Gold Going Down?

Then that'll be a gold buying opportunity, says one mining analyst...

FLUENT in English, Spanish and French – and conversant in German and Russian to boot – Louis James of Casey Research regularly takes his geological skills on the road, evaluating highly prospective targets, visiting explorers and Gold Mining producers across the globe, and getting to know their management.

Here Louis speaks to the Gold Report about why any near-term dips in the Gold Price in fact offer fantastic buying opportunities...

The Gold Report: GDP growing 5.7%; the Dollar rallying, Obama promising to freeze budgets and Massachusetts even voted in a fiscal conservative. Are these glimmers of hope that recovery's coming?

Louis James: I think of it this way – if a patient's on the operating table and you put in an artificial heart and slap on an iron lung, blood pumps, there's oxygen and respiration and apparent life. But is that recovery? And what happens if you switch off the machines?

In this case, despite massive infusions – literally trillions of Dollars – one of the most critical vital signs is still faltering. We've not seen the job creation you'd logically expect. So, yes, throwing money at the problem is having an effect. Yes, some things are working again. Yes, credit is flowing to some degree. But don't mistake this for recovery.

True economic recovery takes business people making rational decisions to invest accumulated capital in new ventures and so on. That's very different from what we're seeing now. We may see a protracted plateau between troughs if the iron-lung economy continues functioning for a time. But that's a far cry from economic health and won't prevent another systemic shock when the repo-man comes for the iron lung.

TGR: To stay with your analogy, don't the positive signs – the pulse not as thready, the breathing less shallow – suggest that maybe the worst is over and we're starting to heal?

Louis James: We at Casey Research are still very cautious. The Keynesian idea of government intervention was to "prime the pump", to inject a little liquidity, and with the multiplier effect turn every Dollar the government spends into $6 as the money works its way through the system.

In reality, that's not the case, it comes at a price, and it doesn't change the fact that you can't build anything solid without accumulated wealth to invest in the future.

Some people argue that businesses borrow to fund growth all the time. That's true, but businesses usually put up real assets to back their borrowing. What the US government is doing is more like a tapped-out head of household with no job asking his bank to triple the line of credit on his already maxed-out credit card. That's not a viable business plan for growth; it's a total gamble, made in desperation, against the odds. So, no, I don't see the interventions as having cured the patient in any way, shape or form.

TGR: That sounds more pessimistic than cautious.

Louis James: I am extremely pessimistic mid-to-longer term on the US economy but not so pessimistic over the longer term for the global economy. The shorter the timeframe, of course, the more foolish it is to say anything specific. No one knows what can happen near term. We may even see more of a semblance of health. But sooner or later, those massive injections already made by Obama and his predecessor are bound to have huge consequences. Regardless of what's done now, that's already baked in the cake.

You can push prices down only so far and for only so long. You can't push below the cost of production without government subsidies, which cost more money, which has to come from somewhere. Because some people can't afford to spend reduces demand for bread, for example, but US bakeries can't drop their prices to a level that would clear the market because they're obligated by minimum wage laws and other costs factors that remain high.

At the same time, money flowing and flowing and flowing from the government is real monetary inflation that eventually will show up in prices as well. It's important not to confuse price destruction in certain asset classes, like real estate, with life actually getting cheaper.

TGR: The Fed keeps saying we can grab some of that money back by increasing interest rates and slow inflation down. Do you buy that?

Louis James: No. They've been keeping interest rates down to encourage economy activity, to stimulate it. We're looking at a stagflation scenario, in which they are truly damned if they do and damned if they don't. Keeping interest rates down at times of gargantuan public spending and deficits guarantees debasement of the currency – but they can't raise rates, because the voters have sent a clear message that they want JOBS NOW and those in power will spend whatever they have to in an attempt to deliver.

Nevertheless, at some point higher interest rates are inevitable. The government wants foreigners to buy T-bills to fund the debt. To do that, you need to offer attractive interest rates, and an effective zero, or less, isn't terribly attractive. If they fail to interest foreigners in buying more US debt, the only alternative is the printing press – the path to Mugabeville.

TGR: Let's add China and India to this mix. Their internal growth rates seem strong enough to offset reductions in exports to North America and Europe.

Louis James: That's diving into some pretty murky waters. How much of China's internal growth is truly internal? The best thing about China is that the government had massive cash reserves, so when they threw a half a billion Dollars at their problem a year ago, they didn't have to borrow it. But will building railroads to nowhere and ghost towns actually have any lasting positive impact? You'll find numerous hits if you Google or do a YouTube search for "empty city China".

Don't get me wrong. I've been to China numerous times and see a lot to be bullish about there. I've seen the enormous accumulation of wealth, and I've met individual Chinese people who have savings – but that doesn't mean that there won't be any bumps in the road. In time, as corrections have their necessary consequences, China and India will spur global growth going forward – to a degree. Meanwhile, it's dangerous to assume they will save the world. To think they can just step in and keep the party going single-handedly is naively optimistic.

TGR: With all of the things you've been talking about as a backdrop, where are investors supposed to put their money if they're trying to build personal wealth?

