 Gold
Stocks - Crucial Information for the Investor - Not All Rosy
Kenneth J.
Gerbino
Archives
Kenneth J.
Gerbino & Company
Oct 26, 2007
The big news globally is
that the U.S. Federal Reserve and the Bank of England both threw
in the towel on monetary policy to deal with market panics in
the last two months. We believe these problems are only the tip
of the iceberg of a massive credit and investment bubble that
is threatening to unwind. Their only answer is more money and
soon more inflation. In the U.S., the Fed lowered important benchmark
interest rates well beyond what was expected and instigated very
lenient bank repayment policies for borrowed capital from the
Fed. This was not to help the man in the street or to "avoid
a recession". Since unemployment is so low the Fed rate
move was obviously made to bail out Wall Street and the major
banking institutions. This resulted in the dollar hitting new
lows and gold moving higher. These trends are likely to continue.
History tells us the truth about the Fed. In the twenty years
before the Fed was created, there were 1,724 bank suspensions,
in the twenty years afterwards there were 15,502. By subsidizing
and protecting the banks they encourage speculation, overleveraging
and excessive credit creation which leads to major banking problems
that are then solved at the expense of the general population.
In England the central bank
announced that all depositors of Northern Rock, Britain's 5th
largest mortgage bank would have their deposits guaranteed by
the government. This was in response to a bank run which had
ensued with world press coverage showing thousands of people
lining up to withdraw their savings at various branches. In
the future this will become a disastrous precedent encouraging
more speculation by institutions and investors. Northern Rock
had a $6 billion equity base and had leveraged its balance sheet
to $226 billion. I suspect they are not alone and this may not
be the last of the bail outs.
These actions are only the
beginning of a new round of paper money injections that will
surely bring on above average inflation. An excellent study by
economist John Williams shows the real inflation rate in the
U.S. since 1991 was annually 4% higher than government figures.
Financial writer Howie Katz reports adjusting the CPI from 1983
to reflect housing costs as opposed to rents shows U.S. consumer
prices have tripled not doubled as reported by the Bureau of
Labor statistics. Gold averaged around $400 in 1983, it is reasonable
to triple this price for a future target just based on a simple
real CPI formula.
The Dollar
With the dollar at new 40 year
lows, it will force Europe and other countries to devalue their
currencies. If you are an international business working on 2-3%
margins or less and you can now buy your U.S. goods 8% cheaper
because of a weak dollar, it is an incentive to do so. This means
other countries that depend on exports will not get that business
and their governments will respond with competitive devaluations.
Devaluations in the current floating currency environment (where
exchange rates change daily in response to supply and demand
as well as government intervention) can be accomplished by 1)
manipulating interest rates lower (which then leads to more money
creation by the banking institutions) or 2) just printing money.
The central banks and the banking establishment in these countries
along with the politicians also have a beautiful excuse to print
their way out of the fiscal mess they are in because they cannot
meet the obligations to their citizens. This is and always will
be bullish for precious metals. This is one reason why precious
metal ownership by way of reserves in the ground of mining companies
is prudent. Precious metals could be one of the only monetary
assets still standing when this excessive global credit and monetary
cycle is over.
China and Japan - The Big Currency
Misconception
Because of competitive devaluations,
already mentioned above, the death of the dollar may not be as
fast as some people think. Also one of the big misconceptions
that I keep reading about is that China and Japan will soon dump
their holdings of dollar denominated Treasuries because they
are losing value with the dollar going down. Not true.
Follow this very carefully.
1. A million dollars of clothing
is exported from China to the U.S.
a
2. A million dollars is sent to China.
a
3. The Chinese factory owners send the million dollars to the
central bank and ask for the equivalent in renminbi so they can
pay their workers and suppliers.
a
4. No problem so far.
a
5. But what does the Chinese central bank do?
a
6. They actually create (print) $1 million worth
of renminbi and send this off to the factories and keep the original
$1 million and buy U.S.Treasuries with it.
a
7. The central bank does not have to exchange the
dollars for renminbi's, they can create an additional
$1 million worth of renminbi's.
a
8. Since China now has $1 million in local currency they earned
for the clothing does the central bank even care if the value
of extra $1 million in Treasuries they own goes down by 20% or
more.
a
9. The answer is no.
China sent $1 million of clothing
to the U.S. and now they have $1 million of local currency and
$1 million of U.S Treasuries. Easy money.
China now has more money in
circulation (M1) than the United States. $1.9 trillion vs. $1.4
trillion. The reason is that they have been double dipping.
In the above example the $1
million they have in Treasuries is all gravy and this is what
the Chinese have done the last 10 years and that is why their
money supply has mushroomed. When the time comes they will most
likely take the trillions they have in U.S. Treasuries and come
back to the U.S. and buy buildings and factories (like the Japanese
did in the late 80's) Spending dollars for dollar denominated
assets in the U.S. will have zero effect on the exchange rate.
