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Interview with Kitco's Jon Nadler: Keep 10% in Gold
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 Kitco’s Nadler: Keep 10 Percent In Gold
In the sea of powerful emotional currents that often characterizes the gold market, Jon Nadler, the senior analyst at Kitco Metals, is an island of tranquility and reason. He told IndexUniverse.com’s Managing Editor Olivier Ludwig that the price of gold is increasingly being supported by investment demand as opposed to credible safe-haven concerns or real demand for jewelry. That’s not to say he doesn’t take economic headwinds that the world economy faces seriously. But he’s an old hand with about 40 years of experience who has seen gold manias come and go. And through it all is a message some money managers, if not gold bugs, can appreciate: Whatever the circumstances, investors need to allocate about 10 percent of their portfolios to the yellow metal.
Ludwig: Can you comment on gold as it relates to resurging concern about deflation?
Nadler: As far as deflation goes, we need to have more evidence that what happened in Europe was perhaps just a hiccup in the recovery process rather than a complete fall into a contractive phase. Things like the velocity of money are really decreasing and there are other indicators showing us that this thing is pointing downward. And people like Jeremy Grantham have tilted into the deflation camp.
If this deflation does materialize, we have to wonder if this will result in a new wave of asset liquidations to raise cash. And will that impact gold less than it did two years ago, which was pretty much $1,030 down to $680? If it doesn’t impact gold as much, to what extent will it? The thinking at the moment is at least in the $880-$890 area, not just because of asset liquidations, but also because of fundamentals.
Ludwig: Regarding fundamentals, do you see seasonality, in the form of holiday demand, picking up and supporting gold prices?
Nadler: I think we’ve had a few years where we could argue that seasonality played a role, but there were so many other factors going on in the same time frame that it’s not as much seasonality that matters right now, but rather, which component of the typical demand side is really dormant and why? India demand, for example, has been pretty bad this year.
North American and European jewelry manufacturers, generally speaking, are not in the game from the June through August period. They are out on vacation. That part of the seasonality is still with us. But I don’t see it really reviving because we have structural problems of the type where luxury goods are still not moving, there’s slack in the economy, there’s uncertainty with regards to job maintenance. Just being employed and saving money seem to be the newfound fondness for Americans as opposed to spending like crazy. So, to that extent, I’m not too optimistic about demand fundamentals.
So we have to look for buoyancy out of India, Vietnam, Thailand, China—the Middle East, to any extent we can get demand out of it—namely Turkey and Dubai. It’s been tricky.
Ludwig: So if these demand scenarios don’t play out positively, it’s back to a macroeconomic frame of reference that is quite murky right now, yes?
Nadler: All of the good news we have factored in from about December to about April has sort of been backpedaled on. So we’re out of the toilet, but we’re certainly not out of the woods.
That definitely gives uncertainty. To that extent, hedging with some gold continues to be wise. But perhaps not as urgent as it was through this period up through June when it looked really dire on the European front and people said it will spill over here. Part of it was fund talk for sure. I saw a lot of jawboning from funds that were obviously long and needed the market to go their way.
But part of it was real buying. We know that Germans bought lots of coins figuring this thing was not going well at all. But there came a point when the market ran out of further buying steam and values got so high that everybody stopped buying but the ETF buyers. It still wasn’t anything like 1980 in terms of the stampede, and it wasn’t even a shadow compared to the first quarter of 2009 when 450 or 500 tons went into ETFs.
Ludwig: What do you make of the bearish case for the euro?
Nadler: I think like Robert Mundell: People betting on the demise of the euro and $2,000 gold will both lose money. And he singled out gold, which is interesting, because all he’s really concerned with is what he invented, which is the euro.
Clearly, there was overreaction to the structural problems that the currency was experiencing. I think it was more a case of the bond vigilantes versus the European Union governments—basically testing their resolve. They pushed pretty far. But at a certain point, the IMF, ECB and everybody else came together and said: “We’ll throw whatever is necessary at the problem.”
My perception is just like it was for the dollar. We were told in writing that the dollar would meet its demise and be gone by November of last year. But it came back. What changed was that there was enough resolve shown on the part of central bankers and Treasurys and actual political leaders to say: The buck stops here and the euro stops there. At that point, the funds said, OK, we’ll back off.
So things have blown over to an extent. At least that gold and euro trade is broken.
