Peak gold + weak dollar = US$2,000, says Byron king
Source: Courtesy of The Gold Report , Author: The Gold Report
Posted: Wed September 30, 2009 10:20 pm

INTERNATIONAL. A highly regarded resource sector expert who discusses his field fervently whenever possible and whose writings include the top-ranking Outstanding Investments, Byron King brings his views direct to The Gold Report audience in this exclusive interview.

Unconvinced that the recession is behind us, he is equally sure that the "bottomless pit" mentality of stimulus spending will wreck the dollar. Those are among the reasons he sees US$2,000-per-ounce gold on the not-too-distant horizon.

The Gold Report: We've seen quite a rebound in the markets since we spoke in May, and governments across the world have begun releasing some positive economic news. Are we out of the recession as Bernanke has told us?

Byron King: I don't agree with that all. It's like at the funeral home where they put really good makeup on the corpse and people walk in and say, "Oh, he looks so good." Then you think to yourself, "Wait a minute. If he looks so good, why is he dead?" That's where we are now, I think, with our economy. We're still in the recession, it has been well-masked.

Let me digress and say that yes, the stock market rebounded. The "sell in May, go away" thing didn't work this year. So if you stayed in the market, you probably benefited very well from the market recovery. But it was a recovery not rooted in fundamentals.

Part of it is that we've had a banking recovery, too. But that was because of massive infusions of new liquidity out of the Federal Reserve and the Treasury Department into the financial sector. That's not the prescription for long-term health.

As with someone really sick in the hospital, the problem isn't putting him on life support; the problem is getting him off the respirator. Now the question is how to stop hemorrhaging public money into the system, and in fact, begin pulling some of it back out.

TGR: Let's assume for now that the government isn't prone to taking the patient off the respirator. Do you expect diminishing returns in terms of less recovery seen for every dollar the government puts into the system?

BK: That's a great point. We're there, at the point of diminishing returns in terms of what it takes to get another dollar of real GDP. It doesn't matter how much green ink they use down at the Bureau of Engraving and Printing or how many ones and zeros they create in the Federal Reserve. At the end of the day, how much have we improved? How much have we built our economy? Look at numbers like new business formations, numbers that indicate the health of growing businesses—hiring, recalls, overtime—certain types of gross output figures, job creation. You're not seeing healthy numbers for those things in the economy.

TGR: And unemployment.

BK: Absolutely. Unemployment may be a lagging indicator, but it's lagging like an anchor chain on your boat, especially when the numbers get up in the 9% and 10% range nationally. And then look at certain critical states. California, Michigan, Illinois, New York and Pennsylvania are all big, populous, busy states with lots going on and high unemployment rates. Where do you go with your economy when you've got that level of unemployment?

And what we're seeing is the nice numbers. There's a lot of ugliness behind them. If you look at the shadow statistics, you may as well add 50% or 75%. You know, 10% unemployment could really be 15% or 17% if you looked at who's really not working. Look at numbers of people applying for early Social Security or disability. They're up 45% and more this year. These are people at the bow wave of the Baby Boom, exiting the workforce, and entering a life of government dependency.

TGR: In a consumer-based economy, can you really have a jobless recovery?

BK: No, I don't think you can. And that's one of our problems. The consumer consumption component of GDP is something like 70% as opposed to what it was historically. In, say, the 1950s, the economy was maybe 55% consumption versus a 45% level of production. At today's 70%-to-30% ratio of consumption, with high unemployment and income insecurity, you can't get economic traction.

A report that just came out within last couple of weeks indicates that something like 70% of households are living paycheck to paycheck. And something like 35% or 40% of households that make more than $100,000 a year are living paycheck to paycheck. Think about that. Almost half of the top income demographic is one paycheck away from being broke. Suppose you get laid off, you get sick, you get injured, some problem comes up, a death in the family, a divorce, or some other big hit comes along. If you don't get paid for a pay period, all of a sudden you're behind on your bills. You burn through your savings, if you have any savings. You miss two pay periods, you're really behind. Three pay periods, there goes the house, there goes the car.

TGR: It's somewhat ironic, but we do hear that people are saving more.

