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Gold At $3,000?

November 28th, 2011

Marshall Auerback: A November 25 Interview

By Kevin Michael Grace

Q: Let’s talk about the effect of the turmoil in Europe on the markets. The line we get from financial reporters is that gold has fallen from $1,900 because of a flight to safety and that people are liquidating their positions in order to cover losses elsewhere. And yet we are confidently informed that not that many people are invested in gold.

Marshall Auerback: A November 25 Interview

A: They’re both right. It’s a small market ultimately, and you don’t have the same level of participation in the gold market that you did in the 1970s where I think 5% of pension funds were in gold. You’ve had a lot of leverage speculators that have held large positions in gold and when they get margin calls, they dump the stuff, and that has an impact on the price. I would argue that gold behaves in a textbook bull market fashion. It goes up; it falls back, it bases at a higher level. Now it’s basing at $1,600, $1,700. Earlier, it was basing at in the $1,400s, but it keeps edging up, and I think it’s poising for another explosive move to the upside. Clearly when de-leveraging strains are very acute, people just want to go for cash. So they sell the profits they’ve been sitting on, and gold gets hit like everything else. In many instances, investors are going after dollars to offset the impact of de-leveraging. How much longer that goes on for I don’t know. If these strains in Europe continue to intensify, I think that will be bullish for gold. I think the policy response you’re ultimately going to see is going to be gold bullish because I think ultimately it will create additional currency turmoil everywhere, and the bid for gold will remain as an insurance policy against it.

Q: When do you see this explosive movement in gold?

A: It could happen in the next six months or so.

Q: How high would you expect gold to go?

A: Ultimately, I think it could go to $3,000 to $4,000 an ounce before this is all played out. I think we’re at the start of a short-term relief rally. I think there will be some short-term fix placed on Europe. I don’t know what form it will take. Then you’ll see the markets bounce. Then there will be an increasing realization that the impact of fiscal austerity policies and all this financial dislocation over the last few months has been to create the certainty of a recession in Europe and the UK. China seems to be slowing down, and the US is likely to slow down as well. At that time I think you’ll get one last global inflationary push, and in that stage I think you’ll see gold go parabolic. That’s something I expect in the first half of next year.

Q: I read an interview with John Embry of Sprott Asset Management where he said, “These guys are brutal, and the CFTC doesn’t regulate a damn thing.” He takes the GATA view of gold and silver suppression for granted. How valid is this thesis?

A: I have no doubt there’s an element of suppression going on, but it’s been going on for 10 years, and it’s not as if it’s totally effective. In the early 1990s, there always seemed to be an invisible hand that wouldn’t allow gold to go above $400 dollars. The idea was that the central banks had enough to hold it forever at this price. Then $1,000 was the base, and now who knows what the level is. The government intervenes in currency markets and bond markets; they could be intervening in equity markets; and so the idea of them intervening in gold and silver markets is not such an extraordinary idea to me. Can they do it with total effectiveness? No. It’s a smaller market, and they have above-ground stocks of gold which makes it easier for them to manipulate than bond markets or currency markets. But they are running out of this stuff, and a lot of the official stockpiles have been lent out. Therefore they don’t have the same kind of resource they did 15 years ago to control the gold price.

Q: How is it possible to have a realistic gold price when we don’t know how much gold exists?

A: The answer is the markets will figure that out. My guess, for what it’s worth, I think at some point in the endgame that they will have to come clean on this. I think the central banks have not actually been selling a lot of gold but lending out a lot of gold. It’s loaned out, melted into bars and the stuff is delivered to some Indian woman as a part of her dowry. Whether it’s a loan or a sale doesn’t really matter; the effect on the market flow is the same. The gold market has been in a perpetual deficit, and if not for these ongoing leasing programs, the price likely would have been a lot higher. I suspect that at some point central banks will realize that they are not going to be able to get that gold back, and they will effectively ratify those loans by converting them into sales and in effect acknowledge they’ll never get it back. They’ll retroactively say these loans were sales and reclassify them on their accounts. This will give us a clearer picture of what the official above-ground stockpile is

I think gold could go to $3,000 to $4,000 an ounce before this is all played out —Marshall Auerback

Q: What will be the effect of the bankruptcy of MF Global and the allegations of co-mingling of accounts on confidence in the integrity of the futures trading system?

