Financial Sense Newshour
The BIG Picture Transcription
August 12, 2006
- Jim's Market Wrap
- The Fed's Next Recession
- Other Voices: 'Zapata' George Blake, Market Analyst
- Dividends Don't Lie
- Other Voices: Dan Gainor, Director, Business & Media Institute
- Margin of Safety
- SOS: Stuck on Stupid
- Backup the Truck
Jim's Market Wrap
[Montage of voices]
– The way I would characterize the economy right now is we have a healthy economy in the US.
– BP is shutting down its Alaskan oil fields due to corrosion that was found along 16 points of this very important pipeline.
– This could be a real slammer for the West coast.
– Will oil possibly be the key when it comes to Fed and the inflation?
– $100 oil I think would knock growth down to about 1%.
– Talk about a fickle market, or a confused market, right after the Fed announcement yesterday a bit of a rally, a bit of a sell off. I mean this stock market doesn’t know what to do with it right now.
– We can always count on the American consumer spending money.
– The Fed could change their mind and decide that hype is on the way.
– The failed terror plot is impacting travel on both sides of the Atlantic.
– President Bush: This nation is at war with Islamic fascists.
– Web bloggers are blaming Tony Blair’s alliance with President Bush for fostering terror in the UK.
– The Defense Minister in Israel has instructed the military to launch a ground offensive. This coming as startling news as we were thinking for the last couple of hours, in fact, this last UN ceasefire was going to be happening.
– If you go into larger invasion, when will we see that build up.
– That’s a nightmare scenario you guys are painting.
JIM: Well, that was the week that was. On Monday, they shut down Prudhoe Bay; on Wednesday we get a typhoon; oh by the way, Tuesday the Fed meets and goes on pause; and on Thursday, a thwarted attack coming on the terrorist front. Well, so much for my planned vacation. Beware of the Ides of August.
Hello everyone, I’m Jim Puplava. Coming up on today’s program two Other Voices, my good friend George Blake or “Zapata George” will join us, as well as Dan Gainor, Director of the Business and Media Institute. [2:45]
JOHN: And it was a rather intense moment on Tuesday as the Fed’s Open Market Committee met, but they did meet, they paused. Is this going to be the pause that refreshes? Are we going to have a soft or a hard landing? What can we look forward to in the future?
You know, if you’re going to invest you want to invest for dividends, and dividend investing requires a certain strategy, especially in uncertain times. We’ll look exactly at what you’re going to look for in a stock when you’re investing for dividends.
Last week we talked about Ben Graham’s The Intelligent Investor which is probably one of the best investment books ever written. But speaking of all of these uncertain times, one of the tenets that we did not cover was that of his Margin of Safety and what that means. It’s probably very important to deal with that, so we shall do it here on the program today.
And now, going to Financial Sense University, we have a couple of questions. When there’s a terrorist attack, you: a) buy gold; b) sell gold; c) buy tech stocks; or d) do nothing.
And when 22% of your nation’s oil production is offline, do you: a) sell oil stocks; b) buy oil stocks c) buy tech stocks; d) do nothing. We’re going to answer by way of what everybody did in the country this week, and if they were in our university they would have flunked.
JIM: Well, let’s head down to Wall Street before we get to the Big Picture today. And I want to make all of our listeners aware, especially if you’re a first time listener, our Experts Series is off for the month of August � we do sort of an abbreviated show the first two weeks of the month, and then we’re going to take a 3 week recess. And the full complemented show � the full 3 hours with the experts, the interviews as well as the Big Picture � will return on September 9th.
Well, let’s head down to Wall Street where US stocks closed lower Friday, with both the Dow Jones Industrial Average and the S&P 500 breaking 3 week winning streaks. We also got some mixed economic numbers: one, we had retail sales numbers pointing towards strength; on the other hand we had business inventories starting to build suggesting sluggishness.
Here’s the way things shaped up on Friday. The Dow was down 60 points, closing at 11065; the S&P 500 was down 70 points at 1264; and the NASDAQ losing 17 points, closing out the week at 2054. For the week the Dow lost 1.4%; the S&P fell 1%; and the NASDAQ was down 1.3%.
Volume is also starting to recede. You’re probably going to see that for the rest of the month of August. We only had about 1.3 billion shares traded on Friday. In fact, after the Tuesday Fed meeting, I would suspect most of Wall Street is now going on vacation. The market focus however on Friday continues to be inflation, but it’s starting to shift now. You’re starting to see a lot more emphasis on this hard landing as we start to get more and more evidence that the economy is decelerating rapidly. Investors are increasingly fearful that the economy is going to slow down from even what we saw in the second quarter � remember we went from 5.6% growth rate in the first quarter, down to 2 �% in the second quarter. Given the fact that they understate inflation, we’re probably already in a recession right now. Investors are afraid, I think, that the Fed has pushed the economy into a recession so the focus is back on what the Fed is going to do. Believe it or not, we still have some probability that they could raise in September.
Meanwhile, on Friday’s action, investors continued to monitor airline stocks one day after that thwarted terrorist attack which fed worries into passenger travel. The AMEX airline index slid 5% on Friday. Cyclical stocks are also coming under pressure, hit by worries of an economic recession. The Dow Jones Transport ended down the week 1.7%.
Also on Friday, General Motors was down almost 2%. Rick Wagoner the struggling chief executive said late Thursday that the company will slow the production pace of its new lineup of full size SUV vehicles during the second half in order to cope with rising inventories that they’re seeing at the dealer level.
On the economic front, let’s take a look at some of those economic reports on Friday. The big one that got the market’s attention, retail sales surged 1.4% in July, but most of that was due to higher auto and gasoline sales. The auto sales were increased as dealers offered all kinds of incentives to clear building inventories. And also, gasoline sales were up because people were paying more for the price of gasoline. Another factor here, is these retail figures are not adjusted for inflation. So that’s the new spin now, they’re not taking out the inflation numbers, so it’s really hard to tell how strong retail sales are. Closer inspection is showing, for example, that personal care stores saw a little bit of an increase; leisure goods stores, music, books, sporting saw their sales fall during the month; grocery stores rose 3%, but you know, once again, people are paying higher prices for food. So you’ve got to factor in the fact that they did not take inflation out of those retail sales numbers in making comparisons, and the fact that people are spending more at the gasoline pump.
Also there was a report out on July import prices which rose 0.9% - most of that coming from imported petroleum prices rising nearly 5%. Year to date oil prices are up nearly 30%. Outside of that, import prices actually fell 0.1% - so there is some little pressure on the inflation front.
Meanwhile, looking at other markets, Treasury prices declined Friday, sending yields higher as data showed stronger retail sales. The strength of the data has got some traders concerned about what the Federal Reserve will do next month. The benchmark 10 year Treasury note was down 8/32, its yield rising about 4.95; the 30 year Treasury bond down 10/32, its yield at roughly 5.09. Spending momentum entered third quarter a little better than anticipated with those retail numbers. Once again, I want to point out that those are not inflation adjusted. So it’s real questionable at this point whether this is a sustainable trend, or just a 1 month blip. The Labor Department also reported petroleum prices, as I mentioned earlier, rose nearly 5%.
And the odds of a Fed increase again at the September meeting has risen slightly. Traders are now pricing a 36% chance of a Fed rate hike in September when the FOMC meets on September 20th. That’s up from 24% on Thursday all of that due to one economic report.
Meanwhile the dollar rose to two week highs against the euro and the yen on Friday after the economic data was reported on retail sales. The dollar traded at about $1.27 against the euro; 116 Japanese yen; and about $1.89 against the pound.
Crude oil prices ended higher but it was a very volatile weak. Oil prices ended higher on Friday, capping a roller coaster week for the market that included a disruption of crude deliveries out of BP's Prudhoe Bay oil field, a foiled bomb plot targeting US bound planes, and data showing a decline in inventories for all petroleum products. Add to that the conflicts in the Middle East, Iran’s defiant stance over its nuclear enrichment program, and new kidnappings of oil workers in Nigeria. Well, pick your worries on the oil front � there was plenty of them.
Also the foiled bomb plot impact on jet fuel demand could last for quite a while. At least half of the United Kingdom’s 400,000 barrels per day jet fuel demand was cut on Thursday. In fact, nearly 5 years after the September 11th terrorist attacks the Atlantic basin jet fuel demand has barely recovered. Prior to the attacks on the World Trade Center and the Pentagon jet fuel demand was growing at roughly about 4%; conversely, as you get fears over flying gasoline demand is getting a lift off from air travel scares.
Meanwhile, British Petroleum, in a key piece of news out on Friday, said it may be able to keep half of its Prudhoe Bay operations going. Company officials said late Thursday it might be able to keep oil flowing from the West side of the Prudhoe Bay oil field. It shut down the Eastern portion of the field after discovering an oil spill and corrosion in a pipeline. The shutdown knocked out some 200,000 barrels per day in output. Most of that Alaskan crude is used most exclusively to customers on the West coast, which obviously include Seattle and the big state of California.
Meanwhile the IEA is lifting its demand for oil at a time when spare capacity is shrinking. The IEA held to its 2006 demand forecast of 84.8 million barrels of oil, even though the economy is slowing down in the US. They’re saying demand coming from China is picking up. In the current environment, the Paris based agency said crude quality rather than overall output is the issue after the BP outage in Alaska. For the time being the market could cope with the current outages but in the light of many possible threats to output, including the current hurricane season, there is very little doubt that the upstream spare capacity cushion remains razor thin. One thing about the energy sector there is no shortage of worries.
And finally, gold futures closed lower on Friday and were down 1.8% for the week rather an anomaly when you consider all the events that were happening. Gold for December delivery was up $1.60, closing at $644.40 on Friday. It was a choppy session all week. Meanwhile, the notion that terror fears would deter people from flying, thereby reducing demand for oil and easing oil price driven inflation is simply misguided � as so many things you hear about energy today. If you’re taking a look at this, this is a strong buy for investors.
Meanwhile, silver closed down 22 cents, ending the week at 11.89. It lost 4.8% for the week and a lot of the gold indexes were also in the red as well.
Well, that’s the way it looked on Wall Street. Coming up next, John and I with the Big Picture, right after this. [13:31]
The Fed's Next Recession
JOHN: I guess the first recommendation I’d have for you, Jim, is please stop taking your boat out, because every time it moves out of the slip the world falls apart.
And the next thing is the Fed’s Open Market Committee met, they paused. Is this going to be the pause that refreshes. What’s really next � a soft or a hard landing? What do you think?
JIM: Just before we begin, it was absolutely amazing, I think I called you what? Thursday. We got up in the morning, had an early breakfast and just headed out to sea. We came back about 5 o’clock, so I have no idea, John, what’s going on in the world and I turn on my TV set and I see Mayor Bloomberg talking about terrorists. At first, you know, when I was just picking up pieces I thought, “Oh my God, did we get hit by a terrorist attack?” And then of course, as I listened in to it and then I called you. And I’ve been on vacation a week: Monday, Prudhoe Bay shuts down; Wednesday they get a typhoon in Asia; and Thursday a major attempted terrorist attack. I mean that’s not bad for 4 days off. [14:49]
JOHN: And guys, he’s going out again next week. So put your seat belts on.
Well, that happened last year, you went out and Katrina struck, remember that?
JIM: Yeah, I was gone for 3 days and I came back and it was let’s catch up on the news, 10 o’clock Sunday night, turn on the TV and holy cow where did this thing come from. So, I still have 3 or 4 weeks to go here, so who knows what’ll happen.