BK: We are seeing big numbers in terms of the savings. The national savings rate has gone from negative to something like 7% since the start of 2009. That's an excellent savings number in the long term. That's a good number for the individuals who are doing the savings, good for them. But in a macro-sense, it's a very asymmetrical type of savings. People at the very high end have cut back on discretionary spending. They're not buying the new Cadillac, they didn't take the fancy vacation, they didn't buy that second house. I think those cuts are what's driving that savings rate up, and they take big consumption dollars out of the economy.

It's not the secretaries, the paralegals, medical assistants or cashiers at the shopping malls. Those folks aren't saving more money than before, not in any gross aggregate kind of way that would move the economy.

TGR: Early on, you said the government's doing a great job of masking the recession. What happens when people see what's been so well-disguised? What will be the impact on the markets?

BK: I think we are living with a very vulnerable stock market. If large numbers of people were to come to the same opinion that I hold, a lot of them would probably want to take sell out. Would it be a meltdown like last year's? I don't think we'd see an overnight crash, but I do think the market would drift down as people take money off the table. I think it'll vary by sector, though, because some sectors are doing well for the right reasons while other sectors are doing well for the wrong reasons.

TGR: For instance?

BK: Sectors depending on the discretionary income I was talking about—high-end home building, entertainment, travel and leisure—those kinds of things have had what I'd call a false recovery. It's a recovery based on antibiotics and steroids. On the other hand, the energy sector and certain parts of the mining sector have done well because there's been an underlying strengthening of demand for the product and a realization that while the dollars in your bank account or your wallet may not hold their value over time, that oil or ore in the ground will protect value. It will hold value over time.

TGR: That's a pretty smooth segue into gold. Can you give us an overview of what's in your Gold US$2,000 report and your thoughts about of the sector now that gold's passed that US$1,000 trading barrier?

BK: I wrote that report when gold was at about $850, so we're moving in the right direction. I think that gold could be $2,000 an ounce, and I'm not alone. Rob McEwen, for instance, is making predictions of $1,500 to $1,600 an ounce within about three years. (Rob McEwen founded (NYSE:GFI)(JSE:GFI) Goldcorp (TSX:G) (NYSE:GG), serving as Chairman and CEO until taking the reins at US Gold Corporation (TSX:UXG) (NYSE.A:UXG) and Lexam Explorations Inc. (TSX.V:LEX), serving both companies as Chairman and CEO.)

I think we're looking at the long-term loss of value in the dollar, what with the tremendous levels of government expenditure—this so-called stimulus. It's the bottomless pit mentality that Congress has toward the money that the federal government spends. It's wrecking the dollar. All around the world people are looking for alternatives.

In China, 15 years ago it was illegal for the average citizen to own gold except maybe for a little gold chain. Today, the Chinese government encourages its people to buy gold. Almost every bank or post office in China now sells gold coins.

If the Central Bank of China ever says, "We're buying gold. We're going to buy as much as we can and put it in the state coffers," the world gold price would spike through the roof. But if the Chinese government tells a billion of its people, "Okay, take a little bit from your paycheck every week or every month, save it up and then every now and then, go down to the bank or the post office and buy a gold coin," all of a sudden they've got stealth rally going. China will build up its gold reserves, but do it in a distributed way.

They're not putting all that accumulating gold in a Chinese version of Fort Knox. They're putting it in safe deposit boxes all across the country. Look around the world and you see people accumulating gold. I think that what we see in China is a harbinger of things to come.

TGR: Are they accumulating gold as a hedge against the U.S. dollar, or as a hedge against their own economy? What's in it for the Chinese government to make that recommendation to the citizens?

BK: It's a way of getting a lot of gold inside the boundaries of China. I'd say that the government wants its citizens to do the buying so as to keep something of a lid on gold prices. They're reinventing the U.S. monetary economy of 100 years ago. The United States used to be a gold standard country. We had a lot of gold and gold was in the hands of the people. And then in 1933 Franklin D. Roosevelt issued a presidential directive essentially confiscating all privately held.

TGR: Might the Chinese government do something like that?

BK: They could if they wanted to, but I think part of it is somewhat like the concept of a "fleet in being"—it's not that you deploy a lot of battleships at once, but if you add individual ships together, you have a rather formidable military force. I would liken the Chinese approach to "Fort Knox in being." They have a Fort Knox in China except that it's not all in one place. It's scattered around in millions and millions of households. If the Chinese government ever needed all that gold in one place for some reason, they would cross that bridge once they got to it.

