In a crisis like this, you would expect gold to perform well...
ONE OF THE WORLD'S leading authorities on Gold Bullion and gold shares, Joe Foster – portfolio manager of International Investors Gold Fund at the $9 billion Van Eck group in New York – recently spoke recently HardAssetsInvestor.com to explain why gold has traded the way it has over the past five months, and where it's going over the next five years.
HardAssetsInvestor.com (HAI): The gold market has been very volatile over the past six months, and the market's been behaving oddly. What's driving the Gold Price recently?
Joe Foster, portfolio manager of the Van Eck International Investors Gold Fund: The fundamentals have not been driving it; that's clear. Ever since mid-July, when Fannie Mae and Freddie Mac started to collapse, the markets have really started to go haywire...all the markets, Gold Investment included.
We are going through a period right now that we have never experienced in history. What we thought would be a normal reaction in these circumstances just doesn't hold right now. We're getting massive liquidation across all asset classes, with a huge deleveraging going on among institutions, hedge funds, etc. People are selling everything regardless of fundamentals, and gold is caught up in that. It's dropped lower than you ever thought it would.
HAI: Where did you expect to see the bottom?
Joe Foster: In a crisis like this, you would expect gold to perform well. It hasn't done that. It's dropped lower than I ever thought was possible at this stage of the cycle. We're still at a period of time when you can't rely on fundamentals. This panic will run its course before we can get back to fundamentals.
We'll have to talk in stages. The first stage is the current stage, the crisis stage. I don't think it's over yet, but no one knows when it will be over. Then we can talk about the post-crisis stage, when fundamentals will reassert themselves and we can consider what the environment will look like at that point.
HAI: How far along are we in the crisis? Do we have any visibility on how much de-leveraging we have already seen in the commodities space?
Joe Foster: The sellers of gold throughout this have been mainly institutions, hedge funds, pension funds and other institutions invested in the commodity indexes. When they sell off a basket of commodities, gold is a component of that and so it gets sold off as well. We've been hearing that the de-leveraging and forced selling could go on through the end of the year, but it is an opaque situation. Nobody knows.
HAI: Once we do get past the crisis, what are the long-term fundamentals? What should investors do right now with gold? Is now a good time to buy, or should they wait?
Joe Foster: Somewhere in here is a great buying opportunity. We might be there today. Given the dramatic fall in the price of gold, and specifically if you look at gold stocks, which have fallen even harder than gold has, it gets interesting. If you want to take a long-term view, now is a great time to get into the gold game. When we get out of this crisis mode, the fundamentals will be and are extremely appealing for gold and gold shares.
I think several things will go in gold's favor in the future. We're seeing this tremendous strength in the Dollar right now. That is what is different in this current crisis: The Dollar has become the safe haven asset, instead of Gold Investment. I think that will unwind eventually. And that's one of the key reasons that gold is doing so poorly right now: We're seeing this incredible increase in the Dollar.
The second thing is that we are going into an economic scenario that is fraught with risk. The level of risk has risen to new highs and I think it will be with us for a long time. I believe we are going into a tough recession. I think we'll see continued banking problems, even after we get out of the crisis mode. It will take a long time for the housing market to turn around. These kinds of things create a good environment for gold.
HAI: One of the things we've been monitoring is the battle between the forces of inflation, such as the massive injections of liquidity by the Fed, and the forces of deflation, such as the massive de-leveraging by the banks. How do those two combine, and what is the outcome for gold?
Joe Foster: I see both of those forces playing a role right now. The way I think it will play out is that we'll go through a disinflationary period, and I think the Fed will be very worried about deflation as they were in 2001 and 2002. I think we'll see very easy Fed monetary policies, and have negative real interest rates because of those policies. That's an environment gold thrives in. Look at what the Fed was doing in 2001-2002: The market was heading lower, gold was heading higher and the Fed was trying to pump up the economy. I think we're back into that mode.
First we'll go through a weak economy and deflationary scare, which will be favorable for gold. How long will that last? Probably a year or two. Following that, once the economy starts to recover, we could be facing an inflationary episode that could rival the 1970s. We're going to see these extremely easy borrowing policies, and a tremendous amount of government borrowing. The federal government is taking on a tremendous amount of risk by taking stakes in insurance companies and banks, and its balance sheet is exploding. Eventually, they'll have to monetize those liabilities, and the way they do that at the end of the day is by printing money. That's hugely inflationary.
If the economy gets back on track, we'll see the same supply issues we were facing a year ago in all the commodities – Metals, Agriculturals, etc. That will feed into an inflationary cycle on top of the Fed monetizing their debt. I see this morphing into an inflationary episode several years out that could be very painful.
HAI: That's an ugly picture of the economy, but a pretty picture for gold. How could it turn out differently?
Joe Foster: One of my jobs as a gold fund manager is to point out the risks in the economy and the way investors can protect themselves. It may not play out exactly as I'm describing, but it may be something similar to that, which means your portfolio will really benefit if it has some Gold Bullion in there.
HAI: Do you favor gold or gold shares here?
Joe Foster: Gold shares have never been this cheap relative to the Gold Price. They have been indiscriminately sold over the past several months. If you wanted to go with gold companies, I would look at the producing companies with good cash flow. We could enter a period of very tight capital markets for a couple of years, which will make it very tough on the smaller companies developing projects with no cash flow. The companies that are producing gold right now...for those companies, with prices at $700/ounce, they are making good cash flow and will get through this crisis well.
Beyond that, we like companies that have growth. Global gold production is in decline right now, so we look for companies that are well-managed and have growth and can fund that growth. Kinross Gold is one example.
HAI: Any other words of advice for investors?
Joe Foster: If it's any consolation, if you look at the performance of gold versus other metals or oil, gold has outperformed just about everything else, I think. It's down, but I think it's still performed better than other asset classes.
And if you look at gold in other currencies, gold actually reached all-time highs recently in Euros, British Pounds, Australian Dollars, Swiss Francs. It hasn't been that bad of an investment, relative to everything else. It speaks to gold as a unique asset class, and I think that might be missed in all this selling. Relative to other things, especially in local currencies, it has actually done okay.
HAI: One last question: How big a portion of a portfolio should be in gold?
Joe Foster: I use this myself, and also recommend it to clients: 10% of your portfolio diversified in gold and gold shares is appropriate.