The
BIG Picture Transcript
January 26, 2008
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Voices: Kelley Wright, Investment Quality Trends
The
Next Great Depression - Part 2
Part
2
The
Catalyst
What
You Need to Know About Juniors
Part
3
Q-Calls
JOHN: Well, Jim, here we go with the Big Picture for another week – the best part of the program. We've been talking about a rough and volatile start to the New Year, and voilŕ, I think we are seeing it right now, Monsieur. Given what's happened in the markets this week, there have been plenty of Maalox moments. One of our Q-line callers, as a matter of fact, started out by taking a big swig from his gallon of Maalox.
What's changing here from the euphoria? It's a radical change. It's amazing. Even what the candidates are talking about; how abruptly the debate both Democrat and Republican shifted. What's changed here from the euphoria in Q4 of last year and the fear that grips us presently? How did we do this so quickly?
JIM: What happens with the markets, John, about 60% of the time, the stock market is doing nothing. You know, you've seen it over and over again: It goes up one day; the next day it goes down. And what is happening here is it’s either digesting a period of rapid gains or it’s digesting a period of rapid losses. The other time the stock market is either going up at an incredible rate or it's going down at an incredible rate. And what happens is sentiment changes in the market with investors and we go from fear to greed or from greed to fear.
What has happened here is three things we talked about would unfold during the first quarter. And that's sort of the outer darker shell of the Oreo that we've been talking about. We've made reference to the financial losses that are going to be coming; and I think it was the second week of the show we said the next shoe to drop was the credit default swaps. And it's interesting on the day that we're talking there was a Bloomberg story that said that banks may need to raise another 143 billion for insurer downgrades. In other words, as these bond insurers like Ambac are downgraded, their bonds get downgraded and then along with that, you know, the spreads on credit default swaps go up. So the financial losses and write downs are accelerating. We talked about that.
Secondly, we're seeing all kinds of numbers about an economic slow down. And third, we've had analysts downgrading a lot of corporate earnings. So the combination of all three as we talked about, now, all of a sudden, the markets have gone from “oh my goodness, we're rich,” to “oh my God, something bad is going to happen.” In fact, let's take a look at a humorous view of this. Why don't we play that Two Johns clip on market sentiment because that's basically what has happened here. [2:50]
Presenter: John Bird and John Fortune.
[John Bird and John Fortune seated]
JOHN: George Parr, you are an investment banker?
GEORGE PARR, INVESTMENT BANKER: I am. Yes.
JOHN: And as such have your fingers right on the pulse of the financial market.
PARR: Yes. Very much so. Yes.
JOHN: And during the summer there has been a great deal of turbulence and...
PARR: volatility
JOHN: ...volatility in the market.
PARR: volatility. Tremendously. Yes.
JOHN: And what has caused that?
PARR: Well, you have to remember two things about the markets. One is they are made up of very sharp and sophisticated people who, uh, these are the greatest brains in the world. And the second thing you have to remember is that the financial markets, to use the common phrase, are “driven by sentiment.”
JOHN: What does that mean?
PARR: What does that mean? Well, the things let’s say they are just going along as normally in the market, and then suddenly out of the blue, one of these very sharp sophisticated people says “my God, something awful is going to happen! We've lost everything, my God what are we going to do! What are we we've got to do!”
JOHN: Shall I jump out of the window?!
PARR: Shall I jump out of the window?! Let’s all jump out of the window!
JOHN: Sell!
PARR: Sell!
All: Sell! Sell!
PARR: Yes. Precisely. And then a few days later, this same sophisticated person says, “you know, I think things are going rather well.” And everybody says, “actually, I agree with you. You know, I think we're rich. We're rich! We're rich!”
JOHN: Buy, buy, buy!
PARR: Buy, buy, buy. Yes. And that is...that is what we call market sentiment.
JOHN: But...uh. Yes. Surely we are exaggerating just a bit, aren't we?
PARR: Well, I don't know. I mean in August, the middle of August this year when the market actually plunged in London, the well known City firm State Street Global Markets issued a statement in which they said, and I quote, “market participants don’t know whether to buy on the rumor and sell on the news, do the opposite, do both or do neither depending on which way the wind is blowing,” unquote.
JOHN: Yes. And this is the kind of rigorous analysis that companies will pay huge salaries for.
PARR: Huge. Yes. Exactly. And a few days later when the markets had gone up a little bit, the senior equities advisor on ABN AMBRO Morgans said, and I quote, “we're back to happy days again.”
JOHN: Well, no price is too high for that kind of mature wisdom.
PARR: Certainly not. These sort of people are paid millions of pounds in bonuses.
JOHN: Yes. Of course.
JOHN: Well obviously, that's a comedy team from Great Britain that have been doing sort of this running commentary on market issues. And of course they had a serious problem with Northern Rock. You should have seen the prime minister's questions a week ago in the house of commons, but certainly we weren't the only ones to see this coming. There had to be others that saw this.
JIM: The market participants by nature are primarily optimistic and especially here in the US. And I think what happened is after the Q3 writedowns, portfolio managers expected more losses. And I believe what unnerved everyone last week was the downgrade of the monoline insurers such as Ambac and MBIA. In those downgrades was the big elephant in the room, that's what triggered this 48 hours of panic selling that we've seen from last Friday that began with Monday in the Asian and European markets and was carried over on Tuesday. And that is what triggered this panic. It was also what prompted the Fed, in my opinion, to move on Tuesday before the markets opened with a surprise rate cut of 75 basis points. The last time they did this, I believe, was probably in the early 80s. [6:44]
JOHN: Why the surprise?
JIM: They were looking at probably a market melt down. In Europe on Monday you had the DAX index down 7%. The Dow Jones stock European index was down 7%. Also, these monoline insurance downgrades are going to impact the ratings of bonds that were insured by these companies which also impacts the credit default swaps, which as we've been talking about is the next shoe to drop. And indeed, on the day you and I are talking on that very same thing, there was a Barclay’s report that came out that says, you know what, they are going to have to write off and raise almost another 143 billion. So the write downs from either CDOs and then also the credit default swaps, John, we’re probably looking more in the neighborhood of 4- to 500 billion dollars right now. [7:35]
JOHN: Well, it's absolutely amazing that the financial markets supposedly didn't see this coming, but if we put this into perspective maybe a lighter note. Okay? Let's listen to the Two Johns again as they explain the crisis with Northern Rock last year. And incidentally this week the British government announced that they hope to turn a profit on the loans made to Northern Rock by offering to back bonds issued by the bank by orchestrating a sale of the struggling mortgage lenders. So here we go with this clip. [08:12]
JOHN: George Parr, you are an investment banker.
GEORGE PARR, INVESTMENT BANKER: Yes I am. Yes.
JOHN: And of course, we’ve just had an extremely serious banking crisis. And there are lots of people in the City like yourself who earn millions in salaries and bonuses. So shouldn’t you have seen this coming?
PARR: Well, we didn’t actually foresee it in the strict sense of the word.
JOHN: Or in any sense of the word.
PARR: Or in any sense of the word. No. No. We didn’t foresee it. But when it happened we did notice it, which is almost as good; isn’t it?
JOHN: Well, we’ve just had the first run on a bank in this country for 140 years! Now you’re a banker, what is your reaction?
PARR: Well, of course, everybody in banking, we all felt deeply embarrassed.
JOHN: You’re embarrassed?
PARR: Embarrassed. Yes. I hardly dared take my Ferrari in for service yesterday.
JOHN: What are you going to do about it?
PARR: Well, what can I do about it! The bloody thing needs a service. I’ve only got two Ferraris.
JOHN: Yes. But what was the cause of this?
PARR: Oh. About the banking crisis. Well, of course, it wasn’t my fault. It wasn’t banking’s fault. It was entirely the fault of Mervyn King.
JOHN: He’s just put 10 billion pounds into the banking system. Isn’t that what you were asking for?
PARR: Yes, but he’s done it far too late. You see. Nobody wants it anymore. He should have done it much earlier because it was obvious that Northern Rock was getting into difficulties. It was obvious that most people in the City were borrowing too much and lending too riskily.
JOHN: Including you.
PARR: Well, I was just doing what everybody else was doing. That’s how we operate in the City. And what I want to know is why didn’t he do it earlier? Why wait until the entire banking sector looked as stupid as it actually was?
JOHN: So what you’re saying is that although Mervyn King might not have been able to prevent the crisis he could have prevented the spectacle of people queuing up in the High Street to try and get their money out?
PARR: Exactly. Exactly.
JOHN: And people were queuing at two o’clock in the morning.
PARR: Two o’clock in the morning! The British people have only ever done that for Tim Henman. And look how badly that always turned out.
JOHN: But these scenes must have been humiliating for the banking industry?
PARR: We don’t like to see it. It makes us look silly.
JOHN: Silly?
PARR: Silly.
JOHN: What about banks falling over themselves to pick up these packages of dodgy mortgages and they have very little idea how much they’re worth, if they’re worth anything at all!
PARR: Well, that’s not silly. That’s a sophisticated market in operation.
JOHN: So you don’t think there is anything fundamentally wrong with the banking system.
PARR: Look. There are some very, very clever men in the City. I mean just as an example, the fact that Alliance in Leicester lost a third of its value in a day and the very next day got a third of its value back, that shows the system is fundamentally sound and rational.
JOHN: Can you explain why at the beginning of the Northern Rock crisis the government made an offer which didn’t reassure the public. The Chancellor of the Exchequer himself said people shouldn’t worry because their money was perfectly safe.
PARR: Well, that’s very simple. The public are used to the government telling them lies.
JOHN: You mean if the government is prepared to tell lies about the reason for invading another country, they wouldn’t be too bothered about lying about people’s money.
PARR: No. Exactly. What Alistair Darling should have done was to say to everybody: “Go down to Northern Rock now. Take every last penny out.” You see. People would have said “there must be some reason the government is telling me to take my money out. I’m going to leave it where it is.”
JOHN: And then the whole thing might have just faded away.
PARR: Just blown over. Well, it should never have happened in the first place. I mean it was only because some bright spark said: How much do you think these American houses are actually worth? And of course, as soon as they asked that question we all panicked.
JOHN: Because you found out?
PARR: We didn’t find out. We still haven’t found out how much they’re worth of anything.
JOHN: Despite what you call a very, very sophisticated market.
PARR: Look. We went on the assumption that property values always go up.
JOHN: Well, that’s not very sophisticated is it.
PARR: It’s as sophisticated as we ever get.
JOHN: Yes. But I mean why if this is the case and that’s what happened, every time you sell someone a financial product you put a big warning on it, saying your investments may go down as well as go up.
PARR: Yes. Well, we have to do that. It’s one of the pettifogging regulations. But it’s only meant for ignorant punters.
JOHN: So it doesn’t apply to you?
PARR: Certainly not. Certainly not. And of course, the punters themselves are now reassured because the government have guaranteed their deposits.
JOHN: Yes. And also, put 10 billion pounds in to the banking sector. Do you think that was absolutely necessary?
PARR: It was necessary as a symbolic gesture because what the market needs is confidence.
JOHN: Whose confidence?
PARR: My confidence. The confidence that I have a 35 room house to go to with six cars in the garage and a private helicopter and that I earn enough on my Christmas bonus to pay my Filipino staff 12 pounds a month.
JOHN: But these are huge sums that we’re talking about here! I mean, where in the end is all this money going to come from?
PARR: Well, I don’t know. Wherever governments get their money. Taxation I suppose. I don’t know anything about tax. I never pay any.
JOHN: But don’t you think it’s wrong that extremely rich people, I don’t know, people that run private equity funds and people like you, hardly pay any tax at all?
PARR: There’s absolutely nothing wrong with that. The City is far too valuable to the British economy. And in any case, as we keep saying, if you tax us, we’ll just go abroad. And that is not an idle threat. We can go and wreck somebody else’s financial system.
JOHN: Finally, can we talk about moral hazard.
PARR: About what? Sorry.
JOHN: Moral hazard.
PARR: No sorry. I know what hazard means, what’s the other word.
JOHN: Oh, never mind. The point about moral hazard is that the thought is that executives like yourself will go on making more and more stupid and more and more risky loans in order to put up the profits of their bank because when everything goes wrong the Bank of England is going to come along and bail them out.
PARR: Well, I certainly hope so. I’m looking forward to it.
JOHN: Look. I don’t want to be insulting but it does seem to me that you haven’t learned anything from this whole episode.
PARR: On the contrary. I’ve learned one very important lesson.
JOHN: And what is that?
PARR: That is: If you’re going to make a cock-up, make sure you make it an absolutely enormous cock-up because then the government will bail you out. [15:37]
JOHN: You know what's surprising about that is that it’s true what they are saying? I like the part about what was the first part of that: “moral? what is that?”
JIM: I know the word hazard, but moral?
JOHN: So we have the Fed cutting interest rates this week and Congress and the President reaching an agreement on some kind of economic stimulus package which is getting a lot of negative reviews in certain areas, so at least the markets have calmed down.
JIM: Well, sort of because we're down about 170 points on the Dow on Friday, down about almost another 1 ˝%. One thing that happens any time you see a major selloff is the markets become grossly oversold, so we were due for some sort of rally. And I would expect next week with the President giving his State of the Union speech more stimulus could be possibly mentioned; and then we have the FOMC also meeting next week where it's widely expected that the Fed will cut interest rates –at least the futures market is telling us – by 50 basis points. So we could see the markets rally further, but not enough of the bad stuff that we're talking about has been aired yet. I mean there is more bad stuff to come, and as we mentioned earlier, the credit default swap problems and write-offs as a result of the downgrading of these monoline insurers I mean that has yet to unfold. So more bad stuff.
We also know we're going to be getting the unemployment numbers in January in the week or two ahead. We're also going to get our first pass at GDP in the fourth quarter, which we know has come down substantially. And then we start the whole process over again with a bunch of economic numbers on the month of January, so lots of bad stuff to come yet. [17:28]
JOHN: So you expect another rally to be followed by another downturn, then?
JIM: That's pretty much the way I see this thing playing out, at least for the moment. We know for a fact there are going to be more writedowns in the first quarter. We know we're going to see lower earnings, and we also know that the economy is going to get worse. And I probably wouldn't be surprised to see an additional stimulus package that supplements the one just passed because, John, this stimulus package, quite frankly, is an economic joke. It's nothing more than, in my opinion, vote buying; besides, it's unconstitutional, but that's another matter. And it does very little to actually stimulate the economy. Okay, so you give some guy 300 bucks, a family, I forget what they are going to settle on because the Senate will meet next week and they are going to have their pass at this, so who knows what these numbers are going to look like eventually; but once you spend this money, then you ask yourself what comes next? It gets back to our argument of give them fish or teach them to fish. And this is give them fish. [18:30]
JOHN: So what do the investors do, basically? They've got to keep their wits about them. So how do you do that if you're trying to look for reference points?
JIM: Despite a lot of the negativity that you've seen out here, there are also a lot of positive things. And I would use the downturns to add to your existing positions if there are things that you like that you own, or you might want to buy things that you may have wanted to buy, let's say, while the markets were going up, the price got away and now the stock has fallen. So Mr. Market is always giving you a better chance to buy at better prices because it gets back to that sentiment that we played at the beginning of this segment with the Two Johns. One day the market wakes up. It's pessimistic.. Everybody is jumping out of windows and it's when everybody is jumping out of windows is when you want to buy. And you don't want to buy on the day when everybody is euphoric. And so I'd use this opportunity to pick up things that you wanted to own or add to things that you already have that you would like more of. [19:31]
JOHN: So I take it, then, that you should use these downturns to your advantage rather than panic with the rest of the herd. Basically figure out what's going on, figure out what your move should be?
JIM: Absolutely. We always have, at least in our firm, we have a shopping list of stocks that we want to buy. And we simply wait for the opportunity for Mr. Market to sell us those stocks at a price that we determine is very attractive. In other words, we wait for the markets to come down to our buy price and then we step in and buy.
JOHN: So I take it then, you were buying on Tuesday.
JIM: We took a major position in a silver junior that we like. We bought an oil service company. We bought a play on agriculture and for a lot of new clients that were sitting in cash waiting for the opportunity, we put some of that money to work in metals, energy, food and infrastructure. And quite honestly, that's what you need to do. You buy when everybody is panicking and the prices are cheap, not when the markets going up 6-, 700 points and everybody is paying a dear price. So I love it quite honestly. We were like a kid in a candy shop on Tuesday. [20:40]
JOHN: It changes one's perspective from one of fear to one of opportunity. Sort of keeping your head when everybody else is losing theirs; to quote Rudyard Kipling.
JIM: It's absolutely amazing. If you take a look at how people buy consumer goods, people will go out if you're buying a new car, you might check out consumer reports, you might check out the sales in the paper. So let's say that Nordstrom’s is holding a 50% off sale, people would be flocking into the department store. The amazing thing when it come to buying or making investments, we do just the reverse. People, instead of saying, okay, “there is a 50% off sale today or a 20% off sale today,” when it comes to investing they say, “I'll wait until they mark it up above retail price.” In other words, I'm going to make sure I pay a premium. You're absolutely right. I don't agree with a lot of this gloom and doom that's out there right now. Yes. There is some bad news. But you take a look at this and just step back. There are plenty of high quality companies out there because of their business models that are going to grow their business revenue, increase their profits, increase their dividends and make money for their shareholders despite all of the other stuff that's going on around us. [21:52]
JOHN: I know you don't give specific examples, say in juniors, for example, but how about a few large cap names or companies to illustrate a point.
