Financial Sense Newshour
The BIG Picture Transcription
June 24, 2006
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- The Sum of All Fears
- Emails and Q-Calls
- Other Voices: Peter Schiff, Euro Pacific Capital
- Sitting Bull
- FSN Follies: "Wall Street Downs"
- Other Voices: Ross Hansen, Northwest Territorial Mint
- Forward Ounces
- More Emails and Q-Calls
The Sum of All Fears
JOHN: Well, here we come to that part of the program I always find interesting: we have geopolitical tensions on the rise, look at the situation in North Korea, Iran, Venezuela; we have economic risks –we’re facing the possible recession, obviously, although we were the only ones talking about it 24 months ago; there are inflation worries. There’s really a whole plethora of worries weighing over the market keeping investors up at night. But, you’re not in touch with reality, Jim. “You no worried, you too calm.” You obviously don’t understand the situation
JIM: What is it I’m missing?
No, you’re right, John. If you look at the headlines, the evening news, there’s a lot to be worried about: it’s Iran’s nuclear program; North Korea ready to launch a missile; Hugo Chavez talking about expropriation and expropriation in Bolivia; a lot of geopolitical tensions.
You’ve got interest rates rising. Central banks are raising interest rates and everybody’s thinking what happens if they keep doing this and something breaks. However, central banks are universally inflating right now. They’re talking tough, but underneath they’re pumping out reams of paper which is in fact keeping the system liquid. So you have to ask yourself if they’re pumping the presses where’s that money going to flow? It has to go someplace, and it’s either going to go in assets, or it’s going to go into goods, and I believe you’re going to see both. You’re going to see assets and goods inflate but you know, you’ll have the occasional pullbacks – as we’ve been talking about the commodity market correction here for quite some time. [1:55]
JOHN: So, you’re not worried, huh?
JIM: Well, yeah, sure, there are things to worry about but at the moment we’ll discuss these worries but what I believe we’re likely to see is some sort of a midcycle slowdown, similar to what we saw in 1994 when the Fed was raising interest rates, and also during the Asian flu crisis of 97, and then the Russian debt default, Long Term Capital Management crisis in 98. Back then, like today, there was similar worries over inflation, there were similar worries over the dollar and also over the financial system. [2:28]
JOHN: Well, alright, let’s go over the issues that we should be worrying about, we’ll just do a brief rundown here on the Big Picture.
JIM: Well, last week’s BusinessWeek cover story was called Bubble, Bubble, Who’s in Trouble? I thought they did an excellent job of taking all the basic worries that people are concerned about: the dollar; China’s economy overheating; the housing market going bust; inflation; commodity prices are rising in heated markets; the emerging markets –especially the swoon we’ve seen over the last 30 days or especially in the month of May. But let’s take each one of those just briefly.
The US dollar: the worry is inevitable collapse, the reason is the US’s huge budget and trade deficits. The rebuttal is in times of worry it’s still the ultimate safe haven.
China: inflationary overheating. First quarter growth in China was 10.3%; the reason – an undervalued yuan. They pegged their currency to the US dollar, and they’re very reluctant to have a major revaluation of the Chinese yuan. We’ll get to why in just a moment. But also a rebuttal to that is China’s got the strongest long term growth prospects.
Let’s take housing – the next big bust. Certainly, we’ve seen a bubble in real estate prices especially on both coasts the East coast areas like Florida, parts of New York; here on the West coast, California and all the way up to Seattle. And the reason is these prices are overly inflated, it’s not worth the money. But on the other hand when you think of an age of inflation and fiat currency, it’s probably a tangible type investment that has more potential to retain its value than paper currencies.
Let’s talk about another worry which is very prominent today: inflation. It’s out of control. The first time we’ve seen inflation rates this high you’d probably have to go back to maybe the 80s to see rates rise at this level. The reason: interest rates are too low. In other words, the borrowing rates on capital are below the inflation rate, and as long as you have negative real interest rates you’re going to get an inflationary type economy. The rebuttal to that is there’s few signs of rising wages –though rising wages is sort of a lagging indicator in a period of inflation.
Let’s talk about commodity prices, another worry. They’ve moved up too far, too fast, and there’s some people calling commodities actually a bubble, which I strongly disagree with. The problem is we still have growing global demand coming from Asia, the emerging world, and we don’t have enough supply. And China’s insatiable appetite, even if the Chinese slow economic growth from 9 to 8% or 7%, that’s still a high level of economic growth.
And then finally, let’s talk about emerging markets. There’s been hot money fleeing the markets, we’ve seen in the last 30 days. The reason is it’s a high risk market, but the rebuttal where have you seen the strongest economic growth? It’s been in the developing world. [5:47]
JOHN: Alright. Why don’t you give us your take on each of these issues you’ve raised so far.
JIM: Well, let’s begin with the big worry which is the dollar. The big worry obviously is the US monster trade deficit. Last year the trade deficit was 6 ½% of GDP, this year the trade deficit will be even bigger – probably closer to 7% GDP. However, to counteract that, the issue at stake here is that it’s in nobody’s best interest right now to see the dollar collapse. Let’s face it, John, we’re like a giant aircraft carrier: if we go down we take Europe and Asia with us. You have to remember nobody wants a strong currency. When the dollar was depreciating against the euro, you already heard central bankers in Europe talking about, “hey that’s enough, we don’t want to see our currencies rise too much,” because it hurts the only strong part of their economy which is their exports.
You saw in, Japan, for example when interest rates started to rise more than what the Japanese central bank wanted to see. As they’re trying to end quantitative easing the first thing they did is in one couple of days they injected 1 ½ trillion yen into the system. If you look at what’s going on right now, it’s just a matter of who is debasing their currency the fastest? So it is in everybody’s best interest to keep the dollar from plunging, and their own currencies from appreciating.
For investors, it’s really a case of picking your poison. For example, even the venerable Swiss franc is a fiat currency. Switzerland is less and less a hard currency compared to where the Swiss franc was in the 70s. Swiss interest rates are lower than everybody else’s but Japan. And if you take a look at the Swiss currency, the constitutional connection between the Swiss franc and gold was rescinded in the year 2000. And the Swiss joined the ranks of nations unloading their citizens gold to the tune of almost 1300 tonnes, or roughly half their holdings. So the Swiss franc is really no longer packing the bullion of the reserves like they used to. The franc is a fiat currency trading on its reputation just like any currency out there. [7:59]
JOHN: Where is all of this going to wind up?
JIM: I think ultimately we’re going to move towards three major currency blocks: the amero – I’ll just nickname it and call it the ‘amigo’ –
JOHN: I’ll guess the French Canadians can call it the ami or something like that.
JIM: Yeah, yeah, it’s just easier…the amigo is the one that strikes me…
…which will be the emergence of the Canadian dollar and the peso. Then you also have the euro and ultimately you’re going to have the ‘aso’ –I don’t know – some kind of Asian currency that they’re talking about; a currency block that maybe will be anchored around the yen or around the yuan. In the interim however I think the ultimate currency, like a phoenix rising from the ashes, is gold and silver, and that’s what I think the rise in gold and silver over the last 4 or 5 years has been telling us.
However, until that system implodes, the dollar will still function as the world’s reserve currency although it’s going to supplemented by other currencies. However, it is still the safe haven of all the currencies given the size of our economy. And what replaces it? The euro is not ready to replace the dollar – it’s a fiat currency just like ours. And the Chinese yuan, or the Japanese yen isn’t ready to replace the dollar.
So until the whole system implodes the dollar will still function as the world’s reserve currency. Although, I think it’s going to be supplemented by other currencies. You have a lot of the central banks right now that are diversifying their currency holdings. Less dollar holdings though they consist of a portion of their currency reserves, but you’re seeing a move into yen, into euros into other currencies. However, the dollar is still considered a safe haven of all currencies despite our trade deficit. There’s nothing on the horizon that is ready to replace it. The euro is not ready to replace the dollar nor is the yen, or the yuan. [10:00]
JOHN: Let me just ask a sort of curious question. If we get this new currency the amigo which everybody else is calling the amero, now is this going to be a fiat currency as well or is this at least at the start going to try to anchor it to something like gold or silver?
JIM: They’re going to try to maintain the fiat system as long as they possibly can. However, until any currency is anchored by gold in some form or another that prevents the central banks from inflating their currency you’re going to have the same problem. The central bankers are trying to act like alchemists with the hope that you can take a fiat currency with nothing backing it and turn it into gold which functions as true money. It’s just not going to work.
Ultimately when all of this implodes we’re going to head towards a universal currency – some sort of global currency. And the only way you’re going to be able to restore confidence in money as it gets debased and depreciated around the globe is to back it by some hard asset, and throughout history that hard asset has been gold and silver. [11:05]
JOHN: At least in the beginning, because as you know Jim, historically rulers and bankers just can’t resist the urge to start inflating the currency. So sooner or later they slide off that standard, but that would be interesting to see where they go with it.
Ok, let’s move on to the next major worry. We keep hearing about the dynamo that China is, but China is really facing some serious problems a lot in the West aren’t watching: they have an overheated economy.
JIM: Sure, but China has a problem and it has one of the world’s largest populations. In fact between China and India you have almost 50% of the world’s population. So, China needs to create roughly about 10 to 15 million jobs annually or they face labor unrest. So it has basically two options in dealing with an economy without triggering a crash. They can raise interest rates in the hope of lowering the demand for money or borrowing, or they revalue their currency. Either choice becomes difficult. If they raise interest rates then there’s a possibility they can trigger a collapse in their overextended property market, or worse, collapse their banking system. It’s been estimated that almost 40 to 50% of the loans on the books of Chinese banks are virtually worthless. They’re in default.
Then they will try to pursue maybe on a limited basis, like the Fed, of raising interest rates gradually. It’s probably going to take the Fed almost 20 to 27 or 28 months to raise the Federal Funds rate back to where it was before they started to lower it. So you might see China gradually raise interest rates but not enough to trigger a collapse. I think if we look at China today, it is very much like the US in the 1920s. It still has the best long term growth prospects especially with 1.3 billion new consumers. So I think they’re probably going to pursue growth until they can build up their infrastructure and consumer class. [13:07]
JOHN: But they also have another issue too, it’s more of a political one, we have the Olympics coming up in China in 2008. And it’s really not in their interests at this stage of the game to collapse the economy.
JIM: Sure. So I think they’re going to try to continue, maybe they’ll revalue their currency somewhat they’ll do it in stages, not enough to throw their agricultural products and their farmers out of jobs. There’s 300 million Chinese that are involved in farming – the last thing that they want to do is destroy their agricultural base. So, I think you’ll probably see them pursue limited means, maybe gradually raising interest rates, or gradually revaluing their currency. [13:46]
JOHN: Alright, let’s look at something closer to home. We obviously look at the housing bubble. Is this going to be a boom, bust or a recovery?
JIM: I think what we’re going to do, we’re obviously experiencing some pain right now on a slowdown. However, if they can stabilize interest rates, slow the economy down, then there’s a possibility that you could see long term rates come down, which would allow this 1 trillion to 2 trillion of adjustable rate mortgages to refinance, to lock in a lower interest rate. Also, if they can reinflate the stock market that helps to stabilize the real estate market and what you get is what happens in England and Australia. That’s what I think they’re aiming for. You get a slowdown but not a crash. [14:32]
JOHN: And inflation’s obviously on everyone’s mind.
