The
BIG Picture Transcript
April 19, 2008
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Part
1
The
Decline of the Giants
Other
Voices: Peter Sepp, National Taxpayers Union
The
Catalyst
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2
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Planning
for Retirement - Part 4
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Q-Calls
JOHN: Well, if we go back to February – I don’t know why February right now is starting to seem further away than ever, but anyway – we did a series on natural resources and energy. And one of the salient points that we discussed is that since 1985, the world has failed to discover what we use every single year when it comes to oil; and then we discussed other issues such as why energy prices were heading higher. And if you remember the prediction here on the program in January was for $125 a barrel oil this year. We’re just about to 115 now so we’ve got 10 to go and I think we’re going to make that before the end of the year easily. So this week we are going to begin the Big Picture with another important fact about oil which is most of our oil comes from giant oil fields; oil fields that were discovered over 40 to 60 years ago and we have not been finding any new big ones anymore.
JIM: We’ve often discussed on the program that we’re not replacing the oil we consume each year with new discoveries – that alone I think would get people’s attention. But it hasn’t – because you always have “well, we’ve got technology, we’re still making new discoveries,” and we always make these assumptions, “well, if demand grows by x percent the supply will be there.” Well, this has been going on for over two decades but I believe there is a related problem as to why this is happening, and the reason is most of our oil comes from oil fields discovered anywhere from 50 to 70 years ago.
Now, most people – and this is a key here – are unaware that just 14 oil fields account for 20% of the world’s oil production. The biggest oil field, Ghawar, accounts for one-half of Saudi production, and Ghawar was discovered back in 1948. That field is now in decline. And if you look at the second largest oil field, Cantarell in Mexico, as we’ve often commented, that was discovered back in 1976. It peaked in 2005 and has now gone into rapid decline. If you take a look at the third largest oil field, Burgan, it was discovered in 1938. It has gone into decline. [2:44]
JOHN: I know that this is something that Matt Simmons has discussed here on the show in the past interviews that we’ve done with him recently.
JIM: Yeah, Matt did a study of the world’s major oil fields back earlier in the decade and this goes back to a meeting Matt had at the Pentagon in the late 90s. They had all of these oil experts and they were sitting around the room and they were saying, “China’s production will be x in 2010, and Saudi oil production will be x.” And then Matt said, “how do you guys know that?” “Well, that’s what our models say.” And so that prompted Matt to embark on a study of the world’s major oil fields. Nobody had done that prior to Matt. Basically, people just made assumptions and just assumed those assumptions would play out.
What Matt found astounded him. The vast majority of our oil production comes from a small number of oil fields that are now very old and are in decline. Basically, John, if you take the world’s oil fields, 120 oil fields account for almost 50% of the world’s daily oil production; 36 of these oil fields were discovered over 45 years ago. And these giant oil fields make up nearly the bulk of our production; 14 of these fields –as I made comments earlier – account for 20% of our production. The problem is we stopped finding these giants decades ago.
The only giant that we’ve found recently in the last two decades is Kashagan in the Caspian which was found in the late 90s, and yet as of this date is still not in production even though that was roughly about 10 years ago.
Put this another way: 120 oil fields produce 47% of our oil. The other 4,000 oil fields produce the other 53%. [4:44]
JOHN: So basically the reason that we’re not replacing these reserves (which quite frequently we’ve noticed the levels never seem to go down on the official books but in reality they are) is first of all, we really just not finding enough oil. That’s all there is to it. And second of all, what we are discovering today really is smaller by comparison to these giant fields that were discovered almost half a century ago.
JIM: That pretty much sums up our predicament. I mean there is a relation in terms of the connection between why we’re not replacing what it is we consume and that is because the major oil fields were discovered half a century ago. No new fields discovered in the last decade will have production that exceeds 250,000 barrels a day. By contrast, if you take the top 19 older, giant oil fields they’re still producing an average of over 500,000 barrels per day despite the average age of those 19 fields being 70 years old. Some of them go back to the 19th Century like the oil fields that were discovered in Kern county, California which still produce a good bulk of California’s oil.
And you know, here’s one to think about. Chances are the oil or the gasoline in your tank came from an oil field discovered 70 years ago. Now think about that for a moment; we know eventually all oil fields go into decline, it doesn’t matter if it’s the North Sea or the North Slope. The problem is when a giant goes into decline like Ghawar, Burgan, Cantarell, North Slope, North Sea, it takes hundreds –literally hundreds – of new oil fields to make up for the decline. And we’re simply not discovering hundreds of new oil fields each year to replace what it is we’re losing to depletion. [6:35]
JOHN: You might expect that a few smart people would be looking into this. I mean as important as it’s going to be for the world economic security this is not discussed very often – at least not in public.
JIM: No. The problem is most of these fields are in the Middle East where production rates and declines are kept secret. And this is a point Matt has made continuously and other experts – virtually no analysis has been on what the production rates of all these giant oil fields might be and especially as the future unfolds because every report that you look at “well, based on current trends, China’s demand is going to be x amount of barrels a day, India’s demand, the emerging world...” – you know, here is where the demand is – and we make these assumptions that the supply is going to be there. Now, realistically, you have the IEA that is looking into this saying: “Wait a minute, we look at these numbers. Each year the Middle East produces x amount of barrels of oil and their reserves never change.” I was watching a documentary last night on oil. One oil expert said “doesn’t anybody question this?” And he goes “if you talk to the people in the Middle East they’ll say that ‘well we produce x amount of oil last year and that’s exactly what we found to replace it, so our reserves never go down because we simply find or replace what it is that we produce’ yet there has been no evidence that there have been major oil finds.” So you know, we’ve got all kinds of problems here that we’re simply not talking about.
In fact, I read recently, one astute investment firm is doing the same thing that Matt Simmons did many years ago; they’re compiling their own survey of the top 250 oil fields which account basically for the majority of the world’s production. But for all practical purposes here, here’s the scary part: We’re flying blind. And I think if we got verifiable data out of OPEC I think it would shatter the current myth that there is plentiful supplies of cheap oil in the Middle East. [8:43]
JOHN: Well, you know, it would seem that if that is the case, if what you’re talking about is true which I’m assuming it is, it would seem that the giant oil fields that have been discovered are going to really have to run faster and faster just to stay even with the demand load. I mean never mind the fact that the demand for oil is expanding in the developing world and actually within the OPEC countries themselves, so they’re beginning to consume more of the product that they used to export.
JIM: That’s the problem that we face that hasn’t gotten much traction. We’re all focused right now on global warming, which may or may not occur 40 years from now. Peak oil, in my opinion, is now on the front-door step. Most of the world’s true giant oil fields were found four decades ago. In the past two decades, most of the oil and gas discoveries have been quite small. Today, a major would be a 100,000 barrel a day field and we’re not finding very many of those. The last million plus oil field that we found was Mexico’s Cantarell field which discovered back 76. And before Cantarell it was Alaska Prudhoe Bay in 1968, and then the following year with the North Sea. All three of these fields are now in precipitous decline, especially Cantarell. The North Slope produces less than a third of what we were producing before the peak in 1988. [10:06]
JOHN: This is really a remarkable story because what you’re basically saying is that the fate of the world is now resting on a relatively small number of oil fields, so our basic supply of oil is concentrated in a small number of fields and the majority of them are old and many of them – just like Cantarell – are in decline. Well, to sound cliché-ish, “Houston, we’ve got a problem.”
