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The
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JOHN: Not sure whether it’s a blessing or a curse, Jim, but there was an old Chinese proverb that said: may you live in interesting times. And if we look around it does look like we’re living in interesting times, especially since the old paradigms of what works – and what doesn’t work – really seem to have changed this decade. JIM: John, you know, if you take a look at all the economic and financial paradigms – the things that you learn or expect – this is the way things have worked for, let’s say the half-century, all of them have changed in this decade. And we can start out for example as we’ve mentioned on this show before – the 2000 recession was brief, it was a business-led recession; there was no downturn in real estate which typically has led all previous recessions such as we are seeing now; the consumer borrowed and spent money instead of saving and pulling back on spending. The recovery was also unusual. All the talk you heard in the press about fewer jobs being created, anemic business spending– very few mentioning building new plant. Real estate and consumer spending and borrowing basically drove the economic recovery. [1:21] JOHN: What about the financial markets and the current Fed rate cycle, they look like they are also different from the past? JIM: Sure, and that’s got a lot of people puzzled. The financial markets also acted differently this time as well. Stocks went up instead of down during this rate cycle. Remember, the last rate cycle which began in 1999, and finished in the year 2000 gave us a very long bear market that lasted for 3 years – as well as a recession. And that did not happen. In fact, long term interest rates declined instead of rose. The dollar and gold rose simultaneously – that had a lot of people scratching their heads; and bond yields fell even while commodity prices were rising – there’s another head scratcher. [2:07] JOHN: Yes, an aspect of this recovery that also seems to stand out to me is that monetary policy has been less effective in generating economic growth. It really isn’t having as much control over the market as it did before. JIM: Yes, when you really consider the fact that the Fed had to bring interest rates down from 6% down to 1% - the lowest interest rates we’ve seen in half a century. There was a lot of talk why the recovery wasn’t more robust, why weren’t more jobs created? And you’re absolutely right, it takes more dollars of debt today to generate a dollar of economic growth. And for example, if we go back almost a decade in 1997, it took roughly $3.60 to generate $1 of real GDP, and about $2.74 of debt to generate nominal GDP. The difference between nominal and real is adjustments for inflation. Fast forward to 2002, we’re coming out of a recovery, it takes almost $14 of debt to generate $1 of real GDP; about $6.40 of $1 in nominal GDP. If we go back for example to last year – in 2005, $9.70 of debt for each $1 of real GDP, and about $4.50 for what I call nominal GDP. [3.33] JOHN: If we make the assumption that this isn’t going into the economy, where is all of that debt going then? JIM: Plain and simple: financial speculation. The economy today is more leveraged than it was 5 or 6 years ago, more leveraged than it was a decade ago, or two decades ago. And I’m just speaking roughly here in terms of numbers, but for every $1 of debt that we generate in the United States about 22% goes into GDP. About another 28% goes into imports – because remember, if consumers go out and buy goods in the store, whether it’s a DVD player, a television set, a camera or even a DVD itself, if it’s made overseas those are dollars going overseas. And then 50% goes into speculation. [4.23] JOHN: That would explain some of the trading and a lot of this roller coaster gyration that we see in today’s markets as all of this becomes more and more institutionalized. But when the Fed goes on pause how does this play out, basically what follows afterwards? JIM: Well, to begin with we’ve got to understand what happens next. In order to understand that you need to know what’s different this time. Are we playing with the same old economic cycles, the same business cycles as we’ve had traditionally over the last half-century? No. In the past, recessions have been caused by monetary tightening, going back more recently to the 91 or 99 and 2000 tightening, which led to the recession of 2001 and bear market; we had a similar experience in 1990 and 91, we had a recession there. This tightening by the way led to reductions in debt, either through defaults or just people getting nervous and paying off debt as they did in the 81 recession and the 91 recession. Credit actually contracted in 1981, actually 1991, and in the year 2001. So we saw this happen in 81, 91, and 2000 that is. You also saw consumers retrench. Therefore as consumers began to pull back on spending you were getting this pent up demand, so that when the recession hit, rates came down, the Fed pumped liquidity back into the financial system, and the economy recovered as pent up demand came back into the economy. [6:02] JOHN: We know that didn’t happen in the 2001 cycle recession. JIM: You’re absolutely right. Debt and credit expanded in 2001, and has expanded every year. In fact, throughout the entire rate raising cycle that began in the Summer of 2004, all the way up to the present, debt expanded each year. [6:23] JOHN: You’ve been arguing that liquidity isn’t tight, money supply is expanding globally, and credit’s at record levels. JIM: I strongly disagree with this proposition that the Fed and the central banks are tightening. The Fed has two levers to influence interest rates and liquidity. The biggest lever which we talked about last week is its open market operations, which involves the buying or selling of government bonds which increases money in the banking system. We talked about coupon passes last week, we got coupon passes this week. And of course, if monetary policy is tight, then the proof of that would be central banks would move to curb credit expansion, and it’s that credit expansion that fuels excess spending in the economy and also inflation. We did not see that this time. [7:15] JOHN: So I guess your view of the Fed is basically the Fed is playing loose goose with credit. JIM: John, credit has expanded every single year in this decade. We’ve gone from 1.6 trillion of new credit in 2001, almost 3.3 trillion in 2005. And already this year we’re tracking at an annualized rate of almost 4.4 trillion. Credit has increased 108% from the years 2001 to 2005. This year so far credit is up at an annualized rate of 32% over last year – that hardly indicates to me that we’ve got monetary tightness. [7:58] JOHN: Alright, given the rate of inflation, here’s the 64 gazillion dollar question, what comes next? JIM: Well, as I’ve mentioned on this show a number of times, in order for the Fed to go on pause – and remember we began talking about this in the Spring of this year which is in our transcripts – it had to get commodity prices down. You can’t keep telling the market you have inflation under control when you’ve got oil at $75 a barrel, or gold’s over $700 an ounce. So they needed to hammer the commodity markets – they hammered gold in May, and they’re hammering gold now, and they’re also attempting to hammer the oil markets. [8:33] JOHN: Ok, but this is just what we’ve been predicting here on the program all along, and now what we said was going to happen is unfolding: commodities are getting hammered. But in your own words if you recall, you used to say we have to ask ourselves what’s changed right now? JIM: Well, let’s take a look at the oil market because all the airwaves are talking about the commodity bubble is over, it’s bursting. I disagree with the commodity bubble thesis, and then also that demand destruction – all these factors. So let’s just take for example oil. The reason oil is down is due to 5 factors. We had the cessation of military hostilities in Lebanon. The Iran ultimatum that came into play at the end of August. There was no supply disruption, they weren’t going to hold oil off the market. You get into the hurricane season which Evelyn Garriss predicted on our program was rather benign – so we didn’t have any Katrinas or Ritas. Now there’s talk of fears of a global slowdown especially in the US economy. And then of course, last week the news of a major oil discovery even though that’s a long ways out. Ok, but let’s take a look at the opposite facts. There is no indication that the world has become a more peaceful place. Secondly, global supply is still very tight – remember, we’ve talked about global spare capacity has shrunk from 10 million barrels of excess capacity per day to somewhere around between 1 and 2. Demand is still growing. What we’ve seen is some of the speculative pressures have been largely wrung out of the markets. A lot of the people that got in late looking for an easy run on commodities – they got hurt, they’ve been sort of retreating in the market. And here’s something that’s very important to understand: OPEC can effectively put a floor in the price of oil. OPEC had a spare capacity of 10 million barrels and prices spiked as we saw for example during the Gulf war in 91, in 95 and also in 2000; and also in 2001 after 9/11; and then once again in 2003. When you had 10 million barrels of spare capacity you can remember John the OPEC press conferences, “hey, we’re going to flood the markets with oil, and bring the price down.” And that generally worked. Now