Jim Puplava’s Big Picture: An In-Depth Conversation on Gold with John Kaiser

The Reasons Behind the Bear Market in Gold Equities and What Comes Next

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John Kaiser

Show transcript of Jim Puplava’s Big Picture: An In-Depth Conversation on Gold with John Kaiser

JIM: Joining me on the program today is a special guest John Kaiser of Kaiser Research Online, a website and newsletter that specializes in the resource sector. And what we’re going to cover today is the gold market. Are we in a bear market in gold? I would say we certainly are when it comes to gold equities. And what is happening with trading today? Shorting; what are the regulators doing? What is the environment in which we operate as gold investors today? What could be the catalyst that could turn this around? What are regulators doing? What do you want to look for when you’re investing in the resource sector? Macro factors.

We’re going to cover the whole gamut today, so I’d like to welcome to the show John Kaiser.

John, thanks for coming on the program. [1:16]

JOHN: Jim, it’s a pleasure to be on your program.

JIM: I want to cover the first issue: Are we in a bear market? And I think if you look at the gold equities going back over the last three years, you would have to say the mining equities have definitely been in a gold bear market; whether it’s happening in the bullion market we’d have to wait to see that. But John, let’s talk about something that happened with gold equities that goes back to late 2010 when we first began to see divergences between stocks and bullion, and I wonder if you’d comment there. [1:48]

JOHN: Well, we had a tremendous run up for the price of gold starting in 2009. That washed over into the equities and the underlying narrative was, well, there is money printing going on – quantitative easing is going to generate inflation and so on – and the price of gold will rise substantially, perhaps faster than the rate of inflation itself. And so we had a massive inflow of capital both funding the gold equities and silver equities too, and of course the prices of the equities went way up, but that stalled in December 2010. And although gold’s uptrend pretty much stalled then too, it has been going sideways, while the gold equities – and silver equities – have been in a terrible downtrend that accelerated during the last three months and now seems to be undergoing a complete washout. [2:40]

JIM: There are a number of reasons I think that could help explain some of this. And John, you have written about this extensively; one is the cost structure in the mining industry. Yes, everybody knows that the price of gold has gone up, but so has the cost and those costs have been going up at double digits. We also had the issue of dilution by a lot of the mining companies that were expanding by going out and making acquisitions at very poor prices. And then I think something that also contributes to this factor has been the poor return on mining equities. In other words, when I look at a company, whether I’m looking at Coca-Cola, I’m looking at return on equity, return on investment.

And then finally, the way analysis is performed in this industry where you have analysts looking at a company – I don’t care if it’s Newmont or Barrick – taking a look at actual costs, which have been going up at double digit rates, but then using deflationary numbers for the prices of gold and silver – the products they sell – when you’re doing forward cash flow models. So I wonder if we might address some of those reasons and get your thoughts. Are many of these fundamental reasons behind why gold equities have underperformed the bullion? [3:50]

JOHN: Well, the big shock that made the news last year was the capital cost and operating cost explosion that has been going on for the past five years and that is due to the strength in the overall bull market in metals that started in the past decade when China started to come on stream with its massive expansion of its productive capacities and infrastructure and so on, which caught the mining industry by surprise in a very big way. And even though the crash happened in 2008, China went on and spent $600 billion expanding its infrastructure and kept demand for raw materials alive and therefore also for engineering services – all the services that go into developing mines – also their reagent and energy costs, they all stayed high. And Nick Holland from Gold Fields last year put forth a statistic saying that every year the costs have compounded 10 percent; that’s substantially higher than the two-to-three percent CPI that we’ve seen during the last five years. So the problem for gold is if you had a project which was marginal at $900, you would think that today at $1600 it should be fabulously profitable. Well, in fact, if you compound the cost at $900, 10% for five years, that’s 60% higher so all of a sudden you’re up at 1400, $1500.

And Barrick dropped a bombshell in January when it said that its worldwide average total cash cost and that includes the depreciation of capex is $1500/oz. Well, we’re pushing $1500 today. That means it’s really impossible to make money mining gold at least with new projects. [5:33]

JIM: What about dilution because everything was about growth in the last decade and you saw companies like Kinross go out and buy Red Back for almost $1000/oz and so if your purchase cost is $1000/oz, you’ve got to think of how much it costs in capex, as we just discussed with Barrick; on top of that, your actual production costs. So what about the dilution? [5:55]

JOHN: Well, 2010 was a fabulous year for takeover bid buyouts, especially of these juniors which had advanced these projects from the resource feasibility demonstration work on it. And while we were in an uptrend, every company – the producers had an even better valuation than the juniors and so they were able to pay with stock or a surplus of cash that was being poured into their treasuries by the market. And the assumption was, well, we’re paying with expensive stock, easy money and the price of gold is heading higher to $3,000 or something like that. And the problem with all of this is that gold has not gone to 3,000 and the only circumstance under which it would do so would be because there is inflation in the system. So the costs would continue to chase gold at $3,000. So all of a sudden these companies are taking huge writedowns to adapt to the fact that there has been this explosion in costs and that is hurting the industry. 