JIM: Well, I’ve contended they needed to hammer the commodity markets which is what they did especially the gold markets. They took gold down $175, the CRB Index down 10%. Commodities for example such as copper are down 85 cents. So this is going to feed into the producer price index and the CPI going forward. They brought down inflation expectations, and that’s the reason you’ve been seeing the Fed Open Mouth Committee very active here in the last 30 days.
And I mean if they had to take down the financial markets such as the stock market with it, so be it. But their main objective was to get commodity prices down because that was what everybody was focusing on, especially the gold price. We’re now starting to see economic growth weaken across the board. You take a look at any of the big ticket items in an economy associated with credit –housing, autos, retail sales, durable goods – the economy is slowing down rapidly.
And I think once, John, the market is convinced of that talk will turn to a recession or a slowdown and when that happens you’re going to see psychology change, and the next worry will become deflation or disinflation. And if that happens that’s going to be favorable for financial assets, which is what central bankers want. [15:54]
JOHN: You know I always look at this relationship between housing and inflation, and I think even if housing starts to roll off the top inflation is going to meet it coming the other way. It should be an interesting interaction.
JIM: There’s no doubt they’re trying to cool down the economy prices, slow the speculation that was going down in the real estate markets. Certainly if there was a bubble anywhere it had to be real estate. And I don’t think we have a bubble in stock prices – we’ll get to that in the next section, that’s going to surprise a lot of people. The real bubble was what we were seeing in real estate. With housing prices going up 15-20%, housing prices here in the last 3 or 4 years have doubled. In your neck of the woods, I imagine you’re telling me the same thing. [16:38]
JOHN: We’re close to 300%, depending on when you bought it.
JIM: So, they want to slow that down, they’ve hammered the commodity market. If they can keep that down for a while, as I mentioned, that’s going to transfer into the PPI and the CPI indexes. So they’re going to try to give us that sort of what we call the ‘soft-landing.’ Now, I think in certain parts of the economy we’re already in a recession, especially in certain areas of manufacturing, but if you have a few areas of the economy that are weakening –they’re in a recessionary mode – however if you can keep the other areas such as service, finance, and assets rising then you get the slowdown which is what I think they’re aiming for. [17:25]
JOHN: Alright, let’s go on to commodities, although really I think that’s been addressed by central bankers hammering down on the commodity markets, but take a whack at it here.
JIM: Remember back 2 or 3 months ago when gold was rising over 600 towards 700; we had oil prices at 75. One of the theses that we’ve developed here is that they needed to take down the commodity markets before they could go on hold. I mean let’s face it, you can’t have the Fed go on pause – as we’ve talked about so many times on the air here – with oil at 75, with gold at $700, the CRB hitting new records day after day, copper prices at $4. Nobody would buy that argument. So, they had to take down the commodity markets which they did, and they’ve done a good job when you consider where they’ve taken gold prices, and also the CRB Index.
They had a lot more difficulty with the oil markets but I think that could be solved if you can take some of the geopolitical risk premiums out of the price of oil, because there’s probably a $10-15 geopolitical risk premium factored into the price of oil. And if let’s say, for example, we make peace with Iran, we begin to pull troops out of the Middle East, things go better in Iraq, then there’s a possibility you could take part of that political premium out. I think also, if this year’s hurricane season is benign, in other words we don’t see what we saw repeated last year as we did in 2004 with Charlie, and then of course Katrina and Rita in 2005. So if we can avoid some major hurricane damage to the Gulf region I think that can help bring down some of the premium in oil prices.
However, the fundamentals remain in place on commodities. You’ve got a growing world population, especially in China and India. You have no major supply coming on line in the area of oil; you don’t have that going on in the gold markets, copper markets; you have growing emerging economies; and at the same time you have global monetary inflation. All of those add up for strong fundamentals for a commodity bull market. [19:33]
JOHN: What about emerging markets?
JIM: I think what you’ve seen over the last month – and especially as part of the yen carry trade was unwinding, and as Japan took some liquidity out of their market for a six week period – is you had risk being repriced into the market. And remember, we got very complacent whether you were looking at the VIX, or credit spreads. There was a lot of hot money that was moving into the emerging markets; that was the hot play in the last couple of years along side commodities. But a lot of that has been taken out of the market. The hot money has exited this sector, and you have maybe a little bit more room on the downside, but ultimately if you look at the emerging markets that’s where the major economic growth is going to take place in the future. [20:22]
JOHN: As Whoopi Goldberg said, “let’s walk it on down here.” If we have to make a picture out of all of these trends, pull it together in one portrait.
JIM: I think they’re going to try to make sure they keep the commodity markets down. In other words, they don’t want to knock gold down from 728 down to 550, and then have it go right back up to 650-750. So I think the commodity markets are in for a short term period of consolidation. I think until the Fed finally goes on pause, and gives some language that we’re almost there, I think they’re going to take the Federal Funds rate to 5 ½%. What you’re likely to see over the next two months are choppy markets for the rest of the Summer, at least for the next couple of months or at least until the Fed goes on hold.
Then once they go on hold, then I think you’re going to see this reflation cycle begin. Remember, when the economy begins to roll over and slow down, it continues to slow down. And as we get more and more weakness as we get into the second half of the year you’re going to hear talk about a slowdown, you’re going to hear talk about a recession; and then you’re going to hear talk about deflation, disinflation. And when the markets start getting focused on that that’s going to give the central banks the cover to reflate. Once again, I hold on to my prediction that this year you’re going to see a record in the Dow Jones Industrial Average. In other words, we’re going to take out the old record of 11,700, we may see 12 or 13,000, maybe as high as 14,000 over the next 12 months. [21:56]
Emails and Q-Calls
JOHN: Alright, Jim, let’s go over to the Q-Line and see what has been queuing up there the entire week. Don’t forget the Q-Line number is 800-794-6480. It is toll-free in the United States and Canada. You can reach us from the rest of the world on that number but you have to pay for the call unfortunately.
Hi Guys, my name is Robert I’m in Sholo, Arizona. I want to compliment you on the show, I listen every week. Here’s my question. Do you think this big dip in oil stocks, as well as gold, is also the kind of market manipulation that you guys were speaking of, that Jim was speaking of, that we might expect he was mentioning in relation to gold stocks? And I’m curious how does the Fed do this? How are they able to do this? And then I also wonder if the economy is going into the tank won’t it take all stocks down, even companies that stand to do well such as energy and gold? And I wonder if puts aren’t the way to go in such a market. Thanks.
JIM: Ok, Robert, how do they take down the commodity complex with gold? They do it with derivatives, and we’re going to talk about that in next week’s gold roundtable, but you can increase your leverage and drive gold down through the paper markets. The paper markets control the actual physical market, it’s sad to say but that’s the way it goes. And how do they do that? They do it through bullion banks; they can lease out their gold; they can use the derivative markets to take that complex down.
But getting back to is this taking place in oil stocks I think the problem that you have with oil stocks, and you can see this whether you read Value Line, or you take a look at the oil analysts themselves is the analysts on Wall Street just don’t believe today’s higher oil prices. In other words, if the economy is slowing down because the Fed’s raising interest rates, demand for energy should be slowing down but that’s not taking place. Energy demand is growing globally, it’s growing in the United States, it’s growing in Asia, it’s growing in Europe – we’re consuming more energy each year. And despite the higher prices most Americans have adapted, I mean there is a little bit of conservation but just look around you and take a look at the type of cars Americans are driving today. And I think one of the main reasons that you’ve seen oil stocks not do well, number one, is their earnings are growing faster than their stock prices, but I really believe there’s just a disbelief, eventually – you hear this all the time, “well, next year oil will be at 40, or it’s going to be at $50 a barrel” – but I just think there’s a lack of belief.
And then finally, if the economy begins to slow down believe it or not that will be a positive for the market. It sounds counter intuitive, but this economy functions more on where interest rates are headed than where economic growth is headed. And despite the series of interest rate hikes we’ve seen over the last couple of years we’ve seen a lot of the profit growth continue. In other words, the best sector out of our whole economy that is in best shape are corporations. Individuals and government are going deeper into debt; corporate balance are flush with cash.
But what I do think you’re going to see is a rotation into larger cap blue chip companies that have stable business models, healthcare, consumer staples. In other words if the economy is slowing down what kind of businesses would be immune to that kind of slowdown: companies that provide an essential service; products that people have to have, that have predictable growth rates. That’s where the next rotation is taking place. And I want you to listen to the second segment of the show where we address this issue. [25:48]
Hi Jim and John, this is Mark up in Reno, Nevada, and I was calling because, Jim, I know you’re expecting a soft landing for real estate, but I have never seen such excessive leverage. I’m seeing exponential increases all over the country in the number of listings. I know that San Diego recently had their biggest one month drop in history in prices and this is showing up in some of the historically hot markets over the last several years. It’s now estimated that one third of all loans made over the last year are negative or upside down. And then over the past several years I guess 45% of new buyers were nothing down, piggy back loans, people singing choir in church declaring $100,000 incomes for no doc loans – things like that. So there seems to be evidence of a tremendous slowing as also look at the home builders down 50% since the 1st of the year is a bell weather of what’s to come. So I don’t understand how there can be a soft landing with all the resets and weak incomes to support existing, much less increasing, mortgages. And 40 and 50, and 100 year mortgages do not significantly reduce payments, particularly with the reset at a higher rate. So I’d really appreciate it if you could explain that to me because I don’t see that happening. Thank you. [37:13]
JIM: Well, in the first place, in areas that are over heated, for example Southern California, Florida, you’re going to see some pain, especially in overbloated areas too like Las Vegas. But you’ve got other areas of the country right now that are doing very well, for example, Texas because of the oil boom. So, it’s almost like in real estate it’s an arbitrage situation
In an economy when you have a bust the first area to go bust are your marginal buyers. And the marginal buyers are going to get in trouble. You’ve got to remember a lot of people have locked in low rates for a long period of time, so what you’re talking about is those marginal buyers on the fat tails of that bell shaped curve. And they’re in trouble – it doesn’t matter what they’re going to do. And there’s going to be foreclosures, you’re going to see increases in bankruptcies, in that area. You’re already starting to see that. But if they can contain the damage to the marginal buyer, and then reinflate the economy, then you don’t get a bust.
And if I can give you an example, go back to the 91 recession where you had real estate lead that recession with the savings and loan bust: you had properties dropping 30 and 40%; you had a lot of financial situations going under and what the government did is come in and swept it up, formed the RTC Corporation, reliquified banks, and remember back in 1991 you had banks such as Citibank on the verge of bankruptcy. They reliquified the banking system through what was the original carry trade where banks borrowed from government, then they turned around and invested in Treasuries made the difference in the spread. that reliquified the banking system, they printed a bunch of money and allowed the banks to get flush with cash again, and then they liquidated the real estate. I was very actively involved in that market buying property and you could buy that property at let’s say 50 to 60 cents on the dollar. If there was a million dollar loan on a property you could offer the banks $600,000. And they liquidated that and we never did get deflation. We got a big downturn in that real estate market but they stabilized it, liquidated it and I think that’s exactly what they’d do again. [29:39]
JOHN: And having handled a few Q-Line questions here, don’t forget you’re listening to the Financial Sense Newshour here at http://www.financialsense.com/, that’s like making sense of something. The new program is posted is posted every Saturday morning by 0700 hours Universal Coordinated Time. That works out to 3 o’clock in the morning Eastern daylight time. And Jim, as you well know, if we don’t have them posted we really began to hear from Australia and Hong Kong early.
JIM: Yep.
JOHN: Because it’s evening there by the time these go up.
