By The Gold Report, on February 9th, 2012
  Preserving wealth in a volatile political and financial world is a job for gold. Greg Weldon, publisher of Weldon’s Money Monitor newsletter and Grant Williams, a portfolio advisor at Vulpes Investment Management in Singapore, will share their insights at the Cambridge House California Investment Conference Feb. 11–12. In this exclusive interview with The Gold Report, they answer the question: How low and high can gold go?
The Gold Report: Recent headlines continue to focus on the debt crisis in Europe as more countries are having their debt downgraded. Greg, you have diagnosed the problem as credit addiction and said that the European Union won’t be able to recover until leaders take painful measures necessary to kick their addiction. What does this mean for commodities and commodity equities?
Greg Weldon: It’s critical for asset prices across the globe. It is a debt addiction, debt refinancing and deficit financing problem, not only in Europe, but also in the U.S. and Japan. Austerity is the real answer to the fact that there is too much debt, and austerity measures in an economic sense are not positive.
My fear is that it’s going to be very difficult to see how economies in Europe, the U.S. and Japan can stand on their own two feet without the assistance of central banks debasing currency through debt monetization. I liken it to filling the sink halfway up with water and pulling the plug out of the drain. Of course, the water level will recede unless you turn the faucet on and start more water pouring into the sink. The level of water represents asset prices, the water flowing out of the faucet represents liquidity provided by global central banks and the drain represents the real macro economy, which has not been fixed.
At the end of the second round of qualitative easing, when the Fed shut off the faucet, the water level (asset prices) started to go down. But now the water is running again—particularly with some of the measures instituted by the European Central Bank, with its three-year loan program, the federal liquidity swaps and the back-ended way that it’s managed to involve the International Monetary Fund.
The problem with all of this is it does nothing to fix the underlying problem, which is too much debt. This is not sustainable. Central banks turning on the water faucet is good for asset prices. The real solutions of fiscal austerity, which are probably not palatable to most politicians in Europe, are the real struggle as we go forward. This problem is not going to go away.
TGR: Grant, in your Things That Make You Go Hmmm…. newsletter, you painted a picture of the final implosion of the euro and U.S. municipal bond meltdown. What would this mean for resource stocks?
Grant Williams: That was part of a prediction piece that I wrote at the end of 2011. It was semi-tongue-in-cheek. My contention was that as volatile as 2011 played out, we didn’t actually get any resolution. And it feels like 2012 will be the year those resolutions start to take place. One of the primary ones is the European situation. A Greek deal to solve the crisis seems to constantly be on the horizon, but they can’t seem to come up with an absolute solution to the public sector involvement haircut issue. When they do, I think it’s going to be the start of a whole slew of legal action to try and either trigger credit default swaps or negate any haircut from those who don’t want to sign up. Greece has a big refinancing coming up in March. It has to raise a little over €14 billion (B), and between now and then it somehow has to get a $130B loan package approved from the Troika. It is very hard to see how Europe can just keep pumping money into Greece. It’s very likely we’ll see Greece exit the Eurozone then, and that’s going to focus everyone’s attention on Portugal. I think Italy will be OK. Spain worries me more than Italy because the economy there structurally is in far worse shape. But if a bunch of countries pull out, that leaves the question of how people unwind any obligations they have in the current euro construct.
What this means for commodities is that the money-printing presses are going to be turned up to the max again. Despite adamant claims from politicians to the contrary, money printing—even if by another name—will have to be implemented at a magnitude much, much higher than ever before to meet current demands. Cash is being given to banks basically for free through the long-term refinancing operation on the quid pro quo that the money finds its way back into the government bond market. The problem is that a lot of this money is going to leak out somewhere other than where it is intended and I suspect it’s going to leak into commodities and equities. We are going to see stock markets float higher, not necessarily on particularly good numbers from corporates, but from the simple dynamic of a lot of freshly printed money looking for a home. We have already seen it in gold and silver this year. They both had big corrections in December, but they are two of the best performing assets of the year so far and I suspect the more money they print this year, the faster these things are going to go up.
People are starting to understand that deflation is not an option for the central banks. Once people realize that if we get a brief period of deflation, it will be fought aggressively with inflation, they will start to look past any deflationary period and position themselves for inflation. That is going to mean higher prices in commodities.
TGR: How high could gold and silver go in 2012?
GWilliams: I think gold trades at $2,200 an ounce (oz) this year. I think silver trades at possibly $60/oz this year, but they’re really just stepping stones on the way to higher ground. This 11-year ascent in both precious metals is only going to change when central bank policy surrounding it changes. I just don’t see that happening in the foreseeable future until they get this debt problem under control.
We are going to see periods with crazy spikes. We are going to see corrections. Some will view this as a collapse but the difference between a correction and a collapse is your entry price. If you bought gold at $700/oz a few years ago and you watched it go from $1,900/oz to $1,500/oz in December, that’s a correction. If you bought it at $1,900/oz, it’s a collapse. I think it’s important to try and take a longer view. The rationale for owning gold and silver is still in place. In a world of printing presses and fiat currencies, no one can manufacture gold and silver out of thin air. I think they are both going to go a lot higher.
TGR: Greg, what are your predictions for 2012?
GWeldon: There is a disconnect in the markets. Currencies really aren’t moving much either. The dollar hasn’t appreciated much. This is why gold is stuck in this range, capped just above $1,700/oz, with potential downside toward $1,300/oz. People are liquidating commodities. My sense is that there is more weakness to come in H112. Commodity prices in Q411 have already come down significantly, pumping some relief into margins. There is a little window of opportunity here where equities and some of the commodities markets could have some upside.
Debt could become an issue again in H212 depending on how central banks deal with that and whether we have a big downturn again in the stock and commodity markets. My longer term view is that when push comes to shove and central banks are staring into the abyss of a potential debt deflation, they will choose to reflate at whatever cost. That is bullish for gold long term. If banks can find the political will to do it, there will be significantly higher prices for commodities across the board in the long term.
China, in particular, has a bullish dynamic. Certain commodities, such as copper, have their own supply-demand dynamics that are detached from the dollar and monetary policies. The Chinese imported copper at a record high in December. Copper stocks on the London Metal Exchange have fallen by close to 30% since October. Copper is one of these commodities that has upside potential regardless of what the dollar is doing.
TGR: Grant, you are based in Singapore. There was a lot of talk at the last Cambridge House Conference in Vancouver about whether China is growing, shrinking, landing hard or soft. What impact will China have on commodities and equities around the world?
GWilliams: China faces a lot of problems. A lot of people think it is in for a hard landing. It is always difficult to believe official Chinese statistics, but the message that the Chinese government is sending through those numbers can be useful. For example, the Chinese growth numbers last week showed an 8.9% increase in gross domestic product. In a world of basically zero growth, that’s a pretty good number, but it’s not the double-digit number we’ve been conditioned to expect from China. Whether it was true or not, it shows that the government is saying: things are OK. We are on top of this, we’re in control. We are not going to slow to zero; we’re just going to grow a little bit slower. The big problem China has is inflation. Roaring food inflation in a society in which half the population lives in relative poverty in rural areas would be a big issue. A lot of people talk about property bubbles—and there are definitely bubbles in Chinese property—but as long as the government can keep people fed, it is going to find a way to get through this—at least for now.
China also has vast currency reserves. The Chinese absolutely understand that paper currency is being devalued incredibly quickly. So, until someone puts a sell-by date on copper and iron ore, it will keep stockpiling the stuff because it will need these commodities to continue growing. China will continue to swap paper money for commodities. The Chinese are bringing gold into the country as fast as they possibly can. Gold is in the DNA here in Asia. It doesn’t take an awful lot to persuade the public to own gold.
TGR: Greg, in your book, Gold Trading Boot Camp, you said gold is at the top of the macro-monetary pyramid. Why does it hold such an important position?
GWeldon: It is a rare and unique mineral that has provided a store of value for centuries that is not backed by any government. It is not subject to anyone’s IOU. Gold stands alone in the level of security it creates in people’s minds as a way to store wealth and protect it from governments that are continually debasing the value of paper money.
TGR: You put the dollar second on the pyramid, but said that could change soon. What will be the catalyst for change and what will be the result for investors?
