Mining's Fimbul Winter
Ok, ok already. You want to talk about gold. So here is some late night thoughts on the mining sector for you insomniacs. Feel free to talk about anything you want about gold and silver but I'm going to talk about the miners. Sentiment is at an all time low and I gotz a feeling things could start turning around soon. I'm not predicting, I'm just saying.
In the Norse mythology, the world experiences a devastating winter that last three years without any sign of light or life. Investors in gold and silver miners are in the midst of their own fimbul winter as we continue to experience a cyclical decline, with occasional glimmers of hope.
As you all know, Barrick and Kinross are closing properties and curbing production, cutting dividends, and writing off billion dollars of loss. Many small and mid tier miners are laying off workers and selling higher-cost operations. We are now experiencing the beginnings of a very painful consolidation period that has been talked about and anticipated for the previous three years. Is anybody surprised? Shouldn't be.
Unlike the 2008 crash, where speculative money quickly rushed back into the sector along with generous portions of liquidity from Washington, QE3 has not provided the impetus for investors to run back into the sector.
Those who have been investing in the miners for any time, remember the previous bust cycle, 1997-2002, when nobody cared about the junior market as investors were focused on high tech and large broader market shares just as many investors are finding more appeal in riding the trend in the broader equity markets over focusing on severely beaten resource stocks.
However, those who remained focused on the resource mining sector during the dark nights, continued to seek out economic deposits through out the decline found themselves well positioned when the cycle turned around.
Shed no tears for this bunch of scoundrels. Barrick has a long history as the bad guy. Barrick and it's bullion bank buddy JPM, were sued in a combined lawsuit of actively manipulating the price of gold and making $2 billion in short selling for profits. They have been called the "Darth Vader" of miners with a long nefarious history of hostile take-overs, and the forerunner of hedging it's production at the expense of it's investors and other miners.
Gold miners protect against falling gold prices by agreeing to sell gold at a fixed price in the future to protect themselves against falling prices. Barrick like many other producers began de-hedging their production back in 2009 to profit from rising gold prices.
According to Zerohedge back in early June, Barrick lost $6 billion of shareholder equity hedging it's production prior to 2009. Yamana, Kinross, Newmont and Goldcorp also did no favors for their investors during the 2001 to 2009 upswing in the price of gold. This is why I've rarely plopped my money into big producers and have opted for more pure gold plays in the junior's through the discovery process.
There is as much disagreement about the effect of miners hedging their supplies on the price of gold as there is the meaning of GOFO and backwardation means for short terms gold prices. I won't be resolving that debate here in this article. Feel free to go at it.
You might consider going back to ZeroHedges article written in June on the great hedging debate http://www.zerohedge.com/contributed/2013-06-27/selling-low-and-buying-high-hedging-gold-miners Briefly: Tyler Durden at Zerohedge makes the case that even if all the gold miners in the world hedged all their production that it would do very little to increase the stock piles in existence. Gold mining production is less than 2% of the annual stock piles of gold in existence. Others contend that hedging future productions is rarely conducive to higher future prices.
As Durden points also points out, that you might imagine that the world's largest gold producer with a board of directors that reads like the characters out of a Dan Brown novel would have employed a hedging strategy that would accommodate both advancing prices in gold as well as the declining cycles. Most of you saw this coming, why didn't the gold producers?
History Repeats. A Looong History
The cycle we are experiencing in the mining sector is as old as the hills. If we consider the history of mining over the centuries especially after the introduction of fiat currencies, gold mining has more often than not been a very unprofitable endeavor. And anybody that has endeavored to understand the nature of junior mining discovery realizes that the odds of an economic grade discovery are extremely low.
John Kaiser made a predictions that we would see around 500 juniors go into extinction. And even more with very little capital to withstand the consolidation phase.
In addition, we are experiencing factors that have historically been bearish indicators. Alexander Del Mar in his book "Money and Civilization" which you can download for free in Google books writes
"Previous to the introduction of paper notes for money the history of prices was one of irregular periodical rises, between which were long intervals of gradual falls, the falls being due to the cumulative stocks and therefore diminishing value of coins of the precious metals, and the rises to new and systematic resorts to mining."
