David Skarica: "Bond Vigilantes" Ultimately Good for
Source: Brian Sylvester of
The Gold Report
Addicted to Profits
Editor David Skarica predicts that in the second half of
2011, Europe's "bond vigilantes" will make their presence felt in
the U.S. by driving up interest rates and driving down the
dollar. That's one of the reasons he remains bullish on gold. "I
think we're going to see gold headed much, much higher," David
says in this exclusive interview with
The Gold Report.
To learn about David's investment thesis for the gold market
and a few names that offer better value post correction, read
The Gold Report:
Hi David, welcome back to
The Gold Report.
It's good to be here. Thank you for having me back.
You're quite welcome. You tend to look at macroeconomic trends
and draw conclusions based on your observations. What are you
observing in the gold market that has led to about a 6% drop in
I think there are just two factors for me. First, gold was
overbought. When gold topped in early December, we were far above
the 200- or 150-day moving averages. And if you get too far above
these moving averages, gold tends to pull back toward them.
Secondly, there are seasonal trends. Gold tends to bottom in the
summer or fall and rallies at year-end; it sees another pullback
early in the year (January or February) and continues the
seasonal rally into the spring. For example, in 7 of the 10 years
since bullion bottomed in 2001, the low for gold for the year has
occurred in January or February. There is an early year pullback,
and then the rally resumes afterward.
Another point I should make is that a lot of hedge funds were
short the euro and long in gold, with the idea that the euro
could get out of control. But then the Portuguese bond offering
went well and those hedge funds had to get out of that trade,
which meant they had to cover the euro short. That's why the euro
rallied so quickly from $130 to $136, which is a huge move for a
major currency just in a week or two. Hedge funds were also long
on gold, so they had to sell. Gold stocks aren't quite as liquid
or as large as the bullion market, so they fell even more. But
this is a very short-term phenomenon. I don't expect it to last
any longer than a month or two.
Goldman Sachs was originally predicting that gold would top in
2012 but now says it will top in 2011. Do you believe that? What
advice are you giving your readers either way?
In addition to my newsletter, I just published a new book,
The Great Super Cycle: Profit from the Coming Inflation
Tidal Wave and Dollar Devaluation
. Part of the reason I wrote it was to dispel myths like those
calling for a top in gold when, really, we're in the midst of a
15- to 20-year mega-super cycle for gold and gold equities.
Essentially, I think we're going to see a continuation of this
move higher for a number of years, caused by factors like the
deficit and the lack of political will to cut spending and get
rid of these deficits. The current cycle started in 2001 for gold
stocks, and they tend to last 15-20 years, which means the cycle
should continue through the 2015-2020 period.
Another reason I think Goldman is wrong is that most of the
major bull gold markets tend to end when the Dow Jones Industrial
Average (DJIA) to gold ratio-or how many gold ounces it takes to
buy one share of the Dow-is roughly 1:1 or 2:1. With the Dow at
12,000 and gold at $1,355/oz., we're nowhere near that ratio. I
think we're going to see gold headed much, much higher. With that
said, I think that after the next rally we're going to see a
significant pullback in gold probably in the 2012-2013 period,
but that will just be a buying opportunity.
Why should we believe David Skarica over Goldman Sachs?
Quite frankly, it is because I am looking at the big picture over
the long term. Brokerage houses tend to make money trading the
short term and only have a quarter-to-quarter outlook. There is
no way Goldman Sachs is looking 5-10 years ahead; 10 years ago, I
don't think Goldman was calling for $1,000/oz. gold by the end of
I am also a contrarian in gold. I have never really looked to
the mainstream "big broker" teams for their opinions on gold. I
have never taken them seriously because I think there is a lack
of understanding of the gold market.