Well, let’s get back to the big story this week which obviously was the Fed going on pause. I guess the question the markets are starting to focus on is are we headed for a soft or hard landing? You’ll notice that the trial balloons have already surfaced. I saw an article that I was reading during the week, “if the economy heads into a recession we’ll have to blame oil prices.” Remember when we went into a recession in 2001 and we had the bear market that lasted 3 years, it wasn’t the Fed rate hikes or the Fed money printing � it was 9/11. That’s what caused the recession. And right now, you’re just starting to see it, it’s very subtle but I’ve seen it already in a couple of articles in different papers on the web that oil prices could lead to recession. So the trial balloons are out there.
But what I’m seeing all the evidence is pointing to a recession. We’re seeing economic growth is decelerating, job formation is starting to slow down, manufacturing and the service sector is slowing, housing is tanking, and the consumer’s become more cautious. In fact, credit card debt is growing again, indicating some financial stress. [16:27]
JOHN: It wouldn’t be typically oil alone that would be causing this, would it? I mean we’re also facing financial issues. So it looks like they’re trying to offload this, is what I’m thinking.
JIM: Exactly. The Fed does not want to take the blame for its own actions, so they’re always looking for excuses to offload the results of their rate hikes. And everybody knows that it’s interest rates which are doing this, because right where we’re staying on the beach there’s a motor home park, and John, it’s packed. In fact, we have our employee party usually the third week in August, we meet on the beach on a Saturday and we had to get a reservation, making it in March, just to get one of the guys that works for me has a sort of motor trailer that we use and we bring it down here for the weekends. He had to make that reservation in March, and the park is absolutely full which really surprises me. So I don’t think it’s higher oil prices; yes, they’re hurting, but it’s definitely the rate hikes that are doing the real job killer here. [17:29]
JOHN: I’m trying to figure out we’re a destination resort type thing here as well, and on Blackwell Island the RV park there is full. It is packed full. And yet, I was out on the lake a week and a half ago, a big lake, normally at this time of year you need traffic cops out there because of all the boating traffic. But this time � and it was a Monday � and we’re out there, and I kept looking around, it was like we had this whole giant bay to ourselves. And I thought, this is unusual. In other words, there seems to be a drop-off in active use of fuel. I’m wondering if the people who go to these RV parks don’t just drive there, and plop it there, in other words � and then they go and do something. So that would account for the difference maybe.
JIM: Yes, because you’re main cost, I mean most of these people that when they get to their destination what you’re paying is your daily rental fee, you’re paying for your food costs, and any entertainment costs. So once you get there you’ve spent your money on gasoline. So the rest of it is just fees and food and everything else, and it’s still if you take a look at the cost of flying or staying in a hotel it’s still cheaper. [18:34]
JOHN: When we’re looking at the numbers however, none of this sounds good and you’ve already pointed out that the CPI is understated, that also may mean the GDP is overstated. So if we really clear away the smoke we could probably honestly say we may already be in a recession.
JIM: I’m seeing a lot of evidence just as you’re seeing where you’re at, John, there’s a lot of evidence here in San Diego. Condo prices have fallen off a cliff, they’re giving away cars, they’re giving away upgraded appliances, granite counter tops, they’re covering your closing costs. And I’ve spent a couple of times, usually as we get closer to a recession I like to do what I call field trips to the mall, just to kind of observe what you see people doing. Are they walking with packages in their arms, or are they just out there trying to get out of the heat? I talk to a lot of the merchants as I go into the luxury stores, as well as what I call the average stores that people would shop at.
And most of the merchants I talk to, tell me the only thing that’s selling is discounted merchandise. In other words, if you hold a sale, they will come. It’s kind of like: have a sale, you’ll get buyers. Although some of the luxury stores basically said � and high end stores, they’re still doing well. Sales people for example � everybody knows I’m a sailor � I was talking to one of the boat dealers here in town and he’s seen the boat buyers have just gone into hibernation. And they’re really not sure where all of this is coming from � interest rates, or oil prices, or a declining housing market. One dealer I know has sold only one boat in the last 6 months. And I know in fact in our neighborhood now we have � gosh there’s only 63 homes in the neighborhood � we’ve got 4 up for sale right now. One home has been on the market now for well over 4 months and I would say if we were to go back to this time last year that house would have sold within a month. [20:27]
JOHN: Yes, it’s interesting here in our area we’re one of the few fastest growing counties in the country and believe it or not, guess who’s buying all of our real estate? Why, it’s Californians.
JIM: You probably look like value investing compared to here.
JOHN: Yeah, and they expected to flip these properties, and now they’re finding stuck with them so they’re all throwing them on the rental market, and rental prices here are plummeting. In other words, if you wanted to rent from somebody this is the time to do it as far as a house is concerned.
What about today’s retail sales figures that show July’s retail sales rose what? � 1.4%. That would probably indicate that the consumer so far anyways seems to be holding up. What do you think?
JIM: I think really the devil is in the details to begin with. Those numbers aren’t adjusted for inflation. So yes, retail sales are up 1.4%, but back out the inflation numbers, because everybody knows that prices have been going up, which is probably the new way of spinning the economic numbers. I know one time when I got out of graduate school I was a retail analyst, and one of the things that we would always do when we were analyzing sales from one year to the next is we would back out the CPI out of inflation, because if we raised prices 5% that didn’t mean we were selling anymore merchandise. Even though the gross dollars would look bigger, they were simply bigger because of inflation.
Here’s the other factor, too, to consider in those retail numbers and this I find hilarious: part of the reason included gasoline sales. So if you’re going to the pump and you’re spending more on gasoline because the price of oil has been over $75, well, guess what, that gets added into the retail sales numbers. So part of the reason that we saw basically higher retail sales figures: number one, they didn’t adjust them for inflation; and number two, is they were including gasoline sales.
Auto sales by the way were also stronger as dealers were just basically giving you discounts, rebates and everything to move the merchandise off the lots. One of the problems we had late on Thursday, General Motors said they would have to cut back on production in the second half of the year because inventory was starting to build up at all their dealers. [22:42]
JOHN: So what is the Fed going to do next? We face another move in another month. It seems like they’ve left the door open for additional rate hikes, but I think they were smart this time not to do anything foolish shall we say.
JIM: Well, the bond market is always worried about inflation, and inflation is a lagging indicator. Looking back over for example the last decade, the Fed paused February 1995, and we got what was called a midcycle slow down. They also happened to pump the money supply at that time, and also put their foot to the pedal. But they paused again in May of 2000, instead we got a bear market in equities and a recession. Odds I would say at this time favor a recession. If you look back, I don’t know, I would say the last 12 recessions or at least the last half century, every time the Fed raised interest rates they tend to push things too far. Almost 95% of the time, we end up in a recession or a bear market. I think there were only two times in a fifty year period, one of them was in 1995. So I would say the odds favor a recession. [23:55]
JOHN: It seems the market’s emphasis has shifted from inflation to the economy. With the housing market tanking there are also worries that the Fed has pushed the car over a cliff. So we come back to the initial question that I asked: a pause that refreshes, soft landing or hard landing, what do you think?
JIM: You know, from my perspective John, it’s beginning to look more and more like a hard landing. The most important aggregates, if you look at employment, retail sales, housing starts, they’re all generating solid recession warnings. In fact, layoffs are usually the first response by business, as things begin to slow down � and that’s exactly what we’re starting to see. I expect layoffs to probably be the next headline and the markets to begin to focus on that, so I would say if we were looking at things it all looks to me like we’re heading into a recession. Although the way they jerry rig some of the economic numbers, I doubt if it would be reported until after the election. [24:49]
JOHN: Or it became deliriously obvious so to speak. Any chance we’re going to get any chance of a reprieve?
JIM: Boy, that’s a hard one to answer, there’s always a chance they could resurrect another asset bubble. Right now, it just isn’t looking good. You take a look at the charts of retailers, home builders, they’re telling us the economy is heading for trouble. And if that wasn’t enough, the economy is already under the weather, and now you have a Middle East war, you just had on Thursday a thwarted terrorist attack. Those events tend to add to consumer worries and that tends to weigh on confidence. If you look at the Fed’s own forecasting gauge � which is the inversion of the 3 month T bill, and the 10 year Treasury note � that puts the odds of a recession next year at close to 40%; and that’s up from 14% six months ago. So I suspect the numbers are only going to get bigger as the year progresses.
And unless they can pull a rabbit out of the hat, because unlike the 2001 recession, that was a business-led recession, you didn’t see the consumer pull back in 2001. The consumer saw his home price get elevated so he was able to refinance as the Fed dramatically slashed interest rates. He used his increased cash flow to go on spending, to buy things, to buy new cars. Detroit was offering all these incentives. So basically what we did coming out of the 2001 recession is we really borrowed from the future. So you have to ask yourself if we’re going to come out of this, and we’re going to avoid a recession what’s going to lead us? About the only thing that is holding up well right now is business spending, and that has not been robust. It’s not strong enough to replace a slowdown in consumer spending. So the other element would be government spending. Unless they either: one, throw in an emergency tax bill, the kind of tax rebates they gave us from 2001 to 2003; the Fed dramatically slashes interest rates; the government goes on a spending binge. Outside of those activities, I just don’t see anyway at this point how we can avoid a recession. [27:05]
JOHN: Well, from an investment standpoint then what actions should one take?
JIM: I would say stick with what is working and what is in a new bull market. I would stick with commodities stocks, such as energy and precious metals � just look at how well they’ve done since 2001. In fact, look at how well they’ve done this year. I would also stick with large cap dividend paying blue chips. And no matter what, John, I think you have to hang on to quality no matter what else that you do. [27:33]
JOHN: And don’t forget, you’re listening to the Financial Sense Newshour on www.financialsense.com. Our files are posted on our website fresh and new every Saturday morning at 0700 hours Greenwich Time � that works out to be about 3am Eastern Daylight Time, here in the United States, but it’s 0700 hours Greenwich Time for the rest of the world.
Time to move on, and hear one of two Other Voices this week, here on the Big Picture.
Other Voices: 'Zapata' George Blake, Market Analyst
JIM: Well, Zapata George, I’ve just been on a vacation this week, starting on Monday, we had about 8% of our oil production go offline, we had a typhoon on Wednesday, a possible terrorist threat on Thursday � not bad for a week off. How are you doing, my friend?
ZAPATA GEORGE: Well, of course, that made the price of oil go down, which is only logical, right?
JIM: Well, you know, I saw that. Thursday they announced a thwarted terrorist attack. And if we were given an investor IQ test, oil goes off line, you have a possible terrorist attack, as an investor you should do the following: a) sell your oil stocks; b) sell your gold and precious metals; c) sell both your precious metals and energy; d) buy tech stocks. What do you think they did? They bought tech stocks, sold off gold and oil. It doesn’t make any sense to me.
GEORGE: Well, you see, if you’re 29 years old, and you don’t understand what you’re doing, and you’re running $42 billion worth of other people’s money, those are the things you do. [29:18]
JIM: George, a couple of things on the oil markets that are very telling, you and I were talking just before we went on the air and I was talking about the BP Statistical Review where total oil production was only able to increase by 890,000 barrels a day for the entire world in the year 2005, and you want to mention a very important speech, given in Australia by the former head of the Iranian oil company. Why don’t we begin with that?