you notice that they tried that in 2004 and 2005 – it didn’t work because nobody believed them because everybody knew that spare capacity had dried up. Now that you have 2 million barrels (or 1 to 2 million barrels) of spare capacity, where the supply is really tight, you have OPEC say, “we’re going to cut back,” – they can put a floor. So OPEC can be more effective on putting a floor underneath oil than they can on capping its price. And finally, a couple of points, you’ve got growing depletion rates. One of the things if you look at the BP Statistical Review, in 2005, is you had new production come online from countries that were expanding production – I think it was like 2.4 or 2.5 million barrels. But then you had depletion declines from countries that are seeing their production decline (the United States being one of them) of 1.4 million barrels, or 1.5 million barrels I think was the figure. So the net increase in production globally last year was less than 1 million barrels. So depletion is something you also have to look at. And seven, there have been no massive discoveries this decade. We’ve got one that has potential here in the Gulf of Mexico, announced last week by Chevron and Devon. But other than that – and bear in mind it takes a long time to bring this stuff online. [12:21] JOHN: Overall, if we look at everything this is all just temporary, right? JIM: Sure. The central bankers need to change the focus of the financial markets from one of inflation to one of disinflation in order to start cutting interest rates. And that’s where they are trying to take this. [12:40] JOHN: And obviously we also have election considerations coming in here as well. So as far as what’s coming, what do you think we’re looking at in the next couple of months? JIM: Well, the talk and focus in the financial market is going to change from inflation to worries over slowing economic growth to then one of deflation – watch for that. This sets the stage for the Fed to begin injecting money into the financial system, and then to begin to lower interest rates. Hammering the commodity markets was a necessary step, and if you go back and look at transcripts of the program we’ve been telling you about this going back to late Spring last year. You can’t talk about getting inflation under control if you’ve got rising record commodity prices. And so they had to hammer the gold market, they had to hammer the energy markets and that’s what we’ve seen. [13:28] JOHN: But it would seem like we’re just opening the door for another cycle. I mean that would be my observation of the whole thing. They’re going to take it down and take it up again. So what are we looking at? Deflation, inflation, what? JIM: First, and let me just repeat this, there will be no deflation. We’re not going to have a financial crash, we’re not going to have spiraling debt defaults, or collapse of the money supply, as for example what we saw in the United States in the 1930s. The Bernanke Fed will cut down every tree in the forest before that happens. They call him Helicopter Ben, I call him B-52 Ben. [14:06] JOHN: Do you think the environmentalists would go along with that? So basically, no deflation, right? JIM: Absolutely no deflation. I repeat: no deflation, no deflation. Every central banker in the world believes in the monetarist view, and that is the minute you start to get the first signs of deflation you put your foot on the pedal, and just flood the markets with liquidity. I like to use an analogy. Picture a plane traveling, it’s up at about 30,000 feet, the engines start to stall – what’s the first thing you would do as a pilot? JOHN: Jump out! Now, you’re not talking about the aircraft stalling, you’re talking about the engines quitting? JIM: Yes, you know, the engines start to stall, what would you do? JOHN: The first thing is you nose over – put the nose down – so that gravity keeps the plane flying. JIM: Sure, put the nose of the plane down to build up momentum and gravity and power, but somewhere from 30,000 feet to 10,000 feet you’re going to have to put the afterburners on, because as you know, John – being a pilot – if you don’t pull out of that nose dive you know what happens. [15:20] JOHN: Well, basically, ultimately you impact the ground. There’s an old expression that says you know what the purpose of the propeller is for on a plane? It keeps the pilot cool – if you don’t believe it, watch the pilot sweat when it quits. But it’s really true, at some point there still comes a point of reckoning. You have a certain amount of play-around-time there from the time the engines go out at 30,000 feet, but you better get them restarted, or you’re going to be in trouble. JIM: And that’s what the monetarists believe, and that’s what central bankers believe. For example, go back and read the Fed papers; read Bernanke’s papers about why we had a great depression, and why they’ll never let that happen again. And he’s already made statements – at I think it was Milton Friedman’s 80th birthday – that we’ll never make that mistake again. The Fed did a study on for example deflation in Japan, and one of the thing they said is that had the central banks there applied the pedal to the metal on liquidity –injecting or basically printing money soon enough – they could have stopped the nosedive and then pulled the plane out of that nosedive back up again. So that’s the thinking that every central banker has grown up with, that’s what they’re taught in school, that’s what the guys on Wall Street are taught, that’s what the politicians that have ever taken an economic course – that’s how they think the world works. So the minute you even get a whiff of deflation then what you’re going to have is money printing like you’ve never seen it before. [16:53] JOHN: Ok, so plane nose-over, we’re in a glide headed down, how is this going to play out in the next 6 months? JIM: I think you’re going to see a short period of disinflation that’ll last between 6 and 9 months, but that period of disinflation will be followed by another higher period of inflation. And if people want to get a better perspective, I wrote two articles on this in my perspective series on my website. I would go to The Great Inflation and the second part of that The Two Bens. [17:21] JOHN: And so, as far as investments are concerned? JIM: The world is heading back towards, in my opinion, tangible, hard assets. We’ve been there since late 98, 99. We’re in the early innings of this process. However, I don’t believe this is a commodity bubble. Investors are going to go long, or should go long, in things from energy, precious metals, food, land, infrastructures, anything that is basic. This is something that not only has worked well, I think since this new decade, but I think it’s going to work well in the future. [17:53] JOHN: For people who read our website, or listen to the program, I know you’ve been writing about this since back to 2001, and we saw it coming and here we are, so we haven’t changed our position on anything so far. So that’s where we’re at. JIM: Nope, I wrote a piece, I think it was April 2003, which was called The Next Big Thing, and the next big thing is going to be in tangible and hard assets. The only problem, John, is this really hasn’t caught on with the public yet. And even on the institutional side you have a lot of people that think that this is just kind of a passing wave – and hence everybody on Wall Street that’s saying this is a bubble, it’s burst, it’s over. I can think of the Summer of 2002, [them saying] that was it for gold; the Summer of 2004, that was it for gold. And remember, John, they’ve been saying the same thing about oil. As oil went from 20, all the way up to almost 80, every single inch of that climb they all told us why this can’t last, and it was going lower. [18:50] JOHN: Yes, but it is fun to watch them wiggle, when you watched CNBC this week. JIM: Well, it depends on what side. If you just got into the oil markets, or the precious metals markets recently I bet that wiggle is not fun right now – but hold on. JOHN: Well, Jim, somebody else who thinks like you do is Puru Saxena in Hong Kong, and he’s coming up next as our featured guest on the first Other Voices right here on the Financial Sense Newshour at www.financialsense.com. [19:20]
