Financial Sense Newshour
The BIG Picture Transcription
October 7, 2006
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- Money, Oil, War & Intervention
- Humor The Economic Ship Compromise
- The Coming Gold Mergers: What the Big Boys are Looking At
- Other Voices: Kelley Wright, IQ Trends
- Retirement Planning: The Importance of Dividends
- Emails and Q-Calls
Money, Oil, War & Intervention
JOHN: Well, from a big picture perspective the focus of the market seems to be gradually shifting away from inflation concerns to a slowing US economy, and central banks tightening. But Jim, that seems to be the market wisdom, you see things differently.
JIM: Well, first of all the high powered money reflected in M3 is growing at an annual rate of nearly 10%, which is why they quit reporting it. If you pull up a graph of M3 which they stopped reporting back in February, it was growing roughly about 8% back then. Several groups have reconstructed M3 from various weekly Fed reports, and I can tell you, it’s now flying. Total money supply is now approaching close to 11 trillion; credit expansion this year is annualizing at a 4.4 trillion rate this hardly reflects tightening liquidity as so many are apt to say. It is also rising globally. And John, liquidity conditions can hardly be called tight. [1:16]
JOHN: You know, despite all the conversation about the housing market, banks are still making loans and credit is as easy to get now as it was 12 months ago.
JIM: Sure, one of my clients recently sent me a marketing brochure from his bank, and the ad featured a no fee mortgage. And John, the fees that they are waiving, and I’m just reading from this ad, it says:
With our no fee mortgage plus, you get a competitive mortgage rate, and you will bring less to closing because we will be waiving the following fees: application fee, loan origination fee, lender closing fee, tax service fee, flood determination fee, appraisal fee, credit report fee, settlement closing fee, title exam, lenders title policy, courier fee, escrow impound requirement not required, and any additional third party fees. And never worry about missing a drop in interest rates again. If mortgage rates go down the no fee mortgage plus allows you to lower your interest rate once a year.
[2:16]
JOHN: Are these fees for real? I mean do these reflect actual expenses, Jim? Or are the banks just making these things up? I’ve got to ask that.
JIM: Oh no, that goes into your closing cost on a loan appraisal fees, there’s a credit report, title exam.
JOHN: Ok, title exam I can see because you pay a title company, right? But it’s like a filing fee, pay the secretary fee. I mean some of the fees I can understand, like your appraisal and your title history, and your title search. Well, anyway.
JIM: When the market was hot they were getting paid for this.
JOHN: Yeah, well anyway, it does not sound like credit is tight. So where do I stand in line to get this kind of a loan, anyway?
JIM: Well, actually it’s much bigger than this. And I’m just going to go back in history for a moment. If you go back to the 1990-92 era, when the US was experiencing a recession, the Fed made changes that led to an effective elimination of bank reserve requirements. And everybody knows we’re on a fractional reserve system where banks are roughly required to keep about 10% of the money in demand deposits. But the moves back in 1991 were in response to the recession of that year, and also the fall out from the savings and loan crisis. What the Fed did in essence was to relax the fractional reserve requirements. And predictably, when these changes were made, total cash reserves in the banking system dropped off a cliff. The economy reliquified nicely, we came out of a recession quickly � just as we did once again in the 2001 recession. And what you now have is a banking system where you have a zero reserve class of money, such as non-personal time deposits, euro currency deposits � that’s what we call these high powered money accounts. And then, even further, from 1994 to 1996, most of the remaining reserves disappeared, and as a result we got the roaring 1990s stock market bubble. [4:13]
JOHN: Just as a sidebar, it’s been interesting to see how the FDIC is also requiring less and less and covering less and less. But how do banks get around what reserve requirements are still in existence?
JIM: What a bank does is it shifts from an account that is subject to reserve requirements to one that is not. And what that does is it reduces its total reserve requirements, with no change in its bulk cash holdings � the depository institution can lower its required reserve balance on which it earns no interest. They can then invest the funds formerly held at the Fed in interest bearing assets. When banks want to expand their lending, basically what they did is they found a technical work around using these retail sweep programs. And John, the Fed approved these measures back in 94-96. You can read back on the Fed website. So what you now have is the creation of classes of zero or near zero reserve ratio accounts; and the ability of banks to move money from accounts with high reserve requirements to accounts with low or zero reserve requirements. The result is a flood of free money. [5:25]
JOHN: It sounds like a shell game, basically is what is going on. It’s just simply a technical move on the books. But ultimately, where is all this going to lead us?
JIM: Hyperinflation. What the Fed learned I think from the Great Depression was never, never reduce the money supply drastically, or allow inflation to fall below zero. This means they will always find a way to mess things up through creative money schemes. You saw a bit of that last year with Katrina with the $2000 debit cards. All you need to do is go to our Fed site on Financial Sense, on our own website, and read some of the research papers to get an idea where they are heading and what they have up their sleeves. Let’s put it this way: B52 money drops come to mind. [6:12]
JOHN: Initial move to satellites, shooting it in on laser beams. You think I jest, Jim.
JIM: Let’s move on to the topic of oil. Everybody’s talking about lower oil prices, the end of the energy bubble, good news for all of us consumers. You’re hearing some really absurd predictions for where oil is going to go down to, but if I had to put some good money down on it you probably won’t buy into that either.
JOHN: No, it’s balderdash. Balderdash, Balderdash.
I fear more than anything else that we’re going to see greater oil spikes ahead of us. This reminds me of the missing million barrels back in 1998 when there was supposed to be all this excess surplus oil in the market that nobody seemed to know where it existed. And if everybody recalls, back in 1998, we got oil dropping down to about $10 a barrel. OPEC cut production in 99 and by 2000, we had an energy crisis with spikes in oil and natural gas � everybody remembers that was the first time we saw $10 natural gas in California and our idiot governor was signing long term contracts at that price.
So even though prices have fallen 20% since August this year in oil the facts tell a different story. For example, if you look at OPEC production today versus where it was let’s say a year ago total OPEC production in August of this year was 29,860,000 barrels a day. That’s down about 600,000 barrels or 2% from where it was in September 2005 when OPEC was roughly producing about 30 million barrels a day. Production is down in Nigeria, which accounts for half that decline, and the situation in Nigeria is going to get worse.
But, we’re also seeing production declines in other countries. Most alarmingly to me is Saudi Arabia. We don’t know if this was done voluntarily, or if it reflects peak production or what Matt Simmons calls Twilight in the Desert being here. The bottom line, OPEC is hardly flooding the world with excess oil, and non-OPEC oil production is already peaked. So the only gains are coming from heavy oil like tar sands, oil shale, and the use of alternatives � coal gasification etc. But if OPEC cuts meaningfully, as they’re talking now, then we could face another spike and a crisis next year because despite the news to the contrary China’s economy is still growing strongly, as is India’s. And demand in the US has not fallen here, it has slowed down but it’s still growing. [8:53]
JOHN: Let’s zoom back in on the OPEC and Nigeria thing though. You don’t hear a lot of talk about this going on. The market’s seem to be ignoring what’s happening.
JIM: Well, if we just look at the last week, Nigerian rebels are stepping up their attacks in an effort to cripple Africa’s biggest export industry through a series of clashes with the military, and also raids on contractors working for the big oil companies. The attacks so far have forced Shell to shut down production of at least 500,000 barrels a day; the Forcados export terminal has been closed since February as a result of these attacks; and the militants are now focusing on shutting down Bonny Island terminal that’s the next big terminal where all this oil comes out.
In the words and I’m going to quote here of the rebel commander:
We have resolved to wipe out the entire crude oil export capacity in one swipe. And John, this is serious. Nigeria is the number six largest oil producer within OPEC, pumping 2.2 million barrels a day and the government there wants to call in the US Navy for help.
[9:56]
JOHN: How serious do you think that is going to be? I mean are some of the intelligence agencies taking this seriously � I think that’s the best way to put it.
