No Middle Ground

Buy Gold , says this investment strategist, because it's "Inflate or Die!" for
the US economy... WHOEVER controls the US Congress, John Embry – chief
investment strategist at Sprott Asset Management – holds out little hope for
economic happiness in the short run. As he tells The Gold Report in this
interview, "It's consequence time..." The Gold Report: Why are equities markets
generally increasing and what should we expect from equities and gold markets
going forward? John Embry: I think the equity markets are reflecting the
enormous amount of liquidity being injected into the market, particularly in the
US. There's no question that POMO [permanent open market operations] are going
on continuously – to the extent that Goldman Sachs has identified the days
they're happening, and recommending people buy equities those days. They're
having an outsized impact on the market. This does not reflect the underlying
economics whatsoever. We're very concerned about what might happen to equities,
because we continue to believe our view on the economy is playing out and that
the US has no real forward thrust. I don't think equities are all that
interesting now, particularly at the level to which they've been elevated due to
these various market interventions. The authorities wanted to make things look
better going into the November elections. Maybe now, there will be less pressure
to inflate things to such an extent and they will focus more on reality than
elections. Now that we're through the elections, it's almost like the roadrunner
off the cliff. The feet are going fast, but look out below. TGR: Do you
anticipate poor economic data will be released after the elections? John Embry:
I think the spin will be less positive. I am a great believer in John Williams'
ShadowStats. His numbers are much closer to reality, but those the public sees
don't look as bad as they really are. I think that perception will change. More
people will start paying attention, see that things aren't as good as they think
and realize we could get into a reasonably unpleasant period. TGR: How do you
feel about Gold Investing ? John Embry: We continue to like gold very much. All
this talk about bubbles and overbought is interesting in that sentiment is
actually quite lousy. Interest in the market amongst the hoi polloi is very
limited. I don't see a lot of enthusiasm toward gold at this point, which is a
precursor to better markets. So, we like gold; we don't like equities so much.
TGR: Ultimately, will the US economy be affected by either Republicans or
Democrats controlling the Senate? John Embry: In the long term, maybe; in the
short-term, no. In the short run, I think the die is cast. They realize how
serious the problem is, and that the Fed is in control and will likely continue
down this path of quantitative easing (QE). That will be the defining thing in
the short run. In the long run, I think the conservatives on the Republican side
– certainly the Tea Partiers – may have an impact along the lines of what's
going down in England now. What the Conservatives are doing in the UK is quite
remarkable; really Draconian. It will be an interesting test case to see how
this works out. TGR: Wouldn't you say they did the same thing in Greece? John
Embry: Yes; but so far, the English are putting up with it; the Greek, French,
etc., are already starting to rebel. It will be fascinating to see how Americans
will respond to that sort of activity. TGR: Given the power of the American
consumer, could something that drastic happen in the US without tanking the
economy? John Embry: No. I am absolutely positive on that point. If the US took
a really hard stance on dealing with the budget deficit, the implications would
be horrific for the economy. I think it would set off a depression that would
make the '30s look good. TGR: When you say, "the die is cast," are you referring
to QE as the proposed solution to counter that? John Embry: Unquestionably. The
government is going to take the path of least resistance in the short run. Do I
believe this is a solution in the long run? No. It just postpones the inevitable
and, conceivably, makes it worse. But that doesn't mean the Fed won't opt for QE
in the short run; it's certainly indicated it will go that direction. TGR: The
Draconian cuts would push the US into a greater depression; and, at the other
extreme with QE, we don't know quite the magnitude. Is there no middle ground?
John Embry: No. This is where I differ from many analysts and pundits; I think
the middle ground was lost years ago. Any opportunity for a pleasant near-term
outcome is long gone. Americans can take the pain now or something verging on
hyperinflation and greater pain later. So, pick your poison. If I were emperor,
I'd take the pain now. TGR: Is it a foregone conclusion that inflation or
hyperinflation would lead back into a depression? Will we end up in the same
place regardless? John Embry: I think we do end up in the same place. There's no
example in history that unbridled money creation works to solve any problems; in
fact, it usually exacerbates them. I'm not sure it's going to be any different
this time because I believe today's financial structure is probably more
vulnerable than it's ever been in history. I don't want to get into derivatives
and all these various collateralized debt vehicles, but the fact is we've never
seen anything like this before. If you try to deflate, that would come to the
fore immediately; if you inflate, that just creates a bigger problem later. So,
I'm kind of stuck; I can't see a more positive outcome. I am a great believer in
the Austrian School of Economics, and with a hugely excessive debt buildup in
the economic system, there's no escaping the consequences. We've had the biggest
debt buildup in history, and here we are in consequence time. TGR: I think
everybody agrees about consequence time; it's a matter of the degree of pain.
