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Financial Sense Newshour

The BIG Picture Transcription

June 9, 2007

Part 1

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Part 2

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Part 1

Tipping Points: Recession or Recovery

JOHN: Yes, indeed and this week, Jim, I get the feeling we’re going to need this and I come armed – Prozac. What’s this? Stomach acid blocker. This is double Ritalin with caffeine – that should get me going there. I get the feeling we’re going to need it this week on the program.

JIM: And a gallon of Maalox.

JOHN: Wait a minute. There it is – a gallon of Maalox. Okay. And if I need anything else I have my doctor on notice, and I’ll just call him up and he faxes over the prescription and somebody runs out during the program.

JIM: What about oxygen?

JOHN: Oxygen? I never thought about that. I guess I could call over to the airport and get an O2 tank from one of the airplanes.

Well, you know what, we started out the year, don’t you remember all the glowing warmth, fuzzy warm stuff, we were going to have great growth and everything. The first quarter here, we’re not doing too well: it’s been slow growth. But now they’re trying to tell us, “don’t worry real estate has bottomed out, stock market is going to take off. The sky’s the limit again. Here we go!” And we keep hearing this. And by the way, this is an on going promise that seems to fizzle each time. We have some differing opinions on this whole thing so let us start out with our first segment here and we’re calling it Tipping Points.

JIM: Well, first of all John, let’s talk about some of the positives. As we examine the economy last week, a lot of our listeners will remember we took a look at a couple of the things that caused economic growth rates to drop in the first quarter. One was a rising trade deficit; second was a less than strong build in inventories; and about the only thing that was positive in the first quarter was consumer spending. So I said watch those three things going forward. So let’s talk about now what I think is going to be sort of a dead cat bounce here for the economy as we get into the second quarter. Let’s start with the positives. First of all, they reported the trade deficit for the month of April, and it dropped to 58 ½ billion; and if you look at some of the details: exports were up 0.2%; and imports dropped 1.9%. So that helps GDP because the lower the amounts of imports – imports into this country subtract from economic growth; the fewer imports we have the less we subtract from economic growth – so that’s a positive. Another report that we got this week in the month of April is inventories grew by 0.3%, so that adds to GDP. So you have inventories that are building, which means that will help on the economic growth side, you’ve got the trade deficit – at least for the first month of the quarter was lower. I think in the month of March it was 63 billion and we dropped to 58 billion – so that’s a positive.

And if we take a look at the consumer – on the retail side April retail sales were down close to 2%, but May retail sales were up 2.5%. So at least on the retail end, that is somewhat neutral. So I think a real key figures to watch going forward here is the June retail numbers because next to Christmas, June is the second strongest month out of the year for retailers so we’re going to have to watch that rather closely. So the bottom line of all of this is I do think we’ll see a bit of a pick up in second quarter growth and that will be a positive.

But let me give you the flipside negative of that. And that is the stronger the economy grows – and they’ll spin this to god knows where, but if the economy picks up that pushes out a rate cut by the Fed, and the market has been counting on this rate cut, so then this pick up in economic growth turns out to be a negative. [4:04]

JOHN: But as we do this bounce that you were talking about and move up, we’re also looking at a rise in interest rates, and this is obviously more of that the Fed being between a rock and hard place that we always keep talking about here on the show.

JIM: Sure, since hitting a low at the end of April where we had 10 year Treasury notes at 4.6%, we have now risen to 5.1%. It may not sound like much, but if you take a half a percent in interest rates and you add that on the long end, that means that those people who are in adjustable-rate mortgages, are trying to get out of the trap of rising interest rates and roll over to fixed rate mortgages. We saw a lot of that in the first part of the year. Those people are going to be trapped. They are not going to be able to get out of that. And then also, longer term interest rates rising as they are now, that spells trouble for the housing market. So just when the housing market is thought to have bottomed, you now have rising long term interest rates so that’s going to be another slug to the belly of the housing market – and coming at a very bad time. So rising interest rates, the market for interest rates is going to worsen. We think we could take out the previous high that we set last June when we got to 5 ¼%; and if we take out that 5 ¼ level and get to, let’s say, 5 ½%, you’re talking about almost a full percentage point rise in interest rates. And John, you take a look at the price of housing today, a one percent increase in mortgage rates becomes very significant, especially if long term rates start heading back to 7%. [5:43]

JOHN: So if we’re already heading down with the housing market, I’d say the housing market bounce is not going to occur right away. It’s going to deepen as we go.

JIM: Sure.

JOHN: By the way, there was a major thing that happened this week. The gentleman who’s considered the king of the bond market, Bill Gross, has gone bearish on the bond market, which means this bond bull market is over.

JIM: Yeah, a lot of people said that some of the sell off that we saw in Thursday’s almost 200 point drop in the Dow was attributed to Gross because PIMCO has changed their views on the bond market. And basically, according to Gross, the bond bull market is over. And he’s predicting that 10 year yields are going to rise to 6 ½% over the next five years, so that means you’d probably be looking at long term fixed-rate mortgages going up closer to 8% – so that’s not going to be good.

The other thing that he also said that’s going to be driving this is rising inflation levels. No kidding. You know, they always exclude it when we talk about the CPI: “Well, if you look at the core rate we’re actually experiencing low levels of inflation.” But people have to drive their cars and eat food and enough of that is starting to catch up with everybody’s budget. So what we have right now is rising long term yields, and that’s going to deal another heavy body blow to the real estate market; it’s going to hurt the refi-market. A friend of mine who’s a home equity officer said they’ve gone from almost 300 refis a day; now they’re around the 75 level – so he’s seeing it in his market. And also it’s going to hit a lot of people who’ve had adjustable rate mortgages whether they were on a 3 year time period where they’re going to be reset. So refis and resets are going to get hit hard. So contrary to what the happy talk on the cable stations from the Fed are telling you that real estate has bottomed. No way. [7:39]

JOHN: It’s sort of a plateau on the way down. Also before we got on the air we were talking about the Comptroller of the Currency coming out with new regulations. I’m assuming it’s going to be a slam into the bond market.

JIM: It could be a slam into the bond market. It’s going to be a slam to the lenders. And what you had is a couple of years ago the Comptroller of the Currency began to look at a lot of these crazy lending practices that banks and lending institutions were starting to adopt, whether it was the subprime market, no-interest loans, no-money down loans, loan-to-equity of 125% (basically no value in a home), you had no-doc loans. So they initiated some legislation and the banks began to tighten and we saw a bit of that hit the subprime market as we did in February. Now they’re talking about another area that they’re going after next, and this is going to hit the Alt-A market, and what they’re talking about is no documentation loans. And what they’re talking about here is people who come in and there is no documentation of employment verification. Most of the good type of lending practices that banks used to practice 10 to 20 years ago was they wanted to see substantiation of your income. They wanted to see tax returns: “Hey, you say you’re making 120 grand a year, and you sing in the church choir. Well, let’s see 3 years of tax returns to prove it.” Well, n,o they’ve got no documentation loans. You heard Peter Schiff when he was talking about one of his clients in his office talking to the mortgage brokers saying she made 75 grand. And then when she got in to a private interview with Peter she said, “no, I make only 30 grand.” So that is what the Comptroller of the Currency is going after. And when they adopt that, that is going to have a rather serious effect on the mortgage markets. [9:32]

JOHN: Jim, define the Alt-A markets for people so they understand it. And how big is this market?

JIM: The Alt-A market is probably in between the subprime market and the prime market. And this market is huge – accounting for almost half of the loans we had last year. And no-doc or low documentation in the Alt-A market represents almost 81% of Alt-A market.

So you now have, in my opinion, two additional body blows that are going to hit the real estate market in the second half of the year. The first body blow is going to be rising interest rates. The second body blow is going to be the banks toughening up on no-doc loans – they’re not going to allow that anymore. So I think this is going to have a serious impact. And rather than bottoming as the Fed and a lot of Wall Street economists are predicting, I think it’s going to be just the opposite. It’s going to worsen in the second half of the year. And remember, a lot of the strong economic numbers that everybody is talking about: “yeah, we realized economic growth was slow in the first quarter, and maybe it will pick up a little bit in the second quarter, but it really starts to pick up in the third and fourth quarter because then real estate will no longer be subtracting from economic growth, it will stabilize and everything else is going to kick in.” I don’t see it that way. I think real estate is going to get worse. Bill Gross sees it happening in the same way, although he was wrong about that last year. Who knows, we could be wrong about this, but I doubt it. I think that in the second half, rising long term interest rates and tightening credit standards on lending practices is going to hit the real estate market even further. And you’re seeing that already with resale inventories rising to over 8 months. So while home builders are tightening – building permits and housing starts are down – and they’re working off their inventories; and I think we’re down to six, six and a half months – on the other hand, the resale market has been rising as more people begin putting their homes for sale as more foreclosures bring more inventory into the market. And remember, those resale homes coming into the market are going to compete with new home sales. [11:46]

JOHN: Well, now, you said on previous programs you didn’t expect us to slam into the ground on this one, it wasn’t going to be the end of real estate as the world’s known it before. So, how far down is the bottom, do you think?

JIM: I don’t think we’re going to bottom in the real estate market till the end of this year or maybe the first part of next year, because I do think by the time we’re done this year the Fed’s going to be in a panic-mode. Remember, this is the gang that can’t shoot straight. Their forecasts 95% of the time you can make a lot of money by betting against the Fed because they’re usually wrong 95% of the time on their growth forecasts. And the same thing with inflation, they’ll always throw, “well, gee, the hurricanes. And it was because of the hurricanes are off.” They’ll always find something to offload it on, but believe me, they’re going to be wrong. [12:31]

JOHN: So, if I’m to sum up what we’re discussing here, Jim, so people understand it. The prediction that we’re seeing right now, that you’re hearing through the bubblies, is the real estate market has bottomed out so things are going to start turning up, and we’re going to start in the second half basically seeing some kind of recovery. But in reality, the housing market has hit a plateau and instead it is going to downturn again. And it is going to get much, much worse due to the factors we have been talking about. It’s worse than people are expecting from bubble talk. And basically what this is going to do is clobber the economy as we get into the second half of the year.

JIM: Absolutely. I think by the time we get to the third and fourth quarter you’re going to see a Fed that’s going to start to go into the panic mode. [13:11]

JOHN: Well, obviously, I should ask the question: are there any other factors that are going to pull us up or down in this general trend that we’re going to see?

JIM: One thing that we have noticed historically, and this has pretty much held true. Another factor is the current shape of the yield curve. When the yield curve goes into inversion – meaning that short term rates are higher than long term rates – we’ve been there for about 9 months – if you look at the yield curve now, it’s gone from inversion to a steepening yield curve. And historically when that happens, that’s when the real trouble begins for the actual economy and the financial markets. Obviously, rising long term interest rates are not good for stocks. It raises the discounting mechanism that people use to value stocks. From an economic point of view it costs more to borrow for corporations that are doing M&A deals or expanding. It’s more expensive to borrow. It’s more expensive to borrow for homeowners. And if you look at all past yield curve inversions, once the market led to a steepening it led to recessions. The only time – the exceptions to this rule were in 1966 and in 1994. In 1994, interest rates rose but we did not have an inversion. So if you look back at the last 50 years, yield curve inversions have always preceded a recession. So it’s not that the inversion is the huge issue. It is when we go from inversion to a positive slope as we now have, it becomes the recognition point of a possible recession.

Now, I want people to keep this in mind because we do expect second quarter GDP to be higher than first quarter GDP. And the bubbleonians are going to go bonkers with that number, John – we’ll probably see a huge stock market rally the day that they report it and then you’ll see a sell-off because along with economic growth or pick up in economic growth you’re going to see rising inflation rates, and so the market will begin to say, “uh-oh, economy picking up, inflation still with us, the Fed is going to raise interest rates.” So it’s not going to be positive.

