The Hera Research Newsletter is
pleased to present the following insightful interview with John Embry, Chief
Investment Strategist of Sprott Asset Management LP, where he plays an instrumental
role in the corporate and investment policy of the firm. Mr. Embry, who is
a world renowned expert on the gold market and on gold and precious metals
mining shares, currently focuses on the Sprott Gold and Precious Minerals Fund.
Mr. Embry has researched the gold sector since 1963 and has more than thirty
years of industry experience as a portfolio management specialist.
After graduating from the University of Manitoba with a Bachelor of Commerce
degree, Mr. Embry began his investment career as a stock selection analyst
and Portfolio Manager at Great West Life, where he later became Vice President
of Pension Investments for the entire firm. After 23 years with the company,
he became a Partner in United Bond and Share, an investment counseling firm
acquired by Royal Bank in 1987.
At Royal Bank, Mr. Embry was named Vice-President, Equities and Portfolio
Manager at RBC Global Investment Management, a $33 billion organization where
he oversaw $5 billion in assets, including the flagship $2.9 billion Royal
Canadian Equity Fund and the $250 million Royal Precious Metals Fund, which
was the #1 ranked fund in Canada for its 2002 net performance of 153%.Hera
Research Newsletter (HRN): Thank you for joining us today. Let's talk about
gold stocks.
John Embry: Gold stocks represent a tremendous value in relation to
the price of gold and to the fundamentals of the sector. There has been tremendous
shorting activity by hedge funds and, as a result, dedicated gold funds have
experienced redemptions. Retail investors, who are natural buyers of these
stocks, have been annihilated by the price action. This has created one of
the finest opportunities, if not the finest opportunity, that I have ever seen.
HRN: Do you have a short term price target?
John Embry: I don't look at short term price charts for gold. In a
market as heavily interfered with as this one, charts can be made to look any
way you want in the short run. As I see it, if you don't like gold at these
prices, then you must like currencies. My partner Eric Sprott often says, the
U.S. dollar is the best looking horse in the glue factory. If the U.S. dollar
is the world's strongest currency, that's the best endorsement for gold that
I can think of.
HRN: Do you believe that currencies are losing value?
John Embry: The fact is that economies are slowly melting down. The
problem is excessive debt in almost every corner of the world. The only way
to deal with the debt is through aggressive growth, but fabricating growth
through more debt won't work. The idea that you can get the economy to move
forward by creating even more debt just doesn't wash. We can't service the
existing debt, even at artificially low interest rates. I don't see any easy
way out. We have to get the excessive debt out of the financial system. Either
policy makers are going to create mounting inflation or there will be a deflationary
debt collapse.
HRN: Europe seems to be a case in point. Do you think the Euro will
break up?
John Embry: The Eurocrats who constructed the currency aren't going
to give it up easily. The key is how much the Germans are going to go along
with. They realize that there's a huge loss for them if the Euro falls apart.
I wouldn't want to be in German Chancellor Angela Merkel's shoes. Germany is
trapped in the Euro because it relies on exports and German banks hold the
debt of other European countries. Despite the bailouts and the inflationary
policies of the European Central Bank (ECB), Germany doesn't have much choice.
HRN: How can European governments solve their debt problems?
John Embry: The problem is that it would take a horrific debt collapse
to set the stage for future expansion. There is no politician on earth that
wants that to happen on their watch. Consequently, policy makers will resist
deflation and we're going down the opposite road, which means mounting inflation
or possibly hyperinflation. I don't think politicians will change the system.
I think the system will change the politicians.
HRN: Can the economy recover in a high inflation scenario?
John Embry: Creating even more debt is not going to work. To me, high
inflation is the most corrosive thing that can happen to an economy or to a
country. I'm really worried that neoclassical, Keynesian economists like Paul
Krugman, who are prescribing even more debt, will bring about a collapse.
HRN: Are these problems the result of Keynesian economics?
John Embry: If you really applied Keynesianism as Keynes originally
envisioned it, the government was supposed to run surpluses when the economy
was growing to pay for the deficits that would be created during downturns.
That's been conveniently forgotten. We've had an astounding build up of debt.
I don't think people fully realize how serious this is. I'm amazed at how complacent
people are. We've never been in a position like this in the entire history
of the world.
HRN: Why do you think people are so complacent?
