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Financial Sense Newshour

The BIG Picture Transcription

June 7, 2008

Part 1

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Part 2

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Part 3

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Part 1

Mega Trends

JOHN: As people pass through a paradigm shift, for the most part, they are unaware of the fact that they are in the middle of that paradigm shift. They only see it in retrospect. And looking in prospect, you could say the same thing about what we would call ‘mega trends.’ Mega trends are longer term projections and trends that generally a lot of people don't see when they are in the middle of it, but it does affect investment because long term investment is based on what people perceive to be the trends rather than just short term items that happen on a day-to-day or month-to-month basis. So the first part of the Big Picture today we're calling Mega Trends and it's a series of issues, but obviously, I would assume, Jim, the first of these is going to be oil has got to be in there somewhere.

JIM: Well, it's not only got to be oil, John, but the day you and I are speaking, we've got crude oil prices up $9.06 at 137 – now another new record. If you think about it, oil prices are up almost 14, $15 in just two days. You've got oil prices up now over 40% this year since January. And you recall in January, we started out predicting $125 oil – and at the time, I was thinking by the end of the year. Then of course when we surpassed that in early May we upped our prediction to 145; and I'm scratching my head here as we look at some of the dynamics that are driving this and we may have to increase that. So any kind of problem, whether they blowup a pipeline in Nigeria, there is something going on in Venezuela, or there is some kind of disruption of oil supply, then you can get what many experts are talking about: that spike high to $200 a barrel.

And what's interesting about this that I find fascinating, you recall, John, when we had Matt Simmons on the show, I think it was probably last fall, and Matt was talking and you remember the presidential elections were now heading into full-time as the candidates were all out making stump speeches and he was saying at that time, he goes “By the time we get to the November elections in 2008, peak oil will replace global warming as the number one topic.” And I can't help but think that – Morgan Stanley just came out and said that we could be looking at $150 oil by July 4th – as we hit that $150 oil and as gasoline prices start going to $5 –here in California, we're already paying $5 for diesel and if you're on the bay trying to fill a boat, you're probably paying $6 for diesel – and I can't help but think that this is going to be the number one topic. [2:51]

JOHN: That's what Matt Simmons said here September of last year here on this program, and you really have to appreciate how dramatic this shift has been because when we were back there, let's even go back 48 months when all of the candidates from both the left and the right –Republicans and Democrats – were debating, peak oil, energy, the economy were nowhere on the radar. It was global warming, health care and a lot of these other issues. And as Matt Simmons said, by the time we got to the election, the whole searchlight would have swung around and that prediction has been proven to be true.

JIM: It's amazing on the day once again on Friday, the International Energy Agency just issued a report and said that the world is going to have to spend 45 trillion dollars over the next two or three decades to come up with an energy revolution to combat peak oil, to come up with alternatives. This is not only a theme that's going to dominate the markets, it's going to dominate the headlines, and probably dominate the headlines for the rest of our lifetimes and especially as we start getting to $200 oil. I've seen predictions now coming from Matt talking between 300 and $500 oil.

And the one thing that's happening here is that this is escalating and it's occurring at a much faster rate than originally anticipated as we very well have seen. There was a dramatic increase last year when we went from a low of almost $50 oil with a warm winter in January of 2007; and of course we ended up close to $100 a barrel where it was like 95, I think it was, at the end of 2007. And here we are on this Friday and we're talking about that oil prices already up another 40% a year.

So if you're taking a look at natural gas prices, any idea where natural gas prices are up this year? [4:45]

JOHN: No.

JIM: Up 70%! And that's going to have an impact on fertilizer prices because natural gas is used in fertilizer, fertilizer is used in agriculture. There was a UN report which came out this week, and you can look at rising food prices going forward here. So peak oil is going to have a dramatic impact. It is a mega trend that is going to dominate economics, it's going to dominate the news. I mean this story is not going away. And you remember last week, they were talking this is a bubble, the prices are coming down, you know, we've got to go down to 80 dollar oil and the dollar is going to strengthen, it's going to bring down oil prices –we'll touch upon this topic when we get to Filtering the Noise which is our second topic on the Big Picture today – but it was as little as last week they were telling you, “This has got to go low. We're consuming less, the economy is slowing and there is going to be less demand. Americans are conserving more, so the prices have got to go down.” And here we are a week later at prices that we have never seen before. [5:48]

JOHN: You know, it's also interesting that Matt Simmons was talking about peak oil replacing global warming as sort of the crisis du jour. We're seeing that collision right now. In other words, these two things – you can see this – are on a collision course. This week we had the Lieberman-Warner bill being debated in Congress, and of course I don't think anybody fails to admit now that a cap-and-trade system is nothing more than another taxation system designed to make energy prices even higher. So you have to picture this: At a time when energy prices are going up to record levels, Congress is actually debating making them go up more. So this is a collision point that's on the near horizon here.

JIM: Oh, yeah. We're going to get to the cap-and-trade system when we get into the second hour, but you're talking about a 6.7 trillion dollar tax increase which would raise utility costs by 45%. It would raise the cost of a gallon of gasoline between 50 cents and a dollar, so you're talking about even making it more expensive. I mean these guys still don't get it.

It was rather interesting this week. There was a comment that came out from Europe, and they were saying, “Look, there is nothing we can do about the price of oil. It is driven by demand and supply.” And what is amazing about this is the only people that don't understand this are people in Congress. So, John, we may have to resurrect our program again of leaving no congressman left behind. [7:15]

JOHN: That was a good program and we should imitate the government more in what the government does, and that is once you start a project or a program –once a king or queen in Narnia – remember that from the movie? – once a pork or entitlement program, always a pork or entitlement program in Congress. We should do that same thing here and just keep that project going.

And we've been talking about peak oil for the last, I might say for a year or better here on the program, but we've done some rather extensive analysis of it. Now it has hit the public consciousness. In other words, now people are just starting to become aware that “wait a minute, this is bigger than something we thought before,” which is what we said would happen, if you recall that. At some point there would become this wake up. For us it's nothing new, for our listeners it's nothing new, but here it is, now they are talking about that it on the street.

JIM: And, you know, there are a series of events – and as we broke it down last week it boils down to simply you have 87 million barrels of demand and you have 85 million barrels of supply. And as we have pointed out repeatedly over the last couple of years with not only in the Big Picture, but also guests that we have had on the program, conventional oil production peaked in May of 2005 and has declined since then. We have alternative fuels, coal-to-liquid, gas-to-liquids, biofuels that have come in to fill the gap. But the problem is our world’s major oil fields are aging. We're down to less than four oil fields that are producing over a million barrels a day. One of the last ones is Cantarell and they are saying that sometime next year, Cantarell's oil production will drop below one million barrels a day. Now, what does that mean for the United States? Well, if you take a look at Venezuela cutting its exports to the United States from 1.7 million barrels down to 1.4, there is 300,000 barrels a day that's gone. If you're talking about Mexico dropping its exports to the United States from two million barrels down to 1.4 – and Mexico just informed that they are going to be cutting their exports to the United States by another 14, 15% – you're talking just between those two countries alone, there is almost a million barrels a day. Where do we find that difference because demand has not dropped by a million barrels a day?

And there was a piece this week that just came out that the Saudis beginning in July are going to charge a $2.50 surcharge to the United States to export light sweet crude oil. And why that is important is a lot of the oil that we're getting or importing into the United States today is heavy sour crude oil and you get less refined products out of sour crude than you do light crude. It has to go through several refining stages to get to gasoline, jet fuel, diesel, etc. So it costs more to refine sour crude than it does light crude and light crude production peaked many, many years ago; so our refineries would love to have more light sweet crude and now it's going for a premium beginning next month.

Just to give you an example of what impact this is going to have, next month, we're going to end up paying an extra 150 million barrels a month to the Saudis just to get this kind of product. And so this year, we're going to transfer over 400 billion dollars to oil exporting countries. And that figure will probably be going up substantially; maybe it might end up 450 to 500 billion, especially as the price of oil on the day that we're talking is almost heading towards $140 a barrel.

So there are a number of issues here and the problem that we're dealing with is when the price of oil goes up at this level, it is going to trigger a reverse of the globalization concept because (as we talked about last week) 40 foot containers on ships have gone from a price of 3000 to ship a container from China, to 9000. And if you get to $200 oil, it's going to go from 9000 a container to 15,000. So reverse globalization is another afterthought that's going to come through as a result of peak oil here.

But the problem is once again, we're still fiddling and we're trying to pass a law to raise energy taxes by 6.7 trillion dollars; and we'll get into this in the second hour of some of the difficulties of this and how it has nothing to do with global warming and the 6.7 trillion has nothing to do with energy. It has to do with another method of raising taxes. And the only response we've gotten from Washington in order to curb this crisis is to increase more taxes for the American consumer. Nowhere, at any point, are they talking about increasing supply. [12:07]

JOHN: All right. That's the background of peak oil. We've covered that here on the program at length. The world, just like Matt Simmons said –and it was back in 2006 here when he said it on the program – that the whole election would begin to shift toward it, and this would become the focus by the time we got to the polls in November of 2008. And that's what we see happening.

The second area that people are not very commonly aware of is the fact that the Third World (or what we would call the Emerging World) is now growing rapidly in a number of areas, and rather than exporting what they are producing, they are conserving it in their own countries for their own internal use and growth and I think Indonesia is one of those. Am I correct?

JIM: Yes. In fact, they just dropped out of OPEC because they are now conserving their own energy for their own economy rather than export it, so they just dropped out of OPEC. So this is just a good example of what you're talking about.

But, you know, it used to be, John, if you looked at trying to figure out the macro trends of the markets and the economy, you mainly took a look at what was happening in the United States. What was going on with the US economy would sort of – you know, the old saying when the US would sneeze, the rest of the world caught a cold. And that was pretty much where the focus was in terms of macro economics. Well, just take a look at what's going on in the United States; if the US economy went into a recession, the rest of the world would go into a recession; if we came out of a recession, the rest of the world recovered.

That began to change in this decade and it's remarkable to see the sea change globally. If you go back 10 years ago, 1997, we had the Asian crisis where you had money pull out of the Asian countries. They were running trade deficits, they were amounting debts that they were building up and there was a crisis. Here we are 10 years later. The emerging world has advanced its economies. They are strong on the industrial side, a lot of manufacturing has moved over into that area, and they have gone from being debtor countries to creditor countries. And the United States has gone into becoming the world's largest debtor nation and now the emerging nations' economies have become creditors to the United States, so you're talking about a dramatic reversal of positions. And that has enormous implications in terms of what's going to happen to our investment markets. [14:38]

JOHN: Okay. But we can actually reverse this whole thing too, Jim, if we looked at it. Say we run on the thesis here that peak oil is going to act as a counter pressure to globalization because it's becoming expensive –remember the 6000 mile Caesar salad. It's going to act as a counter pressure to the transport of goods, so people will tend to start doing it more and more at home. What about in these emerging countries? Wouldn't they be more inclined to do the same thing to try to develop their own industries in their own countries rather than importing items from elsewhere in the world?

JIM: Well, there is a number of things that are happening in the emerging world. Number one, trade in Asia – trade between Asian countries is increasing substantially. If you take a look at a large exporter in the region, Japan, their exports to the United States have fallen tremendously while their exports to China and other countries within that region have increased significantly. So you're starting to see a market develop between these Asian nations trading amongst themselves. You're starting to see talk about some kind of currency mergers between these countries, much like the euro or the amigo here in North America. They’re talking about developing and liberalizing their markets to the point where they can develop a bond market that they can invest in their own region rather than invest in, let’s say, the debt of the United States.

And the thing that you're going to see here is that market is going to develop because when these countries began to run surpluses as they industrialized their economies, as they began to export, they began to build up foreign currency reserves. And when they built up these foreign currency reserves, initially they said “Well, where do we invest this? Well, we don't have much of a consuming society within our country. We've got to find a market to invest these billions of dollars.” And the first market that they went to, which is the largest market in the world is the United States; and probably the most liquid security in the world, which was Treasury bonds. So they begin to finance and recycle their trade surpluses back into the United States by buying –you know, they called it ‘vendor financing.’ They would ship us goods, we would pay for those good in dollars and then they would take those dollars and recycle them back into the United States by buying our treasury debt.

But as these economies become more defined, as they begin to invest in infrastructure in their own countries, as they begin to trade amongst themselves, these countries are now establishing these large investment pools known as sovereign funds and these sovereign funds are now beginning to invest outside of US treasury debt. And as they begin to move away from treasuries, that is going to have a very profound effect here in the United States on treasury yields. You've heard Bernanke talk about this and other people about the savings glut –all of this excess money that was being recycled into the United States – and it was one of the reasons why Alan Greenspan kept talking about this conundrum as the Fed began raising interest rates in 2004. Typically, when the Fed raises interest rates, long term interest rates go up in conjunction with that. It wasn't happening. Long term interest rates were going down at the time short term interest rates were going up; and a lot of it was this money that was being recycled from OPEC and these emerging nations that were buying our treasury debt. That is beginning to reverse itself. In other words, there is less money coming into our treasury markets and as that happens, it's going to have a profound effect on the bond market because eventually, you're going to see long term interest rates begin to rise in the United States, not only from rising inflation but less money being invested in the treasury markets.

So the rise of the emerging world, the emergence of trade among this area – because it's going to become more expensive to ship goods in the United States, consumption is dropping in the United States with the American consumer being overburdened with debt – what you're starting to see is a consumer market develop within these countries. And so as that market develops, more of these goods and trade will be amongst themselves and that market will begin to grow and develop tremendously. So this is a second mega trend, which is the rise of the emerging world. [19:13]

JOHN: And you can also see the impact, Jim, that this is going to have on geopolitics as it becomes obvious to some countries they are now becoming losers in this game whereas before they were winners. So that will change the face of politics as well.

JIM: It's going to change the face of politics, and it's going to change the whole dynamic because you're talking about a huge wealth transfer. I mean if you just take the oil exporting countries – think about this: The United States is going to spend over 400 billion dollars to OPEC and other exporting nations to get that oil. And think of this wealth that is flowing out of the United States; nearly half of our trade deficit is now going to pay for imported oil or imported energy products. [19:59]

JOHN: I'd like to stay with this topic because what I mentioned just a few moments ago was the fact that the face of global geopolitics is going to shift as a result of this between the haves and have-nots. And before, we were talking about the concept of vendor financing where we swap goods, somebody else finances this – a lot of the US debt, for example, as far as China is concerned, has been sustained that way – but as these trends change now, that's not going to be a sustainable situation anymore which again sends more earthquakes through the whole system. Of course, if you know what's going to happen ahead of time, then you're also poised to position yourself in the right places for it.

