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Financial Sense Newshour

The BIG Picture Transcription

March 8, 2008

Part 1

Lessons From the Mortgage Mess

JOHN: Well, there’s nothing like 20-20 hindsight. But sometimes hindsight applied in a proper, constructive manner is worthwhile. Loeffler’s Rule of Thumb #54 –I think I should get this copyrighted, Jim – is: If they didn’t see it coming, they won’t know what to do when it gets here. Which is a corollary to Rule #55: Never appoint the same people to get you out of a problem that got you into it in the first place. I guess if they knew what they were doing you wouldn't be here.

So what are the lessons that we can learn from this whole subprime mortgage issue. Obviously, there are things that can be drawn from this for future financial investing etc. etc. etc.

In this segment we’re going to examine the mortgage mess; we’re going to try to put this in perspective relating it to the economy, its impact and how this will actually impact the markets. And a lot of information that we’re going to discuss is actually a compilation from several reports which have been released recently that frame the issue.

JIM: The one surprising issue about the mortgage mess – and you remember when the bubble was being created, when the Fed slashed interest rates they kept them artificially low and that’s what caused the real estate boom and the mortgage mess. And remember all the politicians who were praising the fact that homeownership in this country had gone to the highest records in history. And they were praising the government agencies that were making the loans. And when we were going through the boom everything was okay, but we knew that this boom was artificial. What has been surprising when the Fed began to raise interest rates in 2004 at the same time they were urging people to get variable rate mortgages – you remember the Greenspan speech?

JOHN: Yup.

JIM: Is the delayed effects of the credit crisis on the markets. In fact, it was right about this time last year, remember February of last year when we had some of the first intermediary financial lenders go bankrupt? We had a crisis in the month of February, the market went down and then it was over and everybody said, “all right, that’s it.” Bernanke said: “uh, maybe we’ll lose 50 billion to 75 billion in the mortgage mess.” But it was not until the last half of last year and then the beginning of this year that it has become a concern. Now it’s front page headlines almost every single day. [2:32]

JOHN: You wrote about this problem though in a four-part fictional piece if you recall back in 2005 when we were talking about this a lot. It was called The Day after Tomorrow and you talked about the issue again in December 2006 in another piece called The Next Rogue Wave, so if you could see this there were reasons why you drew these conclusions long before they became the center of talking piece everywhere. What was that?

JIM: Well, there were a number of things and it began in 2000. We saw a recession coming at the end of 99 and 2000 and we sold all of our technology stocks at the end of December of 2000 and began positioning for what we saw coming. I was in a house at the time and I remember we saw a recession coming, and typically in a recession real estate leads the downturn just like it did in 91– just as it has done in the last year or two. But in 2000, I saw my next door neighbor – I was pulling out of my driveway one day – and all of a sudden a for-sale sign went up with a sold sign. In other words, he listed his house and sold it before the real estate agent could even order a sign to put in his front yard. And when I talked to him about the price that he got on the house, which was almost 2 ½ times what he paid for it in three years I said this is nuts. And so we put our house up for sale – at that time I was going to build a custom house out in the country; I had a ranch that I had bought. And it was just kind of nuts.

But, John, what we saw during that period of time is during the recession instead of real estate going down, real estate began to go up and that was because the Fed was slashing interest rates bringing them down to levels we hadn’t seen in half a century, and this whole boom cycle in real estate - in other words, we had a deflating bubble in technology and the Fed was creating another bubble in real estate to take its place. And consumers were going out and doing nutty things; unlike the recession of 91 where Greenspan brought interest rates down, the average consumer refinanced their home and started paying down debt. During the recession of 2001, the opposite happened. Yes, they refinanced their home as interest rates came down but then they began to spend more. And so there was something different during that period of time.

In 1993, there was a development here near our office that they began clearing and it was a huge development. I gave it a fictitious name and I called it the Big Sky Ranch. And when I saw how nutty things were going because there were ten homebuilders in the development area and I would talk to them. I would go on weekends and I was just kind of curious and it was amazing to see the prices of homes. I’m talking about homes on postage stamp lots that were starting at ¾ million dollars. And it was rather interesting when I began to write my piece on The Day after Tomorrow it was actually based on characters that I had met, interviewing salesmen like I think one of the people I used I came up with Erica Barry; she was actually a salesperson for one of the builders and I had long conversations with her on several occasions over a six month period of time.

I also interviewed the lenders at that time, I called them Citywide; it was actually Countrywide. And I can remember talking to the Countrywide lender and Countrywide was pushing variable rate mortgages, interest rate only, and negative rate amortization loans. And I can remember the Countrywide guy telling me, “look, in California most people only keep their homes three to five years. Why would you want a fixed rate mortgage? Why would you want a 30 year mortgage and pay almost twice as much in interest rates when you can a variable rate mortgage for half the interest rate which would enable you to buy a bigger home and add more options.” And that’s why I began to write about this and then I came up with a hedge fund character. But I had never seen anything as crazy.

I mean this was crazier than the real estate boom that we had at the end of the 80s that led to the S&L crisis. At least back in the late 80s and the early 90s lenders were still requiring down payments. I have a friend who is in the mortgage business, he works for one of the nation’s largest banks, and the stuff he was telling me about…in fact I came up with this fictitious couple I called the Wheelers who were actually based on a compilation of a couple of couples that had refinanced their home several times with my friend and the things that they were doing. And it was just absolutely amazing and you just knew that when you started making loans requiring no money down, requiring no documentation, interest only or negative amortization loans, you knew that sooner or later –and especially when the Fed began raising interest rates – this wasn’t going to end well. And now we’re starting to see the consequences of all this nonsense. [7:48]

JOHN: So basically what you were writing about there was really a real world analysis because these were real people that you were writing about. You simply changed the names to protect the guilty, I guess, in this case. All right.

Let’s look at the situation of how this all came about. What were the dynamics of it and it’s really fictitious to have people say they really didn’t see this coming. They knew what they were doing.

JIM: Yeah, the first thing to understand about the current problem is it’s mainly concentrated in a sector of the market, mainly financial institutions with exposure to mortgage securities. That’s why, for example, there are elements in the economy that are still doing well, in other words, exports. But if you take the current estimates I’ve seen in several reports they’re putting the losses in this mortgage market somewhere around $400 billion with half of that amount being born by leveraged financial institutions. The result will mean a substantial reduction in credit to businesses and to households. And this has a lot of variations and themes that are going to play over in the investment markets which we’ll get into in the next hour. [8:59]

JOHN: Okay, if the losses are going to be ranking somewhere around 400 billion, somebody is going to be holding this hot potato when everything settles. Who’s that going to be?

JIM: The brunt of the losses are going to occur in the financial intermediary sector, mainly banks, broker-dealers and hedge funds because remember banks changed their investment model from making a loan (sitting across the desk looking at the homeowner and keeping the loan on the books) to just basically repackaging the loan and selling the loan; Wall Street would come in, securitize it and slice it and dice it.

And this whole structure of finance is mainly contained at the present time between banks, broker-dealers and hedge funds. And as a result, these entities are going to deleverage over the next few years and that’s why you’ve been seeing some of this play out in the market in the next hour as they face large capital losses. I mean I think the figure has been somewhere around 100… we’re almost close to 200 billion that we’ve written off so far. So these institutions are going to be forced to scale back their leverage and try to rebuild their balance sheets; and what that will mean is they will be reducing leverage on their balance sheets to the tune of somewhere around two trillion dollars of which roughly 900 billion would represent a decline in lending to households. So the net effect is going to be a reduction of credit to businesses and consumers resulting probably in a reduction – I’ve seen figures that depending on whose study you’re looking at, but a reduction of GDP growth in approximately the 1 to 1 ½ percent range. [10:43]

JOHN: So number one, we really haven’t seen the ultimate impact on the economy; and number two, couldn’t we actually say that this is the multiplier effect in reverse. Would that be a fair statement?

JIM: Oh, very much so and we’re going to talk about how this deleveraging takes place, how the debt-to-equity ratios are almost like a constant. In fact, there was a report released on Friday which we’ll get into here in just a moment…

JOHN: But you know, Jim, when these things go over the edge so to speak. It’s amazing how you can actually see this coming. It’s almost like the collapse of the bridge. If you go up and look at the joists and where everything goes together and you check them out and you see them rotting, you can predict what’s going to happen. But when it does happen it happens quickly – that’s the funny part. And it’s always some unusual little thing that triggers it that nobody expected. So what was the trigger point for this?

JIM: It basically gets down to real estate. I mean real estate prices had gotten so expensive that they were using these creative mechanisms to allow the subprime borrowers to get in because people couldn’t afford to buy homes. So it gets down to real estate. You had the Fed raising interest rates which meant mortgage rates went up, which means mortgage resets went up, and real estate –the higher interest rates go, the lower the price of real estate has to counterbalance that, otherwise people can’t afford to buy. So the drop in prices as the boom turned into bust was a result of Fed rate hikes which turned the problem as it spilled over into the mortgage market.

And we had a harbinger of things to come last February, but the real crisis began on August 9^th of last year when a large European bank announced it would close three investment funds because it was nearly impossible to evaluate the underlying assets. That was what triggered it, and a couple of days later the Fed reversed its policy within almost a couple of days of an FOMC meeting and they slashed the discount rate by half a point. This event triggered an intense examination of investor exposure to risk. In other words, up until this time investors were very complacent, risk was not being priced in the market place and the problem spread because the loans under scrutiny were embedded in a wide variety of securities from SIVs to commercial paper to CDOs to Auction Rate Securities. So the problem began to spread from subprime to jumbo loans to Alt-A mortgages to asset-backed commercial paper, SIVs, CDOs, Auction Rate Securities – one domino after another.

In fact, in the case of jumbo loans, roughly 50% of jumbo loans were tied to homes in the state of California. And we talked about this for years on this program, the prices of real estate in southern California and elsewhere: It was just nuts! Imagine a starting middle class home for ¾ million dollars. How do you expect people to afford to make payments on a home like that. [13:46]

JOHN: Yeah, especially a young family trying to get started or something like that. It seems like the American dream in that category just began drifting further and further back. But it also sounds like with the inability to really properly evaluate assets what started to happen there is the credit market just began to seize up at some point.

JIM: That’s exactly what began to happen last August. It hit the commercial paper market hard even though the majority of paper in the market was highly rated. The problem here was investors were having difficulty in evaluating the credit quality of the underlying assets. And remember, they’ve been so sliced and diced and redistributed which also brings up a problem in terms of the latest Fed move to ask banks to forgive mortgages. So the issuers were confronted with the inability to roll over maturing paper. This is what happened in the commercial paper market. This led to either 1) forced liquidation of assets or 2) the triggering of backstop credit agreements with the banks.

And we’re going to get in this in a second because normally when you go through a bust what happens is financial institutions begin to deleverage their balance sheet; that did not happen this time around because of all of these backstop credit agreements with leverage buyout companies, with commercial paper, with SIVs. In other words, instead of contracting the balance sheet, banks expanded their balance sheet because they began to take on credit. They did it reluctantly because they had made these agreements and they had to honor them, but at a time when banks would typically contract their lending and their balance sheets, bank balance sheets expanded. And as these assets came back on to the banks’ balance sheet, banks began to tighten lending standards which is what you’ve seen in Fed loan surveys of banks. Everywhere you look – whether it’s commercial lending or residential lending or even in the credit card market banks are tightening lending standards all across the board. [15:45]

JOHN: Explain backstop for people who may not understand that.

JIM: Backstop might be something where let’s say you’ve got commercial paper that is being financed and if it can’t be rolled over there is a sort of like an emergency credit agreement with the bank that if you can’t roll it over the bank will step in and lend the money. Or you might have the deal going with a leveraged buy out, if you guarantee the leveraged buy out firm of your credit commitments, so even though the bank which would typically raise the money in a bond issue and sell it to investors, if they can’t sell the bond to an investors then the bank has to take the loan onto their balance sheet. So it’s kind of like an emergency credit line. You might call it like a home equity line. It’s there in case of emergency but once it’s put in place and agreed upon the banks have to follow through whether they like it or not. [16:36]

JOHN: It’s almost like an insurance type policy that guarantees and provides some cushion in there it would seem like.

If we look at the last crisis that we ran into in real estate, this was back in 1991. Here we are 15 years plus later, what makes this crisis different?

JIM: I think there are a number of issues but I think probably the major difference this time around is that the securities market was a dominant source of intermediation as a result of this securitization of these mortgages. Remember, we moved from the days when the bank would sit across a desk, you would look at a loan applicant, you would look at their personality, judge their character, you would make the loan and the bank would keep that loan on the balance sheet. This time – and especially with structured finance – banks basically went into an underwrite-and-distribute mode. In other words, they would make the loans but as soon as they made them they would sell them to Wall Street and they were repackaged into various kinds of mortgage securities. So I would say securitization of mortgages is probably what makes this crisis different than the one back in 1991.

JOHN: Does the person who is paying on the loan, do they know that the loan has been sold or securitized or is it the bank still processing the paperwork every month?

JIM: Most people will see that their loan has been sold to somebody. You’ll get a notice of that, but the banks quite honestly didn’t care. They were making the loans. It was like a manufacturing mill: You made the widget and the widget went out the door and it was sold.

JOHN: That was all they cared about because the process just kept on going okay.

JIM: Yeah, because the more loans that they made the more fees they would make.

JOHN: This would seem to be sort of an unsustainable type of situation so why did it take so long for this thing to really unravel?

JIM: I think if you take a look at how this whole structured market is set up, once again the bulk of the damage so far has been confined and concentrated in financial institutions. Who do you see in the news writing the big write-offs? It’s the banks, it’s the brokerage firms, it’s hedge funds, it’s the bond insurers that got involved in this. And here’s the other thing too, as a result of securitization because the assets were so dispersed it took longer to unfold as problems in one area spilled over into another area. In other words, there wasn’t some large bank or institution that held all the loans because when you securitize something you sell it to pension funds, you sell it to investors, you sell it to mutual funds, you sell it to insurance companies. And it was global, it just wasn’t our financial institutions buying this. Foreign financial institutions were buying it. And it wasn’t until something called the TED spread began to rise dramatically that things began to get worse. And just to explain: the Ted spread measures the difference between an unsecured deposit like at a bank rate and a rate on government-backed obligations. And the rise in the TED spread, in the second half of last year rivaled and surpassed the crises that we’ve seen over the last couple of decades, including Long Term Capital Management, the Peso crisis, the Y2K crisis, the crisis of 9/11 or even the 90 and 91 S&L crisis. Then the other thing that you had is a lot of these mortgages were priced according to an index, the ABX indices, which began to plunge. And all of this led to various knock on effects. [20:06]

JOHN: Well, it sounds like far from being contained right now it has really turned into almost spreading disease-like contagion. It’s spilling over into the real economy; you can see credit tightening. Weird things are going on. I mean people who are trying to make loans are trying to figure out why prime is going down but the loan rates are going up. And it’s becoming harder for businesses and consumers to get credit, so now the economy of course starts to contract on the basis of that if they can’t get the credit, if they can’t get what they need to do on their jobs etc.; and we’re now into really a recession. So, where are the big losses? And ultimately somebody’s got to be stuck with this when the music grinds to a dead halt. Where’s that going to be?

JIM: You know, as best as we can guess right now, it’s mainly the leveraged financial community. Most of the mortgages originated before 2004 should be okay because things didn’t get goofy when interest rates were low. Prior to 2004 banks were asking for down payments, they weren’t going to the negative amortization loans, the interest only loans, the exotic mortgages, no-doc loans – they came in during the Fed rate cycle. In other words, the Fed began to raise interest rates in 2004 and as real estate prices continued to go up that’s when these exotic mortgages came in to allow the boom to continue so that people could get in to homes even though they were going up and interest rates were going up. So the problem is contained primarily in the mortgages that were issued between the years 2004 and 2007. There’s where the problems are. And when the Fed raised interest rates in 2004, banks shifted to exotic loans, they lowered their lending standards and the basic issue is that as home prices decline it’s created large amounts of negative equity. You heard about Bernanke this week that in order to create positive equity he wants banks to forgive mortgage debt so that homeowners can get some equity:

When the mortgage is under water, a reduction in principal may increase the expected payoff by reducing the risk of default and foreclosure.

Homeowners, as you know, with negative equity can’t draw upon their capital gains to buffer or cushion against adverse financial effects such as a homeowner losing a job or, for example, a variable rate mortgage is reset. How are you going to finance when you have no cushion in your house? In other words, you don’t have any equity because the house is worth less than your mortgage on your property. And it estimated that a 15 to 20 percent decline in housing which we’ve seen certainly here in California is going to put somewhere in the neighborhood of 2.5 to 2.6 trillion in mortgage debt under water. So what you’re seeing are default rates set to escalate over the next three to four years. It’s probably not going to be until housing finally stabilizes that this trend reverses itself.

We saw this very same thing play out in the early 90s; from 91 to almost 96 here in California you had housing prices declining and mortgage default rates going up. So real estate plays out over a much longer cycle. In fact, there was a report that came out this week, last year mortgage foreclosures rose to an all-time high, new foreclosures jumped to nearly one percent of all home loans in the fourth quarter from a half percent a year earlier, and 40% of these foreclosures were subprime, another 23% were loan modification mortgages. So all of this exotic stuff that was used between 2004 and 2007 to extend the boom is now starting to unravel. And that’s where the problems are. [24:00]

JOHN: Isn’t the real problem that the lenders really pushed the limit by overstretching buyers to get into homes which they really couldn’t afford; or we had property flippers, remember that? That was one of the big things driving this. And the banks were generous and they overextended the credit because the property flippers assumed we’re going to move into this property for six months even if they don’t physically move in, and we’re going to move out and we’ll make 100,000 or 200,000 on the flip; and that was it. And then of course the whole thing came sort of crunching down at some point.

JIM: Basically what happened is as property prices rose the financial community – banks, lenders – came up with creative loans and looser lending practices that were used to qualify buyers. That was the only way you could do it. “We’re not going to ask for three years worth of tax returns to verify what you said you earned last year.” Can you imagine making loans on a home and not asking for tax returns to verify income. And that’s what’s starting to backfire. So assuming politicians don’t make matters worse –and then of course in an election year that’s a big, big ‘if’ – it looks like total losses in the mortgage arena should come in or around 400 billion. And most of that is going to be concentrated with leveraged US financial institutions which hold approximately 50% of that debt. [25:22]

JOHN: If we say that 50% of this is being held by financial institutions what are they?

JIM: And these are just rough guesses from various people that looked at this: banks are sitting on roughly about 5.6 trillion, you’ve got savings and thrift institutions at 1.2 billions; credit unions roughly about 400 billion; broker-dealers a little over 200 billion; and government GSEs are sitting on almost one trillion. [25:53]

JOHN: Wow, that’s quite a bit.

JIM: A trillion here and a trillion there, pretty soon you’re talking about real money. Wasn’t that Everett Dirksen that once said that. “A billion here and a billion there.” It just goes to show you with inflation now we talk about trillions.

JOHN: Yeah, it’s like what’s his face, John Maynard Keynes: “In the long run, we’re all dead anyway.” I guess that’s it.

Well, where is this all taking us?

JIM: Well, I think it’s very important to understand here if you want to look at what’s happening in the market is that there is a cyclical nature to leverage. In good times, balance sheets expand within the financial sector; leverage increases when balance sheets expand and conversely in bad times leverage decreases as balance sheets contract. The problem we face is that balance sheets have not contracted this time around. And the reason behind that is the lending crisis evident in the interbank market. In the fourth quarter of last year, banks – as I mentioned earlier – banks did not contract their balance sheets and that’s because they were taking a lot of these credit instruments back on to their balance sheets, whether it was SIVs, commitments on leveraged buy outs, commercial paper credit backstopped. So banks had to honor these loan commitments with back up credit on everything from LBOs, SIVs and more debt was added to the balance sheets instead of contracting the balance sheets. And that is what has yet to unwind and is in the process of unwinding. [27:30]

JOHN: Yeah, if this is a cyclical type of process then what are the stages in it? How does it look when we go around it?

