Big Picture Banner

Financial Sense Newshour

The BIG Picture Transcription

July 5, 2008

Part 1

Tipping Points - End of the Unsustainable

JOHN: The Bank for International Settlements has come out with its 78th annual report. Now, for people that may not know – the Bank for International Settlements is really like the central bank for the world’s central banks; and in one of its abstracts about the global situation it says:

The unsustainable has run its course. After a number of years of strong global growth, low inflation and stable financial markets, the situation deteriorated rapidly in the period under review. Most notably was the onset of turmoil in the US market for subprime mortgages which rapidly affected many other financial markets, and eventually called into question the adequacy of capital at a number of large US and European banks. At the same time, US growth slowed markedly, reflecting setbacks in the housing market while global inflation rose significantly under the particular influence of higher commodity prices.

And of course it goes on from there.

Why would we say that this report is going to be significant? And that will open up the first part of our talk today on the Big Picture called Tipping Points.

JIM: If you look at what the Bank for International Settlements was saying here, there was a paradigm that was operating in the world and a lot of people have referred to it as Bretton Woods 2, and it worked like this: The US consumer would go into debt, consume more through borrowing; that translated into a trade deficit with the rest of the world; and what we would do is we would go into debt to buy goods from the rest of the world. They in turn would take our dollars and recycle them back into our economy, buying financial assets – whether it was Treasuries, mortgage bonds. But this was pretty much the paradigm that has operated throughout this decade.

And you heard about stories – “because there is such a big glut of manufacturing, the rest of the world needed the US as a consumer to absorb these goods.” We would absorb these manufactured goods, we would give them dollars – you know, it was kind of like vendor financing. And a lot of that money came into our markets between 2003, huge influx of buying Treasuries by the Bank of Japan; and then between 2003 and 2007 as mortgage rates came down, as interest rates came down around the globe, people were shopping and looking for higher yields. Well, in response to that –as the BIS talks about – we got into these structured products – these SIVs (Structured Investment Vehicles), CDOs (Collateralized Debt Obligations), and all of these fancy products that offered higher yields that were sold and billed as Triple-A rated securities. And what the BIS is basically saying now is this whole system is now starting to unravel because it was an unsustainable model. In other words, there would be a brick wall that eventually people would hit – in other words, consumers have a limitation in terms of how much money that they can borrow. And there was a limitation in terms of how much the rest of the world was willing to absorb of the US trade deficit. In other words, we couldn’t take 80 to 90 percent of the world’s savings and channel it back into debt instruments or financial instruments of any kind in the United States – it was an unsustainable model.

So what they’re really saying here, if we summarize it, is this was an unsustainable model. It has now run its course.

I think the other thing – if you read through the fine print here – another thing that they were saying is – John, you remember all the various financial crises that we have gone through over, what, the last two decades – we had the S&L Crisis in 91 but it wasn’t as big as what we’re experiencing today because the US consumer was still saving, the market and the economy in the United States wasn’t as leveraged and we weren’t running the kind of trade deficits that we’re running today. Also, more remarkable, was the fact that other than the brief spike of energy during the first Gulf War when it went from 20 to 40 dollars a barrel; when the war was over, oil prices came back down. But most of the crises that we have gone through – and you know, Greenspan wrote about this in his book Age of Turbulence – most of the crises that we saw in the 90s – the Peso Crisis and derivative crisis in 94, the Asian Crisis in 97, Long Term Capital Management and Russian debt default in 98 – most of the epicenters of these crises were elsewhere; and the United States had a lot more flexibility because of the strength of our economy, because where interest rates were and also our trade and debt levels weren’t as big as they were today – we had a lot more flexibility.

What makes this crisis somewhat unique is the epicenter of the very crisis is the United States. And that’s what is sort of different this time around: the world’s main financial center, the world’s largest economy is where the problems have originated and then spread out from the center out. So we’re the eye of the storm here and that is kind of why they’re saying that this is a little bit different than any other crisis that we have experienced in the past – and what makes it different is the US is the epicenter of the storm. [5:53]

JOHN: Are they proposing any new types of models? Or are they just saying: well, here we are!

JIM: Well, they are proposing some new kind of models. In other words, one of the problems that they said was that there was a complete lack of a governance here. In other words, how did these institutions get so leveraged? How did you get institutions that were able to take this “originate to distribute” model – and what I mean by “originate to distribute” is you take an American homeowner, he goes out, buys a house, takes out a mortgage and then that mortgage is packaged, diced, sliced in so many different ways and into different mortgage pools and tranches, different CDOs, CDO-cubed, CDO-squared – and sold to the rest of the world; and how did you take something which was junk and redistribute as Triple-A securities to the rest of the world. And this something that they said there was a lack of internal and external controls. And we’re going to get to some root causes here in just a moment as they try to define it.

Now, they’re looking at this more from a Keynesian monetarist view – but they do admit one of the root causes of all of this was loose money. And we’ll get to that in just a minute. [7:15]

JOHN: It seemed like this had been going on for some time because we basically plowed into an economic paradox here in that the Fed - Alan Greenspan at the time – was already raising interest rates in 2004. But, surprise, surprise, it didn’t seem to have as much effect because the housing market kept on going – we saw that; foreigners began throwing money back into our economy and banks wanted to see these loans go, so they started packaging all of this type of creative loans which ultimately really got us into trouble – that’s what we saw happen there, and we’re still reeling back from that one. But when did this thing finally start to unravel?

JIM: It really began to unravel in the first part of 2007 when you had the intermediate lenders start to get into trouble. They couldn’t get funding and that happened in February and March of last year.

And remember that little kind of brief storm that took place – a couple of companies went out of business and then everybody said, “okay, the storm’s over.”
And even the Fed was talking about strong economic growth, the economy was still growing. But here’s what was happening – and this gets back to Greenspan’s conundrum, and that is as the trade deficit – remember, in 2006, the trade deficit in the United States equaled almost 7% of GDP so the US was flooding the market and the rest of the world with all of these dollars. If you’re China, if you’re OPEC, you’re getting all these dollars because oil prices were rising at the time, our trade deficit was rising at the time – they kept recycling those dollars back into the US economy, buying long term debt instruments because interest rates were very, very low at the time. And even though the Fed was embarking on a rate-raising cycle, they weren’t doing this like a half a point at a time, they took two years to raise interest rates from one percent to 5 ¼. So, you had this sort of search for yields at a time when risk levels and debt levels were increasing. Credit spreads were narrowing all across the board – I don’t care if you’re looking at emerging market debt or you were looking at even junk bonds, yields kept coming down because we were looking for a way to recycle all of this money and credit. So, interest rates came down.

And you alluded to as the Fed began to raise interest rates and adjustable-rate mortgages began to rise, in order to keep people qualified for loans and a whole new group of buyers came into this market who should never have come into the housing market; the subprime lending segment. And what happened is we went to no-doc loans, we went no-money down loans, we went to these 2-28 loans where we’ll give you an artificially low interest rate for two years to get you get you qualified into the property. But the problem –as we saw, and began to unfold in 2007 – is these two year adjustable-rate mortgages came due at a time that the Fed had already completed its rate-raising cycle from one percent to 5 ¼%. And so what happened is we became overleveraged; a whole segment of the American population got into the housing market who didn’t belong there and there was no way that these people were going to be able to sustain their mortgage payments and payment plans once interest rates got reconfigured.

And so in the third quarter of 2007 we started to see these whole things unravel. All of these structured products – that began over in Europe where some hedge funds put a freeze on redemptions, and then you had all of these structured investment vehicles (which was a way for the banking system to take debt and put it outside the balance sheet and hold assets off their balance sheet – kind of like what Enron was doing) – and all of a sudden now, these structured investment vehicles and structured investments began coming back onto the balance sheet because you couldn’t roll over the markets – a lot of these long term investment vehicles in mortgages were being funded in the corporate credit markets and the money markets with short term debt instruments. And when that market locked up as it did in August and the commercial paper market couldn’t be rolled over – and so banks had to step up to the plate and they had to start bringing a lot of this debt back on to their balance sheets. And then also you had a system where you had hedge funds that were leveraged 30, 40, 50 to 1 – and they were dependent on the banks or the investment banks for income, and they started to face margin calls. And so another thing that we’ll talk about here is this process of deleveraging. [12:02]

JOHN: So basically we had a situation where there was a scramble for cash, which ultimately came up to a liquidity crisis and the perception was that the markets are liquid but then you really didn’t know how much liquidity was out there until you really had to sell something. And at that point it became obvious what the situation was.

JIM: When you get a margin call, all right, you start selling something. And when you have a product that is very complex – as many of these Structured Investment Vehicles, CDOs, and tranches were, all of a sudden you find out, well, guess what, there isn’t the liquidity for the markets so something that you thought was worth a dollar which was on your balance sheet –priced, by the way, by some computer model – well, the computer model said that this vehicle should be priced at a dollar, however when you went to go sell it there were no buyers and so the real price was 70 cents, 60 cents, and 50 cents. And you saw that in the market indexes of a lot of these CDOs, and they began to plunge, which is one of the reasons why the Fed came up with the plan it has now where it’s swapping a lot of this structured product and mortgage products for Treasuries on the Fed’s balance sheet. In effect, what the Fed is doing is taking on the risk that these securities will hold up and they’re giving the banks Treasuries so that these – because what happens in a bank when your assets start to decline, your equity declines along with it. And if the Fed did not do this, a lot of these banks, quite honestly, would be bankrupt because their capital would not be sufficient to back up the reserves that they have because their capital was being eroded by the losses that they were taking on a lot these products. [13:45]

JOHN: So basically you had a scramble for liquidity when there really was no liquidity and then that resulted in the Fed getting into some of these programs, like Term Auction Facilities, or what else?

JIM: Swapping debt and then also loaning money to the investment banks. And it’s amazing because we’re not done with this crisis. And if you listen to Paulson who gave a speech this week, he was basically saying there are more problems on the way. And I would not be surprised – by the time that this plays itself out, which could be some time next year or maybe 2010 – that we see another major investment bank and we see another money center bank go under. I mean there was a Bloomberg story this week that came up that said “can GM survive?” So, we’re not done with this. You know, there have been a number of economists in the past who have talked about this; Hyman Minsky was one and a lot of people who have looked at this as a Minsky moment. A liquidity crisis is only a symptom of the underlying credit problem, reflecting the reality that market liquidity is always crucially dependent on the continued availability of funding liquidity. And when liquidity dries up, when you have no more buyers, that’s when you get to this sort of Minsky moment. Irving Fisher, an economist around the Great Depression painted a similar picture of deteriorating credit standards in his famous research into the origins of the Great Depression; and a lot of the great Austrian economists have talked about this. But you know, the underlying cause of this is the easing of monetary policy that we saw in response to the NASDAQ bubble bursting in 2000 and 2002, the recession of 2001, the events of 9/11 when globally central banks around the globe – we went through a simultaneous recession worldwide and central banks – began to loosen money and credit.

And the origination of all these crises always gets down to a money and credit. When money and credit becomes easy and when it’s not based on savings, when it’s based on creating money out of thin air as central banks do when they loosen credit or bring down interest rates, what it does it creates these excesses and it creates a false signal that’s given to the financial players. I mean when Greenspan brought interest rates down to one percent, what do you do as a saver? What do you do as an investor when Treasury bills were below one percent and the underlying inflation rate even at that time was over 3% -- and those numbers are even questionable? So people began to look for yields, they began to take higher risks, they bid down the price of junk bonds, emerging debt, they bid down the price of even mortgage debt; and even worse, the credit agencies got involved and took junk debt and turned it into Triple-A rated securities. And this what you always get into in a period of easy money conditions.

And I think what one of the reasons – because central banks really don’t understand the root cause of inflation is you had, beginning in the late-80s, the beginning of globalization as production began to build in facilities around the world. As more production comes online –the more you produce the cheaper your costs are – so as increased manufacturing, increased productivity brought down the price of goods as a result of globalization and increased manufacturing, the central banks took that and said, “look, we’ve gotten inflation under control” – never mind the fact that money supply was growing at high single digits. But you know what, we began to import a lot of goods from Asia – those goods came into this country, the dollar was stronger during the 90s. And the impression was, as manufactured goods came down, central banks had conquered inflation. And there was nothing further from the truth. The problem was, as manufactured goods were coming down, since we measure inflation in terms of rising prices and deflation in terms of lower prices (which is a misinterpretation of what causes inflation), the central banks inflated the money supply during that period of time. And what happened is a lot of that money got channeled – there are two ways that money can be channeled – it can go into real goods and services, or it can go into the financial markets. And the chosen vehicle, or, one of the holding tanks for inflation in the 90s, and also in this decade, was asset prices. So, in the 90s, the inflation was channeled into the stock market, and this decade the money was channeled into real estate and into the bond market. But we had inflation, we were just misinterpreting inflation and as a result of the misinterpretation central banks continued to expand and increase the supply of money and credit, making it easily available and as a result they got these asset bubbles and now that’s what we’re dealing with. And unlike before though, we’ve come to that tipping point and that’s where we are today, where any kind of event, any kind of supply shock, oil prices go to 170 or $200, or something happens in the Middle East, or something happens with the large financial institutions, this thing can fall off the precipice. [19:20]

JOHN: You know, if we go back to something that you wrote in your piece The Great Inflation, in 2004, if you remember back in the 90s the inflation showed up in the financial markets, in early 2000 it showed up in the housing market. Why does it seem to be jumping into the real economy now; why doesn’t it just sort of do it each time?

JIM: Well, you know, originally with globalization as central banks inflated in the 90s, remember, Jens O. Parsson’s the “good kind of inflation” – expanded money supply, rising asset markets – the asset markets were the receptacle for all of this inflation. But as the economy began to expand globally, especially in the developing market (China, India, even Latin American, Eastern Europe) the demand for goods and raw materials that go into the manufacturing process – whether it’s iron ore, whether it’s steel, it’s demand for energy – what happened is we had a two decade bear market in commodities. And also, remember, in the 90s, when the Soviet Union broke apart –the Soviet Union was a large producer of commodities – a lot of the commodity stockpiles that the Soviet Union had were sold as the Soviet Union disassembled itself, and it flooded the market. It drove commodity prices down, two decades of commodity bear market, the industry consolidated, a lot of companies went out of business, and so the number of producers in the commodity business contracted. 2) you didn’t have a lot of money spent on either – if you were an energy company, you were just trying to stay alive and make money because energy was in a bear market – you weren’t spending a lot of money, you allowed your energy infrastructure to go into decay because it didn’t make a lot of sense when your margins were narrow and thin and you weren’t making much money to spend billions of dollars. Mining companies stopped exploring, they consolidated. Now, in the meantime, you had world population growing, you have world economic growth which really started to take off. I mean, take a look at China’s economy in this decade alone where it was growing at 10%. In another couple of years, China is going to replace Germany as the third largest economy in the world. And as this emerging economic giant begins to expand its economy, it has this voracious appetite for commodities. So what you saw was during this period of time, as we were inflating the credit markets, as we were inflating the real estate market, China’s economy was growing at 11% and they were having this demand for commodities, so you saw the price of energy go from a little under $20 a barrel; today – I can’t believe we fell 50 cents short of my $145 forecast. I may have to revise that here again. And so this voracious appetite was developing along with it and it was moving into the commodity market as the dollar began to lose its value. Remember, we’ve lost 40% of our value. As money devalues it also looks for a safe harbor, so in addition to demand coming from industrial economies, you now had strong investment demand that was coming into this sector. And so that spilled over into the economy and one of the problems that the Bank for International Settlements is talking about is that you’ve got a period of time where you have weakening economic growth at the same time you have rising rates of inflation. And they’re defining inflation as rising food and energy prices – although they do briefly mention rising money and credit as one of the root causes of this whole crisis. And that’s where we are today.

