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The
BIG Picture Transcript
JOHN: You know, I put up with it last week, Jim, and you’ve really just got to stop it, you’ve got to stop pushing these Dows to new highs. It was funny last week, it’s getting a little old now. JIM: Ok, I forget, what, we’re up 100 points, or more this week? JOHN: Yes, something like that. You know what’s interesting is where does water come from in the mind of the average American? JIM: A faucet. JOHN: Right. Where does food come from? JIM: The store. JOHN: Very good. Where does electricity come from? JIM: The light switch. JOHN: Hey, you passed. You’re a baby-boomer Yuppie. JIM: I thought you were going to ask me next, where does gas come from? JOHN: That comes from eating too much Mexican food at the wrong places. If the health department doesn’t shut it down once a month it’s not a good Mexican restaurant. So there we are. Anyway, these 3 things are really important. We in Western culture have become so acclimated to having these things readily available, unlike Third World countries, you don’t have to worry about these a lot of times as a part of living. We can go on and do other things. And so people don’t think about these things. And I guess that’s what we’re going to talk about today, here, in the first part of the Big Picture entitled A Few Big Ideas. JIM: You know, you’re absolutely right, John. You wake up in the morning you expect to turn on the tap to put water in the coffee pot or take a shower and the water is going to be there; we also expect electricity to brew our morning coffee. We go to the grocery store, we expect food on the shelves, and fresh produce to be displayed. We pull into a gas station we expect to be able to fill our tanks with gas. And when we come home from work, we expect to be able to cook with natural gas on our stove. And when temperatures changes we expect to be able to heat and cool our homes. However, when it comes to basics such as food, water and energy, we expect to have them without thought of being without them. [2:07] JOHN: And I would say, not only have we taken these items for granted, but because we sort of think that they materialize in ways that they do we really haven’t looked at them seriously as investments as well. JIM: You’re right again, John, because there was a report issued recently by the Society of Engineers in the US, and it gave us basically a D report card rating on our country’s infrastructure – whether you’re looking at congested highways; overflowing sewers, which are problems we have here in San Diego; corroding bridges and our water system that are in disrepair. We haven’t kept pace with the vital infrastructure investments that keep our economy running. JOHN: Well, it would seem like – tell me if I’m wrong or not – but it would seem like there must be investment opportunity here, because obviously if we were to ignore these as a culture, which strangely enough in certain ways we are by not dealing with the energy issue, then the culture would suffer for it. But there’s got to be some investment out there growing, declining, what? JIM: If you were looking at long term investment themes that go beyond for example, today, next week, the next quarter, next year, in my mind there’s 4 themes out there that I think investors can latch on to. Hold to them, and I think they’d do very well over the next decade, and that is: water, food, and energy; and I’d throw one in there as well, an additional one, which is precious metals because we live in a fiat world system now, where there’s absolutely no restraints on government as to the amount of money and credit that can be created in the economy and the financial system. Each one of these themes I think are going to be home runs going forward over the next 10 years. [3:56] JOHN: Why would this be a growing type of area for investments? Is it following the commodity rise, or is it some other factor. JIM: I think it’s actually a very basic one and that is population growth and urbanization, and climate change. The urbanization and industrialization that we see and talk about so much in China and India – John, that’s not going to stop. If we take a look at population growth, for example, there are twice as many people on the planet today as there were two or three decades ago. Well, what does that mean? It means the world needs more water, more food and more energy today; and we’re going to need more water, food and energy tomorrow. [4:35] JOHN: Ok, these are the big ideas that we’re focusing on here, so let’s get into them as to how they stand and where the investment points are. JIM: Well, let’s begin with water, a topic we talk about at least two or three times a year. We haven’t talked about this in quite some time, but according the most recent UN report, we’ve got about 1.1 billion people around the world that lack access to good water supplies. And if you look at where we get our water from, groundwater is the largest source of available water, and our underground aquifers are being depleted at rates far faster than they can be replenished. And just thinking back here to the US, one of the largest exporters of food in the world, we’ve been depleting our groundwater resources beyond natural recharge rates for several years now. And especially, if you look at some of our critical food producing regions in the country. For example, our High Plains aquifer which is responsible for roughly about 20% of US crop land is close to depletion. Everywhere you look globally, there’s an increasing demand due to population growth, urbanization, industrialization. And if you combine that with a reduction in supply due to pollution, and the potential effects of climate change. For example, we know we’re going through a warmer season right now in weather patterns, that means more drought. You can see that not only in the United States but other places of the world. That has a potential effect and it’s increasing water stress everywhere you look, not just in the United States, you’re seeing it in the Middle East and even areas of Asia – especially China, which is sitting on close to 18% of the world’s population. [6:27] JOHN: If you look at some of these statistics, it is really sobering as to what the world is going to have to do in the near future for water. If we look at India for example, 70% of India’s irrigation water, and 80% of its domestic consumption of water comes from ground water and that is rapidly disappearing. In China right now, 80% of their waste water is discharged into whatever their river systems are etc, without any treatment whatsoever. And of course, in some parts of the world, they’re even talking about how to reclaim that water for other purposes instead of just getting rid of it. That type of thing. JIM: Well, you know, it’s not only China and India it’s also in well developed countries like the United States; Europe has some issues; they have issues like this in the Middle East. And they also have issues in Latin America where they just don’t have a good source of clean water. We think about things like water, well, without water we can’t grow food. And a lot of water is used in industrial processes, like chip manufacturing, so it’s not just water to grow food. It’s very essential, we can’t survive without it. JOHN: Well, Jim, if we look at the global water situation, what we are seeing, even if we go to places like Israel, Palestine, Jordan where there is radical transition, we are in a water transition worldwide as to where we are going to get our water of the future – especially as we look at the population of the Earth continuing to grow. That is not going to abate anytime in the near future. If you look at major industrializing countries such as China and India, they’re building cities at a record rate. It would seem if we’re changing to a new paradigm here where we’re going to have to find new ways of getting water, obviously that’s going to be through technology, and that would seem to be the groundswell of your basis for investing at that point. [8:26] JIM: Sure. I think there are 3 areas if you want to look at investing in water. One, companies that enhance supply. There’s also going to be conservation methods in terms of better farming techniques because a lot of the water that we consume is used in farming, and improved water management. And for example, in the area of enhanced supply, using sea water for industry and agriculture, diverting water from water rich to water scarce areas – that’s an issue that has become very big in China; recycling waste water using the heat content of waste water as a source for energy; using waste water for irrigation to increase production; new groundwater exploration techniques. Also they what they call microbiological waste water techniques combined with nanotechnology; desalination in areas where you just don’t have enough water – that’s something that California is facing here in the very near future because we have about 11% of the country’s population and we’re running out of areas to get water. Our groundwater is declining, we’re tapping into rivers and to lakes, and so desalination is going to be something that is on the horizon here. A second area to invest are techniques for reducing demand. For example, more efficient agricultural irrigation technology is a great area for investing; the cultivation of drought resistant type crops; high yielding crops; saline-based water agriculture; and increased water use efficiency for agricultural practices, not only just in the developed world, which was also partially responsible for the green revolution here in the 70s, but also in the developing world, especially where they may not have as much access to energy or the capital to invest in this – some of the areas where they can conserve and be more efficient with what they have. So areas that improve efficiency. And the other area for investing – and this is why you’re seeing public water utilities rise to the fore here – is improved water management strategies and structures that need to be implemented from the local to the international level. Privatization may be part of this equation – that’s a trend that we’re seeing here in the United States where a lot of municipalities have simply not had the management or the expertise to effectively manage their water systems, and so they turn over to a public water utility and just say, “look you guys manage this because we’re not doing an effective job doing this.” [11:06] JOHN: Ok, Jim, supposing I were to become an investor in this water issue, how am I going to play this? What are the vehicles that I can get in on? JIM: Well, there are a couple of things. Number