Oct 31

Tea Leaves & $2000 Gold

Gold Price Comments Off on Tea Leaves & $2000 Gold
Yes, some people are still forecasting $2000 gold by year’s end…

BOB and BARB Moriarty launched 321gold.com over 10 years ago, adding 321energy.com the better to cover oil, natural gas, gasoline, coal, solar, wind and nuclear energy as well as precious metals.
Previously a US Marine fighter pilot, and holding 14 international aviation records, Bob Moriarty here tells The Gold Report why he’s 100% certain that a market crash is looming… 
The Gold Report: Bob, in our last interview in February, we had currency devaluation in Argentina and Venezuela, interest rate hikes in Turkey and South America, and a cotton and federal bond-buying program. Just eight months later in October, we’ve got Ebola, ISIS and Russia annexing Crimea plus a rising US Dollar Index. We’ve also got pullbacks in gold, silver and pretty much all commodity prices. With all this news, what, in your view, should people really be focusing in on?
Bob Moriarty: There is a flock of black swans overhead, any one of which could be catastrophic. The fundamental problems with the world’s debt crisis and banking crisis have never been solved. The fundamental issues with the Euro have never been solved. The world is a lot closer to the edge of the cliff today than it was back in February.
About ISIS, I think I was six years old when my parents pointed out a hornet’s nest. They said, “Whatever you do, don’t swat the hornets’ nest.” Of course, being six years old, I took stick and went up there and swatted the hornets’ nest, which really pissed off the hornets. I learned my lesson.
We swatted the hornets’ nest when we invaded Iraq and Afghanistan. What we did is we empowered every religious fruitcake in the world. We said, “Okay, here’s your gun, go shoot somebody. We’ll plant flowers.” We are reaping what we sowed. What we need to do is leave them to their own devices and let them figure out what they want to do. It’s our presence in the Middle East that is creating a problem.
TGR: Will stepping back allow the Middle East to heal itself, or will there be continued civil wars that threaten the world?
Bob Moriarty: We are the catalyst in the Middle East. We have been the catalyst under the theory that we are the world’s policemen and that we’re better and smarter than everybody else and rich enough to afford to fight war after war. None of those beliefs are true. The idea that America is exceptional is hogwash. We’re not smarter. We’re not better. We’re certainly not effective policemen.
The Congress of the United States has been bought and paid for by special interest groups: part of it is Wall Street, part of it is the banks and part of it is Israel. We’re just trying to do things that we can’t do. What the US needs to do is mind its own business.
TGR: You’ve commented recently that you’re expecting a stock market crash soon. Can you elaborate on that?
Bob Moriarty: We have two giant elephants in the room fighting it out. One is the inflation elephant and one is the deflation elephant. The deflation elephant is the $710 trillion worth of derivatives, which is $100,000 per man, woman and child on earth. Those derivatives have to blow up and crash. That’s going to be deflationary.
At the same time, we’ve got the world awash in debt, more debt than we’ve ever had in history, and it’s been inflationary in terms of energy and the stock market. When the stock and bond markets implode, as we know they’re going to, we’re going to see some really scary things. We’ll go to quantitative easing infinity, and we’re going to see the price of gold go through the roof. It’s going to go to the moon when everything else crashes.
TGR: How are you looking at the crash – short term, before the end of this year? How imminent are we?
Bob Moriarty: Soon. But I’m in the market. Not in the general market, but I’m in resources. There’s a triangle of value created by a guy named John Exter: Exter’s Pyramid. It’s an inverted pyramid. At the top there are derivatives, and then there are miscellaneous assets going down: securitized debt and stocks, broad currency and physical notes. At the very bottom – the single most valuable asset at the end of time – is gold. When the derivatives, bonds, currencies and stock markets crash, the last man standing is going to be gold.
TGR: So the last man standing is the actual commodity, not the stocks?
Bob Moriarty: Not necessarily. The stocks represent fractional ownership of a real commodity. There are some really wonderful companies out there with wonderful assets that are selling for peanuts.
TGR: In one of your recent articles, “Black Swans and Brown Snakes“, you were tracking the US Dollar Index as it climbed 12 weeks in a row, and you discussed the influence of the Yen, the Euro, the British Pound. Can you explain the US Dollar Index and the impact it has on silver and gold?
Bob Moriarty: First of all, when people talk about the US Dollar Index, they think it has something to do with the Dollar and it does not. It is made up of the Euro, the Yen, the Mexican Peso, the British Pound and some other currencies. When the Euro goes down, the Dollar Index goes up. When the Yen goes down, the Dollar Index goes up. The Dollar, as measured by the Dollar Index, got way too expensive. It was up 12 weeks in a row. On Oct. 3, it was up 1.33% in one day, and that’s a blow-off top. It’s very obvious in hindsight. I took a look at the charts for silver and gold – if you took a mirror to the Dollar Index, you saw the charts for silver and gold inversely. When people talk about gold going down and silver going down, that’s not true. The Euro went down. The Yen went down. The Pound went down and the value of gold and silver didn’t change. It only changed in reference to the US Dollar. In every currency except the Dollar, gold and silver haven’t changed in value at all since July.
The US Dollar Index got irrationally exuberant, and it’s due for a crash. When it crashes, it’s going to take the stock market with it and perhaps the bond market. If you see QE increase, head for your bunker.
TGR: Should I conclude that gold and silver will escalate?
Bob Moriarty: Yes. There was an enormous flow of money from China, Japan, England, Europe in general into the stock and bond markets. What happened from July was the equivalent of the water flowing out before a tsunami hits. It’s not the water coming in that signals a tsunami, it’s the water going out. Nobody paid attention because everybody was looking at it in terms of silver or gold or platinum or oil, and they were not looking at the big picture. You’ve got to look at the big picture. A financial crash is coming. I’m not going to beat around the bush. I’m not saying there’s a 99% chance. There’s a 100% chance.
TGR: Why does it have to crash? Why can’t it just correct?
Bob Moriarty: Because the world’s financial system is in such disequilibrium that it can’t gradually go down. It has to crash. The term for it in physics is called entropy. When you spin a top, at first it is very smooth and regular. As it slows down, it becomes more and more unstable and eventually it simply crashes. The financial system is doing the same thing. It’s becoming more and more unstable every day.
TGR: You spoke at the Cambridge House International 2014 Silver Summit Oct. 23-24. Bo Polny also spoke. He predicts that gold will be the greatest trade in history. He’s calling for $2000 per ounce gold before the end of this year. We’re moving into the third seven-year cycle of a 21-year bull cycle. Do you agree with him?
Bob Moriarty: I’ve seen several interviews with Bo. The only problem with his cycles theory is you can’t logically or factually see his argument. Now if you look at my comments about silver, gold and the stock market, factually we know the US Dollar Index went up 12 weeks in a row. That’s not an opinion; that’s a fact. I’m using both facts and logic to make a point.
When a person walks in and says, okay, my tea leaves say that gold is going to be $2000 by the end of the year, you are forced to either believe or disbelieve him based on voodoo. I don’t predict price; I don’t know anybody who can. If Bo actually can, he’s going to be very popular and very rich.
TGR: Many people have predicted a significant crash for a number of years. How do you even begin to time this thing? A lot of people who have been speculating on this have lost money.
Bob Moriarty: That’s a really good point. People have been betting against the Yen for years. That’s been one of the most expensive things you can bet against. Likewise, people have been betting on gold and silver and they’ve lost a lot of money. I haven’t made the money that I wish I’d made over the last three years, but I’ve taken a fairly conservative approach and I don’t think I’m in bad shape.
TGR: Describe your conservative approach.
Bob Moriarty: The way to make money in any market is to buy when things are cheap and sell when they’re dear. It’s as simple as that. Markets go up and markets go down. There is no magic to anything.
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Oct 30

Peak Oil? How About Peak Oil Storage?

Gold Price Comments Off on Peak Oil? How About Peak Oil Storage?
Here’s how cheap US energy promises an ‘epic’ turnaround in the US economy…

