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May 27, 2006

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Trouble Ahead in the Oil Patch

JOHN: Well, somebody did it at a gas station in the US this week, they had the various prices of gas, remember the old one where you have regular is ‘arm’, ‘leg’ and they came up with ‘first born’ as supreme.

JIM: When do we get to the grandchildren?

JOHN: Yup. That’s basically it. Well, anyway, if you ask anybody today why oil and gasoline prices are high, obviously the response will come back �what’s the most popular one, behind door number one � “it’s the greedy oil companies,” then number two, peak oil. Do you really think peak oil is one of those?

JIM: Yes, sure, the environmentalists are tying in global warming to peak oil. I mean peak oil is something you hear more often today that’s mentioned as a result of, I believe, Matt Simmons’ book which really called into question the largest supply of oil on the planet, which is Saudi Arabia.

JOHN: OK, I just hadn’t noticed that in terms of the public consciousness. Global warming is a big issue for some reason. And then number 4 is a conspiracy led by the Bush family and Halliburton and Dick Cheney and so forth. So those are the four charges that are laid today.

JIM: The thing if you analyze this debate, and this debate is going on, and I image this debate is going to get much worse as we head into the Summer with the hurricane season, but what you’re not going to get in terms of a response is the real reason plain and simple is supply and demand.

Like it or not demand is coming from two sources, and this is something that we haven’t had in a long time, number one it’s coming from economic demand. Everybody’s aware of Chinese growth, and Asia and India. But the second thing that’s come into this market and you’ve got the pundits like O’Reilly that are complaining about this is investment demand. You have hedge funds now, you have college endowment funds, you have pension plans, you have institutions that are coming into the commodities arena. And so it’s like anything else when you have more demand for something than there is supply the price is going to go up. [2:23]

JOHN: Yeah, but remember you’ve mentioned this in the past, and Jim Rogers was on the show talking about this, but now commodities have finally been recognized as a legitimate investment class.

JIM: There was a very important study done by Yale, by Professors Gorton and Rouwenhorst and they wrote an article called Facts and Fantasies About Commodity Futures, and they talked about it as an asset class. Their conclusion was that commodities have been a better hedge against inflation than stocks and bonds over the last 45 years. So, one thing this Yale study � and there have been others done at Harvard and other universities � what it has done is give legitimacy to commodities as an asset class. So if you’re an asset-allocator now, it’s no longer stocks, bonds and cash. It’s stocks, bonds, cash, commodities and currencies.

And with the rise of hedge funds that are more flexible in terms of what they can do from an investment perspective, you’ve got money coming into the commodity market. And if they want to buy oil futures, and they’re going to drive the price up because there is greater demand for those contracts the price is going up. That is the nature of a free traded market.

So, what you have now John, is you have number one, commodities have gained recognition as a legitimate investment class; two, you have other players. In the past you might’ve had an oil company, for example, that goes in to the market and they want to hedge their future oil production, or you might have had a utility that is burning natural gas, they want to hedge their natural gas cost, or you might have had an airline that says you know what we need to lock in our oil cost. So you had sort of industrial type demand coming into this market from users of energy.

Now what you have is investment demand coming in from funds, institutions, pension funds � I mentioned a couple of weeks ago we’ve seen everything from Harvard to Yale’s endowment investing in commodities more recently the California pension system. And with a lot of this money moving into the commodity arena a lot of it isn’t specific. A lot of this money is moving into indexed commodity funds, and as a result it may be raising all commodities within that index because as everybody knows, for example, if you buy an S&P index fund, that index fund owns shares of all 500 stocks that make up the S&P 500. Well, it’s the same thing in a commodity index fund, there may be a lot of more supply than there is demand, but it’s rising as well as a result of the indexation of the commodity markets. And then you might have let’s say, institutional investors coming in more on a specific basis. They might come in and say, “boy, gold is undervalued or natural gas is undervalued,” and they’re buying specific commodities. The problem with this supply and demand structure is the pundits and politicians don’t understand this. I was watching � and I don’t know if we have that film clip, but O’Reilly when we had that run-up over 70 he was demonizing these fund traders and I quote:

These Vegas type people who sit in front of their computers and bid on futures contracts. supply and demand? My carburetor. This has nothing to do with the free market.

Obviously, O’Reilly doesn’t understand how supply and demand in free markets works. The reality check here is hedge funds don’t have the heft to control a $2 trillion worldwide oil market. An example I would give to back that up is the average commodity hedge fund is barely up 5% this year when you have most commodities, especially energy, up double digits.

And the other thing I think the pundits and the politicians forget is traders add a dimension of liquidity in the market. In other words, when you have more participants buying and selling in the market the market becomes more liquid. So they tend to stabilize prices versus let’s say some unknown commodity or a commodity that hardly trades at all, where all of a sudden you get big demand comes in and it spikes. So, they add liquidity to the market.

And the other thing that I think people like O’Reilly forget is for every long in the futures market there is a short on the other side of the trade. [7:01]

JOHN: Alright, so if we look at the real causes of higher prices, how would we answer that then?

JIM: Well, you know, the oil market is quite complex, there are a number of issues that are coming into play right now. Number one, let’s begin with the oil companies, because after a two decade long bear market oil companies were simply reluctant to invest earnings in additional exploration, expanding their refinery facilities, upstream, downstream, the whole segment of the energy business � they were reluctant. Remember, John, the energy crisis in California, natural gas where we had gas prices spike up we had oil prices spike up, but what happened? The following year we had a recession, the events of 9/11, which cut down on travel, and with the economy coming out of a recession there was less demand.

And so, all of that is fresh in the mind of a lot of oil executives. So, they haven’t made the big investments and number 2 as we covered last week with the editor of BusinessWeek, he talked about 30 years ago 85% of where the world’s oil reserves lie were available for development by the big oil companies. Today, they only have access to about 15% of where the world’s remaining oil is.

The second thing that we have had happen, and we talked about this in the second hour with Yiannis is demand rose in the developing economies especially China, India and Asia. The third thing that we’ve seen, and especially after the events of 9/11, remarkably, is the US consumer has bought less efficient automobiles. The rise of the SUV.

You remember after the events of 9/11 when the big 3 automobile companies were making zero percent interest rate loans � the dealer incentives and everybody went out and bought a new car and a lot of people bought SUVs. When you go into a parking lot at a grocery store in southern California, they have these parking spaces designed for a midsize car and what you’re seeing is Chevy Tahoes, Lincoln Navigators, Cadillac Escalades and all these big cars. That’s what happened. We traded up to less fuel efficient cars.

The other factor that’s thrown in here is geopolitical risk: the pipelines they blow up in Iraq; Venezuela threatening to cut off oil; guerrillas in Nigeria’s shutting down Shell’s oil platform and now they’re trying to work on shutting down Exxon-Mobil. And so another significant factor over let’s say the last 15 years versus the last recession that we got in 1991 is the disappearance of surplus capacity: China alone is consuming 6 million barrels a day. They’re importing the majority of that. That didn’t exist in 1991. So what’s happened this disappearance, in 1991 we had excess capacity between 6 and 8 million barrels a day, so if there was a supply disruption �a hurricane or geopolitical risk � there was enough excess capacity that prices might spike up but they could bring it down.

The other thing is which we will be talking about in Other Voices in this segment is the decadal oscillator. We’re now going through a 30 year warming cycle in climate. That is heating up ocean temperatures which means you get more severe storms, and I’ll get to the implications for the US of that in just a minute.

And then finally probably the second factor is the real players in the world today are the national oil companies and that has changed the whole dynamic of the oil markets. And in fact we hope to get the author of a new book called Oil Titans, and it’s about how the oil market has been transformed. The major players in the oil market today aren’t Exxon-Mobil, it’s Saudi Aramco, it’s the Kuwait national oil company, it’s the Iranian national oil company, it’s the Venezuelan national oil company, it’s Abu Dhabi � these are the main oil players today. The oil markets no longer lie within the control of the majors. They are actually becoming less and less significant and I hope not less significant what we might do politically. [11:28]

JOHN: Well, obviously right now if you watch the politicians on C-Span, or if you watch the media there seems to be an across the board non-comprehension of what is going on internationally, and just exactly how it is that free markets operate � that seems to come out every day.

JIM: Yes, from O’Reilly down to the major anchors in the networks, to the people that write for the major newspapers to politicians, we need to take them on a crash course or a refresher course on free markets. This is especially true because today the globe is connected, the markets are all connected which amplifies price swings that we haven’t seen before. And John, every time they do the politicians throw more gasoline on to the fire by their rhetoric. And that rhetoric is used to assuage the voters and basically they play the blame game � shift blame and attention away from themselves by ignoring the energy situation in this country for the last two decades.

Contrast what we did in the United States after the last oil shocks during the 70s with what you saw in Europe: nuclear power rise to prominence; you saw the development of a very efficient rail system in Europe; you saw, for example, more gas efficient cars � almost 70% of the cars in Europe are diesel, they’re smaller. And because a lot of the cities in Europe are older cities whether you’re in London or Paris the roads aren’t as wide as the roads are here and so you see a lot smaller, more fuel efficient cars in Europe. So, they went through those oil price shocks, and they developed domestic energy sources, they developed rail transport systems for transportation of goods and people; they developed efficiency standards on cars. If you look at Brazil, they went after ethanol, they took a lot of steps.

We in the United States got off easy because not only were we still a large producer �and we still produce 5 million barrels a day today � but on top of that what we did is what we couldn’t produce as one of the biggest economies in the world we simply imported it. It was an easy answer: “hey, if we don’t make it here we’ll get it from somebody else. We’ll buy it from somebody else.” So, what has happened is politicians don’t want to admit they’ve done nothing. What have they done to resolve the energy issue? The simple answer is nothing. So what they’re doing is playing the blame game and at the same time a lot of these people, I mean O’Reilly’s comments about supply traders coming in and has nothing to do with the free markets shows absolute economic ignorance. [14:27]

JOHN: So, what are the realities out there right now if we look in the real world as far as oil supply and demand goes?

