GOLD & SILVER: Speech to the ResourceOne Conference, New York - April 21, 2010
Those of you who know me know that I am quite optimistic about the outlook for gold and silver. This may be good news for those of us in the mining business or invested in precious metals assets.
Unfortunately, to be bullish on gold means that I’m pessimistic about the U.S. economy, particularly the outlook for inflation and economic growth, over the next few years. More about this in a few minutes . . .
Price Projections
But first, at the risk of sounding like a gold bug — which I’m definitely not — let me give you some numbers: I believe we will see gold back near its all-time high around mid-year. In other words, around $1227, give or take a few dollars, by the end the end of June. And, by year-end, New Year’s Eve, we could be celebrating $1500 an ounce.
Now, if these prices seem extreme, let me remind you that last year, we saw gold move up 35 percent in the space of five months from July to its early December record high. A similar performance from today’s price puts gold a few dollars above my target of $1500 an ounce.
What about silver? In an up market, I expect silver will do about as well, if not better, rising to $25 an ounce, give or take 50 cents.
Longer term — without being too specific about the timeline — I think there’s a high probability gold will reach $2000 . . . and, quite possibly, $3000 or higher before this bull market reaches its inevitable cyclical peak and prices start moving in reverse.
Importantly, I think these markets will remain quite volatile with big moves up . . . and down — so much so, that sharp declines may lead some observers to prematurely declare the bull market in precious metals is over.
Bullish Building Blocks
There are a number of solid long-term building blocks that assure higher gold prices in the years ahead. In brief, these are:
- Number One: Inflationary U.S. monetary and fiscal policies — with record monetary creation, negative real interest rates, and record Federal deficits promising accelerating inflation and a diminishing appetite to hold U.S. government debt.
- Number Two: An inherently unstable European currency — with divergent fiscal policies and sovereign risk continuing to be an important theme in currency markets the euro is in no shape to assume a larger role in the world monetary system.
- Number Three: Expanding investor interest in gold, both demographically and geographically — with more people and institutions around the world currently and potentially investing in gold and silver via new investment channels and vehicles that make these precious metals more accessible than ever before. In particular, Asia is emerging as a sponge for gold and silver, for jewelry and investment with important implications for the future price of these metals.
- Number Four: Rising central bank and sovereign fund accumulation — with the official sector becoming a significant buyer of gold last year, after two decades in which central banks as a group sold, on average, about 400 tons a year.
- And, Number Five: Declining world gold-mine production in the years ahead — even in the face of sharply rising prices, mine output will continue falling for at least a few more years as existing mines are depleted, ore grades drop, operating depths fall, energy costs rise, and the cost of developing new mines continues to rise.
The Economy — Not So Rosy
Let’s look at a few of these “bullish building blocks” in more detail, beginning with U.S. economic prospects:
Unfortunately, the U.S. economy still faces significant and painful adjustments in the years ahead following (and a consequence of) many years of profligacy in which federal and local governments along with private individuals and households spent more than we could afford on borrowed time and borrowed money.
Despite recent optimism and signs of continuing recovery in the U.S. economy, the past year’s severe contraction in the broad measures of U.S. money supply — in nominal and in real terms, that is adjusted for inflation — presage a significant deterioration in business activity.
And, with U.S. inflation also heading higher we are heading into a period of stagflation, much like we saw in the 1970s.
The key indicator, the broadly defined M3 money supply for the United States, is now down by 3.7 percent from a year ago . . . and, in real terms it is down 5.8 percent over the past 12 months. The historical evidence suggests there is a strong correlation between changes in the growth of M3 money supply and changes in economic growth, measured by real Gross Domestic Product some six to 12 months later.
Several factors, in addition to the contraction in broadly defined money supply, make a “V” shaped recovery implausible . . . and suggest a “double dip” or, at best, a very sluggish recovery with continued high unemployment for years to come.
- First, households are saving more — as they must to restore household balance sheets follow years of excessive consumption and imprudent borrowing. In addition, heighted uncertainty and job insecurity encourage increased “precautionary” saving. With consumers accounting for approximately 70 percent of total demand, it is hard to imaging a robust recovery when households attempt to save more and spend less.
- Second, falling personal incomes reflecting lost jobs, salary cuts, reduced hours, and lower sales commissions mean that many consumers have less to spend.
- Third, the crisis in state and local budgets is reducing spending on capital projects and social programs. Even local school districts are cutting budgets and laying off staff.
- Fourth, rising home vacancies and foreclosures, empty retail space (like the vacant Circuit City stores we see across the country), and unused commercial and industrial capacity.
- Fifth, limited credit availability to households and especially to small businesses that are so important to the overall economy as banks continue to keep their belts tight and are reluctant to take on risk in this risky business environment.
