Excerpt from the Report to Shareholders for the year ended December 31, 2008 dated April 16, 2008
The Gold Market
Over the past several months, events have unfolded much as we had predicted. The impact of years of lax and excessive lending in the U.S.
residential real estate market finally started to come to light in the form of accelerating delinquencies and foreclosures. All it
took to expose the weakness of the financial system was a U.S. housing market that was no longer rising. Large areas of the credit
market dried up, spreads widened and banks began to take enormous writedowns. A credit crunch commenced and spread around the world.
The policy response of the central banks was immediate and profound. The U.S. Federal Reserve, the Bank of England and the European
Central Bank, among others, embarked upon programs of radical intervention, providing immense amounts of liquidity to the financial system.
In the case of the Federal Reserve, illiquid and possibly worthless mortgage-backed securities have been accepted as collateral and lending
facilities have been opened for investment banks for the first time since the Great Depression. Bear Stearns was rescued from insolvency by
a forced marriage to JP Morgan, which was financed by the Federal Reserve. The gold price sprinted through $1,000...and then fell back as
the market concluded that central bank policies had prevented a financial meltdown.
Where are we now? Is the worst over? Many commentators and analysts tell us that the housing market has bottomed (again), that
credit markets have stabilized and are on the mend, and that the recession that hardly anyone acknowledged a few weeks ago is now
almost over, having proven to be both shallow and short. Stock markets have rallied on this view while gold has fallen into a trading
range 10% below its highs.
In our view, the worst is not over. The bottom is not in. Let's step back and remember how we got here. We are witnessing the
conclusion of the greatest credit bubble in history. An unusually long period without a serious recession, accommodative central
bank policies and financial innovation supported by bizarre credit rating practices enabled a proliferation and accumulation of
debt that has warped every aspect of our economic and financial behaviour. Unwinding these excesses will do more than damage
bank balance sheets and displace marginal homeowners.
The economic boom of the last 25 years has really been a credit boom fueled by, and symbiotically fueling, asset inflation.
Yes, there has been real growth led by technological advances and the integration of the Third World into the global economic system.
But these real developments have provided the cover for an even more consequential use of excess credit to speculate in financial
assets, with ever larger amounts of leverage to enhance returns (the Wall Street strategy). Households have also participated in
the asset inflation by speculating in housing and borrowing against their homes to overconsume. Households have depleted their cash
balances, increased their liabilities and dropped their savings rate to zero during a period of declining real incomes (the Main
Street strategy).
The Wall Street and Main Street strategies have two factors in common an enormous increase in leverage and a deployment
of credit into non-productive activities. Only a small percentage of the excess credit has been invested in businesses that
generate the cash flow to service the debt. Both strategies require rising asset prices, low interest rates and lax lending
standards to continue.
And continue they must. In our view, the current situation is a giant Ponzi scheme, in which evermore credit is required to
repay the existing debt and interest. The underlying economy cannot support the load, even if we do not have a serious recession.
U.S. debt in all forms rose $7.86 trillion in the eight quarters ending in December 2007, bringing the total to $48.8 trillion.
Nominal GDP rose $1.38 trillion over the same period to $14.1 trillion. The U.S. is adding $5.70 of new debt for every dollar of
nominal GDP growth. This ratio has been accelerating over the past 25 years...and must continue to do so if the U.S. is to avoid
a debt collapse of immense proportions. We refer here to the U.S. situation because of its central importance to the global
economy and financial system, but similar problems exist throughout the developed world.
In our view, central banks are willing to go to any lengths to prevent de-leveraging and a consequent debt deflation. They understand
the need to re-inflate the credit bubble and the outlines of their response are already evident. Even more interesting was the
decision by the SEC in late March to suspend SFAS 157. This accounting rule was brought in after many years of immense efforts to
require financial institutions to mark to market their assets on an ongoing basis. This rule was in effect for less than a year.
Regulators have basically told the banks to stop writing down illiquid and non-performing assets until they have rebuilt their
balance sheets and income statements. Nothing could make the severity of the current situation any clearer.
But if the central banks of the world are focused on preventing a de-leveraging of the financial system, democratically
elected governments are focused on preventing a de-leveraging of the consumer. And here the problems are even larger and
more difficult to resolve.
