Why Don Coxe Expects Gold To Soar On Good Economic News

The standard wisdom on gold is that it does well in times of economic bad news such as in the 1970s, a period of stagflation and recessions, when the yellow metal rose from $35/oz to peak at $850/oz in 1980. But this time, Don Coxe, a portfolio adviser to the BMO Asset Management, believes things are different. In this interview with The Gold Report, Coxe explains why gold will rise when the economy improves.

The Gold Report: Are the days of easy money drawing to a close?

Don Coxe: I don't think so. Even if the Federal Reserve begins to taper quantitative easing, the front of the curve is going to stay at zero interest rates. A trillion dollars is going through the Fed's balance sheet, which works its way through the system. As long as the Fed keeps interest rates at zero, it's easy money.

TGR: Will overt monetary inflation return any time soon?

DC: It will return when we have sustained economic growth. The Eurozone has been the big drag. It is definitely stronger than it was a year ago. The Eurozone has lots of problems, but it is experiencing economic growth despite the European Central Bank reducing its balance sheet in the last 12 months by almost exactly the same percentage amount that the Fed increased its balance sheet. This says that it has lots of firepower if it needs it. In addition, the Eurozone government deficits are lower than ours in terms of percentage of GDP. The Eurozone actually, despite all its highly publicized problems, has improved its financial shape relative to ours.

Also, in the last 12 months, Japan, the world's third biggest economy, has gone from negative growth to strongly positive growth. It is doing that by printing yen at a prodigious rate. The days of easy money are going strong.

TGR: If inflation returns, will it first appear in goods or services?

DC: In goods. If I had to pick the one point at which we'll start to see the change, it's when the razor-thin inventory-to-sales ratio comes under strain. Corporations are controlled by people who learned in business school over the last 20 years that the first thing to manage is inventories. This way they don't have to worry about prices going up and don't use corporate cash to finance an inventory that may decline in value. Therefore, when things change, it will show up in the pressure that comes because companies have so little inventory on hand. Corporations will decide that they've got to invest in more inventory because they've got more demand.

TGR: Do you think that will shake loose the vast amount of capital that's being retained by the multinationals?

DC: It will shake loose some of it, but the big thing is it will come because prices are starting to rise. The two reinforce each other.

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TGR: What do increases in monetary inflation and capital growth mean for gold?

DC: Gold rose along with the Fed balance sheet for years. The two have decoupled in the last two years. I believe the reason is people have just thrown in the towel that there will ever be inflation. If you're Waiting for Godot, at some point you can reach the conclusion that Godot may never come.

TGR: Should investors bet on gold's return to previous highs or something in that direction?

DC: I don't think we're going to see anything like the double-digit inflation that we saw back in the 1970s. The big difference was the tremendous power of unions then. They all had cost of living adjustments in their contracts; the Consumer Price Index (CPI) would rise in a quarter, then automatically wage rates would increase and the two fed off each other. The weakened power of unions today has meant that we don't have an automatic reinforcement right at the core of the system.

TGR: Let's talk about monopolies and competition and why does the focus of big investors shift from growth to income?

DC: I'm not convinced that we've got a lot of monopolies out there. OPEC is no longer able to control oil prices, for example, because its share is no longer large enough to give it freedom on pricing. I believe that oil fracking will gradually start spreading from the U.S. to other parts of the world. We don't have that monopoly, which was the big one back in the 1970s that made it possible for OPEC to quadruple the price of oil. A quadrupling of the price of oil here is impossible because the global economy would collapse with a doubling of oil prices.

TGR: Are companies borrowing money at cheap rates to increase dividends and buy back stock? And, if so, how does that affect the system?

DC: Yes, companies are basically removing from the system what I believe is the core of capitalism, that corporate cash is used to grow a business. Investors pay a high price-earnings ratio for companies because they believe the companies can reinvest that cash and sustain their growth. When we see that corporate cash is being used to buy back stock and pay dividends, the decision-making force in the system becomes stockholders redeploying cash. In the past it was the corporations themselves through their retained earnings and effective reinvestment that drove the system.

If money that people got in dividends was invested in shares of companies that were issuing new stock in order to grow their business, then the whole system would not be losing the money. When you have a system where corporate treasurers do not assume strong future growth and they assume that these zero interest rates are going to continue for a long time, the incentive to retain earnings and plan on capital expenditures (capex) goes away.

Capex is putting money out at great cost, where companies get no immediate returns from it, whether it's building a new building or opening up a whole area of the country. When you take that out of the system, the result is that you turn the system on its head. It used to be that the companies would, when they had the cash, decide how much was needed for capex; after that they figured out how much they would payout in dividends. The decision makers within the companies are no longer focused on creating overall economic growth through capex and expanding production.

TGR: Are we in a triple dip or a quadruple dip recession here?

DC: No, I think we're coming out of it, but we've come out of it at a gigantic cost. The Fed had to quadruple its balance sheet, which raises all sorts of problems. We have no precedent in history of this kind of expansion of the Fed's balance sheet.

The ratio of paper wealth to GDP is so high at a time when it's going to be difficult for corporations to expand because, as I said, they will need a large amount of capex to meet rising demand at a time when there's all that money out there. I would regard that as a virtual guarantee that at some point we're going to see inflation.

This time inflation won't come from rising wages. It will come from rising demand and the inability of corporations to swiftly respond to that demand. The technology industry can expand in a hurry because it keeps coming out with new products, but for most of the rest of the economy, it takes a while to build a plant and get the machinery ready and test it out before there actually is any production. That period of time, if you've got strong demand because there's so much paper money, is the moment at which you will see inflation coming.

TGR: How will that affect gold?

DC: It will deal with the problem of faith in gold. When gold tracked the growth in the monetary base, which it did so well, there was a general conviction based on Milton Friedman's theories that expanding the monetary base too fast eventually translates into inflation. Inflation is harder to stop than it is to just watch start growing.

We will see that interest rates will have to rise because of another group that has not been heard from in a long time, bond vigilantes. They are threatened with extinction. It will be a combination of rising interest rates and rising prices that will get people to say, ah-ha, Milton Friedman was right after all, if you print the money eventually you're going to have the inflation.

TGR: When you talk about bond vigilantes are you talking about junk bonds or what's known as private equity?

DC: The bond vigilantes work primarily on government bonds because they are the ones they can trade most effectively. Junk bonds are a small part of the market. With inflation the bond vigilantes sell off their 30- and 10-year bonds and move down to the 2-year note. At that point the cost of capital for expansion rises through the system because corporations can use short-term cash for some of their work, but they tend to use long-term borrowing from banks and the bond market for major projects. The cost of building those projects increases because of the steep yield curve.

TGR: Do you consider yourself to be a bear or a bull on gold?

DC: I am neutral in the short term. I'm not a bear. I'm a bull in the long term because I believe it's not a question of if but when all this money printing eventually comes to haunt us. Gold as an asset class is so tiny in relation to the vast expansion of money around the world. With the printing that's gone on, China has had to expand its renminbi supplies to prevent the currency from soaring relative to the dollar.

TGR: You are appearing at the upcoming disclaimer .

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Written By: The Gold Report