The year-on-year change in CPI-IW,
with target zone superposed.
The best price index in India is the CPI-IW. `Headline inflation’ in India corresponds to the widely watched year-on-year change in the CPI-IW. The above graph shows us the experience of inflation in India from 1999 onwards. The informal target of policy makers is for inflation to lie between four and five per cent. These are the two blue lines on the graph.
In February 2006, inflation breached the upper bound of five per cent. It has never come back in range. Things are so bad that even the overall average inflation of this period (the red line) is now above the upper bound of five per cent. We don’t just occasionally fail to stay within the target range of inflation; we persistently fail to get there. This inflation crisis is a major failure in Indian macroeconomic policy, and is holding back India’s growth.
Many explanations like supply side factors or droughts are offered. They fail to persuade when we see this time-series experience. Did we have fewer droughts before 2006? Or that supply side factors were not a problem before 2006? Sustained failures on inflation are always rooted in monetary policy. In the long run, inflation is always and everywhere a monetary phenomenon.
There is some tiny progress in the latest months in this graph, but we cannot claim that the inflationary spiral has been broken. Policy rates are 7 and 8 per cent, and inflation is almost surely above 8 per cent, so the policy rate is likely to be negative when expressed in real terms.
|Smoothed month-on-month inflation
(annualised, based on seasonally adjusted CPI-IW)
The year-on-year change is a moving average of the latest 12 month-on-month changes. We obtain information about current conditions by looking at more recent month-on-month changes. This requires seasonal adjustment. The graph above shows the 3-month moving average (3mma) [source]. Just as the y-o-y change shows average inflation over the latest 12 months, this graph shows average inflation over the latest 3 months.
There is some progress in recent months. But at the same time, in the entire period, we see many such short periods of decline in inflation. Eyeballing the graph does not give us confidence that there has been a qualitative change in inflationary conditions. As an example, consider the previous dip in inflation. We could have become quite excited by the drop in this 3mma CPI-IW inflation down to 2%. But this was a temporary gain which was quickly reversed.
We should hence be cautious about reading too much in the recent decline in month-on-month CPI-IW inflation. While it is great news if inflationary pressures in the economy are declining, and it will be great news when the cycle of high inflationary expectations will be broken, there isn’t enough evidence as yet to announce that the mission — of achieving low and stable inflation — has been achieved.
The tax this year will increase by two percentage points, to 6.2 percent from 4.2 percent, on all earned income up to $113,700.
Indeed, for most lower- and middle-income households, the payroll tax increase will most likely equal or exceed the value of the income tax savings. A household earning $50,000 in 2013, roughly the national median, will avoid paying about $1,000 more in income taxes — but pay about $1,000 more in payroll taxes.
That tax rates are nominally increasing, or that effective tax rates are not decreasing, should come as no surprise. Government spending must be funded somehow, and the only three possible options for raising revenue are taxation, inflation, and borrowing. The federal government must have money in order to do what it does, and that money must come from somewhere. To think that the federal government can spend close to $4 trillion without imposing any costs on anyone except “the rich”—itself a nebulous, ill-defied concept—is simply ludicrous. And to those who complain about the tax burden they must inevitably bear, I simply ask: what government services do you no longer want provided for you? If you want the government to do something for you, you must—you will—pay for it. Thus, any complaints about taxes, if they are serious, must be accompanied with complaints about spending.
So minting the [$1 trillion] coin would be undignified, but so what? At the same time, it would be economically harmless — and would both avoid catastrophic economic developments and help head off government by blackmail.
What we all hope, of course, is that the prospect of the coin or some equivalent strategy will simply take the debt ceiling off the table. But if not, mint the darn coin. [Emphasis added.]
Here’s how you can tell that Krugman is peddling nonsense: he doesn’t take his argument to its logical conclusion. If minting a $1 trillion coin is so harmless, why not mint a $16.4 trillion coin and pay off the entire federal debt in fell swoop? Why not mint $84 trillion coin and cover unfunded liabilities? Why not mint one platinum coin annually to cover each year’s budgetary deficit instead of going into debt? I mean, if $1 trillion dollar coins are so harmless, why not mint enough of them to completely solve the problem instead of minting one or two and just sort of half-assing it?
In many ways, Krugman’s argument is similar to the arguments made by proponents of the minimum wage. If minimum wage is so good and has no drawbacks, only benefits, why not mandate that minimum wage is $50 per hour? Or $100? Of course, that proponents of minimum wage don’t take their arguments this far suggests one of two things: either most proponents of minimum wage are unthinking idiots who simply parrot the talking points spouted off by people they deem intelligent, or proponents of minimum wage recognize the flaws inherent to their argument and are simply lying misrepresenting the reasons why they desire minimum wage.
The same, of course, is true for Krugman in his defense of minting the $1 trillion coin. If it is indeed so harmless, why not go ahead and mint all the money we need? To ask the question is to answer it. The reason why it’s so bad to mint $1 trillion coins is because they are inflationary, and would jack up ordinary citizens’ cost of living while enabling the wealthy and politically connected to profit at the middle class’s expense. Of course, this effect happens whether inflation occurs monetarily or by credit expansion, but if you admit that one type of inflation has negative consequences—and Krugman is implicitly admitting that monetary inflation is a bad thing, else he would pursue it to its logical end—then you must admit that any other form of inflation has the exact same type of negative consequences, even though the timing of their appearance may differ.
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Thus, it is apparent that Krugman is either a fool or a liar. Given that he constantly reverses himself about every major belief he’s ever had or any opinion he’s ever voiced, one might reasonably conclude that he’s a liar. Unfortunately, though, this would be a foolish conclusion, as the above-referenced post indicates that Krugman has no imagination, which would generally preclude him from being a liar. However, this does make him an idiot and, judging by the scope of his influence, a rather useful idiot at that. And since his devotees and followers are apparently not smart enough to see through him, it would appear that Krugman is nothing more than a blind leader of the blind. Too bad his leadership will drag blind and sighted alike down into a pit.
What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom.—Adam Smith, The Wealth of Nations
Here’s some nonsense on stilts:
Richard Feynman was once asked what he would pass on if the whole edifice of modern scientific knowledge had been lost, and all he could give to posterity was a single sentence. What axiom would convey the maximum amount of scientific information in the fewest possible words? His candidate was ‘all things are made of atoms.’ In a similar spirit, if the whole ramshackle structure of contemporary macroeconomics vanished into thin air and the field had to be reconstructed from scratch, the sentence which packs as much of the discipline into the fewest possible words might be ‘governments are not households.’ The principles of running an economy are in many crucial respects different from those of keeping your own finances in order. The example of the hypothetical tenner is part of the reason why: governments need to keep money moving around. For a household, to deposit the money in a savings account might well be the most sensible course. Governments, on the other hand, need that velocity – they need GDP. In order to get it, they sometimes have to borrow that first tenner, which they can do in a range of ways not available to ordinary citizens (who can’t, for example, just print the money). Once that first tenner is spent, the government’s hope is that it will continue to be spent many more times. [Emphasis added.]
The fundamental fallacy of Keynesian economic analysis is that it is predicated on the notion that the rules of fiscal common sense do not apply to the government. Contra Smith, the Keynesians assume that the government need not live within its means, and that it focus on attaining certain target numbers for highly abstract, generally unrealistic abstract notions of economic productivity.
The shallowness of the Keynesian worldview is apparent in many ways:
First, the Keynesian emphasis on monetary velocity is extraordinarily shallow. It is assumed that government spending increases monetary velocity by spreading money throughout the economy. Even if this assertion is true, what is often neglected is how, at least in regards to taxation and borrowing, the only way the government spreads money throughout the economy is by first taking money from the economy (of course, this is not technically the case with inflation, but since governments do not fund their budgetary expenditures solely by inflation, one must necessarily conclude that governments at least partially fund their expenses by either debt, taxes, or some combination of the two, which requires the further conclusion that, at some point, money must first be taken from the economy to later be put in to the economy). Another observation that is often neglected is that money that is not spent by the government (i.e. privately-spent money) also has some degree of velocity as well. Money does not generally sit stagnant, except among those who wish to store currency under their mattress or such-like, and so money that is spent my non-government market actors has the same velocity as money spent by government market actors, assuming that in both cases, no currency is ever removed from circulation. Thus, the assertion that government policy must needs be different from household economic policy is fallacious because the justification for the assertion that government policy is special is itself specious.