one, there are basic water utilities and that refers to water management. You have water utilities here in the United States, although most of them at least from our perspective tend to be overvalued at this point where the PE ratios are way too high considering their earnings growth. But John, you also need to look globally today because some of the best water utilities with rich dividends, low PEs are international. So you need to look not just domestically but also internationally. Another area is to look at filtration and treatment equipment – companies that make everything from valves, pipes to filtration systems – that are used not only in domestic processes but also in industrial processes. There are companies that work with pumps, valves, water quality analysis that we have to monitor in terms of how pure our water system is. So you’ve got a couple of areas to work in and they boil down to those 3 things that we talked about: companies that can do something to enhance the supply of water; secondly, companies that can help in conservation of water in terms of reducing demand – and especially in the area of agriculture as it relates to irrigation technologies; and then three, which we talked about – public utilities – is improved water management. So there are 3 areas that you can invest in and don’t just think domestically, think internationally today. [12:51] JOHN: Obviously tightly tied to both other topics today, now that I look at it is food, because food requires water for production. And it’s amazing, if you look at the ratios of say 1 gallon of milk, how much water goes into the production of that. It’s staggering in terms of hundreds of gallons to produce 1 gallon of milk. Also energy is connected with that because it takes energy to produce food, to move it, process it and deliver it. But let’s look specifically at food right here in this segment. Food is an issue on a global scale. JIM: Well, you know, if you look at our food stocks, I don’t care if you’re looking at corn, wheat, most of your grains they are at record low levels in terms of inventory both in the US and also overseas. And that’s why I think the grains are going to be in play here because we have to increase our food stock. But what was interesting about this is the big trend right now is ethanol and turning a good portion of our corn and sugar crop into ethanol. But you know what, the one thing that we’re forgetting here is that people have to eat. And if you have an increasing population as we do have worldwide – I don’t know what the population is? Is it 6 ½ billion people on the planet now, and then we’re going to be at 7-9 billion people here in the next two decades – well, all the grains that we use, that’s going to have to be grown, you’re going to need more crops, more output, more agricultural output. I don’t care if it’s corn, wheat, whatever it is that we’re growing, and now what we’re doing is diverting a good portion of that crop into the production of ethanol. Now, as diets improve globally as you see the economies improve in India and China, what’s going to happen is their diets are going to get better – as people have more money, they add more protein in their diet. And what do we feed cows and pigs? We feed them grains. And so there’s an incredible amount of grain that goes into the production of just one head of cattle or one pig. So the more that people put protein into their diet, the more grain consumption we’re going to have. At the same time we’re putting a strain on the grain system because of the production of ethanol. [15:25] JOHN: Well, it’s interesting also to see some of the geopolitics of this thing. If we take a look at China’s economy over the last year, it’s been growing at about 11%; if you stretch that over two decades the average has been 8 ½%. China has 22% of the world’s total population, but only 7% of the world’s arable land; and it’s the second largest importer of foodstuffs, because literally it cannot produce enough food to feed its own population, so it relies on external sources. JIM: Not only is China going to be a large importer of energy to meet its demands, it’s also going to be a large importer of food, because once again you’ve got close to almost 25% or 22% of the world’s population, and yet they just don’t have land. Water is a very, very big issue in China because where they have the most water isn’t where most people in China live. So they not only have a pollution problem with water, they also have a transportation system problem with water, but more importantly getting the water to the areas where people need it – in other words, getting it to areas where they’re farming, and to areas where people live. And related to water is this food issue. And the frightening thing about this is the small supply of our grain stock around the globe, not just in the United States – one of the largest producers – but elsewhere around the world. I sort of got a glimpse of this, and once again I’m going back to water here for a second, but when I took the month of August off I had to go to the grocery store in North County, and on the way back to my house I stopped off at the supermarket, and I wanted to get some water. I love Fiji water or Penta water – it’s a great drinking water. I went into the store and the entire shelf of water at the supermarket had been wiped out and I’m thinking: “What the heck, this is the middle of the week, that shouldn’t have happened.” When I was at the cashier I said, “what happened to your water? Did the trucks not show up?” She goes: “No, we had an E. Coli break out,” and so they closed some of the restaurants locally. And everybody, when they heard that on the news, rushed to the supermarket and cleared out the shelves. And that’s how close we are to any kind of crisis here – whether it’s food, water or it’s energy. Every one of these vital resources and so critical to human life in the production and functioning of the economy that’s how we’re on such a short leash today. And that was just dealing with water. You can imagine what would happen if we had a serious earthquake in Southern California, or some kind of national tragedy or terrorist attack, and people rushed to the supermarket to get food – you know, we don’t have a large supply of it, not only in the supermarkets but also in our silos in this country. [18:33] JOHN: That also says something about emergency preparedness. What always amazes me is that every time we go through one of these crises – like look at the last round of hurricanes in Florida – is that everybody rushes to the pump to buy gasoline and rushes to the supermarket to buy food – when in reality knowing the way that we’re going people should be having a certain amount of food and water on hand. This should be automatic, but they’re not doing it. And they don’t seem to learn from these experiences either. JIM: You’re absolutely right, and that’s something that we’ve been doing: we have a good supply of water in our house; we have a good supply of canned food. And John, it is something in large industrial societies – like I said when we started this conversation – that you expect when you wake up in the morning that you’re going to turn on the tap, water is going to come out of the faucet for your coffee pot, when you take a shower water is going to be there; and when you’re hungry or you have to stock up on groceries you just expect to go to the grocery store and the shelves will have everything you need. I mean here was an example of a small break out of E. Coli in North County in San Diego, and the supermarkets were wiped out of water. One little news item like that and that’s what people were facing. [19:55] JOHN: I guess I live in a part of the country where our power is iffy so we have been disabused of the notion that we don’t need some form of preparation. There have been times in our part of the country where the power has been out for long periods of time – maybe a week or two weeks. And people have to survive, so there’s more of a preparation mentality there. I don’t know, but maybe it’s different in the cities. You know, as we mentioned before if we look at the developing countries, we have a growing population, they’re making a growing demand on food, they’re improving their lifestyle and they most certainly don’t want to go back – say in China, people don’t want to go back from having cars and motorcycles back to the bicycle days of Mao Tse-Tung. And that means an increased demand on energy, just if the lifestyle goes up, with or without public transportation. JIM: Sure. I think we have to be real careful about biomass as a form of energy because as you mentioned we still need to eat. And if we’re going to increase protein in our diet in China and India, and elsewhere in the developing world, that’s going to take grain to grow those pigs or to grow the beef that people that are improving their diets seem to want to have. So we have to be very cautious about the biofuel because it all relates to not only we’re going to need more water to produce the same amount of food that we need to eat, but we’re also going to need more water to produce the additional corn or sugar that we’re going to use in biofuels. And then at the same time, all of this is going to require energy. So all three of these are related. So you’ll here somebody come out and say, “well, we need to increase ethanol production 30%,” or “biofuels need to be 30% of our energy needs.” You’ve got to be very careful there because you need to think that one through. Wait a minute, if we’re going to increase ethanol use to over 30% of our fuel consumption over the next two decades, where’s the water going to come from, how’s that going to affect agriculture we still need that corn to feed pigs, or cattle for our beef production, or our pork production? And then also, where’s the additional energy going to come from to do all this. So this is all interconnected, and that’s why I think people are not really thinking this through here. [22:15] JOHN: One of the things that’s important to remember here is that regardless of what happens in an economy, you’ve got to eat. And so food, water and some form of energy for heating or cooking; or even cooling if the part of the world that you live in is super hot – that becomes life-threatening. And that’s all essential. JIM: Absolutely. And that’s one of the stories I wrote about this. I think it was April of 2003, and I [wrote] The Next Big Thing. John, because of the bear market in commodities prices that we experienced in nearly two decades, oil companies weren’t spending a lot of money building new refineries – in fact, they were closing them down because they were unprofitable