JIM: Let’s just take a look at a simple cycle. When you’re in a bull market, in other words, assets are going up –whether it’s the stock market or real estate. Let’s confine this to real estate. In a bull market assets appreciate in value and the financial sector is a very heavily leveraged sector, whether you’re talking about banks, broker-dealers, hedge funds, financial intermediaries, credit unions, savings & loans, they are leveraged. And a very simple example is – and these are just some benchmark statistics I’m going to give out but banks are leveraged typically 10 to 1, meaning for every dollar of equity they have about 10 dollars of debt supporting their balance sheet.

And let me give you an example. We’re just going to keep this mathematically simple. Let’s say a bank has $100 worth of assets and those assets include securities, loans etc.. Now, on those $100 worth of assets, the bank has a leverage factor of 10 to 1, so they have $10 of equity and $90 of debt. Now, let’s suppose those assets of $100 go up in value because of appreciation in a bull market – let’s say real estate markets go up, security values go up, etc. Now let’s say the security value goes up to $101. Now the back has $90 of debt against $101 of assets, so bank equity has gone up $10 to $11. Now if a bank wants to maintain that leverage ratio of 10 to 1, if their equity increases by one dollar, then what they do is go out and buy another $9 worth of assets. So now the bank has $109 worth of assets and $11 worth of equity. And this keeps compounding. If equity increases to $12 then they would add even more debt on the balance sheet because they keep this constant ratio of 10 to 1.

The problem is: what happens if the assets start to contract? In the example I gave of $100 worth of assets rising to $101, if the value of the assets dropped back to $100 then what the bank would do is shed the $9 of assets they expanded on the balance sheet when their equity was rising. So just as balance sheets and leverage go up when assets are appreciating, conversely in bear market, or a bust, bank balance sheets must contract if they want to maintain that same leverage ratio. Because banks are so highly leveraged that’s why when you saw these huge write offs announced by the brokerage firms and Citibank they immediately went out and raised equity so they could maintain that equity balance and that leverage ratio. [30:45]

JOHN: So if they need to deleverage what does this mean for the financial markets and the economy and how is it going to get resolved?

JIM: Well, there are a number of ways that this can get resolved – there’s actually three ways: 1) banks and brokers can track their balance sheets sufficiently that their capital cushion is once again large enough to support their balance sheet - in order to they deleverage, they get rid of the amount of debt and the amount of assets; 2) banks or brokers raise sufficient new equity capital to restore the capital cushion and a large enough size to support existing balance sheets – and that’s what we’ve seen. Every time, whether it was Bear Stearns or Merrill Lynch, it was Citigroup, any time they were ready to announce huge write offs you notice that before they even announced the write off and the size of it, they said, “oh, we went to Dubai and we got $7 ½ billion from the Saudis” or Dubai, or some sovereign wealth fund. No. 1 and No. 2 is basically what has been happening.

3) The third method is the perceptions of risk in the market place change and in other words, people say, “okay, the crisis is over, real estate is stabilizing. I guess a lot of these mortgages that we thought were going to go bankrupt aren’t…you know, a lot of these people aren’t able to refinance or something comes in and the level of leverage can once again be supported with existing capital. However, I just don’t see the third option happening until maybe mid-year when some kind of bailout or some kind of guarantee comes in, and all of a sudden the emotional tenor of the market changes dramatically to one of fear, to one of relief.

But right now, the primary way that this is being taken of is option 1) which is deleveraging the balance sheet; that accounts for a lot of the selling that you’ve seen in the markets and 2) reliquefying or raising new equity capital which in my opinion is the best way to do this. [32:47]

JOHN: So then there are going to be spill over effects to this – that’s the cycle. What happens when it occurs?

JIM: Because when banks have to contract their balance sheets because they’re losing money – their equity – and remember, banks are highly leveraged as are brokerage firms and hedge funds – we’ll get to that in a minute. So far what has happened is the majority of all of this has been contained in the financial sector. Most of the damage that you’re seeing is in banks and broker-dealers, financial intermediaries, the bond insurers, insurance companies that bought a lot of this mortgage debt.

But here’s the problem: If leverage ratios remain constant then we’re talking about a shrinking of the balance sheet as equity shrinks. In other words, as banks lose money their equity shrinks along with that. So it’s been estimated – and there’s been a couple of people that have looked at this but the bank balance sheets of the financial sector needs to reduce their balance sheet by nearly two trillion dollars. And what you’re seeing – this will explain part of the sell off that you’ve seen in the stock market since the beginning of the year because if you have to dump assets one of the problems that you’ve seen a lot of the blue chip stocks and stocks that have sold off that are relatively cheap is that when you need to get liquid and reduce your balance sheet you’re selling anything you can get your hands on in a rush to liquidity. And that explains some of the market selloff that we’ve seen here since the beginning of the year.

However, eventually this spills over into the consumer sector because banks are not loaning, they’re being tougher on their lending standards both to business and consumers and it’s estimated that lending to the consumer sector is going to contract roughly 900 billion and I don’t need to tell consumers it’s tougher to get a loan today. Whether it’s a home equity loan or a refinancing, banks are taking a tougher standard in terms of before they make a loan because the reason is they’re losing money. So that is why I believe economic growth is going to weaken and inflation is going to remain high as the government and the Fed inflate their way out of this mess.

This Bloomberg story out on Friday, the Federal Reserve announced Friday they’re going to increase their Term Auction Facility next month by 100 billion dollars. So they’re injecting massive amounts of money in to the system; they’re going to be lowering interest rates. The speculation is now that at the next FOMC meeting that it’s all but said that they’re going to be reducing interest rates by another 75 basis points, so the federal funds rate will drop down to 2 ¼. So what the Fed is trying to do is trying to fight housing deflation because remember as prices houses go down, equity disappears both on the bank balance sheet and the homeowners balance sheet. And if we get a serious recession the $400 billion loss number gets much worse, so the Fed by lowering short term interest rates is trying to steepen the yield curve. And over time as the yield curve steepens – meaning the difference between short term interest rates and long term rates gets wider – this improves the profitability that banks can make in lending and thereby it allows them to rebuild their balance sheets and equity capital. And the best course would be for banks to raise new capital, cut their dividends – in fact, probably eliminate them to conserve cash flow to strengthen the system. And the government should also enact incentives to encourage savings. However, it isn’t just the financial sector that needs to deleverage. Consumers also need to deleverage and start saving – and that will be another theme that we’ll take up here in just a moment. [36:46]

JOHN: Well, when you look at it, all of this doesn’t really sound too good for the financial sector in the short term, and for other sectors I would think in the longer term.

JIM: No, it really doesn’t. And what’s really surprising every time we get some announcement that the Fed’s going to inject more liquidity, I mean here we are Friday, the markets down 200 points, people are rushing into the financial sector and they’re selling off gold! And we’ll get to that in the second hour.

But if you take a look at the financial sector over the last 2 ½ decades, the financial sector in this economy has grown at almost twice the rate of GDP. The industry that creates, trades and manages this whole artifice of debt is now going to contract. Banks have shifted we’ve seen over the last couple of decades their business model to an originate-and-distribute model. The security firms repackage this debt and it was redistributed and it has contributed to huge profits in the sector. This whole model is now in the process of contracting. The whole industry is going to downsize. You’re going to see layoffs of brokers, layoffs of analysts, layoffs of real estate agents and you’re going to see large scale layoffs; in fact we’re seeing a part of that right now. The banking sector is going to have to rebuild and that is going to take years to repair the damage. The brokers are going to be shrinking in size.

The stock market returns I believe are going to be mean reverting. I mean just look at the five and six percent returns we’ve seen in the market last year. And this is the reason why I believe strongly in dividends if you’re investing in the market because they are going to account for a greater part of investor returns. It’s also why believe large cap multinational companies that earn enough money that are self-financing and that have access to credit are going to be doing much better. In fact they have because the credit markets are going to be tight for years to come as the financial sector deleverages its balance sheet.

Let me just get to this Bloomberg story that was on Friday. There was a report out by Friedman, Billings and Ramsey and they were saying that the $11 trillion US mortgage market needs about one trillion dollars of new investment to halt the slide in real estate crisis. And as the amount of leverage or borrowed money used to boost investment returns decreases – this deleveraging I’m talking about – the yield and extra yields over borrowing costs on mortgage assets need to increase to allow buyers to earn the 15% returns that are typically targeted in the industry. And here was a story getting to exactly what we’re talking about. Non-banks are being hit. This is from Bloomberg I’m reading:

Non-banks are ``being hit'' the worst by the reduction in allowable or desirable leverage, the analysts [at Friedman, Billings, Ramsey & Co] wrote. The amount of leverage employed ``appears'' to have fallen to 10-to-1 from 20-to-1 for agency securities and to 2-to-1 from 10-to-1 for non- agency securities.

They also talked about some of the mortgage players have dropped their leverage from 20-to-1 to 15-to-1, and people just don’t realize how large this leveraged sector is and the meaning of this. [40:12]

JOHN: We can talk about this on a theoretical level but the real eye-opener is when you realize how badly leveraged a lot of financial institutions are here in this country. And you hear the numbers and then you begin to go, oh my gosh, we’re in trouble. Can you throw some of those out?

JIM: This is just a broad generalization within each category. You may find some institutions more or less leveraged, but generally commercial banks are leveraged 10-to-1, meaning for every dollar of equity they have about $10 of debt. Savings institutions like thrifts are leveraged 8.5-to-1; credit unions are leveraged 8.5-to-1.

Now here’s one that’ll scare the heck out of you – brokerage firms and hedge funds are leveraged 32-to-1, meaning for every dollar of equity they have $32 of debt. GSEs like Fannie and Freddie are leveraged 25-to-1.

And if you average all of these together because obviously commercial banks and savings institutions and credit unions are larger than the broker-dealer/hedge-fund group, but the leveraged sector on almost 20 ½ trillion dollars worth of assets are leveraged 12.2-to-1. So meaning that you take a look at the balance sheet of 20 ½ trillion, there’s only 1.7 trillion of equity behind that $20 ½ trillion worth of assets, meaning that liabilities are almost 19 trillion. [41:52]

JOHN: Could we say this is sort of phantom money. I mean is that a good way of if you were to paint that to people.

JIM: It’s like a fractional reserve system. When the Fed creates high-powered money that’s exactly what this high-powered money goes into. And that’s why, for example, we’ve had John Williams – in fact, he issued a flash estimate: M3 money supply is now growing at almost 17% a year. So when you create this high-powered money that’s where it goes into. I mean when money is created at that level it doesn’t go into a mattress, or people or institutions are burying this money in their backyards. And so what they’re doing is creating as much assets to replenish the assets that are disappearing or vaporizing because of asset writedowns. [42:38]

JOHN: But it would seem like some instability could throw this thing into a crisis.

JIM: That’s why we’re basically in the bunker mode right now. And what the temptation is – and here’s where my depression theory may come in depending on who wins the election – the government creates this mess; the Fed created the real estate mortgage boom by artificially lowering interest rates to fight off the technology bust, so Greenspan bring interest rates from 6 to 1%, they pump the money supply and they kept them artificially low for years. And what this did is encouraged people to go out and make improper decisions, leverage their balance sheets, spend money and drive asset prices up and then you get the crack-up boom which is what we’re getting now. And then what happens is the government comes in and they want to bail out everybody as a result. So the more the government tinkers, whether it’s Bernanke asking banks to forgive mortgage loans, I mean think about that for a moment. Number one, a lot of these mortgages are embedded in some kind of security. So think if you owned a mortgage bond that was worth a dollar and Bernanke told the financial institution to forgive 30% of that debt; that impacts you on the money that you made when you made that mortgage investment. So I mean you’ve got things like many unconstitutional issues that are coming forward here; but this is what government does. This is what we did during the Great Depression that made a recession a depression. [44:16]

JOHN: This sort of comes back to my little theorem that I started out with, and that is don’t put the people who got you into the mess in charge of getting you out of the mess. You know, if they didn’t see it coming they won’t know what to do when it gets here. In reality, they did see it coming but I think they were between a rock and a hard place; and more increasingly so as time goes on. Is there anything I should ask here that we could expect to trigger in the near future.

JIM: You know, there could be all kinds of things that are happening here but I would say, given what I’ve seen coming from the Fed, given what I’ve seen coming from Washington, John, I would invest in chainsaws because they’re going to be cutting every tree down in the forest.

JOHN: Chainsaws!

JIM: Yeah, I mean look at Friday. $100 billion of Term Auction Facility next month and the Fed will be cutting interest rates by another 75 basis points when the FOMC meets this month. And we’re going to get into why the markets don’t understand what all of this means: what a falling dollar means; what cutting interest rates and printing money means; what it means when the government is doing helicopter drops with this rebate which everybody knows will do nothing to cure the economy, this is just buying votes in an election year. [45:31]

JOHN: They’re going to buy chainsaws to roll down Wall Street like the peasants storming the Bastille a few hundred years ago, going after everyone with chainsaws. It’s going to be wild times.

But this is also why your investment portfolio differs from Wall Street which is a topic we’re going to get into in the next hour. Given that this is the climate and the environment and is going to remain that way for some time, how do you invest your money in this type of market?

And you’re listening to the Financial Sense Newshour at www.financialsense.com online all the time.

FSN Follies: Andy Looney

I’m Andy Looney. I went to the gas station yesterday to gas up Big Blue. You know, my 4x4. Wow! It cost me the price of a Lexus to fill up. $80 doesn’t seem fair, especially when my tank wasn’t completely empty. It only took a few minutes to spend what it had taken me hours to earn. My friend Charles says that oil is at record highs and that Hugo Chapstick, or something like that, wouldn’t sell to US oil companies. Didn’t they name a hurricane after him? I think they did. I don’t think I like him very much because he’s messing with Big Blue, and I can’t afford to drive her very far with such prices. Charles also says that the demand is up globally. What’s with demand? I mean my wife Sandy never gave into my demands, so why should that make a difference? Can’t President Bush stand up to this Hugo Chapstick. Come to think of it, President Bush couldn’t stand up to Sandy either. Could you? I can’t. Sorry, Honey. I wonder if Sandy would let me get a bicycle built for two, that way we could get around town without going through the gas station. We tried one of those bikes once but Sandy got to laughing so hard she couldn’t pedal, and I couldn’t make it pedaling on my own. I guess I should think of something else. What do you think? I think so. So if you happen to see a couple on a tandem bike, wave as you drive by, it just might be Sandy and me. Sorry, Big Blue. I’m Andy Looney for Financial Sense. [47:44]

The Slow Death of Consumption

JOHN: Well, here we are back again. This segment follows the lead with which we left – I don’t know if it’s a lead. I don’t know, maybe it’s a trail. I guess we’ll call it a trailer. It’s not a movie trailer, it’s a radio trailer from the last segment.

We ended the first part of the Big Picture talking about a contraction in bank balance sheets and lending. What that means is that credit conditions are going to get much tighter which is going to affect the general economy because there’s going to be less money to spend.

In this part of the Big Picture we’re going to talk about what that means for you the consumer.

JIM: you know what was absolutely amazing is I have seen all of this playing out. I started in this business in 1977, well over 30 years ago.

JOHN: More than you’d care to admit.

JIM: Yeah. I do have gray hair now. But when I got into the business I started out in…well, I started out in corporate life with a Big 8 accounting firm – at least there were eight of them back then. But in 1979 I got into the financial industry, I left corporate life and I became a certified financial planner. And the two issues that we were talking about in guiding people were taxes and inflation. Remember, the tax rates were 70%, the tax rates on estate planning were 70%; they taxed your estate when you died. When the first spouse died the exemption was like only 175,000. The inflation rate was at 14%. People’s taxes were going up each year as bracket creep…in other words, as you got a cost of living increase it pushed you into a higher tax bracket. And those were the two problems facing Americans.

And here we are 30 years later and we’re making the very same mistakes. And most Americans are facing those very same things: higher taxes and inflation. People are seeing inflation in their day-to-day living and next year when they repeal Bush’s tax cuts everybody is going to see their tax cuts – we already did a show on that showing that it’s going to affect everybody more so on the bottom and the middle class than it is the upper class. And the more the Fed lowers interest rates and devalues the dollar the higher inflation we’re going to face. And the more the government intervenes with bailouts and rebates, the more taxes are going to go up and the higher the inflation rate will be.

Also, as the government spends more money than it gets in revenues they will tax and inflate more to pay for this largesse. I thought it ironic on Friday you had Congress interviewing the CEOs of some of these financial firms; they got big bonuses and here is Congress getting in and thinking of regulating CEO pay and they’re saying these guys shouldn’t get this because they lost money. Well, I hate to tell these Congressmen but these Congressmen have lost money for taxpayers for every single year since 1971. We’ve been running continuous budget deficits and are now talking about almost $10 trillion of debt and almost $55 trillion of unfunded liabilities for Medicare and Social Security. These criminals have spent the Social Security trust fund. I see nothing here that tells me that inflation and taxes…we’re almost going to get to the point where most people will be serfs working for the government to pay their taxes. It used to be May and I think we’re into June now, and by the time they get done with the programs they’re proposing for next year we maybe will be working till July or August to pay our taxes. [51:39]

JOHN: You know, it’s interesting that that is the stretch on that because you have to realize that the baby boom issue – the unfunded liability – is separate from all of the financial issues we’re talking about right now. So these are two parallel running but converging trends, maybe it’s important to view like that way which is also converging with the oil crisis as well at the same time. So these are different issues all coming together at one point.

You know what makes it even scarier is that some of the candidates are talking about trillions of dollars of new government programs. At the Institute for Policy Innovation they’ve been trying to put together all of the proposals that the candidates have for new tax proposals. And the funny thing is they finally managed to compile a list and they said: “Look at the list. Everybody is going to get tax credits and tax deductions.” But they can’t figure out who is going to make the tax payments to pay for all of this stuff. We have new government programs, the UN tax. We don’t have the money to pay for the programs already promised; it’s simply not there. So this is going to leave our government here in this country with very, very few options. They either raise taxes as high as politically possible –and frankly, Jim, I think they’re almost there – and print money to pay for the rest which means higher inflation rates which as Congressman Ron Paul would say is the “invisible tax.” So basically you have the tax brackets coming down on the top and the inflation rate nipping at their heels from the bottom shoving them upward. It’s an impossible sandwich for the middle class.

JIM: And we’re on a one way path. Last week we talked about price revolutions in history and I mentioned David Hackett Fischer’s book The Great Wave and all of these big inflationary waves are preceded and begin with higher energy and food costs. Exactly what we’re seeing now. So higher taxes and inflation are going to be the result. And so what that means very simply is people are going to have less money to spend. If they repeal the Bush tax cuts that means that most people – 99% of taxpayers – are going to see what they make will be less because if the government takes more of what you make then you have less money left over to spend. [53:51]

JOHN: And with the inflation chewing you up when you need more money to spend, taxes take more of that money that you need to spend because inflation is shoving you upwards.

JIM: Yeah, because if inflation rises it also means that the things you need to live will cost more, so there will be fewer goods bought because they will cost more money and you will have less money to pay for them. [54:13]

JOHN: Which means then we see a slowdown in the economy. If people are buying fewer things then companies can’t make products and therefore they lay off people because that’s the first place they cut, and you can see this thing as a big giant downward spiral.

JIM: But you know, bringing this back to the economy…

JOHN: Unlike the housing boom say, for example, Americans could use the equity in their homes sort of like ATMs to get cash out of them, banks are reluctant to lend so this contraction of bank lending doesn’t really bode well for the consumer. And I really want to point out it follows the same pattern of the past. You can go back to Weimar Germany, you can go back to all of these inflationary waves we’ve been talking about. We are going lockstep, literally step by step, into this pattern.

JIM: You know, it’s not only that the supply of credit is going to diminish but it also means that demand for credit will also decline as consumers move to reduce their record debt levels. The level of household debt right now absorbs over 50% more of after tax personal income. Just think how bad it could get next year when Congress raises taxes and inflation levels rise. It’s going to take at least in my opinion a very, very long time here before household balance sheets improve.