And on top of that, now the general belief is that, well, gold has topped out, it’s going to start trending down, America’s economy is on the rebound and all of that is incompatible with the prevailing gold bug narrative. [7:07]

JIM: Let’s talk about something also that has occurred in this industry that I have not seen analysts use the same metrics. And let’s say I’m a mining analyst. I’m looking at Barrick, Newmont; I’m looking at the cost structure as Barrick dropped the bombshell in terms of what their cost is. So I’m using these double-digit costs of 10% or more a year, but then, as I’m looking out in terms of cash flows five years out, I’m using declining gold and silver prices. There is an inconsistency with the logic even though we may be heading down to 1500 for all we know right now on the day you and I are talking, but for the last couple of years even when gold has been stuck in this 18 to $1600 trading range, we’re using some prices as low as $1300. [7:54]

JOHN: There’s this perverse rule in the economic study industry where these 43-101 reports for feasibility studies, preliminary economic assessments, prefeasibility studies; the rule is you use the lower of spot price or the three year trailing average. Well, because gold went from 900 bucks in 2008, 2009 all the way up to $1800, its trailing average has been quite low and all of these economic studies have been required to use these low trailing averages. We saw that with nickel in 2007. It went to $24/pound and for a while there the three year trailing average for nickel was substantially higher than the spot price for nickel which crashed back into the 6 to $9/pound range. So the rule is to always use a negative price for the metals in these economic studies. At the same time, they look at oil as the basis for projecting costs and the futures curve for oil is always higher, and so they’re escalating the costs in their economic projections. So we’ve now got two trends going in opposite directions: costs are headed inexorably higher while metal prices are in a downtrend, helped along to some degree in the base metals sector by the fact there has been a huge build out of new supply that’s coming onstream over the next three-to-four years which could put copper in surplus until 2017 and thus represent a lid on copper prices going any higher. [9:24]

JIM: I want to talk about also another factor that has come in here and that is sort of the gold bug narrative and that gets back to macro thesis which I’m going to chime in here, but there was this thought process – and you saw it in 2009 when the gold stocks and the metals really took off from the lows reached in 2008 during the credit crisis – but when the Fed came out and announced QE1 $1.2 trillion here you have a central bank saying openly our policy now officially is to print money. Gold stocks took off, the metals took off. It was a wonderful year for gold stocks. Likewise, we get to most of 2002 when Bernanke came back from Jackson Hole and we launched QE2; we had another upsurge until about the end of December when we talked about this divergence. So one thing we’ve seen since 2010 with the crisis in Europe, the dollar has been a beneficiary. Even in 2011 during the debt-ceiling debate when US debt got downgraded and lost its AAA status because of Europe, money actually came here. The US is seen as a safe haven and I would argue there are a number of reasons why we haven’t seen hyperinflation. The Fed’s monetary base only represents 15% of the money supply, the other 85% of it comes from the banking system and therefore two reasons banks have not expanded credit at a pace where we saw in the previous decades and one has been the Dodd-Frank rules, the Basel II Accord which requires banks to hold more capital in reserves meaning they have less to invest; and the other one a more serious one is the interbank market which has been virtually destroyed by the Fed’s zero interest rate policy. If I’m a bank, why do I want to lend money to another bank and take the credit risk when I can get just the same amount of interest by leaving it at the Fed, especially given the fact that I’m trying to repair my balance sheet from the losses. So the macro thesis, John, let’s talk a little bit about that. The macro thesis in terms of the hyperinflationary scenario that a lot of the gold bugs were talking about has not transpired; we have not seen hyperinflation. [11:33]

