TICKERS: ABX, GFI, K; KGC, LIF.UN, LSG, ORV, WDO, WPM
Embry Still Burns Bright
Source: Brian Sylvester and Karen Roche of The Gold Report (8/16/10)
Sprott Asset Management's Chief Investment Strategist John Embry loves to talk gold. And we love to listen. We thought you might, too, because he's always long on opinion and predictions. John envisages that the "extraordinarily painful" economic times ahead will ultimately lead to a new currency backed by, of course, gold. In the meantime, John suggests you "protect yourself" from downside risk by shifting 25% of your portfolio to precious metals. In this exclusive interview with The Gold Report, John even proffers some names to help you bulk up.
John Embry: It's always a pleasure to chat with you.
TGR: I noted in a recent article in Investor's Digest that you were talking about the M3. You said, "M3 in the first quarter was falling at a rate last seen during The Great Depression." We recently interviewed John Williams of ShadowStats, who noted that the M3 has had its sharpest ever year-over-year decline. He concluded that we will see a deepening recession with inflation/hyperinflation afterward. You are in the camp that believes hyperinflation will occur first, and then deflation will wipe out the remaining debt. What do you see in the numbers to indicate that?
JE: Well, I think I'm being misunderstood because I think we are in a highly deflationary situation as we speak. I don't really disagree with Williams. The basic problem is that the amount of debt in the system is extraordinarily deflationary. The only way to combat it without having the hard 1930s-style deflation is to print more money. The risk of doing that is hyperinflation. I think they will opt for that, but I'm not 100% convinced the economy will go that way. The economy could very well go Bob Prechter's way (Elliott Wave International) and go into a hard deflation, but not without a huge effort from the authorities in the United States to prevent it.
TGR: Let's go down the path where we reduce quantitative easing and start seeing inflation that ultimately becomes hyperinflation. Does quantitative easing ever pay off that debt, or do we go into hyperinflation and still default on the debt?
JE: In the end you will default on the debt. If you go back and look at any hyperinflation situation in history, the currency and the debt that's denominated in the currency get destroyed. I would not do that. I would take the pain. I agree with Jean-Claude Trichet, head of the European Central Bank, who said that you've got to start reining things in. Better to take some pain now than the even worse pain caused by the total social disruption that hyperinflation creates.
TGR: Are we in a situation where, if we really implemented austerity measures, we could avoid debt default and/or inflation? Or are we just too far down the line?
JE: I think we're way too far down the line. If you were to go into a real austerity program in the United States by raising taxes, cutting spending and having interest rates that reflect the reality of the situation, you would go into a hard deflationary depression. I don't see an alternative. I've said many times that the middle ground has long since been lost. We've just had the greatest credit cycle in history, and as a result we're going to pay a huge, huge price for it.
TGR: But if the austerity program would throw us into a deflationary depression, then more quantitative easing would ultimately end in a deflationary depression.
JE: In the end you will end up with a new currency system. And those who invest in the right assets will come out intact at the other end. Those who invest in paper assets of any description will be wiped out.
TGR: That leads into our next question. In your recent column in Investor's Digest you said Fed Chairman Ben Bernanke "knows full well that it is his monetary policy featuring zero-based interest rates for the world's reserve currency and profligacy of his own government that are fueling the desire to own gold." If Mr. Bernanke were replaced by John Embry, what changes to U.S. economic policy would be made?
JE: I sort of pre-empted the question by suggesting I would be inclined to take the pain now. But, if John Embry had been determining monetary policy for the last 15 to 20 years, we would have never been in this position. As I have said before, I believe very strongly in Austrian economics. You've got to rein in the credit cycle early if it's getting out of control, or you're going to end up exactly where we are now. I do not see a solution that isn't extraordinarily painful.
TGR: Are you referring just to the U.S. or is Canada, where you are, going to see the same painful situation?
JE: That's a very good question because there's a lot of hubris up here in Canada. We think we're immune because we have resources and we've done a better job with our banking system, etc. But if the United States gets into deep difficulty, we get into deep difficulty because our economies are so closely aligned. Now, we may not get in as much trouble because we have more resources, we have a lot less people and our finances are in better shape. But the fact is the whole Western world will be seriously impacted by what happens in the United States. The United States is the linchpin of the entire Western world.
