John Embry: As Confidence Returns, Gold Will Rise
Source: Interviewed by Gordon Holmes, The Gold Report 03/08/2010
The Gold Report caught up with John Embry, Chief Investment Strategist, Sprott Asset Management, to get his thoughts on gold and some mining stocks he favors. Embry, an industry expert in precious metals, has researched the gold sector for over 30 years. Read about why he thinks gold could gain another 30% this year as a greater proportion of the public realizes the degree of difficulty that sovereign debt is in. He believes as confidence in gold returns people will seek an outlet in gold stocks, especially small-cap gold producers and junior explorers with solid projects.

The Gold Report: John, in Investors Digest of Canada you recently said you're expecting gold to gain another 30% this year.

John Embry: I would say at least 30%. I said that I thought it would be the best year to date. We've had nine years consecutive higher year-end prices and the best year in that span for a year's return was 31%. I think this will be the year that we exceed it in this, the 10th year of the bull market.

TGR: What's driving this? Why is this year going to be the best year?

JE: I think we're getting very close to the point when a greater proportion of the public realizes the degree of difficulty that sovereign debt is in. And at that point, when you can't depend on your government paper as a safe haven, I think that fact puts gold in a much better light in more people's eyes.

TGR: You might say the first leg down were the individuals who couldn't pay their mortgages and that caused part of the '08 collapse. And now it looks like it's the government's.

JE: It's very simple, actually. Private demand, as you know, was so weak that governments had to step in to maintain order in the economy and in so doing, they spent an enormous amount of money, at the same time that revenue streams fell because of the weakness in the private sector. Governments spent dramatically more money and the results are a budget deficit I never thought I'd see in my life. I'm shocked at the numbers in many places.

TGR: It's been unbelievable. Now when you talk about gold, you're talking about bullion. How do you see the gold stocks? Do you think we're going to have a pullback? Ian Gordon of Longwave Analytics and Richard Russell (Dow Theory) predict the Dow will go to 1000.

JE: I don't agree with them. As much as I love Richard Russell—he's probably been as big an influence in my career as anyone—I don't think that deflation is necessarily the outcome when you have a pure fiat currency system. I think the far greater risk is hyperinflation because I believe that these guys that are in control today have seen the depressionary '30s, and they will move heaven and earth to prevent that outcome. And when you've got the capacity to create unlimited money, I believe you can do it. So I hear Gordon and Russell and I respect them, but I'm in the camp that thinks we'll get hyperinflation first. We'll eventually have to clean out the debt, but I think we go hyper before that.

TGR: So hyperinflation. Would that include stocks as well?

JE: I think stocks will do fine. They may have a violent correction first because a lot of people don't know what the heck we're talking about here. And when they see inflation mounting and economic conditions being less than ideal, they'll sell their stocks. But the fact is that if you go back and look at any hyperinflationary environment anywhere, stocks did infinitely better than paper instruments. So precious metals first, stocks second.

TGR: When you're talking about stocks, you're not talking just about gold stocks.

JE: No, I'm talking about good businesses. I'm not talking necessarily about banks and other stuff that's more dubious, based all on paper, but businesses like breweries, for example. People are always going to drink beer and a good brewing company will do exceptionally well in the debased currency of whatever country it's in.

TGR: So you think that we might have a sell-off and in that sell-off all equities, including gold stocks, would go down.

JE: Gold stocks, maybe. I believe the next time everything goes down, gold isn't going down. And if that were to be the case, I think gold stocks might surprise. They've been awful. Given what the gold price has done, gold stocks, by and large, have been awful.

Well, the well-promoted ones and the odd good one have done okay, but across the whole list, it's been pretty hard slog over the last three or four years, particularly 16 to 17 months ago when it we hit bottom. I thought they were going to zero.

So many of them are trading at less than they were back in November 2003, which was the real peak of the excitement in gold stocks, if you can imagine. Six and half years ago. The gold price has done nothing but go up in that time.

TGR: In this next cycle are you seeing better returns for producers or the juniors that have pounds in the ground?

