: But you know we’re still in my opinion, George, stuck on stupid. Look at the hearings again this week, dragging out the oil companies and bashing them as responsible for higher energy prices. You and I know that, let’s say half a century ago, the major oil companies controlled about 45-50% of the world oil markets, then came expropriation in the Middle East, and elsewhere. Today, these major oil companies only represent about 5 or 6% of the world’s oil production, and yet here they are what six months after Katrina, 8 months after Katrina, and they’re bringing them before the committee and bashing them again instead of doing something intelligent on energy.

GEORGE: Well, the government as always has to have a whipping boy. The oil business has been the whipping boy for 50 years, they’re not going to go look for another one. And the problem is the big oil companies have been buying back their own stock because they know that the easiest place to find the oil is in their own shares. So, the more shares they own the more barrels per share they have –quote – but the total number of barrels is dwindling, dwindling, dwindling. They’re trying to hide that by their stock purchase. Well, folks, hiding, choosing the wrong whipping boy, it doesn’t get the job done. And nobody seems to want to get up and do it. And this is what really upsets me. Nobody is talking any action.

JIM: You know this is something last week I interviewed Stephen Leeb and his new book The Coming Economic Collapse, when he wrote his book The Oil Factor in 2004, it was sort of a long term trend investment book, but 2 years later he was so dismayed by what he saw happening in this country he would’ve of thought by the time we hit $50 oil we would have take dramatic steps towards going towards alternatives or trying to correct an impending crisis, but instead we’ve gone to just the opposite, like once again my favorite saying, we’re still ‘stuck on stupid’.

GEORGE: I think the entire populace is suffering from my favorite thing I call NAM – North American Myopia – but also, there is no fear about these things, absolutely none, they’re like the ostrich, they’ve got their heads stuck in the sand, but I remind folks about the ostrich whose head is stuck in the sand: his derriere is sticking up exposed ready to have a boot planted in it. [52:02]

JIM: Well, George, as we close, any other parting comments, or topics on your mind.

GEORGE: Yes sir, you know, we live next door to each other, and my horse got loose the other day and went through your wife’s flower and vegetable garden, I just wanted to tell you I’m not going to send you a bill for the manure.

JIM: OK, George, we’ll probably end on that note, but as we close why don’t you give out your website, so our listeners if they wanted to find out more about you.

GEORGE: Well, it’s a real tough one it’s called www.zapatageorge.com, it is available through your website.

JIM: As always, it’s a pleasure to have you on the program, thanks for coming back and talking to us.

GEORGE: Hey, it’s a lot of fun. I enjoy it.

First the Gain, Then the Pain

JOHN: You know Jim, this may sound totally unrelated to investing, but when I was getting my private pilot’s license about 30 years ago, I had a retired California highway patrolman as my instructor, and he would always pump out more wisdom than most instructors I’ve ever heard since then, but the one thing that he always did that really struck me really significantly for the rest of my life, he said, “in any situation the rules don’t really count,” meaning what you are and your philosophy, he said, “do your best to understand what is happening and then take appropriate action.” The day he said that I looked at him and over the roar of the engine, I thought that’s a really interesting piece of advice, you know, and I’ve tried to apply that ever since then.

We’re looking at a situation where first of all you gain worldwide recognition for your Perfect Storm series that really ripped around the internet, and around some of the financial areas and it looked like for a while we were just about to hit that storm, but now because we've made some switches here people are having difficulty accepting the fact that, well, you’ve recommended some tech stocks, and blue chip stocks, and they’re going, “what are you doing, you’re changing course, you’re supposed to be pro gold and this and that.”

And I think that philosophy pretty much applies because if we look right now for what you’ve done for most of your clients here, your growth and income portfolios are up 10.3% as a rule, that’s compared to 5 for the Dow, and 4.75 for the S&P; growth portfolio up 12.5%; and precious metals portfolios up 14% versus 8.7 for the HUI, or 3 for the XAU. And if we go back to last year as a matter of fact look at growth and income portfolio last year was 10% which is the same as it is here, so it’s been consistent; and last year on the growth portfolio 18.5; and also on the precious metals portfolio a whopping 28%. So the trick is not to be of a particular philosophy that you stand but you say, “what is really going on here in the markets and what should we do?”

JIM: You know I’m going to explain what we see and what has changed. When I came to the conclusion of the Perfect Storm, I said I don’t know how this storm is going to take shape, is it going to be a hurricane or is it going to be a Nor’easter? In other words is the storm going to be deflationary, are we going to have stagflation, are we going to have inflation, or a combination of a sort of simultaneous inflation-deflation, much as we saw in the perfect storm – the actual one that took place weather wise in 91 where you had a Nor’easter, an arctic cold front, and a hurricane, all three of those three different weather fronts met together off of the Atlantic, and formed that perfect storm that we saw in the movie. And I really did not know.

