J. Taylor's GOLD & Technology Stocks
Gold, Uranium, Base Metals & Oil Are Heading Much Higher
Dr. Michael Berry Explains Why

Jay Taylor
Nov 20, 2006

Dr. Michael Berry
Michael Berry has been a portfolio manager for both Heartland Advisors and Kemper Scudder where he successfully managed small and mid cap value portfolios. Dr. Berry has specialized in the study of behavioral strategies for investing and has been published in a number of academic and practitioner journals. His definitive work on earnings surprise, with David Dreman, was published in 1995 in the Financial Analysts Journal.

Previously, Dr. Berry was a professor of investments at the Colgate Darden Graduate School of Business Administration at the University of Virginia and has also held the Wheat First Endowed Chair at James Madison University. Dr. Berry is a respected and dynamic speaker. He regularly presents around the world on topics such as value investing, the role of Austrian Economics in investment management, behavioral investing strategies and is a specialis t in developing case studies to teach investors how to invest. While a professor, he published a case book, Managing Investments: A Case Approach.

Berry has recently focused on the role of precious metals in the asset allocation of the individual investor. Dr. Berry publishes Morning Notes by Michael Berry, Ph.D. daily. This publication is distributed to clients worldwide to identify current market opportunities and behavioral anomalies. Your editor caught up with Michael from his New Jersey home before he headed off to lecture fellow economists at the Federal Reserve Banks, Treasury, Comptroller of the Currency and other statist bureaucracies on November 1st and we were fortunate to get a preview of what he was intending to tell all those folks who generally bow to Keynesian orthodoxy. I consider Michael a friend ever since another good friend and successful investor from Canada, namely Alex Macdougall introduced him to me at the New York Gold shows a few years ago. We think you will find Dr. Berry's views interesting and helpful in navigating the increasingly troubled waters for investors and American citizens as a whole.

TAYLOR: Dr. Berry, thank you for allocating some of your precious time for our subscribers. I first was introduced to you at a New York gold show a few years ago by a very astute Canadian investor. At that time, I was a staunch deflationist. I have since moderated those views somewhat. I was very encouraged to learn that while you had been a college professor and as such mandated to teach Keynesian economics, you came to the conclusion that that economic theory was riddled with falsehoods. Correct me if I am wrong, but I believe you concluded and still do believe that Austrian economics as a theory of economics much more accurately reflects the world and how it really is than Keynesian economic theory. I don't want our discussion to involve economic theory. Have I explained your professional past accurately?

BERRY: Yes. You have indeed, Jay. I taught at the Darden School at the University of Virginia for eight years and then I taught at James Madison University. I subsequently left there to become a practitioner but also because I did feel that the theories we were teaching in economics and investments were bankrupt. I think that is being proven out today in the marketplace.

TAYLOR: I understand you have been invited to speak to economists at the Federal Reserve Bank in Washington this Wednesday. I am aware of a recent slideshow you have given. Is it possible you might be hitting on some of those same topics when you speak to Fed economists this week?

BERRY: Yes. It's actually a three-hour lecture, so what I tell the Fed will be quite a lot more complete than the slides I sent you which represent a very short presentation. But the theme will certainly be the same. I will try to make sure the economists and bankers at the Fed understand that when you look at real assets, values have moved up significantly over the past four years.

TAYLOR: I wish you well in getting your message to these folks. I would like to focus on your recent slide show your slideshow, which you titled "The US Economy: Expectations"; I think you are hitting on some very important items that can help us determine where we are heading in the near term regarding the inflation/deflation battle that I think is perhaps the most important question of all. For the sake of our readers, the show was dated October 20, 2006. So can you respond to some questions I have regarding your presentation?

BERRY: I would be happy to.

TAYLOR: First you talked about interest rates. Most notably, you brought up "Dr. Greenspan's conundrum." After Greenspan used that word a couple of times, we heard countless numbers of Wall Street talking heads suddenly discover the word "conundrum" and begin to use it as they began to parrot Greenspan's discussion. Can you refresh our memory and tell us what was meant by Greenspan's conundrum?

