By Simon Grey, on December 23rd, 2011
Hale and Hobijn find that the vast majority of goods and services sold in the United States are produced here. In 2010, total imports were about 16 percent of U.S. gross domestic product, and of that, 2.5 percent came from China. A total of 88.5 percent of U.S. consumer spending is on items made in the United States, the bulk of which are domestically produced services – such as medical care, housing, transportation, etc. – which make up about two-thirds of spending. Chinese goods account for 2.7 percent of U.S. personal consumption expenditures, about one-quarter of the 11.5 percent foreign share. Chinese imported goods consist mainly of furniture and household equipment; other durables; and clothing and shoes. In the clothing and shoes category, 35.6 percent of U.S. consumer purchases in 2010 were items with the “Made in China” label.
Foreign trade sound much less important when discussed as a percentage of GDP instead dollars. 16% sounds like a relatively small amount, but once you put that in dollar terms it becomes $2.24 trillion dollars.* Obviously, this is a significant chunk of change, roughly equal to the mandatory spending of 2010 federal budget (and equivalent to roughly two-thirds of the total federal budget). Given that unemployment wavered between 16.5% and 17.1% that year (and was likely higher, given how the government manipulates those statistics), it seems reasonable to conclude that it having even half of those imports produced at home would have had a pretty positive impact on unemployment.** Much of what China sells us has considerable “local content.” Hale and Hobijn give the example of sneakers that might sell for $70. They point out that most of that price goes for transportation in the U.S., rent for the store where they are sold, profits for shareholders of the U.S. retailer, and marketing costs, which include the salaries, wages and benefits paid to the U.S. workers and managers responsible for getting sneakers to consumers. On average, 55 cents of every dollar spent on goods made in China goes for marketing services produced in the U.S.
But why not have, if possible, one hundred cent of dollars be paid to Americans? Saying that the effects of foreign trade aren’t that bad is little consolation to those who are unemployed.
Going hand in hand with today’s trade demagoguery is talk about decline in U.S. manufacturing. For the year 2008, the Federal Reserve estimated that the value of U.S. manufacturing output was about $3.7 trillion. If the U.S. manufacturing sector were a separate economy – with its own GDP – it would be tied with Germany as the world’s fourth-richest economy. Today’s manufacturing worker is so productive that the value of his average output is $234,220, three times higher than it was in 1980 and twice as high as it was in 1990. That means more can be produced with fewer workers, resulting in a precipitous fall in manufacturing jobs, from 19.5 million jobs in 1979 to a little more than 10 million today.
The problem with the technology argument is that it fails to account for the impact of governmental interference. Of course, it is impossible to tell with any degree of certainty how much the government, by its interference, has encouraged manufacturers to pull forward their demand for machines to replace workers. It also fails to account for foregone manufacturing in light of a) regime uncertainty, b) the regulatory thicket that is the federal code, and c) the monstrosity that is the corporate tax code. Basically, there is no reason to assume that manufacturing would be as automated if there was actually a free market, nor is there any reason to assume that there would be as few manufacturing jobs if there were no federal regulations.
Now, as has been mentioned at this blog many times before, federal policy has been directly responsible for the current economic malaise. The federal government has hamstrung domestic businesses while simultaneously giving foreign businesses a free pass for trade. The direct effect of this schizophrenic policy has been to subsidize foreign businesses at the expense of domestic businesses. This has also contributed to a high unemployment rate. While free trade is the undoubtedly preferable state of being, it makes no sense to allow this while simultaneously hamstringing domestic businesses. The government must level the playing field, most preferably by deregulating domestic businesses. In the event this cannot be accomplished, the government should ensure that foreign businesses adhere to same labor and environmental regulations faced by domestic businesses or at least pay the difference.
As Walter Williams states:
The bottom line is that we Americans are allowing ourselves to be suckered into believing that China is the source of our unemployment problems when the true culprit is Congress and the White House.
** Keep in mind that, during 2010, the welfare/unemployment budget was nearly $600 billion. Half of the imports would have been $1.12 trillion, nearly double the welfare budget. I’ll let you draw your own conclusions from this.
By B.P.T., on December 22nd, 2011
At 8:30 AM Eastern time, the U.S. government will release its weekly Jobless Claims report. The consensus is that there were 380,000 new jobless claims last week, which would would be 14,000 more than the previous week.
Also at 8:30 AM Eastern time, the final GDP report for the third quarter of 2011 will be announced. The consensus is an increase of 2.0% in real GDP and an increase of 2.5% in the GDP price index. The real GDP estimate is the same as the preliminary value for the third quarter of 2011, and the GDP price index is the same.
Also at 8:30 AM Eastern time, the Chicago Fed National Activity Index for November will be released, providing an update on economic activity and inflationary pressure in the United States.
Also at 8:30 AM Eastern time, the monthly Corporate Profits report from the Bureau of Economic Analysis will be released.
At 9:45 AM Eastern time, the weekly Bloomberg Consumer Comfort Index will be released, providing an update on Americans’ views of the U.S. economy, their personal finances and the buying climate.
At 9:55 AM Eastern time, Consumer Sentiment for the second half of December will be announced. The consensus is that the index will be at 68.0, which would be an increase of 0.3 points from the level reported in the first half of the month.
At 10:00 AM Eastern time, the FHFA House Price Index for October will be released, providing more information about the direction of the housing market.
Also at 10:00 AM Eastern time, the Leading Indicators for November will be released, and the consensus is that there was an increase of 0.3% from the previous month.
At 10:30 AM Eastern time, the weekly Energy Information Administration Natural Gas Report will be released, giving an update on natural gas inventories in the United States.
At 4:30 PM Eastern time, the Federal Reserve will release its Money Supply report, showing the amount of liquidity available in the U.S. economy.
Also at 4:30 PM Eastern time, the Federal Reserve will release its Balance Sheet report, showing the amount of liquidity the Fed has injected into the economy by adding or removing reserves.
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By Ajay Shah, on December 14th, 2011
In recent months, we’ve had a few slip-ups by the official statistical system in India:
- Yesterday’s IIP release was preceded by a mistake. Mint says: On Monday, the government was guilty of a similar error in its factory output data. Till it corrected the number pertaining to capital goods output, analysts were left scrambling for explanations as to how this had grown 25.5% while overall factory growth had shrunk 5.1%. (The answer: it hadn’t, and had actually shrunk by 25.5%).
- On 9 December, we discovered there were important mistakes in the exports data.
- In December 2010, RBI modified the numbers that it releases about its trading on the currency market.
- In September 2010, there was a mistake in the quarterly GDP data released by CSO.
These examples are part of a larger theme, of problems of the official statistical system. The Indian statistical system is afflicted by three levels of problems:
- The first level is conceptual problems and analytical errors. As an example, the weights of the WPI basket are wrong; the estimation methods used in the IIP are likely to be wrong, etc. Quarterly GDP measurement does not have a demand side (which requires a quarterly household survey, which the government does not know how to do).
- The second level is the lack of rugged IT systems. The production of statistics requires high quality enterprise IT systems. The government does not have the ability or incentive to roll these out. As an example, the September 2010 mistake in quarterly GDP data seems to have come about because quarterly GDP data is produced in a spreadsheet. As with all usage of spreadsheets, this is highly error prone.
- The third level is the problems of truant front-line staff. In a country which is not able to get civil servants to show up at school to teach, it is not surprising that front-line staff of statistical agencies are untrustworthy in going out into the field and filling out survey forms.
The mistakes that we’re seeing are merely a reflection of #2 (the lack of rugged enterprise IT systems). But there is much more going on which holds back the usefulness of official statistics.
