Last Updated : 22 August 2009 at 11:05 IST
'Gold will surge to next leg to touch $1,300'
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The Gold Report: Since starting your Equities & Economics Report, you have called several market sector tops correctly. These days, some experts are saying, "We're going to have a pullback before year-end. Get ready, go to cash." Others claim we're coming out of recession and the economy is in recovery. How do you view what is happening today?
Victor Gonçalves: With the way the economy's going right now, it's a bit of both. You've got to consider the long-term and short-term cycles. When the big crash came not too long ago, we saw drops as much as 80% to 85% on certain exchanges and 50% to 60% on others. That's as bad as the crash that threw us into a 20-year depression.
I've gone back and looked at similar situations historically. Obviously, the '29 crash was first on my list. But I also looked at Japan's scenario. These two played out a little bit differently but had some very similar notes. Both economies crashed, with equities losing most of their value—let's call it 90% for a round number. The U.S. economy rebounded eventually; the Japanese never did. So consider the differences.
I do believe in Keynesian economics, and I believe the big reason for the major rebound in the U.S. goes back to the introduction of the New Deal. As much as people criticize it, the Eisenhower highway system was built, power grids were expanded—as well as other initiatives. The U.S. economy was expanded greatly, and it was debt-financed. Basically the debt-to-GDP ratio went up as high as 125% in that time. The reason why I say this is right after that, the American people and government started saving and kept saving. So, from a high of 125% debt-to-GDP in the late '40s and early '50s, it got back to pre-war levels, in the 30% range.
TGR: Wasn't World War II part of that too?
VG: The war was part of it, yes, and brought the debt-to- GDP ratio to around 60% to 70% from around 30%. The important point, though, is the savings. It wasn't a credit society. Keynesian economics can and does work if you deficit spend to stimulate the economy with productive goods and then put some savings aside. You pay back your debt. That's what happened in the U.S.
TGR: Which way do you expect the inflationary-deflationary pendulum to swing this time?
VG: As of now, I don't know if the U.S. is going to go inflationary or deflationary. Currently, there is definitely going to be some inflationary pressure just due to the sheer amount of paper that is being printed and debt that's incurred to make all this happen. I'm suspecting that not today or tomorrow or the next couple of years, but if we go down the route of Japan, we probably will go deflationary. The long-term perspective is anyone's guess.
TGR: Some people argue that even though we've injected a lot of money into the system, it's gone into the banking system but hasn't made it out to the general population.
VG: There's a difference between monetary inflation and price inflation. Sometimes they spark each other, but they can be two very different things. For example, in the States in the past seven or eight years, when you consider monetary inflation, there's been an annual inflation rate of about 7% to 8%, but price inflation obviously hasn't been nearly that much. That's because a lot of printing was going on during the Bush administration, from basically '01 to '08. So we had monetary inflation without the price inflation. We really saw the price inflation only toward the end of that period, when oil and other commodities really starting taking off and filtering down to what you and I buy at the grocery store.
TGR: And then deflation started creeping in.
VG: We did see deflationary pressures due to lack of demand, i.e., oil, commodities in general, labor, and so on. In mining companies, it's a classic example. The price of drilling a foot of core has gone down something like 30% because the price of oil and cost of labor are way down. People are willing to work for less. In terms of money going into the system, there's certainly more and more money being printed. So we'll see monetary inflation but also see price deflation just due to lack of demand.
TGR: Under these circumstances, are you expecting the market to pull back or just kind of stay in the trading range it's been in recently?
VG: From the bottom last year to where they end up, I basically think the markets have room for a full 100% bounce. Whether that happens is a different story, but historically speaking we've got the makings for that kind of move. This summer we should have seen a pullback as we normally do in the summer. That would have sparked a downleg, which is part of these cycles. You will get a major bounce—some people call that a dead cat bounce—and you will get a re-test of the lows. We didn't see that this summer; in fact, we saw some impressive highs in some markets. If these things hold, I suspect we will see continued strength in the market.
But that will come to an end at a certain point. We're fundamentally worse off as an economy than a year ago. The markets are 80% higher; so there's obviously a discrepancy there that has to get reconciled. I don't think that's going to happen yet. I think we have the makings to continue this bull. But I would caution people that there's not much room left, maybe 20%. Mind you, a lot of money can be made in this 20%. And then we will see a re-test of the lows.
TGR: Would that be 20% of all sectors?
VG: No, I'd say it's 20% overall. The resource sector will do proportionately better and consumer staples will do well, but luxury goods and other wonderful things people can't afford now will go down or at least stagnate. Toronto—where I am—probably will see a stronger run because commodity prices have rallied quite strongly, and I don't think stocks have really fully reflected the rally we've seen in the metals.
TGR: How do you then see playing this market?
VG: The resource sector is the best place to be at the moment, with nickel at nearly $10; gold flirting with $1,000 and copper close to $3. We're seeing just short of a raging bull on the resource side; so I would definitely be there.
TGR: If the market turns, will the resource sector, turn with it?
VG: I think so, but it will be a delayed effect. Last year, copper didn't fall off a cliff until we were well into this whole collapse because it wasn't the resource sector that led it. It was the banking systems. The resource sector took a fall because of lower demand and slowing growth, but also because some of the planned growth couldn't get executed because they just couldn't get their hands on materials. You need large amounts of credit to secure a load of ore or coal or whatnot and ship it.