Time for our first guest here on the Big Picture. An interview with Peter Schiff. [30:31]
Other Voices: Peter Schiff, Euro Pacific Capital
JIM: Well, the financial world seems obsessed with the word inflation: you can’t pick up a financial publication, turn on a financial station and everybody is talking about inflation. But inflation, what is it? Last week there was an interesting debate that took place on CNBC between Peter Schiff and Diane Swonk, and now joining us on Other Voices this week is Peter Schiff.
Well, Peter, that was quite a debate. It really strikes me today that people really don’t understand what causes inflation. We talk about the symptoms but we never talk about the cause.
PETER SCHIFF: Well, of course. The government and I would love to set in with the government but they want to confuse the public, they don’t want us focusing on the cause, because then it would be obvious why there was inflation, they want us focusing in on the results so then they can lay the blame for inflation on somebody else, like greedy corporations or big labor unions, or OPEC; or anybody but themselves. But what they’re doing is trying to get us focused on the results of the inflation, and distract our attention from what inflation really is which is an expansion of the supply of money and credit, and we know exactly who controls that. [31:42]
JIM: Peter, why do you think it is economists like Diane Swonk do not recognize inflation for the roots – in other words, if you bought a house for 100,000, and it’s gone up to 500,000 that’s a bull market. If you bought an Internet stock at a buck or 5 bucks when it went public, and it goes to 100 as some did in the tech bubble, that’s a bull market. Why do you think Wall Street has a hard time…
PETER: Well there’s two reasons. First of all, Wall Street is happy when stock prices go up, they couldn’t care less if it’s inflation that’s driving them higher, or actual earnings that are driving stock prices. They want a bull market, so they don’t care how they get it, and they’re going to justify it. They certainly have a vested interest to the extent it drives up the prices of the products that they’re pushing. But I think the understanding goes a lot deeper than that – basically, it’s this conception that inflation is just rising consumer prices, that if consumer prices aren’t rising, or if they’re not rising that rapidly that there’s no inflation. But the problem with inflation is it could be present even if consumer prices aren’t rising, it could be present even if consumer prices are falling, because the problem is the natural tendency for prices in a market economy is to fall. As there’s economies of scale, greater efficiencies – prices should be falling every year. And you can certainly see this when it comes to things like computers, plasma TVs, digital cameras, cell phones – you can see that prices are falling.
Now to the extent that the government creates a lot of inflation –they expand money supply, they debase the purchasing power of money – they might prevent prices from falling when they otherwise might have in the absence of that inflation. That’s just as damaging, because that’s still robbing the savers and the public of their purchasing power; they’re taking away the benefits of lower prices. But when you have these economists that don’t understand that; in fact, the government has everybody brainwashed into thinking that falling prices are somehow dangerous to society, and that the government needs to be out there making sure that inflation is some positive number because the worst thing that can happen according to the government and Wall Street is that consumers got a break and the cost of living actually fell. And this actually stands reason on its head. It’s tantamount to propaganda that the government can actually pull this off, that it can pull so much wool over so many people’s heads to get them to believe that black is white. I mean how could you really make an argument that falling prices are somehow harmful to society, that the cost of living going down, that if it becomes cheaper to heat our homes, educate our children, to feed ourselves, if all the goods that we want become less expensive, that somehow this is a bad thing, and that the government needs to spare us from this. It’s amazing. [34:55]
JIM: Yes, because that actually the purchasing power if the prices fall everybody’s standard of living benefits from that.
PETER: Of course, they make these phony arguments that say well if prices were going to fall consumers would stop spending because they would wait for cheaper prices. Well, this is absolute nonsense because in real life that never happens. I mean sure, people only wait for cheaper prices if they can’t afford higher prices but people buy cellphones and they buy computers and TVs all the time knowing full well they’re going to be cheaper in the future. The problem is they want them now, and they buy them, and then they make the argument well, corporations can’t make profits if prices are falling which is nonsense because the cost of production is also falling so their margins are intact, but the bottom line is as prices come down they sell more units. I’m sure that Samsung or Sony or these other companies that make flat panel TVs are making a lot more profits selling them at $1500 a pop, than when they were selling them at $10,000 a pop, because a lot more people are buying them for $1500. The cost of manufacturing has come down so much that they’re making more money selling them at $1500 than when they were selling them at $10,000. So everybody is benefiting from falling prices; the producers and the consumers. [35:50]
JIM: Well, this is one of the things that Henry Ford recognized that if he could bring down the cost of a Model T he’d sell a heck of a lot more cars, and make a lot more money. I mean this goes back to America’s great productivity gains in the early part of the 20th Century.
PETER: But you’ve got the public so brainwashed by the government that uses inflation as a tax, that uses inflation as a way of transferring purchasing power from the public to itself, and then goes and spends it in circulation on vote getting schemes so they can play Santa Claus. And then you’ve got Wall Street kind of endorsing it, and this whole idea that prices need to rise every year, that this is somehow something that is beneficial to us, and they don’t look back in history and see from you know the 1790s to 1913 with the exception of the Civil War where we printed money for the first time we had falling prices for 140 years. We had the industrial revolution with falling prices.
And then the other problem with inflation that they overlook is the false economic signals that inflation creates. And inflation tends to create these boom-bust business cycles where when you expand money supply you initially send false signals to the capital markets which kinds of act as if there has been an increase in net savings. And it causes malinvestments which ultimately have to be liquidated when all that’s happened is inflation. And when prices start to rise these mistakes are exposed and you get these big business cycles. And so a lot of damage is being done through the creation of inflation even if it doesn’t immediately show up in the CPI.
But of course, ultimately all of this inflation, even though it temporarily found a home in the stock market, and then found a home in the real estate market, it is all ultimately going to reside in consumer prices. That’s where it’s going. But by the time consumer prices are spiraling out of control it’s way too late for the Fed to do anything about it. The time to do something about it was back in the 1990s. [37:48]
JIM: Peter, just out of curiosity your economic background, have you studied Austrian economics?
PETER: Sure, sure I mean I’ve read most of the Austrians, you know, from Von Mises and Hayek and Rothbard and yeah, I mean that’s basic economics. I mean there’s a lot of fairy tale economics, and I look at monetarism and Keynesianism kind of like that’s astrology, and Austrian economics is astronomy. You know it’s all fantasy, but that type of economic thinking was basically concocted by politicians or economists that are trying to justify a big role for government: that there’s something that government can do to make our lives better as far as interfering in the economy somehow. And the Austrian school basically shows there’s no role for government other than to stay out of the way. I mean they can be there to the extent that you can have a legal system to enforce contracts, and to provide us with sound money, but beyond that there’s really no tinkering that they can do to improve things. All they do is make things worse. [38:45]
JIM: But you know the problem, Peter, is if you’ve gotten an education in probably the last 40 or 50 years you were trained in Keynesian economics. If you go and study 3 years and get your CFA and work on Wall Street you are going to be taught Keynesian economics.
PETER: Oh yeah, you get brainwashed. Probably they wring your common-sense out of you. I mean probably somebody that has no education in economics whatsoever has got a better chance of understanding economics than somebody that’s got a degree from Harvard in economics, because they have to unlearn everything they’ve learned just to get back to zero. [39:22]
JIM: You know it’s funny because my son is studying for his CFA and we talk about economics, but I tell him I don’t want to confuse him so he can pass his exams. When he’s done with his CFA we’ll put you through the Austrian school so you can really understand.
PETER: Yes, I mean I had this knowledge from when I was a kid from my father who wrote books on the subject way back in the 70s. I went to school in Berkeley, and of course it was a very liberal economics department. In fact my poli-sci teacher freshmen year was an admitted Marxist and he was teaching government to freshmen. But when I would take my econ courses I knew the answers that the professors wanted and so I would answer in my blue book what they wanted, and then at the end I would put an asterisk and say, “look, this is what I really think, here’s how I really want to answer the question, but I can’t answer it this way because I’d flunk your course. So I’m going to give you the answer that gets me an A, but here’s what I really believe.” I did that all the time and I think they used to get mad, but I still got decent grades. [40:21]
JIM: Peter, you were on Wall Street, you’ve appeared on many financial shows, you’re quoted in the press, do you come across this bias as frequently as for example the debate that you had last week? The bias from the Keynesian perspective like nobody recognizing that hey, money supply’s growing at 8%, we’re going to have inflation show up somewhere.
PETER: See what they think is as long as prices don’t go up there’s no inflation, which is all nonsense because prices should be falling, and the fact that they’re not still means there’s inflation and it’s doing damage. But of course, they don’t even measure inflation now by rising prices, they measure inflation by a rising CPI. Or actually, a rising core CPI. So they don’t care how much the government manipulates those numbers as long as the government can keep inflation out of the CPI they’re not worried about it. Inflation isn’t even rising prices anymore, even though that’s the wrong definition, it’s now a rising core CPI. And the government can kick whatever it wants out of the core CPI.
But sure, my opinion is way out of the mainstream, and well in the minority when it comes to Wall Street. But I will tell you, I get a lot of emails, you know, whenever I’m on a national television show I get a lot of emails. I get emails from economists, I get them from university professors, I get them from scientists, and relatively intelligent people, I get them from people in Wall Street, from money managers that say, “right on, that’s exactly what I think.” So there are a lot of people within Wall Street, within academia, that think this way. They’re just still in the minority but they are out there, and they do have a significant number. But you know, we’re certainly a minority.
I think too a lot of people think stations like CNBC or Bloomberg actually try to keep people like me off the air, that they don’t want this point of view to come across. I don’t think that’s necessarily true. I just think that there’s so few people with my point of view, and if they do have it they’re not in this profession. I mean you and I are pretty unique, there’s not too many people in the financial industry helping people with their money that have this perspective, and even fewer of us who are putting ourselves out there to be guests on these programs. Because you pretty much have to approach them, they don’t really approach you until they know about you and you get in with the producers. So there is no real conspiracy to keep me off, or to keep anybody off, I just figure so few people in the financial industry have my point of view so we’re just not going to be there.
And of course, the advertisers they want to get people into the stock market so of course most of the people that are going to be on these shows are going to be talking the bullish case for the market, because the advertisers are all advertising mutual funds and brokerage services and things of that nature. [43:08]
JIM: Well, you know it was amazing, in graduate school I was taught Keynesian economics – that’s what I came out of academia with, but it wasn’t until the October stock market crash in 87 that things started happening and I said, “you know, something’s different here.” And that’s when I discovered Austrian economics, and all of a sudden I had to relearn economic thinking in terms of what drives the economy.
Peter, you have a radio show that you do live every week, why don’t you tell people about it?
PETER: I do it every Wednesday, and it started out really as a courtesy to my clients because it enabled me to talk to thousands of clients –theoretically, if they tuned in all at the same time – and give everybody an update on what’s going on. I do a live show, it’s a call-in show, and you can either listen to it on my website which is at http://www.europac.net/, or if you happen to have a shortwave radio, you can listen to it on shortwave as well. And I forget, but on the website it will tell you what frequency it is on the shortwave. You guys are out on the west coast so it’s five o’clock Pacific time, and eight o’clock Eastern time. So if you listen live you can call in. If you missed the live broadcast, usually within a day or two of the live broadcast it is archived on my website. In fact, if you go to the website now there’s about a year and half of programs in the archive – they can be played and the more recent ones are in a format where they can be downloaded to mp3 players. [44:38]
JIM: Alright, well, Peter as always, it’s a pleasure to have you on the program, hope you’ll come back and talk to us again.
