economy is facing a looming crisis on several fronts. Will
it collapse or can it
This article was first seen in the September
2005-1 issue of Resource Opportunities. Most Lawrence Roulston
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I have recently returned from the Las Vegas
Gold & Precious Metals
Investment Conference. Over that two-day event, I had the
opportunity to interact with some of the top minds in the
investment world and with hundreds of investors.
The conference was well attended with a generally upbeat attitude
toward resources. However, there was also a great deal of
confusion and worry.
The biggest concern was with regard to the U.S. economy: Many
people see an economic collapse as imminent. There is also
a great deal of confusion and misinformation with regard to
China, which is quickly emerging as an economic power.
Several other topics with regard to the mining industry came
- When will we see a big discovery?
- With all of the good news flowing, when will share prices
begin to move?
- When will the gold price and other metal prices make a big
- Will a slowdown in China impact metal prices?
- How will Katrina affect commodity prices?
These questions are fundamental to the outlook
for the mining industry. Having heard and read a broad range
of opinions on these topics, here are my opinions.
U.S. Economic Outlook
By far, the biggest concern among investors
at the Las Vegas Gold And Precious Metals Investment Conference
was the outlook for the US economy.
Government debt, consumer debt, escalating government deficits,
the war in Iraq, terrorism, the wilting dollar, and now the
devastation on the Gulf Coast, are all serious issues.
But, will these factors lead to an economic
It is important to look beyond the headlines
and superficial analysis and think through these issues.
I would urge people to go back a few years
and re-read the doom and gloom forecasts from so many commentators.
Granted, some of the events that were forecast
have come to pass. Yet, in spite of the mounting difficulties,
the US economy continues to grow and prosper. It is not the
level of growth that many people would like to see, but it
is a very long way from the apocalypse that was forecast by
I'm not saying that all is well, by any means.
The country faces some very serious challenges. But I have
no doubt that the United States will continue to muddle through
these difficulties and that with proper planning, investors
can protect their wealth and generate some profits.
A very important factor that so many commentators
are missing is the fact that Americans have already seen a
huge adjustment arising from the challenges facing the economy.
To somebody living within the United States, it may be difficult
to recognize that process of adjustment, which remains underway.
You see, each and every man woman and child in the United
States has already handed over nearly a third of their wealth
to the rest of the world. And, they are handing over more
of their wealth with each passing day.
For example, a stock portfolio based on the
Dow Jones industrial average has a dollar value about the
same now as it was five years ago. However, the dollar is
now worth roughly 30% less than it was at that time. In the
context of the rest of the world, that portfolio is worth
about 30% less now than it was five years ago.
As long as that investor spends his money only within United
States, he may not immediately notice that he has given up
a significant portion of his net worth. Over time, that reduction
of wealth will become more evident.
The declining value of the dollar is immediately
clear to that small portion of Americans who venture outside
of their own borders. Even expense account travelers are wincing
at the price of hotels abroad, whether London or Zurich or
Johannesburg or Tokyo. Remember when foreign travel was cheap
for Americans? Not any more.
So far, the escalating cost of imports has
been moderated by the inexpensive goods coming from China
and on-going productivity improvements in the U.S. and other
places. The higher commodity prices will eventually work through
The real estate bubble in the United States
is also cause for serious concern. The extremely high level
of consumer debt is alarming. Many people have paid too much
for the real estate they now own; and borrowed too much to
be able to service it if there is any disruptions in their
lives; and since many of them hold variable rate loans, they
are at serious risk of higher interest rates.
However, a closer look suggests that this situation
may not be as serious as it appears to a superficial analysis.
First off, a portion of the apparent gain in the value of
real estate is a reflection of a hard asset holding its value
in the face of the declining value of the dollar.
As the dollar continues to decline in value,
an obvious investment strategy is to “short” the
dollar. One way to short the dollar is to borrow dollars and
buy hard assets. Many Americans have undertaken an astute
investment strategy, even if they are not aware of the deeper
implications of their real estate mortgages.