GWeldon: I don’t know what the catalyst for change could potentially be. For me, the dollar stays as No. 2. There’s been an interesting little sequence recently where the dollar has rallied and gold has declined. But gold has not declined to the same degree that the dollar has rallied. Gold is appreciating in a lot of currencies outside of the dollar where it’s actually outperforming dollar-based gold.
Investors have a greater degree of confidence that the Fed will do what it has to do to circumvent a bigger issue. Next to gold, the dollar still is the second place that people feel comfortable.
TGR: Mining equities haven’t been able to keep pace with the price of gold. Do you see that changing?
GWilliams: It continues to surprise me, frankly, that these stocks are on such crazy valuations against the metal. I think once we start to get wider acceptance that inflation is going to be the outcome rather than deflation, people will start to look at these companies in a different way. Mining companies will instantly become some of the most attractive companies in the world.
I think there’s going to be a tremendous wave of consolidation in the mining sector. When it comes is a tough one to call, though. We’re going to see a lot of junior miners get taken out because it’s going to become a battle for ounces in the ground. If you have proven reserves, the majors are going to come looking for you—particularly if you are in a safe political jurisdiction—and they can afford to pay very, very good multiples of where the stocks are trading now.
In the last 10 years, we have seen some tremendous finds. We’ve seen some tremendous small companies that are very, very well run with incredibly experienced geologists. It requires a lot of due diligence to go through the sheer number of gold mining companies and find the very valuable ones, but I think having ounces in the ground and a good, proven management team are the two fundamental criteria that you have to look for in these stocks. Once the consolidation starts to take place and once the scramble for ounces of gold in the ground begins, I think the resulting valuations will be quite spectacular.
TGR: You are both speaking at the Cambridge House California Investment Conference Feb. 11–12. Based on all of these trends that you’ve laid out, how can investors preserve wealth or even profit during volatile times like these?
GWeldon: Investors who are focused on preserving wealth are best served by buying gold on the dip that is currently taking place. The gold price has a chance to reach $1,450/oz—that’s a sizable move downward.
There’s a chance that monetary authorities would take gold coming off that hard as a sign that they need to be more aggressive. It will be interesting to see how that plays out. However, being long gold and silver is clearly the best play in my mind to preserve wealth.
For investors who are looking to appreciate wealth, the commodities markets offer tremendous upcoming opportunities. That is because there is one thing that I can be certain about: Volatility will remain high. We are not going back to a low-volatility environment. It’s treacherous for individual investors trying to do it themselves. We run a long-short commodity program that’s non-leveraged. But there is a lot of talent in the commodities space for individual investors looking to profit from this market environment.
GWilliams: Preserving your wealth is absolutely the right way to look at it at the moment. Trying to make a profit in markets when there is so much uncertainty is a very dangerous thing to do because things change midgame. So I think for the next several years, using gold, silver and the platinum-palladium group metals as a store of wealth fundamentally makes a lot of sense. I suspect you are going to see outsized gains as a byproduct of using that strategy because I think the prices will go materially higher despite low headline inflation numbers. Using gold and precious metals to hedge yourself as a safety trade is the smart thing to do. By doing that, you will not only protect your existing wealth but you can also generate increased wealth through price appreciation in excess of inflation.
TGR: When you say gold and precious metals, how would an individual investor protect wealth using gold? Are you talking about holding the bullion, buying gold exchange-traded funds (ETF) or buying equities?
GWilliams: It depends. I think protecting wealth using highly geared gold mining companies is a dangerous thing to do. Yes, if gold goes crazy, you are going to make some outsize returns, assuming the asset in the ground is good, assuming the management is good and assuming you don’t get any collapsed mines or any other geological anomalies that sometimes are part and parcel of owning gold mining stocks. Holding the bullion itself is absolutely the safest way to do it. You have an asset free and clear with no claims on it. It’s yours. But that’s not necessarily an easy thing to do from a logistical perspective. A lot of people look at the ETFs as a good vehicle, and they are a perfectly good gold proxy. You have a claim on some physical metal there. But for pure safety’s sake, owning the bullion itself or as close to pure bullion as you possibly can is the smartest way to go.
If you’re looking for any kind of leverage or any kind of gearing, then you need to start looking into the mining companies. But outside the major miners, it’s a very dangerous place to be unless you have someone very smart holding your hand, and you need to do an awful lot of work on researching the particular stocks you buy. While the returns can be extremely good, particularly at these low valuations, gold is a very, very tricky thing to dig for and mines are very tricky things to operate and to run. So you have to be aware of that.
Most important, try to steer clear of government bonds. In a world of increasing inflation, and a world where central banks have promised to try and generate MORE inflation, to lend money to irresponsible governments at 0.23% for two years in the case of the U.S is just crazy to me. Over the long term, you are absolutely guaranteed to lose money in real terms by doing that.
TGR: Thank you for your advice.
Greg Weldon started his Wall Street career working in the Comex Gold and Silver Pits after graduating Colgate University. He progressed as an institutional sales broker at Lehman and Prudential before joining Moore Capital as a proprietary trader. At Moore, Weldon honed his systematic trading methodology and risk management discipline before joining Commodity Corporation where he became one of its top risk-adjusted money managers. Today, he publishes Weldon’s Money Monitor, The Metal Monitor and The ETF Playbook in addition to operating his Managed Futures Account Program as a CTA. He has a unique ability to define and forecast the market’s direction through his proprietary dissection of fundamental and technical market data. Weldon Financial is now a highly regarded and profitable publishing company, having garnered some of the world’s most respected fund managers as loyal and daily readers.
Weldon published Gold Trading Boot Camp: How to Master the Basics and Become a Successful Commodities Investor, in late 2006 in which he predicted the current global credit crisis and discussed the impact on golf from intensified central bank debt monetization. You are invited to participate in a “one-time” free trial of Weldon’s research @ www.weldononline.com.
Grant Williams is a portfolio and strategy advisor to Vulpes Investment Management in Singapore—a hedge fund running $200 million of largely partners’ capital across multiple strategies. Williams has 26 years of experience in finance on the Asian, Australian, European and U.S. markets and has held senior positions at several international investment houses. Williams also writes the popular investment letter Things That Make You Go Hmmm….., which is available to subscribers.
By The Gold Report, on January 26th, 2012
 Fayyaz Alimohamed, CEO of Altair Ventures Inc. and publisher of the Acamar Journal, offers historical perspective and predictions on the global economic crisis. In this exclusive Gold Report interview, he foresees a “mania” in junior mining stocks and recommends holding physical gold outside the banking system as a safety net.
The Gold Report: Fayyaz, in June 2008, using readily available economic data, you wrote that the global economy was on the verge of financial collapse. What do those sources tell you about where the global economy is headed today?
Fayyaz Alimohamed: In November 2006, I predicted that the U.S. was headed into a recession. Seven months later, the Bear Stearns funds cracked, beginning the crisis. By June 2008 it was obvious to me that the crisis would escalate into a crash.
Today, the U.S. cannot meet its gargantuan future unfunded liabilities. Europe and Japan face debt levels that ensure eventual sovereign debt defaults and declining standards of living. There is potential for all of this unwinding to seriously affect an entire generation.
These economies cannot grow their way out of their problems and the cuts needed to balance budgets would create massive social turmoil because the cuts themselves would lead to sharp drops in gross domestic product, creating vicious negative spirals. The current solution being utilized is more debt and quantitative easing. That can only keep things afloat until it can’t anymore. I would say that we will have the next major crisis within the next two years.
TGR: I would like to flesh that out a bit. What do you believe will trigger the next crisis?
FA: Genuine reform has not been implemented. This crisis was caused by unprecedented levels of consumer and corporate debt and Wall Street greed. When the crisis happened, government rescued distressed debt by massively increasing its own debt. For example, the Federal Reserve and the European Central Bank are using their balance sheets at about a 30:1 leverage. This is the same sort of leverage that Wall Street banks had recklessly indulged in. When government debt was substituted for corporate and consumer debt, the whole system rolled over into a much more dangerous phase.
TGR: Do you think the European debt crisis will remain the dominant theme in 2012 or will other themes take center stage?