they were losing so much money; they weren’t spending a lot of time exploring for energy – we could import it because it was cheap; they weren’t spending time building new farms; or going out to develop new mines. So here we are, what we’ve been doing is drawing down on all our stock pile of not only grains but our stock pile of energy – which topic of energy we’ll get into in just a moment – and also our groundwater. Nobody’s been paying attention to this because we’ve been drawing on our bank accounts, so to speak, in the area of raw materials and commodities that we built up over decades. The problem is now: the population of the world has doubled; countries are industrializing, as they industrialize they consume more, they use more. And now we’re playing catch up. It’s the reason why we’re dealing with $60 oil prices, $3 copper today. And a lot of these stories out there, and this is why I think you need to take the Joe Friday approach to investing that there seems to be this glut out there. Well, I can show you the charts of copper, I can show you charts of energy supply, and our inventory levels compared to where we were 5 years ago are down dramatically. And that’s why you have to think beyond the moment, beyond the panic, beyond the excitement, or whatever the emotional turmoil is in the markets and step back and take a look at what has really changed. Are we experiencing lesser rates of population growth or is the population growth of the world still going to grow? Are we seeing greater industrialization in the world or is China going to stop? I’ve been hearing the ‘China stops’ story for so long and in the second quarter China’s economy grew at 11 ½% rate. So you see all this information fed to the market and when you step back to look at the fact the facts don’t hold up to support it. [24:57] JOHN: Well, let’s see if we can tie these things together, because as we pointed out you have increasing populations around the world which demand more food and water; and you have increased industrialization which demands more water among other things just for industrial purposes; and then you get to the issue of energy. And here we are in what would seem to be a trade-off, you have to have energy to make the industrialization go, to make the food production go – at least on a large scale, you don’t have to in a primitive, agrarian society – but at the same time, you look, and we’re using the food production industry to produce energy like ethanol. And it would seem that there’s a trade-off here because if there’s only a limited amount of water and a limited amount of arable land, and some of that is going to go for food and some of that is now being moved in to energy production. So the third factor is really energy. This triangle is literally a triangle, nothing exists without any one leg of it. JIM: Yes, they’re all dependent on each other, and the problem that we have is that oil provides about 40% of the world’s energy, but it provides almost 80% of our transportation system’s needs. Actually the figure is closer to 90%. You’re not going to get on an airplane, get in your car, have goods transported by truck, rail or by sea without the consumption of energy. And any kind of economic growth – whether it’s in the United States or it’s in China, India, I don’t care where it is – requires increased energy consumption. World energy use has been growing consistently between 1 ½ and 2% a year. Let’s break this down into a very simple solution to understand. What is really at stake here? It’s an inventory issue. You start out with existing reserves, that’s what we know we have in the ground. You add to those existing reserves discoveries. So that would be like you were running a store you would start out with ending inventory, you would add purchases which in this case would be discoveries and that would give you total available for consumption. And then at the end of the year you would subtract what you consumed for the year. The world is consuming 30 billion barrels of oil a year. We are finding on average only 4 billion barrels of oil a year. So what we’re doing, going back to the bank account, we’ve been drawing on our bank reserves for decades now. It’s been well over two decades since we last discovered enough oil in any year to replace the oil that we consumed. Furthermore, 50% of our energy or oil comes from giant oil fields that were discovered 30 to 50 years ago. And so, you have to ask yourself, “yes, we’ve made some new discoveries, those new discoveries will end up producing more oil in the future,” but then you have to ask yourself what about the oil that is declining in production? [28:27] JOHN: One of the things that factors in here when we hear all this optimistic talk about the world’s oil is that people have not reckoned with the fact that we really haven’t had any new great discoveries for quite some time, and the reserve issues have not been factored into what they’re saying either. JIM: No, in fact it often gets confused, especially when you bring up things like the Canadian oil sands which by the year 2018, it may be possible to go from 1.2 million barrels of oil production to 3 ½ million barrels. If that should rise to maybe 5 or 6 million barrels, in the following couple of decades, you’ve got to think about something like 45 or 46 of the 54 major producing countries in the world are passed peak production. If we carried that a little bit further, excluding deep water oil fields, which seems to be where we’re making the new oil discoveries, output from 54 out of the 65 largest oil producing countries in the world is in decline. Indonesia is now an oil importing country instead of an oil exporting country. And if you carry this further, in the next 6 years, for example, 5 more countries are going to peak in their production. Only a few countries, Saudi Arabia, Iraq, Kuwait, the United Arab Emirates, Kazakhstan and maybe Bolivia have the potential to produce more oil than before. And that’s why if you take a look at what the peak oil camp is saying the best guess is by 2010 production from these countries, and from deep water fields will have to offset the decline in 59 countries out of the 65 countries. So if you take the world’s global oil production which is produced by 65 countries by the year 2010, 59 of the 65 countries are going to be in decline. [30:35] JOHN: If you look at that in sober terms that would really imply that every couple of years we’re going to have to find another Saudi Arabia – and that just isn’t happening. JIM: No, in fact the world was taken some comfort, and a lot of the optimists were taking some comfort in terms of the development of the potential reserves in the Canadian oil sands, which are estimated to be as large, or almost as large as Saudi Arabia. But it could take another decade for the output from the Canadian oil sands to triple from let’s say a little over 1 million barrels to over 3 million barrels. And that’s not taking into consideration the amount of natural gas that is used to produce this oil. So yes we’re producing oil but we’re also consuming a lot of natural gas to do it. [31:25] JOHN: What we’re talking about here is a series of trades no matter what we do. JIM: Sure. And it’s just like going back to the food issue. We have a growing demand for increasing diets, a growing population so we produce more food, but now we have a trade-off because we want to divert part of that food production of corn or sugar into producing ethanol for energy consumption. So there’s a tradeoff there. And we have trade-offs in energy; we have trade-offs in food; we have trade-offs in energy; we have some trade-offs we’re making in the area of water. And the problem is these issues are not being connected. The dots aren’t being connected for everybody. And if we want to legislate that 30% more of our energy is going to come from biofuels, what’s that going to do to our food production which is used to sustain us. And also in terms of increasing our protein production, how does all this relate? Nobody is connecting the dots. So you’ll have one group advocating, “Ok, we need to have this,” but they’re not taking a look at the larger picture how all 3 of these are interconnected. [32:33] JOHN: Alright, Jim, if we look at the projections we have for population and energy – and a lot of these are optimistic looking toward the future – one of the assumptions is that whatever energy is going to be required in the future it’s going to be there. And based on current observation, that may or may not be true. JIM: There’s a couple of good examples that illustrate the fallacy of those assumptions. If you go back to 1999, the Energy Information Agency and the International Petroleum Council were both optimistic about the abundant natural gas supplies of North America for the foreseeable future. Even CERA – Cambridge Energy Associates – were very optimistic about natural gas – that was in 1999. The following year in 2000, here in California, we were facing $10 for natural gas and we had an energy crisis. And yet, only a few years ago they were talking about an abundance of natural gas – we had more natural gas than we needed. So all of these optimistic projections that are made a couple of years later, it turns out that these assumptions or optimistic projections just didn’t hold water. And one of the problems, going back again, all our surpluses that we’ve been living on [have been] drawing down inventories of copper, drawing down inventories of gold, drawing down inventories of silver, drawing down inventories of energy, oil, natural gas; drawing down inventories of grains, corn. So all of this, we’ve been living off our bank account and nobody is looking at this from an inventory level: “wait a minute, our inventory levels are going down.” We get lost in this noise, “oh, they increased this week” because of some hypothetical computer calculation. And as we have pointed out over and over when it comes to energy there aren’t people with dipsticks that are measuring this stuff. But look at a graph of copper supplies, look at a graph of energy in terms of inventory levels. Look at for example uranium – the Chinese are going to build 20 or 30 new nuclear power plants in the next decade; we’re going to build 60 new nuclear power plants in the next 10 to 15 years – and we’re not producing enough uranium each year to supply this. We’re drawing down on our uranium stock piles that have been built up over the last couple of decades and also from the decommissioning of nuclear weapons. So nobody is asking the hard questions and we get so caught up in the daily noise in terms of what it is today that we’re really missing, we can’t see