So minting the [$1 trillion] coin would be undignified, but so what? At the same time, it would be economically harmless — and would both avoid catastrophic economic developments and help head off government by blackmail.
What we all hope, of course, is that the prospect of the coin or some equivalent strategy will simply take the debt ceiling off the table. But if not, mint the darn coin. [Emphasis added.]
Here’s how you can tell that Krugman is peddling nonsense: he doesn’t take his argument to its logical conclusion. If minting a $1 trillion coin is so harmless, why not mint a $16.4 trillion coin and pay off the entire federal debt in fell swoop? Why not mint $84 trillion coin and cover unfunded liabilities? Why not mint one platinum coin annually to cover each year’s budgetary deficit instead of going into debt? I mean, if $1 trillion dollar coins are so harmless, why not mint enough of them to completely solve the problem instead of minting one or two and just sort of half-assing it?
In many ways, Krugman’s argument is similar to the arguments made by proponents of the minimum wage. If minimum wage is so good and has no drawbacks, only benefits, why not mandate that minimum wage is $50 per hour? Or $100? Of course, that proponents of minimum wage don’t take their arguments this far suggests one of two things: either most proponents of minimum wage are unthinking idiots who simply parrot the talking points spouted off by people they deem intelligent, or proponents of minimum wage recognize the flaws inherent to their argument and are simply lying misrepresenting the reasons why they desire minimum wage.
The same, of course, is true for Krugman in his defense of minting the $1 trillion coin. If it is indeed so harmless, why not go ahead and mint all the money we need? To ask the question is to answer it. The reason why it’s so bad to mint $1 trillion coins is because they are inflationary, and would jack up ordinary citizens’ cost of living while enabling the wealthy and politically connected to profit at the middle class’s expense. Of course, this effect happens whether inflation occurs monetarily or by credit expansion, but if you admit that one type of inflation has negative consequences—and Krugman is implicitly admitting that monetary inflation is a bad thing, else he would pursue it to its logical end—then you must admit that any other form of inflation has the exact same type of negative consequences, even though the timing of their appearance may differ.
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Thus, it is apparent that Krugman is either a fool or a liar. Given that he constantly reverses himself about every major belief he’s ever had or any opinion he’s ever voiced, one might reasonably conclude that he’s a liar. Unfortunately, though, this would be a foolish conclusion, as the above-referenced post indicates that Krugman has no imagination, which would generally preclude him from being a liar. However, this does make him an idiot and, judging by the scope of his influence, a rather useful idiot at that. And since his devotees and followers are apparently not smart enough to see through him, it would appear that Krugman is nothing more than a blind leader of the blind. Too bad his leadership will drag blind and sighted alike down into a pit.
What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom.—Adam Smith, The Wealth of Nations
Here’s some nonsense on stilts:
Richard Feynman was once asked what he would pass on if the whole edifice of modern scientific knowledge had been lost, and all he could give to posterity was a single sentence. What axiom would convey the maximum amount of scientific information in the fewest possible words? His candidate was ‘all things are made of atoms.’ In a similar spirit, if the whole ramshackle structure of contemporary macroeconomics vanished into thin air and the field had to be reconstructed from scratch, the sentence which packs as much of the discipline into the fewest possible words might be ‘governments are not households.’ The principles of running an economy are in many crucial respects different from those of keeping your own finances in order. The example of the hypothetical tenner is part of the reason why: governments need to keep money moving around. For a household, to deposit the money in a savings account might well be the most sensible course. Governments, on the other hand, need that velocity – they need GDP. In order to get it, they sometimes have to borrow that first tenner, which they can do in a range of ways not available to ordinary citizens (who can’t, for example, just print the money). Once that first tenner is spent, the government’s hope is that it will continue to be spent many more times. [Emphasis added.]
The fundamental fallacy of Keynesian economic analysis is that it is predicated on the notion that the rules of fiscal common sense do not apply to the government. Contra Smith, the Keynesians assume that the government need not live within its means, and that it focus on attaining certain target numbers for highly abstract, generally unrealistic abstract notions of economic productivity.
The shallowness of the Keynesian worldview is apparent in many ways:
First, the Keynesian emphasis on monetary velocity is extraordinarily shallow. It is assumed that government spending increases monetary velocity by spreading money throughout the economy. Even if this assertion is true, what is often neglected is how, at least in regards to taxation and borrowing, the only way the government spreads money throughout the economy is by first taking money from the economy (of course, this is not technically the case with inflation, but since governments do not fund their budgetary expenditures solely by inflation, one must necessarily conclude that governments at least partially fund their expenses by either debt, taxes, or some combination of the two, which requires the further conclusion that, at some point, money must first be taken from the economy to later be put in to the economy). Another observation that is often neglected is that money that is not spent by the government (i.e. privately-spent money) also has some degree of velocity as well. Money does not generally sit stagnant, except among those who wish to store currency under their mattress or such-like, and so money that is spent my non-government market actors has the same velocity as money spent by government market actors, assuming that in both cases, no currency is ever removed from circulation. Thus, the assertion that government policy must needs be different from household economic policy is fallacious because the justification for the assertion that government policy is special is itself specious.
Second, Keynesians neglect to understand that money is not itself production. As was noted in the excerpted piece, households cannot print money whereas the government can. Unfortunately, the mere printing of money does not itself magically cause more products to appear in the economy. Now, inflation can draw demand forward, but only to a limited extent, because ultimately shifting production forward runs into the very serious problem of running out of demand, production materials, or both. One of the reasons why the housing market collapsed in 2008 was due in part to demand exhausting itself. To put it simply, people stopped wanting houses at the prices provided. Sure, the housing supply is at its highest, but now the demand for houses has declined, which is why housing prices remain relatively depressed. Quite simply, demand is not infinite—neither is production—which is why inflation will always fail to permanently increase production. There are limits to everything, and inflating the currency does not change that very simple fact.
Third, Keynesians fail to realize the scalability of hierarchy. The reason why the government is often compared to a household is because the household is a useful metaphor for understanding hierarchy. Every household has a head, every household has expenses, every household has members, and so on. A functioning household is one where everyone contributes to its upkeep, and one that lives within its means, and so on. Of course, the metaphor is not exactly perfect, but it is generally useful, and so it serves as a useful point of comparison, and provides people with simple heuristics for evaluating, say, the long-term reliability and stability of any hierarchical organization, such as a business, charity, church, or government. If a functioning family is one that minimizes deadweight and free riders through the proper division of labor, and manages to avoid fiscal problems by living within its means, then it is generally reasonable to expect that a state or business that minimizes deadweight and free riders, and also lives within its means, well do reasonably well and be expected to have a lot of stability.
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And so, while governments are not households, the difference is more along the lines of scale than quality. Governments are similar enough in form to households that the microeconomic analysis used to evaluate the fiscal health and stability of a household should be a useful heuristic for evaluating the fiscal health and stability of a government. Furthermore, the form of government is not so radically different from the form of households that it justifies a radically different set of analysis and evaluation.
The Seattle Times:
If President Obama wants to avoid an economic calamity next year, he could always show up at a news conference bearing two shiny platinum coins, each worth … $1 trillion.
That sounds wacky, but some economists and legal scholars have suggested that the “platinum coin option” is one way to defuse a crisis if Congress cannot or will not lift the debt ceiling soon. In theory.
The U.S. government is facing a real problem. The Treasury Department will hit its $16.4 trillion borrowing limit by February at the latest. Unless Congress reaches an agreement to lift the debt ceiling, the government will no longer be able to borrow enough money to pay all its bills.
Last year, Republicans in Congress resisted raising the debt ceiling until the last minute — and then only in exchange for spending cuts. Panic ensued.
What happens if there is another showdown this year?
Enter the platinum coins. Under current law, the Treasury is technically allowed to mint as many coins made of platinum as it wants and can assign them whatever value it pleases.
Under this scenario, the U.S. Mint would make a pair of trillion-dollar platinum coins. The president orders the coins to be deposited at the Federal Reserve. The Fed moves this money into Treasury’s accounts. And just like that, Treasury suddenly has an extra $2 trillion to pay off its obligations for the next two years — without needing to issue new debt. The ceiling is no longer an issue.
Obviously, the only downside to this plan is the inflation, but it’s not like the government is serious about that, seeing as how the dollar has lost over 95% of its value in the last 99 years. I suppose it would be technically better to use the trillion dollar coins to buy back US debt and retire it, thereby monetizing the debt-inflation that has already occurred. However, in the grand scheme of things, it doesn’t really matter. What matters is that we extend and pretend for another year until Krugman and the Neo-Keynesians finally Figure Out How To Solve The Economy For Good This Time (We Really Really Mean It)™.
The looming financial meltdown will affect the global economy and the U.S. will not escape, says Greg McCoach. Whatever happens, the precious metals are bound to fly, as investors scramble for tangible cover. Mining stocks will be major beneficiaries of the soaring metals prices, but where mines are situated will be an important factor as governments try to get a bigger piece of the action. In this exclusive interview with The Gold Report, McCoach names some favorite companies that he expects to do well in the coming turbulent times.
The Gold Report: When we last spoke in February, you were predicting a new round of quantitative easing (QE), which we’ve been seeing the last few weeks. Where do you think this is all going to end up?
Greg McCoach: The latest QE3 is open-ended, allowing the Federal Reserve to create money every month, indefinitely. QE3 was announced just a few weeks ago and already there is talk about QE4. So, in my opinion, this is the death spiral of the U.S. dollar.
The same thing is going on in Europe and Japan. It’s very troubling and, in my opinion, totally unsustainable. But, trying to predict a timeline for the ultimate demise is almost impossible. This stuff could last another couple of years. Adding in the derivative problems on top of all this debt, it’s just sheer insanity. So, where is gold going? It’s going way higher because this is the ultimate dynamic that will guide the investment world for the coming years.
TGR: Is there any realistic solution, or are they just getting us deeper into the hole, and ultimately everything is just going to cave in on top of us?
“At some point I know gold and silver prices are going to go way higher than where they are now.”
GM: The days of being able to fix this are long past. I had a chance conversation with a U.S. senator and, when I asked him about the debts and deficit spending, he admitted that everybody in Washington and New York knows that there’s no possible way to pay this back. So, essentially all the politicians are hoping it doesn’t blow up on their watch.
I’m a student of history, which shows that no government that has taken on a fiat currency has gotten past the 41-year mark before it ended in inflationary panic and disaster. The U.S. dollar is now going into its 42nd year as a fiat currency and breaking the record. We’re right on the cusp of what history says is totally unsustainable and will eventually collapse.
Then there is the derivative problem on top of the debt. There’s no historical record of derivatives because they were created in the 1980s for large financial institutions to manage big risks. Unfortunately, the greed in the system overtook them, with everyone trying to make incredibly large returns. Now we have the derivative liability tracking through the world system.
TGR: Hardly anyone is even talking or worrying about derivatives at this time.
GM: Derivatives are the gigantic pink elephant in the room that no one wants to admit is there. As an example, the sovereign debt of Europe is $70 trillion. The derivative liability, that means the unsecured liability that’s associated with that debt, exceeds $700 trillion. It’s a ridiculous number. When we’re talking about trillion-dollar deficits and derivative problems in the hundreds of trillions, it just shows that there’s no possible way this can be fixed.
TGR: Another thing that is looming is the fiscal cliff that we’ll face in a few months. What do you think will happen there?
GM: I think the pressure on Congress to do something is critical. John Mauldin, a very bright economist who writes a newsletter, recently spoke at a conference I attended. He stated that if the U.S. Congress doesn’t deal with the deficit problem in the first six months of next year, it’s over. He said he would go from being an optimist about America to becoming a pessimist and that we’ll go into this death spiral, as he refers to it, of not being able to pay our debt or interest on it. But, he believes that Congress is going to do something.
I’m very pessimistic about that, though I’m more of a pragmatic optimist. I don’t see how Republicans and Democrats, who are so deeply divided, can handle the amount of deficit spending that would have to be cut out of the budget and how badly taxes would need to be raised just to try to have a chance of warding off what’s coming. The chances of that happening, in my opinion, are zero.
