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The BIG Picture Transcript

  Part 1

  Oil: Facts, Fiction & Denial

Announcer:  …And here’s John Loeffler.

JOHN:  Yes, indeed. Welcome back to the Financial Sense Newshour and we start the Big Picture today.  And Jim, last week – or the week before – when they were having the trucker strikes in England and in Spain – I’m not sure how far wide-reaching they were in the rest of Europe – but it really struck me as being very, very strange.  And the reason was:  Europe has been on the case of the United States and Australia for not wanting to get into the Kyoto Protocol because we have this issue of global warming that everybody talks about – and we’ve talked about that here on the show before – but even Europe wasn’t making its targets and the reason is, a lot of European governments understood what that would mean; that the purpose of Kyoto and of caps and trades is to make energy more expensive.  That is what it is designed to do.  So, suddenly energy is more expensive and a lot of European truck drivers don’t like it – but that is what we said was going to happen; you know? 

As a matter of fact, when we talk about predictions, one of Matt Simmons’ predictions came true over the last couple of weeks; last summer on the program he predicted by the time we hit the fall elections, peak oil or oil would replace global warming as the number one topic by the fall elections.  Here we are in June and oil has now become the topic du jour in Washington, and also on the campaign trail. 

Another prediction we made here on the program is the coming clash between peak oil, resource scarcity and what we call the radical environmental lobby which has a 30-year track record of blocking almost all kinds of energy exploitation.  And we’re predicting that the battle between peak oil and radical environmentalism – we call it Rambo vs. Bambi – Rambo is going to win – peak oil is going to win on this because the world demand for oil is beginning to irritate and people are discovering in their pocket what this really means.  So we’re saying peak oil will probably win this battle unless environmentalism finds a way of merging into it.  So put another way, Bambi gets hosed!

JIM:  That puts it in simple terms.

JOHN:  You know, you’ve really destroyed my childhood with this; don’t you realize it?  That was the – no, Snow White was the first cartoon movie I ever saw, but Bambi – you know, Bambi strikes a heart.  And now all I can think of, instead of man is in the forest, it’s Jim is in the forest.  Okay, so Bambi gets hosed.

But what we want to do today is deal with all of the facts regarding the energy issue.  We want to dispel some of the myths –and believe me there is a lot of static and noise out there that is just totally nonsensical – and point out that Washington as a geological area is still in a state of denial.

JIM:  Well, you mentioned something both sides are throwing out facts – and what we’re going to today we’re going to begin this discussion with a fact segment.  And one of the sort of bibles in the energy industry is the Annual BP Statistical Review – that’s BP, British Petroleum – and they just released their statistical review for 2008, which is a look back at the oil markets for 2007.  Now, we’re going to highlight some of the main points of this review study – and you can actually get a copy – it’s free – you can go to www.BP.com and it’s listed there.  And I highly recommend that you download it because it’s a lot of good information about production, consumption, who has the reserves, who doesn’t, what has happened to those reserves; consumption patterns around the world, what’s happening to inventories.  And so you get a lot of factual information because, you know, these people throw out facts in these debates and a lot of this stuff that we’re going to get into is just simply erroneous.  But this report is going to give you an objective review of the world’s energy market; and I might add, should be required reading for our uninformed congressional leaders. 

I’m not going to cover in this segment today the entire BP Review but I do want to highlight some key points within this report.  They begin their discussion – something that we have been highlighting here on the program is this tight balance between supply and demand.  For example, one of the news stories this week is Saudi Arabia is going to increase its production 200,000 barrels a day.  And of course the oil markets went down on that news.  But also this week the rebels in Nigeria just took out an oil platform that was producing 200,000 barrels a day.  So the one good thing coming out of Saudi Arabia was negated by the rebel attacks in Nigeria; and that’s how tight supply is.  But what is amazing – despite the hundreds of billions of dollars in the new investment last year, oil production fell while the output of natural gas and coal actually grew.  And these are also alternative sources of supply besides oil. 

Oil production decline that we saw last year was mainly due to two things:  OPEC production cuts; and the depletion of major oil fields, especially within the OECD countries where output actually fell by over 300,000 barrels a day.  And the combination of these maturing oil basins also limited access to where the oil is – which is one thing which is not just happening in the United States where we’re denying access to oil to companies, but also resource nationalism is on the rise, especially in Latin America; and also constrained capacity within the industry itself.  All of this, if you put it all together is creating challenges making it much more difficult for supply to keep up with demand.  [5:58]

JOHN:  This brings us home to the point made by T. Boone Pickens when he responded to higher oil prices with a very, very simple answer, and here’s what he said – it’s very appropriate: 

Well, it’s not speculators. Speculators have nothing to do with the price of oil.  There’s 85 million barrels and the demand is greater than 85, so supply and demand are in very critical balance.  And so you put a speculator in there, what can they do?  They can’t do anything.  You know.  And they talk about the value of the dollar – get the value of the dollar up and it’ll make oil prices go down.  That too is a myth.

Basically, the bottom line is that demand is greater than supply and prices will keep rising until demand and supply come back into balance.

JIM:  This always amazes.  Now, here’s a guy who has made a fortune, understands – his background is geology, he started out as a geologist and he’s been in the oil business for 30 years.  But it amazes me even today that politicians have a hard time accepting the concept of supply and demand.  I mean this is basic Econ 101 – and that’s why I think we need to make a concerted effort here to resurrect our program, No Congressman Left Behind.  [7:15]

JOHN:  Why do you think there is such a difficulty accepting this concept because any time prices rise and everybody starts screaming –well, from a political standpoint they have to posture as if they’re doing something, but – they hold hearings, maybe some threats are traded like we’re going to nationalize the oil companies, but in the long run they never find anything.  It’s as if they themselves are in denial.  Maybe it’s reality coming home and  politicians panic.  The American people seem to get it, if you look at the polls.  You would think that the politicians would get it but they don’t, so maybe it has to do with large campaign contributions from environmental groups or other areas.  But there is a smokescreen being put up here to dealing with some of the core issues and they’re pretty simple.

JIM:  Yeah, as T. Boone Pickens talked about, it’s supply and demand.  But I predict as this debate heats up as we get to $150 dollar oil maybe 200, $250 oil then eventually $300 oil, this debate is going to change everything.  Just as we have pointed out in this political campaign, last year nobody was talking about the economy; then in the first part of this year the economy was the number one issue; last year and the beginning of this year as oil prices were rising – and here’s something that I find even more remarkable because remember last year we went from $50 oil in January all the way up to $95 oil and that’s when we had Matt Simmons on the program last summer.  He said by the time we get to the fall elections it’ll become the number one issue.  Now, with oil prices on this Friday roughly about $135 a barrel, this has now changed the debate.  It has now become the hot topic in the debate, so we’re seeing Matt’s prediction comes true. 

But as the price of gasoline heads to $6 a gallon, $7 a gallon and $9 a gallon, nobody is going to want to hear about global warming and Bambi.   And especially if they’re freezing in their homes in the middle of winter because remember a lot of homes on the east coast use heating oil; and our second hour interview with Michael Klare and his new book, he’s talking about the big surge in heating oil and they’re expecting heating oil prices to go even higher this winter.  So you start seeing people freezing in the middle of the winter, or if they’re standing in line to get gas or eventually when we go to gas rationing in the next two years. 

However, let’s get back to the facts here for a minute – last year energy consumption globally increased by 2.4% and that was the fifth consecutive year of growth in demand.  As you might expect, Asia-Pacific accounted for two-thirds of that increase; Chinese energy consumption was up 7.7% last year; India’s energy consumption grew by 6.8%.  Meanwhile, in the US and the EU consumption actually declined by 2.2% - most of that coming from Europe itself.  [10:16]

JOHN:  What this report highlights then is that the Asian demand, and demand elsewhere in the developing world, is actually offsetting the decline in the developed countries.

JIM:  Yes, and as you talk to the experts, as we have limited capacity to increase supply and especially if you believe that conventional oil peaked in May of 2005, then the only way that you’re going to get this imbalance to reach equilibrium is for demand to fall dramatically in the United States and Europe, allowing for this increase in demand that we’re going to see in the rest of the world.  And so demand right now – we’re down probably two or three hundred thousand barrels a day in demand here in the United States, but between the US and Europe and let’s say Japan – in the developed world – we’re going to need to see demand decline by roughly about four to five million barrels a day in the OECD to offset the similar increases that we’re seeing unfold in the developing world. 

Right now, OECD oil output is falling.  It has fallen for almost five consecutive years.  Just as we’ve seen five consecutive years of rising demand, we’ve seen five consecutive years of major declines in the western countries, especially in Norway, now accelerating in Mexico.  So what you find when you go through the details of the BP Review is demand is growing by roughly 5% in South America, 4.4% in the Middle East – and that’s very, very important because most of the oil exports come from OPEC countries, and as they subsidize oil consumption then they consume more of what they produce. 

The same thing in Africa – we’re seeing 4.6% demand growth in Africa, 2.3% in Asia-Pacific; and this compares to 0.4% in North America – most of that coming from the United States – and a 2% decline in Europe.  We’re going to see $9 gasoline here in the United States in the next two years.  But they’re already paying $9 for gasoline in Europe.  [12:33]

JOHN:  If demand is greater than supply and it’s struggling to keep up, you would think that our inventory supplies would also be shrinking, which seems to be what we have each week here in the United States.  So that’s really actually happened.

JIM:  Yeah, it’s not just happening in the United States – and you get these reports every Wednesday and Thursday showing for example oil inventory going down or gasoline inventory going down.  But it’s not just in the United States.  If you take a look in the BP Review, total commercial oil stocks have been shrinking for the last three years.  This gets back to something that we had in our energy roundtable at the beginning of the year:  If you have demand of 87 million barrels and supply is only 85 million barrels, where is the difference coming between the two?  The difference is coming from drawing down our inventory levels, which gets me back to the peak oil argument.  It’s getting more prominent but they’re still not talking about it.   But conventional oil production has been in decline since May of 2005, and it has declined every year since then.  [13:44]

JOHN:  Well, what about Saudi Arabia increasing supply because we always go hat in hand to OPEC and say, “please give us some more.”  You’d think about all these new discoveries coming online, right?