MATT BADIALI is editor of the S&A Resource Report, a monthly investment advisory focusing on natural resources from Stansberry & Associates.
A regular contributor to Growth Stock Wire, Badiali has experience as a hydrologist, geologist and consultant to the oil industry, and holds a master’s degree in geology from Florida Atlantic University.
Here he tells The Gold Report‘s sister title The Mining Report that cheap oil prices and the economic prosperity they bring can make politicians and investors look smarter than they are. Hence Badiali’s forecast that Hillary Clinton…if elected in 2016…could go become one of America’s most popular presidents. Yes, really.
The Mining Report: You have said that Hillary Clinton could go down in history as one of the best presidents ever. Why?
Matt Badiali: Before we get your readership in an uproar, let me clarify that the oddsmakers say that Hillary Clinton is probably going to take the White House in the next election. Even Berkshire Hathaway CEO Warren Buffet said she is a slam dunk. I’m not personally a huge fan of Hillary Clinton, but I believe whoever the next president is will ride a wave of economic benefits that will cast a rosy glow on the administration.
Her husband benefitted from the same lucky timing. In the 1980s, people had money and felt secure. It wasn’t because of anything Bill Clinton did. He just happened to step onto the train as the economy started humming. Hillary is going to do the same thing. In this case, an abundance of affordable energy will fuel that glow. The fact is things are about to get really good in the United States.
TMR: Are you saying shale oil and gas production can overcome all the other problems in the country?
Matt Badiali: Cheap natural gas is already impacting the economy. In 2008, we were paying $14 per thousand cubic feet. Then, in March 2012, the price bottomed below $2 because we had found so much of it. We quit drilling the shale that only produces dry gas because it wasn’t economic. You can’t really export natural gas without spending billions to reverse the natural gas importing infrastructure that was put in place before the resource became a domestic boom. The result is that natural gas is so cheap that European and Asian manufacturing companies are moving here. Cheap energy trumps cheap labor any day.
The same thing is happening in tight crude oil. We are producing more oil today than we have in decades. We are filling up every tank, reservoir and teacup because we need more pipelines. And it is just getting started. Companies are ramping up production and hiring lots of people. By 2016, the US will have manufacturing, jobs and a healthy export trade. It will be an economic resurgence of epic proportions.
TMR: The economist and The Prize author Daniel Yergin forecasted US oil production of 14 million barrels a day by 2035. What are the implications for that both in terms of infrastructure and price?
Matt Badiali: Let’s start with the infrastructure. The US produces over 8.5 million barrels a day right now; a jump to 14 would be a 65% increase. That would require an additional 5.5 million barrels a day.
To put this in perspective, the growth of oil production from 2005 to today is faster than at any other time in American history, including the oil boom of the 1920s and 1930s. And we’re adding it in bizarre places like North Dakota, places that have never produced large volumes of oil in the past.
North Dakota now produces over 1.1 million barrels a day, but doesn’t have the pipeline capacity to move the oil to the refineries and the people who use it. There also aren’t enough places to store it. The bottlenecks are knocking as much as $10 per barrel off the price to producers and resulting in lots of oil tankers on trains.
And it isn’t just happening in North Dakota. Oil and gas production in Colorado, Ohio, Pennsylvania and even parts of Texas is overwhelming our existing infrastructure. That is why major pipeline and transportation companies have exploded in value. They already have some infrastructure in place and they have the ability to invest in new pipelines.
The problem we are facing in refining is that a few decades ago we thought we were running out of the good stuff, the light sweet crude oil. So refiners invested $100 billion to retool for the heavier, sour crudes from Canada, Venezuela and Mexico. That leaves little capacity for the new sources of high-quality oil being discovered in our backyard. That limited capacity results in lower prices for what should be premium grades.
One solution would be to lift the restriction on crude oil exports that dates back to the 1970s, when we were feeling protectionist. It is illegal for us to export crude oil. And because all the new oil is light sweet crude, the refiners can only use so much. That means the crude oil is piling up.
Peak oil is no longer a problem, but peak storage is. If we could ship the excess overseas, producers would get a fair price for the quality of their products. That would lead them to invest in more discovery. However, if they continue to get less money for their products, investment will slow. 
TMR: Is everything on sale, as Rick Rule likes to say?
Matt Badiali: Everything is on sale. But the great thing about oil is it is not like metals. It is cyclical, but it’s critical. If you want your boats to cross oceans, your airplanes to fly, your cars to drive and your military to move, you have to have oil. You don’t have to buy a new ship today, which would take metals. But if you want that sucker to go from point A to point B, you have to have oil. That’s really important. There have been five cycles in oil prices in the last few years.
Oil prices rise and then fall. That’s what we call a cycle. Each cycle impacts both the oil price and the stock prices of oil companies. These cycles are like clockwork. Their periods vary, but it’s been an annual event since 2009. Shale, especially if we can export it, could change all of that.
The rest of the world’s economy stinks. Russia and Europe are flirting with recession. China is a black box, but it is not as robust as we thought it was. Extra supply in the US combined with less demand than expected is leading to temporary low oil prices. But strategically and economically, oil is too important for the price to get too low for too long.
I was recently at a conference in Washington DC where International Energy Agency Executive Director Maria van der Hoeven predicted that without significant investment in the oil fields in the Middle East, we can expect a $15 per barrel increase in the price of oil globally by 2025.
I don’t foresee a lot of people investing in those places right now. A shooting war is not the best place to be invested. I was in Iraq last year and met the Kurds, and they’re wonderful people. This is just a nightmare for them. And for the rest of the world it means a $15 increase in oil.
For investors, the prospect of oil back at $100 per barrel is not the end of the world. With oil prices down 20% from recent highs and the best companies down over 30% in value, it is a buying opportunity. It means the entire oil sector has just gone on sale, including the companies building the infrastructure.
As oil prices climb back to $100, companies will continue to invest in producing more oil. And that will turn Hillary Clinton’s eight-year presidency into an economic wonderland.
TMR: The last time you and I chatted, you explained that different shales have different geology with different implications for cracking it, drilling it and transporting it. Are there parts of the country where it’s cheaper to produce and companies will get higher prices?
Matt Badiali: The producers in the Bakken are paying about twice as much to ship their oil by rail as the ones in the Permian or in Texas are paying to put it in a pipeline. The Eagle Ford is still my favorite quality shale and it is close to existing pipelines and export infrastructure, if that becomes a viable option. There are farmers being transformed into millionaires in Ohio as we speak, thanks to the Utica Shale.
TMR: What about the sands providers? Is that another way to play the service companies?
Matt Badiali: Absolutely. The single most important factor in cracking the shale code is sand. If the pages of a book are the thin layers of rocks in the shale, pumping water is how the producers pop the rock layers apart and sand is the placeholder that props them open despite the enormous pressure from above. Today, for every vertical hole, drillers create long horizontals and divide them into 30+ sections with as much as 1,500 pounds of sand per section. A single pad in the Eagle Ford could anchor four vertical holes with four horizontal legs requiring the equivalent of 200 train car loads of sand.
Investors need to distinguish between companies that provide highly refined sand for oil services and companies that bag sand for school playgrounds. Fracking sand is filtered and graded for consistency to ensure the most oil is recovered. Investors have to be careful about the type of company they are buying.
TMR: Coal still fuels a big chunk of the electricity in the US Can a commodity be politically incorrect and a good investment?
Matt Badiali: Coal has a serious headwind, and it’s not just that it’s politically incorrect. It competes with natural gas as an electrical fuel so you would expect the two commodities would trade for roughly the same price for the amount of electricity they can generate, but they don’t. The Environmental Protection Agency is enacting emission standards that are effectively closing down coal-fired power plants. And because it is baseload power, you can’t easily shut it off and turn it back on; it has to be maintained. That means it doesn’t augment variable power like solar, as well as natural gas, which can be turned on and off like a jet engine turbine. So coal has two strikes against it. It is dirty and it isn’t flexible.
Some coal companies could survive this transition, however. Metallurgical coal (met coal) companies, which produce a clean coal for making steel, have better prospects than steam coal. Along with steam coal, met coal prices are at a six-year low. 
Generally, I want to own coal that can be exported to India or China, where they really need it. Japan has replaced a lot of its nuclear power with coal and Germany restarted all the coal-fired power plants it had closed because of carbon emissions goals. We are already seeing deindustrialization there due to high energy prices. Cheap energy sources, including coal, will be embraced. I just don’t know when.
TMR: Thank you for your time, Matt.
Matt Badiali: Thank you.
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Oct 15

What the Bond Crash Will Look Like

Gold Price Comments Off on What the Bond Crash Will Look Like
A lot of very discontinuous action to the downside ahead…

“WHEN sorrows come,” wrote Shakespeare, “they come not single spies, but in battalions,” says Tim Price on his ThePriceOfEverything blog.
Jeremy Warner for The Daily Telegraph identifies ten of them. His “biggest threats to the global economy” comprise…
  1. Geopolitical risk;
  2. The threat of oil and gas price spikes;
  3. A hard landing in China;
  4. Normalisation of monetary policy in the Anglo-Saxon economies;
  5. Eurozone deflation;
  6. ‘Secular stagnation’;
  7. The size of the debt overhang;
  8. Complacent markets;
  9. House price bubbles;
  10. Ageing populations.
Other than making the fair observation that stock markets (for example) are not entirely correlated to economic performance – an observation for which Eurozone equity investors must surely be hugely grateful – we offer the following response.
Geopolitical risk, like the poor, will always be with us.
Yes, the prices for oil and natural gas could spike, but as things stand WTI crude futures have fallen by over 15% from their June highs, in spite of the clear geopolitical problems. And the US fracking revolution, in combination with fast-improving fundamentals for solar power, may turn out to be a secular (and disinflationary) game-changer for energy prices.
China, however, is tougher to dismiss. If we had any meaningful exposure to Chinese equity or debt we would be more concerned. But we don’t, so we aren’t.
Five of Jeremy Warner’s ‘threats’ are inextricably linked. The pending normalisation of monetary policy in the UK and US clearly threatens the integrity of the credit markets. It’s worth asking whether either central bank could possibly afford to let interest rates rise.
This begets a follow-on question: could the markets afford to let the central banks off the hook? Could we, in other words, finally see the return of the long absent and much desired bond market vigilantes?
That monetary policy rates are so low is a function of the growing prospect of Eurozone deflation (less of a threat to solvent consumers, but deadly for heavily indebted governments). Absent a capitulation by the Bundesbank to Draghi’s hopes or intentions for full-blown QE, it’s difficult to see how the policy log-jam gets resolved. But since all German government paper out to three years now offers a negative yield, it’s difficult to see why any Eurozone debt is worth buying today for risk-conscious investors. Cash is probably preferable and gives optionality into the bargain. ‘Secular stagnation’ is now a fair definition of the Eurozone’s economic prospects.
But all things lead back to Warner’s point 7: the size of the debt overhang. Since this was never addressed in the immediate aftermath of the Global Financial Crisis, it’s hardly a surprise to see its poison continue to drip onto all things financial. And since the policy response has been to slash rates and keep them at multi-century lows, it’s hardly a surprise to see property prices in the ascendant.
Complacent markets? Check. But stocks have lost a lot of their nerve over the last week. Not before time.
Ageing populations? Yes, but this problem has been widely discussed in the investment community over the past two decades – it simply isn’t new news.
We saw one particularly eye-catching chart last week, via Grant Williams, comparing the leverage ratios of major US financial institutions over recent years (shown below).
The Fed’s leverage ratio (total assets to capital) now stands at just under 80x. That compares with Lehman Brothers’ leverage ratio, just before it went bankrupt, of just under 30x. Sometimes a picture really does paint a thousand words. And this, again, brings us back to the defining problem of our time, as we see it: too much debt in the system, and simply not enough ideas about how to bring it down – other than through inflationism, and even that doesn’t seem to be working quite yet.
In a recent interview with Jim Grant of Grant’s Interest Rate Observer, Sprott Global questioned about the likely outlook for bonds:
“What would a bear market in bonds look like? Would it be accompanied by a bear market in the stocks?
“Well, we have a pretty good historical record of what a bear market in bonds would look like. We had one in modern history, from 1946 to 1981. We had 25 years’ worth of persistently – if not steadily – rising interest rates, and falling bond prices. It began with only around a quarter of a percent on long-dates US Treasuries, and ended with about 15% on long-dated US Treasuries.
“That’s one historical beacon. I think that the difference today might be that the movement up in yield, and down in price, might be more violent than it was during the first ten years of the bear market beginning in about 1946. Then, it took about ten years for yields to advance even 100 basis points, if I remember correctly.
“One difference today is the nature of the bond market. It is increasingly illiquid and it is a market in which investors – many investors – have the right to enter a sales ticket, and to expect their money within a day. So I’m not sure what a bear market would look like, but I think that it would be characterized at first by a lot of people rushing through a very narrow gate. I think problems with illiquidity would surface in the corporate debt markets.
“One of the unintended consequences of the financial reforms that followed the sorrows of 2007 to 2009 is that dealers who used to hold a lot of corporate debt in inventories no longer do so. If interest rates began to rise and people wanted out, I think that the corporate debt market would encounter a lot of ‘air pockets’ and a lot of very discontinuous action to the downside.”
We like that phrase “a lot of very discontinuous action to the downside”.
Grant was also asked if it was possible for the Fed to lose control of the bond market:
“Absolutely, it could. The Fed does not control events for the most part. Events certainly will end up controlling the Fed. To answer your question – yeah. I think the Fed can and will lose control of the bond market.”
As we have written on innumerable prior occasions, we wholeheartedly agree. Geopolitics, energy prices, demographics – all interesting ‘what if’ parlour games. But what will drive pretty much all asset markets over the near, medium and longer term is almost entirely down to how credit markets behave. The fundamentals, clearly, are utterly shocking. The implications for investors are, in our view, clear. And as a wise investor once observed, if you’re going to panic, panic early.
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Oct 03

