Ask the Expert – Eric Sprott (August 2013)

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In this exclusive interview, Eric Sprott answers questions from our readers about the gold and silver market and his outlook on the economy.

 
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Sprott Money News (SMN): Thank you, listeners, for joining us today on Ask the Expert. My name is Nathan McDonald of Sprott Money News, and we are very excited to have the pleasure of speaking with Eric Sprott this morning.

Eric Sprott is Chairman of Sprott Money Ltd. Additionally, he is CEO, CIO and Senior Portfolio Manager of Sprott Asset Management LP and Chairman of Sprott Inc. Eric has accumulated over 40 years of experience in the investment industry and has earned a recognized standing not only as one of the world’s premiere gold and silver investors, but also as an expert in the precious metals industry. Eric’s predictions and analysis on the state of the North American financial markets have been captured throughout the articles that he authors titled Markets At A Glance.

With this, I am pleased to welcome Eric Sprott this morning. Hello, Eric.

Eric: Nathan, happy to be here, and happy to share our thoughts with your listeners.

SMN: Great, Eric. Recently, there’s been a lot of talk about QE tapering as early as next month. Do you see a possibility of the Fed tapering? If the Fed does taper, how will this affect the price of gold? How will it affect interest rates?

Eric: That’s a pretty big question, Nathan.

SMN: That is a big question.

Eric: You got everything covered in one question. I’ve always believed that they can’t taper, and that tapering, even if it was done, would be so modest that it wouldn’t make any difference. As you well know, just the chatter of taper has driven the ten-year yield up to 272 yesterday, which of course is a huge negative impact; one, on housing, two, on the US government, because interest rates have risen now by over 100 basis points. So, get $17 trillion in debt that was across the spectrum of your debt, your debt cost just went up $170 billion a year. Which is a pretty significant number. God forbid that rates go higher.

If they did taper, because they are buying so many of the bonds, I suspect that rates would continue to go higher. So, I don’t see the taper happening. The minute he mentioned taper and it was this negative reaction in the bond market, negative reaction to stock market, as you and your listeners would know there was recant after recant the next day. “Oh, well, people misunderstood Dr. Bernanke. He didn’t really say that,” and of course, subsequently he said, “Well, you know, we could taper. We could also increase buying of bonds depending on the economical data.”

In my mind, the economic data is very punk these days. I mean, retail sales were up 0.2 percent last month. They were up 0.1 percent the month before. The labor numbers were awful for the last month. Not only did we not have many jobs, the average hourly earnings went down. The average work week went down.

It was one of the most brutal reports I’ve ever seen in my life. My own analysis of what’s going on is we have created a situation in the States where we’re replacing full time employees with part-time employees, and pretending that it’s a job gain. But the reality is that the total income of workers is not going up at all. So, I don’t see taper happening.

If they did taper, I think we’ve seen the worst in gold from the taper talk. Now, gold’s going to live its own life here, based on other fundamentals that are going on. Then, of course, you and I can talk about those fundamentals. So, I think it’s going to have its own determination based on things other than taper talk, or buying extra, fewer than 10 billion bonds in a month.

I don’t see that as having any impact. I think the biggest impact might be if they actually tapered. They said they were going to do it, that rates might just keep going up here, and, of course, that would be an awful economic development for everyone. The stock markets would come under pressure, and the bond market, of course, would come under even more pressure than the crash that we’ve already had in the bond market.

SMN: So, you think it’s basically all smoke and mirrors? It’s all talk?

Eric: I figured it was smoke and mirrors since day one. In fact, in the back of my mind, I suspect they might even have used the taper talk as a reason to hammer gold. Of course, they didn’t realize that interest rates would go up. When Dr. Bernanke was asked that at one of the latest hearings, he said he was very puzzled by interest rates going up. This is the Chairman of the Federal Reserve Bank, puzzled by rates going up. That seems like an incongruous kind of situation that he’d be puzzled.