But the one thing that I really begin to notice especially when we started going through the market downturn beginning in 2000, 2001, the events of 9/11 when I saw – I’ve never seen this kind of money creation in the history I’ve been in the financial business, I mean where we added over a trillion dollars of liquidity in one year. And I began to study this, and the more I began to read about it I became a voracious reader of everything about economic cycles, and also great inflations in the past – in other words, what was common to them, how did they take place, what triggered them. And through research and I guess observation and also viewing the actions of central banks I came to an epiphany when I took my summer break in the Summer of 2004, and I wrote probably in my mind one of the major pieces in terms of our thinking – I wrote The Great Inflation in October of 2004, and then last year I wrote the second part of that called The Two Bens. And if you get a further understanding of this is inflation works its way through the economy, and financial system and if you understand how that unfolds how it takes place, then what you do is position yourself. It’s no different when I’m out on a sailboat, and I’m out on the ocean, I’m looking at the current, I’m looking at the strength of the wind, I’m trying to read the wind on the water through the dark patches, and then I adjust my sails, and trim accordingly, as the weather front and the weather and sea conditions change. The same thing takes place when you’re managing money, how inflation works its way through the economy.

Today I think it’s very important to understand, there is no currency in the world today that is backed by gold. So what you have is you no longer have any limits to money creation, central banks can simply print as much money as they want. The only benchmark you have to judge that against is the rising price of gold and silver. And as money is created this is really important to understand: it has two outlets, it can go what we call the financial economy, that’s the stock market, the real estate market, and the result is you get asset bubbles. Stocks in the 80s and 90s, bonds and real estate and mortgages in this new Century. Or the other outlet for that money it can go into the real economy or things, so you see rising commodity prices.

And more importantly it takes 4 or 5 dollars of debt today to produce one dollar of GDP. So the logical question is if you’re getting 4 or $5 of debt, and you’re only getting one dollar of GDP, where’s the other 3 or $4 going to, and the answer is it’s going into foreign goods. If you borrow money – let’s say you’re a consumer – and you buy a foreign car with that money or you buy a plasma TV, or you buy a big screen, or any other item you get that’s not made here, the money is going outside the United States. So when the money goes outside the United States it gets subtracted from GDP, and one of the main problems that this country has, it’s basically gotten rid of its manufacturing or downsized its manufacturing base, so the bulk of the things we spend our money on today go to department store, Home Depot, or go to let’s say a Best Buys, or a Circuit City. I mean look at the stuff in the store, it’s not made here. Go to a Walmart and take a look at the shelves – where do the goods come from. They come from overseas. So this $4 or $5 of debt translating into one dollar of GDP, part of it is going into foreign goods, the other part of the money is going into the financial markets. What is causing stock prices to go up? Why do you have PEs as expensive as they are over the last 15 years? Why are dividend yields at such historically low levels? Why are bond yields at such historically low levels? It’s because there is excess money creation globally. [1:00:34]

JOHN: Well, that’s sort of theoretical structure. How does it actually change how the economy works when we compare it to similar cycles in the past, in essence what’s different?

JIM: Well, I guess if you take a look at when we were on a gold standard, the way you grew an economy was through increased savings. People denied themselves consumption and as a result there was excess savings. As savings were increased that savings provided the means to increase investment, whether we were building canals, railroads, or factories. It also controlled the rate of interest. In other words, if there was more money that was coming into the economy as a result of increased savings, the rate of interest was lowered. And as a result of lower interest rates it became more advantageous to let’s say finance new plant and equipment. It also created economic growth as you built factories, roads, bridges, infrastructure, plant and equipment – that was what gave you real economic growth, gave you real wages in the economy.

And also because the investments came from real savings it also controlled the inflation rate. Today those standards no longer hold true as the central banks – central banks create money out of thin air. There is no production or wealth creation that went into money that the central banks create. They just simply print the money. In the process, they create distortions in the economy, and the financial markets. For example, by printing a whole bunch of money they can bring interest rates down and that gives a false signal to entrepreneurs – “Ah, low interest rates, that means the economy’s picking up, that means we should go and start producing or spending more.”

Government, for example, with regulations, taxes, labor laws distort the production process. One of the reasons that companies go overseas is the returns on capital are much greater, there’s less regulation, less taxation. And another reason businesses really aren’t investing in plant and equipment, they question I believe the strength or the basis of this economic recovery, where dollars [go into] consumption. For example, let’s say you work for a US company here, they pay you in US wages; you take those US wages, you go to the department store, or an automobile store, you buy foreign made goods, those dollars are not plowed back in to the US economy creating more demand and capital. So, as a result you have these economic bubble that we get. You have asset bubbles – an asset bubble is just another form of inflation.

But we are creating so much money today, not only are you getting asset bubbles, but it’s spilling over into the real economy, into the cost of goods and services. Anybody I think listening to this show does not believe that they’re experiencing some of the lowest inflation rates that we’ve seen in the last 10-15 years. I don’t think people would tell you that. All you have to do is take a look at your check book this month, and compare that to what you were spending on the same goods and services a year ago, and I think you would find it’s costing you more to live today. [1:04:02]

JOHN: Yeah, but the word out there is that Alan Greenspan – may he live forever – was the greatest Fed Chairman we’ve had in whatever: he created all this prosperity, he got inflation under control, yada, yada, yada. I take it you don’t buy that.