JIM: Talking with a lot of the experts in the field based on supply and demand conditions the price of oil would probably be somewhere in the area of about $50 a barrel, maybe $55. Then on top of that you could probably add a geopolitical risk of about $10 a barrel, because one of the things that you’re starting to see globally beginning in the United States is countries are building up their strategic petroleum reserves. And the reason that they’re doing that is they don’t want to be caught short because they know that the global spare capacity has shrunk and it keeps shrinking as world oil demand increases.

So, in the case of a crisis like the United States last year with the hurricanes that virtually knocked out a third of our energy production we had to depend on the rest of the world, and our spare capacity and reserves to get us through that crisis. And so other governments are doing the same thing. So you have accumulation that’s coming in, greater demand as a result of governments increasing their petroleum reserves.

The other thing is the balance is due to investment demand. If Harvard wants to start buying oil futures, if the California pension system wants to start buying oil futures � I hate to tell you � but the price of that commodity is going to be going up. It’s no different than when the public finally caught on to the bull market in stocks in 1995. The bulk of the money that came into mutual funds came in from 1995 to the year 2000, and what happened as the public came in it drove demand for stocks up, and we got the silliness that we saw in the last final phase of the bull market.

So the realities are supply and demand is about 50, but no government anywhere in the world can be content and say, “look, we can live with a 30 day supply of oil.” What would h happen tragically as happened to the US last year, your whole economy could come to a grinding halt had we not had those strategic petroleum reserves. [16:39]

JOHN: If you really look at the whole thing listen to the O’Reilly’s of the world [world] basically[basically] they want the oil companies to sell their production below market. That’s really what it comes to isn’t it?

JIM: Yes, they’re basically saying, “look, we realize that you’re importing oil from Saudi Arabia or Venezuela at $75 a barrel, but you know the stuff that you produce yourself you don’t have to sell it at market prices, sell it below market prices.”

But that would never work, John, number one because if they did somebody somewhere would arbitrage it and that’s something once again called economics that these guys simply don’t understand. And by the way why should somebody sell something below market. What if there was a sudden demand for IPods, everybody wanted an IPod should we go to Apple and say sell the IPod to us because we all want IPods because we can’t afford to sell at less than the market, rather than where the price is today.

Now the pundits would come in and say, “yeah, but an IPod isn’t a necessity.” Well, if we take that logic to the oil companies why not apply it to the farmers, and say look: “I don’t like paying higher prices for grain. I don’t like paying higher prices for beef, why don’t you sell me beef prices below market.” It just doesn’t work, you would actually get shortages which at some point is where we’re going to go because I just have a fear with all the economic ignorance of how markets work that politicians will do the wrong thing at the wrong time. [18:10]

JOHN: Yeah, and to be honest with you, Jim, whenever you open that kind of a door in politics then all of a sudden you get this whole queue of people lined up wanting their products to be covered under the same kinds of regulations.

JIM: Yeah, it just doesn’t work when you interfere with the supply and demand. You know how we’re going to get this supply and demand structure to work is market prices rising. GM, for example, just did a study because I was wondering why in the heck are these guys coming out with a new fleet of SUVs, and according to a GM study, consumers will not change their buying habits on automobiles unless gasoline goes over $4 and remains there for over a year. And they’re betting that it won’t. So that’s why they’re still producing and selling and Americans are still continuing to buy SUVs. [18:58]

JOHN: But that still makes our problem worse because we’re consuming oil at a faster rate.

JIM: Absolutely, that gets back to the supply and demand factor which will drive the prices up even further as we have to import more and as greater demand is put on the supply of oil. But once again the answer to why all of this is happening is simply supply and demand. And nobody here �from the politicians to the pundits � want to recognize that. [19:25]

JOHN: Alright, let’s drag this down to the bottom-line as we always do, and we’re talking about supply and demand here right now.

JIM: The answer to the oil price run-up is the answer I believe nobody really wants to accept and that is supply and demand. And because demand is so inelastic consumers are not going to change their consumption habits when prices go up, and so far they really haven’t. As I just mentioned the GM study when they were looking at should they continue to make SUVs, and their marketing research told them that as long as gasoline doesn’t go over $4 and remain over $4 for over a year they can still sell SUVs which they continue to do.

The other factor, getting on the supply side is new supply takes a very long time to come online. It took us 10 years from discovery in 1968 to bring the North Slope and the North Sea online. If this new discovery off the Gulf of Mexico by Pemex oil turns out to be a major discovery don’t look for that oil to come on line for another 10 years. You’ll recall when we had Matt Simmons on the show he said: “number one they don’t know what that is yet, and if they did it would be 10 years before we see any output from it.”

And then the other thing �I guess the good news � is that the solution to higher oil prices is really built right into the market itself. The longer higher prices stay up that is what’s going to cause people’s habits to change, not some government fiat or some kind of intervention by government. If oil goes over $4 it’s just like GMs marketing survey told them people will start changing their habits. Perhaps they’ll exchange the SUV when their lease runs out into a more fuel efficient car; perhaps we’ll start waiving EPA regulations and finally allow diesel to come in which is more fuel efficient.

But there is something that’s going to have to be done and the market mechanism itself is the best way to solve that problem not some kind of government intervention or subsidizing gasoline consumption as many in Congress are wanting to do in this election year. You know we have stuck on stupid but there’s a different SOS for Congress: during an election year it’s the Season of Stupidity. So, they’re talking about, for example, a $100 oil rebate. Whoopee, what’s that going to do? Or, let’s slap a windfall profits tax, what’s that going to do other than create shortage? [21:53]

JOHN: Well, alright, Jim I’m sitting down, given that we haven’t done anything, what’s the bad news? I can take it.

JIM: The bad news, John, it’s going to get worse. And the reason for that is if you take a look at recent US oil production it peaked in 1970. The only growth in production in the United States has come in the Gulf of Mexico. It’s been our only source over the last 3 decades. In other words, as the Alaskan oil began to decline in the 90s, as the lower 48 states began to decline in the 70s, 80s, and well into the 90s, the only increase in production that we were seeing was coming from the Gulf of Mexico.

And unfortunately, as it now stands is the US Dept. of the Interior’s Minerals Management Service reported that as we begin official hurricane season this year 17% of the Gulf of Mexico’s oil production remains shut-in just from last year. And then also, the Gulf of Mexico and the surrounding region now accounts for fully almost 40% of US refinery capacity. So what happens if you have another storm which would work its way through the Gulf and hit New Orleans or Texas where a lot of our refineries are located you’ve got a problem.

And the other thing that we really don’t understand here is if we take a look at the price of oil today � 60% of the price of a gallon of gasoline comes from crude oil prices, the refiners make another 15% on top of that, and then taxes and marketing take another 25%. You’re not going to see government reduce taxes, they’re talking about increasing taxes. Another factor is this cyclonic activity is going to keep production down anywhere from 17 to 20%.

So, John, all these projections the US government were talking about that by 2010 oil production in the Gulf of Mexico would increase by another million barrels a day is not going to happen. Just from the last hurricane season alone you’ve had a huge setback for new fields and construction delays for these new fields that they’re trying to bring online. And secondarily, the existing production has been shut down, as I mentioned, 17% is still offline.

The bottom line, where we’re heading is today the US imports about 65 to 70% of its energy needs from oil and gas in the raw form to refined products such as gasoline. That is going to increase to 72 to 78% by the end of this decade. And even more important is it’s going to leave the United States reliant on Canada, Mexico, Venezuela, Nigeria, and Saudi Arabia as our main source of imported oil.

We already have a problem with Mexico: Mexico’s oil has peaked. Pemex is projecting that in 2007 their oil production will be down another 14% - that’s less exports to the United States. Venezuela’s oil production is down 46% and they already have said they’re going to diversify away from US markets �that any increases in future production they’re already signing contracts with other countries now, China, India, Latin America. Nigeria: rebels are already taking production offline with Shell they’re going after Exxon-Mobil next. Kuwait, another major supplier their Burgan field peaked last year and Kuwaiti oil production will be down this year.

So that leaves basically two countries left: Saudi Arabia and Canada, and primarily Canada as our only hope. And Canada’s oil production even with the oil sands is not big enough to handle our production decline and demand growth. The bottom line is prices are going much, much higher. Hold on to your oil stocks, hold on to your alternative energy they’re only going to become more valuable as prices head North. [26:17]

JOHN: Other than that, everything’s OK?

JIM: Yeah, other than that.

JOHN: Can I still go on vacation this Summer?

JIM: Will the sun come out tomorrow? Yes.

JOHN: I take my random sample, we have a huge RV park here in town because we’re at a crossroad of two major highways and I keep looking and it keeps filling up with these big motor homes. No change yet in behavior anyway.

JIM: You know, I like to go to the boat shows, they’re still selling the big power yachts. I look at these things and say oh my goodness. We were out sailing a little over a week ago and we were just going in through the harbor and they had this gas stop, and I pulled in to fill my sail boat it only takes about 10 gallons and it’ll probably last me another 12 months. And we were sitting there just chitchatting and the guy said, “can you move?” and he wanted to get me away from the dock because standing from the dock was this big 90’ yacht there’s 20,000 gallons of fuel that was coming in. So I imagine oh my goodness what would it cost to fill something like that. But they’re still selling them.

Emails and Q-Calls

JOHN: Alright Jim, let’s see what people said on the Q-Line sometime this week.

This is Mike from New York City. I’m just kind of shocked and amazed at your complacency here. All 3 averages have crossed their 50-day. The NASDAQ which led the advance up also smashed through its 200-day, and all I hear from you guys is happy talk about the big cap stocks, about how they haven’t moved in hi tech. Quite frankly it’s surreal I thought maybe that I’ve got the wrong show or something. There was nary a comment of at least shuffling some of your stuff to cash, and in case you didn’t realize the Lowry’s selling pressure went up Friday. So I’m just wondering I feel you’re following now the 8,000 other hedge funds that are out there that are all long. Anyway, I still love the show and I get great ideas from you guys, so keep up the good work I just hope that this works out for you. I think a more prudent course is probably wiser and that’s what you should be counseling your people about, but what do I know. Take care.