So, the fiscal cliff is coming. He and I believe that if we’re going to do the right thing, we have to go far beyond what the fiscal cliff is talking about. The way it’s set up right now, only about 5% will be cut from spending next year. That’s nothing. We have to do far more than that. Everybody’s going to have to pay more taxes and government spending will have to be drastically reduced, or we go into the death spiral. That’ll be very good for precious metals’ prices, but it’s a very sad commentary on where we’ll be in this world.
TGR: Do you think the recent prediction by Merrill Lynch for $2,400/ounce (oz) gold by 2014 indicates that the investment establishment is starting to see the light and realizes the dire situation, and that gold is going to have to go higher?
GM: The mainstream media, which has always been slanted against gold, is starting to acknowledge this. For them to make a positive comment about gold is really just a fraction of what’s probably coming. At some point I know gold and silver prices are going to go way higher than where they are now. When I tell people that they should be buying precious metals, they say, “Isn’t the price too high?” No, it’s dirt cheap compared to where it’s going.
After the elections, I think we’ll see gold and silver prices press for a new high. As currencies eventually collapse, it’s going to affect the whole world, and metals prices are going to go parabolic. People are always trying to guess how high that could be. The only justifiable rationale that I can give is to take how many ounces exist in the world aboveground today compared to how much fiat currency exists worldwide, and how many ounces of gold would be required to cover all that paper money? Well, my calculation comes out to about $19,750/oz, and that’s probably conservative.
“We have to focus on the best areas of the best jurisdictions that have existing and rational mining laws.”
I think gold could hit at least that number when it goes parabolic, based on all the emotional craziness that would be going on at that point. The rush into precious metals would be one for the record books. You would have oceans of fiat money that were suddenly trying to find some form of safety. Gold, which has always been the safe-haven asset, is a tiny little market and couldn’t receive it. That’s why it will drive these prices into the stratosphere.
I can’t tell you when all this is going to happen and I could be wrong, but the precious metals bull market could continue for quite some time before we get to those parabolic moves. We might be at the end of that cycle right now and precious metals prices could start to go parabolic within the next few months or year.
TGR: So, when do you think the mining stocks are going to start benefiting from the higher metals prices and where should they be going?
GM: There’s been a real disconnect. The high gold and silver prices have enabled producing mining companies to make money hand over fist, but their lack of market performance relative to metal prices has been troublesome. In the nearly 14 years I’ve been doing this, I can’t remember a more difficult period for the junior mining stocks than the last few years. In August and September, the volume on the Toronto Stock Exchange started doubling and things were looking really good. I was expecting a favorable recovery this fall with higher metals prices, but our mining stocks are still really fragile, maybe because of the election.
TGR: There have been some setbacks recently with geopolitical issues affecting mining companies in certain areas. How is this influencing your investment recommendations and where should investors be focusing or avoiding at this time?
GM: It’s becoming more and more complicated. Some governments around the world are acting like extortionists. They see a profitable mining company in their country and say, “We own your asset now, goodbye and good luck.” This is a nightmare for investors. More and more countries are getting greedy and not wanting to allow mining in their countries unless they get an unfair portion of the profit, or they’re just outright nationalizing these mines. That trend is definitely on the rise.
“I’m looking at companies that can still deliver a big upside, yet have cash flow so they don’t have to be constantly going back to the market to do financings, which dilutes current shareholders.”
What that means for junior mining stock investors is that we have to focus on the best areas of the best jurisdictions that have existing and rational mining laws. That was the topic of my talk at the Toronto Cambridge House Investment Conference. I think it’s so important that I wanted to highlight this issue and show people just how critical it is to invest in the right areas of the best jurisdictions. I’m not just talking about the best countries, but the best areas within those countries or jurisdictions.
TGR: Do you want to talk about some of the companies that you like?
GM: I divide my recommendations into exploration, development, production and permitting situations. In the first eight years, we had great success with exploration stories and a few development stories. Now I’m more oriented toward a combination in the portfolio, but looking more at companies that have cash flow. Because of the volatile nature of our markets, I’m looking at companies that can still deliver a big upside, yet have cash flow so they don’t have to be constantly going back to the market to do financings, which dilutes current shareholders.
I like a company called SilverCrest Mines Inc. (SVL:TSX.V; SVLC:NYSE.MKT), located in one of the best areas of Mexico. There are certain areas of Mexico I don’t like, but this is in a good area. The company is currently working through all the startup bugs, but it’s banking money hand-over-fist, with over $35 million (M) cash and growing every month. It’s using that cash flow to find more ounces around its mine site.
SilverCrest also made a new discovery in another location in Mexico that’s looking very promising. The stock price was around $1.65/share over the summer and it’s at $2.39/share now. That shows it’s in a quality mining spot and is a company to watch. I think the stock will break out to a new all-time high along with silver prices. That should take SilverCrest to a $6–8/share buyout by a midtier company. I’m very bullish on SilverCrest right now.
TGR: How about other ones in Mexico or South America?
GM: Orko Silver Corp. (OK:TSX.V) is still looking very good. It has decent share structure with an NI-43-101-compliant resource in a very good part of Mexico and a new super-pit design with quite a silver asset that’s economic. I think Orko will be taken out as well.
In South America, on the exploration side, I like a company called Tinka Resources Ltd. (TK:TSX.V; TLD:FSE; TKRFF:OTCPK), which is currently drilling some very large, very high-grade base-metal anomalies: silver, lead and zinc. Originally, the company had 20 million ounces (Moz) silver in an NI-43-101-compliant resource that it has built further. In addition, it has found some other very high-grade lead and zinc resources. We’re hoping that this drilling really breaks open the understanding of these areas. This is on a major trend in central Peru going down into Chile that is known to host large volcanic massive sulfide (VMS) deposits, which are known to be very high-grade and highly profitable. I’ve been following the story for quite some time and I like what I’m seeing there. Drilling is currently underway and it should get some assays that could really move this story forward. Tinka is one to watch right now.
TGR: OK. Any other ones there?
GM: I’m going to be taking a trip to South America this winter to look around at some new projects. There are so many areas that I need to check out. If I really like something on paper, I try to visit the site before I make a recommendation. Once you get on site, there are always a lot of new questions that you didn’t realize you needed to ask when you saw everything on paper. So, it’s very important to do these site visits.
I really like Chile as a country that’s moving toward liberty and freedom. Mining law is well established in Chile. I think that’s a good area for investors to look at; Chile has some very big deposits of copper and gold.
I like central and southern Peru because the local people know mining and the mining law in those areas is very well established. That compares to northern Peru, where nationalization is going on. Just because I like a country doesn’t mean I like all areas of that country.
I like the Yukon where there are going to be a lot of big gold, silver and base metal discoveries. Right now we’re focused on the White Gold camp and what ATAC Resources Ltd. (ATC:TSX.V) is doing. The White Gold camp is going to have a lot of big new gold discoveries in the coming years. It will take time and there are infrastructure issues. Investors need to be patient. It’s going to take a lot of money because the lack of infrastructure makes for very expensive exploration. There is no problem getting permits and building mines, but you can’t get to them very easily and that gets very costly. For a junior mining company with no cash flow, that means you have to keep going back to the trough to raise money. If you don’t hit early on, it can get painful for the investor.
TGR: So, what other companies do you like in Canada?
GM: I like Ethos Gold Corp. (ECC:TSX.V; ETHOF:OTCQX). It hit high-grade narrow-vein gold drilling this summer, but it was not the bulk-tonnage targets it would like. It only drilled 60 holes. Kaminak Gold Corp. (KAM:TSX.V), which I also like, has had great success up there and drilled over 400 holes this summer. I also like a new discovery up there called Comstock Metals Ltd. (CSL:TSX.V), still in very early days. I think there are a lot of things that could happen in the Yukon, but it’s going to take time.
TGR: Any thoughts on Explor Resources Inc. (EXS:TSX.V; EXSFF:OTCQX)?
GM: Explor Resources is a company that’s in a great area. All the infrastructure is right there. It got a lot of attention over the last three years from investors and mining companies. Expectations were high to find a big high-grade gold deposit. So far, it’s hit on a lot of very expensive deep drill holes. For a junior mining company without a deep-pocket partner, this has gotten very expensive. Lately the company has had some of its best drill results. It hit 35 meters of 8 grams/ton gold, which is very good. Had it hit that years ago, when it only had 65 or 85M shares outstanding, it would’ve been a multi-dollar stock. Now, in this tough market, we have these great drill results but there are 160M shares out and it needs more money again. Timing is everything in these deals.
I do think Explor will do well because it will be coming out in late November or early December with around a 1.5 Moz NI 43-101 resource calculation, which should be a bankable asset. The rest of the assays on further drilling will be coming out later this fall and will be calculated in another NI 43-101 resource sometime in April/May 2013. I think that will be around 2.2 Moz. That’s a significant resource and the majors have to pay attention because it’s located just 10–15 minutes outside of Timmins, in an area with infrastructure, that doesn’t cost a lot to build a mine and has no permitting issues.
I do think that, ultimately, Explor will perform well. The stock is around $0.15/share today, after hitting a low of $0.12/share during the summer. As these NI 43-101 numbers come out, this stock will get back to a more respectable level and eventually will be joint ventured or possibly taken out by a bigger entity.
TGR: Definitely one to keep an eye on. So, are there any other ones you want to mention?
GM: Up in the Northwest Territories, Canadian Zinc Corporation (CZN:TSX; CZICF:OTCQB) has a mine that was built by the Hunt brothers in the late 1980s, with very high grades but not a lot of infrastructure. It looks like it’s getting a permit right now. If that comes through, I think the stock revalues from $0.39/share currently, to more like $2–3/share. Then it’s a development story with about a year and a half to two years to production. Sprott Asset Management is one of the biggest shareholders. If you believe that silver prices are going higher, here’s an operational mine that could be in production with very high-grade ore by 2014 or 2015. So, I like that one as well.
TGR: What should people be doing now to protect themselves and profit from what you expect is ahead?
GM: If you want to make money and not lose money, number one, you have to get out of U.S. dollars. If you hold U.S. dollars in a U.S. bank account, work for U.S. dollars at your job, or you’re hoping to retire in U.S. dollars, you’re going to be in trouble. This is what’s coming. This deficit issue is beyond sustainable. At some point it means collapse and devaluation of our currency.
TGR: We’ve never had it in this country, so that would be a real shock to people.
GM: A big shock. The only way to protect yourself, that I see, is to own physical gold and silver as the ultimate form of money, and take possession of precious metals, whether it’s American Eagles or Silver Eagles for Americans or Canadian Maple Leaf coins for Canadians. Don’t let other people store them for you or get involved with certificates, pooled accounts or ETFs, because they only have to keep a small percentage of the actual money they receive in the metal that they say they’re buying for you. When these metal prices go parabolic, how can they deliver to you if they don’t own the actual metals? That’s going to be a big surprise to people.
On top of that you’ve got to own the precious metal mining stocks, with their big upside leverage potential. Aside from that, my subscribers know that I’m very oriented toward preparedness. Get some food storage together. Our system works on a just-in-time three-day inventory system. If, for whatever reason, there’s a disturbance to that three-day delivery system, the shelves are empty. Get some canned goods and freeze-dried foods that last for a long time. It’s just a smart way to look at life, regardless of how you feel.
On a positive note, once we learn our lesson and the people keep the politicians accountable and don’t let them abuse a fiat currency as we have the last 40 years, I do believe that good things can happen again with a new age of prosperity that has never been seen in this world. So, that’s my positive note, after talking about the difficult times we’ll have to get through first.
TGR: We appreciate your thoughts today, Greg, and the next time we talk, we’ll know a lot more about how all this has turned out.
GM: Glad to be with you.
Greg McCoach is an entrepreneur who has successfully started and run several businesses in the past 23 years. For the last nine years, he has been involved with the precious metals industry as a bullion dealer, investor and newsletter writer (Mining Speculator and The Insider Alert). McCoach is also the president of AmeriGold, a gold bullion dealer. He writes a weekly column for Gold World.
They are probably right. It is telling that neither Obama nor his Republican opponent has offered much of a plan to spur the economy, at least in the short term. So far as anyone has any short-term impact on the economy, it is the Federal Reserve, and even it is limited in what it can do. As it has been said, the Fed can print money, but it can’t print jobs. [Emphasis added.]
