By Claus Vistesen, on January 23rd, 2012
Global stock markets are up about 10% since the beginning of the year, volatility has collapsed, US economic data continue to defy even the mild slowdown proponents and the ECB seems to have backstopped the European banking system.
Yes, my dear reader. This is how quickly you move from away from the apocalyptic abyss and back to normal. My base case is that we are close to excess complacency in equity markets and a sell off is overdue, but it is exactly also under these circumstances (where smart money start to hedge) that the market may deliver one final run up to get everyone and the postman in before hosing everyone.
In the short term, one of the only remaining stumbling block in the form of the ongoing default proceedings in Greece seem to be no match for the ongoing positive animal spirit of the equity market. Only a week ago, we got news that talks in Greece had stalled, but most recently we have been reassured that talks are back on track.
The main niggle on the first occasion appeared to be what kind of interest rate that investors would get on their new bonds and thus, ultimately, the loss of face value currently said to be 50% but also, by some, claimed to be as high 62.5%. Another issue would be whether Greece would pass legislation that forces investors to participate in the debt swap if a majority of investors agree to the PSI terms. This was specifically being discussed in the context of a particular group of investors holding both CDS contracts and the underlying bond and who would maximize their payout on the former by forcing through a hard default.
None of the terms seems have changed massively in the past week, but time is running out with March the 20th set as the final deadline as this is when Greece would otherwise have to make a payment of 4.5 billion-euro ($18.7 billion) on maturing debt. The general consensus is that if no agreement is reached, this date would mark the hard default. The reason for the optimism is then that we are very close to full surrender in the form of a 90% participation rate of creditors and, we are told, it is only a matter of time before the final 10% agrees.
The details reported so far are as follows;
Quote Bloomberg (21 Jan 2012)
The parties are near an initial agreement under which old bonds would be swapped for new 30-year securities carrying a coupon that would begin at 3.1 percent, reach 3.9 percent and go as high as 4.75 percent, Athens-based newspaper Proto Thema reported on its website yesterday, without saying where it got the information.
The desired macroeconomic outcome of all this is obviously well advertised. In 2020, Greece is supposed to have a government debt to GDP ratio of 120% and presumingly some form of growth that would allow this level of debt to stay stationary or perhaps even decline over time.
Let me be clear absolutely clear here. Within any conceivably realistic macroeconomic model, there is no way that Greece can reach a stable debt level with moderate growth under these conditions. Under the interest rate scenario noted above (let us with a average interest rate of 3.8% on the new debt) the nominal interest rate would still be substantially higher than the growth rate of the economy. The only way, the nominal debt level could then be kept stationary is by forcing the fiscal balance into surplus. However, the problem is that this affects the denominator in the debt/GDP calculation by sucking out demand (growth) from an economy already structurally impaired (within a currency union and all that).
The implications are clear. The promises of stability that the PSI currently holds (even if it comes with considerable pledges of IMF money) are bound to disappoint.
First act of several to come
First of all, let us be clear. Despite, politicians’ mortal fright to use the D-word and the media’s acceptance of this fact on the basis that CDS contracts are not activated under the PSI, this is a stone wall default. Anyone, who bothered to take merely a scant look at the history of sovereign defaults will see that the current Greek situation fits well within all the models. Indeed, the proposition that this is not a default because CDS contracts are not activated is ludicrous since in the vast majority of sovereign defaults, the debtor country begins negotiations with creditors well before the actual default is forced upon it. The fact that insurance contracts bought to protect a creditor involved in such negotiations have now been rendered useless says more about the nature of the our modern financial system than it does about the definition of a sovereign default.
Hence, we come to the real nature of this game.
The deal which now seems to be close to completed by no means closes proceedings. It is very likely in my opinion that private creditors who are currently the only ones being forced to take a haircut to seniority of the IMF and the ECB will face a near 100% loss on their holdings. The argument here is simple. Given the amount of debt held by the ECB and the IMF and the fact that these two institutions are senior debt holders the debt held by private creditors become something else than actual bonds. It becomes equity, i.e. the tranche which takes the first (and often complete) loss in the event of a default.
Of course, once we reach this point the issue of CDS contracts will rear its head yet again since if a 50-60% haircut can be considered voluntary anything beyond this becomes very difficult to characterize as such. Any rating agency would find it difficult not to classify further losses as a default and thus begins the fun in earnest. And then comes the ECB and IMF’s share. It will be politically dynamite if the ECB had to print on the liability side to cover losses on the asset side on Greek sovereign debt [1].
Finally, Greece only represents the starter here. Any deal agreed on in Greece will be ardently watched in Ireland and Portugal who will feel they are entitled to the same deal with their private creditors.
Most tragedies have several acts, twists and turns. Investors should expect no less from the one currently being played out in the European sovereign debt markets.
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[1] – In practice the ECB could do nothing and see its balance sheet shrink with the amount lost on the asset side (i.e. reduce lending to the banking system (delevering) with the amount lost on the bonds). However, it is likely that it would “need” to credit reserves with the amount lost on Greek bonds (hence printing money). Mind you, only a central bank could do this as it is free to increase the assets of the banking system by creating its own liabilities.
By Claus Vistesen, on January 5th, 2012
One point that I have been shouting from the proverbial roof tops in my research, to partners and colleagues is that 2012 may well be the year when all major central banks will be conducting both conventional and unconventional monetary easing at the same time. I think this is a very strong testament not only to the severity of the ongoing debt crisis in the developed world, but also to the propensity of central banks to choose inflation as the desired route to recovery. We need not initially discuss whether they are deploying the proper set of policies or even whether such policies represent moral hazard or a ponzi scheme on government debt.
The main thing is to realise that this is an unprecedented global monetary experiment.
My message to investors in 2012 would then be not to underestimate this inflation bias by part of global central banks. Inflating your way out of too much debt won’t work in the long run without considerable defaults and/or economic stress (hyper inflation). Events since 2008 are ample evidence of this, but the simultaneous inclination to create inflation and debase your currency (to generate more inflation and exports) by all major central banks will continue to exert a profound effect on asset prices and the global economy.
In so far as goes the idea that an investors’ interest in asset prices is conditioned on return and volatility we can say that central bank policy will affect both. Financial assets will certainly benefit from excess liquidity, but the unravelling of too much debt through inevitable defaults and the central bank policies themselves will generate volatility. Whether the combination of such volatility and return means that you should stay out of the market entirely is a question for the individual investor. I believe that
From a macroeconomic point of view, the downbeat assessment remains however that it is difficult if not impossible to paint a picture of where sufficient growth is going to come from and on the investment side of things, the higher level of volatility will tend to shake the foundation of investors even if money is to be made for short periods of time.
Most attention has been centered on the ECB, whether the 3y LTRO represent QE and whether the continuing rejection to buy government bonds outright means that the ECB is a laggard among global central banks (see this excellent report by Hinde Capital for additional analysis relative to the points below).
750 Billion USD, and counting …
Europe remains the center of the global debt crisis, a role the continent has now decisively taken over from the US which stood at the forefront in the initial phases of the crisis in 2008. Apart from the almost endless summits and meetings among government officials the significant measures continue to be the ones coming from the ECB.
In my view, the European interbank market is virtually dead and dusted, and the ECB and the Fed are now effectively the only thing between Europe’s banks and large scale failures. Since early September 750 billion USD worth of liquidity has been provided to the European banking system of which 100 billion sits on the Fed balance sheet through USD swap lines.
Who will bet against the final 3y LTRO auction to take this beyond one trillion USD?
Spanish and Italian curves are now nicely steep again after a brush with inversion which obviously was one of the main objectives even if it was always debatable whether banks would buy government bonds with the liquidity taken up at the ECB.
The question is; how do you unwind all this? 750 billion USD to roll short term liabilities with the ECB and the Fed seems to me to be one of the biggest gamble in monetary history.
While the BOE and the Fed have been transparent in their QE efforts and the BOJ never really having left the zero bound the ECB has been more covert. However, it is my contention that with the expansion of the securities market programme (SMP) in 2011 to buy considerable amounts of government bonds (1) as well as the 3y LTRO the ECB is now fully engaged in quantitative easing.
I base this on two points.
- The ECB has acted as a sovereign debt buyer of last resort in times of crisis. It is common knowledge in the market that the ECB has been Italian and Spanish bonds in times of particular stress on the notion that these two economies in particular could not be allowed to fatally succumb to the debt snowball dynamics.
- ECB support for the banking system in the form of collateralised liquidity and wholesale funding is not temporary but structural and permanent in nature. The interbank market in Europe is not working and has not been working since the crisis started in 2008.
The ECB will of course vehemently deny this but investors should understand that such denial is mainly out of political reasons. When Draghi unveiled the ECB’s attempt to backstop the crisis in Europe by offering full allotment liquidity on a 3y basis, the market was disappointed because the central bank president also reiterated that the ECB would not step up its purchases of government bonds.
I think that the ECB will be forced into a much more direct and active role where unsterilized purchases in the primary market (monetisation) will be needed, but I fully appreciate the political issues. We are currently in a delicate situation where new governments in most of the involved countries are saddled with forced mandates to impose austerity. It is very difficult for all parties involved to push this agenda if the ECB had stepped up a full backstop. Moral hazard risks are consequently paramount here.
As such, investors must content with the ECB’s attempt to shore up the European banking system which is no little feat given the bank rollover schedule in 2012 as well as new Basel II regulation which will further impair already shaken balance sheets. The ECB’s initiatives then follows the steady deterioration of conditions in the European (indeed global) banking system which initially culminated in the coordinated action by global central banks to supply dollars through Fed swap lines and which found its European answer in the ECB’s decision to provide unlimited liquidity yet again.
The problems look ominous for European banks and the global financial system in general. No matter what, European financial institutions will have to delever significantly which will spread its tentacles wide and far due to the high penetration by European banks in emerging markets (Eastern Europe in particular).
