By Ajay Shah, on May 22nd, 2012
Raymond Fisman, Florian Schulz and Vikrant Vig have a fascinating new working paper: Private returns to public office, which gives us new insights into Indian politics.
We know that elections in India are typically rather close. There is something almost capricious about who wins and who doesn’t. The random outcome of an election can, then, be interpreted as randomised allocation into control and treatment. One candidate gets elected, another candidate is very much like him but doesn’t get elected.
We can then ask the question: what happened to the wealth of the bloke who got elected? The authors say that the rate of growth of the assets of the person who won grows by 300 to 600 bps per year when compared with the person who lost.
The strongest effects are observed for a person who makes it to being a minister: his asset returns are 1300 to 2900 bps higher than the person who did not win the election.
The paper reminds us of the conditions under which the most fruitful economic research happens today. It’s got to be a live and interesting question. A high quality dataset has to be the engine; without good quality data, research is just garbage-in-garbage-out. It’s got to persuade us that that the claimed answer is correct. Too often, we in the research profession are failing on these three tests.
By Simon Grey, on May 22nd, 2012
It is astounding how significantly one idea can shape a society and its policies. Consider this one.
If taxes on the rich go up, job creation will go down.
This idea is an article of faith for republicans and seldom challenged by democrats and has shaped much of today’s economic landscape.
And:
Another reason this idea is so wrong-headed is that there can never be enough superrich Americans to power a great economy. The annual earnings of people like me are hundreds, if not thousands, of times greater than those of the median American, but we don’t buy hundreds or thousands of times more stuff. My family owns three cars, not 3,000. I buy a few pairs of pants and a few shirts a year, just like most American men. Like everyone else, we go out to eat with friends and family only occasionally.
I can’t buy enough of anything to make up for the fact that millions of unemployed and underemployed Americans can’t buy any new clothes or cars or enjoy any meals out. Or to make up for the decreasing consumption of the vast majority of American families that are barely squeaking by, buried by spiraling costs and trapped by stagnant or declining wages.
And:
We’ve had it backward for the last 30 years. Rich businesspeople like me don’t create jobs. Rather they are a consequence of an eco-systemic feedback loop animated by middle-class consumers, and when they thrive, businesses grow and hire, and owners profit. That’s why taxing the rich to pay for investments that benefit all is a great deal for both the middle class and the rich.
This was supposed to be a TED talk but, fortunately, the people who run those things aren’t complete idiots and are capable of prolonged rational abstract thought. However, it’s obvious from the excerpts that Hanauer completely out of his league when it comes to economics.
[Aside: before I begin explaining why Hanauer is talking out of his rectum, let me first state that I have no interest in defending the rich per se. Some rich people are terrible, like the banksters of the Fed and Wall Street that defrauded the citizens of the united states out of hundreds of billions of dollars, and some rich people are awesome, like the all the VCs and Angel investors that help to fund the start-ups of hundreds of new businesses. Like all groups of people, there are some complete turds, some good role models, and a decent amount of mediocrity.]
Hanauer is completely out of his league because he focuses solely on consumption as the key to wealth. I’ve addressed this in passing before, but now seems like an appropriate time to pick up on the point again: consumption is not wealth-creating, it is wealth-consuming. In fact, that is the definition of the term. Short-term consumption does an especially good job of illustrating this point. If one day I bake a cake and the next day I eat it, what do I have on net? Nothing. Yes, I created a cake, but I also consumed it as well, and therefore I have nothing to show for my efforts, save for some temporal feelings of being full and tasting something sweet. And feelings, being dynamic and unquantifiable, are not exactly the stuff of wealth. For proof, go to a bank and try to take out a loan by using future emotions as collateral. Real wealth, in contrast, is not consumption but rather accumulation. It is worth pointing out that accumulating wealth does not preclude its usage (think of real estate, for example). In this case, things are produced and/or cultivated, but they are not immediately consumed. This is generally referred to as capital accumulation or capital formation.
Now, Hanauer’s analysis fails because it fails to account for the role of capital in production. You can’t produce anything unless you have materials for production, people and/or machines for production, and a place to actually produce things. And you can’t consume stuff unless you produce it first. These elementary observations are apparently too complex for Hanauer to consider, which is why he claims that the wealthy don’t create jobs.
In a tautological sense, this is true simply because the wealthy don’t often consume more than the poor (although it does beg the question of who buys luxury cars and yachts, but that’s somewhat beside the point). In a technical sense, this can be true as well, as not all wealthy people are directly responsible for the creation of jobs. However, since production—and its attendant jobs—are generally contingent on either having capital or having access to capital, it should be obvious that the rich are necessary for job creation if for no other reason than the simple fact that they have capital that can be used for job creation.
