We have the great pleasure and honor to have with U.S. today, billionaire Eric Sprott: Chairman, CEO & Portfolio Manager of Sprott Asset Management Group. Eric has over 40 years of experience in the investment industry and manages over $8 billion in assets. He has been stunningly accurate in his writings for over a decade, and is one of the most respected industry professionals who accurately foresaw the current crisis. Sprott Asset Management is one of the top firms in the world.
Following is the original transcript of this exclusive interview for Equity Management Academy which took place December 16, 2013.
JP: The 10 year T Note yield has jumped to the 2.88% yield levels currently. This is a jump from the 2.15% since June, 2013. This is a significant jump in the 10 year T Note. Is this possibly the beginning of a trend or just an aberration?
Eric: Well if we go back a year ago the ten year was at 1.40 and today it's 2.88. It's very noticeable and it's going to be particularly noticeable to people buying houses because when you're carrying charges go up by 100 basis points or if your mortgage goes from three to four or from three and a quarter to four and a quarter, that's essentially a 33 percent increase in the cost to carry and plus the price of the house is up 15 odd percent so it really costs 50 percent more for the first time buyer to buy a house and we are definitely seeing signs in some markets that the interest in new home purchases has declined very dramatically.
In fact I was reading an article on how things seemed to be crashing back in Las Vegas, we at one time had the hedge funds all in buying some of these distress properties and they looked like they've stepped away now. No it's a very worrying trend and it's a trend that's been that was brought about the discussion of taper and that's why I guess why the meeting on December 18, 2013 is going to be very critical.
I've always been of the view that they can't taper because literally them stepping away from the bond market I think would cause rates to go higher and of course the impacts of that are devastatingly economically to the average person because the cost of buying things on credit goes up dramatically. I place particular emphasis on cars and homes which are the two meaning sectors in the U.S. economy so far.
Also the cost of doing business for government goes up and that's increasing at the rate they are the last thing a someone needs for example 100 basis point increase in the cost of servicing 17 tn the debt ; that would imply 170 bn extra of interest in 2014. So they better keep it under control. I've written that I've suspect they've lost control of the bond market because between the Japanese coming in for 65 bn and the Fed buying 85 bn rates have gone up anyways so God forbid they taper so we will see what the decision is next week.
JP: Is the long end of the bond market (30 year) under pressure for higher rates or is it just in the short end of the yield curve?
Eric: It's not going to handle it well because literally the Fed is buying the biggest part of all those long issues and if they step away from the market then obviously the rates will go higher and we've already seen many countries, most notably China, saying we have no interest in increasing our foreign exchange reserves, i.e. b buying foreign paper. As you know the Chinese essentially has stepped out of the U.S. market when they use to buy a huge percent of all bond issues and therefore I think the Fed had to come in and buy the bonds the minute that China stepped away from the market. So if they decrease their buying it's highly likely we'll see much higher interest rates here.
JP: We touched on this briefly before, but can you expand on how do you think this will affect the interest payments on the U.S. sovereign debt and what impact could this have worldwide economically?
Eric: As you know the debts of all countries collectively have risen dramatically since 2007 so the first fact is that you have to pay interest on the increase of debt but secondly, if you have to start paying more interest on the existing debt and the crush on the budget deficit becomes staggering and I think that the zero interest rate policy was meant to allow governments to continue to issue debt and not have to pay a charge because the decline in interest offset the increase in debt that the interest was payable on. Now all of a sudden the interest rate goes up and the debt continues to go up and you know you're in a catch 22 in terms of when interest payments becomes a much, much larger part of the government budget deficit yet again.
JP: What would this do the U.S. dollar?
Eric: It would be negative for the dollar but the best thing that ever happened to the dollar was the Euro the Yen and the Pound. The dollar is under a lot of pressure right now. Some people think that the Euro is in better shape because they haven't been as active in their own bond market for example what the Japanese and the U.S. have done. Obviously in the long run when you print money and have zero interest rate as a policy, then your currency will depreciate. I begin most of my presentations by essentially saying that the U.S. in insolvent, which is the easiest thing in the world to prove. So I have absolutely no interest in owning U.S. dollars unless it is absolutely necessary and I would encourage most people not to want to own any fiat currencies because of all the printing that's going on and we all know where it's going to lead. We are all just trying to string it out and we'll all be able to get out before something really happens but the fact that you know something will happen is the thing that you should protect against. So I think it is all very dollar bearish.
