-- Posted Tuesday, 23 December 2008 | | Source: GoldSeek.com
The world’s economic woes may be far from over, but deflation or inflation, gold is as good as it gets, according to Jay Taylor. Jay, whose passion for the king of metals prompted him to pursue geological studies after earning his MBA in finance and investments, has established an enviable track record in the markets. According to webeatthestreet.com, “J. Taylor’s Gold & Technology Stocks Model Portfolio has more than tripled its value since January 2000 while the S&P 500 has barely moved.”
After a career in commercial and investment banking, Jay now devotes himself full time to researching stocks and producing widely acclaimed publications that have evolved into his weekly Gold, Energy & Technology Stocks newsletter. In this exclusive chat with The Gold Report, he talks about how gold has not only sustained but strengthened its purchasing power vis-à-vis other metals and commodities, tells readers what he watches for when he evaluating companies and explains why the time may be ripe for picking up gold stocks while they remain at bargain-basement low prices.
The Gold Report: It seems we are moving into a deflationary environment. What's your take on what's going on, and what it means for gold?
Jay Taylor: My view of the markets in general changed very dramatically with the Lehman failure in mid-September. That’s when we had a real sea change, a real tipping point, if you will, from an inflationary environment to a deflationary environment. This deflationary environment is really changing things dramatically. We’re being much more selective with base metal projects and gold projects, as well as uranium. Since the decline started in the financial markets and in the commodity markets, I’ve shifted my major focus to gold mining. I think that’s where the most money is going to be made. The economics for gold mining look outstanding at this point.
TGR: You mentioned the deflationary environment. But doesn’t gold normally perform best in an inflationary environment?
JT: That’s what people think. Frankly, gold mining does absolutely the best during a deflationary environment. Let me give you some examples as to why that’s true. Since the Lehman collapse, an ounce of gold buys 125% more oil than before the Lehman collapse and that was only the middle of September. Since then, an ounce of gold buys 128% more copper than it would have bought on September 12, and 90% more of the Rogers Raw Materials (Rogers International Commodity Index). The real price of gold has risen dramatically and does tend to rise dramatically in a deflationary environment. That was true in the 1930s and especially since the Lehman collapse it looks to me that it’s true now.
There’s a pretty good reason for that. People buy gold because it is natural money. They would always use gold—and silver to a lesser extent—if they were allowed to choose the money they use as the medium exchange. We’re not allowed to. Government tells us we have to use paper money. That’s why it’s called fiat; it’s the money by law, not by market. But when people lose confidence in the fiat currency system, they go to gold. In nominal terms, it’s true that gold is down from its highs. But, as I said, in real terms, in terms of what an ounce of gold will buy, it will buy a lot more than it would have a little while ago.
We’re also seeing, in the gold mining sector, lower labor costs. Part of the reason is that with copper collapsing in price, with zinc and lead and all the base metals coming down so much, a lot of the base metal mines are closing down and laying people off. That makes lots of labor available now for gold mining and any kind of mining—but gold mining is the one that’s thriving and doing better. I expect to see some very much better earnings reports coming out from the major mining companies starting the fourth quarter of 2008.
TGR: As you pointed out, in nominal terms, gold is holding its own and it does appear that we’re in a deflationary environment. But is this environment likely to be a short-term blip? Won’t the current printing of dramatic amounts of U.S. dollars push us into an inflationary environment? So are we looking at an investment strategy now that’s really only going to be a couple of months in duration?
JT: That remains to be seen. I’m not convinced, as many of my gold bug friends are, that printing money has to necessarily result in an inflationary environment. If you go back and look at the 1930s, and if you’ve read Murray Rothbard’s book (America's Great Depression, first published in 1963, fourth edition published in 1983) and various accounts of the 1930s, it seems to me the policies that we’re pursuing now are not exactly the same, but basically the same and to a much greater extent now than in the ’30s.
It comes down to the question of whether you believe Milton Friedman and Ben Bernanke that they just didn’t do enough fast enough in the ’30s. They did everything they could in the ’30s to avoid the deflation. They were not successful. In fact, Roosevelt’s New Deal was a major flop, propaganda and contrary opinion notwithstanding. It wasn’t until the U.S. involvement in WWII that the economy came out of the Great Depression. By that time excessive debt had been repudiated, setting the stage for a recovery in any event. But the intervention of Roosevelt prolonged the Depression.
We have a debt situation now that is far greater—far, far greater than it was in the 1930s. We have something like 350% of GDP now in total U.S. debt, where it was like 270% at the peak in 1932. And, by the way, that peak of debt to GDP resulted primarily from a collapse in GDP. So far, we haven’t seen a collapse in GDP this time, although it’s starting to look like we may be facing that now, and we have this enormous indebtedness. What people have to realize is that debt is deflationary by its nature.
