John Embry: I've Never Seen This In My 40+ Years In The Investment Business
Tekoa Da Silva

While precious metals and their corresponding equities continue to work through a multi-year painful correction, John Embry, Chief Portfolio Strategist at Sprott Asset Management, was kind enough to share a few comments.

Speaking to the abysmal sentiment toward the sector, John explained that, "I've seen this sort of 'bearishness at the bottom' phenomenon many times …There was a really ugly bear period between '74 and '76 which I remember really well..."

Further describing that period, John noted, "When [gold] was down to $102, off the high of [near] $200, a lot of people were calling for it to go back to $35 again… in '76 it turned around and started to move higher and then it just went nuts at the end of the 70s…and got up to $850-$875, which completed about a 25-fold move."

John emphasizes the belief that this period parallels the mid-70s bull market correction, and when asked about the depth of the current sell-off, noted that, "I don't think I've ever seen, in the 40 plus years I've been following the sector, the shares cheaper in relation to the price of bullion as they are now."

The level of current pricing combined with sentiment, sets up, "An historic opportunity," in high-quality mining shares, John further added. "[So] few people own them today. They don't even talk about [them]…Bonds and stocks are grotesquely overpriced and I think gold and silver and the mining shares in particular are ridiculously underpriced. Those who figure that out when the inflection point [arrives] are going to make a fortune."

Here are his full interview comments with Sprott Global Resource Investment's Tekoa Da Silva:

Tekoa Da Silva: John, your career from what I understand has spanned over 30 years, dealing with precious metals and specifically gold. I'm interested in your observations on the longer bear market periods you've experienced during those years, and any similarities you see when comparing them to today.

John Embry: Actually I'm getting older, so it's over 40 years now. I was around when the London Gold Pool was in effect in the late 1960s and the price was being maintained at $35 an ounce but that was fine because that was an official price and they were fully entitled to do that.

But then it started to break away as the Europeans tired of basically the Americans spreading large deficits. We thought there was a big upside move coming around 1968-1969, but it was aborted and it didn't happen until about '71.

So there was a rough period in there between'68, '69 and '71 for gold enthusiasts and then as you know Nixon officially delinked the U.S. dollar from gold in August of '71 and that kicked off a really spectacular bull market that lasted until about '74.

At that point, we had sort of a recessionary environment development. They actually pounded gold down from $200 to $100 and there was selling by the IMF, but I thought that the reaction was overdone.

But when it was down to $102, I think, off the high of near $200, a lot of people were calling for it to go back to $35. So I've seen this sort of "bearishness at the bottom" phenomenon many times and that was a particularly bad case.

In '76 it turned around and started to move higher and then it just went nuts at the end of the 70s, as you know, and got up to $850-$875, which completed about a 25-fold move. But in the middle of that move, there was a really ugly bear period between '74 and '76 which I remember really well.

Following that, we basically went through another horrible period in gold. It was in a bear market through the 80s and 90s, and it got killed in the post Bre-X period when they drove the price down to about $252.

It was below the cost of extracting it from the ground, there was a lot of hedging done by companies, and the market was just a mess. At that point, everybody gave up and that was one of the great opportunities of all time, accumulating gold at $252—or anything under $300.

That window existed for a year or two and then the bull market we're in now (which is in sort of a hiatus), began around 2001. It has had a few corrections, one certainly being the Global Financial Crisis in 2008. We've been through a tough period, but basically it moved from the high $200s – to over $1900 in a ten-year period.

At that point, over three years ago, I believe there was a concerted effort to knock gold back down (which I think has been the central banks in particular) and discourage people from holding it. It has worked. We've gone through another horrible correction that has lasted over three years now, seeing the price fall from $1900 to under $1150 at one point.

The sentiment here is kind of like it was at the '76 bottom and in 2000-2001. Just those two periods were precursors to huge moves in gold and I think this one is the precursor to the biggest move of all, so I would encourage people to hang in there.

TD: John, what has been your preferred method of playing either the metals themselves or the respective equities? Do you have a buy-and-hold approach, or do you look to play the "cycles" in natural resources?

JE: Well, I think if you believe in gold being "real money" as I do, you always have a basic position in the physical bullion, and you can trade around that basic position but you never get out of it altogether because it is a real asset which I think should be the core of any portfolio.