JIM: A big problem, yet even though these fields, many of which have gone into decline, yet older fields are still producing far higher volumes of oil than the new giant fields that we have found. In other words, if you look at this, we are finding oil fields but what we’re finding is smaller fields with smaller production. [10:52]
JOHN: Any way to sort of quantify that because basically what we’re saying here is alarming and especially if none of our politicians is focused on this issue of peak oil which looks like it’s either here or going to be here very quickly. Now this is very troubling because, like any disaster, the time to begin sewing a parachute is not after you jump out of the airplane. You should have been working on this a long time ago because once you leave the airplane the clock is ticking. And that’s where we are right now, the clock is ticking before the impact.
JIM: You know, Matt Simmons produced a white paper that he did back in 2001 and he sort of quantified this but this will give you a picture. If you take the oil fields that we discovered pre-1950 –you know, that was like Burgan, the Kern county oil fields in California – those oil fields are still producing 550,000 barrels a day. The oil fields that we discovered in the 1950s are producing about [330,000 barrels] a day; the oil fields that we discovered in the 60s are producing 240,000 barrels a day. The oil fields that we discovered in the 70s on average are producing 230,000 barrels and day. In the 80s, the oil fields discovered in that decade are roughly producing 175,000 barrels a day; and in the 1990s the fields that we have discovered are producing 125,000 barrels a day. So you can see the progression of the decline by decade, which only goes to highlight the importance of the supergiant oil fields.
Now, think about this one for a moment: 36 giant oil fields contribute over 80% of the daily Middle East oil production. I think that pretty much dispels the myth that you hear so often that the world’s oil supply is diversified. [12:56]
JOHN: Is there any other data that would drive home this point?
JIM: Well, some of what we know now is dated. It’s not like we get audited field reports from the Middle East each year. I mean a standard thing that you see in the BP Statistical Review is OPEC’s reserves never change. Whatever they find the assumption is made that they replace. But we do know that the large oil fields – Ghawar, Burgan, Cantarell, China’s Daqing – have now all peaked. For example, we know that Ghawar produced 6.3 million barrels a day; the last known report that we have on Ghawar, its production had dropped to roughly about 4.5 barrels a day. We know, for example, Prudhoe Bay produced 1.6 million barrels at its peak. It’s production is now roughly around 400,000 barrels a day.
If you think about our top 10 oil fields declining by 4 million barrels a day and with average discoveries that we’re making today in the 25 to 50,000 barrel a day range, once declines begin the volume of daily production lost will require an exponential number of new, smaller fields to replace them. And if you think about this, the smaller fields tend to peak fast and then they decline at much more rapid rates because they’re smaller oil fields. So you can see we’re on this never-ending, ascending treadmill that keeps rotating faster and faster. I think this is a point that very few analysts have ever thought about. If you take a look at the CERA folks, “well, we’ll just find it.” And this really drives home the fact we’ve been talking about here is we need to step up exploration and push aside all of this bureaucratic red tape that denies access to where the oil is to our energy companies. And it’s not just oil, it’s natural gas.
And I just don’t see how we’re going to be able to avoid at this point an energy crisis. I mean if you look at Kashagan – the last giant that was discovered in the late 90s – here it is 2008, 10 years later, and it is still not in production. They’re talking about it may be the year 2011 before it comes online. So I just don’t see how we’re going to avoid an energy crisis that’s going to involve either, one, shortages, higher prices which we’re seeing today. I mean oil was down earlier in the day. Now, it’s at $116 a barrel as you and I are talking – and so higher prices and accompanying economic pain. And this crisis, when it erupts at least will give a taste of things to come this fall when world demand is expected to rise to roughly around 87 million barrels a day and supply is going to be stuck around 85 million barrels a day. There is nothing coming online this year that is going to be able to bump that supply up to meet demand especially in the fourth quarter. [16:00]]
JOHN: It’s interesting that you’re talking about this, Jim, because if you’re looking at the situation in South Africa – post-apartheid – the government was in a certain amount of shifting chaos. They opted for a socialist model by the way is what they did, rather than one that would be on a capitalist basis. And they were given similar warnings by experts about what their energy situation was going to be and they ignored those warnings; didn’t they?
JIM: They basically ignored them until 2004 and now they’re paying a terrible price for it.
And it goes beyond that because our energy producing industry – whether you’re talking about the oil companies or our public utilities – are saying we need to bring more power plants online. But state governments are stopping clean-coal technology. We should be bringing online clean-coal technology power plants and nuclear power plants and we should be starting right now with almost the equivalent of a Manhattan Project to bring these online. Because, John, you’ve seen this – remember a couple of years ago when they got that heat wave in the Midwest and the grid system failed; anytime in California that we get heat waves during the summer we have rolling blackouts. Think of what’s going to happen five or six years from now when demand increases and think about if we’re trying to come up with a solution –whether it’s plug-in hybrids – I mean if that’s where we’re going with automobiles, well, we’re going to need more power because when you pull your car into the garage at night and plug your car in to charge at night, you are now adding additional load on to the grid system that wasn’t there before.
And even more important, with the shortages and power outages in South Africa even more alarming is neighboring states around South Africa, ESCOM is telling them “we’re going to be cutting our production that we sell to you over the next two years because we need it for ourselves.” Well, think about the United States that now imports 70% of our energy needs. We’re putting ourselves in a very vulnerable situation here, not only in terms of imported oil and oil refined products such as gasoline, diesel and jet fuel, but also power plants. So I mean there’s a lesson here from South Africa – that very same thing is going to come to the United States because we’re not building the power plants that we need, we’re not finding the oil that we need, which makes us each year we have to import more and more oil and refined products from areas of the world that are growing increasingly unstable. [18:30]
JOHN: You know, Jim, what it sort of reminds me, don’t you, what politicians are doing with this: Pull the rip cord now! Right after they hit.
JIM: Yeah, many of these guys will be retired collecting their generous pensions when this crisis unfolds. And that’s why there’s absolutely no accountability. But I mean there’s all kinds of red flags that are going around us and we’re putting ourselves in a very vulnerable position. [19:00]
JOHN: I don’t know if you read the piece by Michael Klare, it appeared in the Asia Times, on April 17th, it’s still there on their website called The Rise of the New Energy World Order. It’s a rather lengthy piece and he comes up with a very sobering analysis of what this is going to mean geopolitically because very few providing countries are going to control all of the oil. And he said you’re going to see wealth transfer to those countries as well as political power transfer. Then he began to look at the alternatives and said they are not on the horizon and he looked at global warming and he said, there’s not a prayer’s chance in heck we’re going to make any kind of reduction in greenhouse gases the way we’re currently structured; we’re just barely thinking about getting a conversion made. So the analysis is pretty sobering. And like you say in your analysis here, it’s pretty frightening.
JIM: Yeah, and the thing is here we have this storm which is heading in our direction, we’ve got all kinds of signs, we’re looking at oil prices at 116. And you remember, John, in January everybody was telling us that the price of oil was going to go lower because the US economy was heading into a recession. In fact, Bubblevision this week had a thing about the next bubble and they were talking about oil and yet here we are at $116 a barrel, you know, we’re less than $9 away from our prediction of $125 a barrel. And think what’s going to happen this fall when demand rises to 87 million barrels a day, and supply capability is only going to be 85 million barrels a day. This is what I think is going to get us to that $125 oil figure that we’ve been predicting here on the program since January. [20:33]
JOHN: Now that I feel like jumping out of an airplane without a parachute just because of what we’ve said, is there really any hope of finding any more of these giants. How are we going to deal with this situation short of chaos because sooner or later somebody is going to wake up?
