Michael Campbell: I’m looking at the overall US financial situation and I think you have to call me pretty darn bearish there, I am not innumerate so it’s pretty easy to add up the numbers. Obviously a lot of focus on the US election, but regardless of who wins isn’t this going to dominate their presidency? 

 

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Dr. Michael Berry: I think it matters little in the short run whether the Republicans gain the Senate and the Presidency or whether President Obama is re-elected. There really are really serious problems fiscally in the US right now and they are going to go through a process here of some kind of austerity in the near term whether its excess taxation or just pulling back on spending. Either one is going to be fairly austere and it won’t matter who wins in the short term, in the  longer-term it will matter because I think the Obama administration is much more social in nature than a potential Romney administration. 

 

Michael: We hear a lot about the so-called fiscal cliff which would have automatic cuts to spending and automatic changes to taxation especially on the investment front. I read a lot of convicting stories about whether thats serious in the way that they actually will find a way of overcoming it. What’s your view on that?

 

Dr. Berry:  I am pessimistic on them finding a way Michael. At this stage of the game we are within 65 days or so of these cuts and tax increases automatically going in. It’s very clear that Democrats want to tax the population and very clear the Republicans do not. I can’t see any way they’re going to come to an agreement so I think there’s at least a 50-50 chance that we will go over the fiscal cliff. If we do, I think it’ll have a tremendous impact on all the world capital markets. 

 

 

Michael: I’m wondering if it would entail a dramatic increase in capital gains and in dividend taxation. I’m wondering if investors wouldn’t want to sell those positions right now and see how it all works out. 

 

Dr. Berry:  I think thats exactly right, you’re right on there. Investors down here in the US are definitely now in a mood that as every day passes and every second ticks by that this isn’t going to be solved. So I’m seeing some weakness in stocks that shouldn’t be weak here. I’m seeing some selling, I’m seeing some deals that are being mandated to be done before the end of the year to avoid this problem of increased taxation. Certainly capital gains taxes will go up in any event but if they go up January 1st it will have a really serious impact on the Stock Market.  

 

Michael: The other big question I see as I start translating this environment we are in into stock investments, is this tug-of-war between inflationary forces and deflationary forces. I know that’s an oversimplification but could you give us some guidance where you think that’s at?

 

Dr. Berry: It’s probably the single most prominent event in the economy now in the US and probably around the world. I’ve been writing on it and you still see this deflation. You would not have seen the Fed come out with the very significant QE3 proposal of $40 billion a month, in the mortgage market primarily, if they were not scared to death of the deflationary situation. 

 

So where is it going to come out? Clearly as the Fed blows up its balance sheet by printing money here, which they are going to do now, you are going to see other countries do the same in a race to the bottom in currency. It’s currently already happening and we’ve seen a nice move up in gold and silver and even copper. Friday they came off quite a bit, but the Brazilian’s are printing, the American’s are printing, you are seeing it around the world right now so there is this strong tendency to inflate. So far they really haven’t done much asset inflation so I think that its still up in the air whether they’re able to do it.

 

But you wouldn’t have seen Bernanke go ahead and talk about such a massive QE3 program and put it into operation without a serious concern for deflation.

 

Michael: One of the other interesting aspects is there was so much focus right through the summer months about whether they would do a Quantitative Easing 3. Which is just another way of say the Central Banks would pump liquidity into the system by in quotes “printing more money”. We saw the talk, especially by the European Central Bank in late July, China did something, Japan’s done something, the US now is taking action. Is it one of those things that now that they’ve shot their bullets is there anything left in the gun. If it doesn’t take hold the way there hoping, what they do for an encore?

 

Dr. Berry: They are pushing a string, its the old Keynesian liquidity trap problem that I think they’re getting into now. Monetary policy will not solve structural or fiscal problems and so Congress and the US Government are going to have to act. 

 

I think there is a serious problem as the balance sheets of the Central Banks blow up. By the way we do know that Central Banks are buying gold, buying a lot of Gold now, more so than even last year.

 

As these balance sheets blow up and increase in size, once inflation starts to run and I’m talking about asset inflation in the real estate market,  they are going to have to drain so quickly to avoid very high rates of inflation. I think that’s what the capital markets or the commodity markets are betting on right now. I think we are seeing that in the commodity markets. 

 

Michael:  Can you give us a further comment on Gold?

 

Dr. Berry: We are buyers of Gold, but Gold Stocks have not followed Gold for whatever set of reasons in this marketplace. We are very bullish on Silver, we are very bullish on Gold. You should have at least 10% of your portfolio either in Bullion, Coins, or in Gold stocks if you’re in the Stock Market – as a hedge against the potential for very serious inflation. 

 

It is very clear that things are very expensive now, its clear that in some parts of the economy there is inflation. There are inflationary forces and Gold and Silver and some other commodities are stores of value, becoming more and more stores of value against this process. 

 

Michael: One of the areas that you were a pioneer in bringing to the publics attention through Discovery Capital and your Morning Notes are the Rare Earths. The Rare Earths have taken a bit of a beating in this downturn, can you give us an update?

 

Dr. Berry: I think that Rare Earths were a novelty. Just like graphite and lithium were novelty things because they’re all about electrification and the new technologies that are coming.

 

So you know we had hundreds of Rare Earth companies and we also have the Chinese who control that market which is a key issue. Now we’re seeing some companies in Québec (one HERE), there may be companies in both Canada and the US that have significant potential to supply these heavy Rare Earths and light Rare Earths. 

 

So I think its time now to do real due diligence. We are not going to get a move up in all of the Rare Earth companies now, we are going to get a move up selectively in those companies that are well managed, have heavy Rare Earths and are relatively closer to production. 

 

Michael: It’s going to be an interesting time. Last question, is there some event that you’re keeping more top of mind?

 

Dr. Berry: It’s very clear the election is over overwhelming everything down here now. 

 

This last unemployment report was not 7.8% as claimed. We are seeing a little bit of a lift in in in the marketplace because the people think that the employment rate is down.

 

Once the election is over then we are going to see whats left of the pie. A pie has $16 trillion of debt sitting on top of it and that has to be solved. So there is definitely going to be cuts in both entitlements and increases in taxes and I think that is going to have a pretty heavy effect on the economy here for the next several years.

 

Michael: Dr. Michael Berry who writes a terrific Morning Notes for Discovery Capital. I really appreciate you finding time for us today.