In fact, a good friend of mine, Brian Pretti, in one of his more recent pieces talked about this inversion problem. And he said the average yield curve inversion lasts about 9.7 months if you look back over the last half century. We’re currently about 9 months into this one before it began to steepen. So the inversion curve going positive – meaning long term interest rates are now above short term interest rates – is not a prescription for happiness as the bubbleonians – you know, all the happy talk you’re hearing on Wall Street. And especially in an economy today that is leveraged as much as the US economy is, and is leveraged as our financial markets are. I mean, there is a heck of a lot more debt if you look at the debt graphs today than there was in, let’s say, the last recession going back to 2001. [16:22]

JOHN: Let’s look at something also that Bill Gross talked about. You know, we’ve been hearing about all these predictions about inflation being brought under control but we’ve had 17 rate hikes over the past couple of years. And the long term rates are tracking with it . 17 – think about that.

JIM: Yeah. We’re now starting to see long term interest rates rise. And unlike past cycles inflation is not receding – although inflation is a lagging indicator, it’s been accelerating. If you take a look at the CPI and dissect it – and I know that guys on Wall Street and the guys in the Federal Reserve like to exclude food and energy, it’s like we don’t eat or drive a car or turn the lights on, but 12 months inflation for food: 3.7%; 6 month inflation rate for food: 4.2%; 3 month inflation rate for food: 5.9%. And so here we have food inflation accelerating and it’s going to get worse, by the way, with all these ethanol mandates that we’re putting into play.

If we take the area of energy – 12 month inflation rate in energy: 2.9% - and these are numbers out of the CPI by the way; 6 month inflation rate for energy: 24%; and 3 month inflation rate for energy: almost 38%. If we look at transportation: 12 month inflation rate less than 1%; 6 month inflation rate: 8.4%; 3 month inflation rate: 16.3%. If you look at housing, housing inflation has been running between 3.4 for the last 12 months, and at a 3.9% over the last 6 months and 3 months. If we look at medical costs, 12 months up 4.9%; 5.6%; and 5.2%.

So they can talk all they want about the core rate, but on Main Street people have to live with energy and food inflation, medical inflation, and all the stuff they massage and statistically remove from these inflation rates. [18:20]

JOHN: We stopped raising interest rates last summer, but if we look at the other central banks around the world they’re still doing it. Now what influence does that have on what’s happening here?

JIM: Well, I go back to the old saying that we always have on the program: central banks will raise interest rates until something breaks. And you’re right, we stopped raising interest rates, although now, long term interest rates are playing catch up in the US. But you have other central banks raising rates globally. The UK just raised interest rates; the ECB just raised interest rates; we’ve got New Zealand raising interest rates; also you’ve got Canada and Japan now talking about raising interest rates. So that’s not good because we have a highly leveraged market today where you have a lot of high speculation that’s going on with the carry trade where people are borrowing money in one currency, especially Japan, and they are investing in every other kind of asset. It could be bonds in the US, it could be bonds in Europe; although the play right now in the yen carry trade seems to be the stock market and also Europe right now. But as central banks start raising interest rates, they’re going to raise that until something happens and when it does it’s going to be fast and furious because of leverage and derivatives. [19:39]

JOHN: So they raise it until something breaks in their own country, or elsewhere.

JIM: Who knows where it can start. It can start in Asia, for example, like the sharp sell-off that we saw in the Shanghai index this week (although it’s done a pretty good job of recovering) But you know one thing, just to give you an idea how leveraged we are, the Bank of International Settlements just released their second half report on global derivatives for 2006; and John, total banking derivative growth is explosive, if not on a tear. I think it’s up like 38%. Let’s put it this way, the growth in derivatives last year is equal to the total amount of derivatives in the banking system in 2001. So just the incremental growth in one year alone is equal to total derivatives 5 years ago. That’s how explosive this is. I think they reported the global derivative figure today is somewhere around 420 trillion, and who’s behind that? Our banks are behind that – the big banks. So in my opinion, a derivative growth rate of that magnitude is like the banks are sitting on top of a pile of C4, or nitroglycerine. [20:55]

JOHN: And they’re banging on the drums.

JIM: And at the same time they’re raising interest rates and it’s like there’s a pile of gasoline and hey, you, light a match and see if you can light this thing.

JOHN: Yeah, and see what happens.

JIM: Yeah.

JOHN: It would seem that the cheerleaders of what’s going on right now are either the Fed governors or the Fed Chairman Ben Bernanke because every time they are giving speeches and talks hither and yon or before Congress, it’s all a lot of happy talk about economic growth picking up in the second half of the year. But that’s not looking that way right now.

JIM: Well, John, you know, they have to talk positive while they’re creating all this fall out and damage as a result of their policies. I mean if you take a look at the Fed’s forecast of economic growth, 95% of the time these guys are wrong. Why anybody pays a lot of attention to them or gives them any credibility when it comes to their economic growth forecast. I mean they’re wrong. And historically, if you take a look at the last half a century, every time that year over year GDP growth gets below 2%, the Fed has invariably cut interest rates, and we usually end up in a recession. So depending on what the economic growth rate is going to be in the second quarter, I suspect we’re going to be back closer to the 2% range – somewhere around there – but we’re going to have to have explosive economic growth rates in the third and fourth quarter to get to this growth rate that they are talking about of 2 ½ to 3%. You’ve got some people on Wall Street talking about 4% economic growth rates in the second half of the year and I think they are crazy – so I just don’t see that happening.

JOHN: If you remember, we were getting this same happy talk in 2000. and we knew that we had flattened out in 1999 – that happened before the end of that year. And the happy talk went all the way through 2000, recession hit in 2001, but that was offloaded to 9/11 – that was the scapegoat that was pulled in for that one.

JIM: I really think that the forecasts, which are based on the housing market bottoming here in the first quarter, second quarter – I think the housing recession is far from over. It’s going to get worse thanks to that double body blow that we were talking about coming from rising long term interest rates, and the government moving against low documentation loans, which means that’s going to curtail credit. So the fall out is going to start spreading. And we’re going to start seeing it in other parts of the economy – most notably in the consumer sector. And we’re already seeing visible signs of that just about everywhere. So we will get a second quarter rebound, they’re going to go with that, they’re going to blow it way out of proportion. But then I think there will be some astute people that realize, “well, gee, if economic growth is picking up that means the Fed’s not going to cut interest rates.” So I don’t think the positive economic growth number is going to be all that positive for the market. And any rebound that we’re going to get in the second quarter will be brief and temporary because I think in Q3 and Q4 – we began to go down to lower economic growth rates – and we could be well below one percent by the time we get to the fourth quarter. [24:10]

JOHN: Well, Jim, here we go. The economy is going to go where? Let’s do a summary for now for people, trying to put all of this together into a resultant factor here.

JIM: Well, as we pointed out, we’ve got a number of tipping points that are hitting the market. I do expect a pick up in the second quarter because some of the things that we focused on that brought us a lower economic growth rate in the first quarter – trade deficit, inventory build – will be much lower. Some of those are reversing – the April trade number was better – that helps us; the inventories started to build in April – that helps us; retail sales are neutral right now – it’s very critical to watch what happens in the month of June because that’s the second most important month out of the year in the retail sector.

However, on the negatives: we’ve got long term interest rates rising; we also have the Comptroller of the Currency cracking down on bank lending, on no documentation loans; we have a steepening yield curve; we have central banks around the globe that are tightening interest rates. So all of this is going to have an impact. We have also an exploding derivatives market which is concomitant to an exploding credit market. So in summary, the longer the Fed waits to cut interest rates, the lower GDP growth is ultimately going to prove out to be this year – if we don’t get down close to recessionary levels or a recession itself. [25:39]

JOHN: And I’m wondering how this is going to play out. We’re 514 days out from a presidential election. It would seem this thing is going to hit about half way through that 500 day period. So there’s a political impact here.

JIM: Oh, I would say by the time we get into 2008, we’re still going to be involved in Iraq and the last thing that any administration wants is an economy that’s dipping into a recession, or a faltering bear market in stocks – that’s disastrous. So I would say that probably by the time we get to 2008, everybody in Congress and the Fed is going to be buying chain saws and cutting down every tree that they can find, because paper printing is just going to go parabolic. [26:24]

JOHN: I’m trying to visualize this.

JIM: We’ve got a picture of Ben Bernanke with a chain saw. Put him in Big Sur. He’s not going for a regular tree, I mean he’s going to cut down redwoods.

JOHN: Plus you can see all the environmental groups out there – “get out of the way, I’m going to cut her down.” “No, no.” Brrrrrrrrrrrrr – as they try to keep this one afloat. Oh well, we’ll have to see where this one spools out. But it’s going to be a wild ride. You know, it’s moving into that crisis window, isn’t it, that we’ve talked about, 2009, 2012 with a run up in 2008. It seems to be “cohesing.”

You know we should probably also look at, remember you’ve had the triple predictions: first of all the real estate market going to bad, spilling over to the financial markets; slow economic growth and some kind of financial crisis usually triggered by a catalyst.

JIM: Well, I think the financial crisis is coming. We’ve got a slowing economy – although there’ll be a dead cat bounce here in the second quarter because of some extraneous factors. But they’ll be one time events – pretty much like we saw in the third quarter, fourth quarter of last year with warm weather and a couple of other things. But I still say the financial crisis is coming and I think we got a bit of a whiff of it this week, and just how quickly and what it might look like when it does arrive.

Other Voices: Monty Guild, CEO & Chief Investment Officer, Guild Investment Management

JIM: Well, over the last several years there has been a plethora of stories about central banks diversifying their foreign currency reserves. And up until recently, that has been thought into other currencies. But just in the last couple of weeks, we have China investing $3 billion in a buy-out firm, Blackstone Group. How does this change the dynamics of the market? Well, joining me on the program is Monty Guild, he’s CEO and Chief Investment Officer of Guild Investment Management.

Monty, we’ve heard over the last couple of years, central banks are diversifying their reserves, the dollar is becoming less important or at least not dominating the foreign currency world as it once did. But now you’ve got a lot of central banks talking about these sovereign funds. That’s a whole new dynamic to the market.

MONTY GUILD: It sure is, Jim. We’re seeing this as a very important influence to impact global markets that can grow, and to cause problems to global markets that have to do financing because they are running deficits over the next decades. [29:23]

JIM: And what happens when you start having, let’s say, governments start getting into equities? Doesn’t that create a problem in some sense? For example, I can remember in the 90s there was talk about Social Security making investments in the stock market, but I’m not sure if the government owns the majority stock of a company, I’m not sure what the implications of that might be.

MONTY: Well, you’re very astute of course and experienced and you realize that politicians make terrible business managers. But Singapore has been doing this for some time, mainly on a hands off basis, as just a simple investor – a non-controlling investor; Taiwan has also done it; Korea and some other countries. In fact, today, sovereign wealth funds is mainly made up of about 16 countries: several from the Persian Gulf; plus Norway, Singapore and others. So you’ve got some very legitimate, high quality countries that make investments both in companies within their own country and companies outside of their country. In fact, China is doing a great deal of that and has been in Africa for a very long time having government countries make investments in the African economies. [30:33]

JIM: I don’t know about you Monty, but when it comes to our government and congressman I don’t know if I’d have the same degree of confidence.

I want to move on to another topic. Peak oil is something that we touch upon here quite a bit. And we’ve got the situation for the United States, if you take a lot at some of the companies that we get, I think our top 5 importing countries are Canada, Mexico, Venezuela. And if you take a look at some of the things that are going on with Venezuela I’m not so optimistic that this is a good source of future oil for the United States.

MONTY: Well, it is not, and in fact, they own not just a lot of oil but a lot of refineries within the United States. Most of the heavy oil refineries in the Southern and Central part of the United States are CITGO refineries owned by the country of Venezuela. This is a further problem but because their crude is heavy crude and has to be refined in very specialized refineries that can deal with heavy crude. The Venezuelans are in the process of shooting themselves in the foot and destroying their economic base which they will do over a progressive period of time. And I think what Mr. Chavez is doing was the same thing done by many quasi-demagogues and dictators in Latin America over the last century. We have a few examples of it in the past. But he seems to be getting more and more controlling as time passes; and he’s trying to manipulate and create the Bolivarian revolution as he calls it in other countries as well. He’s putting his lackeys in as presidents of other countries nearby. [32:04]

JIM: You have a situation where I think the Venezuelan currency lost about 50% last year. Inflation in his country is running over 20%. And infrastructure all over the country is breaking down.