And here’s another key factor demographically with baby boomer getting closer to retirement there is going to be a dramatic shift in consumption and a move towards saving. The next trend that you’re going to see I’m predicting is consumer downsizing. And what does that mean, it means smaller homes, smaller cars, less spending. Just as in the last recession in 2001 where you saw this big leveraged boom in the corporate sector the 2001 recession was a corporate business-led recession. Businesses contracted. Everybody remembers the front page layoffs and what happened is in this recovery businesses rebuilt their balance sheet, they trimmed personnel, they cut cost, they improved the financial soundness of the cp, and that’s what consumers are going to have to do. So in the end the good news assuming that politicians don’t mess it up this is going to be healthy. But for the next decade the consumer trend that you’re going to see is downsizing. You’ll see this become headlines a year from now, they’ll be talking about consumer downsizing, the trend of downsizing homes, of downsizing cars; and it’s going to be driven too demographically. And this has tremendous broad investment implications in terms of how people are going to make money. [57:05]

JOHN: Remember a couple of weeks ago when we were talking about the fact when you’ve been on a roaring drunk all night there’s sort of a repentance period in there; there’s a period where you have to detoxify and that’s not fun. But the downsizing, the contraction, everything you’re talking about is precisely that. That’s exactly what you’re looking at. And there’s no way to avoid it – have you notice that? No matter how hard politicians try to tell you we can avoid this, it never works. What they do is they actually make the headache worse.

JIM: That’s because what they’re urging is they want to see more consumption when the problem was too much consumption and debt. You can’t build prosperity – if you just think about this logically – by going into debt and consuming. You build prosperity by saving your income, investing it, producing things and building capital structure in an economy. And we’ve gone on this debt and consumption binge for 25 years under Keynesian economic assumptions as a means of trying to build prosperity and it’s not working, John, and we’ve reached the limits of this. And unfortunately it’s going to be forced on us one way or another and it doesn’t matter what the Fed does or what politicians do, it’s going to happen. [58:20]

JOHN: And it’s going to cause a revolution at the polls like we said. I think we’ll see this process of throwing one group of rascals out just to put another group in, hoping that somehow we’ll get some relief each time. But unless they really derascalize Congress that’s not going to happen. All right. That’s the situation that we’re facing.

Any other headwinds or issues that consumers really need to know about that they’re facing in addition to taxes and inflation. I should point out that regulation is crushing a lot of small businesses right now, something that you didn’t talk about today. So TIR – taxes, inflation, regulation and less credit availability.

JIM: Yeah, it’s amazing. You can see it. Even in our own industry now we’ve got two or three personnel just to do paperwork – compliance paperwork. One of my doctors has three people dealing with Medicare and two nurses. So there’s three people on the staff that are just dealing with government paperwork.

JOHN: But Jim, it’s really important to recognize socialized medicine is going to eliminate that. Don’t you understand that? As soon as we get government in charge of all of our healthcare, that will eliminate all of that paperwork.

JIM: Yeah, instead of three people on paperwork you’re going to have ten people on paperwork and two people that are actually doing things related medically. [59:35]

JOHN: And that is after they jettison all of the patients. They’ll just be doing the paperwork.

JIM: Yeah. But two other headwinds come to mind and they’re kind of related as the economy goes into recession more people are going to lose their jobs. Also, as we approach peak oil energy costs are going to escalate. I couldn’t believe I saw one anchor go on TV the other day and say, “I wouldn’t invest in energy companies with oil prices at $100, they’re too high.” It’s like: Hello! [1:00:05]

JOHN: You need to address that though because I get…I’ve talked to people and I think people are already getting panicked. They’re looking at their portfolios bobbing up and down. One family member said, “well, we’re thinking about completely jumping out of that and getting into real estate because my gosh, we’ve lost $10,000 here” and blah, blah, blah. And you can hear the panic in these people’s voices. And of course, this is not a time to panic.

JIM: No, and actually I think there’s a great opportunity that’s unfolding here. But anyway, if we get back to where we’re going with this segment which we’re calling “the slow death of consumption” as energy costs go up it’s going to make driving your car, heating and cooling your home more expensive. Energy is also going to make goods produced more expensive, from food to minerals to production goods. And so this is just another factor…if you have to spend more of what you earn on food and groceries or utility bill, that means there is going to be less money left over for the discretionary things you like to do whether it’s entertainment, going out to eat at the restaurant or you know, going shopping for things. But that’s what’s happening. You’re going to see…it was interesting to look at some of the retail statistics; of the retailers doing well they’re the giant discount chains; they’re the Walmarts, they’re the Costcos, they’re the Sam’s Clubs because how do you make your dollar go further as the cost of food and everything else goes up. [1:01:35]

JOHN: I’m predicting we’ll see… I don’t know if they ever went away but we’ll see the rise a lot more in the way of co-ops like church groups form, you know, where you buy food in bulk and everybody gets together. They all agree what they need and they buy it in large bulk and then meet together on a Saturday and all divide it up.

JIM: People haven’t thought through with this what deleveraging of financial balance sheets is going to mean to the financial sector because every time you have like on Friday the Fed’s going to pump another 100 billion into the sector and you know, people rush in to the homebuilders and the financial stocks and then they sell gold. Or they go into Treasuries. You know, on the day that you and I are talking you had the two year Treasury note at 1 ½%; you’ve got headline inflation at 4.4%. And the Fed just told you they’re going to inject another $100 billion through TAF and repos next month. And what do people do? They sell off gold, they sell off oil, they go out and buy Treasury bonds at one third the inflation rate. I mean this is just absolutely insanity. People have no idea what causes inflation. When you watch these dialogues on the financial cable channels it’s like I’m thinking: what has happened to economic understanding or monetary understanding? I mean we have basically become a nation of monetary illiterates. [1:02:56]

JOHN: But isn’t that due to 50 years of Keynesian training in colleges?

JIM: Yeah, sure. Even the dictionary definitions of inflation have changed to rising prices and deflation as falling prices rather than an expansion or a contraction of the supply of money and credit. [1:03:13]

JOHN: Let’s follow this model down the road then now. Consumers are obviously going to cut back, they don’t have any choice. They’re going to have to do that. Now, that will affect the economy. Are there any offsets that we could have coming from the business sector which might offset weaknesses from consumer spending because, you know, you’re an Austrian economist, you believe that production and investment are more important to economic growth than consumption which is the Keynesian side of the issue.

JIM: You know, if there is one bright spot here it has been from the business sector. American manufacturers are becoming more competitive, but most business clients that I have personally – these are entrepreneurs, people who have their own businesses – they don’t know what is going to happen with taxes both on income taxes and estate taxes.

Most people don’t realize that the estate tax rates go up. Many people may not recall this but prior to Reagan becoming president the exemption was like 175 so any asset over 175,000 was taxed for estate taxes and the estate taxes went all the way up to 70%. Also, they would tax you on capital gains. So let’s say that…And the estate taxes were due on the death of the first spouse and so what would happen is the surviving spouse would have to sell off assets to pay off the estate tax. But what if those assets appreciated. Well, then you would not only have to pay the estate taxes but then you would get hit with capital gains taxes. And the idea that they passed with Bush was they lowered the estate tax rates, they increased the exemption on estates (it’s somewhere over two million; I think it’s going to rise to three million); in the year 2010 you have one year where you have no estate taxes and the step up in basis goes away. And then in 2011 we go back to the old pre-Reagan rules – the exemption drops to 600,000, the tax rates go up to 55% and you no longer have step up basis in cost when one spouse dies. So for a businessman who owns his own business who may not be liquid because it’s a privately held business there’s huge estate taxes.

So a lot of the business clients that I have they’re becoming more cautious. I mean there’s a lot of talk about more government relations, more interference in the market place. And John, this is creating an environment of uncertainty because how can you plan a business when you don’t know what interest rates are going to be, you don’t know what tax rates are going to be, you don’t what estate taxes or regulations. Most businesses are beginning to hold back in the CEO surveys because they simply don’t know what Washington DC will look like next year. Is it going to be a hostile environment or is it going to be a friendly one. And right now, it doesn’t look good for the markets or the economy next year. [1:06:17]

JOHN: I’m not sure why but the more you talk the more horrified I’m getting because you realize that people are going to work and work and work and in the end trade it all away. That’s what’s going to happen. They’re going to be trading this into government at some point or another. You won’t be able to pass on to you’re kids; you’ll be lucky to hang on to what you have and I keep wanting to hear what all the pundits are going to say in the midst of all of this as to what’s responsible for all of this.

Getting back to the consumer, I’m thinking of the consumer because the consumer is the little guy. If the consumer pulls back on spending how does this change the investment picture, what sectors of the economy will be hit the hardest and I should probably say on the counter side, what do you think is going to do well during this time?

JIM: I want to get back to the first segment that we talked about and that’s the contraction of bank and financial balance sheets. This debt liquidation phase that we’re going through is going to translate into spending restraints on the part of consumers and also on the part of business. Also, higher taxes and inflation means there’s going to be less money to spend; and money because it is depreciating – just look at the value of the dollar – that means money is going to buy less. What this means is discretionary spending is going to decline. So this impacts a whole broad segment of the economy; with the falling real estate market you’re going to see less money spent on household furniture, appliances, home improvement sales – those sectors are going down. You can see it in the stock charts. Home sales and auto sales are going to fall, and households are going to begin this downsizing that I predicted. It’s going to be driven both financially and demographically. This is also going to impact entertainment and leisure.

(You know, we normally don’t go to the movies anymore and somebody please explain to me what has happened to restaurants. We went to the movies Sunday night with my youngest son and his fiancé and, John, I noticed my parking indicator – we usually go Sunday matinees – and most of the time I have to spend 15 to 20 minutes driving around the parking lot to find a space to park. So I’ve noticed less attendance at movies. And then we went in the restaurant and not only was it to walk in, where before if you’d get there you’d have a half an hour wait, sometimes 45 or 50 minute wait. But then on top of that, in the restaurant we were in we had four TV sets going and then music at the same time. When did this come into vogue that we’re going to blow your ear drums out? We actually walked out it was so loud. I said I can’t even hear what you’re saying. And this was when we were seated immediately and I said, “could you turn the music down.” And the guy just looked at me like, Dude, this is the way we run this. And so we just got up and walked up and we walked down the street to a another restaurant and they had like a side room where you didn’t have to compete with all of that noise. But anyway…)

As consumers downsize this is also going to impact the entertainment and leisure market. There is going to be less money for restaurants, less money for spas, hotels, movies and instead you’re going to see instead of people going to the theater where it costs 15 bucks for just a popcorn and a coke and 11 or 12 bucks for a movie ticket people are going to use Netflix and Blockbuster at 5 bucks instead of 12 bucks and 20 bucks. And instead of eating out I think you’re going to see people eating at home. I mean we entertain a lot and we like to entertain at home because number one, it’s quieter; I can buy high quality food and it’s much more enjoyable not having to compete in conversation with four TV sets and 10 speakers blaring out music. [1:10:09]

JOHN: I know you like to cook. I do too, so does Carol. This is a total sidebar. A couple of weeks ago we got a brand new Mexican food recipe book and we came home one day on Sunday and said, “okay, what are we going to make here today?” And we all split up the task load and created a whole new exotic dinner.

JIM: Some of the things we like, like I’ve got a whole series from Williams Sonoma on Mediterranean cooking, cooking beef and stuff like that, and that’s what I try to do on weekends I try to find a recipe and go to the store and get the ingredients and then a lot of times our dinner guests we invite over we have them participate. Last week I had like five different dishes going on and so it was kind of fun. You know, it was a lot less expensive than going to a restaurant where we would probably have walked out with a couple of hundred dollar bill. [1:10:56]

JOHN: And if you don’t have to call 911 for your guests then you know that the recipe is probably worthwhile, and if you do, you just don’t make it again.

So if consumers are retrenching that’s going to affect business, that’s going to affect their dividend etc. etc., so where will the investment placements be?

JIM: I think and we’ve been talking about this. I think it gets down to the simple things. The things that people have to have. What do people have to have. You have to have energy. You have to have food. You have to have water. And with the dollar depreciating and government and the Fed inflating you’ve got to have precious metals; and I think also because of decaying infrastructure in the United States and Western countries – I mean look at our bridges, our roads, our power plants, our refineries, our airports, our rail system – infrastructure is going to be a theme. And it’s interesting for the first time in a hundred years railroads are going to invest billions of dollars to rebuild their tracks and their freight because as energy prices go up over $100 for a barrel of oil it’s going to be much cheaper to put those containers on a railroad which can operate at a third of the cost of a truck. So infrastructure investing.

Even during recessions, people still have to eat. They need to take a shower, they need to drink water to quench their thirst, they need to put gas in their cars and they need heating and air-conditioning depending on where they live in the country. [1:12:24]

JOHN: Is that why Warren Buffett recently bought into Kraft? I mean here you have the world’s richest man seeing the same thing – also makes Oreo cookies by the way. Buffett has bought into energy, he’s bought infrastructure, railroads. He didn’t get to be worth $62 billion and become the world’s richest person by making silly investments.

JIM: You know you’re right, John. I think he sees the implications of the contracting economy. He definitely understands higher energy prices. He just made a fortune in his investment in PetroChina and he still owns Williams Energy. And I think he also sees the sad shape of the country’s infrastructure. The one thing about all of this is that these trends are long lasting. Bridges, levees, airports, power structures, refineries – I mean these aren’t things that you can fix overnight. I mean right now we have nothing to replace oil and natural gas and there’s also a problem with excess power capacity to generate electricity: It’s diminishing. When the nuclear power plants went out in Florida there was no excess power in the grid system to pick it up. I know here every single summer when we get a heat wave we get power outages. I mean you just plan on it in California because the idiots that run this state don’t want to build power plants. I think we are going into more of this in our next segment in terms of these long trends and what is working in this kind of environment. [1:13:55]

JOHN: So basically what you’re saying is taxes and inflation are going to go up, discretionary spending will go down in proportion as people need to live within a budget. So you’re basically back-to-basic necessity areas – the things that people need. That would probably mean that retail sales of things you don’t need go right off a cliff. What is this, the death of the American consumer?

JIM: No, I don’t think so. That’s not what we’re saying here. You know, retail sales are not going to fall of a cliff, I think they’re going to die a slow death. In other words, as taxes and inflation go up corresponding with that increase will be a decrease in discretionary spending so you’ll see lower levels of consumer spending especially in real terms after you adjust retail prices for inflation. So it’s going to be a gradual rollover as more people get closer to retirement, as they get older, as they begin to downsize. So this is going to be a very long lasting trend and we’re going to get into that in the next hour. [1:14:56]

JIM: That’s going to destroy people riding their pickups on old abandoned rail lines which was going on here in Montana and Idaho about 10 years ago – and driving the rail companies crazy. People would, you know, all these little hookups like the railroad companies have to put pickups on the rails when they want to do maintenance. Well, cowboy types were doing that on the weekend for some fun here but if they start to use rails again…not going to be able to do that.

You’re listening to the Financial Sense Newshour at www.financialsense.com. More to come, we are not done I assure you. We’ll be back.

Part 2

Long-Term Investment Trends

JOHN: Here we are looking at some practical applications about the things we spoke of in the last hour. But here we go: consumer spending is on the way down; credit constraints are going to become more and more prevalent. What will work in this market?

JIM: The very same things we’ve been talking about on this program, gosh, John, for the last seven or eight years. And I’m trying to think of the author we had on recently, it was on value investing and he talked about markets are range bound after they’ve had a tremendous bull market as we saw between 1982 and 2000. If you look at markets become range bound - in other words, the high double digit returns that we saw in the markets for almost 18 years become mean reverting. And that’s what we’re seeing in the stock market. But, while this cycle and paper assets is returning to mean reverting (in other words, you’re going to see lower returns) there is another bull market that has begun in another sector.

And what drives all bull markets fundamentally is supply and demand. Forget the charts. The charts will pick up on this but what drives, what is at the basis of all bull markets are supply and demand imbalances. And for gosh, nearly two decades we saw a bear market in commodities, whether you were looking at mining, whether you were looking at energy, whether you were looking at agriculture. We did not invest in new supply, we did not go out and explore as much as we should have; we did not go out and open new mines. In fact, mining companies went out of business, they got consolidated which is one of the reasons why you see these big behemoths that we have in the gold sector like the Barrick and the Newmonts and the Gold Fields and some of the large companies as a result of consolidation.

And in the meantime, during that 20 year bear market we saw in commodities we’ve added over three billion people on this planet since the 70s in the last bull market in commodities. So as Jim Rogers has talked about, as Marc Faber has written about, and as a lot of the great thinkers in this area have talked about, these cycles are anywhere from 15 to 18 years. And so we’re just in the beginning stages this cycle. We don’t have surplus energy; they’re not finding enough energy each year to replace what it is we consume and what I found rather interesting and it goes to show you, it doesn’t matter whether you’re looking at energy, whether you’re looking at base metals, or even commodities – I mean the president of Potash recently said, “We’re are going to have to have record harvests every single year for the balance of this decade to avoid a famine.” And we’ve had 17 years of record harvests, but our grain inventories are the lowest that they’ve been since 1960.

So the point I’m making here...or even more recently you can talk about the example last week, you had a nuclear power plant in Florida and their wasn’t any excess power capacity in the grid system to resupply it. Our excess capacity in generating electricity has diminished tremendously. And that’s what people don’t understand. And what we are going through, as we go from this consumption-oriented economy which is what has driven the US economy over the last 25 years, we are going to now go back to basics. We’re going to have to rebuild infrastructure; we’re going to have to rework our water systems because water is a diminishing asset too because we’re using too much of it and we’re not upgrading our water systems in cities – they’re falling apart. Just pick up the headlines. It’s almost like every week there is some evidence that we see in the news of declining of infrastructure in this country.

And the more important thing that you have to understand – and I think Jeff Christian and I talked about this in the first hour – is you can’t just look at “oh, the US is going in to recession therefore we’re going to consume less copper because we’re not building as many homes,” or we’re going to consume less energy the economy is slowing down. You have to think of the world today in a global sense. And the United States is not the main economy engine. It’s one of them but it is no longer the only one. And it’s not just the fact that we have three billion more people on the planet, it is the fact that China, India are industrializing; their economies are more commodity intensive. And so one thing I wrote about in my Storm series, going back to 2000, and then another piece I wrote in The Next Big Thing in 2003: If you wanted to make money this decade the very basic necessities of life. At the top of my list were precious metals because when I wrote The Perfect Storm back in 2000 and 2001 the Fed was reinflating so you were going to need that and the dollar was going down in value, so you need too precious metals.

That still applies today: on the day you we’re talking the Fed is talking about $200 billion of injection into the TAF program; they’re talking about repos; they’re talking about cutting interest rates and the dollar continues to lose its value. We’ve talked about water. Water is a segment that I think is being ignored in the market place right now. Greater demand on the agricultural system means greater demands for oil; also, by the way, greater demands for natural gas which is associated with a lot of the fertilizers farmers use. So precious metals, we talked about water, food – gosh, we could do a whole segment on food and we’ll probably do more on that – and then energy.

I am absolutely amazed, we’re sitting at $105 a barrel and people are saying there’s plenty of oil in the world. If there was we wouldn't be sitting at $105 a barrel. Now, part of this price differential is investment demand that’s coming into the commodity complex which always happens. And I dismiss the bearish argument that the only reason it’s this high is because the hedge funds are buying. When a bull market begins, as prices begin to go up, as the fundamentals drive the case for higher prices, money begins to move into the sector. It’s no different from what we saw in the bull market in stocks in the 80s and 90s; by the late 80s, institutions were coming back in to the stock market; by the mid-90s, individuals were coming back into the stock market in the final stages of the bull market. So any time a bull market begins, it begins with the smart money going in first and then secondly institutions follow and then thirdly the individuals will be the last to come in. But by the time the individual gets in on this market we’ll be talking about 3 or $5,000 gold by then. [7:17]

JOHN: Isn’t that typically when the trend’s going the other way, as a matter of fact?

JIM: Yeah, by that time, maybe supply will be up; maybe we’ll have alternatives. Although, I think we’re going to be in a real pickle when it comes to energy in the next decade because, John, I don’t care – and this is something that we’ve defined on the program and you hear it in the political campaign “oh, we’re going to create green energy. We’re going to do solar and wind.” Well, you know what? You’re not going to put a windmill and drive a 747; you’re not going to put solar panels and drive a 747. It’s a liquid fuel problem which is what these politicians don’t understand.