Well, if all the fed can really do is add to the stock of currency (well, that and not enforce regulations), then pray tell what, exactly, is the point of having it? If it’s not going to do anything save debase the currency and in so doing ensure that banksters get first dibs on the redistribution that inevitably accompanies each round of inflation, then why have a central bank? Oh, wait…
Brien Lundin expects money printing by the Federal Reserve to raise gold above its $1,920/oz high, and as editor and publisher of Gold Newsletter, he considers it his job to show people how to profit. In this exclusive Gold Report interview, Lundin explains why he believes it is time to be aggressive in equity positions and names companies that could benefit the most from the coming leg up.
The Gold Report: We just had a third round of bond buying in quantitative easing (QE). Will QE3 help the economy?
Brien Lundin: It will not help the economy, but it will help Wall Street. It will help elevate the stock market, including precious metals and resource stock prices. Although that was not the Fed’s stated goal, it will be the ultimate result.
As I have written lately, we now have “QE as far as the eye can see.” There is no end to it. The Federal Reserve will use QE until it works. If it does not work, the Fed will ratchet up the program and print more money until it does work.
The Fed is using the brute force of money creation to eliminate the U.S. unemployment problem, but that is not a foundation upon which a sustainable recovery can be built. At the same time that the Fed is trying to build a towering economy, it is eroding the very foundation of that economy by issuing vast pools of liquidity.
TGR: At a recent Casey Research Summit, some speakers suggested that the stage is being set for inflation. Do you agree?
BL: I see the danger, but I think it is important for investors to recognize the differences between monetary inflation and price inflation.
Price inflation is a symptom of the underlying disease, which is monetary inflation. Every new piece of fiat currency created in the world that is not backed by gold raises the relative value of tangible assets, primarily the monetary metals gold and silver, but also other commodities.
For a number of reasons, I do not think we will see soaring price inflation in the U.S. as we saw in the 1970s anytime soon. There are other very powerful parallels with the 1970s, but I do not think that retail price inflation will be one. We are living through monetary inflation right now. That is why precious metals prices are rising.
TGR: The August edition of Gold Newsletter predicted what happened in the beginning of September: a gold price close to $1,800/ounce (oz). Where do you see things headed?
BL: That prediction of a mid-to late-summer price breakout was based on two things. First, typical seasonality issues came into play. Second was seeing gold trade into a consolidation pattern of an ever-narrowing price trend.
This kind of consolidation pattern has been evident many times before in this long bull market for gold. Eventually, the price of any commodity will break out of such a pattern and typically will return to the trend that was in force beforehand. For gold, the earlier pattern was an upward trend, so the odds were that it would break to the upside, and it did.
Breaking to the upside, the price pretty much predicted some action by the Fed, but QE3 really exceeded anyone’s expectations for such action. I think the near-term goal for gold is to exceed its previous highs of around $1,920/oz. That will create a foundation for further gains.
TGR: Silver has followed gold higher. What is your thesis for silver going forward?
BL: Precisely the same as gold. Silver provides optionality on gold. It is a lever to gold prices. Silver rises more quickly than gold and it falls more quickly than gold.
Despite its volatility, or rather because of it, silver is a way to realize greater profits along the long-term uptrend by playing the interim cycles.
A lot of people talk about the advantages silver’s industrial uses provide. But the industrial uses really play into the price when silver is under, say, $10/oz. When the price goes north of $10/oz to levels that we see today, it is purely due to silver’s monetary role.
TGR: You have gone from a largely passive position in most of the companies you write about to an aggressive position. What happened?
BL: This summer, a few of the companies that I recommended were too good to resist even in a down market. I recommended that readers peck away at these stocks and accumulate them, buying a little bit here and there on weakness. I advised not jumping in headfirst until we saw signs, or even confirmation, that gold was breaking out of its consolidation pattern. Once we saw that happening, I told readers it was time to get more aggressive and start building larger positions in junior mining shares that remained dramatically undervalued.
TGR: Did you see that as a bottom?
BL: Yes. We bottomed in late July or early August. It was the typical seasonal pattern we predicted, just like clockwork.
TGR: What are some of the companies you are being aggressive with?
BL: Lion One Metals Ltd. (LIO:TSX.V; LOMLF:OTCQX; LY1:FSE) has a great project in Fiji progressing toward production in about 12 or 18 months. It has a feasibility study that just needs to be updated and remarkably low capital expenses to get back into production.
TGR: Lion One Metals is around $0.66/share. What are the catalysts between now and production?
BL: The numbers in its updated feasibility study should show the market that this is a viable project. That would be a catalyst.
Remarkably, it should take only $20–$30 million to get the project into production. Raising that kind of capital should be relatively easy, so the company does not have to get the economics buttoned down too tightly before actually going out and building a mine.
SilverCrest Mines Inc. (SVL:TSX.V; SVLC:NYSE.MKT) has been one of our big winners. Not only is it growing production in a rising silver market, it has plans to double production. This is a production play, but also boasts an exploration upside in another project that it is drilling off. It offers a one-stop shop for investors who like producers, but also like the upside of a development and exploration story.
TGR: SilverCrest is in Mexico. How do you like Mexico as a jurisdiction?
BL: Mexico is a great place to invest. There has been a lot of news about the danger of the drug gangs, but the companies in production or working there are doing fine and handling any issues.
SilverCrest is a well-managed company with two very good projects in production. That is critical: invest in a company that will be there for the long term, is making money and is neither draining shareholder equity nor diluting its share structure to get into production. SilverCrest is ahead of the game, and has a very steep growth curve ahead of it.
BL: I also like Seafield Resources Ltd. (SFF:TSX.V). It just put out a new, very impressive resource estimate on its Colombian project. The next step is to prove the project’s economic viability. I do not think the market appreciates how advanced it is.
TGR: Seafield is at around $0.13/share. Where do you think it should be?
BL: I hate to give specific price targets, but Seafield, with its large established resource, has a lot of upside ahead of it. As the gold market continues to advance and the general market strengthens, companies with established resources will be the big winners.
I followed Rye Patch Gold Corp. (RPM:TSX.V; RPMGF:OTCQX) long before its legal controversy with Coeur d’Alene Mines Corp (CDM:TSX; CDE:NYSE) in Nevada, and I still like it. The staking controversy over Coeur d’Alene’s expired claims gives Rye Patch immediate upside that it previously lacked. I think the two parties will have to reach some accommodation—an accommodation that has a very good chance of being worth more to Rye Patch than its current market cap.
TGR: I was just near that property in Nevada. There is a lot going on in the area.
BL: A lot of jockeying here and there, a lot of people trying to get in on each other’s grounds, court injunctions, lawsuits and a lot of staking. The lawsuit also has a lot of implications beyond that immediate area and beyond the specific issue involved. It could throw into the air the whole system of staking claims and mine ownership in the U.S.
TGR: That is something we all will have to watch together. Do you have other names?
BL: I like Almaden Minerals Ltd. (AMM:TSX; AAU:NYSE), which is expanding the discovery on its Tuligtic project in Mexico. The share price has come back a bit, and it is a great value right now. A recent step-out on its northeast extension produced a great hit. There are parallel zones for development, giving Almaden a lot of growth potential. Its first resource estimate could be a very big number.
TGR: When is that due out?
BL: Likely by the end of this year. Meanwhile, the company is busily drilling away and expanding the resource. Once it has enough to impress the market, a resource estimate would be the next step.
TGR: In out last interview, you talked about Prophecy Platinum Corp. (NKL:TSX.V; PNIKD:OTCPK; P94P:FSE). What is happening with that?
BL: Its big mover is the Wellgreen project in the Yukon. It’s a polymetallic project: platinum, palladium, gold, nickel and some of the rare and valuable platinum metals. It does not yet have good assays on the higher-end platinum metals, but they are there.
Prophecy acquired this large project thanks to the vision of its CEO John Lee. He saw that there were two significant deposits as yet unconnected by drilling. He realized that extending them to depth and connecting them would result in a world-class resource. He systematically drilled it off and proved the theory.
Its next stage is a prefeasibility study. That would be the next trigger point in showing the market greater value.
TGR: Do you have another name in the Yukon?
BL: I recently recommended Precipitate Gold Corp. (PRG:TSX.V), which was founded as a Yukon story. Some friends of mine, including the Coffin brothers, helped launch it.
Precipitate Gold’s management team includes Adrian Fleming, who was the president of Underworld Resources. That company helped launch the new Yukon gold rush and was a big winner for my readers a few years ago.
Precipitate assembled a great land package from the Strategic Metals group, for many years one of the top exploration outfits in the Yukon. Precipitate went public through an initial public offering (IPO) with this big Yukon play.
Then came the big GoldQuest Mining Corp. (GQC:TSX.V) discovery in the Dominican Republic. As an example of how a good management team can benefit shareholders, Precipitate went in and quickly seized an enviable land position in the Dominican Republic on trend with the GoldQuest discovery. Now Precipitate has two tremendous land positions in two of the hottest gold exploration trends in the world. It’s a great company. It hasn’t really taken off yet, but I think as it begins its exploration efforts, we’re going to see the market start to pay attention to it.
TGR: Since its IPO in May, Precipitate’s stock seems to be rising.
BL: Yes. I see Precipitate as a longer-term winner that has tons of potential ahead of it and is a very good buy for investors.
TGR: The New Orleans Investment Conference is approaching. What can attendees expect to take away from this year’s event?
BL: The conference always seems to come at a crucial turning point in the markets, but with the advent of QE3 and the November election, I cannot think of a more important time for investors to be prepared than right now.
We will have a blockbuster roster of geopolitical and economic analysts to talk about the election and its impact on the economy and investors. Charles Krauthammer, probably the most influential political commentator in America, will be there, along with Rick Santelli, the godfather of the Tea Party. Peter Schiff, Sarah Palin, Dinesh D’Souza and Marc Faber are coming. Doug Casey and many of today’s top precious metals and resource stock analysts will speak.
We have some fun events planned as well. This year’s political debate will pit the conservative Charles Krauthammer against the liberal James Carville, with Doug Casey defending the libertarian position. That is always a big hit.
TGR: Before we let you go, do you have an election prediction?
BL: Looking at the political landscape right now, I think the odds favor President Barack Obama’s re-election. I would put the odds at 60/40 right now. Obama’s re-election would be an extremely bullish development for investors in gold, silver and resource stocks.
TGR: Why is that?
BL: It would signal a continuation of government spending and money printing. Mitt Romney has spoken out against QE and has said he probably would not reappoint Ben Bernanke as Fed chairman. In contrast, the Obama administration would apparently continue the policies that have led to these high metals prices.
TGR: Brien, thanks for your time and insights.
With a career spanning three decades in the investment markets, Brien Lundin serves as president and CEO of Jefferson Financial, a highly regarded publisher of market analyses and producer of investment-oriented events. Under the Jefferson Financial umbrella, Lundin publishes and edits Gold Newsletter, a cornerstone of precious metals advisories since 1971. He also hosts the New Orleans Investment Conference, the oldest and most respected investment event of its kind, Oct. 24–27.
Worldwide monetary creation today has implications for the watchful investor in gold and silver. In this exclusive interview with The Gold Report, Leonard Melman, publisher and editor of The Melman Report, explains why, and shows who will be well positioned to benefit from current economic stimulus strategies.
The Gold Report: Now that the curtain has been raised and we can see the Federal Reserve’s much-anticipated program of a third round of quantitative easing (QE3), what are your thoughts? How do you expect QE3 to affect your portfolio?
Leonard Melman: There are two portions to the QE3 program. First, there’s the open-ended agreement to buy $40 billion (B) of mortgage assets every month. The second is the commitment to hold and extend short-term interest rates to near zero through mid-2015. What this tells me is that the Fed is essentially throwing in the towel and abandoning conservative economic policies. It is going to stimulate the economy as long as necessary.
The Fed’s pledge of virtually unlimited money creation will almost certainly have a negative impact on the U.S. dollar, which in turn should have a tremendously positive effect on gold, silver, other precious metals and, to some extent, all other commodities.
TGR: Have the Fed’s prior QE1 and QE2 programs delivered?
