Pac-Man, Clicks, & Bricks
By James J Puplava CFP, December 15, 2003
Historian Roy Jastrum described gold as the "golden constant" because it
always maintained its ability to buy a basket of goods. Throughout all
of history during good and bad economic times, it always preserved its
purchasing power. Gold is the only money that isn't someone else's
liability. From biblical times through the present day, gold has acted as
the ultimate currency -- the currency of last resort. Pharaohs, kings,
emperors, prime ministers, presidents and central bankers have tried to
tamper with its value. Despite their best efforts, its value has remained
constant throughout all of history.
Follow the Gold Trail... to Economics and Power
The history of gold is really an economic story. It is a story about commerce, trade and ultimately power. Gold reserves are viewed as a primary indicator of a nation's wealth. It is one reason why until recently gold represented almost one-third of western central bank reserves. If you want to know where power is shifting, follow the flow of gold. At the moment it is flowing from debtor nations to strong creditor nations in the Far East.
| Money supply % change on year ago |
|
| Australia | 13.2% |
| Britain | 7.4% |
| Canada | 5.7% |
| Denmark | 9.1% |
| Japan | 1.5% |
| Sweden | 6.0% |
| Switzerland | 9.8% |
| United States | 6.0% |
| Euro area | 8.0% |
Much of the world's financial history is a tale of abuse of paper currencies by governments. Money--whether in currency or bullion form--is supposed to be a medium of exchange that remains a store of value. Unfortunately, the minute that governments begin to tamper with the value of a currency, it is no longer a store of value, nor can it be properly maintained as a reliable unit of account in commerce. When governments abuse this power, they inflate their currency and risk, thereby making it worthless. When they tamper with its value, they risk the loss of public confidence in the currency. When that transpires, the value of the currency collapses. Once confidence is lost, it isn't easily regained.
Gold is Real Money
The first constant to understand about gold is that it represents real money. At a time when central bankers around the globe are pursuing policies of currency debasement, gold represents the ultimate refuge and safe haven from monetary debasement. Gold is money and the only money that is durable, portable and divisible. When you own gold or any precious metal you own real money that can’tbe debased. It is the ultimate currency.
The ability of gold to protect its owners from the confiscatory polices of government can be seen in the two graphs below of the dollar and gold. While the value of the dollar has lost 27% of its purchasing power as measured against other currencies, the price of gold has risen 60% protecting its owners from the ravages of monetary inflation.
It's A Matter of Process
Gold is in the process of becoming money again as the general public gradually loses confidence in the monetary system. We haven't quite reached the panic stage yet. However, when we finally arrive at that point, as the public becomes aware of what has happened to money and their savings, all rational behavior will be thrown out the window and panic will follow. At this point only the smart money has been buying gold. The next stage in gold's advance will come when institutional interests come into the sector. There are signs that this is about to take place as various exchanges around the globe begin trading in gold and silver bullion. We will soon see gold bullion traded on most major exchanges around the globe in the form of ETFs (Exchange Traded Funds).
The final stage in gold's advance will come when all general public confidence in the value of the national currency is lost. All the guy on the street knows at the moment is the price of everything he needs keeps going up. He doesn't know why. He is told by the popular media that there is no inflation. Yet, the average American family must go into debt each month simply to pay their bills. Eventually the public catches on that they have been fooled again. Once that realization takes place, the consequences are predictable--but never the magnitude. Gold prices will head higher. How high nobody knows. It will be a safe bet to say that the previous high of $850 will be easily overtaken. The gold market can be gripped by emotion including panic, fear and euphoria. When emotions run the market, no price can be high enough. Until governments once again establish financial order by demonetizing gold, there is no way to predict how high the price will go. Suffice to say that if the world monetary system moves away from the dollar to gold, it could unleash pent up demand as countries dump their dollar reserves and buy gold.
Essential Reasons to Own Gold & Silver
If you want to protect your wealth and capital, then you must own gold and silver. If you have any doubts as to why you should own precious metals, you only need to know one thing. The people who manage the world's monetary system are also owners of gold. They are in fact the largest owners of gold in the world. If they own gold, isn't it time you own the metal?
