Fleck on Mining Stocks, the Endgame for Fiat Currency and the Return of the Gold Standard
Bill Fleckenstein on all things Gold
Bill is president of Fleckenstein Capital, a money management firm based in Seattle. He writes a daily Market Rap column for his website, Fleckensteincapital.com, as well as the popular column Contrarian Chronicles for MSN Money.
Jim Puplava: Bill Fleckenstein of Fleckenstein Capital joins me as my special guest on the program today. Bill one of the things that has struck me, both you and I have been in this business for several decades. I have a broker-dealer and money management firm, and you run a very successful hedge fund. But over those decades I have seen various anomalies crop up in the investment markets and I think we’re seeing one today with physical gold trading around $1800 an ounce. The gold stocks, more or less, have been languishing over the last few years. Is this one of those anomalies? And if it is, make your best case for gold equities.
Bill Fleckenstein: (0:42) Well, you know, of course we never know for sure until after (chuckles). But it seems to me that it all starts with the fact that gold as a commodity is difficult to analyze because it’s been stored and used as money for thousands of years, and so it's hard for people to try to get around their head, you know, what it's supposed to be worth. They can’t put together a spreadsheet like you can with a company and their earnings, and come up with some P/E ratio and all of that. Gold is basically just a price. Which means that everyone can have an opinion about it and so you see lots of people that are certain that gold is in a bubble even though that is preposterous. But I think most people, even though gold has been rallying for almost 11 years now, think that somewhere in the future gold is going to be a lot less or a lot lower in price. So consequently you see in the earnings models and calculations that people use to construct the net asset value, which is just basically discounting back future cash flows and earnings. They have a future price of gold of less than $1000. And thus they appear to have a net asset value that is quite a bit lower than, it is dramatically lower, than it would be if you use something approaching the current price. And thus gold stocks look expensive when viewed that way, and that's how most of the investment community looks at them relative to NAV. On the other hand, if you look at it on a cash flow basis, there are price-range ratio basis, and things like that, they don't look particularly expensive. So anyway, there have been all these forces that have held them back, and I think that’s about to change. As the psychology about gold itself changes, and people’s future expectations change, I think the gold stocks are going to have a very large move.
Jim: (2:38) You talked about something, about, well if you look at these stocks from a cash flow basis, and something that strikes me about this bull market is, unlike the bull market in the 70s, today investors have numerous choices in which they can invest in gold. I mean if you take a look at the bullion ETFs, they’ve attracted hundreds of billions of dollars. The problem though, as you just mentioned, from an evaluation point of view gold bullion doesn't pay dividends. Might one way that gold companies attract future investment capital Bill, is to return some of their increasing cash flow in the form of dividends? For example, Newmont this year has gone from paying $0.15 a quarter in the first quarter, they just raised the dividend to $0.35. So in the last year they've increased their dividends by 78%. They've increased their dividends at an annual rate of 26%. Is returning some of that cash flow to investors one way we might see dividend stocks, or let’s say gold equities start to outperform?
Bill: (3:45) Well, yes. I think that will matter and I think it has mattered. And you’re right. I mean, Newmont has lashed it’s dividend to the price of gold. But I think if you’re convinced that the future price of gold is going to be lower, and therefore the stock prices are not going to go up, then even though you're getting 2 or 3 percent, which is a lot more than a 10 year government bond, you’re still not going to be enticed to buy the equities. I think that what has to happen and what will happen, and I think is happening, is that people have to become comfortable with the price of, that the price of gold is going to stay where it is or move higher over the course of the next 5 to 10 years. And they don't understand that it’s not so much that gold has appreciated, it’s that people have realized this colored paper that we call money is virtually worthless, right? And so it's sort of declining with a curve that looks like a parabola upside down—that being the value of money. So I think as people come realize that geez, now I understand why gold is where it is, and it’s not likely to change. Then they say, wow, these gold stock prices might—like take Newmont—you can buy Newmont, you could go out and if you had enough money, you could buy Newmont, pay $400 to $500 an ounce for the for the 93, 94, or 95 million ounces they now have in the ground. They probably have more, and then you take their cash cost to pull it out of the ground, and you’d be buying gold at $800 or $900 an ounce, you know, with the dirt on top still, as opposed to the $1800 an ounce that it sells for now. Plus you’d be getting the, sorry, you wouldn’t be getting the dividend in that case. But if people start to look at Newmont as buying gold at 50% or 60% off, and say they get a dividend to boot, then I think that will cause them to buy Newmont or some of the other shares. Again, it's really a function of the fact that I think people have yet to accept the price of gold and realized that it probably going to stay here or go higher. And that’s going to then cause the analytical community and investors and Wall Street to look at these shares differently.