To somehow fathom that we will have very heavy, day-in-day-out investment demand from here on out after three years of intense demand, and a full decade of more than average demand means that these headwinds will have to very much continue. But the argument that the sky is about to fall in the U.S. and Europe has, in my book, come and gone.
Those two events were enough to convince the bidders of gold they were really coming up against major government interests here and were not going to be able to convince people that the end was here. That’s why they eased up a little bit—but a little bit was good for $70 or $80.
Ludwig: What do you make of iShares cutting management fees on IAU to beat GLD?
Nadler: It’s an interesting case. They may be trying to get more participation, not just compared to GLD, but maybe they’re sensing there’s a slowdown in inflows.
You would have expected GLD to cut as a leader, because they have so much under management and they can maybe “afford to” give people a break.
Ludwig: All this is coming at a time when the price of gold is being increasingly supported by investment demand, right?
Nadler: A couple of the components bother me about the gold market right now—its ownership makeup, for one. We’re looking at a lot of funds whose objectives are no more than perhaps playing the contango in the market, having a shorter-term horizon and putting in fickle money that can get up and leave easily.
What do we do when 10 or 20 percent of the 1,300 tons are seeking redemption? The market is completely ill-prepared to absorb that kind of tonnage in one fell swoop.
Ludwig: The likelihood of those kinds of redemptions isn’t terribly high now, is it?
Nadler: Not yet—unless the environment changes to where these funds don’t have an appetite for gold or see a better potential in another asset class, or the interest rate environment changes. At that point you’d see an equal effect of the benefits on the way up when you accumulate. So, in the event of a contraction, the sheer tonnage is a problem. If people are making a lot of noise about a 200-ton purchase by India, just think about a 200-ton offset by one of the ETFs selling.
Ludwig: How much time do you think it will take for all the problems to work their way through the global economy?
Nadler: I think it will be another 10 to 18 months before we get a clear trend change in the interest rate environment, which is really what most of this stuff is hinging on in the commodities niche anyway.
It will have to be predicated upon a couple of hard numbers that the Fed looks at—primarily job creation, because there’s no way to pick up the slack in the economy without that. Because demand is demand, and if you don’t work, you don’t demand. You also need housing starts to look better—you need to clear the overhang in real estate inventories. And once that is in order, the quicker the Fed applies the exit strategy, the better off we will be. I’d like to see some real asset sales as a harbinger of a shift in that mentality.
Ludwig: What about this talk about a real estate bubble in China?
Nadler: As far as China goes, it’s been so difficult for them to slow down, and they could overshoot, and that wouldn’t be too much fun for everybody. We can ill afford to have a third location globally where we would have this period of excess followed by liquidation, mark-to-market, contraction, suffering, pain and unemployment and all that. Hopefully China will not be that scene after the U.S. and Europe.
Ludwig: So how much to allocate to gold and other asset classes?
Nadler: Hard to say where one would put their money. I would look at a lot of clients who call and say: Look, I’m liquid, I’m diversified among three or four major currencies—U.S., Canadian, Swiss, and some commodity currency like Aussie dollars or some noncommodity currencies that have their houses in order like Norwegian or Swedish. And yes, I do keep my 10 percent in gold, but I’m hoping not to cash it in at $2,000 or $3,000 or $5,000 an ounce because I know that that means that the rest of my portfolio is in shambles.
Ludwig: At the risk of stoking your passions, what do make of the gold bug phenomenon?
I delivered a speech in London in October called “The Religion of Gold,” and I outlined these various factions in the gold market—everything from the lunatic fringe, to the zealots, to the blind leading the blind—all of the factions that you would normally find in a religious movement are all there. Part of it is an emotional appeal that goes back 6,000 years, part of it is wishful thinking for the good old days, and you can prove statistically that the good old days never actually existed. They want to go back to “kumbaya”—this sort of Ron Paul world where gold is the currency of the realm, not realizing that what they’re asking for is economic growth along the lines of Portugal in the 1500s.
They say I’m anti-gold, which I’m certainly not. I always say you need to have 10 percent in gold—and that’s about double of what most money managers recommend, so I’m quite generous in the allocation model. But, you buy it not to make money but to preserve capital and hope that nothing happens. Treat it like life insurance.
Olivier Ludwig
July 29, 2010
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