LM: The results have been less then inspiring. It’s worth remembering comments made when the Fed first enacted those policies back in 2008 and 2009 and 2010. President Obama and Ben Bernanke assured the world that this was needed to bring about a surge of new and long-lasting prosperity. Obama promised that unemployment would fall sharply and that it would never rise above 8%. Well, those two things haven’t happened.
The most interesting thing to me is that the Fed has returned to its basic premise that monetary creation leads to economic stimulation. As long as old Keynesian theories drive thinking at the Fed, unless the economy takes off with a real bang, I think we are going to see more problems. And, by the way, if the economy does take off with a real bang, that should also be positive for the metals because of enormous associated inflationary implications.
Since the announcement of QE3, the Treasury Yield Index (TYX), showing U.S. 30-year bond interest rates, has shot up from 2.4% to 3.1%. At the same time, the U.S. Dollar Index has weakened and dropped from over 84 to just under 79. In currency markets, that’s one heck of a move. So, all of these things are implicit in the U.S. government’s current monetary policy.
TGR: Should junior precious metals investors or commodities investors buy on the QE3 news?
LM: Yes, I believe they should buy, and here is a brief explanation of why. I’m fully aware that many junior mining companies have hit rough times over the past year and that share prices have fallen. Because of the low share prices, it’s been hard to raise capital and equity financing is very difficult to get. But if the price of gold continues to surge—and it’s already gone up $250/ounce (oz) since the low of $1,520/oz earlier this year—the value of the ore bodies in the ground becomes increasingly apparent. That should bring new buyout offers. Large mines whose resources are being depleted or end-users of the products will be looking for smaller operations to take under their wings. Moving forward, as the increasing value of assets in the ground becomes more and more evident—particularly if gold exceeds $2,000/oz before the end of the year, as I expect it will—I think an amazing burst of activity in the junior mining shares could be triggered.
TGR: Are we back to pre-2010 levels, before junior precious metals equities as a whole went on a bull run?
LM: There are tremendous parallels between the period from which we are just emerging and late 2008/very early 2009. As you recall, 2008 was a devastatingly bad year for the junior mining shares. With the monetary collapse, bank loans for junior miners dried up and shares collapsed. The price of gold dropped from well over $1,000/oz to about $680/oz. Yet investors who stepped forward during the end of 2008 or early 2009 would almost certainly have reaped the rewards.
I believe there’s a great similarity between what happened in 2008 and what is happening now. I would also add that a long-term chart of gold performance going back 25 years would show we’ve been in a gradually accelerating bull market since 2000. Corrections such as those seen in 2006, 2008 and the one we’ve just been through still fit very neatly inside that long, powerful, accelerating uptrend.
TGR: How much does the looming presidential election in the U.S. have to do with QE3 right now?
LM: I think the timing is political but that eventually we would have seen it anyway. I think Bernanke has a sizeable ego and really wants to be remembered as the person who finally and ultimately solved the economy problem. Mitt Romney made it very clear that he would not renominate Bernanke to his position as Federal Reserve chairman. If Romney wins, it’s apparent that Bernanke won’t be around to be that person. So the election can’t help but influence Bernanke to move fast to improve the psychological backdrop of the economy, and to help Obama’s chances.
TGR: Compared to previous attempts at economic stimulus, what do you think of the strategy of buying mortgage-backed securities to the tune of $40B a month?
LM: It is a way of putting more money into the banking community that can then be force-fed into the entire economy in hopes of generating sufficient economic activity to finally drop unemployment rates to 7%, 6% or maybe even 5%. In that sense, I think it could be an effective strategy. It will also reassure mortgage lenders that if their loan judgments are wrong, the Fed will be ready to back them up. And that is going to help the housing market.
TGR: What do you think it will do to mortgage rates?
LM: In the short term, the strategy will hold mortgage rates level and maybe even drop them a little bit. Long term, I think mortgage rates will move in tandem with interest rates. Because these policies have implications for inflation, I think interest rates are going to head higher. I will even be bold enough to predict that, over the next two to three years, a rise in interest rates will be the biggest financial news story out there by far.
TGR: Do you think that there could be a rise in interest rates, despite the Fed’s efforts to keep them at around zero through 2015?
LM: Absolutely. I hesitate to say this but, deep inside me, within the next three years, I believe we could see a psychological background of interest rates comparable to what we all saw in 1979–1981, if not in magnitude, then at least in tone. That’s when long-term interest rates reached 17–18% and short-term rates actually hit 20%. The housing market went into chaos, as anybody who owed money and had to refinance at those rates would well tell you. I think a scary time of the same nature awaits.
TGR: So one place to be is in junior resource equities?
LM: Absolutely. Right now, there is a combination of rising inflation and rising interest rates that have historically been positive for gold. A mistaken notion persists that gold is hurt by high interest rates, going back to 1981 when Ronald Reagan and Donald Regan shot interest rates higher to finally wring inflation out of the system. Interest rates went up, but people also knew they were serious about addressing inflation, so the price of gold collapsed. Thus, people have come to associate high interest rates with collapsing gold prices. But, historically, that isn’t the case.
A better illustration comes from 1976–1980, with a scenario of rising inflation, rising interest rates and exploding gold prices. That’s by far the more typical arrangement.
TGR: A lot of your portfolio exposure is silver-related. What about silver?
LM: In a bull market, silver almost always outperforms gold, and sometimes by a very good margin. I can illustrate using recent figures. Gold bottomed at $1,530/oz about a month and a half ago. As of this morning, gold is $1,780/oz, a gain of $250/oz, or about 16–17%. At the same time silver has gone from $26/oz to $35/oz, which is a gain of $9/oz and well over a 30% increase. Rising bull markets in gold almost always correspond to faster acceleration in the price of silver.
There are two reasons for silver increases. First, silver is not just a precious metal; it’s also an industrial metal. New uses for silver are discovered almost every week. Dual demand works to silver’s benefit. Second, silver is commonly regarded as a storehouse of monetary value. When gold hits $1,800/oz, people who can’t afford to buy an ounce of gold can still afford 20 or 30 ounces of silver. What follows is compressed inflation, hedging and buying into silver compared to gold. So, silver has a very powerful future and that’s one reason I like junior silver mines very much.
TGR: Did you add to your positions over the course of this downturn, which has lasted a little more than a year?
LM: Looking on our website, you’ll see that we’ve added several companies that have a specific feature that we like. Companies that have production to finance additional exploration can avoid share dilution or taking on too much debt. Those companies are out there in growing numbers.
TGR: Right now it takes about 50 oz of silver to buy 1 oz of gold. Do you expect that ratio to narrow over the next six months to a year?
LM: Yes, the gap between gold and silver is starting to narrow. This morning’s price of silver was $35/oz and 50 times that would be $1,750/oz. Gold is just under $1,800/oz. So, this is almost exactly a 50:1 ratio. Historically, the original ratio was 16:1, but at the depths of the bear market in 2000 or 2001, it climbed as high as 83:1. If we get a huge rally in gold, that ratio will start to fall dramatically to 40:1, 30:1, and maybe even into the middle-20s. The resulting leverage on the silver miners’ bottom line could be just spectacular to watch.
TGR: Explorers, let alone producers, are reporting escalating costs. Does this concern you?
LM: Cost escalation has to be factored into decisions about any potential investment. I am concerned about the cost of diesel power generation; crude oil hit $100/barrel (bbl) and the gasoline contract moved back about $3/bbl. That’s a huge cost, particularly when contemplating underground mining operations, because it takes a lot of energy to hoist material from the depth to the surface.
I’m also concerned about the cost of geologic talent. Many of the best geologists have been around for 35, 40, 45 years and are getting a little long in the tooth, frankly. There was a period from the early ’80s right through to about 2000 when the number of geology students dropped off a cliff and a whole generation of geologists wasn’t created. As more and more companies explore, the demand for fewer experienced geologists drives salaries that much higher.
Then there are bureaucratic costs. Servicing all the government bureaucracies with endless reports, filing exchange-mandated reports, etc. creates yet another area of costs to factor in. But, if metal prices can continue to rise at the rate of the last couple of months, potential revenues will still exceed potential cost increases by a considerable margin and I remain bullish on the group.
TGR: Is there a way for investors to limit their exposure to cost escalation?
LM: I don’t think they can. Cost escalation is not going to go away and may even become a bigger factor. But it really becomes the responsibility of the investor to truly understand all the factors that contribute to escalating costs, such as employment, transportation, electricity generation, heating or air-conditioning. Of course, companies have to accurately reflect these variables, so potential investors have enough knowledge and awareness to make appropriate decisions. But, with the monetary creation that is occurring in the world now, I still think that inevitable price increases in gold and silver will more than make up for any cost escalation.
TGR: You like to vett projects “up close and personal.” What companies have you visited recently?
LM: Two visits really stand out in my mind. SilverCrest Mines Inc. (SVL:TSX.V; SVLC:NYSE.MKT) has a terrific setup. SilverCrest has a producing mine in Sonora, Mexico, that is throwing off continually growing revenues used to explore properties near the mine. It’s called the Santa Elena mine, located northeast of the city of Hermosillo. And, while I shouldn’t use terms like “wonderful,” the company has a very prospective property called La Joya located in the famous Mexico mining state of Durango. SilverCrest is using the revenues from Santa Elena to finance the exploration at La Joya and other places, yet SilverCrest has not undergone the share dilution that has troubled so many other companies. I like that.
TGR: Is Santa Elena generating enough cash flow to fully fund exploration activities at La Joya?
LM: Yes. Not only that, SilverCrest is also continually expanding both the size of the processing and the quantity of ore being processed at Santa Elena. So, it looks as if the revenue stream will become even greater. As far as I know, just a few years of ore remain in the mine. But, through nearby exploration, it looks as if its life expectancy could be extended. In fact, SilverCrest has stated that is wants to double production at Santa Elena.
Looking at the history of the share price, starting at a few pennies and now approaching $3/share, it’s frankly been a bonanza for anyone who’s held on for the long haul. I happen to like SilverCrest very much down the road.
Another company I’ve visited that offers excellent opportunities is El Tigre Silver Corp. (ELS:TSX.V; EGRTF:OTCQX; 5RT:FSE), another case where production is expected to finance continuing exploration. The El Tigre property is also located in Sonora and is a huge project area that had operated from approximately 1908 until 1935. It produced around 75 million ounces (Moz) silver and averaged 30–40 ounces per ton (oz/t) for all those years. But the problem was, given the refinery techniques available back then, very high-grade ore was needed for the mine to be profitable. Well, they left behind tailings amounting to 750–800K tons at least. It is ore, the rock has already been crushed, and it’s just sitting there. It turns out that recent studies show that these tailings contain 2.5–3 oz/t silver. There are also smaller tailings piles on the project. Furthermore, mined-out areas were also backfilled with additional material. So, there are considerable opportunities for recovery at El Tigre and it is forecast to be in production before the end of the year.
El Tigre is very prospective in two senses. Good gold results are appearing in one of the project areas and silver exploration is occurring in hopes of finding more 30–40 oz/t ore near the mined-out areas. Obviously, risk is involved, as reflected in the lower share price of $0.25. But my opinion is that the risk-to-reward ratio is highly favorable.
TGR: In addition to the 75 Moz silver mined there historically, the property also produced about 300 Koz gold. It has had a number of owners, but in 1984 Anaconda Minerals walked away from the property. Why?
LM: That’s because of the low price of silver and gold at that time and a lack of enthusiasm in the markets.
TGR: So, it has sat dormant since then?
LM: It’s been inactive. As a matter of fact, traveling through the project area, I was struck by the number of ruins that are very aged and date back maybe a century or more. Suddenly the whole thing has started to come back to life again. It’s very interesting to see.
TGR: What other Mexican silver plays are you following or can tell us about?
LM: None that I’ve seen very recently. But, one that I did visit a couple of times over the past four or five years is Orko Silver Corp. (OK:TSX.V), also located in Durango. Orko has gone through reorganizations, joint ventures and so forth. But, I do remember speaking with the geologist three or four years ago and there is huge potential for discovery. The big questions have been about financing. Orko has done a magnificent job of exploring and has some of the finest core displays I’ve ever seen. Over the past few months the share price has suddenly ticked quite a bit higher. So, Orko is just one to keep in mind: A substantial ore body is there and a huge body of exploratory work has been completed over the last 10 years or so. I think that Orko is worthwhile to look at.