FA: The European crisis is simply a proxy for a global debt crisis. It happens to be focused on Europe because Germany has not been as eager as the Federal Reserve to print money. Germany remembers the hyperinflation of 1924, when unbridled money creation led to prices doubling every two days.
Today, governments have a preponderant influence on the economy, while large corporations, through lobbying, have inordinate influence over the government, to the detriment of other stakeholders. As the danger of a deflationary depression increases, governments are attempting to reinflate the economy; they may well overreach and create hyperinflation.
Thus, the broadest theme by far is debt and the reaction to debt. We just saw France’s debt downgraded and a negative watch put on the European Financial Stability Facility. This negative spiral will continue. Even though the U.S. has tepid signs of economic growth, it is at the cost of enormous amounts of stimulus being put into the economy.
Given that the U.S. and Europe are its two largest export markets, China also is headed for a hard landing unless it can increase internal consumption substantially.
TGR: Much of the discussion of the European crisis has centered on Greece. But a recent auction of six-month Italian bonds was priced at an interest rate of 6.5%—the highest rate of a bond auction since Italy joined the Eurozone 13 years ago. What do you make of that?
FA: In literature, readers are invited to enter into a “suspension of disbelief” to go along with the story, even if implausible. Before the 2008 crisis, that was the mindset of investors. Now they want to believe that governments can solve these problems.
Greece was not the primary cause of the European crisis. It was caused by German, French and U.S. banks. These banks are all insolvent if they were to mark their assets to market and not to theoretical models. But, we are suspending disbelief because we all have skin in the game and need things to work out.
The drive for austerity ensures that Portugal, Ireland, Italy, Greece and Spain (PIIGS) will continue to see their economies shrink, leading to lower tax revenues and the continued inability to meet budget targets, which will require larger debt relief. It is a vicious downward spiral that will lead to declining standards of living.
Greece, Portugal and Ireland would be much better off leaving the EU, defaulting on their debts and devaluing their currencies. That is a time-honored tradition. After some pain things will work out, as they did in Argentina and Russia in the 1990s.
Investors want to believe that heavily indebted countries can solve the problems of other heavily indebted countries; that an insolvent banking system can be rescued by governments through more debt issuance and debt monetization.
TGR: The European Central Bank has floated the idea of euro bonds, backed by all 17 members of the Eurozone, as a solution to this problem. But Germany does not want to go down that path unless the indebted countries adopt more severe austerity measures. Do you think we’ll ever see euro bonds?
FA: We are really into the realm of absurdity. For example, the European Financial Stability Facility is a private company authorized to borrow €450 billion (B) from the private sector backed by a guarantee from all the EU members who are already heavily in debt and being downgraded periodically. One proposal I saw was that it would use the €440B of debt as collateral to borrow another €1–2 trillion of debt to lend to the PIIGS!
Can this type of thinking ever end well?
As Europe enters a recession, the problems will only get worse. Euro bonds issued by indebted countries just mean France and Germany are putting their own balance sheets at risk. It may provide time, but it does not solve the problem. The question is, should they bailout the PIIGS or take the same money and bailout their own banks? There are no good solutions.
A final thought on yields: when I studied economics we were taught that U.S. Treasuries were the risk-free asset to be used as an absolute benchmark. Given the recent downgrade and outlook, perhaps the economics profession should start looking for another risk-free benchmark, just as the U.S. dollar replaced the pound sterling.
TGR: Given all of this, how are you protecting yourself?
FA: One of the primary measures of protection is a healthy cash balance. You have to be in a position where you are able to ride out any crisis and also to take advantage of valuations in case of a crisis. If the crisis is as bad as I think it will be, you will be able to find and acquire assets at generationally low prices.
The other way to protect yourself is to invest in precious metals. I believe precious metals will do well whether we continue to stagnate or actually see another crisis. I think silver and gold equities will do very well in the long run.
TGR: Investors have been seeking greater security for at least seven months. How long do you think that risk-off sentiment will last?
FA: Brian, U.S. domestic stock funds have seen net redemptions for five straight years. Due to negative real interest rates, equities are undervalued in historical terms. This is tempered by the dangerous, rising systematic risk. Fund managers are paid to perform or else they face redemptions. So, the bias is for stocks to rally as we are seeing now, unless the second phase of the crisis clearly emerges, which in my opinion is inevitable.
Ironically, in another crisis, governments will likely turn to quantitative easing with a vengeance, which means that, despite a crisis in sovereign debt, we will see a substantial rally in commodities, particularly gold and equities, as substantial sums of newly created money finds its way into the system and money leaves the bond markets. You may find prices rising while the economy is being undermined.
TGR: Fayyaz, your background is in insurance and finance, how did you find your way into the gold and silver space?
FA: From 2001 onward, I realized that the U.S. seemed to lack the political will to deal with its increasing levels of budget and trade deficits. In fact, the Fed was creating asset bubbles that were bound to end badly. At the same time, I knew from history that fiat money generally ends badly, starting with Kublai Khan. I came to anticipate the decline of the U.S. dollar and the rise of gold. I believe that the price of gold will be much higher in the coming years and that gold will become part of the monetary system in some capacity.
Gold is interesting in another way. Throughout history booms have been localized geographically. As an example, the average Canadian investor is unlikely to invest in, say, Argentinian real estate or in its stock market even if they are booming. The Internet bubble was the first time that a global audience became aware of an asset category that was rising dramatically, ironically thanks to the Internet itself. But you could not participate unless you had a U.S. brokerage account. Gold is the first truly global asset boom that investors at all levels can participate in. Today investors are more savvy and more heavily invested across markets and categories but gold is fundamentally money and all investors and savers can buy it. Local yet global.
TGR: Investors also have different tools.
FA: That’s right. They can do a lot of research. They have a lot more liquidity. The potential impact on the market for gold as an asset class is phenomenal. It appeals to all levels of investors. Someone buying a few grams of gold in China creates demand that directly helps the value of your gold holdings. I mean, how many people sleep with a barrel of oil tucked under their mattress?
TGR: Not if you could help it.
FA: Historically, gold and silver equities leveraged the returns on gold. In 2011, mining companies were producing gold at an average cash cost just under $600/ounce (oz) and were getting about $1,600/oz in revenue. Cash flows are very impressive and price earnings are healthy. Mining companies continue to buy juniors with good assets, especially at these low share-price values. I moved into the sector to take advantage of this bull market in gold. And, I believe we will see a mania in junior mining stocks before this is over.
TGR: And, when will that be?
FA: I think we will see this happen within the next two years as people begin to realize that solutions to the global economic situation are not forthcoming. There will be more and more nervousness and gold will find a larger and larger audience.
We now have a situation where central banks, which were net sellers of gold for 20 years, became net buyers in 2009 and are accelerating their buying programs. We are seeing tremendous support for gold from central banks, institutional and retail investors across the world.
TGR: Do you have positions in any gold and silver juniors?
FA: Yes, one is Colombia Crest Gold Corp. (CLB:TSX.V; EAT:FSE). This company has a huge land package in a prolific gold belt, surrounded by several large deposits including Sunward Resources Ltd.’s (SWD:TSX.V) 8 Moz Titiribi project. IAMGOLD Corp (IMG:TSX: IAG:NYSE) took a 19.9% stake in October 2011, which validates Colombia Crest’s exploration program. With many large, prolific gold targets, the company will commence a 5,000m drill program next month. It also has a high-grade gold resource in Bolivia, a $25 million (M) market cap and $6M in cash. There is good upside potential as the company gets decent drill results.
TGR: Is there one project that will attract notice to Colombia Crest Gold?
FA: It has two projects in Colombia called Venecia and Fredonia.
TGR: And are they underground mine systems or bulk tonnage targets?
FA: I think Colombia Crest has a number of prolific targets. Some will be potential heap leachable targets and others are underground and, therefore, higher grade. So, the company has a dual approach in the Antioquia Province.
TGR: As far as management goes, are there people onboard that you are confident in?
FA: I mostly talk to Hans Rasmussen, the president and CEO. He strikes me as being very focused. He is a geologist and geophysicist and has worked with a number of senior companies. He was brought in by a group of investors to sort out various issues and he created the opportunity in Colombia. Rasmussen is the kind of person that you can have confidence in.