The same factors that brought mining operations to their knees in previous cycles have returned where we are seeing an under-valuation of gold and silver in dollar denominated terms and paper notes flood the market. Del Mar points to 3 basic reasons why mining became unprofitable:
1) Over drilling and exploration beyond the limits of profit
2.) Periods of gold inflation where large quantities of gold were discovered or plundered and put into the market suddenly. I'd point to the period when the Spanish plundering of Incan gold. And this is where I might diverge with Zerohedge in that there have been documented times in history where the market didn't absorb a glut in gold supply. However, this little bullet point is a topic of multiple posts.
3.) Gold and metal prices were manipulated through the issuing of paper notes, credit systems, military conquest and slavery.
Another lesson we learn from Del Mar was a feature of the 1970's bull market. That significant profits in mining do not come until there is a significant inverse relationship between paper money and the price of gold. In the 1970's junior bull market, inflation was a serious concern as we entered a state 2 inflation. It was not until gold reached it's peak levels when the bull market in the junior mining sector began it's historic run. Through fed's intervention and capping of the flow of liquidity into the market, the bull market came to an end but not until investors reaped unprecedented profits.
What makes this bear phase different from the rest? Declining grades of deposits, and an extreme dirth of mines that are positioned to withstand financially the consolidation phase and an incredible demand for the metals by consumers and central banks that screams any sort of discovery in the junior minings could potentially turn into a speculative fervor.
We have yet to see the beginning of the next discovery phrase. Rick Rule, among others, have been talking quite a bit about the 9 year discovery phase. The theory is it takes 9 years of working an area before miners in that area begin seeing discovery. Well, we are in year 10 and there is nothing that says the next discovery phase will be a 10 or 11 year cycle. Once it begins we will certainly know because discovery has a strange way of coming in groups.
Let's examine the flip side of the coin and some of the factors historically that have been attributed to bull markets. Whenever the value of the metals exceeded the value of money astonishing wealth was created as result of mining discovery especially when gold or silver were coin of the realm. This fact alone has sustained an industry through the rise and fall of civilizations where abandoned mines would be reopened and mined for resources that were unrecoverable whether for geological challenges, war or suppression of metal prices.
An important point that Del Mar also makes is known resources in the ground will be mined despite the valuation of the metal even if the mine must change ownership and the price of the metals is suppressed by banks manipulating the prices of the metals. Often this is done through military aggression and slavery but right now I believe we are beginning to see the beginning of the acquisition phase.
The Red Bull In The Mining Sector
On Friday, reports came out that China's inflation only rose 2.7% lower than market expectations. The reports paint a rosey picture of a country that is experiencing a slow down . Well you can trust the official numbers from the ChiComms just as much as you can trust the words flapping out of Bernanke's mouth. Many analysts including Kyle Bass has China coming in for a hard landing and many questioning whether China has the goods to take away the title of world dominance from the Western Anglo elite.
The issue is not whether or not China is a model for fiscal restraint and healthy monetary policy. It's no secret that China operates under a tolitarian political regime and currently sports a very loose lending policy. A debtor nation is a debtor nation by any other name would smell as fusty. However, China has discovered the wonders of capitalism, economic trade and now have become the masters of bargain hunting especially in the resource sector.
It seems China is using Del Mar's historical survey of mining as a playbook. Norton Gold, owned by China mining giant Zinjin announced that it would be seeking to double it's gold output and seek out acquisitions. Folks, those closed mining fields won't be inactive too long if the Chinese have their way.
Rio Tinto is reporting a 71% decline in profits in the 1st half much of it attributed to China's slowdown. Well clearly, China's consumption might have experienced a slow down, but their response to Rio Tinto's lagging profits was going shopping back in late July. China Molybdenum offered Rio Tino $820 million for a majority stake in one of Rio Tinto's Australian Copper and gold fields.
Western media as all but called the bull market in gold and silver over. Recently, Forbes ran an article about the dismal prospects of investing in the mining sector. http://www.forbes.com/sites/ycharts/2013/08/07/buy-the-miners-a-gold-myth-debunked/
With the headlines screaming that the miners are bleeding and more consolidation, my guess is investors who have exited the mining sector will be waiting for some kind of extended upward trend before deploying any amount of reasonable cash back into the sector. However, it seems that the Chinese are not too concerned about the re-establishment of a trend. Larry Roulston sent out a mining update and said that we could see some miners’s start popping while investors are waiting for a trend. Well, it’s a good thought although not sure it’s so but if you are a bargain hunter, you should be having a party.