And, finally, I don't think gold is a trade. This cycle could
spell the end of the U.S. dollar as the reserve currency of the
world. I don't think that's something Goldman Sachs would
That certainly would be unpopular. You said in the December issue
Addicted to Profits
"We're going to see a good old rate spike, South American-style
crisis in the United States, accompanied by the twin evils: 1)
Out of control inflation and 2) Currency declines." Could you
talk about that pending inflation crisis and its ultimate
There are always fundamental underpinnings behind these cycles,
but I've come to the conclusion that what is most important is
the cycle itself. And interest rates run in really, really long
cycles. For instance, the bond bull market lasted from 1981-2008.
It was a 27-year bull market for bonds. Despite all the hoopla
that bonds have done well, long-term bonds actually peaked in
2008. I think we're building a massive top in bonds here. Now,
that doesn't mean we can't rally some in the short term, but
within the context of building this massive secular top, the Fed
is going to issue $1-$1.5 trillion of debt per year for the next
five to seven years. That debt is going to put a huge amount of
supply on the market and, at some point, foreign investors are
going to demand a higher rate of return because they don't think
the U.S. can repay its debts.
At some point, the bond vigilantes will move across the
Atlantic and force rates higher. The austerity measures in Europe
will probably begin to reap rewards late this year or early next
year, and at that point we will probably see the UK, the Irish,
and the Greek debt come down. You will see it come down from
10%-12% of GDP to 6%-7% of GDP. Whereas I don't think the U.S. is
going to undertake any concrete cost-cutting measures, especially
this fiscal year. If a major state has to do a debt
restructuring, or if a major municipality goes into bankruptcy,
that would clearly focus attention on the U.S. I think there is
going to be a trigger point that turns the debt worry from Europe
toward the U.S., and that would trigger bonds to go higher.
You talk about the "bond vigilantes" coming across the ocean and
imposing their will on the U.S., but couldn't the Fed go into the
secondary market, buy those bonds, set the rates and terms and
handle it that way?
At some point, the Fed loses its ability to do that. Is the Fed
going to go into the day-to-day market? Sure, it could come in
and buy the 30-year bonds when the options come up, but are they
actually going to go into the trading market? That's the question
because the day-to-day trades in the market still set long-term
interest rates. So, are they going to go into the day-to-day
market and start trading? The currency will be totally destroyed
if that happens. I think the market has more power than the
Federal Reserve. If the Fed truly had all this power, we never
would have had a crisis in 2008 because it would have done
everything it could to keep the Dow above 10,000 and the S&P
How does this fundamental weakness in the U.S. economy-and the
U.S. dollar, in particular-affect gold in the long term?
It's really positive for gold because gold is one of the
alternatives to the U.S. dollar as the reserve currency of the
world. When Fed Chairman Paul Volker fought inflation by raising
interest rates in the early 1980s, we saw the stabilizing of the
U.S. economy and very good economic growth in fundamentals for 20
years. There was no reason to own gold when the reserve currency
was stable and the economy was booming. But when the reserve
currency gets in trouble, gold simply becomes an alternative.
Gold has stood the test of time. Obviously, other currencies,
including the Asian currencies, benefit from this as well.
What are you telling your readers in terms of a range for the
gold price in 2011?
Conservatively, I have been saying $1,500-$1,600/oz. by year-end.
I think at some point there will be a big spike, and that
scenario plays out when the bond vigilantes move their attention
to the United States and away from Europe. That's when I think
you might see the big spike in gold.
The real problem for the gold price is that the mainstream
public, especially in the U.S., just won't buy it. They just
don't believe in it even if they're worried about what's going
on. Some bank credit analyst recently said that only 1% of
financial assets are in gold and gold stocks. But at a typical
top in gold, that number is 5%-7%. At the bottom of the gold
market, only 0.5% of financial assets were gold related. So, even
with gold moving from $250/oz. to over $1,300/oz., we've seen
only a 0.5% increase in the amount of total financial assets that
people have in gold. For example, mainstream fund managers in the
U.S. won't buy gold because they're the ones telling us it's in a
bubble (even though they have never bought an ounce). The gold
market is so small that when the public finally starts to
accumulate gold, it could cause a big breakout. I am not just
looking at a 20% rally in gold; I am looking for a 50%-60% rally
that will happen over just a few months because people are
finally buying it en masse.