Well, Mike, let me address that. One of the things that I have supreme confidence in is the global money supply which is inflating at levels which quite honestly I haven’t seen in unison in a long, long time. And I’m talking about high single digits, high double digits. And one of the outlets for that money it’s going to go somewhere it’s going to go into commodities it may go into gold.

One thing it’s not going into is cash I can tell you that. We hold cash positions in our account, we’re hedged with gold we’re hedged with silver, we’re hedged with base metals, we’re hedged with energy, but one of the things that we began a process about 2 or 3 months ago was to start moving into defensive consumer staples. And quite honestly it’s worked out. We’ve moved into soft drinks, we’ve moved into beverages, we’ve moved into consumer staples, and many of these stocks are up 10, 15, 20% right now

And like I mentioned as money cannot go into cash, you can’t run a mutual fund 100% in cash or a hedge fund 100% in cash, and if you create global liquidity conditions that money is going to go somewhere. That’s why I think for example as you saw the S&P touch its 200 DMA it bounced right off it and we had a miracle that occurred in the futures pit. We saw the same thing with the Dow, we saw the same thing with the other averages.

So, we’re hedged, we’re in cash but this happy talk isn’t happy talk it was just pointing out when you have an inflation the opportunities are going to be with companies that have international sales. With a dollar decline, companies that have good business franchise that have increased that business.

I won’t mention the company but one of the largest alternative energy producers in the world is a super giant and its stock is doing well and holding up, and it’s going to be probably going to be the most significant factor in alternative energy in the next decade. So, it’s just a perspective on inflation. If it broke through 50 day or 200 day moving averages, I get Lowry’s I’ve seen that, we’ve got technicians that are monitoring this but we’re going on an assumption that we think something’s going to happen, and we’ll just wait to see if it does.

If it doesn’t we’ll be the first to take evasive action. Read the Paul McCulley article on PIMCO where he talked about intervention in the market by the Bank of China, the Bank of Japan, and the Fed putting in a put in the market. And some of this volatility that you’re seeing right now is simply greater recognition that risk premiums are being restored to the market. It’s going to be a choppy ride but I still believe that the Dow will set a record this year. [32:00]

JOHN: Dan’s in Springfield, Missouri. He says:

Thank you for the wonderful public service you provide. Other than fractional reserve banking how are dollars created out of thin air. Does the Federal government really have a bottomless account that the Fed zaps new money to for their spending pleasure.

JIM: Well, you know, fractional reserve banking is one area in which money is expanded. But today, with the securitization of markets just about every kind of debt can be securitized, so the securities market itself is another kind of credit expansion today: money markets; bond funds; collateralized mortgage obligations. I mean we wouldn’t even have talked about these kinds of things 20 years ago, today, they’re another wellspring of credit creation. So it’s not just through the banking system. You can have financial intermediaries that issue credit and then turn around and package that credit whether it’s car loans, credit card loans or mortgages into a security and it’s sold to the investment public.

Hi Jim, this is Jim from Philadelphia. I want to first thank you guys for the great service that you provide through your website and your show. I also want to give you kudos for calling this gold and commodity correction as an orchestrated effort to hammer everything that the Fed can prior to an interest rate pause in June. Now, you’ve said you don’t agree with the doomsayers about a pending dollar crisis because it’s not in anyone’s best interests for this to happen at this point in time. You see the Fed pausing in June and inflating the money supply and possibly raising rates in future meetings to come, which in my opinion is just kind of delaying the inevitable. My question is how much time do you really think that we have before the wheels fall off this trolley. With everything that’s going on from Iran and to now the Fannie Mae situation to derivatives, housing bubbles, etc., I’m thinking it’s sooner more than later and the question is why are we still screwing around with the stock market or any market for that matter. Thank you very much.

Well, a couple of things as I mentioned earlier I don’t think it’s in the best interests for the US dollar or the us economy to decline because if we go down, it’s like the wake of a major ocean liner sinking, we pull everything close to it down with us. What they’re trying to set up and �there’s a great white paper issued by the Bank of International Settlements � what they’re proposing, they’re already getting ready. They know that the dollar’s collapse is inevitable but what they’re going to try to do is set up a super national structure like an international central bank which is what they want to do as we go and move forward towards global governance. That’s where we’re going, they don’t have those institutions in place so the central banks will act collectively to keep a dollar free fall from happening. They’ll intervene to buy US Treasuries, who knows what they’re going to be doing but they’ll throw everything and the kitchen sink to prevent a great drop off a cliff, because they don’t have everything in place yet to replace the dollar.

What I think they’re doing is they know they need to bring the dollar down, they’re going to try to do it in stages and in steps. And I just think they haven’t announced it publicly like they did formally in 1985 with the Paris agreement, because I think if they do that today given the price today where gold is in the 630 to 640 range and also the price of oil you would see gold just go through the roof; you would see hedge fund players come in, readjust portfolios. So I think that they’re doing it quietly.

And the only other thing I would add to that is our theme that we told our clients this year is first the gain and then the pain. The gain stems from like anything else and we’ll probably read this in the next segment is the Jens O. Parsson comment is when you first begin to inflate it’s the good stuff that comes in, it’s the asset inflation. The bad stuff is later on when it doesn’t matter how much you inflate that is when the pain is inflicted, and that’s when you get into hyperinflation. So, first the gain and then the pain.

JOHN: Don’t forget you’re listening to the Financial Sense Newshour at www.financialsense.com, and these programs are posted every Saturday morning by 0700 Greenwich time, otherwise known as Universal Coordinated Time or Zulu time if you’re in the military. 0700 Zulu time, Saturday morning for all of our worldwide listeners. The Q-Line � the call-in line � is 1-800-794-6480 that’s toll-free here in the United States and Canada. It does work for the entire world but it is not toll-free from any place except from the US and Canada. [37:00]

SOS! Stuck On Stupid Award

JOHN: And today’s stuck on stupid award is awarded to the United States Senate which continues to fiddle while the remaining fuel burns and just can’t seem to get an energy policy passed:

Senator: The gas is coming from Louisiana, and if you want more of it, number one help us save our state from washing away in the Gulf. Number two, help us to share some of these revenues that will go right back into these communities to support the industry and the people and the schools and the churches and the towns that make this gas possible. And if not, then go find your gas somewhere else.
Senator: Mr. President, for over 25 years we’ve have a majority in the Senate which approves of exploration and development of the oil and gas resources of the Arctic plain. It’s only a filibuster that’s stopped us.

Oh well, we’ll keep checking in. [you’re stuck on stupid]

I wonder if she really wants them to go and get their gas and oil somewhere else. That really wouldn’t be a very good idea economically I don’t think. Do you?

JIM: No, not for the state and not for the country for that matter.

Road to Ruin

JOHN: Speaking of not good for the country, well here we go into that pain side of things, we’re going down the road to ruin. Several weeks ago we talked about US debt issues and the ineffective of monetary policy to create economic growth. So, let us pursue that.

JIM: Well, just as sort of a recap, a lot of people have wondered with the US taking on almost $13 trillion in debt �I think the figure is 12.7 trillion to be exact in the last 5 years � how come we haven’t seen more economic growth, how come we haven’t seen more prosperity, how come there haven’t been more jobs? And as I try to explain today when a central bank creates money it can’t always direct where that money goes. And if we take for example, for every $4 of debt (it’s actually greater than $4, I think it’s $4.60, well, let’s just round it off to $4 for illustration purposes), we only get $1 of GDP, another dollar goes into imports so obviously that goes to merchandise goods not created here, then you get $2 in financial speculation.

And that financial speculation which is transformed into the markets, the financial markets are really an outlet or a safety valve for inflation. And in the late 80s and 90s that financial inflation showed up in the financial markets with the stock market bubble, the tech market bubble. In this century it’s showing up in real estate mortgage finance, bonds etc. What is not happening in the US, we are no longer saving and investing, that’s what created this nation’s wealth. We’re not saving at the national level. For example the governments have run continuous deficits ever since we went off the Bretton Woods system and the government no longer had to balance its books. Corporations are saving but they’re not really investing in new plant and equipment � it’s much easier to go out and buy your competitor, so you’re seeing more mergers and buy-outs.

And then the third factor on the savings front is individuals are no longer saving. The savings rate in 1991 was somewhat close to 8%, today it’s close to zero. So, consequently, we see trade deficits of 805 billion on the current account deficit last year � close to 7% of GDP. We see budget deficits of around 400 billion, but that’s really understated too because a lot of the government’s budget deficit is off the books. If you look at last year the national debt grew somewhere in the neighborhood of 550 to 600 billion. You’ll see the government report one deficit figure for the year and then you’ll look at the debt level for that same 12 month period and the debt level is higher by $100 billion more � and that’s all the off balance sheet financing that the government has done just like Enron was doing that off balance sheet.

So, we’re really not getting a true picture our debt situation but because we’re not saving and investing we’re not creating the job growth. The only job growth that we saw in this economic recovery I think the figure is somewhere in the neighborhood of 60% of the job growth in this country occurred in the bubble sectors of real estate and finance. And that’s why even though on the surface the economic numbers look good, that’s why people are saying, “gosh, if we’re doing so well how come I don’t feel so good.” [41:58]

JOHN: Well, Jim you say we’re not saving which is really true. A lot of the investment money we see is going into debt or speculation. What should we be doing then?

JIM: Well, let’s talk about the way things used to work here in the economy before we went on the path to Keynesianism and socialism, which was we used to emphasize savings and investment. What happens when a person saves? Well, they put the money in a bank, or let’s say they have some extra money they put the money in the investment markets. The banks take that money they lend for commercial enterprises, or investment bankers may loan the money and raise capital for firms to create and expand business enterprises. And that was pretty much what we were doing at the turn of the century, and through I would say pretty much most of the 50s and 60s and part of the 70s.

