J Taylor’s Gold and Technology Stocks
Published: Volume 23 No. 1 January 8, 2004
Your editor was first introduced to Ian Gordon via a short letter he sent to me on August 27, 1998. "Dear Mr. Taylor, Enclosed are the first three issues of "The Long Wave Analyst," which I am writing on a bi-monthly basis. If you think there is any merit to my work, would you consider a newsletter swap? Yours sincerely, Ian Gordon
Upon reading Ian's work, I knew immediately that it was not only worthwhile but that it was extraordinary. Believing very much in the deflationary views of John Exter-perhaps the only central banker in history ever to urge the use of gold as money-Ian's profoundly deflationary views not only made sense to me, they als o helped explain why John Exter was premature when he predicted an imminent deflationary collapse of the monetary system at the end of the 1970s and in the early 1980s. Exter understood that at a point in time, even the most extravagant efforts to inflate the economy would be overcome by a burden of debt too great to be serviced from income flows. Exter believed that a monetary system run amok, following Nixon's cowardly move to lead the U.S. to default on its Bretton Woods obligation to back the dollar with gold, would selfdestruct in short order.
Exter was absolutely right in suggesting that the ultimate end of this new floating currency regime, ushered in by Nixon's dastardly deed, would be a deflationary default of the global monetary system and a huge depression to follow. What Exter lacked, that Ian Gordon provides, is a bigger-picture view of why over the 60- to 70-year long Kondratieff Cycles, printing money at certain times is inflationary, at other times it is disinflationary, and at the end of the cycle, why it is outright deflationary. Ian's observation of Nikolai Kondratieff's work, combined with historical data following Kondratieff's death, covering four Kondratieff cycles beginning in the late 1700s, provides an insightful understanding of the answer to that question. It also helps us identify the primary trends of the cycle that we are in at any given time. As such, although each of these cycles can last 10 or 20+ years, Gordon's work is not only theoretical, but highly applicable to investors, which is why I have chosen to stick to this still relatively unknown broker/historian like glue and to constantly share his insights with my readers.
The First Gold Bull in This New Bull Market
Some of us gold bugs, your editor included, have almost always been bullish on gold. I must personally confess that I had "capitulated" only after gold headed down toward $250 and when the likes of Blanchard & Company, once the most pro-gold organization on the face of the earth, turned bearish on gold. But through the application of his studies of the Kondratieff cycle, it was soon after that time when Ian began to convince me it was time to start taking a long-term position in gold stocks. To his credit, Ian was the first gold bull I know in the new bull market. Moreover, he was the only broker in Vancouver back in 1999 who was willing and able to find raise equity (mostly from European and Japanese investors) for the small junior mining companies, most of whom barely had a pulse in those days. Many of those companies have since found their way into J Taylor's Gold & Technology Stocks as some of our biggest winners in 2002 and 2003.
Ian Gordon was educated in England and served as an Infantry Platoon Commander with his regiment, the Cameronians (Scottish Rifles), in Germany, Scotland, and under active service conditions in South Arabia. He resigned his commission in 1967 and immigrated to Winnipeg, Canada, that year, where he received a B.A. in history in 1972. From 1983 onward, he pursued a career in investment management. Over the years he worked with Dominion Securities Ames in Thunder Bay, Ontario, Nesbitt Burns in Toronto, and James Capel (later HSBC Securities) in 1994. In 1995 he was recruited to manage the retail sales operation of a small investment firm in Vancouver, BC, and in 1996 he and his partners founded Woodstone Capital, a boutique Vancouver-based brokerage firm. In 1998, he joined Canaccord Capital as a vice president and investment advisor.
About 38 years ago, my first job before going to college was in a titanium wire factory in Ohio. I made all of $1.70 per hour. I remember one "hillbilly" in the shop frequently answering questions with a question: "Do you want to know the truth or do you want me to make you feel better?" In America these days, where getting high, getting laid, and getting rich seem to be far more important than dealing with objective truth and reality, Ian's message has not been nearly as popular as the positive spin provided daily on CNBC. Your editor, who has always tried to ferret out truth no matter what the personal consequences might be, is a newsletter promoter's nightmare. Yet, I have found over the years there is a small remnant of independent thinkers who relish thinking outside and challenging the establishment. Many if not most of this crowd understand that a force much more powerful than man has been at work in history and remains in control into the future.
Ian is definitely one serious thinker who understands mankind is not capable of entirely molding its own destiny. That is clear from his observation of repeated patterns of self-defeating behavior from generation to generation, from one Kondratieff cycle to another. I have no doubt that is why I immediately found Ian's work to be so compelling and why he has become one of my best friends over the past few years. His honesty and integrity are second to none, at least in the tainted investment world. He and I have spent many hours talking about economics and history because I find his insights to be invaluable to me as editor of J Taylor's Gold & Technology Stocks. I believe in the future we will look to this interview (recorded on New Years Day, 2004), as well as prior interviews, and give thanks to God for this disciplined but freethinking stockbroker. I trust you will enjoy, profit from, and be challenged by Ian's fascinating insights. If this interview helped only one of our subscribers avoid the devastation that lies ahead, it would be worth the effort. In fact, we know Ian has already benefited dozens if not hundreds of our subscribers because he was in no small part responsible for helping us recommend the purchase of junior gold stocks that have, in many instances, already increased several hundred percent, even at this very early juncture of the gold bull market.
