A conversation with Doug Casey and Rick Rule, Part II
April 30, 2004

Gold is still under pressure from dollar-strength but this week it was blindsided when the People’s Bank of China (the Chinese central bank) announced its plan to raise banks’ reserve requirement from six percent to seven percent. That means the central bank is tightening money supply, which could result in slower economic growth. China is an important consumer of raw materials and many analysts have argued that Chinese demand is behind the rise in commodity and precious metals prices.

I’ve been expecting a hiccup in China’s economic growth for a while -- it’s a topic I have discussed at several recent conferences -- but cannot claim to have anticipated this turn of events. I do however anticipate that US economic growth will falter with higher domestic interest rates, which I believe are unavoidable given the size of the government’s budget deficit. I also expect to see China’s economy slow down as a result.

I know that many analysts believe China’s growth is becoming self-sustaining due to growing internal demand. I was in China not long ago and I, too, am impressed with the country’s internal growth prospects. But China has a serious banking problem -- too many non-performing loans -- and sustainable growth in the country is unlikely until that problem has been addressed. This week’s move by the People’s Bank of China is the first attempt at doing just that. Don’t be surprised to see China’s growth slow down for a while, even though it doesn’t change the fact that China is likely to rule the world by the end of the century.

Because I do not believe the worst is behind for the US economy, and because I anticipate problems in China (and in many other parts of the world for that matter), I am not very bullish on base metals and other commodities. But because gold is money, and I think we are going to face uncertainty in that realm, I am still very bullish on gold.

However, gold is likely to remain under pressure in the short term, as higher US interest rates boost the dollar. At some point though, higher US interest rates will start impacting US economic growth and at that point gold will resume its upward trend, and we’ll see the largest increase in the gold price yet.

In the meantime, let’s continue with the conversation I had with Rick Rule (founder of Global Resource Investments in California) and Doug Casey (Editor of the International Speculator newsletter) a few weeks ago.

Last week we heard that Doug is a super-bull, and that he is using this downturn in gold and gold related stocks to buy more. This week we get to hear what Rick is thinking. Keep in mind though, that Rick’s comments were made on April 8th, when gold was still trading at $420 an ounce. The comments in brackets are mine.

Paul: “Rick, where do you think we are in the market?”

Rick: “I agree with about two thirds of what Doug said (see last week’s column) and I have seldom disagreed with Doug about the big picture. Although some of what he said is somewhat problematic from my point of view. But let’s focus, to begin with, on what we agree about.

“It is true that gold and mineral commodities are coming out of a twenty-year bear market. However, they never fell as much as they should have, given that the industry was enormously over-capitalized in the late Seventies and early Eighties. That over-capitalization bred monumental inefficiencies, inefficiencies that had to be worked out of the system. One of the reasons the industry lived on capital, of course, is because it generated no wealth, and therefore had to live on capital. It’s one of the reasons why commodities and commodity-stocks fell so far.

“Wall Street, including ourselves, asked gold companies, in particular, to exhibit an interesting investment trait called leverage to gold. You exhibit leverage by being marginal (i.e. operate with high production costs). We asked the industry to be marginal and they succeeded beyond our wildest expectations. Marginality, of course, is not one of the investment attributes that one would normally aim for. And those of us who asked the industry to be marginal got what we deserved.

“Now, with regard to the parallels to the decade of the Seventies, I agree with Doug’s thesis that we are more likely than not in a commodities super-cycle. Unfortunately for people who are too long in gold stocks right now, the place that I suspect we are in the 1970s continuum is 1975, which is where we went over a precipice.

“I don’t think, as an example, that we are in a gold bull market right now; I think we are in a dollar bear market. And I think that the dollar is going to have a fairly substantial bear market rally. My supposition being that whomever wins the presidential election will take whatever bad news he has to take in the first year of his term, making us sick as opposed to making us well, which he will attempt to do over time. That is a long-established American political tradition. And I think that either the President, or the market, takes US interest rates up 150 or 200 basis points, which makes the dollar substantially stronger, which makes gold in the near term substantially weaker.

“Having done that, the US economy two hundred basis points higher becomes sort of an interesting specter of credit collapse, and I think after we have seen interest rates go up 150 or 200 basis points, we see the Fed really put the pedal to the metal with regards to money and credit creation. And I suspect that at that time we go into a gold bull market.

“I define a gold bull market as a market where gold moves not only in relation to the US dollar, but rather in relation to all fiat currencies, which I would expect begins in the 2006 timeframe. So, good news in the longer-term, bad news in the short-term.