While central bankers currently pursue policies of monetary debasement, there are other reasons to own precious metals. Gold and silver also act as a refuge in times of political turmoil and trouble. In times of war or during periods of financial upheaval, gold and silver have acted as a safe haven. Gold has protected its owner's purchasing power in time of war as well as during periods of inflation or deflation. In fact there is no better hedge against a worldwide financial breakdown than gold and silver. Pick up a history book and you will find that gold and silver have acted as a store of wealth throughout all of recorded human history. In times of conflict and uncertainty, there is no better form of protection. You can not say that about any other form of money or currency. No other form of money has survived time or the decline of an empire.
To Coin a Phrase: Supply and Demand
The final reason to own gold and silver is one that is not clearly understood. It evolves around the supply and demand fundamentals facing the gold and silver industry. In my opinion it will act as the greatest catalyst for higher bullion prices. The laws of supply and demand work on gold and silver with a vengeance, forcing the price of precious metals to fly to the moon or to drop in a freefall. Throughout history gold discovery and production have moved in cycles associated with price, politics and technology. The last bull market in gold during the late 60's, 70's and early 80's was fueled by three major factors
- deteriorating financial conditions of the world's reserve currency (the dollar)
- rising prices
- the application of new technology that led to major discoveries in North America and in Asia.
During this period, the Carlin and Hemlo mines were discovered in North America and the Grasberg/Ertsberg mines in Indonesia.
As a
result of rising prices and the application of technology, gold mine
production reached record output. From 1980 to 1992 the production of
gold nearly doubled. Higher
prices motivated companies to expand exploration budgets and explore for
gold in search of profits. Higher prices throughout this period made it
profitable to explore and mine gold. Companies expanded their
exploration budgets, new gold deposits were discovered and production
almost doubled. Although gold prices peaked in 1980, prices remained
relatively high making it profitable for companies to mine.
However, like all economic cycles the trend never lasts. Eventually prices softened as shown in the graph of gold below. In addition, during the early years of production, companies exploit their best reserves to accelerate payback of bringing mines into production and to increase financial returns. Like the giant oil fields that were discovered decades ago, many of today's largest gold mines have now reached peak production and are now entering a period of decline. From South Africa to North America many major mines are now experiencing a period of decline in both production and in ore grades. As high grade ore deposits are depleted, reserve grade starts to fall. This leads to higher production costs. Influencing higher production costs are environmental constraints and increasing demands from workers for higher wages, benefits and better working conditions.
Strong Dollar Policy & Monetizing Debt
Another event during the 1990s would exacerbate conditions in the gold and silver mining industry. This was the "strong dollar" policy of the Clinton Administration. The Clinton Administration's policy of defending the dollar was birthed during the Peso crisis of 1994. From this period forward, the Greenspan Fed began a policy of monetary inflation--the likes of which have never been seen before in history. The money supply began to expand at above-average rates, far surpassing the rate of economic growth. Interest rates were brought down, the value of the dollar was defended and the U.S. began a period of monetary inflation which continues on to this day.
Investor preference changed with the monetary inflation and credit expansion that became the hallmark of the Clinton Presidency and the strong dollar policy of Robert Rubin's Treasury. Administration policy created the greatest monetary and credit expansion the world has ever seen. The outlet for much of this credit creation found its way into the stock market. As the graphs of M-3 and the NASDAQ show, the stock market--especially the NASDAQ and technology stocks--became the magnet for much of that money creation. The public was fed a constant diet from the new financial media and Wall Street about a new era for American companies. The constant hype, combined with the flow of easy money, created the market myths and shibboleths of the period. This era ended during the first quarter of 2000.
While the Fed embarked on a policy of monetary inflation, it also pursued polices to weaken the price of gold. Governments manipulate the price of gold for the same reason that they intervene in the currency markets in an effort to maintain orderly markets. You can’thave an expanding money supply without seeing the price of gold appreciate. It therefore became necessary to keep the price of gold suppressed. This was done through the sale of gold bullion, gold leasing and the issuance of gold derivatives.