Taylor: Since we first interviewed you in 1999, our subscriber base has grown dramatically. For the sake of many of our new subscribers who may not be all that familiar with the Long Wave Theory, also known as the Kondratieff cycle, can you perhaps give a quick overview as to what the Kondratieff Wave is and why it is relevant to investors today?
Gordon: The Kondratieff cycle runs for approximately 60 to 70 years. It is appropriately divided into the four seasons. Spring is the rebirth of the economy. Summer is the time when the economy achieves its fullness, which is characterized by inflationary abundance. Autumn is the "feel good" season and the time in the cycle in which real estate, bonds, and particularly stocks achieve mammoth bull markets, the biggest in the entire cycle. And then winter is the payback season when debt is cleansed from the economy. For investors, each season offers particular investments that give the best returns and, conversely, incorrect investment choices that entail significant losses.
So in the spring, which is the rebirth of the economy, stocks and real estate perform the best. In the summer, which is the inflationary part of the cycle, investments that perform best are real estate, commodities, and gold. Autumn is always the season when investments in stocks, bonds, and real estate make huge gains. Winter is the time to be careful due to the debt cleansing; therefore, gold and cash offer the most security and best returns.
We can always recognize when we are entering the autumn, the big bull market in stocks, bonds, and real estate, because four events anticipate it. One is the peak in commodity prices. Two is the peak in interest rates. Three is the bottom of the bear market in stocks (e.g., 1982 and 1921). Four is the recession; e.g., the 1920-21 recession in the previous K-cycle and the 1981- 82 recession in this cycle. The beginning of winter is always signaled by the peak of the autumn stock market.
Taylor: Speaking of the peak in the stock market, in our June 1999 introductory interview, you felt that the stock market had already peaked. With the benefit of 20/20 hindsight, we now know that at least some of the indexes like the NASDAQ and the S & P 500 peaked early in 2000 as money pumped into the economy allegedly to avert a Y2K disaster served to blow the equity bubble up to its outer limits. Have you revised your thinking on exactly when the autumn peak of the market occurred and as such when the Kondratieff winter began?
Gordon: You could argue, as Richard Russell does, that the peak occurred in 1999 with the top in the advance/decline ratio. However, the peak in the stock prices was achieved in January 2000 for the Dow and in March of that year for the NASDAQ. Therefore, January 2000 is the best signal for the onset of the current Kondratieff winter.
Taylor: But of course none of that is believed by most of the talking heads in the mainstream press, who assure Americans almost every day that we have seen the lows for the market and that we are most likely about to bust out to new highs. Indeed, stocks have staged quite a comeback from their lows since the bear market began. Moreover, PE ratios have come down quite a way from their highs. Isn't it just possible that enough liquidity can be created to send stocks to new highs in the near term?
Gordon: Well, Jay, anything is possible but I don't think it is going to happen. Bull markets do not begin from the kinds of measures normally reserved for stock market peaks such as the current high PE ratios, or book values, etc. We are really at the kind of valuations associated with extreme market peaks like 1929, 1966, 1987, and of course the 2000 peak. Bull markets do not begin when everyone is bullish. They actually begin when people are in deep despair and hate the word "stocks." Anyway, bear markets are always reverse images of the preceding bull markets; therefore, this bear market should be as bad as the preceding bull market was good, and the past bull market was the biggest stock bull market ever. If this is the start of a bull market, why are the insiders selling 20 shares for every 1 they are buying? Everything seems to look so rosy out there. But I think 2004 could surprise us all on the downside, despite the fact that it is a Presidential election year.
Taylor: Your work has revealed four distinct Kondratieff boom and bust cycles in the United States since the U.S. gained its independence from the British. Regarding the Kondratieff cycle, you stated that of the four well-documented cycles, the Kondratieff winter of the Great Depression was the most relevant to the one we are beginning to face now, and you talked about this Kondratieff winter being perhaps even worse than that of the 1930s. Do you still believe that is so, and if you do, could you explain why you think that, especially for the benefit of our new subscribers?
Gordon: What is important is that the previous depression-the 1929 to 1949 depression-followed the first Kondratieff cycle, during which the U.S. became a major if not leading industrial power. In the cycle before that, the U.S. was not an industrial nation. Therefore, previous Kondratieff depressions were not as deep as the 1929-32 experience. Also, the 1929- 1949 winter depression followed a stock market peak in 1929 characterized by large investor involvement, huge margin debt, and overall significant consumer and corporate debt. Previous Kondratieff winters had not shown these characteristics. But the current Kondratieff winter has to unwind significantly greater involvement on the part of investors and much larger debt issues than in the 1929-1949 depression. So this is likely to be just as bad if not worse than its predecessor. As an aside, it should be noted that consumer debt was invented in the U.S. during the 1920s, when businessmen like Henry Ford encouraged consumer purchase of their products through purchase loans.
Taylor: Well consumer debt has certainly kept the U.S. economy from falling off a cliff. Perhaps it has allowed us to climb even higher so that the eventual fall will be all the harder?
Gordon: Right. You just can't keep building debt on debt forever. Ultimately, the piper must be paid. Because of this already horrendous debt bubble, the ramifications for the U.S., indeed world economy, are horrendous.
Taylor: Going back once again to our initial interview in 1999, even though the Nikkei had fallen about 70% to 12,000, you said you thought this Japanese index still had farther to fall. Indeed you were right, because it dropped below 8,000. It has since rallied to close at the end of 2003 at 10,676.64. Do you think this index-the Japanese Nikkei-has bottomed and as such offers Americans a good investment opportunity?
