Keep the Faith: Higher Gold Price Will Come!

• My thoughts exactly. Fiat currencies are in trouble. All the major currencies: USD, EUD, JPY, UKP… look shaky. Quantitative Easing and competitive devaluations are going to lead the world to a monetary meltdown.
   
• The Gold Report interviews Charles Oliver and Jamie Horvat :
    
  On the global stage of currency devaluation and debasement, the reasons for owning gold seem obvious. But have you ever stopped to consider the derivative market? According to Charles Oliver and Jamie Horvat, both senior portfolio managers at Sprott Asset Management, “The impact of the derivatives has yet to express itself.” In this exclusive interview with The Gold Report, Charles and Jamie explain how gold will react in the New Financial (dis)Order. Both foresee $2,000 gold in the next three years and, ultimately, “significant” hyperinflation on a global scale over the next decade.
   
  The Gold Report: Jamie and Charles, on your site you’ve posted a recently updated report, “Reasons to Own Gold.” In it you say that the impact of the derivatives has yet to express itself. Can you explain that for our readers?
   
  Charles Oliver: There are many reasons to own gold. I think one of the biggest ones is the actual devaluation and debasement of currencies. Having said that, one of the lesser-known ones is the derivative market; if you look at the derivative market on a global basis, it is absolutely enormous.
   
  And the downfall of the financial system last year in part was the fact that many of the banks in the financial system in the U.S. and around the world had a capital base that was leveraged up 30 times or more on their balance sheet. The derivatives market is hundreds of trillions of dollars. When you look at that relative to the capital base of the whole financial system, the whole financial system gets dwarfed.
   
  So, in periods of volatility, you can have some huge swings in some of these instruments. Some of these instruments may be off balance sheets, and there’s certainly an element of risk should some of these need to be unwound.
   
  Jamie Horvat: We’re in a deleveraging process now and we need to get our personal savings rate back in line, as well as our personal balance sheets and the banking balance sheets. When you have that leverage you get less lending. You need to continue with that growth; so, as a result of all of that, we’re seeing governments move to quantitative easing, which is printing money and trying to force money into the system and force spending. Then what happens is currency is debased against all hard assets; and gold, as the ultimate store of value and a hard asset class in an exchange of money, over time reacts to that environment. It will have a positive bias going forward.
   
  TGR: We read a lot about U.S. dollar devaluation and expected worldwide inflation. Why hasn’t gold gone over $1,000?
   
  CO: That’s an excellent question. My own personal viewpoint is that today it should be at $2,000 an ounce, but it’s not. I think that sometimes these things take a long time to work their way out. For example, look at something like Freddie Mac and Fannie Mae. Last year they basically fell out of bed. There were people shouting out very loudly four to five years before that these companies were effectively bankrupt and insolvent. It just took a long period of time for the valuations to work their way out. In the case of gold, I do believe that it will be higher, but sometimes you’ve just got to be patient and wait for these things to unfold.
   
  JH: The other thing we’ve been witnessing is the battle between deflation vs. inflation. People in the deflation camp think we’re going into another Great Depression, the Dow is going to 1000 points and the only thing you should hold is cash, as the global economy will continue to shrink.
   
  Since we have come off the gold standard—and the reason I believe we will never go back to the gold standard—governments have used quantitative easing or the expansion of money supply to reflate the system. We’re going through one of those periods again where they print massive amounts of money and debase currencies vs. hard assets, in an attempt to reflate the system. I believe we are in a bottoming phase in the market; but we may retest the lows. The markets will continue to move sideways and be volatile as consumers continue to save and balance sheets are slowly repaired. Governments will continue to print and throw money into the system to expand the monetary supply and reflate the system. As you do that, you simply debase currencies.
   
  So, you have this short-term fight between deflation and inflation similar to the sideways moving markets of 1973 – 1976. Gold moved from $33 an ounce to $38 to $180 or so, and in that sideways, volatile market from ’73 to ’76, it was knocked back down to around $100. Unfortunately, the end result of the quantitative easing resulted in stagflation. And that set up for the euphoric run of gold into the $800 range in the early ’80s.
    
