The
BIG Picture Transcript
December 29,
2007
Part 1 Real
Player | Win
Amp | Windows Media |
Mp3
Part 2 Real
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Mp3
Part
1
The
Rise of Gold & Oil
Part
2
Monetary
& Fiscal Stimulus
The
Return of Inflation
Hello way back here.
Boy: What is it?
Well, actually, it's a time machine. I call it a way back. We just set it, turn it on, open the door and there we are.
JOHN: And the second week of “way back.” Welcome back to the Financial Sense Newshour. The last program for the year, in which we are doing reflections upon the previous year and looking forward to the year that is to come. And Jim and I are sitting here in the studio. This is probably one of the, I don't know what you call it, the “funner-est” show of the year.
JIM: “Funner-est.” New word there.
JOHN: Yes, a new superlative form of ‘funner.’
Last week, we covered what, Jim, here on the program?
JIM: I have no idea.
JOHN: Okay. I didn't either, but I was hoping – I was going to – I was going to throw it to you and say, geez, I hope he remembers, you know.
JIM: It's what happens when you get older.
JOHN: Well, last week on the program we covered the forecast that we made at the beginning of 2007 and looked at some clips from the show back at the beginning of the year, both featuring things that Jim had said and things that our guests have said. We took a look at the bull market, the credit crisis and what we called the crime of the century. Those are some of the issues that we investigated on the first part of the year-end wrap up on the program. Really our time machine here. Today we're going to look at the rise in oil and gold. That's going to be one of the major topics that we're looking at because this is going to be important in the year to come. This will be one topic that will also affect the geopolitics of the world. That's something to keep in mind. Both gold, and its relationship to the dollar as well as to the geopolitical situation with gold.
It is hard to believe that oil was close to $50 a barrel just a year ago (January of this year) after just hitting shy of $100 a barrel. We're still close to 90 with no signs of it going down. This has been close to an 80 percent rise in the price of oil year to date over the process of a year. The experts keep telling us “it's going lower.” But we kept hearing that like some kind of Gregorian chant all of the time. Remember, Jim? It was going “to go back to 50 or 40, don't worry.” But it never has. And it's almost as long as you’ve been saying it's been going higher. Well, we've been saying that and we believe that prices are going higher here on the program. Oil prices have to be one of the year's big stories. [3:01]
JIM: Probably the rise in oil and gold this year to record levels is not only one of this year's big stories but even more remarkable is the fact that the story isn't even on anybody's radar screen. You take a look at investors, we saw a big selloff in oil stocks in the energy sector here. In the last month we’ve had a big selloff in gold. The story, John, is not only being ignored by politicians –especially energy – but investors are also selling oil stocks. You remember the outburst when Katrina and Rita hit when oil prices went for over $70 a barrel, remember the huge outcry that we had back then, John? Here we are on the day you and I are talking on this Friday, oil prices are almost at $94 a barrel, gasoline prices are over $3 a gallon. I think what we're seeing is the public has grown to accept the fact that energy prices are here to stay. [4:02]
JOHN: Okay. What do you believe is actually behind this rise because you're not getting explanations from the mainline crowd. We've heard over the years it's been a war premium –that went back to the beginning of the War on Terror – a terrorist premium and a weather premium. Now we're told it's a dollar premium. Will the real premium please stand up. Higher oil prices this year are due to a falling dollar.
JIM: Well, let's take the dollar premium. If you take a look at the dollar it has lost about a third of it's value in this decade. The problem is that against currencies like the loonie the loss has even been greater. However, this year oil prices are up close to 80 percent since January, so you can't blame it on the dollar itself. The falling dollar may account for maybe part of the rise: OPEC maybe doesn't want to pump out as much because they know the dollars they are getting are depreciating. However, I think, the bulk of this year's rise, I would attribute it to the fact that we have an inability of new supply unable keep up with growing global demand. The real reason gets down to simple economics: The greater demand than supply equals higher prices.
JOHN: Well, this gets back to your peak oil thesis. We're going to circle around back to this.
JIM: What I find rather interesting is that we've seen a number of reports over the last couple of years beginning with Robert Hirsch’s report in 2005; last year we had the CFR report that came out in November; the GAO this year; then of course that blockbuster report, the IEA report in the summer. We've had the Petroleum Council report issued this year. They all address peak oil in some fashion or another and what is very clear if you take a look at these reports, they are all talking about a crisis that's looming ahead of us; that window period that you and I have been talking here on the show between 2009 and 2012. Yet, here is the remarkable thing. Like ostriches with our heads in the sand, we continue to basically ignore the warnings.
JOHN: Well, you and Matt Simmons had a discussion over these issues right after the GAO report was released this year. What we'd like to do for the first of our way-back machine examinations here is go back and listen to that discussion from April 7th of this year.
JIM: What I find fascinating is the range of estimates that they used in their study. It was as wide as the Grand Canyon. If you take a look at some of the optimistic side which says peak is not reached until 2040, yet we get more evidence – I don’t care if it’s hearing about Burgan, Cantarell; and especially, we knew that Cantarell had peaked but the decline that they announced earlier this year is much greater than expected; Ghawar. You know, that seems to me to point out that this is closer than we think.
MATT SIMMONS: Well, also, if you look at the GAO table that they have where they have 20 different groups that basically gave them their sort of forecast, most of them don’t have a single point in time (which is probably wise) – they have a range. Two or three have a range of 40 years, so you say why even have them in, other than to say they obviously don’t have any idea. But it’s interesting you can turn that around and say that if you draw a line down with now being the start of 2007, eleven of the twenty have their peak oil arriving within a timeframe that’s within now. So the now actually has far heavier weight than 2037 – it’s just that basically the outlier was 2037. And so I think they appropriately said that they also said that it takes so long to basically prepare for what we do after that, that even if it turns out that it’s 2037, America is remiss at not having a Plan B in place today.
But they also said is that the reason for the uncertainty is that the data is so fuzzy – of course, this has been a hot-button issue of mine for the last five years – that unless we have urgent data reform and start getting field-by-field production reports then we’ll actually discover peak oil the old-fashioned way through the rear-view mirror. And the fact they say there are 14 entities within the government, spread out across the face of the government, that are sort of collecting bits and pieces of the sort of data you need to have – so one of the strong recommendations to the Secretary of Energy is pull all of those together in one tight, coordinated monitoring and look at this like a hawk because it’s going to happen. [8:34]
JIM: They talked about peak oil being dependent on multiple factors: they talked about the amount of oil still in the ground; how much can be recovered; technology costs; environmental challenges; and global demand. However, they are not getting at – in terms of how much we’re consuming and how much we’re finding – what is the present rate of depletion. I would have expected to see more in that vein.
MATT: Well, the problem is: to do a good job – I mean, I know the team of three people that were working on this came down to Houston and spent really pretty well all afternoon in my office and they had a long, long list of things, and we had a long serious discussion, and I applauded them for having their questions so well thought through – but to do an honest job they’ve got to plow through Exxon’s people, and the USGS’ folks, and Cambridge Energy’s folks. And I think they were bewildered as they started putting it together by...boy!, I mean people are all over the map on this. But what I find so increasingly interesting is that all the people that have data come to the same conclusion. All the people that basically pooh-pooh the idea have a bunch of fabulous theses but they don’t have any data. [9:37]
JIM: Wishful thinking.
MATT: Yeah, it’s really wishful thinking. And it starts right at the very top of the CEOs of virtually all the major oil companies, but they have no data. They just have a really pleasant feeling that bad things don’t happen to good people. [9:53]
JIM: What I also found fascinating – they alluded to the fact and highlighted how much we, as a country, are spending for gasoline each year. I think they pointed out like one year we spent 38 billion more. In California, right now, Matt, super is at $3.52. However we’re still making assumptions that present consumption trends will continue. For example, in this report they are talking about 118 million barrels a day will be required by 2030, but no real answer as to how we get there.
