Rick Rule: The Gold Market Is In Good Shape

This is an interview with Rick Rule. It appeared in the regular newsletter update “Sprott’s Thoughts” (subscribe here).

During the last week, gold has suffered a drop, falling as low as $1,293 in a few days. Janet Yellen recently suggested that the Fed could raise interest rates, as evidenced by Reuters (among many others): “Higher interest rates would encourage investors to switch to assets that, unlike gold, pay interest.” The airplane crash in Ukraine took gold higher from its low, but remains under $1,320 as of July 18.

Rick Rule, Chairman of Sprott US Holdings Inc., comments on the gold price action by saying gold could fall back another 10% as a normal event in this market. What is Rick Rule’s outlook for gold in 2014?

Does the recent drop in the gold price affect your outlook for gold in 2014?

Rick Rule: No, not at all. In a recent interview, I suggested that gold and gold equities would grind higher after reaching a bottom in July of last year. That is precisely what’s happening. We’re seeing higher highs and higher lows, but every new high requires a subsequent consolidation. You’ll be up 10 or 12%, then off 8 or 9%. The ‘backing and filling’ that we are seeing right now is completely consistent with the behavior that we would expect to see coming out of a bear market bottom into a gradual recovery.

I think this market is in good shape. It’s healthy. These ‘j-curve’ advances are followed by appropriate declines on the backside. I am very encouraged by the market action that we are seeing in both gold, and the gold equities.

What to make of Fed Chairman Janet Yellen’s recent comments regarding raising interest rates? Are higher interest rates plausible?

Rick Rule: What Janet Yellen said was that the recovery was tepid at best – if we have a recovery at all. The political narrative dictates that low interest rates are needed in order to help the economy.

My own belief is that interest rates will remain low in the next 18 months or 2 years, but for a different set of reasons. There isn’t much private demand for loans, even at this low interest rate. But there is an implicit transfer of wealth from savers, who benefit from higher interest rates, to spenders. It’s the spenders who are more numerous, which means that the government will look out for the spenders at the expense of the savers.

Secondly, the extraordinary levels of Federal, State, and local debts would be difficult to service at higher interest rates. As a result, I think that the Fed will continue to do whatever it can in order to keep interest rates constrained for as long as possible. As long as the demand for debt from the private sector remains low, I believe you will see artificially low interest rates.

What do continued low interest rates mean for gold going forward?

Rick Rule: Ultimately, it’s probably pretty good for gold. Right now, you are seeing gold being crowded out, because the returns from other assets such as stocks look more attractive.

But the way I look at this nearly ‘free’ capital is ultimately good for gold. It weakens the medium of exchange, the US dollar, in which gold is denominated.

Recent reports show that big companies are issuing debt for the sole purpose of buying back their own shares. What to make of this behavior? Is it the beginning of the end for low interest rates?

Rick Rule: Actually, I don’t think so, because they don’t need to borrow this money for their basic business. The biggest corporations in the United States have good balance sheets and are generating fairly substantial free cash flow. There is nowhere for them to re-deploy the money in their own businesses, because the economy is expanding slowly.

At these interest rates – particularly if these companies can lock in these interest rates for long periods of time – debt is a cheaper form of capital than equity. In a slowly growing economy, the only way that these companies can increase earnings per share is to reduce the number of shares.

Buying back their own stock with borrowed money is a normal response to the Fed’s low interest rates. Right now, debt is much cheaper than equity in the long term.

Of course, there is a downside. Those large companies are weakening their balance sheets, which were real fortresses against potential problems in the economy. When everyone does this, you are replacing more and more equity with debt. You are making the economy as a whole much more vulnerable going forward. That will become a concern for these companies in 18 months or two years from now.

If it is good for big companies, why not for everyone else? Do you think average investors should also try to benefit from these record low interest rates?

Rick Rule: In fact, I do. For an investor who has a stable financial situation, a 30-year fixed-rate mortgage for a house where they intend to live will probably begin to feel like free money once we are 3, 5, or maybe 10 years down the line. If you have the ability to borrow long-term capital at today’s rates, and are able to service the debt this is probably a once-in-a-lifetime opportunity. After real inflation, the costs of this capital over the long term will likely be negative. That’s very attractive!

What is the most important message to attendees of the conference in Vancouver on July 22nd?

Rick Rule: The most important thing to do for attendees is to really take the time to interrogate the exhibitors. We are in the early stages of a resource sector recovery, and the most dramatic parts of a recovery take place in the micro-cap stocks. If you want an in-depth discussion of what to ask, take a moment to revisit the material on our website on how to conduct these interrogations with company. You can use these techniques when talking with the exhibitors at the Sprott conference. There is going to be a lot of money to be made at that conference.”

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