John Embry - Gold ReportHere is an interesting conversation with John Embry and where he thinks gold is going by the end of this year.
WizWiz
The Gold Report: Quite a bit's happened since thelast time we spoke with you back in September of '08. Gold was $874 atthat point, and then dropped considerably in Q4. It has come back in'09, trading in the range of $850 to $950. Is gold still tethered tothe dollar?
John Embry: I don't know thatit's tethered to the dollar per se. Basically, there's a major problemwith the dollar. I believe it is absolutely fated to fall dramaticallyagainst everything, but more against real assets than against othercurrencies. When I look at the other currencies, they don't look verygood either, particularly the Euro and the Japanese yen.
They'retrying to create the impression that paper currency is still good; sothey go out of their way to try to pound gold at every opportunity. Aweek ago, clearly gold was tethered to the dollar on the downside, buton the other hand, for the prior few weeks when the dollar was underenormous pressure, there was still restraint in the gold price. It wentup, but it should have gone up a lot more. They put pressure on to keepit from going up too much, and with an opportunity for a strongerdollar, they knock gold down. It's been the same format for a longtime. But we're getting close to the end of that.
TGR: Why's that? What's going to push it over?
JE: There's no question what's going to push it—the realization that the U.S. is broke.
TGR: Who doesn't realize that already?
JE: Well, 90% of the people don't. Ask the average citizen. They don't have a clue what's going on.
TGR: So we need the public to figure this out.
JE:Absolutely. The U.S. budget deficit is going to be 13% of GDP. That'sunheard of for the world’s reserve currency. There's no way you get outof that easily.
TGR: But most people aren't in the market anyway, so why would their realization affect the price of gold?
JE:Oh, it's not them; it's the people with the money—the people in the FarEast and the Middle East. They will just want out of currency and asquickly as possible.
TGR: Why aren't they buying gold now?
JE: They are. They've already started.
TGR: So why hasn't the price gone up?
JE:It has gone up. But the fact is that, with the paper gold market, ifyou look at the short positions that the commercials, that the bullionbanks, which are the agents of the U.S. government are running, it's acomplete fraud.
TGR: How so?
JE:Because they couldn't possibly deliver on their paper promises if theywere called by the people on the other side of the trade. The goldisn't there to deliver. They've cleaned out most of the western centralbanks. So we're real close. I think gold will be $1,500 before the endof the year.
TGR: When we had the last spikein gold back in 1979 and 1980, was that predominately U.S. individualsor were people buying it globally?
JE: Itwas more U.S. then because, at that point, the U.S. was still therichest nation in the world. Now, the money has gone primarily to theEast. They're the ones that own all the dollars and the ones becomingmore and more concerned about it. This charade with Geithner over inChina, what a joke that was. He spoke to a bunch of students, who brokeout laughing when he said the Chinese assets in the U.S. were safe. Hecouldn't even fool the kids.
TGR: But as youpoint out, so many American people—the clerks at the checkout stands,the butcher, the teachers—don't know what's going on.
JE:They don't. What will inform them is the inflationary impact that willreally start chewing into their standard of living if the dollar fallsthe way I believe it's going to. That hasn't happened yet.
TGR: But U.S. unemployment hit its highest level in 25 years last month. Isn't that chewing into their standard of living?
JE:Yes, for people who have lost their jobs. However, 9 people out of 10still have their jobs and are pretty much maintaining their standard ofliving. That will change if the dollar falls to the extent that Iexpect, which will be fairly precipitous.
TGR:If you project gold going to $1,500 by the end of the year, are youprojecting that the inflationary period will begin before the end ofthis year too?
JE: Not in a dramatic way. Itwill be in the early stages. This obviously presupposes that the dollarwill fall in that environment, but yes, as the dollar falls, you'llstart to see more inflationary implications in my opinion. There willstill be a lot of people out of work and it will start affecting thosewho are working. I think that will have a rather negative impact on theoverall U.S. economy as well.
TGR: What are the implications of all of this on investments, be they in gold or whatever else?
