Gold Mining Stocks: What's Happening Now

by Kenneth J. Gerbino

4 May 2005

 

 

 

There are two parallel markets happening in gold. If you own the mining stocks you are currently caught between these two financial forces.

 

One market is the bullion market and this is showing steady demand and relatively very solid price action. The other market is the mining shares and this market has been in a severe 5 month downtrend. These markets are currently disconnected. The mining share market is divided into three separate sectors. It comprises 1) "hot" hedge fund and "hot" investor money, 2) a regular but small global retail and institutional market, and 3) the "Canadian mining regulars" (brokers, market makers, speculators, promoters, gold mutual funds, entrepreneurs, newsletter writers and their subscribers).

 

The first group has come and gone. When momentum changes this group leaves the party regardless if they believe inflation or a debt collapse is coming. The U.S. deficit story, both trade and budget is old and tired news to this group. For now they are on the sidelines or in biotech or some other sector. Some did well and some came in late and lost money. When inflation heats up again or the dollar starts a serious fall and the mining stocks start a new run, they will be back in even larger numbers.

 

The regular retail and institutional gold mining stock investors with the help of the Internet have grown in numbers and they have been battered in the last 5 months. They are probably fully invested and a percentage of this group who came in late are worried that maybe the inflation crowd is all wrong or maybe the end of the world crowd is all wrong, whichever abstraction got them into gold in the first place. More of these investors will be needed for the next bull phase. The second wave of these investors will be much larger in the next few years as the economic and financial problems (debt, deficits and paper money printing) continue.

 

The Canadian Regulars have been through these volatile swings so many times that many of them have taken some money off the table or made so much in 2002 and 2003, they started to get greedy and overextended themselves. They will be back in force once the dust settles — and that may be sooner than later.

 

As of the end of April, the sentiment on the mining shares was almost as bad as it can get. The very negative call-put ratio on the XAU was at April 2003 and April 2004 levels. Both times a very strong and extended rally took place from those oversold readings. With this kind of pessimism, the sellers are almost all gone. Everyone that wanted out of the pool is most likely out already. In fact we just may have seen a significant low on April 28th.

 

Let's take a roll call of the Who's Who of Finance and see where they stand vis-à-vis gold or concepts that would be conducive for gold going up.

 

• Paul Volcker: His op-ed piece in the Washington Post actually stating the "C" word. He talks about a "financial crisis" possibly if Washington doesn't get it's act together. The title of his article; An Economy on Thin Ice
• Warren Buffet: The smartest investor of all time. He is short the dollar
• David Dreman: Famous value manager who manages $11 billion, recently stated on Bloomberg "Bonds are almost suicidal".
• Bill Gross: Head of the world's largest bond management company ($464 billion), has warned of the dire consequences of U.S. monetary and economic policies.

 

The above people are not gold bugs; they are part of the heart and soul of the establishment of global investments and economics. They know that something has to give. They know that past and present economic policies are beyond reason and that a terrible economic accident or a powerful inflationary period is surely coming to the western world. Either scenario means gold is going to be a very important asset class to own - and if gold is good then mining stocks will be even better.

 

Inflation in the U.S is 3.5% and rising. Globally this number is 4.3%. If the inflation numbers continue then just a small amount of investors buying gold could have a dramatic effect on the price. With U.S. households time deposits and savings accounts at $4.3 trillion, it would require only 1/2 of 1% of this money purchasing gold to create a substantial (1,574 tonne) demand imbalance (more than half the world's annual mine supply). Stock ownership, mutual funds and life insurance/pension reserves of U.S households equals another $20.8 trillion. Again only a 1/2 of 1% allocation to gold would create a demand that would be 3x annual mine output.

 

My investment management firm monitors 61 foreign countries that report regularly on money supply statistics. In the last 12 months these 61 foreign countries have increased their basic money supplies by an average of 15.2%. Most people with savings in these countries will try and protect themselves from inflation that is surely looming and will most likely be buying gold. The Chinese basic money supply from 1998 has averaged an annual increase of 13% for 7 solid years. Inflation is coming to China - and that means plenty of gold buying.

 

Also if the Chinese revalue the RMB, the very next day after a 5-10% revaluation (and this could be very soon) every Chinese saver will be able to go out and buy 5-10% more gold for the exact amount of cash from the day before. The revaluation of the RMB should be very positive for the bullion market. Also if the RMB floats, U.S. dollars held by foreign central banks could more easily be converted to RMB to cover trade with China and this would put even more pressure on the dollar.

 

In the U.S., record trade deficits are continuing at a $730 billion annual pace. Money leaving this country to buy goods has been essentially matched by that money coming back to this country to buy U.S. treasury bills and bonds. On the surface this doesn't sound too bad and economists are saying this shows foreigners have confidence in the U.S. But this return of the money is not a commercial transaction for gain. It is foreign governments and investors owning debt that someday must be repaid. 6% of our entire economy annually is based on buying goods overseas and going into national debt to pay for it. Too much debt and too much money creation are bullish for gold.

 

The key reasons to accumulating a substantial position in the metal stocks in the coming years, especially the precious metals are logical and simple and are as follows:

 

• More population: Up 50% globally since the last big run up in gold in 1980 equals
• More low-to-middle 'middle class' people continuing to buy gold jewelry and this consumes more gold annually than mines produce,
• Industrialization in Asia and India is a mega-trend favoring all commodities
• Inflation in most countries is increasing and excessive money is being printed
• Debt levels in the industrialized countries are at levels that are well beyond prudent limits - and the most important reason to have some gold assets is;
• The Bank for International Settlements reports Exchange Traded Derivatives are now $279 trillion and OTC derivatives are now $220 trillion. This is $100 trillion more than when Warren Buffet declared them "economic time bombs".

 

One does not have to be an economist to know that a basic conservative plan for wealth preservation and accumulation is now critical. Gold mining and related metal companies should be part of this plan.

 

Investors should stay with quality merchandise and leave the speculation and geological hopes and dreams properties to others.

 

​

Kenneth J. Gerbino

 

 

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