JIM: No. I think historians in the future are not going to look very kindly at Alan Greenspan. To me, Greenspan was the John Law of the 20th Century. He created as a result of his money printing, budget deficits, trade deficits, he basically allowed the politicians to get on in spending more than they were taking in terms of revenue. Unlike the McChesney-Martin Fed, where he would basically not put up with Lyndon Johnson’s Vietnam Guns and Butter program, he fought them tooth and nail on that. And you contrast that to the Arthur Burns Fed, which basically ran the printing presses.

Greenspan was nothing but a money printer, and as a result of that we had these huge budget deficits, and the asset bubbles, and then of course what came in along with it was this debt pyramid. All Greenspan and Bernanke were able to do, and now I’m talking about Bernanke, all they’ll be able to do is create more asset bubbles. In other words, in the future it may take six or seven dollars worth of money creation to get a dollar of GDP. So, as a result you’re going to see more asset bubbles, you’re going to see higher rates of inflation, and eventually the central bank – the Fed – will bring about the collapse of the US dollar, and the US economy. The end of the next monetary cycle, the US will no longer be a super power. It is basically, John, an empire in decline. All great empires go into decline throughout history, and one of the first signs of that is the debasement of the currency. [1:05:59]

JOHN: Actually, that would seem what drives it because it affects everything from the military, to politics, to ethics, as a matter of fact. Is there anyway to jump that cycle, can you abort it or are we sort of slated to do it?

JIM: We’ve gone beyond it, there is no control of government spending, as we have pointed out here. You could raise taxes to 100%, and you would still run budget deficits. You take a look at the online and offline budget, deficits are probably closer to 700 billion, than they are the 400 billion that they will be reported this year. We’re stealing money from the Social Security trust fund, we’re taking it from the Civil Service pension fund, we’re raiding just about everything, on top of that money printing. On top of that we’re taking money from the rest of the world of course they are printing too. But we’ve gone beyond that, there’s no way that you can correct this. Ultimately what this is going to do is lead to the ultimate demise of the dollar, the US economy, and the US as a major super power. [1:07:02]

JOHN: OK, Jim, you tend to be bullish in the areas that we have talked about. Why so? In other words if we look at this, you talk about the decline of an empire, that would be a very pessimistic downish type of thing. So why the opposite viewpoint I guess?

JIM: Well, John, our theme for this year when we sent out a letter to our clients at the beginning of the year is first the gain, then the pain. And I’ll come back to that in just a minute as we end this segment. But one of the things I began to see is that central bankers if you get a copy of the Economist, every week in the back section of the magazine, they publish GDP, inflation and money growth for the world’s major economies, and I saw money supply growth expanding very rapidly globally. And one of the things really caught my eye in the US is from October of last year in the 4th quarter, M3 grew by over 200 billion dollars. In fact, since the beginning of January it’s up $140 billion, so there’s been over 14 coupon passes by the Fed, and translating this to my Great Inflation [theme], plain and simple, excess money creation equals asset bubbles. When you create that money and credit it’s going to show up somewhere, it’s going to show up in things, or it’s going to show up in the financial markets in the form of asset bubbles.

And the thing you have to understand about asset bubbles [is] we don’t count them as inflationary. If your house goes up that’s inflation, but if oil prices goes up that’s inflation whereas asset bubbles aren’t inflation. So what we’re seeing now is we’re about ready to begin the next reinflation where it’s probably going to take somewhere in the neighborhood, six or seven dollars of debt to get a dollar of GDP growth. And our theme is first the gain, and then pain. And I want to go back to something that I wrote in my October 2004 Great Inflation piece – it’s in our perspective series on our website – and it’s a quote I often refer to from the Jens O Parsson’s book called Dying of Money, and it perhaps explains best where we are today, and where we’re headed. Let me just repeat this quote because I think it has a lot of significance and bearing in terms of where we’re heading. It goes like this:

Everyone loves an early inflation. The effects at the beginning of the inflation are all good. There is steepened money expansion, rising government spending, increased government budget deficits, booming stock markets, and spectacular general prosperity,

Just look at the real estate market in the US recently

all in the midst of temporarily stable prices. Everyone benefits, and no one pays. That is the early part of the cycle. In the later inflation, on the other hand, the effects are all bad. The government may steadily increase the money inflation in order to stave off the latter effects, but the latter effects patiently wait. In the terminal inflation, there is faltering prosperity, tightness of money, falling stock markets, rising taxes, still larger government deficits, and still roaring money expansion, now accompanied by soaring prices, and the ineffectiveness of traditional remedies. Everyone pays and no one benefits. That is the full cycle of every inflation.

So hence, our theme for this year: first the gain, then the pain. [1:10:53]

JOHN: And it’s interesting no one ever seems to learn this as we go through history, it’s an irresistible lure for politicians to go down this road, they can’t seem to overcome it.

James is in Houston, Texas, and he says:

On your show of March 11th in the 2nd hour you mentioned that the Fed needs to get the commodities market under control before it can go neutral, using derivative short positions is how you said this would be accomplished. Can you please elaborate on these positions, what are they, how do central banks do this? I’m somewhat new to economics and finance, and I’m trying to get my financial house in order. Correct me if I’m wrong but this sounds like some kind of market manipulation.

