James Passin on the Feedback Loop

The Gold Report submits:

Today’s extraordinary loose monetary conditions are “benefiting hard assets,” according to James Passin, co-founder and manager of Firebird Global Fund and Firebird Global Fund II. Surplus liquidity is flowing into ETFs that buy commodity futures and physical commodities, which James says, is “creating a feedback loop” that is driving up the price of resources. James discusses gold’s momentum, as well as its associated near-term risks and shares some hot companies and sectors he’s following right now in this exclusive interview with The Gold Report.

The Gold Report: James, last December, you commented on the low interest rates that the government had on bonds. You said you thought that would spur inflation and an increase in commodity prices. Now that we’re in the last quarter of ’09, how do you feel about your predictions and what do you see going forward into 2010?

James Passin: It was clear to me at the end of 2008 that we were at the beginning of a powerful and lasting recovery in commodity prices and resource stocks. I think that the structural fundamentals are in place to support further increases generally in commodity prices.

TGR: This year we saw, basically, all positions and all sectors increase. What would cause just an increase in the commodity pricing going forward vs. all the other sectors?

JP: We have had a rally in all assets, but hard assets also are benefiting in particular from extraordinary loose monetary conditions. Surplus liquidity is flowing into commodity products like exchange-traded funds (ETFs) that are buying commodity futures and physical commodities, creating a feedback loop, which is driving up the price of resources. But what we thought is that this would be a great year for resource stocks based on our view that capital markets would start to reopen. Resource companies tend to be capital-hungry. So as the cost of capital comes down and as capital becomes available, resource stocks tend to outperform resource prices. At the same time, last year there was a dramatic reduction in issuance of stock by resource companies. This has resulted in a highly bullish environment for resource stocks. But we are concerned about the recent changes in the nature of market sentiment.

TGR: You say you note a changing tone, generally. What’s changing?

JP: It’s interesting to ask how long these extraordinary loose monetary conditions will continue to exist. At what point will the Fed take the view that the financial system and the economy can withstand tighter monetary conditions? Perhaps it seems unlikely with unemployment at 10%. It also clearly in everyone’s interest to allow asset bubbles to develop to enable banks to rebuild their equity through generating profits. But any significant tightening of monetary conditions could undermine the commodity markets in the short-term. There is also a dangerous structural element to the market represented by the ETFs.

The ETF prices increase when the gold price increases and as demand for ETFs increase, then the ETFs actually go out and buy more gold. This is creating a feedback loop. The obvious concern is what happens when it goes the other way, if the gold price actually started to weaken and the ETFs start to sell, creating a negative feedback loop. When I referred to the different tone, I was really referring to the increased level of confidence that I’m observing among gold bugs and to the wave of financings that’s coming out of the gold space. A lot of marginal gold companies are getting financed. Gold has shifted into a momentum phase that is generally characteristic of a topping process.

TGR: I think the most interesting thing that’s happened in the past week is the government of India buying 200 tons of gold from the IMF. People are saying, is China next? So when governments start buying that volume of gold, is there really an issue of gold being vulnerable?

JP: Looking at the history of Central Bank gold trading habits generally would suggest Central Banks are horrible gold traders. Central Banks were happy to sell gold under $300. The fact that that Central Banker mentality is shifting is arguably a sign of capitulation. There is other evidence of capitulation. For example, Barrick Gold Corp. (NYSE:ABX), the pioneer and big proponent of gold hedging, bought back a significant portion of its outstanding hedge book at a massive loss. Whatever happens to gold in the short term, the gold price will tend to rise over time as long as we have the fiat world currency system.

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