Another one of the more informative articles...

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Dig Deep for Gold, Gold Miners: Yellow metal set to rally big in 2009.

Lance Lewis

January 30, 2009

I thought I’d “touch base” with gold bulls. At the end of December, I was looking for a rally in nearly everything as the Fed’s printing presses went into warp speed and created a bear-market rally in stocks.

However, given the inflationary nature of any potential rally in equities, gold should have rallied even more and thus pushed the SPX/gold ratio below 1, as I wrote here.

Let’s go to the scoreboard and see how we did.

The S&Ps are actually down slightly on the month, but up from their lows. Meanwhile, gold has blown through the “monkey zone” on the chart like a bullet going through toilet paper and is up about 5% on the month. The fact that it has pierced this magic line on the chart should now trigger even more enthusiasm among those chart monkeys who hated the yellow metal passionately at $700 - but now can’t wait to buy it at $920.

Click to enlarge: http://tinyurl.com/d7sw6e

As for the SPX/Gold ratio, it did in fact plunge below “1” last week as gold ($924) passed up the S&Ps (845) in price. The last time this happened was in 1973, and gold proceeded to nearly triple over the next 18 months.

Click to enlarge: http://tinyurl.com/ccqzp7

Is history about to repeat? Probably not, but as is often the case, it will likely rhyme. Unlike 1973-1974, gold probably isn’t going to rally due to an oil embargo, but it is going to rally for a very similar reason to why it began to rally back in the early 1970s in the first place, which was because the Bretton Woods monetary system in place since WWII collapsed when Nixon was forced to close the US gold window.

Similarly, while I still tend to believe that gold’s rally is telling us something about the inevitability of more weakness in the dollar, there’s no doubt that there is something else “gold-specific” going on as well, given its continued rise since mid-December in the face of a firmer dollar vs. the other major fiat currencies.

For example, we know gold is breaking out to new highs in all the major currencies except for the dollar and yen, and gold appears to be set to make new highs in these 2 currencies soon as well.

Click to enlarge: http://tinyurl.com/cy6jvv

What is gold’s rally in all these currencies really saying, though? Some will tell you it's “fear”, but that’s never the case. When gold rallies, it does so for rational reasons, just like any other investment class that's been rising for 8 years straight. There are extremely large secular fundamentals driving the rally in the gold.

I believe gold’s clear break from its typical linkage to the dollar is revealing a recognition by the market that the fiat dollar-based monetary system that has been in place since 1980 has collapsed, and it has collapsed for the same reason that the US credit markets collapsed (i.e. - enormous imbalances resulting from too much money printing by the Fed). Thus, we’re now seeing a general investor fear of debasement of all fiat currencies globally (i.e. a fear of future inflation and the loss of purchasing power).

For example, the British (and others holding pounds) see the pound sterling collapsing much like Iceland saw its currency collapse, but they know the dollar has its own problems, as does the euro (although I would argue the euro has fewer problems than the dollar or pound at the moment, even though I know others might disagree).

Thus those who hold pounds exchange them for gold. The same goes for those who hold euros and those who hold dollars. This is what's increasingly happening on a global basis, and it’s this demand that's being reflected in the across the broad rally in gold in all these fiat currencies.

When a monetary system collapses, like the fiat dollar-based one has, people simply don’t know what will be the eventual “winner” among government sponsored currencies that will be the basis of a new system (or if that new currency is even in existence yet).

As a result, people run to what they ran to in the mid-1970s when the Bretton Woods monetary system similarly disintegrated and what investors have always run to throughout history during periods of monetary instability. They run to gold (and to a much lesser extent silver and other precious metals and gems).

And they keep running into gold until there is more certainty as to what the new “rules of the road” will be as far as currencies go. And recall that we don’t have another G20 “Bretton Woods II” pow-wow until April (which is probably too soon for some sort of new system to be thrown together anyway). But when a new system eventually is put together, it’s a good bet that gold is going to be somehow involved for obvious reasons.

In any event, regardless of what one thinks about gold as money (although let’s not forget that the Fed sure thinks gold is money because it’s the Fed’s primary reserve asset), gold’s rally is rooted in the fact that there are only two options for the US in this mess: default or debase. By its nature, debasement is a much more creeping inflation than a default, which tends to be more sudden and violent, but both lead to the same place (i.e. – inflation). Thus, both are bullish for gold. As more people figure this out, the dollar may or may not collapse against other pieces of fiat confetti who’s governments are following similar policies, but the dollar will most certainly collapse against gold.

So, 2009 still appears to be setting up to a be a “golden year”, and I expect both gold and the gold mining shares to make new all-time highs in dollars sometime in the first quarter. In fact, the gold mining shares should have an even better year than the metal given their increased leverage to the rising gold price thanks to the collapse in their costs that occurred in 2008's fourth quarter due to the drop in the price of oil and ironically the decline in most foreign currencies against the dollar since most gold is produced outside of the US, meaning that costs in the local currency also declined in terms of their dollar price.

Gold Fields (GFI) is a classic example of this fact. The company actually guided cash costs lower yesterday, citing the large decline in the rand vs. the dollar, and jumped 10%.

Click to enlarge: http://tinyurl.com/buxx9z

What’s even more amazing is that despit this increased leverage to the rising gold price, gold stocks are actually still historically undervalued relative to the metal, which we can see graphically below in the XAU/Gold ratio, which is the ratio of the XAU Gold Mining Index (an index of large cap senior gold miners) vs. the gold price.

Click to enlarge: http://tinyurl.com/ce9bj3

Many of the smaller junior and senior gold names are even more ridiculously priced. And why did they collapse in 2008 even though the metal was up on the year? They collapsed simply because hedge funds were forced to sell when investors asked for their money back. For those investors that were forced to sit through that, it certainly wasn’t pleasant, but it creates an opportunity of a lifetime for those looking to deploy new capital.

The market seems to agree with assessement too, because Newmont Mining (NEM) was able to offer 30 million shares in a secondary this week (which was increased by 50% from the original size of the deal due to heavy demand).

And even after that increase in the offering, many investors that wanted stock still weren’t able to get a piece of the deal. Unlike the financials, where only the government is willing to show up for a secondary offerring these days, we can see that private capital is eager to invest in the gold mining business.

And why are they so eager? They’re eager because the market knows how this is going end. It’s going to end with a lot more inflation, just as every episode of rampant money printing has throughout history.