Richard (Rick) Mills /> Ahead of the Herd

As a general rule, the most successful man in life is the man who has the best information

The first ever GAO (Government Accountability Office) audit of the US Federal Reserve was recently carried out due to the Ron Paul/Alan Grayson Amendment to the Dodd-Frank bill passed in 2010. Jim DeMint, a Republican Senator, and Bernie Sanders, an independent Senator, while leading the charge for an audit in the Senate, watered down the original language of house bill (HR1207) so that a complete audit would not be carried out. Ben Bernanke, Alan Greenspan, and others, opposed the audit.

What the audit revealed was incredible: between December 2007 and June 2010, the Federal Reserve had secretly bailed out many of the world’s banks, corporations, and governments by giving them US$16,000,000,000,000.00 – that’s 16 TRILLION dollars.

The GDP of the United States is $14.12 trillion, the entire national debt of the United States government spanning its 200 plus year history is $14.5 trillion. The budget that is being debated in Congress and the Senate is $3.5 trillion.

In the past debt ceiling votes have passed the House and the Senate without question by the majority party (remember there’s an election next year so there’s a need for political grandstanding). When Republicans controlled the chambers they passed debt ceiling hikes with the Democrats in opposition. When the Democrats are in power they up the debt ceiling while the Republican oppose it.

Obama opposed raising the debt ceiling when George W. Bush was President. The debt ceiling is simply a limit of how much a government can borrow and owe regarding public debt. By increasing the debt ceiling, a President would be able to avoid spending cuts.

A default would only occur if the US did not make payments on its debt so not raising the debt ceiling will not result in default – a default can only occur if interest payments were not made.

As the audit of the Federal Reserve has just shown whether the debt ceiling hike passes or not is a moot point. The unelected Federal Reserve will, without Congressional authority, continue to create more money.

The majority of US debt is owned by the Federal Reserve.

The Dow on gold’s terms is telling everybody something important is happening:

In 2000 gold made its $260 per ounce low, in January 2000 the Dow was 10,900

10,900 / $260 per ounce = 41.9 ounces to buy the Dow

Today at 12,592  DJII and $1,600 gold it’s 7.87 oz to buy the Dow.

Investors are starting to realize that gold and silver are a storehouse of value and a safe haven in times of turmoil. Gold and silvers prices have risen because of the abuse and mismanagement of our monetary and currency systems – throughout history, gold has always shone the brightest when trust breaks down, confidence falls and fear climbs.

The Dow/Gold ratio has twice before gone through corrections resulting in a transfer of wealth from one asset class to another. 

 In 1928 the ratio peaked at 14.5 and then dropped to 2.9 as the stock market crashed and the U.S. entered a deflationary depression.  In 1965 the Dow/Gold ratio peaked at 27.6, then started a long correction to 1.57 in 1980 as Volker aggressively raised interest rates and stopped inflation. 

As you can see on the above chart we began a third correction in 1999 when the Dow/gold ratio peaked at 41. 

It presently would be very hard to mount an argument against gold being clearly the winning major investment of the last decade.

 

Latest demand statistics from the World Gold Council:

Gold Demand and Supply – First quarter 2011

• Global gold demand in the first quarter of 2011 totalled 981.3 tonnes, up 11% year-on-year from 881.0 tonnes in the first quarter of 2010.
• The quarterly average gold price hit a new record of US$1,386.27/oz (as per the London PM Fix), its eighth consecutive year-on-year increase.
• During the first quarter of the year, investment demand grew by 26% to 310.5 tonnes from 245.6 tonnes in the first quarter of 2010.
• ETFs and similar products witnessed net outflows of 56 tonnes.
• India and China, the two largest markets for gold jewellery, together accounted for 349.1 tonnes of gold jewellery demand or 63% of the total, a value of US$16bn. China’s jewellery demand reached a new quarterly record of 142.9 tonnes up 21% from 118.2 tonnes in the first quarter of 2010.
• In Q1 2011, gold supply declined by 4% year-on-year to 872.2 tonnes from 912.1 tonnes in the first quarter of 2010. This was despite an increase in mine production of 44 tonnes year-on-year, a growth rate of 7% from year earlier levels, and negligible net producer de-hedging. The decline in total supply was due to recycled gold, which was down 6% on year-earlier levels to 347.5 tonnes from 369.3 tonnes in the first quarter of 2010 and a sharp increase in net purchasing by the official sector.
• Central bank purchases jumped to 129 tonnes in the quarter, exceeding the combined total of net purchases during the first three quarters of 2010.

