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Financial Sense Newshour

The BIG Picture Transcription

September 13, 2008

Part 1

Conversations with Jim and Frank Barbera

JIM: Well, it's been called probably one of the sharpest pullbacks that we've seen in the commodity markets in decades. A sharp selloff in oil going from over $145 a barrel on this Friday, they have actually taken it down below $100 a barrel in New York as Hurricane Ike begins to hit Houston.

Also, in the gold market, sharp selloffs where gold has gone from over $1000 an ounce down back to below $800 and the same with silver.

Joining us here on the program is one of our regular experts, Frank Barbera.

Frank, I sort of want to build this backdrop, and I want your technical expertise to explain to our listeners what happened here. We know, for example, in the month of July, and actually if we go back before July, from the month of May all of the way to July, in the futures market we had small speculators that came in on leverage. They were massive leveraged positions. They were in the commodity market.

In July, we saw a 10-fold increase in the short position in gold, we saw a 5-fold increase in silver. We also saw large short positions. And in fact, as we stand on this Friday, there are large put positions at $105 oil and $110 in the market.

With these large short positions coming into the market, the price began to correct. And as it corrected, you had a deleveraging effect that took place. In other words, if you're in the commodity markets, you're leveraged ten to one, and that's assuming that you put down the initial 10 percent equity. And then, when a market begins to change dramatically going in the opposite direction, just as momentum came in the market driving it up, you get momentum coming in and driving it down. I wonder is that sort of a correct sequence, if I'm looking at this technically, or tell me am I wrong here?

FRANK BARBERA: No, Jim. I think you're quite correct. That is exactly what has happened, and this becomes a mechanical process. There is a certain point in a selloff where what I would refer to as the ‘mechanical’ can actually overtake temporarily the technical. And that is what has happened here.

If you look at the derivatives contracts report, the notional amount of derivatives contract report, there was this big surge at JP Morgan bank where we saw basically an 11 fold increase in COMEX gold contracts from around 7787 contracts on the short side, all of the way up to 86,398 contracts. The same with silver: a very large increase, a five-fold increase from around 6200 contracts all of the way up to 34,000 contracts in silver, and what we've seen is a swan-type dive action and that's usually hedge funds. So this is really reminiscent of what we saw a few years ago with the Amaranth failure when large hedge fund Aramanth went broke and had to be liquidated; we saw a tremendous amount of deleveraging and it hit the entire resource sector. There was no differentiation between coal stocks, oil stocks, oil drillers, natural gas, gold, silver, or even base metals. Basically, everything went out the window, and that has a lot to do with the fact that players who are active in this space tend to gravitate towards a lot of the same issues and this was just a market where we had a lot of people on one side of the fence and I believe an intervention was very carefully crafted in the dollar market to trigger some short covering in the dollar and then an unwinding in the leveraged hedge positions where natural resource stocks are concerned. So I have no doubt that that's exactly what we've seen.

The good news is that it looks like it has really run its course. And I'm not saying it has completely run its course, but I would say at this stage of the game through Friday afternoon – we're about an hour from the close on Friday – what we're seeing in Friday's action is good strength in gold, silver, what looks like the beginning of an initial break in the dollar index on the downside and some very interesting trading patterns.

Oil is still the great mystery. To me it is an amazing feat that a storm the size of hurricane Ike has moved into the Gulf of Mexico is now bearing down and gaining strength on Houston which contains most of the United States’ refining capacity, not to mention in the offshore waters between Houston and Galveston a lot of offshore rigs. This is amazing that oil is down. I'm stunned beyond words to see that the price of crude oil was actually down on a day like today. To me that really suggests a market that has been under very heavy short pressure, and I would actually venture to say that this is just not a normal market action where oil is concerned. Some player seems to be trying to hold oil prices down. How high up that goes, it's hard to tell, but it just seems to defy the natural logic with a storm that big moving into such a sensitive area. [5:33]

JIM: You know, it's amazing because I was looking at in talking to people in the oil industry and when Gustav hit they were talking about it would take 60 days before we would reach 65% capacity bringing oil production in that region back online, and it would take 90 days before we got up to 95% capacity, so we would have to wait until almost November before we would be bringing the production capacity in the Gulf back on-line – of course that was two weeks ago. Now you have another storm that is going through the sector.

So, Frank, as we head into the winter months and one of the things that the weather people are talking about is the lack of sun spots, and sun spots have to do with a lot of warming that we see climate-wise, so that we could have a very cold winter and certainly in a lot of parts I know here in California, we've had some unusually cool temperatures here for this time of the year. And what are you going to do when 25% of your production is struggling to come back online – [6:46]

FRANK: That's a great question. I don't see how oil prices are going to stay down much longer. I mean on the technical front –and this is worth while – I can tell you that we're seeing very rare technical readings on the oil market, and in fact, of course the last few days throughout the resource sector, using for example USO which is an oil ETF tracks the price of crude oil and I'll use that because it’s a little bit more readily available for people to track. If you were to run a 25 day RSI, the relative strength index on USO, as of this morning, it's at plus 34.6. And that indicator tends to be range bound between 35 and 60. We have not seen a reading below plus 35 on that particular indicator; 25 days is a very, very medium term RSI for USO going all of the way back to January 19th of 2007. That was a major, major low with crude oil near $50 and USO in the 40 to 43 range. From that point, oil prices basically shot straight up, never looked back and I tend to think with this kind of fully oversold reading in the oil market right now and the nearby spot contract, 100 obviously is very important – psychological support – that's an area where we've heard certain major players including Iran, Kuwait and Venezuela may be cutting actual output in order to support prices. But technically it's also an important area.

We've seen important highs on November 21st of 07, January 3rd of 08, important lows on March 20th of 08 and April 1st of 08, all of them straddling 100. So if you just take a fat pencil marker at the 100 area, it's a very important support area. The price is compressed right now. I would not be surprised to see crude oil moving back up towards 120 over the next 5 to 10 days. I think we're going to see a really sharp V-type move to the upside in oil prices maybe in the wake of this hurricane. I think this will be the opposite type of outcome that we saw with Gustav where we find out there is a fair amount of damage and there will be substantial delays getting output back on-line. It just looks like such a large storm packing pretty heavy winds that it would be surprising not to see some substantial delays in getting things back online; and I think right now, the oil market has not given it any credit in terms of discounting that into the price. The oil price right new seems very unusual to be where it is in the face of this kind of storm, so I think we'll see prices rebound.

We're already seeing on the good news front the dollar index has begun to break back to the downside. That's good news for precious metals bugs, and I think between we're probably heading for a set of interest rates cuts coming up from the Fed. You look throughout the financial sector, you'll see a tremendous amount of problems over the last few days. This has really been quite a negative week. It's semi miraculous that the stock market got through this week without falling apart. I mean I’m looking at the S&P 500 late Friday trading in positive – and it's just shallow negative reading and we've actually been positive during the day; and at the same time, you've got companies like the S&P is up 3 heading into the last hour on Friday. At the same time AIG –American International Group – is down over 28% on the day, about $13.20 cents on AIG. That's remarkable that the stock market has taken that kind of a tumble in stocks like Washington Mutual, Lehman Brothers, Merrill Lynch and now AIG, which is one of the bluest of the blue chips, in that kind of a stride. [11:01]

JIM: Let me stop you there too because here is a story on Bloomberg on Friday. Credit default swaps on AIG, Lehman and Merrill rise sharply. In fact, credit default swaps are demanding a 12 ½ percentage point up front and 5 percentage points a year to protect AIG bonds. I mean that's incredible.

FRANK: And AIG stock has gone from 25 to 12 over the last four days, JP, so I mean you're looking at a 50% drop there on one of the largest market cap financials in the world.

JIM: Yeah. A one third drop in just one week, and you've got credit default swaps. I want to just bring back a couple of more points on oil and then I want to move forward on what your gold readings are because you've seen some extreme readings in oil. You know, Frank, we've got on this day as hurricane Ike builds up it's force, you've got oil that dipped below 100 for a short period of time and it's remarkable to see that. And now you’ve got people talking in the market that oil is going down to 60 and 70 dollars a barrel. I mean jokingly, I mean what do you think it's going to talk to get it there? Do we need two more hurricanes to get us down? [12:21]

FRANK: Maybe we can take the Alaskan pipelines offline or sink a ship in the Persian Gulf or something. I mean you wonder what is the perverse logic that has been driving this market. It doesn't seem to make any sense. And you know what, Jim, that's why I think a lot of what we've seen lately is really a mechanically driven market day.

In all seriousness, I think this has been a lot of hedge fund deleveraging in sectors where there were too many very leveraged bets and that's what people have to understand. And the funny thing about that is once it has run its course, you could see prices really springing back very, very quickly. The same would be true in the dollar market where I think we had some big shorts that have unwound and it’s led to a large short covering market rally in the dollar. Right know, the dollar index is trading down about a full point. In my view that looks like the rally has just about come to an end. I think the dollar around 78.80 is very vulnerable to the selloff down toward the 76 area. If that happens what that will do is essentially it will puncture the upside momentum of the dollar rally. That doesn't mean that you couldn't have a secondary move back up to retest the highs on the dollar, maybe with failing momentum, some of the momentum indicators like MacD, stochastics, RSI, not confirming the high -That’s what you usually see at a big turn. But at very least it looks like we're getting a serious break in the dollar and a nice bounce now in the Euro. I would actually submit that this may be more of a V-shape bottom in the currencies, in view of the huge problems that we have seen in the financial sector this week –the fact that Fannie Mae and Freddie Mac have been placed in conservatorship, the fact that we now see other problems with Lehman, Merrill, AIG – when you start looking at this, it really suggests that a lot of this bad debt is ultimately going to be shifted or is in the process already of being shifted onto the government balance sheet. And ultimately, I think at this stage of the game, we may be getting to the point where the currency market unwinds realizing that heck, there is going to be a lot of digital dollars being created as a result of all of this.

I mean one could make a case that maybe a General Motors or a Ford, if they ran into problems as large industrial companies in their credit default swap situation, maybe they would not be given a government bail out. The problem is with a Lehman Brothers or a Merrill Lynch, it's so intertwined in the nexus and the web of these swap trades that to let one component fall could actually endanger an unwinding of the entire larger structure. [15:24]

JIM: Yes, you've got the domino or what I call the counterparty risk syndrome coming in here, which is why they moved expeditiously on Bear Stearns.

FRANK: And I think we may see that again, and that maybe is what brings the euro back up. A few weeks ago it was sell the euro because the Russians are angry about missiles in Poland and the Russian bear has reemerged, and there was a lot of geopolitical tension in euroland and also the European economy is decreasing at a more rapid rate. At least that was the story that was being put out. I tend to think we may see an unwind now in the other direction in the sense that the US banking system is foundering, the financial system here is foundering and we're still really the home of the highly-leveraged debt play, so I think you might see the dollar sell off.

This has the look of something where you can see the euro rally from where it is now at around 142.30, all of the way back up to maybe 150, 151 in a very short period of time. I know a lot of people would not be looking for that. There are people looking for more like 144, 145. But I really wouldn't be surprised if it turned into some kind of an overshoot on the upside and just left what could be described as sort of the mother of all V-type bottoms. And I think you're going to see a pretty strong snap back in the euro. That should be good for gold. Gold has importantly held very long term support at its 50 week lower band, so I'm grateful that prices held where they did. They came down to a very important longer term support area and what we're seeing here on Friday is very positive action in the gold market. Again, that's not to say it couldn't possibly rally for a little bit further and then come back down and retest these lows, but I think what we're seeing right now is very solid evidence that that lower 50 week trading band is going to hold on gold, that we will make a bottom there and once that bottom is in place if it's not in place already, we should see prices spring back rather aggressively. [17:33]

JIM: Let me just stop you there because earlier in the year, I think it was in the beginning of the year, you wrote a piece and you were looking for a sell-off; that this bull market had gone on for so long and you never saw the extreme oversold conditions that you normally get in the period. Have those overstreamed positions technically been reached in the selloff?

FRANK: That's exactly right, Jim. What I was writing about back on January 8th I made an annual forecast issue where I talked about a top in gold at $950 and a selloff into August to about 677.20. That was the zone I was looking at. What was guiding my view on the pullback was the idea that having gone back through 35 years of gold prices, I noticed that gold has regularly – every five to six years it has pulled back to the 50 week lower band, and it had been eight years since we had seen contact with that lower band, so it was very easy to look at that at the beginning of the year around 640 and extrapolate by August this will be up to 670, 680, we're probably going to have to come down and pull back and make contact with that lower band. Also, the nine week RSI in gold had not seen an oversold reading in about five to six years and I thought that's also very overdue. So there were a couple of big markers there back in January that had led me to come to the conclusion that at some point this year we would see a sharp correction in gold prices, and then that would be essentially a large wave 2, if you will, within the bull market getting ready for a launch to the upside. As it happened, the gold market pushed a bit higher than I thought. It went up to about 1040 and it pushed forward a few weeks longer, so things have sort of shifted up; and what was support earlier in the year – projected support between 670 and 720 has actually worked out to about 750. We hit that 50 week lower band this week right at the low. We also made the RSI fall to a fully oversold reading. So all of those markers – I can just go right down the list – they've been met. And to me it looks like what you've just completed is essentially a large primary Wave 2 in the gold market and the silver market.

Jim, I think right now it's going to sound funny because prices are very depressed and someone to look for new all time highs in the metals that may sound a little crazy, but I think you're going to see prices really bounce back quite nicely over the course of the next few months, and I think by early next year we will see prices making new highs. I think the gold bull market is going to move into over-drive and really the trigger mechanisms, the underlying fundamental, is what we see happening daily in front of us, which is this transfer of bad debt from the private sector to the government balance sheet. [Daniel] Amerman made a very good article earlier this week on Financial Sense, the hidden bail out of 1.4 trillion dollars in Fannie Freddie credit default swaps. All of those credit default swaps are ending up on the government balance sheets, so what we're seeing is Uncle Sam getting into the finance business and that's probably going to mean a huge increase in dollar creation; ultimately very very bullish for gold and ultimately very bearish for the dollar.

So it may take a while. I don't think you'll see new highs right away, but I think within a couple of months, we’ll see the new dollar index at new lows and gold right back up to new highs. So this is a great opportunity for investors with cash to put money to work in the precious metals area. [21:36]

JIM: You know, I want to address this issue, and you and I had conversations all of this week, and I think by this take down in the commodity sector, both oil, the grains and gold, you and I were figuring that what the government has here is a six-to-nine month window period of time. And you and I agree that the next thing they are going to have to do is steepen the yield curve. The way you do that is you bring down short term interest rates, so I think you could see even arguments made for the Fed ready to cut interest rates. And I think this time, Frank, as we look globally, we had the bank of New Zealand surprise the markets with 50 basis points cut in interest rates. We know that Europe's economy is now heading towards recession. Japan's economy is in a recession and I think maybe after the elections from all of the economic indicators that I follow, the Chicago Fed's main indicator which indicates we're in recession territory. [22:43]

FRANK: There is no possibility that the US is not in a recession even though the government –

JIM: We don't call it one.