In a technical sense, it is not necessary for capital to be held by the wealthy, seeing as how anyone can technically have capital. However, it is the rich that, by definition have the capital. And since capital is necessary for production and thus, according Hanauer’s erroneous assertion, wealth, it stands to reason that there must somewhere be the accumulation of capital. And those who accumulate capital are the wealthy.
Thus, the wealthy are necessary for job creation, if for no other reason than by virtue of the fact that they have capital. Thus, taxing the rich, particularly taxes on their capital, means that that there will be fewer jobs because there will be less capital with which to enable production.
The second problematic assertion that Hanauer makes is that the government is better or more efficient at managing capital than the wealthy. This is predicated on two assumptions. First, Hanauer assumes that the wealthy simply sit on their capital. Second, Hanauer assumes that the government is generally more efficient than motivated investors at allocating capital.
The former assumption is easily dispensed with as Hanauer himself notes (chase the link to find it) that the wealthy have become wealthier. While a good portion of this is more than likely due to defrauding taxpayers, as was seen in the housing banking crisis of 2008, it is hard to deny that wealthy people generally make a point of increasing their wealth by a mechanism known as investing. Investing is basically people letting other people use their capital in exchange for money. Thus, the wealthy are allowing their capital to be used productively instead of merely sitting on it.
The latter assumption is a little more difficult to address, but it is worth noting that the government has created a ton of messes when it gets involved with capital allocation. Pretty much every bubble in the central banking era is proof of this. Anyhow, the assertion that the government is generally superior at allocating capital is provably false (see the footnote to this post for further evidence). Thus, when all is considered, Hanauer’s argument is nothing more than Keynesian nonsense, as evidenced by its single-minded focus on consumption as the driver of wealth. It predicated on fallacious assumptions, it ignores basic economic principles, and is nothing more than shallow demagoguery. Incidentally, much like Krugman’s economic “analysis,” this is yet another example of the narrowness and short-sightedness of Keynesian analysis. There is no depth to it, for it focuses on one variable, as if one aspect of the market holds the key to explaining it all. Basically, Keynesians are like children with the way they think, since they cannot apparently consider multiples variable simultaneously, or even guard against common fallacies and short-sightedness.
Finally, note that this analysis, like most other examples of Keynesian analysis, calls for increased government intervention and control. Isn’t it about time we acknowledge that Keynesianism is nothing more than an attempt to justify socialism using capitalistic rhetoric?
By The Gold Report, on May 22nd, 2012
 The elections in Greece and France have shown that in democratic societies the people are the ultimate deciders of how well the best-laid economic plans will work out in the long run. In this exclusive interview with The Gold Report, Leonard Melman, veteran precious metals analyst and publisher of The Melman Report, talks about the implications of the recent European elections on the prospects for the gold and silver markets. He also discusses some of his favorite stock picks for taking advantage of the huge rebound he sees in the metals markets later this year.
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TGR: It seems that economists can plan and recommend, and politicians can negotiate and maneuver, and pundits can analyze and predict all they want, yet when the people don’t want to play along, it can all mean nothing. Of course, we’re talking about the elections in France and Greece. What’s going on?
Leonard Melman: What’s going on is that the monetary authorities in Europe have decided that austerity is the only way out of the financial dilemma, which I find kind of amusing, because it is their Keynesian activities that created those policies in the first place. Their decision now is that austerity, which is cutting back government programs, is the only thing that will work. The problem is that the public doesn’t want their government benefits cut back. So, the message from the French people was that Nicolas Sarkozy, with his austerity, was no longer their friend and François Hollande, with his promise to end austerity, is now the new President. In Greece it’s even more dramatic. Greece has been a funny culture for about 40 years living in a dreamland, thinking that nobody has to work and nobody has to pay taxes, which is sort of their national sport.
TGR: Not paying taxes is a national sport?
LM: It’s a high art with the people in Greece. Yet they still expect their government to give them early retirement, generous unemployment benefits, etc. That has been supported for the last 40 years by massive government borrowing. And, that’s the reality after this election. The people voted out those politicians who, at least on paper, wanted to cut back the size of government. Now there could be a real crisis directly ahead of us.
TGR: Does that mean the Eurozone is going to blow up?
LM: It’s under the strongest threat since its creation 13 years ago. Greece cannot pay its debts. Because of the recent election, the monetary authorities who had been providing Greece with funds can no longer be sure that their program is going to be approved by the Greek government. If that’s the case, they may suspend further payments to Greece and Greece will officially begin to default on its debt, which will be a likely cause for expulsion from the Eurozone.
If that happens, all Greek monetary matters will be restored to the previous currency unit, the drachma. Nobody has the foggiest notion of what the drachma will be worth because it’s a totally artificial currency to begin with. We are seeing one consequence that has showed up in the market the last couple of days. Many people in Greece are getting scared and are converting their funds primarily into euros and U.S. dollars.
