 Important Guidance for Gold Stock Investors
Kenneth J. Gerbino
Archives
Kenneth J.
Gerbino & Company
January 23, 2006
We are currently bullish on
gold but the market is volatile and now dangerous. It is dangerous
to be out and dangerous to be in. A strategy of survival and
common sense is needed to do well in the coming years. 2006
could see some minor and some major corrections in both the metal
and the stocks. These could be very painful emotionally and financially.
The good news is that the trend for many years should be up.
All commodities have moved
up globally in all currencies over the past year. The real world
factors that determine commodity prices in the woof and warp
of daily world economics, business, international commerce and
manufacturing, are indicating that things are simply more expensive
in the world. Almost everything is in more demand and the usual
basic material supply channels are having a hard time keeping
up with the hundreds of millions of new consumers newly created
from the developing countries.
What is a Reasonable Price for Gold
It is possible to arrive at
a true relative economic value of gold in the U.S. We analyzed,
years ago, wholesale price increases since 1789 and based on
those increases applied it to the gold price in 1789 and came
up with the value of gold in 1980 should have been $280. Gold
in 1789 was $20.22 an ounce. In 1933 gold was still $20.22 an
ounce. The wholesale price index was also the same in 1933 as
it was in 1789. It seems amazing that after 150 years prices
were the same. This was because we had a monetary system based
on hard money (gold and silver). From 1933 to 1980 wholesale
prices went up 14 times. Therefore the logic would be gold should
be up 14 times. ($20.22 x 14 = $283. I have rounded it off to
$280 to make life easier. In 1980 it reached $850, a very overvalued
level.
Using the consumer price index
to factor what gold should be valued at in 2005 we arrive at
the following formula. Since 1980 the consumer price index has
averaged a 3.8% increase per year. This rate of increase applied
to the "fair value" 1980 gold price of $280 over 25
years would suggest that in 2005, the relative economic
value of gold should currently be $733 an ounce. This
implies that gold today is undervalued as a basic consumer commodity.
With gold's additional appeal as a monetary substitute and financial
insurance asset, one can easily conceive of the price going considerably
higher than $733 in the medium term. If this indeed takes place
gold mining stocks will enjoy explosive gains.
The World Is Advancing
Despite world problems, economic
progress is everywhere as most of the old socialist systems are
being thrown out the window by large population countries such
as the FSU, Brazil, India and China. The demand for goods and
services is overwhelming the traditional supply/demand equations.
Natural resources will be one of the most important investment
sectors for many years to meet this demand. Remember even with
the gross mismanagement and meddling of economies by governments
the world is moving ahead.
There is no doubt that a new
and powerful commodity bull market is underway with some experts
I respect claiming this will be a generational bull market -
one that could last 10-20 years. Gold and precious metals like
all commodities will also be part of this mega trend. Owning
mining stocks that produce or will produce precious metals, copper,
zinc, lead, nickel and uranium in the coming years we believe
will provide well above average returns. Same for the oil companies.
The problem will be withstanding the volatility.
Don't Be a Sucker
You should avoid the risky
and over promoted exploration and junior mining sector dogs
that number in the thousands and will mostly be losers except
to insiders that sell when you buy. They own their stock for
1-2 cents. Selling to you for 30 cents is a homerun for them.
Many could care less if they ever find any gold or silver. Many
so called newsletter writers write these dogs up and you have
also received the 16 page mining promotional direct mail pieces
which promote some of these stocks. Some are almost fraudulent
and disgraceful.
If you want to speculate on
long shots, you should own companies with plenty of released
drill results and those that are developing deposits that are
1-2 years away from production. Owning a company developing a
huge mineral deposit that already has been discovered is 500
times as smart as trying to find the next big discovery. These
stocks move slowly but many of these developmental stocks still
have 5 or 10 to 1 possibilities...and there is zero exploration
risk. These are future growth stocks and continue to become
more valuable as time goes on.. It is insane to own any exploration
stock that you have paid more than 5 cents per share or has a
market cap of more than $5-10 million. If you do pay more than
5 cents, you are surely buying the stock from insiders that did
pay pennies and they are probably selling to you on the day some
press release is issued. Ever wonder why good news many times
does not make these stocks go up muchinsider selling. Any company
you buy outside of the "already discovered substantial deposit"
arena and you are playing a 1000 to 1 game...and you will most
likely lose.
Companies that have the goods
already in the ground can be analyzed and researched. Many have
lots of upside. Since they have the resources in the ground these
stocks are the ones that can protect you against the usual economic
problems of budget and trade deficit repercussions, a consumer
debt bubble that could burst, excessive money printing, the return
of inflation and a severe deflation (which is possible but highly
unlikely). Think of this. If the world goes up in smoke and gold
explodes upward the exploration stocks with zero gold in the
ground is the last investment in the world you will want to own...they
do not have any gold, therefore you have zero economic protection...
Deflation
Although I do not subscribe
to the "deflation" view, Stephen Roach, Morgan Stanley's
chief economist, stated at a private fund manager gathering in
Boston "America has no better than a 10 per cent chance
of avoiding economic Armageddon". Regardless of the accuracy
of the remarks, smart people in high places are concerned and
owning precious metal assets is certainly a prudent investment
choice in a debt heavy world in the event a deflationary collapse
did occur.