We are at what I call the tipping pointing where there’s some real risk here; and we’re also arriving at a time where central banks do not have the same leeway that they had 10, 15 years ago when you didn’t have rising commodity prices. So they can’t slash interest rates aggressively. If they expand and start monetizing debt – which I think is the next step for the Fed, when it becomes more difficult to finance our deficits – then you’re seeing the full impact of a lot of this inflation; and as the BIS said, “the unsustainable has run its course.” I would add to that the years of inflating and expanding the money supply has now – those chickens are coming home to roost with the higher inflation rates. There is so much inflation in the pipeline now, just as David Hackett Fischer talked about in The Great Wave, all these great waves that begin with population increases and the expansion of money and credit first begin to unfold with energy and food, which is what we’re seeing – shelter, energy and food – and then it spills over into the rest of the economy. And the one of the comments that have been made recently by a lot of economists and even central bankers is that we’re now starting to see this inflation of higher energy spill over into the real economy –because we’ll talk about what to do here in the future, but that’s one of the problems that we have right now that’s hurting corporation earnings. You know, you can’t absorb all of these rising inputs to your manufacturing costs or service costs without eventually passing this on in terms of higher prices of goods and services that you produce – otherwise, you go out of business. [24:55]

JOHN: Let’s see if we can reframe this based on things that we were discussing here on the program at the beginning of the year. We came up with the Oreo Theory – that was your theory here – saying that the beginning of the year would have a rough, dark outer shell, followed by a creamy filling caused by a number of difficult things; and then we’d be back in a hard, crunchy outer shell on the other side as we got into the other end of the year. And we’re right now right at the beginning of July, so here we are – we’re sort of smack in the middle of everything right now. The Oreo Theory basically: there would be turmoil in the markets – this was the first part – the hard part of the year – a weakening economy, a financial crisis caused largely by what was going on in the real estate market, and just generally a tough market overall. The creamy filling we anticipated would be due to Fed rate cuts, a stimulus package, to a bailout package. And we should note two out of three of those have happened so far. And then finally, as we slid into the end of the year –notably, we were guessing probably after the elections – we would see rising interest rates, rising inflation – just a generally worse scenario – things were going to turn dark and rough again. So how is this theory holding up? The creamy filling here seems just a hair lumpier than I think we thought it was – but I don’t know, maybe that’s not a fair assessment.

JIM: There were a couple of things that have happened: number one is, remember, we were also anticipating higher oil prices – we thought we’d hit 125; we hit 125 early May and then we moved right up to $140, and as we got up to $140 it really began to put pressure both on the bond markets and also the stock markets. Remember the 300 billion bailout program which was going to sort of set a floor on the financials and the housing market? John, that never unfolded. So we had two things that sort of brought an abrupt change to the creamy filling. One was higher oil prices – I mean when we hit 125 I upped my forecast to 145, and here we are July 3rd and we’re at 144.50; actually intraday we were up 146. And so, number one, oil prices went much higher. I did not anticipate 125 oil till the end of the year, and here we are in July, we’re talking about almost 145. And we still haven’t got the bailout package which is what was needed to put a floor under the financial markets. Now, we’re dealing with higher oil prices – unless oil prices come down – unless there is a substantial correction where we go back down to below 125 (let’s say, 120, 115, 110) we could be going directly into that hard outer shell.

There were a number of stories this week that the credit crisis is not only spilling over from the large money center investment banks and money center banks themselves, it’s now spilling over to the regional banks. You’ve got a number of regional banks that are having a hard time getting funding and so you’re starting to see that from the top down – the top being the money center banks, the Citigroups, and the investment banks – it’s now working its way down the food chain. Then on top of that, if you take a look at it, Americans are going to spend somewhere in the neighborhood of 500 to 600 billion for gasoline products this year, and that’s substantial. So, I mean, you take a look at the stimulus product that was given to most people, they’re going to need that just to pay their food and energy bills. And so the real risk here is we’ve got four problems that are unfolding for the economy: we’ve got deleveraging – and we did a show on this roughly I think about a month ago – in other words, if you have a 10-to-1 leverage ratio (let’s say you’re a bank) and you have – let’s just make it simple – and you have $100 of assets and you keep $10 worth of equity – so you’re leveraged roughly 10-to-1 – if your assets decline from $100 to $80, then in order to keep that same leverage ratio and equity, you have to reduce your assets to keep that same leverage ratio. So as assets begin to decline, you have a deleveraging that is taking place. I mean if equity evaporates by 200 billion, you’re talking about nearly 2 trillion of withdrawal from the credit markets. So one problem that you have is the deleveraging of financial institutions – not only money center banks, [but] regional banks and investment banks. And deleveraging means like – and that goes across to the hedge fund market. If you’re a hedge fund and you’re leveraged 50-to-1 or 100-to-1 and you’re getting margin calls, you’re liquidating assets. So that’s a lot of what you’re seeing take place in the marketplace today is a lot of these hedge funds – these banks – are deleveraging; and a lot of times when you deleverage, sometimes you’re selling what you don’t want to sell, but what you’re selling is liquid, what you can get a price on. If you have a mortgage security that nobody has a bid for, when you can’t sell that you look elsewhere in your portfolio and you sell whatever is liquid, whatever is up in value and whatever you can turn into cash very quickly. And that’s also why the Fed has come in here with these exchange facilities with these banks, is the Fed is basically saying, “look, the market is deleveraging right now, and what it’s doing is it’s forcing people to sell at a time they don’t want to sell; and the more sellers you have coming into the market at the same time, the more the prices are driven down. And because of that, if you drive prices down too low, you’ll have even greater losses in the financial system. You can have the equity virtually wiped out of your investment banks, or money center banks – and that’s why the Fed is now exchanging a lot of this debt, which is illiquid, and taking it off the balance sheet of the banks and putting it on the Fed’s balance sheet where it can wait it out. And they’re doing that to keep these financial firms from becoming insolvent. And so deleveraging is playing with the economy, and as banks deleverage that means only prime credit gets funded. If you have a low FICO score or if you’re not Triple A-rated or AA-rated, you know, it’s harder for you to obtain capital.

So, number one, you have deleveraging that’s taking place in the economy and that’s going to take at least a couple of years before it plays out. [31:32]

JOHN: So if we posit that deleveraging is a problem, are there any other problems in the economy right now?

JIM: Sure. I mean you’ve got rising costs that are going up. Let’s look at it this way – West Texas Intermediate crude is up 50% for the year. That’s on top of being up nearly 70, 80 percent last year; Brent crude is up 55%; if you’re looking at natural gas prices, they’re up 74%; so energy costs are going up; Coal prices are up 34%; steam coal is up 60%. If you look at aluminum prices – up 27; copper up 34; tin up 40%. If you’re looking in the agricultural sector: corn prices are up 65%; ethanol is up 35%; soybeans are up 40% - and I expect as we get into the fall with the damage of the floods, these prices could go even higher. So your input costs are going up, which means that’s putting some pressure on profit margins and so that’s obviously affecting the stock market.

And there are certain industries that just don’t have pricing power – and we’ll get into that in this next segment that we’re going to do – “Where should you be putting money?” So there is pressure being put on corporate earnings, and especially if you make a product or service that is discretionary. In other words, if it’s dependent on discretionary income from consumers, you don’t have a lot of pricing power right now. So you have some pressure being put on corporate earnings. And then I would say a third factor is monetary policy. I mean the Fed has painted itself into a corner. If it doesn’t talk tough about the dollar or inflation, you could have a dollar rout because one thing the Bank for International Settlements has talked about, if we look at the Dollar Index so far, that index has had an orderly decline. If you look back at, let’s say from 2001 when the dollar hit a peak in July of that year, the Dollar Index has fallen from roughly 121 down to roughly about 72 – it actually got down to a low in April of 71. So the decline in the dollar, if you look at it, has been orderly. But at some point, you may get as the US economy is viewed as being one of the weakest economies in the globe right now, there isn’t a lot of impetus to keep putting money into the US economy. In other words, a lot of the central banks around the globe – and we’ll get into this in the second hour of the Big Picture why a lot of Asian central banks and OPEC countries are diversify their foreign currency reserves – they’re going into other currencies and they’re also starting to buy bullion – and that’s one of the reasons we’re so bullish on gold. And so, there are a lot of constraints right now on the Fed. It can’t slash. It’s dependent on these foreign central banks buying a lot of our debt because it keeps the Fed from resorting to monetizing debt. I think that’s coming, but right now, as long as foreign central banks monetize our debt by rechanneling their currency into buying our debt, it prevents the Fed from doing this. So there are a lot of monetary constraints.

And then the other factor that I think – and this has probably had the most profound impact on this creamy filling, besides no bailout program, is oil prices – but we first hit crude oil prices – but we thought when I made the forecast of $125 oil, the first week in January, I really thought that it was going to be in the fourth quarter that we would see it – but we saw $125 oil towards the end of May; we actually got up to $133 oil. So we blew right past the $125 oil figure, then hit 133 and here we are talking about 145 – that was my next forecast. It was funny because it was Morgan Stanley or somebody who was forecasting $150 oil by July 4th – here we are doing this show on July 3rd and we’ve got over 146.

So I don’t know what it’s like in your neck of the woods where you’re listening – I know that many of you that live in Europe are already paying 9 and 10 dollars for gasoline. In many parts of the world such as OPEC and Asia, a lot of the price of oil is subsidized. But here we’re already looking at $5 gasoline, and I believe by next year we could be at 7 and 9 dollars. And that is what takes us to this crisis window. So unless they can bring oil prices down, we may go right into the crust of the Oreo, but I do believe that we could get a brief rally here coming soon because the markets have become extremely oversold and nothing goes straight up, just as nothing goes straight down. [36:32]

JOHN: So basically what the Bank for International Settlements is saying is the unsustainable – as they say – is running its course. What you’re basically saying here too is that the day of low inflation has run its course. And coupling that with other factors out there such as oil, and whatever bailout measures proceed from this point forward determines whether or not we’re going to chug into that hard, other side of the Oreo. We could chug earlier than expected is what I’m thinking.

JIM: Yeah, we could get into the darker side much earlier, although I think things have become so oversold that you’ve got all the elements here for what I call a brief rally that may take us up over 12000, maybe 12500, before we hit again – and a lot of that’s going to depend whether we’re going to get this bailout package that we were anticipating in the beginning of the year. Remember when we said that – okay, we did the rebate and stimulus package and first helicopter drop – and they did that within in a month; the Fed cut interest rates and they were working on 300 billion dollar bailout plan, but they have yet to put that thing together, and that’s what you’re going to need to stabilize the financial sector. If they don’t put the bailout program, then it just begins to worsen. [37:50]

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

Investing Prudently in a Period of Paltry Prudence

JOHN: One of the things that came up in the commentary by the Bank for International Settlements in the last segment here on the program was the fact that certain controls were lacking in various areas of monetary policy and that’s why we pitched head long into some of the issues that we’re already seeing right now. I would say maybe a lack of ethical control, indeed basically now we are in a period of ‘paltry prudence.’ If we look at the fact that the Bank for International Settlements has issued its report, inflation is on the rise, people are saying, “what do I do?” Well, oil is at 145, did you ever think about investing in oil? “Well, I never thought about that before.” So we are talking in this segment about investing prudently in a period of paltry prudence.

JIM: How fast can you say that?

JOHN: investing-prudently-in-a-period-of-paltry-prudence. There we go. That’ll be two bucks, please. We’re settling a little wager here, ladies and gentleman. Don’t mind us.

JIM: The one thing that the BIS report has pointed out (and a lot of commentators on the market) is that, okay, we have rising inflation right now and stagnating economic growth. When they interviewed Warren Buffett last week, he saw a lot of stagflation and then he broke it down: “a lot of stag- and a lot of –flation.” And there’s been this commentary that has come from central bankers and a lot of economists that have said, well, as the economy slows down, inflation will eventually recede. (As if economic growth produces inflation.) Once again, this gets back to a false interpretation in terms of monetary understanding. It’s not growth that causes inflation it is when excess money and credit are created that causes inflation. So we’re in an environment of inflation. Even the headline inflation numbers in the US, which are over 4%, even if you take them at face value, John, for example, Treasury yields – the 10-year Treasury yield is below 4%. It’s below the inflation rate. If you take a look at the two-year Treasury note, it’s at 2 ½%. And it’s below the inflation rate. And that’s before taxes – well, depending on your tax rate. Tax rates are at 35% -- the highest tax rate. So you have to back out taxes. So what people are doing is if you’re investing in cash, you’re money is eroding in value. And that’s one of the first things that you have to recognize as an investor here: What is the environment that I’m investing in? We’re investing in an inflationary environment, and so you have to decide what am I going to do that’s going to protect my capital? We’ll get into the next hour why I believe oil and gold are two of the best investments along with agriculture going forward.

But the most important thing that you have to understand is your own risk tolerance because if you’re in the financial markets right now – I don’t care if you’re in the commodity markets, you’re in the stock market and even the bond markets, you have a lot of volatility and some people, quite honestly, can’t handle that. They can’t handle the fact that if they bought a stock at $10 and it drops to $8 next month, they’re going to lose a lot of sleep. And if you can’t handle volatility because we are living in an age of volatility, then your best bet is just stick your money in a safe Treasury or a bank CD, but understand that you are going to be losing money. You’re going to die a slow death because the rate of return that you’re getting in terms of income on your fixed income investments is not covering the rate of inflation; and then the value of your investment itself is eroding in purchasing power. I mean think of it today: If you bought 10 years ago, in 1998, you put $10,000 in a Treasury note, do you think that $10,000 today would buy the same goods and services that you were able to buy with that $10,000 ten years ago? And the answer is: Absolutely no! Take a look at your food, energy, the price of a car, clothing, shoes, trips to the dentist, healthcare premiums – all of that has gone up. And that’s what happens with inflation. It is a death of a thousand knives. It’s a death by many cuts – and little by little it erodes. But, on the other hand, if you can’t handle volatility, if you can’t handle something going up or down, then resign yourself – you’re going to put your money in an area that is gradually going to lose its value over time. And that’s the tough predicament that people are in. [43:09]

JOHN: So in this period basically you’re still favoring stocks and commodities – this is something that we talked about last week if you remember, about El-Erian and Warren Buffett, that they’re changing strategies. Remember when we passed through a paradigm shift, when the whole environment changes, you have to change what you’re doing.

