Financial Sense Newshour
The BIG Picture Transcription
December 9, 2006
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- The Next Rogue Wave
- Emails and Q-Calls
- The Fed's Catch 22
- Gold Equity Trends
- First the Gain, Then the Pain
- Other Voices: Roger Conrad, Utility Forecaster
- America's Achilles Heel
- More Emails and Q-Calls
The Next Rogue Wave
JOHN: I guess if we had to start putting things in context now that we’re sliding to the depths of Winter here in the Northern Hemisphere, and the year cometh to an end shortly, 2006 has been very good for the markets � a great year in fact: the major indexes � or is that indices, it should be indices, it’s like �hand me a couple of Kleenices,’ do we do that too? anyway � the major indices are up a couple of digits; the Dow has hit a series of new records just as you predicted; bonds, gold, silver are up; the gloom and doom which all of the Cassandras were predicting at the beginning of the year hasn’t happened. Jim, what did you do?
JIM: Ka-ching! Printing presses. Ben, print another 4 billion.
No, plain and simple they are inflating, as the printing presses globally go crazy. The money and credit spigots are flooding financial markets and keeping them liquid. And you see broad money supply is growing at 10% here in the US, you’ve got it growing at close to 9% in Europe, 14% in Britain, 9% in Canada, 11% in Australia � the result is what you’re seeing today, it’s been double digit gains for North American and European Security markets. [1:29]
JOHN: If you did look at some of the geopolitical turmoil in the Middle East, plus we’ve had a sea change in US policy there and that may not be necessarily all good. There’s a widening trade deficit in the US and also expanding debt levels, I would think at least from a market standpoint these would be raising some red flags of concern.
JIM: If you take a look at the markets today, measures of complacency are probably what we’re seeing as the order of the day. You can see this clearly in option adjusted spreads on corporate bonds, and emerging market spreads in the Treasury market, and the stock market volatility index such as the VIX are at all time low levels. It is usually when credit conditions are running rabid as they are today, and complacency is this low that we see the occurrence of the unexpected event. [2:20]
JOHN: Meaning like a nonlinearity or something that just comes out of left field � is that what we’re talking about?
JIM: Yes, this is where we see the tail ends of the curves - the things that nobody expects. Just when everything seems like they’re perfect with not a thing to worry about, out of the blue they appear.
JOHN: You’re right, the markets don’t see this, but I guess if we looked at the positive side: they see falling oil prices, supposedly tame inflation, low and falling interest rates and very strong corporate profits and plenty of money floating around the system right now.
JIM: Well money in the system is what is pumping up the financial markets, but that money is a two-edged sword: the credit system is exploding in the US. And we only have to look at what has happened in this new Century � the last 6 years mortgage debt alone has gone from 4.8 trillion in 2000, to 9.3 trillion as of the end of June of this year. Mortgage debt when you think about it has doubled in 6 years where it took nearly half a century to accumulate that 4.8 trillion that we started out this decade with. We doubled in 6 years what formerly took a half a century.
And it’s not just mortgage debt: total debt will increase by over 30% this year, annualizing at around a 4.4 trillion rate; commercial and industrial loans are up 16 �% the last 3 months � up 14.4% year over year; we’ve got commercial bank credit up nearly 9 �% in the last 12 months. So if you look at 2006 it’s going to go down as another record year in credit expansion. The rest of the world manufactures goods, here in the United States we manufacture the credit to buy those goods. [4:06]
JOHN: There tends to be sort of a euphoria where everybody’s saying, “what could possibly go wrong, it’s all going up and up and up?” But in reality history shows this just can’t go on forever. At some point, the spigot has got to close, and then we’re going to see a reversal.
JIM: It either implodes under its own weight, or its going to be inflated away. What I believe comes next is a period of disinflation � we’re already starting to hear some talk about that. And what’s going to be behind that is the excess inventories that we we’re seeing in real estate where we have now over a 7-month supply in inventory; and also excess supply in manufactured goods which are going to have to be worked off. However, as real estate continues to decline there should be some kind of exogenous type event that occurs that will force the Fed to lower rates. And when that event occurs we will all know what happens when we’re in a crisis. The first thing the Fed does is it slashes interest rates and just floods money into the system as they did after the events of 9/11. In other words, I think the financial markets are going to be hit by some kind of rogue wave that it doesn’t expect at the moment. [5:11]
JOHN: And the more exotic the exogeny the worse off it’s going to be. Any idea where you expect that wave might come from � any indicators now, or are you still in the dark about it?
JIM: I think most definitely it’s probably going to be the credit markets specifically, and it’s going to be a derivatives mishap at least in my opinion. The credit default swap is a prime suspect � there are just too many contracts that we’re seeing being written today. And the latest gimmick, the CPDO, is just begging for something to go wrong. [5:41]
JOHN: I assume when you say �CPDO’ you’re not talking about Star Wars, so you better explain that first, and then we’ll go on from there.
JIM: A CPDO stands for the latest variation that we’re seeing in the derivative market. CPDO stands for constant proportion debt obligation, and basically the way this works is a Wall Street firm will raise money through a bond issuance. The money that is used from the bond is then deposited at a bank, and so what you have is FDIC insurance, so you get the AAA rating which attracts a lot of investors. But here’s where the upkick comes to this kind of investment � now obviously if you were going to put your money in a CD it’s not going to pay as well as let’s say as emerging market debt, or high yield debt. In order to boost the yield, what happens is the bank then turns around and issues credit default swaps and the premiums that they earn from the credit default swaps is paid into this special purpose vehicle, and these premiums � coupled with the interest deposited on cash equivalents � is what goes to pay the higher interest rate. Normally, these kind of CPDO type of derivatives are paying roughly about 2 percentage points � or 200 basis points � above LIBOR rates. And that’s what makes them very attractive because you’re getting higher yields and you’re getting the AAA rating. And the thing about it, however, is they have to write enough credit default swaps that these kind of contracts start out their life with a leverage factor of 15 to 1. [7:20]
JOHN: They’ve being billed as a safe investment, but is that really a fair statement, or is there some heavy risk built into this?
JIM: There is risk. The stated intention is to put on more exposure as the market goes wrong. What happens if you’re writing credit default swaps on a bond like GM, and the bonds decline? What they do is what sometimes aggressive gamblers or investors do, they double up when the market moves against them. It reminds me it’s very eerily familiar with what happened to a similar product prior to the 1987 stock market crash: they were called CPPI which stood for Constant Proportion Portfolio Insurance � and these came into vogue in 1986. They were sort of an equity gimmick � and think about it � they come into vogue a year before the 87 stock market crash. It was portfolio insurance. Credit default swaps are in a similar fashion coming into vogue before what I believe will be a similar type of event in the credit markets. [8:21]
JOHN: And obviously, there’s got to be some kind of a catalyzing event. So what’s the trigger?
JIM: There are numerous candidates if you just look across the financial spectrum. You can start out with major hedge funds � we saw for example one hedge fund loaded up on natural gas contracts that blue up in August. Not a major problem so far. You’ve got private equity firms, you’ve got investment banks which are caught making one way bets, when they go under it triggers a wave of defaults. All you have to do is look at some of these private equity deals which have become another vogues into today’s markets. Look at the deals that are getting done today � they’re doing these deals with maximum leverage in order to reach their return on equity targets.
