Published July 23, 2012

China, Metals, and Your Money

Dear Readers,

I'm in Shanghai as I type, and the "China Miracle" is in full bloom. Few variables are more important in the world of metals and mining investment than the strength and sustainability of the extraordinary bull run the Chinese economy has enjoyed for years. So many pundits, critics, and cheerleaders keep pouring out opinions on this question that they saturate the news – but leaves no one the wiser.

I'm sorry to say that, as arrogant as I am, I do not have quite the hubris to tell you that I have figured China out and know what is and will be. Certainty is not an option here, and if anyone offers it to you, I suggest you check your wallet afterward.

But I can tell you that I've traversed China from south to north, from east to west. I've spent days driving through the countryside, passed through China's largest cities and smallest villages. I have seen a China that is visibly, radically different than the China I saw for the first time a mere six years ago. Ten percent growth compounded over six years is a 177% difference – and the reality behind such numbers is unmistakable. Yes, there is still great poverty here and a lot of people living on a subsistence basis, but this is not a poor country. The fraction that has been lifted to middle class and above is enormous, and the country's GDP is now the second largest in the world.

Shanghai itself may not be the financial capital of China any more, as in a politically dominated economy like this, all the big decisions get made in the political capital of Beijing, but the wealth here is tremendous. The proliferation of high-tech buildings, modern housing, shopping malls, expensive cars, and more defies belief.

But the real shocker is the modernization of small towns and villages. Oxen have been replaced with tractors, rags replaced with bright new clothes, mud brick and thatch replaced with real brick and glass and electricity and satellite TV. The material improvement in the lives of hundreds of millions of people is spectacular.

To me, the most important economic consideration is that whatever the degree of misallocation of capital may be here, the allocation of most capital is to infrastructure, factories, power generation, mine development, agriculture, housing, and generally to durable and productive assets. China is gearing up to flood the world with products on a scale that could be an order of magnitude greater than what we've seen so far.

What if the EU disintegrates and the US sinks back into recession? What will China do with all its productive capacity then? Some would be wasted – factories and luxury cars can both rust for lack of capital to maintain them – but the productive capacity would still exist. With the investment already made, my guess is that the cost of goods manufactured in China would plummet. Particularly with so many state-owned enterprises – for which jobs and production may become more important than profit – selling at no profit would be better than shutting down. The central committee may even see flooding the world with inexpensive products as a way to help China's trading partners while helping themselves.

Is China in a bubble? Could the China Miracle turn into a China Nightmare?

I suppose it could; some massive misallocations of capital will certainly have to be liquidated. But a system that was already misallocating capital to an extreme degree can see major improvement simply by misallocating capital massively.

Remember that, unlike the US, the Chinese government is not borrowing money to build a network of high-speed trains across the country; it's paying for it out of excess savings. On the household level, people who save 40% of their income every year could lose half their savings and still have a lot more net worth than the average, highly indebted American. And they'll still want new cars, or electric bikes, or even airplanes (I'm told that civil aviation has been legalized in China).

By the way, the high-speed trains are linking more and more cities and are seeing heavy usage. You don't have to drive out of the cities to an airport; you don't have to be there an hour before departure time; you don't need to spend hours making connections; and there are many other advantages. Most critical is that the population density, I'm told, is sufficient to make the thing turn a profit. Plus, where there's high-speed rail, the regular lines are freed up for cargo only – and those trains now carry cargo up to 200kph.

My point is that if China is in a bubble, and if it does pop, this system will still be here, as will all the new highways, houses, factories, etc. This is not a deeply indebted nation of lawyers and hairdressers, but a cash-rich nation building up its productive capacity. If growth here were cut in half, it would still be substantially greater than in the US or EU.

What about social unrest? Well, that's one reason for China to keep manufacturing, even if profit drops off, but my sense is that, a few idealists aside, there is very little real pressure or even desire for major reform. People can see that things are improving, and they just want to improve their own lives.

What about China's military buildup and saber-rattling regarding those islands it and Japan both claim? Well, I was having dinner recently in a very large Chinese restaurant, where a large group of people were making round after round of toasts. The strength of the anti-Japanese sentiment that the alcohol loosened was astounding. Many Chinese – even though few are left alive who witnessed it – deeply, deeply resent Japan's invasion during WWII. But I haven't met anyone here who wants war – they'd much rather just become richer than Japan and show the world who is smarter and better.

Similarly, I'd have to say that there is some sense of people here wanting to take over the world, but they don't want to conquer it; they want to buy it. China wants to be an economic superpower and seems prepared to remove any obstacles to that goal – including outdated Marxist ideas.

Whether that's good or bad is an important discussion, but it's not what we're here for today. The point for now is that all of this is bullish for China's continued demand for raw materials, including metals.

One more factor I'd like to touch on is the question of "internal demand" – are there enough people in China with the money and the desire to buy the output of China's factories and keep the economy here growing? I don't think so... not all of the output of all of the factories. But reduced demand from the rest of the world does not mean no demand, and China's internal demand is certainly growing.

