And why should they be? They’re sitting on the sidelines holding US treasuries worth $797 billion. That’s quite a chunk of change.

Of course I’m talking about China.

The Chinese have been the biggest foreign creditor to the United States and in recent statements they’ve made it clear that Washington needs to maintain the value of the dollar.

“We have made a huge amount of loans to the United States. Of course we are concerned about the safety of our assets. To be honest, I’m a little bit worried,” said Chinese Premier Wen Jiabao.

It’s estimated that around 50% of China’s total reserves are held in US treasuries. And they know that the reserve currency they hold is depreciated with each passing day.

With so much riding on the price of the dollar you can bet that Beijing has been keep a close tally on America’s spending — and the results can’t be pleasing.

To say the least, Chinese faith in the dollar is feigning.

And I’ll give you one guess as to where they are going to spend their $797 billion nest egg… Gold!

Right now China is 6th on the list of world gold holdings with around 1,000 tonnes of gold reserves. Not bad right?

Wrong.

When you look closer at the statistics you can see that China has a mere 1.9% of its total reserve holdings in gold. Compare that to the U.S. with 77% and you’ll start to see China’s future motivation.

China is in the market for a reserve currency that’s stable. And when it comes to stability nothing glitters like gold.

Need proof? Look no further than another developing world powerhouse… India.

Recently India made a bold move to start protecting itself from the U.S. dollar and fiat currencies in general…

News broke that India made a huge gold purchase from the IMF — somewhere in the neighborhood of 200 tonnes.

Previously, the government of India held 350 tonnes of gold reserves. This 200 tonne purchase is a 57% increase in India’s reserves. Now that’s what I call a stand against paper currency!

The Indian transaction may be the largest single central bank purchase of gold ever. The only comparable event was the U.S. government seizure of gold from circulation within the nation back in 1933, along with steady U.S. government purchases in the 1930s and 1940s.

I spoke with an acquaintance of mine who works in the “financial” side of the U.S. government — I cannot say what Cabinet department, but his office has a view of the White House. I asked why the IMF sold the gold to India, and not China.

My acquaintance replied, “It’s all about balance. India holds a lot of U.S. Treasuries and needs gold to diversify its assets. We can’t let all the IMF gold go to China and leave India in the dust. China is already building up its gold reserves due to being the No. 1 gold producer in the world and still a net importer. Besides, if the news hit the wires that China just bought all the IMF gold, it would crush the dollar. So the deal was that India could buy 200 tonnes.”

Put it all together and the global outlook for the U.S. dollar is dreadful. As time passes more countries will try to escape the depreciation of the dollar — and that leads them to one option for wealth preservation: gold.

Okay, so no one wants paper dollars and instead they want gold — that’s easy right?

Not so fast…

Approaching “Peak Gold”

Just like the “peak oil” phenomenon, we’re headed for “peak gold.” It’s all about how much gold is left unprocessed underground. The more we take out, the harder it is to find more. And the harder it is to get to.

For instance, miners used to pan for gold in streams. Today, just to get enough gold for a wedding band, you need to crush up to 20 tons of rock.

And remember, gold isn’t just for jewelry, coins, or bars of bullion. Gold goes into computers, cell phones, and satellites. It’s used in medical lasers, industrial lasers, and in spacecrafts. It plays a major role in medical research. It’s even used for treating some diseases.

According to the World Gold Council, the world mined 2,414 tonnes of gold in 2008 — 64 tonnes less than the year prior. It was even less gold than mined in 2006.

Meanwhile, the amount of gold used in jewelry and industry alone topped 2,186 tonnes — add that to demand for bars and coins (which has really been ramping up lately) and you’ll see that, by necessity, at least 425 tonnes had to come into the market — most likely by central banks out of their dwindling hoards, a practice that cannot continue indefinitely.

And that’s not even including industrial use or the demand from vastly popular gold investment holdings like ETFs!

In fact, when you get down to brass tacks, the supply outlook for gold is down right dismal.

Over the past 10 years large gold discoveries have been inexistent. The discoveries that are being made tend to be in more remote and less geopolitically attractive areas.

Tough new environmental laws and 20 years of low mining investment don’t help. But it’s really geology that’s conspiring against the miners most. Nobody can find the big gold deposits anymore. It looks like they’re all tapped out.

