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The
BIG Picture Transcript
JOHN: Well, Jim, here we go back to one of those sailing or flying analogies that you and I like to use around here. You know if you're out on rough sees, you may be getting pitched quite a bit, and you're worried about tack and everything else that's concerned about keeping the boat upright – and in case of the airplane, it’s keeping it in the air – but the ultimate goal is to know where you are, and why you're there and where you're going. And when we look at oil markets, we go all of the way back to the beginning of winter – remember, we had warm weather – and the perception was that everything was going great; and then in January, it was warm weather, and we began hearing pronouncements that oil was going to go from 50 all of the way down to 30; we were being told that inventories were up, therefore we have this glut of oil. And in reality, these people are simply watching the day-to-day blips on the radar rather than looking at all of the trends – and that really becomes just a bunch of chaff and noise. So what we'd like to do on the first part of the Big Picture here today is to clear out the noise about the oil markets and look at the real, serious trends as things existentially exist. So you have the floor, Jim. JIM: One thing that is very difficult, John, is we are bombarded literally on a daily basis with all kinds of information. You turn on a cable channel, they've got a report – they are telling you one thing; you pickup the newspapers; there's a lot of noise out there. And as you just mentioned, the impression was – if you watched the oil markets since the beginning of the year, with warmer than normal temperatures – there would be less demand for oil therefore; since there's less demand for oil, we had higher inventory levels; and with the economy slowing down, we'd be using less of it. So these are the popular perceptions that are out in the marketplace. And the amazing thing about all of this is that if you take a look at the actual facts, and separate them from the noise that you get a dramatic contrast. For example, crude oil inventories fell 4.8 million barrels last week, it was reported this week on Wednesday – that was a dramatic contrast, and it was in the opposite direction to expectations of a 2 million barrel rise. Gasoline inventories also fell greater than expected: declining 3.8 million barrels, while expectations were for a 1.4 million barrel decrease. Distillate inventories fell 1.3 million barrels below expectations. And here's the key – all three energy levels are below last year's levels, especially with distillate inventories down the greatest: distillate inventories are down 8.4%; crude oil inventories are down 5.1%; gasoline inventories are down nearly 4%; and refinery utilization is down slightly. And so the perception is there's this big inventory glut, inventories have been building, there's less demand for energy – and we'll get to that in a moment. And this is the perception that you're getting if you turn on the financial talk stations, if you turn on the cable stations, that was the impression that you were being given. [3:22] JOHN: Let me see if I can descramble this, though. So what you're telling me is that in all categories the inventories are definitely going down, they are falling. They are not rising in any categories despite all of the nonsense out there. JIM: Yeah. You hear these inventory numbers – and this is the nonsense of it all – they focus on, “okay, inventories are up 150,000 more barrels than expected,” so they are always giving the impression that there's an inventory build. But if you look at inventories, they've been actually falling since 2005. And so for the last two years, there's a down trend in inventories whereas if you turn on the talkies, they are giving you the expectation that inventories are actually rising. The more important figure that I think is very important is to discuss the days of supply. And with the overall supply of crude oil down 5.1%, we're down to only 22 days of supply in this country. And that's the more relevant figure. [4:22] JOHN: Does that include the strategic supply? President Bush was talking about doubling that at one point. JIM: This is the supply of oil in this country without getting to our strategic oil reserves. JOHN: Okay. So it's before that. All right. JIM: Yes. So the strategic oil reserves are there in case of a national emergency, for example Katrina and Rita, when supplies are disrupted. That's what it's there for. But if you take a look at the regular inventory level that they report every single Wednesday and Thursday, these are the inventory levels that we're referring to. And we're down to a 22-day supply. That's the more relevant figure because – we'll get into this section as we get into the demand components – we're not seeing demand destruction. That’s because – remember, the perception is economic growth is slowing down, so there's going to be this lower demand for energy, and anything but that is happening. Actually, demand is increasing in the United States, as well as other parts of the world, such as China and India. So the crude inventory levels have been in a steady decline since last summer. [5:31] JOHN: Yeah. But that's not the picture that's coming down – well, CNBC channels, for example. JIM: Well, no. Because they get you focused on, “oh, my goodness, the inventory was up this week, now it’s down,” and they focus on these small fluctuations of these reported numbers as if inventory levels in the US determine world market prices. It is demand in it's totality around the globe that is more relevant. And that's why I think we need to get to the demand side here in just a minute, but the more important thing is on the supply side: despite rising prices, there has been no demand destruction. Crude oil demand and gasoline demand are up over 2005 and 2006. So despite a slowing economy, despite rising interest rates, the demand for gasoline and crude products is up. [6:26] JOHN: Well, this is sort of sobering if you really begin to look at the statistics that you're talking about here. We are below 2005 inventory levels. We are approaching the summer season when everybody is out driving, and probably lower in these reserves from about the last two years, or something like that. JIM: Yeah. Our inventory levels have dropped and we're now back to inventory levels that were in place in 2005. So, amid all of the chatter about all of this inventory increasing, the actual figures, the actual facts themselves, show just the opposite. We're in a declining trend. And John, I don't know what it's like where you're at, but we've been seeing gasoline prices go up almost every week. It was Tuesday, I think when I filled up my tank, and I paid $3 and 22 cents. So we're already back to paying gasoline prices that were equivalent to when oil was at $78 a barrel. [7:23] JOHN: Yeah. But people don't see that yet. I don't think they see we're en route to $100 ultimately. JIM: No. In fact, if you look at the Energy Information Agency, they reported in the last week that distillate demand is up 71% in the last year. So if you take a look at that, you've got – despite rising production levels – production not being able to keep up with the demand: demand levels are increasing; we are consuming more gasoline and oil in this country today than we were a year ago and then where we were two years ago. And that's why the day's supply is very critical. We're at a 22 day supply in this country. And now as you know, we're entering into that period where refineries are going to have to start gearing up for the summer driving season where a lot more people are on the road taking vacations, taking trips, maybe doing more travel so your plane flights are up because people are taking vacations. So in summary, demand continues to rise both in the US and in Asia – it's been nonstop. Production is struggling to keep place with demand. Inventory levels are at the lowest level they've been at in two years as we head into the summer driving season. I predict, John, by the time we get into summer, we're going to see at least 3.50 a gallon for gasoline, and if we have any trouble whatsoever in the Middle East, supply disruptions in Nigeria, or a bad hurricane season (as we had Evelyn Garriss on last week and she said if you're in Texas and Florida look out, we could have hurricanes hit that area) – if we have anything like that happen, we could be at $4 gasoline in a crisis. [9:09] JOHN: Yeah. Almost overnight as a matter of fact. JIM: Sure. Because inventory levels are down. You can't just look at oil markets from the perspective of the United States today because you have incredible demand coming into this market from Asia – that's especially China and India, and other parts of the world – so whatever inventory levels are in the Nymex aren’t as important as to what global demand for oil is. And I think a more telling story here is that production is having trouble keeping up with demand. [9:45] JOHN: Well, obviously, again, we have investment implications for this whole thing, so what might they be? JIM: Well, number one, John, I think you're going to see refinery margins stay pretty high, so refiners are going to be making money. The other thing is a lot of this perception that the oil markets have peaked, and the demand as a result of the economic cycle peaking, so therefore you don't want to be in energy investments – I think, once again, the facts that we're talking about here are going to prove that to be a false perception about the markets. So you want to hold on the your energy investments, you want to look at areas that are going to be very profitable. Refinery margins, I would suspect, are going to be very wild. So refiners are going to be making money in this, and I think oil companies are going to be making money as will oil service because as demand continues to out pace supply, there's going to be a greater demand on oil service companies – whether it's providing drill ships, drilling equipment, drilling rigs. And we'll get into this when we get into our infrastructure segment that we're going to cover in the Big Picture, so hold onto your oil investments. And indeed, in this market correction, I would be adding to them. [10:59]
