Lagging Gold Prices for more than 12 months, it's now silver's turn to shine...
IT'S NOW 25 years since Peter Grandich found himself working as a stockbroker, paving the way to launching his Grandich Letter, then his blog with www.agoracom.com, and soon his book – coming out in 2010 – Confessions of a Wall Street Whiz Kid.
Grandich tells The Gold Report in this interview that having been left behind in the big run-up in Gold Prices, silver's time has come to steal the limelight for a while. But in the wider market, he's alerting investors "to remove their bullish hats if they're still wearing them." As Peter's motto goes, "It's better to be a live chicken versus a dead duck..."
The Gold Report: When he was in China, President Obama said "It's important to recognize if we keep on adding to the debt, even in the midst of this recovery, at some point people could lose confidence in the US economy in a way that could actually lead to a double-digit recession." He went on to indicate that Congress or he would be considering some tax cuts, but also some fiscal spending to counteract the unemployment. Other than preparing the populace for another potential downturn, what's wrong with this approach?
Peter Grandich: You can't have your cake and eat it, too. So I think it was rhetoric and I think the market realized that he was speaking out of both sides of his mouth. If you're going to use stimulus, someone has to pay for that stimulus and that stimulus will be paid for with higher taxes. The government, just like a company, can look to cut expenses, but they're not; they're spending more. They could work on entitlements and they are working on the healthcare side, but it's evident, at least to me, that in the end we're looking at a much higher cost.
TGR: If it's rhetoric, why would he say there's a potential second leg to this downturn?
Peter Grandich: Political cover. You could argue that he's saying what could happen down the road if people don't support his agenda.
TGR: Wouldn't that increase caution, when people are already cutting back because they fear there's more to come?
Peter Grandich: The problem is that there is no easy solution. Some of us felt a year ago that the best solution, although far more painful initially, would be just let the markets decide. Even if it meant a depression-like state, let the markets adjust for assets that are too expensive and for debt. That seemed better than throwing sand at the ocean, thinking that if you somehow hold the economy together – even though you create a whole lot of new money – you can magically take that money out of the system once things turn around. All we've really done is kick the can down the road and the can is much, much heavier to kick when the next time to kick it comes further down the road.
TGR: In the context of your kicking-the-can metaphor, you recently said that future historians will blame Alan Greenspan for the downfall of the US economy, due to policies that led to the bubble of all bubbles. Can you elaborate on that?
Peter Grandich: I think history will show that he was really a driving force in what led to the enormous problems that the United States now faces. Not more than three or five years ago, and certainly for 10 years before that, Alan Greenspan was hailed as the great financial and economic savior. He received many accolades for supposedly keeping the US economic engine going and creating all sorts of growth. It's become abundantly clear now that people have found what was swept under the carpet, that he really created the worst of all worlds by a monetary policy that was way over-stimulated. In fact, in the aftermath of the mortgage crisis in testimony before Congress, he basically admitted that he didn't realize how severe the mortgage problem was. Imagine what would have happened to the market if he had said that when he was in office.
TGR: Will historians put some blame on Bernanke and Paulson, too, for increasing debt in reaction to the bubble's bursting?
Peter Grandich: I think all of them will share in the blame. The latest group in charge gets most of the flak, but this is not just an Obama administration problem. It was well under way during the Bush administration and probably as far back as the Clinton administration, where a hands-off policy towards the Fed took hold and Alan Greenspan effectively became the economic ruler of the United States.
TGR: Do you think most Americans realize there really is no longer any easy money?
Peter Grandich: Because the stock market has rallied and we've clearly backed away from the abyss, many people feel that somehow the economy will get better and better, jobs will eventually come back, and we'll return to the way it was during the '80s and '90s. They think the worst has passed, when in fact the problem is probably more acute now than a year ago. We've pushed it off and have managed to avoid it. That put us where we are right now – in the eye of the storm. Just like a hurricane, we've been through phase one, we're in the eye, and phase two is about to hit.
TGR: You've stated that you're expecting the Dow to go to 10,500 or 11,000, but then when do you think we'll emerge from the eye and the market will start turning bearish again?
Peter Grandich: After several months and some thousands of points lower, we're finally reaching the target that I thought this bear market rally could reach. I've alerted my readers to prepare to remove their bullish hats if they're still wearing them. I don't think we'll go straight down like as we did in the first leg. But I do think the bulk of the rally is coming to an end. As we get into 2010, I think the market is going to go into a very long Japanese-like trading range. Japan peaked in 1989 at 41,000 and although it had several rallies over the next 20 years, it worked its way lower down to 7,000 or 8,000. I think that's the kind of performance we're going to see over the next five to 10 years in the US stock market.