Government officials in this field have pinned a lot of hope on the implementation of the report of the statistical commission ( headed by C. Rangarajan, 2001). I am personally not optimistic about this. The report seems to emphasise an incremental agenda of building the statistical system, emphasising the interests of the incumbents. What is required is a ground-up rethink about the statistical system, from first principles, so as to address the three difficulties above. Turning to the users of official statistics, most economists attach enormous prestige to phrases like GDP, IIP, CPI, etc. But in India, we cannot unthinkingly use some numbers just because they come with the label `GDP’ from some government agency. We have to always skeptically ask first principles questions about how the data is generated. All too often, the standard Indian government data is useless.
In the class of government data that I know of, I feel the CPI is reasonably okay. The WPI is a fairly useful database about prices but useless as a price index. The quarterly GDP data, IIP, NSSO, ASI are untrustworthy. Decision makers in government and in the private sector need to struggle with these issues, carefully thinking about what statistics are allowed to influence their decision processes. Academic users of data need to be much more careful about avoiding garbage-in-garbage-out problems.
 
By Ajay Shah, on December 12th, 2011
There is a lot of gloom in India today about the broad-based failure of the UPA strategy of combining left-of-centre populism, fiscal profligacy, theft, and a lack of interest in the foundations of India’s growth. We learn from history that we learn nothing from history; India has clearly learned very little from its escape from the Hindu rate of growth. The moment we got a little bit of growth, the old style socialism and theft reared up again. In one of the many pessimistic articles of this theme, Shekhar Gupta in the Indian Express says:
What is the Hindu Rate of Growth two decades after reform? It certainly can’t be the 2-3 per cent of India’s socialist Brezhnev decades. The new Hindu Rate of Growth is 6 per cent, and on all evidence, from macroeconomic data to the empty billboards of Mumbai, we are headed there next year.
In thinking about GDP growth, it’s always useful to think about both growth and fluctuations. Growth is about the underlying trend growth rate. In the olden days, this was all you needed to worry about. The economy trundled along at roughly the trend growth rate (the Hindu rate of growth of 3.5 per cent), being kicked up or down by good or bad monsoons. In that period, macroeconomics in India required thinking in completely different ways, when compared with standard Western textbooks.
But from the early 1990s onwards, India changed. The market-oriented reforms, which began with the Janata Party in 1977 and gathered momentum in the 1980s, had started creating a market economy. And every market economy in the world experiences business cycle fluctuations. So, in addition to the trend, we got a cycle about the trend. There were good periods and bad periods, and the story running in there was much like that found in mainstream Western textbooks, with a prominent role being played by profitability, inventories and investment by firms.
From this viewpoint, it’s useful to decompose two elements of what we are seeing after 2009. On one hand, trend growth has been influenced by decisions of the UPA. Any perceptive observer also tends to rage at the lost opportunities, of policy decisions that should have been taken, which would have accelerated trend growth. But the second big story is that of fluctuations. Corporate investment is a major driver of business cycle fluctuations in India, and there has been a certain deceleration in this. This may have set off a downturn.
The bulk of the drama that we’re now seeing, and what will play out in 2012, is business cycle fluctuations. This is about fluctuations, not the trend. When trend growth is 7 per cent, the fluctuations make GDP growth range from 4 per cent to 10 per cent. Even if trend growth does not change by even a bit, business cycle fluctuations can take us from a high of 10 per cent to a low of 4 per cent, which is a huge swing of 6 percentage points.
Many elements of economic policy are pro-cyclical: when times are good, they make things better and when times are bad, they make things worse. The financial system tends to suffer from pro-cyclicality: when times are good, bankers lend exuberantly (thus expanding the boom) and when times are bad, bankers tend to be cautious (thus accentuating the bust). It is important to look for a framework for stabilisation, of tools that will counteract business cycle fluctuations. India has crossed one major milestone, in getting to a floating exchange rate. The floating exchange rate is stabilising, in and of itself. In addition, it opens up the possibility of stabilising monetary policy.
As of today, by and large, I think of both fiscal policy and monetary policy as being part of the problem and not part of the solution. While floating the exchange rate (decisions from 2007 to 2009) opened up the possibility of sound monetary policy, the logical next step did not materialise. As of yet, we do not have a sound monetary policy regime. We’re going to require far-reaching surgery to laws and institutions, in order to craft frameworks for fiscal policy and monetary policy that do stabilisation. Until these changes are made, Indian GDP growth will have the high volatility that is characteristically found in countries with weak institutions.
A lot of our work in the Macro/Finance group at NIPFP is rooted in this conceptual framework. In particular, you might like to see two relatively non-technical articles: New issues in macroeconomic policy and Stabilising the Indian business cycle.  
By The Gold Report, on December 7th, 2011
 Jay Taylor believes the biggest challenge facing the U.S.—deflation—could mean a better year, or even decade, for junior gold stocks. Taylor, editor of Jay Taylor’s Gold, Energy & Tech Stocks, has ridden some equities to the bottom of this punishing market and is ready to pile more cash into small gold companies. In this exclusive interview with The Gold Report, he explains why market sentiment hasn’t shaken his faith.
The Gold Report: In the Nov. 4 edition of Hotline, you note that America’s ratio of debt to gross domestic product (GDP) is north of 350%. Our total debt as a society is somewhere around $57 trillion (T). That’s worse than Greece. Is deflation America’s biggest economic threat?
Jay Taylor: I believe it is, however, most of my goldbug friends wouldn’t agree. It is important to realize that the U.S. is not a third-world country. It still has the world’s reserve currency. The central bank, the Federal Reserve, doesn’t put money into the hands of the masses. It puts money in banks. It’s all about credit extension. That is very difficult to do now. With the debt-to-GDP ratio as it is, it’s unsustainable. The markets are telling us that—not only in the U.S., but clearly in Europe as well. We are undergoing one of the largest debt-deleveraging periods in a long time, which may be much larger than what we went through in the 1930s.
TGR: You believe there should be no more bailouts, let this debt wrench itself out of the system and let bankruptcies occur.
JT: Absolutely. Most people don’t understand the reason we’re in trouble is because the good times that we had were false. They weren’t based on savings and investment. They were based on money creation through credit extension. The nice homes, the big office buildings, fancy cars, everything—it wasn’t earned, it was based on debt. Now that the debt cannot be repaid, the expansion goes into a contraction. That process has a long way to go.
TGR: Bob Prechter of the financial forecasting firm Elliott Wave International is predicting that gold and silver “should decline in conjunction with the stock market selloff. Gold should work down toward $1,300 an ounce (oz), while silver should fall into the low $20/oz area.” What’s your position?
JT: If you believe that we’re in a deflationary environment, the nominal price of gold could go down and the purchasing power of it could go up a lot. The real price of gold is most important for gold mining companies. Before the Lehman Brothers failure in July 2008, an ounce of gold would have bought only 17% of the Rogers Raw Materials Fund. It rose to 44% by March 2009, but came back a bit to 30%. It was recently up to a new high of 47.5%. Gold’s purchasing power is rising much more dramatically than its nominal price. Gold has fallen off its highs and is around $1,700/oz. As Ian McAvity has said, an ounce of gold is an ounce of gold. A barrel of oil is a barrel of oil. What is a dollar? It’s a meaningless measure because Federal Reserve Chairman Ben Bernanke can create trillions of dollars out of thin air.
TGR: Silver’s purchasing power on the Rogers Raw Materials Fund hasn’t experienced quite the same gain. In June 2008 it was just below 1%. Now it’s just below 3%.
JT: Silver has done very well, but it’s much more volatile. It has outperformed gold in general since Lehman Brothers’ collapse, however.
TGR: The International Monetary Fund (IMF) has agreed to throw the Eurozone countries a lifeline of about $0.5T. Will that be enough?
JT: My view on Europe is the same as on the U.S.—the kindest, gentlest thing to do would be to allow the debt to implode immediately. We’re allowing sick entities to survive and eat up resources. It’s contrary to free market capitalism. It’s really fascism. Large corporate interests are being protected because of their cozy relationships with government. A half trillion is not going to be enough. Where does the IMF get its money? Is the U.S. going to be asked to pony up more money for Europe? Probably. Are they going to sell the rest of the gold they have? Perhaps. That’s what the Soviet Union did before it collapsed.
