& SILVER: Speech to the ResourceOne Conference, New York - April 21, 2010
Those of you who
know me know that I am quite optimistic about the outlook for gold and
silver. This may be good news for those of us in the mining business or
invested in precious metals assets.
Unfortunately, to be
bullish on gold means that I’m pessimistic about the U.S. economy,
particularly the outlook for inflation and economic growth, over the next few
years. More about this in a few minutes . . .
But first, at the
risk of sounding like a gold bug — which I’m definitely not
— let me give you some numbers: I believe we will see gold back
near its all-time high around mid-year. In other words, around $1227,
give or take a few dollars, by the end the end of June. And, by year-end,
New Year’s Eve, we could be celebrating $1500 an ounce.
Now, if these prices
seem extreme, let me remind you that last year, we saw gold move up 35
percent in the space of five months from July to its early December record
high. A similar performance from today’s price puts gold a few
dollars above my target of $1500 an ounce.
silver? In an up market, I expect silver will do about as well, if not
better, rising to $25 an ounce, give or take 50 cents.
Longer term —
without being too specific about the timeline — I think there’s a
high probability gold will reach $2000 . . . and, quite possibly, $3000 or
higher before this bull market reaches its inevitable cyclical peak and
prices start moving in reverse.
Importantly, I think
these markets will remain quite volatile with big moves up . . . and down
— so much so, that sharp declines may lead some observers to
prematurely declare the bull market in precious metals is over.
There are a number
of solid long-term building blocks that assure higher gold prices in the
years ahead. In brief, these are:
- Number One: Inflationary U.S. monetary and fiscal
policies — with
record monetary creation, negative real interest rates, and record
Federal deficits promising accelerating inflation and a diminishing
appetite to hold U.S. government debt.
- Number Two: An inherently unstable European
currency — with
divergent fiscal policies and sovereign risk continuing to be an
important theme in currency markets the euro is in no shape to assume a
larger role in the world monetary system.
- Number Three: Expanding investor interest in gold, both demographically and geographically —
with more people and institutions around the world currently and
potentially investing in gold and silver via new investment channels and
vehicles that make these precious metals more accessible than ever
before. In particular, Asia is emerging as a sponge for gold and silver,
for jewelry and investment with important implications for the future
price of these metals.
- Number Four: Rising central bank and sovereign
fund accumulation — with
the official sector becoming a significant buyer of gold last year,
after two decades in which central banks as a group sold, on average,
about 400 tons a year.
- And, Number Five: Declining world gold-mine
production in the years
ahead — even in the face of sharply rising prices, mine output
will continue falling for at least a few more years as existing mines
are depleted, ore grades drop, operating depths fall, energy costs rise,
and the cost of developing new mines continues to rise.
The Economy —
Not So Rosy
Let’s look at
a few of these “bullish building blocks” in more detail,
beginning with U.S. economic prospects:
U.S. economy still faces significant and painful adjustments in the years
ahead following (and a consequence of) many years of profligacy in which
federal and local governments along with private individuals and households
spent more than we could afford on borrowed time and borrowed money.
optimism and signs of continuing recovery in the U.S. economy, the past
year’s severe contraction in the broad measures of U.S. money supply
— in nominal and in real terms, that is adjusted for inflation —
presage a significant deterioration in business activity.
And, with U.S.
inflation also heading higher we are heading into a period of stagflation,
much like we saw in the 1970s.
The key indicator,
the broadly defined M3 money supply for the United States, is now down by 3.7
percent from a year ago . . . and, in real terms it is down 5.8 percent over
the past 12 months. The historical evidence suggests there is a strong
correlation between changes in the growth of M3 money supply and changes in
economic growth, measured by real Gross Domestic Product some six to 12
Several factors, in
addition to the contraction in broadly defined money supply, make a
“V” shaped recovery implausible . . . and suggest a “double
dip” or, at best, a very sluggish recovery with continued high
unemployment for years to come.
- First, households are saving more — as they must to restore household balance
sheets follow years of excessive consumption and imprudent borrowing. In
addition, heighted uncertainty and job insecurity encourage increased
“precautionary” saving. With consumers accounting for
approximately 70 percent of total demand, it is hard to imaging a robust
recovery when households attempt to save more and spend less.
- Second, falling personal incomes reflecting lost jobs, salary cuts, reduced hours,
and lower sales commissions mean that many consumers have less to spend.
- Third, the crisis in state and local budgets is reducing spending on capital projects and
social programs. Even local school districts are cutting budgets and
laying off staff.
- Fourth, rising home vacancies and foreclosures, empty retail space (like the vacant Circuit City
stores we see across the country), and unused commercial and industrial
- Fifth, limited credit availability to households and especially to small businesses
that are so important to the overall economy as banks continue to keep
their belts tight and are reluctant to take on risk in this risky
- Sixth, and quite important, the coming rise in
medium-term and long-term interest rates. Foreign central banks and institutional investors are just
starting to require higher rates of return to compensate for perceived
sovereign and inflation risks.As higher interest rates cascade through
U.S. credit markets, private borrowing by corporations and households,
for everything from revolving credit to new mortgages, discourages
borrowing and retards economic growth. Since many mortgage rates are
linked to the yield on 10-year Treasury notes, existing home prices
could take another hit along with the residential construction industry.