Derivatives & Gold
Today the notional value of gold derivatives dwarfs the actual physical production of gold. According to the latest OCC report, the notional value of gold derivatives at U.S. banks has grown to a value of $85 billion as of Q3 of this year. The size of derivatives is more than three times the actual value of the world's annual production of gold.
It is the sale of gold, gold leasing, and the issuance of gold derivatives that have been used by central banks to keep the price of gold suppressed. At a time when annual gold demand has exceeded mine and scrap gold supply for over a decade, the price of gold has remained suppressed until recently.
I can think of no other commodity outside of silver where this has remained the case. Veneroso Associates estimates that private and official sector gold sales and loans stood at 9-10,000 tonnes at the end of 1999 and may be as high as 15,000 tonnes today.
The Pricing Suppression of Gold
The pricing schemes to suppress the price of gold have been documented by GATA (Gold Anti-Trust Action Committee) and are summarized below.
1) Suppressing the price of gold has made it a cheap source of capital for New York bullion banks, which borrow it for as little as 1 percent of its value per year. Gold is borrowed from central banks and sold, and the proceeds are invested in the financial markets in securities that have much greater rates of return. As long as the price of gold remains low, this "gold carry trade" is a financial bonanza to a privileged few at the expense of the many, including the gold-producing countries, most of which are poor. If the price of gold was allowed to rise, the effective interest rate on gold loans would become prohibitive. 2) Suppressing the price of gold gives a false impression of the U.S. dollar's strength as an international reserve asset and a false reading of inflation in the United States.
Too much gold is being consumed at too cheap a price. Massive amounts of derivatives are being used to suppress the gold price. If this situation is not corrected soon, there will be a gold derivative credit and default crisis of epic proportions that will threaten the solvency of the largest international banks and the world standing of the dollar. [1]
Only The Strong Survive
The suppression of the price of gold altered the face of the mining industry. This led to lower prices making it no longer profitable to explore and mine gold. Lower prices ushered in a severe bear market in the gold industry that wreaked havoc with gold producers. Only the strong survived. Over the past decade, the trend in the gold mining industry has been towards consolidation, leading to larger gold producing companies. Many of today's behemoths in the industry grew to their enormous size through the merger or acquisition of other mining entities. These mergers and acquisition led to the creation of today's large producers such as Newmont, Barrick, AngloGold, Placer Dome and Kinross. At the end of the 80's, Newmont produced less than one million ounces of gold annually. All of today's large producers such as Barrick, Newmont and Placer produced less than 2 million ounces annually in 1990. Today these large companies are producing three-to-four times what they produced more than a decade ago.
| Top Ten Producers in June 2003 Quarter | |
| Company | Production (koz) |
| Newmont (1) | 1,824 |
| Barrick Gold (3) | 1,467 |
| AngloGold (2) | 1,434 |
| Gold Fields (4) | 1,041 |
| Placer Dome (7) | 905 |
| Freeport-McMoRan (8) | 858 |
| Rio Tinto (6) | 765 |
| Harmony (5) | 707 |
| Kinross Gold (-) | 470 |
| Buenaventura (-) | 368 |
| Figures in parentheses represent positions in June 02 quarter. | |
| Top Ten Producers Four Quarters 2003 | |
| Company | Production (koz) |
| Newmont Mining | 7,908 |
| AngloGold | 5,963 |
| Barrick Gold | 5,704 |
| Gold Fields | 4,398 |
| Placer Dome | 3,295 |
| Rio Tinto | 3,234 |
| Harmony | 2,992 |
| Freeport-McMoRan C & G | 2,955 |
| Ashanti Goldfields | 1,492 |
| Buenaventura | 1,420 |
| Source: World Gold Report | |
Gold and Silver Train Wreck
In "Gold Deposits, Exploration Realities, and the Unsustainability of Very Large Gold Producers", geologist H.R. Bullis argues that these very large producers are unlikely to discover or acquire new gold deposits of sufficient size to allow them to replace extracted reserves. Today's new gold discoveries are predominantly in the 0.5 to the 2.0 million ounce range. Although new discoveries continue to be made, they are not of the size that would allow today's large producing companies to maintain production at the present pace.