MONTY: They are subsidizing basic commodities for the public too.

JIM: Sure. And then a lot of his money is going overseas to foreign ventures to try to control the political process.

The one damaging thing that he did is in order to consolidate power in the country he fired the workers of the state run oil company and brought in his own people. And the direct result of that I believe oil production has dropped off I think in the neighborhood of 30 to 40% a year. So that’s not good, not only for the United States, but the world at large which has a voracious appetite for energy.

MONTY: Your one hundred percent right. In fact, when you travel to Canada or you travel around the United States you often meet Venezuelan engineers and geologists when you’re out visiting oil companies in this Continent who ran away from Venezuela or were fired at the national oil company. Now they’re lending their expertise to Canadian and American oil companies. [33:14]

JIM: I know you follow a lot of the markets but I want to touch on the gold market. We do know that demand is growing. In fact, the CPM gold report talked about how they’ve never seen this kind of gold buying occur globally and consistently for so long. It’s been going on six years now. At least we’ve come to that time of the year – the summer doldrums of the gold market – and I wonder if you might comment on that because this is usually the time of the year where the gold markets weaken for a short period of time.

MONTY: That’s right. Fifteen out of the last twenty-one years we’ve had a decline between now and the end of July. And over the last thirty-five years I’ve been following the gold markets you often see a bottom in late August or late July. So we wouldn’t be surprised to see a choppy market but not a whole lot lower. Longer term we remain extremely bullish on gold and we think these sovereign wealth funds are some of the buyers of gold and will continue to be buyers of gold in years to come. So we see them impacting growing stock markets, the gold market, the growing base metals commodities markets all over the world for many years to come. So if you’re a long term investor I wouldn’t worry about the gold this summer; if you’re a short term trader it might have a small decline. [34:30]

JIM: I’m always amazed any time gold bucks up against a key level, we hear about central banks selling. And Monty, the other side of somebody selling is somebody is buying and we never hear the story about the other side of the trade. Okay, maybe some central bank in Europe is selling its gold but I guess the more important question: who’s buying it?

MONTY: I think the Middle Easterners are buying it. The central banks in the Mideast are buying. In fact, the Kuwaitis have been doing a lot of gold buying. They also disbanded disconnected themselves from the dollar as did the Syrians in the last two weeks. Kuwaitis have been our long term allies but they’re getting paid for their oil in dollars, the dollar is going down so they are not making as much money as they would be if they were – because the oil is not going up in price versus the euro or the Australian dollar or Canadian dollar nearly as much as it is versus the US dollar. Also buying of course is China and India and some of these central banks in Southeast Asia. [35:29]

JIM: There’s a lot of bullish talk about the stock market. One of our predictions this year was the S&P500 would take out its old records. I expected it in the second half of the year, I was wrong. It was in the first half.

MONTY: Well, that’s the kind of mistake to make: be right but early.

JIM: But if you were looking at the stock market going forward, your take of it presently?

MONTY: The US stock market modestly higher, steadily higher, another 4, 5, 6 percent this year; foreign stock markets up much more because the dollar will be declining after – the dollar also rallies for the next month or two but that won’t be prolonged. In the long run, the dollar is heading much lower.

JIM: And then finally, we’ve got the 10 year Treasury note touching 5%. Does that create any hiccups for the market if it goes higher?

MONTY: Well, I think it will go higher because the big problem here and I think the Fed has been underscoring that (and many investors are well aware of it) is inflation is a lot higher than they’ve been announcing. And I think they’re going to have to do something to react to that. So my guess is rates gradually inch higher and the Fed doesn’t raise or lower rates, but that the market raises rates just a little bit throughout the rest of the year. That could have a slightly slowing effect on corporate profits. But since corporate profits are probably at their bottom now and getting ready to ramp up because growing economic growth globally is actually dragging the US economy along behind the European and Asian economies which are all growing faster than the US. So in the old days we used to drag everybody along behind us both up and down. Now the rest of the world is so much more powerful economically than we are that they are dragging us along. [37:11]

JIM: It just goes to show you what a sea change we’ve seen in this new decade. What was the old saying: when the United States sneezed the rest of the world got a cold. Well, we sneezed and nobody got a cold.

MONTY: Nobody got a cold, their growth rate just ramped up a little bit.

JIM: Well, listen Monty, as we close, if our listeners would like to find out more about your services tell them how they could do so.

MONTY: We’re on the web under www.guildinvestment.com, and we’re listed in the book under Guild Investment Management in Los Angeles, CA. So you can look us up on the web. We have a free email letter which we send out about once or twice a week giving our views on global markets. We offer investment management services and hedge funds for global investors. We have been doing it since I had hair, back in 1971. [38:04]

JIM: Well, listen Monty, thanks for joining us on the program, and I might point out you have written several articles for Financial Sense, so if you would like to see what Monty has had to say in the past you can do so. Just go to the left hand column on our website and you can find Monty Guild there. Monty, thanks for joining us on the program.

MONTY: And thanks for having such a wonderful service as Financial Sense, Jim. We’ve really enjoyed it and appreciate being on your show. All the best. [38:28]

Q-Calls

And welcome back to the Financial Sense Newshour at www.financialsense.com. That’s like making sense of something, s-e-n-s-e. these programs are posted by 7am Greenwich time every Saturday morning. So you’ll have to correct that for your own local time zone.

It’s time to go to the Q-Line. The Q-Line is open 24 hours a day for your calls. We record them for the program here – it’s not a live call-in. The number for that is toll free in the US and Canada: 800 794-6480. That number does work from the rest of the world but you have to pay for the call. It’s only toll free in the US and Canada. Just give us your name, where you’re calling from. We’d like to remind you, please keep it relatively short because when it starts to become a master’s treatise we have to pretty well jettison the call.

And also the content we have here on the Financial Sense Newshour is for your information and educational purpose only. You should not consider it a solicitation or offer to purchase or sell any kind of securities and the responses to our listener calls here are based on the opinions of James Puplava. They don’t take into account your suitability, your objectives or risk tolerance. We can’t know that from the limited information you provide in the call. We’re not going to be liable to any person for financial losses that result from investing in anything we profile here on the Financial Sense Newshour.

And the first call comes from Lindsay, in Ontario Canada.

Good day, gentleman, it’s Greg calling from Lindsay, Ontario, Canada. Jim, I’ve often heard you speak about the fuel efficiency of cars as a factor to consider in purchasing. But I think a better approach would be the overall cost of the car. For example, I was looking at buying a Volkswagen diesel Jetta, and the diesel engine was 5 or 6,000 more than the gasoline engine. I did the math, factoring in the price of gas versus the price of diesel fuel efficiency. And from my calculations I would have to drive that Jetta 230,000 km just to break even. So maybe not so practical for your everyday guy who doesn’t have to drive so much. Just thought I’d share that with you.

Greg, one of the comments I’m more worried about. You know you’re right, if you’re looking at cost efficiency you may be better buying something like a Honda Civic where you’re not going to have to pay a premium, and you get very excellent gas mileage. What I’m worried about here in California because we’re so nuts here – we don’t want any form of energy – I’m worried about rationing or shortages. So I’m looking at getting a diesel that’s going to get 780 miles per tank of gas. So if we do have some shortages which are very likely – I mean we always have brownouts here because of our energy situation – at least with a diesel I’m going to be able to go somewhere if I want to. [41:53]

JOHN: Last week on the program, if you remember, we ran a spoof about the Wizard of Oz as far as adjustable rate mortgages and Dorothy trying to buy into a home. We got an interesting call from John in Maine regarding that:

Hi, this is John from Maine. I just heard your little skit on the Wizard of Oz and thought you might be interested in knowing that in 1900 Frank Baum who wrote the Wizard of Oz was a staunch supporter of the Free Silver movement and distrusted the East Coast banking establishment. And the Wizard of OZ is an allegory about the gold standard. Oz, O-Z, is the abbreviation for now gold. The problem with the gold standard was that the government couldn’t print any more money without discovering more gold to back it up. And the Free Silver movement wanted to add silver as another standard. Having the two standards would allow the government to inflate the money supply and provide relief to farmers whose price of crops had plummeted but their debts still had to be paid off in a gold backed currency. In 1896, the Congressman and soon to be presidential candidate William Jennings Bryan exclaimed: you shall not press down on the brow of labor this crown of thorns. You shall not crucify mankind on a cross of gold.
If US monetary policy eased the money supply, farmers might have a chance to survive. So Frank Baum’s book, The Wizard of Oz, an allegory of this: Dorothy represented the average rural American. She’s flung by the tornado to the east where they discover the yellow brick road – meaning the gold road. The road leads to Oz where the wicked witches and wizards of banking operate. The scarecrow is the American farmer who is ignorant as to why he is in such dire straits. The Tin Woodsman is the American factory worker who is forced into employment and unable to feel. And the Cowardly Lion is William Jennings Bryan. The Wizard represented Marcus Hanna who controlled both the Republican Party and the McKinley Administration. And the Munchkins were the simple minded people of the east who did not understand how the wizards pulled the levers that controlled the money, the economy and the government.
At the end of the story, the Wizard, and the witches are exposed as crude fakes; the Scarecrow discovers that he is really intelligent and not stupid. And the cowardly lion, William Jennings Bryan finds courage, and the Tin Woodsman, the American factory worker, receives a new source of strength in a bimetallic tool like a golden axe with a blade of silver. And Dorothy returned to Kansas by clicking the heels of her silver slippers and not ruby slippers as in the movie. There you go guys.

JOHN:They were changed to ruby slippers because the silver didn’t look as good. This was one of the first color films that came out. And when they had kodachrome 1 they thought ruby would look better. It was always interesting that whenever they take out safeguards that were built into laws, whether it was in the monetary system as the Founding Fathers said, our currency should be based on gold and silver, or say the Bill of Rights, it’s always done for a good reason. Do you ever notice that? You know, William Jennings Bryan making the argument, “we shouldn’t crucify anybody here.” But once you take out the safeguard, all mischief starts to flow in. It’s interesting. [44:45]

JIM: We certainly had a lot of that since 1971. Just look what’s happened in the dollar and the cost of living.

JOHN: Yeah, exactly.

Hi Charlie, from Rockford, Illinois. The China tariff – I was wondering how that would affect Walmart and those who shop there. The other question I have on unemployment: how are the numbers affected by the illegal or undocumented workers.

Let’s handle the first one. The China tariff – if that goes through it’s really going to hurt Walmart sales. Walmart already is suffering from declining sales or slower growth rates because of the cost of gasoline. This will make it just much worse. In terms of undocumented workers, you know I don’t know how you keep track of that. One thing it is impacting is the construction numbers because at least out here in the Southwest a lot of the workers in the construction industry are undocumented illegals. And so a lot of these people have lost their job, and that’s something you don’t pick up in the employment numbers. [45:44]

Hi Jim and John, this is David calling from Ontario, Canada. Great show, I recommend it to others. I subscribe to several newsletters – John Williams, Jay Taylor, Bob Chapman of the International Forecaster. Bob makes a good case for slapping high import tariffs on China to protect American jobs and the economy. Of course, the short term that would be bad for the economy. In some ways it would be bad for bonds and interest rates, stocks but something has to be done to protect American and Canadian jobs. Also, people need to be protected from the flood of toxic, unsafe, low quality junk that is being profusely imported from China. Could you interview Bob Chapman on your show – that would be great to really get in to that and hear your side and his side together in a debate. Thanks, Jim.

JIM:Well, one of the ways that we become competitive and to keep jobs here is for companies to invest in plant and equipment. It’s amazing – I was reading a rather detailed report on the economy and investments and it was talking about CAPEX spending here by major corporations. And yes, it’s up. But if you look closer at the numbers, most of the CAPEX spending is coming from the energy sector, and most of the energy sector’s CAPEX spending is being spent overseas because that’s where the oil is – they’re not allowed to drill for oil here in many of the places where the oil is. And so a lot of companies missed the boat by not investing in plant and equipment rather than sitting on the sidelines in cash and buying back their stock. [47:27]

Hey, Jim and John, it’s Chris from Idyll Creek. I took a week off from asking a question but this week I had a two part question. In light of the naked short selling I’ve got a question about backdating options. What is that process and what does that entail for us as investors.

