Eric Sprott…”I Personally Believe That Gold Has Hit Bottom,” Part 1

Posted on June 10, 2013 by Patrick MontesDeOca

Eric Sprott May 31, 2013

Patrick Montes de Oca (PM): This segment is brought to you by Equity Management Academy. Hello, everybody, this is Patrick Montes de Oca. We have the pleasure today of having with us Mr. Eric Sprott, Chief Executive Officer, Senior Portfolio Manager, Eric Sprott has more than 40 years of experience in the investment industry. After earning his designation as a chartered accountant, he entered the investment  industry as a research analyst at Merrill Lynch in 1981. He founded Sprott Securities, now called Cormark Securities, which today is one of Canada’s largest independently owned securities firms. In 2001 Eric established Sprott Asset Management.

Welcome to Trading Talk. Eric.

Eric Sprott (ES): Patrick, very happy to be back again and I look forward to our conversation.

PM: In testimony last week Federal Reserve Chairman Ben Bernanke hinted at the program of Quantitative Easing that has propped up the economy, the markets over the past three years might come to an end before Christmas comes around. What is your opinion, what do you make of it, Eric?

ES: I love the question, because we’ve already…It’s very interesting what’s going on in the world right now because here we have massive quantitative easing on a scale much larger in Japan than even we have in the USA and the bond yields have ratcheted up dramatically. Like the yields have gone up more than 200%. They’ve gone from 30 basis points to, I think, 95 or 96. People are seeing through the printing. And the same thing’s now happening in the US, where the bond rates, the 10-year bond rates, have gone from 160 to as high as 223 two days ago. I think they’re currently around 215, and this is while the Fed is buying. And I, and I’m sure the Fed, would have a total understanding that if they ever stop buying the bonds what would happen to interest rates? Because a lot of this stock market is built on the back of low interest rates and artificially low interest rates with the most important word being artificially low. We know that the zero interest rate policy is ridiculous. And one other thing I should say, you said it was helping the economy or some words to that extent.  And I can tell you that the zero interest rate policy has had two noticeable and meaningful effects in the US market: one is housing recovered, a little, and auto sales have recovered. Both because they are very interest rate sensitive. The cost of each is very much a factor of the interest rates. With rates going back up here, people are going to find out that there’s an immediate effect, a negative impact, on the housing market in the States, and it will also have a meaningful effect on the refinancing of automobiles. Because the interest costs have theoretically gone up by 33 percent as rates went from 160 to 215. So I don’t think there’s a hope in hell of the Fed tapering their purchases because it would have unbelievable consequences in the bond markets which we’ve already seen manifested, both in Japan and in the States within the last month.

PM: Eric, just to follow that train of thought to quote Bill Gross from PIMCO company Chief Investment Officer on a recent interview, “If bond prices go down, stock prices should go down as well. That’s simply because the global leveraged trade is dependent on the stable Japanese Yen and the stable J/GB yield, and a stable treasury yield and once you produce instability, then that leverage starts to unwind. The housing market starts to get affected, and stocks come down.” You’ve been singing the same song for the past couple of years, at least since I’ve been talking with you. Do you still feel as strong now? I mean obviously, you seem to have very strong opinions on that, and…where do you think we’re going from here?

ES: It’s always good to step back a little and whenever I’m presenting in a room and when I’m talking to you and your listeners, I always say to each one of them, do you, in your heart, think that a zero interest rate policy is appropriate? And do you, in your heart, believe that printing money is appropriate? Because if you don’t, you shouldn’t be playing the game that we’re all playing. And the game we’re all playing is basically trying to game the Fed. And so we all love buying bonds. As you know there’s been this huge interest in bonds here, which I think is being completely misplayed. I mean I tell everybody, you should not own bonds in that environment, and a lot of people say, well, I gotta wait for a real sign that it’s not working. Well, we’re getting our first sign by the way. And you can’t wait, because if you’re a long term or even a medium term thinker, you know that interest rates shouldn’t be where they are. And if you imaging that rates were where they normally would be, where would the economy be? It would be a basket case. Housing would plunge again. Car sales would plunge again. Government debt would skyrocket. It would just be the worst possible of all situations. We have totally masked the ability of governments to finance themselves with these low, these abnormally low interest rates. If they ever went back up, the interest costs to those countries would skyrocket and suddenly it’s out of control; not that it wasn’t out of control already. So it would just be a horrible scenario.

