The U.S. economy is facing
a looming crisis on several fronts. Will it collapse or can
it
muddle through?
This article was first seen in the September
2005-1 issue of Resource Opportunities. Most Lawrence Roulston
articles are posted on the Resource Opportunities Free Articles
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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
up repeatedly:
- 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
move?
- 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 collapse?
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 so many.
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 system.
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 adjustment.
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 within
China.
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
drill results.
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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