JIM: Well, it is market manipulation. What they’re trying to do is alter the pricing mechanism. It’s no different from what the Fed tries to do when they raise or lower interest rates, or they put money into the banking system by buying Treasury securities from the banking system which increases the cash balance sheet of the bank, allows them to bring down the cost of money, and make loans.

What they’re trying to do if you take a look at the derivative short position and you can go to the Comptroller of the Currency site – they publish these about every six months – and they’ll show you the derivative position of banks which are top banks – JP Morgan, Chase, Bank of America, and Citigroup – look at the increase in the value of their gold derivative swaps, and compare that to the actual production of gold, the paper market dwarfs the actual physical market. At one time here recently, there was a 1.6 trillion short position in the oil market. So what they’re using is trying to sell a commodity short, they’ll come in, and sell a contract for oil or gold that they don’t own it but by selling a whole bunch of contracts they may try to bring down the price of the metal or the price of the commodity itself.

But you can’t say, “Ah, we’ve nipped inflation,” it’s no longer a problem if gold is north of $600, or you’ve got oil prices of 700. The problem is all this shorting is not going to overcome the fundamentals of the oil market. The oil markets are so tight right now that any disruption whether it’s Nigeria, conflict in the Middle East. If you want to look at copper, we only have about a month’s supply of copper in the investment warehouses so any mine that was to have a major problem or there was a major mishap, let’s say in Latin America, one of the new Latin American dictators decides to nationalize the mining industry, or the energy industry, and boom you’ve got another shortage. So, they’re not going to be able to control this.

They will lose this battle as they have been losing. All they’re hoping to do is contain it so the rise is less precipitous, as we’ve seen over for example following the events of Katrina and Rita last year, the price of energy spiked to 70 and then it came quickly down, right back down into the 50s in the month of October. So, all they’re going to be able to do is perhaps limit some of the price increases but in the end they’re going to lose that battle. [1:14:06]

Hi, my name is Cary, I’m from Sarasota, Florida. My question is regarding the national debt, and how much money that they keep raising it to. What is it – $9 trillion they just raised it too? I’m wondering what the big deal is because they make a big deal about the money in Social Security, they make a big deal about cutting all the benefits in Medicare, they make a big deal about the deficit when all the government has to do is continue to print money which is what they do all the time. They just continue to print money, why can’t they print money and pay all these things off, and then there’ll be no debt, there’ll be plenty of money in Social Security, people in Medicare and Medicaid wouldn’t have a problem, and so I’m just curious – if I’m wrong with this issue, why is it the government continually printing 50, 60, 70 billion dollars at a time for the things that they want outside of this country, but they can’t print the money for the needs inside this country. If you could answer that question I’d appreciate it, thank you.

Well, the problem is when the government creates that money to pay our bills, let’s say our real budget deficit this year is going to be $700 billion, we’re going to take about $160 billion which we’ll steal from the Social Security trust fund, who knows we’ll steal $60 billion from the Civil Service pension fund – there’s 200 billion. So you’re going to have to finance somewhere in the neighborhood 400 billion. If they printed $400 billion you’d get escalating inflation rates, and that was the problem that we had in the 70s, when the government was printing all that money, monetizing that debt, what we had was rising cost of living – yeah, you may get a Social Security check but it may only buy you a week’s worth of groceries. So inflation rates would rise.

[Where] the US has been fortunate as we’ve been able to get other countries’ money – for example Japan. A good example is the Ben Bernanke helicopter speech in November of 2002, Bernanke goes over to Japan, gives the same speech, and between the Q1 of 2003, and Q1 of 2004, Japan bought $300 billion of US Treasuries. Well, where did they get that money? They didn’t get it from trading with the US, they simply printed the money. So, we’ve been getting other people to do our dirty work, but we are going into such debt with our deficit spending and the war in Iraq, entitlements – and it’s only getting worse. Our trade deficit – that they’re going to be chopping down all the trees in the forest, not even foreign central banks can keep up with the amount of money printing that the US is going to require. So you’re right they can simply print it away, but if you want to see what the consequences are look at Argentina, or Germany in the 20s. That’s eventually where we’re heading. [1:16:57]

Other Voices: Kelley Wright, IQ Trends

JIM: Well, if you talk to anybody about long term stock market returns, you probably heard that figure 10% thrown out by many people. But what is often forgotten that 10% return incorporates a good amount of dividends. To discuss that topic, joining me on the program is Kelley Wright, he’s managing editor of Investment Quality Trends, a newsletter that focuses exclusively on dividends with an outstanding long term track record.

You know, Kelley, as you read about stock market returns, I don’t care if you’re reading Jeremy Siegel, or I’ve just read a book over the weekend about long term trends, and they give you that number, they throw out the 9, the 10 percent return, with over half of that coming from dividends. What does that portend about the future today, because in these past studies when they were talking about these returns, the dividend yield was much, much higher than where it is today?