BERRY: In February 2005 I think he first started using the term. Jay, I think it was startling for a lot of people to hear that term used. The idea that the head of the Fed, ostensibly the most powerful person in the world, would believe there was a conundrum in interest rates. As I understand it, the issue he could not understand was why are interest rates on the long end of the yield curve remaining so long when there is so much liquidity being injected into the economy. We had interest rates declining between 2001 and 2004 from 61/2% to 1%. And we also had significant printing of fiat currency in the economy, so there was all this liquidity sloshing around. In theory it should have inflated the economy. In other words, interest rates on the long end of the yield curve should have risen, thus steepening the yield curve. But just the opposite happened. The yield curve was essentially flat to inverted and still is. There is a small-very small-premium. But in many respects, the conundrum-the thing he didn't understand-probably still exists today.

TAYLOR: In other words, the Fed has been printing billions and billions of dollars. Using conventional economic theory, that should stimulate demand for goods and services which should then start to increase the demand for money as the economy grows. Right?

BERRY: That is the conventional wisdom-both Keynesian and monetarist alike. And were it not for Paul Samuelson (Economics 101 textbook author) we would never have had these theories handed down. But it is pretty clear that in today's world, these approaches, while they worked during WWII and subsequently, have clearly debased our currencies and they don't appear to be working in that sense today.

TAYLOR: Is it possible that what we might have is a bond bubble here? That there is so much money going into the system but given paltry returns on investment, they keep on buying long-dated paper, thus pushing the price down? Is it possible we have a bond bubble?

BERRY: That is certainly possible. It was interesting to hear the PIMCO people talk about how now is a good time to go long in the bond markets. I really just have not agreed with that. I think part of this conundrum is a result of the enormous trade imbalances you see in the world-the enormous amounts of dollars that are now literally floating around the world, especially in China, which has about a trillion dollar surplus at present. That money is being recycled into the bond market. I think that probably more than anything else explains why the rates have remained so long.

TAYLOR: So the Chinese choose to buy U.S. Treasuries for whatever reasons. Why do you think they are buying U.S. Treasuries?

BERRY: Because the U.S. has a habit. That habit is consumption. The Chinese still have to rely to a great extent on their export economy, although their domestic economy is starting to develop quite nicely. But that is still a few years off. But China doesn't want to ruin the game here, so consequently, I think they have continued to recycle their trade surplus into the U.S. Treasury markets accordingly.

TAYLOR: I recently read an article from the Economist that talked about the surging demand from within China. While there is still a relatively small middle class, in sheer numbers the middle class is growing rapidly, so that China is less dependent now on the U.S. than it had been in the past. Bernanke has made the statement that the reason we have the conundrum in the bond market is that we have excess savings in the global economy. Would you agree with that?

BERRY: We may, but we don't have it here in this country. Yes, I would agree with that if you look across the world. China is a prime example. They don't really have many consumer goods to buy yet, so there is excess savings there. But certainly not here. I also heard Bernanke say about three weeks ago that Americans need to save more. He wants the U.S. consumers to keep on spending to keep the economy from deflating, but he also wants them to save more. He can't have it both ways.

TAYLOR: Interest rates have been rising, but you state they are still very low. Could you explain?

BERRY: We still have a basically flat yield curve and it is about 5%. Actually it's less than that. It's closer to 5.8% or 4.9%. Just in the last three days we had three significant declines across the entire yield curve. Again we talk about this conundrum. The yield curve is very low. If you look at the mortgage rates, they are up only about 100 basis points in the last couple of years. Thirty-year mortgages are now only at about 6.2%, or only about 100 or 150 basis points over the 30-year Treasuries. But in some sense I think it is extraordinarily important that interest rates stay low for this economy. I think it would be a disaster to have much higher interest rates, because we have refinancing in the mortgage sector that would be quite disastrous.

TAYLOR: I would like to ask you about inflation rates relative to interest rates. I believe you stated that you think actual inflation rates are 2% or 3% higher than the government acknowledges. What is the current CPI year over year?

