"Investors Daily Edge"

Peak Oil… What about Peak Gold?

By Jon Herring

Over the years, I'm sure you have heard a lot about "peak oil" - a condition whereby the remaining reserves of oil become harder to find, harder to extract and of lower quality. This results in declining production, even in the face of rising demand.

But you probably haven't heard much about "peak gold", where a very similar scenario is playing out.

In a free market, increasing demand and rising prices provide a significant incentive for producers to increase the supply of an item. And that's usually how it works. But that's not what is happening in the gold market.

Demand is certainly increasing. According to the United States Geological Survey, the demand for gold reached 1,133 tonnes in 2008, an 18% increase from the previous year. In dollar terms, this represented a 51% increase to an all-time record $31.8 billion.

2008 was also the year when the price of gold hit an all-time high over $1,000 an ounce. In fact, the price of gold has risen every single year since 2001.

These forces should have resulted in the production of gold rising as well, with producers scrambling to capitalize on the favorable conditions. However, despite record demand and record prices, worldwide gold production has been falling since 2001.

• South African gold production peaked in the 1970s
• Brazilian production peaked in 1982
• Canadian production peaked in 1991
• Australian production peaked in 1997
• U.S. production peaked in 1998

Combined, these countries currently represent 40% of the world's gold production.

This does not suggest that we are "running out of gold", just as we are not running out of oil. However, it does suggest three things:

1. The world's mines are depleting their reserves, particularly their high grade ore
2. The remaining supplies of gold are becoming harder to find
3. On average, new gold discoveries are becoming smaller and of lower quality

According to the Metals Economic Group, despite an estimated $18 billion in exploration expenditure over the past five years, the quality and number of new gold deposits dropped.

As with oil, most of the biggest gold discoveries have already been made. This is quite clear in the graph below, from mining company BHP Billiton. Pay attention to the red bars. These represent "world class discoveries" - a gold deposit of more than five million ounces.

This chart shows that there were only four world-class discoveries in the 1990s, with none since 1993. This chart stops in 2001. There has been one world-class discovery made since then, a discovery made by Aurelian Resources in 2006. In other words, there has only been one world-class gold discovery made in the last 15 years.

Now, compare that to the production numbers. In recent years, the world's top five gold producing companies have each produced between 3.5 and 7 million ounces per year. In other words, just to replace their reserves, the top five companies would each have to find one world-class discovery… every year. In total, we have found only a few of these since 1990.

Gold producers could make up for these numbers by adding numerous smaller discoveries, but as you see in the chart above, those are declining as well. It is no surprise therefore that gold production is falling, and has been for almost a decade.

And even if a big discovery is made, it can take anywhere from three to as many as 10 years to build and permit a mine before production can begin.

The bottom line is that the demand for gold is highly elastic and can increase dramatically, even from today's record levels. At the same time, however, the supply of new gold is highly inelastic. It is heavily constrained, and even with an all-out effort can only be increased very slowly - if at all.

The fundamentals for gold have never been stronger. Countries around the world are debasing their currencies at a rate that is historically unprecedented. Demand for gold should only continue to increase as more and more people shift from paper currencies and financial assets to hard assets and tangible forms of wealth.

So where are the new supplies of gold going to come from?

Mining is a depleting business. If a company does not replace the reserves it sells each year, that company will someday cease to exist. The major producers are voraciously hungry for new gold reserves. But they can't go out and find them by themselves. The best exploration geologists no longer work for the big companies. They work for and own the smaller, more nimble outfits - the junior resource companies. In fact, of all new discoveries, 75 percent are made by the juniors.

If these larger companies want to survive in the long run, they are highly dependent upon the junior resource companies. The majors need new finds desperately. And the juniors are the only ones that can bring them in. That is why over the coming few years, there will be a continuing wave of acquisitions, as the major precious metals companies acquire the juniors with the largest deposits and the greatest prospects.

And since the bull market in gold began nearly a decade ago, these companies have never been cheaper.

In 2008, the exploration industry was decimated due to the worldwide bear market. The quality of these companies didn't matter. Elite management teams didn't matter. World-class projects and proven reserves didn't matter. Financial strength and cash on hand didn't matter. The entire sector was sold with impunity and every company in it was caught in the vicious downward spiral.

Take a look at the following chart, which represents the value of the S&P/CDNX Composite Index (the best proxy for the junior mining and exploration sector) divided by the price of gold.

Many of the companies represented in this index are gold producers and exploration outfits that are discovering and proving up new gold reserves. They should obviously do well when the price of gold is strong and rising. And yet, as you can see in the chart above, these companies have never been more out of favor than they are now.

They are selling at a greater discount to gold than they were even when the gold bull market began, when gold was roughly $600 cheaper than it is today. In fact, many of these companies are trading well below their cash value.