MATT: Well, the International Energy Agency and their World Energy Outlook 2006 book had one page that was hand-written by Fatih Birol, the Chief Economist, who shares with me the belief that this is the worst issue of the 21st Century. The fact is that we don’t have the most important missing ingredient in the supply outlook which is what the average decline rate is of the existing fields today. And they say that we think it ranges probably from 2 or 3% in some fields or areas, to 11 or 12% in others. In their models showing that you go basically to 118 million by 2030, they assume an average of 8%. If you take that through a calculator, what it assumes is that the current 85 is down to 10. So we only have to find 105 million barrels a day between now and the next 23 years to get there, which has a statistical likelihood of happening of zero. [11:16]
JOHN: That was from April of this year. Why do you think that with the growing body of evidence that we have here that we're still caught in this rut? It's a thought rut as a matter of fact, like we did back say 30 years ago when we had plenty of oil. You know, you talk here about demand destruction, because the US economy is slowing, because of slower US economic growth oil prices will come down, but we live in a different world today than 30 years ago, and it doesn't seem like people have adapted to that.
JIM: No. And because we've always had plenty of oil, you know, if we don't produce it and our production is down in the United States, we've gone overseas and imported it. So the country finds itself importing 70% of its energy. This reminds me –going back again to that April interview with Matt – of a point that he made about this very issue.
JIM: I guess I see one of the real challenges here, as we’re talking about these statistics, is developing alternatives as soon as we can, but the alternatives are going to depend on the price of oil remaining high. But yet, Matt, I watched a program this morning where you had a bunch of economists and they were talking about, “well, the US economy is going to slow down, as that happens we’re going to have demand destruction and the price of oil is going back below 50.”
MATT SIMMONS: Yeah, they’re crazy. As a group they are so flippant, they’ve been so discredited on the price of oil is going to go back. It was going to go back at 25, go back at 30, going to go back at 40; $30 oil creates a recession – everybody weighed in on that. We blew through $30 like a warm knife through butter. Interestingly today, this morning when the Iranians said we’re going to let the sailors go, oil prices collapsed by a dollar. Well, at the end of the day, I just checked spot prices around the world, and Tapis grade (which is a South East Asia’s light sweet grade) is basically $73.75 today – cash market. Cusiana is $71 – that’s Colombian light sweet crude; Mayan crude in Mexico is $51. So there’s a $20 spread today between heavy oil and light oil. So we’re back to $70 a barrel, it’s just basically not there in WTI even though the forward price it got, the price crossed 70 for December crude. All we need is just a little bit of a hiccup – a little bit of spurt in demand with supply not growing – and we’re likely to have the same thing that happened yesterday in Colorado where a lot of service stations ran out of gas. And that’s a temporary problem because one of their refineries in the Rocky Mountains had some maintenance problems and so they are out of gas. But the world is right on the verge of being out of – run out of oil. But we’re in basically have demand outstrip supply. [13:57]
JIM: You know, I think one of the problems that we have here, Matt, and especially in this country we were so fortunate to have large oil reserves. We were self-sufficient and when our oil ran out we just simply went overseas and bought it from somebody else. So all these economic models that they talk about – the financial guys, the economists, and the Wall Street people – well, typically that held true: if you went into a recession in the past, demand would go down, the price of oil would come down. But we’re not there anymore.
MATT: Yeah, it’s just all the old formulae got thrown out the window. And to basically say, “well, this will be just like the 70s, we’ll have a spike, and then go down.” I say, that’s like somebody saying at the outbreak of World War II, “well, this is just going to be like the Civil War.” It turned out basically it was about the same length, and it was just as awful in its region, but it had nothing to do with the Civil War. [14:01]
JIM: It surprises me, and maybe it’s because of these old paradigms we’re asking the wrong questions. I mean, I am still to this day floored every week when they report these inventory numbers on Wednesday and Thursday. I think something more meaningful might be: What is happening to the depletion rates of the oil fields – as you mentioned; what is happening to car sales in China – some of those things; and how much did we find last year compared to what we consumed? That seems to me more relevant.
MATT: I couldn’t agree with you more. And then the pundits that follow the inventory reports like they’re racing forms don’t have any idea how to properly read the data. You can have ten million barrels more inventory than you did five years ago, but if your demand is way up on a day’s supply you’re in the hole. So we’re operating right now as close to a just-in-time supply as you could possibly get. I’ll tell you what’s most alarming – I’ll go back to Mexico for a minute – is that if it turns out that the 20% decline rate is correct, that it doesn’t moderate (and there’s no earthly reason that it would moderate in my opinion other than just phenomenal good luck), then sometime between now and 2010, Mexico fails to be able to export any oil. And from a US Gulf coast refinery standpoint that is basically a Pearl Harbor day event. And then it puts us unbelievably at the mercy of Hugo Chavez in Venezuela – other than the fact that his oil is basically probably in as big a disarray, other than the synthetic crude projects that he just nationalized. So we have some problems right now that are on our doorstep that are not decades away – they are basically between now and 2010. [16:23]
JOHN: Again, that was in April of this year. You know, one thing that the so called experts always seem to be counting on, Jim, is that whenever the demand goes, they look to OPEC and especially Saudi Arabia and they are going to be there to actually produce it, which even from a geopolitical standpoint is becoming if-ier every single day. So it seems like we have a lot banking on OPEC, and ultimately you believe this is going to be a false hope, and you address that with Matt Simmons earlier this year.
JIM: One of the things I think should get more coverage in the press – one thing that strikes me – is despite spending tens of billions of dollars in Saudi Arabia they’ve been unable to really increase their production.
MATT: Moreover, there are now a growing number of oil sleuths who are plumbing through…I don’t know if you’ve ever gone on The Oil Drum, which is the most sophisticated energy blog on the internet?
JIM: Sure do.
MATT: They’ve had some fabulous exchanges of guys who basically have gone back and lined up all the right data you can get on these new fields that came on in Saudi Arabia, and the fact that they didn’t basically increase production. They did come on. So what we don’t know is where is Ghawar today – is it basically under four, is it under three? We don’t have any idea. Is Saudi Arabia producing nine or eight? We don’t have any idea. What they say is they have 11 million barrels a day of productive capacity, but if we have oil prices up in the 80 or 90 or $100 a barrel this summer because we have too high a demand, they are going to look awfully silly if they basically say, “well, we have 11 million barrels a day but no one wants our oil.” [17:54]
JIM: I was going through the report they were talking about our deepwater oil, and they estimate that will peak in 2016. But if you really boil it down – and this relates back to Saudi Arabia – they conclude that US demand for oil will need to be fulfilled by increases in production from the rest of the world. But here, Matt, you and I are talking about the largest producer in the world, and they can’t increase their production.
MATT: The reality – it would be nice to think otherwise – but the reality of the Middle East oil is that there were 35 giant fields that were discovered, and they were all discovered in a very narrow area. If you sit in the EXPEC center of Saudi Aramco in Dhahran and watch this really well put together 3D movie, the movie starts out with a depiction of the earth cracking and the creation of the Rift Valley and the Red Sea; and what they show is that basically effectively scraped the whole Arabian Peninsula of several thousand feet of what was once rich swampland over until it hit the Zagrous [phon.] mountains – and that’s why these 35 fields are lined up perfectly North to South like they are tankers on a radar screen coming out of the Straits of Hormuz. That’s all the oil that basically got created in the Middle East because of that one event.
What I found out to my unbelievable amazement, as I went back and read some SPE papers about Cantarell before going to Mexico last week, was that in the mid-90s they discovered the most amazing fact that they basically through magnetic surveys the largest meteorite crater that’s ever been discovered was this meteorite they believed hit earth 45 to 60 million years ago and created a ten-by-ten mile crater – that’s the Bay of Campeche. Within that crater floor is every giant oil field of Mexico.