The other thing is if you even look at some of the Wall Street firms such as Goldman today, which is now leveraged 26 to 1, their leverage has increased almost by 50% in the last 6 years alone. And it’s not just Goldman � if you look at Morgan Stanley they’re following the same path; they just bought sub prime mortgage lender Saxon Capital which in my estimation personally that’s a bad idea when you consider that the more knowledgeable people in the sub prime market are scaling back just as Wall Street is jumping in head first. Morgan is also doing private equity deals which makes them less liquid; they’re also doing bridge loans to speculative grade borrowers normally associated with leverage buyouts. In summary, John, the Street is leveraged to the hilt, and you can’t have that kind of leveraging going on and this kind of complacency without something going wrong. [10:03]
JOHN: Yes, there are too many interacting parts. Let’s go back to some of the history here on the Financial Sense Newshour. When you were doing your Storm Series about the perfect financial storm there was a two part article that you wrote called Rogue Wave, Rogue Trader, and basically the theme was warning of a geopolitical event or a financial event. Let me just quote something right out of the article:
There will come a day unlike any other day, an event unlike any other event, and a crisis unlike any other crisis. It will emerge out of nowhere, at a time no one expects. It will be an event no one anticipates, a crisis that experts didn’t foresee. It will be an exogenous event a rogue wave.
JIM: There were two types of events when I wrote that story and that was going back in 2000. One was financial, that would be the first type of rogue wave, and the other was geopolitical. What we got in 2001 was we got the geopolitical event with 9/11. I believe, at least from what I see out there today, I believe the next one is going to be financial. Even our own Treasury Secretary Hank Paulson, in a recent speech, believes we’re long overdue for one. I think with money and credit expanding at double digit rates, the complacency in the markets today, you’ve got real estate prices falling, the economy is slowing I think we could see the next rogue wave appear as soon as next year. [11:30]
Emails and Q-Calls
JOHN: And you’re listening to the Financial Sense Newshour at www.financialsense.com. You’ll find all of these files and the new program posted every single week Saturday morning by 7AM Greenwich Mean Time which now works out to 2AM on the East Coast of the United States. It’s time to go to some of our Q-Line calls. The Q-Line number is toll-free in the US and Canada, 1-800 794-6480. That does work around the world but it’s only toll-free from the US and Canada. We ask, if you call in, to just give us your first name and where you are calling from, and your question. Remember, keep it brief, if it gets too long we can’t deal with it we’re not that mentally equipped for it.
This is Tim in Houston, Texas. Guys, I really appreciate the show, I’ve listened to you for the last couple of years. I’ve been building my Ark and invested in energy and gold. I’ve sold my hi-tech small business, and gotten a job closer to home in the energy industry infrastructure business an engineering company. My question is, now I’m faced with the old 401K dilemma with very limited choices as to what to invest in, I was wondering if you could give some advice in that area. [13:02]
JIM: Well, Tim, it sounds like you’re doing everything right: you sold your tech, you’re getting involved in oil infrastructure. Now that you have a 401K plan you probably have a large cap blue chip fund. That I think is going to be a good area to be in, because as investors become more frightened as the economy weakens you’re going to see a gravitation towards the larger cap stocks; and also with the dollar coming under pressure international companies such as the large blue chips benefit from the falling dollar since they have sales denominated in foreign currencies overseas. So I’d look at a large cap, I’d probably look at money market funds too because I think the mishaps in the credit markets I expect next year I’d hate to see you be in long term bonds. If you’re in the bond market be in short term Treasury funds would be another piece of advice. [13:54]
Hi, this is Grant calling from Toronto. I just have a question I was listening to your program this weekend and an excellent job on your analysis, and my question is about the CERA report which came out regarding peak oil. I haven’t heard anybody besides Henry Graffee [ph] talk about the cost of getting oil from the ground. My question would have to be which companies are going to benefit the most: the explorers, the E&P or the existing producers, as the cost of extraction starts to creep up and will only be compensated by the higher price of energy whether it is oil (carbon-based) or renewable energy? If you have any comments regarding that, it’d be greatly appreciated.
Well, Grant, I think the E&P companies are going to be the greatest beneficiaries. A lot of them are taking on projects that the majors simply wouldn’t touch because they’re too small, so they tend to be more based on-land, whereas if you take a look at deepwater exploration, only the majors have the capital to do that. If you take a look at the Jack well in the Gulf of Mexico where it’s costing between 80 million from each hole that they drill � only the major companies are going to be able to take on those kind of expenses. So I would look to the E&P companies as being the big beneficiaries. [15:25]
This is Rod from Fort Wayne, Indiana, and I have a question for you. I received my proxy information from my broker-dealer with regards to the Kimber Resources change. I know that as a Director of that company that you do hold many millions of shares � I’m a really small shareholder, but I am a shareholder nevertheless, and receiving my information I didn’t receive the green card with is the proxy voting material. I received all of the material for Kimber from the broker-dealer. And I’m just curious if that is reflective of anybody else, whether there is a procedure to try to track down a proxy so they can vote, or whether or not they just missed mine. But I just thought I would pass that information along to you.
You know Rod, Computer Shares [ph.] who’s handling this had a lot of screw ups with this. What I’d try to do if you can is vote online there should be instructions to do so, and if you have any other problems I would call the company at their Vancouver headquarters: 604 669 2251.
The Fed's Catch 22
JOHN: Well, Jim, as the economic numbers continue to weaken, the real estate market continues to fall, although there’s always those rumblings of the imminent rally and that type of thing. The general level of interest rates is falling and the markets are betting on rate cuts next year, so could we say fair game this is why the markets are rallying?
JIM: Everybody knows that the economy is slowing � just take a look at the monthly economic numbers which have now become a trend - we’re seeing a slowdown. And one of the problems is the US economy is driven by consumer spending, and consumer spending was being driven by the real estate market with mortgage and cash takeouts. Now you have real estate prices tanking, so you’re going to see consumption decline along with it. It’ll be interesting to see how this holiday season plays out. We’re going to the malls tonight and I’m just going to do a cursory sort of survey as I always do around this time, I’ll look at my parking lot indicator talking to the store merchants just to see what they’re telling me. So the longer the Fed keeps rates this high, the greater the chance of a recession. In fact, if you take a look at the Fed’s own recession model it’s now forecasting a greater than 50% probability of a recession within the next 12 months. In fact, if you look at the inverted yield curve, the ISM Purchasing Manager’s Index, retail sales, durable goods orders, and all of the other non-government type reports, the odds of a recession are probably as high as 70%. So unless the Fed starts cutting rates now, or at least in the beginning of the 1st Quarter, odds are we’re in a recession by the end of next year. [18:10]
JOHN: You’re referring to a lot of non-government reports here, but I’m guessing that you believe the government reports are, well, rigged that’s the best way I can put it.
JIM: Yes, it doesn’t matter whether you’re looking at GDP figures, or you’re looking at the inflation numbers or the productivity figures, I don’t pay much attention to those because as you said, John, a lot of these numbers tend to be politically manipulated � especially as we were coming closer to the November elections. So I tend to look at industry reports like the ISM Purchasing Manager’s Index which is telling us a lot about what’s going on in the manufacturing sector; I look at retail sales, durable goods orders. These are the kinds of things I like to see that give me a better clue to what’s really going on in the economy. [18:54]
JOHN: The Fed itself I’m sure internally deals in real world issues, and if they can see this coming it would seem to only stand to reason that they would begin cutting rates right now. Like I said, they’re certainly reading the reports, they know the economy is beginning to tank so are they going to do something or what?
JIM: The problem the Fed is facing is a Catch-22 problem. They’re going to have a major problem cutting rates this time. This situation is so different from where the Fed was positioned in 2001: the trade deficit wasn’t as large as it is today � I think this year it’ll come in around 6.6% of GDP, it’s going to be close to $900 billion; unlike 2001 there wasn’t as much debt as we have today � as I mentioned that figure earlier with real estate, we had $4.8 trillion in mortgage debt as we started this decade, today it’s over 9 trillion, so it’s almost doubled in this 5 or 6 year period. Also, if you’re looking at commodity prices we’re dealing with $63 oil instead of 18 and $20 oil; we’re dealing with gold prices that are in the neighborhood of 625 versus 250. So they don’t have as much flexibility.
