How the precious metals markets are manipulated

This week in our musings, we bring you some slightly more unusual items that we have found interesting….

• Central Banks Buy Gold
• A master bullion trader sets the CFTC straight on manipulation
• Treasuries Riskier Than Toilet Paper!
• Fed-up Mainstream journalist starts web-site

Central Banks Buy Gold

From the Daily Bell comes this report….

Central banks around the world added 425.4 metric tons of gold to their reserves last year, the biggest increase since 1964, according to the World Gold Council. That represents a 1.4 percent gain to put their holdings at 30,116.9 tons in total. The increase was the first since 1988. Central banks in India, Russia and China were among those boosting their gold reserves last year, as the precious metal jumped 24 percent, hitting a record of $1,226 an ounce in December. Central banks now possess 18 percent of all gold ever mined. “There’s clearly been a renaissance of gold in central bankers’ minds,” Nick Moore, an analyst at Royal Bank of Scotland, told Bloomberg. “It’s not just been central banks taking on gold, but a general shift for physical gold in the investment sector.” Many are now singing gold’s praises, with the precious metal up about 3 percent so far this year. “Gold is quietly, at the edge, becoming the world’s second reserve currency, supplanting the euro and rivaling the dollar,” money manager Dennis Gartman wrote in his Gartman Letter, obtained by Bloomberg. “The trend shall continue months, if not years, into the future.” – MoneyNews 

Dominant Social Theme: Gold is good?

Free-Market Analysis: So now the West’s central banks are buying gold. They couldn’t sell enough of it when the yellow metal was priced around US$250 just about a decade ago. But now that it is well over US$1,000 they can’t buy enough. This alone should disabuse people of the notion that central bankers are wise and efficient utilizers of the vast money power that they have control over. Like the rest of us, central bankers sell low and buy high.

A Master Bullion Trader Sets the CFTC Straight on Manipulation in the Metals Markets

A good friend of mine in London, Andy Maguire, has traded the bullion market successfully for many years. He has been documenting the manipulation taking place in the metals market for quite some time now and has informed the CFTC along the way. This week on Thursday the CFTC held a seminal hearing to consider position limits, notice of which was the signal to Andy to step up his efforts. GATA have observed this and publicized it. It will be interesting to observe the outcome….. 

A London trader walks the CFTC through a silver manipulation in advance

Submitted by cpowell on Thu, 2010-03-25 23:41.

Additional Statement by Bill Murphy, Chairman
Gold Anti-Trust Action Committee

to the U.S. Commodity Futures Trading Commission
Washington, D.C., March 25, 2010

On March 23, 2010, GATA Director Adrian Douglas was contacted by a whistleblower by the name of Andrew Maguire. Maguire is a metals trader in London. He has been told first-hand by traders working for JPMorganChase that JPMorganChase manipulates the precious metals markets, and they have bragged to how they make money doing so.

In November 2009 Maguire contacted the CFTC enforcement division to report this criminal activity. He described in detail the way JPMorgan Chase signals to the market its intention to take down the precious metals. Traders recognize these signals and make money shorting the metals alongside JPM. Maguire explained how there are routine market manipulations at the time of option expiry, non-farm payroll data releases, and COMEX contract rollover, as well as ad-hoc events.

On February 3 Maguire gave two days’ warning by e-mail to Eliud Ramirez, a senior investigator for the CFTC’s Enforcement Division, that the precious metals would be attacked upon the release of the non-farm payroll data on February 5. On February 5, as market events played out exactly as predicted, further e-mails were sent to Ramirez while the manipulation was in progress.

It would not be possible to predict such a market move unless the market was manipulated.

In an e-mail on February 5 Maguire wrote: “It is common knowledge here in London among the metals traders that it is JPM’s intent to flush out and cover as many shorts as possible prior to any discussion in March about position limits. I feel sorry for all those not in this loop. A serious amount of money was made and lost today and in my opinion as a result of the CFTC’s allowing by your own definition an illegal concentrated and manipulative position to continue.”

Expiry of the COMEX April call options is tomorrow, March 26. There was large open interest in strikes from $1,100 to $1,150 in gold. As always happens month after month, HSBC and JPM sell short in large quantities to overwhelm all bids and make unsuspecting option holders lose their money. As predicted by GATA, the manipulation started on March 19, when gold was trading at $1,126. Last night it traded at $1,085.

This is how much the gold cartel fears the CFTC’s enforcement division. They thumb their noses at you because in more than a decade of complaints and 18 months of a silver market manipulation investigation nothing has been done to stop them. And this is why JPM’s cocky and arrogant traders in London are able to brag that they manipulate the market.

This is an outrage and we are making available to the press the e-mails from Maguire wherein he warns of a manipulative event.

Additionally Maguire informed us that he has tape recordings of his telephone communications with the CFTC, which GATA are taking the appropriate legal steps to acquire.

Bond Market Verdict: Treasuries Riskier Than Toilet Paper!

by Mike Larson of the Money and Markets blog

[Ed: I have respect for Mike Larson; he’s a key analyst at Weiss Research, and has his finger on the pulse of the bond and real estate markets. Emphasis below is ours.]

I have a lot of respect for Warren Buffett. As has been noted by many, he’s one of the world’s best long-term investors. He has a knack for buying low and selling high. And his Berkshire Hathaway holding company has been a great multi-year performer for investors.

It has amassed stakes in everything from the Geico insurance firm to the manufactured home company Clayton Homes to the Dairy Queen restaurant chain.

But Buffett can’t levy taxes on Americans. He can’t wage war in far corners of the world. He isn’t responsible for your Social Security checks. He doesn’t operate the National Park System or make sure the drugs we take are safe. That’s the job of the federal government.

And yet, a remarkable thing occurred recently in the bond market …

Berkshire’s cost of borrowing fell BELOW Uncle Sam’s! Ditto for Procter & Gamble, the company behind brands like Tide detergent and Charmin toilet paper … Lowe’s, the home improvement retailer … and Johnson & Johnson, the firm that makes Band-Aids, medical devices, and baby shampoo, according to Bloomberg.

Bottom line: Bond investors are now viewing Treasuries as riskier than a vast array of corporate debt. They’d rather own bonds backed by sales of toilet paper than the full faith and credit of the United States. If that’s not a sign of how low we’ve sunk, I don’t know what is!

[On the other hand, one might regard toilet paper as more important than a bloated government – Ed.] 

Fed-up Mainstream journalist starts new web-site

Paul Farrell has been writing for  Marketwatch for a long while, and thus might be considered as a mainstream journalist . However, he has started up his own website, http://wallstreetwarzone.com , I guess to better publicize what he sees as what we might term, to borrow a term from Max Keiser “Rigged Market Capitalism”. This website is carrying some definitely non-mainstream material, as we see below…..

“The Happy Conspiracy:” a Brief History of America’s “Shadow Government,” Quants, Behavioral Economists, Brainwashing, Propaganda, Nobel Prizes, Psych-Ops Warriors & a New “Science of Irrationality!”

by Paul B Farrell, JD, PhD

The average Main Street investor is at a distinct disadvantage … you are running a handicap race. If you’re one of America’s 95 million Main Street investors, the odds are better than 100:1 against beating the averages, thanks to the enormous firepower of Wall Street’s War Machine. And the gap’s widening, getting worse every day, now that Wall Street’s arming itself with the ultimate weapons of mass manipulation—behavioral finance, the psychology of investing, neuroeconomics, and the new science of irrationality.

