Finding Safety in Gold & Silver
What behavioral investment analysis says about bonds vs. gold and Silver today...
MATH GRADUATE and quantitative-analysis MBA Dr. Michael Berry specializes in the study of behavioral strategies for investing, and has been published in a number of academic and practitioner journals, including the Financial Analysts Journal.
Formerly professor of investments at the Colgate Darden Graduate School of Business Administration at the University of Virginia and also holder of the Wheat First Endowed Chair at James Madison University, Michael Berry has worked with world-renowned geologists on the Carlin Trend, and now focuses on emerging geopolitical, technological and economic trends for his Morning Notes publication, distributed worldwide.
Here Michael Berrry speaks to the Gold Report about how, traditionally, the bond market is where investors go for safety. But now he believes gold and particularly Silver could be part of the safety portion of investment portfolios...
The Gold Report: In one of your recent Morning Notes you said you were worried about the state of the US economy because the bill for government spending and debt creation is coming due. Can you give us the highlights on your concerns on that?
Michael Berry: The issues here that have been getting increasingly more difficult to handle are the deficits and the amount of debt that we have issued and continue to issue. To be able to push forward on what we're doing in this country, like saving the housing industry and the new healthcare bill will be difficult. They're going to cost a lot of money. They're not going to save us money. They're not going to reduce our deficits. They're going to increase them and they're going to have to be financed.
My concerns are that sooner or later, the debt that we're using is going to be a bill that will come due. By that I mean that we will need to roll the debt forward – just like Greece must now do. We're very likely to have a bond refinancing situation that fails or partially fails. When that happens, interest rates are going up.
You have debt, you have the Dollar and you have interest rates. We're already seeing some pressure on the long end of the yield curve. It's going to cost more for the federal government to sell its debt to foreigners. If indeed they can do it. Now couple this with the issue of what's happening in Greece, and what will likely happen in Spain and Italy with respect to sovereign debt. You're going to have a similar occurrence in the US in terms of how much debt has to be issued. We're actually seeing signs of that happening now.
TGR: Where do you think the solution lies in correcting this problem?
Michael Berry: You can't keep printing money. For 60 years, because we've had the world's reserve currency – the Dollar – it's allowed us to run staggering deficits and to be able to fund our deficits by issuing debt. That's coming to an end. It will mean that we'll have to pull in. We'll be forced to slow the economy, to de-lever the economy and those are going to be painful. There's no easy way to go about doing that, but it has to happen.
TGR: Now for those people who are in the bond market, is this a time they should be looking to get out?
Michael Berry: That's a really interesting question. I mean what do you do? I do discovery investing. The optimal portfolio is 10% in discovery and a 90% in safety. The 10% in discovery is easy. The 90% in safety is no longer easy. It used to be. You could go to the long end of the yield curve, go to a 30-year Treasury or you could go to the short end. Now, you have to find another area of safety and that could be partly in cash and partly in precious metals. Not necessarily in discovery for the "safe" portfolio allocation.
TGR: Last December, you thought inflation was still 18 to 24 months in the future. Is that still your thinking?
Michael Berry: It depends whom you talk to. We don't have any inflation in this economy right now. If anything, there's still de-leveraging. There's excess capacity out there. We're not moving down the unemployment scale very much. We still have 9.7% unemployment, even after a lot of government intervention in the labor markets and hiring for the census. Right now inflation is hard for me to see. In my view, we're still that magical 18 to 24 months away from inflation, or maybe even more.
Certainly, if interest rates move up, we could have inflation, but there's still a lot of excess capacity. There's a lot of debt. The Obama administration and the Bush administration really didn't deal very well with the excess debt. They just kind of rolled it over and pushed it out.
I'm an optimist. If you're an optimist in this market, you believe inflation is coming. If you're a pessimist in this market, you believe that we're going to be in deflation for some time to come. I'm an optimist, so I think within the next couple of years we'll be able to inflate out – at a cost, of course.
TGR: Would inflation be good for the market?
Michael Berry: No. I don't think anything is going to be good for this equity market.
TGR: Do you anticipate continued recession?
Michael Berry: We could have another downturn. The growth that we've had isn't extraordinary. It's been pinned up by the federal spending programs that we have to pull back on pretty soon. You're going to have to be very careful how you are positioned in this market. You're going to have to be extremely defensive. I think being in the precious metals, and from my perspective, being in the discovery arena, are good places to be.
TGR: So is the opportunity for investors in all of this to be in the precious metals, especially in discovery?
Michael Berry: Certainly. I think I'd get a lot of agreement. Gold really doesn't want to go below US$1,100. If you look at gold in any currencies other than the Dollar it's been a tremendous bull market. It looks like it's going to go higher. Gold in US Dollars has been a poorer performer relative to gold in euros, for example. Gold performance in other currencies has been outstanding.