JIM: A good example is last Friday we had General Electric report earnings. They were up 15% greater than expected. It took the market by surprise, and John, here is a company that was overpriced back in the year 2000. I forget what is was selling at, like 30-something times earnings. GE right now is selling at close to 14 times earnings. And if you take a look at their sales, their sales over the last five years have gone up; last year there were a 170 billion; in the latest quarter they were up close to 49 billion. So their sales have risen to almost 200 billion. Their net income has gone from 15 billion. This year it will probably be somewhere in the neighborhood of 24-, 25 billion, and take a look at GE's dividend. They've gone from 77 cents in 2003; then they raised it to 82 cents in 2004. Then they raised it to 91 cents in 2005. In 2006 they went to a $1.03; 2007, it went to $1.15 and this year they just raised it to $1.24. In fact, one of the surprising things that's coming from Davos is in interview with a lot of CEOs, the CEOs are probably a lot more optimistic than market participants.
And I mean, it's not just General Electric. General Electric's business model which over 50% of their sales come from international, and that figure is going to be driven up to 60%. They are in all of the right areas, John: They are in infrastructure, they are in alternative energy, they are in water, they are in green energy, they make nuclear reactors; they build desalination plants; they build filtration systems; they are into wind power.
So one of the themes that I think that you're going to see here and we'll get to this later on, but I think the age of consumerism is coming to an end, and I think one of the strongest plays that you're going to see over the next 10 years is the building of infrastructure –whether it's economies that are industrializing like China or India or Brazil or it's decaying infrastructure here in the US. So it's interesting to see that Mayor Mike Bloomberg and Governor Arnold Schwarzenegger are talking about raising money or pushing infrastructure investments.
Everywhere you look at, I mean we saw the levees breakdown with the hurricanes in 2005. We've seen all kinds of delays at airports. Our airports are overcrowded. They are grossly out of date compared to airports around the world. Our rail system needs to be built up. Our bridge systems were falling apart – last year the Minneapolis bridge. So infrastructure is going to be a great play.
I can go on. Johnson & Johnson announced earnings that were greater than expected. DuPont, which is getting into bioscience and agriculture and biobutanol their earnings were greater than they expected. So you could just go on, on and on. And one of the things with the economy slowing down, I think one of the real plays here is to buy large cap growth companies that have international exposure and the market’s giving you the chance to buy a lot of these companies at inexpensive prices. I have just given a couple of examples, but there are a lot more stories like these out there. You just need to do your homework, stick to the fundamentals, stay focused and remain –and this is very hard to do – impartial and unemotional about the whole process. Too many investors trade in and out of their positions. They miss the big moves or the opportunities that the markets give them. [25:49]
JOHN: So you don't think this is the big one? In other words, everyone is wondering is this it, is she going to go?
JIM: Will we get further weakness? I expect a rally followed by another downturn as more of the bad news comes out, but is this going to be the big, big bear market? Maybe we're down 20%. I don't know, but I don't think this is the big one. To really get the big one, John, you need the politicians to make that happen. And looking at the rate they are going, that's probably what's going to happen eventually, because if you take a look at, as we'll be discussing in the next segment, the thing they did in 1930 and again in 1960 and in 1970 and as what they are doing right now, it really takes the politicians to muck things up to give you the big one.
JOHN: What about now? Well, I mean now is now; right? You might as well –
JIM: Yeah. We've got a pretty good start with this. I believe they are going to enact policies that take us right into the depression. I don't want to take too much out of the next segment. A good example is the stimulus package which is along these lines. It really does very little to stimulate the economy beyond maybe one quarter prior to the election. It will aggravate the budget deficit without any meaningful recovery in tax revenue. See, the purpose, if you do a stimulus properly and you do it with ways that benefit the economy –stimulating investments, stimulating savings – then the government gets back the money that it loses by slashing rates by an expansion in the economy. And that's exactly what happened the second time Bush cut tax rates in 2003: It did stimulate economy, tax revenue came back to the government, they increased, and budget deficits went down. But the first tax cuts that they enacted in 2001 with the rebates didn't work and the deficit actually got bigger. So what I expect is as a result of this dumb package, next year they are going to be raising interest rates because inflation will be on the rise due to monetary stimulus; and then secondly because the budget is going to mushroom out of the control, they are going to be raising taxes and then they are probably going to increase regulations, which is what's going to take us into a major depression by the year 2010. [28:11]
JOHN: With all of what you see coming, is it going to be a wild ride for investors? How do you keep your emotions in check when it's doing that?
JIM: That's probably one of the hardest things or the battle that you have to fight as an investor, but I would say you have to keep yourself disciplined. You have to stay focused on what you're doing, and you need to keep yourself informed. Block out all of this daily noise, and that's what a lot of it is, that you get from the media hype; and more importantly, John, you've got to separate the facts from the fiction and stay focused on what I think are long term trends. At least that's the way I know how to make a success out of investing. I think trying to focus on every little wiggle on a chart or whatever the media is saying on Monday, they can be telling you a different story on Tuesday and then the story changes again on Wednesday. [29:00]
JOHN: And those long term trends are?
JIM: Well, what we've been talking about on this program,– probably what ? for the last four or five years about peak oil. Let's put it this way, if peak oil isn't here, it's pretty close to it. Energy prices are heading higher, perhaps to 200, $300 a barrel eventually. We know that paper money is losing its value. The dollar is eventually going to be toast, so gold and silver in a major bull market, that's clear by looking at any chart whether you're looking at gold, silver, the HUI or even a chart of energy. So they are going to be higher. Food prices are also going to be higher because of emerging Asia and its diet improvement and the diversion of grains to ethanol almost guarantee that eventually we're going to see probably famine. Water tables are dropping around the globe and especially here in the United States. The water delivery system is breaking down. Water systems in the emerging world are becoming polluted, especially in China, and so water is and will become a major issue. Finally, because of industrialization of the developing world and the decaying infrastructure in the developed world, infrastructure is going to be a long term theme.
And more importantly as we mentioned earlier, I believe that this age of consumerism that we've seen in the last half of the 20th Century and the first part of this decade is coming to an end after almost 50, 60 years of debt and consumption. John, one way or another, we're going to be forced eventually to go back to saving and investing. [30:35]
JOHN: So as you've been saying all along, basically the first part of this first quarter is going to be a rough ride, but as we get to the middle things, what, summer time, somewhere in there, we're going to see this creamy soft filling which is going to be really good for the elections now. Bear in mind that there is going to be a certain amount of braggadocio that “we got this back under control;” but again, I think it's going to fall apart after the election again. That would be my analysis of it.
JIM: Yeah. Because we know the stimulus package does nothing but give us a little blip on the economic radar screen because, I mean if you're in business, you're not going to go out and sit there and say, “oh, they are giving them $300, I'm going to go out and build a new plant or I'm going to order all kinds of equipment and expand operations.” Most businesses won't do that. I mean if you take a look at the companies that are reporting terrific earnings and beating expectations, most of them are international companies and the bulk of their sales or their profits are now starting to come from overseas from the emerging world where the economies are growing at a much faster rate. So I just don't think that that's going to happen. I just don't think you're going to see this big boom that's going to come from investment spending. And we know, John, that when you're in a depression or you're in a recession, two things happen with government. Number one, the government collects less tax revenue because corporate profits are down, so that means corporate taxes will be down. We know that, for example, income tax revenues go down too, because business owners, their business profits may decline, people lose their jobs, so the government loses those tax revenues. And on the other hand, government expenses go up because of unemployment benefits and because, for example, the stimulus program. So what they will do, mark my words, is next year as the economy weakens, as the stimulus package fails, as the budget deficit increases, they are going to raise taxes on those who produce and discourage investment even further. And its investment spending by businesses that drive the economy not consumption. They've got it all backwards. They put the cart before the horse, so that's why I think that they are going to lead us right down the road, which is the next great depression, which is our next topic. [32:51]
JOHN: So tune in next week, ladies and gentlemen. for the four horsemen of the apocalypse.
Other
Voices: Kelley Wright, Investment Quality Trends
JIM: Well, with the markets being as volatile as they are, there was a recent interview with Kelley Wright in Barron’s. And Kelley, when I saw that article, I said, good time to have you on, people are a little bit nervous, and sometimes they forget about the long term effects of dividend investing.
KELLEY: Hey, Jim, how are you doing today?
JIM: Hey, pretty good. Nice write-up about you in Barron’s last week.
KELLEY: Shirley has been just a sweetheart to us. And I appreciate it.
JIM: Well, it's amazing as you were talking about this pull back which gives you the chance to go in and buy quality companies that are paying and raising dividends year after year. And I relish opportunities like this! Who wouldn't want to get an 11% pay raise every year? That's why I just love this area of dividend investing? And yet, Kelley, so many people just ignore it. I mean it's, like, “oh, my God, the sky is falling” instead of saying, “wow, what an opportunity.”
KELLEY: You know it's funny. I was on with Maria Bartiromo a couple of months ago and she had me on for about five minutes and talking about dividends and the juxtaposition of her question she says, “well, Kelley, perilous times in the market, investors are worried. Is this a good time to be looking at dividend stocks?” And I said, “Well, Maria, no offense intended, but why do you wait for panic or why do you wait for perilous times in the market. You should be buying dividend stocks all of the time.” And you know, she goes, “well, yeah, obviously, but particularly in these times.” And I said, “well, yes, obviously when times are bad, but it remains the fact, this is the mistake that investors make is they wait until there is upheaval in the market and then they want to run for safety and quality, which is what they should just be doing all of the time anyway.”
So anyway, we had an interesting back and forth and I got an awful lot of calls and mail on that spot, so – [35:24]
JIM: Well, it's amazing. It's one of the real gems of investing in the stock market that's often ignored just like buying value stocks, buying them when they are cheap/ And yet, Kelley, you know if you look at study after study (if you look at Elroy Dimson’s book Triumph of the Optimists, looking at markets around the globe over a hundred year period or you look at Jeremy Siegel’s book, The Future for Investors , or the books that, you know, one of your mentors wrote, Geraldine Weiss, Dividends Don't Lie), it's absolutely amazing that this has provided a good bulk of returns of investing in stocks and has proven to be a very successful method for investing in the market and yet, what would you say? 90, 95% of the people that invest in the market ignore this.
KELLEY: You know, it's not taught, I think because the primary source of information that your average investor gets is either produced by a Wall Street firm or a mutual fund company, you know, or an insurance company that's doing variable annuity. And so you have to consider the source because those aren't really educational sources, those are marketing firms that are doing what they need to do to generate commissions or to gather assets. So investor education is just really bad. And so I think that's why most investors ignore this because they've never really been properly taught. [36:57]
JIM: You know I think there is also probably a conflict of interest here too. That’s because –you've seen the cable station commercials – everybody is talking about that trade, trade, trade, and even though the fixed commission structure is gone away and you can trade today very cheaply, but because you trade today cheaply, all of the emphasis is placed on trading, trading, trading. And believe it or not, Wall Street is making more money today with lower commission rates than they did when they were on a fixed commission system.
KELLEY: Remember how they screamed when I guess it was Schwab who introduced the first discount brokerage. They absolutely threw a fit. “Oh, this is terrible. You're not going to get good service and good advice. It's going to turn into a strip mall.” And you're right. You know, the good thing about the old days with higher commissions was I think folks did take the time to pause and say, “gee, you know, I paid a pretty hefty commission getting into this and I'm going to have to pay another one getting out.” So I think you're absolutely right. This world of lower commissions has definitely made it easier to hit the send button on the computer and hey, it's only $9.95. [38:14]
JIM: But you know something, if you pick up a great company that has been – gives you a real nice dividend and they have a history of raising dividends. I mean, you know, Johnson & Johnson reported their earnings were up, they are raising the dividend in the double digit area. I mean, how would you like to have a portfolio of 10 to 15 stocks with many of these companies raising their dividends 10, 11, 12, 15, even more percent a year. I mean in today's era of higher inflation, who wouldn't want to get a 10% pay raise every year. [38:48]
KELLEY: You know, you just sized up our entire approach, which is to build a portfolio of really high quality companies that consistently raise their dividend year in and year out of at least 10% a year so that at some point down the road, what you're really looking at is your yield on costs is getting pretty close to double digits. And in a world where... I would suggest that inflation is probably going to make a come back here pretty soon with all of the machinations going on between the Fed and the Congress, and so if you're in fixed income, your buying power is going to get eaten alive. And just growth stocks, you've got to be right 100 percent of the time. You've got to be right on the buying and you've got to be right on the sell. And if you don't get in at the low price and don't sell at a high price, then you know your money has been dead that whole time and you've had absolutely nothing to show for putting it at risk, so that's the beauty of dividends. [39:50]
JIM: You know the other thing I think is even remarkable and you talk about fixed income in an era of inflation, I'm looking at a Treasury screen right now. Two year Treasury notes are a little over 2.25%; A 10 year Treasury note is 3.67%. If there is no other major reason for getting into quality dividend paying stocks, I think the bond market by what it offers investors today is a very compelling reason to do so.
KELLEY: No question. And look at it. If you've got good stocks, I mean the good quality blue chips that you and I talking about that, you know, you're probably going to get 6 or 7% price appreciation every year. And you know, if you can tack on 2.5, 3, 3.5, 4% on the dividend, total return is going to get you somewhere up around 10 or 11, if you're lucky 12% a year. If you just go back to the good old fashioned rule of 72 and divide a 10 or 12 total return per year, you're going to be doubling your money relatively consistently and not over too long a period of time. [41:02]
JIM: What are you finding? I mean there was a lot of panic in probably the last week or so, but I tell you, I was like a kid in the candy shop on Tuesday. I know you categorize your stocks into three categories: undervalued, rising and overvalued. In your undervalued category, what does that look like today? I would suspect there are a lot of bargains there.
KELLEY: You know, it's interesting you bring it up and just actually there is a fourth category called the declining trend, and that's where they roll over from overvalued and they are making their way back to undervalued. But in our last issue, our undervalued basket went up to, oh, 91 stocks, which is about 31% of our universe. We haven't seen that many stocks in the undervalued category in years and years and years. So that category is swelling. The yield on the Dow is rising, so you get those two things working together and the upshot is that real value is being created. [42:06]
JIM: You know, this is an interesting point that you bring up because there are some people out there that are saying that we're in the stock market bubble, bear market, this is it. I don't think after what happened between 2000 and 2002 that we ever got to areas that I would consider to be bubble like in the stock market. I mean if you take a look at some of the companies you and I have been talking about in this segment, for example, General Electric, which you know, at one point in 2000 was extremely overvalued. But over the next seven years, they built their sales. Heck, they just increased their sales 18% in the last quarter, which is remarkable for a company that size. But their sales have increased, their earnings have increased and you and I know that until recently and even then it's pulled back, General Electric has basically gone nowhere. [43:00]
KELLEY: You know what? I can give you a handful of stocks, similar scenario. Colgate, Palmolive, Proctor and Gamble, GE would be one of them, look at Pepsi, probably, you know, even a J&J for that matter. You know, those five stocks got pretty richly valued going into 99 and 2000. And for all intents and purposes, they didn't so much as decline, they did go sideways really for a long time, but their dividends increased each year. And lo and behold, earlier this year, we started buying Coke, we started buying Pepsi, we started buying Colgate, we bought Proctor & Gamble again, we bought Johnson & Johnson. I mean just good – just phenomenal old fashioned huge brand names, but we got them at their undervalued area, which is what we like to do.
So and I think also to that point, I was looking at something the other day, and if you go back to mid-year 99, like July or so, you know that the S&P was roughly where it is today. Back then the PE on the S&P was 29. Today it's about, what, 14, about half of that. So that, I think, speaks to the point that you made that these companies did increase their earnings and started creating value by raising their dividends and so whereas their prices aren't really a heck of a lot different than they were then, the value that they offer now, though because their PEs are significantly lower, their earnings are significantly higher and their dividend yields are significantly higher, so it's the kid in the candy store time right now. [44:44]
JIM: You know, that's the thing that I believe if an investor was to take that longer term perspective, look at quality, look at fundamentals, you have a different viewpoint when you see these selloffs as we saw last week and we saw earlier this week, especially the selloffs overseas on Monday. I mean like you, we have a shopping list of stuff that we like to buy; and what we do is they remain on the buy list and then when you get these selloffs, we say, once again, “we're celebrating” and “oh my goodness, I can't believe you can get this stock at this price.” I think that gives you a different attitude towards the market rather than one of fear, it becomes one of opportunity.
