The Global Picture in Evaluating Resource Companies

The gold price is hovering near record territory as nervous investors seek shelter from the barrage of negative economic news.

The crisis-of-the-week flits back and forth across the Atlantic. The US debt crisis was temporarily pushed out of the headlines by the Greek crisis. Contagion from the Greek crisis put Spain in the headlines briefly. This week, the popular press has suddenly realized that most states in the United States have serious budget deficits.

As Europe and America joust for the honor of the weakest currency, investors continue to accumulate gold. Some commentators are calling for a massive escalation in the gold price. To the extent that those commentators have been correct in the past, they will be right in the future. That is, the gold price is up five-fold in less than a decade. Those forces that have sustained a substantial increase in the gold price are still in effect. At the same time, there are market factors that keep the gold price from rising sharply. The most likely outlook is for a continuation of the pattern of the past decade.

An important element in the gold market is the central banks, which collectively hold about half of the global gold stock. The central banks are moving decidedly in favor of gold. Globally, there is a lot of support for gold. At the very least, the gold price is likely to hold its real value: that is, it will continue to increase in US dollar terms. Gold is likely to increase further in real terms, but counting on a big increase in gold should not be a fundamental investment premise.

Gold is gaining favor among conventional money managers who want the currency and inflation hedge that gold provides. At the same time, those managers want to generate a return on their investment, which is not assured by simply holding bullion. The obvious solution is to hold gold equities. However, the big companies are so popular among investment managers that they trade at about two-times net asset value. In effect, the share prices of the major gold companies already factor in a higher gold price.

The manager of a multibillion dollar fund is unlikely to dabble in the smaller gold companies. Individual investors have that flexibility. Investing in a development stage gold company provides exposure to the gold market while at the same time delivering the upside potential of a company that is generating shareholder wealth.

With so much attention devoted to fear over sovereign debt, investors seem to have lost track of the enormous pace of economic development continuing in Asia and other parts of the developing world. Mining companies from those areas, and in particular China, are scouring the world for new sources of metal supply. The junior companies that hold many of the best prospects for new mines are getting absolutely no respect from Western investors.

Trading at absurdly low values, those companies are being closely scrutinized by mining companies that understand the need for new sources of supply. There will be a flurry of takeovers of junior companies as this year unfolds, and the prices paid will be well beyond where the shares trade at this time.

Most people are terrified of risk in this moment. Those investors who are prepared to take on some risk and look beyond the moment can find exceptional bargains in the present markets.