JOHN: Well, I think what’s not well understood is that the expansion of the money system took place during the last decade when we had this global real estate bubble and of course our significant real estate bubble in the United States where homeowner net equity peaked at about 14 trillion and then between 2007 and ‘08 lost $7.4 trillion. Since then we’ve seen household savings go up to $9 trillion earning less than one percent right now as money has gone into the banking system. But the dirty secret is that the looting already happened and all this quantitative easing is in effect the Fed putting money back into empty vaults that are backed by paper that’s still marked to an illusory valuation. And the banks have been deleveraging. Since Q1 of 2008, there’s been $1.2 trillion in reductions of mortgage debt and only in the last quarter did we see any change in this deleveraging process. I think we’re getting close to the point where a credit expansion is capable again, but the banks have not been in a position to lend because they haven’t had the real capital base to enable them to survive. And Bernanke has basically been putting the money back into the banks that was looted during the past decade. Now I think we are heading into a situation where it’s going to be very tricky to see if a credit expansion does not unleash a spending spree and inflation in the system. [13:09]

JIM: I think you and I are both in agreement that the equities definitely have been in a bear market. It would be hard to argue three years of double-digit losses as not being a bear market. As long as gold can hold above its long term trend line, it’s yet to be debated whether bullion has entered into – it looks more like a sideways consolidation.

I want to move on to trading in the markets and the resource sector. And everybody knows about short selling. It’s a legitimate method of making money. If you think a company’s earnings are overstated or the valuation of the company is overstated, you go in and you short the stock and based on fundamentals, eventually the market may either prove your assumption correct or otherwise. But there’s another kind of trading and short selling that’s taking place in the junior resource sector that is so much different than the typical short selling. Number one, when you short sell a stock, you have to go to somebody, borrow the shares to sell short. I’m not sure that’s exactly what’s going on in the junior resource sector. You found something taking place on Canadian exchanges. Explain that. And then I’d like to talk about what I’m seeing on the US side. [14:23]

JOHN: Well, the Canadian exchanges were slow in hooking up algorithmic trading to them, but in the last four years they have caught up. Now, algorithmic trading is a human trader put on technology steroids where you literally have a computer reading the feed of market transactions, market depth and so on, automatically feeding orders/quotes into the system, moving them at such an incredible speed that the human mind cannot even perceive what is going on.

Now, the juniors started to get a positive benefit from that in 2010 because then the trend in the market was up. So these algo traders would go in there and they would accelerate the uptrend and stampede ordinary long investors, who are still making human decisions and calling their broker or entering online through their discount broker, they would stampede them into the market. They would goose the market and then the algos would turn around and sell it back to these people. Then we entered a phase of sideways where then they manufacture volatility by just causing the stock to trade in a band moving it back and forth. And in cases where there are structured products – ETFs, mutual funds, indices, options and so on – that trade on different markets, the algo traders also arbitrage back and forth between them and that’s one reason they eliminated the uptick rule for short selling because they needed to simultaneously execute transactions in these different markets in order to capture inefficiencies. But the negative trend that has started to hurt the juniors started in 2011 when it became apparent that the gold bug narrative was failing and also the China growth story was stalling and that the strong prices in the base metal markets would weaken. Once that macroeconomic downtrend was perceived, then the algo traders moved into the resource sector, particularly junior sectors and started to just lean on these markets to implode them. And this has been particularly harmful for pre-production companies where you can’t point to cash flows and revenues as a basis for valuing the companies. So they have literally been working these stocks down into the gutter and we’re now in the final paroxysm where everything is being reduced to next to nothing. There are in fact, of the 1800 resource sector Canadian companies that we track, 900 are now trading below a dime. And not all of them deserve to be trading that cheaply. [16:57]

JIM: You know, something that I have seen likewise on the US side is when we got rid of the uptick rule, they had something called SEC 201 and which is basically when a stock has a precipitous decline, short selling is cut short; you basically cannot naked short the stock. And what we have seen – and we did a study taking a look at 20 large late-stage development companies listed on the major exchange and we found this 201 rule appear in frequency so many times and one of the things that we have seen – and I want to describe how this takes place for our listeners and we’ll just keep this simple. Let’s assume you have a stock that’s trading at a dollar. Let’s say I’m one of the robo-traders and I’m in cahoots with a couple of other traders, I may have my other traders putting in what I call dummy bids at 95 cents, 90 cents and basically 80 cents. We’re going to take that stock down to 80 cents. Now, I’ve got to be careful if I am doing a lot of naked short selling because junior resource stocks aren’t as liquid so I’ve got to be careful if I’m shorting on any kind of news and I’m shorting into that news because a company could get taken out. But what I can do – and I’ve had this explained to me by a hedge-fund manager – what you do is you set up a dummy corporation and that dummy corporation is the receptacle of a lot of that naked short selling. So you use those naked shorts as you blow through the bids at 95 cents, 90, eventually down to 80, a lot of those bids are going to this dummy entity so you have don’t to worry about the risk of covering those dummy sales. But in the meanwhile, if you do have some long positions, once the 201 rule kicks in, I could use my long position to continue to hammer the stock down and make money. And with the 201 rule, what you’ll see once it kicks in, there’s a couple of companies this month that have been on the 201 rule almost the entire month of March and into April. So there’s a lot of illegal activity here that I think is going on and the regulators don’t seem to pay attention to it. I know of one junior that went to the exchanges to complain about it and the exchanges really didn’t care. They did finally tell the company who the traders were and they were big banking institutions but they didn’t say who they were on behalf of.

