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 Feature:
Gold - the bugs are right, finally. |
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 After
nearly 20 years of a declining gold price—historically, the length of the
average bullion cycle—it appears that in late 2003, the yellow metal entered
a multi-year uptrend.
We firmly believe that SmallCap
Digest readers should seriously consider some exposure to the junior
mining/gold market.
Spot Gold traded at $260 in
mid 2001 and is currently trading in the $400 range-- a net gain of 53%.
While a decent move, we feel that there is still significant upside for
the bullion price and, more importantly, junior mining stocks.
While this price appreciation has
been very favorable for long- term holders of gold bullion, investors who
own junior mining stocks are enjoying even better returns. Historically,
the small mining companies that benefit from considerable bullion price
leverage delivered returns far in excess of simply the mere appreciation
of the gold price.
As gold continues climbing the charts,
many junior mining stocks will follow suit. Those resource companies with
the proper leverage should outperform the gold market by a substantial
margin.
Here are four compelling reasons
to consider junior mining stocks for the speculative end of your portfolio,
and why SmallCap Digest will be highlighting some great junior resource
ideas over the next few months:
 THE
TREND IS YOUR FRIEND - The Technical Picture
Until mid 2001, gold was in an 18-year,
long-term down trend as well as a 5-year medium term down trend. Both downtrends
were broken convincingly in mid 2001, and the metal has been in a solid
uptrend ever since.
Despite it's dramatic increase in
value over the past 2.5 years, bullion is still cheap by most standards.
Gold is just now reaching 50% of the level it traded at in 1980. The last
bull market for gold spanned the time frame from 1972 to 1980. During that
time, the metal appreciated from $35 per ounce to an astounding $850 per
ounce for a 2300% return over an eight- year period.
The age-old market force of limited
supply vs. increasing demand bodes well for the price of gold over the
remainder of 2004. As well, the commercial short gold position through
gold companies and as a result of futures trading is sitting at or near
record highs.
The annual gold production is between
2500-2800 tonnes. Annual demand averaged almost 4000 tonnes over the past
ten years. The short position, while always open to debate, sits
somewhere between 5000 and 15000 tonnes, or two to five year’s worth of
production. Even a modest run in the bullion price will likely
cause, at best, a stampede to cover or, at least, a catalyst for a run
to much higher prices.
 Spiraling
US Budget Deficit Equates To Dollar Down and Gold Up – Macro-Economic Forces
The deficit widened to a record $138.7
billion in the second quarter, or an unsustainable 5.1 percent of the gross
domestic product. The US trade deficit and the federal budget deficits
are currently at $500 billion each—record levels. The Federal Reserve has
been pumping liquidity into the financial system to match these deficits
at the expense of the dollar as measured against other currencies.
Evident in the chart is the inverse
correlation between the price of the U.S. dollar and the price of gold.
The chart measures the value of the dollar against the HUI Index (gold
bugs index). This index measures the performance of a basket of gold stocks
that have not leveraged their future production. Therefore, these stocks
go up and down commensurate with the price of gold. As you can easily see
from the chart, the value of the dollar moves in opposition to the price
of gold and gold stocks.
The U.S. has turned from being a
creditor nation to a debtor nation. With the current administration’s commitments
to aggressive spending on wars abroad, national defense, job creation at
home, and tax cuts, the US deficit will only increase in the near term.
Further, with record U.S. account and budget deficits (at $554 billion,
or 5% of GDP) and the recent move toward more flexible exchange rates,
the dollar will likely continue to weaken in order to address U.S. trade
and world currency imbalances as well as to support the U.S. economic recovery.
Many analysts expect to see a further 10 percent-plus depreciation in the
U.S. dollar over the next twelve months.
To prevent the dollar's decline,
the U.S. must attract $1.5 billion a day in foreign investment to finance
the shortfall in the current account, the broadest measure of international
trade.
Gold provides an investment alternative
for foreigners wishing to hold fewer dollars to avoid losses from a weakening
currency. Also, as the dollar declines against other currencies the relative
price of gold lowers in countries outside the dollar bloc, which, in turn,
stimulates price elastic demand.
Therefore as the dollar continues
its weakness over the next couple of years (with inevitable pauses and
blips on the upside) the gold price will continue its march upwards.
 Imbalance
Between Supply and Demand
Decreasing Production
There has been a radical new shift
in the underground supply of gold over the last couple of years, which
is expected to continue. During the decades of the 80's and 90's gold mine
production increased steadily at about 2.5% per year. International production
doubled over this two-decade period.
Mining executives anticipate that
the industry is moving into a phase that will lead to a supply pinch within
the next few years. One consequence of this shortfall is that gold prices,
anticipating tighter supply, will continue to trend higher.
World production peaked in 2001 and
has since been level to slightly down. As older mines begin to become depleted,
especially in South Africa, analysts project annual production will decline
in the near term. Low gold prices in the latter part of the 90's lend to
minimal capital investment in new production. In the latter half of 2003
investments in new production exploded. However, it takes 3 to 5 years
to put a new gold mine into full production. Therefore, analysts anticipate
a continued imbalance between supply and demand in the near term, forcing
prices higher.
