FM: Giving the current market environment in March 2010, is gold, at about $1,100 per oz., cheap, expensive or about where it should be?
McGhee: We are fairly valued right now. We’ve got the context that gold is holding up tremendously well against the onslaught of a rising dollar and breaking euro. The one downside element to gold would be a knee-jerk reaction if the euro does not hold the lows that were put in place recently, but makes a run into the 120s. Then gold would have an initial sell-off as it is valued in dollars and then turn around.
You have had gold appreciate against all asset classes and all currencies value classes, so on that level it is not only doing what it is supposed to, which is to be a storehouse of value but it is in fact gaining value. The value of gold can go up by simply not going down in the face of everything else.
FM: Are there better inflation plays than gold right now?
McGhee: When you go back to the 1970s when gold made its initial spectacular run from $250 to $800, there were very few alternatives to investing in gold. You couldn’t invest in crude oil. At that time, many currencies had exchange controls on them and money could not freely move, so investing in foreign currency was limited. We have such a different marketplace not that I think the metals have to hold their own and to a large extent they have. I can’t think of another vehicle that allows investors of all sizes to acquire a position that is appropriate to their size of investing. They can buy an ounce of gold or 10,000 oz of gold. It is the multitude of ways to buy gold that makes it attractive at this point in time. It is much easier to own a metal now than it was before. And the metal markets, especially the futures markets having gone electronic, are much more efficient than they were before. Back in the 1970s bid/ask spreads were $10-$15 wide and we would go through daily trading ranges of $50 to $75.
FM: You have been involved in gold for 30 years. How is the recent surge in gold different from that of the late 1970s and early 1980s?
McGhee: The biggest [difference] is the efficiency and the variability in how you can invest in gold. If you go back to the 1970s—keep in mind that prior to 1975, unless you owned pre 1933 gold coins, you couldn’t own gold legally in the country. Forget the concept that there is a futures contract, you simply couldn’t own it. So in the ‘70s, you had the advent of either being able to trade futures (there were no options) you could trade mining stocks, you could trade physical bullion in the form of coins or bars and that was it. Each one of those has its own unique component and each one of them, especially in terms of futures and stocks, were all done in voice open outcry markets and the dealing physical bullion was either done through an exchange delivery or was done over-the-counter in many cases in a coin shop or at a bank. If you fast forward 35 years with the advent of electronic markets you can now trade futures, futures options, exchange traded funds, mining stocks, physical metals all of it electronically, all of it online, all in a fraction of a second, and have absolute certainty your transaction is done and confirmed. In the ‘70s there were days that you would not find out an execution price for hours if not days and that was just [part] of the market so the efficiencies that have come to the marketplace, as well as the explosion of products, and variations of products has made investing and capturing the benefits of gold much easier for a broader number of investors. What that has done is put an underpinning into a long-term bull market. You go back to the GLD, when it goes into the GLD, it generally doesn’t come out. People put it in their IRA, they might buy two or three ounces but you might have 40 million people who now own gold as opposed to 200,000. That is the sort of sea change you have had in the market between the ‘70s and now. That is also why we have ultimately come to a much higher level, even though there are alternatives to gold that can do many of the same things that it does. You cannot discount that since 2002, gold has reflected exactly what it should do. It has shown the change of the dollar, it has reflected a change in attitudes that the investing public has and it has shown the element of fear that is in this market place towards the overall [notion of the piling on of additional spending has to impact the value of the currencies]. If you look at gold as a currency, then what is occurring here is that it is by far the best performer, and that most paper currency is in question and which is least bad. Even the funds that moved in to the dollar has only been a reflection that the dollar is going to hold better than other currencies, but is not going to hold up in and of itself.
FM: Fundamentally how is it different?
McGhee: The fundamentals at that point were an unprecedented inflation shock that took crude oil from $4 to $40, which occurred over a short period of time on the back of food price inflation and wage inflation. We were reflecting those changes. We had a major crop failure in 1972-3 right at the time that the Russians came in and did major international purchases. The inflation picture got so screwed up that you had wage and price controls. The futures contracts were bumping up against imposed limits above which they could not go. Anybody who has ever traded a limit market knows that whenever you have an artificial limit put in place it tends to increase the likelihood of the market continuing to move in that direction. The wage price controls exacerbated the type of food price inflation and monetary inflation you got as a result of oil and crop failures. If you look at the incredible moves you had in the ‘70s and then the ‘80s, ultimately became the period of the equity and not the period of commodities as the main movers that came through were all equity based. You had a couple of major spikes late 70s early 90s and now you come into a decade of commodities as opposed to equities. The fundamentals are somewhat similar but with their own unique differences. We fought an eight-year war that has not been on the balance sheet. You’ve got the financial meltdown that has required a quantitative easing point that initially had to deal with a deflationary cycle. From there, once we start reflating, the question is can the Fed withdraw these funds quickly enough without putting us in a double dip recession? Personally I am in the double dip camp. I think that is very likely no matter the extent of the rally so far. It is a jobless recovery at this point and there is going to be real problems if that can’t get cured.
FM: It is assumed that gold and the U.S. dollar are negatively correlated, which is true most of the time but not all of the time. Talk a little bit about the relationship between gold and the dollar?
McGhee: From a purely mathematical standpoint, the negative correlation is a logical condition. Gold priced in dollars would move to the opposite level of the dollar. However, the most explosive price points have come through when there has been a disconnect between the gold and the dollar. That has occurred three or four times over this move and has always put us in a situation where we’ve seen major rallies in gold when that has occurred because at that point in time you have gold rallying or breaking against all currencies. You have had that again the last six months to a year. That could set up — even if we get a break to the $800-$900 level, which I am not anticipating — a divergence between gold , the dollar and all the major currencies, signaling another major up leg.