KELLEY: I couldn't agree with you more. The thing that we really try to pound into our subscribers’ heads is the underlying value of a stock is its dividend. And if you will buy that dividend stream when it represents, you know, historic good value, you are going to be so far ahead of the curve that what that involves and what that requires is patience. And you know that's just – that's a really tough virtue for most investors. [45:57]
JIM: What I found rather interesting and this came from Jeremy Siegel in his book The Future for Investors, perhaps you read this or recall where he took two stocks and he went back to the year 1950 and he compared a growth stock and the epitome of a growth stock in 1950 was IBM. And one with “oh, my goodness, beginning of the computer age.” And then he took an old line cyclical company, an oil company like Exxon. And he took the price, assuming you put $1000 in IBM and $1000 in Exxon and then reinvesting the dividends, it was remarkable. I think he ended his study in 2003. The rate of return on Exxon was not only higher, but the investor realized much more income during that period of time, a higher dividend yield and even more so was the reinvestment of those dividends got reinvested at a lower rate or lower PE ratio. So over that period of time, the outperformance of this dividend-paying stock compared to IBM was just absolutely remarkable and that's where he wrote that whole chapter. He goes “you know what, you want to make money in the future, you better take dividends into account if you want to come out ahead.”
KELLEY: Yeah. And he got religion, and he got it in a big way in that study. You know, sometimes for laughs and giggles, go look at two stocks, Procter & Gamble and Colgate. They've both paid uninterrupted dividends over 100 years, and if you look at their compounded rate of return, the S&P doesn't even come close. I mean it doesn't even get in the neighborhood of what either of those have done. And if you look at a company like Pfizer who has just been brutalized since 1990, Pfizer has just shredded the S&P 500. And it's primarily on the back of their strong dividends. So, yeah, if you want to do the research, there is the evidence aplenty out there to grab hold of. It's a matter then of wrapping your mind around it and saying, gee, I've got all of this data and I've got all of this supporting evidence, so man, I should probably put it to work. And you know, that's the key. [48:20]
JIM: Kelley, do you find, of course with the recent turbulence –you refer to your conversation with Maria Bartiromo – are you finding a lot more interest? Are you people calling you up more and saying, hey, maybe what these guys have been talking about makes a lot of sense.
KELLEY: Oh, sure. Any time we get any kind of a downturn, it's like a Billy Graham revival meeting. I mean it's like a giant altar call. All of a sudden, you've got people getting religion in a hurry, and it sticks for a while right up to the point where, you know, that kind of complacency sets in again, you know, when we get into the so called goldilocks scenario or goldilocks phenomenon and then nothing bad is ever going to happen again. And then you know, “oh, gosh, you know, this stuff just isn't sexy enough.” So it's like getting on and falling off the wagon. [49:19]
JIM: Well, listen, Kelley, as we close, if our listeners would like to find out more about your newsletter, why don't you give out your website, please.
KELLEY: Sure. It is www.iqtrends.com. And very soon should be here in the next week or so, we've got a brand new website we're rolling out that's really going to be an educational tool and a big help.
JIM: And that's coming in the next week or so?
KELLEY: Yeah. You know what it's like, Jim. We're in that final tinkering stage and getting the bugs worked out, but it's really going to be a nice site.
JIM: Super. And will that have the same domain address? It will be www.iqtrends.com?
KELLEY: That won't change. You'll go to the same place, just one day you're going to hit the URL and a whole new page is going to open up.
JIM: Well, Kelley, we haven't talked for a while and when I saw your interview in Barron’s this week –congratulations by the way – it just sparked some interest. I just wish people would listen to people like yourself or the philosophy of dividend investing because we've got a whole generation of baby boomers heading into retirement where we know that the social security increases are nominal. If they'll be there 10, 15 years from now, some of that is questionable. That's why I think this dividend approach and especially companies that you mentioned that can increase their dividends, I think it's going to play a more important role for people that are getting ready to retire.
KELLEY: If you look at the landscape out there, you know, at the end of the day, you still have to make a choice between the three primary assets, which is stocks, bonds and cash. You know, we could get into a whole discussion about cash and the dollar. If you look at the interest rate being paid on treasuries and corporates right now, they are historically extremely low. And you know, you never know when they are going to go up, although one would think it's not going to be too long based on the amount of money that's being flooded in the system and some of the fiscal and monetary policies. But at the end of the day, it's just these really high quality choice blue chip stocks that year in and year out they know who their customers are, they understand their markets, they really got a good handle on their products and services, they know how to recruit and train and bring up new management to take over for the old and all they do is produce, they are consistent, they make money and they raise their dividends. If you picture that as the basis or core of your portfolio, really, really good things are going to happen. [51:55]
JIM: I would say maybe one final comment as we close. Companies that pay dividends, raise those dividends, tend to be more shareholder friendly. They understand who their customers are in terms of shareholders and you don't see the accounting scandals, you know, the stupid things that sometimes companies do with shareholder money on acquisition fronts.
Well, listen, Kelley, as always, it's a pleasure to have you on the program, all of the best to you, and please do come back and talk to us again.
KELLEY: Jim, it's a pleasure any time. [52:57]
The
Next Great Depression - Part 2
JOHN: Last week we introduced the topic of The Next Great Depression, and this is going to be a four part series on the program. This week is part two. We're going to cover the business cycle, exactly what drives it, do we have to have it, why we have busts, such as the one we're going through right now as a matter of fact; and how because of these busts and the fact that they are politically incorrect –I mean government can't take this because people feel pain – the governments are tempted to tinker and interfere with the marketplace, extending and prolonging the boom and quite frequently making the bust far worse than it would have been had you left it alone.
JIM: In today's session, what I want to do is talk about the business cycle and especially what creates the boom somewhat creates the bust? Why we have these busts as you just mentioned. And as we get into this weakness as the economy and the bust comes –whether it's the fall of technology and the bear market between 2000 and 2002 or the real estate bust that we're going through now – when you see government and central banks, they try to extend the cycle, or if they can't extend it at least mitigate the pain that you go through in the cleansing process. And all they eventually do is end up in a bust. And as we mentioned last week, if you want to follow along with what we are going to be talking about that over the next couple of weeks, you can get a copy of Murray Rothbard's America's Great Depression, which by the way is available free to download at www.mises.org. And you can just go there and you can download a copy of this book. Great, great book. Probably one of the best books ever written about the Great Depression and it's going to give you a great understanding of why we feel we're going to head into another one in 2010 as our politicians tinker and try to centrally plan the economy only in the end to end up with even worse economic conditions. [54:47]
JOHN: Okay. For people to understand this, we've got to do a number of things. We're going to look at the historical nature of this, but we do need to have some kind of backgrounder to frame the issue so people can understand.
JIM: Well, to begin with, business cycles and depressions stem from disturbances that were generated in the market by government and monetary intervention, such as kind of basically what you're seeing today: The Fed slashing interest rates, injecting liquidity into the system, government is coming up with stimulus programs. And it's not just here. We see this elsewhere. We see it in overseas economies as well. But if you look at this from an Austrian perspective, and by the way, the Austrians were the only ones that predicted that the Great Depression was going to come. They saw it coming simply by the actions taken by the central bank or what the government was doing. But if you take a look at this Austrian business cycle theory, money and credit expansion launched by the central bank and the banking system is what gives us our big booms as we saw from, for example, 2002, to 2007. And you recall when the US economy went into a recession in 2001, the attacks of 9/11, the unwinding of the technology boom and the bear market between 2000 and 2002, Greenspan was slashing interest rates, brought them down from 6.5 down to 1%. Not only did he bring down interest rates to the lowest level we had seen in half a century, but he kept them there year after year because, remember, we had the big deflation scare and that's because people don't understand what deflation is. Everybody was worried about deflation in 2003 because they tinkered with the CPI index, they changed housing, they changed new cars to used cars. And they tinkered with the Index; that dropped the CPI down. So everybody said “oh my goodness, we've got deflation.” In the meantime, if you looked at M3, it looked like a NASA space launch. And so they were injecting all of this money and credit in the system because they didn't want the pain of the recession and the market downturn of 2001. And that's what led us and gave us the next bust, which is what we're seeing today in real estate and what is going on in, let's say the credit markets. And you wouldn't have seen this to this extent under the gold standard. The booms and busts were self correcting. In other words, because of the way gold was transferred, governments weren't allowed to come in and tinker in the way they do today, run huge budget deficits or print and create unlimited quantities of money, which is one of the reasons why the dollar has lost probably, what about 95% of its purchasing value. [57:43]
JOHN: All right. How about the gold standard because how do these interact with this boom-bust cycle, or weren't the boom-bust cycles self-correcting?
JIM: Well, under the gold standard, the system corrected itself automatically because the markets, as I mentioned, weren't allowed to work things out, malinvestments were liquidated and governments had a straightjacket on them and kept them from meddling with the economy because it was more of laissez faire economy back then. And under the gold standard, savings determined –actually created – the real rate of interest. In other words, savings came from actual wealth creation. A business, an individual, produced something, they earn dollars from their efforts, either their labors or their business. Now, they could do two things with that. They could spend that or they could spend and save part of it. And when savings were plentiful, interest rates came down because there was a lot of money in the banking system. When savings were scarce, there was an automatic market mechanism that raised interest rates. In other words, when something is scarce and there is greater demand for it, the price of it goes up. In this case, the price of money would go up which means interest rates would go up. So interest rates were determined by market forces rather than artificially the way they are today through central bank intervention. [59:02]
JOHN: We need to explain that a little further, too.
JIM: Okay. This is going to get a little complicated. When you take a look at the supply of goods in the economy, it's one component in the social demand for money. An increase in the supply of goods, with all other things being equal, will increase the demand for money and therefore tend to lower prices. Demand for money will tend to be lower when the purchasing power of money is higher. In other words, when the money has a solid base to it. So for each dollar, it gives you more purchasing power.
Conversely a lower purchasing power –translated: higher prices – means that each dollar is less effective and more dollars will be needed to purchase the same goods and services. That's what we're seeing today.
Unfortunately in today’s modern fiat world, the real rate of interest and money demand is no longer determined by market forces. Central banks interfere in the natural process of the markets, much as Greenspan was cutting interest rates between 2001 and 2003, they were raising them in 2004 to 2006. Now in 2007 and 2008, they are lowering them. So central banks come in, they interfere artificially, inflating the money supply, which artificially when you throw a lot more money into the system almost as if through a natural means, in other words it gives the appearance that there is more savings coming into the system and that lowers interest rates. This is what gives you the boom. I mean just look at technology boom of the 1990s. It was very similar to the technology boom of the 1920s. You had a lot of innovations that were coming in through both eras, but a commonality between the 20s and the 90s is the money supply was expanding at above normal rates. And in fact, in the Clinton era, you had a 7 to 8% money supply growth and when money is created, it's going to go somewhere. In the 90s, it went into the stock market, so the key to the Clinton economic boom was an expanding money supply that began to sky rocket after 1994, and it found an outlet. Remember, when money was created, central bankers can't determine where it goes, and a relief valve for inflation has always been the financial markets. So the stock market was a relief valve in the 20s, it was a relief valve in the 90s. And eventually of course when you get these big, big booms as you saw in both decades (both the 20s, the 90s and then the boom here recently in this decade with real estate) it leads to a bust as all booms eventually do. [1:01:55]
JOHN: But when you get to bust, as we did with the bear market of, say, 2000, to 2002, and the recession of 2001, it's irresistible for politician to tinker again, or in this case the Fed, lower the interest rates, expand the money supply, bring down interest rates and we get another boom as we did with the real estate bubble and the credit boom and the securitization of mortgages, which is what we see unwinding right now. So each point, by the way, you see this goose to the market, and then it becomes a fiasco on the back side of it, you know. They pronounce it dealt with, it's wonderful and then the fiasco follows. So that's why you think eventually we're heading for a depression because we're on a series of downward bumps ultimately. [1:01:40]
JIM: Sure. And I want to refer to Rothbard here because any time you have a boom and it's followed by a bust, he talks about there are three factors you need to look at in trying to analyze the bust that follows. And he refers to the explanation of a depression as never found by, for example, referring to a specific or general business fluctuations. What he is saying is you can't get specific, such as “people aren't buying houses anymore.” It's usually found by getting answers to three factors.
First, why was there a series of a sudden cluster of business errors? What are we dealing with now? We're dealing with nine and a half months worth of real estate inventory. By artificially stimulating interest rates through money printing which brought the rate of interest down, it created the impression for entrepreneurs that there was plenty of money in the system; they went out, they over built condos whether it was California, Miami, Nevada or Phoenix or whenever the bubbles were occurring.
And why did people over build? Well, they were stimulated to make these investments by artificially low interest rates. And there wasn't the savings or the wealth to really back up all of this consumption. A second factor is it's well known that another common feature of the business cycle is the capital goods industry. That is your manufacturing industry is going to fluctuate widely and especially more so than the consumer goods industry like consumer staples. I mean we all have to go out and buy toilet paper, toothpaste, mouth wash or shampoo, deodorant and things of that nature versus, let's say, the manufacturing industry, which is raw materials, the assembly, construction, the equipment industries. And you know, it gets harder hit when you go through a downturn because there is a lot of capital that needs to go in this industry. It's a longer term investment when you build a factory or order large equipment. And another factor is every boom, and I say this consistently, every single boom is one of the chief causes of that boom if you look at it is an inordinate increase in the quantity of money in the economy. Where were banks getting all of this money to make all of these loans? Why were banks reckless with a lot of these loans? Why did they go out and make loans to people that couldn't afford it? Why did they make loans with no money down? Why did they make loans with no documentation in terms of proof of income? Well, there was no responsibility. There was a separation between all of this money that was being injected into the system, they could turn around, securitize it and sell it to some investor, and so there wasn't any direct responsibility. It wasn't going on their own balance sheet. So all of these characteristics, it's the same thing with the tech boom that proceeded the real estate boom. The over building of the internet pipelines. There was too much bandwidth. There were too many telecom companies. There were too many people working in the technology arena where we thought this was just going to go on and on and on forever. And then, of course, the bust came. And this, by the way, you would not in a purely free and unhampered market, which is what we don't have today, you don't see these kind of mistakes made. Maybe you might see some individuals make mistakes, but you won't see all individuals –in this case, all of the home builders – make the same collective mistake at the same time.
This boom-bust cycle really gets created when the central bank interferes in the economy by injecting large doses of money and credit into the markets. And I'm specifically talking about bank credit here because the banks are the vehicle; they might have securitized the loans, but the banks were the institutions that were making these loans. And so it happens every single time and that's why if you learn to study the Austrian business cycle, it's going to help you as an investor because you can see as governments come in and do these things, you know what's going to happen next. The Fed is inflating right now. It's injecting large amounts of money into the economy. The government is interfering with these giveaway. I call them ‘buy the vote’ rebates that they are going to give to individuals just before the election.
And it's not just us. You have other central banks that are going to be doing the same thing, and as a result, they are going to artificially stimulate something. That money is going to go somewhere. All of this money creation. So you've got to figure out, where is the next boom going to take place. And that is, to me, one of the keys of investment success is learning how to operate within this business cycle. [1:07:50]
JOHN: So the cycle then goes from boom to bust all initiated by the expansion of money and credit in the financial system initiated by intervention by the Fed, which is simply increasing liquidity, increasing the supply of money. And then its counterparts in the monetary system. Question: Would it go through a boom bust cycle if you didn't have this expansion and contraction of the money supply? Is that sort of an inevitable thing, or is it just that the expansion-contraction make it's all worse?
JIM: Well, under the gold standard, when you didn't have this artificial injection into the system or government's interfering, it would have been self-corrective. In other words, if for example, individuals started to borrow money because the value of money was cheap (in other words, there were a lot of savings that came from wealth creation in the system which lowers interest rates in a natural sense), as interest rates fell, it would encourage people to go out and borrow. But as there was more demand for money than there was supply, let's say everybody said “hey, interest rates are low, I want to start a business” or “I want to start an expansion.” eventually a lot of that savings would be consumed and as more demand came in than there was supply, the value of money would go up. Interest rates would start to rise, which would discourage people from making some of these investments. Now, the central bank sort of does this in an artificial sense where they inject large amounts of money into the system, and then inflation starts to rise as a consequence because there was no real wealth that went to this money or that was behind this money that lowered interest rates or what was injected into the banking system and eventually, you get inflation. And so as inflation begins to rise, then the Fed comes in and then starts raising interest rates. But it's done from an artificial sense, and that's why if I can explain it, when a bank prints or the Fed prints new money, whether it's bank notes or bank deposits and it lends it to business, the new money pours forth through the loan markets and that lowers the loan rate of interest. And here is where you get this artificiality. It looks as if the supply of savings in the economy for investment has increased, when in reality it hasn't. But by the same token, the effect is the same: There is a lot of money pumped into the banking system taking the place of, let's say, people putting money into the banking system through savings. And then the supply of funds for investment increases and the interest rate is lower. Okay. That is the stimulus. That sends a signal to businesses or homeowners or individuals, who are basically misled by this bank inflation into believing there is a big supply of savings out there greater than there actually is.
And it's when these savings funds increase, businessmen invest in longer processes of production. You know, you go out and build a factory. Let's see you're going to go out and build a refinery. A refinery may take you 7 to 10 years. These are long term decisions that people make. And the problem is the capital structure is lengthened and then you get a whole bunch of people coming in with these newly acquired funds and they bid up the prices of capital and other good and this stimulates a shift in investment from the lower end of the market (consumer goods) to the higher end of the market (manufactured or durable goods) and it changes the whole structure of the economy and we create in most cases a lot of malinvestments. I mean look at the supply of condos in Miami today. Look at the supply of real estate in Phoenix or in California. And this whole process is distorted.