And the other thing is the economy is softening, as we’re seeing in the economic reports; we’ve got profit margins in trouble. However, because of these huge trade imbalances the Fed can’t ease aggressively without provoking a dollar crisis because you now have major central banks such as Japan, China, the Asian central banks in general are diversifying their reserve holdings. And right now, with our trade deficit approaching almost 7% of GDP, the US needs to borrow nearly $2 � billion a day just to pay our trade deficit bills. So in effect, the Fed has its hands tied because our debt position is so precarious. So I suspect it’s one reason why Paulson and Bernanke are going to China � we need foreign central banks to keep buying our paper or we’re going to be in one hell of a currency storm. [21:05]
JOHN: I’m reaching for Maalox already. This doesn’t really sound too good because what are the incentives for them to keep having to do that? We’re already hearing rumblings about the euro replacing the US currency.
JIM: The thing you have to understand is all currencies are inflating. The European money supply is inflating at a rate close to ours, so all currencies are depreciating against each other and against real money which is gold. The main thing going for Europe is exports, so the problem is if the US economy gets hammered � the dollar gets hammered � that would mean real problems for Europe. In fact, they’re even talking about some kind of currency fence that they would erect in case there’s a flight out of the dollar into the euro driving the euro up. You also have a situation in China with the 2008 Olympics and then there’s another major world trade exhibit going on in China in 2009, so they’re not anxious to see their economy collapse. And they’re not quite self-sustaining at this point where they can rely strictly on internal trade within Asia itself. They’re gradually moving in that direction but they’re not quite there yet. So it’s not in anybody’s best interest to see the dollar collapse at this point because there aren’t other structures in place to replace it. I mean if the dollar collapsed, then global trade would collapse at this point. So I still think we’re 2 or 3 years away, maybe by the year 2010 before we have structures put in place to sort of mitigate this. Right now, it’s in nobody’s best interest to do this. So that’s why I suspect Paulson and Bernanke are going to China: they’re going to enlist China’s support, because of the number of dollars flowing from Asia in terms of their trade surpluses, to convince them to sort of coordinate with other central banks in Europe and perhaps OPEC to hold the dollar up. [23:00]
JOHN: That still doesn’t ward off the possibility of a currency storm, even if the dollar might be threatened some time in the future.
JIM: No, but see here’s the problem: in order for the Fed to ease they need the economy to soften, they need inflation to fall, and they need foreign central banks to support the dollar we have to have all those things happening. Because our trade deficit is so massive, they’re really going to need widespread coordination or intervention if the dollar begins to plummet if they lower rates. Right now, they desperately need a dollar rally. In other words, the dollar was approaching 82, and the critical support level of around 80. Had it breached the 80 level then we would be in serious trouble. So they need the dollar at a much higher level before they begin to ease. They can’t cut rates now with the index close to a key support area. So I suspect they’re going to try to hammer gold, get the dollar up and get a deflation scare going which gives them the cover to ease that’s the reason for the China trip. Something’s up here. [24:07]
JOHN: So it looks like this is a totally timed ballet everything has to happen perfectly with the right timing in order to make this all happen. And boy, if you’ve ever been in any kind of a production you know what the possibility of things going off the rails are.
JIM: Sure, you’re absolutely right. If the economy strengthens then bonds are in trouble; if inflation surprises on the upside then bonds are in trouble again. The best outcome would be for the bond market, which is priced for perfection, would be a wave of credit defaults which leads to a plunge in monetary velocity and that creates the scenario for massive easing and rate cuts. [24:43]
JOHN: And what we always do here on the show is look out for the little guy, and so what should investors do given this scenario because obviously they have to protect their interests despite what’s going on in the geopolitical and financial areas?
JIM: I tell you, this scenario I’m talking about is extremely bullish for gold, so I would be loading up on gold right now, and especially the gold shares which are extremely undervalued in relation to the price of the bullion, and of course that’s going to be the topic of our next segment.
JOHN: And time to go back to the Q-Line once again.
Hi Jim, this is Steve in Winterhaven Florida. I enjoyed your latest discussion with Bob Prechter. Because of the uncertainty surrounding the inflation-deflation debate I suspect many of your listeners have adopted a schizophrenic approach to investments: cash for deflation and precious metals for inflation. That said, I don’t understand how the 1929-1933 experience can be used as a template for how an impending Kondratiev Winter might unfold. The current economic conditions in the United States are dramatically different, particularly in regards to the stability of the currency. It made sense to be in cash in 1930 given the strength of the dollar, how can this be a prudent strategy under current conditions? If the economy moves into a true depression, and consumer spending dries up, why would this not trigger a currency collapse as China, Japan, South Korea, Russia and Arab oil nations race to get out of the dollar? It would seem, under these conditions, it would not require a nominal increase in the money supply to create a hyperinflationary environment. The worldwide reduction in demand for dollars would create an effective hyperinflation: too many already existing dollars in the face of collapsing demand. Has Bob addressed how the fragility of currency affects his recommendation to be in cash? Thank you very much. [26:57]
JIM: Boy, Steve, you get an A+ of monetary understanding. You hit a lot of the keys. The US today, as you mentioned, is a different country, we no longer back our currency by gold, so there are no restraints. And more importantly, if you look at the conditions of the United States today, in 1932 and 33 the United States was self-sufficient in manufacturing today, we import most of our manufacturing goods; in 1932 we were self-sufficient in capital � today we have to borrow $2 billion from foreigners; and in 1932 United States was self-sufficient in energy, today we are importing 60% of our raw energy needs in the form of natural gas and oil, and another 10% of our energy needs in terms of refined products such as gasoline, jet fuel and diesel. You’re absolutely correct: the outcome this time around is going to be hyperinflation. You hit it. [27:57]
Hi Jim and John, this is John from Minneapolis, great show lately, much appreciated many thanks there. I had a question on the dollar � if the dollar were to come under fire I could see 3 reasons, first of all foreign countries not wanting to hold depreciating dollar denominated assets; second, the Middle East wanting to bring our economy down; and third, hedge funds or an international group that wanted to profit from a vulnerable dollar. And I wanted to ask about that third question. If somebody wanted to attack the dollar, like Soros et al, as they did against the pound, could you lay that out in the short term on how that would or could happen and what the US Treasury and/or Wall Street would or could do to defend it? And who do you think would ultimately be victorious in the short term? There are so many different operations possible in the US financial markets I just wonder if it’s even possible like it used to be. But I’d like to hear your take on it.
John, I think the third option with a hedge fund like Soros’ attacking the dollar you’d get killed. I think these guys have learned their lesson, especially during the Clinton Administration with Robert Rubin at the Treasury; I think you’ve got another Wall Street guy, Paulson, at the helm � look what they did to commodities by rejiggering the commodity indexes in August. So I don’t think the dangers going to come from there, and I think the central banks united together would overwhelm the hedge funds, because they know what their credit balances are and they know what their short positions are, so they’re in an ideal situation to cause a mishap for those guys. I think some kind of exogenous type event happening here in the United States such as a loss of confidence as we’re experiencing today in Iraq � this kind of gradual erosion or some kind of exogenous event which causes a dollar sell-off, I think that’s more likely the way that we’re going to go. [29:43]
This is Jeff calling from Greenville, South Carolina. I had a question for Jim and John. I’m interested in how Jim feels the new currency could come into effect with the Amero he’s talked about on a couple of other previous shows. How does the government just switch from a dollar to an Amero, and what does he see are the implications for stock holders and overseas bondholders, and just how does the government in general make a currency change?
