Brien Lundin: Gold Revival

Source: Karen Roche of The Gold Report  09/08/2010
http://www.theaureport.com/cs/user/print/na/7302

What do politics have to do with precious metals? A lot, according to Brien Lundin, who writes Gold Newsletter. In this exclusive interview with The Gold Report, Brien reveals how the November elections will be pivotal to gold and why President Obama's policies could provide a big boost to the yellow metal. He also shares some of his favorite producers in the sector.


The Gold Report: Recent reports are signaling that consumer confidence and sentiment are up and that the balance sheets of U.S. corporations are stronger. Yet, gold is going up at the same time. What's happening with the gold market right now?

Brien Lundin: It's a bit deceiving that some sentiment surveys show what appear to be dramatic increases because they're still at very low levels, historically, and have been for months and even years. A sentiment index goes up a couple points compared to the previous month and it makes for headlines in the financial media. However, the smart money recognizes the fact that there hasn't been the level of increase in consumer sentiment that will lead to any kind of an economic rebound.

TGR: Could these small, incremental increases be a precursor to a larger recovery?

BL: They could be. The economic environment is really unique right now, because it's sharply split between the bulls and the bears. There's no clear trend. Positive economic indicators point toward a rebound and the stock market will soar. Then the next week, sentiment takes a 180-degree turn and the market heads in the opposite direction.

There's been talk recently of the "Hindenburg Omen"—an indicator said to predict stock market crashes that uses 52-week stock highs and lows and the moving averages of the New York Stock Exchange. This technical anomaly, or pattern, was triggered a few weeks ago. That's precisely what the Hindenburg Omen is meant to highlight—a situation in the market wherein sentiment is sharply split.

Essentially, this is a trendless market defined by very brief trends that are cut off and reversed periodically. So, it's a tough investing environment. The good news for gold investors is that no matter what happens, no matter which way the economy heads, there's a very good argument for significantly higher gold prices.

TGR: Most arguments that favor gold hinge on inflation caused by an economic rebound, or due to quantitative easing (QE) devaluing the dollar. If we are in a trendless market with the economy essentially moving sideways, are we in a so-called "growth recession?"

BL: Yes, and it's possible we will remain in a growth recession wherein the economy is growing so little it isn't enough to overcome the economic friction of inflation or enough to improve people's quality of life. But right now, the economy is on a razor edge with the potential to fall rapidly on either side of the equation. I really think that this trendless market is going to break one way or another fairly soon.

TGR: What will cause it to break?

BL: It just can't keep muddling along as it is. At some point, the government has to jump-start the economy. The Federal Reserve may panic and expand the money supply dramatically through more QE, which will produce a powerful growth in the amount of currency and a corresponding rise in gold prices.

There's another tactic that Fed Chairman Ben Bernanke hinted at during the Fed's Jackson Hole conference in August. He suggested unlocking excess banking reserves that are now sitting at the Fed earning about a quarter-point interest.

It's been difficult for banks to loan their reserves out, given the severe banking regulations that have come down. But the Fed can force their hand by taking the interest rate it's paying on the nearly $1 trillion in excess reserves. The Fed can cut the interest rate from about 0.25% to 0% and, in the extreme, can impose a holding charge.

There can actually be negative interest rates on those reserves. If the Fed does that, I think money will come scurrying out of their coffers and back into banks to be put to work in the market. The end result would be a shot of adrenaline into the economy. I think there would be a dramatic effect on inflation rates and gold prices, as well.

TGR: Are we so far down the line that the only result is a high inflation rate?

BL: The current level of spending, the debt already baked into the cake, is too large to "grow" our way out of. That leaves the time-tested option that governments have always resorted to—inflate away the debt. If there is a 10% rate of monetary inflation, for example, then that debt is cut in half in about eight years. I think that is the only option remaining for the government. Even if Washington doesn't opt for more stimulus and spending, we could see significantly higher inflation rates purely as a result of the debt load that's already been amassed.

TGR: Could the U.S. experience hyperinflation like that experienced in the Weimar Republic of Germany in the 1920s?

BL: I don't think there will be hyperinflation in the U.S. There are really two types of inflation—price and monetary. Price inflation is not the cause, but rather the symptom of monetary inflation—just too much currency out there chasing too little goods. We don't need to have as high a level of price inflation as we had in the 1970s to see commodities and gold rise in value.