There was a talk earlier, for example, Petrobras may have discovered a giant. But is that true or are we just going to see this fizzle?
JIM: If you take a look when that story first came out they were thinking this oil find may be as large as 30 billion or 33 billion; you remember this was very similar to the Jack discovery in the Gulf of Mexico – they said it had similar characteristics. But if you look at more recent statements by the company, officials are backing off the initial estimates. And at this point they simply don’t know until they do more drilling. And despite hope, the exploratory efforts that we have seen here made in the last three or four decades have seldom found new fields that come close to the size of the earlier giants, which those giant oil fields discovered 50 to 70 years ago still underpin almost all Middle East oil supply today.
And even if you look at what is going on in the kingdom, almost half of all drilling done by the Saudis is occurring in its giant Ghawar field which only postpones if anything the further decline rates of Ghawar, which has gone from roughly 6 ½ million barrels to last reported it was 4 ½ million. Who knows if that 4 ½ million is a good figure. [22:06]
JOHN: So if we begin to summarize all of this, oil is still the world’s most important energy source. It is almost the sole source right now of liquid fuels required for transportation of all types, and there is not much of that changing in the near future. Ethanol is not doing it. We have already seen the ravages of ethanol on the world food market right now. That’s impacting things globally. The oil accounts for about 95% of our ability to transport goods and people. Let’s face it, you can’t – well, you could run trains. Like I’ve said, Europe and other places of the world have run electric trains – they do work. But you have to have power plants generating a lot of power to do that; correct? Correct. So for the rest of the world we’re stuck with liquid fuels, of one form or another. Very few energy substitutes, very little viable right now, even if we did have something in the laboratory. Like Michael Klare said this week in his article, it’s not moving from the laboratory to commercial production. The oil fields that we have were discovered 50 to 70 years ago and we aren’t finding enough of crude oil each year to replace what we consume because basically the majority of big oil fields were discovered decades ago. We’ve finally arrived at the point where demand has caught up with supply and so it’s like a bank account where you keep overdrawing by a thousand dollars a month. Over 24 months suddenly you have really quite a deficit and that’s what we’re going to face, is an energy crisis that will involve shortages and higher prices.
We mention also the geopolitical ramifications of this. Whole new power centers around the world with nations that were formerly dominant becoming beggars in this whole thing.
Have I left anything out?
JIM: No, that pretty much sums it up.
JOHN: That’ll be $5 please!
I think I’ll be joining you for a few bottles of wine and a cigar this weekend and we’ll ask our friends over and we’ll sit and bemoan the loss of civilization as we have known it. We’re going to cover more on this topic in the next few weeks and months. You know, really if we look at it, Jim, is there a point in telling people about all of this? I mean, what can the individual person do that might be listening to this show? How will this impact them?
JIM: Number one, if you haven’t thought of getting a hybrid or a fuel-efficient car or rearranging your schedule so you don’t live and have to travel that far to get to work. Gosh, I hope if you’ve been listening to this program for the last 7 years you own energy stocks by now, and you don’t get panicky like, for example, in January and February when the energy stocks corrected as a result of large financial institutions deleveraging their balance sheets.
And for goodness sakes, I hope you’re not believing the nonsense that – John, I am so tired of hearing every time the price goes up, “oh, it’s a bubble…It’s a bubble” If it is a bubble, show me where the new discoveries that are going to come online that are going to replace and supply all this oil. If it’s a bubble in commodities, show me the warehouses that are full of rice, food, corn; our grain stocks are down to levels that we haven’t seen for almost half a century. In a bubble you see more supply come online and eventually so much supply comes online that eventually the prices fall. We’re not seeing that. And so that’s why I think that you have take with a grain of salt when they’re telling you “oh this is a bubble, you ought to get out of it.” Number one, the sector never got overpriced and we’ll be covering more about these issues on energy. In fact, next week we’re going to take a closer look at the industry and companies.
Oil will become a more important topic here on the program, especially as we head into that crisis window that you and I are talking about that begins to open up towards the end of this year where I believe we’re going to be looking at oil prices at $125 a barrel and gasoline – John, I don’t know what gasoline is like, last weekend we crossed over $4 here a gallon and I think we’ll be roughly $4.50 to high 4’s for gasoline; diesel is up $4.30. I’ve gone sailing over the last two weeks and one of the guys next to me on the dock has a boat and he has 600 gallons – it’s a motorboat – and he was bemoaning he just got back, he wanted to fill his tank and here on the bay in San Diego, you’re paying over $5 for diesel. So you can imagine it cost him over 3 grand to fill his tank. And I agree with Bill Powers that natural gas prices are going to be heading higher, along with heating oil as we head into the fall. [26:41]
JOHN: It’s interesting when economists talk about the oil situation, it almost resembles what we talk about. Remember, a static world, taxation. It’s almost like static world, oil. Their assumption is that the widgets – or the oil – is always going to be out there and that we just apply normal economic ideas to figure out where the oil prices are going to be without looking at the supply or the effect if there is any counterbalancing effect – that’s the whole issue of taxation too, is that assumption that if you just keep raising the rates more tax money comes in. Right? It’s got to be that way.
JIM: Yeah, they’re linear extrapolations; demand rises by x amount, so supply will rise by x amount. Now I do believe there are a couple of people, I’ve read a major brokerage investment bank is now compiling field-by-field study of the world’s top 250 oil fields. You’ve got the IEA which is now beginning to question some of the assumptions about supply. Remember the report that they released last summer. Also, the IEA is going to be releasing a report later on this year, they are conducting their own review of the world’s large oil fields; and when that report is released we’ll be doing a special on that. So there are people who are beginning to wake up. It’s still a small minority but the two most compelling reasons that should get people’s attention is number one, we have not been discovering on an annual basis what it is that we consume.
And related to that is because most of our oil comes to us is highly concentrated in a small handful of oil fields, so contrary to popular opinions that our fuel base and our oil base is widely dispersed, well, that’s true when you consider when there are over 4,000 oil fields, but those 4,000 oil fields that account for 53% of our supply are very, very small oil fields. So in that sense, it’s dispersed; but 47% of our supply comes from 120 fields. And when you have a Ghawar go from 6.3 million or 6 ½ million barrels a day down to 4 million barrels a day, a Cantarell go from 2 ½ down to maybe 1 ½ or below a day, that is a significant impact. In other words, if four oil fields have seen their production decline by 4 million barrels a day, think how many hundreds of oil fields it’s going to take just to replace that to stay even. That’s the topic that people aren’t talking about here. [29:19]
JOHN: You know, you have to look at the history of this whole thing because I think, Jim, for as long as you and I have been doing this program we’ve been telling people that this is the oil situation, this is why prices are going to go up, this is why investing in energy is going to be a good area. And at the same time most of the talking heads out there have been saying, “no, it’s not going to go anywhere, it’s going to go back down.” I’m still waiting for that 40 to $50 a barrel which they were predicting a few years ago. And that’s why I’m assuming you started an energy account as a matter of fact and you own so much oil for your clients. I mean I’m glad we put that into energy because I guess I feel a little better when I fill up at the pump because of that. It takes the pain away from the shock of it. I’m just flabbergasted at how fast the digits go around. You know what I keep right here? I have a charge slip from when I was in college in 1968 at San Francisco state. I filled my car up for 3 bucks, haw haw haw.
