Michael: Do you believe that the commodity bull market is still in play and the gold bull market is still in play?

Martin: Oh absolutely, I think that loosely we have another ten years to run at least on the resource side. We are going to have an interruption, we always have interruptions in these long cycles. By the way these long cycles can last 15 20 25 years, and I would be foolish to argue that the cycle that we’re in now will be the shortest cycle in the history of the data that goes back to 1800. It would seem to me that Asia holds such a key to the overall scenario. Clearly our own commodity markets have been driven by demand, and there’s been major demand out of Asia. The list is a long one,  and it seems to me that if we were going to have a focus it should really be on the ebbs and flow of the Chinese, Indian and other developing Asians.

The Commodity Bull & Gold Bull Update

Michael Campell: Let’s start with what you’re looking at these days, what are some of the factors that are at the top of your list, that trickle down into what your investment decisions are?

Martin Murenbeeld: Well, I’ve got ten bullish factors for gold and I can run through those very quickly. There is monetary reflation. I think that’s one of the things that came back into the market this week when we saw the weekly US economic data. There is certainly a sense there that something more has to be done about the US economy and possibly there has to be a little bit more fiscal reflation although that seems very difficult to imagine at this point. One of my factors is of course that the US dollar has to go down somewhat more. I still think that the US dollar is a little too highly priced relative to the Asian currencies. I was interested to see the recent study they do once a year at the Peterson Institute out of Washington rated one of the, I think the best research sort of research place in the world. They recently came out and said that the dollar was at least 25% if not 30% overvalued against the major five Asian currencies including obviously the Chinese renminbi. Those currencies are, were seriously under valued.

Michael: Yes so another 25% down to get it where they thought equilibrium it will be for the US dollar.

Martin: That is correct.

Michael: Which of course where does that put the Canadian dollar then?

Martin: Well, and actually the Canadian dollar turns out was pretty dead on, and that kind of confirms our models that we run when we look at the commodity prices and so forth, that somewhere in this 102 range is about right at the moment for the…

Michael: But even if the US dollar drifted lower Martin, is that saying that the Canadian drifts lower also by keeping it’s relation with the US?

Martin: Absolutely yes that’s a good point. So you’ve got a dollar that’s got to go down and you’ve got excessive foreign exchange reserves that are being diversified, and we are seeing lots of news on that with respect to some central bankers that are buying gold. The Russians bought some more gold in April as did the Mexicans. You’ve got a major increase in investment demand that is running through the world gold market. One of the things I stress is just how much the regulatory environment in Asia has changed over the last 15 or so years. I might have mentioned before here that back prior to 1995 gold coming into India had to be smuggled. Now you have banks in India that are offering gold ETFs, so over the last 15 years you’ve had a massive change in regulatory environment. In China before 2002 every ounce of gold in China went through the fingers of The People’s Bank, and in fact The People’s Bank had a price for gold that was quite different from the world price of gold. Now all of that’s become integrated, so what we saw in the data that the world gold council put out, is that these two markets are just booming with respect to gold demand. Now that’s also then helped by the fact that people there are getting wealthier and there is more inflation in Asia. So you get a whole bunch of factors beyond just looking at the dollar and what’s going on in the US that are telling you gold is well bid.

Michael: It’s interesting some of the things that you’re alluding to here, especially the currencies. I’ve been saying on this show for nine years that if I only could know one thing I wanted to know the direction of the US dollar, and the big that debate over there is whose got the worst problems. Is it the euro, is it the dollar or is it the yen? I think is a pivotal thing to understand, and I’m interested the way you bring up that we had better recognize this huge shift in global economic power and we’d better start looking at that relationship vis-à-vis Asia.

Martin: Well you know it’s, in my view it’s actually quite normal that the US dollar goes down. I mean the US dollar goes up at times and it goes down at times, and the times that it goes down is against a currency of a country that is emerging. We saw all this all through the 1960s you know Germany and Japan were devastated of course at the end of the Second World War, and they were kind of the emerging economies of that period, and what you saw over that period is constant upward pressure on the yen and the deutsche mark. That’s happening now with respect to Asia. You’ve got a very large motivated labor force becoming more productive, putting better products out onto the market, and it’s very natural that these currencies rise.  Economics determines that’s these currencies should rise because that is one way that these people gain value for their inputs. Now the problem with Asia is that they’ve been sitting on those currencies. They’ve not been letting them rise and that’s been very unfortunate both for them because they are now fighting inflation and it’s unfortunate for the rest of the world including the United States because they’re running a higher unemployment rate than they might otherwise be running.