JIM:  This gets back to the theory that Matt wrote about in his book Twilight in the Desert because when people look at all the oil discoveries or the new projects coming online they’re forgetting the offset to that, which is depletion.  So if you take all these major projects, one thing that stands out and I’ve read this in John S. Herold and other oil reviews is a lot of these projects are falling behind because of manpower, supplies, cost, environmental delays or permits – and so we’ve seen one delay after another and so that’s kept these new discoveries from coming into production.  Also, a lot of these new discoveries are smaller in size and don’t even come close to replacing what we consume each year – so that’s another important point which is why we’re seeing the drop-off in our inventories over the last three years. 

Now, getting back to Saudi Arabia, we’ve got three new fields that are coming online in Saudi Arabia.  One field could possibly – this is the big one – produce maybe 1.2 million barrels a day by let’s say the second or third quarter of next year.  They’ve got another field that is supposed to produce 500,000 barrels a day, but they’re having problems due to supplies.  I mean, there is a shortage of drilling rigs, steel costs are going up, personnel shortages; and then finally they have their field Manifa that could produce nearly 900,000 barrels a day by 2010, maybe 2011. 

Here’s what they’re not looking at though.  You hear this:  “oh, they’ve got three new fields.  One’s going to produce 1.2 million, another 900,000, another one a half a million barrels.”  However, offsetting these new fields is the six giant oil fields in Saudi Arabia accounting for over 90% of the Kingdom’s production are now in decline, and these fields account for last year 7.4 out of the 8.6 millions barrels of production produced last year.  [15:59]

JOHN:  But Jim, Matt Simmons was talking about this as well.

JIM:  Yes, that’s what Twilight in the Desert was about.  I mean if you take a look at Saudi Arabia’s production, they have six giant oil fields – and this gets back to the story that we did on the decline of the giants – the biggest one, Ghawar, was discovered in 1948.  It hit peak production of 5.8 million barrels a day in 1980.  That giant oil field, the world’s largest, is now in decline.  You have another one called Abqaiq which was discovered in 1940 – it’s production peaked at 930,000 barrels a day and that peaked in 1972.  You have Safaniyah which is probably their third largest field.  That was discovered in 1951, it peaked in 1981 at 1.5 million barrels.  They have the Berri field, which was discovered in 1964 – it peaked in 1978 at production of 586,000 barrels a day.  You have Zuluf and the Marjan fields which were discovered in 65 and 67 – they peaked at 658,000 barrels a day; peak production was reached in 1981.  And then finally the Shaybah field was discovered in 1968 and that had peak production at 500,000 barrels a day, and that peaked in 2004. 

So collectively, these large oil giant fields accounted for 7.4 million barrels a day, or roughly 92% of crude oil production in the Kingdom.  So, yes, they have some new fields coming online, but their big giants – Ghawar, Abqaiq, Safaniyah, Berri, Zuluf, Shaybah – these giant fields are now going into rapid decline.   And that’s the thing that the experts forget to talk about, you know, when you hear “well, they’ve got a new field online that’s going to produce 1.2 million barrels a day.” Well, what about these six fields that are in rapid decline? 

And another factor that is not brought in, which Professor Klare talked about in our interview:  Saudi Arabia’s own oil consumption has increased by roughly 44 percent over the last 10 years; and that consumption is now increasing each year.  The Kingdom is building four new cites – and this is key – that are going to be dedicated to producing things like petrochemicals, new refineries, so they can produce more oil products.  So the Saudi’s are going to be consuming more of what it is that they produce, at the same time they’re going to be struggling to replace what they’re losing in their major oil fields.  [18:43]

JOHN:  Well, if we just follow the logic of this so far, if we say that demand is going to keep growing and supply is struggling to keep up and if peak oil is here – remember, we used to talk about choke oil –meaning if there wasn’t peak oil we still have a bottleneck to go through for 20 years, so either way – then I guess the next logical question is:  What should we be doing?  And there is a growing recognition that we need to do something.  What we hear is we are not going to drill our way out of that problem, so the first question though is:  Should we really be drilling? 

JIM:  Yes, absolutely.  And not only should we be drilling, we better start doing it immediately.  But before I explain why, I want to shatter a myth and one thing that I do agree with those who say, look, you can’t drill your way out of this.  I do want to get rid of the myth:  The United States is never going to become energy independent through drilling for more oil.  In other words, we consume 20 million barrels a day, we produce ourselves roughly about 5 million barrels a day.  The United States is never going to go from 5 million barrels a day of production back to 20 million barrels.  In fact, even at our peak we were only producing 10 million barrels.  So we’re not going to go from 5 million to 20 million barrels.  And I agree with that argument. 

However, our demand is so high and our oil reserves onshore or offshore aren’t great enough – nor do we have for example the capacity to produce or refine 20 million barrels a day – so that part of the argument I agree with; that we can’t drill our way out of this mess. 

However, here’s why we need to start drilling:  US oil production peaked in 1970 at roughly 10 million barrels; since 2000 our daily oil production has fallen from roughly – rounded off – 8.3 million barrels of oil equivalent (that includes NGL liquids) in 1997, to last year where we dropped to 6.9 –roughly – barrels of oil equivalent.  And then if we just take the oil production component we were producing 5.8 million barrels in the year 2000; last year we dropped to 5.1 million barrels of oil.  So in this decade alone we have lost nearly 900,000 barrels of production a day.  In addition to this falling production, many of our largest exporters, for example, Mexico, Venezuela are either losing their ability to export oil or are reducing their exports to the United States.  Between now and 2012 – this is this crisis window that we keep talking about – we’re going to lose another 3 million barrels of production and loss of imports.  By 2012, Mexico will no longer be exporting to the United States. 

And the question you have to ask, what is going to replace this 3 million to 4 million barrels that they’re talking about?  That assumes for example other countries that we import from –Nigeria where rebels just took out a 200,000 barrels a day platform, Algerian, Angola, Russia – are they going to be able to increase their supply by 3 million barrels, where you have Russian oil production falling now?  Russian oil production has peaked because it peaked at roughly 12 million barrels and it’s never gotten back to that level ever since.  So there is no way that these other countries are going to be able to make up this shortfall of three or four million barrels in the next couple of years.  That’s why we’re going to be looking at oil prices between 200 and $300 a barrel by 2012.  Even the International Energy Agency (IEA) says that they doubt that we will have the capacity – whether you’re looking at natural gas liquids, coal-to-liquid, biofuels – to increase supply beyond the year 2012. 

So the reason we need to start drilling now is so we’ll be able to maintain our production to help us transition to a new energy-based economy.  I mean, John, you can’t fly a 747 or a cargo freighter on batteries, or a train, or electric power.  It’s going to take at least a decade to change our transportation system and auto fleet.  The average age of the auto fleet is somewhere between 9 and 10 years.  I mean you just can’t pass a law and say, all right, tomorrow everybody has to turn in their cars and buy a hybrid – it’s not going to happen.  It’s going to take a 5 to 10 year period. 

Even in the last oil crisis in the 70s, it wasn’t until the end of the 70s when we were looking at $40 oil that Detroit began producing fuel efficient cars, and the US began to import a large amount of foreign made fuel efficient cars, which we’re doing now.  What you don’t want to do is if you don’t drill – as Professor Klare has talked about, you don’t want to get yourself into military conflict; I mean just take a look at the wars of the 20th Century which were all about oil.  So we shouldn’t disregard history or back ourselves into a corner when the lights go out, and have war as our only option.  [24:22]

JOHN:  Let’s go to another argument that I keep hearing –and this one I always grate my teeth on because when you know the facts behind it, it sort of falls apart, but you keep hearing it posed over and over again – and that is the argument of existing oil leases;  that the oil companies aren’t using the leases that they have and that over 90 million acres have been leased.  And so they’re proposing a use-it-or-lose-it bill, contending that oil companies are withholding land and waiting for higher prices before they go ahead and do this.  So transferring this load over to the oil companies in other words.

JIM:  That is just balderdash!  I mean that argument shows a complete lack of understanding of how energy is produced in this country.  First of all, when an oil company bids on an oil lease, they don’t know how much oil is there.  So they buy large tracts of land – or lease large tracts of land - because they know from experience that they will drill a lot of dry holes.  About 50 to 60 percent of the holes that they drill are going to be dry holes – they are not going to be getting anything.  So only a fraction of the land leased ever pans out. 

The other thing our congressmen don’t understand is that bringing a new oil field into production can require years of mapping, you’ve got to do testing, you’ve got to do drilling, and then there’s just a plethora of permitting and then there is actually the construction.  And until this process is complete the land shows up as non-producing.  These congressmen feel like, okay, you give them a lease permit or they win the lease, and the next day the oil rigs show up and they strike oil like in the movies and you have these gushers and oil begins to flow.  Saying oil companies aren’t working hard to produce oil is either a bald-faced lie or a case of gross ignorance on the subject matter.  [26:19]

JOHN:   Well, what about the issue of – and we get back to the environmental ones, and I can always think of these oil platforms that I used to see off the coast when I’d go body surfing at the beach in California – what about spoiling the beaches or tourism?

JIM:   That’s just another canard and a case for fear-mongering.  I mean if you take a look at Norway, Mexico, Britain have been drilling offshore for three decades now.  In fact, if you want to even take a better example is let’s go back to 2005 with hurricanes Katrina and Rita where you had 150 to 160 mile an hour winds, you had 50 to 70 foot seas, you had almost a hundred oil platforms were destroyed without any major oil spills.  I mean if Katrina and Rita couldn’t produce spills, I don’t know what can. 

And besides, I don’t think Americans are going to want to hear about, for example, right now the Chinese and Cubans are drilling 90 miles offshore of Florida in our own backyard.  But Congress, because of previous laws, is prohibiting American companies from drilling in the same territory.  And the same thing is going on in the Arctic where the Russians and the European oil companies are looking for oil.  I don’t know what it takes to get off this, what we call ‘stuck-on-stupid’ routine, but we’re on the energy Titanic and we’re arguing whether we should lower the lifeboats.  I mean our biggest oil reserves are in Alaska, offshore California, offshore Florida and the Gulf of Mexico.  What is it going to take to wake these people up.  What happens next?  Do the Chinese sovereign wealth funds buy Catalina Island to bail out California from its budget deficit, and then we let the Chinese drill for oil like they’re doing off the shores of Florida.  This whole debate is just absolutely absurd.

