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Gold Forecast & Analysis - Ounces Aren't Just Ounces

Commodities / Gold & Silver Apr 23, 2007 - 01:13 PM GMT

By: Neil_Charnock

Commodities Gold broke out last week and now looks set to run up at US$730 but a few resistance levels above here first. Back at the start of the year I made an educated guess at a May $730 top for the first half of 2007, time will tell. This is not a technical article, if is a fundamental one for my PDF clients and resource investors. Tread warily here is my current take – the ASX is toppy and needs a pull back but there are still some opportunities in the resource arena short term. Full technical and fundamental coverage of this is in the latest GoldOz Newsletter.

The title above is a play on an old advertising campaign I remember from about the 70's. It was actually about oil, engine oil and the advertisement was making a point of difference about their oil – the message went something like this; “Oils Ain't Just Oils Sol”. They were making the point their oil is superior to other engine oils even though they appear the same to the uneducated (about their product – oil) motorist. I see a need to write a piece about ounces of gold and silver being different too – seems like a stupid argument because these metals are elements – they are “fungible” meaning an ounce produced anywhere is the same as one produced anywhere else. Please let me explain as it just might help you with your investing activities, might stop you from overvaluing a stock and getting disappointed when it does not take off.

Hedged ounces: very different ounces indeed

Banking practices had to be conservative during the period from the mid 90's and even up until about 2003 when gold mining began to become more profitable again. It made good sense for banks to insist on hedging to protect the debt they issued – protection from the then continuing metal price deterioration. So, un-mined ounces were “cleverly” sold before they were dug up out of the earth.

Professionals that understand mining as a business also understand the very tough nature of winning metal from the ground and would have to seriously question the wisdom of this as a long term practice. They would have questioned it a lot more if it were not for the “convenience” of being able to borrow to stay alive as an independent company and eat during those long bear market years. Many were forced to hedge a little too much of their future production in this manner and now suffer as costs have risen above the price they sold their precious metals for.

Interestingly enough this hedging became a self fulfilling prophesy as un-mined gold hit the markets in paper form and depressed prices further. More and more ounces were sold forward to “protect” the capital leant by the banks - some of whom took the other side of the trade as paper promises of delivery of future gold.

Problem was it also came at a time of a concerted and coordinated effort by the Central Banks to sell down their gold reserves into even more private hands - hmmmmm. Actually the practice was to lease out their gold for a return of a fraction of one percent which effectively had the same result as hedging except in this case the gold was sold as real ounces and swapped for more paper promises – in effect just an agreement to return the gold at a later date. The combined effect created the bullion buying opportunity of the millennia as so far proven by history. It also created a false dip in the already extremely low - inflation adjusted price of gold to below the US$400 floor. This was a level that should never have been breeched.

These “ounces” also combined to create a false and distorted world view of the true worth of gold both in terms of price and also as an essential mechanism of balance within the financial system. There are a few aspects to this balance that have been well covered elsewhere and are not within the scope of this essay. The dollar price of gold is gradually becoming more and more irrelevant because of the inherent risk built into the USD.

To be clear – tangible gold is worth how many pieces of confetti? That is currently a rough statement because gold is currently worth what someone is prepared to pay for it or to sell it for so lets be balanced about this. This so called confetti pays the mortgage and puts food on the table still too. But is that not what had been claimed about all fiat currencies across time? Even up until the end??? All people interested or not, should be encouraged to do at least a cursory study of this historical subject for their own protection and survival. History does repeat to a large degree and man is doomed to repeat his mistakes without examining his mistakes of the past.

The value of gold as a backing mechanism of currency stability and as a control on money creation by Governments (under pressure from all angles) cannot be understated at this time. If you don't believe me look at the US budget, deficits… the string of dangerous and high risk currency crises – “fires” in the financial system over the last decade that had to be “doused” by ship loads (not a typo) of newly created money supply. Business, export and import - and farmers all need a reasonable level exchange playing field and this disruption causes much harm so this is all very important.

Inflation adjusted ounces: … again very different indeed

Moving forward from the US$400 floor comment just above… as cycles go, in 2001 we were drawing towards the end of a moderately long half cycle – bear market in tangible assets that had started in early 1980. The above ground ounces being sold through the late nineties were very very cheap in historic terms. The ounces below ground were sold (hedged) at what seemed like a good price at the time. However by the time the ounces were to be finally extracted from the earth - this turned out to be below the ever moving cost of production - as some now extinct miners have found out since to their grief and demise.

