Have Violin Must Fiddle

Have Violin Must Fiddle

By Neil Charnock


Interest rates are up again here in Australia as the RBA hikes our prime rate by 0.25% to 3.75%. One bank has already come out with a 0.45% hit on mortgage borrowers of nearly double that figure. The Federal Treasurer stated that the banks have no justification to take this policy course however I beg to differ – truth is they have to rebuild their balance sheets to cover the bad and doubtful loans on their books – some of which are disguised as performing assets.

Could the RBA be trying to keep a lid on our housing bubble which deflated somewhat before expanding again after the economic stimulus package?  Perhaps they are giving themselves more ammunition come the next round of economic weakness?  By raising rates now they can drop rates further later on as stimulus.  Then again perhaps it is just a matter of “have violin must fiddle” and they just can’t leave things alone and feel they have to be seen to be doing nothing.

On top of this news today we have the third leader in the Government Opposition since they lost the last election. I have to resist the chance to joke about bringing back the past Treasurer Mr. Costello to rejoin the new leader Mr. Tony Abbott as no.1 and no.2 (Abbott & Costello) because that would be cheap of me. It’s an old joke but this event makes it seem topical again and funnier. I take no political sides as this is not the venue for comment on climate change or politics.

Then we have the fiasco in Dubai and a major debt default – more on this later including comment on bad loans and remaining weakness within the global banking system.  For now I want to talk about the status of Australia as a leading global gold producer.

Worlds Number Two Gold Producing Nation

Global gold output has been falling and the dominance of South Africa as the leading gold producer for over 100 years has declined over the last few years. China overtook the position of number one gold producing nation in 2007 from the USA which had taken the leading status in 2006. China now produces significantly more than any other nation and is a clear leader.

Just as well because their domestic and Foreign Reserve appetite is immense and growing.  Don’t expect them to start flooding the world with their gold as the Chinese establishment has publicly announced that they encourage their citizens to own the king of metals.  If only our Government had that sort of foresight all credit to the Chinese for this policy.

This year however Australia has claimed the number two spot at least for the first half of 2009 and this is the area of the market that we specialize in here at GoldOz. The ramp up of the Newmont Boddington mine in WA will be responsible for maintaining this rise in world ranking for Australian production.  Boddington commenced mining in July 2009 and produced its first gold / silver concentrate in September this year so the best is yet to come.

The ramp up will take place over 12 months continuing to add to Australia’s production statistics as it heads towards 7 Mt – 9 Mt of gold per quarter. This massive mine took 16 million man hours to construct and has Reserves of over 20 M oz with a projected mine life of more than 24 years.

On November 20th Newmont announced on the ASX that it has now achieved commercial production and expects full design production at Boddington in 2010. This mine will add substantially to Australia’s gold production rate which reached 112 Mt in the first half of 2009 according to Surbiton Associates director Dr Sandra Close.

The giant  BHP mine, Olympic Dam in SA, has a proposed expansion over 11 years which could take production of gold from 100k oz per annum now to over 700k oz per annum for a total of approximately 20 Mt of gold each year. To put this into perspective consider that our two other largest mines, after Boddington, include Telfer with production in 2009 of 629k oz and the Kalgoorlie Super Pit that produced 606k oz in 2008.

By the end of 2008 the Australian gold industry exploration programs had defined an additional 34.8 million new ounces taking our Economic Demonstrated Resources (EDR) to 6,255 Mt of gold which represented 81% of our Demonstrated Resources. In 2008 terms this ranked Australia equal second with Russia for in-ground resources, each with 11% of global resources.

The Australian Bureau of Statistics reported an exploration spend of $570M for 2008 and WA continued to be the prime exploration target with $329.1M spent in the same period. WA also produced 134 Mt of gold which was about two thirds of total Australian gold production for 2008.

The interesting thing about the global gold industry is that it is global and therefore the Australian listed gold stocks based here have operations spread across every continent. Australian domiciled companies produced significant quantities of gold offshore too and the local industry also derived a benefit from these activities as earnings are repatriated back into Australia.

Australia has an exceptional Global Sovereign Risk rating making it an excellent place to do and invest in business. We are right up at the top of this table of rankings too. There is no better business than gold right now and for the foreseeable future. Our gold miners are enjoying an AUD$1300 gold price (approximate) and nearly all of our producers are profitable at this level.

Some of the producers rank in the lowest cost quartile in world rankings making them extremely profitable at these levels. We have several in the second quartile of cash costs too. These stocks are generally in powerful up-trends as indicated by the chart below on the Emerging Producers.

Because they are coming off the hyper low, over sold, panic levels of late 2008 there is plenty of room for new profits for investors. Gold was below A$1,000 in September 2008 before the crash and reached about this level in November 2008 when the index below was considerably higher.

Despite the current low end of year volumes they are still being accumulated ahead of further expected rises into 2010 and beyond.  The XGD, Large Producers Index and Explorers Index are also in up-trends with loads of upside potential.

Performance wise, many of these stocks are cheap and our ratings table in the restricted Gold Members area of GoldOz shows this in graphic detail.  We see gold continuing to rise and become more prominent due to its role in international banking and due to investor demand.

The Dubai shock last week showed exactly what I have been saying about the banking system.  Who could possibly think that the economic shocks are over and all is well again in the garden.