JIM: Well, is the commodity bubble about to burst? And, while we’re at it, is it really a bubble? Are central banks tightening liquidity, and will stocks go into a long term bear market. Well, to talk about that, joining me is Puru Saxena from Hong Kong. Puru, let’s begin with this concept that you hear over and over in the financial press, which is that central banks are tightening liquidity. I disagree with that when we have record credit creation. This year alone in the United States we’re annualizing at almost 4.3 trillion – that doesn’t sound like tightening liquidity to me. PURU SAXENA: Liquidity is not really tightening, Jim. What we’ve seen is that the rate of money supply growth has gone into a decline, so the money supply is not expanding as quickly as it was. However, the credit figures are not captured in the money supply figures. So on one hand central banks are creating a farce of raising short term interest rates very gradually in order to quench the inflationary expectations or inflationary fears, but on the other hand they’re ready with an endless supply of credit to give money away to whoever wants to borrow it. And the irony is because the bond market is still quite strong and the interest rates on the long term maturities are still quite low – in fact we’ve got an inverted yield curve – money is still very, very cheap; and mortgages in the US and in some of the other Anglo-Saxon countries are determined by the bond rates. So as long as the bond market is strong and we still have this rally in bonds, money is still literally being given away. [21:08] JIM: Close to where I live there are two major housing developments that I’ve written about in my Day After Tomorrow, and I stopped by last weekend, and a couple of the builders are covering closing costs now, they’re giving away upgraded appliances, granite counters. And also there is a plethora of different mortgage options available. I didn’t hear anything from the sales people like, “well, you know, you better have good credit, you better have 20% down because [otherwise] banks don’t want to talk to you.” That wasn’t what I heard. I heard, “Oh, there’s all kinds of ways to finance, and there’s all kinds of ways to get into this home right now.” So that doesn’t sound like tighten credit to me either. PURU: No, and if you look at the previous histories in the credit cycle, Jim, I’ve seen that whenever the central banks wanted to really tighten the supply of money and credit the, credit supply actually contracted in a very meaningful way. And this time it just hasn’t happened. As you said, the credit growth this year annualized at $4.3 trillion, was roughly $3.5 trillion last year, so the credit has grown at a record pace this year. Not only that, if you look at the non-gold foreign exchange reserves holdings of central banks, they’re also at a record high about $4 ½ trillion. So what sort of tightening is this? This is not really a tightening, it’s more a show to please the public. And also in Hong Kong credit cards are still being given away. I know because I get 2 or 3 applications a week of pre-approved credit cards. If banks were really serious about monetary tightening and taking money away from the system this wouldn’t be going on. [22:49] JIM: You wrote in your latest newsletter something that I have been much in favor of, and in fact have been talking about it here on the program. You hear all this talk around the world about a commodity bubble, and there are two things I disagree with that concept – and I don’t know [but] I’m sure you’re going to back me on this – one is usually when you have a bubble in something you have all kinds of excess surpluses hanging around because everybody and their brother got into making or producing whatever created the bubble – and I certainly don’t see that in warehouses. I don’t think we’re sitting with giant warehouses of copper, or we’ve made all kinds of great oil discoveries that are now coming online so that we’ve got excess oil. And the second factor is in a bubble, usually towards the tail end of a bubble, even in the gold bull market of the 70s, the public jumps in head first. At least here in the United States, if you were to talk to somebody, “hey, do you have gold stocks, or energy stocks,” they would probably look at you cross-eyed. PURU: Most people have never invested in commodities, and I know that from experience. I deal with extremely wealthy people here in Asia and Europe mainly – our client base is in Asia and Europe – and most people don’t have any exposure to commodities, although prices have risen over the last 4 or 5 years. My observation is most people have invested in properties, they have invested in stocks and bonds but very, very few people – and these are wealthy people – have exposure to commodities. So my argument is how can this be the end of the bubble when the public has not even invested in commodities. Most people don’t even know how to buy commodities, and as you rightly pointed out, my observation with bubbles is that they only end or burst once there is widespread acceptance by the public, and so far the public is still skeptical. If you look at the money flows around the world there is $60 trillion invested in stocks and bonds worldwide, and there is only $100 billion invested in commodities. So if this is a bubble, this would be the first of its kind to burst without any money in it. [25:04] JIM: I want to talk about a phenomenon that we’ve seen this week alone is I see this at night, gold opens up strongly in Asia, and then by the time it opens up here it gets killed. PURU: I have no doubt in my mind that over the past week or so whence we’ve seen this sudden weakness in precious metals there is all sorts of things going on in the US. As soon as the US market opens you see a waterfall decline and I’ve seen that over the last 3 or 4 days. And we are now approaching the mid-term election in the US and you can bet your house that the establishment in the US is doing everything possible to prop up the US dollar, the stock market and to keep the precious metals subdued before the election. [That’s] because a rising gold price doesn’t go down very well in Congress, and also with the public because it signifies there are inflationary fears. And I suspect that for the next few weeks until the election is behind precious metals will tend to be weak, because there are huge forces at hand trying to keep the price down. How do you explain that gold and silver and platinum have been up every day in Asia and Europe, and as soon as the US market opens they collapse? [26:20] JIM: I think we have the invisible hand here at work. And the other thing that I’ve noticed that this even occurred in the oil markets. What I found interesting, Puru, is when OPEC was meeting they were saying how in the heck did oil prices come down this quick? They were polling their members, saying “are you finding out from your customers that they want to cut back on their orders because they have too much in inventory.” In other words, if let’s say I’m a country, and I’m exporting 500,000 barrels a day, and there is this supposed excess inventory and supply glut on the market then I would expect that one of my customers would call me and say, “don’t send 500, only send 450 right now, our warehouse is pretty full.” None of the members within OPEC are seeing that. PURU: No, and again one thing that you have to realize is the size of the commodity markets is still so tiny compared to the currency markets and so forth, so it’s very easy for any group of people to keep the price suppressed or elevated for a very short period of time. I am of the opinion that you cannot change the primary or the main trend in any market, and I think oil as well as precious metals are now in a long term bull market, or in a long term boom, so any interest to manipulate or suppress the price of anything is going to eventually fail. But because the size of the markets are so tiny – compared to say the FOREX market, which is over a trillion dollar market a day – that people can get away with this. And once the public starts getting in to these sectors, then it will become more and more difficult to keep the price low or high, whatever the establishment wants to do. [28:03] JIM: You bring up something that I think is very key that a lot of our listeners may not understand, and that is that the commodity market which is about $100 billion compared to $60 trillion in the other financial markets, is really so small. I mean take a look at the market capitalization of all the world’s gold stocks and it doesn’t even add up to Coca-Cola and Microsoft. PURU: That’s absolutely right, but I also have the feeling that this is going to change because we are still now in my view in the very early stages of the bull market. History has shown commodity booms have lasted anywhere between 15 years to 40 years, and the average duration has been around 20 years. We are now 5 or 6 years into this boom. In 2001, commodity prices were the cheapest they had ever been in the history of capitalism over the last 200 years, and now we’re rising from an extremely depressed level. So you’ve got a question is the bull market over after a 20 year vicious bear market? How can the bull market be over after 5 years – after a 20 year decline – when the public is not even invested. That to me is the most absurd argument that I’ve ever [heard]. [29:17] JIM: Also, on the fundamental side, Puru, if you talk to somebody that runs an oil company, or even a mining company you’re talking about executives who have spent– if let’s say they got in this business 20 or 30 years ago – two-thirds of their career in this industry in probably one of the worst bear markets that they’ve ever seen. And I remember Donald Coxe talking about this where he was talking to mining executives, it’s really hard for some of these people to go sit there and just spend a wad of money, and cut loose with the checkbook when you’re a little bit cautious: “hey, is this thing for real?” And don’t forget Wall Street and the economists are always forever telling us why oil is going back to $40 a barrel, or why gold prices are in a bubble and are going back to 400. So, coming up through that bear market you can’t help but be influenced by what you experience. PURU: Jim, if you think oil is in a bubble, I’ll give you a few figures. In the US you have 300 million people and they consume per capita about 25 barrels a year. So the consumption of the US per day is about 22 million barrels of oil. With 2.3 billion people in China and India, in China the per capita consumption of oil is 1.7 barrels a year – that’s it; in India, it is 0.8 barrels a year. And Asia with 3.6 billion people consumes the same amount of oil as the US does with one-tenth the size of the population. And I suspect as more and more money and capital flows from the Western world into Asia because of globalization, the per