On cable, in ads and sales pitches Wall Street pander to your ego with an outdated idea: You’re “the man,” a “rational investor!” Yes, you’re different, you can beat the averages, the indexes. But behind your back, they’re laughing at you, they know you’re irrational when it coming to investment decision-making. Moreover, they actually prefer a market filled with naïve, uninformed and irrational investors. That way, they can easily manipulate you—usually without you ever really knowing it. Oh, they’ll let you make modest gains, enough to keep you in line, to prevent a full-scale rebellion.

But the playing field’s not level and they’re backed by an elite force of a million experts in the financial industry—brokers, salesmen, advisers, analysts, talking heads, slick admen, slicker lobbyists—foot-soldiers and mercenaries armed with superior tools, advance data, huge monetary incentives, and the protection of friendly legislators and regulators, all calculated to feed the anxieties and addictions of American investors. But you already knew all this, right. Since the Buttonwood Agreement created the New York Stock Exchange back in 1792, Wall Street has always been able to control the markets and manipulate investors to its advantage. It’s been a long “one-way street” for a long time.

Happy Conspiracy’s powerful new “psych-ops” weapons

So what is new? Behavioral finance, the new science of irrationality, also known as neuroeconomics, behavioral economics, quant-trading and the psychology of investing. Wall Street has been rapidly adding these new “weapons-of-mass-manipulation” to their arsenal in recent years. With these new psychological weapons, Wall Street has refined “mind control” to a high art better than anything at the CIA and the Pentagon. Why? Wall Street wants to make it absolutely certain you don’t stand a chance against them…..

Read the full article here. 

Buying gold, what’s more important: Price per ounce or ounces owned?

How do you know when you have enough gold?  And should you just ignore the price you pay and simply count how many ounces you’ve accumulated instead?  Jeff Clark of Casey Research answers these important questions today.  He also touches on what form of gold you should buy….

By Jeff Clark, Casey’s Gold & Resource Report

In a recent conversation with a fellow gold analyst, he was emphatic that the price one pays for physical gold should be ignored. “What’s far more important,” he insisted, “is how many ounces I own in relation to the total value of my assets.”

Building a core position in gold bullion is a smart goal, to be sure, and a strategy Casey Research has been advising for years. However, ignoring the price you pay for gold could be seen as foolhardy; sure, it’s insurance, but isn’t price part of the consideration when you shop for insurance?

So, who’s right? 

The World Gold Council just released their 2009 annual report on gold trends. From the densely populated pages of interesting data, there’s one compelling tidbit I gleaned that may shed some light on the buying behavior of gold investors.

Overall investment in gold was 7% higher in 2009 than 2008. This is significant when you consider that demand in the fourth quarter of 2008 – during one of the worst financial meltdowns in history – was so great that shortages of physical metal abounded everywhere. And yet investors bought more gold in 2009 when investor fear about global financial uncertainty was subdued.

Further, 2009 total funds invested in all forms of gold exceeded 2008 by 20%, and the average price was 11.6% higher. In other words, investors were buying gold even though the price wasn’t necessarily “low.” To be sure, that’s a broad statement. But the fact remains that year-on-year, more gold was purchased at higher prices when the markets were less scary, than when the price was lower and Hank Paulson was on CNBC every 15 minutes pontificating on how to save America’s financial system.

This isn’t to suggest one shouldn’t pay attention to price. And the data doesn’t identify how many of those who purchased gold last year were first-time buyers, as certainly there were newcomers to the sector that contributed to higher demand.

But it begs the question, who would continue to buy gold when the price is higher?

Whoever doesn’t own enough, that’s who. The gold I bought last month was certainly higher priced than what I paid in 2008. But I’m trying to position my assets for protection from eventual dollar debasement and rising inflation. So perhaps focusing more on acquiring sufficient ounces to withstand a storm rather than stubbornly buying none, waiting for “cheaper” prices, however you define that, is a better mindset. Not owning enough gold is equivalent to holding a million-dollar mortgage and having a $10,000 life insurance policy. It won’t help much when you really need it.

Of course we should pay attention to price.

But the trick is not letting that distract you from buying what you need. You’re not buying gold bullion as a speculation (although we expect to make a bundle on our holdings), but as a sound form of cash in an environment where government has no respect for a balance sheet and sees inflation as the only way out of its black hole of debt. During periods of inflation, the government does fine; it’s the citizens that suffer from the lost purchasing power of their savings. It’s clear our currency is being debased. What’s your plan of defense?

For those diligently accumulating gold, how do you know when you have enough?

Check your anxiety quotient. If Ben continues printing money or Obama promises more goodies than he has the money to pay for, and you remain calm, then you likely have adequate gold. These are the investors who can afford to be stubborn about price as they build their holdings. In my opinion, this is where we all want to be.

What form of gold should you buy?

It depends on why you’re buying it. If you understand gold’s role in history, owning a physical form will come naturally to you. If you see the threat of inflation on the horizon, or you worry about what is being done to the dollar, you’ll own both coins and an ETF. If you’re worried about possible exchange controls someday, you’ll consider a Perth Mint Certificate. And the more gloomy your outlook about the global economy, the greater the percentage of all forms of gold you’ll buy.

That said, we maintain a bias toward physical ownership. GLD and other gold ETFs are fine and do offer protection. But the custodian isn’t going to airmail gold to you when you cash in your shares; having the “hard money” in your hand gives you the freedom an ETF cannot. In our book, owning physical gold, in the form of one-ounce coins, is where your first dollar should go.

I remember when my wife and I decided it was time to get life insurance. We just had our kids, and it was time to play grown-up. Given what 5,000 years of history has taught us about the value of gold, and given what’s happening at this moment in history to our currency, are you playing grown-up with your investments?

Is the current price of gold a good time to buy? Check out our four “clues” in the new issue of Casey’s Gold & Resource Report, risk-free here…

And for more detail on 8 different methods of buying gold, get access to our Gold Survival Guide ecourse here. 

Billionaires bet on higher gold prices

As usual in these weekly wanderings, we share some of our thoughts and those of some others that we have observed along the way…

The big guys – billionaires George Soros, Paul Tudor Jones, David Einhorn, John Paulson – are buying into gold and gold shares in a big way. When Soros, for example, buys USD75 million worth of an exploration company like NovaGold, it is a much bigger deal than if you or I buy a few shares. Firstly, this is a deliberate bet on much higher gold prices – NovaGold can only profitably develop a mine at these higher prices. Secondly, this is not a position that Soros can easily extract himself from – you simply can’t sell that quantity of shares in a hurry without driving the price down.  Thirdly, this activity on the part of Soros et al starts to generate wider interest in the precious metals sector in general among other fund managers.

We can take heart from this: those of us who are buying are no longer at the wacky fringe – we’re ahead of the game!

Quote of the day: from Bill Bonner of “The Daily Reckoning”…

“Professors Rogoff and Reinhart show that when external debt passes 73% of ‎GDP or 239% of exports, the result is default, hyperinflation, or both. IMF data ‎show the US already too far gone on both scores, with external debt at 96% of ‎GDP and 748% of exports.”

