Financial System Headed South

Source: Brian Sylvester of The Gold Report 08/13/2010
http://www.theaureport.com/cs/user/print/na/7075

Midas Letter Editor James West is one of the sharpest minds in the gold business, and he puts his money where his mouth is. He owns gold equities, ETFs, coins and even a share of a private Peruvian mine. "Gold is the best investment at this time," he says, a thesis based on the "counterfeiting" of paper currencies and inevitable collapse of the global financial system. In this Gold Report exclusive, James suggests several ways to profit along the way.

The Gold Report: James, in a recent issue of the Midas Letter you said, "The world, according to gold, is in an absolute mess." We're not in a gold price mania, so how can the world be in an "absolute mess?"

James West: You say we're not in a gold mania, but that depends on the perspective of time. If you look at the gold price chart for the last six months, it has appreciated slightly from $1,075 in February, touched a high of $1,260 in June and is now a bit below $1,200. But from the 10-year viewpoint, it has increased about 500%. I would classify this as a very long and slow sort of mania, which might, in technical terms, be a contradiction. Perhaps mania is not the right word. But there has been an ongoing accumulation of gold by a lot of different investment entities around the world since 2000. It continues more or less unabated on a macro level.

TGR: How high do you see gold going?

JW: Well, that's another funny question. When people ask, "how high do you see gold going?" it's like saying, "how long is a piece of string?" It depends on the timeframe. Where is it going to be in 30 days? It could be up $100 or it could be down $100, but it's not going to be at the price it is today. If you're talking a year's time, I think the price is going to be a little bit higher. Gold has been growing at an average of $87 per year for the last 10 years, so if I were going to predict where the price is going to be in five years I would say $1,635. Where is it going to be in 10 years? There are many factors that can come to bear there.

TGR: What sort of factors?

JW: The printing of money is one way to look at inflation. That is going to continue unabated for the near term because all the G8 governments have more or less embraced the idea of quantitative easing or stimulus. I prefer to think of it as counterfeiting.

They are printing money that has absolutely no relation to anything of value. No commodity, no currency. There is sort of a tacit collusion going on among the G8 Nations, and especially China. China says, "OK, we'll keep buying your treasuries and we won't sell them as long as you don't give us a hard time about our human rights abuses and our unwillingness to let the yuan float freely against other currencies." That's why I say that the world's in a big mess, according to gold, because you've got this situation where no one can afford to acknowledge the reality.

This tacit collusion has resulted in a collective untruth being the primary foundational circumstance upon which our financial system is built. To me that's like an inverted pyramid. As long as everybody keeps pushing on either side at exactly the right pressure, the pyramid can continue to balance on its pointy little head. But if one side gives even the slightest or pushes a little too hard or gives up on the support that they're giving, then the pyramid becomes much more difficult for the other entities to support and it's going to come falling over.

TGR: That's an interesting metaphor.

JW: That's the metaphor that I like. All of these different G8 entities and financial groups push on the pyramid, keeping it on its pointed head while all the governments keep printing money and pouring it on top, making the pyramid larger and more unwieldy. This is unsustainable. The systemic problems that are causing this unwieldy imbalance have accelerated in the last 10 years. We're headed to a point where this thing is going to fall over because it's built entirely on a falsehood—that we can continue to print money with abandonment and that's the way to run an economy, and nobody's ever going to call the loan.

TGR: Do you think that will ultimately result in a global deflationary scenario or an inflationary scenario?

JW: Both. I mean the inflationary scenario is happening now, as is the deflationary scenario to some extent. We've got all this money flowing into the system, but it's only flowing into selected segments. The banks that have been threatened by real estate loans that are now underwater because of the global devaluation in real estate are the recipients of most of this stimulus. Little of that stimulus is filtering down to small businesses and small employers on Main Street America.

None of the benefit of these big institutions being rescued filters down to them. In those segments of the economy, there is a deflationary phase where there is no money flowing in. Nobody is spending money. Nobody’s renovating their homes. Nobody’s getting their trucks tricked out. All these little fringe businesses are stagnating. There's a lot of evidence to support that even in the mainstream media. In the Midas Letter, we find the stories to support the theory that this is all an illusion and these guys at the top of the food chain are in fact crooks. Until there's some major systemic change this is going to continue.

TGR: You talked about a line in the sand. What's the next leg down that will tell us that this line in the sand has been crossed?