PETER: Yes, anytime, you know, you and I have a lot in common there’s not too many people with our perspective, and I also understand that you’re a sailor that’s another thing that we have in common.
JIM: You’re a sailor, huh?
PETER: In fact, when I moved out here I brought my boat out here from Newport Beach, have it here now in Long Island – the Long Island Sound here in Connecticut. [45:01]
JIM: Well, listen, thanks for being on the program and if you’re ever out on the West coast…
PETER: I still get out there, I still have an office in Newport Beach. The next time I’m out there…
JIM: Yeah, give me a call I’d love to take you sailing. [45:14]
Sitting Bull
JOHN: Well, Jim, as we move into segment 2 here of the Big Picture today, you know we’re hearing a lot about the Hindenburg Omen out there (“Oh the humanity”), three peaks and a dome, bear market etc., etc., but I know you and Frank Barbera have been talking about this quite often, and you two just don’t see this.
JIM: I really don’t. Frank’s been looking at the markets technically, and I’ve been looking at the markets fundamentally and I know that we’re sort of out on a limb right now, but that’s alright, I feel kind of comfortable when we’re sort of going alone with what everybody else is saying. Frank wrote a piece which he put up on our website Bull or Bear Market, or Just a Bear Market Correction.
One of the conditions for a crash is when you really get things to a maniacal state in the market, very much like you remember what is was like between 1997 and the first half of the year 2000 where everybody and his brother was getting rich investing in tech stocks; or even going back to 1987 when you had the stock market up like 38%; the PE ratios were the highest that we had seen them in that decade; and of course the Fed was raising interest rates just like they are now. But basically from April to October of 1987 you had interest rates go from 7 to almost 10 ½% in a very short period of time as opposed to today, because of the leverage in the economy, [the Fed] has had to go very slowly. I mean it’s going to take the Fed over 2 years – let’s say 2 ¼ years to get the Federal funds rate back up to where it was before they started lowering it.
So what I did is I said, ok, if we’re going to have a crash, then are stocks overvalued? In other words, is this really the mania type thing that we were seeing in late 1999 and 2000, or in 1987, or in similar periods like with the nifty-fifty in the early 70s. And I took a look at the basic Dow 30 stocks, I took a look at the current price of the stocks then I computed the intrinsic value for all 30 stocks, and I wanted to look at where their prices [were] versus their intrinsic value; I looked at earnings for the Dow versus 2005 and 2006; I also looked at PE ratios historically from their highest points to where they are today. [47:54]
JOHN: And what did you find?
JIM: It was amazing. Out of the Dow 30 stocks, 19 of the 30 stocks were selling below their intrinsic value so roughly 63% were below what I call justifiable values, and that was sort of a benchmark. In other words, if you’re looking at stocks in terms of are they valued or overvalued, what do you use as a benchmark? And of course, coming from the value school we like to compute intrinsic value which is really discounting future cash flows for the business.
The other thing that I found, out of the 30 stocks in the Dow, 22 out of the 30 had higher earnings today than they did in the year 2000, which is roughly about 73%, or almost three quarters of the Dow stocks. So we had a rising earnings trend.
And then the other thing I did is I took a look at the PE ratios of the Dow stocks, and I said Ok, what was their highest PE ratio? All 30 are selling well below their peak price earnings multiples. In other words, so even though we’ve seen a trend of rising earnings for almost three quarters of all the Dow stocks, we’ve seen declining PE ratios – in many cases almost as much as 30 to 40% of the stocks are actually selling at lower prices than where they were let’s say 5 or 6 years ago. A good example would be stocks like Microsoft, stocks like Walmart, General Electric – a lot of the growth stocks that people were mortgaging their kids to own and buy at any price. And let me just give you a… [49:31]
JOHN: Yeah, it would be good if you could give us some examples here, Jim.
JIM: Let’s just take a couple of companies. We’ll start out with 3M.
In 2000, 3M had earnings of 1.8 billion, in 2005 they had earnings of 3.2 billion. 3M’s PE ratio has dropped from 30 down to 18.
Let’s take consumer staple company Altria. They had earnings of 8 ½ billion in 2000. Their earnings last year were 10 ½ billion. Their PE ratios dropped from 50 ½ down to 13.
Let’s take some venerable growth stocks. We’ll take a look at Microsoft. Microsoft’s earnings have gone from 9.4 billion to 12.3 billion; Microsoft’s PE has dropped from 74 in January of 2000 down to 17 today.
Another company, take a look at consumer products company Procter & Gamble. Their earnings have gone from 3 ½ billion to 7.3 billion, their PE ratio has gone from almost 39 down to 20.
Let’s take a look at another company – General Electric. General Electric’s earnings have gone from 12.7 billion to 16.4 billion. General Electric’s PE ratio has dropped from 51 down to 18. And by the way, General Electric is moving very heavily into alternative energy.
And this was something consistent that I saw all the way across the board.
The other thing I did is I went and took a look at what I call sustainable earnings. And what I mean by sustainable earnings is the way a company can grow is, let’s say I earn a dollar per share, let’s say out of that dollar per share, I pay out 50 cents in dividends, so I get to reinvest 50 cents in the business. Or to turn it into dollar terms, I earn a million dollars, I pay out 500,000 in dividends that leaves me with 500,000 in cash and earnings. I can reinvest that 500,000 in earnings.
Well, the next thing that you have to take a look at is what’s the return on equity or the return on assets. In other words, if a company reinvests its earnings what is its return on those invested earnings which is return on equity. And so we use something in the financial industry which is what we call sustainable earnings growth which is really: (return on equity) x (the amount of earnings retained in the business).
And as I looked at all of the sustainable growth rates of all the Dow stocks it was just amazing, John, I saw growth rates from 19 [stocks]; almost 60% of the Dow stocks had sustainable growth rates in the teens anywhere from Procter & Gamble which was in the high double digits; all the way to Caterpillar; to companies like AIG; American Express; 3M. All the way across the board, very high return on equity, by the way, for the industry as a group: 32% for 3M; 30% for Altria; 27% for American Express; 17% for Boeing; 33 % for Caterpillar. And I can go on and on and on.
So, as a summary, what I was seeing over 60% of the companies were selling below their intrinsic value; over close to 75% of the companies had higher earnings growth; all 30 of these companies were selling below their PE multiples; and then everyone of these – or the majority of these – had high sustainable earnings growth. In other words, the internal mechanics of the business itself was generating sustainable growth. And this isn’t the kind of thing that you would see if leading up to a crash where you had a bubble in the company.
I mean, if we look for example when we were looking at price earnings multiples – I mean Hewlett Packard was selling at almost 90 times earnings at the end of the tech bubble; it’s selling at 16 times earnings today. You take a look at companies such as Microsoft that were selling at 74 times earnings versus 17 today; Procter & Gamble, 39 times earnings versus 20 today; Walmart 58 times earnings versus 17 today; General Electric, 51 times earnings versus 18 today. So we’ve seen earnings go up, PE multiples compressed, you also had higher rates of return on equity, companies are buying back stock. This isn’t what I was seeing in the year 2000 when I was writing the Perfect Storm. I would say you would see more of this kind of bubble type talk in the real estate market which is now rolling over and softening, than you would see in the stock market. [54:37]
JOHN: Ok, if we assume that the economy is indeed slowing down – which is your position then – how does this translate into higher stock prices?
JIM: Well, let’s take a look at the economy, and I want to give an analogy, something I learned in the 90s. In 1994, you had record earnings on the S&P 500. And literally earnings were up 25-30%, and in many cases 40% that year. So, one would have thought, wow, with record earnings like that you would have seen the stock market go up. It did go up but it only went up like one or two percent, because in 1994 we were going through a little bit of an inflationary concern by the Federal Reserve – they virtually doubled interest rates in a single year. And we got a little bit of a fall out with Orange County; we had a blow-up in derivatives; and the stock market went virtually nowhere. It was up a couple of percent. It wasn’t down but we virtually went nowhere because there was this instability because of interest rates.
The following year in 1995 the Fed steps on the pedal in terms of M3 growth – I mean M3 growth from November of 1994 all the way leading up to the bubble and its aftermath in the year 2000, the Fed stepped on the pedal and money growth was growing at almost double digit rates. And the following year in 1995 earnings were up only 15-20%. They were up half of what they were the year before, but that year the stock market was up. So interest rates play a greater role in our economy than earnings almost. And so I do expect the economy to slow down. In fact, if you look John what we are seeing right now is the traditional front end slowing of an economy. All the sectors of the economy having to do with credit. For example, housing is slowing down and of course we know when housing slows down there’s a direct correlation with consumer spending so hence we’re seeing a weakening of retail sales.
Also, in addition to housing, the other things associated with credit: automobile sales are in a downturn; luxury goods are slowing from boats, to planes to automobiles. And what you’re also seeing is risk is being repriced in the market, from emerging markets to junk bonds. So the economy is slowing down, but it is because the economy is slowing down that eventually the Fed is going to have to take its foot off the brake and then once again start hitting the gas pedal. [57:15]
JOHN: So, Jim once again your synopsis of what you’re going to see in the economy.
JIM: Assuming, now this is a key assumption here, assume the Fed goes on hold maybe after August, they take the Federal Funds rate to 5 ½%, they’re going to have to go on pause, and once the Fed goes on pause, and as you see more economic weakness that’s going to lower the inflationary expectations. And assume they can keep commodities under control, then what I think you’re going to more likely see, John, is a growth recession or a stagflation. And then I think you have to ask yourself what will do well under a stagflationary growth recession type economy?
What you have to look at is where that money is going to be spent. You’re still going to see infrastructure spending, especially in the energy infrastructure, alternative energy, water, you’re going to see money spent on food, you’re going to see money spent on consumer staples. So what I think you’re going to see take place is a rotation from small to large caps. Especially large caps can benefit, especially if the dollar goes down, because usually large cap companies are international companies and you know if you get your sales in euros or yuan or Japanese yen and the dollar’s going down that translates into higher sales. The other thing that I think you’re going to see do very well is consumer staples – in fact a lot of these companies are very undervalued right now. [58:42]
JOHN: Well, it would seem like we’re some evidence of what you’re talking about just by where the averages are playing out right now.
JIM: Sure, you’ve got year to date the Dow’s up 2 ½%, and the NASDAQ is down about 4%. And so you’re seeing this rotational move into the big large cap stocks as reflected in what you’re seeing happen in the NASDAQ or the high beta type stocks. You’re seeing people get more defensive so you’re seeing consumer staple stocks hold up very well. And I think that’s where you’re going to see a gravitational pull by fund managers because you have to ask yourself a question. If the economy is slowing down what businesses are going to be immune to an economic slowdown? [59:25]
JOHN: Well, assuming Jim that they’re going to take things down for a while, not way down, and that sooner or later just to keep everything going they’re going to have to reflate, if you’re going to invest in this environment you’re predicting where would you put your money?
JIM: Well, consumer staples. I mean people have to buy toilet paper, they have to buy deodorant, toothpaste; they have to buy food; they’re going to drink beer and wine.
Healthcare: you know if you get sick you have to take medicine, you’re going to take that medicine.