JIM: Absolutely, and I don’t want to rehash what we talked about last week, but I do recommend if you’re listening to the program, go out and pick up El-Erian’s book, When Markets Collide because one of his key themes in that book is the return of inflation. And as a result of the return of inflation, PIMCO, the world’s largest bond fund manager is changing its strategy. Almost 50% of their investment strategy will be in stocks; 15% will be in large cap US; 15% in large cap developed markets; 15% in emerging markets; and then some private placements. They’re also in commodities. But you have to understand you have to take a longer term view of this when you’re making this kind of investment. And I would suggest you look at two graphs – or, actually, there are probably four graphs. Go back and look at the price of oil and gold in the 1970s during that period of time of stagflation here in the US. Yes, there were periods where gold shot straight up, there were periods that gold corrected, there were periods that oil shot straight up, and there were periods that oil corrected. But during that period of time, oil and gold were going up.

Now, fast forward to the beginning of this decade. In 2001, take a look at the chart of oil, take a look at a chart of the CRB, take a look at the chart of the gold markets and you will see along the way there have been corrections; and when these corrections happened people get frightened, but it should be clear and visible to you as you look at this chart, the general direction of where things are heading – and they’re heading up. So if you’ve resigned yourself to the fact that, boy, I am living in an inflation and I don’t want to see my purchasing power erode, you can take steps to protect yourself. And that’s why I believe large cap international equities – and I get back to something, John, that we talked about in the year 2000 and 2001, and we have talked about, written about every single year on this program. And this is even becoming more important today than when I first wrote about seven years ago. We mentioned in the last segment, one of the problems that you have with corporate profits today is declining profit margins – a lot of companies can’t pass on rising costs to their customers. Well, let’s talk about sectors of the market that can pass on rising costs to their customers. One sector is the energy sector. If you were an oil company, you can sell your product –whether it’s oil, natural gas, gasoline, diesel, et cetera – at the highest price in the market today because there is a strong demand for your product. So, one of the sectors that has pricing power.

A good example is the oil service sector where you’ve seen deep ocean rigs go from $70,000 a day rental rates, to rental rates that are 700,000. And if you take a look at these offshore oil platforms today that are costing nearly a billion dollars to erect, they’re going to need a million dollar a day rental rates. So the energy sector is one area.

Another sector closely associated with that is the agricultural sector, and they’re both linked because energy goes into the cost of producing the food that we eat. Whether it’s fertilizer, whether it’s the diesel that runs the tractors and the combines, or the diesel that goes into the trucks that gets the food to the store, or the energy at the processing plant to turn it into a finished good product. Agriculture is a place where you can see that there is pricing power; and you can see that with the agricultural goods – corn prices up 65, you’ve got soybean prices up 40, sugar costs up 20. You and I were talking Wednesday morning about Congressman who is now setting up a food reserve. We are looking at the lowest stock of our grains in over half a century. So you’re now even hearing about the government talking about stocking up food reserves in case we have years of famine. I mean just look at the floods in Iowa and what that could do to the soybean and the corn crop this year. [47:51]

JOHN: Senator Richard Lugar has proposed a strategic reserve in food as a matter of fact – a regional strategic reserve, but on a global basis.

A renewed convention should include an agreement among states to take preventative steps such as designing a menu of responses linked to the severity of indicators, such as the global food price index. Create a system of regionally placed supplies of food stocks. Such food reserves could be managed by the FAC using as its model the International Coordination of Strategic Petroleum stocks at the International Energy Agency, for an example. Such a system would need member nations to agree to its use in times of shortages to avert crises rather than distort market pricing, and commit to maintain adequate supplies.

That was Senator Richard Lugar, by the way. And you have to realize what this means. We have countries say, for example, talking about cutting down their exports, not only in energy but also in food in order to preserve their best interests, which is going to completely reshape the whole international market as it goes. It’s almost like international hoarding isn’t it? It looks like that?

JIM: Yeah, because you’ve had food riots in over 30 countries, and you know, when you divert as the world is doing, a third of its agricultural crop in corn into making ethanol, that leaves less for feed stock that goes into feeding hogs, chickens or beef. And one of the predictions that we’re making right now is if you have a deep freezer, buy your beef now because the price of pork, chicken, beef is going to be going up as head into the fall. There is another investment theme if you want to look at, and there are ETFs out there that invest in this area.

Another area that has pricing power is in the area of water which we talked about; and also certain base metals – I mean you’ve got a lot of producers of iron ore raising prices 60 to 70 percent. And I also believe, even though they’ve been hit here, is infrastructure because we’re going to be building over 200 something nuclear power plants that are either in the process of being built now globally, in the permitting phase or in the planning phase. We’re going to need to build power plants. Matt Simmons talks about a declining and rusting energy infrastructure that’s going to take trillions of dollars. So whether it’s rebuilding transportation system – roads, bridges, dams, airports – the infrastructure that runs the economy – both here and in the developed world where it’s decaying or in the emerging world. So infrastructure – a lot of these construction/engineering firms have got backlog orders that go out three to five years.

If you take a look at the 80s and 90s, and the early part of this decade, it was based on the American consumer’s discretionary spending. Now, I think if you look at this decade and the decade going forward, it’s all going to be about investment. It’s going to be about investing in infrastructure because our infrastructure in the West is decaying. And you’ve seen it, John, over the years – the levees breaking in New Orleans, bridges falling apart, delays at airports. I mean you take a look at a US airport and compare it to an Asian airport – I mean the US is falling further and further behind. So infrastructure is going to be a growing area where if you can supply – I mean there is right now, in the energy industry, in the mining industry, you don’t even have enough personnel; you don’t have enough geologists, you don’t have enough engineers. So it’s not just that you don’t have enough raw materials, you don’t have the people. And if you’re thinking about a career if you’re listening to this program – you’re a young college student or you’re a parent thinking about advising your children what to do, you know, go and get an engineering degree, become a geologist, and you can basically write your ticket for the next 10 years. And so, unlike the past where consumer companies and retailing companies had pricing power, in today’s environment where consumers are being squeezed due to higher energy and food costs and service costs, it’s getting down to basics; and so energy, agriculture, water, infrastructure – these are the areas that I think are going to do well, and will continue to do well as we move forward because they’re the companies that can have pricing power.

And the more important thing to give you an example here, of not only pricing power, but when you have a company like – let’s take an oil service company like Schlumberger. It’s increased its dividend, compounded at a 15 ½% rate over the last five years. If you take a look at an energy company, and I’ll just take the largest one here – Exxon. Exxon has increased its dividend at close to 10%. If you take a look at an infrastructure company – General Electric; it’s been increasing its dividend at over 10% compounded over the last five years. If you look at a base metals, energy producer – a company like BHP Billington; it’s increased its dividend compounded at 31% a year for the last five years. And so if you take a longer term perspective and can handle some of the volatility in this deleveraging process that we’re seeing going forward, investing in these areas where they’re basic necessities. And the nice thing about getting a dividend yield? Well, guess what? You’ve got cash that you can spend. You’ve got cash that you can live on. And also, if you take a look at these dividend increases, you know, how many people would like to be getting a 16, 30 or 25 percent pay increase each year. And so that’s another important strategy is that you’re going to have to be in areas that have pricing power, that benefit from rising inflation, that have a large, enormous demand for the goods or commodity or products that they produce, and have the ability – because of backlogs and demand – that they can not only increase prices but as a result of that they have more profits, they have higher cashflows and they can increase their dividends. And I think that’s what you’re going to have to do here in this kind of environment. [54:24]

JOHN: So, you’re listening to the Financial Sense Newshour at www.financialsense.com. Part Two of the Big Picture coming up in the next hour.

Part 2

Post Script: Stage Two of the Raging Gold Bull Market

JOHN: Well, back to the future again. Last week we talked extensively, and we have been talking about a series called The Crime of the Century. We were pointing out on last week's program that when you're talking about investing in miners and other related juniors, it is important to stick to fundamentals because if you go into a lot of the chat rooms –and we're going to key in some articles here as well – there are people who are professionally paid to go in there and bash stocks that certain hedge funds are shorting for the purpose of driving the price down. Now, this is illegal activity, part of naked short selling and other related issues. But the point is, you need to know what is going on as an investor and why it's important to stick with the fundamentals. There is – well, there are a couple of ways I can direct you right now. First of all, we've gotten a lot of emails on this subject. We got an email from a gentleman by the name of Ben, who calls himself a flash guru. He's been working in New York with most of the major ad agencies as a flash creative developer, so on and so forth.

Then later on he talks his investments and concern with Minefinders. He says:

My main concern right now is with Minefinders. I've been doing my homework, learning about them listening to your show, reading their website information, reading SEC reports. Only one thing was standing out that technically the stock is in a bear mode.

And basically to summarize this without going on much longer, he looked at the fundamentals which looked good. He saw this discrepancy, Jim, between the fundamentals of the stock but then couldn't understand why the stock itself wasn't going up, and that's the whole subject of this disparity.

JIM: Well, we've been talking about when you're investing in the mining sector, you have to look at fundamentals. If you're investing in a junior or you're investing in a junior mining stock –and what Ben was doing, he was doing his homework, he was going to the company website, he was reading the SEDAR reports, the SEC filings and that's what you want to do. And also, the thing that we have always pointed out is always go to the horse's mouth. And what discouraged him is, you know, going to the chat rooms and then basically saying, “Hey, the stock should be doing a lot better. It goes up and then it goes down.” And he was looking at the stock from a chart. And as Jim Sinclair has said and as we did on the program, the reason that you stick with the fundamentals is a lot of times you have people that are into these – they are large short positions. There was nothing wrong with the company, but there was a massive –and I'm talking about massive – short position that was put into this stock. And so the shorts were trying to control the price of the stock. And that's why we always say when it comes to looking at the mining sector – you're looking at juniors in the case of Minefinders, Minefinders is going from becoming a junior developing company to an intermediate producer, and that's going to happen here in the next couple of weeks.

So what we said is, “look, look at the fundamentals.” So we spent some time on Minefinders trying to value the company to its peers, PE ratio, assets in the ground, market cap per ounce of production, market cap per ounce of reserves. And here was a company that was selling for 25 cents on the dollar. That is the fundamentals. And the difference between what Ben was seeing in the marketplace with this stock and the fundamentals of the company had all to do with the massive short position that came into this company. And so sometimes because the shorts try to paint the tape –and that's why we played that clip with Jim Cramer how if he was short a stock how he would paint the tape and then use the media to try to influence the outcome of the position – in other words, if he was short a stock, he would paint the tape and use the media to put out negative stories and drive the price of the stock down so he could make money; conversely, if he was long the stock, he would use the media to put out stories and then he would use his buying power to drive the price of the stock up. And in terms of short positions, the media in this case – and especially as it applies to juniors – are the chat rooms where we know, for example, that hedge funds will hire bashers to go on the site and put out false information. And there was a particular basher who was part of a criminal ring. This has to do with Gold Triumph, Zimmiezee and there have been a number of them that go out there and try to put information – and you know, the two things that they always try to tell people: the company is going bankrupt or we're in a gold bear market. Give me a break. You know, the price of gold is up nearly five fold. The price of silver is up six fold and the company is not going bankrupt. So we spent a lot of time on fundamentals.

And that's what we're going to be talking about today. We're going to be talking about gold fundamentals – the fundamentals on bullion because these bashers are out there going out and telling people that gold is in a bear market. And it just goes to show you the stupidity of what they are trying to say. And it couldn't come further from the truth and we're going to get into the fundamentals of gold, and we're going to get into the fundamentals of the mining sector itself. And that's going to be the purpose of this hour. Last week we talked about some fundamentals of companies. Now we're going to be talking about the fundamentals of bullion, and then we're going to carry it over into the mining sector with the stocks themselves. And that's why it's important during this period of time of gold consolidating and what looks like, in our opinion, gold is getting ready to launch here into a major leg of the next bull market.

JOHN: You know, if people would like to follow-up a little more on this, if they go to the www.deepcapture.com website, there is a leading article in this whole ongoing blog series, Roger And Me, Insights into the Dark World of Stock Manipulation, and it talks about a consulting group to hedge funds who were then instructed by the hedge funds to have their people go online to some of these chat rooms, like on Yahoo and Raging Bull and Silicon Investor, to bash the stocks that the hedge fund was shorted in, to be able to drive the price down. And in this particular case, some of the gentlemen who were involved in it, they actually received securities manipulations sentences. They were in prison because of that. [6:35]

JIM: Yeah. And that's one of the things that we did. We posted a piece over the weekend called America's Most Wanted. And what we did was we took these nefarious characters, these stock felons and put a compilation of all of their posts so that you could see 200, 300 posts. And just go through every one of them. Just peruse them and you see that it was obvious that stock manipulation is taking place here. And then we said that the best place –and I've been told this now by the authorities, if you're caught doing this, this is a felony and you go to prison. And that's what you'll find at the Deep Capture site about these stock bloggers that were in prison because they were caught for this. And what we did is we had a little post there, how you can post the FBI.

And what we'd like to see is anywhere from 1000 to 2000 complaints to the FBI. And if the FBI gets enough complaints on these characters, they look into it. And John, when they look into it, these people are caught and put behind bars because what they are trying to do is scare people out of a position, so that they'll sell so that they can cover their short position. And John, in the United States, at least, that is illegal, and if you're caught doing that, you are put in prison. So what we would like to see if you're listening to the program, go to our Most Wanted and just take a look at these characters, click on to their Yahoo post, read them for yourself and if you're convinced as we are that this is part of the criminal ring, then turn them into the FBI. And I'd like to see a couple of thousand posts sent to the FBI to get people on this because otherwise you're going to see people like Ben here, who are doing their homework, and all of a sudden you get these characters that come on the board and scare people out of their life savings. [8:22]

JOHN: Yeah. It's important that people know that these things exist. That's the important part, whether anything ever happens with the FBI. At least you as an investor that can understand what's going on out there.

JIM: Yeah. And the other thing is they are paid per post, so the worse thing that you can do is respond to these criminals because every time you do, they are getting paid. So basically put them on ‘ignore’ and don't respond to them because then you cut off their revenues. And if people don't respond, then they are not going to get paid. So that's one of the things that you've got to stop doing is people respond to them and all you're doing is helping these people earn income and at the same time scaring other people.

So anyway, it's time to go back into gold fundamentals here and why we think this is the next leg of a raging bull market is about to begin. [9:07]

JOHN: You know, and just as a final on this –we need to get back over the subject of the fact that we're really in a raging bull market here and we're probably going to see the next leg of it really shortly here – but the cover story for Vanity Fair, which you can get on their website (www.vanityfair.com) is called The Collapse, Bringing Down Bear Stearns,and it's probably the greatest financial scandal I would say of, at least, the decade – where starting on the beginning of the week, Monday, March 10th, everything looked like it was going to be pretty well with Bear Stearns, they'd come through a lot of rough times, they thought they had it under control and by the end of the week, it was a disaster, and that there was somewhat of a concerted effort to achieve this. So this is the type of thing going on out there in the real, big world. But let's get back to the concept of the bull market in gold, Jim.

