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"Pieces of Eight"
Eight Reasons to Invest in Precious Metals in the Present Market Environment
There are at least eight reasons to seriously consider investing in gold and other precious metal mining stocks now:
- The Contrarian Factor
- Many Profitable Companies in the Sector
- There are more choices in the sector than just Gold and Silver
- Demand for Gold and Silver exceeds Supply
- Demand is growing in Traditional Consuming Nations
- Little New Mine Exploration is being done
- Potential US dollar Weakness
- Resurgence of Inflation
- The Contrarian Factor The financial markets' attitudes toward gold and silver mining companies may be a tremendous contrarian indicator. These shares are, in some cases, like Barrick Gold, at multi-year low points, despite excellent cash flow, conservative financial condition, growing production, and low production costs. A market sector that is neglected or hated by investors is, very often, one that has enormous potential to reverse and rally strongly. An example is the energy sector 1½ years ago. Another example is the information technology stocks, which appeared quite overvalued for several quarters, and, indeed, have corrected down to somewhere closer to fair value, in many cases. Gold and gold mining shares are actually negatively correlated with the rest of the stock market.
- There are Many Profitable Companies in the Sector There are several gold-mining companies that are profitable at current price levels. A precious metals portfolio could still have significant price appreciation if it is invested in companies that perform well, despite being in a weak industry.
- There are more choices in the sector than just Gold and Silver In addition to gold and silver, there are other unrelated minerals, uncorrelated in price movement, which can qualify to be included in precious metals exposure, such as the Platinum Group Elements (PGE's), like Palladium, Platinum, Rhodium, Osmium, and Ruthenium. Osmium is the most expensive element per gram, while Palladium is three times more expensive than gold, Platinum almost twice. PGE exploration is booming, and several intriguing discoveries have been made. Diamonds and other gemstones are also still a profitable venture, and there are many companies active in Canada and elsewhere that are making new finds and developing mines. Valuable Rare Earth metals and unusual industrial minerals could also qualify for precious metals exposure.
- Demand for Gold and Silver exceeds Supply I am not going to predict that gold will unexpectedly escalate to prices that are far higher than today's levels. I will point out, though, that gold and silver demand far exceed annual output, the difference being mad up from inventory, principally that of central banks. Those banks announced that they will no longer make large sales at present price levels, and are satisfied with their current stockpiles. Gold mining companies have announced that they are curtailing their forward sales of the metal, which has also been a dampener or ceiling on the upper limit gold prices could reach. The well-publicized financial disasters caused by bad hedging or forward sale policies at firms such as Ashanti and Cambior have disinclined mining company treasurers to use forward sales.
- Demand is growing in Traditional Consuming Nations The nations that buy the most gold for jewelry and as a savings vehicle are also the ones that are performing the best economically: The Persian Gulf states, India, and China. As these nations move from subsistence incomes, most additional spending will be discretionary. Deployment of investment monies by individuals will escalate much more rapidly than GDP growth. The savings rates of these nations are far higher than those of developed nations, and the propensity to buy gold is much higher there than here. Again, this is not to make a case for a higher gold price, but to show the potential for continuing strong demand.
- Little New Mine Exploration is being done There is little exploration being conducted for new sources of gold and silver. Many small companies have given up and are entering other areas, such as internet and other technology-based ventures. Others have gone bankrupt or shut down their mines or exploration sites. The equity market is closed for small explorers, the firms which find and prove up the deposits that larger companies buy and develop. Mediocre prices for lead, copper, and nickel mean little current exploration or development for those sorts of deposits, which produce a lot of gold and silver as by-products. Attention has shifted to exploration for Platinum Group Elements, with some success.
- Potential US dollar Weakness The US dollar is being held aloft by capital inflows, recycling its enormous trade deficit. The strong US dollar is hurting American competitiveness and corporate profits, reducing the rate of return on investment, and the attractiveness of US equity markets. One thing harming the potential for a rise in the price of gold is the strength of the US dollar. Indeed, the price of gold has been rising in every currency except the Canadian and US dollars. The gold price moves inversely to the exchange value of the US dollar.
- Resurgence of Inflation Inflation is no longer quiescent. The price of oil is very high, by the standards of recent years. Natural gas is at even higher record levels. Labour, rent, power, transportation, and other costs to business and consumers have been rising, with some effects masked by the change to a new method of inflation calculation that incorporates performance improvements in electronic equipment. Gold retains its value and can rise very strongly in an inflationary environment, as it did in the 1970's.
Ian Madsen, MBA, CFA
Portfolio Manager, Hendrickson Financial Inc., Edmonton, Alberta, Canada
Publisher, RUMINATIONS Regarding Required Reasonable Rates of Return, a Newsletter
Editor, Market Trend Follower, a Canadian Mutual Fund Newsletter
Telephone: 1-780-466-7977 Facsimile: 1-780-462-9824 Email: email@example.com
2 November 2000