TGR: What about some primary gold exploration plays and some small gold explorers?
LM: I just came back from a very interesting trip to perhaps the most fascinating area of mining history, certainly in North America, and that’s in the Klondike, up in the Yukon. There are wonderful things to see in Dawson City and in Whitehorse, and the general mining history there is simply fascinating. One of the properties I saw was Northern Freegold Resources Ltd. (NFR:TSX.V; NFRGF:OTCQX), which has a substantial area under exploration. Metallurgical work showing very positive returns has just been completed and a press release on that very subject was made just a couple of days ago.
The problem for Northern Freegold has been in arranging sufficient financing because the shares, currently selling around $0.14/share, declined considerably during the latter part of 2011 and the first half of 2012, like those of so many other junior miners. But, with estimated reserves of about 3 Moz, Northern Freegold is the kind of company that should be attractive to a major. Potential financing is there and it is a company that people might keep in mind.
TGR: Northern Freegold completed a private placement financing in August of 10 million (M) units at $0.10 each. Does that sort of dilution frighten you at all?
LM: About $1M was raised, which keeps the door open and the geological staff intact. And, while I’m always concerned about dilution, I think it is a positive development that Northern Freegold was able to raise cash, despite the loss in share price. Dilution is just a regrettable consequence of shares having fallen during the previous year. Somebody out there is saying this is a risk worth taking and they put up their cash to buy, even at those prices.
TGR: What does Northern Freegold need to move the needle here?
LM: More than anything else, what’s needed is an extremely positive background for the price of gold itself. I think that would bring in an interested joint venture partner or end-user of gold looking for a reliable source or, of course, a potential buyout offer from a major who likes the size of the eventual mine that could be created. But, I think the key for Northern Freegold is the positive background for gold itself.
TGR: This is a large low-grade deposit. How close is it to infrastructure?
LM: The Yukon generally has very, very weak infrastructure. There’s only one major highway through the center of the Yukon, and that’s from Whitehorse to Dawson. Then there’s the southern route of the Alaska highway, which goes from Whitehorse to the Alaska border. But, fortunately for Northern Freegold, a government-maintained side road takes off at Minto and heads west, right into where the company’s projects are located. John Burges, the company president, told me that, by comparison, it would cost one of the other mines in the area $100M just to bring in a road. It is a tremendous advantage that NFR has an open, government-maintained road that goes directly into its project area.
Electric power is a little more difficult to access. Right now power has to be generated by diesel. Compared to power grids in the other provinces and states, the Yukon power grid is nowhere near as sophisticated or widely available. It’s only a partial grid and that part of the project’s future is questionable. For some time, Northern Freegold would probably have to count on diesel generation.
TGR: You recently visited sites in Alberta. What did you find?
LM: I had the pleasure of visiting DNI Metals Inc.’s (DNI:TSX.V; DG7:FSE) mineral development projects, located to the north of the famous Alberta tar sands projects. DNI’s SBH property covers a wide area and DNI’s president and CEO, Shahe Sabag, told me that knowledge of metals contained within the oil sands has been known for years, but it is only through the recent discovery of a process known as “bioleaching” that a method of recovery has become available. That process is now being used at a project in Finland.
There are numerous project areas at SBH, and Sabag noted one of the most promising is the Buckton Zone, where there is presently an drill program with the goal of advancing Buckton South through to a preliminary economic assessment.
Sabag noted that the areas under DNI’s control are known to contain sizeable resources of several metals, including 338 million pounds of molybdenum, 34 Moz silver and just under 1 billion pounds of zinc.
TGR: What other companies would you like to mention?
LM: Harry Barr is a mining persona well known throughout the industry, and El Nino Ventures Inc. (ELN:TSX.V; ELNOF:OTCBB) is one of the companies in which he has an interest. El Nino has been able to consolidate its ownership with Votorantim Metals—the big Brazilian company—of a portion of a promising project, Murray Brook, in New Brunswick that has had some excellent assay results recently.
Votorantim has many projects around the world and has sunk some good money into this one. And, with assays now coming in, project development is moving along very quickly. It’s worth noting that the latest Fraser Institute survey has put New Brunswick right at the very top of the list of jurisdictions that are favorable toward mining.
TGR: Murray Brook is in a mining camp that was one of the most prolific in the history of Canada. That’s the Bathurst Camp that Falconbridge [now part of Xstrata Plc (XTA:LSE)] had mined for years.
LM: Exactly. Production just ended one or two years ago. Because a great number of people trained in mining remain there, potential labor staff doesn’t have to be imported from distant areas. Also, a huge backlog of core samples assembled and maintained by the government of New Brunswick exists near the project area. So, very favorable stuff: good background, good province, good regulatory area and good assays that show there could be a real profitable mine developed there some day.
TGR: Some of the companies you’re following have very low trading volumes and thus liquidity problems. What advantages do those companies have that offset their lack of liquidity?
LM: I hate to say this but low price is perhaps their best advantage. If a huge bull market seems to be in the offing, many investors will surge up prices of junior miners that have decent potential discovery but low prices. Heck, if you buy a share for $0.03 and you are able to sell it for $0.06, you’ve made 100% gain. That’s a much more likely scenario than a major like Barrick Gold Corp. going from $40 to $80/share. A lot of people speculate on buying things at bargain levels. It’s the old Bernard Baruch saying, “Buy when there’s blood in the streets.” There has been a lot of bloodshed in mining share prices over the last year, and a body of investors is waiting to pick up bargains.
Of course, low share volume is a problem. If you’ve got to buy 25K shares of a company priced at $0.05/share, you yourself may drive the price up to $0.065 or $0.07/share. Then when you go to sell, you may drive the price down to $0.03 or $0.04/share. That is a risk always inherent in low liquidity stocks.
TGR: What further advice do you have for retail investors at this time?
LM: Keep your eye on the entire world macroeconomic situation because I believe that will be the greatest influence on the price of gold and silver and the base metals. As long as tidal waves of money are created, I cannot see the world escaping inflation and the depreciation of paper currencies. And we have every indication of this happening at present. The Central Bank of England announced it stands ready to hype the British economy. The European Central Bank stands ready to hype the entire European economic structure. The Federal Reserve Bank is advancing strongly to hype the U.S. economic structure. And, just recently, the Bank of Japan made the same type of announcement regarding its nation.
Gold and silver and solid commodities are antithetical to depreciation of paper currency and, therefore, I expect them to profit enormously. So, the best investment advice I can give is simply keep your eyes on the general macroeconomic structure and the longer term. I think both favor the metals enormously.
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.
The lack of excitement haunting the precious metals and mining shares markets over the past year is expected to change in the next few months, according to Michael Fowler, senior mining analyst with Loewen, Ondaatje, McCutcheon Ltd. In this exclusive interview with The Gold Report, he explains why he expects gold to finally break through the $2,000/ounce barrier in 2013 and how this should affect the mining stocks that he covers. While share prices are generally low across the board now, Fowler tells us about a few of the ones that he expects to shine bright when the market turns.
The Gold Report: It seems that not much has happened in either the metals or mining shares markets since you last spoke with The Gold Report in March. What‘s it going to take to get people excited again?
Michael Fowler: Talking about gold, the price has been churning sideways. In my opinion, what’s really going to get people excited is that the gold price should actually go up quite strongly into 2013. The other point is a moderation of some of the current cost pressures in the mining business. On the metals side, we’ve seen a lot of softness in worldwide demand but I think that coming into 2013, we’re going to get a better metals market as China continues easing its monetary policy. So I see a pickup in demand coming into 2013.
TGR: We‘ve experienced all sorts of conditions, events and expectations over the past couple of years that probably could or should have taken gold past $2,000/ounce (oz). What do you see on the horizon that will finally get some major money flowing into precious metals or have the rules changed due to some other factors that are not obvious?
MF: Gold essentially reacts to monetary liquidity and to the concept of depreciating currencies around the world. Looking at gold in terms of euros or some of the other currencies, it’s done quite well. It just hasn’t performed in terms of U.S. dollars. The thing that I see on the horizon is potentially a weakness in the U.S. dollar. This could come about from the U.S. having to raise its debt ceiling, or it could have something to do with the Federal Reserve coming up with Quantitative Easing 3, which could happen in the short term and probably within the next six months. So, a de facto weakness in the U.S. dollar is going to be an important factor for gold to go past $2,000/oz. I’m looking for that to happen in 2013.
TGR: It seems that no matter what happens, the dollar ends up being the refuge of last resort. People talk it down and complain about all of the debt problems and everything else. Yet, when they have a choice, they seem to flee into the dollar, which defeats the price of gold going up.
MF: That is the case now. There seems to be a lot of confidence in U.S. treasuries or the U.S. currency but, in a sense, that’s probably a mistake. The debt situation is going to get some attention when the debt ceiling is hit again. It is certainly going to get some attention during or after the election in the U.S. I think people are going to start focusing on the U.S. situation more and more. For instance, the city of San Bernardino in California recently announced it was going bankrupt. These problems are all over the place in the U.S. I just think it’s a matter of time before people are going to focus on it, and then some confidence is going to be taken out of U.S. assets and U.S. treasuries.
TGR: Turning to the mining industry, there have been some real surprises with the rising costs and changing economics with projects being put on hold and that sort of thing. Besides energy prices, what‘s causing these increases and is this temporary or a new built-in factor of concern?
MF: It’s amazing that, although costs have been going up for the past 12 years, suddenly everybody is getting really excited about it. What’s behind the rise, first and foremost, are labor costs, because there is a lack of qualified people in the industry. When the Internet bubble was hot, people were going into the high-tech sector rather than mining and other sectors. There‘s been a big exodus of baby boomers out of the business, such as mining engineers, explorers, etc., and a lack of qualified people to replace them. So it’s a question of supply and demand. Apart from labor, there is power. Power costs have gone up along with reagents, steels, materials and lots of other input costs. Some of these things will abate but the labor issue is big and not just temporary.
TGR: These things eventually sort of self-compensate, but they do cause temporary problems in the short term.
“What’s really going to get people excited is that the gold price should actually go up quite strongly into 2013.”
MF: Companies are trying to find solutions here, such as putting into production higher-grade ore bodies, which will lower costs on a per-ounce basis. Also, the mining business probably has to rethink itself like the auto industry where car manufacturers source or even produce modules of cars in countries with a lower cost base. An example would be buying SAG mills and equipment in China or other countries. Companies are going to have to start moderating increasing costs, which are a main reason why gold stocks have done quite poorly compared to the gold price. The gold price really has to start outpacing cost inflation for us to get really excited about the sector again.
TGR: You spoke in the past about companies perhaps over-financing themselves at the wrong time. With most stock prices down, raising money for non-producing explorers and developers must be difficult in this environment. What‘s your perspective on that?
MF: There‘s a two-tier situation out there right now for explorers. Some companies, in my opinion, have raised much more money than they need for their programs over the next two years. I think that’s a very bad situation with blame to go all around. Even the investment funds are over-financing some of these juniors. On the other hand, you have some juniors that don’t have any money and are having a hard time financing their programs or even their overheads. It may take at least six months before they can go back into a market where they can actually finance themselves.
TGR: Would you consider the companies that have over-financed successful or maybe not so smart? I guess it depends on what prices they raised funding.
MF: At the time that they finance, they probably feel very smart and are probably very smug about it. In the past, we would raise money for these juniors for a year or two of exploration work, and then they would come back to the market and get judged on their performance. Now, some have enough money for many years of exploration.
TGR: We’re in the summer doldrums now. When things do pick up, where do you think we’ll get the best action among the different mining groups that you follow?
MF: In the gold sector, I would put the majority of my money in the junior to midtier producers. I’d also put money into some of the interesting turnaround and recovery situations. Our company focuses on the junior producers and explorers and I’d be putting roughly 15% of my money into that group. It’s going to take some time for those companies to turn around, except for specific situations.
TGR: You don’t think that the major producers are going to have the first shot at a little bigger movement?
MF: I think they will have better movement but, unfortunately, I don’t think too much of some of the bigger-cap names. With what you see in their earnings and news coming out recently, they haven’t been good at all. I’d avoid them.