That’s one of the reasons why the dollar has become stronger and precious metals have become weaker. It also raises the specter of a true run on banks as people withdraw their euro assets. Lying in the wings are Spain, Portugal, Italy, Ireland, Iceland, etc. In fact, there are nine Eurozone countries that are in recession. So, if the question is could the Eurozone blow up, I think it is a genuine possibility that several nations could be forced out, which would leave the Eurozone in a shambles.
TGR: With all of this bad news, the precious metals markets don’t seem to be responding positively. When will they be impacted by this?
LM: For most Europeans, the U.S. remains the financial bastion of the world. So, when Europeans look to convert assets from weakness into strength, they usually look for U.S. government debt paper. Buying that debt paper makes the U.S. dollar stronger and gold and silver weaker in reflection. That will end when the U.S. dollar weakness begins to show itself; then we should have much more positive action in the metals.
TGR: In light of what’s happened here recently, what are your expectations now for gold and silver?
LM: The number of people who are losing, or have lost, faith in conventional politicians and economists to guide the world’s affairs is growing. As that continues, I believe more and more of their assets will be turned into the precious metals as the haven of last resort. The question is when. In my annual forecast I said, and still believe, that this trend would accelerate throughout the second half of the year, creating pressure for the precious metals to rise dramatically. October, November, December, I believe, will be great months for the precious metals.
TGR: Is it going to take some great catalytic event for this to happen or will it build slowly?
LM: The French and Greek elections could have provided that catalyst although they’re talking about another election in Greece within a month. But, this has shown there’s a great difference between what the politicians and economists want to do and what the public will accept.
It’s like a drug addict who vows to quit because he knows the harm drugs are doing to him. Three or four days after quitting he’s in the agony of withdrawal and will do anything to get more of the drugs. That’s the case with several of the nations in Europe. They know the damage that excessive borrowing has done and now they’re going to stop cold turkey. But, the people relying on that government borrowing don’t want to lose their welfare, retirement or other government checks and they’re rioting in the streets. That rioting and disillusionment is in its early stages and could get much worse. That’s another reason for precious metals to go much higher. The resolution to undergo austerity is not going to be matched by the public’s deeds.
TGR: So how high could gold and silver go?
LM: The downside over the next two months could be about $1,400/ounce (oz). During the latter part of the year, I have forecast a top in gold of about $2,400/oz and a top in silver about $55/oz.
TGR: It seems like $55/oz is a little low on silver compared to $2,400/oz gold. You’re not a major silver bull?
LM: I am. Let’s say gold bottoms at $1,400/oz and then goes up to $2,400/oz. That’s a gain of about 65% or 70%. If gold gets down to $1,400/oz, silver could hit $24–25/oz. If it goes to $55/oz from $25/oz, that’s a gain of about 120%. So, as the acceleration develops, I expect silver to go faster than gold. It’s been weaker than gold, so it will take a little longer to advance. But, I have always believed that in powerful metals bull markets, silver outperforms gold on the upside, just as during declines it falls faster than gold.
TGR: So, you aren’t looking for $75/oz silver as some people are?
LM: Not quite this year. But if this massive disillusion and even distrust of public monetary authorities occurs, who knows what numbers we could be looking at in 2013? But, $55/oz seemed about right when I made the forecast in writing and I’ll stick with it.
TGR: Going to mining stocks, which you cover in your Melman Report, the big question that most investors have is when are their mining stocks going to take off and start behaving the way they expect? What do you think?
LM: A couple of numbers illustrate just how much mining stocks have underperformed. In mid-2008, gold was about $900/oz and the Philadelphia Gold and Silver Stock Index (XAU) was 205. Now with gold just under $1,600/oz, the XAU is 147. So, while gold has almost doubled, the major mining shares have dropped by an average of about 40%, and many of the junior shares have fallen by more. So, it’s been a dismal period, especially in the last year.
The major difficulty during the past few years has been the longer timelines in advancing exploratory projects to production, due to the regulatory and environmental hurdles. When I started writing about gold and trading shares as a stockbroker in the mid-1970s, it wasn’t unusual to advance a project from discovery to production within two or three years. So, you only had to raise sufficient capital to cover that period. Now projects can take 8–15 years to get to production, if they succeed at all. That results in greater capital requirements and a lot more share dilution. That’s having a negative impact in the junior sector. The major mines seem to correspond much more closely to the price of the metals themselves. But for the juniors, that long regulatory process creates a major problem for share prices and dilution.
TGR: Let’s revisit some of the stocks you talked about last April.
LM: Great Panther Silver Ltd. (GPR:TSX; GPL:NYSE.A) continues to produce and have positive cash flow. Its share price in the last year pretty well corresponds to the price of silver, being leveraged in both directions. I like what Great Panther is doing and have no problem suggesting to people that this is a share of real interest.