And what happens when people save, the real rate of interest comes down naturally, because in other words if there’s more money going into savings than there is demand what happens through market mechanisms the cost of money � which is interest � comes down.

And a lot of people are saying, “well, how come interest rates have been going down?” We’re doing that through money creation. So we’re artificially bringing interest rates down. Paul McCulley had a piece on interventionism this week from PIMCO where he talked about the invisible hand of intervention through the Bank of China, the Bank of Japan and the US Fed. And they said basically they had to do that to avoid the pains of deflation from the correction of an economic boom as we had in the 90s. But the problem is they artificially stimulate interest rates, they create imbalances in the economy, and they can’t always direct where that money is going to go.

But John, let’s take the example of what happens when a company invests. So let’s say I’m going to build a new plant, I’m manufacturing widgets, we’ve got an existing plant right now, we’re getting orders for more widgets so we’re going to expand operations. So, let’s say we’re going to spend $100 million to build a new plant. Well, number one it’s creating equipment that we’re ordering, the construction materials and the machines and things that we’re going to put in place to build this new plant is creating orders in the economy. As those orders are created it’s going to other businesses within the economy. And these are going to create high paying manufacturing jobs. People that are in the manufacturing sector, they earn a good wage, a good living that creates real income. That also creates real purchasing power, and as these people are paid, as these jobs are created, wealth expands in this country. On the other hand what we’ve been doing is we’ve been lowering interest rates artificially, so we’ve been getting these asset bubbles to replace real wealth creation. And we call it wealth but it is artificial wealth.

And it’s one reason why there’s been this sort of conundrum why haven’t we created the jobs. The Democrats are accusing the Republicans of terrible economics of not creating jobs. Well, it wasn’t any better except for in the boom period in the 90s when we were artificially creating jobs through a bubble in the stock market and especially in technology, and then of course what we get in any kind of bubble is bubbles eventually deflate because they’re created with artificial demand rather than real demand. So, the net result is we never got the jobs, we never created the wealth, all we got was bubble like wealth � tech stocks in the 90s, stocks in the 90s, also in this new decade it’s been in real estate, it’s been in mortgages. In other words we’re getting asset bubbles instead of real wealth creation. [46:03]

JOHN: Everyone’s talking right now that the Fed is getting towards the end of this interest rate raising cycle, and everyone is expecting more good times ahead, but you’re talking about reflation. But a lot of your critics at the very same time are talking about deflation. Obviously it can’t be both of those?

JIM: Well, first of all, they’re going to reflate. I think that they’re doing that now which is why you’ve seen the markets do as well as they have been this year. And secondarily, it’s one reason why this rate raising cycle has been so different from those that preceded it � stocks did not go down this time around stocks went up; long term interest rates did not go up this time they actually came down. So, it’s been a different rate raising cycle, this economic weakness that’s coming upon us is obvious in real estate, it’s starting to show up in durable goods, it’s showing up in the manufacturing sector, we’re starting to see it in the retail sector. So the economy is rolling over.

And what they do any time the economy slows down then they start gunning the printing presses and start to reinflate. In other words, it’s like John they’re never going to let the guy sober up. We don’t want to suffer the pain or the consequences of this reflation, so if you read Paul McCulley’s article central banks basically put a put underneath the markets. They had to reinflate because they were worried about the consequences of deflation so what we got was inflation, even though we don’t talk about it.

The other thing in terms of the deflation arguments is you have to contrast the world of the 30s in the United States and the world of the 90s in Japan versus the world in which we exist today. In the 1930 we got deflation, we also got deflation in Japan. Well, in the 30s in the US the dollar was backed by gold until 1933. So the central banks you know they always argue, “well, we made a major mistake.” You hear them talk about we’ll never make the mistake we made in the 30s again where they believe that if they had printed enough money they would never have had the Great Depression. I agree with them � all they would have had was just a worse mess on their hands and they made a mess as it is. But the reason they couldn’t print as much money is because we were on a gold standard. We’re no longer on a gold standard.

The other thing in the 30s, this country was a savings country, that’s not the case today. Another factor is the world, and especially the United States was awash in commodity surpluses. We had so much energy at the time that they created the Texas Railroad Commission to regulate the price of oil. We had surplus silver, we were buying it, and the other thing is the US was the world’s creditor nation. We were self-sufficient in manufacturing and capital. Today by contrast, we have a zero savings rate. The US has to import nearly 2 to 3 billion dollars a day to pay its bills. Our manufacturing base has been cut in half and gutted, we’re no longer self-sufficient, go to a department store, a consumer products store or even a Wal-Mart and find out where did the goods come from that you buy.

We also no longer have the commodity surpluses in this country we once had and were endowed with, especially energy. In contrast to being the world’s creditor nation we’re the world’s largest debtor nation and the outcome for debtor nations is always different. The other thing is the tax laws and government policy today encourage debt and consumption versus savings and investment.

I’ll give you an example. If you’re a corporation and you go out and borrow money you can deduct the interest on borrowing that money. However if you don’t borrow money and let’s say you pay your profits out in the form of dividends it’s taxed twice. And the other thing is if you are fortunate enough to have a good paying job or you become successful in your business progressively more of your income is taken away from you by government taxes. So today you have a tax rate of 35% on the income tax; you have a 2.9$ Medicare tax; you have a 15.7% Social Security tax; here in California you have a 10.3% income tax with another initiative on the ballot to raise that to 12%. So, you have progressively higher income taxes and if you’re successful enough to build a business and want to leave it to your family you have progressive estate taxes.

So, the whole tax code is designed to penalize savings and investment instead our economic and tax philosophy and political philosophy encourages debt and consumption. So, the US economy is becoming less a free market economy more of a planned economy, in other words, a socially planned economy with intervention by government and central banks which is leading to progressively higher debt levels, progressively higher tax rates, and progressively higher inflation. [51:11]

JOHN: But if you notice it’s also Jim what happens is as regulations are put in then people, especially investors and business owners become shucking and jiving, trying to avoid the regulations and before you know it you have this escalating game of rules, regulations and taxes and whatever else and that in itself takes a toll on the economy, just trying to play that game.

JIM: Talk to anybody that’s in a medical practice about the amount of staff and time spent trying to collect from the government and just go through the red tape. I have quite a few doctors as clients � and over the years the amount of red tape that has gone in just trying to work with government in healthcare. In the investment business with the Patriot Act the amount of paperwork, compliance and regulations that we have to deal with. I mean we’re going to have to hire our second compliance officer because it’s becoming so complex. The forms every single year the paperwork just gets more complicated.

And anybody for example who’s bought a piece of real estate, my goodness, it used to be I could remember the real estate contract was 5,8 to 10 pages, now it’s like you’re signing a book, it’s gotten so complex because of all the litigation, the lawsuits etc. And you’re right John, more and more of the economy is going into unproductive areas where you’re just basically dealing with bureaucratic red tape. [52:35]

JOHN: Yeah, I call it shucking and jiving. And it’s roughest on the small businessman because people that are large can somewhat afford that, obviously it’s a drag on their business but they can bring somebody in. The middle-sized business especially the ones that are sorting just squeaking by � the Mom and Pop shop � find it more and more difficult until a lot of them just throw up their hands and walk away. You mentioned medical � a member of my close-in family was a respiratory therapist and finally just threw in the towel and went to do something else and said, “I just can’t deal with this government regulation, how long it takes to get paid by Medicare and Medicaid.”

JIM: Yeah, you can really be put in a severe financial crunch where I have had some doctors that have had to have lines of credit with banks because sometimes they do so much Medicare work and just trying to get the money from either the government or the insurance companies it’s almost as if you have to fight for every dollar that you get. [53:25]

JOHN: Yeah, but what’s really strange this never makes the light of day, this always amazes me, that people in businesses are yelling, “stop, stop.” And it’s like the mill in Washington keeps on going. President Bush said a few weeks ago, he said: “you don’t understand how taxes work, if you increase tax revenue they will spend it.” It doesn’t get rebudgeted, we don’t pay off the debt or the deficit it will be spent on something.

JIM: Yeah, there’s just one track growth.

JOHN: Let’s bring this back over to the track of what we were talking about, Jim. One of the things that we’ve been talking about here on the show is that we see inflation actually world wide. And we are seeing that increase of money supply around the world there’s a substantial growth rate. I don’t know of any currency that’s not, is there any such?

JIM: No, all currencies are fiat based currencies today so there is no limitation to the amount of money that governments can print. And hence John, I think where we’re going is like you just mentioned as the President mentioned increased taxes the government doesn’t save money it will just spend it.

And the real position that we are now in there is so much debt in the United States like I said since the last recession we’ve taken on 12.7 trillion in total new debt has been added to the US economy. There is no choice at this point it, it’s either inflate or die, is the only option for US politicians.

The unfortunate thing outside of Ron Paul there is no politician that has the courage to tell the American people the truth. So here we are in the season of stupidity in an election year and everybody that’s running here is promising all kinds of goodies, and I’ve seen national commercials people are promised, “if you elect me I’m going to get you some goodies. We’ll go after those oil companies, or we’re going to give you a hundred dollar tax rebate.” The politicians are handing out the popcorn and lollipops right now, this is the popcorn and lollipop season. They’re not telling people we’re bankrupt.

We need to tighten the belt and just like anybody that has gone through bankruptcy have to go through the tough times, tough it out, pay off the bills, work off your debt and rebuild. That’s not the message that’s being told either from the President office or Congress. And if you think that another political party that will raise taxes is going to make things better you’re delusional. [55:57]

JOHN: Alright, it’s time to look into the crystal ball and say given everything we’ve just talked about what is it going to look like as we move forward?