FRANK: Even though they've done a really great job in jimmying the GDP number to the upside by using a GDP deflator at around 1.5 percent. I mean that is such a bald face lie, it's remarkable. And when you look at non-farm payrolls adjusted for the birth-death model of the three months moving averages below minus 200,000 – that's never happened without the US being in a recession. If you look at continuing claims above 3.45 million, that's a 25 year high. That's never happened without the US being in a recession. The list just goes on and on. The consumer confidence indices have plunged into territory that's only been associated with deep recessions. The home financing index from Wells Fargo, that's in recession territory. So you have to look across the broad spectrum of public and private data and when you look at that, there is just no way that the US is not in a recession. [23:48]

JIM: You know the remarkable thing about this is when you've got Wall Street pundits saying the housing market has bottomed, the credit crisis is over, but yet we’ve got the Lehman problem, you could have a problem at Merrill, you could have a problem at AIG. You definitely have a problem at Washington Mutual.

FRANK: Wachovia, Wells Fargo. Jim, it's a very long list of financial institutions that are in really big trouble here. [24:18]

JIM: And you know the thing that I think that you're going to see is a lot of those financial institutions – you know, Wells Fargo is considered one of the stronger out of the group, and last Friday they had to raise debt at 9 ¾. You've got Washington Mutual debt trading at a yield of over 40 percent – that's a red flag there. But we do know by the end of the fourth quarter –from now at the point you and I are talking –that the adjustable rate mortgages are going to peak in the fourth quarter. They are going to rise from September, they’re going to peak at the end of December and everybody is going to say, wow, we dodged a bullet, the worst is behind us. But you know from the time people stop making mortgage payments to the time it shows up in a mortgage default, there is a six month lag time so we probably won't see the real damage until probably the second quarter.

But here are two things I'm looking at that I think is going to hit the markets next year. One is even the credit rating agencies are saying that corporate bond defaults are going to double in the next year. So at some point next year, we're going to run into credit default problems. You just talked about the credit default swap problem with Fannie and Freddie, but it's also going to hit the corporate sector. And then when you think that the storm has passed, beginning at the end of next year, we have another wave that's going to hit the real estate market and that's the option ARMs, which were almost a third of all of the mortgage financings between 2005 and 2007. These are held – there is a five-year period on that before they can completely reset and these are loans that are accumulating with negative amortization. So that is going to hit the market in 2010.

So if you've ever been to the beach, you know that waves come in sets, or you're sailing. When you're racing, you know they come in threes. There is like these three wave sets when you're out in the ocean. And Frank, we've had the first wave, I think we're going to hit the second wave with the defaults that are going to come from the peaking of adjustable rate mortgages, and then also the credit default swaps, so that will be wave number two; and wave number three are going to be these option ARMs that are going to hit between 2010 and 2012. The only way – [26:47]

FRANK: Jim, just in Southern California, though, in the next four or five months, 15 percent of securitized loans will be coming up, and that's 300 billion dollar in option ARMs, 820 billion in interest-only mortgages are set to recast in Southern California, primarily the Los Angeles area. That's going to be happening even sooner and that's going to put a lot of downside pressure on prices in that area which is, of course, a major sub-economy within the national economy. So I think you're going to see even more price pressure there.

And the important point, if we look at yields on Friday, and this is a point I don't think people should miss. If you were to look at the dollar index which in the last few days moved to some of the most overbought readings that we've seen in the last 10 years, that happened simultaneously with gold and silver moving down to some of the most oversold readings that we've seen in the last 10 years. At the same time all of that was happening, you have treasury bonds, the 10 year treasury yield down at deeply over sold levels at 360; and going out the week we’re at 373 up 11, that's the pretty incredible spike we're starting to see in interest rates. And I would make the case going forward the transfer of this debt to the government balance sheet is going to be essentially a downgrade on US sovereign debt. You're going to see the dollar falling, long term interest rates rising in response to a weak currency, and that's going to force metal prices higher.

If you were to look at the current account over the last decade and so, and if you look at funding for the US current account, in other words what we've been taking in in terms of enticing the rest of the world to send us money, that flow of capital over the last decade, decade and a half, has always been in excess of our basic needs in order to fund our daily external debt. Those two numbers have come very, very close in the last month or so, and I think that's another major issue that we're going to be faced with in coming months. Essentially, I think the Fannie and Freddie fall out will be that a lot of foreign capital no longer wants to come to the US. It's seeing the US as a toxic sort of debt zone, where it’s very hard to predict what's going to default next. So I think one of the key numbers to be watching going forward are these quarterly Z1 reports, these TIC reports that come out that talk about foreign capital because that's the kind of a number that has already been in a big down trend and could continue over the next few months.

If we start to see foreign capital coming in that's not sufficient to cover the current account, what you're going to see is interest rates rising on the long end of the curve and the cost of capital will go up and then at some point, you'll start to see the dollar fall. And I think where we're really heading when you look a year out is a dollar devaluation. And I think we'll see this banking system bad debt problem – with just all integrated and based on housing – that's going to morph into a currency crisis and that's where really the rubber will meet the road. That's very inflationary. That's an inflationary depression, that's not a deflationary depression. I'll be the first to admit that everything you're getting right now is a big whiff of deflation, and inflation hedge investors have taken a very big hit here over the last few weeks, but I think that's about to inflect and turn around. And what you'll find from here forward is deflation hedge investors are going to be hurt very badly and that's going to be a trend that's not going to be short term. That's going to be a rather permanent trend over the next few years I'm afraid. [30:47]

JIM: I want to address something that is circulating around the markets and that is for example the decline in the US trade deficit is going to contract global liquidity. And the arguments that I'm going to make against that, they are three fold here. One, any reduction in our trade deficit because consumption declines in the United States is going to be more than offset by almost double the amount of increase in the federal budget deficit. These actions by the government taking on Fannie debt, buying Fannie mortgages, the decline in economic growth which means that government expenditures increase while government revenues decrease, so that's going to be more than offset. And the other thing too I'd like to point out here, as production declines in the United States, production is declining faster than consumption is declining; meaning that we're going to have to import more and more finished products of I don't care if it's jet fuel or diesel or just pure oil itself. And the other thing that, you know, you go into a store, Frank, it's amazing. I don't care if – where is the stuff made? [32:06]

FRANK: It's almost all made somewhere else.

JIM: Yeah. I mean I don't care if you go to a department store, you go to an electronic store, you go into Costco and outside of the food section and you look at the clothes, they’ve got labels made in China, Peru. Where are the factories here in the United States that are going to rise in response to what we're not going to be able to import?

And the other thing that for our listeners and I would draw this analogy is if you were to draw two circles on a piece of paper, on the left hand circle, let’s just call that circle the United States and on the right hand piece of the paper, that's circled the rest of the world. Now, when money is created, if it could only be contained in one circle, in other words, the money couldn't leave the United States, you'd see inflation everywhere you go. Well, you still are, but the inflation rate would be much greater. But because the US dollar is used as the world's reserve currency, you can export those dollars to the rest of the world. Now, a lot of people do not really understand this concept, but when foreigners decide that they are going to dump their dollars and those dollars come home, that is when the full inflationary impact of our money printing over the last three or four decades comes home to roost. And Frank, this is very similar to what happened to Germany. [33:29]

FRANK: Absolutely, Jim. A lot of the same dynamics. In fact, in the 1920s, ahead of the German inflation, there was a period –a very brief period – where the German mark was one of the strongest currencies in the world and then as time passed, the mark began to implode; and it began to implode because of this storage factor of marks, the sea of marks that had accumulated overseas that came rushing back to Germany. And of course you're always going to have exchange controls. When you start having a currency problem, the first thing that you'll probably see the desire for capital flight and the government will probably put in change controls to prevent that, and that tends to exacerbate domestic inflation once that goes into effect. [34:18]

JIM: We did a piece on this last week where I talked about the inflationary depositories, and those inflationary depositories are what I call end money wealth, like the bond market, debt instruments, sometimes it can be stock market, and Frank, you know, you followed the markets in the 70s. The money wealth that was contained in the bond market, you actually had a period from like 74 to like 76 where interest rates fell despite rising inflation rates. But by 1978 when the money wealth woke to the fact that this inflation is real, it's not going away, from 1978 to 1981, you saw a spike in interest rates where interest rate levels actually doubled in this country in that period of time because money wealth, which is debt instruments, finally woke up and said, “Look, we've got double digit inflation rates. I am not willing to loan money at the rate that is today given the inflation rates.” And that's what I think you're going to see. And when money wealth wakes up to the fact that it's been duped, then it begins to go in the opposite direction, and you saw extreme rates and rises in interest rates. And as I look at the bond market today: we've got headline inflation which we believe is understated, but Frank, you've got a 10 year Treasury note, it's spiking today, so that could be a sign of reversal. [35:49]

FRANK: At 3.73 --

JIM: Yes. You have 10 year treasuries at 3.7. You have two year treasuries at 2 ¼ and you have 30 year treasuries at 4.3, and you have headline inflation at 5 ½ percent. And now, I just want to point this out.

FRANK: We're looking at an across the board negative real interest rates, essentially money is not being paid in anywhere close to fashioned for underlying inflation.

JIM: No. And not only is it not being paid, but even another factor: This is global, Frank. When you take a look at inflation rates around the globe that are approaching close to seven percent and even the bond king Bill Gross acknowledged this as much that the United States would enjoy some of the lowest inflation rates with some of the highest money supply growth is just a phenomenon in itself. But when that recognition comes, then you can see and so I agree with you. I think we've got a whiff of deflation, but I would more appropriately call it stagflation. [36:54]

FRANK: Yep.

JIM: And when stagflation moves to hyperinflation, because there is just no way – David Walker who used to be the Comptroller of the Currency, he's now working with Pete Peterson's foundation, he made a statement last year. He said the physical imbalances in the United States are so bad and they are going to worsen – and certainly with these bailouts you can see that happening now. But he said the only way that we can get our fiscal house in order was to do a combination of two things. He had what he called his optimistic scenario and his doomsday scenario. And in the optimistic scenario, he said we have to increase tax rates 44 percent and cut government spending 20 percent. In his doomsday scenario, he said you had to increase tax rates 88 percent and cut government spending over 40 percent. Well, you know in an election year or in any election year, you're never going to see a congressman say I'm going to cut your benefits or cut spending by 40 percent and increase your taxes. So what he said is if we don't do that he goes, “we're heading down the road towards hyperinflation,” and that, I think, Frank – [38:10]

FRANK: Jim, there is simply no way that we're going to circumvent this. A few years ago back in 2000, 1999, if anybody had heard me talking I was talking about Kondratieff Wave deflation. I mean the tech bubble when the NASDAQ was at 5000, I was really pounding that drum and we got a good whiff of deflation between 2000 and 2002. But what you're looking at right now is a debt situation that's being handed off. The only player large enough to stabilize the private sector and avoid the private sector from imploding, in what would surely be a major meltdown already at this stage of the game, is the government. And so we're putting on – we're using that government liquidity backstop at this stage of the game to keep things moving along and keep life as normal; [it] is really going into a much, much higher inflation rate and dollar debasement down the line.

The FDIC is going to be the next institution that lines up at the government window. I mean they have basically a penny's worth of assets to back up $100 of investor deposits at the bank, so you're looking at something on the order of between 100 and 4 and 500 banks folding in the next 12 months, some of them very large, companies like Washington Mutual, possibly a Wachovia, you're looking at defaults that are going to basically leave the FDIC broke.

Now, the government of the United States is simply not going to let one depositor lose one dime of money over $100,000 in any bank. That's not going to happen because if it did, you would have instantaneous panic throughout the entire country, you would have a run on the banks and the whole financial system would implode. So you're going to have the FDIC basically put on the same life line that we've seen happening in the financial arena already. They’ll get money from the Fed and the Fed balance sheet will continue to expand. So basically the government is going to be underwriting the bad debt and there is just simply no way that the dollar market isn't going to roll over at some point fairly soon, and begin to buckle. You can get these trading rallies that can last a couple of weeks, but folks, right now, the dollar is very overbought. It's at the highest level. It's almost at plus 80 on the nine week RSI. This is one of those moments where it's a good time to take a long look around and see what's happening because once it rolls over and starts heading back towards 70, below 70, that's pretty much an abyss. And I think that's when you'll start to see the real truth. It may be a couple of months down the road, but we're laying the ground work for a very large selloff in the dollar a few months down the road. At least that’s my view. [41:16]

JIM: It's also something that I think that one of the elements that we did not have, when the Fed began to slash interest rates last August and reverse course, we were the epicenter of the storm which was what I think makes this crisis so unique, Frank, in that in previous crises that we've seen over the last couple of decades –outside of the 87 stock market crash – I mean the S&L crisis, that was in the United States but it was contained, the Peso crisis, Asia, Long Term Capital Management, 9/11, but this time the financial crisis is centered here. And when the Fed began to cut interest rates aggressively, as it did bringing interest rates down from 5 ¼ down to 2 percent where they stand now, and I think they are going to cut, I agree with you, but we did not have the cooperation of other central banks. You had the European Central Bank which raised interest rates in July a quarter of a point. Now their economy is heading for the toilet. You've got Japan's economy which is now back in recession and as I mentioned, you had the Bank of New Zealand central bank cut interest rates 50 basis points. This time around, I think you can see some coordination which would give the Fed a little bit more leeway to cut interest rates aggressively because the one thing that I saw in the last week when the treasury took over Fannie and Freddie, you had mortgage rates come down for, I think what was it, 38 basis points or more. [42:54]

FRANK: Right. Credit default swaps on the United States Treasury debt widened out.

JIM: The one thing they are going to have to do is they are going to have to start monetizing because I don't see even if our trade deficit, let's say, improves by 50 billion or 100 billion – you know, take a look at the amount of increase in the federal budget deficit this year alone, which is going to be several hundred billion. And Frank, as you and I know, it's like all of this off balance sheet financing that we found out about a lot of these financial institutions – the money center banks and the investment brokers – whether you were looking at SIVs or whatever vehicles they are using. [43:39]

FRANK: CDOs.

JIM: There is so much debt that the United States has in terms of its budget deficit that is kept off balance sheet. In other words, it's not in the regular budget like the Iraq war is off balance sheet. The recovery of New Orleans is off-balance sheet. But you know what, the fact of the matter is the US debt increased by 900 billion in the last 12 months. So you can say it's off balance sheet – I mean I'd love to take expenses I have in my business and say that's off balance sheet. [44:10]

FRANK: That's exactly right.

JIM: Yeah. Or you'd like to say take your rent or house payment, you’re going to say that's off balance sheet. You still have to pay it.

FRANK: You still have to pay it, and the numbers are too large for the government not to have to basically, as you said, monetize it. Jim, this is a point you’ve made over the years so that I think a lot of our listeners have heard. If you look at the US economy over the past couple of decades, we had in the 60s a manufacturing economy, that sort of morphed in the 80s, the late 70s, and the early 80s into the rise of the service economy and ultimately over time that really moved into the rise of the financial economy. And you go back to about a year, a year and a half ago, to the height of the housing boom, and you look at the debt creation numbers from the flow of funds, the Quarterly Flow of Funds Report, and what you'll find is they were moving exponential. The size of the financial economy actually dwarfed the Main Street economy in the US. So what we're seeing today is just a complete implosion of that financial economy. The banks don't want to lend; you have interbank rates at very wide spreads; spreads throughout the entire system, credit quality spreads widening out. And that's a sign of just what a serious downdraft this is.

