Gold News

Debt, Crises and Gold Mining Stocks

The issue to worry about is debt, not the fiscal cliff...

DEBT is what concerns Jason Hamlin, publisher of the Gold Stock Bull newsletter. If Jason's prediction of Euro breakup comes to pass, he reckons it will bolster the case for Gold Mining equities. He shares his preference for royalty streamers and prospect generators in the gold space and explains his attraction to graphite in this interview with The Gold Report

TGR: Jason, you recently told your Gold Stock Bull readers that you had sold some equities. What were your reasons for selling?

Jason Hamlin: At the time, we were nearly fully allocated and decided to move to a position of roughly 20% cash. Even though this is a high seasonal period for precious metals, we sold a couple of underperformers to take advantage of any potential year-end selloff driven by concerns about the fiscal cliff and its impact on economic growth. There are also year-end opportunities for tax-loss selling and we want to have some dry powder for bargains that may materialize over the next few months in quality resource stocks.

TGR: Do you believe investors should reduce risk and take a more conservative approach until we know what are the repercussions of the fiscal cliff?

Jason Hamlin: I do not. It is sensible to always have some cash available for a selloff, but I do not view the fiscal cliff as some Armageddon-type event like other analysts. I think the politicians will come to a resolution before things become too explosive, but we should never discount their ineptitude.

For me, the true issue here is debt, not the fiscal cliff. Debt is the root cause of nearly all of our economic and social issues.

As it is a mathematic impossibility to ever pay off all of the outstanding debt, neither tax increases nor austerity will solve the debt crisis. As all money is created out of debt and the interest owed back does not exist in the system, the only workable solution is liquidating or forgiving the debt. As controversial as that might sound, one only needs to look up the term "debt jubilee" to see how often it has been used throughout history to clear the slate and allow for a fresh start. So, without getting too detailed, the fiscal cliff in the US, debt crisis in Europe, student loan crisis, home mortgage crisis and every other monetary crisis can be tied back to the fact that our monetary system at its root is unsustainable.

TGR: Do you have a calculation that illustrates how difficult that would be?

Jason Hamlin: One way to view that is to look at the percentage of the US budget now being put toward interest on the debt and how it has grown over time. As long as that percentage keeps increasing, it means less and less money is available to spend on legitimate needs and to direct toward growing and driving the economy. This expanding debt burden stifles any type of economic growth that might otherwise be possible. Until our leaders are honest about our debt predicament, balance the budget to stop the bleeding and face the necessity of massive debt forgiveness, my forecast is for continued slow economic growth with the potential for contraction in the near future.

TGR: What are the threats to the average retail investor, especially in the precious metals space?

Jason Hamlin: I believe that another banking crisis could be on the horizon, driven by the large amounts of toxic derivatives and potential revaluation of assets that could render many big banks insolvent. The same kind of threat we saw in the 2008/2009 crisis is still hiding under the surface, as it was only papered over to buy time, rather than addressing the core issues. This could lead to a sell-off in all assets including gold and another rush to the perceived safety of Dollars. However, I predict that the deteriorating faith in fiat currencies will translate into a very short dumping of true safe-haven assets such as gold and even quicker rebound that we witnessed following the last financial crisis. Given this outlook, I think it is wise to hold through such corrections and keep cash available to take advantage of the panic selling that will occur if such a crisis materializes. 

TGR: While we are talking about the future, do you have any other predictions for 2013?

Jason Hamlin: On a positive note, I think the world will survive the end of the Mayan calendar.

Seriously, I think the Euro will fall apart when one or more countries leave. The strong countries will only support the weaker, over-indebted countries for so long before realizing that their sovereignty is more important than the Euro. I think dissolution is absolutely the right course to take, as the concept of the Euro was flawed from the start. 

TGR: But the European Central Bank (ECB) has vowed to do everything in its power to stabilize and keep the Euro together. Can or should the ECB stave off disintegration at least until the end of 2013?

Jason Hamlin: I think the ECB will try its best, as centralized banking has much to gain from the Euro staying together. This attempt will surely involve more bailouts, stimulus and money printing, which will be bullish for precious metals. Ultimately, I think the attempts will fail and we could see a split of the Euro as early as next year.