On the other hand, John, in this industry, if you’re a junior mining stock and let’s say your stock pops 40% because of drill results or some kind of news, a major discovery, the regulators are all over your doorstep, but on the other side on the short side, I don’t think it’s a legitimate way to do business. In other words, if I begin my day by selling shares short with my algorithmic trading programs that I have in place, plus I’m selling shares I don’t really have, I’m selling them naked, to me that’s an unfair advantage and it’s illegal. But I’ve actually heard some of these guys on television make the argument that, hey, all we’re doing is providing liquidity to the market. I’m not sure, John, if I was counterfeiting $100 bills in my basement that the Treasury would buy that same argument that I was simply creating liquidity in the system. So let’s talk about how this places an unfair advantage not only for the companies but also for investors. And it may be something just as simple as what I call them vampire robo traders. [20:33]

JOHN: Well, there’s two things here. One is the fundamental investor who makes a bet either long or short about the future fundamental value of the company. And that can be based on a number of expectations such as what the grade is going to be, the size of the deposit, what are the costs going to be as well as what is the metal price going to be. And short selling where you say these costs are understated, they’re not understanding the metallurgy properly, the market is overpricing the potential outcome of this company. Eventually the truth will come out and the stock will end up much lower. I will short into this, I will borrow the stock. I will hold that short position. If I’m wrong it will cost me dearly because the upside is theoretically unlimited on a short position that goes wrong.

And on the long side the investors who are coming in there, they are making a bet saying here’s what we think how the future will unfold for this company. It’s based on fundamental research. We’re actually adding value, we’re helping the market discover the proper price for the underlying asset. The algo traders don’t really care about the underlying value. They are interested in trends. They look for some sort of a negative trend when it comes to the downside, for example, the negative macroeconomic perception we have for metals going forward and then they work these stocks down. And they are clearly using manipulative practices in the type of situation which you describe because literally they are selling short to themselves in order to have a long position they are able to sell short on a downtick until that 10% down rule is triggered. Then they can’t sell on the downtick anymore, but a red flag has been raised there is something possibly wrong. In Canada, they simply halt the stock and ask the company to put out some sort of an explanation as to why the stock is down and the usual explanation is, well, we don’t know; there are no material changes. Which of course is the same thing as, oh, they must be lying. So they allow it to resume.

In the case of the United States, now from the pseudo-long position you have created, now you can keep tapping the bids to confirm that there is in fact something going on. That’s negative. And when these companies get lower and lower in price, that 10% rule gets triggered all the time, but the stock is permanently on red alert as something wrong and that spooks the long into selling. Which ultimately is what allows them to cover their short positions that they built up earlier on. [23:10]

JIM: I want to go to three clips here that kind of explain legally some of the issues that John Kaiser and I have been talking about. One of them is Joseph Saluzzi from Themis Trading where he talks about the conflicts of interest at the exchanges today. We have thirteen instead of two, the exchanges are paying for order flow; they’re allowing stops to run and investors to be fleeced. So one is Joseph Saluzzi at Themis Trading.

“There is absolutely no reason why there shouldn’t be an uptick rule in there right now. It was taken away coincidentally right around 2007 when things started getting a little bit hairy and when high frequency trading became very popular. If you are a high frequency trader, you want to be able to zip in and out quickly, which means you don’t have to worry – I don’t have to worry about that tick, the uptick. It made their life a lot easier to trade as a high frequency trader without the uptick rule. So there are two issues with short sales, one being like you mentioned the ‘locate’, that absolutely, and they have been cracking down on making sure they do have a borrow and there are certain regulations that the SEC did come out with on that and that’s a good thing. But the second part of the short sale is, you know, selling short on an uptick. It doesn’t exist now unless the stock goes down 10% or more in a day, then a Reg SHO it’s called comes in and becomes active. But we would think that there’s no reason why you wouldn’t want to put a short sale rule back into effect. And we would recommend some sort of bid test rule where it has to be – you can’t short on the bid unless it’s a plus tick on NASDAQ and so on or some sort of variation of that. I think it’s a good idea and actually should control some volatility intraday.”