And there is no question about it that you have a debt deflation taking place, but in terms of the real world out growth of that, the only way out is going to be currency debasement – monetization. And ultimately, that’s going to prove as hyperinflation because by taking the purchasing power of a dollar down toward zero or very close to zero, ultimately, the government will be able to default on it's debt and start over. Basically, what happens during a run away deflation is even though local prices are moving up, businesses are going bankrupt. You have all of the symptoms of a classic depression taking place at the same time. You have surging unemployment, businesses folding and ultimately real wages collapsing. It's only once you stabilize money at the end of the hyperinflation and you have several new dollars, one new dollar for a couple of the old and they make that swap and they retie the money to something stable, ultimately, whenever that happens, you always have a very badly deflated economy that is revealed. But during that process the savings are confiscated and bad debts, creditors are basically, they are defaulted, they don't get paid back in anything worth much in the way of purchasing power. [46:56]

JIM: And this is something, that it's taken us, Frank, almost 40 years to get here. When we defaulted on gold backing of the dollar, that's when the inflationary wave, government deficit spending really began to gain momentum. And I mean just take a look at the debt that we've added to the US balance sheet, and it takes a while to get here. And so you know, this credit crisis – and I think this is something that Wall Street doesn't understand, nor do they understand when it come to commodities and we're going to be covering that in another part of the Big Picture today – is that when this unwinds and when it takes 40 years to get to this point –we developed, as you mentioned, the manufacturing economy, then the service economy and the financial economy – when it unwinds, when you build up debt imbalances that have gotten to be this large –whether you're talking about the government's debt, you're talking about personal debt or you're talking about unfunded debt, which Laurence Kotlikoff spends a lot of time talking about the unfunded liabilities of Social Security and Medicare – the outcome for debtor nations versus creditor nations is always hyperinflation. It becomes the most efficient way to basically rid yourself and wipe out the debt. It's not like this is an unusual case, Frank. [48:30]

FRANK: This happened many times in the last few decades in different countries.

JIM: Yeah. And if you take a look at David Hackett Fischer's book The Great Wave talking about the great inflationary runs that we've seen periodically every couple of hundred years –and I think that's what we're going through now – the inflation starts in food and energy and then spreads in shelter and moves to the rest of the economy; and that's what we're seeing today. If you take a look at, you know, people have come out, they've attacked “oh, this is a commodity bubble.” What I find remarkable about this is in a bubble, I don't have to tell you this, but in a bubble, you have prices that continue to rise and in response to these higher prices, you have an enormous amount of supply that comes onstream. And eventually, the supply levels get to be so high, inventories get to build and get to such a level that they eventually overwhelm demand and drive down the price. [49:31]

FRANK: That's exactly right.

JIM: Yeah. This time around, and I think this is something that I think the conventional economists don't understand is you've got 3 ½ billion people that have come online now as consumers of commodities. And despite what would be a five-fold increase if we look at present oil prices right now, we have not seen the supply response. We have got, I don't care if you're looking at oil inventories, if you're looking at gasoline--

FRANK: Exactly, right, Jim. Gold mines being brought on or silver mines. There has been no supply bulge. In fact, if anything, it takes longer today to bring on new supply in a lot of the areas of the commodities than it has in years and years. It’s harder to find oil, the permitting and environmental red tape to open a mine, be it a copper mine, a gold mine or silver mine, that process has just gotten longer and longer. So we're not producing as much of this stuff, and the global demand for it has gone through the roof. [50:35]

JIM: That's the surprising thing too because whether you're looking at copper, grains, energy, because, you know, the argument has always been by the economists: If price goes up, supply increases. And the difference here, I think, is natural resources. Natural resources are depleted. If you listened to the conference calls or the presentations made by the CEOs of BHP Billiton or Freeport Copper in gold or Rio Tinto --

FRANK: Schlumberger – I heard that the CEO of Schlumberger not too long ago talking about this in great detail. [51:12]

JIM: Yeah. What is happening, I mean, you've got the head of Freeport saying not only are we not finding large new copper deposits, we can't even get or find qualified personnel because when you go through a bear market that lasts two decades – I mean take a look at the 80s or 90s.

FRANK: People have been leaving the industry. [51:35]

JIM: People leave the industry, and even now if you were to say all right, let's activate, start more mining classes, let's graduate more engineers, let's graduate more geologists, Frank, you're talking about a time lag. I was in a board meeting this Friday. I'm on the board of directors of a company where securing drills is getting more difficult. Maintaining and finding qualified geologists is getting more difficult. And I was talking to an individual at a major Wall Street media outlet, and we were talking about this commodity bubble and I was making a comment, you had a company like BHP that just raised iron ore prices 75 percent. That is not a company that has a business model that's into decline. You don't put through 75 percent price increases if there is a glut of the quantity it is that you produce. And yet, you will have repeatedly, this is a bubble, this is a bubble, this is a bubble. Well, where were these people, Frank, when real estate was going up double digits, when the mortgage markets, I mean where were these people, you know, when real estate is going up – [52:48]

FRANK: You had a bubble. Exactly.

JIM: Yet you call that a bull market. When tech stocks were going up, they never called it, that's a bull market, but when the basic things that people need to live go up, they call that a bubble. That's what I find so remarkable.

FRANK: You know the funniest thing is, the last few weeks I've been putting some charts together, historic charts on gold and silver. If you were to look at silver, the constant dollar purchasing power of silver right now in terms of where it's been in the past going back to 1250 AD, you can look at several centuries of silver prices. Silver prices are in the basement. This is about as cheap as it gets. It's just scraping up off the bottom and that's despite four or five years of a bull market. Adjusted for inflation, you look at gold and you look at silver in constant dollar terms –commodities in constant dollar terms – they are still not high. And that's something people have to understand. You can't pop a bubble when you're leaping out the first floor window, and at this stage of the game, the commodities, when you look at them on a long-term basis, adjusted for the amount of inflation that we've had, they are still very depressed.

I think what people have to understand, when you look at gold and silver and when you look at oil, it's tempting to look at them as the commodities that they are, but another framework to look at them is to look at them all as currencies. Look at them as currencies where the supply can't be readily expanded. In order to expand more gold, you need to build more gold mines, I mean finding more gold, finding more silver – oil the same thing. Those are all very labor intensive, very capital intensive processes that's take years, years to accomplish. So when you at the same time Hank Paulson and Ben Bernanke can push a button over a weekend with the stroke of a pen and create billions and billions and trillions of dollars worth of liabilities on the government balance sheet, this is where the supply of digital money can be created endlessly. And I think what you're going to see in the next few years, all paper money, not just dollars but other paper currencies will follow, will devalue and depreciate against commodities because commodities are getting harder and harder to find. The world has picked a lot of the low hanging fruit: the easy copper deposits, easy to find gold deposits, the easy to find oil wells and we're getting to a point where in order to sustain current supplies, it's just getting much, much more difficult to find new resources to tap. And so that's the argument for a continued commodities bull market and I think investors need to look at prime opportunities like this where there is a big break in prices to really think about positioning themselves on the long side. [55:49]

JIM: I want to relate a conversation that a friend of mine had this week calling up trying to buy silver. And the conversation went like this:

“I'd like to buy some silver.”

I'm going to do both voices. The person on the other line:

“All right, how much?”

And then he goes:

“Let me ask you, can I get it?”

He says, “Yep.”

And then he goes, “Are you guys busy?”

“Yes. Get to your point.”

And then he goes on, he says, “Well, what's a good bargain?”

He says, “What do you want to buy?”

He goes -- and this conversation goes back and forth. In the end the story is: he could buy it, he's going to have to pay a premium and they are telling him, Frank, eight to ten week for delivery. Eight to ten weeks! [56:32]

FRANK: That's remarkable.

JIM: A lot of people are saying the little guy is finally getting in and buying this. You know what, folks? The little guy isn’t buying gold. I interviewed Franklin Sanders.

FRANK: There is no possibility of the little guy coming in to buy physical gold in the face of a 15, 20 percent selloff in gold. That's just – when you see a market that's pulled back like this, the retail tends to put the wallet on their hip. So something else is going on and it's very strange, JP. [57:06]

JIM: It is probably, Frank, I think one of the oddest events that I've ever seen. The disconnect – and I can tell you this, and the this is just from a study of human nature. There is no way and I say, no way, never, never, never, never, are you going to see politicians raise tax rates 88 percent and cut spending 40 percent. I can just tell you, that is not going to happen. And as all of these events talk, and we're only working – we've only gone through the first stage of this credit crisis; the second stage is we're moving into now, the third stage next year is going to be the credit default swaps, and then also the overhang of delayed effects from all of these mortgage resets; and then when we get to 2010, we're going to go to the final stage which is going to be these option ARMs. And then, Frank, who knows what kind of bankruptcies we're going to be looking at right now. And that's why I think that the hyperinflation – and one of the things that disguises the true rate of inflation is if you look at the 20s, when Germany was inflating, England, the United States, other countries were on the gold standard, so they experienced deflation. Today, when you live in a fiat world where every country is on a fiat system, where there are no limitations to the amount of digital money that can be created to the amount of money or assets that can be monetized or the amount of money that can be spent by government where there is no restraint put on government, what disguises inflation is when everybody is inflating, you don't notice it as much where versus let's say 1920, it was Germany that was reinflating where the rest of the countries were taking their bitter pill in the depression of 1920. And I think when you take a look at these events, I think the people that are saying “deflation, deflation deflation” are absolutely doing a disservice and have not studied history very well to say that, once again, as David walker Comptroller of the Currency, “you want to fix this, raise taxes 44 percent, cut spending 20 percent.” [59:36]

FRANK: The solution is too politically unpalatable to even attempt.

JIM: No. You would never get elected.

FRANK: No.

JIM: Both candidates, both candidates are promising us more goodies and one candidate has got so many spending programs that I don't know where in the heck the money is going to be created from other than the fact that maybe we should invest in chainsaws, or forests, because every tree in the forest is going to be cut down. Well, Frank, as we close here, first of all, thanks for spending the time. [1:00:08]

FRANK: Of course, Jim, my pleasure.

JIM: With us here on Financial Sense. What would you be doing here if you would give advice to our listeners?

FRANK: Right now, the values that I see out there, first and foremost, I think the listening audience should be looking to accumulate some physical metal, that's gold and silver – the precious metals. What you historically find is that every time you have a pretty major correction, in this case this is a primary degree correction, it’s a wave 2, we've had for the last seven or eight years in Elliott terms were essentially a primary wave one; we’ve now had the correction to that; that move –that's complete or in the last stages of completing, we're heading into a third wave up. And what people need to do is own physical metal as an anchor to their portfolio because ultimately it is the purchasing power of gold, the purchasing power of silver which will come through any kind of high inflation environment very well.

I think at some point, and I'm not quite sure when, mining stocks will be a tremendous asset to own. In the near term, I can tell the listening audience that technically in the last two to three days, we've seen some of the most oversold daily readings in the mining stocks of the last 35 years. There have been only one or two days back in 1982 at the very bottom of an 80 percent decline where we saw oversold readings that were of this sort, and from that point mining stocks basically went up 100 to 150 percent within a year. So I think mining stocks are going to have a large trading rally. I think the HUI will probably move back up towards 400 over the next few weeks, few months. I'm not sure that mining stocks have turned the corner quite yet, maybe into the next, I can see a period where physical metal could go up over the next 12 months at a very rapid rate of rise. In other words, the rotation within the commodity bull market could move temporarily away from energy and towards precious metals – precious metals being the flight to quality asset of last resort. And I think with the banking system heading into a major period of turmoil ahead, that's going to work very strongly for gold.

When you look at the euro, there is a limit to how high the euro can really go on practical terms because of political reasons. But there is no limit, a lot of that safety valve money can move into gold and silver and drive prices higher without having any political lash back. So in that sense, I think you'll see much much higher metals prices.

In the currency markets, if I had to pick one currency, it would probably be the Canadian dollar, based upon a lot of geopolitics and the fact that Canada has such a strong resource base, the FXC which is a ProShares which is traded on the New York stock exchange that tracks the Canadian dollar. For people who want a convenient way of owning metal, Central Fund of Canada (CEF on the Amex) is 50 percent gold and 50 percent silver. I believe that should be a core holding. This is a great place to go shopping for CEF. Back up the truck and buy as much as you can on this weakness. I think you'll look at that a few months from now and be very happy with that.

At some point, I'm going to be watching inverse bear funds for bonds. I think the 10 year treasury has made a very important low in terms of yield, and I think we're going to start to see yields heading back up towards 4 percent and then eventually breaking out above 4.35. There are some wonderful bear funds out there at Direction at Rydex that can be used to play the selloff in treasury bond prices and a rise in bond yields. That's another trade I'd be looking at here, and at the right time, I think we'll see –

My big caveat on the mining stocks is not so much in the short term. I think in the short term mining stocks will bounce and they’ll bounce hard, we'll see a big rally, but once that rally is over, we could be at a point later on where the stock market, in my opinion, the S&P and Dow they could be heading into a crash next year and mining stocks in a crash can be touchy. So we may need some real timing on that to attempt to trade in and out of mining stocks but ultimately at a stock market bottom –a major bottom in the stock market – I think the mining stocks will be a very long term bull market play that comes around. So right now, I would own them on a trading basis and I think that's the kind of thing that maybe a couple of weeks down the line after they've had a big move we'll have to reevaluate where we're going to go with the mining stocks. It's very possible that maybe they will go the other direction and just buck a stock market selloff. It's certainly enhanced given the chance they've got an oversold charge underneath them now, the likes of which has rarely been seen. That may be just the ticket for what the gold stocks needed to be able to buck a falling stock market, but that's still a little bit higher risk. So right now, my first choice would be physical metal and I think that's what people should be focusing on right now in either deflation or inflation – but in inflation, it's life and death. You need to own it. [1:05:25]

JIM: It's rather interesting because as we speak, Frank, Lehman’s six month notes just crossed my Bloomberg screen with a yield of 34 percent. Bye bye.

FRANK: It's terrifying what's happening. I mean to see AIG for so many years was the sine qua non of the financial world and to see this stock foundering with these kinds of problems, it really has to tell you that there are big problems afoot. [1:05:57]

JIM: And also as we're getting ready to close here – the market, we're just three minutes away from the market closes as we're having this conversation, the HUI is up 11% today. You've got Agnico-Eagle stock up 18%, you've got Yamana stock up 14, if you go to Goldcorp, it's up 13, 14.

FRANK: JP for the record, I think the HUI is heading back up to 400 over the next week, the next few weeks, so I think by the time we get through probably the end of November, I think you'll see the gold stocks having had a very substantial advance off of these levels. So there is definitely on a trading basis even with today, I think there is still a lot of upside in the sector. They've just been hideously overdone on the downside and you'll see some kind of a big whiplash move. So there will be a lot of opportunity to position portfolios, reposition portfolios, but the bigger picture, it's quite the storm. We've got the equivalent of Hurricane Ike over the entire United States. Only it's a financial hurricane, and not the traditional short. [1:07:04]

JIM: Frank, I would throw in, I would short oil, if you see two more hurricanes, an earthquake in Alaska and a ship blown up in the Persian gulf, maybe we'll get to 50.

FRANK: 50 dollar oil. Right.

JIM: Listen, if our listeners would like to contact you, tell them how to do so.

FRANK: My email is the best approach. That’s Frankbgst@AOL.com. My pleasure, Jim.

JIM: All right. Have a great weekend.

FRANK: You too. Take care.

