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Financial Sense Newshour

The BIG Picture Transcription

May 10, 2008

Part 1

What's Wrong with Gold Stocks?

JOHN: Well, it is no secret that gold prices have been heading higher. In March, gold prices headed north of $1000 an ounce; and since then of course, as could be expected, they pulled back. Today they’re close to 900 an ounce – in the high 800s there – which is up from last year; bullion prices of gold and silver equities rose in tandem. However last year, precious metals equities lagged bullion as they have this year. So people are wondering what is behind this divergence? Does this spell either a) trouble or b) opportunity? And that’s our first conversation here on the Big Picture today.

JIM: Looking at bullion prices, we commented actually that performance is starting to change because right now, year to date, we’ve got bullion prices up a little over 3% and you’ve got the HUI up about 2.8% and the XAU up about 2.6%, so they’re getting closer. This divergence which was widespread last year is narrowing this year and I think we’re at that tipping point where you’re going to see gold equities and silver equities start to outperform the bullion.

But anyway, there were probably three or four factors that were behind this divergence. One was costs that were rising faster than bullion prices; 2), with the emergence of the credit crisis last year there was an aversion to risk; 3) the credit crunch, which made it more difficult for some companies to get financing; and 4) is a reversal of hedge fund activity from being long to going short because there were only a handful of five or six stocks within the HUI that made money (a good majority were either neutral or they lost money.) And of course, if you look at the junior sector, juniors were down last year as they are this year.

So one thing that stands out – and I think the reason for this underperformance as it relates to producers is that costs in the mining sector were rising faster than the price of bullion. Remember, up until last August, gold prices were at 650 an ounce and it wasn’t until this credit crisis burst upon the scene that bullion prices really rose at double-digit levels and above the rate of costs. Mining costs have been rising at an annual rate over the last two years between 25 and 30% a year; and it’s attributable to a number of factors. You had rising labor costs; you had the rising cost of energy – look at energy costs where oil went from $50 a barrel to $100 a barrel; material costs – everything from steel to plastic pipe; and also government take – governments began demanding a higher share of mining profits. So as recently as the fourth quarter of last year, margins were hurt as costs were going up faster than the price.

For example, if we take a look globally last year, in the fourth quarter you had costs were up 30% in South Africa, they were up 23% in Australia; Canadian mining companies saw their costs rise 23%; in the US costs rose close to 20%; in the UK, costs were up 23%. So if you take the average of global prices, they were up 28%. Now, if we boil that down to companies, the large producers: Newmont saw its costs rise 19%; Barrick’s costs rose 31%; if you take the South African producers such Anglo, Gold Fields and Harmony – their costs rose anywhere from 31 to 40%. Globally we’ve seen average costs rise from about $175 an ounce in 2001 to around $390 an ounce for 2007. So costs are up over 120% over the last six years and more importantly, they have skyrocketed over the last two years. In 2007 alone, the average cost for producers went from 300 to around $400 an ounce, so that cut into margins which is why a lot of the gold stocks –especially the large caps – underperformed bullion. [4:39]

JOHN: So looking at it from a pragmatic standpoint, if you were an investor should you avoid the stocks and just buy the bullion – I know we see these questions come into the Q-Lines a lot and emails – or what should the strategy be here?

JIM: We have always advocated on this program that you start your base building in precious metals [with] bullion and some people like to recommend at least a 5% position in bullion. So you start out with your bullion base. But now right now, if you take a look at where the value lies in the market, and I think we are seeing this change before our eyes even on this day that you and I are talking – but the real value lies in the precious metals stocks versus the bullion. But as a consequence, also the risk is higher. But I believe if you look at the markets today, the opportunity lies with the equities. Prices have finally risen – on the day you and I are talking the price of gold is at 886 – so the price has finally risen high enough now that margins are also rising for the producers.

A good example is the recent earnings report for Newmont which reported first quarter earnings of 82 cents a share; that’s up from 15 cents a share a year ago and a loss 63 share in 2006. So if prices remain high as they are now at close to $900 and head higher as I expect – I expect we will retest 1000 and then eventually we’re going to go beyond 1000 – so the producers are going to be minting money if prices of gold bullion stay at this [level]. And remember they are very leveraged to the price of bullion if they’re unhedged and that to me represents a better opportunity in my opinion than bullion. [6:31]

JOHN: I know you favor the growth producers who are building resources and growing production but if we do some comparison, how have they fared up against the super majors?

JIM: I actually think the growth producers are doing much better. Some of my favorites actually have negative costs. If you take a look at Agnico-Eagle, their cash costs are a negative $184; Yamana’s costs are a negative $9 per ounce; and the numbers are even looking better as you look at the firs quarter of this year. So these growth producers continue to be the low costs producers, meaning they are making a lot more money per ounce of gold or silver sold and I think that situation is only going to get better going forward. [7:16]

JOHN: Up until recently costs were rising faster than prices and as a result you would expect that would hurt profits which it did, which in turn damaged stock performance. But can anything else be factored in here to explain this divergence between stocks and bullion?

JIM: Sure. I think there is a broad aversion to risk which came in last August with the credit crisis. When that crisis erupted, investors basically said “where did this come from?” and everybody rushed for safety. And what happened is in terms of asset allocation there was a shift to safe haven type investments. And those two safe havens were Treasuries and bullion. Gold and Treasuries became the safe haven of choice and if investors went into precious metals equities – which they did because they did rally in the fourth quarter – it was mainly the large cap producers; the rest of the sector, from junior producers to junior development companies did very poorly since May of last year. And even in the case of some of the majors, investors have been mainly trading in and out of them. When gold pulled from 1000, you saw companies like Agnico whose share price went from 83 and dropped all the way down to $59 a share. So even the shares of majors have pulled back sharply as bullion prices pulled back. [8:41]

JOHN: And what about juniors? I mean I know you favor them – that’s been no secret here on the program.

JIM: Oh my goodness, I mean they have taken these companies out to the woodshed and beaten them up severely. In many cases, you can take a look across a broad spectrum – they’re practically being given away. But juniors sort of travel to their own individual cycle. I know a junior that I’ve been involved in was beaten up severely last year due to management problems; there was heavy shortselling that came in to the stock – in fact, a naked short position came in due to financing. But this year the stock is up almost 130%. What I find I think remarkable is even as things have gotten better for a lot of these companies and especially this one in particular the short position has actually increased. But what is happening to this company I see happening all across the sector. Companies announce spectacular drill results, they increase their reserves and the stocks go down, the short positions go up. [9:42]

JOHN: We’ve done shows before on shortselling. What is behind this anyway?

JIM: I think that part of this explanation is due to hedging, especially with the markets becoming more volatile; a lot more uncertainty was injected into the markets with the credit crisis last year. So, with hedging let’s say you take a long position in bullion which has been the dominant trade, then you hedge against bullion going down by shorting the gold stocks; Or, if you’re long the majors you short the juniors.

Gosh, going back to the turn of the Century, I’ve been involved in this sector since 2000 and 2001, when we got heavily involved in this sector and John, I’ve never seen short positions like I’ve seen today. They short the majors, they short the intermediates, they’re shorting the juniors. [10:35]

JOHN: What would really help here is some examples of what you’re talking about.

JIM: I’m not going to get into specific names but I’m just going to give some examples. One of the companies we own just reported that their sales were up 172%, their profits were up 400-something percent and John, this is a company whose stock is down 19% this year. And the short position went from nothing to almost 5 or 6% of the outstanding stock – and this company is very tightly held. So management is a key holder as well as certain other respectable firms that own this company, but you know, they reported these results and yet the stock got hammered.

Another company that reported spectacular drill results: They reported for example, 8 meters of gold averaging 55 grams of gold; they had 10 meters of 46 gram gold; they had 32 meters of 15 gram gold. You’re talking about an Aurelian-type deposit here and it was amazing because when they announced these results the stock went up and then all of a sudden the stock got hammered and it was actually reported – it went on the naked short position that came into this stock; and short positions just multiplied.

Another company reported drill results: 16 meters of 4.6 grams of gold; 1300 grams of silver; 7000 grams of silver, 28 grams of gold. And this is a company that within a three month period of time reported drill results with these kind of results and each time they reported this, what happened is the short position increased in the stock. So a lot of people are saying, “what’s wrong with juniors!?” There’s nothing wrong. A lot of these companies are either if they’re junior producers are reporting almost in one case, 200 to 300% increase in sales; 4 or 500% increase in profits; drill results that we haven’t seen; or for example they increased their reserves or their resources by 20 to 30%. And what has happened, instead of the stocks going up or if they do go up on the results immediately heavy short selling comes in to drive these stocks down because that’s been the dominant trade – you go long the bullion, you short the stocks. And this is all across the whole spectrum. [13:06]

JOHN: Is this whole process legal or is there something fishy here?

JIM: Shorting is legal and is actually quite bullish, if you think about it, because eventually short sales have to be covered. What is illegal is naked short selling and that is actually equivalent to what we call counterfeiting stocks. And there is a lot of that going on right now and the regulators, just as they were asleep with the accounting and scams of the Enrons and just as they were asleep with this credit problem going on with these CDOs, they’re also asleep now with this naked short selling. In fact, the SEC probably opened the door to this kind of activity when last year they got rid of the uptick rule to accommodate the hedge funds. So there are a lot more shares sold short than shares that are registered.

So part of the problem is the regulators are allowing this to occur because if they really pressed a lot of the funds to come in and cover their naked short positions because its so widespread they would actually trigger another major financial crisis and I think that’s what they’re dealing with right now. This sort of lying underneath and nobody is giving recognition to this in terms of how widespread [it is.] I read a report on a New York Stock Exchange – I think it was like 25 billion shares sold short and it goes way beyond the number of shares that were registered in the companies that were sold short. So it’s a widespread problem right now, not just with the juniors but all across the board. [14:43]

JOHN: It’s something like you said that can’t be unraveled because if they did unravel everything really would unravel if they tried to deal with that issue. You know, speaking of crises: What about the credit crisis because banks are tightening their lending standards, they’re deleveraging their balance sheets so this would seem to be presenting a problem for juniors with credit conditions that are really, really tight right now compared to what they were a couple of years ago?

JIM: Well, look, if you look at the junior sector there are probably about 2,000 juniors out there; and out of those 2,000 probably less than 5% of them will ever turn into a mine or go into production. So for many of these companies times are going to get tough. However, if you have a project that has a defined resource of– I don’t know – anything over a million to two million ounces or more, is in a friendly jurisdiction (especially with political problems of nationalization on the rise), with good mining economics, with good management that is probably equivalent to like having a FICO score of 800. And companies with 800 FICO scores are having no problems getting financing. We’ve been involved in three different financings this year and all three were oversubscribed with money waiting in line to get in. So like the real economy, if a company has a viable project, a defined resource with plenty of blue sky, you’re having no problem getting money. [16:13]

JOHN: So if shares haven’t been performing as well as bullion and hedge fund shorting, then who is buying? I mean for every seller there has to be a buyer in this deal, so who is on the other side of these trades?

JIM: If you take a look a look at what’s happened, probably going back to summer of last year, most of the day-traders and the momentum traders have exited this sector. What I see now is a lot of big, smart money moving into the sector. You see this almost daily. In fact, on the day that you and I are talking, John, I’m looking at my screen of majors, intermediates, and juniors – you have the HUI, the XAU is down and a wide swath of juniors are in the green. Several of these juniors are up 7, 8%. So I think what has happened is there a widespread recognition, I think this short in this sector is in the process of reversing itself.

And if you think about it, ‘buy low, sell high’ we’ve always been told that’s how you make money in the market. Well, when gold was at 1000, everybody was high-fiving going into the major gold stocks. Look at where we are today. The sector is beaten down, it’s ignored; pessimism runs rampant in the junior sector. It reminds me a lot of what I saw in the year 2000 and 2001 when I first began to accumulate juniors. I mean the tech bubble was bursting, the economy was heading into a recession, you remember all the scandals with the Enrons, the WorldComs. Investors were putting their money in cash. Nobody wanted to invest in gold. It was unloved, undervalued and underowned. But gold and gold stocks were being given away during that period of time.

A similar story by the way for oil because nobody was buying oil between let’s say the years 2000 and 2003 when oil went from $30 a barrel; and it wasn’t until oil prices got over 40 and headed towards 50 that money began moving into the oil sector. Even on a day that we are talking where our forecasts for $125 oil was reached on this Friday and the oil prices closed at just a few cents below 125, you know what, they were selling off the oil stocks. And it’s like people are saying, “well, you know, this can’t last – this is not going to be there.”

So if you take a look the fundamentals for gold have never been stronger, especially as we head into that crisis window that you and I have been talking about that begins in 2009 and goes to 2012. In respect to gold equities, the situation has never been better. And as Warren Buffett likes to say, you’re being given a perfect pitch. [19:07]

JOHN: Well, the role of patience or the lack of it in this situation?

JIM: We have talked about this over the years. If you’re not a long term investor, if you don’t understand the fundamentals that are behind gold, and especially gold equities, then you know what, quite frankly you don’t belong in this sector. Keep your money in a Treasury bill or a bank CD. However, if you’re a long term investor and have a long term horizon when you make investments, it just doesn’t get any better than this. [19:41]

JOHN: Okay, but let’s create a theoretical scenario here. What if prices don’t go back above the $1000 mark. I mean gold prices are usually soft during the summer months, so what if the conditions you’ve named that keep juniors from performing, what if they persist now?

JIM: Quite honestly, my ideal scenario I would love for these conditions to stay at these levels for the rest of the summer and early fall. But you know what, I’m in the accumulation mode so I hope they keep prices low because that enables me to buy more shares at much lower prices. And you know, that’s all I care about right now because I know that gold prices are heading much higher. I know that oil prices are heading much higher, commodity prices are heading much higher. And John, when price are going to recognize that – will it be this month, will it be next month, will it be by the end of summer? I would say by the end of summer the price of silver, the price of gold is heading higher. By summer, we’re going to be looking at much higher natural gas prices and as we get into fall, as we’ll get into the next segment I have now revised my price forecasts where we’re going to be looking at 145, $150 oil and certainly by the end of next year, $200 oil. So I don’t care what the price is now – if they want to short the stocks, drive the prices down – I’m in the accumulation mode just as I was in 2000 and 2001. And all I care about is how many shares I’m going to be able to buy and I think that is what is more important. So I hope they keep this down. But you know what, if you take a look at these conditions, they will not last much longer. They never do. In fact, I wouldn’t be buying bullion here as prices at close to $900, I would be buying shares because that’s where I think the value is in this market right now. [21:38]

JOHN: I have to admit that as long as I’ve know you you’ve been a long term investor, but that’s in many cases sort of a contrarian position from what I would call the knee-jerk day to day of what’s been going on out there. It’s a whole different mind-set, let’s face it.