JP: Let's shift gears for a minute to something you're really an expert on ... How would this rise in interest rate eminently will affect the price of gold and silver?
Eric: You know most people would suggest the high interest rates are negative for gold and silver because it is sort of the knee jerk response. One of the reasons why I love gold and silver is because in my mind there's tremendous stress on government and the banking system and a rise in rates causes paper assets to depreciate, the bonds depreciate, and it likely the stocks would depreciate. When you realize the leverage in the banking system when you are levering 20 or 30 to 1, and so in the 30 to 1 situation, if there is a decline of 3 percent in the assets there is no capital left. That of course was the problem of the financial system back in '08 which had to be bailed out by the various central banks at the time. So it would just bring on stress in the banking system faster than it might otherwise bring on and the stress is going to happen anyway, because they are too levered and never should have got in that position in my mind as sort of an accountant looking at how levered these bank statements are. They never should have been allowed and when people finally figure out that people shouldn't have their money in a bank, which has taken people a long time to figure out, but we saw what happened in Cyprus when the depositors lost money. We see the ECB working on what they call a banking resolution which is really a new bail-in situation where the depositors would be included in the bail-in if a "too big to fail bank" failed. You have to know that certain banks in Europe in the weaker countries the deposits must be leaving, it would be foolish to leave them there and yet the assets are all deteriorating in the sense that if I were to use what's the value of a Spanish mortgage today versus 5 years ago or what's the value of a Spanish loan to a commercial enterprise knowing what's going on in these countries that there is no economic growth, in fact there is economic decline. Plus the unemployment situation is becoming untenable and people are distressed and fomenting action on the streets. So it's not a very encouraging situation in the banking area and if people finally figure out that banks are not a place to put money think of where can they put this, yes you can put is as cash but as we described before cash is an asset that naturally depreciate. So I think ultimately it's going to be great for gold and silver, the ultimate win for gold and silver was when people lose distrust in the banking system. I think probably most people lost trust in their government and I would not be surprised if most people, when they have to read the events of what goes on in banks all the time, why would they be building trust in banks? You would think the exact opposite would be occurring and that would be very positive for gold and silver.
JP: We're finding the same template here recently in Detroit.
Eric: Exact same thing. We all knew ten years ago they're broke in 2009, '08 and '07 and then finally they go broke and nobody is surprised. The thing that is most important is what was the result in filing the chapter 9 bankruptcy and the final result was the delivering estimate that the entitlement is the people on pension are going to get 16 cents on the dollar. When I look at the entitlement program of the U.S. where the current estimate of the current debt plus entitlement is something like $85 tn and this enterprise that is suppose to pay these things is $3 tn/year, then that results in a cash deficit of $700 or $800 bn, there is no way for them to meet the entitlement. Just like we knew Detroit wouldn't be able to meet the entitlement, we just had to wait till the guy couldn't pay the check. I don't know if your listeners would've seen this but there's 1000 U.S. economists including 15 Nobel Laureates signed something called the Informant. They said we need to tell people, i.e. the public, that we are in an untenable situation where contingent liabilities continue to rise and we don't have any revenue increases that are nearly large enough to narrow that gap again. It's going to just get bigger like Detroit got bigger and sooner or later we are going to say to those people whom we have obligation whether it's Medicare, Medicaid, civil service pension plans, social security, you are not going to be able to receive what we expected. We will not have the funds and we are just in a situation where it gets worse every year. Of course, as you know, most politicians don't want to deal with it on their watch, somehow hoping that this problem disappears but there's no way on earth that it is going to just disappear because of the whole demographic situation of people retiring. So it's very easy as it was for these thousand of economists and it's easy for me to look at the numbers and to say it's going to break someday. I don't know when they'll finally get around to it but based on this budget resolution that was passed last week that nobody wants to deal with the reality of the situation; we just sit there and fight over $20 bn/year. The gap accounting deficit for last year was something like $5.7 tn and it will probably be over $6 tn this year so we are really doing nothing to address the problem.
JP: Let's shift to China for a minute since you have written extensively about this. Do you think China will continue to import physical gold at the same rates as they have this past year?