Behind the scenes however, significant ink has been spilled to debate and speculate on to the exact significance of the ECB’s liquidity operations.
John Hempton for example suggests that the ECB’s policy move is an open invitation to play the carry trade game using almost free liquidity to buy higher yielding government bonds.
Well the Euro fix is in. Whether it works – that is another question. But the fix is this: European banks can borrow unlimited amounts for three years to buy Euro government debt. The debt often yields 5 percent. The money costs 1 percent.
I agree that the incentives are certainly there for the banks to play this game especially in the context of government bonds as zero risk weighted assets. The problem is that many European banks have spent more than a year and two stress tests to get rid of substantial amount of peripheral government debt (which do not count as zero risk weighted assets according to Basel III) and as such weak governments are unlikely to benefit from this.
The flip side of this is that most of the liquidity taken up by banks go straight back to the ECB at the deposit facility which is now standing higher than at any time between 2008 and 2010.
Quote Reuters
The euro zone banking system starts the new year awash with record levels of liquidity but few signs that institutions are prepared to lend to each other, leaving money markets frozen.Most of the near half trillion euros of three-year funds borrowed from the European Central Bank in the last week of 2011 have made their way back to the ECB’s overnight deposit account.
The Reuters piece goes on to argue that most of the liquidity will probably go to aid the large refinancing need banks face in 2012 and thus effectively as a replacement for a non-functioning interbank market that would normally be able to roll this financing. If this does nothing to solve the problem of sovereign insolvency and illiquidity it will work wonders through the fact that banks won’t act as a drag on their respective sovereign’s balance sheet as long as the ECB is involved.
I would note though that even though the liquidity is mainly reflected in reserves held at the ECB, it still represents excess liquidity as noted by Danske Bank.
Some market commentators have argued that the first 36 months long-term refinancing operation (LTRO), in which banks took EUR490bn in total, has so far not worked as planned because the extra liquidity has simply been placed on the deposit facility at the ECB. However, this argument is false.The sharp increase in outstanding open market operations (MRO+LTRO) increases excess liquidity (defined as open market operations plus recourse to the marginal lending facility minus autonomous liquidity factors minus reserve requirements) and this excess liquidity shows up as deposits at the ECB in just the same way as it did in 2008-10.
However, nothing is easy and despite the fact that collateral can be posted for liquidity the sovereign is still on the hook as my friend Edward Hugh points out.
Banks are being encouraged to keep rolling over what are basically NPLs by financing them at 1% at the ECB (foreclosing on them in Spain and keeping the property on the books may cost something like 8% in comparison). But the ECB isn’t assuming the risk here, the national sovereign implicitly is, and is getting in deeper by the day.
This is certainly true by the letter of the law but one has to wonder whether the ECB will ever get paid back here. I mean 3 years is an awful lot of time. The ECB can roll these loans as long as need be (it has already effectively been rolling bank funding since 2008) while maintaining the figue leaf that it is not funding sovereigns. This may be true, but it is effectively funding the sovereign’s banks and postponing the day of reckoning which is bank failures or nationalisation or both.
If the ECB is then forced take a hit on the collateral or the loans themselves, it will need to create the money to pay for these loans by printing euros. This sounds as a plan to me except that it does not solve the funding risks of governments which may or may not be able to ask their banks for help. The likely answer is that they won’t be unless the ECB and EU decide to wield the ultimate weapon of financial oppression which would be to penalise reserves over a given level with negative interest rates at the same time as banks would be forced, through regulation, to hold government bonds.
But Edward makes another interesting point;
Looking at the Greek PSI, what they would try and do (if all this gets that far, I mean if the Euro holds together long enough in this Byzantine world) ) is load up the private sector share of the haircut, and keep the ECB as untouchable official sector. At the limit they can use ELA to keep the banks afloat while the sovereign restructures and then recapitalises.
(…)
Why would any ex Eurozone third party want to be counterparty to anything which might end up being subordinated to ECB exposure later on down the line. The more I think about it the more it seems to me that the 3 yr LTROs might end up choking the European banking system to death.
It is difficult to disagree on the gist of this point, namely that the ECB is digging itself a very big hole. If banks can exchange under water assets at the ECB for a deposit asset at the ECB (albeit with a negative carry) the ECB is running the risk that it becomes the sole counterparty of bad assets in the euro zone in which case seniority will mean very little.
The Greek situation is a good example. Private creditors face an almost certain 100% wipeout exactly because they represent such a small tranche of the total stock of debt. In such a situation the asymmetric relationship between subordinate and senior debt holders mean that the latter essentially become equity holders. But once subordinate creditors are wiped out the turn comes to the senior debt tranches and the further the ECB goes along the road of providing full allotment liquidity the higher will be its implicit direct claim on assets of all sorts of qualities.
In conclusion, it is my view that the ECB is now the only thing between the economy and widespread bank failures, but I also concur that the consequence of this is a permanent outsourcing of the interbank market in Europe to the ECB’s balance sheet and, quite possibly, Fed’s USD swap lines.
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(1) – Even if such purchases have been fully sterilised.
By Ajay Shah, on November 18th, 2011
How did it happen?
The worst financial crisis in the western world for nearly 80 years broke in September 2008.
It required banking/financial systems to be supported and recapitalised by governments across the EU and in the US.
In June 2009 it became apparent that the peripheral countries of the Eurozone (Greece, Portugal, Spain and Ireland) were grossly over-indebted.
Yet in some instances (Spain) their public debt to GDP ratios happened to be lower than those of the US, France, the UK and Germany.
The continued viability of their public finances depended entirely on markets being willing to refinance them with cheap money.
But, when markets scrutinised the sustainability of their fiscal positions, they baulked from refinancing except at punitive rates.
CDS spreads (against Germany as a benchmark) of peripheral Eurozone countries (PIGS or Club Med) debt began widening relentlessly.
Global financial markets began to price in an escalating risk of partial/full voluntary/involuntary default on PIGS bonds since December 2009.
Contrary to first impressions, except for Ireland, that was a result not just of the financial crisis and bank recapitalisation demands on the fiscus.
It became apparent instead that bank recapitalisation demands on public finance were only the last straws that broke the camel’s back.
Greece, Portugal, Spain and Italy, as a direct consequence of joining the Eurozone, had been running up unsustainable fiscal deficits since 2000.
Ireland had not. It suffered because the bailout of its disproportionately large banking system caused its public debt to rise astronomically.
PIGS became over-indebted despite the supposed self-imposed discipline adopted by the Eurozone of prohibiting fiscal deficits >3% of GDP.
That discipline was violated by almost all Eurozone members, beginning with France and Germany, but more egregiously by the PIGS.
To make matters worse, however, the PIGS were also running increasingly large current account deficits (with Germany, France, China).
Though countries like France (and to a lesser extent) Germany were fiscal sinners, they were at least running current account surpluses.
PIGS had access to excessively cheap public and private money available on terms totally inappropriate to their economic circumstances.
Given their inherent risks, which markets mispriced completely, their borrowing costs should have been 300-500 bp higher than Germany’s.
Instead, they were virtually the same for nearly a decade. That relieved market-induced pressure on PIGS’ governments to behave responsibly.
Consequently, their public expenditures after 2000 ballooned out of all proportion to their intrinsic capacity to fund them from tax revenues.
Such expenditures became almost wholly dependent on access to increasing amounts of cheap public borrowing from capital markets.
In response to access to excessively cheap money, wages in the PIGS rose across the board as did growth in public sector employment.
With the financial crisis triggering bank recapitalisation needs, on top of this unsustainable structure, the edifice began to crumble.
The first early warning signals became apparent in December 2009 but the dam broke in mid-2010 with the first Greek bailout.
How has the Eurozone crisis been handled?
Extremely ineptly; indeed very foolishly, by sophisticated Eurozone authorities (political, fiscal and monetary) that should have known better.
Eurozone leaders learned nothing from the preceding debt crises in Latin America (1982-87, 1994-95) and Asia (1997-2000).
They went through avoidable phases of serial denial that there was a structural debt (solvency) crisis that could spread via contagion.
They treated it as a liquidity crisis that could be dealt with by temporary patch-ups of additional money combined with fiscal restraint.
They reiterated their commitment to ensuring there would be no default – partial or full, voluntary or involuntary – by any Eurozone member.
They believed that their remedial measures would stop the crisis from ballooning beyond the first bailout package for Greece.
They were totally wrong. That package did nothing to convince markets that Eurozone leaders understood the nature/severity of the problem.
In fact, the inadequacy of that first bailout package — which did not provide enough money for sufficiently long – became quickly apparent.
Eurozone leaders were fixated on debt-affected PIGS being forced to live within their means through indefinite austerity without end.
Debt recovery/sustainability models did not provide sufficient new money, or permit debt restructuring, in ways that would restore stability.
Least of all were bailout packages designed to restore growth in a conscionable period of time that would be socially/politically acceptable.
Without financial system (and borrowing cost) stability, and absent growth, debt problems can never become better. They can only worsen.
Instead, as a result of poor design, all the bailouts did (except for Ireland) was to add new debt to bad debt and reduce growth prospects.
To exemplify: In mid-2009 the debt/GDP ratio for Greece was 115% of GDP and the debt service ratio about 11% of GDP.
But, by October 2011 the debt/GDP ratio for Greece was 161% of GDP and the debt service ratio nearly 20% of GDP.
It is projected with the third bailout to rise to 185% of GDP (although debt service will be lowered to 16%) before it comes down again.
In the meantime, over the last 32 months, the Greek economy has shrunk in size by almost 17% in nominal terms. It will be 1/5 th less in 2012.
Such inane ‘remedies’ do not solve debt problems. They only aggravate and exacerbate them.
While behaving in this absurd fashion Eurozone leaders repeatedly asserted for two years that they would do everything in their power to:
- Maintain the credibility of the Euro while ensuring that every member stayed in the Eurozone
- Not allow any default of publicly issued bonds to occur; and
- Do everything possible to avoid contagion spreading beyond PIGS (even as it became clear that markets were worried about Italy.
