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The
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JOHN: Well, here I am, and he we are, I can’t believe tempus fugit. We are down to Q3 of the year. Q3 looked weak, what do you think about Q4? JIM: Well, you know, John, looking ahead I think what’s very important when you’re looking at the economy is to break it down into its component parts. And what I mean by that is the US economy today is made up of manufacturing, which at one time really dominated the US economy all the way up to about the 70s; then we moved to a service economy, so we had the service sector; and then finally, I think more important sector of the economy today is the financial economy. So, why don’t we begin with manufacturing. And it looks to me, like manufacturing is heading into a recession. Even after the last recession, manufacturing in my mind did not fully recover. In fact, we were continuing to shed manufacturing jobs even though we were adding jobs for example in finance, construction and in retail. So it never fully recovered from the last recession, so I suspect manufacturing to continue to weaken. We got the ISM numbers this week which were at 51 (50 is neutral – below 50 is a contraction). And I fully expect that number to go below 50 in the months ahead. The second element of the economy which is the service economy, I suspect it to moderate. And finally, I believe the financial economy – a the part of the economy that runs on credit – to remain strong. [1:41] JOHN: Well, isn’t that part of the problem for economists. They’re always talking trying to analyze the economy from the perspective I would say of the old economic models – a time when the US itself was dominated by a manufacturing economy. JIM: Exactly. That is why I think you have part of the economy in decline, such as what you’re now seeing in manufacturing, and also in housing. But the rest of the economy can be doing fine. That’s why you have higher stock prices. We know for example liquidity is coming into the markets and into the economy, with debt levels expanding at over a 30% rate this year. And when you bring that into the economy it’s going to go somewhere, it’s going to go into rising asset markets, it’s going into things such as stocks and bonds. And that’s one of the reasons I think you’ve seen interest rates fall as much as they have. That’s because one thing that experts really don’t talk about here, is the surpluses that OPEC is running that are somewhere in the neighborhood of 550 to 600 billion; you have Asia running a 500 billion surplus. So you have over a trillion dollars, a good portion of that is getting recycled back into US financial assets from stocks, bonds, mortgages and things of that nature – probably one out of three mortgages is owned by a foreign entity at this point. [3:06] JOHN: Well, obviously, we’re going to go through another shift, so as we go through this why don’t you give us your best sense of what we’re going to see. JIM: I believe that the perception change the Fed and the Administration are trying to convey to the financial markets is to move the markets towards a deflation theme. You want to get the markets worried about deflation as they did between 2001 and 2003, and so you’re starting to hear more and more talk about slowing economic growth, a drop in headline inflation. And what that does, John, is it gives you the cover for the Fed to start the reinflation process, and put it into an acceleration mode through a series of rate cuts which I expect next year. [3:49] JOHN: So you think the Fed’s actually going to be cutting rates next year? JIM: They’re going to have to in order to keep the economy from tanking. You’ve got economists on Wall Street, for example, Merrill Lynch’s David Rosenberg forecasting 2% economic growth next year, all under the assumption that the Fed cuts Federal Funds rate from 5 ¼ today, to around about 4%. Without those rate cuts Rosenberg is forecasting that the economy could drop down to a 1% growth rate or below, which really gives you your hard landing scenario, or even worse: a recession. So the Fed’s own recession model, which is based on the yield curve, is now at 51%. The last time it was at this level was 2001, and we had a recession. [4:35] JOHN: So you’re not forecasting deflation? I mean we’re hearing a lot of that coming from Wall Street right now. JIM: Well, let me repeat as I so often do on this program: we’re not going to see deflation. Only after hyperinflation, will we get deflation. But we’re nowhere close to that now, that’s a few years out. What we get next in my opinion for a 3 to 6 month period is disinflation as manufacturing inventories are brought down, lowering prices, so headline inflation comes down. You’ve got low energy prices, falling from let’s say 78 down to the $59 a barrel. That’s going to work its way through the headline numbers, and what you’ll have then is the perceptions on Wall Street will start shifting focus away from inflation, to slowing economic growth and deflation which is really going to be nothing more than disinflation. [5:33] JOHN: Well, in summary, what does it look like? JIM: Well, I think you’re already starting to see this with the third quarter GDP numbers, although I think the fourth quarter should be a little bit higher. Growth slows in the economy giving us what we call a mid-cycle slowdown. With the financial economy leading economic growth, housing will continue to slow down; consumers should continue spending into Q4. So we get maybe 2 to 3 quarters of below average growth until what I call reinflation kicks in. The Fed will cut interest rates next year in response to weaker economic growth; headline inflation will come down short term through a slowing economic growth and probably some kind of statistical gimmickry, which we’ll get into later onto into the program. And what you’ll see is bond yields should come down into the 4 ¼ or 4 ½ % range; the dollar should start to fall. And I believe you’re going to see large cap stocks power the major indexes higher, which is what we’ve seen recently. [6:33] JOHN: And the obvious question, given this scenario, where would you, the investor, put your money? JIM: Well, it’s going to sound familiar if you’ve been listening to this program. Obviously precious metals – we think the bottom is in in precious metals, as is the bottom in energy. I also think something that people don’t talk a lot about is infrastructure plays. And finally, consumer staples. Metals and energy have a long way to go. And if you look at infrastructure plays, that’s going to become a dominant theme for the next decade. The infrastructure in this country from roads, bridges, airports, to our water system are falling apart. In fact, the American Society of Engineers gives a D on the condition of the country’s infrastructure. It has worsened over this decade instead of improved, and this is the kind of stuff that takes time and money to fix. We’ve been working on expanding the freeway here in North county, and it’s turned into a 3 year project. They’re not going to be done till probably the end of 2007. We’re going to have to rebuild our water systems, airports need to be expanded and fixed; light rail systems put in place; bridges repaired. I mean that’s going to take time to put into place. [7:43] JOHN: And considering how much of the money was originally levied for highway taxes, or taxes at the pump, have been siphoned into other projects, it’s amazing now because those other projects or other programs are now demanding that tax, and the original targets don’t exist there. So it’s going to be interesting to see how they could do this. Any final thoughts as we lead out on this segment? JIM: Sure. The dominant theme that is now at work in the financial markets is the gradual transition from an era of paper assets and disinflation, to an era of inflation leading to hyperinflation. And that’s going to be led by depreciating currencies globally against a backdrop of vast money and credit expansion. And to summarize, basically John, we’re transitioning from an era of paper to an era of things. [8:42]
