Gold: How Much is Enough?

Five per cent...? Ten per cent...? Try nearer 20% says this four decades' veteran...

The GOLD REPORT recently caught up with John Embry, chief investment strategist at Sprott Asset Management, to get his thoughts on gold and Gold Mining stocks.

An industry expert in precious metals, John Embry has worked as portfolio management specialist for  more than 45 years; he's simultaneously researched the gold sector for 30-plus of those years. He joined Sprott in 2003, after 15 years as Vice-President Equities at RBC Global Investment.

Here he tells the Gold Report about his outlook for strong Gold Price gains in 2010...

The Gold Report: John, in Investors Digest of Canada you recently said you're expecting gold to gain another 30% this year...

John Embry: I would say at least 30%. I said that I thought it would be the best year to date. We've had nine years consecutive higher year-end prices and the best year in that span for a year's return was 31%. I think this will be the year that we exceed it in this, the 10th year of the bull market.

TGR: Why is this year going to be the best year?

John Embry: I think we're getting very close to the point when a greater proportion of the public realizes the degree of difficulty that sovereign debt is in. And at that point, when you can't depend on your government paper as a safe haven, I think that fact puts gold in a much better light in more people's eyes.

TGR: You might say the first leg down were the individuals who couldn't pay their mortgages and that caused part of the '08 collapse. And now it looks like it's the government...

John Embry: It's very simple, actually. Private demand, as you know, was so weak that governments had to step in to maintain order in the economy and in so doing, they spent an enormous amount of money, at the same time that revenue streams fell because of the weakness in the private sector. Governments spent dramatically more money and the results are a budget deficit I never thought I'd see in my life. I'm shocked at the numbers in many places.

TGR: When you talk about gold, you're talking about Gold Bullion. But how do you see the gold stocks? Do you think we're going to have a pullback? Ian Gordon of Longwave Analytics and Richard Russell (Dow Theory) predict the Dow will go to 1000.

John Embry: I don't agree with them. As much as I love Richard Russell – he's probably been as big an influence in my career as anyone – I don't think that deflation is necessarily the outcome when you have a pure fiat currency system. I think the far greater risk is hyperinflation because I believe that these guys that are in control today have seen the depressionary '30s, and they will move heaven and earth to prevent that outcome. And when you've got the capacity to create unlimited money, I believe you can do it. So I hear Gordon and Russell and I respect them, but I'm in the camp that thinks we'll get hyperinflation first. We'll eventually have to clean out the debt, but I think we go hyper before that.

TGR: So hyperinflation. Would that include stocks as well?

John Embry: I think stocks will do fine. They may have a violent correction first because a lot of people don't know what the heck we're talking about here. And when they see inflation mounting and economic conditions being less than ideal, they'll sell their stocks. But the fact is that if you go back and look at any hyperinflationary environment anywhere, stocks did infinitely better than paper instruments. So precious metals first, stocks second.

TGR: When you're talking about stocks, you're not talking just about Gold Mining stocks...?

John Embry: No, I'm talking about good businesses. I'm not talking necessarily about banks and other stuff that's more dubious, based all on paper, but businesses like breweries, for example. People are always going to drink beer and a good brewing company will do exceptionally well in the debased currency of whatever country it's in.

TGR: So you think that we might have a sell-off and in that sell-off all equities, including gold stocks, would go down.

John Embry: Gold stocks, maybe. I believe the next time everything goes down, gold isn't going down. And if that were to be the case, I think gold stocks might surprise. They've been awful. Given what the Gold Price has done, gold stocks, by and large, have been awful.

Well, the well-promoted ones and the odd good one have done okay, but across the whole list, it's been pretty hard slog over the last three or four years, particularly 16 to 17 months ago when it we hit bottom. I thought they were going to zero.

So many of them are trading at less than they were back in November 2003, which was the real peak of the excitement in gold stocks, if you can imagine. Six and half years ago. The Gold Price has done nothing but go up in that time.

TGR: In this next cycle are you seeing better returns for producers or the juniors that have pounds in the ground?