- Sixth, and quite important, the coming rise in medium-term and long-term interest rates. Foreign central banks and institutional investors are just starting to require higher rates of return to compensate for perceived sovereign and inflation risks.As higher interest rates cascade through U.S. credit markets, private borrowing by corporations and households, for everything from revolving credit to new mortgages, discourages borrowing and retards economic growth. Since many mortgage rates are linked to the yield on 10-year Treasury notes, existing home prices could take another hit along with the residential construction industry.
Indeed, the hoped for recovery that many mainstream economists and politicians see in the economic tea leafs is not recognized my most Americans. That’s why the latest readings on consumer sentiment are deteriorating. What recovery we’ve seen to date has been underwritten by extraordinary monetary and fiscal stimulus provided by the Fed and Treasury. Take that stimulus away and the economy wouldn’t have a leg to stand on.
So, I am sorry to say, soon comes the second dip of the “double-dip” recession that will be characterized by:
- A further significant rise in unemployment,
- Contracting consumer spending and weaker retail sales,
- Still lower home prices, more foreclosures, and a further reduction in residential and commercial construction,
- Shrinking federal, state, and local tax revenues,
- Worsening public-sector deficits and financing difficulties,
- A wider risk premium on medium- and long-term Treasuries with more pressure on the Fed to monetize a growing slice of American debt, and
- Continuing erosion in the dollar’s purchasing power, both at home and abroad.
- And, importantly, for precious metals — an erosion in the dollar’s “safe-haven” status that sends more scared money into gold and silver.
Even if economic growth hobbles along without an actual double dip and unemployment remains high, we can expect additional stimulus from Washington that aggravates our fiscal dilemma, keeps the Fed’s foot on the gas so that the funds rate remains near zero for longer than now anticipated and quantitative easing further undermines the dollar — all of which benefits gold and silver.
Real Interest Rates
While I’m talking economics, one time-tested indicator of future gold and silver prices I like to watch is “real” or “inflation-adjusted” interest rates.
The historical data show that real interest rates are a very reliable precursor of the U.S. dollar’s performance on world currency markets, of future price inflation here at home, and of the direction of dollar-denominated gold and silver prices in the next year.
As day follows night, low or negative real interest rates (on short-term Treasury bills, for example) are followed some time later by rising precious metals prices.
Not surprisingly, the current bull market for gold that began in 2001 (with gold near $255 an ounce) has, for the most part, been a period of low or negative real interest rates.
Before this, the great bull market for gold and silver in the late 1970s culminating in the January 1980 high points was also a period of negative real interest rates in the United States.
Today, as most of you are aware, real interest rates are still low . . . and I believe this points to higher gold and silver prices in the year ahead.
In fact, I’d allege that, for a variety of reasons, U.S. consumer price data are today under-reporting actual inflation . . . and that real interest rates are actually well into negative territory.
Too Little, Too Late
At some point, perhaps later this year, the Fed may begin raising short-term rates — and precious metals may sell off sharply on the news. But I think any Fed tightening will be too little, too late to reverse the rising trend of inflation, instill renewed confidence in our currency, and break the bull market in precious metals.
As long as the rise in U.S. inflation outpaces each incremental step up in nominal interest rates — so that real rates remain near zero or in negative territory — monetary conditions will remain supportive of the upward trend in gold and silver prices.
It is said that economic forecasters are “often wrong but never in doubt.” Well, suppose I’m totally wrong about the U.S. economy, about U.S. monetary and fiscal policy, about inflation, and real interest rates. Where would this leave us in terms of the outlook for gold and silver?
Gold Investment Infrastructure
I believe that the expansion of precious metals investment interest and the continuing development of what I call the “gold investment infrastructure” will be sufficient to push gold and silver prices substantially higher over the next few years.
Developments in key geographic markets along with new investment vehicles are making gold and silver more accessible and more mainstream to more investors around the world — and the result is a permanent upward shift in the demand curve for these metals such that much higher prices will be the norm rather than a temporary cyclical episode.
ETFs — Volatility Up and Down
The introduction and growing popularity of gold exchange-traded funds (ETFs) are having a profound influence on the gold market. As you know, gold ETFs are gold-backed stock-market securities that track the ups and downs of the metal’s price . . . but as stock-market securities they attract investors for whom direct ownership of bars or coins is too cumbersome and allow institutional investors prohibited from investing in physical commodities or futures contracts a loop-hole through which they have bought many tons of gold.
In fact, since the introduction of gold ETFs about six years ago, the quantity of gold held in trust for fund investors has risen to 58.45 million ounces as of a few days ago.
However, the rapid growth of exchange-traded funds is a two-edged sword, increasing volatility both up and down. ETF investors can just as easily exit the market, selling their gold as quickly and easily as they might sell any equity.