“When I say bad news it would not surprise me, although I am not saying this is going to happen, but it wouldn’t surprise me to see gold at $325 an ounce. It would not surprise me to see the XAU at 70. From my point of view, not comfortable, but not catastrophic. From the point of view of most of the players in this market, whose expectations are perfection, and perfection next week, it would be unpleasant indeed.

“One of the difficulties I have in the market today is that the mania Doug describes as seeing in the tertiary part of the market I think we are seeing right now. I know Doug was there in 1980 and 1981, and knows what a full-blown mania looks like, but I would suspect that the valuations we are seeing today (remember this was several weeks ago) involve at least hyper-stupidity if not mania. We have companies whose chief attributes are that they are losing two million dollars a month, and sporting six or seven hundred million dollar market capitalizations. I have told Doug on several occasions that I would be willing to lose that kind of money for him for a substantially smaller capital contribution.

“My actions are somewhat more cautious than others whom Doug would refer to as the cognoscenti. I am writing more pink tickets (selling) than white tickets (buying) in the middle range of the gold market and I have been using some of the proceeds to buy the very large cap, very liquid gold stocks in case I’m wrong. What I want is the ability to play the game up but set tight trailing stops (again, remember this conversation took place several weeks ago).

“Irrespective of commodity prices, I see us coming into a very, very, very interesting exploration cycle, for all of the reasons that Doug mentioned. For many years there has been, by historical standards, not very much money spent on exploration. The money that has been spent, has by and large been spent foolishly, by foolish people, for market reasons as opposed to exploration reasons.

“In the context of the human resources available for exploration, Doug makes the good point that, were I a geologist, at age fifty one, I would be on the young end of the spectrum, which means that the intellectual capital, and the physical capital in the industry, in human terms, is going away. Mining companies, in the last twenty years, have been run largely by financial professionals rather than exploration professionals and when times got tough, which in their context was most of the last twenty years, what they regarded as fixed costs and necessary expenditures involved things like executive salaries, headquarters’ expenses and equipment necessary for production, and they regarded exploration as a variable expense. Exploration got sacrificed to every other altar for the last twenty years. Many of these company executives are now coming to the realization that their companies are in liquidation by virtue of the fact that every day you mine, your business gets smaller, and there’s nothing in the exploration pipeline to feed the hungry mills.

“So I find myself in the odd position of concentrating my own portfolio in what is allegedly the lowest risk part of the spectrum, which is the large cap, very liquid senior producers, which I own for insurance purposes, and the riskiest:, exploration stocks. I guess the real riskiest are idiotic drill hole plays, which I tend to avoid at all costs. Instead I focus on prospect generators, which are exploration companies capable of generating good projects for further development by joint-venture partners. I think that the exploration stocks, in terms of generating value as opposed to making market plays, are the only place in this context where actual economic value can be created. So I am buying them and the large-cap producers.”

Well, there you have it. Both Doug Casey and Rick Rule are buyers, albeit for somewhat different reasons and with a somewhat different take on the market. Both of these gentlemen are outstanding speculators, and both generated their wealth doing precisely what they are talking about doing right now.

Doug is a self-proclaimed super-bull. He is buying gold related stocks with a long-term view that we are in a secular gold bull market, similar to what occurred in the Seventies, and he believes there remains significant upside in the gold price.

Rick thinks that, in spite of the fact that we may be in a secular gold bull market, we are in the midst of a counter-cyclical gold bear market. But he recognizes that the mining industry, with gold in particular, is facing a severe problem of not having enough competent exploration geologists to ensure the industry does not self-liquidate. For this reason Rick is buying exploration companies capable of coming up with good exploration projects, which, if successful, make them takeover candidates for the larger mining companies.

If you’re interested in Doug’s newsletter please visit his website at www.internationalspeculator.com and if you’re interested in what Rick had to say I suggest you call his brokerage firm in California. Talk to Steve Todoruk; he’s not only a broker, he also happens to be a geologist and is intimately familiar with the junior exploration sector, having run his own public exploration company in the past. I use Global Resource Investments for all my own trading and can therefore recommend them with first-hand knowledge of their expertise. The number to reach Steve at is 800-477-7853 or 760-943-3939.

I will be in London at the Global Mining Forum this week (May 4th and 5th). If you are unable to attend, consider New York in June (see the sidebar for details).

Paul van Eeden

Paul van Eeden works primarily to find investments for his own portfolio and shares his investment ideas with subscribers to his weekly investment publication. For more information please visit his website (www.paulvaneeden.com) or contact his publisher at (800) 528-0559 or (602) 252-4477.

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