Gold Mining, Inflation, and Gold's Tier 1 Prospects

Plus: the case for more public spending...

VALUATIONS of Gold Mining equities have so far failed to keep pace with rising bullion prices, but that makes for some outstanding investor opportunities among a few particularly well-positioned juniors. In this interview with The Gold Report, Rick Mills, publisher of newsletter Ahead of the Herd, points to continued low interest rates and increasing inflation as reasons that precious metals prices will keep climbing. And if discussions about elevating gold to Tier 1 asset status come to fruition, hold onto your hat, because that could shift the rate of ascent from steady to meteoric in a New York minute. 

The Gold Report: Prices of the Gold Mining equities were languishing when we spoke in January, and we've had little respite since then. But you foresee potential for a bullish resurgence in gold equities. What's your rationale behind that outlook?

Rick Mills: I believe we're going to see higher levels of inflation. We're going through a deflationary bout now because most of the money issued by the Federal Reserve is actually parked at the Fed. It isn't out there being spent, so it's not causing inflation. It's basically just propping up the banks. When the banks start lending and when the money gets into circulation, we'll see increased levels of inflation and, of course, that will be good for gold.

TGR: Lack of access to capital for small business due to stringent credit requirements is one factor that has put a damper on the economy. What will prompt banks to ease up on credit standards?

Rick Mills: I'm probably going to stir up a little bit of controversy by saying so, but I firmly believe that the way out of the dilemma we're in is to spend more money. A lot of people don't agree. They think we should cut back on spending, raise taxes and go onto an austerity program. That is absolutely the wrong thing to do. Taxes should be reduced. I believe they should be spending a lot more money.

TGR: Who should be spending more money?

Rick Mills: World governments should implement massive global infrastructure maintenance and build-out programs, and put the money not into the banks but into the small businesses that will build the infrastructure. These small businesses are the ones responsible for most of the job creation. So, give the money directly to the small businesses. Hire them to do this infrastructure build.

Take a look at our global water supply problems, our highways, our bridges, the brownouts because our hydroelectric power corridors are so outdated, the switching stations literally melt when they overload. We can actually spend our way out of this. In a fiat currency regime, because nothing is anchored to gold, the only way to move forward is to keep spending money. 

We saw this when the US Quantitative Easing Two stopped and the lack of liquidity immediately upset the markets. If we undertake the infrastructure build-out program and give the money to the small businesses that create jobs, as people get back to work, they'll have money, spend it and revive the economy. And it's not only the US—every country in the world has an infrastructure deficit.

TGR: What would more capital distribution among small business mean for the price of precious metals?

Rick Mills: The moderate to high levels of inflation I anticipate will make gold a much more attractive asset. The banks will keep interest rates low to help stimulate business borrowing, and with low rates, typically below 2%, you've got higher rates of inflation than you are getting for interest. I wrote an article called "Six Percent Can Draw Gold from the Moon." With high levels of real returns people don't favor gold as an investment. But when rates are below 2%, the exact opposite happens, because the real rate of return is negative. 

For instance, if investors are getting 2% on bonds but the real rate of inflation is running at 3–3.5%, they actually lose purchase power because the real rate of return is negative 1–1.5%. So higher inflation just makes gold all that more attractive. It preserves purchasing power and, of course, the Gold Price is going up at the same time.

TGR: Where do you predict the Gold Price will go during the rest of the summer and into the fall?

Rick Mills: I honestly don't have a price prediction except that gold will go higher. When we talked last year, I was perfectly comfortable with $1,500/oz gold and thought that was a good price for it. Of course, it immediately spiked up to $1,900/oz but has come back to my range. I'm still perfectly happy with $1,500/oz gold. As more people catch on to the fact that they need to own some gold, the price will slowly rise.

TGR: Some people believe one of the reasons gold will go higher is because of the whispers we're hearing that the Bank for International Settlements (BIS) intends to reclassify gold as a risk-free asset in the context of the Basel III framework. Could you help our readers understand why that would be bullish for gold?

Rick Mills: Tier 1 capital is the core measure that regulators use to gauge a bank's financial strength. It typically consists mostly of common stock and disclosed reserves or retained earnings but it might also include non-redeemable, non-cumulative preferred stocks. The Basel Committee for Bank Supervision, known as the BCBS, which is the maker of the global capital requirements, also implemented the Basel III rules that form the basis for global bank regulation. 

The BCBS is studying making gold a bank capital Tier 1 asset. Gold has typically been a Tier 3 asset, which means that it's been discounted at 50% of its current market value. With that discount, banks really never had reason to hold gold as an asset. If the BCBS raises gold to the level of a Tier 1 capital asset, though, banks could operate with far less equity capital than is normally required and gold would be the ultimate backstop for debt, currencies and bank equity capital. It would be a huge move, and making it would really propel some superior interest in gold.

TGR: Certain central banks, such as China's, are stockpiling gold already. If it becomes a zero-risk-weighted Tier 1 asset, countries all over the planet would start accumulating gold, which would of course drive up demand. What's the timeline on the BCBS decision?

Rick Mills: We simply don't know. But if it happens, you're going to see substantial demand for physical bullion and it's going to be a hugely important step toward gold's re-monetization. Moving from a Tier 3 to a Tier 1 asset would have gold compete directly as a safe-haven investment against bonds issued by over-indebted governments and yielding less than zero in inflation-adjusted terms—those negative real interest rates we discussed.

Another factor to bear in mind, one that isn't widely recognized, is that there is a huge shortage of good collateral; banks are increasingly accepting gold as collateral because they're reluctant to take each other's fiat currencies. So there's another huge step toward the re-monetization of gold.

TGR: Would you say you're generally a commodities bull?

Rick Mills: I am a commodities bull. It goes to the fact that a discovery is a discovery, and the market rewards discoveries. It rewards finding a resource and doubling it and tripling it. It rewards companies that go from near-term producer status to producers with cash flow. It rewards management, those who go to work for shareholders, build value and run solid junior companies. It rewards those that run ahead of the herd.

To me it doesn't matter whether we're in a bull market for commodities or a soft market, this kind of quality, this kind of shareholder value-building, will be rewarded. It always has been and I see nothing going on now in the market to change that. When you add in what we talked about with inflationary pressures and gold potentially as a Tier 1 asset, I see this as a perfect time to be looking at these companies with great management teams and projects that can really increase their share value at any time.

TGR: Excellent summary, Rick. Thank you so much for your time.

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