Gold, Silver, Metals and Mining Shares: Part 1 | ||||
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Metal prices have already rebounded strongly from the recent sharp drops. The question now is: When will share prices follow?
The following is extracted from the July 2006-1 Issue of Resource Opportunities
When gold, silver and some of the base metal prices plummeted in May, shares of mining and exploration companies followed the commodities down. Those big drops in share prices have created a lot of pain for some investors.
The metal prices have already rebounded sharply, reflecting the enormous fundamental strength in the metal markets. Mining and exploration company shares are still languishing, as many investors enjoy a summer vacation.
The big consideration now is, when will the share prices get back onto an uptrend?
The short answer is that some of the companies have already recovered their recent losses and others are beginning to follow. As in the past three years, autumn should see a steady upturn in junior resource stocks.
Its worth a review of the metal markets to appreciate the extent of the upside potential in these markets.
Gold reached $730 in May, the highest level since its run-up to the all-time high of $850 in 1980. By mid-June, the gold price was under $570 – a gut wrenching $160 freefall. In almost as dramatic a fashion, gold regained $80, before taking another pause. The events in Lebanon are adding to the growing interest in gold among investors as a secure store of wealth. Yet, investor demand is but one aspect in the story of the gold market.
The silver market, as usual, was even more volatile than gold. Silver climbed from under $9 at the start of this year to $15 by mid-May, before plunging to under $10. Copper dropped from $4 to under $3, and then recovered to as high as $3.70 within weeks.
Perhaps the most surprising story was nickel, which dropped from $10.30 in late May to $8. The nickel price since rebounded to $13 a pound. At the current price of $12, that base metal trades at the equivalent of $.75 an ounce.
Remember the commentators in May who misread the correction in metal prices and argued that it was all over for the metals? Sure enough, the run-up in prices in May was driven by speculators. The present rebound, coming after the speculators were washed out of the market, is part of a long term uptrend that is still at an early stage.
All you have to do is look at the longer-term metal price charts to understand the big picture. Five years ago, copper was $.60 a pound, nickel was $2 a pound, gold was $252 an ounce and silver was $4 an ounce. The stunning gains in metal price reflect fundamental changes in the economic world.
The gold and silver prices will probably continue to ratchet higher over time, in exactly the way they have over the past five years. The gains will be driven by the same factors that have been in place during that period. In the next issue, I will go deeper into the outlook for the gold market.
Nobody expects today's base metal prices to continue rising forever. But, the long-term forecasts that are being used are totally ludicrous. The big brokerage firms, the engineering firms, even the mining companies are showing long term metal prices that start well below the current levels and then drop back to so-called long term averages within about two years.
I keep asking the people who are working with those figures: What are the new mines that will come into production in two years that will bring the prices down?
The answer, from as many knowledgeable mining industry people as I have been able to put the question to its always the same: There are no big new mines that will come into production in that time frame. But, they argue, metal prices have always gone in cycles, and therefore they are imposing the historic cycles on the present situation.
The last cycle ended when economic growth slowed at the same time that several big new mines came into production. At that time, there was not a massive horde of wealth in the hands of oil exporting nations that we have now with $70 oil. China was not a factor. India was not a factor.
While analysts use the so-called long term averages for metal prices, the forecasters insist on using today’s energy price, based on $70 oil, for the life of the projects.
Not too many new mines look attractive with costs at the present level and revenues based on historical figures. We will never see those historical prices again. Those historic figures are measured in dollars that had an entirely different value than today or in the future.
In other words, even if demand for metals suddenly evaporated and an abundance of new mines started producing, the equilibrium in the markets would come at metal prices that reflect the fact that the dollar is worth substantially less now than it was a decade ago or two decades ago.
The handful of smaller mines presently under development won't come near to offsetting the older mines that will be shutting down as they run out of ore. The biggest copper mine in the world, Freeport’s Grasberg mine in Indonesia, has just seen yet another reduction in forecast production.
Instead of building new mines, the mining industry remains totally obsessed with buying, acquiring, merging, consolidating and otherwise shuffling the ownership of existing production. It takes many years to bring new mines into production and there are nowhere near enough new development projects under construction, or anywhere near construction, to come even close to offsetting depleted mines, much less catch up to rising demand.
The demand side of the metals markets is gaining strength. Copper's recent run to $4 was driven by speculators. After many of those speculators were washed out of the market, the current strength is coming from the fundamental demand for metals.
Many investors remain fearful of a sharp decline in the US economy. Certainly, the US economy has serious problems, including consumer debt, government debt, the on-going government budget deficit and the enormous trade deficit.
That situation is clearly unsustainable. There is no question that there must be a readjustment. I dare say that many investors seem to be missing the point that a process of adjustment has been happening for years… and will continue in a way that results in a gradual realignment of the US economy with the rest of the world.
That process of adjustment is based on the fact that the value of the US dollar continues to erode, having already lost 30 or 40% of its value against other major world currencies. The dollar has lost a substantially greater value when measured against hard assets, such as gold.
Many Americans, who are living comfortably within their own borders, are not even aware of how much of their wealth they have already given away. Those people will have a rude awakening if they ever venture abroad. Many places in the world now have a level of wealth and grandeur that makes American cities look old and tired – and comparatively cheap.
Nevertheless, the US remains a great country. Brilliant business minds and innovators and entrepreneurs will continue to overcome the best efforts of the government to wreck what remains the most powerful nation in the world.
In spite of years of forecasts by economists and would be economists about the imminent demise of the US economy, the country continues to enjoy strong growth. The economy will likely slow from this level, yet only a handful are predicting a situation as bad as zero economic growth. Those dire predictions, for the most part, are coming from the same commentators who have been making the same predictions for at least as long as the nine years that I have been following the markets as a newsletter writer. (Those predictions of doom and gloom likely go back even further, but in my previous life as an exploration company president, I wasn't following the market commentators.)
In short, even if a disaster case were to unfold, and the US economy were to plunge to zero economic growth, then America would merely consume the same amount of metals as in the previous year.
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