Indeed, the hoped
for recovery that many mainstream economists and politicians see in the
economic tea leafs is not recognized my most Americans. That’s
why the latest readings on consumer sentiment are deteriorating. What
recovery we’ve seen to date has been underwritten by extraordinary
monetary and fiscal stimulus provided by the Fed and Treasury. Take
that stimulus away and the economy wouldn’t have a leg to stand on.
So, I am sorry to
say, soon comes the second dip of the “double-dip” recession that
will be characterized by:
- A further significant rise in unemployment,
- Contracting consumer spending and weaker retail
- Still lower home prices, more foreclosures, and a
further reduction in residential and commercial construction,
- Shrinking federal, state, and local tax revenues,
- Worsening public-sector deficits and financing
- A wider risk premium on medium- and long-term
Treasuries with more pressure on the Fed to monetize a growing slice of
American debt, and
- Continuing erosion in the dollar’s
purchasing power, both at home and abroad.
- And, importantly, for precious metals — an
erosion in the dollar’s “safe-haven” status that sends
more scared money into gold and silver.
Even if economic
growth hobbles along without an actual double dip and unemployment remains
high, we can expect additional stimulus from Washington that aggravates our
fiscal dilemma, keeps the Fed’s foot on the gas so that the funds rate
remains near zero for longer than now anticipated and quantitative easing
further undermines the dollar — all of which benefits gold and silver.
Real Interest Rates
talking economics, one time-tested indicator of future gold and silver prices
I like to watch is “real” or “inflation-adjusted”
The historical data
show that real interest rates are a very reliable precursor of the U.S.
dollar’s performance on world currency markets, of future price
inflation here at home, and of the direction of dollar-denominated gold and
silver prices in the next year.
As day follows
night, low or negative real interest rates (on short-term Treasury bills, for
example) are followed some time later by rising precious metals prices.
the current bull market for gold that began in 2001 (with gold near $255 an
ounce) has, for the most part, been a period of low or negative real interest
Before this, the
great bull market for gold and silver in the late 1970s culminating in the
January 1980 high points was also a period of negative real interest rates in
the United States.
Today, as most of
you are aware, real interest rates are still low . . . and I believe this
points to higher gold and silver prices in the year ahead.
In fact, I’d
allege that, for a variety of reasons, U.S. consumer price data are today
under-reporting actual inflation . . . and that real interest rates are
actually well into negative territory.
Too Little, Too Late
At some point,
perhaps later this year, the Fed may begin raising short-term rates —
and precious metals may sell off sharply on the news. But I think any
Fed tightening will be too little, too late to reverse the rising trend of
inflation, instill renewed confidence in our currency, and break the bull
market in precious metals.
As long as the rise
in U.S. inflation outpaces each incremental step up in nominal interest rates
— so that real rates remain near zero or in negative territory —
monetary conditions will remain supportive of the upward trend in gold and
It is said that
economic forecasters are “often wrong but never in doubt.”
Well, suppose I’m totally wrong about the U.S. economy, about U.S.
monetary and fiscal policy, about inflation, and real interest rates.
Where would this leave us in terms of the outlook for gold and silver?
I believe that the
expansion of precious metals investment interest and the continuing
development of what I call the “gold investment infrastructure”
will be sufficient to push gold and silver prices substantially higher over
the next few years.
Developments in key
geographic markets along with new investment vehicles are making gold and
silver more accessible and more mainstream to more investors around the world
— and the result is a permanent upward shift in the demand curve for
these metals such that much higher prices will be the norm rather than a
temporary cyclical episode.
Volatility Up and Down
The introduction and
growing popularity of gold exchange-traded funds (ETFs) are having a profound
influence on the gold market. As you know, gold ETFs are gold-backed
stock-market securities that track the ups and downs of the metal’s
price . . . but as stock-market securities they attract investors for whom
direct ownership of bars or coins is too cumbersome and allow institutional
investors prohibited from investing in physical commodities or futures
contracts a loop-hole through which they have bought many tons of gold.
In fact, since the
introduction of gold ETFs about six years ago, the quantity of gold held in
trust for fund investors has risen to 58.45 million ounces as of a few days
However, the rapid
growth of exchange-traded funds is a two-edged sword, increasing volatility
both up and down. ETF investors can just as easily exit the market,
selling their gold as quickly and easily as they might sell any equity.
