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Barbaric Relic

Aphorisms, short pithy observations containing general truths, abound for gold. 1st Baron Keynes of Tilton referred to it as a barbarous relic.

That it may be, but nearly 100 years on from his tract on monetary reform, the principal investor appeal of gold is, in all circumstances, its proven enduring store of value – weighed against Keynesian economics, which shaped much modern economic and political theory, and influenced government fiscal policies.

The father of ‘’creative destruction’’ in economics, Joseph Schumpeter, reckoned the modern mind disliked gold because it blurted out the unpleasant truths. Schumpeter’s relationships with the ideas of other economists were quite complex. This modern day Austrian pants man was a fervent believer of cycles and Kondratiev’s ideas on 50-year wave and chart formations.

Gold purists analyse chart formations. Cycles vary in time, short and long term. And these can come together in a tight time frame by coincidence. Specific events like the inverse correlation between short term real interest rates and gold, or global geo political instability fears, shifts investor’s perception between buying and selling. Of all global commodities, gold is perhaps the most closely scrutinised on price and volume – chartist’s calls generally lead the price. It is a pure market – every day, it trades in the world’s bazaars, souks and markets, as well as on sophisticated electronic exchanges like Comex.

Quoting demand supply fundamentals like industrial production use is but a tiny part of the gold story. It is not about a balance between normal economic forces but about perception – value, a place to park money, against a backdrop of global economic and political uncertainties. Jewellery and consumer demand for gold bullion already represent more than half of the supply of gold annually and could increase their share as the rising middle class of India and China clamour for more gold. But speculative bubbles  can develop or collapse with lightning  speed, as  happened in matter of days earlier this year when the price collapsed to around $1200 an – with staggering consequences for a global industry. The investment commentariat called final time for gold with targets of a $1,000 an oz, and less. It had been lower than this before so why not this time around? The price collapse did slow down production at many high cost production mines. Profit margins overnight became wafer thin and many Australian producers are skating on thin financial ice. Witness the debacle that is now Newcrest. Or the joy in the Saracen share price, one of the few Australian producers to have a large gold hedge book.  The share price, in fact, of many junior gold producers and explorers is now an option on the gold price and some actually trade at a discount to their gold value.

The force unleashed was when Exchange Traded Funds (ETF) suffered a sudden vulnerable gold sentiment change. ETF’s allow investors in buy/sell the underling commodity, without physically owing the commodity. The ETF will hedge price movements by then, either buying or selling the appropriate commodity/ equity for the investor’s performance correlation. For the gold market ETF’s were financial weapons of mass destruction, as the gold price went down by the lift, breaching technical chart support levels, the price turned inwards, feeding upon itself.

Having thudded into the basement and remained there, gold’s chart cycles are showing possible tentative recovery signs – 200 day and shorter moving averages look constructive. It is early days but a speculative buy on cheap Australian gold counters is definitely worth the risk.  As hedge fund manager George Soros says, the worse the situation becomes, the less it takes to turn it around and the bigger the upside.

What has changed in the past few months is that inflation risks are on the rise as the Federal Reserve Board and other central banks seem prepared to pay the price of higher inflation, way beyond the name of achieving full employment targets. The Fed will not begin to taper until unemployment in America drops well under 7%. Cheap money will mean US interest rates, kept artificially low, will engineer a recovery and drive up demand and prices. As some point rates will need to rise sharply, close the gap and try to contain inflation. Gold could rally back to $1600 in such a scenario.

The short term however, will be volatile. And here lies the trading opportunity.

Stocks like Silver Lake around 74 cents look to us to be good value.  A six month price target is around $1.30. The company has raised just $50 million of capital to retire debt and add to working capital to strengthen the balance sheet. It has targeted high grade pod gold production, in an effort to combat relatively high production costs of around $1100 an oz and announced record quarterly gold sales. Reserves stand at about 1.7 million ozs. The current share price is trading below NTA – so the market is assigning a value only to current and not future production.  Over the next couple of years we expect the stocks P/E multiple to come down to around 8-9 times.

A couple of smaller speculative stocks which we also like are Ramekins Resources (RMS) currently around 16 cents. It has no corporate debt, strong cash flow potential, and has just raised $5million in capital at 20 cents with well-known gold investor, Sprott Asset Management. Ramelius has just acquired the Vivien Gold Project and has a revised mine plan for 2013-14 production at Mt Magnet of 90,000 ozs.

Also take a look at Chesser Resources (CHZ) an emerging Turkish gold producer which announced a 52% increase in its JORC resource at Kestanelik to 703,000 ozs – 65% of the total mineral resource lies within 50 metres of the surface at 2.54g/t of gold.  Average life of mine costs estimated at $US 550 an oz.

For the final world on investing in gold producers, please call either Chris or myself. And remember our Kimber Capital axiom of trying to avoid investment lobster pots in smaller speculative stocks!

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