FSN Expert Roundtable
"Economic Roundtable: Forecast 2007"
Transcription of Audio Interview, January 6, 2007
[montage of voices]
We are just getting 2007 off to a gangbuster start. We are at a new record high right now. We're up 109 points on the Dow. Oil is plunging. Things are looking great.
A lot of the positive commentary here on the street as we are hitting these new records.
We're 56 points above the record close.
So it is the lack of weather related demand in the Northern Hemisphere, high global inventory levels, fears of slowing U.S. economic growth and then the expected growth of non OPEC supplies that are combining to paint a very bearish picture here.
Nothing moves in a straight line.
We're also seeing a big sell off in the commodities markets. Normally that would put a floor under the Dow. It hasn't so far. We're down 87.88. We were down a little bit more than that a short while ago, but we're still near our lows.
That just shows people are speculating on the down side in crude oil, a complete reverse of what we saw in January of 2006.
Throw a flag on this one – helmet to the head. Talk about a jolt to the markets. It would appear that markets hate jobs.
Maybe the Fed over stimulated causing a housing boom which has caused us later a bit of a housing bust. But that doesn't necessarily mean the same kind of dynamic then marching towards recession.
We are on a precipice here.
We are going to get bad luck from import prices. We've had very good fortune over the last quarter in energy prices.
Seems like a very knee jerk across the board reaction.
I think knee jerk is the way of putting that.
Happy New Year.
Happy New Year.
JOHN LOEFFLER: Well, what goes up sometimes comes down. She's up. She's down. Started the week with a bang, but boy did it come down with a crash. And welcome to the Financial Sense Newshour everyone. Happy New Years once again. I know we said that last week on the program. Welcome to the third in a three part series of special programs here on the Financial Sense Newshour. Next week we'll get back to our normal program. The last two programs we looked at what happened in the year 2006 based on predictions that were made early in the year here in the show, and ultimately did or did not come true.
Today we're going to do something a little special. We're going to have a roundtable forum of five different experts talking about the things that are on the horizon, and our Big Picture will focus upon that as well. And next week we're starting a new format of the Financial Sense Newshour which will be our regular week to week program, but here we go today with our roundtable forum looking at the future.
JIM: And happy New Year, and welcome everybody to our first show of the year. We're going to have an economic roundtable. The topic: forecast 2007.
Joining me on the program is: Frank Barbera, he's manager of the Caruso Fund; also Joe Dancy, he’s manager at the LSGI Technology Venture Fund; Bill Powers who many of you may recognize the name, is joining us on the program – he represents Powers Asset Management; Peter Schiff, who is president of Euro Pacific Capital; and James Turk, founder and chairman of Gold Money.
Well, gentlemen, probably the question on everybody's mind, let's begin with the economy. I couldn't believe that it didn't matter where you were looking – you picked up a copy of BusinessWeek, you picked up Money Magazine, Kiplinger, all of them – it's going to be a wonderful year. I keep thinking of the Jimmy Stewart movie, It’s a Wonderful Life. Let's begin with the economy. And gentlemen, where's it going?
FRANK BARBERA: Well, Jim, that's an interesting point that you're bringing up about that uniformity. And that opinion, I find that actually really amazing, considering the fact that we see obvious signs to the contrary. Number one, the idea that corporate earnings have been growing at some of the fastest rates in recent decades. And it’s very clear that coming into 2007 we're going to see a slow down in the rate of corporate earnings growth – probably from somewhere around 14, 15% down towards 7, 8%. But that aside, the housing market and the real estate market we're already seeing some big issues present themselves when you look at the facts that over the last since 2001, 70% of the increase in household net wealth has come from the rise in home prices. I think that's a really big issue for 2007 in terms of how it's going to effect consumer spending where we saw a weak Christmas. And also the refinancing issue in terms of the number of mortgages that are set to reset this year. I think that's a very big issue for the global shape up of both the equity market and some of the other capital markets in 07. [5:44]
PETER SCHIFF: There's no question that there's an incredible amount of optimism out there. There's probably more optimism that I've seen in a number of years on the stock market and even the housing market. You mention what's happened to housing. I was on This is Cavuto on Business on Fox last week, and I came on to do a bull-bear debate on housing. And the guy that was the bull on housing was just incredible, but he said: “Well, you know, I think we're going to have a normal year next year in housing. Therefore I expect a 10% appreciation in housing prices.” It's just amazing that this guy thinks that a normal year in housing is prices go up 10%. But they are totally oblivious to what's actually going on in the housing market: all of the homes that are for sale; and just in the last few weeks you've had several subprime mortgage lenders go bankrupt – bankrupt because they can't find people to buy their loans. The credit is drying up in the subprime mortgage area. And that's really what's been fueling the housing boom is the fact that people are able to qualify for mortgages that they can't afford because someone was willing to lend them the money. But as housing prices are starting to fall and we're starting to see a backup in foreclosures and late payments, the lenders don't want the paper anymore. They don't want to buy it, and that's going to be a big problem in 2007. [6:58]
JIM: So do you think that, for example, that Alan Greenspan coming out saying that the real estate market has stabilized as a lot of people are believing, I've even seen some buying of the home builder stocks. I guess the real question I'd like to throw out to this group is will the housing recession sink the economy this year?
PETER: Well, there's no question that it's going to sink it eventually, whether it's this year or next year or obviously other things that can sink it to that all work with the housing market. But to ignore the fact that for the past several years the US economy has been the housing market. It's not only been the fact that housing has created a lot of jobs, but all of the consumption in our economy, [which] is 90% consumption. What's financing that is the ability to extract equity from your home by using the appreciated value and spend it in the economy; and also the fact that interest rates have been so artificially low that it's freed up a lot of discretionary spending that would have gone to making mortgage payments that instead is available to buy other things. So, so much of the consumption in our society is based on housing wealth; and so much of the employment; and the fact that people no longer perceive the need to save because they were going to get rich simply by owning their home. So you take all that away and expect the economy not to collapse – it defies reason. [8:54]
FRANK: Yeah. I have to say I agree with Peter. If you look at some of the price trends and shares for example like LEND, which is Accredited Home Lenders, that topped out in the middle of last year at almost $56 a share – that's down to almost $27 a share right now. Redwood Trust, Downey, a number of these big subprime portfolios, the companies holding them they've been really notable in the fact that even though the stock market itself has gone to higher highs what we're seeing in the subprime area is actually a bear market unfolding – even in the stock market that has been almost a one-way ride to the upside. I think that signals some sort of trouble. And I think probably one of the big issues is going to be a financial accident this year and we may be seeing something again on the order of Amaranth fund type problem hitting the crude oil market and some of the metals markets here early in the year.