  TGR: So would we expect to see something like that again, where gold will cross, and continue to trade, above $1,000? Or would we expect it to cross $1,000, spike and then come back down into that $900 range again?
   
  CO: I don’t think $1,000 is a magical number; it is a round number, so people look at it. But as I said, my own personal viewpoint is that gold will go through $2,000. I think there will be a spike at some point in the future, but I don’t know how high that spike will be. I’ve heard people talk about $5,000, $10,000—I’ve even heard some numbers higher than that—and I can see the potential spike going to such levels. It’s not a forecast at this point in time; I will keep a conservative call of $2,000 in the next three years, which is what I have been saying for a while. But, yes, I expect the spike will likely be significantly higher than that.
    ….. 
  CO: ….. There will be a huge expansion of the monetary base probably over the next decade from a number of governments on this planet, and there will be a significant amount of inflation that occurs during the next decade. We do believe that hyperinflation is going to occur, and it will be quite significant.
   
  So, I think in the next decade you’ve got to put it into a relative situation. I think the long-term norm price for gold will actually probably be well over $1,000 when we look back 5 to 10 years from now.
   
  TGR: When you say hyperinflation will occur, are you expecting that to be worldwide or isolated as it is now while the major countries look at a large inflation period?
   
  CO: I believe that hyperinflation is probably going to be on a large global scale, as most of the countries around the world competitively devalue their currencies. But it’s a fact of life right now as the quantitative easing is going on, and in this type of situation, you are going to get significant inflationary impacts.
   
  TGR: Once we go into stagflation or hyperinflation, I’m going to guess that it makes sense to be holding gold bullion.
   
  CO: Gold bullion or assets that hold their value against inflation. And the stock market, funnily enough, can act as an inflation hedge. In fact, if you look at a lot of the studies, the stock market has been one of the best ways to protect your assets against the ravages of inflation.
     …. 
  TGR: Since last November and December, the gold majors have had quite a run up. Would we expect to see any more significant appreciation in the major gold equities?
   
  CO: The simple answer is yes, because I believe the price of gold is going higher. So, I think many of these companies will benefit from increasing earnings and cash flow. Having said that, being the largest gold producer in the world is not a good thing because it’s very hard to grow when you’re at the top. In fact, most of the big guys, they’re just doing mergers and acquisitions to maintain their current level. I believe that on a long-term basis, the best value and growth really comes from the smaller- and mid-cap sector of a well-diversified portfolio of gold companies.
    ….. 
  TGR: Following the guidelines you’ve just outlined, do you have any companies in that small- and mid-cap sector that you’re looking at that you can share with our readers?
   
  JH: Some of the names that we like and hold in the portfolio include: Allied Nevada Gold Corp. (TSX:ANV) (ANV), Lake Shore Gold Corp. (TSX:LSG), West Timmins Mining Inc. (TSX:WTM), International Tower Hill Mines Ltd. (TSX.V:ITH) (NYSE.A:THM), IAMGOLD Corporation (TSX:IMG) (NYSE:IAG), Osisko Mining Corp. (TSX:OSK), Romarco Minerals (TSX.V:R), Wesdome Gold Mines (TSX:WDO)—a mixed bag of some junior producers and growing production, some mid-cap names, pretty strong balance sheets and located in geopolitically safe jurisdictions of the world.
   
  CO:In the juniors that are currently producing is a company like Wesdome, which is in Quebec. In Canada we also have Rainy River Resources Ltd. (TSX.V:RR) and Detour Gold (TSX:DGC), which are multimillion-ounce deposits currently undergoing studies. Another producer in the junior area in Canada would be San Gold Corporation (TSX.V:SGR).
    …… 
  CO:In terms of the larger producers, some of the names that we have on our top-10 would be companies like IAMGOLD, Goldcorp (TSX:G) (NYSE:GG), Kinross Gold Corporation (K.TO) (NYSE:KGC)—we like all those names. In the slightly smaller areas in the development stages—and Jamie mentioned some of them—Osisko is going to be bringing on a mine in Quebec next year. Lake Shore Gold is ramping up right now. Allied Nevada just commenced commercial production.
      ….
  TGR: During 2008 you increased your bullion percentage, but I see right now from fund stats that bullion is at 5%.
   