So two acts of God created two of the most prolific basins the world has ever known. And yet for a half a century we sort of assumed oil was kind of dispersed around the world equally, and if we just had two million rigs at work we’d basically be producing 200 million barrels a day. No one ever quite said that, but that was sort of the implication of the architecture that we created for the world we now have. [20:06]
JIM: Another issue I find absolutely fascinating in this whole debate, and I’ve interviewed authors who think peak oil is a myth, some think it is far out in the distance, but when I take a look at it and you boil it down, you’ve got about 75% of the world’s oil lies within OPEC, and another 10% in Russia – their reserves are unaudited, so how do we know what they have are real? They increased by 300 billion in the 80s with no major discovery. Then many OPEC countries, their reserves remained constant.
MATT: Well, they’ve produced another 350 billion barrels of oil.
JIM: Yeah. And you know, the government report even acknowledged this. They said, “wait a minute, Kuwait has not changed its reserves in the last two decades, and yet we know that they produced 8 billion barrels of oil.” The fact that nobody questions this is just remarkable.
MATT: I find it so utterly naïve for people to just say, “you’re stupid, just look at the 265 billion barrels that Saudi Arabia has.” And I say, yes, I know because of the research I did that the senior executives at Aramco under oath told the same GAO entity that there were basically 110 billion barrels in 1979 (of proven reserves under SEC standards) and basically since then they’ve produced down to where that same number would be probably today 18 to 20 billion left. And yet they say they have 265 billion, and they have another 200 billion sitting in reserves if we ever need it. And people say, “thank you, I didn’t realize that.” I can tell you on your program that, trust me, my net worth will exceed Bill Gates’ by 2030, and you’d be a fool to believe it unless Bill Gates had a terrible financial collapse. There’s nothing illegal about me telling you that. I can want that – and that’s kind of what the world has done. [21:52]
JIM: But see – they talk about the US government’s assessment of world oil regions and they talk about there’s the potential there for 2.3 trillion; and they’re talking about 890 billion current; and then a 1.4 trillion potential to be added. Where does it come from? I mean, is there a place we haven’t looked at?
MATT: Yeah, there are – the Arctic and the Antarctic.
JIM: But how do we get it?
MATT: Well, we don’t. But if you want to basically be optimistic, it’s like me saying I’m going to be as wealthy as Bill Gates. There is nothing illegal about me wanting that. And that’s the same reliability of these numbers of the USGS. The USGS is a fine group of computer modelers, and there are some trained geologists there. But unless you drill for oil and find something there have been estimates all the time and through the history of the industry of an area that has so much oil, and the sad history of the industry is that most of the new field wildcats we have drilled have always been dry holes. No one has ever intentionally drilled a dry hole. It was just basically an optimistic assessment that went wrong. [22:53]
JOHN: One of the things that came out on the program this summer when you were talking, Jim –this should be an alarming trend too because it shows how it's depleting internally – is that one of the fastest growing areas of demand for energy is actually inside of OPEC itself. That means OPEC countries have a bigger and bigger incentive to begin fueling their own requirements versus exporting that energy. So now they are actually competitors where before they were actually bulk exporters.
JIM: You know, this is something that I noticed in the BP Statistical Review and the IEA report. You know, when you hear energy demand the first thing that comes to mind is the China story. But the analysts I think are missing the OPEC story. The fastest growth in the world lies within OPEC countries where energy prices are subsidized by government. I think they are paying like 45 cents a gallon in Iran, something similar to that in Saudi Arabia.
The other interesting concept, I think, is that despite billions of dollars (and I'm talking tens of hundreds of billions of dollars invested in energy), Saudi Arabian production is no greater today, John, than where it was, say, two decades ago. In fact, OPEC production has been stagnant the last three to four years right around 3 to 4 million barrels a day.
So if you take a look at their production is not going up that much, and they consume more of what it is they produce, it means they have less to export. So you know, you get a lot of the experts to think about this, because all of our supply assumptions are based on this fact: OPEC will be there to deliver and meet all of the world's energy demand needs. That is a very dangerous assumption in my opinion.
In fact, there was a story in last week's Wall Street Journal and it was about Saudi Arabia and the kingdom’s population has gone from about 6 million to 24 million and they've got a high unemployment rate. Saudi Arabia right now is building four new cities –and when I say cities... – and these cities are going to have one of the world's largest aluminum smelters; they are getting into refining plastics. In other words, they are going to say “we are going to take this raw resource that we have –natural gas and oil – we're going to get into making chemicals with it,” whether it's plastics, whether it's refined gasoline. They are building a couple of refineries. And what that means is they are going to be consuming more of their own production. And yet, John, when you take a look at who has the ability to increase production, next year Saudi Arabia has a new oil field coming online that will produce about 250,000 barrels a day, but Saudi consumption increases next year will be about 200,000. So to me, this is a very, very dangerous assumption in my opinion that they are making here. [25:53]
JOHN: You know, another key issue that we've talked about here is the issue of national oil companies (or NOCs) versus international oil companies (IOCs). It is true is that NOCs who are today's oil titans are not the IOCs and this is another profound change in the energy paradigm. You really especially heard this one come out, Jim, when they were talking about the record breaking profits that the oil companies were making. You could hear the built-in assumption behind talk show hosts and everything that our oil companies are the world's giants.
JIM: Yeah. The international oil companies which only control about 15 to 16% of the world's production and it's like they were responsible for that. If you take a look at oil reserves, about 85% of the world's oil is within OPEC and the former Soviet Union. And then you also take a look at production, and it's like they are blaming the oil companies for this. And this paradigm shift – this goes back to early in the program in that people are still thinking 30 years ago when the major oil companies really controlled the oil market. We're dealing in a much, much different market today and I don't care whether it's politicians, investors, analysts or citizens, they are confused. They don't realize where the oil comes from. And we did another interview with Matt in August of this year and let's go to that interview where we discuss this issue. [27:18]
JIM: As you see it, if you were to look back and connect the dots for our listeners, because so many people (I don’t care if you’re watching a cable channel, or you’re listening to a hearing in Washington) they don’t seem to connect these dots. If you were to connect them where would you begin? And how would this story unfold?
MATT: Well, I guess the first thing I would do is remind the hearing attendees – and that’s probably the best format to make up, because in a hearing you’ve got in theory a lot of people that are intently listening because that’s what they called the hearing for. And I would first of all remind people that we really have a bum road map because we have very poor energy data. And unfortunately, we have tons of poor energy data; and the data is so often in numbers that are basically rounded down to a tenth of a decimal point giving the illusion that it’s good data – and that’s in a very important starting place to remind people how little we know.
If you take all those caveats, there are a few things that are basically profoundly true. The first thing that is profoundly true is that about almost two decades ago, as we entered the last decade of the 20th Century, we had a profound view by most of the energy experts that oil demand had basically peaked and would be unlikely to ever exceed 70 million barrels a day.
And in fact, it took until 1995 before oil demand exceeded 70 million barrels a day. So they were directionally correct for two or three years because the collapse of oil demand in the former Soviet Union was wiping out significant growth every place else.
If you then jump ahead to the most recent forecasts – as of last week by the International Energy Agency for 2008 – we will have basically grown by 22 million barrels a day in oil demand in the last 17 years. And it was all by accident. It wasn’t planned. To have 22 million barrels a day of growth come on an unplanned basis is just astonishing. And since it wasn’t planned we didn’t plan on any more refineries; we didn’t plan on any more tankers; we didn’t plan on any more pipelines.
And in fact, we went through a two decade depression where the price of oil was so low that we kept laying off people, we kept skimping on maintenance, and we kept not recruiting the people. And so now we find ourselves in a box, of finally people are starting to realize that the growth even in the United States we’ve grown our oil demand significantly over the last 15 years. And the growth in China and India and the Middle East is just getting started.
And so there is a bona fide need for oil demand to grow from 88 million barrels a day next year, to 100, then 105, then 110, and 120 by, say, 2030. The problem is that use and supply will always have to equal out. And the supply of oil – growth – has petered out; and in fact, crude oil supply peaked in the spring of 2005, and it’s now about a million barrels a day lower than it was at that peak. And I don’t think there are very good odds that we’re going to get back to that 74, so we’re bridging the gap by natural gas liquids and refinery processing gains and inventory liquidation. And that basically can’t last. So we’ve got a global energy train that’s headed right towards a brick wall, or a granite mountain, and there’s no tunnel through the mountain. [30:34]
JIM: I guess a question is: once we hit that brick wall can we fix it? Because we know that to go out and find oil, develop it, process that, energy takes time and money. And I guess can it be done? Or is it too late?