TGR: Do you have another junior name?
FA: I would also mention Coral Gold Resources Ltd. (CLH:TSX.V) with a 3.4 million ounce (Moz) Inferred resource. Its Robertson property in Nevada sits adjacent to Barrick Gold Corp.’s (ABX:TSX; ABX:NYSE) 14 Moz Cortez Pipeline mine, which produces gold at a cash cost of $312/oz. The preliminary economic assessment just came out, showing a net present value at a 5% discount at $1,500/oz gold of $147M for just three of its multiple zones. Its market cap is about $15M. Coral is a natural takeover target. I believe there is good value here for a patient investor.
TGR: Coral has not put out any news since February 2011. The lack of news for almost a year has done nothing but erode shareholder confidence. What is the problem?
FA: From what I understand, unlike nearby exploration companies, Coral has had its mine for a couple of decades and is a past producer. The company was given some very rigorous regulatory environmental conditions to meet regarding migratory patterns of birds and insects and such. Coral had to study these for a given period of time, which delayed its drilling permit. I think that situation is now on the verge of being resolved.
If that happens, Coral has the cash and is ready to drill. You should see movement in terms of activity and, potentially, share price appreciation.
TGR: Let’s move to silver. Great Panther Silver Ltd. (GPR:TSX; GPL:NYSE.A) is led by Bob Archer, a real veteran. The company is producing from its Guanajuato mine in Mexico. In 2012, the company plans to produce 1.72 Moz silver, up from 1.5 Moz last year. It also expects to produce 10–11 thousand ounces (Koz) gold, up from 7.8 Koz in 2011. That news, although good, was not met with much enthusiasm from the market. What are your thoughts?
FA: I think a 20% year-over-year increase is very healthy for any producer. The company’s profit margins are excellent. It has a 30% net margin for the year to date. So, it should generate very decent cash flows going forward. Great Panther has $40M in the bank. It is growing the resource at the San Ignacio project, is looking for acquisitions and it is mining a recently discovered high-grade zone in Cata.
Overall, the junior sector has stagnated over the last few months and I think Great Panther has just been part of that process.
TGR: What are your thoughts on what Bob Archer has done there?
FA: I think Bob has delivered tremendous value for shareholders. He is very competent and is a man of integrity. I think his share price is closely linked to the price of silver, which is generally true for most silver producers. Guanajuato has a rich history. It was mined by the Spaniards and has been in production for 400 years. It was once considered the richest silver mine in the world. Bob has taken it from when silver was down to $4/oz, resurrected it, capitalized it, built out infrastructure and delivered tremendous value.
TGR: In your time in this space, what have you learned that the average retail investor ought to know?
FA: This is a very volatile sector, subject to investors jumping in when there is a bullish trend and a lot of enthusiasm, and those same investors not wanting any part of equities when there’s a pullback in prices.
Given the overall increase in volatility in the markets, investors really should take a look at gold and silver. If they are bullish, any pullbacks in the commodity prices or in the associated equities should be seen as buying opportunities. When there is a lot of enthusiasm, it should be seen as creating selling opportunities.
You also have to have physical gold and silver in your possession. We learned a lesson with MF Global. We saw $1B of segregated funds in clients’ accounts vanish. My understanding is that some of those funds were comingled and used to settle MF Global’s liabilities to other financial institutions. There is this whole issue of counter-party risk, which gold does not have. That should be a cautionary reminder to people. You need to have physical cash balances. You need to have physical gold and silver outside of the banking system as a safety net because, as Warren Buffet said, we are in uncharted waters now.
TGR: You grew up in Pakistan, where gold is part of the culture, given as gifts at weddings and such. Do you think you would have that same opinion about physical gold as a personal asset if you had grown up somewhere else?
FA: Not in my case. I had no involvement or affinity with gold. I was a finance professional. My involvement with the gold sector is purely intellectually driven, from looking at trends within the macro economy and realizing that gold and silver really are hedges against turmoil and currency debasement.
But that is a very good question and it points up the importance of watching out for biases in the commentaries that you read. People have vested interests and they do tend to have agendas, both in the mainstream media and elsewhere. For your own protection, you need to be sensitive to those influences and to study track records at key inflection points before relying on other people’s judgment.
TGR: Fayyaz, thank you for your time and your insights.
Fayyaz Alimohamed is president, CEO and director of Altair Ventures Inc. and publisher of the Acamar Journal. He has over 20 years of experience in investment management, finance and consultancy. He previously worked at the Aga Khan University Hospital, Financial and Management Services Ltd. (a management consultancy set up by Morgan Grenfell & Co. Ltd. and Booz Allen Hamilton Inc.) and as the chief financial officer of the Key Capital Group before becoming director of investments for the Cupola Group, a large operating and investment conglomerate based in Dubai. He holds a Bachelor of Science (Honors) degree in economics from the London School of Economics, University of London, and is a Certified General Accountant (CGA).
By The Gold Report, on August 22nd, 2011
The week of August 15 was one of the most volatile stock market performances in years. Negative news about the global economy, gloomy forecasts and mixed signals on the jobs front battered stocks and sent gold repeatedly above $1,800/ounce. The Gold Report asked an analyst, two newsletter writers and an economist the following: What should be a precious metals investor’s next move?
The Gold Report: John Williams, government economist and editor of ShadowStats, put it this way: “The financial markets remain unstable and the U.S. dollar is viewed increasingly as the investment currency of last choice. . .Any cosmetic actions taken pre-2012 election likely only will add to the long-term inflation and dollar-debasement problems.” Considering these market conditions, is this a buying opportunity for equities or a good time to take refuge in gold and silver bullion as they continue their climb north? How are you adjusting your investing positions in light of global geopolitical and financial unrest?
Nana Sangmuah, Clarus Securities analyst: All indicators point to weakening global macro-economic framework that has stoked the safe haven demand for the bullion. Despite the good run so far, I expect to see some volatility going forward and there will be some pullbacks in the near term. To stay a winner depends on when you jumped on the bullion band wagon. A better way to reap this upside is to move into gold equities with production and immediate leverage to rising gold prices. Most of these have not re-rated to the $1,500/oz. gold price environment so pose little risk to the downside, but a lot of upside, as they continue to report record quarterly results.
John Kaiser, producer of Kaiser Research Online: The valuation lag for gold and silver equities relative to the prices of gold and silver bullion reflects an embedded pessimism about the medium- to long-term global economic outlook, which has been exacerbated by the recent debt ceiling debacle. Private sector deleveraging has been underway since 2008, and it now appears that political pressures are forcing a cycle of public sector deleveraging called “austerity.” China’s fiscal stimulus response to the 2008 curtailment of consumption demand depended on the American economy regaining traction by 2011, but it is now clear that American fiscal stimulus efforts have been ineffectual and China’s slowing economy will not receive a boost from a recovery in American demand. This crimps expectations that China’s growing economy will continue to incur a rising cost structure as domestic consumption assumes a greater share of Chinese GDP and boosts the competitiveness of American-produced goods and expands the Chinese market for them. A slowing Chinese economy, in turn, reduces the willingness of the private sector to invest in American production capacity and boost employment through manufacturing jobs. That will further encourage private sector deleveraging and result in scaled-back consumption, in effect putting in place an economic death spiral accelerated by ongoing job losses at the state and local government levels as the tax revenue base shrinks.
While the prospect of a dysfunctional global financial system boosts demand for gold and silver prices, the arrival of a double-dip recession possibly deteriorating into a full-blown depression has deflationary implications that will “pop” the so called bubble in gold and silver prices. Equities are not tracking the short-term rise in gold and silver, which could exceed $2,000/oz. and $50/oz. respectively, because markets are anticipating a serious medium-term retreat in gold and silver prices. We could see gold and silver head higher while gold and silver equity prices head lower. The buying window would emerge after gold and silver have spiked in the midst of “panic” conditions, with the speculation being that current prices plus or minus 20% are the new long-term reality for gold and silver prices. However, for that to happen there must be signs that the American economy is on a growth track, and that the Eurozone will avoid disintegration. The sharp sell-off in gold and silver prices in the medium term, which current equity prices are discounting, would not happen if the American economy continues its current trend of relative decline within a growing global economy. The latter requires the United States to adopt a fiscal stimulus program that produces assets that flow value to future generations expected to pay off the associated debt.
