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The BIG Picture Transcript
March 15, 2008
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  Part 1
  Humpty Dumpty Had a Great Fall
  Gold's Fundamentals: Even Better Days Ahead
  Part 2
  Three Related Problems: Energy, Food, and Water
  Other Voices: Eric King, Analyst/Trader
  If
  Part 3
  Q-Calls

 Part 1

[music]

JOHN:  Well, there we are.  Dies Irae - Day of wrath, day of doom.  Ta ta da da da da da.  Nothing lacking to talk about this week.  Headlines – Bear Stearns teetering on the brink of collapse from a lack of cash gets emergency funding from the Federal Reserve and JP Morgan Chase in the largest government bail out of a US securities firm.  Without this cash injection, the lights would have gone out on Bear Stearns.  Bear Stearns had its credit rating slashed after seeking emergency funding to just one notch above junk status.  Lehman brothers –tick tock, tick tock, next one on the list – it's on the watch list as it obtains a $2 billion credit line as the bank tries to blunt the stock’s worse drop in eight years, but it's going to assure the investors the firm isn't short on cash.  Of course a thinking man says, Jim --

JIM:  Well, if the firm isn't short on cash, the question comes in:  Why did they need a $2 billion credit line.  [1:28]

JOHN:  This sounds like one of these trick questions that President Bush always keeps throwing out. 

JIM:  Strategery. 

JOHN:  When we started in the subprime mess back in, what was it, July, August, I think, when it first started to roll, I never thought it would go this far at this stage.  I mean we always knew that later on it would probably unravel, but I didn't dream it would get here.

Well, okay.  I guess people out on the street want to know what's going on.  I think your clients are probably sitting pretty securely because we're doing pretty well right now, but everybody else, they are panicking, so what's behind all of this? 

JIM:  You can boil it down to two simple words, real estate and leverage.  Behind all of this, John, is real estate.  Real estate is dropping in value, and then beyond that is the amount of leverage.  Remember last week, we covered the amount of leverage in the system and the leverage models on Wall Street.  A lot of these firms, the investment banks are probably leveraged 25 to 32 times.  You've got the money center banks are leveraged 10 times.  You've got the GSEs leveraged 25 to 1, and remember debt is a two-edged sword.  When things are going up, you can make a ton of money when you're leveraged.  The carry trade so to speak.  But on the other hand, when you have that amount of leverage, if you're leveraged 30 to 1 meaning you only have one dollar of equity for every $30 of debt, just think what happens when the assets you own on the balance sheet start dropping in value. 

And the financial crisis started with the mortgage lenders.  That was what we saw last February with the mortgage lenders who had been careless in a lot of the lending practices.  I mean what was going on in the real estate market and lending market was just goofy.  Then it moved from the mortgage lenders to the commercial banks, and then it moved from the commercial banks on to the insurance companies, i.e., AIG last week.  Then thereafter it moved to the investment banks which then turned around and squeezed their clients, blaming the hedge funds and the private equity funds.  So this has all been sort of a domino effect.

And it didn't stop there.  Imagine if you are the portfolio manager of a pension fund or an endownment fund and you're seeing this stuff go on.  So it's just been one thing after another.  Remember when it first started in February of last year, it was called contained.  Well, it hasn't been contained.  It's become a contagion.  And it gets down to two very simple things.  The asset bubble was in the real estate market, and associated with the real estate market was leverage, whether those mortgages were sliced and diced, put into CDOs, SIVs, auction rate securities, no matter what you call them, but they were leveraged.  And that's what happened as you had leverage upon leverage these asset markets expanded, these investment banks, these money center banks, these hedge funds, everybody kept adding leverage, because that was the way of making a lot of money.  Now what you're seeing is that leverage unwind and then the underlying asset that backs the leverage, real estate, is collapsing in value. 

And it was amazing because you and I were talking earlier in the week, and we were going to do a segment called “get ready for bailouts” and I was referring to the various Congressional programs that we have in Congress right now to bail out homeowners, to bail out the lenders, to bail out the states.  John, every congressman, senator from each party, including presidential hopefuls are coming up with bail out programs and that's the next step in the process.  [5:32]

JOHN:  What people need to understand about this is when we say bail out, we're bailing out the banks and organizations that got into trouble, but the American public is paying for this.  That's not really being pointed out on the Street. 

JIM:  No.  In the end and including these tax rebates that we're going to be sending out to people beginning in May, we don't have the money to pay for that.  We're going to have to borrow the money to send out those rebates, which means the government's deficit is going to get bigger this year.  It's going to be over 400 billion, and likely to get even bigger next year because we're not done with the bail out packages and we're not done with the stimulus packages.  They are still working on various measures of bail out programs as one senator or a congressman after another comes out with their own version and there is a cry from Wall Street and from Washington that we're not doing enough to bail out people.  And this gets back to the idea of “we don't want to go through any tough times.”  In other words, we just went on a drinking binge – or call it a credit binge.  Now that credit binge is starting to unwind, and we don't want to go through the pain.  [6:41]

JOHN:  But we are guaranteeing that really, in short order, the pain will be much worse when we come out of it.  It's sort of like:  “Well, okay.  You had a hang over.  I can put you on this pain killer.  The downside of it is when you come off the pain killer, the pain will be worse from the pain killer, rather than from the other side.”  That's what you're looking at. 

JIM:  Sure.  That's why I get back to my hyperinflationary depression theory because you do get boom-and-bust cycles.  You do have booms.  You have recessions, but it takes a politician or political policy to turn a recession into a depression.  And it's really through government interference in the marketplace that everything just becomes lopsided whether they put in capital controls, price controls, bail outs, punitive tax rates, restrictions, regulations.  And I mean, you just pick up the headlines and especially the kind of information we're getting –we get a lot of stuff from sort of the inside about what's going on in Congress because we keep track of legislation, and that was one of the pieces that we were going to do until this thing hit on Friday.  I mean you've got former US Treasury Secretary Robert Rubin who said the financial markets are in uncharted territory and the government may need to take substantial additional action to help homeowners.  We are in uncharted waters said Rubin, the chairman of Citigroup.  Citigroup is under water right now.  [8:13]

JOHN:  Well, we probably need to dissect this piece by piece and the most obvious one would be to look at the Bear Stearns debacle, which really started to unfold and go into tragic levels really on Friday.  It sort of caught everyone by surprise.

JIM:  Well, there were rumors floating around on the Street earlier in the week that Bear Stearns was in a credit crisis, and they were denied.  But then there were emergency meetings on Thursday night.  Essentially what happened is the Federal Reserve is taking on the credit risk from collateral that would be supplied by Bear Stearns, which, by the way, Bear Stearns approached the central bank for emergency funds.  The Fed, since Bear Stearns is not a primary government bond dealer, they will be lent money through JP Morgan Chase and JP Morgan Chase will use the Fed's discount window to accomplish this direct loan to Bear Stearns.

And the Fed said earlier in the morning that its board of governors unanimously approved the arrangement with JP Morgan and Bear Stearns.  And the Fed typically delegates discount window lending authority to its regional reserve banks when it come to loans to banks.  However, the Fed invoked a little used law that allows it to loan to corporations and private partnerships, John, and this little law goes back to the Great Depression. 

The staffers at the Fed have declined to describe how large this loan is going to be and they decline to say whether a private sector bail out was attempted.  But word on the street is “Bear Stearns is toast.”  They will probably be merged with somebody else.  In fact, option traders have already increased the bets that Bear Stearns survival is in doubt, and that's the way credit default swaps have skyrocketed on Bear Stearns debt.  So that's the bet there. 