And unfortunately when it comes to energy, even if we were to allow drilling; we know that there are about 30 billion barrels of oil reserves off the coast of California; we know there are probably 10 to 15 barrels in Alaska if not more; we know there are probably 20 billion barrels off the coast of Florida; we know there’s probably another 10 billion off the east coast. But if you don’t have access to it, and those that do own most of it – talking about OPEC countries and the former Soviet Union – if they’re not interested in expanding their production, why should they? I mean if you heard the OPEC ministers this week, he said: “Look, we get paid in dollars and dollars are depreciating. We have no interest in increasing production to bring the price down.” Personally, I don’t think they can increase production enough to bring the price down because they’re not only having difficulties in keeping their output up but they’re also consuming more of what it is they produce.

I don’t care what argument you make we’re going to have higher energy prices; and these people who are so US-centric and look at this and say, “well, the US is going into recession” or “I wouldn’t be buying oil stocks here because oil at $100, it’s not going to stay there.” You know what, what are they going to do when oil prices hit 120 and $125 which is one of our predictions this year; and what happens by 2010 where we’re talking about $150 and perhaps more. And especially in the next decade where at some point in the next decade you’re going to see declining production profiles. You’re already seeing this in the major oil companies, I don’t care if you’re looking at Exxon, Chevron, all these companies are starting to produce less and the problem is this is a very capital intensive industry and the only thing I’ve seen the government do is come up with these silly ideas like ethanol or we’re going to tax the smallest segment of the energy market which is international oil companies and we’re going to tax them. It doesn’t work. [9:52]

JOHN: That’s not going to stop them.

JIM: No, it’s not going to stop them but if I was an oil company then you know what, we just move our oil production offshore and we’ll sell to other people.

JOHN: I really want to see the explanation Bill O’Reilly has for all of this as the prices keep going up, if it’s going to be the evil oil companies. At some point that argument has got to die a miserable death.

JIM: It’s no longer going to hold up because I mean his argument is usually, “well, demand is down.” Well, Bill, we’re only 300 million people; there are 6.5 billion people on the planet. What’s more important is if some guy in India for the first time trades his bicycle or rickshaw for a Tata car at 2500 bucks, he’s now consuming energy; if a consumer in China trades his bicycle for a motor scooter or his motor scooter for a car, you now have an oil consumer. And that is the picture often missed out here. Tell me where the major oil finds are. Outside of Aurelian which made probably the largest gold discovery in the last two decades, tell me where the major gold discoveries are, silver discoveries or copper discoveries.

It’s one of the reasons why these sovereign wealth funds especially are scouring the globe trying to secure access to raw materials, while we are cutting off the production of raw materials. We used to be one of the largest producers of raw materials. There was a report out by the US military that they’re concerned that 23 out of 40 strategic raw materials used in the creation of weapons or systems we’re not producing here anymore even though we have the capability to do it. We’re importing it from other countries. I mean this is the most quackonomic economy philosophy that we’ve ever seen, but you know what? You can’t fight it, that’s just the mentality of Washington today, you might as well profit from it. [11:44]

JOHN: You know every year we come in here, we make predictions at the beginning of the year, at the end of the year predictions have come true, oil is still going to be going up at the end of the year, gold will still be doing very well. I keep wondering why the Wall Street crowd doesn’t get it. I mean sooner or later you would think it would sort of break through.

JIM: I think it’s based on education and experience. Imagine, John, let’s say that you went to school in the 70s, you were educated in college under Keynesian economics; I know I was when I went to graduate school. That’s all I did was study Keynesian economics. Although, Milton Friedman’s monetarism was starting to come in when I was in graduate school, not in undergraduate. Okay. So you’re raised under this kind of economic thinking and then you see this tremendous bull market that lasted for almost two decades where the markets went up high single digits –sometimes double digits – every single year; and from 1995 to 2000 the market went up double digits every year. So you are raised in this environment and then all of a sudden the environment changes and during this period of time, especially from the 80s and 90s, the fall of the Soviet Union, the United States became the lone superpower, our markets lit up like a Christmas tree in the 90s. That thinking and that mentality stays with you. That’s what you grew up with, that’s your experience, that’s what your knowledge base is from.

And then suddenly, little by little the world begins to change. You have a country called China that begins to emerge as the largest manufacturing power in the world; manufacturing moves offshore, moves overseas; you have an India that is industrializing and expanding. Take a look where all the engineers are coming from now. We’re graduating I think, what, one engineer for every ten attorneys, where it’s the opposite overseas. So the world changes and people don’t see this change. I forget who we had on, he was one of the top technology analysts, Bull Run, the author of that book, he was one of the best technology analysts on Wall Street and he said, “you know what? The Street is slow to recognize change.” So you see these paradigms when you turn on TV; the announcer comes on: “well, oil prices are up but with the US heading into a recession experts believe oil prices will pull back.” Well, here we are at over $105 a barrel, and they were talking about, John, since the beginning of the year how oil prices were going down this year because the economy was slowing down. Well, I hate to tell you oil prices right now are up 10% and if you think that’s bad natural gas prices are up almost 35%. [14:23]

JOHN: Well, we always talk about the importance of fundamentals, but there is even a sort of a world view issue here; isn’t there? In other words, the primary things that you assume to be true that are untrue about the world then get tested and if you keep holding on to the old world view then you’re in trouble because your interpretation of what’s happening doesn’t reflect a real world view. And that’s what you're seeing happening right now. And for some reason some people will actually go down with their world view. They’ll hang on to it right down to the bitter end.

JIM: Oh yeah, and I mean you can see the fallacy of Keynesian economics: The more the government tinkers with the economy and the markets the worse and distorted that they become; and the worse and distorted they become the more they come back and say well, it just needs more tinkering, and the worst things become.

And one of the things that you’re going to see here with rising commodity prices, rising demand, demand outstripping supply, you’re going to see rationing in some form or another or you’re going to see price controls. I mean China is now putting in price controls on food and they’re going to have to reverse that because what it’s going to do is create shortages. They subsidize energy and so what did they get? They got a shortage of energy production especially from their teapot domes (their small refiners). And that is what we don’t see here and it’s amazing: If you look at a chart of oil going back this decade; if you look at a price of gold; if you look at a price of silver; if you look at the CRB Index; if you look at the price of copper; if you look at the price of lead, nickel, tin, zinc, corn, wheat, soybeans, cotton, sugar, platinum, palladium, silver, gold, natural gas, heating oil, gasoline, crude oil…It’s absolutely amazing. And this has been going on for as long as you and I have been doing the program and it still isn’t picked up as a theme yet.

Yes, you’ll hear it mentioned but you know what? Most people are just trading in and out of the markets. And a good example of this was Friday, the Fed announced the unemployment rate goes down clearly indicating the US is in a recession, the Fed talks about injecting $200 billion, there’s a report out by a well-respected analytical firm saying we need to get another trillion dollars into the mortgage market, money supply growth rates – and what do they do? They sell gold and they sell energy. It’s amazing. [16:47]

JOHN: I noticed one of the Q-Lines today asked something along these lines. Even in talking to some of my own relatives, I’m trying to keep them from hitting the panic button –that seems to be the hard thing – and from saying: “Quick! Sell this! Jump into that!” You know, they begin this ricochet back and forth trying to prevent what they perceive to be losses instead of understanding what is happening and taking a position based on that. And that takes…I’ll be honest, Jim, it takes…it’s like standing up for a moral issue when you’re the only person standing. It takes intestinal fortitude to do that when the herd is going the other way.

JIM: You know, it’s amazing but you’re right. We have a whole industry that has been built up in the financial markets describing why the markets did what they did on a day-to-day basis. And I call this the ‘noise industry’ because are you telling me that, okay, let’s say that you get an economic report – and I’ve seen this a number of times – the economic report was better than expected, it was bad but it was better than expected, and then the stock market is up. So do you mean to tell me that people are sitting there saying, “well, we thought the economy or the manufacturing index was going to contract much more than it did. It contracted but not as bad as expected; my God, I’m going to buy stock. Or, I’m going to buy bonds.” I mean looking at the two year Treasury note that has a yield of 1 ½%; the official inflation numbers which are understated but even if you take them at face value at around 4.4%, a 1 ½% 2-year Treasury note after tax would yield a return of 1% and you’ve got headline inflation at 4 ½%. And that’s what you’re seeing. You’re seeing people say, “oh, my God, jump! Sell!” And I think people just don’t know what to do; they don’t understand why food prices are up, why energy prices are up, why the cost of living is going up. They don’t understand why the markets are doing this, why did the credit markets dry up, why are real estate prices going down and how come the stock market isn’t up double digits? And what happens is they’re running around like a bunch of chickens with their heads cut off because they don’t know where to go. [18:58]

JOHN: Well, so basically, if you’re looking in terms of, not the political area, but the economic area consumption is going to grind to a halt; or at least consumption of things that are non-essentials, people will be getting back to basics, finding ways to make things meet. And also we’re going to have to reinvest in infrastructure because it’s going to become very clear that’s where the turn is going to go; now this is going to have interesting implications in the political arena in the entitlement area –but that’s probably a topic for a different show – because I don’t think that money is going to be there to distribute around. And if people are having a hard time making it they’re not going to tolerate a lot of taxes telling them we have to care about xyz or something along those lines.

JIM: Mark my words, what you’re going to see coming in the next decade for Social Security is means testing and certain people are not going to get it; if you save and put away money for your retirement, you have a company pension, or maybe a pension from a rollover of a 401(k) program and if your income is a certain level they’re going to phase out your Social Security benefits. I know for a matter of fact they’re working on this. So that means, more importantly, saving for retirement and being in the right area because you’re going to have to fend for yourself because government is going to let you down. [20:13]

JOHN: Yeah, I’m not sure how that is going to fly politically but economically that’s where the numbers are steering us.

JIM: Well, what they’re going to do like any politician is when you don’t have the money to pay for the things that you’ve promised you inflate; that’s what governments have done throughout all of history.

JOHN: Well, we have one more segment to go here in the Big Picture of the Financial Sense Newshour (www.financialsense.com) but before that we are going to hear Other Voices this week, and our guest is Louise Yamada. Right after this.

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Other Voices: Louise Yamada Louise Yamada Technical Research Advisors, LLC

JIM: Well, here we are looking at gold prices that are approaching nearly $1000 an ounce, oil prices are over 100, in fact $105 a barrel. What is going on here and what is going on in the stock market. Joining me on Other Voices this week is Louise Yamada from Louise Yamada Technical Research Advisors.

Louise, I want to talk about a call that you made last year and that was “structural bull market for oil and gold.” And also that the dollar would continue to decline, interest rates would be stuck in a narrow trading range and equity markets have fulfilled an alternative hypothesis advance correlating to 1932 and 1937. Are you still holding to those recommendations, and if you are, please expand?

LOUISE YAMADA: Sure. We are, Jim, and actually it goes back even farther than last year when we saw gold breaking out in 2003 and reversing a 22 year downtrend when we suggested that we were in the process of a new structural bull market for gold, and that crossing the $300 – and imagine how far back that was – would set targets toward 450 and 500; and as some of those targets were progressively met we were allowed to project even higher targets. And it’s been quite a ride. The pullback of 25% in 2006 allowed for about a year consolidation, but what’s interesting as one looks at the price of that consolidation every pullback of gold held at a slightly higher low. And that’s really indicative of demand coming in. And that’s all we follow as technicians is supply and demand – the forces of supply and demand in the market place. And when that was finally complete, gold lifted to 690 and we had targets to 750 and 800, 900 and we have measured moves now that could take us to 1050 as possibly the range in which we might get another more extended consolidation. That’s going to depend somewhat on the dollar, but we have longer term targets which we can take from a different methodology which carries towards 1200, 1500 and 1950 to 2000. [24:04]

JIM: So Louise, if you were looking out, assuming these trends remain in place (if we get pullbacks they are stopped at higher lows in the next couple years we could see $2000 gold possibly).

JOHN: I think that it really relates to the dollar because the dollar and gold have had a tendency historically to move inversely. Obviously, if you have a strong dollar, you know with a strong currency, all’s right with the world, so to speak and you don’t necessarily need gold. And what I think we’re losing here is our creditworthiness and our economic base and a currency; that growth driven by high levels of business investment means a strong currency but growth driven by strong consumption and government spending – which is what we’ve had for eight years – leads to currency weakness. And unfortunately that’s what we’ve been experiencing. And so by the flip-side of that is people are fleeing a currency that they feel is losing value and moving into the old, hard asset of gold which has always been a monetary value. [25:08]

JIM: Well, just listening to the political candidates running for office, it just sounds like debt and consumption, bailout – it’s going to be more of the same. I just can’t see how that would be favorable for the dollar, no matter what candidate.

JOHN: I don’t think it is. It’s the old story: if you’re handing out $600, if you give someone a fish you give them dinner, but if you teach someone how to fish and you give them dinner for a lifetime. And I think it’s the same with these bailouts. Rather than that, the governors’ convention that took place in Washington asking for works projects would have been a much better solution because we’re going to have more and more people laid off in the financial industry and then tangentially any of the other affected areas and they’re going to need work. Handing it out is not going to do it. [25:53]

JIM: You have made some bold calls. I can remember reading a call that you made in Barron’s in the 90s calling for the Dow at 7500 and then beyond, which at the time looked so ridiculous, so I imagine someone listening today hearing gold at 980 going to 2000...but you know once again the structural backdrop is there.

What about oil?

LOUISE: That’s another very intriguing commodity and it was 2004 that we suggested oil was embarked on a new bull market. When it broke out through 40 which was the high that had been in place 24 years ago, so basically you could look at the level of 40 as a shelf, if you will; and breaking out through that took oil to a new high. And we looked back in history to see what this could be telling us because obviously it was something very different than anything we had experienced in our lifetime. And if we went all the way back, the price of oil in the 1940s had a somewhat similar step up in price and that was followed by a very volatile consolidation for, believe it or not, 24 years. And then in the 70s as we know we had a step up in the price of oil; both times never coming back to the old lows and it was the 24 years after 1980 through which oil was breaking out. So we had these two incredible neutral periods and then the breakouts in price and so it allowed us to suggest we’d embarked on a new structural bull market for oil never to see prices come back down to their old lows; and in 2004 we had targets at 67 and 80 which finally got achieved somewhere in 2005, much later. And now we have had projections to 90 to 100, we have outstanding 150 and 124.

But what we also did, it was an interesting statistical study looking back at those two prior step ups in the price of oil and calculating percentage and distance traveled and all that sort of mathematical application and came up with a possibility over the next couple of decades that oil could actually go towards 250 and 400. And interestingly, in a conversation with Charlie Maxwell he has a fundamental possibility at 250. But we have to remember that it’s a depleting asset and when I was born there were only about 3 billion on this globe and now there are 6 billion on their way to 9 billion and everybody is competing for finite energy, finite food – land, if you will – and finite water which was another 1995 argument that we were going to see water wars in the 21^st Century; and people laughed quite a bit and I don’t think anybody is laughing today. [28:49]

JIM: No, it’s absolutely amazing. I approach investing more from a fundamental point of view and the very figures that you talk about that Charlie Maxwell – and I’ve read Charlie’s stuff – we see the same thing happening. You know what’s amazing, Louise, and we saw in the latter part of the 90s when the public came into the stock market after 1995 after a very strong run from 1982, but here we have had gold up what now? Seven years in a row; we’ve had oil up just about every single year, we’ve got all the major commodities breaking out – the base metals are still up, the agricultural sector is on fire – and yet when I turn on a financial station they’re talking about “well, I wouldn’t buy oil stocks here with oil at 100.”

LOUISE: Well, it’s an interesting observation. The oil stocks and the materials stocks are two areas that have held up quite well as this market has been deteriorating. That’s not to say that some of them won’t come off and some of them certainly have, but the natural gas as an example, are holding up. But in a bear market it’s what goes down the least that one succeeds in. But, yeah, I think it’s quite intriguing.

I think that one of the things we suggested way back in the mid-90s was that we felt there was a structural shift of inflation taking place out of the capital goods arena where we had known it in the 20^th Century and into what I defined then as consumer essentials (food, water and energy) into the 21^st Century. And part of it had to do with the population explosion and the fragility of the sustainability of those consumer essentials all those people were going to need; and also the fact that our capital goods have all been outsourced to lower wages and come back to us in lower prices, so to speak, so you’re not getting an inflationary spike in things we import from China. And the whole internet and globalization is actually a global wage and price equalizer – The global trade that we’ve been negotiating. And if you think about a see-saw and that process of equalization, it’s the US that has been at the top end of the wage and price cycle; and we have had the most to lose in this global wage and price equalization and that’s why we’re seeing our wages stagnant and we’re seeing our jobs depleted and I think it’s very sad. [31:22]

JIM: What makes you different from some of your peers, I have seen as gold has taken out – especially when it took out 300 and then it was 500 and then it took out 750 and then it took out the old levels – you have become more bullish. A lot of your peers some of them at least have been calling more for tops in this sector and I think they continue to be surprised. And here on the day you and I are talking which is a Thursday gold was down, but it’s still close to 980, what makes you different?

LOUISE: I think part of it is the interpretation of time. When people say it’s a top or a bottom, it’s a question of whether you’re talking about short term, intermediate term or long term. So from a long term perspective we still think there’s more to go on the upside; from an intermediate term or a shorter term perspective are there going to be pull backs, corrections, cyclical bear markets (cyclical being the short term whereas structural or secular being the long term bull that can last for a decade or two)? And clearly the advance that took gold into 2006 was a 75% advance. And then you had a very severe sell off of 25%. From a technical perspective 25% pull back is one-third retracement of the advance; and that’s perfectly normal expectation. What might have been less normal is the sharpness with which it retreated and thereafter we suggested it’s going to take time to revert to the mean and correct it and it’s probably going to take more than a year which it did. But now you’ve had another incredible 74% extension and it’s possible it could start a correction here once again – a cyclical bear market; 25% was a cyclical bear market in an ongoing bull – it’s possible. And certainly the measured target we’re very close to now which was 1050 from the lift off after 2006. So it could be any time soon that we do go into more of a corrective phase. But longer term – see, each corrective phase provides an opportunity to add to or initiate positions in an ongoing bull market – so I think it’s really you have to ask somebody: Are you talking short term or are you talking long term? Do we think the bull market for gold is over? No! Do we think that the short term run in gold is over? It’s a possibility. [33:58]

JIM: Louise, as I take a look at money supply growth rates around the world – double digit in the top 20 countries and I don’t care where you’re looking at (soft goods, base metals, precious metals, agricultural soft goods, energy) the noted historian David Hackett Fischer in a book he wrote called The Long Wave studying inflation over the last over 1000 years, he always talked about the great price inflations and they always began in the food and energy sector, just as we’re seeing today. What is your take on inflation?

LOUISE: I think it’s as I said “shifting seats.” I think we have deflation and inflation going on simultaneously. We have a deflation in financial assets because of the excess of extended credit that has taken us to the housing, to the greed of the banks creating all of these derivative products and selling them, god knows how. And that is creating a deflation of what had become a financial bubble, I guess, if you will. We had the technology bubble in 2000 and it’s been very quickly thereafter followed by this financial bubble which is now deflating. And everything that goes with it is deflating: The housing, consumer discretionary, retail areas, all of the financial stocks.

But on the other side of the coin, you have the 21^st Century area where we anticipated seeing inflation come into the things that are very precious and very consumer essential. And I think that, you know, this is very theoretical and I think of it in broad terms but if we think about what inflation and recessions used to be, they were in capital goods, it was because you had a build up of inventory and then things slowed down until you had drying up or absorption of that inventory before the next cycle could move ahead. And I think the thing that’s a little disturbing is that the inflationary forces are moving into an area where you’re not going to have a build up of inventory. You’ve got food, energy and water and they’re all in demand in a constant cycle. Yes, you may have moments when you know, the weather provides you with an opportunity that you don’t need as much of it as you did before but I think the trend is up. And it’s a consistent up over the years ahead of us, and I think that it’s going to create a real adjustment in our quality of life. [36:27]

JIM: What about the stock market, as we are talking on this Thursday, the Dow Jones Industrial Average is down about 9% this year, S&P’s down about 11...over 16% loss. If you look globally you’ve got double digit losses in Europe and the Middle East and double digit losses in Asia. What’s your take on stock markets?