They’re really not being done through the normal means like Senate approval or some kind of treaty � they’re being done with agreements, and that’s the way they would do it. They would put it together much in the same way as they started with agreements putting the euro together. And there would be some kind of crisis or some kind of momentum, you would see a 3 to 6 month period where the media would continue to brainwash � you know how the media does today, they’ll take a story and just beat it and beat it over and over, much as they do with Iraq today. So they would take the concept and they would make some kind of case for it with the American public. There might be a crisis here in the United States economically or with our currency, and this would be the way that they justify it. But we’re going to go to 3 large currency blocks � that’s where we’re going to go in the next 3 to 4 years. You’re going to see the Amigo as I call it � not the Amero � here between Canada, the United States and Mexico as a major trading block; you’ve already got the euro; and then also you’re going to see something in Asia develop probably around the Chinese currency. [31:20]
JOHN: It’s interesting you should mention that because there are a couple of articles in Australian newspapers now, there are negotiations on for the merger of Australia and New Zealand, and New Zealand will become Australia’s seventh state � and the creation of a new common currency. At least they’re a little more open about it over there, but it’s actually underway and the articles came out this week and last week. It’s an identical process no matter where you are.
When the currency does roll over, I’m assuming typically you have like a grace period for exchange � remember how they did that in Germany after the fall of the Berlin Wall when you had East German Marks, and you had a certain period of time when you could bring them to the bank, and there’s a fixed exchange rate or something like that. Is that usually how it’s done?
JIM: That’s the way it’s done. [32:06]
Gold Equity Trends
JOHN: One trend that we’ve seen throughout all of 2006 is that as the price of bullion has moved up, the gold shares did not advance as rapidly as in past gold price movements. And usually shares move about 3 times the price of bullion because of the leverage effect on gold producer earnings.
Jim, why do you think that is happening?
JIM: You know there are probably a couple of reasons. I think number one has been the widespread belief within the investor community that the higher prices we’ve seen this year when gold crossed over $700 weren’t sustainable. I remember when gold was approaching it was going from 500 to 600, and they said, you know, 600 is the cap. It just blew right through 600 and kept on climbing up to 700. So whenever you see a parabolic rise, as we did from the beginning of the year until we got close to 750 � somewhere in that range � I think there was a lot of disbelief. So people were thinking this can’t last, it won’t stay up there. And so that’s why I think you didn’t see the equities respond to that.
Also I think in the professional community there’s a reason: there’s ongoing concerns regarding cost inflation in the mining industry. We’ve often talked here about the cost inflation that’s occurring in the energy industry � that same cost inflation is taking place in the mining industry. In fact, recently we saw Newmont and Barrick warn that their cash costs will increase by over 20% next year. So even though we’ve seen gold prices have risen, operating costs have risen as fast. So what we’re seeing here is operating margins really haven’t improved that much for the seniors despite the rise in the price of gold. [34:11]
JOHN: I smell opportunity here. Do you think I’m right?
JIM: Absolutely. You know, we’ve talked about this in the show and especially at the end of the first quarter and the second quarter, when I first began to observe this trend take place. Because normally, when you see gold prices rise the gold stocks start selling for large premiums. You can see this almost as an indicator for example, taking a look at the premiums on the Central Fund of Canada which is an indicator I look at. But here, what we have is average premiums for seniors and intermediates right now are only about 2% above their net asset value versus let’s say a 20% average premium that we’ve seen over the last 2 or 3 years. And even more importantly, where the real opportunity is if you take a look at the junior producers they’re selling right now at between a 30 and 40% discounts; and we’re also looking at for example, we’ve found 2 producers that are trading at 40% discounts to their net asset value � both companies are going to double � and in one case, triple � their production; and because of byproducts, these companies have a negative cash cost for production. So you’ve got a lot of opportunities here that the market is ignoring because I believe there is a lot of disbelief right now that hey, this can’t last. I saw one very well done fundamental report that is talking about $400 gold in the year 2008. So the disbelief exists, and I think that’s one of the reasons I think you haven’t seen the premiums on the gold equity shares as much as the price of bullion. [35:59]
JOHN: What if we factor in mergers? We’ve seen a number of them this year but in reality they’ve been largely at the larger company level.
JIM: Yes, that’s been one of the surprising things we’ve seen. A lot of these acquisitions have occurred at what I call the mid-cap level � you saw earlier this year Glamis bought Western Silver, and then Goldcorp bought Glamis; we’ve seen recently IAMGold buy Cambior; Yamana bought Vice Roy; Gamma Lake merged with Mexgold. However, you’re seeing the majors start to take significant stakes in late stage juniors. And what comes to mind right now is Newmont which has significant stakes in Miramar, Gabriel and Southwestern; you also have Rio Tinto is doing a joint venture with Ivanhoe. So I expect this trend to continue and probably next in the food chain would be intermediate producers taking over late stage development juniors and early stage producers, because really that’s where most of the growth stories are going to be in this bull market. The growth stories in this bull market aren’t with the Newmonts, the Barricks, the Anglo-Golds and the Harmonys � you know, take a look at the news coming from these companies and it’s no wonder that their stocks have done very poorly. [37:16]
JOHN: Why is it that the majors aren’t really involved in exploration?
JIM: You know I think there’s a number of trends. Number one, if you take a look it’s far easier today and more economic in this kind of environment, especially with let’s say late stage development juniors, and junior producers selling at a discount to their net asset value, why would go out and spend a whole bunch of money and take the risk of exploration when you can go out and buy a late stage developer who’s already done a lot of the work for you, or an early stage or let’s say lower tier producer where you can buy at a discount? Also I think if you look at it from the development side over the last decade we’ve seen permitting times have nearly doubled � so it’s taking nearly 10 years from discovery to production to bring a mine to the point where you’re producing actual ore and ounces and turning them into a finished product.
On top of that, take a look at the geopolitical risk which you and I have been talking about lately. I don’t care if you’re looking at Latin America, you’re looking at the Middle East, you’re looking at Africa, you’re looking in Russia, Mongolia � there’s just all kinds of geopolitical risk.
And on top of that, you have rampant capital and operating costs. [38:32]
JOHN: So you still like juniors, right?
JIM: I believe the trend in consolidation that we’ve seen this year, the year before, I think that trend is going to continue, and the primary drivers I think are going to be valuation differentials and growth prospects � which means, at least to me, that junior and emerging producers are likely to be the next takeover targets. That’s the only way you’re ever going to see a mid-tier company grow to become a major producer. And several of the mid-tier companies are what we call single mine focused, and we all know the dangers of having a single mine focus � I mean if you take a look at what happened to Agnico-Eagle a couple of years ago with their Laronde mine, and now you take a look at where Agnico-Eagle is going: developing multiple mines, they’re taking a look at different countries. And so you have a lot of the mid-tier companies that are going that route. And that means acquisitions. [39:29]
Other Voices: Roger Conrad, Utility Forecaster
JIM: It’s no secret that the political landscape in Washington has changed with the most recent elections. How is that going to impact investing in energy? Joining me on the program to discuss this issue is Roger Conrad, he’s Editor of Utility and Income.
Roger, the political landscape has changed, are we going green?
ROGER CONRAD: I think there’s going to be a few things happening and it might be difficult probably incrementally over the next couple of years, but I think over the certainly the next 3 to 4 we’re going to see a number of changes on several of those particular issues � particularly regarding energy, how it’s generated and some of the measures taken to control some of the various emissions. So I think that’s not necessarily all bad for the various industries, but it is something that investors particularly need to take a hard look at. [40:25]
JIM: We’ve made some serious changes here in California, we’re concerned about global warming � we’ve almost adopted the Kyoto Protocol. Is this the direction you think we’re heading?