With gold prices up, they’re looking. More holes open up in the ground. More tons of rock go through the mills. But so far, the average quality of the gold they’re finding has gone down.

The low hanging fruit of the gold mining universe — the easy deposits and rich mines — have started to disappear. Gold’s already rare. But it’s getting more rare by the day.

This rarity is running into increasing demand. There isn’t a more fundamental argument for rising prices. And if the U.S. dollar continues to plummet there’ll be no stopping the yellow metal’s upward charge. Again, it’s economics at work. Gold is priced in dollars, so as the currency becomes less valuable, the metal naturally becomes more valuable.

You want to accumulate gold investments now, while prices are still relatively low. Sure, gold prices are at all-time highs, but they still have a long way to go…over $2,000…maybe as high as $3,000…or even $5,000!

Until we meet again,
Byron King
Whiskey & Gunpowder

October 1, 2010

More Reasons Gold Is Going to $2,000 was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Therefore, forward-looking investors might want to take advantage of the current weakness in the gold share market to invest in some of the small mining companies that would be attractive takeover targets.

One of the most intriguing aspects of the current market is the dearth of major discoveries so far in this cycle. This despite record amounts of money spent on exploration since this bull market began in 2001.

Older and smarter minds than mine had predicted that the soaring price of gold would produce a new wave of exploration that would, eventually, produce a new wave of major discoveries.

But so far, as Barrick Gold’s CEO, Peter Munk, recently observed, “There have been virtually no new discoveries.” Only Aurelian (ARU: TSX) has landed a legitimate “elephant” deposit bagged. Unfortunately, the carcass of that particular elephant rests entirely within the sketchy outlines of the nation of Ecuador where the locals are currently circling like a pack of hungry hyenas.

It has been our contention that what was needed to light the fuse on the junior exploration stocks would be, in no specific order:

1. Sustained higher gold prices.
2. Improving financials and free cash flow of the major producers.
3. A discovery to heat the blood of the investing community.

So far, we have had (1) and we are beginning to see (2), but (3) has proved remarkably elusive.

Now, don’t misunderstand. You can have a whopper of a bull market in these stocks without the discovery — that was the case in the 1970s bull market. But a discovery that fires the imagination can jump-start things in a big way, no question about it.

Too bad nobody has found one recently.

In short, we appear to have reached the era of Peak Gold. Whereas a major discovery used to be 10 million ounces or more, the threshold for attention-getting discoveries these days has fallen to more along the lines of 1-3 million ounces…and even those are hardly falling off the trees.

Viewed from the perspective of an investor in the junior resource sector, this lack of discoveries means the fuse is lit — starting with straight-up supply and demand fundamentals — for a rocket shot tomorrow. Adding boosters to the rocket, we have a commodities bull market that shows no sign of ending anytime soon and, while the U.S. dollar will periodically rebound, it is not going to somehow reinvent itself as sound money in our lifetime.

Importantly, as you can clearly read between the lines in Chairman Munk’s words, once the majors get cashed up and get serious about replacing their reserves, they are going to have to look downstream to the juniors with discoveries…even if those discoveries are below the five-million-ounce threshold they previously required to even consider taking an ore body into production.

Of course, lowering the threshold on deposit size will require trade-offs. For example, in order to be considered for an acquisition, a smaller deposit will almost certainly have to be near surface and open-pittable. It will also have to be near good infrastructure, and located in a jurisdiction with good laws and reasonable taxation. There is, in this situation, an opportunity and a risk.

Starting with the latter, if your portfolio now includes companies going after deposits in the one- to five-million-ounce range, you need to make sure they are not in a remote location that would require a massive infrastructure investment.

As for the opportunity, while the odds and the amount of exploration spending still favor that we’ll see the discovery of at least one and maybe two monster deposits in this cycle (there are a couple of companies advancing projects with that potential), and early shareholders will make fortunes as a result, there has rarely been a better time to invest in junior exploration companies with modestly sized projects in good locations. That said, you should still be focusing only on projects with at least two million ounces, or the strong potential of same.

In other words, take the opportunity in these down markets to invest in the kinds of junior mining companies that major mining company might want to acquire… That’s where the big money will be made as the gold market gathers steam again.

Regards,
David Galland, Casey Research
June 2, 2008

Peak Gold was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.