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The Challenge of Diminishing Natural Resources

Commodities / Resources Investing May 13, 2009 - 04:01 AM GMT

By: The_Gold_Report

Commodities

Best Financial Markets Analysis ArticleOnce upon a time, Byron King shunned writing letters to the editor. He was afraid that one might actually appear in print. That sounds like the stuff of fairy tales when you’re talking about someone with as prolific a pen (or keyboard) as Byron. A one-time field historian on the staff of the U.S. Chief of Naval Operations, he has a gift for putting current events into an historical context. Byron King’s credits include writing for Agora Financial’s Daily Reckoning and its Energy and Scarcity Investor newsletter (editor) as well as Whiskey and Gunpowder (contributing editor for this “independent investor’s daily guide to gold, commodities, profits and freedom”).


In this exclusive interview with The Gold Report, he talks about the dollar being today’s “barbarous relic” – whereas back in 1924 that’s how John Maynard Keynes described the gold standard. He talks about the two generations’ worth of “chronic underinvestment in productive assets,” wondering how in the world more than six billion people—all working to achieve a higher standard of living than their ancestors—are meant to manage on a planet whose resources are dwindling.

The Gold Report: Among other things you do, you edit Agora Financial’s Energy & Scarcity newsletter. How do you define scarcity?

Byron King: I look at scarcity in the classic sense of shortages, of not enough to go around. When you look historically at how the world developed, growing from a population of one billion, two billion, three billion and on up, 90% of the people were on the outs and maybe 10% were on the in. The Western world—North America, Europe, Japan and parts of the rest of the world—had access to plenty of resources, whether it’s mineral resources; energy resources; water, fresh water; food, what-have-you. That is where the whole economics and the whole history of the commodity cycles came from. That’s the history that you look at.

We’re living in a world now with over 6½ billion people of whom 1 billion or so are at or approaching a middle-class or better standard of living. Of those other 6 billion people, many, many of them have a complete and accurate understanding of what a better life and a better existence means for them. When 4 billion to 6 billion people are competing for that oil or the mineral resources—the copper, the nickel, the iron ore, the food that you can grow on the arable land, the fresh water, the fish in the sea—you can deplete your resources a lot faster than in the good old days.

So the commodity cycles of old I think are interesting historical examples and that’s what we have to work with, but the commodity cycle that we’re living in now and that’s coming down the track very rapidly is going to be quite different, and we have to really think “outside the box.” That’s where the scarcity concept is coming from. That when people say it’s different this time, well, it’s a couple of billion people different this time than it was 30 or 50 years ago.

Also, in the last year or so, we have the utter breakdown of much of the world financial system. Large swaths of the old investment paradigm have just gone away. They’re broken; they’re shattered. In the olden days, when you had a development of $2 billion or $4 billion, you could raise financing. Can you do that today? Maybe some of the really, really big guys can do a $4 billion development, open that mine, open that industrial system, do that energy development. But it’s much more difficult now than it ever was.

TGR: Is the financing issue systemic? Or is it a temporary issue that will resolve itself over a period of five years or so?

BK: That’s a really great question. We are facing a systemic problem that quite literally gets back to a dollar-and-cents issue. I think we are coming to the end of the post-World War II dollar hegemony system. After 60 or 70 years, wherever you want to start the number, we’re finally coming to a spot where the world is going to move away from the dollar as the world reserve currency.

TGR: But will that happen in our lifetime?

BK: It could that could happen within the next five years. I actually think that it could happen sooner than that. And I think it could happen so suddenly that we would all go to bed one night and wake up the next morning to find the world changed while we slept because something bad happened to the dollar. I’m not saying that it’s all gloom-and-doom. I am saying that the dollar is in trouble, and the remedies coming out of Washington and the Federal Reserve are the conventional remedies, and the wrong remedies. They might prolong the agony but they aren’t going to make this patient well.

So when people say that the gold standard is a barbarous relic, I say that is a snotty, Western, American, Economics 101 approach to viewing gold. You don’t understand what is going on in the rest of the world if you see gold that way.

TGR: Could you elaborate on that?

BK: Look at the dollar from other perspectives in the world. The Chinese think the dollar is the barbarous relic right now. They’ve just gone over a thousand tons of gold reserves for the Chinese Central Bank. They accumulated that gold reserve very quietly, without a lot of fanfare, over the last six years or so. They’ve bumped up their gold reserves by 75%. You might think, “Gee, six years, it’s 2009. Let’s subtract six, what was happening in 2003?” The Chinese are smart people; they read. They get their Sun Tzu with their mother’s milk. In 2003 they looked at the United States invading Iraq and said, “Sun Tzu says wars take a lot of silver and wars can destroy a nation if you spend all your money on them.” They see the United States spending a lot of money invading the Middle East and marching into what they call the “Tomb of Empires.” That’s a Chinese term for a place like Afghanistan or wars in the Middle East.