That $56B was shown as a performing asset on the balance sheets and this was clearly not the case.  Bank balance sheets need time to rebuild and this process will take years. The bad debt provisioning will have to be added to as time goes on and these disasters come into the light of day.  The confidence in the assets (loan books) of the banks has to be under renewed scrutiny again and this is bad for confidence in general – good for gold.

There is always the fear of, and the chance of, the need for new rounds of capital injection into the banks while their balance sheets are weakened.

The debt securitization market is gone because nobody in their right mind will stand there and buy debt in this market given the risks involved. To ram home the point – Dubai illustrates this clearly. Besides, this type of activity is more a feature of the late stages of mature bull markets so a debt securitization market is unlikely to reappear for many many years yet.

This will constrain bank earnings and growth and will slow the process of vital balance sheet repair for the banks and corporate sector. Hence minimal jobs growth will occur which will further constrain growth in particular consumer spending led growth supporting manufacturing and retail.

Investment capital is still looking for safe yield and investors are in still in preservation mode despite the growing appetite for riskier assets post crash conditions. This has led to renewed interest in equities as returns are sought.

It has aided the recovery of gold stocks to above pre-crash price levels which is more than can be said for the rest of the market.  Even the gold explorers and developers who have been able to raise significant money have found traction and are rising strongly.

Main stream investment flows will gradually wake up to gold as time marches on and this will lead to further gold and silver demand. This will in turn create greater and greater demand for gold stocks. I have stated in the past few months that we are now entering the media phase where gold actually receives attention.

Here is the genesis of a new bubble forming to be fueled by the US carry trade, continued fear and new investment interest. The outstanding performance of the gold stocks will generate new interest from mainstream investment flows. It will be fueled by real and totally justified demand for producers that are still undervalued relative to their increasing cash flows – margin over total costs.

Profits will increase as this sector sees the results of new plant development, plant upgrades and increased exploration expenditure over these past few years. We are working on an update to our Capital Raising file for Gold Members to show the phenomenal money that has poured into this sector despite tight credit conditions. Resources will grow thanks to all those new exploration holes and this generates excitement for gold stocks as the price of gold rises.

Australian gold stocks will benefit from global and local demand more and more as time progresses and I fully expect this to turn into a bubble over time.  Fear drives investment demand like no other force – including greed.

See (below) how our gold index (XGD) has outperformed the general market (XAO) here in Australia since they re-listed the XGD. The move to incorporate the XGD into the XMM 300 All Metals and Mining index shocked and annoyed me at the time but I welcomed the obvious return when it finally gained enough interest for the ASX to discover their oversight.

The XGD was axed several years into a bull market which really perplexed me but by the time the XGD was again recognized it was ready to take its worst tumble of the bull market to date. As you see the gold index fell sharper and earlier than the XAO however it also recovered earlier now reaching new heights above those pre-crash 2008 highs.

It has disconnected once again and is looking strong. The RSI on the bottom is for the XGD whereas the XAO RSI picture (not shown) is looking poorly now. This indicates that the disconnection between the two indicies will continue to widen in favor of gold.

As we move forward and the slow growth impinges on the general market companies compared to ever growing interest in and profits from the gold producers the picture will change even more.

This will win new interest in the Australian gold sector as hot money and day traders seek out the leading market sector.  So hot money, offshore investment flows from flight to Sovereign safety, active investors and safe haven investment from the savvy will continue to build investment in Australian gold stocks.  The investment funds will be back early next year looking for another good year of yields too.

These demands will be significant however not to the degree that offshore money can move this index. Once the global rush for gold, silver and gold stocks gets really serious then I expect the excellent status of the Australian gold sector to suck investment flows like debris into a twister, like matter into a black hole only this one will expand.

Our gold sector is tiny compared to the rest of the market for now but this will change. Are you ahead of this game – are you in gold and silver and precious metal stocks?

Our bonus time offer for GoldOz Gold Membership subscriptions is over as of end of November (yesterday) however I allowed a late comer in today on the same deal.  Therefore I have decided to be fair and extend this deal until Friday 4th December for new Gold Membership only.  From then we will just concentrate on new improvements and investment resources at GoldOz as we scale down for the Christmas break.

Good trading / investing.
Neil Charnock


GoldOz has developed a basic Member area (news only) and a Gold Members area with substantial investment tools.  GoldOz web site is a growing dynamic resource for investors interested in PGE, silver and gold companies listed in Australia, ASX share quotes, Aussie Gold Index charts, brokers, bullion dealers in addition to the company research + investment tools via our paid Membership services.

Neil Charnock is not a registered investment advisor. He is an experienced private investor who, in addition to his essay publication offerings, has now assembled a highly experienced panel to assist in the presentation of various research information services. The opinions and statements made in the above publication are the result of extensive research and are believed to be accurate and from reliable sources. The contents are his current opinion only, further more conditions may cause these opinions to change without notice. The insights herein published are made solely for international and educational purposes. The contents in this publication are not to be construed as solicitation or recommendation to be used for formulation of investment decisions in any type of market whatsoever. WARNING share market investment or speculation is a high risk activity. Investors enter such activity at their own risk and must conduct their own due diligence to research and verify all aspects of any investment decision, if necessary seeking competent professional assistance.