In this round table discussion, three precious metal experts discuss the prospects for gold in a Trump economy. You don’t have to be a gold bug to appreciate this insightful analysis.
I don’t want to speak for 7 billion people on earth nor for two other people on the call. For me, personally, I buy gold as an insurance policy.
Transcript
Albert: Hello and welcome to the webcast. My name is Albert Lu and I’m the CEO of Sprott US Media. I’ll be your moderator for this afternoon’s discussion. The topic today is “Will Gold Trump Politics in 2017?” and I’m very pleased to be joined by 3 experts today. James Rickards is a New York Times bestselling author of Currency Wars, The Death of Money, The New Case for Gold, and most recently, The Road to Ruin. He’s also the chief investment strategist of Meraglim Incorporated.
Trey Reik is a senior portfolio manager at Sprott Asset Management who has dedicated the past 14 years to comprehensive analysis of publicly traded gold mining companies. And Rick Rule is the CEO of Sprott US Holdings. Rick has dedicated his entire adult life to many aspects of the natural resource securities investing field and is particularly active in private placement markets having originated and participated in hundreds of debt and equity transactions with private pre-public and public companies.
Gentlemen, welcome to the round table. Today, I want to address 4 specific questions and I like to get each of your thoughts. I’m going to direct the first question to James Rickards for comment and I’d like to invite the other two also to participate. It’s the question that we led with in the title and that is will Trumponomics be bullish or bearish for gold? James, what is Trumponomics? And do you think it’ll be bullish or bearish for gold?
James: Well, the answer to the first question, Albert, is no one knows what Trumponomics is including President Trump. In other words, he has shown himself through the campaign, through the inauguration speech. He’s addressed to joint session congress, has executive orders to be, I would say, pragmatic, flexible but also a little unpredictable. Let me give you some concrete examples. During the campaign, we heard Trump label China as a currency manipulator, said “On my first day in office, I’m going to give an order branding China a currency manipulator, etc.” And if you took that literally, if you took that at face value, you would say, “Well, if he thinks China is keeping its currency too cheap and he’s going to do something about it, that means the dollar is going to get cheaper” which is usually a tailwind for gold. In a lot of ways, the dollar price of gold is simply the inverse of the strength of the dollar, So, weak dollar usually means a higher dollar price for gold. Not always but there’s a pretty strong correlation there.
No one knows what Trumponomics is including President Trump.
So, that’s kind of one way of analysis. But, in fact, Trump has done nothing of the kind. He did not brand China a currency manipulator on his first day in office. So, I mean his job particularly—I mean you can say what you want, but that designation to the extent it has any legal impact comes from the Treasury department. It comes in an annual report. That report actually is scheduled for later in April, So, it’s coming up pretty soon. But I haven’t seen any indications that the Treasury is actually going to do that. Of course, President Trump and President Xi of China had this meeting in Mar-a-Lago and does seem to be at least getting off on a fairly cordial basis, but we will see what happens.
So, the whole analysis that somehow Trump was going to brand China currency manipulator and etc. has disappeared. Now, it might come back; it might not. Looks like the Trump Administration has decided to pursue the economic agenda with China not so much through the currency wars as the trade wars. They have a group—Peter Navarro, Robert Lighthizer, the US Trade representative—I’m not sure it’s confirmed yet, but certainly he’s there. He’s selected. He should be confirmed if he’s not already, and Wilbur Ross, the Secretary of Commerce. So, they seem to be more willing to go after China on the trade front with tariffs and countervailing duties and attacking subsidies, etc., maybe even providing new subsidies of our own rather than the currency front.
So, I give that as an example of how the Trump economic agenda is, let’s say, pragmatic and flexible. Maybe it’s all the art of the deal. You put some stakes on the ground. You lay down some markers and then you give ground in exchange for something else. By the way, we have been getting some help from China in a completely different arena which is North Korea and this is a good example of how the politics of the global capital market aspect and the geopolitics and the strategic considerations have all merged. So, maybe if we’re going easy on China on the currency front, they’ve cut off coal imports from North Korea. I know North Korean coal exports to China had been cut off and China at least acquiesced in what we call the de-SWIFT’ing of North Korea basically kicking them out of SWIFT which is the international payment system. So, we’re back putting sanctions on North Korea.
So, the point is it’s a little bit difficult to say what Trumponomics is, number 1, even from a policy point of view and then from actually getting things done. I think the whole thing has been thrown into doubt by the failure of the healthcare reform based on the actions of the House of Freedom caucus without getting in the weeds on the pros and cons of that debate. I think people can argue any way they want, but the way I look at it, as an analyst, is to say, “Well you’ve got a group of Republicans who want to support you and none of the Democrats will help out. So, basically Trump can’t get anything done. If he can’t get—if he can’t round up a Republican caucus and the Democrats are not willing to throw a lifeline and I don’t see any indication that they are, that puts the tax reform into doubt. That puts infrastructure spending into doubt. It could mean the stock market is way, way out on its skis.
It was interesting to watch the stock market after the election. Of course, it was down in the early hours of the day after election but ended up flat at the open and then rallieand then we had one of the strongest rallies in history over the following 3 months. But the stock market went up in November on the prospect of Trump tax cuts, then it went up again in December on the prospect of Trump tax cuts and then when he gave the State of the Union and a speech to the joint session of Congress in January, it was early February, it went up again on Trump tax cuts. So, I watched the stock market rally 3 times on the same tax cuts. This is almost the definition of a bubble, meaning it’s not as if Trump was going to cut taxes 3 times. He was only going to cut them once, if at all, but the stock market found 3 reasons to rally on the same news.
So, that’s kind of bubble behavior and now there’s some doubt about whether anything significant will happen on the tax front. I mean you think healthcare is difficult. The last time they did a major overhaul of the Internal Revenue Code was 1986 when Ronald Reagan was president. So, that’s 40 years ago and—or sorry, 30 years ago and so it just shows the difficulty of getting these things done.