The housing crisis has not bottomed. At the end of March 2008, an estimated 8.8 million American homeowners had mortgages
greater than the value of their properties. More than three million homeowners were behind in their payments while one million
were in the process leading to foreclosure. These staggering totals are at the leading edge of a wave of resets of the two-year
teaser rates that became immensely popular in 2006. These teaser rates were never intended to reset - the assumption was that
house prices would continue higher and easy credit would also continue, enabling borrowers to refinance before the resets. But
home prices are falling, the mortgage market has frozen up and the resets are about to release a surge of defaults. A recession
will only make the problem worse.
In our view, the stage is set for a massive program by governments to forestall a consumer debt crisis and resulting
severe recession. Over the next year, we predict a major effort to bail out Main Street (it is an election year in the
U.S.), which will transfer the credit-creation process from Wall Street and the private sector to the public sector. The
recent removal of capital and lending limits for the Government Sponsored Enterprises (Fannie Mae and Freddie Mac) point
the way. The consequences for our free market economy are frightening to contemplate. After all, there is no problem that
government cannot make worse.
We foresee a period of rising public credit creation and public debt, rising inflation and inflation expectations, widening
interest rate and credit spreads, slower growth, lower earnings and lower price-earnings ratios – a period where gold outperforms
other asset classes. In this environment, gold will also outperform commodities such as oil and steel, which have driven up
capital and operating costs for gold miners and reduced their profit margins despite the higher gold price. Gold equities should
then once again provide leverage to the gold price, with Seabridge well positioned due to its industry-leading gold ownership
per common share.
Excerpt from the Report to Shareholders for the quarter ended September 30, 2007 dated November 9, 2007
The Gold Market
Re-reading the gold market report from our June 30, 2007 report, even we are surprised by the prescience of our comments.
As discussed last quarter, we have been in a gigantic credit bubble which has inflated bubbles in equities, bonds and real estate. Speculation drove these markets higher, fueled by inflation in the credit supply which was in turn driven by a staggering growth in structured financial products. These products have no real market but, in a momentous feat of financial engineering, they were accorded high standing by credit reporting agencies and granted default insurance by undercapitalized insurers and special purpose entities.
Now, the credit bubble is unwinding thanks to an unfolding collapse in the U.S. real estate market. Leverage is being reduced. Margin calls are being issued. Credit ratings are being slashed. Structured financial products are being forced into illiquid markets. Fictional valuations based on mark-to-model and the even more spurious Level 3 accounting rule are becoming massive write-downs by some of the world’s largest financial institutions. There is more to come. And as predicted, central banks have responded with credit infusions which undermine the value of their fiat currencies. Gold has responded exactly as we had expected, rising against all of the world’s major currencies.
What is next? In our view, the credit-crunch-imposed deleveraging will continue as will attempts by central banks to grow money and credit supplies to offset it. The next step will be an awakening of inflation expectations and greater concern for the stability of all fiat currencies. The U.S. bond market, which has so far shrugged off obvious commodity price inflation in favor of the ridiculously low core inflation rates posted by the federal government, will begin to falter. Further credit contraction and economic recession are likely to follow. In our view, gold will then definitively outperform other asset classes including commodities such as oil.
To date, the costs of building and operating gold mines have outpaced the gold price. This relative underperformance by gold may now be coming to an end and gold projects capable of sustaining mines such as those owned by Seabridge could grow substantially in value in the months ahead.
Excerpt from the Report to Shareholders for the quarter ended June 30, 2007 dated August 7, 2007
The Gold Market
The past several weeks, we have been treated to some of the most extraordinary developments we have seen in financial markets in many years. Gold has not yet expressed its response but, in our opinion, the stage has now been set for reinstatement of gold as a preferred investment in the months ahead.
Let’s return to first principles. Gold is an alternative to the three main asset classes of equities, bonds and real estate. When confidence is high in these three, gold fares poorly by comparison. When confidence in these three declines, gold shines.
Equities, bonds and real estate have performed well over the past 25 years, a crash in tech stocks notwithstanding. It is our contention that bubbles have developed in all three driven by the biggest bubble of all, in credit. Never have so many owed so much. An excess has developed in credit markets world wide for a number of mutually reinforcing reasons: cheap credit in plentiful supply; lending standards which have declined to the point of absurdity in some markets; too many years without a recession, lulling lenders and borrowers into complacency; financial innovation packaging and securitizing credit, removing the last vestiges of prudence and control while also eliminating market pricing and substituting mark-to-model valuations; financial rating agencies applying to these structured credits (often comprised of subprime no-doc mortgages and car loans) the AAA rating previously reserved for seven of America’s largest corporations; credit default swaps and other forms of quasi-insurance issued by unknown counterparties or undercapitalized insurers. All of this has enabled a massive increase in leverage.