The majority of my money would be in the junior midtier producers, emerging producers and some more or less turnaround producing situations. That would be the bulk of it. Then about 15% would be for explorers and developers.
TGR: Tell us about some of the ones you like.
MF: Among the ones we follow, Aurizon Mines Ltd. (ARZ:TSX; AZK:NYSE.A) recently came out with earnings, which were OK, but a bit lower than expectations. The big story for Aurizon is its two large development projects. One is the Hosco-Heva deposit on the Joanna property in Quebec. The other is the Marban deposit. Should these developments pan out, it could mean almost a doubling of production at Aurizon. That could be a very interesting story.
Clifton Star Resources Inc. (CFO:TSX.V; C3T:FSE) is an exploration company in the Val d’Or Rouyn-Noranda area with just over 3 million ounces (Moz) gold in its deposit. The company is in the process of undertaking a preliminary assessment or scoping study. It’s extremely cheap right now in terms of its valuation. So we like that.
TGR: That one really hasn’t recovered from that long trading halt that the exchange put on it after it questioned its classification of resources.
MF: That’s a good point. It was halted for a long period. There are a lot of things that have changed in that company since that halt. First, the question about resources or the NI 43-101 has been totally resolved. It’s not a question of whether or not the gold is there. In fact, it is in greater quantities than in the NI 43-101 that was questioned by the British Columbia Securities Commission. Second, the management of Clifton Star has totally changed. There is a new CEO in the company and some new people in management. I think it’s like a different coat of paint on the company. The assets are good and I wouldn’t be surprised if we saw Clifton Star being involved in another joint venture with a major mining company.
“I would put the majority of my money in the junior to midtier producers.”
Wesdome Gold Mines Ltd. (WDO:TSX) is a producing recovery story. It produces about 60,000 oz/year gold, which doesn’t sound like an awful lot, but it is trading at a market cap of $88 million (M) right now. The company has had production for the past 17+ years. That kind of valuation for a producing company is almost amazing. The reason the valuation is down there is because it had some problems last year with mining dilution. I have a feeling that this year the company is going to turn around, and we’re going to see improved costs and, therefore, an improved share price.
Moneta Porcupine Mines Inc. (ME:TSX.V) is another one of my picks with a property in the Destor-Porcupine area on the Ontario side of the border. This company has a potential of about 4 Moz gold in an open-pit deposit. It’s close to infrastructure, next door to Brigus Gold Corp. (BRD:TSX; BRD:NYSE.A) and St Andrews Goldfields Ltd. (SAS:TSX). This is a potential consolidation situation where Moneta Porcupine could be consolidated into a number of other companies there. It’s cheap on a per-ounce basis as well.
TGR: So you’re thinking it could end up being a takeover target rather than an acquirer?
MF: It could be a takeover target or it could be involved in a tie-up of any number of companies there. This is a resource in a great location and I wouldn’t be surprised if it ended up in another company.
TGR: Certainly 4 Moz that’s open-pittable in an area of underground mines is certainly an incredible resource for a smaller company. You mentioned Brigus and St. Andrews. Do you have any further thoughts on them?
MF: Both are essentially recovery stories. Production has certainly improved in both St. Andrews and Brigus. Costs are improving as well. I think it’s a bit too early to get overexcited on those two names, but I’m definitely watching them. They also have good exploration projects in that Destor-Porcupine corridor and there‘s exploration upside in both companies.
TGR: There‘s been a real revival in eastern Canada among all these old underground mines that have been around for 50–100 years. The higher gold prices certainly changed the economics.
MF: Yes, they have, but costs have gone up as well. There is some potential for open-pit situations in that area and a lot of the companies are actually focused more on that than they were previously because, as you mentioned, they were mostly underground mines.
TGR: What other companies do you like now?
MF: I like Fortune Minerals Ltd. (FT:TSX). It has a large metallurgical coal deposit, Mt. Klappan, in British Columbia. The other property, NICO, is a cobalt-gold-bismuth deposit in the Northwest Territories. It has a mixture of commodities. There is also some copper in there. Both projects need quite a lot of money to get going. The company has been aggressively looking for a strategic investor mining company in Asia. It already has an Asian partner, POSCO (PKX:NYSE) for the Mount Klappan coal deposit and is looking for another Asian partner for the NICO deposit. Despite money being very scarce now, there is a lot of money in Asia. I think Fortune is doing a very good job of trying to find Asian investors for its projects. It’s trading for a song right now, around $0.60, with about a $70M market cap. These two projects have four feasibility studies, and the total net present values of those studies translate into over $5/share. So it’s trading at a big valuation discount.
TGR: What is your target on that one?
MF: Our official target is $2.65.
TGR: How about the targets on some of the other ones you mentioned?
MF: Our target on Aurizon Mines is $8.40. Wesdome Gold Mines, $3.50. Fortune Minerals, $2.65. Clifton Star, $6. Moneta Porcupine, $0.95.
TGR: And all of them are trading for a relative fraction of those prices at this point.
TGR: So all we need is a little more optimism and a catalyst to get people excited.
MF: That’s exactly right.
TGR: Maybe you can summarize what you’re expecting in the precious metals markets, how that’s going to benefit the mining shares over the balance of the year and what people should be looking at so they can get the biggest bang for their buck.
MF: As I mentioned in March, the industry is on sale. There is an even bigger sale going on right now. The valuations are cheap and it‘s a great time to invest in some good names. The catalyst, to my mind, is going to be a macroeconomic situation, which is ultimately going to weaken the U.S. dollar. We may be seeing that coming up into the fall, with a focus on the debt situation in the U.S.
“Valuations are cheap and it’s a great time to invest in some good names.”
I believe that the cost concerns in the industry will abate a bit here because energy prices have come down, but inflation is going to be a built-in factor going forward. I’m looking for the gold price to outstrip the cost inflation. So coming into 2013, I’m looking for a $2,000/oz gold price, which should provide some impetus for people to look at gold shares again. I think investors have to look for growth situations. The ones that I’ve mentioned do show growth, and there is a likelihood that some will be taken over. I wouldn’t be despairing too much at the moment. Despair usually means opportunity, and I think the opportunity is right at hand.
TGR: Thanks for joining us today, Michael. We’ll all be eagerly awaiting that $2,000/oz gold price to see where it takes us.
MF: Thank you, Zig.
Michael Fowler, senior mining analyst with Loewen, Ondaatje, McCutcheon Ltd., has worked in the investment industry since 1987 as a base and precious metals mining analyst for numerous high-profile firms. His coverage list included the major North American gold mining companies, but is now focused on small- to mid-sized companies. Previously, Fowler worked as a geophysicist involved in mineral exploration for 10 years. He was involved in the discovery of the high-grade Cigar Lake uranium mine in Northern Saskatchewan in the early 1980s. Fowler holds a Master of Business Administration from Cranfield University, UK; a Master of Science in mineral exploration from Leicester University, UK; and a Bachelor of Science in geology with geophysics from Liverpool University, UK. He is a member of the Institution of Materials in the UK and a member of the Canadian Institute of Mining and Metallurgy.
John Hathaway, senior managing director of Tocqueville Asset Management, does not particularly trust banks to keep stores of physical gold safe and segregated. Indeed, he considers his black lab Jake a better watchdog than the SEC. That is why he favors the SmartMetals program from Hard Assets Alliance, a new service launched in July. Hard Assets Alliance has partnered with Gold Bullion International (GBI) to offer precious metal purchasing and storage solutions to retail investors. With more investors realizing that safety of capital is the real reason to own gold, safe storage is more important than ever. Read more in this exclusive Gold Report interview.
The Gold Report: John, you predicted $2,000/ounce (oz) gold prices. After rising to $1,900/oz last fall, the price has hovered at $1,500–1,600/oz much of 2012. What will cause it to take the next leg up?
John Hathaway: There are several factors that I think will drive gold higher. On the monetary side, central bankers and treasury secretaries are bobbing and weaving, making it up as they go. They lack a comprehensive solution to the sovereign debt crisis in Europe, to the forces that are pulling the Eurozone apart or to the stagnation in the world’s key economies. Ultimately, all of this will further debase the value of paper currency.
More quantitative easing may also be on the table, and I have read a good deal about taking nominal rates to less than zero. That would mean people who have money in savings accounts would be charged a fee for keeping the money, as opposed to earning interest. It would not surprise me to see that evolve as a way to get all of these free reserves in the banking system into the economy.
TGR: How soon might that happen—in the coming months, by the end of 2012, in 2013?
JH: It is hard to say, but we are at a pivotal point. The economic reports are very lackluster. The headlines out of Europe continue to be, at best, dismaying. The upcoming U.S. presidential election complicates things. The Federal Reserve probably does not want to do anything that would be construed as tilting the election one way or the other.
“I would say $2,000/oz gold is very close.”
Gold has been correcting for almost a year now. Last August, it reached $1,900/oz. It has had every opportunity to sink below the low it made at the end of 2011. Basically, the price has been in sideways movement for the last seven months.
I see gold coiling, moving into stronger and stronger hands. There are not many sellers left. People who wanted to sell it have and have gone on to other things. I am more and more encouraged that the downside to gold is limited; it is all about the upside. I would say $2,000/oz gold is very close.
TGR: Could it go higher than $2,000/oz?
JH: Oh, sure, much higher.
TGR: When we spoke at the Casey Conference, you bemoaned the fact that even gold-producing companies were trading at a discount compared to the commodity price itself. What will change that trend?
JH: A higher gold price. You need a change in the perception of what gold is doing. You only buy a gold stock if you are bullish on gold prices. Since there has not been that kind of encouragement from the bullion market, I am not surprised that the stocks are dogging it. You need a lot of patience and tolerance to go through a period like this.
Everything else you hear about—the arguments about political risk, cost pressures and the competition from the exchange-traded funds—goes away pretty quickly once the perception of the gold market turns and gold starts advancing, as I am certain it will.
TGR: You also said that physical precious metals have a place in a diversified portfolio. What percentage do you usually recommend?
JH: In today’s world, I think 5% to 10%. By physical, I do not mean an exchange-traded fund (ETF) or commodity contracts, which are really paper gold, but actual physical gold that you can touch—gold that is outside of the banking system, that you know where it is stored and what your bar numbers are.
TGR: Are more institutional and individual investors including physical metal in their portfolios?
JH: More and more people are thinking strategically about gold. Owning physical gold should not be viewed as a way to make money. Rather, it is way of saving capital that creates optionality for future spending power and investment resources.
The impetus to get into gold is not because someone like me says the next step is $2,000/oz. The real reason is safety of capital.
TGR: Do you also see precious metals as a hedge?
JH: Absolutely. It is optionality. If you look at what is going on in banking regulations, everything banks are now required to ask for regarding personal finances that are nobody’s business, and you couple that with the trend toward negative nominal interest rates, why would you keep all of your money in the banking system?
TGR: Does it matter what form the physical gold is in—coins, bars, bags?
JH: You pay a premium to have coins. Whenever I try to buy coins, I feel moderately ripped off because you pay a premium over the bullion content. However, there is a convenience factor to coins.
“Owning physical gold is way of saving capital that creates optionality for future spending power and investment resources.”
When buying physical metals, you have to consider your needs. If you intend to take personal possession of your holdings, sovereign coins may be a good option for you. Or 1 oz bullion bars. That’s the convenience factor; sovereign coins are more easily verifiable in the retail market.
If your intent is to have a third party store your metals, and you are comfortable with the storage options being offered, it may make more sense to purchase large bars, as your cost per ounce will be lower. It costs less per ounce to cast a 400 oz bar than it does a 1 oz coin.
Either way, you can do better than hoarding coins in your safe deposit box at the bank or in your house.
TGR: If you do not take physical delivery of the coins or bullion, how do investors know that it exists, that it is not being shared or pooled? And does that matter?
JH: If you have your gold in a bank, you cannot be sure it is not being pooled. Banks say it is safe and segregated, but after the LIBOR scandal and JPMorgan’s issues in terms of marking, who can be sure? There is no integrity left in the banking system.
There are other ways to hold gold that would give investors greater peace of mind.
TGR: What are they?