Well, I’m not sure the two of them are related, Chris. Naked short selling is people selling short stocks without borrowing the stock to short it. And that creates a problem because you have a lot more shares floating out there that cannot be covered. In terms of backdating stock options, that’s when you’ve got the price of your stock and you go back and date your options back to a period when your stock price lower and so you automatically have gains. [48:09]

Hey, Jim and John, this is Art from Calgary phoning back to respond to your question about what do all the bicyclists in Calgary do in Winter. You raise some good points but believe it or not they’ve found work arounds. For a while, what was happening was that adventurous fellows were towing two by fours behind their bikes when it snowed to clean the paths for everybody. But then what happened is then the city put some money toward getting some little – they look like little 4 wheel drive Jeep type things with snow brushes on the front. And so they actually do clean some of major paths in the winter for the bikes – not all of them, but the major ones. And I would just say that ridership definitely drops during the winter but there are a surprising number of intrepid souls. I had one fellow who worked for me until just recently was riding until it would be -15 to -20 degrees Celsius here. So I don’t what that is exactly in Fahrenheit I’ve lost the ability to convert that in my head but it’s getting down to pretty cool temperatures. Well below freezing. And they’re still riding. If we get a real cold snap which happens for a couple of weeks – maybe a month a year – yeah, everybody gets on the bus and it’s quite inconvenient. But you have to dress fairly warmly to do that too because you’re waiting outside a stop generally. So for the people who are being forced to take the bus, you know, if they’re the athletic type, riding the bike is still an option for them. [49:40]

JOHN: Can I address this one, Jim. The temperatures he’s talking about are 5 degrees down to minus 4 degrees Fahrenheit. The coldest I used to ride in Denver was about 5 degrees. And what you have to do is you have to wear thermals underneath your biking tights, and you have to wear a ski mask and goggles because of a little thing called wind chill. Say it’s 5 degrees Fahrenheit out and you’re rolling along at 15 or 20 miles an hour, it gets to be really cold. Would I do it again? No. Those days are over I think. But he’s right, it can be done. You know, people have done it.

JIM: I think with snow and stuff like that the roads would be slippery.

JOHN: There was a flying instructor who had a mountain bike - mountain bikes are good for that and he had found a provider who actually had studded snow tires. And I talked to him one day because I passed him on the freeway, and I said, “I notice you ride all the time.” And he said, “yeah I’ve got these studs. And this bike will stand up on ice when other people are falling down.”

JIM: Amazing.

JOHN: It’s amazing how thick the air feels by the way because you have to push through the air and the air density goes up so high, and about 50% of a bikers energy is taken up plowing through the air resistance he encounters.

Hi Jim and John, this is Dennis in Canaan, New York. Mr. Puplava., I was wondering if with things getting so expensive to ship and so expensive just for the item itself if co-ops are a good idea. If people can band together on purchasing some things that they all need, I’m wondering if the co-op approach works in keeping prices down for people. Have you looked into that at all, how expensive things are to move around. It seems like it may become prohibitive at some point, so then what do you do. But I would like to know what you think about co-ops.

JIM: Co-ops might work on food in terms of trying to keep the cost down, especially if you could develop that between local growers. But you’re right Dennis, as the cost of energy goes up, and especially as oil prices go north of one hundred dollars a barrel and eventually to two hundred dollars a barrel, what you’re going to have (and a theme that we’ve been looking at and thinking about rather extensively) is rebuilding the transportation system: meaning a light rail system, a rail road system, and the barge system in this country because you can transport goods more fuel efficiently through a railroad, and also through the barge system. So we’re looking at that as an investment theme because we think that’s coming. And we also believe it’s one of the reasons that Warren Buffett invested in Norfolk Southern. In fact, he even responded at the annual Berkshire Hathaway meeting when someone asked him why he was buying railroads, and he responded in exactly that same way. It’s much more fuel efficient as the cost of energy goes up to transport goods by rail. [52:58]

JOHN: Yeah, we’re going to have to do something about the infrastructure. I was talking to some farmers groups back in the Midwest and they’re saying we’re allowing our canal system and the various things integrated with that along the Mississippi River – not just the Delta but the entire drainage basin – we’ve allowed that to just decay and that’s going to become a very cheap way on barges to transport items versus on semis, along freeways, or something along those lines. And I don’t know about your part of the country, but in my part it’s really easy to find people say, for example, who are raising cattle, and then to buy a cow once a year. And when you finally get it to your table you are looking at $1.35 a pound for the beef compared to what you’d pay in the stores right now. So like you say, food co-ops do tend to work. But you have to work at them a bit. Everybody has to get their at the end of the day, you split them up and there is some kind of a commitment.

This is Dan from Washington State. Say, I was just noticing on your website this week that you’ve changed your format and it looks like the website has changed a little bit. I think I’m kind of curious about, you know, I like taking your advice and I’ve made a pile of money over the years but Frank Barbera doesn’t have a picture. Is that maybe because we shouldn’t take his advice on where he eats. I’d like to see a picture of him before I start taking that advice. Thanks.

Dan, next time I talk to Frank I’ll ask him for a picture. Many of you, if you’re listening to the program might recognize Frank. Frank used to be on CNN-FN back in the days when it was first starting up with Sue Herrera and Bill Griffiths. So anyway, if you’ve ever seen Frank he used to do a lot of television back in the early days of financial television. So I’ll ask him for a picture. He may not want his picture just in case you run into him in a restaurant. [54:31]

JOHN: When he’s up on Mt. Wilson he’s usually eating Granola bars and bottled water. I don’t want to tell you what Tim Wood eats down there in the bear bunker.

This is Bob from California. I’ve got a couple of questions that are linked. If you think how the market is going to decline this year perhaps begin its decline at the earliest at the end of this year and finishes its decline maybe at the middle of next year, what makes that happen. This uptick was much, much higher than the uptick in 91, so the decline should be much steeper and last much, much longer than 91. That puts it in 09 from my perspective. Thanks.

Bob, I didn’t say that stocks would be down by the end of the year. In fact, my prediction would be that they would be up, and I was predicting that the S&P500 would hit a new record this year in the second half of the year. Instead, it hit a new record in the first half of this year. I think we’re going to get into a financial crisis because of rising interest rates and derivatives. And that would be the third part of my scenario that will force a Fed rate cut. And remember, part one was real estate begins to deteriorate, spilling over into the financial sector; we’ve had the subprime market hit, I think the Alt-A market is coming next, and CDOs will come along with that. That’s number one. Number two is a slowing economy. We had the slowing economy in the first quarter, 0.6% economic growth. We’ll get a bit of a bounce here in the second quarter before we start going down again. And then the third part of that scenario is that we get a financial crisis in the financial markets, and then the Fed will have all three and begin to cut. And when that happens you’ll see a bounce in stock prices and start to head higher. One of the reasons I think you’ll not see a real bear market develop is that in a period of rising inflation and debauched currency as we’re seeing right now, (double digit money growth as we’re seeing in 18 out of 20 of the top central banks), is people – if you listen to Jim Turk on the first hour – would rather have their money in real assets whether that’s a stock, real estate or something else than paper, which is depreciating. [56:43]

This is Peter from Farmington, Connecticut. Not really a question, more a comment. It concerns my previous question about Middle Eastern nations dropping their dollar peg. A Bloomberg article from June 5th in the last two weeks, two Arab countries have dropped their dollar peg including Kuwait and more recently Syria. There’s a suggestion that the United Arab Emirates are soon to follow. One analyst from ING [phon.] Bank in London made that suggestion. Again a comment that for Middle Eastern nations, there is no economic incentive to maintain a dollar peg, and no real incentive to buy back dollars. And it does make sense that the first one out saves the money. And they point out in this article that nations that are pegged to the dollar are experiencing anywhere between 10 and 12% inflation. Again, this was a Bloomberg article from the 5th June. Thanks.

I think you’re dead on, Peter. I think more and more nations, which is going to make it more and more difficult for us. And especially since we import so many of our goods, it means that we’re going to be paying higher prices which means higher inflation rates which means we’re going to be printing more money. I know people don’t think hyperinflation can happen here but I see it coming. [58:00]

JOHN: And you’re listening to the Financial Sense Newshour at www.financialsense.com. Coming up on the next hour we have a storm warning forecast for you. Category 3 financial storm coming, as we continue the Financial Sense Newshour after this.

Part 2

Cat. 3 Financial Storm Coming

JOHN: All right, Jim, here we are. The important that a sailor knows to see what kind of weather is coming, red sky in the morning, sailor take warning. How do you apply that to the financial market? Do you know? Red: inflation in the morning or something.

JIM: No. Red: chart going down.

JOHN: Red chart – we had a Category 3. This isn't the perfect financial storm, is it, but we've got a Nor'easter coming here.

JIM: Well, I tell you, John, it's looking like a Cat 3 financial storm coming. We've got a bit of sort of a reminder this week, a little bit of a shake out, just sort of a preview of things that are coming. But, you know, fortunately stocks bounced. In fact, I was talking to a friend of mine in the business on Thursday and he was saying, “oh, you know, this is it, it looks like this is the top.” I said, “I don't think so. I don't think this is it.” I said, in fact, of anything that we've learned in the past, our authorities have learned to never have three days of draw downs; and that's what they learned from the lessons of 87.

But I think we have very similar type characteristics that exist today to back to the markets of 87. The lesson of 87 once again is never let stocks go down in a big way for three days in a row. That’s because what happens is just as you have upside momentum when stocks are going up, what you don't want developing is down side momentum because it can get deadly because then you have all of this program trading that kicks in. If a certain level is taken out on the downside, that triggers more selling, more selling comes into the market, drives the market lower. Then that kick in another set of levels of more selling, and then all of a sudden you get this downward spiral. So I was betting him last night, I said, “I bet you we'll have triple digit gains in the market.” And that's exactly what we had today. [2:06]

JOHN: One of the reasons you give for the market rebound is the fact that the economy was slowing down. That was one. The other one you kept hearing was the fact that oil prices had dropped a bit and theoretically everything sort of jumped because of that.

JIM: Well, you know, this is how they are talking out of both sides of their mouth. They are talking about, “okay. Oil was down two bucks because slower economic growth means there is going to be less demand for oil.” So that was sort of the spin put on this. But on the other hand, they're talking about growth picking up on the second half of the year, so which is it? Well, first of all, when it come to slower economic growth, the economy has been slowing since the first quarter of 2006 and yet demand for gasoline is up year over year by two to 3%. So we haven't seen demand destruction despite a slowing economy and, by the way, rising gasoline prices. So this is Wall Street talking out of both sides of its mouth. [3:02]

JOHN: You know Wall Street has been yammering about lower oil prices. Of course we've been hearing that since it made its records peak that “oh, it's going to go back down to normal levels,” whatever normal is, put that in quotes, and indeed we've been hearing about normal oil prices at least going back to the first of the year.

JIM: If you take a look at all of the spin over this, first of all, there is no slack in demand for energy, whether it’s the United States, China, India, Europe or any other place. Secondly, John, supplies are very tight right now. I think OPEC's spare capacity is down to maybe one, two million barrels at the most and imagine if another hurricane is – we're going to hear here shortly from Evelyn Garriss. As we head into the hurricane season, if any of these hurricanes come back and hit the Persian Gulf as they did this week and even worse the Gulf of Mexico. So, you know, there is just not enough spare capacity right now to handle an event like that.

The other thing is because global capacity constraints. We can't produce enough refined gasoline products, so in addition to importing more oil and natural gas, we're having to import more refined gasoline, diesel and jet fuel. And I predict by the time that we get to the end of the summer, oil prices are going to be much higher. So ignore the spin that was given for the reason that the stock market was up and bounced back on Friday. That's just nothing but spin and the fact that oil prices are going down because the economy is slowing, they are telling you that on one hand; and on the other hand, they are telling you that the economy is going to ramp up the second half of the year and the markets are going to go up, etc. So this is just nothing but spin. [4:40]

JOHN: How when you talk about oil priced going up, what are we going to see at the pump?