Infrastructure plays, especially in the area of energy, and also energy itself. I mean just take a look at the headlines in terms of what we saw on Friday when you had Anadarko acquire Kerr-McGee and Western Gas Resources for $21 billion. A lot of these energy companies are selling at 6 or 7 times earnings and if you’re an energy company a larger energy company sitting with plenty of cash on your balance sheet, well, you could try and go into very dangerous parts of the world, try to find new oil or you could take a look around and ask who out there is cheap? And my contention is the financial markets have mispriced the energy market. You know, a lot of these energy stocks are not selling at $70 oil; they’re selling at $40 oil, or at least that’s what they’re being priced at. And don’t be surprised if what you’ve seen Anadarko do, you’re going to see others do the same thing. So, I’d definitely be looking at energy.
And then of course, with global central banks reflating in all currencies depreciating you definitely want to be going into precious metals. [1:01:13]
JOHN: Well, coming up in just a moment right here on the Financial Sense Newshour at http://www.financialsense.com/ we’re going to have another Other Voice. We’ll be talking to Ross Hansen, but first have you ever come to the conclusion that figuring out what the Fed is up to is more like a horse race that it is economics? Well, we have too.
FSN Follies: "Wall Street Downs"
Good Afternoon, Ladies and Gentlemen, welcome to the fourth race at Wall Street Downs, brought to you by Prozac where your mental outlook can always be bullish, and by Maalox for an investor, it’s more than a Maalox moment it’s a way of life. Now in new mint julep flavor.
[sound of trumpets]
Well, it is a beautiful sunny day here at the Downs, the horses are moving towards the gate, and they are Lots of Bucks, Clinical Depression, Stagflation, Smart Investor, Greedy Oil Companies, Bernanke’s Core, Economic Growth, Will He Raise It, and Rising Prices. And it looks like most of the horses…Whoops! Aha, they’re having trouble keeping Economic Growth contained in that gate. it’s hard to slow that horse down, he just wants to run.
And they’re off in the fourth race here at Wall Street Downs, and Economic Growth broke right on top down the center Lots of Bucks, and Smart Investor broke extremely well, and Rising Prices up on the inside. And they’re joined by Greedy Oil Companies, and Bernanke’s Core on the far outside. Three wide comes with Stagflation, Clinical Depression and Will He Raise It off the early pace.
Now, they pass the stands for the first time and Economic Growth has a neck out in front, Rising Prices moving up on the outside and then it’s Greedy Oil Companies racing third. Smart Investor and Lots of Bucks being squeezed out of the leading pack. Stagflation moves up on the outside, and Bernanke’s Core followed by Will He Raise It on the outside. Economic Growth on the inside is caught, tight course, oh, that horse is being jousted by Greedy Oil Companies. Look Bernanke’s Core’s exceeding expectations, he’s hot on the heels of Rising Prices, he’s leading the pack, will he raise it. He’s one length back in third place, backed by long shot Stagflation in the fourth. Greedy Oil Companies, Economic Growth are back by two lengths with Lots of Bucks, Smart Investor, and Clinical Depression bringing up the rear.
And they’re coming into the final lap now with Rising Prices ahead by a nose, Economic Growth starting to roll now, trying moving up on the outside. Oh, no! Stagflation’s got economic growth up against the rail. Economic Growth stumbles, he’s fallen back. Bernanke’s Core’s at the top of the lane, Rising Prices ahead by a neck, Will He Raise It by a neck is starting to make his moves on the far outside.
And here he comes, as they make their turn for home. Smart Investor shut down by Clinical Depression. Lots of Bucks in the back of the pack. Bernanke’s Core’s gone ahead in front. Rising Prices full bore on the inside. Greedy Oil Companies on the far outside. Bernanke’s Core looking upside the race, as Bernanke’s Core at 12 to 1 wins by a length and three-quarters. Rising prices in second, followed by Will He Raise It, and Clinical Depression in fourth.
And there Ladies and Gentlemen you have it. Bernanke’s Core wins the fourth race here today at the Wall Street Downs, brought to you don’t forget by Maalox. Don’t forget, for investors, it’s more than a Maalox moment, it’s a way of life. [1:04:11]
Other Voices: Ross Hansen, Northwest Territorial Mint
JIM: Well, the metals have gone through quite a correction. Gold has dropped from 728 to today’s closing price on Wednesday of 590, silver prices are back down to 10.50.
To talk about the metals market, joining me on the program is Ross Hansen from the Northwest Territorial Mint.
Ross, we’ve had quite a bit of a pullback here, and I was just wondering what has changed in the metals market in terms of fundamentals. Are the fundamentals still there in your opinion?
ROSS: Well, Jim, the fundamentals have not changed at all. What has brought the price up to 22 year record highs in those markets are still there. We’re seeing strong demand overseas, we’re seeing strong demand from both investors and industrial consumers, and the like. So the fundamentals are still there. What we saw was just a natural and a healthy correction in the market. In all commodities we’ve seen oil come down; we’ve seen copper, nickel, gold and silver, platinum and palladium, all have corrected. And that’s healthy. [1:05:17]
JIM: Now, Ross, given the corrections that have come about last time we talked I think you were mentioning silver was one of the best buys in the metals market. Looking at the recent correction, in your opinion what’s the best buy today. Jim, I still love silver. I think the fundamentals on silver are just wonderful. You have to understand that 80% of the silver that’s mined in the world is a by-product of lead, zinc and copper mining. So even if the price of silver goes up dramatically you’re not going to see a tremendous inflow of new silver. And with all of the new technologies emerging that are using up silver, especially in the electronics and the photograph industry I think silver with a shortfall is going to continue to widen, and I think we’re going to see higher prices. I love silver as an investment. And the best form of buying silver that I like right now is either the 1 oz rounds, or 10 oz bars, or the 90% US coins – that’s the coins that were made in dimes, quarters and halves in 1964 and before. [1:06:21]
JIM: Isn’t that what they commonly refer in the trade as junk silver?
ROSS: It’s called junk silver, or bag silver, or 90% US coin silver. And that right now, the premiums have shrunk on that silver. Here you have small pieces of silver, you know a 10 cent, 25 cent, or 50 cent issued by the US government at guaranteed weight and purity and right now there’s almost no premium on that silver. So you can buy it at the market price of silver. [1:06:47]
JIM: Ross, given today’s price of silver rounds and 10 ½, what does a bag of silver cost?
ROSS: Right now a bag of silver is running at $7700 per bag; and you can also buy a fractional bag. We have the 10 oz bag, the ¼ oz bag, the half bag. So you don’t have to spend $7700; you can buy fractional bags at approximately the same premium. [1:07:08]
JIM: What about the silver dollars? What about their status? Are those more numismatic?
ROSS: They are. They fall in the numismatic category. An example right now is a silver dollar has about ¾ oz of silver in it, but unfortunately they’re selling for about $15. So to try to buy a silver dollar for the silver content it just doesn’t make sense. [1:07:31]
JIM: And that gets back to something that you strongly advocate and that is buy the metal and not the premium. Explain that again.
ROSS: Well, a lot of the especially the telemarketers and brokers they want to sell you numismatic coins: coins that have a coin collector’s value, or have a premium much higher than the metal content. And I don’t advocate that. What I believe is stick to the fundamentals of buying the metal, buy the metal in a recognized form as close to the spot – spot referred to is the current market price of metal – buy it as close to the spot price of metal as you can, in a recognized form, such as the bag silver issued by the US government; or in terms of gold, either the gold American Eagle, or the Canadian Maple Leaf or the Kruggerrand. When you buy the metals as close as you can to the premium, the dealer such as myself makes a very small commission. That’s why a lot of the telemarketers and the people out there want to steer you away from that. They’re going to try to put you in to numismatic items where their premiums are much higher, and they can make a much higher profit margin off you. [1:08:38]
JIM: Now, there’s something else that is I believe going to happen this week. The US Mint is issuing a new gold coin. Why don’t you tell us about that.
ROSS: It’s very exciting Jim. Right now, we have the US government is just releasing on Thursday the 22nd of June the first pure gold coin ever issued by the US Mint. And it’s based on a really old, unique design. It’s the American Indian Head nickel design, which has the Indian head on one side and the buffalo on the other, and it’s got 24 carat pure gold coin. And the premiums are actually very low. And not only is it a beautiful coin aesthetically, it’s pure gold and the premium is right. And those are being issued on the 22nd, and we’re taking pre-orders for them now. [1:09:31]
JIM: And Ross, I know you do coins, silver rounds, and things like that. Can you explain for our listeners the difference between coins and medallions because I know Northwest Mint makes a lot of medallions for the US government. Can you explain the collectibility or the difference between the two?
ROSS: I sure can. The legal term for a coin is an item that has legal tender status. And in other words, it has value that you can take to the store. You know, it’s either a penny-nickel dime quarter, half dollar or dollar, or some other fractional piece that’s issued by the US Mint. When we set up the Constitution of the United States they gave the authorization to make legal tender coins on to the US Mint. And the US Mint in this country makes all the legal tender coins at their four different mints.
But the US government contracts out to have medallions made. And we’re currently the largest maker of medallions for the US government. And what the medallions are these are items that do not have any legal tender status, but are given away by the commanders, for example the President of the United States has his own coin, all of the top leadership of the US military and many members of Congress and the Senate have coins which they call challenge coins. And these coins were coins that were started by elite military units, and now every unit in the military has their own coin. And if you get caught without your coin you’re in trouble, and if you get caught in the bar without it you’re buying the drinks. That’s the old military tradition.
The top commanders give away these coins as ‘atta, boys’ to deserving soldiers, and they also use them as business cards. So if you ever meet the Secretary of Defense for example and he’s really impressed with you, he might give you one of his coins if you’re fortunate enough. The Chairman of the Joint Chiefs of Staff has his coins made through us. And he gives out many of these coins to nice deserving young soldiers as ‘atta, boys’ for the exceptional work that they’re doing. And we make literally millions of these coins every year, and they’re carried with pride by all of our service men and people serving in uniform all over the world. [1:11:47]
JIM: And Ross, are any of these collectibles? Aren’t there medallions issued for commemorating events, or anything like that?
ROSS: We do do a lot of medallions commemorating a number of different events. For example, businesses that want to reward their employees for production or safety or long hegemony awards use us quite a bit. Many times when their people go a whole year without lost time or accident they’ll reward them with a gold coin, or a silver coin. Also people carry these coins as a new business card, they’ll have their names put on the coin and they’ll pass them out. People will throw your paper card away, but they’ll never throw a coin away that’s got your name on it. [1:12:32]
JIM: And Ross, can these take on the status of a collector’s item. In other words, the coins of the President, or the coins of all the Joint Chiefs of Staff. Do they have collector status?
ROSS: Oh, absolutely. In fact, if you ever get on EBay you’ll see some of the more senior member’s coins going for large sums of money because you know they only give them away to very deserving soldiers. And so for example, the Chairman of the Joint Chiefs gives his coins away to members of the military when he travels to Iraq for exceptional work and heroism. It’s kind of an unofficial medal.
So what you have is if a soldier gets a coin, or somebody else gets a coin they’re not going to give that coin up. They’re so proud of that coin that they’re going to retain that for ever and ever. And so if any of these coins do become available they have a very high market value, and some of these coins trade for hundreds of dollars. [1:13:36]
JIM: Do you get them in coin shops, do you get them at eBay, where do you get them?
ROSS: Well, people who want to make coins will come to us, and we’ll contract with them and we’ll also have foreign leaders, for example we’ve had different kings and foreign prime ministers around the world will use a coin as a badge of office and hang around their neck. And they’ll come to us and have these coins specially minted. And you can come to our website at NWTmint.com, and see over 1400 different items that we carry that are military challenge coins. [1:14:00]
JIM: And Ross, when they make these coins do they make them out of silver, do they make them out of gold? What is the metal content of them?