JIM: Yeah, when I was in college I had a VW bug and thank God I did, John, because remember when the oil embargo hit, the crisis hit – I forget what my Bug had; 10, 12 gallons – well, the price eventually went up to 50 cents but it went up to 5 bucks instead of 3 bucks, and thank goodness I got good gas mileage because you remember the big cars back then with the big muscle cars, the camaros, the GTOs, you remember the 440.
JOHN: The LTDs, the Cadillacs – the really big stuff that was around at the time and that everybody liked to drive, especially retirees – remember that?
JIM: We’re really giving away our age, aren’t we?
JOHN: Dating ourselves. Speak for yourself, Kemo Sabe. I was a perpetual college student so I don’t have to give away my age. Anyway. But people can still get into that energy jump line, right? We can still climb on to that bandwagon because it’s nowhere near the top of where it’s going to go.
JIM: No. I mean if you’re looking at $125 oil by the end of the year, next year we’re going to be over 150 and as we hit the crisis window we’re going to be at $200 and above. The crisis hasn’t even hit yet and we’re looking at 116. Imagine where prices are going to hit when the crisis hits.
JOHN: And then of course, the politicians are going to jump in there and that’s going to distort a lot of what happens. But ultimately reality will come crashing through and when it does, politicians panic.
You’re listening to the Financial Sense Newshour at www.financialsense.com, online all the time.
MCCAIN: All these tax increases are under the fine print of the slogan of ‘hope.’ They are going to raise your taxes by thousands of dollars and they have the audacity to hope you don’t mind.
GEORGE STEPHANOPOULOS: Senator Clinton, two part question. Can you make an absolute read my lips pledge that there will be no tax increases of any kind for anyone earning under $200,000 a year; and if the economy is as weak a year from now as it is today, will you persist in your plans to roll back President Bush’s tax cuts for wealthier Americans?
HILLARY CLINTON: Well, George, I have made a commitment that I will let the taxes on people making more than $250,000 a year go back to the rates that they were paying in the 1990s.
GEORGE: Even if the economy is weak.
CLINTON: Yes, and here is why. I do not believe that it will detrimentally affect the economy by doing that. As I recall, we used that tool during the 1990s to very good effect, and I think we can do so again. I am absolutely commited to not raising a single tax on middle class Americans, people making less than $250,000 a year. In fact, I have a very specific plan of $100 billion in tax cuts that would go to help people afford healthcare, security retirement plans, you know, make it possible for people to get long term care insurance and care for their parents and grandparents who they are trying to support, making college affordable and so much else.
GEORGE: An absolute commitment, no new middle class tax increases of any kind.
CLINTON. No, that is right, that is my commitment.
Other
Voices: Peter Sepp, National Taxpayers Union
JIM: Well, this year another report on Congress and fiscal spending and believe me the report card doesn’t look good. Joining me on the program on Other Voices this week is Peter Sepp from the National Taxpayers Union.
Congress’ fiscal ratings dropped closer to an all time low, Peter. What’s going on?
PETER SEPP: Unfortunately, they are dropping to an all time low. The absolute worst score on our annual rating of Congress (which is based on every single rollcall vote affecting federal spending – taxes, debt, anything fiscal) was in 1988 when the typical member of Congress scored a near 27% in the House and 28% in the Senate. Now, this year we’re looking at 37% in the Senate and 35% in the House, so we are definitely heading into danger territory. The scores were sliding during the last years of Republican control of Congress, now they’re in a freefall. [34:46]
JIM: One thing that I’ve noticed, and I’ve seen your reports every year. It was thought when Congress was taken over by the Republicans we would get fiscal discipline. We got just the opposite.
PETER: Yes, unfortunately when they first took over in 95 and 96 we definitely saw some hope emerging from Congress. The typical pro-taxpayer score was nearly 60%, but since then, unfortunately, it’s been all downhill and getting worse under Democrats. The absolute worst score actually was reached this year with a near 1% rating; that was Alcee Hastings, Congressman from Florida. Truly a disastrous performance. In order to score something that low you have to vote against virtually every piece of pro-taxpayer legislation and vote for every piece of anti-taxpayer legislation. It’s a good thing there weren’t any more one percents in Congress, although I must point out that there were over 200 single digit scores in the House of Representatives which is also a horrible thing. [35:55]
JIM: When the government issued its annual report for last fiscal year, there were tens of billions of dollars they couldn’t even account for; and then recently, last week, we found out about government employees with credit cards. You know, nobody was monitoring that from $14,000 dinners at Ruth’s Chris, one guy paying for a mistress, Ipods, digital cameras, laptops. Don’t they have any auditors within the government that can maybe police the various agencies to make sure they’re living within their requirements?
PETER: Unfortunately, far too few auditors. The problem with credit cards that have been issued to federal employees has been a very thorny one for the better part of a decade. Actually it was first discovered I believe back in 1995 or 1997, there were more credit cards than there were federal employees at many of the issuing agencies. That was problem number one. Problem number two is a lot of the transactions that were supposed to be authorized by a manager simply weren’t, or they were given a rubber stamp. Number three, being there was no follow-up when many of the employees submitted their statements for reimbursement, nobody bothered to question purchases from places like lingerie stores or liquor stores. And so it’s multi-faceted difficulty. [37:25]
JIM: It’s amazing too and I wonder if we might get into the topic of earmarks. We’re setting just record levels. I wonder if you might explain for our listeners what earmarks are and why they’re just basically largesse.
PETER: An earmark is a piece of Congressionally directed spending toward to a specific entity or person, as opposed to a general appropriation for an overall federal program. Earmarking represents the worst instincts of Congressmen, unfortunately. They use these as tools to reward political contributors. If, for example, someone wants a road built in the Congressman’s district and if not a priority with either the state or federal department of transportation, why, the member of Congress simply earmarks two or three million dollars for that project. And lo and behold, the person that wanted it is satisfied. He writes a nice fat check to the Congressman’s reelection and everybody is happy except taxpayers. [38:28]
JIM: And I can’t think of the one Congressman who has set up between him and his brother a construction company and he’s directing all these projects to his own construction company. I mean, my goodness, this reminds me of the last days of Rome when basically everybody was out for themselves.
I want to move on to another issue because taxes are once again on the agenda. If the Bush tax cuts expire you’ll see the largest tax increase in history since World War II. And a lot of people think that this is only going to affect the rich people. And what they don’t understand is rich people got the lowest tax percentage decrease, the largest decrease occurred for the poor and middle class; and you’re talking about a massive increase for poor and middle class people.