the forest through the trees. [35:19] JOHN: Let’s flip this over, and I guess play devil’s advocate here. Groups such as Cambridge Energy Associates are anticipating that all of this new supply is going to come online. So can you make an optimistic argument that we’re going to meet this – in other words, it’s the idea, it’s sort of a Western American idea – that sooner or later, we’re going to slug it through, and we’ll work it out. That type of thing. JIM: Well, if you take a look at the arguments made by CERA. One is they don’t buy peak oil, at least they think we’re going to have undulating plateaus of peak oil. In other words, we’ll sort of plateau, then we’ll make a discovery or a new type of supply will come online. So the world is not running out of oil imminently. That’s their position. Two, I think where they’re coming from is an increasing supply of energy is going to come from non-traditional or unconventional oils from for example: the ultra-deep waters, relating that to for example the Chevron discovery in the Gulf of Mexico; from the oil sands to gas related liquids, and which they include condensates and liquids; and also the conversion of gas to liquids. So that’s why they see isolated peaks and then we’d work our way out of that. And I also think there’s a belief by Cambridge that we’re going to have a new technological breakthrough that will allow us to extract more oil from existing wells. That’s because let’s say you discover a well and based on your preliminary estimates you think there are 100 million barrels of oil there. Well, you know, you may not get all of those 100 million barrels, you may only get half of that but as we invent new technology it enables the existing oil fields we can get more oil from them. In fact, most of the addition of the reserves that we have had over the last decade or so have come from increases from potential reserves from existing wells, not new discoveries. So they’re sort of basing their optimism on somehow we’ll come up with another form of technology that would allow us to extract more energy. But as it relates to the United States, what’s even more worrisome we have 2% of the world’s energy reserves and we’re producing 8% of the world’s oil. So we’re consuming what we have four times faster than anybody else. [37:49] JOHN: Well, you would think that the optimists would have some reservations. They’ve been wrong in the past, if you look at the candid fact that they had been right in the past we wouldn’t have been dealing with $60 oil. So, what gives? JIM: Well, this goes back to something that we’ve talked about in the program. If you look at two decades ago, when we were consuming 60 million barrels but we were producing or had the capabilities to produce 70 million barrels. So we had a spare capacity of 10 million barrels. So any of these crises whether it was in Nigeria, or the Middle East or a hurricane this would never have been a problem 10 years ago in the 90s. For example, when the first Gulf war took place, oil spiked to $40. Saudi Arabia said they were going to pump from their excess capacity, the price of oil quickly went down $20 a barrel. We don’t have that capacity today. Our spare capacity has dwindled from 10 million barrels, down from 1 to 2 million barrels. And this gets back to the fact that we are failing to discover and bring on stream enough oil to replace what it is we’re consuming. And even the CERA folks say there are some caveats to their optimistic projections. One, is we really don’t know what the real reserves of Saudi Arabia are, which is why Matt Simmons wrote his book Twilight in the Desert. There’s a big question mark. A lot of the largest producers of where 75% of the oil produced comes from – OPEC countries – that do not reveal the information. We don’t have GAAP accounting statements on all the existing oil producing fields, so that we could get an accurate measure and say, “Ok, they have the goods there, they have the ability to produce more.” We don’t have that information, all we have is what they tell us. And as anybody knows recently, OPEC’s credibility is at stake because when the price of oil was at $78 a barrel, they’d hold these press conferences and say, “well, we’re going to produce more.” It didn’t work because everybody knows they weren’t producing more. As a matter of fact if you take the last 12 months, OPEC production is down by over 600,000 barrels a day. So all this talk about increasing production, OPEC is producing at maximum today with maybe the exception of Saudi Arabia and even there that’s a question that we don’t know because production has declined in Saudi Arabia, we don’t know if that’s done intentionally on Saudi Arabia’s behalf, or if it a result of declining production from their major oil fields. I tend to think it’s the latter. [40:32] JOHN: Ok, Jim, so if we pull this all together as a long term trend, and look at it as an investor –not as a day trader but someone who is really looking at what is going on in terms of geopolitics and economics long term – this whole thing is being driven by population growth, urban growth and industrialization. It is not going to go away at any time in the near future and there will be a continuous requirement for more and more development in this area to sustain all of this activity worldwide. JIM: Absolutely. That’s why bull markets tend to be long trending in nature. And if you look at it, for example, Jim Rogers did a lot of study on this book Hot Commodities, an excellent book by the way if you want to understand the commodity cycle from probably one of the most astute commodity investors in the world. If you read that book, the cycles have lasted 16 to 18 years in duration. In fact, we did an interview in August 2005 with one of the best analysts in the commodities area, a guy by the name of Barry Bannister, and I’d recommend you go back and take a look at the transcript and some of the graphs in that interview to get a better understanding. It’s going to take a while to bring on excess supply. And it is when prices go higher that we do come up with alternatives, we do come up with substitutes and we come up with new technology to help solve that problem. But it’s going to take higher prices to ration it, to cause people to conserve. You remember, John, for example in the 70s when we went through the oil embargo, when oil went from 25 cents all the way to $40 a barrel – that’ s when people started buying economical cars, that’s when insulating the house came into play, as well as solar, and all these alternatives. And fortunately, the 70s were a geopolitical crisis as it related to energy; where today, it’s a geological crisis. [42:34] JOHN: You’re listening to the Financial Sense Newshour at www.financialsense.com. You’ll find these files posted by 7am Greenwich Time every Saturday morning. And that works out to 3am Eastern Daylight Time. Also, if you didn’t hear it in the last hour, don’t forget Ike Iossif has his guest along with Jim, Sy Harding. And that was an interesting interview, that’s in hour two of the Financial Sense Newshour this week. Time to move on to one of our Other Voices. [43:01]
JIM: Well, just as economic events can dominate markets, so can politics, and we certainly have a plethora of things to worry about. Joining me on the program today in Peter Zeinham, he’s from Stratfor.com, which recently published a 4th quarter forecast. Peter, let’s begin with that, and what are the dominant themes going to be this quarter? PETER ZEINHAM: Well, from an organizational point of view we’re lucky enough to really only have one dominant theme, and that’s the simple fact that Iran is going to be controlling the ebb and flow of international event for the next 3 months. The Iranians have been working for several years to try to position themselves in a place where they can pressure the United States without fear of repudiation, pressure the European Union without fear of sanctions, and in general call the shots in their part of the world. They have now managed to put themselves in that position. Of course, it’s not risk free, you never know when the United States is going to do something with that military of its, but considering all the levers they have in Iraq, all the levers they have vis a vis oil, and the presence of Shia minorities throughout various parts of the Persian Gulf – particularly on the Western side of Saudi Arabia – the situation for them is about as good as it could possibly get; and we see no reason for them to back down from their confrontational tactics over the next 3 months. [44:24] JIM: How did they get to be in the driver’s seat? I mean they’re confronting the United States, major superpower; they’re confronting the European Union – And they seem to be winning the PR battle. PETER: Not to simplify the situation, but it really all comes down to Iraq. Don’t get me wrong, the situation such as being the world’s third largest oil exporter certainly helps give them the cash to play it with a lot of things; but when the United States went into Iraq they removed the single largest strategic threat to Iran. And that’s not just the Iran of modern times. Every time Iran has been unified under a single power there’s been a security threat to whoever happens to rule in Teheran. When the United States broke the back of the Hussein regime, all of a sudden Iran could start thinking outside of the box that it’s normally been in. It could start thinking about what it would be like to have a secure Western border. At first it tried to work with the United States to achieve that but that eventually fell out. We’re now in a situation where the United States is bogged down in a civil conflict in Iraq, and as a result the Iranians have more freedom of movement than they’ve ever had before. And so the nuclear question allows them to jerk the chain of anyone they want to in order to get what any other issues they want on or off the table. This is a very sweet spot for them. [45:33] JIM: You know, Iran is very cognizant of being able to manipulate politics here in the US. For example, they helped to bring Jimmy Carter down in 1980. So they’re very well aware of US politics and how to manipulate it. Given that Iraq is not very popular with the voters right now – the President’s approval ratings are down – if the Republicans however hold both Houses, as you point out, wouldn’t it be best for Iran rather than to take that risk to negotiate now? PETER: I don’t think so. Iran is looking at two things. They know they can manipulate elections and we fully expect them to throw everything they have into a Ramadan offensive at this point – supplying whatever weapons they can to any side of any