JW: There are a few key indicators that everybody follows. First and foremost are the stock markets; they are the canary in the coal mine. The first sign that things are about to go very haywire is when those markets start dropping by 4%, 7%, 10% in a single session.

When you see the market dropping off by huge quantities, you know that people are running for the hills. Now it's going to be difficult to see that because the President's working group has all these mechanisms to prevent the market from dropping more than a certain percentage in a day before it's shut down. That gives the government time to come up with something to stem the panic selling, so that indicator is not going to be readily available like it was in 2008 when we saw the Lehman Brothers crash.

Another sign would be when the big hedge funds are cashing in their chips and sitting in cash. Other indicators are already flashing warning signs. The Baltic Dry Index, which is one of my favorites, has dropped by half since the end of May. That means that the movement of commodities has fallen by half since then. Commodities are the building blocks of all industries.

When the commodities fall off like that, it's indicative that there's a general absence of demand for raw materials. That's a serious sign that the point of no return has been crossed. You will know the financial stimulus, which had the net effect of offsetting the inevitable, has run its course and can't rescue the system. The deterioration in economic activity levels has resumed. Those indicators are the increased number of foreclosures in metro areas throughout the United States, and the spike in unemployment since mid-2009 that remains high.

TGR: Indeed. You have that graph on www.midasletter.com that talks about the U.S. Department of Labor numbers, which claim about 10% unemployment. But there are other sources on your chart. One says U.S. unemployment in July was 16%, while another one says 24%. Which one do you believe is closest to the truth?

JW: I believe that John Williams' ShadowStats is the closest to the truth. John has been hired by large institutions to predict various things. One of his earliest clients was a large manufacturer of commercial airplanes. They were looking to develop an economic model for predicting passenger miles. They essentially used GDP to predict what that would be, but their model wasn't working effectively.

So they hired John Williams, who is an economist, to figure out what was wrong. He realized that the statistics that the government was putting out were not accurate because of their faulty method of determining GDP. He went into the data and fixed the model. Then he started to remodel all the government data and many other sources of data, stuff like retail sales and trade deficits, inflation versus production numbers, durable goods, home sales, housing starts. For all of those there's the government version, and then there's John Williams' version. I know some of John Williams' clients, and they unequivocally state that they put more faith in his numbers than they do in the government's numbers.

TGR: How should people get exposure to gold?

JW: That depends on your risk profile. If you're in the later stage of life and you've got assets that provide some kind of fixed income, then you want to go with the most conservative exposure to gold, which would probably be bullion. The problem with owning bullion is that if you can't protect it, you set yourself up as a target.

Barring that, I think the best way to own gold is probably through the SPDR S&P 500 ETF (NYSE:SPY), which actually buys and holds physical gold. But if you're actually going to use gold as an instrument for trading goods, then that indicates that a line in the sand has been crossed and the financial system has crumbled. And you've got this hyperinflationary phase where it takes a wheelbarrow of cash to buy a loaf of bread and an hour later it takes two wheelbarrows. I caution that if you're going to own an ETF and the whole financial system turns to rubbish, an ETF is not going to be tradable. But let's assume that's not the case and you just want to expose yourself to gold as an investment; the conservative position is an ETF or bullion. Moderate risk would be senior gold producers. Higher risk would be junior producers. Highest risk exposure to gold would be gold explorers.

TGR: You hold positions in all three categories.

JW: I hold gold in every position imaginable. I am a participant in a gold mine in Peru. I own shares in milling operations in South America. I own gold dust, gold bullion, gold coins. I have some positions in ETFs. I have some senior producers, some mid-tier producers, some junior producers and some junior explorers.

TGR: Would you consider yourself a gold bug?

JW: No, I wouldn't because I really have no use for gold personally. It's just the best investment at this time.

TGR: Are there any circumstances under which gold is not a good investment?

JW: Oh, absolutely. Let's say we have a world full of economies that shepherd their currencies responsibly and circulate only money that is essentially the equivalent of their GDP and their asset base divided by their population. There would be no reason to own gold. The systems that issue money should own the gold. If we lived in a world where our governments and our financial institutions and systems were trustworthy, there would be no reason to own gold and invest in gold.

Publisher of Midas Letter, James West has devoted 20 years to helping small companies in the resource sector—helping them raise money, further their projects, build their identities and get their stories in front of investors on the lookout for quality investments with excellent returns.