Jim: (5:55) You know, another common interest that I think you and I both share is that both of us sit on the boards of mining companies. I sit on a late stage development company, Kimber Resources, and you are on the board of the mid-sized silver producer, Pan American Silver. Just out of curiosity Bill, how did you ever get recruited to be on a mining board? Because when you went on, we were right in the midst of a tech bubble. I mean who really wanted to be, or even think of a mining company?
Bill: (6:23) Well, at the time, you know, Pan American had just one mine and was producing about 4 million ounces of silver. We’re on our way to producing 44 million ounces assuming we get these laws changed in this region of Argentina. But I was bullish on silver because, you know, 4 bucks an ounce is below the cost of production and I thought that the policies we were pursuing the time, namely Greenspan‘s money printing was going to lead to trouble and that the bubble, the equity bubble would burst and the printing money policies would ultimately lead to inflation. And of course we wound up with another bubble and lots of other things. So I was bullish on the metals as a way to protect against money printing. Of course, you know, at first inflation only showed stock prices and not in other things, and the fact that you didn't have to be very right to have it work out because the price of silver was so cheap. And it was difficult to find a silver equity where you actually could get silver exposure and find good management and so I found, I bumped into the guys at Pan American Silver early on in ’97, ’96-‘97. And you know, I kept always bugging them for more information. So Ross Beaty, who started the company, said that I knew was much as any other insiders, and so maybe I wanted come on the board. So he asked me to join the board, and so I did. That’s how it came about.
Jim: (7:42) You know, one of the things of being on the board of a mining company, I look at the mining business much differently. In your years on the board what has been, let’s say some of the learning experiences that have come about as a result of being on a mining board?
Bill: (7:58) Well I think that, you know, you just realize how difficult it is to, a) find an ore body that will actually work or pencil out, and how difficult the mining business is. You know, people say you see people who don't really know very much say, that you know, gold has no value. Which is not true because at a minimum it has the value of what it cost you to acquire the property and drill it and pull the gold out of the ground, so it’s got some intrinsic value and it is not that easy to find it and get it out of the ground. So, I think that what you’ll learn being on the board, is just how difficult the business actually is and you can find some management team that are particularly talented in that they can actually run the business with as few hitches as possible. I get a big kick out these people that want to play the “beat the number” game with these mining companies when there are as many moving parts as there are in a mining entity, especially when you’ve got multiple mines, and to think that they’re going to be able to guess what the quarterly numbers are going to be is just ridiculous. I mean why would you care? Why would you even want to play that game? You know, parenthetically, I find that just mind-boggling.
Jim: (9:11) You know, it’s not only that. They are playing very difficult game and trying to estimate what the price of gold or silver, copper, whatever metals it’s going to be. But also, you find even with companies, for example, at the development stage where they are doing pre-feasibility or feasibility studies, on the day you and I are speaking gold has been hit. But It’s at $1800 an ounce and they’re using things like in their feasibility study $1150 gold and maybe $14-$17 silver. It's just amazing how they’re still stuck with these prices as if we’re going to go back to the way things were 4-5 years ago.
Bill: (9:54) Right, that’s the point I was talking about earlier. And I think as people change that, or that mentality changes, they’ll perceive these equities as different. And I think that's been happening. I think you know the gold stocks didn't really participate in a huge chunk of the move, say from I don’t know, go from 1200 to here. And recently, you know, some days you’ve got gold getting hammered like today when it’s down another 60 bucks. You know, the gold stocks are barely flinching because I think people are starting to realize that these, that stock prices reflect a much much lower gold price which is not likely be realized.