Silver "a Screaming Buy", Crude Oil "Going to $60"

Gold Price Comments Off on Silver "a Screaming Buy", Crude Oil "Going to $60"
The beautiful thing about pessimism towards junior precious metal miners…

KAL KOTECHA is editor and founder of the Junior Gold Report, a publication about small-cap mining stocks.
Kotecha has previously held leadership positions with many junior mining companies, and after completing a Master of Business Administration in finance in 2007, he is now working on his PhD in business marketing, and also teaches economics at the University of Waterloo.
Here Kal Kotecha tells The Gold Report‘s sister title, The Mining Report, that to obtain superior results, you cannot do what everyone else is doing. He maintains that much of the risk associated with junior resource equities has been beaten out by the herd mentality and that selectively buying what’s left presents opportunity…
The Mining Report: You’re the editor of Junior Gold Report, but you also follow similar-sized companies in the energy sector. Please give our readers an overview of the energy space.
Kal Kotecha: I’ve been involved in the space since 2002 and I’ve never witnessed anything like what is currently happening. In the energy sector, I see the price of uranium increasing, but to see price appreciation across energy stocks, the price of oil must remain near $100 per barrel. That benchmark could prove challenging, given the growing supply of shale oil in the US Texas produces as much oil as Iraq or about 3 million barrels of oil per day. Most of it comes from two sources: the Eagle Ford Shale in southwest Texas and the Permian Basin in west Texas. Chris Guith, senior vice-president of policy for the US Chamber of Commerce’s Institute for 21st Century Energy, estimates that recoverable resources amount to 120 years of natural gas, 205 years of oil and 464 years of coal at current demand levels.
Fracking has lowered the price of natural gas by about 70% over the previous seven years or so. The price of oil, especially in the US, should decrease to $60-70 per barrel on average because of shale oil. US dependency on imported oil should lessen, too.
TMR: Is that a near- or medium-term forecast?
Kal Kotecha: That’s a medium- to longer-term forecast. I don’t believe in peak oil theory. The US’ savior in the oil industry is going to be shale oil, and there is a lot of it. Ultimately, that’s going enhance the US economy. Basically everything runs on oil. The US won’t have to import as much oil from Saudi Arabia or even Canada.
TMR: What’s your price forecast for natural gas?
Kal Kotecha: Natural should stay between $4-6 per thousand cubic feet (Mcf). It’s more expensive in Europe, but in North America the floor should remain around $4/Mcf. I don’t think it’s going to go back up to $12 or down to $3.
TMR: You mentioned earlier that you expect uranium prices to rise.
Kal Kotecha: Uranium is an interesting space. As oil prices slowly decrease, the demand for uranium seems to increase. Geopolitical tensions, especially in Russia and Ukraine, could lead to much higher prices. Russia is a large uranium producer and Western nations might stop importing uranium from Russia if political fires burn much hotter.
As of last month, China had 21 nuclear power reactors operating on 8 sites and another 20 under construction. China’s National Development and Reform Commission intends to raise the percentage of electricity produced by nuclear power to 6% by 2020 from the current 2% as part of an effort to reduce air pollution from coal-fired plants. Ultimately, uranium demand will triple inside six years.
In India, the government is expected to spend nearly $150 billion to develop nuclear power over the next 10-15 years. India now has nuclear energy agreements with about a dozen countries and imports primarily from France, Russia and Kazakhstan.
TMR: In a recent note on Junior Gold Report you wrote, “I smell smoke, but where’s the fire?” in relation to the current sentiment in the junior precious metals market. What’s your conclusion?
Kal Kotecha: The current pessimism surrounding the junior precious metal space has largely contributed to the fall in price of the commodities, but the beautiful thing about pessimism and hate towards a market sector is that there is plenty of room for error. Fantastic opportunities arise when great companies have been undervalued due to negative news that does not have a long-term impact on the company. So how do you determine which stocks, in a beaten up resource market, are great buys?
TMR: Do you have an answer?
Kal Kotecha: One must understand the essential principles of intrinsic value and the margin of safety. The principle of intrinsic value determines the worth of a stock through a combination of the price and the condition of the company. So no matter how great a company is, it may not always be a good investment. As Howard Marks wrote in The Most Important Thing: Uncommon Sense for the Thoughtful Investor, investment success doesn’t come from buying good things, but rather from buying things well.
The principle of the margin of safety involves minimizing risk and then, therefore, minimizing the potential loss of one’s money. Dealing with risk is a necessary part of investing, as stock price fluctuations occur and are often unpredictable. If the risk perceived by the herd – general investors who follow the majority – is less than the actual risk, then the returns will outweigh the risks. So when consensus thinks something is risky, the general unwillingness to buy it pushes the price down to where it is no longer risky at all, given it still has intrinsic value, because all optimism has been driven out of the price.
TMR: What are some metrics to help investors?
Kal Kotecha: A junior mining company’s ability to produce resources at a cost below its market price is essential for its sustainability. Junior mining companies should be judged by their ownership of mines, the quality of these mines and how management has executed similar projects in the past. Determining whether this data has been incorporated into the stock price is essential when seeking undervalued companies. I think this is where a lot of resource investors get duped.
Do you smell the smoke? I suggest investigating the source. I’d say that the herd is done shouting fire, and smart investors are filling up their baskets with goodies. But don’t forget to do your research, check the facts and invest in a contrarian fashion. To obtain superior results, you cannot do what everyone else is doing.
TMR: Many investors have heard the adage “buy when there’s blood in the streets.” When should investors reasonably expect to start making money again, given the current market conditions?
Kal Kotecha: That’s a billion-Dollar question. A lot of colleagues have predicted prices that have not come true yet. The big upswing in gold in the late 1970s was followed by a collapse and we had to wait 20 years for another upswing. It’s already been three years. I don’t think we have to wait another 5 or 10 years, but there is going to be a time very soon where investors will be rewarded. I think when the upswing happens it’s going to be very parabolic. I think it’s going to take wings on its own. Patience will be rewarded.
TMR: What gold price are you using in your analysis?
Kal Kotecha: $1200 an ounce. Many factors go into determining the price of commodities, especially gold and silver. Some of these factors include price manipulation, which cannot be foreseen; geopolitical strife; and import quotas, which are happening in India. However, I remain very bullish on precious metals in the long-term.
The best buy right now is silver. Silver is a screaming steal at $18 per ounce. I first started buying silver at around $7 per ounce in 2003 and I sold quite a bit in the $48 range a few years ago. I’m starting to accumulate silver quite heavily again. The ratio of gold to silver prices is currently around 68:1. I see that going to 50:1. If there’s another precious metals mania, perhaps 25:1. Silver demand is also very high. A record 6,000 tonnes silver was imported into India last year – roughly 20% of global production.
TMR: What’s your advice for investors in the current junior resource market?
Kal Kotecha: I think a combination of five or six stocks in a portfolio with a mix of junior energy and mining equities is probably a good start. That’s what I do. It’s difficult for the average investor to follow more than five companies. 
TMR: Thank you for your insights, Kal.
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Sep 24

Consciously Shifting to Precious Metals

Gold Price Comments Off on Consciously Shifting to Precious Metals
Resource-stock fund manager explains his current outlook and strategy…

