A foremost authority on the precious metals markets and a leading expert on commodities markets, CPM Group founder and Managing Director Jeffrey Christian brings some holiday cheer to The Gold Report readers. In this exclusive interview, he debunks doomsayers who await the dollar’s demise, anticipates what may well be a more powerful recovery from recession than most pundits do and foresees bright days for gold, silver, PGMs and specialty metals.
The Gold Report: Perhaps you could begin by giving us your macro overview of the world economy and the outlook as you see it.
Jeffrey Christian: If you go back to 2006 or 2007, our view had been that we would see a relatively short and shallow recession in the first half of 2009. Beginning in late 2007, we said maybe the recession would start earlier, maybe in the fourth quarter of 2008. And then we said maybe the third quarter of 2008. Now we find from the National Bureau of Economic Research that the recession officially started in December of 2007.
We still see it ending around the middle of 2009. But it’s obviously going to be much longer and much deeper than we had expected a year or two ago. Economic problems are much worse. What we really have is a financial crisis, a freezing up of credit availability, which has led to a domino effect of reducing demand for products. We started with a bank panic and a freeze-up in the credit market that has now spilled over into final demand for goods and services across the real economy. It’s proving extremely difficult to treat. I happen to think that the U.S. government policies pursued in September, October and November have not necessarily been the best policies to resolve these issues. We’re looking to see what the new government does after January; a different approach may be more palliative to the economy.
But the bottom line for the overall economy is things are bad, they probably will get a little bit worse, and we’re probably looking at a pretty weak first half of 2009. Our view is that by the second half of 2009, maybe early 2010, you’ll see an economic recovery come along. That economic recovery may be a lot more powerful on the upside than a lot of people expect. One of the things that we’ve seen and have written extensively about over the last few years—and it’s become even more prominent with the government largesse—is an enormous amount of money sitting in cash and cash equivalents waiting for a signal that it’s safe to invest again. All of this money is standing by, ready to invest in precious metals, invest in commodities, invest in real estate, equities and corporate debt. So we think that in the second half of 2009, or whenever the recession ends, you could see a rather rapid recovery in overall economic activity globally.
So that’s our economic overview. I will say this. Everybody in the world is looking at the amount of money the governments have pumped into the market, saying it spells death and destruction for the U.S. dollar and inevitably will lead to hyperinflation. I’m not convinced that’s true and I think that’s a very important point. When you look at all of the monetary liquefaction that’s occurred, it’s definitely going to lead to a lower dollar and higher inflation than we’ve seen over the last 25 years. Still, we may well avoid a total collapse of the dollar and hyperinflation if the monetary authorities of the world effectively are able to sterilize the inflationary implications of this once the recovery starts. We won’t know that for a year or so.
TGR: What do you mean by “sterilize the inflationary implications”?
JC: It means suck the inflationary money creation out of the economy. I’ve spent a lot of time looking at what happened in the period of 1979 to 1983; the really critical point here is in the middle of 1982 we were two years into a double dip recession. At the time it was the deepest recession in the post-war experience. In the middle of 1982, Brazil, Argentina and Mexico were about to default on their government bonds. Paul Volcker called the central bankers of the world together and said, “We have to monetize ourselves out of this recession because it’s about to become something much deeper and harder to solve.”
The governments of the world opened the sluices and flooded the world with money. By December of 1982, the world was out of a recession, auto sales had rebound sharply, Geoffrey Moore’s leading index of inflation indicators, which was basically money supply, had gone off the chart. Gold had risen from $290 in July of 1982 to $500 by the end of the year because everybody was convinced that this was going to be inflationary and that the dollar was going to collapse. By the end of ’82, early ’83, it was clear that we were out of the recession.
Fortunately for Volcker, Reagan (Ronald) and an associate named Regan (Donald Regan, Reagan’s Treasury Secretary) had taken a $40 billion Carter (Jimmy) deficit and turned it into a $200 billion Reagan deficit and needed to finance it. So Volcker said, “That’s easy; Let’s sell $300 billion worth of T-bonds and suck $300 billion out of the economy.” And they did it. So they started selling a tremendous amount of bonds to monetize the debt that the government was racking up and thus sterilized the inflationary implications of their earlier monetary creation.