PETER: Oh yes, absolutely. The Democrats in Congress keep paying lip service to renewing some of the middle class and working class tax cuts like the double child tax credit that was once $500, it’s now $1000; or the new 10% tax bracket or there’s currently a zero percent tax rate on capital gains and dividends for people below a certain income level. And even though the Democrats say “we’ll get around to renewing those, we’re just going to let all the other ones expire for those rich people over there,” we are not seeing any major effort from the House or Senate on the Democratic side to make good on those pledges. There’s no legislation I know of that’s advanced far enough to provide such a guarantee. [40:10]
JIM: Now I also understand Rangel is working on a tax commission –to start, let’s say, if the Democrats take the White House – that would impose a surtax two different levels of surtax based on a person’s income. So not only would they let expire President Bush’s tax cuts, but there would also be surtaxes on income.
PETER: Yes, absolutely. People need to understand too if these tax rates are allowed to expire and go back to their Clinton era levels and you end up getting surtaxes much more than millionaires will be affected by it. The top two tax brackets in this country cover people in the single category with incomes of say 140-, 150,000 and above. That’s not a huge income the way it might have been 20 years ago. That’s a lot of professionals, a lot of people who might be at the high earning point of their career and they have to face just gigantic tax increases. Right now the top rate is 35%. Imagine if it goes back 39.6, plus 4-, 4 ½% surtax. That will be absolutely devastating to all the small businesses who pay taxes and file for taxes using the 1040 form and the Schedule C. I mean they are all very high income folks, or at least they are to high taxers and they’re going to get hit badly. [41:40]
JIM: Speaking of small businesses, another onerous tax that could come in is the reduction in the estate tax exemption from I think it’s over 2 million today, due to rise, but then it would drop down to 600,000, the estate tax rate would go up. I mean you’re talking, you know, $600,000 today, I mean that is not even a middle class home in Southern California.
PETER: Yeah, absolutely. And I think that people are deluding themselves if they don’t believe people aren’t also spending tons of time and money trying to avoid these taxes. We like to think that, “oh, well, if tax rates go up everybody will just pay them and go along their merry way.” The estate tax probably causes more costs to the economy in terms of people spending money planning to avoid it than it actually raises. I believe the Joint Economic Committee of Congress studied this matter and said it’s quite possible that the tax costs more to the economy than it delivers in the form of revenues. [42:26]
JIM: You know, it’s amazing because here we are in an election year and you’ve got some of the candidates literally proposing trillions of dollars. It’s almost like every single week they’re on the campaign trail, it’s a new spending program. I mean where in the heck – I mean we can’t even manage and account for the money that we’re spending now. Where in the heck are they going to get the money to pay for these trillions of dollars in new programs?
PETER: Yeah, they certainly aren’t going to be able get it from those ‘rich people behind the tree’ as many of them like to say. In fact, even if the top two tax brackets were allowed to go back to their 1993 or 2000 rates we would barely be raising 50 or 60 billion dollars, if that, after you work in all of the avoidance costs. [43:34]
JIM: You know, Peter, one thing that you just hit upon is I’ve been involved in this financial industry for over 30 years and every single time tax rates go up, you know what wealthy people do – they avoid it. They can hire the legal team, they can hire the accountants, they can go into tax-free income, they can do all kinds of things to minimize their taxes, which has proven when you raise taxes the rate of income to the government drops, where when you lower taxes the rate of taxes coming into the government income rises. You remember when Bush cut his taxes in 2001 and 2002 they said that taxes would go down, instead they went up.
PETER: Yeah, it was actually quite a jump in revenue and the only reason why they didn’t end up balancing our budget was that Congress and the president couldn’t control spending to the degree that they needed to. In fact, if you take a look at the way budget deficit reductions are supposed to occur between now and the year 2011, about three-quarters of all of the deficit reduction is supposed to come from more revenues coming into Washington because of economic growth rather than spending restraint. So when politicians say we are going to reduce the deficit they really mean taxpayers are going to work harder to reduce the deficit – Washington certainly isn’t. [44:59]
JIM: And this is something that is very critical because right now it is widely believed –and I’m one of them – that the US economy is in a recession and the last thing that you do in a recession is raise people’s taxes because that cuts out on the amount of money that they have; and especially raising taxes on small businesses that create most of the jobs in this country. You’ve seen it before and I’ve seen it with my own clients – many of them are small businesses – they stop expanding, they lay off workers, or they cut back and they go “why should I work and expand when they’re going to raise my taxes.”
PETER: That’s exactly what’s going to happen. It doesn’t even take a Bill Clinton to see these kinds of effects when taxes went up in 1993. When they went up under George H.W. Bush, when the third tax bracket was created at 31% and there were clawbacks of personal exemptions and deductions. We saw the economy start to slow – at least we saw the economy not get out of the recession it was in faster – and I think people need to realize that there is an optimal level of taxation in this country and if we exceed it people are going to find it more worth their while to either avoid the taxes through fancy strategies or moving their money offshore, or as you said, they simply won’t work as hard because there is no reward in it. I think this is a natural reaction and for us to deny that wealthy people wouldn’t behave this way is crazy. I mean after all lots of us might, for example, fill up our gas tank at a place that we know where the gas taxes are cheaper, you know, fill up in the suburbs instead of in the city where there’s an add-on charge. That’s tax avoidance just the same way that wealthy people set up a legal tax shelters. [46:57]
JIM: I’m absolutely amazed – that Charles Adams the great tax historian wrote a book For Good and Evil and he also wrote a book called Fight, Flight and Fraud and he tells exactly what happens when you raise taxes. There’s something immoral when the government takes more of your paycheck than what a person earning it gets.
Well, listen Peter, if our listeners would like to find out more about tax issues why don’t you give out your website which has excellent information on tax related issues to the average voter.
PETER: Yes, they can visit us at ww.ntu.org – initials for National Taxpayers Union – where they will find our ratings, a chart on the distribution on the federal tax burdens and lots of other interesting information on how the government’s wasting our money and what can be done about it. [47:46]
JIM: All right, Peter, appreciate you joining us on the program. I wish you could give us a happy report but every year I take a look at your report the numbers keep dropping and getting worse. And you know, the latest stories about credit cards is just one more illustration of that example. Thank you so much.
PETER: My pleasure.
CHARLIE GIBSON: You have however said you would favor an increase in the capital gains tax. As a matter of fact you said on CNBC and I quote, “I certainly would not go above what existed under Bill Clinton,” which was 28%. It’s now 15%. That’s almost doubling if you went to 28%. But actually Bill Clinton in 1997 signed legislation that dropped the capital gains tax to 20% and George Bush has taken it down to 15%. And in each instance, when the rate dropped, revenues from the tax increased; the government took in more money. And in the 1980s, when the tax was increased to 28%, the revenues went down. So why raise it at all, especially given the fact that 100 million people in this country own stock and would be affected?
BARACK OBAMA: Well, Charlie, what I’ve said is that I would look at raising the capital gain tax for purposes of fairness. We saw an article today which showed that the top 50 hedge fund managers made $29 billion last year. $29 billion for 50 individuals. And part of what has happened is that those who are able to work the stock market and amass huge fortunes on capital gains are paying a lower tax rate than their secretaries. That’s not fair. And what I want is not oppressive taxation, I want businesses to thrive and I want people to be rewarded for their success. But I also want to make sure is that our tax system is fair.
JOHN: Well, all of the currencies of the world are now in an inflationary position. I think John Williams was saying our supply was what? 16% a year is what we’re looking at.
JIM: Actually, in the 17 to 18% range.
JOHN: That’s incredible when you really think about it.