The negative scenario for gold would be one where the United States, in an effort to postpone or suspend its relative economic decline, engineers a downturn that inflicts considerable suffering on its citizens, but utterly demolishes emerging economies such as China, which represents the biggest displacement threat to the United States. The political discourse seems to suggest that the best way for America to save itself is to submerge itself and drown dependent economies before they are advanced enough to swim on their own.
Ian Gordon, economic forecaster and chair of the Longwave Group: The majority of gold investors are there because they can see the impending collapse of paper money, but some investors, including many hedge funds, are in the gold market simply because they are trend-followers. In ugly markets, such as the one now unfolding, these trend-followers sell their gold. During the stock bear market, which commenced in October 2007, the price of gold continued to rise into March 2008, even though the Dow had lost about 17.5% from October 2007 to March 2008. But after March, gold sold off into October 2008, losing about 35% of its value. We feel that something similar could happen to gold, this time, in the wake of falling stock prices. As for silver, prices fell by 60% between March 2008 and October 2008. A 35% drop from current prices would see the price of gold fall to something like $1,200/oz. As for the stock market, we are extremely bearish and believe that in the Elliott Wave market cycles, we are entering the third downswing, which should take the Dow Jones Industrial Average well below the March 2009 low of 6,470; perhaps 4,500 will be the target by September 2012.
Jason Hamlin, president of Gold Stock Bull: I am going to continue holding precious metals and buying the dips. The Gold Stock Bull portfolio has been short general equities and long precious metals for the past few months, which has paid off handsomely from both angles. Having already hit my 2011 target of $1,800, I now think gold could end the year above $2,000 rather easily. I have not closed my short positions against emerging markets and the Nasdaq, despite the current correction. I do not anticipate a healthy rebound anytime soon, only dead cat bounces unless and until a much larger QE3 program is announced. But even with the massive liquidity injections, we are seeing the law of diminishing return take hold. Eventually, the house of cards must tumble. I have been allocating more towards physical metals and towards funds that hold the physical metal such as Central Fund of Canada (AMEX:CEF). I have also increased my allocation of gold versus silver, as I think gold will outperform under weak economic conditions.
By The Gold Report, on March 22nd, 2011
 Good rocks and good people are the core building blocks of successful junior miners. Casey Research Senior Editor and Mining Strategist Louis James wants to see the mineralization close up and talk to geologists to verify the powerful upside potential that may be in these stocks, which are also vulnerable to staggering corrections. In this exclusive interview with The Gold Report, Louis reveals how to benefit from the combination of geopolitical and domestic uncertainty and growth potential in the ground.
The Gold Report: You are a fundamental investor and as such you don’t look at macroeconomic trends quite so closely. As you say in one of your reports, you “kick the rocks.” But, are you still bullish on gold?
Louis James: I don’t think those two are necessarily antipodes, nor is there any tension at all between keeping an eye on the big picture while looking for value in a specific opportunity. The one is the context for the other. I look at the overall picture, and the basic idea is to find a trend that’s going to be your friend and place your bets accordingly. But, of course, you want your bets to be the best possible ones. A rising tide may lift all ships, but you don’t want to bet on a leaky one. So, yes, I go out and kick the rocks to try to pick the best ones.
To answer the question—yes, I am very bullish on gold. Gold is in the midst of a $25/oz. retreat as we speak, and I love days like that. That actually helps us to buy gold or gold stocks from weaker hands that are shaken by such moments.
The reasons for the bull market in gold haven’t gone away; in fact, they’ve only gotten worse—or better, depending on your perspective. We were amongst the few contrarians that were calling for a financial crisis leading to a currency crisis, before the crash of 2008. Anybody can look back at our publications to verify that, and the reasons for those predictions are still in full force. If anything, they’ve been made worse by quantitative easing (QE), Bernanke’s non-printing printing of money (he has claimed both that the Fed is and is not printing money) and all the other things governments are doing that are, as our founder Doug Casey likes to say, not only the wrong things but the exact opposite of the right things to do. And what’s bad for fiat currencies is good for gold, so, yes, we’re very, very bullish on gold. That said, one we should never forget that we’ll be taking one step back for every two steps forward.
TGR: You believe there are fundamentals in global economies that are acting as catalysts for inflation?
LJ: That is correct. And, not just inflation but, political. . .
TGR: Catastrophe?
LJ: Trouble. Look at the protest in Wisconsin from the government trying to balance the budget there. Unlike the federal government, state governments can’t print money. So, at some point, they have to cut somewhere or they won’t have anything to pay the bills. The huge response in Wisconsin is quite interesting—part of a bigger trend that is much, much deeper than trouble in the Middle East. There’s a lot of trouble on many different fronts. We don’t think it’s a coincidence that you see political unrest at times of economic difficulties. Look at the price of food and cotton and other commodities. These are things that have immediate and direct impact on the lives of the masses—the transmission belt between economic trouble and political trouble—and eventually social upheaval.
TGR: Were you implying that the Wisconsin protests are similar to the anti-austerity protests and rallies that we saw in Europe, particularly in Greece and Spain?
LJ: I’m saying just that. Belt tightening is never popular, and it’s just getting started. Americans are still relatively comfortable compared to people in other places. You framed your question about Europe in the past tense. That’s just the warm up. The musicians tuned their instruments, and we heard the overture. All the ingredients for significant social turmoil are there, as the concert goes into full swing. The implications are quite significant and they’re global.
TGR: You have written about black swans.
LJ: Yes. A black swan is any unexpected event that upsets your projections. Many people were expecting Arab-Israeli tensions to increase, but weren’t expecting the collapse of Arab despotisms. I can’t say that we saw that specific thing coming either, but I can say that we have stated in print that such despotisms eventually have to go the way of the dodo bird. Actually, it wasn’t so long ago that Doug Casey did a report on Egypt wherein he said it was basically a caldron that was waiting to bubble over. But those are just examples of certain kinds of black swan—anything can come and upset the apple cart. If, for example, some U.S. state is suddenly unable to pay its bills and the lights go off, a lot of people will call that a black swan—though it should be no great surprise. Or it could be China, India or Japan. It could be the Koreas shooting at each other. I just think the climate is right; it’s a black swan-friendly environment.
TGR: Given that you’re a bit cautious currently, you were recommending a dollar-cost-averaging strategy to enter new long positions that your readers didn’t already own.
LJ: Yes.
TGR: If we are in a rising market, a dollar-cost-averaging strategy is a negative. It hurts investors.
LJ: I disagree completely. This is not investing. This is speculation.
TGR: Ok. Go ahead.
LJ: To be able to sleep at night has enormous value. Of course, that’s just a rubric for a larger financial concept here. We are dealing with serious risk, and I think it is very dangerous to imagine that you’re investing when what you’re really doing is speculating. These two are not the same thing.
The junior resource sector, our focus at Casey Research, is without question the most volatile market on earth. These stocks all correct. They all fluctuate. Even market darlings and great success stories frequently will retreat 50% or more, even without a 2008-style crash, before they go on to new heights. So, there’s always reason to be careful, to deploy wisely, to wait for days when the markets pull back to buy, to take cash off the table when you accumulate gains.
Going all-in is a gambler’s game. I can’t stress this enough to people. Gains are not gains until you realize them. At Casey Research, when we report a track record it includes realized gains—not just high-watermarks stocks reach after we recommend them. We include the profits we’ve taken off the table, which we do routinely.
TGR: Back in the fall, you visited some mining operations in Colombia. It was a due diligence trip. What do you do on these trips? You’re fluent, or at least conversant, in multiple languages and I’m sure that’s a big help to you. What are you looking for?
LJ: I use what we call the “8 Ps,” Doug Casey’s formula for resource stock evaluation. As the words “due diligence” imply, my function is to verify all of the Ps, as much as I can. But it does tend to boil down to a few things. One is to go and physically look at the rocks and see if they match what management is saying. They don’t always. You can go down the ladder of the mine and look at the vein on one level, see that the vein continues on levels below and reasonably conclude that there’s mineralization between. That’s the kind of physical verification I do.