From Eric Sprott of Sprott Asset management comes this article in his regular series, Markets at a Glance. Eric looks back at our immediate financial past – the last two years in particular, and wonders why we don’t seem to learn any lessons from history.

It’s Déjà Voodoo Economics… All Over Again

By: Eric Sprott & David Franklin

If you’re of a certain age, chances are you remember exactly where you were when JFK was  assassinated. Similarly, if you’re from Canada or the United States and have an even remote interest  in hockey, it’s highly likely that you remember exactly where you were when ‘Sid the Kid’ scored the  winning overtime goal in the Olympic gold medal game. These were both “significant events”, albeit  for different reasons. We wonder, however, if any of you recall where you were on September 18th,  2008? Do you remember that day? We can’t seem to recall it either, which is strange, because it was  one of the most important days of the decade. October 7, 2008 is another day that should stick out  in our memories, but we’re sure you don’t remember that day either – and we’re in the same boat.  How is it, then, that we can’t recall where we were or what we were doing on the two days the entire  financial system almost collapsed?!? It boggles our mind. These dates should have been emphasized  in every “review of the decade” written at the end of 2009, but we’ve been hard pressed to find them  mentioned in any mainstream publication. This is troubling to us, and makes us wonder if people are  even aware of the incredible events that took place on those fateful days only eighteen months ago.

The financial industry often prides itself on the hindsight principle. We may not predict the future  with great accuracy, but when things fall apart we’re very quick to explain why and how it happened  with authoritative aplomb. “Hindsight is 20/20″, as they say. But is it really? Despite our seemingly  thorough analysis of past failures, the financial industry seems to have an uncanny ability to make  the same mistakes over and over again. Perhaps this is due to the fact that we don’t properly review  events passed. Our obsession with predicting future results impels them away into oblivion. The fact  remains that a cursory look back on the last decade reveals an apparent cycle of asset bubbles that  all grew and burst before our eyes, with little effort made to actually address the underlying causes  that made them possible. We have written at length about the next asset bubble now forming in  government debt and currency. Looking back on the last decade from 2000 to 2009, are there any  lessons that can provide some guidance for the next decade? And are there any lessons that can  be gleaned from September 18th and October 7th, 2008, when we almost lost the entire financial  system? We certainly hope there are.

The seeds of the financial mess we are currently experiencing began in the mid-to-late nineties.  As we approached year 2000, the widespread belief developed that new technology would rewrite  economic rules. The euphoric years between 1995 and 2000 blew the first asset bubble of the 21st  century in the technology-heavy NASDAQ Index. Alan Greenspan first uttered his now famous  “irrational exuberance” warning in December 1996 when describing stock valuations at the time.¹ It  wasn’t until mid-1999, however, that the U.S. Federal Reserve actually increased interest rates in an  attempt to quell the overheated stock market. The Fed actually raised rates six times between June  1999 and January 2000 in an attempt to cool an already overheated economy. The dot-com euphoria  burst on March 10, 2000, when the NASDAQ peaked at 5,132, representing more than double its  value from only a year before. We were watching the bubble closely at the time, and wrote on March  9th 2000, “In the next few months, if not weeks, we anticipate that the Nasdaq will capitulate to market  liquidity. Valuations are screaming at us! Excessive speculation is running rampant! DON’T BE A  PART OF IT!!!” It was a timely recommendation.

In many ways, the NASDAQ bubble was somewhat conventional in that it was born out of over- enthusiasm for the prospects of new technology. The fact that the Federal Reserve actually tried to  cool the bubble down, however feebly, in the years before its peak, is really what differentiates it from  the bubbles that followed. The NASDAQ collapse is well understood now, ‘in hindsight’. This collapse  compelled Alan Greenspan and the Federal Reserve to embark on the largest rate cuts in US history  in an effort to soften its impact. The inability to face the economic pain of the market crash ultimately  set the stage for the second bubble of the decade, this time in housing. The key point to emphasize  here is that the Federal Reserve lowered interest rates thirteen times between January 3, 2001 and  June 25, 2003 in order to cushion the economy. These rate cuts allowed for increasingly easy access  to credit on a worldwide scale. It didn’t take long for the second bubble to develop, and it wasn’t hard  to see the warning signs. Even The Economist magazine noticed, stating on June 16, 2005, that “the  worldwide rise in house prices is the biggest bubble in history.”² Home prices rose at an annualized  rate of more than 11% from 2000 to the peak on July 31, 2006 -more than doubling in that time  period.³ The financial sector became the US economy’s central economic driver, generating up to  41% of all corporate profits and making it the fastest growing sector of the economy.⁴ In July 2005,  Greenspan described certain real estate markets as “frothy” and recommended that the Federal  Reserve rein in lending standards.⁵ We wrote in response at the time that “(Alan Greenspan) should  be careful what he wishes for… it may come true. It’s like throwing stones in glass houses. It may  all end with the Federal Reserve having to bail out the financial system, as it did with the savings  and loan crisis a decade ago.” We now know what transpired in the years to follow – we’ve all lived  through it, and it ended with the biggest bailout in financial history.

So what’s the point, you ask? In hindsight, it’s very safe to argue that the Fed probably shouldn’t  have lowered rates thirteen times between January 3, 2001 and June 25, 2003. It proved to be an  extremely damaging policy. Artificially low rates created a lending mania of enormous proportions  which dragged consumers along for a debt-fueled buying orgy. In our January 2008 commentary,  aptly entitled “Welcome to the 2008 Meltdown”, we opined that “There are meltdowns occurring  everywhere: commercial real estate… car loans…credit cards. It was all a massive Ponzi scheme  sustained by overleverage. Because this has been one of the most egregious bubbles ever, its impact  is likely to linger longer than anyone expects. This is more than just a market failure. It’s a systemic  meltdown.” And it was. But the meltdown happened so fast that it never seemed to burn into our  collective memory. Everyone remembers that we went into a severe recession in late 2008, but do  they know the details of what actually transpired? A quick review is needed to appreciate how close  we really came to a full shutdown.

It was the Lehman Brothers bankruptcy on Sept. 15th that set everything in motion. Most market  participants will remember that date - Bank of America bought Merrill Lynch the very same day, so  it was certainly memorable. What many people fail to appreciate, however, is the mayhem that took  place during the following days in the US money markets. The day after Lehman’s collapse, the  Reserve Fund, one of the oldest and most high profile US money market funds, began to hemorrhage  money as investors redeemed in panic. Large institutional investors soon began pulling money out  of other major US money market funds fearing heavy losses from Lehman Brothers debt. Almost  $173 billion was pulled from such funds over the next two days, threatening to collapse the entire  US financial system.⁶ Two weeks later, on Sept. 29th, investors sent the Dow Jones plummeting 778  points, representing the largest single-day loss in the history of the index. In hindsight, it was somewhat  of a delayed response, because the real damage had by then been averted by the Treasury’s blanket  guarantees on all money market funds.