One upside of the gold price correction that occurred in January
is that it's a lot easier to find value now in the small-cap gold
names. What are some companies that you're following that offer
value at $1,355/oz. gold?
I think the midtiers and the large caps are really the ones that
have sold off. The Small Cap Index has come off the last few
days, but it's held up a lot better than the large caps. And now
you have very good values in the large caps. I was recently
Royal Gold Inc. (NASDAQ:RGLD; TSX:RGL)
, which is a big royalty company. With a roughly 6% or 7% drop in
the price of gold, Royal Gold has dropped from $55 to $46. That
looks like good value to me.
A stock like
San Gold Corporation (TSX.V:SGR)
, which has a producing gold mine in Manitoba, has dropped from
$4 -$2.76, or 32%, on this small move down in gold and no real
negative news on the company. Another is
New Gold Inc. (TSX:NGD; NYSE.A:NGD)
, which dropped from $10-$7.50, or 25%. Of course, it had a huge
run before that, but those are some names I would look for.
Additionally, I would look for newer junior deals. I look for
deals that have just been put together-those that are new to the
market. Those companies can really move; for example,
Golden Phoenix Minerals, Inc. (
. The company has interests in a few properties, including a 20%
interest in a producing mine. It trades at around $0.15 and it
has a $39 million market cap. One other stock I really like is
Kiska Metals Corp. (TSX.V:KSK)
, which is developing a big project called the Whistler Project
in Alaska. Essentially, it's focusing totally on Whistler and is
going to spin out its other projects. That stock dropped from
Yes, Kiska put out a resource estimate that somewhat disappointed
the market. Do you believe the other gold deposits in that play
have the potential to significantly boost the resource estimate
down the road?
Yes. I don't want to get too technical here, but Kiska did a lot
of geophysical surveys to determine where it could expand the
deposit. I would expect the fruits of that labor to come to bear
this year. On top of that, the company stated that it's going to
announce further resource increases from other areas of that
property in the coming months. I like to buy companies like Kiska
when they're small and frothy hot. I actually like consolidation
from $1.70-$1.10 or so. The problem is that the market is very
shortsighted. Everyone wants huge deposits, but plenty of
companies that have developed huge mines have produced
disappointing results along the way.
David, could you give us a couple of other small-cap names you
I talked about
Aberdeen International Inc. (
the last time I was interviewed for
The Gold Report
. The thing I like about Aberdeen is that it has interests in
numerous gold and resource companies. It had a big run from $0.35
to over $0.80, and I have been looking for it to decline into the
$0.60s before I would consider purchasing it again. The net asset
) is probably in the $1.30 range, so it's still trading at a big
discount to NAV. Most merchant banks or investment-type companies
tend to trade right at NAV. It's really frustrating when
Aberdeen's NAV is $1.30 and the stock is trading at $0.76.
Although you don't want to be greedy, as an investor you ask
yourself, "When is this thing going to finally represent the
value that it has in the ground?"
Could one of the problems be the company's ongoing dispute with
Simmer and Jack Mines Ltd. (
To my knowledge, it has not been settled and that's got to be a
big overhang on the stock. But when Aberdeen reports its NAV
numbers, it does so excluding assets related to Simmer and Jack.
Aberdeen just did a lot of share buybacks, as well.
Yes, CEO David Stein told me Aberdeen tries to buy back its
shares whenever possible.