ROGER: I think the plan that the Governor has laid out and enacted with the Legislature in California is very likely to be adapted. It’s basically what you call a cap and trade model, which has been successfully employed in several other areas. For example, in 1990 there was the Clean Air Act passed by the first Bush Administration and the Democratic Congress there, so it’s kind of similar political dynamics. But what they decided to do was basically allow the companies that we emitting the components that caused acid rain such as sulfur dioxide and nitrogen oxide, they allowed them to buy credits from companies that did various things to reduce those emissions. So rather than force a lot of companies that were simply unable to make those changes right away, they enabled the companies to have a little flexibility; and they rewarded other companies that were more able to make changes more quickly to benefit from those.
So I think what we see going forward here is very likely. And again, maybe not in the next 2 years, but maybe a couple more years down the road from there � there will be some sort of legislation on the cap and trade side, that again rewards companies that do things to reduce emissions of carbon dioxide; and give companies that do emit a lot of carbon dioxide the ability to make changes where they emit less � with the net effect of total emissions being reduced. That is what happened with acid rain. And in fact there were a lot of doomsday predictions about the industry before that was enacted, but they were able to make their adjustments and now it’s not really � with one or two exceptions in the industry � a significant burden on operations. [42:19]
JIM: What do you think is going to happen then with alternative energies? Will you see more utilities like FPL in Florida go more towards wind turbines, solar power, alternative energies that come in here that are cleaner?
ROGER: FPL has been very aggressive in terms of promoting wind power and then selling it to utilities � building plants known as utilities; AES corporation has done the same thing; and there are a couple of other companies that are also up on that track. But there are others too that I think that should benefit: one being nuclear energy which doesn’t emit carbon dioxide emissions. It also has the advantage over wind power in that it’s possible to generate huge amounts of electricity from a single plant. One of the things a lot of people don’t understand about wind power is that it’s fairly modular, and even with the advances we’ve seen with technology � it is very cost efficient I think, and certainly a lot more cost efficient than the last generation of wind power, but � it is not possible to really produce it on the kind of scale that you can with nuclear energy.
So I think nuclear companies have already been advantaged over natural gas and fossil fuel companies because their variable costs are low, and also because the ownership of the plants has consolidated under a few very good operators over the last 5 or 10 years. But I think with global warming and some of the problems presented there � at least if we do go to a cap and trade system it will become more expensive to produce from fossil fuel plants, and I think nuclear again gains an advantage there. So it’s not just wind, it’s not just solar I think it’s a lot of different things � nuclear is one of them. You have the utilities out now in California, for example, Edison International have been very big proponents of things like electric vehicles. So if you’re looking for an area where utilities could really do well going forward it would be in that area where power demand goes up � maybe they’re generating it from different types of sources � but people are driving vehicles that maybe don’t burn that many fossil fuels as well. So there are a lot of different avenues out there for companies to profit if they take a look ahead � and I think many of them are. [44:32]
JIM: Do you think we’ll move more aggressively on the nuclear front? Last week I interviewed the President of a uranium company that’s coming to the second year of the permitting process and he was telling me how basically [it will take] another 4 years before they get permits to mine uranium � so basically 6 years. He also said that had this been elsewhere, say in Australia or some other place, that process would only take 2 years. So while the rest of the world it appears to me � whether you’re looking at China, Japan or Europe � have moved very aggressively with nuclear power, we have a lot of delays here.
ROGER: That’s absolutely right, and I think you have to differentiate here between the existing generation, and the generation that might be built down the road which certainly a lot of companies are trying to build or looking to build. But as you mentioned, there are tremendous delays in construction as well as even just getting uranium. Now, there’s a very strong case to be made that companies could fuel their plants simply from their spent fuel, but under a Carter Administration directive that was passed in the wake of Three Mile Island when everybody was talking about closing down all of the nuclear plants around the country � under that directive they’re not allowed to do that. So there are a number of things that could happen that could really speed up our exposure to nuclear power to make new plants a lot more quick to come on line and cut the risk out of them quite a bit.
But I think that the opportunity right now in nuclear power is primarily in the existing plants and those that own them and then the kind of margins that they’re going to be generating. And if you look at companies like Excelon, Entergy, even SPL has a few of these and a handful of other companies, the margins are just absolutely tremendous on these things. They’re running them very well because they have the expertise, and unlike in the past where you had say maybe 4 utilities owning a stake in one nuclear plant or maybe one utility owning one plant or one or two, now you have companies that own a dozen of these things. And so they’re able to apply lessons that they learned in one plant all across the fleet. And this is of course the same kind of economics that the French nuclear industry has enjoyed for so many years and it has made it so efficient. So that part of the equation I think is much more sure � the part involving new plants and so forth I think you have to look in the Southeastern part of the United States where the regulatory situation has been considerably more stable over the years than it has been in other parts of the country. In other words, the regulators and utilities tend to work together much more effectively and that’s one reason why power costs are so much lower in that part of the country. But that’s pretty much where I think you’re going to see the new stuff being built. Other parts of the country I think you know you may never see it built. I think there’s a tremendous NIMBY factor which of course is �not in my backyard’ regarding nuclear power plants. We’ve all heard the horror stories and so forth, so there’s a tremendous resistance to nuclear power. And of course some people are worried the waste problem and so forth, but all these are surmountable but I think the psychological hurdles may be too high in some places. So that’s why I’m really looking at the companies that are producing right now from nuclear power. [47:48]
JIM: Roger, you cover the utility spectrum and I want to move on to another area in the utility sector and that’s water utilities. One of the things these stocks have done well over the years, but if you take a look at price earnings multiples on many of these companies whether you’re looking at Aqua America at 36 times earnings, California Water at 32 so would you be staying away from these companies at these prices?
ROGER: I think quite a few of those companies I’ve certainly turned off of on over recent history just for what you’re saying. I think one thing is that what you’re willing to pay for a dollar of earnings, or what the market is willing to pay for a dollar of earnings depends on what exactly a company is doing. In the case of Aqua I think you can make a pretty good case for sticking with it and buying it when it does make dips � and that is because basically it’s a very steady plan of expansion, they’re acquiring systems around the country. There are still something like 40,000 systems that are under 5,000 people or less that they’re simply incapable of meeting Clean Water Act requirements; Aqua has been able to absorb these systems into their grid and turn those into earnings. And there are a tremendous number of new opportunities out there for them to continue doing that. So it’s a very, very reliable model for generating earnings growth of close to 10% - so that’s sort of a different story.
If you look at some of these and in particular in fact some of the ones in California they seem to be trading at very high valuations and they don’t really have the same kind of business dynamics Aqua has. Aqua is in about 13 different States now, for example California Water Systems or American Water Service they’re more in 2 or 3 States but operating in tougher climates; Aqua for example operates in markets where it owns its own water � in fact, they won’t go anywhere where they don’t own their own water. California utilities have to buy their water, so while you have a very, very strong regulatory environment right now under the Schwarzenegger Administration that could change, and we’ve seen it change several times over the last 20 years. So those are the ones I think I would urge people to be a little bit careful of. Aqua America and maybe Southwest Water is a little bit different story because it combines water system management with regulated utilities. But you know, I think there are some good opportunities in some of those stocks but for many of those I do think you want to be a little bit cautious. [50:17]
JIM: As you look at the utility sector today, the utility index this year is up 13%, not maybe as good as the Dow but certainly a respectable return with double digits, and especially with the dividends. If you were looking at that landscape today where would you be putting money?