So they did substitute I guess it’s SEC Rule 201. But wouldn’t it be a lot more orderly to go back to the old uptick rules. [24:55]

JOHN: Absolutely. I mean it was around forever. It came about I think in the Thirties and it was to prevent the situation we see during the day a lot with these mini flash crashes and so on. But it was also intended to create a stable orderly environment. It’s really the downside of it is not much and I haven’t heard too many people arguing, saying, no, we absolutely shouldn’t have it. So yeah, it should be there. [25:17]

JIM: The second clip you’re going to hear is James Koutoulas who was a CTA who took on JP Morgan and MF Global. It took an independent individual outside the system to go in and stick up to protect investor interests. It didn’t come from the government.

“It really is a shame. I mean culturally – you know, I actually just had lunch with the former DOJ guy and I think he hit the nail on the head that after the Department of Justice had lost the Bear Stearns fraud case in 2009, there’s just been an incredible amount of timidity in that department and they are just terrified of bringing any kind of case in the financial space where they don’t have five years of wiretaps. It’s just they don’t have the technical know-how to correctly prosecute financial cases and it’s led to just one miscarriage of justice after another. Like for example, there’s some settlement with HSBC who had for instance like 20 years been laundering the money for drug cartels and terrorist states. I mean they got a billion dollar fine and DOJ said, well, you’re too big to indict, so we’re not even going to charge any individual there because we think it would be a risk for the financial system if we did so. And it’s just deplorable. And this kind of cravenness, coming from the Department of Justice and as part of the government criminals are supposed to fear in order to create deterrence, has really enabled just the precipitous moral decline within the financial…”

And then the third clip you’re going to hear is Professor Bill Black. He was one of the lead prosecutors in the S&L Crisis and you’re going to hear him say two things. One, in the S&L Crisis we had 30,000 criminal complaints with 2000 convictions of white-collar criminals going to jail. Since 2008 we’ve had zero criminal complaints and zero convictions. And more importantly, he talks about when it comes to the regulators they’re basically doing nothing. In fact, the only people they’re going after are small fry, the little guy where he’s an easy target – and the little guy more importantly that has gone broke where he really can’t defend himself.

“So back in the Savings and Loan days we made it a top priority to make those referrals. To push for those convictions, to do the investigations that led to the convictions and to do so we made over 30,000 criminal referrals. Flash forward to the current crisis, which in terms of losses is 70 to 80 times larger than the Savings and Loan Crisis. The same agency, the same banking regulatory agency that made 30,000 criminal referrals in the vastly smaller saving and loan crisis made zero criminal referrals in this crisis. And that is why the elites don’t get prosecuted. And one thing I would disagree with is many people are being prosecuted, but they are the tiny people. Right? This is Mary or Ted or the appraiser type of thing. What has happened and has happened for the first time in modern US history is we now have an official doctrine that the largest banks and their officers and their former officers, who no longer even work in banking, are too big to prosecute. In other words, that we have repealed the rule of law in America with regard to financial elites. And that nobody agrees with.”

Well, there you have it, Joe Saluzzi was the first clip you heard, James Koutoulas defending investors at MF Global, and Bill Black saying basically the regulators aren’t doing anything, in fact, there’s a conflict of interest with the regulators.

John, how do we fix this? How do we put the investors on a level playing field against these robo vampires who are really sucking the life blood out of the industry and operate in an illegal trading format that gives them a competitive advantage that the fundamental investors – your regular investors – don’t have. If I was to appoint you head of the BCSC commission in Canada or the SEC to fix this problem, how do think it could be fixed? [29:52]

JOHN: Well, the simplest solution is to reduce the number of orders entered into the system that are zero cost to the computers that are submitting them. And that is to introduce a transaction fee per order that represents a certain degree of friction. Right now these computers put in 100 share orders; they stuff the order books with these orders. They are able to monitor them as they start getting filled; they actually are able to pull their big, bogus order that’s underneath it and they are able sort of suck the market down into trying to sell into bids which are artificial. And for all these little tiny orders that they pollute the system with if it actually cost them money, rather than being paid to put these orders in there, then there would be a higher costs for grinding for all these pennies and they would disappear. I think they are violating the whole principle of the market which is to be a price-discovery mechanism.