JIM: Very seriously. The militants basically want Nigeria’s government to cede control of the oil resources to states in the North of the Nigerian Delta. In the words of the rebel commander once again:
Major oil consuming nations will be advised to speedily seek alternatives to Nigerian crude oil, in order to forestall a sudden shock to the markets, resulting from a complete shut down in Nigeria.
JOHN: Well that doesn’t sound like we’re going to have lower oil prices, that’s for sure.
JIM: No it doesn’t. Demand is still growing, and energy suppliers are struggling to keep up. The geopolitical situation hasn’t improved and the world hasn’t become a more peaceful place. You really have a mismatch in my opinion between reality and market perceptions � traders, fund managers I think are making major mistakes by dropping energy shares and resource companies. These moves to me are going to look pretty foolish 3 to 6 months from now. Demand is still growing over 1% annually for oil; 2 �% for natural gas. Supply is struggling to keep up with demand; and finding costs are rising significantly, where we’re talking about a 30-35% inflation rate in the energy sector. Meanwhile, companies are flush with cash. And besides, it really doesn’t make good sense to be selling energy at 5 to 6 times earnings to buy tech stocks at 20 to 30 times earnings, and especially when oil prices are heading to $100 a barrel.
JOHN: Well, I take it then, that you’re holding if not buying even more?
JIM: That’s exactly what I’m doing.
JOHN: Alright, let’s move on to another topic here. We seem to be clipping through these pretty fast today. It doesn’t seem to be on anybody’s radar screen, and it’s the beginning of what we call a new cold war, probably cold war II.
JIM: This is a topic that nobody is looking at the moment least of all the financial markets. What we have under Putin is an effort to consolidate power and rebuild the Soviet empire. Putin has subdued and absorbed the local mafias; and also he’s consolidated his hold on Russia’s 89 provinces. When you have oil prices moving from $20 a barrel to 60 and $70 a barrel, the Kremlin is flush with cash and in the energy driver’s seat just look at how they almost called off the natural gas going to Europe earlier this Winter and at the beginning of this year.
You also have Russia’s economic and military strength has been growing. And with the consolidation of domestic political power, Russia is now branching out internationally. So I think you’re going to see going forward a very aggressive foreign policy backed by oil money and a more powerful military. [12:50]
JOHN: The intelligence news service seems to believe their first move’s going to be to take over Georgia. I would guess it’s going to be the same kind of pretext that Hitler used to take over the Sudetenland in Czechoslovakia back in 1938 � you have to have some ruse for doing this so the world can accept it.
JIM: Well, Georgia is important in what we call the new Great Game, which was Lutz Kleveman’s book we interviewed him back in 2005. what’s really important here is the new western pipeline from the Caspian through Turkey, Baku, Tbilisi, Ceyhan. It snakes almost a thousand miles through Azerbaijan, Georgia and Turkey. And what you have in Georgia is two Russian controlled provinces in South Ossetia, and Abkhazia. And Moscow has already issued passports to residents in that area. The Russians are supplying fuel, arms and direct military support and they have troops in the region. What Putin is now looking for is the excuse to invade Georgia to restore peace and stability. It’s sort of like what Hitler was looking for in Czechoslovakia. They’ve hinted already that backing these dissenting provinces and their move for independence; they’re also looking at a similar move in the Baltics with Latvia. [14:03]
JOHN: You don’t hear this kind of news in the main stream media, of course, they’re always looking in the rear view mirror. You’ll hear it the day that Georgia comes under attack but before that you probably won’t see that. The media is asleep we know, focusing on well, the silly season. We have the scandals going on during this year’s elections. Why do you think this is going to happen, anyway?
JIM: I think what you’re seeing right now, is the convergence of 3 factors. One, NATO weakness and especially appeasement in Europe. High energy prices which bolster Russia’s finances and give it the ability to expand, and also the US’ own position being bogged down in the Middle East. [14:39]
JOHN: With or without doing anything to Iran as well, which could actually change that picture. What do you think are the investment implications are going to be for this? Obviously, like you said about the Great Game, this is all about energy.
JIM: Well, from an investment perspective, if you own energy or precious metals or natural resource stocks or defense stocks you keep them. If you don’t have investments in these areas you buy energy now, especially with many of these companies selling at 5 and 6 times earnings. That’s pretty hard to find in today’s market. You buy the natural resource stocks and also defense stocks. The economic, financial and geopolitical storms are going to dominate our lives for the next two decades. [15:18]
JOHN: Alright, some final thoughts on today’s financial market. You’ve said for a long time, you know, during the year, they needed to hammer the commodity markets, and we mentioned especially oil and precious metals. I think people are really sort of breathless at how quickly this has happened, especially with what has happened to oil this last month, which leads to some of those absurd predictions about where it’s going down to.
JIM: Well, it began with Goldman Sachs, which made a major change to their commodity index. And what they did is they took down the weight of unleaded gas from roughly 8% of the index to a little over 2% of the index. And the adjustment prompted the sell off of nearly $6 billion in unleaded gasoline futures contracts.
You’ve got to remember, when you’re following or trying to mirror an index whether it’s the S&P 500, or the Goldman Sachs commodity index anytime the index changes, you know, in the S&P they take out 1 stock and they substitute another, the stock they take out goes through heavy selling, the new stock they put in goes through heavy buying, and the price goes up. Well, in this case, when Goldman Sachs reduced their unleaded gasoline weight from 8% down to 2%, what it has caused is all this big adjustment in all these major funds that were trying to mirror the index.
There was also a hefty drop by the way, in natural gas weighting from almost 8.6% down to 6.6% - and voila, what happened to natural gas? Well, you saw what happened to the hedge fund that owned 10% of all natural gas futures Amaranth. Even though their have been other temporary favorable factors for energy towards the end of August and September for example, the cessation of hostilities in Lebanon, and also the mild hurricane season- the peak for energy nonetheless occurred on August 9th, the day that the index changed. [17:17]
JOHN: And then we got the hedge fund blowup, which then forced liquidation of their energy contracts. So in essence what you saw was selling creating more selling. It actually accelerates the downward curve. No wonder why the White House brought on Paulson from Goldman, because it’s obvious he knows how to move markets, which appears to be exactly what they did. And consumers are now paying lower prices at the pump just in time for the elections.
JIM: All I can say is enjoy it while it lasts. If you have big fuel tanks in your RV, I’d suggest filling them up now.
JOHN: Good time for a vacation.
JIM: Yes, a good time for taking a vacation, because after the elections who knows where they’re going?
You also have the Fed playing into this game, playing what I call good cop, bad cop with the financial markets. We really saw a good example of that this week on Wednesday. B52 Ben warns the market of this rapidly slowing housing market, the market interprets that as a favorable sign in terms of the Fed lowering interest rates. Bernanke said the slowdown in housing could trim another 1% off economic growth, hinting at lower interest rates; the Dow advances over 100 points to a new record. And here you have Bernanke playing the role of the good cop. On Thursday, you got Plauser [ph.] and Kann [ph.] other Fed governors suggesting that the Fed could keep interest rates at current levels, or even push them higher because of inflation concerns. [18:40]
JOHN: I think they’re trying to play it both sides, both the bulls and the bears. But if you look at it it’s nothing more than market propaganda. They’re trying to keep the bulls in charge in propping up the markets and at the same time keep the bond markets appeased with hawkish inflation comments which you hear floating around everywhere.
JIM: Absolutely, it’s a confidence game and what is really going on here is how long can we keep them fooled.
Humor – The Economic Ship Compromise
Truth the final frontier, these are the adventures of the economic ship Compromise. Its 5 year mission to explore government statistics, to seek out true numbers and reliable data, to boldly go where no Fed chief has gone before.
Inflation date 9522.6 the Compromise is dead in space, stopped cold by rhetorical obfuscation in her pursuit of real inflation figures. We’re attempting to get beyond the core inflation data to explore the naked inflationary truth.
Kirk: What is it, Scotty?
Scotty: Captain, there’s no reason for it but the computer’s fading out.