Many of the large gold producers have increased production, but that has been due to the merging or acquisition of other companies. The size of annual production and the short mine life of these companies presents a particular problem for these companies going forward that can’tbe solved completely by acquiring other companies. If a ten-year life company merges with another ten-year life company, the merged company still has a ten-year reserve life. Production may increase as a result of the merger, but the extension of mine reserves has not improved. The only way to increase those reserves is to go out and discover new gold deposits or acquire existing deposits from that are currently not in production.
| Major Gold Producers | ||||||||
| Notes: | Price (1) |
Reserves (2) |
Resource (3) |
Production (4) |
Cost/oz (5) |
Cost/oz (6) |
Reserve Extracted (7) |
Projected Mine Life (8) |
| AngloGold | $325* | 72.3 | 146.4 | 5.94 | $161 | $203 | 6.7 | 10.7 |
| Newmont | $300 | 84.4 | 20.6 | 7.60 | $189 | $229 | 10.5 | 8.0 |
| Barrick | $300 | 86.9 | 25.4 | 5.69 | $177 | $268 | 7.6 | 11 |
| GoldFields (2001) | $270 | 81.0 | 144 | 3.64 | $190 | ? | 4.9 | 17 |
| PlacerDome | $300 | 52.9 | 74.8 | 2.82 | $178 | $231 | 3.2 | 16 |
| HarmonyGold (2001) | $262 | 32.5 | 65.2 | 2.14 | $234 | ? | 2.3 | 14 |
| "NewKinross" (est.) | $300 | 12.2 | 21.3 | 1.95 | $197 | $278 | 2.4 | 5 |
| Ashanti(2001) | $300 | 21.3 | 36.6 | 1.66 | $190 | 276 | 1.8 | 12 |
Source: H.R. Bullis, "Gold Deposits, Exploration Realities,and the Unsustainability of Very Large GoldProducers," Canadian Institute of Mining, Metallurgy& Petroleum, EMG Vol. 10, No 4, March 24, 2003, p.316.
*AngloGold uses a $400/oz gold price for Resourcecalculations.
(1) Gold price used to calculate proven and Probablereserves.
(2) Proven plus Probable reserves reported at year end2002 (millions of ounces).
(3) Measured plus Indicated reserves reported at year end2002 (millions of ounces).
(4) Reported attributable ounces (millions of ounces).
(5) Production cash cost/oz.
(6) Total production cost/oz.
(7) Reserve extracted is the number of ounces removed fromProven plus Probable reserves, i.e. ounces producedfactored for metallurgical recoveries.
(8) Reported Proven plus Probable reserves divided byounces removed from reserves.
| Gold Discoveries 1991 - 2002 |
| 3 Fields > 10 Million Ounces |
| 7 Fields > 5 Million Ounces |
| 5 Fields > 4 Million Ounces |
| 2 Fields > 3 Million Ounces |
| 2 Fields > 2 Million Ounces |
| 2 Fields > 1 Million Ounces |
Source: H.R. Bullis, "Gold Deposits, Exploration Realities, and the Unsustainability of Very Large Gold Producers," Canadian Institute of Mining, Metallurgy & Petroleum, EMG Vol. 10, No 4, March 24, 2003.
The Pac Man Strategy
As
a result of the size of annual gold production and the short mine life
of the large producers, these companies are faced with a significant
dilemma. The only way these companies are going to maintain size is to
substantially increase their exploration budgets to find or buy new ore
deposits. In addition to acquiring new deposits, companies will also
face issues of finding low cost deposits. Finding new deposits is one
thing, but finding a deposit that is profitable to mine will be the
other problem. Bullis' conclusion is that today's large gold
producer will not likely be able to sustain their annual production over
the medium to long run by making new gold discoveries. In order to
accomplish this feat, these companies would have to be finding somewhere
in the neighborhood of five new 5 million ounce discoveries every year.
