By Patrick MontesDeOca
On September 28, 2012, I had the pleasure and honor to spend a few minutes chatting with John Embry, Chief Investment Officer from Sprott Asset Management , one of the leading and most innovative investment funds in the world, managing more than $10 Billion in assets.
Sprott AM is a fund company dedicated to achieving superior returns for its investors over the long term. In June 2009, Sprott AM reorganized to better define and streamline the key segments of its business. Sprott Asset Management LP currently manages a number of long/short equity strategies and mutual funds. Sprott Private Wealth LP (Sprott PW) provides advisory services to high net worth individuals. Sprott Inc. is the parent company of Sprott AM and Sprott PW.
PM: John, once again, thank you for taking the time to spend with us during this most critical time. I want to move right into the situation with the middle east. What do you make of this, and how is it going to affect the price of gold and potentially crude oil fundamentally?
JE: It's very disturbing. I read a lot of stuff over the weekend. This video is kind of the catalyst which turned everybody on over there. But the fact is, that there is a fundamental problem, and that is, that there's an enormous number of unemployed Muslim youths. They're angry, and they don't like America. Now, they've been given the excuse to sort of basically act up and they're really taking advantage of it. I find it extraordinarily disturbing, and it can't be anything but positive for oil and gold prices down the road, but I think it's a very disturbing development.
PM: Does this kind of throw the wrench on the trend that seems to be developing here with some kind of a correction? In the process, if we do get that do you still feel very strong about buying into corrections in precious metals.
JE: I am not even sure we're going to get much of correction from this level. Admittedly, we're up a couple of hundred bucks since July, but that price to me, in view of the fundamentals, was preposterously low. I think that what's unfolded, particularly in Europe, and latterly in the United States last week with respect to almost unlimited QE, is wildly bullish for gold. The fact that it's not very well understood and it's not very widely owned, to me, can only mean that there's going to be many, many more buyers created as we go forward. So, I am about as bullish at this moment as I have been any time in the bull market.
PM: Friday Egan - Jones downgraded the U.S. credit rating to a AA-, citing the Federal Reserve's latest stimulus program to boost the sluggish economy, and of course, on Thursday the Fed said it would pump $40 billion into the U.S. economy each month, until they saw some kind of a sustained upturn in the weak jobs market. Could this be the beginning of the demand factor finally taking place in the metals that could make a big difference moving forward from here. In terms of price, breaking out of the old highs, as some technical analysts seem to think we're going towards $3,000?
JE: Well, I don't like putting specific numbers on it. It's not gold that's really doing anything. It's the value of the paper money that it's being denominated in, that's changing rapidly. I think developments recently, would suggest that the gold price in these devalued currencies is going to move markedly higher, relatively in the near term. I would actually be surprised if we're not comfortably in record territory before the year is out. Now, I don't have any dispute with these people that are coming up with these, plus $3-5000 numbers, down the road. I am encouraged by that for a number of reasons. One, is that the fundamentals are impeccable. Number two, the sentiment, given the fundamentals, is remarkably restrained, if not almost negative. Many people are totally unaware of the opportunity, and I just think that there is a building shortage of physical gold, and silver, for that matter. I think ultimately, that that will be the arbiter in where these prices are going, as the money just proliferates and physical gold and silver are less and less available.
PM: Why do you think many advisors frown on gold as a legitimate investment?
JE: That's an excellent question and I've thought about this a lot. I think that one of the reasons is that if you really embrace gold as a great investment opportunity here, it sort of casts aspersions on the traditional investments, bonds, stocks, and real estate. Most of these advisors have their clients up to their ears in these things, and I just don't think that they really want to disturb that, and they won't do so until it is too late. To me, that's the main reason. The other one is that I don't think they really understand gold as money. They basically bought into the mainstream press argument that it's the "barbers yellow relic", etc., and they're wrong.
PM: What do you think about the election outcome and has that any bearing on the price of metals moving forward?
JE: I don't really think it is that big of a deal. Both parties, whoever gets elected, at this point it would appear that Obama is leading, which surprises me, given how weak the economy is, I don't think that either party has a lot of leeway. I was just looking at an interesting argument that I had seen put forth before. That is, the idea that the private sector is in a balance sheet retrenchment, and as a result, the only thing that can sustain the economy is even larger government deficits, and what have you. So, as they come up to this fiscal cliff after the election, I think that they're going to capitulate and they are not going to do anything of substance, and as a result, I don't think the outcome of the election is a big factor in where this is all headed.
PM: What if the U.S. makes it mandatory for the budget cuts to take effect? How would that change the canvas?
JE: Well, if they actually do that, and I guess anything is possible, they will throw the U.S. economy into, probably a depression, but certainly, if not a depression, a very deep recession. The implications of that, considering where we are financially right now, is horrifying.
PM: But, does it make sense for that to take place?
JE: Well, that's correct. In my opinion, I think their hands are tied, and that's the thing, that when you get beyond a certain point in your budget deficits, and your embedded debt and that, your options are really limited, and I'm very afraid that the US and many other countries, it's just not the U.S., have reached that unhappy state.
