John Budden: You have long warned of fiat currency's demise, John. Are your worst fears being realized?
John Embry: Financial decay is progressing at an alarming pace. It came to the fore at the time of the global financial crisis in 2007–2008 because the private debt in the banking system was unserviceable. With the banking system in such dreadful condition, banking liabilities had to be taken onto the sovereign government balance sheets.
As a result here we sit today with an unprecedented situation, with the world's sovereign governments in an absolutely unsustainable debt position. It's leading to unprecedented money-printing and essentially negative interest rates, which is appalling. It punishes anybody who has done the right thing—which is saving money and trying to invest it wisely.
Rick Rule: The underlying problem is issuing paper to fund current liabilities that couldn't be sold on the market. Governments around the world are dealing with solvency issues by providing liquidity. That makes me want to see my clients in bullion more than any other reason.
JE: I'm a huge believer in Austrian economics. Among its tenets: It takes more and more debt to get a dollar of real gross domestic product (GDP) growth as you get deeper into an economic cycle. We're as deep into this one as we can go.
JB: Are we beyond repair?
JE: Unquestionably. The mainstream media talks about being in recovery, but the only thing improving is that they're pumping enough money into the system that it's not imploding. Certain financial markets are doing relatively well—stocks and bonds are doing better than they should be. This creates the image that things are better than they are but the real economy continues to suffer, and the markets will reflect that eventually.
JB: Could you speak to the devaluation environment, with almost all-out currency wars, in relation to precious metals?
Eric Sprott: Every week some event reminds us that the crisis is not over. In early February, the Bank of Italy had to bail out Banco Monte dei Paschi, and the Dutch government had to bail out SNS Reaal, the third largest bank in the Netherlands. Peugeot lost $4.9 billion ($4.9B), and the European Central Bank offered a loan of $1.2B. Venezuela devalued its currency by 47%.
Think about what happens every time there's a devaluation. Venezuelans who had their money in gold didn't suffer the devaluation. Japan, where the currency has weakened by 18%, didn't experience a devaluation because the Japanese gold price has gone to a record high. There's no doubt that currency wars are a very apt point of discussion these days, and we've seen many instances where the safety valve is gold and/or silver. As we've said before, comparing currencies is similar to talking about the prettiest horse in the glue factory. History shows us that all fiat currencies end up being valueless.
JB: Rick, could you give us the American perspective on the Federal Reserve printing and buying of bonds?
RR: I've read that we needn't be so concerned about the debt given that we owe most of it to ourselves. From a saver's point of view, that's scary. They're saying it's easier to steal my wealth than a foreigner's wealth. Being willing to do it that overtly, as with the interest-rate manipulation, clearly reinforces that precious metals have been unique for many, many years—media of exchange, to be sure, but media of exchange that aren't somebody else's liability. They aren't just a promise to pay, they are, in fact, payment.
One of John Mauldin's themes is that people have to own stuff they can't print. Americans are way behind the world curve with regard to collectivism, socialism and all those other negative isms. We're a highly competitive culture, and we've decided to win every race, including the race to the bottom. To the extent that some Americans don't want to participate in that foolishness, I'm delighted to be part of the Sprott organization because it gives people certificated bullion options.
JB: Eric, tell us about the economic recovery.
ES: When we started 2012, we were all assured the economy would grow 3.5%. In a Markets at a Glance about a year ago, I wrote that the recovery (like the emperor) has no clothes. If we forget about the stock market and the financial instruments the Fed is trying to control and look at just what's happened to people and what's happened to the economy, there is no recovery.
We're now into 2013, with a 2% tax increase—and by the way, a 2% paycheck reduction means discretionary spending probably goes down by double that rate. I think the average gasoline price was up 12% last year, and prices at the pump now are at the highest average rate ever for this time of year. And this sequester thing, the automatic spending cuts first proposed by the White House in the debt ceiling talks in 2011, is looming. I don't know how anybody could be optimistic about where we're going.
