Ken Gerbino:The World Gone Crazy and Your Gold Stocks

Some crystal-clear thoughts on the continuous global economic seismic shake-up from Ken Gerbino's latest missive: "The World Gone Crazy and Your Gold Stocks"


".... The Inflation vs. Deflation debate is a debate between Knowledge and Stupidity. History and Fantasy. Understanding and Confusion. When a stock portfolio goes from $2 million to $1 million this is in fact a "deflated" value but this does not cause a deflation in the economy. Even with $10 trillion of stock market losses it has little effect on the general price level of goods and services in an economy. The crash of 1987 saw $15 trillion of stock and bond losses in the U.S. An historic loss of asset values at the time. Yet inflation in 1988 and 1989 averaged 3.2% and 4.3% respectively. There was no deflation. The same concept is true for real estate. Real Estate losses in 1990-91 were in the trillions and the inflation rates in 1990, 91, 92 averaged 4% annually. There was no deflation. There never is with paper money."

"... There will be no deflation. If your adviser or broker or newsletter writer ever mentions this word send him this article and wise him/her up. Inflation is here to stay as prices have not gone down in this country in any year for the last 60 years despite the calls of the deflationists. During this time, despite market crashes, horrible recessions, and numerous real estate busts we have had no deflations. Paper money is inflationary and we are going to be flooded with more of it before the bailout of the global financial system is completed."

"...The Great Lie: For almost 75 years the Fed and the Treasury have promoted the following concept. Inflation is caused by a strong economy. This, of course, is a smokescreen for the truth that all inflations are caused by an increase in money supply. But with this stable datum that a strong economy causes inflation, the powers that be always had something else to blame for inflation. Money managers therefore thinking that if a strong economy causes inflation then a slow economy or a recession will cause less inflation. Therefore they reason "why own gold or the gold stocks". These were some of the guys selling the gold shares the last 3-4 months. They are so wrong."

"...Current gold buyers are most likely split between investors that believe a horrible deflation is coming and money will be wiped out so gold should be a good substitute and other investors who correctly understand that trillions of new dollars and foreign currencies are going to flood world economies to bail out the institutions and this will be very inflationary.

Both sides will have great conviction and this $90 move underlines those thoughts. Therefore, with the financial turmoil of this week gold and the quality mining stocks should move much higher with or without the stock market."

To entirely read this sobering article in its entirety, please click HERE

K.J. Gerbino: "Gold Mining Stocks - What's Wrong With The Juniors"

Gold Mining Stocks - What's Wrong With The Juniors

Kenneth J. Gerbino

The reasons Junior mining stocks are underperforming are as follows:

• The larger companies are getting all the action from newly converted gold enthusiasts and interested investors.
• The junior market is still being weakened by insiders and promoters who are always sellers.
• There are hundreds if not thousands of new promotional mining stocks being foisted on the readers of gold pages in the last three years and there is just so much money to invest in this sector. Therefore premium prices are diluted.
• The invasion into the Hard Money camp by the Uranium companies. Every investor I know who owns gold and precious metal stocks but never owned a uranium stock now owns some. This diversion of capital to uranium diluted some funds that would have entered the Junior market.
• Gold ETFs. Investor money can now go into an easy way to invest in bullion. This also could be argued that it helps the miners as it creates demand for gold.
• Delays in drilling, engineering reports, permits.

A Big Rally Soon?

We are very near a major turning point in the mid tier and junior mining sector. The chart below shows the lowest junior mining valuation ratios in the last six years. We are using the TSX S&P Venture Index which is mostly mining stocks. The current ratios are at levels that in the past have signaled a major and substantial rise in the smaller gold and silver mining stocks.

As a reality check we can look at the ratio of the XAU to the Gold Price to see if this ratio is at a speculative level that may be signaling a major top in the making for all the gold stocks, which would of course include the juniors. During the above mentioned time period (September-November 2002) the Gold/XAU ratio was 4.8 (not shown). Today it is 4.8. This means the XAU gold stocks are tracking the gold rise at the same ratio when gold was $320, signifying a stable relationship. It confirms that the juniors on a relative basis are extremely undervalued and that a substantial rally should be starting soon.

