Jon Nadler: Split Camps on a Dual Asset
Source: Brian Sylvester of The Gold Report 12/08/2010
Jon Nadler has never been without gold. In fact, it actually helped saved his life. But that doesn't mean the senior analyst for Kitco Metals wants to see gold's sky-high price edge even higher. In this exclusive interview with The Gold Report, Jon explains why gold is an insurance policy that investors should never want to cash in on.
The Gold Report: Jon, many people classify you as a gold bear. What do you think of that characterization?
Jon Nadler: It's a function of the camps that have been delineated so firmly in this market over the last two to three years. There seems to be very little give or tolerance on either side for the other's opinion. We have staunch bulls and firm bears and, thus, the in-betweens you'll never meet.
Actually, I tend to believe I come into the market picture from a different angle. My good friend, Michael Checkan, over at Asset Strategies International in Maryland, has always quoted my motto as being: If you buy gold for the right reasons, there really isn't such a thing as the wrong time or wrong price. Gold is really a dual asset-it is a commodity, but it is also money. It does certain things for a portfolio that are very positive. Mainly, it reduces overall volatility, slightly enhances returns and, if the barn burns, it's your lifesaver. It's an insurance policy that an investor can cash in on when needed.
However, I caution-and this is where some people, I think, experience a disconnect-you don't ever want to cash in on your life insurance policy. If you have the misfortune to do so, it implies that the rest of your portfolio is a smoldering pile of rubble.
I do know some investors who prefer to have 90% of their assets in gold. Obviously, that's skewed to the extreme and it invites nothing but volatility and potential heartache. The average investor with a portfolio of assets deemed safe, sound and sanely diversified should earmark an approximate 10% allocation to gold. If that were the case, then why would investors hope for that 10% slice of pie to be running off to the moon knowing full well the other 90% of their wealth is imploding? That's the typical disconnect that investors make.
If I say that gold is overpriced, in terms of fundamentals relative to yardsticks like fair value, production costs or any number of other gauges, then we (the ultra-bulls and me) have a discord and we get into arguments about where gold might or ought to go. All sorts of predictions come into question. This is a typical situation, one wherein average investors want to be told what to do. They tend to follow the guru of the moment without regard to what their predictions really entail. That's really a problem because a $3,000, $5,000 or $6,000 gold price implies certain terrible things might be going on, and that's not necessarily a situation investors want.
TGR: Isn't there a happy medium?
JN: I think there certainly is. The best way to approach the idea of gold ownership is to ignore price and price performance (unless, of course, you're a trading-minded investor and you have discretionary funds you can afford to gamble). However, if the name of the game for one is performance, then I can certainly name three or four other metals that have far outperformed gold in both the short and medium terms. That's what I think should be taken off the table. It's the price-performance obsession at any cost and some sort of rigid, formulaic approach that says: Oh, gold must rise to its inflation-adjusted levels because, you know, all assets eventually do so. I've seen no economics or market textbook that asserts such a statement represents a valid equation to follow. Just because oil did it (briefly, I might add) doesn't mean that gold will necessarily do it, as well. If you ask people who bought their gold at the 1980's peak of $850, they obviously are $1,000 short of having broken even on the principal investment. That's not a secret. So, they really have to root for gold to rise to at least $2,300 per ounce.
How many people actually listened to my pleas in the early part of this decade when I said that gold was below production cost, there would be a 'reversion to the mean' and that gold could perform better than it had up to that point? How many folks ran out and bought gold at $250, $300 or even at $400? Not a whole lot of them. Retail investors tend to be habitually late, impressionable trend followers. They want to go with a proven winner. It creates manias when investors are enamored with something that's consistently making headlines; but that, in and of itself, usually does not guarantee continuing performance. Just think dot-coms and Florida condos, for example.
TGR: Where do you see investment and demand in all of this? In 2008, $117 trillion was in financial assets, about $40 trillion was in managed assets like hedge funds and mutual funds and managed commodities accounted for $300 billion-a minuscule percentage. If investors put even a modest 5% of their portfolios into gold, it would bring that figure up to $1.2 trillion. We're nowhere near inflation-adjusted, all-time highs for gold. There seems to be some space there where those two items meet.