Furthermore, in the January 2013 Markets at a Glance, in "Ignoring the Obvious" we referred to the U.S. Department of the Treasury report, which it issues every year under generally accepted accounting principles (GAAP). It shows what the U.S. deficit is. Page 47 of that report shows the increase in the present value of known liabilities. In one year, these liabilities went up by $4.7 trillion ($4.7T). Add that to the actual cash deficit—which I believe was reported as $1.2T but under GAAP would have been $1.5T—and you get a number something like a $6.9T deficit in a GDP of $16T. There is no recovery. The situation is growing more miserable by the day. The deficit this fiscal year, which ends Sept. 30, 2013, has been estimated at something like $8T.
It cannot go on. A lot of commitments the U.S. government has made will not be paid. When Spain and Greece cut entitlements, unemployment rates went to 25% and retail sales fell by double digits. Entitlements have to be cut in the U.S.
JB: We've grown up in this business, learning about central bank shenanigans, which now are mainstream. They're acting in concert, colluding on low-interest-rate policy. An alternative to paper currency is absolutely essential. If you look back to Germany in 1921, just before the Weimar inflation, the stock market did very well for a while and then the valuation plummeted something like 1 trillion%. The point is to educate people and encourage them to pay attention to precious metals.
ES: I personally got involved in the precious metals business in 2000, when gold was at its low. Until recently, it's been an awesome ride, with the gold price going from $250/ounce ($250/oz) to $1,650/oz and silver from the $4/oz neighborhood to as high as $49.50/oz. The precious metals stocks haven't provided the return we might have expected over the last few years, but we've had wonderful success with the precious metals continuing to rise. We have dedicated ourselves to trying to get people invested in them because that's where you have to be to survive the chaotic situation we're in.
JB: What's behind the metals and mining recent poor performance and when will it end?
RR: The equities got so far ahead of themselves in 2009–2010 that it makes perfect sense that they'd have to catch their breath. The industry as a whole performed very poorly—not the equity prices, but the corporate performances that the equities were supposed to represent. We took leave of our senses in 2009–2010 in that we forgot what a tough business it is.
My own suspicion is that circumstances in the junior market will take 12–18 months to unwind–real excesses you have to work through. But the best 10% in the sector have already bottomed. It may feel as if the sector continues to go down, because half the TSX Venture Exchange has a risk-adjusted net present value of zero. Those companies have to proceed toward their intrinsic value before the market as a whole can turn.
Investors who know the sector's history know that bear markets like these cause bull markets. To make money buying low and selling high, you first have to buy low. You can only do that in a bear market. So rather than grieve about market conditions, welcome them and use them to put in place buys on inventory that will almost certainly make people very happy in the up years. Sideways moves in precious metals prices give me the opportunity to buy more personally, which I intend to do.
JB: Let's talk about each of the precious metals.
JE: I'll start with the king of precious metals. Rick alluded to the fundamental basis for gold's attraction, that it has represented real money for many centuries. The problem today is that because financial assets did so well for about 20 years, a whole generation hasn't figured out that gold is real money. Gold is nobody else's liability. It has no counterparty risk, which threatens so many investors today. That's the best advertisement for gold as an investment. Let's face it—gold has provided protection against wealth destruction for centuries. We're on the cusp of another major chapter in that illustrious history.
I can't recommend gold more strongly than at this moment. This is a fabulous opportunity. I would go so far as to say it might be the best buying opportunity right now. The fundamentals get better by the day, but the price has been really held back. It's been down for virtually 18 months, totally out of whack with what's going on in the fundamentals. This has not gone unnoticed by the Chinese or the Russians. It just came out in February that Russia has been the largest accumulator of central bank gold reserves in the last 10 years. I suspect China would easily eclipse Russia, but China tends to report after the fact.