Gordon: No, and here is why. I think the actual low for the Nikkei last year was around 7,200. I don't think that is the bottom. When the U.S. economy seizes, as it will, the Japanese economy will suffer its final blow. I have a target bottom of 4,200 for the Nikkei, which parallels the Dow bottom of 42 in 1932. Actually, it is quite interesting because the Nikkei peaked at about 38,000 in this last cycle, compared to the Dow's peak in the previous Kondratieff cycle at 380. That's why I'm picking 4,200 for the Nikkei in this current cycle.
Taylor: Interesting. So you see a parallel between the U.S. in the past cycle and Japan in this cycle. Besides stock prices, do you see other parallels between the U.S. and Japan in these two cycles?
Gordon: Actually, I do. I anticipate that Japan will replace the U.S. as the leading economic financial and political power in the world. This is because I am convinced that the days of the U.S. leadership are over. A nation cannot be a debtor nation, let alone the world's largest debtor nation, and enjoy those distinctions. Leadership always goes to the world's largest creditor nation: Britain in the nineteenth century and the U.S. in the twentieth century. Japan is the largest creditor nation today and I believe that it will supplant the U.S. in the leadership role.
Taylor: That's very interesting. The notion that Japan, not China, will emerge as Asia's powerhouse is certainly not shared by most mainstream babblers these days. Why Japan rather than China? China is certainly growing rapidly. It is in the news even more than Japan. It is also a large creditor nation.
Gordon: But it isn't the largest. And this process is going to take time, just as it took time for the U.S. to assume its leadership role from Great Britain. With respect to Japan, we already have indications of this transition. The Nikkei's market cap in late 1989 was larger than that of the New York Stock Exchange, and eight of the ten largest banks in the world at that time were Japanese. Too, Japan today is just beginning to take on a new military awareness, such as sending troops to Iraq, which is outside of its given military mandate; and, it is talking about developing a missile shield. So, little by little, Japan is assuming a more predominant role internationally; whereas, China, despite the torrid pace of its growth, is only now where Japan was in the early 1970s. China also faces significant problems, such as a pathetic banking system and major unemployment. What Japan needs to do now is start weaning itself from the U.S. and promoting the yen as an important international currency. This might be achieved by the Japanese Central Bank buying gold as backing for its currency.
Taylor: Let's get back to he U.S. economy. Conventional wisdom holds that the U.S. can simply inflate our excessive debt problems away. Fed Governor Bernanke over the past year even talked about dropping money from helicopters to inflate the economy. I had an interesting conversation with Jim Rogers, a brilliant, freethinking man, whom I deeply admire. He agrees that we will in time have deflation, but that we will have significantly more inflation for quite some time before the deflationary bug turns into a deflationary depression. We certainly are seeing some commodity inflation these days, and Jim makes some very good arguments as to why that may continue for quite some time. On the supply side, he points out that there simply has not been much capital allocated to augmenting the capacity to increase production of many if not most commodities. And on the demand side, he points to the rise in wealth flowing to Asia as a reason to think demand for basic raw materials is likely to grow dramatically. I know your Kondratieff model calls for deflation to be the predominant problem during the Kondratieff winter. Is it possible that both you and Jim Rogers may be right and that increased raw materials prices could in fact actually be more deflationary for the U.S. because it adds to our cost of production and reduces consumer disposable income?
Gordon: I admire Jim Rogers very much. I have read his books. He is a man who thinks far more widely than I do. However, as I see it, we do have commodity inflation for two primary reasons. One is that commodities are priced in dollars, and the dollar has been dropping. Secondly, there is that torrid pace of Chinese growth and the accompanying huge demand for raw materials. But right now China reminds me of Southeast Asia in 1998. Whether it can continue to grow at this kind of pace or whether we will see a complete bust out of China, I don't know. But I'm predicting that China will not be able to continue to grow at this pace.
As I recall, the definition of inflation is too much money chasing too few goods. While it is true the Federal Reserve is doing everything in its power to create "too much money," that money creation is returning mostly to asset inflation, both in the stock market and continuing in the real estate market. On the goods side, however, there is an over-supply. For example, I recently read that the automobile industry can produce in excess of 25% of the total demand. This phenomenon is typical at the end of the Kondratieff autumn, when cheap money leads to massive expansion of the capital goods sector. Thus, we have far too many goods being produced, and that is deflationary. Moreover, as I have always argued, debt itself is deflationary. And we know that the world now has an enormous debt burden Principlely made in the U.S., which is waiting to burst.
Also, you mentioned that the Fed talked about dropping money from helicopters. In a sense they have already done that with the tax rebates that they have mailed to all Americans, and they are scheduled to do that again in the spring of 2004. I don't think they can continue to do that indefinitely. Indeed if the U.S. dollar continues to head down, which I think it will, the U.S. is far likelier to raise rates. That is unlikely in an election year, but we'll see.
Taylor: So far this Kondratieff winter has been characterized by what I like to think of as "Vancouver-like" winter temperatures. We have pleasantly cool temperatures that are just above freezing but certainly not harshly frigid. In other words, we have seen rather lackluster economic growth, but except for a very brief period in 2002, no economic contraction, at least according to government stats. This has led most economists to declare the recession as being over and that we will soon experience robust growth once again. Indeed, GDP reportedly grew by 7.2% for the third quarter of this year, which sounds more like "Indian Summer" than winter. But I take it you still believe the worst is yet to come in this Kondratieff winter, so I have a multi-part question for you.
