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Jay Taylor Envisions Scary Specter of '30s-Style Depression

-- Posted Tuesday, 3 November 2009 | | Source:

Jay Taylor, who publishes Gold, Energy & Technology Stocks and hosts his "Turning Hard Times into Good Times" radio program each week, is hoping and praying for deflation to help the U.S. heal its wounds and find its way back to prosperity. He has reasons to think the dollar might bounce back, too. Nevertheless, Jay reminds The Gold Report readers about frightening parallels to the 1930s and doesn't dismiss the possibility of a hyperinflation that renders the U.S. dollar about as valuable as toilet paper. Although bulls have been charging around Wall Street the past few months, he expects fearsome bears to reemerge soon and feast on equities almost like they did last year. If he's right, he also foresees a "grand buying opportunity" and the potential for "huge upside gains" for savvy investors in some gold mining stocks.

The Gold Report:
The last time we spoke, in July, you expected a market downturn this fall. Is that correction yet to come?

JT: I think we're on the verge of that correction, but I'm not so sure it's so much a correction as a resumption of the secular bear market that started with the Lehman Brothers collapse last fall. We saw the first leg down in the market, a bottoming out in equities, in March; then a very strong rally with the Dow going back up past 10,000. And now we're most likely to see a major decline in equity prices. We can only hope and pray that the March lows hold because if they don't, we could be looking at something very, very frightening on the downside.

TGR: So are you thinking we are not out of our recession?

JT: I don't believe we're out of the recession at all. Not if you use numbers that I think are more valid—and those would be numbers from the likes of the independent economist, John Williams, who's been on my radio show. According to his ShadowStats, inflation is grossly understated and hence our GDP is overstated, that, in fact, we've never come out of recession. If you just look around and see what's going on in the U.S. economy—except for Wall Street, which is really more of a gaming industry than anything else—it's hard to make the case that we're back on a growth track.

We've been in trouble for a long time. I would argue that we've been in trouble since 2000 or even before. Greenspan kept the illusion of prosperity going by digging us into debt and creating the housing bubble. Before that we had the dot-com bubble, the telecom bubble. Every time there was a crisis of one kind or another—the Asian crisis, the Mexican crisis, the Russian crisis the perceived Y2K crisis—huge amounts of money were pumped into the system. That all fueled a stock market bubble and malinvestment in companies that had no commercial viability.

If the banks were not borrowing money through the Fed, their reserves would be hugely negative. Their net worth would be negative; they would be broke. They stopped reporting on a mark-to-market basis, so we're not seeing all of the junk in these banks' portfolios now. That doesn't mean it's gone away. So sooner or later, Pinocchio's nose gets longer and longer and you can't hide it anymore. I don't see how you can make a strong case for growth and a continuation of an equity market boom.

There's just no rational reason to be optimistic about the U.S. economy and I think that holds true to a certain extent with the European economy too. I just came back from Singapore and I can tell you, there's a different attitude in Hong Kong and Singapore, where there's lots of action, lots of economic growth and activity.

TGR: How can we be in recession and have inflation at the same time?

JT: We certainly experienced that in the 1970s. In fact, John Williams suggests we're going to have a hyperinflationary depression. In other words, prices will rise like mad, but unemployment will be extremely high. How could that be? Because the United States doesn't produce anything and we have to import everything. Now if you buy the idea of a continued weak dollar, you could see prices going up, up and up. Most people say a good part of the oil story, for example—oil's rise from $35 or so to $80—is the weak dollar. It's counter intuitive, because in the past we've always thought prices should fall in an economic downturn. Normally that's the case. But we have some major shifts going on in the global economy right now because the dollar is losing its value, and that's inflationary.

Another side of me says I'm not sure that that's going to continue and that the dollar could bounce back, but that's another story.

TGR: If the dollar continues to lose value and prices rise because we're importing, wouldn't the law of free markets say we'll start producing things in the U.S. and begin to export?

JT: In time that would happen, but we're seeing more government intervention all of the time and in some ways capital controls are already secretly being employed. We could well see more and more trade controls put into place. But you're right. If prices go up in terms of our currency, assuming that the cost doesn't go up faster, we could start producing things.

By the way, that's what I think we've seen in the last year with the gold mining industry. The price of the metal has risen more than the costs since the Lehman Brothers collapse. That said, it's a lot easier to mine—a lot less regulation, a lot less political interference—in some parts of the world than in the United States. So it's harder to provide that supply to our industry in the U.S. and it's harder for companies to produce those metals in the U.S. than it might be in other jurisdictions. There are all kinds of nuances in different economies that don't allow free markets to work.

TGR: You mentioned that part of you believes the dollar might bounce back. What's your reasoning there?

JT: Just from a contrarian point of view, when up to 94% of everybody in the market thinks it's heading one way, usually you're getting a little heavy in that direction. Robert Prechter talked about that on my radio show. By the way, he is very bullish on the dollar and I think for some of the same reasons that I am. For one thing, as I said at the outset, I think we're going to see another equity market decline. People are getting rid of dollars, trading their dollars for stuff again, and investing more recklessly again.

But I don't see the justification for the price-earnings ratios we're seeing in equities. I think we're going to see another decline in the equity market and in the commodities market as a result, much the same as we saw last fall. If you think back what happened then, the dollar got stronger as the price of commodities weakened, as the equities market weakened. When you borrow dollars and spend them on a stock or a house or a business overseas or what-have-you, you're basically taking a short position on the currency. When you unwind that trade and go back in the other direction, you're covering your short position. You're buying dollars off the market to repay your loans. That's what happened last fall and it could happen again.

TGR: That's not a very pretty picture.

