The Biggest Threat to the Gold Mining Industry

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The Daily Reckoning | Monday, September 26, 2011 The markets test gold's admirers as the precious metal gets whacked, A tale of two markets: paper claims vs. physical metal, Plus, join us in "Doug's Gulch," a freedom lover's oasis in a world gone mad... ------------------------------------------------------- Supercharging our Military... Post 9/11 One tiny, relatively unknown company has discovered a secret technology that's set to supercharge our fighter jets and other military weapons deep into the 21st Century. And starting today, here's how you can tap into the explosive $707 BILLION market for this astonishing discovery. Our world-renowned resource expert, Byron King, explains it all — including the huge profit potential from this 22-cent penny stock — in his latest report. Click here for all the details. Paying the Price for Profitable Investments Why You Should Brave the Gold Market Selloff Eric Fry Reporting from Zermatt, Switzerland... Ouch! That hurt! The “cheap” gold stocks that your California editor highlighted in recent editions of The Daily Reckoning just got cheaper...a lot cheaper, thanks to the largest three-day selloff in gold and silver in nearly 30 years! The gruesome details are as follows: Since last Wednesday’s New York close of $1,805 an ounce, the gold price tumbled to a low of $1,540 an ounce in Hong Kong last night. Meanwhile, the silver price crumbled from $40 an ounce in New York last Wednesday to $26 an ounce in Hong Kong last night. Accordingly, gold and silver mining stocks imploded. The HUI “Gold Bugs” Index dropped 15% from last Wednesday’s high to last Friday’s closing price, while the Global X Silver Miners ETF (SIL) dropped nearly 20%. It is small solace that silver stocks fell less than silver, itself, or that gold and silver have both outperformed the S&P 500 Index for the year-to-date. Gold still clings to a 15% gain for the year-to- date, compared to a 10% loss for the S&P 500 Index and an 18% loss for the MSCI EAFE Index of international stocks. But as professional investors often observe, “You can’t eat relative performance.” And that’s probably a good thing in this case. Because if you were able to eat this particular serving of relative performance, it would probably taste like shards of glass, blended with rusty needles. Most folks refer to selloffs of this magnitude as a “correction.” We’d call it a lashing, or maybe a keelhauling. A selloff of this size hurts a lot, especially because most holders of precious metals are holding them as a hedge against monetary instability and or/global financial market trauma. Aren’t these the exact conditions we investors are facing right now? Gold is supposed to be a lifejacket in a sea of turbulence, not a gilded leg iron. In the midst of the current global uncertainty, gold is supposed to buoy portfolios, not plunge them even deeper underwater. But gold isn’t helping at all...or, at least, it didn’t help during the last three trading days. This betrayal is enough to shake one’s faith in gold — to thrust even the modest ardent gold devotee into a spiral of doubt and self-loathing. And here’s the real shocker: long-dated Treasury securities have provided a much safer safe-haven than the precious metals. “TLT,” the ETF that’s holds 20-to-30-year Treasury securities is up more than 30% year-to-date. That’s right, the debt securities of the now- AA-rated and heavily indebted US government remain the safest safe haven around. We’re not buying it. In fact, we emphatically reject the companion notions that long-dated Treasurys are a safe haven and that the gold market is a busted bubble. Sharp corrections are never fun, but they are often the “price of admission” to profitable investments. The recent volatility in the precious metals markets demonstrates, once again, that financial assets are volatile assets. And many financial assets — like gold and silver — have become increasingly volatile, thanks to the manic, short-term trading activity of large hedge funds and other institutional traders. Unfortunately, in a market as small as the gold and silver markets, the trading activities of a few big players can produce extremely volatile effects. “The amount of paper gold and silver contracts that trade on the futures and equities exchanges still dwarf the amount of actual physical trading that takes place,” gold market experts, Eric Sprott and David Baker recently observed. “Paper markets continue to set price discovery — thereby allowing for dramatic volatility with little or no influence from actual physical fundamentals. In the London Bullion Market, for example, market participants traded an average 19.6 million ounces of gold per day in July 2011. Keep in mind that the total gold mine production in 2010, globally, was approximately 86.5 million ounces. “Global gold mine production is not expected to increase significantly year-over-year,” Sprott and Baker continue, “so the London Bullion Market is essentially trading a year’s worth of production in less than a week. And this is just one market. When you add the COMEX futures and gold ETFs, the paper trading volume becomes absurdly