MATT: I would think the answer is we’ve run out the clock. And I also think that a probable answer that we won’t ever know until 20 or 30 years from now is that there really isn’t a likely place that we know about that you could actually put an armada of rigs – even if you had them – and hope to basically create another North Sea; or three North Seas. And since the North Sea was the last great frontier that came on in the late 60s and peaked in 1999 at 6.1 million barrels a day; and is now down to about 3 ½ million in just seven years – and even if we found another North Sea it probably doesn’t matter. So we’re headed towards a granite mountain. A brick wall you can crash through, and then you don’t have a brick wall. A granite mountain you basically – the train basically wrecks.
JIM: The one thing, as we survey the world today –and you take a look at where the reserves are, who’s producing the oil – is that the major holders and producers of oil and natural gas are the national oil companies. And I guess there may be a problem here in increasing production because the national oil companies don’t have the same objectives or motives that, let’s say, an international oil company has. An international oil company finds oil and they want to produce it out of the ground as fast as they can; where national oil companies may have political objectives that don’t align with the market.
MATT: Well, I think there’s a more profound beginning of thinking in some of the national oil companies; and you can certainly see this if you look carefully at some of the really sensible dialogue going on in Russia. If you’re a country leader, and your only resource to grow your economy is oil and gas, and you can do one of two things: You can produce as fast as you can and to maximize current revenue knowing that at some point it’s going to go into a steep decline – and the faster that you produce it the steeper the decline is; or, you take a big breath and start cutting back the rate at which you produce so that it lasts for another 50 to 100 years. That in the 60s was called conservation production practices.
And I think you’re going to see more and more of the national oil companies start to realize that this is their only game in town, that they do not have a sustainable economy after oil; that oil is peaking; and they’d rather produce two-thirds of what they’re producing now, and have it last longer and create a lot higher prices, than actually just continue to open their valves until they’re in fast decline. You could argue it’s maybe aligning their long term best interests, but it doesn’t have anything to do with a sense of responsibility that “it’s my job to make sure the market’s well-served.” [33:17]
JOHN: Well, if you look at the date, Jim, here we are again, 2007, right at the end of the year, we're talking about oil just like we've been doing here on the show since 2005. And let's face it, oil has been the hot topic and yet for the last three years it's been ignored by a large part of the mainline crowd. I would expect, if this were December 31st, 2008, we'd probably be talking about the same issues regarding energy prices. But let's see, by the time we get there this time next year will it be much higher energy prices?
JIM: A topic that either Matt Simmons has brought up and some of the experts that we've interviewed over the years, everybody keeps talking about this: it's unfortunate, John, but it usually takes a crisis before the politicians wake up and everybody says this is real. When you start getting gas lines again or you have to go to rationing...I don't even know what the price is going to be that is going to give everybody a wake-up call. Maybe it's 125, maybe it's $5 a gallon, who knows? I mean we're over 3 right now and nobody is complaining. So if you take a look and you boil all of this down, there is a gathering storm in energy that is headed our way and I think very few people at this point see it, least of all the politicians. [34:34]
JOHN: Why do you think this is going to be the case anyway?
JIM: Plain and simple, demand growth is unstoppable and supply is starting to decline. I mean if you take a look at the whole energy complex, the infrastructure is rusty, old, just in that last clip we had all of this increase in demand, but we didn't build refineries, we didn't build pipelines, we didn't build tankers. We've ignored this sector and basically we've been just assuming that the oil would be there but we haven't really thought it through. What does 20 million barrels more a day mean? You've got to have more refiners, which is one reason why today that the country is importing about four-and-a-half million barrels a day of refined crude products. You take a look at alternatives: Yes, we're going to have to go in that direction but alternatives are expensive and they face their own separate challenges. Not only that, they take time to develop. You don't just erect a nuclear power plant. And look at all of the technology and timeline that goes into developing whether we come up with a hybrid car, an electric hybrid, a diesel hybrid, whatever the alternatives are. We fell asleep at the wheel soothed by comforting words from the experts: “OPEC will deliver, technology will save us., there is plenty of new oil to be found.” None of these promises or hopes are real, which is why we're talking about $94 oil on the day you and I are talking here as the year comes to a close.
Demand for energy is unstoppable. We've gone from a little over 60 million barrels a day to 87 million barrels a day in two decades. Demand has grown. Think about this for a minute. Demand has grown by over 50%, yet supply –new discoveries – have failed to keep up with consumption for two decades now; and people are surprised? It's no secret why we're looking at $90 oil. The US, by the way, isn't the only game in town today and I think that's what a lot of people, whether it's the pundits complaining...We now have consumption growing in Asia, India, Latin America, and more importantly within OPEC itself. So if you ask me to make another prediction for next year, this is one I will make, and it will be that oil prices will be over $100 a barrel and the only thing that could stop that would be a worldwide recession. [36:58]
JOHN: Well, Matt Simmons and you discussed that by the next fall's presidential election energy will actually have come to the front burner. What we're predicting for 2008 is a turn over in the topics that are discussed during some of these debates; and especially considering by the time we get further into next year, the candidates will be down to two for the most part. But at the moment we're simply ignoring it. So what can you do at this stage of the game? Obviously, the large picture isn't going to handle it. What are you as an individual going to do?
JIM: I can tell you what I'm going to do. I'm going to be buying fuel efficient cars. I’m hoping that we're going to be able to bring diesel into the State of California. Other options I'm looking at right now are the smart car and hybrid and then eventually to convert to diesels. I'm assuming that we're going to get those in California because, John, 65 to 75% of what we use the in this country comes through the transportation system. So if I can get a diesel that gets over 40 miles a gallon and maybe even 50 on the freeway or a smart car or a hybrid that gets 40 and 50, then that means that I'm consuming less. I mean I have designed my life around what we call the “live, work and play” concept: Everything I need to get to work, home, grocery store – things I need – I can do within five minutes. In other words, I live close to where I work. I can literally, if I had to, walk to work or ride a bike to work. And I think you're going to see more and more of this in terms of planning in the future.
Another thing we're looking at right now is I'm talking to companies about getting solar roof tiles so my house is going to be solar powered. So if you take a look at commuting within five miles round trip to the office. So I'm designing energy consumption in my life to have a smaller footprint; and also I think from an investment point of view, we just started our exclusive energy portfolio. But I'm going to keep buying energy companies, energy service companies and invest in alternative energy because I think this is going to be an investment opportunity that stays with us for the next decade. And if you take a look at on top of that share prices of energy producers are still cheap. So I'm going to keep buying, I'm going to keep investing in this area because the energy sector remains in my opinion undervalued, under owned and still unloved. [39:22]
JOHN: You're listening to the Financial Sense Newshour at www.financialsense.com. We're doing the year end review here on the program. We'll be right back.
JOHN: Well, you know about the story we have been covering here on program, Jim, is the bull market in gold and silver. Talking about ignoring things – in the last segment we were talking about ignoring oil – but all of the way, as bullion's performance was being dramatically raised over the last seven or eight years, everybody was ignoring it; everybody kept repeating that old nostrum “it’s a risky investment, why would you want to invest in it.” Yada, yada, yada. I mean 2001, there was a 4% growth; 2002, 24; 2003, 20%. By the time you got to 2005, 13, in 2006 4%, and 2007 year to date, 26%. Those are really good numbers.
JIM: In fact, the numbers you were just talking about in bullion on the day you and I talking, gold is up a little over 12 bucks, so we're probably up 28 or 30%. But the numbers look even better for silver over the last six years. The price of silver, John, has gone up nearly four fold. So if you look back over the last six years we've seen gold go from a low of 255 to a high of, I think it was like 848 or close to 850 this year. [40:49]
JOHN: Yeah. And silver went from a low of somewhere around $4 to close to 16 this year.