And it doesn't stop there.  Two other companies listed Friday on the watch list because of exposure to leveraged lending are Lehman Brothers and Merrill Lynch.  You had Lehman get a two billion dollar injection from 40 lenders on Friday.  So you know, we talked earlier when we described the Oreo theory at the beginning of the year, before this would take place, remember the bad stuff was going to occur in the first quarter; and this is a lot of the bad stuff coming out.  It's almost to the point of capitulation.  We're probably going to see another securities firm go under and I would not be surprised to see one of the major banks get into financial trouble.  I mean Citigroup is in a precarious position.  A lot of these banks because of the amount of either SIVs, bad debts, so it's almost like an equivalent to a run on the bank.  [10:56]

JOHN:  It has the same sound and feel because that's what CEO of Bear Stearns, Alan Schwartz was saying on their conference call today, and that was the demand for liquidity from investors just kept going up. People wanted their money out and that's what it was.  And it has all of the marks of a run. 

JIM:  And in fact, John, let's go to that press clip on Friday with the head of Bear Stearns.

Our liquidity situation deteriorated.  We started the week and through the early part of the week we continued to have very strong liquidity, but the concerns on the part of counterparties and on the part of our customers and lenders got to the point where a lot of people wanted to get cash out.  We were responsibly trying to deal with those needs and we were meeting those needs in every case, but they accelerated yesterday, especially late in the day.  And as we got through the day, we recognized that at the pace things were going, there could be continued liquidity demands that would outstrip our liquidity resources.  [12:02]

Basically what he was saying there is it's very similar to when people sense that people are in trouble, especially counterparty risks, it's the old run on the bank.  They might have been okay at the beginning of the week, but when people start yanking their money or pulling out of things, then all of a sudden, you find out your cash is gone.  In fact, they said on Friday that its cash position had significantly deteriorated in the past 24 hours.  And so in order to prevent a collapse of the second biggest underwriter of US mortgage bonds and forestall a potential market panic as losses by banks and brokers reached almost 200 billion, basically this is why the Fed had to step in.  They couldn't afford to let Bear go. 

Traders on the street have been reluctant to engage in any long term transactions with Bear because you're thinking, “wait a minute, my transaction, they maybe going under.”  And that's essentially what happened.  Just the company's forth quarter loss was 854 million, which was its first loss.  As you compare some of these write downs, 22.4 billion in losses reported at Citigroup, so some of these firms, JP Morgan and Goldman Sachs are probably in better shape. 

And remember this crisis.  Remember the Two Johns did a little bit of a spoof on this, but the failure of the two Bear Stearns hedge funds which began the liquidation of assets, so here we are.  [13:33]

JOHN:  So is this a terminal case for Bear Stearns?  Are they going to survive this?  Do you think we're going to come around on this - always keeping in mind your creamy center for the rest of the year?

JIM:  I think what you will see, they will be forced into a marriage.  In other words, they will merge them with somebody else who is a little bit stronger because if you take a look at their old business model, John, it's broken.  They just, I don't think, have the wherewithal right now or the ability to go it alone.  And don't be surprised if it goes beyond Bear Stearns.  In other words, if you see the merger of other entities just as, for example, Bank of America taking over Countrywide.  So there is more of this to come.  You almost have to get a little bit more of this, and you're going to get almost the capitulation phase here.  What I call the puke phase, because right now, we have gone from where we were in the fourth quarter of last year to “happy days are here again,” to “oh, my God, there is blood in the streets, I'm jumping out the window. [14:32]

JOHN:  Well, basically now, it's sort of a fait accompli that we are in a recession.  We can't avoid that one anymore.  We can't play any games on it.  I don't think even the mainline talkies are trying to do that at this stage of the game.  But what they are trying to do right now, it's really clear, like you say, there is not a tree in the forest that's going to be safe now because they are going to cut down everything to print – actually, it's not trees from the forest, it's cotton.  That's what our currency is made out of.  But anyway, they will cut down everything to print paper and currency on as much as they can to try to keep this thing afloat.  I mean this is an election year too, Jim.  It couldn't happen at a worse time.

JIM:  Oh, yeah.  Because you have the entire House of Representatives, a third of the Senate and then the White House up for grabs.  It's interesting that the White House says, “well, it’s slowing down and things are getting rough, but we're not there and none of the stimulus packages have kicked in,” and the President is right on that.  But, you know, on Friday, you had Harvard University economist Martin Feldstein who is a member of the group that dates business cycles in the US, he said the nation has now entered a recession that could be the worst since World War Two.  And I'm quoting Feldstein here:  I believe the US economy is now in a recession.  And he told the futures industry in a speech he made and he said:  “Could this become the worse recession we have seen in the post-war period.  I think the answer is yes.  I would emphasize the word, however, could.” 

So that's why they are scrambling here for bail out packages.  And what they are working on now, we've seen stimulus one, which was remarkable that they passed it in 30 days from the day of conception and they first talked about it.  John, when have you ever seen the White House and both parties in Congress work on a package and get it passed in 30 days?  [16:18]

JOHN:  Yeah.  Basically when reality sets in, politicians panic, so that's what we're doing right now.  So everybody is anxious to do this type of thing, but this is only going to be a partial fix.  I mean there is more stuff in the pipeline.  This is not a one shot.

JIM:  Oh, no.  They are talking about one proposal would bail out homes that have already gone into foreclosure, so basically this is a bail out for the lenders.  There is another proposal to allow judges to adjust a person's mortgage and interest rate which would absolutely freeze up the mortgage market and drive rates sky high if you did that because no lender in their right mind would make a loan because you would never know what the terms of the loan would be.  There are two or three proposals that I've seen to come up with a fund that would basically buy these bad mortgages.  You have proposals that would allow people to stay in their house to, in other words, bail out these mortgages or even turn Fannie and Freddie and have Fannie and Freddie which are under-capitalized to begin with to start buying out a lot of these loans that have basically gone worthless.

But there is one thing that I want to point out here.  The market and the sentiment is far worse than it is.  And what is happening, and you know public psychology is things are beginning to snowball, so that's why they are going to have to come in here and start taking dramatic action.  Otherwise, this whole thing takes on a life of its own.  It's like a snowball that as it gets rolling downhill, it gets bigger and bigger and starts moving more rapidly and that's what they have right now. 

They have a major brush fire that keeps jumping.  You know, they put one fire out and they think they've got it contained and then they look around their shoulder and there's another fire that is going up.  So that's part of what we anticipated in this first quarter.  And it's almost to the point of capitulation right now.  And remember, the Fed has been lagging and has been behind the curve.  Remember last year when they first started cutting rates, they were basically saying:  “Well, maybe we shouldn't have done it.  Things are okay.”  And you remember, John, last February when we had the mortgage lenders get in trouble, they said it was contained, “that was it, one month problem.”  Well, guess what?  It resurfaced in August of last year and that's what you expect to see periodically. 

And remember, we are now in the first quarter reporting season.  In other words, first quarter earnings are going to end here March 31st, so, John, in the next two weeks, any financial institution that's going to be airing its dirty laundry is going to want to get out front.  So I suspect you're going to see from either major brokerage firms such as Merrill, Lehman, banks such as Citigroup –in other words, all of the usual suspects that we've seen in the last quarter – are going to be going out and announcing losses for the first quarter.  And what I suspect right now is they are now lining up credit infusions or either equity infusions into their firm before they announce the losses.  [19:24]

JOHN:  It is amazing the rapidity with which this all happened and the euphoria that we transitioned from a year ago.

JIM:  And part of this is the nature of interconnected markets today.  The markets have become globalized.  They are interconnected.  Everybody is watching the same material.  What has happened is now you've got fear into the markets, which explains the low Treasury yields.  And the other thing that you have is people are just selling; and selling begets selling and the more selling that come in, the lower the prices are.  So a lot of these mortgages are being underpriced because it's like everything goes to extremes.  Just as they were bidding up mortgages and bidding up the price of real estate when everything was giddy, well, that's when greed was coming in.  Throw the opposite human emotion of fear, which is what you have now and you're getting the opposite action with that fear which is selling.  It's like:  Sell first, ask questions later. 