Let me reiterate that I am not in any way belittling the enormous
challenges faced by the U.S. economy. I am simply looking
at whether one should expect a cataclysmic correction or if
the country can muddle through.
There is no question that an economy with such
enormous challenges as those faced by the United States must
deal with an adjustment to bring it into line with the reality
of the rest of the world. I believe that a lot of commentators
have missed the fact that the process of adjustment has been
going on day by day, as the decline in the value of the dollar
effectively shifts wealth from Americans to the rest of the
world. That on-going process lessens the pressure for a cataclysmic
I see no reason to believe that the self-correcting
economic system is not capable of continuing to function effectively.
While the prospects of a sudden melt-down of the economy is
remote, Americans must recognize that they are giving away
wealth to the rest of the world to the extent that they hold
dollar denominated assets.
Now, what does all this mean to an investor?
More than ever, gold and gold equities will
continue to prosper in the face of the declining dollar and
uncertainties with regard to the U.S. economy.
It also means that metal prices will remain at a level at
which the producing mining companies will develop new mines.
That being the case, the junior exploration companies will
play an important role in the process of finding and developing
the mines of tomorrow, and thereby provide the potential for
exceptional returns for investors.
China’s Impact On Metal Prices
It is now generally recognized that China has
been a major contributor to the astonishing rise in metal
prices. Some commentators are suggesting that the high level
of Chinese economic activity may be transitory.
It was shocking to hear at the conference the
extent of the misperceptions that still exist with regard
to China. It is astounding, but some people still think that
Chinese economic activity depends primarily on exports, largely
to the US.
Let's think about that. If the Chinese economic
activity is merely replacing manufacturing activity that would
have otherwise taken place in another country, we would not
have seen the dramatic increase in overall metal consumption.
Plain and simple, metal prices have skyrocketed for the simple
reason that there has been a huge increase in consumption
of metals. That additional demand for metals is being consumed
I don’t know anybody who has actually
spent time in China who would downplay the importance of internal
consumption in China. I have toured many parts of the country
in the course of six visits over the past three years. I have
seen an intense level of activity in every part of the country,
both in terms of infrastructure development, and also with
regard to individual consumers.
The major infrastructure projects are clear
for all to see: roads, rail lines, ports, factories, power
plants, huge apartment complexes, office towers, hotels, tourist
resorts and all of the other components of an emerging economy.
Development of this infrastructure projects
is proceeding at a feverish pace, as 30 million people a year
migrate from the countryside to the cities. Each and every
year, China is building the equivalent of 10 Toronto's or
two New York's, and that is just a part of the overall industrialization.
New arrivals in the cities are not being housed
in shanty towns, as is the case in nearly every other part
of the world. New housing is being constructed, with most
of it being good quality apartments.
So far, the economic activity that has driven
metal prices to multiples of their earlier levels has been
largely driven by the infrastructure development. Even as
that infrastructure development continues, the consumer class
in China is growing rapidly.
The latest estimates put 300 million Chinese
into the middle class. That is greater than the middle class
in North America. Those people are just beginning to accumulate
the trappings of wealth and all of the toys that the middle
class in North America or Western Europe find essential.
Anybody that takes the time to wander through
the residential areas of China, whether Shanghai, or any of
the 100 other cities in China with a population greater than
a million, or even in smaller cities and towns will quickly
recognize that the industrial revolution in China is unstoppable.
Some commentators are concerned about the human
rights issue in China. Clearly, from a western perspective,
there are countless cases of human rights abuses. However,
it is vitally important to recognize that there is an enormous
cultural difference between China and the West. Remember,
China has never experienced a democratic system. The present
level of individual freedom in China is far, far greater than
it has ever been and the situation is steadily improving.
These people are wise enough and forward-looking enough to
recognize that the surest route to individual freedom is to
continue the process of building wealth throughout the country.
There is also concern about the widening gap
between the haves and have-nots. In one generation, 300 million
people have elevated themselves from subsistence to owning
multi-hundred thousand dollar condominiums and the trappings
of a comfortable urban existence.