The fact remains that on Thursday, September 18th, the US financial system almost completely  collapsed. The details of that day remain frustratingly murky. The imminence of complete disorder  seemed to scare Congress into action, but we can only piece the story together through random  anecdotes that have been partially revealed through subsequent interviews. In what has been dubbed  ‘the Kanjorski meme’, Congressman Paul Kanjorski recounts a meeting that was held between Ben  Bernanke, Henry Paulson and certain members of Congress where the conception of the “Troubled  Asset Relief Program” (TARP) supposedly took place. To stem the flow of money out of US-based  money market funds, Paulson had to provide an almost instant guarantee on all money market funds  held within the US. Kanjorski recounts, “If they had not done that, their estimation was that by 2pm that  afternoon (September 18th), $5.5 trillion would have been drawn out of the money market system of  the United States, [which] would have collapsed the entire economy of the United States, and within  24 hours the world economy would have collapsed. We talked at that time about what would happen  if that happened. It would have been the end of our economic system and our political system as  we know it.”⁷ Further details of these meetings have been provided by Senator James Inhofe, who  recounted that Paulson had warned of martial law and civil unrest if the TARP bill failed.⁸ It is interesting  to note that while Henry Paulson mentions several meetings that took place on September 19th in his  book, the discussion of ‘imminent financial collapse’ and ‘martial law’ was noticeably absent.

The official record of the events of September 18th, 2008 comes from a research report issued by  the Joint Economic Committee. The reports states, “On Thursday September 18, 2008, institutional  money managers sought to redeem another $500 billion, but Secretary Paulson intervened directly  with these managers to dissuade them from demanding redemptions. Nevertheless, investors still  redeemed another $105 billion. If the federal government were not to act decisively to check this  incipient panic, the results for the entire U.S. economy would be disastrous.”⁹ Between the official  record and the statements by members of congress and the senate, we can piece together an almost  system-wide collapse that was potentially hours away.

The second fateful date to remember was October 7, 2008, when the UK almost collapsed. Bank  of England Governor, Mervyn King, describes the situation: “Two of our major banks which had had  difficulty in obtaining funding could raise money only for one week then only for one day, and then on  that Monday and Tuesday it was not possible even for those two banks really to be confident they could  get to the end of the day.”¹⁰ This was the justification given for the Bank of England to provide secret loans of £61.6 billion to The Royal Bank of Scotland and HBOS to maintain solvency.¹¹ Amazingly,  news of these loans was never revealed until November 24, 2009, more than one year later. Recalling  that fateful day, David Soanes, Managing Director of UBS Bank, and part of the group assembled  to assist with the UK government’s crisis response, stated, “We only really knew by probably about  seven o’clock at night (October 7, 2008), that we, that everyone was going to get through to the next  day.”¹² These revelations raise new questions about the true scope of bailouts undertaken by the  major governments at the time. Lord Myners, the UK Financial Services Secretary, alluded to similar  covert banking operations conducted by the European Central Bank and the US Federal Reserve.13  We have no idea what he is referring to, but we would certainly be interested to learn more.

This type of activity by the leaders of our financial system certainly helps to explain why those two dates  are not more ingrained in our collective memory – strong efforts were obviously made to hide their  severity. The fact that these details were left out of Henry Paulson’s memoirs strikes us as astounding.  It also seems incredible that the best we can do to understand those fateful days is to cobble together  comments made after the fact. It serves to be reminded that the events of September and October  2008 had previously been considered unthinkable, and we must never forget that the ‘unthinkable’ can  happen again. A complete banking collapse would not be pleasant – and it’s certainly not an experience  we would ever wish upon ourselves, but it must be remembered that WE ALMOST WENT THERE.

So where does this leave us for the decade ahead? In bad fiscal shape. It seems as if we’re just  making the same mistakes over again, and on a far larger scale. We have passed the debt obligations  of the financial system onto the governments. We have liquefied the system beyond any rational  explanation, more than doubling the monetary base since the collapse of Lehman Brothers. Social  Security, which was in balance in year 2000, is now underfunded by $15 trillion dollars. Total unfunded  obligations of the US Government are now $104 trillion. If we add the $6 trillion of outstanding Fannie  Mae and Freddie Mac debt and the $12 trillion of outstanding national debt, we arrive at a total US  government debt obligation of $122 trillion. It’s a truly preposterous amount of money that will never  be paid off in today’s dollars. As we wrote in our October 2009 article entitled “Dead Government  Walking”, the US Government is on a trajectory to default on their obligations, and the same can  realistically be said for the UK and Japan. The answer put forward by the US, UK and Japanese  governments? Quantitative Easing and 0% interest rates. Have they learned nothing from the past  decade?!

As our readers know, the flagship funds at Sprott have been managed with the view that we entered a  long-term secular bear market in year 2000. We have never detracted from this view, and it remains in  place today. We will not be bears forever, because the cycle will eventually reverse, but a new secular  bull market will not, and cannot, emerge until the world solves its debt problems. Our overarching  macro view is strongly influenced by the Kondratieff Cycles. The ‘winter season’ began in the year  2000 and continues to this day. We have watched this cycle unfold, and have noted the Kondratieff  Theory’s eery ability to predict the debt defaults and banking collapses that we witnessed over the  past two years. Our analysis suggests that we are only half way through this Kondratieff winter, with  another approximate ten years remaining. They will undoubtedly be an interesting ten years, and it  should come as no surprise to our readers that gold is considered the ultimate asset class to own  during the ‘winter cycle’. It has certainly served us well up to now.

A review of the last decade would not be complete without our predictions for the next ten years.  Rather than bore you with prognostications, we would like to leave you with some titles we are  considering for future editions of Markets at a Glance:

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1. The Federal Reserve Board. Remarks by Chairman Alan Greenspan (December 5, 1996). The Challenge of Central Banking in a Democratic Society. Retrieved on March 10, 2009 from: http://www.federalreserve.gov/boarddocs/speeches/1996/19961205.htm

2. The Economist. (July 16, 2005) In Come the Waves. Retrieved from: http://www.economist.com/opinion/displaystory.cfm?story_id=4079027.

3. Bloomberg, S&P/Case –Shiller Composite – 20 Home Price Index Not Seasonally Adjusted

4. Johnson, Simon (May 2009) The Quiet Coup. The Atlantic. Retrieved on March 10, 2010 from: http://www.theatlantic.com/magazine/archive/2009/05/the-quiet-coup/7364/

5. Andrews, Edmund (May 21, 2005) Greenspan is Concerned About ‘Froth’ in Housing. The New York Times. Retrieved on March 10, 2010 from: http://www.nytimes.com/2005/05/21/business/21fed.html?_r=2&oref=slogin

6. Henriques, Diana (September 19, 2008) Treasury to Guarantee Money Market Funds. The New York Times. Retrieved on March 10, 2010 from: http://www.nytimes.com/2008/09/20/business/20moneys.html?em

7. Kanjorski, Paul (January 28, 2009) Kanjorski: We came so close to complete financial collapse. Pocono Record. Retrieved on March 10, 2010 from: http://www.poconorecord.com/apps/pbcs.dll/article?AID=/20090128/NEWS04/901280302

8. CNN iReport (November 20, 2008). Paulson Was Behind Bailout Martial Law Threat. Retrieved on March 10, 2010 from: http://www.ireport.com/docs/DOC-150837

9. United States Congress, Joint Economic Committee Research Report #110-25 (September 2008) Financial Meltdown and Policy Response. Retrieved on March 10,
2010 from: http://www.house.gov/jec/Research%20Reports/2008/rr110-25.pdf