John Embry: If you went the tough route initially, you'd go through a lot of
pain but you'd probably come out the other end sooner and save your currency.
Now, if you go the unlimited QE route – or, as my friend Jim Sinclair puts it,
"quantitative easing to infinity" – the currency will be destroyed. When that
happens, you unleash an immense amount of inflation in your system; and, in that
situation, people lose all their rudders. There's nothing to hang onto when your
money's value is destroyed. I worry about social unrest; but in the end, you've
got to clean the system out anyway. TGR: That's why you're bullish on gold...?
John Embry: That's why I am extraordinarily bullish on gold. Either way, gold
will be all right because it's a tangible asset – a hard asset that's existed
through centuries. The hardest point to get across is that gold isn't what's
changing. Gold is gold. It's been around for thousands of years, recognized as
money by most societies. What's changing is the current paper-money experiment.
Without exception, paper money is always devalued in the end and always ends up
worthless. We've got a long way to go, but we're definitely en route to that
ultimate conclusion. So, it's not gold that's changing; it's the value of the
paper money in which gold is valued; that's why the price of gold is going up.
TGR: What kind of timeframe are you thinking about? John Embry: It's hard to put
an exact timeframe on it, but I think the direction will become more evident in
the next year and a lot more people will become acutely aware of the extent of
the problem. Only a small minority of people realize the risk at this point. But
once it starts, I use Weimar Germany after WWI as a guidepost. That experience
lasted about three to three and a half years from beginning to end. We're now at
the beginning, so I think it will take at least that long. TGR: But that was one
country. If the world's reserve currency loses all value, it will impact many
more countries. John Embry: Yes, that's why the G20 finance ministers and
central bank governors got together in South Korea on October 23 in advance of
the G20 Summit there, which I think will solve absolutely nothing. Many other
countries are extremely unhappy with the route the US is taking and they'd
probably share my opinion and say, "Get your house in order now rather than
taking the rest of us down with you." TGR: But you say the die is cast and that
this currency, the US Dollar will go down. John Embry: It appears inevitable to
me and that feeling is reinforced by the Fed's statements that it will indulge
in some form of QE. Goldman Sachs chief economist Jan Hatzius said it needs $4
trillion worth of asset purchases to get this thing turned. That number is
astounding – and he knows more about it than I do. QE to infinity is a flawed
concept because the more the Fed does it, the less interest other countries will
have in buying US paper. As a result, it'll need more QE. Once you get on the
slippery slope, it moves quickly. That's why I think it's a horrible policy; but
every indication tells us this is the route the Fed has chosen. TGR: Countries
that hold large amounts of US currency are putting on the pressure against QE.
Will they have any influence on this policy? If so, what will happen? John
Embry: There are only two outcomes possible. One, debase the money to the extent
that it lessens the impact of existing debt so it can be maintained. Or two,
default on some portion of it (i.e., the Argentine route). TGR: Your hedge fund
focuses on a fair amount of precious metals assets as one way of protecting
yourself regardless of which scenario plays out. John Embry: Yes, we have a
considerable amount in both gold and silver bullion, plus shares in both
commodities. TGR: Everyone agrees that gold is money but opinions on silver
vary, including the idea that it's an industrial metal and monetary asset. What
makes you want to invest in silver? John Embry: Quite frankly, silver is a
better story than gold – and I love gold. We'll see evidence of the expression
"silver is poor man's gold" come into effect shortly. More people are looking at
silver as a store of value, and not buying it just to convert into jewelry or
for medical and industrial uses. More people are starting to hoard Silver Bars
and coins. The silver market differs from the gold market in two ways. First,
central banks still have a fair amount of Gold Bullion in their vaults, though
not as much as they'd have you believe (and there isn't a lot of silver
inventory because the central banks have accumulated none to speak of). Second,
silver differs from gold in that the vast majority of newly mined silver is
being consumed for medical and industrial uses, jewelry, etc., and not much is
left over for Silver Investment demand. There's been a deficit for many years.