Part 2

No Virginia, it's still a commodity bull market

JOHN: Well, Jim, I am beginning to call it the Saturday huddle. This is the new label I’ve put on the pattern of behavior that I have seen on the part of the financial powers that be – you know, the Fed the Treasury Department, the Wall Street banking establishment – and what happens is they have a pattern going. What they have to do is when a crisis emerges, 1) they’re not going to announce the crisis before Friday night, so that’s it – they’ll sit on it until then, but they have to figure out what they’re going to do about it prior to Sunday when the Asian market opens – Monday, Asia time but Sunday in the United States – and so what they do is they have a Saturday huddle and that’s when they decide what the action will be. And it goes something like this: the first stage is, “hey, everybody. There’s no problem.” When you’re running up to the subprime…No problem. When the problem becomes obvious they say, “well, yeah, remember that problem there wasn’t a problem? Well, we fixed a problem that didn’t exist. So it’s fixed now. You’re okay.” And then the third stage is “not to worry, we’re at the bottom, it’s going up from here.” And this pattern has been emerging over the last, what, 24 months, along with the Saturday huddle.

So what we’re going to do in this segment is look at the credit crisis. We’ll take a second look at this and why don’t we do a timeline on this, Jim, so it puts the Fannie Mae and Freddie Mac into perspective going back to the subprime issue.

JIM: Well, if you take a look at last year, the crisis began, John, it was February with the intermediate financial lenders and we had a little bit of a brief crisis in February and it was over by March, and they said, “Phew, that’s it. Everything is contained. Moderate growth. No problems.” And you heard these kind of statements coming from not only our Treasury secretary but also remember Ben Bernanke: “This wasn’t going to be a problem.” Well, fast forward to August of last year when the subprime crisis really began to take a hit and that’s when you really saw a lot of these financial institutions begin to fess up. There wasn’t that much capital raising back then, but if we go back to the third quarter of last year, Citigroup announced a 5.6 billion dollar loss, Merrill announced a 9.4, UBS 4.7; and so this was the first sign that, hey, there could be a problem here. But there really wasn’t that much capital raising. Okay. The Fed begins to cut interest rates and the market gets euphoric because the Fed is going to save everything. Well, lo and behold, let’s march forward to the next quarter. In the fourth quarter of last year, Citigroup announces a loss of 18.2 billion. This time they did raise capital. They had to raise close to 12 billion in capital; Merrill Lynch announced an 18 billion dollar loss, a 6 billion dollar capital raise; you had UBS – and all of a sudden you were starting to get some pretty horrific numbers. All right.

We move forward into the first quarter. And remember, the subprime loss is still unfolding as a lot of these resets and mortgages started to take place with a lot of these 2-28 loans that were issued. As the Fed was raising interest rates, banks lowered credit standards and they also came up with this creative financing, and they didn’t care because most of this stuff was securitized. All right.

So first quarter of this year, Citigroup follows the 18 billion dollar loss in the fourth quarter with another 19 billion dollar loss; Merrill announces a 9.7 billion; UBS 19 billion; you had other luminaries – But we had quite a bit of losses cumulatively by the first quarter losses of this year: 168 billion in losses.

Fast forward to the second quarter. Citigroup announces 11.7 billion dollar loss; we had Merrill with a 9 billion dollar loss; UBS 8. And so we had a 115 billion dollars of losses. The fast forward to the third quarter –and remember, the third quarter is not over yet – so far world wide we have roughly about 16 billion dollars of reported losses, but remember we still have another couple of weeks left in the third quarter.

So, if we look at all of this cumulatively, we have a 514 billion dollars of losses; 362 billion in capital raising. Now, everybody said okay it’s the subprime, but here right on this Friday one of the top stories on Bloomberg is Alt-A mortgages could be the next thing that hits the market, and now this is going to have to be written off. And also, as these loans are written off – as properties are put on the market – what happens is you know, when banks have to liquidate properties, they liquidate them at a discount; the average is between 20 and 25 percent between existing prices to move the property. That drives the whole neighborhood value down, so the whole collateral that stands behind the loans is vastly disappearing. And it’s amazing because this goes to show you how dramatically this country has changed with the amount of debt that we have taken on, especially the last four decades. In 1945, it was a different kind of life back then: people paid cash for homes or put substantial down payments. And if you want to take a look at what has happened to home equity – in 1945 you had mortgage debt of 18.6 billion and equity of 98 billion. Fast forward to this year, we have mortgage debt close to 12 trillion and equity that’s around 9 billion. So one of the problems is there’s less equity out there. And these figures are always distorted because there are a lot of people who own their homes free and clear, so the equity that used to be out there has diminished as debt has gone up and I’ve think there’s a reason for that. It’s a combination of, one, the deterioration in lending standards because you went to no-doc loans and then also people who did put money down would later tap the equity in their home from home equity loans. [6:29]

JOHN: Something you just mentioned there is really important because it would seem that what really kicked off this frenzy was a decline in lending standards. You remember. We used to talk about this 24 months ago where mortgage brokers made loans knowing these things were going to go belly up in 24, 48 months – something like that. But they didn’t care because they got their commission out of the whole thing. So if the whole thing went south in another couple of years, they really just didn’t care.

JIM: No. In fact, it used to be the standard even in the S&L crisis where lenders wanted to see 20% down or equity. And it’s amazing, if you take a look at statistically in this decade, you started out the decade with a combined loan-to-value of roughly 80%; you could put 20% down, the bank loaned you 80% - and it stayed around that 80%. Beginning in 2003 all the way to 2007, the combined loan-to-value on all mortgages out there went from the 80% level in the early part of the decade to 90% combined loan-to-value, so the banks were willing to make loans with less money down. If you take a look at for example, 100% financing where you had no money down at the beginning of this decade; that only accounted for about 3% of all financing. Beginning in 2003, when this thing began to take off, 100% financing was at 8% and by the end of like 2007, it was closer to 35% - meaning 35% of mortgages that were made by banks, the buyers of the property had no equity whatsoever. If you look at what we call limited documentation loans, or what’s referred to in the industry as liar loans, they went from 27% in 2001 all the way to 44% in 2007; also, 100% financing and limited documentation loans were 15% of mortgages. So the things that we’re seeing in not only the subprime market but also now in the Alt-A market and we’re going to be going to in just a moment here.

Another type of loan that is even going to be worse than what we’ve seen with subprime loans which is the option ARMs. And we’ll get into that in just a moment, but I mean you’re right – we’ve never seen things like this happen and I think part of this was there was an insatiable appetite on Wall Street for a vast supply of mortgages which they could wrap and securitize, and so banks since they weren’t keeping a lot of this stuff on their books didn’t really care if the loans – look, you made the loans, you made your fee, the more loans you processed the more fees you made and then the loans were shoved onto Wall Street where they were packaged into these CDOs, sliced and diced into all these mortgage products which are now blowing up. [9:34]

JOHN: You know, we’ve seen quite a bit of real estate decline. You hear these pronouncements all the time that we’ve sort of hit the bottom, but in reality, if we look at the appreciation in the value of real estate it has been absolutely breathtaking. I don’t know if it’s been record, but it’s been almost breathtaking in terms of the value of homes going up; probably a lot higher than their real world value would be. So how much more do we have to decline before we get back to something that resembles reality?

JIM: If you take a look at the Real Home Price Index, it’s been as an index configured from 1975, we need to see a 30% decline in housing prices just to get back to normal trend lines. And in certain places like California we’re already seeing that and it’s probably even going to get worse because of the amount of foreclosures. Nothing ceases to amaze me anymore in terms of financial punditry and their comments on this. I mean every other month they’re calling a bottom to the housing market; equally calling a bubble in the commodity market. In fact, one prominent financial commentator said this is it, you know, housing has hit a bottom. I think this is his fourth or fifth call on that. But we still have a ways to go before we’re ever going to get anywhere close to where we’re having – like I said, as we’re going to get into in a moment – there are a number of things that are going to hit this market – we have Alt-A mortgages which are going to hit next, and that could be quite substantial, and I think that when these mortgages start heading – in other words, if you’ve ever sailed on the ocean you know that waves come in sets of three. And I think we’ve had the first set or wave or rogue wave – if you want to call it – and you might just call that the subprime market; then you’ve got the Alt-A market coming; then you’ve got the credit default swaps which I think are going to hit next year and then on top of that you’re going to have the option ARMs, which we’re going to get to in a moment.

But I think that one of the problems that we have right now is we know that the unemployment rate is going up and as the unemployment rate goes up, more people lose their jobs. They are struggling, they can’t make their payments, that means more mortgages – and so in the end the taxpayers or the government owns most people’s mortgages. You will become a slave to the government. When you take the income that you make – you know, 40 to 50 percent of your payment will go to the government on your mortgage and then another third on your taxes, and what’s left over will be – you know, this is worse than serfdom in the Middle Ages. [12:04]

JOHN: How many people see this coming in this genre?

JIM: You know, there have been quite a few people out there. Michael Panzner has written about this; Nouriel Roubini has written about this; a number of people on our site. We wrote about this in 2005 in a series that we called The Day after Tomorrow of how this would unfold, including by the way, we gave some examples of how option ARMs worked and the kind of goofy financing that was going on during that period of time, with a hypothetical couple that I had called the Wheelers. But there was a belief that housing never goes down, and that when you’re in the middle of a bubble you always tend to think to think of it when you’re in the middle of it, you know, this thing will go on forever because we had never seen the kind of declines in real estate prices that we have seen here over the last 12 months. But by the same token we have never seen a surge in real estate price as we saw between let’s say, 2003 and 2006, when the price every single year you were seeing double-digit increases in housing prices and in some areas homes actually doubled. I can remember there was a house that we bought in the summer of 1987, it was 3600 sq. ft. house; it was on top of a hill. It was a half-acre. A nice tract home development. And John, that house at the peak of the bubble was going for like 1.6, 1.7 million – It’s fallen substantially – but that’s how crazy things got when, you know, they started the decade that house was probably worth about 750,000 to 900,000 and it basically went from the 750-900,000 range – depending on the models in the neighborhood – all the way up to 1.7 million. I mean that’s a substantial increase in a short period of time for a major asset such as housing. [13:53]

JOHN: So when things roll out, what would we expect the values of the homes to be at in terms of, say, what we started with?

JIM: If we just wanted to get back to normal trends, and let’s say they’re going to reinflate to stop the hemorrhaging, nationally –if you’re going to look at this as a statistic, as I mentioned earlier, that figure –housing would have to drop by almost 35%. And in areas where it really got crazy – Vegas, Phoenix, California, Florida – you know, the hotspots where the big boom took place, I think you’re probably going to have to see 40 and 50% declines. [14:27]

JOHN: Wow. And then what would the ramifications of that be? Because obviously we were talking at one point about people were borrowing against their homes and this is déjà vu, Jim, because this was discussion on the show four years ago – the values of their houses are going to go right down to the mortgage basement.

JIM: Not only that, I forget what the latest figure is, like, 8 to 12 million Americans are upside down on their mortgages meaning that the mortgage on their home is greater than the value of the home. If you take a look at the record foreclosures that we announced last week along with the increase and the jump in the unemployment rate to 6.1%. As foreclosures begin to soar…And the other thing in terms of recovery – this is very important – and that is if you look at where mortgage rates – now, they’ve come back down – recently there’s been a movement down with the takeover of Fannie and Freddie, but if you take a look at 6 ½% and you take the average person’s income in this country which is about $42,000, at 6 ½% that person is only going to be able to afford maybe a 230,000 mortgage. I mean if you get the figures lower in order to afford that same kind of home today, you’re going to have to get interest rates back down to the 2% level, the 2 ½ and 3% level, the rates which were being offered on these adjustable-rate mortgages during the boom. So the purchasing power is much much less because interest rates are higher today.

And the other thing is that not only are interest rates higher – and this is surprising because even though the Fed has cut interest rates, mortgage rates themselves are just about where they were when the crisis started. So we have not seen a fall off in mortgage rates; jumbo rates have actually gone up – they’re closer to 8% or more. So you have limited buying power to buy this excess inventory that keeps building in the market because interest rates are higher than they were two or three years ago. So that’s number one.

Number two, banks are actually tightening standards so you know, no more nonsense like no-doc loans. They want tax returns, they want proof that the income that you put on the application you’re actually earning that income. So there’s the documentation and the standards are tougher. And then number three, they’re requiring a lot more in terms of downpayment. In other words, they’re going back to a more prudent lending because the losses have been so horrific for many of these companies. So your pool to buy these houses are going to be somewhat limited. Now eventually if enough inventory comes online and they roll a lot of this failed, foreclosed property into something like an RTC, then what will happen is wealthy investors will start coming in and buying large tracts of not only mortgages that are sold at steep discounts like they did during the RTC S&L crisis during 91, but also properties as well. And I think that’s coming because you just have another wave – as I mentioned, the big wave I think that’s coming forward here is going to be the option ARMs; and these option ARMs were used primarily to get people into homes between 2005 and 2007, a good majority when I was writing The Day after Tomorrow back in 2005 describing what is unfolding today back then. That was one of the favorite lending vehicles here in a development – a 3,000 home development – that I called Big Sky Ranch. When I talked to the lenders – and by the way, that lender that was the prominent lender – and I still remember this, John, I was doing the interviews with the homebuilders and also the main lenders, and this lender – and I’m not going to mention them but they have now been taken over by a major bank – but they were saying that: “Why should you put 20% down, why should you get a fixed rate mortgage? With these option ARMs and these variable rate mortgages, you can buy so much more home and then with piggy-back mortgages you can put in a lot more options.” Which is what was happening because people would buy a home for 750,000 and they’d put 20% in options in it; and of course those options that builders were having huge markups on. But these option ARMs were a way to get people in these homes that otherwise wouldn’t have been affordable. In other words, they wouldn’t have been able to make or purchase those homes had they gone with a conventional-type mortgage. [18:57]

JOHN: You know, you’ve been talking here quite a bit about option ARMs and I’m sure that’s throwing up a question mark for a lot of people. So people are familiar with ARMs but are these different – what’s the nature of them?

JIM: What an option ARM is: it’s an adjustable-rate mortgage that provides the borrower with an option each month to make either 1) a fully amortizing loan meaning you’re making your principal and interest payments; 2) you could just pay the interest only; or 3) you had the option called the minimum payment. And these interest rates that were offered were below market. What happened with this kind of a loan is, let’s say, John, that your mortgage payment if it was a fully amortized mortgage was $1500 a month. I don’t know. Let’s say a $300,000 loan, but I’m just throwing this out as an example. And let’s say you had the option to make a minimum payment and that minimum payment was $1200. Well, if it was $1200, the interest only was $1500, you weren’t making the complete interest payment. So the 300 dollars – the difference between the minimum payment of 1200 dollars a month and the 1500 month required to pay the interest, that 300 dollars each month was added to your mortgage. So your mortgage got bigger each month as long as you make that 1200 dollar payment. Now this loan was a five-year loan, and each year under the conditions of the contract, you could adjust the payment or the interest up 7 ½ percent. And so you knew over a five-year period that your payments would rise about 7 ½ percent a year. And depending on how these loans were issued, they would allow your loan to actually grow by an additional 25 percent from your original loan balance to as much as 30 percent of your original loan balance – in other words, the difference between what you should be paying in interest and what you did pay in interest just simply got tacked on to your mortgage. And so the great thing about this – and this is how a lot of people qualified is your mortgage payments could only increase by 7 ½% a year. So people said, hey, I’ve got a real teaser rate to get in; if I make the minimum payment of $1200 and it goes up 70 bucks next year or 80 bucks, you know, I can afford to deal with that. And the idea was, well, real estate goes up each year – “It goes up 10% a year” – so people were willing to get in this with the belief that, my gosh, five years from now, the option ARM comes due – and here’s the killer: in 2010 to 2012 when these option ARMs come due, what’s going to happen then is: 1)you may be dealing with a bigger loan than when you started with; 2) you’re going to go to full market rate interest rates; and 3) it’s going to become an amortizing loan, meaning interest and principal payments. So you’ve got another wave of defaults coming here in the year 2010 to 2012. So just when everybody is going to– the peak in mortgage resets came I think in the month of June or July – each month they declined – but we know that there’s probably a six to nine-month lag period between the time a person stops making a mortgage payment and the time it goes actually in foreclosure, actually into the market and is put for sale. So there’s a lag period that should take us right into next year. That’s why these losses that we reported earlier in this topic are going to be greater going forward, and I think it’s going to be more difficult for a lot of these companies to get capital. And it doesn’t stop there.