But I think he scared the hell out of people, because everyone was assuming they’d just print, print, print. The minute they said they may not print, of course, who’s the biggest loser out of it all? Gold. I think it was meant as part of the whole policy of keeping gold under control, which I think is a major problem that these central banks have in gold today. That’s why it was part of the process of getting the price of gold down.

SMN: So, do you think that the confusion is intended?

Eric: I think we all know the Fed’s irresponsible. Zero interest rates and printing money. I mean, everybody on the planet Earth knows it’s irresponsible. Lots of people are prepared to fade the Fed, and play the game and all that.

So the Fed, from time to time, has to appear like they’re acting more responsibly. That’s why they keep coming out with this chatter in the minutes of the meeting and things like that. “Well, we could plan an exit from the bond strategy after QE1 and QE2.” Of course, there never was an exit, by the way, but you got to keep saying it to make everyone think that you’re being responsible.

Because, you know what, there are not just people in the Western capitalist area that watch what’s going on in the United States of America. There’s the Chinese, and the Russians, and the nonaligned people who are looking in and saying, “Oh my god, what are those people doing printing all that money and having zero interest rates? Maybe I don’t want to own these dollars.”

So, they have to, from time to time, appear to be responsible. I think that’s what they use the minutes of the meeting for. Never, of course, the real action, but the talk is what they use to try to persuade people that they’re being somewhat reasonable, even though when they start the actual activity, they don’t change anything. They talk the talk. They don’t walk the walk.

SMN: That’s right. Exactly. I agree. It seems like it’s just part of the game. It’s part of the strategy, but recently there’s been a big item in the news lately that you’ve talked about, I know. Recently, the municipality of Detroit filed for bankruptcy. This was, obviously, the largest municipality in US history to do so. Do you see this as an isolated event, or do you foresee many more Detroits coming in the future?

Eric: The article I wrote is “Is Detroit a template for the US” and the reason I described it that way, is we all knew Detroit was going broke. We knew it ten years ago, and nine years ago, and eight years ago, and seven years ago. Everybody knew it was going to happen, and of course everyone put it off, and no one ever made any tough decisions. Then, finally, you get to the day when you can’t write the cheque, and lo and behold, everybody loses, let’s say 75 cents on the dollar, and it’s because you delayed so long, that the loss was so incredibly large.

In other words, you didn’t take the steps ten years ago, and eight years ago, and six years ago to try to deal with the problem. The analogy that I made then, in this write up, was that the US government is in exactly the same position, where we have $17 trillion of annual GDP, we have a cash deficit of around $1 trillion, but we have, as reported by the US Treasury Department, a gap deficit of $6.5 trillion a year. And the GAAP (Generally Accepted Accounting Principles), as it recognizes the present value of known obligations and what they change by each year. And, of course, the obligations are silver service pension plans, social security payments, Medicare, Medicaid – all the different commitments that the US government has made to their citizens that have not been funded. So, now we’re up to about somewhere between $60 and 80 trillion in known, present value liabilities. And our productive engine is $17 trillion a year.

Well, I can guarantee you that they will not honor the promises. Just like I could have guaranteed you that Detroit was going bankrupt ten years ago. I can tell you that it’s impossible for them to honor these promises, and we just ignore it. We don’t change the social security value. We try to bring in Obamacare, which I think will make it even worse. We’re not dealing with the issues at hand here, and then finally when we get to the point where we have to say to people, “Oh, you know, we can’t pay your pension.” Instead of saying that “We can’t pay you, we’ll have to take a 20 percent cut in your pension.” It’ll be like Detroit. “Oh, you’re going to have to take a 60 percent cut in your pension,” and it’ll be shocking at the time.

That’s why I called it the Detroit template, and of course, it’s going to happen in many cities and probably in states. Maybe even in provinces in Canada, where it just keeps merrily agreeing to things that we had no basis to think we can honor, and that’s the problem.

SMN: It seems like people just want to live in a fantasy land, where they ignore the problems until you can’t ignore them anymore.