capita consumption levels in India and China and the rest of Asia are going to increase. And at the current growth rates the per capita consumption, or the total consumption in Asia is expected to double to about 40 million barrels a day within the next 10 to 15 years. So if people think that oil is going back down to $30 a barrel they better tell me where this additional oil is going to come from, because most of the oil provinces are in decline. We haven’t seen a single major oil discovery except one in Kazakhstan in the past 35 years; and also the oil reserves claimed or quoted by some of the Middle Eastern countries are highly suspect. So, you have a rising demand situation, falling supplies and you’ve got a bull market, how can you get to $30 oil? And as far as gold is concerned, gold peaked in 1980 at $850 an ounce, now adjusted for inflation in today’s dollar terms that equated to a price of $2100 an ounce. Today, gold is trading at 570, would you classify that as a bubble? [32:10] JIM: Absolutely not, absolutely not. Well, Puru, given your thoughts on commodities, the markets, liquidity how would you be investing today if you were investing. PURU: At present we have invested our managed accounts – and my firm manages investment portfolios for high net worth individuals, family offices and companies – and we’ve invested quite heavily recently after the pull back in precious metals. We own physical bullion, platinum, palladium, gold, silver. We also invested in select mining companies in precious metals all over the world. And we’ve recently started going back into the emerging markets in equities. I continue to feel that on a relative basis stocks in Asia and Latin America are going to outperform stocks in the US. And the economies in the emerging world are growing much more rapidly than the US, the industrial production is quite strong, the savings rate is positive, versus a negative savings rate in the US. And if the economies grow, and I suspect there will be a rally in equities towards the end of the year because we are now entering into the third term for the US presidential elections next year. And over the past 50 years the average return on the third year has been about 20% on average. So if the S&P does what it did over the last 50 years then the third year of the term then you will see a big rally in emerging market stocks. And I know there is a lot of doom and gloom about the economy slowing but as you said there is so much liquidity floating around the system, this money has to go somewhere, and if you look at the market cap of the global stock market it’s around 47% of all the money invested in stocks is invested in the US, so the market cap of the US is 47%; in Asia the market cap, excluding Japan, is 5%. So I suspect more and more money will flow from the US and Europe into Asia and also into Latin America. And I would urge your listeners to invest some money overseas because you’re not only going to make some good money there, but also on the currency front because I think the Asian currencies are quite undervalued compared to the US. [34:19] JIM: Alright, Puru, I would like to thank you for joining us from Hong Kong. If our listeners would like to find out more about your services and your newsletter, tell them how they could do so. PURU: I publish a monthly newsletter Money Matters and it’s available by subscription from my website. My website is www.purusaxena.com and my monthly report as well as my firm manages money on behalf of clients on a fee basis and we invest in assets all over the world, so if you’re interested please visit our website www.purusaxena.com. [34:56] JIM: And I also might want to point out, Puru also has written editorials for our site which you can read and take a look at. Puru, as always, a pleasure to talk with you. I know it’s morning over there in Hong Kong, you have a great day. PURU: Thank you very much, Jim, it’s always a pleasure to be here. [35:13] JOHN: Woof. We meet in the information age – by the way, that’s “woof” – we used to do that in broadcasting, we’d woof down the line to make sure the circuit was open – woof, woof, woof. So, anyway… We live in the information age. News travels down these lines at the speed of sound and is instantaneous but deciphering the news has never been more complex. If you punch around hundreds of channels there is a plethora of information that’s almost noise and static. And the hard part about all of this Jim is, number one, getting to the truth with a lot of the information and disinformation. But probably even more important is doing what I call connecting the dots, not just taking the info but putting all of the inter-relationships between this in such a way so that you can actually understand what’s happening. JIM: You know, John, you’re right. There is a cacophony of voices out there in the media today. I mean Marc Faber in his recent newsletter said he’s never seen a time in the financial world where a lot of people that he respects – a lot of bright guys – you’ve got one guy saying deflation, you’ve got another guy saying inflation, other people saying hyperinflation. You have somebody saying a crash in the stock market, somebody saying a new record; somebody saying the economy is going into a recession – or no, the economy is in a goldilocks economy, or you get the soft landing. Stocks are a great buy, stocks are cheap – or no, stocks are expensive. So much of what you see today out there is a lot of noise. I believe you’ve really got to step back and take what I call a Joe Friday view of the markets and the economy. [37:00] JOHN: Well, remember that in the television series and prior to that a radio series, Dragnet, of quite a number of years ago, the only thing Joe Friday ever wanted were ‘the facts.’ And you’re right about one thing, as you listen to this babble – I call it that because it’s really a cacophony of voices – the average person just throws up his or her hands and walks away: “I don’t understand this.” And the only thing they do know is that it’s getting more expensive to live and some people are losing jobs. That’s about the only thing that they understand, and the rest of it’s also confusing – but they need facts. And speaking of facts, Jim, why don’t we start with a few of them. JIM: Well, John, I want to begin with this myth of tightening liquidity. I had a lot of stuff I had been reading – just stacks and stacks and stacks of stuff – coming back from vacation. And everybody’s talking about tightening global liquidity, tightening central bank liquidity. And liquidity tightness would suggest contracting credit. So the central banks are going in and they’re trying to withdraw money out of the banking system; banks are going to be tight with credit, they’re going to be more stringent in their loans; they’re going to be more circumspect in who they loan money to. And what you would expect to see is a contraction of credit. And what we’ve had is we had expanding credit, all throughout the 90s, and then the Fed began to raise interest rates in 1999, and 2000, and in that rate raising cycle credit actually contracted. From 1999 to roughly the year 2000 credit went from over 2 trillion in 1999, down to roughly 1.6 trillion in 2000. So the Fed was actually taking money out of the system as they were raising interest rates. And guess what, with that contraction we got the recession, we got the bear market. Now fast forward to the year, let’s say 2004, when the Fed began raising interest rates all the way up to the present time with the Fed raising interest rates in June. In 2004 credit was up nearly $100 billion – from 2.6 trillion in 2003, to 2.8 trillion in 2004. In 2005 credit increased by another $½ trillion – from 2.8 trillion to over 3.3 trillion. And already this year – believe it or not – we’re tracking at almost $4.4 trillion. That is not withdrawing liquidity from the system. When you’re doing coupon passes like we’ve never seen which is another reason they get rid of M3, that’s not withdrawing liquidity. [39:57] JOHN: Alright, let’s look at real estate as well. What about concerns in that area? JIM: In my opinion, we’re only in the first few innings of this real estate slowdown, but this is what we know so far: for example, there’s going to be about $2 trillion in adjustable rate mortgages that are going to be reset from now in let’s say the next 18 months for the remainder of this year and next year. That’s got a lot of people fretting. The National Association of Realtors says that translates into roughly– if we look at what’s going on in the market – almost 4 million homes are on the market right now, and that represents over a 7 month supply of inventory at current sales rates. We know for example that 33% of new home mortgages and home equity loans in 2005 were interest-only, so these people aren’t building any equity; 43% of first time home buyers in 2005 put no money down. 15% of 2005 home buyers owed 10% more than their home is worth – these are negative amortization. Another 10% of home owners have no equity at all. And financial institutions – a lot of these sub-prime lenders are booking profits that don’t exist. In other words they are phantom profits from negative amortization loans. [41:25] JOHN: Jim, we need to explain that. A lot of people hear that term – negative amortization loan – and they don’t know what that means. JIM: Well, some people are going to get in trouble with this one. These are people that have taken out a mortgage on their home to buy a home, and their mortgage payment is not covering the interest on the loan. So let’s say the interest on the