Instead they achieved the exact opposite of all three objectives through their inability to understand the implications of what they were doing.
Though now contrite and claiming to have learnt a few lessons from their serial bungling over 30 months Eurozone leaders have no solution.
The EFSF facility they created is woefully underfunded. It can barely deal with financing the third Greek bailout.
The idea of leveraging it or using it as a partial guarantee facility is absurd since it would add to risk and uncertainty not resolve them.
Yet over-indebted governments (including France and Germany) would have to issue more public debt in order to fund the EFSF properly.
That would simply mean requiring their fragile, near-bankrupt, banking systems (or the ECB) or global markets to buy more Eurozone debt.
Except for Germany (and even that will be in doubt soon) the market has no appetite for taking on more Eurozone debt given its risks.
Contagion has spread from the periphery and now lodges at the core of the Eurozone economy in which Italy is the third largest member.
What could have been resolved with about 300 billion euro in additional financing in mid-2010 is now a problem that may require 2 trillion euro.
Where are we now?
Over 35 EU/Eurozone summits in 30 months have resolved nothing. They have made matters worse; despite Herculean exertions!
Right now Greece is in ‘effective’ default; though markets are overlooking that because of the implications of CDS contracts being triggered.
Its borrowing costs for refinancing its debt would exceed 30% if it had any access to private markets; which it does not.
Any refinancing of, or addition to, Greek debt can now only be financed by the ECB; which the Germans will not permit the ECB to do.
Meanwhile the Greek banking system is bankrupt. Indeed the entire Eurozone banking system’s credibility/stability/solvency is in doubt.
Today an outstanding portfolio of about 11-12 trillion euro in Eurozone debt – of which about 80% is held by EU firms – is souring relentlessly.
About 7 trillion euro of that portfolio is sufficiently affected by contagion to require provisioning (France and Belgium may soon be added).
About 5 trillion euro of Eurozone high-risk-debt is currently held by EU banks, insurance companies, pension funds and individuals.
That sovereign debt, which is supposed to constitute the ’safest’ component of any asset portfolio, now constitutes perhaps the riskiest element.
That reality inverts the whole basis of banking/financial system soundness and stability across Europe (including the UK).
It compounds the problem of calculating capital adequacy requirements for these banking systems and puts regulators in a quandary.
Ireland’s bailout programme is working but could be derailed by what is happening in the rest of Europe.
Portugal’s programme is not working as intended. But nobody is talking about it because it pales in comparison with Italy and Greece.
Italy’s outstanding public debt will soon cross 2 trillion euro (120% of GDP) and its debt service payments amount to around 300 billion euro per year.
That is made up of about 120 billion euro in interest payments and 180 billion euro in principal repayments. Average duration is 5 years.
Public debt service in Italy now amounts to around 17% of GDP and will rise to 20% unless Italy’s debt is dramatically restructured.
Italy now needs to borrow about 40 billion a month euro (gross) and about 28 billion euro a month net in private markets to refinance its debt.
The world is holding its breath with every auction of Italian public debt (3-8 billion euro per week) any of which could trigger accidental default.
The cost of refinancing Italy’s public debt has risen from around 4% a year ago to around 7% now. That adds 20 billion euro a year to
its debt.
Meantime the Italian economy is flat-lining and its capacity to service additional debt is diminishing despite its running a primary balance.
Banks around the world are dumping their holdings of Italian public debt but there is no buyer other than the ECB because of the risk.
The ECB’s capacity to refinance Greek, Italian and Portuguese debt is limited and constrained by Germany’s unwillingness to consider
that.
Contagion from Italy is now beginning to affect Spain and France which is supposed to be a bulwark for the EFSF’s borrowing capacity.
The resulting gridlock is pushing the entire Eurozone system toward a catastrophic denouement with a binary outcome. Either:
- Crisis-induced progress toward fiscal union with national sovereign bonds being replaced by a single Eurozone bond with a joint/several guarantee, or
- Sudden disorderly collapse of the Eurozone with unimaginable fallout and consequences that would trigger a global double-dip
recession.
Such a recession would last for a minimum of 2-3 years and would probably be quickly followed by a similar debt crisis in the US.
The resulting fallout of disorderly Eurozone break-up could trigger a break-up or restructuring of the larger EU as well.
So where do we go from here?
With the foregoing in mind it seems absurd that the world is waiting with bated breath to see what the new technocratic governments
in Greece (Papademos) and Italy (Monti) will actually achieve by way of structural reform and increased debt servicing capability in coming months.
These technocratic governments inject new credibility but lack political and social legitimacy. They have been appointed not elected.
It remains to be seen how long their technocratic legitimacy holds out without the backing of gradually earned political/social legitimacy.
The risk is that if the ministrations of these technocratic governments (which their societies believe have been imposed on them
from the EU above) do not work and bear fruit relatively soon (the probability is that they won’t), public patience with them will melt.
Will they be able to convince electorates to accept the inevitability of austerity without growth for the indefinite future?
The next Greek crisis is perhaps 10-12 weeks away.
The next Italian crisis could be triggered by any one of the upcoming weekly auctions of Italian government debt.
Despite these rather obvious realities, global markets deem to be reacting in dream-like hope and optimism that all will be well.
There is of course a solution at hand; and the only one that will work because all the other options seem to have been exhausted.
That option requires Germany to reconsider its refusal to bear its large share of the fiscal burden that will come with Eurozone fiscal
union.
It requires political/social willingness on the part of rich northern Eurozone members to finance fiscal transfers to poorer
southern members through an exponential expansion of structural funds, currently applied to help develop more rapidly the poorer regions of the EU.
Reciprocally, it requires other Eurozone countries to relinquish fiscal, and a great deal of political, sovereignty immediately; in
order to assure global markets of their commitment to structural reform, restoration of competitiveness, and relentless pursuit of fiscal/monetary discipline.
It requires all unwanted national sovereign bonds of Eurozone members to be replaced by a single Eurobond that is jointly and
severally guaranteed and underpinned by the weight and ability of the ECB behind it to print money if necessary to ensure that such bonds are honoured.
This solution would resolve both the over-indebtness problem of the Eurozone and the problem of banking system collapse at a single stroke.
If it were adopted the need to provide for risky Eurozone debt and recapitalise (yet again) the EU banking system would disappear.
Yet, this is the one solution that keeps being discarded because of legitimate German constitutional, judicial and political constraints.
They inhibit movement in such a direction regardless of the consequences for the Eurozone, the EU, and mostly Germany itself.
It is like witnessing a repeat of 1939; not of conquest but of mindless destruction. But, this time with money rather than tanks being involved.
If that only workable solution continues to be discarded, the other possibility that will manifest itself is the disorderly break-up of
the Eurozone; simply because its orderly break-up defies contemplation and imagination.
Talk of Greece being ejected from the Eurozone, or of Germany departing from it voluntarily, is fanciful simply because neither can
afford to bear the costs of the consequences that will follow, regardless of what their populations and political leaders may believe
or think (though ‘thought’ seems to be conspicuously absent from the process just now). Neither can their neighbours, regardless of what they may think.
Yet it is not unimaginable that a break-up will be forced on Eurozone members by global markets if the only workable solution
continues to be ruled out as it seems to be repeatedly by the German Chancellor. But she has changed her mind so often the hope is she will yet again.
A disorderly break-up may result in a reversion to national currencies; which would be better than members trying to retain some
semblance of the Euro through separate residual monetary unions of more compatible economies.
That would probably require four different Euros (for the super-efficient Northern economies a Baltic Euro, for the relatively efficient middling economies a Franco-Euro; for the newly acceding countries an Eastern-Euro and for the inefficient, uncompetitive Club-Med economies, a PIGS-Euro). Other than the first, none of the others would be credible for holding as reserves, or for trading significantly in global currency markets.
Finally, bear in mind that we have spoken of only the public debt problem in the Eurozone.
Should the unthinkable (but increasingly likely) disorderly break-up happen, the public debt problem will be accompanied by an unresolved private debt problem throughout the Eurozone of equally monumental proportions! That really will break the system and the banks!
By Eldon Mast, on October 27th, 2011
European Union leaders unveiled a deal early Thursday on debt crisis measures that includes a 50% loss on Greek bonds.
The agreement came at the end of a series of talks to finalize the details of a comprehensive policy response to the government debt and banking problems threatening the stability of the euro currency and global economy.
The deal will likely resolve three related problems: the debt crisis in Greece, instability in the banking sector and an under-capitalized bailout fund.
Under the new plan, Greek bondholders voluntarily agreed to write down the value of Greek bonds by 50%, which translates into €100 billion and will reduce the nation’s debt load to 120% of economic output from 150%.
The agreement also calls for the creation of a new financing program with the International Monetary Fund worth up to €100 billion.
Stronger bailout fund: The leaders agreed on two ways to increase the firepower of the EU bailout fund, known as the European Financial Stability Facility. The methods will each leverage the fund by four or five fold, the statement said, boosting its resources to about €1 trillion.
The fund will be used to partially ensure new issues of government bonds. In addition, it will be supplemented by the creation of one or more special investment vehicles, which will be open to private sector players such as sovereign wealth funds.
The EU heads of state also agreed to raise capital requirements for banks vulnerable to losses on euro-area government bonds.
Banks would be required to sharply increase core capital levels to 9% to create a buffer against potential losses.
By Claus Vistesen, on October 24th, 2011
As I read the latest round-up of comments by Fed officials that they are certainly not ruling out another round of asset purchases I am wondering whether this signals another round of actual quantitative easing by the Fed or whether investors should change their mindset back to before the crisis where it wasn’t the USD that acted as the global carry trade funder but rather the JPY (or maybe the GBP here?).