TGR: You’re biased toward credit market deflation, but you continue to be partial toward gold and gold mining stocks. What are the reasons for that?
JT: Margins are widening. There is an explosion of profits for major mining companies in production before 2008: Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE), AngloGold Ashanti Ltd. (AU:NYSE; AU:JSE; AGG:ASX; AGD:LSE), Barrick Gold Corp. (ABX:TSX; ABX:NYSE), Goldcorp Inc. (G:TSX; GG:NYSE), Kinross Gold Corp. (K:TSX; KGC:NYSE), Newmont Mining Corp. (NEM:NYSE) and Yamana Gold Inc. (YRI:TSX; AUY:NYSE; YAU:LSE).
In 2008, those companies recorded $5.77 billion (B) of earnings collectively. In 2009, that jumped to $7.05B. In 2010, it jumped to $13.62B. The analyst consensus is that it’s going to go to $20.22B in 2011 and $28.28B for 2012. Margins have increased in this deflationary environment because the real price of gold has risen relative to the cost of mining it.
Bob Hoy, a technical analyst in Vancouver, figures we are in the sixth large credit contraction in the last 300 years. In every case, the real price of gold has risen over 15 to 20 years. The real price of gold started to rise in 2007. We could be in the early days of a super bull market for gold mining shares.
TGR: Those majors probably average $500/oz in cash costs. However, you have a buy rating on small Australian producer Crocodile Gold Corp. (CRK:TSX; CROCF:OTCQX), which just reported a loss of about $6 million for the quarter. Its cash costs are above $1,400/oz and its stock is down about 80% this year. Why on earth would you still have a buy rating on Crocodile Gold?
JT: I believe in the long-term prospects of this company. It’s had a lot of problems. Its costs were $250/oz higher than projected this year because of lower-than-expected grades from its open-pit projects. Clearly, that’s a black eye for management because something went wrong. But I still believe that this company has extraordinary exploration potential and will get costs under control.
TGR: For example, silver producer Great Panther Silver Ltd. (GPR:TSX; GPL:NYSE.A). As of Nov. 18, it was up 355% since you took your initial position. Great Panther is down almost 20% this year despite a strong Q311, however. What’s your outlook for Great Panther?
JT: Its decline is in line with the general market decline. It keeps improving on a fundamental basis and expanding its resource. It’s a fine operation that’s earning money.
TGR: What other smaller gold and silver miners are you interested in?
JT: My favorite might be Sandstorm Gold Ltd. (SSL:TSX.V), which is a royalty play. It has one of the best looking charts in a horrible market. Sandstorm provides the capital to get companies into production and then it gets a royalty. It usually gets the chance to buy maybe 15% or 20% of a project’s production for the life of that project at cost. It has several properties that are producing now. Its projects are getting bigger and production is growing. This is a company that’s going to continue to earn more and more very rapidly. There are fewer risks involved in this model than if it was an operator, too.
TGR: Its production forecast for this year is from 16–18 thousand ounces (Koz). However, that will increase to more than 50 Koz by 2014. That’s certainly strong growth.
JT: The gold price, where it is relative to the cost of mining and the expansion of production, means that earnings are going to grow very rapidly, if not exponentially.
TGR: Do you think that too many royalty plays kill the goose?
JT: That could be the case. With increased competition, they might be paying too much for the deals that they strike. However, I’m not concerned about that with Sandstorm at this point. Royalty plays, like Sandstorm, Silver Wheaton Corp. (SLW:TSX; SLW:NYSE), Royal Gold Inc. (RGL:TSX; RGLD:NASDAQ) and others, generally sell at much higher multiples than mining companies because there’s less risk involved. An operator can have any number of things go wrong and have to put in more capital to get things moving again.
TGR: It’s more of a matter of vetting these projects and being sure the geological model works and the metallurgy is good.
JT: Yes. I have a high regard for the management of Sandstorm. They’re really sharp. They get involved in projects that have enormous upside potential. It’s not just the ounces that might be in a bankable feasibility study. They look at the exploration potential and the expansion of production, too.
TGR: Let’s move down the food chain to the explorers. The portfolio scorecard in each edition of Hotline doesn’t paint a very kind picture of gold and silver exploration plays lately.
JT: Nope, not this year.
TGR: As of Nov. 18, only 8 of 50 exploration companies on that list, or 16%, were up: American Bonanza Gold Corp. (BZA:TSX), Metanor Resources Inc. (MTO:TSX.V), Prodigy Gold Inc. (PDG:TSX.V), Aurvista Gold Corp. (AVA:TSX.V), Meadow Bay Gold Corp. (MAY:TSX.V; MAYGF:OTCQX), Pretium Resources Inc. (PVG:TSX), Nautilus Minerals Inc. (NUS:TSX) and Rye Patch Gold Corp. (RPM:TSX.V; RPMGF:OTCQX). You still have buy ratings on the other 42 companies, however. Why are you still recommending small-cap companies exploring for precious metals?
JT: I believe in the sector. I can’t explain why the markets have treated the sector badly this year. The majors’ profits are up very sharply, yet the share prices haven’t even begun to keep up. It tells me that most of the players in the equity markets don’t recognize this as a gold bull market and they don’t see the potential for turnaround. They don’t realize, as Bob Hoy points out, that there’s probably another 15 years to go.
Gold is going to be strong for a long time because the financial sector, deleveraging and the loss of confidence in fiat money is going to keep the real price of gold and real earnings high. I told my subscribers when things started to turn that they should build some profits and keep some cash on the sidelines because the entire sector is likely to decline in price along with the general market.
The gold sector is being hurt badly and that’s an extraordinary opportunity. Why would I sell companies that I believe in even if, like Crocodile Gold, they’ve lost 80%? It would be a stupid time to sell. It would be a great time to take some of that cash that I suggested investors put aside and start to buy some of these companies as they decline. I don’t see any reason to jump ship now because I believe so firmly in the fundamentals of this industry.
TGR: The biggest gainer on the list of the companies that are up this year is American Bonanza Gold. It’s up about 70% this year, but about 232% since you took your initial position. Why is that junior performing so well?
JT: It’s on the verge of production at the Copperstone gold mine in Arizona. There were a lot of skeptics and the stock was extremely cheap. The costs are very low. It’s not a big mine and the production levels are fairly small, but it has really good exploration potential that can be built into a much bigger mining operation over the long term.
TGR: When is initial production expected?
JT: I believe in Q112.
TGR: American Bonanza should be generating some cash flow at that point.
JT: It should, with the caveat that more often than not startup operations have some kinks to work out. However, this was a previously producing mine. That reduces some of the metallurgical risk and other risks of a new startup. I’m confident it’s going to get the job done.
TGR: You recently interviewed management from Merrex Gold Inc. (MXI:TSX.V; MXGIF:OTCQX), which is not doing too badly this year. What did you learn about Merrex?
JT: Merrex is exploring the Siribaya deposit mine in Mali with IAMGOLD Corporation (IMG:TSX; IAG:NYSE) as its 50% joint venture partner and largest shareholder. IAMGOLD is there because it believes this is going to be a multimillion ounce deposit. And IAMGOLD is committed—it spent about $10 million to earn a 50% interest.
It has about 460 Koz from a relative high-grade open pit at a quarter grams per ton. However, that’s based on less than 5% of the total strike length of two major zones, plus another zone was discovered, too.
Moreover, some of the assays recently from the south end of the zone that was drilled have been much higher grades. The average grade may be even higher than 2.25 grams.
The only real downside is that the company has to rely on diesel fuel for now. There’s some vulnerability to spiking oil prices.
TGR: IAMGOLD is effectively using Merrex as an exploration arm.
JT: IAMGOLD is the operator of the project. It has a joint committee that decides on the strategy and drill programs. In fact, one of the management members of Merrex who I was with in Switzerland was going to Toronto on his return to talk to IAMGOLD about the next drill program.