10. BBC (September 24, 2009) Mervyn King and other key players reveal true extent of financial crisis one year on . Retrieved on March 10, 2010 from: http://www.bbc.co.uk/pressoffice/pressreleases/stories/2009/09_september/24/money.shtml

11. Conway, Edmund and Monaghan, Angela (November 24, 2009) Bank of England tells of secret £62bn loan to save RBS and HBOS. Telegraph. Retrieved on March 10, 2010 from: http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/6646923/Bank-of-England-tells-of-secret62bn-loan-to-save-RBS-and-HBOS.html

12. BBC (September 24, 2009) Mervyn King and other key players reveal true extent of financial crisis one year on. Retrieved on March 10, 2010 from: http://www.bbc.co.uk/pressoffice/pressreleases/stories/2009/09_september/24/money.shtml

13. BBC (November 25, 2009) Alistair Darling defends secret loans to RBS and HBOS. Retrieved on March 10, 2010 from: http://news.bbc.co.uk/2/hi/business/8378087.stm

Lastly, from veteran journalist Gretchen Morgenson comes this timely report on the misuse of derivatives across the USA. Greece is a harbinger of what is to come…

The Swaps That Swallowed Your Town

By GRETCHEN MORGENSON

AS more details surface about how derivatives helped Greece and perhaps other countries mask their debt loads, let’s not forget that the wonders of these complex products aren’t on display only overseas. Across our very own country, municipalities, school districts, sewer systems and other tax-exempt debt issuers are ensnared in the derivatives mess.

Like the credit default swaps that hid Greece’s obligations, the instruments weighing on our municipalities were brought to us by the creative minds of Wall Street. The rocket scientists crafting the products got backup from swap advisers, a group of conflicted promoters who consulted municipalities and other issuers. Both of these camps peddled swaps as a way for tax-exempt debt issuers to reduce their financing costs.

Now, however, the promised benefits of these swaps have mutated into enormous, and sometimes smothering, expenses. Making matters worse, issuers who want out of the arrangements — swap contracts typically run for 30 years — must pay up in order to escape.

That’s right. Issuers are essentially paying twice for flawed deals that bestowed great riches on the bankers and advisers who sold them. Taxpayers should be outraged, but to be angry you have to be informed — and few taxpayers may even know that the complicated arrangements exist.

Here’s how municipal swaps worked (in theory): Say an issuer needed to raise money and prevailing rates for fixed-rate debt were 5 percent. A swap allowed issuers to reduce the interest rate they paid on their debt to, say, 4.5 percent, while still paying what was effectively a fixed rate.

Nothing wrong with that, right?

Sales presentations for these instruments, no surprise, accentuated the positives in them. “Derivative products are unique in the history of financial innovation,” gushed a pitch from Citigroup in November 2007 about a deal entered into by the Florida Keys Aqueduct Authority. Another selling point: “Swaps have become widely accepted by the rating agencies as an appropriate financial tool.” And, the presentation said, they can be easily unwound (for a fee, of course).

But these arrangements were riddled with risks, as issuers are finding out. The swaps were structured to generate a stream of income to the issuer — like your hometown — that was tethered to a variable interest rate. Variable rates can rise or fall wildly if economic circumstances change. Banks that executed the swaps received fixed payments from the issuers.

The contracts, however, assumed that economic and financial circumstances would be relatively stable and that interest rates used in the deals would stay in a narrow range. The exact opposite occurred: the financial system went into a tailspin two years ago, and rates plummeted. The auction-rate securities market, used by issuers to set their interest payments to bondholders, froze up. As a result, these rates rose.

For municipalities, that meant they were stuck with contracts that forced them to pay out a much higher interest rate than they were receiving in return. Sure, the rate plunge was unforeseen, but it was not an impossibility. And the impact of such a possible decline was rarely highlighted in sales presentations, municipal experts say.

Another aspect to these swaps’ designs made them especially ill-suited for municipal issuers. Almost all tax-exempt debt is structured so that after 10 years, it can be called or retired by the city, school district or highway authority that floated it. But by locking in the swap for 30 years, the municipality or school district is essentially giving up the option to call its debt and issue lower-cost bonds, without penalty, if interest rates have declined.

Imagine a homeowner who has a mortgage allowing her to refinance without a penalty if interest rates drop, as many do. Then she inexplicably agrees to give up that opportunity and not be compensated for doing so. Well, some towns did exactly that when they signed derivatives contracts that locked them in for 30 years.

Then there are the counterparty risks associated with municipal swaps. If the banks in the midst of these deals falter, the municipality is at peril, because getting out of a contract with a failed bank is also costly. For example, closing out swaps in which Lehman Brothers was the counterparty cost various New York State debt issuers $12 million, according to state filings.

Termination fees also kick in when a municipal issuer wants out of its swap agreement. They can be significant.

New York State provides a good example. An Oct. 30, 2009, filing describing its swaps shows that for the most recent fiscal year, April 2008 to March 2009, the state paid $103 million to terminate roughly $2 billion worth of swaps — more than a quarter of which resulted from the Lehman bankruptcy in September 2008.

(You can find this report online at bit.ly/cS8ZFV.)

As of Nov. 30, 2009, New York had $3.74 billion worth of swaps outstanding. Even so, New York doesn’t have as much of a problem with swaps as other jurisdictions. Still, New York could have spent that $103 million on many other things that the state needs.

The prime example, of course, of a swap-imperiled issuer is Jefferson County, Ala. Its swaps were supposed to lower the county’s costs, but instead they wound up increasing its indebtedness. Groaning under a $3 billion debt load, the county is facing the possibility of bankruptcy.

Critics of swaps hope that increased taxpayer awareness of these souring deals will force municipalities to think twice. “When municipalities enter into these swaps they end up paying more and receiving much less,” said Andy Kalotay, an expert in fixed income.

Why is that? One reason, Mr. Kalotay said, is the use of swap advisers.

“The basic problem is the swap adviser gets paid only if there is a transaction — an unbelievable conflict of interest,” he said. “It’s the adviser who is supposed to protect you, but the swap adviser has a vested interest in seeing something happen.”

WHAT is especially maddening to many in the municipal securities market is that issuers are now relying on the same investment banks that put them into swaps-embedded debt to restructure their obligations. According to those who travel this world, issuers are afraid to upset their relationships with their bankers and are not holding them accountable for placing them in these costly trades.

“We need transparency where Wall Street discloses not only the risks but also calculates the potential costs associated with those risks,” said Joseph Fichera, chief executive at Saber Partners, an advisory firm. “If you just ask issuers to disclose, even in a footnote, the maximum possible loss or gain from the swap they probably wouldn’t do it. And if they did that, then investors and taxpayers would know what the risks are, in plain English.”

Mr. Fichera is right. At this intersection of two huge and extremely opaque arenas — the municipal debt market and derivatives trading — sunlight is sorely needed.

 

Will the US devalue the Dollar?

