Continued fiscal stimulus, high debt levels and loss of confidence in governments will lead to the return of big inflation and a consequent big run-up in precious and other metals, says Leonard Melman, author of The Melman Report. In this interview with The Gold Report, Melman examines six companies he believes are well positioned to generate stock-price multiples when the bull market returns.
The Gold Report: You've expressed astonishment at the record highs of world stock exchanges. Given the sluggish world economy, can we expect this trend to end, or have equities become completely disconnected from economic reality? Leonard Melman: Equities have become somewhat disconnected from economic reality. We've heard comments from the European Central Bank, the U.S. Treasury and the Bank of Japan calling for more inflation because dramatic action is needed to improve the world economy. How does that coincide with the bull markets in equities?
TGR: Is there a connection between these bull markets and quantitative easing (QE)?
LM: People now believe that central banks like the Federal Reserve are the only means of stimulating economic activity. Therefore, because QE is likely to continue, investors are buying stocks. I cannot think of any other logical reason for these bull markets. Companies are not rapidly increasing sales. They're not rapidly developing new markets. They're not hiring massive numbers of new workers. It's a stagnant economy, and yet the Dow is up almost 20% this year.
TGR: You said during your presentation at the Cambridge House conference in Spokane that without visible inflation, a strong metals rally might be difficult. John Williams of ShadowStats.com argues that the U.S. is already undergoing highly visible inflation and that the official inflation measurement is so politically perverted as to be practically useless. What's your view? LM: I do agree with Williams that there is some underreporting of inflation. If inflation were reported accurately, all the automatic increases in benefit payments that would then ensue, such as higher Medicare payments, higher payments to doctors, and most important, higher Social Security checks, could bankrupt the government.
That said, I don't think we have anything like the inflation of the late 1970s and early 1980s. Back then, every two weeks you'd walk into a restaurant, and they'd have a new menu with higher prices. Interest rates were horribly high. Gasoline prices have actually been in decline now for quite a few months. There isn't the scary, visible price inflation we saw 30 years ago. Inflation of maybe 10, 12, 15% or more will generate the psychological background necessary for rampaging gold and silver bull markets.
TGR: You argued at Cambridge House that perceived U.S. political and economic stability is good for gold and silver. To what extent can the U.S. government continue to persuade investors that all is well, and thus keep gold and silver down?
LM: That is the absolute crux of the problem. Most people have tremendous faith in their government to solve problems. But I feel, I hate to say, that a major breakdown is truly beginning to develop. If it does, then we have the potential for massive disillusionment leading to panic. And when people panic, they turn to gold and silver because they begin to lose faith in their currencies.
TGR: A recent New York Times article lauded inflation as good for people. What is your take on it? LM: Inflation, of course, accompanies virtually every historic gold bull market. There are some who say that more inflation means perhaps just 2 or 3% instead of 1%, but once you open that spigot, it is very hard to turn it off.
We're seeing that in the budgetary debates. The U.S. is still running a $900 billion ($900B) per year deficit. How on earth is it going to cut out $900B in programs and still keep the government operating? It can't.
TGR: How long can the debt problem be managed?
LM: For 150 years, the U.S. had a currency of gold. And so the reputations of the U.S. dollar and the U.S. government were unchallenged. If something was good, it was as sound as a dollar. The dollar itself was as good as gold. However, the dollar is no longer backed by gold, and this has resulted in runaway debt.
TGR: What about the role of government in the mining sector?
LM: Government has the capacity not only to do good, but also to do immense amounts of harm. An ocean of overregulation is having a terrible effect on mining. Some of the juniors I know are just in agony, especially now, when metals prices are weak. How in the world can they raise enough money to finance all the regulations, reports, applications and filing fees they have to pay in addition to important exploration work?
I'll give you some examples of how government regulations affect mining. In Mexico, Congress is seriously considering a 7.5% mining royalty. Grupo México (GMEXICOB:MXN) and Goldcorp Inc. (G:TSX; GG:NYSE) have said that if this tax is enacted, they will pull many of their operations from Mexico and will not invest new money. In Quebec, the leftist Parti Québécois government has made prospecting so difficult that one oil company manager actually said that people are more likely to invest in Africa and Iraq than Quebec.
TGR: Several mining analysts interviewed recently by The Gold Report have argued that it's time for investors to dump all but the strongest stocks in their portfolios. Do you agree?
LM: I do. There are two kinds of juniors that still retain investment consideration. The first has an adequate treasury to see it through the next year or two without having to raise money, if it takes that long to restore a major bull market.
The second kind, even better, has a producing property and is bringing in cash, which allows it to explore and develop other properties, thus enabling expansion without ruinous share dilution. I have seen a great number of offerings in the last few months on the order of 10 million (10M) shares at $0.03/share just to raise $300,000 ($300K). This keeps the office going for three more months before the company has to go to the market again and maybe offer 15M shares at $0.02/share just to raise another $300K. It's ludicrous.
TGR: After these companies pay their brokerage fees, they're not keeping much of this money, are they? LM: Exactly. Juniors are no longer cutting fat; they're down to the sinew and bones. Juniors once prospered by finding a project, immediately developing it and releasing a string of news releases. If these were exciting, share prices would rise. Juniors would use that capital to accelerate exploration and development, go quickly through to a preliminary economic assessment (PEA) and a feasibility study and then bring the property into production. That's how companies like Barrick Gold Corp. (ABX:TSX; ABX:NYSE) and Newmont Mining Corp. (NEM:NYSE) got their starts.
We just don't see much of that anymore. The Australian Stock Exchange and the TSX Venture Exchange have a whole host of companies that are dead in the water, and these exchanges may be at risk themselves because they need income (registration and filing fees) from active companies to remain in business.