JIM: Well, let's talk about one of the things that the bashers have been talking about and scaring people that the major mining companies are going to go bankrupt and that gold is in a bear market. Well, the first thing, all you have to do is if you have access to a computer is call up a stock chart and just take a look at whether you're looking at the Amex Gold Index, the HUI or the XAU, take a look at that index since 2001; or pull up a chart of gold since 2001, or silver, and just take a look at the precious metals –gold, silver, platinum, etc. And one of the amazing things, and we had this happen over the last couple of years – Jeff Christian, who we had on the program with his Annual CPM Gold Book and his silver book – and we recommend if you have a chance go to Amazon or go to CPM Group's website and get a copy of it, and take a look at fundamentals for gold and silver because they have never been better – in fact, as we talked about last week and as Jeff talked about in his gold book and his silver book for 2008, we have seen record gold buying in bullion and record buying in silver – something that Jeff has never seen since he's covered the industry.

Normally, in previous bull markets, you'd see strong bullion buying that would last about two years and then it would sort of phase out and gold would go into another decline. That has not happened. We're talking about the seventh consecutive year of record buying. In fact, the buying of gold and silver bullion has been so pronounced that the US Mint has had trouble –as many of you have reported here – in delivering silver Eagles. There were more silver Eagles sold in the first quarter of 2008 than the entire year of 2007. And the US Mint has had to put a lot of the coin dealers on allocation because they don't have enough. They have been having a hard time getting the silver blanks. And reason for that, John, and you can see this, is that gold is once again assuming its role as the world's global currency: Gold is going up against the dollar; gold is going up against the Euro; gold is going up when priced in Yen; gold is going up and priced in the Canadian currency and even some of the strong commodity currencies. So what is happening as paper depreciates and loses its value, as inflation increases around the globe, you are seeing a very strong inclination by investors to move into something that is tangible, that is preserving its value – just as oil is now playing catch up for nearly two decades of decline in a commodity bull market. If you price gold in current dollars and adjusted for inflation, and even though the inflation numbers are artificially low, we should be looking at gold at anywhere from 2000 to $3000 an ounce, depending on whose inflation numbers that you look at. And so it's obvious if you look at a chart of gold or silver since 2001, contrary to what these criminals are saying on the chat rooms, gold is in a roaring bull market. And you can see that take place today. There are so many factors that are driving the price of gold that I'd say the primary one is gold is now becoming the global currency of choice. [13:18]

JOHN: Well, obviously, strong buying is playing a role in this whole thing. Are there other factors that are pushing this up, and I guess one of these would be lack of confidence in currency, shall we say?

JIM: Yeah. A lack of confidence, the rise of inflation. But I think another thing that has happened is financial innovation. You know, you've seen the gold and silver ETF of the US, which brings in buying. You see the gold and silver ETF in Europe, they are developing one for India, they are developing one for Asia, and it makes buying bullion easier. Because, John, a lot of investors don't have the sophistication or understand the commodity markets to know that, okay, I'm going to set up a commodity trading account and trade futures. Most people are just saying, you know, I don't understand that. And you have a lot of people that are saying, “you know what, I don't even know how to buy gold, whether it's buying it in the futures market or going into a coin shop.” (Although, with the internet today, it's really much easier than a lot of people think.) But I would say that another factor that is facilitating this strong investment demand for gold has been exchange traded funds where you can buy an ETF in gold, an ETF in silver, you can even buy an ETF in agricultural commodities, you can buy an ETF in oil, etc. One thing that has happened, and I want to clarify this for my Austrian friends is gold production is falling way short. Gold is running a deficit. Now, the Austrians would say, “well, all of the gold ever produced still exists today.” But the problem that you have is offsetting the supply of gold, which is coming from miners, which is in decline. Mining production has been declining, so mine production has not kept up with demand. The other source of demand is scrap gold, the recycling of gold and also central bank sales. And central banks sales are in decline. In fact, a lot of people think that the era of large central bank sales as we saw in the 90s are coming to an end. And so that means there is less source of supply.

Now, granted, all of the gold ever mined in existence still exists today, but as you know, John, when prices start to rise or something, the significant thing that you have to understand about the gold market –and this is something I learned from really looking at the fundamentals of gold (as pointed out in the CPM gold books) – is that in almost 50 years of the gold market, there has only been two years where gold investors have been net sellers. So gold investors tend to accumulate gold and they hold on to it, so they don't divulge it. So when you have less supply than there is demand, the price is going to go up.

And I'm going to explain here as we get into the mining sector why I think higher prices are going to be part of our future, just as you're now seeing in oil, and that is because gold investors tend to be holders of gold. They don't flip out. And it's one of the reasons that –as Jeff has pointed out in his gold books – a lot of the investment banks and a lot of the brokers don't like gold bullion or silver bullion is people don't trade out of gold and silver the way they do out of stocks. And remember, brokers only make money if you're constantly trading something. And so that's why it doesn't have a lot of interest in the investment community and especially with brokerage firms as people know that as a broker, if you sell somebody gold, they are going to keep it. And so granted, the Austrians would argue, that, “yeah, all of the gold that ever existed is still in existence.” The point being, gold investors don't sell. They know it represents real money, so they hold on. So therefore, you have a huge supply deficit today where you have production falling below 2500 tonnes a year, and you've got 3600 tonnes of demand. And that demand is growing and getting even stronger as currencies depreciate and as money loses its value, and as the availability of more investment products that allow investors to buy an ETF. Strong demand is coming into the sector.

The other factor, and especially here when you look at the United States, is you look at interest rates today: You have negative interest rates. The two year Treasury note is at 2 ½%, which is well below the headline inflation number of CPI which is over 4. And as John Williams talks about, if you measure CPI by the old method, that rate of inflation is probably closer to 10%. Even the 10 year Treasury note is negative. So you have negative interest rates in the US. You have got declining central bank sales. You have had de-hedging by miners. I think gold miners have all gotten religion, and most of the major hedge book has been unwound, and so you don't have a lot of hedging going on. And you just have increasing geopolitical risk. I mean look at this debate on what is going on in the Middle East: Is Israel going attack Iran? Iran threatening to close down the Straits of Hormuz. I mean you've got rising geopolitical tensions, you have rising inflation, you have real negative interest rates; and you can just see, John, why the fundamentals for gold (as pointed out every year in the CPM gold book or even the silver book by CPM) have never, ever been as strong as they are today. And there will be, I predict, by the time we get to this point next year when CPM Group comes out with their 2009 Gold Book and 2009 Silver Book, it will show that 2008 will be another year of record gold and silver bullion buying as already reflected by the US Mint in putting people on allocation for silver Eagles. [19:17]

JOHN: Well, how about a factor such as peak oil because more and more people seem to be recognizing the fact that oil has been in decline since the -- what? The beginning of this decade. So that's effecting this whole equation as well, so that's going to increase as more and more public consciousness of that comes about. Although, given all of the talk about it on the media now, that's happening pretty rapidly.

JIM: There is a number of reasons that gold production is in decline. We had a two decade bear market. The small gold miners went out of business and closed. The industry consolidated and there was no major impetus to invest large amounts of money to increase capacity. You've got the introduction of the environmental movement over the last two or three decades, which is making it harder to bring a mine in production with permitting process, environmental impact, so it takes seven to 10 years now to bring a mine into production from grass roots discovery to the time you're doing your first pour of gold and silver. That's another element. Also, the shortage of materials and personnel in the mining industry. I mean it is hard today to get personnel, geologists – I don't care if you're looking at the energy sector or the mining sector.

But in my estimation, there are a lot of parallels between what you see going on in energy today and also the mining sector. I mean, you've got large companies such as Barrick that are saying that they expect a decline in mining output is going to be much more pronounced going forward in the years ahead. You've got Eric saying that you can see mining production decline between 10 and 15% going forward, and that could mean – and I'm going to get into what this means for the junior sector here in just a moment, but John, just as in the oil sector, the energy sector is having a hard time replacing its reserves. It's having a hard time replacing what it produces each year. We've gone two decades now in the energy sector where the energy companies or the world as a whole has not replaced what it’s consumed. The same thing is taking place in the mining sector. There haven't been major elephant discoveries. I mean the only elephant discovery in the last couple of decades has been Aurelian and it's Fruta del Norte discovery. But you're just not seeing Fruta del Nortes popping up – and that's a recognition even by mining executives who are saying that “hey, the big elephants have been discovered” and are lowering their sights in terms of what they are looking for.

Also, if you take a look at in the 90s when the price of gold was down, a lot of your major miners, whether you're looking at a Newmont, a Barrick or a Placer (now Placer being part of Barrick) is a lot of companies use their high grade deposit so that they could mine it profitably. Now, the low grade is out there and it's more costly. In other words, you're getting less grams per tonne of ore and so the output or the gains aren't as great. So you're seeing cash costs rising around the world and the mining costs per ounce have increased significantly; and we're close to a cash cost of almost $400 an ounce, which is another reason why if you just take a look over last year, production cost increased over 30% in Canada, close to 30% in the US. Taking a look at other sectors where large producers: Australia over 20%; the world as a whole saw production costs go up nearly 20%; in South Africa (where production has declined) it has gone up over 10%.

So the primary factors that are driving up costs are going to mean that prices are going to have to go up because it becomes uneconomical to mine something when your costs are going up for personnel costs are going up, your steel costs are going up, your energy costs are going up, everything that you do in mining – tires for earth moving equipment in short supply – and that's why you're going to see a major shift here and that's why costs have got to go up. It's the only way you're going to get a supply balance. [23:32]

JOHN: So as you wrap this segment down, here, Jim, let's do a summary on, I guess the fundamentals that are already facing us here, just one by one, and then your reasons for being bullish.

JIM: Well, if you want to summarize it: Gold production is in decline; central bank sales are in decline; and higher production costs for mining gold; and four, you aren't making major discoveries. All of those, John – plus the fact that the monetary environment for gold, the high inflation that we're seeing, the increase of money supply rates that we're seeing around the globe, all of the pipeline inflation – this gets back to what we talked about last week with El-Erian and Bill Gross talking about changing their asset allocation – all of these factors when you sum them all up tell me that gold prices are heading higher. I do believe, as James Turk talked about in our program last week, that we're going to see gold prices –and I think Turk may be right, we could see spike high to 1500. But let's put it this way, at the end of the year, we'll be settling at gold prices that are over 1000. Who knows where we're going to be on the energy front. So as bullion prices head higher, gold and silver, and especially as we retest the previous highs of $1,040 roughly, that is going to be a factor that's going to drive the equity section. Especially the juniors, to levels that you've never seen before. [24:57]

JOHN: Well, Jim, you know, you've been bullish on juniors for all of this time, but over the last five weeks, we've done the series on Crime of the Century which would seem to put up a real red flag to this whole thing if this is widespread as far as naked short selling. Why are you still bullish in this whole area?

JIM: Because, John, the naked short selling –all of the things that are going on right now, they are operating against the tide. In other words, you cannot keep fundamentals down for a long enough period. A lot of people have said, “you know, if central banks control and they are trying to bring down the price of gold or manipulate it” or “the short sellers are trying to bring down the price of gold stocks by shorting…” Well, you can bring down something in the short term and you can manipulate prices in the short term, but not in the long term because in the long term, John, the market always wins. And it's very obvious, and especially as we get into the fall, that inflation rates aren't coming down, the credit crisis hasn't been solved. And a lot of the issues that we've talked about in the outer edges of the Oreo, I think it's going to become very obvious to individuals that inflation is going to demand of investors and bonds are going to be demanding higher interest rates. And contrary to opinion –as some people say, “well, if the Fed begin to raise interest rates, that’ll be negative for gold.” Just the opposite. You can see this with the rise of interest rates in the 70s, and along with it rising gold prices all along the way. And it wasn't until real rates of interest got up to higher than the inflation rates where you saw interest rates at 21%, inflation was at 14, at that point financial assets once became the real value versus commodities.

But the most important thing that you have to understand about this sector is you have to be a long term investor because there are periods of time where a particular asset will no underperform. I mean we got into the energy sector at the beginning of this decade and oil prices went from 20 to $40, and the energy stocks went nowhere from 2001 to 2003. So we were in that sector collecting dividends, but the energy stocks didn't really begin to take off until oil was over $40; and it was between 2003 and currently that the price of energy stocks caught up. Now, I don't expect that to last very long in the gold mining sector because one of the comments made by Barrick that not only did they expect production to go into decline, but the head of Barrick said, “We are now looking for acquisitions to fill our pipeline.”

And unlike the past, John, the majors have now realized that most of the major elephants have been discovered and Barrick talked about companies on their radar screen, they were looking for deposits for two million ounces or more, or companies just about ready to go into production. And that's one of the reasons why we think that companies that have close to two million ounces that are in safe jurisdictions – and safe jurisdictions, my two favorites would be Canada and especially the Sierra Madre gold belt in Mexico. Just about any junior with two million ounces plus, or any miner going into production in the Sierra Madre are going to become a target for acquisition. That’s because one of the things that if you're a Barrick or you're like last week we talked about Northgate, if you're going to go on the acquisition trail, number one, you want a deposit that is sizable – and two million ounces of reserves or two million ounces of measured and indicated ounces means that you could probably turn that project into a 150 or 200,000 ounce producer. Now, in this kind of market, that's a good deal of profit. And also, most of these companies that have two million ounces have a large enough of a property – just as we mentioned in Minefinders: In addition to their 4 ½ million ounces of reserves, they also have underground potential and they have the ability to expand that deposit; just as many of the up-and-coming late stage development plays in the Sierra Madre or in the Canadian belt have the potential to expand beyond two million ounces. We announced last week Agnico-Eagle just invested 50 million dollars into Gold Eagle which is an up-and-coming development play. And so this mergers and acquisitions, last year, were at a record level. I think this trend is going to continue.

I think there is going to be an upcoming trend for consolidation in the sector. That will continue this year, and you're going to see a wave of takeovers. You've already seen the major companies move into this arena. Barrick announced that it is going to be making acquisitions. Northgate has said that it's going to be making acquisitions if you read their registration filing. You've seen Agnico make a move and get invested in another company. So the major companies, the Barricks, all of the way down do the second tier of majors –the Agnicos – have already announced and told you what they are going do. And the thing that is going to be very important, what's going to trigger this wave is the miners (including those that have large hedge books like the Barricks) have now unwound the major problem of their hedge book, and they have a large enough financial space now that they are going to have the assets and the cash to go after. You may acquire a junior just to get not only a deposit but also their acquisition team, especially in the juniors. Late stage development companies have qualified geologists on staff.

And then more importantly, a lot of these companies are recognizing that they have to diversify regionally. In fact, there was a report issued by Price Waterhouse Coopers that talked about takeovers in the mining industry increased by nearly 70% in 2007 with transaction volume roughly about 158 billion. That was up over 189% in the previous year, and they expect that that to continue; the deal volume in Asia was up 72%; Africa up over 80%; South America up over 50%; and also even in China.