First, when do you think "freezing" temperatures will finally come (that is, when do you see negative economic growth), and what are some of the likely indications that cold arctic winds are about to blow? What events might trigger the beginning of a debt collapse leading to corporate and individuals falling over like so many dominoes lined up next to each other? And finally, will there be time for investors to disinvest from an inflationary investment profile (e.g., energy stocks and the Rogers Raw Materials Index Fund) into purely deflationary investments such as cash and gold?
Gordon: When you consider the spin, like hedonic pricing of computers and the vast increase in defense spending, the real growth is nothing like the officials would want us to believe. In 2004 we could start to see the real onslaught of winter because I don't see another up year for stocks. The Kondratieff winter has already been signaled by the peak in stock prices in early 2000. Nor do I see consumers already overburdened by debt continuing to add to that debt to keep the economy going. One has to remember that over 70% of the U.S. economy is driven by the consumer. Also, the dollar is in jeopardy. It is in a rapid decline anyway. If it were not for the Japanese and the Chinese intervening in the dollar market, particularly the Japanese to keep down the value of the yen, the dollar would have fallen much further than it has already. If foreigners start to give up on the greenback, then dollar interest rates must rise, and that would sound the death knell for the U.S economy. A possible trigger for the debt collapse is a sudden failure of China's economy, somewhat akin to the Asian collapse in 1998.
Taylor: Richard Russell and others are saying we are in the early stage of a bull market in gold. Do you agree and if so, how high do you think gold can rise, and how many years do you think the bull market will last?
Gordon: Of course I agree with Mr. Russell on gold because the Kondratieff winter is always the time when gold comes to the fore because the world's financial and monetary systems are always in disarray at that time. I think the bull market for gold could last for many years because of the hiatus caused by the U.S. dollar's demise as the world's reserve currency. It took fourteen years from 1931, when Britain went off the gold standard and lost its monetary leadership, to 1944, when the dollar was established as the world's reserve currency at Bretton Woods, New Hampshire. We are going to wait a similar period of time for the next reserve currency to assert itself, during which time gold is becoming the money of choice. As to the price, I have always stuck around a target of $2,000, content with making that kind of prediction based on the evaluation made by Lord Reese-Mogg and James Dale Davidson in their book, "The Great Reckoning." They wrote about gold rising during deflation- in real terms, 8% above the preceding inflationary price peak ($850 in 1980)-which gives us a deflationary price of between $2,000 and $2,500.
Taylor: Most analysts see the rise in gold as an indication that we may have an inflationary problem on the horizon. They think only of gold as an inflation hedge. But you have pointed out that gold actually does better during deflation than during inflationary periods of time. For the sake of our new subscribers, would you care to explain why that is so, and perhaps provide some evidence of it?
Gordon: During the Kondratieff winter as the debt is unwound, deflation assumes control of the economy. This debt unwinding causes huge problems for the lenders, which are Principlely the banks. This causes people to seek the security of gold. They did this in the early 1930s, so much so that just before President Hoover left office, his Secretary of the Treasury went to him and told him that the U.S. was running out of its gold because everyone was turning in their dollars for gold, as they were legally permitted then to do. And so when Roosevelt came to power in 1933 he confiscated all the gold-I think essentially to replenish the Treasury-and he forbade its ownership. And shortly after he confiscated gold, he raised the price from $20.67/oz. to $35/oz. Homestake Mining's stock price increased 600% between 1929 and 1936. It was up 300% even before Roosevelt raised the price of gold to $35 in January 1934. So there was a huge move to own gold. Once gold was confiscated and its ownership forbidden, the only way Americans could own gold was through owning gold mining shares.
Taylor: So I take it that you see gold shares as a good proxy for gold bullion? To what extents do gold stocks and gold bullion move together, and would you advise people to own both now, while we are still able to do so?
Gordon: I think you have to own both. You always have certain risks associated with shares, whether from political interference, the risks of putting a mine into production, or production problems. Naturally, stocks and gold bullion are going to move together, although stocks themselves are said to be anticipators of the move in the bullion. A general rule of thumb is that stocks are levered 3:1 to the price of gold. When the gold price is rising, as it will during the Kondratieff winter, the best leverage to this is investment in junior gold mining companies.
Taylor: Getting back to the equity market. How many years do you think we have left in the equity bear market? Could it go on for two or three years or five or ten years or what? Gordon: I think the powers that be will do everything possible to try to keep the appearance of a bull market going. I think a good example of how long it might go is what has been happening with the Nikkei. We had a peak in December 1989 and it is still in a bear market 13 years later. The longer policy makers interfere with the markets, the longer the correction process. When things start to unravel in the U.S., like rising interest rates, because foreigners start to sell off their debt, I think the sell off in stocks could start to happen rather quickly. So whereas in 1929 you had the panic in the beginning of the equity decline, here we could have the panic toward the end.
Taylor: I believe it was in 2000 or so that the Japanese people began to buy gold when the government proposed reforms that would have eliminated or at least reduced deposit insurance which had been unlimited-unlike the U.S., which has a $100,000 limit per account. Japanese citizens, realizing that their banks had so many bad loans, knew that if the government reduced its deposit insurance, many of their banks would topple over and their yen holdings could become worthless. In your view, could similar dynamics in the U.S. trigger a Kondratieff winter freeze-up?
Gordon: I don't think it is possible that the U.S. government is going to curtail deposit insurance. Of course deposit insurance was introduced in the 1930s in the last depression. They are almost certainly going to need it again in this one.