BERRY: I saw one estimate of the CPI at 2.9%. That is much higher than they want it. It is much higher than Jane Yellen or Dr. Bernanke officially want it, or Dr. Lacker or any of them want. That is an uncomfortable number. But I have never been a fan of the CPI, because we don't have energy and food costs in there and those are two very critical components in the economy. I would rather use the PCE (personal consumption expenditure number), which is somewhere between 3% and 6%. So, I believe inflation is much higher than we are told it is. I just sense it from the kinds of transactions I do daily, and I think most people who read your work and my work believe the same thing. So we have very slow growth, very low rates, and pretty high inflation rates. Either the bond market isn't doing its job, which is possible, or we are in for a stagflation here.

TAYLOR: You mention there is an inflation/deflation tug-of-war going on. There are inflation hawks at the Fed who express grave concern about inflation rates at 2.9%. And then you state that the real rate of inflation is at least 2% to 3% higher than the government's numbers suggest. Can you give some general explanation as to why the government's numbers are understating the erosion of our dollar purchasing power?

BERRY: I think this is the central issue that I want people to understand. There is an inflation/deflation war. You and I have talked about this quite a lot. It is not clear which is going to prevail in my mind. But the interesting thing is that within the Fed there are two camps. To my knowledge, this didn't happen in the Greenspan era at all. But you have one group within the FOMC (Federal Open Market Committee) who believe we have not raised rates enough. If you look across the pond in England and continental Europe, they look at headline inflation and not core inflation as our Fed does. And they are still raising rates. But in our camp we have one group-Dr. Lacker is in that group-who think inflation is much higher and we need to raise rates. We have another group-that would be comprised of Bernanke and Jane Yellen from San Francisco Fed-who are willing to live with higher rates of inflation. It is a very clear, philosophical shift toward what Dr. Bernanke has written on, namely, inflation targeting. It is really a fancy way of saying that we will tolerate higher rates of inflation but we have to have growth. I think it comes back to something you have written about in the past years. Bernanke is more worried about deflation than he is inflation. That is my expectation about how they are thinking at the Fed now.

TAYLOR: Do you think the Fed is trying to manipulate the psychology of the American people by way of its propaganda machine? Is the Fed perhaps worried about expectations of inflation rather than the actual rate of inflation? Might the Fed be attempting to manipulate the mindset of the American people and thus give themselves more leeway to print more money to ensure ample liquidity to keep the game going awhile longer?

BERRY: Yes. It will be interesting to see it play out. It is simply a different Fed than we had under Dr. Greenspan. Expectations of inflation worry the Fed more. We just live with inflation now. No one can deny it. But the expectation of inflation-and usually higher gold prices-is a precursor of higher inflation. I think all of the real asset prices moving up has been a precursor of higher rates of inflation. When that happens the Fed likes to sell gold and knock it down to keep anticipation of inflation down. But they have not been successful at controlling inflation expectations. I think that is their biggest worry.

TAYLOR: The gold price has not behaved well for them.

BERRY: No, it has not. At $721, gold was way too high. It had gone parabolic, as did all of the metals. Copper had gone to $3.90 and silver was at $15 per ounce, so they knocked it down. But all of them have bounced back quite nicely.

TAYLOR: The long-term charts I look at appear very bullish. I think gold got ahead of itself and this is a very healthy correction we have had.

BERRY: Very much so. You and I would agree on the issue of debasing the currency and what a fiat currency is. I'm not sure that the alternative to the dollar is not now a real asset base including, most importantly, gold. I certainly talk to a lot of people who are buying gold and silver coins. You can say I have a selection bias, but there are a lot of them out there.

TAYLOR: Bernanke is jokingly known as "Helicopter Ben" because he used a picture of helicopters swarming across America to emphasize the need to print as much money as possible to overcome an economic deflation such as the Japanese were experiencing at that time and as we experienced in the 1930s. But then, about the time he became Fed chairman, it seemed the establishment was spinning his image as an inflation fighter. His views of setting targets for inflation suddenly began to paint an image of an inflation fighter rather than one who would fuel the flames of inflation by printing excessive amounts of money. But you point out that he co-authored a paper hinting that rates of inflation of up to 10% or so may not be problematic. Is it possible that, while Dr. Bernanke is spinning a tough inflation fighting line, behind the scenes he is in the process of printing huge amounts of paper money? And if so, what does that mean for precious metals, base metals, and energy prices?