JE:Personally, I have a significant proportion of my own wealth in goldand gold shares. I like most hard assets. What I wouldn't own arefinancial assets, such as bonds or bank deposits—and certainly notbanks and financial institutions. If what I foresee comes to pass,there will be rewards for being in hard assets. That will protect you.
TGR: Will any particular catalyst make the populace wake up and realize that the jig's up?
JE:It's more an issue of the confidence of the people who have to buy thedollar to keep everything afloat. That's the Chinese, the Japanese andvarious entities around the world. The U.S. budget deficit is so hugethat if this plays out, more people are going to start to realize thatwhen the U.S. is forced to monetize the debt, they’re printing moneyand creating the backdrop for considerable inflation.
TGR: It's like the ultimate negative amortization loan. The balance just keeps getting bigger and bigger and bigger.
JE:I know. I debate with people who are deflationists; we talk about itall the time. I could see the thing going to deflation, if this allfails and the whole thing just kind of collapses. But I am from theschool that if you have a total fiat monetary system, which we havetoday—there's nothing backing anything anywhere—you can create as muchas you want out of thin air. The U.S. has done a pretty good jobrecently, trying to fight off the financial issues over the last 12months. The amount of money created is really something.
TGR: Isn't that true of practically every other country on the planet?
JE:Yes. Other countries don't want their currencies to go up sharplyagainst the dollar, so they're forced to print their own currency totry and support the dollar a bit. That leads to sort of a globalinflation, which I think is the ultimate outcome. That's why I lovegold.
TGR: Jim Dines' newsletter recentlyhad a chart of all the global markets, and they're all up like the Dowand the S&P—everything across the board. And people like IanMcAvity, Rick Rule and others are talking about this as a suckers'rally, and saying that we're going to have another big drop.
JE:I think it is a suckers' rally. One of the things driving it up isobviously excess liquidity being put into the system. But on the otherhand, a lot of people think this rally is for real and that because themarket's up, the economy is going to recover. I think the economy willhave a minor recovery, but not nearly enough to support the levelsequities have already achieved. So I agree with as Ian McAvity and RickRule and that gang that we will see another significant test in theequity market. This could be an ugly summer.
I don't see anyeasy way out of this employment (or unemployment) problem that we'reconfronting, either. I think that's going to be ongoing, and again,more and more people out of work isn't particularly bullish for theoverall economy.
TGR: What do you see the economies doing globally?
JE:I see some sort of minor recovery. But if a recovery were to have anyrobustness, interest rates would rise sharply, and with debt levelsstill excessive, higher interest rates would put a very quick end toit. Consequently, I don't think we can have sustainable growth any timesoon. Instead, I think we'll see periodic rallies followed by furtherdowndrafts. So I am not bullish on the economies for the next few years.
TGR: Not even China?
JE: They're pumping it up so badly that they may have an inflation problem sooner rather than later.
TGR: What will come first—the market braking or the dollar falling? Or will it be simultaneous? Is there any correlation there?
JE:Well, it's interesting. Right now, it almost looks like the wholesystem's trading on an algorithm because when the dollar goes up,equities go down and bonds go up. In the fullness of time, conceivablythe market may brake first, and the dollar may come afterward.
TGR: When the market brakes again, will it be different from last fall?
JE:That perfect storm of negativity will not happen again. That was aboutas bad as it gets. I had an interesting anecdotal experience last week.I saw a wealthy acquaintance for the first time since the depths of themarket decline. At that point, he was morose. Now he's absolutelyebullient, thinking the higher market is just great, nothing but blueskies ahead. I think that's a bit of a theme out there. Later that sameday, I ran into a good friend, one of the better proprietary traders inCanada. He was making the same points that I am. He thinks this summeris going to be extremely ugly and that the public has it all wrong.Before long, we will see who's right.
TGR: So it could get ugly but you think not quite as ugly as last fall?
