Our Current Credit Contraction
We are in the midst of a credit contraction. The great tradinginstitutions on Wall St have gone broke, changed their nature or mergedwith other firms. Banks everywhere are under examination as to whetherthey are sufficiently capitalized. Loans by financial institutions areall being examined to see their validity. There is talk of a double diprecession, and fear of a continuing economic Tsunami. Insurancecompanies are under examination to see if their investment lossesthreaten their ability to meet their obligations to their policyholders.We are in a credit contraction.
The Last Major Credit Contraction
The last major credit contraction occurred during the GreatDepression in 1929. During that time, gold miners (such as HomestakeMining) were among the few companies to reward its shareholders.Overseeing the current credit contraction, the striking similaritieshave to make the observer realize that similar sectors will again dowell, for the same reasons. Starting September 2008, gold once again hasstarted to outperform all commodities and assets.
Gold Mining Shares as an Investment
An examination of current factors indicates that that gold miningrepresents the best wealth creation opportunity over the next severalyears. In 1971, the price of gold was $35 per ounce. An investor couldhave bought gold bullion in 1971, and have a thirty-five fold return andcounting as of today. Yet despite the price of gold increasingthirty-five fold, gold mining itself has not generally been a productiveenterprise for investment. Why? Because the input costs (the cost oproduce an ounce of gold) increased faster than the price of gold,resulting in little margin for the industry as a whole.
Finally, a Fundamental Change in the Cost of Mining Gold
In September 2008 private credit growth peaked. Since then, the priceof gold has increased steadily, while the costs of mining gold havedecreased significantly. The real price of gold, as measured against allcommodities and assets, has increased. Today large cap miners haverobust 40%+ operating margins as they are benefiting from the increasein gold prices relative to the costs to mine gold. We are only two yearsinto a twenty year trend. It's not late; it's early to understand thissector and get into buying shares of companies in this sector.
Shares of Gold Miners are Cheap
Examination of shares of gold miners on the basis of price to netasset value or price to book value, shows that the miners as a whole arenot underpriced on traditional metrics. Gold mining today is a valuecreation play in which the macro variables, increased real price forgold and decreased input costs, have aligned and the sector is nowexperiencing a basic change in valuation. As the real price of goldincreases, mining profits will increase dramatically.
In recent years gold and gold miners have underperformed most otherasset classes, but. in late April 2010, there was a turn from relativeweakness to relative strength in gold and gold mining shares. Goldminers are the new leaders and have once again started to outperform allasset classes.
A Credit Contraction Creates an Increase in the Real Price of Gold
Whether we have deflation or inflation, we should remember history'srecord that in a credit contraction, the real price of gold increasesrelative to all commodities and assets. This increase in the real priceof gold and decrease in the price of mining it (including significantadvances in technology), results in increasing profit for gold miners.
Gold mining will be one of the few, if not only, sectors to enjoy this type of tailwind in the years ahead.
Of course, the road will continue to be volatile and laden with pitfalls, but the trend remains our friend.
Larry Cyna -
About the Author:
For more articles on investing visit his blog: https://cymorfund.com
Lawrence Cyna is an accomplished investor in the Canadian public marketsfor over 20 years, and has managed significant portfolios. He is afinancing specialist for private and public companies, and has expertisein real estate and debt obligations. He has assisted private companiesaccessing the public markets, has been a founding director of publiccompanies and continues as a strategic consultant to selected clientele.