Categories: Precious Metals
Topics: General Precious Metals

The Rant

The Rant

There were two pivotal events this week which I'd like to address before getting into the details of two additions to our EI portfolio.  The first event lays the groundwork for a shift in our investment paradigm and the second. . . well, let's just say it symbolizes an era.

No. 1: Federal Reserve abandons the dollar

The Federal Reserve moved the overnight funds rate effectively to zero in what can only be interpreted as their utter fear of a looming depression.  The more significant Fed announcement was that they will be in the market purchasing large quantities of Treasury and Agency debt (agency debt refers to things such as Fannie and Freddie) as well as mortgage backed securities to provide support to the mortgage and housing markets.  The Fed is dead set on re-liquefying the banking system and re-inflating the economy at all costs. 

The cost will be borne by the US dollar, here's why.

Current net US public debt stands at approximately $6 trillion.  The US Treasury needs somewhere between an additional $5 trillion and $8.5 trillion to cover the 23 different plans it has committed to (so far) as part of its massive bailout and re-liquefaction program. That's a one to almost one and a half times increase over the current US Federal debt: a not so insubstantial number except by Zimbabwean standards.  It is more than half of the total annual US GDP, 35% of which is already owned or operated by the US government.

The Treasury has only two authorized options to raise that money: tax or borrow. 

Taxing is not a viable option now.  The US is in the early stages of what will prove to be the worst economic downturn since at least the Great Depression.  Although consumer debt has declined this year most of that decline is the result of foreclosures: people are just walking away from their debt.  Consumer debt stands at approximately $14 trillion and household wealth has dropped 11% this year.  Home values have dropped a total of $2 trillion this year and nearly 15% of all single-family households owe more on their houses than they are worth.   US GDP, 70% of which is consumer spending, is also negative and falling.  All in all, tax receipts are falling dramatically and any additional taxes will only aggravate the current economic crisis.  The US is taxed and debited out.

Given that the government cannot tax its way out of this mess it has no alternative but to issue more debt (borrow).  Up until now buyers of government debt have been willing to accept low rates of return because of the perceived security offered by the US dollar.  However foreign funding is drying up and buyers are unlikely to settle for these low interest rates once they consider that the Treasury needs up to $8.5 trillion on top of $6 trillion in already existing debt and, the fiscal deficit is likely to be over $1 trillion next year.  On top of that, the country (USA) seeking the trillions of dollars in loans has a current trade deficit of about $1 trillion, is in a recession, and is experiencing negative GDP growth.  There is no way any sensible investor would lend money to a company in similarly dire financial straits without being compensated for that risk by high interest rates.  If the US Treasury were to increase the interest rates sufficiently to attract buyers the US economy would come to a total standstill and likely head into a deflationary depression: not good---buy gold!

That is the crux of the problem the US Treasury was facing.  Increase taxes or increase interest rates to attract lenders to cover the up to $8.5 trillion needed to fund our way out of this self imposed calamity.  Either of these options would potentially throw the US into a serious depression. 

The solution to this dilemma, the only solution, was to have the Federal Reserve buy the debt.  That is what the Fed announced it is wiling to do this week.  In so doing the Fed creates money to cover the debt and by default sacrifices the US dollar.  They are essentially monetizing the US debt through monetary inflation.  As this debt monetization process proceeds gold will be the beneficiary.  Gold is the last "safe haven” after the dollar and the reason we here at Exploration Insights are becoming a tad more aggressive in our purchases of junior explorers with potentially significant gold discoveries: buy gold explorers!

What the Federal Reserve, the Treasury and the government are doing amounts to socialization of capitalism for the benefit of those who profited the most after the very same agencies mitigated the inherent risks of capitalism.  This segues directly into item number two for the week.

No. 2: Bush the Dodger 

So this week's shoe-throwing incident brought it all home to me.  Watching Bush dodge that shoe, over and over and over, it became apparent that our 42nd President had finally perfected his one great skill: dodging.  It has taken Bush eight long years to perfect this move but in retrospect he has successfully dodged responsibility, truth and reality while debasing US prestige, freedom and its currency in what has to be one of the most shortsighted, self-serving and unprepared administrations in US history.

On CNN George W. Bush this week explained away the drastic measures the Federal Reserve and Treasury have taken as follows.  "I've abandoned free-market principles to save the free-market system."  He says he made the decision "to make sure the economy doesn't collapse.  I am sorry we're having to do it, but I feel a sense of obligation to my successor to make sure there is not a, you know, a huge economic crisis.  Look, we're in a crisis now.  I mean, this is -- we're in a huge recession, but I don't want to make it even worse."  Ah, one last fix.