JIM: I’ve always looked at long term investing – I’ve been in this business over 30 years and you know what, the long term thinking or long term investing is the only way I’ve ever figured out to make money. I’m more comfortable getting on board a long term trend early and riding it until it plays itself out. And in my opinion - it’s not just mine but others that I respect – I believe that this commodity bull market will move on well into the next decade. And I certainly believe that because we don’t have excess supply, we don’t have excess inventories and we’re living in an age that I would describe as an age of scarcity. So that’s what’s worked for me. Other people may be better at trading in and out of this sector than I am – I’m not a trader so I don’t subscribe to that view because as I mentioned I’m a terrible trader.

But if you look at this market, so either you enter this market as a long term investor, buying on weakness, building your positions or you trade this sector. But when it comes to juniors, you make more money by buying quality companies, holding, building your position on weakness and when it comes to juniors, John, this is as good as it gets. [23:08]

JOHN: So if we have to summarize the whole thing, we basically believe that gold and silver prices are heading much higher – that’s pretty much given where everything is going right now as far as the economy and oil and everything else; precious metals equities have underperformed due to a series of factors – rising costs, there is risk aversion, and the short selling that goes on. But, that whole process is in the act of reversing itself right now. Prices are higher today so mining companies are back in the black and good quality companies are having no trouble getting financed and short positions will eventually – I mean they have to be covered sooner or later. So of course the question to all of this is just one of timing.

JIM: Yes, and it becomes a question of patience and taking advantage of opportunities. Does anyone really think that the credit crisis is over, the dollar is going to get stronger, central banks will stop printing money or that inflation rates are heading lower or that the gold industry will expand and discover elephant-sized projects that will flood the markets with excess supply? That is not happening. If you take a look at it I’ve never seen a period where all the stars are lining up for a higher bullion, and what I believe is going to be an explosive run in precious metal equities. In fact, I think we’re at that tipping point where things are beginning to reverse themselves. Like I said, on this day, we’re seeing the price of many juniors move up and I think it’s going to be a process that’s going to reverse itself. And when these short positions have to covered, it’s going to be explosive because the liquidity – I mean if you’re short 5, 6% or 8% of a company and a lot of these companies are held in strong hands, where in the heck are you going to get the shares? The only way you’re going to get those shares is actually by coming in, paying a higher price for it and that’s what I expect to happen. [24:58]

JOHN: You’re listening to the Financial Sense Newshour at www.financialsense.com.

Andy Looney

I’m Andy Looney. This weekend is Mother’s Day. I don’t know if your mother is like mine, but choosing a gift for her is like waterboard torture. I think I’m drowning. You know, men are cursed with the ‘I just don’t understand women’ gene. We can’t help it. We were born that way. It’s genetic. Don’t you think? I do. I mean how many gift cards can you get away with before you get “you never take the time to buy your Mother a gift.” Oh yes. And just when you think you’ve sound a safe gift, you find out she really didn’t want it after all. Like a box of chocolates and she tells you she’s on a diet. Oh boy! I’m in trouble. There’s always jewelry but you financial types know the price of gold is through the roof. If you’re Warren Buffett, hi Mom; If you’re not, bye Mom.

Maybe somebody should invent gold futures jewelry. Now that’s an idea. Don’t you think. Let’s run with it. You don’t have to buy the jewelry just short the little gold certificates out of gold-plated chain. But if gold doesn’t go down they’ll issue a margin call on mom. Ooops, sorry Mom. See you in 5 to 10.

No, no, I’ve got it! How about I buy Mom a $20 bag of rice. It’s big, she’ll like it. My friend Charles says rice is becoming scarcer so why wouldn’t she like that. I would. Maybe I’ll just get Mom a prepaid gasoline card so she won’t have to be stressed out about the prices at the pump. Last time she filled up I had to go down and drive her home, she was too weak from the meter shock. Actually, I think what I’m going to do is what I always do. I’ll beg my wife Sandy to get my mom something. That’s the only way to avoid the cursed male gene. You know, women know what to buy women. Don’t you think that will work. I do.

Happy Mother’s Day to all you mothers out there, and remember, go easy on the men in your life. Even if they’re great businessmen, they still have a big, congenital handicap to overcome.

For Financial Sense, I’m Andy Looney. [27:29]

The Art of Creating Shortages

JOHN: It is interesting to note that certain things seem to happen throughout history. There’s an old Chinese proverb that says “may you live in interesting times.” It is absolutely amazing as you watch or read the news today: oil at – well, it cracked through 125 this week; gold at close to 900; shortages of rice; other food – corn selling at over $6 a bushel largely due to ethanol and also a rise in cost of production because of energy; the emerging world financing America’s deficits right now – how much longer they’re willing to do that remains to be seen. Ten years ago they were in a crisis mode, now they’re buying up large portions of our debt or taking major stakes in some of our largest corporations.

As we go through this conversation, when we talk about how to create shortages –or the ‘gentle art of creating shortages’ should really be the way we title this – you need to understand when trends move through a culture they largely start – let’s take for example the concept of peak oil – they start with a few visionaries or in some cases elitists in terms of agendas; then they move to the media. They win over adherents in the media and academia. Then it sort of moves into the public consciousness as a result of the media and finally then – and only then – does it get to the politicians.

So by the time the politicians figure out what’s going on, the trend has moved on – it’s either gotten worse or something along that line – and then politicians begin trying to pull all the levers to make things work in response to the public outcry. Look at what we’re seeing with oil right now and both parties are trying to posture themselves, saying, “We were dealing with this all along, yes. Can’t you remember this?”

Well, that’s horse puckey, they weren’t even looking at this six months ago and now they’re trying to posture themselves. And now of course they’re so far behind the power curve they’re almost always doing the wrong thing. And so that is the gentle art of creating shortages. Maybe what’s happening right now in Myanmar – formerly Burma – is instructive as far as the fact that they’ve had a major cyclone over there and the UN and other organizations are trying to send in aid and the government there is interfering with it. It’s a military government. And it’s instructive that sometimes governments can make things very, very worse especially when the governments are busy defending themselves against there own people.

But we’re going to talk about the age of scarcity right now and this is going to be largely worldwide, government-caused in one form or another – depending on which government is involved. We’ll be looking at food and energy in this hour, which of course are the two staples of almost any society in the modern world. [30:30]

JIM: I want to begin this segment with food and then we’re going to get into energy because we’re going to revise our oil forecasts in terms of price. But if you take a look a food today and if you look at food in the grocery store, most grocery stores are designed to carry between three and five days worth of food. Outside of canned food, John, a lot of stuff spoils, like produce, meats and things like that. And so if you take the situation with rice – and as an example with just-in-time inventories, let’s say as a family you consume one pound of rice a week. All of a sudden you hear stories about shortages and you’re thinking “shortages! I’m not going to be able to get rice.” So you go to the supermarket and instead of buying one pound rice you buy three pounds, five pounds or six pounds of rice. What happens to what you see on the shelves? [31:21]

JOHN: That automatically accentuates the shortage because suddenly there is a run.

JIM: And so you get a run because we live in an era of just-in-time inventories where nobody wants to keep large amounts of inventory on hand because it costs money to finance that. So anytime you get an increase in demand because of a shortage or an event all of a sudden people start running in and accumulating and as a result you see this huge upsurge in demand. And so that what we’re seeing in rice right now.

I’ve got a good example of this with water. The summer before last – we stay down at the beach during the summer and I had come into town to buy some groceries and I wanted to buy some bottled water; and when I went to the bottled water section of the grocery store it was completely empty, and I’m thinking “wait a minute. This is the middle of the week, what happened here?” And I went to one of the cashiers and I said, “what happened to your water?”

And they said, “well, you haven’t heard?.” And I said, “No. what happened?”

There was an outbreak of E. Coli in the local area and as soon as that hit the news –and they’re talking about it on the 10 o’clock news – everybody immediately rushed to the store and grabbed water so there was no water left. You see this where you have hurricanes where you have people run to Home Depot, they grab candles, they grab batteries and things like that. And that’s the world we live in today with just-in-time inventories – any time there’s a surge all of a sudden the product disappears off the shelf.

And then on top of that: what does government do when these things happen? If you take a look at the case of rice where the price has gone up over 100%, our large exporting countries are now cutting their exports. They are forcing local farmers, they’re freezing the price - in other words, they’re putting in price controls. And John, you know what happens when you have price controls. You start putting in price controls – China is doing this, other nations are doing this – what happens is the people that produce say “wait a minute, I’ve going to pay more for diesel fuel to run my tractors, I have to pay more for fertilizer to grow my crops, why in the heck am I going to do that it you’re capping the price.” I mean China had this problem not only with its producers, they had this problem last year with the price of energy going up. A lot of the refiners in China are what they call ‘teapot refiners.’ They’re small refiners that produce between 10 and 15,000 barrels a day. The government was freezing the price and they stopped producing because how can you import oil at $90, or today $125 if the government is freezing what you can charge. And so what has happened is production went down in China, they had riots in terms of truckers lining up; they had shortages. And so now China is going out into the world market and buying finished gasoline prices from diesel fuel to gasoline, competing with the US which has to import close to 4 million barrels a day of refined products because we don’t make enough. [34:55]

JOHN: So isn’t that the ultimate result though whenever something like that happens (and it’s usually a government entity that jumps in and then tries to artificially mandate what the market is going to do) that there’s a compensation almost immediately elsewhere. That’s because let’s face it, there are certain rules of monetary exchange that you really can’t override in the long run. You may be able to do it in the short run.

JIM: Yes, and unfortunately whether it’s the United States Congress mandating ethanol in 2005, last year they passed a bill that’s going to mandate ethanol be 31% of our corn crop is going to go to ethanol. And what that’s creating is higher prices for food, grain which is a feedstock which goes into the production of chickens, cattle, dairy farming, pork. And you know, you and I were talking about this off the air recently, that what the ranchers are doing now is they are now slaughtering their herds because they can’t afford to feed them and so what we’re going to see – and I just want to tell you if you’re a consumer and you have a freezer, buy your beef and chicken now because by the time the third and fourth quarter you’re going to see escalating beef prices, escalating chicken prices, salmon prices are going to go up because they’re restricting fishing. All of these prices are going to be going up because a lot of government policies – you can’t mandate that over 30% of your corn crop go to making ethanol, which is the dumbest thing we’ve ever done, and not expect some kind of side-effect to be carried through in terms of the feedstock to our main protein source. So here’s a good example.

And you’re seeing governments come in, they’re making mandates like the Congress is. You’re seeing overseas more and more governments – in fact there was a story this week: food prices of rice and other type of products are rising not only just in the United States, but in Latin America, in China. India, the world’s second largest importer of vegetable oils, is banning future trading in soybean, rubber, chickpeas and potatoes as the government seeks to reign in the fastest inflation they’ve seen since 2005. There’s absolutely no proof by banning futures trading – and you know, you could see that come next with the idiots that are running the country right now. [37:03]

JOHN: I was thinking about something you were saying talking to some dairymen in California. A lot of them are having to dump milk – raw milk that they have produced – because they can’t get it into market due to a lot of conditions. They’re being squeezed by regulation and taxes on one end, and then what the market will bear in terms of what the food processors will actually pay for it. And so here we have a situation where we talk about a worldwide food shortage and yet we’re throwing stuff away. Another image that should be presented here: we have had record harvests in the past in recent time and yet our grain stocks are now at the lowest that they’ve ever been. They going to go towards critical levels here. It’s very strange we have these dichotomies.

JIM: You’ve got world population which you’ve got another 2 ½ billion people on the planet. We’re using less of our land – whether it’s in China or elsewhere in the world because you know, what’s the Joni Mitchell song “pave paradise, put up a parking lot.” And that’s what we’re doing, we’re plowing over agricultural land and we’re turning it into cities.

And here’s the scary part: We have had 18 years of record harvests due to great weather and this warming weather has been great for producing crops, but the unfortunate thing is you would have to go back – I forget what the figure is – 5 or 600 years to find an equivalent period of time when you had 18 years of back-to-back good weather.

And despite that – as you mentioned – our grain stockpiles are the lowest that they’ve been since 1960. So here we have had record harvests. By the way, wheat output last year was up one percent and yet our wheat stockpiles are the lowest that they’ve been in probably three or four decades. And so what happens as you know, the head of Potash made a comment, he said “we are one storm from famine.” And that’s what we expect to start seeing as weather conditions change because it’s just asking too much to have perfect growing weather for 18 years – that’s never happened. You’d have to go back like I said, multiple centuries where that actually occurred.

And so if you have a bad harvest – and we’re already having with problems right now with corn which is temperamental. Corn needs to be growing, when it needs rain it needs to rain; when it needs to be dry it needs to be dry. So they’re already delayed in planting this year’s corn harvest. So what can happen going forward is I think you’re going to see shortages of certain food staples as demand begins to outstrip supply and where we get into a situation where we have less than perfect weather. [39:53]

JOHN: We’ve been talking about food here, but a very closely related one is energy and we need to look at something we were talking about at the beginning of the year here on the program.

JIM:The other thing I expect this year is oil prices will hit at least $125 a barrel. It may even go higher if we get into a crisis.

I would say your credibility is lacking here, Jim, because you were off by $1.25 – the June futures for oil closed at 1.2625 and instead of being in December, which is what you had allowed it for, it actually happened earlier in May which I think events are transpiring here more rapidly than we had anticipated to start.

JIM: And you know what is absolutely surprising given all of this, the latest response by politicians: “this is speculators.” And what they don’t understand is OPEC production – especially Saudi Arabia – has been flat; conventional oil production has been declining, it peaked in May of 2005. So conventional oil production has already peaked and we’re a country that has to import close to 70% of our energy needs in the form of raw oil; we’re importing somewhere close to 13 million barrels a day and then we’re importing another 4 million barrels a day of refined products. And so I thought we would probably see 125 oil, but I thought we would probably see it by the end of the year.

But one thing that has been remarkable is actual consumption of energy is down in the United States but on the other hand energy consumption is up in OPEC; it’s up in China, it’s up in India, it’s up elsewhere. So for every one barrel decline of consumption here in the United States, you’re seeing between 10 and 14 barrels of increased demand coming from the rest of the world. And John, that is something that they don’t understand. Our politicians in Washington do not understand. In fact, let’s go to a clip here between Bill O’Reilly and Senator Clinton:

SEN. CLINTON: I do want a gas tax holiday but to pay for it by putting a windfall profits tax on the oil companies.

BILL O’REILLY: But what does that mean though?

CLINTON: What it means is that the oil companies have made out like bandits. You know that.

BILL: Right. Record profits.

CLINTON: We all know that; right?

BILL: Yeah.

CLINTON: and there is no basis for them to have these huge profits. They’re not inventing anything new.

BILL: So what do you do? Take 20% of their profits away from them.

CLINTON: You set a baseline and above that baseline you begin to tax their profits.

BILL: So Congress has got to say yes to this.

CLINTON: Congress has got to say yes. Now, I know that’s an uphill climb.

BILL: You bet!

CLINTON: But I’m trying to lay the groundwork so that when I’m president we can get in there and say, “this has been going on way too long.” I also want to take on OPEC. You know, OPEC is a cartel. It’s a monopoly.

BILL: You want to take them on?

CLINTON: Yes.

BILL: They don’t care what you say. They’re in Saudi Arabia and Venezuela.