JIM: Sure. Because if you look at where the economies of the world are growing the most rapid, it hasn't fallen on deaf ears with international corporations. Just about every major international company in the United States is opening up plants and markets in the emerging world because this is the fastest area of economic growth and you want to be a part of that. And if you take a look at whether you go into a department store, electronics store, just about everything you see on the shelf in a Wal-Mart or a department store, John, it's not made here. It's made elsewhere. So you're not just talking about the amount of energy that we're importing into this country. You're also talking about how the United States is still –even though our trade deficit has come down and has improved over the last couple of years – spending 700 billion dollars a year that we're sending overseas. So that's why if you take a look at the foreign currency reserves that are being accumulated by these countries, it is probably the largest wealth transfer in history. And this is something that doesn't change overnight. In other words, if your factories were shipped overseas and moved overseas over the last couple of decades, it's not something that, you know, once again you can flip on the switch and all of a sudden those same goods that you were buying in the store today are now going to be made in the United States. Eventually, that's what's going to have to happen. You're going to have to reengineer the US economy and move more towards home manufacturing, especially as the cost of transportation goes up. That's a process that takes time. It's something that you're not going to do overnight. You're talking about that trillions and trillions of dollars that we're going to be transferring overseas, either to energy producers or to the producers of manufactured goods. And that's a trend that's going to be with us for the next three-to-five years, so this wealth transfer that you're seeing and the emergence of this new economic power, now you're talking about a new economic force that's going to emerge in the markets and I think that's our next trend that we need to discuss. [22:53]

JOHN: Well, so far, recapitulating here on mega trends, we've talked about peak oil, which is pretty much coming to the street now, people understand that. What they don't understand is that following in the trail of this is the rise of the emerging world and the resulting transfer of wealth. That leads us very naturally right into the next topic, which is sovereign wealth funds and what that will mean ultimately in the long term.

JIM: What sovereign wealth funds are doing, as these countries become more confident in their own economy, confident in their exports, confident in their economic growth rates, and as they accumulate this huge amount of foreign currency reserves from this wealth transfer, they are now shifting and saying, “Look, until our markets develop and we develop our own debt markets that we can put money in, the interest rates in the world today, and especially in treasuries are below the inflation rate. We want a better return on our investment because we're investing for future generations for our own countrymen.” And so what they are trying to do is get a better rate of return. I mean this has gone on for decades. I mean Norway with the development of the North Sea developed a sovereign wealth fund; but you're seeing more and more of these sovereign wealth funds.

And at one time, it was the rise of the mutual funds in the 80s bull market, they became a force dominating trading. Then it was the pension funds as people began to contribute more towards 401(k) programs. We went away from defined benefit plans, so institutional investing and then in the late 90s, we got the development of the hedge fund. Hedge funds became a dominating force. But I'll tell you, the new power broker on the block is going to be the sovereign wealth fund. They are over two trillion in size right now and they are projecting in the next three or four years to go to 12 trillion. Take a look at, for example, the recapitalization that we've seen with a lot of the money center banks and investment banks. Where did all of these investment banks go when they needed money? They didn't go to US institutions. They went to Abu Dhabi, they went to sovereign wealth funds in OPEC, or in Asia. So I think another significant trend to watch is now you have a new power player in the global markets, the sovereign wealth fund; and I think more important is what are these sovereign wealth funds investing in because that's another trend that needs to be captured is where are they going to invest the money, and that is the trend you want to follow. [25:28]

JOHN: Yeah. And regarding the sovereign wealth funds, it would seem that what they are investing in right now are resources or other commodities required to keep their economies going.

JIM: Well, absolutely. I mean China is importing large amounts of energy, a lot of the Asian countries, whether it's Japan, South Korea are importing energy. And it's not just energy, it's raw materials. I mean producers – iron ore producers increased their price of iron ore almost 70% to China; makers of Potash and fertilizer are passing on tremendous increases.

The one thing that keeps an economy going if you're a manufacturing economy and you're industrializing, what are the raw imports of manufacturing? It's raw materials. And so you've got China investing in base metal companies, you have China investing in energy companies and then also you've got some of these sovereign wealth funds that are investing in financial institutions. But I think probably the most dominant area that they are going to be investing in is in commodities – and we'll talk about in the next section, Filtering the Noise, this nonsense that people keep taking about which, you know, we're in a commodity bubble. No. We're facing the dawn of scarcity. We mentioned earlier how the IEA talked about in the area of energy alone, we're going to need to invest 45 trillion dollars; and we're going to need to invest trillions of dollars in water infrastructure; we're going to need to invest trillions of dollars in mines. In other words, how are we going to increase this supply to match the demand that is growing from these economies? When you take a look and try to understand the macro picture, it's going to involve not just getting the economies of the US, Europe and Japan right, it's going to be following what's going on in the emerging world in terms of getting the macro economic picture right. And I think that is going to become more prominent. [27:23]

JOHN: You know, something that you just mentioned in there is a concept that not too many people are thinking about right now and that is the dawn of scarcity which dovetails in with these countries using sovereign wealth fund to invest in their own future, which is basically what they are doing. But at the same time, the availability of materials is going to become more and more scarce which radically affects prices, and again, I guess we come back to the geopolitical situation.

JIM: Absolutely. In fact, there was a UN conference this week with the major industrialized countries on food in terms of prices. I mean you've got people rioting in over 30 countries because of rising food prices. I hate to tell people it's going to get worse. And according to the reports coming out on this UN conference this week, they said that high food prices are going to be with us in years to come; and, you know, none of these countries can agree on what to do.

Especially alarming is, according to the UN, they are concerned about large food producers such as the United States devoting 33% of its corn crop to biofuels. In fact, the UN was blaming the United States for 30% of the increase in food prices had to do with our biofuel problem. Of course, Washington said only 3%, but we know how they hedonically adjust their numbers…But the other thing, it's not just the fact that we're devoting a large amount of our food crop to producing biofuels, but it's also a lot of key exporters are using trade restrictions.

So you've got a number of things that are going on here with food. You've got the change in biofuel policies where you're devoting a large part of your grain crop to biofuels; you've got the implementation of trade restrictions by key exporters – a lot of these exporting countries are saying, “look, we've got rising food prices within our own country and in order to keep the population from rioting, we're going to stop exports or restrict exports so we can keep prices low.” What they are doing is they are shrinking supply. And then, you know, John, we've had 18 years of perfect weather, and so now you've got the corn crop this year is being planted later than usual, so that could create a problem and bad weather is contributing to some of these recent spikes.

CNBC was doing a special piece on hog farmers and they were saying thank goodness we can export our hogs to China and get higher prices because we wouldn’t be making it.

On this Friday, you've got corn prices at $6.62 a bushel. A couple of years ago it was a little over $2 a bushel. And then in the futures market they’re predicting that we could see corn prices as we head into the fall close to $7 a bushel. We've got soybean prices just hitting another record. So we've got these situations here. And remember, fertilizer goes into agricultural production and you've got fertilizer prices that are almost doubling, and a lot of farms have been put on allocation because they can't produce enough of this stuff like Potash. That is one of the reasons why the agricultural sector has just been going ballistic this year.

And it's not just food, John. You're talking about water too. Corn uses a lot of water. You've got water tables dropping in the main aquifers in the United States so you've got water conditions globally. You're going to have to invest trillions of dollars to bring water up to speed. I mean if you look at China, you've got cities where the water is so polluted people are getting sick. China is going to have to devote a lot more of its currency reserves to clean up its rivers and its water system. And so this whole nonsense thing about commodities being in a bubble...In fact, I would recommend to our listeners, the Commodity Research Bureau, which follows the CRB Index, publishes a book called the CRB commodity Yearbook. And the Commodity Yearbook has just been published for 2008. And it's amazing as you just go through production, you take a look at supply –whether in any commodity – and you can just see why commodities are going to be on the rise for quite some time. In fact, we're going to do a special on that next week in the program as we go through this year's CRB Index and just tell you why food costs are going up, energy costs are going up – just about every basic commodity you can think of is going to go up. And also it goes right back to one of the raw inputs of producing goods which is energy. If you've got energy prices at close to 140 dollars a barrel, well, I don't need to tell you – oh my goodness, we've got oil prices up here as we speak almost up 10 dollars on the day. We've just hit 138 in the futures market in after-hours trading, so it's just amazing. [32:09]

JOHN: You were mentioning earlier that say in Third World countries, when prices go up here say because of ethanol, I did have to sort of smile if the UN is blaming the US and notably Brazil as well, by the way, because they've been doing the same thing. But it's been the UN that's been promoting this all along, ostensibly to fight global warming. Now, they are sort of turning here a bit if you notice in the direction…but having said that anyway, the poorer worlds are really hard hit by this and the wealthier sections of the world, they can absorb this. It may not be fun or comfortable or what they want to do, but in poorer areas it can actually become life threatening. That's in the food issue. But also the classes that are most likely to get struck by this are going to be the middle class. And so are we seeing the death of the middle class or diminishing of it, or something along those lines in line with what we are talking about here.

JIM: One thing that you're going to see through all of this and this goes back to, and we'll talk about this in the next hour –back to the future – taxes and inflation are eating away at the middle class. We've talked about this so often on the program, but when the real inflation rate in the country –and I'm talking the inflation rate on Main Street, not the inflation figures like the core rate that they talk about in the financial press – but when you talk about inflation rates of 10% on Main Street, most people who work for a company and they have a salaried job, you can't go in to your boss and say, “look, my costs have gone up 10% and with my taxes, I need a 15% pay increase to keep me even.” And so that's why you've even seen on the retail sector where more people are shopping at Wal-Mart, more people are going to Costco and a lot of the luxuries in the discretionary spending are being done away with. I mean restaurant sales are down, main department store sales are down. And we went through this expansionary period with debt and the real estate bubble and the credit bubble that people took on more debt, now we're going to talk about down sizing.

It was interesting. I was reading a story in fortune about KB Homes started by Eli Broad who built these small starter homes in the suburbs. That was their forte. And they got caught up recently in the real estate boom where they were building McMansions. Now the company is refocusing itself, and they are taking and they are using the same facade that they used with the McMansions –and they look the same at the street level – but inside the homes they are actually cutting the size of the home in half. Instead of building 4000, 3500 square foot homes, they are building 1800 square foot homes, 2000 square foot homes. They are getting rid of maybe the dining room and living room. I always called the living room the ‘museum’ room – nobody ever uses it. And they are building sort of the great room concept right off of the kitchen where you spend most of your family time almost going back to the way homes were built 40, 50 years ago.

And so the whole concept that we're seeing here is you're going to see the downsizing of the middle class. And especially as more of the boomers head into retirement in the next decade, that's going to have tremendous implications for discretionary spending. It's going to have tremendous implications for the housing market, the investment markets and what I think is a mega trend that you're going to see develop and is developing and unfolding as we speak is ‘downsizing’ is going to be the key word. Downsizing the car, the SUV, the gas guzzler is traded for the Honda Civic or the Prius or something that's more fuel efficient; living closer to home; A smaller home versus the McMansion. So you're going to see downsizing in discretionary spending; you're going to see downsizing in the housing market; you're going to see downsizing in the automobile market. And all of this is going to have tremendous implications for investments going forward over the next decade. [36:24]

JOHN: Well, so far we have talked about peak oil, the rise of the emerging world, the transfer of wealth that will result; and also sovereign wealth funds which are directly interconnected with all of these three issues and fact that the middle class is going to find itself under more and more duress, so the middle class is going to start downsizing in a lot of what they do which will affect what they consume as well. And finally, we need to talk about the return of inflation which is now a global phenomenon.

JIM: Yes. And we have discussed this over the years. One of the problems is you remember the inflation of the 70s, and we had Paul Volcker come in, he raised interest rates and brought inflation under control. But there was an event that took place in the 80s as the world was changing. The investment banks said, “look, instead of monetizing debt, which creates inflation, we'll just start tapping into the bond markets. And if you use existing savings to finance your debt, it's non-inflationary because you're using savings rather than printing money out of thin air.” And so a lot of the governments begian to go and tap the bond markets to finance their debt. This is a topic that Peter Warburton discussed in his book Debt and Delusion.

A second factor that was going on at the same time is the world began the movement towards globalization, and so we began to increase the amount of goods that were produced and as we know, the more goods you produced and especially as a company, you bring your costs down. And so there was sort of a disinflationary effect that was coming in as manufacturing expanded around the globe, and especially as manufacturing went to cheaper areas for production. It went to Mexico, went to Latin America and then eventually to Asia. And so during the late 80s and 90s, even though the money supply was growing faster than economic growth rates, the cost of the goods were coming down because the supply of goods were increasing. I mean it's basic economics. If you have more goods than there is demand, the price comes down. If you're manufacturing, the more goods you can produce, your fixed costs go down, your marginal costs go down and so the price of whatever you're making comes down. So this was offsetting, so inflation found an outlet. Remember, inflation can go into one or two areas. It can go into the economy in terms of real goods and services or it can go into the financial markets and that's exactly what we saw. We saw the inflation of the financial markets, that's where all of that excess money went. I mean all you have to do is take a look at the growth of M3 when we used to report it in the 90s and it was growing at 7 and 8% a year, the economy was growing at growing at 3% a year, that excess money creation went into the stock market giving us the stock market bubble. Well, in this decade, it went into the real estate market and the credit market gave us the bond market bubble and the real estate bubble. And I believe the bond market bubble is the next bubble that is going to burst. They keep talking about a commodity bubble. No. The real bubble out there is the bond market where you have negative real interest rates.

And so that is now beginning to reverse itself. You know, you've got labor costs going up in China, the dollar is going down, so import costs are going up. And as these governments, whether it's the US government, the Canadian government – I mean I have this money supply screen on my Bloomberg of money supply growth rates that are still double digits; and now it's starting to show up in the real world, John. And as these manufacturing centers which were once the source of a disinflationary trend (because they were increasing the supply of manufactured goods), now as their economies have grown, they are becoming mass consumers of commodities and you're seeing commodity prices rise and now those costs are starting to go up. And so if you take a look at a long term trend that we're seeing in the market, is we're starting to see inflation rise. I mean I don't care which country you're looking at – whether you're looking at China, you're looking at even Japan, you're looking at South Korea, you're looking at Australia, you're looking at Latin America, you're looking in the United States, this is a global phenomenon because there is nothing backing currencies. And you're also looking at a demographic trend where you have these increased social costs of pensions, Social Security, Medicare that are growing as the world's population ages in Western industrialized nations. And as a result of that, governments are not going to be able to keep up with the costs that they are incurring. And the only way out of it is going to be to start inflating which they are doing and to start monetizing.

Indeed, there was an editorial in the Wall Street Journal regarding the housing crisis and the credit crisis that were occurring and suggesting that the only way out now is to monetize. And I think you're going to see that in the next 12 to 18 months as government revenues go down, as the US government has more difficulty in financing its trade deficits and budget deficits –especially as sovereign wealth funds begin to diversify outside of treasuries. And so the trend of inflation is something that investors are going to have to reckon with and we're going to get into our topic in terms of “filtering the noise” of why your asset allocation for your investment portfolio needs to look much differently than the two-decade period that we went through in the 80s and the 90s where we were in a disinflationary trend. Take a look at where we are now. We're in an inflationary trend. And I've often referred to or quoted the historian David Hackett Fischer, when these great inflationary waves hit the world, it shows up first in housing, food and energy. And that's exactly what we're seeing unfold today. [42:37]

JOHN: But if we continue destroying the currencies – we'll say it that way – we talked about the middle class having to downsize, but here the middle class is also going to be trying to keep up in terms of its pensions, its retirement planning and other related issues as the currency becomes worth less and less and less, so they’re in a horrible squeeze here it would seem.

