The Gold Report: Europe is in the headlines daily: more leftists coming to power, regional banks suffering, renewed recession appearing to take hold. What is your take on Europe?
Frank Barbera: In the headlines, Europe looks like quite the mess. Imagine being a Greek who saved over a lifetime now facing the possibility of devaluation or Greece leaving the euro. If Greece pulls out of the euro and devalues, most of the people will see their life savings collapse in terms of purchasing power.
In my view, there is a pretty good chance that would spark a contagion. When people in Spain or Italy see Greece pull out and return to a devalued drachma, there will be bank runs in other countries. Money will move out of those banking systems into perceived safer havens. That is how a contagion gets started.
The situation in Spain also is very serious. It has chronically high unemployment, in excess of 24%; youth unemployment is nearly 50%.
All of the leading indicators for Europe are pointing down. Europe seems to be descending into a major recession; even Germany is backsliding toward recession. The breakup of the euro would greatly exacerbate that. Interest rates would shoot up in bond markets around Europe, spreads would blow out.
If you were an Austrian school economist you would say, let it unwind, let the debt default and the governments stand back and do very little. That would be a very severe dose of medicine to take.
Instead, I think we will get more government intervention, as we saw in December 2011, when some of the big Italian and French banks were staring into the abyss of default. The European Central Bank came in, expanded its balance sheet with a long-term repo operation and loaned money to the commercial banks that needed liquidity. At that point, 547 banks asked for help. That liquidity infusion helped the markets stave off a bearish, deflationary downturn for a few months.
Politicians will act only when the cost of not acting exceeds the cost of acting. With markets nearing a panic now, that Minksy moment demanding a political response to market contagion is growing very near. As a result, I think we will soon see more money being printed and more liquidity injections as politicians attempt to stretch the problem out.
TGR: You do not expect a big explosion, but a long, painful, downward spiral?
FB: Not quite either one. I think Europe is on the edge, tap dancing with a deflationary collapse. I do not think the politicians want it to collapse; there is too much of a vested interest in keeping the euro together despite it being an inherently flawed structure.
If Europe wants to stay together, it must take steps toward becoming a real fiscal union. That means buying time by continuing to create liquidity and infuse money. Essentially, the politicians will resort to the printing press. The outcome of that will, over time, be higher inflation rates.
I do not expect an explosion of inflation, but over time there is a definite risk of an increase in inflation, as more and more money is created. Higher inflation combined with rather static “managed” exchange rates will over time amount to an internal devaluation of debt and paper money purchasing power.
TGR: What would that do to commodities?
FB: That is fundamentally very bullish for commodities, especially the precious metals but to some degree also food and energy. Commodities are generally scarce. If you exhaust an oil well, you have to find a new oil well to replace it. Gold is basically very scarce. Both commodity equities and commodities will probably do fairly well, especially equities, in the countries with the biggest problems.
TGR: And what about China? If China is not growing as much as predicted, what impact will Asia have on commodity prices?
FB: I think Asia is going to slow down. Europe is one of Asia’s biggest export markets. If Europe slows down to a recession level, that will naturally trim growth and the inflation rate in Asia. China has a potential overcapacity problem due to overinvestment in capital over the last decade. That could take some time to work through, but it is a state-run economy with a better chance of navigating it. The Chinese government may be able to control credit by telling the banks they cannot lend and having the banks obey. Right now, China has an easing policy in place, which might help it mitigate some downside risk. I think China could be heading for a recession, but not for a major collapse.
TGR: Turning to the U.S. economy, we hear that things are improving: upticks in construction spending, declines in joblessness claims. This is an election year. Do we sell in May and go away, or can the markets continue to make further gains?
FB: There are a couple of interesting points to be made. With respect to sell in May and go away, the historic data suggest that is not a bad idea except in an election year. Typically, the few months in front of the election—May to October—are pretty good.
Seasonally, the stock market has a nice tailwind behind it. However, that said, I am afraid that the current news trends show just a steady sequence of bad news coming from Europe and that implies that markets will likely be hostage to the European debt crisis for some time to come. In addition, later this year, around Labor Day, it is estimated that the U.S. will face a second debt ceiling crisis, which is already looking to become a major pre-election issue, and could ultimately result in more credit rating downgrades, so the next few months have several major wildcards already built into the deck.
Finally, I want to acknowledge that this concept that PIMCO has stressed, the “New Normal,” still seems to be the overriding theme, which is one of very slow nominal growth and actually flat to negative real growth. As an example, go back and take a look at the U.S. economy between 1995 and 2005, you had a little over a 5% growth rate. In 2008, the U.S. economy slowed to about a 2% growth rate. I think that is what we will see for quite some time to come, so one can say that we live in a world where growth itself is becoming a very scare commodity. In my work, I have dubbed the current recovery, the “Subdued Recovery” as you need to look past the headlines about employment improving to see the devil in the details.