JN: Yes, but there are also a lot of arguments out there that we would quickly run out of gold if every Chinese and Indian person bought an ounce of gold. We cannot convenience every asset manager, pension fund and individual investor to give a favorable nod to gold-not even at the 3%-5% level in a portfolio; that's become clear over 35 years of market history.
Why, after roughly 35 years of legalized ownership and trading opportunities in the U.S., 5% of the investing public even considers gold remains somewhat of a mystery to gold advocates. It bears out the argument that you're not going to get a whole lot more than that minority segment of the population interested in this asset for various reasons-not the least of which is that the U.S. hasn't undergone the experience of other traditional gold-friendly countries. Those countries have had huge dislocations, wars, regimes failing, currencies demising and so on.
The investment cycle in the U.S. seems to be driven by real-interest-rate environments and the market flavor of the day. Unfortunately, this is where I see a lot of problems in the gold market. Hedge fund/exchange traded fund (ETF) demand that came about in the wake of the Fed's incessant rate-cut campaign has really been the true and almost sole driving force in this gold market cycle. Just today, I received an update from Goldman Sachs that forecasts a peak in gold at $1,750 by the end of 2012. That's when it sees the reversal of the ultra-cheap U.S. dollar environment and the end of real negative interest rates. Goldman characterizes gold as a compelling trade but not a long-term investment.
That has to bother a pension fund trying to decide where to put its money. I spoke to a pension fund in New York just three weeks ago. Its representative said the fund had a 9% allocation in gold. I said, Well, that's terrific. The fellow responded, Yes, but we sure as heck hope that gold doesn't 'perform' because just think of the other 91% of our portfolio at that juncture.
JN: Investors have this idea that gold is a perfect inflation hedge-far from it! It has, at best, a 10% positive correlation to inflation over the long term, which means it does not tend to preserve capital in the long run in a 4%- to 5%- type of inflation scenario. Gold does very well as an inflation hedge if you live in Zimbabwe, of course, or if you expect the Weimar Republic's levels of hyperinflation to come to U.S. shores.
Looking back to 1980 bears something else out, as well. The correlation for gold as a dollar hedge, as an anti-dollar play, if you will, is -0.27. That means investors are likely to lose money at least two-thirds of the time if they buy gold just as an anti-dollar bet.
So, what is it that gold does for a portfolio? Many institutional investors, the World Gold Council and academic studies say that a minimum 6% allocation in gold will tend to slightly enhance returns without adding unwelcome levels of volatility and that it will also slightly decrease the overall level of risk without sacrificing returns. For your investment soup, gold is a sort of MSG (monosodium glutamate)-a perfect ingredient. Still, it's not being treated in that fashion by everyone. There are strictly performance-oriented hedge funds out there that want to squeeze the last buck out of a 'hot' trade. For those funds, gold's diversification attributes and long-term insurance benefits are absolutely meaningless. They will push the sell button when their particular price target is reached. Individual investors tend to be far more loyal to gold and see it as a long-haul asset.
TGR: I think very few people argue that gold is for everyone.
JN: It certainly isn't the case anymore. I say this because we've seen what happened in the summer where certain gold-selling companies were being dragged in front of Congressional investigators. We hear stories about the elderly lady who's income oriented, has very little lifesavings and is being urged to put the majority of what she has into gold because, you know, the end is near.
TGR: What about the monetary base in the U.S., which has grown from $1 billion in September 2008 to $2 trillion now? That certainly seems like it would be in favor of gold in the long term.
JN: Certain metrics, M2 and MZM, are contracting and falling to the floor, so it is apparent there is no 'naked' round-the-clock type of money printing going on. What has been printed has been successfully sold off as debt. How will the Fed's exit strategy be achieved? It will be achieved in the same fashion as the previous 11 contractions were dealt with after World War II. Liquidity was injected into the U.S. economy up to a point, and then extraction followed. The effects of inflation at a much higher-than-desirable level were sanitized. On we go with another cycle.