BERRY: Your question is right on target. Bernanke not only wrote a paper, he also wrote a book titled Inflation Targeting Lessons from the International Experience, with Fred Mishkin and several other people. I'm sure he wishes he had never said that, but he pointed out the 10% level. He said that it is unclear if inflation rates below 10% are harmful. I can't prove this, but in my mind but I think they have no choice to provide liquidity to the market. I think they are printing like crazy right now. It is clear that Bernanke's bias is stimulating growth at any cost. That would be 2%, 3%, 4%, 5%, and 6% up to 10%. I won't say 10%, but he said it in his book. And of course you point out the image of Helicopter Ben. I'm sure he wishes now he had never made that comment. But it was in 2001 when he was an aspiring Fed chairman. He made the connection between gold and U.S. dollars. He said they have value only to the extent they are strictly limited in supply. Of course gold is strictly limited in supply. U.S. dollars are not limited in supply in any way. That is where we are today, so I think the dollar has to fall, and that is very bullish for gold and other tangible assets.

TAYLOR: Why do you think it is so necessary that he has to keep pumping money into the system?

BERRY: I'm not sure I can answer that question well. But here is a man who wrote his Ph.D. thesis on the Great Depression. So I think in his mind-this is just my opinion-but having written a dissertation once, I think in his mind the greater evil in the world is deflation and lower growth and he would rather take the risk of inflating, and he is doing that now.

TAYLOR: Do you think he is worried about housing?

BERRY: Absolutely. I think housing is of great concern to everyone in Washington. I have to think the Bush Administration is holding its breath right now. Housing doesn't look good right now. I don't think anyone can say for sure whether there will be a soft landing. The positive spin is that it hasn't happened yet, there is no hard landing. But we have seen dramatically big default rates in California. In the third quarter of this year, there were 26,000 or so defaults, which was double the number of defaults in 2005 in the same time period. And last week, we saw some of the biggest declines in housing prices in 15 years. I think the jury is out on real estate. We don't know how far it will fall or when it will fall.

TAYLOR: I made the mistake of selling my house too early. Mrs. Taylor and I would like to have a house again, so we have been watching the markets here in New York City. On Sunday we went over to visit an open house in Forest Hills, which is one of the nicer neighborhoods in Queens. The real estate agent told me housing prices in Forest Hills have "plummeted." Real estate agents usually don't like to paint a bleak picture because they are working for the seller, so to talk in those terms doesn't help to sell properties.

Overall, I think the New York City real estate markets have remained fairly strong because we have the financial markets here and financial markets are about the only sector in our economy that is doing really well. Would you see a major decline in the equity markets as something that could cause a major decline in the financial centers in the U.S.-in cities along the East Coast and, to a lesser extent, the West Coast?

BERRY: Yes, and I think the equity markets are very overbought here. The key element in my mind, Jay, is the way the housing sector has been financed with one-year variable-rate mortgages that have to reset at some point. And that is one reason why I think the Fed has to keep rates low. Maybe it's the best of all worlds now for the Fed. But the consumer has been the savior of our economy and to the extent the consumer goes away in the U.S., that is very problematical. Somehow oil fell from $78 to $58 and we had gasoline prices plummet from $3.25 to $2.08 today. And those declines have really helped the economy a great deal. But if the consumer is unable to continue fueling growth, then this economy is slowing. By the way I saw statistics this morning and this economy is starting to slow significantly.

TAYLOR: Then that would bode well for an even more rapid rise in the printing of paper money.

BERRY: Absolutely! I don't see that there is any way around that. I can't imagine rates being raised in this economy. In fact, as I said in my presentation, I think we will see interest rate cuts in the overnight lending rate much sooner than most anyone expects.

TAYLOR: And then a steepening in the yield curve as people begin to opt for more liquidity and shorter-term rates?

BERRY: Yes. Absolutely.

