Gold Meltdown or Mania – Batten Down the Hatches

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As
Doug Casey said recently
, we expect things to come unglued soon.
With the ongoing madness in Europe, it seems to me that things are
starting to look visibly less well glued already.

In contemplating
the possibility of another stock market meltdown, it seems important
to me that in spite of the exuberance with which investors rushed
back into the market over the last year, the memory of 2008 remains
vivid, tempering enthusiasm with caution. For example, the market
still has relatively little appetite for early-stage, grassroots
exploration projects; by our latest estimates, Mr. Market is willing
to pay on the order of ten times more for Proven & Probable
ounces in the ground than for less certain resource categories.
With this evidence of caution in mind, and the great unwinding of
the broader credit markets well underway, it seems likely that our
sector is less leveraged than it was before the crash of 2008.

If a panic
in the broader markets put liquidity-crunch-induced pressure on
the gold price, the meltdown should be less severe than in 2008
and the eventual rebound could be dramatic, possibly triggering
the mania we’ve been calling for. Remember: the market crash
drove gold almost down to $700 in October ’08, but the same
fear drove it almost back to $1,000 by February ’09. Silver
topped that with a 60% rebound over the same period.

As the debt-glue
holding everything together continues to lose its grip, the ride
will only get rougher. As bad as 2008 was, if the Crisis Creature
appears to be coming back when everyone on Main Street thought it
was dead, the fear should be much worse – and that should drive
gold way, way north. It’s possible the fear, coupled with the
lack of any safer alternatives, could prevent gold from melting
down at all, sending it instead straight through the roof into the
clear blue Mania Phase sky.

With its industrial
metal aspect, however, another big economic meltdown could hit silver
harder than gold, and it might take longer to recover, especially
if base metals don’t rebound the way they did in 2009. That
said, silver has always tracked gold, so when gold heads for the
moon, we expect silver will as well. It could reach even higher,
if supply is cut by reduced base metal demand, as most silver production
is as a by-product of base metal mines.

Either way,
I don’t care if gold drops in the weeks and months ahead; the
overall trend is for widespread economic fear and uncertainty to
continue, holding gold prices up and eventually driving them higher.
That makes the current retreat look like a great buying opportunity.
In fact, putting my money where my mouth is, I picked up some more
gold buffaloes just yesterday, when gold dropped to $1158. As I
type, it has rebounded to $1181. I plan to buy more every time I
see a sharp drop like this over the summer.

So, in addition
to our multiple recent calls to take profits and go to cash, I want
to reiterate that gold is cash. And it’s a whole lot more attractive
than the dollar, the euro, or any paper money at present –
not just as a speculation but for security as well.

What about
the stocks?

Unfortunately,
the stampede to safety that drives investors to gold is not likely
to drive them immediately to junior exploration stocks. “The
most volatile stocks on earth” is not what fearful people will
be looking for – not until the panic sufficiently recedes and
greed joins fear in equal measure in the marketplace…or in
greater measure, come the Mania Phase.

If I’m
right about fear being the driving force in the markets in 2010,
whereas greed drove them in 2009, gold will have to deliver a serious
wake-up call – perhaps holding over $1,500 – to really
get the show on the road again for the gold stocks. If that happens
while fear of a global economic slowdown continues to push oil prices
lower, gold producers should be able to report extraordinary profit
increases, even as other industries are tanking, and finally penetrate
deeply into the awareness of broader pools of investors.

Cashed-up majors
won’t have to wait for that to benefit; they may seize the
opportunity created by market weakness to buy successful explorers,
with significant discoveries in hand, while they are on sale. Well,
some of the more nimble ones, like Kinross or Agnico-Eagle, might.
The bigger companies, like Newmont and Barrick, didn’t lift
a finger to pick up any bargains after the crash of 2008 and may
be too cautious to act the next time around as well.

Be that as
it may, acquisitions will increase the demand for quality exploration
projects – the pipeline from exploration to development must
be kept full – and good prospectors should at last get their
day in the sun.

Punctuating
this sequence will be the occasional big win on a new discovery.
There haven’t been that many this cycle – not enough to
replace all the gold the majors are depleting every year –
but there have been some, and the market always loves a discovery.

After the first
quarter of ‘09, greed outpaced fear and great development stories
did phenomenally well; we saw better gains on large and growing
gold stories than we did on the big producers. If fear retakes predominance
in 2010, it’s profitable production that should do best, and
I’d expect the biggest winners overall to be new, emerging,
and highly profitable precious metals production stories. Spectacular
discoveries should also do spectacularly well, but those are harder
to predict. New and rapidly expanding production should be the sweet
spots.

Generally,
I think we’ll see our markets trading largely sideways over
the next few months, with great volatility, until the debt-fueled
“growth” in the global economy is exposed for the sugar
high that it is. We’ve been forecasting that scenario for long
enough here at Casey Research.

I expect this
to play out by the end of this year, or 2011 at the latest, depending
on how fast fear returns to the broader markets.

What to
do

If I’m
right about this, the strategy called for is a more cash-focused
version of our “Buy only the Best of the Best” program.
Buy nothing new unless you’re offered a great bargain in a
solid company that can deliver significant new or expanding production.
Nothing less than 50,000 ounces gold-equivalent per year in production
will get much notice, and anything less than 100,000 ounces per
year AuEq will have to struggle for respect. A solid company, of
course, has great people, lots of cash, and the goods in hand.

If you want
to speculate on a discovery, make sure you have very good reason
to believe the project has much better than average odds of delivering
a discovery – and it has to have world-class potential.
That’s not hundreds of thousands of ounces but millions of
ounces of gold, or equivalent.

If things do
come truly unglued this year, we may well see 2008-style bargains
on great companies with the staying power to recover and go on to
new highs. Watch for it. Prepare for it.

Buy Low, Sell
High – it’s a formula that requires patience but is the
only way to go.

Louis James
is senior editor of Casey’s
International Speculator
.

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