TGR: Will the impact be felt in the Eastern countries?
JE: Yes, I think the impact will be felt there, too. I believe China will be the emerging power in the next century, and I've believed that for a long time. But before the United States became the emerging power in the previous century, they went through a depression followed by a World War. And China's not just going to glide through this without difficulty. If the U.S. were to get into major difficulty, China would have a real economic setback. It wouldn't be for the long term, but the short term could turn very ugly.
TGR: To what extent will China incur economic pain?
JE: The problem with the Chinese is that the Communist government basically has to provide improved living standards for China's massive population. If they don't do that, I think you will see incredible unrest. I foresee that happening if this thing goes in the direction that it appears headed.
TGR: What do you make of reports from China on the pending real estate bubble and the Chinese government telling its citizens to buy gold?
JE: I think there is a huge real estate bubble in China. I saw some statistics and I can't even remember the number of homes that were apparently not inhabited. But it was massive. I find it fascinating that the Chinese government is telling the public to go to gold, which is the exact opposite strategy that's being followed in the Western world. I think they realize that this is probably the safest place for their people to be invested in the coming period. The Chinese are very smart. I think, quite frankly, that in the end the Chinese will back their currency with gold.
TGR: You mentioned that we were ultimately going to get a new currency system. Would it be just the Chinese going to a gold standard, or would it be the world?
JE: I think that if we get a new currency, which I firmly believe we will before this is all said and done, I think gold will be a component of the new currency. You've seen the Chinese on occasion mention the idea of a kind of Special Drawing Right (SDR, an IMF currency unit) backed by a basket of currencies and gold. I believe gold will be reintroduced to the system because there will be so much bad feeling toward fiat currency. They're not going to get away with it a second time, at least not for another 100 years.
TGR: When we start moving to a new currency that you say will be backed in part by gold, won't almost all currencies have to hyperinflate and become devalued because there's just not that much gold being mined?
JE: Oh, I think that's in the cards. The United States might be the linchpin for the whole problem, but because of this competitive devaluation that's going on nobody wants to have a strong currency. If the U.S. currency is failing because of the problems we've discussed, there's no question that the other currencies are going fail with it. That's why I hold all of my assets in hard assets, be it gold, silver, oil companies—anything that's producing something tangible.
TGR: Other than precious metals, gold and oil, are you invested in anything else?
JE: I own a couple of iron plays. I like iron longer term. There's a good income trust up here in Canada, Labrador Iron Ore Royalty Corporation (TSX: LIF.UN), which pays a pretty handsome dividend. I'm getting old; I have to get a little dividend income along with my precious metals.
TGR: You had an interesting interview with Mineweb recently. The headline used a quote from your interview. It reads: "If gold is not between $1,500 and $2,000 in the next 18 months, I'm dead wrong." What specifically would you be "dead wrong" about? The price? The timing? The underlying fundamentals?
JE: I would say probably the underlying fundamentals, because I think that they're sufficiently bad that we will not be able to hold this together for another 18 months. In that event, I would see the gold price moving up sharply. They could conceivably keep this thing stuck together for 18 months. I just don't believe it. If it's not $1,500 to $2,000 by then, clearly I'm wrong in the sense that they've been able to allay the difficulties in the system longer than I thought. The United States is plunging back into a hard recession, if not worse. The implications of that for the gold price are extraordinarily bullish.
TGR: So, really it would be the timing that would be wrong.
JE: Yes, I guess you can't change the fundamentals. The timing would be wrong. But at the same time my analysis of the underlying fundamentals would suggest this is getting relatively imminent. I was fascinated to see that Niall Ferguson, a brilliant historian and economist, is of the mindset that this thing is going to fall apart within two years. At least I'm in the company of intelligent people.
TGR: John, do you think it will fall apart slowly or rapidly?
JE: That's a really good question and Ferguson addressed that. He thinks it will come quickly and so do I. I have a friend who thinks if you're not positioned the right way financially, one day the curtain's going to come down, and when it goes back up, you're not going to be able to alter your position. That means you better own the right stuff going in.