But because of the extreme volatility that we experience in gold, I think you have to adjust your position at times. You can take large trading positions, but in your mind you keep note of a minimum position that you go to if you thought we were heading into an extended bear phase.

The shares, however, are the real leverage in the play, and you've got to be totally out of the shares if you're in a bear phase because, as you've seen this time and as you've seen in all of the previous bear markets, they get slaughtered.

But when the time comes and the gold price is moving to the upside again, you've got to be in the shares because that's where the leverage is. This opportunity that's been created – I don't think I've ever seen, in the 40 plus years I've been following the sector, the shares cheaper in relation to the price of bullion as they are now. Given my extreme bullishness on where bullion is headed in the next three to four years, I think the opportunity in the shares is historic and I encourage people to take a very close look at them. What really encourages me is very few people own them today. They don't even talk about it.

TD: John, do you recall the actions you took during the '81 to '85 bear market period on behalf of your shareholders in terms of making money during that time?

JE: Well, in that time, it was difficult because the bullion was moving into a significant bear market. But strangely enough, there were opportunities during that period for exploration stocks. You could actually manage gold funds and not get slaughtered even though the bullion was doing poorly because there was a huge unfolding exploration boom.

I remember in the late '80s and in the '90s in particular. The price of bullion was doing nothing. But you had all these massive discoveries in various parts of the world. You could have made an exceptional return just on exploration success and you didn't have to pay attention to the bullion price. But I think today we're a long way from that. We've got to get the bullion price straightened out, get the companies with real ore bodies moving up in price, and then I think the exploration stocks will come in to rally behind them.

TD: John, I saw a chart recently depicting the number of discoveries made across different commodities over the last 10-15 years, and the data I've seen (in this anecdotal example) seemed to be pointing downwards in terms of fewer discoveries being made. Is that accurate based on your view point? Is the world becoming a bit 'picked over' in that sense?

JE: Well, that's an excellent question because I think there's a reason gold and silver are called precious metals. There isn't very much of them in the earth's crust. The low-hanging fruit particularly in geopolitically attractive areas has been picked over pretty well.

So I think explorers are going to need to go further and further into the field to find real new greenfield discoveries and as a result, any company that has a real ore body today that isn't in production represents a fabulous opportunity if their shares have been crushed by the market and they're intact financially. If they have enough money to withstand the remainder of the bear market, I think it's a phenomenal opportunity. Because as you said, there aren't many discoveries out there. They're just not finding many of them.

TD: John, I'm reminded of a speaker who said, "Ants think summer all winter, and think winter all summer." When you think back on previous bull market periods, late 70s to early 80s, and 2010-2011—what do you remember investors doing? I guess another thought that comes to mind was the movie Trading Places, a popular movie about trading commodities. Do you remember people getting "swept up" into the market?

JE: Oh, there's no question. That's just human nature. People extrapolate into the future, whatever is going on at present. If something is booming, people can't get enough of it. I remember the end of the '79-'80 period when gold was flying and people thought we we're going to have inflation forever.

The tip-off then was Paul Volcker coming forward and basically saying, "We're going to defeat this," and hiking rates up to a dramatic level. That was pretty obvious and you could figure it out.

The 2011 top was to me a phony top. It was created by the central banks. They're scared to death of people finding out that the fiat currency system is in a terminal state and they're just pumping money into the system under QE or whatever else you might call it.

They were terrified that gold and silver would be the canary in the coal mine. If the metals went shooting up it would reflect how terrible the monetary policy was going to be in the longer run.

So it was a tougher top to call in my opinion compared to say the one in 1980 in particular which really did usher in a true bear market. I do not believe we're in a true bear market. I think we're in a very deep, difficult correction in what will prove in the fullness of time to be a spectacular bull market.

TD: What crosses your mind as you hear bearish statements being made in the investment community, such as hedge fund manager John Paul Tudor Jones, indicating that commodities are a "dead story" until 2020?

JE: Well, I think he might be right on commodities per se, but I don't see gold and silver as commodities. I think they're monetary metals. Silver has more of a commodity aspect to it, but so much of it is consumed. Gold is primarily a monetary metal that is held by people who understand that it's real money and can't be created out of thin air like paper money can.