JASON MAYER joined Sprott Asset Management LP in November 2012 with more than 10 years of investment industry experience as lead portfolio manager on a number of funds with a focus on growth-oriented resource equities.
Now Mayer tells The Gold Report‘s sister title, The Mining Report, how miners are having a tough time getting funded, and although Canadian oil and gas has performed well over the last few quarters, some companies might be overvalued…
The Mining Report: In February, you gave a speech at The Vancouver Club that acknowledged the impact of investor fatigue on the junior mining equity space. Seven months later, are investors starting to get excited again about the space?
Jason Mayer: Investors have been reacting in fits and starts, and everyone is still very cautious. I track a number of funds, and I watch how they perform on a day-to-day basis. What I have found interesting is that a number of resource funds in Canada continue to be underweight, particularly in gold equities. I notice they underperform on days that gold stocks have good moves. The generalists out there among the institutional money have little to no presence in various gold equities. For the most part, people have abandoned the space.
TMR: What will it take to get them excited again?
Jason Mayer: They’ll want to see some upward trajectory. I don’t know if it’s going to be a couple of data points that confirm the arrival of an inflationary environment, or the cessation of this disinflationary environment that we’ve been in since 2009, but people would have to feel comfortable that the gold price isn’t going to resume the decline it experienced in 2013. There are still a number of analysts and commentators out there who are calling for gold in the $800-1000 per ounce range.
TMR: Is it the seemingly never-ending rise of the blue chip stocks that makes people less likely to look at the juniors, whether energy or precious metals?
Jason Mayer: I don’t know how much it has to do with that, but, certainly, the very strong US Dollar is influencing the gold price and precious metal equities. Everyone has their own opinion on what drives gold. Mine is pretty simple. I look at it as a currency investors can choose from among a number of currencies worldwide, the US Dollar being the primary driver of gold, because gold is typically quoted in US Dollars. The strength of the US Dollar has led people to doubt the need to hold either gold or gold-related equities in their portfolios.
TMR: What about the impact on energy stocks?
Jason Mayer: We’ve had a pretty good run for a number of the energy companies here in Canada. In fact, our energy fund that is run by Eric Nuttall is up 40+%. That is an overall reflection of how the energy equities have done, both the exploration and production (E&P) companies and the service companies.
TMR: The lack of excitement has also impacted financing. You estimated that in 2011, miners raised $1 billion in flow-through funds, and in 2012, that number was down to $700 million. In 2013, it was $350m. So far this year, it is even 15% lower than that. Why has it been so hard to raise money right now?
Jason Mayer: When we look at it over a multiyear horizon, we’re at a 10-year low. The companies that have been hit the hardest are the miners. They’re the ones that have seen the appetite for flow-through decrease the most, certainly much more than energy companies, where the appetite for flow-through continues to remain pretty healthy.
The companies that have very high-quality projects have been able to access the capital markets and issue equity. In some cases, they have turned to royalties and, in very rare cases, private equity, but for the most part, the juniors are very challenged, especially the exploration companies. They’re hanging on by a thread. Essentially, a lot of their expenditures are really on just keeping the lights on, so they’re no longer advancing projects because the capital is just not available to them.
TMR: Will this lack of capital lead to more mergers and acquisitions?
Jason Mayer: I thought that would have happened by now. But that is the logical conclusion. There are two major impediments. In many cases, we see management teams that are entrenched – just there to collect a salary and a bonus. The second issue is with the acquirers, especially the majors. These are companies that went on spending sprees in 2009 and 2010. Although there are a number of very solid acquisition opportunities in this environment, some of these companies are gun shy because of their experience over the past couple of years, and support among the shareholder base can also be quite tentative.
TMR: You manage the Sprott Flow-Through Limited Partnership and the Sprott Resource Class Fund. The 2014 $11.7m Flow-Through L.P. is 90% in cash, correct?
Jason Mayer: The 2014 fund initially raised north of $17m. It’s a process of identifying candidates, engaging them to issue flow-through and then actually consummating the transaction. So, in fact, right now, I’m 100% invested – a bit of an update, which the public documents don’t reflect at the current time. I am approximately 60% invested in energy names, 40% in mining. 
TMR: You mentioned that the Sprott Flow-Through L.P. is 60% in energy. The Sprott Resource Class Fund flipped, from 56% energy and 42% minerals to 54% minerals and 46% energy. The energy and non-energy percentages flipped. Was that a conscious shift or a result of changes in equity valuations?
Jason Mayer: That was a conscious shift. I started reducing my exposure to Canadian energy names. It was a function of both profit-taking and repositioning. Some of these companies’ valuation multiples had expanded quite dramatically. I took some profits and deployed a significant portion of that into some gold-weighted equities.
TMR: What are your projections for oil and gas prices?
Jason Mayer: Gas is a tough one to call, but I think it will bounce around $3-4 per thousand cubic feet (Mcf). The upside will be predicated on very cold weather, which will drive additional demand. Without that, it’s going to be mired in a $3-4/Mcf trading environment. The part of the equation that’s a little more transparent is the supply side. The bottom line is North American natural gas production continues to hit record highs. It’s going to continue to hit record highs based on a number of projects that are in the process of being commissioned and developed. That’s going to bring new gas to market. A lot of this new gas that’s coming onstream is highly economic, so even at $3/Mcf gas, the operators of these projects are going to continue to drill.
The wild card is the demand side of the equation. There are some longer-term developments that are going to be bullish for demand, such as gas-fired electrical generation, utilizing natural gas as a transportation fuel and liquefied natural gas exports. The problem is that these are very long-dated and uncertain demand initiatives. Because of that uncertainty, I don’t want to invest now based only on whether I think it’s going to be a cold winter or not.
TMR: That makes sense.
Jason Mayer: For oil prices, I’m expecting $90-110 per barrel. The Brent benchmark is what we use. I think the demand backdrop is pretty positive. China seems to be back on track. There was a lot of concern over the past few months on where its economy was going. It looks as if the Chinese central planning authorities are committed to a 7.5% growth target, and its most recent gross domestic product number was just that.
In the US, the numbers have been just spectacular. The economy appears to be picking up speed and momentum, whether you’re looking at manufacturing activity, employment figures or job openings. There really don’t seem to be many negative data points right now. The one area of concern is the European Union. It looked as if it was coming out of its recession, and then it had a bit of a hiccup. The whole Russia/Ukraine situation could have an impact. But generally, demand is pretty solid.
On the supply side, it just costs a lot of money to produce oil. Some 96% of the supply growth outside of Opec in 2013 came from the US If you’re looking at the US full-cycle costs, they’re about $60 per barrel. You really need $70-80 a barrel as an absolute floor to ensure that the US will continue to drill.
TMR: Do you see energy services as a less volatile way to leverage the energy space?
Jason Mayer: The short answer is no. It’s a very volatile group. There are a lot of different specialties within the energy services, so it’s really dependent on which particular area you’re talking about. But if you want to get leverage to the energy space through services, then you’re probably buying something that is quite leveraged to the energy space and will do very well if the whole space does well, but it’s a double-edged sword. That leverage can also work against you if things don’t work out according to plan.
Earlier this year, I pared back some of my services holdings; I felt that these companies really got ahead of themselves. Personally, if I want that torque and leverage to energy, I’ll just play the E&P companies.
TMR: You mentioned that you are consciously shifting to the materials companies, the precious metals. What number are you using for gold and silver prices in your estimates? What companies are you picking up?
Jason Mayer: I’m using around $1300 per ounce. For the most part, my focus is on companies that are all-in cash flow positive. To try to capture the full picture, I like to look at the margin after adjusting not only for cash costs but also for royalties, taxes, general and administrative expenses and sustaining capital. If the gold price is under pressure, I try to pick companies that have the best chance of surviving if things get ugly.
TMR: Do you have any words of wisdom for investors who are feeling stock fatigue right now from the resource space?
Jason Mayer: I think the biggest thing you need to have is conviction and fortitude when a lot of these names are volatile, and try to keep your wits about you. Try not to trade based on emotion; trade based on your logic and thought processes. If your logic has not changed, stick to the tune.
TMR: Thank you for talking with us today.
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Aug 18

New Cold War? Cold Facts

Gold Price Comments Off on New Cold War? Cold Facts
Commodities fuel a resurgent Russia. So what will “sanctions” mean…?

THERE is talk of a new cold war, pitting the United States against the Russian Federation, with Europe being a main battleground where both adversaries’ grievances are playing out, writes Amine Bouchentouf – author of Commodities for Dummies, a partner at Parador Capital LLC, and founder of Commodities Investors LLC – at Hard Assets Investor
This was the state of affairs between America and Russia for decades, following the end of World War II up until the collapse of the Soviet Union. Many of the battles that were played out in the 1970s and 1980s are now repeating themselves, characterized by periods of “détente” and “escalation” of tensions.
We are currently in one of those phases of “escalation,” where both adversaries are digging in their heels and firing “testing shots” to see the reaction of the other. The stakes are high, especially for the commodities markets, particularly the oil and natural gas markets.
Vladimir Putin claims that the greatest tragedy of the 20th century was undoubtedly the collapse of the Soviet Union. Ever since Putin came to power, his laserlike focus has been on creating a stronger Russia, flexing its muscles and spreading its influence regionally and globally. Ironically, one of the main factors that allowed him to do this has been the global boom in commodities.
Russia is undeniably a resource-rich country and has ridden the commodities boom to the fullest extent, benefiting from the sale of key raw materials such as crude oil, natural gas, aluminum, iron ore, coal and nickel.
This natural resource powerhouse saw its cash coffers grow exponentially as countries such as India, China and even Europe consumed and purchased its raw materials. As its commodities sales increased, so did Russia’s influence in world affairs including in military technology, espionage and industry.
Russia’s influence kept increasing as the months and years went on. First, Russia’s influence on the crucial Middle East was felt in Syria as Russia supported and backed Bashar Assad with weapons and military intelligence against American-backed insurgents. Assad remains in power while the insurgency is weak, fragmented and uncoordinated.
Russia scored another major coup when it lured Edward Snowden, the former NSA employee responsible for the greatest intelligence leak in American history. More than the symbolism of the act (that America’s most-wanted former intelligence officer is living in Russia), the treasure trove of information Snowden is suspected of giving to Russia could be game changing.
The Kremlin’s most in-your-face move came on the heels of the Sochi Winter Olympic Games, when Russia unilaterally annexed Crimea, a region under the territorial jurisdiction of Ukraine. And to add insult to injury, Russia is sending military personnel and equipment into Ukraine to arm pro-Russian separatists.
These same separatists are now suspected of downing a commercial civilian Malaysian Airlines Flight flying from Amsterdam to Kuala Lumpur last month. This event seems to have been the last straw for the United States and its allies, and has resulted in the US and EU imposing economic sanctions on Russia.
Recently, President Obama announced sanctions aimed mostly at Russia’s oil industry. The thinking at the White House and with its allies is that the administration would like to target the source of wealth that is expanding the Kremlin’s influence: natural resources, primarily crude oil.
While the logic is sound, in reality, these new sanctions are going to have very little impact on the Russian economy and therefore Russian behavior in the international scene. When you examine the sanctions closely as released by the Commerce Department, you quickly realize that the sanctions are targeted at future projects aimed at increasing Russian production of unconventional crude supplies, primarily located in the Arctic.
The sanctions are aimed at preventing Western-based technology from making its way into Russian hands to develop these fields. In practice, these fields are several years from reaching production (in most cases, five to seven years out) and so will not have any immediate impact on current Russian production.
Russia produces about 10 million barrels of oil per day (greater than Saudi Arabia) and exports a vast majority of that. The sanctions do not target this current production; the Brent crude benchmark was little changed as these sanctions were announced.
In addition, it’s very relevant to note that Russian gas production was completely left out of the sanctions list – not a coincidence since a material amount of Europe’s gas supplies come from Russia.
Russia Oil Production (mmbbl/d)
Russia Oil Production (mmbbl/d)
The bottom line is that these sanctions will do very little to influence Russian behavior on the world stage. When looked at through the prism of the last two years, these sanctions amount to very little more than a slap on the wrist.
For investors and traders, this means that production of Russian commodities (an important factor in the marketplace) will remain intact. Therefore, I would not advise going long crude oil or commodities thinking that the latest sanctions are going to take away critical supply from the market – it won’t.
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Jul 23