And so the final coup d'état of this administration is the successful re-branding of American capitalism.  In the new America the invisible hand of Adam Smith helps the capitalist reap huge gains while the egalitarian hand of Karl Marx steps in to socialize his huge losses. 

Stock Talk

Gold stocks, plus we're buying XXXXX and XXXXX

Although we may have missed out on catching the bottom of the gold market, I suspect those who did, did so with the many knife cuts of previous attempts.  If the macro scenario laid out above is accurate we are still in the very early stages of a market move towards gold and, eventually, gold juniors.  With that in mind Exploration Insights is becoming a tad more aggressive in its stock selections and I offer up two new companies below.  With these picks we are sticking to the principles discussed in several previous EI issues whereby we need to see the geologic potential for a major deposit and identify a possible buyer of that deposit.  So far I am not interested in small deposits or junior companies that want to build big mines.

I recognize that there are a number of ways to play an increasing gold price and my approach is certainly not the only one.  First let's look at some companies that probably offer good leverage to the gold price but did not make it into the EI portfolio.  These are offered up to help you in your own investigations: these are not recommendations and each has its own issues.

The first class of gold stocks includes those companies with very large, low-grade deposits that are highly leveraged to the gold price. 

Of the mid-tier to junior producers Allied Nevada (ANV.AMEX) and Western Goldfields (WGW.AMEX) offer current production from low-grade oxide deposits.  An added bonus is that their production costs are in US dollars, providing leverage to both a falling dollar and rising gold price.  Both are mining previously operated deposits that were shut down when gold prices were low and reserves running out.  The production upside is offered by the very large low-grade sulfide resources that are currently not economic, or at best only marginal.  The sulfide gold recoveries are low but metallurgical studies currently underway may show methods to increase the gold recovery.  If gold prices increase appreciably the low-grade sulfide resources offer very good leverage.  My reluctance to include these in our portfolio has to do with an eventual reliance on high gold prices and improved metallurgy for the upside (sulfide ore) to work.

Also within this broad class are the "still to be built” large low-grade deposits.  The list includes: Osisko (OSK.TSX) with proven and probable reserves of 6.3 million ounces grading 1.07 grams per tonne gold; Detour Gold (DGC.TSX) with measured and indicated resources of 10.7 million ounces grading 1.38 grams per tonne gold; Rainy River (RR.TSX-V) with indicated and inferred resources of about 3.6 million ounces grading ~1.1 grams per tonne gold and; Brett Resources (BBR.TSX-V) with indicated and inferred resources of about 3.6 million ounces grading ~1.1 grams per tonne gold.  Andina Minerals (ADM.TSX) also has measured and indicated resources of 6.6 million ounces grading 0.85 grams per tonne gold, however I think it has some serious development issues given the low grade and difficult location high in the Andes.

In a pre-credit crisis world and with confidence in a rising gold price some of these stocks would be easy purchases.  My hesitancy is due to the economies of scale required to make large low-grade bulk tonnage deposits economically feasible.  This translates into huge upfront capital commitments of several hundreds of millions of dollars.  For junior companies seeking to raise that sort of money on favorable terms it will be difficult, if not impossible, for the foreseeable future.  The fact that major gold mining companies have not stepped in to buy these assets is also telling us something (Asset problems? Management's fear of committing? Credit issues of their own?).  When (and if) financiers and major producers are able to look back over a sustained period of higher gold prices these hurdles will probably fall.  

Within our EI portfolio XXXXX and XXXXX offer the sort of potential we are after: new gold discoveries with relatively low capital and operating costs. 

Today's portfolio additions are what I would call entrepreneurial junior exploration companies generally following the prospect generator model I've laid out in previous letters (EI August 16th).  What differentiates them is that they are in the early stages of discovering and proving what could turn into major gold discoveries.  These are of course risky investments in companies whose properties will most assuredly prove to be more complicated than we would like.  However I believe they offer us the chance to participate in a discovery with competent management teams that will do the best by their shareholders.

.................................................. .

That’s the way I see it,

Brent Cook

Exploration Insights offers the sophisticated speculator independent and unbiased information analysis on the junior mining and exploration market.  It is written and produced on a weekly basis by Brent Cook, a veteran geologist and mining stock analyst. To learn more about subscribing to Exploration Insights visit our web site here https://www.explorationinsights.com/pebble.asp?relid=26

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Disclaimer

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