And here is one of the favorite things that come in from the economists because eventually, you get into a bust and the favored explanation given by the economists and the government is “well, the only reason we have the bust is people aren't consuming enough, so we need to get people to consume more.” And hence –this is the very thing that you're seeing today with the stimulus package – we'll give people more money to consume in this tax rebate and that's just the opposite of what people should be doing. We should be increasing our savings and increasing our investment. And the problem here is the boom, which created this period of wasteful malinvestments, errors are made with entrepreneurs over building, over investing, the crisis arrives when eventually we get into this bust cycle; and here is a real key point that politicians don't understand, economists don't understand. It is the depression. It is the recession, which is the recovery process because at the end of the depression, it heralds a return to normal business conditions, normal economic conditions.
The depression, far from being discouraged that politicians claim it is, it is a necessary and beneficial process to cleanse all of the garbage out of the economy, and I use the analogy of a hangover. You go out on a drinking binge, you're putting a lot of toxins in your body. The hangover comes and it's your body's effort trying to cleanse the body of the toxins that creates the recovery. But the problem is, John, we want to keep feeding people drugs and alcohol. We never want the economic body to recover. [1:13:44]
JOHN: So ultimately, a recession is part of the cleansing process. It's almost like a detoxification which allows the economy to return back to normal, clear out all of the bad investments. It's literally a hangover that cleans the economy from just too much financial toxicity. And when this happens normally (say, the Fed were “all things being equal, money supply constant”), well, don't you normally get deflation at this point?
JIM: Sure. Because as you get into the bust, what happens in a bust? Prices begin to fall. People begin to default on debt. And the money supply begins to contract. And by the way, it's a contracting money supply which gives you your deflation. Now, when that happens, the price of goods fall, the price of investments fall whether it's stocks, real estate, bonds, etc. And as those investments fall and the money supply falls, the price of labor falls, prices fall. But John, it's exactly this deflation, falling prices that allow a lower supply of money to buy the same goods and services.
Now, what politicians do, and this is what they did during the Great Depression, as prices were falling, instead of allowing prices to fall along with it, the government comes in and artificially begins to hold prices up. We're saying that, for example, well, we've got to boost labor prices. We've got to keep the wages up. But it's actually falling wages that allows the economy to recover, that allows entrepreneurs to hire people. So by artificially keeping prices up, either through farm supports or through labor agreements that you have this misallocation between what is actually occurring with the money supply and what is occurring with prices in the economy. And so therefore, what they'll end up doing, and this is what we do today without a gold standard is they maintain prices and we'll get into a couple of things in terms of why they lead us into a depression through the various actions that they take. But that's what you're seeing today. They are injecting larger and larger amounts of money into the system as the system typically would begin to contract. When you see Citigroup write off $18 billion of bad losses or Merrill Lynch writing off 17 billion, normally that would contract the money supply as debt is written off and the system is cleansed. But they can't have that because they can't have falling prices, so they come in and try to counter act that with more drugs and alcohol through monetary stimulus. [1:16:27]
JOHN: Okay. But governments just don't like depressions, let’s face it, because politicians get thrown out of office pretty quickly. People don't understand exactly what controls the economy; they assume the politicians can do something about it. And you heard that this week about it: Isn't President Bush concerned about, you know, stimulus for this and that etc? This happened to Herbert Hoover, let's face it, and that's what flipped the whole thing from Republicans to Democrats there. And so basically, they feel compelled to tinker with the economy to show that they are in control and they are doing something in this in an effort to speed up the recovery process, which they can sometimes do; but then they try to postpone it and they make the next crisis even worse, which is what we're doing today. As a matter of fact, if you look back at our history over the last century, we're probably doing it more so today than we did before, which means we are going to get a bigger bang at the bottom.
JIM: Yeah. And that's exactly what they do. I mean there are a number of ways that policies that they try to extend or prevent the system from cleansing itself. And if you're following along with us in the Rothbard book, he talks about six or seven things that governments do to prevent depression. One is they can prevent or delay the liquidation of debts by making loans to shaky businesses and call on the banks to lend further. They are doing this with this stimulus package. They are going to have a temporary increase in Fannie and Freddie’s lending limits. I think they go up from 417,000 on loans to 700,000.
Secondly, they come in and they inflate further. We're seeing that right now, and this blocks the necessary fallen prices because they don't like to see that. They will come in and maybe keep wages up by increasing the minimum wage, which is something they did last year. They will try to come in with price supports to keep prices up. And instead of encouraging savings an investment, they will come in with programs to stimulate consumption. What do you think this package is they just passed? They are doing the same thing. And then what they'll do is they'll subsidize unemployment through the extension or prolonging unemployment benefits, which delays in the economy the shift of workers in one field of endeavor where jobs are possibly available, it prevents this shift or this natural correcting mechanism that takes place in the economy.
So once again, what are we seeing? They are doing pretty much every single one of those. [1:19:02]
JOHN: Well, if we were to do something positive, say Jim Puplava is head of the Federal Reserve –aside from shutting it down – what should the Fed or the government do that actually would be positive in this case to speed up the recovery compared to say, here, offering this stimulus package which is just a quick feel good shot in the arm and it's going to come back with a vengeance again.
JIM: You know, probably the best thing government can do is take their hands off. It could drastically lower its role in the economy. First of all, slash its spending. I mean there is so much government waste. I mean just read the government's old audited financial statements that came out about a month ago. John, they had, what was it, $715 billion that they couldn't even get the auditors to sign off that they really couldn't account for. So it could slash its own expenditures and also slash taxes. And that's what Bush did in 2003. The tax stimulus rebate that they did in 2001 didn't work. It wasn't until he cut tax rates in 2003 that it actually worked. But unfortunately, what Bush did not do is he did not cut government spending. In fact, instead of not only did he cut taxes, but he accelerated government spending, so taxes, and especially cut taxes that interfere with savings and investment. That's what we need in this country. We need to built factories, we need to manufacture, we need to save. We're borrowing almost 3 ˝ billion –it's probably down to about 2 ˝ billion to 3 billion a day – from foreigners. And the reason you heard some of the politicians lament about a lot of the US banks having to go to foreign sovereign wealth funds to get money. Well, you know what? They are the only people that are saving. The savings rate in this country is negative. The other thing is when they are reducing taxes they also make sure that the spending levels are automatically reduced as well, so you move and shift to a saving/investment consumption ratio in favor of saving and investment. That's not what they are going to do. They are going to spend money, this temporary rebate, they are really not cutting taxes. And one thing weighing over the economy is we know by the year 2000, if we don't extend it, we know that we have about one, one-and-a-half trillion dollars of tax increases coming: The tax brackets for all tax payers is going to go up; the marriage penalty is coming back; the capital gains rate is almost going to be doubled; they are going to increase the taxes on dividends. I mean, you just see this thing coming, it is so clear and yet it's like they never picked up a textbook and read about the Great Depression. And those who did study it like Ben Bernanke, if you read his PhD thesis,, he thought the only problem was they should have printed more money. And that's exactly what we're going to do and that's why I think we're headed for a hyperinflationary depression. [82:05]
JOHN: Well, Jim, and obviously we're going to have fall out shelter for sale and Puplava financial survival kits. Actually, that would be an interesting idea. I was just making a joke there, but it would be interesting to come up with a little financial survival kit, a checklist of things people to do. Maybe we should chew it over. But let's face it. Everybody is Keynesian out there right now. The type of economics you're talking about is not in vogue, you're not going to cut spending, so we are sort of committing ourselves to this course that we are on.
JIM: And that's exactly that the topic we're going to take up in Part 3 next week: The mistakes that were made during the Great Depression by the Hoover administration where they took a stock market crash, and what might have been a correction in the market and a recession, turned it into a Great Depression. Hoover began to tinker with the economy. We're going to show and talk and discuss about the tinkering that was done by Hoover and Roosevelt. We'll talk about and then relate that to today. It was amazing. If you looked at the tax rates, the tax rates in the 20s, the top tax rate was somewhere in the rate of 24 to 25%. Beginning with Hoover, Hoover raised tax rates to 63% and then Roosevelt raised tax rates to 94%. [1:23:19]
JOHN: Wow.
JIM: And John, it was just incredible. They just killed the economy and it would take a war to pull us out of one.
JOHN: Why would he do that?
JIM: I mean they were spending more money than they were taking in in terms of revenue, and so the simple static form of Keynesian analysis was “we'll just increase higher tax rates.” And they got less and less revenues. The budget deficits even got better, which has been proven time and time again. Remember when Bush cut taxes in 2003 and they talked about the deficits were going to mushroom. Instead, the government got more tax revenues. [1:23:54]
JOHN: Well, I think economics at times can be like philosophy or religion is that you all have your own theology or philosophy, and unfortunately, the only proof of whether your theology or philosophy is correct is (what do you call it? econology here) are your theories correct are reality. But I noticed, remember when Peter Schiff was on MSNBC and everybody was still arguing against him and he finally says, “look, guys, I've been proven correct.” And they all sort of sat there with egg on their faces going, what could they say, but they were still arguing their view points.
JIM: Yeah. “It doesn't matter because, well, I know it didn’t work last time, but we're going to tweak it some more and it will work this time.” [1:24:37]
JOHN: That's what it is. I don't know. Listening to the Financial Sense Newshour at www.financialsense.com.
JOHN: Well, let's see. Getting into the next subject. I just want you to know, Jim, that your Oreo theory is wrecking my eating habits because they just announced this week that they were no longer –a competing company – going to make Hydrox, since Oreos seem to have cornered the market. And frankly, I preferred Hydrox to Oreo. It was my childhood sandwich cookie.
JIM: I like the new Oreos with the really thick –
JOHN: You mean the double in the center?
JIM: Yeah. The double in the center. That's the good stuff.
JOHN: What about the vanilla ones? They have the vanilla ones now, and they taste pretty good too.
JIM: You're really with it. I didn't even know that.
JOHN: I am a connoisseur of the Oreo cookie, monsieur, or the biscuit as they would say in Great Britain.
Here we go. We have a great stimulus program coming up. The Fed is doing its thing monetarily wise. There is a dumb fiscal stimulus being promoted by government. Largely by the Congress more than anything else, even though President Bush is involved with it. We have headline inflation numbers and you would think, a thinking person would think, that gold would be strong right now, and especially gold stocks would be going up, but that is not the case. So what gives?
JIM: If you look at a chart, whether you're looking at the XAU, looking at the HUI, the gold stocks have been in a long term consolidation pattern going back to 2005. And only recently, in the latter part of last year, especially in August when the Fed began to slash interest rates, we saw a break out in the gold stocks. But that was sort of misleading because if you take a look at the 15 stocks that make up the HUI, John, you could probably boil it down to a handful about four or five stocks that really drove the HUI; and there were, I think, something like six stocks that lost money and the rest of them went nowhere.
What is happening, you can see this in the stocks themselves. They are sort of like, okay, gold will go up and then they'll rush into the gold stocks and then there will be a pull back in gold and then they will move out of the gold stocks and that explains much of the consolidation that you've seen. Well, what is happening because there is all of this trading in the gold sector, they are going into the big stocks and here is a good example. Since the beginning of the year, the HUI is up roughly about 13% and if you take a look within the HUI and the XAU, it's really the large cap stocks that all of this trading is taking place. That’s because if you're only going to go in short term, you're going to go into a large cap stock. You're not going to buy small cap junior producer or a junior stock. So year to date, you've got Barrick up nearly 24%, you've got Agnico-Eagle up about 15%, you've got Goldcorp up nearly 12%.
And so all of the main movement, all of the money that is going into the equity side of precious metals is going into the large cap stocks. It's not going into the juniors. You still have juniors struggling this year. You still have some juniors losing money because, you know, Danny Day Trader is panicking.
And the reason for that is this sector is being ignored, and what is happening is people are just trading the gold sector. And you remember in the first hour, John, when we were talking with Dave Morgan began, you said, you know, every bull market, and especially the gold bull market goes from pessimism to skepticism to optimism to eventually euphoria. And that certainly, for example, if you take a look at the bull market and stocks that began in 1982, probably up until 1985, you had pessimism. You can remember all of the negative books that were coming out, and then we had the stock market crash in 87. And so people became skeptical, and then eventually in 95, it was one of optimism until right around 97 it became one of euphoria from 97 to the first part of 2000. So I think when you look at the gold market right now, despite the fact that gold has gone up every single year from 2001 where it bottomed at around 255 and today we're looking at gold prices that are over $900 an ounce, we're looking at silver that's gone from 4 to over 16, it still hasn't caught on. So there is a lot of skepticism, and those who do go into the market are mainly trading the large cap stocks because the minute it dips, they are right out. They trade right out of the stock. And that's something that you can do with a Newmont, or that’s something that you can do with the Barrick because it's a big, liquid stock. And if you look at, for example, Barrick's stock, which is the stock that's outperforming most of the majors this year, Barrick is up, what, 24%. But on Friday, 13 ˝ million shares traded in Barrick.
So if you just wanted to go in and trade on a position, you have to go in to these big liquid stocks. So I would say what characterizes much of this gold bull market right now is a healthy dose of skepticism. You heard Dave talking about that: the Vancouver Gold Show where the gold bugs themselves are skeptical of anything. And I get a lot of emails on a daily basis and I get the same thing. When is this thing ever going to turn? I don't believe it. It's going to go down. The government controls the price of gold. All of this kind of stuff. So that's healthy. The skepticism is I believe the period we're going through right now. [5:33]
JOHN: Okay. Then we have to really ask the question what is going to be the catalyst that then turns this whole situation around where the up turn in gold equities ultimately filters down to the juniors because that's what people were looking for.
JIM: I think perhaps it's going to take a series of catalysts. Probably three come to mind. It could be one catalyst or maybe it might take all three, but the first one that come to mind would be a series of acquisitions by the majors in large intermediate companies of the juniors because over the last two years, you've seen the market price of the majors keep going up. And there has been this wide gap between the performance of the major stocks and the juniors. So you've seen companies like Agnico-Eagle for example, go from a market cap of two or three billion to (on this Friday) Agnico-Eagle's market cap was close to nine billion dollars. You've seen Newmont go to a market cap of almost 24 billion dollars. You've seen Barrick go to a market cap that even exceeds that of Newmont.
You know Barrick's market cap, it was one of the number one performing stocks in the HUI last year and the number one performing stock in the HUI this year. Barrick's market cap was 45 billion. So one catalyst, I think, that would come to mind would be a series of acquisitions of juniors by these larger companies because the larger companies, yes, they are exploring. But as I mentioned, it's much easier to go buy somebody who has already done the work because you can short circuit that process from discovery to production, which today takes 7 to 10 years. It's like Agnico's purchase of Cumberland. They'll bring Cumberland into production in the year 2011, so they are going to shave four or five years off the process.
So the first catalyst, I think, would be that a lot of these companies like a Barrick or a Newmont are going to need to make acquisitions because they are not finding –just like the big oil majors – the gold deposits that are replacing what it is that they produce each year. So catalyst number one would be a series of takeovers as the large cap companies begin to use their stock as currency to purchase the stocks of other companies. [7:59]
JOHN: Okay. So the first catalyst that we can list out here is the fact that the big guys buy the little guy's stock because the big guy's stock is expensive. The little guy is relatively cheap, so they subsume it. It's a natural thing to do. That's number one. Any other in the list?
JIM: The second catalyst that I can see happening, and I'm surprised nobody has thought of this is consolidation in the junior industry. I mean let's take, for example, silver producers. There are a bunch of emerging silver producers, companies that are producing two, three million ounces, maybe on their way to five. There are too many of them.
So one thing might be is to start consolidating. You know, you take three or four silver producers that are producing maybe two or three million ounces. You consolidate them all into one company, and now, all of a sudden, you have 15 to 20 million ounce producer and now you're on the category of, let's say, Pan American Silver, which has a larger market cap. You take a look at a Pan American silver, which has a market cap of almost 2.7 billion, and you compare that to the market caps of some of these smaller producers that have market caps of only 100 million. This would be one way to bring shareholder values, so look for somebody to become a consolidator.
And you can do it not just with producers, but let's say that you take two or three later stage or emerging stage juniors and consolidate them within a district. It's kind of what you're seeing Rob McEwen do with US Gold. Well, just take that concept and expand it and maybe not just a district area like Rob is doing in Nevada, but you may, say, take somebody in Canada, somebody in Mexico, somebody in Nevada. Three companies or four companies that have good viable projects and all of a sudden you merge them together and all of a sudden now, you have a company that has 10, 15 million ounces of reserves or resources that then you have a bigger company. It might be much easier to finance, so I think you're going to see a consolidation phase that will probably come into this market. And it's going to take somebody that has the initiative to go ahead and do that because simply right now there are simply too many juniors out there. And we really need a bunch of silver producers at two million or three million ounces [more than] do we need 2000 juniors that are all drilling and looking trying to build a deposit, which we know many of them aren't.