JIM: And then if you take a look at the performance of the two major gold indexes, the American Gold Index and the Philadelphia Silver and Gold Index, the returns have been even more spectacular, especially the unhedged HUI index which has gone from a low of 41 back in the summer of 2001 to a high of 463 this year. Think about that. That's a return of over 1000%. [41:19]
JOHN: Yet, at the same time, gold and silver just aren't on the radar screen here for most investors. In fact, you have precious metals selling off right now as we tail out the end. You have Goldman Sachs talking about shorting gold in 2008 as a part of their top ten trades. That's rather significant although something suspicious about that. And now you have the hedge funds selling and shorting gold stocks, so what gives? I mean why is it investors don't see this yet?
JIM: First of all, and this happens with all bull markets, we're still early in the cycle, we've got, at least in this cycle, a long way to go yet. The average investor is not in gold stocks, period. Institutions don't really own the sector beyond a few token shares and then you also have the hedge funds which are simply trading in and out of the sector. They go long, they go short. So you have very few long only funds that are basically saying “hey, we see this as a bull market, we're buying, we're holding.” So the sector is unrecognized, underowned and most of all, it's unloved. They are always bashing gold. I saw one of the financial shows and one of the commentators was talking about the price of gold was going up this year. And he said, “why would anybody want to own gold.” So that's still the attitude out there, which just tells me that we're still early in this cycle. [42:33]
JOHN: What about the inflationary environment we find ourselves in right now. After all, the headline numbers are still rising, money supply figures are growing at double digits and rising inflation is becoming a global phenomenon, so it seems this would be sort of an environment where gold would be shining for that matter. People would be rushing to it.
JIM: You know, I think part of the problem gets down to education. If you went to a public or private school you've been taught Keynesian economics, so you've been taught to understand inflation by its symptoms, i.e., let's say rising prices, not its route cause which is monetary, which is an expanding money supply. If you're a CFA, if you work on Wall Street or in Washington, you've been taught that the Fed is an inflation fighter rather than the creator of inflation. You also have central banks intervening in the gold market to try and limit the rise in gold and silver and then you also have rising bullion prices calling into question government's monetary and fiscal policy, so you're not going to hear anything favorable, John, about gold coming from financial institutions, coming from Washington. And let's face it, people are taught the wrong reasons of what causes inflation. That's the way most people are educated.
And you think about it: you grow up in an education system, whether it's grade school, high school, civics classes, you're taught Keynesian economics, you go into college, you're taught Keynesian economics, you go into Washington, you practice Keynesian economics; or if you go on and get an MBA or become a CFA, you're taught the same thing. So part of this issue is an education problem. And you see it obviously on days where you see nonsensical things like headline inflation is up, but the core rate is okay, and you exclude everything that's going up like food and energy which most of us have to buy every single week. [44:27]
JOHN: Yeah. But the problem is that the lack of education here is endemic, whether you look at Washington or Wall Street or the financial media, they don't have a firm grasp on what caused inflation. So as a result of when inflation happens, they turn to the institution that is causing the inflation, saying, “save us from inflation.” In other words, their idea is we just need to tinker with this some more rather than: “No, the way the system is set up, that's the problem to start with.”
JIM: Yeah. And I think that's what Ron Paul was trying to stress last time that Bernanke was before Congress. He said, “look, we've got an inflation problem and your solution to this inflation problem is to treat it with more inflation.” And people just don't understand that. [45:10]
JOHN: Walk into your bank, ask the teller what causes inflation. He or she, this lady or gentleman, handles money all day long. They for the most part can't do it. I was actually surprised when a lady at our bank who was from Great Britain, believe it or not, I said what causes inflation and she just pounded right out: An increase in the money supply. And I literally, Jim, stood there with my mouth hanging open. I kid you not. I said I can't believe I just heard you say that. You know, you got it right.
JIM: Yeah. But it gets back to an education issue and you have all of this nonsensical talk about central banks worried about inflation, yet they are allowing money and credit to expand at double digit rates in their country. And this is global, John, and that's a point that we have tried to make here: All central banks are allowing money supply to grow at double digit rates and, voila, what do you see? Real inflation rates are probably closer to 8 to 10% than what were reported. Even the doctored headline numbers are in the high single digits, yet we talk about the fictional core rate of inflation as if this was a real number. Inflation, which is what we tell people, is seen as rising prices rather than the rising monetary aggregates. [46:24]
JOHN: Well, that's amazing. Last week the PPI and the CPI rose more than expected, yet gold and gold stocks sold off in response to that, which gets back to what you've been saying about financial ignorance.
JIM: This is fascinating and this will kind of illustrate it because on the date that those numbers came out, there was a financial cable show and they asked a panel of Wall Street pros that they had on the show how best to invest when inflation is rising as it was reported last week with the PPI and CPI. And here was the multiple choice that they asked the panel. The panel was given four options with rising inflation: Option one, you invest in Walmart; option two, you invest in Procter & Gamble; option three, you invest in Lehman TIPS which are Treasury Inflation Proof Securities –they go up by the amount of inflation; or four, you buy the gold ETF. What do you think these Wall Street pros went with? [47:23]
JOHN: They bought those gold ETFs. They had to.
JIM: Wrong, my friend. They chose stocks or TIPS. One pro even went on to disparage gold and said you wouldn't want to own gold. And here the good news for investors is that no one but smart money gets the gold story; and so that goes to show you how early on we're in in this cycle at this time.
JOHN: Let us go back to April of this year, we had an interview that we did with Jeff Christian. This was on April 28th and this was his take on the situation of which we are discussing.
JIM: You know, Jeff, as I was reading your book, I was taking a look at one of the things that you talked about, and you said last year average annual prices for gold increased by 36%. That was the second highest average price in history surpassed only by a 611.98 in 1980. This price performance follows five years of rising prices. What’s driving gold’s performance in your opinion?
JEFF CHRISTIAN: It all comes down ultimately to investment demand. There has been a modest decline in mine production over the last five years, and there’s been a significant decline last year in central bank sales. But when you look at what’s really driving the gold price higher, it comes down to investment demand. [48:49]
JIM: Investors have been buying – speaking of this demand – enormous quantities of gold by historical standards. As you point out in your book, 241.5 million ounces have been bought, I think, from 2001 to 2006. In your 2007 Gold Book, you state: Never before have so many investors, spread throughout the world, bought so much gold for such an extended period of time.
In the past for example when this occurred it usually coincided with periods of severe economic, financial and political unrest, such as let’s say 1970, 74 and 78. But Jeff, right now, the economy seems to be doing okay, the markets are doing well, there is some political unrest, what do you believe has triggered this buying?
JEFF: I think the political risks have been a very important factor. But you also have to look at the economic things. You have to go through each one. We’ve been probably less bearish on the dollar than most people in the world, and we’ve been more bullish on the stock market than most people in the world. But our views don’t necessarily count as what people in the markets are saying. And if you look at it over the last five years and go back five or six years to the start of this –it was 2000, 2001 and 2002 – the stock market was in dreadful shape, interest rates were extremely low, we had 9/11 and then we had the SARS epidemic, we were in a severe recession, we had tech bubble having popped. There were a number of economic factors and then political factors that were scaring people into buying gold as a safe haven against all of those different things. As you go forward, for example, in 2002 the dollar started falling, you have had an extended period of time where people have been saying the dollar is going to plunge to become worthless at some point. And that could happen, but in the near term we don’t think it’s going to, but again it doesn’t matter what we think. What you have are groups of investors who are saying to themselves I want to reduce my exposure to the dollar and I’m going to put some money into gold.