Taylor: What about bonds? During deflation, I would think the U.S. Treasuries might be a good place to invest since you would gain at least some return from coupon payments even as the dollar gained purchasing power. Also, during a deflationary period of time, the value of the bond might rise as well as interest rates decline with a stagnant or declining economy, right?
Gordon: I think I have a problem with your question here. You say, "even if the dollar gained value"-I don't understand how that would be.
Taylor: Well, if we define deflation as declining prices, then by definition, the dollar should actually buy more. Gordon. Okay, I see what you mean. The dollar will buy more house, more car, more suit, or whatever. I don't like bonds but I do like Treasury Bills. I want to be short term and not long term. The U.S. is so heavily indebted that it is at the mercy of its foreign creditors. If they begin to dump U.S. debt-and in the longer term it is likely that they will-interest rates must rise. Thus the value of bonds would fall. Interest rates rose in the depression between 1932 and 1934, even though the U.S. was not a debtor nation, but they rose to support the dollar. The situation is the same now. The dollar is falling, and foreigners who own almost 50% of the U.S. debt are losing money. They might well demand higher rates to offset dollar depreciation. The Federal Reserve can influence the short-term rates but it has no influence on the long-term rates.
Taylor: But in theory, at the end of the Kondratieff cycle, perhaps as the old cycle comes to an end and when economic activity has hit bottom, bonds might be a good investment as we get ready for the next 60- to 70-year cycle; might not bonds be a good investment then?
Gordon: Yes, they will be at the end of the winter, but not now. Interest rates reached their lowest levels in about 1949 or at the end of the winter in the last cycle. The whole process of washing debt out of the system means that interest rates are more likely to rise to satisfy creditors on account of increasing credit risk.
Taylor: You noted in our 1999 discussion that the Japanese issued something like 90% of all the debt that was created that year. If the Japanese simply printed money to try to inflate their way to prosperity, it doesn't seem as though it has worked very well, because according to an article I read about a week or two ago in the "Financial Times," Japan is still experiencing declining prices although their economy has recently been somewhat stronger. Given the apparent lack of success for Japan, why do you think Bernanke and Greenspan think the outcome would be any different with the U.S. running its printing presses full speed? Is printing money the only solution they know or perhaps is that the only politically palatable solution?
Gordon: You know, the Fed really has two options. One is to bring interest rates down, which it has done. The second is to flood the banking system with money, which it is doing. The difference between America and Japan is that Japanese debt is essentially funded within Japan. The Japanese people own something like 35% of the world's savings, or $13 trillion. Unfortunately, Americans are not savers. Thus almost 50% of U.S. debt is loaned by foreigners. This is not a healthy predicament. This dependency can result in not only higher interest rates, but also in a falling dollar. This places the U.S. economy in jeopardy. Given U.S. indebtedness and the country's dependence on foreign creditors, U.S. dollar denominated bonds are especially a bad investment, at least in the early days of this Kondratieff winter.
Taylor: You and I have talked about the gold manipulation allegations of GATA, and now we are seeing the Blanchard case going into discovery and scheduled to go to trial in April of 2004. Still we see evidence from time to time of apparent downward manipulation of the gold price, such as on Monday, November 17, when-even as the stock market was getting trashed on the heels of a 3.5% decline in the Nikkei-gold dropped $5 or so in a matter of minutes, but then almost as quickly, it rallied just as sharply. That pattern has been more and more common since gold has begun its bull run, and it contrasts sharply with the pattern of a couple of years ago when a $5 hit in the price of gold would take weeks to recoup, if indeed it was recouped at all. So now we see the big name bullion houses hitting gold very hard in early New York trading, followed by what are obviously some very serious buyers of gold ready and able to take advantage of this pattern of selling to buy gold at very low prices. Who do you think these new serious buyers might be? Do you think it may be a foreign central bank or two? Or perhaps some very wealthy investors or hedge funds?
Gordon: Let me talk a bit about the gold manipulation issue. I'm sure that the gold price is manipulated. We know throughout history whenever governments have imposed a fiat currency, they always try to keep the price of gold down, because a rising gold price is basically a condemnation of their paper currency. So it was when the U.S. organized the London Gold Pool in the 1960s to hold the price of gold to $35. Of course that was a failure, because the price of gold ultimately reached $850 at the inflationary summer peak and America had long since abandoned the gold standard. In the 1970s, the U.S. and the IMF sold gold to try to hold back the advancing price of gold, but to no avail. When the gold price peaked at the end of summer, it went into a long-term bear market because during the Kondratieff autumn 1980-2000, paper assets like stocks, bonds, and real estate (mortgages) became the investment of choice as they always do during that Kondratieff season. Thus gold was not a threat to the paper dollar and there was no need for the government to try and keep the price down; the market was looking after that anyway. But, when it appeared that paper assets were losing their investment attractiveness, and investment in gold began to stir, the U.S. government was forced once again to declare war on gold. This it did by using its friend and accomplice Great Britain, which announced an ongoing auction of British gold. Subsequent sales were undertaken by such patsies as Kuwait and other minor countries. So this has happened throughout history, but it has always failed. That is why I don't get terribly upset about it. After all, it allows us to buy gold at a cheaper price than it might be, had there not been the interference in the orderly market. Anyway, I am confident that gold will be the investment of choice in this Kondratieff winter, as it has been in previous winters, but more so, because the dollar's days as the world's reserve currency are numbered.