Spock: Fascinating.
Kirk: Computer! Request security procedure.
Computer: Not to worry, inflation is contained.
Dr. McCoy: Jim, Spock, what in the name of sanity is going on?
Spock: My readings indicate a contradiction.
Computer: You do not have the security clearance to access data which you have requested. You can only access the core inflation rate.
Scotty: Captain, what’ll we do?
Kirk: Start your computations.
Spock: Computing now, Captain.
Computer: Please do not attempt to access the M3 or self destruct sequence will commence. Warning! Warning! Warning! You should have contained your activities within the core rate. Self destruct sequence initiated. 3 minutes and counting.
Kirk: Scotty, Warp speed in 3 minutes or we’re all dead.
Scotty: My engineers are working on it now, Sir. You’ll have it within the hour.
Kirk: Stop the computer, destroy it.
Scotty: Going down, Captain.
Kirk: I’m going to sleep this off. Please let me know if there’s another way we can screw up tonight.
Dr. McCoy: I don’t know if you’ve got the whole picture or not but he’s not exactly working on all thrusters.
Spock: Humans make illogical decisions.
Computer: 3-2-1. [sound of explosion]
The Coming Gold Mergers: What the Big Boys are Looking At
JOHN: Well, in recent programs we have been covering the fundamentals of the gold market and where things are headed. And one of the trends we have been talking about since the beginning of the year, has been the coming mergers which we have seen plenty of � since the beginning of the year as a matter of fact. In looking ahead, what kind of companies and projects do you think are on the shopping list of the larger companies?
JIM: Well, to begin with the juniors have been taking the lead in the discovery game, and this is something � a thesis � that we’ve put forth over the last 3 or 4 years that this bull market was going to be different than the bull market in the late 60s and the 70s. And if you take a look at let’s say the next 10 years, it’s going to be the juniors that dominate exploration. And it’s not going to be the majors. It is going to be also, I believe, the juniors that become the primary source of new major discovery deposits and I’m talking about deposits in the 2 to 3 million ounce range.
Right now, if you look around the world � and Ralph Bullis has documented this in a study he did a couple of years ago � there is a scarcity of new, quality 3 million ounce major gold deposits on the planet. You also have a situation where gold production is outpacing reserve replacement in 4 out of the last 6 years. That’s why I think the seniors are relying more and more on juniors for discoveries or they’re simply going to go out and buy their reserves, or their replacements. It’s very much as we have said so many times there are similarities between the mining industry and the energy industry where you’ve got the big behemoths like Exxon-Mobil, Chevron and BP that aren’t replacing their reserves, so the only way they’re doing that is through acquisitions. [23:44]
JOHN: So what are the giants looking at?
JIM: I would say right now, what the majors like to see are 3 million ounce deposits with long life mines � in other words, 10 to 20 years in production quality for a mine. They want 3 million ounces because that gets you roughly 250,000 ounces of gold production a year. Those are the kind of numbers that they’re looking at. And you’ve got to remember, a lot of these guys, like Barrick, with its takeover of Placer is now producing 8 million ounces of gold a year. Where are they going to find 8 million ounces to replace those ounces produced? I don’t see very many 8 or 10 million ounce deposits out there.
Same thing when you had Newmont, when they merged back with Normandy-Franco back in the early part of this decade � Newmont was producing 7.6 million ounces and they’re down to 6. And one of the disappointing facts at the Denver Gold Show, they were talking about their production declining even further.
And the other thing too, is it’s not that they want 3 million ounce deposits, it’s also that they want some blue sky. They’re looking for some upside potential because that’s what really extends the life of a mine, and brings down their acquisition costs. So they might look at a deposit with 3 million ounces but really what they want to do is see more than that 3 million. [25:02]
JOHN: So in your view, when does a junior actually get in front of the cross-hairs of a major.
JIM: I would say a junior moves into that sweet spot for a potential takeover when it makes a discovery that meets a lot of the senior’s main criteria. One of them being a 3 million ounce deposit.
JOHN: Why don’t we break those out.
JIM: Well, the first criteria is as I mentioned is a project that has quality, undeveloped ounces in the ground in the 2-3 million range. 3 million for the majors, and I would say probably 2 million for the intermediate producers. And when I refer to quality I mean mineable economic ounces. Not all ounces are created equal. A lot of times you get analysts that just count ounces a lot of these ounces are just plain dirt that’ll never be brought into production, because they’re either not mineable or they’re uneconomic.
Another criterion, and this is a very important one, is 100% ownership of the discovery. A discovery that is mined out to other companies or that have multiple interests in the discovery becomes less attractive, because what the majors want are 100% ownership and that enhances the takeover appeal. [26:15]
JOHN: Is there anything else?
JIM: Sure, as I mentioned that in addition to the 3 million ounces they want to see some blue sky upside. So a large land package is also important. The majors are looking for not just a small mine, they’re looking for a large district scale land position � large scale district size projects are really coveted by seniors because that means � let me explain it this way � let’s say that you’re looking at an area of land and there are say 3 million ounces there but it’s a larger land package. There’s the potential there if you’re in a gold belt and especially if you’re surrounded by other projects of other mining companies where they’ve got large gold positions too, there’s the chance with more land that you’re going to find additional or make additional discoveries. And that becomes very important because this blue sky potential to discover and find more ounces, the large scale district play will usually command a takeover premium.
So when you look at juniors, you have to look at a concept I call forward ounce potential, not just what they have banked or put on to the balance sheet. So if they have two million ounces, or a million ounces, you just don’t look at that figure � you also take a look at are they continuing to explore, are they making new discoveries, are they adding additional ounces? It’s that additional ounces, the possibility of new discoveries which is the blue sky potential that the majors are also looking for. [27:50]
JOHN: What about political stability?
JIM: That’s a final criterion, one that I think is going to come increasingly more important. 3 million ounce projects that are large district plays in politically safe countries with low to moderate political risks make the junior that much more attractive. The big boys, John, want safety and security in their investment. A politically risky deposit will either be avoided or sharply discounted to account for that political risk. Because what a mining company doesn’t want to do is buy a position in a company for 300, or $� billion, 500, 600 million dollars and then you’re going to have to put in a mill, infrastructure, so it could cost another couple hundred million to put the infrastructure in, and then all of a sudden they buy the company, they put the infrastructure in and the country you’re dealing with says, “you know what, we’re going to change the royalty fees and the taxation on this project,” and if it really looks enticing and who knows how high gold prices go, you may actually have the politically entity say, “what was yours is now mine.” And so political risk is now becoming a very important factor in terms of what the seniors and the intermediate size companies are looking at. [29:14]
JOHN: Let’s go back to the blue sky. This really provides sort of the upside for an acquirer.
JIM: Sure, let’s take an example. Let’s say a senior is buying a junior � they have 3 million ounces and let’s say they are paying $100 an ounce. So they’re buying the company for 300 million. If you look at that they’re paying $100 an ounce in the ground � if you look at some of the more recent acquisitions however, the average increase in resource ounces has averaged almost 100%. So in other words, they may have paid for 3 million ounces, but it had a large enough land package in a district area that the senior � once they bought the company actually went out and made discoveries on the property and actually discovered more ounces in the ground. [30:13]
JOHN: Yes, could you give some examples, Jim.
JIM: Sure, when Barrick bought Arrick keepa [ph.], they paid for over close to 5 million ounces when they bought the project, but through discoveries they were able to drive that up to nearly 8 million ounces. If you look at Barrick over Sutton Resources � over 6 million ounces, now through discovery almost 10 million ounces. If you look at Homestake, taking Argentine Gold back in 1999, they paid for almost 2 million ounces and discovered an additional 6. In other words, 264% increase in terms of the amount of ounces in the project. If you look at Glamis over Francisco Gold way back in 2002 Glamis bought nearly 2 million ounces in the ground but discovered another 4 million ounces, a 230% increase. So if you’re buying ounces in the ground at $100 an ounce, and you double the ounces through discovery on the project then you drive down your acquisition cost from $100 an ounce, let’s say, down to $50 an ounce. [31:19]
JOHN: But I guess you probably remain as bullish as ever given the criteria which we discussed here.