And then you can go through each factor. You look at the stock market; the stock market did very well in 2003 and 2004. It’s had a good run in the last few weeks but 2005 and 2006 was a period of time where even though the stock market was doing halfway decently there is a tremendous amount of concern about prospective stock markets moves. And you get into this weird situation, it’s sort of like the goldilocks economy here: It’s actually not too hot and not too cold, it’s looking pretty good. And a lot of investors don’t want to believe it. So you have a situation right now in the US economy and the US financial markets, where if anything goes wrong, people say, “you see, it’s going to get really bad let’s buy some more gold.” And if anything goes right they say, “this can’t last that much longer and my wealth’s just gone up because the stock market has gone up, therefore I should buy more gold to protect my increased wealth against the ultimate demise of this.” So it’s kind of this win-win situation for gold on a short term basis in that if good things happen investors say this can’t last and they buy gold; and if bad things happen they take it as a confirmation that things can’t last and they buy gold. [52:44]
JOHN: That was Jeff Christian talking on the program here on April 28th of 2007. Given the strong fundamentals for gold, you know, weak dollar, rising inflation, geopolitical tensions and well, we should mention global credit risk too and strong investment demand, why hasn’t the story caught on yet. And I have to ask a question straightforwardly, Jim, and that is does Wall Street tend to gain or lose if gold gets recognized as something in which you should invest?
JIM: I think, John, that Wall Street loses in this. I mean if people start buying gold, start buying tangible assets it's because we've got inflation, stagflation. Wall Street wants people buying equities, buying bonds. If you take a look at the 70s when the equity markets went through a tremendous bear market in 73 and 74 and you had the outperformance of tangible assets in the last commodity cycle, that wasn't good for Wall Street. And so they would rather have people buying stocks and bonds, and that's why I think Wall Street is somewhat negative on it.
But I also think it goes back to a lack of this concept that we've been talking about here which is a lack of monetary understanding. I also believe that the gold market is so small in relation to other asset classes, I mean if you add up all of the companies in the HUI and you take a look at their market cap and you compare that to, let's say, the S&P 500 stocks, I mean the entire market cap of the HUI, which is 15 stocks is only 121 billion. That doesn't even equal one of the major blue chip stocks in the Dow. So movements into and out of this sector produces large price swings. When you look at the charts, John, when you're looking at gold, silver, the major gold indexes such as the HUI or XAU or even the prices of platinum, it becomes clear that we're in a bull market. I think what scares people out of this sector are the sharp price swings and that's why you have to hold on to your position because you're going to miss the majority of the price moves. When bullion or gold stocks move, they move quickly. That's why even the smartest technicians that I know get caught off guard. I mean, Richard Russell has been preaching this message consistently and my hat’s off to Richard. He said “hold on to your bullion and your shares because this bull is going to try to throw you off and shake you out.” As Dave Morgan states it, It's either going “to wear you out or shake you out.” And that's why we prefer looking at the fundamentals versus the technical aspects of the market. The fundamentals, I believe, are what are going to keep you firmly strapped onto the saddle as we go through these up and down moves. You know, 20 and 30% corrections in the gold market are very routine and they happen on an annual basis. [55:13]
JOHN: One sector you favor, which is the juniors really hasn't done that well this year. Why do you think that's the case anyway and we've gotten a lot of emails from people on this one as well?
JIM: You know, I think there is a number of reasons. Number one, its gold market has been very volatile this year, so the institutions, I think, are playing the big cap stocks. If you manage money and you have a lot of money and you think “okay, I want to go in a gold sector,” it's much easier to go in and trade the gold ETF or buy in Newmont because if we get a correction, you can get out of it. If you go into juniors it's not as easy.
Also, I think this has been a year of divergencies. We've seen gold stock performance has diverged from bullion. Bullion is up roughly around 28% for the year versus the HUI index which is up about half of that. Also, I think, the small cap junior development companies most have gone negative for the year. As an example, a junior development company like Aurelian, which was up close to, let's say, 6000% last year, if you take a look at Friday you and I talking, Aurelian is up 10%, but for the year, 1 ½. So despite reporting one of the largest resource estimates in the last two decades –and there is still growing evidence that particular deposit is going to get even larger – so it didn't make a difference.
I've seen juniors going up from being 50 to 70% to giving back 100% of those gains and then actually going negative. And so I think some of the volatility of the sector scares people, and you have to understand the gold sector and the resource sector is so small in comparison to the stock market, to the bond market, to the currency market, to the money markets that an influx of money can drive things through the roof. On the day that you are talking, John, I'm looking at my screen of juniors, like I said, Aurelian up 10%, others are up 8, 12, 15%. I mean when they move, they move very quickly. And so that's why I think in some ways this scares a lot of people. [57:25]
JOHN: So all things being equal, you still favor the sector?
JIM: Well, look at it this way. You've got gold selling on the Friday you and I talking, it's roughly at about 812 an ounce. You've got silver selling at over $14. And I can buy majors or intermediate producers and I can buy gold in the ground at 500 bucks an ounce, 900 bucks an ounce, 400, 500, 600, 700 an ounce, or I can buy, let's say, a junior at 15 to $25 in the ground or buy silver at 3 to $5 in the ground. I just think that if you're looking at this and you're taking a long term view, when we've got gold prices at 800 and we've got silver over 14 (and I think silver is going to 25 and 30, possibly next year, and you could see gold over 1000) I can buy the larger companies 5, 6, $700 dollars an ounce or I can buy gold in the ground at $15 an ounce or silver at 3 to 5, then I'm going to go where I can buy things on the cheap. [58:32]
JOHN: Well, obviously, with the juniors in this case, but with the juniors there’s really greater price risk because of the huge price swings too.
JIM: This is why we talk so often on this program about the fundamentals because sticking to the fundamentals is important – in addition to a good dose of patience. And I want to stress that: Without patience, you can't succeed in this gold market because without that patience, you're not going to be able to hold on for the big moves. And I don't want to get into our annual forecast into next year, but if you take a look at this gold market –once again on the day you and I are talking these stocks are up 10% – when this sector moves, it moves like a NASA space launch. I mean it just sky rockets. And it happens so quick, John, it happens out of the blue. On the day we're talking, gold is up 12 bucks, silver is up 15 cents, the HUI is up 4 and 5%, and I doubt if very few people saw this on Wednesday and Thursday of this week. So that's why I think you have to understand the fundamentals, that's what keeps you in the market. And secondly you have to have the patience. [59:40]
JOHN: Obviously, we don't want to get into our annual forecast shows which we feature in January, but any hint as to where we might go next year?
JIM: I'm just going to throw this out and this is just once again one man's opinion, I believe both gold, silver and oil are heading higher next year. Gold will go above 900. There is a good possibility it could spike above 1000. And if it hits 1000, then gosh, John, it can probably go to 14 to 1500. When it hits quadruple digits, that's going to get quite a few people's attention and then like anything else, you get this mad rush with everybody moving into the market. Silver is going to $20. Oil is also going above 100; possibly 125 to 150 depending on demand and supply issues.
And it's also going to be one wild ride, especially in the first quarter, so my advice is buckle up and fasten your seatbelts, but if you are patient, if you understand the fundamentals, understand the companies that you own, then I believe the rewards are going to be phenomenal.
However, I want to caution with two pieces of advice. once again understand the fundamentals. That's going to keep you in the saddle and keep you from making emotional mistakes. And secondly, and I can't stress this enough, you need to have a major dose of patience. If you don't understand these fundamentals or you just find yourself too emotional or you just don't have the patience, I think you're better off putting your money in T-Bills. [1:01:06]
JOHN: You’re listening to the Financial Sense news hour year end review at www.financialsense.com.
JOHN: Well, we kept hearing pronouncements over the years as we worked up to 2007 that inflation was low, always hearing the core inflation rate preached to us. But even to the most casual observer at this stage of the end of 2007, it's very clear that even the core rate is up. And of course, the core rate doesn’t include important things like food and fuel and health care for reasons that only arcane economists can ever figure out. So we're obviously facing some kind of a credit crisis and that is going to stay on the horizon for next year, Jim. And with this credit crisis, governments have a wonderful track record of coming back and trying to deal with the problem by providing more stimulus, usually in the way of more liquidity, more credit, more monetary inflation.