JE: Oh, I think the juniors. The whole thing is a matter of confidence. They've got so much volatility in the gold price. You get a good thrust up and you got a violent correction and I think they've got so many people discouraged and going the wrong way on these gold stocks that right now the degree of confidence is very low. If I'm right and the gold price stages a dramatic breakout in the next 12 months—and I'm talking hundreds and hundreds of dollars on the upside—then I think the confidence will return and people will seek an outlet in gold stocks because so many of them have been beaten up. More importantly, the overall market cap of all the gold stocks is really small in the context of all the money around.

TGR: What's the seasonality of this year?

JE: I think that probably we may continue to wallow around here for maybe the better part of another month. Maybe not quite that long. But, historically, mid-March to mid-May has been a really good period. When I look at the fundamentals and everything that's going on, I see no reason why it shouldn't be a very good period this time. And there's one other development. I don't know whether it will come to fruition, but on March 25th the CFTC is going to be investigating position limits in gold and silver on the COMEX. And if they ever put any teeth into those things and kept these bullion banks from what they're doing on the short side with their large positions, I think that could have a salutary impact on gold and silver prices.

They're finally going to have to address this because there's been so many complaints about the bizarre price action on the COMEX in both gold and silver.

TGR: What about some individual stocks? Any that you'd like to comment on?

JE: Gold Fields (NYSE:GFI) remains very cheap. It's been under a cloud, I think, because there's been a lot of conversation among some of the more radical factions in South Africa about nationalizing the gold mines. I don't believe it's going to come to that. I talked to a chap who knows South African President Jacob Zuma fairly well and Zuma is certainly not in favor of that. There's always going to be radical factions. If they want to destroy their gold industry, nationalize.

TGR: That'll do it.

JE: Hopefully, cooler heads will prevail. On that basis, Gold Fields is extraordinarily cheap based on its reserve base.

TGR: What about consolidation plays? Do you think the time is right for that?

JE: I think the big problem is that the guys that head up some of these gold companies don't have the confidence in their own product that they should have. As a result, they're reluctant to pull the trigger on acquisitions that to me would be brilliant at this stage in time. We've seen some activity, as you mentioned, in Mexico. I know Goldcorp (NYSE:GG, TSX:G) has been picking up a few around its big silver play down there. And I think that's a great move. My attitude is that these guys, without exception, all have long-term reserve issues. If there's ever been a better time, based on my outlook for where all this is going, to pick them up, I can't think of one. These guys should be looking for anything that's real and using their paper right now to buy it.

Another stock I like that I sound like a broken record on is a Canadian-based company called Wesdome Mines (TSX:WD). They've got two operating gold mines, one in Quebec and one in Ontario. You couldn't be operating in a better geopolitical environment. They're both profitable. They had a dividend last year; they will pay a dividend this year. I believe the Canadian dollar, despite other people's belief that it's going to be very strong, isn't. Given the budgetary problems and everything that are coming up here, Canada will move heaven and earth to make sure its currency doesn't move up against the U.S. dollar, so I don't see any further cost pressures because of a stronger currency in Canada. They're having success with extending their ore bodies and they've got absolutely blue chip mining facilities and the stock, which probably earned something like 20 to 25 cents last year when it reports, trades at just over two bucks. I just think the thing is dirt cheap. I look at a lot of stuff that's years from production with market caps three times as big as this one. This one's got a total market cap of $215 million. So I think, of all the small stocks that I look at, I like small producers that are basically overlooked and this, to me, is probably the most overlooked small producer. I'm always interested in profitability and the ability to extend their reserve life related to market cap.

TGR: Any others?

JE: One that I like up here in Canada that I've liked for years that's just coming into production, and they are really adding to their reserve base, is Lake Shore Gold Corp. (TSX:LSG), which trades around three bucks. I think that they'll eventually prove up multi-three, four million ounces just outside of Timmins, which is another great place to be operating because of its long mining history. I'm a little less adventuresome these days in the sense that my greatest concern down the road for gold stocks is if my maligned view of where this is all headed occurs, one of the few sources of revenue for governments may be taxing gold mines. So I want to be in a geopolitical area where there is some respect for law and people aren't totally rapacious like they are in some of the third world countries.