TGR: You were managing funds with gold holdings long before the era of $1.5 trillion deficits and sovereign debt issues in Europe. How has your strategy for asset management changed over the last decade, and more specifically, pre-2008 versus post-2008?
JE: That's a very good question. I'm working here with my partner Eric Sprott. I'm not managing money on a day-to-day basis anymore. I'm just working on strategy and the gold scene. But I know that the long side of Eric's hedge fund has gone almost exclusively to precious metals, and he's short housing, banking and all of those industries. Clearly this is something that's evolved. I mean we have gone more and more in that direction as we've become more and more sure of our point of view. I recently read Michael Lewis's The Big Short, which I found fascinating because the fellows who figured out that subprime mortgages were going to be a major problem were in such a minority that their clients were turning on them almost until the whole thing broke. I feel much the same way today about the public's view on the economy. Everybody is being told things are fine and that the economy is going to return to normal and growth will continue. I think that underlying assumption is dead wrong.
TGR: In reading your recent interviews and columns, one thing that comes through quite plainly is the passion behind your arguments that the public is being duped and not being told that they should own gold. Why are you so passionate about what's happening?
JE: I appreciate your saying that because I am. I think it's really important to tell the public the truth if you really believe that this is what's going on and you want them to protect themselves. I think the public is getting horrible advice from a lot of financial establishments. It's amazing. I can draw parallels to when the subprime thing blew up. It was astounding to me that people thought housing prices in the United States would rise forever. I mean housing prices are related to underlying income. They were so far out of line that it had to crash.
TGR: Let's move into investing in gold equities. Kinross Gold Corp. (TSX:K; NYSE:KGC) just bought Red Back Mining. The markets certainly didn't respond well to the purchase. What's that deal telling us?
JE: I think it's telling us a number of things. First off, I think Kinross paid too much. The people behind Red Back—the Lundin family—are extremely clever. They got an outstanding price. I know the assets very well. Don't get me wrong; Kinross is buying some decent assets. It's just what they paid for them. But what that might be telling you is that those gold projects will look inexpensive if the gold price goes where I think it's going. Anybody that's buying assets today is going to be seen to be doing the right thing.
TGR: Certainly the call options on Kinross were up a few days afterward on the belief that Kinross shares might do better come September.
JE: Oh, I think they will. I'm not a great fan of Kinross, but on the other hand I think there's just such a limited selection of big cap gold stocks. The fact is Kinross has bought some interesting properties. They bought the Aurelian property down in Ecuador. They're topping off their inventory of properties. From that perspective, they're doing the right thing. The great problem for senior companies going forward is that their reserves are declining and so are their production profiles. The big funds are going to be on them to go out and buy something.
TGR: If you're not a fan of Kinross, what senior companies do you like?
JE: The big cap stock I like the best, and one that controls a massive number of ounces, is Gold Fields Limited (NYSE:GFI). That carries a fairly significant discount because it's in South Africa. But given the number of ounces it has, I continue to like Gold Fields as the best of the big caps.
A company that I had not liked for many years was Barrick Gold Corporation (NYSE:ABX; TSX:ABX). I've moderated my view because by getting rid of their hedges, Barrick has set itself up nicely. They're a big producer. If the gold price goes up a lot, they're going to be able to take advantage of that. They're not terribly inexpensive at current gold prices, but that isn't a particular problem because I think the gold price is going materially higher. There will be so much money trying to get into senior equities that the price could look Internet-like before it's over.
TGR: What about the impact of some of the near-term juniors?
JE: I think they're a much better value. They've mostly been crushed. I mean there's been very little buying. They are so far out of line with the gold price that this is a great opportunity. If gold really moves up and sentiment changes, I think it won't take that much money to drive some of these juniors nuts. I think there will be five and ten "baggers" in the good ones.
TGR: Do you have some "good ones" you can share with us?
JE: Well, I'll tell you a couple that I like. I really like Wesdome Gold Mines Ltd. (TSX:WDO), which I've mentioned before. It's got two operating mines, one in Ontario and one in Québec, which are great geopolitical areas to operate. Wesdome makes money and they're improving their reserve base. That's always been an issue because their underground mines have never reported large reserves. But now they're undertaking a large drill program to enhance their reserves. I think that's going to change the view of the company.