And a final issue I want to get to is if we take a look at these 91 million acres that have been leased, production from that land has dropped from over 30% in the last decade to 27% or less in this decade.  US production has declined almost by one million barrels – and these are simple facts – from the year 2000 to the year 2007.  So in this decade we’ve seen production drop, and if we don’t take steps now to arrest that decline until alternatives and our transportation system has time to change and adapt – we need to do what we need to do and if we don’t do what we need to do, we’re going to get ourselves in deep-do-do.  [29:00]

JOHN:  We’ve been talking about this crisis window, 2009-2012, and that 2008 would see a lot of squall lines in a run-up to it.  We’re already seeing that.  I will admit that the squall lines are a little more abrupt and violent than I even thought when we were talking about it a couple of years ago.

JIM:  Here’s something that I think is very important as you look at crises.  When you study history and you look back and say, oh my goodness, if we didn’t do this, or we didn’t raise taxes or adopt Smoot-Hawley, didn’t start trade wars, maybe we would have never had World War II or these kind of things.  But what we do now is really going to determine if this becomes the storm of the century or just a bad nightmare.  We’ve been in denial in this country for three decades.  You take a look at our response in the 80s and 90s compared to what was going on in Europe – they went to more fuel efficient cars; you have countries like Sweden and France which now get over 75% of their power from nuclear power – without an accident by the way – and you compare that to what we’ve done.  The higher that prices rise, we keep looking for scapegoats,  and that’s one of the topics – I don’t care if you go back to the war, if you go back to the hurricanes in 2005, the oil hearings now – I mean how many oil hearings do we need, they never find anything. 

And so now the latest scapegoat is the speculators; before that it was the oil companies. And you take a look at these – from the war to weather to a weak dollar to speculators – what we do, instead of addressing the problem, our politicians do what most politicians do which is play the blame game, and we refuse to face reality.  I mean the reality is demand is growing far faster than we ever planned; supply is failing to keep up with this demand.  If you take a look at the infrastructure in the oil industry – oil rigs – there is a shortage of them.  We simply ran out.  If you take a look at refineries – we don’t have the spare capacity if we get a hurricane that takes out refineries in the Gulf.  I mean we don’t even have enough even under the best circumstances to produce or refine all the oil that we consume.  And this is just absolutely nonsense about no environmental laws, there’s been a gentleman in Arizona that’s been trying to build a small peak refinery – he’s been trying to do it for 10 years, and they’ve sued him, they’ve put up roadblocks and they’ve tried to stop him every step of the way.  The same thing happens with pipelines –and this goes back to California’s energy crisis – the natural gas crisis back in 2000 and 2001 – we didn’t even have enough pipelines to bring the natural gas in here if we wanted to. 

And then the other thing that we have mentioned over and over again is our production – especially in the mature fields and it’s not just here but elsewhere – is in decline.  Those are simple facts.  [32:05]

JOHN:  Jim, one of the biggest things that we’re trying to deal with right now is –you and I discuss all of this stuff – is the fact that if you listen to the tube –and it was really what I call ‘barf-worthy’ this week to listen to Congress this week on C-Span – there is so much static clogging the actual facts that are there, people are very, very confused.  And then, when they’re talking with each other they’re using a lot of these facts which are really non-facts.  So how are people going to find out what the real core issues are? 

And like T. Boone Pickens said, most of these core issues are a pretty straightforward and sober assessment of what’s happening; once you make that assessment it’s on to doing something. 

JIM:  The first thing that you can do – as we recommended at the beginning of the Big Picture here – go to www.bp.com and you can download free the BP Statistical Review and I would read it every single year.  I’d look at previous years.  So the first thing you can do is get some facts.  Secondly, gosh, John, just type in “peak oil,” or “oil” on Google or Amazon and there is a plethora of books; I mean there is more than a hundred books on oil out there that you can read, so you can take a look at both sides of the argument.  Or, heck, just go back and look at interviews.  Any author that’s written a book we’ve had here on the program over the last couple of years. 

And even something that is even simpler than that – there are two documentaries that are out there.  We interviewed the producer of one, Basil Gelpke, last year.  There is a documentary out there called A Crude Awakening; and another documentary out there called Energy at the Crossroads.  And that is something that I recommend that people do, either get the books, read the BP Statistical Review or even I think much easier is just rent those two documentaries – both of them are very, very well done in my opinion.   [34:03]

JOHN:  One of the things that I would say are a prerequisite for doing anything – and this is where I really get irritated by a lot of the static and nonsense out there, which are plying other agendas – but you have to clearly recognize what is going on – just look at the whole history of what we’re talking about here and what we’ve talked about here on the program – since we’ve been doing this program, oil has gone from $20 a barrel to $135 a barrel, we’ve sort of followed it all up.  But you have to be able to know what is going on in order then to make sober decisions, and right now we’re not at that point as a country. 

JIM:  No, in fact, if you take a look at – we seem to keep wanting to dig ourselves deeper in the hole.  Just turn on the tube every night and you’ve got pundits pondering why oil is so high and “what do you see?”  And you see this in the BP Statistical Review – demand keeps rising as I pointed out, in the Middle East, Latin America, and Asia-Pacific.  Supplies keep shrinking as inventory levels fall.  Our ability to  produce more has been limited.  Spare capacity is ended – I mean everybody got excited because Saudi Arabia is going to produce 200,000 more barrels starting next month, and one rebel attack on an oil platform in Nigeria just negated that. 

If you take a look at our systems:  our infrastructure is breaking down; in a lot of the countries in the world that own the resources, you’re seeing the rise of resource nationalism and saying, “Why should we invest a lot of money and increase production to bring prices down so western consumers can produce their SUVs?  Instead, why don’t we conserve this and use it for ourselves and sell it at a higher price.”  These are the realities that are going on right now.  [35:47]

JOHN:  Despite current prices at the pump, oil is still the cheapest liquid around and it’s going to be the only real main source of fuel for the next 5 to 10 years at least.  You know, Matt Simmons actually always put it in terms of price per cup compared to other liquid commodities that are sold. 

JIM:  Yeah, if you take a look at $4 gasoline, I think that equates to about 25 cents a cup.  Matt gave a presentation recently just putting this in perspective – I mean Vicks Nyquil is $98 a gallon; Right Guard is $57; Budweiser beer over $13 a gallon;  Coke, $8 a gallon;  Water, such as Evian, $7.50 a gallon.  So as Matt still contends, oil at $125, $150, $200 or even $400 will still be the cheapest liquid around that we can buy.  [36:37]

JOHN:  Let’s assume that both Senators McCain and Obama see the light and they bow out of the presidential race, and everyone looks around and there is no one left but Jim Puplava, you’re just president by default.  What would you do?  I mean, if you really cut through the static and you were able to wave your little wand, what would you do?

JIM:  Well, I think I would do what we’re already seeing consumers do is one of the first things we need to do is begin conserving and that’s already happening.  The amount of miles traveled by Americans is dropping; a lot of people are trading in their gas guzzling cars for more fuel efficient cars, so higher prices in the market are starting to work their magic.  So this is already happening and I think it’s going to continue. 

We also need to start building a light rail system.  I just came back from Phoenix over the weekend where they’re building a light rail system.  Also, I think people need to start living closer to work – at $200 oil, the 100 mile commute no longer works. 

I also think another trend that you’re going to start to see is we need to grow our food locally, and that means organic food.  You’re already seeing that in the concept of the whole foods here in southern California – we’ve got a store similar to that called Jimbo’s that gets their produce, gets their protein from local growers – and also, as James Kunstler has pointed out the 3,000 mile Caesar salad doesn’t work with $200 oil, nor will airliner-flown-in fruits and vegetables all year round – where you can have whatever is in season around the world – that doesn’t work. 

I also think you’re going to see – and it’s beginning – we’re going to start to move production back home.  In fact, this just came in, John, I’m looking at the front cover of this week’s BusinessWeek – “Can the US bring back jobs from China?” – and I think you’re going to see that one of the trends is deglobalization with higher fuel  prices.  And we also need to allow oil companies to use higher oil prices to rebuild the energy complex which is old and rickety, and rusting.   I mean I don’t care any aspect of the industry – whether you’re looking at drilling rigs, to refineries to pipelines.  [38:57]

JOHN:  Well, you’re really talking about remaking the economy, and it almost seems like reversing globalization.  And we’ve had this trend toward a global integration I guess is the term that we’ve been using here – the global governance crowd have been using.  But this seems to be driving it the other way.  At least it seems to be on the surface.

JIM:  Oh, I think you are going to see a deglobalization – if you look at what was really behind it, it was driven by cheap energy.  As long as energy remains cheap, John, you could take raw materials from Brazil, ship them to Taiwan or Korea, ship them to China, then back on a boat to Long Beach, then on Long Beach put it on a truck and get it across the United States.  The era of cheap energy is over.  I think almost every side agrees about that point. 

I also believe there is another argument to be made here:  the US economy, in my opinion, is heading into a depression by the year 2010.  Now, rebuilding the country may be the only thing that brings out of that depression.  Now, remember, severe bear markets and depressions as we’ve been talking about on this program are caused by politicians.  It takes a politician to turn a recession into a depression.  And given the current debate and the holes that we dug ourselves in, I don’t see how we’re going to avoid this crisis.  I mean the things that we’re talking about doing today should have been done 10 years ago.  [40:17]

JOHN: One of the things you hear out there all the time is we can’t drill our way out of this problem.  Or we should invest in alternatives, so let’s not do anything to support further oil exploration.  So basically the question is should we drill or research alternatives or conserve?  And the answer is:  Yes.  In other words, it’s not this or that or that – everything relieves the strain.  You have to do them all.  And frankly, we should have been doing them over 10 years ago. 

I want to read some tabulation here of some figures that we put together of votes as far as oil and gas exploration here in this country.  This is over the last couple of decades:  ANWR exploration – Republican 91% for, Democrats 86% against;  coal-to-liquid processes – Republican 97% for, Democrats 78% against;  oil shale exploration – Republican 90% for, Democrats 86% opposed; exploration of the outer continental shelf - Republican 81% in favor, Democrats 86% opposed; and finally, increasing refinery capacity here - Republican 97% support it, and Democrats 96% opposed.  So historically, 91% of House Republicans have voted to increase the production of American-made oil and gas; 86% of Democrats in the House – and this is just the House and not the Senate – have historically voted against increasing the production of American-made oil and gas.   That is the track record to a large degree of why we are where we are, right now. 