This will prove to be a daunting challenge if not impossible in the
years ahead.
For these reasons, the game of Pac-Man is about to begin. Large companies will acquire mid-tiered companies. Mid-tiered companies will acquire small producers, while small producers will acquire juniors and other undeveloped properties. This game which has been played over the last decade as viewed by the number of acquisitions below will accelerate.
| GOLD MERGERS & ACQUISITIONS > $250 m | |||
| Buyer | Target | Date | Millions of US$ |
| Anglo American | AngloGold | 1997 | 3,100 |
| Newmont | Santa Fe | 1998 | 2,500 |
| Newmont | Franco-Nevada | 2001 | 2,428 |
| Barrick | Homestake | 2001 | 2,264 |
| Newmont | Normandy | 2001 | 2,243 |
| Battle Mountain | Hemlo Gold | 1996 | 2,100 |
| AngloGold | Ashanti | 2003 | 1,630 |
| Franco | Euro-Nevada | 2000 | 1,200 |
| Placer Dome | Getchell | 1999 | 1,100 |
| Kinross | Echo Bay | 2002 | 688 |
| Barrick | Sutton Resources | 1999 | 619 |
| Newmont | Battle Mountain | 2000 | 540 |
| Gold Fields | WMC gold assets | 2001 | 521 |
| Mvelaphanda | Gold Fields SA mines | 2003 | 508 |
| Barrick | Share buy-back | 2003 | 500 |
| Meridian | Brancote | 2002 | 334 |
| Normandy | Yandal Gold | 2000 | 300 |
| Placer Dome | East African Gold | 2003 | 298 |
| AngloGold | Geita | 2000 | 295 |
| Placer Dome | South Deep | 1999 | 252 |
| TOTAL | 25,972 | ||
Source: Finance Week, "Gold Bull Run: 2001- 2003", 19 Nov. 2003, p. 6.
| Ramping Up the War Chest | |
| Newmont Mining | US $986 Million |
| Placer Dome | US $530 Million |
| Gold Fields | US $195 Million |
| AngloGold | R $2 Billion |
| Wheaton River | C $100 Million |
| Kinross | US $182.1 Million |
Already companies are ramping up their exploration budgets and have been busy raising capital. Momentum is building in the merger and acquisition area in the gold equity sector.
We have seen several large companies from Newmont, Placer, and Gold Fields to Wheaton River raise large amounts of capital. Wheaton has gone from a relatively small and obscure producer to becoming Canada's fifth largest gold producing company in a few short years. Wheaton has been playing the Pac-Man game by acquiring private properties. Others will follow in Wheaton's footsteps buying properties, acquiring producers and buying out juniors with sizable and profitable ore bodies.
Junior mining companies have been among the best performing companies within the gold sector. Over the last few years, the share prices of many high quality juniors have risen ten and twenty-fold. This is just the beginning as the gold and silver mining sector heats up and as investment demand continues to accelerate. The price of high quality juniors is about to go parabolic. It takes between 5-7 years from the time of discovery to the time a mine is brought into production. Several of the majors recently have announced production cutbacks and higher costs for producing gold. Today Placer Dome disclosed that gold production next year will fall by 200,000 ounces. At the same time, the company said that cash costs will rise to $225-$230 an ounce with total costs averaging $290-$295 an ounce. Placer's capex budget will increase from $245 million in 2003 to $275 million in 2004.
With several of the major companies experiencing production and cost difficulties, the Pac-Man game will accelerate. The Prize will be to acquire those juniors with large resource deposits in the 2-5 million ounce range. In addition to high resource deposits, premiums will be paid for resources that can be mined profitably.
