Gold Feedback Loop

Gold is rising because money is too easy in the financial markets...

TODAY'S extraordinary loose monetary conditions are "benefiting hard assets" according to James Passin, co-founder and manager of Firebird Global Fund and Firebird Global Fund II.

Describing him as "the Indiana Jones of frontier stock markets," the Financial Times praises James Passin for visiting "rough, difficult places...rather than swanning around the more comfortable nightclubs."

Here he tells the Gold Report that surplus liquidity is flowing into exchange-traded funds that buy commodity futures and physical commodities. James Passin says this is "creating a feedback loop", driving up the price of resources, starting with Gold Bullion.

The Gold Report: James, last December, you commented on the low interest rates that the government had on bonds. You said you thought that would spur inflation and an increase in commodity prices. Now that we're in the last quarter of '09, how do you feel about your predictions and what do you see going forward into 2010?

James Passin: It was clear to me at the end of 2008 that we were at the beginning of a powerful and lasting recovery in commodity prices and resource stocks. I think that the structural fundamentals are in place to support further increases generally in commodity prices.

TGR: This year we saw, basically, all positions and all sectors increase. What would cause just an increase in the commodity pricing going forward vs. all the other sectors?

James Passin: We have had a rally in all assets, but hard assets also are benefiting in particular from extraordinary loose monetary conditions. Surplus liquidity is flowing into commodity products like exchange-traded funds (ETFs) that are buying commodity futures and physical commodities, creating a feedback loop, which is driving up the price of resources. But what we thought is that this would be a great year for resource stocks based on our view that capital markets would start to reopen. Resource companies tend to be capital-hungry. So as the cost of capital comes down and as capital becomes available, resource stocks tend to outperform resource prices. At the same time, last year there was a dramatic reduction in issuance of stock by resource companies. This has resulted in a highly bullish environment for resource stocks. But we are concerned about the recent changes in the nature of market sentiment.

TGR: You say you note a changing tone, generally. What's changing?

James Passin: It's interesting to ask how long these extraordinary loose monetary conditions will continue to exist. At what point will the Fed take the view that the financial system and the economy can withstand tighter monetary conditions? Perhaps it seems unlikely with unemployment at 10%. It also clearly in everyone's interest to allow asset bubbles to develop to enable banks to rebuild their equity through generating profits. But any significant tightening of monetary conditions could undermine the commodity markets in the short-term. There is also a dangerous structural element to the market represented by the ETFs.

The ETF prices increase when the Gold Price increases and as demand for ETFs increase, then the ETFs actually go out and buy more gold. This is creating a feedback loop. The obvious concern is what happens when it goes the other way, if the Gold Price actually started to weaken and the ETFs start to sell, creating a negative feedback loop. When I referred to the different tone, I was really referring to the increased level of confidence that I'm observing among gold bugs and to the wave of financings that's coming out of the gold space. A lot of marginal gold companies are getting financed. Gold has shifted into a momentum phase that is generally characteristic of a topping process.

TGR: I think the most interesting thing that's happened in the past week is the government of India buying 200 tons of gold from the IMF. People are saying, is China next? So when governments start buying that volume of gold, is there really an issue of gold being vulnerable?

James Passin: Looking at the history of central bank gold trading habits generally would suggest central banks are horrible gold traders. Central banks were happy to sell gold under $300. The fact that that central banker mentality is shifting is arguably a sign of capitulation. There is other evidence of capitulation. Whatever happens to gold in the short term, the Gold Price will tend to rise over time as long as we have the fiat world currency system.

TGR: You mentioned that gold is hot – it was about $1145 today – has that overshot the value of the market at this point?

James Passin: It's hard to say what the fair price of gold is. I think that gold is vulnerable and maybe it will experience a violent correction from a higher level. I'm not an investment advisor and I don't provide investment advice, but personally I think that owning some physical gold makes sense. However, unless you're a very good short-term momentum trader, it's strikes me as a dangerous time to be heavily long gold.

TGR: During 2009 the equities outperformed the commodity, which is the reverse of 2008. So are we at a point now where gold stocks are overvalued relative to the commodity?

James Passin: A lot of gold stocks seem undervalued, but there's a huge financing pipeline. It depends on your view on the Gold Price.

TGR: What other commodities or resource areas are you following?

James Passin: We're very interested in strategic metals and minerals, which would include not only rare earth metals, but other metals and minerals that have critical applications in the energy, military, and industrial sectors.

TGR: How does an individual investor play the boom through the Mongolian stock market?

James Passin: There are no restrictions on foreign ownership of stock and the currency is freely exchangeable. It's easy to open up a and fund brokerage account. The hard part is finding shares to buy because the market is very thinly traded. It's possible to get a small amount of stock from time to time, although the entire market capitalization is only $500 million and the free float is much smaller. I think that it's certainly worth taking time to do a little bit of research and look at some of the larger stocks that are listed on the Mongolian stock exchange.

TGR: You mentioned there are 24 mineral projects and one big copper project. With the recession worldwide, would we expect to see any return from anything in Mongolia for the next five years?

James Passin: The copper prices had a massive recovery. And Mongolia has other commodities, including coal, uranium and iron ore.

TGR: Thanks so much for your time today, James.

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