Albert: James, if I could just jump in here for a second. You made some good points. I personally was thinking Trumponomics meant weak US dollar and I just want to shift to our other two panelists. If—are we looking at a situation where gold just continues to trade inversely to the US dollar? Let’s get Rick Rule first and then Trey. That’s what we’ve seen. Do you expect to continue to see gold trade inversely to the US dollar and that the US dollar remains strong because Trump is not weakening the dollar? Is this a bad sign for gold?
I have some physical precious metals stored privately, by the way, not at home. I’m not one of these guys who advocates midnight gardening. It tends to invite people by your house who you normally wouldn’t want to have over for lunch …
Rick: I would actually defer to the other two speakers mostly on that topic. I will say that in my own experience, gold has traded partially inversely to the US dollar and probably more specifically inversely to the US 10-year Treasury. Sort of echoing, however, what James said, it’s going to be difficult for Trumponomics to affect it given that he appears to be starting 50 or 60 fights simultaneously. In a political organization as small as Sprott, I find I have to win one battle at a time and I’m not so sure in a country the size of the United States that Trumponomics has any particular chance of succeeding if he isn’t able to focus on sort of one pick at a time.
My own personal suspicion, and it’s just that, I’m more a credit analyst than I am an economist, we have a situation where both gold and the US dollar are simultaneously doing well in the global circumstance. That could be as Doug Casey says because we’re the prettiest mare at the slaughterhouse because there’s so much problem in other parts of the world. This has happened twice before that I remember in my career. In 1975 it happened and in 2001 it happened, and in both cases, the US dollar softened afterwards and it had a wonderful impact on gold. Whether past is prologue, I’ll have to defer to James and Trey.
Albert: OK. I want to ask Trey something because I know you follow not just the gold price but the gold price across major currencies. I’m wondering, is that the way you look at it, as a currency? And how much do you consider politics when you’re investing in gold and gold stocks?
Trey: Well, I think—I think I would answer that this way. First of all, Rick Rule has sort of encyclopedic knowledge of most of the world’s mineral deposits and so I’m always fascinated to hear what he has to say about stocks. One of the things that I share with Rick is I’ve spent a lot of time in the last 15 years examining the monetary, economic and financial variables that support a portfolio allocation to gold. So, while Rick approaches the gold and all minerals frankly in a sort of situational basis, what I try to figure out is when—you know, what years, what decades does it make sense for gold to be in a portfolio what are the investment merits and do the background of fundamentals support it.
With the Trump situation, there’s no question that people are as James said over their skis. What I find amazing is that the 10-year yields have maintained this elevated level since election night. And since 1990, anytime 10-year yields have demonstrated a year-over-year increase of 75 basis points, we’ve had a crisis. Similarly, anytime since about 1980 when the dollar has sustained a 7.5% year-over-year gain, we’ve had a crisis and that’s without exception. So, I don’t think Trump is as much the question. The question is with this much debt outstanding both in the United States and globally, can the world take the level of interest rates even since election night or the dollar strength since election night, and my answer would be no. So, I think gold’s relevance really is determined by the monetary backdrop in the gross over-issuance of claims on future output most frequently measured by the prices of stocks and bonds versus that underlying output.
Albert: OK. So, given where gold is now relative to other things like the dollar which is embedded in its price or implicit in its price, but also the stock market and, in general, Trey, do you feel that gold and gold stocks are attractive at today’s prices?
Trey: In the sort of decade and a half that I’ve spent analyzing fundamentals related to the gold trade, I’ve learned a couple of things. Number 1, in that 15-year period, I don’t think I’ve ever successfully convinced anyone to buy gold just on my recommendations. So, it’s a very personal decision and it really has to come from an understanding of monetary and underlying fundamentals but it’s pretty difficult to convince anyone of gold’s merits. Number 2, I am always surprised that investor attitudes towards gold are held at such surprising conviction generally unburdened by any command of relevant facts. So, most people are dead set in their view on what gold represents.
I’ve actually read the rule books of all the major exchanges. They have a rule that says they can change the rules. So, when they change the rules, they’re not really changing rules because that rule is in the rule book.
The third thing I’ve learned is there’s no asset class that has as many varied investment cues. Some people think it’s an inflation hedge, other a deflation hedge. Some people look at gold as a risk-on trade, others as a risk-off holding, and in times of stress, some favor gold but some still favor the dollar. My point there is that there’s so many different investment cues. It’s very hard to generalize about gold’s intrinsic value at any one point in time because it means different things to different investors. But one thing I do know is there’s no empirical formula I think for figuring out the appropriate price for gold at any point in time.
Now, having said that, because gold has done as well as it has for the past 15 years basically outperforming all other global assets, not only in terms of total return but in the consistency of its advanced, increasing 14 of the past 17 years on average of the world’s 9 fiat currencies. You know, I would argue there’s something more overarching in terms of gold and its price performance and that would be that I view a sort of slow migration of global wealth, very small and at the margin, from the 290 trillion in global financial assets to the relatively small pile of investable gold which is about 2.6 trillion.
And to me, the whole gold trade is about that rate of migration expanding from, say, 1/10 of 1% a year from the financial asset pile to something like 1/2 of 1% because 1/2 of 1% of 290 trillion is about a trillion and a half and that’s not going to get into a gold pile measuring 2.6 trillion very easily. And I think the big fundamental that’s motivating this methodical migration, if you will, is this incredible mismatch between global claims on future output as measured by bonds and stocks and the output itself. So, I would argue that until that mismatch starts to be rationalized, which would involve 20 trillion or so of default in the United States or household net worth in the US falling 30 trillion to get back into some balance with GDP, gold will remain a mandatory portfolio asset. So, it’s not as much the price in my view as the ability to get a little money out to the side what could be perceived as an increasingly shaky financial system.
I view a sort of slow migration of global wealth, very small and at the margin, from the 290 trillion in global financial assets to the relatively small pile of investable gold which is about 2.6 trillion.
Albert: Thank you, Trey. I want to go back to James. James, it’s very rare for someone who runs in central banker circles to recommend gold as an investment. I mean most don’t even really recognize it as a portfolio asset, but you have recommended it in your books along with other alternative assets as well. What I want to ask you though is where do gold stocks fit into the mix? Like I said, I know you like gold, where do gold stocks fit in?