JOHN: And as we segue into the next segment – I don’t know why they call it a segue, Jim, it’s spelled S-E-G-U-E, how do you get segue out of this, it’s like a ‘segyoo’. JIM: A segyoooo. JOHN: A segyooooo. I don’t write this language, I just have to read it on the air! Ok, we’ve seen oil prices fall over 24% since they reached a high in August. Now the analysts are predicting 40 to $50 oil because of an economic slowdown in the US. Boy, that’s hard to swallow. JIM: Yeah, I think a lot of these guys are in la-la land, John. That’s a lot of the spin, but you know, those aren’t the facts. Let me begin with the oil service sector. In the second quarter, drilling activity was up 7.3% quarter to quarter – that’s the strongest sequential increase that we’ve seen since Q2 of 2003, when the rig count expanded by over 14%. Now, worldwide, drilling demand is high, and we’ve got tight availability which is driving up day rates. For example, in the Gulf of Mexico, day rates on super drill ships have risen from 190,000 a day, to over $500,000 a day; backlogs at drillers are at record levels. [10:22] JOHN: Before you go on, give us an example of that. JIM: Well, for example, one company Pride International, their backlog has risen to 3.1 billion. That’s probably the highest in the company’s history. Their daily rig rate, reflecting what I just said earlier about rig day rates rising, have risen from $43,000 last year to almost $110,000 this year. Now, does that sound like a contracting market to you? JOHN: Is this a trick question? Then why hasn’t this translated into higher PE’s for drillers in the oil sector. JIM: I really believe Wall Street doesn’t get it, they’re still operating with models that were based on large, global production surpluses – you know, going back to the 80s when we had 10 million barrels a day of surplus excess capacity. That surplus has virtually disappeared, we’re down to 1 maybe 2 million barrels. So, in my opinion, those models are no longer valid today. You also have earnings for the drilling sector that is up anywhere from 3800% this year, to 100% in the sector; and then you still have backlogs that are still growing, and the majors are really struggling to keep up with production. [11:36] JOHN: What about the phenomenon called demand destruction? JIM: I don’t know about where you live, but I don’t see it anywhere. The economy may slow down here in the US, but you know you have to take a look at the global economy where you have China and India that are now growing at growth rates between 9 and 11%. Their growth rates are red hot. And also when you take a look at the next 5 years, China is going to become the largest consumer and manufacturer of automobiles – the Chinese aren’t going back to bicycles. Car sales continue to expand in China, and once you own a car you become an oil consumer. [12:12] JOHN: Yes, that society isn’t just going to turn around and go back, so what we really have is a situation where the demand is going to keep growing. And the real question is the supply going to be able to struggle hard enough to keep up. That’s the real issue. JIM: Well, what you have right now, when you really think about it is production for light sweet crude has already peaked. And I think in non-Western countries you’re seeing a lot of peaking in production. Not only just in the United States, but in other countries: the North Sea; you’re hearing a peak in production in Mexico and Kuwait. So what is enabling us to keep up with rising depletion rates at this time is really an increase in non-conventional oil, which is coming from heavy oil sands, shale, and what we’re seeing now in deep-water.[13:01] JOHN: And we hear about new oil discoveries such as Jack #2. JIM: We heard that last November, with PEMEX making a discovery, and then more recently, and of course everybody says, “look, look, there’s plenty of oil out there.” What’s really missing from the news of this discovery is really a realistic appraisal, and quite honestly, whehter the economics of commercial development are favorable. Last week we had Zapata George who said we don’t even have some of the technology to make this stuff work. And the estimates of this discovery, I’ve seen figures everywhere from 3 to 15 billion barrels – a 15 billion barrel discovery would put it on par with Prudhoe Bay. But you really need to pull the oil out of the sea, over 275 miles of ocean, which would take up at least 35 contiguous lease blocks in the Gulf of Mexico. Furthermore, you’ve got like, for example, the head of Devon stating each new test well – just talking about expense here – that they’re going to drill is going to cost the companies between 80 and $120 million a well. In addition, even if you could discover oil there and make it economically viable, your capital development costs are now approaching close to 1 ½ to maybe as high as 2 billion. And then you also have a logistical problem in the sense that deep water rigs are very scarce right now, they’re very expensive, and since this oil deposit lies roughly about 275 miles offshore from the coast of Louisiana, you don’t have any pipelines to carry the hydrocarbons back on shore. So what they’re going to have to use and develop is floating storage facilities and offloading vessels instead of pipelines. And of course, putting that stuff in place making it strong enough to withstand hurricanes – we saw what happened with Katrina and Rita, what they did to the regions oil facilities – imagine what this is going to be like because in sea conditions the further away you get from land the longer the swells can become. We call it fetch in the sailing world. And so you can get bigger waves. And a lot of those platforms that were built close to land in the Gulf of Mexico were designed for 50 to 60 mph winds, they weren’t designed for 100 to 150 mph winds, and 50 to 60 foot seas as we saw during the hurricane season in 2005. [15:32] JOHN: So I guess this translates into the fact that we aren’t going to see this oil for quite sometime, for years to come. JIM: No, absolutely. We’re a long ways off. In fact, more testing and drilling needs to be done out there. We need to develop new technology. They’re going to have to build new kinds of structures, as I talked about – offloading platforms and storage facilities. So the best estimates you’re not going to see production until somewhere around 2014. And even then, the most optimistic forecasts are daily production will range anywhere from 300,000 to 500,000 barrels a day. So at that point, we’re probably replacing declining production, we’re not increasing it. And according to the US Energy Information Agency, the supply of oil coming from the Gulf peaked in 2002 at 1.7 million barrels; since then production has declined; and since peaking in 1971, US oil production has fallen, on average, roughly about almost 6% a year. [16:33] JOHN: Well, that would seem to indicate that we really need to look elsewhere. JIM: Well, it’s not just us, it’s a problem that all Western governments are going to have. 85% of the world’s oil is controlled by people that don’t necessarily like us. Of that 85%, 75 of the 85% is OPEC, 10% is Russia, so you’ve got countries scrambling to secure supplies. For example, recently Japan, which imports all of its energy, just lost out on securing oil and natural gas from Russia’s Sakhalin Island. Instead of that oil going to Japan – making up to about a fifth of the country’s current natural gas imports – that gas is now going to go to China. And even worse, for Japan’s case, is Iran is now canceling the rights held by Impex holdings as Japan’s largest oil company to participate in a development of a new oil field. [17:28] JOHN: So what you have here is all the major Western countries competing against each other to secure oil supplies as the demand goes up, and the supplies still remains relatively constant despite the effort to make everything go up. This does not sound like a bubble or what’s being touted as this glut in energy. JIM: Hardly, in fact as many knowledgeable experts – and I’m talking about real experts, guys like Charlie Maxwell, Matt Simmons – a lot of these guys believe that peak oil is at our front door step. Some as early as 2010, some as late as 2015, but the bottom line here is energy is in a bull market. And what has happened here and what we’ve seen in the month of September is froth has been taken out of the market, and at least now, in my opinion, the correction is over. With the global economy cruising, the oil markets should stay firm, and I think the real opportunity is going to be in oil stocks, both on the international and domestic producers, the drillers and refiners. I just think that it’s going to be one of the key places to be in the next 10 years. [18:35] JOHN: And you’re listening to the financial sense Newshour at www.financialsense.com, online all the time. And the new programs are posted every week, by 7am Greenwich Mean Time, which works out to 2am on the East coast of the United States. And as we always do on this part of the program, it’s time to here from an Other Voice. [18:55]