KELLEY WRIGHT: Dividend yields historically have been significantly higher than they are today. You can make an argument that that was also during a time when yields on the risk free instruments like Treasury Bills and other government notes were higher, so that was the prevailing environment at the time. If you look at any slice and any segment of history though, you see that we have these cycles, where you’ll have high yields and they’ll cycle down to low yields, because markets and consumers and investors always adapt to the environment of the day, and that changes the way they consume items, it changes the way they invest. And so cycles have been here since the beginning, and unless something dramatic happens I think cycles are here to stay. [1:18:51]

JIM: Kelley, could this be a matter of risk premiums because certainly after the Great Depression when investors learned that the stock market could be a risky place to invest, they demanded higher stock premiums and higher dividends to compensate for that risk. Now, if you take a look at the number of books on investing, in fact many that came out towards the end of the 1990s, Dow 36,000, Dow 40,000, Dow 100,000 they portrayed the stock market as sort of a less risky place to invest. Do you think that has anything to do with it?

KELLEY: Well, I guess we should agree on what risk is, you know, the academics would say and the institutions now have accepted the theory that risk is the deviation of returns around a mean. That’s a little esoteric for us humble stock pickers over here, we determine risk as whether we’re losing our principal or not, and that’s one of the things that we try to avoid. So in order to avoid losing principal you have to have a mechanism or a means by establishing value, meaning that when you go into the market and put your hard earned capital at risk, how do you know that the stock you’re thinking about buying represents value?

And that’s why dividend yields to us are so important, because, if you take the criteria of our newsletter, it’s six pretty simple items, and none of which is by themselves you know anything extraordinary, but when taken together it’s a very, very good filter. And it filters out…you know there are about 13,000 tradable stocks, our filter filters out roughly 12,600 of them. So out of the 13,000 tradable stocks we’re looking at 400 of those. Now, those 400 stocks have certain characteristics that they share. One of the characteristics and it’s actually the straw that stirs our drink if you will is repetitive patterns of price and yield, which is to say that the stocks in our universe have repetitive patterns of when their prices are low, and their yields are high. Capital is attracted into those stocks at that time, and eventually they’ll reach a point to where the price has risen significantly to where the yield has declined, and then you can literally look at a chart and see as capital starts to flow out of the stock. So for us, we want to minimize our risks, so we look for these opportunities in those repetitive areas of low price and high yield, that’s how we establish value, that’s how we protect our principal, that’s how we manage risk if you will. [1:21:34]

JIM: And I know the old Dow theorists, especially George Schaefer used to have this sort of benchmark that when the dividend yield on the Dow got to 6% it was undervalued, and when it got down to 3%, it was overvalued, but given the low interest rates that we’ve seen over the last 15 years, perhaps you think that bench mark is changed?

KELLEY: Well, our founder Mrs. Geraldine Weiss was a very big proponent for a long term of the 6%-3% theory, but the fact of the matter is that the complexion of the Dow changed because the well-meaning editors over at Dow Jones moved out some of those old, higher yielding – what we used to call old economy stocks – and they started moving in the newer younger, hipper, more technology based stocks like Intel, and Microsoft, etc. That was in part due to the fact that in the mid to late 90s obviously technology was taking off it was becoming more important to our economy, more important to the way we invest, so they wanted the indexes to reflect those changes. But it changed the complexion of the Dow so that the yield did drop significantly. So when the market peaked beginning about 2000 the yield on the Dow actually did drop all the way down to ½ %. So, 3% is now 8200 on the Dow – right around there. If we were to go back to the old 6% number, Jim, that would have to take us down to I think about 4200 – something like that. If we were to go to 4200 on the Dow I would suggest you and I would be discussing other things than the prices of the Dow and the yield on it.

JIM: Depression or something. Who knows?

KELLEY: Something which I don’t think any of us want to see happen.

JIM: You know, given this fact that let’s say you’re not finding much in the way of dividend yields, I know in your universe rather than just looking at the markets in general in terms of dividend yield you think each stock has its own dividend yield characteristics. Why don’t you talk about that for a minute?

KELLEY: That’s correct, Jim. We look at each stock in our universe individually. Each stock has its own historical blue print if you will. It’s kind of like DNA in that there are repetitive patterns of when capital flows into the stock and when capital exits the stock. So, we look at each stock in our universe individually and that’s why you can’t just say, “well, this yield applies to all of the stocks in this category, or this yield pattern applies to all of the stocks in that category.” Each company’s individual investors treat them all individually and we have to look at them that way.

What’s happening though is we’re going through an interesting little period right now. If you were to go through the archives of our newsletter and you look at periods say from 87-92, maybe a little bit beyond that, we would go through periods where we had tremendous numbers of stocks in the undervalued category, and subscribers would call us and say, “you know, you folks might want to really go look at your overvalued numbers and reevaluate them because stocks are never, ever again going to get to those points.” Well, Jim, as you and I both know in the mid to late 90s, stocks not only did go to those overvalued levels but in many cases they exceeded them. So they declined going into the beginning of the bear in 2000, 2001, 2002 but since 2003 now we’re seeing a situation where the majority of our universe is overvalued. Now we’re starting to get phone calls from people saying, “you know what? You may want to go back and reevaluate your undervalue targets because stocks are never ever, ever going to go down there again.” But we think that while technology may change that human nature and the way that investors treat stocks is pretty much going to stay the same. [1:25:54]

JIM: And given that, I know your universe has shrunk considerably but that’s not to say that there aren’t companies out there that have attractive values. So you’re still finding things to invest in?