JIM: Sure. Let me just put some caveats. Not everybody holds the same views as I do. There are a lot of people out there that think the bull market in gold is over, the bull market in commodities is over. I happen to be one that disagrees with that view. I think this bull market in my opinion is just getting started, and like I’ve said over the years this is going to be a different type of bull market. It’s not like the late 60s and 70s when a big mining company produced 500,000 ounces of gold per year, or even if you go as far back as the late 80s, you had Newmont producing 7 or 800,000 ounces a year that was considered a major back then. Today, that’s almost an intermediate type production level for what we see today with the 7 and 8 million ounce producers as a result of all these acquisitions in the 90s.
And the problem as we’ve talked about here, it takes longer and longer and longer time from discovery to production. And you may discover something, and it may take 10 years by the time you go through the permitting process to bring that mine into production. So one of the areas that we feel and I’ve written about this over the years, and we’ve talked about it numerous times on the radio show � is I believe the juniors are going to be what dominates this bull market in my opinion. They’re going to be the Cisco’s, the Dells and the Intels of this bull market � where the seniors are going to be more like the IBMs.
And what we have done is put together a list of over 30 companies that meet this criteria that a lot of the majors are looking at, and I would expect that these companies are going to look attractive to an acquirer because they meet the criteria based on analyzing past acquisitions over the last 5 or 6 years in terms of what were the qualities of the companies that were acquired. And so I believe very strongly in this area as many people are well aware of. [33:30]
JOHN: It’s not a perfect world, so what’s the downside?
JIM: Well, once again, not everybody agrees with my view. Some people like to say, why invest in juniors, you know just trade the gold bull market based on technical analysis, and some people have been very successful doing that; others are out there saying that this bull market is over which I strongly disagree with.
So one of the criteria which is very important if you’re going to invest in this area is you have to have patience and a cast iron stomach. We’ve talked about these Maalox moments, and you and I have seen them over the last 5 or 6 years. We get these annual corrections, as Frank Barbera is fond of saying most of the time a 25 to 30% correction in the gold market is normal and we get these each year in the gold market. And at times they can scare you out if you don’t know your facts or understand what it is that you’re buying. I happen to enjoy them because it allows me another opportunity to buy at heavily discounted prices. And quite honestly I don’t mind the fluctuations because from our perspective we’re long term investors. I could care less what the price is today when I consider what I think the price is going to be 2 to 3 years from now. [34:43]
JOHN: And coming up next here on the Financial Sense Newshour at www.financialsense.com on the internet we have Other Voices and Kelley Wright coming up in just a minute.
Other Voices: Kelley Wright, IQ Trends
JIM: Well, this is the year that the Dow set a new record we haven’t seen since the year 2000, but even more important the dogs of the Dow are trouncing the returns on the Dow � mainly coming from dividends.
I couldn’t think of someone else I’d rather talk to than Kelley Wright at Investment Quality Trends.
You know, Kelley, you classify your 350 stocks in your newsletter � you have 4 categories: undervalued, overvalued, rising trend, declining trends. In your latest letter you have 31 stocks in your undervalued category, where does that stand historically? Are you seeing more stocks in this category or less?
KELLEY WRIGHT: From a historical perspective our undervalued category is pretty slim right now. As a matter of fact it’s right around 10% of our universe which comparatively speaking is very, very low.
JIM: If you were to go back to the Summer of 2002, where we saw 2 years of declining stock markets, what did your undervalued category look like back then?
KELLEY: It was about 1 larger than it is now � approaching I believe it’s a little over 80 stocks. So the number of stocks which were trading at their historic levels of undervalued based on their dividend yields has slimmed down considerably. [36:27]
JIM: Is there anything that you’re finding in terms of the type of composition of stocks that are in the undervalued category, or overvalued category. Are there particular sectors, for example, financials, oils, drug stocks, etc.?
KELLEY: Well, in terms of the overvalued sector the oil companies are phenomenally overvalued in terms of their dividend yield profile. Chevron, Texaco, Exxon-Mobil, Conoco-Phillips � while they’ve had phenomenal price appreciation the companies have simply not kept their dividend payments up to where they offer anything in terms of the type of value that we would look for. In the undervalued category, it’s pretty interesting. There are quite a few financials, and there have been a handful of the pharmaceuticals as well. And I would say that those would be the two dominant areas, particularly if you throw in insurance companies. [37:27]
JIM: We’ve recently started a series on retirement planning with the idea that people are living longer today because of advances in medicine, and because of that, income and assets have to work harder and work longer. And what we’ve been emphasizing for individuals getting ready to retire is an emphasis on dividend growers. In your latest newsletter, talk about what has happened to McDonald’s dividend because I think this is a good illustration what a difference a focus on dividends can make to someone’s retirement.
KELLEY: Back in December of 2002, McDonalds boosted their dividends significantly. Simultaneously, if you’ll remember that was when we had one of those mad cow scares, and consumers were scared to death that they were going to get a bad burger, and a lot of the restaurant stocks fell off. But because of that dividend boost in December 2002, McDonalds was moved into their historic area of undervalue, and we swooped in and picked it up at about $16 a share. Now, at that time the dividend was only 23 cents, and the yield was about 1.45%; and we had subscribers and people that said, “Geez, why are you buying a stock that has such a low yield?” And the thing that we told our subscribers is that you have to look at the pattern that the company is following in terms of raising those dividends. And if you look at McDonalds today, you know it’s up around $40, so in a short time span � relatively � we’ve more than doubled our capital but more importantly the dividend yield is now considerably higher because McDonalds has raised their dividend to $1 a share. So, our yield on purchase is about 6 �%. Now, we bought McDonalds again later in 2003 at $25, and so our average cost is about 20.50; and our average yield on purchase is about 4.90. [39:37]
JIM: That’s better than a 10 year Treasury.
KELLEY: It’s better than a 30 year Treasury. And I don’t think the Treasuries have pulled a double in that time frame as well. So the lesson to stockholders is this: that it’s not just enough to look at the current dividend, you have to look at the company’s history of raising that dividend. And in just a short time, you can get a company like McDonalds that doesn’t have an attractive yield right now, but because of the way they raise their dividend in a few short years your yield is spectacular � particularly when you compare it to some of the fixed income alternatives like Treasuries. [40:15]
JIM: You know I’m just looking at a Bloomberg dividend screen for McDonalds and the 5 year historical growth rate for dividends is 25 �%. In fact if you started, let’s say the last year of the century, in the year 2000 the dividend went from 21 cents as you just pointed out, to $1 a share. I mean that’s absolutely fabulous. If you had 10 of those in your portfolio just imagine what your income would be.
KELLEY: And that’s pretty much the point that we try to drive home. I’ll give you another example. If you take a look at that little bank from New York called Citibank. Back in 1998, you could have bought Citibank anytime during that year for about $12.50 a share; and their yield was down about 1 �%. If you look at Citigroup now, it’s just moved over $51. So on just a capital appreciation basis alone it’s been marvelous. But if you look at their dividend now it’s around 4%. If you would have bought it in 98 at 12.50 and held it until today, your yield on purchase is over 14%.
Now, Jim, you know better than anybody that to get yields like that you’re not generally going to find it in a blue chip type of investment certainly not one as strong a company as Citigroup. [41:40]
JIM: This is not only very important as you have illustrated, when you find these blue chips, companies that have a track record of doing this, this is the kind of reward maybe you’re not going to get as in the case of Citigroup, 27% 5 year compound dividend growth, or in the case of McDonalds almost 26%.
But Kelley, talk for a moment about some of the historical things you look at. Normally if you see a blue chip company, and they have a track record of consistently raising dividends, over � I think you guys look at over 25 years � I mean that should give an investor a high degree of confidence that they might expect something like that in the future � maybe not as much � but certainly you would expect to see increases.
