 The Mighty Metal
John Myers
May 10, 2004
The Daily
Reckoning PRESENTS: The demand-side fundamentals for gold are
excellent. But won't supply increase as the price increases?
Not necessarily.
"There
are a zillion people looking for gold these days, because with
the gold price up and money flowing in that direction, people
can get financed to go and look for it," says John Embry,
chief investment strategist at Sprott Asset Management. "But
the fact is gold is a precious metal, and the reason it's a precious
metal is that it's not that easy to find. So I think that, much
as in the exploration boom of the mid-'90s where incredible amounts
of money were put into the ground, remarkably little was found."
Like us, Embry believes that despite intense efforts, very little
gold will be discovered over the next few years. And also like
us, he believes that we are entering an era of new wealth creation
that will fuel demand for precious metals.
"We've
got a worldwide boom going, particularly in the Third World,
much of it driven off sort of the consumer strength in the United
States," adds Embry. "The United States is desperate
to avoid deflation and they've been printing money... creating
credit at a rapid pace. And the bad news for the U.S. is that
an awful lot of that demand that they're creating is leaving
the United States shores and it's going over to China and India
and other places in that part of the world, and what is underwritten
is a very significant boom. I would submit that China is almost
out of control at this point, on the upside in the sense that
credit creation is growing at extremely rapid levels."
So close is
Embry's reasoning to ours that you may think that your editor
"word-jacked" his story. But the truth is we both see
the same sorts of trends that will power gold to much higher
levels.
Who Will Seek Gold?
Why am I so
confident the Midas metal is set to soar to higher levels? Two
reasons - or really two certainties... first of all, Washington
refuses to accept a crushing deflation. Second, vast numbers
of people are generating new wealth - wealth that they will no
doubt spend but also save... some of it in the form of gold bullion.
With so little
confidence in the dollar these days, it seems certain that some
of the world's new bourgeoisie will look for other instruments
in which to stash their savings. If even just a fraction of the
world's new wealth is invested in gold, it will have an explosive
impact on bullion's price.
Demand Squeezes the
Earth
As more of
the new wealth invests in gold, we encounter the same old problem:
lack of supply.
Gold is extremely
scarce. Each year, all the gold mines in the world produce only
about 80 million ounces. A world-class gold discovery yields
a million ounces... but they are rare. When you consider that
the world's three largest gold mining companies produce less
than 15 million ounces a year, you get the picture.
South African
production peaked in the 1970s, while Canadian gold production
has been in decline since 1991. The truth is that it is getting
harder each year for blue-chip gold companies just to replace
their reserves. In fact, over the past decade, many gold conglomerates
have shut down exhausted gold mines.
Of course,
there have been plenty of mergers and acquisitions, but they
don't add a single ounce to the world's inventory of gold. They
merely change the ownership of the same gold.
Today the mining
industry is on a treadmill, desperately trying to replace 80
million ounces of annual production, just to stop from shrinking.
With larger discoveries harder and harder to find, it is almost
certain that world gold production will decline this decade.
"Consider that to mine the 80 million ounces of gold that
is produced each year, assuming that the average worldwide grade
is 10 grams per tonne (it is probably less), would require moving,
crushing and processing 250 million tonnes of rock," writes
analyst Paul van Eeden. "That would make a 3.4 billion cubic-foot
hole, and the gold produced would be only 4,500 cubic feet. No
wonder it is tough making money mining gold."
Profits Rise With
Tight Gold Supply
Of course,
higher prices over the past year have made gold mining more profitable
for most companies, and we are, in fact, within striking distance
where even the most expensive deep-shaft miners will become profitable
(more on this in a moment).
But what I
think is so fascinating about the gold market is that the entire
amount of gold discovered this year will be worth approximately
$30 billion. That is less than one-quarter of Coca-Cola's market
cap and a minuscule fraction of the $11 trillion-plus U.S. bond
markets.
