It’s Time to Think in Terms of Gold

Louis James, Chief Metals & Mining Investment Strategist

Dear Reader,

Earlier this year, we advised readers of our metals publications to reduce their exposure to political risk in Peru, a country where mining is one of the main pillars of the economy. We didn't like the way then-candidate Ollanta Humala seemed to be riling up anti-mining sentiment – especially among indigenous peoples – to rock the ruling party's boat. Well, Humala won the election and now those chickens seem to be coming home to roost – and we are double glad to have reduced our exposure to the country in our portfolio.

Rock & Stock StatsLastOne Month AgoOne Year Ago
Gold1,747.001,743.001,389.00
Silver33.1533.8328.50
Copper3.523.583.98
Oil101.1392.5187.98
Gold Producers (GDX)58.0759.9661.18
Gold Junior Stocks (GDXJ)29.6531.4041.87
Silver Stocks (SIL)22.9024.0125.31
TSX (Toronto Stock Exchange)12,075.0912,241.7613,163.53
TSX Venture1,556.881,622.042,095.74

Specifically, villagers in northern Peru have been protesting Newmont's (NYSE.NEM) Minas Conga gold project, even going so far as to destroy the company's construction equipment. People have been hurt and Humala has just declared a state of emergency. He's sending the army in to clear out the protestors – just the sort of people who voted for him.

I'd like to draw your attention to two lessons from this sad turn of events:

1] Mining is an increasingly unpopular business all around the world. "Not in my back yard" sentiments as well as environmental opposition are making it harder and more expensive to permit new mines – where they haven't already made it impossible to do so. And there must be new mines, or there won't be any of the metals upon which our civilization depends. Mines by their very nature deplete resources. In other words, however prices fluctuate in the near term, supply constraints are very bullish for metals and mining stocks in the mid and long term.

2] It's absolutely essential to keep a close eye on developments, even in countries that seem as pro-mining as Peru did just a year ago. There are great profits to be made in our market sector, but no one can afford to rely on yesterday's wisdom. Eternal vigilance and fleetness of foot is what one needs to not just survive but thrive in this volatile sector. This is what we're here for.

In short, there's great risk, but also great reward in our sector. We believe it's worth it, and Jeff Clark's article below makes a great case for why one metal in particular is much more than worth it.

Sincerely,

Louis James

Senior Metals Investment Strategist

Casey Research


It's Time to Think in Terms of Gold

By Jeff Clark, BIG GOLD

A young woman – let's call her Andrea – inherited some money from her father in late 1997. She was only nineteen at the time. Not knowing the first thing about investing, she kept the money in stocks and bonds as her father had, wanting to hold on to it until she really needed it. She played it "safe."

She got married last year and so began to withdraw the money. She was pleased to see a chart from the broker that showed her portfolio was up about 20%. While admittedly not a great return over 12 years, her account had nevertheless survived both the 2000 tech crash and the 2008 market meltdown. She knew not all investors could not say the same thing.

Andrea began spending the money, thankful that she'd saved the money to start a family. But a cruel reality slowly began to set in: the money didn't seem to be going very far. She couldn't quite put her finger on why, but it all clicked when she saw the lofty price of a new SUV she wanted. She remembered her Dad's favorite vehicle back in the day – a Ford Ranger pickup – and recalled him boasting that he paid only $8,500 for it in 1992. A comparable vehicle today costs more than twice as much.

It hit her like a slap in the face. While the number of dollars in her portfolio was greater than what she inherited, they bought less stuff. It was such a revelation that she actually uttered the words out loud…

"My investments didn’t keep up with inflation… I LOST money!"

Gold Is the Benchmark

Whether they realize it or not, the same thing is happening to most people's investments. Over time, real returns are diluted because of inflation. The only reliable way to measure the value of investments is in terms of a financial intermediary that cannot be inflated: gold. That way, investors can tell how they're doing in real terms.

