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TRANSCRIPTION OF INTERVIEW - Part 1
July 20, 2002
James E. Sinclair, Chairman & CEO
Tan Range Exploration Corp.
"The Fundamentals on Gold"
Editor's Note: We have edited the interview in this transcription for clarity and readability.
The original real audio interview may be heard on our Ask The Expert page.
Mr. Sinclair's interview was taped on Wednesday, July 10, 2002.
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JIM PUPLAVA: Joining me on the program today is James Sinclair. He is President of Tan Range Exploration Corporation. Mr. Sinclair is experienced in precious metals and commodities and has been a foreign currency trader. His past experience includes that of Founder of the Sinclair Group of Companies, which offered full brokerage services of stocks, bonds and investment vehicles. Mr. Sinclair has also served as the Precious Metals Advisor to the Hunt Oil and Hunt Family from 1981-1984. He was a General Partner and Member of the executive committee of two New York Stock Exchange firms. Mr. Sinclair, welcome to the program.
JAMES SINCLAIR: Thank you for having me.
JIM: I want to talk about an article that was written about you last December in Forbes Magazine. The article talked about a gold forecast you made in 1977. At that time, gold was about $150 per ounce and you predicted it would go to $900. Well, it never got to $900, but topped at $887.50 on January 21, 1980. You sold out your gold position. What did you see back then that made you bearish on gold and conversely, what makes you bullish on gold today?
JAMES SINCLAIR: What I saw back there can be really encapsulated in one name: Volcker. His intentions and activities within the economic system then was to drive interest rates as high as 14% on 10-year money. It was a clear indication of his willingness to do what he saw necessary to fight the then in-place inflationary trend. In fact, there was an editorial written in Barron's which basically called me a "pinhead" for calling Volcker a class act. I saw the opposition come up, and quite honestly, it was exactly opposite of what we have today. Rates were running up to 12 7/8 to 14 percent on government money. The rates we are looking at now were, I think, the beginning of burning up the store (dollar) that is taking place now. There was the beginning of an attempt to defend the dollar. The gold market was running hard on the upside. Although you would like to claim to be a genius, I personally think I just got sober one day before everyone else. But for the grace of God, I might also have gotten myself caught.
JIM: You made good money back then and now you are bullish on gold again. You wrote an editorial for Financial Sense and included five reasons for being bullish on gold. I wonder if you might talk about that. [Ed: note below the 5 Keys to a Long Term Bull Market in Gold from 6/7/02 editorial]
The US Current Account must be in a Deficit position and growing. Yes, this is a present condition and shows no fundamental signs of reversing for a significant time. This is the account that measures the amount of US dollars in the hands of non-US entities. It is usually invested primarily in US Federal Debt instruments.
An intact negative trend in the US Dollar overall must exist. It should have the characteristics of a bear market. This is in fact true for the US Dollar today. We have a classic long-term top called a Head & Shoulders formation, which was subsequently confirmed by price and volume action. Even the dollar bulls now are looking only for the dollar to stabilize at lower levels. This criterion is in place for a long-term bull market in gold.
The general commodity market is showing in many ways, both fundamentally and technically, that it is in a base formation from which one can expect higher prices. We shall discuss the technical characteristics further to sustain that this ingredient has begun to support gold long term.
Trust in paper assets must be waning for gold to assume an investment role internationally. We see the recent decision against Andersen, the comments on GE & IBM accounting practices and Enron as examples of causative items, which have turned investors away from the absolute belief, in existence from 1980 until now, that paper assets were storehouses of value. We believe this ingredient is in favor of gold’s long-term bull market.
The momentum in the appreciation of the bond market must be decelerating. We see this ingredient as positive now to a long-term bull market in gold.
JAMES SINCLAIR: Well, Jim, and to our listeners, I believe that those five reasons that we will go through now are really the fundamental basis for any gold market. They have been in the past and I think they will be in the future. Gold didn't misbehave in the last 22 years. In truth, it did exactly what it should have done.
The U.S. Dollar & Current Account
The dollar was so extraordinarily strong, rising let's say on an index, the USDX, from an area below 70 to slightly above 120. The dollar has clearly made its top. The first and primary fundamental to a gold bull market is the US dollar. It is in a sense where gold represents one side of the equation and the dollar and US bonds represent another side of the equation. The first is what the dynamic condition of the dollar is. By dynamic verses static, I don't mean a picture of where it is at a point of time, but what is the trend development. The first and most important fundamental characteristic of a gold bull market is that the dollar has established a definitive top. Fundamentally and technically the dollar's decline is in an intact trend. The reason why this is so important is because so many dollars tend to be held now, and in the past, and probably again in the future, by overseas entities. We will come into what that means in a moment. But, first, what is the dollar doing? The dollar has definitely established a top. The fundamental reason is in place and it supports a long term bull market in gold. The linking factor in here is the current account. That means the amount of dollars by foreigners reaches a deficit level upon which you generally begin to see currencies decline. The condition of the current account, again in dynamic not in static terms, is something which is reported again dealing with the flows of money resulting in overseas holdings.
