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
mentioned the deflationary environment. But doesn’t gold normally
perform best in an inflationary environment?
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?
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.
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
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
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.
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.
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?
don’t know to what extent that’s happening but I know it’s
happening in North America.
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.
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.
So we can assume that you’re more bullish on gold than you were six
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.
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.
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?
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.
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
How about the juniors?
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.
Can you tell us how your balance of those categories breaks out?
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.
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.
“C” companies bring with them lower levels of risk.
Those in the "C" categories seem to be really more balance sheet
plays. Do they have enough capital to continue exploration?
are really more exploration plays with some potential in the ground. You
can’t even look to their balances sheets for protection.
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.
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.
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
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