CLINTON: Nine of the 13 biggest oil producing countries that are in OPEC are also members of the WTO. I would file complaints. I would also change the law so that citizens and businesses could file antitrust actions. We’re going to begin to hold them accountable.

BILL: And then if you hold them accountable, they say “we’ll slap another 20 bucks on the price of oil. So there!”

CLINTON: See, but at the same time, we’re not going to be sitting idly by acting like we can just get away with this. We’ve got to change the way we behave, the way we drive, we have not paid attention for more than 35 years as to what’s been happening to us.

BILL: And I’m with you 100%.

CLINTON: Good. Good.

BILL: Your husband was president for eight years and Al Gore – Mr. Global Warming – was vice-president for eight years and they didn’t do bupkis about this.

CLINTON: And I say we’ve got to elect a president who’s a fighter, who’s going to take on the oil companies, is going to take on the oil countries. And is going to say to Americans, you know we’ve got to really be focused on how we’re going to save money and be more efficient.

BILL: As long as you understand that I’m angry and so is everybody watching here because both parties sold us out. [43:43]

JOHN: So that was sort of a ship of fools conversation there, wasn’t it?

JIM: You know what’s funny because on Friday there was an article on Bloomberg by Caroline Baum called Silly Solutions and I’m just going to read a couple of things here, but it’s going to dramatize some points:

The confluence of record oil prices and a presidential election year is providing to be an irresistible combination for Congress and the candidates. Two of the three presidential contenders are promoting the idea of a federal gas holiday this summer. Two of the three U.S. presidential contenders are promoting the idea of a federal gas-tax holiday this summer. Two of the three (a different duo) want to enact a windfall profits tax on oil companies, a bad idea whose time has apparently come (again).

And then Carol goes on here in talking about:

Populist millionaire Clinton (millionaires make the best populists) …labeled OPEC (Organization of Petroleum Exporting Countries) a monopoly and threatened to file a complaint with the World Trade Organization…

And then talking about price gouging that a lot of the candidates are accusing the oil companies and as Carol Baum pointed out:

Never mind that the Federal Trade Commission has never found evidence of price-gouging when Congress has asked the FTC to investigate oil prices. Or that oil companies aren't more profitable than other manufacturing industries…

If you take a look at the oil companies, believe it or not the oil companies made more per gallon when oil was at $30 a barrel than it was when oil was at $125 a barrel. That’s because, once again, going back to the first segment, costs were rising faster than price. And this is something that they don’t talk about. Or as Carol goes on in her article:

Or that taxing businesses' excess profits -- How much is excess? -- will lead to a decline in oil exploration and development. [JIM:Look at Alberta. They raised the royalty tax; production is down, taxes are down] Or that taxing business usually means taxing consumers.

The Energy Information Agency of the government said from 1981 [JIM: now this is going to blow people’s minds] through 2006 cumulative oil industry profits totaled $1.12 trillion compared with cumulative taxes of $2 trillion; 1.65 trillion in taxes on domestic production and another 519 billion on foreign income taxes.

It just gets back to…it’s almost like one-way capitalism. We don’t want to subsidize oil companies when they’re losing money or when the price is down. It’s okay to lose so then their profits go back to normal. And oil company profits are 8 to 9%, or one of the best run companies, Exxon – Exxon’s net profit margin has averaged between 10 and 11%. It’s been that way for probably the last two or three decades. [46:42]

JOHN: Let’s do a comparison between Exxon – that seems to be the favorite for people beating up – and pick some other company in a different sector (for some reason, Microsoft comes to mind, but you could pick it) in terms of what their profit margins are.

JIM: Well, if you take a look at Exxon – and this is a comment I made earlier – they actually made higher profit margins when the price of oil was much cheaper; and that’s because the cost of finding oil, developing oil, producing it and transporting has gone up faster than price. In 2005, and 2006 when oil prices were much lower Exxon’s net profit margin was 10.3 and actually the highest point it got was 11.7 in 2006. Their profit margins fell last year because costs went up higher than price to 10.3. And then in this year, it’s anticipated 10%; and in the next two to three years, the profit margin is expected to drop down to 9 ½% as the cost of finding energy is going up much faster. [47:47]

JOHN: And since O’Reilly is always talking about the oil companies and their horrible profits, why don’t we look at what News Corp is making – that’s the company that holds Fox News.

JIM: News Corp’s profit margins have gone from 8.9% to 10.6% to 11.7%. So why is it okay for Fox News to earn 10, 11, 12% but it’s not okay for Exxon?

JOHN: Okay, so that’s what news companies would be doing there. Let’s look at microchip producers or corporations like Intel. Intel makes the processor chips. What do they do in terms of a profit margin.

JIM: If you look at the late 90s, Intel’s net profit margin after taxes was in the neighborhood of anywhere from 27 to 32%. I mean lately they’ve fallen down to almost 19%, you know. So it’s okay for Intel to make 18, 19 percent because they’re in technology – and less capital intensive by the way than oil companies. Exxon spent tens of billions of dollars last year yet their production was still down 5 percent. And that’s something that we just don’t want to talk about, John. [48:56]

JOHN: Let’s look at Microsoft now because obviously everybody – it’s a huge distributor of Windows and other products. What do they make?

JIM: Microsoft’s net profit margins range from 40 percent in 2001, to this year their profit margins are expected to be anywhere from 28 to 29 percent.

JOHN: 40 percent at some point? Wow!

JIM: Yes, that was their most profitable year going back to the tech craze. In 2000, Microsoft’s net profit margins were 41%. [49:27]

JOHN: Let’s go back into entertainment. We were talking about Fox News Company. What about general entertainment companies let’s say, Disney, of course which is more like a holding company for entertainment parks and movie production houses

JIM: Well, Disney’s earnings have been on the down-cline until recently. In fact, their profit margins dropped down to four or five percent; they’re back up to 10 percent though. This year, 2006, their profit margin was 9.8%. 10% for 2007 and their profit margins –depending on how well their film studio does – is expected to rise to 11%. [50:01]

JOHN: So the oil company profits then –just by the numbers that we’re looking at here across quite a broad array of different types of sectors, that’s not an unusual profit margin. I think the reason everybody is astounded is because of the large dollar amounts involved simply because of the volume that is sold. That’s what accounts for those numbers; right?

JIM: Yeah, because if you take a look today, Exxon’s sales have gone from in 2003, Exxon’s gross sales were 213 billion; in 2007, they were 358 billion. But more importantly, the reason being is that the price of the product they sell – and remember, Exxon imports a lot of oil because what they refine they don’t produce all by themselves. So it’s coming from other areas of the world. If you remember, we talked about last week the amount of oil we import from various countries in the world –from Mexico to Nigeria to Algeria, Iraq, Saudi Arabia, from Venezuela; and you know, if Hugo Chavez says “look, I’m going to sell my oil to you for $125 a barrel,” that’s going to be the price that you’re going to pay; you’re going to pay $125 a barrel.

But if you take a look at operating costs and things like that, operating costs are going up much faster. It’s the same thing we talked about in the last hour with the mining companies. I mean some of these drills like for example you take a look at where the oil companies have to go – they have to go out to places like offshore, drill deep – some of those drilling rigs are costing these companies anywhere from 600,000 to over a million dollars a day; or if you take a look at Conoco Phillips or Shell Oil, they’re drilling in the Arctic and costs there can run easily over a million dollars a day. So the oil companies are having to go to harsher environments to find the oil and that means higher costs. [52:02]

I will tell you it’s taken us a while to get in this fix and therefore it’s going to take us a while to get out of the fix, but I want to remind you that an energy policy that basically prohibits America from finding oil in our own land is an energy policy that has led to high gasoline prices…

PRES. BUSH: But in the meantime, in the short run, we didn’t allow exploration for oil and gas in places like Alaska or outer continental shelf. And guess what happened? World demand exceeded supply and now you’re paying for it. If Congress truly is interested in helping relieve the price of gasoline they would do two things: they would recognize that we can drill for oil and gas in environmentally friendly ways here in the United States where there is good reserves; and they would build refineries, they would encourage the construction of refineries. Do you know there hasn’t been a new refinery built in America since 1976. No wonder there’s constricted supplies.

That’s the very familiar voice of President George Bush.

If you notice, Jim, this whole thing is polarizing out now and there are some pitched battles coming over this whole issue as the country continues downward into this crisis. [53:12]

JIM: You know, it’s amazing, for example, we know there’s 30 billion barrels of oil off the coast of California. John, in Santa Barbara, oil is seeping up on the beaches and we don’t want any drilling. [53:27]

JOHN: Okay. That was President Bush. Let’s go for some contrasting voices because this battle now is going to increase in fever and pitch over the next 48 months.

SOLIS: And the suggestions that I don’t want to hear are that we’re going to keep drilling where we already know folks in our district, particularly California, do not want to allow for more drilling along our coast and opening up old refineries like in the city of Whittier – Nixon country it used to be known as where we have some oil fields owned by, I think, Chevron.

That was the voice of Congresswoman Hilda Solis from California.

Here’s another voice in the mix.

RAHALL: This morning your committee on natural resources once again defeated a ho hum proposal to open up ANWAR for drilling. This proposal was defeated by a large margin and to follow up on what the speaker has said, we simply cannot drill our way to lower gas prices….

There is simply no correlation between opening federal lands to oil and gas drilling and lowering the price of gas. It’s not there. You cannot drill your way to lower gas prices.

Congressman Nick Rahall, Democrat from West Virginia. One more voice.

PELOSI: The price at the pump is a terrible threat to the economic security and health and well-being of the American people. In light of that, and for a long time now, the Democrats and the new direction Congress have tried to address this issue. It is a national security issue to reduce their dependence on foreign oil. It is an economic issue in terms of what it means to the US economy and the economic security of America’s families; it is an environmental health issue and that’s why we’re so pleased in our energy bill last year to pass the fuel-efficiency standards for the first time in 32 years. And again, it is a moral issue to preserve our planet. This new direction Congress has made this a priority from day one. On day one – on day two actually, we passed HR 6 to reduce our dependence on foreign oil by supporting renewable energy sources. The leader in that fight was Mr. Rangel who is going to report to us on that in just a moment.

But first I want to say that two weeks ago we sent a letter to the President. I’ve talked with you before about this, asking him to take several steps to help either pass legislation or enforce the law in a way that would help reduce the price of oil and certainly the price at the pump. I received a response from the President –which many of you may have – which basically was that he not only did not support what we were doing, he would veto any of these initiatives to reduce the price of oil and he would instead drill. Veto and drill. Veto and drill. Veto and drill. That is the President’s message. [56:30]

And that was the voice of House Leader Nancy Pelosi. But you have to understand she was talking about alternative energies. Jim, we know from guests we’ve had on the program, these alternatives must be worked on but they are 5 to 10 to 15 years out before they will be commercially viable – meaning we’ll have the infrastructure in place to let people use them. What do we do in the meantime?

JIM: Well, in the meantime we’re going to have to work on alternatives but at the same time, cars, trucks, trains, planes, boats run on liquid fuels. And the only thing that we’ve done in the way of liquid fuels is ethanol. And look at the consequences of that and the surprising thing about ethanol is it’s energy neutral. In other words, it costs as much energy to produce ethanol as it gets in output of energy. So you know, there is no net gain and then look at the side consequences of what it’s done to our food costs. And so, granted, yes, we need to go to hybrids – and we’re going to get into the next hour with an interview with a gentleman who was on the design team at Toyota that designed the Prius – but planning for automobiles are 5 years in the making, and our average automobile in this country is somewhere I think around 9 years. And so it’s going to take a full decade before we can convert the existing automobile fleet to more fuel efficient vehicles.

And it’s going to take an increase in technology. But in the meantime, our production of oil and natural gas decline; in the meantime our imports of oil from countries that don’t like us increase; and what are you going to do in the transition? There is nothing Congress is doing. Raising taxes on oil companies reduces production, reduces supply which makes us more beholden to foreign producers. And that’s why a country that imports 70% of its energy needs today is not in the driver’s seat anymore. And you know, you heard Sen. Clinton’s proposal “we’re going to file a lawsuit against OPEC.” You think that’s going to bring oil or they going to drop the price down? I think these people think that gas comes from a gas station. [58:54]

JOHN: Let’s see if we can see if we can tie this all together so that people understand. Right now, we look at the situation we’re headed into: alternatives will not be online, so we are faced with a liquid fuel situation for the 5 to 15 years. That’s just the way it is in reality. Ethanol is the only thing out there that we’ve been moving on at all on the part of Congress. The only response, first of all, is to stop drilling; 2) there is a fight whenever someone wants to put in a wind farm or a nuclear, there is a fight for that one so we’re not doing that one; and 3) what we call the carrier battle group option means we’re going to station our troops offshore wherever the next conflict is going to be as far as oil is concerned, rather than making ourselves oil independent. Other than that there is no comprehensive energy policy, and as a result we’re headed into this crisis window and with all the posturing and whatever they’re doing, they are guaranteeing we are going to hit it full on. That’s where we are headed right now.

All right. Let’s just take one incident. If we start to look at our crystal ball here, you did predict 125. It happened in May of this year rather than in December which was the original call; if we look over the next couple of years what’s the price of crude, where will everything else be?

JIM: We’re revising our energy forecast and by winter I think we’re going to be looking at somewhere between 140 and 150 on a barrel of oil. By the end of next year we should be closer to $200 a barrel; and god forbid, either a conflict erupts or a terrorist attack on the Saudi oil facility or you know, they blow up the pipelines in Nigeria; and especially if you take a look where the United States gets its imported oil, I mean we get it from Canada, we get it from Mexico. And we know by 2012 Cantarell will be dry, in other words, Mexico’s exports to the United States are going to drop. If you take a look at Chavez, Chavez has already cut exports to the United States by 300,000 barrels a day and is diverting that to China and he plans on reducing that even more. We get oil from Nigeria, you had a Shell platform that just shut down; 160,000 barrels a day because the rebels blew up the pipeline. You take Iraq – we’re getting half a million barrels a day from Iraq. And so all you can do at this point…let’s put it this way: it takes 10 years to build a refinery and as the president said, we haven’t built one since 1976, so as a result today our oil imports of finished products are now close to 4 million barrels a day – that’s going to get larger.

And so we’re heading into an energy crisis and I really don’t think personally…all you’re going to do is see this bickering “we’re not going to drill, we’re not going to build refineries.” And I hate to tell speaker Nancy Pelosi, but you’re going to run cars on wind turbines, and ethanol is not going to bring us energy independence. That does not work. And so we’re heading towards $200 oil and by the way, at $200 oil we’ll also be rationing oil. So it’s not until you’re in gas lines, it’s not until there’s rationing…if they’re unhappy about $4 gasoline now which we’re over in California, what are they going to do when gasoline in the two years goes up to 7 and $8 a gallon? What are they going to be saying then?