ROGER: I think very collectively I think there’s a group of companies that I like that I consider to be large, dominant companies and they own a lot of nuclear capacity and so forth � companies again like FPL and Dominion Resources; Duke energy, which is spinning out its natural gas infrastructure or operations; companies like that which are very, very strong I think are going to do well in many environments. Outside of them I think there’s a time to be very selective and really keep a close eye on what I call buy targets. It’s kind of hard to believe just looking at things right now where the utility average has made new highs several times this month already and think back to where things were 4 years ago when certainly no one wanted to own this industry � and it’s kind of a very good market lesson I think in how things can turn around and why you basically want to try to buy low and sell high. But there are some things in the letter that we’re looking at � again, those dominant companies, I think there are some what I call come-back companies that are still in fairly reasonable valuations although many of those have picked up as well. I think the rural telephone companies are still a pretty good bargain position; and then there’s some of the limited partnerships that are also generating some pretty good income as well. So, again, I think you really have to pick your spot at this point because things have really gone to the moon for many of these companies, and I’m pretty positive there will be a correction � you know December has traditionally been a really strong month for utilities and January and February have been very weak ones, so if nothing else I think we can probably expect something like that to happen. But right now, stick with good companies and pick your spots � there are a few bargains out there. [52:18]
JIM: Well, Roger as we close, why don’t you give out your website, you are Editor of 2 or 3 newsletters The Utility Forecaster, Canadian Edge, and Utility and Income.
ROGER: The one I like to give out to people and urge them if they do access the internet is Utility and Income, and it’s a weekly that I do and it covers the water front of income investments and from there, if you’re interested in what I write, you can take a look at some of the paid products that I do. You can subscribe to it absolutely for free, it’s www.utilityandincome.com, and that’s a complimentary site you can take a look at. If someone is interested in getting a copy of Utility Forecaster � the hard copy � our number is 800 832 2330, we’re open 9-5 Eastern Time, so you’ll have to I guess call before 2 o’clock your time, but we’ll be happy to send you a copy. And again, you can go any time to www.utilityandincome.com, and click on and you’ll get an email every week that will give you my current thinking on an issue and again if you’re interested in one of our paid products there’s information there on how to go about getting it. [53:34]
JIM: As always, it’s a pleasure to have you on the program, a happy holidays to you, and I hope you’ll come back and talk to us next year.
ROGER: Thanks, Jim, I’ll be happy to.
America's Achilles Heel
JOHN: If I had to assess where Congress is running right now with everything going on geopolitically, I would say everybody is running in the wrong direction � if we should be encouraging oil exploration they’re running in the opposite direction. Although there is some move now to allow offshore drilling and things like that. The area where everybody is looking right now is global warming � in other words, that seems to be the hype or focus � rather than what I call the looming energy crisis which is almost upon us. If they would solve that problem we would solve a number of problems. First of all, the intensity of the Middle East conflict wouldn’t be quite the same for the United States anyway because of the reduction in dependence on oil; and also global warming would start to resolve itself because we bought some alternatives on line that probably didn’t produce as much CO2, and other related hot house gases � assuming you buy into that particular theorem which a lot of scientists still do not. But something as important as the Council on Foreign Relations report number 58 National Security Implications of Dependence on Oil, this was a committee that was chaired by John Deutsch and James Schlesinger, and they talk about a number of myths about oil, and if there’s one thing floating right now it’s myths about how alternatives are going to come on line tomorrow and solve our problems etc.
JIM: Yes, it’s actually about a 70 page report, and we’ll try to have a link up on our site so our listeners can read that, John, but you know it was rather interesting because they dealt with a lot of myths that the media and our politicians keep feeding the public. And myth number one is that the United States can be energy independent. And their answer is no because liquid fuels are essential to the nation’s transportation system, and that’s where we use the bulk of all the oil that we import. Barring as the Council feels draconian measures, the United States will depend on imported oil for a significant fraction of its transportation fuel needs for at least several decades. And the problem that we have here is the United States with about 5% of the world’s population consumes 25% of the world’s oil. Unlike other countries and the last oil crisis in the 70s, you saw France and other European nations implement taxes on gasoline, they encouraged fuel economy � you see more smaller diesel-powered cars in Europe than you do here in the US, they built up the rail system, France went nuclear where today they 75% of their coming from nuclear power plants, never had an accident; and if you take a look at other countries whether it’s China building nuclear power plants, Japan; or China scouring the globe trying to secure oil contracts. And by the way, we’re going to a geopolitical pricing mechanism that’s really going to harm the United States � this is going back prior to the pre-OPEC days, and I’ll talk about that in a minute.
But what they’re talking about here is, look, this country, our transportation system � our trains, our planes, our automobiles, all of that runs on oil, like it or not. And if we were to start today, it would take at least a good 10 years before we could get fuel economy into the economy. In other words, we could see a complete change and turnover in the type of automobiles that people own today � that takes time, you just don’t snap your fingers and everybody goes out and buys a diesel car, or they buy a hybrid car. But you know it’s amazing that we keep telling people, “oh, it’s just those greedy oil companies and prices are coming back down,” which is really another way of telling Americans, “hey, keep on buying those big SUVs, and don’t conserve.” [58:06]
JOHN: So basically what we’re saying is what we’ve been saying for a long time here, we’re approaching a bottleneck: no matter how you cut it, whatever you believe about the status of oil and peak oil there is a bottleneck right now, and that is not easily going away. And that is what has to be dealt with.
JIM: Yes, because basically you have had rising consumption � as we have pointed out in our earlier programs that we’ve done in the last month � you have not seen demand destruction, so you’ve got rising consumption here in the United States, declining production and an increase in net imports. And that in a nutshell, makes the United States very, very vulnerable. [58:47]
JOHN: They talk about a number of myths here, so let’s look at what these myths are.
JIM: One of the second myths they talk about is if we could just cut oil imports that will lower fuel prices. There answer: absolutely not. Policies aimed at cutting imports also reduce demand for fuel then prices in the market would decline. However, policies that mandate reduction of imports while demand stays high will force some consumers to turn to high priced substitutes to meet their needs. So you can’t just say, “look, we’re going to stop importing oil” � what do you do with demand? [59:26]
JOHN: Yes, and one of the other problems here would seem to be now does the increasing demand but we have no way overnight of increasing our production capacity � that takes a lot of infrastructure construction and it’s simply not there, so that’s going to require time to do it.
JIM: Absolutely, I mean we haven’t built a refinery in 30 years, they’re still trying to build one in Arizona and a refinery today would take 7-10 years. So any of the solutions that could ease this problem, you’re looking at decades away. In fact, when I was talking to Matt Simmons � he thinks I’m being a little bit more dramatic here � I think the United States is committing energy suicide. [1:00:04]
JOHN: Let’s talk about myth number 3. This one of course was really frumped in the popular media during the last run up in oil prices � that large oil companies like Exxon-Mobil, BP-Amoco, or Shell control the oil price � they actually rig the price.
JIM: That is the favorite whipping boy. Any time that we see the consequences of our lack of policy here, you’ll see the Bill O’Reilly’s, you’ll see politicians holding press conferences and start attacking the oil companies. We should treat our Western oil companies as a national treasure instead of which we’re browbeating them. And according to the Council of Foreign Relations, no, resources and production are not controlled by Exxon-Mobil, by large international oil companies, they’re controlled by national oil companies � we had Valeria Marcel here on the program interviewing her on her book The Oil Titans � and that’s where 85% of the world’s oil reserves are: with national oil companies. Let’s look at this logically, somebody that owns 85% of the oil, or somebody that owns 15% of the oil � who do you think is going to control the price? [1:01:16]
JOHN: umm � I’ll have to think about this for a while.
JIM: Go back to basic math, 1 plus 1 equals 2.
JOHN: Ok. I get it, I get it.