I think silver is going to go much higher. Silver is very strong. So are platinum and palladium. You're seeing tremendous upside pressure in precious metals. We did have a pullback last year, and I think it was healthy, but I don't think we're going to have another big pullback in precious metals.
TGR: So you don't see another correction on the horizon when it comes to gold at this point?
Michael Berry: I really don't see a big correction. I don't think we're going to see under $1000 again. There are so many issues that are positive for gold right now. We've already talked about some of them. I think gold could reach $1500 to $1600 over the next year to two years. It's going to be a place investors want to be. What's also interesting, and we talked about this in our last interview, is that the Chinese government not only is buying gold, but they're encouraging their citizens personally to Buy Gold and silver. That speaks volumes.
TGR: That's certainly a big change for China.
Michael Berry: Absolutely. They're being very vituperative and very stubborn, perhaps rightly so. They are not going to float their currency until they decide it is in their best interest. They are going to continue for as long as need be, because they have a trillion Dollars or more worth of US assets in their foreign exchange kitty. Because of that, they want their citizens to have some protection, and that's why they've allowed ordinary Chinese citizens to purchase gold and silver. And Chinese citizens love Silver.
TGR: Other countries are Buying Gold as well...
Michael Berry: It's not just gold. To build out an infrastructure in China, India and Brazil, you're going to have to have a secular and strong commodity cycle. It'll probably vary in the short run, but it's going to go on. We've got copper at $3.50 now. Nobody would have expected that in September of 2008, that's for sure. It's a good place to be. The mining industry generally is a good place to be, and the commodities sector in general.
TGR: Where do you see gold, let's say by the end of 2010?
Michael Berry: Higher. It might be a couple of years before we really see Gold Prices in the $1600 to $2000 range. It could definitely go there.
I'm probably going to be branded for saying this, but I'm convinced from my work over the last 15 years that the futures markets have been somewhat of an impediment to the spot markets in both gold and silver. Silver's a very small market. If the Commodity Futures Trading Commission (CFTC) were to modify position limits and margin requirements on the futures contracts, I think that you'd see these commodities go to their true values, particularly Silver. You could have much higher levels of Silver, which interests me because I deal with a lot of companies that mine silver.
TGR: Do you think that gold could approach $1400 by the end of this year?
Michael Berry: It could. Resolution of the Greek debt refunding situation in Europe will be important. It's also important where interest rates go in our country, and how much more the Dollar has to fall. I think it has further decline potential. Once gold breaks over $1250, all bets are off. It's been trading in a range. I'm really not a trader. I'm a real long-term investor. Frankly, I really don't care about short-term volatility, but I know it's going higher, and I want to have a position in it.
When gold comes off, I buy it in preparation for something higher. Gold hasn't really fallen much below $1,100. Once gold goes over $1,250, I think we're away to the races. Once Silver Prices appreciate to the $18.00 to $19.00 range, we're away to the races there as well.
TGR: When you're looking at Silver companies, are you looking primarily at explorers or producers?
Michael Berry: In discovery investing, we have three classifications, based mostly on risk-to-reward classification. I happen to like to invest mostly in the first one, which is primarily early explorers. I like to find the best geologist and go in drill and find that first discovery hole and then expand it and eventually get a NI 43-101 resource on it. We call these Incubator companies. I call them Incubator because they incubate their resources. Then with more drilling and discovery, and lower risk profiles, they move into a classification as Mature Discovery companies. There are different risks-to-reward ratios as you go forward.
Then, of course, you get to the major producer, the Legacy companies. They've got a lot of resources and reserves. In any of those three areas, you have a different risk/reward ratio. Different analysis when you go through them. I tend to like to start at the beginning and follow a company. Of course, a lot of Incubator companies don't work out because there's a lot of risk.
TGR: I think in one of your other interviews you likened it to a baseball, saying a good hitter is only going to hit 300, so 7 out of 10 times they're not going to make it. That seems to be your attitude when it comes to discovery investing, right?
Michael Berry: It is. I used to manage money, so as a money manager, I wanted all my stocks to be winners. I didn't want to lose on any of them. It's not that I want to lose on them, but I think when you play in this micro-cap mining game, you are in an area where there are many unknowns. They offer a great upside potential because you're looking for world-class discoveries. But sometimes they just don't work out. If you find a Peñasquito, a Nieves or a Guanacevi, you're going to do very, very well. You're buying stocks at $.05, $.30 and $1 and they are going to end up being $5, $10 and $20 stocks.
TGR: When it comes to the Gold Mining companies, I'm assuming that you manage things the same way?
Michael Berry: Absolutely. I have a factor model which I developed when I was a fund manager at Heartland Advisors. The 10 factors allow me to rank companies in any of the three categories that we discussed. You're dealing with young companies in the early stage of development of their mines. I use exactly the same model for any of these companies. Is this a world-class asset? Has the management team got a great track record? Is it capable?
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