Michael:One of the things that I love about your research is that you always provides scenarios and the probability of the movement. Run me through a couple of the more prominent scenarios you’ve got right now for pricing of gold as we go out?

Martin: Our baseline scenario is actually very, very modest and it certainly wouldn’t gladden the heart of a gold bull. We have a sort of a 1,500 1,550 dollar range going into 2012, the kind of range that we’re in now. The underlying aspects of that are no interest rate hikes but not much more monetary stimulation. The more interesting scenario is a high price scenario, and there we have significantly more monetary inflation. One of our key variables is global liquidity when we do the models for the gold, and global liquidity is essentially the sum of foreign exchange reserves around the world and including some monetary base, specifically the US monetary base. That could blow up more and we have seen it blown up of course over the last several years. For that to continue in the line that it is now we’d be looking at gold prices somewhere in the $1,800 range next year. So those are the two key scenarios, we have a very low probability on an alternative scenario and that of course is the bearish scenario, and the kind of numbers we have in that scenario are sort of low 1,100s. Now that would shock everybody to see gold going in that direction, and some of the assumptions that are included in that scenario are not really extremely likely that’s why of course we have a low probability on it. But, so that sort of gives you a range of the kind numbers that we’re looking at. When we do a probability weighted outlook we have an average for next year of 1,675, and I think that’s not a bad number to kind of plan on.

Michael: It is fascinating because there are so many variables that do come into play and it’s great to hear you elaborate on some of them. What is the relationship with silver on that, because silver has been such a huge performer. What do you look for, for silver?

Martin: We don’t actually have a price forecast for silver, and mostly I, as an economist, say to people if you have the iron stomach for the kind of volatility that silver is going to deliver be my guest. It’s a high beta gold, gold prices go up silver prices are likely to go up at a more rapid pace. But as we saw recently we saw a little bit of softness in the gold price, and of course silver plunged from whatever $47 down to about $34 or so. That’s the kind of thing you’re dealing with in silver; it’s not something that I could recommend as an investment unless it is absolutely well diversified so that the volatility in silver doesn’t affect the volatility in the whole portfolio.

Michael: Let’s talk a little bit about diversification. It’s kind of one market meaning if the US dollar goes down or if it goes up all the other market moves in tandem. For example the world equity markets seem to go in one direction, and so it’s hard to get diversification now on a portfolio.

Martin: Well yes and no. We saw some interesting things just this week that kind of highlighted how we might want to play diversification and one of my favorite things to say to an investor who’s looking for diversification to buy some gold and hope it doesn’t go up. The World Gold Council have run lots of statistics to show that the correlation between gold bullion and the equity markets is essentially there. Now of course there’s a little higher correlation with respect to the TSX but that’s because the TSX is more heavily dominated in materials relative to the S&P for example. Even gold equities are not that highly correlated with the equity indices. So that’s one area of diversification, a little bit of gold. The second one is obviously debt, you know we’ve not been that bullish on debt, but we have stressed repeatedly do not have debt in the portfolio because there are all kinds of potentials for the economies of the world to slow down or for the other prices to appear where you get a rush into the safety of US government debt, and in fact that’s what we’ve seen again. So the equity markets are struggling a little bit, and the debt markets have done very well again. I know what you’re saying,equity markets tend to run a little bit more together as of late, but we do get diversification out of debt. Now I’m not saying let’s be loaded up on debt. I mean if you’re loading up on debt you’re saying my gosh let’s invest heavily in the countries that are borrowing trillions of dollars. On the surface of it that doesn’t sound like a great thing to be doing.  

Michael: Bottom line what is your interest rate scenario?

Martin: Well our baseline is kind of like the baseline for gold, not that exciting. We’ve got US ten year treasuries which are just hovering around 3% at the moment, staying around there for the next few months and then possibly drifting up a little bit towards the middle of next year to something in the order of 3.35 to 3.40 that sort of thing. So that’s kind of the baseline in terms of the Fed funds target and that gives you a sense of what the Fed would be doing. We don’t really see the Fed changing anything until around March or so of next year, and at that point it is likely to move its range from 0 to 25 points, so I mean it’s not anything that we’re likely to notice. With respect to The Bank of Canada, I think some of the numbers that have been coming out would tend to encourage them to stay their hand. We had been looking for them to maybe move in September, we were never part of the group that thought they might move in May. But we are starting to think that maybe The Bank of Canada is going to hold off a little bit more as well, because the first quarter GDP numbers that came out this week kind of set up a good number for the second quarter, and they’ll come out about the time when the Bank of Canada is thinking about raising rates up. If those numbers are weak then I think The Bank of Canada will stay off. So sort of our baseline is more of the same basically very, very low interest rates.