Another billion people are still eking out
a living on farms or menial factory jobs. While still facing
hard lives, the majority of these people are much better off
now than they were in years gone by. There is not the desperate
poverty that one sees throughout Latin America, the Middle
East, Africa and other parts of Asia.
Nearly everybody in China has the basic necessities of life
and anybody who wants to can build wealth. This is a land
of energetic, hard working entrepreneurs. Most importantly,
every child in the country has the opportunity to participate
in a fine educational system, and education is the key to
achieving a better life.
Undoubtedly, there will be corrections and slowdowns. The
growth rate of nearly 10% per annum cannot be sustained forever.
However, to say that the infrastructure in China is overbuilt
is ludicrous. It may take some time to fill up all of the
office towers in Shanghai and there is undoubtedly excess
capacity in some other parts of the system.
But, remember, the Chinese believe in long-term
planning. How often in North America have we seen a newly
built freeway or bridge reaching capacity six months after
it opened? The Chinese are building infrastructure that will
last for a few years.
Energy shortfalls remain a concern. A second
hydroelectric project on the scale of Three Gorges is already
well advanced. New coal-fired power plants are being built
at a feverish pace. More than 30 new nuclear power plants
are in the planning stage or are already under construction.
The spectacular rate of industrialization going
on in China has driven metal prices to a level that is perhaps
impeding development in other parts of Southeast Asia, such
as India. Any slackening of metal prices would provide a boost
to the pace of economic development in the rest of the region.
In other words, if China’s growth rate did slow, and
the metal prices began to moderate, India and other Asian
nations would quickly take up the slack and thereby moderate
the metal prices.
In short, we are seeing exactly the same fear
and uncertainty that accompanied the industrialization of
Japan. Fear-mongers told us then that all of our manufacturing
jobs would be exported to Asia and the Western World would
be over-run by the Asian threat. In reality, the new-found
prosperity in Japan led to the emergence of another wealthy
trading partner and enhanced the economic well-being of the
rest of the world.
Some western companies will undoubtedly be
hurt by what is going on in China. On the other hand, companies
that have the wisdom to take advantage of the enormous opportunities
afforded by the emergence of China as a world economic power
will pay off in a big way for shareholders.
In short, the industrial revolution that is
affecting 3 billion people in Southeast Asia is an unstoppable
process that will drive the demand for commodities for many
years to come.
When will we see a big discovery?
We have seen many important mineral discoveries.
Recent grassroots discoveries include the Eleanor gold discovery
of Virginia Gold, the Corani silver discovery by Bear Creek
Mining, Silvercorp’s Ying silver deposit and Brazauro’s
TZ gold deposit. Other companies have expanded and upgraded
early stage discoveries to create valuable deposits. For example,
NovaGold's Donlin Creek and Galore Creek deposits, Regalito’s
copper deposit, Western Prospector’s uranium deposit.
All of those discoveries and advances have resulted in big
gains in shareholder value.
With all of the good news flowing, when
will share prices begin to move?
Share prices are moving. The companies mentioned
above are a few examples of companies that delivered positive
results and were rewarded by investors.
However, it is pretty clear at this stage that much of the
buying is coming from sophisticated investors from within
the industry. For example, the big move in Bear Creek’s
share price was largely driven by Silver Wheaton accumulating
a 15% position in the company after the announcement of favorable
Many of the retail investors who follow the mining industry
are pretty much fully invested. The broader retail market
has not yet begun to embrace mining shares. There are several
reasons why investors remain wary, including the factors discussed
in this article. More investors are recognizing the potential
for big profits and are looking at mining companies.
When will the gold price and other metal
prices make a big move?
Many investors are fixated on metal prices
as the driving force for mining shares. Certainly, moves in
the metal prices impact share prices across the board. However,
the biggest moves in share prices come from companies creating
value through exploration and development results. As long
as metal prices remain above long term trends, mining companies
will develop new mines and many of those mines will come from
the juniors. Regardless of the metal prices, discoveries and
advances in deposits will generate shareholder value.
There is every reason to believe that the strong
metal prices will be with us for at least a few years. However,
investors may find it frustrating to simply own a company
exposed to a metal and then wait for a rising metal price
to add value.
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