If you take a look at – there’s also home equity lines of credit because remember people that did put money down and even people who have put no money down still could get a line of credit on their home. And John, there is a huge exposure. This is another area and unlike first or second mortgages you know, these stand further away in terms of foreclosure. You know, you take a look at the lending institutions Countrywide which has been taken over by Bank of America, their home equity lines represented almost 31% of their loans, 16% of their assets and over 236% of their equity. Washington Mutual – 26% of their loans, almost 19% of their assets, 258% of their equity. You get to First Horizon Bank, 26% of their loans, 18% of their assets, 314% of their equity. And even Wells Fargo, which is in fairly good shape, their home equity line represents 21% of their loans, 15% of their assets and 178% of their equity. So, you’ve got two other aspects of this home mortgage loan. It’s not just the subprime, it’s Alt-A, then it’s going to be option ARMs, then it’s going to be home equity lines. So John, there’s just a whole set of waves that are going to be buffeting the financial system and we’re just going to see one bailout after another. [24:33]

JOHN: You’re listening to the Financial Sense Newshour at www.financialsense.com, and coming up next we’ll have a delightful conversation here with Franklin Sanders talking about the difference between the physical and the paper bullion markets. There seems to be a lot of, well, multiple personality disorder out there right now. Well, we’ll be back as the Financial Sense Newshour continues.

Other Voices with Franklin Sanders, The Money Changer

JIM: Well, this interview is taking place on Thursday where the price of gold has fallen below 750, silver is down below $11. Joining us on the program is Franklin Sanders who runs a bullion business.

And Franklin, you know, we’ve seen the price of silver and the price of gold fall off a cliff in a seven week period of time, but unlike previous corrections that we’ve seen in the metals market we are hearing stories from dealers, from all the way across the United States to Mumbai to Dubai to Johannesburg, to even Zurich that the stuff is just flying off the shelves and that dealers are having a hard time getting that. Is that what you are experiencing in your business? In other words, as a bullion dealer, if I called you up today, Franklin, and said I want to buy 10,000 ounces of gold, could you get it for me?

FRANKLIN SANDERS: Only in the form of 90% silver coin and only at premiums that are more than three times what the premium usually is. [26:20]

JIM: And what is the usual premium?

FRANKLIN: Well, back at the peak on the 18th of March, the wholesale price of 90% silver coin was 25 cents an ounce less than spot silver. In other words, it was trading at a 25 cent discount to its silver value at wholesale. And today, the cheapest I could buy it is 80, 85 cents over, so about four times what it normally is at. You know, it’s usual that premiums go up and down with the market, and premiums will strengthen just a little bit when you’ve got a lot of demand coming on, but we have not – I’ve never seen in 28 years this kind of strength and especially not this kind of strength on a decline that lasted over 40 days. [27:16]

JIM: You know, you can see this whether you go to Kitco’s website, where they’re saying we can get you the stuff but we just can’t tell you when we can get it. I have a friend of mine who lives in Switzerland and he just cleaned out the largest coin dealer there today for silver and he is buying a metric tonne of silver and he was told that he would have to wait until the end of October, maybe the beginning of November; he’s buying the silver coins of Austria. And, you know, you’re seeing this take place around the globe. And like you said, you’ve been in this business 28 years, have you ever in that 28 period seen anything like this?

FRANKLIN: No. And here’s what doesn’t really make sense about it. Normally, you’ll get – you might get an initial lag where prices have been very high, they begin to come down and the premiums don’t move. But then if you get a protracted drop the premiums always give in after a few days. And the reason is that dealers especially who are holding that silver and gold are used to higher prices and so if the price drops off a little bit they won’t sell, and that’s reflected in a rising premium. But then they capitulate after a few days. I have never seen anything like this. I have never seen public demand like this because you know, unfortunately, human nature is such that everybody wants to buy a rising market, right? You know, when silver was down at $4.02 an ounce, I was begging people to buy it. And very few would listen. But when silver was $20 an ounce, everybody was pouring through the door wanting to load up their boat and go home with it. That’s just human nature. But this has worked completely differently. The orders that are coming in – the farther it goes down, the more they buy and the bigger the orders get. And I’ve never seen that before. That’s not normal. Not after a decline as protracted as this. I mean think about it. [Gold] has gone from 950 dollars down to 745 today, and that’s a 200 dollar drop and the demand is just as strong as it was up at the top in March. In fact, I think we had better August than we did March. [29:33]

JIM: You know, I’ve talked to some dealers and one dealer told me his book of business in July was up 400%. His business in August was up 800%. And you know, when you see this kind of buying coming in, Jeff Christian from CPM Group and in his Gold Book for 2008 talks about that in previous gold bull markets you’d see maybe two to three years of strong buying of the metals, the market would peter out and then things would get back to normal. But this is the first time that he has seen in any bull market in history where there has been continuous record buying year in, year out; and earlier in the year when I interviewed him on his Gold Book he said I think this is going to be a record year. And what you’re telling me is the price of bullion has gone down, you’re seeing the orders multiply even more.

FRANKLIN: Right. And that is not normally the case because usually the public runs away from a falling price, and they run toward a rising price; and it’s just the opposite. These people who are coming in are absolutely determined to get out of dollars and convert their dollars – their paper dollars into silver and gold. There is something sort of ironic about the metals market. I’ve been buying gold and silver since 1975 I guess, first as an investor and then in the business, and in 1980 I was in the scrap business and maybe you remember what happened but price shot up to 850 dollars for gold and 50 dollars for silver and all of these scrap buying operations showed up to buy your jewelry, your sterling silver – tableware and so forth. And at that time it was interesting that at the peak of that market the public was right, which runs contrary to the Wall Street adage that the public is always wrong. They were right to sell. And now they’re buying. It sort of makes me wonder if when it comes to physical gold and silver the public isn’t always right instead of wrong. So the people that we see piling in now are people with a good deal money, and you assume that people like that know their own minds and they’ve been successful at something already so they’re pretty good at making decisions.

Another thing, Jim, I think most people don’t realize is that the gold and silver markets are very, very small. I mean in terms of the door to get into those markets to buy physical gold and silver, those are very, very small doors. There are not that many dealers in the country when you compare to something like bond dealers or stock dealers or other investments like that, so it’s not surprising when you get huge new demand that market backs up. You know, there are a lot of people who like to write sensational stories on the internet because sensational stories sell better than rational stories, but you can explain away a lot of these delays in products if supply – simply by the supply chain. You know, if there’s just not that much in the supply chain, there’s not that much gold and silver in the supply chain and it takes a while to replenish it. It’s just that simple. There’s just not that much stock out there. [32:48]

JIM: You know, one mint, Franklin, that I was talking to, they couldn’t get silver blanks so what they were doing was paying premiums to Johnson Matthey to get a thousand ounce bars and they were melting down the thousand ounce bars and they were told that instead of getting their bars within a week that the delivery from Johnson Matthey was out three to four weeks. So even Johnson Matthey – the people that actually mint the bars and create the bars – they are having bottlenecks.

FRANKLIN: Right. I don’t doubt that’s true, but again, if you take an industry and it has a certain level of activity and suddenly you demand two, three, four times as much supply from those producers as they normally put out, then you’re going to have bottlenecks. There’s no question about it. I think another thing that’s pointed out here too, which is something that I’ve expected as I’ve contemplated this bull market – you know, Jim, the last bull market was driven by the paper price of gold and silver; that is, it was the futures price that was driving the market. And I was in the scrap business then and you could buy physical silver – you could buy a lot of physical silver from the public and you could buy it at a huge discount to the paper price, but it took six months or more to get that refined and into deliverable form – that is, deliverable on the COMEX where you could sell it. So the problem was that you had the price risk of the next six months while you were in the queue at the refinery.

Now, what I think we’re seeing is a decoupling of the physical price from the futures price. In other words, I expected to see this all along. I expected during this bull market to see some point where the physical price would actually be higher than the futures price – and that’s what you’re seeing now. This has come much sooner than I thought it would, and I don’t think that this is that dramatic breach that I do expect to see where there may be a 30 or 40 percent difference in the physicals and the futures prices. But I really expect because there’s so much paper silver and paper gold has been generated, I’m sure a lot of that’s been generated irresponsibly without backing, without cover. There’ll be some sort of scandal some time in the course of this bull market and when that scandal breaks and someone who owes – who has sold paper silver is proven not to have any physical to back it up, I think at that point there will be a race to the physical silver that will drive the physical price – both silver and gold – up much higher than the paper price. Does that make sense? [35:40]

JIM: Sure. Franklin, do you ever envision the day where simply that when you take a look at the bull market in the 70s when the public really got on board – what was it? 78 to 80, or 77 to 80; I forget when it was – there was a window when the gold market just really lit up. Do you ever see a point when you just simply won’t be able to get it? In other words, demand not only – we know that gold and silver has industrial applications – you have that element of its use, but also it’s seen as real money and a store of value and a safe haven; that the demand becomes so overwhelming and as you mentioned earlier, this is a very, very, very small market – it isn’t like the bond market or the global stock market – that when any kind of money comes into the market it simply overwhelms it and you won’t be able to get it.

FRANKLIN: Well, the problem is that we’ve been in that situation in the last six weeks or so. The delivery times are staggered anywhere from two to eight weeks. They’re not that bad, but the fact is you can’t call me up in a lot of cases, you can’t call me up today and say I want x number of ounces in the form of this coin or that coin and actually find me able to ship it tomorrow. So, yes, I think it’s possible that you could get to the point where the shortages are great enough that not only the shortages but the public’s desire to hold onto silver and gold are so great that it’ll be very difficult to buy; and at that point, again, that’s when you begin to see premiums applied to these various forms of physical gold and silver. And that premium’s going to raise up way higher than the futures price. [37:20]

JIM: Isn’t that what you’re seeing take place today? I mean, if you go to EBay and type in ‘silver Eagle,’ what do we have? Silver today at roughly about 10.58, and you type in ‘silver Eagles’ and you just can’t believe how much people are asking for it on EBay.

FRANKLIN: Jim, I have never been able to believe silver Eagles. I’ll be honest with you because they used to travel at about 35 to 40 percent premium over their silver content; and today I think with silver at around 10.50, at wholesale they’re 3.25 and you have to wait 30 days to get them. And I have never been able to figure out why people would pay those premiums. Of course, that premium as you observe has grown now that this shortage has come up, and people are just crazy for them. [38:11]

JIM: I mean looking right now. I just typed in EBay ‘silver Eagle’ and here’s 10 bids for a 2,008 one ounce American silver Eagle, right now the bid is at $20.01; and I’m looking at the price of silver spot at – let’s round it off – at $10.60. So you’re almost looking at a 90% premium. I mean this is nuts.

FRANKLIN: It’s crazy. But of course, you know, EBay tends to be that way, but even now at wholesale right now I would have to pay with silver at 10.53, I would have to pay 14.03 which is a $3.50 premium. That’s almost 32% or so – 30 percent. That doesn’t make sense to me even as 90% has risen, still – it doesn’t have a premium anything like that, it’s about 12%. [39:07]

JIM: When you have this discrepancy and when you have, you know, this almost complete separation between what’s going on in the futures paper market and what you have going on in the actual physical market that you do. I mean, when you have silver at – round it off - $10.60, you’re telling me you’re paying three to four dollars for a premium, silver Eagles are going for 20 dollars on EBay, how long can this last? What is it going to take? In other words, either 1) the demand for silver has to get exhausted and falls; 2) usually the supply all of a sudden, who knows, maybe the mint will double or triple their production of silver Eagles. I mean what’s it going to take to bring this market back into balance in your opinion after spending nearly 28 years?

FRANKLIN: Well, I think prices will have to rise before the market clears, or else we’ll have to undergo a very long period of low prices to fatigue this demand that’s out and to get all of this demand satisfied. But as far as ramping up production is concerned, it just can’t be done. The US Mint doesn’t even – they don’t make their own blanks. They used to get them from Sunshine Minting – I’m not sure if they still do, but there is no way they could substantially increase production. In other words, I don’t think any of them are in a position to increase their production by 50 percent, or 25 percent even. I don’t think they could do it. Of course, the Mint is so strange. The vagaries of their production are so strange anyway, why would you if you had a popular product – and this is the way the socialist economy works – and anything the government does is socialist – if you had a popular product, wouldn’t you make more of it? Not them. They announced in the middle of the biggest run on their product that has existed in the last 12 months or so, they announced they’re going to stop making it. Where do these people get their orders? From Moscow? I mean it just doesn’t make a bit of sense, but that’s what they’ve done. So I think there’s a non-confirmation here. There is a strong non-confirmation between the physical demand we see and the price. And whenever you see a non-confirmation, that means one of two things. Either there’s something wrong, somebody has got their signals wrong and they will be corrected. Is it the public who’s guessing wrong? Has the price of gold and silver actually turned down, have they fallen out of a bull market and will they go down? Or, is the futures market – that is, the paper market – wrong. Has the paper market overdone things. And I say I think the paper has overdone it because I’ve been doing this 28 years and I’ve never seen demand like this. I lived through Y2K. I lived through the peak in 1980. I have never seen demand like this. I have never seen it. So, it’s difficult for me to swallow that that demand is transitory; that those people are all going to fatigue out after a month or two they’re going to say, “oh, well, we’re tired of this gold and silver, we’re going to sell it.” I don’t think that’s going to happen. And besides, where are they going to go? Even if they bought silver and gold this year at the peak versus stocks, stocks have not changed that much in relation to silver and gold. The Dow hit a new high for this move – actually, it’s not really a high, it’s moved up to the top of its range of about the last few months – today, against gold. But stocks still have not really outperformed silver and gold. I mean they’ve climbed a little bit against them but they haven’t [inaudible], so where else are they going to go? Or, are people going to go to bonds? And very, very few people are equipped to trade currency, so you know, and very few people do trade currencies. So even if they have a loss in silver and gold, I think most people that I deal with are convinced that they are long term holds and all they do is they buy more if they go down. What that points to is we may have a long period in front of us when the market goes flat and finally this demand is worked off. Or, - and this is what I think is more likely case – we are experiencing a V bottom in which you had a waterfall slide down to these new lows and then you’re going to get the same kind of water spout rise up out of that that should begin probably sometime this fall. [43:50]

JIM: I want to come back to something that you said earlier, Franklin, that you’re seeing new buyers. Now you said these people tend to be monied people, so this is kind of like smart money. But are you seeing John Q. or Joe Sixpack show up and is Joe Sixpack starting to buy?

