By Sumit Roy
Adrian Day is chairman and chief executive officer of Adrian Day Asset Management and the author of Investing in Resources: How to Profit from the Outsized Potential and Avoid the Risks. Last month, it was announced that Day is partnering with Peter Schiff to launch a new mutual fund, the EuroPac Gold Fund. HAI's Managing Editor Sumit Roy recently caught up with Day to discuss the outlook for gold and miners.
Hard Assets Investor: What's your view on the decline in gold over the past year, and your outlook going forward?
Adrian Day: To some extent, gold was a little bit ahead of itself. If you look at the long-term chart of gold, you see that it actually moved above its trend line for really pretty much the first time in September 2011.
And it was largely because of the expectation that the European Central Bank was going to do more than it actually wound up doing in terms of monetary stimulus at that time. And what's happened particularly over the last year is you've had everybody look at gold through what I like to call "a bearish prism." In other words, if something is positive for gold, it's ignored; if something's negative, people pounce on it and the market goes down.
And you always see this when a market is falling; or when a market is going up, you see the opposite. People say, "It looks like stocks are a better buy than gold, so we don't need gold anymore, let's jump into stocks." And then of course, more recently, we've had expectations that the Fed is going to cut back on its stimulus.
Frankly, in my view, the gold market's reaction to the comments of Ben Bernanke and the Federal Reserve has been grossly overdone. All Bernanke and the Fed are talking about is possibly pulling back on the additional stimulus sometime this year if the economy continues to do well. You've got quite a few qualifiers there, but all they're talking about is reducing the additional stimulus.
The market expectation is that they might reduce from $85 billion a month in bond-buying to $65 billion a month. Well, even if they do that, let's remember that's still an additional $65 billion a month. No one is talking about the Fed shrinking its balance sheet, let alone exiting. Remember the concept of exiting, which we talked about in 2008 and 2009? When will the Fed exit?
Thus, we're not even talking about reducing the balance sheet; we're talking about reducing the rates of growth. The market is now understanding that and that's why we've had this good rally in gold. In addition to that, of course, you've got extremely negative sentiment -- particularly up until the last week or so -- with very heavy shorts. You had record speculative shorts on the Comex. And not just a little bit of a record, but record by a very, very wide margin. The sentiment was negative, and that's why I expect this rally to be quite powerful.
HAI: How high are we talking for gold in the near term?
Day: My sense is that we're going to get a little bit of resistance perhaps at the $1,400 level. But if we don't, then I think for sure shorts will scramble to cover and we could get to $1,600 pretty quickly. I'm expecting $1,600 by the end of this year; that was where gold was at the beginning of this year for the first three months before that very mysterious two-day collapse in mid-April. My base case is for gold to get to $1,600 by the end of the year, but if we break through to $1,400 pretty quickly, then I think we could get there by the end of September.
HAI: You touched on it a bit, about the Fed and QE -- do you think they're really going to ever end QE, as they say they will? Some argue that the Fed will have a difficult time completely ending these ultra-loose policies.
Day: What I do think is clear is that the Fed has painted itself into a corner, and the longer these policies go on, the more difficult it's going to be for them to withdraw. We saw the market's reaction when the Fed made its comments about maybe cutting back on the bond buying later in the year. The stock market collapsed and the bond market fell sharply as well.
How they're going to withdraw stimulus, I don't know. What we're probably going to see is just a slow run-off. If the economy improves, both in the U.S. and abroad, we'll probably see the Fed just simply run off its existing holdings without buying any more. But that's going to take a long time.
HAI: Will there be any unintended consequences from all these Fed policies? Will we see inflation down the line?
Day: There are always unintended consequences. The biggest consequence that we've seen so far is the fact that market participants are now relying on stimulus for the markets to stay up. That is a very dangerous thing. Everybody just relies on the Fed now.
What happens with monetary stimulus is it doesn't necessarily have to show itself in high price inflation in the near term. But that money goes somewhere. And what we're seeing now is it going into financial assets. It's gone into bonds, it's been going into stocks more recently, and it's been going into real estate more recently. Those particular assets get priced above the fundamental level because of that sort of speculative money that's created.
If you withdraw that speculative money, and the fundamentals aren't there, then those particular markets can drop quite significantly. At some point, we're likely to see higher consumer price inflation. But I don't base my bullishness on gold on the fact that we're going to get higher inflation.
HAI: What do you base it on?
Day: The Federal Reserve's credit-creation policies and inflationary monetary creation policies, not necessarily in the end result of inflation. Again, when they create money and credit, it has to go somewhere.
HAI: Silver got beat up along with gold this year. Do you see it as a legitimate alternative to gold?
Day: Clearly, there are some differences between silver and gold. I mean, gold has a much greater monetary role than silver. But on the other hand, silver has greater industrial uses. Silver can be gold on steroids. I look at silver as more of a trading vehicle. I look at gold as much more of a core asset. The rallies in silver can be much more dramatic than the rallies in gold, but so can the declines.
I like silver, I'm bullish on silver, but I would always buy my gold before I buy silver.
HAI: Do the gold miners look cheap right now?
Day: Absolutely. We had a very good rally, even if you look at the XAU, which includes a bunch of pigs and dogs. We've had a very good rally in the XAU from 82 to 108. My math tells me that that's more than 30% since the end of June. But gold stocks remain exceedingly cheap.
If you look at the senior miners, on any metric you care to look at -- stocks relative to bullion, cash flow, price to earnings, price to ounces in the ground, price to ounce of production, etc. -- gold stocks as a group are as cheap today as they have been for this entire gold bull market. That's 12 years, other than a couple of weeks at the end of 2008, during the financial meltdown. That is just astonishing when you see that the gold stocks have cheaper valuations today than when gold was at $250.
The negative sentiment on the gold stocks is astonishing. For example, let's take Barrick Gold, the largest miner. You've got 27 million shares short as of last week. Up until this year, it had never been more than 5 million short. And I could punch in stock after stock after stock and show you the same thing.
The sentiment on gold stocks is extremely negative. What that means is that if these things continue to move up, I think a lot of people are going to scramble to cover. And rallies could be explosive. But even on a longer-term basis, notwithstanding that you need to be selective, the multimonth rallies could be extremely strong. And for the best of the companies, this is the buying opportunity of the decade.