JIM: But you know, if you take a look at that the presence of national oil companies is important because many of these companies do not respond to market forces as would a private company or a competitive firm. In some circumstances this could benefit consumers, but you take a look at a lot of these national oil companies � in Venezuela, Africa � where the main source of revenue to the state is oil revenue, and so they need these oil revenues for example to pay for social programs, the running of government. And the thought of “wait a minute, the price is up, let’s respond to that, let’s take these oil revenues, throw it back in to exploration and to increased production” [is different] from the point of view of a national oil company [where] the fact that oil prices go higher is fine with them, that means they preserve a limited resource, and they’re getting a higher price and they can use the revenues to take care of their population and keep themselves in power. And this is something, that the O’Reillys of the world really are doing a disservice by always saying, “if we could just get those greedy oil companies to lower prices we would be able to take care of this issue.”
If you look at the world’s oil reserves by country: Saudi Arabia, reserves of 264 billion, that’s a little bit questionable; Canada, reserves of 178 billion, of course that’s mainly the tar sands; Iran, 132 billion; Iraq, 155; Kuwait, 101; United Arab Emirates, 98; Venezuela, 78; Russia, 60; Libya, 39; Nigeria, 35 � the United States, only 21. Now, we know we have more than that, we just don’t have access to it. We know for example there’s probably anywhere from 20 to 30 billion barrels of oil that lie off the Pacific off the Western part of the United States; we know there’s more oil around Florida in the Gulf, but we don’t have access to it. But the point the Council is making here is Western oil companies which only control about 15% of the world’s oil reserves no longer control the price of oil � it’s really national oil companies. And our politicians and our media pundits have not come to grips with that so they enforce this myth anytime the price spikes up, because we don’t have spare capacity as we did 20 years ago. [1:03:58]
JOHN: And remember then what that does is because that reinforces the myth for the guy on the street who says this is what’s going on, they put pressure on Congress then we hear the �lets penalize the oil companies,’ yada, yada. Remember what we said at the beginning of the segment we’re running in the wrong direction.
JIM: When you really think about it � let’s slap a windfall profits tax on Exxon Ok, what’s that going to do for energy? Is that going to make the cost cheaper for you as the politicians promise? No it just lines the pockets of politicians who use it for all the wrong purposes. [1:04:31]
JOHN: Ok, myth number 4. There’s plenty of low cost oil out there just waiting to be tapped from the pipes as soon as we can get them out.
JIM: That might have been true if you take a look at the beginning of the development of the oil age which began around 1850. So if you take a look at the last 150 years, there was a lot of low cost oil out there. In fact, during the Great Depression the government put in place the Texas Railroad Commission to regulate the price of oil because we had so much of it, but that was mainly because of Saudi Arabia and Texas. However, what we’ve seen over the long run is progressively higher cost sources of oil need to be tapped � if you take a look where you’re getting it right now, alternative or heavy oil, tar sands, we know it’ll cost almost $30 a barrel to develop that oil just to break even so you need higher prices there. If you take a look at where Western oil companies are getting it � deepwater; just take a look at the Jack discovery by Chevron and Devon, the test wells they’re drilling are costing $80-100 million just to drill the holes. So the cost of oil is going up, and I don’t care if you go to alternatives such as tar sands or shale, there isn’t a lot of cheap oil out there that is in large quantities and that is easy to gain access to � here’s another myth that permeates the business. [1:05:58]
JOHN: And there’s another factor that has to be brought in here, and that is, remember we said that the quantity of oil that the US consumes per capita compared to the rest of the world while we were one of the first countries to develop using oil, but now we have competitors out there: Japan, China, India, the European Union � and a lot of the suppliers don’t like us. So in other words we’re not the only [kid] on the block anymore. They can turn around and say, “well, we’re not going to sell to you.”
JIM: Yes, and the other problem here is this not only puts us into a very vulnerable position but we aren’t taking the steps that we should be taking now to take care of that and encourage through tax incentives for people to get more fuel efficient cars which is a great way to have a market mechanism come into play. And when oil prices rise or spike as they do, instead of bashing the oil companies, rising prices is the market’s way of saying that prices are high which encourages people to make conservation efforts or take moves that would mitigate that. Part of it might be for example getting a more fuel efficient car, when the lease comes due. The other things that we should be doing is for example building up our light rail system, taking a look at mass transportation � I mean here in California we literally have about 11% of the country’s population, it’s all located along the coastline, and we keep bringing in millions and millions of people each decade into this state, and we are now just getting to widening one of our main freeways inland here, when instead, to relieve freeway congestion we should be putting in some kind of light rail system, as for example they’re considering in Phoenix. So, of all the States that propose be green, California is really doing nothing. [1:07:51]
JOHN: There’s a psychological change here that has to happen � you’re talking about California, the land of freeways. And there everybody’s used to jumping in the car. The only place I can think of where light rail is running anywhere well is BART for that matter in the San Francisco Bay Area � just because of the topography of the area and the nature of what’s laid out. Southern California I see as having a really hard time of getting people to use that. This would be an elaborate system, Jim.
JIM: And you know, John, that stuff takes time and then you have to deal with the whackos even if they were to clear land for a light rail system to put in, who knows, they might discover an endangered ant or some kind of bird that could hold it up in courts for the next 10 years.
JOHN: It seems like we’re the only ones who aren’t getting this. It’s like a lot of the policies running the wrong way. We’re almost in a la-la land in a lot of different areas, but one of them is this whole thing: Europe, Asia they’re going nuclear in a heavy way. And by the way, it’s not polluting in terms of greenhouse gases. As far as that goes, it’s a clean fuel. But we’re still diddling around here as if these were the 70s instead of the first part of the next Century.
JIM: The problem that you have with this � you’ve seen some of these problems already � there was a news story I was watching the other night on the treadmill and there was a snow storm that knocked out power in the Midwest, and the politicians were yelling and screaming at the utility like they were responsible for the snow storm. These kind of things � back-up power systems, lines, things like that � all of this is infrastructure; and as Matt Simmons talked about here on the program is that we’ve allowed our energy infrastructure to go into decay. And so all of this nonsense talk that you hear coming from politicians, coming from Wall Street, coming from the Bill O’Reilly’s of the world � “Gosh, if we could just beat up on Exxon we’ll get lower oil prices.” These are all myths. And for the crazy people out there talking about $40 oil � forget it, we’re more likely to see $80 oil than we will any time soon $40 oil. And that’s why next year I see energy prices hitting $80 oil, if not beyond. Already, one of the foremost hurricane forecasters in the world � Dr. Gray out of Colorado � was forecasting the 2007 Atlantic hurricane season should be above average activity. He’s predicting 14 major storms next year, including 3 major hurricanes and 4 other hurricanes. The point that we have here is we do not have any spare capacity � that has nearly dwindled so any time we have either a weather related problem, terrorist related problem, and you know, all of a sudden the price of oil is spiking, or the price of natural gas is spiking.
We’re going to put up this report and link this weekend. We’re probably not going to do it till Saturday. But read the Council of Foreign Relations report 58, it’s about 70 pages and it’ll just tell you about all the myths. A lot of it will document things we have talked about here on the program, or the things that I’ve written about in the last 5 years, but do yourself a favor and read it because it does tell you how precarious and how vulnerable the United States is to energy. [1:11:17]
More Emails and Q-Calls
JOHN: And time to go back to the Q-Line for a few more questions.
Hi Jim, this is Joe calling from New Jersey. I caught your San Francisco show about gold and silver this weekend and it was really great. My question is I know that a lot of your guests were concerned about the dollar falling especially this week, it hit a new low. About investing your assets overseas rather than in the United States. I’ve been hearing a lot of other pundits saying the same thing in the industry, and my question Jim to you is do you really want to invest all of your assets from the United States overseas in foreign exchange funds or currencies? And I’d like your take on that Jim. If so, please let me know why.
