Richard Fifer Web, Think of gold as the chicken soup for all the world’s ills. Gold’s price is influenced by numerous factors, including supply and demand, stock market performance, interest rates and geopolitics.
Robert Lenzner, Forbes.com
Date: Saturday Mar. 27, 2010 7:28 AM ET
Vancouver native Frank Giustra has been in the venture capital business for decades. After a hard look at gold and paper currencies through history, he became convinced in 2001 that gold was poised for a long-term climb in direct contrast with a long-term fall for the U.S. dollar.
Giustra founded Wheaton River and began buying small gold mines. The firm was merged in 2004 into Goldcorp Inc., the giant ($27 billion market value) mining concern.
Giustra next founded Gold Wheaton to buy gold from mining firms that were primarily interested in excavating copper and iron ore. Giustra is also behind New Gold Inc. and Northern Orion Resources, Inc., which are both involved in mining gold.
Another Giustra venture, Endeavor Resources, trades in Toronto and owns 41 per cent of Etruscan Resources, Inc., operator of a gold mine in Burkina Fasso, another West African nation. Endeavor is in a bidding war for Crew Gold, whose shares have quadrupled from 12 cents a share to 49 cents a share. Below, Giustra shares his views on gold’s prospects.
Why should I buy Gold?
Think of gold as the chicken soup for all the world’s ills. It’s certainly not the investment of choice for Pollyannas or, for that matter, for 90 per cent of the world’s economists.
Gold’s price is influenced by numerous factors, including supply and demand, stock market performance, interest rates and geopolitics. But I will focus on the two factors that, in my opinion, will drive gold’s price for years. Both fall under a broad category of policy reflation.
The financial crisis that began two years ago was the result of decades of economic mismanagement and binge behavior. I say “began,” because I believe that we are far from out of the woods. Greece is just one of many financial time bombs lurking in the shadows. What of the PIIG (Poland, Italy, Ireland, Greece) economies?
Could another one of them be next? And what of the commercial banks? Have we seen the last surprise in terms of toxic assets come to light, or could more be triggered by a further collapse in commercial real estate prices?
What does all of this have to do with gold?
The system is still extremely fragile and any nasty surprise will be met by continued policy reflation in two categories. The first involves continued high levels of bank reserves (via printing of money). The second involves high levels of sovereign debt as a result of historic budget deficits.
High bank reserves will lead to high inflation down the road. High sovereign debt will lead to the deteriorating creditworthiness of many countries and eventual currency debasement. Historically, both the above outcomes have been a boon for gold prices.
Let’s start with the U.S. America has had the privilege of acting as custodian of the world’s reserve currency since the end of World War II. It’s a privilege that it started to abuse in 1971 when [Pres. Richard] Nixon de-pegged the dollar from gold. Deficits, debt and printing of money followed, and a 40-year process of numbing ourselves to moral hazards brought us to a near-breaking point two years ago.
So how did we respond to all those lessons and a near-collapse of the entire financial system?
We ignored them and implemented policies that will only serve to exacerbate the problem for future generations. Unfortunately, to do a proper fix would require courage and leadership that is not politically feasible.
Behind the problems lie deep structural problems with the U.S. and other advanced economies and with the global trading system as currently structured. It can’t be fixed with a band-aid remedy of monetary and fiscal policy, but that’s another story.
For the purposes of predicting gold’s price, we need only accept that when governments can’t make ends meet they are faced with two unpopular choices: raise taxes or cut costs. (Politicians) will take the third choice: print money, borrow money and let future generations suffer the consequences. This is not a novel concept. It’s been practiced to devastating perfection throughout history.
The U.S., with a $12 trillion debt, generated a $1.4 trillion deficit in 2009 and will likely hit $1.6 trillion this year. Trillions more are projected over the next 10 years. Add to this unfunded liabilities of Social Security and an aging population and one has to ask how this debt will be serviced, much less repaid!
This dilemma is not America’s alone. Japan and Europe share some of the same problems. Japan has a gross debt to GDP ratio of over 200 per cent. What will happen when its saving pool runs out as a result of its aging population? How will it service its debt if it can’t borrow at exceptionally low rates?
How will these countries cope?
I predict that both the U.S. and Japan will eventually have to coerce their central banks into becoming buyers of last resort for their own sovereign debt, meaning they will have to print money. This will serve the dual purpose of keeping rates low to keep their fragile economies above water and maintaining their sovereign debt service at manageable levels.
What about smaller countries like Greece?
I predict with Greece there will be no default allowed, despite all the political posturing. The last thing the global financial system needs is a sovereign debt scare and all the policymakers know it. The bailout will come in some form that will serve to save face for all participants. The same goes for future candidate countries in Europe. Bailouts cost money and that means heavier debt loads for the Eurozone. As the debt piles up and creditworthiness becomes questionable, countries will print money to keep rates down.
The end result when you print far too much paper currency is that its value declines against real assets. In other words, inflation kicks in. Gold has been the best performer in inflationary periods. When investors become wary of sovereign creditworthiness and all currencies share similar symptoms, meaning there is nowhere to run, they run to hard assets such as gold.
That said, what risks do gold investors face?
Gold can come under short-term pressure in times of crisis when there is a rush to liquidity. In those situations gold can be just another asset to be sold to raise cash. During the crisis two years ago gold was briefly sold off in a rush to liquidity in the form of U.S. T-bills, which resulted in a dollar rally.
A second risk for gold is that investors will become fearful about exit strategies as the recent reflation causes economies to strengthen and interest rates to rise (something that is not good for gold). I doubt this is much of a risk because I believe economies are too anemic and the financial system too fragile to allow for much higher interest rates. The U.S. Federal Reserve (and other central banks) will end up being a buyer of last resort of U.S. debt if it has to keep rates at acceptable levels.
Will central banks remain big players in the gold market?
Central bank sales have always been the most unpredictable component of the demand/supply equation for gold. But as I predicted long ago, the day would come when central banks stopped selling gold. (Quite a few have in fact become buyers.) This past year was the first time that European central banks didn’t sell their 500 tons under the Central Bank Gold Agreement (in fact last year they sold just 150 tons, and I expect them to sell even less in the current year).
Since the U.S. closed the gold window in 1971, gold has traded inversely to the U.S. dollar. Recently, however, that hasn’t always been the case, and I sense a decoupling of that relationship. The U.S. dollar is just another abstract vehicle trading against other abstract vehicles. Gold and other hard assets will slowly trade as a group inversely to all paper currencies.
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