So in a way, the policies that are being put into effect increase that debt, which is the root cause of our problem because fiat money is debt money. Unlike gold-backed money, unlike silver-backed money, it’s not asset money. It’s money that’s created out of thin air through the creation of debt and debt is growing exponentially. If you look at the growth of debt relative to GDP—and this is a slide I show frequently in my talks—debt is growing exponentially and GDP is growing in a linear fashion. Actually, of course it’s not growing at all now; we’re in a recession so we’re having negative GDP growth. Sooner or later, we will not have the ability to meet those debts. So the argument is, do we inflate, can we print so much money that we just overcome the debt by debasing the currency, by making the units of currency worthless that we pay the debt back in.
I’m not convinced that they’re going to be able to do that and we’re seeing now the enormous amounts of money being put into the banks, but the banks aren’t lending. This is exactly what happened in the 1930s; the banks would not lend. Why are they not lending? Well, they’re looking around for credit-worthy borrowers and they can’t find many because the easy credit conditions, especially during the Greenspan years, resulted in a virtual default of a very large percentage of American consumers. The corporations aren’t in as bad a shape, at least not yet, as we are now just entering a recession. But because individuals borrowed beyond their ability to pay we now have a U.S. landscape littered with insolvent consumers.
The mining industry is having quite a time raising capital. I think that’s going to change with the gold mining industry. I’m seeing evidence just within the past couple of weeks that some very worthwhile gold projects are going to get funded. I think where the return on investment is outstanding, where the risks are low, we’re going to start seeing some life breathed back into the economy. But, quite frankly, in the mining sector, the only place I’m seeing any real ray of hope there so far is in the gold. Again, this is for the reasons I mentioned a moment ago; the economics are improving with the cost of production going down very dramatically relative to the price of gold.
TGR: You say the economics of mining are working well because other base metal miners are stopping projects so more workers are available. Is that true worldwide or is that a U.S. phenomenon?
JT: I don’t know to what extent that’s happening but I know it’s happening in North America.
You see, copper prices collapsed and a collapsing copper price suggests that global economic growth is slowing down and doesn’t look very bright. Copper is sometimes referred to as “Dr. Copper” because its price foretells global economic activity. We’re looking at a copper price of about $1.40 now, when it was up close to $4 not that long ago. So with the prices falling that drastically, the base metal mines are shutting down.
But again, gold will buy more than twice as much copper as it did two or three months ago, twice as much oil as it did two or three months ago. Gold has come down in nominal terms from its all-time high of slightly over $1,000; it’s around $800 or so now. But in percentage terms, its value has risen, and the margins are improving because the cost of production hasn’t come down nearly as much as the price of the metal itself.
TGR: So we can assume that you’re more bullish on gold than you were six months ago.
JT: Yes, I’m more bullish on gold. I’m much more bullish on gold than uranium too. When you have a boom period, people don’t want gold too much. Everybody’s happy because everybody’s making money and there’s no worry about credit and all of that. But when you start to have a problem and the credit markets seize up as they have now, then people go to the ultimate money—gold—but not until they completely give up on paper.
Now, for goodness sakes, people are buying Treasuries and actually getting negative yields or zero yields because they have no confidence in the highly leveraged monetary system. People are lending their money to the government and saying, “We don’t want anything; we just want our capital returned.” Ultimately they go to gold because its value is intrinsic—unlike paper money, its value is not dependent on the ability of people to pay their debts. And by the way, low to negative yields are extremely bullish for gold. An excuse for not buying gold has been that it provides no yield. Well, now U.S. Treasuries provide no advantage over gold even in that respect.
If we start to inflate, as you were suggesting, it could be a concern and I don’t disagree with that. If we start to inflate, the dollar loses its value and then I think you see people fleeing from Treasuries and going into tangibles of one kind or another, including gold. But that doesn’t mean the economics of gold mining will improve with inflation because the cost of producing gold, unlike now, might rise faster than the price of gold. The nominal price of gold would likely rise; but profit margins may or may not rise along with a higher price of gold.
For example, in March of 2008, when gold was briefly over $1,000, mining company shares were not performing very well and I believe the main reason was that their profits were being squeezed. They were reporting disappointing earnings because the cost of energy, the cost of labor, the cost of steel, capital costs in building projects were going up very much more rapidly than the price of gold was going up. Now the opposite is happening. The system becomes very illiquid at that point when the debts can no longer be repaid. That’s clearly where we are now. Debts cannot be repaid; there’s an implosion of the credit system, forcing people to sell everything they can get their hands on. But gold is under the least amount of pressure because as that happens, the price of gold gains versus everything else.