KELLEY: That’s absolutely right, Jim. You know our criteria � it’s pretty tough. If you look at it just up front, our criteria eliminates about 96% of the tradable universe, the domestic universe here in the US. So we start here with a universe of only 4% of the tradable domestic stocks. And like you said, one of our criteria is that they do have to pay dividends, uninterrupted on a 25 year basis. One thing we do in the newsletter though is we have a special designation for companies that have raised their dividend in excess of 10% a year for the last 12 years in a row. And we give those what we call the �G’ designation. And the G designation is the IQ trends designation for growth. That’s what we call a growth stock a company that has raised their dividend at that spectacular amount but for at least 12 years in a row.
And if you take a look at those companies that have a G designation, and you use those in your portfolio you’re going to increase your odds significantly that you’re going to get a McDonalds type of a situation, or a Citigroup type of a situation. And that’s the type of stock that you want to put in to your portfolio because then you’re not going to get into that situation where down the road you’re looking at the safety versus the return. Because if you buy a high quality company when it’s at its historic level of undervalue and you hold it and they’ve consistently raised their dividend not only is your capital going to continue to grow, which it’s not going to do in fixed income, but your return in the form of dividends is going to grow which once again you can’t really do in fixed income.
So for investors that are planning for an event down the road, if they take this into consideration and they realize that you know what, I can invest safely in high quality blue chip stocks and continue to grow my capital and my income but still be safe and not put my portfolio at risk for investors that will do that, they are going to be handsomely rewarded over time. [44:39]
JIM: You know another comforting thing too, about dividends, as investors found out in the first part of this century is that dividends are tangible. Cash is real, you can cash it, spend it, save it and the other thing is to pay that dividend the earnings have to be there to pay it.
KELLEY: You know, as our founder Geraldine Weiss has said dividends don’t lie. You have some pretty crafty people that work in some corporations and they can do some phenomenal things with balance sheets and financial statements. But the one thing that you cannot fake is a dividend payment. When you present the check to the bank it either clears or it doesn’t, you know, the money’s either in the company’s bank account or it isn’t. And once that check has cleared that money has gone from that company forever. So the dividend is tangible evidence that, number one, you’re invested in a profitable concern that can share the company’s growth and rewards with their shareholders. [45:38]
JIM: Another advantage also too I think is as you and I know Kelley, most of the time the market is going nowhere. It’ll be going sideways, it’ll be up one day it could be down the next, and we can go through long periods of time where you see this sideways action in the market, and then you’ll get either a sharp rise up or a sharp rise down. But the one advantage about dividends is while you’re sitting there at least you’re being compensated on your investment. You’re getting something in terms of an immediate return. And I also think that’s more stable � companies that pay dividends tend to be more stable in downturns, they don’t get as roughed up as much when you’re paying a 2 or 3 or 4 percent dividend versus a stock that pays nothing.
KELLEY: No question about it and we have plenty of evidence in our history that when the market enters into an emotional period and stocks that don’t offer dividends, or whose return is based for lack of a better word on hype and hope, you can look at the dividend as a tangible piece of evidence that here is a solid going concern that is producing ongoing revenues and returning part of it to the shareholders.
You know with a stock that doesn’t pay dividends that tangible floor is not there to protect you in a downturn. If you look in 1987, I know it’s a long time ago, and I know for many investors, they didn’t experience it, they didn’t go through it, but we did and on the day that the Dow lost 25%, our undervalued category did decline, it declined about 12% but we still ended 1987 with a positive return for the year. And in the first quarter of 1988 we returned over 19 �% in our undervalued category. So what happens is that Wall Street � Jim, you know better than anyone � is fickle, fickle, fickle, and those two things called greed and fear there’s a very, very sharp line between them. And I’ve seen fear turn on a dime and become greed, because you know when folks look at some of these stocks and you realize what value they are and they see those dividend yields, the capital flows into them and they’re right back into the black. [48:05]
JIM: It seems like this dividend strategy is playing out very well this year. The dogs of the Dow were beating the Dow. The Dow is also doing very well against the other indexes. Do you think this is a return to this philosophy of dividend investing, or is this simply a year where there’s a lot of uncertainty and investors are playing it more cautiously and trying to be safe?
KELLEY: You know I think there’s a combination of those things. The small and mid-caps led for so long and the larger cap stocks had kind of been ignored. And if you look at the PEs on the small cap and mid-cap indexes they’re really, really inflated. The PE on the S&P at 17 is no bargain either, but compared to 30 or 40 on some of those other indexes the S&P looks comparatively cheap. I think though you have to look at this advance � it’s been pretty narrow. It’s in a handful really of issues. If you look at the Dow itself, I think only 13 of the 30 Dow components have really made a profit since 2000, and 17 of them still haven’t gotten back to their old highs. So we’re seeing a pretty narrow movement right now and I think some of that is fear. And I think that consumers and investors are worried because if they felt better I think we would see better breadth in the market. [49:43]
JIM: Alright, Kelley, as we close, tell people about your website and newsletter and how they can find you.
KELLEY: Ok, Jim. I appreciate it. On the web of course, you can find us at www.iqtrends.com. We publish on the 1st and 15th � on or about the 1st and 15th � of every month, and we’ve done so since April 1 of 1966. We can deliver it to you old fashioned snail mail or we can send it to you in a PDF document in your email on publishing day. [50:14]
JIM: Kelley, as usual it’s a pleasure talking with you, I hope you’ll come back and visit us once again, and all the best to you.
KELLEY: Jim, thank you so much, it’s our pleasure, we’d love to be on with you any time.
Retirement Planning: The Importance of Dividends
JOHN: On the last program a week ago, we sort of started this broad brush approach to retirement and now it’s time as we go over the next few weeks to begin looking more and more specifically. What do you have to do to get ready for retirement? You’re setting a certain amount of money aside, in a perfect non-inflationary world you could start with a budget � you need to start with a budget no matter what happens, you have to at least take today’s dollars and say what would I need to retire at today’s figures � but the problem is we’re inflating even though they’re telling us we’re not inflating, you and I know we are.
JIM: And you can’t live on the core rate.
JOHN: And I can’t live on the core rate. So basically, let’s take a nominal sum here, if you start with $30,000, say that’s what you’re going to retire on, you’re 60 right now � at different rates of inflation what am I going to have to have to have the same thing as $30,000 income in 10 years? And check several different rates of inflation here. Do you follow what I’m doing here? This is important that people follow this.
JIM: Sure, because you start at out year � you retire at age 60 � and you’re saying, “Ok, I’m going to live on $30,000 a year.” That’s what it’s going to take, maybe you have a free and clear home and this is what your expenses are. Now, obviously you can extrapolate larger figures depending on your lifestyle and where you live from.
But what you have to account for is inflation, because I think if you look at where you are today and the money that you’re spending to live, and buy and pay for basic necessities, take a look at what these things cost 5 years ago or 10 years ago. And you know, when you look back and you say, “Wow, look at the cost of housing, look what a new car costs, look at what a pound of hamburger costs, a steak or a carton of milk, or a gallon of gasoline, or medical premiums.” Whatever it is that you’re spending money on.
So what we’ve done is we’ve taken this $30,000 figure � we just sort of wanted to give you an example � and we took 3 different inflation rates. We took the official statistical inflation rate of about 3%, and then we took an inflation figure of 5% and 8%. If you talk to guys like John Williams who still records the CPI the way they did before they started jiggering with it, the inflation rate is running as high as 8%. So what we wanted to do is give you an idea of what happens to you with inflation. So, we’ll take our benign scenario, the one that the government tells us of 3% inflation nobody believes it, but let’s put those figures out.
What happens with 3% interest rate? You would need $34,800 to buy the same thing 5 years from now at a 3% inflation rate that $30,000 buys today. Now, these figures have been rounded off, so if you’re putting this in a calculator, yes, Jim took a little liberty here, I rounded it up a little bit to the nearest $100.