As far as we can determine, above-ground inventories are being reduced down to
almost nothing. So if people want to invest in both gold and silver, it's going
to have an outsized impact on the Silver Price . TGR: Are you saying the price
of silver will outpace that of gold? John Embry: Without question. I virtually
guarantee the Silver Price , on a percentage basis, will outperform the Gold
Price by a considerable amount. That's not to denigrate gold at all, because I
think it will outperform virtually everything else. TGR: In the October
Investor's Digest , you said, "I firmly believe the primary reason Western
central banks hold any gold today is for purposes of manipulation." If the
government can manipulate the Gold Price , why are you so excited about gold?
John Embry: That's an excellent question. It's because they're running out of
ammo. We'll know for sure when that time comes because the Gold Price will go up
$100 in one day. I believe these banks don't have a fraction of what they
purport to have, because they have been lending, leasing and swapping it
surreptitiously for years, rather than selling it outright. Their gold has
gotten into the markets through the back door, not through any overt policies
that made it easy for the public to discern what they were doing. The vast
majority of what has been leased or swapped will not be retrieved and, as a
result, they're close to reaching the limit where they don't want to part with
what's left. The theory is that Western central banks own 30,000 tons of gold
give or take. If they have a third of that, I'd be surprised. Many of them are
starting to realize the error of their ways now. But their ability to influence
the Gold Price is rapidly coming to an end. They're being pressured dramatically
by the Eastern central banks that have made no bones about diversifying out of
paper into gold. As far as I'm concerned, the Western banks already look
extraordinarily stupid for what they've done; and they'll look even more stupid
if they continue in this vein. I don't think they will. There's no better
example than what's happened under the European Central Bank Agreement, where
they were able to sell up to 500 tons of gold a year and after meeting their
quota year after year, they slowed down dramatically in 2009 and stopped in
2010. They sold nothing, which indicates either they don't have it or have lost
any appetite for selling it. TGR: So, do the holders of that physical Gold
Bullion get all of the price appreciation or do the governments get some of it?
John Embry: No. When it gets loaned, particularly in a financial transaction, it
goes to a bullion bank that sells it into the market; and the gold migrates to
the Middle and Far East where the wealth is being created. It's gone, and the
central bank's counterparties can replace it only by going into the market and
buying it from existing Gold Mining production or whatever inventory is
available. But to do that would drive the price to the moon. I think a lot of
these loans will be forgiven in the end. TGR: In the Investor's Digest , you
mentioned the IMF sale to Bangladesh. Obviously, the IMF is bearish on gold if
it's selling that much, and people like Paul Walker with GFMS are also quite
bearish on gold. John Embry: To be fair, Walker's been wrong the whole way up.
TGR: But how do you respond to those who look at your argument and say, "No, the
supply/demand fundamentals say this." John Embry: Well, I think they hang that
on two things. They say investment demand is transient, which means that paper
money is going to regain its luster and people will want to hold it. That would
require interest rates that give people a real return, though; and I can't see
that happening in, say, the next two to three years. So the idea that Gold
Investment demand is going to evaporate is preposterous. I would argue the other
way. I think it will accelerate because, to this day, it's still the purview of
only a limited number of investors. So, I think the demand side of their
argument is dead wrong. Conversely, on the supply side, I think two issues are
debatable. For one thing, they seem to think there will be an unlimited mine
supply of gold. Gold is a precious metal because it's hard to find, and most of
the new stuff being found is around existing mines. Very few greenfields are
being discovered. At the same time, existing mines – particularly the open
pits – are being depleted at an alarming rate. So, I don't see any threat from
higher mine supply over the next five years. TGR: What's the other debatable
issue? John Embry: Scrap. This one is a little bit more controversial, because
if the Gold Price gets high enough, people might sell even more jewelry and
anything else from which they can recover gold. But we see a lot of that today
– all of these TV ads with jewelers screaming, "Sell us your gold, yak, yak,
yak." Then they rip them off. I think people are wising up to that; so I don't
see scrap – which is not that huge a factor to begin with – rising so
dramatically it will have any significant impact on the overall supply/demand
equation. Over the last 15 years, central banks have pumped a lot of gold into
the market and they've likely reached the end of their rope in that activity
while Eastern central banks are becoming buyers. Rather than supply 1,000-2,000
tonnes a year into the market, the central banks will be taking gold out of the
market. With everything else going on – namely more investment demand and no
new mine supply – the supply/demand equation becomes enormously positive. The
only way it can be balanced is dramatically higher prices. So, I don't see a
negative aspect on supply and demand. TGR: Point taken. But is there any way
they could be right? John Embry: They could be right if, suddenly, the world
magically rights itself and the economy starts to grow with no inflation. I
don't think that's going to happen. Get the safest gold at the lowest prices by
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