Sticking to my guns
October 3, 2005
Since the dollar started falling in 2001, mining companies’
costs have gone up dramatically from their 1990s feasibility studies.
Because all these studies were done in US dollars the cost increases
reflected the fall in the dollar more than anything else. There
is no doubt that raw materials such as steel have gone up in price
in real terms, and that the recent highs in energy costs are having
a noticeable impact on operating costs. But I still think that both
the mining industry and the market are completely oblivious to the
impact of exchange rates on the industry.
At the same time, gold investors are extremely bullish,
convinced that we are in a roaring gold bull market, while gold
mining companies are unable to increase revenues even though the
gold price has almost doubled.
There is a reason the mining industry is not making
money. All we have seen thus far is a bear market in the dollar:
that means that companies that operate in non-dollar environments
have seen very little, if any, margin expansion at their mining
operations. There is no evidence of a bull market in gold. That
does not mean a real gold bull market is not imminent and, as I
will discuss in my next commentary, there are reasons to be bullish.
Personally, I prefer to bet on a continuing decline in the dollar
and to invest in such a way that I would benefit if the increase
in the gold price continues to be dollar related. Should a real
gold bull market develop, I would still be able to benefit from
it, but I would not be dependent on it.
What is the strategy? Since mining is a depleting
business, the biggest problem facing the mining industry is reserve
replacement. This is where the exploration industry comes in. Fortunately,
there are very few people in the exploration industry itself that
are capable of making new discoveries: like any other industry,
the majority of the people are average, some are below average and
some are above average. I look for those above average groups and
invest in a big way.
If we can participate in a mineral discovery we will
make money regardless of what happens to commodity prices. The mining
industry severely curtailed its exploration efforts during the 1990s,
so even if commodity prices decline the industry cannot afford an
extended hiatus from exploration. But I would not take a chance
on base metal exploration because declining base metal prices would
reduce the economic thresholds of new projects, so fewer discoveries
will be economic discoveries. Given how rare new discoveries are,
you want the cards stacked in your favor as much as possible.
But gold is not a commodity. Gold is an international
monetary asset and its price is a function of exchange rates and
monetary inflation. So even if we encounter economic stagnation
that would hurt commodity prices, the gold price would not necessarily
be affected. In fact, the gold price is likely to outperform other
metal prices going forward. That’s why I focus on the gold
sector.
I continue to believe that the most likely course
of events is a deflationary economic slowdown in the US that will
result in global economic stagnation. Given the US’ dependence
on foreign capital it will also result in a further, major devaluation
of the dollar and that, in turn, will cause the US dollar gold price
to rise. It is also possible that a substantial increase in the
US dollar gold price will spill over into other currencies, driving
the gold price even higher. However, a worldwide slowdown in economic
activity would hurt the commodity bull market.
The risk is that a decline in commodity prices
and commodity stocks will then weaken the gold market, especially
the exploration sector, and that is a dilemma I have been grappling
with for a while. I am becoming more and more convinced that the
end of the current boom in US real estate, equities and bond markets
are upon us. Of course, it is not only impossible to predict when
markets will turn but also how the future will unfold. So I have
decided to stick with my original plan, which is to focus on mineral
exploration because of the depleting nature of the mining industry
and, within that, to focus on gold.
Paul van Eeden
Paul van Eeden works primarily to find investments
for his own portfolio and shares his investment ideas with subscribers
to his weekly investment publication. For more information please
visit his website (www.paulvaneeden.com)
or contact his publisher at (800) 528-0559 or (602) 252-4477.
Paul van Eeden works primarily to find investments for his
own portfolio and shares his investment ideas with subscribers to his weekly
investment publication. For more information please visit his website (www.paulvaneeden.com)
or contact his publisher at (800) 528-0559 or (602) 252-4477.
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