FRANKLIN: Well, there are a few like that, but they are by far the smallest part of our business. They’re just not – you’re talking about a hundred dollar or a thousand dollar orders, that kind of thing. There are those people, but I’m talking about big orders. I’m talking about, you know, 50, 100 thousand and bigger orders. And people who come back time and time again and every time the market goes back they come back. [44:29]

JIM: Really what you’re talking about is smart money. These are affluent individuals. People who see the credit conditions of the country – the inflationary conditions – and they’re looking…this is smart money moving in it sound to me like what you’re telling me. And that’s what other dealers have –

FRANKLIN: Let me give you two examples. I’ve had one fellow call up and say, “I’ve got about a million and a half dollars that I want to put into silver and gold.” And then I’ve got another one who calls up and says, “I’ve got 350,000 dollars. I want to put it into silver and gold.” Now, it’s just been my experience that a person who can get together a million and a half dollars in the course of his life is not generally an idiot. You know, generally they’re sagacious and far- seeing people, and those are the kinds of customers that we’re seeing now. [45:18]

JIM: You’re confirming what I’m hearing from dealers globally. Like I said, I have a friend in Switzerland – and you probably heard the story of one Swiss investor that called up the refiner in Johannesburg and brought 5,000 Krugerrands and wiped out their inventory. And this friend of mine in Switzerland wiped one of the largest coin dealers – just basically cleaned out their inventory; bought everything that he could sell. And these are the kind of people that see the times for what they are, and I think can read through this disconnect.

In terms of product availability, you can sell either junk silver or you have silver Eagles or you have silver rounds. In terms of what you see as most available today, what is it?

FRANKLIN: Well, it’s 90% silver coin by far. That’s the easiest thing to get and of course, it remains the lowest cost form of silver – and it has other advantages too. It’s the most divisible. It’s self-authenticating just like the American Eagles are. You just get so much more silver for your money that it makes the most sense. I know people think, oh my goodness, that’s too much weight to fool with, but you wouldn’t telled it – you can hardly tell the difference between 90% silver and 99.9% silver by the way. That’s the best thing to buy. And if it’s a question of availability as it today, are you going to wait for 100 ounce bars? Are you going to pay 40 or 50 cents an ounce more for 100 ounce bars and wait for them rather than get 90% silver coin? I wouldn’t. Markets like this make me very, very nervous, Jim – and nervous in the sense when markets are relatively calm, you can pretty much count on people to fulfill their obligations. But when they get roiled like these markets, all those dirty secrets – all of those secrets that haven’t been – those problems that haven’t been taken care of tend to rise to the surface. So in a market like this, I don’t want people to owe me anything long term. I want to settle my accounts very quickly and keep very short accounts. [47:23]

JIM: It’s absolutely amazing to see. Outside of junk silver, are you seeing difficulties in trying to get like let’s say, silver rounds or five, ten ounce, hundred ounce bars?

FRANKLIN: Oh, goodness, yes. I mean, I have seen something that I have never seen in my career before and that is dealers telling me I am not selling anything. Can you imagine that? A wholesale dealer, whose business is buying and selling silver and gold, telling me I don’t have an ask price for you on 100 ounce bars because I don’t know if I can get them or not. I mean I’ve got one wholesaler that I’ve been doing business with for over 20 years and he literally has shut down except for buying. He is not selling anything because he doesn’t know when he can deliver it. You know, 100 oz bars which normally ought to carry a 20, 30, 40 cent premium at the wholesale, I think they’re a $1.25 or $1.65 - $2 now something like that. [48:28]

JIM: Per ounce?

FRANKLIN: Per ounce, yeah, premium. I mean it’s just – that’s what I’m saying it’s just nuts paying two dollars an ounce – I’m paying $2 an ounce for 100 oz bars and for 10 oz bars and two dollars for one ounce rounds too. So of course you can get them at a better price if you don’t mind waiting, but how long do you want to wait? Two days to eight weeks is what they’re quoting. You know, eight weeks is November already. [48:53]

JIM: You know, if I called you up and I know the Mint has stopped minting silver Eagles. If I said Franklin, I’d like to buy a thousand silver Eagles in the next time they start issuing coins, I’ve been told it’s going to be January or February to get that. Is that true?

FRANKLIN: That’s an exaggeration. I can right now get probably up to six, eight thousand silver Eagles and get them delivered tomorrow. In other words, these – someone already had and they were stockpiled so to speak. I have those available to me.

JIM: What about gold Eagles or gold Buffaloes and some of the other popular coins? What are you finding there?

FRANKLIN: The Buffaloes are really actually have not gone up much in premiums and they’re still available. American Eagles also still available.

JIM: How much of a premium?

FRANKLIN: They’re really not terribly bad right now. At wholesale I would have to pay 779.50. Winds up at retail that would be about an 8.2% premium, which is up about 2%. That’s not too bad. They’ve actually come down in the last two weeks. [50:00]

JIM: Okay. So it seems to me like the real trouble is in the silver side and there’s gold out there. Anything else that you see that’s of value if somebody wanted to – I mean what about British sovereigns?

FRANKLIN: The availability of sovereigns is pretty good. The premiums have come back down on those. But you know, I think American buyers really miss – they’re so focused on American Eagles that they tend to pay too much for the Eagles instead of buying the sovereigns or French 20 francs. You know, French 20 francs and sovereigns we can sell at retail you know, at a 5% premium – 5.3, 5.8% premium; and sometimes cheaper than Krugerrands. And Krugerrands today are about 7%, so could actually buy French 20s or sovereigns at a lower price per ounce than you could buy Krugerrands. [50:52]

JIM: that’s absolutely amazing. Well, Franklin, as we close, if our listeners would like to contact you, please give out either your website and tell them how they could do so.

FRANKLIN: The website is www.the-moneychanger.com. And they don’t want to go to just plain moneychanger.com because that’s a porno site and I have anything to do with that, okay?

JIM: I’m glad you pointed that out.

FRANKLIN: I want to make this clear! And they need to be sure to have the dash in there, because if you don’t that takes you to another wrong site. But when you scroll down the homepage there’s a little yellow banner with a window which asks you for your email address. If you put your email address in there, then a form will pop and you can sign up for my free daily commentary. I have a host of prices that I send out every day along with a short commentary on the markets. [51:49]

JIM: Okay. Well, listen, once again it is www.the-moneychanger.com. Correct?

FRANKLIN: That’s it.

JIM: Okay. Remember the ‘the’ and the dash before the ‘moneychanger’ otherwise you may have to cover your eyes from what you see on your screen. Okay, well, listen, Franklin, thanks for joining us on the program. My best to you, Sir.

FRANKLIN: Okay, thank you so much for giving me the opportunity.

Part 3

Q-Calls

JOHN: Well, you've heard me say it before. We're saying it again. Welcome back to the program. Time for the Q-lines, which means our Question Line and our call in. We have these open 24 hour a day to record your questions or comments for the show. A few rules as far as doing this, first of all, please keep the questions under a minute. We just have far too many people calling in –which is really good by the way, we don't object to the calls but for everybody to get in here, we have to come up with some kind of a rule.

The second thing is, please remember that radio show content here on the Financial Sense Newshour is for informational and educational purposes only and you should not consider it as a solicitation or offer to purchase or sell securities. And our responses to your inquiries are based on the personal opinions of James Puplava and because we don't know a lot about you, we cannot take into account your suitability, your objectives, your risk tolerance. You should always consult a qualified investment counselor before you make some decisions. Financial Sense Newshour is not liable to anyone for financial losses that result from investing in any companies profiled here on the program.

By the way the toll-free number from US and Canada is (800)794-6480. That number is toll free from the US and Canada. You may reach that number from anywhere in the world, but you'll wind up paying an international call charge.

First call today comes from the UK.

Matt from the UK. Nice to have you back, Jim and John. There has been a lot of talk about deflation coming in and the commodities bubble has burst including on your website on the 2nd September by Joe Average an article written called Once in 100 Year Crisis which he states that there is an imminent and deadly deflationary collapse into a global recession/depression ongoing and that gold, silver bullion precious metals stock provide no shelter from this. There is also some stuff coming out on 321gold and several other articles by Bob Hoye and other distinguished writers who are questioning the current inflationary recession which might be approaching, that at some time there will be a deflation. If you could shine a little bit of light on this –if we have deflation that’s coming or not – it would be much appreciated.

JIM: You know, Matt, all of this is a set up. I've seen a lot of these deflationary arguments. They came out in 2001. They came out in 94, and they always come out any time you have a credit contraction as we're seeing right now. The unfortunate thing is the conditions in the world today are much, much different than they were in the 30s where they make so often or make reference to. If it was a commodity bubble, you would see stock piles. I don't care if you're looking at grains, if you're looking at oil, or gasoline inventories, for example, the lowest they've been probably since this decade began. If you're taking a look at grain supplies, they are at the lowest that they've been. If you're taking a look at even base metals. And as far as even deflation, if that was to transpire, I think you're going to get a deflation scare, but I think that's the set up for more reinflation. I think what's coming is global reflation in response to a deflationary scare. And remember today in a fiat world, none of the restraints that existed back in the 30s exist today. [3:32]

Jim, John, this is Dave from Virginia. Listen, fellows, you've been talking inflation ad nauseam for at least a few years now, but I want to know if you realize what’s going on: We're getting the exact opposite. Commodities are getting crushed, resource stocks are getting destroyed and the XAU has been absolutely slammed, it’s never fallen so hard over such a short period of time. These indices are not saying inflation. They are screaming deflation.

JIM: You know, if you take a look at what inflation or deflation – if an asset bubble corrects or a category corrects as sharply as it did –and please listen to the show last week that we talked about the London Gold Pool, listen to some of the fine interviews and writings of Donald Coxe, just because an asset pulls back sharply, just take a look at the things you have to buy at the store and I don't see deflation anywhere. Yeah, I can buy a plasma screen cheaper this year, but the stuff I need like putting gasoline in my tank is up this year over last year, the food I have to buy at the grocery store, the services I have to pay, and so I think you're mistaking a correction in a market that has been sharp and there is no doubt that has been that way, but I think this is a set up for another bout of reflation. [4:53]

Hi Jim and John. This is Ross from Ohio. I'm currently an undergraduate studying finance and economics at a public university here in Ohio. However, as you'd expect, everything we learn is Keynesian based. Classes on monetary policy are completely useless and the professors are equally useless when it comes to Austrian economics. Mention gold and they'll look at you like you have two heads.

The question is what school private or public do you recommend for studying Austrian economics at the graduate level. I know you Auburn University has had this reputation in the past. Does it still hold today. I also heard that NYU and George Mason have Austrian economics department, and I know that you went to Thunderbird, but I do not know much about the program. Any help would be greatly appreciated. Keep up the great work. Your show is a true financial savior.

JIM: You know, Ross, there is a couple of areas, Auburn University, Hillsdale College, George Mason – some of the others that you mentioned. And there is another thing that you can do if you're going to college is that the Mises institute has a boot camp that they run every summer, and it's for that very reason it's kind of like a scholar's conference and it's a chance if you want to really get in depth into Austrian economics you can attend these. I think they are like a week long or two weeks long. I'm not sure. Also, there is a self study course that you can take. I think it's about $300 with CDs tapes and books, includes almost 16 books with exams and you can even go on-line. It's a home study course in Austrian economics and it's probably the most practical. It's very, very well done. You may want to study it during the summer if you're taking Keynesian economic courses like my son who just passed his second level CFA exam. I told him, we'll reprogram you after your exam. You've got to be careful here that when you're studying Austrian economics and you're trying to take a Keynesian economic course, it's going to mess up your thinking. So anyway, if you want to take a course, check out the Mises Institute actually, it's www.mises.org. [7:01]

Hey guys, appreciate your show. It's a wonderful thing you're doing for us. I'm Tom from beautiful Tennessee, and there was an article and I hope I pronounce his name correctly, Stephen Kovaka. It was written on your Financial Sense university September the 4th, Silver End Game?. Take a look at that article and I’d enjoy hearing your comments on that and your perspective.

JIM: All right. Definitely take a look at that article and we have so many things that we read, I just can't keep up with it. I'm taking a look at it right now. I'll print it. I’ll read it tonight. [7:37]

Hey, Jim. This is Sam from Chicago. You're totally wrong about gold. The gold stocks are about to take out the 2007 low. It shouldn't be happening in the environment a few days out. Kind of interested to hear your answer.

JIM: Tom, I'd recommend you listen to last week's show where we talked about the London Gold Pool, and also remember as we talked about last week where it was set up as an orchestration, this is a prelude to a reinflation effort. And once you set off a selling wave, the second thing that happens to anybody that's leveraged is forced to deleverage, and when you're deleveraging, you're selling anything that you can get your hands on. Just because things pull out and go through corrections, if you look at a chart of the bull market in the 70s, there were severe corrections along the way, even though silver went from what was it a couple of cents, 50, 60 cents went all of the way to $50; and if you take a look at gold going from 35 to almost $850 all along the way just as there was in the bull market in stocks there were corrections along the way, and that's going to happen in the commodity markets. With one difference: It is a much, much smaller market. It is a much thinner market, so any kind of move, whether money moves in the sector or out of the sector, the moves tend to be more dramatic. [9:01]

Hi. This is Steve in Salt Lake City. With silver near $12, I noticed that the local store that the spreads were around 12.93 to 14.46, they were charging. And so with a spread that wide, you would think that somebody would be arbitraging that spread by getting delivery off the COMEX and capturing narrow dollar spreads. Why isn't this happening more given the prices and maybe somebody might just buy a bunch of silver and sell it for 14 if that's what's happening out in the physical market.

JIM: You know, if you were an investor and you are a well-heeled investor and had the money to do it, you know, silver contracts are 5000 ounces, so if you look at price on the day we're doing this, silver is roughly about 10.65, so that would cost you a little over let's say $53,000 to buy one contract and take delivery. If you're an individual investor and planned on holding it, that would be a great thing to do. [10:10]

Hey Jim and John. This is Donald calling from the UK. I just listened to your interview with Curtis Burton of Buccaneer. I was absolutely fascinated. I could have listened to that guy for hours. It would be really good if you could get him back again and just let him talk. That was excellent. I know you’re conversational with him and fantastic.

JIM: Well, Don, thanks for the comments. [10:37]

This is Winston from Virginia. I just had a question on this article I read on Financial Sense University Once In A 100 Year Crisis by Joe Average on September 2nd, 2008 last week, but he mentions the Elliott wave financial forecast and talks about a cycle Wave C, and in that he says there will be no place to hide and that warning the price the precious metals and their stocks as well. And this is talking about a major downturn in the market and in stocks in general and evidently precious metal stocks. I just wonder what your opinion is on that position.

JIM: I would probably say for every couple of hundred points down in the S&P 500, I think you'll see the Fed start taking dramatic action. In fact I'm one that believes that next move by the Fed is going to be to cut interest rates. In the next reflationary wave which is already global, in fact on the day we're talking New Zealand just cut their key lending rate by 50 basis points which was rather a surprise. I think you're going to see another reflation effort globally, so I do believe we're in one of those hundred year storms, probably a 500 year storm if you want to take a look at the next couple of years. But I think in 5000 years of human history for gold and silver, it has held its value and if you're looking at the kind of storm that he's talking about and we see a storm coming, when financial institutions are going bankrupt or are going under or having to be salvaged or merged almost every other day, and governments are willing to expand their balance sheet and subsidize any kind of loss, the outcome is inflationary. [12:19]

Hello, Jim and John. This is Ahmed calling from Toronto, Canada. I have been listening to your program for the last three years. Great job, guys. Keep up the good work. I have a question regarding gold majors such as Yamana, Agnico-Eagle and Goldcorp. Since I don't want to take the risk involved with juniors, I have a question regarding those majors. I'm building a portfolio of gold and silver bullion and in the next gold bull run, do you think that the majors will perform better than the gold or will they lag the commodity itself?