JIM: Well, Gluttons at the Gate – private equity firms are using slick new tricks to gorge on corporate assets. It’s become a story of excess, and that’s the cover story of this week’s BusinessWeek. Joining me on the program is the author of that article: Emily Thornton. Emily, tell our listeners what’s going on here, and just for example, I’m thinking of Thomas Lee Partners buying an 80% stake in Iowa Falls ethanol producer, Hawkeye Holdings. Within several weeks of making that investment, Thomas Lee collects payments of 27 million by year end, despite the company having earned just 1 ½ million in six months through June. EMILY: Right. Well, Jim, this is a story of how we’re seeing signs of excess on the fringes of private equit. And Hawkeye is one of those examples because basically in the case of Hawkeye, Thomas H. Lee Partners, which is a pretty big private equity firm, announced that it had agreed to acquire the firm in May, and then several weeks later filed to take the company public or rather Hawkeye filed to go public, and then after that it completed its ‘going private’ transaction. So what I think is interesting about that example is just how much there is emerging between the private world and the public world; and a question being raised about what it is exactly private equity firms do – because it’s been most people’s understanding that they take struggling companies, that they take years to fix them up, and then they take them public or they sell them to another company. And in this case, Hawkeye’s case, you have a private equity firm – even before it has finished buying the company – is working with the company to take it public, which could make all sorts of sense for that company, but raises a lot of questions about sort of what private equity is becoming. [21:09] JIM: You know you raise a question there, if you look at some of the buyout firms – and I’m thinking of the 80s, and maybe even the 90s – they would spend 5 to 10 years reorganizing and fixing the company, polishing it up, before they would file to take them public. I mean here you have something that was done simultaneously, and done within what, a 3 or 4 week period. Is this one of the things that has changed here in terms of the market today as exemplifying excess, versus let’s say, what we saw in the 80s and 90s? EMILY: What’s interesting here, and let’s not kid ourselves, this still happens often, right? we still have private equity firms buying companies, spending years, taking them public, selling them to other companies, but we’re also starting to see these examples that we refer to as ‘instant gratification’ examples – which, you know, it’s logical that the private equity firms would be trying to make money as quickly as they can. But the question is raised when that happens do they still have the same incentives to accept companies as much as they did – as you’re saying, in the 80s and 90s – because in those time periods, ultimately, private equity firms and their slash-and-burn tactics that have now become sort of standard corporate procedure actually did have a positive effect on the economy in the end. Folks would say they made companies more competitive, but the question being raised now with these examples that are a little bit extreme, and the big fees that are being taken in, the question being raised is will they still have the same impact after this buyout boom – being the second – and I think it’s a real question and that’s what we’re examining. [22:56] JIM: One of the things that you mentioned in your article too is a few of these firms are using financial engineering in bankruptcy proceedings to wrest control of companies. At the extreme, you’ve got the quick money mindset is manifesting itself in possible illegal activities – and aren’t some of these equity executives being investigated for fraud? EMILY: Yes, they are. Well, there have been two cases of fraud so far. And we really haven’t seen this so much in private equity as we’ve seen it in hedge funds, but yes, we saw one example recently where the SEC charged a founder of a firm with taking investors money and routing it to a horse farm in Michigan which he owned; as well as a company which runs a strip club in Detroit. So, it’s a rather brazen approach, and another sign of froth in the market. [23:52] JIM: You know any feeding frenzy sort of begins with quiet. Why don’t you set the stage of what you think led to this? You talk about the stock market crash in 2000 to 2002, which sent corporate valuations plummeting; and then also in a low interest rate environment, it made it very easy for these companies to borrow money. EMILY: Right. Well, what we try to do in the story is take a step back and look at how we’ve gotten to where we are which is a pretty unprecedented state. I mean at this point, we have private equity firms raising $15 billion funds, which has never happened before. You know, not so long ago, maybe even in 2000, you’d be lucky if you could raise a billion dollar fund. So we just took a look at how is it that private equity ever became so popular. And what we found was basically after the stock market crashed in 2000, and there were lots of low valuations that basically set the perfect stage for private equity. And also, as you were mentioning, interest rates were so low so they basically had a lot of cheap money, and valuations had nowhere to go but up, so their returns looked fabulous. Meanwhile we had pension funds that were struggling to have good returns, and are still struggling to have good returns, so that they were looking someplace else to put their money. And of course venture capitalists had lost a lot of credibility, and so they started giving their money to the private equity firms. So basically, we’re sort of in a period where because they’ve had such positive returns, because so many people were dying to invest in private equity, that private equity firms in some ways are treated as if they could do no wrong – which means, when they started to pay themselves dividends (this started maybe around 2002-2003), lenders were more than happy to lend them money to pay themselves big bucks. And the same is true with fees – these firms are taking very big fees for services which in some cases are unusual, and not even services, and people at this point seem to be fine with it. And lenders seem to be fine with it. And we’re raising the question here though if that will change, as credit markets tighten and we start to see an increase in defaults. [26:23] JIM: Emily, one of the things that strikes me, is this sort of maybe the next fad for returns because certainly during the bear market of 2000-2002 returns were terrible in the market, a lot of money started going to hedge funds, we’ve seen the hedge fund field crowd – I mean how many different strategies can 8,000 different hedge funds have? – and now kind of like the next big thing is private equity. EMILY: Right, well that’s exactly what is driving people to start looking more closely at these fees and dividends right now, because