James: Well, I think gold stocks, it’s a fairly straightforward analysis in general. I’ll speak in general and get a little more specific. In general, a gold stock is a leverage bet on physical gold. So, because of the accounting and the difference between fixed cost and variable cost, when you’re a gold miner and you’re raising capital and spending money and digging up gold and selling the gold at the market, you can sell forward, of course, but it’s just a different way to fix your price. There comes a time when you recovered your fixed cost and then all of the incremental cost goes straight to the bottom line and the stock market applies a multiple to that.
So, gold miners generally go up faster than the price of gold in a bull market and they go down faster than the price of gold in a bear market which is what leverage does, so they’re kind of a leverage bet. So, that’s what it is. You can have physical gold if you like, and if you want more exposure, if you have a bullish view of gold, it’s probably a good idea to buy gold miners because it’s going to outperform the gold itself in most cases.
Now, having said that, that’s not the end of the analysis because the way I look at gold miners and let me stipulate that I’m not a stock picker. I think about gold as money and so I analyze gold in the context of the international monetary system. I don’t have a background in mining or gold stocks or—you know, I’m not what some people call a gold bug. I haven’t been sitting in my basement for 30 years stacking gold coins. My background is in the bond market, government securities and derivatives and hedge funds and other types of trading. But I come to gold through my study of government finance and fiscal instability and just thinking of ways to preserve wealth and what’s the real meaning of money. So, I kind of come out from the monetary aspect.
I’m not what some people call a gold bug. I haven’t been sitting in my basement for 30 years stacking gold coins.
So, having said that, when I look at gold mining stocks, to me geology is geology. Feasibility study is a feasibility study. Finance is finance. In other words, there are a lot of aspects of gold mining that are not going to vary a lot from miner to miner. What does vary, however, is the quality of management. So, when I think about gold mining stocks, the first question I ask myself is who’s in charge? Are they high integrity? Are they fly-by-night? Have they done this before with other companies? Is this their first venture? What’s the alignment of interest with the investors? In other words, to me the—any gold mining stock if it’s well-selected, if you’ve done your due diligence, is just a leverage bet on gold and then the key to investing in the sector at all is the management. Are you dealing with good management? Or are you looking at some—because there are a lot of frauds and crooks out there and a—because one of the great things about Rick Rule and Sprott and their associates is that’s exactly what they do. They look for—you know, you care about the quality of the ore and the samples and tests and all that, but what you really look at is management.
Albert: OK. Thank you, James. I want to key in on something you said about the miners being basically leveraged exposure to the gold price. I know that’s Rick something—that’s something that you’ve talked about and you’ve also talked about the most leveraged are the most marginal at times. It reminds me of an interview that Wilbur Ross did at one point on CNBC. Someone asked him about commodities and how that played into this textile investments and he was quick to point out that if all I wanted was exposure to commodities leveraged or not, I wouldn’t have to go out and buy a textile company. The same is true with precious metals, isn’t it? If you want leveraged exposure to precious metals, you don’t have to go out and buy a mining company. So, why would you buy a mining company?
Rick: Well, I think that’s a very good point. I personally—and I don’t want to speak for 7 billion people on earth nor for two other people on the call. For me, personally, I buy gold as an insurance policy. I buy the physical metal for very different reasons than I buy the stocks. It is precisely true as James said that in aggregate, the mining companies provide you leverage to the gold price. They also ironically provide you a way to underperform if you don’t pick carefully because there is, if you will, process risk within a mining company.
It’s important to note that for 40 years, the investment community has asked mining companies to exhibit precisely leverage to gold after the events of the 1970s when the gold price went from $35 to $850 and the gold stocks outperformed even that fairly markedly. Now, asking companies to exhibit leverage is an interesting challenge because in one sense, the most marginal companies, as you said, exhibit the best leverage. We’ve asked the gold mining companies for the last 40 years to be marginal. And sadly, they’ve complied. So, it’s very important that in the next 10 years, the investment community in general, but individual investors too, ask the gold mining companies to be very selective in capturing that leverage. Mercifully, in the mining business, there are a few factors that one can pay attention to; management efficacy being one that really point to well-run businesses.
One of the interesting things now in the market is that there are some new equity-like tools. In the first instance, if someone wants to buy physical gold, they don’t really have to buy physical gold anymore. They can buy certificated gold, the ETF or our own trusts, which are much easier and in many ways much cheaper than physical gold. Similarly, to capture beta in the gold market, one doesn’t necessarily need to buy individual gold shares. There are several exchange-traded funds on the market, again, including our own Sprott Gold Miners ETF and our Sprott Junior Gold Miners ETF.
We’ve asked the gold mining companies for the last 40 years to be marginal. And sadly, they’ve complied.
So, for people who want to be in the leverage inherent in gold equities but don’t want to take the time to pick and choose among miners or in terms of gold itself, there are increasing numbers of investment vehicles that give investors and speculators the opportunity to do that in different and in some ways superior ways.
James: But if I can just jump in on that, I agree with what Rick said but I disagree a little bit with the premise to the question as expressed maybe by Wilbur Ross saying, “Well, why do I—if I want to make a leveraged bet on a commodity, I’ve got futures and options and other forms of contracts. I don’t need to buy a commodity company to get the leverage. I can just go to a futures exchange and get the leverage that way.” And, indeed, you can put 5% or 10% down and buy gold futures contracts on the COMEX and you’ll have all the leverage you can handle.
But I don’t think that’s the right comparison. I don’t think those are interchangeable and the reason is that a gold miner is—for the reasons Rick mentioned—can be, anyway, a leveraged bet on gold depending on their capital structure, and a COMEX futures contract is a leverage bet on gold. But they’re not the same. In extremis, the time when you really want your gold, the time when gold is going up not $10 per ounce per day but $100 or $200 per ounce per day in another 2008 style financial panic in extreme conditions, the time you most want your gold.
My expectation is that COMEX will shut down and that the London Bullion Market Association will send out notices to holders of unallocated gold forwards saying “Dear Customer, your contract was terminated as of close of business yesterday on a force majeure clause” or other termination clause embedded in agreement that no one read. I’m actually geek. I do read these contracts. And they’ll send you the money for yesterday’s close but you’ll be sitting there saying, “Wait a second, I want today’s price. I want tomorrow’s price or the day after. It’s going crazy. That’s why I bought it in the first place.” And they’ll say, “Sorry, you’re out.”
