Focus on the bobbing cork and you'll lose sight of the rising tide in the Gold Price...
CAPITAL MARKETS entrepreneur James West has spent over 20 years working in finance, including business development at companies involved in mining, oil and gas.
Now editor and publisher of the Midas Letter, West here tells The Gold Report why confusing short-term undulations in the Gold Price, plus the shaky long-term foundation of the US Dollar, could result in long-term opportunities for junior silver and Gold Mining stocks.
The Gold Report: James, Comex gold futures hit an all-time high yesterday before falling back to about $1431 per ounce. We're seeing dramatic daily swings in the Gold Price of $20-50 regularly. How do you explain the volatility?
James West: The gold market is about as nEurotic as a schizophrenic Hollywood starlet hooked on coke. Trying to keep abreast of daily price fluctuations is an exercise in futility. My favorite line on the gold and silver markets is, "He who focuses on the bobbing cork loses sight of the rising tide." That really sums it up beautifully. All of the negative macroeconomic factors on the stability of the US Dollar that started the precious metals bull market back in 2000 are now stronger by a factor of at least 10. The US economy has crashed twice since then as a result of too much liquidity in the system, causing asset-class hyperinflation, which, in turn, causes price collapses that engender general market panic.
The first pro-gold/Dollar-negative fundamental was the excess commercial and residential real estate inventory based on former Federal Reserve Chairman Alan Greenspan's easy money policy. The result was bank leverage:capital ratios that exceeded 100:1 in many cases. Retail lenders ended up with so much capital they had to reduce the difficulty of borrowing money for individuals with questionable credit histories. Otherwise, the money would just sit there doing nothing – and that is not a tenable situation for bank capital. It has to keep moving. Real estate exceeded inventory, people bought cars and recreational vehicles, took trips and built second homes. Yes, that created the appearance of a robust economy, but it was built on credit that was not going to be repaid.
Just as the Fed set the example by making it so easy for banks to leverage their balance sheets, consumers started to do the same thing. The major difference was that the banks were bailed out, whereas the consumers were thrown a rock to keep them from drowning. That is why we now see two distinct tiers in our economy. The retail consumer is trying to tread water carrying this massive debt rock, while the banks, granted a pair of wings in the form of bailouts and quantitative easing, are busy finding a new generation of retail consumer suckers to encumber with debt.
New home prices in the United States just established an all-time low since the crisis began, so all this nonsense about the economic recovery, obviously, is meadow muffins. The only thing that is up is the stock market thanks to the financial services sector, which was the primary beneficiary of exponential increases in the amount of US Dollars in the market. Issuing more currency against a deteriorating asset base and shrinking real GDP (not nominal GDP as is generated by measuring the massive numbers resulting directly from the multiplication of ersatz Dollars through derivatives trading) is counterfeiting. How can you print more money when, technically, you are in a state of default on your current obligations? The only reason that a default hasn't been declared is because the two biggest holders of US debt – Japan and China – don't dare upset the global economic apple cart by pulling the rug out from underneath the US Dollar. That would have dire implications for their own economies and central bank balance sheets. Three times as many US Dollars are in circulation today than in 2000. That should result in a Gold Price at least three times higher than a decade ago.
The severe instability of the entire Middle East and, by extension, implied instability within any country that is not a democracy (i.e., China, Russia, Saudi Arabia, Venezuela, Sri Lanka, Indonesia, Mexico, Bolivia, Argentina, Zimbabwe, Yemen, Sudan, etc.), the safe-haven demand for gold and silver is multiplied theoretically. So to answer your question – yes, absolutely. There is daily volatility, but it's meaningless. All that matters in the price movement of monetary metals are the macro movements, which are both heading upward fundamentally and technically.
TGR: Recently, the Portuguese government rejected proposed austerity measures and Portuguese Prime Minister Jose Socrates resigned. Portugal is facing financial collapse and will likely need a bailout from the European Union. At first blush, that would seem to be good for the Gold Price. However, weakness in the Euro generally pushes the US Dollar higher and that leads to weakness in precious metals usually. How do you see the Portuguese situation affecting the Gold Price?
James West: There are two primary reasons why gold will not be influenced positively by Portugal's collapse. First, the whole idea of the Dollar as safe haven makes sense only to people who don't perceive the riskiness of the US Dollar. During the last crash in 2008, everything went down except the US Dollar. That demonstrated, in no uncertain terms, that the US Dollar was perceived to be a safer place for value preservation than even gold (in the absence of any speculative market). And that showed clearly that the world's largest capital positions fail to comprehend that the US Dollar and its excess capacity is the largest catalyst causing asset bubbles and general economic instability in the world. The supposed 'smart money' is actually the dumbest money on earth. The US Dollar is the cause of the majority of our global economic pain.