Costs inflated… those ounces underground were not equal to above ground ounces which is one very strong reason I have so far not given into the almost expected commercial modern reporting benchmark of… ounces as Resources : shares on issue calculation . Big difference between the ounces in the ground of the producers, developers and explorers don't you think??? The difference in cost terms due to the time factor of when the ounces are extracted is substantial. That is not to say I will not finally succumb and provide such a calculation – I would prefer to devise a way of discerning between the various types of ore bodies and ounces in the ground.

Ounces are not just ounces if they are still in the ground . I certainly do not knock those who practice this calculation (sincere) - as a possible indicator because it can be viable in some instances ; problem is that it cannot be applied as a “blanket” rule. Some very intelligent and clever (there is a difference) clients have requested this of me and I have so far refused to do so because I do not see it as a viable way of understanding a company or resource as an isolated measurement. It helps to a degree but the picture can be highly clouded by such a calculation. Right now a big light should be going “flash flash flash” for a lot of less experienced resource speculators.

Sovereign risk ounces:

Then there are resources in the ground but happen to fall within unfriendly international borders that have little respect for project ownership. I make no value judgment here – “food for the masses” may be the case however not usually applied this way… more like “palaces for the despot” some of the time. There must be “fair reward” for all the risk input by the miners, venture capitalists and share holders - to find and delineate a resource and nobody should have the right to “move the goal posts” (change the rules) after this type of investment input but it happens. I fear that when gold gets really valuable this malpractice will get much worse in some parts of the world.

The professional view: of ounces

My colleague Colin Emery - who rates the leading ASX resource stocks on the Gold Oz spreadsheet product and writes the Gold Oz Newsletter; happens to agree with me. This is why he devised the more balanced star rating system as a general guide for our spreadsheet and not just based on ounces either. The highly accomplished professional investor like Colin thinks in terms of management, the nature of the resource (host ore style, grade + depth + scale + to put it in lay terms: the cost of extraction and processing), debt, hedging, sovereign risk, sector performance & outlook, P:E, EPS, project pipeline, age of plant and equipment… even down to fashion.

Yes stocks can be in and out of fashion too and then there is the “word on the street” that only professionals have access to + then there is also professional “gut feel” that comes from close association and decades of experience. When I refer to “word on the street” I do not mean inside information so let me be clear about this – it is about sentiment on the street from professional investors + the profession - and rumor which strongly affects cash flows into and out of stocks – often based on intangibles. Finally he balances all this against current price being paid in the market place for that stock.

Of course a deeper rating system is possible - to create wealth from the business of trading and investing in shares which is why we created the Newsletter with expertly deciphered technical analysis combined with fundamental understanding that can result in a reasonable degree of accuracy amongst this sea of complexity. Now Colin is an accomplished professional having traded for many international banks and having worked as a consultant for major mining houses too – risk minimization is also a factor amongst all the above, responsible investing. The other major factor is all about the individual investor's circumstances and risk profile and that is the job of a competent financial adviser - back to the subject.

More on inflation: the confusion of the masses

Inflation is an interesting subject, growth in money supply, cost push inflation, demand pull inflation, price inflation… no wonder most Politicians are completely lost on the subject. To make matters worst you get some economists taking sides between different theories and even worse the syllabus of many educational institutions have followed Keynes to the detriment of a potential balance on the subject.

To complicate the picture even more for Mr. Joe citizen; he has seen socks and shirts and other cheap manufactured goods fall in price (and quality so there is a ripe subject for debate), at the same time he is told his house going up in price is different – not inflation… Then you get the CPI linked to all sorts of social security payments and the parameters of calculation of that CPI change in order to accommodate budget concerns I suspect and to the detriment of the tax paying working masses and the poor under classes. Confusion and chaotic thinking are induced and perpetuated by these complicated views and ignorance. People suffer needlessly and the pain spreads through society like a cancer.