Contributing to the anxiety among gold investors this past week was the news that hedge-fund mogul, John Paulson was an important player in the Goldman Sachs debacle. Paulson’s hedge funds have also been substantial investors in gold, so much so that Paulson & Co. is the largest institutional holder of the SPDR Gold Trust, the largest gold exchange-traded fund.
My back-of-the-envelope math puts Paulson’s total gold ETF holdings at more than three million ounces (about 95 tons). Â If investors in Paulson’s funds start pulling their money out, Paulson may need to sell gold to cover redemptions — putting a temporary dent in the price of gold . . . and, I might add, offering an excellent opportunity to establish or add to your gold investments.
Asian Action
India, the historically the world’s largest gold-consuming market has also seen the introduction of new investment products that are beginning to make this largest market even larger. A gold ETF now trades on the Mumbai stock exchange. Financial-service companies are offering a variety of products to their clients via the Internet. A gold physical exchange trading spot gold has been established to rationalize the Indian gold market. The Indian postal service in the past year or so began selling small gold coins, making gold investment more accessible in some of the rural or agrarian communities that lack local banking and other financial institutions. These are important developments that will, over time, support significant growth in Indian gold consumption.
In China there are even more important developments. The Chinese government allowed private gold investment only two years ago and has subsequently encouraged its citizens to buy and accumulate gold. A gold investment distribution system has developed rapidly — and gold bars, bullion coins, and other gold-backed vehicles are now available across the country through the banking system, at jewelry and department stores, and through gold retail shops that have sprung up in many cities.
Gold investment markets are expanding through the East Asia region — from Thailand and Vietnam to Hong Kong and Taiwan to Singapore and Indonesia.
Last month, when the price of gold dipped below $1100 an ounce, physical demand from India, China, and other gold-friendly countries in the Asian region stepped in as Western investors abandoned ship.
A year earlier, these very same price levels engendered selling from India and restrained demand in China.
It is important to recognize that the price points that trigger both buying and selling by gold jewelers and investors throughout the gold-friendly Asian region are fluid — and, in the past few years have moved significantly higher.
This is a trend I expect will continue . . . aided in some countries by currency revaluations that temper the rise in local-currency gold prices.
Moreover, strong economic expansions and rising personal incomes across the region mean that residents in these countries will have more money to purchase gold jewelry and more money to save and invest in the form of gold — gold that has been a favored medium for savings and investment in these countries for centuries.
Many countries across Asia and the Mideast share an historic affinity and allegiance to gold an adornment, as a symbol of wealth and good fortune, and as a preferred vehicle for saving and investment. Even gold jewelry in many of these counties is purchased for its investment characteristics and as a symbol of wealth and status.
Longer term, as their share of global income and wealth continues to increase, these countries will demand a growing share of global gold supply for jewelry, for private-sector and sovereign wealth investment, and for additions to central bank reserves.
Importantly, much of the gold bought by savers in many of these countries will probably never come back to the market, at least not for many years unless gold prices multiply several times over . . . or if political and economic developments prompt distress sales.
Mine Production — Renewed Growth Years Off
While I could talk about gold all day, the conference organizers have limited me to 20 or 25 minutes — and with miners and mining investors in the audience I do want to say a few words about the downward trend in world gold mine output.
Annual world gold-mine production peaked in 2001 at 2645 tons — and has been more or less falling ever since. Despite a brief uptick in global production last year and possibly again this year, the long-term downtrend is expected to continue for another few years . . . and by 2011 output will likely have dwindled to less that 2300 tons — a decline of 14 percent over the prior ten years.
Over the long term, mine output is a reflection of price versus the rapidly rising cost of production and the increasing difficulty and expense in finding new deposits large enough to offset the loss of production from the on-going depletion of existing mines.
In addition, increasingly stringent environmental regulations are adding to costs . . . and unfriendly government attitudes toward mining or foreign ownership are discouraging exploration and development in some countries.
Moreover, the global economic crisis has slowed funding for exploration and development — particularly for exploration and junior mining companies.
As a result of higher prices in the past few years and expectations of still much higher prices in the next few years, I expect that total world gold-mine output will begin rising during the second half of the decade.
At the same time, the continuing rationalization of the mining industries and exploration of virgin territories in countries like China, Russia, Mongolia, and Kazakhstan could possibly contribute significantly to the recovery in world output.
It is interesting to note that the locus of world gold-mine production is shifting from the previous “big four” producing countries — South Africa, the United States, Canada, and Australia to the emerging market nations — especially China and Russia, both of which appear intent on consuming or hoarding most, if not all, of their gold-mine output, rather than sell bullion into the world market.
Ladies and gentlemen, there’s so much more to say about the price outlook for gold and silver, but time is limited. I hope these highlights give you some food for thought. But I’m running short on time . . . and I do want to leave some time for questions . . .
Thanks again for your attention.