conflict in Iraq. It doesn’t matter to them which faction comes out ahead in a month, because no faction is going to be able to get in to a position where they’ve actually won. And so long as there is chaos in Iraq, you’ve got chaos on American television screens, and that’s plenty of other ammo to be used against the Bush Administration or anyone who’s perceived to be aligned with it. In the second case, Iran realizes that no matter what happens in this election, no matter what happens with the next Presidential election, what happens to the United States at all, it’s always going to border Iraq. It will always have to deal with whatever is over there. So from their point of view if you can just bloody the American President for another 2 years – fantastic. You negotiate not when you have something to gain, but when you have something to lose. And at this point, Iran is making so much progress that it doesn’t need to sue for peace. If anything, it’s the United States that needs to go to Teheran in a ‘Nixon goes to China’ sort of way, and figure out if there can be a new operating relationship. Iran is not yet in a position where it feels it needs to give an iota. [47:31] JIM: What are the chances that the Republicans hold on to both Houses in November? Would that change Bush’s opinion or position with Iran? PETER: Probably not. Bear in mind that the Bush Administration has had Republican allies in Congress for the last 4 years and during that period the Iraq war has happened and this descent into Iraq that has strengthened Iran so much has happened. You flip it to a Democratic Congress, the only thing that has changed is the perception of the American people – very little changes in Teheran because they do not see a Republican dominated government (not just a Republican dominated Administration) as necessarily a stronger point for the Bush Administration. Now that said, they would sorely love to embarrass the Bush Administration come November. [48:14] JIM: And what do you expect to happen over the next year? If you were to take out your crystal ball, taking a look at the next two years, do you think the Bush Administration will be forced to sue for peace with Iran? PETER: Be encouraged to certainly, but I do not see this Administration be the one to finally make some sort of rapprochement with Teheran. [There are] two things you have to consider here: first of all the Bush Administration is not one that is known for back tracking in a great many ways. Say what you will about the Bush personality – whether it’s strength of convictions or foolhardiness – this does not seem to be an Administration particularly in its final two years that is going to go out on a limb and trust the world of the Iranian President to suddenly become a moderate and a pragmatist. That’s just not going to happen. On the flipside, from the Iranian point of view you want a President that is showing no signs of compromising. It makes it very easy to mobilize public opinion and to divide international opinion. [49:12] JIM: Let’s say that on the other hand the Democrats retake Congress, would that change anything? PETER: Probably not very much. Iran, if they see the Bush Administration being incredibly weak, maybe even terminally weak, they have no reason to let up until they get to a point they feel that they can dictate terms. Those terms are terms that the United States is not going to like. Iran would love to be exercising de facto sovereignty over Iraq because it would mean that the foe that has time and time again threatened them would be gone forever. But the United States is never going to sit back under any Administration and allow for an Iranian dominated Iraq, because then you’ve got not just the oil reserves of Iran but also of Iraq under a Shia thumb, and Saudi Arabia and Kuwait look quite vulnerable then. [49:56] JIM: If that is the case then what do we have to look forward to here in the next couple of years – more of the same? PETER: Everybody’s perception in the United States is that in the last 3 months the situation in Iraq has gotten considerably worse. We can look forward to a fat two years of that. Iran has no interest whatsoever in making this pain end anytime soon. And the only way the United States really can get out is to simply leave and declare defeat. That’s something the Iranians might want but I don’t see that happening on this Presidential watch. [50:29] JIM: Let’s move on to another topic that’s going to dominate the news here in the 4th quarter, and that’s the downside of the cycle – you’re talking about the yield curve. Do you see a recession in the cards for the US? PETER: It’s an open question whether it’s going to be a technical recession which is defined as two quarters of negative growth, but we’re definitely seeing a very sharp slowdown in growth. We’re going to see that last bits of growth this 4th quarter and probably the first two quarters of next year are going to be flat to negative. We’re in a situation where we’ve had strong growth since October of 2001. Bear in mind the American recession of 2000 was not started by September 11th, it was ended by the stimulus spending that happened after the September 11 attack. So we’ve had 5 years of fast growth. Five years if you look at it and average it out is actually faster than the 1990s growth spurt. We’re due for a slowdown and now it’s happening. So far we’ve been pretty lucky with the way the housing market has cooled but not crashed. Assuming you don’t live in San Diego, or Las Vegas you’re probably going to be Ok. [51:32] JIM: Going back to another couple of troubling situations, we have the recent events in North Korea, and then also you wrote about the Soviet Union with Moscow strengthening its grip. Address those two topics if you would. PETER: Sure. First with North Korea, bear in mind we haven’t even confirmed that this was actually a nuclear test yet. The total explosion strength was about half a kiloton which can be done by conventional explosions and has been done in the past by North Korea for its land reclamation activities. Assuming though that this was a nuclear explosion, look at the startling lack of interaction from the rest of the world over this. Half a kiloton – that’s a really pathetic nuclear explosion. It’s a fizzled nuke that clearly failed in terms of an explosive test. Most security folks the world over are actually sighing a faint sigh of relief because everyone’s assumed that North Korea has had a functional device now for several years, and if this is the best that could be done – a non-deliverable weapon of only half a kiloton – the security situation in Korea is not nearly as bad as we’ve expected. And we actually have a bit of breathing room. Now, in Russia, you’ve got the flipside. For as the United States is bogged down in Iraq, and the Iranians are taking advantage of that, so are the Soviets. Assuming for the moment that the Iranians get everything that they want, it doesn’t kill American strategic interests. Imagine what would happen if the Russians got everything that they want. We know right now that they’ve managed to help push back a pro-Russian government in the Ukraine; they’re heavily pressuring the Georgians right now. They’ve basically kicked the United States out of Central Asia. We’re getting to the point that the Russians are managing to reassert themselves throughout their entire periphery, and they’ve won almost everywhere they’ve picked a fight. The next logical place for the Russians to go is further West, into the countries that just joined NATO and the European Union – back into their old traditional stomping grounds. That’s a fight the United States doesn’t want, and right now can’t fight. There’s the problem for next year and the year after. [53:31] JIM: Is this the end of the empire, and our superpower status. It seems like the United States is being besieged on multiple fronts – the most serious one being bogged down in Iraq. But because of being bogged down in Iraq we’re unable to deal with issues, whether it’s Latin America with Chavez or it’s the Soviet Union. PETER: Bear in mind, one massive advantage the United States has that no other country that has been a world power ever throughout human history has for all practical purposes had its own continent. And if you look at where these geostrategic defeats have been – Iraq, Georgia, Ukraine – you’ll notice that they’re not even in the same hemisphere. The United States has the advantage of pushing out from its continent and influencing events far abroad. Whereas whenever the United States suffers a defeat, it happens in those far abroad regions. The core strength of the United States – the $12 trillion economy, the dynamic and growing population – these are things that no geostrategic defeat can affect unless it manages to cross the Atlantic and Pacific somehow. And that’s just not in the cards. And the United States will always have that strength. It’s one of the reasons that no matter how bad foreign policy is – whether it’s under a Clinton or a Bush – the American society, the American government, the American military and economy, is going to live on. That’s very hard to get rid of. And so when you can talk about the United States losing a foothold here, or a position there, or an ally over here, ultimately the United States position is fundamentally sound. It may look bad, particularly from the pictures that you see in the newspapers everyday, but the core reason that you shouldn’t be too concerned is ultimately the United States is in the United States – it’s not in Eurasia. [55:16] JIM: Let’s move on to something that I found quite remarkable and that’s Latin America. You wrote a piece in your 4th quarter – The Beginning of the End for the Left. Explain. PETER: We’ve seen the rise of leftist politicians throughout Latin America for the last several years. First and most famously is Hugo Chavez of Venezuela. These are people who see the survivability of Cuba and the aftermath of the cold war as something to herald to. Leftist politicians have always been very popular in Latin America because the level of economic inequality is much, much stronger than they’ve ever been here in the United States. It’s very easy to rouse the people with a leftist populist message. Well, that seems to have crested this year. We’ve seen the Venezuelan situation where they’ve tripled state spending, and now that oil prices have fallen back to, from their point of view, the lows of the 50s, they’re having problems keeping up with all of the expenditures they once committed to. You’ve got governments that looked a couple of years ago, like they were destined to shift over to the hard left that have gone to