We’d like to play two different sets of clips here from congress-critters.  First of all, those who are desperately in need of our No Congressman Left Behind program as far as oil.  These are real clips of real congress people, Ladies and Gentlemen. 

There is still 68 million acres of land that they have under lease that they could drill on.  They have decided rather than drilling there, they want to drill where we want as a nation to protect because of the sacred nature of that land, which is where our beaches and our pristine wilderness areas are. 

They want to control more of these leases.  They don’t want to produce more oil because if they produce more oil then the price of gasoline and home heating oil would go down.  They don’t want it to go down.  They want to keep holding on to it and gain as many leases as possible until the price of oil goes up to $200 a barrel, or $300 a barrel, so that they can increase their record profits. 

Supply is part of this – that’s why we encourage the oil companies and we have legislation to encourage the oil companies to drill on the 68 million acres you already own, are not drilling, and is fourteen years worth of supply in the United States.  Use it or lose it.  That simple.

There is no evidence whatsoever that any environmental law has stopped the construction of a new refinery in the United States.

Is there any thought having bills that would nationalize some of these refineries or national oil company?

Yeah, there’s thought going on about this.  Frankly, this is something that I think is essential and I think it’s only a matter of time before it takes place.  I think that what we have to do has to be in the interests of the American people, primarily, basically, in the interests of the American people; not in the interests of some major companies.  And the determination as to how much of this very important material gets refined and consequently out on the market is in the hands of the oil companies and they just do.  They make those decisions based upon their effort to drive up the price as high as they can and keep it as high as they can for as long as they can.  So I think that this is something that this Congress should be thinking about.  [44:12]

JOHN:  Now, those are congresspeople who desperately need to enroll in your No Congressman Left Behind program because it’s clear they don’t have a clue about what is happening in this issue.  What is scary this is that they’re lawmakers.  That’s the freaky part. 

All right, let’s go to another group of people who are freshman in your school.  Let’s see if they seem to understand what’s happening here.

A reasonable observer presented only with these numbers of consumption and production might draw the conclusion that America has accepted this fate because we have no choice in the matter, because we have no resources of our own.  But just the opposite is true.  We do have resources and we do have a choice in oil, gas and coal deposits.  We have enormous energy reserves of our own and we’re gaining the means to use these resources in cleaner, more responsible ways.

So this morning I asked Democratic congressional leaders to move forward with four steps to expand American oil and gas production.  First, we should expand American oil production by increasing access to the outer continental shelf.  Second, we should expand oil production by tapping into the extraordinary potential of oil shale.  Third, we should expand oil production by permitting exploration in the Arctic National Wildlife Refuge or ANWR.  And finally we need to expand and enhance our refining capacity.

All a windfall profits tax will accomplish is to increase our dependence on foreign oil and hinder exactly the kind of domestic exploration and production we need. 

Recent changes in the make up of our fuel supply – upgrades in our refining capacity are urgently needed, yet it has been nearly 30 years since our nation built a new refinery, and lawsuits and red tape have made it extremely costly to expand or modify existing refineries.  The result is that America now imports millions of barrels of fully refined gasoline from abroad.  [46:12]

JOHN:  You know, what I also like to do here, Jim, is I have some clips here of oil executives thinking about why these leases don’t magically appear.  Remember, we heard the one congressman saying, “use it or lose it.”  And as you were discussing, it’s not that simple.  But here’s an oil executive exactly what the whole process is.

Congresswoman:  Could you tell me specifically why you have not been able to develop those leases you currently have that have about 80% of the oil – the US oil – that is available.  And I’ll go to Mr. Simon.

Mr. Simon:  I don’t know of any that we’re not developing – is those that we already have access to, developing as rapid a fashion as we can. 

The leases are generally a 10 year time horizon and during that period of time we’re continuously evaluating where we can best use our technology and science to develop those leases.  Sometimes 10 years isn’t long enough because of the tremendous capital expenditure that is necessary.  For example, in the Gulf of Mexico it’s easily a billion dollars now for a major deepwater project and just one lease. 

Congresswoman:  But then how do you explain your record profits that are well over one billion that can’t be redirected in some way – or a portion?

Oil Executive:  The profits are cumulative around the world, but in the case of let’s say the Gulf of Mexico we’re limited by the amount of manpower that we have.  We can’t – we don’t have the kind of human resource that can do all of the leases simultaneously and so we do…

Congresswoman:  So the obstacle isn’t from the federal government – that’s – it’s a market obstacle.  That’s your obstacle.

Oil Executive:  The federal government’s obstacle has been to prohibit the granting of leases in the outer continental shelf more broadly.  Had we had the confidence that we could do more leasing we would be scaling up our operations to go after more leases. 

I’m not sure whether there’s a misunderstanding here, but certainly all the leases that we have that we’ve spent money on with the government we are working on and trying to develop.  And we obviously – we work the biggest prospects.  I mean, once you get a lease then you do some work on it, do some seismic work, you do some drilling and you see which ones are the best to develop, and we develop them. 

Congresswoman:  But there are different stages of that development.  The spigot isn’t open on all of them is what I’m trying to get at.

Oil Executive (Chevron):  After a period of time if we don’t do something we have to turn it back to the government.  So we’re working on the leases.  You asked another question about – so many years ago – 20 years ago – Chevron started developing geothermal energy in California.  Today, Chevron is the largest geothermal energy company in the world.  It’s still a relatively small in the scale of the world’s energy business but it’s 1200 megawatts, so I think we’ve been doing this for many, many years.

Oil Executive (ConocoPhillips):  When lease acreage has become available, for example, two Gulf of Mexico deepwater lease rounds last fall, or recent Chukchi Sea lease round off Alaska, ConocoPhillips has been high bidder on a billion dollars for those leases, so we are starved for access.  Access really is the issue.  [49:06]

JOHN:  You know, the impression that you get is whereas Congress is saying, “well, we provided all these leases…” but what they’re saying is, “yeah, but you provided them in an environment where it’s very difficult to operate.”  I don’t mean a physical environment -  I mean “you’ve given us a small window and we either do it here or we don’t and if we don’t then we’re out, so we’re shucking and jiving trying to play this game.”

JIM:  If you take a look at how an oil lease is developed, let’s say that you bid on – I don’t know, 100 acres, you don’t know where the oil is or if there is oil on this 100 acres.  So the first thing you’re going to do is seismology, you’re going to take a look, you’re going to do some geological mapping and then what you do is you have to apply for permits.  Once again this process isn’t one where you’ve got the lease and then the next day the drilling rig shows up and you strike oil. 

I think it would be very helpful if they took a group of these congresspeople, took them onto an offshore platform and they could see that, for example, one of these drill ships is costing $700,000 a day; or to take them out and take them through the process, from the time they bid on the lease, what amount of money is spent, what amount of time, where all the hurdles, where all the delays are from the various permits. 

Like I said, there’s a gentleman in Arizona who’s been trying to build a refinery for 10 years and still hasn’t got his permits.  So it’s not an easy process and I think that’s because these people are so far removed from it that they go by soundbites and clichés and they don’t want to get themselves informed.  In other words, if I was looking into this – you know how you see it, John, where all of a sudden you have a tragedy – there’s a flood or hurricanes – you have like the President or a politician touring an area – I think a lot of these congressmen need to go and just spend a month with an energy company to find out how oil is found, the amount of effort.  Or even go out to the Gulf of Mexico, 200 miles offshore; take a look at the cost of running one of these platforms – and remember, these platforms have to be disassembled – the pipes, the drills and all of that any time a hurricane comes through and you have to evacuate, plug the hole, bring the pipes, put the well-casings on to a ship, take that to shore, take the crew and then when it’s clear again, you have to make the decision, okay, do we reassemble it or do we have another set of hurricanes coming through the area.  We live in this technological era where we think we just flip a light switch on and we have instant energy.  It just doesn’t work that way.  [51:44]

JOHN:  What might be good here on the program – I don’t know if we can do this is get someone on to walk our listeners from day one (“I want to build a refinery” or “I want to put in an oil rig”) and from day one through what is usually a 10-year process of what is required in terms of money, permits.  People have no idea as the increase of regulation burden goes up, that you just spent a heck of a lot of money on permits alone with no guarantee of anything. 

JIM:  That’s a good idea.  In fact, I have some contacts in the industry.  I’d like to get an exploration company that has bid on some leases in this country and just have them take us through the process – what it costs, where the delays, where the bottlenecks are, how much money has to be spent.  And then I’d like to get somebody from an oil company who says, all right, you’ve got a refinery in Long Beach or in the Midwest somewhere, and you would like to double the capacity of that refinery, what does it take?  What does it cost?  And what are the delays?  So we can get this information out to people because the stuff that’s being put out on the news is basically balderdash.  [52:54]

JOHN:  We’re going to continue the Big Picture changing topics right now.  You’re listening to the Financial Sense Newshour at www.financialsense.com.

 Oreo Theory: What Happened to the Creamy Filling?

JOHN: Well, I’m going to stage a revolt here on the program.  We’ve been calling the Oreo theory –the creamy filling in the middle of the year – saying that the beginning of the year was going to be hard and crunchy like the outside of an Oreo; the inner section would be creamy; and the end would be hard again and crunchy.  I’m going to call it the Hydrox theory of the year from here on in.  That’s my revolt on the whole thing. 

By the way, for a lot of people listening in Britain and Australia, these are chocolate cookies with chocolate outsides and then white creamy on the inside.  I had a friend of mine, Jim, from the UK who said they don’t have Hostess Twinkies over there, so I packaged a big box of Twinkies and sent them to him.  A friend of his had actually brought some over.  He said these are pretty good.  Yeah, they’re totally junk.

JIM:  Nutritious!

JOHN:  Nutritious.  Really good stuff.  So that’s what we talk about Oreos.  I don’t know whether you have Oreos in your part of the world, but that’s what they are.  And Hydrox has been their major competitor for the same type of cookie, so I’m a fan of Hydrox. 

We’ve been hearing from listeners:  What ever happened to the creamy filling?  Do we still have it?  Is it curtailed?  Because we’ve said the run-up to the crisis window has been a little more rapid and a little more violent than I think we thought, Jim. 