In 10 years, with a 3% inflation rate, you would need $40,300.
Now, let’s look at what happens when the inflation rate increases to figures which I believe more widely reflects where we are today. At a 5% inflation rate, in 5 years, you would $38,300 to buy the same lifestyle that 30,000 buys today. In 10 years, $48,900.
Now, let’s take a look at where people like John Williams think we are today which is an 8% inflation rate. You would need $44,100 in 5 years to buy the same goods and services that 30,000 buys today. And in 10 years, $64,800.
So you can see even at a 3% inflation rate if you buy in to the government numbers and 10 years from now you would need $40,300; and at a 5% inflation rate you would need almost $49,000. And under an 8% scenario you would need 65,000. I mean it’s incredible. [55:07]
JOHN: You know what, would you really stare at these figures you go this is unfair, you’re really taking it in the shorts from the cartel between the Fed and the Federal government. It is eroding away everything you worked on. You have to keep pumping it to stay even is what you have to do.
JIM: And what is even more important is if you take a look at most people that retire, let’s say you work for a company or you work for the government, you’re going to get a pension. In corporate life, most of your pensions are going to be fixed and they’re going to be far below what it is that you’re going to be earning when you were working. On the other hand, if you work for the government you’re more fortunate because most people can retire with as much as 80 to as much as 100% - depending on the programs of your retirement. And in some cases you sort of get cost of living adjustments of 2 to 3% a year.
So if you take a look at most people, a good majority of their income is going to come from their pension: company pension, government pension or social security. So most of that with the exception of a certain government pension and social security they’re indexed to this phony CPI rate, so you may get a little bit of relief adjustment. But one of the things that we’ve seen over the years is in the area of social security � remember, John, Social Security used to be non-taxable; then they began taxing 50% of it; then in the 90s they began taxing 85% of it. And I predict in the future 100%, and even phase it out as we get closer into this Social Security problem directly ahead of us.
So if your pensions aren’t keeping pace with inflation then what an individual has to do is rely on their investments to keep pace with inflation; or, as I’ve seen some people do, they continue to work during retirement, maybe they have a part time job, they’re doing some consulting work or maybe holding a part-time job to supplement their income. I’ve seen that even with my own clients, where one of my clients was a consultant to the legal industry regarding car accidents, and he was so good at what he did that they would call him in on certain cases, and he’d do a little consulting work. So your investments have to keep pace with inflation. You have to have something that is going to take care of when your living expenses go from 30,000 to 40,000 or 50,000 or 65,000 with inflation � because people are living longer today, things are costing more.
And that’s why I think it’s very important to have something in your portfolio that has the ability to increase your income every year and over a period of time, or even more importantly if you’re 5 years away, or even 10 years away from retirement, you have a kind of portfolio that can compound your money so that when you do get to that time you’re going to retire, or if you have retired, you have something you can look forward to each year, “ah, they raised the dividends, Ok, so I’m getting more income.” [58:20]
JOHN: As I look at this Jim, what can I reasonably be expected to bring in percentage wise. Say, for example, you have an investment account with a money manager and during the growth period he’s bringing in what’s a reasonable percentage figure per year, if he’s managing your money properly?
JIM: Well, let’s take some figures and I’m going to put some strong caveats around. So, if you take a look at the last 100 years, the return in the stock market has been around 10%. A good half of that has come from dividends and the rest from growth. That’s historical � so, let’s put that in caveats. If you take what happened in the 90s, when we were in a stock market bubble, I really think you can’t use those figures. So I think if you look at the average over the last 10 years it’s more reflective, because you’ve had 5 years of the stock market bubble in the 90s, and you had 5 years in this new century when you had a 3 year bear market, and the mediocre returns that we’ve seen in the recovery from that bear market in 2002. So you’ve got to take in more recent evidence where the stock market didn’t do as well.
And what I would do is I would look at those figures and they are closer to 5 or 6% at best. Any time you have a period as we did through the 80s and especially the 90s, when a particular asset class out performs and tends to go way over to the extreme side as we saw from 1995 to the first quarter of 2000, there’s a tendency to extrapolate those figures into the future. You can’t do that, and history shows us that when you have periods of high returns as we did in the late 90s, they’re usually followed by extended periods of low returns � and I think that’s what we’ve been facing in this new century. If you took a look at 3 years of a bear market, 2000 to 2002; a good year in 2003 and really mediocre returns for 2004 and 2005, and then until recently in the last month 2006. In fact, even as I look at the NASDAQ today, it is only up 4%. Now, the Dow is up 10 �% and the S&P is up 8%. So in nominal terms, you really have to look at this. Then if you look at the fixed income returns, a 10 year Treasury is at 4.6%; a 30 year Treasury bond is below 5%. So, on the fixed income side the returns are really in that 4 and 5% level. [1:01:04]
JOHN: A lot of people don’t have a lot of downside safety nets, so when they retire they’ve earned all this money and typically there’s an emotional drive to this they want to put their money into something that’s secure. So they’ll say, “I’m just going to tuck my money away in the bank and it’s going to be AOK.” That’s what they’ll say.
JIM: Sure, there’s a tendency, “Ok, the bank, I’ve got FDIC. I buy a government bond and it’s backed by the US government.” But John, take a look at the rate of returns today on fixed income of 4 � to less than 5%. That’s not even covering the inflation rate in my opinion. So if you spend the income your principal is eroding because of inflation. Now, you may want some in fixed income, because you may be that kind of person that that’s what is going to give you your comfort level � that’s what allows you to sleep at night. But on the other hand, you better doggone have something in your portfolio that’s going up.
And the reason we sort of recommend large cap blue chips, and especially companies that have a very stable business model, they sell a product or service that people have to have and need that is more immune to let’s say recessions. I mean you’re not going to stop buying food because we’re in a recession; you’re not going to stop putting gas in your car; you’re not going to stop taking drugs if your doctor says take this to lower your cholesterol, you’re not going to say, “I don’t know, you know, the economy is slowing down, I’m going to stop my medication.” Or a company that provides a service; or consumer staples things that we consume on a daily basis.
And the reason I recommend blue chips is because, let’s take an example, you’re not going to worry about Exxon going broke; you’re not going to worry about a Johnson & Johnson � a healthcare company that’s involved in all aspects of medicine. Those are the kinds of things that should give you a little bit of a comfort level, and especially as, for example Kelley Wright did in the Other Voices segment, when you talk about companies that have paid dividends for 25 years, I mean that pretty much is going to encompass several recessionary boom and bust periods. And you can see that, hey, they’re still around, they’re still making money, they made money during the recession and they’re strong financially. So those are the kinds of things that ought to give you that kind of comfort level. [1:03:35]
JOHN: In the past we’ve done illustrations like this, and during the week we were talking about reconstructing another one of these so people could understand it. So if we had to assemble this all, what would it look like? Paint a picture.
JIM: Well, what I did is I put together just 10 blue chip companies. I went back to 1995, and I assumed you had $100,000 to invest. Maybe you had an IRA, a 401K plan, or you retired that year. And with this $100,000 investment, you put $10,000 equally into 10 different stocks.
And I just kind of picked out some blue chips trying to stay within the Dow type stocks, the large big cap stocks. So I picked Bank of America, AIG, McDonalds, Exxon, Johnson & Johnson, Altria (formerly Phillip Morris), Proctor & Gamble, General Electric, Pepsi, and 3M. So you had industrial stocks, consumer staple stocks, medical, oil, financial and restaurant type fast food.
And let’s assume, that you took $100,000, you invested it January 1 of 1995. On that $100,000 investment, had you bought those stocks, at the beginning of the year, at the end of the year you would have received roughly about $2800 in dividends; and at the end of the year your stock portfolio would have been worth roughly $145,000. Now, remember, we’re going back to the booming 1990s.