And they did a rather interesting study. If you take a look at the companies that make up the large producers, if you take a look at the large producers in the HUI, there are only two companies that have been able to increase their production. If you look at Barrick's production, it's gone down from almost 8.6 million ounces in 2004 down to 8 million ounces and it is in decline. Anglo Gold has gone from 6.l4 million ounces down to 5.4, so they've seen their production decline by a million ounces. Newmont has gone from 7 million down to roughly 5.2. You've seen Gold Fields go from 4.5 to less than four. Goldcorp –as I talked about last week, the companies that are being rewarded with higher market cap are those companies that are increasing their production because in a gold bull market, you want to be with companies that are not just making more money because the price of gold is going up, [but] the companies that are producing more gold. So Goldcorp has gone from roughly a 1.4 million ounces to producing roughly 2.6 million ounces this year and they are on their way to 3 million. Harmony, Kinross, all of the majors are seeing their production go into decline and that's why they are saying that they are now lowering their sites and they are saying, “You know what, if you're in a safe jurisdiction, if you have two million ounces, you're on our target list.” And that's why I think you're going to see, John –once gold takes off and heads over $1000 an ounce – you're going to see wave upon wave of acquisitions that are going to take place by the majors –from the Barricks, the Newmonts, all of the way down the line to the Agnicos to the Goldcorps and to the intermediate producers, the Yamanas. I mean you've already seen Yamana make a major wave of acquisitions, including their take over of Meridian here in the last year. But I think you're going to see more of that take place as we get into the second half of the year. [33:30]

JOHN: Well, obviously, you think that the fundamentals are calling for higher gold and silver prices, but if you're looking for indicators in terms of takeovers like is there is a list of which companies are going to be on that shopping list as far as take over candidates.

JIM: It's something that I've maintained for a long period of time is you want to look at a late stage junior, somebody that has got close to two million ounces, preferably measured and indicated because that gets you closer to a feasibility and it gets you closer to the economics. And so something with two million ounces plus is a good candidate and that's what Barrick has said, and that's what some of the other majors have said. Two, you also still want to have some blue sky because remember, if a take overtakes place and you buy a company, let's say that has two million ounces, if you can take the development drills and find another million ounces or another two million ounces, you just drove your acquisition cost down in half. So you want close to two million ounces in preferably measured and indicated because it gives you better economics or you have a better idea about the economics. Two, you want blue sky potential, so you want the potential to increase the size of the deposit. Three, you want it in a safe political jurisdiction. You don't want to go after a company and then find out, you know, the greenies show up and shut down the project. So you want a mining friendly territory, or a company that's close to its permits or getting its permits.

Four, you want a company that has good personnel because a lot of these mining companies – remember, there is a shortage of drills, there is a shortage of personnel. So if you have a crack acquisition team right now, that also becomes an important attribute because not only do they get the deposit, but they can hopefully convince the existing personnel for the company to stay on, through incentive bonuses, and help develop that project because there is a shortage of personnel. So those are some of the key characteristics, I think, right now: Two million ounce deposit, blue sky potential, friendly jurisdiction and then also have qualified personnel that can help run the project if the mining company takes over. [35:51]

JOHN: If you were looking for these areas, the best areas for these thing to take place, where are you going to find this information?

JIM: You know, if I was looking right now and I was a mining company, I would be looking at safe jurisdictions and I would say, just as you saw Agnico make a play for Gold Eagle last week investing 50 million, Canada, safe jurisdiction – I love the Yellowknife area. You saw Newmont take over, Miramar. So, I like Canada as another area. But I think even more so, one of my favorite areas is Mexico, and especially the Sierra Madre gold belt because one of the problems that miners have had in maintaining their margins is that they sell their product gold or silver denominated in dollars. Commodities are priced in dollars. However, you want a jurisdiction where your cost in the local currency aren't going up against the dollar because that is going to squeeze your margin. And one area that has been very attractive compared to the rest of the world has been Mexico because Mexico's currency has not been going up as dramatically as some of the other currencies, so your costs are close to what it is in terms of dollars, which is what you mine. So I would say the Mexico would probably be number one because number one, you have mining friendly laws; two, the currency isn't an appreciating; three, you've got good labor costs, infrastructure, a mining culture. So I would say anything in the Sierra Madre gold belt, which is probably one of the most prolific gold and silver belts in the world. So I would say probably number one on the list has been the Sierra Madre belt and you've already seen takeovers in that area take place, not only last year with Coeur D'Alene’s takeover of Palmarejo, you've seen Glamis come in and take over Francisco Gold; you've seen Glamis taken over by Goldcorp. You just take a look at that neighborhood. It's like Rodeo Drive of the mining area. And so that's where I'd expect these thing to take place. [37:57]

JOHN: You know, you've always stressed sort of three factors here: Property, of course –looking at the factors of the mine that's involved – the people, the quality of the staff and the management of such an operation. But there is also a factor called patience, and why is that just as important?

JIM: Well, you know, anything worthwhile investing in plays out long term and I believe in long term trends. You know, a number of years ago, in the 90s with the S&L crises, I began investing in real estate because you could buy properties for 60 cents on the dollar. In 1995 I bought my first commercial office building, and it was located up in the hills up in Poway, and there was a large commercial industrial development that was going on. A builder had gone in there, built his office building and was going to develop 500 acres in an industrial park, and it was based on the idea that you would have defense contractors or subcontractors come in here, build their plants and they would supply parts to General Dynamics which was the largest manufacturing firm and employer in San Diego at that time. But with the 91 recession, California raised income taxes, they raised workers comp. General dynamics just packed up and moved out of the state and they really created a major recession in real estate here in San Diego. But I was leasing at the time, and my lease came due and I was able to buy my first commercial building for almost 60 cents on the dollar. Now, the problem was it was in an area that was located probably four or five miles from the freeway, and I used to give – when I was building my practice back in those days, this building had a room that would facilitate 100 people for a seminar, so I gave seminars. When people would come to the seminar, John, they would get off the freeway and they would be driving east and thinking they were going out to the desert because you'd have to drive almost four or five miles until you got to that place. And when we first relocated there, we were the only building around and for three or four years, you know, our only company was coyotes and snakes.

But today, around the corner from that building is one of Geico's largest headquarters. Geico built a major center, processing center. Across the street from that building is a Costco and a Home Depot, and now that whole area is filled up.

And so most important thing if you're going to go into this sector of investing, if you're going to go into investing in juniors, you've got to know your fundamentals, you have got to know your company, you have got to believe that we're in this bull market and you have got to have the patience to hold on even during periods where you get these corrections, whether they are correcting because the gold market is correcting or the stocks aren't doing well because there are short positions. You've got to hold on. In the end, this will play out and this is no different than the tech sector in the 90s where, you know, at first everybody went into the Intels, the Microsofts, the Dells. By the time you got to 95, it was the small tech stocks that you got the 10-baggers, the 20-baggers, the 50-baggers and that's what's going to happen in this sector and I believe that firmly. And so rather than looking at this as negative, I would look at this as an opportunity. You have a chance to buy gold in the ground at 25, $30 to $50s an ounce ,or you can buy an up-and-coming producer at $100 an ounce, versus $300 an ounce or 3000 an ounce. And to me, you don't get these opportunities very often in life, but this is one of them. [41:36]

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

Dragnet vs. Naked Shorts

Ladies and gentlemen, the story you are about to hear is true. The names have been changed to protect the guilty.

This is the net. Some people bash for pleasure. Some bash because they think they can get away with it.

JOE SATURDAY: You never know. My name is Saturday, Joe Saturday. I'm a blogger. I was working the day channel on the blog when I got a post from Financial Sense. There has been a bashing.

FINANCIAL SENSE: There has been a bashing.

JOE SATURDAY: Yes, sir. I just said that. What was it?

FINANCIAL SENSE: My stocks.

JOE SATURDAY : Your stocks.

FINANCIAL SENSE: Yeah. You know those things you buy when you want your share of the securities.

JOE SATURDAY: The security shares?

FINANCIAL SENSE: That's right. We call them stocks in this business.
JOE SATURDAY: Stocks scandal.

FINANCIAL SENSE: What's that?

JOE SATURDAY: Nothing, Sir. Now, can I have the facts. What kind of scandal would bashers share?

FINANCIAL SENSE: They were short sellers, Sir.

JOE SATURDAY: What kind of short seller?

FINANCIAL SENSE: Naked short sellers.

JOE SATURDAY: Why were the short sellers naked?

FINANCIAL SENSE: They’re not really naked. They’re insufficient.

JOE SATURDAY: Would Viagra help?

FINANCIAL SENSE: No, sir. Not that kind of insufficiency.

JOE SATURDAY: Sounds silly.

FINANCIAL SENSE: It's not silly. Insufficiency. Their short stock stockpile is insufficient.

JOE SATURDAY: Insufficient short stock stockpiles sold by silly short sellers.

FINANCIAL SENSE: That's right.

JOE SATURDAY: And they do this on the blog?

FINANCIAL SENSE: Yes, sir, Mr. Sunday.

JOE SATURDAY: I'm Saturday. Sunday is my sole day off. Let me get this straight. They scribble shady sayings on the site to send securities short?

FINANCIAL SENSE: There is one other thing.

JOE SATURDAY: What is that?

FINANCIAL SENSE: They do it at the last second of the trading day.

JOE SATURDAY: The last second?

FINANCIAL SENSE: Uh-huh.

JOE SATURDAY: So short sellers scribble shady sayings in the last seconds of selling sending securities south for species sake?

FINANCIAL SENSE: Sad, isn't it?

JOE SATURDAY: Sure shooting. Sure stinks.

I'm Dreaming of an Oil Crisis by David Farant, FSN listener

Gentleman, rather humorous adaptation. I'm Dreaming of an Oil Crisis submitted to us by David Farant here on the program. (http://www.financialsense.com/fsu/editorials/2008/0705.html.)

Shut Up and Drill!

JOHN:Well, there is still static in the pipelines, so to speak, Jim, about exactly what nature of the oil crisis is, which typically happens whenever crises catch up with politicians, they get into a finger pointing frenzy. But, of course, that does absolutely nothing to solve the problem. And you know, one of the biggest arguments I'm hearing every time somebody brings up a possible solution, it's like a) we can't drill our way out of this, or b) that's not going to solve the problem or c) we can't achieve independence or d) the alternatives are not going to do it. And in reality if you look over all of the picture, it's really a, b, c and d. We have to do all of it. It's not this or that or that or that or this or that, but that's the way the static-y debate is being conducted right now.

JIM: Well, it's not only being conducted in – number one, we can't drill our way out of it and a couple of weeks ago we did a show on this and said the reason to start drilling is over the next three-to-five years we're going lose close to 3 million barrels a day in the United States. We are going to lose almost one million barrels of our own production which will be going into decline, and we pointed out as we began this decade, we were producing close to, I think it was 5.8 million barrels of oil. Now, I'm not talking about oil equivalent (coal-to-liquids or gas-to-liquids or the other forms we're bringing in as a supply). And we said that also a lot of the areas that we import oil from, Mexico being one, beyond 2012, 2013, Mexico will cease to be an exporter of oil, much as Indonesia, which used to be a member of OPEC and was an exporter of oil is now an importer of oil, or Great Britain which used to be an exporter of oil because of production out of the North Sea is now an importer of oil. I think it was 2006 that Great Britain began to import oil. So the reason to start drilling right now is, number one, I think it would help the psychology of the market. It would say, “the US is finally waking up and is going to do something about it.” But also it is to help transition to a point where we either go to plug-in hybrids, hybrid technology, electric cars, whatever the solution is going to be on the transportation front, it's a liquid fuel problem right now. And John, we still have trucks on the road. We still have railroads that run on fuel, and we still have airplanes that run on jet fuel. So you're still talking not just about the American consumer driving, but you're also talking about the transportation system – the way we get people to places or we get goods to the store or across oceans – it still runs on liquid fuel. And so, there is a number of reasons why, but I still think that we're still stuck on stupid and the blame game. [48:08]

JOHN: You may have to put this into perspective, too, Jim, because back in 2001, you and I were talking about this as an emergent event. Remember, we go all of the way back there when oil was still at $20 a barrel, and when if you said it was going to 50, of course you were a little strange and probably not in accord with what Main Street happened to think. Now, we're at over 140 in 2008. We still see a lot of the congressional hearings looking for someone to blame. It's like “just make the pain stop, get those prices down again” – without realizing that we really have passed into a new paradigm here, and yeah, you can work to get the price down, but it will not happen overnight and that all of these alternative are going to be necessary to do it.

JIM: And also the problem, John, of blaming it on somebody, how do you fix a problem if you don't recognize it as a problem? If you're simply trying to shift the blame to somebody else to deflect from the fact that you've done nothing – I mean, our solution right now is: Let's don't do anything but bring down the price. And I think this comes from the arrogance of government that, you know, they can just pass a law and say “we want low oil prices, we're going to pass a law and we're going to bring it down.” That's not the way markets work. In fact, a number of specials that have been done on the oil crisis, the best one I've seen, was the one that was done by Fox News, but they were basically saying the only people that don't understand supply and demand are people in the US government and particularly the US Congress. And until we start recognizing that this is a problem that's not going to go away, we're not going to solve it.

The rest of the world, when we came out of the 70s oil crisis, Europe went to higher taxes to discourage consumption, so you see if you drive, go throughout Europe, you see smaller cars. Europe – I mean if Americans are upset about $5 and $4 gasoline, imagine in Europe where you're paying 9 and 10 dollars for equivalent gallon of gasoline. But also, in addition to building more fuel efficient cars and using tax policy to drive that, they also built nuclear power plants. So you have Sweden, countries like France today that are getting 75 to 80% of their electricity needs because remember throughout the 80s and 90s, look at all of the electrical devices that we have had. Computers now are ubiquitous and everybody has a plasma TV, big screen TV; and it's not just the TV, it's surround sound. So we're using more electricity. And think of if we go in to plug-in hybrids; so instead of the demand for electricity going down at night, everybody is going to have their car parked in the garage plugging in to the grid system recharging their batteries. And the problem is we keep denying we have a problem and we keep trying to point our finger. And that's why we have said the only way we begin to solve this crisis is when we actually have a crisis. One of the next crises to unfold is, I think, we'll eventually get to rationing, and I think we're only, what, 18 months to 24 months away from seeing that happen here in the US. [51:23]

JOHN: Put gasoline tanks in your backyard. Do it quickly before everybody else figures this out.

JIM: Or get a hybrid or an electrical car. And we've been telling people that one of the things that you can't do and get them now, even Toyota is having a hard time of cranking out enough hybrids to meet demand. And even the big automobile manufacturers – there was a story on Bloomberg where GM is now coming out with a 40 mile per gallon mini car because buyers are getting burned by $4 gasoline. The market is doing, contrary to what politicians say, the market is doing exactly what it should do: It is price rationing. As the price of gasoline goes to four and then goes to five and eventually to seven and nine dollars a gallon, what are people doing? When their lease comes due on their SUV, they are trading it in. They are getting fuel-efficient cars. And even here in California, John, where the remarkable thing I'm starting to see are more fuel-efficient cars. I'm seeing Priuses everywhere here in Southern California. And you're also starting to see some of these mini cars. In fact, it was last weekend when I was on the freeway and I came across this new smart car that Mercedes has come out with. My goodness, I thought it originally it looked like a golf cart that was on the freeway; but I was surprised, this car was going 75 keeping up with the rest of the traffic. But you know, the market is doing exactly what it does best.