With the price of gold at US$1600 it’s definitely living up to its oft proven history of  acting as a safe haven in times of turmoil but after being the best performing major assets of the last decade, are the price of gold and silver going to continue higher?

The settlement of the U.S. debt impasse could see a sharp correction in  gold’s price – news of positive results could trigger a temporary price retreat.

Over a little longer term there exists reasonable, sound, and at least as far as I’m concerned, convincing arguments, that precious metals and their stocks are undervalued:

• Central banks are adding to their official gold holdings

• The European Union’s sovereign debt problems are worsening

• The Federal Reserve will continue to create money

• Expanding Chinese, Indian, and other Asian economies means growing wealth and rising inflation. An historic affinity to gold in the form of jewelry and as a saving and investment option means continued demand growth coming from the East

• Gold mining supply declining

Conclusion

Considering the seasonally strong period for gold and gold stocks is right around the corner:

• Jewelry manufacturers step up fabrication demand ahead of Christmas gift giving
• Indian dealers begin stocking up ahead of the autumn festivals and the Indian wedding season
• Chinese lunar new year
• Increased news flow from junior work programs
• Resource and Investment conferences

They might be even more undervalued then we think.

History proves the greatest leverage to a rising gold price is gold mining stocks.

I think gold juniors are going to be the most rewarding, the most lucrative way to garner the huge rewards from the coming freight train rush to gold. Those golden tracks are being laid today using the world’s currencies as ballast – when your cash is trash your gold is shining.

Monetary and fiscal authorities around the world are setting us up for an inflationary cycle. This will be the ultimate driver of the gold bull market going forward.

Gold, and gold stocks should be on every investors radar screen. Are they on yours?

If not, maybe they should be.

Richard (Rick) Mills /> rick@aheadoftheherd.com /> www.aheadoftheherd.com

If you’re interested in learning more about the junior resource sector, bio-tech and technology sectors please come and visit us at www.aheadoftheherd.com

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Richard is host of Aheadoftheherd.com and invests in the junior resource sector. His articles have been published on over 300 websites, including: Wall Street Journal, SafeHaven, Market Oracle, USAToday, National Post, Stockhouse, Lewrockwell, Uranium Miner, Casey Research, 24hgold, Vancouver Sun, SilverBearCafe, Infomine, Huffington Post, Mineweb, 321Gold, Kitco, Gold-Eagle, The Gold/Energy Reports, Calgary Herald, Resource Investor, Mining.com, Forbes, FNArena, Uraniumseek, and Financial Sense.

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Legal Notice / Disclaimer

This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment. Richard Mills has based this document on information obtained from sources he believes to be reliable but which has not been independently verified; Richard Mills makes no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of Richard Mills only and are subject to change without notice. Richard Mills assumes no warranty, liability or guarantee for the current relevance, correctness or completeness of any information provided within this Report and will not be held liable for the consequence of reliance upon any opinion or statement contained herein or any omission. Furthermore, I, Richard Mills, assume no liability for any direct or indirect loss or damage or, in particular, for lost profit, which you may incur as a result of the use and existence of the information provided within this Report. /> Richard Mills does not own shares of any companies mentioned in this report.

Perhaps the most prevalent mental images of the Great Depression of the 1930s are the photos of the soup lines and breadlines where the “down and out,” those with absolutely no hope, stood waiting meals.  Today, however, soup lines are a thing of the past, and they will not be evidence of just how bad the economy is.   Today, we have statistics to illustrate the state of the economy.

But, statistics stir no emotions.  They are numbers in tables, figures on graphs.  It’s hard to identify with a graph of rising food stamp recipients, but even the old photos of the 1930′s Depression causes one to feel for those standing in line, who want only meals.

Yet the graph below is evidence of just how bad things are in the US.

Since just before the recognition of the Global Financial Crisis, food stamp recipients have climbed 65%.  That’s a huge increase in Americans living on food stamps.  Perhaps one could argue that the 26 million on food stamps in 2007 were institutionalized, and that they viewed food stamps as a way of life.  However, as for the 17 million added in the last four years, they are probably productive members of society who no longer can find work.

 

Mac Salvo, in an article on www.lewrockwell.com, discusses this topic further.  Included in Salvo’s piece is a 1:27-second video of Treasury Secretary Timothy Geithner asserting that TARP and quantitative easing “averted a second Great Depression.”  That remains to be seen, but so far there is little evidence that we are out of the recession.