GEORGE: Well, this gentleman is now retired, he was the senior adviser to the national Iranian oil company � his name is a jaw-breaker, you can pronounce it, I can’t � but he appeared in front of the Australian Senate giving testimony. And I mentioned on your show last Winter that I had it on anecdotal authority that there were horizontal wells being drilled in the oil caps of the world’s largest oil fields. Well, in his speech he says there’s 220. Well, for those who are not in the oil business the significance of this is probably meaningless, but to those of us who’ve spent our life there it tells us volumes. And it’s this: they’re pumping 7 million barrels a day into the biggest oil field in Saudi Arabia of salt water. Now, they are extracting volumes of fluid that are 38 to 39% water. Out of the horizontal wells, they’re extracting 100% oil and zero water. Well, that means that 38, 39% is a lie, because they’re averaging in the 100% oil. So the real mark is in excess of 40% water which is a magic mark that water flood management engineers look for. So one, they’re lying to us again; two, when one of those horizontal wells, when the oil-water contact reaches it, it goes 100% water and oil production falls off a cliff. Well, falls off a cliff in a super giant oil field means numbers like have happened to the second largest oil field, the one in Mexico, where I suspect this phenomena we’re describing has already occurred. [31:56]
JIM: You know George, it’s not just the fact that the world’s largest oil field has peaked but even more important for the United States, especially when we have 10 to 15% our Gulf oil and gas production down, now we have Alaskan production down, the United States has relied more and more over the years for imported oil from Mexico. So, let’s turn our attention to one of the second largest oil fields in the world Cantarell.
GEORGE: Well, we do not have it on authority that they have done this horizontal drilling in the oil cap. But, when you look at the volume of water that they’re using to perform that flood with, and you look at the recent announced sharp decline of 13% year over year. See, when you have water flood in a super giant you ought to be looking at decline numbers of somewhere between 1 and 3%. When you see a drop-off of 13, year over year, something serious of a structural nature has happened. Now, the first thing they did is they denied that such a thing, that it was structural it was a short term phenomenon. Well, short term phenomenon my foot. I know enough about it to know they’ve got a serious problem. I suspect it’s just exactly what we’ve described. Some of their horizontal holes the water reached them and then bang they went 100% to water. [33:28]
JIM: George, I’m looking at a report from a large brokerage firm on Mexico, and the title is whoever becomes Mexico’s next president will face a major challenge � peaking oil production. And it has graphs of oil production which peaked in the year 2004, and they’ve been declining ever since, and also if you take a look at their oil production over the last 3 years it’s been stagnant, despite the fact that they’ve increased a lot of offshore rig activity. So, it seems at a time when you have Ghawar peaking, Cantarell peaking, Burgan peaking, I can’t believe George, when you follow the media they talk about statistics they’re so irrelevant to where we are in the energy markets that they keep the public, and especially the investment public in complete ignorance.
GEORGE: Why would you waste your time announcing each week what the inventories are? This is the most meaningless set of statistics that are on the air. The only statistics that count about oil is where is the barrel of oil. Is it in the ground or is it past the wellhead, and above the ground? Because once it’s above the ground, we all know that we don’t save any of it, we burn it up. Well, who cares where it is, is it in your gas tank, is it at the gas station, is it in front of the refinery, is it behind the refinery? Who cares, it’s meaningless. Yet we don’t ever hear about decline of the major fields in the world. This is what’s important and attention to it whatsoever. [35:18]
JIM: You know the other factor too, George, even though they spend every single week talking about these inventory numbers, you and I know these are statistical numbers that are done with computers. It’s not somebody out there every week, and it’s Harry dropping a dipstick into the oil tank and saying, “Ok, that’s what it is this week.” That’s not taking place, and I think that’s another important factor that makes these numbers so irrelevant.
GEORGE: Well, I’ve reported on one show that I got completely aggravated with the natural gas numbers, and that there’s a Washington, DC number that you can call. So, I spent a morning wading through the US government system of reporting natural gas story. Everything is a seasonally adjusted smooth curve report. And when you call the people who manage the storage facilities they don’t read the gauge, and report the numbers �the pressure and the volume � to the government. They smooth it before they report it. In other words, the numbers we’re getting are double smoothed, double averaged, double bogied � they are meaningless. [36:40]
JIM: George, why do you think that the financial markets and the traders then place so much emphasis trading in and out? Is it just habit? Is it just the way the market functions without really looking at the underlying trends? Because one thing that strikes me, and you’ve seen this and we’ve commented on it on this show over the last couple of years, is that every single year you get the analysts on Wall Street, and they’re always telling us why oil prices are going to go down, why oil profits have peaked. And every quarter, and every year, George, at least going back to the year 2002, we’re looking at higher oil prices, higher oil profits, and the price of oil keeps going up. It doesn’t go down.
GEORGE: Ok, well, you’ve asked a multi-faceted question, but let’s address the first part of it. Why does the media, and why does Wall Street trade in this manner? And I have a fundamental basic concept that you’re either an investor or you are a gambler. Now, you may say, “oh, I’m a trend trader,” or “I trade this, I trade that.” Well, no, in my book you’re one or you’re the other. Now, if you’re an investor then people should think like you and I do � where is this thing going to be in 10 years? If we know where it’s going to be in 10 years, and we know where it is now, draw a line between those two, and if that point is higher than it is now, when it dips below your line you’re a buyer. If that point out in the future is lower than where it is now, and you draw a line between them, every time it’s above that line you sell. You do not trade against that trend regardless of what Wall Street may say. You’re an investor so you place your trades on the long term side; you have patience, which is the hardest lesson for an investor to learn. It was my toughest lesson. You have patience and then you profit.
Now, let’s get back to the oil price itself. In 2000, we passed a true watershed event. The paper market ended January 2000, it had blown disproportionately out of shape for years, it finally came to an end, and the hard asset market came on board. Now, it was unrecognized for several years, but it became apparent to those of us who take the time to look at the history books, who had some knowledge of the true fundamentals, not what Wall Street calls fundamentals. In other words, how much copper does China produce, versus how much do they use.
I was a copper bull at a buck and a quarter, and everybody told me I was crazy. And I said, “look, you only have to know one set of numbers � China produces 16% of all the copper that they use. China’s going to build 30 Megawatt atomic power stations, and 7 huge hydroelectric projects. Imagine the copper, that’s just used for those facilities, it ain’t rocket science folks, it’s third grade arithmetic, and common sense.” The price of copper is going to go up. Well, every time the price of copper went up 20 or 30 cents I would get all these phone calls telling me what an idiotic I was. And I said why don’t you call me back when it gets to $4. Well, finally it did almost get to $4. And I said, “now, if you’re looking for a reaction this is a good place.” But I said, “don’t get trapped on the short side because it may have a percentage wise,” but I said, “it’s going to recover. It’s going to recover quick.” Well, it’s already back to 3.60. And I still stick with the idea that China still only produces 16% of the copper that they’re using and they’re not through using it. [41:06]
JIM: It’s always amazing � this reminds me when the paper markets took off in 81 and 82, it probably wasn’t till 87 that people caught on, “hey, this is a bull market in stocks,” because people kept expecting oil was going to go to $100, gold was going over 1000, and silver would be at 100. And of course, stocks were selling at 7 times earnings, dividend yields were over 7%, bond yields were at between 13 and 15. And it was a new bull market in paper but I don’t think most people caught on to that. I know individual investors did not catch on to the bull market in stocks until right around after 1995, when we were in the final stages of the bull market.
GEORGE: They really got the bit in their teeth about 94, 95, 96 and then of course they ran off with it.
JIM: Well, it seems to me, George, as I look at oil stocks today, especially those that have the ability to increase production, you’re looking at stocks anywhere from 6 to 9 times earnings; you’re looking at precious metals companies and base metals companies that have the ability to increase prices and demand for their product as a sell-out. And you and I know, I can’t think of any major new oil discoveries that are coming online that are really going to wash the market with a surplus of oil, nor can I think of any major mines that are coming onstream. I would say miners would be somewhat reluctant with the economy looking like its heading into a recession, why would you want to spend money and build a new mine right now?
GEORGE: Well, see, every time that the price of copper has gone up, the big producers have gone out, geared up, bought claims, blah, blah, blah, only to get dumped on their heads. And so the burn child fears the fire so they’re not going to do it. Well, that leads to the problem of a shortfall of production. Well the shortfall of production in all of the critical things like we’ve just been discussing � oil and base metals � is exacerbated this time by the greatest demand that the world has ever seen � and that is not an understatement.
For the first time in the history of the financial world, we have 2.3 billion consumers entering the market. Now, up until 1910, all of us were consumers � we had mouths, we ate. But around 1910 we created a new kind of consumer on the earth. Mr. Henry Ford introduced the Henry Ford consumer. He paid these guys enough on the line to buy the gadget that they were making so everybody could have one. Well, it was called a car. Well, I got news for you, a car consumes more than an individual ever dreamed of consuming. You want to talk about steel, rubber, plastic and of course our old friend oil. And see, you consume all of those metals and stuff building a car, but then for the life of the car it continues to consume oil by the thousands of barrels.
Well, that means we’ve got a different kind of consumer on the face of the earth. Well, he only had a potential of about 110 million to sell those to. Well, guess what folks? Things happen a whole lot faster now than they did in 1910, and guess what? All of those people there, those 2.3 billion of them, not the 110 million, all have color TV or access to one, and they see the advertisements. And no, they may not be buying a new Buick like they sell in Shanghai, they may be buying a mini car, with a 20 horse power engine. But I got news for you, there’s a gasoline tank on that 20 horsepower engine. There will be hundreds of millions of new gasoline tanks in Asia. And on Friday night, if there’s a 17 year old boy that has access to that vehicle he will beg, borrow or steal the money to put the gasoline in that tank because he’s going to go cruising. So folks, with hundreds of millions of new gas tanks, and billions and billions of 17 year old boys, I don’t care what the economy is doing the demand is built in. We are facing the greatest consumption demand in the history of the world. Period. [46:09]
JIM: George, given that as we summarize, I take it you wouldn’t be selling your oil stocks or precious metals and buying tech stocks.
GEORGE: Well, I have a new rule. I got burned on a copper stock I had talked about on your show because the communists took over the country. My house sits on the Texas-Mexico border on a lake, I’m just on the North side of it, you can see Mexico from my back porch. I have a new rule. I buy no company whose assets are South of my house. Now, like that rule? I love it.
My friends in Canada have all kinds of oil stocks, gold stocks, copper stocks, coal stocks, all kinds of stuff. Canada is one of the richest asset places in the world. Well, we still have a few resources left in this country. So, I am limiting my purchases to North American stocks that have assets � or potentially have assets � I am buying some exploration companies. I just put out a new thing called the wolf pack, where I presented some Canadian junior stocks. You’ve got to buy them as a package, but I put out the leader, every pack has to have a leader right? So I put out the leader of the pack. Now, you can buy the leader of the pack separate, but they’re all oil and gas Canadian companies, their assets are in Canada, and I’m a buyer of all of them. [47:42]
JIM: Well, George, if our listeners would like to find out more about what it is that you do why don’t you give out your website as we close.
GEORGE: Well, it’s really simple folks, it’s www.ZapataGeorge.com, and they will find my phone number on there, they’ll find the newsletter and the book, and I love to talk but of course we couldn’t have figured that out, could we?
JIM: Ok, my friend, thanks for joining us on the program. George, I look forward to talking to you in the future.
GEORGE: Amen, and it’s always my pleasure. [48:20]
Dividends Don't Lie
JOHN: Well, in a time of rough and stormy seas, it isn’t so much to worry about the roughness and storminess of the sea, it’s just a matter of understanding what heading you’re going to take, and what other things you need to do during that rough period. And Jim, I know you are a big believer in dividends in a time of uncertainty, which I think is beginning to resemble the one we’re in right now. And so, what would the ideal investment strategy be in such an environment?