JIM:  Well, absolutely.  If we go back to the first show of the year where I articulated the Oreo Theory – kind of a rough first quarter and the reason that we were seeing this rough first quarter – and then we’re also predicting a rough latter part of the year or the final quarter of the year – and that was because we saw the financial writeoffs that were going to be coming to the industry, huge losses being reported by the financial industry; and then of course the collapse of Bear Stearns in the month of March. 

So the first part of the Oreo began to play out and it looked like the creamy filling – and the assumptions by the way, we were making on the creamy filling in the second and third quarter were a couple things.  1) we expected the Fed to aggressively cut interest rates, which it did; 2) we were expecting a stimulus package which was amazing that they got together and they passed one within a month, which is amazing for the White House and Congress to do that.  And 3) we were talking about some kind of major bailout of the financial industry, the mortgage industry and the housing industry.  All of that would equal the creamy filling. 

Now another prediction that we made at the beginning of the year is that we saw oil prices heading to $125 a barrel, and it turned out I was way too conservative on that and I didn’t think that the $125 oil price would be reached until we got maybe in the third or fourth quarter – in other words, into the winter months, late fall of this year.  Instead, as the Fed came in and bailed out Bear Stearns, we saw the markets begin to rally.  In fact, if you go back to the probably February lows which were reached somewhere around the middle of March when the Dow got down to 11-thousand-roughly-743 – we saw the Dow go from 11,743 all the way into roughly May where the Dow hit 13,000.  So we had a nice, big run-up and it looked that way.  But here’s the problem.  If we take a look at oil prices – and we started out the year, I think it was roughly around $95 – and if we take a look at oil prices since the beginning of the year, we went from roughly around $95 a barrel – yeah, roughly about $95 a barrel on December 1st – and then we hit some low points in January, but from the January low of roughly about $85 in that correction period, we went from 85, we took out roughly 125 in the second week of May, and then went all of the way up to almost $140 a barrel.  And so, unless we can see oil prices drop to below 120 – get down into that 110, 115 and gasoline prices drop below $4, there is absolutely going to be a limitation.  In other words, the creamy filling is not going to be as creamy. 

At one time I thought we might hit – with the Fed rate cuts, the bailout package and also the stimulus package that we would actually hit even a new record, but I was wrong on that and the issue of oil is almost negating almost everything that we’re seeing here.  So I think that the real issue is what’s going to happen to oil.  Now, you’ve got a lot of people saying that it’s going to peak – I don’t think so.  I think that we could hit maybe 140, 145 as my next target, and if that happens that’s going to negate just about anything that has taken place from the stimulus package with those checks going out in the first couple of weeks in May and we were expecting the spending from that stimulus, the rate cuts and also a housing bailout package.  They were talking about a $300 billion bailout package of the lenders and homeowners, that this would sort of put a floor underneath the market but that’s not taken place.  [59:01]

JOHN:  You know, we might point out here that it’s looking like this whole bailout bill which really hasn’t been that popular – a lot of people who do make their payments are wondering why everybody else gets bailed out, but it looks like that bill is dying on the vine.  Especially since it turned south, we’ve had a lot of members – no, they wouldn’t do this! – on the Banking Committee seem to be taking campaign contributions from members of the banking establishment etc; and also Chris Dodd, because he’s being investigated for ethics charges, he got his loan through Countrywide.  So there’s all sorts of entanglements right here – now that this has become public this thing is dying.  So that probably will not go through – at least in its current form.

JIM:  Yeah, and if you take a look at what’s happening on the housing front, we’re seeing more foreclosures, we’re still seeing continued drop in real estate prices across the country and as that continues, probably by the end of summer, we’re going to see the end of the stimulus.  In other words, the rebates will have been spent, used to pay down credit card bills and what we’re looking at is if we can’t get oil prices down by the end of this summer – in other words, get them down to maybe even 120 – then you’re just not going to see the market rally. 

I mean one day you saw a drop of oil prices by three or four dollars a barrel –talking about increased production, China is going to increase the cost of energy, so we had a nice drop in oil prices on Thursday, and then on Friday we had Israel talking about planning military exercises on bombing runs and we’ve got the price of crude oil up almost $2.60, and so you almost have the rise and fall of stock prices having to do with the oil markets.  So I think if this doesn’t happen by summer, the stimulus program that was enacted in February begins to peter out, you are probably only a third of the way through the writedowns of the mortgage industry.  So a lot of people say there’s much, much more to come.

And here’s another risk too, as we get into the fall, and this is what we saw with the dark outer sort of covering on the Oreo Theory, is that as the economy weakens what we’re starting to see now is the widening of bond spreads between Treasury and corporates.  And as the economy weakens you could now start to see junk bond defaults, and as junk bond defaults start to increase because now as we’re seeing with the unemployment report, it’s not just the retailing industry or the construction or the financial industry, it is now starting to spread across a broad swath of industries in the economy.  So now we’ve got the unemployment rate at 5 ½%, and as companies begin to take a look at their sales and begin to counteract rising costs, one of the big costs of operating any company is labor.  And as writeoffs start to increase, as layoffs start to increase, another issue that has not unfolded here and could be the next crisis is these credit default swaps where you’ve seen a lot of the hedge fund players have been making a lot of money by collecting premiums by writing insurance protection on a lot of these junk bonds.  And if they begin to default, you could see a lot of hedge funds go under and that’s another risk here.  So it looks like this creamy filling that we were anticipating is going to be less creamy than we originally thought.  [1:02:35]

JOHN:  You know, there’s a lot of talk out there right now about the Fed finally getting tough on inflation and raising interest rates and then that’s always causing a typical market jitters trying to anticipate that.  So talk a bit about that. 

JIM:  I think at this point with the dollar falling and with inflation rates rising, they had to sort of switch gears and especially with talk of the Europeans raising interest rates as soon as next month.  I think a lot of this is just jaw-boning.  I just don’t think that you’re going to see the Fed raise interest rates with the economy continuing to weaken.  In fact, it could start accelerating and getting much weaker as we head into the fall as the stimulus package peters out.  And like I say, the housing bailout is dead on arrival because of corruption investigation now of the Banking Committee.  So if the economy begins to weaken I just don’t think that the Fed is going to raise interest rates.  They may be forced to raise interest rates but that may come next  year.  I just don’t see it happening before the election.  And especially if the economy begins to accelerate on the downside as we get in to the fall.  [1:03:43]

JOHN:  Let’s go back to the Oreo concept again because as we were sliding into the fall – remember this is going back to our original thesis here – as we were sliding into the fall area we would be begin to see the dark side of the Oreo cookie emerge once again.  And there were some other predictions that you had made – are these still standing, or how have they been altered?

JIM:  No, in fact, one of the things that we saw was higher interest rates and higher inflation rates, and I still expect that to happen.  In fact, we’re already seeing it in the report of headline inflation numbers and the headline PPI numbers.  We’ve also seen the 10 year Treasury note reach a bottom during the Bear Stearns crisis on March 17th where the yield got down to 3.3% and here we are on this Friday looking at a yield of 4.15%.  So interest rates are starting to rise and we see that trend continuing into next year. 

We also see higher inflation rates, not only here but also abroad.  And then also you’re going to get all kinds of nervousness as we get into the month of October depending on what the political polls are showing who could be the likely candidate.  It’s too close to call, that’s going to make the market nervous because markets don’t like uncertainty, and also I think if one candidate really begins to move ahead – in other words, there’s a widening gap between the two, then also I think you’ll see a short term shift come into the markets as short term traders begin to adjust, say, okay, an Obama presidency – that might favor certain industries, or if it’s a McCain presidency, that might favor certain industries.  And so you’re going to see a short term shift in traders anticipating the election outcome.   So that’s also going to be – you could see rotation in the market taking place.  [1:05:38]

JOHN:  Maybe it’s important to point here too, that no matter who wins, we’re still facing tough times ahead.  We didn’t get into this situation easily.  We’re not getting out of it easily because we hear like a lot about the “Pelosi premium” (this is a charge being hurled by Republicans against Democrats), “we didn’t do anything.”  This took 30 years to build us into this corner.  It’s going to take a lot to get us out.

JIM:  Yeah, it doesn’t matter whether it’s McCain or Obama, the economy is going to struggle.  We may get a slight recovery, but depending on what kind of adverse legislation is passed – and especially if we start violating the five cardinal sins on bear markets and depressions then what could happen is a meager recovery or slight recovery goes into a recession.  That triggers subsequent policy response which could eventually turn it into a depression.  At the same time, I think we’re going to see rising oil prices where we could see that $200 spike, maybe even 250 a barrel, and so that’s why that – if we don’t get this energy price that we go from the creamy filling to the darker outer edge much sooner than I anticipated.  So I think the real key issue here in terms of how this creamy filling unfolds now is what’s going to happen in the oil markets and you can see this almost on a daily basis: the markets going up and down depending on what’s happening to the price of oil.  And it’s my belief that we’re still going to see higher prices in oil.   [1:07:12]

JOHN:  So what you’re basically saying is by the, what?  The middle or the end of summer you should really get your foul weather gear because the next squall is moving in.  When do you think it’s going to really hit hard?  We talk about the crisis window.

JIM:  I really think it’s going to be probably towards – if I’m right on the inflation numbers which I think I am, if we start to see a consistent rise of headline inflation, if we see a consistent rise in producer price inflation.  And bear in mind, even though they’re monkeying around with these numbers, it’s pretty hard to hide these things.  As Bill Gross has pointed out in a recent article that he’s written on his site this month, you’ve got world headline inflation running at 7% and you’ve got the United States with one of the lowest inflation rates and it’s just not adding up given the fall of the dollar, what we’re seeing with energy prices and what we’re seeing with food prices. 

Now you also have the situation in the Midwest where you’ve had these floods, and if you take a look at corn prices, they’re down on this Friday but we’ve got corn prices just slightly below $7.50 a bushel, so that’s something also to keep your eyes on and I think people just aren’t buying [it].  I mean I even heard a commentator report on some of the inflation numbers “well, here they are if you can believe them.”  So even when the anchors are saying we don’t know if you can believe this stuff, I think that’s going to start to weigh on the market.  And remember, probably by the end of summer most of these rebate checks will have been spent.  So what’s going to be the catalyst for strong economic growth once the stimulus package wears itself off.