Quote Bloomberg
Fed Vice Chairman Janet Yellen said yesterday that a third round of large-scale asset purchases “might become appropriate if evolving economic conditions called for significantly greater monetary accommodation.” A day before, Governor Daniel Tarullo said buying mortgage-backed securities “should move back up toward the top of the list of options.”
They join Charles Evans, president of the Chicago Fed, and Boston’s Eric Rosengren in calling for consideration of further stimulus to boost growth and bring down a jobless rate stuck around 9 percent or higher for 30 months. A stock-market rally and gains in manufacturing and retail sales may convince the Federal Open Market Committee, which meets Nov. 1-2, to decide that it’s too soon for a third round of bond purchases.
You see, the recent initiative of the Fed in the form of Operation Twist is not quantitative easing since it does not involve an expansion of the balance sheet. In stead, it is what we refer to as qualitative easing as the bonds the Fed intends to buy on the long end (to move long rates down to help the mortgage market) will be paid for by proceeds of selling bonds on the short end.
The biggest problem for the Fed here is not necessarily that Operation Twist is a bad idea. Indeed, to the extent that it fixes the effort squarely on halting the slide in the housing market and supporting volume and price in the primary and second market for mortgage securities I think it is an excellent idea.
But we are forgetting the auxiliary objective of QE by the Fed; to weaken the USD. Make no mistake that this is an important objective for the Fed even if they have never declared this formally. And herein lies the rub. Quite simply, with the recent announcement by the BOE of another round of QE worth £75 billion, with the ECB now willingly or unwillingly being forced into increased support of peripheral debt markets and with the BOJ also pledging more stimulus, the Fed is starting to look like the conservative central bank in the G4. [1].
In my opinion, this is very significant and also one of the reasons why Fed officials are busy ensuring markets that they have plenty of ammunition left should economic conditions merit it. But investors should not take anything at face value I think. Before the Fed actually starts to buy those MBS and/or moves to lower interest rates on excess reserves there is a real chance that especially the JPY will start to act more like the JPY of old, a.k.a global carry trade anchor of choice. Of course, this requires the BOJ to back up all the pledges with real action. For now though, the only thing we can say is that the Fed looks set to be outgunned by its peers in the G4.
EMU Outflanked
Is Europe now finally getting down to serious business or is it just another round of fudge from the fudge factory that investors have learned to respect for its ability to produce relief rallies out of nothing. Looking at the evidence I thoroughly inclined to go for the latter even if each failed attempt to shore up market confidence brings Europe closer to full fiscal union.
Even if Merkel and Sarkozy, and rightly so, appear most concerned with putting pressure on Italy, the most significant issue remains Greece which is now in default a fact that was un-sanctimoniously confirmed by the leaked bailout document which has the Troika admitting that the medicine they were mandated to administer would only make the patient worse and not better.
Quote FT
Greece’s economy has deteriorated so severely in the last three months that international lenders would have to find €252bn in bail-out loans through the end of the decade unless Greek bondholders are forced to accept severe cuts in their debt repayments.The dire analysis, contained in a “strictly confidential” report by international lenders and obtained by the Financial Times, is more than double the €109bn in European Union and International Monetary Fund aid agreed just three months ago.
The most recent estimate of haircut has now risen to 60% and this, mind you, would only reduce the debt to GDP to 110% and this without any consideration on how Greece is supposed to grow itself out of this level of debt while simultaneously dealing with the default. In addition and only adding to my disdain for the ECB, Reuters reports that the central bank opposed a 60% haircut on account that it the private sector would refuse likely refuse this leading to a “fullscale” Greek default.
I am continuingly amazed by the denial here. Ever since the first Private Sector Proposal (PSI) was put on the table, Greek has been in default and figuring out who would pay for recapitalising banks as a function of how large the final haircut ends up are merely steps in the actual default process.
The second issue on the table is what to do with the increasingly freakishly looking EFSF. There has been no shortage of suggestions on how to increase the scope of the fund using the same guarantee by the same countries for the same amount of money (currently €440 in effective capital). The suggestion that might actually work came from France which has aired the suggestion that the EFSF be turned into a bank which would then allow it to access liquidity from the ECB. Both Germany and the ECB however have vehemently denied this which indicates that there is still notable reluctance to allow the ECB to wield the full arsenal of quantitative easing.
The proposal which currently seems to have most traction is to turn the EFSF into a monoline insurer which would essentially use its capital to insure anything from 10% to 30% on any new issuance of sovereign debt by Italy and Spain. Crucially, the idea is that this “leverage” would bring calm to markets as this insurance could cover as much as 2 trillion worth of debt.
I really struggle to find adequate words here. I think this is madness and if any Eurozone politician were afraid that an equivalent of AIG would certainly enter the scene, they now seem content on creating one. The first and most widely flagged issue is this would obviously create a two tier bond market.
Quote Reuters
This would create a division between insured and non-insured debt, that could split a country’s investor base and suck liquidity out of the market unless new bonds were carefully constructed to allow them to trade on a par with existing debt.”The issuer would have to create a new curve of insured debt, limiting the liquidity in both curves with risks that investors would dump the old non-insured bonds,” said Commerzbank rate strategist Christoph Rieger.
Based on a 20 percent insurance model, JPMorgan estimates that insured bonds issued by Italy would trade at a yield around 100 basis points below existing debt with new, insured Spanish debt likely to be priced 80 bps lower than existing bonds.
I think this is significant, but we are missing the main point here. If this is set ut Spain and Italy will likely never be able to issue un-insured debt again and the contingent liability here is not only complex but will lock in future capital commitments to this aim of providing first loss insurance. For me, this is a horrible way to spend already scarce capital.
Another issue is obviously that it assumes that it will make the Spanish and Italian problem go away which it clearly won’t. However, much more fundamentally; while the idea is to ring fence Italy and Spain it almost guarantees painful haircuts in the case of Ireland, Portugal and Greece and once again, who will pay for those I might ask.
The only silver lining I have seen in the latest reports is that it seems to me that while the imminent objective is to fiddle with the EFSF, there has also been serious talk about bringing forward the ESM which would have a much stronger mandate and essentially constitute a first step towards socialising of sovereign risk in the euro zone. Until that happens, the EMU and her politicians will be continuously outflanked by economic realities.
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[1] – I repeat that with the ECB not formally in ZIRP mode, the Fed still has the yield disadvantage here but do we really expect the ECB not to lower going forward?
By Doug Gentry, on October 18th, 2011
Just a quick update on my previous post – about the Greece debt crisis.
Pundits and observers, who are no smarter than you or me, are assuming that Greece will default on its sovereign debt. This is as if the United States decided not to pay off our U.S. bonds one day.
To avoid a total market meltdown, the “grownups” in the European community would probably insist that the private banks holding Greek bonds accept cents on the euro. If Greece owes me $100 on a bond I purchased last year, I would only receive $45.
 Haircut for Greece Creditors? The term of art for this reduction in the payoff is a haircut. Lots of figures rattling around the news sphere. I’ve seen suggestions/estimates of a write down of 30 to 60%. That qualifies as a buzz cut.
By Claus Vistesen, on October 17th, 2011
It was telling that just as the ECRI and other notable research outfits decided to push recession button on the US economy the data flow became notably more positive. This could be a sign of the times that the cycle is just too volatile for even capable analysts to call or it could simply be a blip to the otherwise fundamental issue that economic weakness is here to stay for now.
Risk asset markets however made no mince of the recent stabilisation of the euro land crisis as well as the better news flow from the US economy. Just take the following headlines from Bloomberg and you know exactly what kind of sentiment I am talking about.
Quote Bloomberg
U.S. stocks advanced, giving the Standard & Poor’s 500 Index its biggest weekly gain since July 2009, as retail sales beat economists’ estimates and the Group of 20 nations began discussions on Europe’s debt crisis.
(…)
U.S. 30-year bonds capped the longest weekly losing streak since January as concern eased that Europe is unable to curb its debt crisis and U.S. retail sales climbed, damping bets the country will fall into a recession.
The question is then whether it signals a decisive and lasting breakout or whether it was simply a rally to the top of a choppy range before we start another descend to test the lows. Recent weeks’ market movement will suggest that you sell the current levels as top of a post crash range and I, for one do not think we are out of the woods yet. It is important to emphasize two issues on the US economy when it comes to the likelihood of a recession.
Firstly, the US housing market has never recovered and inventories remain low. This means that there is not much room for the economy to slump even if it does enter a recession. Any recession is then likely to be relatively short. Secondly, all liquidity gauges we are watching are pointing strongly upwards which is likely to provide strong tailwinds for risky assets 9-12 months out. Excess global liquidity, US broad and narrow measures of money are all shooting up.
In addition, we should consider the slow but sure movements by all four major central banks to increase either the short term liquidity or simply re-starting QE.
The BOE put itself at the front of the pack with the recent addition of another bn 75 GBP worth of QE, but likewise at the ECB it was interesting to see that long term liquidity operations was re-instated together with an expansion of the covered bond purchasing programme. Additionally, the ECB has been and will continue to be more or less forced to support bonds in the periphery, particularly in Spain and Italy, in order to ring fence the periphery from the coming Greek default. In comparison, the Fed’s latest much debated Operation Twist looks almost modest since it is, by the letter of the theory, not quantitative easing but rather qualitative easing [1]. Of course, the market is fully expecting the Fed to act aggressively should the economy falter further with a joint financing programme with the Treasury for long duration mortgage products as the most likely initiative alongside the more technical move in the form of reducing interest rates on excess bank reserves to negative.
I think it is important to realise that the Fed, with its latest actions, have its gaze firmly fixed on stimulating a recovery in the US housing market which is seen as the most important missing leg in an already faltering US recovery.
In Japan, the BOJ’s situation is different in the sense that economic has been distorted by first the devastation of the earthquake and then obviously the technical recovery as supply side disruptions have eased off. I take note of the fact that the BOJ has verbally put a lot of promises on the table in terms of stimulating the economy not least, one would imagine, in relation to the ongoing strength of the JPY. Finally, it is worth pointing out that the BOJ’s balance sheet has actually expanded briskly in the past two months.