Geithner also wants to rebuild America with “make work” projects.  “Make work” projects, although they provided jobs for some in the 1930s, only extended the Great Depression and were one of the reasons it lasted ten years.

A primary principle of Austrian economic theory is that bad investments must be allowed to fail, the assets liquidated and the capital redeployed in productive projects.  When politicians get to decide what businesses remain afloat (usually through bailouts but sometimes through protectionism), the economy stagnates until finally it becomes evident that those businesses cannot make it, even to politicians.  Unfortunately, by then it is a full-blown depression, and that may be what we are facing.

Sadly, Geithner also assets that we are in this horrible economic situation because of “a long period of lost opportunities to do things to make America stronger.”   As a former President of the New York Fed and a member of the Board of Governors of the Fed, Geithner endorsed the Alan Greenspan’s 1% discount rates that gave us the housing crisis, which, according to most analysts, was the cause of the Global Financial Crisis.  You have to wonder what Geithner was taking about when he spoke of “things to make America stronger”

At the end of World War I, the American economy faced the enormous task of retooling for peacetime. No longer needed were the factories used to support the war effort, or the giant agricultural exports to a Europe that couldn’t grow its own food. The process of shuttering excess war capacity, and its associated layoffs, produced a huge contraction in economic output.

Gross National Product declined nearly 7% in 1920-21, compared with a fall of 8.6% in 1929-30. Unemployment rose from 5.2% to 11.7%. Automobile production declined by 60%, and all industrial production was down almost 30%. The stock market fell 47%.

When performing the task of reorganizing resources, the thing to understand about free markets is that they do so in the quickest manner possible. Time is money, as almost everything depreciates. For owners of assets being liquidated, their goal is to sell as quickly as possible to obtain the best price. Purchasers of these assets are motivated to put them to use in the shortest amount of time in order to start earning a return.

For the recession of 1920-21, the free market reorganized the economy in about a year and a half. By Late 1922, industrial production had returned to peak levels and the unemployment rate was down to 6.7%. In 1923. the unemployment rate was only 2.4%.

And, what was the government’s response to the recession of 1920-21? Nothing. Well, that’s not quite true: President Warren G. Harding cut the federal budget by half and reduced taxes. There were calls for government aid and stimulus from Congress but Harding ignored them all.

So what then is the difference between a recession and a depression? The answer is time. A depression is a recession that drags on for an extended amount of time. And there is only one way that can happen – through government intervention.

When governments and politicians become involved in recessions, there arises a great need to do something. But invariably this something always amounts to preventing the economy from making the necessary changes to align itself with the present needs of the market. In an effort to maintain the status quo, bailouts and stimulus spending are called upon to calm a concerned constituency.

This was not Harding’s approach. In fact, he put it fairly bluntly in his inaugural address:

“Our most dangerous tendency is to expect too much of government, and at the same time do for it too little. We contemplate the immediate task of putting our public household in order. We need a rigid and yet sane economy, combined with fiscal justice, and it must be attended by individual prudence and thrift, which are so essential to this trying hour and reassuring for the future.”

Along with:

“There is no instant step from disorder to order. We must face a condition of grim reality, charge off our losses and start afresh. It is the oldest lesson of civilization. I would like government to do all it can to mitigate; then, in understanding, in mutuality of interest, in concern for the common good, our tasks will be solved. No altered system will work a miracle. Any wild experiment will only add to the confusion. Our best assurance lies in efficient administration of our proven system.”

It is interesting to note that Harding’s secretary of Commerce, Herbert Hoover, favored intervening in the economy in 1921. He would later have his chance in 1932 when he pursued a massive increase in the Federal budget to stimulate the economy. Included in his budget were numerous make work projects. He also bailed out failing banks that made bad loans during the booming 1920s.
We are all aware of how the recession of 1929-30 turned out; the decade-long Great Depression.

The case of America in 1920 presented a situation in which significant changes to the economy were necessary to align its production with the needs of the peacetime market. So what would the government’s response to such a situation be today?

It would probably start with bailouts of the factories producing war materials in order to “save jobs.” Provide them with the time and money to produce a new product that someone else, with the relevant expertise, was already making. Society ends up with an inferior and more expensive version of the product. And if that weren’t bad enough, it is forced to finance its development via taxes – taxes that, if left in the private sector, would have been spent in other areas to create new jobs.

