The Gold Report: James, from your perspective in Europe, is the region in as bad a financial crisis as it appears in the headlines here in the U.S.?
James Turk: Yes, it really is. However, Europe is a big place, and you have to look at the individual countries one by one to understand the situation. Generally speaking, the Mediterranean countries are in the worst shape. Germany has been in the best shape, although recent economic data indicate it may be falling into a recession again. France is not quite as bad as the Mediterranean countries, but in economic activity, it is worse off than Germany and the rest of Northern Europe.
TGR: What role does the euro play in all this, and where might the next crisis take place?
JT: Most of the problems we have seen in Europe are not really euro crises; they are banking crises. That was clearly the case in Cyprus.
The hot spot now is Slovenia, a small Alpine country that is part of the European Union and the Eurozone. Its banks are overleveraged and under scrutiny because of the number of bad loans they carry.
The banks in Luxembourg and Malta are also very highly leveraged relative to the size of those countries' gross domestic product (GDP). This concern follows on what happened in Iceland, Dubai and Cyprus, where the perception was that the banks were potentially vulnerable to "hot money" withdrawals due to the banks' high percentage multiple to the country's GDP. In other words, if depositor money were to flee, those banks might experience liquidity squeezes too big for the government to manage. That is what happened when the European Central Bank (ECB) pulled the plug on Cypriot banks after Russian depositors pulled out large sums.
Economic activity is the second part of the problem. Italy is probably the most vulnerable at the moment, and that is saying quite a bit, given how bad off Spain is. But Italy has more political uncertainty.
TGR: Italy has a new coalition government. Could that calm things down?
JT: It could calm things down for a while, but there is so much difference of opinion as to what is needed to solve Italy's problem, the various groups are too polarized. I do not see this coalition government lasting very long.
TGR: What will it take to cure this banking crisis?
JT: Capital. The banks are overleveraged and have too many bad assets on their balance sheet. Capital has been wiped out, even accounting for reserves set aside by the banks. That was clearly the case in Cyprus and is the case in most other countries.
The banks look solvent because the ECB is keeping them afloat with liquidity. If the ECB removes that liquidity, as it did with Cyprus, it will soon become apparent which banks are truly insolvent. Bank crises occur overnight for that reason: When the liquidity is gone, the bank closes up because it is not solvent. It lacks quality liquid assets that can be sold into the market to raise cash to meet depositor withdrawals.
Capital cannot be created out of thin air, which is something that politicians have yet to learn. They think that by borrowing more money from the market they can save the banking system. But they are just adding fuel to the fire because most European countries are already overleveraged.
TGR: Looking to the east, Japan just announced its own quantitative easing (QE). Will it win the currency race to the bottom?
JT: We seem to have a horse race going on that no one should want to win. Which is going to the fiat currency graveyard the quickest: the yen, the dollar, the euro or the pound? Right now, Japan is leading the race with its debasement of the Japanese yen through QE and government spending programs. This is astounding because when you look at economic activity around the world, Japanese GDP growth is better than most, and it has one of the lowest unemployment rates in the industrialized world. Japan was in pretty good shape until its new prime minister took over and laid out his policy to debase the yen.
TGR: Why has the dollar remained so strong despite QE here?
"Capital cannot be created out of thin air, which is something that politicians have yet to learn."
JT: Is the dollar really strong? When you look at the dollar against gold—which is what it should be measured against—the dollar has lost 16% per annum on average for 12 years in a row. At any moment, the dollar might look OK compared to the euro or vice versa, but you have to measure the dollar against something meaningful. I do that by looking at the dollar relative to the gold price.
I expect this multi-year weakness in the dollar to continue because, just as in Europe, Japan and in the U.K., the U.S. government and the Federal Reserve are following destructive monetary policies that are eroding the dollar's purchasing power.
TGR: Will that lead to hyperinflation and is there a tipping point for that to happen?
JT: I think it will lead to hyperinflation. There have been signs for quite a number of years.
You have to keep a couple of things in mind. One is that the inflation numbers released by the U.S. government and most governments around the world have been massaged and doctored to make inflation look lower than it really is. I rely on the inflation statistics that John Williams of ShadowStats.com puts together. Right now inflation in the U.S. is running about 9.5%. For example, commodity prices and the cost of things like property taxes and insurance premiums have been running much higher than what the U.S. government reports inflation to be.
Second, hyperinflation always comes from one cause: excessive government spending, forcing it to borrow. When a government borrows, it can only borrow what the market is willing to lend or what the market has the capacity to lend. If the government is borrowing more than the market is saving, it is, by definition, debasing the currency.
When no one is willing to lend to the government, it tells the central bank to buy its debt and turn it into currency. The central bank then puts this newly "printed" money into the government's checking account, which the government then spends.