But if you can take, let's say, some juniors with maybe the potential of two million ounce deposit, take two or three of them, put them together, you've got a 6,000,000 ounce company and then, you know, when they go into production, they are producing 400-, 500,000 ounces of gold instead of 50,000, 75,000 or 100,000.
So I think consolidation needs to come to this industry. There is simply too many companies out there, and it's not being done efficiently. This kind of reminds me of what Rockefeller did with Standard Oil. There were just so many oil producers and wildcat drillers and too many refineries and he began to consolidate the industry and bring stability. And I think that's something that needs to be done to the mining industry. There is just simply too many mining companies out there, so it's going to take somebody with some financial acumen and somebody with a vision and just start doing this and consolidate. [11:18]
JOHN: Let's see if we've got this in a list here. Okay. Number one, big guys use their marketing power to buy the little guys. That's number one. Number two, there is a trend towards consolidation. What's number three?
JIM: I think the third one is going to be an explosive move in gold. Let's say gold going north of 1000. And let's put it this way. Gold crosses 1000, we get that four digit level for the price of gold, that is definitely going to start getting the attention of the media, it’s going to start getting the attention of institutions.
And then all of a sudden we cross 1000, you could see a huge spike in the price of gold as momentum comes in the industry. John, we've seen this in the energy industry. Remember after Katrina and Rita hit, the Gulf oil was shut down, production was shut down and the price of oil just skyrocketed. It went from the 50s all of the way up to close to 75, and there was a big huge momentum spike that came into the oil markets in the month of September in the year 2005 and part of October.
So if gold crosses $1000 an ounce, you could definitely see a spike in momentum that maybe takes gold up to 1200. Who knows? Even 14-, 1500 depending on how much money. And boy, I tell you, they are printing a lot of it right now. And then the other thing that would happen is: :Okay. What are you going to do if the price goes up like that?” Well, you can go in and – you can't have everybody bidding up the price of Newmont and Barrick and I think then you would see, okay, where is the next play? What is cheap? What is neglected? Then I think you get a trickle down and then it moves to a junior sector, and when it does, you get a huge explosion. Because right now, if you look at the market cap or ounce, which is one of the best ways to valuate the juniors, you can take a look at producers which are selling anywhere from 400, 500, $600 an ounce, or you can buy gold in the ground at 15, 20, $25 an ounce. And I think that's what a lot of the majors are going to do. That's why I do expect to see acquisitions. I do expect to see consolidation because even with the cost of mining going up, the cost of putting in a mill going up, the cost of permitting –everything in mining is going up – but the price of some of these companies is so incredibly cheap today that you can buy these juniors at 50 to 75 bucks an ounce and maybe a takeover. Some you can get even cheaper than that, that even if you add the cost of mining per ounce and the cost of capital expenditures per ounce, I mean, you can buy these things well below what it would cost you to go out and find it yourself and develop it.
So I think the third catalyst is going to be a definite spike in the price of gold. [14:10]
JOHN: It's really amazing when you think about it, Jim. Today gold is surpassing 900, and of course it's been going up steadily anyway, and despite all of that, this whole rising trend in the gold market, this seems to be escaping investors. They don't seem to be grappling with this issue.
JIM: That is generally how most bull markets unfold, John. It's, you know, going back to pessimism, skepticism. If you take a look at the stock market in the great bull market of the 80s. I mean it started in 1982 but the investment public didn't come into the stock market until 1995. And so I would not suspect it to be any different this time around. At some point, I think institutions and especially if gold goes north of 1000, that institutions would come in.
But take a look at what we define inflation as. We define inflation today as rising prices, so if oil prices go up, if food prices go up, we call that inflation. But we don't look at what the root cause of inflation is, which is monetary expansion, just as we talked about in the first hour The Next Great Depression. And so as the central banks cuts interest rates, we've got people clapping their hands and saying, yippee, the Fed is cutting. But they don't understand the inflationary implications of that. All they know is, well, when they go to the store, food prices are going up. They don't think, wait a minute, government is mandating ethanol. We're diverting 25% of our corn crop into producing ethanol which is energy neutral. They don't follow through with that thinking. And part of it gets back to education, whether you're taught Keynesian economics in the school class room. It is perpetuated by everything you hear on television or read in the newspapers. If your inflation rates are going up, gosh, it's the oil companies, it's OPEC. If food prices are going up, gosh, it's drought. It's a bad harvest. They don't tell you, well, it's a government program that's causing food prices to go up because we're rewarding the farmers by mandating all of these ethanol programs. You don't get the carry through of thought in this process. So as a result, people are sitting there puzzled. I've actually seen on days that gold has gone up, the Fed has cut interest rates and they've had experts on TV and they’ve sort of dismissed gold as an investment: It's like a barbaric relic. They really don't understand what causes inflation. And that's, I think, one of the problems that we're actually dealing with here. [16:33]
JOHN: The bottom line is a lot of people just aren't educated, and anyway, they just don't understand which way it goes and then they hear all of this talk, and they just start to repeat that and that's where they stay. It's the lack of understanding all around.
JIM: The thing that has fascinated me through this, the Fed is slashing interest rates, the money supply is growing at 15%, and high powered money all around the globe is growing at double digits at all of the world's major central banks, with headline inflation numbers at 4% (and we know those numbers are cooked),
why would you be buying Treasury notes at a little over 2%, or Heavens, going out and investing in a 10 year Treasury note at a little over 3.5%. Do you realize at 3 ˝%, not even counting taxes, you were getting about 0.6 to 0.75% less than the headline inflation number? Now, back out a third of that in the way of taxes, and John, you were falling behind and with the amount of money printing, the amount of government deficit spending, the trade deficit and all of these things,
why anybody would go out 10 years and buy a Treasury note at 3 ˝% is beyond me.
But, you know, nonetheless, I think people in other cultures that have gone through financial turmoil, currency turmoil, government turmoil as you've seen in the Middle East and in China and India, they have a healthier respect and understanding for gold and silver as a precious commodity representing real money.
I have a lot of communications with people overseas, and if you take a look at a phenomenon that's developing today, in India, they used to buy their gold jewelry, but even the India markets are opening up. You're seeing ETFs. They are talking about an ETF for gold in India. We're going to see them in other countries around the globe, which means that as more money pours into this sector, that means these ETFs are going to have to go out in the open market and buy more gold. They are going to have to go out and buy more silver. As you see more money go into the sector, they are going to be buying more of it.
And I think it's going to be dawning on most people that this inflationary environment that we're operating in today is not just a US phenomenon. It's a global phenomenon. So there is this incredible, incredible demand that's coming in. But, John, it has to go on long enough before people finally catch on. And we've got to move from skepticism to optimism.
And so the next two phases that will follow the skepticism phase, the optimism phase, the euphoric phase, that is why you take advantage of it right now, that people don't understand this. Because by the time you get to the optimism and the euphoric phase, the only thing you're going to care about is how many ounces of gold do you have, how many ounces of silver do you have and how many shares do you own of your favorite mining company, a junior.
And I would submit to you that by the time we get to the optimism phase and the euphoric phase, the price of juniors are going to make the upsurge in the internet stocks in comparison will be paltry in terms of the kind of return that's you're going to see. When all of this money starts going in to a market this small and demand increases versus supply, this thing is going to look like a moon shot when people finally wake up to this. [20:20]
I'm Andy Looney. Have you heard this about the federal government giving tax rebates to stimulate the economy? My friend Charles says President Bush wants to give every worker $300 to spend right away. Has he been shopping lately? $300 doesn't buy very much, at least anything that might save the economy. Does he even know we're using bar codes. I do. Don't you? Because daddy didn't. It won't pay college tuition for my kids. It's not even enough for a vacation with the price of gas nowadays. Certainly can't fly anywhere. It certainly doesn't help much with health insurance.
Now, if they cut my taxes, I could afford that, but I guess the government's health is more important than mine. I think I'll stimulate the economy by buying an X-Box. Hey, I'm married. Maybe we can get two. Don't you think you should buy an X-Box?
Maybe I could splurge and take Aunt Fanny to the buffet here in town. No. We send too much money to China already. Don't you think so? I do. Hey, if they are going to drop money from helicopters, the least they could do is make it worth my time to pick it up. Who thinks these things up? I'm just an average guy trying to support my family and get through life.
The president once said he wants to help me succeed in the 21st century, but the government is the biggest obstacle to my success. Oh, well. It's probably just as well they don't give me a lot of money because I'm just going to turn around and write a check back to pay my taxes. Believe me, that won't help the economy one bit. For Financial Sense, I'm Andy Looney. [22:22]
What
You Need to Know About Juniors
JOHN: Well, Jim, the big problem of trying to make investments to a large degree is if you go out on the internet, there is quite frankly a lot of contradicting information.
A lot of stuff that's bogus out there, sometimes it's deliberately bogus to try to achieve certain outcomes in the market, which we've talked about pump and dump schemes and other things related to that. So in this kind of an environment, how do you sort of figure out exactly what you should be doing and what's really happening?
JIM: You know, I think there is a number of questions if you're going to go into the junior mining sector as an investment that you need to be asking, and it's all part of the due diligence process.
But the thing you have to understand, and I've seen somebody sent me a link to a chat room where an individual was posting some stuff that was just, I mean it was obviously this guy was either uninformed or he had alternative motives. But the first thing that you need to understand about investing in a junior: It's not a producer. They are a company that are exploring or developing an area that they hope to bring into production. So as a junior, they don't have mining revenues. And what you hope is that people that are running the company have integrity, they know what they are doing.
So the first thing, the question I would ask when looking at a junior, is I'd take a look at who the CEO is, who were the technical people, the geologists that are on the ground, the boots on the ground so to speak that are doing the exploration work. What are their track records? Are they green field people, you know, somebody out of college, or are these experienced geologists that have a track record working for other companies with exploration success? Because really, when you're investing with a junior, you're really investing with people because it's the people that run the company, and you hope that these people have integrity. You hope they have a high degree of expertise.
And not only in the field of geology and mining, but also management expertise because there are two sides to a junior. There is the administrative side which means managing the company, paying its bills, going out into the capital markets, raising it, understanding marketing. And then secondly you have the technical expertise side which is do they have the exploration success?
So the first thing that you want to take a look at is the people that are running the company. Not just manage but also take a look at the directors of the company because remember when we were interviewing Sean Boyd with Agnico-Eagle, Sean had said, and I remember having lunch with him one day, and he said: “Mines are not found. Mines are made.” And it's management and their expertise that are going to turn out whether it ends up becoming a mine.
So the first thing you want to look at is the management, the people running the company and also the board of directors. What kind of expertise do they have on the board? What's the experience of the people they have on the board, or is this just a bunch of cronies, family members or things like that, that would raise some eyebrows. So management is the key thing. So that would be the first question I would want to know and have an answer to. [25:56]
A second question I would want to know is I would ask the company: What do you think the value of your company is worth? That's going to give you an idea of what management thinks of itself, what they think of the property, what do they think of the company. And then also, you know, given that, it sort of opens up the door: How does this company stack up to its fellow peers, maybe in the same region in the world. If you're looking at companies in Mexico, what is the market cap, what is the size of the property. How is this company valued against other companies with favorable prospects in the same area? So what is the value of the company?
The third question, and this is something that we usually ask in most of the gold shows that we have done over the years, how are you going to make me money and when? And how are you going to make it? And this is, you know, this is very important because this is when they are probably going to tell you about the blue sky and you want to make sure that they are not feeding you a line of bull. I've seen this over and over again where they tend to exaggerate what the upside potential is. But how are you going to make me money, and how is that going to translate into per share? In other words, okay, if you've going to explore, you've got upside potential. What are the amount of grams or ounces per share that you intend to add? That would be something that, okay, you're going to make me money because you're going to explore. You hope to find an increase and double your reserves. Well, translate to that to me as a shareholder. How many grams per ounce or how many ounces is that going to translate to me as a shareholder, so that would be one question. [27:39]
JOHN: You know, right here, I think you're addressing the issue of juniors, but if I'm listening to what you're saying, it would really only make sense that you can apply the same things to other sectors, such as energy.
JIM: Yeah. Because I mean any company, I don't care if you're looking at a Proctor & Gamble, a General Electric, a Johnson & Johnson, a Barrick a Newmont or even a junior is you've got to take a look at the CEO. Who is running the company? What is his track record? What is his background? The management and directors of the company, and then what is the, you know, when you ask them how are they going to make money, what is the plan of the company over the next 12 months? What does the company see? How are they going to increase sales. How are they going to increase profits?
And that brings me to the fourth question, which is what are the company's goals; what are you going to do for me as a shareholder in the next 12 months? And more importantly, what is the strategy that you're going to employ to help reach those goals? In other words, basically you've told me about the blue sky. Now tell me what's your business plan. And run for the hills if the company doesn't have one.
So dealing with the third question, related to how are you going to make me money, is what are the goals and what is the execution strategy. What are the steps that you're going to take in the next 12 months to help reach those goals? [29:06]
JOHN: Okay. But, you know, juniors as a rule don't produce income so you have to look at the company's finances then.
JIM: Well, sure, and that's probably a fifth question I'd want to know. Okay. Where is the money? The first thing you'd want to do is you want to know what do you have. And number two, okay, you just told me about your business plan – you're going to get three drills on the property, five drills or something: How much money do you need? What is your burn rate per month over the next 12 months? If you're going to accelerate your exploration program, what will your burn rate increase? How much more money are you going to need?
And then once you ask that, you need to ask yourself a question. How are you going to get it? Who is your investment banker? What is his name? Can I talk to him? And, you know, you need to have as part of an execution plan, you need to have a financial aspect as part of that business plan because once again, juniors don't produce revenue. They are spending money and they are raising it mainly by going out and doing financing. And something in terms of looking at a company's budget, how much of each dollar is going into exploration versus administration? You usually want to see probably three to four times going into exploration versus administration. [30:22]
JOHN: But you know, you're talking here about financing, but when you look at this whole field, there is a lot of hanky panky that goes on in terms of the financing itself. So the would seem just as important to look at this side of what you're going to do here.
JIM: Yeah. That's something that I've also learned over the years. How a company is being financed. You know, when we did the year end show, when we talked about the crime of the century, the pump-and-dump schemes and naked short selling. And I told a story about a company that we had been talking to that we were going to finance. And we were going to do a financing and then all of a sudden I got a call from this company and they said “we want to do the financing now, we’re getting calls from the investment bankers. They are excited about the company, and they want to do it now.” And I said I thought you weren't going to do that. I thought you were going to do a non-brokered private placement. There would be less dilution. They go, “well, no, they are really excited about the company. They want to do it now.”
And it was interesting as I was talking to this individual, I was on my Bloomberg and then I was looking at short positions in the stock. And I said how long have you been talking to these guys. And they said just in the last two weeks. I said, “Do you realize the short position in your stock just quadrupled?”
They go, “no.”
And so they were quite alarmed. And I had a conversation a week later with the company’s CEO and told them this very same position. I said, “you know what, your stock is at an all time high right now, and I can tell you, short positions are coming into your stock. And you know what, we're just going to bow out because what is going to happen to your stock is they are going to short your stock, they are going to take it down to a lower level, at which case you'll probably end up giving it to a discount, you'll probably end up giving them larger commissions, you'll end up giving them warrants and then what they are going to do is play the pump-and-dump game. Eventually, they will dump their shares and they’ll keep their warrants.” [32:12]
I said, “you know what, we’ll just hang loose. We'll sit back. And I like what you're doing, but we'll just wait until your stock price goes much lower because I can tell you that's exactly what's going to happen.”
And you know, John, that is exactly what happened. The stock lost 40% of its value in the next month. And by the way, the short positions went up to a record level with this company. They went from basically almost 30,000 shares short to over half a million, which is why – why these guys panicked and why they were scared into doing the financing at a lower price because the investment banker scared them.
But it's the same old pump and dump scheme, so yeah, definitely, how the company is being financed, who they are working with, because what is going to happen now is a lot of these shares are going to be dumped and what will happen next is the hedge funds that were probably brought in on the financing wind up turning around and shorting the stock. That's probably what accounts for the short position. They'll cover their shorts through the financing so they won't have to go into the open market and cover the shares and drive them up, and then when the four month time period expires, they'll start dumping their shares and then what they'll do is hold onto their warrants which will be free money. And eventually, the stock is going to go much, much lower and so that's when –if we do buy them – that's when we'll pick them up. [33:37]
JOHN: Okay. So far we've looked at the directors and the management of the company, which is important, what kind of business plan they have, how they are using money. What about the ownership of the company because that's not always the same as the directors obviously.
JIM: You know, that's also a very important thing because you don't want to invest in a junior where, you know, the main compensation of the people running the company are coming from their salaries because, remember, juniors don't generate revenue, so you want to look at a company where the owners take a large stake in the company, they own a large stake in the company. That’s because how do I expect management to make money for me if they don't own anything or don't have anything at stake in the company. So you want to look at a company where the management, the officers and directors of the company aren't relying on their salaries to make their money and that management and the directors of the company have a large stake because that way their interests are tied with your interests as a shareholder.