PM: You know, just recently, obviously the bond market has been in a tumble the past few weeks, down about 9 basis points, and obviously rates rising and the prices reflecting what they say is strong economic data. Is this real or…? Are we going to see bubbles bursting in world markets, in stocks, bonds, especially in the US?

ES: We are seeing a bubble burst. The bubble that is bursting, is what’s happening in Japan. They announced a good-sized QE2 program and the bond market crashes because people see through it and therefore, once the Japanese bond market start going down, then people think, oh my goodness, the Bank of Japan has been buying all these bonds, yet interest rates are going up. How’s that work? And then they start getting concerned that the same thing is going to happen here in the United States. And even though Bernanke’s buying all the bonds, he still can’t keep rates down. They’ve gone up 50 basis points here in the last 6 or 8 weeks, and that’s with him being almost the sole buyer in the bonds. What would happen if he wasn’t buying the bonds? And the comment you made, you suggested, that Bill Gross made, and he goes right to the problem, there’s so much leverage in the bond business that when it gets off side, everyone has to start doing things and it brings huge volatility into the bond market. So we saw the volatility in Japan. We’re now seeing the volatility in the US bond market, where all of a sudden people are going to scramble because they own these things on a leveraged basis, which of course is ridiculous, as well, and in order to cover off, they’re over-leveraged, they have to sell the bonds. So as rates are going up, they become the seller and it almost becomes self-perpetuating, if they’re too leveraged.

PM: Are we looking at a top on the US dollar?

ES: You know, Patrick, what’ so difficult with that question, I find it almost laughable that we have the Yen, we have the Euro, we have the pound and we have the dollar, and I have no idea, I mean, I wouldn’t want to own any of those currencies. They all have their individual problems. I can say to you that it looks to me like the Yen is the worst of the bunch, but I could also say to you, I would say to you and I have written, that as far as I’m concerned the US government is bankrupt already, so how would I possibly, in the long run, want to own dollars? You look at the carnage that is going on over in Europe, how would I possible want to own the Euro? And the only reason these currencies look good from time to time, is that they look better. One thing you and I know and most people may not appreciate, is that there is one other currency, and that’s gold. And gold has gone up 500% against all currencies in the last 11 years. I grant you that it’s gone down recently, but the fact is that it’s been by far the best performing currency and if we pull ourselves out of this funk that we’re in in the precious metals, that I think we’re in the process of doing right now, gold will yet again reassert itself as the place that’s way better than any fiat currency.

PM: Let’s talk a little more about gold and silver for a minute. Eric, can you verbalize what you think is happening in the physical gold market as opposed to the vapor market?

ES: I’d be happy to. I have my own views on things and I’m, as you know, very much a student of the physical gold market and watching what people are doing in terms of buying and selling, because I wrote an article about gold about a year and a half ago, asking the question, do Western central banks have any gold left? Because you can see all this new demand coming in while at the same time the mining supply has been flat every year for thirteen years. In fact, it’s even down last year and I suspect it’s going to be down this year, by the way. So how’s all this new buying coming in? How’s China get an extra 700 tons and how do central banks, which used to be sellers of 400 tons get to buy 500 tons, all in a 4,000 ton market? I can identify 2,300 tons of new buying and that’s without using the new data we’re now seeing where all of a sudden demand for gold and silver products has been going up by, in April and May, by hundreds of percent greater than the previous year when you look at China, India, the US, the Canadian Mint. I don’t think they have the gold they say they have. I was sensing pre the April crash that there were lots of anecdotal stories of delays and shortages and defaults on deliveries whether they be from commercial banks, from commodity exchanges, et cetera. And it was getting quite apparent that there was a problem. So along comes this take down of gold, which has been described as a eighth derivative event, and eight derivative events can only happen once every million years, which probably means it was perpetuated. I mean it didn’t happen naturally, in other words. I think the intention of that smash was to have people, to make people, to convince people they should not own physical gold. Unfortunately, for the gold cartel, it totally backfired on them. The buyers came out in force and the volumes that we’re seeing are unbelievably large and they’re not going to be able to supply delivery.