Will There Be Another 2008 Style Crash?

I think there is going to be a point where QE will become ineffective. There will be a point when countries with a more sane approach, like China, stop buying US bonds and instead start selling them. That would lead to higher interest rates and have a negative impact on stocks. We have already seen the effects of the rise in interest rates on home and auto sales – the two biggest motors of the US economy since the beginning of QE3.

On top of that, I believe that the US government is insolvent. In fact, everybody knows the US is broke but people will stand by and let it happen.

An analogy for the Federal government is the city of Detroit. Five years ago, they already knew that they were broke. But it is not until they finally had to write a check that they could not write that they declared bankruptcy.

Even though the bankruptcy was inevitable, it shocked people. The City of Detroit recently announced that pensioners would get 16 cents on the dollar. Had Detroit faced its budget problems five years earlier, pensioners may have gotten 60 cents on the dollar. Allowing the situation to get worse led to great disappointment and damage.

The Federal government looks about as bad as Detroit five years ago. In financial year 2013 it brought in $2.8 trillion in revenues and spent 3.5 trillion, as reported by the Treasury department. Their current liabilities are something like 87 trillion with a national debt of 17 trillion. The situation is hopeless.

It is propped up by the Fed. When the Fed does an open-market operation, the stocks go up. When they are not doing any such operations, overall, they go down.

- Source, Eric Sprott:

http://sprottgroup.com/thoughts/

Sprott's 2014 Outlook for the Markets and Precious Metals

As demonstrated in our Open Letter to the World Gold Council, there was a large supply-demand imbalance in 2013. The evidence presented here suggests that the decline in the price of gold in mid-2013 and the subsequent raid of gold ETFs (but not silver ETFs) was engineered by Western Central Banks to help solve their physical gold supply problem. However, the resulting increase in Indian gold demand exacerbated the problem. The solution was to restrict Indians from importing gold by all means possible in order to help the Western Central Banks regain control of the gold market.

However, the rate of drain in gold ETFs cannot continue forever; at the current pace of 930 tonnes/year, there are less than two years of gold left in ETFs. Moreover, Indians have proved highly creative at finding ways around import restrictions. Smuggling is on the rise and will most likely increase as smugglers become more sophisticated. Overall, we believe that interest in physical gold from emerging markets will remain a driving force.

Besides, mine production is unlikely to grow, as reflected by the significant decrease in capital expenditures expected for the major gold producers (Figure 5).

Accordingly, we believe that the manipulation of gold prices by central banks, as demonstrated by the above analysis, cannot continue in 2014. Therefore, we expect substantial increases in the price of precious metals as the true shortages become obvious.

Figure 5: Capital Expenditures ($mm) - XAU Index Members

Source: Bloomberg. Consensus analyst estimates are used for years 2013-2015.

- Source, Eric Sprott via Markets at a Glance:

http://www.sprottglobal.com/markets-at-a-glance/maag-article/?id=8816

Supply and Demand Imbalances: The Indian Effect

We have already discussed at length the supply and demand imbalance in an Open Letter to the World Gold Council, asking them to revise their methodology because it grossly understates the amount of demand coming from emerging markets. Our gold supply and demand table (Table 1) reflects the latest available data (2013 Q3 in most cases). World mine production, excluding Chinese and Russian production still stands at about 2,100 tonnes a year. Chinese net imports most likely exceeded 1,700 tonnes in 2013 (81% of world mine production) and demand from the rest of the world is rather stable.

The overall picture has not changed much since our last article, with the exception of Indian imports. As of the second quarter of 2013, India had cumulative net gold imports of 551 tonnes, which annualizes to 1,102 tonnes. However, Q3 data shows net imports of only 31 tonnes (for a total of 582 tonnes YTD), which annualizes to 776 tonnes.

This incredible loss of momentum for “official” gold imports was the result of concerted actions by the Reserve Bank of India and the Indian Government. While the “official” justification for those restrictions is the large Indian current account deficit, this argument makes little sense. According to government officials, Indian’s taste for gold and the corresponding imports worsens the country’s trade balance, worsens its current account deficit and puts downward pressure on their currency, the Rupee.

But, without going into too many details, the classification of gold as a “good” in the trade balance is at best misleading. Since gold is more of an investment vehicle and is not “consumable” per se, it should instead be accounted for in the capital account of the balance of payments instead of the current account. Indeed, Switzerland, which is a large net importer of gold, reports its trade balance “without precious metals, precious stones and gems as well as art and antiques” to reflect fact that those are “investments” rather than consumption goods. In this case, why should India be any different and report their trade data excluding gold? To us, all the fuss about gold imports by the Indian Government is a red herring.