TGR: You also have a buy rating on Calico Resources Corp. (CKB:TSX.V; CVXHF:OTCQX), which is drilling the Grassy Mountain gold project in Oregon. Oregon is generally not considered the most mining-friendly state. Why does Calico make your scorecard with a buy rating?
JT: Washington is probably considered one of the most difficult states in the country for mining. California had been very difficult, but it’s getting tougher everywhere. Calico management discovered by doing research that Oregon is no more difficult than any other Western state.
Politicians with common sense know the local people want jobs. Where are the jobs going to come from? Mining is a wealth-creating activity. It’s not going to be easy. Getting permits moved through the pipeline can be difficult, but I have confidence in the management team at Calico led by Chairman Buck Morrow, for whom I have a high regard.
Grassy Mountain was worked on during the last gold bull market. The potential there is extraordinary. It has gotten some really nice assays back.
TGR: What are some other precious metals explorers that you’re following closely and remain excited about?
JT: I love Rye Patch Gold in Nevada. It has 3.1 million ounces (Moz) gold, but it has 3.9 Moz gold equivalent including silver. Rye Patch clearly has a shot at building something much bigger than that with its good management and miniscule market cap.
I also like Metanor Resources a lot. Since Sandstorm provided capital, the company has been focusing on its underground Bachelor Lake mine in Le Sueur, northeast of Val d’Or, Québec. Bachelor Lake is going to be put into production within the next six months to a year. It should do very well with that. It also has the Barry deposit, which has the potential to be a very large deposit similar to Osisko Mining Corp. (OSK:TSX).
Québec is one of the best provinces in which to run, explore and develop projects. Aurvista Gold in Québec has 2 Moz and huge exploration potential. Pretium Resources also has a huge deposit up there next to Seabridge Gold Inc.’s (SEA:TSX; SA:NYSE.A) gold-silver deposit. Pretium is headed by Bob Quartermain and a very strong management team. It’s actually been one of the winners this year.
TGR: Do you have any parting thoughts?
JT: It’s painful sitting with stocks in this kind of a market, but that’s the nature of the beast. You hold a junior mining company and all of a sudden it takes off. You just don’t know when. You have to believe in the fundamentals of the story and the chance to come up with something big. A couple of times I’ve walked out of a stock and a day or two later the company made a great discovery—that is really painful.
TGR: How would you respond to someone like Rick Rule who says it’s not about the 80% you lost, it’s about what you do with the 20% that you have left?
JT: I suppose that’s right. Rick is a very conservative investor. He really likes to buy stocks when they’re cheap. He’s a very disciplined trader. You want to protect that 20%. When you get a market that’s on the upside, you can make that 80% back very quickly if you’re in the right stocks.
Of course, I’d never recommend that investors back up the truck and bet the farm on any one company. I have a lot of companies on my list because I believe in diversification. These little penny mining companies, the miniscule market-cap companies, can be tenbaggers in a hurry if they’re successful. Whenever you invest in a deal, you can lose 100%, but you can’t lose 1,000%. The upside is limitless.
With 20/20 hindsight I should have sold everything and waited until now to buy, but I didn’t know for sure how the markets were going to treat gold stocks this year. But I’ve been telling investors to build some cash for this kind of environment. Now is the time to be buying.
TGR: Thank you.
As he followed the demolition of the U.S. gold standard and the rapid rise in the national debt, Jay Taylor’s interest in U.S. monetary and fiscal policy grew, particularly as it related to gold. He began publishing North American Gold Mining Stocks in 1981. In 1997, he decided to pursue his avocation as a new full-time career—including publication of his weekly Gold, Energy & Tech Stocks newsletter. He also has a radio program, “Turning Hard Times Into Good Times.”
By The Energy Report, on November 30th, 2011
 The prospect of significant U.S. natural gas production may not be powerful enough to overcome the hot air coming from government quarters, but ShadowStats Editor John Williams identifies it as one bright spot in his otherwise dark outlook for the U.S. economy. As Williams tells The Energy Report in this exclusive interview, increased domestic shale production may not save the U.S. dollar from extinction but it just might have a major positive impact on the GDP, the trade deficit and employment.
The Energy Report: You’ve been tracking macroeconomic trends and their impact on energy commodities for decades and since 2004 through your Shadow Government Statistics newsletter. In a Nov. 10 piece on the trade deficit, you wrote:
Massive fundamental dollar dumping and dumping of dollar-denominated assets may start at any time with little or no further warning. With the U.S. government unwilling to balance or even address its uncontainable fiscal condition and with the Federal Reserve standing ready to prevent a systemic collapse so long as it is possible to print, spend, loan or guarantee whatever money is needed, it puts the U.S. dollar at increasing risk of losing its global reserve currency status. Much higher inflation lies ahead in a circumstance that rapidly could evolve into hyperinflation.
What would be the first sign that hyperinflation is taking hold?
John Williams: I’d look at the dollar. You’ll see massive selling of the U.S. dollar and dumping of U.S. dollar-denominated assets as an early indication. That will be very inflationary, and an indication of global loss of confidence in the U.S. currency. We’ve already crossed that bridge.
Based on generally accepted accounting principles, the annual U.S. budget deficit is running in excess of $5 trillion. Such a deficit is beyond control and containment and dooms the U.S. government to ultimate insolvency and a likely hyperinflation. Money is printed to meet obligations; the government cannot cover its debt otherwise. The efforts by the Fed and federal government to contain the current systemic solvency crisis have moved the onset of a hyperinflation from the end of this decade to the relatively near term.
If you look at the debt-ceiling negotiations and the deficit-reduction deals that were in progress back in early August, it became clear to the rest of the world that the people running the U.S. government had absolutely no political will to address its long-term insolvency. You saw a very heavy selling of the U.S. dollar right after that. This was even before the Standard & Poor’s downgrade.
TER: The downgrade was an indicator of the loss of confidence, though—not the cause.
JW: The downgrade only exacerbated the problem. Once it was clear that there was no political will to address the fiscal issues, dollar selling became intense. Official actions followed that provided temporary support for the U.S. currency. You saw the Swiss franc soar relative to the dollar. The Swiss then intervened, with a quasi-tying of the franc to the euro, which effectively also meant intervention to support the dollar. Gold prices soared, and gold future margins were narrowed.
The lack of global confidence in the dollar underpins the extremely volatile markets since that time. We’ve seen all sorts of interventions and all sorts of rumors floated, but I believe the fundamental global confidence in the dollar has been mortally shaken. As you see mounting selling pressure on the dollar, you’ll generally see spikes in commodities that are denominated in U.S. dollars, particularly oil. That’s very important to the U.S. in terms of inflation. That’s where heavy dollar selling will be seen as a trigger for rising consumer prices and as an early trigger for hyperinflation to move into full speed.
TER: What happens to oil prices in hyperinflation?
JW: It depends on how they’re denominated. I suspect if the dollar becomes weaker, we’ll see a very rapid and strong movement to base oil pricing in something other than U.S dollars. The value of the OPEC (Organization of the Petroleum Exporting Countries) members’ income will drop very quickly as the dollar value drops in terms of international exchange. If oil were denominated in Swiss francs, you might not see too much of a spike, but looking from the perspective of someone living in a U.S. dollar-denominated world, the pace of increase in oil prices will be directly and proportionately tied to the weakness in the dollar against whatever the valuation base is for oil.
TER: The Department of Energy (DOE) reported that gas prices declined 0.8% in September. Are you seeing that gas prices are declining or increasing according to your statistics?
JW: I think the DOE aggregate prices are reasonably accurate on gasoline. You’re going to have ups and downs in the market with very volatile oil prices, as we’ve seen over the past couple of years. Various factors will affect it. For instance, a crisis in the Middle East can spike oil prices very rapidly. But as the dollar comes under massive selling pressure, oil prices will spike, and a rapid decline in the U.S. dollar will result in a very rapid rise in oil prices in dollar-denominated terms.