Contributing to the
anxiety among gold investors this past week was the news that hedge-fund
mogul, John Paulson was an important player in the Goldman Sachs
debacle. Paulson’s hedge funds have also been substantial
investors in gold, so much so that Paulson & Co. is the largest
institutional holder of the SPDR Gold Trust, the largest gold exchange-traded
math puts Paulson’s total gold ETF holdings at more than three million
ounces (about 95 tons). If investors in Paulson’s funds start
pulling their money out, Paulson may need to sell gold to cover redemptions
— putting a temporary dent in the price of gold . . . and, I might add,
offering an excellent opportunity to establish or add to your gold
historically the world’s largest gold-consuming market has also seen
the introduction of new investment products that are beginning to make this
largest market even larger. A gold ETF now trades on the Mumbai stock
exchange. Financial-service companies are offering a variety of
products to their clients via the Internet. A gold physical exchange
trading spot gold has been established to rationalize the Indian gold
market. The Indian postal service in the past year or so began selling
small gold coins, making gold investment more accessible in some of the rural
or agrarian communities that lack local banking and other financial
institutions. These are important developments that will, over time,
support significant growth in Indian gold consumption.
In China there are
even more important developments. The Chinese government allowed
private gold investment only two years ago and has subsequently encouraged
its citizens to buy and accumulate gold. A gold investment distribution
system has developed rapidly — and gold bars, bullion coins, and other
gold-backed vehicles are now available across the country through the banking
system, at jewelry and department stores, and through gold retail shops that
have sprung up in many cities.
markets are expanding through the East Asia region — from Thailand and
Vietnam to Hong Kong and Taiwan to Singapore and Indonesia.
Last month, when the
price of gold dipped below $1100 an ounce, physical demand from India, China,
and other gold-friendly countries in the Asian region stepped in as Western
investors abandoned ship.
A year earlier,
these very same price levels engendered selling from India and restrained
demand in China.
It is important to
recognize that the price points that trigger both buying and selling by gold
jewelers and investors throughout the gold-friendly Asian region are fluid
— and, in the past few years have moved significantly higher.
This is a trend I
expect will continue . . . aided in some countries by currency revaluations
that temper the rise in local-currency gold prices.
economic expansions and rising personal incomes across the region mean that
residents in these countries will have more money to purchase gold jewelry
and more money to save and invest in the form of gold — gold that has
been a favored medium for savings and investment in these countries for
Many countries across
Asia and the Mideast share an historic affinity and allegiance to gold an
adornment, as a symbol of wealth and good fortune, and as a preferred vehicle
for saving and investment. Even gold jewelry in many of these counties
is purchased for its investment characteristics and as a symbol of wealth and
Longer term, as
their share of global income and wealth continues to increase, these
countries will demand a growing share of global gold supply for jewelry, for
private-sector and sovereign wealth investment, and for additions to central
Importantly, much of
the gold bought by savers in many of these countries will probably never come
back to the market, at least not for many years unless gold prices multiply
several times over . . . or if political and economic developments prompt
— Renewed Growth Years Off
While I could talk
about gold all day, the conference organizers have limited me to 20 or 25
minutes — and with miners and mining investors in the audience I do
want to say a few words about the downward trend in world gold mine output.
gold-mine production peaked in 2001 at 2645 tons — and has been more or
less falling ever since. Despite a brief uptick in global production
last year and possibly again this year, the long-term downtrend is expected
to continue for another few years . . . and by 2011 output will likely have
dwindled to less that 2300 tons — a decline of 14 percent over the
prior ten years.
Over the long term,
mine output is a reflection of price versus the rapidly rising cost of
production and the increasing difficulty and expense in finding new deposits
large enough to offset the loss of production from the on-going depletion of
increasingly stringent environmental regulations are adding to costs . . .
and unfriendly government attitudes toward mining or foreign ownership are
discouraging exploration and development in some countries.
Moreover, the global
economic crisis has slowed funding for exploration and development —
particularly for exploration and junior mining companies.
As a result of
higher prices in the past few years and expectations of still much higher
prices in the next few years, I expect that total world gold-mine output will
begin rising during the second half of the decade.
At the same time,
the continuing rationalization of the mining industries and exploration of
virgin territories in countries like China, Russia, Mongolia, and Kazakhstan
could possibly contribute significantly to the recovery in world output.
It is interesting to
note that the locus of world gold-mine production is shifting from the
previous “big four” producing countries — South Africa, the
United States, Canada, and Australia to the emerging market nations —
especially China and Russia, both of which appear intent on consuming or
hoarding most, if not all, of their gold-mine output, rather than sell
bullion into the world market.
gentlemen, there’s so much more to say about the price outlook for gold
and silver, but time is limited. I hope these highlights give you some
food for thought. But I’m running short on time . . . and I do
want to leave some time for questions . . .
Thanks again for
Managing Director, American
Precious Metals Advisors
Senior Economic Advisor, Rosland Capital
Jeffrey Nichols, Managing Director of American Precious Metals
Advisors, has been a leading gold and precious metals economist for over 25
years. His clients have included central banks, mining companies, national
mints, investment funds, trading firms, jewelry manufacturers and others with
an interest in precious metals markets. Please check his website and register
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