When you look at the entire picture of economic intervention, and follow all of its consequences, it becomes clear that the only thing government can do is delay a recovery, and waste a tremendous amount of money in the process. It is ironic that we now look to copy the economic policies of the Great Depression – because it was the worst economic period in American history – when it was precisely those policies that made it the worst economic period in American history.

HSBC Bank (China) Co announced on Friday that it has been approved as a member of the Shanghai Futures Exchange, becoming the first overseas bank to engage in China’s gold futures market.

“China is an important producer, user and investor of gold. The access granted for China’s gold futures market is a welcome addition to our existing gold spot trading business with the Shanghai Gold Exchange, and reinforces HSBC’s leadership in the global precious metals market,” said David Liao, managing director and head of Global Markets at HSBC China.

“We look forward to playing a greater contributing role in the development of China’s fledgling gold market, where we see vast growth potential,” Liao added.
HSBC China was one of the first overseas banks to become a member of the Shanghai Gold Exchange in February 2008, and the first overseas bank to obtain approval to start gold trading in June 2008.

The approval “reflects the opening up of China’s futures market,” Wu Jian’gang, researcher at the CEIBS Lujiazui International Finance Research Center, told the Global Times on Sunday.

“Gold is not quite closely related to industrial production, so introduction of foreign companies would not create a big, unmanageable impact on China’s commodity market,” Wu noted.

Gold futures should be in tune with the foreign exchange reform and opening of the financial market, so it is appropriate to open the gold futures market first in the process of foreign exchange reform and yuan internationalization, he added.

“The country would intensify efforts in the futures market, including reducing rates and increasing the liquidity and diversity of investors and agents. The opening up of gold futures is just a start and in the future, not only institutions, but also advanced global technologies and experiences will be introduced,” said Wu.

China is the largest gold producer in the world, with the output increasing to a record high of 340.88 tons in 2010, data from China Gold Association shows.

Australian miner Norton Gold Fields expects its top shareholder, China’s Zijin Mining , to lift its stake to 19.9 percent, using Norton to expand offshore, Norton’s chief executive said.

Zijin, China’s top gold producer, last week agreed to invest $30 million in Norton, buying shares to lift its holding in the company to just under 17 percent.

Norton Chief Executive Andre Labuschagne said he plans to meet Zijin executives in the next few weeks to discuss what their longer term intentions are.

“All indications are we are the Australian arm for potential growth,” Labuschagne told reporters late on Sunday.

Labuschagne told two reporters separately that he expects Zijin will want to raise its stake to 19.9 percent, the threshold above which an investor would have to make a full takeover for the company if it wanted to increase its stake further.

Norton sees Zijin as a useful partner as it has expertise in the heap leaching process of extracting gold.

Norton Gold is considering developing its Navajo Chief lode using by heap leaching, alongside several other expansion opportunities on its tenements spanning 700 square kilometres in the gold belt around Kalgoorlie.

Zijin agreed to buy its stake for A$0.20 a share, a 14 percent discount to the stocks price on Monday.

The company’s shares have been languishing relative to its peers as it has an A$80 million debt load, compared to others who have no debt.

The share sale to Zijin will allow it to cut debt to A$50 million, and its recent sale of coal tenements in Queensland and the planned sale of its Mount Morgan mining leases in Queensland will cut debt to below $30 million by March 2013, if not sooner.

Once its balance sheet is strong enough Labuschagne is keen to get into merger activity which is sweeping the gold sector, and sees Norton as a predator rather than target.

“If I can help it, I’ll do it,” he said, adding that Norton would look at takeover opportunities in Australia and offshore.

“I feel disappointed we can’t at this stage participate in that consolidation process because of where the share price is.”

China Nonferrous Metal Industry’s Foreign Engineering and Construction Co said on Monday that it would increase its stake in Australian miner Terramin Australia Ltd in a deal worth 32.35 million yuan ($5 million).

Terramin will sell 12.3 million shares to China Nonferrous Metal at A$0.37 ($0.406) apiece in a private placement that would increase the holdings of the Chinese developer of non-ferrous metal resources to 19.86 percent from 14.38 percent, according to a statement to the Shenzhen Stock Exchange.

Terramin will use the share sale proceeds to develop two zinc and lead mining projects, the statement said.

Terramin posted a loss of A$9.875 million last year and its assets totalled A$147 million.