JIM: At the same time, you have the government trying to increase energy costs, increase inflation and also increase taxation. It's almost like back to the future. We're going back to the staginflationary era of the 1970s. Instead this time I think it's going to be much worse. [43:18]

JOHN: And you're listening to the Financial Sense Newshour at www.financialsense.com.

Filtering the Noise

JOHN: I just love in my pastime to get out and talk to people out in the real world and see what they are thinking about all sorts of issues – political issues, the elections, the economy, oil especially, that's a big topic of conversation. What happens a lot of times, Jim, when I do that is you begin asking, “what do you think about this, what do you think about that?” and you hear parroted back at you –they are not aware of the fact they are doing this – what comes out of the main line media, which as we both know tend to add a lot more confusion to this whole mess than actual information. The first prerequisite to solving a problem is to correctly identify what the problem is. But by the time you're done listening to a lot of the blather –or the noise which I think you would call it – the real issue is so confused that the general public are confused or they are making very bad decisions based on poor information. So what we want to do in this segment here is try to start stripping away some of the noise and look at the real causes of things.

And honestly, Jim, in the political process, a lot of the noise is deliberate. Now, that's not necessarily on Wall Street but elsewhere because of the fact that politicians follow a fundamental rule of thumb and that is “guard your own six.” In other words, they have to keep off loading responsibility for things that they have done on to someone else, and so as things get worse, they keep trying to off load the problem. And that's where making very sound decisions becomes very, very difficult. So let's see if we can peel back some skins on the numbers here.

JIM: Well, there were a couple of events this week. We had Fed Chairman Ben Bernanke giving a speech about the 70s. You had one speech he gave earlier where he was concerned about the dollar. And so a lot of people said, “aha, a strong dollar.” You had people like Larry, “King dollar,” etc. And there was this feeling well, the reason that commodity prices – and remember, when we deal with energy, they have given us excuse after excuse after excuse from the time oil went from $20 a barrel to 30, so it's always something else that rather than look at the fundamentals of what's going on, it's, like, “well, gosh, it's got to be speculators.” So the idea was, if the dollar got stronger, therefore people would dump their commodities and commodity prices would come down because the only reason that commodity prices are going up is speculators and the fact that the dollar has gone down. Well, you can't explain oil going from 20 dollars a barrel to almost 140 dollars a barrel based on speculators, weather or whatever excuse du jour that they come up with. And so there was a feeling earlier in the week that the Fed is going to be concerned about the dollar now, the futures market were pricing rate hikes coming as soon as November – I think that went away on Friday with the jump in the unemployment report. But there was a big selloff in oil, there was a big selloff in gold, you had a selloff in the natural resource stocks, and then everybody was saying, “we'll go into retail stocks because Wal-Mart reported better sales, the rebate checks are coming in and this is going to strengthen the economy.” So we have all of this background noise and we're telling people, “look, this is unreal, this is a bubble.”

But look where we were: We had the selloff in oil on Monday, Tuesday and Wednesday, and look what happened to oil on Thursday and Friday. And once again, if it's speculators, remember that for everybody going long a contract in oil, there is somebody on the other side of that trade that is going short. And unless the speculators are going to start taking delivery – then you can say they are speculating, they are taking delivery, they are holding oil off the market. But that's not what the case is. Because when your contract gets ready to expire, you get out of it or you roll it over, otherwise you're going to start taking delivery.

The other thing that they’re talking about is interest rates going up and “it's because the economy is getting stronger.” No. Interest rates are going to be going up because inflation is heading up, number one; 2), there is less demand for treasuries – and this gets back to the Alan Greenspan conundrum when the Fed was raising interest rates in 2004, why didn't long term rates come down? And that was the recycling of our trade deficit that was coming back through entities such as China, Japan or OPEC buying treasuries as they brought in all of this money that we were giving to them as our trade deficit rose as a result of larger imports.

And it's amazing there is a book that comes out every year. It's the CRB Commodity Yearbook and the year book for 2008 just got published and I would highly recommend if you want to understand the fundamentals going on in the commodity market you pick up a copy and read it. And now the 2008 Yearbook is basically dealing with 2007. But here are some simple statistics, John. In the year 2000, the US was producing 5,822,000 barrels of oil a day on average. We have gone from 2000, producing 5.8 million barrels a day rounded off, to the year 2007 when US production dropped to 5.1 million barrels a day. So since 2000, we have dropped by 700,000 barrels a day of production. During that same period of time, we have gone from 9 million barrels of imports of oil to over 10 million barrels to almost 12 million to almost 13 million barrels; and that doesn't count the nearly 4 million barrels we are now importing of refined products from diesel to gasoline to jet fuel.

And if you look at commodities such as corn, and you look at the corn production increasing and yet you're looking at, “wait a minute, we're increasing our production of corn yet the price is going up.” It's because there are other sources of demand. We are diverting now almost one third of our corn crop and we are now putting it into ethanol. And this week when the UN was meeting on rising food prices, you had the United States arguing that, “no, it's really not us, it's not us diverting a third of our crop into ethanol that's causing it.” They said it's only about a 3% increase, but it's the kind of information that's out there that you never see brought up in the debate. So people are saying, “my goodness, I go to the store. Somebody sent me an email this week that they are seeing that the packages of food are starting to get smaller.” You remember, that, John, from the 70s, how the candy bar package got smaller and yet the price went up. They are seeing less cereal and a box of cereal is getting smaller. So we are seeing these food prices going up and they are looking at everything to blame it on, and yet you just have this new farm bill (it ought to be called the pork bill). We are going to pay farmers at a time of rising food prices $30 billion to withhold planting crops. I mean most of the stuff – this goes back to what Ronald Reagan said when he was running for the presidency in 1980: Government isn't the solution, it's the problem. [51:04]

JOHN: If we relate what you just said back to the first hour of the program, where we were talking about major paradigm trends, mega trends are happening right here; and if we assume that you're right, this isn't a bubble, then that means these are long term permanent trends and what things are going to be as far as commodities –just like Tim Woods said in the first hour by the way. And that means there is a fundamental shift in how people invest and spend their money and budget and everything else related to that.

JIM: There have been a number of articles one in this week's Barron’s. It was an interview with PIMCO's co-chief executive, a gentleman by the name of El-Erian, and he's also written a new book by the way, When Markets Collide, and you had Mohamed El-Erian talking about “look, the world is changing and it's changing in many ways.” And he talked about four significant changes:

One is a real alignment in global growth. The big engine, the US consumer, is going by the way side and is getting exhausted and the new engines are coming on in the BRIC countries – mainly China, India, Brazil and Russia.

A second is the return of inflation. Now, he's looking at this from a Keynesian point of view, but basically, he's saying, “look, as countries go from being just producers to becoming consumers, there will be an upward pressure on commodity prices; and we're going from this world of disinflation to a world of inflationary pressure.”

Third, is he talked about as we globalize, as the markets expand, we're basically going through this structured finance despite the backlash that we're seeing here in the mortgage market, it's going to continue. Maybe it develops in the emerging market.

And then he talked about, fourth, the transfer of wealth as debtor countries now become creditor nations and what were formerly creditor nations –mainly referring to the United States – become debtor nations.

And so here he's talking about that these major changes in terms of what is transforming – in other words, he's saying, “Look, the world that we've lived in in the last three or four decades, that's changing. And it's in a process of changing until we're going to reach some kind of new equilibrium and a new kind of paradigm.” [53:21]

JOHN: If we're talking about looking at the world's largest manager of bond funds and at the same time assuming that inflation is a global phenomenon that's returning, and it's not going away at any time in the near future either, then theoretically, PIMCO itself should actually be revising the strategy of what it is going to do.

JIM: And he talked about this. In fact, in the Barron’s article, El-Erian is talking about a new portfolio, in other words a different allocation strategy. And I'm just going to go through this and I'm quoting from the Barron's article. His strategy for this new environment is only to have 15% in US stocks; 15% in advanced economy stocks; 12% in emerging economy stocks; and then 7% in sort of private equities, which is, you know, what you can do at a large institution.

Here is what is amazing. Under bonds, he's only recommending 5% in US bonds; 9% in international bonds. And then the rest of the strategy is in real assets. He's taking about 6% allocated to real estate, perhaps you invest in real estate globally; 11% in commodities; 5% in inflation-protected bonds; and another theme here that has been something that we have talked about – 5% in infrastructure.

John, this is totally a different kind of portfolio. We wouldn't be talking like this if this was 1980 or 1990, so roughly half the portfolio is in equities of only which 15% is in the US and the other 30-odd percent is either in developed economies such as Europe, Japan or emerging economies. Only 5% in US bonds.

And then he's talking about real assets because of inflation, real estate, commodities, inflation-backed bonds, infrastructure. And this is something that we've been talking about on the program here in terms of where the five areas – I mean we're going almost exclusively into this area – you know, we've talked about this over the years – energy, water, food, precious metals and then the fifth area that we've talked about is the infrastructure. As we mentioned earlier in the program, the EIA is talking about 45 trillion dollars invested in the energy sector, which is decaying; it's aging. Think of the implications for that for investments longer term. Probably almost a five to ten trillion dollar investment in water infrastructure. You're talking about massive amounts of investment that are going to be needed in mining.

I mean you've got people just in the mining sector alone, these big tires that they use on these big bulldozers and big dump trucks for moving ore, these giant tires are in short supply, so they are going back to the junk yards and the dumps and trying to put retreads on these tires because there is a shortage. And that is the story that is not being told here.

So once again, if you're looking out in terms of this paradigm shift, a different world, a different investment environment and if you aren't re-shaping your portfolio to that kind of environment, John, you're just going to see destruction in what’s going to happen to your wealth because inflation is going to destroy it, a lower dollar, you're going to lose purchasing power. And all of this is coming about at a time the largest retirement population in the history of this country is heading into retirement. So these conventional models that they've been telling people, if you go to these sites, “you're retired, put 60% of your portfolio in fixed income investments.” That is an allocation strategy that is designed to bring poverty into your retirement years because that's not the paradigm shift that's taking place; and that's not the investment environment that we're going to be dealing with as we go forward and especially as the crisis window begins. And it looks like this crisis window, John, is accelerating at even a more rapid pace than I ever would have thought of in the first week of the year. [57:40]

JOHN: It's amazing. It's picked up speed far more than I thought it would.

You're listening to the Financial Sense Newshour at www.financialsense.com. We have had so much response to the series we've done on the Crime of the Century and naked short selling, we're going to devote the better part of the next hour to an interview with attorney Wes Christian who is dealing with this, and hopefully that will respond, like I said, to all of the emails that we have pouring into us. And I think, Jim, if there is anything ever going to be done about this, it's going to be done from the ground up. I don't think it's going to happen from the top down, but we’ll see in the next hour.

You're listening to the Financial Sense Newshour at www.financialsense.com as the Big Picture continues.

Part 2

Crime of the Century, Part III: Stock Fraud with Wes Christian

[Bloomberg Phantom Shares]

The same conviction motivated Patrick Byrne to hire 6’6” John O’Quinn, one of the few attorneys in the country tall enough to look him in the eye; and by reputation, a giant killer. In Texas, they call O’Quinn the “Billion Dollar Man” because he won billion dollar judgments against makers of silicone breast implants and Fen-phen, and against Big Tobacco.
“The deal is rigged so bad I can make this statement safely: You have more chance to be treated fairly in a casino in Vegas than you do in the stock market. The securities industry has things rigged where they can deal from the bottom of the deck regarding your stock and your money.”
O’Quinn’s co-counsel is another Houston-based attorney, Wes Christian. Together they represent some 20 US companies that all claim damage from naked short selling, including Overstock, Sedona Corporation and Taser. They represent Overstock in a lawsuit seeking 3 ½ billion dollars in damages from Wall Street’s biggest prime brokers, accusing them of executing short sales with no intention of delivering stock, causing Overstock’s share price to drop. All of the accused have declined comment on pending litigation.
“If you’re a shortseller and you abide by all the rules governing short sales, then fine – it’s legitimate, it’s legal, it’s proper. That’s not what is going on on Wall Street. What’s going on on Wall Street in our cases –and we’re now seeing in many companies – is a rigged system.”

JIM: That was the Bloomberg special on naked short selling and of course one of the attorneys featured in that special was attorney Wes Christian, who joins me as a special guest this week.

Hi, Mr. Christian, glad to have you on the program. I really appreciate the work that your firm is doing for investors.

WES CHRISTIAN: Well, it’s been a long, hard road and there’s more work to be done. Let’s not forget that the fearless leader of this legal consortium is John O’Quinn, who is a dear friend and a colleague for many, many years. So actually, Mr. O’Quinn and I are the ones that started the consortium and that consortium, of course, has grown over the last seven-and-a-half years. [2:28]

JIM: What I’d like to do today – I want to talk about naked short selling, how it works and the crime that is inflicted on investors, you know, where you have shareholder meetings and you have more shares voted than exist and how this just is basically – in its rawest form – just stealing from investors. What can be done? Because apparently – I know the SEC is trying to do something but I think they’ve fallen far behind in my opinion.

WES CHRISTIAN: I concur. Let’s first talk about from my perspective the scope of the problem, how it works, and what I think could be done about it. And first, you should know, we filed our first case seven-and-a-half years ago. We now have about 15 cases in about 7 different states. We’d be up to get one to a jury trial yet because basically the defendants are very good at what they do; we’re fighting essentially every big Wall Street firm in New York. And secondly, unfortunately, because of Federal laws that were put in place in 1996, the Private Securities Litigation Reform Act, and other acts, it makes it very difficult to bring a case in federal court. Fortunately for us, we’ve been able to bring most of our cases in the last four or five years in state court, which ultimately we will get a jury trial.

Naked short selling actually takes many different forms. It really is in its basic form a form of lying, cheating and stealing. And if you look at it historically, you’ll see that the same very thing happened on and around the time of the Great Depression. There were bear raids led by many famous New Yorkers – New York families – who sold unlimited amounts of shares to unknowing purchasers, the result of which ultimately those companies failed likewise, because ultimately at the end of the day if you can sell an unlimited supply of any asset the price is going to go to zero. And that of course is the end game of the perpetrators of this crime and of this fraud. Naked short selling is about selling something you don’t own and you never intend to deliver. Essentially, under SEC rule 15(c) 6(1), it requires a three day settlement. Also, under Reg SHO which is rule 203(b), now brokers must go out and make a positive determination of the ability to borrow a real share before they short a share. That’s not occurring, hence the term ‘naked’ – that is, they didn’t have the requisite stock that they borrowed before they sold it. That’s where the term or phrase ‘naked short selling’ came from. Actually, because of some of our progress with the SEC, with state regulators, with federal prosecutors and others you’re going to see that this crime has expanded. Why? Because of Reg SHO, which even though I don’t like it in its present state, like you’d commented on, it’s better than nothing. And because of that, you’re going to see that most Wall Street firms have been fined now numerous times for marking shares long, when in fact they’re short. We’d call that a ‘disguised’ short versus a naked short – and that is, the little trading ticket says ‘long’ or ‘short’ proprietary sale, which is on their own behalf or agent, they’re marking them long. That again is another lie, similar to when they sell naked, they’re saying – they’re representing to the public they’re doing a legitimate sale. That is also a lie. Of course, buyers and people who look at their Level 2 screens and look at the ticker tape, so to speak, are relying on everything –that this information is disseminated into the market to be the truth; well, it is a lie.