The ECB has constraints that the US Federal Reserve, operating in just one country and with the world reserve currency, does not have. The ECB cannot employ the same bag of tricks as Ben Bernanke and the Fed, so I think it has fewer ways to kick the can down the road. This is why we are seeing the crisis escalate first in Europe, but it will eventually come to the shores of America as we witness a loss of faith in the US Dollar as world reserve currency.

TGR: That makes a nice transition into gold. Precious metal investor Paul van Eeden recently said that gold is overvalued. Do you agree?

Jason Hamlin: Mr. van Eeden correctly pointed out that the problem in the US is not inflation, but debt. And I agree with him that the predictions for imminent hyperinflation are overblown. But that is where our agreement ends. 

I think his methodology for calculating money supply and gold's true value is flawed in that he incorporates worldwide gold supply, but compares it only to the US Dollar. Demand is strong worldwide and gold has been making new highs in several currencies, not just the Dollar. 

I also disagree with his notion that the Fed will be able to easily sell assets back into the market to control the inflation that is likely to occur. I'm not sure there would be many buyers of such low yielding bonds in an inflationary environment. The Fed is already forced to buy over 50% of bonds the government auctions during the current environment of relatively low inflation.

Mr. van Eeden has been calling gold overvalued for years now. I think he is a bright analyst and I enjoyed his commentary on gold earlier in this bull market, but he has now joined the ranks of a few other gold bears who have been consistently wrong about the gold price. They will eventually be correct about gold being overvalued, but I suspect it will be a number of years and a few thousand Dollars higher before that happens. 

That being said, I could see some sell-off in gold occurring as a knee-jerk reaction by leveraged investors, but interest rates would have to rise substantially above the true rate of inflation for any serious or lasting impact. Such a move would sink the stock market, which is not something the politicians or central planners would allow. They would prefer to print more money, debase the currency and present the illusion of continued prosperity rather than take their medicine. I do not see interest rates rising any time soon.

The only way to deal with a banking system that is so overleveraged and a government so burdened with debt is to allow the free market to reprice the debt—to reprice housing and equities to their true free market value. However, that would cause the banking system—and possibly the entire world economy—to collapse.

The alternative is to fire up the printing presses, inflate away the debt and hope that the bad loans will once again become solvent. If you study history, you are likely to forecast that the government will choose this option over a deflationary collapse, which will continue to push gold higher in Dollar terms. 

More broadly speaking, if you take two forms of money valued relative to each other (demand being somewhat constant), the one that increases in quantity faster will lose value against the other. Growth in the gold supply is relatively flat, about 1.5% annual growth. The growth of the supply of almost all fiat currencies ranges from 8–10% on average. To me, that says that gold priced in Dollars or any other currency being debased will go up in value relative to that currency.

The other factor to consider is velocity of money, which has been low and has held inflation in check thus far. But in light of quantitative easing (QE) to infinity, which is essentially what QE3 is, recent improvements in housing and the stock market, and some proposed legislative changes to get banks lending, we might see this change in 2013. If velocity picks up, we could see inflationary forces start to take hold. If just a small amount of all of the new money created over the past five years were to begin flowing through the economy, the impact could be significant.

TGR: You rely on technical charts for your advice to your readers. What do your technical charts tell you gold will do in 2013?

Jason Hamlin: I just ran this exercise for my subscribers, and came up with a chart showing the minimum target price of gold at $2,200 an ounce (oz) and over $3,000/oz on the high end by the end of 2013. These prices represent gains in the 35–75% range from the current price. It is a much more aggressive annual return than I would usually forecast—much higher than the average annual rate over the past 10 years.

However, precious metals have been consolidating for well over a year. The chart has an incredible amount of pent-up upside potential for 2013. Plus, the gold price is now bouncing around the bottom line of its trend channel. A failure to push higher and break $2,200/oz by the end of 2013 would mean that gold has fallen out of its long-term trend channel and signal the end of the bull market. I put the likelihood of that outcome at less than 5%. Thus, I think the official, inflation-adjusted high of $2,400/oz will be taken out within the next 12 months. 

TGR: Given that prediction, should investors be buying gold, gold equities or both?

