In a wide-ranging phone interview last week we had the pleasure and honor to chat with Rick Rule, Founder and Chairman of Sprott Asset Management USA, we discussed the outflow of gold from the United States, Goldman Sachs' poor gold prediction record, default on the installment plan, and the potential of junior mining stocks.
The United States exported almost 500 tons of gold in January, primarily to Hong Kong and Switzerland. Rule believes much of the gold came from GLD and from leveraged long hedge funds. But, he cautioned, "The truth is, no one really knows." There is some anecdotal evidence that Western Central Banks may not have as much gold as they claim. When the Germans asked for their 1,200 tons of gold back from the US, they were told it would take seven years to return all of the gold.
Goldman-Sachs recent statement that gold would fall to $1,085 an ounce ("a sure bet"), reminded Rule of their call at $1,800 that gold would hit $2,500 an ounce. Rule called Goldman Sachs, "An extremely accomplished firm that is out of their element." He said, "Their track record in regards to gold seems to be one almost unblemished by success."
Turning to interest rates, given the still weak economy, some may wonder why the Fed is continuing to taper its bond buying. Rule said the Fed policy was never really about the economy. It was, "To make up for the difference between what the Federal Government spends and what it takes in." Rule said last year's tax reform was "a populist scheme to steal more money from the most productive members of society." With the changes in the tax code, the government "Now needs to counterfeit $10 billion a month less, because [it] is stealing $10 billion a month more." Therefore, it can taper.
Rule said, "Central bankers on a global basis have done a wonderful job of convincing a citizenry that was desperate to be convinced, that liquidity was a substitute for solvency. The idea that increasingly insolvent central banks can pay record lower interest rates, when their ability to service the debts is at record low levels is implausible."
Rule views stocks favorably. He said that when he looks at the S&P 500 companies, "I see a fine collection of businesses." However, they are thriving in an almost artificial, low-interest rate environment. Rule said, "I am concerned about what will happens in a high interest rate environment." He said of the current environment, "It almost couldn't get better, so as a consequence it will probably get worse."
Rule does not believe that China is in a bubble. He believes the structure of the economy has led to "Extraordinary misallocation," but has great respect for the resourcefulness and educational focus of the Chinese people. "All the Chinese have to do to fix China," he said, "is to do nothing. However, they may not have the courage to do that." Even so, Rule said, "In the intermediate and long term, I am extremely bullish on China."
If, or when, interest rates rise, Rule said things will get "truly ugly." Everything will go down, including gold and silver. The holding costs of gold and silver will go up, and the greed side of the fear/greed balance that drives gold and silver will be affected. Even so, Rule warned, that we need "an honest interest rate." Savers have to be reward for saving and not spending. He suggested that if the United States had allowed interest rates to rise in the 1990s, we would have had an "ugly" recession for two or three years, but we would have emerged far stronger today.
Discussing the massive US debt of $17 trillion on balance sheet liabilities and $65 trillion off balance sheet liabilities, Rule said, "The simple math argues for default." Put simply, the older generation made promises to themselves, which now the younger generation is expected to pay, and can't. We could just announce that we are not going to pay those obligations, but we will not do that. Instead, Rule said, "We are going to default on the installment plan" by printing money to create inflation which will decrease the debt obligations.
If we do enter a deflationary period or a chaotic one, gold and silver should do well. "For many societies in many times, gold served as real money." Rule explained that one of the problems in deflation is that "no one trusts anyone else to pay," and currency is a promise to pay. Gold, however, isn't a promise. Gold is payment in and of itself. The Vietnamese in America, who have the most recent experience of chaos of any group of Americans, are "all gold bugs." They experienced the chaos in South Vietnam as the war ended, and those with gold bought their way out and those without gold, did not.
As he has mentioned before in my interviews with him, Rule said that gold mining shares appear to have hit a bottom. However, Rule said, "The recovery will be saucer shaped, not V shaped." He expects a 12- to 18-month gradual recovery with higher highs and lower lows alongside 15 to 20 percent swings. He recommended buying corrections but focusing on which stocks to buy. Overall the junior mining stock sector is "worthless," but the top 10 percent, he predicted, will make amazing returns.
Past, Present and Future
The gold and silver markets are slowly unfolding and validating the multi-year cyclical bottom anticipated in a report first published December 22, 2013. In this report we mention a completion of this long-term bearish cycle no later than December 23/24 of 2014.