Another thing I think they could fix also is to follow the idea of first come, first serve absolute transparency. Have a single order book for a stock where all orders get put into it and they are there for everybody to see on the bid side and ask side and if your order is in there ahead of somebody it gets filled before them. Right now we have parallel order execution systems which fragment the market. The general investor maybe only sees the one from the official exchange. They no longer have a good feel for what’s really going on with the market in terms of liquidity and so on.

And of course the third thing is the elimination of the uptick rule. I mean it’s much easier to make something go down than to make it go up. That has been a destructive development. It’s been deemed necessary because if you’re arbitraging between different products that are related and on different exchanges, you can’t have the uptick rule in existence or you will not be in compliance with the law.

I’m pessimistic that it can be reinstated, but perhaps by introducing friction by making it more expensive to do this in and out computer-assisted trading, perhaps that would stabilize the market in order to return it more to its value-discovery purpose for which it was developed. [32:12]

JIM: I would probably agree with you because there is so much lobbying effort by these big firms. I asked a regulator and I also asked hedge fund manager and he said, Look, the regulators are, number one, outmanned, outsmarted and outlobbied. And you know, you take his book Throw Them All Out where you have senators and congressman basically trading on inside information they’re getting in the committees that they serve on and then you take those same individuals that sit on those committees and they’re getting huge contributions from these Wall Street firms to their campaign. And I’ve also heard you’ve had a case where, you know, somebody is making a complaint, you have a regulator looking into it and all of a sudden one of the big hedge funds or Wall Street firms are feeling some heat, all they do is call their lobbyist, the lobbyist calls a senator or a congressman and all of a sudden the congressman calls the regulatory agency and says, Back off. So I think there’s less chance of dealing with corruption in that way. But one thing Congress is looking for is revenue and so I think, John, your revenue idea has a better chance of passing than the uptick rule which would protect investors because there is just so much conflicts of interest between government and Wall Street today against the individual investor.

I want to move on now to a next category. We’re in a downturn clearly today and I think we’re getting to what we always see when we get close to a bottom is you really have to get to what I call that Maalox moment, that puke moment where you’re seeing this downtrend accelerate rather rapidly. I’m just taking a look at a chart of the HUI and we may be going back to 2008 levels if we continue on this trend. But that may be the puke point where people say that’s it, I’m washed up. They sell off their positions which allows the robo vampires to come in and cover all their short positions and then the vampires having sucked all the blood out of the system need to go find fresh blood, so leaving the system they go off. What’s not to say that they switch sides and do what they did in 2010 and drive it on the upside. Any thoughts on a turn around? [34:30]

JOHN: Right now I’m looking at my screen today of 500 stocks and it’s like maybe there’s a dozen that are green but the volumes are not very substantial. I think the liquidation by the hedge fund industry, the institutional money is almost at the end; and they have had no choice. They’ve had the redemption runs forcing them to sell what they can sell, similar to what happened in 2008 except then it all happened in six months and then we had everything crash immediately. Now we’ve had a two-year grinding redemption run in the resource sector and there are no buyers, really, out there. The bids are disappearing; the people who are longs are resigning themselves to this situation, well, I like the fundamentals of this company, it’s got good results, it’s done everything they said they would do, and yeah maybe gold might temporarily go down to 1400 or so for a while, but I’m confident that there is a general uptrend still in place. So what you have is almost a withering away of the sector and you know, the prices – some bid gets tapped out for 100,000 shares at a nickel and then that’s the end of that. Nobody is building a bottom yet. So I think we’re probably heading into a dreary period between now and September where there will be complete lack of interest in the resource sector and there may be some gradual capitulation selling where somebody sells, well, I like this other stock here at 4 cents a lot better than this one here at 3 cents so I’m going to dump my entire position, capture the tax loss and reposition in this other one. That sort of wash out I think we’re looking for in the coming months, it could be a very profitable position for this resource sector. Meanwhile, the algo traders – you’re right – will go away. They will not accumulate on the long side because they cannot predict when the turning point for the perception of the sector will happen. They will return when we start accelerating back out of the bottom. And then they’ll help us on the upside. But they will actually disappear and as you say, go find some other sector that’s suddenly running out of perceptual steam and start leaning on that sector. [36:41]