JIM: And that's exactly what we're going to see, John. We've seen a bit of it the beginning of this week with Europe injecting nearly half a trillion dollars into their banking system. There has been a number of experts that have talked about this. There is a group in Canada called Bank Credit Analyst and they call it the debt Supercycle. And I want to get into a bit of their thesis because it will sort of explain what governments are doing now, what central banks are doing now.
And basically, according to Bank Credit Analyst, the Supercycle is a description of long term decline in what we call balance-sheet liquidity and the rise of indebtedness. And if you take a look at economic expansions, they've always been associated with the build up of leverage. However, and this is key, and this gets back to that clip that we played last week with Greenspan: “Prior to the introduction of automatic stabilizers such as the welfare state, deposit insurance, balance sheet excesses tended to be fully unwound during economic downturn at the cost of declines in activity.”
Well, what happened with the introduction of Keynesian economics, government policies were developed to smooth out the business cycle and what we've seen is these business cycles have gotten longer, the recessions have become less painful. I mean if you take a look at as a result of extending this money and credit, we had a recession in 1981 and we went 10 years before we had another recession in 1991, and then we had another recession in 2001. Now, it's questionable whether we're going to be able to avoid one next year. But the problem is that these balance sheet imbalances and these financial excesses, which were built up during the expansion phase, were never allowed to fully unwound. What did the Fed do? As soon as we got into a recession in 2001, boom, Greenspan was cutting rates down to the lowest level we've seen, flooding the market with liquidity.
So the cyclical corrections that we see in the periodic buildup of debt and illiquidity that occurred during recessions were not enough to reverse the long run trends. So liquidity is rebuilt during a recession which is exactly what we're trying to do right now with lowering interest rates and you hear the word liquidity, liquidity, liquidity; what does that mean? It means they are creating more money and credit to pump into the system to prevent the system from going into decline. So whenever you see, for example, a Fed has cut interest rates 100 basis points, they are doing that because they want to avoid the pain of a recession. And you hear Bernanke saying about insurance. So what happens overtime is this growing illiquidity and the instability of the financial markets, the greater degree of illiquidity in the economy, the greater is the threat of deflation. So the bigger that balance sheet excess becomes, the more painful the corrective process would be. So the stakes become higher in each economic cycle. And what this does is put an ever increasing pressure on the authorities to reflate demand by whatever means are available. So this Supercycle that BCA talks about is driven over time by these building tensions between rising underlying deflationary risk in the economy and the ability of policy makers to create inflation. [4:40]
JOHN: So whenever we hear terms like liquidity injections, slashing rates, which just causes an increase in the lending, basically what they are trying to do is there is a natural force there which tries to correct for all of the excess credit in the system. That's painful. So because that doesn't fly politically, what they are trying to do is avoid that with another round of injection of cash out there. Ironically this sounds exactly like some kind of drug habit. The analogy is just perfect because it requires more and more and more each time to get the same result as you did the previous time, and the only way off it is a big crash.
JOHN: Yeah. Just take a look at the numbers that the ECB announced this week: $500 billion they are injecting into their banking system. There used to be a time when numbers like that would have spooked the bond market. Instead, the bond market rallies because what they are trying to do is break and bring down the LIBOR rate which is tied to so many of these subprime mortgages that are due to reset next year. So rather than have the painful crash, rather than have the painful correction which cleanses the system, you know, like I said, John, our tolerance for pain today is less and less. And so because our tolerance for pain is less than what it used to be, what are the cries? I mean you hear it not only on Main Street, “government do something about this,” but you hear it on Wall Street, from traders, “hey, more liquidity, we want you to cut more, we want you to get more aggressive.” We cannot have a recession or more bear market in stocks. There is just no tolerance for that anymore within a society and especially a society that is overleveraged and so debt-ridden as the US economy is. [6:28]
JOHN: And the one thing that I think we should point out is when we talk about these fiscal injections of currency, that's what they are, this is not just a United States problem. This is one that is really global. So all of the currencies of the world are being affected by this – at least those whose central banks are inflating at a pretty good clip.
JIM: Yeah, because I think as we talk about so often on this program, money supply growth around the world is growing at double digits. I hate to see what the money supply growth rates are going to be in Europe after that injection. And at the same time, what we are seeing globally is we're also seeing an increase in inflation rates around the world. It's not just that CPI and PPI are rising here in the US, they’re rising in Canada, it's rising in Europe, it's rising in England, it's rising in China, it's rising in Mexico, it's rising in Latin America. So, housing bubble, higher inflation rates – this is all a global phenomenon because there are no limitations in terms of the amount of money creation, fiscal deficit spending stimulus that governments can use today, because they are not range bound as they were under a gold standard which would prevent or try to keep the government from depreciating the currency. [7:44]
JOHN: Maybe, at least on a global scale –compared to what we were talking about that in the area of Wall Street – that's why gold is rising globally because people ultimately recognize that as currencies begin to die or become devalued, that’s an store of asset value.
JIM: Absolutely. And I think that's it, because no currency in the world is backed by gold anymore or if it is, it's so small and inconsequential. I mean central banks do have gold reserves, but there is a theory that half of those reserves have been sold or leased out. And so what you're seeing is rising inflation. I don't care which country you go to. You go to Latin American countries like Chile, the inflation rate is at 7.5. In China it's close to 7. If you look at Colombia, it's in the five or 6%. Venezuela, it's over 20%. Argentina it's close to 20. You go to Eastern Europe and the Euro zone, inflation rates are rising. France, Germany, I mean everywhere you look around the globe, inflation rates are rising along with this increase in the supply of money. And I think that's why the smart money –whether you're looking at central banks in Asia, central bank in Latin America, central banks in the Middle East – John, that's what's driving the price of bullion is people know worldwide...In fact, if you take the major currencies, whether it's the dollar, whether it's the euro, whether it's the yen, the loonie, and put it in terms of gold, all of the world's currencies are depreciating against gold, which is why gold is once again resuming and becoming the world's money. [9:28]
JOHN: Well, what is really becoming clear is that we're going to continue on another round of inflation here. We also have these mortgages and these mortgages are going to reset –a lot of them sometime next year –which isn't going to sell politically either because suddenly people are not going to be able to afford them. Whether they should have gotten into them or not is almost immaterial, or whether they got sold a bad deal and not realized it, there’s obviously going to be some call, especially in the election year for the government to do something; what?
JIM: I think they are going to do three things. It's going to take three things to continue this around. It's going to take currency depreciation, we've certainly seen that with the dollar this year. It's going to take monetary policy, which is creation of more money, lowering interest rates. And it's going to take fiscal policy. Just as it did, John, in the 2001 recession, which they said was the most mild recession that we went through, because basically it was a business-led recession and not the consumer-led recession. So they are going to continue to depreciate the dollar. But in terms of the dollar collapse, I don't see that at this point because there is no other currency that can replace the greenback. I mean is the euro and the euro bond market big enough to replace the dollar as a reserve currency, I don't think so. Nor is the yen. Nor is the Chinese yuan. So you are going to see some diversification out of the dollar, which will weaken the dollar, because there will simply be less money coming in and supporting it. But what you are going to see is dollar depreciation, you are going to see the Fed cutting interest rates, although I think with inflation going up (and we're starting to see more evidence of that) that they will be some what limited in terms of how aggressive they can get. And then also I think you're going to see more fiscal stimulus. Look for next year.
What I found rather fascinating is this week Lawrence Summers –
JOHN: Just so people know by the way, he was an advisor during the Clinton administration on economics.
JIM: He was sort of a deficit hawk. Lawrence Summers came out with a piece this week urging Congress to cut taxes. Imagine that coming from a Democrat: “Cut taxes.” And he's calling for a $75 billion tax cut next year in order to avert from going into a recession. And that is going to be surprising because you watch the political debates, John: Almost in every single democratic presidential debate, what are they all talking about that?
JIM: Well, they are talking about, first of all, all of the new social programs including socialized medicine; and then we have to have everybody pay more of their fair share. That's what I keep hearing.