Eric: Exactly. And in the care of Detroit, what made them go bankrupt? They couldn’t write the cheque. That’s essentially what happened. They ran out of money, and they had to declare bankruptcy. They didn’t have a choice.

In the case of the United States, they can keep writing cheques because they can just print money. But it’s when you have to keep printing more, and more, and more. You know, if your obligations, because some of these obligations become cash obligations in due course, because as people retire and as more people over 65 get Medicare and Medicaid, there’s a real cost to this stuff. And in order to write that kind of cheque, you have to print more and more money all the time, because it just goes onto the budget instead of not being on the budget.

So, that day is going to come when your deficit goes from a trillion to a trillion and a half, to two trillion, to two and a half trillion. Then everybody’s going to know this is ridiculous, and try to finance it in the market, i.e. if you asked real bond holders to buy those things, what would interest rates be when you have such a low grade credit when looked at in the true light of day. I mean the interest rates could be substantial, which would just cause an even worse deficit.

There’s no way out, as far as I’m concerned. We’re all just living through it here, just as we did with Detroit. There was no way out. There’s no way out for the US, in my mind, and many other governments and states and cities and the whole bunch. I don’t know the day, but I know it’s going to happen.

SMN: Eventually, it will. It’s going to have to happen, just to restore normality.

Eric: Right.

SMN: So, Eric, in the gold and silver community, there’s a vicious attack that began in April. Do you believe this was a coordinated effort by central banks to stop the flow of gold? Do Western central banks have the gold they claim to have?

Eric: I’ve written three articles all on the topic of whether or not the Western central banks have any gold left. Because it’s my view, based on all the data I look on physical gold, that the Western central banks have been surreptitiously providing gold into the physical gold market. The first article I wrote was in 2012, and it basically said that we have an annual 4,000 ton a year gold market, of which about 2,700 tons is mined, and about 1,300 tons is recycled.

This year, I think the mining production will be less. I understand the recycling will be less. We’ll even have a smaller supply this year. But we continue to see the Chinese buying immense amounts of gold. The Indians, the mint sales, the other central banks have become buyers of gold. What I identified in that 2012 article was I could identify over 2,200 tons a year of net new demand in a 4,000 ton market. This is real gold, so somebody has to be supplying this real gold. I think that it was the Western central banks.

It’s my view that this was becoming a crisis at the end of last year, that the central banks had come up with some plan of, “Here’s what we’ll do with gold to try to reverse everything.” Of course, a lot of it started with the Germans saying, “We want our 330 tons back,” and the Fed of the Treasury saying, “It’ll take seven years,” even though it only represents about four percent of the theoretical gold they own. It’s going to take them seven years to deliver 330 tons? To put it into reference, China imported 100 tons last month. So, moving 300 tons doesn’t take seven years. It’s preposterous that it would take that long.

Then we saw some of the commercial banks, who would not honor the physical contracts of people who thought they had gold there. I’m referring to ABN AMRO bank, and there’s another Dutch bank that did it recently. Then, of course, we come up with all the investment dealers telling everyone to sell short gold. Then we come up with things in India, which I should talk about as a separate item.

Then, of course, they orchestrate these raids on the Comex, which had the one beneficial effect that it had for the people who needed supply, was it got people to sell the shares of the spider gold throughout the GLD. And all the people who recommended that their customers sell gold who are participants in the GLD, they bought the shares and redeemed them for physical gold. They’ve cleaned out about 600 tons of physical gold, which on an annual basis would be 1,200 tons, because this was all done in six months. Twelve hundred tons would increase the supply of gold by 30 percent, just from that redemption, which helped them meet this new demand, because people got scared out of these products.