Fast forward, 5 years later, in the year 2000, that same portfolio at the end of 2000 assuming you kept everything, which remember, at the end of 2000, the stock market was going down, we were beginning that bear market period � your dividends from these same companies would have gone from $2800 to roughly over $5100. So, almost a doubling in that 5 year period in your dividends; your portfolio at the end of 2000, interestingly, would have been worth $232,000. Actually this portfolio actually went up from the beginning of the year even though the stock market was going down, because investors, as they all do during market turmoil, go for safety and stability.
Fast forward another 5 years and let’s go to the end of 2005, with that same portfolio the dividends would have been almost $8800. So you’ve seen almost 3 � times increase in the amount of income that you would have been receiving from this portfolio versus where you started. And your portfolio would have been worth almost close to $400,000. So not only did your portfolio keep pace with inflation but more importantly from an income perspective, which is very important if you’re living off dividends when you’re retired, you had almost a 4-fold increase in the amount of your income. [1:06:49]
JOHN: Ok, let’s assume you’re 5 or 10 years away from retirement. What about returns? Could you apply the same thing?
JIM: Sure, in fact, I would recommend somebody 5 years away from retirement or even 10 years away from retirement start thinking about this because even though the last illustration I assume for example starting out in 1995 where the dividends from this portfolio were $2800, you spent the money, you used it to live on. So, 5 years later when the dividends went to $5100 you spent the money, but your portfolio was increasing.
Now, let’s take that same concept but this time, instead of spending the money, say you’re saving for retirement so you’re reinvesting the dividends in additional shares with the same company, so you’re compounding your money, your rate of return during that period of time was incredible. Because during that 10 year period, your rate of return would have been almost 300%, and that’s assuming the dividends were reinvested.
So it’s also very important, as you’re getting closer and closer to that retirement date, that say you’re 5 years away that you start setting that portfolio so that you don’t want to sit there 5 years away from retirement and say, “you know what, I don’t have enough money, let’s roll the dice and go for it.” I mean that’s not the thing that you want to do, as many people were doing as we got closer in the latter part of the 90s when it looked like the stock market was just printing money and you had people putting 100% of their portfolio into tech stocks or internet stocks because it was next to printing money. You don’t want to do that.
So the closer you get to the retirement years that’s when you really want to and I would say at a minimum 5 years out you need to start rethinking what it is you’re doing from investments. And John, trying to put your money in a 4% bond, if you’ve got a lot of money maybe you have that luxury and you can afford to do that, but at 4% return or 4.6% return on a 10 year Treasury note, you’re not even keeping up with inflation. [1:09:08]
JOHN: Which means ultimately your lifestyle is going to go down and down and down as you live in retirement, or you’re going to be forced to go back into the job force. But that’ s going to drop, you know, as we talk about Social Security � now there’s a trade-off, Jim, say as you go back in because you’re going to lose your Social Security benefits. So there’s a law of negative declines there too.
JIM: Yes, that happens, it’s up to age 65, you lose a certain benefit, and up to age 70. After 70 they don’t care, you can go back to work, but that’s not the most comforting thing you want to do. You retired at age 60 and age 70, you’re looking at those figures that we talked about where if you were spending $30,000 when you’re age 60 to live on depending on the inflation, now it’s taking nearly 55 or 65 thousand dollars to live. What you don’t want to do is at age 70 is just say, “gosh, I need to maybe do some part-time work at Ralph’s and become a checker or bagger, or do some part-time work.”
Or what you may see, John, is sometimes you’ll see couples sell their house and they’ll move to an area where the cost of living is less expensive, so they have to move to maybe some area where they really don’t want to live, but they are forced to do so. Or you see cut backs in living expenses. Instead of going out to eat a couple of times a week, maybe it’s only once a week; or instead of taking two or three trips a year it’s maybe only one trip, or it’s maybe not the kind of trips you wanted to do. Instead of maybe going to Europe, going to Australia, or a trip that’s going to cost quite a few bucks, maybe it’s getting in the car and driving across country. I’ve seen this over and over again. And there’s always that inclination especially when you see markets gyrate as you see today, that, “oh my goodness, I want to put my money in the bank, or I’m going to put it all in a T-bill,” and you just watch this purchasing power just being eroded away with inflation.
And if you go back to what we were talking about in our first topic the money supply is growing at close to 10% today; we’re inflating; we have our budget deficits are anywhere from 300 to 700 billion a year depending on which figures you’re looking at. If you’re look at an accrual basis, based on our liabilities for Medicare and Social Security we’re running almost 700 to 800 billion dollar a year budget deficits. If you look at our trade deficits it’s 900 billion; if you look at the debt that we’re taking on � I mean how many people realistically expect you’re going to see politicians rise to the front and say, “hi, elect me, and if you do, I’m going to cause pain. I’m going to put the economy in a recession, I’m going to raise taxes to 50, 60, 70 percent; we’re going to cut back your Social Security benefits and Medicare or welfare payments, or whatever it is that we’re spending money. And if you’re not working today we’re going to make you go back to work if you want supplements from the government.” I mean that’s just not going to fly. Have you ever seen a politician like that? [1:12:10]
JOHN: No, but they ultimately do it anyway, they just don’t tell you about it. In other words, it happens by surreptitious means rather than by direct means, where you can directly point the finger at exactly what the problem is.
JIM: Sure. I had Bob Prechter on this week and Bob’s a big deflationist, and he thinks we get deflation first, then hyperinflation. I come from the reverse point of view, I think it’s hyperinflation first because I just do not see under any circumstances a politician that’s going to say, “hey, we’re going to cut your benefits, we’re going to raise taxes, we’re going to do a lot of things that you don’t like, but by the way, vote for me.” I just don’t see that happening. [1:12:52]
JOHN: But the average person though, you’re talking about people putting it in T-bills, I’ve seen people do this � elderly people. Yes, it’s safe and they’re getting x percent a year, the x percent lately hasn’t been very good. And they can’t understand how their purchasing power is eroding, “my gosh, I still have the same numbers in my account, the money’s all there.”
JIM: Sure, yeah, if I put $100,00 in a CD, the $100,00 is still there but the $100,00 doesn’t buy the same goods and services 5 years from now or 10 years from now. And that’s really the inflation problem which is a problem they just don’t factor in when they retire. And that’s why I understand that need for safety, that need for saying, “I can’t go back and earn this again.” And that’s why we like the big, dividend blue chip companies that make products that people have to have, consumer and use � food, water, utilities, electric power, energy, medicines � you know, the basic staples of life that people have to have. And those are the things I think should give somebody comfort.
John, if I told you this company had been around 100 years, and paying dividends consecutively, that it had been through the Great Depression, wars, booms, busts, recessions, and maintained their dividends, and always maintained a strong balance sheet I would think in some way or another that would give you some comfort that, you know, this company’s going to be around. [1:14:21]
JOHN: Well, Jim, as the weeks come by we are going to be discussing this more and more, but for people who are in the baby boom bracket it is really time to start thinking about this whole thing because though that time is approaching. And we may well find someday that Mother Hubbard’s cupboard, despite the promises of government, are bear. And you know what? They’ll still say the benefits are still there, but they’ll renege on them by putting all the means testing in there. And taxing is just a way of recollecting it, you already paid that money as a tax once, remember. That’s what it is it’s a tax, and now you’re going to pay it again.
JIM: Sure. And it’s something that a lot of people never would have thought when they retired they’d end up paying tax on this Social Security, because when they were paying into it during their working years they were saying hey, you’re paying into it, the money you get back is the money that you’ve paid into it. But that’s not the way the system works. So they’ve already been able to change that part of the system and renege on a promise. What’s to stop them from reneging on future promises. [1:15:20]
JOHN: Well, what really surprises me about this that you don’t see more reaction from the public on that. I’m sorry I guess I’m not being realistic and my emotions are coming into it here. I don’t like cheating.
JIM: Well, you know, one of the things I can guarantee you, politicians will always change the laws, and they’ll change the rules which you and I have to live by. And you just need to take that into consideration when you’re doing your planning. Don’t expect the government to stand behind its promises; and rely on your own initiative in terms of taking care of yourself rather than saying, “well, I’ve got it all taken care of, the government’s made me all of these promises, I’ve got nothing to worry about.” I think if that’s the case you’re going to be sadly disappointed. [1:16:07]
JOHN: Yes, you have to take that into account.