Jim: (10:32) You know, one thing that we know and that we've seen is that Bill, governments intervene in the currency markets. In fact yesterday the Swiss just reminded investors of that. Bernanke has telegraphed his plans that he wants to bring down interest rates which have included anything from quantitative easing, perhaps now the twist which could affect the yield curve. So I guess my question is, where do they draw the line, and why, and how involved will they become in, let’s say, any other market? In other words, where does this all end?
Bill: (11:10) Well, I think ultimately when it ends... If we take a step back for a second. For the last forty years, since the last vestiges of the gold standard were ended by Nixon, we have been slowly running down the credit quality of the Unites States and other western countries as central bankers have pursued money printing and seat-of-the-pants, you know, Politburo type economic decisions. You know, where they’re going to set interest rates. I mean, first we had the ‘70s, which was inflation and when Volcker stopped that, and then we turned the printing press over Greenspan. We had two bubbles and now we've got Bernanke trying to bailout the last bubble with more of the same medicine. Well, if you a long look at it, we’re kind of in the endgame. Over that time until a few years ago, you know, people, first they tried to speculate their way to prosperity with equities, and then they tried to borrow their way to prosperity via houses and as a society, no one really worried about tomorrow. No one worried about the off-balance-sheet liabilities the government. The budget deficit grew and grew and grew. And slowly we basically ruined the credit quality of the United States, such that now the contingent liabilities are here and they're massive. So we’re at the endgame of this paper money, “unlimited credit card” as Jim Grant likes to say, sort of a way of life. The same is true in Europe. They have a bigger problem right now because they don't have a printing press, but that’s the little twist on the story. And I think in the next couple years, all this printed money and currency problems it’s created, and all those things will come to an end. I think the markets eventually will take the printing press away from the Federal Reserve and we will be forced to deal with our problems which are like Greece and like Ireland and like all those other countries. Only they’re maybe not be as bad here as they are in Greece. Well almost certainly not as bad as in Greece. And we can fix them if we have the political will. It’s not like it's impossible to settle up these off budget so-called entitlement problems, healthcare issues. We can do this. We just have to have the political courage and there will have to be a crisis for that to occur. And you know if we had in this country flat tax, tort reform, term limits, and a gold standard, which is to say abolish the Federal Reserve, you know, the sorting out process of getting from here and there might be a little bit brutal, but for the next 20 or 30 or 40 or 50 years, we’d be fine.
Jim: (13:36) I guess a follow-up question, do you foresee a day in which the world returns to a gold and silver standard? And how would you see that happening?
Bill: (13:45) I think that it is as impossible as it would have seemed for us to talk of this two years ago. I now think it's inevitable, because I think that for one reason or another countries and individuals in those countries will become fed up with what's happening. I mean the euro is going to be forced to change from what it is now. I think eventually we will have a problem in this country that will scare people. I mean, obviously the Swiss now have lashed their currency to the euro. You know, all these different currencies, you know, ping-pong all over the place. And I think that in the end, while the politicians hate gold because it stops them from over promising, they’re kind of out of the ability to over promise because all these sovereign debts are, all these sovereign entities are essentially broke. So if you can't promise it takes away one of the, if you can’t over promise, it takes one of the major political reasons not have a gold standard away. And of course the beauty of the gold standard, and this is what I think people will come to love, is the sort of self balancing nature of, if you start pursuing policies which don't make sense, then foreigners ask for their gold back, and you have to tighten up. And so the elegance is not the mysticalness of gold, it’s the check and balance under the pure gold standard. And I think that's the part that people will come to pursue is a lesser evil than what we're going through. Now of course to get to there, something’s going to have to be done with all the debts and the future liabilities we have to deal with, and whether we have inflate them away to some degree or we have to really settle up these issues by means testing different things, I don't know. I know if you picked the 50 smartest people in America, and that weren’t politically oriented and they were experts in all these different areas, you can come up with a solution to these problems, I believe it could be worked out over, you know, 5, 6, 8 years. Enough for the market to believe in it and we could go back to functioning, you know. So I don't think it's intellectually impossible, it is politically really difficult.