So, without the intervention in the Indian gold market, the shortage of gold would have wreaked havoc in the market, a situation that Western Central Banks could not tolerate.

Table 1: World Gold Supply and Demand 2013, in Tonnes

- Source, Eric Sprott via Markets at a Glance:

http://www.sprottglobal.com/markets-at-a-glance/maag-article/?id=8816

Strong Gold Buying by Emerging Markets and Central Banks

The April raid on gold and gold ETFs almost backfired by creating a tsunami of buying in India and increased demand to unsustainable levels. In May 2013 alone, Indians imported 162 tonnes of gold in a market where monthly global mine production is about 182 tonnes. A continuation of this trend, coupled with strong buying from other Emerging Markets and their Central Banks, would have been overwhelming. But, the response was swift. We suspect that, at the behest of Western Central Banks, the Reserve Bank of India reacted by enacting, in incremental steps, restrictive measures to prevent gold imports (See Figure 4 for a timeline of the major changes made by the Indian Government).3

Figure 3: Traded Value - Ratio of SLV to GLD

Source: Bloomberg. Traded Value is calculated by taking the total trading volume for a quarter and multiplying it by the average price over that quarter. A ratio of 1 indicates that SLV traded as much, in $ terms, as GLD.

Figure 4: Efforts to Curb Indian Gold Imports

- Source, Eric Sprott via Markets at a Glance:

http://www.sprottglobal.com/markets-at-a-glance/maag-article/?id=8816

2013 Was a Puzzling Year for Precious Metals Investors

As we very well know, 2013 was a difficult but also puzzling year for precious metals investors. The price of gold, silver and their related equities declined by a significant amount while demand for physical bullion from emerging markets and their Central Banks was exceptionally strong.

A common argument that has been made to explain the precipitous decline of the price of precious metals in 2013 is of investors’ disenchantment with precious metals, which had been piling up in exchange traded products as a way for investors to gain exposure to the metals. Proponents of this theory point to the large declines in the total holdings of those ETFs as evidence of investors fleeing the precious metal trade. As shown in Figure 1, the price of both gold and silver suffered very significant declines throughout 2013. Therefore, if this explanation is correct, one would expect the total ETF holdings of both metals to be lower as well.

However, this is not the case. As shown in Figure 2 gold ETFs suffered large redemptions whereas silver ETFs saw their holdings remain more or less constant throughout the year, and this without any observable change in trading patterns in the two largest ETFs; GLD and SLV (Figure 3 shows the ratio of the trading values in the ETFs over time). If redemptions are a symptom of investors’ disenchantment with precious metals as an investment, shouldn’t silver have suffered the same fate as gold? Indeed it should have, but we think the reason silver ETFs were not raided like gold was that Central Banks do not have a silver supply problem, they have a gold problem. As we have argued before, the raiding of gold ETFs is bullish for gold because it reflects an imbalance in the physical market.

Figure 1: Gold and Silver prices declined significantly in 2013

Source: Bloomberg

Figure 2: ETF Holdings - Troy oz (millions)

- Source, Markets at a Glance:

http://www.sprottglobal.com/markets-at-a-glance/maag-article/?id=8816

What Will Turn This Market Around?

It has to be something to do with the physical markets. When the physical shortage becomes apparent – in an extreme case there could be a failure to deliver – is when gold and other precious metals should really get going.

Traders in the gold markets have their views that we are in deflation or in some kind of economic recovery where the dollar is going to strengthen. I think that what will break this perception is the recognition by the market that there is a gold shortage.

Of course, a kind of recognition has already occurred. The GOFO (Gold Forward Offered) rate has recently gone negative, as it was at the June low in the price of gold. It has only been negative 5 times in the past 15 years, and is generally linked to strain on the physical gold supply.

- Eric Sprott:

http://sprottgroup.com/thoughts

Not the Time to Get Out of the Sector

Yes, you are always prepared to take losses. That is just the nature of our business. Lots of stocks will lose money – in fact, I might lose money on half of the stocks I choose. Of course, the other half can go up by hundreds of a percent if I am right. This is the nature of investing in small to mid-sized businesses. Some of them run afoul due to problems with their projects, and some run afoul due to the market. They can also fail due to government interference or environmental problems. So there have been lots of situations where we have taken losses on stocks.

When you talk about taking losses, you mean that you would be selling one thing to buy something else. Either way, I certainly would not recommend, if somebody had seen a decline in their portfolio of 50 percent, that they sell their positions right away. They may want to sell a stock to buy another, but I certainly would not be selling everything and getting out of the sector here.