Emailsand Q-Calls
And now it’s time to take some questions from our Q-Line. The Q-Line is open for your telephone calls 24 hours a day, it doesn’t have to be during the program - we record them. It is at 800 794-6480. That’s toll-free from the US and Canada. It does work from everywhere else in the world but you do have to pay for it outside of the US and Canada. We ask that you keep your question brief and also just leave your first name, and where you are calling from. We’d like to know where people are listening.
So here we go with the Q-Lines for today.
My name is Heinz, I live in Las Vegas. My question is this. In that oil discovery that they made in the Gulf of Mexico, they said they struck oil at 28,000 feet. Now, to my knowledge oil does not exist at that depth, it becomes gas. So what’s going on?
Heinz, I wouldn’t know what to tell you, that is a strange phenomenon. What you’re talking about is the oil window which is from 7500 feet to 15,000 feet that’s when the heat is just at the right temperature to create oil; and below 15,000 feet you normally get natural gas. But apparently they found some pockets. The geologists have a better explanation of that than I would, it gets quite complicated but it certainly does raise some questions in terms of deep oil discoveries. And most of the reports I’ve seen about peak oil in terms of what’s left out there, most of it is based in deep water, and that’s certainly what they’ve found here, especially when they go down to 28,000 feet. Heinz, I wish I could explain it geologically, if I did I think I would confuse myself. But anyway, it is rather unique. [1:17:56]
Jim, I’d like to ask you a question. My name is Leif, I’m calling from St. Johns, New Brunswick, Canada, and it’s a question about oil and gold. Seeing that oil is trading off or vice versa or gold is trading off oil and every time oil is going down, gold is going down, I’m wondering why I would want to own gold stocks if I could buy oil income trusts that’s paying me 10% while I’m waiting. And if oil takes a pop up which I think it’s going to hopefully any day now, you know, I get paid to wait. So I’d like for you to address that question.
Well, a couple of things, Leif. One of the things when gold takes off it happens so quickly in a two or three day period you can see gold stocks move up 20 and 30%. The gold recoveries can be just as quick as they are on the downside, so that’s one reason. And number two, a lot of times they come out at you just out of the blue when you least expect it, all of a sudden the gold market has turned around, and all of a sudden the sentiment changes very quickly and depending on what you’re buying you can see this 20 to 30% movement in the stocks before you would even get around to recognizing that, “wow this is a new trend maybe I ought to get on board.” And given the nature of these gold movements to happen very quickly you could be getting on rather late.
Now, addressing your oil income trust. I happen to like them and I’m more in favor of you keeping a balanced portfolio in natural resources so you do have if you’re in the energy market which sounds like you are, you’ve got the oil income trusts which are paying you very handsomely while you’re waiting for the price of energy to move. But also I would recommend that you also hold onto your gold stocks, because I know of even the best technicians I know can miss a movement in gold because, you know, technically, the way technicians work it’s not until a trend line is broken on the upside and moves through a certain level before a buy signal is given � and with gold that can happen very quickly, and the stocks can move very steeply. [1:20:05]
This is Scott from Chicago with a new, all time highs bull market “booyah,” Jim. And John Loeffler, a great big Dow 40,000 and here we come “booyah.” My question is, I have 95% of my IRA in Google should I hold or should I buy more. Without your show to make sense of everything I think I’d go crazy. Thanks.
JOHN: Well, I think going crazy is the wrong description.
JIM: Well, Scott, I don’t know about your Google, but if I was looking at what is overvalued versus what is undervalued I suppose I would be more inclined to look at energy, and the natural resource sector here. So maybe if you want to buy something more, or add to it, I’d strongly recommend that you look at natural resources versus Google. Sounds like you’ve got the Google story covered pretty well here
My name is Joseph from Niagara Falls, New York. My question is relating to corrections. We have a correction going on in the precious metals market now, when it comes to an end what events usually occur to cause reversal? Thank you very much and I like your show. Goodbye.
Human psychology. You have technicians who are watching the chart, they’re looking for a break out; maybe the smart money starts to come in and they start looking, “Boy, gold was at 700, now it’s at 570, or 580 at that level it looks cheap to me.” And so smart money starts moving in and starts buying. That starts to reflect in the movement on the charts; technically the chart pattern starts to look through a breakout; and then that triggers technical buying and who knows, there might have been fundamental factors that preceded it but was ignored except for the smart money. And then all of a sudden you get a new movement on the way up and then people climb on board. [1:22:18]
Hi Jim and John, this is Rohan from New York, love your show. I have a question, you always mention energy and precious metals are very good investments for the long term, but off and on you bring up non-traditional investments like large cap growth as another place to be. I guess my question is when you say large cap growth is this a long term investment or is it more like a six month trend that you see money moving into before peak oil becomes more known to the public and so on. I would appreciate an answer, Sir, and love your show, bye, bye.
Regarding the non-traditional investments where we’ve been talking about the large caps, I think that could be an intermediate move that can last 6-12 months, maybe even a little longer because one of the things you have Rohan is money goes somewhere, and you’ve got 8,000 mutual fund managers even more so in the number of hedge funds out there, and money is looking for a safe place to go right now. They’re saying, “Ok, what’s the next big thing. Where do I need to be. Well, we’ve been in small caps for 5 or 6 years small caps are not doing as well in this kind of an economic environment. There’s the possibility of the dollar going down. What’s cheap?” And that’s why at the beginning of the year I’ve said a new record in the Dow, which happened this week; and also I said the next move was going to be in large cap stocks and those are the growth stocks that have virtually done practically nothing in the last 2 or 3 years. And so you’re seeing a sector and money rotation right now. And depending on what is happening with the money supply, especially as we head in to an election next year this could even more as I call, [move] into a long intermediate trend, and those intermediate trends could be with us some time more than 12 months. [1:24:02]
JOHN: Well, as they say in broadcasting and other parts of the industry, that’s a wrap. That’s it for the week, Jim. What are we looking at in the weeks to come here on the Financial Sense Newshour.
JIM: Ok, next week Ike Iossif will join me for Ahead of the Trends, and following that Richard Heinberg will be joining me, he’s written a new book about the peak oil protocol. In other words, how do we work our way through this once peak oil hits. October 28th, Andy Kilpatrick, he’s written a book called Of Permanent Value: The Story of Warren Buffet. November 4th, G. Edward Griffin, The Creature from Jekyll Island. November 11th, Jonathan Knee The Accidental Investment Banker. And once again, on the 11th of November Ike Iossif, Ahead of the Trends.
Also we’re trying to put together a whole show on buying bullion. We’re going to try to get 4 or 5 experts from buying numismatic coins to buying just straight coins, silver rounds etc, investing in bullion overseas. And so we’re going to bring 4 experts I’m going to try to put together, and we’re going to have a bullion roundtable. How to buy bullion personally.
And then of course the week after that, I’ll be going to the San Francisco Gold Show where I’m going to be interviewing and it’s all going to be about juniors this year rather than talk to the guests and the speakers, you know they tend to get the same speakers, and we’ll probably try to get the keynote speaker, but it’s all going to be on juniors. So I hope to interview between 8 and 10 companies, upcoming companies and get their perspective, their stories.
And this is probably going to be the last year I do the San Francisco Gold Show. I think in the future we’re going to do different kinds of shows, more at the professional level. Kind of what I did last week which was up at the Denver Gold Show, because I think you get a lot more insightful information at those shows versus let’s say the retail investor shows. So this will be my last San Francisco Gold Show this year, and it’s going to be strictly devoted to juniors.
Well, in the meantime, we’ve run out of time. On behalf of John Loeffler and myself, we’d like to thank you for joining us here on the Financial Sense Newshour, and until you and I talk again, we hope you have a pleasant weekend.