TGR: You did an interview with Hard Assets Investor in May when gold was about $1,250 where you said you believed gold was retreating. Now gold has surpassed $1,400. Were you speaking to a longer timeframe?
JN: In May, we did have a retreat to about $1,150. It should have gone below $1,150, but it didn't because the bids hedge funds kept piling on remained in the driver's seat of the market. I ask anyone to show me the lines around the corner at the coin shop where people are panicking and lining up 1980s-style because they see manifest inflation. Gold is not in a bull market is what I remarked not long ago. For that, I received a lot of incoming (criticism). However, look at the metrics that make for a true gold bull market. First and foremost, the supply/demand basis of the market is absolutely out of kilter. That's been corroborated by all of the statistical houses-GFMS, CPM Group, VM Group, etc.-that track gold's tonnage flows in the market. They've concluded-not just me-that the market has become a complete junkie to this [mostly fund-driven] investment niche.
TGR: The tonnage flows included the huge influx of scrap gold into the market. There are indications that scrap is going to be reduced drastically.
JN: Scrap supplies rose 27% last year to a historic high. They were 68% higher than scrap supplies in 2007. I don't see it abating until prices come down and/or stabilize at a lower level, say somewhere around $900-$1,100.
TGR: Is there an indication that gold is going back to its traditional status as a backer of currency versus its more modern use as jewelry?
JN: I wish that were the case. At some point, gold was 60% of global reserves. The central banks' selling campaigns of previous decades have marginalized it to about 10% of global reserves. Even if we get back to 20%, gold is not making a return as a de facto alternative currency or the sole basis for some new supra-currency.
TGR: Why is that?
JN: We can't have current global GDP growth levels with the relatively infinitesimal amounts of gold that are available. We would simply have to cease growing and go back to the 17th century, economically speaking. I don't think we're near the day where gold makes that type of comeback on the international monetary scene.
TGR: You mentioned earlier that you could list some other metals that have vastly outperformed gold. Could you give us a brief overview of each?
JN: Well, for example, these days, investors are quite excited about silver because it has outperformed gold in the last few weeks. I, on the other hand, have been looking very closely at platinum, palladium and rhodium, all of which show very decent fundamentals, unlike the situation we find in gold and silver at this juncture.
Performance? Well, in 2009, gold returned about 25%. Silver returned about 53% last year. Platinum and palladium, on the other hand, returned 212% and 230%, respectively.
Silver has recently performed very well, but the risk profile for that metal remains at the very top of the heap of a bunch of portfolio assets-gold, platinum, the S&P 500, the trade-weighted dollar, etc. It carries fully double the risk entailed in investing in gold.
Demand for platinum, palladium and rhodium has been growing thanks to the industrialization and growth of Brazil, Russia, India and China (BRIC). The one standout feature has been that everybody wants to have wheels in China and India. Of course, you cannot build 'wheels' these days without making the tailpipes emit cleaner content. The minute you commit to that mandated environmental standard for auto emissions, you have to employ these metals. All three of them are absolutely vital in producing a car that meets today's stringent emissions rules.
The noble metals market is also awaiting the return of robust sales in the Western European and North American car markets, which have been in a sort of nuclear winter for the last two years. We have had to use cash-for-clunkers gimmicks in order to keep the sales from going away completely. The carmakers might be turning the corner next year, however; that's when we would expect even better performance to come from the noble metals group.
TGR: Bloomberg Markets magazine recently featured a story about how BRIC has become BIIC. Russia was taken out of the mix and Indonesia added because corruption in Russia inhibits investment there.
JN: Russia is a double-edged situation because some palladium market followers have almost declared that state stockpile sales are finished. Other people have disputed that whole scenario. It's hard to get accurate information out of the country. One thing I would look for is continued demand for vehicles in Russia-everybody wants a car. As long as Russia doesn't implode economically, I think its car demand will be ok.