TAYLOR: Is it possible then, Michael, that we might see foreigners have less of an appetite for U.S. Treasuries and that would cause a steepening in the yield curve as they buy fewer long-term Treasuries?

BERRY: Yes. I think that is exactly right. Yesterday I saw a senior official in China talk about how they were happy about their trade surplus, but they noted the fact that they only had 1.2% invested in gold and Japan was 1.8% and they quoted the Europeans as having 25%. And they said they were going to start diversifying away from Treasuries and into assets like gold. So that would also push the price of gold up significantly. That may be why the price of gold is up some $10 this morning. I think we will see interest rates start to move up generally and we will see the yield curve steepen, and that could be really interesting for our economy, given that there are a lot of mortgage resets out there.

TAYLOR: If foreign capital stops flowing in here as it has, might that not force the Fed to monetize our debts and thus cause a real inflationary spiral?

BERRY: Let's hope not. But that is true and it will be interesting to see how our representatives-and maybe Congress is also a big problem here-perhaps they simply don't understand what is happening. We could have higher inflation and slower growth, and that is not a very appealing prospect.

TAYLOR: Because housing is such an important part of our economy and where it is, I want to get back to that topic for a moment. Adrian Van Eck, a very well known investment analyst and former speechwriter for Nixon and Reagan, has recently said that Bernanke will pump massive liquidity into the system, and as a result he thinks we are near the bottom of the housing decline. Do you think that is possible?

BERRY: They will pump massive amounts of money in. I agree with Adrian on that point. I wish I could be more positive on housing, but right now what we are seeing is not very appealing for the housing market. We are seeing growth in the default rates and prices are falling. As long as interest rates stay low, we may be able to squeak through here. But if interest rates begin to move up, it will be very problematic for the housing industry. The one great graph that came from Dr. Shiller of Yale-you probably saw that graph on housing prices that he devised. . . . We have had an enormous increase in real valuations in real estate. I believe in regression to the mean and, as you pointed out with the real estate agent, I think we have a way to go on this thing. We might squeak through if rates do not kick up. But if they do, it will be very problematic for the economy.

TAYLOR: But housing is not the only problem you see on the horizon. You mention that our trade deficit is leading to a potential collapse in the dollar, increasing rates of inflation and much higher interest rates. And yet, you also note that the dollar must fall? If you are right, what does that mean for the stability of global markets and precious metals, base metals, and energy prices?

BERRY: First of all, it means the dollar will cease to be the de facto standard of trade in the world. I don't see how over the next decade, what with globalization, the Chinese, the Russians, the Brazilians, the Indians, the Europeans-I think they are going to want to trade in something else, because we have engaged in a reckless debasement in the dollar. So I think we will see a different money, if you will.

TAYLOR: So you think the dollar could lose its status as the world's reserve currency?

BERRY: I think it is certainly possible for that to happen at present. In fact in time, I think it will happen. I don't think there is any way the dollar can be held up. So I think alternative investments such as the metals are going to be very attractive. And there is another issue here. Despite the fact that we might have slower growth here-maybe housing will work out well and we will have a soft landing-but growth in China is still 10% and growth in India is 7% or 8%. I'm convinced there is a quality of life cycle going on in the world and there will be an adjustment in the standards of living around the world, and I think that is happening right now.

TAYLOR: Oh sure. But I think the question in my mind has always been will the U.S. fall significantly or will the rest of the world rise and we stay right were we are?

BERRY: I don't think we will fall significantly, but I think we will learn to be more effective and more efficient. There is absolutely no reason why we have to burn 25 million barrels of oil out of 85 million barrels of oil per day globally. It is nonsensical. So I think there will be some productivity improvement and some efficiencies gains, but I think our quality of life will moderate to some degree, and it is certainly significantly improving overseas.

TAYLOR: Debt is growing much more rapidly than income in the U.S. You show a slide suggesting that in 2001 or 2002 it took over $7 of additional debt money to generate $1 of additional GDP. That figure more recently is down to $5, but the longterm trend, which has risen from a little over $1.50:$1 in 1965, has been rising steadily ever since then. Isn't this trend decidedly deflationary since it means that more and more cash flow has to be devoted to servicing debt than to buying goods and services?