When you have more demand than there is supply, the price rises until it encourages or reduces demand. So you're hearing stories about Americans driving less this year, gasoline demand is down, and also that more Americans will be staying home this 4th of July weekend, so the market with higher prices is doing what it's supposed to do. The only people that aren't doing what they're supposed to do are politicians. [53:19]

JOHN: Yeah. But they're doing what they always do.

JIM: That's the problem.

JOHN: That's the problem. And all we're hearing right now from politicians, it's the usual clichés. Look at ads everywhere, in television, I thumb through magazines to see what's going on and it's green this, green that, green this – and even that's all questionable. Bottom line is a lot of the green isn't really going to solve this problem, not in the short term.

JIM: No. And the problem that – the reason why we're here today is the rest of the world began to industrialize; and industrial economies are more energy dependent, so they are consuming more energy in China, in Latin America, in OPEC, in India. And that's competing with our demand even though we are conserving and our demand is going down – like last week when we did the BP Statistical Review, demand was down here but it was growing elsewhere. But more importantly, and one of the reasons why we're getting to that crisis stage that the international energy agency talked about is excess capacity has evaporated. It used to be if we were to go back nearly over a decade ago, you had excess capacity within OPEC that was, you know, between six and eight million barrels a day. We don't have that today and there are people that are questioning that excess capacity has now fallen to nearly one million barrels a day. So if you have a hurricane this summer that takes out part of the production capacity in the Gulf of Mexico, or you have some kind of disruptive event in the Middle East or Nigeria, you don't have that spare capacity.

And it's not just spare production capacity –whether you're dealing with well head shut-in supply, physical delivery system, you're talking about drilling rigs – there is a shortage of drilling rigs; oil service assets, refinery capacity. One of the problems that we have: when the EPA changed the sulfur content of gasoline and diesel, refineries have to run at higher temperatures, and a lot of America's refineries are 50 to 70 years old, so running refineries at higher temperatures, you're seeing a lot more shutdowns and a lot more repair in maintenance because, you know, it's just like a person. As they age, when you're 70 years old, you don't recover from an injury the same way you did when you were 50, 40 or 30; and it's the same thing with a refinery that's 50 to 70 years old. And I mean the whole energy complex is aging and rusting. And that's why you have seen not only do we have a shortage of supplies, but you know, you take a look at the energy industry, the infrastructure of energy is steel. Steel rusts. It decays. It has to be replaced. And that's why you're seeing shortages. Materials have gone up, supply additions have waned, demand has grown, prices have soared to new heights. Periodic shortages or spot shortages. There is a tightness in just about everything. For example, we reported a number of weeks ago, you had one oil company, Petrobras, that has tied up nearly 80% of the world's deep ocean water rigs. And the other thing, John, is if you take a look at what some of these rigs are going for today, where the lease rates are at $700,000 a day, you know, some of these platforms –remember, a lot of these got destroyed in 2005 with Katrina and Rita – a lot of these platforms that would have to be rebuilt and replaced because a lot of the platforms in the Gulf of Mexico were designed for a cooling era in the US when we had cooler temperatures and you had less hurricanes and warmer weather. Now, we're going from that decadal oscillator cycle where we had warming weather –and warm weather creates more storms in the Gulf of Mexico. And a lot of these platforms that were built 30 or 40 years ago weren't designed for today's hurricanes where you can get 150 mile an hour winds and 50 to 70 foot seas. And a lot of these platforms, if we're going to replace them, they are going to take nearly a billion dollars just to build a platform. And if you take a look at the raw materials that go into the energy industry: You've seen this carry over into steel costs; tin costs are up 200%; Nickel cost up 630; Copper costs up 500%; Iron ore prices up several hundred percent. I mean, how high can prices go? Well, it's going to go higher. You don't have the supply. You don't have the personnel. You don't have the materials. You don't have the rigs. You don't have the refineries. You don't have the pipelines. You don't have the discoveries, and we're still debating looking for somebody to blame. That's why I think that despite where we are today, we're still going to be looking at much, much higher prices.

JOHN: Well, if you remember, you've been forecasting all of the links as we've gone up the ladder, so to speak, 50 and then 100 and then 125, and we've now reached the 145. Do you really think we're going to go a lot higher? Will this thing plateau?

JIM: I think you could see especially if we have any kind of major storm problems and as Joe Dancy talked about in the first hour, we're seeing hurricanes or storms emerge in the Atlantic much earlier than anticipated. And so, if we have a serious hurricane go through the Gulf of Mexico or hit any of the coastal areas where 40% of our refinery capacity is located, we could have some serious problems. So at this point, you could see oil prices hit 150, 170 – what I call the ‘spike high’ based on some kind of non-linear event: a hurricane, something that goes on in the Middle East, another oil platform taken down in Nigeria, something happening in South America. The fact of the matter is, conventional oil production which peaked in May of 2008, continues to decline. So when you have conventional oil declining and non-conventional oil becoming more expensive –remember, non-conventional oil, whether you're talking about shale, tar sands, coal-to-liquids, gas-to-liquids requires more energy input for energy output. And you know, in 2005, the average production was roughly 73.8 million barrels a day. It declined to 73.5 million in 2006; in 2007, conventional oil production fell to 73.3 million, and I would suspect it's much less, so we're continuing to see that conventional oil continues to decline, non-conventional oil continues to require more production to produce. It takes more energy, takes more natural gas consumption, more consumption of water to produce oil from the tar sands. And so, John, the market is going to do what it does regardless of what politicians say, which is: Prices will continue to rise until we're going to get a major drop off in demand and major demand destruction. And it will continue to climb until both the forces of supply and demand come into balance. [1:00:46]

JOHN: You know, there is this very, very funny quote we've run across here by Rashid bin Saeed Al Maktoum, the Prime Minister of the United Arab Emirates by the way from 1979 to 1990, and this is his quote, he said: My grandfather rode on a camel, my father rode in a car. I ride in a jet. My children will ride in cars, my grand children will ride on camels. So that shows his outlook for the situation.

JIM: Yeah. Here is a sheik in the Middle East basically taking a look at oil being a finite resource. And that's the problem, John. This oil crisis –you asked me earlier, how high are oil prices going to go. We already hit my second forecast. We already hit $145 oil, and I think we could see 150, 170. And the problem is until we recognize we're going to have a problem and start doing something about it, the price will continue to rise. And any attempt by politicians to somehow either penalize oil companies or try to artificially change market forces will only make the crisis worse and will lead to rationing and shortages. And so that's where we're heading in the future, and it's one of the reasons why in the last hour I said that one area that I would be investing in, continue to invest in that has pricing power is the energy sector. I don't care if it's domestic producers of domestic oil and gas, if it's a large national oil companies that have, let's face it, they control 85% of the world's oil –whether you're looking at PetroChina, Petrobras, or Gazprom or any of the large national publicly traded oil companies, whether it's oil service companies. The major oil companies may not be doing well in Russia right now, but the oil service companies like Schlumberger, which earned over 5 or 6 billion dollars in fees from the Russians last year for providing services. So whether it's small cap stocks that can grow their production, the oil services, the national oil companies, energy, to me, should be a large part of anybody's investment portfolio.

And, you know, there is always this thought that, well, I already own a few energy stocks, but let's put it this way, if you only have three or four things that are working in a portfolio, that's exactly were you want to be. And just to put this into perspective, by the time we got done with the 70s when oil prices had gone from $2.50 a barrel all of the way to $40 a barrel, the energy sector was almost 30% of the weighting in the S&P. It's only about 15%. Where conversely, in the 90s, you saw the tech sector rise to over 30% of the S&P; or for example in this decade, you saw the financials go to almost 25% of the S&P. Now, they are reversing: the technology sector has come down significantly, the financial sector is also being reduced in the S&P, and the oil sector is increasing and it's going to increase and I predict by the time this all plays out, we could be back up to 25 and 30 percent of the weighting within the S&P. And I believe that you'll see more smaller cap companies or mid-tiered companies added to the S&P –whether it's an oil service company or a domestic producer. So John, I'd be investing in energy because notice only going to get worse because we have yet to deal with the crisis. [1:04:30]

JOHN: You're listening to Financial Sense news hour, www.financialsense.com.

Part 3

Q-Calls

JOHN: All right, everybody. Queue up time. Time for the Q-lines. Q-lines means Question Line. The question line is open 24 hours a day for your calls, questions and comments to the program. We ask you to keep the comments under a minute because we have a lot more people calling nowadays; and if it gets too long, we just can't take your phone call. The toll free number for the US and Canada is 800-794-6480. That's toll free US and Canada, but it does work for the rest of the world.

And please remember as we answer your questions here, that the content on the program is for information and educational purposes only and should not be considered as a solicitation or offer to purchase or sell securities; and responses here to your inquiries are based on the personal opinions of Jim Puplava and because we don't know a lot about you, we cannot take into account your suitability, your objectives, your risk tolerance – any of these important factors. Always consult a qualified financial advisor before making some investment decisions. And as such, Financial Sense Newshour shall not be liable to any person for financial losses resulting from investing in companies or other issues profiled here on the program. The first call is from Raleigh, North Carolina.

This is rich from Raleigh. I have a quick question for you. Natural gas, natural gas stocks, would you be buying the dips right now, or would you wait for a significant correction to increase the value of your natural gas positions?

JIM: You know, Rich, we're going through a correction here and I would be buying the dips because if you're looking at the S&P sectors this year – there are 10. Within the S&P there is only one sector that's in positive territory this year, and that is the energy sector, which is up about 5 percent. And I do expect in the area of natural gas –on this Thursday, we have natural gas prices, Henry Hub spot at 13 bucks, and I think it's heading to 15 by August. And the warmer temperatures that we're seeing in the Midwest is also driving demand for natural gas used for air-conditioning; and God forbid we have some serious hurricanes, so I would buy in the dips and continue to accumulate. [2:23]

Hi, Jim and John. This is CJ from Massachusetts. Love your program. I'm talking fast so I can get this all in. You keep mentioning that you suspect there’s going to be in the future means testing to qualify for Social Security. I'm suggesting that maybe here in a de facto way already. I have a friend who’s based his retirement plans on an estimated retirement amount of $1100 per SSA mailing –the statements that they mailed out. When it got down to the last few days work, she gave her notice to her employer, went back to SSA and they said, “Well, 1100 was just an estimate. We've done the actual pencil and paperwork and you're eligible for $821 a month.” And my friend said, “how can you be off by that much.” And they said, ”well, let us take a look at it again.” They went back and pretended to do some more digging. They got back to her a week later to make it all seem real like they had invested real time in this and they said, “after further review, we figure it looks like $930 a month.” To me, this constitutes a thinly veiled, de facto, after the facto, gun to your head, back to the wall, negotiated means testing. It's probably as effective as actual means testing would be in the future. I suspect the government employee pay and promotions are probably dependent on successful execution of this scam. I'm wondering if you can point out any recourse that you may know of and also suggest ways to prevent your listeners from this vicious scam in the future.

JIM: You know, CJ, that's not the first story I've heard. I had a client that told me they did the same thing, negotiated his Social Security settlement down. They are already doing that, and I guess the only thing you can do is try to get an attorney and try to fight them. But remember, the government has unlimited resources, but they are already going to means testing right now. I've had five or six people who have told me instances just as you describe. So it may already have arrived. [4:44]

JOHN: Does anybody know why that is happening, Jim? In other words, in terms of it they are giving you an estimate, and we all get these, a lot of us every year, “this is what we estimate you're going to get” and like he said, how can they been that far off? What changes the supposed estimate? They have to be giving some kind of a reason.

JIM: You know what, I think things are tight and I think they've been given the directive to negotiate this down. I had a retired orthopedic surgeon as a client. He went into Social Security and they told him he didn't qualify for Social Security. And I said “what!?” And that's what they told him. They said, “You make too much money, you don't qualify.” And I said, “you know what, you go back there and you tell them and you take your statement. You paid into Social Security, you have a right to Social Security, and if they don't give you your Social Security, hire a lawyer.” And he went back. But that's what they told him. So I'm hearing more and more stories of this. And if you are out there, if this has happened to you or you have heard stories, email us or call us on the Q-line because we'd like to alert people that this process is already taking place or is taking place today. It just hasn't been formalized, John. [5:43]

JOHN: Yeah. But either way, it's basically reneging on the promise that – and what's really tragic here is they are taking these people all of the way up to retirement, now, Jim, and saying, “Whoops, we made a mistake.” You see what I'm saying?

JIM: Yeah. Because the money isn't there.

JOHN: Because the money is not there. Oh, well.

Hi Jim and John, this is Rob calling from Niagara Falls. Quick question. Silver certificates from Switzerland – I have a Swiss bank account, and my Swiss bank swears up and down that silver certificates are actually backed by physical metal. They are not actually by law allowed to sell short, so I'm kind of leaning to buy them, and I'd like your opinion on those. The problem is if I have to take possession of the metal, I have to pay 7.5 percent VAT over there, and of course, fly over to Switzerland. Any comments you have on these particular certificates, if they are safe. Of course, I would prefer the physical, but in this case, I'd like to have some money in franks out of the country in case the government does decide to come up with a windfall profits tax, and again, I'd like your opinion.

JIM: Rob, if your Swiss bank tells you they are backed by bullion, I would be inclined to believe them. And it's better off than paying the seven percent, and especially having some bullion held outside of the United States. You also might want to take a look at GoldMoney which is a way that you can own gold and silver without paying the seven percent VAT tax. [7:05]

Hey, Jim, John. Thanks for everything you guys are doing a super job. Keep up the good work. If you need to start a money bomb or people need to donate a couple of bucks at a time to help you with lawyer fees to fight these short sellers, just keep us all informed. The question is, I made a big purchase. I did 111,000 shares of Tyhee a few weeks back and I was talking to my Scottrade accountant, and he said that there is no way that I could have any type of counterfeit shares and blah blah blah. And you know, after listening to the show and reading a couple of different forums, I'm awful nervous, so he suggested it was like a $90 fee to convert that into the certificates. Definitely like to hear your opinion. And then one other quick question: could you give us a one year three year and a five year on your opinion on these junior gold miners?

JIM: In terms of getting your certificates, if you're going to hold it long term, I'd take possession of your certificates because you don't know because Tyhee was on the naked short list in Canada. I know that for a fact. In terms of where juniors are going to be one to three, five years, I think they are going to be higher a year from now, but the gold stocks tend to be weaker during the summer months. So if you're holding this to 12 months out and we're talking about next summer, I would suspect they would be higher, but they even may be correcting from much higher prices. Three years, five years, definitely higher. If you listen to the second hour of the Big Picture when I talked about what the major companies such as Barrick have now got on the radar screen – two million ounce deposits in safe political jurisdictions – certainly Tyhee would fit into that category. [8:54]

Hi Jim and John, my name is Robert. I am from Ontario. I have stocks in two silver companies ICU Silver and Scorpio based in Mexico. My question is: I'm getting very nervous about the state of Mexico, the stability. How long would you recommend keeping the stocks in the silver companies before they might nationalize the silver companies like what is happening in Central America and South America. I’d really appreciate…I’m a little bit concerned.. I have major holdings in these stocks.