We also talked about Commerce Resources Corp. (CCE:TSX.V; D7H:FSE; CMRZF:OTCQX) last year. Commerce has done excellent exploration work. It still has the major tantalum project that has been its focus for many years. But, it’s also advancing rare earth projects in Québec and other places. So, Commerce continues to do the things that in the past have produced positive results. It’s just simply faced with a very adverse marketplace at the moment.
TGR: What do you mean by “adverse”?
LM: The rare earths have been hot numbers and then cooled off. When China first announced that it was going to reduce exports to the West, rare earth shares in North America went crazy on the upside and have come back almost as rapidly. So, it’s a different situation with them. They’re more a hot play of the moment as opposed to gold, which is much longer term.
TGR: But, it’s not too late for rare earth to help Commerce’s stock price?
LM: Not at all, because rare earths blows hot, then cold. But, then they could very easily blow hot again. The fundamental argument for rare earths is excellent. They are absolutely essential for modern technology, including defense weaponry systems. The fundamental demand for them has nowhere to go but up and questions have been raised about Chinese supply, among others. So, I think the North American rare earth junior mining shares could easily get hot again.
TGR: Will the fact that Commerce has both heavy and light rare earths make a difference?
LM: That’s certainly a positive. The more markets you can attract, the better the prospects become.
TGR: How about some of the other companies you talked about that you think are pretty attractive at this point?
LM: I just visited El Tigre Silver Corp.’s (ELS:TSX.V; EGRTF:OTCQX; 5RT:FSE) project in Sonora State, Mexico. It’s a fascinating story. The previous operators from approximately 1900 to about 1935 mined approximately 75 million ounces of silver. It was incredibly high-grade material grading an average of 40 ounces per ton (oz/t). They left behind tailings containing around 2.6 to 2.7 oz/t silver. At current prices, that’s potentially very profitable material. I believe there are about 1.2 million tons of tailings plus other material that was used to backfill where previous operators had mined.
The net result is that El Tigre is working to get those tailings into production as fast as possible. It hopes to start producing revenue in late 2012 or very early 2013. The project area is entirely prospective. It has very large landholdings near the tailings deposit with the prospect of very early revenues, which will then finance continued exploration. There certainly is the possibility of finding more 40 oz/t ore in the future. Plus, it is also searching for gold and has some very good target areas for that. So, I like the El Tigre story from that basis along with the revenue coming in to finance exploration and development.
TGR: How is it going to reprocess these tailings?
LM: It’s going to build a Merrill-Crowe process facility adjacent to the tailings. The material’s already crushed so it can do the basic recovery right near the project. That is a very good simple plan.
TGR: What about SilverCrest?
LM: SilverCrest Mines Inc. (SVL:TSX.V; STVZF:OTCQX) is another company I like that is in a similar situation. It has a producing project in northern Mexico called the Santa Elena mine, northeast of Hermosillo in Sonora State. It produced 134,000 oz silver and 9,000 oz gold in the first quarter of the year, giving it significant revenues. It’s using those funds to develop additional resources around the mine, particularly to advance a very prospective project called the La Joya, which is in Durango State. So, again, it has revenues, financing and significant exploration and development, rather than having to raise borrowed capital or encounter heavy dilution.
TGR: How soon might it have results or a preliminary economic assessment (PEA) on La Joya?
LM: It’s moving very rapidly but I have not yet heard of a PEA or a bankable feasibility study. But, it is advancing its exploration quite rapidly and it could be a very sizeable discovery. Those are the kind of companies that I really think people should do their own due diligence on and explore seriously because the long-term prospects seem to be valid.
TGR: How about some others?
LM: One of the companies I wrote about several years ago is Barkerville Gold Mines Ltd. (BGM:TSX.V), which started production, but apparently encountered some sort of difficulty and temporarily suspended it. It’s near the town of Barkerville, which is a great historic mining site in British Columbia surrounded by active exploration and development, where the prospects for future discoveries appear very solid. Now it’s just a question of getting back into production and kicking up the cash flow once again.
TGR: What about anything in South America?
LM: I was recently on a tour of GMV Minerals Inc. (GMV:TSX.V) in Guyana, which has great mining prospects and excellent geology. GMV has a very prospective property, which it’s already drilled and it has a new program underway. Given the potential for sizeable discoveries, it’s a prospect with an excellent risk/reward ratio. Unfortunately the shares have been beat up in this dismal market and have fallen fairly rapidly, from about $1/share last summer, and are $0.09 to $0.10/share now. So, you’re risking $0.09 or $0.10/share but with a very significant upside if it makes an excellent discovery.
Just a little note about the geology of northern South America. One of my noted geologist friends told me that the region from Colombia, across Venezuela and the small three countries of Guyana, Suriname and French Guiana, and all the way across to Africa, is excellent elephant hunting territory. So, GMV’s in a good place and just has to overcome some problems.