BERRY: Yes, it is. And that may be at the heart of what Dr. Bernanke is seeing and worrying about and why he is so concerned about growth in the U.S. economy. There is a huge debt load underneath our economy and no savings to speak of in this economy either. I think that is problematical of where we are now. It is potentially deflationary.

TAYLOR: I would like to focus a bit on energy, if you don't mind. In a slide titled, "Quality of Life," you show the relentless rise in the price of oil. On that same slide you show a dramatic rise in economic growth for China. You also show a slide depicting a very skinny surplus of oil, from a surplus of something close to six million barrels per day in 2002 to a little over one million barrels per day in 2005 and 2006. You also show a slide titled "Maxwell's Hammer," dated 10/13/06, in which West Texas Intermediate Crude is projected to rise to $85 by 2010, $180 by 2015, and $300 by 2020. Clearly, the dynamics are extremely bullish for oil. Growth in China and India and other lesser-developed countries is dramatic. But recently there was a major oil discovery at great depth off the coast of Mexico. Isn't it possible that, given our technologies of today, we may find huge amounts of oil that may negate these high oil projections?

BERRY: In my opinion, the answer to your question is "no, it's not." Here is why I say that. It is true there may be plenty of oil. But the major oilfields are peaking in places like Saudi Arabia and Mexico. For various reasons they are beginning to peak. And people are, more and more, accepting the concept of peak oil. One of the slides you are referring to was by Charlie Maxwell of Weeden & Co. He published this in Barron's. His view is that the oil is there but it is going to be much more expensive to get to. For example, the oil sands of Canada could produce three million to five million barrels of oil per day by 2015. But it's $50 to $60 oil and it is going to be much higher by that time. More and more industry experts are accepting the fact that some of the easiest oil will come off stream by 2015 and 2020, thereby raising the price. And incidentally, the well you mentioned-it was a Chevron well and it was a $100 million well. So we are drilling these things, but they are vastly more expensive than they were coming out of Saudi Arabia in 1936.

TAYLOR: And might there be technical problems not foreseen yet when bringing oil up from those great depths?

BERRY: Indeed. All you have to do is look at the vagaries of weather. We didn't have any bad weather in the Gulf this year, but last year we did, and some of the production is still offline as a result of the hurricane season. So technologies will improve, but production will be much more expensive-an order of magnitude more expensive so oil has to go up in price. Of course we have only talked about the supply side. The demand side is also significantly increasing around the world. So the way I see it, we have at least a decade, Jay, of no alternative. We don't have nuclear online. We don't have bio-diesel online. Ethanol is clearly not a solution. So I think we have at least a decade of higher oil prices.

TAYLOR: Some very smart people point out that although China is becoming more capitalistic, it is still very much a managed economy. That is to say, economic decisions are made by a committee of statists and not by free market directives. As such, it is hypothesized that sooner or later China is going to suffer a major economic collapse and with that could come a global decline in economic activity that could push oil prices back down to $20 or $30. Do you share the concern that China could implode and lead the global economy into a depression that could send not only energy but also base metals prices into the tank?

BERRY: No. I'm not concerned about the possible implosion of China. I do agree with you that China is a dictatorship. It is rife with problems in its banking system. But it really has a huge surplus, so it can paper over a lot of these things. I believe that other countries such as Brazil, India, and Russia are caught up in a quality of life cycle that will overwhelm everything else that is going on. Could we have slower growth and lower oil prices over the next couple of years? Could we have lower oil prices? Yes, that could happen. But not over the long run. Not over the next 10 to 20 years. I think China is on a road to provide a quality of life for its citizens, and its leaders are being pushed by its citizens to provide that quality of life. Once you have communications like iPods, cell phones, and computers, you can't deny people a higher quality of life, and that is happening all over the world now. So I don't share the dramatic concerns of some. Anything can happen, but I don't think that is going to happen in China.

TAYLOR: They have a lot of environmental problems in China. Water shortages could provide some difficulties for industry, not to mention a quality of life for the people. Any thoughts? And while we are on the topic of water, any water plays you might want to share with our readers?