mortgage is $1500 a month but your mortgage payment is only $1200 a month. So that $300 of extra interest that you’re not paying is being added on to the total value of your mortgage. So if you’re paying $300 a month less than what you owe, multiply that by 12 months then at the end of the year you would owe $3600 more on your mortgage. [42:14] JOHN: Can I ask a question? Why are people doing that? In other words, are they doing that because they’re intending to flip those homes and they’re just saying, “Ok, yeah, the balance goes up a bit, but I’ll flip out of it at a much higher rate and make a profit.” Or are they actually doing this to live in this home? JIM: I think it’s a combination. There are a lot of people thinking, “hey, so what if my payment is 300 less, I’ll make it up on real estate appreciation.” And then I think there are other people that are just hoping that with appreciation in the house – how can you ever lose money in housing – that it’s just a means of getting into a home and getting into the housing market. So it’s what makes the home affordable. So that’s from the consumer side. But also you have to look at the other side of the coin which are the banks which make those loans. And so some of this credit expansion, the 4.4 trillion that I’m talking about, some of it is what I call phantom credit. It’s negative amortization that’s being booked into the income statement of banks – on their balance sheets – as what is owed to them, but it is credit that isn’t going anywhere. It isn’t new credit that is being used to purchase goods and services, it is just negative amortization – it’s just additional interest that people owe the banks that they’re not paying. Well, the banks are booking those profits into their income statement even though they haven’t received them. And we’re seeing some of these companies where negative amortization loans are representing 25 to 30% of their profits. So those are what I call phantom profits. The other thing that we know is that no doc loans, where you don’t have to substantiate [your income] – you know, somebody could be making $50,000 a year and they tell the bank, “hey, we’re making 100.” And that’s almost 40% of the entire mortgage pool. So when you add all that up, even if the Fed goes on pause the housing market [has] got further to go on the downside. But look, the Fed is well aware of all this stuff which is why they’re going to move to start cutting interest rates so they can bring the short term end of the market down so we don’t face this big 2 trillion mortgage reset, and it doesn’t come out as bad. It’s going to be bad but you know, instead of making it an outright disaster. But in order to do that they’ve got to prepare the mindset, they’ve got to change the focus of the bond markets, especially the bond market players – the bond vigilantes. They’ve got to change their mindset. [44:54] JOHN: But that’s what they did in 2003 when there was the big deflation scare, remember? JIM: Sure. In 2003 the CPI went from 3.1 to 1.6. You had the Fed, you had financial officials, you had the media talking about, “deflation, deflation, we’ve gone from 3.1 to 1.6 on the CPI.” But a closer look at the numbers [shows] statistically the Bureau of Labor Statistics went in and changed the way they computed CPI. Instead of new car prices, which were going up but the financing was attractive, used car prices fell. So they substituted used car prices for new car prices. And instead of watching what was happening to the price of homes and real estate what they did is substituted owner’s equivalent rent. Had they left the CPI unchanged we would have been at the 3% CPI rate and nobody would have been talking about deflation, but this gave the Fed the cover to go in and flood the market, get everybody worried about deflation. You saw the long bond – the 10 year Treasury note – get down in the 3% range, very low 3% range as the markets worried. Now they’ve got to do the same thing, they’ve got to change the focus of the bond market and the financial markets, get everybody worried about deflation or disinflation and then that sets the stage for them to go in and cut rates. That’s what they’re trying to do. [46:21] JOHN: Ok, so what is going to come next? Do I need to hold my breath here, reach for the Maalox? JIM: Well, the real estate slowdown continues, foreclosures are going to rise. So what you want to do as an investor is you want to stay away from financial intermediaries, and financials in general until the Fed starts easing. [46:40] JOHN: Ok, but they’re saying the commodity bubble has blown off. What’s going to happen in the commodities? JIM: Well, let’s begin with oil because that’s the topic du jour this week in the media, and let’s once again restate why oil prices are down. Peace in the Middle East, cessation of hostilities in Lebanon; peaceful outcome of the Iranian ultimatum, you know there was no oil cut by Iran or threatening to withhold oil; no major hurricanes this season. Now you’ve got people talking about a slowdown in the economy; and of course last week a new oil discovery. And so all of this comes in and everybody starts bailing out of oil. And remember when they triggered this with derivatives a lot of the commodity markets are leveraged, you usually put 10% down on a commodity market – so you’re almost leveraged 10 to 1. So as the price goes down you’ve got a lot of the specs that have to unwind their positions. So they know it’s very easy to hammer the commodity markets because the commodity markets represent about 100 billion in capital. You compare that to the financial markets – bonds, stocks, currencies – which are about 60 trillion. What we know, however, at this time, is you have to ask yourself is peace and stability returning to the Middle East? In my opinion, I don’t think so. And has the world become a more peaceful place? I don’t think so either. Global supply we know is still very tight; demand is still growing. Maybe it isn’t growing by leaps and bounds in the United States, but what is becoming more significant is what’s going on in China and India in terms of oil demand because all things occur at the margin, and it’s at that margin where the greatest demand is coming. We know that a lot of the speculative excessive has been unwound – you can see that from the commitment of traders report. We also know OPEC ministers already talking last week saying $60 prices is a price they’re now going to defend. And also as I mentioned earlier the BP Statistical Review [shows that] taking all the new oil that came on the market last year and taking all the oil that went off the market from depletion (Cantarell field in Mexico declining 15%, Burgan in Kuwait etc.) we were only able to increase global capacity 890,000 barrels a day last year when demand was growing by over 1 million barrels a day. [49:11] JOHN: Well, anything else man Friday. JIM: Well, let’s go back to the money supply. The money supply is still growing, the credit bubble is still alive and well, as I just mentioned credit this year at 4.4 trillion annual rate versus last year’s 3.3 trillion – that’s up 32% over last year. My name’s Friday, and I’m a money manager. JOHN: Sorry Ben, just the facts please. Just the facts. What have we not looked at? JIM: This idea about money supply you’ve heard me talk about it – is money supply growing as fast as it was two years ago? No. In certain places of the world, certainly yes, it’s still growing. The credit bubble is still alive and well. As I mentioned when you go from 3.3 trillion expansion of credit in 2005, to 4.4 trillion this year – an increase of 32% – that’s not a credit contraction. JOHN: It still sounds inflationary. By any other name, it’s still inflationary, all claims to the contrary. JIM: You know, Marc Faber several years ago talked about an analogy and you picture the world’s financial system as this big bowl, and what you have is central bankers continuing to pour water into this bowl. Well, what we know is if you were to do that eventually something’s going to overflow out of the bowl. And he goes, “that’s what you need to watch.” Where is all this excess liquidity going to go to. For example, these leveraged trades, where do they go next? And by the way, I think you’re going to see a resurrection of the carry trade. It’s still profitable to borrow in certain currencies and invest in interest rates elsewhere and make a difference – or the carry – on the spread. And lastly, even central bankers believe in the efficacy of monetary policy. When money supply grows or we get a whiff of deflation, the standard remedy is: step on the monetary pedal and that leads to the things that we’ve seen, excessive debt as we have today; asset bubbles that we had in tech stocks, now real estate ; consumption never taken into consideration. The standard prescription is just simply print money. However, unlike the past there are no restraints today as we had when we were on a gold standard. And more importantly for what’s going to happen going forward we have no excess supply of commodities. I would dare challenge anybody of these huge stockpiles of commodities that we’ve got all over the globe – it just simply doesn’t add up. If you’ve got a drilling rig, good luck if you want to get another one. If you’ve got a drilling rig for oil, or deep water rig, there are very few of them. And they are getting premium rates, as I mentioned. BP’s got a drill ship in the Gulf of Mexico where the contract expired – a contract that was signed several years ago – and the drill rate on the new contract is going to go from 190,000 to 520,000. They wouldn’t be paying 520,000 if there was an excess supply of these kind of drill ships around the globe. So, unlike the past, we’re going to see something different this time. [52:37]