TGR: Would you put Abzu Gold Ltd. (ABS:TSX.V; ABZUF:OTCQX) in Ghana in that bucket?
LM: I’ve recently talked to Abzu and it is exploring and developing some very excellent projects in Ghana in areas where many of the majors have opened mines. It appears to have great potential. I’ve only had one telephone meeting with the president of the company and I’m still in the learning process on Abzu. It has what appear to be some very exciting prospects and Ghana has a reputation for being one of the very best African nations for mining/development.
TGR: How about companies in the U.S.?
LM: I like good projects in the United States. Bullfrog Gold Corp. (BFGC:OTCBB) has two projects, one in Arizona and another in Nevada, that have had a lengthy history of exploration and a mountain of material to work with, so it’s not starting exploration from scratch. Besides the Bullfrog Hills project in Nevada, its Vulture Mountain project in Arizona has metallurgical work showing gold recovery of up to 90% and even 96% on finely ground material, which is very high. Again, it’s early stage but the potential exists for some very excellent risk/reward ratio investing.
TGR: Any others in North America?
LM: There is another company of significant interest called GreenLight Resources Inc. (GR:TSX.V). Its projects are located in New Brunswick and Nova Scotia in the Canadian Maritimes, which haven’t had a lot of precious metal mining. It’s mainly been coal mining. Coincidentally, New Brunswick was just named the number one jurisdiction in the Fraser University survey of mining jurisdictions. The province encourages mining very significantly. GreenLight has a host of projects and it’s already found joint venture partners for two of them, enabling the company to bring in cash for other purposes plus having other companies advance the projects on their own dollar. Greenlight has properties that include graphite and rare earths, which are certainly as hot as you can get, along with magnesium, gold and silver. With a good inventory of projects, joint venture partners and cash at its disposal, I think this is definitely a company worth investigating.
TGR: Where do you think things are headed from here and what should our readers be focusing on to avoid the pitfalls and make some profits when this market turns around?
LM: I like the juniors with production financing that are actively building facilities to go into production, or those like SilverCrest that have already achieved production. That enables them to grow so much faster without serious dilution.
I still love gold and silver. Silver has the added bonus of being an industrial as well as an investment metal. My big picture tells me that the great force behind gold and silver in the coming months and years is the growing fear factor. Once the public perceives that international financial matters are really getting out of control, they will start moving assets from conventional investments into the precious metals.
There was an article in Barron’s in December 2010 where the author stated that, according to his research, when inflation begins to accelerate toward hyperinflation, the precious metals tend to rise 2,000% to 50,000% faster than the rate of deterioration of currency. That’s an enormous factor down the road and I think, historically, it makes some sense. So, my big picture is that disillusionment with international financial monetary authorities is growing and fear will be rising. Once the image of the U.S. dollar as a pillar of strength begins to diminish, which I expect in the second half of this year, I think we will see real fireworks in the precious metals.
TGR: What is the best investing advice you’ve ever received, that you’ve either taken or wished you had taken? And, what’s the best advice that you have for people who are just starting out as investors?
LM: The best investment advice that I’ve received and want to pass on is to look for the one play that, considering the risk involved, has odds that are truly powerful in its favor and that will provide outsize rewards. And, I’ll tell you exactly which one I like; the only question is the timing. Right now, interest rates are the lowest they have ever been in history. The one interest rate future that stands out in my mind is Federal Reserve funds that are yielding virtually zero for the short term. Short-term notes are quoted at about 99.87 vs. 100.00 face value. So, they’re yielding 0.13% with virtually no risk to the downside. All you’re risking is 13 basis points because interest rates aren’t likely to ever go below zero. The kicker is that those contracts extend more than two years out. The spring of 2014 contracts are trading now at about 99.65. So, there’s 35 points potential downward action. Over the next two years, the pressure to start raising interest rates is going to become severe. If rates reach 3%, these contracts fall to 97.00, which would provide about 265 points of potential profit. Anytime you can put logic behind an investment and have a potential reward that’s 9 or 10 times the potential risk, then I’m very interested. I think the logic behind interest rates starting to rise within the next two years is quite powerful.
TGR: Great advice. Thank you so much.
Leonard Melman will be sharing his Precious Metals forecast for the for the 2nd half of 2012 during the World Resource Investment Conference in Vancouver, which takes place on June 3-4, 2012. Click here for more information.
Leonard Melman, publisher of The Melman Report, has been writing about precious and base metals for more than two decades as monthly columnist for California-based ICMJ’s Prospecting and Mining Journal and Vancouver’s Resource World Magazine. He focuses on how political and financial considerations impact the world of mining and the prices of the metals.
From gold and silver to energy and oil services, Frank Barbera, editor of The Gold Stock Technician Newsletter, sees a bright future for commodities and their equities. In this exclusive Gold Report interview, Barbera cites large blue-chip and midtier mining companies, especially those now paying dividends, as favorites and suggests that investors looking to protect retirement savings invest in bond funds outside the U.S.