Taylor: You mentioned a little while ago about the Japanese buying U.S. Treasuries. There is an interesting thing going on now where the Japanese are printing huge amounts of yen to try to keep their currency from rising against the U.S. dollar, and then they turn around and use those yen they create out of thin air to buy U.S. Treasuries which puts upward pressure on the value of the dollar. This sort of competitive devaluation process is certainly not limited to Japan. In fact it seems to be very widespread and growing as nations look for ways to cheat against their competitors by lowering the value of their currencies. Would you agree that this is the most pronounced competitive currency devaluation at any time since the 1930s?
Gordon: Yes, I would. Everybody is trying to get that advantage, as they did in the 1930s.
Taylor: And this would get back, I think, to something you said earlier in this interview. During the Kondratieff autumn, enormous over-supply of goods and services is created, which then puts increasing downward pressure on prices and is one of the forces that ultimately lead to the collapse in the Kondratieff winter. And it is this very extensive over-supply that in fact is pushing these countries to cheat against one another in attempting to export primarily to the U.S., and devaluing their currencies. Would you agree that is happening and that it is very similar to the 1930s?
Gordon: It is. And the parallels to the 1930s are many. In the early 1930s President Hoover signed into law the Smoot-Hawley Act, which imposed a range of tariffs on imported goods. Similarly, President Bush has imposed all kinds of import duties on foreign goods. Most noticeable were the steel tariffs, which were ultimately denounced by the WTO, but not before the President had bought a year's grace for the U.S. steel industry. In like manner, corporate corruption was rife at the peak of both autumn markets and only came to light after the stock markets had peaked. Both presidents of the NYSE were disgraced. There are other less prominent similarities as well.
Taylor: I also note in reading some of Murry Rothbard's books that some remedies-fiscal and monetary policy-were tried in the 1930s, and the same remedies are being offered now.
Gordon: Right. The Fed printed money like crazy back in the 1930s and it reduced interest rates in the hope of jump-starting the economy, but it failed, as Alan Greenspan's Federal Reserve will fail this time. I see a similarity in terms of returning consumer confidence and rebounding stock prices and a nascent economy now, with the period immediately following the stock market crash, which bottomed in November 1929. Stocks, confidence, and the economy all rebounded in April 1930, following that first stock market bottom, because the Federal Reserve responded to the crash by dropping interest rates and flooding the banks with money. But after April 1930, it was all downhill.
Taylor: I would like to return for a moment to the discussion of debt. Correct me if I am wrong, but according to your understanding of the Kondratieff model, I think you have stated that a point in time is reached during the cycle at which there is no possibility of inflating debt away. Can you explain why that is true, and, are we there yet?
Gordon: Printing money and inflating is only adding to the debt burden faced by Americans. Eventually it becomes impossible to sustain the debt bubble. And, I think we are so close to that point right now. Increasing levels of personal bankruptcy and foreclosures in the housing industry are all indicative to me that we are reaching the point of no return. Regardless of the spin put on the improving unemployment numbers, jobs are in fact scarce, it is taking longer for unemployed Americans to find jobs, and many people are taking low-paying jobs or going into self-employment. Once that debt bubble does explode it will result in a cataclysmic burst of bankruptcies, which will cause unprecedented levels of unemployment. Printing more money can delay this, but that only adds to the already massive debt. The larger the debt, the greater will be the ultimate economic disaster.
Taylor: There is a chart I like to show frequently to my subscribers that displays the almost exponential growth in debt. The curve is going straight off the page while GDP grows in a linear fashion if at all. And the gap between the amount of income that is being earned in the U.S. compared to the amount of debt is just getting wider and wider, and one wonders if we must not be getting close.
Gordon: I really think we have reached the point of no return so that even if policy makers tried to do the right thing, it would be too late to stop the impending deflationary depression.
Taylor: But we are looking at such long periods of time in the cycle so that whether it is one month or several months away, the problem is too big to fix without some very difficult times, right?
Gordon: That's what I think.
Taylor: About 15 months ago, Mrs. Taylor and I sold our house. We put most of the net proceeds into short-term government instruments (under two years) and made about 4% after getting a 1% kickback from our credit card company that gives a 1% rebate on credit card purchases. We put about 10% of the net proceeds into GoldMoney http://goldmoney.com?gmrefcode=jtgts, and obviously, with gold on the rise, we did pretty well. Housing prices in New York have risen, we are told, by about 3 or 4% since we sold our home, and we could have gained more equity as we continued to pay off our mortgage which was at the back end of the 30-year term. In other cities in the U.S., however, the housing market has registered double-digit gains. My question to you is this: Do you think Mrs. Taylor and I made a mistake in selling our home in Queens, New York?
Gordon: No, I don't. The real estate bubble is a part of the overall debt bubble. The primary purpose of the Kondratieff winter is to purge the economy of debt. Now that we're in winter, we know that the debt bubble has to collapse, which means that ridiculously high real estate prices based on a mountain of mortgage debt must collapse too. And Jay, as you know, I rent. I don't own.
Taylor: That is reassuring. We are looking forward to taking the cash we have from the sale of our house and using it to buy another home once the housing bubble bursts. The only problem is we don't know how long that process might take.
Gordon: I think the bust in real estate is going to take at most three or four years. I am surprised that the real estate market has continued to prosper for as long as it has. According to Hugh Hendry, a very capable hedge fund manager in London, the combined debt on the books of Fannie Mae and Freddie Mac is 30% of U.S. GDP. Imagine the fallout when real estate prices do start to fall in earnest.