But I think, as Matt Simmons has said on the program and this is something that I agree with Matt – we’re going to rationing, we’re going to higher prices and we’re going full bore right into an energy crisis because as the price rises, as supply struggles to keep up with demand because we’re competing now with 3 ½ billion people on the other side of the planet and their economies are growing, their incomes are increasing, their consumption of energy is going up, and that’s absorbing all of our excess capacity. And in the meantime, another factor that we have to deal – and this is something I’ve pointed out on a couple of programs that people aren’t picking up on: OPEC is consuming more of the product that it produces. The more they consume of what they produce means there is less for exports. That’s why exports from OPEC has been stagnant whether it’s Saudi Arabia or other countries. And then more importantly, they’re taking it a step further beginning with Saudi Arabia where they’re actually going to be building petrochemical complexes and refineries because they’re looking at the opportunity. “Why should we sell raw oil to the United States when they don’t even have the capacity to refine all that they import. So what we’ll do is we’ll build the refineries and get even higher profits by selling finished products instead of just raw oil.”

So we’re heading into a crisis window, John. We’ve been talking about it and this example of this debate that you just saw, I mean there was also a debate where you had some Congress people that were upset that the government of Iraq is subsidizing oil to their people. Well, you know what? They own the oil! And they’re not the only ones. Saudi Arabia does it, OPEC countries do it. They do it in Venezuela because those who own the oil have that ability as a government to subsidize the product to their own people. And we absolutely do not understand this whole oil scenario. And I think a lot of this stems back to the fact that the United States up until 1970 was the world’s largest producer of oil. We were producing in 1970, over 10 million barrels a day. We were the Saudi Arabia of the world but that’s no longer the case, we only produce 5 millions barrels, we import 13 million barrels and 4 million barrels of refined products. So a crisis is on the way. [64:55]

JOHN: So basically what we’ve said here in this part of the Big Picture is the fact that our politicians are steering us directly into the perfect financial storm: we’re going to see food shortages, higher prices of food couple (those naturally go together); higher energy prices (we’re already seeing that); and there may well be shortages and rationing at the rate we’re going.

So now the question is – and we’ll deal with this on the next hour here on the Big Picture: what can you do? Since this is where we’re steering us, and I agree with you, Jim, they are not going to do anything until reality sets in. When reality sets in, politicians panic. But at least people on the street, the little guy, can do something for him or herself.

You’re listening to the Financial Sense Newshour at www.financialsense.com. And Jim and John will be right back.

Part 2

Behind the Numbers: The Make Believe Economy

JOHN: During the station break, Jim, I came to realize that some things never change. I’ve got to read to you a paragraph from Time magazine, March 24^th, 1980 – that’s how far back we’re going here, almost 30 years. This is right at the height of President Jimmy Carter trying to battle all of this inflation. Here’s the quote:

As this barrage of resolute rhetoric might indicate, inflation is not only a frightening economic problem but is rapidly becoming Carter’s most dangerous political liability as well. Campaign audiences for the President’s numerous rivals are showing at least as much interest in the economy lately as in Iran or Afghanistan.

Gee! Where have we heard that one before. Keep listening.

In Carter’s own party, Ted Kennedy has made a demand for wage and price controls his major issue, and is apt to answer any question on any other subject with an attack on inflation. On the Republican side, front-runner Ronald Reagan has been hammering increasingly harder on economic issues. Said he, campaigning in Illinois, Friday night: “It’s government that causes inflation and government can make it go away by cutting out deficits and stopping the printing of money.” George Bush assails Jimmy Carter’s raging inflation during almost every appearance.

The rhetoric – including Afghanistan and Iran – hasn’t changed. This is amazing. I just happened to run across this.

JIM: Yeah, here we are almost 30 years later dealing with the very same issues: inflation, Iran, Afghanistan. Well,...

JOHN: Some things never change. All right.

We’ve been talking for a long time here on the program, Jim, it’s been one of your better topics about funny numbers as far as government stats and other sources. John Williams, of course, has been a guest on the program here a number of times from Shadow Government Statistics. So let’s look at that. And of course, this also by the way, in the debate to try to get something done if you’re dealing with funny numbers which aren’t real world numbers and then everybody quotes them, but we’re trying to use that as a guide to correcting a problem.

JIM: If you take the big three numbers today that are reported in the economic press, you know, the big one is the unemployment rate; then follow that by the GDP numbers –you know, “what is GDP growth?” and then of course another factor, which we dismiss all the time, is the CPI rate.

And you know, Americans – if you’re talking about consumer sentiment being the worst it’s been in probably two or three decades – and the reason is the numbers that we report bear no reality to what is actually occurring in the economy. In other words, instead of a five percent unemployment rate today, the unemployment rate is probably closer to eight and nine percent if we reported it accurately. And if you look at the economy, instead of 0.6% growth rate, we’re probably experiencing a contracting of two to three percent. Even the headline inflation number, which is about 4%, the real inflation numbers are more than double that. And that’s why I think there is a big disconnect. You know, you turn on the evening news and they report, “Gee, the economy is not in recession, it grew at 0.6%, the unemployment –“ we didn’t lose that many jobs because last month thanks to the birth-death model we were creating jobs in the construction industry, the finance industry and the restaurant industry and retailing. And you know, John, it just doesn’t add up when you take a look at what’s actually occurring in the real economy. [3:28]

JOHN: So how do we reconcile that with the real economy, meaning what would the real numbers look like?

JIM: A lot of this, believe it or not, politicians have been fooling around with the economic numbers because obviously if you are in the White House or you’re trying to campaign for reelection you want the economy to look good. And if you can report better numbers. And believe it or not, this goes back all the way to the Kennedy administration.

There was an article in Harper’s in the May magazine. You can pick up a copy and it’s called the Numbers Racket: Why the Economy is Worse Than We Know. It’s Kevin Phillips who has written this new book. And as Kevin Phillips outlines in his article, changing economic numbers go all the way back to the Kennedy Administration which was experiencing high jobless numbers, which was tarnishing this Camelot image. And what the Kennedy administration did is they took what they called – and they came up with a category of “discouraged workers.” These were people who had lost their jobs and couldn’t find one. And the first thing that they began to do is they excluded these discouraged workers from the ranks of the unemployed where many if not most of them had been previously classified. And as Phillips talks about, it even got to the point where in the Johnson administration, Lyndon Johnson used to ask the BLS “I want to see the economic numbers before they publish them;” and if he didn’t like them he’d have them change them.

And he also began a very clever thing. Remember, the United States began to run deficits with the Great Society programs and the war in Vietnam. And it was Lyndon Johnson who took and changed the way the government accounted for its budget. What the Johnson administration did is they came up with the concept called the unified budget where they combined Social Security with the rest of federal outlays, which we still do today. So in other words, the deficit numbers that we report each year are actually much higher because we’re taking surplus Social Security funds that are generated from higher Social Security taxes and we’re spending the money and we’re putting over into the general fund.

Every single president has changed the economic numbers. Kennedy changed and excluded discouraged workers from the unemployment. Johnson gave us the unified budget where we began to spend the surplus revenues from Social Security; Richard Nixon came in – and remember, Nixon was the first one to implement wage and price controls when inflation rates hit 4%,which is where they are today – but Nixon asked Arthur Burns the Fed chairman then to come up with the core inflation number. Basically the core excludes inflation if you want to look at it. [6:30]

JOHN: Basically, Nixon messed with the unemployment rate. They ultimately began diddling with the CPI. What about other indicator factors that suddenly began suffering ‘tamperage’ shall we say?

JIM: Well, in 1983 the Reagan administration added owner’s equivalent rent to the economy measurement based on what a home-owner might get renting his house and we added that to GDP. Also during the Reagan administration we began to reclassify members of the military as employed instead of outside the labor force. The big one really came - it began in the Bush administration with the Boskin Commission and it was implemented by the Clinton administration where we changed how CPI was measured. And the underlying goal was this worry over federal budget deficits, especially with these COLAs that were going into government pension programs and Social Security. The idea was to reduce the inflation rate in order to reduce federal payments from interest on the national debt to cost-of-living outlays for government employees, retirees, and Social Security recipients. So in 1996 the Boskin Commission on changing CPI was implemented and it was promoted by then Fed chairman Alan Greenspan. But in 1994, the Bureau of Labor Statistics (BLS) redefined also the workforce to include only a small percentage of discouraged workers. So if you take a look at in this Harper’s article they take the way we used to measure unemployment – and if you were to take the way we used to measure unemployment today, that unemployment rate would be closer to 10% versus the 5% rate that we’re reporting now.

And then also, if you take a look at the current Bush administration where the Federal Reserve stopped reporting M3 which was capturing rising inflation impetus coming from credit activity. And so if you take a look at these economic numbers these statistics which are the big three that we report almost every month – we report the unemployment rate, and of course the inflation rate for each month and then every quarter we report what the GDP numbers. But I mean you take a look – remember when last week we reported the unemployment report we only lost 20,000 jobs but you know what happened, John, is it turned out that we were creating – I forget what the birth-death number was like – 267,000 jobs; we were adding jobs in construction – how believable is that? We were adding jobs in finance – how believable was that? And we were adding jobs in retail and restaurants – I mean how believable was that when discretionary income is contracting by most consumers? [9:27]

JOHN: So basically what this accounts – if we put this in layman’s language is I think the person on the street senses some kind of a disconnect. There’s this dissonance and he or she feels it, but they can’t always put their finger on what it is. But you have these numbers coming out from – what do we call it? the Washington/Wall Street complex telling us that the economy is growing, that jobs are doing okay, that inflation is not bad, that “okay, well, I guess yeah, I guess we are in a recession but it’s going to be a shallow one.” But what the people are feeling out here is a lot greater and they can’t put these two things together – there is no basis for that.

JIM: Yeah. I mean if you take a look back at 1983 when we substituted owner’s equivalent rent for homeownership costs – I mean look what happened to housing, the cost of housing from 2001 to 2007, imagine where our CPI would be had we included housing prices. And what’s even more, there are many people saying that the interest rates would have never been this low had the inflation rates been reported at much higher levels. And the thing that is happening here is this distortion, you know, where homeownership has gotten to be unaffordable, and yet here we are trying to pass bills to prevent foreclosures, to prevent prices from adjusting downward which is exactly what the markets need to do. And just like in our last segment about how to create shortages, the more the government gets involved in saying “look, we can’t have market forces at work here, we need to intervene with price controls, mandates such as ethanol and things like that.”

We create all these distortions and the worse the by-products of these distortions, the greater the call is for more tinkering. And so there is talk now about redoing the Consumer Price Index because there are many people at least in Washington, especially the baby boomers, now starting to collect Social Security checks so the number of recipients is going to grow and get even larger, they’re talking about changing CPI. I mean you take a look at the things – you know, you’ve heard about they began using substitutions. So if beef prices go up on steak, you switch to hamburger. If hamburger goes up, you switch to chicken. I don’t know what they’re going to do this fall on substitution when you have beef prices going up, chicken prices going up, pork prices going up, fish prices. Maybe we become vegetarians.

Or you have other things like geometric weighting which if you understand what it does, geometric weighting – the things that are going up the most get reduced weighting in the index and the things that are going down the most get an increase in weighting. And then the other thing – and this one I love – is hedonic adjustments which is let’s say the cost of a car goes up a thousand dollars but they say through quality improvements it really only went up $70. And these are the kinds of distortions we have here and that’s why I think there is this big disconnect. People are saying “gosh, I’m seeing it everywhere. I’m paying more at the pump, and yet we don’t want to expand energy production.” I’m paying more for food prices and yet we just mandated more ethanol in our gasoline. And as a result of that there’s this sort of disconnect people can’t figure out who it is. They’re getting angry and yet the more dangerous thing is they’re looking to government –which is the cause of this problem – to fix it. [13:03]

JOHN: So if we look out there at what the funny numbers are telling people – at least, this is the official party line – we would say inflation is growing about 4% and that means the core rate is at about 2%. The unemployment rate is 5% and the economy they’re saying is actually growing 0.6%. But there is that cognitive dissonance again. That doesn’t mean anything to people: What do the real world numbers mean – if we create the Puplava Index of all of these things?

JIM: A lot of people that track the way that we used to account for unemployment – including discouraged workers or for example, when your unemployment benefits run out, you’re no longer counted as unemployed, you theoretically have a new job – the real rate – people are saying the unemployment rate today is averaging somewhere between 9 and 12%; and the inflation rate, depending on whose measurement you look at is probably closer to 7 to 10%, and the economy is clearly in a recession.

In fact, even after the recession of 2001, we probably remained in a recession all the way to 2003 instead of coming out of it in the fourth quarter of 2001. So the recession was much longer lasting, it was much deeper; and you know, if you think about this here we have a situation where you have bond yields that are at 4% when the real inflation rate is somewhere between 7 and 10%. Or you have short term rates such as the two-year Treasury note a little over 2%; the headline inflation number is 4% and even that number is grossly understated by almost 100%. In other words, the real inflation rate is probably closer in that 8% range. So it is distorting not only the economy and actions and decisions that business people and individual consumers make, but it’s also distorting the financial markets because bond yields…if there is another bubble that’s going to burst that bubble is going to be the bond market because these yields in terms of where they are today have no basis in reality when you consider what the underlying inflation rate is. I mean how can you stay even when you have real headline inflation numbers between 8 and 10% and pre-tax you’re earning anywhere from 2 to 4% on your fixed income investments. It just doesn’t make sense and as a result it’s forcing people to go out and get more speculative in their investments. In other words, that’s why people were buying these CDOs and these complex mortgage investments; that’s why people were in emerging market debt; that’s why people were going into junk bonds, which is not a good place to be right now, because people were looking for higher yields to help keep even with the rate of inflation. [16:00]

JOHN: But as things get worse – and this really portends for the coming Congress and the coming president – the dissonance is going to be so bad that the only thing that the taxpayer can do ultimately is to begin throwing out one group of rascals – I’ve said this before – and put another group in, hoping that they can do something about the situation because they sense the dissonance, they feel the pain and yet they can’t get a handle through the politicians on exactly what’s happening. So that’s what these numbers are doing, they’re reading an increasing distrust of the official numbers that are coming out.

JIM: And that’s why the President’s approval ratings are low, but you know, the approval ratings of Congress, believe it or not, are much, much lower. And just like we saw that little discourse between the President and his counterparts in Congress, we’re doing absolutely nothing. We’re not doing anything – you know, raising taxes on oil companies will reduce production meaning we’ll have to import more oil. And so there’s nothing you can do about this right now. About the only thing that…you know, we’ve been telling people here is “look, don’t look to Washington, it’s time to start taking care of yourself” because if you don’t, you’re going to be left sadly – in this segment here in just a moment we’re going to be talking to a car company that invented the hybrid and where they’re going so if gas prices…I mean if you think $4 is bad, believe me, folks, we’re heading to $7 and probably $8 in the state of California in the next I would say 12 to 18 months. [17:35]

JOHN: you’re listening to the Financial Sense Newshour and the location is www.financialsense.com.

Other Voices: Bill Reinert, Nat'l Mgr., Advanced Technology Group, Toyota Motor Sales

JIM:With oil prices hovering near $125 dollars a barrel, experts are talking about 150, and $200 oil, and some day in the next two years, maybe $7 gasoline. All of that is bringing about a broad swath of changes in the auto industry. Joining me in Other Voices this week is Bill Reinert, he is National Manager for Advanced Technology at the US sales unit in Torrance, California for Toyota Motors.