It is this infrastructure which has enabled the simultaneous levitation of equities, bonds and real estate in the early 21st century, with the further assistance of the yen and Swiss franc carry trade in which loans made in these weak, low interest rate currencies have been used to fund speculation in the securities of strong currencies.
Real estate has been the first to fall. All it took was a slowdown in price inflation to cause the late-to-the-party, marginal borrower to default in record numbers. No leverage, no problem. But the leverage is immense, in hedge funds, brokerages and banks. Structured credit products designed for a mark-to-model world have had to be sold into illiquid markets to meet margin calls. At Bear, Stearns, several billion dollars disappeared overnight.
The naïve among us might suppose that the problem is the subprime mortgage default rate. In our view, it is not. The problem is system wide leverage at historic levels. This is how exponential growth in the credit markets has been maintained. This is how equities, bonds and real estate have developed into bubbles.
All eyes are now on the credit markets. After reaching historic lows in recent months, credit spreads have begun to widen. Liquidity appears to be on the decline. We have little doubt that central banks will come to the rescue with the one weapon at their disposal, additional liquidity, and we are confident that order will ultimately be restored. The consequences, we believe, will weaken public confidence in fiat currencies as a store of value. Savers and savings will be sacrificed to bail out debtors. And gold will move to center stage, a currency without a central bank, a store of value which cannot be printed or duplicated electronically, and an increasingly attractive alternative to equities, bonds and real estate.
It is not with pleasure that we survey the current uncertainty. However, we at Seabridge take some satisfaction from accomplishing our task of providing exceptional and growing leverage to the gold price for our shareholders and, we hope, helping them preserve precious capital in volatile times.
Excerpt from the Report to Shareholders for the year ended December 31, 2006 dated May 2nd, 2007
The Gold Market
As we write this, the mood is somewhat sour in the gold market. Gold has failed to reach the highs of last May, never mind the 1980 record high. Recently, other investment classes which are normally countercyclical to gold such as equities and industrial metals have performed better than gold although the gold price remains in an up-trend against the U.S. dollar. In general, gold shares have underperformed gold itself for more than the last three years, with notable exceptions such as Seabridge.
What is the long term outlook for gold? In our view, answering this question requires that we understand the nature of the current environment. Virtually all asset classes are rising simultaneously throughout the world. This unprecedented, synchronized bull market in just about everything except the U.S. dollar and residential real estate is characterized by a total disregard for risk. Risk premiums, the additional return investors demand for taking additional risk, are at record lows. Emerging market equities and debt are outperforming more senior markets. The spread between junk debt and highly rated senior corporate issues has never been lower.
The explanation for the current environment, in our view, is that we are now in the midst of the first global speculative credit boom. The broadly defined money supply in most industrialized countries is growing at 10% to 15% annually, 20% and more in key Asian markets and 50% in Russia, This is not money supply in the traditional sense, not money saved or held within the banking system, but rather purchasing power created by credit markets from the leveraging of inflating assets. It’s a rising tide of liquidity which is not derived from operating cash flow and is not invested in the real economy but rather in financial instruments unconnected to productive, wealth-creating capital goods.
Consider M2 (a measure of cash and near cash resources) as a percentage of the total market value of equities. In the U.S., 20 years ago, M2 was more than 120% of total equity values. Now, the ratio is about 36%, a testament to the increase in credit financing of financial assets (see contraryinvestor.com, April 10, 2007).
Our economic system has become immensely dependent upon this liquidity – low cost credit in abundance for asset purchases by investors and lifestyle enhancements by consumers. In the 1960s, a dollar of additional real debt (after applying the GDP deflator) generated $0.64 in real GDP in the U.S. economy. Now, a dollar of real debt buys only $0.15 of real growth. Why? Because debt is increasingly incurred for non productive consumer purchases and investments in real estate and financial assets. Corporations have discovered this, not only financial companies (where proprietary trading outperforms traditional business lines) but also operating companies which have acquired financial or investment subsidiaries. Economists are perplexed by the fact that corporate profits are at record percentages of GDP and continue to rise. The reason is that speculative profits are not capacity or supply constrained and accordingly account for a rapidly rising percentage of all profits.