Second, Keynesians neglect to understand that money is not itself production. As was noted in the excerpted piece, households cannot print money whereas the government can. Unfortunately, the mere printing of money does not itself magically cause more products to appear in the economy. Now, inflation can draw demand forward, but only to a limited extent, because ultimately shifting production forward runs into the very serious problem of running out of demand, production materials, or both. One of the reasons why the housing market collapsed in 2008 was due in part to demand exhausting itself. To put it simply, people stopped wanting houses at the prices provided. Sure, the housing supply is at its highest, but now the demand for houses has declined, which is why housing prices remain relatively depressed. Quite simply, demand is not infinite—neither is production—which is why inflation will always fail to permanently increase production. There are limits to everything, and inflating the currency does not change that very simple fact.
Third, Keynesians fail to realize the scalability of hierarchy. The reason why the government is often compared to a household is because the household is a useful metaphor for understanding hierarchy. Every household has a head, every household has expenses, every household has members, and so on. A functioning household is one where everyone contributes to its upkeep, and one that lives within its means, and so on. Of course, the metaphor is not exactly perfect, but it is generally useful, and so it serves as a useful point of comparison, and provides people with simple heuristics for evaluating, say, the long-term reliability and stability of any hierarchical organization, such as a business, charity, church, or government. If a functioning family is one that minimizes deadweight and free riders through the proper division of labor, and manages to avoid fiscal problems by living within its means, then it is generally reasonable to expect that a state or business that minimizes deadweight and free riders, and also lives within its means, well do reasonably well and be expected to have a lot of stability.
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And so, while governments are not households, the difference is more along the lines of scale than quality. Governments are similar enough in form to households that the microeconomic analysis used to evaluate the fiscal health and stability of a household should be a useful heuristic for evaluating the fiscal health and stability of a government. Furthermore, the form of government is not so radically different from the form of households that it justifies a radically different set of analysis and evaluation.
The Seattle Times:
If President Obama wants to avoid an economic calamity next year, he could always show up at a news conference bearing two shiny platinum coins, each worth … $1 trillion.
That sounds wacky, but some economists and legal scholars have suggested that the “platinum coin option” is one way to defuse a crisis if Congress cannot or will not lift the debt ceiling soon. In theory.
The U.S. government is facing a real problem. The Treasury Department will hit its $16.4 trillion borrowing limit by February at the latest. Unless Congress reaches an agreement to lift the debt ceiling, the government will no longer be able to borrow enough money to pay all its bills.
Last year, Republicans in Congress resisted raising the debt ceiling until the last minute — and then only in exchange for spending cuts. Panic ensued.
What happens if there is another showdown this year?
Enter the platinum coins. Under current law, the Treasury is technically allowed to mint as many coins made of platinum as it wants and can assign them whatever value it pleases.
Under this scenario, the U.S. Mint would make a pair of trillion-dollar platinum coins. The president orders the coins to be deposited at the Federal Reserve. The Fed moves this money into Treasury’s accounts. And just like that, Treasury suddenly has an extra $2 trillion to pay off its obligations for the next two years — without needing to issue new debt. The ceiling is no longer an issue.
Obviously, the only downside to this plan is the inflation, but it’s not like the government is serious about that, seeing as how the dollar has lost over 95% of its value in the last 99 years. I suppose it would be technically better to use the trillion dollar coins to buy back US debt and retire it, thereby monetizing the debt-inflation that has already occurred. However, in the grand scheme of things, it doesn’t really matter. What matters is that we extend and pretend for another year until Krugman and the Neo-Keynesians finally Figure Out How To Solve The Economy For Good This Time (We Really Really Mean It)™.
With nary a glimmer of hope that economic sense will supplant political expedience, Stansberry & Associates Investment Research Founder Porter Stansberry expects rampant inflation to roar in once the cost of capital rises. How is he preparing himself? Stansberry tells The Gold Report he continues to buy and hold gold and also discusses how real estate can cushion against the fiscal cliff.
The Gold Report: Not a day goes by that we don’t hear or read something about the fiscal cliff. To what extent are you worried about the fiscal cliff? Or do you foresee a resolution?
Porter Stansberry: You can be sure of a couple of things from Washington. One is spending will not slow down. The increase to spending in 2013, 2014, 2015 will be the same kind of increases we have seen in previous years. We will continue to spend 24% of GDP at the federal level.
TGR: And what else can we be sure about?
PS: Some actions will be taken to increase the tax rates on some taxpayers, but they will produce no material change in revenue. The government will continue to take in far less than 20% of GDP in taxes, probably only 16% or 17% of GDP. Further, those changes also will narrow the tax base, which is to say that fewer people will be asked to pay more in taxes.
“People should fear not going over the cliff.”
Those two things—more spending and higher tax rates for some taxpayers—will happen because they’re the only politically expedient things that can happen. That’s been driving politics and the budget since 30, 40 years ago, and will continue to do so because voters demand more from the government and voters demand that they not pay. That will continue until the system completely collapses.
TGR: The fiscal cliff was set up a couple of years ago in theory to force Congress to do something. There’s a lot of fear about it, but at what point will there be enough fear that voters say we can’t proceed in this fashion anymore?
PS: People should fear not going over the cliff. If we go over the cliff, the tax base will greatly expand. The payroll tax cuts will be done away with and the broad middle class—the people who have benefited from the tax cuts—actually will have to pay taxes again in America. There’s no other way to generate the amount of revenue that is required. You cannot finance the federal government on the backs of the top 5% of wage earners because even if you charge them 100%, it wouldn’t come close to being enough money.
Right now the U.S. takes in something on the order of $1.5 trillion (T) a year in income taxes, but we have an annual deficit of $1.6T. Even doubling the amount of income tax collected would leave a deficit. Taxing the rich cannot solve this problem. It can be solved only by freezing spending and broadening the tax base. That will never happen because it’s unacceptable politically.
TGR: Eventually something will happen.
PS: Yes, it will. Our trading partners and the people who finance our debt finally will say, “We’re not doing this anymore.” But look at the Treasury bond market. It’s not happening yet.
TGR: It’s amazing that the U.S. hasn’t been downgraded just on the basis of all the political bickering.
PS: That’s partly because the Federal Reserve keeps buying up all the excess Treasuries. People have no idea how dangerous this is, but they will find out when inflation goes crazy. Another big reason is that there’s not a really viable alternative. What would the Russian Central Bank or the Chinese Central Bank do with their trade surplus? Buy British paper money? Or European paper money? Where’s the hard dollar alternative? There isn’t one. No government-backed money is any more secure than the dollar. Even the Swiss have turned on the printing presses to equalize exchange rates with the Europeans. There’s nowhere to go. That’s why these central banks are buying all the gold they can get. And that’s why gold prices are going to absolutely go higher.
TGR: China particularly has been buying a lot more natural resources such as copper or iron ore.
PS: I have been following the strategic buying of the Chinese and you’re right, it has been buying up lots of resources, especially in Canada. That will continue for sure, but it is also buying lots and lots of gold. I think Russia and China have been neck and neck in gold purchases since the 2008 crisis, spending almost half of their current account surpluses on gold every year.
“I do believe we’re still in a global finance crisis.”
Some folks have been critical of my prediction that the U.S. will lose its world reserve currency status, but I think it has already happened. When two of the world’s largest economies would rather buy gold than Treasury bonds, you’ve got a big problem.
TGR: When do you suppose the gold price will start climbing again?
PS: I don’t have any timetable. I can just tell you that I haven’t sold any of my gold and I won’t until there is a gold-backed, well-financed national currency that offers me a reasonable yield for the risk I take to finance the government. There’s nothing like that in the world and I don’t see any prospects like that.
TGR: The last time we chatted, you discussed the pros and cons of returning to the gold standard. One of your observations was that the U.S. dollar has lost something like 20% of its value since 2008 and you projected it losing another 20% in 12 months. Do you still see the dollar value decreasing at that rate?