I definitely think you want to have some assets overseas that just makes good financial sense pardon the pun here. But especially with the depreciating dollar and hyperinflation coming to the United States, that’s part of it that’s just a safety mechanism just in case government puts in currency controls, because when a currency hyperinflates that’s what governments do in response to it: they’ll put in currency controls (whether you looked at Argentina, you looked at Russia, or Germany) � all of these kind of things go into effect today when a currency comes under attack. So that’s one reason why you want to have some of your money overseas or you do it indirectly by having your money overseas but yet inside the country. And one way you can do that is through direct ownership of foreign bonds where you have or own something that’s denominated in a foreign currency but yet you hold it inside of let’s say a brokerage account here. There are ways which you can own gold too through a security and have that gold held outside the United States. I think even on top of that, but just not being specific on that one aspect alone, you also need to be making the transition from paper assets to tangible assets because if you take a look at the markets going back to 2001 that’s exactly where we’ve been going over the last 5 or 6 years. Yes, you’ve made money in stocks, and yes the Dow is at a new record in nominal terms but the real money has been made in tangible assets, raw materials, foreign currencies, gold, silver, oil, base metals, commodities in general. And that’s the general direction I think you need to go. [1:13:52]
Hi Jim and John, this is Denny from Canaan, New York. And Jim, I would like to get your perspective on just how important the Federal Reserve is, because I hear both sides of the issue: one is that they created all this liquidity and created all these bubbles and that’s having a huge effect; and then there’s other people who’ve been on your show who’ve said � it seems to be just as validly � that with the financial system the way it is and so many big financial players calling the shots in the world, that the Fed doesn’t really have a lot of power any more. And so I would like to know, how you look at the Fed, how important are they and sort of how you reconcile these two points of view which is one that they’ve created a huge problem, and two aren’t really that important any more. So if you could address that I would appreciate it, because we all seem to be Fed watchers, and I would like to know if I’m just wasting my time.
The Fed has less monetary control than it used to and that is something that has just involved in the financial markets � they can no longer control markets as much in the same way that they did say 40 or 50 years ago because of globalization, the interconnectedness of markets today, the huge amount of debt, and also the weakened financial condition of the United States where basically we’re now a debtor nation instead of a creditor nation. They’re important in the sense that they can either make things worse, or take us in the direction of hyperinflation which is where they’re leading us. Just take a look at the value of the dollar since the Fed’s creation, we’ve lost over 90% of our purchasing power � so much for the idea that the Fed is an inflation fighter. But the Fed tends to be more reactive today than proactive and the best example I can give you is this last rate raising cycle where they did it incrementally over a 2 � year period in these � point little baby steps, because they knew with the amount of credit and debt in this country that if the raised rates abruptly as they did in 94 the whole system would come crashing down. So at this point the only thing that the Fed can create and the only thing that they’re capable of creating is protecting the banking system and creating inflation � except at this point things have gotten so bad that they’re going to be responsible for hyperinflation. [1:16:32]
Hi, this is Chris calling from New Zealand. I have a question about what happens when banks start selling the US dollar. Who’s doing the buying? And what are they actually paying with?
Well, they could be doing it with credit, they can borrow at will. They can do that by creating deposits out of thin air from let’s say checking deposits or maneuvering checking deposits into overnight accounts where they can actually loan out that money. When they sell, somebody else is buying � it could be a foreign institution, it could be a major corporate institution an endowment fund, a corporate pension plan, corporations themselves, or in fact hedge funds, financial intermediaries, or in the case of the Fed itself there are a lot of people that are speculating that the Fed has set up a special purpose vehicle in which it is now monetizing debt which is not showing up on its balance sheet. [1:17:28]
Hi Jim this is Steven from Phoenix, Arizona. I just wanted to know if you could elaborate a little bit on a brokerage house like Fidelity, not going under, but maybe having a tougher time during the downfall of the dollar, and if there was a possibility that someone that had their shares being held by Fidelity having trouble getting those out, or maybe losing those shares, during that downturn.
Boy, I would think just the opposite, Steven. Unlike major Wall Street firms that are leveraged to the hilt, if you look at Goldman they’re leveraged about 26 to 1 � just take a look at the balance sheet of your major firms whether it’s Morgan or Merrill. Fidelity makes most of its money from online brokerage accounts and managing mutual funds; and they have very little debt, it’s privately held. I think if there was going to be a major problem in the dollar you can do international stuff with Fidelity; they’re going to have international currency for money market funds � those kind of things available. So I would say your risk with Fidelity is far less than with other major institutions which are far more leveraged that would be in greater danger from a dollar downfall and its impact on inflation and interest rates. [1:18:42]
This is Sam, calling from the Mississippi Gulf Coast. Last week during your interview with Marc Faber you indicated that his newsletter was in your top 5 list of newsletters. I was wondering if you could share that top 5 list with the listeners. Thanks, love the show.
Sam, probably at the top of my list are professional newsletters that I get from Bank Credit Analyst � they’re for institutions and those are some of my favorites. They have international markets, equity markets, emerging markets; Kurt Richenbacher letters � the Richenbacher letter is another one. So 3 of my favorites are from Bank Credit Analysts, Richenbacher and Marc Faber � that’s what makes up my top 5. [1:19:25]
This is Michael calling from Taiwan. I have a question regarding natural gas. Recently, because of warmer weather, warmer Winter, I think natural gas has been going down in price. What are your views for natural gas, long term and medium term in price because of this warmer Winter effect? It would be great if you could give me your views on this, and I really enjoy your show.
You know Michael, short term trends, we go with these inventory reports whether we get a Winter storm or not, but if you look at the decline rates of natural gas production in North America and the United States, in Canada, it is in decline. And a lot of the so called natural gas reserves in the world are in areas that are stranded and have yet to be proven that they actually exist. And so just as we’ve been talking about peak oil here, we’re also going to be talking about peak natural gas. But unlike oil, before natural gas peaks we’re going to start running into problems because for example a large consumer like the United States or Canada we’re going to have to start importing this stuff. And unlike oil, where you can put it on a tanker, you can’t do that with natural gas; you have to have a special kind of tanker, you have to liquefy it first, and then you have to put it on a ship and then it has to arrive and dock at a special facility. And we don’t want to build them here in the United States except for a very few areas like Louisiana. We vetoed every proposal here in California, we’re vetoing proposals on the East coast, and so once again the prospects for natural gas intermediate and long term boy, I’d be buying natural gas stocks left and right. [1:21:10]
JOHN: Jim, it’s going to be an interesting couple of programs over the next few weeks. We’ve come into the holiday season here in the United States, so what are we going to do on the program?
JIM: Well, next week is our final interview of the year. I’m going to be interviewing Ken Fisher, he’s written a new book that will probably be available right around the week before Christmas, and so he will be my guest. We’re going to talk about his book, The Only 3 Questions That Count.
And then, John, you and I are going to do something special the last 2 weeks of the year. Next week will be our last week with our guest experts, and then just to give you a heads up, the show is going to be changing some of its format next year � we’re working on that. But for the last two weeks of the year we’re going to do a look back over the past year of the experts, some of the key themes, we’ll have some outtakes from some of the guests that we’ve interviewed here on the program, and we’re going to try to weave that in for the last two weeks of the year as we put this past year into perspective and give you sort of a heads up for the year ahead. [1:22:12]
JOHN: So on behalf of�
JIM: Thank you, John.
JOHN: We’re waiting for Jim’s medication to kick in, so while we’re doing that
JIM: Thanks for the reminder.
JOHN: 50 mg take it with plenty of water.
JIM: Well, listen everyone, on behalf of John Loeffler and myself, we’d like to thank you for joining us here on the Financial sense Newshour. Until you and I talk again, we hope you have a pleasant weekend.
