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Melt-Down or Muddle

By Lawrence Roulston         Printer Friendly Version

October 13, 2005

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 page before being posted elsewhere or are only posted on

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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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