And especially when you see, like, for example, a financing when the owners of the company participate or family members participate with that financing, that's telling you that the owners of the company have a direct stake. So you know, they are going to do everything they can to make this thing work versus a company where you know, they have very little ownership and you take a look at generally you'll see compensation levels higher than what is standard in the industry because they have no stake in the business, and basically all they are doing is just sucking money out of the company through large salaries for themselves and they are not buying the stock.
You know, when management starts buying the stock and participating in financing, that tells you a lot. So ownership of the company is also a big part of what you want to ask when looking at companies. [35:26]
JOHN: Okay. Now that we've outlined all of that stuff, is there anything else that you think is important?
JIM: Yeah. One that I see very...you just don't see this too often is marketing sophistication. I see a lot of times where a lot of companies will spend a lot of money going to gold shows and you see them at every gold show and sometimes wonder why their stock never goes up.
I mean you want to pick one or two gold shows as some key gold shows you want to be, but, you know, I think having accurate says to institutional investors and talking to institutional investors is how you're going to market your company because what you don't want is a Danny Day Trader in your stock, a guy that's going to flip in. You don't want a hedge fund that's going to participate in a financing and flip out of it. What you want are long term investors, institutions that believe in the gold sector, that are long term investors, and especially institutions that are large enough that; institutions aren't going to trade in and out of your stock as readily as they would with, let's say, a large cap stock like a Goldcorp, a Barrick or a Newmont because by their very nature because they are more apt to take larger positions in a stock and especially a junior, they know that institutional fund manager knows that they can't trade in and out of a stock because they would drive the stock down. So you see very little marketing sophistication in juniors and those that do, that go the institutional route, that court institutions, end up not only having long term investors support the company, they have access to capital. And you're going to have less of this pumping and dumping and flipping that you see with so many juniors today where, you know, somebody will come in, buy a junior for 80 cents and then the stock goes up 10 cents or 20 cents and they flip out of it. That's not what you want. You want long term investors that are going to come in, that will help you finance the company, or go into the marketplace buying shares in the marketplace and take liquidity out of the market so, you know, eventually the price of the stock goes up. So how you're going to promote the company I think is also very important. [37:45]
JOHN: You know, we know this isn't a perfect world and in any business you can anticipate that if things can go wrong, it will. And so in trying to put something together that you're going to invest in, what else do you need to anticipate especially in those areas that require monitoring just so they don't go wrong?
JIM: One thing that I like to ask in a question is: What can go wrong? Because invariably if you're in a mining business whether exploration company, development company or even a producer, eventually something is going to go wrong. You know, we saw for example with Northgate. They were developing Kerness North. They got shut down due to environmental reasons. Or in the case of Agnico-Eagle, they had one of their mines got into a problem. The LaRonde mine had a problem with one of the shearing walls where it disrupted production.
So if you're in mining long enough, something is going to go wrong, so another question to ask of a CEO: what can go wrong? And more importantly, you know, I usually ask: What are two are three things that can go wrong with your business plan? And if the CEO tells you what these things are, then you follow-up questions, what are you doing as managers to anticipate what can go wrong, how are you monitoring the possibility that these things can go wrong? And let's say they do unfold. Let's say you have a series of disasters. If that happens, how would you mitigate it? What would you do? So asking what goes wrong, then probably another question that I would like to ask somebody. This can be a very revealing one and it can sometimes throw management off, but it's a very good question to ask, and that is: Is there anything else that I forgot to ask you? That is usually a stopper. And sometimes it may take a couple of minutes as they think, but, you know, sometimes what they tell you when you ask that question can be very, very revealing. [39:52]
JOHN: Well, Jim, is there anything I forgot to ask you?
JIM: Hey. Touché. Touché.
JOHN: No, seriously. There is all kinds of public information on these things, but can you get other information. How do you do that?
JIM: You know, that's probably another question you want to ask of management is: How can I learn more about your company? Well, you know, you can go to quarterlies or annuals that are filed (they are obligated to file as a result of SEC rules or Canadian regulation rules); you can look at proxy statements. You can ask the company: Are there any analysts who are covering your stock or have initiated coverage and can I have their names. Are there any newsletter writers who are covering your stock?
And here is one I always find rather interesting: When you ask the company CEO, if you were to put your own money into your competitors, what competitors would you be buying? And that's always an interesting one, so you may get the names of three other companies that you can talk to and then talk to these companies because this gets back to what we call the scuttlebutt that was used by Phil Fisher is he would find out more about the companies that he was thinking of investing in by asking them what they would invest in. In other words, in terms of asking what they thought about their competitors and he would go talk to their competitors. So ask him are there any other companies that you would invest in or put your own money in and sometimes you get some really good information.
One of the companies that we have had and did very well, it was a silver company that went from one dollar to, basically, as high as 16 bucks. I got that by asking that question. I was talking to somebody, and I said if you were to invest in another silver company, who would you be investing right now? I got that name and it turned out to be one of our best silver picks actually going up almost 15 fold from where we got in. So you never know what you're going to find when you go into this process, but that's why it's worthwhile. It will teach you a lot about the company that you're investing in.
And the great thing about this, John, is when you're investing in juniors, it's not like you’re buying shares in General Electric where you're going to call up General Electric and say, hey, listen, I want to talk to Jeffrey Immelt. Chances are, unless you’re Fidelity and you own a gazillion shares of General Electric, you're not going to get Mr. Immelt on the phone. But most juniors or small companies, you can go to the company's website. You can get a lot of this information. You can get the quarterlies, the annuals, the proxies. Most company will have an investment presentation on their site. They might tell you who the analysts are that are covering their stock. But also I think that people would be surprised. You can pick up the phone and talk to these CEOs. Let's put it this way. If the CEOs don't return your call and they don't want to talk to you, well, that will tell you a lot about this company to begin with. So I think people would be surprised at the information that these companies are willing to share with you.
I mean they are not going to give you inside information, but the various questions that we talked about, finding out who the management and directors are, you're going to get that on the company website, who the CEO is, maybe the background of these people. Talking to the CEO, how are you going to make money and what's the blue sky? All right. You just told me how you're going to make money.
My fourth question: what are the company's goals, what are the strategies that are going to be put in place, what is the business plan?
My fifth question: where is the money, how much do you have, how much do you need, how are you going to get it, what is the financial part of the business plan? Also a lot of public websites, Yahoo and some of the others. How much do the owners of the company, management and directors own? What is the company's promotional plan. How are you going to get exposure to the company?
My eighth question: What can go wrong? What are you doing to monitor and anticipate it, and if it does happen how would you fix it? And then how can I learn more about the company? These are all questions that you can get either on the company's website or by calling up the company directly and, you know, I think you'll find a lot more information. You might even find it a fun process to find out more about the company that you've invested in. [44:14]
JOHN: And what about the issue of chat rooms any way, as far as evaluating this?
JIM: You know, once again, I always recommend the primary source of information, go to the horse's mouth. Go to the company. I've seen chat rooms with good discussions, people that sound like they are interested shareholders who put out good information. You may even see, you know, discussion or talking to management, but sometimes I'm a little bit leery because you get a lot of people sometimes on chat rooms that may be shorting the stock and they put out a lot of disinformation.
Once again, my favorite source is go to the horse's mouth, go to the company's website, take a look at their financials, take a look at their filings. Talk to the company management, talk to the geologists, the CEO. That should be your number one source.
But hopefully, the things that we've discussed would probably add some clarity if you're going to get into the sector because let's face it, the juniors in the last couple of years have not done well. It's mainly been the large cap stocks, but there is going to be a catalyst as this bull market moves from its, basically, pessimism, which is where the industry was four or five years ago to today where it's even in – within the gold camp itself, it's skepticism to eventually getting into what I call optimism and then euphoria. And that's where I think, you know, the launch pad for the juniors is going to be. I just shudder to think at the staggering heights that a lot of these companies will go to when money starts pouring into this area and it becomes mainstream and it catches on. Not only with institutions but also with the investing public. It will be, like I said, it will make the internet days from 97 to the first part of 2000 look calm by comparison. [46:05]
JOHN: Financial Sense Newshour online all of the time at www.financialsense.com. Coming up the next hour, Q-lines. Time to take your phone calls. We'll be back.
JOHN: Time to go to the Q-lines, Q-line meaning the question line. It's available to you 24 hours a day to record your questions for the program. We ask that you give us just your first name is fine and where you're calling from. We like to know where listeners are listening. And try to keep your questions brief. People are tending to splatter out and get longer and longer and longer again, and that's not good because at some point we can't run them. The toll free number in the US and Canada is 800-794-6480. That is toll free in the US and Canada. It does work from the rest of the world, but you have to pay your normal long distance international rates for anywhere outside of the US and Canada.
As we answer your questions, please remember that the radio show content here on the Financial Sense Newshour is for information and educational purposes only. You shouldn't consider it as a solicitation or offer to purchase or sell securities, and our responses to your questions and inquiries are just based on the personal opinions of Jim Puplava and cannot, because of the fact we don't know you, take into account your suitability, your objectives or risk tolerance. And as such, financial sense is not liable to anyone for financial losses resulting from investing in anything we discuss here on the program. Please remember to consult a qualified investment counselor –whenever – before you make any investments. Preferably someone who agrees with somewhat our philosophy, meaning more of an Austrian school of philosophy rather than Keynesian. But it's important to have someone who understands you and your situation before you go out and invest.
The first call is from David in Cleveland.
Hello, Jim and John. This is David from Cleveland. Thank you for all of your help. I have a question for you. I recently bought stock, recently being in 2007 a small gold mining company in the Yellowknife region of Canada. And shortly thereafter, they went through a financing package and their stock went down significantly, and I assume it's short selling, that sort of thing. And my question to you is this: What should I do? Should I just weather this thing out? How long does it take before the shorts decide to liquidate their positions? Need some advice along those lines. Should I hold and how long does it take for this thing to work itself out. Thanks for your help.
JIM: David, I'm familiar with the company. Actually, there isn't a short position in that company right now. We got a question similar to yours last week, and I think the combination is a result of three things. Number one, they have some warrants that are coming due in this February, March period, so sometimes people in order to pay for the warrants will sell their existing shares, so you have some selling ahead of warrant expiration. That's taking place.
Number two, the juniors have been hit as a sector. Remember gold was up in the first week of the year. They went up and then they hammered gold, and with that the HUI came down and the junior stocks have come down. So as a sector, as a class, the only stocks that are doing well right now, once again, are similar to what happened last year, which are the majors, you know, the Barricks, the Newmonts and the Goldcorps. There are a lot of juniors right now that are down, so the whole sector, as a class, has gone down with this correction.
And so the warrant expiration, the juniors as a class, and remember, we had a correction in gold here. This happened a couple of times, and then the whole general stock market as a whole has been hit. I mean if you take a look at the major stock indexes, not only just in the United States but around the globe. The Dow is down 8% year to date. The S&P is down almost 9 ˝%. The NASDAQ is down 12. If you go to Europe, the Dow Jones stock index is down 14%. The Nikkei is down 11%, so on top of that, you've got a liquidity as investors panic with general selling in the stock market.
So I would say three days that caused us to go down, and my advice would be hold. As I recommend, if you're going to be in the junior sector, if you bought shares and you don't want to buy all of your shares at once, but any time the market weakens or the shares pull back, then you dollar cost average and then add to your position. [4:33]
Dominick from Germany. I've got a question. There is a political force that's a natural ally for our purpose and it's the anti-globalization movement. They are very angry for the same reasons as the goldbug community. And they haven't realized it yet. Instead of blaming the government and central banks, they are attacking the markets. So my proposition would be to let your show slide down to the Davos social forum in Porto Allegro and do a workshop for them like “the printing press” and imagine a year from now Davos forum demonstrators protesting for the gold standard.
And one more thing, in Germany, we had in the lost three or four months prices going up for milk products some 30% and the state propaganda works so good that when you ask a German on the streets, he will tell you the milk is too expensive because the Chinese are drinking our milk. Everyone knows that Asians don't like milk. They cannot digest milk, so it makes no sense at all. Thanks for your show. Great show.
JIM: Yeah, Dominick. You bring up a point that we've been covering and a topic that we call the next Great Depression because the interference in the market place with money printing and all kinds of government schemes was blamed on the marketplace instead of the real cause why inflation was going up in the streets or like in your own country in the 20s. They blamed it on foreigners, and just as you said, in Germany, they are blaming it on the Chinese, and that's government propaganda because the government can't say, “hey, look, the reason things are going up is because we're inflating.” They can't do that. Yeah, it would be nice if we could have a workshop and teach these people in terms of why their taxes and inflation are going up. It's all due to government. [6:29]
Hi. My name is John. I'm from Phoenix, Arizona. I have a couple of questions. One was the uptick rule change on July where they did away with the uptick rule for short selling, how that may be affecting volatility; and also what happens if sovereign wealth funds keep bailing out these companies that need to go bankrupt in the future and it just keeps perpetuating - your thoughts on that. Thank you, and I love the show.
JIM: John, getting rid of the uptick has made it easier to naked short, and by the way, there is a petition that we're going to put up on the website, if you live in the US, that you can sign that we're going to – there's a petition going to the SEC to do something about the naked short selling and you can sign it. The more signatures that they get from investors, the more likely they are to take it seriously, But getting rid of the uptick certainly made it easier to short and create volatility.
In terms of the sovereign wealth funds, we are a debtor nation, and unfortunately, we need to import so much money in this country and we're inflating maybe the side bet or the consequences that we make of that, you know, we sell our asset to these sovereign foreign fund to pay for our consumption. It's what happens when you're a debtor. Remember when you're a debtor, you have to put up collateral and one of the collateral that the US is putting up right now are our assets which we're selling in exchange for trinkets. It's kind of like when the Dutch bought Manhattan for 24 dollars. It's unfortunate, but that's what we're doing. [7:56]
This is Mike from North Carolina. Jim and John, I love the show. My question is how do I participate in the movement of the agricultural markets? Is there an ETF that would be appropriate? Thanks for all of the help. Continue doing a good job.
You know, Mike, there is a number of ETFs out there. There is one that buys the agricultural commodities themselves. It’s Market Vectors Agribusiness ETF, the ticker symbol is MOO, and the fund seeks to buy the price and yield of the DAX Global Agribusiness Index. And that's one. There is a couple of others that buy Ag sector stocks that have John Deere... I can't think of the other index offhand, but there are several indexes out there that you can look up if you're doing some research on ETFs. MOO would be one. [8:01]
Hi, Jim and John, this is Bert in Arizona. We're hearing all the kind of explanations for the underperformance of the junior mining sector as gold and silver reached record highs this past week. And I just don't buy that the money is going into ETFs. I mean this is not the same investors. I can see Barrick and Newmont money going into ETFs; but in the junior sector, I think it's a different investor. I'm wondering how much of this underperformance is due to the head winds provided by this naked short selling, this counterfeiting of a stock? And I know there is not much that a little investor like myself could do, but I know you're looking at it, Jim, and I'd like to know what actions you're taking to protect your portfolio and what a small investor can do? Thank you very much.
JIM: Bert, there is a number of things you can do. We've got a petition that we're going to put up this weekend as a US investor you can sign. It's going to be a petition sent to the SEC. There is a large short position in a lot of these juniors and you can see this. By the way, we report this on our website every week. We have short positions that we post and we also post once a month short positions, even in the major stocks. So you can take a look at that and I would say you would use it to your advantage. When you see those short positions building, when you put your bids if they put your bids, and they keep taking the stock down, lower the price of your bid and force the short sellers to sell you shares at a lower price. You see a lot of this goes around, especially when companies are doing financing. Just listen to the last hour. I described one of those situations. [10:29]
Hi, Jim and John. This is Rob calling from Niagara Falls, Canada. Great program. Loyal listener. Just a comment actually. Following US politics from up here in Canada kind of makes me wonder why you get so excited. You've only got two choices, two parties. You can choose between bad and worse, so I don't know why you're getting so excited.
Anyway, I've got four questions here. Question number one is commodity prices. If there is a slow down, does demand for commodities should slow down as well so you get a price drop in commodities. If there is inflation as you're talking about is there an increase in the price for commodities because you’re saying that the next asset bubble is going to be precious metals. Commodity prices and I'm talking about precious metals are they going to go up or down?
My next question is stocks. I'm looking at juniors or even producers. You mentioned Yamana on your program, Silver Corp, Silver Standard. You've all had them on your program. I've noticed their stocks have gone up two or three times over the last couple of years. Is that the end of the line? That seems like a huge increase to me or is there still more room to go, and I'm not talking about investing in these companies, just a general comment.
My last question or my third question, sorry, is what happen to commodities if Iran gets attacked. What’s going to happen to the junior companies and the commodity prices if the United States does go in and attack Iran just before George Bush leaves office?
The last question has to do with takeovers. I'm noticing at least in platinum companies there are a lot of takeovers. As far as I'm reading you can have a friendly take over where the stock prices are more, or you have a hostile take over where the stock gets hammered and the stock goes down. Is there something an investor can do to protect themselves from these takeovers; is there any kind of a warning signal. Anyway, guys, great program, thanks for having me on and hope too hear your answer.