Then oil prices fell 15% in the first quarter of 1983, from $34 to $29 per barrel, gold prices fell $100, inflation went from about 7% to 3% and is only now getting back up there. We entered a 25-year period of the lowest inflation in a long, long time right when everybody was convinced that all of that money creation would lead to hyperinflation. The government has followed that model every time we’ve gone into a financial crisis since 1982. This time around everything is much bigger and the question is, “Can they do it again on an even grander scale?”
TGR: We didn’t have the fundamental problems back then that we have today. We didn’t have all these derivatives. So many things are so different, and we’ve seen nothing of this magnitude.
JC: Actually, the two biggest and most important differences are that we had extremely high U.S. interest rates then, and a very strong and persistently rising dollar. The dollar was rising then, as it is now, but it has been weak from 2003 until the middle of this year. You’re right—we didn’t have the derivatives and all of this enormous financial liquidity that we have now. And as I said, we’re playing a much higher-stakes game this time around and we’re doing it in a situation with low interest rates and a fundamentally weak dollar. People talk about how strong the dollar has been in the last few months, but it’s still very low compared to what it had been.
Funny, I just got an email from someone who attended a conference I spoke at in Zurich about a year ago. He said this is amazing, that a year ago everybody laughed at me because I said the dollar would be strengthening—but I didn’t say what kind of environment it would be strengthening in.
TGR: Isn’t another difference between the current situation and the one 30 years ago the fact that back in ’79 it was basically the U.S. and the Banana Republics that were having problems? It wasn’t Germany, France, Switzerland—it wasn’t everybody, was it?
JC: No. It was everybody. The U.S. was in a deep recession, Europe was in a deep recession. That’s when they coined the term “Eurosclerosis.” I was at J. Aron at the time and we were doing a lot of gold loans with Eastern European governments, because they needed the money. We found ourselves in workout situations with sovereign debt in Eastern Europe in 1981; whereas Latin America didn’t erupt until 1982. But it was pretty much universal. The U.S. was a bigger part of the world economy back then, too.
TGR: So a decoupling, when you look at the BRIC countries, will help carry us through or avoid an international recession this time around?
JC: I don’t think so. I think we’re in an international recession. The IMF seems to think so. When everybody started talking about how the economies of the world could decouple from the U.S., I said it’s just one of those pater nosters that makes no sense and doesn’t stand up to statistical scrutiny. You’re seeing that. You’re seeing India, China, and all of the other emerging countries really suffering from a decline in demand for their products, much of which are exported into the United States and Europe, and it’s having catastrophic consequences. Granted, there is a movement away from being dependent on the American consumer on a worldwide basis, but it’s a very slow movement and hasn’t progressed far enough to insulate the rest of the world from the problems in the U.S.
TGR: You were talking about Volcker, who issued something like $300 billion of debt—Treasuries— in the ’80s and sold them to cover it and continued to do more of that. At some point, don’t we have to pay that back? Isn’t there a Piper to be paid?
JC: In theory, yes. But there’s a problem with the doomsayers. Look at Jim Grant, who publishes the Interest Rate Observer. I think it was in 1980 that he said, “Oh, my God, look at this $37 billion debt that Carter’s ramping up. This is unsustainable; the Treasury market is going to collapse.” At some point, he probably will be right and the Treasury market will collapse. But in the meantime, we’ve had 28 years that make a $37 billion deficit pale. We wish we could have a $37 billion deficit.
In the meantime, several things mitigate against any imminent collapse. One is the fact that the world economy basically always has been and always will be a giant confidence game, in the sense that there has to be a certain level of confidence to keep things going. The other thing is that for the dollar to collapse, some other currency has to rise very sharply. The problem that the world’s in right now is that for the dollar to fall sharply, investors have to have greater confidence in some other currency. This is really great for gold. It makes you really bullish for gold. Another currency has to rise if the dollar’s going to fall. Ask people “Which one do you have more confidence in?” There’s silence in the room and then people buy gold. No one has any confidence in any of the other currencies or the governments behind them—the Euro, the Yen, the Swiss Franc or anything else.
