Interview: How Investors' Irrational Behavior Can Drive Commodities Trends

by: Hard Assets Investor

Mike Norman (Norman): Hello everybody. Welcome back to I’m Mike Norman, your host, here with the second part of my interview with Dr. Henry Jarecki. And I was fascinated. We ended our last discussion talking about irrational behavior, or how people believe a certain thing, that perception is reality, right? How much of that do you feel, now, is driving the trends in commodities, for example, gold and oil?

Henry Jarecki, chairman, Gresham Investment Management (Jarecki): Well, I think you've seen so many commodities having moved up in the last years at the same time as we've seen the monetary authorities putting out a lot of paper under the heading of quantitative easing, or pump priming, or whatever it is. There's a natural balance between the amount of paper money and the amount of goods in the world. And when you increase the amount of paper money, the price of each of the goods in the limited-goods world will diminish.

Norman: But they’re not, really. Because you’re talking about one thing, which is monetary policy. But if you look at bank credit, that’s contracted almost 1-for-1 with the amount of reserves that have been added as a result of the financial crisis, QE 1 and QE2. So I hear this argument a lot. But you can’t really justify it in the numbers. Bank credit, total loans outstanding, have contracted by about $800 billion since the financial crisis. That’s a big withdrawal of money.

Jarecki: The bank credit is, I don’t think, the proper numerator, because it’s really only what the monetary authorities are doing with the amount of money. Sure, there is more money within the banks. And so the banks are more prone to buy bonds and to buy various purportedly safer assets. Whether they’re safe or not safe, goodness only knows that maybe everybody isn’t getting paid properly.

Norman: I’ll tell you what I think it is, and it goes back to what you said earlier: I think most people believe that when central banks set interest rates lower, they have to add reserves to the banking system by definition; that’s the mechanism. If people believe that causes inflation, they will act on that belief. And I think that’s what’s playing out right now. It’s not necessarily creating an inflation. But their belief pushes prices higher. You don’t think that’s a part of it too?

Jarecki: No. I think it’s the reality of …

Norman: I forgot you are a psychiatrist.

Jarecki: No, no, there’s more money sloshing around the system. And I don’t think the bank credit is that germane. If the banks had something to do with that money, they would do it. But there’s an enormous pool of money ready to jump in when they would feel there was some safety in the assets. And people can continue to take risks. And the monetary authorities really are winking and saying, “Go ahead and take some risks. We’ll bail you out all over again.”

Norman: You look at, for example, equity markets, which have come back smartly from the low depths that we saw in March 2009. Corporate profits have never been higher. Economic growth around the world − with some exceptions, I’d say, in Europe, where austerity is being imposed − is starting to come back. In some places, it’s strong, like in Asia and Latin America. Equities are gaining more of a following. But people want those hard assets, it seems.

Jarecki: Well, I think it’s the sense people have of an illusion of an earnings stream, and an earnings stream that will continue, that leads people to be willing to have equities at the moment. That may work out very well for them, if the enthusiasm can be, again, stimulated. But naturally, there is anxiety. The only things that people know that are real assets are gold and silver and objects and commodity assets; they do not evaporate the way earnings can.

I’m not saying ithat it’s better or worse. If you believe in the current earnings enthusiasm, maybe nothing can catch up with the leverage that stocks give people.

Norman: In your management activities, now, with Gresham, your fund, what markets are you most focused on? Which ones do you feel have the best potential, let’s say, in the next year? And which ones maybe are you less exposed to?

Jarecki: Well, we don’t think that way. We have 32 different commodities in our pool. We have six groups of commodities. The only decisions we make are whether we’re going to have 3 percent of that or 7 percent of that. And we have some complex economic algorithms that guide us in that. But we try to provide for investors access and exposure to the entire gamut of commodities.

Norman: So would you say it’s a long-only strategy?

Jarecki: Ours is exclusively long-only, and fully invested. We don’t use leverage in it. And we’ve got $10 billion or $15 billion worth of people who say that those are investments in which they want to engage.

Norman: Fantastic. Dr. Henry Jarecki, thank you very much for being on the program. I appreciate it.

Jarecki: Good to see you, Mike.

Norman: That’s it for now, folks. We’ll see you next time. This is Mike Norman. Take care. Bye bye.