LOUISE: Well, we’ve been very cautious since late 2007 because under the surface we saw evidence that people were selling into the 2007 rally. The underlying statistics, the advancing and declining issues, the up volume and the down volume and the new highs versus new lows were very different in 2007 rally than they were in the 2006 rally. In the 2006 rally every thing was moving up and you continued to have improvement in all of those statistics. And if you think about the markets as the generals, and the statistics that we follow as the troops, when you have the generals and the troops going into battle together you have a success in the bull market. But what happened in 2007 was that the indices or the generals continued to march to new highs but the troops were running and fleeing. And when the troops disperse eventually the generals are going to have to turn and flee.

And I think that we are in a bear market; I think for some stocks it is a continuation of the 2000 structural bear market that began then. Financials are an example of that. They rallied in 2007 but many of them never made new highs versus 2000; and now we’re seeing these terrific declines and I wouldn’t in any way try to catch a falling sword. One question we can never answer is how low is low. All we know is we want to step aside and get out of the way. We’d much rather be out of the market wishing we were in than in the market wishing we were out. So we tend to have protected against these which started turning negative on home building in December of 05 because we saw distribution patterns – we saw evidence of selling – which is another way of saying supply and what we watch is of course just supply and demand; and then in 2006 we started to see the same thing happening in financials and in consumer discretionary as we move through the year. And so we’ve been pretty much protected by the time this has happened because we did feel there was a top in place. [38:55]

JIM: I guess that’s the big question: When is the bottom? How low is low. But the one thing that we seem to have is the very things that are shaking the foundations of the dollar, and the dollar losing its value, whether it’s new bailouts that the Fed’s talking about, new stimulus programs. I mean these checks that everybody is getting here in a couple of months, we don’t have the money to pay for those checks.

LOUISE: We don’t have the money to pay for it and all it does is give them one fish.

JIM: We’re going to give them a fish.

LOUISE: It doesn’t teach them how to fish for themselves and I think that’s very sad. And also I think that these bailouts are very unfair to a certain degree to the people that saved their money and are paying full rate on their mortgages. The values of their homes are going down too. Why should the bailout simply be for people who were overextended and did more than they should have. There are all kinds of questions out there that create a very moral dilemma, Jim. [39:49]

JIM: I’m very much concerned because if you go through with some of these programs, for example, one proposal to allow judges to decide in bankruptcy what the renegotiated mortgage or interest rate is. You and I know, Louise, what that’s going to do is it’s going to spark lenders to demand higher interest rates almost equivalent to junk bonds because every mortgage can be viewed as being risky because you don’t what the terms are going to be, or if some judge is going to change them. I think we’re going down a very dangerous path here.

LOUISE: I agree. But I think there are some other things that we’re doing that are equally foolish and one of them is ethanol from corn. I’ve always felt that you shouldn’t be using food for something else. And the things that are never brought out is that something like ethanol from corn is not very efficient. It takes eight gallons of gasoline to make nine gallons of ethanol. And it chews up an enormous amount of water – all precious supplies and basic needs for nutrition and daily life. Why can’t we do it from cellulose; why won’t we focus on doing it from waste products, not from food products? And I think that’s part of pushing things up. [41:00]

JIM: Well, it just points out to me another reason why we don’t want government handling energy policy because that’s what they gave us is ethanol. Louise, as we close here, I’m going to give out your website which is www.lyadvisors.com. And tell our listeners a little about what it is that you do.

LOUISE: Well, we have for 26, 27 years done what’s called technical analysis which is nothing more than the study of the forces of supply and demand in the marketplace and we track it through price movements. So that very simplistically as a price begins to rise and pulls back occasionally from minor profit taking and then goes up to rise some more, what we look for is that series of higher lows and higher highs that represent aggressive demand. And as long as that continues we can suggest that one can participate in that stock or that commodity or that equity market. Now, what happens eventually is that the price no longer goes to new highs and you start going into horizontal patterns and you no longer put in place higher lows, which means your demand and your supply forces are starting to reverse; that there’s more supply coming in which is preventing price from going to a new high and demand is coming in at a lower level or an equal level, rather than at a higher level, so the demand quotient is weakening. And when the level of that demand quotient, which we could call our “shelf,” is broken that indicates to us as technical analysts that someone...their perception of that company has changed and they are now willing to accept less money to get out and that’s when your forces of supply take over and the price goes to a new low and when it rallies it can’t get above the prior rally because somebody is meeting the rally with selling into it. So what you get are a series of lower highs and lower lows which creates the downtrend. But what it represents is aggressive supply for the stock or the commodity or the market place.

And when you get tremendous tops and tremendous declines as we’re seeing in many of the financials the old saying it’s as though the steel ball wrecker and crane came to your house. It takes time before the plumber and carpenter and electrician can put everything back together. And that’s one of the reasons we don’t want to bottom fish because once you see these declines it can take 5, 10, 15 years as we’ve seen with the technology stocks to come back. [43:38]

JIM: Louise, do you have newsletter.

LOUISE: We don’t have anything for the retail investor. We are primarily institutionally oriented. We do have a woman who is managing separate accounts based on our work and that is all on the website if anybody is interested. But we ourselves do not.

JIM:All right. Well, the name of the website is www.lyadvisors.com. And I’d highly recommend you pick up a copy of Louise’s book Market Magic. I still have my copy, Louise.

LOUISE: Thank you, Jim.

JIM: Thank you.

LOUISE: It’s a pleasure.

Buy Them While They're Short - In Supply

JOHN: Well, as we sit here on a Friday doing this program, the Fed has announced it’s going to inject another $200 billion of liquidity. That’s a breathtaking amount when you think about it. They’re going to lower interest rates, commodities and inflation are roaring upwards. And what’s everybody doing: They’re selling gold and they’re selling oil. You work that logic out!

JIM: You know, it was absolutely amazing and I think this gets back to our US centric thinking. We got the unemployment numbers on Friday, they were higher than expected, so the idea is the US economy is going in recession so there is going to be less demand for energy and commodities in general. In fact, you saw a sell-off in commodities all across the board if you look at the CRB Index on Friday, grains were down 3%, soft commodities like orange juice, sugar, coffee and cocoa were down a half a percent, the precious metals were down, the industrial metals were down. About the only thing that was up was livestock.

But once again, John, I think people really don’t understand inflation here. When you have a central bank talking about injecting 200 billion in the TAF program, when you have a report coming out talking about we need to bring mortgage liquidity injections up to about a trillion dollars to stabilize real estate, I mean it’s no wonder. And the dollar keeps dropping against most foreign currencies. Its on par with the Canadian dollar, on par with the Swiss franc, and I think by the end of the year it will be on par with the Australian dollar and the Kiwi. So it just doesn’t make sense. And what they do is they rush to the financials or some other sector and I really don’t think people understand the monetary implications of inflation. [46:17]

JOHN: You know, Jim, over the last six months you’ve been pounding obviously not only on the concept of the value of metals themselves but also precious metal stocks. And I think one of the questions that people are wondering about is why it is that the PM stocks haven’t taken off in the same way that the metals have, given the atmosphere that we’re in?

JIM: Well, last year you had bullion outperform precious metal stocks. Bullion was up over 30%, the precious metal stocks, at least the HUI was up only 20% and even that was misleading because you’re only talking about six stocks in the HUI that did well; some neutral and some actually lost money. I think there are a number of things going on: 1) the price of gold up until August of last year was lagging the price inflation that you were seeing in the mining industry. Mining costs have been going up at 25 to 30%. And remember, up until about the middle of August when the Fed began slashing interest rates gold was in the $600 range. But, today we’re looking at gold closer to 1000 and now the price of precious metals has gone up high enough that all of these mining companies are going to start making some higher levels of profit. In other words, the price has finally caught up and exceeded the cost of production.

And as a result of that you’ve seen a shift this year. You’ve got gold prices which are up roughly about, let me see, spot gold is up about 17% and you’ve got the HUI which is the large cap stocks up about 19 ½%. So the big cap gold stocks are doing very well; they’re beating bullion. I mean Agnico-Eagle is up about 34%; if you take a look at, for example, Yamana gold it ‘s up 43%; if you look at Goldcorp, it’s up 27%; or Kinross up 37%; I can just go down the list. So the liquidity that’s come into this market, it is still largely going into the large cap gold stocks and what is happening is they’re shorting the juniors. I have never seen the kind of short positions I’ve seen in juniors and some of them are absolutely insane. It doesn’t matter if you’re looking at soon-to-be producers. I mean one soon-to-be producer the short position increased almost 50% alone in that stock. The short position has gone from almost 2 million shares to 3 million shares and you’re talking about a stock that has only 50 million shares outstanding and is tightly held by some long term investors.

And I think…It’s like Rob McEwen on the roundtable last week said the hedge funds exited the mining sector last May; well, I think they went beyond that. They’ve gone from being long the junior sector to being short the sector. I don’t care if I’m looking at late stage development plays, if I’m looking at silver stocks. Just to give you an example, one of the silver stocks, Silver Standard, has about 62 million shares outstanding. This is a tightly held stock but if you look at the short position in this stock, this is the highest I’ve seen it: almost 2.5 million shares short. This reminds of a couple of years ago, one of the plays in the market was to write credit default swaps on GM bonds and then as a hedge short GM stock. But unfortunately for that hedge a guy by the name of Kirk Kerkorian came along and all of a sudden made a potential bid for GM and all of a sudden the hedge just blew up and people lost a lot of money; and that is what I think has happened here.

I think a lot of these hedge funds and investment banks have taken large short positions in these juniors and they were not counting on the explosion in the mining stocks, and especially gold. And so what they’ve done to hold this rise in the stocks is they’ve bumped their short positions, which is just absolutely insane because there is strong money as we heard from Jeff Christian. Last year, bullion demand went up 12% globally. That’s almost the seventh year in a row – consecutive year – that we’ve seen an increase in investment demand; and John, this is just beginning. And one of the things that you really have to watch out here is when markets go up as we’ve seen in the last week, for example, gold stocks, liquidity comes into the sector. In other words, all of a sudden there is more buying and at the same time the selling comes in so liquidity increases but then once you go through one of these moves liquidity dries up. So what happens if you’re short almost a month’s supply of trading? I mean this is a very dangerous position to be in. [51:15]

JOHN: So if the stocks are pulling back, then what should the investor decide to do. Do you try to trade them, stay in accumulation mode; which way?

JIM: You know what, I do believe that we’re going to see gold go over 1000. I would not be surprised to see gold go to 12, 1500 by the end of the year. If you’re going to trade them I recommend you trade the large cap stocks, and you’d probably be better off trading some kind of ETF like the GDX where there’s plenty of liquidity and you can get in and out. The GDX is sort of the HUI index. And if you’re going to trade and you’re a nimble trader that’s what you do: You trade the large cap stocks. But the juniors when they’re shorting them like this and trying to hold the price down, you use that as an accumulation.

I hate buying juniors when the stocks are going up. I’d rather buy them when they’re going down and especially someone like ourself that is institutional, I prefer when a large block of liquidity comes in on the sell side which is what we saw in quite a few of the juniors because I mean we’re sitting on $50 million in cash that we’re going to put to work in about four or five juniors. So we look for those liquidity moves to provide us with the ability to buy these stocks without driving them up because when stocks are going up if we were to go in and buy we would drive the price of the shares up. So at least from an institutional side, you use these pull backs and these huge short positions, you take advantage of it. In other words, let them take the price down and as they take the price down go in and pick these shares up at a cheaper price. [52:59]

JOHN: You wouldn’t recommend trading juniors then?

JIM: No, we have, for example, a uranium junior that’s up 200% in the last two weeks because they just hit a spectacular...they made a uranium discovery. I mean that’s the risk that you run in the junior sector because you never know what’s going to be…what are juniors doing? They’re going out and they’re putting drills in the ground and you’re not going to know when one of those drills hit. And that’s one of the reasons why you’ve got to take a longer term view when you’re in this sector. And I think trying to trade in and out of this sector, and especially the juniors you’re just going to outsmart yourself. [53:35]

JOHN: So how do you know if a Junior is short, and then if you assume that you know, how do you play that as an investor?

JIM: The short positions on the mining stocks are listed. In fact, if you go to our website on Financial Sense on the right hand side you have our precious metals page, we have two links to short positions. We have the HUI short positions and then we have the link to overall short positions. And one of the things that you do is, and you can see this. I mean it’s obvious, you’ll see it. And especially when they do this at the end of the day because when stocks are rising and these hedge funds are shorting the stocks and the investment banks are shorting the stock, they don’t want to have their books in negative territory. In other words, if they shorted the stock and the stock goes up what’ll happen is their short position goes into negative and they might have to post margin and cover that. So what they’ll do is they’ll try to manipulate the price and they’ll come in like 30 seconds left of trading at the end of the day, what they’ll do is they’ll come in and they’ll whack all the bids. Let’s say a stock is up 20 cents and the last 30 seconds they’ll just start whacking and taking the stock down. So they close the price of the stock negative. So when you see that kind of action, what you do is let them drive the bids down. In other words, if they’re trying to drive the stock down then lower your bid for the stock. If the stock is at a dollar and they drive it down to 95 cents at the end of the day, then reduce your bid to 95 cents. In other words, make the shorts come down to you. Don’t try to chase them. In that way you can get these shares at a cheaper price, but more importantly if you pick them up – let’s say you buy them at 95 and the next day they drive the price to 90 cents then what you do is lower your bid to 90 cents. In other words, don’t chase the offers.

And it’s very important that you have a broker that understands that; that you have a Level II so you can see where the bid and ask prices are; and then you can pinpoint also who the brokerage houses who are behind the short positions because they’ll tell you which house is shorting, which house is buying and this is the kind of information you need if you’re going to be in the junior sector. But I think these guys are going to be committing economic suicide because all that has to happen is if the market goes up, it’s some event – a financial event or whatever it is, maybe it’s the price of gold going north of 1000 – what’ll happen is they’ll go in and increase their short positions. And all across the board this week in a lot of the juniors (with the exception of one particular junior that we’re following where the shorts are starting to cover because they’re in a very precarious position) that we have our eyes on, you could just see the short positions increase. One short position increased by over a half million shares this week alone. So that’s how you use the shorts position to your advantage. When you see this kind of activity on Level II, then just reduce your bid. Make the short seller come to you and sell you your shares at a lower price. What you don’t want to do is chase the stock so that the shorts can sell it to you at a higher price and then when the price goes down they can come back and cover it at a lower price. You don’t want to play their game, you want to make them play your game. [57:03]

JOHN: And the worst thing you could do in this case would be to sell your shares, you know, you panic and you say, “aagh, I’ve got to get out of this real fast” and then you sell the shares going down. because you’ve actually rewarded the short sellers in that case.

JIM: What you’re doing is you’re playing their game because that’s what they want you to do. They want you to chase the price higher therefore they will short the shares to you at a higher price and then what’ll happen is then when they drive it down at the end of the day because they don’t want to be in a negative position, they’ll pick up the shares at a lower price because what they’re going to do is they’re going to…they’ll come in and they call them bear raids where they’ll just carpet bomb the stock. They’ll drive the price down and then as a result as the price goes down people see the price go down, they don’t understand what’s going on, they panic, they go “my stock’s down 10, 15% I better get out.” You panic. And that’s exactly what the short seller wants you to do. They want to scare, they want to panic you and they want you to sell your shares so they can cover and profit off you. And that’s why it’s a losing game when you play that. So when you see that kind of activity make the short seller come to you, make them sell, lower your bid, make them sell the shares to you at a lower price; and more importantly, increase your position, buy more stock. But more importantly, don’t panic. Understand that they’re giving you an opportunity and you hold your shares. You don’t trade them. And the unfortunate thing is they try to scare you out by coming in and doing these carpet bombs and hoping they’ll shake and panic people so they can cover their short position. [58:48]

JOHN: Now, when you talk about carpet bombing that’s obviously a slang phrase. What does that mean?

JIM: Usually what they’ll do when they’re trying to create liquidity or cover a position they’ll come in and use maybe two or three brokerage firms and what they’ll do is all of a sudden a stock is hardly trading and one day volume just goes through the roof, they slam the stock and they drive it down 15 to 20%. And you know, investors say, “What the heck just happened. There’s no news. There’s nothing.” And what they’re trying to do is start a bear run on the stock because they’re shorting and what they’re hoping to do is scare a bunch of people out of the stocks so they can pick up the shares and cover their short position. So these are just some of the tricks that they use to scare people out. And the hedge funds and the investment banks have been playing the individual investor.

In fact, next week we’re going to have an author of a new book called Lost on Bay Street, Alex Doulis, who talks about a lot of these games that the hedge funds and the investment banks play against individual investors. So there are two things you can do: you can either get bummed out and play their game, in which case you’re going to lose; or you can make them play your game – and that I think is the most important thing to understand in this kind of market. [60:05]

JOHN: So the point of carpet bombing is to really to start a stampede is what they want to do.

JIM: Yeah, that’s what they want to do is they want to panic people. And you see this – we get a lot of emails (we don’t cover these on the program because I don’t want to get into individual stocks): “What happened to XYZ, I can’t believe the stock went down 10, 15 percent. There was no news,” or “they released incredible drill results and they sell the stock off.” That’s exactly what’s going on: the short sellers and the investment banks working in conjunction are coming in here and trying to drive and stampede investors and get them to panic because you’ve got to remember, John, liquidity can seize up in the market. I sure would not want to be short a lot of these juniors when these things explode because the losses these guys are going to suffer are going to be incredible in this kind of market. I mean the Fed just came out on Friday saying they are going to be flooding the markets with liquidity; we know they’re going to be lowering interest rates; we’ve got commodity, gold prices on fire and money – smart money – is moving in to this sector and I’m talking about big money here.

But once again, you don’t want to play their game. And too often that’s what happens with investors. That’s why we always talk about fundamentals on the program; understanding the company, go to the company website, read the press releases, talk to management about their particular project so that you understand the fundamentals; so that you know these fundamentals, you don’t let these games of the hedge funds and the investment banks be played against you. Therefore when you see them carpet bomb or try to stampede a stock or you follow the short positions and you see that they’re increasing then use that knowledge to your advantage, so that you can use the short sellers price manipulation to your advantage so you can pick up your shares at a lower price and more importantly you hold your positions and you don’t panic because that’s exactly what they’re trying to do. And they will try to do that, you’ll see them carpet bomb the stock in the last 30 seconds, two minutes of trading; they’ll send people on chatrooms – we call them ‘bashers’ – and they’ll plant all kinds of rumors and little innuendos. That’s one of the reasons why I think Agoracom is going to become the standard in chatrooms because they don’t allow a lot of this manipulation that you see so often on Yahoo and Stockhouse where you can say anything. You could go on anonymously and say the president of a company is a pedophile, he was in jail, or you can just say anything you want and there are no standards. [1:02:41]

JOHN: So in summary, basically, you’d be buying at this time, adding to your position while the pullback is en route.

JIM: Yeah, I would take a look at some of these stocks. You’ve got some of these juniors are selling for $25 gold in the ground; you’ve got a soon-to-be mine coming into production selling at almost 25% of the mine’s value. But once again, make sure you understand the company, you understand the story. And make sure you understand what is going on in the marketplace each day. In other words, is it a short position that’s driving the stock down. If it is, use that to your advantage. Lower your bids, make the short sellers come to you, increase your position. But more importantly: Hold your position. [1:03:33]

JOHN: and this is the Financial Sense Newshour (www.financialsense.com). Coming up next, time for the Q-Line. We’ll be back.