high. When price discovery is dictated by levered paper contracts with no physical backing, it’s extremely easy and relatively inexpensive to jostle the spot price around. The result for gold has been many days of extreme downside volatility, despite a strong and consistent overall upward trend.” In other words, when very large investors (with very short-term investment horizons) become the dominant price setters in the market, the process of price discovery can feel a lot like a price lobotomy. So what does the selloff in precious metals mean? Does it mean that the world economy is heading for a depression...and not just a depression, but one that does not trigger a monetary crisis and/or inflationary response from central banks worldwide? Seems unlikely. If lackluster economic growth is triggering a massive inflationary response form the Federal Reserve and other central banks, wouldn’t the prospect of recession or depression trigger an even larger response? Net-net, we suspect that gold and silver are better bought than sold at today’s quotes, at least in the context of a mid- to long-term hedge. But we’ve been wrong before. In fact, we’ve been very wrong before. So let’s turn to Bill Bonner, The Daily Reckoning’s founding editor. Bill may have been the most reliable voice of reason lately. In several recent editions of The Daily Reckoning, he warned that gold stocks were due for an imminent drop. “A big sell-off yesterday. The Dow down 283 points. The 10-year T- note yields only 1.87%. And the price of gold barely budged,” Bill remarked on the eve of gold’s historic three-day selloff, “In our opinion all three should be going down. Because the world is edging towards a global depression...” One day earlier, Bill remarked: Could gold be finally testing its admirers? Though still in a major bull market, could it be correcting...possibly falling back to the $1,000-$1,500 range? Yes it could. Gold’s time will come. But we don’t think it is here yet. Gold has risen in anticipation of trouble. But the trouble gold buyers foresaw hasn’t come...not yet. There’s been massive money- printing. Still, in terms of the goods and services it will buy, gold has held up pretty well. Gold will take off — when the anticipated trouble becomes real here- and-now trouble. And that probably won’t happen for a while. Bill made very similar remarks throughout late August and early September. So kudos to the Chief on a great call. But no one really knows when anticipated trouble will become “real here-and-now trouble.” So if it’s trouble we anticipate, better to invest before the fact than after it, no matter how painful the waiting game might be. In the September 19 issue of Barron’s, an interviewer asked James Grant, editor of Grant’s Interest Rate Observer, whether the gold market was in a bubble. Grant replied: “A bubble is a bull market in which the user of the word ‘bubble’ has not fully participated. You can think of gold as a stock that went from 2 5/8 to 18 in a dozen years. I’m not sure that’s a bubble... What I do think is gold is simply the reciprocal of the world’s faith in the institution of managed currencies. It is one divided by T, where T stands for trust. And trust is a shrinking number and will continue to shrink. Therefore, I am bullish on gold.” So is your California editor, even if the gold price falls again tomorrow. The “Lost” Gold Bible Congress Never Wanted Anyone To See “Locked away” for almost 3 decades. Kept virtually secret...until now. You’ll soon discover why all the secrecy surrounds this book...and why it would to your great benefit to read this book now. Click here to read more. The Daily Reckoning Presents The Biggest Threat to the Gold Mining Industry Matt Badiali My friend Brent Cook is buying gold right now... But not for the reasons you’d expect. Brent is no “doom and gloom” gold bug. He doesn’t think the dollar is going to collapse any time soon. Brent simply knows the world is running low on gold... which could drive the price of his favorite stocks much, much higher. He has unique insight into the gold business. He’s one of the best mining geologists in the world...and he spends an extraordinary amount of time visiting mines and analyzing mining data. He shares his thoughts in his Exploration Insights newsletter. Last week, Brent told readers about the latest on a huge story happening in the gold business: Gold companies are spending enormous amounts of money to explore for gold...with little to show for it. According to numbers from the world’s largest gold miner, Barrick Gold, the entire industry is having more and more difficulty finding new gold deposits. Here’s how Brent summed up the situation... Current global mine production is in the order of 85 million ounces per annum, whereas...the last time the industry found that many ounces in a year was 1999. This dearth of new discoveries is despite the significant increase in exploration spending since 2002. Particularly disconcerting (to the larger mining companies at least) is the decline in discoveries since 2006 notwithstanding exploration spending has more than doubled from $2.5 billion to over $5 billion. The years from 1850 through 1900 were incredible for gold discovery. That’s when