JOHN: Yeah. And what I think you're going to see and you could see next year, depending on how weak the economy gets, you could see the extension of the Bush tax cuts which are due to expire in 2010 because that doesn't cost them anything. It’s already in place right now. Imagine if they let those tax cuts expire. You're talking of a trillion dollar tax increase in that alone.
Secondly, I think you could see some kind of stimulative fiscal policy in the form of a tax cut because let's face it, if you cut somebody's taxes, that puts money in their pocket right away. That means that each person will take home more from their paycheck. So you're going to see fiscal stimulus. And Summers talked about with the deficit now down to less than 2% of GDP, the US is running some of the lowest deficits in the world as a percentage of its economy. So the US, and this is why some of the people that are positive about next year are saying, “look, the Fed has plenty of room to cut interest rates, the government, because the budget deficit has got down to blow 2% of GDP, has plenty of room to stimulate spending with tax cuts and some kind of fiscal stimulus, you know, jobs, programs.” So what I expect you're going to see next year and especially after the numbers come out in the month of January, February, and March because the first quarter growth and GDP next year is going to be below 1%, and technically, you can say that we're already in a recession with those kind of numbers. [13:41]
JOHN: So how are we going to handle all of this, because if the government is creating more economic stimulus obviously that leads to more demand for the money out there which leads to higher inflationary rates. What is all of this going to do ultimately?
JIM: I do think you're going to see the inflation numbers go up and let's talk about inflation in terms of the Keynesian view. In other words, the Keynesian view of inflation is rising prices. You could see within the economy falling prices and rising prices at the same time. So in manufactured goods coming from Asia or with inventories building you could see inventory liquidation which drives down prices, because, for example, if you're an automobile dealer, Ford, GM and your dealers are sitting on a lot of cars on the lot, you slash prices. So you could see falling prices and certain goods in the sector. That will bring down some of the core numbers of inflation down.
On the other hand, with all of the impetus especially with this energy bill on biofuels, you could see rising prices for energy and food. And John, you already heard and you hear it on many of the financial shows: “Well, you know, the core rate of inflation is within a range that the Fed is comfortable with and you can't do much about food and oil.”
And I was watching on Friday, there was a panel of people talking about this issue of inflation and deflation and one of the panelists said, “you know what, we need to be willing to tolerate a little bit more inflation to get us out of this mess we're in.” So look for that kind of language to become more prominent – and especially if we get a 10 to 15% correction in the first couple of months of the year, because we know what's going to happen next month. We know, for example, the retail numbers for Christmas are going to be weak, they are going to be less than expected. Because the retailers had to slash prices and put everything on sale to move the goods out the door, the retail numbers are going to be bad. So you’re going to have [weak] corporate profits. You're going to have companies announcing in the third week of January that they are not going to meet their numbers, so that's a negative. You're going to start to see economic numbers that are coming out on the economy, whether it's the leading economic indicators, the unemployment numbers, the economic growth numbers, you're going to see a lot of economic weakness and so you're going to see a response to that: You're going to see lower bond rates. But you're going to see a lot of volatility. And I would not want to be Mr. Bernanke in February when he goes before Congress and says “oh, we're concerned about inflation” when the unemployment rate is rising. And especially since next year is an election year, where all of the House will be up for election, a third of the Senate, and then of course the presidency. So look for goofy ideas to start coming out in the first half of next year as these economic numbers come in and shows that possibly we could [be in a recession]. I mean, Bill Gross came out and said we're in a recession. [16:46]
JOHN: I don’t suppose it would be a breach of fiduciary, or whatever to ship him a large gallon jug of Maalox; do you?
JIM: You know, Maalox – you might want to have a jug of it, probably in the first two months of the year, because in addition to the weakening corporate profit numbers, the weakening economic numbers you're also going to see more write-offs because even some of the banks that are trying to clean up their balance sheets have come out and said “we don't know how bad it's going to get, we don't have a firm handle on it.” So you're going to have more write-offs because we're going to have a lot more mortgages that are going to get reset which is why I think the Europeans are injecting half a trillion dollars because they want to knock down LIBOR rates which is what is tied to most of these mortgages. So you're going to see more write-offs, more bankruptcies. So the economic news is going to get kind of ugly in the first quarter of the year. [17:34]
JOHN: Basically, what you've done is transformed a Maalox moment into a Maalox month.
JIM: I would say probably the first six weeks. If the numbers get as bad as I think they are in the month of January as they start reporting them, you're going to have a selloff in stocks – and look for a 10 to 15% correction; you're going to have, you know, once again, weakening economic numbers. Now, whether the National Bureau declares it a recession, it will be too early to tell. But definitely you're going to have a call for the Fed to do something and get more aggressive, for the government to do something and get more aggressive which means more monetary and fiscal stimulus. So you can see, John, some falling prices in the economy and manufactured goods and you may have rising prices from basic necessities and services and so [they] just dismiss it and say, “hey, food and energy is up, not much we can do about that, our greater concern is economic growth.” So they’re going to have to walk a very fine line.
But overall, I think we'll get through this and I think if we were to have this conversation, in other words the day you and I were talking December 31st, 2008, I would expect that you and I would be talking about higher energy prices; you and I will be talking about higher gold and silver prices. And believe it or not, I do expect, especially when you start hearing the news in the first part of the year, I expect new records in the S&P next year and I expect new records in the Dow Jones Industrial Average. [19:06]
JOHN: But that only makes sense given where –all things even being equal – if inflation is taking us up, then we would see those new records anyway, just by virtue of the devaluation of the dollar. But then given everything else, you could see why that would be.
JIM: Yeah. So I do expect you're going to see nominal increases in the stock market, because when we're talking about liquidity –as we have been here – where is all of that money in credit going to go. It has to go somewhere. It's not going to go into somebody's mattress. And that's why I think by the time we get towards the end of the year and especially by the time we get through the first quarter, I think one of the problems that the markets have with the financial system right now is this lack of transparency. We have written off roughly about 100 billion dollars and the estimates are we've got about another 200 to 300 billion. Once that is put on the table and everybody can see it, and everybody can say, “okay, there are the numbers, everybody is coming clean, we're dealing with it.” There is even talk about putting together an RTC to buy these mortgages; and don't be surprised if that gets resurrected next year to just clean this up. Once these numbers are out in the open and then markets can deal with it, then we're going to begin a road to recovery. So I'm optimistic, John, that once again, if we were having this conversation one year from now, we'll be looking at higher prices all of the way across the board. [20:34]
JOHN: So basically, though, although we’re going to see it get real stormy in the first part of the year, we're still not into the Armageddon scenario. Let's put it that way.
JIM: No. I simply don't see it. I would agree with the folks at Bank Credit Analyst that the debt Supercycle has a ways to go. They have plenty of room to cut interest rates, they have plenty of room to use fiscal policy. If you look at this 3 to 400 billion or whatever this number turns out to be, it's not as bad as it sounds if you just look at the numbers when you compare it to the size of the mortgage market and also the size of liquidity out there. Even though within certain sectors of the US and Europe, you may have liquidity drying up, John, you've got $400 billion of savings and surpluses in Asian countries and almost 600 billion in surpluses in OPEC countries. And take a look at the amount of money that is available in sovereign funds. I expect sovereign funds to be one of the catalysts for higher stock prices. I'd also look and believe that next year is interest rates come down probably in the first part of the year that you could see the revival of private equity deals. So, no, I just don't buy the doomsday scenario right now even though it may get a little ugly in the first quarter. [21:54]
JOHN: So why don't you summarize that and let's do it on an itemized bullet so people have it. What do we expect? A, B, C, D.
JIM: I would say probably you're going to see much, much slower economic growth. We may not even call it a recession, but certainly it's going to feel like one. If we do get a recession, it will be a mild one, pretty much like 2001 because you'll see massive monetary and fiscal stimulus brought to bear. And I think that you're going to see weakening activity globally, not just in the United States. You're seeing it in Japan right now. You're also going to see it going forward in Europe. That should take some pressure off prices and then I think you could see a sea change in central bank policy. In other words, less concerned about inflation or more worried about economic growth.