JIM: During the middle of the Summer we did an Other Voices with Evelyn Garriss who is Editor of the Browning Newsletter. Often we feature her here in the segment Other Voices, and this is what she said about the hurricane season. Well, the other thing we saw was the volcano in the Caribbean put a lot of dust in the air. And remember, as I said, the dust absorbs moisture, it stalls the development of tropical storms because the dust absorbs the moisture of the storms. By having a very large volcano go off in the Caribbean we have a lot of dust there and it has been absorbing the moisture. By this time last year, we had six tropical storms. We’ve had 3 this year, and we have seen the dust from Soufriere Hills in Montserrat absorbing moisture, and calming down the tropical storm season. The Atlantic waters are very warm but that dust has made it a lot calmer in the Gulf and the Caribbean which is great news for our oil producers. Well, Evelyn, looks like you were right. It really sort of played out just as you thought it would. Do you bring us good tidings for the Fall and Winter? EVELYN GARRISS: If you’re in Southern California and you like warm weather – and I presume if you’re in California you must have liked the warm weather – expect more of it this Winter. [54:00] JIM: And why’s that? EVELYN: It looks like this year we’re going to have a very mild El Niño. Not enough to give all the drama like you had back in 98, but enough to give you some warm weather and some rain. [54:11] JIM: Well, that’s good news. I wonder if you might explain for our listeners that may not be familiar with El Niño what exactly is it? EVELYN: An El Niño is a combination of ocean and weather patterns that shapes global weather. What happens is you get warm water in the center of the tropical Pacific, and the air above that water is unusually warm, and it distorts air patterns. And here in the United States the impact tends to be that we get warm water off the California coast, the air is moist overhead, so a lot of rainfall is brought into California and the Southwest – lots of good snowfall if you think about skiing – and the weather tends to be warmer than average. So, from the Southwestern point of view it’s quite benign. The only problem is usually in a El Niño if you’re in Oregon or Washington or Vancouver they typically have a drier winter than usual, which is not good news for producing hydroelectricity. [55:18] JIM: As this weather pattern goes across the United States how does it affect the Midwest, and the Eastern coast? What is that looking like? Will it be cooler, warmer? EVELYN: In the Southern United States we can expect cooler weather. Large El Niños like we had in 98 affect the entire country, and back in 98 it was warm clear across the nation. But we only have, according to the forecasters, it looks like this is going to be a very mild El Niño, and when that happens you frequently have about half the country warmed by the Westerlies carrying the warmth from the Pacific. However, you still have cold air in the Arctic. And when that air has to drop South it can’t drop over the West because the West is protected by the El Niño, so instead it drops in the East. So you very frequently find late Winters in the East can frequently get unusually cold, and you can have Nor’easters. In fact, during a very strong El Niño the East coast once had snow as far South as Georgia in May. [56:23] JIM: Evelyn, I guess the question on everybody’s mind – and especially with energy prices being as high as they are, although they’ve moderated recently now that we don’t have this hurricane problem that everybody thought might have existed – what does this Winter look like? Because certainly with energy prices this high, natural gas prices, I guess maybe that’s a big question on the mind of investors? EVELYN: Well, one of the things that’s going to happen is investors tend to know about El Niños, so they’re going to be betting on a warm Winter. They may be surprised later in the season – in Winter, slightly cooler than average temperatures towards the end of Winter. So people will have prepared for a warm Winter, they’ll have started most of the early part of Winter with the weather warm, and then boom, towards the end of the season it gets colder, and that will catch a lot of people by surprise. [57:15] JIM: You know, Evelyn, we seem to have dodged a bullet last year because they had unusually warm temperatures in the Winter months. Can our luck hold out this long? EVELYN: We’ve seen some extremes. What we’ve seen is unusual heat, and in parts of the world unusual cold. So I think this year what we’ll find is some very extreme weather. So there’ll be parts of the year where you’ll just sit there and go, “this is a warm and wonderful Winter, we’re going to dodge the bullet a second year.” And then there’ll be a few weeks in Winter when you’re really going to go, “we’re making it up for all the good weather;” and some spectacular nor’easters. I expect California will dodge the bullet again; I expect most of the West will dodge the bullet but I don’t necessarily think that the Midwest will dodge the bullet this year. [58:08] JIM: Well, one thing that we’ve been thankful for last Winter as well is that we got a little bit more rain than we were expecting. So we’re going to get an El Niño even though it’s a mild one in certain parts of the West of California, and I’m sure other States, the rain would be welcome. So is there going to be good news for some of States other than California that could use the rain? EVELYN: Well, certainly this year heavier than last year precipitation in the mountains: Utah, Colorado, Arizona, New Mexico. The northern Rockies are going to be out of luck, but I think California and the central and southern Rockies can expect more snowfall than last year. [58:51] JIM: Let’s go back to the Midwest in terms of what weather is looking like especially the agricultural belt. You talk a little bit about drought, how serious is that? EVELYN: Well, we’ve had about as much as 60% of the country with a drought weather. What has happened is we have had a major change in the Atlantic ocean. The Atlantic ocean is warmer than it’s been, and this is a pattern that tends to last 20 to 30 years, and when we have this pattern less moisture goes into the interior of the country. And so we are seeing some patterns of drought end. For example, in the Southwest the drought that we’ve had for quite some time is ending, but we’re seeing some increasing droughts in the grain States which is just not good news. [59:40] JIM: Let’s talk a bit about a larger weather pattern and that’s the Pacific decadal oscillation. What is it and how is that impacting us? Certainly we’ve seen 3 storms pound Asia recently. EVELYN: Yes. Well, what’s happening is for about 30 years the Pacific was warm, it was in a warm pattern. This made any El Niño that came much larger as we saw in 98 and we saw in 83, and it bought a lot of moisture to California. And everybody moving to California during the 60s, 70s, 80s and 90s took it for granted – you know, California is the golden State. Then the Pacific has begun to change. Now, just like when the ocean starts going to high tide, it ebbs and flows, so we’re fighting the Pacific gradually becoming cooler in its tropical area and this is changing weather patterns. So what’s happening is now we’re finding that the West is drier, and sometimes the drought is in the northern part of the country in the Pacific Northwest. And other times like we had for about 5 years it’s more in the southern part, so that the Colorado River basin for example had the driest weather that it had had in over 500 years. So what we’re seeing is droughts in the West because the Pacific and the Atlantic are changing. And the Pacific, whether or not we have an El Niño or a La Niña, determines whether we’re getting that unusually dry weather in the northern part of the West or the southern part. Right now, California and the Southwest can look to a Winter where it will probably be quite wet – but don’t hold your breath, it’s not going to last. [1:01:25] JIM: Evelyn, do these two decadal oscillators – you have the Atlantic ocean and the Pacific, the Atlantic is warming, the Pacific is cooling – always go like that in this 30 year cycle that we seem to repeat over and over? EVELYN: No, they’re irregular. Usually they don’t tend to align quite as much as they are now. Right now we’re getting a double whammy. We had both oceans through the 70s and 80s and 90s where the Atlantic was cool, the Pacific was warm, and that just produces the best weather in the United States. It produces lots of moisture for California, lots of moisture for the croplands, the weather tends to be stable and predictable. Now both oceans are changing and the weather is becoming a lot less stable. Most of the time they don’t line up but they lined up to give us perfect weather for about 25 years, and now they’re lining up to give us a really exciting ride for the next 20 to 25 years. [1:02:26] JIM: Well, I guess maybe another question is this an unpleasant truth? Is this global warming or are we heading for another ice age which is what some experts seem to be indicating? And I’m seeing another frame of reference to what may be coming differ from just the global warming. You’ve got people now talking about another mini ice age. Any truth to that? EVELYN: They certainly are covering all their