The Gold Report: Europe is in the headlines daily: more leftists coming to power, regional banks suffering, renewed recession appearing to take hold. What is your take on Europe?
Frank Barbera: In the headlines, Europe looks like quite the mess. Imagine being a Greek who saved over a lifetime now facing the possibility of devaluation or Greece leaving the euro. If Greece pulls out of the euro and devalues, most of the people will see their life savings collapse in terms of purchasing power.
In my view, there is a pretty good chance that would spark a contagion. When people in Spain or Italy see Greece pull out and return to a devalued drachma, there will be bank runs in other countries. Money will move out of those banking systems into perceived safer havens. That is how a contagion gets started.
The situation in Spain also is very serious. It has chronically high unemployment, in excess of 24%; youth unemployment is nearly 50%.
All of the leading indicators for Europe are pointing down. Europe seems to be descending into a major recession; even Germany is backsliding toward recession. The breakup of the euro would greatly exacerbate that. Interest rates would shoot up in bond markets around Europe, spreads would blow out.
If you were an Austrian school economist you would say, let it unwind, let the debt default and the governments stand back and do very little. That would be a very severe dose of medicine to take.
Instead, I think we will get more government intervention, as we saw in December 2011, when some of the big Italian and French banks were staring into the abyss of default. The European Central Bank came in, expanded its balance sheet with a long-term repo operation and loaned money to the commercial banks that needed liquidity. At that point, 547 banks asked for help. That liquidity infusion helped the markets stave off a bearish, deflationary downturn for a few months.
Politicians will act only when the cost of not acting exceeds the cost of acting. With markets nearing a panic now, that Minksy moment demanding a political response to market contagion is growing very near. As a result, I think we will soon see more money being printed and more liquidity injections as politicians attempt to stretch the problem out.
TGR: You do not expect a big explosion, but a long, painful, downward spiral?
FB: Not quite either one. I think Europe is on the edge, tap dancing with a deflationary collapse. I do not think the politicians want it to collapse; there is too much of a vested interest in keeping the euro together despite it being an inherently flawed structure.
If Europe wants to stay together, it must take steps toward becoming a real fiscal union. That means buying time by continuing to create liquidity and infuse money. Essentially, the politicians will resort to the printing press. The outcome of that will, over time, be higher inflation rates.
I do not expect an explosion of inflation, but over time there is a definite risk of an increase in inflation, as more and more money is created. Higher inflation combined with rather static “managed” exchange rates will over time amount to an internal devaluation of debt and paper money purchasing power.
TGR: What would that do to commodities?
FB: That is fundamentally very bullish for commodities, especially the precious metals but to some degree also food and energy. Commodities are generally scarce. If you exhaust an oil well, you have to find a new oil well to replace it. Gold is basically very scarce. Both commodity equities and commodities will probably do fairly well, especially equities, in the countries with the biggest problems.
TGR: And what about China? If China is not growing as much as predicted, what impact will Asia have on commodity prices?
FB: I think Asia is going to slow down. Europe is one of Asia’s biggest export markets. If Europe slows down to a recession level, that will naturally trim growth and the inflation rate in Asia. China has a potential overcapacity problem due to overinvestment in capital over the last decade. That could take some time to work through, but it is a state-run economy with a better chance of navigating it. The Chinese government may be able to control credit by telling the banks they cannot lend and having the banks obey. Right now, China has an easing policy in place, which might help it mitigate some downside risk. I think China could be heading for a recession, but not for a major collapse.
TGR: Turning to the U.S. economy, we hear that things are improving: upticks in construction spending, declines in joblessness claims. This is an election year. Do we sell in May and go away, or can the markets continue to make further gains?
FB: There are a couple of interesting points to be made. With respect to sell in May and go away, the historic data suggest that is not a bad idea except in an election year. Typically, the few months in front of the election—May to October—are pretty good.
Seasonally, the stock market has a nice tailwind behind it. However, that said, I am afraid that the current news trends show just a steady sequence of bad news coming from Europe and that implies that markets will likely be hostage to the European debt crisis for some time to come. In addition, later this year, around Labor Day, it is estimated that the U.S. will face a second debt ceiling crisis, which is already looking to become a major pre-election issue, and could ultimately result in more credit rating downgrades, so the next few months have several major wildcards already built into the deck.
Finally, I want to acknowledge that this concept that PIMCO has stressed, the “New Normal,” still seems to be the overriding theme, which is one of very slow nominal growth and actually flat to negative real growth. As an example, go back and take a look at the U.S. economy between 1995 and 2005, you had a little over a 5% growth rate. In 2008, the U.S. economy slowed to about a 2% growth rate. I think that is what we will see for quite some time to come, so one can say that we live in a world where growth itself is becoming a very scare commodity. In my work, I have dubbed the current recovery, the “Subdued Recovery” as you need to look past the headlines about employment improving to see the devil in the details.