PS: I actually think it is but it’s not reflected yet in consumer prices. Manipulating the bond market is so greatly reducing the cost of capital that so far companies have been able to maintain profit margins without raising prices. As a result, we’ve been exchanging capital cost for commodity costs but you can only do that for so long.
Imagine what your purchasing power would be if you’re going to go buy a new home today. If you have $10,000 for a down payment, you could buy a $100,000 home with an FHA mortgage, and you’d only pay something like 3% for the mortgage. But could you afford that if mortgage rates were actually market set? If you had to pay 7.5%? No. Your purchasing power, your standard of living, would be completely destroyed without reasonably priced financing, and that’s absolutely what will happen.
“I’ll continue to buy gold on a regular basis and I’ve never sold a single ounce.”
Look at other markets. General Electric Co. (GE:NYSE), for example, has $600 billion (B) in debt on its balance sheet and its combined annual cost of finance is less than 2%. That makes no sense. Imagine what GE would charge for turbines, light bulbs and appliances if it had to pay a market rate of 9% on that debt. The price of capital is so low that it is retarding the impact of ongoing inflation, but sooner or later all this debt will have to be financed at real prices. When that happens, the impact to the economy will be both a weaker dollar and higher prices for everything.
TGR: But you are making it sound as if the actual financing costs now are artificially low. When interest rates increase, wouldn’t it be more like 4% than 9%?
PS: Look historically what high-yield debt has traded for—9% isn’t even aggressive. Over the last 20 years, I think average yield on a high-yield bond has been 14%. People don’t think of GE as a high-yield credit but they ought to.
TGR: So many of these large companies have a tremendous amount of cash on the balance sheets. They could double their interest payments.
PS: All I am saying is that 9% is a reasonable cost for a GE bond, given its cash flows and given that it owes $600B and still owns all kinds of dicey real estate mortgages. GE is a huge American business. It employs 160,000 people. It is an example of how the Fed’s manipulation of interest rates affects the real cost of things. GE can afford to charge low prices for its goods because it pays so little for its capital. And across our economy, companies have been exchanging capital costs for commodity costs. GE’s commodity costs have gone up, but it has not passed it along to the consumer because it has been able to save so much on financing.
But as I said, that game can’t go on forever, and the minute the game ends it’s going to end badly. The shock to the consumer will be amazing. It’s not just inflation devaluing the purchasing power of wages, which is going on continuously. It’s going to be that suddenly consumers will have this huge price impact. It could reduce the purchasing power of the average consumer by 20% or 30%.
TGR: The way you’re explaining it, it sounds as if it could happen almost overnight.
PS: It will be extremely quick. Nothing particular changed in Greece, Italy or Spain between 2006 and 2009. No significant catalyst caused people to all of a sudden wake up and realize these sovereigns were bankrupt. They’ve been bankrupt for decades. All that changed was the realization that others were unlikely to continue to finance them. There’s no real credit analysis being done with GE. One investor buys the bonds because he’s convinced the next investor will do so, but that’s all based on faith. There’s no real critical thinking going on. All of a sudden, if some investor loses faith, it can happen very quickly.
TGR: Isn’t playing the markets all about faith and what you think the general population is going to do? Markets aren’t always based on fundamental economics. They’re based on fear and greed.
PS: Of course they are, but with the Fed skewing the bond market the way it has, people have become convinced that the yields will always go lower because the Fed will not let them increase. So far that’s been a great trade, but you cannot print your way to prosperity. Sooner or later these policies will destroy the credit of the United States and send interest rates soaring in our domestic economy. That will absolutely happen, no doubt about it.
TGR: Aren’t the Europeans—even the Chinese—in the same game of artificially low interest rates?
PS: China’s not in the same game, nor is Europe to the extent that the U.S. is. Germany has been very reluctant to monetize the European debt. It has certainly increased that greatly this year so maybe there will be runaway printing, but paper money has always been this way. Show me the paper currency that lasted for more than 100 years and was worth anything at the end. Paper money gives human beings the illusion that they can get something for nothing. They believe in it until it falls apart.
TGR: Until we get to a gold standard, we as investors need to be doing something to retain our wealth. You can put a certain amount in gold, which some people are doing, but we also have other types of investments, which for people in the U.S. is based in U.S. dollars. Until it unravels, isn’t the U.S. dollar the best bet?
PS: Yes. I think that’s fair. But it doesn’t mean anything to me because it’s similar to going on death row and asking who is the best guy.
TGR: But we’re looking at an unfortunate situation where individuals need to put their money at risk in equities or the bond market at this point.
PS: I disagree. I don’t believe people have to put their money into bond markets or stock markets. For the last 24 months I’ve been buying real estate almost exclusively. I might have bought a couple of small gold stocks along the way but miniscule positions compared to my net worth. I’ve been buying real estate because it’s an asset I can control, that I could finance extremely cheaply if I chose to. I do not choose to; I buy my real estate in cash. I’m not interested in making money on it. I just want to keep my money safe. I’m happy to make returns of 4% to 6% a year on my real estate portfolio. If inflation comes along I’ll be able to increase rent and have capital appreciation roughly in line with inflation. For me that’s all there is.
Porter Stansberry is intense when it comes to investing and recreation. His Atlas 400 Club brings together intelligent, successful people from all over the world for adventures that last a lifetime. See a video from his travels, including a recent trip that included racing Porsches in Germany.
I do believe we’re still in a global finance crisis. Things are not right with the world. In a situation like this, I think your goal as an investor should be to keep what you’ve got. It’s going to be very difficult to survive this with your wealth intact because so many forces are aligned against you. I just button up and I’m super-conservative.
By buying off the bottom in the real estate markets, I’m doing the best I can to protect myself from any future calamity. Time will tell whether it will work. And if there’s just ongoing inflation instead of a calamity, I’m going to make a lot of money with my real estate.
TGR: Absolutely. Any other insights you’d like to give to our readers of The Gold Report?
PS: I’ll continue to buy gold on a regular basis and I’ve never sold a single ounce. So if you’re buying gold I think you’re going to do very well. And I will continue to be cautious. I don’t believe it is a time to be aggressive, especially in the bond markets around the world.
TGR: Thank you very much, Porter. Have a happy—and I hope prosperous—New Year.
Porter Stansberry founded Stansberry & Associates Investment Research, a private publishing company based in Baltimore, Maryland, in 1999. His monthly newsletter, Stansberry’s Investment Advisory, deals with safe value investments poised to give subscribers years of exceptional returns.
Stansberry oversees a staff of investment analysts whose expertise ranges from value investing to insider trading to short selling. Together, Stansberry and his research team do exhaustive amounts of real-world, independent research. They’ve visited more than 200 companies in order to find the best low-risk investments in the world.
Many goldbugs like gold as a hedge against Federal Reserve policies and high inflation. Paul van Eeden, president of Cranberry Capital, says he does not fear high inflation due to Fed policies. Van Eeden is a different kind of goldbug and in this interview with The Gold Report, he explains how his proprietary monetary measure, “The Actual Money Supply,” is the reason why.
The Gold Report: Paul, your speech at the Hard Assets Conference in San Francisco was titled “Rational Expectations.” You spoke about monitoring the real rate of monetary inflation based on the total money supply.
You take into account everything in your indicator that acts as money, creating a money aggregate that links the value of gold and the dollar. You conclude that quantitative easing (QE) is not resulting in hyperinflation and is not acting as a driver for the continuing rise in the gold price. What then is pushing gold to $1,700/ounce (oz)?
Paul van Eeden: Expectations and fear. It’s very hard to know what gold is worth in dollars if you don’t also know what the dollar is doing. When we analyze the gold price in U.S. dollars, we’re analyzing two things simultaneously—gold and dollars. You cannot do one without the other. The problem with analyzing the dollar is that the market doesn’t have a good measure by which to recognize the effects of quantitative easing.
Since approximately the 1950s, economists have used monetary aggregates called M1, M2 and M3 (no longer being published) to describe the U.S. money supply. But M1, M2 and M3 are fatally flawed as monetary aggregates for very simple reasons. M1 only counts cash and demand deposits such as checking accounts. M1 assumes that any money that you have, say, in a savings account isn’t money. Well, that’s a bit absurd.