bases. Whether they say it’s warming or cooling they’ll blame man, right? We’re actually seeing at this point a period of warming. It’s been warming since the 1880s. We were in a little ice age, it lasted till the 1800s, and now we’re coming out of the little ice age so we’re in a period of global warming. It’s not any warmer than when it was in the Middle Ages, and certainly if a group of peasants could handle it I imagine our civilization might be able to stand up and face it. But right now we are seeing some increased warming. We’re seeing the sun – a lot of measurements are indicating the sun is radiating more energy that it has radiated in about 1000 years. And since the sun provides the energy that runs the weather machine we’re getting a bit warmer. Then we have people building cities and creating heat islands over their cities – like LA is much warmer than the surrounding countryside and so you can have a heat wave, and then guarantee you live in a hot city you’ll get heat stroke. So yes, we are seeing more warming. A lot of people who are trying to cover their bases say, oh, if it gets too warm then the glaciers will melt, they’ll put so much freshwater in to the northern oceans that it will stop the flow of what’s called the Atlantic Thermohaline current, which is just a fancy way of saying the big current – like the Gulf Stream that brings the warm water from the equator up to the Arctic – and they’re saying it’s getting so warm the glaciers will melt and will stop that current. Actually what we typically see is about every 30 years the glaciers melt enough the current slows down, as it slows down, it brings less warm water to the Atlantic. Less warm water flows through the Atlantic, the Atlantic cools down and the glaciers start to build again. That typically takes about 30 years. That’s the source of that 30 year cycle I’m talking about. [1:04:50] JIM: So a lot of the unusual events that we’re starting to see – last year’s hurricane season, the year before that some of the colder storms before that – so a lot of that unusual weather is because these two oceans aren’t in alignment now, and it’s creating a lot of this strange pattern that people seem to think is unusual? EVELYN: Yes, and if you look at the hurricane season, for example, we used to have very busy hurricane seasons in the 1930s, 40s, 50s and 60s, but we didn’t have the satellite technology to count each and every storm. So who knows how many hurricanes there used to be? [1:05:28] JIM: I was watching the great hurricane that got into New York and Long Island, it was on the History Channel and it was amazing that they were relying – at least the weather people at that time – were relying on reports that were radioed in from ships at sea. And then when the guys down in Florida said all the ships [must] stay in port they lost an important piece of information and here was this big hurricane that hit Long Island and the eastern seaboard. EVELYN: And nobody knew what was coming. We have found just looking at tree rings– and some of this is thousands of years ago – times when hurricane years that we consider 1 in 100 years that you get a year that bad used to strike every couple of decades in Florida. History shows that what we consider unusual is not that unusual, we just haven’t experienced it before. [1:06:22] JIM: Evelyn, I want to thank you for bringing us a bit of good news, especially in southern California where we wouldn’t mind extending the Summer season for a little more warmth, and especially more rain. As we get closer to Winter I’d like to have you come back and tell us if we’re still on course to have a benign one or maybe it could get worse. EVELYN: Well, I wouldn’t be surprised if you see a bit of exciting cooling going on in Autumn but expect a warm Winter. JIM: Alright, Evelyn, if people would like to find out more about your newsletter why don’t you let our listeners know how they could do so. EVELYN: Well, they can email linda@fraser.com, and Linda will be glad to send you a sample. JIM: Alright, Evelyn as always thanks for bringing us the good news, you’re my favorite weather forecaster and I can tell my wife a lot more sailing this Winter. EVELYN: Ok, great, enjoy. [1:07:18]
JOHN: Well, Jim, I think you and I have been doing this program since – I know you’ve been doing it a little longer – but we’ve been doing it together since 2001. I can’t believe it’s been 5 years already, that to me is flabbergastative – how’s that for a word. JIM: New word to the English lexicon. JOHN: Alright, so anyway, a flabbergastative phenomenon – anyway, having said that one of the things I know I’ve learned over the year that is always close to your heart is the little guy, and sort of keeping people oriented properly in times of chaos. Let’s face it, in the last 5 years we’ve been over quite a number of rollercoasters here on the show. This week it was another one of these white knuckle rides where everyone starts panicking, and the urge to start jerking and tugging the levers gets important. But we need to give them some focal points so that in these times they understand how to behave economically. JIM: What has been really important to me, and I’ve commented about this once before but in about 2000, or maybe it was 2001, I was being mentored by a very well-known person in the financial industry. And one of the things that he taught me about is the art of contrary thinking and also about refining that. And one of the most important things that he had learned, and this gentleman has a pedigree that goes back to some very famous people on Wall Street, and he said: “You know, Jim, you can be right and it’s not the fact that you’re right and other people wrong, you’ve got to have your own convictions. And when you have your own convictions it takes a tremendous amount of courage to stand your ground, not panic and do what others do when they panic – either when they’re panicking in fear or they’re panic buying in terms of greed.” And he said one of the most important things that he had learned, that he was mentoring me on, is learn to control your emotions. And let’s face it folks, I mean turn on the television, pick up a newspaper you’re going to find some headlines that are going to scare you – war, terrorism. I mean, John, look at, what was it? The first week, or second week we were going on Summer break: we had the BP pipeline breakdown on a Monday; and was it a Wednesday they announced that they had caught these 23 guys that planned to blow up 10 major passenger planes over the Atlantic and the Pacific? And so I mean you can look at that stuff and there’s always a lot of noise, and one of the difficult things to do is grab a hold of your emotions and learn to train yourself. And one of the things my mentor taught me is you have to have a system of procedures – he called it ‘step back.’ And think of the time where you lose your temper and you react irrationally – just think of times in your own situation in your own life where you’ve lost your temper and you say things you didn’t want to say, you do things you didn’t want to do, and had you just sat back and remained calm and said, “Ok, I’m upset right now, let me collect my thoughts, go kick a soccer ball, relax a little bit until I’m in complete control of my faculties, then I’m going to make a decision.” And that’s something that he taught me that probably I would say has increased our performance 3-fold. I mean we’ve beaten all the major indexes every single year in this decade, and that has been one of the keys I think to our success because we put in a system when we go in to buy a stock, or we’re making a move we have like 2 or 3 what I call analysis sheets: why are we buying this company, what do we like about it, what are the key assumptions, how does it look technically, what’s going on fundamentally with the company, the industry? Why do we like this sector? And we write these things down and we have them before we even go in and make that recommendation, and make a purchase for our client accounts – and heck, even the way I manage my own money. And what we do is when things like that happen, I mean we had a meeting this week, we sat down and we said, “Ok, what are the things changing in the oil markets, what are the things changing in the gold markets?” And we start analyzing this and say, “ok, these were our assumptions, do they still hold up? Yes. Does this still hold up? Yes.” And so then what you do is you sit back and you say, “Ok, we’re holding our ground.” I can’t tell you the number of times, John, and you’ve been through these roller coaster rides – you’re a client – and whether it’s the gold market or the oil market, how many times can you remember, John, of them telling us when oil went from 20 to 30 that it was going back to 20, when it went from 30 to 40, it was going back to 30, all the way up to nearly 80. Every time gold would break out, or silver would break out, they would tell us why this can’t happen. You’ve had prominent technicians that say $300 was it, and then it was 400, then it was 500, then it was 600, and every single time what has happened? [1:13:21 JOHN: As they were telling us it couldn’t happen, it did – that was the one thing that I remember. JIM: Sure. I mean oil prices, yeah, they went down – but they went back up. Gold prices went down but they went back up. And that is a perspective that people don’t keep to themselves. In other words, Ok, oil prices went down – one thing I want to put into perspective is why that happens? It is because the commodity markets today and the equity markets even in like for example in the