There are many other rules such as 15(c) 33 that requires – that’s under the Securities and Exchange Act – that require that brokers possess the actual shares that they say they possess. In today’s form, an electronic delivery is the equivalent of a real share in the old days. As I’m sure you know, in the old days people would go down to Wall Street with physical shares – ‘runners’ they would call them – they would exchange those shares for cash or a money order or a cashier’s check or some form of payment and they would trade physical shares. Well, ultimately the size and volume of those shares became so large that brokers came up with a great idea at its inception to form the Depository Trust Corporation, referred to by acronym as the DTC. That’s a privately-owned corporation in New York – principally by the NYSE and the prime brokers. It for all intents and purposes is the national clearing firm for the entire world – and certainly for the United States. It trades about 30 trillion dollars of financial instruments a month and has admitted anywhere between 6 billion and 12 billion a day of fails in public statements, or other proceedings, that are failing to be delivered. So at the end of the day, what naked short selling in its various forms is really about is about a seller selling something it doesn’t own; it’s about a buyer not getting anything for his real or her real hard-earned money. So it’s just another form of stealing as you said, or cheating people out of their hard-earned money, when in fact they don’t own anything.

And the reason we know this is in many of our cases and frankly, separate from the litigation we’ve had the ability to figure out –through systems I will not talk about because it’s proprietary – that a brokerage firm X –I’m not going to mention any names – has printed out 12 million shares of the ABC company on account statements of its customers, but on the same day we go to the DTC and that same broker X only owns one million shares of the ABC company in total. And so we know there are 11 million shares out of balance which conceivably could occur if they had lent all those shares, but then we total all the firms and find out actually there’s 50 million more shares printed out on customer statements than exist in totality at the DTC. This is just one of the things that we’ve uncovered in our journey through this process. So that tells us that the remaining – the difference between the shares printed out on broker’s statements and the shares in totality at the DTC – represent counterfeit shares.

That of course causes numerous problems: one, it grossly distorted the supply on a given day that incidentally caused the price to drop significantly because any time supply outweighs demand the price goes down. Any economist will tell you that. Two, it distorts voting greatly as you alluded to earlier in the interview. Why? because during tough proxy battles and close votes, ultimately how does the corporate secretary know which votes to count. Is it the first 50 million that come in because that’s all the shares that the company has issued – even though 100 million shares have come in to vote, which we have actually had something substantially similar to that. It destroys corporate governance and again, has many other ramifications beyond that because when you used to own shares – when you thought you owned 5% of a company and now because twice the number of shares have been sold into the market – and equal amount of which are counterfeit – now you own two-and-a-half percent of the company. So what you thought you used to own even as a shareholder who owns real shares, you in fact have been involuntarily diluted by virtue of the counterfeit shares. [10:12]

JIM: Mr. Christian, say, for example, I decided I wanted to get a sophisticated Xerox machine and start printing money to pay my bills, because I can make – I mean just imagine that I can do that – that’s what counterfeit share people are doing – the government would be knocking on my doors, I’d be handcuffed and I’d be in prison. Why do you think they have not been more aggressive given the widescale abuse of this? It’s estimated – I forget what the figure is – that you just alluded to on a six billion dollars of failure-to-deliver on a daily basis. That’s a lot of money.

WES CHRISTIAN: It’s a lot of money. What the DTC will argue and others is that it’s miniscule compared to 30 trillion, but when you look at a six-sigma world that we live in banks are able to catch every check but one or two out of you know, hundreds of millions of shares. The technology is there to do it. The answer to your question is – and of course, this is all speculation on my part – is 1) the problem is so systemic and so large that if they were to truly do something about it on an accountable basis that the whole market would crash. Now, of course, I don’t have facts to support that – that’s just one possibility.

2) The government does not have the staff sufficient to go out and prosecute these people, who certainly – and being in this 7 ½ years and what I believe at least –our consortium is the ring leader at least of law firms that are doing this – it’s my belief that the SEC and the state regulatory agencies simply do not have the manpower to take this on because of the magnitude of it.

3) The demographics in this fraud have changed. This is very important to understand. Why? Because we’ve been to Lichtenstein, we’ve been to Bahamas, we’ve been to Bermuda, we’ve been to Cayman – we’ve looked at the registry of these offshore companies (which, incidentally, the offshore accounting is what brought down Enron, it’s what brought down WorldCom, it’s what brought down Parmalat) – that same central theme is at the very center of this fraud because there are multiple companies every day being set up by these perpetrators. In one of our cases, you know, they were setting them up –companies – a hundred at a time. Can you imagine? Okay, to perpetrate this fraud offshore – now that electronically you can do things and you can set up identities and domains almost anonymously in these offshore havens – you can move them around, you’re transient – if a group of shares that don’t exist are parked on the New York Stock Exchange, all you’ve got to do is move it to the London exchange and then to the German exchange and around.

And then of course by the time you do all that you’re broke or out of money or you don’t have the people et cetera. So the demographics have changed such that this has become an international fraud.

In fact, we have people from Great Britain and other countries – some of which I can’t mention – calling us to consult with them and some of our experts because on our team we have the best experts – consulting experts - because we’ve developed them over seven years – 7 ½ years – and because of that the international nature of this has made this almost so big that you almost have to figure out which segment of it are you going to take on. Which is kind of what we’ve done in our litigation strategy. You of course then have the private sector – that would be us and others – that are attempting to rectify it, but frankly it’s my belief that thousands and thousands of companies have had this fraud perpetrated on against them; but only probably less than a hundred at the end of the day will be prosecuted – of which we have only 15. And just that 15 costs tens of millions of dollars of cash and time to prosecute. You can see the task is so large that it possibly aids your understanding of how this could happen. [13:53]

JIM: The real issue here – the gatekeepers are the investment banks because if let’s say I’m a hedge fund, I call up and I have a relationship with in investment bank. I want to short ABC company. Now, if they loan it to me – okay, that’s legitimate, that’s okay. But what happens if I want to really drive the price down and I don’t have the shares and the investment bank allows me to continue shorting the shares. Isn’t one solution here is to go after the gatekeepers? Because when you boil it down, if the investment banks were really policing this, this couldn’t occur. So essentially these guys are the ones that are doing and causing this.

WES CHRISTIAN: Well, again it varies firm by firm, but let’s just talk about some of my beliefs. These are only my beliefs and I can’t talk about evidence to support it because a lot of that is protected by protective orders that certain courts have entered, so I’ll just tell you generically. We have a saying in Texas – the fox is in the hen house; well, the DTC, as it’s known, is a self-regulatory organization referred to by acronym as an SRO. What that means is they more or less regulate themselves and of course the SEC has supervisory oversight over them and a couple of other institutions in New York. But the point is they’re not subject to the normal things that a prime broker is subject to – even though the prime brokers own them. They have a stock loan program that their subsidiary the NSCC does, which for all intents and purposes is the national stock loan program for the United States. And that company was only acquired by the DTC in the late 90s. It is our belief that it was then that this problem began to accelerate at an incredible pace.

Before then, imagine the DTC is the keeper of the stock, they are the stock vault - just like the bank vault keeps the money. But then what happened is they set up the stock lending program. That stock lending program is something that most participants – as they call them – and you can learn all this on the DTC website – subscribe to and ultimately get to relend their customers’ shares. And incidentally, most of those customers don’t even know their shares are being lent because can you imagine, if you have a margin account (and now we’re finding even a cash account which is supposed to be prohibited) those shares are lent because in the fine print of the agreement – the account agreement you signed – it gives them the right to do so with respect to a margin account. Well, the only reason for all intents and purposes you would lend shares is to a shortseller, which incidentally is going to help make the very stock you bought to go up go down. So it really creates a conflict of interest between and the broker and you – that’s number one.

Number two, the DTC needs to be regulated by somebody else other than themselves because, indeed, with this new stock lending program it creates an enormous conflict as you pointed out, in my opinion. So between that and the fact that if you look at the financial statements of most prime brokers you’re going to see that the number one profit center for them – more or less, it depends on which year – is proprietary trading. It is our belief that Wall Street stood by and watched its hedge fund clients make lots of money out of this and ultimately decided to do it themselves.

Number two, they make an enormous amount of money out of stock lending – if you look at their financial statements. And then of course they make the standard brokerage commissions. But the big money is made from proprietary trading and stock lending.

Now, of course, some of that trading and lending is legitimate. Some of it, I believe, is illegitimate. And ultimately, that will be proved in a court of law and then I can say it is a fact. And that includes also something else we’ve learned in our journey which is bigger than the DTC problem and that’s called ex-clearing – that is where stock is traded firm to firm in big blocks between broker A and broker B outside the national clearing system. It’s referred to as ex-clearing. So we’re now finding ex-clearing is a bigger component of counterfeit shares than the DTC. [17:59]

JIM: You know, the amazing thing that I’ve seen – we saw the scandals on Wall Street with the Enron, the IPOs of the internet age, here we’re dealing four or five years later with all of this garbage debt that was sold to everybody as Triple A; and another thing that I’ve seen happen and I see this happening, not only just here in the United States but also in Canada, where you get a lot of these investment banks will finance companies and prior to the financing they’ll go in and naked short sell the stock, drive it down 30 and 40%, and then let their hedge fund buddies or themselves cover the short position with the financing. I mean how does this get solved when it’s so pervasive? You just said that the SEC is overwhelmed, they don’t have the staff. The government doesn’t have it and if they even were to try to rectify it they would probably collapse the market system if they forced these Wall Street firms – which are hemorrhaging from their mortgage debt – to cover their naked short positions. So what’s the solution here?

WES CHRISTIAN: It’s a great question. And of course I’m just speaking personally – first, the solution has to be there must be integrity in the market place. I want you to look at – and I don’t have the statistics in front of me because I didn’t anticipate this type of question but I can tell you the generic answer. Look at how many new IPOs have been done here versus abroad like in Great Britain or on other exchanges; look at the number of companies that are electing to not go public because of this environment; okay? What you are going to see is thousands – I mean in excess of five or six or seven thousand, I saw the other day; companies have evaporated from the NYSE, the national market’s NASDAQ and the small cap NASDAQ and the AMEX. There’s a reason for that. Some of those companies certainly would have failed anyway, but I believe a lot of what it is – certainly this fraud that is going on; and secondly, the general awareness of the vulnerability of a new start-up company, regardless of its capitalization – companies like Taser, other big companies with great products who become victim of this in my opinion. Why? because they only have 20 million, 50 million, 100 million shares. This fraud can’t be perpetrated against Microsoft; even organized crime doesn’t have that much money, which incidentally is involved in a lot of these cases. What ultimately I think the solution is first you have to make a conscious decision that you’re going to reinstill integrity into this market place. And to do that, at some level you have to make everybody settle up somehow. I don’t know – I mean much like the S&Ls would be a good example – maybe you have to underwrite debt with bonds to figure out a way to help these firms out of the whole. You remember the S&L crisis?

JIM: Sure.

WES CHRISTIAN: RTC, you know, et cetera. RTC, DTC kind of rings a bell. So the point is that ultimately that’s one way that that could happen in my opinion. So you have to reinstill integrity, you have ultimately make everybody settle up. And number three, you have to put real rules in place that have teeth. The existing Reg SHO, you know, has exemptions – still missing an uptick rule, still has a problem because it hasn’t dealt with this market maker exemption for options. Okay. Because what we’re seeing is the option markets are being used to further perpetrate the fraud, principally out of Chicago and of course other venues around the world. So you have to put teeth – and frankly, you’ve got to start putting some people in jail because as you said at the beginning of the program, if this was somebody printing 20 dollar bills in their garage they’d be in jail by Friday. But because it’s so complicated and it’s such an international nature and these firms are so big and so wealthy and have such great lawyers – frankly, the people on the bad guys side outman any government who wants to try to take them on and possibly some of the private sector, except on a case-by-case basis on select cases like we’re choosing to do in our business plan. So that’s what I think the solution is. [22:00]

JIM: Well, I agree. I think that you know, there was a case recently in Canada where a company – an investment bank – was caught naked short selling with one of its clients on a financing it was doing for the company. But they were fined $75,000. I mean that’s like, Mr. Christian, that’s like giving a bank robber a parking ticket.

WES CHRISTIAN: It really is. It’s the cost of doing business. I can send you a sheet if you want that shows every firm that’s been fined for mis-marking tickets and violating Reg SHO; they’re fined a million, two million, five million. Of course, I don’t know how many dollars - how many tens of millions or hundreds of millions they made off of that illegal undertaking, so it’s the cost of doing business. Okay. You’ve got to change that. You’ve got to put some people in jail, you’ve got to disgorge their ill-gotten gains, like you would any other crime, okay. You’ve got to sue them for racketeering which incidentally our consortium has now figured out a way to do that. You may have seen the Taser press release in Atlanta, Georgia, where we’re suing them under state law racketeering which is kind of a landmark case with actually the law firm there in Georgia, who wrote the racketeering statute, who agreed with us that this meets the requisite cause of action and predicate acts necessary to sue them for racketeering. So you’ve got to put some teeth in this. Until the perpetrators take this seriously, nothing is going to happen. And you hit it on the head – treating them in a token way is not going to work. [23:23]

JIM: It’s just amazing – this goes on not only in the United States, it’s going on in Canada. And it was interesting because there was a study done between the Canadian markets and markets overseas and over a 10-year period the Canadian markets for resources underperformed the overseas markets for the very reason that you were talking about, the naked short selling, this crime that’s being committed against investors. Does it take the population – I mean Senator Bennett from Utah recently gave a speech on how pervasive, how they move the naked short positions between themselves so they can cover it. Does it take people rising up, writing to their Congressmen? I mean, you know, politicians all want to get elected and if they hear enough from people and it becomes an issue and enough people have been defrauded, do they then pass a law like we did in the 30s where we created the SEC and we passed a series of legislation. I agree with you. I think you need to take the head of these investment banks that are involved in this and give them 10 years in prison like a Bernie Ebbers, or life, and all of a sudden you send a message to the rest of the community: Crime doesn’t pay.

WES CHRISTIAN: You do. And of course we’ve been blessed enough to be in maybe 10 or 12 financial articles: Forbes two or three times, BusinessWeek et cetera, - Mr. Quinn and/or myself. So that financial press has picked us up. What I have found in this 7 ½ year journey is there are a few brave souls like yourself and others who are willing really to go to the mat – people like Patrick Byrne of Overstock.com and others who are willing to carry the torch. But until the financial press gets behind this, which incidentally is going to be hard for them to do since Wall Street principally is their biggest advertising payor body for virtually every financial press, Wall Street Journal or otherwise. I don’t know how that happens. But clearly, if we could get a big enough grassroots following to get behind this, it would make a material difference because having the laws changed especially at the federal level, and the state level would change this. And then of course you have to have the people to prosecute it, which is a whole different set of problems.