I expect China to really ratchet up interest rates to try to cool inflation and growth, as well as avoid a real estate implosion. However, any tempering of the 'hotness' in China could mean lower sales of everything. So, we have to continue to count on the traditional automobile markets in Europe and America. I think they're making a comeback, and I think we're looking at a much better situation going into next year. The U.S. is a lot more accepting of diesel-powered vehicles, which are one of the major consumers of platinum group metals.
TGR: On a personal level, what percentage of your portfolio contains gold?
JN: Not that long ago, I was on a panel with certain notables in the gold business and the MC asked all of us point-blank: Gentlemen, what do you have in gold? You're telling your followers to own lots of gold. I think all of those present, besides me, admitted to gold ownership levels of far less than 10%. Most were clustered around 5%, at best. I think the audience found it quite surprising, as some folks are practically advocating putting your lifesavings into gold and running for the hills. Their own exposure to the physical side of the precious metal was pitifully small. Maybe they dabble in junior mining shares and consider that exposure to gold. Maybe they play gold futures or options, I don't know. They didn't explain. However, I am sure we would all like our gold gurus to put their money where their mouth is. I've never shied away from saying that gold was my entire asset basket when I fled communism back when I was 18 years old, which is certainly corroborated in the introductory chapter of The Golden Rule: Safe Strategies of Sage Investors, a book published last summer by Jim Gibbons. I wrote the intro chapter for Jim's book, which describes my story and how gold really did save my life many years ago.
TGR: How did it save your life?
JN: Gold was the only asset that I could effectively flee with, in a physical sense. It was my nest egg that I started a new life with in North America. We sewed it into our clothing when we left. It was given to me by my grandfather, who was a gold miner. So, I've never really been without gold.
TGR: And now you hold about 10% of your portfolio in physical gold?
JN: Correct. I did reduce it previously from 15% as the metal rose beyond $1,100. I don't plan to dispose of more than that because I don't need to. I'm hoping not to make stupid decisions in other assets, which would precipitate a need to sell gold to mitigate such losses. If it comes to any other forms of exposure to the sector, I'm very conservative. I don't play or trade metals for fun and profit. When it comes to mining shares, for example, if I were to own any, I would stick strictly to the two or three majors everyone knows. Why? I always want to go with proven entities and those that I can research easily. I don't have a profile where I like to put my assets at risk.
My gold holdings are not stashed in a coffee can, either-not these days. I'm very comfortable having my gold stored by reputable, specialized custodians and having it spread out in a variety of worldwide locations. This is not because I'm expecting any North American crisis or imminent government confiscation but simply because I like the idea of asset diversification, as well as geographic diversification. That's why I also hold a number of foreign currencies in my modest little basket. Some currencies that I think are well managed are the Swiss franc, Australian dollar, New Zealand dollar, Swedish crown and Norwegian crown. Of course, none of that means I have any nightmares about being mainly in Canadian and U.S. dollars as the base.
TGR: What's some parting advice for investors?
JN: Gold is essential as an insurance policy on an investor's financial life. If investors have none, they should start accumulating it 1% at a time until they build up to my preferred threshold of 10%. But investors should not be without gold because, at the end of the day, this is the sole liability-free asset that can be owned outright. As Karl Malden used to say: Don't leave home without it. I would update that motto to say: Don't be home without it, but keep hoping for the best. Ignore the gold price, but focus on your percentage of ownership thereof.
TGR: We'll hope for the best. Thanks so much for your time, Jon.
Jon Nadler's 33-year career has focused exclusively on the precious metals market and its related investment products. After graduating from UCLA Business School's management program, Nadler established and managed several precious metals operations at major U.S.-based financial institutions, such as Deak-Perera, Republic National Bank and Bank of America. He currently is a metals market analyst for Kitco Metals Inc. He has long-standing ties in the global precious metals community and has consulted on marketing and product-development issues for government mints, precious metals retailers and trade and membership organizations, such as the World Gold Council.
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