prospectors found the giant goldfields in Australia, Canada, South Africa, Colorado, and California. However, the modern era of discovery didn’t begin until the 1960s. Geologist Forbes Wilson found the world’s largest gold mine, Grasberg, in 1960 in Papua, Indonesia. Geologists John Livermore and Alan Coope discovered the largest gold producing region in the United States, Nevada’s Carlin Trend, in 1965. Since then, we’ve scoured the planet for the “easy gold” — the stuff that sticks up out of the ground in relatively safe, functional countries. But now, all of the “easy gold” has been found. (It’s a lot like the situation in oil, which I’ve told you about here.) Mining and exploration companies are still finding some good deposits... They’re just generally in inhospitable, remote, or downright scary places. For example, one “top 10 in the world” deposit that I like, Seabridge Gold’s KSM Deposit, is a monster gold deposit... The only problem is that it’s in a far-off corner of British Columbia. To mine this deposit, the company needs to build a long tunnel...just to get the construction equipment in. I still like owning the stock. But it will take billions of dollars of capital investment to develop the deposit. Another monster gold and copper deposit, Alaska’s Pebble Deposit, is next to a pristine wildlife area. This creates just as large a hurdle as a lack of roads. Plus... The costs of gold production (things like fuel, labor, and infrastructure) has more than doubled from 1997 to 2009. The price tag to build a new mine these days can run into billions of dollars. The mine must be able to repay that cost within a year or two and then produce a reasonable return on the investment. The huge upfront costs set the bar high in terms of the size and quality of deposits that big gold companies are willing to pursue. This just means the highest-quality, large, undeveloped gold deposits in the world are getting increasingly valuable. As $1,500- plus gold sends a surge of profits into the coffers of big gold miners, you’ll see fat premiums paid for great projects. Mining giant Newmont paid a big premium in 2010, when it spent $2.3 billion to acquire junior explorer Fronteer Gold. One day, Fronteer was worth about $10 per share. The next day, it was worth $14. Investors doubled their money in a few weeks on that deal. In sum...the world is running low on gold. The “easy gold” has already been found. That’s why Brent is scouring the world looking for great gold projects... Right now, he’s a fan of investing in deposits in Mexico... Although you hear lots of negative “gang related” headlines from mainstream media sources, Mexico is actually a great jurisdiction for miners. And he’s made good money by owning shares of Almaden Minerals, which is exploring a promising gold project called Ixtaca. Potential deposits like that aren’t easy to find... But they’ll be worth hundreds of percent more in the coming years. Regards, Matt Badiali, for The Daily Reckoning P.S. You can follow Brent and his research in Exploration Insights. It’s targeted to experienced mining investors and traders. Learn more about it here. We also follow this “big idea” in my S&A Resource Report. You can get the details on a subscription here. When Will Obama Confess to the Secret “Timebomb” Event Ahead? Obama and Congress won’t even talk about it...but we’ve got a much bigger problem ahead than anybody cares to admit...and it could hit harder than the 2008 banking collapse. What problem? Nothing less than a secret new meltdown for world oil supplies — with gas potentially doubling in price and oil potentially about to hit $300 — and it could hit as early as the end of this year. Find out how in this urgent new report... Bill is still wandering around in northern Argentina... Actually, we sent you a few pictures of a little place up there last week...along with an invitation to join us there, at Doug Casey’s La Estancia de Cafayate. Missed ‘em? Here’s a couple of refresher photos... We’ll be there with Addison and a group of Agora Financial Reserve members in November for a special investment/lifestyle conference. If you’re interested in joining us, here’s how to get started. Hope you can make it... Regards, Joel Bowman, for The Daily Reckoning ------------------------------------------------------- Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor at joel@dailyreckoning.com Give Collapse a Chance Fake Fixes for the Real US Debt Problem When Economic Growth is a Thing of the Past How to Promote Growth by Debasing Your Currency Gold and Silver See Tons of Selling The Fed Chooses Operation Twist The Daily Reckoning: Now in its 11th year, The Daily Reckoning is the flagship e-letter of Baltimore-based financial research firm and publishing group Agora Financial, a subsidiary of Agora Inc. The Daily Reckoning provides over half a million subscribers with literary economic perspective, global market analysis, and contrarian investment ideas. Published daily in six countries and three languages, each issue delivers a feature-length article by a senior member of our team and a guest essay from one of many leading thinkers and nationally acclaimed columnists. 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