JIM: You know, Robert, I wouldn't be concerned of Mexico, the Fraser Institute rates Mexico as one of the third safest places for mining in the world, and I expect that to continue. There is a strong mining tradition in Mexico. And also as Mexico's oil revenue start to decline, as they are doing today, another source of jobs for the people and another source of income for the government has been from mining and I expect that to continue. They always get the threat of a leftist candidate. Just take a look at what's happened to Venezuela. You have high rates of unemployment now in Venezuela. The inflation rate is over 31 percent. People are beginning to revolt against is Chavez, which is the reason he's forming an armed police to protect himself. And then the other thing is food shortages. He's trying to control the prices of goods and food is disappearing off the shelf, so I mean he's ruining the Venezuelan economy at a time when oil prices are at 145 dollars a barrel, so I wouldn't worry about Mexico. [10:36]

Hello, Jim and John. This is Richard calling from Buenos Aires, Argentina. Jim, in the 1970s, the proportion of resource companies comprising the S&P was much higher than it is today. Will we ever see that proportion again, and if so, when? And if not, why not?

JIM: You know, Richard, I made a reference to this earlier in the Big Picture, but resource companies, I think energy at one time was like 25 to 30 percent of the S&P, and certainly the Barra index, it was closer to 30 percent. It has already moved from a couple of years ago from 6 percent, I think the weighting today is in the teens. I think it's 12, 14, maybe closer to 15 percent. I do see that weighting going up, and I think it's going to go up into the 20s again – whether it's 25 or 30, I think it’ll be closer to 30. And so I do expect to see that again. [11:31]

Ian, from Boca Raton, south Florida. and I just saw something in the news that might be of some interest. There is a 1.7 billion dollar deal with US sugar, when I first thought my instinct was that they have finally have done something right, they take sugar and turn it into ethanol like they do in Brazil instead of this crazy stuff with corn ethanol. When I read the rest of the news, it said they were actually going to be buying out US sugar to turn it back into Everglades. So I thought from going from a really cool idea to insanity, and I thought this is just the sort of thing you guys would like to be aware of.

JIM: Yeah, Ian, it's absolutely crazy just like taking a third of our corn crop and turn it go into ethanol when we know it's energy neutral. [12:15]

Jim and John, love the show. This is Donny from Las Vegas. Just wanted to let you know about a little program Citi is offering for the next four months, we will match 10 percent of the opinion time payment you make over the minimum amount due on your Citi premiere pass card account. Within three billing cycles after your credit period ends, we will credit your account with everything you’ve earned up to $50. Citi card is actually going to pay me to make a payment. Amazing.

JIM: Donny, thanks for sharing. [12:46]

Hi Jim and John, I thought metal stocks would rally in the announced spectacular rhythm. I have been listening to you and invested in Palladium as it seems to have more room to run. I chose to invest in North American Palladium. That company announced some spectacular results. 40 of the 43 drill holes returned positive and they do not know the boundaries of the reserve. And the same results indicate richest palladium concentration in the world. And it is not in a new location but under the same current mine. You would think that it’s bullish. Soon after the release, the drill hole results, they released lackluster economic assessments. Only if you read carefully, in a small spot, that this is based on older estimates and it will be updated for the new results. So many did not catch it. The stock tanked anyway. Went into naked short list. Only Friday it is out of naked short list as metals started moving and stock had some movement. But my question is: Do you have any opinion on PAL, North American Palladium. And how can stocks tank after such great results? What is the point of investing in mines if the stock doesn’t move from such great news.

JIM: You know, you're talking about fantastic drill results and how can a stock go down. You found out it was on the naked short list. Look, the play right now and the play since May of last year is to go short the sector, whether you have to drive the stocks down through naked short selling or just regular legitimate short selling. That seems to be the play, but I think that's going to reverse itself. And I think what's going to happen is you're going to see a series of acquisitions that are going to start to be made by the majors and the intermediate companies and I think that's what's going to change the dynamics; and especially if you get higher gold and silver prices, palladium prices or platinum prices. Eventually, you can't go against fundamentals. And since palladium and platinum are in short supply and that's being reflected in the prices that we've seen, I think, you know, eventually, you're going to see these stocks move. But right now, the play is to bash the stocks; and what is happening is the short sellers don't want the stocks to rally because they are shorting, and so when news hits, they are on the alert and they come in aggressively and short the stocks, which is probably what happened here. [15:02]

Hi Jim and John. Mike from Ontario. By preventing oil exploration and nuclear power plants, I'm wondering if the environmentalists have actually done us a big favor because the only thing scarier to me than a faltering energy supply is a collapsing environment. This evidence of this accruing is as fundamentally strong as the peak oil story. Ultimately a healthy world is more important than a healthy economy, something I think a lot about and thought I'd share with you guys.

JIM: You know, Mike, eventually, peak oil is going to solve the environmental story because as oil production goes down, as natural gas production goes down, it's going to solve it naturally, but the unfortunate thing is in impoverished economies where people don't have money, there is a disregard for the environment. And so when an economy becomes impoverished –in other words, if you can't get energy, you can't produce, you can't build your economy, the economy weakens and when the economy weakens and you come on tough times, it gets back to our debate “Rambo vs. Bambi” and in that case, Rambo wins. And the unfortunate thing is we need something to transition ourselves until we find out whatever the silver bullet in energy is going to be –whether it’s going to be clean coal, nuclear for electricity supplemented by wind and solar, electric cars, whatever it's going to be – it's going to take time. And we're going to see that technology develop but we need something to get us through there, especially as production falls. [16:24]

Hi Jim and John, it's Daniel in the UK. I was just wondering what your thoughts were on – at the moment I'm in the process of – I've got a year left on my fixed rate mortgage, and I was just thinking about getting out of it and getting a longer term fixed rate because I think interest rates could be going sky high, and I was wondering what your thoughts were on that. But also, in the BP Review, it says that the production is 81.5 million barrels to date. I thought it was meant to be 85. I just wondered if you could clear that up for me as well.

JIM: Daniel, if you can roll over and get a fixed rate mortgage because I think over the balance of what remains of this decade and the next decade, we are going to begin that long climb up in rising interest rates. Pick up When Markets Collide by El-Erian, that will kind of tell you about that, so I'd lock in that. In terms of production of fuel, this is conventional oil, which peaked in May of 2005. It's somewhere today around 73.3 million barrels a day, and the difference between that 73.3, and what is like 85 or 86 is non-conventional oil, and that can come from coal to liquids, gas to liquids or some of the biofuels. [17:38]

Hi, this is Chris from Florida. Man, you guys are the best. I can’t say enough about you – just the best. You’re the first stop on Saturday morning for me. Listen, I've cruised a couple of boards, and you probably read these too but a lot of people are asking out there for a naked short list, especially on small cap Canadian stocks. Is there any way to find that? I would maybe even pay for a service on it. I'm a Dines subscriber, so I'm long suffering. I doubt very much I'll resubscribe, so you'll probably get a flavor of which Dines stocks I mean. I'm rolling the dice with the highly speculative ones. What I've been hearing about basically the Canadian market allows naked short selling, and I'm not asking you for specific advice but just as a general thing, but shouldn't I just sell them and go somewhere else. I mean, isn't it too risky? Or, are they hitting rock bottom and the hope is that all of this attention to naked short selling is bringing some relief or some clean up to the whole industry?

JIM: You know, Chris, what I would do is either take delivery of your securities. I know the one that's you're subscribing to. We're getting probably closer to a bottom. The stocks themselves have been in a consolidation pattern. I don't know if you look at charts, but if you go to let's say a 5-, or better yet, a 10-year chart of the HUI, or at least go back to the year 2000, and you take a look at the chart going back to, let's say, 2001, you'll see that the Index itself goes through a corrective pattern. We go through sort of a consolidation pattern, then the HUI will go up and hit another high. Then we go through a consolidation pattern, then it will go up and hit another high. And these consolidation patterns last for, you know, sometimes 12 months up to 18 months, probably the longest lasting one was between 2005 and the August of 2007. And I think we're going through one of those short consolidation patterns. Especially on the juniors. But listen to my second hour segment when I talk about the next leg of the raging bull market. [19:52]

Hi Jim and John, Reg from North Carolina. Would you please address the wealth transfer in terms of the dollar taking in account the sub prime mortgage mess and the exponential increase in directives. The way I see it, we are in deep doodoo right now, and for some time to come. As Richard says [Spanish].

JIM: Sure. John, translate that Spanish there for me.

JOHN: He said what Richard normally says which is have a good day, and he added [Spanish] may God bless you.

JIM: Okay. You know, Reg, I do think we're in deep doodoo. You can take a look at the Fed and that's why we're talking we maybe heading for the darker outer shell of the Oreo sooner than I thought, and it may be darker than I originally thought because we seem to be not making the right decisions right now. And because we are so leveraged, the Fed is sort of in a box and we are dependent on the kindness of foreigners right now to still finance a good portion of the US debt. And I think we're going to be seeing that over the years as foreigners amass heavy losses in dollars – they are diversifying, they are doing that at a much more rapid pace today. They are not financing as much of our debt as they used to. They are diversifying out of dollars into Euros, although I think next year the Euro could get in trouble. And they are also diversifying into gold. And we haven't even hit the derivatives crisis and it was one of the reasons why you had a quick bail out of Bear Stearns, which is counter party... And we haven't even gotten to the credit default swap crisis; we didn't have time to touch upon it in the program today, but corporate bond defaults are expected to go from under 3% this year to double, to over 6% next year and there is -- what is it? 60 trillion or 53 trillion dollars worth of credit default swaps that are written out there by a lot of these hedge funds that have no reserves to back up. And if you start seeing corporate defaults go up to 6%, like I said, we're heading into a crisis, darker outer edge of the Oreo. But next year we're predicting from 2009 all of the way to 2012, it's going to be a crisis window eventually with the depression and then, well, I don't want to go much beyond that right now. I don't want to ruin your 4th of July weekend. [22:17]

Hey Jim and John, it's Brian in Tennessee. I just want to give you a thumbs up on your program when you talked about the oil companies from exploration and actual production and what the process is. A few years ago I lived in Louisiana and we had a lease to duck hunt in a swamp. I don't know what oil company came in, but the land owner told us they were going to be coming in and doing some survey work, maybe do some drilling. They came in air boats, multiple air boats worked seven days a week doing survey work as well as seismic work to determine the best place to drill. They did that for months, probably at least four months of riding around cutting trail in air boats. Then they decided on two sites to drill, and when they decided on the sites, they had to build a road into the swamp. We're talking mountains of gravel to build up into that filthy sludge so they could drive their 18-wheelers out there. Then they drove in there, erected these derricks and rigs and drilled. One of them reached nothing and they had to pull it out. The other one, it struck, and they ended up taking the drill out and putting in a pump. Now, they ran that pump for three months and then took it out, so -- Now, when they got done and it was all said and done and they pulled out, they had to remove the power line, the data line, as well as remove the entire road out of there to make it look like the swamp it was prior to them ever coming in. I can't even think of the millions of dollars that were wasted that they didn't strike any oil, at least none that would have paid for it. So, you guys are right on target when you're talking about how these congressmen don't have a clue as to what it takes.

JIM: You know, Brian, you bring up an interesting point, and that's why we thought maybe we ought to resurrect our program “No Congressman Left Behind,” but I think it would be rather useful for all of these just-say-no people in Congress is to spend one month on a job site on going through a company that has a lease, the things that they have too do and the cost that they go through and incurring, like you said, building the road, bringing in the drills and then cleaning up afterwards, and then also to go out on one of these deep sea oil platforms in the Gulf of Mexico. These people have no idea. I think most of them think that gasoline just comes out of a pump. [24:48]

Hi Jim and John, I'm Sandra from Texas. You keep saying that credit default swaps is the next leg to fall and you think the time is right for that next domino. You are not like me who has limited means or ability to do research. It would be very helpful if you would please – if you or one of your guests could name the names of the companies that are highly exposed to this toxic debt.

JIM: Sandra, the companies that are exposed to credit default swaps are the same companies that you're talking about, the money center banks, the investment banks and even worse the hedge funds because the hedge funds have no reserves or collateral to back them up. [25:32]

Good afternoon, gentlemen. This is Dave from far up-state New York. As always my compliments for the depth of your insights and the service they provide, but I have to say your financial insights far outweigh your environmental insights at times. Now, gentlemen, as you stated, humanity has consumed about one trillion barrels of oil, probably; about 1.1 trillion by now, in fact. Truly a staggering amount in the short petroleum era to date. Here’s a rhetorical question. Do you guys have children or grand children? Would they be entitled to any light sweet crude in the future? I was born in 1952, so I'm definitely in the consumption generation. The 30 billion barrels of oil on a continental shelf and at ANWAR represent only 3% of what we consumed, and a barrel of oil is not like a package of shell fish in the refrigerator. Relax, guys, the oil will keep. Trust me. My suggestion would be simply to get a man like Richard Heinberg, author of Peak Everything on the program. This would provide a coherent picture of resources and resource depletion going ahead because oddly enough, many of your comments dovetail remarkably with early 1970’s environmental textbooks on this subject, which saw the era of depletion and the era of shortages. I thank you once again for taking my comments and let's hope that the Oreo gets a generous portion of creamy filling in the weeks ahead, and let's hope that John Q. Public will spend a little more time getting a clear picture of both his environmental and economic world in the future.

JIM: You know, Dave, I think if you listen to the program we did a couple of weeks ago – I am an environmentalist. I'm a sailor. There is nothing worse I like to see than polluted water or people polluting the ocean. But one of the points that I was making on drilling, you're absolutely right and I made – if you listen to the program, the myth that we have is we can drill our way to energy independence. I dispelled that myth and said it doesn't exist. We never will become energy independent through oil again. What I'm pointing out simply is that in the next three-to-five years, the United States is going to lose another three, four, five million barrels of either production or imports from the rest of the world. Until we come up with alternative energy and an alternative transportation system that your children, my children and my grandchildren will use – whether it's hybrids, fuel cells, whatever that's going to be, we're going to need liquid fuels to help get us through that transition; or, you mention Richard Heinberg, we could end up seeing Richard Heinberg’s worst scenario unfold which is last-man-standing, which is we go to war over the last remaining resources. So my only point is until we find what the alternative for clean energy is going to be in terms of whether we go to hybrids, fuel cells –because it's mainly a transportation problem, that's where we consume most of our energy –we're going to need something to get us through the transition. Otherwise, the lights go out. [28:49]

Hi Jim, this is Bert in Yuma. I remember your referring to an indicator as far as shopping mall activity. Well, this is Sunday afternoon and this morning I went to a pawn shop to look for a guitar for my son, and there were probably a good 15 to 20 people lined up out the door to try to pawn stuff; and I've got to tell you, I was the only one who walked in there with nothing but my wallet. I think even there was even one man what looked like a carpenter who was trying to pawn his tools. I mean, how is the man going to make a living without tools. I'm interested in knowing what your mall indicator is looking like because at the lower end of the economic scale, it seems like there is a lot of pain out there.