I am as fearful as Jones is that we could be coming into a horrific economic period over the next few years and the demand for things like copper, zinc, and maybe energy to some extent will be muted. But that would be extraordinarily bullish in my opinion for gold which does extremely well in either highly inflationary periods which would result if they keep printing money into a weak economy, or in a hard deflation. In the 1930s, gold was one of the assets you wanted to own, and in particular, the gold shares.

TD: John, would your expectation be that in a tough economic environment "the people" would demand a stimulus, and serving that demand, politicians would then step forth and deliver?

JE: That's an excellent question. I'm a big believer in Austrian economics and there's infinitely too much debt in the system. Anybody who's prepared to be honest will acknowledge that.

When you reach that position as a country there are only two outcomes; either you take a hard debt-deflation which leads to a '30s style scenario or you try to avoid it in the short run and print whatever amount of money is necessary to keep everything afloat.

The only problem with the latter approach is that it ultimately leads to hyperinflation and people begin seeing what's going on. Then they try to bail out of the currency.

If I had to put the odds on it, I would bet on the second outcome—which would be a continuation of money printing until they trigger a hyperinflation.

If that's the case, it would be a nirvana for the gold price. But it wouldn't have been the gold price that will have changed. It will be the price of the money it's valued in. Nevertheless the gold price stated in currencies in that environment will go through the moon.

TD: What is the biggest hole in the thesis for the monetary metals? What could go wrong?

JE: Well, at this point, I don't think very much could go wrong with the thesis. There are people in the world (they don't really reside in the West, they reside in the East) who happen to agree with us and think that gold and to a lesser extent silver are real money. They're also loaded up with U.S. dollars because of all their trade surpluses.

So they're basically acquiring gold at a really aggressive rate and now I think there's less and less gold remaining in the West. What we're talking about here in my opinion isn't outcome. We're talking about timing of the outcome, and that is, "How long can the East continue to consume gold from the West to meet its physical demands, with prices that are infinitely too low?" And on top of that, you can no longer pull gold out of the ground in most instances at this price. So this can only go on for so long.

TD: Circling back around to the equities for a moment—what's your favorite segment of the precious metals equities space here?

JE: Well, right now, I like small producers who are extraordinarily undervalued because they're illiquid and large funds don't own them. I think they will adjust in price rapidly when the gold price rises because the profitability will likely exceed the current market cap in a fairly short period of time.

It also depends on who you are. If you're trying to max out on making money, I would own them and I would also be looking for companies with legitimate ore bodies that haven't been exploited. Those that carry extraordinary amounts of gold in the ground valued at next to nothing are the ones you want to look for.

I think the upside in small producers and companies with real ore bodies that haven't been exploited yet is where maximum opportunity lies right now.

TD: Would you lump the marginal producers into that category too?

JE: Yes, the marginal producers, the ones that have high cost basis would be in that category too. The companies that will be fine but won't have as much lift will be the majors, because they haven't been beaten down as much as some of the smaller stocks.

TD: What would you say is the biggest risk these companies face?

JE: I think the biggest risk, quite frankly, is that if the world unfolds in a very negative fashion (which I think is highly probable), governments will be desperate for money and they will target groups who are making money. I think you could see excess profit taxes, maybe even seizing of mines. But that's a problem to worry about after we've had a huge upward move, so I'm not focused on that at the moment. But down the road it is the largest problem in my mind

TD: Would that be a possibility in all countries, not just the ones that speak English?

JE: I think in varying degrees. A place like Canada has been more respectful of capitalism. Some of these third world countries make me a little nervous. But I think the way things are valued right now, you get to buy stuff in the third world at a discount because of that fear. So I wouldn't worry about that too much at this point.

TD: John, in winding down is there anything you think we would have missed?

JE: Well, I'd like to reiterate that I think it's extraordinarily important that people understand what's going on here and recognize this as an historic opportunity, because so few people do.

I have close friends who have known me for years and they still think I'm nuts, but price action drives people's thought processes and the price action has been negative for precious metals and positive in bonds and stocks. Bonds and stocks are grotesquely overpriced and I think gold and silver and the mining shares in particular are ridiculously underpriced. Those who figure that out when the inflection point comes are going to make a fortune.

TD: John Embry, Chief Investment Strategist at Sprott Asset Management, thanks for sharing your comments with us.

JE: My pleasure.

For questions or comments regarding this article, or on identifying high-quality precious metals mining companies, you can reach the author, Tekoa Da Silva, by phone 800-477-7853 or email [email protected]. 

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