In the meantime, all the commercial banks that were short gold and silver have now covered their shorts. While they advised their customers to sell, they were buying. We’ve seen the short position of the hedge funds go to new highs. We’ve seen two other manifestations of physical, but before I go to that, I want to talk about what India’s done, because I believe the central banks, who all work together, who are all trying to protect their paper currencies, of which India is one. I suspect they went to India and said, “You’ve got to get your people to stop buying gold,” and they said, “Yes sir, yes sir.” Two percent, four percent, six percent, eight percent, ten percent announced yesterday, tax on gold, and now silver by the way. And they changed the credit arrangements for people buying gold in India. They had to put up the cash first, the dealers. They told the banks not to lend against a gold purchase.

They got agreement from the jewelers, that beginning on July 1st they wouldn’t sell bars and coins through the jewelry stores. They had some other arcane rule just recently, where if you were importing gold it had to be held in customs until you could prove that you’re exporting 20 percent of it, some bizarre notion, which has almost frozen the Indian gold demand through normal channels, I might add. But you’ve tried to take the biggest buyer of gold out of the market because you had this imbalance of supply and demand. Because the Indians were buying it in huge amounts, even with the eight percent tax, by the way, and this got more extreme.

Every week, there’s some new measure in India to keep people from buying, because if they ever came back into the market here, it would be unbelievable now that we know what the Chinese are doing every month. The Chinese have gone from buying 200 tons a year two years ago, to 1,200 tons a year. That’s 1,000 tons extra. That’s 25 percent of world demand. If I told your listeners that China is going to buy 25 percent of all the world’s corn this year, oil, extra, or wheat or any commodity, would you have thought that the price would go down? It’s preposterous. We’ve got a new buyer who’s buying 25 percent of everything produced, and the price has gone down in that two-year period.

It’s because it was orchestrated. Because I don’t think they have the gold. Western central banks are looking and the cupboard is basically bare. And they’ve arranged to take it out of the ETFs, and they’ve arranged to have India dampen demand, and they’re going to lose the battle, but they’ve staved it off for a few months, but it’s not going to last long.

SMN: They seem to fight it every step of the way. One thing I’ve noticed, that I wrote about quite a bit recently, is the fact that even though India has installed all these archaic new laws, and tried to stop the flow of gold entering the country, it’s still getting in. The free market develops new ways, such as, obviously, one of the oldest ways: smuggling. Smuggling has increased huge in India, it’s shown.

Eric: That’s why, for example, was it Pakistan that banned imports?

SMN: That’s correct. That’s what I’ve heard about recently, how a lot of gold flow is flowing through Pakistan into India now.

Eric: I think Nepal has done the same thing, and there are other countries that are doing the same thing. It’s like they’re all working together here. It’s ridiculous. It’ll find its way in, I’m sure. Of course, it won’t get reported in the official data, which is of course the data I have to use, and by the way, there’s a lot of nonofficial data I can’t get my hands on. I don’t know what individuals are buying in the Middle East, in terms of gold, because there’s no public record, or Russian billionaires, things like that. All of which you have to imagine the demand’s even higher than I am able to calculate. I think there’s a shortage of gold today. There’s been a physical shortage of gold for a long time that’s covered up by the western central banks, and it will explode one day.

So, I was going to tell you the things that manifested themselves because of this tightness. So, we end up with a gold forward rate going negative, which means that people are prepared to, one, pay money to own gold today, but also pay any interest on the borrowing of the gold, which is unheard of. It’s only happened about four times in the last 12 years, and every time, gold had a major rally. We’ve had backwardation in the price of gold on the commodity markets. We’ve had inventories on the Comex go from something like 11 million to under 7 million ounces. So, all these signs are signs that there’s a severe tightness in the physical market, notwithstanding the Indian government forcing the Indians out of the market. So, it’s tight and the premiums in China and India have gone up sharply here.

All the elements for us being right are manifesting themselves here, so I’m very optimistic of where we’re going to go here in the short term.

SMN: Another hot topic, Eric, which has come up a lot recently is the topic of bail-ins. As we’ve seen in Cyprus, the possibility of a bail-in occurring is now a real threat that we have to be on guard for. Is there any possibility of precious metals stored at Sprott Money / Brink’s Depository in your fully allocated and segregated accounts in Toronto, Canada, of being bailed in? Do they face any threat at all?