Storehouse of Value
The third fundamental to any gold market, bull or bear, in this case bull, is the relative attractiveness -- or not -- of equities as a storehouse of value. Now, if the dollar rose over the last 22 years, so did the assumption by an entire investment generation and double generation if you will. The values would be found as a storehouse. That is paper assets -- stocks, bonds, derivatives, and so forth -- would be a storehouse of value. There has been a very significant change in that storehouse. The tech stocks and general securities have declined now, and very importantly, because there is the distinct distrust of the integrity of the individuals running these companies.
There has been an assault on paper as a storehouse of value. It is not simply because of a price trend, the extreme decline of the Dow Jones and NASDAQ indexes, but now because there has been such constancy in revelation of fiduciaries. People, who the general stockholder has trusted to run the assets and affairs of a company as a sacred trust, have turned out to run their companies as a private candy store. That has had a very serious impact. Everything relates to everything else. In other words, nothing can be looked at as an isolated item. The stock market has continued to decline as the events of lack of integrity of the leadership of the corporate world become more evident, almost on a daily basis. Money flows out of the United States or out of securities, are further depreciating the price of the already declining dollar.
Equities as a storehouse of value will have a significant impact on the fundamental characteristic of gold. Quite naturally and subjectively, when value is less attractive in the equity paper as a storehouse of value, the off-setting result is that hard assets become more attractive. In that transition -- that investor transition -- is the third and very important fundamental in a bull market or a bear market, in this case a bull market.
Foreign Holdings
Now, where is this money overseas? Money overseas is not held in U.S. dollars in a bank. It is invested. It is invested in U.S. securities and in U.S. corporate debt. The bulk of it finds its way into the sovereign exterior, non-US quasi-sovereign investment entity. It finds its way through that, back into U.S. government bonds. You can see that when the dollar declines, the potential is that it will gather that many dollars internationally, which are now invested U.S. government bonds. Which do what? Even though the prices of the bonds are rising now, they are not rising as fast as the dollar is depreciating. You are losing money. So now the overseas investor in the U.S. government bond begins to lose money. That goes on for awhile, till all of a sudden, it dawns on them that this is not necessarily a great investment.
Putting the bond market up now is a flight to liquidity from the general equities, which is fund-managed money. It will find its way into short and medium-term U.S. government paper. That isn't a constant flow. That will, as the stacks are liquidated, have a finite end. The criteria -- not yet supportive to gold, but in my opinion will be and I think cyclically by November of this year -- will be a less than positive U.S. government bond market. That is the fourth criteria not yet supportive of the gold.
One, two and three are in. Four is not in and number five is beginning to develop. The means now to prevent a meltdown of all that is taking place -- and by the way when push comes to shove with the DOW down over 300 points, with the NASDAQ having formed an ugly technical formation, what is called a "bankruptcy head and shoulders" -- that means their top is larger, then it can go to zero. I have long held the position and I still do, that when this situation -- a once and a lifetime technical occurrence -- that we have today, which would indicate the most serious possible problems in general business and in markets, I believe that the sitting incumbent administration will literally burn the store before accepting the implications of the technical development of the market today.
Commodity Markets
That brings us into the fifth criterion that is necessary for a long term positive market in gold. That fifth criterion is the condition of the general commodity markets. I said that they would burn the store. The store is the dollar and the matches that would use to burn it are the only tools that are now left functional to attempt to prevent an economic meltdown, which is expansion of monetary aggregates. This is in fact occurring now. We have deficit spending and we are in a war economy now. The terrorist, anti-terrorist military and the national defense actions we are undergoing right now are a constant rolling significant war. We are on a war spending, budget and strategy.
The last criteria that seems to be happening almost as we talk, is the condition of the general commodity market turning positive. The Commodity Research Bureau [CRB] index has moved above its 200-week moving average which is quite bullish for the index. Commodities like, coffee, sugar, cocoa, wheat, corn, are all showing extremely positive formation which indicate the probability that they are moving out from very long-term bear markets themselves. I tend to believe that the money that comes into the economy through the strategy of war economy spending and deficit spending and expansion of monetary aggregates, isn't going to find its way into general equities. As much as the probability suggests from historical precedent, I believe it will find its way into general commodities. I am of the mind that the five fundamental characteristics required for a long-term bull market in gold are four in and one I firmly believe will find its way in by November. It is my opinion that we do not have simply a little blip in the gold market, but a significant fundamental change. It is a change of a long-term nature, that should sustain a significant period of time and significant dimension of price in terms of a positive environment for gold.