In a speech a few weeks ago, I said, “The dollar is like your mother. You’ll sit around and complain about her and how she’s so mean and nasty and you’ve got to get away from her. But as soon as you cut your knee, you go running back to her crying.” That’s what’s happening right now in the world economy, in the financial markets. Everybody has been saying for five years that the dollar is toast and the dollar is no good and the U.S. debt is unsustainable. But as soon as you get into a banking panic, everybody converts their money into dollars and Treasuries and CDs held by banks that are guaranteed by the FDIC. Why? Because even though we’ve lost a tremendous amount of faith in the U.S. Treasury, we still have more faith in the U.S. Treasury than we do in, say, the European Central Bank or the Bank of Japan or the Bank of England.
TGR: So if the dollar devalues and some other currency has to rise, it bodes really well for gold. But considering the trillions of dollars of debt out there, is there enough gold for it to be a viable alternative currency? Or will the price for every ounce of gold become something cataclysmic like $3,000 or $4,000?
JC: Yes. If you tried to monetize the debt in gold, or if you tried to go back to a rigid gold standard, you would either have to have $3,000 or $4,000 or $5,000 or $6,000 gold, or you would have to severely contract the world economy back to where we were in, say, the 17th century. But I don’t think that’s what you’re looking at. Rather, you’re looking at some portion of the world’s assets moving into gold as an alternative to currencies. In that situation, you “only” see $1,000 or $2,000 gold.
TGR: Some of us might like $5,000 or $6,000 gold, but maybe not everything else that would be going on with gold prices at that level.
JC: Right. You definitely wouldn’t like everything else going on. It’s interesting. It depends on how a gold standard would be created. The last time we had a “serious” discussion of a gold standard in the United States was during 1980 election campaign. The Republicans actually had a platform plank written by Arthur Laffer to return to a gold standard. What Laffer said was that for the U.S. Treasury notes in circulation, you would have to have 40% of the value of the Treasury notes in gold held by the U.S. Treasury, or a 40% cover. It sounded really stringent, but then you realized that since the 1960s almost all of the bills printed actually had been Federal Reserve notes—not Treasury notes. When asked about that, Laffer said that’s right. What you need from a gold standard is the public’s sense of confidence in it. If you tell them Treasury notes are backed by gold, they’ll be more confident in the value of the dollar. They won’t bother looking at the fact that we’re printing Federal Reserve notes ’til the cows come home. It was a very disingenuous and cynical approach to the American voters.
TGR: So we may see some rush to gold, which may lift it up to $1,000 or $2,000. What about other precious metals like silver? Will that tail along with gold?
JC: I’m actually now in a situation where I like silver, platinum, palladium and the other platinum group metals as well as gold. I like silver for a couple of reasons. One is it’s a financial asset like gold, it is benefiting from the move of investors into silver and gold, and it will continue to benefit from that. But you’ll also see several other things. First off, there is not a lot of metal in the silver market, half a billion ounces in bullion and maybe a half a billion ounces in bullion coins. In gold you have a billion-plus ounces that investors own and another 980 million ounces that central banks own. There aren’t those large enormous stockpiles of silver if you’re looking at it on a dollar value basis. In addition, silver is an industrial metal with some very interesting new uses coming up. It’s losing some of its traditional uses such as photography; but in other uses, such as batteries and electronics, it’s actually growing very sharply and could grow more sharply over the next few years. So I think silver’s got a lot of good things going for it. It’s an alternative financial asset like gold. It’s a smaller, less liquid, more volatile market than gold. And it has the industrial base that gold doesn’t have. So I like silver for those three reasons.
TGR: What brought silver down so much? It got up to $21; now we’re at $9 and change.
JC: The massive amount of leveraged investment in these things has brought all of these metals down. Everybody keeps talking about de-leveraging, but if you ask them to explain it, they can’t. But let me try to explain what I mean when I say leveraged investment. You had hundreds of billions of dollars of institutional money invested in gold and silver forwards, gold and silver over-the-counter options, and gold and silver indexed notes—all written by banks and all with major leverage factors. Some were 10:1; some of them were actually 30:1 or 40:1. As the financial crisis occurred, institutional investors had their credit lines pulled back. Consequently, they had to reduce the amount of investments that they’d borrowed money to make. So a hedge fund that has $10 billion under management and a leverage factor of 20 might have $200 billion of leveraged trades. Then suddenly you don’t have the money to support $200 billion worth of leveraged trades. You have to liquidate most of them because you really only have $10 billion—which is going down in value fast. So there’s been this massive sale of leveraged products. It’s like running for the exit in a theater when somebody yells fire. It’s a very small door, a very illiquid market, and all of a sudden there’s no provision of credit. Everybody’s trying to get rid of their leveraged exposure all at once and these prices have just plunged down. That’s really what it’s been.
