Why the Credit and Currency Markets Are Driving Gold

Victor AdairWhite Bear Capital Corp

Vancouver Resource Investment Conference January 18, 2010.

Disclaimer - I’m a Private Trader

• Not an analyst

• Not a broker

• Nothing to sell

• No axe to grind

• Just a guy trying to make a buck trading his own money in the market

• Talking points to get you thinking

The Inflation/Deflation Forecast

• The range of analyst’s forecasts vary from deflation/depression to hyper-inflation

• Why would your forecast be any better than theirs?

• Your forecast/opinion may be your biggest financial risk

My Historical Framework

• Generational Credit Boom produced an Asset Boom and a huge appetite for Risk

• The Credit Crisis led to de-leveraging which pressured asset prices and re-priced risk

• Lenders are less willing or able to lend• Borrowers are less willing or able to borrow • Global policymakers are trying to counter de-

leveraging/deflation with stimulative policies• Is it working? Wall street or Main street?

Perspective

• Prolonged prosperity wore down the scepticism of creditors. (James Grant, Money of the Mind, 1992)

• …the current combination of high asset prices, low interest rates and massive fiscal deficits is unsustainable. (The Economist, 2010)

We are in a Credit Contraction

• This is not an ordinary recession

• De-leveraging is powerful and relentless

• Demographic change

• Periods of optimism – embracing risk

• Periods of fear – avoiding risk

Opposing Forces

• Private sector de-leveraging

• Balanced (?) by

• Massive fiscal deficits & easy monetary policy

Credit Supply & Demand

• Massive Gov’t debt supply• Balanced (?) by demand from • Retail (safety)• Banks (balance sheets)• Hedge funds• Central Banks (Domestic and Foreign)• The degree of balance/imbalance will help set

the level of interest rates and the availability of credit to the private sector

• So far the Gov’t sells debt at historically low yields

Credit Spreads / Risk Premiums

• Very wide at crisis peak – huge counterparty risk

• Narrowed dramatically during optimism rally (March 2009 to date)

• Corporate

• Sovereign

• Credit Default Swaps

• Yield curve

More Government

• Gov’t revenues are down, expenses are up - deficits get bigger

• Cut services? Raise taxes? Borrow more? Break promises? Depreciate the currency?

• Expect the public to welcome more government into their lives

• Expect the government to default on some of their promises

Flow of Funds to Gold/Commodities

• Flow of funds into commodity sector greatest ever in 2009 – bigger than 2008

• Commodities seen as an “Asset Class” that is a risk diversification (wrong?)

• Flow of funds a dominant force in commodity prices

• Gold ETFs now world’s 6th largest holder of gold (1500 tons?)

Gold Has Rallied

• Gold is doing what it should when global policymakers are trying to fight deflation – Martin Murenbeeld, 2009.

• Since 1999 Washington Accord (supply)• Since Obama elected – socialist and

inflationist fiscal policies, implicit weak dollar policy,

• Because Central Banks will remain extremely easy for an extended time

Risks to a Continuing Gold Rally

• De-leveraging accelerates (which causes)

• Deflation worries to escalate• Counterparty risk to soar• Capital to seek safety – US$ rises• Hot money to leave commodities/gold• Credit spreads to widen

• Possible triggers: geo-political event, China stalls, Euro fails, stimulative measures don’t work

Risks to a Continuing Gold Rally

• Economies recover (which causes)

• Inflation worries to escalate which causes

• Interest rates to rise

• Real interest rates to rise faster

• If USA recovers first then US$ rises

Why Gold Goes Higher

• Fiscal and monetary policies designed to battle deflation debase fiat currencies – which means:

• Inflation – which dictates:

• Buy hard assets – diversify out of paper assets.

Conclusion

• Opposing forces in the credit markets impact the gold price

• Private sector de-leveraging (deflationary trend) is negative for gold

• Vs.

• Gov’t and Central Bank stimulative efforts (inflationary trend) are positive for gold

• Which force wins?