Eric: That's a great question. I just was off the phone with someone from the World Gold Council who is a Chinese expert and they are sticking by that their GFMS data that the World Gold Council publishes is correct. This person said he has a pretty good idea of what goes on in Chinese jewelry demand. Two years ago China imported 100 tons gold into mainland China and this year they are probably running at a 1200 ton rate, so in two years they have gone up 1100 tons. If you, Mr. China expert, know what's going on in jewelry demand in China, then you can look at the change in demand in jewelry from 11 to 13, take it off the 1100 ton increase and you must make some conclusion of where it's going. But they don't want to do that and the obvious "where it's going" part is either substantial savers in China or the People's Bank of China and I suspect it's a combination of both. Nobody wants to say it's true until someone comes out and confirms it even though there is an unexplained difference. We have an 1100 ton change in Chinese demand which is 29 percent of the total gold market which is a 4000 ton market and nobody seems to be willing to explain it and yet every year they come out and say demand equals supply which I don't believe the data for a second. I think that the demand is way beyond the supply of gold and that the western banks have been involved in supplying that gold non-transparently. And as you and I and all your listeners know that zero interest rates and printing money is financially irresponsible; we all know it. I can assure you Ben Bernanke Knows it, Julia Coronado knows it, Rene Carne knows it, and Mario Draghi knows it. They know it's irresponsible; they just have to do it to try to get through to the next crisis because if they didn't print rates would be up already and we would be in Armageddon.
JP: You have pointed out recently the major discrepancy between the paper markets and the physical markets based on world supply and demand data points for gold and silver and yet the price of metals keep making new lows. What are the price dynamics that we're dealing with today as opposed to "normal market conditions"?
Eric: That's why I am after the World Gold Council because I think it's up to them to put some analysis into all this buying of physical gold, and of course the bigger question is where is all this coming from? In my mind it is unquestionable that the demand for physical gold vastly exceeds the supply of physical gold every year. I wouldn't even be surprised if the total demand is 7000 tons and the supply is 4000 tons and somebody would say shouldn't the price go up? Yeah well somebody is supplying that extra 3000 tons because this is real, physical gold and I suspect that the western central banks have been supplying the gold that their inventories are down to fume. That is why they have created this sell off in the gold market so they can extricate the thousand tons of gold out of the various ETFs they did to help make deliveries against those physical shortages. Of course it culminated when Germany asked for their measly 300 tons back from the U.S. Fed, which would have represented 4 percent of the gold that the Fed had and they said it would take 7 years. It never should have taken 7 years, that's ridiculous. I suspect they don't have the gold and there is a shortage of gold and in order to cover up, they're messing around in the paper markets to look like the gold bull market is over when the physical data says the opposite. The demand is unbelievable and if we'd ever not taken India out of the market that the monthly numbers would be so stunning in terms of total demand for gold that they would be wondering every month who supplied 100 tons this month; who supplied 100 tons that month. Then of course then the spotlight goes back to who could possibly sell 100 tons, there aren't 20 people who have 100 tons of gold. So then the spotlight would go back to the Western Central Banks who I believe absolutely are involved with the sell side of the gold market
JP: What do you think the price should be outside the manipulation just based on the fundamentals that you mentioned?
ES: The price can be anything based on the amount of outstanding debt, there's been many people that have done those kind of calculations, you come up with $5000 an ounce and many other numbers and I just know that it should be way beyond what it is today at around $1250 and I've expected it should double here in the next year just based on the data I see. All of a sudden we could get a shortage of delivery on Comex. The Comex dealer's inventory today which I think is 18 tons. It's all been spoken for in the delivery notices so essentially it could be 0 tons there. I mean there's going be a time when someone asks for the gold and they aren't going to get it then all hell is going to break loose when the world figures out we all thought we owned gold but it was just paper gold and when people go get the real thing, I mean things can happen quite dramatically in the gold and silver and gold markets.
JP: Eric, what do you make of the Volcker rule regarding the banking system?
Eric: I haven't read the Volcker rule; I listen to what people say about the Volcker rule. I've had differences of opinions, mainstream media saying it's going to get tied down but I have others saying doesn't come in until 2015. Others say it sounds like there are all sorts of loopholes, and others that it can still be contested in court. So I'm not sitting here assuming that implementation of the Volcker rule will change the manipulation that goes on in the metal's market at the present time. Most of these banks that say they are leaving commodity trading always continue to say they are going trade in gold and silver. I'm not looking for any change in the Volcker rule to help the market at this point in time.