And so that's why you're seeing large vulture funds that are amassing large amounts of capital, and let's put it this way, one of the shrewdest investors around, Warren Buffett is thinking of foraging, if he hasn't already, into the junk bond market because a lot of these bonds and mortgages have been grossly underpriced as a result of, you know, when everybody sells at once, you don't have any buyers.  Sellers overwhelm the market, and you have these huge steep waterfall declines and values get distorted.  So you know, when you've got the smartest guy in the world, and the richest guy in the world getting ready to go in the market, but that's typical Buffett.  You buy when there is blood in the streets.  [21:06]  

PRESIDENT BUSH:  Now, root cause of the economic slow down has been the downturn of the housing market.  And I want to talk a little bit about that today.  After years of steady increases, home values in some parts of the country have declined.  At the same time many homeowners with adjustable rate mortgages have seen their monthly payments increase faster than their ability to pay.  As a result, a growing number of people are facing the prospect of foreclosure.  Foreclosure places a terrible burden on our families.  Foreclosure disrupts communities.  The question is what do you do about it in a way that allows the market to work and at the same time helps people?  Before I get to that, though, I do want to tell you that we fully understand that the mounting concern over housing has taken a broader market that has spread up certainly to global financial markets and it has tightened the credit which make it's harder for people to get mortgages in the first place.  The temptation is for people in their attempt to limit the number of foreclosures is to put bad law in place.  [21:59]

JOHN:  So we're now looking at a declining real estate market.  That thing has come nowhere near the bottom at this stage of the game.  This has affected the leverage that's present on Wall Street.  And the next step down on this whole thing? We're not done yet.

JIM:  No.  And like I said, we're getting into the first quarter earnings season, so I'd watch the markets in the next two weeks because if Bear Stearns has got a run on the bank, they are not the only ones out there.  Watch the major Wall Street brokerage firms and also watch some of the major money center banks.  I mean these guys were announcing losses in the forth quarter, and they did that before the quarter was over.  And that typically is what happens in an earnings season, if you're going to miss your earnings, you're going to have some bad news, you want to get that news out before the quarter closes.  The analyst community will take your earnings down, they'll slash it, they'll downgrade you etc; and then what happens is maybe the losses aren't as bad as expected and then you announce the news after quarter closes and you beat expectations. 

But in this case, what we've seen in the fourth quarter as this thing has progressed is the losses they initially announced before the quarter closed when they announced their actual earnings, they were actually worse than anticipated.  So you're also going to see in addition to first quarter earnings announcements, you're also going to get year-end financial statements as companies have to divulge all of this in their annual financial reports which are also going to be coming out here.  [23:33]

JOHN:  So if we go back to your Oreo theory which in case people are listening for the first time, we said the first quarter of the year would be rough.  It's like an Oreo cookie, a hard crunchy outer shell, creamy center for the middle two quarters and another crunchy shell on the back side.  So here we are.  We're still on the first quarter.  This is March.  You said it was going to get rougher.  It did get rougher, and I think at some point it will smooth out though.  They are going to pronounce it one more time rescued, and that may hold until the – that's the big thing to hold through to the elections, I think.

JIM:  If you take a look at where we've gone with this, in December, the Fed announced its Term Auction Facility.  The beginning of this weak it announced basically swapping with the lending banks their mortgage debt for Treasuries with the Fed.  I think the next step is the Fed just starts buying this stuff.  These are some of the proposals that are coming out there, so basically they are going to say “look, this is bad stuff, that's the next step.”  So this thing is progressing in a logical manner from one step to progressively more intervention, more bailouts and look for more bailouts to come.  We're not done with this yet.  And it's only after they've put enough money where the government starts bailing out all of these things that we're going to get from a market of fear to, okay, we'll get this brief euphoria that we may have starting probably sometime in the second quarter going into the third quarter.  But unlike before, what is going to accompany this is the hard outer shell dark period that we see coming in the fourth quarter as interest rates begin to rise with inflation rates.  We could be looking at oil prices well over $125 a barrel.  And we could be looking at who knows where gold prices are going to be.  I mean we're already over 1000 and oil is already 110, so we're only $15 away from our target of $125 dollar oil.  And remember, the other thing is with crack spreads being as thin as they are right now for a lot of these refiners, we as consumers haven't really felt the full effects yet of these higher oil prices.  That's yet to come.  [25:45]

JOHN:  So when it smoothes out, what will it look like? 

JIM:  When it smoothes out, you could get a large rally coming in, you'll have the economy get a bump from the helicopter drops that are coming out in the form of checks starting in May the second week.  By then, you'll see the federal funds rate below 2%.  Who knows where it's going to be where it will stop, will it be 1 ¾, 1 ½?  The futures market already has it below 2% right now.  And eventually, you'll get some stability here and then people say happy days are here.  But all of this tree chopping or money printing or bailouts comes at a cost; and that cost is going to be higher rates of inflation.  And we're certainly seeing that as the commodity complex has now taken the place of the bond market as being the vigilante, and that is certainly what we're seeing.  

And then you add supply deficits and growing demand for commodity complexes, add into that a monetary mix, and John, it's no wonder we're looking at crude prices up 14% this year.  We're looking at coal prices up 17%.  We're looking at natural gas prices up 36%, gold prices are up 20%.  Silver prices are up 39%.  Platinum prices are up 48%.  Palladium is up 57.  Aluminum up 29.  Copper up 27.  Lead up 22.  Nickel up 24.  You go to the corn complex, corn prices are up 24%.  That means higher food costs.  Ethanol is up 12%.  If you are looking at soy beans, they are up 15%.  Sugar up 17%.  Cotton up 18%.  And look at the dollar.  It's hitting a record low.  [27:33]

JOHN:  So would we expect like if we get into that period the soft part, will we pull back in things like the metals, do you think the panic driving that up with will cause a pull back? 

JIM:  Yeah.  You'll get a bit of a pull back and then you'll get a sector rotation.  When we get to that creamy filling you'll have people doing a switch.  They'll be going into the financials because they've been beaten up, you'll see them going into the builders and you'll see a whole rotation in the market.  But don't be surprised with all of this as the market rises along with it, you're going to see a take off in the gold stocks because I think it's beginning to dawn on people, especially with gold over 1000 and silver over $20, that we've got inflation in the wings here.  You can't be bailing out all of these financial institutions and bailing out all of these homeowners, and John, there is not a consequence to this.  I mean people don't really understand the root causes of inflation.  [28:21]

JOHN:  The average public person does not understand that.  They will not see this one coming either.  It's going to take some time to be felt in the system too.  There is a lag effect here.

JIM:  Yeah.  There is a lag effect just as when the Fed started raising interest rates in the summer of 2004.  The real estate market peaked out at the end of 2005, and the crisis in financials, John, we didn't see until 2007, so there is a lag effect between when they raise.  There is also a lag effect on the other side of it as when they lower.  And you pump enough money in the system, you're eventually going to get the after-shock effect, but they are going to come in the form of delay. 

Right now, you cannot have raw input prices as we're seeing all across the board now with commodities and we're going to be doing a whole topic on commodities in the weeks ahead.  We did one, I think it was about a month ago we did, but we're at critical levels here for food.  And I think we're going to see some things –and we're going to cover this in another topic today – where if anything goes wrong on the weather front to disrupt agriculture, we will see famine.  And I think in the next couple of years we're going to see protein shortages globally.  You just cannot take one of the largest producers of wheat, corn in the world, the United States, and also Brazil and if you devote a good portion of your crop to producing ethanol and people don't think there is going to be some after effects?  We're going to cover that with three related problems in the second hour.  [30:01]

PRESIDENT BUSH:  The temptation in Washington is to say that anything short of a massive government intervention in the housing market amounts to inaction.  I strongly disagree with that sentiment.  I believe there ought to be action, but I'm deeply concerned about law and regulation that will make it harder for the markets to recover.  And when they recover, make it harder for this economy to be robust, so we have to be careful and mindful that any time the government intervenes in the market, it must do so with clear purpose and great care.  Government actions have far reaching and unintended consequences.

JOHN:  And you're listening to the Financial Sense Newshour at www.financialsense.com. 