JIM: Well, number one, I think what’s coming is round two of the great inflation is ready to be launched. I think it’s in the process right now. And I think the giveaway was the elimination of M3 to hide it. And then also we’re seeing it surface globally, whether you’re looking at Europe, Australia, Canada, Japan, China, all central banks are inflating universally. And what’s amazing their was a comment made Thursday by Ben Bernanke �he’s sort of setting the stage for this � he’s basically saying that the CPI numbers overstate inflation by 9/10ths of a percent. So they’re sort of paving the way and getting ready here to go on pause, but in order to do that they have to hide it somewhat so look for some magical numbers to show up in the CPI. [56:55]

JOHN: But Jim, this is what you’ve been talking about since the beginning of the year when you read certain books they stick with you and we’ve been citing the quote from the Jens O. Parsson’s book, first the gain and then the pain. It’s the reverse of what people think, people say no pain, no gain.’ So head back to that one.

JIM: Let’s just remind, this is from the Jens O. Parsson book Dying of Money, and he said:

Everyone loves an early inflation. the effects at the beginning of the inflation are all good
[hence you have the stock market bubble in the late 90s, the real estate bubble of this decade] � there is steepened money expansion [remember before they stopped reporting M3 it was growing at over 8%] �rising government spending [just look at the government’s deficits], increased government budget deficits, booming stock markets and spectacular general prosperity, all in the midst of temporary stable prices. Everyone benefits, no one pays, that is the early part of the cycle. [That’s what we call: first the gain]
In the latter inflation, on the other hand the effects are all bad [that’s what I refer to as the pain] 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’s 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 all traditional remedies. Everyone pays and no one benefits. That is the full cycle of every inflation.

And that’s why you often hear me refer to what’s going on as first the gain and then the pain. And you’re not going to want to miss next weeks Other Voices between Frank Barbera and myself as we paint the picture of what the real perfect storm is going to look like. And for those of you who think I’ve gone soft take some aspirin, maybe some tranquilizers because next week is going to be a doozy. [59:00]

JOHN: Yes, but basically right now we are in a situation like you say: there is no way out at this stage of the game, especially as far as the dollar being the reserve currency of the world. There’s no way out. We’re on the ramp, we’re going to do this, it’s just a question of what it’s going to look like as we’ve described on the way down. That’s it we’re stuck with it.

JIM: Yes, the dollar’s demise is inevitable as the world currency. Hyperinflation in the United States is also coming. Capital controls are going to be coming as well, and then eventually as Aaron Russo was talking about in his new film a loss of individual liberty. And there’s a great book out it’s been out a couple of years and I hope I don’t butcher this guy’s name his name is Jesus Huerta De Soto, and he’s out of Madrid. He’s an Austrian economist and he’s probably written one of the best books I’ve seen come out of the Austrian community since - the equivalent would have had to have been Human Action. But he’s written a new book, if you’re a money manager, if you’re an astute investor this must be a collector, it’s a must read book that you have to have in your library. It’s about 800 pages long, I’ve just started it, it’s called Money, Bank Credit, and Economic Cycles. It deals with the Austrian business cycle � probably the only accurate forecaster of business cycles. And it also deals with how money and bank credit has changed over the decades with the change in central banking. And it is just going to be a must read, but I think really if you’re a money manager, if you have a lot of money at stake, a well to do investor, or you’re just an eager economic student, maybe you’re going to school right now majoring in economics ,it’s a book you have to read. It’s published by the Von Mises Institute. It’s something that you will not see on the college campuses which basically teach Keynesianism and socialism, they don’t teach free markets. And this book deals with how this unfolds, some of the tragedies and what we’re going to be heading into.

[music: Steve Doré]

Financial Sense Troubadour: Steve Doré Listen

TROUBLE IN SIGHT

My mansion’s in the village
Big tanks are sucking gas
In a rising sea of money few doubt is going to last
We’ve got a debt tsunami racing towards each coast
Put faith and trust in government is looking like it’s toast
The poor house on the left, and the good life on the right
The middle class is fading fast, and trouble is in sight

This deficit infection is feeling mighty sore
As we sat back for inflation that’s rising to the door
Our course is pathological, the outlook growing bleak
A commonsense future is out to lunch so to speak
The poor house on the left, and the good life on the right
The middle class is fading fast, and trouble is in sight

[JOHN:] Some of the musical wit with Steve Dore who tends to be a Financial Sense Newshour listener, so we regularly hear from him, his ideas and a musical version of what’s happening out there in the financial world.

Well, Jim, my, my, my how time flies. It seems like last year half the country was getting blown away, and that’s figuratively as far as wind goes, and here we are back at the beginning of hurricane season and the government is just coming out with its hurricane forecasts as do a number of private hurricanologists as well.

Other Voices: Evelyn Garriss, Editor, Browning Newsletter

JIM: Well, the government issued its hurricane forecast for the year and I’m afraid it isn’t a lot of good news. Forecasters from the National Oceanic and Atmospheric Administration forecast a very active 2006 hurricane season with 13 to 16 named Atlantic tropical storms. To discuss this issue joining me on the program is Evelyn Garriss, she’s editor of the Browning Newsletter.

Evelyn, you’ve been talking about this in your newsletter, it’s going to be another tough season, tell us about it.

EVELYN GARRISS: Well, what we are seeing is warm water and some good conditions to create a lot of storms, just like we saw last year. However, the water is not as warm as it was last year and we don’t expect as many storms. There are a number of conditions this year different from last year, and they’ll create a very different season. [1:03:47]

JIM: In terms of the direction that these storms are likely to hit, the things I’ve read they’re more likely to hit the East coast than the Gulf of Mexico. What would cause that?

EVELYN: One of the things that happens is we have a steering mechanism �the Bermuda high � that tends to determine to some extent what directions the storms are going to go. And the position of the Bermuda high appears to be where we’re going to be seeing more of the storms steered towards the East coast, in particular towards north Carolina. There’s a reason why that area there is called Cape Fear.

Also the Gulf is not near as warm as it was last year. Last year it was like having a pool of kerosene waiting for somebody to throw in a match, things were going to flare up. This year the Gulf is much cooler. It is much less likely to generate hurricanes, especially in the early part of the hurricane season. And while we may see some hurricanes particularly along the Texas coast the likelihood of them being big hurricanes like we saw last year in the Gulf is reduced. We may see a level one hurricane but the bigger hurricanes it looks this year as if those types of hurricanes will be steered either through the middle of the Atlantic where they don’t bother anybody, or towards the East coast. [1:05:04]

JIM: You know, one thing that we’ve seen since 1995 we’ve seen more active hurricane season, we know that for example the oceans’ temperatures are heating up. There’s a new movie coming out that’s going to scare the bloomers off everybody, but talk about this decadal oscillator cycle, how long it is, have we seen these kind of conditions before, because I can think back 30 years ago when I was in college it was global cooling. Now we’re in global warming. Explain what causes these two temperature changes.

EVELYN: A lot of what we’re seeing is a cycle in the ocean. people are familiar with the short cycle, the El Niño, La Niña in the Pacific, well the Atlantic has a very long cycle about 70 years, and for about 30 years the Atlantic is warmer, and for about 30 years the Atlantic cools off. And when you were hearing about global cooling everybody was getting upset because the water in the Atlantic was cooling off, it affected the fishing population. On the other hand it also affected hurricanes and we saw for 30 years fewer hurricanes. Now the water has warmed up so we are basically reliving the 1950s as far as a lot of our weather patterns. And during the 1950s there were a lot more storms, people weren’t living on coastal islands where it was hard to evacuate. We are back to conditions like we had in the 50s, and you know, people survived pretty well in the 50s, it wasn’t all gloom and doom. [1:06:36]

JIM: Evelyn, people that follow weather like Joe at Accuweather, they’ve been talking about the same things so this 60 year cycle that you’re talking about this has been known by scientists, this isn’t for example a new discovery today?

EVELYN: Oh no, people have been studying cycles in the Atlantic since the 1700s, because temperatures in the water affect fish populations. The Scandinavian countries have been keeping track of these cycles since the 1700s. So we have a lot of records and we see these cycles come and we see them go. The Atlantic warms up and then it cools off again, and it’s nothing to get upset about it just happens. [1:07:15]

JIM: Ok, so 30 years ago they were scaring the bloomers off us.

EVELYN: Global cooling.

JIM: global cooling.

EVELYN: We were all going to freeze.

JIM: Now we’re going to boil to death, but this is something that’s been around. And in terms of relationship of temperatures there’s people that are siding for example the melting of glaciers. Why don’t you address that, and how this all fits in.

EVELYN: Well, one of the things that’s happening is when weather patterns shift some of the areas that previously had growing glaciers they melt. On the other hand areas start having the glaciers grow. If you go to the Antarctic what we are seeing is some of the glaciers melting especially where we see some of the remnants of some old El Niños � the warm waters. on the other hand the center part of Antarctica the ice is getting thicker, some of the same things are happening with Greenland. We are seeing areas where the ice is getting thicker, and we are seeing other areas where the ice is thinning, and the alarmists are concentration only on the areas where the ice is thinning. [1:08:17]

JIM: So they’re not talking about it thickening?

EVELYN: No. The other thing we’re seeing is in the pacific we’re seeing like the Atlantic the Pacific has a long about 70 year cycle, and we went through a period where the tropical Pacific was very, very warm and the polar regions were very cool. Well, the currents carried the warm water more towards the Poles, so now we’re seeing warmer water in the Pacific towards the Poles, and cooler water in the Tropical regions. So that warmer water is melting a lot of the Alaskan glaciers. And if you look at the layers of ice in the history in that region about every 30 years Alaska goes through a big ice melt � about every 70 years or so. [1:09:04]

JIM: And how would you put this in perspective of looking at temperatures going back like let’s say over the last 1000 years so to speak.