PM: Do you like the gold mining sector as well, since we have seen this move in gold. We have come off the lows really nicely?
JE: We've moved quite smartly off the lows. I mean the HUI, the unhedged gold index, has probably moved almost 25%. They were so oversold. I don't think I've ever seen them cheaper, in relation to the gold and silver prices. So consequently, if I'm right, and the gold and silver prices really stage a major break of the record highs in the not too distant future, the shares still have a long way to go. I'm extremely bullish on good quality ones. One of the things that undermined the shares is that there was so much junk, and there was so much badly promoted garbage, that I think it really did damage to the whole sector. Going forward, I think the good ones are really going to assert themselves and you're going to make an awful lot of money in them.
PM: So at current levels there are still some fairly good values?
JE: Oh, very good, excellent value, even at current prices. I think that one of the things that has concerned people has been the rising costs within the companies and the fact that they're not chalking up the cash flow and earning gains that have been anticipated. I think that what we're going to see going forward, is the gold and silver prices will outrun costs and there will be a huge improvement in the bottom line, and the sentiment towards these shares will change dramatically. I don't have a problem seeing them going up many multiples of the current prices.
PM: The latest figures coming out of China seem to indicate that China is buying gold in massive quantities and possibly, going directly to some of the mining companies. In your opinion, do you think that China will continue to purchase gold in large quantities, and is there any kind of specific reason besides the debt, the weakening currencies and so on, that could be the catalyst for that, such as possibly putting the Chinese yuan as the competitor for a world reserve currency?
JE: I think everything you've said is correct. I think, initially, China was buying all of its own mine production. They became the largest producer in the world recently, but that was insufficient. Recently, these enormous amounts of gold going in through Hong Kong, I think it's 500 tons already this year, is a huge development, because you're only talking about roughly 2500 tons of mined new ore a year in the whole world. I think that the Chinese are very smart people, and they are very cognizant of what is going on in the world, and the relentless debasement of money, and they own an awful lot, still, of U.S. paper. They can see what's happening in the U.S. I believe that they will continue, if not accelerate their accumulations of gold, with the idea that they may actually back their currency ultimately, and make the yuan the strongest currency in the world, because there isn't much competition these days. They all look pretty terrible.
PM: You know, we've been looking at the bond market recently. In fact, last week, on the face of the Fed's announcement of QE3, the bond market dropped 2 points. The chart doesn't look friendly. Its got what technical analysts consider to be a triple top. My concern, is that if interest rates break away from the government or political manipulation, which markets will do at some point, break away from any country or individual, no one is bigger than the market, what is going to happen to the price of gold if, in fact, if interest rates begin to put on a higher risk for ownership of U.S. bonds?
JE: Well I think what you just said is all very true. That's exactly what's going to happen. I have an extreme view on bonds. I think anybody who owns one has got to have their head examined. I think that Bill Gross, the world's biggest bond buyer, has been pretty outspoken that he sold 32 billion worth of U.S. Treasuries recently, and he's been recommending gold, real estate, houses, anything tangible, and if anyone knows the bond market he does. It is interesting, because when interest rates rose sharply in the 70's, and one of the few good things about being old, is that I was around then, that was extremely bullish for gold. When gold was making it's record high in 1979-1980, interest rates were going through the roof. I see this exact thing happening, but the problem is, that this time the financial system is so stressed, that this could have a horrific impact. That is one of the reasons that they are keeping interest rates as low as they are, in order to keep everything afloat. So, I'm not very optimistic about owning traditional assets. That's one of the reasons why I'm wildly bullish about gold and silver in this environment.
PM: So, you continue to expect money to be flowing more and more into precious metals as the perception, or the public consciousness increases, will that be enough to trigger a hyperbolic rally?
JE: Absolutely! That's an excellent point. Basically, in previous bull markets, gold, silver and their shares got to be as much as 5 - 10% of outstanding financial assets. Right now, they are comfortably under 1%, so there is all sorts of opportunity for a lot of money to go in this direction. There's not a lot of extra physical gold and silver around, so, if this money moves in that direction and wants into the market, the price impact is going to be outsized.
PM: Will the price have to start another large move before the public will get involved?
JE: Yes, I think the sophisticated money is going in, Chinese money, Indian's and Russian's, and what have you, but more at a very senior level. Even in North America and Europe, where gold is being bought, its being bought by sophisticated and wealthy individuals. I think you are going to have to get a major move in the price from here, certainly to record levels. You will also need more positive headlines before the public will get involved. I think they will be late to the party and that will put another leg on.
PM: You have been in the business for a long time John, and certainly I think if anybody has seen all of it in this particular market, it is in you career. Once again I do appreciate the time you spent with us here for the benefit of our audience and I look forward to possibly catch up with you again sometime in the near future.
JE: I would be delighted to talk with you at anytime.
PM: Thank you again John.
JE: My Pleasure.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within 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.
Additional disclosure: Trading in the financial markets involves significant risk of loss and is not suitable for everyone. Past performance is not necessarily indicative of future results.