A: It’s devastating, because if you don’t think your money is going to be safe, you won’t play as much. The cynic in me says that’s one of the reasons why the feds let MF Global go—they were worried about the number of speculators in commodities. They’ve issued repeated warnings; the Justice Department said they were aware of what was going on. They were giving signals that they were prepared to take the hammer out. I think what MF Global has done is outrageous. Tragically, it may not be illegal. It will impact confidence and drive speculators out of those markets. Over a longer term that may not be a bad thing, but it’s a terrible way to resolve a financialization for the commodities complex.

Q: I saw a video by Jon Stewart where talked about Jon Corzine lobbying the SEC to relax the regulation requiring MF Global to keep more capital to back its positions. He said it was rather like someone being stopped for speeding by the cops and calling up the police commissioner and saying get this guy off my back, I’ve got places to go.

A: Absolutely. My understanding is that you could co-mingle the accounts that brokers could buy risk-free assets, like US government bonds. I think that Corzine lobbied to extend this to European government bonds which clearly have more of a solvency risk than US government bonds. He will likely make the case that he has done nothing illegal. To me, what he has one is comparable to a builder who has spent the last 10 years lobbying his local municipality, or local state government, to ease the building and safety regulations on the stuff that he builds, and then one of his buildings collapses. He can easily say, I didn’t do anything illegal; I built it according to the code, not specifying that he spent the last 10 years gutting the code.

Q: Have you seen Gerald Celente video talking about his own experience with MF Global? He gets into the role of Goldman Sachs, all these Goldman Sachs people everywhere. If it becomes a popular belief that there’s a handful of men pulling the strings behind the scenes, enriching themselves and remaining untouchable, what effect will this would have on the markets and on politics?

A: I think it’s going to have a very radicalizing effect on politics, and it will lead to a different political environment where these guys are brought to heel. It may take a considerable social dislocation first, so it’s not going to be very pleasant to live through the next three years. I’ve been writing about this for 15 years, government by Goldman Sachs. This is nothing new to me, but we’re seeing now more and more people are unafraid to call a spade a spade. But you probably won’t see the change until you start seeing blood literally flowing on the streets of Athens, Madrid and Paris.

Q: Precious-metals equities have largely collapsed since spring, and I keep seeing the explanation that the prices of gold and silver must stabilize before equities recover.

A: That’s a lousy explanation. The problem is that you have a market frozen into inaction because of volatility. There’s a premium being placed on liquidity. In this environment, for good or for worse, small caps tend to get hurt because people don’t want to play. The other problem is that these companies are particularly capital intensive and aren’t getting the funding. That’s why they’re not trading well. People think, why should I buy this, if they’re going to have fundings at a discount, and they’ll attach a warrant to it? It’s a sort of self-feeding negative cycle. My guess is that at some point the good ones do ultimately take care of funding, and you get some sort of great story developing and some speculative interest, but you’ve got to get these macro environments out of the way first. You’ve got to get Europe sorted out; you’ve got to get some more clarity on the physical front in the US before you actually see people prepared to leap into those markets again. They will; they always come back, but it has nothing to do with the stability of the gold or silver price per se.

Q: Couldn’t this uncertainty in Europe drag on for another six months to a year?

A: Possibly, but I don’t think it will. The fact that it has spread into Germany—the core has been infected—means that the policy responses will become more urgent.

Marshall Auerback: A November 25 Interview

Marshall Auerback is Director of and Corporate Spokesperson for Pinetree Capital Ltd, a Toronto-headquartered diversified investment, financial advisory and merchant banking firm focused on investing in early stage micro and small-cap resource companies. Pinetree is invested primarily in Uranium and Coal, Oil & Gas, Precious Metals, Potash, Lithium and Rare Earths and Base Metals. Mr Auerback was previously an advisor to a number of fund management organizations, such as PIMCO, the world’s largest bond fund management group, RAB Capital and David W Tice & Associates. He has a BA from Queen’s University and a law degree from Corpus Christi College, Oxford.