Taylor: How long do you expect the Kondratieff winter to last?
Gordon: Well, the short answer is that it will last until bad debt is cleansed from the economy. The more the government intervenes to prop up ailing banks and other corporations and consumers, the longer it will take. Fear of disaster and social upheaval will undoubtedly mean that the government will try to delay the process. So it's likely to be a long and very cold winter.
Taylor: A multiyear downturn in other words. Shifting gears back to the topic of gold stocks, are you more positive on producers or junior mining companies that are exploring and developing new gold deposits? Could you explain your answer and perhaps offer a caveat or two?
Gordon: As you know from my talks at the Canadian gold shows, I like the juniors because that is where you get the best leverage to the gold price. We have already had some outstanding price moves in many of these companies. The producers are all reducing their gold reserves via production. The key, I think, to investing in junior gold stocks is investing in the management. I never recommend a junior mining company until I have met with management and am comfortable that it will always act in the best interests of the shareholders by advancing the company's properties and, if necessary, dropping properties that do not meet its objectives. Of course, junior mining stocks are a high risk/reward investment, and they certainly do not meet every investor's risk criteria.
Taylor: And I guess, if you believe we are in the early stages of a gold bull market as you and I both do, so that gold prices are likely to rise to much higher levels, then it might not make sense for producers to deplete their reserves by selling at these low prices.
Gordon: Well, I don't think they can stop production to wait for a higher price. There was a very good article, I think on miningweb.com or some such place, that said that producing companies have limited reserves, which are being depleted every year. For example, the article mentioned some of the larger producers including Newmont, which is the largest gold producer. Newmont produces a little less than 8 million ounces of gold per year, which means that at that rate, its reserves will be exhausted within 7 years. Of course the company will bring new reserves on stream, especially as the price of gold rises, because that will make marginal deposits profitable. Anyway, I don't want to single out Newmont, because I do believe that it is perhaps the best-managed major gold producing company out there. From discovery to production takes about 7 or 8 years. The nature of all mining is to deplete reserves and therefore the assets.
Taylor: Exactly right. So some of our junior companies that are finding some nice good, big deposits might be acquisition targets of Newmont and some of the other bigger companies down the road, don't you think so?
Gordon: Yes, I do. It is still possible to find junior gold companies with an established gold resource in the ground who are trading in the low teens per ounces of gold in the ground.
Taylor: Given your dim view of our financial future, what kind of political changes and changes in the quality of life might Americans have to look forward to? During the last Kondratieff winter, in the 1930s, Roosevelt made it illegal to own gold under punishment of a $10,000 fine and 10 years in prison. Do you think that is a possibility again in America, and if so, how would you advise our readers to protect their wealth stored away in gold?
Gordon: Taking the first part of the question first, I think if we look to the last depression to try to anticipate what kinds of things might happen this -coming Kondratieff winter, we should be very concerned. At the depth of the last depression, 25% of Americans were unemployed. There were huge amounts of banking failures, so much so that when Roosevelt assumed the Presidency, he shut down all the banks, and only those that were considered solvent were allowed to reopen. Things like the "New Deal" saw greater involvement of the U.S. government in the economy. So there was a greater encroachment by the government interfering with the way of life for Americans. I really don't want to speak to what the U.S. government might do to the U.S. ownership of gold. But we do know of course that it was confiscated by Roosevelt in the last depression. But at that time, the U.S. was on the gold standard.
Taylor: Richard Russell is asked this question frequently. He doesn't believe the U.S. government will confiscate gold again. He doesn't see that the U.S. government would have anything to gain from it, and the U.S. citizens would be angry, he thinks, if Americans in the leading democracy in the world are not permitted to own gold while everyone elsewhere is.
Gordon: Well, I think that they would gain from it, particularly if, as some think, there is no gold in Fort Knox. Confiscation would allow the Treasury to replenish its gold stock, just as it allowed President Roosevelt to do that in 1934. If indeed the U.S. does not possess the gold it purports to own, confiscation might happen, because I do believe the world will return to some form of gold standard at some time during this Kondratieff winter.
Taylor: And so as backing to the U.S. currency?
Taylor: Well, the folks at www.gata.org think the actual amount of gold in the central banks is probably less than half of what is being reported
Gordon: I think the thing we have to understand is that the Kondratieff winter is always a desperate period in the cycle. During desperate times, people and governments do desperate things.
Taylor: Unfortunately, that sounds logical enough. Ian, before we let you go, I had a couple of questions my readers have asked me to ask you. The following was from Jeff Hagen, who asks, "Why must interest rate yields go down in this Kondratieff Winter? We keep hearing about the Fed increasing money supply, and how this will lead to increased interest rate yields. Which is it?" But I guess as we discussed earlier, your position is that interest rates are likely to go up during the early days of the Kondratieff cycle and that they won't go down until the back of the economy is broken.
Gordon: They have gone down, particularly on the short end, but as I have already noted, interest rates are likely to rise-as they did, by the way, between 1932 and 1933-because the dollar is in jeopardy, and the U.S. is too dependent on foreign creditors.
Taylor: Well, certainly foreigners who are owning U.S. dollars are getting hurt rather badly now with the dollar's steady decline.
Gordon: But of course the Chinese are not getting hurt because the renminbi is pegged to the dollar. But the Japanese are getting hurt very badly and are spending lots of yen in an attempt to push up the value of the dollar and hold down the value of the yen.