ROSS: Well, typically the ones that they’re going to give to the soldiers are usually made out of a brass, and many times they’ll have enamel coating on them that has some color to them. But on some special occasions they’ll make them out of gold and make them out of silver and platinum and palladium. [1:14:25]
JIM: How about the President. What’s his coin?
ROSS: His coin is a brass coin. And so is the Chairman of the Joint Chiefs of Staff. But on some special occasions they will give out some silver coins to head dignitaries. [1:14:35]
JIM: Ok, Ross, I’m looking at a chart of silver. I bought silver and gold from you this week. If I was to go out and let’s say buy silver from the mint, talk about your minimums and take us through the process. I don’t think people realize how easy it is to buy coins, or buy silver rounds, because a lot of people are thinking gosh maybe it’s easier to buy a stock. I’m not sure about going into futures, so take me through a process. Silver closed at somewhere around $10.52 in the futures market, I call you up today and place an order – take me through that process.
ROSS: Sure, Jim. What we would do is we will look at the current market price of silver ,and we’re going to quote you based on that market price of silver, and we have many different items and each of those items is going to have a different premium. Let’s just say for example a person called us up today, and wanted to buy let’s say 500 ounces of silver. We’re going to be looking at the current market price of silver, which is approximately $10.50, plus there’s a 55 cent premium. And that premium that we charge not only includes the manufacturing cost to manufacture the round, for example the 1 oz round, but it also includes are commission and the shipping. So, that price that we’re quoting is a delivered price.
Now, what you would do you would is call us up and place an order. We’re unique. Most of the precious metals brokers are going to require you to deposit monies ahead of time. And we’ve tried to make it easy for your listeners to have the ability to call us up when they see the market at a price that is attractive to them to be able to call us up and place an order without giving us any monies ahead of time. And then what we do is once we take your order we normally email you a copy of the invoice with our payment terms.
Now, we’ll take a personal check, and we’re really unique in that. Most companies will not take your personal check. We’ll take a money order, bank wire – however you send us the funds, each of those has a different clearing time. For example, when we get a personal check we hold the check 10 business days because we don’t have the ability to look in a person’s account to see if it’s cleared or not, and we just assume that after 10 days the check is cleared. Once the check has cleared we try to get all orders out within 10 days of your check clearing. Sometimes though, it depends on market demand, the [availability] of the different products, you know, sometimes for example the Royal Canadian Mint or the US Mint will get behind on their shipment of gold or silver to us. It can take us up to 30 days to ship your product once your check has cleared. [1:17:12]
JIM: Alright, let’s go on the reverse side. I need to pay for college tuition next semester I have a kid in school, I need to sell some of my silver. What do I do?
ROSS: Not a problem. You just call us up and we’ll just reverse the whole process. You tell us what you want to sell, we’ll quote you a price. And we’re going to lock you into that price, both when you buy the metal from us we’re going to quote you a price and lock you into the price at which it is at that very moment. So if you call us up and you want to sell some silver or gold or platinum or palladium to us we’re going to lock you into the current price, and we’re going to retain that price, whether it goes up or down, you’re locked in. We’re going to issue you a purchase order and we’re going to email you a copy of it, and we’ll send you your metal, or we can arrange to have it picked up. The day we get your metal we confirm it is what has been claimed then we turn around and fire you off a check – we can overnight you a check or we can send you a bank wire. [1:18:07]
JIM: Alright, well, Ross, I appreciate you joining us here on Other Voices, if our listeners would like to contact you please tell them how they could do so.
ROSS: Jim, it’s Northwest Territorial Mint, and you can call our toll-free line at (800) 344-6468, or you can visit our website at NWTmint.com, and one of our people will be happy to talk to you. our traders. We also have the ability to send you and information package if you go online and fill out the card, we’ll send you a package on how to get started buying precious metals. [1:18:38]
JIM: Alright, as always Ross, a pleasure to have you on the program, thanks for joining us.
ROSS: Thank you, Jim.
Forward Ounces
JOHN: Well, speaking of gold – I don’t know, were we speaking of gold? This is a segue – that’s what they call it in the business, right?
JIM: Well, I think we were. Gold and silver, anyway.
JOHN: Yeah, gold and silver. Let’s assume that you are bullish on gold which is no secret to the world, but in particular you are especially bullish on juniors versus senior gold shares, and warum as they say in German, why?
JIM: John, I think first of all this is not going to be an ordinary bull market. This is going to be what I call the mother of all bull markets in gold. And to put this in perspective, the bull market of the 70s are going to be a shadow of what lies ahead. [1:19:36]
JOHN: Alright, if there’s going to be a super bull market, sort of a tsunami bull I guess, then like a rising tide everything goes up with it. All the boats go up. Is that why you believe juniors are going to do well in this kind of an environment?
JIM: Not really. The reason I believe John is we’ve been running gold and silver supply deficits for well over a decade. The deficit has been made up by dishoarding, either central banks have been selling their gold or the government’s been selling silver, and not just the US. I mean at one time we had a 2 billion ounce stockpile of silver. That stockpile has gone. In the meantime, the industry consolidated after a two decade long bear market. The environmental movement took off shutting down access to resources or delaying projects. So really what we haven’t seen is new supply coming on stream – that has been lacking.
In addition, like I mentioned a lot of the stockpiles of silver have diminished considerably. I mean all the gold that was ever produced still exists, but every year we get about 4,000 tonnes of demand and the gold industry only produces about 2500 new tonnes of gold production. The difference between 2500 tonnes of production and 4,000 tonnes of demand is made up of either gold scrap or central bank sales. And there are a lot of people – I know for example the GATA folks that think that nearly half, if not more, of the central bank gold has been dishoarded. [1:21:00]
JOHN: Why then do you believe the real story in this bull market is juniors? I don’t quite understand it.
JIM: I want to use an analogy here of this bull market, and I want to go back to let’s say 1991 and 1992, when the technology revolution was taking off. For example, if I was to think of a premier technology company what comes to mind?
JOHN: IBM?
JIM: IBM. The supercomputer company, the super growth company, one of the stellar growth companies throughout the 50s, 60s and 70s. And had you invested in IBM, in the early part of the 90s you would have done well, you would have probably made 4 or 5 times your original investment. But there was a change that was coming to the marketplace: servers were replacing mainframes, the personal computer was becoming ubiquitous; laptops. So if you take a look at the technology revolution the real growth story wasn’t IBM, it was Dell, it was Cisco, Intel, and Microsoft. That was where the real growth rate took place in the technology revolution.
Well, if you look at where we are in the gold industry you take a look at the majors such as Newmont, Anglo, Barrick, they are sort of like the IBM of the tech world. They’re going to grow their earnings as the price of gold rises, but let’s face it, Newmont is not going to grow their production from 6 million ounces to 12 million ounces, 18 or 24 million ounces. And even if they could the only way they would be able to do that is by buying somebody else and if they did that then you would just see their production go down. On the other hand, you’re going to see companies like Yamana, the Goldcorps go from 100,000 ounces of production to a million ounces of production, or from a million ounces of production to 2 and 3 million ounces.
You’re also going to see a lot of juniors that are in late stage development go into production. Maybe they start out 50 or 100,000 then you’re going to see them rise to 200 to 300[,000] ounces. So they’re going to grow beyond that, some will eventually merge or grow enough to become majors. That’s where the real growth story’s going to take place. And unlike the bull market of the 70s when there was plenty of gold around, there were a lot of companies out there looking for gold. If you look at it today the capitalization of the world’s gold mining industry is not much over 100 billion. They’re probably half the value of General Electric or a Microsoft, and that includes the entire bullion industry itself, the actual price of gold production and silver production. [1:23:42]
JOHN: I know you had a formula that’s actually proven quite successful for investing in juniors. In fact, you have really helped finance some of today’s most successful juniors. Could you share that formula? We always gets requests for individual picks, especially for your next 2 favorite plays. And we don’t mention companies here but at least we could tell listeners here what to look for.
JIM: Well, I treat the junior market no different than any other investment market of the gold market. In other words, we come from a value background, and so one of the things that I always look for, just as I look for investing in any company, the first thing you look at is top management with plenty of integrity. Let’s face it, John, if you don’t have integrity and the right people at the top it doesn’t matter what you’re going to do, you could botch a program, you can botch a deposit, you can make a lot of mistakes, and especially in the junior market, if there isn’t a lot of integrity they’re not running the company for the best interests of the shareholders they’re running it for the best interests of management, so there’s a lot of conflicts.
One of the things I always look at is top management, and I like to meet with these companies, maybe if you’re a gold investor if you want to be in a similar situation I’d highly recommend you go to some of the gold shows that are featured all around the country – in New York, Las Vegas, San Francisco, you have Vancouver, Toronto – and you know, go to these gold shows and spend a couple of days there. Go up and there’s a first hand chance for you to actually meet the guys that actually run the company. Talk to them, size them up, ask your questions.
So, the one thing that I have found is it’s a lot like investing. Sure, you’ve got a lot of geologists out there, but just like investment returns most fund managers underperform the index. You only have a handful that beat the indexes consistently. Well, you know what? It’s the same thing in the area of geology and mining. You’ve got people out there that are veterans, there’s just a knack, John, of finding things. You have certain geologists that can go look in an area where others have looked before and didn’t find anything, and then all of a sudden they have the history of making discoveries, or bringing mines into production. So I like to look at management’s track record, I like to look at integrity because that is really important when you’re looking at a junior. I usually sit down face to face with them, ask them a lot of questions and just kind of size up. I like to see how they answer the questions, whether they try to –pardon the expression – BS me, or try to fend off these questions. And especially sometimes when things go wrong, how do they handle it. I like to see straight answers. So the first thing I look for is management integrity.
The second thing I like to look for is value. I like to buy gold and silver in the ground, below market prices. One of the companies that we began accumulating last year we were buying gold in the ground at $19 today we’re buying it in the ground somewhere in the neighborhood of 20 to $25. So, I like to buy something for less than what market prices are. Take a look at the average junior today, they’re selling at anywhere from $63 to $65 an ounce in the ground. Well, if I can buy gold in the ground at $9, or $10, or $15, $20, or $25 there’s less risk to me because I’m buying value. [1:27:12]
JOHN: Quite often we use the term here: juniors. And that can be a fuzzy term for people so when you use at least in this context what are you talking about?
JIM: For the most part when I say a junior producer I’m talking about somebody who is maybe producing 25,000 up to 100,000 ounces of production a year. So, they’re not an intermediate company. And then you have what are called junior development plays. And I like to buy late stage development plays because number one, there’s less risk involved. In other words, the mining company has staked a claim and they’re mining an existing area where either they’ve mined there before, or they’re in a prolific gold or silver belt, or copper belt or maybe they’ve brought something. They know there’s gold reserves there so what they’re doing is they’re basically drilling out the property, taking it toward prefeasibility.
So I like to look at a company that has two options. I think many times people look at only one option where there only hope is that some major or intermediate is going to buy them out. To me, that’s wishful thinking. I like to see two possibilities. Either: number one they can become a producer. In other words, the deposit itself is economical, it’s large enough to go into production and make it worthwhile and they have what I call mineable ounces – in other words, these are ounces that can make dollars for their shareholders. So if nobody buys them out the project can stand alone by itself, and become a mine into production and make money.