JIM: You know, Ahmed, I would say that probably when you have the kind of technical damage that you have and the liquidation and deleveraging that's gone on, you may see something similar in the months ahead that occurred last year. Last year bullion outperformed the HUI, and then within the HUI you had a handful of your major producers, and I expect almost a repeat performance in that regard because of the technical damage that has been done to the market right now. [13:18]

Hey guys. This is Joe from Chicago. Trying to figure out how exactly the Fannie Freddie bail out affects the money supply. Is money being printed to do this? And another thing I was curious about is that these stocks are down 90% since last October. Is that not wealth destruction contributing to money contraction and hence offsetting the creation of money? So if you could answer those questions, it would be greatly appreciated. I don't know just exactly how that's all broke down, so if you can do that, thank you.

JIM: Joe, if you take a look at what the Treasury is going to do, they are going to be buying from their own balance sheets and spending. They are going to be buying some of Fannie's debt. They are going to be injecting capital which means the government itself will have to go out and expand its balance sheet. How that balance sheet is going to be financed, how that debt is going to be financed – a good portion of it so far has been financed by foreigners. But eventually, I think ultimately because of what you're going to see with all of these bailouts and also as the economy slows – I think we're in a recession even though we don't tell people that – I think in the end the government is going to end up monetizing and that means they'll simply just print the money to pay for it. [14:32]

This is Mark. I'm calling from Guatemala City and my question is I would like if you could bring on John Gordon. I listened to his interview from 2002, his views on the Winter Kondratieff cycle as he mentioned that we have entered, and now since the market and all of the stocks and commodities and everything actually started to go down, I'm not sure if it would be a good idea to have him back on and get his outlooks and scenario from the market. I'll appreciate it. Thanks for a good show and keep it up.

JIM: Mark, we'll take that into consideration. [15:10]

Hello, Jim and John. My name is Phillip calling from the United Kingdom. I'm a regular listener since 2003, but a first time caller. I'm an investor in mid-tier and junior mining stocks, but I now really struggle to understand the latest movement in gold and gold mining stocks. With Fannie Mae and Freddie Mac effectively having been nationalized on the Sunday 7th yesterday, I think this would be highly inflationary and bad for the dollar. So I expected that today, Monday the 8th, gold and gold stocks would shoot up as the dollar went down. However, the dollar index was up by over 1% today to a whisker just under the significant level of 80. Gold has cratered and the HUI has dropped below 300. All this is really counterintuitive. I'd be grateful if you could comment.

JIM: You know what I think they are trying to do here, Phillip, is they are trying to keep this under and get commodity prices – and please listen to the discussion between Frank Barbera and myself earlier in this program as we talk about what's being done here, and the next thing they are going to do is reflate; and you're right, everything is counterintuitive. You would never have thought that gasoline inventories are down, production is down in the Gulf. Now we've got another major hurricane and you'd never think oil prices would go down, OPEC is cutting production, we have had the Russians now control one of the access point to a big pipeline and yet we have oil prices down. So a lot of this is counterintuitive. That's what happens when you get government intervention in the markets; that the things you would expect to happen don't happen because of all of this interference. [16:51]

This is Joe in Walnut Creek, California on Monday September 8th. I'm glad you're back from holiday and I've listened to most of Saturday's segments. I'm unclear how the current discrepancy between paper and physical gold and silver will resolve. Do you believe that physical will turn up, but what about paper such as ETFs, GLD and SLV? How and when does the disconnect resolve, or does it remain for an extended period? Ian MacDonald seems to imply that ETFs will correct. The question is: When and how? Meanwhile, many technicians have been right and see further sharp declines in precious metals prices despite opposing fundamentals. Please comment.

JIM: You know, you can always have a divergence in the market, and that's what you have right now between the physical market, which we're seeing explosive demand, which if you think about it is basic economics. If you have something that's in great demand and you have the price go down, well, if you want something and the price goes down, you get more demand for that. And there is a divergence right now between the paper market which keeps falling and the physical market where demand keeps growing and it's getting very difficult. And eventually you know, those two things are going to have to come into some kind of equilibrium or balance. Either one, demand will have to sharply fall off. In other words people say, gosh, I've been buying and I shouldn't have been buying and they start dumping and then they would dump their supply into the market which would bring in physical supply to the market. Or, you have the paper price eventually catches up with what's going on in the physical market. And that's what I expect to happen. [18:37]

Hola, Jim and John, this is Richard calling from Buenos Aries, Argentina. Jim, not too long ago on the Q-Line, I asked if you disagree with Marc Faber who said that we should not invest in gold mining stocks, but instead only invest in bullion. Do you still disagree with Marc Faber?

JIM: You know, Richard, we always say that the fundamental portion of a portfolio, the basic portfolio building blocks and precious metals begins with bullion. I've been consistent on that, and we still recommend it. In terms of stock, I think you're going to get to a point, I still like stocks because you have the upside leverage. I still like some of the juniors, although I think we're getting in a rough patch here for many juniors, as I mentioned. I think the well-defined deposits, the ones that are large in safe countries and jurisdictions that have economics to them, I think they are going to get taken out, but there are going to be a lot of juniors that are simply not going to be able to get financing and they will simply disappear. So the one thing I do like about gold stocks, they are leveraged to the price of metal, they've under performed the price of metal in the last 12 months, but that's not unusual. If you take a look at bull market that was in the 70s, there were periods of time where the stocks out performed the bullion and at the very end the bullion outperformed the stock. So I disagree that I think if you want the upside leverage, then you've got to be in the stocks and that's where they are. And in many ways, a lot of juniors are what I call the ‘perfect option’ on the price of gold because it's an option on the movement of the gold price that never expires. [20:14]

Brent from Swiss Pine, North Carolina. I listened to the second hour twice. How can the Fed get away with selling paper gold and silver. Doesn't that make it short selling. The way that Bush teed off the Russians, wouldn't it be logical for them to corner the market? If the Fed could not deliver, dump their dollar and stock holding. Wouldn't that be a nice kettle of fish. Keep up the good work and thanks again.

JIM: You know, actually, they are investment banks and they are selling it in the paper market; and much of the futures market that trades today in the futures market is a paper market that never gets to physical delivery. In other words, people are just trading contracts. If we got to the point where everyone that was in the future's market that went long demanded physical delivery – this wouldn't take place –the price would be much, much higher. [21:13]

Hi Jim, this is Josh in Atlanta Georgia. Want to compliment you on a great show. As probably many of your guests have been aware, there has been a serious bear raid on most of the junior mining stocks. I guess the question that I have for you and any of your experts that can come on and disclose what they know is it's quite common to see 20, 30, 40% corrections in the commodities markets, but with a lot of clients that I deal with personally in the financial world, as well as my own personal account happen to be IRA. Unfortunately in many cases a lot of these clients have become more than 80 percent fully invested in some of their gold positions. The problem, and I'm sure you're very much aware is that most of these stocks have been crushed by, much more than the 20, 30, 40% corrections. In some cases, some of my securities are down as much as 80 or some cases 90%. Is this truly a correction, or is the bear finally here for most gold bugs. Any help you could provide would be greatly appreciated.

JIM: You know, we're still in a bull market. The one thing you have is you have a lot of shorts – the junior market especially with major short positions. I've got a screen of probably 100 stocks, both majors, intermediate companies, junior producers, junior exploration companies. And when the float is very thin, you can orchestrate and if you get a panic, you can orchestrate a major selloff that is way out of proportion to the fundamentals of what’s actually going on in the market. And because these markets are so thinly traded, they are very easy to move. I mean If I wanted to, I could move the chart pattern on these stocks by just going in by selling or going in by buying and that's just the nature of this kind of market, and when you have this kind of sharp selloff, then you have to understand that when you have the kind of deleveraging that's taking place and you have the amount of – I mean you just look at the Reg SHO list on a lot of these juniors and the amount of naked shorting that is coming in here and in addition to the amount of shorting that's gone into a stock. I mean when you have companies that have 15 to 20% of their stocks sold short, that's what you see in this kind of market. [23:26]

John, Jim, this is Dave in Ohio. Been in the market since about 2003, and this latest drop in the miners has pretty much wiped me out. Not calling to complain or point fingers. I subscribe to the buy right, sit tight, looking forward to how many shares I'll have at the end. I've taken advantage of dollar cost averaging, but apparently, that approach has not worked out. My question is fundamentally, something significant must have changed. I know week after week we keep hearing that fundamentally, everything is still the same, and there is a very compelling reason to own gold and gold related assets, but obviously not the case. Something has drastically exchanged and I'm just curious if you can give some insight to what that might be.

JIM: Dave, listen to the London Gold Pool piece that we did last week on the site. We did a number of pieces and listen to this week's show where we talk about the London Gold Pool again. So take a look at that. People judge short term price action that is extremely violent as this has been in the last seven weeks –almost relentless selling – and I think if you want to understand that, just take a look at the piece we did with the London Gold Pool, Eric King's interview with Ian MacDonald, also inflation depositories and try to understand what is going on and we're going to continue to elaborate more on this subject – not only in this week's show as we've done but also the shows up ahead in the next couple of weeks. [25:12]

Hello. This is Phillip from Ontario, Canada. I've listened for many years and I really enjoy the show. I walk to work as I listen to it. I have two points. Your discussion of the great demand for physical gold in exchange for fiat currency seemed a beautiful example of Gresham's law with the good money –that's gold and silver – displacing the bad money, the paper money. People are buying up and hoarding gold and silver at the expense of the paper money. And the second point, with the talk of Johnson Matthey winding down there refining operations through the lack of silver, I don't understand why they can't buy futures on the COMEX and take delivery. And if they won't, I wish somebody else would. I can't imagine anyone couldn't make a dollar or more an ounce just making a hundred ounce bars from the thousand ounce COMEX bars with the added benefit of drawing down the COMEX inventories and increasing the pressure on the silver shorts.

JIM: You know, you bring up a good point about what's going on, Phillip. Why they don't do that? I have no idea because I do know there are some limitations. I think it's about 7 ½ million ounces of silver, and I think if you were to start taking 7 ½ million ounces of silver delivery although they are a commercial, they could probably get away with it, but they would probably get some phone calls from the change because there is not really that much kind of inventory that is on the exchange if everybody started taking delivery in terms of the amount of contracts compared to what was in the physical delivery category at the COMEX. [26:38]

Hi Jim and John. This is Richard calling from San Francisco North Bay. Awfully glad to have you guys back to give a perspective on things. I have a question. I hear and read about a lot of cash being on the side lines. I know there is a lot of money in treasuries and other near cash instruments, but to convert the cash, these instruments have to be sold to somebody else. In fact, near cash is not really cash until it is sold, so the term near cash seems to refer to liquidity rather than cash. So how much actual cash is there available to buy near cash instruments that have to be sold in order to buy the roll over, in order to buy other the debt and new debt that’s coming out? It seems like there’s a bit of a crunch with regard to the availability of cash.

JIM: You know, Richard, remember, in addition to money that's sitting on the side lines, there is also new money that is being earned and created or printed, so even though there is money on the side lines – and you're right. If you own a money market fund and you're cashing out, that means if enough people cashed out, they would have to find buyers for their cash instruments. But you know what, if that was happening, you know, maybe what would happen is the price would increase or the price would decrease, meaning the yield would go up and if the yield would go up, there would be institutions –whether it's pension funds or insurance companies – that would respond to the sale of these short term debt instruments and that's the way the market functions. Even though there is money on the side lines, remember every single day there is new money that's being created. [28:20]

Jim, John, it's Pete from Philly. Gosh, the precious metal stocks and the other resource stocks are trading at some very, very attractive level now. However, I am a bit hesitant to get in because the way the Fed took down the commodity index from July through September. I'm just wondering: can they do it this easily? Can they do this indefinitely?

JIM: You know, Pete, people have said and because there is – you know, you talk to people in the field, professionals will tell you that there is something fishy about all of this, and that if the government intervenes in the market and we know they do, they intervene when they change interest rates, they intervene in the bond market, we know they intervene in the currency market. We also know they intervene in the stock market. But if intervention worked, believe me, central bankers would not want to see gold prices even where they are today, which is close to $750 an ounce or silver prices at close to 11 dollars an ounce. So if intervention worked, then we wouldn't be talking about the prices that we are seeing today. You wouldn't be talking about $100 oil, you wouldn't be talking about 750 gold or close to 11 dollars in silver. We'd still be talking about 3 and 4 dollar silver, $20 oil and we'd be talking about gold at 250. [29:40]

Hi Jim, it's Mara from North Carolina. Thanks very much for all of your good work and John’s too on our behalf. You're a very very reassuring pair. Question, I know you like to study economic history: Are there examples of bull markets that peter out and disappear in the wall of worry phase which we're clearly in now and they never reach the mania phase, or do most bull markets or all of them really eventually go through a mania phase? Even though my portfolio is on life support, I'm not losing heart or confidence because the fundamentals haven't changed, but I don't know anything about economic history and I thought you might be able to address that question for me.

JIM: You know, Mara, in long term bull markets – whether we alternate between bull markets in paper (meaning stocks and bonds), in bull markets in things (meaning commodities, collectibles, real estate etc) – and during these periods of time if you look at these over a 200 year period, these cycles both in commodities and paper markets have like a 16 to 18 year cycle to them, and in that period of time, you can see some severe corrections. And let's just take precious metals. In the bull market that began in 1971 and precious metals, you saw the price of gold go from 35 to 200, and then when it hit 200, it corrected back to 100. Even in a bull market, you can get these severe selloffs. If you take a look at gold being at 200 in 1974 and then correcting down to 100, I mean you were talking about a 50% correction, and yet it went from 100 all of the way back up to 850. So if you're in a long term bull market, most bull markets always end in some kind of mania phase. The commodity bubble in the late 70s ended up where gold spiked up to 850, silver spiked up to 50. If you take a look at the internet bubble and the tech bubble, I mean you would have thought at the end of 1999 when the NASDAQ was up 70% that, you know, the first three months of 2000, the NASDAQ went up another 20% before it corrected. So bull markets always usually end in some kind of mania where supply overwhelms demand, while prices are still going up until a point where you get so much supply it eventually overwhelms demand and then you get these crushing deflationary episodes as we've seen in technology, and as we've seeing in, let's say, the mortgage market right now and real estate. [32:21]

Hi Jim and John. This is Ram from the USA. I'm just wondering if you guys could include the short interest in silver, the number of contracts that you were talking about last week to update it in your daily show so that we know whether the short interest is increasing or decreasing. It seems upper end that the short interest has static relation to the price of Silver, so I just want to make the recommendation because it's not found in any of the articles that were on the site or it wasn’t mentioned even in your earlier shows but it was like after the fact kind of thing. Now we know why it happened. I'm just wondering what your thoughts on that are as well.

JIM: The CFTC reports the Commitment of Traders report as of Tuesday. It's late Friday – you know, maybe what we can do is start making some effort to cover that a little bit more thoroughly and see what happens with that. We'll try to make an effort to do that. [33:22]

Hi Jim and John. This is Raul in Virginia. Jim, just trying to get a read of what your feelings are with the sell-off in the juniors that's been taking place and one junior in particular, Tyhee Development Corporation. I know you've mentioned in the past you like to back up the truck on this selloff, but it looks like some in Tyhee may have fallen off your truck. Just want to get a sense if you're still as bullish, equally bullish or more bullish or less bullish on Tyhee.