John Embry: Oh, I think the juniors. The whole thing is a matter of confidence. They've got so much volatility in the Gold Price. You get a good thrust up and you got a violent correction and I think they've got so many people discouraged and going the wrong way on these gold stocks that right now the degree of confidence is very low. If I'm right and the Gold Price stages a dramatic breakout in the next 12 months – and I'm talking hundreds and hundreds of Dollars on the upside – then I think the confidence will return and people will seek an outlet in gold stocks because so many of them have been beaten up. More importantly, the overall market cap of all the gold stocks is really small in the context of all the money around.

TGR: What's the seasonality of this year?

John Embry: I think that probably we may continue to wallow around here for maybe the better part of another month. Maybe not quite that long. But, historically, mid-March to mid-May has been a really good period. When I look at the fundamentals and everything that's going on, I see no reason why it shouldn't be a very good period this time. And there's one other development. I don't know whether it will come to fruition, but on March 25th the CFTC is going to be investigating position limits in gold and silver on the Comex futures market. And if they ever put any teeth into those things and kept these bullion banks from what they're doing on the short side with their large positions, I think that could have a salutary impact on gold and silver prices.

They're finally going to have to address this because there's been so many complaints about the bizarre price action on the Comex in both gold and silver.

TGR: The International Monetary Fund is going to be selling some gold, and India stepped up earlier. What are your thoughts on that?

John Embry: The whole thing irritates me. The IMF has announced the sale of this gold 500 times and every time with the express purpose of knocking the price of gold down. It was interesting the last time when the Indians actually relieved them of over 200 tons because that was what basically vaulted the market from about $1,045, which the Indians paid, up to $1,225 in the space of less than a month. That has been followed by the third significant correction in the last three or four years.

I think we've seen the vast proportion of the correction and I think what may be one of the factors that could get this thing going again is when somebody does relieve the IMF of the gold, the 191 tonnes still to be sold.

There's speculation that India might be prepared to go to the plate again because the Chinese have been reluctant to step up. Number one, I don't think they want to be seen publicly doing it. They'd probably rather do it more clandestinely because they've got so much money to convert into hard assets. And, secondly, as somebody pointed out, the Chinese at least have a domestic supply of gold. They can buy all their domestic output to augment their reserves, where the Indians really don't have that.

So I think the Indians conceivably have a bigger vested interest here in taking that IMF gold. And there's also sort of the suggestion that the Chinese wouldn't want to be seen to be paying more than the Indians did. So they're reluctant to step up with the Gold Price some $50 higher currently than the Indians paid.

If gold really was a free market, if they were really prepared to sell it to anybody, I think I could name any number of institutions, organizations, individuals that would be more than glad to relieve them of it. It's not much money. It's $6 billion. They throw it around as if it's a big deal. Heck, given the budget deficits in some of these countries, $6 billion is literally a piss in the ocean.

TGR: What did you think when George Soros came out and said that gold was a bubble?

John Embry: I wrote about that and I got it right. I was very pleased about that because some people got all upset. The people that were negative on gold thought this was great, brilliant George Soros doesn't like gold. But if you read between the lines, if you read really what he said, he said gold is the ultimate bubble, but he didn't say gold is currently the ultimate bubble. I believe that it will be the ultimate bubble. I think the Gold Price is going to go crazy and at that point I'd be worried. And then it came out after the fact that Soros had been a major buyer of gold for his funds in the fourth quarter. So who knows what he was doing? The fact is, depending how you interpreted his remark, he was speaking at Davos, which is a very mainstream event, and he said something that can be interpreted any number of ways.

TGR: And, again, I think the financial talking heads used it as the negative.

John Embry: Absolutely. The mainstream guys were all over it. The guys who have never like gold have been wrong all the way up and said, oh, my god, George Soros doesn't like gold. But I think George Soros' remarks were misinterpreted and if you saw what he was doing, not what he was saying, he was Buying Gold...

TGR: Any last comments?

John Embry: The only comment I'd make is I really think things are sufficiently serious here in a financial or monetary debasement sense that everybody – and I have never been a table pounder – but I think every single person with a serious portfolio has got to have a reasonably significant exposure to precious metals. This isn't something that's just insurance for those who've got cold feet. This is something I think is a mainstream thing that people must have.

TGR: When you say a significant portion, what percentages are you thinking?

John Embry: I used to say 5% to 10% when it was just an insurance thing and the market was pretty sanguine. I say at least 20% now. I see the other assets as being less attractive. I wouldn't buy a bond if you gifted me with the money to do it.

TGR: John, once again, I appreciate it.

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