JOHN: As John Lennon might have pointed out, imagine this, imagine that – but then there's reality in place of our imaginations. We're going to start a new series right now in this segment of the Big Picture. And this will not necessarily follow week after week, but it's the first installment In what will ultimately become a series spread out over the next couple of months. And we're going to talk about infrastructure – this is an important thing in various parts of the West, especially in the United States. What do we mean when we say infrastructure? First of all, it covers quite a panoply of things. Basically, infrastructure is the technological framework that enables our economy, a modern economy especially, to work: mining, water works, farming, oil, and gas; the power grid is important; the communications structure – how it exists, the webs that we have out there, not just the internet, but the various webs of communication; roads, railroads, bridges, aviation, shipping, tunnels, docks and locks, and canals – things of that nature. A lot of these right now, as the country has been focused on other things the last 40 years and spending its money in many, many different programs some of which I think are irrelevant to reality, but aside of all that, the infrastructure has been falling apart. And now we're discovering that so much funds have been channeled into these other areas that there is no money to repair these things – and yet this is essential to keeping us going. So that's the framework for this series: we're going to talk about what things look like. Jim, why don't you frame the opening of this. [12:58] JIM: You know, John, it's interesting because the American Society of Engineers have issued several reports, and what they said is that America's infrastructure is crumbling. For example, aviation they gave a D+ in terms of gridlock on America's runways. It’s eased from crisis levels early in the decade due to a reduced demand and recent modest funding increases. However, air travel and traffic have reportedly surpassed pre-September 11 levels. Airports are facing challenges of accommodating increasing numbers of regional jets, and new super jumbo jets. Bridges are given a C rating. Dams are given a D rating. Since 1998 the number of unsafe dams has risen by 33% to more than 3500. Drinking water is getting worse. They give drinking a D-. America faces a shortfall of 11 billion annually to replace aging facilities, and comply with safe drinking water regulations. Energy – our power grid has fallen to a D. They're talking about the transmission system is in urgent need of modification; growth in electricity demand and investment and new power plants has not been matched by investment in new transmission facilities. Hazardous waste a D. Navigable water ways – and you're talking about barge and the nation's river systems – has fallen to D-. You know, we're right next to F, John. Public parks are C-. Our rail system in this country – they are listed here for the first time since World War II – limited rail capacity has created significant choke points and delays. This problem will increase as freight rail tonnage is expected to increase at least 50% by the year 2020. So rail is down to C-. Roads are D; schools are D. Security an I. Solid waste systems, or recycling systems, a C. And transit systems are D+; and waste water D-. And the trend, John, has been one of continuing deterioration. So all of this is getting to the point that if we don't do something soon, this is all breaking down. We first pointed out on the show I think it was last December we did a show, and I said the next big thing is going to be infrastructure. This is for two reasons: the developing economies in Asia, such as China, India, Thailand and countries in that region that are emerging and becoming the future strong economies in terms of economic growth rates – so that was one catalyst; the second catalyst was a deteriorating infrastructure network in the West, and most especially in the United States. [15:58] JOHN: I was just thinking as you were talking, Jim, that as the financial storms begin to hit, and government has to renege on a lot of its promises and things, it tends to have to fall back to more basic services which it has been ignoring to a large degree. In essence, there will just not be enough money to go around, and somehow you've got to keep the basics going. So that's a sobering thought in the middle of all of this stuff. But given the fact that this is a very broad subject and it's very difficult to cover all in one bite, we started with oil. So let's just segue from that and look at the oil infrastructure: just the process of delivering energy to where we use is it here in this country. JIM: Let's talk about the sector itself, John. And what we have seen is America's energy infrastructure is in disrepair. It's falling apart because it's an aging infrastructure facility. Our drilling fleet, the average drilling rig out there is 25 years old. If you take the pipeline system in this country, it's 40 to 60 years old depending on what part of the country. Obviously the pipelines in the Western part are not as old as some of the eastern pipeline system. Our tank farms for storing fuel are 40 to 70 years old. Our refineries are 40 to 100 years old. And, you know, there's not a week that goes by that you're not hearing about leaks, fires or breakdowns that are occurring almost every week within our nation's energy infrastructure. And that's what happens when you have a system that's 25, 40 or 100 years old – you know, things start to bring down from use. [17:40] JOHN: You do need a certain amount of maintenance. It's interesting also how we're talking about oil highway taxes. You know, you pay a lot of highway taxes at the pump, but that money has been diverted into other areas rather than maintaining highways. JIM: And it’s the same thing happening here in California. We passed numerous tax increases on gasoline that were supposed to be used to maintain the road system, do the repairs, expand, get rid of congested areas. And obviously that did not happen: a lot of that money was diverted into the general fund. So what has happened at the state level has also happened at the federal level. But I want to begin with the oil infrastructure itself, and everything in oil begins with a discovery. And for a discovery, you need a drill rig, and that's what begins the process. I mean, you need to poke holes in the ground, or poke holes in the bottom of the ocean to find oil or natural gas. First of all, we don't have enough of them – whether on land or sea – and much of what we have today is it needs to be replaced and modernized. For example, a lot of the oil platforms in the Gulf of Mexico were designed for a weather pattern cycle, with cooler ocean temperatures, where storm conditions were less severe than what we've been experiencing since 1995 when the decadal oscillator changed from one of a cooling cycle to one of a warming cycle. And a warming cycle means more storms, more hurricanes, which means higher wave activity as we saw the pictures after Katrina and Rita hit where you had these giant oil platforms that were not only destroyed, some of them were washed to shore. So that whole system needs to be replaced, and needs to be rebuilt. And that's why I think the demand for oil service companies and drillers have plenty of demand for product. If you listen to a lot of conference calls that accompanied a lot of the earnings reports that came out from these companies in the fourth quarter, they are saying: “You know what, we're booked out for the next three-to-five years. There's greater demand for our services.” This is basically lining up with something we talked about in the first segment which is demand is outpacing supply, so a lot of these energy companies are having to run faster and faster just to meet current demand. So we start out with our infrastructure on the drill side. Then you also have processing facilities that are often done exactly at the point that oil comes out of the ground. That’s because you just don't pull it out of the ground and send it to the refinery; sometimes there's a lot of processing that's done in the field, and most often it's done at the well head. So a lot of that equipment needs to be updated. [20:27] JOHN: You know, it's interesting we talk about supply and demand as if at one point there's a demand, another point a supply. Everybody forgets that you have to get it from supply to demand – and that's your pipeline structure. So how does that look? JIM: You're right, John. There's two ways we're going to get the oil to a refinery: either it's going to be pumped through a pipeline, or put on a ship. And quite honestly, we need investments in both. Not only that, whenever you have a pipeline, you also have to have pump stations to push the oil through the pipeline. So pipeline investments are fantastic opportunities. That's why you've seen Berkshire Hathaway – Warren Buffett – move into this area; you've seen some of the very astute hedge funds move into this area. And the great thing from an investment opportunity is you can get dividend yields that range from 6 to 7%; and you're seeing those dividends rise from 5 to 6% a year. And also tank farms – you know, a lot of times you have to have these tank farms because when you get the supply, you keep them there in storage. A refinery needs to have access to these tank farms, so when they need certain kinds of fuels when they change their production mix at certain times of the year. [21:45] JOHN: We seem to have what I call a lot of declining returns here because if you look at the total number of refineries in this country (we went through the 80s and 90s when there was a real bear market in anything relating to petroleum and petroleum production), the number of refineries that we had in this country were cut in half during that time. And despite the increase in oil demand, and this is a double negative, so to speak, going in opposite directions here. JIM: Yeah. One of the problems that we had in the 80s and 90s is that with energy prices falling from their highs in 1980 at $40 a barrel, the price of oil declined, and at times got down to $10 a barrel. You couldn't make money refining oil products. And so a lot of the oil companies were losing literally hundreds of millions of dollars with their refineries because we had so many of them. And so what happened is they were auctioned off, they were sold off, or they were shuttered. The problem now is beginning in the late 