JH: We have invested in a company called Gold Bullion International (GBI), that to date had solely focused on servicing financial institutions and wealth management firms. GBI provides them with trading and logistics platforms to buy, sell and store precious metals in the U.S. and abroad. Noticing that the direct retail market was underserved when it came to institutional-quality platforms for sourcing and storage, GBI decided to partner with the Hard Assets Alliance to introduce the SmartMetals program. Now retail investors can store their metals in secure commercial vaults, outside of the banking system. This is important.
TGR: How does Hard Assets Alliance differ from SPDR Gold Shares (GLD) ETF, gold coins or bars?
JH: With SPDR Gold Shares, you cannot get your hands on the physical gold; it is segregated gold and it performs the very useful function of allowing investors to hold a security that tracks physical gold in their portfolios. But the gold itself is held at a bank, HSBC. If worse came to worst, all you would have would be a portfolio holding that is still part of the banking system.
“Physical gold is one of the most liquid assets you can think of.”
If you want to take the next step, having physical gold in your possession or outside of the banking system, that is just a further degree of protection of your assets should we go through a difficult period of severe market disruption. This is a better way to ensure your preserved capital, buying power and investment power.
I am also concerned that government intervention into our personal lives and financial assets will become more and more intrusive. Having physical gold may be not perfect, but it is the best way to counteract that. This is why I keep coming back to the idea that people need to think about more than capital appreciation when they buy physical gold. Gold is actually the antidote to what we think of as money, which is just basically scrip that’s issued by governments.
TGR: The other problem often with bullion is its liquidity. How would something like Hard Assets Alliance make it easier for individual investors to buy and sell their gold, silver, platinum or palladium?
JH: Physical gold is one of the most liquid assets you can think of. Hard Assets Alliance facilitates not only the purchase but also the sale. Whether you do it through its website or through its trading desk, liquidity is simply not an issue, in my opinion.
TGR: That does sound easier than going to the guy downtown who offers to buy your jewelry for cash.
JH: If you need cash, you do not want to be carrying a bag of coins to a dealer, especially in a time of stress when he will take advantage of you in terms of valuation. This is a much better system.
TGR: Do you have any other advice for investors looking to diversify their portfolios in a volatile market?
JH: I think you have to be conscious of the risks in the financial system, the risks of paper currency and the assumptions that we make about what it represents in terms of current and, more importantly, future buying power.
I am perfectly fine with owning blue-chip stocks and high-grade corporate bonds, but the world is so different today. I am talking about an additional degree of protection. I wish buying stocks and investing in bonds were enough to protect peoples‘ savings, but I just do not think that’s the case today.
TGR: John, thank you for your time and your insights.
Learn more about the Hard Assets Alliance.
John Hathaway, senior managing director of Tocqueville Asset Management, manages all gold equity products and strategies at Tocqueville Asset Management. He holds a bachelor’s degree from Harvard University, a Master of Business Administration from the University of Virginia and is a chartered financial analyst. He began his career in 1970 as an equity analyst with Spencer Trask & Co. In 1976, he joined investment advisory firm David J. Greene & Co., where he became a partner. In 1986, Hathaway founded Hudson Capital Advisors and in 1988, he became chief investment officer of Oak Hall Advisors.
With a perfect storm brewing on the horizon, investors should be building their cash cache and running for cover, warns Harry Dent, author of The Great Crash Ahead. In this exclusive interview with The Gold Report, Dent explains how central bank stimulus programs are fighting a futile battle because a huge army of aging baby boomers has reached the stage in their economic lifecycles when they curb spending. How is Dent preparing for the gathering storm? Read on. . .
The Gold Report: Your considerable research over many years indicates that the size and age of its citizens drive a country’s economic growth or decline. Because people have predictable consumption patterns throughout life, you can predict well in advance national economic growth or decline. How does that work?
Harry Dent: We’ve identified a peak spending wave indicator that correlates strongly with the stock market and the economy. It doesn’t apply so much to emerging countries, where we look at urbanization rates, which greatly affect incomes, and workforce growth because emerging nations don’t have a middle-class curve where typical consumers earn $60,000 a year at the peak of their careers.
In developed countries, though—countries with higher-tech infrastructures and a solid middle class—this spending wave indicator peaks at around age 46. People slow in spending way ahead of retirement, from 46 on. That is basically when the average person’s kids are leaving the nest. In fact, the greatest slowing comes from age 50 on. That’s the correlation, that people earn and spend more money dramatically as they approach midlife. On average, they enter the workforce at about age 20, marry at 26, have their first child when they’re 28, and hit 46–50 when that child gets out of school. Then their spending drops like a rock. Part of that is because they’re saving for retirement but, more importantly, they don’t need bigger houses and don’t drive their cars nearly as much. It’s just a natural life cycle in developed countries. It’s the ultimate leading indicator.
We saw the spending slowdown we’re experiencing now coming 20-some years ago, when we came up with this tool. We said baby boomers’ spending would peak around 2007 and slow down from 2020–2023.
TGR: Is the pattern the same across the globe, or do slowdown years differ from country to country?
HD: There’s some degree of variation, but the post-World War II baby boom pretty much happened around the world. Birth rates in most developed countries peaked in the late 1950s to early 1960s, so the whole developed world is pretty much synched on this baby boom, all peaking together. Japan is the one exception, where births peaked twice, once in 1942 and again in 1949.
TGR: So you’ve gone back through history and now can predict that every 40 years or so a country’s economy slows as waves of babies come through. Is the age-related consumption pattern the only demographic you use to evaluate what influences economies?
HD: Another cycle comes into play as well. It’s an 80-year economic cycle consisting of two generational booms and busts, like the Bob Hope generation that drove the U.S. economy up from 1942–1968 and then down from 1969–1982, and then the baby boomers who drove it up again from 1983–2007 after that 46-year lag, and now down again from 2008–2023. Additionally, these boom-and-bust pairs go through a pattern we relate to the four seasons.
“We’ve identified a peak spending wave indicator that correlates strongly with the stock market and the economy.”
If you think of the consumer price index (CPI) in temperature terms, a high CPI is hot, or inflationary, and a low CPI is cold, or deflationary. A deflationary period or depression, as we’re going into now, is the winter season. A spring boom follows, with a new generational spending pattern and the modest inflation that comes with it.
In the summer, with that generation entering the workforce, inflation continues to rise. We do a lot of research to demonstrate that young people are inflationary. They have more to do with inflation than any other factor, and nobody has a clue of this in economics. The last summer in the U.S. occurred when the baby boomers entered the workforce in large numbers, basically from the late 1960s through the early 1980s.
The fall boom brings bubbles and the resulting expansion of debt. Stocks, real estate and so on bubble up and when that boom ends, those bubbles burst. Winter sets in again, with restructuring and deleveraging of debt, which create deflation.
The 1970s was a difficult recession time, but it was inflationary, not deflationary, and not similar to the downturn that the Federal Reserve is trying to prevent now. The Fed is actively and constantly inflating the economy to prevent deflation to avoid a replay of the Great Depression. But it won’t be able to hold it off indefinitely.
TGR: Let’s talk a bit about the debt issue.
HD: In the U.S., most people focus on government debt. Under George Bush, the national debt grew from $5 trillion (T) to $10T in 2000–2008. At the same time, the banking system, financial systems and shadow banking—in the private sector—created $22T in debt. That was the greatest debt bubble in history, and it occurred in developed countries all around the world. So we have this global debt crisis and this debt has to deleverage. Everybody is in too much debt—financial institutions, consumers, businesses and governments, with central banks propping them up and bailing them out. Obviously, this can’t go on forever.
If the demographics weren’t working against the Fed and the other central banks, it might be different. But they’re fighting a battle they can’t win because the baby boomers are working against them. How do you stimulate an economy when the largest part of its workforce, the aging baby boomers, wants to save and not spend, to pay down debt?
“How do you stimulate an economy when the largest part of the workforce, the aging baby boomers, wants to save and not spend, to pay down debt?”
That’s the problem. The money the Fed creates gooses up the markets, but doesn’t do much for the economy, and banks aren’t lending. It’s crystal clear in history. Every time you see a big debt bubble in a fall boom—as in the 1860s and 1870s—a depression follows. We saw this from 1873–1877 and into the early 1880s. We saw the next big bubble into the roaring 1920s, followed by the Great Depression and debt deleveraging after that. In short, debt bubbles ultimately burst and then deleverage. Deleveraging debt destroys money, so there’s less money in the system and it means deflation in prices.
That’s very important for investors to understand. In a deflationary crisis—whether in the 1930s or what started in 2008—everything goes down: commodities, stocks, real estate, even gold and silver in many cases. In deleveraging an asset bubble, all assets go down and there’s nowhere to hide. Investors have to be in the U.S. dollar and very safe bonds and cash and wait for the crash, and then buy at the bottom. That’s the trick. Cash is king—cash and cash flow.
In contrast, in an inflationary crisis such as the one we had in the 1970s, commodities, gold and silver were booming. Japan was in a positive demographic cycle. Emerging countries benefited. Real estate loves inflation. In that environment, a lot of things go up, but stocks and bonds go down. In this environment, though, there’s nowhere to hide.
So people just have to get out of the way. Even with all the stimulus, the Fed has no way to restore normalcy with this debt level and this demographic downturn. The stimulus has merely created bubbles in stocks and commodities, and commodities are already going down pretty fast. We think stocks are next, so we expect another stock crash within the next few years. And the next crash will be worse than in 2008–2009 because the Fed has pumped everything up and stretched the system to the max.
This is what happens in the winter season. It’s a survival-of-the-fittest struggle for businesses to see who will dominate their industries for decades to come. So it’s a huge payoff for the companies that simply survive and it deleverages the whole debt and asset cycle and brings things back to affordability. So it’s a difficult season, but it’s necessary and actually good in the long term. Lower prices in general will increase the standard of living.
The government is trying to skip winter. It keeps heating things up, pouring the money into the economy so the banks don’t deleverage debt and the banking system doesn’t collapse as it did in the 1930s. The truth is, it’s only keeping us in high debt and maintaining a bubble that’s not sustainable. Sooner or later, this stimulus will result in a crash that takes down the economy.
The top 10% of consumers are the only ones still spending. We know from demographics that wealthier people marry and have kids a little later. Their kids go to school a little longer, so their spending peaks four to five years after the average person’s. After these folks’ spending peaks, which will be by the end of this year, we’ll have a second demographic drag on the economy.
TGR: So we’re basically just getting into this 2008–2023 winter depression. How deep will the trough go? Will it bottom at the midway point? What should consumers expect over the next 20 years?
HD: A winter season lasts from 13 to 15 years or so. The worst collapses in stock prices and real estate hit when the banking system deleverages. In the 1930s, that happened early on. In this case, the government took a lesson from the 1930s and decided to keep pouring money into the banking system to prevent its meltdown. But it can’t be done. There’s a limit to how much you can stimulate. It’s like a drug. It takes more and more of the drug and it has less and less effect until it has almost no effect, and then the drug itself kills you.
We’re seeing that in Europe already. The last round of stimulus there—Qualitative Easing (QE) 2—was massive and came well after QE2 in the U.S., but Europe’s already back in trouble again and is having to implement all sorts of emergency procedures. There’s no bailing out Spain. It has one of the biggest real estate bubbles in the world and a rapidly aging population. The Spanish people won’t be buying housing for decades.
TGR: What do you see in terms of stocks?
HD: The worst is likely to hit in the next two years. It’s a matter of when the stimulus stops working or when governments throw in the towel. At some point, for example, German citizens may just say they won’t bail out another country. They’ve been doing it to protect exports and avoid defaults on all of the money they’ve loaned out already, but considering the demographics, it’s a losing game.
We’ve studied all of the major debt bubbles and depressions in history, and this one is different because Keynesian economics, which came out of the Great Depression, wasn’t adopted as economic policy until the 1970s recessions. So now, for the first time in history, central banks around the world—the European Central Bank (ECB), the U.S. Federal Reserve, the Bank of China and the Bank of Japan—are actively fighting deflation. When banks start to deleverage or when deflation starts to step in, they just push money into the system. The question is: Do they lose control?
Japan has been through all of this before, but when it came into its crisis in the 1990s, it had budget and trade surpluses. The rest of the world was experiencing the greatest boom in history, which we’d predicted. There was mild inflationary pressure and everybody thought Japan was about to take over the world when it was about to collapse. We were among the few who predicted that ahead of time in the late 1980s.