Bill, you were written up in a Bloomberg article called The End of the Oil Age and you made a comment and you said: The car based culture business as usual of building cars and trucks is going to change dramatically. Follow up with that please.

BILL REINERT: And of course as you can already see it is changing dramatically. I think what you’re going to see is that the taste of the American public – the buying public – is starting to shift pretty dramatically; not one-hundred percent, but folks are really starting to take the cost of operation – the cost of filling their car up – seriously, and really making decisions on do they need the big six and seven liter V8s, or maybe can they get by with a smaller car with a higher fuel economy. [19:23]

JIM: Now you believe the industry is endangering itself by basing sales and profits on let’s say the big, fast – almost like the muscle cars of the 70s. You know, if you look forward into the future maybe five years from now with oil shortages, global warming, that could be a danger for some car companies.

BILL: You design your cars – you start your product planning for your cars – most cars – five years out. So you put the cake in the oven thinking that you pretty much have an idea on what it’s going to be like five years out. Now, if you’re betting wrong and if you’re betting that gasoline is going to be a buck and a half a gallon or something like that and it ends up being 4 to $5 a gallon, we end up with a product that is out of phase with energy prices. So that’s the risk you run when you’re working that far ahead, and you really have to have a kind of a discontinuous view – a futurist’s view. It used to be that we could count on kind of a linear assumption that the future would be somewhat like the past. Those days are pretty much gone and you have to bring new skills into the product planning aspect now. [20:33]

JIM: You know, one thing that has struck me that has been unusual about this economic cycle – normally when the economy begins to slow down, demand for fuel and commodities slow down and you see prices come down. Here we are in an economic slowdown and you made a comment: we really don’t have a past – a history or a database that allows us to explore the simultaneous impact of let’s say recessions and disruptions and energy supply and climate change.

BILL: I mean of course we had the oil embargoes of the 70s and 80s so we know what that’s like and the shortages and of course they did lead to some economic conditions. But what we’ve got now is a real economic downturn based upon some credit issues and I don’t really need to go into that – I think most of your listeners understand that – but what we’re getting now are not artificial ramp ups in gasoline costs or oil costs. Essentially what we’ve got is a real clear lack of spare capacity throughout the oil industry that’s going to drive prices up at the exact same time that you’ve got a recession that’s driving the economy down. Planning around that is very difficult and on top of that now we’re layering CO2 regulations either at the state level or the federal level and global level, and to the extent that these CO2 regulations are not common across – you know, hopefully across the globe but certainly across the United States increases our product planning efforts. It’s that much more difficult as you start to design regionalized products rather than global products. So it’s a real problem. [22:05]

JIM: As you get into this next decade – as you’ve been talking about, your product planning is usually thinking five years out in the future – most of even the big agencies like the International Energy Agency see a crisis window where supply is struggling to keep up with demand, so there could be some real problems in the next decade.

BILL: Yes. I hesitate to say exactly when, but certainly if you look at the International Energy Agency’s data or Energy Information Agency from the US Department of Energy, everybody is pretty much in lock-step that we’re headed towards a 121 million barrel per day demand somewhere around 2025, 2030. And currently we’re about 86 million barrels a day.

But we’ve run some numbers and some other folks have run some numbers and we think if you throw in ethanol and biofuels and coal-to-liquids and pretty much throw the kitchen sink in there you’re going to struggle to make about 100 million barrels – maybe 105 million barrels. So there is a point where the demand that’s already built into the economy (it’s not just the US economy but to the global economy), that’s already there and the inertia of that demand, will cause us to go beyond where we can actually produce enough oil to meet that demand. [23:22]

JIM: You have likened yourself to a 21^st Century Cassandra when you speak on an oil crisis to come, you’re predicting one crisis on top of another crisis before energy policies change. Has it surprised you in the automobile industry, given where oil prices are, that we have not seen a greater response let’s say from other companies or even Washington itself?

BILL: No, I’ve been doing this oil racket for a long time, since about 1989 or doing energy stuff and I never cease to be amazed at the lack of attention that’s paid to energy policy or how you figure that into your product mix because you know, frankly, I think that the mindset was that these issues are transitory and we’ll all get back to the $50 a barrel oil –and in fact that may be for a short period of time, we might see prices decline – so I’m not shocked at it. I wish there was more demand paid to it. I think from a political point of view it doesn’t parse well. It’s not easy to get into a sound bite message, it’s not easy to talk about climate change and the economy and energy policy and geopolitics and make something that is palatable for the evening news.

From the automakers point of view, you know, we’re used to designing cars that respond to customer demand and frankly the cars that you’re seeing coming onto the market and the cars that you are going to see come on to the market for the next few years responded to customer demand; and the customer wasn’t demanding high fuel-efficient cars. [24:59]

JIM: The fact that we’re mining oil sands shows that we’re already into depletion of conventional oil. The cheap stuff is gone because why else would you be mining it in the tar sands.

BILL: There’s a whole lot of issues about that. I mean there is some light sweet crude left – ‘sweet’ means it’s low sulfur content and easy to refine. That’s primarily in the Middle East. But yeah, I mean if you look at the Brazilian stuff, they’re dealing in the sub salt caverns 20,000 feet under the seabed; we’re looking at oil in the Arctic; we’re doing enhanced oil recovery pumping water into old oil wells to try to get water out. Even in the United Arab Emirates – I was just there – and they’re using their natural gas assets; instead of providing a cheap electricity for Dubai and Abu Dhabi, they’re using their natural gas to enhance their oil recovery out of their wells so they can get more oil out. So you’ve got the tar sands – in the United States we’re looking at Colorado and Wyoming and Utah to do oil shale which is more environmentally damaging than the tar sands; you’ve got the heavy oils in Venezuela. And all of this stuff – it’s not just the damage – the land use damage – to harvest it; it’s the CO2 emissions from turning it into a usable product. [26:18]

JIM: You believe as oil and natural gas gets scarce, at Toyota, you have a sense of a crisis that there are only several years left to let’s say, do something about this. I mean what if we start running into demand continuing to grow in the developing world and supply struggling, what do we do in the next decade? I mean, do we have time to figure this out?

BILL: Well, that’s not just an issue for Toyota, that’s an issue that world governments and public policy at large. But I’m getting ready to get on an airplane pretty soon and go to Japan and talk to my compatriots over there about it. For us, it’s not a crisis. I mean it’s dead serious. I don’t want to underestimate it. I don’t want your listeners to underestimate how serious Toyota takes it, but to say it’s a crisis means that somehow it catches us by surprise. And we take a 20 year outlook on there. In fact, that’s why there’s a Prius now is because we started developing our outlook in 1992 – trying to think back – [I’m] getting old now – to look at what the 21^st Century’s going to be. We’re not 20/20 about it, you know, we don’t have perfect vision. So we don’t say it’s a crisis but we’re certainly concerned. [27:27]

JIM: You also believe, I think, that as prices grow and it gets more difficult to get oil, let’s say supply not keeping up with demand, that energy security is going to trump all environmental concerns worldwide. And if you take a look at some of the alternatives you just mentioned – oil shale in Colorado, or the tar sands or even ethanol – could make climate change and water shortages actually worse.

BILL: Oh yeah. Right now, depending on whose study you have, I mean we’re facing a profound drought. I mean look what happened to Atlanta last year and the fight over water in all the Southeast. And if you look at the Southwest and the fight over the Colorado River, and the crisis we’re facing with electric power – you know, it takes a lot of water to cool the steam generators for power plants. So when you look at like ethanol now might take three to five hundred gallons of fresh water to irrigate the land to grow the corn, so for every gallon of ethanol you get the estimates are between three and eight hundred gallons of water is necessary in that process. It takes a huge amount of water to produce tar sands, to produce oil shale it takes an additional amount of energy. Same thing if you’re going to take coal – we actually have the technology to take coal and turn it into a synthetic diesel but the problem is you know, you can’t just wish that that would happen. It happens, but with a huge penalty. And generally, those penalties are water contamination, land use, and very importantly, CO2. And everyone of these fuels that I’ve talked about has double or triple or even worse the CO2 signature of regular gasoline from oil. [29:10]

JIM: I want to get into the product that your company makes, the Prius, which was so ahead of its time. What were you guys thinking? I mean product development takes a long time and at the time that you guys were looking at coming out with this product, oil prices had to be in the high teens or low 20s.

BILL: Yes, absolutely. Actually, we started this project in 1992, it was called Project G-21, and it was really one of the most secret things we’ve done. Because remember, nobody had ever even heard about a hybrid until 1997 when we brought the Prius to the market. And basically, we didn’t set out to build a hybrid. We set out to build a car that was the most fuel efficient and lowest emission car we could to meet the conditions that we thought we were going to see in the 21^st Century – oil depletion, climate change, that kind of thing. And that wasn’t on anybody’s radar.

And of course, I don’t want you to think that we had unanimity among our management because I mean we were looking here at gasoline, I don’t know, a buck a gallon or something like that and they’re saying, “hey, you’re spending all these engineering resources like this.” And so as we started developing that more and more and more, it wasn’t just a car that would get twice the fuel economy, we were challenged to develop a car that would get four times the fuel economy of what our average cars were. And at the same time we’d been fiddling around about new drive trains and hybrids and we started putting the hybrid technology in our test cars and started to look at what we could to do to tune it, and we started to get really successful really fast.

And so we started tuning and tuning and tuning and finally in 97 the cake came out of the oven and that was the Prius. But when we launched it we knew right away that car wasn’t the target of where we wanted to go, because you know, to do this, to be successful you’ve got to have a lot of customers buy these cars. And that first car, I mean it looked kind of funky and you couldn’t put baby strollers in the back seat; and it wasn’t very fast. And so as we were launching that first generation we were designing its replacement. I mean it was an incredible time and we had very small teams. Everything we’re doing we do in-house: our batteries are in-house; are motors are in-house; I guess we don’t make our own tires – but everything else. And we’ve got a lot of patents on it. So we finally came out with the car you see today – the Prius you think today, the one they made the Monopoly piece after that was the result of being a customer focused. You can’t legislate this, you’ve got to let the market pull and it’s a holistic product. So that’s how we got there. [31:42]

JIM: And where do see this going in the future. I mean if you take a look at the average driving pattern I think of most Americans maybe round trip on a daily basis, 60 to 70 miles to and from work. What about the electric plug-in, do you think that’s where the future is heading?

BILL: Well, let me say, we’re working on advanced fuels that probably I can’t share with your listeners today. We’re working on electric plug-ins, we’re working on fuel cell vehicles. Electric plug-ins may work if we get our battery technology to a point where it’s so inexpensive and so reliable that we can provide some electric miles. And if we get the electric utility industry to a point that their transmission and distribution and generation assets are modern, and if we find a way to use coal or some other fuel with low carbon emissions and if we really get the American public to try it and get used to it. I mean here we’re asking the public not to fill their car up, we’re asking them to plug their car in. And if they do that or not, and whether the car is successful or not, depends a large part on preparing society for these kinds of things. Remember now, we’ve got a quarter of a billion cars on the road in the United States –our market is 17 million cars a year – so for us to effectively address stuff like oil depletion and climate change, we’ve got to sell in, not tens of thousands or even hundreds of thousands, but in millions. [33:10]

JIM: I just have a feeling just looking back historically that as prices head higher, if the experts say that 150, 200 dollar oil is on the horizon in the next two years (and I happen to believe that and maybe $7 gasoline) that all of a sudden buying habits change. It reminds me, Bill, in your age bracket, where I remember the 70s and by the end of the 70s the muscle cars were gone, you had the VWs, you had the Hondas and the imports and all of a sudden we were changing our habits.

BILL: We were. And of course we had gas shortages then. It’s not the same situation today. And we knew that there was these artificial shortages. But given the geopolitical situation we find ourselves in today, that you’ve got two producers who aren’t in decline – and that’s essentially the former Soviet Union and OPEC. And that’s why you see so much volatility because most of the oil is being produced in unstable regions of the world. And as you look further out, you’ll start to see declines in the former Soviet Union, and that then makes OPEC the producer of last resort and you really start to see larger and more substantial volatility and price swings.

Now, it’s like climate change: I wouldn’t want your listeners to think that this is just a steady progression upward because there is new capacity that is going to come online one of these days and prices could drop. Prices respond very quickly to new capacity. But my fear is that the prices go down for a little bit and people quit being worried about it; they don’t take it seriously anymore. And that would be just exactly the wrong thing to do. [34:58]

JIM: Yeah, it almost reminds me of when Katrina and Rita hit, when oil went from 50 to over 70 and then a month later it started coming down, everybody breathed and said, “phew, it’s over.”

BILL: …when we got through that one.

JIM: Yeah.

BILL: Yeah, that would be big mistake this next time when the prices come down – and they will – you know, supply and demand. When the prices come back down it would be a mistake not to continue to take this issue seriously. [35:22]

JIM: Well, listen, Bill, I want to think you for joining us in Other Voices this week on the Financial Sense Newshour. I hope your design team keeps bringing us more fuel efficient cars because I’ve got a feeling there’s going to be a bigger market as prices head higher. Thank you so much.

BILL: We’re always working on that. Thanks a lot.

Opportunities Inside the Oreo

JOHN: Well, grab yourself a glass of milk, we are going to be inside the Oreo for this segment. I still maintain that Hydrox made a better cookie than the Oreo, but it’s all gone now since the Oreo won out.

But we’re going to be inside the creamy center here for a few months of the year. What is that going to look like, Jim, for people; what does that mean for investments assuming on the back side after the elections we’re going to hit the real crunchy hard side again? And frankly, the back crunchy side is going to be a lot harder than it was crunchy going in I’m afraid.

JIM: There was an interesting article – and as hard as some people may find it to believe right now that stock prices could head higher, there was an article in Barron’s this weekend by the venerable Dow theorist, Richard Russell and the name of the article was A Rally with Serious Muscle. And Russell was going on and he was talking about a plethora of technical indicators that tell him that the great bull market that began in the early 80s is still intact. I’m paraphrasing Russell here: new highs are coming, maybe not immediately but in the weeks and months ahead. And of course, Tim Wood has talked about this on the program.

One of the great Dow theorists was George Schaefer and George Schaefer had come up with something called the 50 Percent Principle, and this is what Russell is citing here. And Schaefer traced his understanding of this principle back to Charles Dow who took special note of market level mid-way – or in other words, a 50% between a major advance and a decline. And the 50 Percent Principle named by Schaefer, according to Russell, tells us that the primary trend of the stock market remains intact and bullish if the Dow doesn’t break below this mid-way point in the course of a pull-back.

He goes on to give an example. The low of the stock market before the great bull market began was 759 back in 1980, and the high reached in 2000 was 11,722.98. The mid-way point between those two numbers is 6241. Well, the very low of the stock market in this decade occurred October 9^th 2002 at 7286, which was a thousand points above the 6241. In other words, it was a thousand points above mid-way point. He then goes on and said, if you take the low 7286 and take the run up to October of last year – 14,164 – the mid-way point, or 50% between those two moves, is 10,725; and on March 10^th of this year we got down to 11,740 – roughly again about a thousand points above the mid-way level. So this is why he’s talking about that stock prices could go higher.