 FSN Follies:  Andy Looney

Hi.  I'm Andy Looney.  Did you ever notice how some people get into a rut?  My wife Sandy always falls into a rut about what to have for dinner.  Let's face is it.  You can only eat meat loaf and macaroni so often before you finally demand that we go out for Chinese food.  Hmm.  Maybe that's what she had planned all along.  What do you think?  I do.  Don't you?  Anyway, I notice the guys on the financial channels are in a rut as well.  Three or four years ago they said gold at 400 was a risky investment and to buy those collapsing financial stocks instead.  Then when gold went to 600, they asked “when did anyone ever make money investing in gold.”  I never did understand their logic on that.  Don't you think 50% profit is good enough?  I do. 

Now, when gold passed 800, they said it had topped out and golly gee willickers wouldn't stay there for long before sliding back to disaster.  Now that gold is nearing 1000, they are still telling gold is a risky investment.  “She's going to blow!”  I think with stocks sliding down and inflation zipping up, maybe investing in stocks might be a risky investment.  Don't you?  They don't.  I do.  Oh, well, I guess I'm just too stupid to figure out this whole thing.  After all, the guys in the financial talkies went to Harvard, so they must know what they are talking about.  Don't they? 

Anyway, Sandy and I are going out for Chinese food tonight to celebrate new highs in our gold investments.  I'd use any excuse to avoid another night of meat loaf.  Now that's a risky indigestion.  For Financial Sense, I'm Andy Looney.  [32:37] 

 Gold's Fundamentals: Even Better Days Ahead

JOHN:  If you watched the financial channels this week, the anchors seemed absolutely bewildered as oil prices approached about $110 a barrel and gold prices crossed over 1000.  It was almost as if they didn't believe what they were seeing.  So that's what we need to really lay out here.  They saw what was happening, but you could tell there was no comprehension of why it was happening.

JIM:  You know, I am not really surprised that they were bewildered because that is how it usually plays out in the early stages of a bull market.  I mean if you take a look at how commodities have been in a bull market run for the last eight years and the concept of a bull market still hasn't caught on.  John, how many times have we talked on this program when oil went from 20 to 30 and 40 to 50 to 60, they always told you why it was going to go lower.  And in fact, right around this time last year, after they were predicting oil was going to go down to $40 a barrel, we began that run that took us almost to $100 a barrel by the end of the year.  The situation that we have today is we're in a different economic environment than we've been in terms of where we were eight years ago.  There is a global power shift that's taking place right now and most people, I think, haven't recognized this change because we keep talking about the center of the universe reverting around what happens in the United States.  We are only part of the picture today. 

But if you look at what's been going on from, let's say, historical perspective, I mean China and India were major economies for almost 2000 years.  And what you're seeing today is China and India are reasserting themselves.  They were dominant economic powers until roughly about the 1800s when the Industrial Revolution began in Great Britain.  China and India missed out on the Industrial Revolution over the last two centuries.  Now, they are industrializing and they are playing catch up and eventually they will surpass the West.  But from a historical perspective, given several millennium, things are reasserting more back to the mean.  They are creating wealth while the West is consuming wealth.  They are ascending while we're descending.  [35:12]

JOHN:  So where does the gold factor go into all of this?  I mean the price has gone up four-fold since we began doing the show together, so what is supporting the rise right now? 

JIM:  The first thing you need to understand is that the world's entire financial system is based on fiat currencies.  There is nothing backing paper money today.  The vast gold reserves that once backed national currencies have fallen dramatically.  In fact, since 2005  –now, this is really key – since 2005, individual ownership of gold has surpassed the holdings of central banks and that gulf is widening.  The difference is just incredible in terms of the ownership of gold in terms of almost a wealth transfer from central bank to individuals.  And the reason people around the globe are buying gold in record amounts is that the value of all currencies are depreciating.  People talk about the dollar depreciating.  Well, guess what?  All currencies are depreciating against gold.  Gold in essence by default is once again moving into its 5000 year role as money. 

In a fiat world, which is what we have today, there are no checks and balances against government largesse.  Governments can spend and run infinite deficits.  Ever since 1971, John, when we reneged on the backing of the dollar with gold, the US has run continuous deficits and they've gotten larger.  Just listen to this year's presidential race where some of the candidates are promising voters trillions – and I'm talking about trillions of dollars of new spending programs.  We don't even have the money to pay for the programs we have in place, not even talking about what they are proposing to spend.  So budget deficits are going to get bigger, taxes are going to go up and inflation is going to rise and squeeze the vast majority of citizens who don't protect themselves.  There is nothing new here.  John, I know you've read history.  I don't care if it was the Roman empire, the Spanish empire, this is what governments have done throughout all of history.  They always promise more than what they can pay for, and the result is they debase their currency.  And just look at what is happening with the US dollar hitting a new low on the day you and I are speaking.  [37:31]

JOHN:  You always wonder why there isn't some kind of wise ruler somewhere that comes up and says, “Ah ha, I see what we're doing, it's been done before.  We don't want to go down that trail.”  It seems to be an irresistible trail. 

We often talk about here on the program, by the way, about the global money supply, growth rates both here and domestically and elsewhere in the world which is why gold is rising against all currencies in the world, so beside debasement of the currency, what other fundamentals support gold? 

JIM:  There are a number of reasons that are supporting gold's rise.  People all over the world are buying gold for different reasons.  Some are buying gold to protect against a falling dollar or the depreciation of their own currency, because remember it's not just the dollar that's falling against gold.  And that's the key point here.  This is a global event.  Gold is rising against all currencies.  Other people are buying gold as a portfolio diversifier.  Other people are buying it as a protection against falling in a volatile stock market, or they are buying it because there is low yields on interest bearing bonds and notes.  Real interest rates are negative now, meaning the headline interest rate that you get on a government bond is below the headline inflation numbers.  And still you even have others that are buying gold as a safe haven against political turmoil and yet you have others that are buying it as an inflation hedge.  Whatever the reason, depending on who you are, where you're living, what your circumstances are, whatever reason, gold has gone up for eight consecutive years.  It's being accumulated in massive amounts, and this is something we have not seen before.  [39:13]

JOHN:  I think this massive accumulation is really due to the fact that all currencies are fiat now, they are all depreciating against gold.  When people realize that their buying power is eroding away due to debasement of the currency, they go to something that they perceive as being the ultimate currency and for some reason that's always been gold.

JIM:  Yeah.  And this concept is probably better understood overseas where they've seen political turmoil.  They've seen hyperinflations in the past.  But we're going to be covering this topic now because it’s going to obviously garner more media attention now that gold has crossed the thousand mark.  In fact, next week we're going to have Jeff Christian on the show to talk about his 2008 Gold Book which is must reading for the intelligent investor that wants to know why prices are heading higher.  And this is taken from Jeff's book.  Last year, John, around the globe, individuals bought 43.7 million ounces of gold.  That was up 11.7% from the year before.  And here is the key point.  Half of that demand came from just India alone, but demand was also strong in Asia.  It was especially strong in the Middle East where all of the wealth is being accumulated.  So if you take a look at where the wealth is emerging in the world, it's emerging in Russia because of its oil and natural resource revenue.  It's emerging in Asia, it's emerging in the Middle East because of oil.  And guess what?  They are buying gold.  Put another way, since you and I have been doing this show, John, investors globally have bought 279,200,000 ounces of gold since 2001.  The buying is coming from more parts of the world and has more continuous buying for longer than any other bull market in gold's history. 

Now, the bright spot is that it really hasn't caught on here in the West in a way that it has let's say in Asia or the Middle East or even Latin America.  They, I think, have a better understanding about what real money is than we do.  That’s because remember, the United States was the dominant economic power.  We had low rates of inflation.  We had political stability.  The dollar was backed by gold through much of the last century, and so we haven't experienced the hyperinflations, the political conflicts that comes with those hyperinflation as other countries have –whether it's Turkey, Argentina, Latin America in the 80s, the Soviet Union, China and these countries that have gone through this turmoil.  So they have a better understanding and know that gold represents more money.  [41:53]

JOHN:  Don't higher prices mean more selling is going to come into the marketplace as the prices of metals go higher? 