Clicks & Bricks
However as this game heats up, investors should be leery of buying just any junior. Wall Street counts ounces. The way juniors are sold to investors is by the number of potential ounces they may hold or potentially discover. It is similar to the Internet era when Wall Street sold investors Internet companies on the basis of clicks or visits. The problem is that these clicks never turned into bricks or profits for the companies or investors. Most of these companies folded or went bankrupt during the bursting of the tech bubble. This same problem exists for junior mining companies today. The industry has been notoriously deficient in turning ounces into profits for investors. Many juniors purport to claim large ounces on their balance sheet when in fact many of these ounces remain untouchable. They may never be mined unless the price of gold goes parabolic. Even then there may be mining difficulties due to geology or there may be environmental roadblocks or political risks that make extracting those ounces uneconomic. For these reasons, investors should proceed with extreme caution at this stage when investing in juniors.
Remember Wall Street pays little attention to economics and looks more at what sells. Investors need to do their homework to find out if the juniors they are investing in can turn their clicks (ounces of resource) into bricks (actual profits).
Conclusion: Phase Two About to Begin
As I have written in "The Perfect Financial Storm," in numerous Storm Watch Updates, and more recently in Market Observations, the bull market in precious metals has just begun and is still in its infancy. The second phase of this bull market is about to begin with institutional interest in gold beginning to pick up. Several of the world exchanges are initiating programs to begin trading in gold. Several ETFs are now going through the registration process and interest in gold and silver equities is growing by the day. Gold and silver prices continue to deliver spectacular returns for investors for the third consecutive year. Once again, gold and silver equities will become this year's best performers if present trends continue. The HUI is up over 65% this year and the XAU is up a respectable 41%. Both indexes have beat all of the major averages for the last three years running with returns of over 100% and 485%. This bull market is still in its early stages and very few have discovered it.
There are two main reasons that are going to drive this bull market to even higher ground and I believe to levels never dreamed before. The main drivers of this new bull market are still going to be for monetary and fundamental reasons. Central banks and especially the US. Fed are printing money as never before. In order to keep their own currencies from rising too rapidly, other central banks are also expanding their money supply and intervening in the currency markets. In this fiat paper money system now used globally, the creation of money is made by a handful of men. As governments pursue polices to foster growth and avoid deflation, they are actively involved in debasing their currencies. Western governments and other nations around the globe are saddled with onerous debt burdens. There is no way out, but to inflate. There isn't enough money to bail the U.S. or any other large debtor of its debt predicament. It has become only a matter of time before the present monetary system begins to unravel and the people find out that the emperor has no cloths.
Monetary debasement has been and will continue to be one of the main drivers behind gold and silver's new bull market. The supply and demand train wreck will be the other driver--one that will be equally as forceful. The best way to play this new bull market is to own and be in it through the ownership of gold and silver bullion and equities. The most profitable strategy will be to own companies that will be acquired and are able to turn clicks into bricks and the companies who employ the Pac-Man Strategy.
Today's Market
Major stock indexes closed lower on Monday as the capture of Saddam Hussein
over the weekend failed to hold the markets up. After an initial rise
stock prices fell as concerns over this holiday's retail sales weighed
in on the markets. Retailing giant Wal-Mart warned that Christmas sales
were now tracking at the lower end of expectations. Wal-Mart shares
tumbled 3.4 % and contributed 13 points out of the Dow's decline.
Declining issues outpaced advancing issues by a 20-12 margin on the NYSE and by 23-10 on the NASDAQ. Selling was heavy with volume levels rising 1.45 billion shares on the Big Board and 1.8 billion shares on the NASDAQ.
Gold was the one bright spot. Gold futures closed at $409.90 on the New York Mercantile Exchange, well off session lows of $405.20. Oil was another winner with crude oil prices gaining $.14 to $33.18 per barrel. Experts now believe that crude oil prices could hit $40 a barrel and that gold prices may surpass $450.
Saddam's capture failed to give a lift to the dollar. The dollar fell against the Euro and Yen.
[1] Gold Derivative Banking Crisis, GATA Charts courtesy: Stockcharts.com, BigCharts.com
James Puplava
© 2003 James Puplava
Contact Information
James J. Puplava CFP
PFS Group
PO Box 503147
San Diego, CA 92150-3147
(888) 486-3939 Toll Free
(858) 487-3939 Tel
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