KELLEY: We are. I mean we’ve got roughly 20 odd stocks in our undervalued category. They’re kind of interesting in that you’ve got the Bank of America, Citigroups and AIG’s, Washington Mutual’s which represent the financials; we have Bristol-Myers, Pfizer and Abbot which are pharmaceuticals; we have McDonalds still is undervalued; Superior which makes the wheels for cars. But other than that – Sigma-Aldrich which makes the chemical building blocks for biotechs – but the greatest concentration is in the financials and in the pharmaceuticals which are classic defensive plays.

We’ve found what’s happened is that there’s a lot of stocks that used to be in our regular universe which we’ve had to shift to an area which we call the faded blue chips. And you lose your select blue chips designation generally when your S&P earnings and dividend quality rating drops below B+. So, there’s roughly 80 some odd stocks that used to be in our universe which now are in what we called the faded blues. It’s kind of a purgatory if you will, and when they capture their S&P rating we’ll move them back in into the newsletter when it’s appropriate. But we used to always have about 350 stocks in our active universe and right now we only have about 307, so we haven’t figured out entirely Jim what that means other than the quality that we look for simply isn’t there, in addition to value not being there. So, we’re going to have to wait and let Mr. Market tell us what all this means and we think we’ll find out soon. [1:27:54]

JIM: Well, Kelley, as we close why don’t you give out your website, tell our listeners about your newsletter as we close.

KELLEY: Thanks, Jim. Our website is of course www.iqtrends.com, and on the website you can download a free sample, you can go in and look at our investor education area, get an idea of our methodology, how it works. We publish twice a month, right around the 1st and the 15th both the old fashioned way and hardcopy where we print it out, put it in an envelope and mail it to you. Or you can get it in an electronic version with a pdf which we’ll email you to your email address.

JIM: Alright. As always Kelley, it’s a pleasure to have you on the program, hope to talk to you once again in the future.

KELLEY: Jim, we love to come on any time you want to have us. We’re grateful to be here.

JIM: A parting question – how’s the release of Dividends Don’t Lie coming along.

KELLEY: Dividends still don’t lie –we are going through the painful process of edit, rewrite, edit, rewrite. So, we hope to get it out in the second half.

JIM: Alright, as soon as you do, please, give us a call and we’ll have you back on the program.

KELLEY: Jim, I appreciate it, thanks so much. [1:29:14]

SOS: Stuck on Stupid

JOHN: And this week’s Stuck on Stupid Award is awarded to Congressman Chuck Schumer of New York, who totally fails to understand what’s going on in the energy markets:

I think we need to step back and apply some common sense here. There are fewer more massive players in the markets, prices have spiked, and what has gone up has not come down. Coincidence? I don’t think so. The result of course has been egregious profits for the mega oil companies. Exxon announced a record breaking 10 billion in profits in the last quarter, with 36 billion profits for all of last year, which is a record in corporate history. Examine the numbers and it yields an inexorable equation: concentration in the industry equals obscene prices, plus record profits.

[music: Eve of Destruction]

Back to the Future

Well, Jim, it is time we take people back to the future because if we go back to the 70s when this song came out, the Middle East was in full conflict. We had the Yom Kippur war, inflation was beginning to run out of control, caused as President Jimmy Carter said, many strange and mysterious things interacting in strange and mysterious ways. That’s a very good definition. Oil, we had the oil shortage crisis of the 70s; the Cold War was in full bore – the US confronting Russia and looking again the US confronting Putin’s Russia dominated by former KGB used to be agents. We had political discord between the US political parties when public television carried gavel to gavel coverage of the Watergate hearings every single night; and there were new rising powers challenging the United States. We began to see morals and civility among groups decline; the commodity markets were doing their thing; and the return of horror films. How did you get that one in there? It’s really haunting isn’t it?

JOHN: You know I was sitting down a couple of weekends ago with some friends after dinner, and over a glass of wine and one of my friends is a history buff like myself, and you’re looking at for example the violent almost uncivil confrontation between the two major political parties in the US today. There are people that literally hate this President. And the discord between the two parties, and you even have some of the older Congressman and Senators remarking on the same thing. So, that almost takes us right back to the 70s, when there was a very violent confrontation between President Nixon, the Democratic Party, the hearings on Watergate.

Take a look at the Middle East conflicts, the Yom Kippur war, following the 67 war. You’ve got the tremendous spike in oil prices following the Yom Kippur war. Oil prices have tripled, just take a look at where we’ve come from the low of 1998 where oil got to 10; today we’re looking at $60 oil. Inflation on the rise despite kind of the best efforts to sweep it under the carpet with all kinds of machinations with the way we play around with the consumer price index. One of the reasons that I think that you’re seeing most people have difficulties today is the stagnations with wages aren’t keeping up with inflation; taxes are going up. Taxes and inflation were the two key issues when I got into the business in the late 70s. Here we are full cycle again – 28 years later.