the private equity funds have become so large that folks are arguing that they are driving valuations up – meaning that, before they could buy a company for a fairly cheap price, and now because so many of them are going after the same companies, there’s a risk that they are buying them at a higher price than might be sustainable. So there is a significant risk out there in many experts point of view that we might see them buying companies for too much which could result in worse returns going forward. And in fact, we’re starting to see the private equity returns decrease at just the point where we’re starting to see the compensation levels of everyone in private equity soar – so we’re definitely at some sort of a turning point. [27:48] JIM: However, a lot of these firms are just brimming with cash, and you say critics liken what they’re doing to strip mining, and say the dividends and other fees are becoming goals in themselves. You can make a lot more money than just on fees. EMILY: Yes, there are those critics out there, and there is definitely a different point of view in private equity as to when it is appropriate to take out big fees and dividends than exists in the public markets. And what I’m referring to is in a lot of the cases where private equity firms were taking out fees and dividends they’re taking them out of companies that are not profitable. And that would, at first glance, may strike you as a little strange but the private equity firms argue that that is not really relevant because they are taking these fees and dividends out of companies that have a lot of cash, even if they’re not profitable. So there is a big debate now about the appropriateness of the fees and dividends that they are collecting. And I guess another aspect of this is because they have become so large at this point – for example, they charge fees for their management expertise, so their companies are paying them for management expertise. But at the same time they’re charging their investors which are pension funds and endowments for their management expertise as well – and that’s basically a 1 to 2% fee on their assets which are so large now, maybe 25 to $35 billion – that you kind of wonder since they’re getting hundreds of millions of dollars just from those fees if they have any incentive to do any fixing up of these companies at all. [29:39] JIM: That’s my next question, because as you point out in your article, the corporate raiders of the past did some beneficial things for the business world and their sole purpose obviously was to make money, but they often succeeded in adding value to the broken companies, they would fix them. Now, many of these companies they get involved with, they leave these companies worse off because they’re saddled with debt to pay these fees or dividends to the private equity firms. EMILY: Right, we’re starting to see that. And it’s interesting, for example, Harvard did a study that looked at IPOs that were the result of buyout firms fixing up a company from 1980-2002. And that study revealed actually the IPOs of companies that have been fixed up by buyout firms did much better than companies that had not. But what we’ve seen in 2006 is actually the opposite. We’ve seen the IPOs of companies that had no involvement with private equity firms have done very well, and the companies that have been involved with private equity firms their IPO’s I think are trailing regular companies IPOs by 10 percentage points – so this has raised the question of what kind of value private equity firms bring. [31:03] JIM: This raises a question because the leverage that’s being used is also being financed by banks so banks for example in your article have lent companies 71 billion since 2003 to pay dividends to private equity owners. So here the companies are borrowing money to pay these guys these big fat dividends or fees – in addition to the fees they’re collecting from clients. And doesn’t this kind of leverage, as you point out, raise the risks of defaults here where for example, going back to your original article, Thomas Lee was paid 27 million by year end – and yet the company only earned 1 ½ million in six months. What does that tell you? EMILY: Well, this is a big concern of Standard & Poor's, which like BusinessWeek is also owned by McGraw-Hill companies. And in fact Standard & Poor's has in fact been taking down the rating of many companies almost systematically every time they’re about to do a buyout. They assume that the company will be more leveraged and there goes the notch, which raises their cost of capital going forward. And in a couple of cases now, we’re seeing companies that are going bankrupt as a result of the amount of debt that they have on their books. So you might speak to a private equity firm that will tell you that it doesn’t matter how much debt is on a company’s books if the lenders have lent them that money, obviously lenders are very sophisticated and they would not do something to harm a company. However, we’re starting to see cases of bankruptcy where perhaps the amount of debt on a company’s books was acceptable, but some unseen spike in something like let’s say oil, or gas prices, or resin prices – some surprise – has ended up putting a company in bankruptcy. So I think the point is that private equity firms are managing companies very aggressively, and sometimes the reasons that they’re taking out debt may make a lot of sense at that moment, but they are making assumptions that are not giving companies a lot of wiggle room when something surprising goes wrong. [33:18] JIM: If you take a look at the raiders of the past, you always knew when they took over a company, it was going to be restructured, there were going to be job losses, but in some way there was probably a rationalization that the companies became stronger when they got done. Today, I think – as you point out in your article – critics are alleging that some of the new tools are intentionally driving target companies into bankruptcy as also a means of seizing control of their assets. In your article, you call it ‘loans to own’ – explain that one. EMILY: Well, it’s not even my phrase – it’s a common Wall Street phrase. And it’s a common Wall Street practice. According to many bankruptcy lawyers, basically they believe that private investment firms, private equity firms – also hedge funds – might make a secured loan to a company so that they can, if a company goes bankrupt, they will be at the top of a company’s capital structure. Of course, by doing so, that means they feel more comfortable with the company going bankrupt. So the allegation is that they might make the decision to push a company into bankruptcy more quickly than somebody that had not positioned themselves in that way to benefit. And there are allegations flying in a company called Radnor Holdings, which is in Radnor, Pennsylvania, in which a private equity firm basically first bought equity in the company, and then ended up lending money to Radnor, and some of the creditors allege they did that because they expected Radnor to go bankrupt and end up taking all their assets. And the private equity firms say there is absolutely no truth to that, but that is a controversy that is being watched as potentially an example of loans to own. [35:10] JIM: Emily, how does this all end? Will this end as a passing phase like the junk bond financing of the 80s, or the VC financing of the 90s? Do you think this passes into time? EMILY: Well, Jim, I think that just depends on these firms. I mean they have gotten a lot of money, and they can do many positive things with it, and with the companies they buy. And I would say our story is nothing more here than a warning, and hopefully will be read closely and taken to heart. [35:41] JIM: Alright. Well, Emily, I want to thank you for joining us on Other Voices on the Financial Sense Newshour – great article. Once again, the name of the article is called Gluttons at the Gate – it’s in the current issue of BusinessWeek, dated October 30th. Emily, thanks for joining us on the program. EMILY: Thank you.