TER: September gross domestic product (GDP) numbers showed a slightly narrower trade deficit compared to August, partly due to declining oil prices and import volume. Your newsletter suggests possible inaccuracies in federal data. Can these numbers be trusted?
JW: I pay no attention to GDP as an indicator of what’s happening in the broad economy. There’s a major problem with the way the government adjusts its data for inflation. The way it comes up with the headline number, growth is deflated by its estimate of inflation. To the extent that the inflation is understated, you end up with overstated GDP growth. Perhaps not too surprisingly, government-reported inflation is understated, which causes significant overstatement of official economic growth. That’s one reason the GDP is out of whack.
The GDP inflation estimate includes what the government calls hedonic adjustments, where nebulous quality adjustments are factored in and subtracted from inflation. I estimate this takes about two percentage points off the annual inflation number. If you deflate the GDP corrected for that, you’ll see that we never recovered from this recession.
TER: Is that the case with oil price estimates?
JW: Oil price impact on the GDP is not obvious to the casual observer. If oil prices rise, that usually means a higher inflation number and, therefore, it could be expected to weaken the inflation-adjusted economic numbers. So in terms of domestic oil production reflected in the GDP, in nominal terms—before inflation adjustment—part of the production number increases because oil prices are higher, but that gets reduced out when inflation it is factored in. That’s what most people think of as the inflation effect. But remember, we import more oil than we export, and the imports are subtracted from the GDP. So high oil inflation, which would traditionally lower the rate of growth, actually increases the pace of total GDP growth because the negative effect actually is subtracted out as part of the aggregate negative net exports.
In other words, higher oil prices actually spike GDP reporting because of the way the net exports are handled. That’s the nature of the GDP. Again, I put no value in the GDP as an indicator of economic activity.
TER: That’s for prices of oil. What about volume? In September, oil volume was down according to government statistics.
JW: I believe the government has fairly good measures of the physical flow of oil. The reporting of the flows, though, does not always hit when it should. The paperwork flow on imports is better than it is on exports. Duties are sometimes assessed on the imports so they keep much better track of that than they do for goods where they don’t collect money.
TER: So if oil imports were down from September to October, is it simply because, as you said, we never came out of the recession? Or does it mean we’re going into a double-dip recession?
JW: I wouldn’t read much into that because you can argue it either way. You can make all sorts of stories from it, and the people who hype the GDP numbers for the market are pretty good at spinning their yarns.
TER: So if we’re looking at hyperinflation sooner rather than later—which would affect oil prices very directly—how can individual investors protect themselves?
JW: They need to preserve their wealth, assets and purchasing power by getting into hard assets. If you look at oil as a hard asset, it will tend to preserve purchasing power, but it’s a consumable and not easily portable. You can’t stick it in your briefcase and carry it with you if you move from one place to another. It’s difficult to spend physically. So in terms of hedging, I would look primarily at the precious metals and getting assets outside the U.S. dollar into the stronger currencies, particularly the Australian dollar, the Canadian dollar or Swiss franc—despite the Swiss interventions. I’m looking long term. We can expect a lot of volatility short term, but when massive movement against the U.S. dollar begins, those areas will do very well.
TER: Any other energy-related issues that our readers should be aware of to prepare for hyperinflation?
JW: I’m looking at the hyperinflation primarily in the U.S. dollar, not in other currencies, so it’s largely a dollar problem, and the basic protection for those living in a dollar-denominated world is to be out of the U.S. dollar. If you live in a world denominated in Swiss francs or one of the other stronger currencies, you need to think seriously about where you have your dollar investments. That’s the basic consideration from the standpoint of hyperinflation, whether you’re in the energy industry or you’re a farmer or Wall Street trader.
TER: Is there any way to create store-of-wealth value in agriculture?
JW: Farm land is a good hedge, but there’s a difference between holding hard assets with short-term liquidity, such as physical gold, to get through the tough times until after things stabilize, versus assets that may have short-term liquidity issues. Real estate may present liquidity problems at various times, although long term, it’s a fine hedge in terms of maintaining purchasing power. Up front, though, your core assets hedging a hyperinflation have to have enough liquidity so that you can respond to circumstances as they evolve.
In this environment, those invested in the energy sector also have to realize that demand for energy goods will tend to be lower than it might be otherwise, because the U.S. economy will continue to be weak, and not much is being done to fundamentally address that. On the other hand, if domestic oil production could replace foreign production, you could still have a positive domestic demand environment. I’d push for that as much as possible.
TER: Could drilling for natural gas in the U.S. really have an impact on the import/export statistics going forward?
JW: If we can increase exports, that would be a plus. To the extent we produce it domestically and import less as a result, that also would be good for the economy. To the extent anything is produced domestically, that’s a big plus for the economy.
TER: Can we pump and use enough natural gas domestically from the shales to actually make a difference or are we talking too small of a number compared to the amount of oil we import?
JW: I am not an expert on natural gas production. Of course volume is an important factor, and a major increased production would have a significant, positive impact on the GDP. Anything that increases U.S. production and reduces the trade deficit is a plus. Usually increasing domestic production would have the effect of decreasing the deficit. The deficit is a negative for the economy and for jobs. So anything that reduces the trade deficit will be a positive factor for U.S. employment.
TER: That makes sense and is very helpful. Thank you for taking the time to talk with us.
Walter J. “John” Williams has been a private consulting economist and a specialist in government economic reporting for 30 years, working with individuals and Fortune 500 companies alike. He received his AB in economics, cum laude, from Dartmouth College in 1971 and earned his MBA from Dartmouth’s Amos Tuck School of Business Administration in 1972, where he was named an Edward Tuck Scholar. Williams, whose early work prompted him to study economic reporting and interview key government officials involved in the process, also surveyed business economists for their thinking about the quality of government statistics. What he learned led to front-page stories in the New York Times and Investor’s Business Daily, considerable coverage in the broadcast media and a joint meeting with representatives of all of the government’s statistical agencies. Despite a number of changes to the system since those days, Williams says that government reporting has deteriorated sharply in the last decade or so. His analyses and commentaries, which are available on his ShadowStats.com website have been featured widely in the popular domestic and international media.
By B.P.T., on November 22nd, 2011
At 7:45 AM Eastern time, the weekly ICSC-Goldman Store Sales report will be released, giving an update on the health of the consumer through this analysis of retail sales.
At 8:30 AM Eastern time, the preliminary GDP report for the third quarter of 2011 will be announced. The consensus is an increase of 2.4% in real GDP and an increase of 2.5% in the GDP price index. The real GDP estimate is 0.1% lower than the advance value for the third quarter of 2011, and the GDP price index is the same.
Also at 8:30 AM Eastern time, the monthly Corporate Profits report from the Bureau of Economic Analysis will be released.
At 8:55 AM Eastern time, the weekly Redbook report will be released, giving us more information about consumer spending.
At 2:00 PM Eastern time, the FOMC Meeting Minutes will be released, which will provide insight into how the Federal Reserve board governors and bank presidents view the economy.
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By The Gold Report, on November 15th, 2011
 A $3,000/ounce gold spike could boost equity valuation. In this exclusive interview with The Gold Report, John Kaiser, editor of Kaiser Research Online, shares the catalysts that could propel gold and silver stock prices higher in 2012.
The Gold Report: Gold prices reached historic highs during the last quarter. However, in a recent Kaiser Bottom-Fish newsletter, you showed the Toronto Stock Exchange Venture (TSX.V) listings since February have had dramatically more down than up days. Is this a correction or a long-term trend?
John Kaiser: What we have seen is a negative response by ordinary investors to a deteriorating economic outlook for the United States and the world, which we might call a correction of expectations. But what worries me about a long-term trend is the growing prevalence of volatility-based profit harvesting, high-frequency and algorithmic trading paired with the elimination of the downtick rule for short selling, which allows traders to push markets down or up at will and in the process destroy perceptions of value in the market. This has been particularly intense in the junior resource sector, which the TSX.V is dominated by, because these companies, generally, do not have revenues and cash flow, the usual measures by which value is assigned.