Part 3

Q-Calls

JOHN: Now time for the Q-Lines here on the program in which we have the Q-Lines open 24 hours a day to take your questions. We record them. We ask that you give us your first name is fine and where you're calling from. We like to know where all of the callers are and then a question. Please try to keep these brief. They are getting longer and longer and we're getting more and more phone calls. Let me see. We've got -- let me see how many we've got here today people that want to talk to you, Jim. 47 people today, so we're going to try to get to as many of these as we can in this part of the program. Please remember, first of all, the toll free number to use if you're calling in is 800-794-6480. It’s toll free in the US and Canada. It does work for the rest of the world, but it's not toll free from anywhere but those two highly privileged countries. And remember that radio show content is for information and for education purposes only. You should not consider the information you hear here as a solicitation or offer to purchase or sell security stocks, etc.

Our responses to your inquiries are based on the personal opinions of Jim Puplava. Say hi, Jim.

JIM: Hi, Mom.

JOHN: And do not – does your mother listen to this show? My mother used to listen to my radio shows. Do you know that?

And do not take into account suitability, objectives or risk tolerance. The Financial Sense Newshour, because we don't know enough about you, about your personality, your risk, etc, your conditions, is not liable to anyone for financial losses that result from investing in companies or stocks profiled on this program here. This is just for informational purposes only. Always find someone who has a like mind that you want to do an investing, like an Austrian investor, a consulting advisor, etc, broker, whatever you want, before you make financial decisions.

And here we roll. First call is from Vancouver, British Columbia.

Jim and John, it’s Rich calling here from Vancouver, British Columbia. Two quick questions. With your predictions of a US depression in 2010 to 2012, what is your view of what is going to happen to the Canadian economy, and the second question I've got is living here in Vancouver, what do you think real estate is going to do during that time? Keep in mind we have the Olympics in 2010. Look forward to your answer. Thanks.

JIM: You know, Rich, if the US economy goes into a depression, it will obviously impact the Canadian economy because I think 80% of your exports are to the United States, so the Canadian economy will weaken. But you also could divert a lot of your natural resources to other parts of the world, so I would imagine you would see a trade shift. So your economy will be impacted, maybe not as bad as ours. And with the Olympics coming to BC, and also the revival of the mining industry, you might see foreign demand coming because even though, like the dollar is weak, your currency has gotten stronger since you're at parity with us. But remember for foreign investors, especially in Asia and elsewhere where their currencies have gone up, your real estate prices may still look attractive. [03:02]

Hey guys. This is Joe in Stanley, Idaho. Love your show. One of the things that I don't believe you've covered in your hyperinflationary depression scenario is how indexing impacts budgets and especially with the social programs. Lawrence Kotlikoff did a very good article in the May 17th, 2004, Fortune magazine. It was one page but he got right to the point why things get very bad, but covering indexing would be very good. One of the questions that maybe you could cover (or one of your guests) would be I've heard that different bullion sales are not taxed. I assume that is because they are legal tender. It's basically a currency exchange. At some point, if you could cover which bullion sales are taxed and which ones are not that would be great. Thank you guys. Love your show.

JIM: You know, Joe, indexing impacts government budgets because as inflation goes up, entitlement spending goes up. It was one of the main reasons why they jerry-rigged the CPI rate in the 90s. They wanted to bring the level of inflation down to reduce the amount of entitlement increases, particularly for Social Security, government pensions. So as inflation goes up with indexing, government budgets go up and deficits go up.

As far as taxation of bullion, you've got to be careful. If you're buying stocks, stocks are taxed on a long term capital gains basis if you own, let's say, a precious metal stock for over year. However, bullion is considered a collectible and that includes the GLD, and it's taxed at 28%, so it doesn't get the more favorable 15% afforded to capital gains on stocks. [4:40]

JOHN: Yeah. Here in Idaho, by the way, silver is exempt from sales tax.

Hola, Jim and John, this isn't Richard from Buenos Aries. This is Mark from Vancouver, Canada. I have two questions today. The first question really has to do with gold stocks, equities, juniors and intermediate stocks. I think my main problem or reluctance in investing in these has been the fact that they don’t pay any dividends and therefore what value do they really have? How are they better than fiat currencies? Are there any gold stocks, precious metals stocks that actually do pay a dividend? Are you hoping for eventually that these stocks may get bought out and you can get more money that way? I'm just a little bit confused as to that because for me right now there is perhaps a lot more incentive in buying good energy trusts in Canada or a good oil stock with a good dividend.

Another question I have is I have a few stocks actually in a brokerage account in America, and should I be worried about that? Is there any chance of capital controls that you see that might cause me to get the money confiscated; and if so then maybe I should consider transferring that money or shares out of America and into a Canadian brokerage account.

JIM: You know, Mark, if you want dividends and, yes, there are dividend paying stocks. You can look at Freeport McMoran Copper that pays a dividend yield of 1 ¾%. They have been increasing the dividend at an annual rate of about 6%. You can take a look Agnico-Eagle which raised its dividend from 2 cents to 18 cents – a tremendous dividend. And Sean Boyd has talked about as the company grows its production and cash flow and profits increase, they would be increasing that. You're going to have to go to the large stocks for that.

Otherwise, if you want dividends you would have to go to probably even more the base metals producers. You take a look at a company like BHP Billington (which by the way is one of the largest producers of silver in the world), they have a dividend yield of roughly about 1.64, and they've had an average increase in their dividend of 33% a year for the last five years running.

And as far as gold and confiscation and capital controls, whenever possible you should always have different methods of owning bullion, owning it personally, owning it outside of the country, and there are various ways you can do that through either ETFs or through organizations such as GoldMoney. [7:12]

Hi Jim. This is Ram. I'm calling from the USA. Oil is up. Gold is up. Bernanke says he's going to crank up the printers again. It may have been plain vanilla to you when you saw this coming but your predictions are nothing short of amazing to me. I have an interesting question for you. I read an article in the BBC website about the situation in Zimbabwe. The journalist photographed a place where stable currency was lying all over the place and the car center there is working on a barter system with a local farmer for his food. Do you think barter systems have any future? If I do work your yard and you mow my lawn to return the favor, how is government going to tax it? What if the same is done by companies? I refer further to a company called International Monetary System, contrary to the name they actually provide a platform for business to do the barter system. They say their business is exploding since last year and this year and have huge insider buying. I just wanted to know your opinion on the legality and taxation of barter system for a serious tax policy. Love your show. Listen to it every Saturday, and thanks a lot.

JIM: You know, Ram, as currencies get out of control with hyperinflation as you're seeing in Zimbabwe, that's what happens. The money system breaks down and barter takes over, and you're probably going to see it take over. I mean take a look at eBay, which is almost like a barter system in a way. It's an auction system, so the advent of eBay is already telling you that we have the technology and mechanisms to go to some kind of barter system if currencies breakdown. [8:53]

Hi guys. This is Mark calling from Houston again. First of all, I want to thank you for a great show. Your vision over the last few years has just been phenomenal to date. I have a question related to just a general investment strategy. What is your opinion of the safety of money market funds other than Treasury money market funds? Just talking in general terms, you know, funds like ones that have a lot of commercial paper or funds that have government agencies. The reality of the situation (especially with the larger investment companies, especially the one starting with the letter F or the one starting with the letter V), I just want to know if I could take my money out of the treasury money market and get a little higher yield with say one that has more commercial paper or one that has government agency mortgages. Just give me a little reality. Just your general opinion would be appreciated. Thanks so much and look forward to further shows.

JIM: You know, Mark, for the very same reasons that we're seeing right now with a lot of these money market funds blowup because of commercial paper, asset-backed paper, I would stick with the Treasury securities. I just don't think the yield is high enough yet to compensate you to go in this market and especially when they are talking about that writing down securities, things of that nature, the freezing up, the commercial paper market starting to contract. I would stay with the Treasury market and the F and the V mutual fund families. [10:43]

Hi, this is Bruce calling from the Indian Himalayas and great program as ever. One quick question. Where could I find a realistic inflation calculator or something that includes increases obviously in energy. It would be great if you could put one on your site. I really appreciate all of the extra details that you're putting in. And I have another suggestion. It's a book by David Sanborn Scott I believe his name is, called Smelling Land and he's got a wonderfully broad perspective. He includes hydrogen for one thing as a possibility for the airline industry. It's already doing the space shuttle. It's a third of the weight of normal fuel, and it's also got better payload capability also it’s actually believe it or not it's safer. So that was one suggestion. Thanks a lot.

JIM: Bruce, if you go to your computer, go to Google and just type in ‘inflation calculator’ and you'll get a whole page long. There is westegg.com. There is also a site called inflationdata.com that has an inflation rate calculator, but there is a whole page of places that you can go including the Bureau of Labor Statistics and also the Federal Reserve Board that includes based on CPI. Now, bear in mind that CPI is sort of manipulated, but at least the headline CPI number uses both food and energy even though they manipulate it somewhat. But type in ‘inflation calculator’ at going will. [12:25]

Hi, Jim and John. This is Jeff from Naples, Florida. I have two questions for you. One is the Central Fund of Canada (CEF) charges or has presently a premium to their NAV (Net Asset Value) of 8.5%; and ASA Limited, which I know doesn't have bullion, but it is a gold fund, has a discount of 8.4%. Is there something wrong with ASA Limited? I don't ever hear you guys talk about it. Another question is the Canadian royalty trust, ERF, which is Enerplus, has an earnings per share of $2.84 and yet it pays out a dividend of $5.02. How long can it keep doing that? Like to hear your thoughts. Thanks a lot.

JIM: Let me address – there were three questions there. Central Fund of Canada actually, the premium over Net Asset Value is actually 5.47%, and getting back to ASA, which is selling at a little over an 8% discount, it gets back to what we've been talking about here where the bullion is doing better than the stocks. ASA has a lot of South African stocks, and so it's selling at a discount because the stocks haven't done as well. And I think that's one of the reasons that you're seeing that.

Getting to your question on the ERF, the difference between their earnings and their pay out is cash flow or depletion. So when you're in one of these funds, remember you're getting actually back some principal here as a result of cash flow that's coming back from -- because these funds get to use depletion against their oil and gas revenue. [14:09]

John from Minneapolis here. I found some great video footage of some of my favorite investment gurus from Dr. Marc Faber, David Tice, James Turk, all one has to do is type in their name in quotes on YouTube.com, and you wouldn't believe how much great video coverage you can view in just that one click.

Second question is the dollar versus euro, can you comment why the euro keeps going up against the dollar when clearly at a purchasing power parity basis the euro is over extended and it would appear that Europe has the same demographic, debt problems as we do here in the US, yet everyone comments on the crash of the US dollar, but I don't hear about that on the euro? Maybe I'm not getting it right, but I'm wondering if you can just comment on specifically dollar versus euro. Thanks.

JIM: You know, there is a number of issues here, John, that come into play. One is the interest rate differential. You've got the federal funds rate here at 3%. The equivalent rate in Europe is at 4%. You've got higher money market yields. You've got higher 10 year bond spread yields; and also as an alternative to the dollar. So I mean, you take a look at central banks, they've been trying to diversify out of the dollar. Where do you go? Well, you go to Europe or other places, so it's a combination of interest rates and diversification because no other currency, I mean you can't go in the Swiss frank. It's too small to absorb all of this influx of liquidity that we're seeing from sovereign wealth funds and from OPEC. [15:45]

Hi. This is Jeff calling from Las Vegas. Having worked in jobs related to both high tech and real estate and also being a listener of your program, I'm very interested in what you see in the area of jobs growth and jobs dying off. I know that job forecasting isn't the focus of your program, but since it's very related to investments, I was wondering if you wouldn't mind making a quick job forecast over the next few years. Which jobs will suffer most? Which ones will benefit the most, and what advice are you giving to your children right now? Thank you.

JIM: You know, Jeff, if I was looking at where you're going to see job growth, you're going to see job growth in the mining sector, in the energy sector, in the alternative energy sector, in the farming sector. In other words, in things that people need, so a great future job is going to be a geologist. I mean if you're a geologist today, you can write your own ticket in the mining industry and the petroleum industry. Another thing that is going to be in high demand and we're not graduating enough of them is engineers. I don't care if it's manufacturing, industrial engineers, chemical engineers, electrical engineers, aeronautical engineers, engineering, the sciences, you're still going to need people in technology. I see a growth in that area. One area that is not going to do well is the financial sector. You're going to see brokers lose their jobs, real estate agents, you're going to see appraisers because that was the last bubble and we're moving towards more of a basic necessity. If you listen to the topics covered, the first two, in the Big Picture, that's what I would be in. In terms of what am I doing with my kids, one of my sons is a CMT. He's my oldest son, he heads up the trade desk. The second son is a CFA candidate. He's in the business. And a third son majored in technology, and he's in the business. He runs the website. So I've been blessed. I have my children in my business. [17:41]

Hi. This is Barbera from Oregon. My question has to do with my precious metals stocks in my Roth IRA. Because I am retired and can't contribute more money to my Roth IRA, I was thinking that if the market might make a correction around part of March or April, would you do this: Would you sell maybe a third of some of your precious metals holdings about mid March or early March and then after that buy some more after the correction? That's the only way I can see to get more money into my account to be able to purchase more shares. Appreciate your answer. Love your show. Thank you.

JIM: You know, Barbara, I would be real careful about trying to trade in and out of precious metals. I mean your Roth IRA can grow just by the fact that the metals themselves appreciate. But if you were to get into trading, I would wait until gold crosses a thousand, maybe a 1,050 or 1,100 before I would take part of my position off. And remember, the way this market is, the thing that can happen with gold is in a blink of an eye, and this is -- if you look at a chart of gold or even the gold indexes, I mean who would have known August 9th that a crisis would erupt in the credit markets beginning in Europe where two days previously the Federal Reserve met and said that they weren't going to lower interest rates, that they were worried about inflation. Two days later in a off-meeting the Fed lowers the discount rate by 50 basis points. That's the kind of world that we live in today. I mean who would have thought that, you know, we've got troops in Latin America today where you could see a conflict erupt in the oil district of Ecuador and Venezuela. I mean that's the kind of world we live in, so I'm not in favor of trading and if you are not an experienced trader, do not have a very strong background in technical analysis, you can out smart yourself here. So be very cautious in doing this if you don't have the experience and if you still want to do this, you know, I would wait until gold crosses over 1,000, maybe the 1050 level before I would do something like that because we're in uncharted territory. And on the Friday I'm answering your question, Ben Bernanke just talked about a $200 billion injection into the banking system, so be very cautious here about trying to trade in and out of the market. [20:21]

Hi Jim and John, this is Dennis calling from Connecticut. Just a quick question regarding the aggressive trade that seems to be out there right now, which is some of the hedge funds might be looking to go long muni bonds and short Treasuries. It seems like these muni bonds have been beaten up substantially, and I was wondering if they were capturing your attention at all at this point and if so, maybe you might have a closed end fund in mind. Anyway, thanks for the show.

JIM: You know, you bring up an interesting point. They have been beaten up very badly. I wouldn't be opposed to trading something like that. You might want to look in the Nuveen sector or the BlackRock sector for closed-end muni funds. [21:04]

Greetings. Jason from Tampa bay. I happen to be looking at the Bloomberg television, and I noticed on Friday the Dow was down 350 points and immediately following the Dow being down was the Dow futures, which stated it was down another 271 points. Could you clarify this and translate what this means. Thank you for answering my question. Great show.

JIM: I think what the large selloff, as you saw last Friday, usually when you see the futures after the market close go down like that, they are anticipating what might happen to the markets on Monday. [21:38]

Hey guys. This is Brian from New Orleans. Listen, I'm listening to the show two weeks prior. You know, you guys are starting to lose a little bit of your luster here. You've been doing this show, what, seven years and all of a sudden, the tone of your commentary is taking the tone that everything that is about to happen that is bad is just coming about in the last year or two, and in particular, looking forward to the next president. I mean come on, guys. I mean we've been talking about that this for seven years. And the problems facing this country have nothing really to do with the next president. I mean it's a train wreck. We're arranging the deck chairs on the Titanic and for all of a sudden for you guys to start complaining about tax cuts and inferring that the candidates running for president, now trying to give folks their take, is going to be the reason for our demise is silly. I mean your listeners know that for the last seven years you've been talking the deficit spending has been out of control. Let's just keep this cognizant and that the future is not necessarily the cause of the problem. The problem is imbedded and there is no fix in it, and we're going down together. Thank you.

JIM: You know what, Brian? I think you're missing the big picture here for the last seven years. We haven’t been talking about tax hikes. We've been talking about tax cuts. That's what happened in 2001 in response to the recession, the events of 9/11 and also in 2003. Now, yes, what's going to happen with the next president, things are bad, but they could get worse by the decision that we're making. And the best example I could give you is what happened in 1929. We had a stock market crash. We had economic weakness, but it was the policies that were implemented by the Hoover administration that raised tax rates, that put in regulation and that was followed even further by Roosevelt that took what should have been nothing more than a recession and a market correction and turned it into the greatest depression in this country's history. So I disagree with you. If the economy is weak and you're talking about raising tax rates to 60% and you don't think that's going to make things worse, you need to do a lot more economic reading, my friend. [24:03]

Hi, Jim. This is John from Las Vegas. I just got a question and comment on the Federal Reserve and their latest helicopter drops. The thought I had was that Bernanke is trying to create a carry trade for the banks to reinflate their balance sheets. And he has no choice but to do that because some of these banks probably are getting close to being insolvent and that Bernanke realizes what he's doing. He realizes he's creating inflation. He has no choice but to do this. And he also realizes that their problem is going to be a financial catastrophe down the road. He wants at least a big bank solvent so they can weather the storm of any financial, you know, catastrophe that occurs in the future. I’d like your comment on that if possible.

JIM: John, you hit the nail on the head. That's exactly what he's doing. He's reinflating and creating a carry trade. In fact, that's exactly what Greenspan did in the 91 S&L crisis where they steepened the yield curve and at that time, banks were reluctant to lend, so they steepened the yield curve and what banks did is they made the spread by investing in Treasuries and that was where the carry trade first became very popular. But you're right. He doesn't have any choice at this point, and that's what's going to happen if you listen to the first section where we take about deleveraging. In the next couple of years, the financial system is going to try to rebuild the balance sheet just as corporations rebuilt their balance sheets as a result of the 2001 recession and that's exactly what he's aiming for, but you've got this 100 percent accurate. [25:42]

Hi, Jim and John. This is Peter from Seattle. Hey, I just wanted to share a quick observation and get your take on this. There is the one basic thing that I think has been overlooked by the media in terms of all of the problems of items going up such as housing or stocks and bubbles and bubbles deflating. It's the fact that you say when people lose faith in money, they put it somewhere where they believe it's going up, but I don't believe most media or even on your program I've heard this connected to the very fact that I think most people really don't -- the housing bubble is an indication that people don't have faith in their currency and also still with stocks. On the one hand you can say, okay, hey, let's all get rich and buy it. But on the other hand you can also look at it and say that they know that if they hold that their money is going to be worthless. I was wondering if you can comment on a distinction or a link between inflation expectations which you always mention that the Fed wants to know what people are thinking, the little guy on the ground and why; and obviously once we understand inflation and our expectations are for more inflation and the cat’s out of the bag. But I wonder why nobody has ever connected the link between housing that basically it maybe in my view a lack of faith in the currency, but I have know people that said I have to buy in now because I will never be able to afford it again forever because they are going up the way they are, so they ran into housing because, you know, they figured they'd be priced out. Is that not inflation expectations ran amuck already, and anyway, I've never heard the link mentioned to that by too many people, so I'm just curious about your thoughts. Thanks.

JIM: Peter, we talked about this for quite some time on the program, and actually, I've written about it. The inflation that we saw in the 80s and 90s, they talked about a disinflationary period of time meaning that manufactured goods and the headline CPI came down. But if you take a look at when Greenspan slashed interest rates in the 91 Savings and Loan crisis and recession, he drove bond yields and interest rates down from double digits down to single digits. And the first influx of that is exactly what happened as people came out of CDs and they went into the bond market. Then when the Fed raised interest rates and crashed the bond market in 94 with the Peso crisis, money moved out of bonds and out of CDs and it moved into stocks and we got the stock market bubble. So it's not just the housing bubble that you're referring to. It began with equities and bonds in the 90s and then moved on to real estate in this decade, so we've had continuous inflation. It's just been asset inflation. [28:24]

Hello, gentlemen. I can't be brief. I'm depressed. Listen, you had a caller this weekend, two part question here. First part not second part. The second part was actually very important. The second part of his question was about his existing debt. Is it better to maintain existing debt now because it will be easier to pay back in a hyperinflationary environment, or is it better to do something else with that money to invest it or to -- here is my personal situation. I'm lucky enough to be getting a tax refund this year, so I could a) pay down credit card debt with it; b) invest in a solar hot water system to get through the energy crisis you say is coming; or c) invest the money in sectors that are being inflated right now. These are the personal choices I think a lot of us are struggling with. Those of us who are lucky enough to have some discretionary income but not much, we can't do all three of those things. We have to chose one. And I'm having a really hard time trying to decide what is the right thing to do. I never went through a hyperinflationary depression. I know you haven't either, I’ve never been through an energy crisis of the magnitude that's coming, although I did live through the 70s, and so I'm really struggling with the choices that I need to make to try to prepare for what's coming.

