"I don’t know how the Dollar problem will be resolved…"
AS PROFESSOR of investments at the University of Virginia for eight years, the investor, mathematician and former fund manager Michael Berry PhD spent considerable time with some world-renowned geologists working on the Carlin Trend gold deposits.
Now his complimentary Morning Notes, distributed worldwide, provide analyses of emerging geopolitical, technological and economic trends, as well as identifying opportunities for the Discovery Investing strategy he has developed.
The Gold Report: As part of a short-term plan to sell $66 billion in debt, the US Treasury recently auctioned $32 billion of three-year Treasury Notes at an all-time record low rate of 0.57%. Why is this negative for the economy?
Michael Berry: The deficit problem is very significant. Deficit spending is not working. So, ultimately, we have to grow out of this economic malaise, but right now organic growth doesn’t look like a plausible solution to the problem. I think the Obama administration has realized this. I’m not sure the Republicans have a better approach. In fact, in a way, I hope they don’t win the House back because I’m not sure they have a plausible solution. From an investment perspective, people are seeking assets other than Treasuries in which to invest.
TGR: Fed Chief Ben Bernanke is saying that inflation is too low. It’s obvious that he’s going to do something. He can print a trillion Dollars via electronic transfer of funds if he wishes. Does that scare you?
Michael Berry: Well, yes, it does in a way that probably is not too traditional. I don’t think quantitative easing will have much impact. We’re talking about the idea of quantitative easing here, or increasing the money supply and reducing interest rates. But right now we’re not seeing either the velocity of money or the multiplier picking up. We’re not seeing enough lending. So I don’t think the easing, or monetary approach, is an adequate solution to the problem now. I believe most of my colleagues agree at this stage of the game. So the question, the real question, is how do you stimulate demand? The kind of inflation that’s being stimulated now is cost-push inflation rather than demand-pull inflation. What Chairman Bernanke really wants and needs is demand-based inflation, but it is not evident in the economy at this time. That’s what he really wants.
TGR: Is there a solution to this problem?
Michael Berry: Yes, there is a solution to the problem. The solution is a very painful one but not a terminal one. It is painful because we must reduce our deficits. We have no choice. We may have to cut Social Security, which will be painful for people my age. Obviously, we are certainly going to have to pull back on entitlement spending. Fiscal programs such as government spending are not the solution. The monetarist approach of manipulating the money supply is no longer a solution.
I think it’s going to be a matter of cutting entitlements and balancing the budget; but these are all very painful approaches to the problem, and they take time. So there’s no immediate solution to this problem. That’s why unemployment is stuck at 9.6%. Underemployment is 18.6% and it’s not coming down. That’s why the Democrats may lose control of one or both of the houses of Congress in this year’s elections.
TGR: Recently, the Commerce Department reported that the trade deficit expanded to $46.3 billion in August due largely to our big competitor, China. Imports for the month jumped 2.1%, while exports rose only 0.20%. Is China waging economic warfare against the United States with its pegged currency?
Michael Berry: That’s a great question. There is no doubt that fiat currencies and floating exchange rates are manipulated. There is no doubt that China manipulates its currency. There is no doubt that the US is manipulating its currency now by continually depreciating it. But is China waging war? I don’t think so. This is a question that President Obama has to answer in the next few days at the G20 meeting because he has to declare that China is or is not a currency manipulator. So it’s a very delicate political question. But basically, I do not think China is waging war against us in the sense of the currency system.
Americans have become addicted to Chinese goods, and that’s a tough addiction to kick. China is also addicted to exports. I think the war they are waging is a war to sustain their economy, not necessarily to impinge on or damage ours. We do have to remember that they hold several hundred billion Dollars worth of our debt and that tally is growing. So presently we need them and they need us. I don’t know how this problem will be resolved. It’s interesting; however, if you look at moves in the Chinese currency, you’ll see that in the last couple of weeks they have allowed the Yuan to begin to appreciate. Of course, it’s not nearly enough to suit Washington, but it means they are listening to us. No, they are not waging a currency war on the US economy. They simply realize that if they allow the Yuan to appreciate to a large degree, it will have dramatic negative impact on the Chinese economy and they’re not going to let that happen.
TGR: How undervalued do you believe the Yuan is?
Michael Berry: Relative to the Dollar right now it’s probably 30% to 40% undervalued. So it’s significantly undervalued. I read recently in The Economist where a Big Mac in Beijing is 40% cheaper in Dollars than a Big Mac here in New York.
TGR: Do you see anything coming out of the G20 meeting [Editor’s note: the G20 meeting took place a few days after this interview] in November, specifically regarding the Chinese and their currency?
Michael Berry: No, I really don’t. When it was the G5 that ran the world, we had the Plaza Accord in 1985 and the Louvre Accord in 1987. Then the world allowed the US to depreciate its currency and get out of a similar but much smaller bind. That was because the US at the time was the strongest of the five or six strongest countries in the world. Now we have 20 countries, both developed and emerging, trying to agree. They all want either import controls, in the case of the emerging countries, or to have the US Dollar depreciate because it is the reserve currency of the world.