Eric: We’re not a bank, thank God, because bail-ins have to do with banks. There is a chance that banks for sure in the world will be bailed in here. I mean, you can see the setting for that as the ECB has passed such rules. Recently, Canada passed the rules, US passed the rules. They’re all set up for bail-ins.

In fact, the Bank for International Settlements even said, “Well, we’ve got a simple process for too big to fail. We just close them on Friday. We may have the depositors take a haircut, and we’ll start them up again on Monday,” which the Bank for International Settlements calls simple. But it’s not so simple if you’re the depositor, as we’ve witnessed in Cyprus, which was so egregious it was a joke. And you can see that.

When I look at the landscape of banks and various areas, there’s no way they’re solvent. There’s just no way they’re solvent, because the value of their assets plunges but the value of your liabilities, i.e. the deposits always stay the same. So, your balance sheet doesn’t balance. There’s going to be all sorts of banks in trouble here that will someday face a bail-in.

So, okay. Now back to Sprott Money. “Could the gold be confiscated,” is probably the better way of putting it. We have no control over that. I mean, Canada didn’t do it when the US did it back in the ’30s. It’s hard for me to predict the recklessness of the people in charge, particularly when you see nothing but recklessness all the time. Who knows what they’re going to do?

So, we provide our customers with the ability of buying their own gold and storing it. They can store it with us. I can’t predict with any certainty whether the Canadian government would or would not. I suspect in a world where there’re so many other people who have huge interests in gold now, outside of the capitalist countries, that there’s probably not even a lot of gold to confiscate, quite frankly, in those countries. Particularly if the central bank doesn’t own any.

I mean, it’s not going to make a hell of a lot of difference to go to a bunch of Canadians and say, “We’re going to confiscate your gold.” It wouldn’t make any difference to the amount of gold that the central bank should have, particularly when you’re starting with zero. But I can’t give people total comfort on it.

All I know is, if I had a choice, the thing to me that I look at, I’ve got a choice of buying some paper assets or I’ve got a choice of buying something real. I’m absolutely convinced the real thing is going to way outperform the paper currency, as we’re kind of in the middle of this Ponzi where people have zero interest rates and printing money all the time. We all know it’s a Ponzi scheme. We just think we want to continue to play it until the music stops and we’ll all get out. Well, we’re not all going to get out, and you got to plan accordingly to have some of your assets in physical commodities.

SMN: I agree. Just got to make the right decisions and hope for the best. I also agree with the fact that I can’t foresee confiscation happening again in North America. Like you said, there’s just too little gold in North America. It’s not an overly owned asset. The gold is moved east. It’s left the west, and I can’t see there even being a reason for the government to begin a gold confiscation again.

Eric: Yeah, not to say it won’t happen. I’m not going to sit here and say it’s not going to happen. You deal with people who make very unwise decisions. We’ve seen that all the time. So, I’m not going to try to predict what they’re going to do, but it’s something everyone has to bear in mind that it is some form of risk.

SMN: That’s right. Eric, you, along with a few other investors, have shared the real facts about the financial problems that are facing the United States and the rest of the Western world, which everybody in the gold and silver community thanks you for that. When the next big correction occurs, what do you see in store for Canada? Do you see Canada being dragged down with the rest of the western world, or do you see Canada weathering the storm?

Eric: Well, we’re in way better shape. We have a pension plan. We have a pay as you go healthcare plan. We don’t have the amount of unfunded obligations that the US has, although we have unfunded obligations. We won’t be as badly off as the US will be, because they’re just not dealing with issues down there, because of the political quagmire they have.

But it’s not saying that we’re going to have a problem; we’re always the tail that’s wagged by the dog. But on a relevant basis, we’re going to be better off. I think we’ve got a better banking system. We have better budgetary controls, although some provinces seem to be out of control. I don’t think we have quite the same issues with the municipalities. We have more natural resources per capita. So, we’re definitely going to be better off, but that’s not to say we’re going to be unscathed.