From a standing start fewer than 20 years ago, China has built the world's largest gold-producing network within its borders, and it's now the largest producing nation. On top of that, it recently started importing enormous quantities of gold. It ended 2012 with record net importation of more than 500 tons in December. When you think of that, bear in mind that production outside China and Russia, which never gets back out once it gets in to those countries, is only about 2,000 tons. So the Chinese effectively took in 25% of the world's mine production last year, which begs the question: Where is it coming from? That gets back to the subject of the rest of the world's central banks.
On the surface, in the last two years central banks basically have swung from selling almost 500 tons/year to accumulating 500 tons/year. The fly in the ointment that goes unspoken, I believe, is Western central banks continue to lease considerable amounts of gold, which is used to keep the price under control. The good news is their inventories, as far as we can determine, are being seriously depleted, so those inventories have a very limited shelf life. Consequently, I expect the central bank supply of gold to come to an end within a reasonably short period of time. When you put that in the context of the demand for gold generated as an alternative to paper, I think it's a fabulous supply-demand situation.
JB: How can individual investors expect to win buying gold and silver when they're competing against such formidable opponents as central banks?
JE: They are formidable, but their Achilles' heel is the physical market. It's getting exceptionally tight, so the pricing mechanism will swing away from the paper markets into the physical market. They can't make gold and silver out of thin air.
ES: We analyzed the change in the gold supply and demand from 2000 to today, and it's been particularly dramatic for the last two years. We see a 2,400-ton net change in what we all think is still close to a 4,000 ton market, even though recycling has definitely come down. Of course, we've also seen even greater buying by the Chinese and the Russians, but an interesting U.S. Department of Commerce report showed that U.S. exports of what's called "non-monetary gold" were $4B in December 2012. Of that, $2B went to Hong Kong. You have to wonder about these statistics, because for the year, I believe net U.S. exports were 15.9 million ounces above the total U.S. production.
This is physical gold leaving the country, and it had to come from somewhere. The source is most likely to be the U.S. Department of the Treasury. That would support our thesis that all the Western central banks have been supplying gold to the market and suppressing the price to keep the market from seeing how ridiculous the money-printing policies are. The tell would be the price of gold and silver going up. So those banks are supplying gold to the market. Even though the central banks didn't report it, the export department did.
JB: John, would you explain what the term "paper gold" means?
JE: That counterparty risk comes into play with paper gold, which means you own a promise to receive physical gold, not the gold itself. I think the paper gold issue will rear its ugly head in the not too distant future. It could unveil one of the great Ponzi schemes of all time. As far as we can determine, there might be as much as $100 worth of paper claims for every $1 of underlying physical gold. As we get deeper into this morass and people get more interested in gold and more concerned about where their gold is, I suspect the issue of paper gold will come to the fore.
My advice is that if you hold a paper gold vehicle, know exactly what it is and how it's backed. If you have the slightest question and can get your gold, be the first in line and go get it. Even the allocated gold is being hypothecated and re-hypothecated in certain institutions. I can't emphasize strongly enough that the best thing in today's market is you own physical gold or you own a paper product that's fully audited and you are 100% sure it's 100% backed by the gold it's supposed to be.
JB: How about silver, Eric?
ES: Anyone can go to the U.S. Mint website and get a reading on investors' interest in silver and gold. In 2011, 2012 and so far this year, investors are putting the same amounts of money into each of them. When the price ratio exceeds 50:1, it means they're buying 50 times more physical silver than gold. Because 11 times more silver than gold is produced on a yearly basis, we won't be buying it at 50:1 forever.
We also know that most silver is used in industrial production. So we made a calculation that literally you can only buy 3 oz silver for every 1 oz gold for investment purposes. Most gold is available for investment purposes, and most silver is not available for investment purposes. We see it in many other proxies. For example, in our last Silver Trust and Gold Trust issues, we bought 50 times more silver than gold, with people making up their own minds what they wanted to invest.