TGR: What comprises M2?
PvE: M2 does include deposit accounts, such as savings accounts, but only up to $100,000. That implies that if you had $1 million in a savings account, $900,000 of it doesn’t exist. That’s equally absurd.
“If gold is money, we should be able to look at gold and compare gold as one form of money against dollars, another form of money.”
M3 describes money as all of these—cash, plus demand deposits plus time deposits, but to an unlimited size. One may think then that M3 is the right monetary indicator. But the problem with both M2 and M3 is that they also include money market mutual funds, a fund consisting of short-term money market instruments.
That’s double-counting money because if I buy a money market mutual fund, the money I use to pay for that mutual fund is used by the mutual fund to buy a money market instrument from a corporation. The corporation takes the money it received from the sale of the instrument and deposits it into its bank account, where it is counted in the money supply. I cannot then count the money market mutual fund certificate as money, as it would be counting the same money twice.
TGR: So there is no accurate indicator.
PvE: M2 and M3 double-count money; M1 and M2 don’t count all the money. All are imperfect measurements. That is why I created a monetary aggregate called “The Actual Money Supply,” which is on my website at www.paulvaneeden.com.
TGR: How is your measurement more accurate?
PvE: It counts notes and coins, plus all bank deposit accounts, whether they’re time deposits or demand deposits. This is equal to all the money that circulates in the economy and can be used for commerce—nothing more and nothing less.
TGR: How does that separate out gold from the dollar in value terms?
PvE: I’m a goldbug. I believe gold is a store of wealth and gold is money. If gold is money, we should be able to look at gold and compare gold as one form of money against dollars, another form of money.
Changes in the relative value of gold and dollars will be dictated by their relative inflation rates. If I create more dollars, I decrease the value of all the dollars. If I create more gold, I decrease the value of all the gold.
TGR: The relationship is determined by both quantitative easing and mining?
PvE: Correct. Essentially most of the gold that has been mined is above ground in the form of bars and coins and jewelry. We can calculate how much that is. That’s the gold supply. That supply increases every year by an amount equal to mine production less an amount used up during industrial fabrication. That’s gold’s inflation rate.
“If the Federal Reserve starts to see an increase in price inflation or a rapid increase in loan creation—monetary inflation—it can sell assets back into the market.”
We can also look at the money supply and see how it increases every year. That’s the dollar’s inflation rate. The value of gold vis-a-vis via the dollar will be dictated by these relative inflation rates.
I have data on both gold and the U.S. dollar going back to 1900 and thus can compare the two. By doing that, I can calculate how the value of gold changes relative to the U.S. dollar and what gold is theoretically worth in terms of dollars.
Keep in mind that the market price is not the same as the value. In the market, price is seldom equal to value. Price often both exceeds and is below value. But it will always oscillate around value.
For example, in 1980, gold was trading much higher than value. By 1995, the gold price had sufficiently declined and U.S. dollar inflation had sufficiently increased to bring the gold price back to value, vis-a-vis the dollar. By 1999, gold was substantially undervalued. By 2007, it was again reasonably valued. But in 2012, it is again substantially overvalued.
Gold price and U.S. dollar inflation (blue) 1970–present
TGR: The value of gold is not $1,700/oz?
PvE: No. The value of gold is about $900/oz. Expectations of monetary inflation are keeping gold prices high.
In 2008, after the financial crisis, the Federal Reserve Bank announced the first round of quantitative easing. The gold price started to rally because there was an expectation, with the Fed openly engaging in quantitative easing, that we would see massive U.S. dollar inflation. But that didn’t happen.
“Whether annual mine production goes up or down, it makes no difference to the price of gold.”
When the Fed engages in quantitative easing, it does so by buying assets in the open market, such as Treasury notes or bonds. When the Fed buys a government bond in the open market it creates the money to pay for it out of thin air. The payment is credited against a commercial bank’s account at the Federal Reserve Bank and is not available for commerce in the economy. It’s part of the monetary base, but not the money supply, as the money supply only counts money that can be used for commerce.
Thus, the money that the Fed creates is not in circulation. It’s not part of the money supply because it cannot be spent. The commercial bank in whose name it is credited cannot withdraw it. The only thing it can do is to create new loans against that reserve asset. But the bank can only create new loans equal to the demand for such new loans.
Right now, as a result of QE1 and QE2, there is an enormous amount of excess reserves on account at the Federal Reserve on behalf of these commercial banks. These excess reserves in theory could be used to create new loans. The reality is that new loan creation by commercial banks have proceeded at a very normal pace, and not at all at a rate that should cause fear of hyperinflation.
TGR: Is it that there isn’t a demand or that the banks don’t see creditworthy people to loan to?
PvE: It doesn’t matter; the result is the same. The point is that the marketplace is not creating those loans.
Money that is counted in the money supply is created when consumers and corporations borrow money from commercial banks. When a loan is created by a commercial bank, the banking system creates that money out of thin air just as the Federal Reserve created its money out of thin air.
When a loan is repaid, that money is destroyed. The natural increase of the money supply is the balance between loan creation and loan repayment from consumers and corporations to commercial banks. Their ability to create those loans is dependent, to some extent, on their reserve assets in the monetary base that they have on account at the Federal Reserve. Right now, those reserve assets are much, much larger than what is necessary to account for existing loans of banks. So banks have enormous capacity to create loans, but capacity to create is not the same as having created. We are not seeing runaway inflation in the market. The U.S. money supply is increasing at an annual rate of around 7%, which is high, but not high enough to cause the type of hysteria that the gold price is exhibiting.
TGR: The expectation that banks will eventually loan up to their lending capacity is what is causing the fears of hyperinflation and the gold price to go up.
PvE: That is correct.
TGR: When will banks start lending?
PvE: They are lending, which is why the U.S. money supply is increasing. But they are not lending at a torrid pace—the U.S. money supply is increasing only very slightly faster than the average annual rate since 1900, and slower than it was in the period from 2000 to 2009 before quantitative easing started. It is highly improbable that we will see the kind of monetary inflation the market is afraid of—the fear is misplaced.
The Federal Reserve alone controls the level of money in the monetary base. If the Federal Reserve starts to see an increase in price inflation or a rapid increase in loan creation—monetary inflation—it can sell assets back into the market. When those assets are sold back into the market the money that the Federal Reserve receives for the asset is destroyed. It evaporates.
Just as the Federal Reserve created money, it can destroy money. The Fed can absolutely prevent runaway inflation by selling assets back into the market, therefore constricting the ability of commercial banks to make loans.
TGR: If the Fed-created money isn’t loaned out, will the inflationary expectation in the market eventually disappear? Will the price of gold go to $800–900/oz?
PvE: That’s a possibility. The gold price rallied in response to QE1 and QE2 and when QE2 ended, the gold price started falling.
Prior to the announcement of QE3, the gold price rallied again in anticipation, but since QE3 has been announced, the gold price has been falling.
When the Federal Reserve announced QE1, there was a massive increase in the monetary base. When it announced QE2, there was another substantial increase in the monetary base, but much less than with QE1. But there hasn’t been an increase in the monetary base since the QE3 announcement. The Fed is “sterilizing” QE3 by offsetting sales of assets at the same time it is purchasing assets.
TGR: So the key is how the Fed implements quantitative easing?
PvE: Correct. The question is whether the gold market is rational in expecting hyperinflation or massive runaway inflation. That expectation is not being supported by the money supply, or by price inflation, or any other data. The only place the expectation is being manifest is in the prices of gold and silver.
TGR: If you look at the supply and demand expectations for gold versus the inflated valuation for gold, do you see more gold producers bringing gold out of the ground? If so, is that going to have an effect on the price?
PvE: If the gold price is high relative to production costs then yes, it does bring marginal mines into production, which increases the supply of gold. Incidentally, the increase in production from marginal mines then causes production costs to increase as well.
Does that have an impact on the price of gold? No. The reason is very simple. Approximately 1,000–2,000 tons of gold is traded each day. Annual production of gold is roughly 2,000 tons. If annual gold production increases by 5%, which is a lot, it’s 100 tons. We trade that in a couple of hours.