JIM: Well, John, one of the most important concepts of investing is total return. Any time you hear about a long term return in the stock markets � studies that have been done over decades, over centuries � they’re always talking about total return. And in total return is dividend yield plus capital gains. And that concept I think of total return is what has made stock investing so appealing to investors, because it’s not just the fact that you invest in a stock and it goes up in value, but also a very important component of that return has been dividends. In fact, dividends reinvested offer superior compounding rates of return. So it’s a concept I believe that’s returning back to the market place. And especially if you look at, for example, the dismal returns of the stock market this decade, where you’ve had the first three years of a bear market � the market was down in 2000, 2001, and 2002. We had a very good year, sort of a nice, strong rally in 2003 � especially after the Gulf war was over. But since that time, the market has barely kept up with the inflation rate. In fact, with most of the return coming in the stock market coming in the final six weeks of the year. [50:28]
JOHN: But it would seem that this would be an argument in favor of dividend investing.
JIM: Well, you’re absolutely right, dividend investing is beating growth investing hands down in this decade. Let’s face it, without a dividend an investor is entirely dependent on stock appreciating. And once again, if we look at those stock market returns this decade, growth has been anemic and in fact, at times, negative.
JOHN: And it also goes back to the analogy, that a bird in the hand is worth two in the bush.
JIM: If you look at investing in the market today, and all the fundamental measures of value, you can look at dividend yield, you can look at price/earnings ratios, price to book ratios. To me, I think the dividend yield is the most revealing measure of value because in addition to producing income, dividends really tell you something about the company’s state of health that earnings and book value may not show. Obviously, earnings can always be manipulated by management, we certainly saw a lot of that in this new decade with all the earnings scandals at Enron, World Com, all of the other scandals that surfaced that we had to pass Sarbanes-Oxley legislation to just to try to rein that in.
The problem with earnings is they may not square with reality. And that was the problem we saw in the latter part of the 90s. These companies were reporting just unreal earnings increases that were basically being financially engineered. You compare earnings manipulation, on the other hand, dividends are real money. Once a dividend is paid, it’s gone from the company forever. They can’t call you up and say, “hey, send back the dividend checks, it turned out we really didn’t have the cash to pay that to you.” You can’t restate your dividends the way you can restate your earnings. In essence, a dividend can’t be faked or fudged: it’s either paid or it isn’t. And if it isn’t paid there’s a good reason. [52:18]
JOHN: Putting it in other words, basically, dividends are the real deal, earnings can quite frequently be a chimera.
JIM: Yes, and the other thing too, you take a look at these directors of these companies, the directors of the company aren’t going to pay or increase a dividend unless that pay out is physically justified and sound. In other words, they’re looking at the business and saying, “are we actually earning the money to pay the dividend? What are the prospects for future earnings, how’s our cash flow?” In other words, consistently rising dividend trend dramatically reveals more about the company’s profitability than earnings do. A dividend increase will tell you more about a company’s financial health than any other measure that I can think of. In fact, dividend payments, and dividend increases are probably the surest confirmation of a company’s profitability, since dividends can arise only from the reality of earnings. [53:11]
JOHN: Well, it would also seem to provide under a stock as well.
JIM: That’s something that we’ve talked about in our Expert’s Series with Tim Woods who’s following the dogs of the Dow. You take a look at the dismal returns of the stock market this year for all major indexes, and you compare that to the dogs of the Dow, which are the highest paying dividend stocks, and once again it’s starting to shine. Investors really pay close attention to dividend yield. And unlike a stock that doesn’t pay a dividend, when the price of a stock falls that pays a dividend the dividend yield increases because the dividend is still the same, except that you pay less to get it. So, what that does is it provides investors with an attractive return. So, whenever the yield increases on a very healthy blue chip stock, you’ll see large sums of money come into the stock and start buying it which generally halts the decline.
Now, in contrast, you compare that to a stock that doesn’t pay a dividend, it has no such safeguard on its price. [54:16]
JOHN: Ok, so assuming that we’re going to invest for the purpose of achieving dividends, what am I going to be looking for in a stock?
JIM: Well, this is something I think all investors should look at but one of the most important things is you want an uninterrupted track record of dividend payment � 10 years in terms of a minimum. I prefer to look at 15 to 20, and some even say 25. The longer the dividend paying track record the better. So that would be the first thing I would want to look at.
The second thing I’d probably look at is you want to make sure the dividend payment’s are no higher than 50% of a company’s earnings. That means that the company is still generating enough in earnings so they can plow it back in the business, unless for example you’re in a unique industry, such as maybe a utility or a food company. I mean how many things are you going to do to food, basically you have packaging and advertising, and whatever your raw materials costs are, but you’re not spending a lot of money in R&D. So, the second thing is a dividend payment no higher than 50%.
Third, I think is a very important one is a strong balance sheet with very little debt. And if you’re not an accountant you don’t know how to analyze financial statements, I would at least look at a Value Line rating or an S&P rating of A, or A+, or better, so that’s going to tell you if the company is financially strong.
And fourth, I would look at dividend growth equal to or exceeding the inflation rates. So if inflation is running at 5 or 6% a year, you would want as a minimum 5 or 6% dividend growth rates.
And then finally, I would say earnings growth out of the last decade, earnings to have increased at least 7 out of the last 10 years, because when you do get a recession you could see earnings decline. But normally the US economy has been averaging a recession in about once every 10 years. We had a recession in 1981, we had one in 1991, and then we had one in 2001. So within a full decade, earnings increases in at least 7 out of the most recent 10 years. [56:27]
JOHN: Well, it seems these are pretty straightforward criteria, namely because they make financial sense: a strong record of earnings, dividend payments and a healthy balance sheet. Any other thoughts on that?
JIM: Well, we use 2 proprietary indicators in making our final stock selection, but the 5 that I think I mentioned should keep investors on the right path, and avoid any problems. In other words, you don’t want to find a company that pays a high dividend.
And don’t necessarily look for the highest yielding stock, if you do you better look closely at it there’s a reason that that may be the case, unless it’s a rather unique type of stock like for example a royalty trust, where you can get dividend yields of 6 to 10% ,which are very much the norm; or for example, in the energy area you might see limited partnerships that are listed on the exchange, they pay no income taxes so all those earnings are passed on to investors; or for example, a real estate investment trust that doesn’t pay tax, that would have a higher dividend yield. But when you’re looking at regular common stocks, and you’re getting a dividend that’s way out of the ordinary you better do a little bit more homework.
But emphasis would be that in a time that we’re looking at, let’s say, mean reversion in the stock market, I think dividends are going to play a more important role in producing a superior market beating returns. When the stock market goes down, or goes no where, believe me, John, you’re going to be glad you have a dividend paying stock in your portfolio. [57:57]
Other Voices: Dan Gainor, Director, Business & Media Institute
JIM: Well, the experts keep telling us that the price of oil is going to head down; that as the economy slows down pressure will be taken off the oil markets, but yet week after week, or month after month, the price of oil keeps going up, and Americans are producing less of it, which means we’re having to import more of it.
Joining us on the program is Dan Gainor, he’s a reporter for the Business & Media Institute.
Dan, let’s begin with the supply-side of the oil equation, and there’s two parts: you have demand, which we know is growing not only here in the United States, but also globally, especially in Asia; the other side of the economic equation is supply, and we seem intent in the United States to do nothing to increase it.
DAN GAINOR: Yes. I was talking just a few minutes ago about how much this is really an environmental shell game. They’ll say, on the one hand you can’t talk about carbon-based fuels it’s the Al Gore mafia we’re afraid that somehow we’ll endanger the environment and cause global warming. So anything having to do with oil, whether it’s drilling in ANWR or drilling off the coast, coal anything like that they oppose. So when you talk to them and say, “well, what about nuclear power? France gets 70% of its energy from nuclear power, how about that?” And so they move away, you’re not talking about the first thing, then when you get them talking, then they say, “well, we can’t do that either, because then you run into dangerous nuclear waste,” which somehow France is coping with but apparently the US can’t.
So then you move onto something else � dams. We used to build dams in this country, it used to be a great accomplishment, then the Left wanted to tear them down so they could save the salmon. Wind power � Ted Kennedy has the audacity to worry about the view for some of his rich friends in Nantucket, rather than worry about where we’re going to get energy for windpower. We don’t have an energy policy in this country, we have an energy lack of policy in this country. It’s being driven by the Left and mandated by the environmental movement. And we all end up paying the price. [1:00:18]
JIM: You know, Dan, what is surprising, and no matter what kind of crisis that we have � whether it’s Katrina, Prudhoe Bay with the pipeline � the way the media covers the energy situation, as you just mentioned, it’s almost appalling to look at the fact that everywhere in the world whether you’re looking at Europe, Japan, China, they’re building nuclear power plants. They’ve done so in Europe for over 3 decades now � no accidents, no problems. They can build nuclear power plants, but somehow we can’t in the United States. You take wind power � they’re putting up wind turbines off the coastlines in Europe, but we can’t do it here. If you’re talking about clean coal technology, they can build them in China but we can’t build them here. If you’re talking about drilling, if you’re a foreign company or a foreign national company, such as China, you can drill off the coast of Florida, but US companies can’t. We’re absolutely insane.
DAN: Yes, it’s almost like we’re schizophrenic. We know that we need something, and then we spend all our time ensuring we don’t have it. But it’s not us, I mean as much as we might want to say it’s us, it is a very small subset of Americans who are opposed to just about everything. And we left out� probably we could add to this list for hours and days. I mean the refineries � yes, the oil companies cut back to some extent on the refineries because they weren’t very cost-effective, but there’s a company roaming around the Southwest, that’s been trying like a lost child to find a home. And nobody wants it, because of course we can’t have that � nobody wants an actual refinery.
And Richard Branson, who runs Virgin Air, and that whole business line, he said he wants to build a refinery as well, but he’s not even going to bother trying to build it in the United States. Why? Because of all the environmental regulations. The media refuses to look at this as ordinary Americans would � which is we have an energy based economy. You know what? We’d like it not all blow away and disappear so Americans all end up unemployed or starved to death in some crazy Mad Max future. [1:02:08]
JIM: you know, it’s amazing, here in California, I live in San Diego our local utility
DAN: My sympathies.
JIM: Thank you, I need it.
DAN: I was going to say, not for San Diego – San Diego is a beautiful city, and a lot of parts of California. But the California environmental regs, and just the left-wing mafia that runs things in California are the reason why we have some of these problems. [1:02:59]
JIM: You know, it’s absolutely amazing, our local utility wanted to build a new natural gas power plant. They couldn’t get the permits here in San Diego, after fighting and fighting, so they went across the border. They’re building a power plant in Mexico. You remember our natural gas crisis in the year 2000, we don’t have enough pipelines to supply our natural gas plants, the only kind that we built. So they’re building LNG terminals in Mexico. It’s absolutely crazy that the US thinks that its only policy is we import it from somebody else.
DAN: It’s not like that’s any better for the environment. If the Left wants to pretend that dumping anything that they’re not happy with on the Third World is somehow better for the environment, well, it’s a complete and utter lie. About a year and a half ago, over 2 years ago, I met with a couple of Chinese journalists, I asked what it was that most impressed them about the United States. And they said the quality of our air, because of course, they’ve got all the pollution that Americans don’t want. That doesn’t do anything. If you want to be a true environmentalist, that doesn’t solve anything. All it does is remove the problem from one place and puts it somewhere else. [1:04:13]
JIM: Dan, let’s talk about this week’s headlines, which is the leaks in Prudhoe Bay, with BP. Every time we get higher energy prices the favorite whipping boy of the politicians, environmentalists and the media, are always the oil companies. But you and I know that the major oil companies only produce about 15-16% of the world’s oil production � most of it comes from national oil companies. We have been trying to access oil in the United States. Let’s talk about ANWR, because this issue in ANWR is so misrepresented to the American public that I wonder if you might address that.