Oil Unrest to Drive Gold Price Higher

Gold Price Comments Off on Oil Unrest to Drive Gold Price Higher
Summer correction ahead amid geopolitical uptrend…

BYRON KING writes for Agora Financial, editing their flagship Outstanding Investments plus two other newsletters, Real Wealth Trader and Military Technology Alert.
Studying geology and graduating with honors from Harvard University, King also holds advanced degrees from the University of Pittsburgh School of Law and the US Naval War College. He has since advised the US Department of Defense on national energy policy.
Now he says global unrest and inflation will play a role in improving fundamentals for gold and silver, as he tells The Gold Report here. But miners have to control costs and clean up their internal cash flow, too…
The Gold Report: Byron, gold is above $1300 per ounce – although not by much – and silver topped $20 per ounce. What was holding their prices down, and what are the fundamentals that will move the prices going forward?
Byron King: The short answer is that, for all its faults, the Dollar has strengthened, which holds down gold and silver prices. The longer answer is that gold and silver are manipulated metals. That is, the world’s central banks have an aversion to things they can’t control, and one of the things that they can’t control is elemental metals like gold and silver.
Let’s ask why the Dollar has strengthened. The US is probably in its weakest geopolitical situation in decades. The Wall Street Journal on July 17 had a front-page story about the confluence of crises across the world – Ukraine, Middle East, Southeast Asia – all of which are profound challenges to American power militarily, diplomatically and economically. But the Dollar is still holding up. Why?
I believe the dramatic recent increase in US energy production is what’s behind the stronger Dollar. With more oil and natural gas from fracking, the US is the world’s largest energy producer. In addition, we’re importing far less oil and exporting a lot more refined product. It helps the Dollar.
Still, when I look at the big picture for gold, I see a resource whose production is challenged on the best of days. Gold mining output is declining in the major traditional sources: South Africa is in decline; Australia is challenged; some of the big plays in Nevada are getting long in the tooth.
TGR: Is there a cycle that builds on itself? As the gold price goes down, companies – especially the majors – spend less on exploration and development, which depletes their reserves, production declines and their costs increase. Are we in that part of the cycle where lower prices are setting the stage for less supply and the need for a higher gold price later?
Byron King: Yes, exactly. Falling supply and static price makes a classic economic case. We are setting the stage for less supply and higher prices. The market is dancing around the reality, but it’s still the reality. Consider that, in the last year or so, gold has been as cheap as $1200 per ounce. In late March or early April, the price almost touched $1400 per ounce. That’s a 16-17% price swing in two months. Is this the sign of a well-balanced market?
Now consider how macro-events drive things. In the first half of 2014, geopolitical events – Ukraine, Syria, Iraq – drove the gold price. And to me, these locales bring it back to that Dollar-energy relationship.
Iraq produces 2.5 million barrels per day of exportable oil. In June, when it looked as if Iraq might not survive, the idea of those 2.5 million barrels being taken out of the market helped drive the price of gold from $1240 per ounce to over $1300 per ounce.
Or look at Ukraine. It straddles key gas export lines to Europe, and the situation involves Russia, which is one of the world’s largest energy producers. Problems with Russia, let alone sanctions and such, affect perceptions of future energy supply, which tends to benefit the Dollar.
All in all, where is the gold price headed? Long-term, I think the answer is up. Inflation is not going away. I think that the central banks of the world, and the people who run university economic departments and train the leaders of the future, really do believe that we ought to have long-term inflation. If that is indeed where they’re coming from, you need to own gold and silver.
I think the long-term prospects for demand – the long-term prospects for gold as money and as backing for money – are much better than they used to be.
TGR: Given the volatility that you discussed and the challenges of the US Dollar, is there significant retail and institutional cash on the sidelines waiting to find the confidence to jump back into precious metals, as commodities and mining equities?
Byron King: There is an immense amount of money waiting for the next step. In the last few years, the big indexes have done incredibly well; everything has gone up, from airlines to consumer electronics, Silicon Valley, aerospace. A lot of people have made a lot of money in the big markets and in traditional investments.
Now, where does it all go? All that recently minted money needs a new home. If you have balance sheet appreciation from the large caps and the big blue chips, you’re looking for something else. My sense is that a lot of people are looking at the basic resource sector.
We have already seen some of that money step back into the market in the first half of this year. Some of the highest-quality small and midsized mining plays have seen large moves.
TGR: The last time we talked, you explained that, in the context of history, we’ve just entered the early stages of the materials revolution, using advanced forms of graphite and rare elements. Can you give us an update on that revolution?
Byron King: When you get into the graphite space, you quickly realize that graphite is more of a technology play than a basic resource play. There is a materials revolution going on with carbon, certainly with graphite. It’s extremely investable, but you have to have patience, and be willing to learn some complex new science. If an investor doesn’t want to become educated on the high-end carbon chemistry that’s happening out there, this could become an uncomfortable space in a hurry.
Look at it this way. If I mine gold, silver or copper, I can sell it to pretty much anybody, from dentists to jewelers to wire makers to electronic makers. The end users will buy it as long as there is a basic spec or quality to it.
Graphite is different. Once you mine it, what you do with the graphite depends on who your user is. The end user has a specific use in mind – battery anodes, fire suppression, heat dissipation, high-strength materials – that requires an entire industrial chain that has to happen between the mouth of the mine and the end user.
TGR: Do you have any words of wisdom for investors who are trying to decide when to enter the market?
Byron King: We’ve seen several strong investment points for gold and silver in the last six months. Right now, I think we might be due for a summer correction, although geopolitical events seem to be exploding all over the place. Sorry, but I just don’t have a subscription to next week’s Wall Street Journal. My issue only comes every morning.
Still, we’ve got tremendous volatility. Just in the time we’ve been talking, the price of gold dropped $33 per ounce [Mon 14 July] which is a bit of an eye-opener. It makes you want to look at the rest of the world and see what’s going on, what might have prompted that drop.
The question for the investor is, what are you going to do? Well, if there’s a downdraft to gold and silver prices, then you want to be involved in companies that can get their costs down faster than the market can beat down the price. But whatever happens day to day, I think metal prices will go up over the long term, because of inflation.
When it comes to picking companies in which to invest, you need to be willing to diversify across many ideas. While it’s great to put a lot of money into a couple of plays and see one or two do really well, that’s usually not the way life works. In the small-cap resource space in particular, you need to find 6 to 10 quality plays – or more – and spread your investments around.
Then you need to watch carefully, and be willing to cut your losses. You also need to be ready for surprises on the upside. When a company gets a takeout offer or has a good piece of news from the drill rig, you can see fabulous gains flowing to patient investors. Just remember that, when good things happen, you need to sell some shares and take some of that gain off the table.
TGR: Byron, it’s always a pleasure. Thanks for your time and your insights.
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Jul 23

6 Stupid Claims About China’s Gold Demand

Gold Price Comments Off on 6 Stupid Claims About China’s Gold Demand
Don’t worry about the gold price, says this Western analyst. China’s got your back…