So I don’t see how there could be any serious agreement at the G20 meeting later this month. What eventually will happen, I think, is that a completely different currency regime will materialize out of the G20. I don’t know whether that will be backed by a commodity basket or gold. Ultimately, this new currency regime will be much less dependent on the Dollar. The best thing that could happen to our Dollar would be that it loses its reserve currency status, and I think it must happen within the next decade.
TGR: I believe six to nine months ago you had an 18- to 24-month target for gold hitting $1500. Is that still your target?
Michael Berry: Yes. I guess I haven’t really revised my targets. We got there a lot faster than I thought we would with gold trading at roughly $1338 and silver trading in the $23 to $24 range. I think this is very characteristic of a world concerned with fiat currencies, devaluations and depreciations, and once again it properly identifies gold and silver as real money capable of storing value and assets in which Americans ultimately place their confidence. But I’m not suggesting that they will be used as a currency backing. It’s interesting to learn that J.P.Morgan and other banks in New York City are actually rebuilding old vaults to store gold and Silver Bullion because demand for physical metal is so strong. Yes, I could see $2,000 to $2,500 gold, and I could see $30 or $35 silver.
TGR: What’s your longer-term upside to gold? Also, what about silver, platinum and uranium?
Michael Berry: I don’t do point estimates very well, but it’s possible you could see $3,000 gold in the next five years. I think that’s very possible. I also believe it’s possible that you could see $50 to $75 silver in the next five years. Having said that, I hearken back to October 2002 when we had $5 silver and we were hoping it would rise to $6. Nobody dreamt it could be $24. Similarly with gold when it was trading below $400 in 2004, nobody dreamt that it would be $1300 or $1400. People thought "gold bugs" were fools. No longer. Platinum and palladium are both also industrial in character, and the emerging world is rebuilding. So I think there’s upside in both of these metals and of course they’re significantly higher. Uranium is going to increase because even though the United States is not building out its nuclear industry quickly, the rest of the world is. So I think we could see $70 or $80 uranium in the next two years quite easily.
TGR: What is "Discovery Investing"? Is it small stocks? Is it a company philosophy?
Michael Berry: Well, let me explain a little bit of the history behind its development. I was a mutual fund manager for Heartland Advisors in the 1990s. As a value investor, I bought stocks that were out of favor, those with low P/E multiples. What I found out was that whether you’re investing in growth or value, small or large cap, these disciplines all experience times when they excel in performance and times when they underperform. So, I decided that I would build a fundamentally different investing philosophy that would focus specifically on discovery and would not go out of favor nearly as often as value investing. I carefully designed this strategy over the last decade.
The central thesis is that all great wealth is created through significant discovery. This discovery can be in natural resource exploration and development, it can be in food stocks, or it could be in a cancer cure, for example. If you have one great discovery, and if you have accumulated a diversified portfolio of these discovery opportunities, you’re going to do very well over time. In fact, we have done well. We’ve had some great successes, and we’ve also had some failures in the Discovery Investing world. But there is much less downside than upside and it’s caught on with a lot of people. Overall we’ve done very, very well at wealth creation. Finally Discovery Investing is, in effect, a socially responsible investing strategy strictly from the perspective that discoveries in health care or natural resources improve the quality of life for our citizens.
TGR: Tell us more about how it works.
Michael Berry: I divided DI companies into three different categories. First, companies who have not yet made a discovery but are in the process of exploration. I call these "Incubator Stocks". I love them. They sell for pennies. They’re looking for new gold mines and uranium mines, or a cure for ALS or a new technology. I don’t recommend more than a 5% to 10% allocation to the portfolio, but these stocks often add significant performance.
Incubator companies are small and illiquid, and they are very risky. You don’t invest unless you’re willing to wait a long time and possibly lose your investment, but some of them will graduate into what I call Mature discovery stocks once they have made a discovery.
So the other two categories are Mature discovery stocks and Legacy stocks. People should understand that discoveries happen across the spectrum. For example Boeing used discovery technology to produce the 787. Apple discovered the iPod and the iPhone and created tremendous wealth. They are what I call Legacy stocks because they aren’t as risky, and you can hold them for a long time. They’ve got a lot of resources and reserves. In any of the three areas, you have a different risk/reward ratio.
TGR: This is something of a philosophical question. Would you differentiate the terms ‘clean energy’ and ‘green energy?’
Michael Berry: Well, yes. I have to tell you honestly I don’t believe in green energy because if you’re building windmills, each windmill needs tons of copper. So for wind energy you’ve got to mine the copper. Same sort of thing for solar energy. So I’ve always had a little bit of a problem with the word "green." But certainly there’s no doubt that electricity produced from passive systems like windmills and solar panels is cleaner than electricity produced from coal, which gives off all kinds of contaminants, including radioactive contaminants. I would classify nuclear energy as clean in the sense that there are no carbon dioxide emissions. Essentially, there are no contaminants resulting from nuclear energy production. It is true, however, that we must find a cure for our addiction to fossil fuels, but that I am afraid is a few decades away.
TGR: Mike, I have really appreciated the time that you have given us.