Increasing Demand
The demise of Communism in favor
of capitalism has been embraced more efficiently in China than any other
formerly Communist country. Nearly 1/4th of the world's population lives
in China, and they are becoming more affluent everyday. Chinese consumers
have a much higher savings rate than their western counterparts: the Chinese
middle class has a savings rate of nearly 40%.
The Chinese are prolific gold consumers
as of form of savings. As well, they view gold as a sacred commodity. In
October of 2003, China allowed the Shanghai Gold Exchange to open; which
allowed free trade for the first time in China’s history. Although limited
to only 108 institutions (producers, corporate users and banks), volume
on the exchange has risen six-fold in less than six months.
On November 18, 2003 the Bank of
China opened gold trade services to individuals. The Bank’s own gold
business expert, Xi Jianhua, recently estimated that local investors were
expected to purchase $36 billion of gold: the equivalent of more than one
years total world production.
 The
Chinese Central Bank has also been buying gold. It recently purchased 200
tonnes, adding to the 600 tonnes of gold in reserve ($7 billion), no doubt
as a hedge against the falling dollar.
China is rapidly becoming the largest
consumer of gold in the world and the emerging pool of one billion new
consumers only suggests more robust demand for gold down the road.
As well, India has emerged as a new
source of gold demand. The government's recent deregulation of gold investments
led to a 350 percent increase in demand overnight.
Emerging ETF's (Exchange Traded
Funds)
Further new demand for gold is expected
to come from a new class of investments that represent ownership in the
metal. Exchange Traded Funds will trade on stock exchanges. Their value
will be backed by physical gold bullion held at a depository. The proposed
NYSE ETF --with proposed symbol of GLD-- is expected to begin trading sometime
this year. Each share will be backed up by 1/10th of an ounce of gold.
Therefore, if the fund were trading today, it would trade at about $40
per share, and go up and down with the spot gold price.
A Gold Bullion Fund (ASX: GOLD) already
trades in Australia. It was launched in March of 2003, and has grown 2.7
times since June. It currently holds 245,703 ounces. The Fund’s success
has prompted filings for similar funds worldwide. Similar funds are expected
to open for trading on both the New York Stock Exchange and the London
Stock Exchange later this year.
As demand for the Australian fund
grows, and the NYSE and LSE funds begin operations, these "trusts" will
have to purchase gold bullion as the underlying security for their funds.
This represents a potentially prolific new source of demand for gold.
Junior Mining Stocks- Invested
Capital Equals Potential Returns
The rising price of spot gold has
stimulated massive investment in new mining operations for the first time
in many years.
Financing for mining companies trading
on the Toronto Venture Exchange (which has a high concentration of emerging
and small cap mining companies) jumped from $231 million in 2001 to
$575 million in 2002 and is expected to greatly exceed that number
this year. Worldwide financing for all mining companies has now surpassed
$4
billion since May 2003.
This massive investment will undoubtedly
yield returns. Junior mining companies will take this new capital and turn
it into profits.
An investor in mining stocks can
have considerable positive leverage to the price of gold in a number of
ways:
Through exploration many companies
will find more ounces in the ground. An investor will increase their indirect
exposure to and ownership of gold as these deposits are discovered; provided
the discovered gold increases more rapidly than the issued and outstanding
shares in the company. Also, through further exploration and development
(mainly by drilling and feasibility work) the value of those newly found
ounces will increase as more confidence in the amount of gold and its grade
becomes better known and more reliable.
As reserves get upgraded from
possible to probable, to proven, share value increases.
When the price of gold increases,
the value of gold in the ground is enhanced in a couple of ways: (a) gold
in the ground, which cannot be produced today at a profit and therefore
of little value, can become economically feasible at a higher gold price
(an effect taking place in the market today). Further, potential profits
of mining companies increase exponentially as the gold price rises. For
example, consider a mine where costs are $300 per ounce. Should the price
of gold jump from $400 to $500 per ounce, investment in the physical metal
increases by 25%. However, the profit of the mine per ounce roughly doubles
(from $100 to $200 per ounce).
These factors explain why the average
gold mining stock (as measured by the Philadelphia Gold and Silver stock
index) is up 130% since the low in 2000 as compared with a 50% increase
in the gold price during the same period.
At SmallCap Digest, our interest
in gold and junior mining shares is as it is with just about any sector
we cover—to bring our readers the best and brightest plays to enhance various
sectors of your portfolios. Whether it’s gold, tech, biotech or
some way cool product, that mandate remains the same.
We feel that the time is right to
add junior gold mining shares both to our coverage and your portfolio.
Got comments, questions or suggestions?
Send 'em on over:
Editor@smallcapdigest.net
If you wish to send a written request
or inquiry, please send it to our physical address:
TGR Group, LLC
3525 Del Mar Heights Rd #334
San Diego, CA 92130
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