This has practical ramifications for all of us. Someday, we (or our heirs) are going to spend some of the wealth we are accumulating. How much we can actually buy with our gains will directly depend on how hard inflation has hit whatever our investments are denominated in. A 15% gain in dollars is only 9% in real terms if USD inflation was 6% during that time frame. A money-market return of 1% is a losing investment if denominated in something inflating at 3%. In Andrea's case, by keeping all her funds in dollars, her 20% gain turned into a 16% loss in purchasing power.

In other words, since most people don't adjust for inflation, their investments are not doing as well as they think.

In contrast, if Andrea had kept part of her inheritance in gold, that portion would have grown 332% (from December 1998 to June 2010, when she got married). More importantly, she would have lost no purchasing power during that time. In fact, after inflation and taxes, Andrea could've bought 50% more in goods and services than in 1998, if purchased using liquidated gold. She could buy two small pickup trucks today with the same number of gold coins it took her father to purchase the Ford Ranger in 1992. (This all while gold went nowhere for those first three years and lost a third of its value in the fall of 2008.)

Why don't we use the CPI? Not only is the government's Consumer Price Index a poor measure of true inflation, we're measuring currency inflation, not just price inflation. This gives us a more accurate reading of the dilution that's occurred to the dollars we use for spending. The same would apply equally to other currencies.

With gold as her savings vehicle, she could have completely sidestepped the erosion in the dollar.

How have you done?

Re-Indexing in Gold – "This Changes Everything"

To demonstrate the effect of currency dilution, we've developed a tool for re-indexing popular indices from dollars to gold. Doing so provides a more accurate picture of the dilution of investments made in dollars (and would work just as well in euros or other currencies). We use gold in grams so the indices won't be priced in decimals.

Here's how the DOW has fared since 2000 when measured in both dollars and gold:

(Click on image to enlarge)

While the Dow Jones Industrial Average is up 4.7% in dollar terms, it's lost 82.5% when measured in gold grams. An investment of $10,000 on January 1, 2000 would total just $10,470 today (excluding dividends) – but in gold it's worth only $1,750.

In other words, investments made in the DJIA Index have not only lost money in real terms, they're worth a pittance when measured in gold. This is a breathtaking loss.

How about a broader measure of stocks, like the S&P 500?

(Click on image to enlarge)

The S&P 500 is down 15.1% in dollars since 2000, but it's lost 85.8% against gold. If you’ve owned an S&P index fund, you not only have fewer dollars that what you started with (excluding dividends) but have fallen dramatically behind when compared to the monetary asset of gold.

How about the technology sector?

(Click on image to enlarge)

Tech stocks show a whopping decline of 38% in dollars over the same time period, but money invested in that sector has lost 89.7% when measured in gold grams.

We also decided to look at some foreign markets. Are they doing better than the US?

(Click on image to enlarge)

The stock market for Hong Kong, one of the largest exchanges in Asia, shows an increase of 6% in dollars. However, it’s lost 82.3% when priced in gold.

(Click on image to enlarge)

The primary stock market for UK companies is down 22.4% since 2000 calculated in dollars, but has fallen 87.1% in gold grams.

Conclusions

Obviously, measuring portfolios in dollars exaggerates performance in real terms. This isn't to say that one shouldn't invest in stocks. It means that one must: a) be cognizant of how results compare to gold or other real assets that one might buy with whatever currency one is dealing with; b) adjust brokerage statements to allow for currency dilution; and c) not rely on stocks in general to outpace inflation.

In fact, it isn't just investments that are eroding. Our entire world is being devalued, even as one reads this article – from groceries and gas to cars and college. Someday we'll want to spend the gains we're making; how will we avoid the long-term erosion of the currencies we invest in?

The answer is simple: save in gold. The dollars you keep in a money-market account will steadily lose value year after year. In fact, monies deposited into a simple savings account in 2000 have lost an incredible 25% of their purchasing power since then. Conversely, if those savings were denominated in gold, the wealth would have not only been preserved but increased. We believe this trend will continue – and accelerate. It will become increasingly important to your financial future that you cash in earnings from time to time and save them in precious metals – not in dollars, euros, yen, yuan, or even Swiss francs.