90s, demand began to increase tremendously, as demand is still increasing in this new Century. The problem, John, is we haven't built a refinery in this country in 30 years. The last refinery was built in Corpus Christi in 1976. And our capacity – what we have seen is it’s much easier for an existing refinery to expand its capacity, so our overall refinery capacity is down 10%, even though the number of refineries is down by half, because existing refineries have expanded. The problem is today you cannot build a refinery. They've been trying to build one in Arizona for 10 years, and they've been just thwarted by a series of environmental suits. Try to build a refinery. I don't care if it's 100 miles away from any city, and I guarantee you there's going to be a number of environmental lawsuits. So as a result today, we have a number of problems. A lot of the refineries we have left were designed for light sweet crude, and light sweet crude oil production has peaked in the globe. So a lot of the refineries aren't designed for this heavy oil we're getting from Saudi Arabia, or the heavy oil that we get from the tar sands. So as a result, in addition to bringing in 60% of our oil needs into this country, we're importing another 10% of finished petroleum products because we don't have the capacity to refine all of the oil that we consume – whether it's jet fuel, gasoline, diesel fuel. So America, in essence, is importing 70% of its needs when you take into consideration refined-oil products. And what we're trying to do is instead of build them, you might think if you have 40% of your refinery capacity along the gulf coast subject to hurricane damage, it might make some sense to build some other refineries designed for heavy oil built elsewhere, where you're not going to have weather problems. But we're not doing that. [24:59] JOHN: Not only are we not building them here, but we're trying to convince our neighbors in Mexico and Canada that they should plop them in their territory for our benefit. So we're back to NIMBY again. JIM: Yeah. You know, what was amazing in 2005, when King Abdullah from Saudi Arabia was visiting President Bush at his Crawford ranch – and this was after the hurricane damages – he said, “even if we could ship you more oil, which we could, you don't have the capacity in the country to refine it.” So we've got two problems: one, we're not producing enough of our energy needs, and our production of energy is declining each year as our older fields go into rapid decline rates; but on top of that, what we do import into this country, we don't have the refinery facilities to process it. So it's a dual problem that we have. That's why I think that we’ve got double problems here. We're not producing this stuff, and we don't have the ability to refine it. JOHN: Well, first of all, I guess, is anybody noticing this? That would be the first thing because obviously some corrective action is going to be required. And if so, there would probably be investment potential in any company that is involved in doing just what we talked about. JIM: Yeah. I think what you are going to see is with inventories tight, with demand high for gasoline, refinery margins are going to remain high; and I think they are going to remain probably high for the next decade because we're obviously not going to bring on the capacity that we would need to get anywhere near what is required to process all of the oil for our energy needs. And John, like it or not, we live in a carbon-based society. There's nothing there that we can wake up and say, “all right, tomorrow, alternative energy will replace this and we will no longer need that.” We're decades away from that taking place. So throughout our life times we're going to still be using refined-petroleum products, and we will not have the facilities, so the one thing that we need to be doing is we should be doing everything we can to increase drilling to increase supply – whether it's natural gas, especially since most of the power plants that we've built have been natural gas power plants. So we need to increase drilling; we need to build pipelines. And we do need to get some additional refineries located in areas that are away from the hurricane belt; and also that can handle peak demand so that if you have something happen like a Katrina or Rita you would have alternative refineries that can pick up the slack so that we're not faced with these shortages. [27:37] JOHN: Yeah. But the problem you've got with that is, right now, the efforts are to stop drilling, stop refining and stop pipelines. Other than that we can get done what you just talked about. JIM: Sure. It's not that we don't have the technology or the expertise to get it done. It's just caught in a complex web of environmental suits that is tying up this whole process. And that's why people like Matt Simmons said that a lot of knowledgeable people are saying we are heading for a series of energy crises – whether it's triggered by hurricane storms that hit the oil sector in the Gulf of Mexico where we're getting almost 40, 50% of our production of oil and natural gas; whether it's guerrillas in Nigeria shutting down production; whether it's a rapid depletion-decline rate in fields like Cantarell; or it's an event in the Middle East. We don't know. But currently, when I go back to our 22 days of supply, we are very, very vulnerable. And I think it's going to take a series of crises when people are inconvenienced – John, you remember the gas lines in '73 and '74, for almost a five or six-month period the inconveniences were just tremendous. When you have your life disrupted for a period of time, then it starts to hit home and people demand action. But fortunately, whether it was Katrina and Rita, the United States was able to go into the open spot market, buy supplies of diesel and gasoline from overseas, and within 30 days have them ship to the United States. And so we've always been able to go elsewhere and buy the product. And the ability to do that in the future is going to become more limited. [29:19] JOHN: It's interesting when people talk about the conversion from a carbon-based society, say for example, carbon fuels in automobiles, there is quite frequently a sort of a blurry area where people confuse that with power plants. And right now, we don't have cars that run off of energy provided by power plants. It could work if you had some hybrids in the future where you came home and plugged them in outside and they charged up – those hybrids that run say 40, 50 miles on a charge without ever using a gasoline engine. But a second issue is the power plant infrastructure: how we generate the power, the various sources of energy, and also the infrastructure used to distribute it – and a lot of that is old. And our grid, a lot of times we’ve found is sort of a catch-as-catch-can system; you wonder why a tree limb falling across a power line near Boise Idaho will shut down the rides of the San Diego county fair. That actually happened at one point. Why is it that there aren’t safeguards built into the system? And the reason is the grid’s an old system. JIM: Exactly. We saw that, I think, in the summer of 2005 where we had a heat wave that overloaded the system and people died from that heat wave. And so our next discussion in the infrastructure is power plants. And right now, coal fuel is the fuel of choice. But John, it's very difficult to build a new coal power plant. Just look at the problems that TXU is having in Texas. Even though we have clean coal technology. The only power plants we've been building, and this just gets absolutely nonsensical, are gas-fired plants. But if you're going to build a gas-fired plant, you need two things for it: you need natural gas; and number two, you need a pipeline to get the natural gas to the power plant. And so not only do we have the need for more power plants, but I'm not sure basing a power system on a fuel source that is in decline in terms of its production in the United States and Canada makes a lot of sense. That’s because if our natural gas production is going into decline, then we're going to have to import it and most gas is in stranded places which means it's going to have to be liquefied and put on a ship. And as you know, John, you can't build an LNG terminal – nobody want to build them. So if the only kind of plant you want to build is a kind of plant that consumes a fuel that is in diminishing supply or difficult to get to, I'm not sure that makes a lot of sense. So there's another problem there. Not only do we need more power plants, and especially peak plants for times such as during the winter where you get Nor'easters, or the weather really drops and you get blizzards and storms, but also during the summer too when you get these heat waves that tend to hit the Midwest. And heck, even last summer for the first time – I've lived in San Diego since 1982 – and last summer was the first year in which I step outside my door in the middle of July and it was 105 degrees outside; I thought I was back living in Phoenix. So when you have those kind of temperatures, and you get this peak demand, you better have some kind of power plant or peak power plant that can come on line to handle these energy needs. [32:40] JOHN: I take it investing in beach front property in northern Nevada doesn't help the LNG terminals. JIM: No. Because you'd probably… I don't know what you'd have to do. You'd have to get it into a special LNG railroad car. But no. The investment implications here, look at companies that are expanding their existing facilities or consolidating the industry by acquiring or building new facilities. And the other thing I think that we're going to realize is what the rest of the world is realizing which is nuclear power, in terms of providing electricity, is going to be a great source. And I think the sooner we wake up to that and start building these power plants the better off we're going to be. Right now, we have about 100 commercial power plants and that supplies roughly about 14% of the nation's electricity. But the problem is many of these power plants are due to be taken off line because of their aging facilities, so we're going to be retiring plants. So the new ones that are on the drawing board will basically replace those that we've retired – so we're not seeing any net new gains in terms of providing electricity. The other problem that you have if you're going to build