Taylor: And so I guess the rising interest rates that would follow a run out of the dollar could break the back of this economy and thus trigger the freezing point of the Kondratieff winter where the debt repudiation process begins in earnest.
Gordon: I think that is the likely catalyst.
Taylor: And, after the economy hits rock bottom and you have huge rates of unemployment and idle resources, then you could see interest rates coming back down I suppose. Just no demand for money or capital.
Gordon: Then as the banking system really gets into trouble-when you start to see major failures in the economy-you will see interest rates rise in the initial stages of the decline because companies borrow to try to stay alive, and creditors cut back on their lending because of rising risk. Companies with poor debt ratings will have to pay exorbitant interest rates, just to keep alive. Of course, that will be the cause of their demise. Tragically, interest rates ris e in the face of rising bankruptcies, causing even more bankruptcies. It is only after all the bad debt has been washed out of the system-when the demand for money is very weak-that interest rates will start to fall.
Taylor: Another subscriber of mine, namely, Winston Bearkiller, asked the following question: "Given the Fed's excesses in the past year at enlarging the M's (various measures of money supply), what is the current status of debt relative to GDP? I no longer accept the $35 trillion level as valid, given Mr. Magoo's (Alan Greesnspan's) activities. Would you agree that money velocity reaching near zero would equal "the tipping point" where frank deflation actually occurs and we launch into the pit of depression?" It seems to me what Mr. Bearkiller is looking for here coinciding with a collapse in the velocity of money would take place after the debt repudiation phase has largely run its course don't you?
Gordon: At present, the debt to GDP is about 330% in the U.S. Actually the collapse in the velocity of money starts as the economy starts to fail. At that time bankruptcies start to rise, as does unemployment. Instead of spending, consumers start to save, and the velocity of money falls.
Taylor: Ian, would you care to make some predictions for our subscribers as we head into 2004 and beyond? I personally don't believe it is possible to predict a time frame for the gold price or equity prices. But perhaps over the longer term-during this Kondratieff winter, at what level do you think equity prices will fall? What about the dollar index? Do you still see parity for gold and the Dow?
Gordon: I think it's reasonable to anticipate the end result, because the Kondratieff cycle provides us with an incredible road map. It's much more difficult to give the time frame or the actual values of certain assets. All I ever do is use the last Kondratieff winter as a blueprint for what one might expect will happen this time. To this end, the Dow peaked at 381 in September 1929 and fell to 41 points by the end of June 1932. This was an 89% loss in price. A similar loss today would take the Dow to about 1300. However, one could come up with an even more frightening target. The 1921-1929 autumn bull market started with the Dow at 66 points. The ultimate bottom in 1932 at 41 points was 38% below the start of the great autumn bull market. The current cycle great autumn bull market started with the Dow at 777 in August 1982. A 38% target below that would see the Dow just below 500. 1300 points or 500 points, both would mean a horrifying economy. Of course, the Kondratieff winter does not project good news on that score, anyway. I have already given a potential price target for gold.
Taylor: One more thing. What about silver, which really seems to be coming to life recently? Do you still think investors should avoid silver in favor of gold given the fact that silver is more of a commodity and less of a monetary asset than gold?
Gordon: Well, I think silver may well become poor man's gold. Throughout history, gold and silver often acted together as money. It wasn't until Britain went on an exclusive gold standard system following the Napoleonic wars that bi-metalism ceased to function in the world monetary system, even though the U.S. retained both metals as money until the 1860s. The British currency denomination pound comes from a pound of silver. But silver has for some time taken on more of an industrial role, whereas gold has always been viewed as money. Nevertheless, silver may well resume a monetary role in the future. This being said, it is still valued at approximately 1/70th of an ounce of gold and is therefore cumbersome to store. One way I get around this dilemma is to purchase gold/ silver exploration companies. There are a number of excellent such companies.
Taylor: Yes, there are quite a few companies, mostly in Mexico, that are about 50/50 in terms of relative values of silver and gold.
Taylor: Alright Ian, this may be a good place to end our conversation, unless there was something else you wish to add?
Gordon: You asked me if you thought we would see a 1:1 relationship between the Dow and gold. Based on my predictions for the Dow and for gold in this Kondratieff winter, I think the relationship could be considerably less than 1 to 1. $2000 gold and 500 Dow equals a quarter of an ounce to buy the Dow Jones Industrials.
Taylor: I want to thank you again for your willingness to share your thoughts with our readers. I'm sure our subscribers will, after reading this interview, have a very good understanding of where you think the U.S. and global economies are headed and why. In short, you are a stockbroker who has been a big help to more people than you can possibly know by simply viewing the global economic and financial landscape objectively. Where others have chosen to pick up a quick buck wherever they could find one and by doing whatever it takes to get rich with little regard for objective reality and the best interests of their clients, you have dared to take the path less traveled because it was the right path to take, rather than the expedient one in the short term. I thank God for your honesty and integrity and for sharing your insights with our readers, many of whom have also benefited from your work.
Contacting Ian Gordon - Because of U.S. securities laws, Ian is unable to sell securities to U.S. citizens. Investors outside of the U.S. can reach Ian at 604-643-0280. U.S. investors can open an account through Ian's colleague, Rick Langer, at Canaccord Capital in Vancouver, BC. Rick holds a Series 7 license and is thus able to sell Canadian stocks to American investors. Rick can be reached in Vancouver at 800-667-5771 or at 604-643-0113.