The Gold Report

Adrian Day, publisher of Adrian Day’s Global Analyst, tells The Gold Report that he has 'huge optimism' for where the gold price could go, because the public 'isn't even in the market yet.

TGR:Would you agree that we’ve finished the first leg up of the bull market for gold? And if so, where are we now, and what’s next?

Day: I’m assuming from the $250 an ounce back in 2001 to the high of $700-plus we reached earlier this year, that the move was the first leg of the current bull market. The really interesting thing to me is that the public doesn’t seem to be in this market at all. The ordinary, everyday investor just isn’t in the market. The Merrill Lynch broker isn’t calling his clients and saying, “You ought to buy some gold.” Hedge funds are in it, and the traditional gold people are in it, the people who have already bought. So that gives us huge optimism for where these prices could eventually go.

I’m surprised that gold has been as resilient as it has, that we have not experienced a bigger pullback. That may be partly my conservative nature. It’s also partly because those of us who have been around the block before have become a little more cautious. We’ve been hurt in the past. I do think it’s a very positive sign that gold has managed to hold up as well as it has, even in its pullbacks. It strikes me that the pullback from the highs in the spring is now definitely over, and I think we’re about to begin the next move up. This time of year, normally, is very good for gold. So it’s very good for the gold stocks, particularly for the juniors. I believe we’re in that second phase. How long that second phase will last, I don’t know. It’s probably going to be for a couple of years, and it will probably take us to $1000. That’s just the second phase, not the manic end-phase.

TGR: So which segment of the market should we invest in at this point?

Day:Given the fact that there’s no sign at all that the public is yet in, we’re still in a fairly sensible market. It strikes me that the seniors still have a long way to go. I don’t think we’re in that phase of the market yet where investors should get out of the seniors and move into the juniors. There are some great juniors that are going to do very, very well. However, I don’t think one needs to get out of the seniors yet. When institutional money enters the market, they have to buy those big companies. And that’s also where the Merrill Lynch broker and his clients are going to go.

At this point I don’t think you need to be too conservative or too cautious. Of course a lot depends on the particular investor. The 50-year old investor with a couple of million dollars, and a couple of hundred thousand in cash, and who doesn’t yet own any gold, shouldn’t wait. However, those who are already heavily invested in gold stocks can afford to be a bit more selective when adding positions.

TGR:Speaking of good buys out there, you have a 2 o’clock presentation coming up on global markets and where to invest. Can you share some of those opinions with our readers?

Day:When I look around the world, most markets on a basic fundamental basis do not appear to be particularly inexpensive. Most are selling at multiples above, and in some cases considerably above, their own historic averages. Hong Kong, which is selling at 14X earnings and yielding 4%, sounds like a reasonable value compared with the U.S. However, it’s selling above its own long-term historic average multiples. That doesn’t mean those averages can’t change, but as an historian I always like to look back. On that basis, the broad markets don’t look particularly cheap to me. That said, I think there are some turnaround situations and there are also some individual situations that are very good.

For instance, I think Japan is definitely a place you want to be. The Japanese economy has definitely turned the corner, though it may still have some problems. The most compelling evidence of this is that the debt levels are way down, particularly with the banks. Nonperforming loans have almost evaporated over the last several years, compared with both China now and Japan’s own economy five years ago. I think we tend to forget that Japan, though it’s been in recession or deflation for more of the last 16 years than it’s actually been growing, is still the second largest economy in the world. Therefore, what happens to Japan is still very significant to the rest of the world economy. It takes time to recover from 16 years of recession and deflation. The turnaround has been slow and it will continue to be slow. The average multiples for Japanese stocks are about 40X or 50X earnings, which does not seem particularly cheap by any measure. Market multiples are often at their most extreme precisely at turning points because the leverage is so great at the turning point. That applies to the tops as well as the bottoms. People often look at markets that are selling at 4X earnings and say, wow, that must be great. However if the market is at its peak, and the earnings fall, the multiples suddenly become very expensive. And at the bottom the reverse happens. About 18 months ago Japan was selling at 100X earnings. It doesn’t take much for those earnings multiples to come down.

What is also significant is that Japanese companies have a lot of cash on the balance sheets. In many cases, 50% to 70% of the market cap of the company is cash. So I think investors should look at Japan.

I also like the rest of Asia because if the Chinese economy continues to grow, and Japan recovers, countries such as Singapore, Thailand, and Malaysia are going to do very well. Those markets have already come up quite a bit in the last nine months.

TGR:Do you see China growing beyond the Olympics?

Day: Well that’s the big question, isn’t it? I think we’re safe at least until the Olympics.

TGR:I’m being told there are buildings that are not being finished in Shanghai, and various cities throughout China. They’re just empty. That’s a bad sign, isn’t it?

Day: I agree, that’s not a good sign. I think we could easily have a crash in China over the next several years. However, when you look at today’s numbers, the economy is still continuing to grow. Inflation is still low. Imports are still very strong. I think the government is trying to eliminate some of the excesses, and a lot of those excesses were in construction. So it’s just more noticeable there. The real question is will they trim back too far, and I don’t think there’s any indication that that’s happening now.

TGR:Frank Holmes mentioned this morning that China has established about seven or eight tax-free trade zones, for auto manufacturing and exporting. What are the implications of this?

Day:China is concerned about moving some of the money out of speculation, particularly real estate speculation, and into more substantive issues. That seems to be working. However these strategies can of course backfire.

TGR:What do you think will bring down the dollar? Is there going to be a tipping point?

Day:I believe all the basic long-term fundamentals are telling us that the dollar should be lower. So the question I then ask is, why isn’t the dollar lower? I think we all know the reason, which is that the growth differentials between the U.S. and the rest of the world favor the U.S. And the interest rate differentials between the U.S. and the rest of the world still favor the U.S. If you are a global investor, 2 years ago, a year ago, even at the beginning of this year, you could get 6% in the U.S. compared with ½ % in Japan, or 1% in Switzerland, for instance. The U.S. is still growing, so the choice of where to put your money is fairly clear. That’s beginning to change. Though the growth differentials and the interest rate differentials still favor the U.S., the trend is changing. The U.S. economy seems to be slowing, certainly the rate of growth is slowing, whereas in Japan the economy is growing again. Japan has abandoned its 0% interest rate policy. I believe at some point people will just say that a 2% interest rate differential isn’t enough, and they’ll begin to look outside the U.S.

I don’t know if there will be a particular tipping point. But to me the fundamentals certainly suggest that the dollar should be lower. The big story over the next 3-5 years is that the dollar will be significantly lower. What tends to happen with all these markets, as we know, is they start off slowly, and then they just build momentum. How many people do you know who are waiting to sell the dollar? Everybody talks about the dollar being lower, and then you ask them how much they have in foreign currencies, and many of them have nothing. So there’s a lot of pent-up pressure, a lot of potential movement into foreign currencies.

Adrian Day, publisher of Adrian Day’s Global Analyst, is also the owner of Investment Consultants International, and President of Global Strategic Management (GSM), a registered investment advisor, and a separate company.