Michael: This backdrop of low interest rates I personally believe are having an impact on the market in that you’re not giving an alternative for major amounts capital looking for places to go,  so the stock market can be a beneficiary. I’m one of those guys who looks at the Canadian banks and sees them with a 4% dividend that’s higher than the 10 year treasury rate and I got more faith in the banks than I do in the treasury. It’s hard to make sense of the kind of growth numbers that we’re seeing. I’m not seeing too many scenarios that have robust growth coming in the next half year to two years.

Martin: No and it’s difficult to find growth. I mean if you go through the US GDP numbers and some of the listeners will remember from economics how they put these together. It’s household consumption plus government spending plus investment business investment plus the trade balance, and you know when you’re thinking about that you say now exactly out of which one of those four components is growth going to come? Well you know the household sector in the US is heavily in debt, so the best we are going to see there is maybe a 2% spending rate, that’s kind of your bedrock. Now that’s about 70% of the economy so, but you know we’re not getting anything out of exports minus imports. That goes back to what I was saying earlier with respect to the dollar being overvalued, and why would companies want to invest at the moment if the companies that are investing are investing in Asia.  Of course the idea is that we’d like them to invest in North America. In Canada there are some reasons to invest, so but you know Canada in the scheme of things is a small economy. So you got some problems there that make it very difficult to see anything like the kind of growth numbers that we’ve been used to in years past.

Michael: I certainly have a problem seeing anything robust coming out of the broad European Union. I mean those problems just seem like early innings of a game that’s going to run a little further.

Martin: Yes I know this is actually a very sad situation. Many of us who are not believers in fixed exchange rate systems, and we probably have more of those in Canada than we have elsewhere because Canada is a devout flexible free floating currency kind of country. For those of us who don’t believe in fixed exchange rate system have seen something like this coming. You kind of knew that if Germany gets into a fixed exchange rate system with a country like Greece, Greece had better start to look more like Germany or we’re going to have problems, and of course Greece didn’t start to look like Germany. In fact what they got was a mass of convergence in interest rates as they joined the euro, which encouraged them to borrow even more than they were already borrowing, and so now of course we find out that they are heavily over borrowed. The same thing has happened with Portugal, and I’m concerned about Spain as there’s 21% unemployment in Spain. Someone said, it wasn’t me, that Spain is sort of an Egypt waiting to happen. You know you have these kinds of problems, so it’s difficult as you say to see growth there other than growth in Germany. Germany has a very good mandate in Asia, you know Germany makes products that Asians want, and so Germany actually is doing quite well.

Michael: It would seem to me that Asia holds such a key to the overall scenario. I mean clearly our own commodity markets have been driven by demand, and there’s been major demand out of Asia. You were mentioning earlier the accumulation of gold, the changing of holding rules in China and India, and them being big buyers of gold now. Copper has also had a big boom on that, uranium probably is going to get out of demand out of China. The list is a long one,  and it seems to me that if we were going to have a focus it should really be on the ebbs and flow of the Chinese, Indian and other developing Asians.

Martin: You’re absolutely right on this, in fact I was at a conference earlier this week and that was one of the key things I tried to get across to our, to our investment advisors. You know that the focus here should should be on China with respect to the Canadian market. I know that the US is very important to us, but at the margin now China is driving things. Resource demand of course plays directly into our equity markets, and we’re seeing here with China raising interest rates trying to slow the economies a little bit that there’s been some pullback in resource prices, and of course right away our equity markets feel that. But my biggest concern looking forward is some kind of an economic speed bump that China hits. I expect it’s going to hit it, I wish I knew when, but when it hits it we’re all going to feel it.

Michael: Yes, interesting stuff Martin and let me just finish with a bottom line question. Do you believe that the commodity bull market is still in play and the gold bull market is still in play?

Martin: Oh absolutely, I think that loosely we have another ten years to run at least on the resource side. We are going to have an interruption, we always have interruptions in these long cycles. By the way these long cycles can last 15 20 25 years, and I would be foolish I think to argue that the cycle that we’re in now will be the shortest cycle in the history of the data that we have, and that data goes back to 1800. So this is going to go on for quite a while but there will be interruptions.

Michael: Great stuff Martin I really appreciate you coming into work on a Saturday with us, your insights are much appreciated.

Martin: You’re more than welcome Michael.