If it’s all just a big Ponzi scheme, we all just print money as all these major capitalist countries are doing, there’s an unintended consequence of it. I don’t know whether it’s going to be inflation or massive deflation, but there will be something come out of it, because the life and the place we’re living today is not normal. I’m talking about the financial area for now, and there’ll be consequences for that. I don’t think it’ll be as bad here but that’s not something that says we won’t have to endure some pain.

SMN: That’s right. I think when, say, the whole system collapses, everybody’s going to feel a certain amount of pain. It’s just some countries who will be better than others.

Eric: Yes. We’re lucky because we have a lot of natural resources and those will be in demand. So, we should be much better off.

SMN: That’s right. Gold and silver have shown some strong strength recently, just in the last week. Do you believe that the worst is behind us? Do you believe gold and silver have begun the next leg up in this bull market?

Eric: Yeah. I think we saw the bottom on June 28th. My way of defining a bull market in a commodity, I always say if a product can go up 20 percent in a reasonably short time, from a declining trend to up 20 percent, you’re in a new bull market. And silver has to go, I think, probably about another 20 cents from where it is at this moment, and we’re in a new bull market. It will have risen 20 percent. We’ve had the silver stocks go up to 37 percent. They’re already in a bull market.

Both silver and the silver stocks have broken the 50-day moving averages, and I think gold’s gone through its 50-day moving average. So, it has all the signs of being in a new bull market. If I believe my own analysis that there’s a shortage of physical gold, and there’s a huge fight going on, they lost the fight. The fact is that demand surged for gold and silver, when the price got knocked down. I personally believe we are going to see a very, very dramatic increase in the price of gold and silver. And when I mean dramatic, I mean they could double in a year.

In the case of silver, it probably would go up more than that. Of course, the spill off effect to the equities could be gargantuan, because the equities always double or triple the performance of gold. So, I think we have the set up for it. We have all the indications of tightness. We have the technical indicators starting to come together here, and I think it looks very, very exciting for precious metals owners and investors.

SMN: I agree. The scenario that’s setting up looks like it’s going to be a fantastic opportunity for anybody that’s able to weather the storm or hold strong. In conclusion, Eric, can you tell our listeners about the many ways that they can invest with Sprott Asset Management?

Eric: We have lots of precious metal products. We have a precious metal mutual fund. We have a silver equities class mutual fund. We have a silver bullion fund that owns physical gold here in Canada. We have a gold bullion fund in Canada. These are mutual funds.

We have three separate trusts. We’ve got the gold trust that trades on Toronto and New York. We got the silver trust that trades on Toronto and New York, and we have the platinum and palladium trust that trades here. So, those are the products that are central to specific precious metals investing.

We also, of course, have the Canadian equity fund, which, for the most part, is probably well over 50 to 60 percent involved in precious metals. So, they should be stellar performers with what we envision happening going forward.

Of course, our hedge funds are very significantly invested in precious metals, and, of course, have some shorts on the other side. And, of course, my big concern is the stock market might come down here, because things aren’t normal, and things that are abnormal correct themselves. So, those are the various list of products.

People can go to our website at Sprott.com. We have a couple of publications that are available. Markets At A Glance is on there. That’s my monthly commentary. We have something called Sprott’s Thoughts that they can sign up to. It doesn’t cost anything. That’s probably two or three issues a week, just giving comments on various things, economic and precious metals. We welcome them to go to the website and check it out.

Of course, they can always go to Sprott Money, if they’re in need of gold and silver coins or bars. We have quite an inventory, and happy to provide that service.

SMN: Well, Eric, thanks once again for joining us on Ask The Expert, and I hope we can have you back again in the near future.

Eric: Okay, Nathan. My pleasure. All the best.

SMN: Thank you.

Eric: Okay. Bye now.

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