EVELYN: Well, just as I’ve talked about these 70 year cycles there seem to be even larger periodic changes in global temperatures and some of this seems to be related to the amount of solar radiation. In the Medieval period we went through what was called the Medieval warm spell, and things were warm and toasty even with peasant economies people had enough spare food they could afford to build enormous gothic cathedrals. It was a time of population growth. Then you had what was called the Little Ice Age, and it started in the 1400s, and it lasted until around the 1800s. And starting at the end of the 1800s we have come out of the Little Ice Age. So when you come out of a little ice age you have global warming and that’s what we’re going through.. This century we’re coming out a little ice age and so we’re getting warmer. We are beginning to get the same type of temperatures that we saw back in the 1200s, and people weren’t driving then. [1:10:06]

JIM: So you don’t believe we’re all going to boil to death and the world’s going to end.

EVELYN: I think to boil to death you’d have to pick a hot day in Arizona or California and stand on the asphalt.

JIM: Well, you know, we’ve talking about the hurricane season and obviously everybody’s worried about where these storms will hit. What are some of the other implications for weather? And I’m thinking of the Midwest with this La Niña and what impact that will have on this year's crop.

EVELYN: Well, one of the things we’re seeing the La Niña has pretty well faded. We are in the middle of a long term Atlantic cycle and one of the things when the Atlantic is in this phase and the water’s are getting warmer, less moisture goes into the interior of the United States, and so I expect the interior of the United States to be much drier. Now, it’s going to be extremely dry in the southwestern part of the US, and this includes large parts of Texas. You can expect the wildfire season to be insane. We may get enough moisture for some of the pasture lands to keep their cattle around Nebraska and further North but around Texas they really have been hurting, especially western Texas. [1:11:20]

JIM: Yes, my wife just came back from there and she told me how unbelievably hot and dry it was. What about the West coast?. One thing I’ve noticed, what was it, Monday night I went to bed with my windows open, we had a rain storm in the middle of the night that was pretty severe. We normally don’t get that.

EVELYN: Now you can blame the California weather on Russia. It’s all the Russians’ fault. They had a volcano go off and the volcano Bezymianny had an explosion over 10 miles high but it put a lot of dust in the air, and then the dust drifted over the pacific and moisture coagulated around all the dust, so you had a lot of moist air hitting your coast line, and it’s just been raining out. And this typically happens when you have a large volcanic eruption on the Kamchatka peninsular along the Pacific coast of Russia. So, it started going off April 28th, and continued exploding until May 10th, and for the next two weeks after that you can expect lots of moist air, lots of dust particles and indeed considering how high it is you may have a prolonged period of moisture hitting the West coast. So, blame it on the Russians.[1:12:38]

JIM: In summary, Evelyn, then, we’re going to have an active hurricane season because the ocean temperatures have been warming but the temperatures in the Gulf aren’t as warm as let’s say where they were last year. And you know maybe we get one or two severe hurricanes that hit the East coast but that’s pretty much it the way you see it.

EVELYN: Yes, I wouldn’t be surprised if we might see a landfall in the Texas region but not a big one, a level one which Texas copes with all the time.

JIM: That’s going to be good news for the energy industry because we still have some production platforms that are still offline in the Gulf.

EVELYN: Yes, but there’s very strong probability of a hit or a brush near by of the North Carolina region and a lesser possibility but still a fairly good one of a hurricane going inland and then going up along the East coast, and not bringing problems with winds just bringing a lot of heavy rains which for some reason people in Massachusetts don’t seem to like very much.

JIM: And finally, if you were to look out and extend your crystal ball into this year’s Winter, what do you think it’s likely to be? We’ve gotten off lucky over the last year or two where we’ve had warmer Winters than normal, especially in the Midwest around Chicago.

EVELYN: A lot of it depends on whether or not the volcanic activity continues. If it did we’d have to deal with cooler Winter, but barring something major like an earthshaking volcano it looks like we’re probably geared once again to have a warmer than average Winter, which is not bad news if you are paying your heating bills in Chicago.

JIM: Or natural gas bills elsewhere.

Well, Evelyn as we close, tell people about your newsletter and if they wanted to get more information about it how they could do so.

EVELYN: Our newsletter is in its 30th year, and we talk about not just climate and weather but the economic impact of the upcoming climate. Anyone who wants to find out more or get a sample copy should contact linda@fraser.com. [1:14:47]

JIM: Evelyn, as always I appreciate you joining us on the program and keeping us posted on weather. Thank you so much.

EVELYN: Thank you.


The Perfect Option

JOHN: Well, Jim we talk about the perfect financial storm from time to time here on the program but there is opportunity in any circumstance, I guess it’s called thriving in chaos, I think one marine once said. What about the perfect option?

JIM: I wrote a story about investing in the precious metals market several years ago �what was it, 2003? I wrote the Perfect Option � and I think the following year I did the Perfect Option Part II, but a lot of people like to use leverage, you hear about derivatives you hear about hedge funds, last week you heard Tim Wood talk about a subscriber leveraging in futures, and then when the price of gold turned around he got wiped out.

One of the reasons I like the junior market is number one, I think this gold bull market is going to be different from the one that preceded it in that late 60s and 70s because during that period of time the gold companies were able to grow their production. In other words, they grew that production through the gold bull market. As the price of gold went up they spent more money started acquiring more properties, looking, drilling, exploring and they grew their production during that period of time because they weren’t the big behemoths that they became during the 90s bear market, as a result of consolidation.

The other thing is that the US government was sitting on a large stockpile of silver, you know the environmental movement wasn’t as entrenched stopping exploration and development as it is today. Back in the 70s you could pretty much discover gold deposits, stake, file a permit and it didn’t take you too long to go into production. It could take 7 to 10 years today from the time of discovery to the time you get into production � if you’re lucky. And so it’s going to be a different kind of market.

The real growth in this bull market is going to come from the junior producers, and the junior exploration and development companies. It’s not going to come from a Barrick, it’s not going to come from a Newmont, it’s not going to come from some of the larger companies. Newmont isn’t going to go from 6 million ounces of production to 20 million ounces. They’ve already gone from 7.6 million ounces as a result of a three-way merger to only around 6 million ounces. So that’s not where the growth is. But another reason I like the junior sector is I believe juniors are the perfect option. [1:17:29]

JOHN: Before we do that Jim, for people who are not familiar with how options work etc. Why don’t you go through an example for us here.

JIM: Ok, let’s just take something people are familiar with, the stock market. Let’s say, John, in the next couple of months I think IBM’s stock which is currently trading at about $80 a share is going to go to $90 a share.

So, let’s say I call up my broker and I say, “buy me 100 shares at $80/share,” that’s going to cost me $8,000, a second alternative to that would be for example I could go out and buy July 80 calls at $2.90. So in other words I could control � a call contract is 100 shares � so at $2.90 per share it would cost me $290 to buy a call on 100 shares of IBM at $80 a share. And that option would last for roughly about 3 months. It would expire in the 3rd week of July.

Now, what I’m talking about is investing only $290 versus $8,000. On the other hand if I wanted to spend $8,000 I could buy roughly about 27 contracts or calls on IBM which would enable me for that same $8,000 to control 2700 shares of IBM.

Now, let’s say everything goes my way, and by the 1st of July IBM’s stock is at $90. Now, let’s take the case of somebody who just paid cash bought 100 shares of IBM stock. Well, if IBM goes from 80 to 90 my investment just went from 8,000 to 9,000, so I made $1000 profit on an $8,000 investment. That’s a return of 12 �%.

However, let’s take the same example with the options. IBM is up $10 a share, and remember with 2700 shares controls through 27 contracts, I have a profit of $10 a share times 2700 shares that I control, my profit instead of being $1000 is $27,000, so I have a 338% profit instead of a 12 �% profit.

So that’s why you’ll see a lot of people leveraged through the use of options because for $8,000 if I just paid cash for IBM at $80/share I can only buy 100 shares. However, with $8,000 I could buy 27 option contracts - $80 July calls on IBM � and control 2700 shares of IBM. [1:20:18]

JOHN: Yeah, but the problem here is that options contracts expire.

JIM: Yeah, that is where the real problem runs into. I could be right that IBM goes to 90, but lets say it doesn’t go to 90 the 3rd week in July. Usually the way the options market works it usually goes to 90 the week after the options contract expires, in which case I would have absolutely nothing. The $8000 I spent on options contracts would expire worthlessly.

You know it could be that IBM hits $90 in December instead of July. So, when you’re in the options market your timing has to be almost perfect because options decay, they expire, and as you get closer to expiration you start to lose value in that option even though the stock might be going up a little bit.

So, the big problem is the time factor, and that’s why I believe that juniors are the perfect option. Number one, they don’t expire, like options they are leveraged to the price of gold, they are a perpetual option on the future price of gold and silver. [1:21:24]

JOHN: Yeah, but there’s some warning in here too as well.

JIM: Sure, mining is a risky business. You know, you may invest in a company that’s going to go make a stake on a piece of land, they’re going to drill some holes and they get dry holes, and also they could be financially mismanaged. The other thing that we’ve seen in the past is you may have some crooks running the company like for example Bre-X where it was a big scam. So, there are risks to mining companies, but there are if you look hard some of the best bargains in the mining business right now in the gold business are in the juniors. [1:22:00]

JOHN: OK, then let’s go through some of the fundamentals now on this.

JIM: Well, the first thing that you have to understand is when you’re buying a junior exploration company, or a late stage development company, they’re not into production, they don’t have any source of revenue. They get their revenue through equity financing. So, basically what you’re hoping is this company is going to find a valuable deposit, they’re going to drill that deposit out, and they’re going to start accumulating ounces.

And when we talk about ounces there’s a trap that you have to be really made aware of. Too many times I’ve seen investors chase ounces. You’ll hear, you know some company say, “oh we have a gazillion ounces.” The real question you have to ask is there’s basically several kinds of ounces. The kind that you’re looking for are the mineable ounces.

The first category of resource categorization is inferred ounces. These are ounces you’ve drilled a couple of holes, the holes aren’t very close together, but so far from what you’re finding you can make an inference in terms of what you think is there. These are inferred ounces, they’re not proven.