The other thing, I like to see a project that is large enough. I like projects that are either going to either develop into two or three million, or as much as four million or five million ounce deposits. In that way –I call it my 2+2, or 3+3 formula in the industry: 2 million ounces, 200,000 ounces of production; or 3 million ounces of reserves, 300,000 ounces of production. There aren’t a lot of these believe it or not around the world that are 2 and 3 million ounce deposits. You start getting into the 2 and 3 million ounce range, especially if you’ve got a prefease study –or close to a prefease study – that shows these ounces are going to be mineable that starts to become very attractive to an intermediate, and even a major, depending on the location.
And then I would say probably the fourth thing I like to see is a project in a politically safe territory of the world where they respect property rights, and where those property rights are withheld so you don’t have to worry about somebody like a Chavez or a Morales in Bolivia that are going to expropriate your property. [1:29:57]
JOHN: You also focus on restructuring companies, especially how they’re financed.
JIM: Yes, I’m very big on that. I think for a lot of junior mining companies make their mistakes everybody knows about the dump-pump cycle in juniors where you get the brokers and investment bankers, what they’ll do with the company is prior to financing they hammer their stock, they get the stock down, then they do a financing on a lower price. The brokers get their broker’s shares, and their broker warrants and their commission and then what’ll happen is after the restricted period is lifted then what the brokers do is they begin unloading their shares in the market as they pump the stock.
You see it done over and over again in the industry. So when we get involved in companies we like to restructure the way they’re financed, we like to get rid of the pump and dump shops and get rid of the flippers, and then limit the amount of people that can come in on a financing, because we want people that are long term investors that are going to see the company grow their ounces, eventually be taken over or go into production. In other words, we want investors not traders. [1:31:03]
JOHN: Why don’t you explain the concept of forward ounces?
JIM: Let’s say you’re looking at a junior and you read through the literature that they had 1 million ounces of either inferred ounces or measured and indicated ounces, well, one of the things that juniors do when they acquire property is they’re going to drill out that property, and they’re going to try to add more ounces. In other words, they’re going to try to find out how big is this deposit. And so they may be starting out with 1 million ounces today or 500,000 ounces and what happens is let’s say they go through a financing cycle, they’re going to raise a bunch of money, and what they’re going to do with that money is they’re going to start drilling out the property. So what we like to do is take a look at those drill results, and see what they’re producing, in other words, how many grams of gold or silver or gold equivalent are they finding, because eventually that’s going to translate into higher ounces. In other words, are they growing this deposit, are they finding more ounces? And so you can’t just look at a company and say, “alright, how many ounces do they have today?”
Well, if they just raised money and they’ve got 2 or 3 drills on the property, or they’ve got 4 or 5 drills on the property then you know they’re finding more ounces and you can see that just by the drill results. And when you start seeing that, you know they’re going to be adding more resources. And then what you do you take a look at what’s been their track record? What does it cost per ounce for the company to find? And you can sort of take a guess. Oh alright, they just raised $10 million, they’re finding ounces at let’s say $10 an ounce, and you can take a look at the drill results and it gets a little complicated but you start saying, “OK, based on this we think we’re going to have these kind of ounces.”
One of the things that you have to do is take a look at not just where they are today but what’s been their track record of success. Where are they going to be a year from now, or a year and a half? We like to see deposits that continuously grow, that they continually drill out the project to take them closer to measured and indicated, and eventually reserves through a prefeasibility study. At some point in time, you’re going to have to make that decision: “Ok, we’ve poked a bunch of holes in the ground, what do we have here? Do we have a mine, and if we have a mine is it going to be economical.” And those are the things sometimes people forget about. [1:33:23]
JOHN: Yes, this is inline with what you were talking about earlier about getting rid of flippers but nowadays people jump into stocks and jump out of them. You jump in and you stay there for the long term, and you help the company grow. And one of the investments you have made quite some time back had some rather major improvements this year. What happened?
JIM: We like to get involved with people that we know and we like to finance them but we financed companies several years ago, and quite honestly after we financed them about 4 months later, or 5 months later, there was a severe correction in the gold market – everybody remembers what happened in the spring and Summer of 2004. And let’s face it, until let’s say the early part of this year it was pretty miserable for the junior mining index, I mean compared to what was happening to let’s say the majors or the intermediates. So after we financed this for this particular company it went down, and it stayed down for quite some time, but then this year they had spectacular gold discovery, and fabulous drill results and the stocks up 4100 % this year. And you know, we knew the company, we knew the people behind them, in fact, one of the people that started the company is a good friend of mine, but you know we stayed with them and that’s the difference.
A lot of times, people will buy a junior, the minute we get a pullback they get frightened, they trade out of the stocks. And that’s the thing that you have to be real careful with the juniors. If you know you’ve got a good management team, a good team of geologists that really know what they’re doing, know where to find the gold this is what’s going to happen. They’re either going to have a new gold discovery, spectacular drill results, and you never know when that’s going to happen because you don’t know when these drill results are going to be released until they’re released. And then the other thing, you’ve got to have the patience to stick with it.
Another company that we’re involved with, they’ve not only increased their resources by 400,000 ounces and will probably double that again this year, but I mean their latest drill results have been getting higher and higher grades, and you take a look at those higher and higher grades, and that tells me not only is the deposit getting bigger, becoming more profitable, but also they’re going to have a substantial revaluation in terms of their resources they’re going to be adding as the year progresses. But few people want to take that long term view. And I think when you invest in juniors if you get good ones what you do is you have to take that point of view. Trying to trade in and out of juniors, you’re going to outsmart yourself. [1:35:51]
JOHN: So I would take it then that this latest correction is not really a worrying event for you. Does this mean you’ve been out there with your shopping cart?
JIM: Oh, we have been busy. In fact, one of my favorite picks we just doubled my percentage ownership of this particular company. I’ve been buying bullion, as we talked about with Ross Hansen because I just don’t think you’re going to see silver prices... I remember Jim Rogers, I think it was in the year 2002, when he came back after his whirlwind 3 year tour around the globe and he wrote his second book. And I can remember John, you actually did this interview with me, you remember when Rogers said, “I don’t think you’ll ever see $25 oil again?”
JOHN: Yup, right.
JIM: I doubt very seriously if you’re going to see $5 or $6 silver again. Those days are gone. And if you can get silver in anywhere near the ballpark of where you’re getting it today when you think silver’s going over $50 and $100 an ounce that’s the kind of view you have to take. So whenever you get these corrective pullbacks which is what this is, then you pony up: you add, you accumulate your positions, and add to those positions, and that’s exactly what these pullbacks give you. It’s kind of like having a Nordstrom’s sale and you’ve got your favorite brand of clothing has been marked down by 30%. Well, what do you do? You go shopping. [1:37:09]
JOHN: Yes, so despite all of the panic we’re hearing come over the mainline media, you’re pretty optimistic, as a matter of fact, bullish about the whole thing?
JIM: Oh, I think where we are in this cycle with juniors, John, this hearkens back to 1991 and 92 where you could have picked up Dell, Cisco and Microsoft at bargain prices. And a lot of these top quality juniors are selling at 40 and 50% discounts from their net asset value. I can guarantee you that when this cycle ends, or even when the second phase ends, you’re not going to be seeing high quality top notch juniors that have the capability of becoming a 3 and 4 million ounce deposit are going into production, you’re just not going to see those selling at 40 and 50% discounts. I would venture to say you’re probably going to see those selling at probably 50 to 100% premiums over where they are now. You remember what the tech market looked like in 1997, and all the way through the year 2000. And so I would say, right now, where we are with the junior market is very similar to where we were in 91 and 92. So you’re absolutely right, I’m bullish and I’m buying. [1:38:17]
More Emails and Q-Calls
JOHN: It’s time to go back to the Q-Line for more questions.
Hi Jim and John, this is Chris from Tempe Arizona. I enjoyed the discussion on taxes last week, and just as a suggestion I wonder if you would be interested in getting Steve Forbes with the flat-tax and his ideas on the flat-tax, and also Neil Boortz, the libertarian radio commentator and his ideas on fair tax. I wonder if you could do that, that would be interesting. Thanks.
Chris, Great idea, I’ve interviewed Steve Forbes in the past, perhaps we’ll have him back on. I think the flat-tax is a great idea, and it’s shown anytime you have a flat-tax, and especially if it’s low enough, it’s been tremendous for economic growth. [1:39:00]
JOHN: Yes, as a matter of fact, Jim, every time that this has been attempted if we go back to the Reagan tax cut, or any other issues the government itself reports that revenues tend to spike rather dramatically. I think it was the World Bank that did a study that found out when tax rates are around 10% that’s your optimum tax rate. As you go over 10% you actually get less revenues, and the more you increase it the less you get, until like we saw in the former Soviet Union in the time right after that you could increase it all you want and nobody pays the tax anymore, just because it just gets so absurd. But this is a lesson that politicians never learn, that there’s a limit to the universe. What about the sales tax. What do you think about that anyway?
JIM: I think as we get close to a flat-tax they’ll probably go to some kind of VAT tax, which is I think coming up with tax reform here in the next couple of years. It’ll depend on what happens in Congress, and of course ultimately what happens in the election of 2008. But you’re right, John, just look at the economic growth rates that came out of Hong Kong where they had between 10 and 15% tax rates. [1:40:03]
JOHN: Right, especially when Putin slashed the capital gains rate he got the income tax down to around 13% and all of a sudden the Russian economy sprang into life. I think the advantage of a sales tax over a flat tax. Flat taxes businesses everybody still has to do all these reportings and forms, sales tax gathers pretty much the same amount of income but we do away with everybody filing on April 15th. Only businesses have to file those forms. I don’t know about your business but we file on a quarterly basis. It takes 15 minutes to fill the form out and write the check, compared to the pain.
JIM: The only problem with a sales tax or a value added tax you have to make sure that essential items like food and things like that that could dramatically impact the poor are exempt, as they are for example you don’t pay sales tax on food here in California. [1:40:50]
JOHN: Right, but that’s a simpler thing to do. Look at the monster that is the IRS code, if you pull it off your shelf if you have a copy sitting there, you go: “can anyone understand this?” And the answer is: no. And the IRS doesn’t understand it, tax attorneys don’t, nor do CPAs. So maybe this tells us something about it.
Hello Jim, my name’s James. I come from London, England. I’ve got a couple of questions, the first one regarding the Fed’s intention to try to reduce their debt by inflating, currently we’re looking at 8.4 trillion as a public debt but the trade deficit is 800 billion which is 10% per year. This would mean that in real terms to reduce the amount America owes they would have to devalue the dollar by 10% per year plus – 10% would keep it in the same place. Do you really think we can suffer 10% per year plus, say 15% to reduce it by 5% per year, or is that just too much for the market to handle?
The second thing is, I’m long gold and with the recent downturn and consolidations we’ve seen, gold seems to have followed the equity markets quite strongly. The explanation that was given was that fund managers have to balance their books and sell off gold to cover short falls on their equities. What circumstances do you see for a breakaway for gold? Do you see a breakaway for gold, because otherwise it doesn’t seem much different to investing in equities if they’re both moving together? Thanks very much. [1:42:33]
Ok, Mark let’s answer your first question, can the market withstand a 10% depreciation in the dollar per year got that James through 2001 and 2003 and I think it could, whether they could withstand 20 and 30% I don’t think so. So I think Paulson’s job being appointed to Treasury is to manage the dollar in terms of its downturn. And I think we can withstand a 10% drop in the dollar per year. One of the things all currencies are doing is depreciating against each other but I think we can do that. When you start getting a 25% drop or a 35% then you start getting into major problems.