We are headed for hyperinflation—not necessarily the paper-currency hyperinflation that occurred in Germany's Weimar Republic or in Zimbabwe—but a deposit-currency hyperinflation, like Argentina 12 years ago. There is not a lot of paper currency being printed, but there is a lot of money in bank accounts; this is currency that people spend with checks, wire transfers and plastic cards.
TGR: Recently, you talked on the "Keiser Report" about Bitcoin. Does it matter if digital currency has no value beyond accounting? Are there parallels between gold and Bitcoin?
JT: Bitcoin is not only a digital currency, it is a crypto-currency, a technological innovation we have not seen before.
The parallels to gold are quite interesting. I did a study recently for the GoldMoney Foundation showing that the aboveground stock of gold grows by about 1.8% per annum, year after year after year. That number is approximately equal to world population growth and new wealth creation, so gold's purchasing power has been consistent over long periods of time. Gold mining does exactly what Milton Friedman recommends in his K-rule: it grows the gold money supply by the same amount year after year after year.
Bitcoin is designed in essentially the same way, but instead of mining the earth you are mining mathematical formulas to arrive at a very consistent growth of Bitcoin until 2040, when approximately 21 million Bitcoins will be in circulation.
"Bitcoin is not only a digital currency, it is a crypto-currency – a technological innovation we have not seen before."
Bitcoin and gold each have advantages and disadvantages. The piece of gold you hold in your hand has 5,000 years of history. Bitcoin has maybe four years of history. On the other hand, because you can hold gold in your hand and store it in vaults, it can be confiscated by governments. Bitcoin, because it is a crypto-currency based on mathematical formulas stored in computers all around the world, cannot be confiscated.
Bitcoin has value to people who understand that confiscation is a real risk. In the last century, Lenin, Mussolini, Hitler and Roosevelt all confiscated gold to increase the power of the state. Once the state controls the money we use, it can control economic activity, which explains what we are seeing today around the world.
Crypto-currencies are here to stay and should be looked at closely by everybody, particularly those who understand sound money and appreciate the value and usefulness of gold.
TGR: Is Bitcoin an investment vehicle?
JT: No, because neither gold nor Bitcoin generates cash flow. Both are sterile assets. Investments generate cash flow. You put your money at risk in the hope of getting cash flow from your investment.
Gold is money. When the price of gold goes up, you are simply taking wealth that is already created and in the hands of people who own fiat currency, and transferring that wealth to people who own gold.
The same concept applies to Bitcoin. Bitcoin is money, not an investment. Its exchange rate can go up or down just like the price of gold. In that sense, Bitcoin could be called a store of value just like gold. The difference is that gold has a 5,000-year history; Bitcoin is much younger. We will have to see how Bitcoin plays out as a store of value in the years ahead, but regardless, Bitcoin is a useful currency because it makes possible low-cost global payments. It is a technological advancement that leaves bank payment systems in the dust.
TGR: Will governments see Bitcoin as a threat because it is an alternative currency not under their control?
"The rule of thumb is to have gold bullion equal to your age. A 65-year-old should have 65% of his or her assets in gold bullion; a 25-year-old can have 25%."
JT: They may see it as a threat, but there is nothing they can do about it unless they seize every personal computer in the world. People are studying it, becoming familiar with it. Some day there may be a Bitcoin2 or a Bitcoin3 that is even better than the original.
That is the beauty of technology. Technology enables society to move forward and improve everyone's standard of life. Crypto-currencies may be the technological innovation that gets us out of our current monetary malaise arising from state control of money and enables us to return to vibrant economic activity that results when we use sound money.
TGR: Based on your Fear Index and the Gold Money Index, would you explain the difference between value and price?
JT: Price is the measurement we use when we enter into an exchange with someone else in the marketplace. Value is what something is truly worth.
In other words, I might have a house worth $500,000, but I sell it at $400,000. The purchaser is buying it at a price below its true value. On the other hand, I might sell that house at $600,000, in which case the purchaser is buying the house above its true value.
To correctly analyze gold, we must look at its value. We can measure gold's value by comparing it to national currencies.
I use the Fear Index to compare gold to the dollar and the Gold Money Index to compare gold's role in international trade and finance against all of the foreign exchange reserves held by the world's central banks. Gold is undervalued by both of those measures. Even though its price has been rising for 12 consecutive years against the U.S. dollar, it remains undervalued because the dollar itself is being debased at almost as rapid a rate as the gold price is rising.
The other thing about gold is that its value is not only expressed numerically. Gold is money that is outside the banking system. Because it is tangible, it has no counterparty risk. It is not money that depends on a bank or a government promise.
Given what happened in Cyprus and the fragility of many banks around the world, I think everybody should have some gold to protect themselves from the eventuality of a much larger banking crisis than what we have seen so far.