TGR: What signs should those wearing bull hats look for that tell them it's time to take money off the table?
Peter Grandich: The bulk of the corporate growth that's aided the market rally has come from corporations becoming lean and cutting back as much as they can. From a fundamental standpoint, with consumers trapped, overburdened with debt and with employment such a big concern, you have to wonder how corporate earnings can grow further. If you're like me and you don't see that, why would you want large exposure to equities? From a technical standpoint, there are a lot of reasons to turn bearish as well, so both technically and fundamentally, I think we're coming to an area where there won't be reason to warrant expectation of much higher prices.
TGR: Why do you see the something like a long-term Japanese downward trend as opposed to a crash like last year?
Peter Grandich: Last year it was a liquidity crisis, with rugs being pulled out from underneath everybody. Albeit we have to pay a dear price for it, enough money has been put into the system where we're just not going to wake up one day and nothing's running. Growth in other areas of the world will continue and the eternal optimism that Wall Street tends to breed among the "don't worry, be happy" crowd will keep enough people thinking somehow it can filter over to us. But like Japan, which greatly underperformed world markets and economies for almost 20 years despite being the second biggest economy in the world, so will be the case for the United States. Investors who want equities ownership outside of metals need to look in the areas of the world where growth should continue – places such as China, India and Brazil.
TGR: If we're looking at the peak of this rally and then a Japanese-style long-term downtrend, should we expect gold to continue on its rise?
Peter Grandich: Very good point. My expectations have basically been almost fulfilled now. I've looked for a $1,200 price target. There's a correction coming here somewhere; there always is. But the fundamental factors that have driven the Gold Price since the bottom have only gotten better. So despite a correction or consolidation, there's absolutely no sign of any significant long-term top in the price of gold at this point.
TGR: What do you consider those fundamental factors?
Peter Grandich: First and foremost, gold has become an asset class. Even though jewelry demand has declined, purchasing of physical gold as an asset has offset that decline and then some. Part of that comes from the fact that people look at gold as the ultimate money. Even the most ardent economic bulls will agree that the US Dollar is certainly in trouble. Where do we look if the world reserve currency fails?
The second thing that's probably more bullish for gold now than any time since it has been free trading is the dramatic change in how central banks view gold. For years they were not only net sellers, just always sellers. In the last few years we started to see some select buying, and now central banks are net buyers. And finally, what for many years was the "cut your nose to spite your face" act of gold companies hedging future production has become a no-no. We no longer see that supply of forward sales by gold producers in the market.
TGR: Your last remark about gold companies makes me wonder whether you would put them up there as an intellectual barometer of world economic trends.
Peter Grandich: No. Our business is minuscule. The total market cap of all the major gold producers probably doesn't equal the market cap of Coca-Cola or IBM. We're a small industry compared to other types of industry worldwide. If you think about it, what's interesting about the mining companies is that their earnings don't track to the metals prices. We've seen gold basically double or triple from areas where it's traded over the years – $300, $400, $500 an ounce, which it did for a lot of years. But we've not seen the doubling and tripling in gold company earnings over those years. In fact, there should be even more leverage, because normally expenses don't go up a lot so most of that increase in metal prices should flow to the bottom line. But we're not seeing that. Given what metal prices are doing, it's somewhat puzzling, but we're certainly not seeing it in share performance in most of the major mining companies.
TGR: How should investors prepare for when we emerge from the eye of the storm you were talking about earlier?
Peter Grandich: This rally has been a gift for those who are heavily exposed to US equities. When I look at people's portfolios in the United States, I still find that if they have equity ownership outside of metals, it's almost exclusively in US equities. They would concur that we have one big world economy, yet most Americans still don't have much exposure to companies outside the US If you're going to have exposure to equities, you have to go to the areas of the world that are clearly going to perform better. And as I've said, that's China, that's India, that's Brazil.
TGR: So one way investors should start preparing for this downturn is to look at international equities because that's where the growth will be?
Peter Grandich: Right. But let me clarify – it's not so much a downturn that I'm expecting as I'm looking for a peak after which there won't be much equity growth going forward. We could stay within a fairly tight trading range for a few years. It's not that we're going right back down to 6,600, but equities will no longer look as if they have a lot of upside potential or are worth buying based on corporate earnings, growth opportunity and so forth.