The main conclusion to draw here I think is that while it is certainly not over yet, developed market policy makers are starting to open the floodgates. The euro zone crisis will remain a severe drag and like an almost chronic illness will continue to flare up. A disorderly Greek default can still not be ruled out and as the euro zone policy makers seem to take comfort on even a second of calm it seems to me that the market will have to push harder before we get a realistic proposal for a Greek default.
The recovery in the periphery (or obvious lack thereof) is still not working. The internal devaluation in the European periphery is alive and well when it comes to nominal wage increases which is getting a beating but in the context of lingering inflation in core and headline it leads to a squeeze in real wages and further depresses the recovery. The problem is that a sharp reduction in living standards through a decline in real wages to restore competitiveness is needed but if it occurs without any form of nominal currency depreciation not to mention in the context of very sticky core inflation, it just becomes counterproductive. Absent a fiscal union to socialise the risks it is difficult to see how the euro zone policy makers will be able to come with a fudge that will satisfy markets. In that regard I agree with Chris Wood here.
Ultimately, GREED & fear’s view on all of the above remain the same. This is that the only coherent end game for Euroland remains a formal move towards collective fiscal responsibility, which would ultimately address the fundamental cause of the present crisis. This is the financial fault line represented by monetary union without fiscal union. Euroland either has to go down this path or it has to confront all the problems associated with a break up since in GREED & fear’s view there is no “middle way”
One positive development on Greece is that the private sector involvement (PSI) proposal originally envisioned seems to have been abandoned for a much more realistic haircut.
But more challenging issues remain.
It was hardly surprising that the S&P downgraded Spain last week which only serves to underline the issue that while Greece may be the imminent worry the real problem lies in Spain and quite possibly Italy. There is a limit to the amount of Italian and Spanish bonds that the ECB can buy as long as it is evidently clear that growth prospects continue to remain difficult.
In emerging markets and touching on the theme I dealt with in my last installment the recent inflation data from India indicate why I continue to think that investors may hold too high expectations for easing in big emerging markets.
Quote Bloomberg
India’s inflation exceeded 9 percent for a 10th straight month in September, maintaining pressure on the central bank to extend its record interest-rate increases.The benchmark wholesale-price index rose 9.72 percent from a year earlier after a 9.78 percent jump in August, the commerce ministry said in New Delhi today. The median of 21 estimates in a Bloomberg News survey was for a 9.75 percent increase.
Elevated inflation in India and China are crimping room for policy makers to ease monetary policy and support global growth amid Europe’s debt crisis and a faltering U.S. recovery. India’s central bank Governor Duvvuri Subbarao said yesterday that a more than 9 percent inflation is above “comfort level.”
Of course, the picture is not uniform here with notable economies such as Brazil and Indonesia already lowering interest rates but all eyes are currently on China (and secondarily India) and here I think that we will have to see stronger signs of a hard landing or a relapse into a more severe global slowdown we can expect policy makers to actively stimulate.
In summary, I think that we are indeed nearing an inflection point at which money printing in the developed world will once again provide relief to risky asset markets but the problem is that the underlying economic backdrop has not improved much. In particular, the ongoing lack of resolution in the euro zone represents an issue but Eastern Europe as well as a housing bubble in Australia (and perhaps even in Denmark) are also potential sources of uncertainty not to mention the unravelling of credit excess in China. As such, “it” is far from over but a tradable bounce in risky assets which goes beyond the current choppy range may soon represent itself.
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[1] – The distinction between quantitative and qualitative easing is simple. The former refers to an expansion of the balance sheet through the central bank increasing its liabilities and adding a corresponding amount of assets. The latter refers to changing the composition of the asset side of the central bank’s balance sheet and as I am reading the gist of OT the Fed has committed to keep its balance sheet unchanged by selling short term bonds and buying long term bonds. Try this one for a good recap of what QE is and isn’t.
By Doug Gentry, on October 12th, 2011
So, who cares about the Greek debt crisis? It’s a small country, a long ways away.
Answers:
Greece as a Country: “We care!”
The Euro currency countries: “We care!”
Europe Generally: “We care!”
U.S. and International Financial Community: “We care!”
Stock Investors: “We care!”
All right, already. Here’s why they care.
The background
Through a series of missteps over the last 10 years the Greece government amassed a large government (or sovereign) debt, and then disguised it from its citizens, lending institutions, its Euro partners, and international financial organizations. The recession exacerbated the problem, threatening to push the Greece government into bankruptcy. Annual deficits as a percent of GDP or total national debt as a percent of GDP are higher but not that different from the United States, but in contrast to the U.S. the global investment community has very little confidence in Greek bonds and the ability of the government to repay them. That means Greece has to pay much higher interest rates on its debt, if it can borrow money at all.
What Can Greece Do?
When faced with larger government deficits, policy makers typically turn to two economic “levers” – fiscal policy and monetary policy. On the fiscal side the government can cut spending and/or raise taxes. Both of these actions have met strong resistance in a country used to heavy subsidies of middle class citizens and notoriously poor tax collection records.
Monetary policy can be an effective tool – often because it does not require the approval of the legislature or the voters. Normally a central bank can inject funds into the economy (electronically “printing” money) and use that to pay debts. This injection of money can also lead to the devaluation of the local currency. While devaluing doesn’t sound appetizing it can be very effective, since it encourages more exports and more tax revenues, and because it makes it easier to pay off debts denominated in the local currency.
BUT, Greece can’t execute its own monetary policy. It is a member of the Eurozone – using the Euro as its currency rather than the drachma. As a result Greece cannot unilaterally change the supply of its currency. It does not have control over monetary policy. To make matters worse for Greece, the Euro has held a fairly high value against other world currencies – just opposite of the direction Greece needs to help with its problems.
 Euro
How Does the Crisis Affect the Euro?
The Euro is a common currency, currently used by 22 European countries. Decisions on the supply of the Euro are made by a representative body at the European Central Bank.
When a member country, like Greece, threatens to default on its loans, global investors pull funds out of Greece and the Eurozone. This reduces the demand for euros, and causes the value of the euro to fall. This is a mixed blessing. Countries often prefer a strong currency, but a weaker one can encourage exports. Europe is an export driven continent.
Joining the Eurozone initially, countries have to prove that their economies and government budgets are healthy. It is like welcoming someone new onto a lifeboat. You prefer the new person to be healthy. It appears that Greece hid or obscured its economic reports when applying for membership and now its fellow lifeboat members are not happy.
Commentators, such as Paul Krugman, have argued that Greece should never have been allowed in the Eurozone. They also argue that the Euro common currency is flawed if monetary policy is directed centrally, but fiscal policy remains with individual countries. Macroeconomic theory suggests that both need to work in concert, and the slow, deliberative and political style of the European Central Bank is not well suited to crisis management. Here’s one of many Krugman posts on the crisis.
Why the Large Bailouts by European Governments?
Other European countries, particularly those who share the use of the euro currency, want to stabilize the currency in their own self-interest. In additional many of the large banks and financial institutions in Europe hold Greek debt. If Greece defaults on that debt, those institutions are in trouble. France and Germany have been two of the largest contributors. French voters have been relatively quiet about the bailout, but German politics are much more sensitive to the issue. Chancellor Merkel of Germany has to balance the need to preserve the Eurozone economy against the indignation of German taxpayers who feel little affection for Greece.
European policymakers also worry about other members of the Eurozone – including Spain and Ireland. These two countries have stressed economies for reasons different than Greece. Neither of them had profligate government spending, but both have been hit particularly hard by the recession. Additional stresses on Europe could tip these countries further into trouble.
Why the International Community and Stock Investors Worry
The source of concern in the stock markets and among international investors is mostly fear of default. Large financial institutions and other holders of Greek debt would be seriously hurt. If a Greek default pushed other European countries like Spain and Ireland over, the impact grows significantly.
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By The Gold Report, on July 25th, 2011
 With the price of gold hitting record highs and equity prices lagging behind, Bob Moriarty, founder of 321gold.com, says it’s time to gather some precious metals as insurance against hyperinflation or deflation—whichever may be coming our way—and to stock up on junior resource stocks. Prudent picks, he suggests in this exclusive interview with The Gold Report, stand a good chance of yielding returns up to 500%.
The Gold Report: Bob, you’ve told us that you avoid investments that appear to be slam-dunks because they never work out. But you’re a longstanding gold enthusiast, and you hear many people talking about gold as a slam-dunk investment—and now silver as well. How do you reconcile this?
Bob Moriarty: All the attention paid to gold scares me. If you looked at gold in terms of the cost of a postage stamp or a house, gold is very expensive at $1,600/oz. Same thing is true of silver; silver got very frothy two months ago, and every idiot in the world was running around saying silver is going through the roof. We actually had a higher bullish consensus on silver on May l of this year than we did in January of 1980, and that scares me, too.
TGR: You’ve also expressed serious concerns about international governments and their debts underpinning the increase in the gold price. Are you still making that argument?
BM: Well, here’s the key, and this is what the gold bugs totally ignore. You can die of lung cancer or a heart attack, and the end result is exactly the same. In a financial system, you can die of hyperinflation or you can die of deflation. With $600 trillion worth of derivatives in the world, the risk of deflation is enormous, and that means that gold could drop to $500/oz. It might buy 10 times as much as it does at $1,600/oz., but everybody in the gold arena believes we’re going to go into hyperinflation, and that’s a slam-dunk. What if we don’t? What if they’re wrong?
TGR: It’s interesting that you bring up the need to look at the price of gold in terms of what it can buy, but if you believe in the theory that gold at $500/oz. will be able to buy 10 times more than it does today, doesn’t that make gold great regardless of whether we’re in a hyperinflation or a deflationary environment?
