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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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