But what really has me concerned is the end of the tightening cycle. If you go back over the last twenty to 30 years, every single time we've seen the Fed raising interest rates in a tightening cycling, at the end of that cycle as interest rates have pushed higher (and it's very clear we're in the eighth or ninth ending of the Fed tightening) you've always seen some kind of financial accident whether it was Penn Central or the Asia Crisis. There has been a problem that has surfaced from the over leveraging of the previous credit cycle. And I think this time it's going to be centered around real estate and of course the lowest quality mortgage area which is the subprime. I think that's going to be the catalyst to start something negative. [9:55]
JIM: Let me bring Jim Turk here. And Jim, you have written that in an inflationary era, which I think many of us all believe that we're in, be very careful about things going into a crash or deflating tremendously because of the amount of reinflation, or inflation, that's being poured into the system. You pick up a copy of The Economist, go to the back section of the magazine every week, and take a look at global money supply. It's being cranked all around the globe. So I'd like to get your take on real estate.
JAMES TURK: Two things. First of all I agree with what Frank was saying that there is going to be some kind of financial institution impact on this. If you go back to the 1980s for example, with the real estate collapse then, it literally brought down the Savings and Loan industry. I don't know what the weak spots are, but subprime lenders are obviously the first candidate, and that's probably going to spread to other areas as the problems with real estate become more apparent.
But in response to your question, Jim, about the inflation-deflation issue, in my mind it's really quite simple. You first have to adjust which currency you are going to measure prices in. If you measure the prices of homes in terms of gold, you're going to see deflation. In other words, the price of gold in dollar terms is going to rise and the price of homes in dollar terms is going to go down. But if you look at the price of homes in dollar terms, other than maybe some areas which are particularly unique because of circumstances of over building, condos in Florida etc., things of that nature, generally speaking, real estate is probably not going to be significantly impacted in dollar terms much like it was in the 1970s. You had monetary problems that ultimately caused people to leave the dollar into tangible items and real estate is a tangible item. There were areas in the 1970s that were particularly hard hit: Southern California for example during the Lockheed crises, home prices went down. And this time around you're probably going to see areas hard hit as well in dollar terms, like I say, the condo market in Miami. But generally speaking, I think you're better off owning real estate than having dollars on deposit in a bank account. [11:57]
PETER: Well, fortunately though those aren't our only choices. Yeah, I think between dollars and real estate in middle America, you might be better off. But I don't think real estate is going to be a good inflation hedge, as I think people who have wealth in real estate are going to be a lot poorer as a result, relative to people around the world. So rather than having money in real estate if you're worried about the dollar going down in inflation, you should have your money in something else: like if you're going to real estate own commercial real estate in Europe or Asia, or own commodities, or own gold or just own bank deposits in foreign countries. [12:26]
JAMES: Yeah, I agree with you there.
PETER: You're going to be a lot better off there. I mean personally, I don't own any real estate. I have no problem renting beautiful houses for next to nothing and I use the income from my foreign investments to pay my rent. And eventually, when the dollar does collapse even if real estate prices don't go down in dollars but they lose 90% of their value relative to everything else I own, then I'll sell some of the things that I own and buy real estate. [12:49]
BILL POWERS: I just want to make a comment as far as diversifying away from the dollar and that's something we're seeing increasingly from OPEC countries who had a real boon over the last couple of years as far as revenue. We're also seeing the Russians also move money away from dollars. That's something that is becoming much, much more common. I know especially in Muslim countries there is a strong affinity for gold, and not holding dollars. So I think that really what we're going to see as far as inflation goes, I think there's definitely going to be inflation in commodity prices – specifically oil because it is priced in dollars. We are seeing as the dollar will weaken, there's plenty of support for oil at $60. And well above that for a variety of reasons, not just political but also geological reasons that I think oil will head a lot higher from today's level. [13:35]
JOE: I have to agree with Bill and some of the commentators. I think real estate is going to be one of the major issues or major stories in 2007. And we see continued weakness in the real estate market especially with the subprime lenders. I find it real interesting that the Wall Street Journal had a front page story in the last week where essentially most economists on Wall Street essentially think we've seen the worst is over in real estate. And I don't think we assume that yet because I think we still see quite a bit of foreclosures and subprime lenders having difficulties. In a backhand way, that might be good for the market for two reasons: I guess first of all at some point, the Fed is going to have to add liquidity to address some of these loan issues; and secondly, some of the hot money that's been going in the real estate may move over to stocks. And I know the neighbor across the street, she teaches school, and she has 13 rent houses. And I know she isn’t going to be buying many more now, because I think a couple are in foreclosure. And I think the hot money that you saw going into real estate maybe going into energy or some other sectors going forward. [14:45]
JIM: Let me bring up the issue of energy here because a lot of positive comments that you saw the opening day of the year, where the market went up and then it pulled back, was because of the sharp drop in energy. And the feeling is the global economy is slowing down. There's going to be less demand for energy, you've seen the CRB index breakdown, you've got oil prices at around $56 a barrel, you've got gold getting hammered in the markets. For Joe and Bill, I want you to come in and give your take on energy because the fundamentals, I think, have never been stronger for energy. And is what we're seeing in the market more market motivated than it is fundamental oriented?
BILL: Really my thought as far as what happened – and here we sit three trading days into the year and it's really been a very ugly episode so far this year, especially with crude going down close to $6 in two sessions – is what part of that was commodity prices (or at least on the NYMEX) were able to be pushed to extremes for relatively short periods of time. And I think a lot of that had to do with the very warm weather that we are experiencing. I mean, it really doesn't have anything to do with such a violent move over such a short period – anything to do with fundamental supply and demand. It has more to do with the outlook of weather for next week, or how warm it was over the holiday.