By the way, this is John from Maine. I didn't say where I was from. So maybe what we need guys is a roundtable of experts to help us make choices. Maybe you could have a week or couple of weeks where people just call in their personal situations and say these are the choices that I need to make given these set of circumstances because I know that no one solution is going to fit everyone. Everyone has different personal situations that have to be addressed differently, but I think we need guidance. And no one is better, I think, than you, Jim, it seems to help us with this given your level of expertise, given the amount of reading that you do and so on. And I think I'm feeling lost. I think probably a lot of your listeners are also feeling lost.

JIM: John, a lot of these questions come in, and obviously, I don't know enough about you, but some very simple things. I am reluctant to see people take on debt if they don't have secure jobs, they don't have adequate savings so that if an emergency comes up, they don't have anything to turn to. You mentioned one of your options is credit card debt. I would suspect that your credit card debt is costing you double digit interest rates, so if you've got a tax refund coming here, I would take it and take care of your credit card debt so that way if another emergency comes up, you have those credit cards available to you and you can use it. So in your situation where you have credit card debt, I'd pay the credit cards off. [31:08]

Hi, Jim and John. It's Lori calling from Winnipeg, Canada. Love your show. Never miss it. Been listening to it since about 2005. Anyway, I wanted to make a suggestion for Eric from Calgary who called in last week asking about the best places to live and invest and they are looking to avoid government trouble. Well, Doug Casey was interviewed on your show during the second hour and I guess it would probably still be available in the archives, but he talked a lot about this subject and I recently subscribed to a new publication of his, the monthly newsletter called Without Borders and its tag line is “the best places in the world to invest and enjoy your time.” It's a great publication, very affordable, so if Eric or any other listeners are interested, they can go to www.Caseyresearch.com and click on the publications link, and I believe they offer a three month risk free trial. Thanks, guys. Take care.

JIM: Lori, thanks for bring that up for Eric's benefit. [32:03]

Hey, Jim and John. This is Craig calling from Charlotte, North Carolina. Quick question for you. What's it going to take to get a five or ten fold pop out of some of these juniors? I'm just wondering what would trigger it. I'm watching some of the news releases come out of companies like Great Panther and Tyhee and it seems like the drill results are just phenomenal and although we've seen some movement in the stock, it hasn't been as much as one would expect, or at least what I would expect, so just wondering what your thoughts are or what it's going to talk to get significant movement in these funds. Thanks a lot and enjoy listening to your show. Look forward to your answer.

JIM: What is it going to take? It's going to take gold moving up much higher than most people anticipate, money going into the gold stocks, the gold stocks going through the moon. And then you're going to see spillover affects, and then all of a sudden people are going to say “the price of metal has gone up, the gold producers have gone up tremendously, where is the next value.” And then you normally see it filter back into the juniors. Very much in terms of what happened when gold took off between 2001 and 2004. [33:06]

This is Dan in Missouri. Some hedge funds are in the process of closing as they have to close their positions. What is the market effect? Are these primary short or long positions? What is the effect on the securities? You mention electric power limits. This means that there are limitations to growth as electricity is a requirement of manufacturing. What happens to all of the power used by the companies that have closed? Just recently Robert Prechter was on Bloomberg showing the Dow Jones versus gold. What is your opinion of this analysis? Is there a chart of the GDP versus gold? Comments, Jim?

JIM: Dan, I'm going to answer just a couple of these here. When hedge funds are in the process of closing, you have long hedge funds, short hedge funds, some hedge funds that use both; but when they close down, they liquidate assets, and part of this deleveraging that we've been talking about the first hour is one of the very things that you've seen in the market. In terms of energy production, energy shortages, I think you're going to see more of those and that absolutely will have an impact on the economic growth rates. In terms of the Dow Jones industrial average, in terms of gold, well, you know, Prechter is using one graph, but you can do that almost against anything, any kind of index. You can take the Dow Jones Stock 50 Index in Europe and index that versus gold and everything is going down against gold, which is just another indication of inflation. [34:40]

Hi, Jim. My name is Hans. I'm calling from Oregon, Wisconsin. Thank you very much for your show. I'm learning a lot from it. What I'm calling about today concerns inflation. You very often on your show emphasize the recklessness of the government’s printing money as an inflationary thing. And I do not at all disagree with you on that. However, it seems to me that rising energy costs also cause inflation too and I seldom if ever hear you discussing that on your program. To take an extreme point of view, if you look at oil sands from Canada, that stuff just plain costs a lot more per barrel to produce because among other things because of the energy return on energy invested. It seems to me like while governments around the world and in the United States are certainly doing a lot to cause inflation, by their fiscal policy, they are certainly not the only factor at work out there. It seems to me as we move into peak oil that the inflationary effects (or whatever you care to call it on peak oil) will become ever more important. Thank you.

JIM: Hans, what is happening with inflation, if governments weren't inflating, then there wouldn't be the money to create the demand for energy that we have today. In other words, if the price of energy was going up, then there would be more money spent on energy there. There would be less money to spend in other areas. But when a government inflates, they create the money and credit. And remember the money and credit that governments create through inflation did not create any wealth. There was no savings or production. When Ben Bernanke creates $200 billion out of thin air, no plant and equipment came online, no production of wealth was created behind that, and that's the big difference. What you're seeing is when more money and credit are created than there are goods produced, then the cost of those goods rise, so rising commodity prices, rising food prices are the shock effect or the symptoms of inflation. And that's the thing that we get confused so often is we talk about the symptoms, rising prices as inflation when it's a monetary phenomenon. Too much money and credit that are being created. [36:59]

Hey, Jim and John, Colby from Missouri. Quick question for you. In my Roth IRA is made up of a Vanguard International stock index fund and the Vanguard Asian stock market index fund. Both have taken a little dive pretty much in October. I think I discovered you guys and want to move into precious metals, but I was wondering if I should wait until we get the creamy center of your Oreo theory in summer when all of the markets inflate back up or if I should mover into precious metals now or what's your thought on that subject? Again, I appreciate the program and thanks for all you do.

JIM: Colby, I think you're going to see a pullback here. I don't know if it's April or March. You may see gold go up to 1000, 1050, you'll see a euphoric rise and you'll see the commercials come in and start shorting it and usually the summer months are the soft months for bullion. But who knows, anything can happen here. But my Oreo theory is as they got this thing under control and stabilized then you'll see a rotation. You'll see money shift off commodity assets, energy prices should be weak as we get into the shoulder months, they’ll move into the financial assets and that will last for a period of time before the inflation numbers start to come back. So at this level, when you're talking about oil or gold prices at 973, you have a greater amount of risk of getting into gold at this time because you're chasing it after it's gone up tremendously since last August. If you were to get into energy right now, you would have to take…or precious metals, you would run some risk on a pull back but also you would have to take a longer term view. In the longer term, you would make a lot of money in this sector because of inflation, but I think there is a little more risk short term getting in at this level. [38:52]

Hi Jim, this is Robert in San Francisco. I have a question about large cap tech stocks. I know you're a huge advocate of dividend paying stocks. Most of the tech stocks like Intel and Cisco never paid a dividend. Management says they never plan to pay a dividend. If you even ask them about it, they react like you accuse them of committing some kind of crime. Now, I understand a company should not pay a dividend if it can reinvest for internal growth and earn a higher internal rate of return than what you could do with the money, but a lot of these tech companies have to invest usually lots of money just to develop new product and stay in the game. And even if they could invest for higher than average return during a growth phase, at some point growth has to level off and you should become a mature company. At some point a company is going to die. If you look at the tech companies from the 60s and 70s most of them are gone now. So a lot of people think, when they think about tech companies, they think about capital gains, but why would a stock have a capital gain if management has promised the shareholders that they'll never get their money back? My question are these tech stocks, are they just projects to consume a lot of capital and never pay the shareholders back? I'm interested in your opinion.

JIM: I would say a couple of things. Yes, they have to reinvest in R&D because they are so – I mean they are in the technology business, so they are going to consume. It's like an oil company that has to make a lot of capital investments, but if I take a look at -- let me just take a look at the book value here of Cisco, it's gone up as a result of increased profits; but they have taken a lot of that and what they are more inclined to do is buy back shares, so Cisco has bought back nearly one billion of its shares back from 2003 to 2007, which drives up their earnings per share. Earnings per share have gone from 59 cents to a buck 23, so they are more of a hyper growth vehicle, so what you're counting on is capital appreciation. And the one thing that I have to give some of these tech companies credit for is the return on common equity in the case of Cisco is up over 30%. And so if you take a look at their five year average, it's gone up -- it's almost doubled. So they are a different kind of a vehicle. If you're looking for cash flow and dividends than technology is probably not the right area, although I do believe that companies like Microsoft are generating so much free cash flow that you could see companies in the software area especially, give back special dividends much as Microsoft did a couple of years ago when they gave back a special dividend of $3. You might see even more of that in the future. [41:41]

Hi Jim and John. It's Craig from Sydney. I have to say your show just gets more and more interesting. This financial reality is unfolding almost exactly as you guys have been predicting for years. It's spooky. Good thing we don't burn witches and warlocks anymore. Anyway, I find myself more and more glued to your show every week, which is why I beg you to please make it shorter. Normally I listen to every minute of every show every week which lasted for five hours and 29 minutes. Come on, Jim. We have families. And while I'm looking a gift horse in the mouth, I'd like to observe that your gold roundtable last week was completely devoid of opposing people. Maybe I don't know what a round table is supposed to be, but aren't there well educated analytical people with data that can make it a good counterpoint; maybe argue that we are seeing a commodity bubble or that gold won't be recognized as money again and therefore it isn't the same haven it used to be: Anything different and contrary so that we the listener might be exposed to the same quality guests but on the other side. Having them on would help bring out the truth better than a roundtable of like-minded folk. Thanks so much for the show.

JIM: Greg, I want you to listen to our commercial. We want people to get into financial health but also physical health. The show is five hours long and it's based on a five hour work week, one hour workout a day, you go to the gym for one hour, one hour of Financial Sense. No. Just kidding.

If you listen to the round table, there were disagreements there. There were people like Bill Murphy who believes the price of gold has been manipulated by central bank sales. Jean-Marie Eveillard disagreed with that. You even had Rob McEwen who disagreed on that. And if you look at the show, we often get authors on the show, even when it comes to energy, I've had people on that believe that oil prices are plentiful, will never run it out, I've had the environmentalists on, I've had the geologists on and geologists of different persuasions. I've had people on the show that are bullish on gold and people that are negative on gold. Look at some of the people that write for the site. They talk about gold pulling back. It's topped out. So take a look at the show and also people that write for the site because we encourage all view points. And a lot of times I can't get people to come on the show that have some various view points. For example, in the area of oil, when CERA came out and said there was plenty of oil out, we invited the people on CERA on to the program to debate it. They refused to come on. [44:07]

This is Thomas calling San Jose, Costa Rica. I have a question on gold confiscation. I was wondering if you guys could address the issue on the program. It seems like with gold approaching $1000 an ounce that that possibility becomes more likely. Thanks a lot.

JIM: Thomas, I think people are more educated today, especially with the internet. I don't think you would have people blindly lining up around banks to turn in their gold for worthless paper money. Although I think you could see some form of taxation that would make trading in and out of gold more prohibitive. And we already have that right now; if you trade bullion you're subject to a 28% tax rate versus the more favorable 15% tax rate that is assessed on, let's say, gold equities. [44:50]

Jim and John, this is Al from Jefferson city. Hey, John, it's interesting you had that 100,000 mark note. I had a friend of mine actually who had kind of I guess you called it a gag gift. He wanted to get me for Christmas last year a continental, an actual continental for the United States. It cost something over $100,000. He had no idea what it was going to be when he went out shopping for it, so obviously I didn't get that for Christmas. But I'm wondering about this 100,000 mark note, I'm curious, how much does something like that cost? Where did you get it and could you just give us information? Thank you very much. Great show. Keep up the good work.

JOHN: If you go to any coin shop, you can usually find these things if you rummage through there, they are paper notes and it cost me, it was really hard to get but I did. It was a whopping $3.

JIM: 100,000 for $3. [45:41]

JOHN: That's what it is. That one wasn't bad. I collect historic coins that show things that go on; coin and paper that are more demonstrative, not necessarily that have numismatic value.

Hello, Jim and John. This is Lan calling from Hanoi, Vietnam. Jim, my 93 year old grandmother has always been a gold fanatic, buying gold is her number one priority in life and she insists that I do the same. I'm 32 years old and I have a masters degree and a good job, and for the first time in my life, I'm able to save some money, but I'm confused about what to do. Should I set everything down that I earn and put it into a savings account? Should I buy gold like my grandmother told me? Should I invest in gold juniors or spend most of my money and time to get more education so that I might have a better chance for a higher paying job in the future? Thanks for helping me figure out what to do.

JIM: Lan, I love the wisdom of your grandmother. I would be buying some gold. You said you have a masters degree. I don't know what kind of profession you're in and if you've got a masters what another masters or PhD if it would get you a better paying job than what you have right now. But in terms of your excess savings right now, I'd definitely put a portion of it in gold, I'd put a portion of it in gold stocks, I might even invest in energy as well. There are five key areas to make money. And you can invest in these areas with ETFs, precious metals, your grandmother's advice, energy because of peak oil and rising energy, demand especially in your neck of the woods, food, water and infrastructure. Those are the five areas to make money and at the top of the list would be precious metals. I would take my hat off to your grandmother. [47:23]

Jim and John, this is Blaine from Utah. I haven't missed an FSN webcast in the last four years. You guys are doing a tremendous service to the little guy who is trying to invest his hard earned dollars and preserve his nest egg in these truly perilous times. My question is why are the mining companies, especially the precious metals like gold and silver, valued on their reserves in the ground and the oil companies are not. I'm looking at the financials on the internet home page for one of the large integrated oil companies in America. I see it has a market cap a bit over 130 billion. It owns almost 13 large domestic refineries, which in my mind would equal the market cap in and of itself. This is not to mention a host of other tangibles in its portfolio, such as pipelines, terminals, chemical and gas plants, etc. The list of hard assets is truly impressive. Where are the billions of barrels of oil equivalent of proven and probable reserves accounted for in the valuation metric? Why the difference between the way the miners and the oils are evaluated? Thanks again for all of you guys do.

JIM: Blaine, the reserves are accounted for. One of the things that if you take a look at appreciation of energy stocks right now, a lot of these companies cannot increase their reserves, in other words, they are not replacing what it is they produce, and they are not finding as much. And those companies are selling at lower PE ratios than those companies who have the ability to not only increase and replace their reserves but also increase their production. So there is a differentiation in the energy sector right now, and the premiums are paid for those companies that can increase production and also replace their reserves. [49:09]

Hi Jim and John. My name is Tom, and I'm from the area around Tucson, Arizona. I very much enjoyed your recent discussion on gold stock and especially the information on Minefinders. My question is: How do investors in mining stocks make a profit? Even the majors seem to pay a paltry dividend of well under 1%. If you consider that gold mines are a depleting asset, it seems essential that investors would receive a regular distribution from profitable companies. Otherwise it's like a game of musical chairs with later investors maybe receiving nothing. So I guess the thing I would say is if I invest money in a gold mining stock, say Minefinders or even Newmont Mining, when do I get paid? Thank you very much.

JIM: When you invest in mining stocks in many ways you're investing on a call on gold. Especially the juniors. That's what you're buying there. And remember, this is just in the first part of the cycle. In one of the discussions that we had in terms of why the stocks haven't done well, probably in the last year or so, was that costs in the mining sector were going up at 25 to 30%. So today you're talking about the average production of gold for most miners is somewhere around $400 an ounce. And remember up until last August, gold was in the 500 and $600. It was at 650 I think last August before taking off. Now that we're looking at thousand dollar gold, $20 silver, you’re going to see an increase in not only profits and cash flow for these companies, but also that will begin to be reflected in the dividends.

And the best example I can give you a company that's growing its production, its production is going to go up five fold. Its cash flow is increasing is a company called Agnico-Eagle. In the year 2000 it paid two cents a share in dividend. Not much. The following year in 2002, it paid 3 cents. It stayed there for two or there years. They had a little bit of a mining problem early on in the decade. Then last year, they increased the dividend to 12 cents a share, and this year they increased the dividend to 18 cents. And when I interviewed Sean, Sean talked about as production grows and cash flow grows, we're still early in the cycle, so just be patient here. [51:27]

Hi. This is Dave in Fort Davis, Texas. Let me see if I can phrase this question without any profanity. I continue to hear Larry Kudlow and the CNBC crew carry on about how wonderful our free market economy is, and at the same time, they all claim to subscribe to the Keynesian theory of economics. How can the two go hand in hand? Keynesian theory advocates government intervention as necessary as determined by a privately-owned central bank and one of its former employees hand-picked to run the Treasury. Where the heck do they get off with this so called free market? Does the government intervene in contract law or offer a bail out whenever this gets convenient in order to provide investment banks and mortgage insurers a loose environment in which to operate? Would someone like to take a stab at a definition of free, or maybe listeners would like to hear the definition of Fabianism, you know, one step at a time. Thanks. Love your show.

JIM: Dave, they do get the confusion of free markets. The minute that a government puts in a central bank, you no longer have a free market because a central bank by its very nature is an interventionist institution. And so you're absolutely right. They get confused. We don't have free trading markets. When you have the government doing helicopter drops, the central bank lowering interest rates or doing term auction facility for 200 billion, no, we don't have free markets today. [52:59]

JOHN: It's also interesting to note that the Fabian socialist logo is a wolf in sheep's clothing. Isn't that interesting? Maybe that should tell us what Fabians are up to all of the time.

This is Tom from Tennessee again, John and Jim, and I do appreciate your views and enjoy your show. I've got to remember to breathe when I try to ask this question. I don't want to talk like a guy in the first year forensic club as a freshman. Anyway, I'm retired and presently have approximately 40% of my investment in physical silver and 15% in physical gold. The stocks that I have mostly are in silver juniors an some gold juniors; and the company stocks I have are in GE and Anadarko Petroleum. Today, Wednesday March the 5th Anadarko entered a new 1.3 billion five year committed revolving credit facility with a group of lenders, a revolving credit facility was arranged by none other than JP Morgan. I do not trust JP Morgan nor the shrinking credit situation in the world. Questions, two, what is a committed revolving credit facility and two, is it time to disengage in Anadarko because of the JP connection. That might be too political for you answer on that, but if it is, if I do disengage those guys what area of investment? And I thank you for taking my question and keep up the great work guys and may God bless you all. Thanks.

JIM: What that might mean is a revolving credit facility is a line of credit just like you would have a credit line on your home and it might mean the company is going to be making acquisitions, so they want that line of credit there in case they do buy somebody else; they may buy a smaller producer. But that's to give the company flexibility so if opportunities come up for investment, capital expenditures, thing of that nature that they have the credit facility there. If you take a look at Anadarko, gosh, you've done very well in this stock. It's down about 3% year to date, but the one year return on this stock has been over 60%. This is the company that could get taken out. So, nope, I'd stay there. They are very well positioned. They have wells in Texas and the surrounding states especially the Rocky Mountain region, Alaska, the Gulf of Mexico; internationally, they have production operations in Africa, Asia, South America and the Caribbean. I'd hold on to this. [55:23]

Hi, Jim. This is Andy from Connecticut. You have frequently referenced the rapid money supply growth occurring around the world. And last week, Tony Allison in his March 3^rd article Commodities on Fire, posted to your site, featured a chart showing some of the year-over-year money supply growth figures in various countries. My question has several parts. Where are these money supply figures obtained from? Are they truly comparable in being properly adjusted for any relevant factors so as not to distort the true picture? How confident are you that they accurately reflect what is indeed happening in these countries? I ask because in Tony’s article we see a mix of M2, M3 and M4 figures for different countries, so why is this? Also, in the United States, M3 growth is being calculated or shown to be around 16% while M2 is growing at a more moderate 6.8%. Which of these monetary measures do you generally prefer to use? Thanks.