The same kind of thing – look at oil. One of the surprising things that I’ve seen over the last two years, probably the last 12 months, especially since Katrina and Rita, oil is reported constantly now on CNBC. The oil inventories on Wednesday and Thursday which they’re focusing on are the wrong things –typically of the media. Instead of focusing on oil discoveries, oil production, long life reserves, where’s the oil coming from, questioning the published numbers that come out with the BP Statistical Review in terms of OPEC reserves, I mean they’re really not getting to the issue.

And then this fiasco that we went through this week of having the oil companies which only produce about 5 or 6% of the world’s oil production today and parading them and saying, “you know the price of oil went up, and it’s not coming down and it’s you guys.” Chuck Schumer needs to become a little bit more internationally aware of what drives oil prices. We’re no longer the world’s major producer as we once were. And I hate to tell Chucky Schumer that when you import 60% and now 70% – when you consider refined energy products – you’re no longer in control of your economic destiny. It’s not Exxon, Chuck, it’s what’s going on in OPEC; it’s what’s going on in Venezuela; it’s what’s going on in Nigeria; it’s what’s going on in Indonesia; it’s what’s going on in the Caspian states – that’s where all the oil and gas comes from. [1:35:25]

JOHN: There was some discussion this morning in line with what you’re saying Jim, and actually during the hearings this week, the issue was when we had Katrina, and the interruption of power going on in the Gulf, when we had that, there was price increases in California, and they said if we would break up all of these oil companies – the big ones – into smaller regional things, say for example there was a disaster in the Northeast, it wouldn’t affect the rest of the country. And I sat there shaking my head during this whole thing.

JIM: What a bunch of idiots. It just goes to show you how out of touch they are. When you have 50 different varieties of environmental gasolines – you cannot ship California gasoline to other states, they’re unacceptable. Nor would California accept gasoline other than its blend of environmental gasoline. And you can break up the oil companies all you want, but if you’re not going to let an oil company build a refinery, if you’re not going to let them explore for oil, natural gas, oil shale, whatever it is in energy, you’re not going to get any more energy.

I remember the Washington Congress Lady who was beating up on the oil companies for not building refineries: “you know, you need to build more refineries, so we don’t have these bottlenecks,” and yet she voted down for one building a refinery in Puget Sound. I mean this is just absolutely absurd. It’s Ted Kennedy trying to stop windfarms. I don’t care what it is in the United States, you can’t build nuclear power plants, even though they’re building t hem in Europe, they’re building them in France, they’re building them in Germany, they’re building them in Japan, they’re building them in China; they’re going to build them in India; they’re going to build them in Latin America; they want to build them in the Middle East – but we can’t build them here.

Why is it that you can’t build a refinery here? And the best example I can have is we’re building natural gas power plants here, but we’re not going to allow companies to explore for natural gas, we’re not going to build a natural gas pipeline, nor are we going to allow an LNG terminal in the State of California. So, you have the local utility going to Mexico to build an LNG terminal instead of building one here in the US, creating US jobs. We’re stuck on stupid! [1:37:46]

JOHN: I was going to jump in and say, “and you passionately believe that.”

JIM: I just throw up my hands and I’m thinking, my God, the United States is becoming a banana republic when it comes to energy – I mean bananas – ‘build absolutely nothing any time near anybody’ is the new energy policy of the United States. And then like this idiot Chuck Schumer like, “Wow, the prices are up, it must be the oil companies.”

Oil Executive: We would not have a new refinery online today for 5 or 6 years, if we started in the US. Southern California, the East coast two years to get a permit at best. You’ve heard of nimby, have you ever heard of banana – build absolutely nothing near anywhere near anybody.

JOHN: If there’s one thing that came out of the hearings again this week is that these people do not understand what is going on, they’re only looking at a very microcosmic view, they have not grappled with the fact that while the United States used to be the world’s major energy power producer, it is no longer – we import 70% of our energy. And not all of it from nice people, we have unstable parts of the world, and we’ve actually allowed it to attrition down to that point. That’s the interesting part, Jim. While we were pursuing other agendas we allowed it to fall apart.

JIM: And the thing that they don’t understand are their own actions. If you block energy companies from finding oil and natural gas, and you don’t substitute that for other alternatives, what do you think you’re left on doing? You are dependent on the rest of the world.

And I go back to this concept, John, which is I’m sure in the minds of Congressmen, that they’re thinking back about 50 years when the major oil companies controlled about 45% to 50% of the world’s oil production versus today. If you take a look at the top 15 oil producers, Exxon is number 12, the others ones NOCs, they’re all National oil companies of these states very many of them that don’t like the United States. And you can’t sit there and say we’re not going to let you drill for oil, we’re not going to let you drill for natural gas, you’re sure not going to build a refinery anywhere near where anybody lives; you’re not going to build a nuclear power plant, in fact we’re going to shut them down; you’re not going to be able to put in a windfarm off Nantucket, and Hyannis port, because they’ll get Ted Kennedy ticked off; you’re not going to be able to put in large solar arrays in Northern California, or Southern California because you know you might disturb the plant life, or the insect life; you’re not going to be able to pipelines; you’re not going to be able to put in or expand the energy grid; we’re not going to let anybody put in an LNG terminal, other than perhaps New Orleans where we have plenty of natural gas. You know, what the heck do you expect. When we don’t produce enough refined gasoline products we’ve got to import gasoline from Hugo Chavez; and if you listen to Hugo every month, he doesn’t particularly like the United States, and threatens periodically to cut us off with oil and finished products.