BERRY: Unfortunately, I wish I had some water companies on my list. I follow a little company called Senesco Technologies. They find a way to produce plants with a lot less water. China has problems. There is no doubt about that. But so far they seem to be able to grapple with these problems.

TAYLOR: Richard Maybury points out that the U.S. military efforts in the Middle East are going terribly wrong. He is convinced for reasons we don't have time to go into now that the U.S. expenditures for military hardware has just begun. He is convinced that trillions of dollars will be spent in the next decade for bombers and other heavy military machinery as the war with Muslim countries worsens. He suggests this is exceptionally bullish for energy prices as well as base metals. Would you care to comment on that thesis?

BERRY: I am very concerned about our war in Iraq. It is certainly not going well. We are fighting insurgents. You and I were both around during Vietnam, and it seems like it's taking some returns that are "déjà vu all over again," as they say. I'm very concerned about what we are spending there and that we are on our own there. I'm also concerned about Afghanistan, which is a NATO effort. I'm trying to get my readers to invest accordingly. By that I mean discovery investing in natural resources. I just don't see any way out of Iraq. I think our leaving Iraq would leave Iran as the major power in the Middle East. I'm sure the Saudis wouldn't want us to leave. I just don't see how this or a new administration could get us out. I think we are stuck there for a while.

TAYLOR: Maybury would agree, and he makes the point that the U.S. since WWII has always used high levels of capital rather than labor in our war efforts. It is hugely costly but results in fewer casualties on our side. So what we do is use all the heavy artillery we can get our hands on, but this is extremely costly, and we are going have to print enormous amounts of money to fund this effort. Maybury believes this is hugely bullish for energy and base metals.

BERRY: I think he is certainly right, especially with regard to energy prices. I keep writing that we need to become energy independent. I keep wondering why we can't have a 70-mile-per-gallon automobile. If we can put a man on the moon, why can't we avoid being dependent on Middle East oil? I just can't understand it at all. I don't think Congress understands it. I don't think the Administration understands it. I'm really worried about our position in the world and about going it alone. I wonder if there isn't another rationale that I don't know about it.

TAYLOR: You travel a lot in Canada, as do I, so you know there is a fair amount of hostility toward America, especially with respect to our policy in Iraq. They think we have really messed things up in Iraq.

BERRY: Yes, that is true. I think we need a North American currency and a North American Free Trade zone. I think we need to support immigration from Mexico. Canada only has 35 million people. It needs people to exploit its natural resources. Canadians are very critical, but as the U.S. goes, so goes Canada in many respects.

TAYLOR: You also mention some other major problems facing the U.S., such as an inability to produce cheap and effective medicines, the graying population, declining birthrates, and the declining U.S. savings rate. Would you care to briefly comment on those points?

BERRY: There was recently an editorial in the Wall Street Journal by Professor Siegel out of Wharton. It's not just a U.S. problem, but it is a worldwide problem. Every country around the world except for India, birthrates are declining. When you and I, Jay, and our colleagues who were baby boomers begin to ride off into the sunset, there will be fewer and fewer workers. There will be more productive workers but instead of 10:1 in Japan and 7:1 in the U.S. as was true during the 1950s, there will be three workers for every retiree. And this brings into issue the sustainability of Social Security and Medicare. Again my admonition is for investors to be prepared for that problem because it is going to be big. In fact, we are now seeing corporate pension plans being decimated now. Now we are into 401-K programs, and if you are taken out of a guaranteed pension plan and put into a 401-K plan, you are basically responsible or at least you are not diversified across the spectrum. So it is going to require a lot more wealth to retire and to stay healthy. From the viewpoint of infectious disease, a lot of what needs to be done, especially in the developing world but also in the developed world, are TB and malaria and some of the viruses that are quite bad. There are a lot of issues that need to be resolved. And while everyone is focused on resources and a lot of money is going into that sector, the biotechs have been largely ignored. That hasn't been a good thing for the health care sector.