The second category which you have to have when you want to do a prefeasibility study are what we call measured and indicated ounces. These ounces this is when mining company is drilling their holes closer together so they’re really getting a better handle on what is in the ground and then the next category is what we call reserves.

Once a company has gone through feasibility studies, or prefeasibility studies those measured and indicated ounces are added into the reserve category which they’re worth more, because those ounces are more valuable, they’re more certain. So as you move from inferred to measured and indicated you have a greater comfort level that’s what’s in the ground is actually there, and as you move from measured and indicated to reserves you have a greater comfort that what’s in the ground is actually there, and it’s actually mineable at a profit.

That’s one of the reasons you want to do a prefeasibility study. So, what profitable ounces are, which is another key is actually ounces that are going to end up being mined and produced at a profit. And that’s what I call the best kind of ounces, or what I call profitable ounces. You could be in a smaller deposit, maybe not as much in reserves but a very profitable deposit because it can be mined easily, for example, through an open pit.

And then the third category is what you get is dream able ounces, they’re there but they may not be there. You don’t know. They haven’t been drilled out, it may be in a very difficult area, and may be a deposit where you’re never going to get a permit because of environmental constraints, or it may not be economic to mine itself, trying to get it, put in a mill, the infrastructure isn’t there. So you get what I call dreamable ounces.

And that’s why if you look at investing in the junior market there’s only 3 possible outcomes for a junior. Number one, they eventually go into production; number two, they develop sufficient ounces that are economic that they get acquired by another producer; or number 3, the company goes bankrupt or just fades into oblivion.

What I like to see � I want to keep my risks to a minimum � so my first criteria is I look for a late stage development play. I’m not interested in somebody who says, “I’m going to go out and find the Lost Dutchman mine and stake a claim.” I’m looking for a gold deposit that’s been proven through drilling, they have a lot of measured and indicated ounces, usually over 1 million with the opportunity for more. Also, that they’re getting close to a prefeasibility study so I know that those ounces are going to go into the reserve category, then I’m also going to get a better feeling through that prefease or feasibility study that these ounces are profitable, they’re actually capable of being mined and the company will make a profit on it.

So, what I like to do is take a look at what I call my �two plus two’ or �three plus three’ equation: two plus two million ounces equaling 200,000 ounces a year of production; or 3 million ounces and 300,000 ounces [a year of production]. So I look at a feasibility study.

And then when I get involved I like to take a look at their financial structure and help management change their financial structure so they’re not doing as many dilutive offerings, and in placing the shares in strong hands, in other words investors that are going to invest with that company, hold onto their shares and watch that company develop the project, eventually take it to prefeasibility and eventually to production. But the reason you want those two options, either the capability of going it on your own or being attractive enough to be acquired.

In some case you may see your stock price run up and somebody takes you out, and you make a major discovery you become economic, or your stock price gets to be so valuable that you just become too expensive for somebody to take you out, so in which case you better be economical enough, financed well enough, and have strong backing so you can actually take that company into production. [1:27:17]

JOHN: Jim, you’ve mentioned before that when you get involved in companies you like to change the financial structure, and you’ve also talked about these pump and dump, and short cycle schemes, so maybe we better explain this again because we’re always picking up new listeners.

JIM:Well, first of all, when you’re investing in a junior, remember as I mentioned earlier juniors don’t have a source of income, they’re primarily dependent on the equity markets to raise capital, to pay the bills, to pay for the drilling and pay for the staff, the geologists the property claims, and fees of holding and staking property.

So, they have to raise that money in the equity market. And a lot of times a lot of these guys are good geologists but they get involved with what I call the pump and dump shops. And what’ll happen typically and you’ll see this happen and play out over and over again, the owners of the mining company start talking to the investment banking firm, and they want to strike up a relationship, that investment banking firm is going to raise capital for them.

So they reach an agreement and lo and behold all of a sudden you know the stocks at a buck and 3 months prior to the financing all of a sudden you know they’re driving your stock down. So they drive it down to 60 cents and then what they come in and do is finance you at 60 cents with maybe warrants at 80, and what happens is then they’ll pump the stock up once it gets to 80 they’ll pump it up a dollar or more, they’ll start promoting it with their clients because one of the ways they get compensated is what you’ll see in many of these deals � 8% commission to the broker, and 8% broker shares, and 8% in broker warrants. So the underwriting firm is making 30% up front. Well, the underwriting firm is not in the investment business, they’re not long term investors, their job is to turn over capital as often as they can.

So what’ll happen is you’ll start seeing the investment firm unloading their shares, especially after the 4 month restriction gets up, and I’ve seen it in fact, I’m not going to mention the company, a very well known junior, they did a financing and what happens is when you do a private placement financing the shares are restricted, you’re prevented from selling them in Canada for about 4 months. And 3 months after the financing all of a sudden their stock price was really getting hammered and starting to weaken. And then all of a sudden one of the hedge funds that was involved in financing was calling and saying, “when can we get our shares the restrictions or the legend lifted off the shares,” because what had happened is they had shorted into the market ahead of that 4 month restriction, the market had started bouncing back and they were getting killed because they were short, so they were getting margin calls. So they wanted to have that restriction [] so they were playing that game already 3 months after the financing.

And most of these funds that get involved most of the time you’ll see an investment bank, they know that they’ve got large institutional clients and maybe hedge funds, and they let these funds know that they’re going to be doing a financing in the company, those funds start going in and shorting the stock and then what’ll happen is they get in on the offering at a lower price, and then they can cover their shorts from that.

You see all kinds of monkey business that goes on like this, and that is not good for investors and it’s really not good for the mining company itself, because what’ll happen is after that 4 month restriction you’ll see a large block of stock come into the market as these - you know they get into the pump and dump scheme � the investment bankers want turnover of capital so they’re unloading, and then the firms that got privy to the idea that they were going to do financing they want to come in and cover their short position. A lot of times what they’ll do is they’ll short the stock, they’ll cover the short position from shares that they get in the underwriting, and then what they’ll do is they’ll sell and cover their short positions with the shares they’ve bought and then they’ll just strictly keep the options. So, basically at that point they have no money invested. And that’s not how you build a mining company.

So, what we try to do is get involved, get people away form those kind of investment banking firms, we try to bring in stronger players, people that are known, people that are very bullish, that are long term investors so you can help build a mining company. So you can take a company from 500,000 ounces, a million ounces to a two million or a 3 million ounce producer in terms of ounces and then eventually into production. And then that way you don’t get this pump and dump cycle because the pump and dump cycle will perpetually dilute the shares, it’s an ineffective form of financing. And I’ve seen it ruin more companies because you may have a good deposit but by the time you issue a gazillion shares, by the time you go into production where that production is going to be spread out over a gazillion shares versus a million shares makes all the difference in the world in terms of your return on investment.[1:32:21]

JOHN: If this is such a good area to be in that it would only seem logical to ask why do we get into these pump and dump cycles and why more investors aren’t more aware?

JIM: I think the reason for this is two fold, number one I don’t think a lot of investors have the stomach for volatility in juniors, because they’re thinly traded so you have greater price fluctuations. And then I think another thing that’s very characteristic of our investment markets the last 10 years investors strictly lack patience, we want the quick buck, we want to make the money overnight. And that’s not how you grow good businesses.

I don’t care if you’re making widgets, building a retail establishment or building a mining company that’s not how you build a business. Businesses are built with patience with good financing, with good business management, with knowledge of what it is that you’re doing. And in order to do that you have to have all those skills but at the same time you also have to have financial skills, which is in other words bringing in good investors, and bringing in people who are going to help you grow a company.

The investment bankers don’t do that, they’re more interested in rapid turnover of capital a lot of the hedge fund managers are too worried about next quarter, or this year’s compensation fees so they’re short term performance oriented, rather than people that are willing to take a long term approach. But I think the long term approach in any bull market is how you build real wealth. people that bought tech stocks in the early 90s and just sat on those tech stocks and road that particular trend made more money than those who were always trading in and out of the market itself. And that was something that I believe firmly in investing. [1:34:07]

JOHN: I think you wrote about that philosophically as a matter of fact in The Next Big Thing which is still up on the site, but where are we going with this anyway.

JIM: I think what we’re going to do, I don’t think that the correction has completely run its course. I think the worst of it is over for the stocks but we still have a little bit more to go � maybe another 10% on the downside. Then I think we’ll go through a consolidation period for a while because that’s generally what happens after you have these steep rises. But then the next stage of lift off is going to begin and will probably be initiated by the Fed going on pause.

I’m no longer calling Bernanke helicopter commander. I’m calling him B-52 commander. [1:34:51]

JOHN: You know we’ll have to change the sound effects now.

JIM: Yeah, John we need a B-52 taking off.

But I think in stage one of the next lift off I think we go back and take out the previous recent highs around 728, that’s stage one. Stage two is we go and take the old highs of the last bull market of around 850, and then stage three is the breakthrough through the 1000 barrier and you better be fully invested as we get through the end of stage one and the beginning of stage two, because it is going to be one heck of a ride in my opinion. It gets really risky once you start taking out the old highs because, John, as investors have seen once we went through the $600 barrier, we cleared that very easily and then went on and just took out the $700 barrier in the blink of an eye it happened so quickly you know investors had very little time to react to that. [1:35:48]

JOHN: Do you have any timing on this? That’s the first question you always here somebody say, so I might as well ask what a bunch of people are thinking.

JIM: I would say a good chance of that in the next 12 months.

JOHN: You mean breaking out of stage one?

JIM: No, stage one, stage two and stage three. All three stages the next 12 to 18 months and even sooner. I’m trying to be conservative on that, you know obviously you can’t time this thing perfectly and I can’t give you a date stage one starts August 1st ,and then October 15th we start stage two, you know, I mean I’m not the technician.

JOHN: Well, bummer.