The rising tide of liquidity explains the lower credit spreads and the yield curve inversion. There is unlimited purchasing power available to buy bonds and press down interest rates at the long end of the curve. Japan’s all but zero interest rate policy (now 0.5%) provides cheap funding for asset purchases as do Japan’s prolific savers who search abroad for higher yields. Meanwhile, the U.S. is running an $800 billion current account deficit – dollars are created out of thin air and recycled into financial markets to fuel the credit boom.
In our lifetime, we have seen a growing and innovative financial system reshape our economy. We have gone from Commercial Capitalism, where entrepreneurs borrowed capital from commercial bankers to build businesses, to Money Manager Capitalism, where managers court investment funds and analysts to drive their stock prices, to Financial Arbitrage Capitalism, where Wall Street sponsored hedge funds and private equity pools multiply leverage to complete buy-outs at the top of the market, redirecting immense amounts of credit into non productive transactions. The equity bubble of 1999-2000 became the housing/mortgage bubble of 2005-2006 and has now morphed into the private equity bubble of 2006-2007. Each of these is itself just a manifestation of an underlying credit bubble (see Doug Noland, Credit Bubble Bulletin, April 13, 2007, prudentbear.com).
Every step of the way in this transformation of an operating economy to a financial economy, traditional standards of lending and investing have been progressively abandoned. What passed for investment analysis in the dotcom mania has been mirrored in the ridiculous laxity of “non-doc” Alt-A option arm mortgages and the six page bridge loan documents for LBOs totaling billions of dollars. Speculation rules the day and easy credit makes it possible.
What does all this mean for gold? In our view, as long as the credit bubble is expanding, gold will underperform most other asset classes. In fact, it is remarkable that gold has performed as well as it has over the past three years. Historically gold has done best in periods of contracting liquidity and slower growth, when investor confidence is weak and faith in financial markets and currencies is waning, when inflation expectations cause yield spreads to widen and economic weakness increases credit spreads, and when risk aversion outweighs the desire to speculate.
In our view, gold has performed as well as it has because it is under accumulation by smart, long-term money anticipating an end to the credit boom. The investing public at large is not yet involved in gold.
At Seabridge, we believe that the global liquidity boom will exhaust itself and a contraction will set in. Central Banks worldwide will try to forestall a slowdown by attempting to maintain system liquidity at any cost because they know that we are in the midst of a credit boom, not a real economic boom. Yield and credit spreads will widen as inflation expectations and perceived risk begin to mount. In these circumstances, gold will outperform all other asset classes and currencies including industrial commodities. With input costs such as oil and steel falling relative to the gold price, gold equities will outperform gold as operating margins improve. That is what we see ahead, but we cannot know when.
In the meantime, we have much to do at Seabridge as this report identifies. As long as the gold price remains in the current neighborhood, all of our major projects have the potential to be economic and enhancing them will enhance our share value. This year, we expect to add more resource ounces, improve the quality of those we already have, and further define the economics of our best projects.
We will also continue to avoid or minimize many of the risks inherent in the gold business. We will not involve ourselves in projects outside North America, a strategy now amply validated by the difficulties experienced by other companies operating in South America, Africa and Asia.
We will not issue shares to augment our cash position just because the money is available. Dilution is a critical risk for the shareholder of smaller gold companies searching for deposits or trying to put them into production. We guard against this risk by adhering strictly to our primary objective of increasing gold ownership per fully diluted share.
We will never attempt to build or operate a gold mine. The risks involved are immense, suitable only for large, well-diversified companies with strong balance sheets and deep technical teams. From permitting and environmental risks to financing, technical and market risks, the likelihood of failing to meet expectations is very high.
At Seabridge we are clear that our task is to provide you, our shareholder, with maximum exposure to gold and reduced exposure to the risks of the gold mining business. Compared to a gold ETF, we provide the leverage of finding or acquiring additional ounces and the leverage inherent in defining and improving the economic parameters of our projects. This approach has produced disproportionate gains for our shareholders to date. We remain confident that this record of success will continue.
I would like to express my personal thanks, and that of other directors, to Henry Fenig, who joined our board in 2002 as a representative of Albert Friedberg, our largest shareholder. Henry has decided to step down as a director in order to dedicate more of his time to his other obligations. We will miss his experience, his wisdom and his sense of humour at Board meetings but expect to have his continuing advice as a senior officer of the Friedberg Mercantile Group.
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