Don't make the mistake Andrea did. Save in gold. That new car or retirement home or world travel you want to spend money on someday will be a lot easier to afford if your savings are denominated in the one asset that can't be debased, devalued or destroyed.


Gold and Silver Headlines

The latest news from our industry that deserves your attention

Coeur May Consider Holding Some Silver Instead of Cash

Coeur d'Alene Mines (T.CDM) – the largest US-based primary silver producer – announced last week that it will consider converting some of its cash reserves (US$208 million as of September 30) into physical silver.

The move is backed by reasoning familiar to Casey readers: Silver is a metal that in addition to industrial use also has strong currency appeal. In the face of the unresolved debt issues and concurrent currency debasement, diversifying a portion of one's financial resources into physical assets only makes sense… something that's becoming more widespread and accepted.

It is also bullish for the metal itself. As Eric Sprott and David Baker point out in their recently released article Silver Producers: A Call to Action:

If GFMS's [silver] mining supply forecast proves accurate, it will mean that silver mine production will account for roughly 74% of the total silver supply this year. If silver miners were therefore to reinvest 25% of their 2011 earnings back into physical silver, they could potentially account for 21% of the approximate 300 million ounces (~$9 billion) available for investment in 2011. If they were to reinvest all their earnings back into silver, it would shrink available 2011 investment supply by 82%.

Either result is stunning, but the projections, as the authors admit, are not quite realistic (yet). On the other hand, the silver market is small compared to the gold market and it doesn't take a lot of money to move it dramatically. An attitude shift like the one Coeur demonstrates can both decrease supply and increase investment demand significantly.

Bank of Korea Goes Shopping for Bullion

According to the Bank of Korea, it’s not too late to buy gold…

After the World Gold Council reported a mind-boggling increase in central bank purchases of gold in the third quarter, the Bank of Korea – which controls the world's eighth-largest foreign exchange reserves – purchased 15 tonnes in November alone. "We bought the gold as part of our diversification strategy and based on long-term investment considerations," said Lee Jung, an official at the bank's reserve management group. After the purchase, Asia's fourth-largest economy still only holds 0.7% of its reserves in gold. Think it will buy more?

Metals Economics Group: Exploration Budgets Hit All-Time High

Metals Economics Group (MEG) has estimated a total 2011 budget for nonferrous metals exploration of $18.2 billion. That is 50% higher than a year ago and is a new all-time high. The report states that "most countries are seeing increased exploration investment this year and explorers are demonstrating a higher tolerance for risk despite additional concerns and uncertainty about security, policy, and tenure in many countries."

Mining companies are becoming increasingly active in less politically stable jurisdictions. However, the report also outlines that early-stage exploration (and generative work) comprises only a third of overall allocations, a historically low proportion. Mining companies prefer mature projects as a less risky and cheaper way to replace depleting reserves. In other words, the market is clearly willing to pay for a quality discovery, even those made in riskier jurisdictions.


This Week in International Speculator and BIG GOLD – Key Updates for Subscribers

International Speculator

  • An IS stock has increased its gold resources by 460%. The market sent a clear message that it likes the story – what did our analysts think?

BIG GOLD

  • We have a brand-new stock pick in the December issue of BIG GOLD, due out tomorrow (December 6). It's a budding, intermediate gold producer that fits perfectly into our strategy of buying today's companies that we hope will become tomorrow's big producers. If you aren't a subscriber, learn more about our gold newsletter.

[Editor's Note: Casey Research is running a holiday special that offers an incredible bargain – order International Speculator for $749/year and receive Casey Energy Report free (for one year; a value of $995). If you've ever wanted to speculate on junior mining stocks, this is your chance to get our best recommendations in both the mining and energy sectors for one price. The offer also comes with our new special report, 7 Tiny Gold Stocks Ripe for Takeover, one that can easily jump-start your portfolio. With many juniors trading at low prices, now is the time to invest. Check it out.]

Dec 05, 2011