October 16, 2007

Metal Markets Update October 2007

A look at the metal markets in the aftermath of the debt crisis

The gold price has rebounded strongly in reaction to the crisis in confidence suffered by the financial markets. The base metal prices are also recovering after a reassuringly modest reaction to the financial turmoil. Share prices in the mining sector have already begun to recover their recent losses. It is only a matter of time until mining shares resume their upward trajectory.

There remain serious problems with the U. S. economy. The dollar continues to be under long term pressure as economic growth remains sluggish. The high level of debt throughout the economy and the eroding trust around the world of U.S. financial institutions makes it clear that the dollar will have a great deal of difficulty in mounting a big recovery in the near term.

That bearish outlook for the dollar makes the outlook for gold fairly straightforward. Gold will continue to hold its value as the dollar depreciates. The six year bull market for gold has gained even more momentum as investors grow ever more wary of paper assets – whether currencies or other forms of government or corporate IOUs. It is only natural that investors – both institutional and individual – are increasing the amount of bullion they hold. That growing demand is increasing the value of gold in real terms.

On top of the growing investor demand for gold, jewelry sales are being spurred by the unprecedented level of wealth creation around the world. India, which for years has been the largest consumer of gold, is experiencing spectacular economic growth. It is only natural that gold consumption has been growing in India, with forecasts for growth to further accelerate.

Even in the face of rising demand, production of gold remains flat. New mines are not even offsetting mines that are being shut down as they run out of ore. Producers continue to reduce total hedge positions, with shareholders insisting that management minimize or avoid new hedges.

Some central banks are still selling their gold reserves, but those sales are being offset by other nations that are expanding their bullion holdings.

Add it all up and the outlook for gold is even more bullish than it was during six year period that saw the gold price soar from $252 to the current $731 an ounce.

While the gold price will undoubtedly continue to climb, it is unlikely to do so in a straight line. I continue to urge caution against an expectation of a rapid and sustained rise in the gold price. We have seen too many spurts that suddenly reverse course, leading investors to watch as the gold price pulls back. The trend is clearly upward, but in a similar manner to the past six years.

The story for silver is also extremely bullish. A more comprehensive update will be presented in an upcoming update.

The uranium price has settled back to $85 a pound from a high in excess of $130. That correction brings the market back to a more sustainable level with room for growth over time.

The long term outlook for uranium remains extremely positive. World-wide economic growth is driving the need for more energy. The oil price at nearly $83 vividly demonstrates the limits to the ability of the oil industry to find and develop new supplies. On top of all that, the environmental movement has, albeit grudgingly, lessened their opposition to uranium as new reactors provide an alternative to burning more fossil fuels.

There are still far too many uranium exploration companies. The good news is that the valuations of many of those companies are now more rational than they were earlier this year.

The base metal story is more complex... and far more controversial. A few commentators in the United States hold that the debt crisis will trigger a recession in the U.S. With American consumers unable to shop, the world will fall into a deep economic funk, according to those commentators. To them, it follows that base metal prices will plummet and the mining industry will suddenly no longer need to build new mines.

To a person whose feet remain firmly planted on U.S. soil, and whose information sources consist of headlines from select American publications, that scenario may seem credible. To those with a more global perspective and who draw on a wider range of opinion, an entirely different story emerges.

The media is full of talk of recession, but short on any sort of real evidence to back up their gloomy forecasts.

To those who have hard data and are in a position to make objective evaluations, the outlook is for a slowdown in the U. S. economy, but for growth to remain positive. For example, the National Association for Business Economics, a highly regarded group of professional economists, lowered their growth forecast for the U. S. economy for next year. In May, they expected growth next year at a level of 3.1% above the level of the current year. Their revised forecast, released in early September, shows a consensus outlook of 2.8% growth in the U.S. economy for next year.

That 3/10% reduction in the expected rate of growth might have an impact on the share price of Ford or General Motors. A slowdown of that magnitude will have no impact on the rest of the world and will certainly not impact base metal prices.

Economic growth around the world is stronger at this time than it has been at any time in history. The United States remains the single largest economy in the world, but is far less important as a driver of the world economy than it was in years gone by.

China is now the world's largest consumer of metals. A few people cling to the out-of-date notion that the U. S. consumer powers the Chinese economy. Hard figures and/or even a brief first-hand look at China will make it clear that the majority of metals imported into that country remain within the country. Infrastructure is being built throughout the country at a pace that is impossible for people to comprehend without seeing it first-hand.

In addition to the infrastructure development, hundreds of millions of consumers are just beginning the life-long process of accumulating consumer goods. They are also discovering leisure travel. An example of that trend is that the Chinese city of Macau has now replaced Las Vegas as the world’s largest gambling center.

A similar growth story holds throughout much of Asia. Growth is also strong in Brazil and other parts of Latin America. European growth remains robust. Oil exporting nations in the Middle East are awash in profits, with some areas competing with China in terms of their pace of economic development.

I want to be absolutely clear with my message on this topic. The debt crisis is a symptom of a very serious structural problem in the United States financial system. The fallout and the subsequent adjustments in the economy will undoubtedly slow economic growth. In fact, it is entirely possible that the pace of growth may be even slower than the recent consensus outlook. Growth in other parts of the world may also slow a little, but overall growth throughout the world will remain positive.

With worldwide economic growth remaining positive, metal consumption will continue to grow. Even as demand for metals continues to grow, production remains nearly flat. Metal mines that have seen their lives extended well beyond their projected limits because of the extraordinarily high metal prices will continue to run out of ore.

Metal prices may not rise beyond the current levels, and that will scare off those investors who see profits in this sector related only to rising metal prices. Investors prepared to look a little more closely will see one of the most extraordinary investment opportunities ever presented to them.

Regardless of the level of economic growth, new mines are urgently needed and the exploration and development companies present exceptional profit opportunities.

*****

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