Jason Hamlin: I recently published an article on this topic and the answer is: It depends. From 2001 to 2005, gold was up roughly 92% and gold stocks up 648%. In this period you would have seen seven times greater returns investing in gold stocks.

From 2006 to today, the NYSE Arca Gold BUGS Index (HUI) of gold stocks advanced by about 39% while gold itself is up 232%. That equals about a six times greater return for physical gold than mining shares.

However, if you combine both periods and look at the entirety of the current bull market, gold stocks have been the better investment. From 2001 through Nov. 12, 2012, physical gold has appreciated by 537%. However, gold stocks have gone up nearly twice the rate of gold for a gain of 936%. This is the leverage that seasoned investors remember and it drives our decision to allocate a significant portion of our portfolio to mining stocks. That said, I believe it is best to own both bullion and mining shares, because they serve different purposes.

Just from the start of August through mid-November, the gold price advanced 8%. Gold stocks were up 18%. That is leverage of roughly 2.4 times. It is hard to say if that will continue, but it is a positive sign for investors in mining stocks.

TGR: When you look at technical charts for precious metals equities, what do you look for, other than an upward trend?

Jason Hamlin: I view technical analysis as just another data point for reference, not as a panacea for forecasting price movements. In markets that are as manipulated as ours, where large firms tilt the level playing field via high-frequency trading and collocation, and banks use their leverage to push prices, I take technical analysis with a large grain of salt.

That being said, I look for the usual trend channels, support and resistance indicators, volume levels, momentum indicators, (Fibonacci) retracements, whether the stock is making lower lows or higher highs. I couple these insights with the timing of fundamental developments for miners: drill results, resource updates, upcoming preliminary economic assessments (PEAs) or feasibility studies to try to time our entry and exit points on trading positions. Our model portfolio also contains long-term holds or core positions that we do not trade.

TGR: What is your investment thesis for precious metals equities?

Jason Hamlin: The equities are undervalued right now relative to bullion. A lot of that has to do with distrust of the stock market and of Wall Street in general, after all of the fraud and failures in the past years. But if the market holds up for a while longer and current trends continue, I think we will see mining stocks continue to outperform gold.

TGR: Which precious metals equities are you telling your readers about?

Jason Hamlin: I have been an early advocate of the streaming royalty model in the mining sector. Streaming companies make an advance payment to a company with a pre-production stage mineral deposit in exchange for a negotiated percentage of the metal produced for the life of mine.

This model gives companies diversification and risk mitigation because it has agreements with several different miners. There is unlimited upside potential in that the deal is usually for a percentage of the production mine life and limited downside risk if a miner sees its profit margins squeezed as the agreed purchase price is fixed.

Streamers also enjoy an advantageous tax situation, with rates that are usually much lower than tax rates for mining companies.

TGR: What other models do you like?

Jason Hamlin: Another business model with great merit is the prospect generator model. It has some similarities to the royalty-streaming model that has treated us so well.

TGR: You also follow the graphite space. What is the latest news there?

Jason Hamlin: Overall, graphite is attractive due to strong supply/demand fundamentals. Prices have come back down from lofty levels last year, but have stabilized recently and remain elevated. This means that a number of graphite projects that might not have been economic in the past are economic today.

Given that graphite is a key ingredient in so many established industries, from aviation to automotive, steel and plastic, I see prices holding up well. However, future demand growth is likely to come from the high-purity, large-flake graphite that is used in lithium-ion batteries for electric cars and such.

People talk about the big run-up in lithium a while ago, but 10 times more graphite is used inside a lithium-ion battery than lithium. There will be significant demand as we move toward electric vehicles and electric-based power.

The other exciting driver in investment demand for graphite is the potential of graphene, which is reportedly the thinnest and strongest material ever developed. Graphene is 200 times stronger than steel, several times tougher than a diamond and it conducts electricity and heat better than copper. It could even replace silicone in semiconductors. Also, graphene is nearly impossible to break. You could throw a graphene mobile phone display on the ground and it will not shatter like the glass on current phones. Researchers claim graphene is the most important substance to be created since plastic.

There is a lot of potential for graphene in the expanding cell phone and green energy markets. The military has an interest as well.

TGR: Jason, thank you for your time and your insights.

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