JIM: Still bullish and like I said, we own a considerable interest in that company and that large interest still remains. [33:58]

Hi Jim and John, this is Harry in Toronto. Today has been quite a day on the markets. Bloomberg has reported that consumer prices rose at the fastest pace in 17 years, yet we see oil plunging, we see gold plunging and gold stocks plunging and the dollar shooting for the sky. Is it time to just admit that it's over for gold and to bail out? I'm up to my neck in gold stocks and I'm retired, so would just like to hear what you say about this here, and I listen to your Saturday program to see what you think we should maybe get out of gold and forget about it for a while.

JIM: You know, Harry, I don't know when you called in. These are the Q-Lines that we had got leading up to last week's show, so I'm just getting to your question because we didn't have time last week because of the amount of content that we needed to cover on the program. No, I don't think it's over for gold and silver and oil. I think there is a great discrepancy between the real world, the economy and what's going on with prices of things and the same thing with commodities. [35:18]

Hello, Jim and John. This is Brian from South Carolina. The American voter is asleep at the wheel of the Winnebago. All of the listeners should go see IOUSA, a documentary about the financial condition of the United States. The film premieres Thursday with a special live broadcast featuring Warren Buffett. I challenge you to get Laurence Kotlikoff or David Walker on the show. These men are highly qualified to describe the financial situation of the United States.

JIM: You know, that's an excellent movie and we've had Laurence Kotlikoff here on the program. In fact, I made references to it, Brian, last week to also David Walker who said that given the future unfunded liabilities, the Social Security and Medicare, that it would take an increase – depending on whether you take as base case or his pessimistic case – it would take tax increases of 44% to 88% and a cut in government spending from 20% to over 40%. And he goes “outside doing those kind of thing to correct this imbalance, the only other way out of this is hyperinflation,” and I think that's the road we're going to travel on. [36:32]

Tom from Ontario. Jim, just wanted to inquire about the actions that are forthcoming in the naked short positions and the program you mentioned about the companies who will pay a price here. Jim, just want to inquire about the process of actually putting heat on the regulators, ie, a class action suit against the regulators for not doing their job. Those are the very people who we've put in this position to make sure that these type of legal activities don't transpire and yet they are very much the people who are creating the problem by not enforcing the rules. Just want to get your feedback there and if anything can be done on your whole process and having the heat put on these guys by having class action lawsuits.

JIM: You know, Tom, listen to the second hour interview this week. We talk about I think the way this is going to be solved is not by regulators because you're right, they are not doing their job. I think it's going to be solved in the court room. [37:29]

Hi Jim and John, this is Steven from Louisville, Kentucky. I have a question about coal to gasoline or coal to diesel. I understand that at $50 oil, that this is an economically sound proposition, but yet I don't hear anybody talking about using up large coal reserves to make liquid fuel, at least as an interim measure. Is there some reason why this isn't being done?

JIM: Gosh, don't get me started, Steven, there are so many things we're not doing here. We're not using clean coal. We're not building nuclear power plants. We're not putting the amount of wind turbines that we should be putting up. We're having difficulty getting land for developing or building solar arrays to provide electricity. We're not drilling offshore. There are so many things we're not doing here and it's because it's environmentalism grown amuck. We're nuts here. [38:26]

Jim, this is David in Los Angeles. I tried to back up my truck to the bullion dealer yesterday, but guess what? They were almost all out. This was California Numismatic Investments in Inglewood, California. As far as I can tell, they are a pretty big bullion dealer. They didn't have any gold products left to sell. They didn't have any silver rounds, they didn't have any silver bars. All they had left were silver Eagles. There appeared to be a true scarcity of these metals, yet the price keeps dropping.

JIM: Once against, go back, listen to – I'm not sure what day you called in here because, David, we're taking this Q-Line calls we're supposed to be our first weak back last week. But if you listen to the London Gold Pool and this week's conversation with Franklin Sanders, I think it will describe very much what you're experiencing. [39:16]

Hi Jim and John, this is Joe in New Jersey. Jim, last week on the Q-calls, you mentioned that your favored ways of accumulating bullion would either be through the Central Fund of Canada or by actually just taking physical delivery of bullion. I know that James Turk is a contributor and we all respect him. I personally use GoldMoney and I just wanted to get your feelings on the GoldMoney service – your thoughts about it. Do you have any reservations about sending money overseas and I know that might send up some red flags with the IRS given the world that we live in? Do you use the Central Fund because obviously you're a stock broker and that's easier to have access through an exchange for your clients bullion?

JIM: You know, I think when it come to accumulating bullion, I think you have to take three different approaches. I like the Central Fund, obviously being in the brokerage business, being in the money management business; I like GoldMoney as a convenient way to own gold and silver overseas, and I also like bullion stored in a vault. So everybody has talked about gold confiscation, they've done it in the past. Certainly gold and bullion trading is penalized. You pay a higher income tax already of 28% versus the favorable capital gains rate of 15%, so we don't know how all of this is going to unfold. I think people are more sophisticated today and I think there would be a revolt if they tried to confiscate gold. But at the same time, they may make it very expensive to own with a wealth tax or prohibitive taxation if you traded it. So that's why I think you need to use a multiple approach, which would be something like the Central Fund or something like the Millennium Bullion Fund or GoldMoney, or for example, taking possession and storing your bullion in a vault. [41:12]

Hello, Kipling calling from British Columbia. I'm long 1 December COMEX silver and considering taking delivery, but I'm a long way from New York city and we're talking over 400 pounds of metal. The last time I bought some 100 ounce Johnson Matthey bars at my local bank in June, they cost me $1.70 an ounce over spot plus commission and shipping, but at least they showed up in three days. An alternative might be COMEX warehouse receipts. Would they be allocated or unallocated, and what are their fees for that? How practical would it be to retender the silver into the market if it were stored in a COMEX warehouse? Maybe I should just buy another large safety deposit box and bite the bullet and buy it at the bank. Your thoughts, please.

JIM: You know, I don't know the amount of – you say you're long one contract, so that's 5000 ounces of silver. If you wouldn't mind paying the storage, I think that's probably the most efficient way. You’re going to have to arrange for transfer payment, but if you take a look at the discount you're getting in terms of what you're paying for it. I don't know what contract or what period you've bought it or what your price is, but you might want to consider that because certainly, there’s – the day that I'm answering your question, unfortunately silver closed at around 10.60 on this Thursday, which is the day we're taking these Q-Line calls – and I think the spread between the products and the premiums, that if you listen to Franklin Sanders who we interviewed this week, I think you'd be better off going to the COMEX. [42:51]

Hello, Jim, this is Jeff from New Jersey. I’m basically calling because I was really puzzled about this bull market in the gold sector. I look for example at the GDX, which is the index and I use this as a proxy for all of the gold stocks because it's got the major miners in there. In August of last year it was at 33. Gold was at 650, I believe, somewhere around that time. From there, gold went to 1,033, GDX went up pretty much in the same percentage to about 56, I believe. Now, gold is in the upper 700 and GDX is down to 34 dollars, so it’s back down to where it was about exactly a year ago. But basically if you started to invest in 2004, 2005, you would not have made as much money as had you invested in the gold metal. What would change that, is anything going to change that and why is it this way for such a long time? Appreciate the show, it's a true treasure.

JIM: You know, Jeff, one of the things that happens in a bull market, there are periods of time where the bullion outperforms the stocks, there are periods where stocks outperform bullion. This is one of those periods of time. And it’s being brought out, I think, because of adversity to risk. In other words, with the credit crisis unfolding, the sharp selloff that we've seen in financials with credit being tight, I think that people are more risk adverse so that is one of the reasons why I think that bullion outperformed the stocks last year because of this risk aversion to everything that's going on right now. And until that lifts, I think you'll see bullion outperform the stocks because of that credit crisis. And remember, this isn't over, and as long as there is risk aversion, it's only when people wake up and say, “Wait a minute, this inflation isn't going away. It's actually getting worse despite what they tell us on the news.” And it becomes more widely accepted: If you listen to Franklin Sanders where he's talking about the kind of new buyers that he's getting coming into his business where people are placing a million and a half dollars for buying bullion. This is smart money, this is big money, and they are starting to move into this area, they'll move into bullion and this will be a period of time of risk aversion where bullion outperforms the stock. [45:15]

Hi. This is Joe in Arizona, a fellow Thunderbird alumnus. Two quick questions that I think I know the answer to, but I need you pros to give me the straight scoop, and that is who is doing this intervention on the precious metals market as we discussed today on the 16th? Who is doing it and how are they doing it? I think I know the answer, but I'd like to hear it from you fellows.

JIM: They are doing it through the futures market and also they are doing it both on our exchange here – In fact, one of these character’s massive short position on the TOCOM during this period of time that we talked about in last week's show and that's the way we're doing it. They’re going in – I think what figure is I know here in the COMEX, they represented their short position was 21% of open interest and then it was 24% of open interest on the silver, so that's one of the ways that they are doing this. [46:09]

Hi. This is Paul from Phoenix. Thank you again for the show, Jim and John. Jim, you mentioned that you bought a tonne of silver and are going to send it overseas to be stored. I was wondering would you mind sharing with us the name of the storage facility or could you give us the website and is this something that you need to report to the IRS? And if you would also, please, I was wondering how else did people protect themselves from currency controls in the past? To my understanding, Barack Obama was criticizing Hillary for beginning to ship some of her funds or her investments overseas. Do you know what else our members of Congress are doing to protect themselves from their own currency controls?

JIM: You know, Paul, if you transfer money overseas, you do have to report that. I'm trying to think of the forum on the Treasury. Although, I'm keeping mine right now on vaults in this country. It’s in a safe, protected area. I'm looking at what they are proposing here in terms of penalties. And you're right, Barack Obama criticized the Clintons because the Clintons own quite a bit of their money overseas and so do a lot of members of Congress, so that should tell you something. But I do believe that having overseas investments whether it's currencies, you know, depending on what makes you feel comfortable, or owning bullion overseas is a smart choice. [47:38]

This is Bruce from Connecticut. Aside from some physical bullion holdings accumulated over the past couple of years, I also have a single mini silvers future contract which expires in September, for 1000 ounces of silver. I can either roll it over at the end of this month, August, or else simply take delivery. Is taking delivery on a futures contract – a mini – silver in particular –straight forward, pretty much risk free and not subject to delays? Or is there a downside to doing this? Since I'm already long the contract, I figured that if might be easier to get the thousand grams of physical bullion this way rather than initiating a new order through somebody like Kitco, for example. Your show is a God send to us all.

JIM: You know, Bruce, I'd take delivery. [48:22]

Jim and John, this is Mike from Chicago. With the upcoming perfect storm and crisis, hyperinflation, what not, what are your thoughts of investing in rental properties? Me and a group of friends, we're thinking about buying a four flat in Chicago. With real estate values, do you think that's a risk right now?

JIM: You know, Mike, I do think it's a risk because I think this real estate crisis is going to get hit in several waves. The next wave is upon us now and then in 2010 to 2012, you're going to have these option ARMs that are going to reset that's going to create another crisis. Also I think eventually, they are going to have to roll a lot of this stuff up into the RTC and if you keep your powder dry and they start having an RTC and they start auctioning off these properties for 50 cents on the dollar, if you guys have some cash and you’re liquid, I think you’re going to see some great buying opportunities. [49:14]

Hi Jim. This is Randy from Florida. This is just a comment that the head of the Richmond Fed, Lacker, on Bloomberg said that he would be surprised to see a big bank fail, and saying that he's noting that he's highly confident in the ability of big commercial banks. And I just wondered what does he think IndyMac was and Bear Stearns and Freddie and Fannie. And when these type of idiocies come out of the central bankers it doesn't really make you sleep well at night.

JIM: That's even scary that they run the country. [49:58]

JOHN: But a good time to invest in Lunesta; right.

Hello there. Jeremy from North Carolina. Been listening to the show for several years now, Jim and John, and in talking about your crime of the century, what will happen if the American legislative or judicial branches decided that these bankers were too big to fail. So what would happen if a president in his declining days or a newly minted president in his or her first days that want to stop the pain decides to pardon these people that have been doing the crime of the century with the short selling? Just a thought. What would be the outcome from such an action?

JIM: You know, I don't think your regulators, it's gotten to be so big, I think they've lost control over it. I think where it's going to be solved is going to be in the court room with tort lawyers because that's what's going on here. And it's also going to be starting in Canada and I think that's going to be an issue that is going to solve the problem. It's not until they are forced to feel the pain that they are going to do anything about it and unfortunately right now, there is no incentive to do it. [51:16]

Greetings, Jim and John. This is Jason from Riverside, California. For the last five years I've been in a graduate program at University of California, Riverside. I blindly bought a house for 417,000 in March 2006. I completed a degree two months ago and soon began a good stable job 70 minutes drive to the west of here in the La Mirada Fullerton area. Today my house could be sold for $280 to 290, in which case I would only pull out 30 to 40,000 in equity. Our plan has been to wait this downturn out for a year or two and do the commute so we can sell for enough to buy near my work which we've been thinking we would need closer to 100,000. However, with the noise of many more foreclosures to come, we're considering selling now, taking a loss and bank the cash, renting near work and trying to buy before the market significantly moves up whether due to hyperinflation or otherwise. The primary concern is not so much the loss of cash but rather the ability to afford to get into a decent house with what we have left when the time comes. Your much appreciated advice is one part of my overall research into this question.

JIM: You know, Jason, if you can sell your house now, take that loss, go rent and find a place closer to work where you don't have to commute 70 minutes in either direction because I do think that there are going to be more foreclosures in the area that you're talking about, you're going to see a lot more property come on the market. We have -- I forget what figure was. I was just reading this in a credit report last night. I think we have something like 800 million – no; it's got to be more than that – of option ARMs that are going to be resetting here, so there's more foreclosures. And wait for some of the these foreclosures and wait until the banks where they form some kind of RTC where you can pick up something closer to work because I do believe that oil prices are going to hit $200. They are going to hit, I think by the end of the year; there is a good chance we're going to be back up to 145, and when oil starts going to 200 and eventually 300 in the next decade, you're going to see gasoline prices at six, eight, nine dollars a gallon much as they pay in Europe right now and you're not going to want to be spending nine dollar on a gallon of gasoline and spending two hours, two-and-a-half hours to 3 hours a day commuting. Think what that takes from your family life. So if you can get over there, rent, save your money, put it aside live as cheaply as you can, I think you're going to see even better values in the days ahead. This isn't over yet. [54:05]

JOHN: You know, there are 1001 ways to say you've run out of time and what's coming up next week, Jim. But let me see if I can make this a little different this week. Jim, we've run out of time. What's coming up next week?

JIM: Well, next week, we're going to take a look at – hey, John, that's original.

JOHN: I thought it was.

JIM: Yeah. It was. Coming up next week we're going to do a segment on silver with existing and upcoming silver producers. My guests will be Lorne Waldman of Silvercorp metals, Keith Neumeyer of First Majestic Silver, Mark Bailey of Minefinders and Robert Quartermain of Silver Standard. That's next week. And then on September 27th, Doug Noland of the Credit Bubble Bulletin fame, he is the guy who’s been documenting everything you've been seeing on headlines since, gosh, the beginning of this decade. So we're going to get Doug’s take on where we stand right now and if it's as bleak as what we're seeing.

And then October 4th a new book out there called The Gold Watcher and Frank Holmes the portfolio manager of US Gold is going to be my guest in October and then we're going to be doing some surprise things we're working on now. But Well, John, can I say anything different?

JOHN: Well, folks, we've run out of time.

JIM: We've run out of time. Gosh. On behalf of John Loeffler and myself, we'd like to thank you here for joining us here on the Financial Sense Newshour. Until we talk again, we hope you have a pleasant weekend.