In a follow up report published in Seeking Alpha, I made the following comments:
Our published weekly VC Price Momentum Indicator posted on December 29, recommended to cover shorts at 18.97 on a weekly basis and reverse to a long position using the 18.97 as a weekly protective stop loss. A close below would usher the possibility of testing the 17 price levels. If this level is reached, I would call it a divine gift, as prices are well below the cost of production and could become very difficult to actually purchase physical silver without a large premium cost attached to it. This would inevitably precipitate a self fulfilling prophecy of creating a shortfall in production.
With the price well below the cost of production and the long-term cycle in interest rates changing (higher rates), it might become a very difficult environment to finance future production. As prospects for global economic growth increase, this will support a record physical demand to continue to increase in the foreseeable future. A shortage of supply mentality might develop as demand shifts to silver from a speculative demand base product to an industrial demand based product, putting tremendous pressure on the shorts.
The gold market rallied from a low of 1186.70 completed on December 31, 2013 to a high of 1392.20 made on March 17 of this year. This was a $205.50 per ounce (17.3%) gain, confirming the first leg of this developing multi-year cyclical low. Silver rallied from a low of 18.915 from December 31, 2013 to a high of 22.24 made on February, 24 2014. This was a $3.32 per ounce (18%) gain during the same time frame.
The gold and silver markets currently are unfolding into a '2' or 'b' wave decline. As long as June gold does not close below 1277 (turning its weekly trend down) it supports the potential for a second advance or '3' 'c' wave up in May and potentially extend its monthly patterns converging with some larger weekly cycles indicating the possibility this extended rally can peak in the middle of August/September time frame.
Echoing my comments made last week for gold I said, "Cover short on corrections at the 1280 - 1255 levels and go long on a weekly reversal stop." As the market spiked to a monthly low of 1272 on Friday, the VC Price Momentum Indicator triggered a Buy signal at the 1280 level. Use the 1293 as your stop close only daily level of protection. Look to take some profits next week as we approach the 1315 to 1328 weekly resistance levels.
In this report I also commented about the silver market and I said, "Cover short on corrections at the 19.16 - 18.53 levels and go long on a weekly reversal stop." As the market spiked to a monthly low of 18.68 on May 1, the VC Price Momentum Indicator triggered a Buy signal at 19.16. Use the 19.33 as your stop close only daily level of protection. Look to take some profits as we approach the 19.97 to 20.42 weekly resistance levels.
For a more detailed technical picture, let's take a look at the gold and silver markets and see what trading/investing opportunities we can identify for next week.
The June gold futures contract closed at 1301. The market closing above the 9 day MA (1293) is confirmation that the trend momentum is bullish. A close below the 9 day MA would negate the weekly bullish short-term trend to neutral.
With the market closing above the The VC Weekly Price Momentum Indicator of 1293, it confirms that the price momentum is bullish. A close below the VC Weekly, it would negate the bullish signal to neutral.
Cover short on corrections at the 1280 - 1258 levels and go long on a weekly reversal stop. If long, use the 1258 level as a Stop Close Only and Good Till Cancelled order. Look to take some profits on longs, as we reach the 1315 - 1328 levels during the week.
The July Silver futures contract closed at 19.52. The market closing above the 9 day MA (19.46) is confirmation that the trend momentum is bullish. A close below the 9 day MA would negate the weekly bearish short-term trend to neutral.
With the market closing above The VC Weekly Price Momentum Indicator of 19.33, it confirms that the price momentum is bullish. A close below the VC Weekly, it would negate the bullish signal to neutral.
Cover short on corrections at the 18.87 - 18.22 levels and go long on a weekly reversal stop. If long, use the 18.22 level as a Stop Close Only and Good Till Cancelled order. Look to take some profits on longs, as we reach the 19.97 - 20.43 levels during the week.
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 herein constitutes a solicitation of the purchase or sale of any futures or options contracts.
Trading derivatives financial instruments and precious metals involves significant risk of loss and is not suitable for everyone. Past performance is not necessarily indicative of future results.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AGOL, AGQ, DBS, DGL, DGLD, DGP, DGZ, DSLV, DZZ, GLD, GLDI, GLL, IAU, PHYS, SGOL, SIVR, SLV, SLVO, TBAR, UBG, UGL, UGLD, USLV, USV, ZSL over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.