a power plant that runs on nuclear fuel (uranium), just like the natural gas power plant: you've got to have uranium. So we need to expedite the mining of uranium and speed up the process. We've had David Miller here on the program who is with Strathmore minerals, and they have a deposit in Mexico and they've been working on that over four years. It takes six, seven years just to get the permits. So this whole area – that's why we have so much disinformation that's going on out there; and a lot of people think you can either flip on a switch and all of a sudden you've got instantaneously some kind of alternative energy that can step in the place of oil, and natural gas – and that's just simply not the case right now. When you take the look at renewable energy, it's literally 1 or 2% of the power of this country. [34:49] JOHN: One of the things that people are always popping up with, Jim – and we have to take a look at it again because it affects both investment, but also a certain level of reality as to how fast alternatives can be brought on line, or are they really viable – the big thing right now, look at President Bush being in Brazil this week, and that is the issue of ethanol. But that may not be pragmatic. I talked to another environmentalist this week who said, “do you realize if we try to produce it on the level in North America that the Brazilians have been doing, we're going to be hacking down forests, and scouring farmland just to plant enough corn to do this.” So this is not the end-all-and-be-all that it would seem. JIM: No. Even if you're looking at alternatives such as wind you run into lawsuits too. They have wind farms in Texas and environmentalists are bringing lawsuits to try to stop them – so it's not easy to get alternatives. You just can't stick a windmill anywhere. They don't want them in the water; they don’t want them off Hyannisport; they don't want them here in California – and so where are you going to put a windmill. So you've got a legal battle in terms of finding a place where nobody is going to oppose you. And even then, wind power can be intermittent. It's not continuous. You get a day when the wind isn't blowing, you don't have power. You're also looking at solar. Solar has some potentials, but in terms of getting to the point where alternative energy is going to replace 100% of fossil fuels, John, from where we are right now technologically speaking, we're talking about decades away. [36:25] JOHN: Yeah. I mean, it's a viable thing – I don't think people should misunderstand us. We need to do that, but I keep talking about a 10 or 20 year bottleneck here where we're just simply not going to press a switch and overnight we’re using these other fuels. What do you do in the meantime? JIM: In the meantime, you've got to do what we were talking about earlier. You've got to expand drilling for oil and natural gas to arrest the decline rates that we're experiencing in the country – because as our decline rates accelerate, that means we're going to have to import more of the stuff from other parts of the world, and from people that don't particularly like us. So you need to have repairs in the infrastructure – whether it's pipelines, whether it's peak load refineries, and also refineries in the areas that aren't subject to major weather damage. You need – as I mentioned – the pipelines, the storage tanks, the processing facilities. And I will go back to what we first started talking about – the aging infrastructure of this country where the drilling fleet is 25 years old, the pipeline system is 40 to 60 years old, tank farms are 40 to 7[0], and refineries are 40 to 100 years old – I mean, as I mentioned with the American Society of Engineers, the nation's infrastructure is crumbling. And the great thing about this is that this can create a lot of high paying jobs in the country at a time where we need something like that. [37:51] JOHN: What we're seeing worldwide is population growth, and that almost immediately translates into greater demand for energy, especially as countries are moving up in their standard of living, and that means we have supplies struggling to keep up. And right now, struggling is probably a good word in this area. JIM: Sure, and the one thing we've seen despite the increase in production is crude oil supply is flattening out; crude oil is getting extremely heavy. And it's more sour crude – so instead of the light sweet crude, which many of our nation's refineries are set up to process, we’ve got incremental growth coming from natural-gas liquids. But there are too many regions in the world, John, that have passed peak production. We've got oil field decline rates that are accelerating in the North Sea, and Cantarell. And all of these things are out there, and we're not informing the public that this is the condition of our energy infrastructure that is so vital in terms of making this economy grow. [38:52] JOHN: Well, then there's always this issue about the public view of this whole thing, and what they believe to be true. It's amazing how much media shapes our opinions – whether it's right or wrong – and the popular media don't seem to be saying what you're saying right now. They saying that demand growth is slowing and they are forecasting for example supply surges, building inventories, yada yada yada, so on and so forth. If you've got the wrong information, you can't make the right investment decisions. JIM: Absolutely, and that's why the reality is supply is peaking, and that's going to result in higher prices. We're not at $30 oil, as they were predicting in January. We're at $60 oil, and we can hit eighty or more this year if we get into the summer driving season at some of the lowest inventory levels that we've seen – so the result is higher prices. And that's why if you take a look at that picture, you ought to own energy for the long run, and what I suspect we're going to see is we're going to go from one energy crisis to the next. Wait until you see the media, by the time we get to May, when gasoline prices are at $3.50, or God forbid, we have a bad hurricane season that knocks out the Gulf production, we'll be looking at $4 gasoline. [40:09] JOHN: Yeah, but just in line with what we were just saying here, though, even as each of these crises walks up and smacks us in the face so the media finally have to deal with it, they offload the reason for it. And so once again, if you don't know what's wrong, you can't fix it. JIM: Exactly. And one of the reasons is the facts that we're talking about here on the program, that's not the message. That's not the news that's being given to the public. It's more of an agenda driven news rather than a factual basis that's being given out there. I think the public is intelligent enough to say, “wait a minute, our production in this country is going down, we don't have anything on the horizon that can step in place and say, ah, tomorrow we'll all be driving electric cars, and we won't need to use gasoline anymore.” I think eventually we're going to have to go that route, but we're not there yet. And by the way, most of the areas of the world that we get our gas, natural gas or crude, don't particularly like us; and the money that we give them is used to sponsor terrorism against people like ourselves. So I think if the public were more informed with these kind of facts I think they could make the basic decisions and say, “you're right, start doing something about it.” Instead of, okay, it's blame it on the oil companies, blame it on something. And that's typically what will happen. Just wait until gasoline gets to 3.50 by May or June. You can see O’Reilly going off on the oil companies, politicians will be calling for more taxes – none of which is going to solve this problem. [41:44] JOHN: You also see this collision coming in the global warming areas because of the fact that the methods that are being proposed for dealing with global warming are frequently the opposite of what needs to happen to deal with the energy crisis. You dealt with the energy situation in terms of getting into these alternatives, and what we need to do in the interim. Global warming would also ride along with it. But right now, they are not running parallel tracks, they are running criss-cross track with each other,. So there's a collision point coming here one way or another.
JOHN: Well, investors woke up to quite a bit of a storm last week, and once again were presented with the concept of risk. Well, there is a way to diversify your portfolio, have less risk, and enjoy a greater retirement security: and that's investing in blue chip stocks that have raised their dividends. To speak about this topic, joining me on the program is Kelly Wright. He's the editor of Investment Quality Trends. You know, Kelly, in the last probably six months, Social Security is once again on the front burner of some of the hottest topics. You've got Congressmen worried about how there isn't enough money to pay out benefits. Last week we had the Chairman of the Federal Reserve saying the money really isn't there in a trust fund; you had Congressmen also saying how do we get around these benefits. And I thought that perhaps we might talk about dividend investing because it looks like for many baby-boomers that what kind of retirement lifestyle they are going to have is going to depend on what they saved, and the type of portfolio and the return that they get. KELLY: No question. I agree with that. I believe that if you're under the age of 45 you probably have to question whether you're going to see those Social Security benefits. JIM: You know, Kelly, you've been following in your newsletter service, you focus on dividends and especially blue chip companies that have a history of paying those dividends. And I wonder if you might set up this scenario because one of the things that people do, and you see this over and over, you’ve seen it written up in financial planning magazines: okay, you retire and they recommend you put 50, 60, 70% of your income in bonds, fixed-account CDs, and cash. But you and I know that we've been dealing with inflation for as long as I can remember, and we're probably going to be dealing with inflation in the future – what's wrong with putting all of your income in a fixed income portfolio? KELLY: Well, you say inflation has always been with us, and you're absolutely right. Unless something dramatically changes with the way the capital markets work