Will the US inflate its way out of it’s debt problem or will it devalue the dollar?  Darryl Schoon explains the subtle differences of these two outcomes in this guest article.  We heard Darryl speak very eloquently last year (see our previous take on his lecture: China and the introduction of paper money) and his thoughts are worth following especially given his background as a Chinese American and his study of Chinese history.  Links to his website and Blog are at the end of the article…

The ability to wage war on credit gave the West an insurmountable advantage over the East. The West’s credit, however, has now turned to debt and the West has lost its advantage. But the return to parity will not be easy.

The three hundred year economic expansion fueled by debt-based capital markets is coming to an end and with it, the hegemony of the West over the East. During that period, debt-based paper money propelled first England then the US to world dominion because of the ability to wage war on credit and to print money ad infinitum.

That era is now ending because the critical balance between credit-driven expansion and debt-driven contraction has now shifted significantly in favor of the latter; and in 2010, both East and West now find themselves on the edge of a growing deflationary sinkhole created by the sequential collapse of two large US bubbles, the dot.com and US real estate bubbles.

The US caused the 1930s deflationary depression and is again cause of the current contraction; and although similarities exist between the two, the differences between them insure a far more consequential outcome today than in the 1930s.

Global demand is again falling as credit contracts, a sign that debt-driven deflation is back but, today, there is an additional danger as well. Since 1971, because of the US default on its gold obligations, money no longer possesses intrinsic value and the consequences will soon become apparent. Deflationary depressions and a collapse in the value of fiat money have happened before but never simultaneously. Soon, they will.

We are in what Stephen Roach, Chairman of Morgan Stanley Asia, calls the end-game, the resolution of past monetary excesses and imbalances, excesses and imbalances that reached never-before-seen heights in the last decade. The long awaited day of reckoning has arrived.

THE PROBLEM

Capitalism cannot function unless its constantly compounding debt is serviced and/or paid down. Today, the US, the world’s largest debtor, can no longer pay what it owes except by rolling its debt forward and borrowing more, what the late economist Hyman Minsky called ponzi-financing, financing common in the final stages of mature capital systems.

The amount of outstanding US debt has now reached levels that can never be paid off:

… the United States government and its agencies have, by far, the largest pile-up of interest-bearing debts ($15.6 trillion), the largest accumulation of unsecured obligations (over $60 trillion), the largest yearly deficit ($1.6 trillion), and the greatest indebtedness to the rest of the world ($4.8 trillion).

Martin D. Weiss, www.moneyandmarkets.com    

The unpayable levels of US debt are not just the problem of the US. Because the US dollar is the lynchpin of today’s fiat money system, US debt is everyone’s problem. The US dollar is the world reserve currency and a default by the US will have far-reaching consequences, especially in China, its largest creditor.

INFLATE, DEVALUE AND TAX

Bill Gross, co-founder of PIMCO, the world’s largest bond fund and an expert in matters of debt, wrote in 2006, the way a reserve currency nation [such as the US] gets out from under the burden of excessive liabilities is to inflate, devalue, and tax.

Inflation destroys the value/cost of liabilities by eroding the value of money. Debts are paid back with inflated currencies, a process which benefits the debtor and injures the creditor. This is why reserve currency nations usually inflate their way out of debt by printing what they owe.

Devaluation is another option afforded reserve currency nations. By devaluing the value of their currency, the value of what they owe falls relative to other currencies. Again, the benefit is to the debtor at the expense of the creditor.

Taxation is another option but is no longer available to the US, as its liabilities are now too high. It would be like forcing the elderly and morbidly obese to engage in strenuous exercise to regain youth. Of the three, inflating away debt is by far the preferred option but it is one the US can no longer choose.

Managing Director and Chief US Economist at Morgan Stanley, Richard Berner, recently discussed the reasons in We Can’t Inflate Our Way Out, February 24, 2010. http://www.morganstanley.com/views/gef/index.html#anchor6647bf63-2073-11df-978b-bbc960980e46

It’s tempting to think that the US can inflate its way out of its fiscal problems.  A faster, sustained increase in prices would erode the real value of past debt, and higher future inflation would - other things equal - reduce the real resources needed to service and pay back the promises we are making today.

However, inflating away US debt won’t work because as Richard Berner points out nearly half of federal outlays are [now] linked to inflation, meaning that increments to debt would [also] rise with inflation.

Inducing monetary inflation would also raise aggregate US debt resulting in a self-defeating cycle of higher prices and higher debt. However, there is also another more fundamental reason why inflating away US debt won’t work, to wit: Inflation is almost impossible to induce during severe deflationary contractions.

Fed Chairman Ben Bernanke understands this difficulty quite well. Bernanke’s late mentor, Milton Friedman, theorized the Great Depression could have been prevented by sufficient monetary stimulus and so in 2008, faced with the possibility of another deflationary depression, Bernanke put Friedman’s theory to the test. It failed.

 

http://jutiagroup.com/2010/01/27/looking-over-into-the-abyss/

 

Unfortunately, when tested, Friedman’s theory didn’t work. Despite Bernanke’s massive monetary expansion, global credit is still contracting and lending is drying up.

The Telegraph UK reported on February 17, 2010:  lending has fallen by over $100bn (£63.8bn) since January, plummeting at an annual rate of 16%.  “Since the credit crisis began, $740bn of bank credit has evaporated. This is a record 10% decline,” he [analyst David Rosenberg of Gluskin Sheff] said. The article continues: The M3 broad money supply – watched by monetarists as a leading indicator of trouble a year ahead – has been contracting at a rate of 5.6% over the last three months. http://www.telegraph.co.uk/finance/economics/7259323/US-bank-lending-falls-at-fastest-rate-in-history.html

Inflating away debt is virtually impossible in the presence of deflation, but if US monetary expansion is sufficiently large, it could result in the hyperinflation of the US money supply, which would destroy both US debt and the US economy as well.

DEVALUING THE US DOLLAR

Devaluation is the US’ only remaining option. But, on February 25^th, Comstock Partners’ special report, The Cycle of Deflation, Impediments to Debt Relief, pointed out the major impediment to a US devaluation to reduce debt—China.

…there is a stumbling block to the normal competitive devaluations that typically take place. In the past, a country that incurred too much debt just did what they could to devalue their currency in order to export their way out of the dilemma by exporting their goods and services to their trading partners. ..[But]The Chinese have linked their currency to ours, so as we debase our currency, one of our major trading partner’s currency is also declining and China becomes the major beneficiary of the debasement of our dollar.http://www.comstockfunds.com

 

The China peg to the US dollar thus prevents the US from altering its trade deficit by currency devaluation, but it does not prevent the US from devaluing the dollar for other reasons. If the US does devalue the dollar, it will not be to reduce debt—it will be to maintain its advantage over the world in general and China in particular.

YESTERDAY JAPAN TODAY CHINA

In 1985, when Japan was challenging the US for economic dominance the Japanese economy was in danger of overheating and Japan signaled the US its intent to raise interest rates.

The US responded by threatening Japan with trade sanctions, cutting off Japan from US markets. During the 1980s, the US badly needed Japanese savings to fuel Reagan’s multi-trillion dollar debt-based military buildup; and if Japanese rates were raised, Japanese savings would stay at home.

Threats of US trade sanctions forced Japan to keep interest rates low but at a perhaps fatal cost to Japan. Low interest rates combined with inflows of burgeoning trade profits ignited a speculative frenzy in stocks causing the then largest stock market bubble in history; and when the bubble collapsed in 1990, Japan fell into a deflationary trap from which it has never fully emerged.