DAN: ANWR is painted as this crazy garden of Eden place, that they show clips � the whole Arctic National Wildlife Refuge is 19 million acres � it’s equivalent to a couple of times the size of the State of Maryland where I’m from originally. And so it’s a huge place. And because it’s so huge, parts of it are absolutely gorgeous, but you go back a few years ago, CBS and Leslie Stahl did a very nice piece, she actually went to the area that would be affected by drilling in the ANWR, and then you go from this beautiful, pristine place to a place that if it was a trailer park it would be a step-up. We’re talking about a place that looks like Siberia on a bad day, and that is what we’re talking about drilling in. And even then it’s not a large area.
Congressman Jack Kingston used a wonderful analogy at a seminar we had a few months back about energy, and he said, “imagine a basketball court, and then place a dollar bill in that basket ball court, and this dollar bill is by comparison the size of the area we would be drilling, if that basket ball court was all of ANWR.” And it is minor in scope, and it’s enormous in the amount of potential oil. The median estimate of the US Geological Survey � in between the high and low estimate � is 10 billion barrels of oil, which is second only to Prudhoe Bay. And that’s what they found, not what was estimated but what they’ve actually found at Prudhoe Bay that’s an enormous amount of oil. It would be the second biggest find in US history, and we’re supposed to not even worry about it that’s insane. [1:06:34]
JIM: You know, Dan, if we were to drill in these 2,000 acres, that would still leave 99.99% of the Arctic wilderness untouched.
DAN: Yes it would. And because we’d be doing that and protecting the rest of America, we’d be protecting the environment at the same time we continue to ensure our economy doesn’t collapse from a lack of oil.
JIM: You know the one issue I think that the media never really gets across to the public in an intelligent way is we are a carbon-based society. If you look at our transportation system, whether you’re looking at air travel, railroad transportation, trucking, farming, driving to and from work � this is a carbon-based society. Now, if somebody was to say, “Ok, we don’t drill for oil, but here’s a new technology that we have that’s cheap, inexpensive that will replace it all,” I’d be the first to say let’s do it. But we have nothing on the horizon right now, that can completely take the place of oil, and yet they’re basically saying, “we’re going to do nothing to create it, nothing to refine it, we’re going to do no alternatives to supplement it.” How does an economy work like that?
DAN: Ultimately it doesn’t. We’ve had years � decades really � of warning about this. And it used to be though, that when oil was plentiful, world demand was only so high. But what’s happened is world demand has gone up a lot � China and India, every expert will tell you there incredible growth in their oil economy, because they’re basing it on a Western model, not so much the freedom of the West, but the energy based nature of their economy. So as that’s gone up, the difference between supply and demand has narrowed, and now we have all these pressures on the supply. We have two lunatic regimes: we have Iran and Venezuela that constantly go around saber rattling, threatening to cut off world oil, so that raises the price, builds in fear into the equation. Then you have hurricane Katrina and Rita afterwards, that do some damage to where we get supply. And then you have the situation whether it’s BP or any sort of little blip on the horizon has more and more impact. And this is not going away. So it’s time to step up to the plate as a nation and say we need oil. We need it now, let’s worry about the long term over the long term. Let’s worry about the short term, darn well right now. [1:09:10]
JIM: You know the other surprising statistic is the BP Statistical Review showed that globally last year, the world was only able to increase oil production less than 1 million barrels a day. Dan, is it going to take a crisis � in other words, as long as an American can go to the gas station, fill his tank. I’m right here in a vacation resort and there’s motor homes in the parking lot, it’s entirely filled up, so it doesn’t look like people are being starved but right now you can go to a gas station, you can get it. But what happens, Dan, when the price of gasoline goes to $4 or $5, or you’re on the East coast and you have a severe Winter and you can’t get heating oil to heat your home? Is it going to take something like that before Americans demand something be done?
DAN: Well, I think enough Americans have wised up to start demanding something. It’s just Congress is not listening; the Left continues to battle a delaying action because, again, their claim is 10 years that it would take to bring ANWR online. What they fail to remind you of is that Congress voted for this, and Bill Clinton shut it down 11 years ago. Ha. It would be online now, and so we would not be so sensitive to this Prudhoe Bay problem, or to the threats from Iran, or Venezuela. We are talking about someone, anybody who is listening right now, who is either worried about the economy, or national security or both, this is an issue of paramount importance: we don’t have enough long term energy and we are held hostage by nations that don’t like us. We’ve got to do something about it. Congress is not stepping up to do anything. [1:10:54]
JIM: It’s absolutely amazing, since just in the last 6 weeks with the heat wave we’ve been going through rolling black outs here in California, and most people have sort of gotten used to it � it’s sort of an inconvenience � but when they start to happen more often I think a lot of people think that maybe politicians think that oil comes out of a gas station.
DAN: As a nation, we dodged a huge bullet with that heat wave. Heat waves happen this was an unusually slow one, but still it moved across the country and while we had some blackouts in the East coast and West coast and a few spots in between. Generally speaking, the energy grid and the energy supply held, but suppose it hadn’t. It could easily have gone the other way and then when you lose power you don’t just lose economic productivity: some people die, they can’t live without the air conditioning because they’re old, or they’re ill, or something like that. You’re talking about just chaotic problems. Yet we refuse to do anything about it. We have our blinders on so strong that we seem unable, unwilling to notice what’s going on around us. And for that I really do fault the media because they don’t do a good job of covering this and reminding people: “oh, there is other oil out there, we’re sitting on tons of oil in ANWR, we’re sitting on tons of oil off the coast and tons of natural gas there.” And we can’t do anything about it. [1:12:29]
JIM: Do you think this is just a political bias, or what’s behind the media coverage? Because certainly if I majored in journalism, and I looked deep into the issue there is plenty of evidence out there that we need to be doing something about it. In other words, if you’re a journalist how can you say that we can’t have nuclear power, wind power, clean coal technology, or drilling for energy when you look at Europe, you look at Asia, China, India, Latin America they’re doing these very same things? As a journalist, how can you justify that?
DAN: Well, a career journalist, what they do, it’s a combination. On one hand, they’re naturally suspicious of - and you can read into that �antagonistic towards’ � big business. And they see the oil companies and energy companies in general, they see them as prime examples of companies that they should be going after that are the potential bad guy or the actual bad guy. And so it doesn’t matter, anybody who opposes them, whether it’s crazy Hugo Chavez in Venezuela, or even downright insane Mahmoud Ahmadinejad in Iran, they treat them as normal, sane people. Look at Mike Wallace’s up coming piece on 60 Minutes on Iran, he treats Ahmadinejad as a normal guy. This is a guy who wants to wipe Israel off the map, and is trying to get nuclear weapons so he can do it. That’s not someone you can say, “oh, he’s a statesman, just like Ronald Reagan or FDR.” [1:14:08]
JIM: I am just absolutely amazed, and I think it’s probably going to take Dan � I’m getting more pessimistic. We’re going to have Matt Simmons on, and Matt gave a presentation to the Defense Department, and he did a piece called The Energy Crisis has Arrived. Have you noticed over the last couple of years, you know, the black outs, the problems with energy are surfacing much more frequently than they have in the past? This issue hasn’t gone away.
DAN: But this issue has been with us � I’m unfortunately old enough to remember the oil crisis of the 70s, and we knew then that we were in a problem. The difference is OPEC � the cartel that is OPEC � decided to stop viewing us in an antagonistic way and work with the West. But now, two of the major OPEC players Venezuela and Iran, are no longer playing, they’re causing problems on a regular, often daily, basis. I mean for people that are listening, they see what is going on in the Middle East, who do you think is funding Hezbollah? It’s Iran. Who is backing Iran? It’s Venezuela. These are nations that have it in for us, have it in for the West. It’s not just an issue between a terror group and Israel. This is a world wide problem. And until we wise up about it, and say, “hey, this has been getting worse every year.” Do you remember the movie, Three Days of the Condor? [1:15:37]
DAN: We’re going back again into 70s conspiracy-land movies, where oh my god, the government is planning a conspiracy to capture the oil fields in the Mid East. But what has changed? We know that we need oil, we have an energy based economy and we know our oil supplies are in jeopardy. You know, maybe somebody’s going to hit the rest of the American public up side the head with a �2 by 4’. But I’m listening, I’ve heard it, and I certainly would like to see us do something about it.
JIM: You know what I really think will happen, Dan, and I’m old enough like you to have gone through the gas lines and the rationing that we had in the 70s, and it was going through that when people really began to get irritated. You see, right now, I guess if your gasoline price of filling your tank goes up $15 a month, well, maybe you do without something else. But you know when people can’t get it or we ration so you can’t get on an airplane, or you can’t drive across country during the Summer on a vacation, or you have to wait in line for two hours to fill your tank, or perhaps you can’t cook dinner in the evening because your power went out and it happens frequently enough, I think it almost takes it seems like in this country, it always takes a crisis before we finally get up and do something.
DAN: Well, I’d like to think that we won’t need that kind of crisis but who know? And you’re right, we have been going through this problem for a long time, it isn’t different than it was before. And you know this is an issue I’ve been following for the last couple of years and people that want to track all this stuff we’ve written can find it at www.businessandmedia.org. The problem we have here is it’s not most Americans. Most Americans thoroughly understand that we need energy. You know, we’re the energy based economy. It is a few people in Washington, a few environmental groups that have decided they’re going to hold our energy policy hostage. And we’ve let them do it to us. And I’m for one darned sick of it. [1:17:51]
JIM: But how do you get around that. I guess when you turn on the news, anytime oil prices spike up, or you have a quarter � I mean in the second quarter it was no secret that oil prices were above $70 a barrel for the entire quarter. The highest prices that we’ve seen in history. If I’m an oil company and the product I sell in the open market place goes from $69 a barrel to $75 a barrel, one could expect that my sales are going to be higher. One could expect that my profits are going to be higher. But the whole thing that you saw, Dan, was demonization of the oil companies, and we’re still stuck on stupid in my opinion.
DAN: And one of the problems with that although it’s the highest real price that we’ve ever paid, it’s not the highest price. You go back into the dark days of the early 80s, the inflation adjusted price would have been a lot higher. We have to hit close to about $87 to get to a new record price for oil, and we haven’t even reached an inflation adjusted record price for gasoline yet either. And that is one of the flaws the mainstream media keep warning us, “oh, my God, this is a cataclysm.” When you go to the movies, you know the movie prices are higher than when you were when you were a kid, and we all seem to recognize that. Why is it that the media can’t understand that that applies to other things as well. I don’t know. [1:19:18]
JIM: I guess cheap energy has always been an entitlement. I mean if you look at the United States we were the largest producer of oil in the first half of the 20th Century, and we’ve always had plenty of it and at least it’s always been available. If we couldn’t produce it, well we’ll just buy it from Saudi Arabia or Venezuela. But as you pointed out, Dan, a lot of these people don’t particularly like us right now.