we're always going to have inflation and it's in a large part because we have a fiat currency. If you have a fiat currency (which for your listeners that aren't familiar with the term, that just means paper that's not backed by an asset like gold), you have to have inflation. That's what makes that type of capital system work. So the problem with fixed income is that you get your bond and it's got a yield's rate right on, stamped right on it, and that's guaranteed assuming that it's a good credit quality, and you're always going to get that yield. But the thing is you have no opportunity for capital appreciation. So every year your yield is going to be minus the effects of inflation. Now, if you take a very high-quality, blue-chip stock that has a history of paying consistent dividends and consistently raising those dividends, those dividend increases generally help provide a rising tide underneath the price of the stock. So you get two things going for you: You get capital appreciation on your original investment; and then you get dividend appreciation as those dividends are increased. And the net result is the total return that gives you a return above and beyond inflation. And if you stick with that, your returns are going to compound above and beyond inflation – and that's just not something you can do with bonds or other fixed income instruments. [46:24] JIM: Another thing about dividend investing, and I think this is going to play a more important role as we look at the markets, especially since the year 2000, but Kelly, last week investors got a bit of a wake up call that what goes up can go down. And we are now hearing after almost, I forget, 19 quarters of consecutive earnings growth, they are now talking about a downturn – in other words, earnings have peaked. One of the important things about dividend-paying stocks, and especially those companies that can increase dividends, you usually will find – and I think you'll back me up on this – that they are companies that have reliable business models that are predictable; less subject to the whims of the economy – in other words, whether the economy is booming or it's heading for a bust. Therefore, since their business models are more predictable, the management of these companies can increase these dividends with more confidence because they know they'll have continued revenue growth, continued earnings growth. And doesn't that give investors a little more peace of mind, and also at least a return that they can rely on when markets are fluctuating. KELLY: No question, Jim, you hit it right on the head. Competent management is absolutely crucial, and it's critical to the investor. One of the ways we do that, Jim, is one of our six criteria in our quality screen is at least 25 years of uninterrupted dividends. And what that tells you is that this is a company that understands what their market is, they understand what their products and services are, they understand who their customers are; and they know how to manage the company consistently and competently to not only pay dividends 25 years in a row, but to consistently raise those dividends. And another thing about competent management that you really have to look at is what we call the payout ratio. What percent of their earnings are they paying out in the form of a dividend. Now, obviously as a shareholder and an owner of the company, you want to get as much of that payout as you can. But what we found, Jim, is that the better run companies generally keep their dividend payouts below 50% of their earnings. Now, that's very, very smart and the reason why is you have two things that can come at you: some things can come at you by the macro economy – and that effects everybody; but then you have those things that are specific to an individual company. All companies no matter how well they are run go through cyclical, soft patches and when you keep your payout ratios manageable, you can go through a soft patch and not have to lower or discontinue your dividend. And that's something very important for investors to pay attention to: what percentage of those trailing 12 month earnings are they paying out in the form of a dividend. [49:23] JIM: You know, the other thing that would also strike me too is if you have a good business model where management is producing a high rate of return on equity, you want that company to be reinvesting at least 50% of their profits. That’s because if they can make 15 to 20% return on equity, that means every dollar that they are investing they are growing the book value, they are growing the shares, the revenue and the profits for the company which is going to allow them to even offer higher dividends down the road. KELLY: No question about it. Even the best run company in the world has to take a percentage of the profits and plow them back into the business. That's what sustains a business. That's what grows future revenues. And you're absolutely right – ROE (return on equity) is something we look at, and if you can find a company that consistently grows their earnings between 15 and 20%, fantastic. [50:17] JIM: In terms of your criteria, I wonder if you might share with our listeners some of the experience that you have found. In other words, why did you come up with this criteria. You have five or six that you look at when you follow these blue-chip companies, but briefly address a couple of these, and then share with our listeners why you think this is so important. KELLY: Sure. Well, IQ Trends is built on the twin pillars of quality and value. Our academic roots go back to Benjamin Graham and Charles Henry Dow. And one thing that we've learned from Graham and Dow is that before you go to establish value, it's really a necessity that you establish what is quality. So we developed a criteria for selecting blue chips which is six individual criteria. And taken individually, none of these are rocket science, but when you put them together, it's a very, very powerful filter, and it actually eliminates about 96% of the tradable domestic market. And the first one is dividend increases five times in the last 12 years, which shows that a company is able to manage their business properly, and they continue to reward shareholders by increasing dividends. We look for an S&P earnings and a dividend quality ranking in the A category. This has nothing to do with debt. This is their dividends and earning quality; and this is a very, very comprehensive measurement of the company's ability to grow the business and manage it correctly. This is very important to this – this A rating. We look at liquidity – at least five million shares outstanding. This has nothing to do with capitalization. You have a lot of people that talk about small cap, mid cap and large cap. We have absolutely no bias towards a company's size. What we're concerned with about is liquidity: meaning, if we're going to buy a stock or sell a stock, we don't want to have to make an appointment. We want sufficient liquidity to be able to trade. The fourth one is at least 80 institutional investors. The reason why having institutional sponsorship is important is the way that our system works is we identify historically repetitive extremes of high and low dividend yield. So when the dividend is high, that's what we call our undervalued area – and we're generally early. We readily admit that. We buy a company early, and then the rest of the market eventually picks up on the value. So we get in and we get our position, but then you have to have those institutional investors come in to start driving the price up so they get your capital appreciation in addition to your dividend. And then I've already discussed the 25 years of up interrupted dividends. And the last one is earnings improved in the last 7 to 12 years. The fact of the matter is you have to have earnings before you can pay dividends; and a company that can consistently grow their earnings within measurable amounts of time like 12 years, they generally continue to grow those earnings and to pay their dividends. So those are six things that we look for and that's how we identify a quality stock. [53:31] JIM: One thing that you know when you follow the market that even the best run companies sooner or later are going to have a problem. They are going to have a quarter, or maybe two quarters, where they miss their earnings estimates, revenues fall behind, they have difficulty with a product launch; or, there's something that happens in the business. And it's temporary – it's bad news investors react to by coming into the market, selling off the shares and driving it down. But to me, that's when of the best opportunities present themselves because if a company has been well managed for a long period of time, then obviously they have the competent management that can turn that problem around. [54:14] KELLY: No question about it, Jim, and those are actually situations that we look for. You know, so many investors really have a very short timeframe; they don't really take the time to look out over the horizon. One of the benefits of working with very high quality companies that do have a consistent record of paying dividends for 25 years and raising them consistently is that you understand that a company goes through a situation exactly like what you're talking about. And to our benefit, though, when the market does have that knee-jerk, emotional reaction and they do drive down the price of the stock, we are Johnny-on-the-spot, lickety-split, and [we’re] generally picking them up. [54:56] JIM: I wonder if you might give an example of how that worked, and the one that I can think of that's been on your list that you've done well with was McDonalds. JIM: McDonalds back in 2002 – we'll go back a little bit – everyone will remember the mad cow scare where no one was ever going to go to a restaurant and buy a hamburger again. What we found was that number one, there really wasn't the science and the US Agriculture Department wasn’t really that afraid; and so we thought that maybe this might be one of those situations. Now, we're not that subjective, though. In addition to that, McDonalds also significantly raised their dividend in December of 2002. And so the combination of those two events, the mad cow scare and then raising their dividends significantly moved McDonalds into our undervalued category. So we purchased McDonalds in the first quarter of 2003, and we bought it average price