New money into the gold arena is going into the big names. These managers and investors have not started to look at Canada and the junior sector yet. But as they eventually get more familiar and comfortable with the industry they start looking for smaller growth and value situations and that leads them into the junior sector. Quality juniors will eventually have a substantial move up from these levels but most others with speculative exploration programs will be left behind because of the stark reality that only one exploration stock out of a few thousand ever produces an ounce of minerals. This old ratio should change for the better as high metal prices, technology, more sophisticated exploration groups and increasing demand for resources increase their chances but it is still long shot investing.

The Three Amigos

Gold has many developments impacting it's price and we have mentioned them many times. But currently we see three drivers at work that spell out a higher gold price: 1) The dollar has no where to go but down since interest rates are being sent lower and lower by the Fed to bail out the banks and our friends on Wall Street. 2) The credit/mortgage/real estate bubble dictates inflating the money supply or face possible immense institutional disasters. 3) Global money supply increases are continuing at a torrid rate especially in India and China.

Mining Analysis

The mining sector despite the volatility allows one to have a very clear idea of value. This intrinsic value is an inventory of basically rocks. These rocks contain a certain known percent of minerals. When companies spend $20-50 million with hundreds of drill holes and thousands of man hours on an area the size of 3-4 city blocks (maybe 400 feet thick, and underground) you have a pretty good idea what is in that mass of rock and what it is worth at various metal prices. When they do sophisticated testing on sometimes 5-10 miles of drill core, one can evaluate how easy or hard and costly it might be to extract the minerals.

Basic mining costs are known from hundreds of other mining projects: the cost to build the roads, buy crushers, build small towns for the workers, power and food costs etc. These are known factors and estimates can be made. Then it's a matter of math and know how. That's how you find winners. That is how you know if you have a good project. That is all we care about at my company on hundreds of projects and mining companies. You should try and do the same if you want to get serious about investing in this sector.

The key to making an above average return is competent evaluations and patience. This sometimes takes many years. Patience will outweigh the volatility of the gold and silver mining sector as intrinsic value eventually gets recognized. The laws of supply and demand let you sleep comfortably.

Inflationary Future

With all the money, people, and industrial progress globally we are confident that minerals (especially the precious ones) will be well above average investments for the next decade.

We are at a time when the central banks should be at least attempting to control inflation but instead most are printing more money. As the future unfolds and inflation accelerates, tangible assets especially mining companies with known resources of valuable minerals should be a top priority for investors.

For more articles on Gold, the Economy and the Stock Market visit our website: www.kengerbino.com

Kenneth J. Gerbino
1 February 2008

Gold Stocks - Crucial Information for the Investor - Not All Rosy

By Kenneth J.Gerbino

The big news globally is that the U.S. Federal Reserve and the Bank of England both threw in the towel on monetary policy to deal with market panics in the last two months. We believe these problems are only the tip of the iceberg of a massive credit and investment bubble that is threatening to unwind. Their only answer is more money and soon more inflation.

In the U.S., the Fed lowered important benchmark interest rates well beyond what was expected and instigated very lenient bank repayment policies for borrowed capital from the Fed. This was not to help the man in the street or to “avoid a recession”. Since unemployment is so low the Fed rate move was obviously made to bail out Wall Street and the major banking institutions. This resulted in the dollar hitting new lows and gold moving higher. These trends are likely to continue.

History tells us the truth about the Fed. In the twenty years before the Fed was created, there were 1,724 bank suspensions, in the twenty years afterwards there were 15,502. By subsidizing and protecting the banks they encourage speculation, overleveraging and excessive credit creation which leads to major banking problems that are then solved at the expense of the general population.