More Emails and Q-Calls

Well, Jim let us go back to the Q-Line and we’ll see what people have been queuing up to ask, since I mentioned once before the call in line is 1-800-794-6480, that’s online 24 hours a day all week long, so you can phone in your questions, give your name, your location, and your question. And please try to keep it under a doctoral dissertation, it’s easier for us to deal with at that stage.

Hi this is Michael, from Laurel, Maryland � love the show. My question is recently Jim Puplava mentioned that Paul Volcker off loaded public debt into the bond market, and since as I understand it the bond market the bonds are public debt that just doesn’t seem to make sense. Could you elaborate or explain that a little bit further? Sure would appreciate it and keep up the good work. Great public service.

JIM: What I was referring to there is prior to the 1980s what the Fed was doing was monetizing the government’s debt. It was just simply printing it. What they did in the 80s instead of monetizing debt which creates massive amounts of new money and we got inflation, instead of monetizing debt they said look, “let’s just finance this in the financial markets.” So what we’ll do is we’re not creating new money by doing that, we’re just taking existing savings, people putting money in bank accounts, people putting money in brokerage accounts and we’ll sell debt to the public, debt to financial institutions. That was the sea change in monetary policy versus the previous Fed Chairman in the Arthur Burns era who basically said look, “the government, you need more money, tell me how much you need and we’ll just simply create the dots and zeros and transfer that into your account. We’ll print money out of thin air.” And that is basically what I meant by that, they tapped the bond markets instead of just printing money, and that helped to quell some of the inflation by controlling the supply of money which is what creates inflation. And you know tapping existing savings is not creating more money, printing money is.

JOHN: [unknown] writes from Trondheim, Norway and he says:

In commenting on people’s outrage over high gasoline prices and Congresses misguided attempts to address it, and the profits of oil companies, you have repeatedly stated that 45% of gasoline prices are made up of government taxes. What I’m wondering is what would the economic consequences be of further raising the taxes on gasoline? For a country such as the United States which has a huge trade deficit, in large part made up of oil imports it seems to me that reducing energy consumption would make much economic sense. In terms of taxes, wouldn’t higher taxes on energy consumption if coupled with lower income taxes encourage energy conservation as well as work?

JIM: If they were trying to raise taxes to discourage consumption to get people to change, you know, higher prices in the market place are going to accomplish that without the government raising taxes. Now when you start getting gasoline prices over $3 it would almost be disingenuous of the government that said basically after 9/11 go out borrow, shop, spend more money, we’re going to create the incentives for you to get deeper into debt, the automobile companies created 0% financing to sell you these big gas guzzling cars.

A couple of years later they say, “oh, we’re changing our mind, we’re changing philosophy now.” It’s interfering in the market place, you can accomplish the same thing through the market mechanism itself, and that’s what I believe is the ultimate answer. As the price of gasoline moves from $3 to $4 eventually to $5 here in the next 12 to 18 months even GM has done studies and prolonged prices over $4 people are going to start changing their habits. In other words the market is going to solve that problem without the government interfering in the process as it is.

And what I said about taxes, basically tax and marketing costs take about 25% of the cost of a gallon of gasoline, and what I meant when I also referred to taxes the government gets 3 times the amount of taxes on energy, versus what the oil companies make. So when you talk about somebody price gouging the government makes 3 times what the companies that produce the energy make. [1:41:04]

Hi Jim and John, this is Deborah in Tempe, Arizona. First of all I want to thank you Jim for having Aaron Russo on, I think he has a very important message and I hope all of your listeners will pressure their movie houses to show that film. As far as my question goes, just recently I’ve been getting several emails from newsletter writers touting the discovery of a big find of oil in Colorado and Utah, but I believe it’s oil shale if I’m not mistaken. My only understanding of oil shale is up in Canada, I understand it’s quite costly to extract and it’s also very water intensive, and I know Utah and Colorado already have water problems. I’m not really sure if this is even viable, of course they’re telling me if I subscribe to the newsletter they will give me the companies that will benefit. So I thought I would call and get your take on it. Thanks a lot and thanks for the show I never miss it.

Well, Deborah, a couple of things. There are large oil deposits in the form of oil shale, in Colorado and that area, I’m trying to think if it’s the Green River � the name of that deposit. They were looking at going into that area in the 70s when oil was at 40 bucks, you had a lot of the big majors going in there. Then of course the price of oil collapsed and all projects were shelved. Yes, we’re going to be tapping it. That’s where we’re going to be going. The reserves are almost as prolific as the Canadian oil sands. It’s a very expensive process.

But as Matt Simmons has talked on this program, you’ve got to be very careful when you hear numbers thrown out in terms of reserves like for example 175 billion barrels in the Canadian oil sands, and the oil shale is supposed to be even bigger than that. You know the reserves may be that large but in terms of extracting them and actually getting them out into production, you know 175 billion barrels in the Canadian oil sands doesn’t mean that the Canadian oil sands will be producing 10 15 25 million barrels a day. That’s not going to happen.

In fact, what we are now is we’re on the downside of the slope of cost effectiveness of energy. In other words, it’s taking larger and larger amounts of inputs of energy to produce energy itself, but it will be a source of future oil production, I can tell you the majors are going to be there, they’re the ones with the capital wherewithal, and the large intermediate oil producers. It may be one of the few areas left open to the international oil companies because as my guest last week, Stanley Reed of BusinessWeek talked about, you know there’s only about 15 to 16% of the world’s oil reserves that are now open to the majors. Everything else is occupied or controlled by the national oil companies. [1:44:01]

JOHN: Mike’s in Vancouver, British Columbia, Canada:

Hi Jim, on the last show you mentioned several times there are no new deposits of oil. I’ve heard this one too many times. I recently got a promo in the mail talking about the shale deposits in the US. The biggest amount of oil on the planet. You talk about South American companies expropriating oil, but what has the US government done but expropriate the oil shale deposits in any real sense of the word. Private companies would love to develop that deposit but aren’t allowed to. The feeling outside the US is that the US wants to keep this as a reserve and use up the world’s oil supply before they can tap into this resource. All of this talk of a shortage seems a tad disingenuous.

JIM: I want to go back to what Deborah’s question is. Once again you may have 200 billion barrels of oil and oil shale but trying to develop that to any meaningful amount of energy production, it’s not like finding light sweet crude, or sour crude. It’s more expensive to develop, you’ll never get the production that you did at the great gushers that you had in Texas, for example, at Spindletop, or a Ghawar. You’re not going to see 5 or 6 million barrels a day produced in that area. You may see 300,000, maybe eventually a million barrels.

But here’s the thing that you’re forgetting. Maybe we find a new source of a million barrels of production from oil shale, or an additional million barrels in the next 10 years in the Canadian oil sands, you’re forgetting Kuwait gone into peak oil, gone into decline. Cantarell field in Mexico gone into decline. The North Slope of Alaska gone into decline. The North Sea, Indonesia gone into decline. Venezuela gone into decline. I can just go on and on.

And what a lot of the optimists see is they all talk about we just have a new deposit here and they’re going to bring this kind of oil production increase out of the Canadian tar sands, and they forget to talk about that Mexico’s oil production is going to drop by a million barrels. You’re going to see Kuwait’s oil production drop by almost a million barrels; you’re seeing production out of Ghawar out of Saudi Arabia drop. So, they never take into account depletion. And you really need to understand the depletion decline curve to really grasp an understanding of what we’re facing. [1:46:29]

Hi, this is Daniel from Los Angeles. I have a question on dividends. One of the hallmarks of the great gold stocks in the 30s was they paid high dividends. This time around do you expect dividends to increase in proportion to their earnings. Also I’d love to see more shows on gold roundtable with experts recommending particular stocks. Thanks so much.

JIM: Ok, dividends. Companies will start paying dividends, let’s say that. The large producers they’ll be forced and they’ll have to. But I don’t see the big increases coming along because they’re not going to see a production increase in the majors. What I would look at is some of the intermediate companies that are going to go from 200,000 ounces to 500,000 ounces to a million ounces, or the million ounce producer that becomes a 2 million or 3 million ounce producer. And several of those companies are already starting to pay dividends. Those are going to be the dividend leaders and they’re going to be special companies.

I think the majors on the other hand are going to have trouble going forward in the sense of maintaining production; they’re very much exposed to areas that are very unfriendly to mining. They also can have some risk of expropriation. They’re also running the risk of what I call extreme environmentalism which basically wants to stop everything, and there’s environmental risk that they run. And so these are some of the problems that the major gold companies are facing, very much in the same shoes as the major oil companies. They don’t have as much access, they’ve gotten too big, they’re going to have difficulty producing their reserves.

And as far as a future gold roundtable it’s funny that you should speak, I’m going to try to make it up to the Denver gold forum up in San Francisco in June at which I think 20 to 30 companies are presenting, and that’s if we can do that we can put together a roundtable of probably the companies themselves. What I like to do is interview the CEOs of these companies, let them tell their story, and let you the listener decide. [1:48:47]

JOHN: Well, I always say when it gets to that time it’s that time and it is that time, Jim, so�we could go on for another two hours, but what is coming up in the weeks to come here on the Financial Sense Newshour.

JIM: Well, next week we’re going to get into alternative energy, and by the way we’ve got a slew of alternative energy interviews that we’re working on for the remainder of the year. Also some interesting interviews on oil and especially we’re trying to get the author of a new book called Oil Titans, and it’s a book about the national oil companies. Everybody’s talking about Exxon-Mobil and the Big Sisters, they’re becoming insignificant, the real players in oil are the national oil companies, so we hope when we get that we can make an announcement.

But coming up next week Paul Kruger will be my guest, he’s written a book called Alternative Energy Resources; following him Fred Pearce When The Rivers Run Dry, as we turn our attention to water a very big issue that nobody’s really talking about; of course, Ike Iossif the third week of the month; and we’ll top out June with Gary Weiss Wall Street versus America.

In the meantime, as John has said we have run out of time. We’d like to thank you for joining us here on the Financial Sense Newshour, on behalf of John Loeffler and myself until we talk again we would like to wish you a great holiday weekend.

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© 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.