JOHN: You know, Jim, we hear from people time to time wondering when you’re going to start writing again for the website – you’ve been derelict in your duty. JIM: Gosh, shame on me. Well, you know, I mentioned earlier in the year, this year I was sort of taking the year off from writing, and I’m kind of thinking of something different, John. You know I’ve been writing for the web since 2000 – actually 99, when I was doing it for my clients strictly, that’s how Financial Sense started, as an electronic newsletter for my clients. And the thing that really surprises me is I write a technical piece, and all my pieces tend to be rather long because of the complex nature of the topics I cover, but if I write a technical piece I have between 15 to 20,000 people who maybe read the piece. When I did my fictional series called The Day After Tomorrow – the last piece that I did you get 50 to 60,000 people reading it. So what that tells me is that there’s a limited audience for reading technical pieces and what I did with The Day After Tomorrow was I would take technical aspects and weave it into a fictional story that people could relate to. And so if I do anything in the future it’s going to be something along those lines. I’ve been thinking in the back of my mind a new series called the Peak Oil Chronicles which is what I’m working on. I’ve got 4 or 5 characters representing the ordinary person; I’m going to bring back the Wheelers. It’s going to deal with geopolitics; it’s going to deal with the issues of oil; it’s going to deal with fiat currencies, hedge fund managers. And so what I’d like to do is take fact and analysis and research and weave it into fiction, which seems to be more palatable to the reader. So I’ll actually be coming back to it. I’ve been toying around with this over the last couple of months and it’s just an idea I have right now. [38:21] JOHN: A friend of mine used to call it a faction. You’re writing fiction but it has lots of facts. You know, we talk from time to time, gold fields, gold mining and prospecting. There are very few elephants left to buy out there anymore, what does that mean? JIM: Well, Ralph Bullis, a well known, respected geologist did a piece a couple of years ago, and he looked at all the potential gold deposits in the world that were either coming into production or currently producing, or were in the discovery stage. And what he was basically saying is there are very few large elephants out there –an elephant being a 5 million ounce deposit. And even with all of the money that has been spent in the last 4 or 5 years – with all of the money that has gone into financing juniors, all the exploration that’s been done – you basically have today 17 companies out there that have deposits bigger than 5 million ounces. Obviously, the biggest one out there is Nova Gold which their global resources are estimated to be 34 million ounces, and of course, they’re being taken over by Barrick. You’ve got Crystallex with about 22 million ounces, but a lot of cloud surrounding them on that because it’s in Venezuela. You don’t even know what you’re going to have if Chavez changes his mind. And you’ve got companies like Gabriel; Bendigo; Canyon – which has problems due to environmental reasons; Miramar Mining. So the point being is if you’re a large company like a Barrick or a Newmont, or a Gold Fields, or a Harmony, if you’re producing 4, 5 or 8 million ounces as the case of Barrick, where are you going to find enough new projects to replace what it is you’re producing. I mean if you take the 17 major projects owned by juniors out there that are 5 million ounces and above, that would only give you two years worth of mine supply at current rates of production of about 2500 tonnes a year. So the point being is the more realistic scenario for takeover candidates are 2 and 3 million ounce deposits which have some blue sky potential to work their way up to a 5 million ounce deposit. And there are just not [a lot of those]– even in the 2 to 3 million ounce, yeah you’ve got a lot more of those around. But those are going to be some of the more realistic candidates for takeovers. [41:01] JOHN: Jim, you’ve often said here on the program, having been on the board of some mining companies that when you look at companies, you use a different approach than most people do. Why don’t we review that again? JIM: When you’re looking at juniors, let me begin by saying that we’ve changed our strategy – we are not going to be buying majors going forward in this market, especially after hearing a lot of the majors give their production profiles at the Denver gold show. And what we’re looking for are intermediates and junior producers and junior development companies. Now, what I think is going to be one of the most profitable areas is late stage junior development companies. And what I look for is a junior that is pursuing a two-pronged strategy, because remember, if you’re a junior then there are only 3 likely outcomes for your project: one, you go into production, in which case you become a producer; two, you become attractive enough to be taken over by a major or intermediate company; or three, you just kind of fade away into oblivion, you never do anything – you’re not economical to become a mine, you’re never developed and nobody’s interested in taking you over, and so day traders just trade your stock. So given the two likely scenarios – the best type, either going into production or being taken over – you don’t know that from the way things are developed in a company which way it’s going to go. So I think a company has to pursue both strategies, because if you take a look at a company like Mine Finders that developed 5 or 6 million ounces at Dolores, well, you know what, they’re going alone – nobody was interested in buying them. You’ve got companies like Gammon Lake; you’ve got companies like Los Alamos. So a lot of these companies are going into production because nobody has had the interest to take them over. And I think the majors are living a game of unreality here, in the sense of where in the heck are they going to be replacing their reserves. Are they going to want to get up at every Denver Gold Show, or every year at their annual shareholder meeting, and say, “Hi, our production declined by another 10% this year, but thanks to higher gold prices we made some money.” You’ve got rising production costs. And so what I think is going to start happening and you’re seeing it already, you’re seeing a lot more takeovers and these takeovers are going to start to accelerate as it really begins to dawn on the majors and intermediate companies – the intermediate companies who are producing let’s say 250,000 ounces a year – they all have ambitions of becoming major, increasing their production profile to a million ounces a year. That’s where the real growth story is. And where are they going to get that? I think the intermediate companies are the real growth story – they’re the Ciscos, they’re the Intels and the Dell computers in this gold bull market. And then what becomes attractive to those intermediate companies are juniors – late stage development plays that have 2 to 3 million ounce deposits with the opportunity to take that deposit and double it. In other words, the advantage for an intermediate to buy a company that has two to three million ounces with blue sky potential is that the intermediate company, if they take them over they have 2 million ounces, they buy them at $100 an ounce – well, if they can discover another 2 million ounces they bring their production cost of acquisition down in half. That to me is the big attractive takeover play that you’re going to see develop over the next couple of years. [44:49] JOHN: Actually, if you remember you wrote about this a couple of years ago, it was called The Pac Man Strategy. JIM: Sure, and a good example of Pac Man is what you’ve seen with Wheaton River and Gold Corp. They’re the leaders, they’re the first Pac Man out but I think you’re going to see others, you’re now starting to see it in Yamana developing and taking over companies in a sphere of the world that they feel very comfortable. So this is a strategy I think that is going to unfold with the point being here is that there are very few elephants out there. And an Aurelian type gold discovery deposit only comes along – that’s probably one of the richest discoveries made in several decades. So very few elephants. I think the ‘two plus two,’ and the ‘three plus three’ strategy - ‘three plus three’ meaning 3 million ounces, 300,000 ounces of production; or 2 million ounces, 200,000 ounces of production – those are going to be the key take over plays going forward. And basically, our gold fund is strictly going to be – our gold account – is strictly going to be intermediates, intermediate producers and late stage junior development plays, because I think that’s the winning strategy in this gold bull market. Forget the majors, unless you’re comfortable, you’re very conservative, well with gold prices going higher you’re going to make money in a Barrick, a Newmont, and Gold Fields, but that’s not where the big money is going to be made. [46:13]