JIM: Let me make reference to Tony's article. The figures that are used, I do have confidence in and it's one of the reasons why you're seeing inflation rise globally. It's not just higher inflation rates in the United States. You're seeing it in Europe, you're seeing it in the United Kingdom, you're seeing it in Asia, Chinese inflation is 7%. My son Chris writes the Wrap Up on Wednesday, and he took this a step further. He took these money supply growth rates and then he related it to the CPI in these countries. And by the way, you can see some of this each week in a publication called the Economist in the back page they'll talk about money supply growth rates. The difference between M2 and M3 and some countries their financial markets aren't as developed with sophisticated things like repurchase agreements and some of the high-powered stuff that goes into M3. I prefer M3. It's a broader measure. Whenever the Fed inflates and they use high-powered money, that's where it shows up and that's why it's growing. And when high-powered money is created, it's going to go into an asset market somewhere. [57:34]

Hi, this is Ed calling back from Toronto. My question this week is I was speaking to someone who was speaking to someone who was talking to someone else who was an analyst, a senior analyst in the industry, a senior Asian analyst who basically was saying that while they agreed with the supposition that precious metals and energy and those kinds of commodities would increase, that unknown to most people are what is being ignored by a lot of analysts: that China and India have become over the past few years major agricultural food exporters. They've taken the wealth that they built and invested it back in their ability to basically grow food. And the supposition was that potentially, the anticipated explosion in agricultural prices might not occur in that the potential might be that we might actually be in a short term bubble in terms of expanding food prices and food prices might actually collapse. I just wanted to get your comment on that. Thanks so much.

JIM: Ed, whoever was saying this doesn't know what the heck he's talking about. China has become a net importer. In fact, they just took half of our soybean shipment this year. You've got people like the president of Potash that are saying that unless we have record harvests we're going to have to have record harvests in grain production every year just to avoid famine. So, no, this isn't a commodity bubble, and this also lines up with if you go back and listen to an earlier show we did where we showed that the commodity stock, the grain stock of our major grains are at the lowest level that we've seen since 1960. So, no, whoever is talking about that this is an agricultural bubble doesn't know what they are talking about that. [59:25]

John, and Jim, this is Joe from Chicago. Excellent show. Also excellent interview with CEO of Tyhee and Minefinders. That was great. Question was: Can you do that every week? Maybe just one a week. That would be great. Look forward to hearing your answer. Thanks and take care.

JIM: We are going to do some CEO interviews, Joe. I'm going to probably do some in either April or May. This time I'm going to take some up-and-coming silver companies. One company going into production, one company developing and get some interviews. We're looking at doing a roundtable also on various aspects. We may do one on silver, so we're looking into that. [1:00:01]

Hello Jim and John, I was listening to your discussion with Peter Schiff about the bond market bubble. It seems that you believe that the proper holding period for a government bond is the amount of time after you pull out the pin. So my question is: Would you consider shorting bonds at this point? I kind of agree with your Oreo theory except I believe the negative effects of inflation will show up much earlier, not at the end of the year. I mean $105 oil and so on I don’t think we will have to wait until October to see inflation being a big drag on the economy. None of it is good for the bond market. So I'm just wondering if I short the long bond is it a good hedge against the problems ahead. Thank you and have a good day.

JIM: Wait for the creamy filling of the Oreo because there will be a shift. Right now, money is going into Treasuries as the credit market locked up this week, and that's what's driven the two year Treasury note down to 1 ½ and the 10 year Treasury note down to 3 ½. If you short now, you may be going in a little early because when you have credit markets seize up as you did this week, money shifts out. When you see stock markets going down like we did on Friday, then the money moves over into the bond market. [1:01:24]

Hi Jim. This is Howard from Nashville, North Carolina. I would appreciate it if you would have on at some future date Robert Bryce, current author of Gusher of Lies relating to his perspective of the energy situation. While I don't agree with him, I think it would be an interesting interview for you. Thank you again.

JIM: You know, Howard, we may have him on the show. In fact, his book, A Gusher Of Lies: The Dangerous Illusions of Energy Independence is on my reading list. It's one of the books I have in my study. I just haven't gotten to it. I have about 15 books to get through. If I get through it and I like what I see, we'll try to get the author on the program. [1:02:01]

Hi Jim and John. Thanks for everything. This is Kevin calling from central California. My question is over a six-month timeframe, would it be a good time now to take my profits I've made in Goldcorp, buy financials. Something. The reason: I realize they are not going to let the bankers go out of business. They don't care if their clients take the stick, but the bankers, they are going to bail them out. The reason I ask that is originally I lost my contrarian bent because everybody was doing tech stocks and I quickly turned $30,000 dollars into $5000. And the only reason I have it back is because I started buying a few small silver companies, one of them Western Silver which is where I got my Goldcorp from because I listened to you. A step in the right direction anyhow.

But right now you say that nobody is talking about metals and energy and it seems the last time I turned on CNBC everybody is saying “metals and energy,” so I'm trying to hold onto my contrarian nature. I haven't sold any of it. I've moved it around a little bit, but I think over a six-month timeframe or something like that getting into the tasty part of the Oreo it might be a good move. Just wondered what you thought. I'm afraid that the tendency is to buy in, even dollar cost average. I’m holding on to any cash I have to buy some more silver and precious metals, energy blah blah blah. But right now it seems like the thing to buy would be what everybody is afraid of. Wondering what you think. Just for a trade that is. Six months or so. Bye.

JIM: Kevin, I don't think the run in gold is quite yet finished. I think we're going over 1000, and maybe 1050 somewhere around March or April. You might want to consider reducing that and also make sure you don't get in too early in the financials. When we get to the Oreo part, the creamy filling, I do believe there will be an asset rotation into the financials and especially if we can get some semblance of calm in the credit markets, then yeah, the next trade would be financials. But it will be a short trade. [1:04:05]

Greetings. This is Robert from Olympia, Washington. I've been a listener since about 2003. I podcast every one of your shows and listen to them several times during the week. It makes my cubical existence a little more bearable. I appreciate your analysis and commentary which is proven to be quite astute and keeps me up at night because I sincerely worry about where this economy is going and the fact that inflation among other things is seriously eroding the very hard work that people like myself and my wife –she is in her late 20s and I'm in my late 30s – are doing to be responsible when saving for our retirement and not relying on Social Security or pensions to fund a retirement down the road. Which brings me to my first question, and I'll make this brief.

Regarding the core inflation rate, can you give some kind of explanation as to why the government uses a core inflation rate given that it excludes food and energy. It makes absolutely no sense to me to use this, other than a political agenda to make the general public feel better that the core rate is lower and if they really did include food and energy, it would be significantly higher.

My second question is I have a small exposure in a no load mutual fund. It’s a commodities fund and I've been trying to add to it, but I don't have a lot in there and I'm pretty under-exposed to commodities in general and after listening to your show for all of these years, that's one area that I know I need to increase. So do you have any recommendations for ETFs versus mutual funds as far as getting more exposure to commodities? I don't have the funds to really make buying individual stocks viable and I just wanted to get your sense on that. And to put this in a context, this would be housed in a Roth IRA.

I appreciate the show and please continue with what you're doing. A lot of people out there listen to your show and I don't think the mainstream media is doing the general public any kind of justice in their lack of reporting on any of the issues that you raise in your show. Thank you very much.

JIM: First let me address your core issue. Core issue, originally the thinking behind it was, and this goes back to, let's say, the 80s where you would have like a little crisis in the Middle East and the price of oil would spike like it did in the first Gulf War. And the concept was since these things spike and they are just short term and they are so variable and uncontrollable, they excluded them from the index. But it's mainly used more as a propaganda piece to convince the public that, hey, the core rate isn't going up or the real inflation rate isn't going up as much. I mean why in the heck would anybody buy a two year Treasury note or a 10 year Treasury note with the yields as they are today. So that's one thing.

In terms of commodity ETFs, you might want to look at, for example, the agricultural ETF s, but be very careful here. At this point, if you're going to do something like that, I would dollar cost average. If you're going to go into either energy, commodities such as the ag sector or even the precious metals because we have had a large run up in price, so there are some out there. Look at the ag sector and that's something you can have a pure play on commodities, but at this point, I would dollar cost average. [1:07:15]

Hi gentlemen. My name is Beth. I'm from Los Angeles. I have two questions. First, I've been amassing silver over the past five years, silver bullion, and I have about 2000 ounces that's being held at a bank in an allocated account. How vital do you think it is that I spend the expense and the effort to have it shipped to me and stored locally? If they do confiscate gold, will they also confiscate silver? And second question is, if they do decide to confiscate gold, how will that affect the miners? Will they become companies of the state, or will they automatically have access to the gold that they are mining? How would that work? Love your show. I appreciate your input, and have a good day.

JIM: Beth, I would go through the expense and have the two [sic] ounces of silver shipped to you. Even though they are allocated, I just don't like –unless you're holding it offshore – not having access, especially if it's in a bank. That's question number one.

And if they confiscate gold, as they did in the 30s, one of the gold stocks, Homestake did extremely well because the price of gold went up. We still need to produce gold. If they confiscated gold, it would be because it was a higher price. I think they are going to have a hard time confiscating it to be quite honest. People are more literate today thanks to the internet. What I think they might do instead is more punitive taxation. [1:08:41]

Hi, Jim, John, this is Richard calling from the San Francisco north Bay Area. I'm becoming increasingly alarmed at both the rate of economic change and the extent of economic change. Economics is an aspect of our social systems and social systems can only sustain certain rates of change before internal disparities and resistance to change cause them to start to fly apart. Now the central banks have collapsed the reward for savings and as a partial remedy to the lack of savings, the Fed, for example, is using what I term beneficial use of the value of our dollar holdings as a basis for issuing more money. This is compounded by lost bank lending capacity that now measures in the trillions of dollars. And I can go on. But all of this implies perhaps we are facing a new reality that we may not see clearly. So I wonder if you could talk a little bit about what you think has changed as it relates to value investing. Again, many thanks for a really fabulous program.

JIM: You know, one thing and you're talking about the rates of economic change, what's going on in the banking system, listen to what we talked about in the first hour of the Big Picture about deleveraging because that's taking place. In terms of value investing, value investing is not a fashionable form of investing. It doesn't go out of fashion. You find values in different kind of companies and different kind of sectors and that changes overtime. And that gets back to Ben Graham’s concept of Mr. Market. Mr. Market at one time will value a particular sector like technology or it could be biotechnology, it could be large cap growth stocks like in the late 90s and then at other times Mr. Market can lose interest in those sectors and those sectors become undervalued. So value investing applies to all markets and all sectors and value is what it is. You find it wherever it might be and that may change overtime. [1:10:54]

Hi, Jim. This is Charles from Huntington Beach. I have a question in regards to the price of gold. If hypothetically the Federal Reserve hiked up the interest rates suddenly, say back up to 20%, what would happen to the gold price? Would it crash suddenly, or would it still maintain a lot of its value? Thanks.

JIM: You know, first of all, I just don't know if you'd ever see that unless we got into hyperinflation. And remember, through out the 70s bull market, interest rates went up progressively from the early part of the 70s to the last part of the decade in 1980 where, you know, eventually at that point Volcker raised interest rates, but more importantly, he was curbing the supply of money creation. So you've got to have both of those in conjunction because just as when the Greenspan Fed began raising interest rates in 2004 in incremental baby steps, they were still allowing the money supply to grow at double digit rates, high single digits eventually becoming double digits. But I think the economy is so leveraged today, if they raised interest rates to 20%, there is just -- I just don't see interest rates or the Federal Reserve raising them to that leave. Let's put it this way. If they did raise them to 20%, you would be talking about inflation rates that are running at 40 and 50%. [1:12:15]

Hey, Jim, just wanted to say congratulations on the new addition to your family, and I have two quick questions. I'm a client of yours and considering the blood-bath we've had in the juniors lately, what do I tell my wife to keep her calm. And number two, we’ve done very well on our bullion purchases and my question is: with silver topping $20 an ounce, what price should we accumulate up to? Thanks.

JIM: You know, you're -- just show your wife a chart of the HUI, the gold market, show the pull backs, the times when they dip and we've had quite a few of those going back to 2001. And that, I think, is you have to focus on the long term.

In terms of looking at silver accumulation at this level, although I do think we could see 25 to $30 silver this year, we're already over 20, I would wait for pull backs. I like buying bullion or stocks, whether it's juniors or majors on pull backs rather than when they are going up. So one of the things that you might want to do, and I always tell this to gold investors: Take a look at a chart of gold, take a look at a chart of silver, take a look at a chart of the XAU, take a look at the chart of the HUI, and go back over the last eight years because what you're going to see are pull backs and then you're going to see price hikes, but, you know, the clear direction of those charts, they are going up at about a 45 degree angle. [1:13:53]

This is from Hugh from Albuquerque. Again, thanks for your show. It's given me quite an education. I’ve started taking your advice and buying some juniors that look promising, especially the ones slated to start producing this year. Looking at the potential production rates, costs and profit potential makes sense to me. However, if a major takes them over, how does that benefit the current stockholders. You mentioned that for the juniors, especially exploration companies, getting bought by major is the point. How are these juniors priced by the majors and what are the typical benefits or returns we can expert if our juniors were bought out by a major? Again, thank you very much for your answer. I look forward to hearing to your show.

JIM: You know, the best thing I would tell you is juniors go through a cycle that you see them go through over time and the best example I can give you is a company called Minefinders, which was a late stage junior (actually, started out as an exploration play) and then they went into development and then made the decision back a couple of years ago to go into production.

Now, if you look at a chart of Minefinders going back to, oh, gosh, I can remember buying this when it was 50 cents, but it went up from 2001 where it was trading in the 50 cent range and went all of the way up to $10 in 2004 and then we had the infamous correction in April of that year, the stock went down to about $6. Then gold corrected. It was in a consolidation period, went back up, and then it went town again, got down to about $4 when they make the decision to go into production. But as they began to carry through with their production goals and are starting to achieve them, you know, the stock went from $4 to $12, so you've seen a 3 fold increase in this stock. And one of the things that is a possibility that you know, something like these up and coming producers that go into production could be eventually taken over. It's going to be a matter of how big their market cap is and how profitable they are. And if they do go into production depending on when you bought them, you are still, even if they are taken over, they are going to be at substantial premiums and especially companies that are undervalued as many of these companies are. [1:16:13]

Jim and John, this is Al from Jefferson city, Missouri. Jim, you had Eric King on the show last week and he was great as usual. I think the last time you had him on before that was in Other Voices. You introduced him by saying that you got a lot of requests for him, so I just wanted to ask you to add my name to the list. His advice has made me a lot of money. I made a little bit in Agnico-Eagle, and I made a ton in Yamana. But recently, I've liquidated most of my position in Yamana and I’ve taken on a large position in another one of Eric's favorite picks, that being Kimber Resources. There was quite a big pull back recently, I'm sure you're aware of that, but I took the opportunity to buy a bunch more when it appeared to be on sale. I scooped up quite a bit in the 75 cent range and let me tell you, I'm glad I did. Over the past two weeks watching the big run up has been great. It's been a great time for me. It's Thursday today and it closed at a $1.09. So I basically made enough on this recent run up to pay off my house if I were to sell it tomorrow but I'm not going to sell it tomorrow because based on what I know of Kimber and the story appears to still potentially it has a long way to go up. And thus my dilemma.

Eric speaks a lot about emotional stability involving investments, but I discovered though that emotional stability often ties in directly with the amount and quality of information I get involving those investments. And I need to get more information really about Kimber. So can you help me with this. It was great to hear Eric mention Kimber again on the show last week. I understand you're on the board of directors and of course it makes sense for you to want to protect yourself involving what you say about Kimber on the air, that's no problem. But could you please get Eric King on again soon and have him talk more about Kimber. You've had some great ones on your show over the past years, but let me tell you Eric King is the real deal. Let me tell you. And he is the real deal. I listen to his interviews over and over again on my Ipod. There are some good life lessons on there. Here, let me show you. These are my kids. This is Ruth. “Hi.” This is Sara. “Hi.” This is Annie. “Hi.” And this is Joe. Joe, are you going to say anything? No. Joe is eating his Apple sauce. Joe is two. Okay. You guys ready? Okay. What does Eric King say: “Go Eric.” There you go. I'm getting them trained at an early age, so do us all a favor and see if we can Eric King back on the show. All right. Thanks a lot.

JIM: You know, Al, we may get Eric. He's a private investor. We got a ton of requests over the last weekend with Eric on the show. We may have him back in a week or two. [1:18:48]

Hey Jim and John, this is Michael calling from Vancouver. I have two questions for you guys. The first question is regarding the hyperinflation that according to you guys the Oreo theory will happen in 2009. My question is: will hyperinflation then cause stock prices to sky rocket. And secondly, can you name some of the best dividend growth investing books out there? That's it. Keep up the good work, guys. Thanks.

JIM: You know something, in all economies that have experienced hyperinflation, their stock markets have gone up. It doesn't matter if you look at Germany in the 20s, Argentina recently, Russia recently in the late 90s, Turkey recently, because what happens is people see paper and they look for something tangible. So if we were to go to hyperinflation, you would see nominal increases in the value of the stock market itself.

In terms of dividend books, one I'd recommend is go to Amazon and type in “dividend investing” and there is just a whole list of them out there. In fact, let me do this for you. Let me just type in here on the computer “dividend investing” and you're going to get a whole list of companies that come up here. I'll tell you some of my favorites. One of them is a new book. In fact, he's going to be on the show. It's called The Ultimate Dividend Play Book. That's a new book that came out this year by Josh Peters. Another guy that we had on its program last year that I did an interview, Lowell Miller, The Single Best Investment and also let me see if I can find a couple here that I really like. These are harder to get. One is called A Relative Dividend Yield and that's by Anthony Spare. That's another one and there is another one by Nancy Tengler on dividend investing called New Era Value Investing : A Disciplined Approach to Buying Value and Growth Stocks.

Well, there we have it, John. We did it. Hey, Greg, sorry about going too long – 5 ½ hours this week but we wanted to get through, you know, if you’re going to take the time call us on the Q-Line we’re going to make the time to answer your questions. And John, we got through all of them. I would like to recommend for those calling in the Q-Line make it as brief as possible. That way it allows us to get through more of these questions as they come in. But remember our Financial Sense Financial and Physical Health. Go to the gym one hour a day, five hour workouts a week, five hours of Financial Sense. [1:21:34]

JOHN: And looking forward to the next weeks to come, what are we going to be doing?

JIM: I haven’t the slightest clue. Oh, let’s see. Next week my guest will be Alex Doulis, he’s written a book called Lost on Bay Street, some of the corruption that occurs. Josh Peter, The Ultimate Dividend Playbook, March 22^nd. Steve LeVine, The Oil and the Glory, the story about the great game being played in the Caspian oil sector. William Fleckenstein will be my guest April 5^th and his new book called Greenspan’s Bubbles. Lila Rajiva, Mobs, Messiahs and Markets, April 12^th. Richard Lehmann Income Investing Today on April 19^th, and Pat Dorsey The Little Book that Builds Wealth on April 26^th. So a lot of great stuff coming up in the weeks ahead. Also, we’ll be doing some roundtables with our experts panel. In other words, we’ll get the economic guys, the oil guys together and just sort of have a short roundtable. Some of those kind of things coming up.

Well, on behalf of John Loeffler and myself, we’d like to thank you for tuning in to the Financial Sense Newshour, until you and I talk again we hope you have a pleasant weekend.