Gold News

Black Swans & Entropy

A grim outlook for risk-taking makes gold and silver yet more appealing...

CONVINCED that gold and silver were at a bottom eight years ago, and wanting to give others a foundation for investing in resource stocks, Bob and Barb Moriarty launched 321gold.com – now receiving more than 1.8 million hits per month.

Now speaking here to the Gold Report, Bob urges an ultra-conservative approach to your portfolio, warning that "black swans" – defined by Nassim Nicholas Taleb in his book of the same name as events that come as a surprise, have major impact, and are later rationalized by hindsight as if they had been predictable – are threatening to swarm...

The Gold Report: How do you see the overall market these days?

Bob Moriarty: Investors need to understand fully the concept of Black Swans and of entropy. Entropy is the state of total chaos. Basically, all of life and all of physics goes from a state of stability into increasing chaos. It's very, very hard to predict exactly what's going to happen in the near future – the next six months to a year – because so many potential Black Swans are on the horizon.

Chrysler has gone broke now, GM is going to go broke in weeks, Chrysler just dropped 700 dealerships, GM is going to drop 2,600 total. They're dropping 1,100 now. All of this is adding enormously to the unemployment rate. The automobile industry is the financial backbone of the United States and it's going to have a substantial impact.

But basically the government's solution to any problem is to do more of whatever they're doing. The entire problem was caused by government in the first place. We need to go back to more savings and to real jobs. We need be exporting goods rather than pieces of paper. We need to develop a manufacturing economy. Unfortunately we're nowhere near that.

We need less government, not more. The government's taking exactly the wrong approach, slapping Band-Aids on very real problems. The American taxpayers have pumped $16 billion into GM and, while we need to rebuild manufacturing, that money is not going for factories in the United States. It's going for factories in China and Mexico. When the American people find out that the $16 billion is going to build factories in Mexico and China, they're going to be upset.

TGR: What are some other Black Swans? What would have our readers be on alert for?

Bob Moriarty: They're fairly unpredictable and the range is enormous. The bond market is on the verge of a crash. It's gone from $142 in December to $122 and the only thing that's propping it up is the Fed coming in and buying bonds periodically. When they run out of money, bonds are going to tumble and interest rates are going to go up. Even Obama said we're headed for trouble with a low Dollar and much higher interest rates.

The Dollar's on the verge of a collapse. We have the geopolitical situation in the Middle East. Israel seems intent on attacking Iran and we really need to solve that. The Middle East could easily start World War III.

TGR: What do you see happening in the markets?

Bob Moriarty: There has to be a lot of deleveraging. We could easily run into a situation like last fall. We have not come to the bottom of the stock market in any way, shape or form. The Bank for International Settlements (BIS), released derivatives numbers on May 19 and although it reports that the total notional amount of over-the-counter derivatives contracts outstanding fell a bit from the previous numbers, there's close to $600 trillion in derivatives outstanding. Nobody knows what is behind those bets. We could have forced selling in the stock market.

TGR: Are Gold Mining stocks in a good position, though?

Bob Moriarty: Forced selling could take the gold stocks with it. Gold stocks are low by historical standards; but if you get into forced deleveraging, you could get into a situation where people just dump everything. The stock market's going to continue down. It's nowhere near bottom. Housing is going to continue down and as I say, the government's doing exactly the wrong thing. They need to encourage savings; they need to reward savers. They need to encourage business to do smart things. People went out and bought houses they couldn't afford, the banks made loans they couldn't afford. It shouldn't be on the back of the taxpayers to pay for that, but it is.

TGR: According to the BIS, outstanding credit default swaps have contracted. Does that surprise you?

Bob Moriarty: Not really. Credit default swaps don't make any sense at all. They are like casinos taking bets on their own demise. Why would a casino bet that it's going to fail? That's what a credit default swap is – getting into a situation where a lot of people have a vested interest in seeing it fail. A lot of GM bondholders would be better off in bankruptcy court than they would with GM continuing operations. So there's some really dangerous stuff.

The credit boom of the last 40 years has set up enormous instability. We need to wipe out all the bad debt, we need to start over, and that's what the government refuses to do.

TGR: Is this unique to the US government? Or are other governments, such as those in Europe and Asia, doing the same thing?

Bob Moriarty: Absolutely. Everybody's doing it. We're just doing it in far greater numbers. The United States government is in debt to the tune of $60 trillion. We are bankrupt in every way you can measure it. I'll give you a perfect example.

I was talking to the president of a mining company that I wrote up about six months ago and asked how he was doing. He said, "We can't get our drill permit. We drilled last year and these guys are dawdling with the drill permit. We've got the equipment on site and we've got the people and we can't get them to sign off on the drill permit." I said, "They'll get around to it sooner or later." He said, "That isn't the worst of it. Immigrations won't let our chief geologist through Customs. He's been in the United States 200 times. They said, 'You need some more paperwork'."