BM: Yeah, I absolutely believe that the financial system of the world will collapse—and I think lots of people have now come into this camp. Even Tim Geithner came out just a few days ago saying that we’re in some really, really, bad times. I was saying that five years ago and 10 years ago, and now Mr. Geithner’s finally figuring it out.
But the gold bugs need to understand that Greece could default, Italy could default, Spain could default, starting a series of cascading defaults and the banking system could close in a month. Then maybe gold isn’t $10,000/oz.; maybe it’s $500/oz.
TGR: Speaking of some of those European economies, on July 12 you wrote an article describing Greece as a “serial deadbeat,” and said that the European Union (EU) should kick Greece out and let them sort out their own financial situation or face a revolution. But realistically, wouldn’t kicking Greece out of the EU also trigger a revolution in Europe as the various banking systems begin to collapse?
BM: But they’ll create a far bigger monster if they try to keep Greece in the EU. This is a case of Hobson’s Choice. Hobson was an innkeeper in England back in the 18th century, and he was a lazy sod. When you went to Hobson, if you wanted a horse he would give you whatever horse was nearest the barn door. If you wanted a riding horse, you might wind up with a plow horse, and if you wanted a plow horse, you might end up with a thoroughbred.
Hobson’s choice is the choice of the least bad of alternatives. One alternative is for Greece to go out on its own and sort out its own problems. Another alternative is to have Germany, Sweden, Norway and others in the EU pay for Greece’s problems. Sooner or later, people will say, “Hey, wait a minute. It’s Greece’s problem; it’s not our problem.”
TGR: Isn’t it both? Greece’s problem, but not Greece’s alone.
BM: That’s true. What’s going on in Europe is the most serious financial issue in world history, and once the defaults start to cascade, it will be time to head for the bunker.
Almost everybody believes that governments are all-powerful and can prevent chaos. I believe that market forces are all-powerful. If the banking system in Europe collapses, it will be a week or two before it hits the United States, but I don’t think the government can do anything about it.
A two-year Greek note is paying 39% interest. When you’re paying 39% interest, it means the market believes you’re going to default. The United States is paying probably 0.05% for the same thing, but what nobody has taken into account is globalization means that everybody’s in bed together. So, when Greece and Italy collapse, it’s going to cause a collapse in the United States.
TGR: Tea Party representatives have been adamant that the U.S. doesn’t need to raise its debt ceiling because we can cut our way into living within our means―a position that’s resulted in a complete stalemate in Washington, D.C. while the debate continues. How do you see this playing out as the August 2 deadline approaches?
BM: They’ve pulled the pin on the hand grenade, and they’re tossing the hand grenade back and forth. No one wants to get stuck with it when it goes off. It’s totally insane. If Moody’s downgrades the United States, it would double our interest rates overnight and put every bank in the United States out of business. These guys are playing a really stupid game, and playing it for political purposes. They can’t even understand how dangerous it is.
But to some extent the Tea Party is right, in that we don’t need to increase the debt ceiling. We need to go back to real-world economics and match what we spend to what we collect.
TGR: How can we do that by August 2?
BM: Suppose you called me up and said, “Hey, Bob, I’ve got a problem. I owe $5 million and I make $50,000 a year. I don’t know how I can pay my bills.” I’d tell you that you need to default, start all over, and match your income with what you spend. In that sense, there’s no difference between a country and an individual. Under these circumstances, it’s ridiculous to be talking about raising the debt ceiling. The United States hasn’t paid a penny of the debt off since 1960. It simply cannot go on forever. It’s going to blow up. It has to.
TGR: But wouldn’t defaulting trigger that downgrading by Moody’s, the rise in interest rates, and the bank failures you mentioned? We wouldn’t even be able to pay the interest. If we don’t raise the debt ceiling, won’t our huge house of cards come tumbling down?
BM: It’s going to happen no matter what we do.
TGR: So, how do you see this playing out?
BM: I think they will raise the debt ceiling. But it’s a house of cards, it’s going to collapse here very soon, and everybody’s going to say, “Gee, why didn’t somebody warn us?” The fact of the matter is that 49 other guys and I have been trying to warn people for 10 years now, and nobody’s wanted to listen. People’s heads are buried in the sand because they don’t want to know.
TGR: What do you suppose this will do to the price of gold in the near term?
BM: Gold will drop off in August, as it always does, and then pick up again in September. What’s really interesting to me is that gold is at the highest price it’s been in history and nobody seems to care.
TGR: What do you mean by that?
BM: Well, we’ve got the highest price for gold that we’ve ever had. I was around in 1979 and 1980, and it was a big deal on the news every day. They were tracking the price of gold and the price of silver, and nowadays everybody kind of ho-hums. We’re almost at $1,600 and nobody really cares.
TGR: Could the ho-hum attitude reflect the fact that it’s not really a big market?
BM: I think Americans are so clueless as to what’s going on financially that they don’t understand how important it is. But it is important; it’s a barometer. It’s the canary in the coal mine and it’s saying something is seriously wrong.
TGR: Do you think the fact that gold has been decoupled from currency for several decades might also make it more humdrum?
BM: Yes, that’s absolutely true. Most Americans wouldn’t have any idea what a U.S. gold coin is like because they’ve never felt one, never touched one, never bought one, never sold one. The gold markets and the silver markets are tiny markets now, but I’ve been saying for years you need gold and silver as an insurance policy. Certainly, anyone who reads the headlines today should realize that this is a time for an insurance policy.
TGR: Right, and as you said earlier, it’s an insurance policy for either hyperinflation or deflation. It will work in either direction. Your July 11 article mentioned that the Canadian junior shares have languished relative to the price of gold. So is this also a time to get into gold equities?
BM: It probably is. If you go back to 1980, gold and silver hit their highs in January but the junior market didn’t hit its high until that fall. So gold went up to $875 and then collapsed; silver went up to $50.25 and then collapsed. The stocks didn’t move at all until nine months later. They roared higher when people said, “Okay, it’s time to get into gold and silver.” Sometimes gold and silver lead; sometimes stocks lead, but gold stocks are very cheap now compared to the metal.
TGR: Which means they’ll only get cheaper if the metal continues its upward path.
BM: Obviously. With $1,600 gold, an extraordinary price, every gold mining company in the world should be making money hand over fist.
TGR: You’ve said the best place to find a new mine is to find an old mine. Why is that true?
BM: Mines aren’t usually closed because all the ores have been mined out; they’re shut down for economic reasons. Management spends too much money or busts their picks on another deposit. It’s as simple as going into a known gold or silver district and using modern exploration techniques. I’m writing a piece about a company I went to visit in Colombia. The locals have been mining in the area for 400 years. It would surprise me if they have found 5% or 10% of the gold available there.
TGR: Can you share this company’s name with us?
BM: It’s Red Eagle Mining Corp. (TSX.V:RD ), which just went public toward the end of June. People can get into the stock today at pretty close to the same price that they came out in the Initial Public Offering (IPO), about $1.25 per share. I went; I found gold; I panned gold; I saw gold being mined. Better yet, the company has a big land position. I think it will be very successful. I think anybody in Colombia will be very successful. It’s an extraordinary country.
TGR: You’ve said before that over the next five to 10 years that Colombia once again will be the largest gold producer in the world.
BM: Colombia was the biggest gold producer in the world for 300 years, and there’s still an enormous amount of gold there.
TGR: Did you look at other companies during your visit to Colombia that you consider particularly good investment opportunities?
BM: Continental Gold Ltd. (TSX:CNL) is one; I think its mine has 1 oz. average material. Solvista Gold Corp. (TSX.V:SVV), Sunward Resources Ltd. (TSX.V:SWD), Bellhaven Copper and Gold Inc. (TSX.V:BHV), Colombia Crest Gold Corp. (TSX.V:CLB; Fkft:EAT) and Galway Resources Ltd. (TSX.V:GWY) are a few others. Some 50 companies are located in Colombia. The real issue will be how good the management is, because the gold is certainly there.
TGR: Tell us a little more about some of those companies.
BM: I really enjoyed my visit to Sunward. It’s just a great company and they’re doing good stuff. It’s in an area with a gold-rich copper porphyry. It’s not high grade, with an average of 0.53 grams, but the tonnage is enormous. Sunward could end up with 800M–1B tons, and as the size of the deposit grows, it’s getting cheaper to mine. It has a 3.7 million ounce resource right now, and I expect that to double or triple by the time they finish drilling.
TGR: You said that it gets cheaper to mine as the size of the deposit grows. Is there a point in Sunward where you’ll see a tipping for those economies of scale?
BM: They’re there now, with enough gold to go in with bulk tonnage techniques and really get the costs down.
TGR: Going back to your comment about looking for an old mine to find a new mine, you recently wrote up a company working in a series of old Idaho mines that produced for about 40 years until 1942.
BM: When the United States entered the war after being attacked in December of 1941, the government shut down 165 mines because the men and the equipment were needed for the war effort. In fact, 100% of those deposits were economic. The one you’re alluding to is Musgrove Minerals Corp. (TSX:MGS; OTCQX:MGSGF). Its mine was the biggest copper producer in the United States until the Bingham Canyon in Utah came along. It has a lot of oxide copper right at the surface.
TGR: Given that the price of copper has gone up so much over the past several years, why wasn’t it put into production a decade ago?
BM: A decade ago, copper was $0.65 a pound; today it is $4 and change. There also were some management issues with the company that had the project before Musgrove. Musgrove came in and sorted out the issues, and it’s very viable today. It would be viable probably at $1.50 copper.
I’m not particularly concerned about the price, because everything in life is cyclical. It takes years to develop a mine like this, so you don’t care what the price of copper is on a day-to-day basis. You have to be looking at the long term.
TGR: An interesting company that appears on your website describes its approach as a focus on “generative exploration targeting under-explored gold belts.” That seems contrary to your old mines, new mines proposition.