JE:Not that ugly. In terms of gold and gold shares, particularly, that wasthe cleanout that got rid of everybody who didn't really know thereason for owning them in the first place. I'd never seen anything likeit, to be quite honest. I was dumbfounded. The fundamentals hadn'tchanged much, but perceptions did. And people threw the baby out withthe bathwater.
I actually bought a lot of gold at that point. I bought some shares, too, and already have a couple of five-baggers.
TGR: On that note, what stocks you would have our readers look at today?
JE: I don't do a lot in stocks any more, but I wouldn't change many of the ones I picked last time. Wesdome Gold Mines (TSX:WDO),for example, has done well. It was driven down to as low as 40 cents inthe doldrums last fall, and it's traded up to $2 recently. In the goldmarket I see, Wesdome will make an awful lot of money. It made 8 centsper share in the first quarter, and that's what I want. I wantsomething in production and in a safe geopolitical environment. If I'mright on the gold price, there are so few good vehicles that they willattract a lot of money.
The larger ones—such as Barrick Gold Corporation (NYSE:ABX), Goldcorp (TSX:G) (NYSE:GG),Agnico-Eagle Mines (TSX:AEM), etc.—are all expensive. You have to ownthem if you have a large portfolio because you can't get enough intothe smaller ones. That's why they will become even more remarkablyoverpriced.
TGR: Are there any other smaller production companies in safe geopolitical environments that you like besides Wesdome?
JE: I like Lake Shore Gold Corp. (TSX:LSG);I own a lot of that. Colossus Minerals Inc. (TSX:CSI) down in Brazil,Andean Resources (TSX:AND) (ASX:AND) in Argentina, and a number inCanada, such as Rubicon Minerals Corp. (TSX:RMX) (NYSE.A:RBY) and Premier Gold Mines Ltd. (TSX:PG).The list unfortunately isn't as long as you might think. Some of thesearen’t in production yet but possess exciting ore bodies.
TGR: What would you advise investors who are just coming into the gold market?
JE:I was responding to a questionnaire recently about how to construct agold portfolio in today's market. If you're being relativelyconservative, you would always have a solid core in bullion. I don'tmean ETFs. I mean real bullion or a vehicle where you can audit thefact that the gold is there and not just trust someone saying that itis.
TGR: How much would you put in that core holding?
JE:Physical gold would be 20% to 25% of my portfolio. But for theequities, as I indicated, I would not focus on the majors whereeverybody huddles and prices are too high. Instead, I would tilt mystock positions—the major weight of my stock portfolio—toward thosesmall producers and explorers with legitimate projects that arereasonably advanced. Getting into the really junior explorers, you'dhave to know the company to make sure you have a real asset to takeadvantage of the rising gold price.
TGR: So would you put maybe 50% of your gold investment in those smaller producers?
JE:Yes, small producers and advanced exploration vehicles. I'd put another25% for the sake of stock liquidity into some of the big ones. The bestof the big ones is Gold Fields Ltd. (NYSE:GFI)(JSE:GFI);given their reserve base, their discount for having half their assetsin South Africa, and the fact that it's relatively very cheap.
TGR: But you see the real opportunities in the smaller stocks because that's where you get the leverage?
JE:You get huge leverage and, right now, the public isn't there in any bigway. We've seen some strength recently, but nothing compared to whatwill happen if gold makes a clean breakout through $1,000 and reallystarts moving—which I think will happen. At that point, investors willwant exposure and, quite frankly, the whole sector's market cap is sopuny that it won't take much to really drive these stocks north. I'mquite convinced that there will be numerous 5- and-10 baggers over thenext few years.
TGR: Even after the run-up they've had already?
JE:They're barely back to where they were a year ago. The big surprise isthe degree to which they fell. And there's one other thing. What does$950 gold mean for gold equities? Believe it or not, $950 isn't a goodprice for the economics of gold mining. There's been a lot of smoke andmirrors about the economics of this industry. The fact is that it'sstill very expensive to mine and that is why gold mining production hasbeen falling steadily now for three or four years.