DAN: Back in the era where we had two super powers � and I’m certainly not going to wax nostalgic about the Soviet Union, one of the worst nations in the history of mankind � but when we had two super powers it was a lot of these nations I think were a lot more reluctant to go toe to toe with the United States because they realized truly what their options were. And their options in that case were us or them. And they were not too interested in buying into the �them’ part of the program. And maybe they need that kind of reminder now. I don’t know. I mean that’s what we’re running into with the terror groups. If it’s us or them, they’re the �them’ now. [1:20:21]
JIM: I guess I keep looking at this, and saying maybe the higher prices� the one thing I do believe in is the marketplace. You know as we move from $2 gasoline to $3 gasoline to you know 4 and 5, you know the marketplace is going to produce some answers to this � people might say, “well, when the lease expires on the Hummer or the Chevy Tahoe, maybe I might want to consider getting a Prius, or something more gas efficient.” I mean that’s the way it evolved in the 70s. People start saying, “maybe I don’t want the GTO, I’m going to get something that is more fuel efficient,” and hopefully the market place will be allowed to work here, and we’ll work out a solution to this.
Anything you see on horizon that is going to be very important here regarding energy in the months ahead.
DAN: The thing on the horizon is the one good thing we can look forward to is both the House and the Senate have voted to allow us to drill off the coast. The problem is those bills are not close to one another so they have to reach a compromise on that, and we have to hope they can get it out of committee and vote on it in Congress sometime between now and November. And I’m not so optimistic about that, but hopefully, if they can do that then maybe we will expand our ability in places to drill. That’s one plus.
But there’s no silver bullet here unless someone listening right now has some sort of idea in their mind that we can convert air into gasoline and solve all the problems. Failing that, we’re in for a long haul. And although it’s not as bad as the media paint it out to be, they still need to start representing what’s really going on here, that it’s not just a problem of oil companies, it’s a problem that we’ve made and we’ve allowed to have happen. And it’s about time that we try to solve it. [1:22:20]
JIM: Alright, Dan, if our listeners would like to follow more about what it is that you do, and your organization why don’t you tell them how they could do so?
DAN: They can find us at www.businessandmedia.org.
JIM: And Dan, your organization and purpose.
DAN: We’re part of the Media and Research Center, we monitor the media and try to correct the obvious biases. Our part of the organization’s goal is to try to make sure the media does a better job covering economic issues, and we want to advance one of the pillars of American society which is the free enterprise system. [1:22:54]
JIM: Well thank you for joining us on Other Voices this week on the Financial Sense Newshour, all the best to you, and I hope you’ll come back and talk to us again.
DAN: Absolutely. [1:23:02]
Margin of Safety
JOHN: Every once in a while you run into those books you consider a gem. Not only do you read it once, but it goes on to your shelf and you find yourself referring to it year after year. I actually have textbooks that go back 30 years from college that I’m still referring to.
JIM:You save books just like I do.
JOHN: Yes, well, my wife won’t let me near a bookstore, especially a used bookstore. It’s like you won’t see me for hours, and you’ll be surprised what I come out with.
Last week we were talking about one such book Ben Graham’s Intelligent Investor which you said you believe was one of the best investment books ever written. And one of the things that came up during the discussion was Graham’s tenets of investing, but there was one we didn’t get to and that was what he called the margin of safety. And this is probably one we really need to look at as we revisit his book.
JIM: The very important thing about Graham’s concept of margin of safety � probably the most important concept in investing as it relates to a margin of safety � is relating what is paid to what is offered in terms of investing in stocks. I mean it’s trying to buy a stock at a price that is less than what a company is worth. So for example, if a company business is worth $10 a share, you would want to buy that stock at less than $10 a share. The lower the price the greater your margin of safety.
On the other hand, if you were buying a bond you would want to buy a bond where their earnings are much higher than the interest payments. The greater the interest rate coverage, the greater the margin of safety you have as a bond investor. The problem I think that we all have as investors is that of predicting the future. For example, no one really knows how the future will unfold. How do you predict, for example, a 9/11, a Long Term Capital Management, or the bankruptcy of Orange County in 94, the crisis in Asia that erupted in 97, a Katrina or Rita, or for that matter a Middle East war?
What you don’t want to do is over pay for an investment on a hope that there will be another buyer around � or basically, another sucker around the corner � that’s always going to be willing to pay even more to buy the same stock. So, in other words, you don’t want go into investment on optimism and hope, you want to go in because you made a very attractive purchase. You bought it at a good price. So a lot of the profits that are made investing are determined really at the purchase price. [1:26:11]
JOHN: Isn’t this one of the issues that really devastated investors during this tech boom which came crashing down right at the end of the 90s. Back in 2000, investors believed that the prices paid for a stock, or even the earnings, didn’t matter. And for them they learned the hard way, very painfully, that that was not really true.
JIM: Yes, investment when you think about it is like owning a business: it’s most intelligent when it’s most business-like. Anytime, you’re buying a stock � if you really think about it � you’re buying an interest in a business. So, the more business like the purchase, the less risk there’s likely to be when making that business decision. Investors always need, once again, to relate the prices they’re paying for a stock to really what is the underlying value of a business. That was something that they weren’t asking in the latter part of the 90s. In fact, it got to be very fashionable, stocks and especially in the tech area where actually making money or profits were shunned upon. You can look at examples when AOL bought Time-Warner, the stock of AOL really went down because, you know, they wanted the growth story, they wanted the sizzle. The fact that they would buy a business that actually had cash-flow and income was just anathema to investors.
And probably I would say a corollary concept to that principle of relating what you pay to what it’s worth is knowing what it is that you’re doing � meaning knowing the business that you’re investing in. And you can add to that the fact that you should never, never enter into a transaction unless you understand or believe you have a reasonable chance of making a profit. Translation: the business opportunities for profit should be based on sound fundamentals, not on optimism or hype � “hey, this is really hot right now, everybody’s excited about this, so I’m going to buy this or invest in this area, because everybody else is doing it, and everybody tells me people are going to keep buying.” That’s not the way that you make an investment.
And I would say, probably finally, you need to have the courage of your own knowledge and convictions and experience, and then probably the patience to endure, because especially if you’re buying something at a real value, it may take time before the market realizes that the stock or business is undervalued. And one of the comments that Graham wrote in The Intelligent Investor, he said:
You are neither right nor wrong because the crowd disagrees with you. You are right because your research and reasoning are right.
To that I would probably add, you must learn to think for yourself ,and not allow the market to direct you. And that means learning to control your emotions. [1:29:04]
JOHN: Yes, because let’s face it, there is a certain emotional warm fuzzy if you’re running with the pack, you feel like they’re all going there, and it feels good and it must be the right thing. Whereas if you’re going to stand on your principle, you may find yourself running against the pack, and then you always have those second little �gee willickers’ thoughts that come into your head.
JIM: Sure, and you also have to understand that the great majority of institutional investors are plagued with short term relative performance: “Ok, how well are we going to do this quarter against the S&P.” And there’s this short term relative performance orientation. And there’s also I think a growing lack of a long term perspective. The prevailing mentality on Wall Street is consensus. I call it group think, and acting with the crowd ensures an acceptable mediocrity versus acting independently runs a risk of unacceptable performance. I can remember when we were buying gold or even oil when this new decade began, and talking to fellow peers in the business it was like, “what in the heck are you doing.” [1:30:17]
JOHN: Let’s chase that one down. We know that Wall street has 3 principal activities: trading, investment banking, and then merchant banking. Now, how are these going to work for and against the investor, and then what does Wall Street gain by hyping that to the investor. In other words, Wall Street is thinking about itself, not necessarily the investors, so how does that work?
JIM: Sure, because if you take investment banking, they make a lot of money when they can take a company public. The higher the price they can get for the business owners the more money they’re going to make. If they can take a stock public at let’s say, $10 a share, or $20, obviously they’re going to make more in commissions on $20 a share, than they would make on $10 a share. And if you take a look at retail banking, commission products � if you can move a lot of commissions through the front door you’re making money.
And have you ever noticed, you’ll see commercials always encouraging you to trade. If you watch CNBC I would say almost 70% to 75% of the commercials are talking about trading: the best trading execution; they show people trading part time, and they have more time to enjoy living because they can trade and make a lot of money. Not that I have anything against trading, but none of it is designed to get you to think as a long term investor, to get you to think about fundamentals � it’s always getting you to make transactions. You always have to have a reason to buy and sell, because let’s face it, if you were a long term investor, let’s say you bought an oil stock 5 or 6 years ago, think of how much money you made if you did nothing more than own and held that oil stock. But remember, if you’re sitting on an oil stock and you’ve held it for 5 years, your broker isn’t making money, and the brokerage firm isn’t making money. So there’s always going to be a reason, “oh, it’s up $10 a share, let’s take some profits, I think you need to�we’ve got a better idea.” So, they’re always encouraging you to trade or get out of your positions.
There’s nothing wrong with trading. I mean there are some opportunities that come into a market. I mean even in our own portfolios we hold a concept that we allocate 15 to 20% for trading positions, because you’re always going to see that in the market. A large big sell-off in a sector, or a company, it’s over done, you pick up, you scoop the stock. That’s what we did at the beginning of the year when I think I made people spill their coffee or take a drink when I said we were buying tech stocks. But you know, that was it, it was oversold, we saw it as a trading opportunity, and we took advantage of it. [1:33:03]
JOHN: Once again, soberly evaluating the market, not necessarily grabbing onto a creed of orthodoxy, or running with the pack, now those are different positions people take.
JIM: I’m not sure when it’s getting so unpredictable to look at the future. I mean just look at the events as we’re seeing them today, the shut down of one of one of BP's pipelines in Prudhoe Bay, a tsunami, last year it was hurricanes, we have a Middle East war which is going on, Iran is getting more belligerent. I mean there is a lot of hostile things; Hugo Chavez.
You know, unless somebody can point to me we just discovered another North Sea or North Slope, and I haven’t seen that and even if we did discover another North Sea tomorrow it may be a full decade before all of that oil could be brought on stream. So I think we’re clearly in a long term trend for commodities here. And the most amazing thing, John, about on all of this is we still have more demand than there is supply, and as long as that imbalance exists we’re going to see higher prices. [1:34:14]
Backup the Truck
JOHN: Well, I was actually trying to find the theme song from the 1960s television show which was political commentary and satire That Was The Week That Was because when we got done with this week that’s what I was thinking. I mean it goes as follows: this was a week in the life of john and Jim. Monday, John calls Jim and says look at what’s going on in Prudhoe Bay; now Jim’s down at his condo on the beach so he shouldn’t be watching this, that’s why I called him there. Tuesday � the Fed’s open mouth committee announced they went on pause, this should be a major indicator that we’re teeter tottering right towards a recession, front wheel’s over the edge of a cliff, given the Fed’s previous track record of pushing us over and then hoping they can bungee us before it goes too far. Thursday � this is always a real bad indicator, Jim goes out sailing, there’s a positive correlation here between bad things and Jim’s sailing. And he comes back and lo and behold a major terror attack has been thwarted at Heathrow affecting the air space system here and everywhere, and obviously in total chaos there. And this was a dry run for a potential terror threat.
So for all of you fundamental freaks out there, as far as fundamentals in the stock market, given all of this, what would a rational investor do:
a) Sell your oil stocks; b) dump your gold and silver and precious metals equities; c) sell both your gold and oil investments; d) buy tech stocks; or e) sell all your commodities and buy tech stocks?
For $4,000, Mr. Puplava what is the correct answer?
JIM: Well, the correct answer looking at Thursday was e).
You know, I think I got back to the docks about 5 o’clock turned on the news, and I was watching, and it really took me about, I would say probably about 10 minutes, to figure out what was really going on, because the news clip that I saw when I first turned on my TV was Mayor Bloomberg giving a press conference. My heart just about stopped, and I said, “not again.” And I was thinking something had happened, and of course, as I switched channels and found out more of what happened, I thought, “Oh, my God, I can’t believe this.” But then what was worse, is when I turned to the financial station and found out what happened that day. You had oil sell off a couple dollars a barrel; you had gold prices that were down 15 to $16 an ounce; and you had tech stocks rally for the day � the NASDAQ was up. I mean does any of that make sense? [1:37:12]
JOHN: No, but as I always said if the logical does not happen, then I would say something else is afloat. What do you think was going on?