He mentions a couple of other things too that since January the new lows have contracted dramatically which means that stocks are pulling back on down days but not breaking support – and that’s an important difference. And then the other thing he goes on to talk about is the huge short position which is at a record 15.2 billion shares short. I would probably add not only is there a record short position right now, it’s been a one-way play, John, but also there is a huge amount of money that is in money market funds. And as interest rates have come down with Fed rate cuts, we’re hearing this even on the Q-Lines, we’re seeing it in emails, and people are saying, “my goodness, you know, I’m getting nothing on Treasuries, I’m getting nothing on CDs and you know, my costs are going up and I can’t keep up.” And what that does is when you have an inflationary credit environment, what it does is it pushes people into alternative assets as people try to find means and ways of protecting their principal from the ravages of inflation. And that’s why in Germany in the 20s, in Argentina in this decade, in Turkey, in Russia in periods of inflation you’ve seen a rise in nominal stock prices. [40:29]

JOHN: Well, are there any other things that are holding up, and you know, we’re looking at the financial sector – we’ve got all these write-offs which are now occurring as a result of the subprime crisis and all of the downshot from that.

JIM: Surprisingly, if you go outside the financial sector – and I know some people will criticize “well, you’ve got to include them” – but you know, profits are still holding up, and especially outside of the financial sector, where profits are still growing at around 10%. And you still have that going on. And then you’ve got the helicopter drop that’s taking place this month with these rebate checks and you can almost see this with the way they manipulate the economic numbers and with the stimulus that’s coming and it’s not just that. I was reading a repot that IRS refunds this year are expected to be somewhere in the neighborhood of 225 billion, you add to that 150 billion in rebate checks and you’re talking about $375 billion that’s being returned to consumers or voters in the next two months. And it’s estimated according to past rebates, two-thirds of that will be spent. And so you can see that you may end up spending it on higher grocery bills, and higher gasoline prices, but nonetheless you are going to see that money hit the economy and it will have some effect. So you can just see it: The economic numbers or the retail sales numbers go up briefly for a three or four month period of time; you could have robust profits outside the financial sector or maybe in the next quarter they don’t write off as much. You’ve got a $300 billion stimulus package coming from Congress; it looks like both parties are trying to iron out the difference between the Barney Frank and the Chris Dodd program coming from the Senate and the House. And also, the Treasury Department is working on refinancing or passing a program where they’re going to bailout one million mortgage holders where they’re going to allow them to refinance 20% of their mortgage, in other words, to get some equity where you would pay the government a low interest rate and wouldn’t have to pay the principal back for 5 years. So there is going to be enough money thrown at this that it’s going to give us a temporary reprieve. And when that happens and especially with the huge amount of money sitting on the sidelines in cash which is earning a low rate of return – not even commensurate with the inflation rate – and then you add that to the massive short positions we have and you have all the ingredients for an upside breakout or explosive rally. It could be quite quick especially if short-covering comes in. [43:13]

JOHN: Obviously if we going to have all of this money flowing around, certain sectors are going to do well. So while we’re in the creamy filling here, there are some opportunities while we’re here. What sectors would be that area?

JIM: The sectors that probably stand out are energy obviously – we’re sitting here talking about $126 oil; industrials – and in industrials I would include infrastructure and technology. Another area that I think is going to do well is international commodity producers: people that can produce copper, iron ore – the type of commodities that are very much in demand in the developing world because we don’t have surpluses, we don’t have stockpiles. These are areas that I think they’ve shown, if you take a look at and dissect their earnings reports, those companies that were doing well, that were beating estimates were exactly in these areas.

And surprisingly, given the fact that we’re looking at oil prices – West Texas Intermediate crude prices are already up 30% this year, Brent crude is up 33% and if you look at natural gas prices they are at $11.70. So despite the rise in commodities the stocks have been diverging. A lot of that as we have pointed out in earlier programs have been deleveraging, a lot of it is you know, on the day that oil hit 126 you had the XOI, OIH and XNG indexes down for the day and a lot of the S&P energy sectors only up about 3.4%. And so as we get to the next leg and higher prices as we head into the fall where we could be looking at $15 for natural gas, and next winter where we could be looking at oil prices anywhere from the 140 to $150 range – that’s just going to mean the one sector that has a product that they can sell is the energy sector. So energy would be at the top of the list. [45:12]

JOHN: Any other sectors?

JIM: I really like the industrial sectors. I think investors are treating the industrials – especially the infrastructure companies like they’re cyclical companies. But if you take a look at the build out of China, the build out of India, the building that’s taking place within OPEC itself and Saudi Arabia alone, huge engineering and construction contracts as Saudi Arabia builds four brand new cities. They’re going to build the largest aluminum smelter plant, and at some point I suspect – and it’s probably in the works right now in Congress – we’re going to have some kind of infrastructure spending-job creation act as things get worse. And I mean, just look at it, from bridges collapsing to levees collapsing, to congestion on freeways, to water systems in disrepair that are breaking down, the grid system which can’t handle overloads, to power plants – anything that you can think of that causes an economy to run is breaking down. I mean just in the oil sector alone – this is one thing I think most people don’t really understand is that the oil industry everything that you see out there – platforms and everything – is steel; and steel rusts. And the whole energy infrastructure is in decay and needs to be rebuilt. And I’m talking about trillions of dollars. At some point, you know, eventually as we head into the depression we’re going to have to have the equivalent of a WPA program, but this time it will be to rebuild the country’s infrastructure. [46:48]

JOHN: What about technology. Remember the tech boom of the 90s, is there anything future in that?

JIM: I think technology is going to be a little different in this decade and the next. Companies that can come up with alternative forms of energy, companies that can reduce energy costs, companies that can come up with products that create energy. I mean there is a massive amount of money. The venture capitalists are getting into this area. Green energy – whether it’s wind, whether it’s ocean energy. I mean you have companies like General Electric that are building wind turbines; that are building and experimenting off Europe with wave energy as a new energy source; they’re building more fuel efficient – kind of like hybrid locomotives that get more gas mileage. I mean that’s the kind of thing that’s going to be in much demand and there’s a new electric car company. It’s a sport car right now – gosh, it’s 90 to 100,000 and it can go almost close to 200 miles on one charge – but electric cars.

In other words, in the future any company that can get greater output in the agricultural field – more fuel efficient tractors, more fuel efficient cars, alternative forms of energy – that is where the whole technology sector is moving into. In other words, when we think of technology you think of the internet, or you think of now there was a company, they're coming out, John, with a digital meter – most of the meters that we have reading the energy that we consume in our homes are basically analog meters. And by going to a digital system they can not only use energy more efficiently, they can perhaps cut down on the amount of leakage in the grid system and also spot check problems before they arise. For example, the problems we had a couple of years ago in the Midwest when the grid system fell apart with a heat wave. And this is going to be a way that they can save almost the equivalent of building 60 new power plants. So this kind of technology that uses energy or creates energy more efficiently is the big technology run that we’re going to see in the next decade and especially as we move – there are a lot of companies that are seeing the price of energy at 125 or 126. Imagine what people are going to look for when we’re at $200 oil. [49:15]

JOHN: So far we’re saying that within the United States anyway, energy will probably look good, industrials are very, very attractive; tech is attractive. What about on the international scene. What do you see in terms of this?

JIM: I think international commodity producers, companies outside the United States that own or have large deposits of natural resources, I think that’s going to look good. I think the emerging market still looks very good. They’ve had a severe correction. I mean if you take a look at gosh, some of these markets have corrected quite substantially but are still looking very attractive because this is the place of the world where economies are growing at rates of 5, 6, 8, 9 and 10 percent. So emerging markets look good. I think large cap international growth stocks – whether in the United States or elsewhere because they get their revenues in other currencies besides the US dollar. But overall the most attractive markets to us right now are the US market, the Hong Kong market and the Japanese market, and that has to do a lot with the currencies. That’s because some of these markets where the currencies are going up substantially, those markets aren’t doing as well as the exporters in those countries are hurt by their currencies rising against, for example, the international currency which is the US dollar. [50:35]

JOHN: So in summary, I guess you think that stock prices are going to continue higher and I’m sure we’re going to hear much ballyhooing about that on the mainline talkies, they’ll champion this as being a recovery from all of the previous problems but at least you’re in agreement here with Richard Russell.

JIM: Oh absolutely. And that’s part of the creamy filling because the rebate checks are heading out there, the tax refund checks are heading out there, they’re working on a $300 billion mortgage bailout program; there are other stimulus programs that they also work on. I mean Congress is in a massive spending mode, and I think you’re going to see that take place and especially as we get closer to election because all of these people are scared stiff of losing their jobs. [51:18]

JOHN: Which is highly likely they’re going to do anyway given the way things are going. You’re listening to the Financial Sense Newshour at www.financialsense.com. Coming up next we’ll take your calls off the Q-Line.

Part 3

Q-Calls

JOHN: Well, we have some good news and we have some bad news here for you boys and girls out there in the audience. The good news is that we're time for the Q-lines to take your calls. The bad news is the fact that since we took a week off and the Q-lines are becoming ever more popular, our box was swamped, so there is no way we're going to get to all of them today. Unfortunately, we're going to have to be a little more selective. Sorry about that.

But, let me give you the basic information for calling in. Please remember when you call in, to keep your question as brief as possible. We're trying to fit in as many people as we can. Radio show content for the Q-lines in for information and educational purposes only. And you should not consider this as a solicitation or offer to purchase yourself any securities. Our toll free number is 1-800-794-6480. That is toll free in the US and Canada. 800-794-6480 does work from the rest of the world, but it's not toll free from there. And please remember that our responses to your inquiries are based on the personal opinions of Jim Puplava. We don't know enough about you and your financial situation, etc., because we can't take that into account –your objectives, your risk tolerance, your suitability – we won't be liable for any financial losses that result from investing in companies or information profiled here on the program.

First call is from David in Vancouver, British Columbia.

Hello. This is David from Vancouver, Canada. A couple of weeks ago, you mentioned keeping bullion in the safety of a bank and since the caller was asking ”when would the investor know was a good time to take the money out of the bank due to risk” and Jim said he'd be letting people know on the program. My concern about that approach is the black swan event, the type of event that occurs so quickly, maybe even overnight when markets are closed that the next morning you wake up and gold and silver are unavailable for any amount, and you can't get in your bank. So I don't know that we will have the luxury of the time that Jim speaks of and I’d just appreciate a little bit more comment on that.

JIM: You know, David, if you look at even in the 30s with the Roosevelt administration and confiscation of gold in the bank holidays, it was very clear that the country was in the banking crisis, and of course government intervention made it actually worse. So when those kind of headlines get even worse, those kind of things, you can have a black swan event where you have one major bank like a Citigroup or maybe a JP Morgan gets into financial trouble or reports some huge loss or some huge hedge fund, there is always those kind of things, but in terms of a national banking crisis, one thing that is a little different today is we're operating under a fiat currency so I mean as fast as the Fed can print stuff and chop trees, we can get digital money to the banks. So I still believe that you would have plenty of advance notice of that, but you know, once again, you've got to do what you feel comfortable with. And if you're not comfortable with that, then keep it at home, but you know, you have risks there too as well. [3:13]

Hi Jim, this is Joe in New Jersey. I was just wondering what you see the effect of $125 barrel of oil being on the mining industry. That's $125 and looking more and more like we could get to $200 plus. There is a lot of different ways that you could kind of view that. Just wondering, you know, do you think it will be positive that production might be actually taken off line in places where they can't come up with the amount of energy required if it's too expensive; or do you ever worry that the price of gold is just not going to keep pace with it and margins are going to get squeezed?

JIM: You know, Joe, if you look at last year, this was one thing that did impact the producing mine companies. You had oil go from $50 to $100, and it just wasn't oil. It was the cost of drilling, the cost of personnel, materials, steel, etc. And that cut into margins because remember it wasn't until late August when the credit crisis erupted that we finally had gold moving from a low of $650 on its way up to over $1000. If you look at where gold prices are now, these companies can make very good profits at this level. A lot of these companies will be hedging, but I do expect energy prices to go to $200, but then I expect gold prices will be going north of $2000. So there will be periods in between where energy and costs are moving faster than the price of bullion but over all I expect bullion prices to hit much, much higher in the years ahead. [4:41]

Hi Jim and John, this is Dave calling from near Frankfurt, Germany. Two quick questions for you. Could you please explain what is meant by the US ‘exporting inflation.’ I can't really find anything that makes sense to me about that, and is it more prevalent in countries that peg their currencies to the dollar or just in general?

And secondly, I haven't heard much about uranium lately. I was hoping you could comment on where that's going in the future.

JIM: Dave, when I say ‘exporting inflation,’ America is running a current account deficit over $700 billion so that means we're giving foreigners over $700 billion for the goods that we buy from them, whether that's OPEC countries for energy or China for manufactured goods. They take those dollars and in order to neutralize them and keep their currencies from rising too fast against the dollar, they print money in order to buy up our dollars, and so that creates inflation in those countries. And those countries that do peg their economy or currency to the dollar –like Hong Kong, for example –have had to match Federal Reserve policies. So even though Hong Kong's economy has been doing very well, they've had to cut interest rates and, you know, you've got real estate prices that have almost doubled in a year. [6:02]

In terms of uranium, you know, I'm glad you brought that up because I've been looking at it, and it is just an incredible opportunity. Right now you've got uranium prices roughly around $65. That has come down from the highs reached early last year. And right now the uranium stocks have been hit hard, but let me tell you between 2010 and 2014, I think you have 20 nuclear power plants coming on stream and a lot of these power plants are going to be trying to lock in their uranium supply because you don't want to spend a gazillion dollars building a power plant and then not have the uranium.

Another thing that happens in the next decade, and I think it's 2011, a lot of the uranium that's being supplied for example to the US from the de-stockpiling of Russian nuclear weapons, that ends, I think, in 2011. And so you're going to see spot prices of uranium jump. But right now uranium is a sleeper. [7:00]

Hi Jim and John. This is Mike. I had a question about our strategic oil and gas reserves. The EIA petroleum status report came out today and it showed an increase in our reserves. Exactly what is this, and what does this mean to the consumers? And is it just the United States building their strategic reserves and holding onto them? Do you think they are actually going to open up reserves to help ease prices; or does the government realize that we're in trouble in the future with oil and they are stockpiling as much as they can right now before other countries start cutting us off?