Today, US dominance is again being challenged, this time by China. While it is not possible to know what the US will do, it is naïve to believe the US will do nothing; but whatever happens, US debt and the US dollar will be affected.

China has now significantly reduced its buying of US debt leaving the US with growing deficits and a virtual boycott by China of new US IOUs. This will impact future US/China relations.

The tentative but mutual benefits of the past are being replaced by self-interest as US spending and consequent debt is increasingly perceived as being out of control by China. That perception is correct. Since the 1980s, America’s focus has been on borrowing more, not spending less and the implications are clear.

 

U.S. government borrowing, percentage of outstanding U.S. Treasuries owned by China (2002-2009) – Sources: US Treasury, Haver Analytics, New York Times

With China moving away from increasingly risky US debt, the US is now far more likely to treat China as a challenger than as a needed creditor; and, while devaluing the US dollar would have minimal impact on overall US debt, it would have a significant impact on China.

In December 2009, total foreign holdings of US government debt equaled $3.29 trillion. With total US obligations now close to $100 trillion, a 30 % devaluation of the US dollar would impact only that debt held by foreigners—but the losses to China would significant

China currently owns at least $1.7 billion in US dollar denominated securities; and, if the US devalued the dollar by 30 %, China’s losses on its investments would be in excess of $500 million.

As stated earlier, it is not possible to know what the US will do. But since WWII geopolitical considerations have always outweighed economic factors in US policy decisions and there is little reason to expect this to change—even as the end-game approaches.

THE END GAME AND SOVEREIGN DEFAULT

The US is trapped. Caught between rising expenditures and the need to borrow more, outstanding US debt is incapable of ever being repaid and should the credit rating of the US ever reflect its actual state, sovereign default, not devaluation would be the result.

In 2008, Kenneth Rogoff and Carmen Reinhart in This Time Is Different: A Panoramic View of Eight Centuries of Financial Crisis reviewed the history of sovereign defaults concluding the then dearth of defaults was in actuality a warning of more to come. They were right.

Then, Rogoff and Reinhart mistakenly described the US as a “default virgin”, belonging to a small group of nations that had never defaulted. But on February 26^th Rogoff said that the US had, in fact, defaulted during the Great Depression by changing the price of gold from $20 to $35 per ounce.

While technically a default, the US action was actually a currency devaluation. The real default occurred in 1973 when the US officially reneged on its gold obligations under Bretton-Woods, leaving other nations holding US paper dollars that could no longer be converted to gold.

Professor Antal Fekete noted the significance of that default when he wrote in 2008, Thirty-five years ago gold, symbol of permanence, was chased out from the Monetary Garden of Eden, replaced by the floating irredeemable dollar as the pillar of the international monetary system. That’s right: a floating pillar. The gold demonetization exercise was a farce. It was designed as a fig leaf to cover up the ugly default of the U.S. government on its gold-redeemable sight obligations to foreigners. The word ‘default’ itself was put under taboo even though it punctured big holes in the balance sheet of every central bank of the world, as its dollar-denominated assets sank in value in terms of anything but the dollar itself.

As the end-game progresses it is impossible to know what the US will do. It is likely the US doesn’t know itself. What the US does know is that it is now trapped by increasing levels of mounting debt from which there is no easy exit.

NO EXIT

What if – to put it simply – you couldn’t get out of a debt crisis by creating more debt?

Bill Gross, PIMCO, March 2010

 

 

The question, What if you couldn’t get out of a debt crisis by creating more debt? will, in fact, be answered in some way by Mr. Gross himself. As Managing Director of PIMCO, the world’s largest bond fund, Mr. Gross is in the business of buying debt and betting on the outcome, an avocation that increasingly resembles Russian roulette.

Spreads on sovereign debt are rising and credit default swaps reflect the higher premiums being charged to protect against default. Investors such as Mr. Gross compare risk to reward in regards to debt and when the reward is believed to compensate for the risk, the bond is bought and the bet is placed.

As we enter the end-game, the odds, as in Russian roulette, exponentially increase making previous yield curves irrelevant. The trigger event may be Greece, Spain, the UK, the US, Latvia, Japan or some other nation. But, one thing is certain, when someone takes a bullet, all bets will be off. No one can cover what can’t be covered.

THE END GAME AND HUNGARY

Professor Antal E. Fekete grew up in Hungary during the most virulent period of hyperinflation in the world. Perhaps the experience made the good professor more sensitive than most about the possibility of its reoccurrence in America but he is not alone in believing so.

The possibility of a US hyperinflation was raised by Professor Laurance Kotlikoff in the July/August 2006 Review, published by the St. Louis Federal Reserve Bank: …The United States has experienced high rates of inflation in the past and appears to be running the same type of fiscal policies that engendered hyperinflations in 20 countries over the past century.

Since Professor Kotlikoff wrote those words, US monetary expansion has far exceeded what preceded it; and, what follows may be more predictable than we want to know.

 

 

From March 25-29, in Szombathely, Hungary, Professor Fekete will present a seminar on the unfolding financial crisis. Mr. Sandeep Jaitly, along with Professor Fekete will discuss how the basis can be used to predict movements in the price of gold and silver.

Mr. Jaitly is the publisher of The ‘Gold Basis Service’ a monthly subscription newsletter that describes movements in the basis and co-basis along with predictions for the coming month for gold and silver, proceeds will benefit the Gold Standard Institute. For details, see http://bullionbasis.com/index.php?p=1_3_Gold-Basis-Service.

I will also be in attendance and will speak on capitalism’s journey to the East and its mixed reception. The end-game is in progress and I have found few more knowledgeable about its origins and progress than Professor Fekete.

To enroll, contact GSUL@t-online.hu. Those who attend will receive a complementary 6 month subscription to Moving Through The Maelstrom with my monthly commentary and daily news updates, see http://www.drschoon.com/members/join/view_membership_options.asp.

I have always believed the financial crisis to be part of a far greater shift involving more than money and power, although both will be affected. Yin and yang, the universal polarities, are rebalancing.

The return to parity will not be easy.

Buy gold, buy silver, have faith.

Darryl Robert Schoon

www.survivethecrisis.com

www.drschoon.com

Blog www.posdev.net/pdn/index.php?option=com_myblog&blogger=drs&Itemid=81

What’s a Company’s Gold Worth?

Interested in buying shares in gold mining companies but don’t know what they’re worth and how much to pay for them?  This article from Casey Research will give you an introduction to how to value a gold miner or explorer’s gold resources…

 

Louis James & Andrey Dashkov, Casey’s International Speculator

At any given time, there’s a single international spot price for an ounce of refined gold. Gold is priced in U.S. dollars: $1,076.50 per ounce as we go to press. But what about the gold an exploration or mining company has in the ground – how do we value that?Given sufficient data, you can estimate a reasonable net present value (NPV) for a project and deduce what each of the company’s ounces should be worth. To do this, you need to know annual output of the proposed mine, proposed capital expenditures, energy and other costs, and many more things. For most deposits held by the junior companies we tend to follow, there’s just not enough data available.

Another approach is to compare the value the market is giving a company per ounce of gold in hand against the average value the market gives companies with similar ounces.