And really, I don't believe that we're going to see crude under $60 for very long. I certainly think that natural gas also, which has now fallen almost $3 over the last six weeks or so from $9 all of the way down to a little over $6, has support to trade in the 7.50 range for 2006. And I think crude could easily trade around $65, since I don't think the economy is going to affect it as far as the dampening demand. That’s because if we go back, and history tells us, slowing economies don't necessarily mean dropping oil and gas prices. If you look at 1984, in inflation-adjusted dollars, crude oil traded between $55 and $65, but yet we had 7 ½% GDP growth that year. So clearly we could have high commodity prices and a fairly decent economy – as well as an economy that is slowing. [16:55]
FRANK: I'd like to jump in on that for a second. And just add to that the idea that there's a real U.S. centric view of the weather when it comes to energy, and we tend to look at our own inventory levels, and act like that is the sole driver for setting prices worldwide. And I think that's a big variable that a lot of people aren't taking into account: the fact that when you look at China's growth rate, India's growth rate, those economies are still in the early stages of an industrial revolution – the type of event you don't see more than once every hundred or 200 years. It's a unique event and within that type of growth process, even in years when the economy slow a bit, the demand for energy tends to consistently rise. It just doesn't rise as much. So I think there's a bit of a US centric view that is distorting the overall view on the commodities right now. It's a lot more bullish than people think. [17:48]
JOE DANCY: Of course in the long term, you've got a supply problem too. I mean even if demand is contracting, if supply contracts faster, prices can still go up. I think the recent move down in oil prices is not so much a function of the weather, that might have been one of the catalysts, I think it's a function of having 9000 hedge funds out there. A lot of them are in these markets. A lot of them are very leveraged. When you get 20% of the upside of someone else's money, there's a lot of reasons to take on a lot of leverage. And so we can see moves – you have a lot of people coming to the same conclusion at the same time trying to get in and out of the market – and you can get big volatility. And I think this type of volatility is a function of the number of people in the market and how much leverage there is. And I think it can work just as quickly the other way. So as fast as oil prices are dropping they can go up almost as fast. [18:35]
JAMES: I agree with you on that. This week particularly it looked like it was a selling climax and was driven principally by margin selling, not by any kind of rational decision making. Just the tempo of the way the market was selling the news items and everything else. This may very well be a selling climax, not only in commodities in general but gold and silver as well. [18:55]
JIM: I would throw something out and I don't know why the markets focus so much on the inventory numbers. I'm going to address this to Bill Powers, but I'm looking at a graph of crude oil in terms of days of supply, and we're down to a little over 21 days supply. So you can trumpet all you want about all of these inventory levels, but we consume a lot more oil today than we did five or six years ago. So I think the more relevant figure is how many days of supply of oil do we have.
BILL: Yes. I would say that's an excellent point: days coverage is really the important number to look at, not the absolute level of inventories. One of the things that I have been somewhat surprised at is while we've had a weaker than expected inventory report this week, which has a lot of faith put in because it is a holiday shortened week and a week like that you can get numbers that are well out of the range, but we've had the supply of crude really come down significantly over the last six weeks. And I think the trend is really what is important here. That is we're getting that back to inventory levels that are more normalized, and that are on an absolute basis, and actually at the lower end on a days coverage basis. So I think you're absolutely right. And fortunately there is going to be some very cold weather – at least hitting Chicago here in the next 10 days – so I think that it's very likely we will see a reversal very soon. [20:15]
JIM: I want to throw some numbers out. Every year the Wall Street Journal and BusinessWeek puts together assumptions on the economy. They get the top Wall Street guys to take a look at Ok, where will GDP be. The consensus this year is the economy grows at 2.6%. You've got people on the high end of that figure that think it will grow close to 3.7 or 4%. Business operating profits will be up anywhere from 7% on the high side. The consensus is five and a half. We are going to get 2 ½% inflation – just right. The Federal Funds rate will average about 4.9%. Treasury bills or treasury yields on the 10 year will be about 10.9. And the jobless rate will go to 4.8%. Nice consensus – what I call the goldilocks economy. What can go wrong besides real estate where with this economy?
PETER: Well, there's a lot of things that can go wrong. Remember that story about Goldilocks in the end, right, she gets chased out of the house by a bunch of bears. And there are a lot of bears that can show up. I mean you've got the dollar, you've got bonds, you've got inflation. I mean, all kinds of things can hit the economy. And I think the dollar is probably the most important. It bounced a little bit recently. Today we've got the jobs numbers and there was a little bit more jobs created than the market was looking for and the dollar got a bid on that. But long term – I wrote a commentary about that, that's on your site – because when you add 185,000 service sector jobs but destroy 12,000 manufacturing jobs, that's bad for the dollar. You're creating more people who want to buy product and fewer people who are making them, so it increases the trade deficit. It puts more dollars into global circulation. We already know there's no private demand for those dollars. The demand now is 100% coming (or mainly coming) from governments, from foreign central banks. And are they going to continue to do that throughout the entire 2007? I don't know. What if they stop? Then the dollar drops sharply, interest rates go up, consumer prices go up. And how can we possibly have that rosy scenario when that's going on. [22:18]
JIM: You know what's interesting, though, Peter, is that BusinessWeek took a look at the stock market’s view of the economy, and the bond market’s view of the economy – and obviously both can't be right. From the stock market point of view, people that are bullish on the stock market believe stocks are cheap, profits will fall but not off a cliff, the Fed will lower the interest rates because inflation is tamed, corporate coffers are flush with cash. You go over on the bond trader's side and they are saying the housing market is still scary and it's going to get scarier, the meltdown of economic growth will be global, the Fed will lower rates because the economy needs rescuing because it’ll be in a recession and consumer spending will fall off a cliff. Now, obviously, both views can't be right.
PETER: Well, right. It’s all this talk. These are the same people buying stocks and bonds. It’s all the same firms. I don’t think it has anything to do with the fundamentals. Stocks are going up because people are buying them; bonds are going up because people are buying them. I think a lot of the bonds are going up because governments are buying them or central banks or people that are doing some kind of leveraged trade, but they are only going up because they are going up. Eventually, when this momentum shifts, it's going to go the other way. It’s going to go away fast – particularly in the bond market. There's absolutely no reason for anybody to own bonds. I can't imagine that the people who are buying bonds are long term investors that plan on holding these bonds to maturity, and they are going to clip the coupons. [23:37]
FRANK: That doesn't sound very likely, does it?
PETER: It's all speculators or central banks or hedge funds. All of these guys have one foot out the door. The problem is they are not going to get the other foot out the door at the same time. It's going to be too crowded.