JIM: You know, Mike, the strategic gas and oil reserves are the stockpile – you know, the Strategic Petroleum Reserve. And one of the things that is a hot button issue, that President Bush has to look at the long term interest of the country, especially if we were to go through another oil embargo, and especially we're more vulnerable today where 70% of our energy comes from overseas versus, let's say, 25 percent in the 70s. And they are wanting the president to use the strategic petroleum reserves to drive the prices of energy down and this is just absolutely stupid. But one of the things we have to do is build this up. And by the way, it's not just us. Other countries are doing the same today. China is building their strategic petroleum reserves. Because countries realize how vulnerable the system is today to any kind of disruption whether it's a terrorist attack or refineries going out. I mean we're stretched very, very thin right now. And that's why countries are doing it, and that's why the president is building it up. [8:30]

Hello Jim and John, this is John from Pennsylvania. You guys have mentioned the TIC report, that is the Treasury International Report. Could you give additional information on what you're seeing and possibly how we can take a look ourselves.

JIM: John, the TIC report measures inflow into this country in terms of foreign inflows – where it's going to. And it kinds of gives an idea of whether foreigners are buying our stuff or whether they are selling our stuff. You know, the reports have always been positive, but it's the degree of how big those inflows are that determine what happens, let's say, with the dollar and what happens with interest rates because foreigners are basically financing our trade deficit; and that's why people pay a lot of interest to it. When the numbers go down, you usually see a weaker dollar, higher interest rates when they go up. Foreigners are buying a lot more. Right now, the last report showed that foreigners were changing from the purchase of Treasuries over into more higher yielding securities, especially after this rally we have seen. [9:35]

Hi. This is Bruce from Oceanside. Jim and John, I'd like to recommend a book to yourselves and your fellow listeners called Into the Buzz Saw: The Myth of a Free Press written by former 60 Minutes producer Kristina Borjesson, basically a collection of short stories by journalists, some of them Pulitzer prize winners. Just some sickening stuff. Dan Rather wrote the forward, by the way. I think it's important to point out that this same group of thieves control the world's largest mining company as well.

JOHN: Thanks for the recommendation on that. Also, by the way, that is why the alternative media, since about the mid 1990s, especially on the Internet and then talk radio have done so well, both on the left and the right, because the people who were supposed to be the watchers of the gate, so to speak, the main line media weren't doing their jobs, then they had new watchers watching the watchers. And that's where shows like this came from. [10:28]

Hello, Jim and John. This is Mike from Victorville, California. My questions is: Could you explain exactly what a currency crisis is, what we can expect, what we can do to protect ourselves? I'm not quite sure I follow what you're talking about. Appreciate your show and appreciate everything you do.

JIM: Mike, a currency crisis is when there is a run on the currency. In other words, people started dumping it because of loss of faith, either financial mishap or poor economic conditions or a change of sentiment towards that country in terms of the economic opportunities. And it usually evolves into a crisis when there is a sudden collapse in that currency. Now, other countries that are dependent on income or cash infusions are borrowing from outside their own country, that is more serious. The currency crisis that I see coming up – I see two of them. I see one coming in with the dollar, where the dollar starts to head lower, and then it gains momentum as speculators and shortsellers pile in on it. And then what happens consequently, the dollar is going lower and other currencies are going higher and that has impacts on those countries that have higher currencies because that impacts their exports – the price of their goods to sell overseas becomes more expensive and it creates a whole panic in the market, it drives up interest rates, it drives up inflation rates. So I see a currency crisis occurring with a dollar, and I also see one occurring with the euro. But the euro currency crisis is probably further out. [12:01]

This is Kent from Texas calling, and I was wondering what you thought about the article with William Engdahl, the May 2nd Financial Sense where it said: 60% of oil's price is speculation.

JIM: You know, I would have to disagree with that. If you take a look at, whether you're looking at the International Energy Agency, even our own government, the supplies for energy are very tight. The depletion rates around the world are accelerating and you take a look at the price of energy, 60, if you take a look at where we are on Friday and say that 60 percent of that is speculation, which would bring oil prices down to about $50 a barrel, I just don't buy that whatsoever. [12:47]

Hello, Jim and John. This is Richard from England. I have really enjoyed your show for four years now. I missed the show this week. I wanted to ask Jim, with the time you take over the show each week, how do you have time for reading? And then you've got to see your business clients and then maybe Mrs. Puplava will recognize you sometimes when you turn up to eat. How can you pack in everything into a week because always you're coming up with things that show that you researched subjects very well. That takes a lot of time, so it's really how do you cope in a week and how much research do you do?

JIM: You know, Richard, gosh, it's just something that has evolved over a period of time. I mean in the 80s, I usually would read on a weekend on a Sunday. Perhaps I'd pick up a copy of BusinessWeek and Barron’s, and there would be a few things to read. But as I've moved into money management, beginning at the end of the 80s and the world has globalized, there are a lot more things you keep track of. And I've just been a lover of books and reading. It was something my mother taught me when I was a – gosh, in first and second grade, the highlight of my week. During the summer, it used to be when my mother would take me to the library and I'd get 10 books and she instilled in me a love of reading.

So I begin my morning making phone calls, talking to traders, various people in the industry in the morning. I head to the office, and the bulk of my day is either meeting with staff members, portfolio managers. And then I spend probably six hours out of my working day at the office reading, and then I come home with another pile and probably spend another four hours at night reading. It's just something that I do, and quite honestly, I enjoy and it is just a part of my day. You know, after dinner, I turn on classical music, I get my favorite reading chair and I read stuff because I find learning is fascinating, so it's just part of me. [14:56]

JOHN: But you'd be surprised at how many conferences occur at 4:00 in the morning. Carol and I will wake up in bed. She goes, I've got this great idea for this cut we can put into the Financial Sense News Hour. We wind up talking. I don't know. Maybe that's the time we get to do it.

JIM: Yeah. You end up doing this on weekends. A lot of the people that I hang around with aren't in the industry and they are fascinated by what they see going on, especially the price of oil, what's happening to food, rice shortages, things that we're starting to see today that we've never seen before and people are puzzled.

So I just enjoy it.

Hey, Jim. Todd from Washington State. Hope you enjoyed some time off. I've been really researching agriculture investments. I see that as a great place to be going forward, and I have come to the conclusion that perhaps maybe the best way to play peak water and peak oil for that matter is potentially just going into agriculture stocks and agriculture-themed investments. Can you poke any holes in that for me, please.

JIM: I definitely think, Todd, in the next couple of years and probably into the next decade, we're going to see famine, so we get into the next decade, it's going to look like the four horsemen of the apocalypse. I'd be careful chasing some of these agricultural stocks here where they've gotten extremely expensive. Let me give you a hint. There is an agricultural stock within the Dow that gets about 25 to 26% of their revenues from seeds, and it pays a great dividend. So do a little poking around. It's undervalued. Also, take a look at some of the ETFs that owns the grains such as DBA where you can own them directly because I do expect prices to go higher mandated by what we're seeing on government. In fact, after doing the Big Picture on Friday, India banned futures trading in four more commodities, so governments are going to drive the prices higher. But I think you're onto something here. I'd just be a little careful getting into some of these fertilizer-and-seed companies and tractor companies because they've had a tremendous run up. I'd wait for a pullback.

Hello. This is Nick from Germany. I'd like to know if you could make an interview about alternative energy. I know there is still no solution for peak oil, but with every additional dollar on the oil price, there are more and more innovative possibilities and long forgotten inventions are almost economical. And I'm not just talking about regular suspects like wind and sun, but many more are now available. I'd like to mention the cheap Tata car but there is also a small car developed by a Frenchman Nègre that will also be built by Tata and runs on compressed air. Your point against [hybrids] is lack of a necessary grid system but isn’t it decentralized energy that everyone can produce on his own . A world with less power for big utility firms can produce energy with products from New Zealand-based WhisperGen that runs on oil and delivers heating and electricity; or Stirling Motor that runs on oil with an efficiency of almost 90% and a modern coal plant I guess has about 50 or 60% efficiency. Firms like EON and RWE in Germany are trying to stop any development into more decentralized system but they can’t stop the future forever. So when will the Puplava family put some solar panels on the roof and trade the Mercedes diesel for a plug-in car? When will it be economical.

And another thing about juniors, and I loved the interview with Eric King and I wanted to say I'm buying into it and they can get my shares only from my dead hand or for another big, big price but not as cheap as like I think I buy them now. Love your show.

JIM: We have done some interviews in the past with authors on alternative energy. There were a couple of new books out. I'm not going to mention the author, but they were afraid to come on the program. I don't know what they are afraid of. I don't know, stage fright or something. But if we see alternative energy books come out, we're always interested in interviewing those kind of people. Just take a look at this week's interview with the inventor of the Prius who is working on some other alternatives.

This is Bruce from Connecticut. I just wanted to ask a question about the creamy filling and the Financial Times this weekend, two articles that maybe indicate the lift off of that. One article entitled Mood Lifted by Optimism over the US Economy. The other article is Tide Begins to Turn for the Dollar. Just wanted to let you comment on these articles in the Financial Times, and you guys do a wonderful job.

JIM: You know, Bruce, I do think as tough as the market has been this year, I do think we're heading into the creamy filling. My gosh, Congress is spending more money. The money supply is expanding at 17 to 18 percent, and so I do think we're getting right into that creamy filling area, and I think it will be surprising and it will be quick when it happens. [19:52]

Hello Jim and John, this is John from Pennsylvania calling. I've heard some of your guests talk about the values of coins, their intrinsic values, they’ve given dates. Some I remember, some I don't. So I did a little hunting around on the Internet and it was relatively quick to find. So the website, and I'm sure there are many, but a particular one called www.coinflation.com . That's coinflation. And they offer an actual calculator that shows you the true value of current coins; i.e., the true melt value. And it gives the dates of when the minting swings. In short, pennies minted before 1982, dimes essentially before 64, quarters before 1964 and nickels before 1945. And one side note, even current nickels are worth more than their face value. The current nickel is worth about 6.7 cents, roughly 34 percent above the face.

JIM: I'm at that site right now. It's kind of interesting. They are talking about, for example, the pennies between 1909 and 1982, 95 percent copper. The metal content is 248 percent of the value of the coin. You take a look at pennies between 1982 and 2008, 97 and a half percent of the penny is zinc, so the metal content is about 57 percent. Interesting website. It's called www.coinflation.com. [21:41]

JOHN: Remember, it's illegal now to melt down those coins for their value, so don't try this at home, boys and girls.

Greetings. Jason from Tampa Bay. I was reading an article written by Steven Pearlstein in the Washington Post, Commodities Conundrum. He indicates there is a bubble in the commodities market, and he says perhaps the best proof of all that there is a speculative bubble in the commodities market that it may be about to burst because ConAgra last month sold the commodities trading division to a hedge fund for 2.1 billion cash. Could you comment on that? Thanks.

JIM: You know, Jason, I'm always amazed that they are calling it a bubble. One of the characteristics of a bubble is that the prices continue to go up despite the increase in supply. And if you've been listening to the Big Picture in the last segment, we've had record harvests in the last 18 years with perfect weather and our grain stock piles are the lowest they've ever been. I don't care if it's iron ore or copper, it's getting harder to get and if you define what bubbles are –whether it’s stocks or if you take a look at technology in between 97 and 2000, the price of technology stocks continued to go up even though the supply of broadband chips and everything else was increasing.

And show me the large inventories of all of these commodities. They have been talking about a commodity bubble, commodity bubble. Show me the new big oil finds that are going to supply the need of not only depleting oil fields like Cantarell, North Sea, North Slope or even Ghawar or show me the new mine discoveries that are going to -- gold production is down in the world. It was down 1 percent last year. It is down in South Africa. That is not characteristic of a bubble. A bubble is excess supply with rising prices due to speculation. [23:38]

Hola, Jim and John. This is Richard calling from Buenos Aires, Argentina. Jim, today on CNBC, Dillon Radigan referred to investors who were pulling their money out of commodities as “patriotic Americans.” CNBC has been very pro-Paulson and very anti-commodities throughout the entire credit crisis. Do you feel that Paulson, the Fed, and the new voice of America, CNBC, are raising a war against commodities and if so, would you elaborate on it and the possible outcome?

JIM: You know, Richard, they've been trying to talk commodities down. I mean every time commodities pull back you've got somebody talking about a bubble, “the bubble, that's it, it's burst.” Or any time the price of the commodity goes up, you've got to remember from Washington's point of view, rising commodity prices are a manifestation of credit policy and inflation, so they don't like that, and so they are always trying to talk it down; either that, or dismiss it. And secondly on Wall Street, Wall Street has very few analysts even covering the commodity sector. A lot of analysts left the sector. A lot of the major Wall Street firms closed their commodity trading departments in the 80s as the bull market took off. And so Wall Street knows if people start buying commodities, start buying oil stocks, gold stocks, agricultural stocks or commodity ETFs, that means they are not buying paper, the other kind of financial stocks or bonds. [25:06]

Hi Jim and John, Al from Texas calling. Wondering if you might be able to get someone like Matt Simmons or one of the other energy experts to talk a little bit about the new fields that they are talking about in Brazil, the Tupi field that's five to eight billion barrels and the Carioca field that they are saying could contain as much as 33 billion barrels. My understanding is that the Carioca field is about 33,000 feet down below the surface of the ocean and the extreme temperature that that oil is at, combined with the extremely cold temperature of the ocean floor could cause some significant if not impossible technical conditions. Any way, I'd appreciate learning more about that as I continue to look for information on the web and so on.

JIM: Al, I'm sure we can get Matt Simmons back. I tell you, I'd like to get Matt back as soon as the IEA releases its study report. They are conducting something that Matt did almost eight years ago – a study of the major oil fields because they are quite alarmed in terms of they are projecting all of this demand that's going to be coming about in the next two decades, but yet the supply response has not been there. You know, I think a lot more people are waking up to the fact of peak oil. One of the problems that we have today is despite oil prices going up almost five and six fold is that we're not seeing the supply response. And a lot of these oil fields, whether it was the Jack oil field discovered a couple of years ago, what was it, Devon and Chevron discovering it off the Gulf of Mexico, initially first pass, they thought it was one of the biggest oil fields. We don't even have the technology to extract it. In fact, Matt has commented on that on the show, but certainly hope to have Matt back on later on this year.

Hey Jim and John, this is Walt in Wisconsin. Everybody is well aware of the PPT here, which is apparently a nickname for guys who are supposedly controlling the markets to some degree. I was wondering if you would have any idea if they have any way of manipulating or moving the market other than to buy or sell different stocks. Do they have any way they can actually set or manipulate prices?

And then the second question: James Turk or one of your guests mentioned you guys talked about a possible dollar crisis, which I guess would mean the dollar plunging and people dumping the dollar. And I'm wondering if you might talk about some of the implications of that, and particularly to the banks, the financial sector, mortgage companies, etc.

JIM: You know, one of the ways they can influence the market – in addition to buying key market cap weighted stocks or price weighted stocks depending on whether it's the DOW or the S&P – is they also do it in the futures market. In terms of a dollar crisis, what James Turk is referring to is a sharp drop in the dollar where even speculators, shortsellers, hedge funds and maybe even some countries start exiting the dollar. It drops precipitously and that's what he refers to as a currency crisis. [28:28]

Hi Jim and Team, this is Larry from Rockford, Illinois. I just wanted you to comment -- I'm just reading now that a Drudge Report today six trillion in housing wealth has disappeared and you're saying, I believe, Jim, that inflation is our number one problem. I'm seeing that there are really large sums of money that are deflating, disappearing. And the discount rate is dropping. And I'm wondering which force is a larger concern, the deflationary force that seems to be wiping out huge amounts of money, or are we to be more concerned with inflation? Your comments on this would be greatly appreciated.