Those are the five, Jim, but what makes this unusual is that gold rarely leads the commodity market. Historically, gold follows the commodity market.
JIM: You said that the government will burn the system. There are many respected people in the financial industry that say we are headed for deflation. What is your view with the government pulling out all stops? We are in a war economy. The money supply is increasing. What are your views on deflation verses inflation ahead of us?
JAMES SINCLAIR: The definition of inflation is monetary aggregates. Price inflation is a result of that. Deflation is being looked at in terms of economic conditions. We need to get our terms defined. One of the major proponents of deflation has not historically distinguished itself in market timing. So is it possible that we will find ourselves in a business deflationary environment? The answer is most certainly, yes. The political reality of that is just what we have gone through in the five criteria to a long term bull market in gold. When you discuss deflation, you need to say in what terms you are discussing. When you discuss markets, it may be that it is a different order of events before the risk of a deflation.
What I suggested to you in the opening remarks and what has occurred today, don't for a moment think that the Federal Reserve or the Treasury, are not technically savvy about markets. They are extraordinarily savvy about the technical characteristics of markets. They know very well what a "bankruptcy head and shoulders" looks like. They know very well what has occurred in the NASDAQ. They know very well that that indicates the NASDAQ stocks have very little, if any, value. Every action and activity -- every tool that is available -- will be brought in to try and prevent that. Before you get to the point of discussing whether or not you are headed for this "Prechter type" deflation, I think that you need to take a look at what the impact of the tools will be that are applied to change or to avoid, and what those effects will be on the market.
When markets are concerned, I think that Jesse Livermore was the greatest speculators have ever lived and Seligman, Both of them said one thing. It is of no value to pontificate what you think is going to happen, because nobody tells markets what to do. You have to listen to the market and let it tell you what is going to happen. In that sense, I suggest to you that 302 to 305 on gold is a support, 317 to 318 is resistance, 329 to 330 and 354. Before you decide that the entire world is going to implode into deflation, it is better to watch what gold does as a primary indicator of the inflation, price wise, deflation, price wise, scenario.
JIM: Mark Faber, out of Hong Kong, wrote a recent piece. He said that if you picture the world, and on top of that world is a bowl of money, as long as central banks continue to print paper and pour money into this bowl and it overflows, it’s going to go somewhere. Money is going to seek its own outlet and that outlet could be commodities. Do you agree with that assumption?
JAMES SINCLAIR: I agree completely with that assumption. And I think that if you listen to markets and take a look at base formations breaking out to the topside while equities up top have huge, outrageously big top formations today breaking down to the bottom side, you’d have to say that, technically, the markets are giving the same story as was just given. The money will go somewhere. Monetary aggregates are the grease of the wheels of markets. The money makes markets happen. The question is which market is it going to go to? The answer is it’s going to go to the market that doesn’t have any human between you and it. Because, as of late, have not the humans been less than good administrators in the corporate sense? It’s going into the hard asset -- not into the paper asset.
So, we do have the aggregate expansion at historic rates. We are deficit spending and will continue to. We are on a war footing. Where is all this going to go? The answer, I think, is into commodities. And I think that gold will, for not only the five reasons that I’ve given you, but for another and rather extraordinary technical reason, perform very nicely. One thing I don’t believe is you’re going to get a bear market in gold with the five criteria fundamental positive bull market's functioning to support the market. Now, again, the argument of deflation, definitions are terribly important. What are we talking about? The price of commodities or how the corporate world is performing? So, if we get into that argumentation, certainly we need to get a basis of definition before we proceed too much further.
JIM: Let's carry on with that. On the business side of deflation in the economy, we certainly have seen that corporations have no pricing power. Yet you’ve got Detroit now giving away free financing and goodness knows what else is coming down the line. You’ve got other companies, like the furniture retail industry, where everything is on sale now. You’ve got furniture companies offering no payments for 2-4 years. You could easily say deflation in pricing or deflation in profits. There isn’t anything there.
Getting to commodities -- and I want to talk about basic economics when we look at that -- when you have something such as gold or silver -- it could be coffee, soybeans, lead, zinc or anything else -- when you have an extended period of low pricing as we have seen in these commodities, we know from basic economics that the industry contracts. The weaker players in the industry go under or are taken over. The industry consolidates and you get less in supply. We have seen this take place over the last couple decades. I think it’s rather unusual as we now look at the price of gold.
I want to move into the derivative portion of this argument. We know that silver is in its twelfth year of supply deficits. Gold is running a supply deficit. I wonder if you might talk about the role of derivatives is playing in keeping this market somewhat surprised. It’s been alluded that there is a conspiracy here or a concerted effort by certain financial individuals or institutions that have desired to keep the price down. I want to get your take on that.