We need to liquefy the system. When we bottom out, when we get all of this debt behind us and it’s repudiated and wiped out of the system to the point where we can start to grow again in a healthy way, then I would expect to see some of the other things—the base metals and all those other items—coming back.
TGR: What do you think about buying into juniors versus buying into seniors, and about investing in physical?
JT: Obviously, owning physical gold is much safer. There’s, less risk involved with owning the physical gold. It’s a completely different investment than owning a mining company. In a mining company you’re betting on a company’s ability to produce gold—or whatever the metal is—at a profit. If you actually own the metal outright in your safe at home or in a safe deposit box or somewhere overseas, clearly it’s the bird in the hand so to speak.
And with the mining companies, you’re looking at a lot of risk. We suggest building a gold share portfolio starting with lower-risk larger-scale producers.
TGR: How about the juniors?
JT: With respect to the juniors, the further down you go in the food chain, the greater the risk. We categorize our companies. A-Progress companies are those that are producing. B-Progress companies are those that have done enough work to have an economic picture in sight. They’ve done the bankable feasibility or at least some scoping studies and so they can pretty well define the economics of at least one of their projects. Our C-Progress companies would be those that haven’t done sufficient work to have formalized the economic picture of one or more of their projects, but have some deposit in the ground.
TGR: Can you tell us how your balance of those categories breaks out?
JT: Actually, we have one more category, D-Progress companies, which haven’t really outlined a resource yet. So the C-Progress companies have a resource, but not an economic resource; the B companies have defined their economics and the A’s are in production. So you can go down the risk level and with risk, of course, comes returns. The majority of companies we cover are C-Progress companies, and they are among the riskiest—companies that are looking for gold and silver and other metals, too. While "C" companies bring a high level of risk, they also provide the biggest returns because when they succeed in finding a viable deposit, the amount of wealth they create is usually very large relative to their market caps.
If you were to ask me which companies on my list I think can do the best, right now the B-Progress companies are my favorites in this environment when raising capital is so difficult.. I’m betting my “B” companies are going to be successful and if they are, they jump into the "A" category. Then they should rise dramatically in price as they become “respectable” investments for institutional investors.
Certain “C” companies bring with them lower levels of risk.
TGR: Those in the "C" categories seem to be really more balance sheet plays. Do they have enough capital to continue exploration?
JT: They are really more exploration plays with some potential in the ground. You can’t even look to their balances sheets for protection.
TGR: So isn’t there a chance that a lot of those "C" companies, not to mention the "D" companies, will end up going bankrupt. They just won’t be able to survive for long.
JT: Indeed. That has historically been the case, and they’re even more vulnerable in this kind of a market environment where the share prices have been obliterated. How do they raise capital to put more holes in the ground? So those are companies to be very, very cautious of. You have to recognize that they’re higher risk. But having said that, in the gold sector especially, I believe that if this deflationary environment continues, gold mining is going to be one of the few industries in the world that’s going to be profitable. As that happens, there’s going to be more and more capital flowing in at the top of the food chain to start with and then it will find its way down to the “C” companies. Cash produced by the A companies will eventually find its way down to the "B" and "C" companies. A major amount of capital is likely to flow to this industry because it is providing the world with much needed legitimate money to replace mountains of illegitimate fiat money.
It’s those companies that are lower on the food chain, the "Cs" and the "Ds," that are the highest risk. At the same time, however, you’re buying these companies a lot of times at 10 cents a share and if they find something really big, it’s not a stretch of the imagination to see a dollar or two or three or four or five dollars a share and you’ve got a huge return on your investment. Returns are commensurate with the risk.
A baby boomer born in Ohio, Jay Taylor was drawn to the world’s financial capital in 1973, when he went to New York to work for Barclay’s Bank International after earning his master’s in finance and investments. As he followed the demolition of the U.S. gold standard and the rapid rise in the national debt, Jay’s interest in U.S. monetary and fiscal policy grew, particularly as it related to gold. This led to his first investments in junior gold shares toward the end of the 1970s. Sometimes called “the buy and hold guy,” he began publishing North American Gold Mining Stocks in 1981. He was involved in the first modern-times gold loan made in the U.S. (to Amax Minerals, a 250,000-ounce loan facility led by Citicorp). To better understand the potential of the mining stocks he researched, Jay added a BA in geology to his CV in 1988. Pursuing his interest in researching and writing about mining companies as a sideline, Jay maintained his full-time banking career for nearly 10 more years. In August 1997, he left his position in the ING Barings mining and metals group to pursue his avocation as a new full-time career—including publication of his weekly Gold, Energy & Technology Stocks newsletter.
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-- Posted Tuesday, 23 December 2008 | Digg This Article
| Source: GoldSeek.com