And then, of course, you’ll always have people saying, “Oh, gee, the futures exchange, they’re trading for liquidation only or terminating the agreements. They’re changing the rules.” You know, that’s what they did to the Hunt brothers. What they don’t understand, again, being the geek I am, I’ve actually read the rule books of all the major exchanges. They have a rule that says they can change the rules. So, when they change the rules, they’re not really changing rules because that rule is in the rule book.
So, my point is those types of contracts, in extremis, it’s not on a calm day when no one cares when you don’t even need your gold. But when you most need it, they’ll be terminated early and you’ll get as I said yesterday’s close of business not the forward exposure that you bought it for in the first place. That’s not true with the gold miner. With the gold mining stock, you’ll actually be along for the ride, you’re an equity holder. Now bad things can happen. I mean they can file for bankruptcy. Nothing is risk-free. But, why would they? I mean that would be the environment they’ve been waiting for.
And so, to me, a gold miner and a COMEX futures contract are both leverage bets on gold but one will be terminated when you most want it. The other one will be most prosperous when you most want it. So, I think you have to consider those conditional correlations in comparing the two.
My expectation is that COMEX will shut down and that the London Bullion Market Association will send out notices to holders of unallocated gold forwards saying “Dear Customer, your contract was terminated as of close of business yesterday on a force majeure clause” or other termination clause embedded in agreement that no one read. I’m actually geek. I do read these contracts.
Albert: What a great point, James. And I’ll add compared to what you just laid out the scenario anyway, this is a very minor thing. But rolling these future contracts will cost you money; whereas, if you pick a good mining company, it’ll actually yield you a positive dividend. Let’s return back to Trey because you spent over a decade studying these gold mining companies. James pointed out perhaps the most important or one of the most important aspects to look at when you’re considering a company, that is, the people, the executives. Can you just talk briefly about some of the other factors that you like to look at when you’re selecting the best gold stocks?
Trey: Sure. I think that there’s 4 or 5 things that are important. Management obviously prominent among them. Another would be jurisdiction in terms of the stability of the government and existing stability packs on taxation, etc. Another would be the environment in not only the country but the area where the deposit is. So, those two I think are—you know, 20 years ago, all the gold in the world was found in 4 countries—South Africa, Canada, the United States and Australia. And in the next 20 years, it’s all going to be Burkina Faso, Mongolia and that type of thing.
So, stability packs, stable government, good communications, that type of thing are very important. Ironically, there is a lot of concern that in a place like the Congo there’s an appropriation risk. And in my experience in places like Burkina Faso and the Congo where mineral rights are so darn important to change the prospects of the citizenry there insofar as their—one of the few things for economic betterment that exists, I’ve actually in my experience found that it may be an area where appropriation is less of a risk than in some of the developed countries of the world. So, I think that’s important.
Grade is also a very important factor these days because peak oil is nothing like peak gold. We really haven’t had a major deposit in a couple of decades of world class value and most of the gold mines that the majors are looking at these days are sub-1 gram per ton which obviously brings capital cost into more of a microscope. So, I think another very, very important variable in the next 10 years will be grade and I would yield to Rick.
When somebody tells me that something is going to be absolutely wonderful for me over the next 5 years and they know more about their company than I’m ever going to, if they think it’s so great, how much of their own money do they have invested in that greatness that they see?
Albert: Let’s bring in Rick. Rick, what would you add to this list?
Rick: Well, that was a very good start. I like to look at producing gold mining companies the same way I’d look at an oil and gas company, which is to say net present value. You take the scheduled cash flows, projected cash flows from developed producing reserves measured and indicated inferred reserves and you do an after-tax net present value on them, taking out historical and forecasted costs and cost of capital. And try and figure out what the company is worth as it sits and then put in a pricing matrix, a low-side pricing scenario and a high-side pricing scenario to figure out what the business is worth on different gold price scenarios.
The second thing that you do becomes much more difficult. You look at the company historically and you look at something called the ‘recycle ratio’, that is, from the cash flow they produce how many ounces, how much net present value in ounces are they able to establish either through exploration or acquisition. In other words, is the management team accretive or dilutive in terms of the value that they add from exploration and acquisition?
Finally comes the qualitative part because companies are really collections of individuals. What you need to do is look at the résumés of the individuals in place and figure out whether those résumés are actually suited to the task at hand. Many people will tell you that they’ve been successful in the mining business when their history in mining is in a task which is completely at odds with the task that they’re hired for now. An executive can tell you that he or she has been successful in the gold mining industry when the success was operating a gold mine in French-speaking Quebec in 2 billion-year-old Archaean terrain, and the task at hand is developing or exploring for copper gold deposits, as opposed to producing them, in tertiary volcanics, very young rocks, in Spanish-speaking Peru. And although the tasks or broadly speaking, both mining, success in one task certainly doesn’t qualify one to be a success in another.
So, I think that you need to look at the numbers in terms of return on capital employed and particularly things like general and administrative expenses relative to exploration and development expenditures and relative to free cash flow. You need to look at those net present value calculations. You need to look at exploration and acquisition efficiency, and I think importantly, in the—really in all size companies, you need to look at management buy-in. Does most of their upside have to do with salary and bonuses? Or does most of their upside have to do with ownership in the businesses that they are running?
When somebody tells me that something is going to be absolutely wonderful for me over the next 5 years and they know more about their company than I’m ever going to, if they think it’s so great, how much of their own money do they have invested in that greatness that they see?
When I think about gold mining stocks, the first question I ask myself is who’s in charge? Are they high integrity?
Albert: You laid out a couple steps there, Rick, and I’m wondering about the first one, this net present value calculation. Is this pretty much the same calculation that someone like Whitney George would do on an Under Armour or an Apple computer? Or is it different because it’s a mining company?