So the argument that these Treasuries are a huge overhang on
the U.S. dollar because the Chinese don't want to lose value
is not true. They are so far ahead already it doesn't matter.
Of course the local citizens will now have to put up with plenty
of inflation that is coming to China from all the new money floating
around the country.
Gold Demand
High oil prices are flowing
huge amounts of money to countries in the mid east that have
been historically pro gold and the higher oil goes the more gold
will be absorbed by these governments, their financial institutions
and investors.
It has been estimated that
all the gold in the world ever mined equals 5.3 billion ounces.
This has a value of $3.7 trillion. Much of this gold is in woman's
jewelry cases and on men's wrists or resides in peoples teeth.
Global liquid financial assets are in the hundreds of trillions
of dollars and global derivatives are over $450 trillion. Therefore
the ratio of gold available for investment is a tiny fraction
of the other investment alternatives. When further financial
problems arise gold will have to rise when too much money chases
too few ounces.
The U.S. Economy - Where's the Beef?
The U.S economy has been skating
on thin ice. Subtracting out the money that people have spent
from refinancing their homes, the U.S. economy (GDP) has averaged
only one half per cent growth annually for the last six years.
This means we are living in an economy that has been fueled by
consumers borrowing home equity money and this has now come to
an abrupt end. This, coupled with the underlying problems in
our banking system, means the only way out is a loose monetary
policy. The overleveraged banking system cannot handle
a recession. This unfortunate scenario coupled
with more trade and budget deficits will have a positive effect
on the gold price and will also contribute to future inflation.
Since 2002 crude materials
in the U.S. are up exactly 100%. This is more anecdotal evidence,
that the inflation rates in the U.S. will rise substantially
in the coming years.
Money Creation Versus Gold
Our survey of the seven largest
countries in the world and Europe show that they created $775
billion in new money in the last year. The supply of gold available
for investment, outside of jewelry and industrial demand which
would include bars, coins and bullion funds was approximately
$13 billion. This is a ratio of 60 to 1 and does not include
the money creation by the other 175 countries in the world.
The point is that there really is not much annual gold supply
around for investment purposes or financial insurance or a money
substitute. Sooner or later the price will dramatically reflect
this imbalance. India has increased it's money supply 15.3% in
the last year. This is probably why in the first eight months
of 2006, gold imports increased by 86%. India could be on track
to consume over 35% of 2007 global mine supply all by itself.
Because mining companies have
gold in the ground, their valuations over the next decade are
logically bound to increase substantially. These companies provide
an outstanding opportunity to own gold in the ground via stock
ownership.
Volatility and The Gold Stocks
The recent volatility of the
precious metals and the mining shares unfortunately is part of
the equation of this investment sector. We attempt to balance
these fluctuations in our hedge fund but it is a difficult task
and requires focus and discipline. You should expect volatility
with your personal portfolios in the future and realize that
volatility in this sector is normal. But, in my opinion, this
type of volatility is a small price to pay for the long term
trend that is clearly in your favor and the excellent growth
and value attributes of a well diversified and hedged portfolio.
The mining sector should continue
to be one of the top performing investment sectors in the coming
3-5 year period. The past actions of the Fed and other central
banks mean they will surely do everything they can to avoid a
credit and debt implosion that according to many experts could
be in the trillions of dollars of potential defaults and bankruptcies.
If this estimate is true then bailing out the institutions that
are in danger will require the greatest expansion of paper money
in history. The winner will be gold and other natural resources
because the more money that is created the higher the prices
of basic commodities and monetary substitutes (gold and silver)
will go. Gold mining shares are the beneficiaries of the economic
excesses of others.
It is important to be careful
of exploration stocks and allocate only a small amount to this
sector. The large mining stocks are now being bought by huge
non gold savvy hedge funds and will create lots of volatility
as we go forward. A stampede by these players either way can
be profound. The developmental mining companies with solid resources
in the ground and a 1-2 year horizon to production will be targets
for buy outs by mid-tier and major mining companies.
Good luck - you are going to
need it especially if gold goes to $1,200 and then back down
to $700 and then to $2,000, which is very possible in the coming
decade. So always keep a core portfolio as insurance (and long
term appreciation) and a trading portfolio that rolls with the
punches. Do not go on margin and do not spend much time or money
on the exploration stocks as more than likely every share you
buy is usually from an insider who is selling. Also if there
ever is a major economic upheaval gold and silver mining companies
with known and verified resources in the ground will go up dramatically
but exploration companies with nothing but a geologist
and promoter's dreams will go no where because they have nothing
in the ground. Remember that - they have nothing - so be careful.
For more information on the
economy, stock market and gold please visit our website at: www.kengerbino.com
Oct 25, 2007
Ken 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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