John Embry: I think it's cognitive dissonance. When confronted with
something that's really unpleasant, and to which there's no easy solution,
the average person will basically block it out and look for somebody to tell
them that everything is fine. The mainstream news media and the government
are doing that as we speak. Consequently, the average person doesn't have a
chance of understanding what's going on. The man in the street doesn't have
a clue what's coming.
HRN: What about investment professionals?
John Embry: I have a lot of close friends who have been in the investment
business for 40 years and they don't want to hear it.
HRN: Won't the Federal Reserve and other central banks simply bail
out the system?
John Embry: They think that printing money will buoy the markets and
that that's good, but it won't solve any of the problems. Although you may
get a momentary lift in the financial markets, when it plays itself out we'll
be back in the same situation, but with money that's being systematically destroyed.
HRN: Does printing money work in the short term?
John Embry: There are nominal prices and real prices. Printing money
is very deceptive and people are confused by its effects. I am only interested
in real returns, not nominal returns. If you have a nominal return that's caused
by inflation, you're losing money because governments tax nominal gains.
HRN: Can governments inflate their way out of debt?
John Embry: The U.S. federal government, for example, has reached a
stage where forty cents of every dollar spent at the federal level is borrowed
and a lot of that money has been printed. There has never been a case in history
where that hasn't led to financial disaster. If you study any empirical evidence,
they're in a hopeless position. They've only been able to get away with it
so far because the U.S. dollar is the world reserve currency. If the United
States wasn't able to print money and was trapped in the European Union, it
would just be a massive Spain.
HRN: So, governments can't inflate away their debt?
John Embry: Inflation is the easier, more expedient route to take,
but I would not rule out an accident. For example, if policy makers push austerity
too far they could trigger a deflationary spiral that would be impossible to
reverse. I subscribe to the Austrian theory of economics. In his book Human
Action, Ludwig von Mises wrote that there is no way to avoid the collapse of
a credit boom and that more credit expansion simply destroys the currency.
HRN: Don't inflationary policies help banks and support the financial
system?
John Embry: The ECB could do another Long-Term Refinancing Operation
(LTRO) or the Federal Reserve could buy more U.S. Treasuries in the open market
but that's not really solving the problem. If you actually evaluated the banking
system and marked all the assets to market, the system would be insolvent.
HRN: And the basic problem is too much debt and leverage?
John Embry: The over the counter (OTC) derivatives situation is so
surreal I can't begin to express it. Correctly calculated, the notional value
of all OTC derivatives is in excess of one quadrillion dollars globally. The
vast majority are related to interest rates. Central banks have to keep creating
liquidity to prevent these instruments from collapsing.
HRN: What can the Federal Reserve and other central banks do?
John Embry: They're lost either way. They're running a massive lab
experiment with monetary policy and don't have a clue what the outcome is going
to be.
HRN: Do you think the U.S. economy can grow its way out of debt?
John Embry: When I was a kid back in the 1950's, most women didn't
work. Americans maintained their standard of living by putting a second person
to work. When that was expended they made up the difference by going into debt
and, eventually, they used their homes as cash machines. Now student loans
total more than $1 trillion. I just don't see where the consumer demand is
going to come from going forward. You can't get blood out of a stone.
HRN: What do you think the outcome is going be?
John Embry: I believe that before this is over we'll have a new currency
system, probably backed by gold.
HRN: Do you support the gold standard?
John Embry: One of the greatest periods of wealth creation was when
we had a gold standard in the second half of the 19th century. It's hard to
believe that it's going to be 41 years since there has been gold backing for
any of the major currencies in the world. That is what has allowed the massive
build up of debt that we have today. If there had been a gold standard, we
wouldn't be in the position we are in. Western governments don't want the gold
standard because it restricts their ability to dole out favors.
HRN: But the gold standard doesn't prevent financial panics.
John Embry: There are always going to be financial panics, but, under
the gold standard they tend to be short term. If we had had a gold standard,
there would have been a number of cleansing periods where excess debt was eliminated.
The Federal Reserve allowed the build up of debt that led to the stock market
bubble and crash of 1929 and to the Great Depression, which was followed by
World War II. It took about a decade to build up the debt and more than a decade
to deal with the fallout. It's taken more than 40 years to build up the debt
we have today and I don't know how long it's going to take to correct it.
HRN: What does this mean for the average person?