And it blows my mind but even more than that, unlike the 70s, John, when we finally woke up after the oil embargo when the price of oil went up 300% - you remember the gas lines – oil companies started exploring for oil and we started opening up lands for exploration, we started requiring better gas mileage for raising the CAFé standards, we lowered the speed limit; we started insulating buildings. We started reacting rationally. Instead, you’ve got people like Chucky Schumer that wants to sit there – you know it would be interesting if I was an oil company executive and they called me before Congress, I would look at every place that we try to go find energy, every place that we wanted to put in a refinery, or if I was a nuclear power plant, and I would just say, “alright, Congressman, let me just review for you, your voting record on energy: you voted against refineries, you voted against exploration, you voted against nuclear power plants, you voted against this, you voted against that, you’ve voted for this – and you wonder why oil prices are high. And do you think there’s any correlation between importing 70% of your energy needs from people like our friend Hugo Chavez, or the rebels in Nigeria, or perhaps the good folks in the Middle East that perhaps really love us that there might be a problem. These are the guys we have to get our energy from and you don’t think they control the price? You think Exxon goes to Saudi Arabia and says: ‘Well, Chuck Schumer says the price is too high, you’ve got to lower the price to us so we can sell it to American voters at a cheaper price.’ ”

That’s not the way the markets work. [1:43:04]

JOHN: Jim, we really need to pull this up into a point of where things are going, and sort of a summary.

JIM: All we need to do is take a look at the Middle East: conflict is on the rise; war fever is on the rise; terrorism – you know whether you’re looking at blowing up train stations in Spain or in London or in Egypt last year. The price of oil has tripled, commodity markets are back on the rise, money supply is rising, we’ve got the return of Marxism to Latin America, Putin’s KGB has taken over Russia. Just take a look at the political discord, and we’ve got new economic powers challenging the United States. We’re no longer the big guy on the block any more. [1:43:48]

JOHN: You know, it is hauntingly reminiscent of the 70s. I think you and I were just out of college – actually I was still in college at the time – when we saw all of this come down. And it seems to be that things tend to go in cycles like we opened up with the opening theme here. The most interesting thing Jim is going to be how it all spools out when it does, because you and I have a handle on the facts but we can’t always predict how they will interact as they go.

JIM: Yes, I’m trying to think of the historian, maybe it was Mark Twain, who said history never repeats itself, but it rhymes. And here we are – Middle East conflicts, rising oil prices, rising inflation, rising commodity markets, political tensions globally. I can’t think of a time, John, in probably the last 20 years, where there’s been so much geopolitical tension, whether you’re looking at what’s going on in the Caspian states, what’s going on in the Middle East, what’s now going on in Africa, parts of Africa, Latin America, with Chavez and the new Marxist revolution going sweeping through Latin America; political discord between both major political powers. And once again, the United States is no longer the big guy on the block, we are now being challenged by growing economic powers especially China and India. [1:45:11]

JOHN: And all of that said, we have rounded out our time for the week where are we going next week on the program.

JIM: Clueless.

JOHN: I figured as much.

JIM: Well, John, you’re right we have come to the end of our time. Coming up in the weeks ahead in the program – next week John Howe will be joining us John Howe, The End of Fossil Energy; Gwynne Dyer, Future: Tense: The Coming World Order; Russell Napier, in April Anatomy of the Bear; and Dan Reingold, will join us also in April Confessions of a Wall Street Analyst; and that will be followed up with an interview with Matt Simmons.

Also we’re probably – some time at the end of April – we’re going to do an energy roundtable, the Society for Peak Oil is meeting in New York City, in fact I was honored to be asked to come and speak but unfortunately I’m not going to be able to make it as a result of a previous commitment, but they are going to be putting together a roundtable of speakers. So we’re going to have a roundtable coming to us from the Society for Peak Oil, and that should be rather interesting. Gosh, the speakers reads like a list of people we’ve interviewed, just about all of the speakers have been interviewed here on FSN over the last two or three years. So a lot of great stuff coming up in the weeks ahead.

In the meantime, as John has said, we have run out of time, but we’d like to thank you for joining us here on the Financial Sense Newshour, until you and I talk again we hope you have a pleasant weekend.

Back To Top
Contact Us | Copyright | Terms of Use | Privacy Policy

© 1997-2011 Financial Sense® All Rights Reserved

The opinions of the contributors to Financial Sense® do not necessarily reflect those of Financial Sense, its staff, or its parent company.

Contact Us | Copyright | Terms of Use | Privacy Policy | Site Map | Financial Sense Site

© 1997-2011 Financial Sense® All Rights Reserved.

The opinions of the contributors to Financial Sense® do not necessarily reflect those of Financial Sense, its staff, or its parent company.