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Definitions may change, and governments may fiddle the figures, but inflation goes up regardless. A special report from Dominic Frisby and our U.K. affiliate MoneyWeek says it's time to buy commodities. Money Morning contributed to this report.
Unless your name is Rip Van Winkle, or you work in a drab, windowless office in Washington and prepare government budgets for a living, you will know that the price of virtually every commodity – be it animal, vegetable, or mineral – has risen dramatically since the turn of the century.
This boom has two key drivers. The most obvious is the huge rise in demand for raw materials, largely from the Far East, without a corresponding increase in supply. The other is less widely recognized – inflation.
How to "Inflate" Commodity Prices
If you inflate the supply of goods – that is, increase productivity – the price of those goods is going to fall. At the moment, 19 of the top 20 economies in the world have double-digit money-supply growth, with Putin's Russia in the pole position. Russia's money supply is growing at a whopping 43.7%, India's at 20.2%, China's at 17.1%, Australia's at 16.6%, and the United Kingdom slips in at 13.1%. The United States stopped reporting its M3 money-supply figures, deeming it too expensive a job. But John Williams at Shadowstats.com generously does it for free. He puts U.S. money-supply growth at 14%.
It doesn't matter whether you call this frightening phenomenon "money-supply growth," or plain old "inflation." It doesn't matter how many indices you reconfigure, or what kind of statistics you fudge to try and hide it. It doesn't matter how many [in truth, how few] folks really understand this problem, or how well you manage "inflation expectations." It's still there. And it will keep driving prices ever higher.
This "inflation tax," as U.S. libertarian politician Ron Paul calls it, erodes the value of your savings. Let's face it, even in these post-Northern Rock PLC (NRK) days, you certainly won't find a savings account yielding 14%.
The only winners in the inflation game are the long-term borrowers who have 10% of their wealth in gold and are hoping that it doesn't go up.
For that group, I have some bad news: Prices will continue to rise. Silver is still a whopping 80% off its all-time high of $50 an ounce. And despite gold's recent run-up, it is still cheap on an inflation-adjusted basis.
Nonetheless, the real time to buy is when these assets are cheap. After all, why wait until after the market has made its move?
The time to buy gold and silver, as in most years, was August. Since then, gold soared more than 20% and the HUI [the index of gold mining stocks] climbed a whopping 45% to reach its peak. Even though prices have backed off a bit, the market is still wildly overbought, and knocking on the door of short-term bubble territory [To read our recent report, "How to Profit From a Stock-Market Bubble," please click here. The report is free of charge]. Seasonally, October is not normally a good month for gold, though an October low can be a good month to buy gold. But we didn't get the usual October correction this year.
Will the correction come this month?
That's impossible to say. As noted, we saw a bit of a pullback in some commodity prices, such as gold and oil. But it's hardly enough to call it a "correction." And oil has already rebounded and resumed its march north, hitting an all-time record of more than $98 a barrel on the New York Mercantile Exchange [NYMEX] yesterday.
The cautious angel in me thinks we are going to get a pullback. This is based on no fundamentals whatsoever, which are all in favor of higher gold prices. It's just that the U.S. dollar is actually due for a bounce [financial assets rarely fall forever, and despite the travails of the U.S. market, the United States still has assets with tremendous value backing the greenback].
So what I'm saying is this: As far as gold goes, my predictions for gold prices are long-term higher, medium-term higher, short-term possibly lower, but don't count on it. [For a recent Money Morning investment research report on the interrupted advance in gold prices, "Breather or Bear Market? Gold Bulls Stumble in Trading Yesterday," please click here. The report is free of charge].
In this highly volatile – and highly uncertain – period, dollar-cost average, which as veteran investors such as yourself understand, means investing a set amount at regular, pre-determined intervals. The other piece of good news is that despite what gold and the major miners have done, the juniors are only just starting to get going.
Sell Your Gold at $1000?
The HUI index tends to have year-or-so periods of sideways consolidation before bursting to the upside. Each such burst seems to last six to nine months, with the HUI rising roughly 150%. We are about three months into this move and have been up as much as 40%. If past performance is anything to go by, we have at least another three or four months to go.
The world gold bullion price has been averaging about $810 an ounce this month, according to the Gold Field Mineral Services (GFMS) group, which projects prices will reach $850 an ounce by the end of the year, Purchasing.com reported yesterday. For what it's worth, I think we may see $1,000 gold by the spring, and $22 silver – possibly even $25. If we get that high by then, then sell, sell, sell.
Since August, as is fairly typical, we have seen a big move in gold and in the XAU [the index of the major gold miners], but the junior miners and silver have lagged. This frustrates many investors. There is nothing more annoying – except possibly congested traffic and unsolicited phone calls after 6 p.m. – than owning a quality junior that has barely budged in price, while gold rocketed more than 20% in the a three-month period.
What has happened before – and I see no reason why it can't happen again – is a psychological pattern that goes like this.
Many investors sit on the sidelines watching this move in gold [one reason why you should always keep a core position in the yellow metal]. They have been burned by gold's volatility before and are reluctant to get back in. Gold keeps rising but nobody "believes" the move is real. Finally, investors realize the move is real – and strong. They're now waiting for a pullback to get an entry, but it doesn't come. Meanwhile, those already taking profits start hunting for bargains. Before long, the smarter money "discovers" some quality junior producers – a much smaller market and therefore one that's much more volatile.