In England the central bank announced that all depositors of Northern Rock, Britain’s 5th largest mortgage bank would have their deposits guaranteed by the government. This was in response to a bank run which had ensued with world press coverage showing thousands of people lining up to withdraw their savings at various branches.In the future this will become a disastrous precedent encouraging more speculation by institutions and investors. Northern Rock had a $6 billion equity base and had leveraged its balance sheet to $226 billion. I suspect they are not alone and this may not be the last of the bail outs.

These actions are only the beginning of a new round of paper money injections that will surely bring on above average inflation. An excellent study by economist John Williams shows the real inflation rate in the U.S. since 1991 was annually 4% higher than government figures. Financial writer Howie Katz reports adjusting the CPI from 1983 to reflect housing costs as opposed to rents shows U.S. consumer prices have tripled not doubled as reported by the Bureau of Labor statistics. Gold averaged around $400 in 1983, it is reasonable to triple this price for a future target just based on a simple real CPI formula.

The Dollar

With the dollar at new 40 year lows, it will force Europe and other countries to devalue their currencies. If you are an international business working on 2-3% margins or less and you can now buy your U.S. goods 8% cheaper because of a weak dollar, it is an incentive to do so. This means other countries that depend on exports will not get that business and their governments will respond with competitive devaluations. Devaluations in the current floating currency environment (where exchange rates change daily in response to supply and demand as well as government intervention) can be accomplished by 1) manipulating interest rates lower (which then leads to more money creation by the banking institutions) or 2) just printing money. The central banks and the banking establishment in these countries along with the politicians also have a beautiful excuse to print their way out of the fiscal mess they are in because they cannot meet the obligations to their citizens. This is and always will be bullish for precious metals. This is one reason why precious metal ownership by way of reserves in the ground of mining companies is prudent. Precious metals could be one of the only monetary assets still standing when this excessive global credit and monetary cycle is over.

China and Japan – The Big Currency Misconception

Because of competitive devaluations, already mentioned above, the death of the dollar may not be as fast as some people think. Also one of the big misconceptions that I keep reading about is that China and Japan will soon dump their holdings of dollar denominated Treasuries because they are losing value with the dollar going down. Not true.

Follow this very carefully.

1. A million dollars of clothing is exported from China to the U.S.
   
   
2. A million dollars is sent to China.
   
   
3. The Chinese factory owners send the million dollars to the central bank and ask for the equivalent in renminbi so they can pay their workers and suppliers.
   
   
4. No problem so far.
   
   
5. But what does the Chinese central bank do?
   
   
6. They actually create (print) $1 million worth of renminbi and send this off to the factories and keep the original $1 million and buy U.S.Treasuries with it.
   
   
7. The central bank does not have to exchange the dollars for renminbi’s, they can create an additional $1 million worth of renminbi’s.
   
   
8. Since China now has $1 million in local currency they earned for the clothing does the central bank even care if the value of extra $1 million in Treasuries they own goes down by 20% or more.
   
   
9. The answer is no.

China sent $1 million of clothing to the U.S. and now they have $1 million of local currency and $1 million of U.S Treasuries. Easy money.

China now has more money in circulation (M1) than the United States. $1.9 trillion vs. $1.4 trillion. The reason is that they have been double dipping.

In the above example the $1 million they have in Treasuries is all gravy and this is what the Chinese have done the last 10 years and that is why their money supply has mushroomed. When the time comes they will most likely take the trillions they have in U.S. Treasuries and come back to the U.S. and buy buildings and factories (like the Japanese did in the late 80’s) Spending dollars for dollar denominated assets in the U.S. will have zero effect on the exchange rate. So the argument that these Treasuries are a huge overhang on the U.S. dollar because the Chinese don’t want to lose value is not true. They are so far ahead already it doesn’t matter. Of course the local citizens will now have to put up with plenty of inflation that is coming to China from all the new money floating around the country.

Gold Demand

High oil prices are flowing huge amounts of money to countries in the mid east that have been historically pro gold and the higher oil goes the more gold will be absorbed by these governments, their financial institutions and investors.