I like Orvana Minerals Corp. (TSX:ORV), which is another small company with a tight market cap that is developing the El Valle gold-copper project, one of the old Rio Narcea properties in Spain. I think that one is just starting to catch on. They're very competent underground miners. They proved that at the Don Mario mine in Bolivia. Their stock was always extraordinarily cheap because of its Bolivian base. It's moved fairly significantly recently. I think it's got a lot further to go.
Another one that I've always liked because they're finding a lot of gold in Ontario is Lake Shore Gold Corp. (TSX:LSG). They continue to have success. They just got some interesting new drill results on another part of their property. I can see this one being a stock that money will gravitate to.
The one thing I tell people is that you have to be careful rifle-shooting juniors because you might just pick the wrong one. The worst thing that could happen would be to load up on one or two juniors, watch gold skyrocket, only to find out your company didn't have the goods and you didn't make any money. That would be a terrible mistake.
TGR: What's your view of silver compared to gold in this economic environment?
JE: I like it better, believe it or not, as much as I love gold for the simple reason that there's so much less aboveground inventory in silver. Unlike gold, silver gets consumed at a reasonably rapid clip because of its medical and industrial uses. The current price ratio of gold to silver is about 65 to 1. Historically, it has been as low as 15 to 1. As the whole precious metal cycle really starts to lift off again, I suspect that the silver ratio is going to fall fairly significantly from 65. If that happens, clearly you're going to have a better percentage gain in silver than you are in gold. I wouldn't have all my money in silver,but I would certainly have solid exposure.
TGR: Will silver equities also have the opportunities for five and ten baggers?
JE: Oh, for sure because there are a lot more gold stocks. Silver is a pretty scarce element in the earth's crust and it's pretty hard to find. There are not a lot of silver stocks. Of the silver stocks that I like, the only one that's outperformed silver over the last while is Silver Wheaton Corp. (NYSE:SLW; TSX:SLW). To me that's a great silver stock, because they can control their costs through the approach they have.
TGR: If silver has a rapid rise, are any of them going to outperform silver in the future?
JE: Yes, I think they will. I mean both the gold and the silver stocks are miles behind the bullion. That reflects the negative sentiment in the whole area.
TGR: Why are there negative sentiments?
JE: It totally baffles me in the sense that the fundamentals couldn't be more compelling. But at the same time that isn't what the public is being told by the financial establishment. Just the other day The Economist featured an article on the front page with the question, Has Gold Topped? It was the standard questionable statistics, dubious conclusions, etc. But if you actually read it closely, you could have drawn the exact opposite conclusion and become a roaring gold bull. Essentially, the public doesn't know a lot about it and it's not their fault. Nobody's telling them. To me, that isn't an accident. This is being orchestrated. But I think it's just about to become spectacularly unstuck.
TGR: What do you think will be the tipping point?
JE: If the U.S. is lapsing back into some serious economic difficulty, there will be a sudden realization that the financial situation is hopeless. As a result they're going to have to create so much money or take such a brutal deflationary depression that people will change their philosophy and not invest in U.S. bonds at 2.85% for 10 years. It won't take much money coming in the direction of gold and silver to have a significant impact.
TGR: Do you have any parting thoughts?
JE: My one parting thought is that people have to understand how serious this is and protect themselves. They've got to have some precious metals in their portfolio. If they don't, I think they'll rue the day they didn't.
TGR: How much should they have?
JE: I used to say 5% to 10% before this mess started rolling. I'd say a minimum of 25% now.
TGR: Thank you for your time, John.
JE: You're quite welcome.
John Embry is chief investment strategist at Sprott Asset Management and Sprott Gold and Precious Minerals Fund. He also co-chairs the Central GoldTrust Board of Trustees. An industry expert in precious metals, John's industry experience as a portfolio management specialist spans more than 45 years; he has simultaneously researched the gold sector for 30-plus of those years. He joined Sprott in 2003, after 15 years as vice-president of equities at RBC Global Investment.
Want to read more exclusive Gold Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Expert Insights page.
1) Karen Roche and Brian Sylvester, of The Gold Report, conducted this interview. She/he personally and/or her/his family own none of the companies mentioned in this interview.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Gold Fields.
3) John Embry; I personally and/or my family own the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None.