Louis James: I think it makes a lot of sense to continue to be cautious, to keep your powder dry, have a significant cash holding, and of course we're very bullish on gold – regardless of short-term fluctuations. We had quite a year in 2009, a lot of gains. Not as great as they might have been if we had left all the money on the table, but we slept a lot better because whenever we got a double, we recovered our initial investment. So we have all our capital back plus large positions in highly prospective companies. And having cash is not a bad thing.

In terms of the bigger picture, sitting on cash ready to deploy into good opportunities and maintaining a significant position in gold (and silver, of course) are smart things.

TGR: And you say you remain very bullish on the precious metals...

Louis James: Absolutely. We like precious metals a lot. We can see Gold Prices going down if the Dollar remains strong near-term, because gold still varies inversely with the Dollar. But that's a buying opportunity. It's nothing to cry about; it's something to take advantage of.

As for silver, we'd predicted that it would outperform Gold Bullion by a wide margin in 2009, and it did; that was an easy one to spot, because the price was out of whack. The natural ratio of silver to gold in the world is something like 16:1 in terms of the frequency of the element in the earth's crust. The trading ratio between the two has resembled the natural scarcity ratio for most of history. Yet over the bull cycle of the aughts (2000s), the ratio went to about 50:1 by and large, and in the crash of 2008, it dropped to about 100:1.

That was just silly. Silver is not 100 times more common than gold. Still, silver is an industrial metal as well as a precious metal. It actually gets used up. If business demand goes down with the economy, it stands to reason that there are fewer silver buyers. But with that precious metal component, if there's a big economic scare and gold makes a major move up, silver will climb too, regardless of the industrial demand. So when the economy got whacked, silver got whacked.

That gap narrowed significantly over 2009, but it's still a gap. Silver is still relatively cheap. So we like silver a lot. Even if economic conditions reduce industrial demand, the precious metals demand would increase for the same reasons. Meanwhile, we still have supply destruction. Most silver is a byproduct of base metal mining, so if copper or lead prices fall and companies cut back production, that would constrain silver supply at a tie when demand may rise.

TGR: Where should our investment focus be in the near term?

Louis James: In economic environment that remains so uncertain, you should run the other way if someone tries to tell you what's going to happen next month. In these circumstances, you should respond like a value shopper – with a feeling of "Wow, I can't believe what a great deal this is!" – before taking advantage of an opportunity.

Don't buy anything because it's cheap relative to comparable deals – most of them are probably overvalued. Relative valuation should never be confused with real value, meaning, a company trading for less than net asset value, or even less than cash. There are times when speculating on relative value can work out – as in hot area plays – but when you can buy real value at a discount, that's always better.

TGR: That strategy worked for a lot of people after the crash...

Louis James: It sure did. When things went south in the fall of 2008, a number of really good companies – companies that had been extraordinarily successful, had no discovery risk and little technical risk – went down with everything else. Savvy investors were able to buy high quality at a huge discount. When I saw some of the prices on the tickers, I thought, "Wow, I can't believe I can buy this company for this little." One example of that was when Teck dropped to the C$3-range. Sure, the company had serious debt problems, but this was Teck, a major mining powerhouse, off from $50 a share to $3 a share. That was "stupid cheap" and an obvious buy, regardless of whether or not the market had hit bottom.

I have to admit that we did not make this recommendation to subscribers, because we were not sure base metals would recover, but I did bring it to the team, and the stock rose by more than 1000% in 2009. When you see those kinds of opportunities, that's a good time to deploy some of your cash.

TGR: But incredible returns on the market in 2009 brought equities up across the board. Have we missed out on those value shopper opportunities?

Louis James: Maybe, but that doesn't make it right to rush into the market now if you've been on the sidelines. If you're not feeling that something is extraordinarily cheap, you're taking a risk because otherwise it can correct in a big way and stay lower than your entry point for a long time. All it takes is one bit of really scary economic news to bring the whole house of cards tumbling down.

TGR: A side effect of the last downturn was a significant seize-up in capital, which prevented lots of Gold Mining juniors, in particular, from pressing projects forward. As you look at upside potential now, how much weight are you giving the balance sheet factors that were so critical a year ago?

Louis James: It's a red flag when a company doesn't have at least a year's operations money on hand – preferably two years' – and I am much more hesitant to recommend it. I am far more likely to put it on my watch list for a private placement. If I really like the story and the only thing missing is cash, I'd most likely recommend that subscribers who are qualified investors, like most of those who subscribe to our Casey Investment Alert service, watch for seats at the private placement table, so they can get warrants and add leverage to their investments.

TGR: So the balance sheet is still critical even though the capital markets are loosening up.

Louis James: The money is flowing again, but it could freeze up again in an instant, given the right shock. I want to stress that I don't have a crystal ball, but the longer-term "baked in the cake" reality of what the US and other countries have already done is very clear to me. Whether there's near-term deflation or not doesn't matter, except in that it may create great buying opportunities. What's already been done is so huge, it's going to have seriously bad consequences for the Dollar, and other paper currencies, and therefore seriously positive consequences for Gold Investing.

So look at the reality, grab hold of your courage and have faith in your analysis. If you believe all the massive money supply that has been created will affect the Dollar and the price of gold, don't sweat the near-term fluctuations. Look at them as buying opportunities if you can. If you can't, just hold on because this gold bull cycle has a long way to go to the top.

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