TGR: In light of all the volatility of gold and silver recently, how are you adjusting your portfolio? What roles do cash, physical gold, mining stocks and exchange-traded funds (ETFs) play?
JT: When you buy gold, you have to first identify your objective. Do you want to profit from movements in the gold price, or do you want a safe haven as protection from monetary and banking turmoil? You want the right tool for the right job, which depends on your objective.
If investors want a safe haven, physical gold with no counterparty risk is the way to go—you want to hold gold bars and coins. If investors want to trade to profit from fluctuations in the gold price, then you can look at what I call paper-gold instruments. These would be futures, options and ETFs. In this case, you do not own gold; you own exposure to the gold price and that exposure comes with counterparty risk.
I recommend focusing on gold as a safe haven: own physical gold and leave paper-gold to the professional traders and the speculators. Gold is part of the cash—the liquidity part—of your portfolio.
Mining shares go into the investment part of portfolios. Investors need to look at mining shares using the same process they do when buying any equity. What is the quality of management? What does the balance sheet look like? What do the assets look like? What is the political risk where the company operates? And so forth.
If you are prepared to shoulder those investment risks, you might then decide to have some mining shares in your portfolio as well. Generally speaking, I have never seen mining share prices this undervalued in relation to the cash flow they are generating, and, as a result, many mining companies have increased their dividends. If I am correct that the gold price will go much higher, I think mining company shares will rise much higher as well.
TGR: Is the TSX Venture Exchange a bargain basement right now?
JT: Everything is pretty much on sale. The question is when the mining shares go up, which ones will go up first?
There are a couple of characteristics that may give us a clue. Good dividend payers with secure cash flow will probably rise first. I would stay away from any mining shares that have any hedge positions, because those hedge positions will cut into profit as we have seen in the past.
I also would look to the mining shares with management teams that have proven themselves. There were a number of disasters over the past few years caused by companies focusing on growth rather than cash flow. They overpaid for investments and diluted their shareholders. Many of those executives have left and their successors have, I hope, learned the lessons of those departures. You always have to look at management first and have complete confidence in management before investing in any company.
TGR: Some people have predicted that hundreds of junior miners will be gone by year-end. Do you agree, or are you more optimistic?
JT: It is possible that a lot of them will go by the wayside and disappear, simply because capital is very hard to come by today. A lot of these little companies are the explorers looking for a resource, but even those that have a resource cannot always find the capital they need to develop it.
A lot of the smaller companies are at bargain-basement prices, but they come with a lot of risk. The less risky play would be companies that have a dividend record, a good management team and a strong, solid cash flow that will likely continue into the future.
TGR: Based on the five standard deviation decline that occurred in mid-April, what would the technical analysts predict for the price of gold this summer and the rest of 2013?
JT: The present drop in prices is very similar to what occurred in 2008, although it is not as severe a percentage decline. And remember, within one year of the low of 2008, gold made a new record high above $1,000/ounce ($1,000/oz) and silver more than doubled within 12 months.
I think history will repeat. Within the next 12 months a new record high in gold above $2,000/oz is possible, and I think silver will double.
TGR: Any last advice for investors looking to preserve or increase their wealth?
JT: When you are preserving wealth, you want a safe haven. Physical gold has been the best safe haven over the past 12 years, and I expect that to continue. You just need to make sure you store it with a professional storage firm where you have the assurances of integrity, that your gold is safe.
If you want to grow your wealth, you have to focus on investments, not the money in your portfolio. Here, you might want to look at the mining companies because there are some very good opportunities because of today's low prices.
I guess it comes down to a question of age. If you are older, you want to be more conservative and take less risk. If you are younger, you might want to take more risk. For me, the rule of thumb is that you should have gold bullion equal to your age. A 65-year-old pursuing a less-risky portfolio strategy should have 65% of his or her assets in gold bullion and the rest in various investments. A 25-year-old can have 25% of his or her assets in gold bullion and invest the remaining 75%, which means the portfolio has less liquidity and more risk.
Whether you are the 65-year-old investing 35% or the 25-year-old investing 75%, look at the gold mining shares because they are extremely undervalued right now. I do not think the gold mining industry is going to disappear, for the same reason that gold, with its 5,000-year record, is not going to disappear.
TGR: Great advice. Thank you so much for your time.
James Turk is the founder and chairman of GoldMoney, which launched in 2001. GoldMoney is an online bullion dealer in gold, silver and other precious metals , which its customers can store in Canada, UK, Switzerland, Hong Kong and Singapore. After positions with The Chase Manhattan Bank (now JP Morgan Chase) and Abu Dhabi Investment Authority, Turk began the Freemarket Gold & Money Report in 1987, which published until 2009 when he began occasional blogging at fgmr.com.
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