I DON’T want to say that mainstream analysts are stupid when it comes to China’s gold habits, writes Jeff Clark, senior precious metals analyst and editor of Big Gold at Casey Research.
But I did look up how to say that word in Chinese…
One report claims, for example, that gold demand in China is down because the Yuan has fallen and made the metal more expensive in the country. Sounds reasonable, and it has a grain of truth to it.
But as you’ll see below, it completely misses the bigger picture, because it overlooks a major development with how the country now imports precious metals.
I’ve seen so many misleading headlines over the last couple months that I thought it time to correct some of the misconceptions. I’ll let you decide if mainstream North American analysts are stupid or not.
The basis for the misunderstanding starts with the fact that the Chinese think differently about gold. They view gold in the context of its role throughout history and dismiss the Western economist who arrogantly declares it an outdated relic. They buy in preparation for a new monetary order – not as a trade they hope earns them a profit.
Combine gold’s historical role with current events, and we would all do well to view our holdings in a slightly more “Chinese” light, one that will give us a more accurate indication of whether we have enough, of what purpose it will actually serve in our portfolio, and maybe even when we should sell (or not).
The horizon is full of flashing indicators that signal the Chinese view of gold is more prudent for what lies ahead. Gold will be less about “making money” and more about preparing for a new international monetary system that will come with historic consequences to our way of life.
With that context in mind, let’s contrast some recent Western headlines with what’s really happening on the ground in China. Consider the big picture message behind these developments and see how well your portfolio is geared for a “Chinese” future…
#1. “Gold Demand in China Is Falling”
This headline comes from mainstream claims that China is buying less gold this year than last. The International Business Times cites a 30% drop in demand during the “Golden Week” holiday period in May. Many articles point to lower net imports through Hong Kong in the second quarter of the year. “The buying frenzy, triggered by a price slump last April, has not been repeated this year,” reports Kitco.
However, these articles overlook the fact that the Chinese government now accepts gold imports directly into Beijing.
In other words, some of the gold that normally went through Hong Kong is instead shipped to the capital. Bypassing the normal trade routes means these shipments are essentially done in secret. This makes the Western headline misleading at best, and at worst could lead investors to make incorrect decisions about gold’s future.
China may have made this move specifically so its import figures can’t be tracked. It allows Beijing to continue accumulating physical gold without the rest of us knowing the amounts. This move doesn’t imply demand is falling – just the opposite.
And don’t forget that China is already the largest gold producer in the world. It is now reported to have the second largest in-ground gold resource in the world. China does not export gold in any meaningful amount. So even if it were true that recorded imports are falling, it would not necessarily mean that Chinese demand has fallen, nor that China has stopped accumulating gold.
#2. “China Didn’t Announce an Increase in Reserves as Expected”
A number of analysts (and gold bugs) expected China to announce an update on their gold reserves in April. That’s because it’s widely believed China reports every five years, and the last report was in April 2009. This is not only inaccurate, it misses a crucial point.
First, Beijing publicly reported their gold reserve amounts in the following years:
  • 500 tonnes at the end of 2001;
  • 600 tonnes at the end of 2002;
  • 1,054 tonnes in April 2009.
Prior to this, China didn’t report any change for over 20 years; it reported 395 tonnes from 1980 to 2001. There is no five-year schedule. There is no schedule at all. They’ll report whenever they want, and – this is the crucial point – probably not until it is politically expedient to do so.
Depending on the amount, the news could be a major catalyst for the gold market. Why would the Chinese want to say anything that might drive gold prices upwards, if they are still buying?
#3. “Even with All Their Buying, China’s Gold Reserve Ratio Is Still Low”
Almost every report you’ll read about gold reserves measures them in relation to their total reserves. The US, for example, has 73% of its reserves in gold, while China officially has just 1.3%. Even the World Gold Council reports it this way.
But this calculation is misleading. The US has minimal foreign currency reserves – and China has over $4 trillion. The denominators are vastly different.
A more practical measure is to compare gold reserves to GDP. This would tell us how much gold would be available to support the economy in the event of a global currency crisis, a major reason for having foreign reserves in the first place and something Chinese leaders are clearly preparing for.
The following table shows the top six holders of gold in GDP terms. (Eurozone countries are combined into one.) Notice what happens to China’s gold-to-GDP ratio when their holdings move from the last-reported 1,054-tonne figure to an estimated 4,500 tonnes (a reasonable figure based on import data).
At 4,500 tonnes, the ratio shows China would be on par with the top gold holders in the world. In fact, they would hold more gold than every country except the US (assuming the US and EU have all the gold they say they have). This is probably a more realistic gauge of how they determine if they’re closing in on their goals.
This line of thinking assumes China’s leaders have a set goal for how much gold they want to accumulate, which may or may not be the case. My estimate of 4,500 tonnes of current gold reserves might be high, but it may also be much less than whatever may ultimately satisfy China’s ambitions. Sooner or later, though, they’ll tell us what they have, but as above, that will be when it works to China’s benefit.
#4. “The Gold Price Is Weak Because Chinese GDP Growth Is Slowing”
Most mainstream analysts point to the slowing pace of China’s economic growth as one big reason the gold price hasn’t broken out of its trading range. China is the world’s largest gold consumer, so on the surface this would seem to make sense. But is there a direct connection between China’s GDP and the gold price?
Over the last six years, there has been a very slight inverse correlation (-0.07) between Chinese GDP and the gold price, meaning they act differently slightly more often than they act the same. Thus, the Western belief characterized above is inaccurate. The data signal that, if China’s economy were to slow, gold demand won’t necessarily decline.
The fact is that demand is projected to grow for reasons largely unrelated to whether their GDP ticks up or down. The World Gold Council estimates that China’s middle class is expected to grow by 200 million people, to 500 million, within six years. (The entire population of the US is only 316 million.) They thus project that private sector demand for gold will increase 25% by 2017, due to rising incomes, bigger savings accounts, and continued rapid urbanization. (170 cities now have over one million inhabitants.) Throw in China’s deep-seated cultural affinity for gold and a supportive government, and the overall trend for gold demand in China is up.
#5. “The Gold Price Is Determined at the Comex, Not in China”
One lament from gold bugs is that the price of gold – regardless of how much people pay for physical metal around the world – is largely a function of what happens at the Comex in New York.
One reason this is true is that the West trades in gold derivatives, while the Shanghai Gold Exchange (SGE) primarily trades in physical metal. The Comex can thus have an outsized impact on the price, compared to the amount of metal physically changing hands. Further, volume at the SGE is thin, compared to the Comex.
But a shift is underway. In May, China approached foreign bullion banks and gold producers to participate in a global gold exchange in Shanghai, because as one analyst put it, “The world’s top producer and importer of the metal seeks greater influence over pricing.” The invited bullion banks include HSBC, Standard Bank, Standard Chartered, Bank of Nova Scotia, and the Australia and New Zealand Banking Group (ANZ). They’ve also asked producing companies, foreign institutions, and private investors to participate.
The global trading platform was launched in the city’s “pilot free-trade zone,” which could eventually challenge the dominance of New York and London.
This is not a proposal; it is already underway. Further, the enormous amount of bullion China continues to buy reduces trading volume in North America. The Chinese don’t sell, so that metal won’t come back into the market anytime soon, if ever. This concern has already been publicly voiced by some on Wall Street, which gives you an idea of how real this trend is.
There are other related events, but the point is that going forward, China will have increasing sway over the gold price (as will other countries: the Dubai Gold and Commodities Exchange is to begin a spot gold contract within three months).
And that’s a good thing, in our view.
#6. “Don’t Be Ridiculous; the US Dollar Isn’t Going to Collapse”
In spite of all the warning signs, the US Dollar is still the backbone of global trading. “It’s the go-to currency everywhere in the world,” say government economists. When a gold bug (or anyone else) claims the Dollar is doomed, they laugh.
But who will get the last laugh?
You may have read about the historic energy deal recently made between Chinese President Xi Jinping and Russian President Vladimir Putin. Over the next 30 years, about $400 billion of natural gas from Siberia will be exported to China. Roughly 25% of China’s energy needs will be met by 2018 from this one deal. The construction project will be one of the largest in the world. The contract allows for further increases, and it opens Russian access to other Asian countries as well. This is big.
The twist is that transactions will not be in US Dollars, but in Yuan and rubles. This is a serious blow to the petroDollar.
While this is a major geopolitical shift, it is part of a larger trend already in motion:
President Jinping proposed a brand-new security system at the recent Asian Cooperation Conference that is to include all of Asia, along with Russia and Iran, and exclude the US and EU.
Gazprom has signed agreements with consumers to switch from Dollars to Euros for payments. The head of the company said that nine of ten consumers have agreed to switch to Euros.
Putin told foreign journalists at the St. Petersburg International Economic Forum that “China and Russia will consider further steps to shift to the use of national currencies in bilateral transactions.” In fact, a Yuan-ruble swap facility that excludes the greenback has already been set up.
Beijing and Moscow have created a joint ratings agency and are now “ready for transactions…in Rubles and Yuan,” said the Russian Finance Minister Anton Siluanov. Many Russian companies have already switched contracts to Yuan, partly to escape Western sanctions.
Beijing already has in place numerous agreements with major trading partners, such as Brazil and the Eurozone, that bypass the Dollar.
Brazil, Russia, India, China, and South Africa (the BRICS countries) announced last week that they are “seeking alternatives to the existing world order.” The five countries unveiled a $100 billion fund to fight financial crises, their version of the IMF. They will also launch a World Bank alternative, a new bank that will make loans for infrastructure projects across the developing world.
You don’t need a crystal ball to see the future for the US Dollar; the trend is clearly moving against it. An increasing amount of global trade will be done in other currencies, including the Yuan, which will steadily weaken the demand for Dollars.
The shift will be chaotic at times. Transitions this big come with complications, and not one of them will be good for the Dollar. And there will be consequences for every Dollar-based investment. US-Dollar holders can only hope this process will be gradual. If it happens suddenly, all US-Dollar based assets will suffer catastrophic consequences.
In his new book, The Death of Money, Jim Rickards says he believes this is exactly what will happen. The clearest result for all US citizens will be high inflation, perhaps at runaway levels – and much higher gold prices.
Only a deflationary bust could keep the gold price from going higher at some point. That is still entirely possible, yet even in that scenario, gold could “win” as most other assets crash. Otherwise, I’m convinced a mid-four-figure price of gold is in the cards.
But remember: It’s not about the price. It’s about the role gold will serve protecting wealth during a major currency upheaval that will severely impact everyone’s finances, investments, and standard of living.
Most advisors who look out to the horizon and see the same future China sees believe you should hold 20% of your investable assets in physical gold bullion. I agree. Anything less will probably not provide the kind of asset and lifestyle protection you’ll need. In the meantime, don’t worry about the gold price. China’s got your back.
We think you don’t have to worry about silver either, because we think it holds even greater potential for investors. In the July Big Gold, we show why we’re so bullish on gold’s little cousin, provide two silver bullion discounts exclusively for subscribers, and name our top silver pick of the year. Get it all with a risk-free trial to our inexpensive Big Gold newsletter.
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Jul 10

Stocks Bullish, Gold Range-Bound

Gold Price Comments Off on Stocks Bullish, Gold Range-Bound
But US rates are not going to shoot up, despite the improving data…