But nonetheless, undoubtedly a grassroots group rising up to complain about this would help because at the base of this problem is that there are a lot of buyers out there who do not own the shares they think they own and the only reason that they don’t know that is because if you pick up the phone and ask the broker – that buyer, if you were to pick up the phone and ask his broker, “Can I sell my shares,” the broker would say, yes, because nobody has made a run on the stock bank. It’s no different than a cakewalk at church or synagogue that you used to go to. And if you remember, they had 12 chairs but there was 20 people walking around in a circle and everybody that sit down got a cake. But there’s going to be a lot of people left in this scenario at the end of the day that don’t get a cake. And unfortunately they paid their hard-earned money – that’s number one. Number two, a lot of people’s stock has been intentionally manipulated and sadly enough, a lot of that is by its own broker because the broker has been lending shares to shortsellers that do something with their stock, which is diametrically opposed to the reason for which they brought it to start with based on their own broker’s advice. You understand? [26:40]

JIM: There’s so much conflict of interest here, but you know, the sad thing about it is as you mentioned these are big boys, they’re well-capitalized, they have a fortune. I mean think of the fortune I could make if I could just print dollars to pay all my bills; I mean think of the lifestyle I could have.

WES CHRISTIAN: We see it sometimes in increments of 20, 30, 50 million – not 100 dollars or 20 dollars. We see these big block trades, you know, in other places –Chicago and other places – that we believe are just total naked, total unsubstantiated. But nonetheless it’s being done. And again, what you’re going to see is there is a lot of very interesting, colorful – and in some cases bad people in a lot of this – I refer you to go to a couple of operations called Operation Uptick – you can google that up – Operation Bermuda Short and others, and look at the people who have been involved in a lot of that. And of course that gets expanded over time to even larger companies. Look at the companies on Reg SHO. I think there are 5 or 600 companies on it today. A lot of those are NYSE companies – look at Fairfax financial, a great company that’s been on SHO for some time off and on; look at Overstock.com; look at Taser. I could go down the list, you know, of great companies that have this disease and the problem is once that cancer is in these companies you know, you’ve got to work to get it out because these guys don’t want to go away because they’re sitting on a huge contingent liability and they’ll do anything not to have that stock go up because as that stock goes up so does their contingent liability. [28:11]

JIM: But how does a company fight this? You know, they do this a lot with the smaller cap stocks. I see it done in Canada repeatedly with the small mining stocks; they even do it with the mining stocks listed on the AMEX and you know, biotech, technology. How does a company fight that because I mean it costs money to litigate or take these guys to task?

WES CHRISTIAN: Well, there’s several things – one you can go through your state regulator; who knows if that’ll help you. You can go to your federal regulator; who knows if that’ll help. You can certainly do some corporate governance items, some of which are proprietary to us and there are some other non-lawyer firms that do that type of thing, like share entail and others; but you can also initiate litigation; you can also essentially have a lot of your shareholders – depending on how closely held the stock is – take your share certificates out of the DTC, which you can still do, and hold them physically in your vaults. And of course that keeps them from getting lent. You can take them out of margin accounts and put them in cash accounts (although now we’re finding at least in some cases, actual cash account shares are being used to facilitate a loan or facilitate a failed delivery, which of course is absolutely prohibited because cash accounts are supposed to be segregated and kept safe). Unfortunately, that’s not occurring – at least at some firms – at some firms in some cases. So I think those are some things that you can do to try to focus in on the problems. [29:41]

JIM: What about the idea of class action. You take let’s say a small mining company that by itself doesn’t have the wherewithal to take on its own investment bankers or you know, these big firms that are profiting. But what if they grouped together as a class action lawsuit so that in numbers they can get bigger. So it’s not just one company against – you know, they’re taking on Goliath and they’re going to need something here bigger than a sling shot.

WES CHRISTIAN: Yeah, I’ll tell you we’ve looked at that. And again, this is just my opinion, like everything on this talk show. Number one, I think that’s going to be very difficult. Here’s why: 1) I don’t think you’ll get a class certified because each company is different; in order to become a class you have to have so much similarity that you can be treated equally so to speak. You could not combine multiple companies in my opinion in a class, that’s number one.

Number two, most class actions now because of how the law has changed during the Bush administration has ultimately made it extremely difficult to file class actions except in federal court.

Number three, in securities cases because of some recent cases by the Supreme Court, it’s very difficult to file a private cause of action for securities fraud under federal law because you are pleading standards – that is, the specificity by which you have to plead it is so high that frankly it’s become grossly unfair to private citizens because unless you’re the government and can go in and get the evidence in advance it’s been very difficult. Unfortunately, that’s the result of this Private Securities Litigation Reform Act which was passed in 1996 by Wall Street, who of course I guess saw this coming – or didn’t. But nonetheless, have inherited something that’s very beneficial to them because essentially you’re wrists are tied until ultimately you get past the motion to dismiss which could take years. And we have a case in New York – I’m not going to mention it – where they’ve actually filed a criminal complaint against some of the defendants. The defendants have actually paid a million dollar fine. There’s a criminal in flight in that case, there have been other indictments that have come out of that case and the court originally ruled in our favor that we could proceed to trial. They denied the motions to dismiss. The defendants moved to reconsider that motion and here we are four-and-a-half years after that case was filed and I still haven’t been able to take one deposition or get one piece of paper as discovery. [32:01]

JIM: Let me give you a hypothetical. Let’s say that I’m a mining company, I hire an investment banker to raise money. Let’s suppose that I find through trading records on Level 2 that this investment bank now begins to short sell my stock. They’re the largest shortseller. Then, let’s say, following that, our stock goes on a naked short position for three months. All of that is documented. Wouldn't that be a strong case if you could prove that they did that?

WES CHRISTIAN: It would be, assuming those defendants could pay and were subject to process here in the United States. The SEC – and I take my hat off to them in this regard – has actually prosecuted several cases exactly like that involving Societe Generale who you know is a big French bank, involving other people. I have that in a file if you need that. But there have been about 6 to 10 very good prosecutions and the SEC has taken the position that that violates many laws, but the two most important are 1) the sale of unregistered securities – by that I mean these short sales that firm executed and sold before the ‘pike’ was done as we call it –is the sale of unregistered securities – which incidentally is not a private cause of action I could bring, that’s something the SEC and other regulatory agencies could bring; 2) it’s fraud because in most of those cases the investment banker told the company “we love your company, we want to invest long term,” not knowing that at the same time that same company or its affiliate was offshore selling short. That’s what we call fraud. That is they told you something, you relied on it, they lied and you were damaged by it. That’s fraud.

So ultimately the SEC has prosecuted several of those cases, all of which to my knowledge have resulted in guilty pleas – or not guilty pleas, they’ve resulted in settlements; you know, the defendant didn’t admit or deny anything but nonetheless paid a lot of money. [33:56]

JIM: Let’s say a Canadian investment bank but it involves a company that’s listed both on the Toronto and the American Exchange. So wouldn't they be subject to the SEC rules if there’s a US listing?

WES CHRISTIAN: Certainly with respect to trades on the AMEX they would. The law did change several years ago to where even if a broker from Canada trades with a broker in the United States, ultimately the broker in the United States becomes responsible for the Canadian brokerage firm’s compliance with US rules – or certain exchange rules and US rules. So the answer is probably yes, but again, you’d have to look at the specific case in order to determine that. [34:34]

JIM: Well, listen, I'd definitely like to talk to you in the future and we’re going to continue to broadcast – we’re calling it Crime of the Century because it’s become so flagrant and abusive it’s a crime. Mr. Christian, we know we have a lot of companies listening to the show, if you have a website or a contact that people can get in touch with you.

WES CHRISTIAN: Certainly. We have a website. It’s www.csj-law.com.

JIM: Well, let’s definitely talk in the future.

WES CHRISTIAN: Sounds good. Thank you. Enjoyed being on the show. [35:15]

JOHN: Just to reiterate here, that was an interview here with Wes Christian that we – as our guest and we were talking about the subject naked short selling. I’m sure most of our listeners have figured that out right now. He’s part of a law firm with John O’Quinn dealing with the fraud of these issues now – some of the first legal cases that have been brought in this whole issue. And as far as our program here, Jim, we have not seen more response since the day a few years back when we did some stuff on global warming and all of the emails that we received in that area.

JIM: I was absolutely floored when we did Part 1 which was with Eric King a couple of weeks ago. But John, we have been literally flooded. They now have blog sites that are tracking this. This is really hitting an issue here because I think people are saying, “you know, now I understand what is going on with my junior mining stocks. I couldn’t figure it out, I could not understand when a company increased its reserves or reported just incredible drill results, why this stock would sell down.”

So what we’re going to do is continue with that discussion. Next week we’re going to talk about legal issues that companies can use and strategy to protect themselves when their investment bankers start carpet bombing and shorting their stock ahead of a financing and diluting a company; and also what investors can do to protect themselves if they’re investing in this sector. So we’re going to continue this next week with Part IV.

I’m just absolutely amazed. In fact, once again we are putting up on a link on our website, the complaint section at the SEC and also with the Canadian investment authorities, how you can file your complaints. And we’re also going to be listening to a clip here with Christopher Cox who’s head of the SEC currently and this was in a testimony in a hearing that they had on naked short selling where they’re talking about revising the standards, proceeding with criminal prosecution and also increasing the size of the fine. I mean it’s a first step, but you know what, the first step is taken. A lot of people are saying, “Well, what can I do?” Well, you can make a difference here by turning in and filing a complaint when you see these kinds of activities. Last week we talked about the seven different methods that these investment banks and their hedge funds used to manipulate stock prices and it was amazing because I must have got 10 calls from mining companies; one gentleman mentioned three of the techniques. He goes, “This has happened to us and they were all involved with the financing.” [37:51]

JOHN: When we were talking last week about the seven cardinal sins in investing, they’re all there, they’re all important, but what about predominance or frequency of them. Are some happening more than other – more endemic?

JIM: Of the seven different techniques that we talked about last week there are probably three or four that probably stand out and investors in mining stocks will recognize these when I talk about them. One – and this applies in particular to companies that are getting ready to hire an investment bank to finance them – is what I call the carpet bomb; and that’s where they will come out of the blue, usually for no reason, the stock is trading 20, 30, 40, 50 thousand shares and all of a sudden, in one day, you’ll see 500, 600 thousand shares, 800 thousand shares, come into the market in heavy selling. I call that carpet bombing. That is usually a shortselling raid on your stock and what that is, that is kind of like the opening salvo in a war that they’re going to begin operations to crush the value of your stock before they do the financing; and the carpet bombing technique is very noticeable. It always involves short selling and when they can’t drive it far enough, what they can’t do in short selling, is immediately they begin naked short selling your stock and so you’ll eventually see that the stock will show up on the naked short list. And that’s usually a prelude to a financing. So that’s something you see quite commonly with financing. [39:26]

JOHN: Wes Christian pointed out in the interview is a lot of times they used offshore accounts to place all of these trades and then they collude with each other, so you actually have a conspiracy level going on here to begin moving all of this around and make it work for everybody.

JIM: Yeah, this is actually another level of fraud that’s being perpetrated; and they do it through offshore accounts. It’s one of the ways they keep a lot of these naked shorts off the books. It’s another way that they move around – last week we presented the speech given on the Senate floor from Senator Bennett from Utah where he talked about when you short sell a stock, you’ve got 13 days to come up with the shares. Well, let’s say after that it shows up as a failure to deliver so it’s reported as a naked short sale. One of the ways that you can do this is they play musical chairs; they’ll call up one of their buddies in the conspiracy and they’ll say, “hey, I’m on the hook here for a naked short sell, can you loan me some shares?” And so what they’ll do is one of their conspirators will give them shares and then what’ll happen is that way you don’t have to report the naked short sale, or you go off the books on a naked short sale. But then the other firm is naked short, so they’ve got 13 days – and you can just keep moving this around and around. I mean there are billions of shares that are now offshore in these offshore accounts where they can keep it hidden from the authorities and it’s amazing how they do this.

And it’s like Christian said, this crime has gotten so big it has almost overwhelmed the markets. It’s overwhelming the markets here, it’s overwhelming the markets in Canada and they’re all in the act. And once again, you’ll hear – as we heard last week from Harvey Pitt, former SEC Chairman – and then you’re going to hear today from Chris Cox, the new SEC Chairman – how they’re now taking steps…but John, you know, it’s just like Christian said, it’s not until you put these guys in prison – send them to prison like they did with Andrew Fastow from Enron or Bernie Ebbers from WorldCom. It’s not till these guys get life imprisonment and the fines become prohibitive – and we’re going to have some solutions for that next week and maybe some suggestions. But I would say the carpet bomb prior to short selling is something you see commonly.

Some other techniques that we see almost commonly is you always have to watch these stocks on a Friday just before the market closes because they will come in and try to do a raid on the stock and probably the one that I almost see on a daily basis, you see these two, is the end-of-the-day drop-down: there’s two minutes of trading at the end of the day or even 30 seconds and if there are not bids below where the stock is trading they’ll actually do an in-house trade between themselves and knock the stock down a couple of pennies; and I see it across the board almost on a daily basis. It’s one of their common techniques; it’s really telling you that they’re short the stock and they’re trying to actually do harm by scaring investors out.

And then another favorite that you also see is the stock is moving up, maybe the price of gold is up 30 bucks, and then all of a sudden they start putting these whopper bids that are way out of proportion to the trading in the stock. And listeners know that is done to manipulate the price of the stock. Whenever you see the show out there trying to scare you because that’s not the way institutions sell stock; they don’t go out and crush a stock and put large offers to scare buyers away. So it’s done with the intention of defrauding the investor. [43:07]

JOHN: Something that we really need to stress here is that if you have a margin account say especially with Canadian types of stocks, then your broker may be using your margin account against your best interests. They’re actually working you against them and they intend to come out on top on this.

JIM: Oh, absolutely. One thing – if you have a brokerage account and it’s on margin you are aiding and abetting the investment banks and the hedge funds who are working to short and manipulate the price of the stocks. So one of the first things that you can do is get rid of your margin account. Just close it out and move it over into a cash account. But even, once again, we find that these crooks are even using cash accounts to actually loan out your shares. And a second method would actually to be to take delivery of your stock certificates. So those are two methods.

But closing out your margin account would be your first approach or line of attack against this. And if you have a margin account and you’re invested in Canadian juniors, just understand you’re working against yourself and you’re allowing your broker to loan out your shares to the people that are doing the very things that are self-destructive and working against your interests. So that’s one thing that you can do. [44:25]

JOHN: Well, as people begin to talk about this, Jim, and I think this is the only thing that is going to actually push it in this direction – as people begin to talk about this, then at some point or another the regulators are going to have to notice. In other words, if something blows up it’s going to be really hard on the regulators to say we didn’t know about it because there are going to be a lot of people coming in and saying, “oh, yes you did! And here’s when we told you about it!”

And as that happens, then look at what happened to Enron – and this is typically what goes on in politics – is suddenly the SEC, or whoever it is, comes to life and they have to make it look like “we’re doing our job to make your trading safer and safer” and then they’ll do a couple of high profile prosecutions – and at least that puts word out on the street when they get some convictions. I mean look at Martha Stewart – why did that happen? Well, because of Enron they started to need convictions, and so a number of people were prosecuted and convicted and that tends to put the message out that this may not be something you want to engage in. But until that happens it will most likely go on because it’s not going to come from the top down; the foxes are in the hen house – that’s what we have right here.