When I speak to bullion dealers in the U.S., Canada and Europe, my favorite question—which I encourage anybody who wants to do their own research to ask a bullion or coin dealer—is about what percentage of their business dollar-wise is in silver and what percentage is in gold. I think they'll all answer that at least half their business is in silver, which means their customers are buying 50 times more silver than gold. We know it's not available on that basis, because the amount of gold available to purchase relative to silver in the world is a ratio of something on the order of 150 times more dollars of gold are aboveground than silver. So even though I love gold and believe the gold price will go up to significantly higher levels, and that fiat currencies will be valueless over time, I'm on record saying that silver will be the investment of this decade. I say that is because of the physical evidence I see of the willingness of people to buy silver.
JE: Silver has been in huge undersupply for the last 20–30 years, and now that the monetary demand for silver is accelerating, I couldn't agree more with Eric. I too love gold, but I think silver is going to go up a lot more, and that gold/silver ratio is going to fall toward the historic lows.
JB: Let's switch to platinum and palladium. The prices have been rising lately, with platinum now past $1,700/oz. Rick, is this a good time to be buying?
RR: Things have gone very right for platinum and palladium since the launch of the Sprott Physical Platinum & Palladium Trust, which had its Initial Public Offering in December 2012, and platinum could trend lower in the short term. I guess from a biased long, the answer is yes. But I basically think someone looking out one to five years needs to consider owning the whole suite of bullion products—gold, silver and platinum group metals (PGMs).
Platinum and palladium markets differ substantially from the gold and silver market. An aboveground supply effectively doesn't exist in platinum. Both gold and silver bullion markets have metal that was mined during the time of the Incas, so 200-year-old supply is still in those aboveground numbers. But with effectively no aboveground PGM supplies, there's no government ownership and the metal is much less politicized.
Furthermore, a simple supply-and-demand squeeze is in place. Remember that PGMs aren't metals that get mined and stored. Most of the platinum and palladium used simply goes up a smokestack or out a tailpipe. What does this come down to? At current price points, the global platinum and palladium mining industry does not earn its cost of capital anywhere. The price must go up to maintain current levels of production.
Another thing that's important on the supply side that differs from gold and silver is that gold and silver are produced fairly ubiquitously in many locations around the world, so political disruption has less impact on the supply. But platinum and palladium are produced in South Africa, Zimbabwe and Russia, so they are really constrained politically.
Because South Africa produces in excess of 70% of the world's platinum and 39% of its palladium, it's the country that matters in PGMs. The situation is dire. The South African industry has not been earning its cost of capital for many years and as a consequence, there has been a production decline of 19% over six years. More than 50% of the existing production is in fact losing money. In mining parlance, it's stuck between a rock and a hard place. The mines are extremely capital intensive, and can't be mechanized for both geological and social reasons. Wages and working conditions are deplorable. Mine workers' wages must go up, but they can't because the industry doesn't earn its cost of capital. There is widespread social agreement in South Africa that through royalties, tax and carried interests, the government take from mining must go up, but it can't because the industry doesn't earn its cost of capital. The industry requires between $6B and $8B in new capital expenditures to open up new faces on the reef, but they can't because they aren't earning any money. And nobody will give them any money when they don't earn their cost of capital.
Finally, mining is extremely energy-intensive. The monopoly power supplier in South Africa says it needs 18% annual price escalations to meet electricity demand, but can't do so for political reasons. South Africa is in a very difficult place in terms of maintaining any semblance of current production at current platinum and palladium price points.
North of the border in Zimbabwe, you go from the fat into the fire. Zimbabwe President Robert Mugabe in effect stole 50% of the industry five years ago and has set out to steal the rest. He's just taken 30,000 hectares (ha) platinum leases from Impala Platinum Holdings Ltd. (IMP:JSE), and is prepared to run on nationalizing Zimbabwe's mining industry in the next presidential election. So, as a force for platinum production, Zimbabwe is an absolute nonentity for the next decade.
Russia is the bright spot, if you will. The problem is Russia isn't so much political. The difficulty there is that grades decline as the Norilsk orebody gets deeper. This has been ongoing for 10 years, so it's steadily whittled down the Russian stockpile. In fact, Johnson Matthey Plc (JMAT:LSE), which supplies PGMs to auto catalyst fabricators worldwide, sees no indication of any inventory available in Russia.