BM: Despite what that description may imply, Revolution Resources Corp. (TSX:RV; OTCQX:RVRCF) is doing exactly what we were talking about. All of the deposits that they’re drilling now are prior mines that I went to see about two months ago. Revolution is indeed exploring, but it’s in an area known for America’s first gold rush, for the oldest silver mine in the U.S. and for the fact that it led the country in lead production for Civil War munitions.
TGR: The first gold rush?
BM: In 1848, when gold was discovered in California, the miners from the Carolinas and Georgia all headed for California. The head of the U.S. Mint in Dahlonega, Georgia tried to convince them to stick around Georgia because there was so much gold there. The phrase “Thar’s gold in them thar hills” is how he put it, to persuade them to stay. The Carolina Slate Belt, which produced more gold than anywhere else in the country until 1848, may still be the most prolific mineral belt in the eastern United States. When Revolution management looked at it, they said, “These things didn’t stop producing because they ran out of ore; they went out of production because of economics, and we’ll go back in with modern techniques.” I think Revolution is going to be a wild success.
TGR: Have you researched or analyzed any other companies in base metals or precious metals that you’d like to talk about?
BM: I don’t think so. Across the board, mining stocks are so cheap that if a company passes the management test, you could have a 200%, 300%, or 500% return.
Convinced that gold and silver were at their bottoms, and wanting to give others a foundation for investing in resource stocks, Bob and Barb Moriarty brought 321gold.com to the Internet 10 years ago, and later added 321energy.com to cover oil, natural gas, gasoline, coal, solar, wind and nuclear energy. Both sites feature articles, editorial opinions, pricing figures and updates on the current events affecting both sectors. Before his Internet career, Bob was a Marine F 4B pilot and O 1C/G forward air controller with more than 820 missions in Vietnam. A captain at age 22, he was the youngest naval aviator in Vietnam and one of the war’s most highly decorated. He holds 14 international aviation records, and once flew an airplane through the Eiffel Tower’s pillars “just for fun.”
By The Gold Report, on July 12th, 2011
  Opportunities abound in small- and mid-cap silver companies, according to Sprott Inc. Chairman Eric Sprott. In this exclusive interview with The Gold Report, Eric Sprott and Sprott Money Ltd. President Larisa Sprott say the fundamentals that drive the price of silver are as strong now as before the spring selloff—maybe even stronger—even though volatility is causing buyers to hold back a bit.
The Gold Report: The Greek economy is making headlines again, with the Greek Parliament recently voting in extreme austerity measures that include budget cuts of $40B plus a selloff of $72B in assets. When we spoke in March, Eric, you were quite worried about collapses in Greece, Ireland and Iceland. Do you see these new austerity measures as another step toward collapse, or do they signal a reprieve?
Eric Sprott: It’s the European troika advancing the money that’s really preventing the collapse, from the financial market point of view. The austerity program will create a collapse in Greece economically, but it at least gives them the opportunity to get the troika bailout. I refer to the troika as the ECB (European Central Bank), the IMF (International Monetary Fund) and maybe the BIS (Bank for International Settlements).
I think Greece is not much different from others that have gone before, whether Iceland or Ireland. Most governments in the world have taken on added monetary and fiscal responsibilities because of the financial collapse. For example, the U.S. wouldn’t be running a $1.5T deficit had there not been the collapse in 2008 because we wouldn’t have had the programs that we now have, trying to support the banking system that everyone thinks is too big to fail.
For quite a long time, my view has been that the banking system has been over-levered. The assets on the books aren’t worth what they would be in a normal monetary environment, and if they had to sell the assets, most banks in that situation would become insolvent. Who would you sell those assets to?
Imagine a Greek bank knocking on the door of any other bank in the world saying that they have Greek mortgages, loans to Greek companies and Greek bonds they’d like to sell. There’s no buyer, so the government basically has to step in, as happened in Ireland, Iceland, the U.K., the U.S. and Japan. It’s happened in almost every country, where the governments have come in to bail out the financial system.
This country with all of 11M people—as many people as live in Ontario—has almost taken down the whole system, as Lehman Brothers almost took down the whole system. What was Lehman? It was like a pimple, and on a relative scale, Greece is not a big situation either. But they want to prevent the falling of the first domino, because if the first one goes down, I can assure you what will happen. That’s what everyone’s guarding against. It would just spread amongst various banking systems.
TGR: Is there a possibility that Greece and other countries with debt issues could negotiate for pennies on the dollar to reduce their debts by 20%, 40%, or whatever? It would have an impact, of course, but not as bad as a default.
ES: That would be defined as a default for all intents and purposes. Some rating agencies have suggested that the voluntary rollover they’re talking about might still be officially a default because everyone knows that what they’re getting for what they’re giving up isn’t worth 100 cents on the dollar.
If a new party comes to power in Greece, they might say they’re going to rip up that agreement and take the default because Greece might be better off defaulting. Of course, the powers-that-be don’t want that. It’s as much the troika that doesn’t want it as the government in Greece. They’re all trying to prevent this contagion from starting.
TGR: But you’re suggesting that eventually the contagion will take hold.
ES: It’s kind of taken hold already, right? The weakest—Iceland and Ireland—have been knocked off already. Greece was the third weakest. Who knows where we go from here?
TGR: When we had our conversation in March, you said that sooner or later people will realize that it’s better to have real assets in physical metals than bank accounts.
ES: I’ve always believed that, and it’s even truer today. Would you rather have your money in a Greek bank or in gold? Would you rather have your money in an Egyptian, Irish or Icelandic bank or gold? Iceland took a devaluation; if the people in Iceland had their money in gold, they wouldn’t have lost a damn thing.
You also take a currency risk when you own a bank deposit. Even a U.S. resident who owns gold instead of a bank deposit would be better off, because the purchasing power of the dollar is going down on an international basis.
TGR: That’s why you called gold the investment of the last decade.
ES: Right.
TGR: And you’ve called this the decade of silver, saying that on the basis of the historical gold-to-silver ratio, silver may even triple the performance of gold. Do you still believe there’s the potential for outperformance at that level? And, if so, over what timeframe?
ES: It’s very difficult to pick timeframes, because so many events can transpire, but I really believe that silver will trade at a 16:1 ratio to gold. I certainly believe that gold can get to $1,600/oz. this year, and while I’m not suggesting that silver will make it to $100/oz. this year, it’ll certainly trade at a 16:1 ratio to gold within three to five years. By then, who knows? Gold could be at $2,500/oz.
TGR: The gold price has been climbing neatly along the 200-day moving average, while the silver price has been all over the place. Do you foresee a time where metals just go hyperbolic?
ES: Yes, I think that will happen. When people ask when I’d get off the gold train, I say that it would cause me to reconsider things if governments and central banks appeared to be getting responsible. I’d say if it evolved into a mania ala NASDAQ 2000, you might decide to exit the investment. Of course, if they made gold the official reserve currency, I wouldn’t need to own it anymore because I could convert my currency to gold or silver at any time.
So, it’s hard to define when it’s going to happen. Earlier this year, I was totally convinced that silver would easily make $50/oz., and for all intents and purposes, it has. I think silver will rally pretty powerfully from this little selloff we’ve had, and hit a new high this year.
TGR: Larisa, has Sprott Money seen a corresponding increase in silver to gold this year?
Larisa Sprott: When we last spoke in March, in terms of dollars, silver was outselling gold by a ratio of about 5:1—we were selling five times more dollars of silver than dollars of gold. The silver market has had a price correction and it’s been a volatile commodity over the last month or so. I’ve seen a rather dramatic shift in sales toward gold. In terms of dollars, gold is now outselling silver on a 3:1 ratio.
It’s not that people have lost their taste for silver, but they’re holding back on purchasing silver because of the increased volatility in the market. I think that once the silver price demonstrates less volatility, our sales will return to the aforementioned ratios.
TGR: Do people still tend to take possession of their purchases, or are more keeping it in your storage depository?
LS: They’re taking possession simply because at this time we only offer storage in the United States. Some of our U.S. clients fear that a 1933-type confiscation scenario will happen again, so they would prefer to store in Canada or internationally. I’ve even seen people drive from places such as Florida and Washington to take possession of their bullion so that they may store it in a safety deposit box in Canada.
We’re opening a storage depository in Canada, but that’s still three to six months out. I’ve had a lot of interest from clients who say that as soon as that facility opens they’ll be moving their bullion up here.
TGR: What else is new at Sprott Money?
LS: We are working on increasing our U.S. presence. We anticipate opening our New York office by October of this year. We are also minting a Sprott silver bar and coin set to be ready for sale in early 2012. And as a proud supporter of GATA (Gold Anti-Trust Action), I am pleased to announce that we will be selling the GATA gold coin at their upcoming conference in London this August.
TGR: We’ve seen that Sprott Money is the major sponsor of the GATA Gold Rush 2011 conference coming up in London in August. How did your organization get interested in GATA and what it has to say?
ES: When I started investigating an investment in gold and silver in 2000, among the most outspoken—to whom I’m ever so thankful—were the GATA people, who suggested that central banks, in a somewhat coordinated fashion, were suppressing the gold price. There seemed to be some compelling evidence for that because central bankers were huge sellers of gold, which retrospectively looks like the dumbest thing they could ever have done. With 20/20 hindsight, that decision looks like one of the greatest knucklehead moves of all time. Here we are 10 years later and where they were sellers of 400 tons of gold a year, now they’re buyers of 400 tons of gold.
GATA was prepared to challenge the system and to explore the data behind various government moves, why they did it and why they always advertised that they were selling gold, which almost necessitated getting the worst price possible instead of the best price. The whole attitude they were taking to gold seemed ridiculous.
The GATA people have been a big influence on the increasing interest in gold. They’ve been incredibly helpful in terms of keeping people focused on what’s going on in the precious metals markets. They had a wonderful conference in Dawson City in 2005.