JP: What is it that we should be concerned with mostly as we move into 2014?
Eric: I think that the big thing that we have to watch is that, are we really in a recovery? When everyone tries to tell us we are in a recovery. You keep seeing the food stamp usage go up in the U.S. and the unemployment being at incredible levels in Europe, Japan's recovery is very modest considering they are spending $65 bn/month buying bonds. So I suspect if it is a recovery it is the most modest recovery of all time. Going into 2014 I think the biggest concern from the U.S. government's perspective besides the fact that the interest rates are rising which is a stake to the heart. I worry about this whole Obamacare thing. Everybody needs health insurance, it has been a nightmare so far just to get your health insurance and then when you get it and you find your healthcare insurance costs have skyrocketed. Of course health care costs are big costs for people already, so you can't have someone's health care costs go up 50 percent and expect you're going to have a strong economy next year. It will be very interesting to see when we transition to the new year and everyone has theoretically has put their health care to bed, it sounds to me from what I read that it is not the case and a lot of cases between rising deductibles and rising monthly fees that the cost of healthcare went up dramatically and it will be very negative for disposable income. So I think keep looking at the economy, see if it is really improving or not and we all really know that the mainstream media rarely wants us to know the truth. I found it interesting that this Informant that I mentioned was suggested in the Senate that they moved forward with it, there was not one commentary in the mainstream media which I find so ironic that we try to inform people but the mainstream media won't even report on the Informant. So you have to be very careful with what you believe in the newspaper because it is all in their interest for all to have a rosy feeling because it is good for their business. I think that the reality is that we have not had a good recovery and considering all the money that's being spent the recovery so pitiful, it's a joke, for every dollar we spend we got something like 27 cents GDP growth; that's a losing formula. Looking for signs of economic weakness would be the most important thing.
JP: The rise in interest rates could be the Fed's worst nightmare?
Eric: Unquestionably. Because as you know you get an awful catch 22 when your deficit is rising because of interest rates and because the deficits rising people like your bonds even less because they like your bonds even less than the interest rates go up and you get into a vicious catch 22. We saw what happened when finally the world realized that Greece was not in good credit, if I recall their interest rates got into 60 and 70 percent and almost over 90 probably in the three month they went from 10 to 50 because it just became apparent to everyone that the debt was not to be paid in some bond losses would be sustained. That's what happens when people worry about the credit of a country and if interest rates continue to rise here and is really no control over the deficit, you can get into a very dangerous catch 22 which could negatively impact all in a manner financially.
JP: Any last comments you would like to make to our audience as we end 2013?
Eric: Well, it has been a devastating last two years, the sentiment for the gold and silver and equities can't be any lower really. Yet all the data we look at says that the demand for gold is as strong as can be and if we ever get a new government in India, which I think is scheduled to take place on May 14 and who by the way the challenger is now the favorite (he is pro gold), and if we bring India back in the gold market, then I think everyone will be stunned by what the price of gold does. This is because there is lots of demand all over the place, the concerns of a government are high and the concerns of a currency are high. So I'm looking forward to 2014 and I think that what we have been put through was orchestrated by central banks and they will meet their comeuppance with the amount of physical demand we see in the market today. I'm still very, very hopeful of a very major recovery and of course outside's returns in gold equities because they will go up many times more than the price of gold. We are keeping our fingers crossed, all the data is supporting us and we got to get the paper market not to be in control of things and we have to have the physical market to get in control of things and I can assure your listeners that things in the physical market couldn't be better.
JP: Eric, How can our audience get in contact with you and your products?
Eric: We have a website called sprott.com, as you know we have a number of products that would appeal to many people whether it is their gold trust that's listed on New York Exchange, the PSLV silver trust in New York, the platinum/palladium trust; we have many equity funds that are precious metals. There are lots of products, most of the items we write are on that website and I would encourage people to look at the records and in fact study some of these articles, particularly the ones that are written about if the Western Central Banks have any gold left because I believe they are on fumes here and our day is going to come.
JP: On behalf of Equity management Academy and our audience, we sincerely wish you and your family, peace and joy during the Holiday Season!
The information in the Market Commentaries was obtained from sources believed to be reliable, but we do not guarantee its accuracy. Neither the information nor any opinion expressed therein constitutes a solicitation of the purchase or sale of any futures or options contracts