JIM: Larry, one of the confusions that we have in today's market place is inflation is a rising money supply, deflation is a contracting money supply and if you look at M1, M2, M3, the money supply is not contracting. And even if you have debt that disappears because it's either bankrupt or default, you can have the Fed absorb that and take it over; much as it's doing with the investment banks right now and the banks themselves. And so an asset going down in value is not deflation. Deflation is when the money supply contracts; and I think that is where we have confused the definition of what inflation is today. Prices go up – we call that inflation, but really rising prices are a product of expanding money. [30:03]

Hi. This is Jim from Pennsylvania. I was listening to public radio this morning and they were saying that the world inventory of crude was actually higher than it was a year ago, but your last interview with Zapata George was saying how low the inventory levels were. I'm confused. I thought these things were factual and I don't know where to check the facts.

JIM: You know, Jim, a lot of these inventory reports that we get in the public every Wednesday and Thursday are a hypothetical. They are computer models that estimate. And if you take a look at inventory levels and look at them over two or three year period, let’s say since 2005, inventory levels have dropped. [30:48]

Hi Jim. This is Bill from San Diego. What would be the relative values of proven and probable versus measured and indicated ounces of gold in the ground?

JIM: You know, Bill, it’s a measure of how much sampling has been done, how close the drills have been drilled. For example, probable reserves value the mineralization but it’s not sampled enough to accurately estimate the terms of the tonnage and the grade; also called indicated reserves. If you get to proven reserves – proven reserves have been sampled extensively by closely spaced diamond drill holes and developed by underground workings in sufficient detail to render let’s say an accurate estimation of the grade and the tonnage. It’s also called measured reserves. [31:36]

Hi Jim, this is Mara from North Carolina. I was just reading something that Jim Rogers wrote and I wondered if you would explain it to me. It’s a pretty basic question I think. It’s about the commodity futures market and he writes – without the commodity futures market many of the things you depend on in life from your cup of coffee in the morning etc would be either scarce or nonexistent and certainly more expensive. What is it about the commodity futures market does that makes things less scarce, non-existent and less expensive.

JIM: You know, the commodity futures market goes back several hundred years. Actually, into even earlier times than that. Let’s say that you were a farmer and you were getting ready to plant corn this year, you don’t know what the harvest is going to be. You don’t know what prices are going to be – in other words, if there’s a whole bunch of corn that comes to the market at the time that you harvest your corn, prices could be much lower and so what farmers will do to sort of lock in their profits or enable them to operate. They’re going to say, “I don’t want to take the risk. So right now the future’s market is x amount of dollars and at that price I can plant corn, sell my corn, deliver at that price and make a profit.” So it’s a way of hedging.

I’ll give you an example, Airline fuel costs – if you take a look at a company like American Airlines, they are losing money for every plane that has taken off since the beginning of the year. They’re losing 3.3 million dollars a day. An airline such as Southwest is not losing money and the reason is that Southwest went into the futures market years ago and they hedged and locked in fuel costs at a much lower price. And what it does is hedging in the futures market allows business to be conducted because it would be very difficult to conduct business if you have no idea of what the product or the price for your product is going to be. Also, in the financing market – whether it’s mining or any other kind of area when you’re trying to get financing from a bank, a bank will have you go into the futures market and hedge and lock in a price so the bank knows that you’re going to have a certain amount of revenues that they can count on. It makes it a lot more predictable in terms of controlling your output. Without the futures market it simply wouldn’t function, which is what I think India is going to find as it closes more of its futures trading.

Oh, wow, John, we’re going to pause here for a second, as we speak we’re having an earthquake in California; that’s what makes living here kind of exciting. The building is shaking a little bit, the ground underneath my chair is shaking. It is so funny when my wife and I got married in 1977 – at that time I was fluent in Spanish and we were going to go to Mexico for our honeymoon and that time Portillo had just been elected and they had killed several American tourists so the travel agency is saying “you know, wouldn’t recommend it.” So they recommended we go to San Francisco and we went to San Francisco for our honeymoon and John, the day we got there they had earthquakes. And you know, coming from Phoenix I was thinking “earthquakes! Oh my god, the city is going to fall apart.” And now that I’ve lived here in San Diego since 82, I mean they happen – we just had one and you just kind of live with them. And you know, my mother-in-law too, remember the Northridge earthquake and what was the one they had during the World Series up in San Francisco? [35:19]

JOHN: Loma Prieta earthquake.

JIM: Remember the Bay Bridge collapsed and then they had the fires from the natural gas lines and of course the media kept showing the same footage. We had relatives, family calling from Phoenix and wondering if we were still living because they thought the entire state had fallen off into the ocean.

JOHN: Yeah, that’s when the top deck of the Nimitz freeway in Oakland collapsed. And by the way, that’s the concern that they have right now for the Alaskan Way Viaduct freeway in Seattle because it’s basically the same construction and Seattle has earthquakes. So they’re really concerned about the same possibility. We were there last weekend and you know, there’s a big parking area underneath the viaduct and whenever we park there I get in, pay my money, and get out from underneath the viaduct as fast as possible.

All right, back to our Q-Lines here now that we’ve had that little interruption

Hey Jim and John. I don’t have a lot of disposable income. I do have a nice position from listening to your show in some gold juniors, but as far as buying physical metal, when we’re paying – or what I’ll be paying looking around anywhere 22 to $26 each for silver Eagles in my area, is it worth buying a little bit at a time or should I not even bother with it?

JIM: One thing that you might want to do is consider buying silver rounds. And silver rounds are not Eagles because I think there is an 8% government premium in the price of an Eagle that the government tacks on, and then of course the coin dealer has to tack on 2 or 3%. So I would continue doing it but I might suggest that you do exactly what you’re doing but switch to silver rounds where you can buy silver at close to the spot price. [36:58]

This is Pete from Philadelphia. I’m calling you on a Tuesday morning when once again precious metal stocks are being trashed. I guess my question is, Jim, the XAU-to-gold ratio has been so low for so long and where normally this is a very bullish signal, precious metal stocks keep on going lower. So could you tell me why the precious metal stocks have underperformed so miserably compared to gold and silver since the August lows and if this has any negative future implications for the gold markets.

JIM: Pete, I would suggest you listen to the first hour of the Big Picture where we spend 45 minutes addressing that very same issue. [37:50]

Jim, this is Bert in Yuma. Could you explain what is capitulation?

JOHN: It is when Jim and I make a bet and one of us loses.

JIM: Capitulation is when people finally give in, throw in the towel. It’s like, for example, holding on to a stock, it’s falling, it keeps going lower and lower and finally you just wake up one day and say the “heck with it, I’m cutting my losses and running” and everybody sells. [38:15]

Hi this is Marv from Myrtle Beach, South Carolina. I have a two-part question. I’ve been reading an article by John Mauldin on the slowing velocity of money. Jim, I wonder if you could explain if you think that’s true and how that plays in with your picture of inflation. And secondly, somebody mentioned a guy named ‘Mish’ last week. I think Mish’s point of view on deflation is that it’s going to be a massive credit implosion. I think you don’t think that’s possible. But I just wonder if you think it’s absolutely impossible or if you think it’s simply unlikely. It’s not clear that the Fed has infinite power and the credit implosion could be very large. So I wonder if you could comment on that.

JIM: Let’s begin with velocity of money which peaked – I’m just looking at M2 here, peaked around 97, 98. And remember these figures are a little bit jury-rigged because velocity of money is the GDP divided by the money supply, and GDP is somewhat distorted. But nonetheless it peaked in 97, 98; it bottomed in around 2003 and since then it’s been going back up. I would suspect the same would hold true for M3 even though we no longer track it. [39:31]

JOHN: By the way, the USGS just popped up their earthquake report. It’s a real time earthquake report and I guess the earthquake you just had was northwest of the Salton Sea in southern California, south of Palm Springs up in the mountain range there, southeast of Hemmock [phon.]. And it looks like it’s probably a 4 to a 5. It would have had to have been that strong for you to feel it – to get some good shaking out of it.

You have to forgive us! Californians or ex-Californians get all jazzed about this.

This is Robert from the Albany area of New York. And I was just wondering if they think that the diesel prices will come down closer to gas prices and why the diesel prices are so high? Thank you.

JIM: Robert, I’m glad you ask that question. Number one, the reason that diesel prices are so high, we don’t have enough diesel refinery capacity; 2) we import a lot of our diesel into this country; and right now, China has got a diesel fuel shortage because of their teapot refiners, so China is going into the market and buying large amounts of diesel fuel. And especially so they have plenty of fuel ahead of the Olympics. So I think you’re always going to see a premium for diesel because we simply do not refine it nor enough of it or have the capacity. [40:49]

Hi Jim, this is Howard from Lafayette, Louisiana. A couple of weeks ago I asked a question about what happened the other week when Bear Stearns almost went under, and you said we all survive. But you and Tim Wood both said we went to the edge and one day we’re going to go over. My question is: what’s it going to look like on that day – not this time but in the future when we do go over the edge? What’s that Monday morning going to look like for regular folks?

JIM: Oh boy. You know, it’s frightening thinking of what it’s going to look like. But you could have a collapse of the banking system. A collapse of the currency, the currency collapses and since we import so much of our energy in this country and so many of the goods you see on manufactured stores you might see those that ship to us refuse to take our currency. But I think when that happens it’s going to be a global event; it’s not just going to be here. I mean if you look at the credit crisis and the derivative write-offs, look what’s happened to the Swiss banks which were considered stellar institutions 20 and 30 years ago. So I think it’s going to be a global type event and there’s going to be a scramble that is for anything that’s tangible and safe. And that’s when I think you could see gold bullion prices…I shudder to even think of where the price of bullion would go under that. It would be anybody’s guess. [42:16]

Hi, this is Dan calling from New Jersey. I’ve got a question about money supply and M3. I’ve read a lot about how M3 keeps going up and the expansion of money and credit in the US, but at the same time I keep hearing about how we have companies losing financial firms losing and writing off billions of dollars and how trillions of dollars are being wiped out in wealth in the housing market. So I was wondering if those two things offset each other or if M3 is just growing so fast that all the destruction of money and credit as a result of subprime is completely irrelevant. Thanks.

JIM: Well, just take a look at is as much as these companies whether it’s Citicorp, Merrill Lynch or other people are writing off their bad debt expense, they’re back into the market, tapping into global liquidity and replenishing their balance sheet. And just take a look at what the Fed’s doing where the Fed is taking illiquid securities from broker-dealers or even banks and taking that risk onto its balance sheet and issuing Treasuries to these institutions. So the Fed can always mop up that.

In fact, there is an article by an economist by the name of John Makin, he’s a visiting scholar at the American Enterprise Institute in Washington DC and a principal of Caxton and Assoc. LLC, a leading New York hedge fund and he said: In the end there are two things that are going to happen with this crisis as it unfolds. Either the Fed starts printing – meaning monetizing money, just creating dollars out of thin air – and starts buying up all this debt or the government nationalizes it and the printing of money is a more attractive outcome. And I think eventually that’s where we're going to go. In fact, I’m just reading here. He said:

The proposal for the Fed to contain the damage after collapse of the housing bubble by printing money carries with it many risks. But a case can be made that this approach is preferable to the alternative: a virtual nationalization of the mortgage market and extensive financial re-regulation that may come anyway. A reflationary approach by the Fed, printing money to slow the fall in home prices, and to alleviate the rapid rising distress created for American households and lending institutions of an accelerating fall in home prices deserves serious consideration as the least costly of the two unattractive policy alternatives.

And that’s exactly where we’re going. And that’s why I just disagree with the deflation people. They just don’t really understand what a government can do when you have a fiat currency. [44:52]

Hi Jim and John, this is Roger calling from the island of Antigua. Can you discuss what a novice investor could get out of attending a gold and mining investment show such as the Vancouver show being held in June. And would this be a good place to start.

JIM: You know, Roger, one of the good things about attending these gold shows is usually if they’re large enough they will have 200 companies and you know, a lot of times you go to these gold shows the company CEO or the head geologist are there. So you can pick up information about the company, you can talk to the company CEO and I think it gives you a good flavor of the type of companies that are out there, what’s attractive and I think it’s an excellent way to become more knowledgeable about the industry. So a very good idea. [45:38]

This is Steve from Rochester, New York. I was wondering if you guys could give your updated thoughts on the best options for fuel efficient cars, hybrids versus diesel and which diesel cars you feel maybe a better option than a hybrid. I’m kind of on the fence between diesel and hybrid and would like your opinion. Thank you.

JIM: You know, Steve, listen in the second hour when we interviewed the gentleman from Toyota, Bill Reinert. I was leaning more towards diesel but we don’t have enough refinery capacity for diesel and we’re having to go out into the global marketplace and compete against countries such as China and elsewhere and that’s why diesel prices are so high. Plus, it takes more energy to refine diesel. The refiners have to run hotter and I think that in a crisis I’m beginning to think that the transportation system will get priority over diesel, so I’m leaning more towards gasoline hybrids even though I think diesel hybrids would be more fuel efficient because diesel fuel is about 30% more efficient than gasoline. But right now I’m leaning more towards gasoline because I think that will be more available for the average driver than diesel which is going to get harder and harder to get; and especially with the transportation industry screaming right now in terms of what they’re having to pay for costs. [47:04]

Hey, Jim and John. This is Michael calling from Vancouver. I would like to hear your views on alternative energy such as solar and wind power. Do you have any holdings in alternative energy companies at the moment. And do you think this is a smart idea to invest in these green energy companies if you’re looking at the next 5 to 10 years.

JIM: I do, Michael. We own alternative companies. My only criteria – we try to look for companies that are making money so be careful whether you’re looking in solar – only a few companies are profitable in that area. And the same with wind. [47:46]

JOHN: Jim, earthquakes not withstanding, it looks like we’ve rounded out the hour. We still have a lot of Q-Line questions. Remember to try to keep your questions under a minute. Some people run a minute-and-a-half, two minutes, three and we just can’t fit those in any more. So done with the show for today, we will be back next week when we will be featuring, ta da da…

JIM: My guest will be Josh Peters for those of you getting ready to retire and looking at dividends. Josh has got a new book. He’s a Morning Star analyst and also he writes their Dividend Newsletter. His book is called The Ultimate Dividend Playbook. On May 24^th, Charles Morris The Trillion Dollar Meltdown as we take our first crack at what transpired in this credit crisis. Jeff Christian will be joining me with the CPM Silver Yearbook May 31^st. On June 7^th, Barton Biggs Wealth, War and Wisdom. And on June 14^th, Louis-Vincent Gave A Roadmap for Troubling Times. So a lot of great guests coming up in the weeks ahead, including Other Voices.

So I guess it is that time again, John. On behalf of John Loeffler and myself, we’d like to thank you for joining here on the Financial Sense Newshour until you and I talk again we hope you have a pleasant weekend.