Employment reports have improved, but when you look at the composition of the jobs that have been created since 2008, most of them have been in low- to moderate-wage categories. Since 2008, the U.S. has actually shed high-wage jobs. That has big implications for something like housing. To buy a house, the first thing you need is a job. The second thing you need is a high-wage job so you can afford to carry a mortgage. Oversupply in the housing market and scarcity of new high-wage job creation is not a recipe for a housing turnaround. To me, that means housing will stay low and maybe plateau for a long time.
On the average personal balance sheet, the two most important assets are a house and retirement savings. In a consumer-led economy, 72% of gross domestic product is consumer spending. If real estate and housing are going to remain depressed, it becomes very important to keep a retirement account buoyant because if any of those asset classes are depressed, a negative wealth effect is created. This leads to a slowdown in spending and the U.S. could easily relapse back into recession.
I think that is why we have seen more central banks intervening. Quantitative easing programs are being enacted every time the stock markets start to weaken. The idea behind that is to create asset inflation and keep retirement accounts at least reasonably buoyant. This way you keep a positive wealth effect and maintain consumer spending, at least enough to sustain slow growth. That is how you give the economy time to restructure and eventually work down and deleverage the big debt load.
TGR: Going back to the commodities, gold and silver are way down from last summer. Are you still bullish on precious metals and other commodities?
FB: I am getting very bullish on gold and silver. I think precious metals as an asset class will do very well and you will see new, all-time highs in both gold and silver over time.
TGR: The equities behind those commodities have not kept up even with the step-up that happened from last year. What will take those equities higher?
FB: That is a pretty interesting situation, a one-off anomaly. It looks as if the mining industry has been negatively affected by rising costs over the last few years. That, along with the fact that there has not been much yield for a long time, left the mining sector and some of the other resource sectors languishing.
I think that is starting to change. Looking out two to five years, if we do see a rising trend in inflation, I think money will look very favorably at resource-related stocks. Today, the multiples on some of those stocks are as cheap as they have ever been. A few years ago, gold mining stocks were selling at 30 to 40 times earnings. They are now down to 6 to 8 times earnings and, in some cases, 8 to 9 times cash flow. That is something you see maybe once every two or three decades. That means there are very cheap stocks and some outstanding values.
In addition, many companies are starting to boost dividends because, even with rising costs, they are doing very well and are reporting solid cash flow gains. So now, all of a sudden, you have a yield kicker. I think that could be the beginning of a very long, positive trend. Given the large markdown we’ve seen in the last few months, it seems that the market perceives a deflationary threat from Europe and is marking mining stocks down. I suspect that will turn out to be an over-reaction and you will find mining stocks at very attractive levels.
You can say the same thing about a lot of other groups: energy, oil services, large-cap energy, some of the master limited partnerships (MLPs), some major commodity producers in the grain market. There are a lot of areas that investors should be looking at.
TGR: What are some of the undervalued stocks you see in the mining sector?
FB: I like all of the large, blue-chip gold miners: Barrick Gold Corp. (ABX:TSX; ABX:NYSE), Goldcorp Inc. (G:TSX; GG:NYSE) and Newmont Mining Corp. (NEM:NYSE). I probably should disclose that I actually own some of those, so I’m talking my own book.
These companies are selling at very depressed multiples. Newmont recently instituted a nice dividend program, where if the price of gold goes higher, it will automatically boost its dividend. If gold goes through $2,000/ounce in the next few months, Newmont yielding a 4–5% dividend would be an attractive situation.
There are some good quality, midtier emerging seniors like Yamana Gold Inc. (YRI:TSX; AUY:NYSE; YAU:LSE) and Eldorado Gold Corp. (ELD:TSX; EGO:NYSE). You have the royalty companies that look attractive, like Franco-Nevada Corp. (FNV:TSX).
SteelPath has a very good fund that has MLPs yielding 6–7%. In the oil services sector, I would name Schlumberger Ltd. (SLB:NYSE) and land drillers like Baker Hughes Inc. (BHI:NYSE) and Nabors Industries Ltd. (NBR:NYSE). It may take a little bit more time and may be a little bit early on some of the land drillers, but as we get closer to the end of the year, they will have some write-downs coming. Once we get past that, a lot of the bad news will be up. Some of those stocks are selling at 7 to 8 times earnings. I definitely see good value in energy services and even in some of the larger-cap oils, like Murphy Oil Corp. (MUR:NYSE), Occidental Petroleum Corp. (OXY:NYSE), ConocoPhillips (COP:NYSE) and Chevron Corporation (CVX:NYSE).