TGR: But silver has lost nearly half, while gold is down less.
JC: Silver prices are always more volatile than gold prices. That’s just a fact of life. It has to do with the fact that the silver market is about one-twelfth the size in dollar terms. The other thing is that gold is money and silver is like money. Silver has this schizophrenic personality. It is an industrial commodity, but it’s also a financial asset and you do see more people investing in gold than in silver worldwide right now. As the prices plunged, you have seen an unprecedented volume of physical gold and silver being purchased by investors around the world. So you have this dichotomy, where the price is being hammered down by de-leveraging in the paper market, while people—in some cases the same people—are taking what’s left of their chips and putting them into physical gold. One of the things I think you will see going forward over the next many years is a lot of institutional investors, including sovereign wealth funds and government funds, wanting exposure to gold and silver but not on a leveraged basis where they’re really owning IOUs issued by major banks. They are wanting the physical material.
JC: It really depends on the investor and their perspective. The high net worth individuals we deal with own some physical gold and silver and maybe platinum group metals that they actually store in their own vaults. They own other material that’s being held for them in depositories in various parts of the world. They also own some ETFs, some options, some mining companies and some exploration companies. So it’s really a diversified portfolio.
Except for these high net worth individuals, we don’t deal with retail investors directly as customers at CPM Group. We talk to them, though, and we do deal with people who supply the retail market. A lot of people are moving into the physical material. Demand in the ETFs also has been strong over the last few months and some of that demand comes from people who can’t get their orders filled for one-ounce coins or 100-ounce silver bars. They’re buying ETF shares instead because they’re the next best thing.
TGR: Does that carry implied leverage?
JC: The ETFs do not. The ETFs are ounce-for-ounce and it’s held in an allocated account. If I’m an investor and want to own a 100-ounce bar, I can’t find one in silver. Northwest Territorial Mint will sell me one if I want to wait 16 weeks for delivery. Silver Recycling Company [TSX.V:TSR] is also selling them and they have it for relatively prompt delivery, but that’s a very new development just in the last few weeks, in response to this market. If I’m an investor and I want to buy 100 ounces of silver and can’t find Maple Leafs or Eagles and I can’t find a 100-ounce silver bar, I can buy a share of an ETF and have it stored for me on an allocated basis through the ETF mechanism.
TGR: Suppose the economy actually does start to turn around, as you’re projecting maybe in the second half of 2009, and you have all this money on the sidelines, which you indicated might flow back into the marketplace rapidly. Does that mean gold will rise through the recovery and then go back down?
JC: Because gold is money and an alternative asset, gold and silver probably will rise in the first half of 2009 in response to the economic distress that we expect at that time. And then as the economy recovers—let’s be hopeful and say it starts in the second half of 2009—you actually might see gold and silver come off some. Platinum group metals, which we’ve only mentioned in passing, are the other way around. They’re really industrial metals, heavily tied to auto sales and so probably will remain weak until auto sales recover. But when that happens, expect platinum group metal prices to rise sharply.
TGR: You mentioned Silver Recycling starting to sell physical silver. What else can you tell us about this company?
JC: For purposes of full disclosure, I personally own some stock in Silver Recycling and they are a CPM Group client. We are financial advisers to them. I can talk about who they are and what their ideas are, what their plans are. I like the company a lot because they’re basically a consolidation play to create a publicly traded company in refining silver from scrap. They’ve identified three initial targets of small privately owned silver recyclers in the United States and are working with them. They have agreements with all three to acquire them and bundle them together, consolidate them and benefit from the economies of scale. And then there are other companies they can target later. It’s a very interesting operation. If you compare them to a silver mining company, they have the capacity to produce silver from scrap without any of the capital costs, country risks and operational risks that are common with a mine. So lower costs, less capital, fewer risks, still producing silver.