TGR: So if we're looking at this multi-year, dispersed approach to accumulating gold while keeping a lid of gold prices, why would gold go to $2,000?

BK: Because we're in a world that appears to have encountered peak gold as well as peak oil. If you look at historical production, worldwide gold output reached a top right around the year 2000–2001. Overall output has declined and we're not replacing output from the big mines of the past. Despite discoveries here and there, miners have to dig deeper and deeper into the reserves. In a big mining country such as South Africa, for example, some of the deepest mines now are at 4,000 meters. That's 13,000 feet.

TGR: So your view is that scarcity rather than a weakening U.S. dollar will drive the increase in the gold price?

BK: Well, it's really both. More and more dollars are chasing less and less gold. You're piling the monetary inflation coming out of Washington, D.C. on top of the dwindling production coming out of the mines of the whole world. Beyond that, a lot of what kept gold prices down and the dollar strong for years was the impression that the United States had its act together and would pull through over the long term, despite all of its various flaws and faults. In the eyes of the world, we've somehow managed to blow off a lot of that impression and I don't know what it will take to recover it. It took winning World War II the last time.

TGR: How would you characterize prospects for silver?

BK: I think that silver has more opportunities to appreciate percentage wise than gold. If gold goes from $1,000 to $1,500, that's a 50% gain. If silver's at $15 and goes to $30, there's a 100% gain. Silver is a monetary metal, but it also has more industrial-type uses than gold. We're seeing more and more silver go into the electronics industry, even into biotech. With uses at both the monetary end and the industrial end, there are a lot of good opportunities in silver.

TGR: Since their March lows, stocks in some senior and junior mining stocks—both silver and gold—have doubled or even tripled, while the metals themselves have not climbed nearly so steeply. Does the rapid appreciation in these mining company shares leave any investment opportunity remaining for the equities?

BK: I think you have to be very careful. You have to pick and choose where you're going to go with small companies, medium companies, large companies. A lot of gold and silver, for example, are produced as byproducts of copper mining. If you want to see some of the biggest silver producers in the world, you're also looking at some of the big copper producers. But in terms of smaller companies, one that's done very well would be like Pan American Silver Corp. (TSX:PAA) (Nasdaq:PAAS), Ross Beatty's old company. It's a nice pure silver play. I've been watching another smaller one called ECU Silver Mining Inc. (TSX.V:ECU), which has operations down in Mexico. It's had ups and downs, but it's done well for the investors.

TGR: Any other interesting equity plays for gold and silver?

BK: Another company that's done really well is Rob McEwen's new company, U.S. Gold Corp. It's just an exploration play at this point, working out of Nevada in the area that's related to the Carlin Trend. It has an incredibly good land position in some very prospective acreage.

One larger company that has done very well, is very well-managed and still well-positioned to grow in the future with a rising gold price is Kinross Gold Corporation (K.TO) (NYSE:KGC). Another one with room to go is AngloGold Ashanti Ltd. (NYSE:AU) (LSE:AGD) (JSE:ANG) (ASX:AGG). CEO Mark Cutifani, who's been there for about a year now, has really taken that company by the horns, changed the whole management style and turned it from the stodgy, sleepy South African gold mining company into a real dynamo. The market has figured it out to some extent, but I don't think it has yet given AngloGold Ashanti everything it deserves. So in terms of a big mining company, I think AngloGold Ashanti can still have some reward for investors.

TGR: Thank you, Byron. We appreciate your good humor as well as your good advice


Note. A self-described "old rock hound," Byron King earned his bachelor's degree in geology (with honors) at Harvard, and then worked as a geologist in the exploration and production division of a major oil company.

He "earned his wings" in the U.S. Navy and the U.S. Naval Reserve, logging more than 1,000 hours of flight time in tactical jet aircraft and recording 128 aircraft carrier landings. Based in Pittsburgh, Pennsylvania—site of the historic G20 Summit last week— Byron practiced law there after earning his Juris Doctor credentials at the University of Pittsburgh School of Law.

A prolific author and popular speaker with a gift for wrapping historical context around his observations, Byron contributes to Agora Financial's Daily Reckoning, Whiskey and Gunpowder and Penny Sleuth. He also edits Energy and Scarcity Investor and Outstanding Investments newsletters.

Streetwise - The Gold Report is Copyright © 2009 by Streetwise Inc. All rights are reserved.

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