JIM: Probably the fastest money supply growth in the history that we’ve seen. You’d probably have to go back even to – gosh, I don’t even know – the 70s and I think we’re even exceeding those levels. [50:42]
JOHN: No wonder why prices are rocketing up. And of course, this has a double effect because as energy pushes prices up to simply because everything we do, make or consume in this culture is oil related; at the same time we have inflation pushing us up, so that really a double demon there. You know we’ve been talking about the global money supply and rising inflation since 2004, as a matter of fact when you wrote a piece I remember called The Great Inflation. Back then the chitter chatter was worry about deflation and some people are still worried about that. Definitely I don’t think we could brand anybody on this show in that camp and this probably goes back to its basic fundamentals in Austrian economic values and views.
JIM: We’ve talked, I’ve written about this, we’ve spoken frequently here on the program that governments and their central banks can postpone or mitigate the effects of a recession by pumping more money, expanding the money supply. However, this comes at a cost and that cost is a higher rate of inflation which is really what we’re starting to see now. I mean the PPI numbers and the CPI numbers – the PPI number is up 7% year-over-year; the CPI numbers are up over 4% year-over-year. So we’re starting to see that, but the blame is often off-loaded to, well, it’s higher oil prices, or gee, it’s higher food prices. Well, what’s causing higher oil prices, what’s causing higher food prices. So they always talk about inflation in terms of the symptoms and never acknowledge its root cause. [52:19]
JOHN: You’ve often explained the steps by which they postpone the process – and by the way, the off-loading of the cause ultimately prevents you from effectively dealing with it. That’s important to recognize as a phenomenon of political life even though we can figure out what’s wrong, if you can’t get the right answer you can never solve the problem. Perhaps we should review the steps by which politicians largely, and the banking establishment (the Federal Reserve here in this country) try to postpone the process. But that’s all it is: a postponement of the inevitable.
JIM: If you take a look at this, when you have a bust and you have an economic recession you can postpone or mitigate some of the effects of the recession but it involves more money printing. You’ve got to expand credit, you’ve got to do so and accelerate the credit expansion and money supply. High powered money is growing at close to over 17% a year. Governments have three choices in terms of avoiding or mitigating. You have people now admitting that we are in a recession but they’re saying that well, it’s going to be a mild recession because of the stimulus programs and because of the steps that government is taking. However, you can postpone the crisis but the strategy of increasing credit expansion in order to postpone the crisis or mitigate cannot be indefinitely pursued.
And sooner or later, the crisis will be provoked by a number of factors which brings you in to another crisis which also eventually gives you the recession or in a worse case a depression. And there are a number of ways that can happen. One, the rate at which credit expansion accelerates either slows down or stops due to fear experienced by bankers and economic authorities. What are we seeing today? Bankers saying: “You know what, I don’t trust other banks, I don’t want to loan to other banks, I’m tightening credit, I want more money down, I’m not willing to talk to certain people unless they have a certain credit score.” The moment that credit expansion ceases to increase at a growing rate or even begins to increase at just a steady rate or is completely halted then the day of reckoning begins to take root.
A second way that this problem can eventually bring you back to another crisis is credit expansion is maintained at a rate of growth which nevertheless does not accelerate fast enough to prevent the effects of a reversion back to normal. In other words, lenders get more cautious or you even have an ordinary growth rate of credit instead of an expanding rate of credit. So the sharp rise – and then there’s another problem that kicks in here and thus when the crisis and the economic recession hits, which is where we’re at now, you could see a sharp rise in the price of consumer goods and a simultaneous increase in inflation and hence higher rates of unemployment. And we’ve got all three of those. We’re in a recession, we’ve got higher rates of inflation and you’ve got rising unemployment. So all the authorities can do with these artificial interventions is postpone the day of reckoning. And finally you can get to a moment –and I think this is the crisis window that you and I have been talking about – where individuals finally realize that the rate of inflation is certain to continue to grow. That’s why you see the Fed always talk about inflation expectations. It’s like, okay, they’re abandoning tracking money supply, you’ve had Fed governors who have said the quantity of money created is no longer important, what is more important is can we keep the people fooled. That’s why they always refer to the inflation expectations. And once people wake up and say, “hey, inflation is likely to increase or get even higher,” then there is a widespread flight towards real assets along with an astronomical jump in the prices of goods and services. And finally, you’re going to get a collapse of the monetary system – an event which will ensue when a hyperinflationary process destroys the purchasing power of the monetary unit – the dollar here. I mean since 2001, the dollar has lost 40% of its purchasing power.
And I think the next crisis that we’re going to see unfold here is a dollar crisis. I mean you’ve got gold getting whacked on Friday by over $25 – I think it was like $27 an ounce – on the fact that the dollar index was up a fraction. I think it was up about 40 basis points and they go, “oh, a dollar rally,” back up to a little over 72. “oh, I’ll dump gold.” But if you look at all the factors, we know that for example our trade deficit, even though it’s been coming down, remains persistently high because almost half our trade deficit is now going for imported oil. We’re going to transfer over $400 billion to overseas oil producers this year. And that number gets bigger each year, and gets bigger each month, especially as the price of energy rises for both natural gas and for oil.
We’re also still running a trade deficit. We’re running a budget deficit.
And most people don’t realize how close we came to the precipice in mid-March with the bailout of Bear Stearns. A lot of people who are looking deeper into the issue speculate that one of the reasons JP Morgan was brought into the question is because JP Morgan was the counterparty on a lot of Bear Stearns derivatives. So you’ve got the government getting ready to come out with a $400 billion bailout. The idea is, well, if we can bailout Wall Street, why not bailout Main street. So you’ve got fiscal stimulus kicking in, you’ve got monetary stimulus kicking in, you’ve got rising inflation levels kicking in, and you’ve got a surfeit of dollars flooding the globe right now either through our balance of payments or our budget deficits. And all of this, John, is putting ultimate pressure on the dollar. [58:50]
JOHN: I would think by the way, that if we raised capital gain rates again as I think Barack Obama and Hillary are talking about right now, that also wars against protecting themselves in precious metals because obviously the taxation on that is so high. But if we look at the foreign investment in the dollar, you know, it’s almost like a shell game. It always reminds me of musical chairs. People need to stay in dollars right now because it’s sort of the language currency of the world – the default currency. But they’re also looking over their shoulders, don’t you think, at any indication that maybe it’s going to stop being that currency at which point there will be this rush to get out of them. Everybody tries to get out before everybody else gets out.
JIM: You don’t even need to have foreigners dump Treasuries for you to have a dollar crisis. Just the fact that they buy less Treasuries. Ultimately, if this crisis continues... there was an editorial in the Wall Street Journal a little over a week ago that said “look if the Fed doesn’t start monetizing, with the way the crisis is developing you’re going to have the government ending up nationalizing a good portion of the mortgage industry.” In fact, if you look at the Dodd or the Frank plan, you’ve got the government under the Frank plan owning 5% of your mortgage if it’s refinanced through Fannie and Freddie. A couple of years ago they were going after Fannie and Freddie for accounting problems and capital inadequacy. Now they’re lowering the capital requirements for Fannie and Freddie and they want them to expand going out and buying mortgages as a way of sopping up some of these mortgages that are under right now.