JIM: You know, Bert, my parking lot and mall indicator, it depends on where you go. On the upper end, we have a mall here in San Diego called Fashion Valley –upper-end-scale shops, all of the Gucci, all of those kind of Tiffany-type shops – and of course what I saw the last time I went two weeks ago, I went at 5:30, I was picking up something at a store coming back from sailing for the day –and I was amazed to find out how busy the parking lot was. There were people standing around a line at the Cheesecake Factory. This was on a Saturday. The stores were full. Now, remember, this is upper end people; also, that mall is located along a strip of hotels and we get a lot of tourists that come here during the summer months, so I figured a lot of the shop keepers were telling me that a part of this is tourism; and also we get a lot of wealthy people from Mexico that come here for the summer months. So the mall was bursting with energy and people, the parking lots were full. On the other hand, one of my friend's wives works at a retail store in another mall where the income scales are less, and they are hurting, so – and especially in this area, but a lot of people are telling me and you see a lot of stores closed. So it depends on which income bracket you're talking about. On the upper end, still doing fairly well, but on the lower end, definitely hurting. [30:54]

Hi. Mara in North Carolina. Jim, I'd like your comment about a comment that was made by John Mauldin in his weekly commentary. He's talking about John Williams and the Shadow Government statistics and notes that if we were using the methodologies to figure inflation that existed in the 70s and 80s, inflation currently would be 11% or more. And what Mauldin says is, I think, what Williams’s numbers do show is that the government did not know how to calculate inflation back then. If inflation were actually 11%, then that would mean the GDP was a negative 6% today and then the US would have been under a recession for the past several years. This is obviously not the case. You can simply look at corporate profits and tax receipts to see if the economy has been growing for the past five years. I don't know how to evaluate his reason and his logic. Would you help me with that.

JIM: You know, I disagree with John, respectfully – with John Mauldin that is – and I tend to lean more towards John Williams. However, and I will say this. Some of the things that into the old inflation indexes, there has been some substitution, and so measuring a whole index the way we did back then, obviously spending patterns and the things that we spend money on are different today. However, I still don't buy the 4% inflation rate. I believe we are in a recession, and I believe we went into a recession probably at the end of the third quarter of last year. And you can see that with corporate profits that have been falling since then, and also in the national income accounts. And then the other thing where I guess I'd lean more towards John Williams, this hedonic adjustments in substitution. Quality adjustments. Look, if a car goes up $1000 and the government says, “well, gosh, the radio and stereo system are better and you've got better seatbelts or you've got better rim tires, so we're going to adjust that cost out of the car” – I think that's balderdash. Now, the fact is, the costs of the car went up $1000. The other thing is substitution effects. That only works to a limited extent. I mean if the price of beef goes up and so people switch over to chicken, and chicken goes up and then you switch over to fish, and fish goes up and – what do you do? Do you switch to dog food? Some of this stuff, I just don't buy. I think that the truth is somewhere between the government’s number and somewhere between the top end of John's number because not everything in that number is reflected in the way we buy things. I mean, if a cost of certain things of going out to dinner go up and people don't go out to dinner, then obviously that inflation that you're seeing at a restaurant doesn't impact you as much, but more so of what you're seeing that's going on at the table, which is the cost of food. So, I think the answer lies somewhere in-between those two figures. [33:45]

Walt from Wisconsin. Like a few of your callers have mentioned, I think probably a crime that’s even bigger than naked shorting is what the Fed is doing. It seems quite evident that those guys are very likely confiscating the wealth of this country through the manipulation of interest rates and markets and creating bubbles and popping them and inflation; money is being sucked out of the economy through the drop in the housing and stock market; and then they are replacing the money that the banks are losing. And then that question between inflation and deflation, even though the Fed is pumping at 18% or so, giving that money to the banks, they are keeping most of that to short their bottom line; aren’t they? Not that much is getting into the economy, so it seems like that should be a considerable deflationary effect?

JIM: You know, Walt, as we started the Big Picture this week with the Bank for International Settlements, we're coming to the end of the unsustainable. And one of the reasons that they listed that we got into this position in the first place was loose monetary policy. And it was driving down interest rates under the Greenspan Fed to 1%, and now under Bernanke down to 2% and then also pumping and allowing the money supply and even the shadow banking system to arise as an alternative to the banking system in expanding money and credit. And, you know, we are now living with the consequences and, you know whenever you ever the Central bank, you always have inflation. [35:18]

Greg in San Jose, California. Jim, couldn't the presence of naked short selling on a particular junior miner be considered a short term positive in that it provides an opportunity to build a position in a stock at a reduced price. If the fundamentals of the junior are solid, what is the probability that the shorts will cover in the future. In your view, is there a scenario in which a naked short position could continue to suppress the stock price far into the future?

JIM: You know, Greg, I do agree with you. When they come in and they short sell a stock or they naked short sell it, they drive the price down and it allows you to accumulate more shares. That's what I do. Every single month, I'm buying four juniors in addition to buying bullion, and I buy a portion of each one of these companies every single month, and I'm buying them at incredible prices. Eventually naked short positions, if the company is strong fundamentally, will be reversed. In fact, one of the companies I'm buying had two naked short positions. Both involved around a financing and those naked short positions have disappeared and that is what happens eventually. And also, if you're buying a junior with good, strong fundamentals, and especially when you start getting up to a two million ounce deposit – and a junior if it's located in a safe jurisdiction and an expanding property with good economics – you're talking about a company that either, one, can eventually go into production, or, two, that is going to be acquired because right now, even the large giant gold mining company such as Barrick are announcing that they are now looking on their radar screens for companies that have two million ounce deposits to take them over. That's what they are going to be looking at and there is going to be a wave of takeovers that are going to start – especially as gold prices head higher. But I agree with you. Short selling in the shorter term allows you a chance to pick up more shares at a lower price and that's why I say take advantage of it. Look at the fundamentals, understand them, keep accumulating your positions and more importantly hold onto your positions because it's only when you panic and sell to the short sellers that you have lost the game. In other words, you're playing on the short seller's terms rather than your own terms. [37:41]

Hi, this is Mark calling from Bethlehem, New Hampshire. In a recent John Mauldin mailing, Vincent-Louis Gave, a recent guest on your program, made a pretty strong argument that inflation will start to abate. Essentially what he said was that inflation we're seeing today is really an echo of the excessive credit splurge or the crazy lending by US banks. They are now under pressure their lending will be reduced and therefore inflation will start to reduce. I'd have much appreciate hearing Jim's position on that.

JIM: Mark, I think as the economy weakens, I think what you're going to see ultimately play out here is just as we have relied on consumers going into debt to spend, well, what is going to happen if as this crisis worsens is what you find like with this first helicopter drop that they just gave us that the government passed the tax rebates and now they are already talking about ‘helicopter drop 2.’ What you have in that situation especially as the economy weakens is the government becomes the spender of last resort and the Fed becomes the lender of last resort, and under those aspects, you have inflation. [38:51]

This is Ron from Corpus Christi. And I have a question about Minefinders. In your program last week, you stated that there was 15% shorts on it, around 7.5 million shares. I have an Active Trader Pro pool [phon.] that I use with Fidelity, and it does not show any shorts at all on Minefinders and I wonder where the disparity is. If you can answer that, I will appreciate it. I love your program, use it very successfully.

JIM: Well, I can tell you. I don't know -- I think your information isn't updated with Fidelity. If you look at Minefinders, Minefinders is listed on the Toronto exchange and it's also listed on the Amex exchange. And if you look at the sort position right now in Canada, the short position on Minefinders – and I think this is actually going up higher because I've seen the shorts come in here and do more short selling with this rally that we've seen and that's what they typically do – but currently, and this gets reported about every two or three weeks, in Canada, the short position of Minefinders is 3,346,000 shares, and then on the American side the short position is 3,958,000 shares. Now, Minefinders only has 49,567,000 shares outstanding, so we have a short position now that's equal to close to 15% of the stock; and not only that, this stock is held in very, very strong hands with people taking large positions in the stock –and these are some very sophisticated investors that believe in the gold bull market, people like Jean Marie Eveillard, one of the best fund managers in the world. His First Eagle fund owns over 2 million shares, 4% of the company; Van Eck and Assoc. owns 1.5 million, 3% of the company; IG Investments almost 3% of the company; Fidelity management, 1.1. I mean I could go on and on – Sprott, a million shares. So there are a lot of people that own this, but I think your source there isn’t giving you accurate information. [41:10]

Hey Jim and John, this is Steve calling from New York City, really enjoy your show. I've listened for about two-and-a-half years. I adjusted my portfolio accordingly and have done very well. I have some money invested in the metals and mining ETF, XME, and I was wondering if you would consider that an infrastructure play, and if not, what category would you put it in? I've also invested in the ETFs for Canada, Australia and Brazil and wonder if you think those will be good to hold during the crisis window that you talk about?

JIM: Steve, you know, the XME, which is the S&P metals and mining ETF, a lot of the companies in here, that's more of a commodity producer play. Their top holdings are companies like Newmont, Hecla, Peabody Energy in coal, Reliance Steel, Freeport copper. These are more producers than it is infrastructure. And in terms of your other ETFs –Australia, Canada and Brazil, strong resource companies – if you're going to hold them long term, I think you will do well there. [42:19]

Hi Jim and John, this is Brian from Georgia. I'm trying to add some more options to our company's 401(k) plan. Our 401(k) is with Fidelity, but we can add other people's funds to the 401(k) plan. I was wondering if you would recommend a precious metals, an energy and possible foreign currency-type mutual fund or commodity mutual fund that would be good for a 401(k) plan. I’d like to give the employees some more options than that. And also the Central Fund of Canada, what range does it usually trade in relationship to the net asset value. I know sometimes lately it's been above net asset value. I was wondering what normal range is for that.

JIM: You know, I would, Brian. You would definitely want an energy sector fund. You would want -- actually, I'd just go with my five areas. I would go with energy, you would want an energy sector fund. Secondly, you would want a fund that invests in precious metals. You would want a fund that invests in water or water infrastructure; or infrastructure in general would be a great place. And then also something that invests in agriculture. So if I could give you five areas: energy, precious metals, food, water and infrastructure. In terms of Central Fund of Canada, the premium trades anywhere from sometimes 3 to 5% premium, all of the way I've seen it to 12 to 15%. As we stand on this Thursday, the premium over net asset value right now is roughly about 10.4%. [43:59]

Hello, my name is David. I'm calling from the Irish Republic. Hello, Jim and John, great show. My question is: could you recommend some newsletters –I know you've given out ones for John Doody. Would you be able to give some out for the four sectors that you cover which is water, energy, commodities and infrastructure?

JIM: Gosh, I'm just trying to think – energy newsletter. Probably Casey Research if I was looking at energy, but that's going to be small cap. We get more institutional kind of things like we get John S. Herold and Company as our energy research, so that's a rather expensive way to go. [44:40]

Jim, Brian from Phoenix. I have a comment about the naked shorts followed by a question. Jim, like you said, just take delivery of your shares. Yes, it is inconvenient. But you have a stock certificate that is the actual shares, rather than some book entry on a computer that could just drop into cyberspace. And like you said, if you're counterfeiting $20 bills on Monday, you can probably anticipate the government knocking on your door by Friday. Likewise, if your broker delivers a counterfeit stock certificate, well, there is nothing like a real paper trail that can't be buried in cyberspace.

This leads me to my question. As you suggested, I'm taking delivery of my shares certificates, but some companies no longer issue certificates. They now call it a direct registration system or DRS. I understand AT&T does this, and I know for a fact that Chevron no longer issues stock certificates. Jim, to make a long story short, I am unable get a satisfactory answer from financial people including my stock broker of what is DRS registration and how it functions. Jim, my question, what is this DRS, the devil is in all of these details. So in your response, could you explain the ownership trail that starts with my broker statement backwards to what owner actually appears on the corporate books.

JIM: Brian, rather than take up the next 15 to 20 minutes to describe a DRS registration, I recommend that you Google “DRS registration” and you'll see. There are a number of links that will take you exact directly. There is one at Wachovia, for example, that will describe which is, you know, in its essence, its book entry is “a form of electronic registration enabling shareholders to be directly registered on the books of the company's transfer agent with no need for physical stocks. So the transfer agent will show you...” –then they give you an example there, but I would Google that because trying to explain this on a radio program without a board to diagram this would be quite difficult. [46:41]

Mr. Puplava, I'm not going to identify myself because in doing so I can leave myself open up to some sharks. I do work in the industry. I'd just like to give you some information on your naked short selling, one piece of information that you should know is that I have worked for the industry and I know one way that a lot of these people actually cover themselves. And the largest way they cover themselves is they or their partners actually go in and buy calls, okay, prior to having to cover their positions. And this is the way that basically the industry doesn't lose and I'd just like to inform you and your partners that basically the loss is passed on to the unknowing [inaudible] individual of the market. But I am going to leave this small piece of information with you to deal with. You have a great show and thank you very much.

JIM: You know, you bring up a point, and this is something that we noticed, for example, last week we talked about in the company Minefinders where there is 7.5 million shares sold short. We did see a period of time where people were actually coming in and it was one particular individual I could tell by their trading pattern and they were buying calls and I think their position has become so massive, that's one of the ways they are trying to hedge their short positions. So you're absolutely correct and thanks for sharing that and I appreciate you being straight forward and honest about that being in the industry. [48:04]

JOHN: All right, Jim, that terminates the program for today.

JIM: No way. I'll be back.

JOHN: And when you come back, what will we do?

JIM: Let me see, coming up in the weeks ahead, next week Ronald Wilcox will be my special guest. He's written a book called What Happened to Thrift. I'm looking forward to that. Also one of the editors at Barron’s, Thomas Donlan has written a new book called A World of Wealth. He'll be my guest on July 19th. July 26, Richard A. Ferri The ETF Book. And we've done that in response – we've had a lot of request from people, “what are ETFs, how do they work, which are the best ones, what do I need to need about an ETF?” And this is one of the best books out there on ETFs, so Richard Ferri will be my guest. At the end of the month August 2nd Chris Nelder, Profit from the Peak,and probably one of the best books I've read on peak oil, and I think I've read up to 100 of these books now that I've seen in a long time. He'll be my guest. It's very well put together, succinct, lays out the case – pro, against, those that say it's a long way off, those that say it's close – and he's done a very, very good job; and more importantly what we need to do, how you can participate, invest and he’ll be my guest August 2nd.

And of course, John, I go on summer recess for the month of August, so we'll have two program in August and then I'm going to take a couple of weeks off, you're going to take a couple of weeks vacation, and I just want to say, I know this is past tense, but Happy Canada Day for all of you listening into the program in Canada and for those in the United States, we just want to wish you a safe holiday weekend, and for everybody else, you have a pleasant weekend.