Whether annual mine production goes up or down, it makes no difference to the price of gold. The gold that’s trading globally is not just the gold that’s being mined; it’s all the gold that’s ever been mined, that’s sitting above ground in vaults and in storage. That’s where the price is set. Not on the margin of incremental production.
TGR: As you’re looking at the gold companies that are out there, are you seeing that we have some good prospects or are you seeing that the producers aren’t able to replace what they’re using and the juniors aren’t able to get the funding to find new sources?
PvE: I agree with your last statement. Producers are not able to replace their reserves. New exploration is not keeping up with reserve depletion and the juniors are not getting the funding to do the exploration.
The reason juniors aren’t getting funding is because the market has become quite risk averse. Junior exploration companies are among the most risky investments you can imagine. When risk aversion increases in the market, the ability of juniors to fund exploration evaporates.
It’s also true that the miners, particularly gold and copper, are having a tough time replacing reserves. Is that something that’s going to cause a calamity in the next 12 or 24 months? No. But, it is a reason why, over the long term, investing in mineral exploration is an interesting business. Without mineral exploration, there can be no mining industry and without a mining industry, our society does not function.
TGR: The last time we spoke to you, you said that you were very scared and that it was a healthy thing for investors to be scared because it keeps them from making mistakes. Are you still scared?
PvE: I’m definitely concerned that the market is going to look worse in 2013 than it looked in 2012. I think risk aversion is not yet ready to be replaced by risk appetite. The big concern I have for next year is further deterioration of the Chinese economy. In particular, a tipping point is being reached in China where its banking system can no longer sustain the bad loans it has created.
If economic growth in China takes a really big hit at the same time the financial problems in Europe have not yet been resolved, I see more risk aversion creeping into the market. That’s not good for junior exploration companies.
What makes me optimistic is that I think the worst is behind us in the United States. I think that slowly but surely the U.S. economy is going to get better and better. With time the improvement in the U.S. economy will bring risk appetite back into the market, but I don’t see that happening in 2013. We’ll have to see this time next year what the prognosis is for 2014.
TGR: In 2008, you told your investors to sell everything. Is that still your position?
PvE: The end of 2007 and the beginning of 2008 was the top of the market for most metals and certainly for mineral exploration stocks. That was the time to sell everything. Now we’re very close to the bottom of the market. It could be a long and drawn-out bottom but, nonetheless, I think that we’re close to a bottom.
This makes it a very good time to be accumulating mineral exploration assets or junior exploration companies. It assumes an investor has the patience and financial ability to wait for the next bull market and stay with the trades. Remember that junior exploration companies don’t generate revenue. If the bear market is protracted, these companies will need several rounds of financings in order to stay alive.
TGR: You also invest in silver, base metals and energy. Are some of these sectors doing better than others?
PvE: Copper, like gold, is very expensive. So is silver. The other base metals, such as aluminum, zinc, lead and nickel, are much more reasonably priced. Oil is also very reasonably priced at $85/barrel. I see less systemic risk in those sectors than I see in gold, silver or copper.
TGR: What specific companies do you like in those sectors?
PvE: I have recently acquired additional shares of both Miranda Gold Corp. (MAD:TSX.V) and Evrim Resources Corp. (EVM:TSX.V). I’m on the board of both of those companies and so I am not at all independent, or impartial.
I also recently acquired shares of a company called Millrock Resources Inc. (MRO:TSX.V). And I continue to scour the market for more opportunities. I intend to be a buyer of mineral exploration companies for the foreseeable future.
TGR: Why do you like those three?
PvE: All three of those companies share one element that is critically important. All have competent, experienced management and they have management that I trust: trust that they’re not going to squander the money that we give them and trust that they will use their best efforts to create shareholder value. It is my confidence in management teams that causes me to invest in mineral exploration. Mineral exploration is a business about ideas. It’s not about assets. And when you’re dealing with ideas, the asset that you’re de facto buying is people—it’s management.
TGR: You say that you’re doing this for the long term. How long do you think that you’ll have to wait?
PvE: Who knows? 5, 10 years? Maybe we get lucky sooner. Maybe we don’t.
TGR: Thanks for your insights.
Paul van Eeden is president of Cranberry Capital Inc., a private Canadian holding company. He began his career in the financial and resources sector in 1996 as a stockbroker with Rick Rule’s Global Resources Investments Ltd. He has actively financed mineral exploration companies and analyzed markets ever since. Van Eeden is well known for his work on the interrelationship between the gold price, inflation and the currency markets.
As we head into the last quarter of the year, James West questions how important macroeconomic trends are for individual investors. But he does believe stock catalysts in the energy space are easier to understand than precious metals market forces. In this interview with The Energy Report, West updates us on some possible top performers in the space and what they’re doing right.
The Energy Report: James, with the U.S. election behind us, we are currently looking at a couple of looming and significant issues. One of these is QE3. You’re not a fan of easing; tell me why.
James West: Quantitative easing is just the issuance of more money. Since the onset of the crisis, two episodes of stimulus/quantitative easing injected $2.3 trillion into the economy between 2008 and 2011. Real gross domestic product (GDP) numbers in that timeframe show GDP grew by roughly a net of $2.3 trillion, demonstrating that the “recovery” GDP growth rate of 1.2% was not in fact growth at all, but was merely the addition of 2.3 trillion newly fabricated dollars to the weak and stagnant GDP number. By distributing free money to the top layer of the financial food chain, Obama and Bernanke get healthy numbers. In other words, they are focused most intently on maintaining a delusion, and expend no effort on tackling the real problem, which is income and opportunity disparity.
TER: You have cited the practice of dividend recapitalization as a consequence of near-zero rates. You’ve written that it leads to a doubled rate of bankruptcies in companies undertaking that strategy. But shouldn’t easing promote higher rates?
JW: Dividend recaps are the exclusive domain of private equity-owned corporations. The private equity owner causes the company to borrow so that the owners can be paid a dividend by the company. With such low interest rates, they can completely destroy the company over time, while paying themselves large dividends until the company goes bankrupt, and then they just walk away. They know that the United States can absolutely not withstand a rise in interest rates, or else it would have to declare bankruptcy as the cost of servicing debt would then rise to truly unsustainable levels. Super-low interest rates create the illusion of sustainable debt service levels to persist.
TER: Do you see this practice of dividend recap occurring in energy companies?
JW: Not necessarily. For private equity-owned energy companies, it’s possible. But that would only happen if the earnings from energy sales were insufficient to provide income to the private equity owner. If the board of a public company tried that, they would be voted out, as the self-destructive nature of dividend recaps is obvious. The key requirement that makes a dividend recap possible is a strong balance sheet that throws enough cash flow to service a debt, which disqualifies 99% of the juniors. And again, it’s not an option for a public company.
TER: Let me ask this counterintuitive question: Do you believe higher rates are important to the health of the economy?
JW: Interest rates are essentially the value of money. If you have interest rates at zero, and money is being created arbitrarily, then what does that tell you about the value of money? Zero interest rates mean banks don’t make anything lending or investing money, so why should they? Meaningful and stable interest rates are absolutely characteristics of a robust and healthy economy. Zero interest rates are likely signals of impending economic collapse.
TER: The other major issue looming over the U.S. right now is a threatening fiscal cliff. What could be the upshot of this issue if it is not resolved between the president and Congress?
JW: There’s all kinds of posturing by both sides to suggest there won’t be a problem resolving the issue, and there won’t be! It will likely go to the eleventh hour of course, as each side tries to exact concessions from the other, but at the end of the day, there’s no choice. The bigger issue ahead of the fiscal cliff is the debt ceiling. Watch how quickly that gets raised. The U.S. can’t afford another ratings downgrade.
TER: How do investors play your general economic theory? Back in the summer you told us you favored energy over gold. Is that still the case? Why?
JW: I don’t think individual investors play economic theories so much. I don’t think there are anywhere near the number of investors right now that there were in 2007. Yes, I favor the energy sector over the precious metals sector generally because it’s easier to understand the market catalysts, which in energy are a little less controlled than in precious metals. The precious metals markets make no sense, unless you subscribe to the theory that the U.S. cannot permit higher gold prices, because a suppressed gold price is critical for maintaining the illusion that all is well in the United States Treasury and Federal Reserve.