We need less government. We need government to get out of the way of the people who are trying to drill, out of the way of people who are trying to build mines, and out of the way of people who are trying to come to the United States and create wealth.

TGR: What's an investor to do? It sounds like we're worried about total financial collapse, we're looking at the general financial markets going down, we're looking at major countries going bankrupt. How do you play this market?

Bob Moriarty: It's a time to be very, very, very, very, very conservative. When you have a bubble – and this has happened in every bubble in history – it takes a generation for that bubble to clean itself up. Real estate is over for a generation. The stock market is over for a generation. We're probably going to have another bubble and for all I know it could be Gold Bullion and silver. The government is just pumping money into the system. At some point, it has to result in hyperinflation and destruction of the Dollar and probably of the United States.

It's a time to be ultra conservative. It's a bad time to be buying real estate, a bad time to be investing in the general stock market. An investor must – and I repeat the word MUST (in big capital letters) – have some gold and some silver for immediate expenses in case of a total collapse of the system. The only safe investment I personally can think of is to invest in resource stocks and preferably producing resource stocks, producing gold and silver resource companies.

TGR: Are you limiting it to precious metals? What about other resources?

Bob Moriarty: As I've said in the past, you need to invest in things. If currencies around the world are going to fail, you want to own things – energy and the other commodities, copper, lead, zinc, nickel, platinum. The prices have gotten hammered so bad that the number of mines shut down has actually been greater than the reduction in demand. So copper is as much in shortage today as it was a year ago. Natural gas, oil – everybody can stop producing everything and that will create some tremendous opportunities, but this is not a time to be taking financial risks. It's a time to be ultra-conservative.

TGR: And part of your definition of ultra conservatism is to own physical gold and silver and also producing or near-term producing gold and silver companies. You have also mentioned energy.

Bob Moriarty: This is an example of how investing is quite simple. You have to be a contrarian. Everybody wants to see gold go up 20 days in a row and on the 21st day they think it's finally safe to buy. Likewise, the stock market goes down 20 days in a row and on the 21st day they think it's finally safe to sell. They always end up buying at the absolute high and selling at the absolute low. They do it because we are by nature a crowd animal. We want to swim in schools; to do what everybody else is doing. If you're going to be a successful investor, you have to do exactly the opposite. You want to buy things when nobody wants to touch them with a 10-foot pole.

So, I would not suggest people buy energy hoping $147 oil goes to $200 a barrel. But natural gas got down to about $3.60 and almost every rig in the world has been shut down. That's exactly the time you want to invest in it. We know peak oil is real and that we need energy even if we're in a massive depression. We know we need food and food is an analog of energy. CBM is drilling in Indonesia and will know a month from now where they stand. That's exactly the time you want to invest.

TGR: If we're going to be crashing at the end of this year or next year, why would we wait 15 years to get into the general stock market? Why not in late 2010?

Bob Moriarty: The absolute low in the 1929 crash came in July of 1932, but it took until 1954 for the stock market to get back to where it was in 1929. The market moved nowhere for 25 years.

When everybody hates stocks, that's when you want to get in. Right now we're going to crash. We've got the biggest suckers rally in history going on. We've got record short selling by insiders. They're the people who know the best and the market's already started down. If you look at the charts since the first of May, it's an accident waiting to happen. I like markets like energy; everybody hates energy now. That's a wonderful market to be in.

TGR: We're talking about May being a good time to 'sell and go away' except for the resource stocks. So if I look at various portfolios, what would you recommend at an aggregate level should be the allocation of an investor's portfolio right now?

Bob Moriarty: That's a really good question. Back in 1998 or 1999 I read something about investing the same percentage of your assets in gold and silver that you give the probability of a financial collapse. If you think there's a 10% chance of financial collapse, you should put 10% of your assets into gold and silver. So we put 100% of our assets into gold and silver and that's where we've stood ever since.

TGR: If we get a Black Swan and the market falls off another cliff – looking at an S&P of 450 – won't it take these stocks with it again?

Bob Moriarty: I don't think so. Everybody has forgotten that gold did exactly what it was supposed to. Gold went from $1,030 an ounce in March of last year to $770 or $780. But while gold was going down 30%, everything else was going down 50% or 60% or 70%. What you've got is an enormous number of paper assets that actually have no real value and the system is going to shake itself out until we understand what things are worth.

There's going to be an enormous transfer of wealth. But I don't care if my gold stocks go down next week because I'm not in it for next week. I'm not going to be selling stuff next week. If it got cut in half, I wouldn't sell it. I'm in it for the long term and the day-to-day fluctuations are relatively meaningless.

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