mining sector, even in the oil sector, is so small by comparison. I mean you could add up all the world’s mining companies – precious metals, base metals – they don’t even come close to stocks like GE and Coca-Cola added together. They don’t even approach that. And the commodity market itself, it’s a $100 billion market versus a $60 trillion financial market. So when you’ve got everybody running around with their head cut off – what was the old Rudyard Kipling quote – if you can keep your wits about you when all others are losing theirs, you know the world is yours – it’s pretty close to what Kipling said. But that’s what happens, and what happens today everybody has a computer, it’s very easy to just type a few words into a laptop and do a trade. So all these millions of eyeballs worldwide react simultaneously, and what people are doing is they’re jumping off bridges and then they ask the questions later. That’s exactly the opposite of what you should do. [1:15:00] JOHN: Well, it’s the opposite of what good investing is that you’ve been talking about here on the program, because I would say a lot of this is driven by what I call a day-trader mentality. That’s where you’re in the market to try to make money on the moves that are going on, and therefore you feel that you have to shuck and jive with the market every time it hiccups and burps, rather than as you say looking at the fundamentals, and understanding the picture. But it does require a certain amount of intestinal fortitude let’s say that. I mean when the whole crowd is rushing for the exit door yelling, “fire,” it’s really hard for you to sit there and say nope it really isn’t. JIM: Yeah, I don’t smell smoke. And when the crowd is saying fire and everybody’s running what you need to do is step back and say, “Ok, where’s the smoke? I don’t smell it, I don’t see it, and if I don’t smell it and don’t see it what is it that everybody else is reacting that I shouldn’t be reacting to?” because that’s an easy way to get yourself in trouble. [1:15:56] JOHN: Or even if there is smoke run the proper way. In other words, figure out what’s going on. JIM: Yeah, figure out the best exit or will it be contained. And this is the difference today between investing and speculation. And we did something like this just before we went on our Summer break and I talked about Ben Graham’s margin of safety, and buying with a margin of safety, buying based on fundamentals and facts because, when you know your facts, when you know your fundamentals this is what holds you up when these little mini storms periodically come through the financial markets. And I hate to tell you folks, you’re going to see them over and over. Nothing goes straight up everyday, every week, every month, every year – although during the 90s it certainly seemed that way in the stock market. But what goes up goes down. And what you need to do is once again take that sort of Joe Friday approach, and ask yourself if you’re making an investment and let’s say you listen to the program and you’ve done some research on peak oil and the oil sector and commodities in general, and when you come to the conclusion that you’re going to go into an energy fund, a precious metals fund or basic commodities – whatever it is – you write down why am I doing this, why am I going in to this investment, why am I spending this kind of money? And write down your assumptions and the facts for the reasons why you’re doing this. You don’t want to write down, “well, Jim Puplava says so.” That’s not a good reason, you need to do your own homework, not just listen to me. But do your own homework, get these facts about you, write them down, prioritize them and then when something like this comes up you can ask yourself that question: what has changed? And what has changed is the most important question you can have. If you see the sheep running off the cliff in a herd panic, you need to step back and say, “I’m not ready to join the sheep off the cliff, I’m going to hold back here, and just wait to see till I know the facts before I decide to jump off a cliff.” [1:18:08] JOHN: You know Jim, we started out in the Big Picture talking about shifts in paradigms, and most people when you use that word paradigm don’t quite know what it means. Basically, it means the frame of reference that a culture uses to view the world – its assumptions about finances, the economy, morals etc. And when you go into battle, or you make an investment, or you do anything, it’s very much like religious faith and world view issues, before you get into the time of crisis and struggle you really have to know what your philosophy is ahead of time. Because once the punches begin flying and the blows begin landing, it’s very hard to keep yourself oriented and to know which way is up, except by using those very reference points that you thought about earlier. And it gets real hard to hang on to those. It’s almost like a matter of faith and conviction when you go into one of these things. And I know you’ve mentioned that before – it was develop your own philosophy. You said that a few weeks ago on the program – develop your own philosophy. And then you hold on to that until such time you say wait a minute there is a radical change here I need to rethink something. You can rethink your philosophy, reexamine it, especially your assumptions. But that’s important to have those reference points because otherwise you’re just subject to the herd mentality. And the herd doesn’t know anything about anything. JIM: John, you bring up a point – and we did this with the Ben Graham topics we covered before we went on break – you really need to understand the difference between investing and speculation. And you really need to understand that for yourself personally as an investor because that is really important in the investment world. And going back to your faith analogy you can’t be a Catholic on Monday, a Jew on Wednesday, and a Moslem on Friday – that doesn’t work. Referring it back to investing – you can’t be an investor on Monday, a speculator on Wednesday, and then back to an investor on Friday. That is not going to work. And simple as some of this stuff sounds like investing, for example, buy low and sell high, if you don’t develop an investment philosophy in terms of what drives you, however you make your decisions. If you don’t develop a frame of reference on how you invest then this is what’s going to happen: you are going to get rocked back and forth; you’re going to go with whatever wave is currently going through the market whether it’s a wave of greed in good times, or a wave of panic and fear. And that’s what I don’t want you to do as an investor. There are a number of good books out there about investment psychology, learning to control your emotions. I’ll just emphasize again, I am glad I had somebody to mentor me, somebody that I respected because of his stature in the financial community that taught me that very valuable lesson. And I can tell you it has made a world of difference in terms of our investment returns, in terms of my own life, in terms of what I’ve been able to do personally in the investment world. And I want you to have that same experience and learn to control your emotions, because going back to just psychology – think about it, just throwing temper tantrums or getting over excited or giddy or something and just doing something that you regret later on. And that’s what I don’t want you to do right now listening to this program. I don’t want you to regret what you’ve done if you’re in the metals market, or you’ve bought into energy. Hold your position, we’re in a period of time where we’re transferring from paper assets to tangible assets. It’s been going on for at least 5 to 6 years now. We’ve gone through these little rocky rides together before, so there’ll be more of them in the future but this is where you hold on based on your convictions, based on your facts and based on your research. And I don’t want you to be one of those that panic and jump off the cliff with the sheep. [1:22:25] JOHN: Well, Ladies and Gentlemen, we have been running quite long on the program today but given all of the activity in the market this week we decided to run long on this topic and soothe a few frayed nerves that may have been out there among our listeners. We are going to skip the emails and the Q-Line till next week. Don’t forget you can call in your questions to the Q-Line. It’s open 24 hours a day in the US and Canada, it’s 1-800-794-6480. That number does work without the ‘1’ by the way from anywhere in the world but it’s only toll-free in the US and Canada. Coming up in the weeks to come, what shall we see here on the program? JIM: Well, coming up next week my friend from Prudent Bear, Doug Noland, who writes The Credit Bubble Bulletin will be joining us as my special guest. And following next week, especially if you’re holding on to oil, Matt Simmons will be back on the program as we take a look at peak oil. Is there a surplus of oil around the market? According to Matt, who just gave a great speech to the convention of CFA analysts – and also a major talk to the Defense Department – our energy gauges are broken. He’ll be joining us at the end of the month. A lot of great guests coming forward, hope you’ll be there to join us, remember our Q-Line is open, we will promise you we will get to those next week but in the meantime, as John has mentioned, we’ve gone a little long, so I hope you’ll forgive us for that. But,
until you and I talk again we hope you have a pleasant weekend.
[1:24:00] © 2006 James J. Puplava, Financial Sense™ Newshour |