JOHN: Well, as they say, Jim, no one’s life, liberty or property is safe while Congress is in session. I know in States where they have legislatures that meet 3 to 5 months in the year, as soon as the last legislative session runs through, those of us that watch these things go, “phew!” JIM: Thank God they’re over. JOHN: Yes. You know you’re safe for another seven months before you have to spool up again. I guess it’s time we begin looking at something I called a long time ago the great reneging that the US government and other governments in the West, by the way, sooner or later are going to have to begin reneging on all of the social promises they’ve been making to their citizens. And we really know that’s going to be true in the area of Social Security, largely by denial of benefits, increasing means testing, delaying the age of collection. Now something has come across the horizon, so we should be advising everyone to hold onto your wallets, because here comes another scheme in sheep’s clothing. JIM: Sure. The one I’m talking about, as many people remember, when you put money into Social Security, or received it when you retired – it was supposed to be tax free, you were getting your money back. And then in the 80s, they not only increased the level of Social Security taxes, but they also indexed the payroll amount on which that tax was assessed. And then what happened with Bush Sr. is he said, “look, if you take Social Security taxes – roughly 15.3%, roughly 12.4 is Social Security, and the rest (2.9) is Medicare – and what you have now under Bush Sr, in 1991 (remember, “Read my lips, no new taxes”), well, part of the new tax increase was saying after you reach the Social Security limit we’re going to assess an additional Medicare tax on income up to 125,000. So back in 1991, the Social Security limit was somewhere between 50 to $60,000; anything over that up to 125 you would pay the Medicare tax. Then, in 1993, Clinton came in and said: “No, we’re not only going to tax 50% of your Social Security. Up to 85% of your Social Security would become taxable.” And then on top of that Clinton lifted the limit on Medicare taxes so you paid Medicare taxes on all your earned income. Now, the latest rumblings is that AARP – the American Association of Retired Persons – is calling for an increase; well, they don’t call it taxes, the word they use is additional contributions from workers. [49:23] JOHN: It’s like our voluntary tax payments. You know, we volunteer to pay our income taxes. JIM: And so, what AARP is calling for is additional contributions – translated, higher taxes – and also modest adjustments in future benefits. And as I point out, anytime you hear the word contribution, hold on to your wallet, because a contribution means a tax increase. Now, right now, the limits on which Social Security earnings are taxed are $94,200 which is for 2006 income level of which you pay 12.4% Social Security tax. If you work for an employer you pay half of that 6.2, and your employer pays 6.2, and then you pay 1.45% for Medicare and your employer pays a like amount; or, if you’re self-employed you pay the entire 15.3. What they’re calling for now is basically that this cap be lifted, and so that you would pay Social Security taxes on all your income. And there’s something wrong with this: number one, they’ve been stealing from the cookie jar – all the surplus revenues they’ve been raising since 84 when those tax increases went into place, those are IOUs now, that tax money instead of being invested has been spent, and now they’ve issued IOUs. The problem they’ve got now is the boomers are heading into retirement, and they know those cookie jar IOUs are worthless. So they’re looking for some kind of scheme, and they’ve got 9 Democrats that are in hotly contested races that are vowing to go along or sponsor this increase, and it’s getting them into trouble in the polls, because remember the Democrats lost Congress in 94 after those tax increases in 93 that went into effect, and were phased in over 93 and 94. So basically, if you make $100,000 a year, or from 100 to 150, it could cost you an additional $7,000 a year in Social Security taxes, not to mention what you’re already paying in Federal tax, and also Medicare tax, and then also State tax. And there’s something wrong, John, if you take a 35% top tax rate, add 2.9% for Medicare tax, or let’s just lump it all together – Medicare and Social Security – so the top Federal tax rate is 35%, throw in 15.3% for Social Security and Medicare tax – now you’re at over 50%. And in the State of California, you have up to 10.3% in State taxes. There’s something wrong when the government takes 60% of what you make, and you have less than 40%. And we all know, throughout history, what happens when taxation gets this high. [52:23] JOHN: Yes, it’s the three ‘F’s: fraud, flight, or fight. People either commit fraud and those rates are starting to soar as well here. They flee – that’s the flight part – the taxing area or at least move their money out of that area; or failing the above they fight, either at the polls or sometimes violently – that’s what the Boston Tea Party was all about. There have been other tax fights. The other thing too, by the way, about our FICA system is it’s very unfair to the self-employed individual because if you work for somebody you pay 7.6%, but if you work for yourself you pay both shares. So you’re effectively paying double what your neighbor is paying. It’s just not fair. JIM: Well, the amazing thing about this is that you have AARP, which basically uses scare tactics for its own political clout and it’s built that clout entirely on scaring seniors. And here you’ve got some proposals about, for example, allowing younger workers to devote some of their payroll taxes into private accounts where their returns would be much, much higher; and to tap into higher return investments. I mean the returns on Social Security that’s assuming number one you ever get it: in other words, politicians keep their promise. And what they’ve shown and demonstrated repeatedly is they continue to break it. And so, what AARP is making the case for is a lousy Social Security deal for young workers. They’re making it even worse. So what they’re doing is they’re calling for lifting the cap on all Social Security taxes. So you could have a lot of people there, depending on what State they’re going to be living in are going to end up paying 50 to 60% taxes. And you can remember, for example, a lot of the famous rock stars like the Beatles, the Stones, where they were giving up their citizenship because they had 90% tax rates. So you get right back into that flight or fraud syndrome. And another tax issue that really took the markets by storm this week was the proposal by finance minister Jim Flaherty in Canada, who’s talking about taxing income trusts. And essentially what happens is that a lot of companies have gotten rid of their corporate status and moved into income trusts, and are avoiding the corporate tax, because like the US corporations are taxed twice. Say a corporation earns a dollar of profit, it pays a corporate tax rate, then it distributes it to an individual, that individual pays an individual income tax. So profits at the corporate level are really taxed twice: once at the corporate level and once at the individual level when it’s distributed. So the income trusts were designed to get around that double taxation. And you’ve got a lot of politicians in Canada who are saying, “that’s not fair.” It’s this double taxation concept, they’re making the case that a corporation that doesn’t pay double taxation like a trust is not a fair set up. And I tell you, if they go ahead with this – the way the law would work, supposedly is existing trusts would keep their tax exempt status till 2011, but new trusts that would go into place would begin being taxed in the year 2007. So it’s going to be amazing to see where this goes and all of this from a conservative government, which is just absolutely amazing. But politicians around the globe are looking for ways to increase taxation [like] here in the US where you have a Social Security system that’s bankrupt that needs to be fixed. You’ve got AARP here, although AARP is trying to backtrack on this, and you’ve seen some of the AARP ads. Whenever you talk about Social Security reform and you talk about contributions – translated that means they’re going to pick your pockets and raise taxes. And certainly, somebody that makes $100,000 here in Southern California Los Angeles, San Francisco, any part of California where rents can be as high as 4 or $5,000 a month, making $100,000 a month does not put you in Beverly Hills. [56:30] JOHN: And a lot of times by the way, these things are floated out there by politicians and think tanks as trial balloons. They