Government Debt Is Not Like Household Debt

February 15th, 2011

By Marshall Auerback

Politicians and the media argue that the current US Federal budget deficit is unsustainable. Politicians personalize this — if my household continually spent more than its income year after year, it would go bankrupt. Hence, the Federal government is on a path to insolvency, and by implication, the budget deficit is bankrupting the nation.

This is a fallacy. It ignores the full impact of budget deficits. We can divide the economy into three sectors. The private sector that includes both households and businesses. The government sector: Federal, State and local. And the foreign sector that includes imports and exports. We use the current account balance (trade surplus or deficit) as the measure of the impact of the foreign sector on the balance of income and spending.

Government Debt Is Not Like Household Debt

At the aggregate level, the spending of all three sectors combined must equal the income received by the three sectors combined. But there is no reason why any one sector must spend an amount exactly equal to its income. One sector may run a deficit, so long as another runs a surplus.

Historically, the US private sector runs a surplus. Historically, the US ran a balanced current account — our imports were just about equal to our exports. That has changed in recent years, and the US today runs a huge current account deficit.

Now, if the foreign sector is balanced and the private sector runs a surplus, this means that the government sector runs a deficit. And, in fact, the US government sector taken as a whole has averaged a deficit, spending about $1.03 for every dollar of national income.

Note that that budget deficit exactly offsets the private sector’s surplus — which was about three cents of every dollar of income. In fact, if we have a balanced foreign sector, there is no way for the private sector as a whole to save, unless the government runs a deficit. Without a government deficit, there would be no private saving.

While it is commonly believed that continual budget deficits will bankrupt countries, they are in fact the only way the private sector can save and accumulate net wealth. If households save by spending less than they are earning, and businesses save by reinvesting less than their retained earnings, both incomes and total economic activity will tend to contract until saving is reduced or until depreciation leaves businesses and households inclined to invest once again in durable assets.

Common sense suggests that when personal incomes fall while personal debt is high, debt defaults and insolvencies will follow–unless creditors are willing to generously renegotiate. This situation invites what economist Irving Fisher called the cumulative debt – deflation spiral. So unless some other sector is willing to reduce its net saving (as with the foreign sector recently, via a reduction in the US current account deficit, as US imports have fallen faster than US exports) or increase its deficit spending (as with government sector of late) the mere attempt by the domestic private sector to save from income, given the existing private debt, can prove very disruptive.

Would that our politicians recognized this. Instead, we have the spectacle of governments across the world engaged in significant fiscal retrenchment at a time when the private sector is demonstrating a strong predisposition to save. This is understandable, given high unemployment, low-capacity utilization ratios and relatively sluggish aggregate demand.

Who, then, can fill that gap? If it doesn’t come from exports (and it’s impossible for all countries to run trade surpluses), it can come only from governments. A lack of jobs is the result of a lack of spending. Governments have the capacity to provide that extra aggregate demand and could do so easily by directly creating the necessary work.

Government Debt Is Not Like Household Debt

The question is whether the US government can run deficits forever. The answer is: that depends. Too much government spending in times of full employment (approximately 4% to 6% unemployment) would clearly be inflationary, as it would represent the government competing with the private sector for scarce resources. Full employment is when government spending should be cut.

The truth is that governments can run deficits considerably longer than private households or businesses, both of which are users of currency, not issuers. Going back to 1776, the US Federal budget has been in continuous deficit except for seven short periods. The first six of those were followed by depressions, such as the Great Depression, which followed a 1930 surplus. The one exception was the Clinton surplus, which was followed only by a recession.

Why has this happened? Budget surpluses suck income and wealth out of the private sector. This causes private spending to fall, leading to downsizing and unemployment. The only way around that is to run a trade or current account surplus.

I don’t want to give the impression that government deficits are always good or that the bigger the deficit, the better. The point I am making is that we have to recognize the macroeconomic relations between the private sector, the government sector and the foreign sector.

The US government’s situation is in no way similar to that of a household because its deficit spending is exactly offset by private sector surpluses; its debt creates equivalent net financial wealth for the private sector. This is not “Keynesianism”; it’s Accounting 101.

Marshall Auerback is Director of and Corporate Spokesperson for Pinetree Capital Ltd, a Toronto-headquartered diversified investment, financial advisory and merchant banking firm focused on investing in early stage micro and small-cap resource companies.