It is very difficult to develop a visualization of what a venture project is all about, what it could become and turn that into a market valuation that enables the company to finance its projects at minimal dilution to existing shareholders. It is much easier to pound the order book, fill it with sells and completely undermine the perception of the people who have been investing for value. The bottom line is that we have seen a withdrawal of value-style investors from this market, both at the retail and sophisticated levels. As an example of how significant this has been, during February, the Venture Exchange averaged $310 million (M) worth of trading per day. By October, the average value traded had plunged to $94M per day.
TGR: Are you saying that the difference is not because of the fundamentals of the stocks and the companies behind them that are on the TSX.V, but because the rules have changed and people are playing around the volatility?
JK: It is a combination of the two. We had a surprise recovery in the resource sector in 2009 and 2010, facilitated by U.S. quantitative easing and China’s stimulus program that injected $600 billion into infrastructure development. Coupled with strategic Chinese stockpiling, that helped pull up raw material prices from the end-of-2008 lows. But the Fukushima nuclear disaster with its supply chain interruptions and the emergence of the Tea Party as a major force in the debt ceiling debate conspired to make the world very concerned that the creeping recovery is going to tip back into the garbage can. That has stalled the post-crash recovery in raw material prices, leading investors to price in the possibility of the global economy descending into a 1930s-style depression. Contrary to the beliefs of many goldbugs, a depression would also be negative for gold and silver prices.
TGR: In addition to some of these short-term trends, you have talked about the possibility that the United States is moving away from its power position. Europe and America are descending while China and India are ascending. Do most people see this? And is this impacting the stock market?
JK: The “declinist view” says that the U.S. economy and its military power are in a long-term downtrend. In at least economic terms, this is supported by gross domestic product (GDP) statistics. In 2000, the U.S. GDP was 32% of global GDP while China’s was about 5%. Since then, American GDP has sunk to about 22% while China’s sits at just under 10%. At the same time, we have seen America’s share of total military expenditures rise from about 40% to 43%, where it seems to be going sideways. The U.S. is carrying an unsustainable burden of the cost of keeping the global peace. With America’s share of global GDP in long-term decline, the ability to fund almost single-handedly a global military force is not sustainable.
TGR: Based on that, what is your prediction for the final quarter of 2011?
JK: What I have described is a long-term trend that is underway. Right now, we are in the throes of sorting out what is going on with the Eurozone. Europe is in danger of imploding upon itself. It needs to stabilize its financial situation. At the same time, we need to see some signs that the American economy is rebounding. Employment statistics are going to be important. After losing nearly 6 million manufacturing jobs between 2001 and the end of 2009, some 303,000 manufacturing jobs have been created since 2010. This trend stalled earlier this year because of the Japanese supply chain disruption and concern that the political quagmire will result in consumer demand destruction. We need manufacturing capacity to come back to the U.S. in order to support the growing service job economy. The uncertainty about the growth of real jobs could result in a very volatile market during the last couple months of this year.
Wall Street sees down as easier than up, so the tendency is to lean on the market and pressure it down. A big tax loss selling window is going to emerge soon. We may even see a bottom-fishing window open up. My concern is that shareholders who understand why they own quality stocks will be reluctant to sell at the bottom after enduring what amounted to a nearly yearlong slow motion crash. On the other hand, low quality stocks will probably be sold ruthlessly. That means poor liquidity in the better stocks, but very high liquidity at very cheap prices in the stocks that do not have staying power. We may, in fact, see an icicle-type formation where prices dip down because there has been lots of selling into the bids without significant replacement by new bids. Too many investors remember how unwise it was to catch half-price bargains in the fall of 2008 that turned out be falling knives and anvils. When people finally go looking for quality stocks at depressed prices this December, they will find little available. As they start to reach for stocks, prices will spike upward and kick off Q112 with a strong uptrend.
TGR: In an environment like this, what is the best way for an investor to protect wealth or maybe even profit?
JK: My area of specialty is the resource sector, both the mining companies and the resource exploration and development companies. If you accept my belief that the strength in gold and silver prices reflect anxiety about the relative decline of the United States as both an economic and military power, which I see manifested in the fact that the value of all the aboveground gold and silver has risen to 12% and 3% of global GDP, respectively, from the 4% and 0.5% levels that prevailed a decade ago when America was indisputably triumphant, we will see prices head modestly higher from current levels over the next five years.
That is very significant for the gold and resource producers and juniors because they are pricing a bubble-type perception, namely that gold is going to go back to $1,000/ounce (oz) and that silver is going to go back below $15/oz, prices that could make many of these companies unprofitable. That is the reason we are seeing very low cash-flow multiples similar to what we often see in industrial mineral-type companies. So the big bet here is that we will witness an inflection when people start to accept that the current gold and silver prices are the new reality, which will result in an upward repricing of anywhere from 100–300% for gold and silver companies.
One strategy is to look at the solid, cash flow-positive silver and gold producers right now, and take a position in them. A secondary strategy would be to look at the gold and silver ounce-in-the-ground development companies, which are trading at valuations considerably lower than what you get by plugging current metal prices into the discounted cash-flow valuation model.
TGR: What would be some examples of companies that fit either the cash-flow positive or the development company trading at a lower-valuation model?
JK: Fortuna Silver Mines Inc. (FVI:TSX; FSM:NYSE; FVI:Lima Exchange) has a mix of silver and base metal production. It would benefit considerably if people expect the current cash flow to be sustainable over the next few years.
TGR: It looks like it is trading at $6.58 right now. It has been as high as $7.22.
JK: Right now, Fortuna is being priced at roughly a very conservative six-times multiple of 2012 cash flow based on forecast production and the current $34/oz silver price. The reason it is so low is that people do not think the cash flow is sustainable. That can be either because they think a mine will encounter a problem and cease production or because they expect the commodity price to go down substantially.
So far, Fortuna has not disappointed us with production from Caylloma, but we do need to see production ramp up for San Jose to proceed next year as expected. But a lowish 5–7 multiple for next year’s forecast production at current silver prices seems to be the norm for primary silver producers. To help my readers better understand the situation, I have created a couple of graphics based on our production and cash-flow forecast for Fortuna. The annual production and price target chart shows the impact San Jose coming on stream will have on silver production over the next four years. In 2012, San Jose will add 1.7–1.9 million ounces (Moz) from Caylloma, growing overall silver production to 5 Moz annually by 2015. The chart shows the stock price that would result at a 10 times cash-flow multiple at different average silver prices for 2012.
As you can see, the current $6.58 stock price is not far from the $7.01 price target that corresponds with a $20/oz silver price and a 10 times cash-flow multiple. But if we apply the current $34.64/oz silver price, the stock price jumps to $11.20 at a 10 times multiple. At $50/oz silver, the price target jumps to $15.59. You can also see what happens at more optimistic silver prices such as $75 and $100. A five times cash-flow multiple is too conservative for a precious metals producer such as Fortuna whose silver production at $20/oz silver is 60% of revenue.
Once there is acceptance that silver prices are not going back to the bad old days, you could see a 15:1-type multiple emerge. It is hard to predict what sort of cash-flow multiple the market will eventually settle on during these volatile times, but the second Fortuna chart helps me see the price target for Fortuna during 2012 at various average silver prices and cash-flow multiples.
For example, suppose you think, like I do, that silver could average $50/oz in 2012 and silver producers attract a 15 times multiple. Slide that vertical silver bar reflecting the current silver price over to $50/oz, and move up to the green line corresponding with a 15 multiple and you get a price target just short of $25/share for Fortuna. It should be obvious that the market is biased toward a pessimistic scenario where silver crashes back to $20/oz. Keep in mind that this cash-flow-based valuation metric assumes that higher silver prices are not due to substantial cost inflation or U.S. dollar exchange rate declines, which would gobble up any gains in silver revenues caused by price increases.