An anecdote: I happened to be near the famous Kumbum Monastery near Xining, Qinghai, in western China, so I stopped in for a look. The ancient Tibetan architecture and relics were fascinating, but I noticed that the biggest gold-plated temple of them all was not ancient, but built five years ago. The monks are re-paving the streets with heavy blocks of tight-fitting granite. I saw – literally – piles of cash at the Buddha's feet and elsewhere, as the throngs left their offerings. But I saw only one other Westerner the whole day I was there. The renewal of this monastery is a testament to China's capacity to spend internally.

(Click on image to enlarge)

New temple at the Kumbum Monastery, home of the "yellow" branch of Tibetan Buddhism. If you abase yourself 100,000 times, you can get a better life – but in your next life, not this one. I don't know how much gold is on that roof, but I do know that it's paid in full – there's no mortgage – and people seem to have plenty more to give.

What I am trying to say is that China's economy may slow, but I don't think it will dry up and blow away. There may be a lot more correction in industrial metals in the near term, driven by lower demand from China, as the growth rate moderates. There will certainly be an acute downward plunge if or when we get another 2008-style meltdown. But mid- to long-term, major demand is baked in the cake. There will be money to be made in metals and mining for decades to come – and should we be so lucky as to get a meltdown before the metals peak, what a fantastic buying opportunity that would be.

We'll be watching to see how that unfolds and will let you know when we see major turning points and buying opportunities.

Stay tuned.


Louis James

Senior Metals Investment Strategist
Casey Research

Louis will be sharing his latest findings on the junior mining sector and his favorite stock picks in Carlsbad, California at the Casey Research/Sprott, Inc. Summit, Navigating the Politicized Economy. The event will be held September 7-9 and will feature an esteemed faculty of financial experts and Washington, DC insiders who will help you understand today's overly politicized economy so that you can leverage it to outsized gains.

You'll hear David Walker, former United States Comptroller General, 1998-2008, and founder and CEO of the Comeback America Initiative... John Mauldin, best-selling author, chairman of Mauldin Economics, and publisher of the wildly popular Thoughts from the Frontline and Outside the Box... Donald Coxe, strategy advisor to BMO Financial Group, with $500 billion under management... Dr. Lacy Hunt, executive vice president of Hoisington Investment Management (he presented at the last Casey Summit and was voted its most popular speaker)... and, of course, our own Doug Casey, as well as a host of other financial luminaries and members of the Casey Research team.

Attend this event and you'll discover how to turn government-caused dislocations in the marketplace into powerful gains that have the potential to be life changing. If you sign up on or before Tuesday, July 31, you can take advantage of early-bird pricing.

Rock & Stock Stats
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Gold Producers (GDX)41.7247.2760.35
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Gold and Silver HEADLINES

Gold Discoveries Not Keeping Pace with Mined Production (Metals Economics Group)

Metals Economics Group (MEG) released a study on gold reserves replacement. MEG reports that 99 significant gold discoveries (defined as a deposit containing at least 2 million ounces of gold) have been made from 1997 to 2011, yet they will potentially replace only 56% of the estimated gold mined during the same period. Actual numbers may be lower, as not all of them may be deemed economic to mine. Economic viability involves many factors such as location, infrastructure, political risk, capital and operating costs, and market conditions, all further reducing the amount of resources that will reach production.

The situation is better for some individual gold producers than for industry as a whole:

"Over the past decade, the top 26 global gold producers (those that mined at least 600,000 oz. of gold in 2011) collectively replaced almost 208% of the gold they produced. Individually, 21 of these major producers added enough reserves through exploration and acquisitions to keep ahead of production, maintaining a strong pipeline of projects to insure stable or increased gold production."

The researchers conclude that the biggest challenge to replacing reserves is not that there is no gold left to dig up, but that all the "easy" gold has been mined:

"Increasing risk of political, regulatory, and tax instability in many resource-rich nations, declining grades, rising costs, and dramatically longer development times, the amount of gold available for production in the near term is likely far less than has been found."

The report suggests that a shortage in gold mine production in the coming years should be an expected outcome. This has obvious implications for the price.

Tea Compound + Radioactive Gold Nanoparticles = Prostate Cancer Treatment (Mineweb)

Researchers at the University of Missouri discovered that gold nanoparticles can be used to treat aggressive prostate cancer. Nanoparticles and a compound found in tea leaves are more efficient in targeting prostate tumors than toxic chemotherapy. This new cure would require doses that are thousands of times smaller than chemotherapy and do not travel through the body, inflicting damage to healthy areas.

This particular discovery won't have a significant impact on demand, as the amount of gold needed for cancer treatment is tiny, but it does show there is continuing interest in medical uses for the precious metal.

Infographics on Gold Mania (InformedTrades)

Follow the above link to see a compilation of gold charts, some based on our own research, that point to the possibility of a gold mania.

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