As I see this playing out, while this is happening with gold, investors also suddenly realize that silver has lagged its more-precious sibling, and so "smart money" starts flowing into silver, too. The bottom line: Gradually, the junior producers begin to move. And silver does, too.
What makes it exciting is when the trend-followers jump aboard, more money enters the market, and these stocks really set sail for the stratosphere. If that sounds a lot like a speculative mania, you're very observant. And just think about the vertical price ascents one sees during such periods in the market. Braver speculators then move from the juniors and into the actual metal explorers. These are the last to move, but they fly the highest. You can understand why, as now everyone's in the market.
The juniors, the explorers and silver will make much bigger moves than gold; they'll make those moves quicker, but later in the metal's bull-market run. When this phase comes, you have to make sure you are already positioned and, what's more, have a clear exit strategy in place. The market will eventually turn back the other way. And like a game of musical chairs, you don't want to be left standing and looking lost when the music stops playing.
Unless, that is, you are planning to just buy and hold for the duration of this bull market – a noble and highly effective strategy.
I believe this cycle that began in August will continue to move up until the spring. I believe many investors now "believe the move" and are "waiting for a pullback," while silver and the juniors look like they're starting to take off. In fact, one of the juniors I had been planning to tip, Capital Gold Corp. (CGLD), soared 75% in the two weeks before I wrote this, which is rather inconsiderate. It could have done the right thing and waited so that I looked like a prescient hero.
Playing Junior Mining Companies
If you aren't yet positioned in gold, and you fear you may have missed the move, fear not – all is not lost. There are plenty of junior mining companies that could erupt like Capital Gold – and others that could explode like Krakatoa, which is why care and careful research is warranted.
But before you decide to invest in junior mining companies, it's important to note a few rules:
- First, remember that juniors are extremely volatile. Don't chase them up. Be patient. Let the price come to you. If it doesn't, don't worry. There will always be another trade. And don't be scared to sell at a profit.
- Secondly, I only buy where I have met the management, or seen them present.
- And, third, I only ever buy when I like the chart set-up.
Let's take a look at some juniors with upside potential.
- Peak Gold Ltd. (PIK). Imagine a soccer team with Pele and Dalglish up front, Maradona on the left, Cruyff on the right, and Beckenbauer at the back. That's kind of what you've got with this management team: Frank Giustra, Ian Telfer, Julio Carvalho, Robert M.D. Cross, Gordon Keep and Pierre Lasonde. This is the nucleus of the side that brought you Wheaton River, Canada's eighth-largest gold producer. With producing mines bought from Goldcorp Inc. (GG), this is a buy at below 70 cents.
- Capital Gold Corp. (CGLD) made its first gold pour in the summer, then massively increased its reserves. This is a hugely underappreciated, well-managed, well-run Mexican-based miner with both exploration and takeover upside – which is producing at below $300 an ounce. Buy below 50 cents if you can, but it looks like it may already have broken out.
- Gold Resource Corp. (GORO). One of my favorite companies. The only problem is that it's not looking cheap. But it has great properties in Mexico that produce consistently good drilling results, and it could be moving into production by 2008. In short, it has loads of further upside potential, even without a move in the price of gold. Put it on your personal "watch list," and buy if it moves back below $3.50.
- Jinshan Gold Mines Inc. (TSE:JIN) is now moving into production in China. A buy at $3, or just above, if you can get it on a correction.
Let's also take a close look at some silver stocks to watch:
- Excellon Resources Inc. (CVE: EXN). This cleverly financed silver producer in Mexico is growing through exploration, and boasts highly innovative management. I like it. Unfortunately, it looks like it's broken out through long-term resistance at $1.50, meaning it's no longer cheap. Buy below $1.40, if you can, on a pullback.
- First Majestic Silver Corp. (CVE:FR). This is another silver producer-explorer from Mexico with Keith Neumeyer [who also founded African-based miner First Quantum Minerals Ltd.] in charge. Its share price has underperformed, and it is highly volatile, but the company also has lots of upside potential. Neumeyer is highly ambitious, and could transform this junior into a major. It's a buy below $4.00 – but not a good stock to hold if you suffer from heart trouble.
- Great Panther Resources Ltd. (TSE:GPR). Another Mexican silver play that has been sold down aggressively. I'm almost reluctant to recommend this stock, because it has so significantly underperformed, and is out of favor, to boot. But at $1.25 or below, it's got to be a buy.
- Aquiline (TSE:AQI). This group's Navidad project is one of the biggest undeveloped silver deposits in the world. Buy if it pulls back below $9.
- [For Money Morning's recent investment research report, "The Five Top Plays to Profit from the Gold Boom," which details the best opportunities in gold stocks, mutual funds and exchange-traded funds (ETFs) worldwide, please click here. The report is free of charge].
Dominic Frisby is a private investor who concentrates on junior mining and energy stocks. He also hosts the Internet radio show Commodity Watch Radio (www.commoditywatchradio.com). Money Morning staffers contributed to this report.
News and Related Story Links:
- Money Morning Investment Research Report:
Breather or Bear Market? Gold Bulls Stumble in Trading Yesterday.
- Money Morning Investment Research Report:
The Five Top Plays to Profit From the Global Gold Boom.
- Money Morning:
How to Profit From a Stock Market Bubble.
World Gold Prices Could Hit $850 by Year's End, GFMS Says.
Crude Oil Futures Rise Above $98 on Weaker Dollar.
Rip Van Winkle.
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