Industry facing one of those “sweet spots”

We think the economics for gold mining remains very positive. And while not as good as it may have been a few months ago, when the price of gold was lower, it still looks very good. And if I am right about another major leg down in the equity markets, gold mining economics should get even better, much as was the case during the Great Depression.

Let me explain. When it comes to gold mining, the price of gold isn’t as important as you may think. Just like any other business, what matters is your volume of production and the profit margin on that production. So, what really matters is the real price of gold. What will an ounce of gold buy relative to the cost of getting it out of the ground and into a pure form?

Bob Hoye has looked at the real price of gold and he has discovered that during the contraction phase of a major credit cycle, like we are in now, the real price of gold as measured by base metals and silver rises. Since we calculate a host of metals and equities prices as well as gold, we have been tracking the real price of gold relative to other items in our IDW to see how gold is faring. Here are some of the ratios we think are most important in asking whether the real price of gold is on the rise or not.

Gold/Commodities: Jim Rogers put together the Rogers Raw Materials Fund (upper left) to reflect “the cost of staying alive.” This is a basket of soft and hard commodities. It contains food, cotton, energy, base metals and precious metals (silver and gold). Check out the rise in gold relative to the Rogers Raw Materials following the credit implosion of last fall. Just before the Lehman Brothers debacle set off the decline, an ounce of gold would have purchased 0.17 share of the Rogers Raw Materials Fund. After the crash last fall, by Feb. 20, 2009, would have purchased 0.44 share of the fund. That represented a 159% increase in the purchasing power of gold in terms of a broad basket of commodities from just before the credit implosion until Feb. 20, 2009. As I write this to you and as the risk trade has picked up again in the current bubble, I see that the ratio has slipped to 0.35. But that means that gold still buys TWICE AS MUCH OF THE ROGERS FUND as it did before the credit implosion of 2008.

Gold/Oil: Check out the chart above on your right. It shows the ratio of the price of gold to oil since we began our IDW in 2005. The ratio here is even more pronounced than in the Rogers Raw Materials fund. Just before the Lehman Brothers collapse set off the credit market implosion, an ounce of gold would have purchased 7.6 barrels of oil. On Feb. 13, an ounce of gold would have purchased 25 barrels of oil or 3.3 times more oil than it would have purchased just before the crash.

Next week I want to talk a bit about the importance of watching the gold/silver ratio for a hint about impending credit market conditions. This is also an insight that comes from Bob Hoye who has been a guest on my radio show. I’m hoping to get him on again soon, perhaps in January when I begin a two-hour weekly show.

But the point I want to get across this week is that when you have a massive de-leveraging in the credit markets as inevitably takes place in major credit expansion/credit contraction episodes like the one we are currently facing, the real price of gold rises and gold mining becomes one of the most profitable businesses on earth. I think we are facing one of those “sweet spots” for gold mining. And if I am right and that we are still facing another major leg down in the equity markets, gold mining as a business should get sweeter still and quite frankly should provide a basis for American rebuilding its wealth again so it can overcome the destruction of the current pathological Keynesian promoted fiat money-socialist system.

We continue to recommend that you sell some shares and add to your cash position. A review of the autumn of 2008 will reveal just how quickly very strong returns can dissipate into the same thin air from whence the bubble was created in the first place. I learned that lesson well last autumn and that decline also taught me to keep a daily eye on Dr. Robert McHugh’s work and just as before the crash last fall, Dr. McHugh is again warning us that we are facing another monster decline. The timing is obviously impossible to pinpoint precisely. But the storm clouds continue to gather and the policies that are creating the next impending storm ensure we are in for a dozy. Our feeling is that it is better to be prepared than not to be. Hence I have personally built a cash position of about 35% in my IRA, including approximately 8% in SDS, the double down S&P short.