the center. And in the case of Brazil, we even have a challenger – President Lula is of the soft Left, you know, he believes in the general idea of leftism but not to the point of Chavez of tearing down the entire system, and he’s proven to be quite moderate from an economic point of view. Well, the guy who challenged him and is now in the run-off campaign for the Presidency is not of the hard Left, he’s of the Right. We’re seeing a shift. And a lot of these states that have flirted with the Left are starting to come back towards the center. [56:52] JIM: So this year, in the 4th quarter, the dominant theme will be what’s going on in Iraq and especially Iran... PETER: Iran, Iran, Iran. JIM: Iran. And next year in your opinion? PETER: Next year, the global economy could be forefront. We’ve got a situation where when the United States slows down, as a $12 trillion economy, everybody else has to figure out if they can keep going without. We know in the case of Japan, and the European Union, that probably won’t be the case. They’re probably be following the United States down; and they’ll probably not come up until the United States does. The rest of the developing world, areas that export commodities of whatever flavor are going to have to deal with the fact that 3 of the 4 largest consumers of their commodities are going to be dealing with slow to no growth. That is going to set the tone for a lot of events the world over. For example, in Latin America it’s very difficult to be a leftist, populist in power when oil revenues fall out. In the situation in the former Soviet Union they have been cash rich for a very, very long time. It’s not clear that they remember how to operate when they’re cash poor. [57:56] JIM: Alright, Peter, as we close, why don’t you tell our listeners about stratfor.com, how they can find you on the web, and tell them about the services that you provide. PETER: Stratfor is a public intelligence company operated out of Austin, Texas and Washington, DC. We do geopolitical analysis for a select group of clients as well as an open site at www.stratfor.com – where you can subscribe to our daily and weekly newsletters and see our geopolitical analysis on global events. [58:28] JIM: Alright, Peter, it’s always a pleasure to talk to somebody from Stratfor. You provide a great service I think that investors would profit from. Thank you for joining us on the program. PETER: Not a problem, thank you. JOHN: Welcome back to the Financial Sense Newshour. It’s time to go back to our Q-Line this week – our question line – which is a toll-free line which is actually available to everyone in the world but it’s only toll-free from the US and Canada. It is 1 800 794-6480. That is toll-free from the US and Canada. It works everywhere in the world but elsewhere in the world you have to pay for it. We’re not that generous. Let’s go to the first question: Hello this is David calling, thanks Jim Puplava, great program, I’ve been a listener of your program since Fall of 2002. Listening to the Robert Prechter interview this Saturday, and I learned that Robert Prechter was recommending cash positions in Treasuries and Swiss Francs. You asked him a question regarding silver and gold – precious metals – he answered it by talking about silver and copper. He never got into his position on the actual gold market, gold bullion and the gold stocks. He avoided answering that question either purposefully or just inadvertently. I was wondering if you know his position there. I’m trying to find out what’s on his website about it, I haven’t been able to find anything yet. But if you could answer that question it would be great. JIM: I believe Bob’s position is he’s still negative on gold. In other words, he thinks it’s coming down and that it may have peaked. And so I think that position is consistent with the position he has held all along. And being on the deflation side he sees deflating asset markets, and that’s why he is a big proponent of cash and the Swiss Franc. Although, the Swiss Franc would be very indicative of safety, but also would be very indicative of a dollar decline which I would see as inflationary. So I see those two as inconsistent. But as far as I know he’s still negative on gold. [1:01:20] Hi, my name is Tom, I’m in Woodvale, Washington and I want to say that I really enjoy and profit from your weekly broadcast. I want to discuss a little bit Robert Prechter and his interview. I really have to say I take the side of Jim Puplava in the debate about inflation first. And I wish Robert Prechter would be put on the spot, or at least asked to verify at least one place where he can show in history where a country operated under a fiat currency, without a gold backing and had inflation in its history has had a major depression first – one place in history. The United States went into depression in the 30s but it was gold-backed. So that’s my question and I wonder if he can give us an example of where he bases his thesis. I think he’s using the post that he has preconceived and he’s looking for evidence to support his thesis rather than trying to throw out the facts as you do and come into a conclusion. I agree Tom that I think because of Bob’s position being grounded in Elliott Wave theory he’s looking for that to play out. The problem is when Elliott Wave theory was developed earlier in the last Century we were on a gold standard. In fact, one of the reasons that the government confiscated gold back in 1933 is that they wanted to increase the money supply and they wanted the gold to back it. And you’re absolutely correct, that a fiat-money system where there are no restraints on government, history would tend to side on the side of inflation. And the only difference being Japan, but if you look at what happened in Japan, there, deflation was in terms of prices. You’ve got to remember there were two reasons for that, even though their central bank was creating money and printing money, why you never saw it take place is they were exporting those dollars. So instead of keeping those dollars contained within their own society which would have created inflation, they were exporting those dollars mainly to the United States and elsewhere in the world. That was number one. And number two, the Japanese people were increasing their savings rate which is why you never saw a lot of that money get into circulation through spending it. But I agree with you, I think history would tend to favor the inflationary argument, and that’s why I’ve been such a strong proponent of it. [1:03:47] Hi, this is Jeff, in Minneapolis. Great show, love listening to it here. A general question – it would be fun to contrast the cost of creating nuclear energy versus the cost of our defense presence in the Middle East. Great question, Jeff. This is something that we spend almost $½ trillion on defense today, and unfortunately we’re spending very little on this country’s infrastructure. In fact, as I mentioned earlier in the Big Picture we talked about the American Society of Engineers gave the United States a D in terms of its infrastructure. Our basic infrastructure is falling apart and part of that is our energy infrastructure which is also falling apart. It’s old it’s outdated. And whether it’s nuclear power plants, it’s pipelines, it’s refineries, it’s new rigs, it’s personnel needed to operate all of that equipment – we’re falling further and further behind, and I think that’s going to be a big problem going forward. [1:04:54] JOHN: You know as you just said that to the Gentleman who called in, it really has struck me, and I’ve been watching politics for 40 years professionally as a news type person, and if you look at the fact that the roads, the infrastructure – everything – the canal system, we don’t think about that. We talk about economizing energy – the best way to move things around the whole Mississippi Basin is through barges, we’re letting the lock system decay. Politicians seem to be arguing about all sorts of things that have no bearing on where we’re headed. The little red warning lights are going off in the cockpit, and the pilots are discussing what they’re going to have for dinner. And I don’t care whether you’re a Republican or a Democrat but it’s like there is no consciousness of this. JIM: You know, it was amazing, one of the things I like to do to relax is I like in the evening after I’ve done all my reading, I watch documentaries. And probably the first part of the year I was watching World War II documentaries. I watched several documentaries on the life of Winston Churchill – to me, one of the greatest politicians in the Twentieth Century – and Franklin Roosevelt. And you know, you’re absolutely right, John, I was looking at the effort that was made in this country to fight World War II. Our industrial might, the things that we use to fight that war, how we were able to produce planes, ships and things like that, and you compare that to our capacity today. Lately I’ve been studying Rome, I’m reading two books right now on the decline of Rome itself as an empire, but also last night I watched a piece I got from the History Channel called Engineering an Empire, and it was about Rome and they were going through the different Caesars, from Julius Caesar going forward, until Rome eventually collapsed. And one of the things that you really got from watching this like for example Rome burning, and we got the saying “Nero fiddled while Rome burned.” And then also towards the end of the Empire the things that were breaking down in Roman Society and government and also on the frontiers, the politicians were infighting over some of the smallest and trivial things rather than focusing on the real threat to the empire itself. And that’s where I think we are today. I mean just take a look at we’re in that silly season right now, and I can’t wait until the elections are over so I don’t have to take these computerized phone calls or watch the garbage ads that they put on TV. [1:07:26] JOHN: You know we even get them on our Q-Line here. JIM: Are you serious? JOHN: Seriously, one came in this morning. You know, “so and so doesn’t understand reducing taxes is good for the economy, don’t vote for so and so.” – that type of thing. JIM: Hey, we object to you using our Q-Line time for that. JOHN: But it is interesting how the culture just drifts in that direction and we begin fighting over things which are not relevant to anything. If there’s one tag I would put on both political parties here – irrelevance is probably the core issue. And of course, when something strikes whether it’s a national security issue or a hurricane then all everybody does is run around pointing fingers. JIM: Yes, a good