I thinkit's going to take dramatically higher prices to lead to expansion ofgold mining output, and when higher prices are realized, it will takeyears to achieve the actual higher output.
TGR: Where does that price have to be for it to make economic sense?
JE:I think at $1,500 you'd get good returns on the capital employed. Thisis a very risky, hard business; and if you're in it, you deserve to berewarded for your efforts. If you look at returns on capital over thelast 15 to 20 years, they're pathetic if there's any return at all.That's going to all change one day.
The thing that peoplehave to realize is that the central banks and the western governmentshave made a concerted effort to control gold because they see it as themajor competition for their fiat money system, which is failing. Andwhen it fails—and it will—that's when gold comes into its real heyday.
TGR:You said you don't do a lot in stocks any more. Who's doing theday-to-day portfolio stock picking at Sprott Asset Management?
JE: Oh, we've got a great team—Charles Oliver and Jamie Horvat. They're absolutely outstanding.
TGR: And what are you up to?
JE:I spend most of my time studying the macro. It's a good time for thatbecause I think it's going to be the thing that separates the men fromthe boys. For most of my career you could assume a relatively levelplaying field, but we're in a situation now that none of us has everseen before. People are just throwing stuff at the wall to see whatwill stick.
I'm from the school of Austrian economics, and Ibasically believe that all economic cycles are credit cycles. We hadthe mother of all credit cycles. It broke, with far too much debt inthe system, exacerbated by derivatives. There's no easy out. You can'tjust recreate what we've had because we overdid it. The idea that wecan print ourselves out of debt is not going to work. It will lead tosome sort of hyperinflation if it's successful, but the economy will besloppy at best.
This is not novel thinking on my part. Justlast week Angela Merkel, the German Chancellor, did something a Germanpolitician has never done before—she criticized central banks. She saidwhat the U.S. and Great Britain and the European Central Bank weredoing in terms of ‘quantitative easing,' which is just money printing,is wrong and won't work. In fact, it probably will exacerbate problems.I think Ms. Merkel must be a bit of an Austrian economist at heart andI certainly don't disagree with her.
But if they don't keepcreating money, we will have some sort of deflationary event, and theone thing people remember clearly is the 1930s. Nobody thinks abouthyperinflation very often, because very few have experienced it.
TGR: That's true. The poor souls in Zimbabwe.
JE:I don't think we'd ever get anywhere close to that on a worldwidebasis, but we could certainly see some very unpleasant inflation asgovernments continue creating more money just to keep the debt afloat.Hyperinflations always have been contained within a region. Clearly Idon't think a global experience would be as preposterous as some of thedomestic, local hyperinflations but it would be worldwide inflationlike we've never seen before. It certainly would dwarf what we saw inthe '70s, which was pretty bad.
TGR: How high might the inflation rate rise worldwide?
JE:I don't know. It tends to be an accelerating factor; you can't get to30% before you get to 10%. I think it's headed in that direction, butit will take a little while to stick. We're nowhere close to 10% yet.Ask me again when we get to that point.
I certainly canpicture Americans taking it worse than a lot of other people who havebeen the underdogs over the last 60 years. It's a matter of relativity.In the post-war era particularly, America has clearly been top dog; andbecause of that Americans have been somewhat insulated in many ways.They can't imagine hard times. I don't think they really have anyominous sense that there's something going horribly wrong yet.
DISCLOSURE: John EmbryI personally and/or my family own the following companies mentioned inthis interview: Wesdome Mines, Lake Shore Gold, Goldcorp. I personallyand/or my family am paid by the following companies mentioned in thisinterview: None
John Embry is chief investment strategistat Sprott Asset Management and Sprott Gold and Precious Minerals Fund.He also co-chairs the Central GoldTrust Board of Trustees. An industryexpert in precious metals, John's industry experience as a portfoliomanagement specialist spans more than 45 years; he's simultaneouslyresearched the gold sector for 30-plus of those years. He joined Sprottin 2003, after 15 years as Vice-President Equities at RBC GlobalInvestment.
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