WAYNE KAUFMAN is chief market analyst at Rockwell Securities. Here he talks to Mike Norman at Hard Assets Investor about the outlook for gold prices amid better global growth…
Hard Assets Investor: Half the year is now gone. We saw negative prints in GDP, gold positive, and some improvement in China, with copper prices perking up a little. What do you make of all this?
Wayne Kaufman: I think it’s a slowly improving economy, certainly here in the States. China is doing better. And it has been a surprise. I was not expecting second quarter to be quite as strong for the equities markets. I’ve been expecting a real strong fourth quarter for the year, good first quarter, kind of flat second and third, real strong fourth, but we had this very strong second quarter. And when we have a first half of the year that is this strong, it does foreshadow a strong finish to the year, so I’m expecting the market to remain good.
HAI: Particularly curious in light of the fact that the US economy has been weak, with a negative 3% GDP in the first quarter. Yet stocks continue higher.
Wayne Kaufman: Yes, there is tremendous momentum. There have been a lot of statistics, like a tremendous amount, over 40 days in a row where the S&P didn’t move greater than 1%. Very low volatility of that type also forecasts strength in the future. The No.1 characteristic of this market though, to a pure technician, has been the lack of sellers. Any time we’ve seen the pullback it’s been because the buyers have gotten a little tired. We haven’t seen any type of aggressive selling.
HAI: How do you measure that? Is that looking at volume?
Wayne Kaufman: The classic way of doing it is exactly what you said. When you get overbought and you start to pull back, if it’s on lighter volume, then you see that there are no aggressive sellers. I keep a couple of other statistics, mostly stocks making four-week closing-price lows and 13-week closing-price lows, and I do 10-day averages of those, and these are very, very, very low levels, so there are just no real sellers. 
And it’s not just a US phenomenon. We’re seeing around the world that there just aren’t sellers. So the concept that if investors around the world are not interested in selling, why would all of a sudden it happen here independent of that? So the odds are saying it’s not going to happen.
HAI: A lot of people are saying this is just a big bubble. In my opinion it looks like the classic wall of worry that we’re climbing.
Wayne Kaufman: I think you’ve got it right on the button. Valuations…why aren’t we seeing sellers? Because on a historical basis, valuations are excellent. A lot of people are talking about price-to-sales being at high levels, and I look at all that stuff, but the most important thing to me is valuations based on the spread between bond yields and equity yields, and that spread has been going sideways if you chart it for a year and a half, so it’s in a very, very stable range. 
So unless we see a big spike up in yields along with a lack of an increase in aggregate S&P earnings, then we’re going to stay in that range, maybe we level off for a little while, earnings season is coming, so that will tell. And aggregate earnings estimates are moving up, so they’re not even stagnating at this point; they’re moving higher.
HAI: So valuations actually get better…
Wayne Kaufman: They get better or they will stay the same even if yields move up, but on a historical basis, they’re still ultra-attractive. And going back to years before the crisis, we could be at 4% on the 10-year note and we would still be okay on historical valuations. 
So then what am I looking for? Well, a spike in interest rates on a short-term basis might hurt. We got over resistance at 2.6% on the 10-year note, 2.8% and a fraction is next resistance, a fast spike. That might shake some people up temporarily.
But will rates rise sharply? We’ve seen great jobs numbers and other good economic statistics. But I don’t think it shoots up. The other thing would be a price in the spike of oil – $110 to $113 a barrel; that’s a pretty key resistance level. It’s possible we do go above it. It’s how we go above it. And the fact is with the US doing so much of our own energy now, those prices benefit a lot of the companies and a lot of the workers here. So, it’s a balancing act and we have to watch for sector rotation.
HAI: But the Obama administration just approved exporting our oil for the first time in 40 years. We hear a lot about energy independence and yet we want to sell it off. Does that make any sense?
Wayne Kaufman: Well, it might as long as you’re not driving up the price too much over here. That’s going to be an interesting thing, because there’s a bunch of dynamics there, the quality of the oil, how it’s able to be used by our refiners. Our refiners are now having to retool in order to use a lot of the fracking oil, because some of it has very high content of natural gas in it and it’s catching fire, so they are finding they need to… it may be better to be exported. 
HAI: So now to sum it up, I guess, and it seems to me given the complacency that you mentioned, and low volatility, which I guess is a reflection of the complacency, and the fact that valuations are good and the fact that the economy, we had a bad first quarter, but we could come back, China looks like it might be getting a little bit better, some indications there, we could possibly really start to take off in the second half, and don’t you think that would include many commodities and materials?
Wayne Kaufman: Great point, commodities and materials. We have just started to see money now flowing into them. Some of the bigger names like Freeport McMoRan, and copper and gold, that stock all of a sudden has started to move up, some of the other ones are starting to get…and gold you mentioned going sideways, I think that’s accurate. Gold looks like it wants to trade just in that range, $1200 to $1400. I think the bottom is in, but it needs to really break $1400 to give a real bullish signal.
HAI: Always great perspective. Thank you, Wayne.
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Jun 19

Low Gold & Silver Prices "Disrupting Mining"

Gold Price Comments Off on Low Gold & Silver Prices "Disrupting Mining"
Mineable properties will dry up from demise of exploration companies…

