Best Leverage in Ounces-in-the-Ground Plays

Best Leverage in Ounces-in-the-Ground Plays




-- Posted Friday, 8 October 2010 Share this article | Source: GoldSeek.com


Kaiser Bottom-Fish Report Writer John Kaiser sees the gold price reaching well into thousands—one of a series of events that, ultimately, could result in the kind of area-play fever not witnessed on the junior board since the mid-1990s. John believes all it would take is a "holy mackerel"-type gold discovery in the right area.

The Gold Report: John, you were recently at a mining conference in Toronto where you told the audience you could see gold spiraling well into the thousands/oz. without worldwide financial Armageddon. Other gold pundits think such prices can be attained only with global financial ruin. Tell us how gold investors can have their cake and eat it too.

John Kaiser: I regard gold as a special asset class, whose specialness is derived from the fact that gold is very rare, hard to bring above ground and generally useless due to its high cost, unlike silver, which is more abundant than cheap and gets fabricated into all sorts of industrial applications. Gold would be a wonderful conductor for electronics, too, but it's just too expensive. We have just over 5 billion oz. (Boz.) scattered around the world in safes, vaults and jewelry boxes not doing much at all.

Because gold has limited utility, its price is irrelevant to ongoing economic activity. As a comparison, if oil shoots to $500/barrel that means that your paycheck would allow you to drive just one-fifth the distance it allows you to drive now. Such a move in oil would have drastic implications for the global economy. But if gold shoots to $5,000, what happens? Well, the gold stays in my teeth. Jewelry demand goes down even more, but nobody makes any decisions to substitute out of gold because it really isn't being used for much. In other words, it really should not affect the economy.

TGR: Then why are people buying gold?

JK: People buy gold because it's a very exchangeable asset class and one that can't be forged, counterfeited or multiplied like paper or digital assets. Gold is an asset you want to own because the world is changing in terms of its geopolitical and economic center of gravity; it's moving from West to East and that shift will be turbulent. The East, to some degree, is still communist. We really do not know how financial and other assets and currencies will play out over the next 20 years.

TGR: But what's driving the demand? If it's not an economic collapse, what is it?

JK: It's the conversion of money into a different asset class because investors are concerned about currency gyrations; they're concerned about equities. Imagine a corporation that sells lots of widgets but no longer has access to the rare earth elements (REEs) needed to make them. Well, the company dies.

We're entering a period of massive change in the viability of businesses as new players from China enter the global stage and as new technology undermines yesterday's technology. Then you have all these financial entities and investment banks. They have thrived because they've engaged in a systematic looting of other people's wealth. Ultimately, the crash of 2008 will usher in a dramatic decrease in the lucrative fees collected by the financial sector. What are these Wall Street entities worth when they no longer make these extraordinary trading profits? They're not creating any real wealth. The market value of all these entities is under siege. You also have a boomer generation that owns all this paper, either directly or through pension funds. But the boomers need income. Everything is geared toward capital-gains growth, yet the current generation has few real jobs that would enable it to accumulate the capital needed to buy this paper from the retiring generation. This means companies are going to shift from a capital-gains model to a dividend-based model where pricing is based on the dividend they're able to pay. As these industries mature, carve out their niche and cease to be grow-forever entities, their stock prices will stop going up. Share prices may even have to go down, so they're worth owning for their yield.

All of these things potentially undermine the value of other asset classes. So it's just common sense to park 5% or maybe 10% of your wealth into gold and let it sit there, because gold is unlikely to go down in relative terms.

Gold investors don't own gold because they want to sell when it's up 300%. They want a sense of security; when everything goes haywire like it did in 2008, at least they have one portion of their asset base to convert into other assets when the dust settles.

TGR: How did we get to the point that gold is now a preferred asset class?

JK: This shift comes after a 30-year bear market in gold caused by the 500% real gain that happened in the span of less than eight years in the 1970s. This, in turn, unleashed 2 Boz. of new mine supply.

The mining industry said: "Wow, gold's at $350/oz. and these low-grade deposits are economic and these exploration targets are worth chasing because we can develop them as bulk tonnage deposits." We've had to digest all of this. But if you inflation-adjust $350 forward over the last 30 years, gold should now be at $1,000. That means gold is currently about 30% higher than it should be in inflation-adjusted terms. We're facing a real gain in the gold price because this period of Central Bank liquidation is over. The mining industry has exhausted the available pool of gold that was easy to exploit at $350 and rising all the way to $1,000. We actually need a higher real gold price to mobilize new supply.

Do we need new supply? Well, global GDP in 1970 was $3 trillion. Today, global GDP is around $50 trillion. While the world has grown much wealthier during the last 30 years, gold has remained a small percentage of that GDP. Now, more and more people want to own it, and those that own it are reluctant to sell. I think we're facing a period where, as gold starts to move, it could rise to the $2,000–$3,000 level. People will worry and there'll be all kinds of end-of-the-world hysteria. But then gold will pull back, maybe 20%–40%. And that's fine. This will happen without currencies collapsing and without inflation going through the roof, which also means that the cost structures identified by prefeasibility studies (PFS) of junior miners with gold ounces in the ground will still be the same tomorrow as they are today. Thus, when you mine the gold, you will have HUGE profit margins. In my view, the big gains will be in gold juniors that are advancing ounces-in-the-ground deposits in anticipation of a real move in the price of gold.

TGR: That sounds a lot like what other people are saying, but just not to the same extreme.

JK: That's exactly why I am a gold bug in a sense; but I'm not what I call an apocalyptic gold bug. What you'll find hidden beneath a lot of the gold bug thinking is an intense bitterness about how they feel the world has turned out. People on the left and right are bitter; they're both experiencing the same thing—the compression of the middle class—the crushing view that, in the West, we are dealing with the contraction of our standard of living. That makes us sort of diametrically opposed to China and, to some degree, India, where they have a small light at the end of the tunnel that is growing. In percentage terms, it's not huge; but on their perceived level, it's extraordinary—they are optimistic about the future. They want to own gold because they don't trust their communist or half-communist leadership, which could screw it up.

In the West, people see that their leadership has screwed it up and it's not going to get better. But you've got both groups wanting to own gold.

TER: Any final thoughts you'd like to leave us with?

JK: As gold grinds higher, these ounces-in-the-ground companies get absorbed, cash enters the system and then you add in a 'holy mackerel'-style gold discovery and you wind up with an all-out crazy bull market similar to what we had in the mid-1990s. What happened in the mid-1990s was far more exciting than in the last decade, when more than $60 billion worth of takeover bids was handed to the junior sector. I think we're heading back to something like those heady days.

John Kaiser, a mining analyst with 25-plus years of experience, produces the Kaiser Bottom-Fish Report. It specializes in high-risk Canadian resource sector securities and seeks to provide investors with a framework for intelligent speculation. His investment approach integrates his "bottom-fishing strategy" with his "rational speculation model." After graduating from the University of British Columbia in 1982, John joined Continental Carlisle Douglas, a Vancouver brokerage firm that specialized in Vancouver Stock Exchange listed securities, as a research assistant. Six years later, he moved to Pacific International Securities as research director and also became a registered investment adviser. Not long after moving to the U.S. with his family in 1994, John cast his own line in the water, so to speak, with publication of the premier edition of the Kaiser Bottom-Fish Report.