JIM: Let’s talk about some scenarios for gold to head much higher along with silver and some very explosive upside with the equities. And you find when you’re talking about gold, John, there’s two perceptions here. There are the Armageddites who are saying we need to see Armageddon for us to realize these higher gold prices, but also I think there can be an equally powerful argument made that in a growth scenario which China, with more people being born on the planet, more difficult to find deposits, that you could actually see gold and silver along with the equities rise in a more positive economic environment. In other words, we don’t need to see the end of the world scenario for gold and silver prices to head higher. Let’s talk about that because you find the arguments in the gold camp tend to be, oh, it’s going to be the end of the world. And the end of the world happens and Armageddon comes then we all get rich and gold prices and silver head higher. Let’s talk about an alternative scenario to that. [37:43]

JOHN: The way I look at gold is I look at it as a type of insurance policy with regard to future uncertainty. There aren’t too many uses for gold. All the 5.4 billion ounces that exist would fit into an auditorium right now. It’s value is about 7, $8 trillion which is a fraction of the global GDP. So I was curious as to, you know, what drives the value of gold as opposed to all these crazy beliefs about inflation and so on. So I took all the gold that exists or is estimated to exist each year and multiplied it by its average gold price during that year and then divided it by the nominal global GDP and I saw an interesting thing happen. In 1980 when America looked like it was losing it with Teheran and OPEC and inflation and all that, when gold spiked to $850 all the gold that had existed was worth 26% of global GDP. Then we entered a 20, 30 year bear market which culminated in 2001 ahead of 9/11 when all the gold that existed then was worth only 4% of GDP. Now, when you plot this and of course this takes into account all the gold that’s mined each year and there’s been over 2 billion ounces mined since 1980, you get a very different looking chart than the bubble chart that you get when you look at the price of the nominal price of gold. When gold peaked at 1850 a year or so ago, that was only 14% of global GDP. Right now, it’s parked at about 12% So that’s about halfway between the stress level of 1980 that we reached then and it’s not at all bubble like.

Now, I look at things from a sort of historical perspective and I see the United States as the biggest economy, the military superpower, but it is a relatively mature economy with only 350 million people compared to the 7 billion in the rest of the world. And I see China, Asia emerging as the strong new economies which are borrowing all the methods of the United States and growing their economies bigger. And by 2030 the Chinese economy will be much bigger than that of the United States. So I look forward and say, how can the United States with its single US dollar as the single reserve currency and the biggest economy for now, how can it be the peacekeeper of the world, guarantor of globalization 15 years from now especially given our entitlement expectations for our retiring boomer generation going forward. And I say, you’ve got to own gold right now to hedge against this long term uncertainty. So I’m saying that this anxiety level of 12%, this is here to stay. We’re not going back to 2001 when the United States was the undisputed champion of the world. We are in a transition period where the balance of power, economic and military is shifting and with that comes long term instability. And China is still a communist nation, a central command economy and therefore I think there is a structural uptrend in gold that is a real price uptrend and not at all linked to inflation. And it’s tied with America, the world’s host economy getting back on track and pulling all these other parasite economies out of their trap and ultimately strengthening them to the point where their economies will eclipse that of the United States. So a strong global economy is actually good for gold because it rearranges the future in ways with outcomes we cannot really predict. [41:32]

JIM: You know, I couldn’t have said it better, John. And it does pose an alternative besides, let’s say, hyperinflation or many of the things that we’ve seen taking place. I mean if you take a look also going back to the 1970s we had a period where the United States no longer backed its currency with gold; we went to a sort of free-floating exchange rates. We had the central bank under Arthur Burns printing money. We had inflation, we’ve had global conflict, we had the United States economy was structurally changing with the beginning of what I call globalization and moving assets and manufacturing facilities outside the country. And that was a period, we saw gold go from 35 to 850, silver go from a buck or two all the way up to 50. But it was also a period that it wasn’t Armageddon. We saw inflation, we saw the loss of purchasing power – Mom went to work in the workplace – but it wasn’t that Armageddon scenario in which this great bull market in natural resources took place. So I think this argument of this growth scenario has a lot of validity to it because it’s what has happened historically.