The bull market in gold is fully intact and only shows signs of heating up in the years ahead. The demand for the metal is at record levels and growing. Production has been falling steadily for nearly a decade. And the major mining companies are starved for new reserves and they do not currently have the resources to discover them on their own.

And yet despite it all, the companies that will benefit the most from this scenario are as beaten down and undervalued than they ever have been. I won't try to predict the time frame, but the stage is clearly set for a massive rally in the exploration and junior mining sector. And when these stocks blast off, they really blast off. From the end of 2002 through May of 2007 the CDNX gained nearly 280%. It rose almost 70% from October of 2005 through May of 2006. Numerous smaller companies within the index rose by many multiples of these amounts.

The dislocation in this sector is unsustainable. And we're not just talking about precious metals. The entire commodities supply pipeline begins with junior exploration and mining companies. These are not intangible financial instruments, but real assets that require years of search and development before they can be brought to market.

With all that said, the junior mining and exploration companies are experiencing challenging times. With their stock prices depressed and credit markets in a freeze, these companies are having a difficult time raising money. Undoubtedly many will fail.

But the strongest will survive and lead their investors to rich rewards. Here is what you should look for:

• Companies with highly experienced management with a long-term solid track record
  
  
• Insiders and key people within the company should hold a meaningful equity stake to ensure their interests are aligned with your own
  
  
• The companies that are exploring for resources (as opposed to those that are already producing) should be hunting for elephants in elephant country. To compensate for the risk, the potential reward must be a large one.
  
  
• Companies with large existing discoveries and proven reserves should be favored over those that are exclusively in the "exploration" stage
  
  
• Projects should be located in mining-friendly countries
  
  
• Projects must be economical at current gold prices
  
  
• The company must be in a strong financial position with cash reserves and a slow burn rate. Companies that depend on new financing are in a position of weakness in this market

That might seem like a lot of due diligence to do on your own. The good news is that you don't have to do it yourself. My colleague, Dr. Russell McDougal, has specialized in the junior resource sector for more than 15 years. He has studied the precious metals markets daily for two decades. And his success in this field speaks for itself. In recent years, he has closed out gains of 3,851%... 2,912%... 2,445%... and more. Not to mention dozens of triple-digit winners.

If you are interested in profiting from what I believe will be an inevitable turnaround in this sector, followed by a bull market mania as the price of gold soars, you can't do much better than Dr. McDougal as your guide. You can learn more about his service, Resource Windfall Speculator, here.

[Editor's Note: Are you prepared for a tidal wave of paper dollars? The storm of the century is raging in the financial markets. Wealth has been destroyed on an unprecedented scale. And what most don't understand is that the "solutions" will eventually make the problems even worse. But what will be hardship for many could prove to be a windfall for those who are prepared. Let The 21st Century Prosperity Report be your guide to solutions, profits and protection in the coming years.]

P.S. To let me know what you thought of today's article, send an e-mail to: feedback@investorsdailyedge.com.

Market Watch

You Can’t Squash a Gold Bug

By Rusty McDougal

Gold Bugs are a resilient lot. They’ve been around since ancient times and tend to proliferate during times of monetary and economic chaos. The Feds attempt to squash them on a regular basis, but that’s simply another of their failed strategies. You would be wise to investigate the foundations of this bug’s staying power.

Wikipedia describes gold bugs as “investors who are very bullish on buying the commodity gold”. The label is often used in a disparaging manner. Wikipedia needs to do a little more research, as they haven’t scratched the surface of the layers of intricacies of a true gold bug.

Their description has merely described a gold bull. Many people come and go in the precious metals arena. On the other hand, there is no such thing as a periodic gold bug. Either you are a gold bug or you’re not. Wikipedia also describes gold as a “commodity” with no hint whatsoever of its monetary use. How shallow. That’s contemporary America for you.

This essay might aptly be called “Confessions of a Gold Bug” as I’m going to explain exactly how I’ve become such a critter. My precious metals roots go back to 1973 when I first boarded the silver train. It was a bullish time for silver and the Hunt Brothers eventually climbed aboard. Unfortunately, I was out of the market by the time they ran it up and were railroaded by the commodity exchange. This was the first of many lessons regarding staying power… patience grasshopper.

It wasn’t until 1993 that the topic of precious metals next found my attention in a serious manner. I read Jim Blanchard’s Gold Newsletter (that’s their gold bug pictured above) and decided it was a great idea to attempt to make a few bucks via gold stocks. That made me a gold bull, not a gold bug. Little did I know how profoundly that decision would ultimately change my life.

I read a lot and have made the gold market my daily focus for the last 15 years. Shockingly, you would be hard pressed to find a keener and straighter route of entry into understanding world finance, economics and politics. This study is what has subsequently turned me into an unabashed gold bug.