The people who spoke there—and who will speak at this GATA conference in London—are all independent thinkers who aren’t swayed by the conventional. They’re typically contrarian. You have to work hard to be a contrarian, because you have to win what would seem to be very difficult arguments. They’re just top-notch people. When I look back over the last decade, I think those who were skeptical and outspoken are the true heroes.
If more people had listened to them, they wouldn’t have suffered the kind of financial damage that has transpired in the last decade. Certainly, if they owned gold and silver in lieu of any other investment, they would’ve been better off.
TGR: You noted that when the central banks started selling gold about a decade ago, they pretty much locked in the worst possible price by announcing their intentions ahead of time. Is it the same now that they’re announcing in advance their buying intentions?
ES: They only announce after they’ve bought. For example, in either 2008 or 2009, the Chinese Central Bank revealed that it had purchased 400 tons of gold over about four years, but that was well after the fact. Obviously those purchases were an active force in the market. China hasn’t announced anything in the last three or four years, but I suspect it’s been a buyer all this time. The Central Bank of Mexico recently announced buying 93 tons, which undoubtedly concluded its purchasing program.
There probably should be transparency in these transactions anyway. The central banks should be telling the populations they represent where they are investing their money.
TGR: You’ve indicated that GATA was founded on evidence of collusion among financial institutions that resulted in suppressing the gold price. We also hear about market manipulation through derivatives. Tell us a little bit about this.
ES: First, understand that commodity markets rarely settle in physical commodities; they’re really paper markets. Let me give you an example.
We produce 900 Moz. (million ounces) of silver in a year. When silver was up around $48/oz., between the London Bullion Market Association (LBMA), the COMEX, the SLV Silver Trust and some vehicles in China, we were trading 1 Boz. (billion ounces)/day silver in the paper market. We produce just a little over 1 Moz./day for consumption as an investment. So we trade 1 Boz. of paper silver and yet there’s only 1 Moz. of physical quantity available for investment. That makes you wonder.
They get after the silver speculators who are long. I can understand being long silver, because maybe those speculators think they’d like to own it. What are those who are selling the billion ounces thinking when there’s no physical silver to settle with?
TGR: What might change to slow this down?
ES: There should be position limits, and trading limits per day. What’s the net effect of trading 1 Boz. when the stuff doesn’t even exist on the face of the earth? The short position in the silver market was so concentrated amongst the four largest bank-owned firms that it was shocking. Why they should be short that much silver is beyond me.
TGR: Let’s talk a little about options for the individual investors.
ES: I’m very comfortable having a very large weighting in precious metals, which are way more likely to hold their value than paper assets. And I feel so involved in trying to get people to own more precious metals because I think it’s the one thing that will save them in a very difficult financial time. But most won’t take the steps of getting a little bit of insurance by owning precious metals.
TGR: If another financial trauma is coming, should investors be more weighted with the actual physical metals or should they continue with the equities too?
ES: People worry about the banking system, and I think ultimately they’ll put their money into gold and silver. If the prices of gold and silver go up because of that, notwithstanding a short-term decline in the market, ultimately people also will realize that gold and silver stocks are good things to invest in. But you may have to go through a six-month swoon.
We went through a swoon like that in 2008. Gold was probably $900 at the time. Owning gold and silver would’ve been very propitious. Today it’s $1,500. I think this next time around, as we see gold and silver gaining more recognition as to their intrinsic merits, that will get transmitted into the gold and silver shares.
TGR: As you look forward, are you holding or considering some equities that you feel will swoon less than the market?
ES: Let’s face it—if you use the HUI Index, precious metal stocks have gone up by a factor of about 12 to 13 times from the 2000 bottom. On a long-run basis, there aren’t many losers in those stocks, and certainly on a relative basis, they’re all winners.
Until a few months ago, any silver stock on the board had such a massive run that everybody could sell at a profit. It’s important to know that most people like to sell their winners. At the first sign of problems, you sell the stock that’s got the biggest profit for you. And, it’s very easy to sell it. Maybe it’s not so easy to sell some bank stock that’s still 60% from its high, but it’s not too tough to sell a gold and silver stock that’s 5% from its high because it has had a good run.
We get more volatility in this group because of that. Any stock that has gone up a lot will be more volatile than one that hasn’t. That’s just the way it is. The high flyers always get knocked down the most, because they’re easy to sell. That’s the situation we find ourselves in. Most of these stocks have been the best performers of the last decade.
Every time there’s a little hiccup in the market, people sell them. It doesn’t mean that the fundamentals have changed. That’s just the way people react in a market selloff. Give it time. People will get calm again about where they should have their money.
TGR: We were talking with Rick Rule and Brent Cook a couple of weeks ago about the fact that most juniors are off 10%–20% since April and May. They suggested it might be a good time to own some mid-caps and seniors. Considering the profit-taking you just described, do you agree?
ES: I’ve been investing in small-cap stocks for roughly 40 years, and the opportunities in small caps are far superior to those in big-cap stocks on a sustainable basis. It’s always been the case because they’re under-owned, under-followed and under-capitalized. You can do a lot in the small- to mid-cap area that you can’t do in the large-cap area. You can buy a junior gold stock on a relative valuation of probably a third of any major stock just because they’re seasoned and that’s where the big money goes. Opportunities abound in the small- to mid-cap area, so that’s where I’m going to stay. In a sustainable rally, I guarantee you they’ll outperform the large caps.
TGR: Peru is one of the best mining addresses on the planet, but we’ve seen a lot of decrease in share prices in some of the Peruvian mining equities. You have some interests there, too, that have been specifically affected by government action. Could you comment on that?
ES: Bear Creek Mining Corp. (TSX.V:BCM) has been one of my favorites because of its two ore bodies. It’s unfortunate the governments have made the decisions they’ve made. We see this in different places, not just in the less-developed countries, where governments come in and change the rules. If it’s not Ecuador, it’s Peru. If it’s not Peru, it’s Bolivia. Somebody’s always doing something.
TGR: In the case of Peru, though, this was an injunction signed by outgoing President Alan Garcia that halted Bear Creek’s Santa Ana silver project specifically.
ES: You take those risks with any country. People always ask if I think the U.S. government will confiscate gold. You hear chatter about the U.S. government nationalizing the gold mines someday. If you want egregiousness, that’s almost as bad as Ollanta Humala (Peru’s new president) declaring that one property is not going to continue to be owned by somebody. It could happen anywhere. That’s one of the problems you face when you’re an investor; you don’t know exactly what the political flavor is.
If I were a betting man, I’d bet the Santa Ana mine comes into production within the next 10 years. The stock market doesn’t like delays, but they don’t detract from the merits of the property. When people calm down and know the regulation is in place to try to prevent environmental problems, it will ultimately get the go-ahead.
TGR: Do you feel just as bullish on small caps in gold as you do in silver?
ES: Because I think the price of silver probably will outperform gold by maybe 2.5 times, I have to look much harder for silver equities than gold equities. That’s what we’ve done in the last 18 months. So I prefer silver junior equities to gold for sure.
When I look at the demand and supply fundamentals, it’s all in place as far as I’m concerned. Lots of times the market doesn’t corroborate your view for a while, but the important thing is the market corroborates your view along the way. Yes, we had to deal with that gut-wrenching selloff in the gold stocks in 2008, but when you look back at it now you wonder what the hell the market was thinking.
TGR: What are some of the good silver small caps you found in your search?
ES: We’ve been in lots of companies. We’ve been involved with Fortuna Silver Mines Inc. (TSX:FVI; Lima Exchange:FVI), First Majestic Silver Corp. (TSX:FR; NYSE:AG; Fkft:FMV), Argentex Mining Corp. (TSX.V:ATX; OTCBB:AGXM), SilverCrest Mines Inc. (TSX.V:SVL), Silver Quest Resources Ltd. (TSX.V:SQI), Aurcana Corp. (TSX.V:AUN) and Mirasol Resources Ltd. (TSX.V:MRZ). I’ve got a long list.
TGR: Those names have assets all over North America and South America.
ES: Most of them tend to be in North America, particularly Mexico, Central America and South America. But I own stocks in companies with silver in other places, too. One example is Minco Silver Corp. (TSX:MSV), which has its Fuwan silver deposit in China. I’ll buy a silver asset wherever it is located.
TGR: So clearly, you still do see this as silver’s time to shine.
ES: I do. And I’d refer readers who’d like to know about why I believe the robust fundamentals for silver are only getting stronger to the Caveat Venditor! article we’ve just posted to Markets at a Glance on our website.
TGR: We’ll be sure to check that out, too. Thank you both for your time.
Eric Sprott is chairman of Sprott Inc., CEO, CIO and senior portfolio manager of Sprott Asset Management LP and chairman of Sprott Money Ltd. He has more than 40 years’ experience in the investment industry. After earning his designation as a chartered accountant, he entered the investment industry as a research analyst at Merrill Lynch. In 1981, he founded Sprott Securities. After establishing Sprott Asset Management Inc. as a separate entity in December 2001, Eric divested his entire ownership of Sprott Securities to its employees. Eric has been stunningly accurate in his predictions, including foreseeing the current financial crisis. He chronicled the dangers of excessive leverage and the bubbles the Fed was creating, while also correctly forecasting the tragic collapse of the housing and financial markets in 2008. Eric’s predictions on the state of the North American financial markets, as well as macroeconomic analyses have been presented in Markets at a Glance, a monthly investment strategy newsletter.
Larisa Sprott joined Sprott Money Ltd.(www.sprottmoney.com) in the role of President in December 2009. As one of Canada’s largest owners of gold and silver bullion, the company’s goal is to facilitate ownership of precious metals to the general public. Larisa has more than 15 years experience in the financial industry, having worked at Sprott Securities Inc. (now Cormark Securities), first as an office administrator in the Vancouver office, and later in roles in research and corporate finance at the Toronto headquarters. Larisa then spent five years with Sprott Asset Management in the capacity of client services, sales and marketing. In November 2007, she became an investment advisor responsible for servicing and managing high net worth clients.
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