Batten Down The Hatches

¹²Gold Meltdown Or Mania— Batten Down The Hatches

By Louis James | 5 August 2010

As Doug Casey said recently, we expect things to come unglued soon. With the ongoing madness in Europe, it seems to me that things are starting to look visibly less well glued already. In contemplating the possibility of another stock market meltdown, it seems important to me that in spite of the exuberance with which investors rushed back into the market over the last year, the memory of 2008 remains vivid, tempering enthusiasm with caution.

For example, the market still has relatively little appetite for early-stage, grassroots exploration projects. By our latest estimates, Mr. Market is willing to pay on the order of ten times more for Proven & Probable ounces in the ground than for less certain resource categories. With this evidence of caution in mind, and the great unwinding of the broader credit markets well underway, it seems likely that our sector is less leveraged than it was before the crash of 2008.

If a panic in the broader markets put liquidity-crunch-induced pressure on the gold price, the meltdown should be less severe than in 2008 and the eventual rebound could be dramatic, possibly triggering the mania we've been calling for. Remember: the market crash drove gold down almost to $700 in October '08, but the same fear drove it almost back to $1,000 by February '09. Silver topped that with a 60% rebound over the same period.

As the debt-glue holding everything together continues to lose its grip, the ride will only get rougher. As bad as 2008 was, if the Crisis Creature appears to be coming back when everyone on Main Street thought it was dead, the fear should be much worse— and that should drive gold way, way north. It's possible the fear, coupled with the lack of any safer alternatives, could prevent gold from 'melting down' at all, sending it instead straight up through the roof into the clear blue Mania Phase sky.

With its industrial metal aspect, however, another big economic meltdown could hit silver harder than gold, and it might take longer to recover, especially if base metals don't rebound the way they did in 2009. That said, silver has always tracked gold, so when gold heads for the moon, we expect silver will as well. It could reach even higher, if supply is cut by reduced base metal demand, as most silver production is as a by-product of base metal mines.

Either way, I don't care if gold drops in the weeks and months ahead; the overall trend is for widespread economic fear and uncertainty to continue, holding gold prices up and eventually driving them higher. That makes the current retreat look like a great buying opportunity. In fact, putting my money where my mouth is, I picked up some more gold buffaloes just yesterday, when gold dropped to $1158. As I type, it has rebounded to $1181. I plan to buy more every time I see a sharp drop like this over the summer.

So, in addition to our multiple recent calls to take profits and go to cash, I want to reiterate that gold is cash. And it's a whole lot more attractive than the dollar, the euro, or any paper money at present— not just as a speculation but for security as well. Unfortunately, the stampede to safety that drives investors to gold is not likely to drive them immediately to junior exploration stocks.

What About The Stocks?

The junior exploration stocks— "The most volatile stocks on earth"— is not what fearful people will be looking for— not until the panic sufficiently recedes and greed joins fear in equal measure in the marketplace or in greater measure, come the Mania Phase. If I'm right about fear being the driving force in the markets in 2010, whereas greed drove them in 2009, gold will have to deliver a serious wake-up call— perhaps holding over $1,500— to really get the show on the road again for the gold stocks. If that happens while fear of a global economic slowdown continues to push oil prices lower, gold producers should be able to report extraordinary profit increases, even as other industries are tanking, and finally penetrate deeply into the awareness of broader pools of investors.

Cashed-up majors won't have to wait for that to benefit; they may seize the opportunity created by market weakness to buy successful explorers, with significant discoveries in hand, while they are on sale. Well, some of the more nimble ones, like Kinross or Agnico-Eagle, might. The bigger companies, like Newmont and Barrick, didn't lift a finger to pick up any bargains after the crash of 2008 and may be too cautious to act the next time around as well.

Be that as it may, acquisitions will increase the demand for quality exploration projects— the pipeline from exploration to development must be kept full— and good prospectors should at last get their day in the sun. Punctuating this sequence will be the occasional big win on a new discovery. There haven't been that many this cycle— not enough to replace all the gold the majors are depleting every year— but there have been some, and the market always loves a discovery.

After the first quarter of '09, greed outpaced fear and great development stories did phenomenally well; we saw better gains on large and growing gold stories than we did on the big producers. If fear retakes predominance in 2010, it's profitable production that should do best, and I'd expect the biggest winners overall to be new, emerging, and highly profitable precious metals production stories. Spectacular discoveries should also do spectacularly well, but those are harder to predict. New and rapidly expanding production should be the sweet spots.

Generally, I think we'll see our markets trading largely sideways over the next few months, with great volatility, until the debt-fueled "growth" in the global economy is exposed for the sugar high that it is. We've been forecasting that scenario for long enough here at Casey Research. I expect this to play out by the end of this year, or 2011 at the latest, depending on how fast fear returns to the broader markets.

What To Do

If I'm right about this, the strategy called for is a more cash-focused version of our "Buy only the Best of the Best" program. Buy nothing new unless you're offered a great bargain in a solid company that can deliver significant new or expanding production. Nothing less than 50,000 ounces gold-equivalent per year in production will get much notice, and anything less than 100,000 ounces per year AuEq will have to struggle for respect. A solid company, of course, has great people, lots of cash, and the goods in hand.

If you want to speculate on a discovery, make sure you have very good reason to believe the project has much better than average odds of delivering a discovery— and it has to have world-class potential. That's not hundreds of thousands of ounces but millions of ounces of gold, or equivalent. If things do come truly unglued this year, we may well see 2008-style bargains on great companies with the staying power to recover and go on to new highs. Watch for it. Prepare for it.

Buy Low, Sell High— it's a formula that requires patience but is the only way to go.