throw it out there and they just see what the sharks do so to speak. And if they get negative feedback then they backpedal and they find another route. That’s how this is done in politics. So that’s what you’re facing. But sooner or later they’re going to have to face this, right? I mean the economics war against them, no matter how they dice it. JIM: Sure. JOHN: You know there’s a lot of talk about terror today, Jim, and there have been a number of books written – The Little Black Book of Communism, and also Death by Government – that prove that the biggest source of terror in the 20th Century worldwide were people’s own governments. More people died at the hands of their governments than as a result of war, or any other related cause. Now, there’s a new book out we’re talking about a new war of the worlds, it sounds like the new great game, doesn’t it? But we’re talking about geopolitical stresses here that will obviously affect the financial markets as well. JIM: Yes, there’s a new book out and we’re going to try to get him, he’s the Laurence Tisch Professor of History at Harvard University, and he’s also a Senior Fellow at the Hoover Institute at Stanford University. His new book is called The Next War of the World. In fact, our listeners can pick up an extract of that book – it’s about 5 to 600 pages, I just got mine yesterday – but in the current issue, the September, October issue of Foreign Affairs there’s a great issue by the way of all kinds of topics, if you follow geopolitical events. But as he talks about in the 20th Century was probably the bloodiest century in history: you had between 167 and 188 million people that were killed as a result of organized violence. And you’d have to go back to the era of Genghis Khan and Tamarlane to find a history that was this violent. And as Mr. Ferguson goes on, it occurred in a period of unparalleled material progress. I mean you had the average per capita GDP roughly quadruple between 1913 and 1998; you had longer life spans, people are living better lives with improved nutrition and healthcare. And yet it was the worse violence that we’ve seen since the 12th Century. And he goes on to document all the various reasons, and he said, “a lot of people say, it was the depression, it was the weapons systems,” but a lot of the ethnic cleansing that took place in the 20th Century basically occurred in small wars where they were killing people with everything from hatchets to machetes. [59:06] JOHN: Well, in his mind, what were the primary, core factors of this violence? JIM: You know, he sums it up to basically 3 factors: one was ethnic disintegration which we’ve seen with global communications, communities thrown into disarray; another one was economic volatility – just go look at what was going on in Germany in the 20s and 30s; and also empires were in decline, as we saw throughout most of the 20th Century with the decline in the Hapsburgs, the Romanovs, and the Hollerzollens and the Ottoman Empires. And the thing about this is he talks about economic volatility, a lot of people say, “well, it was caused by depression.” Not really. Germany didn’t go on a war footing until its economy recovered. When Hitler took over as Chancellor in 1933, he really had to get the economy going before he had the economic means to create the military and the war machine that he would be able to use to start really World War II. And the other thing is, just like the late Roman Empire as it went into decline, as imperial powers crumble you’ve got local elites could compete for the perks of power, and empires rarely break up peacefully. If you look around the world today, and you can just see parts of this, you’ve seen a number of people have written about why you’ve had all of this violence – Samuel Huntington in his Clash of Civilizations. You’ve had all kinds of theories that have come forth about this but it’s just amazing as he points out and what he’s saying is that we cannot learn our lessons from this. This next century could even become more violent than the next century, especially given all the conflicts we see going on around the globe today. [1:00:53] JOHN: You know if there’s one part of the world that would actually encompass all 3 of those categories like ethnic disintegration, economic volatility, etc. it would be the Middle East. I mean this is an area of the world that classically matches all 3 of those. JIM: Sure, it’s probably the one area that has an abundance of all these characteristics of the worst conflict zones of the 20th century. Economic volatility has remained pronounced throughout the whole region even as it has diminished in the rest of the world. As an empire, albeit one that dares not speak its name, it’s losing its grip over the region. Worst of all, ethnic disintegration is already well underway even though many commentators still conceive what is currently the main conflict there as an insurgency against foreign invaders, or what we call Samuel Huntington’s clash of civilization between Islam and the West – but that place is definitely the Middle East. It’s a very unfortunate zone where you have imperial conflict. Most Americans would probably reject the proposition that the United States operates as a de facto empire but we’re very much tied to that region of the world. I mean just look at the fleet, what makes this so disturbing is the escalating civil war in Iraq. What most people don’t realize is that it has the potential to spill over into neighboring countries: the Iranian government is taking more than a casual interest in the politics of post-Saddam Iraq. [1:02:22] JOHN: And one of the areas, I just spoke to former Defense Secretary William Cohen this week, and we were talking about the fact that the US seems hyperfocused on say, Syria, Israel, Egypt – but not a lot of Americans are really watching carefully what’s really going on in Russia, and some of these other interactions. JIM: Sure, and in fact one thing that you’re really starting to see is the rise of a more powerful Russia today but its oil revenues and its rebuilding its military, and Russia is very much involved in the Caspian region; the Caucasus; they’re very much involved in the Middle East. And I’m just going to give you some headlines, for example, one of the shows that we did is a New Cold War a couple of weeks back, and I said, sooner or later you’re going to see Russia make a play in Georgia and Latvia. And I’m just going to read some headlines going back the last couple of years. July 2002, Russian plans 5 more nuclear power plants in Iran – that was from the Washington Post. New railway link to Russia and Iran via Azerbaijan – that’s from Agencie France. Russia favors Iran route for crude exports – that’s the Tehran Times. Putin: Iran doesn’t plan to build atomic weapons (Al-Jazeera) Putin defends arms sales to Iran (Associated Press, April 2005) Iran regards Russia as possible partner to build 20 nuclear power plants (Moscow News, September 7th) Kremlin ready to defend Iran (September 2005, Associated Press) Russia agrees 1 billion arms deal with Iran (December 2005, Washington Post) And just a few days ago: World demands stiff UN sanctions against Iran Putin tells the President of Iran that Russia wants Iran nuclear talks to continue (October 30th Associated Press) Russia calls for gas alliance (October 31st) And then you know if you take a look at news affairs, even on this Friday you’ve got Russia basically saying control of Iran’s nuclear program to go forward. So you’ve got Russia backing Iran. And then a lot of people don’t even realize, for example, at a UN ceremony on December 9th, of 2005 at the UN they had a map of Palestine in place of Israel. In other words, Israel’s name was even on the map. And you take a look at that and the whole exhibit and meeting and celebration was about this new map of the Middle East, and nowhere did you find the word Israel there. So there’s a new war of the worlds that is really developing around geopolitical lines and something that Lutz Kleveman wrote about in his book – we interviewed Lutz back in 2004 – called The New Great Game. And you’re seeing so many of these things unfold here that nobody’s really picking up on it, until one day we’re going to wake up and the Russians are going to invade Georgia, which I think they’re just looking for a [pretext] to attack, much in the way that Hitler was looking for in his invasion of Czechoslovakia. So it’s a new book out, it’s called The New War of the Worlds, it’s by Niall Fergusson. It’s out right now, or if you don’t want to read that you can pick up the current issue of Foreign Affairs September-October issue – it’s all about religion and US foreign policy; it’s got things about Mexico’s election; France and Moslems; it’s got a whole new section on for example the next UN Secretary; the international economy. A great issue, and a great publication to subscribe to and read if you want to know what our elites are thinking in this country and globally.
