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Source: Brian Sylvester of The Gold Report (8/6/12)
Edward Karr, CEO of Geneva-based RAMPartners, favors a disciplined, patient and steady approach to investing in junior gold mining companies. In this exclusive interview with The Gold Report, Karr shares his thoughts on the European crisis, its effect on gold prices and some of his favorite junior gold mining companies.
The Gold Report: Edward, because you're based in Switzerland, it would be interesting to get your perspective on the Eurozone's new rescue fund, the Eurozone Stability Mechanism (ESM). There is talk in the market that it could get a banking license, which would provide it access to European Central Bank (ECB) funds, aiding it in bailing out Spain and other economies. Do you believe that will happen?
Edward Karr: The idea of the ESM actually getting a banking license was floated recently by ECB council member Ewald Nowotny. The question you have to ask is why would it want to give the ESM a banking license? The answer is leverage. The ESM right now has about €500 billion in it, large enough to handle Greece. But now bond yields in Spain have gone above the critical 7% level and banks in Spain and specific regions of Spain, such as Valencia, have asked for their own bailouts, meaning the whole house of cards is starting to tumble. With yields above 7%, Spain has effectively gone over the event horizon of the financial black hole. A deflationary gravity and negative feedback loop is so strong that there is no return once you go over the event horizon.
Next in line are two countries that are going to give the European governments and global central bankers nightmares-Italy and France. The ESM is just not large enough to handle these bailouts in its current configuration, so it has to be increased. The ECB is looking to give the ESM a banking license so it could leverage up to handle some of these larger countries.
TGR: Recently ECB President Mario Draghi said he would do "whatever it takes to support the euro." Your thoughts?
EK: I believe the ECB will do this. I think that it is going to print and print and print. We're talking trillions and trillions of euros to bail out these countries.
TGR: How does the ECB get around European law that prohibits it from undertaking liquidity measures?
EK: First of all, there will be a big ruling coming in September from a German constitutional court about the ESM's legality. Nevertheless, there are a number of ways the Eurocrats can get around European law. The aforementioned banking license for the ESM will leverage it up; they can also change the law to allow the ECB to lend directly to banks. We're going to see creative solutions and we're going to see a lot more liquidity pumped into the system.
TGR: That is what many economists believe the European economies need. What are your thoughts?
EK: It's really a path of no return and it's going to be very difficult to change course. I don't believe that this is what the economies need. Printing money out of thin air is never positive. What is needed, in my opinion, is for a massive cut in government spending so it does not crowd out the free market. The solution is for government to get out of the way and let the private sector flourish, but that is not happening.
TGR: The Bank for International Settlements is discussing the idea of reclassifying gold from a Tier 3 asset to a Tier 1 asset. That would mean that gold is valued at 100%. How do you think that would affect the gold price?
EK: It would be interesting if that does happen. Historically a bank's gold holdings under a Tier 3 classification have to be discounted 50% of the current market value. So a lot of commercial banks have little incentive to hold gold as an asset because they could only lend out half of it. If the Basel Committee does agree to let banks use gold as a Tier 1 capital, I think it could create substantial demand for physical bullion. That would be an important step toward gold's remonetization, having commercial banks and ultimately central banks hold a lot more gold as reserves on their balance sheets. More bank lending may have inflationary effects, too, which would give physical gold bullion a nice double whammy effect if this happens.
TGR: Marshall Auerbach, an economist with Toronto-based Pinetree Capital, wrote in a blog that central banks routinely take hedge positions against their underlying reserve assets but never report the derivative overlay. He writes, "if the European national central bank, with 2,000 tons of gold in its vault, sells forward against that position, basically thereby eliminating it, it doesn't report the corresponding forward position. Consequently, it may be that the official institutions do not have the gold they report to hold on their balance sheets." Do you think that's happening and how would that news affect gold equities?
EK: I think this has been happening for a long, long time. Groups like Gold Anti-Trust Action Committee have done an excellent job documenting this fact. The major central banks around the world have entered into forward contracts to try and gain a slightly higher return on their physical holdings. If central banks were caught short and had to cover, it really could have the potential to send the gold price higher. And this would be a big positive for gold equities.
TGR: Where do you see gold finishing this year?
EK: I think that gold will end 2012 a little lower than the current levels today. So, I'll say $1,500/ounce (oz).
TGR: Let's talk about fear. In the fall of 2011 you said, "When people get scared, markets and stock prices get way out of line. That is when you need to have the courage to really step in and accumulate." Lately it's taking even more courage than it used to, to do just that. Did you expect the fall in the junior mining companies to be this steep?