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The recent sell off in the mining stocks was brutal
and half of the decline took place in 48 hours. At this point it
is important to analyze the major macro reasons mining stocks are
good investments. You all know most of these; Global money supply
increases, excessive debt, demand – supply imbalances of most
minerals due to China and India, world tensions regarding the mid
–east and possible huge financial imbalances due to excessive
derivative speculation.
The two charts below, I believe, are as important
to precious metal and base metal stock investors. These charts show
how basically undervalued the mining sector is based on real world
factors. These two charts tell us the big move in these mining stocks
is ahead of us not behind us.
The chart below shows the CRB (Commodity Research
Bureau) World Commodity Index. We have adjusted this by the CPI
from 1963. It shows in real terms
that the commodity move of the last five years is just in a beginning
stage.
Even with the roaring bull market in the metal markets
and in other commodities, the actual real values have not even approached
the price levels people accepted as normal back in the 60’s
in the U.S. This means in real terms the CRB needs to at least double
from here in order to just catch up with the 60’s. At that
point these commodities will again be influenced by future inflation
over the next 5-10 years. It is not inconceivable to anticipate
commodity prices to rise much more in the future. In the great commodity
boom of 1970-73, prices went way beyond any of the values expected
by the floor traders, analysts, brokers and the commercials. The
reason was that a huge macro-economic wave of paper money increases
from the last 20 years and the Russian wheat deal combined to move
nominal prices (not shown on the graph) up dramatically.
Gold and silver, base metals and other commodities
could go much higher.
The next graph takes the Gold price and divides the
price by the value of the XAU (Philadelphia Gold and Silver Mining
Index). This shows if the mining stocks are under or overvalued
in relation to the gold price. The higher the graph the more undervalued
the shares are in relation to the present gold price. Gold stocks
are currently more undervalued as
of Friday (19th May) than they were on 7 Oct. 2006 when gold was
$474 an ounce.
The above graph is short term in nature and coupled
with the first graph which is long term in nature they clearly show
owning the mining stocks is a solid value proposition.
The metal markets have been in a strong bull market.
Currently a correction has taken place. Because of its severe and
fast decline it may be ending right here. Pullbacks and consolidations
are part of all long term up-trends. They should be managed and
intelligently handled.
Two Distinct Forces
There are now two distinct forces at play in this
metal market that are new to this century.
The normal industrialized world economic cycle usually increases
demand for metals for buildings, cars, infrastructure etc. When
the economic expansion runs out of steam, a recession ensues and
metal prices decline as demand decreases. Now there is something
new.
The two new forces are 1) metal demand from the industrialized
world economic cycle is now second fiddle to China and India (developing
countries) who are consuming vast amounts of natural resources and
2) Not enough large mineral deposits are being found to sustain
the demand from global population increases. This, along with currency
depreciation, is why copper, zinc, other minerals and precious metals
are moving higher.
The Third Force
Wall Street momentum players and high powered hedge
funds with trillions to invest are also now involved with the natural
resource sector. Prices have been going higher from real demand
and speculation, but there is another third
force - a sea of liquidity (money and credit) increasing
globally.
India in the last five years has averaged about 16%
a year in money supply increases and they are currently at 22%.
When someone tells me silver is too high, The billion plus people
in India could care less if silver moves down a few rupees when
their entire life savings could go up in smoke as their government
continues to debase the local currency. China
has had annual money supply increases over 12% for ten straight
years- currently at 17%. The U.K. has averaged 9% for the
last five years and the U.S., 7% per year for the last five years.
In an honest economic system zero
money supply increase is the ideal. Higher prices for almost everything
are coming. One needs to have a hedged economic posture and that
means a core position in gold and silver and the mining stocks.
The correction we have just witnessed appears to be
over but there will be many more in the future. Stay with solid
merchandise and make sure to take something off the table when valuations
of certain stocks you own get out of hand and use that cash to re-enter
the market on sell –offs. But always keep a core position.
Please visit our website for other articles on gold
and the mining sector. www.kengerbino.com
Kenneth J. Gerbino
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