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May 16, 2008

Gold, What Gold?
by David Galland

Wonder what's happening with the gold market lately? So has David Galland, of Casey Research. (publishers of Casey's International Speculator) Here he offers some insights into the current state of the precious metal... and the companies that mine it.

One of the most intriguing aspects of the current market is the dearth of major discoveries so far in this cycle. This despite record amounts of money spent on exploration since this bull market began in 2001.

Older and smarter minds than mine, minds resting in the cranium of Explorers' League members, for instance, have been convinced that a number of major discoveries would be announced.

But so far, other than a small handful that appear to hold the stuff, there has only been one legitimate elephant bagged; by the team of Aurelian (T.ARU). Unfortunately, the carcass of that particular elephant rests entirely within the sketchy outlines of the nation of Ecuador where the locals are currently circling like a pack of hungry hyenas.

It has been our contention that what was needed to light the fuse on the junior exploration stocks would be, in no specific order:

1. Sustained higher gold prices.
2. Improving financials and free cash flow of the major producers.
3. A discovery to heat the blood of the investing community.

So far, we have had (1) and we are beginning to see (2), but (3) has proved remarkably elusive.

Now, don't misunderstand. You can have a whopper of a bull market in these stocks without the discovery - that was the case in the 1970s bull market. But a discovery that fires the imagination can jump-start things in a big way, no question about it.

Evidence of that statement is provided by the gold share bull market of the mid-1990s, the most powerful to date, which occurred against a back drop of flat to falling gold prices. In case some of the big winners from that market have slipped from your memory, they include returns such as; Cartaway, up 26,040%; Pacific Amber, up 4,376%; Arequipa, up 5,692%, and so on and so forth.

So, What's Going On?

According to MineWeb, Peter Munk, the somewhat unpopular chairman and acting CEO of Barrick Gold, the world's largest gold producer, stated at the company's recent AGM that there have been "virtually no new discoveries."

While we might disagree around the edges of that statement, Chairman Munk is technically correct in that the level of discoveries being made is a small fraction of that needed to replace the depleting reserves of the gold producers.

In short, we appear to have reached the era of Peak Gold. Whereas a major discovery used to be 10 million ounces or more, the threshold for attention-getting discoveries these days has fallen to more along the lines of 1 to 3 million ounces... and even those are hardly falling off the trees.

Viewed from the perspective of an investor in the junior resource sector, this lack of discoveries means the fuse is lit - starting with straight-up supply and demand fundamentals - for a rocket shot tomorrow. Adding boosters to the rocket, we have a commodities bull market that shows no sign of ending anytime soon and, while the U.S. dollar will periodically rebound, it is not going to somehow reinvent itself as sound money in our lifetime.

Importantly, as you can clearly read between the lines in Chairman Munk's words, once the majors get cashed up and serious about replacing their reserves, they are going to have to look downstream to the juniors with discoveries... even if those discoveries are below the 5-million-ounce threshold they previously required to even consider taking an ore body into production.

A Risk and an Opportunity

Of course, lowering the threshold on deposit size will require trade-offs. For example, in order to be considered for an acquisition, a smaller deposit will almost certainly have to be near surface and open-pittable. It will also have to be near good infrastructure, and located in a jurisdiction with good laws and reasonable taxation. There is, in this situation, an opportunity and a risk.

Starting with the latter, if your portfolio now includes companies going after deposits in the one- to five-million-ounce range, you need to make sure they are not in a remote location, or will require going underground or building a mill to process sulfides. (Under 1 million ounces? Fuggedaboudit!)

As for the opportunity, while the odds and the amount of exploration spending still favor that we'll see the discovery of at least one and maybe two monster deposits in this cycle (there are a couple of companies advancing projects with that potential), and early shareholders will make fortunes as a result, there has rarely been a better time to invest in junior exploration companies with modestly sized projects in good locations. That said, you should still be focusing only on projects with at least 2 million ounces, or the strong potential of same.

In other words, take the opportunity in these down markets to focus on getting positioned ahead of the majors... that's where the big money will be made as things gather steam again going forward.

David Galland is managing director of Casey Research, publishers of the International Speculator, now in its 28th year. The current edition includes "Courting the Majors," a feature on what attributes the major mining companies are looking for in a junior explorer. All new subscribers are invited to give the International Speculator a three-month trial with an unquestioning 100% money-back guarantee. Learn more and sign up now to receive the current edition.

David Galland
Big Gold

Information contained herein is obtained from sources believed to be reliable, but its accuracy cannot be guaranteed. The information contained herein is not intended to constitute individual investment advice and is not designed to meet your personal financial situation. The opinions expressed herein are those of the publisher and are subject to change without notice. The information herein may become outdated and there is no obligation to update any such information. Doug Casey, entities in which he has an interest, employees, officers, family, and associates may from time to time have positions in the securities or commodities covered in these publications. Corporate policies are in effect that attempt to avoid potential conflicts of interest, and resolve conflicts of interest that do arise in a timely fashion. No portion of this web site may be extracted or reproduced without permission of the publisher.

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