JIM: Boy, Rob. I don't know where to begin. You've got a lot of questions there. Let me see if I can get through them rather quickly. What happens, will commodity prices go up and down, if the economy gets worse? You know the one thing that people don't look at is demand fundamentals. There is some weakness in commodities right now based on the fact that the US economy is going into recession. The rest of the world will also slow down, so there is going to be less demand for commodities, but you know the one thing they don't look at. There is a supply response. And let me throw something out that we're going to be talking about that more and more, which is actually quite frightening. Despite 17 years of record harvest, the supply of grain, our inventory levels of grains have dropped. The amount of arable land devoted to farming has dropped. And so here we've had record harvest and our supplies keep dwindling, and that's because demand has grown faster than supply. You see, economists and a lot of these people that are negative on commodities have missed the whole supply and demand picture, and that is they are only looking at the demand side and therefore with slower economic growth. Well, I hate to tell people, just because economies slow down, it doesn't mean that people stop eating food or for that matter stop using energy. If you listen to the segment that we did with Joe Duarte where I mentioned that our depletion rate of existing oil fields is dropping by 4 ˝%. Many feel like, for example, the president of Schlumberger has said that he believes the real depletion rate is closer to 8% in the North Sea. And for example, in Mexico, the depletion rate is actually 18%, so they are not looking at the supply side. So I think commodities are in a long term bull market and I would use any weakness to add to commodities. You mention some of the stocks that have gone up that we've had on this program: Silver Standard, Yamana, Silvercorp and others. Is this the end of the line? No. We're just beginning in this bull market. We're still in the skepticism phase. We haven't even got if where it gets crazy, so no, this is not the end of the line.
What happens if the US attacks Iran? Oil goes to $200 a barrel or $150 a barrel of oil. [14:38]
Hi, Jim and John. Howard from New York here. A faithful listener since the summer of 2003. I don't know about you, but with stocks dropping, interest rates dropping and commodities starting to selloff the current environment is feeling pretty deflationary to me. Would it be fair to say that how the markets react to the upcoming rate cut stimulus package, helicopter drops of dollars, that we should experience in the next few months will go a long way to resolving whether the inflationists or the deflationists have it right?
JIM: Howard, once again, we get down to what we call “what creates inflation and what creates deflation.” I adhere to the Austrian view, and that is inflation is caused by an expanding money supply. Deflation is caused by a contracting money supply. And as we speak, the money supply is increasing. It's growing at 15% rates in the United States. It's 12% in Europe and China; it's close to 20% in India it's 22 percent; and then Russia it's 46%. I can go on and on.
Here is the key thing that you have to ask yourself. Remember when we went through the bear market between 2000 and 2002, the Fed began to cut interest rates in 2001. Initially in 2000 and parts of 2001, the stock market sold off, the gold market sold off.
When eventually there was enough inflation pumped into the system, they began to figure this out, and what you saw in the summer of 2001 is the gold market began to turn around, especially the gold stocks and they began to take off. So if you want to know if we're heading for inflation or deflation, watch the money supply. If the price of a plasma screen goes down, that is the natural order of production. When more goods are produced, the price always comes down because you get manufacturing efficiencies. So just because real estate, which is deflating right now, look at oil prices which is inflating. So the key is watch the money supply. That will tell you if you start to see the money supply starting to contract and go negative, then that's deflation. [16:56]
Good afternoon. My name is Suda. I am ringing from Fort Lauderdale, Florida. I would like to pose in a question for your team. Can you see effective solutions or attempts at solutions out there that will bring stability to the banking system, the monetary system, and will drop inflation and bring real growth to the globe? I mean outside of Asia. Okay. That's my question. And then I had just a feeling that I wanted you to confirm. The Fed, you know, it seems like it's lost its capacity to organize and drive the central bank and that it can no longer sort of steer this ship. Is that the case? Thanks for your time. Thanks for your great program.
JIM: Suda, about the only thing that can bring stability to the banking and monetary system is to go back to a gold backed standard where central banks and governments are not allowed to inflate or deflate. Otherwise, you're going to have these boom-bust cycles that will become worse and worse. We saw it with the tech boom. That was followed by the tech crash. Now, that was followed as they reinflated by the real estate boom. Now we're seeing the real estate crash. Now, what do you see today? You see Congress spending money it doesn't have, in a program that will do nothing to stimulate the economy’ the Fed is slashing interest rates.
And finally your second question, has the Fed lost some of its ability to steer the world. Well, yes, it's becoming less relevant as we become more and more of a debtor nation. In other words, we no longer have the economic muscle that we once had. And we're losing that as a result of our indebtedness, but if you look at the stimulus programs that they are coming out with, we are just going to go deeper and deeper into debt which will mean we are losing more of our economic power in terms of directing things because we're now the world's largest debtor nation. [18:48]
Hello, Jim and John. This is Dave from New York. First off, I'd like to thank you for taking my call and certainly thank you for your invaluable and informative show. I was just calling to suggest that maybe we can skip the Oreos all together, go on a diet, because if this blood bath in the market this week suggests we're heading straight to the depths of depression, or is there a Plunge Protection Team going to come to the rescue, throw a life line as it were? I'd just like to get a response on is that, and once again, many thanks for your great program.
JIM: Dave, as we sit in the Oreo theory, we still have a lot more rough stuff to get through in the first quarter, but eventually, they are going to throw enough stimulus, the Fed is going to cut interest rates enough to give us kind of that creamy filling that I see just before the election. In fact, we didn't get a chance to cover this in the Big Picture segment that we did on the great depression, but just coming out on Friday, there was an announcement by Chuck Schumer of New York that said that the Senate is going to have their own version of the agreement reached between the House and the President. They want more unemployment and food stamps and more stimulus. I don't think this is the year that it happens. We're predicting 2010 is when the depression hits and it's going to be a series of compounded policy mistakes made by the government. And you're going to want to listen to next week's program as we get to the policy mistakes in response to the market downturn and what was going on in the economy by government because you're going to see so many parallels to what we're doing today and that's why I think we're headed down the road to perdition. [20:32]
Hello, Jim and John. Great program you guys have. My name is Felix. I'm in Houston. And my old investment advisor wants to use UIC unit investment trust. What are these? He doesn't seem to understand the inflation as growth in money and believes that things will be back to normal in houses and the economy in a few years. What am I to do? I'm skeptical to say the least. Where can I find gold juniors? Help, please.
JIM: You know, Felix, I’d probably recommend ETFs that carry the various sector that we talk on the program whether it's agriculture, food, water, infrastructure, energy or gold, I think you're going to be better off. And if this guy thinks we're coming back to normal, I tell you, you need to be talking to somebody else because he's going to be steering you in the wrong area. If he's steering you in the bond market, you don't want to be in bonds right now with the headline inflation greater than the return on bonds before taxes. So you may need to fire this guy and find somebody that is more cognizant of the kind of climate that we're operating in. [21:37]
Hey, Jim. It's Jeff in Myrtle Beach, South Carolina. I'm curious about your opinion on coal bed methane, specifically in China. I have a large position in a small company that's exploring hopefully going to go into production with their coal bed methane. I appreciate it. Thank you.
JIM: It's one of the areas if you take a look at the primary energy source of natural gas is a substance called coal bed methane, so it's very promising. That's where we get a lot of our natural gas, and if they can find a large deposit, it could turn out to be a very good investment for you. [22:14]
Hey, Jim. This is Mike from Wisconsin. How are you doing? Thanks for all of your hard work. I've got a question regarding gold. If you look at some of the newsletter writers that have been bullish on gold for the last four or five years, such as Steve Sjuggerud, have now turned very cautious on gold saying it's gotten too popular and too many people like it, and to me it just seems that's not a great excuse because it doesn't change the supply and demand picture at all. So I'm wondering, do you agree with this? It obviously sounds like you don't, and if this is the case for them to try to sell more newsletters to get people nervous or what do you think it is? So obviously the run has been good but it hasn't been great yet. So what are your thoughts on that?
Secondly, any thoughts on Russia. It seems to be Russia hasn’t been an emerging market that has moved like China has. I tend to think they can do well here in the future given the state of things. I was just wondering if you would add comments on that. Thanks for everything you do, and I appreciate it. Bye now.
JIM: You know, Mike. In terms of its become too popular, I'd disagree with that. This is certainly not mainstream. Just listen to the cable channels. Any time the Fed cuts interest rates or the prices of gold goes up, the last thing, I've seen people go on the cable shows and say gold is a barbaric relic. Why would you want to invest in gold? When you start seeing Maria Bartiromo broadcasting from the commodity pits and talking about the next gold IPO that's going to go find the Lost Dutchman Mine or your neighbor has quit his job and he's day trading junior stocks, then you're going to know that this is probably gotten to that euphoric stage. But we're so far away from that. I disagree with that.
Investing in Russia, I don't trust the Russians. They always change deals. Just look at what they did to mining companies in the early part of this decade. Especially a lot of silver companies that went in there, and also look at what they've done to Western oil companies that have invested there. [24:03]
This is Steve calling from Seattle, Washington. I sold my home two years ago, and I'm recently trying to decide whether I should get into another home now listening to your program and the Oreo cookie analogy. I'm trying to decide whether getting back into real estate would be the thing to do right now or if I should wait until 2009, 2010 time frame. If you can answer that question for me, I'd really appreciate it. Thanks a lot. Really enjoy the show.
JIM: Steve, I'm not really familiar with the real estate conditions in Seattle. I'd check with your realtors in terms of what's going on. I think real estate is going to get weaker. We've got a lot more finances and resetting that’s going to go through. We know, for example, nationally with the statistics, I don't know what it's like in Seattle, but we've got almost nine and a half to ten months worth of inventory on the markets, so that just tells me the prices have got to go lower before they can liquidate. My gut feeling would tell me I would wait because I think prices will get weaker. [25:05]
Jim and John, this is James from Phoenix. On this week's Q-line, you listed books about the economic depression of the 30s including Murray Rothbard's America’s Great Depression. I'm just reminding you that one of the best and most comprehensive books that you have reviewed is Nathan Lewis’s Gold: The Once and Future Money. Nathan has a great chapter on the Great Depression, with a critique of Rothbard’s [that] though outdated it's still a great analysis. This is one of the better books for Financial Sense listeners that I'd recommend that everybody reread it and also listening to your interview. Thanks a lot.
JIM: Well, James, I appreciate you bringing that to our attention and if you want to listen to the Nathan Lewis interview, you can look in the 2007 archives. Yeah. I think it was 2007 that we interviewed him. Once again, I still like Murray Rothbard's America’s Great Depression. You can get that at mises.org and download it for free. One of the best books written on the depression. [26:04]
Hi, guys. My name is Lance from San Pedro, California. I've got a comment, basically, about precious metals junior stocks. People talk about how silver is undervalued relative to gold, which is certainly true when it comes to bullion, but if you look at the juniors it appears it's quite the opposite situation. With gold you can get juniors with gold at about $30 per ounce in the ground. You can get a typical silver junior for about $3 per ounce in the ground, so gold is about 10 times what silver is. If you're buying a junior, whereas in bullion form, it's about 60 times. So it seems to me that if you're buying bullion, you want to buy silver, but if you're buying juniors you want to buy gold because silver could go up a whole lot bullion wise and yet gold juniors would still be way cheaper than silver juniors if you compare that particular aspect of the precious metals market. So I was just curious what your opinion would be on that observation. I have a lot of my money in gold juniors. I was thinking about going more into silver juniors, but I decided actually it probably makes sense to keep most of my money in precious metals mining companies in the gold juniors, and if I'm going to go into silver, I'll probably buy bullion. Thanks. Love your show.
JIM: You know, Lance. I think if you look at the gold/silver ratio, it takes about, it's 55 ounces. I think it's about 55 right now, a little over 55 ounces of silver per ounce of gold. A lot of the silver producers, especially the juniors have been beaten up and a lot of the smaller silver companies have also been beaten up. I quite honestly like some of the silver juniors better right now. [27:59]
Hi, Jim. My name is Toby. I'm a military officer and I have the opportunity of getting my hands on a $25,000 precommissioning loan, which has a 2% simple interest. The loan payment would be around $450 a month and wouldn't be due until about six to eight months from now. I'd like to take this loan and invest it in the Canadian trust PGH, which I'm already actively involved in. The trust pays a very handsome dividend each month and I would like to take the dividends from that and invest it into an automatic gold and silver savings. What is your thought on that type of strategy? All the bills basically I have right now is just a car payment and a student loan, so pretty much free as far as financial obligations. Like to get your input, love your show, thank you so much.
JIM: I'm generally, Toby, not in big favor of borrowing money to go into investment, but you've got a chance here to get money at a very inexpensive rate, so if you'd like to invest in this. You're talking about Pengrowth. The stock is unchanged. Year to date it's down about 3%. The only thing that you've got to be real careful here and this is why I don't like debt is if you're borrowing money at a lower rate and you go into a stock, what if the oil market is correcting at the time that you're doing that. Because Pengrowth is a royalty trust and if oil prices correct, and who knows when they do that, you could see their dividend go down because they are selling oil in the current spot market and that's what they pay your dividend. You've got to be careful of principal going down. So if you have some other liquidity that you can make up, I would rather see you invest from income or do something that is a little bit more stable in terms of the spread between the cost of borrowing and what you're going to invest in. When you go into the stock market, and especially commodities, when they have their corrections, I don't care if it's energy or gold, those corrections are much greater. I'm not a big candidate of going into debt to do that. [30:07]
Hello, Jim. This is Hugh from Cleveland, Ohio. I'm calling with a lot of questions about hyperinflation. You recommended a couple of leads and there is one that you missed. That is called Fiat Money Inflation in France. It's by Andrew Dixon White and it's available through mises.org. And this is undoubtedly something that parallels so much where we’re at right now that they can take a look and see if this would satisfy people's questions about what the government would do in terms of hyperinflation. This has been in my textbook. That's it. Loving the show. Keep it up.
JIM: Hugh, thanks for bringing that to our attention, and once again, you know, there's a lot of great stuff you can find at the mises.org. A lot of great stuff and we mention Murray Rothbard's America's Great Depression and, Hugh, thanks for bringing it to our attention Andrew Dixon’s piece Fiat Money Inflation in France. [31:07]
Hi, Jim and John. This is Ron from Illinois. I listen to your program every week. I've been in gold and silver stocks for a long time, and the main thing that aggravates me is takeovers. I had several good small companies taking off that were literally given away, and I mean literally. The companies are either in production or going into production. The shareholders of a little mining company aren't allowed to vote. Everything is a done deal. The management of the little company goes to the bigger company and ends up with big jobs and the shareholders after being with the little company end up realizing very little. This has happened to me quite a few times. The bigger company in the takeovers, sure, they are smart: They are creating value for their shareholders but the shareholders of the little company end up with very little. I heard the bigger company mentioned on your show quite a bit. I will not buy their stock after what I've been through with the takeovers. If it goes to $100 a share, I wouldn't buy it. I have one company in Canada that right now is in production and they are finding gold all over the place. They have good drill results. I think this company could be another Goldcorp in the making. I hope this doesn't happen to me again. Thanks. I appreciate your show and I listen to it every week.
JIM: Unfortunately, Ron, listen to the segment that we did on the catalyst in the second hour of the Big Picture because unfortunately, that's what's going to happen. The big companies aren't replacing what it is that they produce, so the only way to do that is go out and buy somebody else. It's no different. You see the same thing going on in the oil business, but, you know, some of these companies, you may want to keep or hold on to, or depending on how long you've held the junior, maybe after you get taken out, if it's 12 months or more, I forget if it's 12 months you'd have long term capital gains, but unfortunately, it's the nature of the market right now. The only thing that's really done well in the last couple of years are the big stocks versus the juniors and the big companies are doing what any smart CEO would do. He's using his stock as collateral or currency to buy other companies. I hate to tell you, my friend, it's going to continue. [33:36]
Hi there, Jim and John. This is Ronnie I’m calling from Israel and I have a question for you. I'm invested in gold and silver and mining stocks and besides that I'm also invested in an Israeli company, which has potash which is used for fertilizers, it’s also a commodity it takes it out of the ground in Edzi [phon.], Israel. It rose ten fold since 2003. I want to know your opinion in this bull market for commodities will it go on rising. There is also Canadian company, symbol POT which has risen a lot. I'd like to know your opinion about that. Thank you.
JIM: Ronnie, hold on to them because one of the problems we're going to see is eventually we're going to see famine. We've had 17 years of rising record harvests. And despite all of that, our grain stocks are dropping globally. In other words, demand as diets increase and improve in the developing world, more protein is added to the diet, protein is used in the feed stock for animals, and so fertilizer is going to become a more important ingredient. Hold onto those stocks. [34:51]
Hi, Jim and John. This is Jason from Ontario, Canada. I was wondering how would you comment on the fact that the shares of most mining companies have a high PE ratio. Thank you.