They'll always go where the money is and in this case they may be even more desperate for money, so that's why when people ask me how should I be exposed to the gold industry, I say, well, the first thing you've got to have as the core of your portfolio is bullion, because that's forever. You don't have the same leverage to the upside necessarily, but on the other hand you know what you've got. The gold stocks are ephemeral, but if you hit them right, you're going to make a fortune. You will get a three- or four-time bigger move than you will in bullion at some point in time. But the long-term hold is bullion, in my opinion.

TGR: Would you speculate? I read that the IMF is going to be selling some gold and India stepped up earlier. What are your thoughts on that?

JE: The whole thing irritates me. The IMF has announced the sale of this gold 500 times and every time with the express purpose of knocking the price of gold down. It was interesting the last time when the Indians actually relieved them of over 200 tons because that was what basically vaulted the market from about $1,045, which the Indians paid, up to $1,225 in the space of less than a month. That has been followed by the third significant correction in the last three or four years.

I think we've seen the vast proportion of the correction and I think what may be one of the factors that could get this thing going again is when somebody does relieve the IMF of the gold, the 191 tons to be exact. There's speculation that India might be prepared to go to the plate again because the Chinese have been reluctant to step up. Number one, I don't think they want to be seen publicly doing it. They'd probably rather do it more clandestinely because they've got so much money to convert into hard assets. And, secondly, as somebody pointed out, the Chinese at least have a domestic supply of gold. They can buy all their domestic to augment their reserves, where the Indians really don't have that. So I think the Indians conceivably have a bigger vested interest here in taking that IMF gold. And there's also sort of the suggestion that the Chinese wouldn't want to be seen to be paying more than the Indians did, so they're reluctant to step up with the gold price $50 higher currently than the Indians paid. If it was really a free market, if they were really prepared to sell it to anybody, I think I could name any number of institutions, organizations, individuals that would be more than glad to relieve them of it. It's not much money. It's $6 billion. They throw it around as if it's a big deal. Heck, given the budget deficits in some of these countries, $6 billion is literally a piss in the ocean.

GR: That's right. What do you think when Soros came out and said that gold was a bubble?

JE: I wrote about that and I got it right. I was very pleased about that because some people got all upset. The people that were negative on gold thought this was great, brilliant George Soros doesn't like gold. But if you read between the lines, if you read really what he said, he said gold is the ultimate bubble, but he didn't say gold is currently the ultimate bubble. I believe that it will be the ultimate bubble. I think the gold price is going to go crazy and at that point I'd be worried about. And then it came out after the fact that Soros had been a major buyer of gold for his funds in the fourth quarter. So who knows what he was doing. The fact is, depending how you interpreted his remark, he was speaking at Davos, which is a very mainstream event, and he said something that can be interpreted any number of ways.

TGR: Right. And, again, I think the financial talking heads used it as the negative.

JE: Absolutely. The mainstream guys were all over it. The guys who have never like gold have been wrong all the way up and said, oh, my god, George Soros doesn't like gold. But I think George Soros' remarks were misinterpreted and if you saw what he was doing, not what he was saying, he was buying gold.

TGR: Alright. Any last comments?

JE: The only comment I'd make is I really think things are sufficiently serious here in a financial or monetary debasement sense that everybody—and I have never been a table pounder—but I think every single person with a serious portfolio has got to have a reasonably significant exposure to precious metals. This isn't something that's just insurance for those who've got cold feet. This is something I think is a mainstream thing that people must have.

TGR: When you say a significant portion, what percentages are you thinking?

JE: I used to say 5% to 10% when it was just an insurance thing and the market was pretty sanguine. I say at least 20% now. I see the other assets as being less attractive. I wouldn't buy a bond if you gifted me with the money to do it.

TGR: John, once again, I appreciate it.

John Embry is chief investment strategist at Sprott Asset Management and Sprott Gold and Precious Minerals Fund. He also co-chairs the Central GoldTrust Board of Trustees. An industry expert in precious metals, John's industry experience as a portfolio management specialist spans more than 45 years; he's simultaneously researched the gold sector for 30-plus of those years. He joined Sprott in 2003, after 15 years as Vice-President Equities at RBC Global Investment.