JIM: Looking at the charts, with the gap down in gold, I would say there was probably some intervention that was taking place in the markets by authorities, not wanting investors to go to gold as a safe haven � especially now, when we’ve got inflation problems and the Fed’s credibility is really questionable. I can’t think of how many times Bernanke has flip-flopped.
I couldn’t believe that a rational investor would be sitting � let’s say I’m a portfolio manager and if this is the way that they’re thinking, God help us � I’m sitting here, I turn on the news, they just thwarted a major terrorist attack, I know that for example that almost 8% of the nation’s oil production could go offline depending on what happened at Prudhoe Bay. I know that for example, 15% of our Gulf production still remains offline. Now, as a rational fund manager, I’m going to say to myself, “hmm, inflation on the rise, monetary troubles, growing debt problems and balances, a war in the Middle East, let me dump my gold and silver. Hmm, while I’m at it, I think I’ll sell my oil too, and let’s buy Cisco and tech stocks.” [1:38:33]
JOHN: What would drive that, then? Assuming you’re looking at it through rational eyes like we’ve just described here, what would drive them to do that? Is it the herd instinct we were talking about on the previous segment?
JIM: I think probably maybe you had a bit of intervention that started the trend, and then traders just quickly jumped on board, and you get that whole herd and crowd mentality: “oh, oil and gold are going off the cliff, we’ll join the crowd in the selling. And oh, Ok, they’re buying over here, so let’s go and buy over there.” Boy, I tell you, it’s either a trading mentality that might have been induced by some intervention, or what I call the invisible hand, and then everything followed suit. But if you think about it, with all the growing evidence,..in fact you and I were talking about, I think we’re going to try and post it on the web, was it the Chicago Tribune that did a great piece on oil and also a video. [1:39:30]
JOHN: Yes, a 40-45 minute video. CNBC just reran addicted to oil last week, and that thing was a disaster. The Chicago Tribune covers the flow of a gallon of gasoline backwards. They start at the pump in Chicago, Illinois where it’s delivered and work it all the way backward to the point where it came from showing the economics, describing what the oil companies are going through, their risks, the low returns, all the way back to the political risks [from] the countries that it’s coming from. And you can watch this online.
JIM: Yes, it’s probably the best piece of journalism and also that was followed up by a written piece that they did in the paper talking about peak oil, and the predicament that not only this country is in but also the rest of the world is in. And John, one of the things I could say for investors right now is if in waiting for an opportunity to add to your energy portfolio or maybe you don’t have any energy stocks or maybe you’ve been thinking about, “ok, I’d like to buy a couple more oil stocks but I’ve been afraid to because they’ve been in a definite uptrend all year,” this is another chance.
And we’re calling this segment Back Up the Trucks, because we’re heading for an energy crisis. In fact, one of my guests that we’re going to have when we come back from Summer break, we’re going to have Matt Simmons back at the end of September. And Matt gave a presentation to the Department of Defense which he called The Energy Crisis is Here, and I just keeping thinking back John, let’s go to that clip that basically is saying we’re heading back to way lower oil prices.
The first thing is these stocks correlate very highly with the 6 month forward gas prices and the oil prices. And quite frankly, unless you see those going higher, it’s hard to see much upside in it. The second thing is when you look at the oil market fundamentals rather than news float all you’re seeing is fair gasoline up a million barrels a day, I also see crude inventories at 20 year highs. And even daily cover’s been rising over the last 3 years, we think we’re about 4 to 6 months away from global inventories actually being full. If that’s the case you’re going to see significant pressure on the spot market on crude. As far as we’re concerned in the energy sector, we really struggle to see any stocks that are attractive right now. I think there’s an argument that Apache and some of the majors are attractive on a valuation basis, but it’s hard to believe as the commodities oil and gas go down these stocks outperform. [1:41:57]
That’s amazing because you can look at a stock like Exxon that’s selling at 9 or 10 times earnings, one of the most profitable companies in the world; you take a look at Chevron-Texaco, it’s selling at 9 times earnings; you’re looking at let’s say British Petroleum which is also by the way in alternative energy, and that stock is selling at 11 times earnings; you look at some of the natural gas stocks, Apache � he did mention some of the natural gas stocks. But you know, you’re looking at companies that have been leading the market in terms of earnings the top performing sector in 2005 earnings, the top performing sector in 2006 earnings, the top performing sector in 2004 � for almost the last 4 or 5 years running and the stocks are still selling at 7, 8, 9, 10 times earnings when the general stock market is selling at 17 times this year’s earnings, 14 times next year’s earnings. He’s finding no value? This is the same guy that was telling us energy stocks were overpriced when oil was at 40. [1:43:04]
JOHN: You know, Jim, maybe this goes back to what you and Zapata George were talking about in the early Other Voices segment, but also things we’ve discussed weeks past here on the show � look at what’s going on out there, it’s short sightedness is what I think you’re seeing as far as investors. First of all, oil fields are peaking. We know that. They’re rolling off at the top and they’re going down, and they’re not being replaced. Spare capacity is disappearing. Oil isn’t something we just simply store, basically it comes out of the ground, it’s moved, refined, and used all within a very finite amount of time. And with some exceptions � there’s a little storage for defense purposes and other things � that is it. They don’t seem to be looking at these fundamentals.
JIM: The fact is one of the more disturbing trends that we’re starting to see is that despite the higher prices � you’ve got to remember if you go back to 2001, right after the events of 9/11 when oil prices were at $20 a barrel, we’ve gone from almost $20 a barrel to almost $80 a barrel. So the first you would is say is aha, the economists’ argument against peak oil that as the price increases more of it will come onstream to the point where you’ll have so much over supply that prices will eventually come back down. Despite the fact that we’ve had increasingly rising prices now for the last 4 years, US energy inventories continue to recede.
A second factor is even though we’re starting to see softness in global economic activity and especially here in the United States we have not seen the price of oil come down.
A third factor is you would think with oil prices over $70 a barrel, OPEC’s production has been running below quota, and that at a time when we’re seeing sky high crude oil prices. If OPEC oil output stays weak throughout the Alaskan pipeline shutdown, it’s only going to reinforce in my opinion the view that, as we pointed out last week, spare capacity remains minimal. In other words, there is no major excess capacity in the system. And it’s this lack of excess production that is going to ensure that a gradual decline in US energy inventories stays intact. And if you translate that into what it means for energy prices, energy prices are going to stay elevated if not increased, that also means profits in the industry are also going to increase.
So we’ve been dealing with skeptics on Wall Street, that I don’t know what these guys are smoking, or what the heck they are reading, but everything I pick up, for example Value Line talking about average prices of $60 a barrel. Well, we’re into the eighth month of the year ,and we’re over $70 a barrel, and have been above $70 a barrel. So to get an average price of 60, we’re going to have to see oil prices drop back down into the $50 range, and I don’t think you’re going to see that with our inventory levels starting to recede, and also now the fact that we’re going to lose, it depends on whether BP can keep one part of the North Slope working, but we may lose at a minimum an additional 4% of our capacity to produce oil, on top of 15% of our oil production in the Gulf of Mexico down. [1:46:29]
JOHN: So when this all collides together, obviously it’s going to collide at the gas pump, that’s all the guy who pulls up with his pickup sees when he starts to fill it up. How is this going to come together?
JIM: I think you’re going to see eventually, I don’t know, maybe it’s going to take $90 oil, maybe it’ll take $100 � I think it’s probably going to take $125 oil before we really start to see major conservation efforts put in place. And also at the same time a major to put through exploration, and remove all this environmental red tape that is basically shutting down energy production in the United States. I mean you take a look at what our competitors are doing in Europe and Asia and China and Latin America. If you were an independent observer looking at what other nations are doing to reinforce and build up their energy complex compared to what the United States is doing you would have to say, “what the heck is wrong with these people?” [1:47:29]
JOHN: Yes, that’s the bottom line. Good question.
When you watch international events even in finances or elsewhere, you have to say what would the logical thing be to do? And you look, does that happen? No. Alright, what else is afloat? You have two chances here: a random chance of idiocy or something else is afoot � like you talk about intervention from time to time. But in reality when it happens over a period of time on too regular a basis then it violates the laws of random chance.
JOHN: The most surprising thing is when you watch these financial channels, and I saw a number of experts besides the idiot you just played there, but you have the same people coming on year after year, month after month and telling you why oil prices are going lower, or why oil stocks are overvalued. These same people will tell you an Exxon is overpriced at 9 or 10 times earnings, and then they’re justifying paying 30 or 40 times earnings for some kind of tech stock, or some kind of momentum stock. It absolutely does not make any sense, and it’s amazing these people have credibility. If I was a news anchor one of the questions I would ask a guy, I would go, “you’ve been saying this for 4 or 5 years, and for 4 or 5 years the price today is higher than when you were last on the program. It was higher the last time you were on the program to the previous time you were on the program. What’s it going to take to change your mind?” [1:48:50]
JOHN: So basically, you are still committed to buying energy and I’m assuming that you would advise listeners to do the same?
JIM: We’ve been holding on to our energy stocks for 5 years, we keep adding to those positions. New clients coming on board, we’re putting them in energy, and any time you get an opportunity or a sell off that’s this irrational I just say wait for it to play out, and back up the truck. [1:49:14]
JOHN: Let us go back and check into something that we keep hearing come down the mainline, and that is the concept that if prices go higher � now, right now we’re talking about base metals, precious metals, or energy � but if higher prices are a fact of life that’s going to bring online all of this supply. Do you think that’s true or untrue?
JIM: I think that’s grossly untrue, in fact it’s been demonstrated to be untrue. If you take a look at the bear market in commodities from the 80s and the 90s, we had a twenty year bear market, and what has happened as a result of that is we’ve used up capacity all over the place � I don’t care if it’s copper lead, zinc, energy, gold, silver � and at the same time we’ve put extra strain on the supply of skilled persons and raw materials, and the transportation system.
Let’s face it, in the 80s, the commodity industry was contracting. So what you saw were the bigger companies bought the smaller companies and the industry consolidated because it was like last man standing: just trying to make it and stay alive in a bear market. A lot of companies went out of business, the energy companies, the big ones, couldn’t operate a refinery at a profit, so they were shut down because they were losing so much money. Just take a look at the financial statements of any of the major oil companies which thank goodness the Chicago Tribune did a good piece of journalism in pointing that out, instead of this garbage that gets reported in the mainstream media. And that’s what happened, the industry shuttered equipment. And let’s face it, in the 80s and 90s, who wanted to go out and go to college to become a geologist.
So not only are we out of excess capacity and strained for that capacity we don’t even have the skilled employees to come into the sector and replace those that now maybe got in the industry the late 60s and 70s, who are now heading towards retirement. There’s a shortage of personnel, and if you are a geologist today, you can almost name your price, especially if you’re experienced one with a track record � whether you want to work in the oil industry, or the mining industry. So as I’ve pointed out something that is so simple to understand, and if you really want to get a grasp in terms of why we have oil prices over $70 a barrel: in 1985 , 60 million barrels of oil consumption a day; 70 million barrels of oil production capacity; we had a 10 million barrel spare capacity. That spare capacity is all but gone. Refineries � 93% capacity today, compared to only 78% capacity. So, John, we haven’t spent a lot of money exploring for oil, we haven’t spent a lot of money exploring for copper mines, lead, zinc.