example of that was last year when the hurricanes hit in 2005 – Katrina and Rita – and the levy systems which had been allowed to go into disrepair. In fact, they stopped them from repairing them, then all of a sudden all we did is we got stuck on stupid, and people pointing fingers – nothing was actually done. [1:08:32] JOHN: But that’s Washington. Yesterday, I spent about half an hour talking to former Attorney General John Ashcroft, and I finally said, “Ok, why is it that we didn’t see 9/11 coming? And why was it that there really were people with boots on the ground that were in the FBI and elsewhere that understood what was actually happening?” And no matter how loudly these people banged on the political infrastructure of Washington within the CIA and the FBI, they could not get anybody’s attention. Washington was focused on something different. So that’s just the way bureaucracies are though. I don’t think you’re going to avoid that are you? They didn’t avoid it in the time of the Caesars in Rome. I don’t think we’re going to avoid it now – it just tends to happen. Somebody once said when reality sets in that’s when politicians start to panic. JIM: And that’s what I think we’re going to see – panic. We’re going to see more blame-shifting, finger pointing as we tend to do in election times, until people just get tired of it, people are tired of the lights going out, they’re tired of gas lines, they’re tired of power outs, tired of rising prices and all of a sudden that gets the attention of politicians. But I think we have a ways to go there on the pain front before politicians take it seriously and do something about it. [1:09:47] JOHN: I was walking through the living room this morning. We’ve always got CNBC or C-Span or something on here, and they were beginning to talk about the current investing environment. And they were saying the street is deeming it essential we get back to looking at the fundamentals and long term investing on an investment basis rather than day-trading. And I blurted out, “Duh!” Give them enough time, they’ll eventually catch on. That’s going to be our next topic: in a world of low returns dividends really do matter.
JIM: You know, John, if we take a look at the rates of return in market and this is one of the things that has been frustrating I think for a lot of people retiring today. I’ve got a screen where I’ve got bond rates from around the globe, and just look at the US today where a 10 year Treasury note is roughly about 4.8%; if we go to even riskier places in the world, if we go to Mexico it’s 5.8%; in Brazil, it’s only 6.2%; in Colombia, it’s only 6 ½; if I look at returns in Europe and Africa, rates of return range from a high of 4.6% in the UK, to low returns on a Swiss 10 year Treasury note of 2.46%. If I go to Asia, a 10 year Japanese government bond only pays 1 ¾%. So globally, it doesn’t matter where you’re looking the rates of return are so low today, we’re really living in a low return world. And it’s not just that interest rates are low, not even covering inflation rates. If we look at for example the 10 year Treasury note today, at 4.8% isn’t even covering nominal GDP growth. So, you’ve got inflationary effects that aren’t being reflected in the bond market because there’s all this money-creating in the world – not just on the US side but globally – and rates of return have fallen commensurately. And as a result today, you have hedge funds which are increasingly having to use more leverage to squeeze profits out of pennies in terms of arbitrage spreads. So the ability to arbitrage, the ability to earn high rates of return, just aren’t there. [1:12:15] JOHN: I don’t think people have gotten used to this. I think that’s the issue – people tend to be creatures of habit, and when the environment’s changed it’s hard to recognize that. We went through a 20 year period when people were getting double digit returns in the stock market, and then the recent flurry when they were getting the same thing in the housing market, and now that that’s changing – you know the interesting thing about human beings is they always keep trying to go back to the patterns they knew well that worked well even when they don’t work well anymore. JIM: That’s exactly right, because if you take a look at the 3 major indexes in the US – the S&P, the Dow Jones Industrial Average, and the NASDAQ – if we take a look at for example the last 6 years beginning with the S&P, in the year 2000 the S&P was down 10.2%; 2001 the S&P was down 13%; 2002, the S&P was down 24.4%. We had a good year in 2003, where the S&P was up 26.4%; 2004 was halfway decent – we were up about 9%; and last year we were up 3%. Now, if we take those same rate of returns and contrast that with dividends, instead of being down 10.2% in 2000, with dividends, you would have been down only 9.1%; instead of being down over 13% in 2001, with dividends, you would have been down 11.9%; in 2002, instead of being down over 23.4%, we were actually down 22.1%. So it’s clear dividends increase your rate of return over a long period of time, and also on an annual basis. But more importantly, John, you always hear these figures that people throw out, “Oh, the stock market produces 10% long term.” If you take a look at any financial planner he’s doing a financial plan let’s say for a couple that’s saving for retirement, the automatic numbers that they plug in are this 10% rate of return. And what people forget is the majority of that return came from dividends. In fact, the S&P, whose dividends have gotten to be pretty low over the last couple of years as a result of the stock market mania in the 90s, the Dow has performed much better. The Dow was down only 4.7% in the year 2000; it was down only 5.4% in 2001; and it was down 15% in the year 2002. Certainly, people that were in Dow type stocks – large cap dividend paying stocks – did not suffer as greatly as those that were, let’s say, invested in the NASDAQ, where the losses were horrific during that period of time because the NASDAQ stocks were number one riskier and they didn’t produce much in the way of dividends. I mean people experienced a 39% loss in the year 2000; over a 21% loss in 2001; and a 31, almost 32% loss in 2002. You even take a look at the returns we received in the stock market in the year 2004 and 2005 – both years experiencing positive returns – most of those returns came towards the end of the year. In 2004, it came roughly in the last 6 weeks of the year after the Presidential election. Last year, likewise, you know the Santa Claus rally of the last six weeks of the year the stock market was in negative territory until those last six weeks. That’s why in a low rate of return world, where you can’t get much in fixed income and I think anybody going out long term today in a bond – whether you’re going into Treasuries, corporate bonds or mortgage-backed bonds – in an age of inflation where the true bond yields are lower than nominal GDP growth, and where the money supply is growing at 10% a year you are just asking for trouble for yourself in my opinion in terms of the inflationary impact of what we’re going to be facing in the next decade. That’s because what are the chances that politicians will level with voters and say, “look, we don’t have the money to pay for all the goodies that we’re giving you. We don’t have the money to pay for infrastructure; we don’t have the money to pay for our military expenditures; we don’t have the money to pay for our entitlements; we don’t have the money to create economic growth here – we have to borrow it.” And when you create money and credit, the easy way out for politicians is always to create more money than we are effectively earning and saving. And in the long run that means devaluation of the currency, depreciation of assets – so you may see asset values rise over a period of time but you’re going to have to adjust them for inflation. And that’s why I think in this kind of world today where we know we’re still having accounting problems, earnings problems, that’s why I think dividends are more important when it comes to basing your returns or the kinds of returns you’re likely to receive looking forward over the next decade or more. [1:17:47] A long time ago, in an economy not so far away… The next chapter in the inflation wars saga – Return of the Fedi. The battle between good and evil economic forces rages on. Join the further adventures of Lukewarm Economy: “I can’t go on alone.” Obi Ben Bernanke: “you must learn the ways of the Fed.” Princess Hedona:, “Save me, Obi Ben Bernanke.” Fedi master Quota:, “use the Fed, Luke.” And the faithful robot 3CPI and RUDuped2: “we seem to be made to suffer.” And of course, the arch villain Darth Inflator: “I find your lack of faith disturbing.” 21st Century Fed presents the most extraordinary picture of all time: Inflation Wars. An adventure of epic proportions, a rebellion against recession, a battle we must win. Return of the Fedi, coming soon to a theater near you. May the Fed be with you. [1:19:24] JOHN: Well, those who forget history are condemned to repeat it. So let us look at some history here on the show. Early in the year, Jim, you said that the Dow would hit new records. Stop that! Stop it! It keeps hitting new records – it’s getting old! You said around Spring time they would be hammering the commodities before the elections. We see some real hammering back in the metals market, especially oil – that’s happening. Large cap stocks seem to be fulfilling the predictions that you have. “oh, great guru, tell what is going to happen in the markets in Q4 – the 4th quarter?” JIM: Well, looking forward, the contention that we had as things were developing at the beginning of the year there were just a plethora of bad news everywhere you looked. And I can remember reading a lot of things – a lot of publications that were coming out. But then there’s one thing that I do and I’ve done it for probably the last 15 or 20 years is I do my own surveys – now granted, we in California are a little bit different, but you know this is the sixth largest economy in the world – and I like to go to supermarkets, and restaurants. And when I’m going out I’m always observing what’s going on, what are people doing. I talk to merchants in the stores, I talk to restaurant owners, people that work in the restaurants. [1:21:06] JOHN: You do that too, huh? I talk to everybody – I mean in stores, check-out boys, “what’s going on?” and you walk up to somebody and you see – I don’t know what it’s like in San Diego but I can walk up to anybody at the pump and start talking to them. JIM: Yeah, I do the very same thing. It doesn’t matter where I’m going, now if I’m