John, any closing comments that you would like to make? I mean we are definitely in this wash out period right now, this puke point and we all know that during the summer there isn’t a lot of enthusiasm for the sector and as a sector goes through these puke points and sell offs, you just don’t have a lot of people that jump in immediately and start buying. So what would your advice be, if let’s say, you own some juniors that you know are valid projects, they are good resources, it’s a good company or you even own some producers? What would your advice be? You’ve been in this sector for many decades. [43:20]

JOHN: With regard to advanced companies, the ones engaged in resource feasibility demonstration, I would suggest hold those positions. Be prepared to endure lower values and be prepared to buy more. If you’re uncomfortable with these lower values, you need to move on. These companies are going to have a difficult time raising the money to advance their projects during the next 12 months, so they will be going sideways. There may be a predatory takeover bid that doubles the prices, so that might be a reason to just hang on to them. For my subscribers, what I’m suggesting is that in this type of transition zone, the junior sector typically only attracts capital for new discovery plays. And we saw that in 1983 after the 1980, ’82 recession: Hemlo came along and breathed life back into the sector. We saw it later in ’89 with SK Creek [phonetic]. Then we saw it in ’92, ’93 with diamond discoveries in northern Canada and then the nickel discovery in Labrador in ’94, ’95 and then of course there was the ultimate hoax of all with the Bre-X discovery in Indonesia which turned out to be a fraud. But all these things came out of relatively soggy markets.

And one area that I’m looking at right now is back to America itself which has not had a lot of exploration during the last 20 years in part because the environmental reign of terror with its not-in-my-backyard mentality has made it very difficult to explore and to develop projects. I think that pendulum has reached its limit going forward as the United States becomes more of an equal player in the rest of the world. It’s not going to be able to rely on goods coming from everywhere, raw materials. We do see a manufacturing renaissance in its infancy here. China’s role as the lowest cost manufacturing jurisdiction is under siege. They can no longer be the cost dumping ground for emissions and so on for the cheap parts that go into for instance and iPhone. And of course, we need to have global trade rebounds; all the negativity about the United States was premised on the idea that no job would ever come back here because it will always be cheaper to do stuff elsewhere. And so with regard to the junior resource sector, I think we’re going to find some company somewhere makes a fabulous discovery; I would say Nevada is probably the most likely place and it will have replication possibilities that allow other juniors to come in there and look for something similar. And there can be a case made that of the 200 million ounces of gold found in Nevada since 1960, there is at least that much if not more that remains to be found largely under gravel cover. And somebody starts finding something like that and you have an exploration boom erupting in our own backyard. And hopefully, the whole environmental movement will realize that as the US dollar in the long run ceases to be the world’s reserve currency, it would be good to have gold production in the United States going forward. [46:29]

JIM: I couldn’t have said it better, John. And for our listeners, John has been kind enough to send some graphs illustrating some of the points about GDP and some of the other things about the gold market. We are going to be posting those on the Newshour webpage. So you can look at some of John’s charts and so you’ll kind of understand the argument that John has been making here. We’re going to put those up on the website; they are free and available to anybody listening to the program. And you can kind of take a look – sometimes when you look at a chart and see, ah, okay now I see the point that John was making here.

As we close, if our listeners would like to find out about the work that’s done at your website, Kaiser Research, give out your website, if you would, so that our listeners can find out more about what you do. [47:12]

JOHN: Well, we’re called Kaiser Research Online. We’re based in the Bay Area of San Francisco and the url is kaiserbottomfish.com. And what we have is a search engine which allows you to put in any combination of factors about the company level, project level, to do your own bottom fishing in this market. We ourselves try to do this by coming up with picks and that, but you may have very different ideas. So it’s a subscription-based service; one price gets you access to everything and it is the ultimate research tool to take advantage of this wash out that’s coming, especially for the advanced projects where it’s very data intensive if you’re doing it just on your own. But with our tool it’s a very effective way to figure what’s available there for picking up during this wash out. [48:02]

JIM: And John’s website, that’s kaiserbottomfish.com. And we’ve been speaking with John Kaiser.

John, thanks for joining me on this very important program because I think there’s a number of issues that we were able to cover today: the bear market in equities, the trading structure, the regulatory environment, as well as the catalyst in the turn around that could cause prices to go back in the other direction. I want to thank you so much for joining us on the program and don’t be a stranger. Come back and talk to us again. [48:36]

JOHN: I would love to, Jim. And thank you for bringing me on your program. [48:40]

Jim welcomes special guest and independent gold analyst John Kaiser of Kaiser Research Online and Kaiser Bottom-Fish Online. In a wide-ranging discussion on gold and gold equities (click here for charts), John and Jim look at the reasons behind the bear market in gold equities; the fundamentals of the mining business, the rise of the Robo-Traders, and the role (and complicity) of the regulators. They also discuss catalysts for why the gold market can recover and continue higher, and why it won’t take Armageddon. John and Jim also advise what to do as a gold stock investor, and how to not fall prey to the Robo-Traders. Also, Jim answers more of your Q-Calls in this segment.

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About James J Puplava CFP