So with all of this is the environment for the gold market in my mind has never, ever been better. You’ve got a lot misperceptions out there, just like you’ve got people telling you, “well, you shouldn’t own gold.” You’ve got Treasury rates that are half the stated official inflation rate. You’ve got headline inflation running over 4%, you’ve got Treasury yields at 2%. Even Treasury notes which have been backing up lately, you’ve got the 10 year note at a little over 3 ¼% that’s still below the inflation rate, and we know the inflation rate is understated. And you cannot have the type of monetary and fiscal stimulus that is occurring now in the United States with the fragile financial system that is going to take even larger bailouts, it’s going to take fiscal bailouts to put the market at rest.
And it’s not just what is occurring here as we had Jeff Christian on a while back with his Gold Book where he talked about we have got record gold buying for almost eight consecutive years. This year 2008 could be another record year and I mean they tried to take gold down today and it came back toward the end of the day and it’s still down for the day, but we’re right at where we started the week. And anytime they take it down, buying just comes in and gets stronger. I mean everywhere I look money supply growth rates in Russia are 44%, in India they’re 24%, in Denmark they’re 22, 22% in Australia, 17% in China, 17% in Brazil, 13% in Mexico. And Mexico could have a real problem if the decline rates continue at 20% on Cantarell. You’ve got UK money supply growing at 12%; Korea 11%. In Europe it’s 11%. You have even M2 in the United States is closer to 7% now. The environment for gold has never been better and I would just look at days like we had on a Friday, I was like a kid in a candy shop all week this week whether it was buying bullion or buying my favorite juniors. [62:45]
JOHN: Well, you know, last time we hit right around a thousand on gold, and then of course it pulled back and I think people had wondered how high it was going to go. Obviously the perception of the general market is not that gold is the way to go, but there will come a point when the attention of the public at large turns towards that and then you see the next take off in the bull market as everyone else jumps into that. What is it going to take to get us there?
JIM: I think you’re going to see a mini dollar crisis here. I mean the dollar is not about to be replaced as the world’s reserve currency, the euro is in no shape to replace the dollar nor is the Japanese yen or the yuan. But what you are seeing is central banks and institutions are diversifying more and more out of the dollar. They own dollars but not all of their portfolio is in dollars. But I think you could see a situation here where you have the dollar begin to break down and when that happens you could see the euro go from roughly a $1.58 to maybe $1.75 or even $2, and at that point you’re going to see the European central bank change its tune and cut rates. And if that happens, because even if they try to intervene in the dollar right now to prop it up, I mean with the interest rate disparities by so much higher interest rates in Europe and other place on the globe, then what we’re having here –and also considering the Fed will be cutting interest rates probably about another quarter point at the end of the month – that disparity in interest rates is going to widen which even weakens the dollar even further. Which is maybe one reason why they’re trying to hammer it right now ahead of what’s coming because they’re real paranoid right now of gold going over 1000.
But a currency crisis can overwhelm and I think what we're going to do is face a currency crisis. With that currency crisis you see the central banks begin to cut interest rates; we’ve got Canada and the UK already joining with the US. And that currency crisis produces a massive flood and then what you’re going to see accompany that is massive monetary injections and with that you’re going to see a boom in the stock market and all asset classes and gold stocks rising with general stocks and we get to that creamy filling. The only thing difference is this time is as nominal values are going up in the stock market, you’ll also be seeing the gold stocks rise with that. So I think the next catalyst to come to the gold market to ignite it is going to be a currency crisis. [65:24]
JOHN: What would trigger that and then sort of how would it appear to the public, how will it be different from the subprime mortgage from the public perception?
JIM: I think you could see more financial fall out, more losses, it could be a hedge fund, it could be further losses within the brokerage or banking industry because remember every week you’ve got the pundits telling us that all right this is a bottom in the financial crisis just like they did last February in 2007. Remember when we got the blip in February and March, they go “that’s it, crisis over.” Well, guess what? Six months later in August we were facing a bigger crisis. So we still know that for example in California things are actually worsening on the mortgage front. And California is one of the epicenters for the credit bubble and the housing bubble. It’s one of many, I mean it’s not just California; it’s Florida, Nevada, place like that where you saw this huge influx buying of homes at ridiculous prices with no money down. So it could be a governmental crisis. I mean what are people going to do when they have the stimulus program, depending on how that’s structured. So maybe the Fed cuts again in May and you get some kind of currency crisis. But I think we’re headed for a currency crisis here. We’ve got a rising trade deficit because of higher energy prices. We’ve got rising budget deficits. I mean think of the stimulus program. And they’re coming up with new stimulus program on top of that; I mean they’re not done with this yet.
JOHN: It’s also interesting too, if you hear in the debates politicians are sort of caught between a rock and a hard place: they want to keep jacking taxes because they talk about their own deficit, but the welfare of the government side of the deficit doesn’t really necessarily impact the taxpayers welfare; does it? They’re almost warring against each other, right now. And that’s what the discussion is, and that blurs back and forth if you’ve noticed that. There’s a blurred area in people’s minds about need to balance budget versus the need to stabilize the economy.
JIM: Yeah, and at this point monetary policy cannot handle this. It’s not capable of pulling it out and that’s why we saw the fiscal stimulus bill, the helicopter drop that’s coming next month, now they’re working on stimulus 2 and stimulus 3. And stimulus 2 is going to be a mortgage bailout for Main Street.
It was interesting, I was reading a report to shareholders by a very well known fund manager in the fixed income area and he said what they’re doing with contract law with this new program –where the government wants mortgage companies or banks to write down mortgages – in exchange for writing down the mortgages they would then have those mortgages refinanced by Fannie and Freddie. He said now they’re changing contract law and the validity of contracts are going to be less secure. He said “we in the future will demand higher rates of interest as a result.” And remember, one of the provisions in the mortgage bailout was to leave it up to bankruptcy judges to decide artificially what a person’s new mortgage and interest rate is. So when you start violating contract law and property rights like that, those who then make the loans or the creditors in this case, in order to protect themselves are going to demand higher rates of interest, which I think this gets back to my Oreo Theory that at the end of the year the hard, outer darker shell after the creamy filling is going to be higher inflation rates with higher rates of inflation.
In fact, one of the next big plays that may be coming is shorting the Treasury market because if there’s a bubble out there it’s not in commodities, it’s in the credit markets. When you have bond yields that don’t even cover the rate of inflation. In fact, one of the plays right now that is working out well, we’ve seen Treasury yields back up tremendously. I mean even on this Friday we’ve got the yield on the 2 year note at 2.16, so if the Fed cuts to 2% you could have a mini crisis here. [69:24]
JOHN: So I guess what we’re seeing here generally then is what is going to shove gold prices contrary to efforts to hammer it down is going to be some kind of a currency crisis. What are we going to see it? The early part of next year?
JIM: No, I think we’ll see it by summer.
JOHN: Oh really, that early!
JIM: John, you can’t be doing the kinds of things that we’re doing. I mean we’re spending money with stimulus programs like drunken sailors; our trade deficit, even though it’s been going down because we’re exporting more than we’re importing the other problem is half the trade deficit is what we’re importing in energy and we’re not done with this crisis. We’ve seen a good portion of it but there’s still more to come. [70:03]
JOHN: So basically what we're seeing is we’re seeing a catalyst in a currency crisis which will cause the next round of runs in the gold market and what we need to do in the next segment coming up is look for a way people can profit from this run.
You’re listening to the Financial Sense Newshour at www.financialsense.com, online all the time.