It has been estimated that all the gold in the world ever mined equals 5.3 billion ounces. This has a value of $3.7 trillion. Much of this gold is in woman’s jewelry cases and on men’s wrists or resides in peoples teeth. Global liquid financial assets are in the hundreds of trillions of dollars and global derivatives are over $450 trillion. Therefore the ratio of gold available for investment is a tiny fraction of the other investment alternatives. When further financial problems arise gold will have to rise when too much money chases too few ounces.

The U.S. Economy – Where’s the Beef?

The U.S economy has been skating on thin ice. Subtracting out the money that people have spent from refinancing their homes, the U.S. economy (GDP) has averaged only one half per cent growth annually for the last six years. This means we are living in an economy that has been fueled by consumers borrowing home equity money and this has now come to an abrupt end. This, coupled with the underlying problems in our banking system, means the only way out is a loose monetary policy. The overleveraged banking system cannot handle a recession. This unfortunate scenario coupled with more trade and budget deficits will have a positive effect on the gold price and will also contribute to future inflation.

Since 2002 crude materials in the U.S. are up exactly 100%. This is more anecdotal evidence, that the inflation rates in the U.S. will rise substantially in the coming years.

Money Creation Versus Gold

Our survey of the seven largest countries in the world and Europe show that they created $775 billion in new money in the last year. The supply of gold available for investment, outside of jewelry and industrial demand which would include bars, coins and bullion funds was approximately $13 billion. This is a ratio of 60 to 1 and does not include the money creation by the other 175 countries in the world. The point is that there really is not much annual gold supply around for investment purposes or financial insurance or a money substitute. Sooner or later the price will dramatically reflect this imbalance. India has increased it’s money supply 15.3% in the last year. This is probably why in the first eight months of 2006, gold imports increased by 86%. India could be on track to consume over 35% of 2007 global mine supply all by itself.

Because mining companies have gold in the ground, their valuations over the next decade are logically bound to increase substantially. These companies provide an outstanding opportunity to own gold in the ground via stock ownership.

Volatility and The Gold Stocks

The recent volatility of the precious metals and the mining shares unfortunately is part of the equation of this investment sector. We attempt to balance these fluctuations in our hedge fund but it is a difficult task and requires focus and discipline. You should expect volatility with your personal portfolios in the future and realize that volatility in this sector is normal. But, in my opinion, this type of volatility is a small price to pay for the long term trend that is clearly in your favor and the excellent growth and value attributes of a well diversified and hedged portfolio.

The mining sector should continue to be one of the top performing investment sectors in the coming 3-5 year period. The past actions of the Fed and other central banks mean they will surely do everything they can to avoid a credit and debt implosion that according to many experts could be in the trillions of dollars of potential defaults and bankruptcies. If this estimate is true then bailing out the institutions that are in danger will require the greatest expansion of paper money in history. The winner will be gold and other natural resources because the more money that is created the higher the prices of basic commodities and monetary substitutes (gold and silver) will go. Gold mining shares are the beneficiaries of the economic excesses of others.

It is important to be careful of exploration stocks and allocate only a small amount to this sector. The large mining stocks are now being bought by huge non gold savvy hedge funds and will create lots of volatility as we go forward. A stampede by these players either way can be profound. The developmental mining companies with solid resources in the ground and a 1-2 year horizon to production will be targets for buy outs by mid-tier and major mining companies.

Good luck - you are going to need it especially if gold goes to $1,200 and then back down to $700 and then to $2,000, which is very possible in the coming decade. So always keep a core portfolio as insurance (and long term appreciation) and a trading portfolio that rolls with the punches. Do not go on margin and do not spend much time or money on the exploration stocks as more than likely every share you buy is usually from an insider who is selling. Also if there ever is a major economic upheaval gold and silver mining companies with known and verified resources in the ground will go up dramatically but exploration companies with nothing but a geologist and promoter’s dreams will go no where because they have nothing in the ground. Remember that - they have nothing - so be careful.

For more information on the economy, stock market and gold please visit our website at: www.kengerbino.com

Ken Gerbino
26 October 2007

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