When North Americans wake up to the dangers of relying on China and Russia for essential metals like zinc, rare earths, antimony, niobium and scandium, the juniors now suffering with anemic stock prices could turn into cash producing machines worth writing home to mom about.
In this frank assessment of everything from gold and diamonds to potash and zinc, Kaiser Research Online author John Kaiser names for The Mining Report readers the companies that could be swept up in a rush to security of supply.
The Mining Report: John, what are the global issues you are watching that could have an impact on commodities, particularly gold?
John Kaiser: There is a risk that the economic growth slowdown already underway can deteriorate further, precipitating major general market declines and causing demand for raw materials to flag. This would worsen the current situation where the supply response from the bull period of the past decade is already, in most cases, exceeding demand and, therefore, resulting in a further glut to depress prices and hurt companies involved in both development and mining of raw materials. At the same time, the subdued global growth outlook is creating domestic stresses that in turn are translating into geopolitical conflicts, which have me thinking about security of supply risks should globalized trade come unglued.
TMR: What effect does political instability in Russia and the Middle East have on gold prices today? History would suggest that uncertainty would drive prices up but that doesn't seem to be the case right now.
JK: A major market correction and evidence that the world is sliding back into recession would be negative and push gold down toward that $1,000/ounce ($1,000/oz) level. Many projects are not viable even at the current $1,200/oz level. This would certainly harm the valuations for producers and the near producers.
On the other hand, even if we avoid a global economic downturn, we are still vulnerable to geopolitical disruptions such as Russia's gradual annexation of Ukraine and its increasingly precarious relationships with Europe spinning out of control and creating some serious supply issues in the gas, oil and nickel sectors. In the Middle East we are witnessing a regional power struggle between the Sunni and Shiite branches of Islam with America's ally, the Saudi monarchy, as potential roadkill. If Obama is unable to bring Iran out of its pariah status and establish a balance of power between Sunni and Shiite, we could see major oil supply disruption.
Meanwhile, China continues to assert its dominance in its neighborhood, as seen by the creation of man-made islands within the Spratly Island chain in the prospective oil rich South China Sea. This expansion of China's footprint is largely at the expense of American influence in that part of the world. That could be geopolitically destabilizing if the U.S. attempts to push back.
TMR: But wouldn't that hurt the dollar and, therefore, be good for gold?
JK: China pushing against the U.S. would have the perverse effect of boosting the dollar higher because the U.S. is still the biggest economy and the military superpower controls the world's shipping lanes. It can function as an island unto itself, especially if it forges a closer relationship with South America. In fact, its attempts to end the cold war with Cuba are part of this initiative. I would say that cases of this sort of instability would cause the dollar to rise and gold to go up. The main hope for a gold uptrend that is beneficial to gold developers and producers because it is not just a reflection of a declining U.S. dollar or global inflation is geopolitical uncertainty. Bad news for gold would be a scenario where the world peacefully sags into a depression.
TMR: You have talked about gold as a store of energy. What does that mean?
JK: I point that out in reference to people who call gold money. Money is an information system, which keeps track of credits and debits. It allows an economy to go beyond the barter system by enabling the exchange of goods and services extended through space and time. Gold has in the past served as a guarantor of the integrity of money, but that is not the same as money, which is an information system whose underlying cost should be as low as possible.
Gold requires a fair amount of energy and time to bring it out of the ground into concentrated form. In that sense, gold is a form of stored energy that cannot be unleashed to produce work in any other form. If you wanted more gold aboveground to back the expansion of economic turnover, you would have to invest energy.
Unfortunately, the energy required to bring incremental gold out of the ground is rising as we deplete the low-hanging fruit at the surface of the earth. That, by the way, is a key problem with the gold sector in general. We are now producing 89 million ounces (89 Moz) annually, the highest ever in history, and the price to bring this gold out of the ground is also at an all-time high.
Gold makes sense as an asset class because it is a reservoir of expended energy, and the ability to "make" more gold today requires a higher input of energy per unit gold than ever before. The existence and size of an abstract information system such as money should not be linked to the cost of energy.