In fact, I don't think there will be that level of price inflation because, unlike the 1970s, we have export economies like China, Thailand, Vietnam and India with very low labor costs that are restraining the Consumer Price Index (CPI). We can go to Wal-Mart or Costco and buy items at much lower prices compared to the options available to us in the 1970s. That directly impacts price inflation.

TGR: What effect will an export economy like China's have over the next year or two?

BL: I think China will have a significant and prominent influence. The rebound in Asia has been a remarkable story. The rest of the world caught pneumonia in 2008, but Asia seems to have had only a few sniffles.

China has also highlighted some new themes and trends in Asia. China is just beginning to experience a relative shortage of cheap labor, which is driving up wages and benefits across the board. While this has removed some of its economic advantages as an exporting nation, it's also correspondingly building greater domestic demand in China. Domestic consumer and business demand are going to become important drivers for China and other Asian export economies.

There will still be bubbles inflating and popping here and there in Asia, but I don't foresee these economic engines suffering major collapses in the near future. I think Asia is going to be a continuing story for commodities and particularly for base metals, including copper.

TGR: We are entering the Indian wedding season, China is motivating its population to buy gold coins and the holiday season is coming up. What's your prediction for gold in the fourth quarter?

BL: It is the traditional season for demand in precious metals to ramp up, but this type of demand is price sensitive. Seasonal buying, particularly in India, will dampen if gold prices go much higher than they are now. Previously, I think I predicted gold would be $1,350–$1,500 an ounce by year-end. Now, I think $1,500 is a long way to go from here. It would require a weaker dollar and some indication that the Fed's going to undertake additional quantitative easing to get gold prices to those levels before the end of the year.

Asia will still have demand for gold and that will support prices. In order to drive the market ahead, however, it's going to be a story of what's happening with the Western economies and will there be more monetary and quantitative easing. The good news for gold investors is that type of monetary and quantitative easing is very likely.

TGR: How do you think the November elections could impact the timing of any monetary and quantitative easing?

BL: In my view, the upcoming midterm elections in the U.S. actually represent the greatest near-term risk to gold. I believe the country is going to experience a dramatic backlash toward the conservative/Libertarian side of the political spectrum. Therefore, the markets are going to factor in restraint in spending, restraint in Keynesian stimulus policies and the type of gridlock in Washington that has proven positive for business and the economy. A short-term reaction will likely be a stronger dollar and weaker gold.

Long term, there are other political risks that I think will be positive for gold. There will be a lame duck, unaccountable Congress that could force through some dramatic spending and social plans. President Obama could go into full campaign mode; he's already campaigning, but you haven't seen anything yet. He's really going to be campaigning toward 2012. I think he is married to a political and economic philosophy that will end up being very good for gold and probably very bad for the U.S. economy.

They say it took President Nixon to go to China in the same way it took President Clinton and a Republican Congress to reform welfare, balance the budget and cut taxes. But Obama hasn't shown any inclination to triangulate like the more pragmatic Clinton. He's a true believer in a world where government runs the economy and picks the winners and losers.

He's not going to back down, and he'll retain control of the Treasury and, to some extent, the Fed. Obama will still be able to cause some economic mischief, and he'll try his hardest to do so. For gold bugs, at least, that's going to be a good thing because it's going to lead to higher gold prices over the long term. But investors need to look at those midterm elections in November as being a stumbling block for gold along the way.

TGR: Gold prices have increased substantially since the beginning of August. You said in one of your alerts that, even though gold's low price may be behind us, junior resource stocks have yet to respond. Why are the juniors lagging?

BL: One refreshing thing about this summer is that a sense of normalcy has returned to the gold market. It's been a couple of years since that happened. Historically, gold prices bottom somewhere between mid-July and mid-August in a bull market. Juniors follow along a little bit later in August or September.

With a career spanning three decades in the investment markets, Brien Lundin serves as president and CEO of Jefferson Financial, a highly regarded publisher of market analyses and producer of investment-oriented events. Under the Jefferson Financial umbrella, Brien publishes and edits Gold Newsletter, a cornerstone of precious metals advisories since 1971; he digs into not only small caps of every type but also macroeconomics and geopolitical issues that ultimately affect every resource investor.