TAYLOR: Before we conclude this discussion, I would like to get back for a moment on the topic of housing. Clearly the housing market is of grave concern to you and other smart investor Wall Street folks. What do you think is going to happen? Will we have a soft landing? What will it all mean for the inflation/deflation tug-of-war?

BERRY: I guess I want to be optimistic, because many people say I'm not very optimistic. Somehow-you know John Mauldin always talks about "muddling through"-that is, somehow no matter how bad things look we seem to find a way to get through with no catastrophe. I guess there is a 50/50 chance we will "muddle through." I think this Federal Reserve will liquefy and do whatever they need to do to sustain the housing market. But in fact, the default rates are booming in California, as I noted earlier. But somehow I think we have a good chance at squeaking through.

TAYLOR: Before we finish our conversation, let me ask you about a term you use to describe what you do. You use the term "discovery investing." Can you tell our readers what you mean by discovery investing?

BERRY: The concept is one that I developed when I was managing money for Heartland Advisors in 1998. I was a value investor buying cheap stocks. But value went out of favor as the market began to revere the dot-com stocks. Values stocks- natural resource stocks-were extremely out of favor when oil was selling at under $10 per barrel. I never wanted again to be in a market that was out of favor. But as the commodity market began to kick in, I began to see that if you bought discovery plays and diversified properly and allocated only a small amount, you could create good wealth.

One stock that helped me base my theory was Western Silver. It was a $0.50 stock that was taken out by Glamis, and Glamis is being taken out at $51 by GoldCorp. That deal is still pending, but I got involved with that. In the oil sands, Birch Mountain was an example. And I said, gee, if you could do discovery in natural resources you could also do it in biotech and high tech; and some other things, like Rentech, which I think is a discovery play. I began to see that there were a number of characteristics that are identical across the spectrum. So, I built a discipline using ten criteria to select these stocks. I try to tell people to take some portion of your portfolio that you are comfortable putting at higher risk for discovery plays. Look for the next oil sands project. Look for the next bio-diesel project or the next water project or what have you. If you buy 10 or 12 of these high-risk plays and if you are patient with them and one or two hit, you can create a lot of wealth. Buy them when they are cheap and buy enough of them, and you will create enough wealth. It has worked out well for quite a few people.

TAYLOR: Patience is required a lot of times.

BERRY: People make the mistake, when they make a discovery, of thinking they will cash out instantaneously. I was in Western Silver for eight years, but eventually it certainly paid off.

TAYLOR: Is there a way our readers can take advantage of your wisdom and research?

BERRY: If they will send me an e-mail to ISA529@aol.com, I would put them on my list to receive my Morning Notes.

TAYLOR: Thank you, Dr. Berry, for sharing your views and wisdom with our subscribers. I hope we can talk again about the economy sometime in the not-too-distant future. Best wishes to you in your discovery investing endeavors.

Nov 15, 2006
Jay Taylor

email: jtaylor9@ix.netcom.com
website: www.miningstocks.com

J. Taylor's Gold & Technology Stocks (JTGTS), is published monthly as a copyright publication of Taylor Hard Money Advisors, Inc. (THMA), Box 770871, Woodside, N.Y.Tel.: (718) 457-1426. Website: www.miningstocks.com. THMA provides investment ideas solely on a paid subscription basis. Companies are selected for presentation in JTGTS strictly on their merits as perceived by THMA. No fee is charged to the company for inclusion. The currency used in this publication is the U.S. dollar unless otherwise noted. The material contained herein is solely for information purposes. Readers are encouraged to conduct their own research and due diligence, and/or obtain professional advice. The information contained herein is based on sources, which the publisher believes to be reliable, but is not guaranteed to be accurate, and does not purport to be a complete statement or summary of the available information. Any opinions expressed are subject to change without notice. The editor, his family and associates and THMA are not responsible for errors or omissions. They may from time to time have a position in the securities of the companies mentioned herein. No statement or expression of any opinions contained in this report constitutes an offer to buy or sell the shares of the company mentioned above. Under copyright law, and upon their request companies mentioned in JTGTS, from time to time pay THMA a fee of $500 per page for the right to reprint articles that are otherwise restricted solely for the benefit of paid subscribers to JTGTS.

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