In terms of gold, one of the reasons you’ve seen gold pullback is a lot of people were leveraged into gold. You get a margin call, whether it’s on gold equities or you borrowed money in yen, that tends to accelerate the downturn in gold. So that’s why I think you’re seeing that.
And as they were taking down the gold markets and commodity markets they pretty much have taken all markets with them. Just as we’ve seen all markets rise together in this cycle you see all markets decline together as liquidity is withdrawn from the market, as margins call are made. So I think that’s why you saw that. But eventually the perceptions as the bull market develops, those perceptions begin to change and all of a sudden you’re going to see the commodity markets become the front runner, very much in the way they became the front runner from the Summer of last year. And I think you’ll see that redeveloping again especially once the Fed goes on pause and other central banks begin to go on pause as the economies globally begin to slow down. [1:44:14]
Hi this is Steven, and I’m from Salt Lake City, Utah. I was calling concerning the debate about the minimum wage, and it appears one side doesn’t like it and the other one does. Instead of making the employers pay the extra money on the minimum wage why doesn’t the government just eliminate taxes of all the different layers on the income classes that seems to be need help with the minimum wage? That way they could actually get more money back than just the minimum wage, and then the employers wouldn’t have to pay too much and then the people that complain about how this would hurt government income, why you just end the drug war. Then not only would you be able to pay for that, but you would have extra money to put down on the deficit, and government shrinks a bit, people become more free, everything works out. What a happy, happy scenario. Thank you. [1:45:06]
JOHN: I can give you one reason: because it’s too rational.
JIM: I would probably second that. That’s one thing you can do because one of the things that’ll happen is –think about this – the Fed is worried about wage inflation, the so called cost push inflation we talked about last week. Raise the minimum wage to $7 that’s going to raise all labor contracts, all wage contracts, create unemployment and then everybody’s going to be worried about wage inflation. Yet, it’s counter intuitive. You’d be better off by eliminating the taxes on lower income groups than raising the minimum wage. I couldn’t agree more. And by the way, why not end the drug war, let’s end a lot of frivolous government spending, start phasing out entitlements which is what’s going to bankrupt this country, and get us back to an independent country again, where we depend on ourselves rather than depending on government. When you depend on government you’re going to get disappointed. [1:46:09]
JOHN: You really are deluded, you realize, if you ever think that’s going to happen. Historically, that has never happened. Actually, I think we’re going to be forced into it, don’t you? I mean when we talk about currencies going bust that’s sort of nature’s way of resetting the whole thing.
JIM: Sure, and eventually governments aren’t going to be able to afford to pay this out as they get into trouble, and they’re going to have to restructure, as I mentioned, they’ll probably go to means testing on Social Security. Social Security will become a welfare program rather than some kind of supplemental pension income, and only the very poor are going to get it. That’s where we’re going. The amount of money government is spending today is unsustainable, you could raise taxes to 100% for all the tax freaks out there that just feel rich people aren’t paying their fair share. [1:46:58]
JOHN: Jim, we have an email here from Marco who’s living in Germany. He says:
Dear Jim, every week I listen to your show and it’s a fantastic one. I’ve got a question: I’m heavily invested in the oil and oil services sector but in recent weeks I lost money. PE are low, dividend yields are high but the stock market ignores that. Should I cut the losses or is this just a normal correction.
JIM: Just a normal correction, and the story I would tell you is look what happened on Friday when Anadarko acquired Kerr-McGee, and Western Gas Resources. I think for the fourth year in a row, Wall Street still doesn’t get it. They’ve mispriced this whole run up that we’ve seen in oil prices. These stocks are being priced as if we were selling at $40 oil – when today’s oil prices are at $70. And that’s why you’re seeing a lot of these companies – Conoco-Phillips selling at 6 times earnings. Most of the oil sector is selling in the mid to high single digits compared to the rest of the markets. So what I would advise you to do depending on how much your portfolio is in energy and how much you’re comfortable with, but when you see these pullbacks like this I would add to your position, especially those companies that have the possibility to increase their production and reserves. No, this is just a mispricing by the market. [1:48:16]
JOHN: I like emails like the following one here. This is from Joe, he’s talking about your transcript from November 5th:
Go back and read it, you sleazy clowns are wrong on everything.
JIM: You know we’ve actually started, I’ve got my son Chris taking the nasty-grams, and we’re putting them into charts now. I’m not sure what we’re going to make out of them. Usually when I say something that’s controversial, you remember john the first show of the year and I said there’s a trade here in tech stocks and I think people about fell off the couch or table. One guy said he spilt coffee on his keyboard. But you know, that turned out to be the case, there was a nice trade there in the first quarter. And I’m sure when I told people I expected the Dow to hit a new record they thought I was crazy. Just as when we start talking about for example they were going to hammer the commodity markets as gold was going from $600 to $700. First of all that kind of rise wasn’t sustainable and it was doubtful the central bankers were going to let that one fly. They can’t keep this down in the long run but what they can do is slow its rate of ascent. [1:49:19]
Hi Jim, my name’s Dominic, I’m calling from London, across the pond in the UK, I’m a big fan of your show, and I’ve got 3 questions for you if I may. The first is that it’s not just in financial markets but generally what happens in the US tends to happen in the UK as well, but not to the same extent. Do you think if the scenarios you’re describing unfold, they’re likely to unfold in the UK as well? That’s question number one.
Question number 2 is are there examples of inflated fiat currencies in history that haven’t collapsed? And my third question is if we get this mass inflation, or even hyperinflation I saw an interview with Arch Crawford the planetary forecaster and he was forecasting hyperinflation next year – if we get that inflationary scenario what is the point of holding stocks that are dollar denominated because surely inflation will rise faster than they will. That’s all, I look forward to hearing your answers. Goodbye.
Dominic, your first question where you describe these scenarios, what happens in the UK usually follows what happens in the US, vice versa That will happen. In other words, if we go into an economic slowdown you’re going to go into an economic slowdown. If we begin to reinflate you’re going to reinflate; if our markets start to rise, generally you’re going to see your markets rise, although in the last couple of years the European markets have been outperforming the US markets, simply in the fact that our Fed was embarking on a rate raising cycle compared to the rest.
Are there examples of inflated currencies that haven’t collapsed? None to my recollection, I mean if you take a look at the empires – the Roman Empire, it’s currency debasement, the Spanish, the Dutch Empire – take a look at what happened to your own currency, the same thing’s going to happen to our currency. It’s a one way street. When you inflate eventually your currency becomes so debased you go to a whole new system. Usually when you’re seeing currency debasement it’s a currency debasement that eventually takes the country into decline. It’s a sign of loss of economic power, which is what you saw for example with England, and which is what you’re seeing gradually take place here with the United States.
And then I guess the third question is what’s the point of holding dollar denominated assets if we hyperinflate? What we’re seeing is all central banks hyperinflate. China’s hyperinflating with their money supply growing at almost 19%; Europe is growing at 10%; the United States – who knows what that [rate] is? I suspect the reason they got rid of it is because it was increasing from 8 to probably even 10%, or even more. So all currencies are reinflating at the same time, which is another reason why I like tangible assets, in terms of one’s own country whether it’s oil stocks out of London or oil stocks here and ultimately gold's stocks and bullion itself. [1:52:34]
This is Ben from New York. I wanted to get your opinion on foreign bonds. I know you liked them a while back and I was wondering if anything has changed. Do you like them as a hedge against a falling dollar, and given the changes in global interest rates I was wondering what your current opinion is of foreign bonds? Thank you.
I like them in comparison to US bonds in terms of the dollar going down. Obviously, if you’re in a foreign currency denominated bond you’re going to get the upside of that if the dollar goes down. I’d keep it in short term maturities –1 year to 2 year – no more than that, because you do have rising interest rates overseas. But ultimately, Ben, the best hedge against a falling dollar, or a falling currency, or depreciating currencies around the world is bullion itself. That is the ultimate hedge. [1:53:31]
Hi, this is Greg in California. A quick question, great show by the way. Do you think in light of the recent news items on terrorists and client accounts – the government going after the accounts of terrorists – do you think eventually that might lead to confiscation of gold where the government might view gold itself, the holding of gold and the trading of gold, as being a haven for terrorist activity and a way to confiscate funds from public tracking or tracking by the government? Thanks.
I think they will try to make that case. I wouldn’t be surprised if they were trying to make that now. It would be a hard one for everyone to buy in, and especially with the internet now, that’s going to be a tough one to sell to the American public. That’s like weapons of mass destruction. I just don’t think people are going to believe that one. I think where you might see gold in terms of confiscation would be in a severe currency crisis, an exodus out of the dollar where they call in the gold like they did in 1933. A currency crisis is probably the best reason for gold, especially when people try to exit the currency and there’s a mass exit. Picture a stadium and everybody’s trying to head for the exit gates at once, and what that would do to a currency.
But you might see that globally, central banks have done a disservice to their citizens by dishoarding all of their gold, but central bankers are not know for being very bright. I mean you take a look at the Bank of England at the price at which it sold its gold compared to where gold is now and its return on assets. This one’s going to be a tricky one to play out in terms of when this unfolds, but I think you will see it well in advance because they will start demonizing. Whenever they are getting ready to pick somebody’s pocket the first thing you have to do is demonize them and discredit them – that will be the key to watch out for. [1:55:26]
JOHN: Yes, that’s the key that makes it politically acceptable to be able to do that. That’s why that’s done.
JIM: Yes, they have to sell the idea first, and they’ve got to make people that own gold into villains first, and you’ve got to sell that and it’ll be interesting to see how they would sell that. But a currency crisis would be one of them. [1:55:40]
JOHN: I think people who invest in gold and silver are now a lot more savvy, don’t you, than people were in 1933?
JIM: Oh absolutely. I mean in 1933 people willingly stood there in lines with their sacks of gold coins, and turned them into the bank, got 20 bucks, and then the government turned around and basically devalued the currency by 40%, and drove gold prices up to $35. That’s originally how they got the money for the stabilization fund. Yeah, I think people are too savvy with the internet today to buy that. That’s why I think it’s going to be a harder sell to demonize and take people’s gold away today. [1:56:18]
JOHN: It’s going to be interesting because that was the question I asked early on, remember if we get this new currency, the amero, which you and I are calling the amigo, then how are they going to base it. Are they going do it on gold, and say, “Ok, you can’t use gold in transactions and what.” This is going to be the interesting part.
JIM: One of the reasons they took gold away in 1933 is they needed to inflate the money supply, so they needed the gold that they took from the people to do that. Today you no longer need that – government’s can inflate the money supply at will. There’s nothing holding them back, which is one of the reasons why you’re seeing this global reflation effort right now which is disguising the full impact of that as all currencies are depreciating at the same time against one another. It’s just who’s depreciating the fastest. And then what you’re also seeing is gold rise against all currencies. So all currencies are debasing themselves, or depreciating against the ultimate money throughout all of history which is gold and silver. [1:57:17]
JOHN: Well, Jim, what is coming up next week here on the program?
JIM: Well, as promised next week we’re going to have a gold roundtable. Joining me for the roundtable will be James Turk of Goldmoney, John Hathaway of the Tocqueville Fund, Leanne Baker of Investor Resources, and newsletter writer Peter Grandich, and Don McAlvany. All that coming up, really looking forward to that next week.
So, in the meantime on behalf of John Loeffler, and myself, we’d like to thank you for joining us here on the Financial Sense Newshour. Until you and I talk again we hope you have a pleasant weekend.