JIM: Yeah. You heard Wes Christian talking about taking the supervision of the DTC away from the foxes themselves, which are the large investment banks. And it needs to happen on both sides. In fact, there’s a movement to start coordinating the securities laws of Canada and the US. There are hearings going on on doing that. I mean Canada has a big catch up to do in terms of what’s allowed there and it’s coming.

But a lot of people say, “What can we do?” Well, we’re going to put up links to file complaints with the SEC and the Canadian authorities because you’re going to hear a clip here in just a moment from March of this year, the current chairman of the SEC, Chris Cox. They’re having hearings and they’re going to start passing some regulation – they’re going to start upping the ante for committing this criminal fraud against investors. And they did it –as you’ll hear Cox say – they got 400 complaints. Well, imagine if they got 10,000 complaints what would they say? And unfortunately, that’s what it’s going to take.

And so once again, we have the Canadian regulators – if you want to file a complaint. And a lot of people say, “Gosh, it’s just me. They won’t do anything.” Well, believe me, if they start seeing this happen on a daily basis, a weekly basis, thousands upon thousands of people, you know what, that’s what it’s going to take. You’ve got to start a movement and you’ve got to continue because people say, “well, I’m not going to do anything. What difference does it make what I do?” Well, you know what, you can make a difference. You can close out your margin accounts so you don’t give the enemy the chance to use your shares against you. You can file complaints when you see this kind of activity.

And more importantly, if you’ve done your homework and you’ve done your fundamentals, don’t fall prey to their crimes because one of the things they’re going to do is when they’re trying to short sell, knock this stock down, what they’re trying to do is scare you out of your investment. And so if you panic because they carpet bomb your stock, or at the end of the day the company announces fantastic drill results, they increase their resources and you go out and panic and sell your shares, you are doing exactly what they want you to do. They want to scare you because, remember, they’ve committed a crime and what they want to do is they’ve shorted this stock – they’ve naked shorted it and one way that they can cover is if they scare you out of your position and you sell the shares, then they can cover; and you’re aiding and abetting them in their crimes. So, holding your position. In fact, as we mentioned last week, one advantage is force them to sell to you at a lower price and just take the shares from them. Add to your position; don’t go in all at once. And so collectively when individuals take action and they hear enough from you, they will do something about it because if they know that this has become such a big issue – it’s gotten so big – you heard Wes Christian, if they were to force the investment bankers to come clean on this, it would create a financial crisis that would be biblical in proportion. And that’s what they’re afraid of.

But you heard Christian saying that maybe what they’re going to have to do is maybe create some kind of lending facility so that these people can come clean. But I would say that, you know, what you need to do is you need to put a couple of these people behind bars and shut a few of them down; disbar the brokers from the business. There are all kinds of things that you can do, but you have to start somewhere and the way to start this is they need to hear from investors. And it’s only when they hear from investors that they take action.

In the internet IPOs where they were committing these crimes, when companies were cooking their books, it wasn’t until the NASDAQ lost all this value, investors lost trillions of dollars did the authorities come in and start investigating these companies and putting some of them behind bars. And it’s only when that kind of an event happens that they take action. And so don’t believe that you can’t do anything. You can close out your margin account; you can write to the authorities; and more importantly, don’t aid and abet the criminals when they’re trying to short and carpet bomb your stock and drive the share price down and get you to panic and sell the shares so they can cover because what you’re doing is playing on their field and they’re going to win that game. [50:05]

JOHN: Jim, as we go out here in this segment of the program, we’re going to run a clip from the current chairman of the Securities and Exchange Commission, Christopher Cox. This was on an April 8th press conference that he had talking about their intention of dealing with the naked short selling issue.

As the staff are coming to the table, we’ll begin on the next item on our agenda which is a recommendation from the division of trading and markets.
This recommendation, if we adopt it today, will put in place a new anti-fraud rule, specifically aimed at the abusive and manipulative practice called naked short selling. A half century ago, securities trading required legions of messengers who scurried about lower Manhattan with parcels filled with stock certificates and checks. And in those days the New York Stock Exchange would have to close for part of each week to catch up with the paper work.
Today, paper has largely been replaced with electronic data and that’s a very good thing. It’s allowed trading volume on the nation’s securities exchanges to rise exponentially, and it’s helped to drive down the cost of trading for individual investors for a small fraction of what they had to pay in the old days. But it’s also given rise to new opportunities for fraud. In particular, today’s elaborate system of electronic net settlement has enabled a particularly pernicious form of fraud called naked short selling.
In a garden variety short sale, the operation of the market is a powerful discipline on the shortseller because he or she can experience unlimited losses if the stock’s price rises. But that potential for loss and hence the discipline the market exerts on shortsellers disappears if the shortseller doesn’t cover the sale as required. Legal shortsellers have to borrow the shares that they sell. Illegal naked short sellers don’t bother with that part. They sell shares of stock that they haven’t borrowed and that they have no intention of borrowing. In some cases they sell shares that don’t even exist. Illegal naked short selling is an especially serious threat to smaller, public companies whose relatively thin market capitalization can be more easily manipulated. And in the same way, it threatens the savings and investments of many retail investors in these small companies.
There are many legitimate reasons why a trade might fail to settle. But the extreme abuses that are reflected in securities being chronically listed on Reg SHO’s threshold security list for months or years at a time is ample evidence that there is also fraud in the market that needs to be arrested. Periodically, there are reports that following a legitimate purchase of 100% of the outstanding shares of a micro-cap company, millions of phantom shares continue to be traded by naked short sellers. Reg SHO has done a good job of making the data surrounding these issues public and bringing the problems to the attention of companies and investors as well as the SEC and our fellow investors. But identifying market manipulation isn’t enough. Manipulating the price of a security is a serious fraud and the SEC can investigate it and punish it. Reg SHO needs teeth and this recommendation is aimed at providing them.
It shouldn’t be enough that an illegal naked short seller can break the law a little bit, and then when he breaks it a lot all that’s required is that he covers the short which the law and the seller’s contract would have required in any event. That’s particularly true since the manipulative activity in these cases is aimed at driving down a stock’s price, which gives the naked shortseller the opportunity to cover at an undeservedly low price. Reg SHO has accomplished a good deal, but our experience has shown that Reg SHO can’t be effective without enforcement. The Commission’s Office of Investor Education and Advocacy has received more than 400 investor complaints related to short selling of this kind in just this last year. The Commission continues to hear from business leaders and policy leaders on this issue as well because of the injury that this kind of fraud inflicts on investors, on companies and on our economy. It’s been four years since the Commission adopted Reg SHO, requiring that shortsellers locate securities before selling them short, and imposing order marking and closeout requirements was an important step forward.
But it was not enough. We found for example that the grandfather exception to Reg SHO created a significant gap in Reg SHO’s application. It accepted fails to deliver that occurred before Reg SHO’s effective date or before security was added to Reg SHO’s threshold list. And so last year we closed that loophole. The Commission also voted last year to repropose an amendment to Reg SHO that would narrow Reg SHO’s options market maker exception. The market maker exception applies to fails resulting from short sales made to hedge positions that were created before an underlying security was added to Reg SHO’s threshold list. In this regard, the Commission is currently considering more than 350 comment letters that we’ve received on the proposed changes to the options market maker exception.
The Commission is also carefully analyzing data related to the impact that this exception has on investors and on the markets. At the same time, the Commission also is in the process of analyzing preliminary data to examine the impact of the elimination of the grandfather exception on the level of fails to deliver.
While we’re speaking of data in this area, I should to point out that this past December the Commission began publishing monthly aggregate fails to deliver data on our website at www.sec.gov. The Commission is updating this data quarterly. The availability of this information should help inform public debate on this important issue.
Today’s proposal to craft a specifically tailored anti-fraud rule to the abusive practice of illegal naked short selling is an important next step in the battle to end behavior that is corrosive both to the rule of law and the trust that market participants necessarily place in one another. Abusive naked short selling saps the confidence of investors and issuers who depend upon our markets to value securities in a fair, efficient and orderly way. Reports of this type of abusive conduct is already receiving increasing scrutiny from our division of enforcement. Within the past year the Commission has sued naked shortsellers who were deliberately misrepresenting to broker-dealers that they obtained a legitimate ‘locate’ source and their orders were long. And we’ve charged sellers who misrepresented that their sales were long in order to circumvent the provisions of the Commission’s Regulation M.
Today’s proposal would add to the Commission’s enforcement arsenal a new anti-fraud rule, rule 10(b)21, squarely aimed at naked short selling. It would include within its ambit broker-dealers acting for their own accounts. A person will be found in violation of rule 10(b)21 if they do the following two things:
First, deceive a purchaser, broker-dealer or certain others about their intention or ability to deliver securities in time for settlement; and second, fail to deliver those securities by the settlement date.
Among other things, rule 10(b)21 would target naked shortsellers who deceive their broker-dealers about their source of shares that may be borrowed for purposes of complying with Reg SHO’s locate requirement.
The proposed rule would also apply to sellers who misrepresent to their broker-dealers that they own the shares being sold. Importantly, proposed rule 10(b)21 is firmly grounded in the Commission’s anti-fraud authority under section 10(b) of the Exchange Act. That means that a finding of scienter will be required to establish a violation under the rule. That’s an important element to note because legitimate shortselling offers our markets many benefits in the way facilitating liquidity, managing risk and promoting pricing efficiency. Today’s proposal is in no way intended to discourage any of that very healthy market activity. The Commission intends this proposed rule change to provide further detail on the Commission’s views regarding the types of abusive conduct in this area that constitutes fraud. Proposed rule 10(b)21 also would help to streamline the Commission’s prosecution of these kinds of abuses.
Additionally, this rule would underscore for market participants in this area the continuing importance of having policies and procedures in place to protect themselves and the markets from the irreparable damage that can be caused by fraudsters operating in this area.
Finally, this rule proposal will put market participants on notice that the Commission’s division of enforcement will remain vigilant in stamping out abuses in this area. And as is the case with all egregious violations of the Federal securities laws, the Commission will be prepared to make criminal referrals in this area where appropriate. [59:28]

JOHN: Next week we’ll do Part 4 of the Crime of the Century, right here at www.financialsense.com.

Part 3

Q-Calls

JOHN: And now time to go to the Q-lines. Before we do, we have a couple of messages that are important for people who have been listening to Q-lines over the last couple of weeks. First of all, for those of you who do not like Jim's theory, his Oreo theory, Kellogg’s has announced that Hydrox cookies will be back on the market by August of this year. So everybody breathe a sigh of relief. You can have your Hydrox cookie theory of where the economy is going. That's very important.

Also a week ago, I said on the program, Jim, that when I was in college in San Francisco, I still have a receipt here from when I filled up my gas tank for $2.50 at a gas station at the top of Portola Drive. It comes up from Market Street and goes down to 19th avenue on the way to San Francisco State. Eric in San Francisco emailed me that gas station is still there and there is another one now too. “I should take a picture of the price board and send it to you to clip onto your old receipt.” So there we go. Okay. Radio show, what are we doing? Q-lines!

Q-lines are open 24 hours a day to take your questions and comments. Please keep them short. We just can't use long comments anymore. We have too many people here. The toll free number for the US and Canada is 800-794-6480. It does work from the rest of the world. It's only toll free from the US and Canada however. And as we answer your questions, because we don't know a lot about you, remember that radio show content is for information and educational purposes only and should not be considered as a solicitation or offer to purchase or sell securities.

And our responses to your inquiries are based on the personal opinions of James Puplava and do not take into account because we do not know a lot about you, your suitability, objectives or risk tolerance. And since it's generic responses to your questions, Financial Sense Newshour is not liable to anyone for financial losses that result from investing in companies profiled here or other information provided to you. And besides, Jim may not be of sound mind and body and we haven't had psychologists to come in this month and give his normal check up and see whether he's competent in these whole things. And anyone that would call it an Oreo theory and not a Hydrox theory, Jim, is not in his right mind. I think Hydrox are much better than Oreo.

Hey, this is Michael from Vancouver. Jim, do you think it's a good time to start buying Asian country ETFs such as FXI (Xinhua). That gives me exposure to emerging markets in Asia like China, India. I would like to hear your comment.

JIM: You know, Michael, I would be leery of some of the emerging markets, especially of India; one market in Asia, that looks attractive is Vietnam. You might want to look over on Brazil’s side. If there is one super power when it comes to natural resources, I love the area of Brazil. There are a lot of companies out there, and you can probably buy an ETF that invests in that country. [3:00]

This is a contrarian thinker from Washington. Jim, I'd be interested in your take on a sector that has been languishing all year that nobody in your program has been talking about that and nobody seems interested in and that is health care. Also, a comment for Richard, formerly from Argentina: Now that you're in New Hampshire, I think it's time to drop the Spanish and just stick with English only.

JOHN: Well, I think you're going to be surprised, but I think you'll find Ricardo back in Argentina again, so lo siento, senor, but I think he's going to continue doing his little boiler plate there. Besides, I don't know if you knew this or not, but when Franco came to power in Spain, he prohibited the speaking of Catalan. That's another dialect that's related to Spain and it was an imprisonable offense. Franco is dead and people are still speaking Catalan today.

JIM: Let's get back to contrarian thinker. You know, you are bringing up an issue on health care. In fact, I'd highly recommend you pick up a copy of the current issue of Fortune magazine. One of the top analysts in the health care sector has now gone off on his own, and he’s started his own hedge fund to invest in this very sector simply because the bargains – the cash flow of these companies are looking remarkable and at the same time, not only are you buying their earnings at low PE multiples, but the cash flows from these companies are incredible. You're investing in a company that takes four or five cents to make a pill that sells for 4 dollars, so I love the health care. There are some very attractive companies in the sector that have very attractive dividends and a history of increasing those dividends. Pick up the Fortune magazine article which agrees with what you're saying. [4:44]

Hola, Jim and John. This is Jonathan from New York. Jim, I'm calling on Thursday May 29th. I wanted to checkup on the Oreo theory. Based on that scenario, we should be experiencing the creamy filling by now. However, the recent market action is not adhering to that theory. The price of oil has skyrocketed and it's having a major impact on consumer budgets. Food prices are very high and impacting consumer budgets. Pundits are declaring that we've seen the bottom of the financial mess, yet home prices are continuing to fall which extract value from consumers’ portfolios. Indeed, I recently read that due to resets, foreclosures may climb in the third and fourth quarter. In addition, the banking situation is still a mess with no sign of transparency. It seems that we continue to require large doses of Maalox, rather than the calming effect of milk with our Oreos. While there is indeed money sitting on the side lines, are you still comfortable with the Oreo theory timing?