around $15. And at the time, their dividend was about, I'd say, 20 to 21 cents a share, or so, right around there. Well, now McDonalds is in the upper to mid-40, their dividend is new a dollar. So on a capital basis alone we've had over 300% capital appreciation, but our dividend yield on those purchases of those shares is now right around 6%. So when you get these opportunities handed to you, you go in and you pick something up like that (like a McDonalds), you will be rewarded, and we still are long that position, and have no intentions of selling it for any time soon. [56:39] JIM: Well, if you look at their five year dividend growth rate, it's almost 35%. KELLY: Absolutely. It's been phenomenal. If you think about it, when we first started buying them, their dividend was about 20 or 21 cents, and now it's a dollar. If you go back to the beginning of our conversation, Jim, you're never going to get that in a fixed-income instrument. Whatever the yield is that's stamped on the coupon, that's all you're going to get as long as you hold that bond; but you buy one of these high quality, blue-chip stocks when they are undervalued and they raise the dividend consistently, you too can get a 400% income increase like we did on McDonalds. [57:18] JIM: That's the thing that, as you mentioned, one of the problems with being an investor sometimes is keeping your horizon short term because if you were looking at McDonalds dividend, Kelly, when you were buying it at 20 cents per quarter, you might have looked at that dividend yield and said, “you know 1 ½ to 2%, I can do better, I can go in the treasury market get 4%.” But, you take a look at that dividend yield today where it's a dollar, I mean that's incredible. That is a big, big jump in the price, almost a four-fold increase in a period of five or six years. How many people have seen their income go up five-fold during that period of time. KELLY: Absolutely. And that's the key to beating the market is you have to have some patience. You have to be willing to let these values develop and show themselves. And you know, if you will do that, you know, you could take a look at a Citigroup, if you go back like nine years eight years Citigroup was a similar situation. They were yielding down in the 1% area. Today, Citigroup yields a little bit over four. If you would have bought them back then in 1997, 1998 when they were only yielding 1%, your yield on your purchase today would be 14%. And I don't know many places where you can go to an A+ rated company that raises their dividend on a 10% annual basis for the last 12 years in a row, and get that type of not only capital appreciation but income appreciation, and this is the only place we know how to do this. [58:59] JIM: Well, Kelly, I know you're an xpectant father, so I'm not going to keep you too long. And by the way – Congratulations! KELLY: Thank you very much. JIM: You may be getting that phone call. As we close, why don't you tell our listeners how they can find out more information about your newsletter. KELLY: Thank you so much, Jim. The easiest way is to go to our website which is of course www.iqtrends.com. And we have some primers on there, some introductions, sample issues and lots of material where you can read about IQ Trends, and our approach – what we do, and how we do it. [59:33] JIM: And Kelly, how's that book coming along? KELLY: You know, we write a little, and we edit a little, we write a little and then edit a little, and we're closer to the end now than we ever have been, so I'm still hoping to get it out this summer. JIM: Well, Kelly, all the best of luck to you, and to your wife, and thanks for joining us on the program. KELLY: Jim, it's my pleasure. I love being with you. JOHN: Well, time for a weather forecast here on the Financial Sense Newshour. We're going to have a derivatives fund moving through the area come early this afternoon. And there will be flurries. JIM: Heavy showers of defaults. JOHN: Flurries of activities in the commodity pits on the stock exchange, but other than that, expect regular weather as normal. In realty, Jim, at the beginning of the year, you wrote rather extensively a forecast for 2007 and it revolved around three issues. And the reason I'm bringing this up for listeners’ benefit is that we're going to track this as we go through the year to see how correct we were. Number one, the first premise was that the real estate market would continue to deteriorate and that would actually spill over into the financial sector. Number two, the economy would slow down, and by the end of the year would be teetering on the verge of a recession. And number three, that there would be a capital market crisis, so at least a severe pull down somewhere in there. JIM: Yeah. And as we're tracking, John, there's not a week that goes by that we're not getting more evidence. For example, this week New Century (a lender in the subprime market) stopped accepting loan applications after lenders refused to grant the company additional credit lines. I mean their stock is down. On Friday it's down another 50 cents. Year to date, the stock prices lost 89 percent of its value. In the last five days alone, it's down 77%. So we're getting more evidence. This week GM was talking about how they are running into problems in their lending division, the GMAC division, that makes a lot of loans. A lot of people don't realize that GM loses money making cars, but they've been making money financing cars and financing consumer purchases through their GMAC division. They are running into problems. So every week we see more companies that are going under or in trouble. Also we read this week there was a report out by the Federal Reserve about foreclosures rising. The Federal Reserve’s Board of Consumer Advisory Council, including consumer advocates and banks met in Washington with various Fed governors, and they said home mortgage foreclosures were the first agenda item; and the Fed officials heard anecdotes of defaults and families at risk. And mortgage borrowing which rose by 793 billion last year was the smallest gain since 2002. But even more so have been the problems in certain areas of the country where they are starting to see whole neighborhoods seize up and deteriorate, where people are basically just walking away from housing areas from foreclosures by filings by lenders who are coming in and seizing the borrower's property. So where it's turning out to be a crisis, in fact, even Fed governor Bies says that the subprime defaults are the beginning of a wave of what they anticipate to be further fallout in this area. So our first forecast of real estate continuing to decline leading to a financial crisis, I think you're seeing that play out. And there's not a week that goes by, in fact, even on Friday, there was more news after that Fed meeting in Washington this week by a Fed governor basically saying that, “you know, this is going to get worse.” It's going to spill over. And she's saying that what's happening in the front of this wave of teaser rate loans that are coming into full pricing, and so we're talking about some of the Alt A type mortgages, not just the subprime market. So this is still going to be continuing to unfold and unwind and it will worsen as we go forward. [3:47] JOHN: Remember at the beginning of the year, everybody was talking about economic growth of 3.2%, but you were saying when this type of thing happens, what? – Fourth quarter one-off events? JIM: Yeah. We had a lot of one-off events in the fourth quarter, warm weather, we had ten year Treasury notes get down to 4.4% the first week of December, and then also we saw the price of oil which in the first week of January got down to about $50 a barrel. So a lot of these were one off, but as it turned out, as they made the second pass on GDP, it turns out that economic growth in the fourth quarter was only 2.2%. I expect the economic growth rate to continue to decline dropping below 2%; and when that happens and especially –now, if you look at interest rates in this bond market rally, they’ve gotten down to about 4 ½% – so that's helping. But oil prices are at 60, gasoline prices are over $3, and probably at $3.50 by the time we get to summer, so demand will be there, prices are going to be going up, that's going to be taking money out of consumer pocket books. And if you add any correction in the stock market – I mean the stock market is having difficulty holding up. You'll see the market be propped up in the morning, the stock market will be up, and by the end of the day the rally fades; and certainly on the day you and I are talking on Friday, that's certainly what is happening. [5:12] JOHN: So I would anticipate, from what you're saying, the little storm front that came roaring through the markets a week ago is not an isolated event, this is probably a front that is ahead of a much bigger one following behind. JIM: Yeah. Even though all three indexes have given up their gains for the year and they are in negative territory as we speak on this Friday, markets are having a hard time holding up. I suspect we're going to see more weakness in economic growth here in the United States, maybe not elsewhere, but in the United States. And also you're going to see a peak in profits. I think profits peaked last year. So as we get into the first quarter earnings you're going to hear more and more companies saying they are not going to meet expectations, there will be warnings; and we should start to get those warnings for the first quarter here in the next couple of weeks because companies certainly know what their first quarter is beginning to look like since, you know, we're only three weeks away from the end of the first quarter. So you'll see some profit revisions downward, slower economic growth and I think a lot of that is going to spill over into the market. So I don't think we're done with this correction yet. I think there is more damage to be done here and especially if we start getting more fall out with these subprime lenders and that starts spilling over into the banking sector. So what we're seeing, I think right now, is just a market bounce and a lot of the technicians I talk to is that we may be forming the right shoulder of a head and shoulder pattern, so expect more weakness in the stock market. [6:40] JOHN: So, what then? We're expecting the Fed to cut rates even though the money supply is currently expanding. JIM: Exactly. I mean if