JIM: Well, we got pretty close here recently. I think we got up to 3.72. I would suspect by summer, we're going to see and especially if we get some disruptions as a result of hurricanes or some kind of geopolitical event – one thing that we're paying close attention to is what's going on in Israel right now that they seem to be preparing for war with Syria, and Syria seems to be preparing for war with Israel. I imagine by July or August, a Middle East war. That would be great for the price of oil. [5:12]

JOHN: It's going to be interesting to see where that situation goes because Prime Minister Ehud Olmert is already talking about giving back the Golan Heights as part of negotiations with Syria and for how long has that been sort of a non-negotiable issue. But also stuff brewing on the border between Turkey and Iraq right now because there has been discussion about giving the Kurds some kind of state of their own or section and of course there are Turkish Kurds as well as, and Turkey doesn't want to see that. Turkey made the first incursions in Iraq a few days back. You know, last week you were talking about the fact that this is an institutional market and the amateurs and others are sort of sitting off on the side lines. Why don't you go further with that this week.

JIM: I keep mentioning that a lot of what I'm seeing here reminds me of the events leading up to October 1987 and you're absolutely right, John, the equity markets have parabolic. Just look at a chart of the S&P, the Dow, the Utility Index, Transport Index since last summer. The equity markets have gone parabolic and yet individual investors are not climbing on board. You take a look at for example, and this has been confirmed by inflows into equity mutual funds which have been negative. If you take a look at the last 12 months, only four months out of the last 12, we've seen positive inflows in to stock mutual funds. So if we've had this big run up in the Dow – almost three thousand points in the Dow since May of last year – the little guy isn't participating because if they were, you would be seeing the inflow in to mutual funds and inflows roads into mutual funds just haven't been there. And as a whole, the public has been a net seller during this period.

And I think there is a reason for that, John. You know, you take a look at it from the guy in the street’s point of view. First of all, he took it a major body blow between 2000 and 2002 where he saw his stock portfolio basically shredded. All right, so then to counteract that, he's seen a rise in the value of his real estate. Now he's getting a second body blow. The stock market, you know, he never got back into the market to take advantage of the recovery that took place at the end of 2002. Now, he's getting it again in a real estate blow. And then a third thing, contrary to what the happy talk is on inflation, he's dealing with riding food and energy inflation. And unfortunately, you know, as we talk about and joke about here, those rising food and energy prices are real. That's something you have to pay each week every time you go to the pump to fill up your tank. That's something you pay every week when you fill up the grocery cart. That's something that you pay every week when, you know, or every month when you flip on your utilities. And I hate to say with all of this global warming and all of this other nonsense going on, you ain't seen nothing yet when it comes to utility bills. You think your gasoline bills are high. Wait until you see what's going to happen to your utility bills over the next two or three years. [8:10]

JOHN: One has to wonder how much more the public can take this type of abuse. I mean they took these whops in their portfolio – losses there; and then the real estate market rolled over. Look how many people were trying to flip houses. I don't know what it's like in your part of the country, but here people were jumping in on spec and everything else like that. And now we have rising inflation. How much more willpower are they going to have to take in order to survive this?

JIM: One of the things we're starting to see is rising stress levels with the public, John. And that's being reflected since mortgage equity takeouts have down dramatically. It’s very hard to refinance your home when your home values have dropped and especially when you had no equity in your home. So what we're starting to see, which indicates stress, is credit card debt levels are starting to rise. So, you know, yes, they are spending, but they are spending on necessities and a lot of credit card debt, a lot of people pay their gas on credit cards. So credit card debts are rising and it's one way that they are coping with these rising cost dollars, they are building up their credit card debt right now. [9:12]

JOHN: Well, right now the market is keeping on up and we're always hearing the term global liquidity floating around there, so what is really pushing this so far. It's not going to go often forever. That's for sure.

JIM: Well, what's pushing it as I mentioned earlier, it's been an institutional market. It's hedge funds, pension funds, institutions, it’s not John Q. Public. And even on the institutional side, John, there's some doubt in terms of how much further this could be pushed up because if you take a look at mutual fund cash levels, they are down to 3%, probably the lowest level that we've seen at the mutual fund level since 2000. So there's not a lot of cash to rescue this market or drive it forward. Same thing also with bond funds. Bond funds are down to about a 4% cash level, so there's not a lot of money that can be redeployed in the bond market. And with rising rates right know, I would be prone as a bond fund manager to go into the short end of the market for safety reasons, because if interest rates go up and you own long bonds you're going to be taking some big hits in terms of losses. So this has primarily been an institutional market and institutions are in equities at a time that rates are rising, John. That's why this is very reminiscent of what I saw in between 85 and 87 when we were trying to correct the value of the dollar. In 1987, interest rates began ramped up by the Fed and until the point where we got 10% interest rates in October of 1987 and just a period of over 3 days the stock market lost over 30% with 22% lost in a single day. I don't think that will happen before magic occurs in the futures pits, but certainly a 10 to 15% correction or maybe even 20 in the worst case scenario is certainly not out of line. [10:55]

JOHN: How much of previous cycles are we going to follow this time around?

JIM: We are really chartering a new territory here. A lot of the paradigms, the economic models, all of those things have been thrown out, John, because everything is just been upside down. You've got all assets correlating, you have the bond market – basically long term rates going down, when the Fed was raising interest rates, you had riding inflation rates with lower bond rates. I mean we've just had one anomaly after another in this kind of market. So, you know, we're braving new territory here.

And another factor that leads me to believe that when it does arrive it could be very quick and violent is that this is a very highly leveraged market. You've got a lot of hedge funds, a lot of players in this market that are up to their eyeballs in debt. And when you're leveraged like that and markets start to move against you, you'd better go to cash as quickly as you can, and you don't care what you're selling to get that cash because other than that you may not survive. I mean just take a look at some of the hedge funds that blew up over natural gas trading last summer such as Amaranth.

And then you know something, I think another unique feature here is that a lot of this money and credit is not just loose policy by central banks because they wanted to curb this they could and they've been playing chicken with us by these little baby steps of quarter point interest rate hikes. But a lot of this credit, John, is being created by institutions themselves. They are the source of much of this credit expansion and so that's why this is a market that is so highly leveraged that one mistake can sink you. I mean we talked about earlier how the derivatives market is now somewhere in the neighborhood of $420 trillion – trillion, I might add. So this is one of the problems that we have here and why you can have these sudden sell offs if things starting to go against you is because the amount of leverage that a lot of these key players are using right now. [13:02]

JOHN: Okay. Well, the little guy is not driving this market. He's up to his eyeballs in debt, he's spending his money on gas, groceries, health care. So what's pushing?

JIM: You know, this has been a liquidity driven market. It's the yen carry trade. When you're borrowing money of 1% and you're going anywhere that you can arbitrage at a higher rate, it could be emerging markets, it could be the European markets whatever, but it's the Yen carry trade which is huge. It's merger and acquisition activity, which is, you know, I think we're over a trillion dollars of mergers in the first quarter alone; it's stock buy-backs – a lot of companies are buying their earnings now instead of making their earnings. Once again, it’s institutions that are driving this and in order to do this, whether it's making decisions, whether you're a private equity firm or you're just a corporation buying out another company, expanding, corporations are releveraging their balance sheets again because they know that if they are a corporation sitting on a ton of cash, they become a take over target for, let's say, a private equity firm. So releveraging a balance sheet, and as long as borrowing rates themselves are less than their earnings yield, deals are going to get done. But when rates start rising further and faster, then that's going to put an end to this. So deals are at this point a lot of people that got in early are telling a lot of the private equity people that I read about, the smart ones are saying things are getting very pricey. As we mentioned last week, one well known private equity firm says right now they are selling everything they have that isn't bolted to the floor. In the words of what in guy said is almost in conceivable or unimaginable prices. So that kind of tells you where we are. [14:56]

JOHN: Always remember that line. Inconceivable. “You keep using that word, but I don't think it means what you think it means.” A great line from the Princess Bride.

JIM: You know, the other thing too is this scheme to arbitrage with interest rates is also going to narrow because you've got global interest rates rising. Central banks globally are raising interest rates. We raised ours here. Canada is talking about raising theirs. The ECB just raised rates and says they are not done, there are more rates to come. Britain has raised interest rates saying there are more interest rates coming. Now, you have Asia talking about raising interest rates; the Chinese central bank has raised rates. They are taking about raising rates some more. Other central banks in the region maybe talking about raising interest rates. So that's what they are going to do. They are going to keep raising interest rates until they break something and this time I think the break is going to come in the financial markets. [15:49]

JOHN: So what are some of the sign posts and other indicators that we should be examining right now?

JIM: One thing that we're looking at ,and boy, I tell you, we're burning the midnight oil with my various groups that I confer with and also here internally, we're spending a lot of time because I think this is going to be a very, very tricky one to maneuver. But we're looking at, John, at perhaps a bounce back in the S&P 500. Especially, as we get to the end of the second quarter. You get a lot of window dressing is they kind of pump the numbers the last week and a half before the quarter ends to make the numbers look better for the quarter, so we may see this bump back at the 1530 level. And that's going to be a key level to watch to see if we possibly run into resistance, and that really becomes the top or as some technicians are talking about maybe the right shoulder is hit at that level. So what happens at 1530 is very key: if it breaks down from there, they been there's trouble ahead.

You could even get a temporary rise – a very short term blip with the Q2 numbers coming in on GDP a little bit higher, people will be talking about, “see, the economy bottomed, we are back up and away,” and maybe better than expected earnings. They always go through this little game as we get closer to the end of the quarter. The analysts start slashing the earnings for companies and then what happens is the companies come in and warn they had to slash the earnings estimates lower and then they come in and beat the estimates. So you can always have that scenario that takes place every quarter: the earnings game where the companies beat analysts expectations.

But at this point, watch long term interest rates, watch and see if that continues to trend upward because if it does, it has going to keep trending upward until something breaks. Watch central banks raising their interest rates, watch what they say. In other words, if they raise rates, watch if they say, “hey, we're not done yet,” that will tell you there's going to be more pain inflicted. Central bank rate hikes are going to keep the Fed, I think, from lowering. Watch the government regulations especially if you start hearing talk this summer about a new regulation coming to the banking sector on no-doc loans because if they pass that regulation that's going to hit the credit markets in Q3 and Q4 and that's going to impact real estate. Also, in terms as we get out of the second quarter or even the month of May or June, watch for inventory builds, watch for that to stall, watch consumer spending, especially in the month of June when we get those numbers next month in July (as I mentioned earlier, June is one of the key retail months, second most important retail month next to the month of December). And I just think watch third quarter financial fall out especially in the Alt-A market. [18:45]

JOHN: I'm going to be wondering how long they can keep the happy talk going because if you notice the pattern, by the way, in watching the mainliners is: happy, happy, happy…gee golly willikers, what's happening?

JIM: We're happy as heck. We don't have a clue of what's going on in the rest of the world or maybe our own, but we're happy.

JOHN: Anything else we need to watch as we just keep an eye on the scenario.

JIM: Sure. We're already starting to see a breakdown in the retail numbers especially on consumer discretionary. So watch consumer discretionary spending. Also watch anything housing related. You're seeing it in the breakdown of, let's say, the home building retailers, also stores like Bed Bath and Beyond, the furniture stores, all of those are starting to break down. This tells me this is going to get much worse. Also watch the breakdown in gold prices because if gold continues to break done, it may be signaling a whiff deflation that may be ahead of us and we're going to talk about that in the next segment. [19:44]

Other Voices: Evelyn Garriss, The Browning Newsletter

JIM: Well, this is the first week in June. The hurricane season is upon us. And we got a glimpse of what it might look like this week as a category storm hit the Oman area, and almost went into the Persian Gulf area. Joining me on the program is Evelyn Garriss, Editor of the Browning Newsletter.

Evelyn, let's begin with this summer's hurricane season and we've got the first one to hit the country of Oman and, you know, we usually don't expect to see that area of the world hit. We usually expect it, you know, Florida, the Caymans, maybe Texas, but this one started in the Persian gulf.