And just look at all the restraints that are placed with environmentalism today. Environmentalism has almost become like a voodoo science that is totally out of control. At one time it had a lot of good intentions but today it has become almost a religion, almost an extreme religion in the sense of what these guys are doing. They’re trying to shut down mining of any form around the world or any production of energy. Just look at what’s going on in the United States. Name me a nuclear power plant that’s built, a refinery that’s been built, wind farms that are being put up. I mean just name me where we’re doing anything on the energy infrastructure front. [1:52:57]
JOHN: It’s interesting I was talking with a writer for New Scientist magazine in London a couple of weeks ago, and this whole issue came up. And the two things I sort of pointed out to him was number one, if you notice global warming is an issue maybe on the horizon as a political hype issue, but as far as an action item it is not: Germany’s backing down, other countries are backing down etc. I said the only way global warming is going to stay afloat politically is because most of the countries in the world don’t have the political will to do this � to take the economic hit � is to tag itself on to peak oil. He never thought about that one before.
But the second thing I pointed out is if the environmental movement in and of itself does not get that under control, then you’re going to see a slingshot to the other side of the road, you know, from the left ditch to the right ditch, in which all of it will be impugned. Because let’s face it, when environmentalism came around in the 60s, when it first began to kick in, there was a lot of damage, we had to start cleaning things up. But you’re right, it has gone to absurd points right now, and any environmental policy has to be scientifically sound and economically sound. And they’ve tried to operate in part without some of either at times. So, it’s going to be interesting to see where it’s going, but I’m going to predict it’s going to go there very quickly. [1:54:07]
JIM: Yes, I almost feel that within the next couple of years, and especially when we get to gas lines, shortages and enough power out, I mean I’ve already gone through in the last month 3 rolling blackouts, and so just the inconvenience. In fact, one night this week, we lost power, it wasn’t long, it was only for about a half hour, but losing power for a half hour�We just assume in our modern day life today, with the Internet and all the technology and the gadgets that we have, you just expect that you flip on a light switch you expect to see the light; if you flip on the switch to the air conditioner, the air conditioner goes on; you expect to get natural gas to your stove to cook at night; you expect to be able to pull into a service station, and at any time of the day and fill your tank. These are all the modern conveniences that make up the world that we live in today, and the way our economy functions, and we just assume they’re going to be there. And as more and more of this happens, I think you’re going to see a rising tide and a shift in the opposite direction. [1:55:16]
JOHN: Let’s get back to the issue we were talking about earlier that rising prices will cause people to spend more money. I’m still not sure how that’s working, so go ahead and hit me with it again.
JIM: The most important concept I think you need to understand here is if you were and executive, let’s say you ran a base metals company, or you were president of a gold mining company, or even president of an oil company. For two-thirds of your career you went through probably the worst downturn or recession in your business, and I’m talking about from 1980, to the year 2001, where every year you saw declining prices, your costs were going up and yet the price of the product you sold was going down, your margins thinned. Basically, you got by with prudent cost management � that was the only ways to survive.
Now, you’ve spent, let’s say 20 years of your 30 year career in the industry, you’re getting ready to retire, you see the prices go up, do you believe they’re going to stay that way, or are you believing what the economists and what the guys on Wall Street are always telling you? “No, it’s going to go down. If we have a recession demand will go down. If we had a hurricane you’re going to see demand destruction. China’s economy’s going to slow down.” This is what you’re constantly being fed by the analysts and the economists. And are you going to sit there and take the chance. “Look, Jim, I’m about a couple of years away from retirement, let’s take all this profit that we’ve finally made, we’ve finally had a couple of good years of profit, let’s take it, spend the money, and expand capacity.” What do you think they’re going to do? [1:57:01]
JOHN: I don’t know. If we take some lessons from people who went through the Depression, that lasted two decades ultimately, affecting largely commodities, a couple of things have struck me in talking to people who lived through that era, one of whom was my Mom. And number one was people who actually went through it don’t necessarily understand what caused it, that’s the first thing. But the second thing, as far as money, when you thought things were tight, you didn’t know if you were going to see money next week because maybe you had a temporary job, or whatever it happened to be, you were not inclined to spend money. If there’s one thing that came out of all my parents, father-in-law and his family from the Depression was the fact that they hoarded money, they did not spend it.
JIM: The same thing with my parents � they came over from Europe and they went through the Depression. I can remember my Dad telling me, walking along the railroad tracks, collecting coal so they could burn it at night so they could keep themselves warm. My Mother to this day, even though my parents have done well, my Dad is now deceased, but even though they’ve done well in real estate my Mom still collects coupons � even though she doesn’t need to. I mean it’s that mindset.
And this is one of the things that I can remember. I think it was back a couple of years ago I think it was back in 2004, I interviewed Donald Coxe and he was giving a talk at a base metals or precious metals conference, and he was basically telling them, “open up the check book, guys, and start exploring and build capacity, because we’re in a new bull market.” And I remember Coxe telling me that after the convention was over he was at the airport and he said � I think this was the President or CEO of one of the world’s top 5 base metals producers � and the guy came up to Coxe and said, “you know, we’ve seen guys like you over the last two decades, you come and go and you give your little talk and you tell us the sun’s going to come out and shine, but it shines for a day or two and then the clouds come back.”
And what this executive was referring to, John, is exactly what you and I just talked about. If you had an experience where you went through two decades of a depression in your industry � and that’s exactly what the 80s and 90s were for the commodities industry. For us consumers we didn’t feel that, that was a good time, we had cheap oil prices, we had low prices as a result of that, all commodities and food prices were low. But if you were in the industry as a business those were very tough times and you were very much conditioned by those tough times. And that’s why they haven’t opened up the check book. [1:59:48]
JOHN: Do you know how bad it really is, Jim? Do you remember my Mother lost her home in the wild fires of Southern California in 2003. It was all gone, and here we go, I’ve got an advance check from the insurance company. So we’re heading down to one of the furniture stores to buy furniture, and my Mother’s going well, we could go by Goodwill and maybe we could pick up some second hand stuff. Maybe we could economize.”
Finally, I said, “Mother, stop it. The insurance is paying for this. This isn’t coming out of your pocket.”
JIM: My Mother would do the very same thing. You know my parents invested in rental properties, and whenever they would have to furnish a place, Mom would go to Goodwill, or she’d go to some auction, or she would go to a garage sale. I mean she never went and bought furniture new. And that was just the way. And I mean we grew up with 10 kids and that was just the way. Mom never had to work fortunately because Dad was a good provider and they did well investing in real estate, but that’s just the way they lived. That’s the way they think.
And that’s the way a lot of these guys that spent the last 30 years in the commodity business that’s the way they’re thinking. They’re just not going to open up the checkbook and go out and spend wildly just because like that one executive Donald Coxe talked about because they’re always afraid the bad times will return. We have not been in this bull market long enough for those memories of the depression in the commodity industry to fade away. And you get a new generation that comes in the industry that did not have to go through that depression, and they’re more willing to say look at the opportunities, and say, “look, we can sell everything we can produce, let’s start building more mines or exploring for more oil.” [2:01:33]
JOHN: I also remember bad decisions people made in my father-in-law’s case, he was born on a ranch in Colorado, and during the depression he and his brothers and sisters decided to bust up the ranch, sell the ranch and divvy it up because everybody was desperate for money � rather than realizing the value of that real estate which is now fantastic given the size of the ranch would have really netted them something if they had just done what you’re always talking about � sit on it, and wait until it earns money. You know people make decisions by the moment rather than the long term investment idea.
JIM: You know, that is so true and if you can do that with things that you really know, I mean my grandfather came over here and he went to work for John D. Rockefeller in the oil refinery in Indiana, and all Gramps knew how to do was Standard Oil had a stock investment program, so every paycheck Gramps would take part of his paycheck and buy Standard Oil stock. And the other thing that Gramps knew was basically that real estate, they’re not making any more of it and it always goes up in value, so he bought � I don’t what you would call them today, I haven’t seen them out here � a 3 storey, almost like a flat, you had a general lobby at the street level, and off to the side was my grandparents’ home and there was a flight of stairs that went up to the second and third level where there were apartments, and then a basement below. But he bought real estate and he bought Standard Oil stock, and it’s just amazing over a lifetime of hard work what that grew for my Grandparents, and then of course, it was passed on to their children and my Mother being one of them. And it’s amazing what that little stock investment in Standard Oil, which later became Amoco and Exxon turned out to be. It was just absolutely amazing. [2:03:23]
JOHN: Alright, well, we’ve obviously plowed through this week. And was this a one, two or three bottle week? This is a joke Jim and I have � a bottle of wine on Friday night, right?
JIM: Yeah. I don’t know, John, who knows where we’re going. It’s amazing it used to be that you would say the markets are no picnic in September and October; and if you’re a sailor the common phrase is the Grand Banks are no picnic in September and October. I’m beginning to think we’re going to have to add August to the list. [2:03:46]
JOHN: You know, I think in all fairness to your listeners though, if you’re going to go sailing next week, at least tell us which day, so we know when we should be prepared to run for the storm shelter.
JIM: Well, I’m going to actually take a break, guys, so maybe nothing will happen. I’m just going to sit on the beach and read a couple of books that I sort of postponed. I want to finish Money, Credit and Banking by de Soto � I want to finish that. I still have about 300 pages left in that. So I want to get to that. Just nothing much but sitting on the beach and watching the waves.
JOHN: By the way, I’m reading his book Why Capitalism Works in some countries and why it doesn’t in others, and�
JIM: Oh, you’re reading� No that’s Hernan de Soto.
JOHN: Right. We’re not talking about the same guy then.
JIM: No, the guy I’m reading is Jesus de Soto.
JOHN: Ok, well, there’s two de Soto’s, they’re probably brothers right.
Anyway, Hernan de Soto did an interesting thing, he went down to Peru with his team, and they wanted to see what it cost to legally establish a business in that country. And I forget, but it cost him an incredible amount of money given the daily wage. He was just opening up a little laundry shop or something like that, but it cost him 7 or 8 months of standing in lines every single day trying to register the properties and get all the proper permits. And he argues that in countries where the governments are regulation friendly, businesses tend to thrive. He said where it doesn’t they’re forced into black markets just to stay afloat, or they’re forced to flout the system just to be able to stay afloat. He said that’s a core to a free society. And in the West here, we’ve just been piling on regulations after regulations. So, it’s an interesting book.
You should write a book.
JIM: Oh gosh, if I could only find the time.
Well, listen, gosh, it seems hard to believe we’ve come to the end of the show, and as everybody is well aware we’re going to take the next 3 weeks off, we will return September 9th, and a great month by the way in the month of September. September 9th my first guest will be Peter Hartcher [ph.], he’s written a book called Bubble Man, it’s all about the Greenspan Fed, and I’m really looking forward to that, it’s a great book. September 16th, we’re going to have a double show: Ike Iossif will be back from Greece and we will have Ahead of the Trends; also, I’m going to be interviewing Brett Messing and Steven Sugarman � they’ve written a book called The Forewarned Investors, great sage advice. Doug Noland from Credit Bubble Bulletin will be joining me September 23rd. And September 30th, we’ll take a look at one of the foremost experts of energy Matt Simmons, Chairman of Simmons Intl, and author of Twilight in the Desert will be our guest. And we’re working on a great month of October, we’ll let you know.
But in the meantime as we’ll let you know if something does develop, John and I will be back on the air, but assuming nothing does happen for the remainder of the Summer we want to wish you a pleasant August. Until you and I talk again, have yourself a pleasant weekend. [2:06:54]