Rick: It’s different. Under Armour presumably will be able to make underwear from effectively the same mills until the end of time. So, from Whitney’s point of view, EBITDA to enterprise value and price earnings and earnings to enterprise value are important because there is some continuity of the brand. Every day in the gold mining business, if you aren’t replacing ounces through acquisition or exploration, your business gets smaller. So, net present value has a terminal calculation in the gold mining business whereas the multiples can be higher in other businesses because of their ongoing concern nature. Yes, you look to optionality in our business. There’s not much optionality in underwear is an example. But there’s substantial optionality in the gold business. But, the valuations in the gold business, you need to understand that net present value rather than ongoing concern value is much more important.
Albert: Very interesting. OK. You mentioned earlier that you think of physical metal strictly as insurance, So, I’m going to go to James Rickards once again. With regard to physical precious metals, (a) do you look at it just as insurance or speculation? And how do you like to hold precious metals? In your view, what is the best way to hold the physical?
James: Well, the answer to the first question is it definitely is a form of insurance, So, I concur with Rick on that, but I think it’s more than that. It’s really—I think of gold as money. I’ll leave it at that. If you want some money, then you should have some gold. I hear people say, “Well,” you know, “I don’t understand gold” or “gold is a barbarous relic” and I hear all these usual criticisms and “How can you hold it?” And you hear disparaging comments, “You’re a gold bug,” blah-blah-blah.
And my reaction is I don’t understand how you can sleep at night if you don’t have gold. To go through the world we’re living through now with the geopolitical risk, the cyber risk, the financial risk, systemic instability, and basically all the—you know, the risk coming from a lot of different directions. And say I’m going to bet my entire net worth, all the work I’ve done, all my savings, all my investments on digital assets held in one of a small number of banks and brokers. That would keep me up at night.
I don’t understand how you can sleep at night if you don’t have gold.
So again, having some physical gold I think is a way to preserve wealth and some peace of mind. It’s not the only way. I think land serves that purpose. Fine art serves the purpose. I think silver tags along. I’m not—I don’t spend as much time thinking about silver as I do gold but it’s certainly a precious metal. There’s no way gold is going to go to the levels I expect and silver would not be along for the ride. So, I think silver has a place. It’s also very practical because if you ever did have to go out in an extreme scenario and buy food for your family a gold coin might be a year’s worth of groceries and a silver coin might be a week’s worth of groceries. So, I think the silver has some practical value when it comes to that. And, of course, throughout American history, it was the—you know, people did have gold coins, but it was the silver dollar and not the gold coin that was most commonly used.
In terms of how to hold it, I recommend physical gold in non-bank storage. The thing about banks again when you most want your gold is the day when the banks are most likely to be closed. In a financial panic when the authorities haven’t had time international monetary elites haven’t had time to convene whether it’s a new Bretton Woods style conference or a mass emergency issuance of Special Drawing Rights to re-liquify the system or some other change in whether or not it’s the rules of the game. All these things you can see coming but they don’t come overnight. I mean they could take weeks or months.
Again, just use the last crisis as an example. The height of the panic was September 15, 2008, when Lehman Brothers filed for bankruptcy. I mean it started in the summer of 2007. Recession wasn’t over until June 2009, So, you can really look at a 2-year—almost a 2-year window. But if you had to pick a day, say, when was it most acute, when was fear at its height? That would have been September 15, 2008. Well, the IMF issued SDRs in August of 2009. In other words, it took them 11 months to organize their response function. So, that was in a scenario less extreme than what I’m expecting, and so even if you said you could do it in 3, 4 or 5 months, that’s a long time to basically be done with the banking system that’s probably partially shut down. So, you certainly don’t want your gold in a bank.
And I’ve seen this in recent trips to Switzerland. I go there—I talk to bankers, but I spend more time with secure logistics operators, people who do transportation and vaulting, people who handle the physical gold, in other words, and refiners. And the vault operators told me that they’re seeing outflows from the banks to them, meaning people are taking their gold out of UBS and Credit Suisse and Deutsche Bank and others and moving it into a Loomis or Brinks or some other facility. Of course, that has zero impact on the total supply of gold, but it has an enormous impact on what’s called the floating supply because once you take it out of the bank and put it in a private vault, it’s no longer a part—you know, as long as it’s in the bank, the bank can sell the same bar of gold 10 times over if it’s unallocated, So, that’s what I mean by floating supply. But when you put it in a private vault, it’s just your gold and it’s not hypothecated at all. So, that means that the entire paper edifice is resting on a smaller and smaller amount of physical gold which means more physical gold which means more leverage and more instability potentially.
Well, I don’t like numismatics if you mean old coins. They’re usually a rip-off. They’re not worth very much more than the actual gold and they—a lot of dealers charge unconscionable premiums.
Albert: James, can I interrupt for a second? On the topic of holding the physical—you’re leaning toward coins, I can tell. Do you have a preference for bullion or numismatic coins?
James: Well, I don’t like numismatics if you mean old coins. They’re usually a rip-off. They’re not worth very much more than the actual gold and they—a lot of dealers charge unconscionable premiums. You know, I like American Gold Eagles. They come from the US mint, pretty good insurance and quality. They—you know, they say “In God We Trust.” The designs are beautiful. There are other good coins around the world. I mean Maple Leaf, Austrian Philharmonic—by the way, I’m not a gold dealer. I’m not in the business of selling gold. I write about it and talk about it. I analyze it quite a bit, but I’m not a gold dealer. I don’t have any horse in that race, but I do think that American Gold Eagles are a good way to buy. If you have a lot more money, if you’re talking about hundreds of millions of dollars or you want to allocate 10% of a billion and that’s 100 million. That’s an awful lot of coin so—in that world, I think the four nines kilo bars depending on the market today. They’re going to run—I don’t know, $45,000 to $50,000 a bar. That’s a good way to hold it. I think the old 400-ounce bars, I mean that’s—they’re actually obsolete as a medium for holding gold.