The huge disparity in gas prices between east and west hemispheres is creating massive opportunity, and the rapid increase in North American shale-borne production is changing world energy dynamics by the day. In precious metals, you’ve got all the same fundamentals, but they’re castrated by government-sponsored price suppression in futures markets.
TER: What about junior companies?
JW: Junior explorers are divided into two camps, as far as I’m concerned. Two years of severe underperformance have capped any possible upside in a lot of these older companies. They’re practically pariahs, just waiting for the inevitable day when they run right out of money, and can’t raise it at any price. There are many such “zombie” companies out there, but there will be a lot fewer this time next year.
Still viable are companies that match strong management with solid structures where the share price can still respond to success without battling through a wall of cheap paper from past financings. These are generally newer companies.
For specific ideas in junior explorers, my favorite companies now are Atico Mining Corp. (ATY:TSX.V), which we own in the fund. The Ganoza family is essentially recreating the winning recipe that they applied to Fortuna Silver Mines Inc. (FSM:NYSE; FVI:TSX; FVI:BVL; F4S:FSE), though this time in Colombia. The company is acquiring a producing mine with plenty of exploration upside, and so you’re buying into cash flow.
Mason Graphite (LLG:TSX.V) is a new graphite deal in which I own shares. I’ve been familiar with its graphite project for many years and I’ve spent time traipsing all over it. It’s called Lac Guéret, and this was a hot graphite property in 2006, when it was owned by Quinto Mining, which was sold to Consolidated Thompson Iron Mines Ltd., which then was bought by Cliffs Natural Resources Inc. (CLF:NYSE). More importantly in the graphite game, however, is not so much grade and purity, both of which you need, but end users. Who are you going to sell it to? Graphite is not scarce. It’s common. But CEO Benoit Gascon built the entire graphite sales channel at his former employer, Stratmin Graphite, from nothing to the point where it was bought by Imerys (NK:PA), one of the world’s largest graphite vendors. In my mind, that is a critical differentiator that will make Mason Graphite one of, if not the graphite company of this cycle.
For lithium, I like Critical Elements Corp. (CRE:TSX.V), again not so much because it’s the biggest lithium deposit, but because management is making all the right moves to put the deposit into production on a fast track. Ron MacDonald, the company’s executive chairman, has a high profile within the alternative energy materials space, and serves several companies among whom synergies exist. Critical Elements is working to secure non-dilutive, commodity-based financing that could see it leapfrog ahead of other, more apparently advanced companies. Production I think will happen as soon as the company can find a buyer who wants to secure a supply of lithium, and will advance the funds to go to production on that basis. I know discussions are under way with a few groups, though nothing concrete has emerged yet.
TER: Do you have some other ideas you could share?
JW: I own the most shares in a stock I think is a billion-dollar company in the making. It’s an OTC-traded company called Abakan Inc. (ABKI:OTCQB). It has now filed for a NASDAQ listing, and it has received investment from and is working with Petrobras, the world’s fifth-largest petroleum producer, to supply Petrobras with a continuous supply of its nano-composite coatings for pipelines. Petrobras is producing highly corrosive oil from very deep fields, which creates stress for pipes gathering and transporting oil from offshore Brazil. Without Abakan’s pipeline coating, much of the oil that Petrobras owns would be uneconomical to produce. And Petrobras is the tip of the iceberg for Abakan. Seventy percent of the world’s remaining oil and gas supplies are “sour,” meaning highly corrosive, and so that means demand for Abakan’s MesoCoat pipelines should keep ramping up for decades to come. The company is looking at building plants in Indonesia, Bahrain, Brazil and Canada, besides its first plant, which comes onstream soon in Euclid, Ohio. The company recently won the Wall Street Journal’s Technology Innovation Award in the manufacturing category.
TER: James, I’d like to get some updates on some of your picks from past interviews with us. To start, Aroway Energy Inc. (ARW:TSX.V; ARWJF:OTCQX) announced that it had acquired an additional 265 barrels per day (bbl/d) of immediate production. That’s a runrate of about $1.3M per year just on this addition. The company has now increased production six fold this fiscal year. Shouldn’t these additions be significant for a $27M cap company? When is this company going to get noticed?
JW: All the junior producers in the patch are in a state of suspension pending the outcome of Industry Canada’s rulings on the two big mergers currently underway, yet not yet done deals. I’m referring to China National Offshore Oil Corp.’s (883:HKSE; CEO:NYSE) acquisition of Nexen Inc. (NXY:TSX; NXY:NYSE), and Petronas (PETRONAS) acquisition of Progress Energy (PGN:NYSE), which was initially turned down. This arbitrary move has put a big question mark over the valuations of the whole patch, from seniors to juniors, because the possibility of a buyout from a bigger company is one of the key price drivers in the sector. With the denial of the Petronas-Progress deal, global investors don’t know who qualifies and who doesn’t as far as purchasers go.
As that story starts to resolve itself, I think Aroway will start to see more of a lift in its share price. These days, if you don’t produce 1,000 bbl/d, you’re not even on the radar. So the company is technically already over that hurdle because it will exit 2012 with 1,200 bbl/d.
TER: EFLO Energy Inc. (EFLO:OTCQB) has recoverable access to 1.8–3.3 trillion cubic feet of natural gas. Gas may be cheap, but this stock is cheaper. Clearly the company suffers from being so small in market valuation where small-cap funds can’t participate. But is it just a matter of time before the company is discovered by small hedge funds and investors? What catalyst can we anticipate?
JW: EFLO is owned by the Midas Letter Opportunity Fund, and has already been a double and then some for us. That’s certainly one to watch, though it’s early days for the company at this point. The big picture for EFLO is the development of pipeline capacity and a liquefied natural gas (LNG) plant on the west coast, which still has a lot of hurdles to clear. But it’s going to happen. Canada needs the addition to the GDP. When the company starts drilling and bringing wells onstream, it will be able to move its gas to market—that’s going to be the ongoing catalyzing event for the company’s shares. That and getting a listing on a senior exchange, which I understand is in process.
TER: Prophecy Coal Corp. (PCY:TSX; PRPCF:OTCQX; 1P2:FSE) shares have had a rough time. It seems like the stock began to turn south when the company announced it was going into the power generation business in Mongolia. Did investors hate this deal because it took focus off of its core business?
JW: Not at all. Its horrible share price performance is attributable exclusively, I would say, to the political situation in Mongolia, which is still uncertain, especially with the passage of the Strategic Entities Foreign Investment Law, passed in May 2012. This document has created more uncertainty than it has assuaged, and that’s why Prophecy shareholders are suffering right now. Unofficially, there is basically a sense of optimism for the long term, and pessimism for the short term.
Just look at Oyu Tolgoi—no investment hesitation there on the part of Rio Tinto. Obviously, Prophecy Coal isn’t Rio Tinto, and that’s probably the main roadblock to reversing the share price performance. When it becomes apparent that Mongolia is not going to make a grab for the power plant, and clear investment and power offtake agreements are in place, the share price should start to appreciate. At this level, I think it’s attractive.
TER: Recently the company announced a preliminary economic assessment on its Chandgana Tal coal mining licenses in central Mongolia, reporting 124 million metric tons of measured coal with a mine life of 30 years. How significant will this be?
JW: Well this was a big cloud put over the company by the Ontario Securities Commission, which has now been quite thoroughly addressed. In any other market, that should have been sufficient to attract buyers in the company’s shares, but there just aren’t a lot of those around right now, thanks to the overall weakness in mining companies for the last two years. Add to that a dose of political uncertainty, and you get the share price Prophecy has right now. But there’s certainly no longer any question of there being sufficient coal to supply the power plant.
TER: James, thank you for your time today.
JW: My pleasure.
James West is publisher and editor of The Midas Letter, an independent capital markets entrepreneur and investor. He has spent more than 20 years working as a corporate finance advisor, corporate development officer, investor relations officer, and media relations and business development officer for companies involved in mining, oil and gas, alternative fuels, healthcare, Internet technology, transportation, manufacturing and housing construction.