Summary: let us simplify

Enough of that – here is this stuff we call money and it is worth far less than it was and this is continuing to get worse and wages are stretched further and further because of inflation and now it has become so obvious except we are told “it” is “under control”. The heck it is – even the obviously self serving and cooperative Central Banks have lost control to some degree and gold is gradually telling us that. After all they cannot control where the money they pump into the system is actually invested. Not only is gold ringing the gong - so is the increasing volatility at the moment which has come off the lows of an unusually quiet phase. Well… all this is “quiet” is changing too.

Some facts about ounces: in ground ounces that is…

Back to my point now; ounces. So they are vastly different if they are paper… that is obviously not gold, the paper is as good as… well the trust and stability of the Parties and well… actually it is as good as the paper it is written on when or if it comes to a crunch. Paper is not gold and never will be even if the futures markets can temporarily be “the tail that wags the dog” by way of influence. The physical market has to regain the upper hand at some point due to rarity – you know basic supply and demand - reality.

And ounces are vastly different if they are underground because of the uncertainties of inflation and the cost of extraction. The following will be expanded on in a future article:

Now look at ore types - refractory ounces (lay terms – really hard and expensive to separate from the host ore, note there are some new technologies to be widely tested at scale) and sulphide deposit ounces (sulphide refers to chemical composition) and poly-metallic deposits (nice bonus credits from other metals = at times the difference between viability and failure) and vein swarms and ounces two miles underground or near surface. Then there are oxide deposits (free digging) and porphyry and etc each with different extraction characteristics which is why samples are taken for metallurgical tests.

These tests will indicate how much metal can be extracted and by which method and also give an indication of cost. When it comes to mining costs you have to consider economies of scale and operational costs… you find a nice shallow high grade deposit nowhere near a mining district so you have to build a town and roads and a mill right there so you have to ensure the size of the deposit is viable in any commodity price climate. It is really about the potential profit in each ounce and this depends on all of the above and more.

Take into account the grade, size and the nature of the ore that allows the long term operation to justify all that expense. There is much more to all this that I would love to cover here and it would require a book but given time much can be covered in these types of articles. I hope I have made my points; do not go for simplistic measures of mining stocks, get basic education about that which you invest in, adopt a holistic view of the entire picture and lastly get the “technicals” right for excellent timing via the art of charting so that your money grows. After all you can be right about a stock and still lose money because of timing.

Pulling the investment “trigger”

My last point is that if more investors understood how the world has changed and more about the mining business they would have the confidence to “pull the trigger” and invest in precious metals and the miners. If they understood fiat currencies and inflation they would buy physical gold and silver too, as fast and as much as they could. If and only if, your individual circumstances can allow some form of investment in this area, then it is a very good idea to find out more. At Gold Oz we are slowly building the education side of our site as a free service and we sell helpful products to pay our way. I write these articles to help spread the word about PM investment in general and to promote our wares.

We specialize as full time professionals – Colin is a professional consultant, author and broker, I create broad educational tools to aid investors in the ASX mining sector. I have developed a convenient time saving & broad snap shot view in thumbnail format to cover and classify about 280 PM stocks, another in the same PDF format to cover 60 uranium stocks. Then there are the deeper products, with our unique professional input in the spreadsheet - and lastly the Newsletter by Colin. We are still getting set to automate delivery of this service and luckily the investment world has not caught on as to how valuable, usable and accurate this product is - for we would get buried in the demand (manual delivery) and I have other work to do. See the About Us page at our site for the details of Colin's stellar career to date. We are running a top value introductory discount special on the Newsletter at this time and the response has been excellent – you still have time and details are on our web site at .


Good trading / investing.

By Neil Charnock

Copyright 2007 Neil Charnock. All Rights Reserved.
Neil has traded bullion, shares, options and futures for over 25 years as a private investor.  He has also worked with small business and real estate.  Also the Author of articles on global economics and resource investment, has been published on over 30 web sites and recently provided input for a book on Junior Miners in Australia.  Neil has been self employed in numerous businesses including consulting and organic waste management - corporate contract, has also been a founding Director on a number of occasions.  Now the founder of GoldOz, a full time occupation, and is assembling a distinguished team with impeccable professional credentials in order to provide data services and general independent investment advice products.

Neil Charnock is not a registered investment advisor. He is a 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 my current opinion only, further more conditions may cause my 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.

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