JIM:  Well, absolutely.  It's the only way we're balancing out our supply deficits.  Mine production has declined seven out of the last eight years and it has been decades since mine production has been able to keep up with demand.  The difference between what the mines produce each year and what is demanded by the marketplace is made up by scrap supply and official selling.  Most all gold mine over the century still exists.  I mean it's not consumed in the same way that silver is, so the difference between what mines supply and what is demanded is made up from existing gold sales.  And I'm sure as prices go higher there will be people that will sell off or maybe they'll trade in coins or whatever it is; but sure, part of the reason this deficit is being handled is from the sale of scrap gold.  [42:55]

JOHN:  And it seems like over the last few years the rise has been absolutely explosive.  You know it's interesting.  It still hasn't caught on yet with the investment public.

JIM:  The thing that is just absolutely amazing and I think this has even amazed a lot of people that follow the gold market is the rise that you're talking about that that we've seen in this decade is unprecedented in the history of free gold trading prices.  There had been five gold bull markets.  Most of them lasted between one and two years and they were followed by four or five years of weak gold prices.  I mean 2008, the last gold bull market was in 1993 and none of these past bull markets came close to what we've seen in this decade.  What we are truly witnessing today and what we will see unfold is probably going to be the greatest bull market in the history of the world.  Similar to what we saw –if I was to use probably even an analogy that I don't even think is going to come close to what's going to happen – in technology in the nineties, but even greater than that this time, gold above 800 is more sustainable.  I mean, John, pick up the papers.  Look at the day you and I are talking on Friday, the bail out of Bear Sterns.  There is a plethora of economic financial and political problems.  Greenspan wrote his book and it was called The Age of Turbulence.  In my opinion, the age of turbulence has just begun.  [44:23]

JOHN:  Why do you believe this is going to be the mother of all bull markets for gold?  Maybe the mother of all historic markets too.

JIM:  You know, I think, to put this into perspective, I think this market is still young.  It hasn't caught on with institutions and investors.  I've seen these guys.  I've seen institution holdings.  The hedge funds are in the sector, but they mainly trade it.  The other factor is that the gold market is so small.  I mean it is infinitesimal compared to the larger paper wealth that exists today around the globe, and this is the largest paper wealth that we've seen in any other time in history.  And if we look at the world's liquid wealth – and I want to point that out, liquid wealth, and this doesn't include the nominal value of derivatives – you've got 45% of the world's liquid wealth is held in the equity markets.  You have about 15% of the world's wealth is held in bond markets.  And roughly about another 39% of the world's wealth is held in bank deposits.  Only 1.4% of the world's liquid wealth is held in gold.  So think of this.  Just imagine what happens if money goes into gold, doubles or triples to let's say 5% of the world's liquid wealth.  This market would explode three to ten fold from where it is today. 

I'm going to let you in on another secret, and this is something I think most people don’t understand.  Gold investors –and I'm talking about investors, not traders – gold investors don't sell.  In the last half century, we have only seen three times that gold investors were net sellers on an annual basis and even when there were some net sellers, they didn't sell by much.  So when this money moves out of this liquid wealth, let's say money comes out of the stock market, the bond market or the cash market and goes into the gold sector, it's going to be at much, much higher prices.  I mean people have no idea how small this market is.  I mean you can take a look at, for example, the HUI index (which is the 15 largest unhedged gold producers) and the market cap on all of these markets is only about 174 billion.  I'm just going to call up here and let's take a look at Coca Cola's market cap.  Coca Cola has a market cap of 134 billion.  You take a look at, let's go to something like Microsoft, which has a market cap of 260 billion, and that's just one company. And so you can see how small this market is in relation to these other paper markets around the globe.  [47:15]

JOHN:  All right.  We know gold is money, but it is also a commodity because it's used in manufacturing especially electronics as a matter of fact, fabrication, people also obviously get it for jewelry, so what is the big driver here?

JIM:  Unquestionably right now and also over the last five or six years, the number one driver is investment demand.  There has never been, and I keep saying this, there has never been anything like this before in history.  And it still isn't on the radar screen of most investors, so you ain't seen anything yet. [47:48]

JOHN:  So if it's investor demand doing it, then what's driving investment demand.

JIM:  As I mentioned earlier, there are a number of factors that are driving investment demand.  It depends on where a person's mind set is, what their circumstances are, but there are six drivers that are driving investment demand.  One is an alternative asset.  There have been a number of studies by college professors showing commodities as an opposite correlation to financial markets, so that has gained a lot of recognition here in the last 10 years.  So alternative asset is number one. 

2)  It's being used as a currency hedge, the dollar is falling in value against gold.  The euro is falling in value against gold.  The Swiss franc has fallen in value against gold, the Canadian dollar, the Australian dollar, the Chinese currency, all currencies are falling against gold.  So a second factor is currency hedge. 

3)  A third, as we've seen, I mean the inflation rate is 7 ½% in China right now, so people are using gold as an inflation hedge is a third factor. 

4)  Fourth, depending on political instability or financial instability, it's being used as a safe haven. 

5)  It's being used as a commodity as an input to manufacturing, fabrication of jewelry;

6) and six, if you go to the Middle East or you go to Asia, we in the West think of savings, we think, oh, we'll put our money in the bank; when you're in the Middle East and you think of Asia, when you think of savings, you think of putting your money in gold,.  So it's used as a savings factor for much of the people in the world. 

And here is the part that's just absolutely amazing is right now all six of these factors are flashing a green light and I think are going to remain green for quite some time to come.  Once again, pick up a daily paper, turn on the evening news and just take a look at the stories that support all six of these factors including the bail out of Bear Stearns on Friday.

JOHN:  Yeah.  The Street still hasn't picked up on the gold aspect of it.  Something that really amazes me about that is in the 1970s, it almost seems like deja vu all over again.  1970s and also 1929.  President Nixon then in 1970s had implemented wage and price controls.  That's when inflation rates rose to 4%.  Last year the headline inflation rate was 4.3% and we all know that that number is vastly understated.  It's somewhere between 9 and 11 or possibly a little higher and here we talk about inflation expectations are well anchored.  People really don't understand what causes inflation.  If you don't believe me, go out and just ask people when you meet them out in restaurants or everywhere else, see if they know.  They only know it by its symptoms which then allows politician to off load the cause of the inflation onto something other than government policy or Fed policy, which is what causes it.  So a fiat currency is inflationary.  Politicians promising trillions.  New spending programs are inflationary.  If they can't get it from taxes, they have to get it from inflating the money supply.  The Fed pumping hundreds of billions into the banking system and lowering interest rates is inflationary.  Government bailouts are inflationary.  Yet all we here from Wall Street to Main Street is give us more inflation.  And that goes back to Ron Paul.  Remember, in the hearings a couple of weeks ago, he said, “you're complaining about the effects of inflation and you're solving it by having more inflation.”  And what does Uncle Ben do other than sit there with that look on his face, you know, beard scratching.

JIM:  Yeah.  “I don't understand what you're talking about.” 

The problem that we have is we're a debtor society and there is only two ways that you get rid of debt.  You allow it to default, and we've seen a lot of that, but what do they do?  They are bailing out a lot of these defaults.  So because we're a debtor society, debt evaporates as it is inflated away.  And we are now putting into place programs and policies that are designed to do just that, to inflate, which is one way of liquidating your debts.  [51:56]

JOHN:  Well, it is.  Why don't you think people understand that?  That's why people say should I get out of all of my debt right now.  I say well, if you can keep making your mortgage payment, your household domestic product so to speak, the amount of money you have to bring in to keep up with this is going to have to be more and more and more.  You're going to have to see to it or you just won't survive, and if you can do that, then you are going to be paying off your debts with increasingly inflated dollars.  So in fact, it actually works in your favor against the banking system here.