Employment reports have improved, but when you look at the composition of the jobs that have been created since 2008, most of them have been in low- to moderate-wage categories. Since 2008, the U.S. has actually shed high-wage jobs. That has big implications for something like housing. To buy a house, the first thing you need is a job. The second thing you need is a high-wage job so you can afford to carry a mortgage. Oversupply in the housing market and scarcity of new high-wage job creation is not a recipe for a housing turnaround. To me, that means housing will stay low and maybe plateau for a long time.
On the average personal balance sheet, the two most important assets are a house and retirement savings. In a consumer-led economy, 72% of gross domestic product is consumer spending. If real estate and housing are going to remain depressed, it becomes very important to keep a retirement account buoyant because if any of those asset classes are depressed, a negative wealth effect is created. This leads to a slowdown in spending and the U.S. could easily relapse back into recession.
I think that is why we have seen more central banks intervening. Quantitative easing programs are being enacted every time the stock markets start to weaken. The idea behind that is to create asset inflation and keep retirement accounts at least reasonably buoyant. This way you keep a positive wealth effect and maintain consumer spending, at least enough to sustain slow growth. That is how you give the economy time to restructure and eventually work down and deleverage the big debt load.
TGR: Going back to the commodities, gold and silver are way down from last summer. Are you still bullish on precious metals and other commodities?
FB: I am getting very bullish on gold and silver. I think precious metals as an asset class will do very well and you will see new, all-time highs in both gold and silver over time.
TGR: The equities behind those commodities have not kept up even with the step-up that happened from last year. What will take those equities higher?
FB: That is a pretty interesting situation, a one-off anomaly. It looks as if the mining industry has been negatively affected by rising costs over the last few years. That, along with the fact that there has not been much yield for a long time, left the mining sector and some of the other resource sectors languishing.
I think that is starting to change. Looking out two to five years, if we do see a rising trend in inflation, I think money will look very favorably at resource-related stocks. Today, the multiples on some of those stocks are as cheap as they have ever been. A few years ago, gold mining stocks were selling at 30 to 40 times earnings. They are now down to 6 to 8 times earnings and, in some cases, 8 to 9 times cash flow. That is something you see maybe once every two or three decades. That means there are very cheap stocks and some outstanding values.
In addition, many companies are starting to boost dividends because, even with rising costs, they are doing very well and are reporting solid cash flow gains. So now, all of a sudden, you have a yield kicker. I think that could be the beginning of a very long, positive trend. Given the large markdown we’ve seen in the last few months, it seems that the market perceives a deflationary threat from Europe and is marking mining stocks down. I suspect that will turn out to be an over-reaction and you will find mining stocks at very attractive levels.
You can say the same thing about a lot of other groups: energy, oil services, large-cap energy, some of the master limited partnerships (MLPs), some major commodity producers in the grain market. There are a lot of areas that investors should be looking at.
TGR: What are some of the undervalued stocks you see in the mining sector?
FB: I like all of the large, blue-chip gold miners: Barrick Gold Corp. (ABX:TSX; ABX:NYSE), Goldcorp Inc. (G:TSX; GG:NYSE) and Newmont Mining Corp. (NEM:NYSE). I probably should disclose that I actually own some of those, so I’m talking my own book.
These companies are selling at very depressed multiples. Newmont recently instituted a nice dividend program, where if the price of gold goes higher, it will automatically boost its dividend. If gold goes through $2,000/ounce in the next few months, Newmont yielding a 4–5% dividend would be an attractive situation.
There are some good quality, midtier emerging seniors like Yamana Gold Inc. (YRI:TSX; AUY:NYSE; YAU:LSE) and Eldorado Gold Corp. (ELD:TSX; EGO:NYSE). You have the royalty companies that look attractive, like Franco-Nevada Corp. (FNV:TSX).
SteelPath has a very good fund that has MLPs yielding 6–7%. In the oil services sector, I would name Schlumberger Ltd. (SLB:NYSE) and land drillers like Baker Hughes Inc. (BHI:NYSE) and Nabors Industries Ltd. (NBR:NYSE). It may take a little bit more time and may be a little bit early on some of the land drillers, but as we get closer to the end of the year, they will have some write-downs coming. Once we get past that, a lot of the bad news will be up. Some of those stocks are selling at 7 to 8 times earnings. I definitely see good value in energy services and even in some of the larger-cap oils, like Murphy Oil Corp. (MUR:NYSE), Occidental Petroleum Corp. (OXY:NYSE), ConocoPhillips (COP:NYSE) and Chevron Corporation (CVX:NYSE).