But I would prefer it to pay a dividend to shareholders. Right
now, investors are starved for income. We talked about the
interest rates heading higher in the long term, but 10-year bonds
are giving you only 3.5%. If Aberdeen has roughly 90 million
shares outstanding, and it's paying one cent per share each
quarter, you would be at about a 6% dividend; a half-cent per
quarter would be a 3%-4% dividend. I think that would be much
more effective for gathering shareholder interest than would
Maybe you should talk to David about that. Aberdeen is a Forbes
and Manhattan (F&M) company; and as a merchant bank within
that fold, F&M Chairman Stan Bharti uses Aberdeen to help
finance other companies in the F&M stable. Aberdeen has
significant positions in
Sulliden Gold Corp. (TSX:SUE; OTCQX:SDDDF)
Avion Gold Corp. (TSX:AVR; OTCQX:AVGCF)
Allana Potash (TSX.V:AAA)
, among others. You once recommended Avion Gold. What's happening
with that company now?
Well, Avion is probably my best recommendation ever because I got
in right at the bottom in 2008-2009, but I don't know if I would
be chasing that name at these levels. I know Avion is coming in
with really good production and cash flow numbers and I would
really like to see it consolidate here before I would even
consider looking at it. Avion was $0.50 last summer.
Yes, but Avion wasn't in production in the summer.
No, it wasn't in production. But we were talking about Aberdeen
as a merchant bank, and part of the reason you buy Aberdeen is so
you don't buy those stocks individually. It gives you nice
exposure to all of them. One other Forbes & Manhattan stock
that's interesting is
Dacha Strategic Metals Inc. (TSX.V:DSM;
. I really like Dacha, but I don't like most rare earth companies
because most of them are just moose pasture, right? There's
nothing really there; they're just taking advantage of a hot
market. What I like about Dacha is that it actually owns a lot of
physical rare earths, and the long-term outlook for rare earth
prices is really bullish. Dacha is an interesting way to play it;
I don't think it has as much downside as some of these other rare
earth names that have kind of spiked up based on nothing.
What should our readers watch for in the gold market in 2011?
I am still really bullish on gold. I would be absolutely shocked
if this seasonal decline we've seen, which is very similar to the
decline in January/February of last year, turns outs to be
anything more than just a short-term pullback.
I've been really bullish on the equity markets for the past
two years. I would look for a really significant top to occur in
the equity markets because of the short-term effects of the tax
cuts in the U.S. and the increased economic output for a quarter
or two. Then, later in the year, you're going to see pressure on
the U.S. to start reining in the deficit. In the second half of
2011, I'm worried about the dollar accelerating that long-term
downtrend because all the bad news out of Europe will be making
its way here. We could certainly see an all-time low on the
dollar here in 2011.
Thanks, David. Interesting as always.
At the tender age of 18, David Skarica became the youngest
person on record to pass the Canadian Securities Course. Skarica,
a Canadian and British citizen, is the author of
Stock Market Panic! How to Prosper in the Coming
(1998), which provided thought-provoking arguments on why a
great bull market would end in the most vicious bear market of
all history. He is also the author of
The Contrarian Who Saved the World
which explains how markets work. His new book,
The Great Super Cycle: Profit from the Coming
Inflation Tidal Wave and Dollar Devaluation
will be published by John Wiley & Sons in November.
In 1998, Skarica started
Addicted to Profits
a newsletter focused on technical analysis and psychology of
markets. From 2001 to 2003, Stockfocus.com ranked
Addicted to Profits
third out of over 300 newsletters in terms of performance. He
is also the editor of
Gold Stock Adviser
The International Contrarian
services, which focus on gold and global investing. Dave has
also been a contributing editor to
Investor's Digest of Canada.
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1) Brian Sylvester of
The Gold Report
conducted this interview. He personally and/or his family own
shares of the following companies mentioned in this interview:
2) The following companies mentioned in the interview are
The Gold Report
The Energy Report:
Golden Phoenix Minerals, Kiska, Aberdeen International, Sulliden,
Avion, Allana Potash and Dacha.
3) David Skarica: I personally and/or my family own shares of the
following companies mentioned in this interview: Aberdeen
International and San Gold. I personally and/or my family am paid
by the following companies mentioned in this interview: None.
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