Particularly crucial is the first “P”—people. I meet with management and the technical people who will actually do the work that adds shareholder value. Do they seem to know what they’re doing? What kind of experience do they have? Is it relevant to the task at hand? Will they look me in the eye when I ask them questions? Sometimes that’s the most important thing. You could call it the smell test. And yes, the languages help.
TGR: So, you want to get away from the guided tour. What happens when you feel like there’s a discrepancy between what you’re seeing with your eyes and what management has said?
LJ: It’s rare to get a flat out lie. It’s more common for something to be not quite as rosy as described. Typically, when there’s some kind of discrepancy, I discuss it with management and give them a chance to explain. I’m not interested in conflict, and we don’t generally report negatively on companies. If something doesn’t make the grade, we just move on to the next opportunity.
TGR: What about takeover targets? Antares Minerals is gone. Newmont Mining Corp. (NYSE:NEM) is picking up Fronteer Gold Inc. (TSX:FRG; NYSE.A:FRG). Ventana Gold Corp. (TSX:VEN) is in the process of being taken over. What are some of the good opportunities left for investors, particularly in Colombia?
LJ: In Colombia, one obvious candidate would be Sunward Resources Ltd. (TSX.V:SWD). It’s developing a new project that has big multimillion-ounce potential, but the company hasn’t finished drilling it off yet. There’s still a lot of work to do. It’s a new story, gathering a lot of interest.
The other obvious one in Colombia would be Galway Resources Ltd. (TSX.V:GWY), which is immediately on strike from Ventana. It’s got more going for it than just the proximity—good drill results show that Ventana’s mineralization does indeed continue onto Galway’s property. On the other hand, Galway did not get taken out with Ventana; so you have to ask yourself: If Brazilian billionaire Eike Batista is not in a hurry to take Galway over, is there any reason for us to hurry to own the stock?
Colombia is perhaps my favorite jurisdiction in Latin America. The country is now headed in the right direction with new free-trade agreements and a population that wants to work and is very focused on rebuilding the economy. There are environmental issues, particularly the high-altitude Páramo ecosystem protection legislation with which Greystar Resources Ltd. (TSX:GSL) has run into trouble recently. It’s important for people to understand that this was not a new regulation slapped onto Greystar. It was an existing regulation that the government never had the power to enforce before because they were in a war for 40 years or more. The government did not start changing the rules on the company—that was always a risk there.
In line with that and your question about disciplined buying, we like to recommend that people buy in tranches. Buy a first tranche, maybe just 20% of your ideal position to make sure you don’t miss the boat. Then, when it corrects—and they always do—buy another 20%. That gives you 40%. Then, if you get a big reversal without any bad news from the company—things go on sale periodically in our sector—back up the truck and buy a big block at low prices. That would be the sort of approach I would recommend with something like Sunward, which already has seen a great deal of share price appreciation in advance of the anticipated results. I also like Colombian Mines Corporation (TSX.V:CMJ).
TGR: Colombian Mines is down 20% over the past 12 weeks, while Sunward is up 24% over the same period.
LJ: Yes. Sunward has had some good drill results. It drilled into thicker and higher-grade mineralization than previously at its Titiribi Project, which is known for being big but low grade. The new results are not high grade—but higher-grade, which is important for a big bulk-tonnage project like this. It makes sense for SWD shares to appreciate.
Colombian Mines hasn’t had a game-changer like that yet. The company has identified a gold porphyry at its Yarumalito project. It’s big and potentially could be a company-maker; but so far, the drill results haven’t really sewn that up. There are assays pending that may bear on that. We’ll have to see. Colombian also has the higher-grade El Dovio project, which is earlier stage but potentially very rich for the company. CMJ also has joint ventures (JVs) on some of its projects. I like using OPM (other people’s money) on high-risk exploration, so I like Colombian Mines. We already own the stock and are happy with our position. We’d like to see the company gain some traction on these projects before we buy anymore.
Miranda Gold Corp. (TSX.V:MAD) is a newcomer in the region, but I know the management and I like them a lot. In spite of the good people and prospective properties, Miranda hasn’t had a lot of luck with its projects yet. That does happen sometimes; even with the best geologists, Mother Nature isn’t always cooperative. So, I like the company but I’m waiting for it to have the tiger by the tail, or at least some indications of a company-maker on hand.
TGR: What about others?
LJ: Pulling back to the global picture looking for takeover targets, one of my favorites is Premier Gold Mines Ltd. (TSX:PG). That’s Ewan Downie’s spin out of Wolfden Resources Inc. with projects that are all potentially big, high grade and in top mining jurisdictions. Most are within spitting distance of Goldcorp Inc.’s (TSX:G; NYSE:GG) producing assets. Premier is working to proving up significant high-grade, multimillion-ounce potential targets—it has takeover written all over it. I don’t know when it will happen, but I think it will. Goldcorp might be happy to see Premier spend its money and do a lot of work for it, but if Goldcorp starts thinking that somebody else may come in and scoop them up, I would expect it to move aggressively.
An earlier-stage one we’ve mentioned in our publications would be Bayfield Ventures Corp. (TSX.V:BYV). It has a continuation of the Rainy River deposit called the Burns block. This has graduated from being just “the property next door” to having a high-grade gold shoot immediately on the Bayfield side of the property line. And you know that high-grade pocket is not going to be left hanging in the wall of an open pit. Somebody’s going to want to produce that gold—it’s just crying out for a takeover.
Trade Winds Ventures Inc. (TSX.V:TWD) is a similar situation but not quite as extreme. It’s got a multimillion-ounce gold resource growing on trend from Detour Gold Corporation’s (TSX:DGC) Detour Lake deposit. The project is a 50/50 JV with Detour already, so there’s a natural synergy there and potential for takeover, but it could get big enough to justify a stand-alone operation.
TGR: Any other companies you might be able to discuss?
LJ: Because you’re interested in Colombia, I could mention Mercer Gold Corp. (OTCBB:MRGP). I like the company, I like the people and I like this particular model, which is to try to explore on the other side of the mountain from the famous Medoro Resources Ltd. (TSX.V:MRS) project in the Marmato district. Marmato is an infamous environmental disaster zone in Colombia with hoards of illegal miners dumping cyanide down the mountainside, and Medoro is the company that’s working to clean that up. There aren’t any swarms of illegal miners on the other side of the mountain; in fact, there are only five miners and they’re all in an association with which Mercer has formed an alliance. There’s no established gold resource on Mercer’s side, however, and so far, Mercer’s drill results have not produced any company-making discovery holes. It has the right kinds of rocks, so it’s got potential but it’s early stage. Medoro’s riskier at this point but certainly has a great deal of upside if the company hits what it’s looking for.
TGR: Louis, are there any closing comments you’d like to leave with our readers?
LJ: Yes. We see a great deal of possibility for correction ahead. If the trouble in the Middle East settles down, and if the economy seems to be continuing to recover and the fear factor recedes, we could see gold retreat significantly. The retreat we had in January was only about 5%, which is really quite small as far as gold corrections have gone during this cycle. Gold has retreated as much as 25% in this cycle before going on to new highs. We really haven’t seen a major retreat in gold since the big ramp-up last year; so, we are urging people to be cautious. If you do buy anything now, make it a first tranche and keep some powder dry for lower prices ahead. If that doesn’t happen, and if the market doesn’t correct, the market may go really manic, inflating a major gold bubble. If that starts happening, you’ll be able to see it and there will be time to redeploy into that bubble. So, we do urge caution right now.
TGR: Many thanks, Louis.
LJ: You’re very welcome.
Always on the lookout for the next double-your-money winner, Louis James is the master of metals at Casey Research where he’s the widely read and well-respected senior editor of the International Speculator, Casey Investment Alert and Conversations with Casey. Fluent in English, Spanish and French—and conversant in German and Russian, to boot—Louis regularly takes his skills on the road, evaluating highly prospective geological targets, visiting explorers and producers at the far corners of the globe and getting to know their management teams. In addition to subject matter expertise, he’s built a following on the basis of a dynamic combination of investment savvy, practical advice, experience in physics and economics and a gift for comprehensible technical writing.