JIM:  Yeah.  And especially if you've gotten or locked in a fixed rate mortgage because I do believe by the end of the year, you're going to see inflation rates up, and you will start to see interest rates given to rise and they'll be doing that over the next couple of years.  But you're right. 

JOHN:  Countrywide always keeps calling me.  They want me to refi.  And they don't understand why I turn it down.  Yes, but you can lower your monthly payments.  “Yeah, right.”  That's my response to them.

JIM:  Yeah.  With a variable rate mortgage.  Yeah.  Good luck with that. 

JOHN:  Yeah.  The last time they did that I burst out laughing on the phone.  So anyway. 

We talked about asking people at the gas pumps or the stores, restaurants are good places, banks are good places, I like to talk to bank tellers to see what they know.  Why don't people understand what inflation is?  It's a pretty simple principle.

JIM:  I would probably say government schools.  If you have been educated in a government school, government schools teach Keynesian economics.  Even private schools teach the same.  I mean you're taught Keynesian economics at Harvard, Stanford and Princeton.  That is why you hear politicians propose Keynesian solutions to problems created by Keynesian policies.  What was Richard Nixon's comments?  I think he said: We're all Keynesians now.  That is also why when banks or brokerage firms get themselves in trouble, they call for Keynesian bailouts.  It's also why gold has risen from 250 to $1000 and why it's going to go to 3 to 5000, maybe even higher if we continue on this path.  It is only when people realize the root cause of inflation and experience enough pain that they are ready for real economic change.  If you look at the 16 years of pain that we had probably in this country from the late 60s all of the way until about 1980, the country was not ready for Reagan.  Ron Paul, for example, the country is not ready for a Ron Paul.  Ron Paul is ahead of his time.  Once again, people haven't experienced enough pain yet.  Right now, the public is calling for more opium from  the politicians, and John, that's exactly what the politicians are going to give them.  [54:43]

JOHN:  Yeah.  With the people not understanding they are still paying for the opium.  That's what it is.  So in summary, the fundamentals are all an argument for higher gold prices.  It has gone up seven consecutive years now, well, make that eight years if we include this year.  And you think it's just getting warmed up? 

JIM:  I live in a neighborhood where they call our cul-de-sac area the financial district because the guy next to me is a well known hedge fund manager, you've got the guy above me is a syndicated national financial talk show host, down the street there is a guy that runs a mutual fund and they are all financial guys.  And if you were to mention gold to these guys, John, they would look at you like you're cross-eyed.  Now, I can talk about oil.  Everybody understands oil because they see that when they pull in their sport cars into the gas station and we're almost near $4 here in Southern California.  So everybody understands oil, but when you mention gold, they look at you – you're almost, like, oh, you're one of those people.  It’s like there is a stigma.  They don't understand it. 

And remember when we had the roundtable, the gold roundtable a while back, Leanne Baker, who used to be a managing director at Salomon Brothers, mentioned what is it that Wall Street doesn't get, and she clarified that and said they don't know how to value it.  They don't know how to think about it, and they still don't get it.  And that's why I think we're just getting warmed up.  I mean most of last year's buying of gold, half of it occurred in India.  So John, imagine what happens when it catches on here.  I mean you have people here buying, but John, it's far from becoming mainstream.  So I just think we're just getting warmed up.  [56:26]

JOHN:  We had that gentleman a couple of years ago that was talking about the thieves that had broken into his home.  The burglars took the stereo system and all of the other stuff and left the bullion sitting on the table.  It's a funny story, but it's true, isn't it.  They really don't understand it.

JIM:  They are taking used appliances, electronics and you have bullion.  “Oh, gosh, what's that?”

JOHN:  What do we do with that?  I don't know.  What do we do with that?  All right.  We're listening to the Financial Sense news -- you're listening.  We're speaking.  You're listening to the Financial Sense Newshour at www.financialsense.com.

 Part 2

 Three Related Problems: Energy, Food, and Water

[montage of CNN reporters]

Russian investors are increasingly concerned a global economic meltdown would slash demand for oil and that eventually the boom Russia has been enjoying will come to an end.

In Islamabad, Pakistan, where the average cost of cooking oil has almost doubled in the past year, it’s a clear indication the economy here in Pakistan is suffering.

But elsewhere in West Africa, the picture is very different with a series of riots and demonstrations across the region.  In neighboring Cameroon, a week of violence after the government raised petrol prices.  And in Burkina Faso a government crackdown after riots against the high price of food.  And all these riots and demonstrations are against government who people feel have not done enough to prepare them for the high price of the most basic commodities, petrol and bread. 

Weak dollar and the sliding US stocks will affect this country.  But that is not what ordinary South Africans are worried about.  Electricity shortages, high food and fuel prices are the main concerns here.  And as a result of the inadequate power supply, this country – the second biggest gold producer in the world – is unable to fully benefit from the high gold prices. 

But today, this is a headline in the Financial Times:   “Fed believes it can prevent a deep recession.” Hell, no one believes that. 

JOHN:  Staying on top of it as we always do.  That was what was happening on CNN this week.  You know, occasionally we will get emails, Jim, when we sort of stray from what seems to them to be economics.  They come here to get financial information and then we talk about global warming, or international treaties or governmental policies and they say, “you should stick to your area,” because there’s a phenomenon of the 20^th Century and that is what is called compartmentalized truth.  This is another phenomenon which has come out of the American…well, it’s actually the western education systems, part of what is called dialectical thought.  And that means that all of these little areas are all separate from each other, whether we talk about politics or religion or economics – they’re all tied together; you can’t separate them, they all interact with each other. 

And the same things relate with three related problems.  And if you’re listening to what we say here in this segment you have to remember you climb to the top of the mountain and you say, “oh great guru, what is the fundamental lesson of economics?”

“All of economics is interconnected.”  And we’re going to look at this.  Energy, food and water.  And you don’t think of this as being related to economics, but how these things are intertwined with each other intrinsically, and it’s really easy in the West to forget this because it’s always come to us through the pipe and things and the supermarket and everywhere; people aren’t aware how all of these things interact in their productive level.

JIM:  Let’s begin this segment and talk about the first one which is energy.  The price of oil is over $110 a barrel and we are thinking the price of oil is going up.  Okay, maybe I can make the connection that I’m paying more at the gas pump but look at the way the press portrays it:  It’s not because demand is growing faster than supply and supply is struggling to keep up, it’s because we have greedy oil companies that just want to charge you more money for oil. 

You know what?  This country imports 70% of our energy needs,  our liquid fuels; over 62% we import into this country are oil and natural gas and the other 8% or more comes in from refined oil products.  We don’t have enough refinery capacity in this country for diesel now.  And that’s one of the reasons why diesel prices are going up even more and because we are now competing  in the open market with the rest of the world; we are competing with China for diesel fuel.  So we don’t have the refinery capacity to meet all of our demands for diesel, jet fuel and gasoline.  So it’s not just raw inputs. 

If you look at some of our trade deficit figures, one of the reasons the trade deficit figures were up so much last month (or the two months before that because they report with a one month lag) is energy accounted in nominal dollars for almost half of our trade deficit.  And if the price of energy is going up, we’re consuming more quantities of it because we’re producing less of it, and the same goes for natural gas.  So if we take, for example, energy and you think politics don’t matter into this, what have we done? 

I just watched a special last night where there was a wind company that was trying to put wind towers offshore where the wind is stronger off Cape Cod and they’re trying to stop it.  And that gets back to NIMBY:  “Yeah, I’m for green  power but not in my backyard.  I’m all for wind, but not in my backyard.  I’m for solar, but not in my backyard. I’m for natural gas as a clean fuel, but not in my backyard.”  And so government policy has stifled…I mean the environmental movement as well as other policies in this country have put a stop to the production of energy or thwarted attempts to produce more energy whether it’s oil offshore,  oil onshore or natural gas.  And as a result, our only policy is carrier battle groups in the Middle East.  And people say, “well, just pull out of the Middle East.”  And then people are going to wonder what are we going to do for energy.  We’re dependent on most of our energy, 70% from the rest of the world – a lot of people that don’t particularly like us. 