FRANK: One of the issues with Fed policy this year, the real box the Fed is finding itself in, is where they bring down interest rates to help housing – which seems like an imminent need, given the fact that you've got so much in the way of interest-only loans that are due to reset this year. That's pretty much an upward stair step the whole year in terms of each month adding more loans that are due to reset. So to bail out housing they have to bring the short end of the curve down to give people an option. But on the other side of the coin, if they do that, does it trigger a currency crisis given the fact that you've got a trade gap moving towards $1 trillion, and a capital account that's now negative. [24:48]
PETER: Lower interest rates of a ¼ point or ½ a point – that's not going to be enough to help the housing market. I don't even know if they can cut rates enough to help them, but they would have to cut them drastically.
FRANK: They'd have to cut them down a couple of hundred basis points.
PETER: Yeah, because otherwise there's no way because there's just too many houses. I moved out to Connecticut a couple of years ago and when I moved here, there was like one house for sale. That house is still for sale, but now there are hundreds of more. Everywhere I go there's a ‘for sale’ sign. And the house that I rented two years ago and I moved out of there, but I rented it, it's been vacant for eight months. The guy is trying to rent it for about 15% less than I was paying, and he can't even rent it because there's so many houses for rent. [25:07]
JIM: Well, let's talk, then, about how this plays out with the Fed. Let's take this question. Is the Fed's next move a rate cut or a hike?
BILL: I clearly think it's going to be a rate cut. For a variety of reasons. And most notably that there's not the fear of commodity price inflation that there was six months ago, 12 months ago. I think there's clearly – one of the things that helps the dollar vis-à-vis the Canadian dollar recently is that David Dodge, Chairman of the Bank of Canada, came out and said, “we are no longer going to raise interest rates and we're going to be leaning towards a loosening policy.” And I clearly think that that's going to be much sooner than a lot of people think because I think we saw very slow sales at Walmart this year. While there were a couple of specialty technology retailers such as Best Buy that did have good retail sales, I just think without commodity price inflation fears, and with definitely some political pressure to stimulate the economy, I think that the next Fed move is definitely a cut. [26:17]
JIM: Does that come in the first quarter, the second quarter or when?
BILL: In the first half.
PETER: I think the Fed is going to do nothing for as long as possible because regardless of what they do, if they cut rates or they raise them, it's going to blow up in their face and they’re going to screw something up. So I think they have to pretend that they are really watching inflation and may raise rates, but the economy is still so good that they don't have to or they don't have to cut. I think they want to do nothing, and just hope that they can bluff their way into keeping this house of cards together. [26:48]
FRANK: I’ll throw another opinion out. I agree with both Peter and Bill. I think Peter's right: They are going to hold back as long as possible. But I think Bill is also right: when they finally do get around to it, they are going to cut. And the one idea that's going through my mind a lot was in regards to the stock market and the fourth quarter rally, I think there's uniform opinion that's bullish on the market which I would also agree with earlier comments on. Technically, in the work that I'm doing – following some of the cash inflows and outflows of Rydex – back in July, that work was all super bullish because we had very negative sentiment in Rydex in the July lows. And it's flipped around 180 degrees now. It's as bullish as it's ever been. And that tells me that when they finally do cut, I would expect the stock market to actually be going down. And I think that's what we're going to see again, which is sort of a repeat of the 2000, 2001 environment where the market moved into a bear market; and even though the Fed was cutting interest rates (which they did repeatedly in that period of time) the stock market continues to build downside momentum. [27:55]
PETER: Right. Long term rates might actually start to rise and rise very rapidly once the Fed starts cutting short term rates.
FRANK: That's exactly right. And that would be – that would be pretty ugly.
JIM: Let me throw a scenario out there that could happen, and I'm just thinking like a criminal here. You have all asset classes falling in the first part of the year; the stock market, bond market, commodity market; you get a continuation of the fall in real estate. It really starts to get ugly. In other words, it doesn't level off as the experts agree – so there's a second factor. And then the third factor, the economy continues to weaken. And then all of a sudden you've got people like Paul McCulley going on CNBC and saying, “Bennie, Bennie, save us, reinflate,” as they did in, let's say, 2003. What about that scenario?
PETER: It's probably going to pan out, especially when the Spring comes along, and there's a lot of houses that are going to come on the market. But they can't save us – they never stopped inflating. That's the problem. They’ve been inflating all the time. And I don't think that we have the ability to do it. You know, back in the late 1990s, we were able to run these deficits because everybody wanted to buy our stocks. We had them conned in this new era of the internet, there was a wait – people wanted our stocks, and they even wanted our bonds because interest rates in the US were quite a bit higher than interest rates in Asia or in Europe. But now, there's just no real demand. There's a limit to how much of our paper the foreign central banks are going to buy when they're already upset that they own too much of it, and a lot of them want to diversify out. So there’s no way to save us by printing money. [29:34]
JAMES: This actually brings up a point that I've been looking at recently. The similarities today in the early part of Weimar Germany are really quite amazing. And I've been studying Weimar Germany particularly to get a better understanding of the events back there. One of the key things that happened was that the German central banks kept printing money because they essentially wanted to put liquidity into the market to keep the economy going. That's exactly what Ben Bernanke is saying. To me it seems more and more clear that we're ultimately heading into some type of dollar hyperinflation. [30:08]
PETER: Sure. And they had to print reichsmarks to pay the war reparations much the way we're going to be printing dollars to pay the Japanese and Chinese the interest on the bonds that they hold.
JAMES: The big foreign debt – exactly. Right.
JIM: I'm glad you brought that up because a couple of years ago I spent studying the hyperinflation in Germany – and I'm trying to think of the pronunciation of their central bank minister back then – where they never looked at the increase in the supply of money as inflationary. They always thought it was it's because the dollar was going up against the mark, et cetera. And if you look at that same line of reasoning, you almost have the same pronouncements coming out of the Fed today: “well, we no longer look at M3 or money supply because that isn't as relevant to our thinking any more.” So you have the same kind of concept as you had in Germany. But what you did have in Germany was an increase in the nominal value of the German stock market. Because this goes back to what you said earlier, Jim, when people start realizing that the paper they hold in their wallets is turning to be worthless, people start getting out of that paper and they start buying tangible things. And that's why you got the reflation of the German stock market – and then people were cashing in their reichsmarks for wheelbarrows and tangible things. And I think eventually that's where we're going.