you look at M3 as it's reconstructed that's still expanding by over 10%. You've got M2 which is less inclusive. That's still expanding and that just took a sharp jump by almost 50 billion here in the last couple of weeks of February. But we are starting to see some problems here. The Fed is almost in a trap because you've got a problem with the dollar because a lot of foreign central banks are diversifying out of the dollar; OPEC is diversifying out of the dollar. So if we take a look at the net purchases of U.S. Treasuries in the month of December, a net purchase of only 15 billion – this country needs to take in between 70, 80 billion a month just to finance our trade deficit. So that is not happening. And as banks diversify out of dollars, and especially as interest rates are raised as they were in Europe and also New Zealand, there are other places around the globe where the economic growth rates are much better and interest rates are much higher. So the Fed has a dilemma – they can either save the dollar, which would mean raise interest rates, or save the economy and the financial markets. In the end, I think they are going to elect to save the markets and the economy, and they will reinflate. [8:11] JOHN: Well, you know, we're talking here about economy weakening, but if we look at Ben Bernanke's testimony on Capital Hill a little over a week ago as well, there was all of this happy talk, [saying] not to worry, he sees economic growth accelerating, what?, in the second half of the year. This really begins to look like a speech designed to achieve an outcome rather than speech reflecting a real situation. JIM: Sure, because the Fed has got to do is reflect confidence. And it was funny to see this little dynamic that was going on between Greenspan, in contrast to Bernanke's happy talk about accelerating economic growth the second half of the year, his predecessor was saying by the time we get to the end of the year there’s a one third probability we'll be in a recession. So maybe Greenspan is a little more honest and can speak openly now that he is out of office. I don't see anything that would kick in here right now that would really speed up economic growth in the second half of the year. And real problem is if the Fed waits too long, then plunge us into a recession that we may not be able to recover from because a lot of the demand growth that is coming from consumers has been accelerated and satiated. I mean who hasn't bought a new home? Who hasn't bought a new car? Demand for consumer goods is almost satiated. So what is there left to simulate other than the financial community with speculative investing? [9:33] JOHN: Well, if we were to analyze the track of the storm, how would we do that? JIM: Well, I expect further stock market weakness ahead. I also look for the economy to slow further. And I also think that what is happening in real estate is beginning to rapidly spill over and deteriorate rapidly. And the financial system – in fact, Fed governor Bies on Friday alluded to that, that what we're seeing now is just the beginning. And I quote her words: “the beginning of a wave.” So there is going to be a lot more financial damage and remember, John, we always say the Fed raises interest rates until they break something – break the economy or they break the markets – and now we're starting to see those 17 rate hikes, the damage start to unfold. So what they are going to need now is all three of these things to develop before they get to the point where they'll be cutting interest rates. So far, our storm track or our forecast is tracking fairly accurately. JOHN: Well, Jim, we come to the point where we're going to begin talking about investment catalysts, and you know, people make money various ways looking at the market. Some do it by trading and chasing everything around. Others pick fundamentals about investments and hold that through the various ups and downs and storms. You describe your approach as being that of a global macro. It sounds like something in computer programming. So it seems to work though because consistently you've been out performing the market, so why don't we describe to people what a global macro is. Does it really outperform, or is it just in the ranks of everyone else? JIM: One of the key things that I have learned John in investing in the markets and then also managing money for a while is markets tend to be long trending in nature. There are themes that develop in markets that play out over a longer period of time. And I wrote about this in a piece that I wrote in April of 2003 and I called it the Next Big Thing. And what I referenced in that article, you take a look at the investment markets over the last half Century and the 20th Century, and basically from about 1948 – right after the war – all of the way to 1966, you could have made a ton of money if you were in the US stock market. I mean everything – you did very well because the markets doubled and tripled during that period of time. However, the Dow hit a peak in 1966 and we were beginning an inflationary cycle in the United States that would lead to us abandoning gold backing for the dollar. And we began an inflationary cycle that ran from 1966 to roughly about 1982. And beginning in the 80s, if you were invested in stocks anywhere in the world, the United States or elsewhere, you made money. But most especially in the 80s, the best place to be for that whole decade was Japan. It was the strongest running stock market. So from about 1980 to about 1990, that long trending market, Japan was the place to be. And then from about 1990 until about March of 2000, the best place to be for investment returns was in the United States – and especially technology. And so there were catalysts that were driving these markets, but if you look at since the year 2000, the place to have been is in commodities. You hear a lot of talk about the commodity markets, and that the commodity cycle is over and nothing is further from the truth. That’s because one of the catalysts that I saw early on in this decade was the development of the emerging markets – especially China and India – and we were seeing this also, by the way, in the 90s as more and more manufacturing globally moved to Asia. So the emerging markets of China and India have become what I call a primary catalyst. It's driving the demand for energy, it's driving the demand for commodities. So you're looking at now where the United States, at one time, used to be the major economic locomotive that drove the world economy; you have a second locomotive that I think is going to eventually surpass the United States and that's China, India and the emerging world. So that's the first casualty that we see. And we'll get to investments. And as China building up its infrastructure, as they build up their manufacturing facilities, that is a long trending cycle that is going to spill over into demand for energy, demand for commodities and it certainly is driving that. You know, you've heard in the markets that the commodities cycles over and the only thing that drove the price was hedge funds getting into the market. Nothing could be further from the truth in that. And if you look at the raw industrial spot commodity index, it is hitting new records. In fact, on the day that we speak, it just hit another record. You know, if you look at a chart of that going back to the summer of 2001, it has been a relentless upward driving chart with new records set in 2007. So contrary to what you're being told by, the ‘blow dries’ on bubble vision, is you're seeing a continuation of this trend; and that tells me that although the economy may be weakening in the United States, the demand for raw industrial commodities continues to go up, and that speaks very broadly for the strength of the global economy, especially the emerging economy. So that is a catalyst that I see that is going to be driving investment returns well into the next decade. [15:56] JOHN: Well, how do population dynamics – remember we talk about that earlier in terms of energy – how do population growth, we have a lot more people on the planet right now, how is that effecting global economics? JIM: If you take a look at another driving and especially in the emerging world is population growth, and especially in the emerging markets of the globe. And contrary to what is happening in the emerging economies, you have an aging population from many, many countries around the globe and especially in the Western economies – both the United States, Europe and also in Japan. And so when you have population growth occurring in a emerging economy, what does that mean? That translates into greater demand for all basic things whether it's food, water or it's energy. And so you have a couple of things that are driving some interesting dynamics here as a catalyst. You've got growing populations in the emerging world. That means greater demand for the economy. You've got aging population in the western world which is going to be driving demand for health care, and also is going to overwhelm problems for governments with their entitlement systems which means that they are going to have to inflate. So I see population growth and especially in the emerging world as another catalyst or dynamic that is driving the demand for basic necessities. [17:23] JOHN: You know, this refers back to what we were taking earlier about infrastructure. We have emerging markets going on in certain parts of the world and decaying infrastructure elsewhere in the world, and this ties into the very same thing you're talking about here. JIM: Sure, because we talked about one catalyst was the emerging economies of China, India, and Asia. That's driving demand for commodities and basic necessities. We talked about a second dynamic which is population growth. A third driver, John, is that as these economies grow and expand, that's also going to spill over and create a demand for infrastructure. And we're going to be covering that over the next probably weeks and months because there's so much that involves infrastructure. So a third driver or catalyst that I see out there is this demand for infrastructure, whether it's roads, bridges, airports communication – all of the number of sectors that make an economy work. So that's a third catalyst. [18:22] JOHN: We'll go back and look at the concept of ageing populations in the West and the demand characteristics. That’s true in Europe and North