JIM: You know, Jonathan, I think I'm still comfortable with the creamy filling. I think what you could see here as oil prices go up to 150 then pull back, selloff, and you're going to get a rally in the market. But I don't think it's going to be as creamy as originally thought. When I put forth that forecast at the beginning of the year, I was thinking of $125 oil – but I was thinking of $125 oil by the end of the year. And here we are on this Friday we're almost looking at 140, so the tremendous jump in the price of oil is obviously impacting some of what I expected on the creamy filling. There is going to be a creamy filling. It's just not going to be as creamy as I originally thought. [6:17]

Hello, Jim and John this is Bruce from Connecticut. A question about the gold market and yet another jaw dropping instance of an overnight attack on the gold futures. In this case, the smaller mini gold contract traded on the electronic CBOT (the Chicago board of trade.) This week, I don't know if you noticed, early Wednesday morning at 4:18 a.m. EST, the mini gold contract thereby lost 58 points – over 7% – in a matter of a few seconds, plunging from 901 down to 843 in a blink of an eye. I looked at the one minute bar at 4:18 a.m. and the up volume there was 23 contracts with the down volume being 274 contracts. Gradually over the next six minutes, the contract did manage to claw its way back up to 895, thereby nearly unchanged over a span of less than 10 minutes. Well, this is truly remarkable. Obviously a small trader holding the position overnight with stops may or may not be affected and thankfully I wasn't holding a position at the time. Well, who is responsible for this and why is it done? I also noticed the regular gold contract didn't get hit like this at all nor did silver. Thanks for any comments on this and you provide a wonderful service to all of us.

JIM: You know, there is something that Bill Murphy has talked about on the P.M. fix where they are always – you know, you may see gold up overseas but then they hammer it in the morning over here, and it's part of trying to keep the price of gold down here. And it's done – a lot of the bullion trading desks are behind this; and then what also happens is when it comes down very quickly like that, I just think you have just a lot of demand that's coming into the market, so is it quickly overwhelms the attempts to short sell t and bring it down because when it dropped down as much as it did, buyers came into the market. [8:06]

This is Tom from Southfield. I don't understand why you're so worried about the CBSs, CDOs. Most of these are over-the-counter contracts and as you've been saying week after week, nobody would buy these things. People could declare bankruptcy and have a judge modify the terms of payment on a contract, or are you maybe more callous, like Leona Helmsly, where only homeowners and people with student loans, people with credit cards have to be debt-payers forever, while all these hedge fund managers can keep their bonuses while running their companies aground declaring bankruptcy, having all of the contracts they’ve ever written and all of their debts cancelled. So as long as you're a rich wealthy fat cat, you get to keep your house, your sail boat and everything, but if you're one of the little people, “oh, we have to have the power of government force you to keep your contract forever.” So is that really what you intend or should we also hold the Wall Street to the same level of accountability for their debts as homeowners and students and whomever? That's my question.

JOHN: Well, I'm not sure where this gentleman is coming from, Jim, but I remember –Remember when they revamped the bankruptcy law a few years back right here on the program, we made – I remember doing this specifically – a number of times that this was a bad thing for the little guy –exactly the person he's talking about that, the one holding mortgage debt, college debt, credit card debt – that they were actually blocking off the safety valve here as we were going to go into the perfect financial storm. And we said that was a very, very bad thing. Especially considering the fact that for the last few weeks here on the program, we've been talking about naked short selling and how people who engage in this fraud, which affects the little investor should be prosecuted and should not be allowed to get away with this.

JIM: No. I don't follow that at all and these guys have been taking tremendous losses and you have a firm like Bear Stearns who after a history of Wall Street of over 80 years is now out of business. So Tom, I don't know where you're coming out with this because that's not what we've been saying here. [10:09]

Hi. It's Don in the UK. Great show. I was just wondering what your thoughts were on the UK. We’ve just had leveraged ETFs coming out which track gold and silver and precious metals that go up twice as much as the actual market. And I just wonder what your thoughts were on these, whether that means not to buy any junior stocks and just concentrate on the ETFs?

JIM: You know, Don, I'm not a big proponent of leverage unless you have plenty of cash reserves to match margin calls and then also if you're a very technically confident trader because when you're talking about that adding a leverage to the equation and especially as you can see gold move here very quickly both up and down. I mean on this Friday, we saw gold prices up almost $30. So I'm not in favor of using leverage. If you're using an ETF of gold stocks, I would go unleveraged because if you think the markets are volatile, you add leverage to the equation and you could you suffer some dramatic losses if you're not very sharp on your, let's say, technical trading. [11:16]

Hola, Jim and John, this is Richard calling in Buenos Aries, Argentina. Jim, you mentioned that you could buy gold in the ground for between 20 and $50 an ounce way back in 2002. Do you think that the rising cost of mining over the last six years has been essentially a wash to the tripling in gold prices since then. And that would explain why you can buy gold in the ground now for about the same as you could have back in 2002.

JIM: You know, Richard, I'm going to disagree with you on that point. If you take a look at where the price of gold is today, which is roughly 900 dollars and where it was, let's say, last summer, when it was below 650, you had mining costs going up at 25% a year, although it's – they are curbing that. But if you look collectively at the industry, the cash cost of mining today is closer to $400. But since August of last year, when gold was around 650 moving to 900, up to 1000, it has impacted the profit margins dramatically for these producers. And you've seen that reflected, for example, looking at first quarter earnings where you had Newmont which was losing money, and I think Newmont earned about 15 cents share in the first quarter of 2007, where they earned 80 cents a share in the first quarter of 2008. So, no, I think one of the things that's happened with juniors is a lot of this naked short selling and the things we've been taking about that's going on with these bad apple investment bankers and the all of the manipulations that you see that we've been talking about that in our series called Crime of the Century.

But, here is something that I think is going to change. You've had a number of companies, major mining companies that are saying they are going on the acquisition trail and rather than buy an existing producer, they are going to buy late stage development plays where they can add their mining expertise, cut down their cost and timeframe from taking a grass roots exploration play into production that can take seven to 10 years. Where you can buy a late stage development play, you can buy it for cheaper dollars, gold in the ground, and especially if it's in a good friendly location, then take it into production within three years, that's where they are going to create value. In fact, I'm aware of a company that just did a shelf registration that they are raising 250 million and they plan on going on the acquisition trail and this is a company that's going to be buying, in my opinion, late stage development plays because that's where the bargains are. Watch what happens in the second half of the year. [13:54]

Hi Jim. It's Chris from the UK. Just a question on the naked short situation on the TSX and Venture. Isn't it probable now that there are so many hundreds and millions of shares, worth billions of dollars being undelivered that these crooked brokers have basically taken the money and stuffed it in foreign bank accounts and have no intention of ever delivering the shares. And if the SEC called them into deliver, they would just go bankrupt. So it's an only unresolvable problem and such. Could I have your opinion on this possibility.

JIM: You know, Chris, there is a lawsuit right now that is going on against seven BC brokers for doing exactly this, dealing with offshore accounts. This lawsuit is being generated, the grand jury indictment is coming out of North Carolina. Listen to the second hour of the Big Picture with Wes Christian, and he talks about this going on in offshore accounts. But there is a problem – and you heard him make reference that it has gotten so big and they are trying to make these guys come clean, you're talking about how you could bankrupt the financial system. And that's where I think there is a lot of this stock that's just floating on in limbo. But you know what, as more and more people complain, I think what would talk to clean this up is start putting these guys behind bars, taking the brokers on the trading desk that are involved with this, the guys that are running the bashers on the chat rooms, putting them in prison and make just a few high profile examples of this; and then also actually just put a brokerage firm out of business because it's so blatant. I think you'll get the message across and you can start fixing this. [15:35]

This is John from the Minneapolis. I have a question about oil. You know, I don't believe the abiotic oil theory either that it's being created and replenished, but it's hard to believe that oil comes from fossils. Everybody talks about it as fossil fuel, but how could so much living matter have decayed to create billions of billions of barrels of oil when in fact, you know, if you decayed just one forest which is probably 50 years plus of growth and condense it down into decayed matter it doesn't even amount to very much. So my question is this: if one believes in Creation, is it possible that the earth being created in seven days, the oil was too, just like the gold; and we have a finite supply in the earth's surface just like we have gold. We had peak gold production before, I believe, and now it's just peak oil. Could you address that question.

JIM: Boy, John. That's a difficult question. I believe in Creation too, but we've seen it. I've talked to engineers, petroleum engineers about this because I looked into abiotic and I thought, maybe that's the solution. But then of course when you look at the evidence, you don't see the evidence of it really because otherwise the US production would still be producing what we did before and that isn't the case. Very difficult question, and I admit that it's something beyond my knowledge and scope to answer, because I'm not a scientist that can give you something definitive on this, but if you talk to those who have PhDs in geology…You know, maybe that's an idea. Maybe we'll get somebody on here with a PhD in geology and have them explain that. [17:15]

Hello. My name is Shannon, and I'm in Casper, Wyoming. Thanks, Jim and John for your show. I listen every week. You guys have taught me so much and thank you for teaching me in time to protect myself. My question is this: Jim, would you please talk about the economics of putting solar panels on someone's house at this time. At what cost do they start to make sense? I ask because it seems to me that with energy costs sure to continue rising in the years ahead, that the sure thing of having lower electric bills sounds more appealing than keeping money in CDs. Also, what is the state of the art regarding solar panels at this time? How efficient are they? Should I put them on now or wait for technology to improve?

JIM: Shannon, the economics without tax incentives are very hard to justify because they don't have the critical mass in terms of production yet to bring the cost down. They are getting there. We looked at this and we looked at putting roof tiles –solar roof tiles – and it just turned out to be economic – so we're looking at maybe just panels that we might be able to use; and we might use it for things like the water heater, heating the pool. But right now, the economics, unless you're going to be in a home for a long period of time. And number two, if they go to this cap-and-trade system that they are talking about passing, you're talking about that your energy bills going up 50 percent, so watch what's going on in Washington. But I think it’s a few years out before they can bring down the cost of solar at a critical level, get the critical mass of production to bring it down. So at this point, unless you're going to be in your home for a long period of time, it's still cost prohibitive even throwing in the tax benefits.

JOHN: Some people are doing it in the outback areas of the country where it would be too expensive and I think it's somewhere around $20,000, to have yourself an electrical system that works. Dave Morgan, as a matter of fact, I drove to see one of these a couple of years ago and the house was completely off the grid, but they had to have a wind generator, solar panels and then for the for the dark months of winter they did have a 7000 watt generator running off of a car engine, so they were independent, but they weren't that half-and-half hybrid. I think that's what you were looking at, wasn't it?

JIM: Yeah. I was looking at the hybrid and more importantly, I wanted to be off the grid. And to get the tax benefits, you've got to be on the grid unless you can prove that you have, you know, maybe some kind of medical device that is life threatening where you couldn't afford to have your power shut down – because I'm so tired of seeing it here in Southern California, John, every time we get a heat wave, you get these rolling blackouts in Southern California because we don't have enough power because they block the construction of power plants. And so that's what I was working on as a back up system when we go through these black outs because we can see more of them coming in the years ahead. [20:04]

JOHN: See, up here, in the Northwest, when we get a heat wave, we don't have rolling black outs, we just black out together.

Hi. My name is Mike. I'm from Illinois. My question is: I hold 105 shares of Devon Energy Corporation. You probably know they are an oil and natural gas company in the United States. Do you think it's a good idea to sell it right now or should I hold on for a better day? Just a question. It's been very good to me. I've had it since it was about $25 a share and with the price of oil going up, I think it's good to hold, but I'd just like somebody else's opinion.

JIM: You know, given its current price roughly on this Friday at about 116, it's still selling at 15 times current earnings, it's probably selling at 12 times next year's earnings and they are a large producer of natural gas. If you look at natural gas prices that are on this Friday $17.71, and you could be looking at 15 to $20 natural gas prices. This is something that I would hold long term. You think it's been good to you now and in the past, it's going to get even better going forward. [21:10]

Hello, Jim and John. My name is Max. I’m in California. I'm on your website and there is a link to short positions in precious metal stocks on the HUI, and one of them is Apex Silver, ticker SIO. This stock has a short interest ratio that’s almost double the highest of the next highest stock with the high number of shorts. I'm wondering is this stock typical of what happens in naked shorting or not? I'm not even sure what a short interest ratio means, so maybe you can help clarify that.

JIM: Max, this is very typical of what's going on. You've got here Apex silver. You've got 20% of the outstanding float has been sold short, very similar to what you're seeing going on in Minefinders. And if you take a look at I'm just looking at who owns this stock and you've got a lot of big firms that are behind this but this is very typical, you'll find it, you'll see it in Silver Corp, you'll see it in Silver Standard, you'll see it in Silver Wheaton, you'll see it in Pan American Silver. They have just carpet bombed and shorted and who knows how big the naked short position is?

Max, another issue too on this Friday, it was one of the industries and one of the companies with the largest short interest as a percentage of its free float. They are in a very, very dangerous position if silver really begin to move and this equity market turns around. This could give us the explosion in mining shares that I think is coming at some point this year because it may be triggered by either higher bullion prices, it may be triggered by buy outs, but what you're seeing here in Apex, you're seeing all across the silver spectrum. It's not just this stock. They are doing it to all of them. [22:52]

Good morning, Mr. John and Mr. Jim. This is Mario from Canada. Sometimes I feel as if I'm back in school when I listen to Financial Sense. It is an awesome financial education. By the way, professors, I have a delicious BC Apple for each one of you.
My question is in regards to your excellent tutorial on how they scam individual investors. I don't have a Level 2, but my brokerage website does provide a list of transactions of who sells and who buys. I believe that one of my speculative stocks Golden Goliath has been manipulated. They released very good news results, but the stock price usually either goes anywhere or down. I have been checking to see who is the seller, and what I've noticed is that there are a large proportion of buyers and sellers that say only anonymous. So my question is: How can I tell who anonymous is? And two, does your short position in precious metals stocks web page show all companies and their shorts or just some of them? On Stockhouse I am putting a link to your article and suggesting that all investors pass it on to all of their own personal chat boards and to the CEOs of the mining companies. Finally, when and where is our graduation party?

JIM: Mario, this company has been shorted and it's amazing, but one of the things I do recommend, if you are investing in juniors, spend a couple of extra bucks and get yourself a Level 2 because you'll see that it is not just this anonymous that often appears, but you'll see other companies. But more importantly you can spot all of these activities that I've been describing here on naked short selling, the end of the spoil your weekend, the end-of-the-day dropdown, and you can see more activity and which firms are doing this. Sometimes you can see when they are colluding together because it becomes obvious and you'll see who these bad apples are. But the other thing I think you need to do is with a Level 2, when you're buying these stocks, you can see where the bid and offers are, and you can see if its bad apples are trying to manipulate the stock and you can make a better purchase. In other words, rather than just calling up your broker and making a market order, you can specify an order based on what the supply and demand is telling you between the balance between buyers and sellers that you'll see using your Level 2 system. [25:26]

Hello, Jim. Great show. I listen to it every week. This is Frank here in Wiltshire, England, I'd just like to ask a question. I see in the news now China has about 1.8 trillion dollars in foreign reserves – I was wondering what do you think they are going to be likely doing with this money, whether they likely to be investing it. Where do you see them going with that? I see they have already bought 1% of British Petroleum. Are they going to be going down that road in the future?

JIM: You know, Frank, a lot of these countries are setting up sovereign wealth funds and what they are doing is going after natural resources, especially China. They are not only buying oil companies, they are investing in base metal companies, they are investing in natural resources all around the globe. They are trying to diversify and then I think you're seeing a lot of these sovereign wealth funds are going to be major factors in the market, but the one area that stands out with China as does many others is they are going into the natural resource sector. [26:32]

Hey Jim and John, Chuck from Dallas. Just reading an article by Ed Wallace, a financial columnist here in the Dallas Fort Worth area with his “dark telegram, another perspective on fudging the numbers.” His argument is that oil prices spiked so high because ships were not off loading their crude and they were sitting out in the Gulf of Mexico. Enjoy the article.