MICHAEL BERRY was professor of investments at the Colgate Darden Graduate School of Business Administration at the University of Virginia, and the Wheat First Professor of Investments at James Madison University.
Managing small- and mid-cap value portfolios for Heartland Advisors and Kemper Scudder after that, he now co-edits The Disruptive Discoveries Journal with his Chris, who founded House Mountain Partners in 2010 to focus on the evolving geopolitical relationship between emerging and developed economies.
Together Mike and Chris Berry analyze the commodity space and junior mining and resource stocks. Here they talk to The Gold Report‘s sister title, The Mining Report, about the importance of disruptive discoveries to help companies beat sideways commodities markets…
The Mining Report: Do you think investing is a skill that is learned or inherited?
Chris Berry: I suppose there’s some sort of a gene for analytical ability, but there’s no substitute for real-world experience. While my father taught at the Darden School at the University of Virginia, I received a good grounding in theory-based finance and investing. Being out in the investing world for the last 15 years, I’ve seen what works and what doesn’t compared to what you read in a textbook. If the last few years have taught us anything, it’s that markets aren’t as efficient as academic theory would have us believe.
TMR: Mike, when did you first know that Chris had the knack for investing?
Mike Berry: When I realized that Chris was interested in what I was doing, I sent him to see a good friend to talk to him. I wanted to stand back. Chris came back and said this is what he wanted to do. We have all heard Chris say he loves what he does now. If you love what you’re doing, you’re going to put a lot of effort into it and you will be successful.
I think it’s more environmental than genetic. If you’re in a family where everybody’s reading The Wall Street Journal all the time, it probably comes more naturally.
In 2000, I came up with the idea of discovery as a different kind of investing discipline. Chris and I have worked together now for four years and he’s adapted that into the idea of one of disruptive discovery. This is more defining and in the current market a lot more powerful. We reinforce each other’s work. It’s a really good relationship in that we’re in sync and yet we cover different interests in the destructive or disruptive discovery space.
TMR: You recently changed the name of the publication you co-edit to Disruptive Discoveries Journal. Which industries are being disrupted by macro forces, and how can investors profit?
Chris Berry: A number of macro forces have combined to deliver compelling challenges to the global economy. Globalization has increased trade among countries and benefited many people through higher living standards. The globalization of technology gives a farmer in an emerging market access to the same amount of information that, say, the president of the United States would have had 15 years ago. These two forces are leveling the playing field between East and West. As a result, both challenges and opportunities are presented. This means that as many more people live what I call “commodity-intensive” lifestyles, we’re starting to see living standards converge. This has been one of the main factors in stagnant real wage growth in the West in the past decade.
However, the confluence of globalization and technology has begun to raise a number of issues for us in the West. One challenge is an excess of labor. Hundreds of millions of people globally are joining the middle class, which is flattening wage growth. China’s middle class is forecast to grow by 200 million in the coming decades. Other countries like India, Indonesia and Mexico are experiencing similar phenomena. Greater access to technology, for example free online education through Coursera or edX, has exacerbated this issue by allowing anyone with an Internet connection to learn what a better life can be. This will continue to have far-reaching consequences for us in the West as the global labor pool expands and can grow at a relatively lower cost of living. Technology, specifically disruptive technology like online education, is simultaneously our best friend and worst enemy. A number of industries are set to be upended and herein lies the opportunity.
We broadened our reach because to thrive in the commodities markets of the future, investors will have to be much more selective about the sectors, the companies and the commodities they look at. I look for companies anywhere along the value chain that have a disruptive technology or unfair competitive advantage. Maybe it’s a deposit, maybe it’s a technology. These companies offer the opportunities in a global economy awash in labor and capacity.
TMR: Mike, which commodities could benefit from today’s disruptive technologies?
Mike Berry: Oil and natural gas come to mind first. Fertilizers and potable water also will benefit. Mineral exploration and recovery will also be revolutionized with new technology. There will be a revolution in energy use, food production, clean mineral production and, therefore, quality of life here and around the world.
It took a decade for hydraulic fracking to take hold, but now it has almost completely restructured the global geopolitics. In the second quarter of 2014 the US produced 8.4 million barrels of oil equivalent, the highest in 26 years. By 2016 the US will produce 12 million barrels of oil a day and will become an exporter of natural gas; it’s just a matter of time. That’s the best, most recent example of a global disruptive discovery.
It’s not about discovering a mine; it’s about discovering a technology. I talked recently with someone about plasma torch technology for processing minerals. That technology is still very early in its development, and many in the mining industry don’t believe in it, but it has the same potential as fracking has had to oil and gas production to change the economics of the mining industry and impact the geopolitics of the world.
TMR: Many of these technologies are costly. You’ve said that society needs access to cheap commodities to sustain a high quality of life. Many commodities are now being sold at below the price it takes to produce them. That can’t be sustainable. With these new technologies, will prices catch up with the cost of production?
Mike Berry: It takes time to perfect these disruptive discoveries. In the Eagle Ford Shale, the cost of producing a barrel of oil is around $40. The best the Saudis can do using traditional finding and recovery technology is $45 or $50 a barrel. New exploration technologies and recovery technologies in mining will dramatically reduce costs. So the answer to your question is yes.
Chris Berry: Selling commodities below the cost of production is obviously not sustainable. We’ve seen countless companies either mothball mines or abandon projects altogether in recent months. However, every commodity is different and I think it’s important to look individually at the distinct supply-demand dynamic for each. As an example, lithium and rare earth elements (REE) offer different opportunities. Lumping them together and saying ALL energy metals are bad bets now is patently false.
Take uranium, for example. By some accounts, 60% of the uranium being produced today is produced below cost. That can’t continue because companies have shareholders who invest based on the capability of management teams to generate profits and cash flow. You can only produce something at a loss for so long before you lose the trust of the markets.
Yet, uranium is a critical component of our energy infrastructure, and it will remain a critical component, despite its challenges. In an environment where the uranium spot price is $28 per pound and the term price is $45/lb, you must find the companies that can exist in low-price environments. Right now, that means in-situ and near-term production plays in the western United States and Kazakhstan. The Athabasca Basin has great grade, but that kind of hard rock isn’t economic right now, and won’ be until we reach much higher uranium prices.
If you want to invest in uranium right now, I would look at the lowest-cost producers in the industry. Another strategy would be investing in hard rock plays that aren’t economic now, but will be at higher uranium prices. I have been discussing this theme of optionality frequently.
TMR: In last year’s father-son interview you were sharply divided on the prospect for uranium. Mike, you were adamant that we should be moving to thorium to avoid more Fukushimas. Do you still feel that way?
Mike Berry: One of the great things about our relationship is that we don’t always agree, or disagree. We go back and forth. It’s a very healthy relationship because you can avoid “drinking your own bathwater.” We’re still divided on uranium long term.
Uranium is not the best nuclear fuel, thorium is. Thorium is more plentiful and easier to store. The burnt material doesn’t give off much plutonium. Its byproducts decay faster and are safer. The problem is that we spent billions of Dollars building and retrofitting uranium-based nuclear plants, as have the Chinese. We’re unlikely to move to thorium anytime soon. We’ll probably have green energy before we have thorium reactors, although both China and India are working on them.
As to what Chris said about uranium not being ready for a turn, I agree. I don’t see a turn for two to five years. That’s why we’re looking up the value chain for disruptive discovery investment opportunities in technologies, as well as the natural resource discoveries. In the nuclear space small modular reactors provide a disruptive technology. They are in their very early development stages.
TMR: Is that partnership new?
Chris Berry: No. I think it’s been overlooked by the market. Lithium Americas is a well-run company with a great asset in a region of the world with history of lithium production. It could be producing a commodity whose demand looks to remain steady and growing. Despite some of the excess in the global economy I spoke about above, lithium has dodged this bullet. Lithium Americas has partnered with one of the more influential multinational companies in the world in the commodity space. It’s a really positive story.
Also, as a brief aside, Tesla’s recent announcement to not enforce its patents on its Supercharger technology will likely be more revolutionary to the electric vehicle industry in the long run.
TMR: Mike, are you as excited about lithium?
Mike Berry: Yes, very much so, although I’m skeptical about Tesla’s plans for its Gigafactory. Battery technology has not yet found its steady-state niche. I am looking for disruptive battery technology today. You can’t build a battery factory – or a car factory to use all those batteries – until you’re sure you’re at the point of sustainability.
Lithium-ion battery technology is clearly important. Whether or not it uses graphite anodes is another issue. It’s evolving. We may or may not have the expected demand for lithium and graphite; that’s another issue.
I also want to comment on graphene, which is a one-atom thick extract from graphite. In my view disruptive graphene technology is coming but it is a decade or two away from serious cash-flow generation. It will definitely be a disruptive technology when it develops.
TMR: You’ve emphasized that not all critical metals are alike. There has been lots of volatility among the REEs. Could China’s recent announcement of its plan to tax REE producers and require environmental protections be good for non-Chinese companies?
Chris Berry: I hate to sound cynical, but probably not. Every quarter, China makes an announcement about how it’s going to change this or that. I don’t expect the pronouncements out of China to benefit non-Chinese REE exploration and development plays in the near-term. Remember, this entire supply chain from mining to manufacture now takes place almost exclusively in China. This has been in place for years and we can’t expect to change this overnight. Trying to use rulings from entities like the World Trade Organization to get China to dismantle its supply chain in the name of “fairness” is a wrong-headed strategy. Both the private and public sectors in Western economies need to garner the political and economic will to comprise a strategy that can compete with a dominant low-cost Chinese production scenario.
I have a five-year view on the REE space outside of China. That is how long I anticipate it will take an REE junior to achieve commercial production.
An investor has to be very patient and have a long window to make money in the REE junior space.
TMR: Mike, do you agree?
Mike Berry: I certainly agree that the US has given up on supply-chain development. It takes billions of Dollars and lots of time to build a workable and economic supply chain. The Chinese have worked pretty hard at that. They made mistakes, but they learned how to do it. We need to be focused downstream, as well as upstream.
TMR: Mike, you’re going to give your biannual talk to the Federal Reserve on the economy next week. What will you say?
Mike Berry: The overriding issue now is the battle among the central banks of the world trying to generate inflation, escape velocity growth and avoid deflation or shrinking of the money supply and their own economies.
I think the world is much more disinflationary or perhaps deflationary than it has been since the Great Depression. The Fed is printing a lot of money. Yes, it’s tapering its quantitative easing, but the real money supply in the real economy is not growing. The Fed’s money supply is. The Fed has $4.5 trillion of bonds in its portfolio. The real question now is, “How does the Fed raise interest rates without imploding the economy?”
The European Central Bank recently said it was worried about deflation. It instituted a $100 billion program to buy bonds and make loans. So the ECB is now embarking on its own quantitative easing program.
We don’t have an economy of robust, sustainable growth. Since 1970 GDP growth has averaged 3.4% coming out of recessions. Here we are 70 months down the road and we can barely sustain 2% growth. Without escape velocity growth, you cannot deal with the amount of debt that was incurred back in 2000-2008. I’m worried that we have three to five years of growth capped by the slow deleveraging process we are in today. That will affect how quickly the capital markets can turn and a new credit cycle evolves to support needed economic growth.
The equity markets are much overvalued. I expect a correction. I think we’re facing two to five years of deleveraging. It’s not an optimistic presentation in the short term. Longer term, of course, we will recover.
Chris Berry: All of that underpins our disruptive discovery thesis. It’s not a viable strategy to hide your head in the sand and not participate in these markets. Rather, you need to find those opportunities that can provide above-average returns in what looks to be a very muted growth profile over the next couple of years. You do this through finding those opportunities that can produce an attractive product either through a disruptive force in their business model or another element. Tesla has done this in the automotive business. Uber (though privately held) has done this in the mass transportation business. Netflix has done this in the streaming video business.
Mike Berry: Remember, there are two kinds of deflation. One comes from excess supply and insufficient demand. That is part of what we’re facing now. For example, there is lots of supply of iron, aluminum and copper, but the Chinese have scarfed it all up. Who knows when that will come back and hit us on the head? That’s bad deflation: excess supply and stagnant demand. Prices fall, expectations are formed and people start to save, because they can buy the washing machine cheaper next month. As a result, growth spirals into a decline.
The other kind of deflation comes from disruptive discovery. That’s where new technological discoveries tend to replace labor or at least cap labor’s real disposable income. That’s happening in the labor market now. It is struggling to maintain growth in real wages and get people back to work.
The US announced the creation of 217,000 new jobs in May, equal to the number of jobs lost in 2008. Everybody cheered. The problem is there are 15 million more people in this country than in 2008. We still have tremendous excess and underproductive labor. Labor is not being rewarded; productivity, through new discoveries, is being rewarded.
We have both kinds of deflation right now, and we have to clear them out. I just don’t see anyone in Washington DC being willing to do what is needed to make that happen.
TMR: A lot of people turn to gold when things are disrupted. The gold price is down from the beginning of the year. What do each of you think of the prospect for gold and silver?
Mike Berry: In terms of the real inflation rate, gold is going to be capped. I think it will test $1200 per ounce, or maybe $1100 per ounce. Wall Street is arrayed against gold right now, and the futures market is the tail that wags the dog in both gold and silver. At $1200 per ounce, we’d be buyers.
I suppose the good news, although it’s not really good news, is that exploration is stopping. This will also be disruptive. It’s very difficult to raise money for exploration now. There will be very few new gold or silver mines coming on stream. Some of the midtier silver producers will have real problems as silver finds its bottom.
We might have to wait one to three years, but at some point we will run out of mineable gold properties as a result of the demise of exploration companies. I think gold and silver will find the bottom when we start to see marginal costs equal to the price of gold and silver. Then, there will be a bounce.
TMR: Chris, do you agree?
Chris Berry: I still maintain that most commodities will go sideways for a while. It is difficult to say how long this will last, but I can’t see many macro catalysts at all auguring for explosive demand in the near-term. You must find low-cost production or disruptive technology stories.
In the precious metals sector, in particular, perception is reality. If you’re hearing a lot about disinflation or a lack of inflation, you stop thinking about some of the traditional reasons to buy and hold gold or juniors and producers. That’s one of the main reasons they’ve been pushed down hard and will probably stay there for a while. The perception is that there is no inflation in the economy and economic growth is now stable. The reality is quite different if you’ve been to a grocery store or filled your car with gas recently.
That doesn’t mean gold might not explode to the upside based on world events in the short term. We saw what happened to gold when Vladimir Putin started saber rattling and invaded Ukraine. Gold hit $1380 per ounce, but fell once things calmed down. We are now seeing a similar phenomenon as Iraq devolves into a civil war. I’m unconvinced these singular events can push precious metals prices dramatically higher in the near-term.
You want to watch traditional factors such as supply and demand and exchange-traded funds inflows or outflows.
It’s unfortunate that in the past 10 years, gold and silver have turned into asset classes in and of themselves and we’ve forgotten their traditional roles as stores of value and insurance policies against inflation. As a result, we’ve seen a lot more volatility with gold and even more with the price of silver.
Mike Berry: In my mind, gold and silver have decoupled. Silver has a huge industrial application; gold does not. With a mere 2% growth rate in the world’s economy, industrial uses will shrink until we can get to 3-5% GDP growth.
There are a lot of silver investors out there. Some 245 million ounces of silver coins and bars were purchased in 2013 – 76% more than 2012 and triple the silver purchased by investors in 2009. When you add in jewelry and silverware purchases, almost 500 Moz silver were purchased in 2013. That does not include industrial usage, investment only. Last year we incurred a 113 Moz deficit in silver supply.
Two years ago, the silver price averaged $35 per ounce; today it is $19 per ounce. Investors must seek companies that can sustain their silver production. They have to be sure that companies can maintain their properties. I think we will find a lot of great silver properties that come free.
We see a lot of private equity players now. They’re rolling up properties for pennies on the Dollar when they can. Will silver turn? Yes. When will it turn? I don’t know, probably a ways off.
TMR: Chris, in addition to being a son, you’re also a father, which, of course, Mike, makes you a grandfather. Is there an investment in a commodity or a stock that you could make now when your children are young that would be worth enough 20 years from now to pay for their college degree?
Chris Berry: I can’t think of a single investment or a commodity. You can’t control financial markets or the performance of the economy. You have to a have a flexible strategy and a plan in place to weather these storms. Buy and hold is not the only strategy to employ and has been a losing strategy in recent years.
I focus on energy metals and I have a thought process, a timeframe and a strategy for each one of them. The convergence of lifestyles is a real and credible phenomenon. It’s not a parabolic boom; it’s slow and steady and it will continue. We think that convergence only happens to the extent that people can live more commodity-intensive, more affluent lifestyles. If you’re going to invest in the commodity world, whether it’s juniors or anywhere along the value chain, you need to have a strategy, a plan and a philosophy that you stick to, but you have to stay flexible enough to adapt when times change. It’s not 2006 anymore and you should not be investing as if it is.
The ability to adapt is probably the most important lesson that I hope I can leave to my kids.
TMR: Mike, do you agree?
Mike Berry: One of the things Kate and I did was to make sure that we put stocks in trust for the kids. In the discovery sphere, landing on one major discovery – I’m thinking a world-class Peñasquito, which was one of our big early discoveries – can make you millions. These also increase wealth for everyone. Not all of them work, but you learn so much from every single discovery opportunity, disruptive or not.
I think it is incumbent upon parents to teach their children to understand implications of disruptive discoveries. In terms of a single investment that will put my grandchildren through college, that’s a question I would rephrase. What can I teach my grandchildren to focus on as they approach college and life beyond?
The point I would make is the necessity for disruptive discoveries in food production and healthcare. These are areas that we are heavily involved in. Cancer technologies and therapies, stem cell technology and medical device innovations, as well as nutritional discoveries, are of great interest to both of us. (Editor’s note: Click here to read Michael Berry’s ideas on life science investing).
TMR: Thanks for your time and insights.
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