Chinese companies have been eager to secure supply of raw materials through overseas acquisitions to meet rising domestic demand in the world’s fastest-growing major economy. ($1 = 6.437 Yuan) ($1 = 0.910 Australian Dollars)

Metals prices pushed upward amid the same unresolved concerns that moved China’s futures markets Tuesday, including the ongoing strike at world’s largest copper mine and the unbroken stalemate in the US over raising the country’s debt limit.

The most active copper contract, for October delivery, rose about 0.6 percent on Wednesday to settle at 72,830 yuan ($11,307.08) per ton on the Shanghai Futures Exchange. The contract jumped 0.8 percent at the market’s opening, following the rise in international copper prices overnight.

The benchmark three-month copper contract on the London Metal Exchange rose 1.7 percent in Tuesday’s session, but then retreated on Wednesday. It was trading at $9,821 per ton, down 0.2 percent, at 3:15 pm Beijing Time on Wednesday.

SHFE gold prices rose steadily on Wednesday, with the most traded contract rising 0.4 percent to settle at 336.84 yuan per gram. The price of gold for immediate delivery hit a record high of $1,624.55 an ounce on the COMEX on Wednesday.

Other SHFE base metals benefited from the rise in international prices overnight, with the most active aluminum contract spiking 1.9 percent to settle at 18,210 yuan per ton. The contract was up more than 3.5 percent for the week due to strong fundamentals, according to Tong Changzheng, an aluminum analyst with Huatai Great Wall Futures.

A bulletin on the China Nonferrous Metal Industry Association website highlighted a rumor that may have influenced aluminum futures, according to an analyst surnamed Yuan with Shanghai East Asia Futures.

The bulletin said that Indonesia may impose export restrictions on aluminum ore to China, though probably not this year.

“China, the largest consumer of aluminum, imports 80 of its aluminum ore from Indonesia, so the change could constrict supply,” Yuan said.

Zinc for October delivery rose 1.3 percent to settle at 19,010 yuan per ton.

The September delivery lead contract gained about 1 percent to settle at 17,740 yuan per ton at close on Wednesday.

National Aluminium Co., India’s third-largest producer, increased its alumina capacity 33 percent to boost exports and tap global demand for the raw material used to make the lightweight metal.
Capacity at the Damanjodi refinery in the eastern state of Orissa was expanded to 2.1 million metric tons from 1.58 million tons, Production Director A.K. Sharma said today in a telephone interview. The additional output will start on Aug. 1 and stabilize in a month, he said.
Rising incomes and public works in China and India, the fastest growing major economies, are driving consumption of aluminum, used in everything from aircraft to beverage cans. Japan, Asia’s largest aluminum importer, is placing more orders as the nation rebuilds from its worst earthquake and tsunami. Alumina prices have risen 20 percent from start of this year until May 27, according to Metal Bulletin.
National Aluminium, based in the eastern city of Bhubaneswar, exported 702,554 metric tons of alumina in the year ended March 31. Shipments fell in the last two years as the company used more alumina to feed a 40 percent increase in smelter capacity. Bauxite is turned into alumina that in turn is refined into aluminum.
National Aluminium shares fell 1 percent to 78.15 rupees at the close of trading in Mumbai. The stock has declined 20 percent this year, compared with a 10 percent drop in the benchmark Sensitive Index.

According to the data for the first six months of the current year, Ukraine’s metal product exports increased by 3.1 percent year on year to 12.587 million mt. In June alone, Ukraine’s metal product exports declined by 2.2 percent compared to May, to 2.43 million mt.

In the given period, Ukraine registered a 9.7 percent increase year on year in its metal product imports to 804,000 mt. In June alone, Ukraine’s metal product imports increased by 7.3 percent compared to May, rising to 152,000 mt.

German aluminum output of 428,369 tonnes between January and May was up 5.3% from the same period a year earlier.

Mr Christian Wellner MD of GDA said that “The outlook for aluminum remains optimistic because customer industries are also continuing to develop positively. Germany’s aluminum industry is confident that production growth will continue in the H2 of 2011.

Preliminary GDA data showed that German January to May production of primary aluminum rose by 21.9% to 180,632 tonnes. Output of secondary aluminum smelters declined by 4.3%. Production of aluminum products is also rising. Output of rolled products increased by about 4.3% to 814,637 tonnes. Extrusion press producers raised output by 11.8% to 255,847 tonnes.