John Embry: I think living standards of most people in the world, particularly
in the West are going to decline precipitously. The Federal Reserve recently
reported that the net worth of the median American family has fallen nearly
40% since 2007 after adjusting for inflation. Before this all plays out, I
think the percentages are going to be far larger.
HRN: Do you foresee any wider impact on society?
John Embry: When I was growing up in the United States after World
War II, I didn't realize how remarkably fortunate we were as a society to have
such a strong middle class. Seldom in history has there been a middle class
to equal what transpired in the U.S. and Canada from the 1950s to the 1980s.
We basically took it for granted because that's all we ever knew. The middle
class in the United States is disappearing. What happens is that you have massive
poverty and a small wealthy class. It's one of the worst things that can happen
to a society and it can lead to civil unrest. If there's no reason to buy into
the system, people will act up.
HRN: Do you view gold and silver as commodities?
John Embry: I view gold and silver as monetary metals. The mainstream
news media conflates gold and silver with industrial commodities, but they're
really a competitor to the currency system. Gold is the antithesis of paper
money.
HRN: I've read that central banks are buying gold.
John Embry: Confidence in currencies is misplaced. There is a strong
flow of gold from West to East. The Chinese, Indians, Russians and Vietnamese
know perfectly well what's going on with the U.S. dollar and the Euro. They
are buying physical gold and the West has been stupid enough to sell it to
them.
HRN: What's your view on China?
John Embry: I'm not optimistic on China in the short run. The People's
Bank of China (PBoC) recently cut bank reserve requirements by 150 basis points
to stimulate 1.2 trillion yuan ($190 billion) of new lending because they don't
want growth to fall from around 8% to 7%. As I see it, they've dined out on
Western profligacy for 20 years and have become the most unbalanced economy
in the world. An inordinate amount of China's economic activity is generated
by exports and by all manner of capital spending on manufacturing, real estate,
infrastructure and more. The slowdown in the world economy has revealed massive
overcapacity in many sectors.
HRN: Can China develop a consumer-driven economy?
John Embry: The idea that China's economy can morph into a consumer-driven
economy is preposterous. The very same consumers are employed in sectors like
manufacturing where there is massive overcapacity. If the world slides into
another global recession, which is not beyond the realm of possibility, I don't
see how China stays out of it and if they don't then there's no engine of growth
left in the world.
HRN: So, even with a rising middle class, China remains dependent on
exports?
John Embry: The fact is that China has become the world's manufacturer
but the ability of their two largest customers, Europe and the United States,
to consume is being constrained. China is not going to be able to keep selling
more year over year. The HSBC manufacturing index has fallen to recessionary
levels.
HRN: It has been predicted that China will become the world's largest
economy. Do you think that's true?
John Embry: I think China will probably dominate the 21st century.
The U.S. dominated the 20th century but it went through some very tough times
in the first half of the century.
HRN: With a slowdown in China, what's your view on commodities like
copper or crude oil?
John Embry: In the short term, I'm worried about commodities. In a
deep global recession, I expect there will be extreme monetary debasement,
which will hold up the nominal prices of commodities more than supply and demand
factors would suggest.
HRN: Do you foresee a bear market in commodities?
John Embry: We are in a short-term bear market that will be arrested
by monetary debasement.
HRN: But there are value buying opportunities?
John Embry: Given my views on currencies, commodities that are already
depressed could be decent repositories for wealth. I like agricultural products.
As the global economy continues to develop, I think the supply of food is going
to be a major issue.
HRN: How can investors protect their assets in a global recession?
John Embry: The only things I'm comfortable holding are precious metals
and, because they are so cheap now, precious metals mining shares.
HRN: Where do you think the price of gold will end up?
John Embry: I'm more concerned with how many ounces I own than with
how many U.S. dollars I can get for them at any given point in time. Gold and
paper money are going in opposite directions.
HRN: Thank you for your valuable time.
John Embry: It was my pleasure.
After Words
John Embry doesn't mince words and his track record speaks for itself. A defender
of the gold standard, John Embry sees gold and silver as currencies competing
against the U.S. dollar and the Euro, which are losing value because of extreme
debt levels, weak economic fundamentals and policy induced inflation. According
to John Embry, abandoning the gold standard has led to unprecedented debt levels
that could take decades to unwind. In the mean time, inflation seems likely
to wipe out the middle class. While his outlook for commodities is bearish,
John Embry believes that gold and silver and related mining shares remain the
best way for investors to preserve their wealth.