Japan continued to push money into the system and never let private debt deleverage at all in either consumer or financial sectors. Japan is still carrying very high private debt, and its government debt has risen from 60% of gross domestic product (GDP) to 230% and still climbing. So Japan didn’t really go through a depression. It was more an on-and-off mild deflationary recession because the stimulus eased the pain. But now Japan’s debt is much larger than before the crisis and deleveraging still looms ahead. Japan has been a lost economy for 22 years now. Real estate is down 60% and stocks are still down nearly 80%, 22 years later.
Demographics say the Japanese economy will weaken even further after 2020. The interest on its debt will go up in a spring boom with rising inflation worldwide, and it will be bankrupt immediately because its debt is so high. It’s only because it’s borrowing at 1% or less that it can handle its deficits now. Sooner or later, this game has to end.
TGR: So Japan’s QE has raised government debt to more than 200% of GDP but only managed to postpone a depression?
HD: Yes, it kicked the can a couple of decades down the road. It’s like trying to resuscitate a patient with a defibrillator. You keep hitting the chest, clear, boom. At some point, the patient dies. If the bond markets allow the U.S. to keep putting in money like Japan, we’d end up with a balance sheet on the Fed at $5–6T and up with QE of $4–5T before this is over. We’ve only gone about $2T so far. The Fed stimulus pushes money into the banking system, but the banks don’t lend it to fuel economic growth. They cover their losses and reserves, and then turn around and reinvest the rest in government bonds and stocks. They’re speculating. The money ends up in the stock markets. It’s like crack in the markets, and the markets just want more crack. But the markets can’t continue to go up when demographic trends are pointing down.
TGR: Your earlier mention of losing control brings to mind the people of Greece out in the streets rioting because demands for further sacrifices and more fiscal austerity have become unbearable.
HD: It is true. One of our financial advisers who was there recently reported every third store is closed or boarded up. Greece is in a depression and Spain’s headed there. The ECB has already pumped $270 billion into Spain and Greece just to cover its bank runs, which may happen faster than the governments can fend them off. In the U.S., the vulnerability is much more in real estate, as in Spain. We have a backlog of close to 4 million foreclosures already in the system. At some point, the banks will realize that home prices are not coming back. That they haven’t come back in Japan after 21 years gives us a hint. But if the banks start dumping these millions of foreclosures that aren’t on the market, it would kill the housing market and trigger a bank crisis that the Fed couldn’t stop with stimulus.
China also is vulnerable. Exports, which drive most of its economy, are declining rapidly while government spending on vacant buildings and empty cities has created a real estate bubble. If that bubble begins to seriously break down, Chinese consumers with disposable income, the top 10% of the population, own the real estate that will lose its value.
TGR: A while ago, you said businesses that manage to survive the winter would dominate their industries for decades to follow. What advice do you have for those running companies to help them come out the other side of a depression?
HD: First, those who are running a company and thinking about retirement within five years should sell their companies and retire now. Those who want to keep their companies and hand them down to the next generation or continue to grow them should hunker down, cut costs, cut overhead and put off capital expenditures. Rent your building; don’t own it. Sell real estate. Sell marginal product lines. In fact, sell everything you don’t need. Do everything to raise cash because, as I said before, cash and cash flow are king. Be lean and mean. Office space, real estate, factories, warehouses, anything you want to invest in your company will be a lot cheaper after deleveraging. Even if your business weakens, if your competitors weaken more rapidly, you’re winning. At some point, a lot of your competition, just like a lot of banks, will fail.
“Investors should be looking to invest more in emerging countries because they’re going to outperform.”
We saw this phenomenon after the Great Depression. There was a big payoff for the companies that survived; they dominated their industries for decades to come. Everybody thinks the market leaders were born in the technology revolution in automobiles and electricity in the early 1900s and into the roaring ’20s. Certainly, the race was on then, but the shakeout of the Great Depression decided who was left standing. General Motors survived and absolutely dominated the automobile industry from the 1930s through the 1970s. In electronics, it was General Electric.
TGR: You’ve also emphasized the importance of cash and cash flow for investors, advising them to either exit the equity markets or greatly reduce their exposure to stocks.
HD: Yes. Take advantage of the fact that the Fed has revived stocks and sell when the market is high. Reinvest when the prices are low. Joseph Kennedy made his fortune in the early 1930s, getting out at the top of the market when his shoeshine boy was giving him advice. When stocks were down 87%, he was buying at $0.10–0.20 on the dollar.
TGR: What are you doing personally to preserve or grow your wealth during this winter?
HD: I moved from Miami to Tampa in 2005, at the top of the real estate bubble and I’ve been renting, so I avoided a huge loss. Real estate in my neighborhood is down about 50%, and probably will fall another 20–30% before it’s over. I’m just looking at investments to actually be short stocks. I’m looking at ProShares Ultra Short MSCI Europe (EPV), which is an exchange-traded fund (ETF) at two times short the MSCI Europe index. The ProShares UltraShort Financials ETF (SKF) is another good one, two times short financials, because the financials in Europe are tending to get hit the worst. I think there’s a rising chance in Europe in the next few months of either a mini-crash, about 20% off the top, or a major crash like 2008–2009, where Europe just blows up. One way or the other, you need to either be out of stocks or you need to bet on things going down.
TGR: Any other insights?
HD: We’re buying natural gas, which seems to be going up since it bottomed out at $2. We’re buying agricultural commodities because that’s the last thing to go down in demand, and emerging market demand is still strong. Apart from natural gas and agriculture, though, pretty much everything else we see going down.
TGR: What about gold?
HD: I think gold has another run in it. It’s trending down right now, but I’d expect gold to benefit from the early stage of this crisis. If we have one more big QE coming in the U.S. and Europe—especially in Europe—gold is likely to rally. We told people to sell silver when it hit $50/ounce (oz) in April of last year. Now we’re suggesting selling gold if we see a good rally, say, $2,000/oz or higher.
Ultimately, there’s a natural instinct to expect gold to go up in a crisis, but if you look at 2008, gold and silver went up in anticipation of a financial crisis. But when the crisis actually hit and debt started deleveraging and money supply started contracting, which happened in the second half of 2008 and early 2009, gold went down I think 32% and silver went down 50%.
TGR: Everything went down.
HD: Exactly. That’s the point. The only thing that went up was the U.S. Dollar Index and Treasury bonds. This time, I think Treasury bonds may turn around. People act as if German, U.S. bonds and United Kingdom bonds are risk free. They are not. These U.S. and UK governments are in terrible debt, and Germany is holding the bag for Europe. People are throwing money at negative yields just because they don’t know where else to go. A better bet might be to go long the dollar or, even better, short the euro. That would be a good hedge.
TGR: What’s the best investing advice you ever received, Harry?
HD: Basically, I think you have to think contrarian, because it’s just human nature for people to pile into something, especially in these bubbles we’ve seen. They pile into tech stocks or real estate, thinking they can’t go down, and then the bubbles burst. I learned early on to think contrary to the crowd, something like Joseph Kennedy. Right now, most investors think these markets can’t go down because the Fed won’t allow them to. They call it “the Bernanke Put.” Well, if everybody’s thinking that, I don’t think that.
TGR: Whom do you view as the best investors?
HD: The classic ones are Benjamin Graham back in the good old days and Warren Buffett these days, although I think Buffett’s off base now that he’s become a cheerleader for the U.S. government.
TGR: You’re speaking at the MoneyShow in San Francisco in late August. What major themes will you cover?
HD: Basically three things: debt, demographics and deflation. People who argue that hyperinflation is ahead are dead wrong. Japan had zero inflation for the last decade despite massively more QE than we’ve done relative to its economy. It would have been a deflation if it hadn’t stimulated so much and the world hadn’t been in an inflationary mode. Debt deleveraging leads to deflation, and aging societies are deflationary. Old people are deflationary, young people are inflationary. The inflation of the 1970s had nothing to do with monetary policy. It was the baby-boom generation partying in college, spending their parents’ money. It’s expensive to raise kids, who don’t contribute economically until they get into the productivity curve in the workforce. At that point, productivity drives down inflation.
TGR: Do you expect the U.S. to fare better than Europe over the next two decades because of the echo boom, as the millennial generation gets into a serious spending cycle?
HD: Yes. The echo boom kicks in from about 2023 forward in the U.S. and in a lot of countries. It’s nowhere near the size of the baby boom generation, but enough to create growth again. But there’s no echo boom in Southern Europe or in China, where the workforce will start shrinking like Japan’s after 2015. Japan’s little echo boom runs out by 2020, and because Japan never deleveraged its economy, it’s not even benefiting much from it.
But, yes, there should be a worldwide boom with the stronger developed countries—Northern Europe, North America and Australia—doing fairly well, though as I say, not as strong as the boom we saw in the 1980s, 1990s and early 2000s. Excluding the developed countries of East Asia—Japan, Korea, China—the emerging world will really dominate in terms of demographics and workforce growth. Investors should be looking to invest more in emerging countries because they’re going to outperform. I would look first at India and Southeast Asia.
TGR: Should we be doing that now?
HD: Not yet. I’d wait until after the shakeout. China’s slowdown is hurting emerging countries, which depend on exporting resources, and so are the collapsing commodity prices. By the way, the 29–30-year commodity cycle has nothing to do with the 40-year demographic cycle, but they happened to peak in the same timeframe, around 2007–2008.
TGR: Other than going to cash, what else should people be doing to prepare for the depression/deflationary period ahead?
HD: Cut expenses and high-interest debt. I wouldn’t cut a mortgage if I’m paying 4–5% tax deductible on it, but get rid of credit card debt with interest at 22%. Don’t make any big capital expenditures. Don’t buy a house and don’t let your kid buy a house. If you’re more aggressive, you can bet on markets going down. For example, you actually can make money in the downturn if you short the euro, European stocks and U.S. financial stocks. But for most people, it’s just better to be safe.
TGR: Easier said than done these days.
HD: Unfortunately, the government is making it very difficult. The stimulus programs are knocking down interest rates on safer, long-term bonds so people can’t get yield anymore. If they go after yield, if they rush into bonds, stocks, commodities or especially dividend-paying stocks—which are the most popular thing now—they’ll get creamed when the stock market crashes. The alternative is to give up the dividends and low yields. Just be safe. You’d be crazy to buy a 10-year Treasury at 1.4% yield or a 10-year bond at 1.3% yield. All the countries are going to be in trouble.
TGR: Thank you, Harry, for your time and your insights.
Harry Dent will be a keynote speaker at the upcoming MoneyShow in San Francisco on August 24–26, 2012. Click here to register for free.
Harry S. Dent, Jr. is founder and CEO of the economic research and forecasting organization that bears his name and publisher of the HS Economic Forecast and the HS Dent Perspective. During the early 1980s, while a strategy consultant for Fortune 100 companies and new ventures at Bain & Co., Dent recognized the force that baby boomers exerted on the trends of the time, which led to his development of The Dent Method, a long-term forecasting technique based on the study of and changes in demographic trends and their economic impact that financial advisers and individual investors use via Dent’s Monthly Economic Forecast, Economic Special Reports, Demographics School and The Financial Advisors Network. HS Dent also provides two newsletter services. Former CEO of several entrepreneurial growth companies and a new venture investor, Dent also is a sought-after speaker and best-selling author. Since 1988 he has been presenting to executives and investors around the world, appearing on Good Morning America, PBS, CNBC, CNN and FOX and featured in Barron’s, Investor’s Business Daily, Entrepreneur, Fortune, Success, US News and World Report, Business Week, The Wall Street Journal, American Demographics, Gentlemen’s Quarterly, and Omni. Dent’s books include The Great Crash Ahead (2011), The Great Depression Ahead (2009), The Next Great Bubble Boom (2006), The Roaring 2000s Investor (1999), The Roaring 2000s (1998), The Great Jobs Ahead (1995), The Great Boom Ahead (1993) and Our Power to Predict (1989). Dent received his Bachelor of Arts degree from the University of South Carolina, graduating first in his class, and his Master of Business Administration from Harvard Business School, where he was a Baker Scholar and was elected to the Century Club for leadership excellence.
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