The gold market
is so very thin that if just one in 1,000 of the world's nouveau
riche were to buy even a paltry few ounces of the Midas metal,
its price would soar. And while the U.S. bond market is growing
by a trillion dollars every year, and M1 money supply has grown
on average by more than 7% per year over the past five years,
the aboveground gold supply is growing by about 1%.
Eying Our Golden Future
Meanwhile,
the gold price is now hovering around the $400 level. It has
also broken below what some feel is an important psychological
level several times, perhaps signaling trouble.
Don't believe
it. The great gold bull market of the 1970s had several corrections,
one of which was of a far greater magnitude than this hiccup.
Newmont Gold
President Pierre Lassonde agrees with us. He also points to the
1970s to demonstrate why gold could soar in an era of what he
calls a "manic-depressive dollar." "We haven't
even started to correct the U.S. financial imbalance of the last
three years, said Lassonde. "Don't tell me that the gold
bull market is over. It has hardly even started."
Newmont's president
predicts gold will outperform other assets for some time to come.
"As long as they don't cure the financial imbalances, the
dollar will continue to go down and be very volatile. I don't
know how long it will take, but it will take quite a few years
[to work through], and that is the gold story in a nutshell."
Gold Soars Over Falling
Dollar
The truth of
the matter is that Asian holdings of American government debt
have soared, while the U.S. government is spending at a record
rate. But I think what is most interesting is another fact Lassonde
points out - that technical innovations in mining have dried
up.
Even if he's
wrong on this point, though, and cheaper exploration extraction
methods are developed, gold production is certainly going to
lag future demand. There have been incredible advances in finding
and mining gold over the past hundred years, but on average the
aboveground gold supply has grown by scarcely 1% per year. If
the advances in geology, particularly in the 1940s and '50s,
could not break this barrier, I am doubtful anything that science
has to offer tomorrow will, either.
"The last
real gold bull market was in the 1970s," Lassonde recalls.
"It went on for 9 years, from 1971 to 1980. What we've had
in the past 20 years are bear market rallies. So when you read...
that the average gold bull market is 40 months and we're 36 months
into it - and that's bad. Well, you know what, they haven't seen
anything until you go back to the 1970s."
Citing a strong
dollar-euro correlation, Lassonde said, "Over the past two-and-half
years gold has been a currency, not a commodity. That's because
the dollar, as currency of last reserve, is not acting that way,
thanks to the U.S. financial imbalances that are enormous, unresolved
and growing."
On the last
point I couldn't agree more. But Wall Street is having a hard
time coming around to this point of view. You must remember that
most stockbrokers don't know a darn thing about commodities,
other than the fact that a bull market in gold is typically bad
for business. Not one in 50 stockbrokers has even a rudimentary
education in geology, and is far more likely to have an MBA on
his wall, a testament to the fancy business ratios he learned
in grad school.
Just one problem:
Resource companies don't fit many of these ratios. What does
fit is good management, and, most of all, opportunity... opportunity
to find and produce gold, and opportunity to profit and grow
through sound practices and a good (we prefer great) exploration
team.
Don't pass
up on sound resource stocks just because they're not Wall Street's
darlings. And if you miss the coming bull market in gold, well...
...you can't
say we didn't warn you.
John Myers
May 10, 2004
Editor's note:
John Myers - son of the great goldbug C.V. Myers - has
been helping readers earn suprisingly lucrative returns in stocks
largely unknown to Wall Street's wunderkinder since his
early 20s. Our man on the scene in Calgary, John has his fingers
on the pulse of natural resource profits - including oil, gas,
energy and gold.
Osama Bin Laden
has recently offered 1,000 grams of gold for the head of any
U.K. or U.S. citizen, and 10,000 grams for the head of Paul Bremer
and other senior U.S. staff in Iraq. This is exactly what John
was concerned with when he put together the shocking exposé
on the advent of a new "secret currency" in the Middle
East...
which could
have disastrous effects on the U.S. economy. Don't miss it -
the effect on your portfolio could be significant:
The New Secret Currency - A Deadly Threat to the U.S. Economy.
This article
appeared on the The
Daily Reckoning
website.
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321gold
Inc
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