Fear of a recession will keep gold trading in
the $800-$1,000 range for most of 2008, says Joseph McAlinden, Chairman
and CEO of Catalpa Capital LLC, a small-asset management company. Prior
to founding Catalpa, McAlinden was managing director and global chief
investment officer for Morgan Stanley Investment Management.
TGR: Let’s start with the big question on everyone’s minds these days. Are we headed for a recession?
JM: The unfolding consensus is that the U.S. economy, dragged down by the housing mess, is sliding into a recession. The broader global view is that there is a high risk that a failing U.S. economy will have a negative effect not only on Europe’s economy, but also Asia’s. Until recently, economists were clinging to the notion that the emerging economies had become self-sustaining, that their own domestic demand would sustain economic growth even if exports to the U.S. fell off. But in fact, the U.S. continues to be the primary consumer of goods in the world. So what happens here affects economies worldwide. The markets now seem to recognize and reflect this.
TGR: Do you agree with that consensus? And what does it all mean for gold and silver in the coming months?
JM: Not necessarily. World central banks do not want to preside over a big recession or depression. Neither does Bernanke. It is a safe assumption that the Fed and the world banks will act aggressively to stop any slide into recession. That belief is what drove the gold price from its mid-December level to the recent high.
TGR: So you don’t think a recession is inevitable?
JM: I think the economic conditions in the U.S. and the world are a lot stronger than the markets think. However, I understand why so many economists are shifting their views and beginning to worry about recession. The problem is, I believe, that if the Fed continues to react as aggressively as it did between the summer and the end of the year, it’s going to be like throwing more fuel on the fire and contributing to a build-up of inflationary pressures into 2009 that will be more pervasive and harder to rein in than the pressures we’re experiencing now. It’s true that the numbers are not overwhelmingly pointing to a big resurgence of inflation. On the contrary, commodity prices are up, but the indexes show that the prices of everything else have been pretty well contained.
TGR: Yet most of us are feeling the pinch right now, with food and energy prices going up, right?
JM: It’s true. While the indexes may show that prices are contained, that’s not what I experience in my personal life. The cost of driving over the bridge has gone up. The cost of going to the movies has gone up. My healthcare costs have gone up. I think there’s a disconnect between what people are actually experiencing and what’s being reported in the CPI. That said, I believe the recent moves by the Fed are making things worse in the long run. The U.S. stock market was making new highs; the sub-prime problem began to unfold; the Bear Stearns hedge funds problems came along, and it got worse, and it got worse, and it got worse.
TGR: And the stock market headed south.
JM: That’s right, the Dow is down a little over 12% [as of this interview]. That sounds like a lot because there haven’t been a great many corrections throughout our history that have been greater than 10%. But a decline hardly signals a slide into a recession. This recent decline reminds me a lot of a similar one in 1998 when the Dow dropped 19%. Everyone was worried. There was a lot of talk of systemic risk in the system. The Fed got involved. People worried about Long-Term Credit and what kind of derivatives they had in their fund, and how that would affect the world financial system.
TGR: And yet, we didn’t slip into a recession then, did we?
JM: We didn’t. The Fed became more accommodating to help the economy get through that period and to prepare for the Y2K. The stock market shot back up, and made new highs early in the year 2000. I think we’re dealing with a similar situation right now. I think the market will bottom out in the next month or so. And then all of this monetary stimulation is going to carry stock prices back up into stronger territory.
TGR: How long do you think the recovery will last?
JM: I think we’ll end 2008 in positive territory. A bigger decline may be lurking out there, but my guess is that it doesn’t catch up with us until 2009 or 2010. In the meantime, the monetary easing will re-energize the market, stabilize the economy, and probably push commodity prices even further into new high territory.
TGR: Do you think we’ll see a broad-market recovery? Or are you referring only to commodity stocks?
JM: I think the broad stock market is going to have a broad recovery, and I think a lot of the consumer discretionary stocks that have performed so poorly are going to have a powerful, maybe even shocking, recovery as we make our way through the second half of the year.
TGR: Will some sectors recover faster than others?
JM: Things like home furnishings and, believe it or not, home builders, which until lately I’ve been very bearish on. Economists look at the real estate market and say, “Oh, my god, people are selling their homes for 10% less than what they sold them for last year.” But, guess what? There’s another guy who maybe couldn’t have afforded that house last year, but can buy it now, for 10% less. As economists, we look at a number that captures that—called the Housing Affordability Index—which takes into account home prices, as well as income trends and mortgage rates. Mortgage rates have come way down; income growth may hold up; home prices have come way down, and so housing affordability has improved dramatically. There’s a lead of about a year between the turns in housing affordability and the turns in home building. So, housing affordability started to improve in the second quarter of last year, improved very modestly in the beginning, and now it’s improving at a stronger pace. So while it’s true these sectors aren’t performing well now, there will probably be a big comeback in those sectors.
TGR: And you think this will ultimately lead to more inflation?
JM: Yes. In a nutshell, I think the Fed is going to be forced to take additional, aggressive steps to ease rates, even though I believe it’s probably not as necessary as everybody thinks. And as a result, we’ll see more inflation. And I think that’s what the moves up in the dollar and gold and silver have been telling us.
TGR: What about today’s setback in precious metals?
JM: Investors have the jitters and are selling erratically right now. But I think that’s going to stabilize and turn around. I think that overall for the year, gold is going to trade in a range between $800 and $1000.
TGR: What effect might the elections have on the markets?
JM: In the short run, whether it’s Hillary or Obama, or McCain or Romney, I’m not sure it matters all that much. Now, if Ron Paul or Huckabee won, it would matter; but I don’t see it going that way. I think who gets the nomination and how the polls are going won’t affect the market much up through November. Once we see who the winner is there may be a reaction of some kind or another, but I don’t think it’s going to be significant.
TGR: So it comes back to the banks and the Fed?
JM: Central bank policy is key. Of course if the Fed were to take my view, and recognize the risk of easing excessively, maybe it would change course and that would change everything. For example, if the Fed were to look at only 25 basis points at the next meeting, instead of the 50 basis points it’s considering now. If that were to happen, then I think the market would drop sharply and dramatically lower, probably on a sustained basis into the second quarter.
TGR: Do you think that could happen?
JM: I doubt it. It’s more likely the Fed will continue to take more aggressive steps to ward off a recession. And I believe this will lead to inflation, which is bullish for gold and silver.
TGR: When you say gold and silver, are you referring to the commodity, or to gold and silver stocks?
JM: I’m talking about the commodities. However, the basket of the respective stocks could be even more rewarding. There are interesting ways to hedge both the stocks and the commodity, which is a good thing to do because they’re highly volatile. You can buy the gold ETFS or gold futures, and then you can look for puts to hedge your position. This gives away some of the return. However, in terms of the kinds of swings that we’ve had in gold, it’s not a bad idea. And I would suggest people think about doing that.
TGR: Where do you think the better return is – with the gold and silver commodities or the mining stocks?
JM: I think the mining companies will return better than commodities in the next three to six months, but it’s going to be close.
TGR: What companies do you like better – the discoverers or the producers?
JM: The producers. If gold rises from the $800s to $1000, the companies that have known deposits in the ground will see their earning power go up in proportion to the price rise. I shouldn’t say in proportion to; it’s the leveraged effect to the rise in price. The discoverers, on the other hand, face a host of idiosyncratic risks. So I’d look at commodities and producers right now.