JT: No. That's a very scary reason for the dollar to rise. A better reason would be vibrant growth in the U.S. economy and producing things efficiently. But I think it's this unwinding of the dollar short trade that could really cause the dollar to get stronger.

TGR: Wouldn't we see a corresponding decrease in the price of gold and oil if the dollar gets stronger?

JT: I don't know about a corresponding decrease. If you go back to last fall again, the price of gold did come down in nominal terms, meaning that the value of the dollar went up versus gold. However, the value of the dollar went up an awful lot more versus oil and everything else.

If you look at the relationship between gold and oil from the Lehman Brothers collapse until oil hit its bottom, at one point an ounce of gold would have bought six times more oil than it bought right before the collapse. The point I'm making is that these things don't necessarily go down in the same proportion.

So I believe that this kind of event would be extremely bullish for gold mining companies and for gold itself in terms of its purchasing power. The question is whether paper gains even more than gold. Again, harkening back to my discussion with Robert Prechter, he thinks that paper will be a better investment than gold. But he is also quick to say that gold will buy more than almost everything else.

TGR: What do you foresee in terms of inflation and its effect on gold mining costs?

JT: If we get this pullback in the equity markets, we'll also possibly see a decline in the price of gold in nominal terms. But I think we're going to see a bigger decline in the cost of the inputs of producing gold. Energy can be a very, very big cost factor in certain mining projects. Materials costs went down dramatically last year, as well as energy costs. And labor became much more plentiful when the base metal mines shut down after the copper and zinc and other base metal prices went down; so gold mining costs have come down. They've come up some since the bottom, but of course the price of gold has come up a lot more too since then.

So if the inflationists are right, if we're going to see hyperinflation as John Williams thinks and some of the other people on my radio show have suggested, then gold mining is not the greatest place to be, honestly. But throughout history, the best place to be in a serious deflationary depression is in gold mining. That was true in the 1930s. Bob Hoy, an analyst out of Vancouver who's also been on my show in the past, has provided great insights into this. He's looked into the last six major credit expansion/contraction events, going back 300 years. The first four of those were UK-centric. This one is U.S.-centric and, of course, the 1930s was, too, because the United States has had the world's reserve currency since then.

In each of those environments we've seen the real price of gold surge—the real price meaning the price of gold relative to other commodities, relative to other costs. So I'm extremely bullish about gold mining given my still deflationary views.

So the good news is that if the economics improve for gold mining, as I suggest they will in a deflationary environment, we will start to produce real wealth again. We'll have real money that has real, intrinsic value. When we do that, those gold miners will make lots of profits. Assuming the government doesn't tax all those profits away, we can rebuild this country on the basis of real money again. That's an optimistic tone from someone who believes deflation is a possibility. But people who think we can keep going along as we have been with fiat money, living beyond our means and thinking we can get rich by printing money and not working hard, must be smoking something funny. Wouldn't it be nice if we could just put on our rose-colored glasses and see the world that way?

But there are lots of good mining companies out there—good companies that are starting to produce gold in many cases, others that are developing viable projects. We've had a bull market in gold for a number of years now, a long enough period of time to allow a lot of money to be put into the ground in exploration and proving out deposits. So I think we're on the verge of seeing a lot of new companies emerge as producers. They will be household names in this bull market in gold—which I think will continue for quite a few years yet.

TGR: Any last thoughts you'd like to share with our readers?

JT: Just that I think we're approaching some very difficult times in the equity markets now. I could be wrong, but I just sense that we could have a severe pullback. The bear market for stocks began last fall and it is not over. Maybe you can make a case using government numbers that we're technically out of the recession, but I don't buy it. In reality, unfortunately. I wish that weren't the case.

I really look back at the 1930s—the first leg down in 1929, when the equity market was the one getting all the media attention. After a big wave up, everybody thought it was all over, the worst was past. People got suckered back into the stock market and there was lots of optimism, just as we're seeing now in this equity market. Then the big one came. Why did it come? Because there was no growth in the economy. There was nothing to support the equity prices and there was lots and lots of debt that could not be repaid. I see a replay of that in many ways.

There is increasing tension among trading partners now, but a lot of it is more subtle through this beggar-thy-neighbor currency devaluation. Countries cheapen their currency, hoping to be able to export more and get an advantage over their trading partners. When everybody starts playing that game, you have a real problem and prices keep falling.

I think today's parallels with the 1930s are much closer than people recognize and that's partly by design. Policymakers don't want people to think in those terms because if they do, it becomes a self-fulfilling prophecy. If people think we're heading into a deflationary depression, why would they buy anything today? They want people buying things. But consumers can't buy because they're broke. The government can buy because it can print money, but how long can that continue if the rest of the world doesn't want your money anymore?

These are questions that are in my mind. But I do think we have some very turbulent times in store and this debt is really strangling the American economy. I remain tipped toward the deflationary side, but I want to be nimble and ready to change my thinking. For that reason, I put out my Inflation/Deflation Watch (IDW) and look at it every day to try to get a sense of it. We shall see.

As he followed the demolition of the U.S. gold standard and the rapid rise in the national debt, Jay Taylor's interest in U.S. monetary and fiscal policy grew, particularly as it related to gold. He began publishing North American Gold Mining Stocks in 1981. To better understand the potential of the mining stocks he researched, Jay added a BA in geology to his CV in 1988. He already had a master's in finance. A native of Ohio, he migrated to Wall Street in 1973, working first at Barclay's Bank International. He was with the ING Barings mining and metals group when, in 1997, he decided to pursue his avocation as a new full-time career—including publication of his weekly Gold, Energy & Technology Stocks newsletter. This year, he debuted a new radio program, "Turning Hard Times Into Good Times."


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