Let's look at demand briefly. The demand that really matters is as an industrial catalyst, particularly in automotive applications. In this regard, the thesis is very interesting, too. The utility we enjoy from platinum and palladium is spectacular in Western nations—Western Europe, North America and Japan. The political and social tradeoff is platinum versus smog. Only about $200 worth of platinum in a new car generates the air quality we enjoy in the West. That's important. If PGM prices doubled, the impact on the shelf price of a new automobile would be very small.
This is magnified because auto sales are growing in frontier and emerging markets, where platinum and palladium loadings are less than 10% of North American loadings. In fact, in what has become the world's leading auto market, the Chinese government expects to quintuple loadings per vehicle to address very bad pollution conditions there. Because the utility associated with platinum and palladium for air quality is so high, my thesis is that the price not only must rise and can rise, but that it will rise.
JB: We have gold up slightly, silver up slightly, platinum up $26 and palladium up $13. Are these metals non-correlated and complementary as a hedge against currency devaluation?
RR: I would argue that the metals are non-correlated and complementary. Each has its own individual market and its own strengths, and each should be part of a bullion portfolio.
ES: I have to believe the price of platinum and palladium will go up because of supply-demand. I can't wait for the time that people translate the shortage of platinum and palladium to what is in our minds, the obvious shortage of silver and gold in the real physical market. The Western central banks must be selling gold into this market, because no way can you have so many come into the market—the Chinese bought 47% of the world's production in December, and yet the price went down. I'm hoping that the platinum and palladium story will in turn make people focus on the silver and gold and the desire to own it through our trusts.
I got into gold and silver because I thought there was a physical shortage of both products, and I believe that to this day. But I never believed I would get the tailwinds of printing money and bank runs. The devaluation in Venezuela could easily happen in Argentina and Egypt. Think of all the money that wouldn't be at risk if people would just own the precious metals.
Read Eric Sprott's extensive interview with The Gold Report here.
Eric Sprott has over 40 years of experience in the investment industry. In 1981, he founded Sprott Securities (now called Cormark Securities Inc.), which today is one of Canada's largest independently owned securities firms. After establishing Sprott Asset Management Inc. in December 2001 as a separate entity, Sprott divested his entire ownership of Sprott Securities to its employees. Sprott's predictions on the state of the North American financial markets have been captured throughout the last several years in an investment strategy article that he authors titled "Markets At A Glance." Sprott has been widely recognized for his strategic insights and his accurate market predictions over the years. His newest ventures are Sprott Money Ltd., one of Canada's largest owners of gold and silver bullion, and the recently launched Sprott Physical Platinum and Palladium Trust.
John Embry is chief investment strategist at Sprott Asset Management and Sprott Gold and Precious Minerals Fund. He also co-chairs the Central GoldTrust Board of Trustees. An industry expert in precious metals, his experience as a portfolio management specialist spans more than 45 years. He joined Sprott in 2003, after 15 years as vice president of equities at RBC Global Investment.
Rick Rule, founder and chairman of Sprott Global Resource Investments Ltd., began his career in the securities business in 1974. He is a leading American retail broker specializing in mining, energy, water utilities, forest products and agriculture. His company has built a national reputation on taking advantage of global opportunities in the oil and gas, mining, alternative energy, agriculture, forestry and water industries.
John Budden, who has 47 years of diverse domestic and international investment experience, runs an Ottawa/Boston-based strategic consulting practice that advises major international financial services companies on mergers and acquisitions, strategic alliances and emerging trends in the U.S. and Canada. A market commentator on Business@Night, he also hosts Market Minute and Sprott Market Insights for CFRA, Ottawa's leading business/talk radio station. Budden also spent several years as a contributing editor for The Financial Times of Canada, co-founded Rabin Budden Partners, an investment counselor and no-load mutual fund manager, and served as president and CEO of Dynamic Fund Management.
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