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The looming financial meltdown will affect the global economy and the U.S. will not escape, says Greg McCoach. Whatever happens, the precious metals are bound to fly, as investors scramble for tangible cover. Mining stocks will be major beneficiaries of the soaring metals prices, but where mines are situated will be an important factor as governments try to get a bigger piece of the action. In this exclusive interview with The Gold Report, McCoach names some favorite companies that he expects to do well in the coming turbulent times.
The Gold Report: When we last spoke in February, you were predicting a new round of quantitative easing (QE), which we’ve been seeing the last few weeks. Where do you think this is all going to end up?
Greg McCoach: The latest QE3 is open-ended, allowing the Federal Reserve to create money every month, indefinitely. QE3 was announced just a few weeks ago and already there is talk about QE4. So, in my opinion, this is the death spiral of the U.S. dollar.
The same thing is going on in Europe and Japan. It’s very troubling and, in my opinion, totally unsustainable. But, trying to predict a timeline for the ultimate demise is almost impossible. This stuff could last another couple of years. Adding in the derivative problems on top of all this debt, it’s just sheer insanity. So, where is gold going? It’s going way higher because this is the ultimate dynamic that will guide the investment world for the coming years.
TGR: Is there any realistic solution, or are they just getting us deeper into the hole, and ultimately everything is just going to cave in on top of us?
“At some point I know gold and silver prices are going to go way higher than where they are now.”
GM: The days of being able to fix this are long past. I had a chance conversation with a U.S. senator and, when I asked him about the debts and deficit spending, he admitted that everybody in Washington and New York knows that there’s no possible way to pay this back. So, essentially all the politicians are hoping it doesn’t blow up on their watch.
I’m a student of history, which shows that no government that has taken on a fiat currency has gotten past the 41-year mark before it ended in inflationary panic and disaster. The U.S. dollar is now going into its 42nd year as a fiat currency and breaking the record. We’re right on the cusp of what history says is totally unsustainable and will eventually collapse.
Then there is the derivative problem on top of the debt. There’s no historical record of derivatives because they were created in the 1980s for large financial institutions to manage big risks. Unfortunately, the greed in the system overtook them, with everyone trying to make incredibly large returns. Now we have the derivative liability tracking through the world system.
TGR: Hardly anyone is even talking or worrying about derivatives at this time.
GM: Derivatives are the gigantic pink elephant in the room that no one wants to admit is there. As an example, the sovereign debt of Europe is $70 trillion. The derivative liability, that means the unsecured liability that’s associated with that debt, exceeds $700 trillion. It’s a ridiculous number. When we’re talking about trillion-dollar deficits and derivative problems in the hundreds of trillions, it just shows that there’s no possible way this can be fixed.
TGR: Another thing that is looming is the fiscal cliff that we’ll face in a few months. What do you think will happen there?
GM: I think the pressure on Congress to do something is critical. John Mauldin, a very bright economist who writes a newsletter, recently spoke at a conference I attended. He stated that if the U.S. Congress doesn’t deal with the deficit problem in the first six months of next year, it’s over. He said he would go from being an optimist about America to becoming a pessimist and that we’ll go into this death spiral, as he refers to it, of not being able to pay our debt or interest on it. But, he believes that Congress is going to do something.
I’m very pessimistic about that, though I’m more of a pragmatic optimist. I don’t see how Republicans and Democrats, who are so deeply divided, can handle the amount of deficit spending that would have to be cut out of the budget and how badly taxes would need to be raised just to try to have a chance of warding off what’s coming. The chances of that happening, in my opinion, are zero.
So, the fiscal cliff is coming. He and I believe that if we’re going to do the right thing, we have to go far beyond what the fiscal cliff is talking about. The way it’s set up right now, only about 5% will be cut from spending next year. That’s nothing. We have to do far more than that. Everybody’s going to have to pay more taxes and government spending will have to be drastically reduced, or we go into the death spiral. That’ll be very good for precious metals’ prices, but it’s a very sad commentary on where we’ll be in this world.
TGR: Do you think the recent prediction by Merrill Lynch for $2,400/ounce (oz) gold by 2014 indicates that the investment establishment is starting to see the light and realizes the dire situation, and that gold is going to have to go higher?
GM: The mainstream media, which has always been slanted against gold, is starting to acknowledge this. For them to make a positive comment about gold is really just a fraction of what’s probably coming. At some point I know gold and silver prices are going to go way higher than where they are now. When I tell people that they should be buying precious metals, they say, “Isn’t the price too high?” No, it’s dirt cheap compared to where it’s going.
After the elections, I think we’ll see gold and silver prices press for a new high. As currencies eventually collapse, it’s going to affect the whole world, and metals prices are going to go parabolic. People are always trying to guess how high that could be. The only justifiable rationale that I can give is to take how many ounces exist in the world aboveground today compared to how much fiat currency exists worldwide, and how many ounces of gold would be required to cover all that paper money? Well, my calculation comes out to about $19,750/oz, and that’s probably conservative.
“We have to focus on the best areas of the best jurisdictions that have existing and rational mining laws.”
I think gold could hit at least that number when it goes parabolic, based on all the emotional craziness that would be going on at that point. The rush into precious metals would be one for the record books. You would have oceans of fiat money that were suddenly trying to find some form of safety. Gold, which has always been the safe-haven asset, is a tiny little market and couldn’t receive it. That’s why it will drive these prices into the stratosphere.
I can’t tell you when all this is going to happen and I could be wrong, but the precious metals bull market could continue for quite some time before we get to those parabolic moves. We might be at the end of that cycle right now and precious metals prices could start to go parabolic within the next few months or year.
TGR: So, when do you think the mining stocks are going to start benefiting from the higher metals prices and where should they be going?
GM: There’s been a real disconnect. The high gold and silver prices have enabled producing mining companies to make money hand over fist, but their lack of market performance relative to metal prices has been troublesome. In the nearly 14 years I’ve been doing this, I can’t remember a more difficult period for the junior mining stocks than the last few years. In August and September, the volume on the Toronto Stock Exchange started doubling and things were looking really good. I was expecting a favorable recovery this fall with higher metals prices, but our mining stocks are still really fragile, maybe because of the election.
TGR: There have been some setbacks recently with geopolitical issues affecting mining companies in certain areas. How is this influencing your investment recommendations and where should investors be focusing or avoiding at this time?
GM: It’s becoming more and more complicated. Some governments around the world are acting like extortionists. They see a profitable mining company in their country and say, “We own your asset now, goodbye and good luck.” This is a nightmare for investors. More and more countries are getting greedy and not wanting to allow mining in their countries unless they get an unfair portion of the profit, or they’re just outright nationalizing these mines. That trend is definitely on the rise.
“I’m looking at companies that can still deliver a big upside, yet have cash flow so they don’t have to be constantly going back to the market to do financings, which dilutes current shareholders.”
What that means for junior mining stock investors is that we have to focus on the best areas of the best jurisdictions that have existing and rational mining laws. That was the topic of my talk at the Toronto Cambridge House Investment Conference. I think it’s so important that I wanted to highlight this issue and show people just how critical it is to invest in the right areas of the best jurisdictions. I’m not just talking about the best countries, but the best areas within those countries or jurisdictions.
TGR: Do you want to talk about some of the companies that you like?
GM: I divide my recommendations into exploration, development, production and permitting situations. In the first eight years, we had great success with exploration stories and a few development stories. Now I’m more oriented toward a combination in the portfolio, but looking more at companies that have cash flow. Because of the volatile nature of our markets, I’m looking at companies that can still deliver a big upside, yet have cash flow so they don’t have to be constantly going back to the market to do financings, which dilutes current shareholders.
I like a company called SilverCrest Mines Inc. (SVL:TSX.V; SVLC:NYSE.MKT), located in one of the best areas of Mexico. There are certain areas of Mexico I don’t like, but this is in a good area. The company is currently working through all the startup bugs, but it’s banking money hand-over-fist, with over $35 million (M) cash and growing every month. It’s using that cash flow to find more ounces around its mine site.