EVELYN GARRISS: The average Arab feels pretty safe from drowning. But unfortunately, this was a Katrina-sized cyclone, the largest they’ve ever recorded and it first brushed the bottom of the Arabian Peninsular the country of Oman and killed 20 people. Heavy flooding and land slides just washing out the capital and then it went up the Straits of Hormuz and hit the West Coast of Iran. It just was gigantic. This area just didn't know what hit them. They hadn't ever encountered anything like that or any warning that something like that could happen prior to the limited warning they were given before this storm hit. [21:25]

JIM: Evelyn, how unusual that is that because like I say, when you take a look at hurricane that's build off the coast of Africa, they usually don't cycle up into the Arabian Peninsula. They usually head towards, led say, the Caymans, the Gulf of Mexico the Atlantic coast. Is this very unusual?

EVELYN: It's the first time a storm this size has ever met the area in recorded history. They have no records of it. As you said, the path of the African storms tend to be out to see. It's really like our Pacific, east Pacific, storms, the West Coast and Central America and Mexico usually go out to see. Sometimes they brushed the coast of Mexico, but we once had a year where one swelled up far enough north that it was seen off the coast of California and California got really excited. Well, it was sort of like that happening to the Arab countries. They just were not prepared for anything to come that direction. [22:25]

JIM: Well, let's talk about something that you wrote about in your recent issue and that's called the recipe for tropical storms. And you said basically that to have an activie hurricane season it's necessary to have the following: one, clear exercise without aerosols; two, warm waters; three, favorable winds; four, thunder storms drifting onto the Atlantic; and then you end – we have all four conditions this year.

EVELYN: Yes. We do. Last year we had a lot of aerosols in the air because we had a volcano going off. And then by the time the aerosols started to filter out, and this was from a volcano in the Caribbean and African dust, by the time the dust began to fall, the El Nino hit and it had shearing winds. But now we have no volcano, which is good news if you live in the Caribbean and don't like volcanoes, but it has terrible news if you don't like hurricanes. [23:26]

JIM: So Evelyn, if you were a real estate investor, I'd suspect you would not be buying Florida beach front or Texas beach front property this year.

EVELYN: Only if the doctor told me I needed a lot more adrenaline and stress in my life would I decide it was a great time to buy Florida, Gulf Coast real estate. Unfortunately, the conditions, the Gulf waters are warm, the Atlantic is warm. We are in a condition where a La Niña seems to be building up. and that creates some ideal winds for developing hurricanes and we're seeing a lot of storms coming off of Africa, so all four conditions are on. This is going to be a great year for hurricanes. And if the wind directions continue the way that they are, it looks like we probably should see at least two storms. And I'm not saying, you know, Katrina or Rita, I'm talking about named tropical storms entering oil country. And I would expect that at least one of those would be around the next can oil patch as opposed to the US.

JIM: And if that happens, I mean, are you talking about something in the neighborhood of maybe a Category 2 or Category 3 storm?

EVELYN: There is a possibility of it. I'm being cautious enough in that very frequently the storms come early in the season in the Gulf and those tend to be the milder storms. They don't destroy as much as they stop oil production and raise the overall fear level in the Gulf. So it's not necessarily big storms, although I cannot rule that out. A lot of it depends on how quickly this La Niña develops. [25:00]

JIM: Yeah. I was just going to say, what if La Niña develops and hits in August. The Gulf and the Atlantic waters at very, very warm temperatures as they heat up as the summer proceeds, that, to me, spells like that could signal some trouble.

EVELYN: That could signal some real trouble. If we had a La Niña and very frequently you end up with La Niña comes with a lot of heat waves developing in the Gulf. And if you have a lot of hot water in the gulf, it's like having a pool of gasoline and waiting for somebody to throw in a match. So the later the La Niña develops, actually, in some ways, the better it's going to be. Unfortunately, scientists are saying that they think it's going to develop sometime in the next three months. [25:53]

JIM: So boy, this is going to be a year of some very unusual temperatures. I know in your earlier newsletter, you talked about maybe a heat wave as a result of La Niña hitting, let’s say, the Midwest this summer.

EVELYN: Yes. It looks like a lot of conditions are building towards at least a summer heat wave somewhere along the east. And if we don't have a La Niña, then the probabilities put the heat wave more towards about mid Atlantic states and the Great Lakes region. If the La Niña that you comes, then traditionally the heat wave and La Niña is further west, so you'd have heat in the Great Plains. Also, you would have and this is sort of bad news for any Canadians in your audience: a higher probability of dry your weather in the Ontario region which creates hotter waters which creates real stress. And we depend on Canada for a lot of energy. So either way, I think we're going to have a heat wave. So with the La Niña, the odds of the heat wave arriving throughout the grain belt is much higher. [26:51]

JIM: What about the west coast this summer? Your best guess, what are weather temperatures looking like here, normal warmer or cooler?

EVELYN: Actually, the temperatures, I'm looking at things and I would say that if the La Niña arrives, typically La Niñas bring cooler water off the California coast, so California typically, gets cooler weather, but –

JIM: Also drought though.

EVELYN: Also a drought. Yeah. Particularly in winter time which is when California gets so much of its moisture, La Niñas frequently create slightly cooler temperatures in the summer, but really create drought conditions and that's not good news. From what I'm hearing they are already, what is it, Los Angeles is being told to take fewer showers now. [27:35]

JIM: Yeah. And all things they've got drought conditions in Florida too.

EVELYN: Yes. That's a cause for concern. One of the things that steers the tropical storms is the Bermuda high and the Bermuda high is a semi permanent high air pressure zone. And when you have a high air pressure zone, the air goes around it clockwise and right where the high pressure is, it tends to be very dry, so having it so dry in Florida makes it – seems to indicate to me that what we're going to be seeing is until that thing moves, the storms are going to be guided clockwise around Florida and into the central and Western Gulf, which is oil country. So the dry weather, at this time, but don't expect it necessarily to last. The last time we had a season like this where it had been this dry in May was 2004 which at some point, the Bermuda high moved and in 2004 is when Florida got hit by so many tropical storms especially in the Pensacola region like the one storm that was going up the West Coast, and then all of a sudden decided to make a straight right turn and mow into central Florida. So what we're seeing is we're seeing the Bermuda high which steers the storm awfully close to Florida. Well, that's just a steering mechanisms for storms into the Gulf. [29:02]

JIM: Evelyn, what are the chances, I know, for example, 2005 which was a horrendous year for hurricanes and we got those late storms, Katrina and Rita late August, early September. What about a lengthening hurricane season? In other words, maybe the season lasts throughout September and October if La Niña arrives.

EVELYN: If La Niña lives it typically encourages storm season to last a long time. So I would expect – last year we were lucky. We had an early storm season. It came and by mid October it stopped. That was El Nino. When La Niña arrives or the conditions similar to La Niña, it lets the Atlantic stay warm and you see Atlantic hurricanes through November. You even have a strong possibility of December storms.

JIM: And do you ever run in conditions that we saw, for example, in 1991 where you had the perfect storm where you had a hurricane coming off Bermuda meeting up with Arctic cold fronts and also a Nor'easter. So you had three storm fronts producing something we hadn't seen in probably a century

EVELYN: Well, when you have a La Niña, the jet stream gets very – gets extremely variable whipping very far north and very far south. You get these extreme temperatures. You also get a cold front with cold fronts going extraordinarily far south entering tropical water and beginning to turn into tropical storms. Just like we saw earlier this year a May named-storm and that was a cold front that went on the East Coast, got hit by the hit the warm water and while the top side of it where the hurricanes were looking, I mean where the satellites observed it, looked rather like a cold front. The bottom where people were having to endure all of the weather felt like a tropical storm. That was tropical storm Andrea. When you have a La Niña, these storms that start as cold fronts and end up as tropical storms are called sub tropical storms. And you see a lot of those towards the end of the season, late October and November. Mostly, they tend to form in the middle of the ocean and just scare the shipping lanes. But occasionally, you'll get one coming offer the east coast and it will turn tropical. And just like the cold fronts typically go from west to east and tropical storms go from East to west and you'll see this cold front enter the Atlantic, the bottom of it will turn warm and all of a sudden it will make a U-turn and start heading back to the states. And we've seen that and those types of storms are more common during La Niñas. [31:40]

JIM: All right. Well, certainly a lot to keep our eyes focused on this summer as we look at the weather reports. Evelyn, as always it has been a pleasure to have you on our program. If our listeners would like to find out more about your newsletter, please tell them how they could do so.

EVELYN: If they get in touch with Linda at Fraser.com. That's F-r-a-s-e-r. Oh, if I may add one more thing.

JIM: Sure.

EVELYN: When you asked about the weather on the West Coast, I should mention if the La Niña arrives that's when you get the nice cool weather. If you don't get the La Niña, expect, unfortunately, warm weather. So early summer you can expect some warm weather – just to make everything more comfortable and sweaty there.

JIM: Well, at least when we get warmer weather here as a sailor, the winds pick up and I get more breeze, so you've got to make the positive out of it, Evelyn.

EVELYN: Yes.

JIM: All right, listen. It's always a pleasure to have you on the program. If your forecasts keep getting more accurate, I tell you, Evelyn, I'm going to have you back with some stock picks so take care of yourself.

EVELYN: Thank you so much.

The Problem With Correlated Assets

JOHN: Welcome back to this section of the Financial Sense Newshour and the Big Picture. You're at www.financialsense.com. I was looking at the script for this next segment, Jim. I thought it said corrugated assets. I thought: “that's my roof.” But you're talking about correlated assets, right? Okay. Correlated assets. You better intro this one.

JIM: Let's talk about this, John, because in the investment world, there's something called hedges. And usually a hedging strategy is you're going to buy an asset that is uncorrelated to your other main assets. So for example, if one part of your portfolio is hit, the uncorrelated part or the other part of the portfolio gives you an offset. And what we have here is you want to have something that goes up when the rest of your portfolio goes down. That's the theory behind hedging.

However, the problem that we have here is since 2003, all asset categories have been rising. In other words, they've been correlated instead of uncorrelated. You've seen since 2003 rising stock priced, rising bond priced, rising commodity priced and rising currencies. And this is reflecting this ocean of liquidity that is being created by this money and credit that is expanding; and especially now at double digit levels. So it is just money fleeing paper and looking for real returns and anything that is positive and is not negative. I mean if you have your money in CDs or cash right now, the rate of return that you've been offered on banks since 2003 doesn't even keep you even with the level of inflation, so you've had a real negative rate of return. So as a consequence since 2003, it doesn't matter what you were investing in, it was going up. If you were in stocks, stocks were going up and if you were in emerging markets stocks, international stocks were going up. If you were in bonds, bonds were going up; if you were in commodities, you were making money there. If you were in the dollar, since 2004, the dollar was going up. So you were making pretty much money in just about every assets class. [35:17]

JOHN: Okay, if we follow your theory about hedging, basically you're see-sawing this whole thing so you're – say for example back in February, stocks and bonds begin to drift downward. How did commodities do. Did they hold off in counter balancing that.

JIM: No. And that's the point I want to get to is that your hedges didn't hold up because in the month of February when stocks and bonds got hit, so did commodities: the CRB took a tumble, energy prices took a tumble; gold and silver prices also took a tumble. In fact, we got – I can remember getting a lot of calls on the Q-line, “hey, what happened to, I thought my gold stocks would go up or my energy stocks.” And instead they went down, and that's because all asset markets have been correlated as a result of this ocean of liquidity that's been created. [36:06]

JOHN: This is really an important point because when you say correlated assets it sounds like one of these sort of fancy technical terms, but basically what we’re saying here is that if we look at a hedge fund, you're supposed to be see sawing your assets: when one goes up, the other goes down and vice versa – that type of thing. But now we're saying that a lot of these things are moving in the same direction simultaneously, which creates problems if you're going to manage a hedge fund.