And as Zapata George was talking about in the first hour, even if we were to make a giant oil discovery, let’s say we opened up Alaska and offshore California and we made a discovery, it may be eight to ten years before that oil or natural gas comes online.  So it takes a long time to build a refinery, it takes a long time to take a discovery to production.  People who don’t think politics play into this, I hate to tell you but you’re not going to put a 747 in the air on solar batteries or solar power or a wind turbine.  And we’re a long, long way off – well over a decade away before you know, we even convert our transportation fleet to either mass transit or to more fuel efficient cars such hybrids or plug-ins.  [6:50]

JOHN:  I was just trying to picture a jet liner lifting off with a belly full of lead-acid batteries.  Have you ever picked one of those up and seen how heavy they are.

JIM:  Oh yeah.  And even if you did, maybe you only have ten passengers on the plane.

JOHN:  It’s true, it’s true.  But you know what’s really tragic about it is ironically we have actually painted ourselves into this corner.  We didn’t have to be here.

JIM:  No.  In fact, I’ve cited this army report that was given to Congress.  The military is concerned because the United States used to be one of the largest producers of raw materials; everything from lead, zinc, copper.  And we have basically through the environmental movement shut it all down.  So all of these materials today we’re importing from other countries.  And that’s one of the problems that like any movement it started out as a good cause and it’s gone to extremes.  And we have done nothing in this country to handle our addiction to oil.  Okay, you don’t like oil companies, you don’t like oil; but tell me what you’re doing to replace it.  You’re doing nothing.  The only policy we have in place is we’re importing it from somebody else and from very unstable regions.  And one of the growing trends in the world is a lot of these countries – whether it’s OPEC or the Former Soviet Union, these national state oil companies are saying, “wait a minute, we’re getting all these cries from the West and especially the United States, ‘come on, produce more so you can bring the price down.’” 

And they’re saying:  “Why should we?  The less we produce, the higher the price we get for the goods that we have.  So we should we go out, make huge investments and increase our production to drive the price down?”  And you know what, something that we’ve come to grips here.  [8:35]

JOHN:  Let’s take energy which is starting to come on some people’s radar and look at the issue of food because that’s something that’s way behind it, and really off the radar for most public’s perception. 

JIM:  Well, if you take a look at the production of food, whether it’s livestock or grains, if you’re going to grow something you need two things; you need fertilizer, you need feed and you also need water to make things grow.  And a lot of the fertilizers that we have used to increase the output on crops and reuse land over and over again is made from natural gas.  Natural gas prices are up roughly about 36% this year.  And natural gas production is in decline.  So fertilizer costs are going up and then you take a look at what do you see on a farm – you see tractors, you see combines.  Well, guess what:  they run on diesel and the price of diesel is going up.  And let’s say at the end of the harvest season, you harvest the crop – whether it’s corn, wheat or soybeans, whatever it is you’re growing – then you’re going to put it on a truck and get it to either a silo or get it to a food processing plant where it takes energy to produce it or refine it or whatever you’re going to do with the food, whether it’s grain into bread or some other kind of food product; and then eventually it’s going to have to be put on a truck again, and it’s going to be taken to the local food store; and you are going to get in your car and drive to the grocery market.  So energy is greatly involved in the production of food. 

One of the big agricultural revolutions that we had came in with seeds and fertilizer in the 70s.  But you take a look at a modern farm today.  All of the equipment that runs on diesel fuel; the fertilizers that come from natural gas.  So the higher energy costs are also spilled over into the food area.  [10:30]

JOHN:  Remember what I was saying before about we take the issue of things that interact with each other, one area is science, the other area is food production which is tied to energy; but then there is also the political aspect because in order to try to make a showing for alternatives we’re now diverting a huge part of our food crop and energy – not liquid energy but capital energy, meaning what we put into it – we’re devoting about 25% of that into the production of ethanol which is now driving the price of everything else upwards.  So that has an immediate effect.

JIM:  Yeah, and so here’s a good example why you do not want government getting involved in energy policy because they gave us ethanol.  Ethanol itself is energy neutral.  It takes almost as much energy to produce ethanol as we get in terms of its output.  It gives us lower gas mileage; it’s harder to transport, it’s corrosive.  And if you take 25% of your corn crop and you devote it to the production of ethanol that means that you have less to grow – you know, farmers are growing more corn because the price of corn is over $5 a bushel, then they may be growing less wheat, or they may be growing less soybeans.  And this is probably the dumbest thing that we’ve ever done is turn food into fuel.  What we should be doing is using cellulosic ethanol – wood chips or waste matter – to create ethanol, rather than using a food crop which is driving up the cost of grains; which means that feedstocks for animals is going up, the price of bread is going up, pasta is going up, corn tortillas are going up.  And here is one more example of how energy, not only in terms of the higher input cost of diesel fuel and fertilizer, but also diverting a good portion of our crop into food is driving up food costs.  [12:27]

JOHN:  Okay.  So this loops around to first of all the progression of what may be an onsetting drought here in our country moving up towards the breadbaskets so to speak from the southeast part of the country.  At the same time, we're finding because more and more energy is being put into this ethanol crop, the water tables are dropping so this affects…all of this stuff is interacting with each other. 

JIM:  Oh absolutely.  And I just want to come back to the issue of food.  I think I mentioned this on the program when we covered commodities a couple of weeks ago, but you know, William Doyle who is CEO of Potash Corp, one of the largest makers of potash fertilizer for farming, he said if you have a major upset anywhere due to let’s say a weather-related event, he said we’re going to have famine.  And he said we’ve had 17 years of bumper crops in our grain levels –I don’t care if you’re looking at soybeans, you’re looking at wheat, you’re looking at corn – are the lowest they’ve been since we began record keeping back in 1960.  And this is with 17 years of bumper crops.  And I think at some point in the next couple of years this kind of policy of devoting 25% of our food crop to ethanol is unsustainable.  And I think you’re going to see global food supplies become a major problem here.  And I think you’re going to see a global shortage of proteins within our lifetime.  I mean there’s only a finite availability of agricultural land anywhere in the world.  A lot of it is being plowed over and there is only so much that we can do.  And just imagine what the price of food is going to be when we’re looking at $200 oil prices, or $250 oil prices.  And we haven’t even begun addressing even the water issues.  So all three of these are all related.  The more of our crop, the more intensity of our crop, the greater the water usage; we’ve got drought areas so the water table aren’t replacing themselves – the underground water aquifers are declining each year.  And this is all occurring in some of the largest water aquifers in this country that are close to the Farm Belt where we grow all of this food.  [14:47]

JOHN:  This gets back to what you were saying, right at the turn of the millennium as a matter of fact, and that was if you wanted to make money in this decade because we could see where we were going with all of this, there were four areas to do it in:  Energy, food, water and precious metals.  And now we see that all emerging.

JIM:  And I think this is going to be a trend that is going to become more pronounced.  I do see a time when we’re going to have famine because if we have our grain stockpiles declining every year with record bumper crops what happens if you have a bad weather year.  What happens if drought moves to the bread basket or other areas, or other countries decide that, hey, we’re going to make ethanol with food?  At some point in the next three to five years, we’re going to have critical decisions to make:  Do we eat or do we drive our car?  I mean it’s going to get down to those two basics. 

And these problems have gone ignored especially on the energy front.  We have done very little to build our electricity grid.  We aren’t building the amount of power plants that we need to.  We’re not using clean coal technology; we’ve barely even got started thinking about nuclear power here.  Clean coal and nuclear are what we should be doing with electricity and supplementing that with solar and wind and some of the other geothermal and some of the other as supplements.  But we’re not doing that. 