If you want to look outside the U.S., there are the large Chinese oil companies. In Brazil, Petrobras (PBR:NYSE; PETR3:BOVESPA) is selling at some of the cheapest levels in years.
This is a good time to look at the natural resource-related stocks and look to take a very broad, cross-section approach where you own a little in different areas.
TGR: How do you evaluate a royalty company? Just because it pays a dividend does not mean it is a good company.
FB: The royalty companies in the mining space are Royal Gold Inc. (RGLD:NASDAQ; RGL:TSX) and Franco-Nevada.
Franco-Nevada is a blue-chip company. It has stellar leadership in Pierre Lassonde, who built up the company from nothing years ago. It has an outstanding portfolio and an enticing balance sheet. Franco-Nevada has resisted this particular downdraft. Large-cap, senior companies like Barrick, Newmont or Goldcorp have seen 30–40% declines in the last few months. Franco-Nevada has basically held even. I believe that Franco-Nevada today is a truly great growth story on the order of some of the best growth stocks we have seen in the last few decades. Royal Gold seems like a pretty well-run company, but in my opinion, I would not put Royal Gold in the same category as Franco-Nevada.
TGR: Assuming that we are facing an inflationary situation over the years ahead, what is your best suggestion in terms of an asset class for conservative investors?
FB: That is a major issue for the large number of retirees in the U.S., people who used to invest in certificates of deposit, because right now the banks are paying nothing. We have financial repression coming from the Federal Reserve. The book This Time is Different by Carmen Reinhart and Kenneth Rogoff talks about how the Fed will run negative real rates for years and reduce the value of its debts.
Federal Reserve Chairman Ben Bernanke is telling people he will keep the interest rates low for the next three years. I would take him at his word. When I look at the U.S. yield curve, with a 0% short-term rate and negative real yields all the way out to the 30-year bonds, I think that is a recipe for a weakening dollar. Of course, we could have a deflationary outcome in the near term, which could temporarily lift the value of the dollar, but I think a falling dollar will be a major theme over the next few years.
It will be really important for U.S. investors to look at non-dollar bonds. There is a good chance that we will see the final lows in Treasury bond yields in the next 12 months and Treasury bonds will move into a bear market. We hear about this bond bubble a lot. The bonds you have to be worried about are Treasury bonds, not foreign bonds, not emerging market debt, not necessarily even junk bonds.
There are a lot of bonds around the world that are negatively correlated to Treasury bonds. When Treasury bonds move into a bear market and long-term yields start to back up in the U.S., American investors will need to start looking at other income generating categories including assets like global bond funds and emerging market debt funds, and even TIPS funds and MLPs. There are bond categories where you can earn a conservative yield and generate a relatively safe total return. That is one idea: to think globally and become globally diversified.
TGR: Lastly, what is the best investing advice you ever received, whether you took it or not?
FB: The best advice I ever received was not to buy and hold anything, but to maintain a tactical approach and be flexible. Diversify is another good piece of advice.
In difficult economic times, your biggest single advantage is the ability to be tactical, to be nimble and to react to changing market conditions. The one big positive most investors have right now is that the menu of potential investment vehicles has really grown in recent years, including a proliferation of exchange-traded funds (ETF) and mutual funds.
Ten years ago, the average individual could not access Australian or South Korean bonds. Today, we can buy Hyundai stock denominated in South Korean won or South Korean bonds or Australian bonds. There are even ETFs for things like this. Last week, PIMCO launched an emerging market debt fund denominated in local currencies. These are the kinds of products I think will be very useful over the next few years in helping people tactically navigate the kind of economic conditions coming our way.
TGR: Great advice, Frank. Thank you for your time and insight.
Frank Barbera, CMT, is a veteran money manager and is currently the editor of The Gold Stock Technician (GST) newsletter, published since 1993. He uses technical indicators to analyze precious metals and mining stocks, as well as oil and the overall market. Barbera has also managed private equity capital for a number of years, most notably for the Los Angeles-based Caruso Fund, which earned returns in excess of 20% during the last bear market. In his role as a hedge fund manager, he sought to regularly trade precious metals, energy and currencies along with the broad stock market indices. In 2006, Barbera was included in the book Master Traders: Strategies for Superior Returns from Today’s Top Traders.
By B.P.T., on May 22nd, 2012
At 7:45 AM Eastern time, the weekly ICSC-Goldman Store Sales report will be released, giving an update on the health of the consumer through this analysis of retail sales.
At 8:55 AM Eastern time, the weekly Redbook report will be released, giving us more information about consumer spending.
At 10:00 AM Eastern time, the Existing Home Sales report for April will be released. The consensus is that existing homes were sold at an annual rate of 4.66 million last month, which would be an increase of 180,000 from the previous month.
Also at 10:00 AM Eastern time, the Richmond Fed Manufacturing Index for May will be released. The consensus is that the index will be at 11, which would be a decrease of 3 points from the previous month.
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