The primary silver producers are companies that did all the heavy lifting in the past few years, putting their silver deposits into production. They are now getting an enormous amount of cash flow, but are not being priced as if this cash flow will be sustainable over the life of the mine. So, the big bet is whether current silver prices are sustainable over the next five years. I am arguing that they are sustainable and we will see a valuation paradigm shift where these low cash-flow multiples of 5:1 will jump up to a 10:1 or 15:1 ratio. What will follow is an aggressive development of more silver production absent the concern that capital expenditures will end up being lost because silver prices collapse.
TGR: Could a shift to 10:1 pricing boost all silver producers?
JK: If the silver price proves to be sustainable, we could see the stocks all undergo significant gains as they adjust to this new paradigm, as is evident in the Upside Potential chart for the 15 primary silver producers we track. The one apparent exception is Aurcana Corporation (AUN:TSX.V), which looks weak because in 2012 its Shafter mine will add only 900,000 silver ounces to the existing 1 Moz production from La Negra. But Shafter is forecast to hit 3 Moz in 2013, bringing total production to 4.8 Moz in 2015. So Aurcana might be the laggard to watch for those speculators who prefer to react to the inflection rather than anticipate it.
TGR: On the gold side, you pointed out in a recent article that the inflation-adjusted equivalent of the post-1980s bubble of $400/oz would be $1,032/oz and that $1,800/oz gold represents a 74% real gain. What are you predicting is going to be the new normal for gold?
JK: Much of the discussion about gold treats it as an inflation hedge. We can argue that the big move during the 1980s was a slingshot effect that allowed gold to catch up for decades of inflation while its dollar price was artificially fixed. Goldbugs today will argue that the “real price gain” I am observing is just an anticipation of the inflation that will come once the world’s debt problems are monetized. If they are correct, then it explains why there is such muted interest in gold equities despite record gold prices. Whatever profits are present today will vanish tomorrow when costs undergo an inflation big bang. But I think there is a different reason for this “real price gain” to be present, and it is not bad for gold equities, at least not in the medium-term future.
Rather than relate the value of the existing gold stock to measures such as the money supply, I look at gold’s value as a function of global GDP. Given that GDP represents the total value of exchanged goods and services whose turnover one can assume created wealth while gold just sits there growing incrementally while accomplishing very little, you might wonder what the connection would be between wealth creation and the value of the gold stock. This chart graphs the annual value of the aboveground gold stock based on the average annual gold price as a percentage of nominal global GDP expressed in U.S. dollars at the average currency exchange rates prevailing each year.
That description is a mouthful, but I find the graph fascinating because it shows a massive spike to an $850/oz gold peak of 26% in 1980 when it looked very much like America was losing it on the global stage, plunging to a low of 4% in 2001 when it looked like the world was America’s oyster. Since then, we see a gradual increase to a peak of 15% in 2011, but still well short of the 1980 peak of 26%. We see a similar pattern with the aboveground silver stock.
Note that during the past 30 years miners added 2.2 billion ounces (Boz) gold to the 3.2 Boz that existed in 1980, and 17 Boz silver to the 30 Boz that existed then. This graph includes the value of that additional gold and silver.
The possible meaning of this trend begins to take shape when we look at another chart that plots the American and Chinese GDP as a percentage of global GDP, along with plots of each nation’s military expenditures as percentages of global military expenditures. America’s GDP percentage has declined from 32% in 2000 to its current level of 22%, while China’s has grown from 4% to nearly 10%. At the same time we see America’s military spending stuck at about 43% of global spending, while China’s share has nearly doubled to just over 7%, a trend that closely tracks the growth of its GDP. Given political efforts to contain government spending, and the fact that military spending is the single biggest item in the spending budget, an obvious question is what exactly does this overwhelmingly high percentage of global military spending accomplish, and do American taxpayers proportionately benefit? Regardless of the answer, what happens if these inversely related American and Chinese GDP percentage trends continue along their trajectories?
In my view, the expansion of the value of the aboveground gold and silver as percentages of global GDP reflect growing international uneasiness about the next two decades during which America and China respectively become relatively weaker and stronger on the global stage. The real price increases we have seen in gold and silver reflect this growing structural uncertainty rather than fear about hyper-inflation and fiat currency collapse. And short of a catastrophic global economic collapse that causes China to implode worse than the United States, I do not see anything on the horizon to make this anxiety diminish.
So let’s assume that, rather than an escalation of anxiety such as we saw in 1980, we are stuck with persistent medium-level anxiety that, for argument’s sake, stabilizes at a level where the value of the gold stock is 10% of GDP and in the case of silver 3%. These are levels less than half the peak percentages of 26% and 14% achieved for gold at $850/oz and silver at $50/oz in 1980. If we accept the global economic growth projected by the International Monetary Fund and gold production increases over the next five years along the lines projected by CMP or GFMS, then at a 10% “anxiety” percentage of GDP I can see the gold price trading in a range of $1,400–1,700/oz during the next five years. In the case of silver at 3% of GDP I see a range of $45–60 which is even better than the current $34 price.
I am confident that these new levels are the new reality, which means that this 50–70% real gain that we see in the price of gold represents a lot of potential profit to be harvested by putting into production deposits that three years ago would not have been economic. This is good news for producers and ounce-in-the-ground projects that have a significant profit margin to be captured if they are put into production and can sell their gold at prices of $1,500–2,000/oz over the next five years.
TGR: So if we assume $1,500–2,000/oz gold prices, what are some of the juniors that could profit in the next year or so?
JK: One that has been an ongoing recommendation is Spanish Mountain Gold Ltd. (SPA:TSX.V), which was formerly Skygold Ventures. It trades at about $0.80 right now. At a gold price of about $1,750/oz, it has a potential value of just under $2/share when I run the parameters published in the junior’s 2010 preliminary economic assessment through a discounted cash-flow model at a 10% discount rate. At a gold price of $1,100/oz, Spanish Mountain is worthless. So this is an example of a large-tonnage, low-grade deposit, which at the prices from a few years ago is basically dead in the water.
But at the $1,750 level, it’s potentially a $1.50–2 stock. If gold ends up at $2,500/oz, I could see Spanish Mountain being worth $4, but only if such a gold price rise is not accompanied by capital and operating cost escalation. I certainly do not rule out a spike toward $3,000/oz over the next few years—$3,300/oz right now would be the equivalent to $850/oz in 1980 if we take gold’s value as 26% of GDP as the bubble limit. Although unsustainable, such a move would create a tidal wave of interest in the sector. It would trigger a gold price valuation paradigm switch for gold equities similar to what I am predicting for silver. People would start taking the current prices seriously and plug them into their cash-flow models instead of using $1,100/oz 3-year trailing averages for gold projects.
Instead of suspiciously viewing today’s gold prices as a trend that will end terribly, people need to look back at a long-term gold chart from the early 1970s when the price went from $35/oz to $850/oz. Yes, that was a hyperbolic chart and it still stalled out. But gold stalled out at $400/oz and stabilized there. And that was a huge, 500% real increase. So we had 30 years of gold production where all this fruit that had previously been very high in the trees was suddenly turned into low-hanging fruit that the mining industry systematically harvested and added 2 Boz to the 3.2 Boz that existed in 1980. What we are witnessing now is on a somewhat smaller scale, but if you use this measure of the gold value as a percentage of global GDP, then the current percentage of about 12% is still halfway from a bubble limit where it starts becoming too much of a self-fulfilling phenomenon that has to burn out and crash back.
TGR: So what about a hybrid company? You have written about Geologix Explorations Inc. (GIX:TSX). It is trading at $0.28 now. Is that factoring in higher metals prices? Where could that go?
JK: Geologix is copper and gold. An important message I am trying to send to my audience is that gold is not inversely related to economic strength anymore. It is not a hedge against the world economy collapsing, which normally means what is good for copper is bad for gold, a reason miners who understand the meaning of “hedge” like copper-gold mines. The real price strength of both copper and gold is now twinned.