JAMES SINCLAIR: Well, you’ve said an awful lot there, Jim, so I just need to backtrack a bit if you’d allow me to. When we consider…when we speak of gold as a commodity, gold is a commodity when the dollar is strong. When the dollar becomes weak, gold begins to transition to a currency. The nature of gold is that, as a commodity, its value is debatable while, as a currency, its value can be infinite. Now, you know, taking gold out of that equation, because that’s what I think is happening, and just putting it over on the shelf for a second, let’s begin to discuss, as you want, the derivative side.
Gold Derivatives
Derivatives is a very broad category and certainly the derivatives -- and they mean only “derived from” -- that trade on listed exchanges such as the Futures Exchange or such as on the stock exchanges, the puts and calls, the options on securities, are very well regulated, completely transparent. They have clearing house funding, which means that losers pay in and winners are paid out in the sense of the writer, meaning the person who actually creates the derivatives. They are under administrative law and are generally sound instruments.
But, there’s a huge other market out there and this huge other market is simply a market made by over-the-counter dealers around the world that simply contract with each other in the main without standards. The strength of any derivative market is really determined by what it’s derived from. Simple definition. And the strength is the ability to trade the underlying asset. So, where you have a huge trading market in debt instruments, the derivative on a listed exchange, has a degree of soundness. Securities, huge markets…listed derivatives…sound. But the listeners should know that when you get into the area of the gold market, you’re discussing something that may trade around the world when the market moves a significant amount. Such as the drop that took place two Friday’s ago [6/28/02 See editorial.] from the upper 20’s down into the 310 area. During the middle part of that move, if 5,000 ounces traded around the world, I’d eat my hat.
The market for gold, when it moves significantly, is a pitifully small market. Now, what’s developed and was actually somewhat invented by the gold producers, is a market that has facilitated the gold producers' desire for non-recourse loans. That means they could borrow money and the banks would lend them the money, with recourse only to that project, but not to any other assets of the gold producer. But in order to qualify, to get this non-recourse lending, the gold producer had to accept a package that was offered to them. This was generally through the bank they were dealing with and through a subsidiary of that bank. It would allow them to sell the gold that was to be mined from that project short, into the future, for the amount of years that they would be borrowing the money. Now, gold projects are normally looked at economically as having a ten-year life. Generally they have more -- but if they have less, they don’t qualify for financing. So that meant that this over-the-counter agreement with the gold producer to sell the gold short into the future was ten years forward or eight years more than what was available on listed exchanges.
The second tactic that was used was called leasing gold. Where the gold bank would arrange for the gold producer to, through the gold bank, lease from a central bank a dollar amount of gold which then would be sold into the market. The case would come to the gold producer to be used for the purposes of financing new developments. But today that represents only 11% of the amount reported by the Bank for International Settlements and the IMF as to what’s called the “notional value” of gold derivatives outstanding.
The "Wise Guys"
So where the market was first functionally created by the gold producer, it now is a market which is participated in, mainly, by people who have absolutely nothing whatsoever to do with the production of gold. I think that the best name for these folks are “the wise guys” who have found out that they could borrow money at under 2% and under 1%, sell that, and invest that money in government paper earning interest. Then when it came time to replace the gold, they would then be able to purchase the same amount of ounces they had leased for a lot less money because the price of gold declined. And, in a sense, the gold companies, who think even to this day that they’re the main participants in this market, are simply accidents waiting to happen, for a reason that none are willing to put their attention on and that’s the inherent financial weakness in these contracts.
Where those that are dealing in the derivative contracts are wholly dependent on the balance sheet of the counterparty gold bank, which is not a primary but rather a subsidiary of the holding companies of the large good name bank holding companies. Now these contracts are not listed on any exchange. There’s no clearing house funding of these contracts which stands to reasonably guarantee their financial integrity. There’s no transparency in dealing. The prices of these contracts generally are computer-simulated models -- not anything to do with the market place. In many situations, the dealers and the gold companies don’t have right of offset, which is similar to say having a deposit in a savings bank and a mortgage from the savings bank. If the savings bank were to go broke and you had no right of offset, you’d have to pay back 100% of the mortgage while you lost probably 100% of your deposit. So those gold companies, now, that are proud to have their hedge books balanced, are not taking into consideration the financial weakness of an agreement which stands only on the balance sheet of the counterparty and which has no clearinghouse funding to protect it. Now this has grown to a rather enormous number. The number reported by the IMF and the BIS right now, if you were to convert it into ounces, is equal to 900 million ounces. And 900 million ounces, if you take present production and the tailing off of production, is more than 24 years production. And because all of these contract have been developed within a long declining period of gold, there’s only one side the contract can be on and that’s called a “short spread”.
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