JIM: Sure. And the reason is global liquidity is driving money into assets other than cash and the reason is rising inflation and low real returns on cash. I mean if you look at bond yields today and you look at, for example, world bond market yields – Okay, we've got 10 year Treasuries now at 5.1. Now, remember, that's just occurred in the last month where we've seen interest rates go from 4.6 to 5.1. But 5.1 is not even keeping you up with the real rate of inflation which John Williams who tracks the old CPI is saying is closer to 8 percent. And then if you back out taxes out of that 5.1% you're down to 3%. You're not even keeping even with inflation. In Canada, the 10 year note is at 4.6%. That's not keeping you even with inflation. In Mexico, their 10 year note is 5.9%. That's not keeping you even with inflation. Columbia, Brazil, you're down to 6%. In the UK you've got 5.4%. In the Euro area you've got interest rates anywhere from 4.6 to 4.7. That's not keeping you even with double-digit monetary growth in the European area. And in Japan you've got 1.8%. That's not matching real monetary inflation in that country. Australia, you've 6.2%. Australia's money market growth rate is over 14 ½%. That's not keeping you equal with inflation. New Zealand – you've got double digit monetary growth and only 6.8%. So that's why money is going in all of these other assets looking for a real return. And that's why everything has been sort of correlated right now because money is just looking everywhere that it can get a better return and try to hopefully recoup from the real rate of inflation. [38:20]

JOHN: Yeah. But wait a minute. I mean we keep telling people sometimes here on the show, you know, gold and silver are supposed to be different. They are supposed to counter weight this. Why this common move here?

JIM: Well, there's something that James Grant wrote an article in Forbes talking about gold joins the main stream. And I think he's really hit the nail on the head with this one. If you look at the gold bull market, you've got two buyers. You've will the gold bugs and believe me, with gold bugs, gold is religion. They are not going to part with their gold and I think – remember when we interviewed Jeff Christian on the CPM Gold Report, he said there was only one year, I think it was 1993 in the last half century that gold investors were net sellers of gold. So gold investors, and especially gold bugs, they buy their gold, they hold; they are very remiss on selling, and they've only done it once in the last half century. So gold bugs tend to add to their position, they hold what they have. Now, as a result of the increase in global liquidity, you've had – and also the increase in technology that has brought new products into the marketplace and I'm talking about the gold ETFs, the oil ETFs, the silver ETFs, platinum ETFs, base metal ETFs and all of these ETFs representing commodities. So what you've brought into this market is a whole new class of investors and I call them momentum traders. James Grant calls them opportunists; and as Grant points out, the opportunists are quick to buy, but they are also quick to sell.

And more importantly to the opportunists or the momentum people is they don't have a solid monetary understanding. So in other words, to an opportunist or momentum, all monetary assets are the same, there's no conviction, all money is the same whether it's the euro, it's the dollar, it's the yuan, it's the peso, whatever it is or it's gold or silver. They are all the same. There's no difference. They don't recognize gold and silver as representing real money. And because they don't have this monetary understanding, when you see the monetary kind of inflation that we're seeing now with double digit interest rates, to them gold and silver is just a trading vehicle. And the gold ETF and the silver ETF just makes it easier for them to do it. So when gold goes down or when it's correlation characteristics change, as it has recently, the opportunists or the momentum people just dump their gold without a thought. Now, they’re not thinking wait a minute, you've got 50% year over year monetary inflation in Russia; China’s monetary inflation running close to 20%. And all of these kind of numbers that we're talking about, they don't see it that way.

This is isn't the 70s where there was a greater understanding of what monetary inflation was. And so what will happen is they are very quick to get in these markets when all asset markets are going up, they can move in and drive the gold market up very quickly. And by the same token, when let's say gold or silver corrects, they are very quick to get out of it. But watch silver. Silver has been showing incredible, incredible strength. And as you heard in the second hour with Jeff Christian is last year was the first time since 1979 that silver investors turned out to be net buyers and the last time that happened, silver just went sky high and went parabolic. So keep your eye on silver on that. [42:05]

JOHN: Is it going to go opposite gold in this case, or are they still going to track together?

JIM: If gold goes down silver goes down, I mean, if you take a look at Friday. But here's a good example. Friday, we had gold priced down 10 to 12 bucks depending on spot or future and yet silver prices were only down about 35 cents. So silver is showing incredible resilience in this type of market, so keep your eye on silver. [42:31]

JOHN: You know if central banks are all inflating, obviously, they are not wanting to want gold floating up with that because that's a telltale give-away of what they are doing. That's sort of a bald faced admission. What about the negative gold crowd that's out there?

JIM: Sure. They'll use any kind of opportunity like this, “hey it's a relic, see, it's not holding up as a hedge.” I've already heard that story on the bubble channels. So, yeah, you do have the gold distance believes that always slam gold as a monetary relic. And in that category, I put the central banks and the bullion banks who basically implement central bank strategy in the market. So yeah, you have those people coming in.

JOHN: You know, we've been recommending gold since 2001, but we also admit that there are these periods when gold goes through some kind of consolidation phase and then after sort of a period of dormancy takes off and flies again. Is that what we're looking here, or some something different?

JIM: No. If you take a look at a chart of the HUI, the XAU, which are the gold stock indexes, or look at gold itself, that's exactly what's happened, John. We get these kind of two year consolidation periods, 2001, 2002, then we had another one at the end of 2003, really 2004, I would say 2005; and then we had another one that began in May of last year. So this last consolidation which began in the second quarter of 2006, if you take a look at the HUI or the XAU, we've virtually gone anywhere since last May. So I still think we have further to go and essentially as those whom Grant calls the opportunists continue to sell at the first sign of weakness that gold is drifting down and these guys are going to bail out of the trade which is very easy to do today. It's very easy for these kind of investors to sell a gold ETF or a silver ETF. And so at the first whiff of trouble, that's why you see these gold market pull backs. And so I think that goes to explain why gold and energy was not a hedge in February when let's say the stock and bond market sold off. It is because all assets have been correlated as a result of this liquidity wave. And it usually takes a while before that separates in gold and energy begin to travel along their own path. [44:58]

JOHN: And so given that, there must be a course of action. What should you do?

JIM: If you want to raise some cash and we are raising cash, even on our gold side, I would say I would sell the majors because that's the least growth aspect of this market. You know, I always make the analogy between IBM and Cisco and Dell and in this kind of gold bull market, your Newmonts, your Barracks are your IBMs; and your junior producers and your juniors are your Ciscos, your Dells and your Intels, so you might want to sell majors. Several of the intermediate type stocks – intermediate producers – are selling. And one of the figures that we try to watch and look for is when the market cap per ounce is much greater than the current spot price for a commodity – whether that's gold and silver. And several of the intermediates right now are selling at market cap prices . And several of the intermediate's, John, that we follow are selling at market caps per ounce of proven reserves that are, you know, I've seen one over 1000, 1100 per ounce; I've seen another one at 619; another company at 554, another company at 2800; another one at 700 and even an old line producer that is selling at levels that I never thought I would see. So, you know, you get rid of your stuff that is just overvalued, hasn't responded and you lighten up a bit on this rally because I think we will get a bounce back. But you really build some cash because there's going to be a great buying opportunity and when that great buying opportunity comes around, I want you to be prepared to add heavily; especially when the Fed gets ready to cut. That’s because when it does, maybe by the end of Q3 or Q4, gold is going to go higher and should take out the old record set back in 1980. [46:57]

JOHN: You know, it is interesting. We had Jeff Christian on a month ago talking about his gold book and now he's got a silver book, but he points out that this is the first time when we can say that the quantity of buying and the length of gold buying have really established a new record right here. This indicates something.

JIM: Sure. And it's because there is no currency that's backed by anything solid today. All currencies are fiat and that's why since 2001, gold buying has been going on at almost 40 million ounces a year. And it's global, John. And it's been back to back now going on for six years. We're going to have another record level of gold buying this year. And then as Jeff talked about in the second hour: for the first time since 1979, it's almost been 18 years now, silver investors have now turned to net buyers for the first time since 1979. So add those two pieces of information together, add together the talk that the information that we have on global money supply growth of double digits, in 18 of the top 20 countries around the word, and that tells you, I think it goes a long way to explain why there is such a large amount of gold buying and silver buying that's going on right now. [48:21]

JOHN: And I was thinking about a buy signal here. What is going to be the cue to do that?

JIM: I think in this next downdraft we're going to go through in the gold market and especially, John, when pessimism runs high, when you see the people on CNBC consciously pointing out how terribly gold goes and you start seeing the weakening economic numbers, the financial mishaps that I'm talking about, it will be time to back up the truck. [48:45]

Q-Calls

JOHN: And time to go back to the Q-line. We're www.financialsense.com.

Hi, Jim and John, this is Richard calling from Buenos Aires, Argentina. I love your show listen to it every week. I can't live without it. Keep up the good work. Here is a quick question for you. I own about a million shares of a Canadian gold exploration company that I bought from US online discount broker. When the price of each share goes well over a dollar, I'm considering selling all of the shares. What's the best way to do that? Going back to the discount broker, putting in a limit order perhaps or going to a company itself and asking management if they would like to buy back the shares or if they know of an institution or an individual that would buy them. Looking forward to your comments. [Spanish]

JOHN: [Spanish]

JIM: Richard, a couple of things you may want to consider. Number one, I don't know what volume is in the junior mining stock that you have. So you've got to be very careful there. If you've got plenty of volume and you have a big volume day, that's the time to unload it into the market. You may want to call the company. They may have a large shareholder, for example, that may want to do a cross trade. They might be able to place it for you. That's another reason. But I’d be real careful that they don't play a little game with you and knock the price down to take that cross trade. I had that happen to somebody else. But, you know, unfortunately, I don't know what volume is, but look for big volume days, look for a big volume day that let's say gold goes up, we get a mini rally and maybe your stock that you own goes over a dollar, if volume picks up, that's the time you want to unload your share. And if you can do it on a high volume day, I'd stick with your discount broker. [50:36]

Hi, Jim and John, this is Dan from Connecticut. I was wondering if you or one of your guests could comment on the price pattern of silver and gold. Basically for the past two years it's obvious they've been following a very defined upward trend line, and last month I was surprised to see that they broke below that for the first time. So I was wondering if this is something we should question concern about or what your thoughts would be. Thanks. I love the show.

You know, what they are basically doing and remember, listen to the previous segment where I talked about what has happened to gold as a result of what has happened with momentum traders or what James Grant calls the opportunists. We've been in the consolidation pattern. And I don't care if you're looking at gold, looking at the HUI or the XAU, we've been that way since May. And we maybe going a little bit lower here and continue that consolidation pattern a little further for another couple of months and it may not get stronger until we get into the fall. [51:28]

Hi, Jim and John. This is Dave from Rochester, New York. My wife has a beneficiary IRA, primarily in two behemoth mutual funds which have done quite well over the last two years. One is made up primarily of US stocks, the other one more internationally focused. Her financial planner who is a family friend doesn't recommend individual stocks and he says don't try and time the market and in the long run you'll be happy. I don't necessarily agree with that philosophy, but I'm concerned that these funds are so large they are almost unmanageable and will pretty much follow the overall market. I know you've been moving your overvalued stocks to cash. She doesn't want to move her overall IRA, but she would be willing to move it into a more conservative fund or money market, at least a portion of it, and wait for a buying opportunity. My question is do you think that's a good time to do that, or should we just depend on the fund managers to do their best. Thanks. Love the show.

JIM: Dave, the fund managers are going to be primarily fully invested and you're absolutely right. If the indexes go down they are going down with it because they are fully invested. Also cash levels of mutual funds are down to 3 percent, the lowest level that we've seen since the year 2000. Perhaps if she doesn't want to move them, maybe what I would do is wait for this rally back as we get closer to the end of the second quarter because we play the asset shuffling and earnings game which might be a time to move out of the mutual funds and move some of that over to cash. [52:54]

Hi, Jim, this is Paul from Atlanta. I would just like to get your opinion on ETFs especially the pros and cons versus mutual funds and how the average investor should use them in their portfolio. I'd specifically like your thoughts on Barclays Ipass [phon.] Dow Jones AIG commodity index (DJP). It seems like that might be the best way for the average investor to invest in commodities. Anyway, thanks for your help, listen to the show every week.