This perverse paradox is going to correct itself when the penny finally drops in the very limited imaginations of the economists who drive such decisions. Like Pavlov's dog in the famous conditioned-reflex experiment, markets respond when they see familiar situations arise. So, although Portugal's problems should be mildly bullish for physical gold demand, they will in fact manifest as a Dollar-positive/gold-bearish effect.
The second reason that the Gold Price performs less like a safe haven than it should is because the Gold Price is determined by futures markets, which lead the spot price rather than the other way around. Futures markets long ago ceased to be the price-discovery mechanism they were intended to be, and instead are a way for the biggest banks to influence the direction of the spot price. That gives them the ability to profit from the extreme volatility such massive capital positions can have in a relatively small market. The size of the futures market – which now functions as a betting mechanism for price direction – is infinite, whereas the size of the actual physical gold market is limited by how much gold can actually be moved around. So, the future price of gold is a separate number than the actual price of gold, even though the actual Spot Gold price is influenced by the futures price.
TGR: With inflation creeping up and the economy stutter stepping forward, we hear whispers of further quantitative easing (QE). What are you hearing? And what effect would QE3 have on gold and Silver Prices?
James West: In the news this past week, we've heard that St. Louis Federal Reserve Bank President James Bullard said the Fed should review whether to complete the $600 billion purchase of T-Bills, which is QE2, because the economy was looking so strong. Now we know that the various Fed branches suffer from persistent irreconciliation based on what is happening both within the Fed and in the economy, so it's not much of a surprise that the St. Louis Fed believes the chairman needs to rethink his strategy. Such statements really just confuse the general public. It doesn't matter one iota what the various Fed governors think. All that matters, and all that becomes US central bank policy, is what Chairman Ben Bernanke and the president's economic advisors decide they are going to do.
So, while Bullard might not be cognizant of the fact that the positive economic indicators that led him to think the economy is improving is a direct optical result of QE, there is no doubt that Chairman Bernanke is aware that the only thing propping up the stock market – and, therefore, the appearance of improving GDP growth – is quantitative easing. That's why there's no question that the US Federal Reserve's policy of kiting checks to itself through the US Treasury absolutely must continue. However, I also think the Fed is cognizant of the fact that the term "quantitative easing" is now perceived as negative in the mainstream financial media; thus, it will transition to an unnamed feature of US monetary policy.
TGR: James, you recently sold your equity position in a Peruvian mine to focus on the Midas Letter and to be involved in a precious metals fund based in Luxembourg. First, why Luxembourg? And what are the fund's criteria for investing in companies?
James West: I'm a portfolio advisor to two corporate investment groups. I also launched a fund based in Luxembourg. Combined with the expanded publication products offered by Midas Financial Publishing Group, this is forcing me to streamline my obligations in the interests of time management, which is to say, I still want to have a life outside of work.
The first reason we elected to domicile the fund in Luxembourg is that the private family wealth offices that are the primary sponsors of the fund prefer its very tough regulatory framework, which is managed by the Commission de Surveillance du Secteur Financier. If the bank where the fund is held in Luxembourg goes belly up for whatever reason, the assets of the fund are protected in their entirety, including all cash. The second reason is that these private wealth groups are excellent long-term shareholders, which means we can bring a higher-caliber shareholder to the companies we invest in.
In terms of criteria, we invest only in opportunities brought to us by A-List capital markets entrepreneurs with serial track records of value creation for shareholders. They do this through premium access to projects and superior financings that provide a lower-weighted average cost of capital to the companies, which result in better-retained earnings for the fund in the long run and, therefore, its unit holders. We hold no more than 9.9% of any company and no more than 40% of our holdings will be pre-IPO or private.
TGR: What are your goals for the fund in 2011?
James West: The number one goal is to deliver the best performance possible to unit holders. We achieve that by capturing the absolute best of pre-IPO investment opportunities, as well as IPO and secondary financing opportunities, in the resource sector with particular emphasis on gold and silver explorers and near-term producers. The Midas Letter has access to these companies because we've been around for as long as we have and deliver triple-digit returns consistently, based on the superior product in our portfolio.
TGR: What excites you today, in terms of equity investing?
James West: The thing that excites me the most at this juncture is the incredible as-yet-unrecognized opportunity in junior Gold Mining and silver explorers and producers (E&Ps), as well as in some select oil and gas plays. Increasingly, other asset classes are becoming less attractive, in terms of speculative returns. I think, in the not-so-distant future, the only game in town worth playing will be TSX- and TSX Venture-listed exploration plays.
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