JOHN:  You’re listening to Financial Sense Newshour and our website, www.financialsense.com.

 Part 2

 Crime of the Century - Part V: Summary & Conclusion with Eric King

JOHN:  Over the last few weeks we have been doing a series which has attracted a rather substantial amount of attention called The Crime of the Century, and it’s called naked short selling.  Today’s installment in this program is going to be the last in that.  And joining us here in the roundtable discussion today is Eric King. 

So, Jim, let’s lead off to see where we are – well, where we have come from and then where we’re going today.

JIM:  Well, about five weeks ago, Eric, you joined me on the program as we introduced this topic called Crime of the Century, something I covered in the last part of December of last year.  This is the fifth installment of this.  And Eric, one of the reasons I wanted to have you on the program today is in the second segment I addressed seven issues of how these criminals try to manipulate stock prices – the various techniques they use to try to scare investors and steal their life savings. 

So what I wanted to do is to go over these briefly and then we’ll go on to a broader subject matter here, and especially with the SEC now revising its naked short selling rules and upping the ante in terms of fraud.  But I want to talk about these seven techniques of manipulating the tape or the stock so they could steal money from investors; and I want to get your perspective because you watch the tape and you see this. 

And I want to start out with one that we saw here, in fact I saw it with two stocks on a Friday and it’s called ‘ruin your weekend.’  You know, Eric, for most people, it’s Friday night, it’s 15 minutes before the market closes, you know, your mind is elsewhere; you’re thinking, okay, where are we going out to dinner this weekend; I’m thinking about the kids’ baseball game, I’ve got a soccer match I’ve got to go to; honey-doos.  The last thing you’re thinking of on Friday, 15 minutes before the market closes, is probably following the stocks that you’re invested in.  Why don’t we talk about the 15 minute market close on a Friday and ruin your weekend, and how this occurs and what they’re trying to do here. 

ERIC:  Well, very simply, Jim it has to do with – and before I get into that – I’ll come back to that – but let me just put in a thank you for Ted Butler last week.  As you know, I guest hosted.  Jim, he doesn’t do interviews and he came of came on as a personal favor for me and does so many writings in the silver sector, and I appreciated him doing that, so thanks, Ted. 

But moving back to what you were saying, Jim.  The idea there is basically as you said to just kind of send the people home a little wounded psychologically, so they worry over the weekend.  Look, the manipulators’ job is to have – basically in this case you’re describing a short sold an equity, and while driving and manipulating the price, now try to create fear or worry and therefore create selling so that they can cover at lower prices, or basically just a cascade of selling in an attempt to drive a company out of business.   [3:04]

JIM:  And usually they do that on weekends because, you know, a lot of people might look in the paper or they might go on their computer Saturday morning (“okay, let me look at my portfolio, how did I end up the week?”)  And a lot times people are shocked, it was like, my goodness, the stock was doing well on Friday, what happened?  And that’s what I think they’re trying to do here is the shock effect of trying to drive something down all of a sudden – and we’ll get to another technique that they use here – but basically it’s trying to create doubt, wouldn’t you say.  It’s like people are saying, “what happened, why is it down 20%.  It was up 10% in the day and it ended up down 20.  Is there bad news coming.  Is there something that we don’t know.  Is a big investor in the company selling out?”  And what they’re really trying to do here is create doubt. 

I want to go to another one that you see across the board, almost on a daily basis and that’s the two-second dropdown.  The stock is doing well and two seconds – literally two seconds – before the market closes they take a stock down from being up five percent to taking it down maybe 10 percent or eight percent.  I mean, how many times do you see that across the junior sector.  I see it all over the place.

ERIC:  Yes, that’s chronic.  And the bottom line with that is that what we’re talking about here in the broad scheme of things is criminal activity. And what we’re discussing now is this is the attempt to drive investor psyche negative to create selling pressure or additional selling pressure.  You bought up a two-second example – I don’t mean to laugh, Jim, but I don’t own this particular stock but I know you do – I know your fund does – and I happened to be watching it and it was two seconds before the close, the stock was up on the day and somebody went and sold a few levels down on the bid with literally two seconds left on very little volume.  But it was an eight percent swing on the stock.   And it took it from positive on the day to negative on the day which a lot of times is what this manipulation is about.  Just show a bad close constantly – have it be closing badly.  And it’s done chronically as I said and it’s done all the time.  And when this is uncovered these are the kinds of things that are going to come out because people will roll over on each over and it will be exposed that this is what was being done.  And it is going to be shown to be criminal because it’s either done in syndicate or it’s done strictly for the price manipulation purposes, which isn’t legal.  [5:37]

JIM:  Now, I want to do another one and this is usually the heads up alert that your stock is going to be subject to a bear market raid; and that’s what I call the ‘carpet bomb.’  Let’s say you take a stock that trades maybe – I don’t know, two or three hundred thousand shares a day if it’s a midsize company producer or an upcoming producer, or maybe it’s a stock that trades 50,000 shares a day – and all of a sudden I’m looking at a silver producer that is probably one of the most profitable silver producers in the world and this stock had been trading in the average roughly around  two hundred thousand shares, and in a series of quick jumps over a two-day period, all of a sudden one million share of selling came into the stock; and it was done late in the day, driving the stock down 10, 15, 20 percent. 

Usually what I see when you see this kind of event take place, it’s a bear market raid; it’s done in collusion.  They’ll hit it from multiple houses all at once and 30 days later when the short sales are reported you will see that the short position in the company goes up.  So talk about, if you would, the carpet bombing.  I can remember – I think it was when you were at the gold show – there was a particular company that had been doing very well – in fact, it was up quite significantly and all of a sudden, within two days, there was a carpet bombing on this stock. Explain what is being done here. Once again, I think – as you pointed out here earlier – the strategy here is to discourage investors or create doubts in their mind that something not good is happening to the company, there maybe bad news or something.

ERIC:  You know,  it’s interesting you bring that story up – I didn’t know you were going to do that – but I had recommended that stock and I think it was the top performing gold stock in the world or certainly one of them for this year – but what was interesting is as the value was being recognized in this company, there is a short position in there.  Now, we don’t know what the size of the naked short position is, but we do know that there is roughly 1.2 million shares short – and it was kind of funny because I’m a long term holder so for me it doesn’t matter – when they take it down I’ll just buy some more – but all of a sudden, selling came in.  But it wasn’t natural selling – it was over the course of a week or so and you know, I don’t want to say exactly where the stock price was but when they were done selling they probably averaged about 17 to 20 percent lower than where the selling emanated from.  It was done pretty violently.  It was straight down.  And that’s not natural selling because, Jim, you and I have both seen professional sellers and what they’ll try to do is basically say, okay, you want out of this position – I’m just going to do this in a very low key manner and just distribute paper and we’ll unload half a million shares –or a million shares or whatever it is – we’ll do it as delicately as possible because the goal obviously is to get the best price.  Well, this selling just hammered the stock straight down.  I mean it was just comical.  And I believe it all to be shortselling.  But I’ve seen this in the markets for so long it doesn’t really surprise me.  And the methods and the things that they’re using to do this – and by the way, those shares were not reported short, so in the end if those were short then they’re naked short and that gets back to the illegal action.  But it wasn’t natural selling.  And people are seeing this in their stocks – they’re going, “this doesn’t make any sense.  My stock went straight down and there was no news, nothing happened, nothing changed fundamentally.”  And so they’re realizing now that these are orchestrated bear raids.  And so now you start to get into the – I guess the description would best be described as short pool operations – you know, where you have a pool of operators doing this.  But again, Jim, that’s a crime. 

And I think that a lot of these people at these brokerage houses forget exactly what the rules are because they either haven’t been there long enough, or they’re young or they just don’t know – but that’s criminal activity;  you can’t engage in that – you can, but it’s not legal.  And we just saw a couple of hedge fund guys carted off to jail, there’s more of them over time that will be put in the cage for illegal activities and their lives will be destroyed – but they’ve helped destroy some of these companies.  This is very damaging what is being done to these corporations, to these companies and to these shareholders.  You cannot do things like that to benefit yourself financially – be involved in a pool and manipulate a stock down like that.  It’s totally illegal.  [10:17]

JIM:  I want to go to the next technique and have you explain this because you see this a lot.  It’s called the morning pop, the last minute drop – where you’ll see a company – a junior will go up five, ten percent in the morning and then all of a sudden, at the end of the day they take it down.  So they’re shorting in the morning – what are they trying to achieve with this technique which you see quite frequently.

ERIC:  Well, I want to pick on the Canadian brokerage houses again. And again, it’s not everybody but it’s some bad apples.  And I’ve talked about this on this show before, but you know, gold will be up maybe in the morning, silver is up, the gold stocks are up, so people are coming in to buy a particular equity that they like – and they’re just sitting there on the offers, just shorting it in the morning.  And then they’ll start to take it down towards the end of the day and then it’s time to hit the phones, which is why I think it’s so dangerous to put paper in the hands of some of these Canadian brokerage houses because then they hit the phones; right?  They get people to sell for whatever reason.  Meanwhile, they’re on the bid and they’re covering the shorts they did earlier in that morning by getting the people who they’ve done the stock offering with that was to supposedly bring funds into this company to help; right?  Now they’re shorting this stock, driving it down, hitting the phones and they’re getting people to sell and they’re on the bids meanwhile covering their shorts.   These are like cash registers for these brokerage houses – that’s the dirty little secret.  And that’s been done for a long, long time, so nothing new there.  But is it sleazy?  Yeah, it is.  If I’m running a junior mining company, do I want to put paper in those people’s hands.  No, I don’t.  And I think going forward you’re going to see the smart ones discontinue doing business with them because they see this going on with their stocks.  [11:58]

JIM:  It’s amazing because one of the things that Wes Christian –who is one of the attorneys leading this battle, and he was featured in the Bloomberg special with John O’Quinn on naked short selling – told me is that you’ll look at a company and you’ll look at the reported short positions but those aren’t necessarily true because he was looking into one company, the company had 60 million shares that have been issued and outstanding but when they took a look at the DTC there was close to 100 million shares.  One of the ways this became obvious was at the annual shareholder meeting; you had 20 million shares voted on more than there were outstanding.  And I mean that’s how bad it is. 