TGR: That's a good clarification. Can you compare investment in metals and mining stocks to international equities?
Peter Grandich: I think most portfolios should have some equity exposure that isn't related to metals because you don't want 80% of your portfolio in an industry that makes up only 2% of industrial growth worldwide. And again, if you're going to have that industry exposure worldwide, you have to be where the growth is.
TGR: Your model portfolio includes a lot of various ways to play the metals market, but recent additions have been mostly junior mining equities. Can you tell us a bit how you came to bring them into your portfolio?
Peter Grandich: The more you go down the food chain, the more profoundly the metals companies have underperformed given what we've seen in the large-scale price increases in the metals they're going after. The junior resource market has not come close to returning to what it once was. I like to take us back to the last decade when they saw the last major boom. We don't have the same amount of institutional interests now, partly because institutional investors with excess cash that were doing real well in general equities worldwide got killed a couple of years ago and are no longer throwing money at junior resource stocks.
The second difficulty is the retail investors, the lifeline to junior resource stocks, aren't in the same position that they once were to play the junior resource market either. And third, while financings are certainly back, we still don't have an excess of money chasing junior companies. So it has been more difficult for them to enhance shareholder value from expansion on the marketing side because their audience has shrunk.
Another difficulty is that it has become harder to get to retail investors. At one time, stockbrokers were very active in the junior resource sector, and great marketers for junior companies. Brokers who liked your company would gather 200 or 300 of their clients and buy your stock. We don't see that much anymore, because few brokers still drive their book of business through commissions. The changeover from a commission-oriented business to an active management business doesn't sound like much on the surface, but it's a dramatic change from 10 years ago in terms of how the junior resource market is affected.
TGR: But these all sound like reasons to stay away, as opposed to investing.
Peter Grandich: Supposedly the whole idea in investing is to buy when no one wants a company and sell when everybody wants it. Given the dramatic increase in metal prices, finding and developing an ore body now is far more lucrative in terms of potential returns than it was a few years ago. So those who identify significant deposits will command a premium. That's what I've tried to concentrate on in my model portfolio, particularly in the gold area. Those are the companies I think have been undervalued.
TGR: Would you expect these companies to start seeing better earnings now as a result of the metals rising or are most of your plays basically acquisition targets?
Peter Grandich: Most of my plays are based on increasing value and possibly an acquisition as juniors. But for the majors, I think we will continue to see more consolidation, more mergers. Even juniors will continue merging together to become more efficient and effective. Part of the excuses that miners had a year or so ago, particularly the major producers, was that their costs went up so much, especially the cost of energy. Those costs are no longer such a factor, but we're still not seeing significant production.
Yes, the general cost to mine has gone up because the very inexpensive heap-leach type deposits that everybody could make money on 15 years ago and are gone. One of the world's premier districts, South Africa, has all but shut down its Gold Mining. Their costs have become so much higher because of the depth of the mines, and they've also been hit hard by the weak Dollar and strong rand.
In these circumstances, I think we need to look for and concentrate on majors that are streamlining their operations and have deposits that are very cheap to develop.
TGR: When you're looking at junior mining, do you think there's any advantage in looking at pure plays? Or does the combination of silver and gold mean two better reasons to buy?
Peter Grandich: Purists probably like to see something pure silver because silver is the poor man's gold, it's every bit as good as a monetary instrument, it's the black sheep of the family that never gets put in the same light as gold, yada yada. I don't think that's the case because silver simply is not in the same boat as gold, especially when it comes to a monetary investment. But it is close enough and has a relationship to gold; you don't throw out the baby with the bathwater. And, like I said, because it's been out of the limelight, I think silver is about to have some time in the sun. Some of these purer silver plays have not seen the percentage gains that some of the gold plays have, so it looks like their turn is coming.
TGR: Any other comments you'd like to provide to our readers?
Peter Grandich: While I don't look for the stock market to go down a lot, I don't think investors should feel that somehow the junior market stays up if the stock market does go a lot lower. If there's another large-scale fairly fast move down, it will take the junior market with it; so I think investors need to be selective. I don't think we'll see rises in metal prices lift all boats. It's a far more selective market now, tougher to see gains. You just can't throw darts as you could have 10 or 15 years ago and expect the stocks to go up.
TGR: Well said. We appreciate your insights.
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