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How supply helped break the gold bull market of 1980, plus the Gold Price outlook today...
A MINING ANALYST with over 25 years experience, John Kaiser is editor of the Kaiser Bottom-Fishing Report, specializing in high-risk speculative Canadian securities and the resource sector.
The Gold Report: John, you have said that you believe gold may go up to $1,300 to $1,400, but probably not higher. Can you give our readers an overview of how you achieved those targets?
John Kaiser: I think we're ready for a real increase in the price of gold, which is why I am looking at more modest targets, such as $1,300 to $1,400, happening fairly quickly, probably bouncing plus or minus $200 or $300, around that level, but it's a real price increase without a corresponding catastrophic collapse in the US Dollar or hyperinflation descending upon us.
TGR: What time frame are you looking at?
John Kaiser: I think we're getting very close. We're knocking on the door of $1,000, which is a very important psychological level. I would say in the next six months, as people realize that the banking system is still troubled and will be for a long time because an uptrend in real estate prices is not in the cards for a very long time. And, in order to make the banks solvent, the underlying collateral needs to have liquidity and a stable price.
I'm saying that in the next six months the realization will kick in that the world has changed in a significant way and the United States is losing its role as the overwhelming economic superpower and will continue to do so over the next 20 years as other countries such as China and India come into their own and pick up the slack that's created by the collapse of consumption right now. If it breaches $1,000, I think it'll very quickly go to $1,300-$1,500 and establish that as a new base.
What I'm arguing is that the uncertainty about the next 20 years is going to encourage more and more people to put part of their wealth into gold and keep it there. This expansion of investment demand differs from the situation we had in 1980. Back then we had a tenfold increase in the real price of gold from 1972 to 1980 and part of that was because gold's value had been artificially suppressed through the gold standard and once that was removed, we had a slingshot reaction and gold adjusted to a price ten times higher. There were mines being shut down in the '60s because their costs kept rising while the Gold Price remained fixed. Then all of a sudden we had new technology in the form of heap leaching and new economies of scale that unleashed an enormous amount of new gold supply.
During 1980 the new mine supply of gold was 42 million ounces, which was actually lower than the 48 million produced in 1970. It rose steadily after that, peaking at 82 million ounces in 1999 when gold was also under pressure from official selling by central banks and indirect selling through the gold carry trade made possible by gold leasing. From 1980 through last year gold producers added 1.9 billion ounces to the above ground stock, bringing it to about 5 billion ounces today. But mining costs have kept going up and up and the annual mine supply has been declining since 2004.
TGR: If the Gold Price continues to rise but costs remain stable, wouldn't one want to invest in the gold production companies?
John Kaiser: Yes. In the last four years the gold producers have not actually done very well despite the recovery from $260 to the current level. We've had a base metals commodity boom that drove up the costs of producing gold at a much faster rate than the price of gold was increasing. On an inflation-adjusted basis, $400 gold in 1980 today should be about $1,000. The rise since the low of 2001 is not a real price gain, just a catch-up. But in the current deflationary environment another 30% to 50% boost in the price of gold would be a real gain that has a profound impact on the bottom line of gold producers.
For companies that have deposits that are marginal when gold is $600-$700 an ounce, you wouldn't dream of putting them into production with gold now at $925-$950. But at $1,300-$1,400 an ounce, with the cost staying at $600, all of a sudden there's a huge margin available to be tapped. So we would see a rush of capital going into these deposits and companies and producers to develop these ounces in the ground and turn them into cash flow, which, of course, the market will use its discounted cash flow model to put a value on. And the key thing is, again, to see that this is a real increase in the price of gold and the sense that this is now the new reality, not just a temporary spike that will correct and drive gold back down to, say, $600.
TGR: At a recent conference you highlighted strategies or approaches that gold companies should pursue to create value. Can you give us an overview of those strategies and some examples of companies who are doing that well?
John Kaiser: You've got to look at it as producer and non-producer categories. The big producers have been creating value by putting existing deposits that they have in their inventory into production and they have been growing themselves bigger by doing mergers of equals – so that the big mining companies just get bigger and bigger by consolidation.
But the more popular route is for a bigger company to take over near-development assets. The stronger company comes in and buys out the distressed company because it has the internal capital to develop those assets. With the non-producers, the idea is to look at the projects that have the ounces in the ground where it may not be so great right now, but if we are expecting a significant increase in the price of gold, value will end up being created, courtesy of the Gold Price increase.
So in anticipation of this type of takeover bid what these non-producer companies are doing now is raising the risk capital to push these projects along the exploration cycle. They're doing their in-fill drilling, metallurgical studies, and pre-feasibility studies. And even if the pre-feasibility says, well, this is kind of so-so at the $700-$775 three year trailing average the engineers are plugging into their cash flow models – if we do get this move, everybody will say, well, that pre-feasibility study established the cost side of the equation. And now we're seeing the revenue side expand massively thanks to a higher real Gold Price, now there is value being created, and the stocks will adjust upwards five, ten times in price to reflect the new reality of a significantly higher Gold Price.
TGR: Thanks, John. This has been very informative.
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