Because Geologix is still perceived as more of a potential copper producer than a gold producer, when copper prices retreated earlier this year, the stock followed. While we can argue into the wee hours whether or not my analysis of the factors driving the gold price is correct, few will dispute that strength in copper is a function of expectations that the global economy will continue to undergo growth rather than go back into a major recession.
If you are inclined to believe that the global economy is more resilient than most people think, but still lean toward the notion that what is good for people in general is bad for the gold price, then a copper-gold project such as Geologix’s Tepal project in Mexico merits attention. I have run discounted cash-flow models of Tepal based on the preliminary economic assessment parameters presented by Geologix in April 2011 in which I assume a pessimistic scenario of $2/pound (lb) copper and the optimistic scenario of the current $3.50 price. At the current $1,750/oz gold price, the model shows a price target of only $0.67 using a 10% discount rate, but at $3.50/lb copper the target jumps to $2.03. At $1,400/oz gold and $2/lb copper, Tepal is dead, an outcome the market already seems to be pricing into the stock at $0.29. But if copper stays at $3.50/lb and gold soars to $2,500/oz, the Geologix price target blossoms to $3.50. Geologix is thus a good example of a leveraged play on my theory that gold’s strength is linked to a growing economy rather than a faltering one.
TGR: Any other good examples of how the rerating of gold prices into stock prices could impact companies you are following?
JK: One of my newer picks is a company called Probe Mines Ltd. (PRB:TSX.V). A year and a half ago, it was pretty much just limping along on the basis of a small claim it had in the McFauld’s Lake area of Ontario where it covered a fraction of a chromium deposit. But since then it has made a brand-new gold discovery in the Borden Lake area of Ontario, and it just published an Inferred resource of over 4 Moz at a fairly low grade of about 0.7 grams/ton. At current prices, this represents about $40/ton. It is one of these large, disseminated gold systems that will be amenable to open-pit mining, a similar concept to Spanish Mountain. Probe has not yet done the economic scoping studies needed to identify operating and capital costs, the key to evaluating the impact of the current gold price on undeveloped gold deposits. Here is an opportunity to benefit from comparing similar deposits such as, say, Brett Resources Inc. (BBR:TSX.V) and its Hammond Reef deposit that Osisko Mining Corp. (OSK:TSX) bought for about $500M while gold had a lower price than today. Probe’s total valuation is only about $187M based on 80M shares fully diluted. With expansion drilling underway there is potential to get a stock price boost from the discovery of additional ounces, not just growing confidence in the current gold price and optimism about mining costs at Borden Lake.
TGR: How high do you think it can go?
JK: In the short term, I would expect $3–4 if it delivers its preliminary economic assessment by the end of Q112 and the numbers are similar to Brett’s Hammond Reef, if not better, but if the exploration drilling establishes similar mineralization along the fold of this belt where no real work has ever been done in the past, it could end up boosting this resource to a 5–10 Moz system. At that level, it starts becoming interesting to a major. Then we could see this stock flirt with a $5–10 range. Plus, it was financed earlier this year to the tune of $25M, and again a week ago for $15M, so there is no need to worry about financing dilution risk in the near term. And the Black Creek chromium asset could be a target for Cliffs Natural Resources Inc. (CLF:NYSE), which is developing its Big Daddy chromite project in Ontario. That could give this company another injection of capital without having to undergo equity dilution.
TGR: You mentioned that you now see gold as positive toward economic development, not inverse to economic health. Do you think that higher gold prices are driven by goldbugs or by investors who are looking to profit?
JK: It is my view that goldbugs are a minority. I believe the buying is by investors who are simply hedging some of the wealth, higher net worth people who are putting a portion, maybe 5%, of their wealth into gold. They have the most to lose if the world becomes unstable, and currencies fall apart relative to each other. They don’t need that 5% of their wealth that they are stashing in gold. A similar thing is happening with silver, except it is driven by people in emerging nations where they cannot really afford a 1 oz gold coin and they don’t trust their governments, so they are using silver to store accumulated wealth. Therefore, a lot of silver, which primarily was fabricated into industrial applications, is now being pulled out of those applications by the high price and being redistributed as a very dispersed asset class. It is not going to come back into the system quickly, just as I don’t think the gold overhang is going to come back because investors decide to grab a profit and run. Frankly, I think gold and silver ownership will be quite boring in profit or loss terms during the next year, which is very good for gold and silver equities.
TGR: Thank you, John, for your insights.
John Kaiser, a mining analyst with over 25 years of experience, is editor of Kaiser Research Online. He specializes in high-risk speculative Canadian securities and the resource sector is the primary focus for an investment approach he developed that combines his “bottom-fishing strategy” with his “rational speculation model.” Kaiser began work in January 1983 as a research assistant with Continental Carlisle Douglas, a Vancouver brokerage firm that specialized in Vancouver Stock Exchange listed securities. In 1989 he moved to Pacific International Securities Inc., where he was research director until April 1994 when he moved to the United States with his family. He launched the Kaiser Bottom-Fishing Report (now Kaiser Research Online) as an independent publication in October 1994 and developed it into an online commentary and information portal. He has written extensively about the junior resource sector, is frequently quoted by the media, and is a regular speaker at investment conferences. Since 2008 he has developed a focus on security of supply issues and how they relate to critical metals such as rare earths.
By Eldon Mast, on October 31st, 2011
Last week stocks surged, extending the biggest monthly rally for the Standard & Poor’s 500 Index since 1974, and the euro strengthened as European leaders agreed to expand a bailout fund to stem the region’s debt crisis. The 20 percent monthly advance for the Dow Jones Transportation Average, a proxy for the economy, is the biggest since 1939. The S&P 500 rose to its highest level in almost three months and has rebounded 17 percent since Oct. 3.
In addition to remembering 1974, Economic growth strengthened in the third quarter and the component mix is more favorable than expected. GDP growth improved to a 2.5 percent annualized increase in the third quarter. The advance estimate matched market expectations for a 2.5 percent gain. (For once the majority was right!)
Optimism is clearly now appearing as the consumer sentiment index jumped to 60.9 compared to 57.5 at mid-month to imply a 64.3 level for the final two weeks of the month. The improvement the last two weeks is centered in the leading component of expectations which jumped 4.8 points to 51.8. The current conditions component also rose, up 1.3 points to 75.1. Inflation expectations show no change from mid-month, at 3.2 percent for the one-year outlook and 2.7 percent for the five-year.
And on the job front, initial jobless claims are holding steady in a narrow range just above 400,000. Claims came in at 402,000 in the October 22 week, a bit better than expectations. The four-week average of 405,500 is 10,000 below the month-ago period to point to continued improvement and a positive October employment report.
By B.P.T., on October 27th, 2011
At 8:30 AM EDT, the U.S. government will release its weekly Jobless Claims report. The consensus is that there were 405,000 new jobless claims last week, which would would be 2,000 more than the previous week.
Also at 8:30 AM EDT, the advance GDP report for the third quarter of 2011 will be announced. The consensus is an increase of 2.5% in real GDP and an increase of 2.5% in the GDP price index. The real GDP estimate is 1.2% higher than the advance value for the second quarter of 2011, and the GDP price index is the same.
At 9:45 AM EDT, the weekly Bloomberg Consumer Comfort Index will be released, providing an update on Americans’ views of the U.S. economy, their personal finances and the buying climate.
At 10:00 AM EDT, the pending home sales index for September will be announced. The consensus is that the index was unchanged last month.
At 10:30 AM EDT, the weekly Energy Information Administration Natural Gas Report will be released, giving an update on natural gas inventories in the United States.
At 4:30 PM EDT, the Federal Reserve will release its Money Supply report, showing the amount of liquidity available in the U.S. economy.
Also at 4:30 PM EDT, the Federal Reserve will release its Balance Sheet report, showing the amount of liquidity the Fed has injected into the economy by adding or removing reserves.
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