If you want to look outside the U.S., there are the large Chinese oil companies. In Brazil, Petrobras (PBR:NYSE; PETR3:BOVESPA) is selling at some of the cheapest levels in years.
This is a good time to look at the natural resource-related stocks and look to take a very broad, cross-section approach where you own a little in different areas.
TGR: How do you evaluate a royalty company? Just because it pays a dividend does not mean it is a good company.
FB: The royalty companies in the mining space are Royal Gold Inc. (RGLD:NASDAQ; RGL:TSX) and Franco-Nevada.
Franco-Nevada is a blue-chip company. It has stellar leadership in Pierre Lassonde, who built up the company from nothing years ago. It has an outstanding portfolio and an enticing balance sheet. Franco-Nevada has resisted this particular downdraft. Large-cap, senior companies like Barrick, Newmont or Goldcorp have seen 30–40% declines in the last few months. Franco-Nevada has basically held even. I believe that Franco-Nevada today is a truly great growth story on the order of some of the best growth stocks we have seen in the last few decades. Royal Gold seems like a pretty well-run company, but in my opinion, I would not put Royal Gold in the same category as Franco-Nevada.
TGR: Assuming that we are facing an inflationary situation over the years ahead, what is your best suggestion in terms of an asset class for conservative investors?
FB: That is a major issue for the large number of retirees in the U.S., people who used to invest in certificates of deposit, because right now the banks are paying nothing. We have financial repression coming from the Federal Reserve. The book This Time is Different by Carmen Reinhart and Kenneth Rogoff talks about how the Fed will run negative real rates for years and reduce the value of its debts.
Federal Reserve Chairman Ben Bernanke is telling people he will keep the interest rates low for the next three years. I would take him at his word. When I look at the U.S. yield curve, with a 0% short-term rate and negative real yields all the way out to the 30-year bonds, I think that is a recipe for a weakening dollar. Of course, we could have a deflationary outcome in the near term, which could temporarily lift the value of the dollar, but I think a falling dollar will be a major theme over the next few years.
It will be really important for U.S. investors to look at non-dollar bonds. There is a good chance that we will see the final lows in Treasury bond yields in the next 12 months and Treasury bonds will move into a bear market. We hear about this bond bubble a lot. The bonds you have to be worried about are Treasury bonds, not foreign bonds, not emerging market debt, not necessarily even junk bonds.
There are a lot of bonds around the world that are negatively correlated to Treasury bonds. When Treasury bonds move into a bear market and long-term yields start to back up in the U.S., American investors will need to start looking at other income generating categories including assets like global bond funds and emerging market debt funds, and even TIPS funds and MLPs. There are bond categories where you can earn a conservative yield and generate a relatively safe total return. That is one idea: to think globally and become globally diversified.
TGR: Lastly, what is the best investing advice you ever received, whether you took it or not?
FB: The best advice I ever received was not to buy and hold anything, but to maintain a tactical approach and be flexible. Diversify is another good piece of advice.
In difficult economic times, your biggest single advantage is the ability to be tactical, to be nimble and to react to changing market conditions. The one big positive most investors have right now is that the menu of potential investment vehicles has really grown in recent years, including a proliferation of exchange-traded funds (ETF) and mutual funds.
Ten years ago, the average individual could not access Australian or South Korean bonds. Today, we can buy Hyundai stock denominated in South Korean won or South Korean bonds or Australian bonds. There are even ETFs for things like this. Last week, PIMCO launched an emerging market debt fund denominated in local currencies. These are the kinds of products I think will be very useful over the next few years in helping people tactically navigate the kind of economic conditions coming our way.
TGR: Great advice, Frank. Thank you for your time and insight.
Frank Barbera, CMT, is a veteran money manager and is currently the editor of The Gold Stock Technician (GST) newsletter, published since 1993. He uses technical indicators to analyze precious metals and mining stocks, as well as oil and the overall market. Barbera has also managed private equity capital for a number of years, most notably for the Los Angeles-based Caruso Fund, which earned returns in excess of 20% during the last bear market. In his role as a hedge fund manager, he sought to regularly trade precious metals, energy and currencies along with the broad stock market indices. In 2006, Barbera was included in the book Master Traders: Strategies for Superior Returns from Today’s Top Traders.
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1) JT Long of The Gold Report conducted this interview. She personally and/or her family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Goldcorp. Inc., Franco-Nevada Corp. and Royal Gold Inc. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) Frank Barbera: I personally and/or my family own shares of the following companies mentioned in this interview: Newmont Mining Corp., Franco-Nevada Corp., Yamana Gold Inc., Barrick Gold Corp. and Goldcorp Inc. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this story.