Gold and Copper
The gold/copper producers are
especially appealing because even with a very pronounced economic
slowdown in India and China, to lets say 2-3% growth, (which
has not happened yet) from the current 8-10% would still require
above normal demand for metals. Considering global copper inventories
are at decade lows and U.S. economic growth is still intact,
a solid base metal market should continue for some time.
The underlying fundamentals
for a sustained and multi-year bull market in the mining stocks
and especially precious metals are still intact. Record high
U.S. budget and trade deficits, low interest rates, currency
devaluation risks from all major exporting countries outside
of Asia, and continued budget shortfalls (which will have to
be met with the printing presses) in the major European countries
are all long-term bullish for precious metals.
Various U.S., Chinese and Indian
economic reports in the last quarter have generally shown above
average gains. These are major gold consumption countries and
solid economic gains by these nations will lead to higher gold
jewelry demand. Higher gold prices can lower jewelry demand,
but this decreased demand phenomena from higher prices only lasts
so long in the real world because sooner or later people usually
adjust their thinking to new price levels as fair value especially
if most other prices of goods and services are rising.
One of the key sea changes
in the economic world is that global GDP growth is increasing
faster in the developing countries than the industrialized countries.
Led by Asia and India, these countries are becoming more and
more economically self sufficient within their own borders. Developing
countries need basic materials and mining is a key industry to
supply these materials. Mining will benefit significantly from
this new global economic model as these developing countries
create enough economic activity within their borders to demand
more and more raw materials. Also since they have established
extensive manufacturing and export industries to the U.S. and
Europe, even more of a demand for raw materials is required.
Why Developing Mining Companies
As of this writing gold is
$552 an ounce and I expect the price in 2006 to range between
$500 and $625. Using very basic valuation guidelines many of
the developmental stocks that we track are undervalued by wide
margins. We use only a $400 gold price and a modest production
profile to arrive at a reasonable cash flow from their expected
mining operations. A precious metal company making $1 cash flow
per share should sell for at least 15-20x cash flow or $15-20.
Some of these companies currently are selling at only a 4-5x
expected future cash flow value. Therefore we see continued appreciation
in these stocks.
Mining companies sell at discounts
if they are not yet in production. As the mine becomes operational,
valuations then move up rapidly. Investors should patiently wait
for these valuation increases in these companies since the future
gains could be substantial. Our basic premise to owning a non
producer is that they must have a very large mineral deposit
- a minimum of $2 billion of extractable value.
Barrick Gold Buying Placer
Barrick Gold buying Placer
Dome for $9 billion is a good sign. Large multinational companies
with world class business and political figures on their Boards
usually have access and an inside track to high level government
opinion leaders and information. These billion dollar companies
also know their businesses well and spend a lot of money and
time on economic and monetary intelligence. A big buy out like
this is indicating that one of the big players in the industry
thinks the gold price is most likely going higher or is expected
to now stay in a new higher range in the future. This makes sense.
Review the Rationale
There are two global mega trends
occurring simultaneously that make investing in mining companies,
especially precious metals, one of the most compelling investments
available. One is the continued mismanagement of global economies
by the advanced industrialized countries governments to keep
their pensioners and publics happy. This includes huge debt levels
and money printing to make ends meet. The numbers are staggering
and cannot possibly lead to a happy ending. This coupled with
the growth of the two key developmental economies (India and
China) who consume large amounts of gold and gold jewelry equal
a very strong case for higher precious metal prices in the years
to come. One factor pushes these metals higher based purely on
the commercial supply and demand for jewelry and the other by
the 5,000 year old tradition of owning a monetary asset that
the politicians cannot debase or manipulate.
The best news is that with
the gold price now most likely to stay in a higher range in the
future, let's say above $450, an entirely new mind set will prevail
in the mining industry. Hundreds of new projects and companies
will form to develop the many "old" projects that were
considered uneconomic many years ago. There are plenty of very
competent mining people in the world and plenty of mining finance
houses mostly centered in Toronto, London and Vancouver that
will bring forth a lot of new companies that could be big winners
in the future. Having been around these mining people professionally
for 33 years, I like to think that I know most of the good guys
in this industry. There will be plenty of good deals that will
be coming along and should make excellent investments.
Many projects will enhance
an existing operating company and add value to their stock price
and other projects will be the basis for an entirely new company
to be formed. Either way more value will be presented to you
in the future that will be outside of the pure exploration sector.
Look for these projects and companies.
2006 should be a very exciting
year for the mining sector.
Please visit our website
at www.kengerbino.com for more articles on gold, the economy
and the stock market.
January 20, 2006
Kenneth J. Gerbino
Archives Kenneth J. Gerbino & Company
Investment Management
9595 Wilshire Boulevard, Suite 303
Beverly Hills, California 90212
Telephone (310) 550-6304
Fax (310) 550-0814
E-Mail: kjgco@att.net
Website: www.kengerbino.com Copyright ©2004-2016 Kenneth J. Gerbino & Company. All Rights Reserved.
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