The reason the 400-ounce bar was invented. That is the one, the bullion market association standard. But the reason it was invented, they wanted to make gold ownership as inconvenient as possible, meaning the little guy couldn’t afford 400 ounces So, he didn’t have any gold and if you were wealthy or an institution or a country, you could get your 400-ounce bars but that format was created in the early 20th century to make it difficult to own gold. But now we have better formats. You know, the American Gold Eagle is actually a continuation of the British Sovereign. It’s 22 karats, not 24 karats and people prefer the American Buffalo, which is a 24-karat coin. I like the Gold Eagle. You still have an ounce of gold. There’s an ounce of pure gold in each coin. It’s just that the eagle has a little alloy for durability and I think that’s good. That’s why the Sovereign was a 22-karat coin because if you’re going to carry it around and use it for anything other than just looking at it on a shelf, you don’t want it to wear out and that’s a problem with the Buffalos.
But whether it’s Maple Leafs or—I wouldn’t buy anything from China. I think that China has a counterfeiting problem. So, I’d keep away from those. And numismatic value, I mean if you—you know, if you wanted to interest me in a 5th century AD Byzantine gold solid that might have some—you know, a museum quality coin. In other words, that might be interesting. But this stuff about pre-1933 Morgans and all that stuff, I think it’s mostly nonsense.
Albert: OK. I want to go to Trey, same question. So, when you’re looking at portfolio gold, this is the physical, not companies, are you looking it as an insurance policy? Are you looking at it as money? Are you looking at it as a uncorrelated asset? Can you just talk about that? And then also to follow up on what James said, what’s your preferred method of holding?
I wouldn’t buy anything from China. I think that China has a counterfeiting problem.
Trey: Sure. So, I just while Jim was speaking reached into my pocket and I have my 6 Buffalos in my pocket, So, I’m going to say I prefer the Buffalos because when you walk through a metal detector at the airport, it doesn’t set it off. So, that copper becomes a little bit more problematic when you’re trying to tease the TSA guys. But, with respect to the way I would view holdings of gold, I think coins make an enormous amount of sense for an individual for the first, say, 20% to 25% of their gold allocation because—I’m sort of in between Jim and Rick on this point. I think the advantage of coins is that they’re accessible. They’re portable. They’re recognizable you can get your hands on them, not that you would go down the street and buy a head of lettuce but just having access to the gold at your convenience and at your decision and being able to carry them. You know, you can take $10,000 in US currency abroad and declare that through customs. This country, the United States, allows that to be gold coins So, you can take 200 Eagles or Bisons with you that would satisfy the $10,000 in currency and take an enormous amount of capital with you very easily.
So, I think coins are important and I think the next allocation would probably be some sort of bullion ETF like the Sprott Physical Bullion Trust. The Sprott product has some advantages in terms of preferential tax treatment which I think make it the best among many. And then once you have that type of gold exposure established, then I think in a tactical basis, for short periods—by short I mean sort of 3 years. I think old equities can add an enormous amount of alpha. And I favor gold equities in periods when faith in US financial assets is being recalibrated. So, if you look at the performance of gold equities since 2000, there’s really been 3-year periods and during those periods which were 345, 185, and 309 percentage gains. The S&P during those periods was down 22, up 10 and up 39 percent. The compound performance of gold equities if you were to combine those 3 advances, that comes out to a little over 5000% in a period of time where the coincident performance of the S&P was 22%.
So, gold stocks believe it or not have outperformed the S&P by a factor of 250:1 for 55% of the past 16 years those 9-year periods. The problem is the corrections between those advances were 36, 75 and 85% and that comes pretty close to 100. I think it comes out to 98.5%. So, my point there is that the tactical allocation in a gold portfolio for an individual or an institution gold equities can be very powerful as that final commitment when faith in US financial assets is being recalibrated.
Although the royalty companies are by and large—in fact, absolutely finer companies—my suspicion is that in a manic bull market, they will ironically underperform because of their quality.
Albert: Thank you very much, Trey, for that. I want to go to the listener-submitted questions. We had thousands of people register for this webcast and hundreds of people submit questions, So, it’s going to be difficult to get through all of them. But I picked out some of the more common ones and we’re going to try to get back to the rest of the submissions via email afterward. So, this is a gold webcast but, of course, people always want to know about silver as well. So, I’m going to direct this first question—the first two actually—to Rick Rule and then get the other two gentlemen to comment if they desire. “Will the silver to gold ratio normalize—” and he says, “to 1:16?” And another question that’s related, “Will silver outperform gold?” And let’s put a timeframe on it. Let’s put 3 years on it. Rick, what do you think?
Rick: Well, the first thing is that I’m not sure why the 16:1 should matter. I realize that that’s the relative abundance in the Earth’s crust. But I would suggest to you that gold and silver have somewhat different functions. Silver functions partially as an industrial mineral, which makes it a little more bullish in the sense that it goes away. It gets used for industrial applications and comes out of the vault. Gold has a longer-term value as money and a medium of exchange. So, I’m not sure that the 16:1 ratio does or should matter.
If you look at the performance, the relative performance of the two metals over the last 40 or 50 years, it’s pretty obvious as James said that gold and silver operate in correlation, although silver would appear to me the more volatile of the two, that is outperformed to the upside and underperformed to the downside. And I would expect in that case the past is prologue. I think that the characterization of silver as poor man’s gold is accurate. As an example, in some cultures where they have a cultural affinity to precious metals—I’m thinking particularly of South Asia, Bangladesh, Pakistan, India, Sri Lanka where there’s strong cultural affiliation to precious metals as a consequence of their distrust of their own sovereign currencies.
In periods of crisis, the populace has often stored their wealth and precious metals. And for about 400 million people in that part of the world, gold is not affordable and the amount of silver that can be stored in private hands in South Asia during times of crisis can be absolutely amazing. So, my own suspicion is that the 16:1 ratio is probably mostly a floating abstraction. And if past is prologue, and I think there are reasons why it should be, that from a speculative point of view, silver might outperform gold in the bull market that I suspect all 3 of us see in the future.
Albert: OK. Another question, “Which one has a potential to go higher? Gold mining shares or gold royalty companies?” Anyone want to take that question?
Rick: I’m happy to take it. My suspicion is that the gold royalty companies are the highest quality, least leveraged companies. So, in a rocking and rolling gold bull market, they will exhibit less leverage to the upside. They are in almost every circumstance better companies, however, better allocators of capital, no ongoing capital expense, no sustaining capital expense, no operating cost. So, although the royalty companies are by and large—in fact, absolutely finer companies—my suspicion is that in a manic bull market, they will ironically underperform because of their quality. That doesn’t mean that you shouldn’t own them. I have extensive holdings in them, but they would underperform the general ironically lower quality gold companies in a very active market.