And we ought to in the meantime to make the transition until we can find alternatives till we can replace the current car fleet with hybrids or plug-ins – even if we go to plug-ins that means more electricity; that’s another appliance that’s plugged in in your garage at night that is using electricity.  So we’re doing nothing on that end.  And that’s why infrastructure I think is another thing that we’re going with because we’ve ignored these areas and  they’re starting to catch up with us.  It was a power outage in Florida last week, we’ve had refinery outages and you know what happens during this summer if you get a heat wave you know, here in California we get power outages.  So all of these issues are going to have to be addressed. 

And I see nothing and I mean absolutely nothing in the political realm, outside of a handful of people like Congressman Roscoe Bartlett, who is even addressing the issue of peak oil and how serious.  This is going to be the single most defining issue of the next president.  And God help whoever that is because you and I have said, John, the crisis window begins and the Age of Turbulence is just getting started.  The crisis window begins in 2009.  [17:30]

 Other Voices: Eric King, Analyst/Trader

JIM:  Gold breaks out at $1000 an ounce intraday, we have silver prices close to $21 an ounce, oil prices intraday over $111. 

Joining us on the program is private investor Eric King.

Eric, normally we get a lot of requests to have you on the program after we get these big sell-offs or corrections that we get in the gold market, but I’m having you on for a different reason, besides the fact that we got a lot of requests after last time you were on the program.  But all of a sudden now, with gold close to $1000 an ounce it’s getting people’s attention.  Even with oil prices at or over $100 a barrel, which some people are still finding unbelievable even though I think it’s going to 125.

I want to talk about some of the fundamentals and with gold prices close to $1000 an ounce, where do investors go this time?  Last time on the program you were a little bit cautious about nearing $1000 an ounce, chasing the large cap mining companies which is where all of the movement has been if we look at the gold equities market. 

Why don’t we talk about a couple of things.  Let’s talk about some of the fundamentals because I’ll tell you, some of the anchors that you see on the financial stations had a look of disbelief.  It was like, “I can’t believe oil is here, I can’t believe gold is here.”  And even though we’ve been telling people about this for six or seven years now.  So why don’t we talk about fundamentals first and then we’ll get into what investors should be doing.

ERIC KING:  Well, again, you do have to go to fundamentals.  If you look at the Dow/Gold ratio going back to 1929 you can see it hit a peak of around 19-to-1.  I think we had the Dow around 385 and I think gold was fixed at $20.35 or so, meaning it took about 19 ounces of gold to buy one share of the Dow; and then by 1933 you had the ratio back to roughly 1-to-1, meaning one ounce of gold to buy the Dow.  Moving forward to the late-60s, you get a big bull market and the ratio climbed even higher than the peak in 1929, reaching 26-to-1.  So it took 26 ounces of gold to buy the Dow at that time.  And then of course, by 1980 we had the ratio back to 1-to-1 because the Dow was around 850 and so was gold.  In 2000, the Dow-Gold ratio – it was kind of amazing it reached a top 43-to-1 and that had to be the point in time where gold in all of mankind’s history was the single most undervalued.  So it took 43 ounces of gold to buy the Dow at that time.  And of course, now you fast forward it to today, we’ve got the Dow close to 12,000, we’ve got gold close to $1000 and the ratio has fallen from 43-to-1 to 12-to-1, and probably on its way back to a 1-to-1 ratio.   So clearly the trend is in favor of gold and against the Dow longer term and that’s what the public has to wake up to at this point. 

And you can bring up oil which is just in an amazing bull market and it’s been kind of a joy to watch but except of course for people at the pump but if you’re in it – and I know your clients are, Jim, they’re making a lot of money – but you know, moving on to oil and people are buying oil as an inflation hedge  but really until recently they’ve been largely ignoring gold.  And you have to look at the gold/oil ratio at that point.  So the average ratio is around 15 ½ barrels of oil to buy an ounce of gold.  And today, with oil trading at roughly $100 a barrel and I don’t know what it did today but gold at $1000 it takes roughly 9 barrels of oil to purchase an ounce, so this ratio is interesting.  And the reason is because when it swings in favor of gold it doesn’t revert to the median but it tends to overshoot the other way in favor of gold reaching the 20-to-1 or in extreme cases 30-to-1 area.  So what this suggests is that going forward in the longer term, gold will dramatically outperform oil on the upside.  Now, this doesn’t have to discourage the oil bulls, it just means that gold will have to – it will have its turn to shine and it suggests an outperformance on the order of say, 2- or 3-to-1 longer term.  So – and of course, in the short term it’s possible for gold to correct.  So I kind of think that’s where we are on a summary of the gold situation.  [22:31]

JIM:  CPM Group publishes their Annual Gold Book and I got an advance copy.  In fact, Jeff Christian will be on my program next week.  And it was amazing even to CPM, there has been so much gold bullion buying around the world, last year saw gold prices surpass their record high settlement price of 834 which was reached on the 21^st of January 1980.  But what was incredible is investors bought over 43 million ounces of gold last year and it wasn’t just people in the Middle East or people in Asia, it was global.  And if you think of the things that move gold prices fundamentally whether it’s strong  physical demand – and if you take a look at what investors have been buying gold for and we’re seeing all kinds of variations of this theme, they’re buying it 1) as a portfolio diversifier 2)they’re buying it against a falling dollar – on the day you and I are talking which is Thursday the dollar just hit another low 3) they’re buying it against volatile stock markets 4) they’re buying it against low yields on interest rate bearing bonds 4) they’re buying it as a safe haven against political turmoil 5) they’re buying it as an inflation hedge 6) serving as protection against financial money problems.  So if you look at all of these factors which were in place in the 70s bull market, multiply them by three or four in this bull market and this has according to CPM Group the first time in history of any bull market that you have seen eight consecutive years of rising gold prices. 

And yet you look at people – I was at a party a couple of weeks ago where there were financial people, people in my industry and obviously they know I’m in their industry and so the topic got around to “what are you buying?”  And you know, you mention gold and oil – it’s funny because if you mention oil they sort of understand it because they’re paying for it at the pump, but you mention and gold and you know, their eyes kind of roll “oh, oh, okay, you’re one of those people.”  It’s absolutely amazing.

ERIC:  It’s fascinating because we’re seeing two things in the gold market and really it’s sort of a panic by some into physical bullion.  I was reading one of the commentators today that was saying that some of the clients that were coming in were literally putting a hundred percent of their savings into gold.  But then at the same time, so really we do have the investment side on that side going up, but then you know, at the same time we’re also seeing the jewelry demand drop off and I think some of the buying in India, in Asia and in the Middle East as gold sort of spiked here.  So it sort of gets ahead of itself a little bit in bull markets and it’s not that it’s at a frothy level in terms of fundamentals, it’s just that people have to get used to you know, gold at these prices.  And so after over time I think we’ll see some of that demand start to come back in from the Middle East, from Asia and from India.  But they tend to be smart buyers and so we are seeing sort of a drop off on that side, but then we’re seeing other people, I think in the Western world beginning to say to themselves, “My God, every day I get up the dollar goes down!”  Or you know, whatever the case may be.  And so we’re sort of – some of these folks are behind the curve, right, Jim because they haven’t been in a fund like yours or Sprott’s up in Canada; and so they really don’t have the exposure necessarily of some these proper, appropriate inflation hedges. 

And God knows on the brokerage side, the United States shamefully they have not been telling their clients during one of the great bull markets in resources and resource stocks, they have not really had much of any exposure for their clients to these stocks.  And of course, they’re coming around.  It takes time.  But you know, if it was 1980 they were telling everybody at that time and I think 40% of the S&P was resource stocks.  So they’re coming around and the word’s getting out and clients are coming into it, but you kind of have to try to in these bull markets to catch the pull-backs and catch the significant pull-backs if it’s a major stock that you want to be in. 

You talked about the large caps, Jim.  I don’t think people should necessarily be chasing those stocks here.  I think there are better ways to deploy your money probably of course in the junior side of things where things are very discounted and you have to be a good stock picker.  But I think that’s what people have to look at is ways to buy the physical metals on the significant pull-backs or even the quality stocks that they want get – but again, on the pu