China and the Gold Miners
China and Gold both have a huge role to play in the unwinding of US debt...
ACCORDING TO Cameron Alexander of GFMS Limited, speaking Monday here in Sydney at the Excellence in Mining show, writes Dan Denning of the Aussie Daily Reckoning, gold production is in the midst of what he calls a "secular decline".
Not only are cash costs of production rising for Gold Miners (up 27% in the first half of 2008 according to GFMS), but mine production is in decline globally. Why?
Well, Gold is not like paper money or digital money. You can't just create it out of thin air. You have to find it. You have to hire people to mine it. You have to refine it.
The costs (labor, energy, and infrastructure) are rising...and for some producers are already higher than the Gold Price itself. Not many businesses can stay in business for long when the cost of production exceeds the market value of the commodity. You can't make it up on volume.
What about demand for gold? Gold's run to US$1,000 dampened demand for gold jewelry, according to Alexander. But the recent dip to $750 is already showing signs of sparking that demand. It's just too good a buying opportunity to pass up.
Alexander also noted that the demand for Gold Investment is driven largely by the gold exchange traded funds (Gold ETFs). Then there is gold's role as a monetary reserve. The US claims to have 79% of its official reserves in gold. Japan's central bank, by comparison, holds just 2% of its reserves in gold, and China just 1%.
Do you think China would like to convert some of its $2 trillion in forex reserves into gold? Or would China, through its various state intermediaries, prefer equity in resource shares listed abroad, so that is actual ownership of key strategic resources? Why not both?
"Both" appears to be the answer suggested by Paul Glasson from KPMG, who has lived and worked in China for years. He helps Aussie firms do business with Chinese firms. His presentation on Monday was fascinating. He explained in detail how Chinese investment decisions wind their way from the Communist Party in Beijing to the stock market in Sydney.
China and Gold both have huge roles to play in the coming months. It's clear by now that the American model of asset-based wealth generation through leverage, debt, securitisation, and trading is failing badly. But there is still a lot of wealth denominated in US dollars to be put to the sword.
Parties who are not interested in having their dollar-based wealth evaporate will be looking for ways to trade dollars for other assets. We're betting equity in resource companies – which once again are absurdly cheap – is one way they'll do that.
Of course, there are plenty of people content to crowd into the lifeboat that is the US Treasury bond market. That seems to us like a strategic error of the first order, akin to sending your 6th Army down to Stalingrad for the weekend, only to find that it never returns. Or crowding into a medieval castle just before a long siege.