Jim: (15:41) And that brings me, because we were talking earlier about the Euro currency, and I was just wondering how do you think that resolves itself? Because we have four major currency blocks. Say, we have the dollar, we have the euro, we've got the yen, and we’ve even seen the Swiss franc as a safe haven. The Swiss have told us they want to cap their currency. Japan is intervening in the currency market. Europe is in a mess, so it almost tells me Bill, that all roads are leading us back to gold as we just discussed.
Bill: (16:15) Yes, I think that’s really where we’re headed and it’s difficult to say exactly what the twists and turns are going to be. But I think as much as the people don't like it, it will be perceived as the lesser of two evils. And we just have to finish running out the string on these bad currencies. For the moment, the world is looking at the Euro as the worst currency. It’s ironic that the problem is that they don't have a printing press and they’re actually trying to pursue some rules as opposed to what we do and that's what got them in the soup. I don't know how the Euro’s going to wind up. I assume Greece will default. I assume probably Greece will be ejected. You know, the ability to leave the Euro is not a rather difficult but you can be kicked out as I read the rules. I could be wrong about that. So maybe what they’ll do is they’ll kick out Greece and need that to be a lesson, or maybe you know, maybe they'll replace the euro with a gold euro and they’ll do something like what we’re going to have to do. I don't know, it’s a mess. I know the euro won’t exist as it is today most likely in the absence of a massive amount of unsterilized intervention on the part of the ECB, which I don't know that they can actually do. But in the end, that’s only going to buy time, because eventually world fixed income investors are going to revolt, they’re not going to lend money the governments at these stupid rates. There’s going to be an end to the money printing era. I can't, I couldn’t begin to tell you exactly what the twists and turns are going to be along that road.
Jim: (17:44) In my investment career over the last couple of decades, Bill, I have seen things take place that I would've never thought would occur when I began my career. I never thought I'd see the day United States would be running trillion dollar deficits. I never thought we'd see a period of time where we'd have 0% interest rates or multiple bubbles follow. Especially, for example the tech bubble, where we were buying companies with no earnings, no sales, followed up immediately by a real estate bubble. Have there been anything in your investment career, or any curveballs that you have seen that the market’s thrown your way that you didn’t expect?
Bill: (18:25) Oh, man, of course. I mean, but if you think, let's talk about when I got into the business 30 years ago. Interest rates, you could buy long-term government bonds at 14% when the government was, when the Fed was pursuing exactly the policies to make the money good and the people didn't want them. You got another bite of that apple in 1984, when they backed rates up to about 12 after the Fed had loosened up and the people starting to, inflation was coming back. Those were wonderful opportunities to me. I mean, when you look at it now who’d have ever thought you’d see that. And of course once you saw that, and you saw stocks priced eight times earnings paying 5% dividend yields, and the earnings and multiples were on depressed earnings, you know, who would've thought that 20 years later and we’d have the NASDAQ craze. You know, look at the Japanese bubble. We’ve had the exceptions that you might be referring to as sort of becoming the rule and I think that's because, again we been on this confetti standard and as you get further down the road, and things get more and more, get crazier and crazier and more out of control, these five standard deviations of events Every six months instead of every 70,000 years or whatever it’s supposed to be.
Jim: (19:38) Investment has always been about, to be successful, being one step ahead of the game. What unanticipated or unexpected events could you perceive playing out in the near future?
Bill: (19:48) Well I think, (chuckles). Well if it’s unexpected, I don’t know how I’m going to figure out what it is, but I guess if by some miracle the Euro survived just as it is. And the reason I say that is because you know, I think it was Newsweek, or Time had the end of the end of Europe on the cover a month or so ago. In the back my mind, I wondered if they’re going to be just like they always are when they make a statement like that, you know, dead wrong. So might the Euro as a currency skinny on by? Can they make it through? I guess that would be possible. I’m not sure what the ramifications would necessarily mean, it would probably mean then the market would come after the dollar sooner rather than later. But I think it's interesting to contemplate that. And the reason I bring up that Time magazine cover, there’s something that could surprise people. There will be surprises, but I don't know how to guess at the completely unanticipated. But that’s one that has occurred to me.