Enough about me… this essay is actually about you. Maybe you, too, should become a gold bug. We are in an era where the fiat monetary system is crumbling just as it always has on an historic basis. The gold bugs clearly saw this coming and screamed it from the rooftops to little avail. The gold guys and gals have the keys to the path out of the present carnage.

Gold and silver backed money have been dismantled. History has a way of trumping such arrogance.

Gold represents honest money, honest markets as well as true freedom. This is the foundation of the United States and it was put in place for essential reasons. Our Constitution was birthed through the hands, minds and souls of incredibly wise and divinely guided men. We’ve now devolved to the point where gold is the enemy of the present state. That is sad. The precious metals represent competition to, as well as an escape from, dishonest money and markets.

The funny money gang would have you believe it is gold that is the anachronism. History speaks against this shortsighted claim. Lack of discipline in the global monetary system has sponsored the likes of Bear Sterns, Fannie and Freddie, Lehman Brothers, AIG, the year of the bailout, Madoff, all of the other recent officially sponsored atrocities, and those yet to come. This infestation has just begun. The US is now an economic wasteland and you can clearly see why a system with no discipline (gold) always leads to fraud and excess. Human nature doesn’t change and our Founding Fathers insightfully warned of current events.

Roosevelt illegally confiscated gold from the American people in 1933. Nixon reneged on the international agreement to exchange foreign currencies for gold 38 years later. We can thank this dynamic duo and most of the administrations ever since for our present predicament. The world has been on a fiat standard (no standard) since Nixon’s default. Gold has been targeted for at least the last 76 years in one form or another. The Fort Knox gold vaults are likely barren.

• The Ghost of Fort Knox Past - 10/3/2007
• The Ghost of Fort Knox Past: Part 2 - 10/10/2007
• The Ghost of Fort Knox Past: Part 3 - 10/17/2007
• The Ghost of Fort Knox Past: Part 4 - 10/24/2007
• The Ghost of Fort Knox Past: Part 5 - 10/31/2007
• The Ghost of Fort Knox Past: Part 6 - 11/7/2007

Gold and gold bugs are the recipients of regular foot stomps. Citizens are dumbed down, distracted and guided away from the safety and freedom represented by precious metals. The attempts to squash always fail and are for the most part pathetic and laughable. That is not to say they aren’t temporarily painful.

Why exactly are gold bugs so resilient?

• Bugs tend to study true history as opposed to the revisionist state sponsored agendas.
• They tend to understand, claim and advocate Constitutionally guaranteed freedoms.
• Bugs study free market economics or Austrian Economics as opposed to the failed socialistic ideas that dominate the present landscape courtesy of John Maynard Keynes, Karl Marx and Milton Friedman.
• They aren’t afraid of going against crowd mentalities.
• Bugs care deeply about their country and their fellow citizens.
• Some incredibly bright people lend their analysis in this sector.
• Bugs are born with antennas that detect pure bullshit.
• They tend to be far sighted.
• Bugs are a self-reliant lot as opposed to wanting to be wards of the state.
• They demand a level playing field for all members of society.

This essay is primarily about the impossibility of squashing a gold bug. Let’s look at an example. The Bank of England announced in 1998 that they were going to give away half of their gold reserves via periodic auctions. Gold had been a foundation to their monetary reserves for the previous 300 years. The auction system was designed to pound gold and demoralize its advocates. They considered gold followers to be little more than roaches and called in the exterminator.

It worked for a spell as gold fell to the lowest point since 1979 and subsequently plummeted to the $250 range. It cost the British dearly and citizens are raising hell about it to this day. Gold bulls were smashed but gold bugs were undaunted. They saw through the ploy and remained steadfast.

At this point, the Bank of England’s raid (chuckle) is little more than a blip on the radar screen. The same holds true for all of the various announcements of central bank sales, IMF gold selling, paper market takedowns on the New York Comex market, leasing and loss of citizen gold, or the most recent contrived events of last summer. Yes, the precious metals were taken down last July in one more failed attempt. How tedious.

Gold marches on because it’s not just Superman that stands for truth, justice and the American way. Gold bugs will not be silenced. Did I mention gold bugs are tougher than nails and will stand on principle? They also have keen senses and know the difference between paper claims to precious metals and the real thing. Others insist on learning this the hard way.

You can extrapolate the above chart forward for a picture of gold’s rising future. That bug doesn't get stomped.

You may or may not choose to become a bona fide gold bug at the present time. The learning curve is steep and the wounds can be painful at times. You should, however, be a precious metal bull. These are the times for which gold was born. Safety, profits and sound sleep lie therein. Buy precious metals while you still can. Gold stocks are the primary focus in my Resource Windfall Speculator advisory and they are leveraged to a rising gold price.

Invest Resourcefully,

Rusty