TGR: What sort of volume are we talking about?
JC: The first company they have an agreement with has 5 million ounces of production a year. The others have somewhat less. I don’t know the numbers off the top of my head, but I believe that the three companies combined would be producing something in excess of 10 million ounces a year.
TGR: Using that as rough estimate, what publicly traded silver producers come up with 10 million ounces a year?
JC: I think Coeur d’Alene Mines Corp.(NYSE:CDE) is slightly less than that this year, but maybe more than that next year. Apex Silver Mines (AMEX:SIL) and Pan American Silver Mines (Nasdaq: PAAS) probably produce more than that. Silver Standard Resources (Nasdaq: SSRI), which is moving toward opening its Pirquitas mine, will produce more than that when they’re up. There are probably a few other companies—Hecla Mining Company (NYSE:HL), maybe—that I’m going to anger people for forgetting. And then there are some larger diversified mining companies that produce much more than that. Penoles [MX:PE&OLES] is a good example. A lot of people think of Peñoles as a silver mining company and it does produce an enormous amount of silver, but it also produces lead, zinc, copper and gold. Also KGHM and BHP, but they’re not silver companies per say, either.
TGR: What other companies, either in silver or gold, would you recommend our readers take a look at?
JC: Well, we’re really commodities analysts. I’m proud to say I am not an equity analyst. I don’t sit there and tell people which equities to buy on any given day. I won’t tell anybody what to do with their equity investments, but I’ll tell you what I do with mine. I have a diversified portfolio.
Let’s look at the gold market. I have physical gold. I sometimes have futures and options in gold. In the equity side, I have AngloGold Ashanti Ltd (NYSE:AU) shares. I have Goldcorp (NYSE:GG) right now. I don’t have Barrick Gold Corp (NYSE:ABX) right now. I have in the past. I like Barrick a lot. And I have some smaller exploration and development companies in my portfolio. I tend to look for really well managed large companies that are cash flow generators, like Goldcorp, and I also look for exploration and development companies that have the capacity to bring production on stream within a couple of years, they have attractive mines, and management that I find good. So that’s it in gold.
TGR: What are some of these other companies?
JC: It’s not an exploration company along the lines of that, but one name I’ll throw out is Tanzanian Royalty (AMEX:TRE), Jim Sinclair’s company. It’s been hammered down along with everything else lately, but I still like it a lot.
TGR: And switching to silver?
JC: I like Silver Standard. I like Silver Standard’s management a lot. I think this Pirquitas mine that’s coming on stream will be a company maker. I also like Apex Silver Mines; I’ve been involved with Apex since before it actually was officially organized as a company. I think that’s good. Pan American is a very interesting growth story. Coeur d’Alene has been hammered in this market, but it has some very interesting properties, so it could do well. And Hecla is probably a tremendous turnaround story. Management over the last several years has done a remarkably good job in rebuilding Hecla Mining.
TGR: Gosh, they’ve been beaten up, too.
JC: Yeah, everybody’s beaten up. I spend a lot of time these days talking to clients about the difference between value and price. Six months ago we were talking about the fact that the price was over the value of a lot of mining assets and now we’re talking about the fact that the prices are woefully under the value of a lot of these companies. A company like Great Panther Resources [TSX.V:GPR] is a pretty interesting story. Fortuna Silver Mines [TSX.V:FVI] I like a lot. Endeavour Silver Corp (AMEX:EXK) is a good company, an emerging company. I’m afraid to leave out people. I own some Silvercorp Metals [TSX:SVM], a very interesting company with lead and silver mines in China. What I do is I look at companies from a management perspective and a property perspective. First thing is I’ve got to be comfortable with management.
TGR: What about platinum group metals?
JC: I thought platinum was overvalued years ago and it just kept rising and rising, but now it’s clearly undervalued. The cost of producing platinum or palladium at most mines in the world is higher than the current prices. About 50% of platinum in the world goes into auto catalysts, 60% of palladium and 80% of rhodium. With the auto industry and the auto market on their back in North America and Europe, these markets have spiraled down. A lot of investors who poured into the platinum markets partly based on the auto story are now pouring out. I think platinum group metals prices will rise sharply once the auto industry turns around.