Jim: (20:41) You know, one thing that strikes me that could be, may be a possibility, maybe this is wishful thinking on my part, but I think when you and I both got in this business, you know interest rates on treasuries were 14%. I think the inflation rate was equally as high. We had oil prices close to 40. Gold was on its way to $800, and then we got a Federal Reserve chairman Paul Volcker. Then we got Ronald Reagan. Just as we thought the best days of America were over, we had a Renaissance and we had two wonderful decades. Do you think that's possible again?
Bill: (21:18) Yeah. I mean, I think, but again, I think it has to come from, we’re so far down the path to ruin, we have to get to the end game there, which I think will be taking the printing press away from the central bank. And I mean particularly in this case, you know the Fed. And I think that into that crisis which could happen in the next 18 months or two years, or maybe revolving around the next election, we could maybe get some real leaders instead of politicians. And they could come to recognize that maybe, as the world does too, that they, you know, the central bank to print money and target interest rate, that’s wrongheaded. Why this Keynesian stuff hasn’t worked. And so perhaps in that crisis, we in America maybe we’ll take charge and we’ll come up with a real leader and some Congress people will get charge. The people who will get control of Congress who are real leaders, not politicians. And we can, you know, settle up the liabilities that we have and put ourselves back, and you know, and clean up the waste in the government, any excess bodies that we have in government, that sort of thing. And perhaps get back the gold standard and set ourselves up a good 20 or 30 year run before we screw up all over again.
Jim: (22:27) A final question. I know you're always looking for the next investment opportunity. Recently, I seem you've joined the board of Mongolian Growth Group. What opportunities do you see there?
Bill: (22:40) Well, Mongolia is a kind of that rare thing. It’s a very small country. There's only just shy of 4 million people, about 3 million of them live in Ulan Batar. And yet they’ve got what looks to be maybe the world's largest coal deposit that’s been found and will be built out. They have one of the largest, if not potentially the largest copper deposit there as well. And my friend Harris, who runs Mongolian Growth Group, says you stick a hole in the ground and you’re going to find some minerals. Energy and all kinds of other minerals. And of course it sits right on the door to, I mean, on the doorstep of China, who needs all this stuff. So what is occurring is there is a huge capital spending boom to find these resources, put the infrastructure in place to extract them, and of course along with that goes an increase in salaries, jobs, and growth in real estate. And you have a boom that is almost virtually guaranteed to continue for the next 5 to 10 years. Maybe 10 years is too hard say guaranteed, but the next five years or so. As these projects get built out, and the follow-on projects get built out, and the rails get built out, and all the thing that have to go, to occur to be able to get the minerals out of the ground, you’ve got a small population base. So my friend Harris, who runs the company, was there on vacation and saw what was happening, and said, “Wow, this is going to be the best opportunity I've ever seen,” and yet there were no investment vehicles. So we decided to start up a company to be able to invest our money, and then eventually other people's money as well along with ours in Mongolia. And so he's now living there and we have a public company we got through that of the Canadian venture exchange. I think that we’ll be moving the TSC one of these days. But in any case, we made some real estate investments. And we have an insurance company, and things like that. But this is a company that’s been set up specifically to invest directly in Mongolia and not go by—I’ve seen some, now there’s been some other funds that been set up, and there’s gonna be an avalanche of money headed that way from an investment standpoint in addition to the capital inflows that are going in for other projects. And I see some people talking about making a Mongolia ETF, which is ludicrous. There aren’t enough companies to even do that and if they invest in the big mining companies, we’re specifically not investing in the mining companies, we’re investing in other types of businesses. So it's kind of an exciting project, in fact I will be headed to Mongolia. We’re having a board meeting out there a week from Friday, so I’m going to go spend some time there for the first time ever.
Jim: (25:18) Oh, super. Well Bill, as always it’s a pleasure speaking with you. If our listeners would like to follow your work or find out more about what you do, how can they do so please?
Bill: (25:29) I have a website that I write a daily column on, FleckensteinCapital.com. It is a paid site. It is a whopping $10 a month. I also write a column on MSN.com, it’s a free weekly column. But I think for 10 bucks a month, it's pretty good deal at my regular site if I do say so myself.
Jim: (25.46) Alright, well Bill, listen, safe travels and as always it's a pleasure speaking with you.
Bill: (25:52) Thanks for all the great questions.