JIM: I'll look at the article, but I can tell you this, Chuck, the basic reason that oil prices are up is production peaked –and especially conventional oil production peaked back in May of 2005 – and starting this year, you've seen demand outstrip supply. Supply is simply not keeping up with demand. [27:17]

This is Carlton. I'm extremely tired of all of the inflation lies put out by my government, predatory confiscation of most of my wages in taxes and bailouts for all the crooks and bankers on Wall Street. My question is: are there any investor advisors out of the United States that don't give a damn what this phony government says, and offers investment advice and where accounts can be set up without the black ops SWAT team visiting them and reminding us who is in control? Further question, when do we become more communist than the communists. I'm really tired of these jack-booted thugs trying to control every aspect of my life. I don't need to be taken care of and controlled from cradle to grave by these idiots.

JOHN: He's obviously a man of strong opinions. [27:59]

Hi. This is Michael calling from Ottawa, Canada. Assuming that naked short selling occurred for a gold junior and therefore there are more shares outstanding than a company had issued, and a larger company has come along to acquire that gold junior, does that larger company need to acquire all of the shares including those that have been counterfeit, or do they just need to acquire as many as the company records show that they had issued? And if the latter, do some people end up holding shares that are completely worthless.

JIM: You know, Michael, you bring up an interesting question because if I was taking over a company and, let's say I'm going to pay a dollar a share and I think that the company has sixty million shares so I'm thinking, “okay, it's going to cost me sixty million to take over this company” and I find out that there is eighty million shares outstanding, you would have a lawsuit against the naked short sellers and particularly the investment banks that allowed this to happen because they cannot allow this to happen without the selling that goes on through the investment banks. But you bring up an interesting question. I would suspect also that some kind of negotiation would be going on because, you know, you think when you’re buying something for sixty million and it turns out the price is eighty million. [29:15]

Hey Jim and John, this is Mike from Chicago. Two quick questions. What do you think about George Soros, his statements about the current price of oil, he likened the oil bubble to the 1987 crash? What are the differences between now and then?
As far as companies that are subject to naked shorting – some of the junior miners of exploration – is it better to pursue those companies that are traded on the AMEX and those companies that are actually going into production? Would those be safe investments to protect us from those bankers that you tell us about every week?

JIM: Mike, I like AMEX-listed stocks because number one, they are more liquid and two, if there is a naked short position or companies are involved in it, talking to our attorneys, it's easier to bring the people – it's easier to sue. Let's put it that way. And then the other thing is George Soros –getting to your earlier question – that this is equivalent to the 87 stock market crash. I just don't buy it. I mean you've got a situation here that's real. Peak oil is real. You've got increasing demand, and supply is no longer increasing. And that's the reason we're looking at the oil prices that we're looking at today. [30:25]

Hi, John and Jim, this is Terry from Oklahoma. Great show. Two weeks ago you were talking about interviewing various mine operations. I was kind of surprised that you had one in China – curious and intrigued. I was wondering, one, would you recommend to usually stay in like Mexico, US and Canada? That's what threw me off about China. Do you think that's a good investment, do you think China is stable enough for that? And secondly, being as I know about the US stock market, how do you invest on the TSX? How can you basically get stock? How can you buy stock up there?

JIM: Terry, I do like that company investing in China. And remember, China is emerging as one of the world's largest gold producers and also, I think, eventually, they are going to become a large producer of silver. And as long as you govern, operate by the laws, you treat the people fairly, work with the government – in China, the economics of mining are a little bit different. The costs are cheaper and what government wants companies to do is rather than spend 5 to 10 years trying to prove out a deposit, the sooner you go into production, the better the government likes it. And that's what this company's strategy is where they took a mine into production within two years. And so I do like China.

And then how to invest on the TSX? You know, you can open up an account. I know that the TD used to have one. I'm not sure. I mean I know for example ourselves while a lot of times when we are buying juniors, we'll buy them either in the TSX or on the Toronto exchange if they are not listed here on the AMEX where they are more liquid. The reason we go onto the Toronto and the Vancouver exchange is they trade more often there than the pink sheets here in the US. I just don't like pink sheet companies and buying them because there is such a wide gulf between the bid and ask price that you pay almost sometimes the equivalent of a 10 percent commission. [32:20]

Hey Jim. It's Greg from Charlotte. I had a question about I was watching Dennis Gartman on CNBC last night talking about a new change within in one of the commodity exchanges about a regulation redefining hedgers. He said that would have a significant downward impact on commodities sometime within the next three or four weeks. He expects about a 15 to 20% correction in all commodities if that happens. I wanted to get your thoughts around that on the possibility of that and if you do agree, how long that would last?

JIM: You know, Greg, they've already increased margin requirements on several of these commodities and remember, in all commodity transactions, any time there is a buyer, there is a seller so there is always the opposite party to each trade. And yes, could you get a big run up here with a spectacular blow off in commodity prices before you would see a 10 to 15% correction, that's certainly a possibility. [33:17]

Hi Jim and John. This is Tom from New Jersey. I was reading an article recently about the Dakota oil fields and it stated there that there could be enough oil deposits that it would dwarf Ghawar. And I was wondering if you had looked at this and what your reaction to that was. And I suspect that it's not quite as easy to get to the oil as it might be in Saudi Arabia, so appreciate your thoughts.

JIM: You know, a lot of these fields that they're talking about which involve shale, getting shale oil, it's already difficult to get tar sands. Shale oil – we're still working on the technology to make that economically feasible, so I think you're talking about large shale deposits if it’s the one I'm thinking, like the Green River- type bed. And under those circumstances, it's a mining operation –versus an oil operation where you have pressure below the surface and the oil comes out a lot easier versus getting a shovel, loading it on to a conveyer belt – and using a lot of energy to either melt the process. I know Shell is working on one where they would melt shale oil in the ground before they brought it up, but you're talking about technology that is yet to be fully developed here to make that economic. And we’d also have to have oil prices and would have to keep them here at the side prices in order for this technology to come onstream. Eventually, as our conventional oil production continues to decline, all of these alternatives, whether it's tar sands or shale oil, are going to be used because the price will be so high it will be over $200 a barrel. We're going to be scrambling to get some kind of alternatives or some kind of liquid fuel until we can come up with some kind of technology and transition in our transportation system. [35:07]

Hi Jim and John. My name is Andre and I'm from Australia. I found your program about six months ago and it is really great. An eye-opener – self-educated myself a lot since then. I’ve got a suggestion – you talk about the Great Depression around the world in 1929, and you mention that there was something similar in Japan in 1990. And I'm not sure that it is commonly known what happened in Japan, and I thought if it was something similar and something like this can happen in the US and Australia and in other countries this time around, would it be possible to do a special, maybe one hour maybe longer about this deflation and depression in Japan? It think it would be really helpful.

JIM: You know, Andre, we actually covered the similarities between 1930 US and 1990 Japan. The commonalities between those countries being large creditor nations at the time. And then the difference between the 1930s and today. We've done that on previous programs. We did a whole series on this, and I know in the fall of 2004 and 2005 we did a big series on this, and then last year we did a series on the dying of money and what happens. So if you can go back and look at our archives and our transcripts, I think you'll find that we've already covered this subject. [36:31]

This is Bill from Vermont. I heard an expert over the internet state that the reason that junior mining stocks have not increased in value is that the hedge funds do not invest in them. The regulators will not let hedge funds leverage Canadian juniors or stocks in the US under a dollar and a half. My questions: Are these statements correct? I thought hedge funds were unregulated. Could you discuss hedge funds and leverage.

JIM: You know, I believe those statements are incorrect, Bill. Hedge funds are unregulated. They can do anything that they want. And I happen to know that they are shorting this sector. The reason that these juniors are going down, a lot of hedge funds have short this sector; and you can see this across the whole mining spectrum, from late stage development plays to exploration plays, to up-and-coming producers. And you've got hedge funds that are shorting them. So, no. Those statements are incorrect. [37:32]

Hi. This is Mike from North Carolina. The past week there was a good bit of conversation about bonds during the technical roundtable. In simple terms, where do you see mortgage interest rates headed in the next three months?

JIM: You know, Mike, I don't pretend to be a market technician. I would say as we get into the fall, September forward, we're going to see higher interest rates. We're already starting to see interest rates back up. They've been backing up since February, and as we get into the fall, I think we can get much higher because the inflation rates are going to be higher. [38:07]

Hey Jim and John, this is Hugh from Vancouver here. I just want to comment last week's program and the ongoing series you're doing on the crime of the century. I think that's really great. Growing up in Vancouver, I'm well aware of the antics of Howe Street and Bay Street and promoters like Murray Pezim. But for most of my investing career, I've been able to steer clear of this, but today is Wednesday June the 4th. I've been accumulating a small junior. I have a large position. The stock was trading relatively less today and then about 20 minutes before the close of the market, lo and behold as per your scenario last week, somebody came in and carpet bombed the heck out of it. It went from a buck 44 to a buck 10, and finally closed at $1.36. No financing is in the offing. I’ve never seen any activity like this in this stock in the last two years I’ve held it. I think you guys cursed me. Just wondering, aside from financing, I guess it would just be the naked short sellers going after these guys, or maybe somebody shaking the tree because there is some substantial news coming out in the next week or two. I’m wondering what your thoughts are on motives behind this one, but again I think it's either somebody shaking the tree for the last cheap shares or maybe some naked shorts coming into the market, trying to hammer this thing down.

JIM: Well, if they have some great news coming forward, maybe what they're trying to do is shake some apples off the tree and pick up some cheap shares. And they'll often do that too especially if they have some information and they know some great news is coming forward. That's another technique they'll try to do; or it could be either just naked short selling. It could be either one of those two, but sounds to me like if there's some great news forward, they are trying to shake and get investors to panic and drive them out of their shares through shorting and then pick up and cover those shares on the position at a lower price. [40:02]

Hello Jim and John. This is Daniel from Auckland, New Zealand. First I just wanted to let you know that you do have an audience here down under. And I would also like to thank you for the opportunity to listen to your comprehensive discussions every week. I am quite interested in your views about how I, as an individual investor, can protect myself against the 2009 and 2012 crisis window. Specifically, I would be interested in your suggestion of asset allocation assuming that I would like to invest in ETFs and mutual funds only, as opposed to stocks. I will be interested in your opinion as to the percentage breakdown across each individual asset class.

JIM: Yeah. I'm just going to give you, Daniel, an article and if you can -- I don't know if you subscribe to Barron’s but if you can get the current issue of Barron’s, there was an article called profiting from global change. It was an interview with Mohamed El-Erian. This is his recommendation but it will give you an idea: 15% US equities; 15% advanced equities; 12% emerging markets; real estate, commodities, inflation-protected bonds. I'll make it even simpler. I would find an ETF in water, I would find an ETF in energy, I would find an ETF in food and I would find an ETF in infrastructure and an ETF in precious metals. [41:25]

Hey, Jim and John, this is Matt from Jefferson City. I'm invested in a junior mining company out in the Sierra Madre that has recently undergone a private equity financing very successfully; and they just recently announced a shelf-registration with the SEC. I'm not real familiar with the benefits of doing something like that or what situations a mining company would be in that would warrant them doing that. If you can explain that in your Q-calls, it would sure be appreciated.

JIM: You know, Matt, usually when they do something like that, a lot of the financing in mining companies is done through private placements and that penalizes fund managers in the US. In other words, if you participate in a private placement on the US side of a Canadian junior, you can't sell the stock for two years. And plus, a lot of the US fund managers do not like the little games that are played and exactly the things we've been talking about in Crime of the Century; you know, the little pump and dump schemes the investment bankers pull off. And then not only that, there is also the tremendous dilution that comes in the stock; you know the big commissions that they charge and then also the broker's shares because they know the manipulative games. So fund managers on the US side don't like these kind of deals. They like liquid securities with low commission costs, so that the shareholders aren't diluted; and so a shelf registration is more appealing and means that the company is going after larger institutions because if you're a large US institution, particularly like a large mutual fund, large mutual funds don't like these kind of private placement securities. They much prefer liquid securities, and so that's probably why the company was doing that. [43:10]

Hello, Jim and John, this is John from Pennsylvania. This is a concept check and I've just been giving it some thought, but it would seem to me that when a country goes from a gold standard to a fiat-based system that at the moment that they switch over to the fiat system, it would seem to me that they would be required to unleash their assets, i.e. the gold, into the market because it would seem to me that if they could not do that, then of course the value of the fiat currency would plummet relative to the assets. So conceptually that makes sense to me. I was just curious what your thoughts were.

JIM: Actually, they don't want to release their gold into the market because eventually they know what happens. You notice that when we went off the classic gold standard and we had the currency debasement that occurred in the 30s and the trade wars that resulted, notice the first thing after when World War II was coming to a close they began to come up with some kind of semi gold standard because it's the only way you are going to put your currency on a stable basis. So no, you would want to release your gold. [44:23]

Hi. This is Angela. I'm calling from California. And this is more of a comment. I wanted to ask you guys to have some Congressmen Bart Stupak of Michigan. He's chairman of the Energy Committee on your show to talk about the price of oil and commodities and things like that. He really explained a lot on KNX 1070 when he was interviewed by Frank Mottek on June 5th between the hours of 1:00 and 2:00 p.m. PST.

JIM: I would love to get Congressman – we haven't had good luck getting congressmen on the air. These guys are very busy. Their days are booked. It took a long time to even get Congressman Ron Paul. I'll tell you the guy I'd like to get is Congressman Roscoe Bartlett who’s head of the Peak Oil Caucus. There are about 15 congressmen in the US Congress that are aware of peak oil and they formed a caucus. He would be my first choice of getting somebody on. But so far, we haven't had much luck. Maybe I can try some connections I have and try again, but we haven't had much luck with Congress people. [45:30]

JOHN: That ends the Q-lines for today, and as a matter of fact it ends the whole program, so what we usually do here is look at coming attractions for the coming weeks to come.

JIM: Next week, my guest will be Louis-Vincent Gave. He's written a book Roadmap for Troubling Times. 21st of June, Michael Klare, Rising Powers, Shrinking Planet. Richard Bitner on June 29th, his book Greed, Fraud and Ignorance. July 5th, Marshall Goldman, Petrostate; and July 12th, Ronald Wilcox, What Happened to Thrift. And so a lot of great programs and then we're working on a special roundtable. And if we do hit 150 dollar oil, I'd like to get some of our peak oil guys on the program together and start talking about this because I think when we hit that level, maybe that's the point where we get a selloff and we get a correction of 10 to 15% correction at that point where oil drops back down to 125. But certainly, I would expect higher oil prices, so as we head higher, who knows? That can come as soon as next week. You heard Zapata George. He's saying 160. And of course, there are people out there that are saying that we could see a spike to 200. And we'll be doing another oil round table, especially if this really starts to become critical in the weeks ahead.

But you're right, John. We have run out of time, so on behalf of John Loeffler and myself, we'd like to thank you for joining us here on the Financial Sense Newshour. Until you and I talk again, we hope you have a pleasant weekend.

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