John Embry: Sit Tight Don't Let Gold's Volatility Bother You


". . .those who worry about the short-term volatility of gold and silver would be well-served to sit tight. In my opinion, the bull market in precious metals is alive and well and has many years to run."

The action in the gold market at the outset of February was intriguing to say the least. An all-time record high price was achieved on the morning of Feb. 1 in the wake of severe power-related production shortfalls in the entire South African mining industry.

This occurred just as the market was digesting a 30 percent drop in U.S.-administered interest rates from 4.25 percent to 3 percent in the latter half of January. Coincidentally, the Gold Anti-Trust Action Committee ran a full-page colored advertisement in the Wall Street Journal (at a cost of $264,000 for one day) succinctly describing the activities of the central banks and their allies and revealing to anyone who was prepared to open their mind to the full extent of the gold manipulation.

As a response to all this, gold then proceeded to drop roughly $45 per ounce over the next 48 hours of trading. The ostensible reason was that gold was overbought, which was true, but so were platinum and palladium that continued to rise as gold was crushed. This is standard antigold cartel practice and is designed to quell excitement and drive investors who don't really understand what is going on out of the market.

In the end, this ploy won't work because there is too much big money on the sidelines that realizes perfectly well what is unfolding and will use these periodic, orchestrated takedowns to add cheap physical gold to their portfolios.

In this instance, a little extra spin was added to the story with the suggestion that the dramatic reduction in U.S. Interest rates would have such a salutary effect on future economic growth that it would essentially terminate the bear market in the U.S. dollar.

According to this notion, investors would flock to the U.S. dollar as the focus shifted from relative interest rates to relative growth rates. I must admit that this strikes me as sophistry of the worst sort because I believe that any economic-policy response in the U.S. will be of limited success due to the depth of the financial problem.

I much prefer the analysis of Bill Buckler, who publishes The Privateer newsletter in Australia and has been remarkably prescient on the unfolding financial disaster. Buckler postulates that now that the U.S has the third-lowest central-bank-administered interest rates in the world, it will be seen as the place to borrow and will essentially become a new source of capital for the massive, worldwide carry trade.

The resultant dollar outflows from that activity, in conjunction with those already existing due to the massive current account deficit, could have a potentially catastrophic impact on the value of the U.S. dollar internationally.


In that event, inflation would accelerate rapidly with a concomitant devastating impact on the U.S. consumer and the U.S. economy in general. As the inflation intensifies, monetary orthodoxy would demand higher interest rates and would thus present Fed chairman Ben Bernanke with a perplexing conundrum: fight inflation or provide whatever liquidity necessary to prevent an economic implosion.

This problem isn't going unnoticed internationally. Somewhat surprisingly, Dominique Strauss-Kahn, the new head of the International Monetary Fund, has endorsed a very significant relaxation in U.S. policy to deal with the crisis and has voiced his approval of sharp interest-rate cuts and significant fiscal stimulus. This is fascinating.

Over the past 25 years at least, the IMF has approached other countries with problems not dissimilar to those currently plaguing the U.S. and recommended tough macroeconomic policies to deal with the excesses of spending and borrowing. I believe its volte-face this time is motivated by the seriousness of the economic problem and the very real threat of worldwide contagion.

I was somewhat amused by President Bush's recent observations about future U.S. budget deficits. After a considerable period of unjustified optimism, Bush now acknowledges that the deficit will more than double to $400 billion in the next fiscal year.

This assumes ongoing economic growth of more than 2 percent and relatively static government spending, neither of which appears realistic at the current time. A more credible number would probably be between $600 and $800 billion and I wouldn't rule out a $I trillion annual budget deficit in the not-too-distant future.

The foregoing is all part and parcel of an accelerating debasement of paper money, with the epicenter being the U.S. As a result, those who worry about the short-term volatility of gold and silver would be well-served to sit tight. In my opinion, the bull market in precious metals is alive and well and has many years to run.

A major contributing factor will most certainly be dwindling mine supply. The power problems in South Africa apparently are not a passing phenomenon but a fact of life for the foreseeable future. This will further exacerbate the already pronounced decline in South African gold production.

At the same time, permitting issues continue to crop up worldwide. The most recent one impacted Iamgold's Camp Caiman project in French Guyana, which was thought to be a done deal. The French government's flat-out rejection of the permit came as a considerable surprise. However, it is symptomatic of the changing mindset in the world today.

Arguably, the most interesting new ore body in the world today belongs to Aurelian Resources in Ecuador. Yet the head of government there, Rafael Correa, is a populist who is doing his best to discourage those who would be prepared to get involved and advance the project. I strongly suspect that rationality will ultimately prevail because the economics are too good to ignore forever, but with each day's delay, the production date gets inexorably pushed into the future, intensifying the near-term supply issue in the gold market.

On a different, somewhat more theoretical front, we at Sprott Asset Management are very big believers in Peak Oil and think that oil prices will eventually ascend to levels that will appear surreal to the petrobears. In a world where traditional hydro-carbon supplies could become increasingly difficult to obtain, some sort of rationing may ultimately occur. This has caused my partner, Eric Sprott, to ponder this subject in detail. With respect to gold mining, he poses an interesting question:

"Should we use increasingly scarce hydro-carbon supplies to exploit marginal gold properties? Gold is not an essential product in that most of the newly minted gold goes into jewelry. As a store of value, we can just revalue the existing above-ground stocks."

Given the high percentage of operating costs devoted to energy and the considerable amount of energy used in large low-grade open-pit gold mines, this is a very legitimate question and could be a major factor in restraining future mine supply.

John Embry is chief investment strategist at Sprott Asset Management. Views expressed are those solely of the author and should not be considered an indication of trading intent of any investment funds managed by Sprott Asset Management Inc. Sprott funds may hold above-noted securities.

Copyright 2008 by MPL Communications Inc., Reproduced by permission of Investor's Digest of Canada, 133 Richmond St. W., Toronto, ON M5H 3M8

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