America and places like Australia and New Zealand. Number one there is going to be an increasing demand on entitlement programs. If we break those out, one would be a retirement-type of situations. The other, what I would think, would be healthcare because as people age, they have more health issues – so that's going to be something else. This is all happening in times when government's ability to support that, especially here in this country – Medicare is a debacle right now. A lot of doctors won't even take Medicare anymore because of the nonsense it involves taking, so how is that going to affect this whole thing? JIM: I think we are living, John, in the age of inflation. Central banks are inflating. Currencies are depreciating against each other and there are deficits and money printing. You can see it around the globe because as populations age – which means retirement, pension, Social Security, health care – greater and greater demands are going to be placed on the entitlement system. And the governments simply don't have the money, or the revenue to deliver those benefits. So what they are going to do is inflate those benefits. In fact, we have reference to several Congressmen, who as we've been playing here on the program: “how can we get out of delivering these benefits.” You heard Chairman Bernanke last week saying basically the money isn't there. So when you're talking about the largest retirement population in the history of the United States hitting the Social Security and Medicare system in the next five to six years, the demands on the government to supply those benefits are going to be enormous. And you simply could not raise taxes to pay for it. There isn't enough tax revenue. You could raise tax rate to 100% over $100,000 dollars of income, and you basically run the government for one month. So if you can't raise enough taxes, the only other option is going to be printing their way out of it. And that's why the governments have no choice but to inflate or die. No politician, John, that I can think of in either party would admit that we're bankrupt. It's much easier to inflate. In fact, I've been watching political candidates on both sides, both parties, and what are they doing? They are promising us a better future and more goodies so you if elect those people. How are those goodies going to be paid for? [20:46] JOHN: All they are doing is promising. You know what's really tragic about this, for people in the baby boom generation? The baby boom generation was really the first generation to pay their entire life into Social Security, so it had the earning ability siphoned off by Social Security, at least a part of it because think what would have happened if you and I when we started out working in the job force had been able to channel that money into investments instead of into this system here. And yet, despite the fact that all of that real earning was siphoned off early on, they are not going to see that come back. So they've lost on both ends. Like I said, first the gain then the pain and the first groups that got Social Security had gain, and now there's pain. JIM: And that's what we're going to have. Last year, I said first the gain and pain as you mentioned. And we're going to go through a pain period, and then we're going to go through a gain period following as they reinflate. But eventually, we're going to have more pain because eventually this all leads down the road to hyperinflation. So in summary, I see four catalysts that are driving investment markets for a long period of time. One is the emerging markets of China, India and Asia, which is going to be a primary catalyst and driver, for not only energy demand but demand for commodities. A second catalyst that I see is a growing population base in the emerging world and an aging population base in the Western world. That's going to drive dynamics for health care, problems entitlements and also demand for basic necessities. A third driver that I see is demand for infrastructure in the emerging markets because of their growth rates and their industrial development. And then decay in the Western areas of the world that we talked about – especially the United States. And fourthly, another driver is going to be central banks inflating their currencies, inflating the money supply to pay for things that they can't pay for, or have enough tax revenues. So those are the four drivers that I see. And that is sort of what I see as a longer term picture that's going to drive the kind of investments that we make for not only our clients but also the kind of investments that I'm also making for myself. If you look at the markets, as I referred to earlier, is that they tend to be long trending: once a trend is in place, it becomes a long trending place. And if you can get on board that trend, early enough in the game and ride that trend through the bumps and bounces that you go through, for example, as we did in commodities last week, then that's the way you make real wealth. That's the way you grow your assets. That's the way you grow your portfolio because these trends that we've been talking about – whether it's infrastructure, emerging markets, an aging population, and problems with entitlements and deficits and money printing, these problems aren't going to go away over night. They are going to take years, if not a decade to unfold and complete itself. And that's why I think if you could get on board that trend, and stay focused, clear the mechanism, ignore the noise that you're being fed by the media, I think that's what brings long term success in investing.
Good Afternoon, Ladies and Gentlemen, welcome to the fourth race today at Wall Street Downs, brought to you by Prozac where your mental outlook can always be bullish; and by Maalox, “for an investor, it’s more than a Maalox moment, it’s a way of life.” Now, in new mint julep flavor. [sound of trumpets] Well, it is a beautiful sunny day here at the Downs, the horses are moving towards the gate, and they are Lots of Bucks, Clinical Depression, Stagflation, Smart Investor, Greedy Oil Companies, Bernanke’s Core, Economic Growth, Will He Raise It, and Rising Prices. And it looks like most of the horses…Whoops! Aha, they’re having trouble keeping Economic Growth contained in that gate. It’s hard to slow that horse down, he just wants to run. And they’re off in the fourth race here at Wall Street Downs, and Economic Growth broke right on top down the center. Lots of Bucks, and Smart Investor broke extremely well, then Rising Prices up on the inside. And they’re joined by Greedy Oil Companies, and Bernanke’s Core on the far outside. Three wide comes with Stagflation, Clinical Depression and Will He Raise It off the early pace. Now, they pass the stands for the first time. Economic Growth has a neck out in front, Rising Prices moving up on the outside, and then it’s Greedy Oil Companies racing third. Smart Investor and Lots of Bucks being squeezed out of the leading pack. Stagflation loops up on the outside of Bernanke’s Core. followed by Will He Raise It on the far outside. Economic Growth on the inside is caught – tight course. Oh, that horse is being jousted by Rising Prices and Greedy Oil Companies. Look! Bernanke’s Core’s exceeding expectations, he’s hot on the heels of Rising Prices, he’s leading the pack. Will He Raise It is one length back in third place, backed by long shot Stagflation in fourth. Greedy Oil Companies, Economic Growth are back by two lengths with Lots of Bucks, Smart Investor, and Clinical Depression bringing up the rear. And they’re coming into the final lap now with Rising Prices ahead by a nose. Economic Growth starting to roll now, trying moving up on the outside. Oh, no! Stagflation’s got economic growth up against the rail. Economic Growth stumbles, he’s fallen back. Bernanke’s Core’s in the top of the lane in the race, Rising Prices ahead by a neck, but Will He Raise It is starting to make his move on the far outside. And here he comes, as they make their turn for home. Smart Investor shut down by Clinical Depression. Lots of Bucks in the back of the pack. Bernanke’s Core’s got a head in front. Rising Prices full bore on the inside. Greedy Oil Companies on the far outside. Bernanke’s Core looking upside the race, and as Bernanke’s Core at 12 to 1 wins by a length and three-quarters over Rising Prices in second, followed by Will He Raise It, and Clinical Depression in fourth. Well, there Ladies and Gentlemen you have it. Bernanke’s Core wins the fourth race here today at the Wall Street Downs. Brought to you, don’t forget, by Maalox: “for an investor, it’s more than a Maalox moment, it’s a way of life.” [26:41] JOHN: Time to go to the Q-line, known as the question line. The Q-line is active 24 hours a day for your calls and questions and comments. It is toll free, U.S. and Canada 1-800-794-6480. That 800 number does work for the entire world, but if you're outside the US and Canada, that's your misfortune and unfortunately, you have to pay for the call. Tell us just your first name and where you're calling from. And please, the calls are getting longer and longer and longer and this makes it difficult to roll in here on the program. We received quite a few calls this week. We're not going to be able to get to all of them, but we'll see if we can roll some of those forward in the week to come. Keep it short and pithy, if you're good at pithy things. And also no statements, please. No long editorials or diatribes, unless of course you're running for political office in which event we would prefer to be reimbursed for running your campaign ads. And we have to fill out a lot of paperwork as involves that as well, so here we go. Jim, this is Clarence calling in Chicago, Illinois. I've been hearing talk about the yen carry trade as being significant. And I don't understand it. The bank of Japan raised its interest rates from a quarter percent to a half a percent. Why is that so significant? And I don't understand if you can borrow money at a half of a percent annual interest rate and buy US Treasuries that pay, you know, 4 ½% or whatever, why doesn't everyone do that? And the whole world would be rich. I don't understand. Maybe you could explain it. Thank you, Jim. [28:37] JIM: Okay. Clarence, you may want to listen to the discussion with Gary Dorsch in the first hour of the program in the Expert Series because we get into the carry trade. But basically the carry trade is b |