JIM: Jason, mining companies tend to be valued more on market cap per ounce and market cap per ounce of production than they do PE ratios because, to give an example, and especially in the commodity markets where a lot of these mining companies are only marginally profitable. I'm not talking about the big companies but even the smaller companies. Given the fact that they are marginally profit, they are still in high PEs, but what happens is when the price of bullion goes up, and assuming they are not hedged, a 10 dollar rise in gold or a two or three dollar rise in silver can magnify those profits and turn those high PEs to low PEs. And I've seen is that with a couple of emerging producers who start out as 200,000 ounce producers. Now they are a million ounce producers and as that production increased and as the price of the metal went up, those PEs came down. [35:57]
Hi, my name is Brent from Colorado. My question is: In the face of hyperinflation and potential depression in the United States, do you think it would be better to try to get out of debt, or do you think that investing in precious metals would be more wise? I'm kind of in the position of either/or. I think if it's inflation that it would kind of offset the debt because although you are paying a set amount of interest, the value of the dollar would kind of even out. Thank you very much.
JIM: Brent, in a period of inflation, if you look at it today with where Treasury yields are at 3 ˝% and inflation is running over 4, debt is being depreciated through depreciation of the currency. As long as your debt burden isn't burdensome and let's assume that your debt is at a fixed rate, so it doesn't have the possibility of escalating because I do expect higher interest rates by the end of the year and you have a good job, plenty of liquidity and assets, then I would be in gold. [36:58]
This is Robert in Wenatchee, Washington. Hi Jim and John. You got me hooked on your weekly program. I've got to have my fix every week. In your disclaimer in the first part of your Q-call program, you recommend that anybody wanting to invest first consult a qualified financial advisor. In my opinion, unless the advisor is a hard core conservative, you should avoid him or her like the plague. My daughter and son-in-law have their investment money all invested in the so called high, low and medium risk stocks on Wall Street and bonds. They've got nothing in precious metals. So far this year, they've already lost over 10% of their retirement money, which is a considerable amount for them. They asked me if I think I'm smarter than the so called financial advisors on Wall Street. Up to now they think I'm screwy. Now in the last five years, I've turned about $40,000 into a half a million, but I'm also in the futures on the COMEX and make quite a bit there, over $100,000 in the past couple of years. Anyway, I'd like your comment on this. They still think I'm crazy and these people on Wall Street, they are the ones they've got these stocks in these low, high risk; and nothing in precious metals. And yet you say here, you recommend we get hold of a financial advisor, which I think is the financial advisor should be yourself. Anyway, I wish you'd comment on this. I've got to watch your show every week. Thank you.
JIM: You know, Robert, when we say you get a qualified advisor, you've got to get an advisor that agrees with your outlook on life. And one of the things that may happen to your kids is let them lose enough money and then they are probably going to listen to you who has been making money. But you're right: You've got to have an advisor that has a view point of the world or the markets that are similar to your own. In other words, if you think we're seeing inflation weakness, you're watching rising commodity prices and you have an advisor that says “hey, I think you ought to stick your money in bonds because everything is okay and we have no inflation,” then, yeah, you do have a problem. [39:09]
Hi Jim and John. Thank you so much for your wonderful program. This is Jim from Thunder Bay in Ontario, Canada. My question is: When will you sell your gold juniors. You mentioned a while ago that it would be at the very end of the bull market, so what indicators or signs do you look at so that you don't get burned and lose everything. Thank you so much. May God bless.
JIM: Jim, when you see your next door neighbor do nothing but talk about the fortune he's making in the junior mining stocks, Maria Bartiromo is broadcasting from the commodity pits and every single day on CNBC they are talking about that the next gold IPO, Cramer is doing somersaults telling everybody to get into gold, and everybody you see is talking about that how much money they are making in the gold market or silver market and then you see them like you did in the late 70s, they are lined up around the block to buy gold and silver bullion, when you see all of that, you'll know we're at the end. [40:06]
Hi, Jim. Gary calling from Los Angeles. I was interested in finding out if the coming depression that you're talking about that that is going to be countrywide or worldwide. I would really appreciate the answer, and I guess it would lead a lot of us in the future to decide on which way we want to invest. Thanks a lot.
JIM: I think it's going to be global in nature, but it will be less severe in some countries like Asia versus what's going to happen here in the United States because the United States is the world's largest debtor nation and that is very significant in terms of the outcome. [40:43]
Hola, Jim and John. This is Richard back in Buenos Aires, Argentina. Jim, Dan Arnold, author of The Great Bust Ahead is also predicting a major depression in the next several years. And to that extent, he forecasts a crash in US GDP by 50%. And believe it or not and associated with that crash, $10 a barrel oil. Jim, do you believe we'll see ten dollar a barrel of oil in the next several years? If so, how will that affect the price of gold.
JIM: I've read Dan Arnold's book and I've read others. Harry Dent sees the same thing, depression but he's basing it on demographics and he also believes the lower commodity prices. One thing, Richard, that these people don't see is they are looking only at the demand side. In other words, let's say demand begin to fall off because of a depression or economic weakness. What they are not looking at is the supply side could fall faster than demand. In other words, if the price of oil was to go down to $10 a barrel as he believes, I guarantee you: All drilling would almost come to a stand-still. There is no way that, for example, you could produce oil out of the Canadian oil sands at 10 dollars a barrel. I think the cost right now is about $30 a barrel, or I think it's 27. It's gone up. And the other thing that they are not looking at is world depletion rates. You know we having since 1985 was the last time that on a global basis we actually found as much oil as we consumed that year. So every single year, we've been having deficits in terms of what we produced versus what we find to replace what it is we consume. And if you take a look at right now, conventional oil production peaked in May of 2005. It's down about two million barrels. We have the CERA report that just was released last week that says world depletion rates are 4 ˝%, which means we have to find 4 million barrels a day just to stay even. What these people are doing is they are only looking at part of the equation, which is the demand side. They are really not looking at the supply side and fundamentals behind supply. And if you take a look at the world's oil producers, one country after another have peaked in their production and seen their production go into decline. Mexico more recently. Indonesia in the last couple of years. And last year there was a handful. I can count on one hand of the countries that were able to increase their production. I don't see oil going down to $10 a barrel. And if we're in a depression, I think you're going to see the price of gold sky rocket. [43:33]
Hi, Jim and John. First time caller, long time listener. Reg from Sun City, Arizona. With US statistics being tampered with by the politicians is there any reliable information anywhere? Does anyone really know how much gold is actually left in Fort Knox? I've heard anywhere between a filing cabinet full of IOUs and half of the world's gold. Sometime ago you we're talking about naked shorts. What chance is there they are doing the same thing with gold to keep the price from rising or depressing it all together? Thank you. Keep up the good fight.
JIM: Reg, I like to use industry statistics more so than government. I still look at the Flow of Funds –the Federal Reserve report. I find a lot of useful information in that. John Williams from Shadow Statistics publishes real CPI rates, real M3 rates. That's a great source of economic information. John does yeoman’s work in terms of digesting these statistics and so in terms of the gold in Fort Knox, John, I don't think anybody has audited that in 30, 40 years. We do know that the Treasury has accounted for gold differently. It shows more as a liability than it does on the asset, at least the way we're accounting it, and that brings me, maybe we've told this joke before, but the joke goes like this: They were taking President Bush down to Fort Knox, and when they took him in there, there was no gold, and he said, “Quick! double the guards.” [45:11]
JOHN: It's what you don't know that's really important as opposed to what you do know in the whole thing.
Hi Jim and John. This is John from Maine. You just had a caller that asked about the theory that taxation was a form of keeping money out of the hands of us in order to not bid up goods and services. And if you're familiar with it with E.W. Griffith’s book The Creature from Jekyll Island, the caller was spot on. I mean Griffith makes the point that whether you can print money out of the thin air and the government can and will borrow it with abandon with no intention of ever paying it back, there is no need for an income tax when you think about it. They print all of the money they want, and so the purpose of the income tax, when it was first came out was to temper the amount of money available to the consumer. Certainly you can't drain all of the money out. They don't want to drain all of the money out, but they do want to temper it so that they don't overbid goods and services and overinflate prices. I mean that's what's coming eventually. We all know that, but this scam has been going on for over 100 years now since 1913, the inception of the Federal Reserve bank. So I've got to disagree with you, Jim. I think the caller was spot on. You're not going to pull all of the money out of the system, but they do want to temper it with income taxes. There is no use for income tax and you can print all of the money you want when you've got a central bank that can print money out of thin air and the government just has to borrow it. So I love your show but, Jim, you’re wrong on that one.
JIM: John, taxes and inflation go hand in hand. What they can't take from the wealthy, they take from the poor through inflation. But I'm going to disagree with you to some extent. The whole purpose of it is there are actually people, and you study it in the economic textbooks and especially if you're a Keynesian is the idea is when government need to stimulate these programs, in other words stimulate the economy, they go into deficit spending and then the concept is you take the money back through taxation, eventually, when you get to periods of prosperity. We simply distorted that notion to inflate and tax constantly. And certainly taxes do temper the spending, but I probably disagree completely with that whole theory. Taxes and inflation are simply the way that they have to pay for a lot of these things that they are spending money on; and taxation is one method. The inflation is the other way that they pay for it. [47:44]
Hey guys, this is Eric from Aspen, Colorado. I have a question on the energy trusts in Canada. I invested in them a couple of years ago just because I liked the good dividend and I wanted to stay invested in energy and natural resources. And since then, Canada announced they are going to tax them. They pretty much bottomed out, and they haven't really recovered even though natural gas and oil have gone up dramatically, they are still at their lows. What do you suggest? That we stay in them still? It sounds like from everything you were talking about that we should, but they still haven't adjusted. If so you should stay in them, what do you expect to happen in the future? Thanks, guys.
JIM: Eric, part of the reason that some of these Royalty Trusts probably haven't increased recently is because the price of oil has come down. We had the big pop towards $100 a barrel, and of course now we're talking at $90, so there has a correction in the energy markets. And also, remember, there has been a correction in the stock market this year where you've had a lot of these, the major indexes, but you look at some of these royalty trusts, they are only down 2 and 3% year to date. I would stick with them because I do expect higher oil prices and higher natural gas prices. And when you can get dividend yields of 12, 15%, you're being well compensated to be patient for the price to go up. [49:05]
Hi, Jim and John. This is Steven from Louisville, Kentucky. My question concerns the relative merits of using extra cash to buy more gold and silver bullion versus using the same cash to pay down a home mortgage. The gold and silver stands to appreciate in dollar value, the better to eventually pay off the mortgage. On the other hand, paying down the mortgage with extra cash means future mortgage payments would consist of less interest and more principal. Which do you think is a wiser use of cash? Also, is it likely that bank problems will cause existing equity credit lines to be curtailed or terminated, thus locking home equity in the banking system. Thanks in advance for your answer.
JIM: Let's talk about paying down debt. My answer to paying down debt deals on a number of situations, and obviously, I don't know enough about you, Steve, to know how secure your job is, what is your overall total debt levels to your income levels, what are your overall assets. In other words, do you have liquidity, do you have other assets? How stable is your job is real key, because obviously, if your job isn't stable; then? I do expect the price of gold to go up substantially, and as long as you have a good job, you have a fixed rate interest on your home, you have plenty of income, you're not stretched, then I'd put your money in gold. [50:32]
Hi, Jim and John. Brian here from Alaska. Just a second. I just had to take a quick glug of my super strength Maalox. In your scenario of the Oreo cookie and let's fast forward to the rally you anticipate, why wouldn't a guy want to get out of the top of that rally into a cash vehicle before what very well might be the end game before its end of the rally? Other than physical gold and silver, which I do own, if what is happening this week to all of the stocks worldwide is any indication of what will happen in the end game, wouldn't it be wise to get out on top of the upcoming rally and then buy back in eventually. You know the high net worth investors are still receiving huge dividends and probably won't be hurt as much, but the little guys that they are still relying on the individual stock price appreciation to build a net worth will have to wait out the upcoming recession or depression for their stocks to just to break even. I really want to know what your thoughts are on a personal guide and love your program and keep it up. Thank you.
JIM: Brian, if things go, as I think they are going to go, and when we get to the real hyperinflationary state, you even have stocks going up during that period of time. The best example I can give you is what went on in Argentina in this decade. What went on in Germany during the 20s. The stock market is hyperinflated in nominal terms, not in terms of gold or what happened in Turkey and Russia during their sort of depressions that they had when their currency was debased. So in nominal terms of hyperinflation, you can see real assets go up.
And once again, if we take a look at what happened in 2000 when the stock market went into a bear market that lasted three years, in the middle of that bear market in 2001, as the central bank began to slash interest rates, began to inflate, in the summer of 2001, gold began to move along with the gold stocks themselves, just as they did during the Great Depression, so I would expect the gold equities to start separating from the pack. And I think if you can take the long term view, I think gold and silver is going to be your life preserver. [52:47]
Hi. My name is Doug. I'm calling from Indiana. What I'm looking for is a website, either free or paid that I can punch in a ticker symbol and get a chart of that stock or security of in terms of ounces of gold, that is the ratio of that stock price in dollars to the price of gold in dollars and it would go back, I don't know, five days, 10 days, a month, a year, so on so you could think of doing technical analysis of some sort on it. If this is not available, I think it would be a great thing for your website to have, and it might also, if we indeed do head into a hyperinflation economy as you expect, help to get people to think of gold in terms as money again. I really enjoy listening to your show and looking forward to hearing your answer.
JIM: I'm not aware of any website that does that, but if we have listener to this program, if they are aware of it, please send that to me in email or call us on the Q-line and we'll get that information out. Sorry. [53:47]
Hi, Jim and John. Paul calling from Toronto, Canada. Just wondering about junior mining companies. It's been recommended that people start buying junior mining companies. I was wondering how we determine a quality junior miner from a run of the mill junior miner. I was wondering if you could give certain characteristics that we should be looking for in these companies. Thanks very much.
JIM: Paul, I'm going to refer you to the last hour where we covered two segments. We covered the catalysts (what would move the junior market) and then also what you need to know about a junior where I go through ten questions that you would want to ask or find out about a junior minor that you're going to invest in. So if you go back and listen, if I may suggest so, I think I’ve given a number of questions out there that you may find helpful.
Hi, Jim and John. This is Phillip from Santa Clara again. This is kind of a follow-up question to the question that Richard from Argentina asked you last week. This is regarding the price of gold and oil. I read from articles which chart the price of gold to oil, the ratio or the average over the last 40 years has been about 15 and I would take extremes ranging from 35 in the early 70s to about 6 ˝ early in 2005, which as it turns out, was a great time for buying gold. So the price of gold to oil ratio is right now about ten. So either gold is underpriced or oil is oil is overpriced or a little bit of both. So my question is: Since all the gold that has ever been mined has entered circulation except for the small amount of gold that has been lost at see or whatever, whereas all of the oil that has been mined has been spent. So in what way is it going to change going forward. Do you put any faith at all in such a ratio? Please let us know. Thank you.
JIM: Phillip, these have been historical ratios that people have used in terms of what's transpired in the past. But I would submit to you that we are in, I'll tell you, a brave new world right now. We've never been here before where we're actually getting to a point where oil is running out. In other words, the cheap oil is running out. We're not going to run out of oil, but our ability to produce it in ever increasing quantities is coming to an end here shortly if it hasn't already. If you look at conventional oil, it's been declining. We're only making up that difference by greater productivity of refiners, bio fuels and coal-to-liquids, gas-to-liquids etc. I can't remember a time in history where you have had every single nation on earth on a fiat paper system so there is nothing backing any currency in the world today where any government can spend and print as much money as possible. I think you're going to make money in both of these. So in terms of these ratios, I'm a little suspect of some of these ratios right now because we're in a brave new world. We've never been in the position we are today. I wouldn't put a lot of emphasis on that, but I would say right now in relation to where oil is and where gold is, I would say gold is the better value right now. [57:05]
JOHN: Coming up in the next few weeks on the program, we have some interesting roundtable and other discussions coming up.
JIM: Yeah. A lot of great stuff coming up in the weeks ahead and especially next week. I hope you'll join us on the program. We're going to have energy roundtable and on that roundtable, Matt Simmons will be joining me along with Robert Hirsch and analyst Jeff Rubin as we have an energy round table. Vitaley Katsenelson he's written a book called Active Value Investing. On the 16th, we've got Stephen McClellan, Full of Bull. Michael Stathis Cashing in on the Real Estate Bubble, and then a gold round table with James Turk, Jean-Marie Eveillard, Bill Murphy and Leanne Baker. That will be on March first. Lila Rajiva, she's coauthor with Bill Bonner, Mobs, Messiahs and Markets. March 8th. Sy Harding, Beating The Markets The Easy Way and Alex Doulis Lost on Bay Street. So a lot of great stuff coming up in the weeks ahead. Hope you'll be there to join us, and once again our apologize gees to not getting to everybody on the Q-line, but we might have turned this into the financial news day if we would have continued and John, it's getting late here. A lot of people don't realize that we don't get done to producing and editing the show until 9 or 10 o’clock on Friday, so it's been a long day for both of us. So my apologies and we'll try to get to those next week.
In the meantime, on behalf of John Loeffler and myself, we'd like to thank you for joining us here on the Financial Sense Newshour. Until you and I talk again, we hope you have a pleasant weekend.
© 2008 James J. Puplava, Financial Sense ® Newshour