Here’s the particular problem here.  When they began to look closer into this one of the brokerage firms was showing on their clients statements that their clients owned 12 million shares and yet that brokerage firm was only holding one million shares at the DTC.  And we’re going to get into the new updated proposal by the SEC on naked short selling here – but another issue that comes into play here is I think the crime has gotten so big that I don’t know you can cover.  And let me throw this example to you:  Let’s say that you have a company and let’s just make this easy for simplicity’s sake – you have 60 million shares that the company has outstanding, but there are 40 million shares out there that have been sold short through naked short selling, so you have 100 million shares outstanding.  Eric, how do you get and cover a 40 million share naked short position because if you go in and start to cover, you know, what’s going to happen?  You’re going to start driving the price of the stock up.  As the price of the stock starts to go up, what happens?  It attracts the people with technological trading programs so you get the momentum players and then you know what happens psychologically with investors – “oh my goodness, my stock is really going up.  I’m holding on.  I don’t want to sell.”  So how do you convince 80% of the shareholders in that company to sell you their stocks so you can cover your naked short position.  I don’t know how you get out it. 

ERIC:  This gets into speculation, Jim.  I will tell you how I think this will resolve itself.  I think that there is going to be a lot of people put in prison over this.  The exit strategy from that?  I don’t know how they’re going to lay that off.  Are they going to lay that off on the taxpayers, are they going to lay that off on the brokerage houses?  Who in the end is going to pay for this type of criminal behavior particularly in situations, as you said, where it doesn’t look feasible to cover the short position?  I mean you got a call or we talked– you called me in fact, this was late Saturday and you had been speaking to a guy and he used to head one of these places – he was the head trader.  And he was telling you a story about a company that only had half a million shares outstanding roughly – and basically they had an order to sell 700,000 shares.  So people have no idea the type of criminal activity that is going on here.  And maybe you can elaborate on that a little bit, Jim.  [15:23]

JIM:  It was amazing – I was at a social event last Saturday and most of the people at this social event were financial types.  This particular individual I struck up a conversation with used to be the former head trader for one of these major firms.  We had hedge fund managers there, we had portfolio managers  - a lot of financial people.  So the conversation is going on – the evenings get a little later.  Obviously this individual had a few beers to drink and so we struck up a conversation. 

And I start telling him some of the things that I was seeing going on across the border in Canada with junior mining financing; and then I was talking about these various techniques that are used to move the market.  And you know, it was amazing, Eric, he just opened up and enlightened me on other techniques.  Like, one of the things that he told me about, for example, when you have a naked short position where you have let’s say 13 days or whatever it is to deliver your securities – okay, you don’t want to report it as a naked short sale, so what you’ll do is you’ll call up one of your buddies in the collusion syndicate and you’ll say, “you know what, we’re a million shares short, we don’t have the shares, why don’t you give us a million shares?”  Well, the other firm may not have it but they’ll give him a million shares so you don’t have to report the naked short position and then when those 13 days run out for the other firm to report the naked short selling, the other firm will give them back their shares so they don’t report it.  So they keep this whole thing going in circulation, so you cannot take as gospel the short positions that are reported on a daily basis. 

And he was telling me one particular case.  The way the story went is the float – the average trading of this stock average about 400,000 shares.  And he got a call – literally about half an hour before the market closes with an order to sell 700,000 shares.  And he said, “you know, the float is 400, if I put 700 we’re going to crush it.” And the order was: “Crush the stock.” 

And I mean some of the stories that he was telling me about if people only understood how pervasive this is.  And this guy – and I could see it looking in his face – he has left this particular firm and the industry and you could just see sort of the pain in his eyes.  It was like, “I didn’t want to do this anymore.  I didn’t want to be a part of this.”   Because I think he had enough of a – almost you could see, Eric, like a conscience, like “I’m not proud of this, I don’t want to be doing this.”  And this guy is no longer in the industry.  [18:02]

ERIC:  Jim, why don’t you share what this trader told you was their greatest fear for these shortsellers.

JIM:  Oblivously when you’re shortselling a stock, you’re getting those shares from a margin account and he said one of their greatest fears is where people either took delivery of their certificates or closed out their margin accounts because what happens is – imagine a company that has 15 percent or 20 percent of its shares sold short and those shares have been borrowed.  Let’s give them the benefit of the doubt and let’s say that this has been done on a legitimate basis – but what’ll happen is if somebody starts closing their account, closing out their margin account what it does is it forces them to go into the market and start buying those shares back and it just drives it up.  And you’ve seen this sometimes in the stock market where you’ve seen the Dow is down and all of a sudden you’ll see the Dow up three or four hundred points and that’s what it is – it’s shorts covering their short sales.  And so his biggest fear – and especially when it gets to microcap stocks.  And this would apply to Canadian junior mining stocks where you know Eric, these stocks don’t trade –there is not a lot of volume – and then all of a sudden people will start closing out their margin accounts or they start asking for their certificates, basically their goose is cooked – the shortsellers.  That’s their greatest paranoia if something like that happens because you cannot counterfeit – if somebody asks for a stock certificate, a company cannot go out and basically counterfeit a share certificate – I mean, boy, they would be really in hot water and talk about a federal offense!  And the same thing happens when people close out their margin account.  [19:48]

ERIC:  Well, Jim, the bottom line is that if you own juniors or junior shares and it’s in a margin account, you are in fact aiding the enemy because you’re helping them to destroy the value of that company.  Now, Jim, I know you manage money so what steps have you taken, or how are you dealing with this in terms of managing the client accounts?

JIM:  We handled this issue a while back and especially when I got wind when this was being practiced at such a large scale.  We went all the way to the top of our clearing firm and we got it in emails and we also asked them to put it in writing and that absolutely that they adhere to regulatory rules that they were under no circumstances loaning out shares in cash accounts.  So we’ve got it in written letter, we also have it in emails.  And we just didn’t settle with one individual at this firm, we kept asking more questions, getting more detailed especially in terms of working with our attorneys how to ask the questions.  And so we’re satisfied that this isn’t being done because we’ve got not only emails but we also have letters from our clearing firm that none of this was being practiced by our clearing agents.  But people think that this doesn’t go on. We’re going to play a couple of film clips here:  one from a senator from Utah of how they play the kind of pass the hot potato on the naked short position; and then we’re going to play a hedge fund manager.

I want to move onto another technique and it’s called the hand off, and you’ll see this where you have a mining company that has a dual listing.  They may be listed on the Toronto exchange and the AMEX exchange.  And what’ll happen is it’ll start out in Canada where you’ll have one member of the crime syndicate sell shares to the other member of the crime syndicate, so there is a lot of activity generating – and it’s done in onesie, twosie-type stuff.  Let’s say bad-apple bank A sells bad-apple bank B a thousand shares of this stock.  Then bad-apple bank B turns on the AMEX and then sells a thousand shares on the AMEX.  So if you’re watching the tape you’re seeing heavy selling in Canada in the stock, heavy selling in the US in the stock.  Why don’t you explain what they’re trying to do here because you were aware of this particular incident because you and I were talking and watching this unfold.  What were they trying to do here?  Explain that for our listeners.  [22:23]

ERIC:  You know, you start getting in to some of this criminal activity where basically they’re driving the price of the stock down and you could have a hedge fund engaged in this, for instance, that’s going to take – and I don’t want to name names – but let’s just say they use a brokerage house in Canada and you know, lately the thing to do is to have “anonymous” on the bid, right?  So then they’ll have this brokerage house sell to anonymous and then anonymous immediately arbs on to the United States’ side knocking this stock down and hitting the bids.  So you have this almost electronic selling that’s computer generated, designed specifically for price manipulation to disperse these shares to anonymous; and then anonymous will turn around and knock the bids and knock the stock down during the day. 

But this is what people don’t realize that are involved in this because you know, we’re hearing complaints, now that we’ve been exposing this, Jim, about the use of anonymous in Canada.  And what they don’t realize is that in discovery, anonymous will fall like a stone.  That’s because right behind anonymous is the normal paper trail from broker to customer.  So when this all comes out and people are going to prison, there’s not going to be any way to hide this because the paper trail is going to be there.  And that’s going to be the problem in the end.  There isn’t going to be any anonymity when it’s all said and done and people are being put in a cage; okay.  It’ll all be exposed.  [23:49]

JIM:  That’s exactly what my attorneys told me.  In fact, we covered this last week – it’s not like a crime scene where a criminal goes into a bank and he’s wearing gloves so there are no fingerprints.  Every single trade done on a daily basis is a record that has to be kept.  So behind that trade there is a name, there is a party that was executed either on the buy or the sell side.  So you’re absolutely correct – it’s unlike other crime scenes, the evidence will be there and is be required to be there. 

You know, what was interesting to me and I want to go back to this conversation with this trader that I had last Saturday and I was amazed – and maybe this is where some of the guilt was coming in in terms of what he was doing or what the system had made him, it almost reminded me, Eric of the movie Wall Street with Charlie Sheen, who towards the end develops a conscience – and I almost saw this in him.  And I said, “explain to me, don’t you guys – you know, my attorneys have told me that the brokerage firm has the obligation to police this.”  Because let’s say, Eric, you called me up and you said, “Jim, I want to sell a thousand shares of ABC mining company.”  First of all, I would have to look into your account and made sure that you owned the shares, so that if we go to put in a trade I see the shares are in your account.  By the same token, if you came in – in this case you’re an institutional client of mine.  You come in and you say, “Jim, I want you to sell one hundred thousand shares short of ABC mining company.”  I have an obligation to ask you where are the shares going to come from.  And what this guy is saying is, “you know what, it may look like that, but it’s overlooked in the industry because the prime brokerage industry coming in from the hedge fund business is the most profitable part of the business.”  And you’re almost put in a position, “look, if you won’t execute this trade for me, I’m going to go elsewhere.”  And you don’t want to do that.  And you kind of look the other way and you say, “well, do the best you can to come up with the shares.” 