JOHN: I don’t know about you, Jim, but the older I get the shorter my fuse gets for nonsense, especially when somebody is trying to put something over on you. And you know we hear numbers being thrown out all the time – the jobs figure, the inflation figure, the oil reserves figures – people act like we’re actually out there counting noses, heads or jobs, or dropping dip sticks in the world’s oil supplies. These are all artificial numbers. Some of them are so disconnected from reality we have intelligent people with PhDs and everything else behind their names quoting these as if these were the real McCoy. JIM: Yeah, it’s just like they’re gospel. One of my favorites is they’re always talking about the core rate. They’re worried because the core rate is a little bit above the Fed’s comfort level at 2.4 or whatever the number is, and I’m thinking what person in the world has a cost of living that’s driven by the core rate. I mean it’s such a nonsensical figure that really distracts people from inflation. The other thing that you have to understand is the way the CPI is configured, they use geometric weighting, and what happens in geometric weighting if you have something that is very high priced like say the price of oil starts going up quite a bit from $20 a barrel to $80 a barrel, under geometric weighting a lower price automatically increases the component’s weight. So the lower priced item in the index gets a higher weighting in the index versus the higher priced item. So that’s one way they distort the way they compute the CPI. So anytime there’s something high priced that’s really going up, it gets a lower weighting in the index. And you say to yourself, “my goodness, my utilities, my gas bills, my food bills,” but they get a lower weighting as the costs go up. Another component that they use is what we call the substitution effect and this is the old idea if you’re eating steak and steak prices go up, maybe go to hamburger; if hamburger prices go up, go to chicken and fish; if chicken and fish go up, you go to dog food – I don’t know, you’re eating Alpo. And it’s just not realistic. I mean if people have certain kinds of diets that they’re used to, or accustomed to, if the price of hamburgers go up this week, you don’t automatically just say, “alright, next week we’re going to fish or chicken.” And so there’s a substitution effect. And then we get the seasonalities, where they come in and kind of smooth things out, and it’s just absolutely amazing. So the end result of that is you get an inflation figure which is far lower than what most people are experiencing on a day to day level, and then they’re kind of scratching their heads: “you know, this doesn’t make sense to me, how come I don’t have as much money at the end of the month? Why do I have to use my credit cards? Why do I have to pull out equity out of my home?” [1:14:14] JOHN: You know, Jim, what this does create in the mind of the average American is a certain cognitive dissonance. In the back of their heads they know that something does not add up here, and adds a lot of confusion and also affects other numbers such as GDP and productivity figures. JIM: Sure, because what you get is you have two GDP numbers, you have nominal GDP, which is the GDP number without taking out the effects of inflation then you have the real GDP numbers which what they do is let’s say GDP was $1 million in 2005 – and I’m using this for illustration purposes – the next year, GDP is $1,050,000, well it looks like GDP went up. But what if the only reason GDP went up, is that we had 5% inflation. So what they do is they take nominal GDP, back out the inflation numbers to get at real GDP. Well, obviously, the lower the inflation number, the lower that you subtract from the nominal GDP figure. Otherwise, you’d have a higher inflation figure which today, experts such as John Williams who tracks the old GDP numbers the way they used to compile them, [estimates] that the CPI number is somewhere in the neighborhood today of almost over 6 and 7%, versus the alternatives that they’re using in the 2 to 3% rate. So you’re absolutely right, John, that distorts the GDP numbers. It also distorts the productivity numbers. So as we began this segment, in terms of what we think is going to be in the 4th quarter, I really believe because of the distortions in GDP, manufacturing in this country is already in a recession – and I think that’s being confirmed by the ISM numbers dropping from 54 to 51, and over the next couple of months it will be going below 50 indicating a contracting manufacturing sector. I think the service sector is slowing down, but that will be less volatile than let’s say manufacturing. But more importantly, you have to take a look at the financial sector of this economy which is where money and credit are created and that’s a more powerful segment of the economy today. You have Fortune 500 companies that are getting a good portion of their financing on the credit side look at how much money GM and Ford made from their credit divisions versus what they made from manufacturing cars. You have companies all the way from Caterpillar Tractor to IBM making money from the financial side of the balance sheet. But the point we’re making here is a lot of these numbers, whether we’re seeing these job revisions with the birth-death model, the bogus CPI numbers, the GDP numbers – we live in an almost Alice in Wonderland fantasy world with what these economic numbers really mean. And that’s why you have to go beyond these numbers, and do your own research, otherwise you’re going to have a very distorted view of the world. And I think one of the reasons analysts on Wall Street get the oil picture wrong is they’re going by the old industrial economic models that were valid 30 to 40 years ago, when we have plenty oil – not applicable to a world where excess capacity has shrunk and you’ve got countries around the world scrambling to secure oil supplies. So, you’re absolutely right, John, beware of the numbers. [1:17:41]
JOHN: Well, as part of the ornery, contrarian thinking here on the program – we were talking about lessons in contrary thinking – here we are a few days away from the election in the United States anyway, and the maxim is that the Republicans may lose control of Congress. You’re not necessarily convinced of that. JIM: No, it’s just become so obvious. It was like all the media polls, and all the political pundits that said that Kerry was going to win by a landslide in 2004, and we know that that was not the case. You’ve got a lot of public opinion polls and a lot of popular thinking in the financial press: a doomsday scenario for real estate; you’ve got a doomsday scenario for the financial markets; you’ve got oil prices going to $40 a barrel. I mean all of this stuff is part of what I call propaganda and crowd thinking, and I just don’t buy it. I always question something when it is just accepted without facts as we so often do in the financial world, whether it’s looking at the CPI numbers, or also looking at very popular opinions that, in other words, in the middle of the Summer, they were talking $80 oil, we were in a crisis mode reflecting tight supplies, we had political risk premiums brought in to the oil price, you had weather factor fears coming in, geopolitical fears. And then all of a sudden Goldman Sachs changes its index weighting, they go against the large hedge fund Amaranth – as we talked about earlier in this segment in Joe Duarte’s section. And then all of a sudden everybody is saying, “no, $40 oil, demand destruction, the Chinese economy is slowing down, the US economy is slowing down, so there’ll be less demand for energy.” We just kind of stood there and said, “you know what, that’s what they’re telling you, but that’s not what the facts are telling me.” [1:19:36] JOHN: You know there’s two books out right now, Gustav Le Bon and Charles Mackay have both written about the foibles of chasing after crowd opinions and thought, which are constantly proven wrong by the way. JIM: Sure, I think what both of these gentlemen have written about is the basic distinction of course between a crowd and an individual is this: whereas an individual may act after reasoning and analysis, a crowd acts on feelings on emotion. And what happens is the crowd follows leaders, or follows what they assume to be the actions of leaders. So, in this case it’ll be television anchors, popular financial shows, or popular financial magazines, or newspaper publications. And I think what you always find is the crowd is susceptible to what Le Bon calls contagion, because a crowd does not think but it acts on impulses. Public opinion as we’ve seen so often are frequen |
Q4
- A Look Ahead
"Indecision 2006"