JAMES: Yeah. And my point has been this past year that the stock market is going higher. The US stock market is going higher not because of the good US economic condition, but simply because there's so many dollars overseas and people (the big overseas holders of dollars) are now taking 4.9% positions in a lot of stocks across the board in the States. I think that trend is likely to continue.
PETER: And too, one thing that is different now is that people really have a real alternative if they want another paper currency. They've got the Euro. And the Euro now is eclipsing the dollar as far as if you look at the currency that's being used on a black markets around the world now, there are more euros being used than dollars. There's more of them now globally in circulation, especially since they have a 500 Euro note as opposed to the highest denomination bill we have, which is $100. It's very easy now for people to start moving out of dollars into an alternative. But obviously gold is a better alternative than the Euro, but you certainly have another fiat currency that you can own that's now more acceptable, more widely used than is the dollar. [32:36]
JAMES: Yeah. The knee jerk reaction is to move out of dollars and buy another fiat currency until problems with those other fiat currencies become more apparent. And then the logical conclusion is you move out of all fiat currencies into gold and silver.
PETER: I already see in the media too a lot of talk about they’re saying: “The dollar isn't weak. It's just that the Euro is strong.” Just like what your point is about what they did in Weimar Germany.
JAMES: In Germany. Exactly.
PETER: Well, what's the difference? If the dollar is losing value against the Euro, then the dollar is weak.
JIM: I guess another question, and let's apply this to the economy and also to the markets, we've had almost 18 quarters of double-digit profit growth. Where does that go, going forward? There's no way that I think that corporations continue to grow their earnings at a double-digit rate while economic growth is slowing, because mathematically you just can't do that long term. What happens to profit growth and then let's translate that eventually into what happen to the market?
BILL: Over the last 18 quarters we've seen a lot of the profit growth come from energy companies and I don't think that's going to continue in 2007. Energy companies, I think, will on the whole detract from profit growth because they are having spiraling finding and development costs, as the commodity prices have come down so their margins are becoming squeezed. So I think we will see somewhat of the – you know, from the larger contributors such as Exxon Mobil, Chevron, that had huge profit growth over the last four years, I think that's going to reverse itself at least in a small way, and definitely possibly in a fairly significant way in '07. So I think profit growth at least from the energy sector and from the S&P as a whole is definitely going to be muted if there's any growth at all. [34:17]
PETER: Yeah. Especially when you look at the fact that I think the biggest part of S&P 500 profits comes from financial services. Even from manufacturing companies, if you look at where their earnings are coming from, they are actually coming from financial services or interest. And obviously, that's going to turn around once the housing market really drops, and people stop making payments on their mortgages or on their other consumer debt or on their car payment – a lot of these earnings are going to evaporate. A lot of them are phony.
One of those things about loans when banks or lenders have these negative amortization loans or people have option ARMS and the borrower opts to make a payment that creates a negative amortization, basically what the lenders are able to do is take that negative amortization and claim it as current earnings – even though they didn't actually earn the money. All they are doing is adding it to the balance of a loan which will probably never be received. So I think there's a lot of phony earnings being created by sleight of hand and by accounting. And eventually, all those earning are going to go away when they have to take big writedowns – charges – on phantom earnings that were never actually received.
That's also going to happen to a lot of the home builders. A lot of these homeowners are booking earnings based on the fact that they took deposits on homes that they are probably are never going to sell. And I read stuff too about home builders who are guaranteeing when someone comes and wants to buy a house that can't sell their existing home, they are guaranteeing to make their mortgage payments for 12 months; or they are guaranteeing that if you can't sell your house a year from now, we'll buy it from you. So who knows all kinds of crazy deals that are being made behind the scenes that are really contingent liabilities that are being absorbed by these companies that aren't being disclosed and the earnings are really phony. [36:00]
FRANK: You know you're right about that, Peter. In fact, in some of the areas of Miami, the apartment condo area, those types of deals are already starting to go south.
I also see two other areas that are worthy of discussion and one is the Capex. There was a whole train of thought going on last year that if the consumer did slow down that it would be Capex that would come on to pick up the broad economy, and also to give earnings a boost. I think one of the points that has to be illustrated there is: number one, Capex would have to grow at an extraordinary rate to offset any slowdown in consumer spending, because consumer spending is roughly 70% of the economy. And if you look at what CEOs are saying right now in the sentiment polls, which have been extremely accurate over the years, there is really no confidence being manifested out there that would illustrate a big Capex boom. And I think a lot of the bullishness that went into technology stocks late in 2006 is really misplaced. I mean there are a few one off exceptions – maybe companies like Microsoft and Cisco which has kind of gotten on a better footing – but on a broadly based spectrum, I don't see a Capex boom coming to help S&P earnings in 2007. I think that's going to be a big area of disappointment.
And also, the way we ended 2006, it was still building evidence of a cyclical downturn. If you look at the transportation companies, which have been very good cyclical barometers, the Cash Freight Index, and some of the leading companies like Fed Ex and Yellow, they've warned only about a month ago, the Christmas season looks very weak. And now that we're in January, this looks like we're heading into the year with a basic economy that's in a consumer slowdown – a cyclical slowdown. And it looks like it has more to go. [38:01]
JIM: So if we were looking out and let's say, guys, we were getting together, it's December 31st, 2007, from where the stock market is today, do you expect it to be high your, or do you expect it to be lower?
JAMES: First, I expect in nominal dollar terms to be higher, but in real gold purchasing power terms to be lower. You're going to be better off in the stock market than you are in a bank account, but you're not going to be as well off, as you would be in precious metals. [38:32]
PETER: I agree with that. I'm very confident that in real purchasing power terms relative to gold or foreign currencies or the real rate of inflation, I expect the stock market to be lower a year from now. But I think there's a good chance that it can be lower in nominal terms as well because there's just so much optimism out there right now that when you get that kind of sentiment, it's rare that it follows through. And with so many people expecting a big rally (I've seen a lot of strategists and everybody is on board with a big rally this year), so to me, I think that the stage is really set for the market to go down in nominal terms as well, which means the real decline would be magnified that much more? [39:12]
FRANK: Yeah, I agree with that as well. I think there's at least a shot we could end the year down 15, 20%. Work I’ve done on the S&P so far, I wouldn't be surprised to see the S&P close out 07 below 1100, which is a long ways from 14-something that we're at right now. That would fit with the cyclical bear market. And one of the things that it would really fly in the face of is this very strong seasonal free election cycle. This year is usually a very positive year. I think we're going to break that and disappoint a lot of people. Keep in mind, the S&P has not seen a 2%, even a 2% down day in 3 ½ years. You can look at this market in a lot of ways where essentially volatility and rich premiums right now, the way they went out at the end of 2006, have never been lower. And I think you're going to see a big return of volatility in '07, and I think it's going to have a pretty good shot at putting the market down on the year. [40:12]
JAMES: What would be the driver if the Federal Reserve holds steady or lowers interest rates. That would not be the driver. You know, if the Fed was going to raise interest rates and tighten liquidity, that would be a driver for a lower stock market.