  CO: As we all know, the market was horrible last year. Gold stocks were being treated like any other stock; they were, in fact, probably being treated worse. So we felt that bullion was probably better, and increased the bullion weighting. We actually ramped up bullion from single digits to about 20% when we peaked in November, and that was because we liked the defensive nature of bullion. In retrospect, the bullion held up much better than the stocks, so it was a good thing to do.
   
  As we looked at the valuations last fall, we said, “You know what? These stocks are so cheap it’s ridiculous,” and we started to reduce our position in bullion and redivest into the market. If you look at what’s happened since that point in time, it’s been a good call. We’ve taken our bullion down to about 5% of the fund, and if you look at the stocks, year-to-date, we’re up 50%. If you look at gold bullion itself, in U.S. dollars, it’s up 5% to 10%. In Canadian dollars, I think it’s actually flat to down.
   
  TGR: Well, that turned out to be a brilliant move. Let’s talk silver. Many people are saying silver is really going to run up faster than gold due to its increased volatility. Do you have any thoughts on silver, and is it a counter-hedge inflation play like gold?
   
  JH: We like silver. We expect silver to move with the gold price. Obviously, silver is often viewed as poor man’s gold. Basically, it’s easier to buy in smaller quantities because it’s cheaper by the ounce and it’s easier to store for the smaller investor.
   
  If we want to look at a cycle and break it up into thirds, during the first two-thirds of a gold cycle, as we see it, silver largely trades as an industrial commodity. But in the last one-third of a cycle, it tends to play catch-up to the gold price and close that silver-to-gold ratio. So, historically, if you go back to 1971 when gold really came off the gold standard and you look at that silver-to-gold ratio, the median has been about 55- or 56-to-1. If you go back to the 1980s, it’s hovered around 65- or 66-to-1. We got as high as, I believe, 81- or 82-to-1 in that gold-to-silver ratio, and now we’re back down to that 65-to-1 range. So, it depends on your viewpoint of how much movement you see in the silver price going forward. As we see the precious metals or gold price appreciate, we obviously expect silver to move along with that.
   
  TGR: In the last third you would expect it to move faster than gold, but it would really be more of a spike?
   
  CO: If you look at what’s happened in the last six months, silver has way outperformed gold. And I would say it’s now sort of getting to that point where it’s pretty close to fair value with gold under the models we’ve been running. So I am almost indifferent to owning either gold or silver right now, but silver’s momentum from the last six months is probably still with it somewhat. So, it could overshoot to the downside, but, again, I think I am largely indifferent at this current level.
   
  TGR: Are there any other observations you’d like to convey to our readers who are precious metals investors, as we look across 2009?
   
  CO: Last year was very tough—it really took a toll on all of us. I’ve got scars on my back to prove it still. What I want to say is continue to believe in that higher gold price because that it is going to come. I am still convinced of that. Keep the faith.
   
  JH: I was going to make a comment along similar lines. You know there were a lot of people who, I think, were in a very similar cycle from 1965 to 1984. We’re experiencing that again, and we’re in the ’73 – ’76 volatile sideways market. A lot of people made significant money from that first gold move from $35 to over $180 an ounce. And then a lot of people lost the faith during the quantitative-easing phase in the sideways volatile market and got squeezed out of gold. Whether you believe in this conspiracy theory or not, gold was pushed down to $100—or just below a $100—an ounce and missed that last euphoric run from ’76 to the early ’80s.
   
  So, as Charles said, I would keep the faith; don’t lose sight of the larger picture. Don’t lose sight of the quantitative easing and the debasement of currencies versus hard assets and real things, and you will do well going forward.

Disclaimer – I am not a financial advisor. This is not an advice to buy, sell or hold any stocks or bonds or any precious metals.

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