Albert: Is it fair to say though, Rick, that if you overstay the bull run and you own royalites you have less of a probability of suffering an enormous crash that may come afterward?
Rick: I think unless you’re a speculator, you are always well-advised to buy the best of the best.
Albert: OK. James, you referred briefly to Chinese counterfeiting in the gold market and this lines up with the question I have here. How big of a problem is the counterfeiting of coins and bars?
James: It’s hard to say how big of a problem it is, but since it is a problem, why go there? In other words, if you’ve got plenty of first-grade Swiss refineries and other refineries and plenty of excellent coins from the US Mint whether it’s Buffalos or Eagles, what’s the necessity of messing around with Chinese product at all?
Albert: What about Chinese counterfeiting of American products? I know that Silver Eagle has been victimized that way?
James: Yeah. I mean I was in a dealer once and he had some silver coins and he picked up a magnet and lifted up the stack with the magnet and, of course, silver is non-magnetic. So, I guess nothing is immune. I learned a long time ago that nothing is risk-free, but I don’t consider the low risk of US counterfeiting to be a reason to jump into a deeper pool with Chinese counterfeiting. I just—I just can’t think of a reason to buy any Chinese product.
Albert: OK. Another question. I’ll direct this one at Trey. The person says, “Are Sprott precious metals ETFs a safe way of owning precious metals should there be a gold shortage in the future?”
Trey: I think the way I would look at—again, with the disclaimer that that gold is one thing and the shares offer another, the Sprott equity ETFs in the gold space that Rick mentioned earlier—SGDM and SGDJ, which are the Sprott sort of equivalents of the GDX and GDXJ, do have, I think, a very rational overlay of analysis that redistributes the portfolio from the cap-weighted nature of the two more commonly owned indexes into one that offers a little, I think, smarts in collecting which are the appropriate companies.
So, one of the problems with gold mining, it’s the only industry I’ve ever seen that has such a strong negative survivorship bias. And by that, I mean the Barricks and the Gold Fields and Anglos of the world, who are larger companies, have a much more difficult time replacing their reserves. Their mines are generally more aged and they’re forced into decisions of development and acquisition that don’t always work because, quite frankly, gold mining is extremely difficult scratching the earth’s crust for something that appears at 3 parts per billion in inherently difficult and the best laid plans sometimes hit hurdles which are not foreseen.
My point there is that perhaps a Detour or a Torex, a company that’s successfully developing a new mine and bringing it into production profitably, in my opinion offers a lot more upside. The way the Sprott products are organized is there’s a balance sheet consideration and a revenue growth consideration, the theory being that if your revenues are going up in the gold business, you must be doing something right because you’re selling more gold, and that overlay reweights the highest beta names in the publicly traded arena in preference for that high-quality balance sheet and high-quality demonstration of growth.
So, with the caveat that all gold share investment approaches are volatile, I do think there is some inherent benefit in calling the names to get away from that negative survivorship bias that exists in the gold industry.
Albert: I don’t know if the questioner was referring to those or to the physical products, but I just want to make a comment and put a question out there for the panel about physical. One of the criticisms about ETFs even the ones that have physical holdings is that in a crunch, maybe they don’t have those holdings. As an investor and as an adviser, I’ve always worried a little bit about that. Not that this would actually happen but if this was rumored to happen with one ETF, maybe all of them would suffer a drawdown. So, my question is does the redemption feature in the Sprott physical ETF somewhat insulate that product from, say, a speculative panic of that sort? And do you see the possibility of a divergence in these ETF products? Meaning, that they would not be all considered the same under that situation.
Rick: OK. I mean my own suspicion is that the redemption feature would make the Sprott product more acceptable in the market relative to its competitors simply because at a certain size, you can redeem, and people have redeemed the shares for physical precious metals. The other thing is, of course, that with regards to a trust, the size, the corpus of the estate doesn’t rise and fall, shrink and swell every day, like it does in an ETF where there’s inflows and outflows of assets. What that means is that in liquidity crunch like we saw in 2008, it might be that if a defaulting—if a counterparty to an ETF, a delivering counterparty defaulted, the ETF becomes an unsecured creditor of the defaulting party; whereas, the assets of the Sprott product are always physical metal, never promises to pay. It’s never hypothecated. We never take delivery receipts. We only take physical precious metals.
If you ask a really open-ended question like what will happen in the event of a total panic, my suspicion is that the immediate 90-day aftermath of the total panic is just that, total panic. And if the situation that you’re trying to insure against is all or partly that, then probably you want to confine your own holdings to physical precious metals and perhaps stored privately. For myself, I have some physical precious metals stored privately, by the way, not at home. I’m not one of these guys who advocates midnight gardening. It tends to invite people by your house who you normally wouldn’t want to have over for lunch and exposes you to a whole different series of risks. I thought I’d get that off my chest.
In liquidity crunch like we saw in 2008, it might be that if a defaulting—if a counterparty to an ETF, a delivering counterparty defaulted, the ETF becomes an unsecured creditor of the defaulting party; whereas, the assets of the Sprott product are always physical metal, never promises to pay. It’s never hypothecated.
For most of my own holdings, my belief is that I’ll have plenty of time as the situation begins to proceed from bad to very bad to worse. And the ease with which I can buy and sell the Sprott products on the New York Stock Exchange gives me some of the insurance function that I’m looking for without the necessity to have to pay large markups to spot when I buy it, receive discounts to spot when I sell it and physically transform it from where I bought it to where I store it and vice versa. I’m not arguing against that. I’m just saying that I’m sort of old and rich and lazy, and for the circumstances that I foresee for most of my own holdings, I prefer to have certificated gold. And because also I have a moral and a practical objection to paying tax, the fact that on the trust, I pay tax at the capital gains rate while on the ETF, I would pay tax at the ordinary income or collectibles rate leads me to favor the trust product.
Albert: Great answer, Rick. I’m going to go back to James. James, we had a discussion recently on my show and this question is directly related to that actually and that is, “Will the changing 2017 Fed membership be more gold-friendly, gold-neutral or gold-unfriendly?”