And, the auto industry will turn around. Not necessarily because of the situation in the United States, but if you look at the BRICs, for example, you have a tremendous growth in auto sales and it’s fallen. In China it’s gone from 15% per year down to about 8% per year, but that’s a cyclical thing. It will turn itself around and people will start buying more. An interesting thing about platinum is that you don’t have the share market similar to what you have in gold and silver. In North America you have North American Palladium Mines (AMEX:PAL) and you have Stillwater Mining Company (NYSE:SWC). Both are having problems right now.
TGR: With costs exceeding current prices, the issue on the production side is clear, but what’s the problem on the exploration side?
JC: They can’t get financing. And insofar as some of these companies are exploring in South Africa, problems related to electricity and electricity allocations predate the bank panic. South Africa basically has not really invested in electricity-generating capacity for a decade. Those power shortages and outages are going to take many years to solve. They’re saying they’ll pay attention to existing mining companies, existing corporations, existing consumers of electricity. When you’re building a mine, you have to go to Eskom, the state electrical utility. Unless you’re already in the construction phase and have your electricity allocation, they’re just going to say they don’t know when they will be able to supply you electricity. That’s going to delay exploration and development. On top of that, the financial freeze will delay a lot of new capacity coming on stream. That will make the platinum group metals that much tighter.
TGR: As we come out of this recession, many people say certain sectors will emerge faster than others. You talked about how gold’s going to have a nice run up while we’re in recession. What commodities should we expect to come out of the recession first?
JC: I think gold and silver come out first. We’re looking at some specialty metals like ferroalloys—vanadium and molybdenum—because those markets are much tighter. The prices have been beaten up, as have the prices of larger metals like aluminum and copper. But if you look at molybdenum, for example, a lot of its uses are in transmission pipelines for gas and oil, offshore platforms for gas and oil production, and drilling pipe and production pipe for oil and gas. Even with lower oil and gas prices, these areas are going to be very strong over the next five, 10, 20 years. So we think you’ll see a relatively fast turnaround for a lot of these specialty metals, things that are harder to come by, but generally speaking are indispensable in critical economic applications. I think steel will also do very well because I expect the new government in the United States to undertake a major new program to rebuild all of these bridges that are about to fall down. I think you’ll see steel do very well from that perspective.
A graduate of the Missouri School of Journalism (University of Missouri, BJ, 1977), Jeffrey M. Christian chose his course of study because he was interested in chronicling developments in places such as Africa, Asia, Latin America and Central and Eastern Europe (well before they emerged as significant world economies). In 1980, Jeff left his job as an editor at Metals Week, an industry publication—having decided that metals markets he wrote about appealed to him more than journalism did. A year before Goldman Sachs acquired it, J. Aron and Company brought him on board and he soon managed the Commodities Research Group’s precious metals and statistical work there. In 1986, he engineered a leveraged buyout of this group—of which he was then VP—to create CPM Group, which he has led to become a world-class research, consulting, investment banking and asset management company that focuses on the fundamental analysis of global commodities markets. Jeff continues to write extensively.
Since the late 1970s, he has authored many pieces on precious metals markets, commodities and world financial and economic conditions. In 1980, he wrote World Guide to Battery-Powered Road Transportation: Comparative Technical and Performance Specifications. Now out of print, it remains a great index of many of the earliest electric cars. In 1981 he wrote one of the first market reports on the platinum metals group. Fast-forward to the 21st century, he and his staff of analysts write six major reports per year for publication and 12 monthly reports plus several more weekly reports and special reports. He published Commodities Rising in 2006. Jeff has pioneered application of economic analysis and econometric studies to gold, silver, copper, and platinum group metals markets, as well as efforts to improve and extend the quality of precious metals and commodities market statistics and research overall. As passionate about his work today as he was 22 years ago, he loves the fact that it gives him a tremendous network of contacts at high levels and a tremendous amount of discretion as to the work CPM Group undertakes. CPM counts among its clients many of the world’s largest mining companies, industrial users of precious metals, central banks, government agencies and financial institutions.