- Eric Sprott:

http://sprottgroup.com/thoughts

Eric Sprott on Rick Rule

Rick has a very long view that I cannot take because I run open-ended funds, whereas Rick runs partnerships with a long-term capital base, full-service brokerage accounts, and investment advisory accounts. These give him the ability to take a more long-term stance. Running open-ended mutual funds generally requires that we acquire shares of companies that have a good chance of performing well within a time frame of a few months rather than years.

- Eric Sprott:

http://sprottgroup.com/thoughts

2014 Sends Gold North of $2,000 and Silver Over $50

CEO Eric Sprott of Sprott Asset Management predicts, "The price of gold and silver will both hit new highs in 2014. The price of gold goes north of $2,000, and silver will quickly go over $50. When it does, it will get a little crazy." Sprott says, "They know a day of reckoning is coming, and they are setting up for it. . . . I am convinced some sovereign banking systems fail in 2014."

- Source, USA Watchdog:

http://usawatchdog.com/what-happens-when-you-have-to-admit-the-golds-not-there-eric-sprott/

Get Involved in Something Where you can Salvage your Net Worth

“I think so, Eric. I mean we have way more leverage than we ever had. And when someone thinks they are going to get their $100,000 pension, or $50,000 pension, and the next thing you know they are informed, ‘Well, you know your $100,000 became $16,000,’ or ‘your $50,000 became $8,000,’ just think of the shift that has to take place here.

Think of the poor guy making $8,000 and he finds out his health care bill is over $8,000. The whole thing makes no sense. The numbers don’t work. And we are going to face that reality. I don’t know when the US government, and not just the US government, but when other governments face up to, ‘OK, how are we going to right the ship here?’ It’s not going to be easy to right the ship. There are going to be very, very hard times that we are all going to go through to get there.

And I’m not one who is imagining that one tries to prosper in that. Whenever I got into gold back in 2000 I said, ‘You know what, I just want to try to survive this thing. I want to try to survive because the paper assets will end up with no value.’ Any study of currencies will show that the currency ends up being worth zero, and we have abused it so immensely here recently with all this printing going on.

I always ask investors, smart people, ‘Do you believe in zero interest rates, and do you believe in printing money? And if you do, fine, play the game. If you don’t, don’t play the game, and get involved in something where you can salvage your net worth at the end of the day.”

- Eric Sprott via King World News:

http://kingworldnews.com/kingworldnews/KWN_DailyWeb/Entries/2013/12/7_Billionaire_Eric_Sprott_-_The_End_Game_Is_Absolutely_Horrifying.html

My Greatest Fear is that Governments are Broke

“My greatest fear is that governments are broke. Governments have overspent and there is nothing they can do about it. They are going to fail on their obligations, and when they fail the economic impact will be so dire.

Imagine what the outlook for Detroit must be as all of these pensioners finally figure out they are going to get 16 cents on the dollar. How is it going to work in Detroit when there is no spending power? What if it moves on to Chicago, or the US government? Oh my God, there are so many governments, cities and states which are in trouble that have to face the music.

And once they face the music, the guy who thought he was going to get something is not going to get it. What does that do to the economy? It’s not a pleasant outlook. So that’s what I worry about. I worry about the final recognition that we’ve overspent, we’ve borrowed from the future, massively borrowed from the future, and when you massively borrow from the future, the present gets impacted someday.”

- Eric Sprott via King World News:

http://kingworldnews.com/kingworldnews/KWN_DailyWeb/Entries/2013/12/7_Billionaire_Eric_Sprott_-_The_End_Game_Is_Absolutely_Horrifying.html

All The Misinformation

When people finally realize that there’s a shortage of gold, the price starts to go up. The most incredible thing to me is that because of all the misinformation out there, China can buy an extra 25% of the gold market over the last two years, and the price goes down. Do you think that could happen in any market like oil, corn, wool or anything? It goes against the rules of supply and demand.

- Source, Eric Sprott via:

http://etfdailynews.com/2013/11/18/could-bad-data-be-depressing-the-gold-price/2/

ETF Gold Was Raided

The ETF was raided in H1/13, and I think the World Gold Council should wonder why. I believe it is because there was no gold. The plan was to slam the gold price down, get everyone to liquidate their SPDR Gold Shares ETF (NYSEARCA:GLD) shares, then buy the shares, redeem them for gold and deliver the gold out to the counterparties that are demanding it. The whole thing was a setup because of the shortage of gold.

- Source, Eric Sprott via:

http://etfdailynews.com/2013/11/18/could-bad-data-be-depressing-the-gold-price/