[52:48]
JOHN: Have to sink back into that one. Welcome back to the next hour of the Big Picture. Just be thankful, Jim, we don't sing too much on the program here. That would drive off most of the listeners
JIM: Maybe we can hum together.
JOHN: I like that idea. Well, in the last part of the Big Picture, in the last hour, we talked about the fact that we are expecting more catalysts to drive gold prices even higher. Obviously, energy prices are going to keep going up. We're talking about that $125 a barrel here real shortly. We were just looking at 115 right at the end of the week. So given the fact that these markets are moving in that direction, where can we capitalize our investments in this?
JIM: Well, you know, basically, John, if you take a look at what's happened in the gold market – and especially last August when gold took off from the 650 range and went all of the way up to over $1000 – in the last probably since May of 2007, the gold stocks have been consolidating. Last year the major gold stocks underperformed bullion. I think bullion was up over 30% and the HUI was up only 20%. And then underperforming the major gold stocks were the junior stocks. I mean a lot of juniors had negative years last year. It's pretty much the same story this year. You've got a lot of juniors not doing that well this year overall.
And money has gone back into the gold market, but once again it's going into the large cap stocks, so as a result, you've seen a disparity between, let's say, what is happening with the large cap stocks, you know, the big stocks like a Goldcorp, Yamana, a Barrick, let's say an Agnico, who are seeing their stock prices even on the day that you and I are talking, a day when gold was hit pretty hard, you know, you're still looking at Agnico's stock is up roughly 32% this year. If you look at Yamana, Yamana is up 11 ½% this year. If you look at Goldcorp, Goldcorp is up 22%. If you look at Kinross, Kinross is up roughly almost 30%.
So, once again, the money is going in the big, liquid stocks. And as a result, the juniors have been sort of lagging, and I think there is a little bit of a caution in the market because people are saying, “boy, I'm worried about liquidity,” so they are piling up into the large cap stocks. But by the same token, because a lot of these smaller producers are selling at incredible prices, I think you're going to see consolidation in this industry. [2:44]
JOHN: Are there any examples so far that would show us this is already happening something under way?
JIM: Well, absolutely. I think more recently, you've seen a three-way merger between Metallica, New Gold and Peak Gold. And, you know, you're talking about a veteran in the mining industry, Pierre Lassonde sort of put together a plan to combine all three of these companies, so what you're seeing is three junior firms being put together that will create a mid-size gold producer. I mean Lassonde owns 5% of Metallica and 2% of New Gold and of Peak. But basically in an interview, he said he was fed up with the poor valuations the market was affording. And he said each of the companies on their own, the combined entity will have a market value of roughly about 1.6 billion. It will become an intermediate producer and their combination they'll be sitting on a half billion dollars in cash.
So this is just a harbinger of things to come because one of the things that you're seeing right now is not only are the juniors grossly undervalued, but it even applies more so when you look at the silver sector. I propose a thesis that you can take the three or four junior silver producers, companies that are producing somewhere in the neighborhood of two to three million ounces of silver and combine them together, and, you know, you take a look at a company like Pan American Silver that has a market cap of 3.1 billion, and you put together three or four of these silver companies, they would produce the same amount of ounces, but unfortunately, a lot of these junior silver producers have market caps of 70, 80 million. John, I mean the whole sector has just been so beaten down that it's creating incredible values. And you've got veterans like Lassonde who is value-oriented who are saying, “you know what, this doesn't make sense and here is a way to create value.” And I think this is just the beginning of – you'll see more of this as the price of gold goes up.
I mean if gold goes over 1000, which I think it's going to do here this year and maybe hit as high as 1200 or more, who knows, but then, that will be the catalyst that will bring more of this kind of merger combinations or takeovers. I mean what was it, a little over a couple of weeks ago, Sean Boyd at Agnico was interviewed and he was saying, “look, we made three quarters of a billion dollar in acquisitions in the last couple of years that added 9 million ounces to our balance sheet, and this year we're looking at somewhere in the neighborhood of 1.6 billion.” [5:23]
JOHN: What is genuinely out there that would drive this type of phenomenon? What can we ascribe it to? The disparity in prices or something?
JIM: Yeah. Because you have a market that's nervous and basically since May of last year, you've got people trading in and out of the market, they go in, they go out, so you know, you don't have a lot of long term holds in here. So much of what you see today in this sector is momentum based. You know, something is going up, people jump on board, they ride it, when it starts to go down, they jump off the ship. And so you have a lot of this kind of momentum trading that's taking place.
Also, with the credit crisis, you've got a lot of people saying: “You know what, I don't know what the heck is out there, I'm a little frightened at what I see. We've got rising inflation, we've got credit problems, so, okay I’ll go in the gold sector. But in case I have to get out, I want to parachute.” So that's why they are going into the large liquid stocks, but as a result, you've seen a large disparity where you've got, you know, large cap companies like Agnico that are selling over $600 an ounce. You've got companies like Goldcorp that are selling at almost $730 an ounce. You've got companies like Yamana that are selling at close to $730 an ounce.
And one way to create value, and I think this is what Sean Boyd was referring to: If I have paper that's selling for over $700 an ounce or $600 an ounce, how can I create value? Well, I can create value by going out and buying a company that's a late stage development play much like Agnico bought Cumberland, and you can buy ounces in the ground at a much, much cheaper price. And especially today, John, when you have got, you know, gold prices that are still holding up over $900 an ounce. At $900 an ounce, you know, gold mining companies, I think, are going to surprise a lot of people that they are going to make a lot of money in this kind of environment. At $900 when the average cost has risen to $400, you're making $500 an ounce of what you mine. That's a good profit margin here. [7:34]
JOHN: You know, if we compare the junior sector when a gold mining company goes out and tries to bring in a gold mine, it looks like a lot like the oil situation, as a matter of fact, out there because when you go out, you find something. First of all, you have to deal with national issues if you are in a particular country and always the risk of nationalization or whatever else happens to exist in that environment. And speaking of environment, environment is the next thing: What does it take to get your mine up and running and complying with all of the laws and things related to that? It takes about 7 to 10 years to do this. It's a much longer process.
JIM: Yeah. And that's exactly why, like late stage development plays, you know, you pick up a mine, you can pick it up for, let's say, a late stage development play for 100 bucks an ounce. Maybe it's going to cost you a couple of hundred dollars in capital expenditures. It may cost you $300 to mine, and your total cost is somewhere in the 4- to $500 range. With gold selling at 900, it's very profitable to go out and buy these companies; and more so in the fact that you can basically shortcut the development process from a 7 to 10 year period to, let's say, a three or four year period. In the case of Agnico’s purchase of Cumberland, they are going to bring Cumberland into production within a three-year period. So instead of 10 years, John, you're looking at three years and that makes a heck of a lot more sense for a mining company because, you know, who knows the risk. You know if you discover something today, where the gold market will be 10 years from now it's much easier to take a look at there is strong demand now, if I buy something the economics are in my favor, so something that I can bring into production in two to three years makes a heck of a lot more sense than trying to go out and discover something and bring something into production 10 years from now. 10 years from now if I'm the CEO of a company, I may be heading into retirement, so there is a lot more pay back in terms of share price of growing your production now versus growing it 10 years from now. [9:40]
JIM: If they are going to unfold and develop in the way that you think they are going to, what particular charact