SilverCrest also made a new discovery in another location in Mexico that’s looking very promising. The stock price was around $1.65/share over the summer and it’s at $2.39/share now. That shows it’s in a quality mining spot and is a company to watch. I think the stock will break out to a new all-time high along with silver prices. That should take SilverCrest to a $6–8/share buyout by a midtier company. I’m very bullish on SilverCrest right now.
TGR: How about other ones in Mexico or South America?
GM: Orko Silver Corp. (OK:TSX.V) is still looking very good. It has decent share structure with an NI-43-101-compliant resource in a very good part of Mexico and a new super-pit design with quite a silver asset that’s economic. I think Orko will be taken out as well.
In South America, on the exploration side, I like a company called Tinka Resources Ltd. (TK:TSX.V; TLD:FSE; TKRFF:OTCPK), which is currently drilling some very large, very high-grade base-metal anomalies: silver, lead and zinc. Originally, the company had 20 million ounces (Moz) silver in an NI-43-101-compliant resource that it has built further. In addition, it has found some other very high-grade lead and zinc resources. We’re hoping that this drilling really breaks open the understanding of these areas. This is on a major trend in central Peru going down into Chile that is known to host large volcanic massive sulfide (VMS) deposits, which are known to be very high-grade and highly profitable. I’ve been following the story for quite some time and I like what I’m seeing there. Drilling is currently underway and it should get some assays that could really move this story forward. Tinka is one to watch right now.
TGR: OK. Any other ones there?
GM: I’m going to be taking a trip to South America this winter to look around at some new projects. There are so many areas that I need to check out. If I really like something on paper, I try to visit the site before I make a recommendation. Once you get on site, there are always a lot of new questions that you didn’t realize you needed to ask when you saw everything on paper. So, it’s very important to do these site visits.
I really like Chile as a country that’s moving toward liberty and freedom. Mining law is well established in Chile. I think that’s a good area for investors to look at; Chile has some very big deposits of copper and gold.
I like central and southern Peru because the local people know mining and the mining law in those areas is very well established. That compares to northern Peru, where nationalization is going on. Just because I like a country doesn’t mean I like all areas of that country.
I like the Yukon where there are going to be a lot of big gold, silver and base metal discoveries. Right now we’re focused on the White Gold camp and what ATAC Resources Ltd. (ATC:TSX.V) is doing. The White Gold camp is going to have a lot of big new gold discoveries in the coming years. It will take time and there are infrastructure issues. Investors need to be patient. It’s going to take a lot of money because the lack of infrastructure makes for very expensive exploration. There is no problem getting permits and building mines, but you can’t get to them very easily and that gets very costly. For a junior mining company with no cash flow, that means you have to keep going back to the trough to raise money. If you don’t hit early on, it can get painful for the investor.
TGR: So, what other companies do you like in Canada?
GM: I like Ethos Gold Corp. (ECC:TSX.V; ETHOF:OTCQX). It hit high-grade narrow-vein gold drilling this summer, but it was not the bulk-tonnage targets it would like. It only drilled 60 holes. Kaminak Gold Corp. (KAM:TSX.V), which I also like, has had great success up there and drilled over 400 holes this summer. I also like a new discovery up there called Comstock Metals Ltd. (CSL:TSX.V), still in very early days. I think there are a lot of things that could happen in the Yukon, but it’s going to take time.
TGR: Any thoughts on Explor Resources Inc. (EXS:TSX.V; EXSFF:OTCQX)?
GM: Explor Resources is a company that’s in a great area. All the infrastructure is right there. It got a lot of attention over the last three years from investors and mining companies. Expectations were high to find a big high-grade gold deposit. So far, it’s hit on a lot of very expensive deep drill holes. For a junior mining company without a deep-pocket partner, this has gotten very expensive. Lately the company has had some of its best drill results. It hit 35 meters of 8 grams/ton gold, which is very good. Had it hit that years ago, when it only had 65 or 85M shares outstanding, it would’ve been a multi-dollar stock. Now, in this tough market, we have these great drill results but there are 160M shares out and it needs more money again. Timing is everything in these deals.
I do think Explor will do well because it will be coming out in late November or early December with around a 1.5 Moz NI 43-101 resource calculation, which should be a bankable asset. The rest of the assays on further drilling will be coming out later this fall and will be calculated in another NI 43-101 resource sometime in April/May 2013. I think that will be around 2.2 Moz. That’s a significant resource and the majors have to pay attention because it’s located just 10–15 minutes outside of Timmins, in an area with infrastructure, that doesn’t cost a lot to build a mine and has no permitting issues.
I do think that, ultimately, Explor will perform well. The stock is around $0.15/share today, after hitting a low of $0.12/share during the summer. As these NI 43-101 numbers come out, this stock will get back to a more respectable level and eventually will be joint ventured or possibly taken out by a bigger entity.
TGR: Definitely one to keep an eye on. So, are there any other ones you want to mention?
GM: Up in the Northwest Territories, Canadian Zinc Corporation (CZN:TSX; CZICF:OTCQB) has a mine that was built by the Hunt brothers in the late 1980s, with very high grades but not a lot of infrastructure. It looks like it’s getting a permit right now. If that comes through, I think the stock revalues from $0.39/share currently, to more like $2–3/share. Then it’s a development story with about a year and a half to two years to production. Sprott Asset Management is one of the biggest shareholders. If you believe that silver prices are going higher, here’s an operational mine that could be in production with very high-grade ore by 2014 or 2015. So, I like that one as well.
TGR: What should people be doing now to protect themselves and profit from what you expect is ahead?
GM: If you want to make money and not lose money, number one, you have to get out of U.S. dollars. If you hold U.S. dollars in a U.S. bank account, work for U.S. dollars at your job, or you’re hoping to retire in U.S. dollars, you’re going to be in trouble. This is what’s coming. This deficit issue is beyond sustainable. At some point it means collapse and devaluation of our currency.
TGR: We’ve never had it in this country, so that would be a real shock to people.
GM: A big shock. The only way to protect yourself, that I see, is to own physical gold and silver as the ultimate form of money, and take possession of precious metals, whether it’s American Eagles or Silver Eagles for Americans or Canadian Maple Leaf coins for Canadians. Don’t let other people store them for you or get involved with certificates, pooled accounts or ETFs, because they only have to keep a small percentage of the actual money they receive in the metal that they say they’re buying for you. When these metal prices go parabolic, how can they deliver to you if they don’t own the actual metals? That’s going to be a big surprise to people.
On top of that you’ve got to own the precious metal mining stocks, with their big upside leverage potential. Aside from that, my subscribers know that I’m very oriented toward preparedness. Get some food storage together. Our system works on a just-in-time three-day inventory system. If, for whatever reason, there’s a disturbance to that three-day delivery system, the shelves are empty. Get some canned goods and freeze-dried foods that last for a long time. It’s just a smart way to look at life, regardless of how you feel.
On a positive note, once we learn our lesson and the people keep the politicians accountable and don’t let them abuse a fiat currency as we have the last 40 years, I do believe that good things can happen again with a new age of prosperity that has never been seen in this world. So, that’s my positive note, after talking about the difficult times we’ll have to get through first.
TGR: We appreciate your thoughts today, Greg, and the next time we talk, we’ll know a lot more about how all this has turned out.
GM: Glad to be with you.
Greg McCoach is an entrepreneur who has successfully started and run several businesses in the past 23 years. For the last nine years, he has been involved with the precious metals industry as a bullion dealer, investor and newsletter writer (Mining Speculator and The Insider Alert). McCoach is also the president of AmeriGold, a gold bullion dealer. He writes a weekly column for Gold World.
They are probably right. It is telling that neither Obama nor his Republican opponent has offered much of a plan to spur the economy, at least in the short term. So far as anyone has any short-term impact on the economy, it is the Federal Reserve, and even it is limited in what it can do. As it has been said, the Fed can print money, but it can’t print jobs. [Emphasis added.]
Well, if all the fed can really do is add to the stock of currency (well, that and not enforce regulations), then pray tell what, exactly, is the point of having it? If it’s not going to do anything save debase the currency and in so doing ensure that banksters get first dibs on the redistribution that inevitably accompanies each round of inflation, then why have a central bank? Oh, wait…