James: In terms of their policies, it will be gold-unfriendly, but in terms of the result, it will be gold-friendly and that’s because the Fed doesn’t have as much influence as they think. So, let me explain—let me unpack that just a little bit. Right now, Donald Trump owns the Fed and the reason is there are 2 vacancies today. There’s a third resignation announced effective in April, so literally in a matter of days, there’ll be 3 vacancies. There’s already 1 Republican on the board, Jay Powell. You don’t hear much of Jay because he’s been the only guy in his sandbox, but he’s going to have 3 more people in his sandbox pretty quickly. So, count that as a fourth sort of Republican, but there’ll be 3 new faces in a matter of weeks.
And then Janet Yellen’s term is up January 31, 2018, but it requires Senate confirmation, so they’ll have to announce her replacement perhaps as early as Thanksgiving or so to get the hearings done and to get somebody in place when her term is up. So, there’s a fourth appointment as I said in a matter of months. Then just to top it off, Stan Fischer’s term expires in June 2018. So, if you just go out slightly over a year, Trump is going to be able to appoint 5 of the 7 seats. There are only 7 seats on the Board of Governors. He’s going to appoint 5 of those seats and has 1 Republican in place. So, all of a sudden, our friend, Lael Brainard, is going to be the only Democrat on the board. She’s going to be the one with no one in her sandbox.
No president has had that many appointments to the board at the same time since Woodrow Wilson and that was only because—that was when the Fed was created and he had an empty board but for 2 statutory appointments—Secretary of the Treasury and Control of the Currency. But Wilson got to fill all the seats because it was a vacant board. No president has had that much power since Woodrow Wilson in 1914.
So, Trump owns the Fed. The question is what does Trump want? He’ll get what he wants but it’s not clear he knows what he wants. But having studied this, and again without repeating the whole analysis at the beginning of the call, Trump is leaning to a hard money set of appointments. The number 1 name is Kevin Warsh. Interesting thing about Kevin, he was on the board before and left and resigned—I think it was 2010 or early 2011 or right in there. There’s no reason for Kevin to go back to the board unless he’s going to be the chairman, then it would make sense. I think the White House is reaching out on that basis. If you see Kevin Warsh appointed in the next let’s say month as one of these 3 vacancies, you can be certain that he’s the next chairman. So, that makes Yellen instantaneously a lame duck. Yellen—imagine going into a—you know, anyone who’s been involved in corporate governance, you’re going to a board room, you’re the chairman, but the next chairman is sitting right next to you kind of staring you down. So, that’ll pull the rug off from under Yellen months ahead of the expiration of her term.
And you look at the people around Trump whether it’s Larry Kudlow, Art Laffer, David Malpass, Stephen Moore, Judy Shelton; a lot of these advisers are hard money people. So, my expectation is that—you know, just in the steady state, leaving Trump aside, the Feds are on a path to raise rates. They’re going to raise rates 4 times a year, every other meeting from now on until 2019 until they get interest rates above 3% and that has nothing to do with the business cycle for the first time in history. It has to do with the fact they skipped a cycle. Should have raised in the 2010 but didn’t. They’re now playing catch-up trying to raise rates so they can cut them in the next recession because you have to cut interest rates 3% to 4% to get out of a recession.
So, they are doing something they haven’t ever done before which is why Wall Street doesn’t really understand the dynamic of these interest rate hikes. But the finesse is, can you raise rates to cure coming recession without causing the recession you’re getting ready to cure? My answer is probably not, but we’ll see how that plays out. But be that as it may, the Fed is on a tightening course now. That is going to get more hard money when these appointments come in because Kevin Warsh would say interest rates should have been 2.5% 3 years ago using the Taylor rule.
So, Trump owns the Fed. The question is what does Trump want?
So, we’re on a hard money tightening path, so that’s a headwind for gold, but—and here’s the big caveat. The economy is fundamentally weak. They’re on this jihad to raise rates to play catch-up. You’re not supposed to raise rates in a weak economy but that’s exactly what the Fed is doing. So, they’re very likely to cause a recession and when they do that, they’re going to have to flip for only the 9th time since May 2013 to easing.
You know, look at all the flip-flops the Fed has done. You know, they were all set to do the famous taper in September of 2013 and they didn’t. They pushed it off until December. They were all set to do the lift-off in September 2015 but the Chinese stock market crashed and the US stock market was right behind it in August 2015 so they pushed the lift-off back until December. So, the same thing; they were set to raise rates in March 2016, but they didn’t because the stock market fell 11% between January 1 and February 10.
And so, you have this whole series of flip-flops. So, in the short run, I see tight money headwind for gold. Gold kind of going sideways. But by the summer, I expect the economy will hit stall speed because of the Fed’s policies. I expect they’ll raise rates in June, but by the summer, we’ll see visible signs of weakness and then a flip-flop to ease. And then the market will look at that and say, “Here we go. Risk on” and I would expect the price of gold to perform very strongly in the second half.
Albert: James, I’m glad you added that last part in because certainly they could do things that would be unfriendly for gold, but anything that resembles a strong dollar policy, in my view, would be absolutely lethal for the stock and bond markets, which would cause them to turn around. Now, I got one more question I want to end off with and we’re running out of time, so it’s just 1 minute each. It will be a challenge to answer this in 1 minute, but let’s start with Rick Rule. What is the most important lesson you have learned in investing?
Rick: Bear markets beget bull markets. Bull markets beget bear markets. So, if you’re not a contrarian, you’re going to be a victim.
Albert: Trey Reik, same question, the most important lesson you’ve learned in investing.
Trey: Boy, Rick really wrapped it all up with what he said. I think it’s important to have a long-term perspective. I think that we become increasingly short-term in our approach and because gold is volatile, therefore, to many it seems risky. But I think that it’s important to look at portfolios especially in this type of environment for a 2- to 3- to 4- to 5-year time horizon and I think in that type of environment gold starts to lose the risky moniker that it earns through its volatility and that diversification has time to give your portfolio benefits.
Albert: Thank you very much. Finally, James Rickards, same question.
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