FRANK: I would argue contrary to that, James. I think the Fed can cut interest rates and I think the stock market can fall on its own weight. It did that in 2000 to 2002 – just take a look at the Fed fund rate against the S&P. And I think that can happen again. I think it may be the case of just too many people on one side of the boat at the end of last year. [40:47]
BILL: Speed of drivers – one of the things that was a real catalyst to get the markets going in July was oil falling from $79 to below $60. And I think that while we may not see $79 in '07, I think there's a really good chance that we can see $70 or $75 if there's any supply disruption, or if there's a hurricane, or really if there's – you know, even just political tensions continue to escalate in the Middle East. So I think that energy could work in reverse in '07, unlike in '06, where it was a catalyst for the market to go up. I think a spike in energy prices and also a potential natural gas [spike]. I mean everyone thinks natural gas is going down to 4.50, or is it going to stay at $6. I think that's a big mistake. I think there's a very good chance we could see $10 in natural gas late this year, and I think we could see somewhere between 70 to $80 oil this year. So that could definitely dampen the market. [41:52]
JIM: I'm going to throw out something and I want to get into something like wild cards. Right now, we've got the John C. Stennis strike aircraft carrier battle group joining the US Dwight Eisenhower, and that is also joining the US Boxer strike force in the Persian Gulf. So we've got 16,000 US sailors moving into the region. We have another carrier battle group. We have 7 escort war ships, 10 air squadrons, 2 submarines and helicopters all moving into the area. What about a strike against Iran?
BILL: You know it was interesting, I did an interview at beginning of the five with Dr. Marc Faber, and he had mentioned that two years ago now. And I think that he gave a very compelling case as far as why Iran's desire to expand the nuclear program is going to really cause problems for Western countries who are vehemently against it. He thought there was a possibility two years ago of that happening. And I think the chances of it happening are increasing and I think people will wear out their political options with Iran sometime this year. And I think it's definitely an increasing possibility. And it would probably put oil to triple digits. [43:19]
FRANK: There's a well documented fact on that with regard to the Bushehr reactor that the Iranians are building with the aid of the Russians. I almost dated myself there, but that reactor is supposed to come on line in September. And for Israel, that becomes a very important point. Once the reactor goes hot, if it's on time, it becomes a very difficult issue. You can't bomb it. You can't hit it with an air strike – it will vent radioactive material out into the atmosphere. So the way to do it is to take it out before it goes hot. That puts you on a very short countdown in terms of 2007 for dealing with Iran. I think the odds are radically escalating on a lot of levels: both the way the spiral down in Iraq between Sunnis and Shiites; I think you have something of a synergy developing between the Israeli thinking and even Saudi Arabia's thinking where those two moderate countries are also very worried about a nuclear Iran.
PETER: And a second wild card, you know, obviously those type of military events would be negative for the market, but they could be a lot more so because in the past there's been an offset to that. The dollar has enjoyed a safe haven status, so whenever there's been some military tension or uncertainty, a lot of money has moved into US assets and moved into the dollar and that’s provided a bit of a buffer. But what if this time the safe haven flows goes the other way out of the dollar? Maybe they go to the Euro or they go to gold. That could take a bad situation and make it a lot worse. [44:54]
JIM: You know there was something that happened in the final days of the Roman Empire where they no longer had the military strength to maintain the Empire. And one thing that they would do sometimes is put all of their forces or use it against one particular country to make it an example. And I can't help but think, gentlemen, that the fact that Iran is talking about denominating oil in euros, that is, instead of dollars, the same way Saddam Hussein did, that that's a direct threat to the U.S. dollar hegemony in the world. There was a program on C-Span during the Christmas holidays where they had a bunch of people from political think-tanks and they were talking about the Iraq and Iran issues. And one of the guests on the program was a retired senior Air Force colonel, and he said the war plans were on the Vice-President's desk.
FRANK: See, Jim, if that's the case, and we move in that direction, that's incredibly bullish for gold and oil. And I don't see how that becomes a positive for the stock market. I think the stock market is going to hate that. If – because the other side of the coin is even if we use the stealth weapon, stealth bombers, the cruise missiles, things like that in an attack against Iran and try to project US military power, at some point, you're still dealing with an enemy where you’re far afield. They can hit back on other levels. We've got a lot of exposure in the region and a lot of energy infrastructure on the region that could be really vital life lines for the US. And I think those assets are at risk. So it doesn't seem like a very easy plan to execute if we go down that road. [46:41]
PETER: It's not like we did such a great job in Iraq.
JIM: Well, gentlemen, if we were looking once again going back to the December 31st date of this year, taking a look at the stock market, the dollar, interest rates, commodity prices, specifically I’m interested in gold and oil – I'd like to get your take on those points.
PETER: Certainly, the dollar could go down and we're at a level right now where it's just above some key long term support. So it certainly could bounce from here. It's done it before, but the key is if it breaks through that support. And if it really does, which eventually it's going to do, then it's going to drop like a stone. And that support is going to be massive overhead resistance and if the dollar really does break through that kind of support, that would be the most bullish development for gold, and silver or other commodities, which would also move up dramatically in an environment where the dollar had no support whatsoever and was basically in free fall. And that's about where we'd be. And I'm talking about the 80 level on the dollar index. And at some point that's got to be negative for the bond market and stock market. There's no question about that. [47:48]
JIM: So Peter, in your mind, if you were looking December 31st this year, stock market, the economy, you'd expect what? The economy to be lower?