By Claus Vistesen, on January 17th, 2011
It would have been hard to believe only a few weeks ago that the euro zone could be the source of any good news let alone news to help push the market forward. Yet, with last week’s successful bond auctions and the pledge of international superpowers such as Japan and China to buy Euro zone debt and the ECB’s sudden more hawkish tones, the obvious question is; are we out the woods yet?
Hardly, but it was interesting to observe the almost coy manner in which the ECB slowly but surely began the move towards contemplating to think about raising interest rates. We are not there yet of course, and I still think that any hike in the ECB’s refi rate are, for now, confined Weber’s dreams and a very distant playbook sitting around somewhere on the lower levels in the Frankfurt tower. But let us be honest, stranger things have happened than the ECB raising rates just before the next downturn. Indeed, you might even call this a leading indicator.
In the meantime, the patchwork which is the Euro zone rescue/bail-out/backstopping mechanism is frantically being sown together. Barclay’s Capital collected the following from the market drums in terms of modifications to the hybrid (EFSF) already in place;
He [commissioner Oli Rehn] indicated that various options would be discussed among European policymakers but that it was too early to comment on this in more detail. However, Rehn mentioned that one modification could be related to the rate charged on EFSF loans, with a view to reduce those. Other media reports suggest this could also include the provision of short-term credits to euro area member countries requesting support, the purchase of government bonds through the EFSF, or a change of collateral rules to boost the fund’s effective lending ceiling.
A lot of things on the menu then it seems, but the most important question is really that no one has talked about yet; as Jack Barnes points out;
The system has reached the stage that a bankrupt sovereign state is issuing debt to buy bonds in a vehicle that is tasked with buying debt from a bankrupt Sovereign state that is no longer able to go to market. Folks this is reaching the level of a Monty Python skit.
This brings up a serious question not seen answered in the public yet.Who is ultimately responsible for the bonds that the rescue fund is going to be selling as AAA investments? Whose AAA balance sheet is guarantying these bonds that will be sold to investors like Japan?
So, apart from the obvious issue of issuing more debt to pay off the debt used to finance the debt of bankrupt sovereigns, there is a question of what exactly it is China and Japan will be buying. I am willing to give the EU some benefit of the doubt here especially since I have long been a strong advocate of issuing Euro bonds. But then, these are not Euro bonds as such, but rather instruments used to capitalise a fund which, as Jack Barnes succinctly notes, is in dire need of a capital injection even before it has deployed a single euro of capital. Obviously, the EFSF was created as an attempt to ring fence the problem in the periphery and thus to hedge against a future blow-up . But this always missed the point in the sense that we didn’t really need a bailout fund, but a rather a structural change in the way we perceive and organize the link between fiscal and monetary policy in the euro zone. As traders like to remind newcomers to the business, hedges are things you buy at a B&Q, not at your broker.
The EFSF could conceivably bailout a large part of the inflicted economies, but then there was always going to be Spain not to speak of Italy which it cannot deal with. On that note, it was eye-wateringly embarrassing to hear both the Spanish finance minister and the Portguese prime minister daftly using their respective “successful” bond auctions to note that neither of the their respective economies were going to need any form of bailout simply because they don’t need it!
This is then not to play down what was a long awaited successful event in the context of the European debt crisis which I unilaterally applaud (and hope for more to come) it is merely my attempt to put things a little into perspective. In this light, the gradually more hawkish tone by the ECB could be be seen as a little bit of stick to show economies that while we are here to help, we are also here to do our job which is to protect the purchasing power of all the euro zone citizenry. This may of course be waffle, but the ECB has long had a legitimate problem with simply playing the game in the form of providing liquidity and and even buying up peripheral bonds while playing into inability and flatfootedness of euro zone policy makers. Naturally, my bet is that we have only seen the nascent moves of what will become a full fledged measure of QE by the ECB and much more aggressive buying of sovereign bonds (simply because they have to), but this does not mean that policy makers can simply ignore the facts as they are presented by economic data and common sense.
But I might just be too harsh here and all it might be me who are behind the curve as those very same policy makers are now moving ahead of the curve in the form of, allegedly, a two-front attack on the situation with a bail-out of Portugal and a full euro zone backstop to whatever black hole the Spanish banking sector might turn out to be. Especially this last bit is interesting because it coincides with the news (albeit not fully confirmed and digested by the analysts) that Spain would stand ready to inject a hefty sum of money to shore up its banking system.
Here is Tracy Alloway from the FT Alphaville;
Just as the European Central Bank announced that Spanish bank borrowing resumed its upward trajectory last month (€70bn in December, up from €64.5bn in November) El Confidencial is reporting that Spain is preparing a massive capital injection of between €30 and €80bn to clean up the cajas, or local savings banks.
Having long been the twenty thousand pound elephant in the china shop this is indeed something worth noting more than in passing. Going into perma bear mode I am thinking about Ireland and the sudden reversal of a relatively good sovereign who was brought to its knees by its promise to see through the bailout of its financial sector. The point is that Spain is structurally similar with high private debt, and relatively low sovereign debt and while Ireland was probably going to hit the canvas in any case, its situation got worse by the ongoing quibble about what euro zone bailout funds could be used for. Specifically, the explicit refusal to allow the funds to bail out banks put the whole Irish situation in a tight spot although it was eventually an academic demarcation as the two got fused through the dreaded Irish government guarantee to backstop its largest banks.
So, I am carefully assuming that whatever Spain is brewing on here they have the potential firepower of the euro zone in the back. I have passed on this notion to a friend of mine much closer to the Spanish situation (guess who!) and here are the main points;
1) This is only the cajas, there will then need to be more for the banks (somehow). In fact, once the political argument is settled, the thing is much easier in the cajas case, since because they can’t go to the market with shares, the only thing to do is semi nationalise them, and then refloat later.
2) This then will be the first de facto step of Spain into the arms of the EFSF, since obviously the Spanish sovereign won’t be able to fund the injection (at least not at viable interest rates). Spain should be in completely between May and August.
As such, if it is part of a general euro zone backstop to the Spanish financial system it may be quite a move (and also as noted a sea change since all the quibble on Ireland concerning the use of bailouts would be presumably have been put in the past). I emphasize this since the clock is ticking and the same momumental structural challenges lie ahead even if one country’s successful bond auction may seem to have changed the situation for a while.
As such it might be worth having a look at those fundamentals of the euro zone again and what the proposed (and inevitable) correction mechanism presents in terms of challenges.
Remember the Catch 22
Structurally then we are still faced with the same seemingly irreconcilable issues in the form of imposing internal devaluations, fiscal austerity and returning to economic growth all at the same time from within a currency union. I have called this the catch 22 of euro zone imbalances not least in relation to the idea of a debt snowball;
[...] the forces which have lead to the build-up of imbalances are joined at the hip with the same forces which make it almost impossible to correct from within the Euro zone. Specifically the idea of a debt snowball effect is a good way to show why it will be almost impossible for some economies to correct their external imbalances without an explosive evolution in government debt and since they need to correct external competitiveness issues in order to achieve economic growth, the whole thing turns into a vice and essentially a catch 22.
It is consequently, the rapid deterioration in the private and public debt dyanmics which euro zone policy makers and the IMF are so concerned with and thus trying hard to backstop and reverse. But it might not be so easy as to focus entirely austerity since debt dynamics are also driven by your ability to grow.
At this point you may rightfully wonder then what the hell a debt snowball looks like? Well, why don’t I show you then (see this paper for the model).
Now, in any economic model we need assumptions and instead of feeding in any of the forecasts for the periphery (which are hugely uncertain) let me take the point of view in a model economy with somewhat better fundamentals than many of the peripheral economies. As you shall see, the initial condition matters less than the underlying dynamics for creating a debt snowball.
As such, I assume that my model economy starts with a debt/gdp at a humble 60% to GDP (say in 2010) and that it pays 5% on its entire sovereign debt portfolio. The point here is that while e.g Portugal might have paid 6.7% on its last issuance it does not pay this on its entire portfolio of liabilities. This is also why we have been talking so much as about roll over schedule since if you are so unfortunate that you need to roll over and refinance in times of trouble you are likely to incur a high cost that affects your entire liability side.