And it’s absolutely amazing that there is no policing in the industry which is why that the way this is going to be tried in the US  is under RICO – racketeering - because there is responsibility – you can’t walk away from this and say, 1) there are no fingerprints on the crime and 2) you can’t walk away and say, “well, gosh, I forgot to ask him where the shares were coming from; and lo and behold they never arrive and the shares never show up.”  So you do have a situation where you’ve got clients in a brokerage house holding 12 million shares that don’t actually exist.  It was just absolutely amazing.  [26:44]

ERIC:  Well, let me just jump in here and just say this, Jim:  here’s the problem – and I don’t want to say “this gentleman” – but here’s the problem the industry is going to have – what you just said is true – it’s very profitable for these brokerage houses.  Right?  So therein lies the problem.  But let me just say this because this is how it’s going to shake out:  They can’t erase the paper trails behind them and the financial industry – these entities being cowardly like they are will not commit another crime to sustain a relationship.  So these institutions will roll over on these hedge fund conspirators when the time comes.  Somebody wrote recently there is a line at the federal building in New York for fund employees giving up their bosses for immunity.  Well, Jim, I can promise you that line is going to be getting a lot longer in the next year.  [27:34]

JIM:  Well, let’s move on here because I want to get to the new proposals by the SEC that are up for discussion and we’ll get some response to that.  Okay.  So we just talked about five techniques:  the ruin your weekend, the two second drop down, carpet bombing, morning pop last day drop, the handoff.  Let’s talk about another technique that is used and that is the ‘whopper offer.’  You take a junior – and you know Eric, some of these juniors may only trade three, four thousand shares, maybe some days 10, 20 thousand.  And let’s take a junior that maybe only traded 20, 30 thousand shares for the day or even less than that and all of a sudden, you know, gold is up, the stock is starting to move up and all of a sudden the company has traded maybe 20,000 shares and all of a sudden somebody shows up on the tape with a 100,000 share offer; what are they doing here?  [28:25]

ERIC:  Well, you know, you use an example like that – let’s say you had 30,000 traded and you’re two-thirds of the way through trading.  If you get an order for 100,000 shares you don’t want to take it and drop a 100 or 105 thousand shares on to the offer because nobody who is intelligent does that.  So this, again, gets into manipulation.  So here comes this offer.  Now, two things:  1) people who wanted to buy don’t want to buy anymore because there is a big offer there (if they’re looking at Level 2); but 2) people who may have been in this trying to trade it during the day, they’re going to start selling because they’re going to get spooked; and 3) people who are on the bid are going to pull their bids because they’re looking at this big offer.  And these may not be sophisticated people but the bottom line is the intended effect is to arrest any type of movement in the stock price higher; and not only that, if possible, drive it lower either through creative selling or the elimination of the bids.  So, yeah, nobody with any brains is going to drop 100,000 on the offer like that.  That’s nonsense.  [29:22]

JIM:  And another thing that you see quite often is sometimes when you do get a buyer coming in, and I’ve seen this even for our own purchases, you see this whopper offer come in and all of a sudden you start hitting the offer and all of a sudden, it’s pulled and it’s disappeared.

ERIC:  They don’t want to sell you the shares, that’s why.   So if somebody goes, “wow, there are 100,000 shares  there, let me hit it for 25 or 30 and just kind of tap on this thing…”  – and then it’s gone.  Well, they didn’t really want it, they were just putting it there for manipulation purposes.  They don’t want to give you 100,000 shares.  [29:54]

JIM:  And that happens quite often; in fact, I got an email Friday from a hedge fund manager I know that he was buying and that’s exactly what happened; the offers were pulled at the end of the day as they were put out at a higher price, and as they began being hit, the offer was pulled.   So here’s another manipulation technique which is the whopper offer.

Finally, Eric, the seventh technique that you see is called ‘bash and cover.’  And let’s say that, okay, I’ve done a number of techniques to manipulate the stock; I’ve done the carpet bombing – usually is how the raid starts off – I’m trying to suppress the price of the stock so I’m doing the two second drop down, ruin your weekend, whopper offers etc.  Now, I’ve got a huge short position – okay, I want to cover that short position and what happens when maybe there’s just not enough people selling the stock.  They understand the company, they like the fundamentals and they’re just holding on. 

But all of a sudden you see these characters - because remember, if you’re a shortseller you want to use the media to your benefit; if you’re going long a stock you want to pump the media to pump the stock; if you’re going short the stock you want to use the media.  Now the common place in which this is done – especially the mining stocks – is through the chatrooms.  And you get the – all of a sudden the stock gets hit, it gets whacked, there is no news, and all of a sudden you get the infamous basher who shows up and he’s there to help you and then he’s there.  Let’s talk about the bash and cover.  What’s the purpose – why does this guy show up on these websites and what’s his purpose?  [31:32]

ERIC:  You know, Jim, I don’t follow this probably as much as you do, but I guess the concept – you read an email on the air from somebody who apparently was engaged in this and basically the bottom line is it was a broker and they worked for a brokerage house and the bottom line is they would go on the message boards and so would their cronies to scare people and get them to sell their shares.  I really can’t elaborate any more than that because I don’t know anymore than you do.  I guess it’s pretty obvious – look, when people don’t have a stake in a company and they’re spending tremendous regularity on some board somewhere telling people why they shouldn’t own something, it should be pretty obvious to people there’s really no financial gain for that person unless they’re short this stock.  Right?  So you don’t to be a rocket scientist here on that one.  [32:17]

JIM:  It’s amazing because we get a lot of emails, especially since we started this series pointing out these characters; in fact, we get them I would say, Eric, quite frequently, gosh, seen a lot of it over the last year and it’s my position that the naked short position of the juniors really began in May of last year where the hedge funds and the investment banks went from being long the sector to short the sector because a lot of these irregularities that we have been talking about – but the one thing I want to bring up is going on a chatroom, spreading false information for the express purpose of manipulating the price of the stock, either 1) to get people to buy the stock because you’re long the position; or getting people to sell their shares because your short the position is a federal felony offense.  This was done quite frequently during the internet craze and there were a lot of people who got caught.  There were a few characters who were manipulating the price of some of the large internet stocks and they’re now in prison.  But people don’t realize that you know, a lot of these brokers who are getting paid 5, 7 bucks for each little chatroom, they don’t realize that they can get 5 to 10 years for this.  And this is a rather serious crime. 

And a lot of people think that this doesn’t go on, and they don’t use the media.  And I’m going to ask John Loeffler to come in here and play a clip.  This is a clip of Jim Cramer – it’s not quite clear if Cramer was either talking about when he was running a hedge fund or people he knows in the hedge fund [industry], but let’s if we can, play that clip of Jim Cramer here:

AARON TASK:  Welcome to Wall Street Confidential, I’m Aaron Task, joined again by Jim Cramer.  Jim, Welcome.

JIM CRAMER:  Good to see you.

AARON:  There is a lot of economic data out today, but I want to talk about something else first.  Again today we have the misdirection from the futures, the futures price is up market and as of right now stocks are down again.  Is this just because it’s the holiday period that we’re seeing this?

CRAMER:  You know, a lot of times when I was short at my hedge fund and I was positioned short – meaning I needed it down – I would create a level of activity beforehand that could drive the futures.  It doesn’t take much money.  Similarly if I were long and I would want to make things a little bit rosy I would go in and take a bunch of stocks and make sure they’re higher and maybe commit 5 million in capital to do it and I could effect it.  What you’re seeing now is maybe – it probably is a bigger now, maybe you need 10 million in capital to knock this stuff down – but it’s a fun game and it’s a lucrative game and you could move it up and then fade it.  That often creates a very negative feel.  So let’s say you take a longer term view intraday and you say, listen, I’m going to boost the futures and then when the real sellers come in – the real market comes in – they’re going to knock it down, it’s going to create a negative view.  That’s a strategy very worth doing when your value on a day to day basis.  I would encourage anyone who’s in the hedge fund to do it because it’s legal and it is a very quick way to make money – and very satisfying. 

AARON:  Okay.

CRAMER:  And by the way, no one else in the world would ever admit that but I couldn’t care.

AARON:  That’s right.  And you can say that here.

CRAMER:  I can.  I’m not going to say it on TV.

AARON:  There are so many more hedge funds today than when you were managing your hedge fund.  Do you think that that – does it exacerbate the moves or does it make it tougher because there is…

CRAMER:  Well, you know, the hedge funds are positioned long-short, not just long with mutual funds, so it’s really vital these next six days because of your payday, you’ve really got to control the market, you can let it lift.  When you get a Research In Motion, it’s really important to use a lot of your firepower to knock that down because it’s the fulcrum of the market today.  So let’s say I were – I was short.  What I would do is I would hit a lot of guys with RIMM.  Now, you can’t foment.  That’s a violation of –

AARON:  Foment?

CRAMER:  Yes, you can’t foment – you can’t create yourself an impression that a stock is down – but you do it anyway because the SEC doesn’t understand it so you – I mean it’s – that’s the only sense that I would say this is illegal.  But a hedge fund that’s not up a lot really has to do a lot now to save itself.  So this is different from what I was talking about at the beginning when I would be buying the QQQs or stuff like that.  This is actually just blatantly illegal, but when you have six days and your company maybe in doubt because you’re down, I think it’s really important to foment if I were one of these guys – foment an impression that Research in Motion isn’t any good because Research in Motion is the key today. 

So you know, you would hit this guy and that guy and you would see it offering – when you see a guy who’s bidding – you’d wipe back that guy very quickly and what I used to do was call – and if I wanted to go higher I would take the bid – taking bid, taking bid.  And if I wanted it to go lower I would hit an offer, hit an offer, hit an offer.  And I could get a stock like RIMM for maybe – that might cost me 15, 20 million ante to knock RIMM down.  But it would be fabulous because it would beleaguer all the moron longs who are also keying on Research in Motion.  So it’s…

AARON:  There’s a lot of that going on today?

CRAMER:  Yeah, we’re seeing that.  That’s – again, when your company is in survival mode, it’s really important to defeat Research in Motion, to get the Pisanis of the world and the people talking about it as if there is something wrong with RIMM.  Then you call the Journal and you get the bozo reporter of Research in Motion and you would feed that Palm has got a killer that’s it’s going to give away.  These are all the things that you must do on a day like today.  And if you’re not doing it, maybe you shouldn’t be in the game. 

AARON:  Okay.  Another stock that a lot of people are focused right now seems to be Apple…

CRAMER:  Yeah.  Apple is very important to spread the rumor that both Verizon and ATT have decided that they don’t like the phone.  It’s a very easy one to do because it’s you want to spread the rumor that it’s not going to be ready for Macworld.  And this is very easy because the people who write about Apple want that story; and you can claim that it’s credible because you spoke to someone at Apple because Apple doesn’t&he