PETER: I'd expect there to be a recession. I think a recession is coming. I mean is there a chance that we could push it past into 2008? I guess, but the later the recession starts, the worse it's going to be and the longer it's going to last. And it's already going to be pretty bad. I mean it's not going to be over in a few quarters. We're going to be mired in recession for years. It's going to take a long time to transform our economy from a borrower-consumer bubble to a savings and production viable entity. That can't be done overnight. It can't be done without a lot of pain. And we're going to have to bite the bullet eventually. And it could mean that we start in 2007. Hopefully we will, because the sooner we can get started the sooner we can get back on the right track. [48:41]
JIM: So at the end of the year, lower economic growth, possibly a recession. Your take – will stocks be lower than they are today?
PETER: I'd say stocks will be lower, bonds will be lower and the dollar will be lower and gold and oil will be higher.
JIM: Jim Turk, same questions.
JAMES: Starting first with gold, I expect gold to be much higher. I think we're going to see a continuation of the trend. And I think that's really the key thing to take a look at. I'm very much a believer in following the trend, and there are several key trends out there: higher precious metals prices, and higher oil prices. In nominal dollar terms, at least, higher stock market prices and probably much lower dollars. In terms of things that could surprise us over the course of the next year, I've been focusing on capital controls. The government’s been moving more and more towards limiting our freedom, more and more tracking and control. And I think one of the things that are inevitable to try to keep this dollar bubble in the air is to impose capital controls. [49:42]
PETER: They started it a little bit. It's illegal now to take large quantities of pennies and nickels out of the country. It is also illegal to melt them down.
JAMES: Yeah. That's a good example of it. Another example is just everything related to the Patriot Act and all of that reporting. And every time you send a wire outside of the US it has to be recorded. It's very easy for them to flip a switch and say you're only going to be able to convert dollars into Euros if you get central bank approval just like they do in third world countries. I think that's where we're headed, and I think that's the biggest concern we should be focusing on over the next year. [50:12]
BILL: As far as the general market, I think, Jim, there is a chance for – I don't have a big opinion that it's going to be lower because I think there has been some good productivity gains. However, I think that definitely oil prices will probably be closer to 70. I definitely think the dollar will be lower, especially vis-à-vis the Canadian dollar which is one I track very, very closely. I certainly believe that gold and silver should do very well as an alternative, but especially because one of the things that is really going to come to the forefront is the spending by exporters of energy commodities: how they are going to be really shying away from the dollar and putting more money into other tangible assets, into euros, into real estate, as well as into gold and silver. So I think that really the dollar will probably fall and I definitely think that there’s a very positive outlook for energy this year. [51:23]
JOE: Well, Jim, I think looking at the stock market, the economy, we've done a regression analysis and our portfolios really don't correlate well with the economy, regarding the interest rates, with regard to the market, regard to the energy prices, so we really don't do a lot of forecasting of those four sectors. But I will agree with Bill, I think that as we enter 2007, I fear very strongly we are approaching the gate to a new energy era. I don't think we're going to get there possibly until the end of the year, but we are looking at crude oil and we're looking at natural gas, we're looking at nuclear, we're looking at coal. We think there are incredible opportunities for investors in those areas. We think the prices for all of those commodities will be higher at the end of the year than they'll be at the beginning of the year.
One of the reasons we say that is because if you look statistically at historical data, when you have economic growth, you need more energy. I mean it's statistically significant, growth and energy use are highly correlated. You know, as someone already mentioned earlier in the program, if you look at China, it's growing at 10.2% last year. It's going to grow at 10% again next year. It's grown at 10% for the last 2 decades. You look at India. India has grown at 7% last year. It's going to grow at 8% next year. The IMF says most developing countries are growing at 5 to 7% per year. These are countries whose energy efficiency is very poor with regard to economic growth; the energy efficiency of these developing economy is much lower than the United States and Canada.
The good news is, or the bad news is, I guess, US and Canada are growing and we’re much energy efficient, but we’re growing at a much lower rate. So going forward, we think with the supply and demand issues with regard to all of those major fuel groups are going to offer compelling investment opportunities. Now, I don't know whether the economy is going up. I don't know whether it's going down. I don't know what the market is going to do, but I can tell you I think energy prices are going to be much higher and our portfolios are based on that premise. [53:37]
FRANK: Right now, Jim, I would say I'm looking at the real estate market as a primary driver. I think you're going to see a lot more fallout there – something in the way of a financial crisis that emerges from the over leverage of the credit cycle and the real estate mortgage cycle. And I don't see how that's going to be contained from impacting the broader economy in a negative way. I think there's a pretty good shot that the Fed will cut interest rates in response to it. I also think there's a pretty good shot that the stock market will go down – that not withstanding. So I’m a market bear. I think we're going to move into a cyclical bear market on the downside in the S&P. I think the high for this cyclical bull was probably seen in the late fourth quarter of last year. I think on the same note, as a recession builds in the United States in 2007, I think that geopolitical factors will underpin metals, and in the energy – I'm bullish on both of those. I think commodities will do very well and I think energy and metal stocks will completely decouple from the broad market and move higher. So I think that's going to be the area to look to make money in 2007 and that's where I'm trying to get position. [54:55]
JIM: My position last year, I said first the gain then the pain. I think we're going to go through the pain cycle, which in my opinion translates into sort of a disinflation cycle and then comes reinflation. I expect the nominal value of the stock market to be higher. We barely squeaked by avoiding a recession. If you look at it in term it's of real CPI numbers we're probably in a recession. Higher gold prices and higher energy. Final question to the panel. Your favorite play for the year? And let's go ahead and start with Peter.
PETER: I don't know. There's so many good investments out there, I don't know what the best play on a risk-reward basis would be. I like the short subprime mortgages themselves – it’s difficult to do, but we're short the risky tranches in the collateralized mortgage obligations which are packages of subprime debt. I think there are no-brainers. I think if this paper is going to zero, the only thing that can stop it from going to zero is hyperinflation, in which case I'm going to make a lot of money in all of my other investments that are in mining or natural resources or foreign currency denominated.