TGR: Are there certain segments of the resource sector that you anticipate doing better than others?
VG: Sure, there are definitely sectors that will do better than others. I have talked to a lot of my colleagues, and people like base metals right now. I was of the opinion months ago that base metals were nice. I'm getting a little more cautious because they've actually broken through what I consider the fair value prices. They can keep going for a really long time before they correct to where they're supposed to be. I suspect that specialty metals—the rare earths, tantalums and many of the "iums" such as iodium, lithium, zirconium, cerium, Terbium, Dysprosium, germanium, niobium—are set to do really well. As for gold, I think it's do-or-die right now. It's either going to really move or peter out, and I think it's really going to move. There are certainly some factors that are saying it's going to move.
TGR: In one of your blogs you said gold should hit $1,000 this summer, but it's been trading in a very tight, narrow range the whole time.
VG: That's true, it has. And it hasn't quite reached the $1,000. It's been right around that level, but hasn't broken it. Part of what my readers enjoy is that I don't give them insanely complicated ways of finding things out. I go back to the basics. Supply and demand is a good start. All you have to do is look at the pricing historically and the supply and demand. When I was doing a thorough review of their numbers back in June, as I do a couple of times a year, I saw the price of gold year-over-year was 2% lower. Demand was up 38%. That normally doesn't make a lot of sense, so I did some quick back-of-the-envelope calculations to see where the price of gold should end up in relation to the increased demand. In theory, it should be $1,273, and I suspect it will get there.
The economics of it and the numbers—the supply and demand—will come forward at the end of the day. It will happen. And then I think gold will see the next leg, about $1,300, when we get the next pullback in the market. Whether that's right away or later in the year we'll leave to our crystal balls.
TGR: Tell us a little bit about investing in gold as a physical metal, either through ETFs or actually owning the coins or bullion, versus equities.
VG: Owning physical gold does make sense. If the market were to tank tomorrow the way it did last year, shares are shares and if everybody is making a run for the door, they will sell anything liquid. Physical gold, not so much. So if we have another market collapse, gold is good to hold.
There are a lot of arguments as to the right amount to hold; it just depends on how risk-tolerant you are and what you think the market is going to do. I personally lean a little more to the risky side, so I tend to hold more on the equities. I like to keep between 10% and 15% in physical gold. But even then it's not so much a matter of how much gold you keep in your portfolio; it's how much cash you keep. If you had a lot of cash last November and December, buying gold wouldn't have done much for you, but if you'd put it into resource stocks it would have done you a world of good. You'd be up 500%, 600%, 800% right now; some of my picks have been terrific in that regard.
So what I suggest is to keep a core gold position; it need not be very big. Right now, keep cash, because that's what you can use to buy the market when it tanks, because I believe when it tanks again, we will still see another rally.
TGR: So should investors take their profits, sell and convert to cash now?
VG: I wouldn't sell yet. On companies that are making 52-week highs or running absolutely crazy without a lot of reasons to do so, by all means, get out. If you also have seen a 5- or 10-fold appreciation of your money in these companies, sell your initial investment or even half of it. After all, walking away with money is what you want to do. So, for people who are a little more risk-averse, I would take some profits at this point, yes, but I wouldn't go gangbusters because I do think come September we should see a continued move to the upside. That's barring no more shoes drop; I don't think they'll come yet, but they are due for sure.
TGR: You indicated that some of your stocks have gone up as much as 800%. Are you recommending people take money off the table or keep going because you're looking for this market rally to continue for at least a month or so?
VG: That depends on what a company has planned. A lot of the companies with those returns have been juniors, which are dependent on another factor that the majors aren't so dependent on. A new gold discovery by Teck Cominco Ltd. (TSX:TCK.A) (TSX:TCK.B) (NYSE:TCK) or Goldcorp (TSX:G) (NYSE:GG) isn't going to have a huge impact on the share price, because it is already worth a lot. But a multi-million ounce discovery in a junior company is revolutionizing for that particular company. It's worthwhile holding onto that, because as the market has gotten a lot less risk-averse they're willing to pay for such things. So hold companies poised for growth; definitely take profits companies that had their major push and are now coasting. There's nothing wrong with having money in your jeans.
TGR: Do you have any juniors you'd say are worth investing in now?
VG: One I've been following for quite a while is Kent Exploration Inc. (TSX.V:KEX). The first Kent project I ever looked at I found on their website when I was looking for some new companies to consider, where I saw historical drill results such as 1.5 ounces of gold over 40 and 60 feet—significant intersections. So I went and formally met Graeme (O'Neill), the CEO, and chatted with him. They subsequently figured out that project had a historic resource 1.2 million tons of barite. Graeme decided that, "While the going is good, let's get a purchase order for the barite. Let's get it out on the market. Let's get a cash flow for the company." And I think that's golden—no pun intended.
TGR: Even though other means of financing may be available now.
VG: Yes. People can raise money again. How soon we forget how bad it was, even just last October.
TGR: What kind of money are you talking about?
VG: If all goes well, Kent could have anywhere from $800,000 to $1.2 million a year in cash flow from their property in Washington State. That's very significant.
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