The most obvious way to define “similar” ounces in the ground is to use the three resource and two mining reserve categories defined by Canada’s National Instrument NI43-101 regulations – the industry standard. We combine these into three broad groups, as we believe the market tends to do as well:

• Inferred: the lowest-confidence category, based on just enough drilling to outline the mineralization. 
• Measured & Indicated (M&I): these higher-confidence categories have been drilled enough to establish their geometry and continuity reasonably well. 
• Proven & Probable (P&P): These are bankable mining reserves – basically Measure and Indicated resources with established value. 

So, what does the market give a company, on average, for an Inferred ounce of gold? M&I? P&P?

To answer this, we combed through every company listed on the Toronto Stock Exchange (TSX) and the TSX Venture Exchange (TSX-V) and pulled out the ones with 43-101-compliant gold resource estimates (or mostly gold) – no silver, copper, etc. Of these, we kept only those with resources that fall almost entirely into only one of our three broad groups: Inferred, M&I, and P&P. In other words, we did not include companies with half Inferred and half M&I resources (though we did include companies with mostly P&P reserves, because most are producers – or soon will be – and are regarded that way). That left us with about 90 companies to calculate some averages on.

That’s not a large sampling universe, and we had to make some judgment calls when it came to defining what companies should fall in each category, but it’s what we have. So take these averages with a large grain of rock salt, but here they are:

• US$20 per ounce Inferred 
• US$30 per ounce for M&I 
• US$160 per ounce for P&P 

Armed with this information, if you didn’t know anything else about an M&I resource (political risk, type of ore, etc.), but you saw that the company that owned it was trading at $10 per ounce, whereas its peers are valued at around $30 an ounce, you can conclude that there must either be something very wrong with the project or the stock is a great speculation. If there’s nothing wrong with the project, there’s an implied growth potential in the stock price, based on the difference between what the company is getting per ounce and the market average for similar ounces. In this case, it would be:

$20 x # Ounces ÷ # shares.

As a matter of perspective, a few years ago the market was giving a company about $25 per ounce Inferred, $50 for M&I, and about $100 for P&P. Then, when gold ran up over $1,000 before the crash of 2008, these valuations went out the window, and some companies were getting over $100 for merely Inferred ounces – do we have your attention now?

Conversely, just after the crash, there were companies having a hard time getting $10 for M&I. That was clearly a sign that it was time to buy, and we did, with gusto.

It’s also why, when the Mania phase gets underway, we’ll be selling into it as gold approaches the top; we will not be attempting to time the top. It’s far better in this business to be a day early than a day late.

Today, the market is willing to pay more for advanced and producing stories ($160 P&P) but is discounting earlier-stage stories, hence the lower M&I valuation than in previous years ($30). These figures will change again as the market’s appetite for risk changes.

Now let’s compare these numbers to those of a few sample gold companies. This table includes the market capitalizations (share price x # shares) of our sample gold companies expressed in USD (because that’s what gold is priced in), not the usual CAD. The second column has the value of each company’s resources, as per the average numbers given above (i.e., [# Inf. ounces x $20] + [# M&I ounces x $30] +[# P&P ounces x $160]). The implied growth is a simple ratio of these two numbers, expressed as a percentage.

	MCap (US$M)	Value of Gold Underground (US$M)	Implied Growth (%)
Luiri Gold (LGL.V)	18.6	17.44	-6.2%
Gabriel Resources (GBU.T)	1,420.5	2,230.13	57.0%
Coral Gold Resources (CLH.V)	16.3	68.0	317.2%

Gabriel and Coral Gold look pretty cheap, Luiri slightly expensive, but in most cases there are good reasons for this. For example, these averages by confidence category ignore the typically greater cost of extracting gold from low-grade sulfide ore, as compared to high-grade oxide ore. 

We don’t follow the companies in the table above — they are just examples — but here’s our take on their implied growth ratios: 

LGL: Luiri’s flagship Luiri Hill project, located in Zambia’s Central Province, has only 800,000 ounces in total resource, 82% of which fall within the least reliable Inferred category.  

Although the current resource estimate is based on lower-grade material, the company’s gold looks fairly valued. However, LGL is working to define more high-grade areas of mineralization both within and outside the resource boundaries, and not without success. For example, drilling from the Matala deposit, lying in the heart of Luiri Hill, has delivered high-grade intercepts from the central shallow zones, like the recently published 21.1 g/t Au over 5.6 m (starting from 56 m), including 41.1 g/t Au over 2.8 m (starting from 56 m of the same hole #114). 

Conclusion: The company looks a bit expensive at the moment, probably because the market sees Luiri’s upside potential coming from the new high-grade ounces being added in forthcoming resource estimates. If the marker were underestimating how much gold Luiri might be adding, it could still be a good speculation, but you’d have to be pretty sure of your calculations projecting that greater value to be added soon. 

GBU: Gabriel Resources appears undervalued when using average ounce prices, plus there is a lot of upside outlined in the economic study on the company’s Rosia Montana project in Romania, released last March. The study suggests excellent project economics, including low cash cost (US$335/oz), after-tax NPV of almost 1 billion USD at 5% discount, and after-tax IRR of 20.4%, all at an uber-conservative US$750/oz base case gold price.  

However, the company was sued by environmentalists in September 2007 and suffered regulatory setbacks. GBU shares tanked, and this is why the company’s gold is still selling at a discount; there is high political risk. Gabriel’s share price has soared recently on words of support from the government officials, but it’s still perceived – rightly – as high-risk. If Rosia Montana gets permitted to go into production, GBU shares should make very rapid gains.
Conclusion: The government of Romania has made supportive noises about Rosia Montana before, to no avail, and the company doesn’t appear screamingly cheap right now, so the risk-to-reward ratio looks too high to us.

CLH: The company is focused on the Robertson project located on the Cortez Trend in Nevada. Coral Gold has recently revised the project’s resource estimate at $850/oz gold (which looks fairly conservative, given the recent price action) to 3.4 million ounces, all Inferred. Our guidelines suggest that these ounces should be worth about US$68 million. Mind you, this gold is contained within what CLH believes to be well-known Carlin-type mineralization in a mining-friendly jurisdiction. Why does the market value these ounces way cheaper then? 

We think it’s a metallurgy issue. Lacking sufficient metallurgical data from all Robertson targets, CLH used numbers from a deposit called 39A to stand in for the whole project. The problem is that 39A is one of the deeper Robertson deposits, and large-scale heap leach operation, the preferred scenario for Robertson, showed high strip ratio, which would probably result in high capital expenditures and operating costs.
Conclusion: Robertson ounces are cheap due to valid concerns over the project’s economics. If the company can fix these problems, its resources could be revalued upward dramatically. 

Bottom Line

We often get asked what an Inferred, or M&I, or P&P ounce is worth in the ground. The $20, $30, and $160 figures are only rough guides, and you must consider the reasons why some ounces are given more or less by the market, but they’re a good starting point. 

What makes Casey’s International Speculator so different from other investment newsletters? You don’t just get stock picks, you get an education… and before you know it, you’ll be recognized as the mining expert in your social circle. And most likely as “the wealthy guy” as well. For more on how Canadian junior mining stocks can literally make fortunes for smart investors, click here.