I also think probably one of the great plays could be some of these Chinese investments that we're making. I think maybe 2007 could be the year where the Chinese yuan really makes a move up. It's been held down artificially by the Chinese government. If they allow the currency to rise it could rise big and that's huge profits for Americans who have owned shares in Hong Kong-based or Chinese-based companies that derive their revenues in Renminbi. [56:31]
JAMES: Well, as bullish as I am on gold, actually I have to admit that my number one play, if I could only have one play over the course of the next year, would be silver. It was up 45% in 2006. And I expect it to do better than that in 2007. I think we're going to see silver over $20 during the next 12 months, so I think that would probably be my number one play.
BILL: US unconventional gas producers. Companies that produce from either tight sands or shale gas. There's very, very compelling opportunities there right now. The valuations have come off significantly. A lot of the this has to do with the very bearish weather we've had over the last couple of months here. There's compelling evaluations and these are long life reserve companies that are trading at significantly discounted values compared to where they were a year ago or even a few months ago. [57:25]
JOE: You know, someone asked Charley Munger how he and Warren Buffet did so well investing. They said in response, good investment ideas are really rare. I mean they don't grow on trees. You have to be extremely patient, you have to study the trends, you have to look at opportunities. But when a rich reward relationship that's in your favor you need to bet heavily. You need to invest your capital. And right now, you know, I read papers every day and I am on different screen for companies looking for attractive growth, attractive valuation, attractive technicals and I don't feel comfortable really with very few companies outside of the energy sector. And I have to agree with Bill Powers to a certain extent. However, I think there's a number of different energy companies and different energy sectors that you can find extremely attractive companies including the oil and natural gas, coal, nuclear, pipeline, refinery, services, equipment, even the railroads that deal with the coal transportation, offers some tremendous opportunities. And I think in any of those sectors if you find companies, especially small companies that are growing and are reasonably valued, I think for 2007, you will do incredibly well, especially if you put a portfolio of several of those companies together to reduce risk. And that would be my choice for 2007, which would be a portfolio of small energy companies; diversified- especially energy services, Jim, I think is extremely attractive because historically energy services companies have done incredibly well when energy prices are increasing – at least historically in the seventies.
FRANK: I couldn't agree more with the last comment on energy services. That's certainly an area that I'm looking at. I think they are priced at bargain levels especially given the fact that their earnings this year is going to be something to behold. I mean a lot of those companies are getting day rates that are two and three times what they were just three years ago. And they are selling in single-digit PE. So I like the oil service group a lot. I think gold will do very well this year. I think it has a good chance of breaking 1000 on the year, so I like all of the major mining companies. I guess if push came to shove, the most leverage and probably the biggest return will be in small cap – the junior mining stocks. That's one area. And the Venture Exchange – the Toronto stock exchange – I think there's a lot of good value and great stories in the small cap mining sector. So that's my favorite pick. [1:00:01]
JIM: I'm going to throw out a term, I think metals and energy once again by the end of the year will be stellar performers, but I'm going to throw out a concept or a theme out there and that's infrastructure plays. You take a look at a growing and emerging industrialization in India, Asia and especially China, so that requires infrastructure. And then if you look at the Western countries you've had declining infrastructure over the last two decades. In fact, it's been ignored. I think the Society of American engineers did an evaluation on America's infrastructure and I think we got a D-. So infrastructure plays.
Gentlemen, finally as we close, why don't you tell our listeners about what it is you do and if they want to find out more about what you do how they can do so, beginning with Peter Schiff.
PETER: I run a small brokerage firm, Euro Pacific Capital. I used to be out in your neck of the woods out in Newport Beach. I still actually have an office there with about a dozen people working there, but I’m now based out of Darien, Connecticut. And we handle individual brokerage accounts mainly for Americans who are interested in investing abroad. And what's unique about my firm is that we enable people to invest directly in stocks and bonds around the world on local exchanges rather than having to buy them through domestic market makers who often trade foreign securities on the pink sheets. And by doing that you're able to reduce the cost of international investing because you're not dealing with these wide spreads that are on the pink sheets. And I've got a number of brokers that are very familiar with my strategies, with the stocks that I recommend. And, you know, we focus mainly on international investing from a conservative standpoint because we're looking to get out of the US to avoid risk. So we're buying generally very mature developed markets, very conservative income-generating high yielding stocks. So we end up buying a lot of utilities, a lot of commercial real estate trusts; we buy a lot of the natural resource companies that tend to pay good dividends. And for the speculative part of our portfolios, we concentrate on mining and precious metals and other metals. [1:02:11]
PETER: My website is www.europac.net. And you know, I do my own radio show on site every Wednesday. It's live. And I've got a book coming out next month. I called it Crash Proof: How to Profit from the Coming Economic Collapse and that book will be out in February. And I would recommend reading it. It took me most of the year to write. And you can order it on my website as well. As I said, it should be out in mid February. [1:02:43]
JIM: Well, please come back and talk to me about that book. James Turk.
JAMES: I'm the founder and chairman of GoldMoney. We offer a very convenient economical, and safe way to buy and sell gold and silver online. We store the gold and silver for you in the UK. We presently have approximately $180 million stored there for our customers. And you can find us at www.goldmoney.com. Also I have a number of commentaries on markets from time to time on the website. Just look on the front page, go for the “founder’s commentary”, click that, and you'll see my alerts that I have issued and I'd be happy to if you wanted to add your e-mail address to that, we will notify you every time I post a new alert to the Gold Money site.
BILL: Yes. I currently run Powers Asset Management. We manage a hedge fund of small and midcap oil and gas companies that are focused on the US and Canada. If you’d like more information about what we do, you can send me an e-mail at firstname.lastname@example.org. That's Powers Asset Management all spelled out.
JOE: I'm an adjunct professor at Southern Methodist University School of Law here in Dallas, and I teach oil and gas law, environmental law and environmental litigation. In addition, I also run a small investment partnership. We invest in small companies that are public, that are growing, that are undervalued. We're very quantitative in nature. The fund is very small. We’re only 8 million in total assets, so it's a really small fund. But if you're interested in what we do and our niche, we are at lfgifund.com. [1:04:30]
FRANK: I run a small market timing newsletter called the Gold Stock Technician and that uses market timing and technical analysis to track gold and gold stocks. If they have an interest I can be reached at frankbgst @ aol.com.
JIM: Well, gentlemen, I want to thank you all for joining us on this panel as we get the New Year off to a start. And I hope, gentlemen, we can all get together at the end of the year as we look back at how 2007 developed. In the meantime, we want to wish you a very prosperous and healthy New Year. Thank you so much for joining us on the program.
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