in Costco, if I’m at a big mall, if I’m at my favorite restaurant, I’m talking to the owner, you know, “how’s traffic been, what’s it like during the week?” When I’m in a store talking to merchants, it drives my wife crazy, she goes, “why don’t we just leave?” [1:21:40] JOHN: My kids are always doing that, “Dad, come on,” you know. JIM: Yeah, but I’m striking up a conversation because I’m curious. For example, the year 2000, and 2001, I remember walking and remember up until the events of 9/11, nobody was talking about a recession. In fact, in the 2000 election they accused Bush of talking down the economy. But I can remember to this day, it was late Fall of 2000, and I was at Brooks Brothers – I was getting fitted for a suit – and they were so happy to have me in the store, and I was talking to the guy and I said, “what’s it been like?” And he said, “Man, it’s like a ghost town here during the week.” And I said, “what are people buying?” “Well,” he said, “last year – meaning 1999 – somebody would come in here and they would buy a suit, 2 or 3 shirts to go with the suit, 3 or 4 ties. They’re coming in now buying a shirt and tie, and dress slacks,” but their suit sales had dropped in half. And people were being more circumspect in the way that they were spending money. I heard the very same thing from the people in the Bowes store [ph.], the guys at Nordstrom were telling me the same thing. And I could see it in the parking lot – I called it my parking lot indicator because at Christmas I do a lot of sailing on weekends, and when I’m coming back home from a day of sailing coming from the Bay, a lot of times I’d stop off at my favorite mall in San Diego which is Fashion Valley. And I can remember my parking lot indicator where on a Saturday I could drive up and have no problem in parking. Today, when I go to Fashion Valley, usually on the weekend, I have to have my car valet parked, because I don’t want to drive around the parking lot for 15-20 minutes trying to get a parking space. So once again, it’s kind of like research, I’m always thinking this whenever I go into a place of the consumer economy where consumption by the consumer accounts for over 75% of GDP. So what a consumer is doing in a restaurant, what he’s doing in a store, you know, I like to hear from people, so I talk to the merchants. And that was the one thing that I started to see mid-Summer, as I keep asking these questions about how if the economy is slowing down I was not getting any visible evidence of that. And I’ve gotten a lot of emails from a lot of you that are listening to the program that are telling me, “you know, in our area of the Twin Cities, in Minneapolis, the malls are packed on weekends.” And so I think, number one, the economy in the 4th quarter is going to surprise people by not being as weak as most people expect, and that should be enough to keep the Fed on pause. So the expectations now in the futures market that the Fed would be cutting interest rates by Christmas, I don’t see that. Although I do see a bond market rally coming here as the GDP numbers are released for the 3rd quarter – the preliminary number – because we have been experiencing record trade deficits. And when you have a record trade deficit the amount of money you’re sending overseas subtracts from GDP. That’s because those dollars aren’t going to the US economy, they’re going to economies overseas. So I think the GDP number for the 3rd quarter is going to be weak, that will cause a rally in the bond market; I also think that the Christmas retail season is going to be stronger than expected. And I think if rates can be kept relatively narrow in this narrow trading range that we’ve seen in the 10 year Treasury note, I think the housing market is not going to be as weak as the gloom and doomers are predicting, because credit is still abundantly available. However, there are new regulations that are being put into effect with lenders on no-doc loans, negative amortization loans, that lenders can’t assume today that the client will automatically be able to refinance. Now lenders have to look at the ability of that borrower to make payments if interest rates go up. So that may restrict credit of marginal buyers, but I think it is the marginal buyer who is unimportant in terms of keeping this economy, or this housing market from collapsing. It’s really the middle income buyer who is going to be more important, because these are the people that are saying: “Look, we have a 2000 sq. ft. house. We’d love to get a bigger house – there’s been one more kid added to the family. We’d like to move to a nicer neighborhood, and a 25-2600 sq. ft. house, I’d like to buy one, but I can’t until either the price softens or interest rates come down.” And we have seen over the last 3 or 4 weeks 30 year mortgage rates come down. So what hasn’t come down yet, as much, has been adjustable rate mortgages. So I don’t think the housing market is going to be as terrible as people are anticipating. And more importantly, I think the stock market is going to be much higher than where it is today. The Dow is going to be over 12,000 – whether it’s 12,500 or 13,000 is anybody’s guess, I just know it’s going higher; the S&P 500 will be higher, and the NASDAQ will be higher. And the odds, at least at this point of a recession are low, and I think that sometime because the economy will begin to slow down and as we get to those 2% GDP growth rates, then you’re going to have the Fed more willing to cut interest rates. That’s because at that point the one lesson they learned from the Great Depression is never allow deflation or low economic growth to get a firm foothold or otherwise you’re on a downward spiral. So judging by what we’ve seen in the reconstructed M3 figures, money supply growth has grown by around 10%; and that’s even growing at double digits elsewhere around the world. So I do expect Treasury yields to shift a little bit lower, the bull market in equities to remain in force. I still believe we could see some weakening in base metals, although I believe oil will finish the year closer to $70 a barrel than it will $50. Natural gas prices should be a little higher, and especially as Evelyn Garriss is predicting we start out this Winter on the warm side, but we’ll finish on a very, very cold side as the Winter ends. So I do not expect things to be as bad as people are predicting. [1:28:17] JOHN: What would that do to things like the metals market, would you say? JIM: I would say that metals should have a very strong run. Frank Barbera who has written a piece on our site, and of course we talked about this in the first hour, that the metals and energy have bottomed, though Frank is still somewhat negative on stocks in general, but I disagree with that point of view I think the stock market is going to be higher. But I also think metals prices are going to be higher, the bottom is in on gold and we may consolidate here for a little bit more until after the election; and I think higher energy prices. So we may be in an all asset bubble. You may see all asset classes rising at the same time as excess liquidity from credit and money creation tries to find a home to reside. [1:29:04] JOHN: Well, Jim, given the fact that we always bring things down to the final picture of where would you be putting your money at this time, where are you going to be putting your money as an investor? JIM: Ok, spin the wheel. [sound of roulette wheel spinning]. Ah, black – energy! Let’s go back to the first item in the Big Picture. First of all, I would be investing in large cap stocks. I’ve been pounding the table since Spring on that. I think that’s where the big money is going to be going. I think small caps have had their day. I think large caps are the place to be, the large cap growth stocks, Microsoft, General Electric, Proctor & Gamble, Coke, Bud, you know, the consumer staple stocks. You still want to be on the defensive side. I also believe that if you don’t own energy by now this is your chance to do so again; the energy stocks are being given away. When you see high quality stocks such as the large international energy stocks selling at 5 or 6 times earnings, with dividends of 2 to 3%, some at 4%, this is your chance to pick up energy on the cheap. I don’t care if you’re looking at international oil companies, integrated companies, the domestic companies, the drillers, the refiners – everything is on the cheap. I would invest in infrastructure plays. I would definitely look at water globally. I’d definitely be picking up on gold stocks, although of the gold stocks I really like the juniors especially deposits that are in Canada, Nevada and Mexico; companies with 2 to 3 million ounces on their balance sheet with the possibility for more and large land packages because I think a lot of these companies are going to be taken out. But I still like energy, water, consumer staples. John, basically everything we’ve been talking about this hour. [1:31:04] JOHN: And all of that said, time has run away from us again for another week, what’s coming up next week on the program of interest? JIM: I have no idea. JOHN: Well, I figured as much but I was really hoping you could fudge it. Our listeners think you’re smart and we fool them every week, but you know, give it a shot. Hey, and everybody, it’s Jim’s birthday. And how old are you anyway? JIM: 35. JOHN: Really. Yeah, you were 35 last year. How long have you been 35? JIM: Well, I figure it this way, John. Like the government, as I get older my computational powers increase so I’ve been hedonically adjusting my age backwards. JOHN: So you realize that’s going to work against you as far as Social Security is concerned. JIM: I haven’t thought that far. See I’m only 35, I don’t have to worry about that for another 30 years. JOHN: Alright, Jim, what’s coming up in the next few weeks. JIM: Well, next week, I’m going to be interviewing Richard Heinberg, he’s written a new book The Peak Oil Protocol. Coming up the last week of October, Andy Kilpatrick he’s written that book I read during Summer vacation. A great book by the way if you want to learn the genius of Warren Buffet, it’s called Of Permanent Value: The Story of Warren Buffet. It’s 1700 pages. The first week of November we will have G. Edward Griffin, The Creature from Jekyll Island. Jonathan Knee, November 11th, The Accidental Investment Banker. Then we’ll have Ike Iossif and then I head off to the San Francisco Gold Show where I hope to interview Ron Paul, Marc Faber, and then the remaining I’m going to try to interview between 8 and 10 junior companies – real up and comers in the junior mining sector. So it’s all going to be about juniors for |
A Few Big Ideas