Paul, I think for the average investor ETFs are the great way to go. And the reason I like them over, let's say, a mutual fund – although we tend to be individual stock pickers – an ETF allows you to trade in and out of the market throughout the day unlike a mutual fund where if you wanted to get out of a fund, you'd have to wait until the market closed and you'd get out at the end of the day. So an ETF allows you to trade at any time. The other thing is there is a whole bunch of ETFs out there that let you invest in individual sectors. You can an get ETFs with individual commodities or you can get the commodity one you just mentioned. You can get ETFs invest strictly in oil, gold, silver, you'll see one in uranium. You'll see them in coal and other metals and then also in specific sectors. For example, I love energy, there are plenty of ETFs specifically in oil services, the international oil companies. So it's a great way to diversify, the expenses are lower and you can get out of them at any time you want. [54:23]

Hi, this is Jason from Southern California. I have a few questions. I'll keep it short. I've been reading some you have your stuff about Austrian economics. I listened to that guy's speech you had posted some time ago. I was wondering if anyone has ever actually implemented the policies suggested by Austrian economics in a country for any extended periods of time or comprehensively probably never totally, but with or without a central bank and how that has worked out historically. I'm also confused about your definitions of democracy and republic. You've been saying we're more of a democracy and less of a republic than we used to be. But I've been taught that a republic is you have representatives where you have a Congress or a parliament or whatever and that seems to be what we have. I haven't seen that disbanded. I'm wondering what your definitions are that you would say we’re more of a democracy that we used to be. The same thing with Venezuela. I mean Hugo Chavez is elected. You can disagree with his policies, but his policies, if he's been elected it seems to me he's actually a republic or some form of democracy. So I was wondering if you could clarify your terms in that and again has Austrian policy ever been implemented in any comprehensive way and what happened. Thanks.

JIM: I would say the closest thing that we had to Austrian economics was classical economics in the 19th century when we were on a gold standard. We moved further and further from Austrian economics as we moved into the 20th Century, especially as we went through what we did in the 20s and 30s; and especially in this country with the adoption of a central bank. Once you adopted a central bank it's very difficult to have Austrian type policies because central banks are designed to inflate an economy.

Now, when I say we're moving more and more towards democracy, if you take a look at a lot of the lays that Congress is passing about equal outcomes, equal opportunities and where you have Congress now and the public more and more the public is on the dole feeding at the trough. And one of the dangers of republics is as they move or they discover that they can vote at the voting booth benefits for themselves, and lay the cost of those benefits on somebody else. A good example is what's going on right now. There's a Democratic bill to raise a surtax as much as 4 or 5% on people making income over $200,000 to pay for other benefits for somebody else. I mean so that's what you tend to see in a democracy. And as far as Hugo Chavez, yes, you're absolutely right. He was elected president, but since he's become president, he's turned that presidency into a dictatorship. Much in the same way Adolf Hitler was elected chancellor but he ended up becoming a dictator using his power as chancellor to become a dictator just as Hugo Chavez has.

JOHN: Yeah. Hitler had to convince president Von Hindenburg to give him emergency powers too.

JIM: Just as, by the way, Chavez did.

JOHN: So it's not a question of how they come to power. It's how they behave especially towards what we would call in our country constitutional rights, freedom of speech, freedom of the press, who control organs of speech in the country, the newspapers, the media; who controls the monetary policy, is it the parliament. Maybe the core policy is who makes the decisions, they or the parliament, or does the parliament just rubber stamp what they are doing. Again, the question is it what do they do after they achieve power. Also what do they do in the area of the preservation of rights especially of opposing parties. And Chavez right now is working very hard to shut down responses, organs of television and newspapers on behalf of opposing parties. He’s doing basically what dictators want to do. It's really sobering when you understand the Holocaust and the Third Reich were all legal events sanctioned by the legal governing body at the time, the Reichstag, which then began to consolidate more power in the hands of Adolf Hitler.

JIM: The other thing regarding the Republic, I think our founding fathers, in fact, I just watched a documentary last two weeks I've been focusing on the Constitution and the founding fathers. And I think that they would be turning over in their grave when they think of our fiat currency. A central bank which, you know, for the first almost what, 100 something years of our republic, we fought against and especially for example, Andrew Jackson who fought dearly to get rid of the central bank; and the ills it has brought in ever since we put one in place. The other thing is a lot of the laws that were enacted under the great depression are unconstitutional. So we've moved further and further away from a republic. [58:59]

JOHN: What most people don't understand is there was a bill passed in 1917 which was called the Emergency War Powers act. This was amended by Franklin Delaware Roosevelt in 1933 and a lot of the government programs today, if you check with Congress, Congress regularly renews states of war or emergency. This is done all of the time either by the president furthering a declaration of some emergency somewhere, or there are other things which were set in motion in the past. That is to get around the constitutional restrictions on these areas. This is how it's done. This gets around the 10th amendment restrictions on a federal government that says those powers not specifically given to the federal government are reserved to the states or to the people respectively. And the way they do the end run on this is there are provisions in the Federal Constitution which allow for emergencies and other related issues. And so we have these little on going states of emergency that are regularly declared either in presidential executive orders or by the Congress which allow this ongoing end run around the Constitution.

And look at our money supply. Remember the Constitution says that Congress shall make no money. I can’t quote directly here – but basically backed by gold or silver. Well, how did they end run that one? They created the federal reserve bank and said we won't make the money, we'll let a private bank make the money. That's how they got around the constitutional provision there because the intent of the founding fathers was that we should have a gold-based currency. So much so that they built it into the Constitution of the country. And the third way is to dangle the golden carrot in front of the states for example, the federal government is totally unconstitutional for it to be involved in education. Never the less we have a department of education. How does it coerce its will upon the states? it can't mandate things into the states in education. But what it does is it givens the states money and holds out the golden carrot and says if you want the money, you will do such and such and you hear teachers complaining, “oh, Bush's policy on No Child Left Behind, they are making us do this and that.” No they are not. Just don't take the money. So that's how we've been sliding from really what is a republic into what looks more like an active democracy where mob rule takes place. And in 250 years doing a large number of end runs around the Constitution by all sorts of little artifices of law. [1:01:15]

All right. Back to the Q-line.

Hello, Jim and John, this is Don from Crystal Lake, Illinois. Thanks for taking my call. John, I know you said to keep the call brief, so I'm going to rapidly fire off five questions for you, Jim. This is easier then just calling you back five times. First question, you've talked about investing in consumer staple stock. There’s a global ETF KXI is the symbol, is that something that you're referring to. Should I been investing, should we be looking at the global consumer staple ETF KXI. Your thoughts on that.
Second thing is I came across an interesting investment, a unit investment trust that is made up of all shipping stock. Dividend yield on this thing was 9%, which is the next best thing to Canadian energy trusts. I want to know what your thoughts were on shipping stocks so you can comment on that, please. Third thing is speaking of Canadian energy trust, master limited partnerships here in the US, centered around energy, natural gas and oil. I haven't really heard you talk much about the master limited partnerships here the US. These are dividend yields and certainly participating in a sector that you love, so maybe you can dedicate a show on many MLPs here in the US, our version of Canadian energy trust, wonder what your thoughts on that.
Fourth question, uranium stocks, is the party over, should we be liquidating our holdings, taking some profits, I've got anywhere between a 35% gain and a 100% gain in some of the uranium stocks that I own. I want to know if you think I should keep my eyes closed and invest for the long term in uranium, or is it this is more of a speculative play and I should be looking at taking some profits and trading this sector for when than buying and holding like you suggest in gold and silver.
Last question maybe more of a comment. We've had an inverted yield curve in the US for quite some time now and there's only been four time in history, Jim, I’m sure you're aware of this, where the yield curve has been inverted for more than six months. And in all four occasions, short term bonds have appreciated one year after the yields curve had straightened back to normal. On average of 9%. The standard deviation is very, very small, those four year periods, I think the worse return was about 8.9 and the best return was about 9.9. And of course US stock, the returns after the yields curve went from being inverted to more normal again – the returns were all over the board and the four different occasions. So rather than owning cash and money market funds, I want to know if maybe you would recommend or advise moving to a short term bond fund. And I guess I'm kind of limited term treasury yield bond. Thank you for taking my call.

JIM: Wow. Let me see if I can remember all of those, Don.

JOHN: I'm going to go get a soda, Jim, I'll be back.

JIM: Don, let's get to your first question investing in consumer staple stocks, the ETF KXI is IShares Global Consumer Staples, that's exactly the type of thing I'm talking about – although it got hit here recently with the sell off that we've seen, so, you know, even consumer stocks can go down a bit. But you're certainly not going to see the big sell off in consumer staples as you would in other sectors of the market. So your KXI Is exactly what I'm referring to here.

Unit shipping cost, you've got a yield of 9%, a lot of the shippers are master limited partnerships out of the Caymans, shipping is very, very strong right now. Although, if we get into economic weakness and the Baltic Freight index starts to come down, you can see the shippers come down, so if you're going to invest in that area, keep your eye on the Baltic freight index. Master limited partnerships here in energy, I think that's the up and comers and we will be doing a show on it. We like them. The only thing we don't like about them is the K1s they always send out and correct right around tax time when you're waiting to have them and they come out late.

Uranium stocks have gotten a little bit frothy here. Uranium prices are at 138 bucks. But I do think that as long as the price of oil keeps going up, you're going to see the price of uranium go up and also this is an area that hedge funds are moving in and accumulating. So you have to be a little bit careful and then a question on short term bond funds.

If I was going to be in the bond market, I would be in one year Treasuries or short term bonds, but I think you can wait a little bit here before you start jumping in short term bond funds. Follow the charts and I would suspect if you look at the chart of these short term bond funds, they took a tip this week just like long term bond funds. So Don, I hope I got all of those answered for you. [1:05:52]

Hello, gentlemen, this is Adam from New Haven, Connecticut. Thank you so much for all of the hard work and all of the research and all of the effort that you put into your show. I do have a question about interest rates. Over the last several weeks I've heard you mention that rates are going to be going higher and that the Fed might lower short term rates to stimulate the economy once they've proven that the economy is in a recession. Can you please tell me whether rates are going to increase or decrease in the short and mid term, short term being the next three months and long term being the next year. Thanks very much and keep up the great work.

JIM: Adam, in the short term, short term rates will remain the same because the Fed, I believe, will leave the Federal Funds Rate at 5 ¼, but in the short term, long term rates are going to be going up. In terms of mid term, once the economy starts to weaken, you will see the Fed start to lower interest rates. They, you know, that's probably not going to happen until we get into the end of Q3 or sometime in request 4. It's going to become very obvious to the Fed by the end of the year, we're into the going to be hitting the growth targets for GDP that they are anticipating. [1:07:05]

JOHN: It's interesting, Jim, we're out of Q-lines for today, but I was thinking about the question about emergencies and how unconstitutional things are done legally. And I remember in Colorado, there was a provision in the state Constitution that said that all referendum referred to the people for election are final and the only exception to that was where the – and this was intended for like states of emergency, the imminent health and safety of the people in Colorado is in jeopardy. And so what happened is the Colorado state legislature and does to this day on every single bill puts a little thing down at the bottom that says this is for the public safety and health of the people of Colorado, which means this bill cannot be taken as a referendum to the people. And originally, the founders of Colorado had intended that votes referred to the people would be final and override anything that the state legislature does, so that’s how the game is played. Next week what are we looking at on its program or the weeks to come?

JIM: Well, a couple of things. Next weak David Holtzman is going to be my guest. He's written a book called Privacy Lost. June 23rd, to be announced, we had to do a little shifting around this week. Jeff Christian was going to be my guest on June 23rd, but we had one guest that couldn't make this week's schedule. He is doing a lot of traveling, so we don't know if we're going to get him back, so June 23rd is unannounced. I'd love to get Ron Paul. We're trying to get him on the program. So far not any luck, but we're going to keep trying. June 30th, Jim and John are on vacation; July fifth, we have no idea. So we're trying to find a guest for that slot; July 14th, Basil Gelpke, he's the producer of a film called A Crude Awakening, it's about a 50 minute documentary on peak oil. Fascinating and recommend if you have a chance to pick up a copy and watch it, it's definitely worth your while. But Basil Gelpke, the producer of A Crude Awakening will be my guest July 21st. Richard Bookstaber, a book called A Demon Of Our Own Design and a couple of surprises that we're working on. We don't want to announce them because we don't know if we can pull it off. So lots of stuff coming up on the weeks ahead. In the meantime, we're out of time, so 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.

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