Finally, I crucially assume that you can’t have both austerity and growth at the same time. If you want growth it will cost a higher fiscal deficit and if you to run down the fiscal deficit you must endure deflation (negative nominal GDP growth in essence) and it is this latter which the ECB and EU are pushing. Especially this last assumption is absolutely crucial to understand since it is this situation the periphery faces with an internal devaluation in the euro zone (click on all pictures for better viewing).
The bar shows the average from the simulations shown by the line plots. As you can see the numbers are obviously fantasy numbers, but since this an average across many different scenarios where both the fiscal decifit (austerity measures) and growth are dynamic it might not be entirely irrelevant. The set up of these simulations are quite simple. I can change three things in my model; the growth rate, the interest rate, and the budget deficit (primary deficit) [1]. In all the simulations the interest rate is set at 5% and then I build a cross section where I dynamically change the growth rate and budget deficit building in the trade off that you cannot have a low budget deficit and “high growth” at the same time.
Obviously, the results are quite sensitive with respect to how strong you believe the trade-off is between growth and fiscal austerity. I have built in a pretty strong trade off in order to demonstrate what I believe are signficantly worse short term growth dynamics than the consensus. This is also why the model’s result becomes exponential at longer time horizons.
Consider then the debt/GDP dynamics of our model economy in the first 10 years;
Suddenly, the numbers look more realistic but not less scary since you need to remember that this is the average evolution of public debt across all policy mixes (i.e. in a continuum from high growth negative and large budget deficit and low negative growth and fiscal surplus). It is exactly because correcting from within the euro zone imposes this trade off that you end up in a catch 22. Take the example that our model economy manages to realize a constant budget deficit of 6% of GDP which results in a zero growth rate of GDP. In that situation the model predicts a debt/gdp ratio of 160% in 2020 (98% in 2015). It goes without saying that if your initial level of debt is higher, the corresponding level of debt will be corrected up.
I am not presenting this as truisms and prediction tools since evidently economic models are anything but. Instead, they should serve mainly as evidence that bailouts are going to be needed and also sadly that defaults of both the sovereign and private ones are coming and they will be costly.
Finally and just for the sake of argument I thought that I would demonstrate that this model is not simply about exponentially increasing debt/gdp ratios. Consequently, the “good economy” and “bad economy” below both pay 5% on interest on their government bond portfolio but the former has a budget surplus of 3% a year and grows at a rate of 3% a year as well. The latter on the other hand looks more like the periphery with a budget deficit of 5% and a negative growth rate of 1%.
Again, the point is not to extrapolate into the infinite unknown, but to observe that even in the very short run this creates unsustainable debt dynamicsfor the “bad economy”.
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[1] – So I am being very nice here not even considering interest rate payments on existing debt.
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By Claus Vistesen, on July 2nd, 2010
Steve Waldman has a very good post this week about the folly about the austerity vs non-austerity discussion which seems to be going the rounds at the moment. In fact, it you take a mental picture of the current financial market discourse most arguments can be bracketed along the two axes of austerity vs non-austerity (as a matter of preference) and inflation vs deflation (as a matter of prediction). Note in particular the following from Steve;
I think the austerity debate is unhelpful. There are complicated trade-offs associated with government spending. If the question is framed as “more” or “less”, reasonable people will disagree about costs and benefits that can’t be measured. Even in a depression, cutting expenditures to entrenched interests that make poor use of real resources can be beneficial. Even in a boom, high value public goods can be worth their cost in whatever private activity is crowded out to purchase them. Rather than focusing on “how much to spend”, we should be thinking about “what to do”. My views skew activist. I think there are lots of things government can and should do that would be fantastic. A “jobs bill”, however, or “stimulus” in the abstract, are not among them. If we do smart things, we will do well. If we do stupid things, or if we hope for markets to figure things out while nothing much gets done, the world will unravel beneath us. We have intellectual work to do that goes beyond choosing a deficit level. The austerity/stimulus debate is make-work for the chattering classes. It’s conspicuous cogitation that avoids the hard, simple questions. What, precisely, should we do that we are not yet doing? What are the things we do now that we should stop doing? And how can we make those changes without undermining the deep social infrastructure of our society, resources like legitimacy, fairness, and trust?
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Elsewhere, in the world of academia, I also noted this piece by Mark Bauerlein, Mohamed Gad-el-Hak, Wayne Grody, Bill McKelvey, and Stanley W. Trimble in the Chronicle of Higher Education on the avalanche of poor research. The authors point towards a growing problem of sub-par research in general pointing to, as far as I can see, three things. First, that the growing amount of poor research is a strain on the system of peer-reviewed work (too many articles to review by too few able reviewers); secondly, that the pressure to produce in academic circles leads to quantity over quality and thirdly that the increasing tendency of money to flow to the amount of publications by default exacerbates the problem.
While brilliant and progressive research continues apace here and there, the amount of redundant, inconsequential, and outright poor research has swelled in recent decades, filling countless pages in journals and monographs. Consider this tally from Science two decades ago: Only 45 percent of the articles published in the 4,500 top scientific journals were cited within the first five years after publication. In recent years, the figure seems to have dropped further. In a 2009 article in Online Information Review, Péter Jacsó found that 40.6 percent of the articles published in the top science and social-science journals (the figures do not include the humanities) were cited in the period 2002 to 2006.
(…)
Our suggestions would change evaluation practices in committee rooms, editorial offices, and library purchasing meetings. Hiring committees would favor candidates with high citation scores, not bulky publications. Libraries would drop journals that don’t register impact. Journals would change practices so that the materials they publish would make meaningful contributions and have the needed, detailed backup available online. Finally, researchers themselves would devote more attention to fewer and better papers actually published, and more journals might be more discriminating.
In the context of the world of academic economics which I am accustomed to I can see most of the issues the authors point. Especially, I would point towards the pressure to produce which is extensive in the context of economics. However, I am not sure about the point that a large bulk of research is bad because it, in itself, takes a lot of time to digest. I like to think that a study which might not be deemed relevant today may find its day in the sun in the future if the consensus and discourse changes.
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Economist Kartik Athreya from the Richmond Fed (Virginia) is not too fond about econbloggers voicing their opinions on macroeconomic because, as he says, it is a topic much too complicated for econbloggers to understand (the original link to the essay is gone, but FT Alphaville and Scott Sumner provide good coverage and quotes). Now, I don’t even know where to begin here but as both an econblogger and a semi-academic economist I naturally ought to be able to muster some opinion. But really, where do you start here? Well, I especially noted this;
So far, I’ve claimed something a bit obnoxious-sounding: that writers who have not taken a year of PhD coursework in a decent economics department (and passed their PhD qualifying exams), cannot meaningfully advance the discussion on economic policy. Taken literally, I am almost certainly wrong. Some of them have great ideas, for sure. But this is irrelevant. The real issue is that there is extremely low likelihood that the speculations of the untrained, on a topic almost pathologically riddled by dynamic considerations and feedback effects, will offer anything new. Moreover, there is a substantial likelihood that it will instead offer something incoherent or misleading.
Let me be very, very clear here. The ability to solve dynamic optimization problems, to solve complex differential equations, to derive, on paper, various statistical estimators do not make a good economist. You do all this in order to become a part of the initiated crowd and in order to speak a language which dazzles colleagues and the greater public by its complexity and, crucially, is the main reason why economists today still form a gated community. This is natural since it takes half a mathematics degree to say anything which your fellow colleagues will accept as a real economic argument.
But I digress (and rant too). Math is not the problem as such but a symptom of some of the problems with modern economics. In general though, Math makes you smart and helps to build rigorous arguments which helps in any scientific context. As such, I will reciprocate Mr. Athreya’s point; just as the econbloggers are not stupid neither are academic economists (they are devilshy smart for the most part). Yet, the latter have remained stuck too long and too far up the ivory tower to see that the econbloggers are not leeches who prey on the public through simplification of a complex topic, but in fact helps to bring an otherwise unworldly macroeconomic discourse down to earth.
We as economists should encourage this, not move further up the ivory tower.
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