I think that in 2003 the Chinese said to themselves, “The United States is dooming itself; they’re going to wreck their economy fighting a war in the Middle East. We had better begin to build up our gold reserves so that when something happens at least we’re ready on the other side.” So they bought the gold as a commodity through the State Administration of Foreign Exchange Office, the SAFE office. But just within the last month they transferred ownership from the SAFE to the Chinese Central Bank. In a sense they took a commodity—they bought the gold like it was copper or oil or nickel or zirconium—and stockpiled it. And then with the stroke of a pen they transferred ownership to their Central Bank. All of a sudden, they have monetized their gold.

TGR: Could the world be on the gold standard again?

BK: Oh, I could see that very easily, yes. I think it could take less than a decade to go back to a gold standard. Just as Richard Nixon closed the gold window with one speech on August 15, 1971, within a very, very short amount of time we could find the dollar moving away from its capacity as the international exchange medium. I can’t tell you exactly how it’s going to work because I don’t have tomorrow’s newspaper. But I can tell you that people who don’t own physical gold could wake up one morning and find out that all the money they thought they had in the bank is going to be worth maybe 1% or 5% of what they thought it would be.

TGR: One of your newsletters suggested that if you don’t own physical gold and silver to go get it now. You say 5% to 10% of a portfolio in gold and silver. Given what you’ve just outlined, that seems a low percentage.

BK: Well, I think I always qualify it by saying 5% to 10% is the official recommendation, more if it helps you sleep better at night. I think everybody— everybody—should have some gold. That’s absolutely not the way it is right now. What percentage of American people own physical gold, and I don’t mean your wedding ring or your necklace or your earrings. I mean how many Americans really own a gold coin, even one? It is an exceedingly small percentage, probably less than 1% of people own any at all, let alone having a safe deposit box at the bank filled with gold coins. I think everybody ought to do it, just the way I think everybody who drives a car ought to have automobile insurance.

TGR: It sounds as if you’re suggesting that people own the physical gold more as an insurance policy, as opposed to a wealth-creating investment based on the belief that a gold coin you buy for $900 today is going to be worth $2,000 at some point.

BK: I don’t want to over-promise. Here’s the way I’d look at it. You don’t wait until you smell smoke in your house to call the insurance agent and buy fire insurance. You don’t wait until the roof’s on fire and say, “Oh my goodness, I guess I better get some insurance.” No, you buy the insurance and you pay the premium every year. When you’re stroking that check to the insurance company, you’re thinking it’s a lot of money but it’s a lot less than you’d lose if your house burns down. So, you pay the insurance.

The same thing with buying physical gold—5% to10% of your portfolio ought to be in physical gold in a safe, in a safe deposit box, or whatever, and you can say to yourself, “That’s a bunch of money tied up in gold and it’s not doing anything.” To which I say, “Well, actually, yes it is. On the day the dollar crashes, that will be the best investment you ever made because it will save your life. Literally.”

TGR: It certainly could appreciate, though.

BK: Sure. Could that $900 or $1,000 gold you buy today become $2,000 or $3,000 gold? Over time, with the trends and inflation and the history of investments, I actually think that $1,000 gold could be $2,000 gold or even $3,000 gold in the next several years. When will it be there exactly? When people pin me down and say, “Come on, give me a real number,” I say I could see gold being at $2,000 within 24 months, say by the middle of 2011. Maybe sooner, maybe not, but I could see that very easily.

On the other hand, look at the way we’ve mismanaged the U.S. dollar, the immense levels of spending coming out of Washington with no heed toward productive investment in the economy. That’s the other side of the coin. In 1980 gold was $800 an ounce, and then by the mid-1980s Paul Volcker at the Federal Reserve jacked interest rates up to 16% to 18% to just squeeze inflation out of the economy. That brought gold back down. It took it down off of its $800 high.

TGR: If we’re looking at the projection of possibly $2,000 gold within months, that suggests there might be some additional plays, opportunities, in the equity side.

BK: Oh, sure. Here’s how I look at it. Let’s say that you don’t know much about gold. You’re not a gold scholar, or you’re not really a stock market player in equities or anything. You don’t own any gold. Maybe you own one or two gold miners but don’t really understand who they are or what they are. You bought them because you saw the name in some newsletter or your stockbroker said something. You need to do baby steps and then longer steps and then the big steps. Finally you can compete at that varsity level.

TGR: What are the baby steps?

BK: The first baby step is to pick how much money you have in your portfolio to invest in anything at all as opposed to the money that you need to live on. Then look at your portfolio money. How much is there? At least 5% to 10% ought to be in physical gold—gold coins, gold bar, gold ingot, whatever— in a safe or in a safe deposit box.

So the first thing is to determine your number. Do you have $100,000 to invest? Do you have $500,000? Do you have $1 million? Where are you going? Five percent to 10% of that ought to be in the physical metal.

The next thing that I would say is if you’re going to have precious metals in a well-balanced portfolio, go with big, established outfits that are well run, have good reserve positions, but still have some appreciation potential.

TGR: Such as?

BK: A company that I would consider in that rank, a much undervalued large play right now would be AngloGold Ashanti Ltd. (NYSE:AU) (LSE:AGD) (JSE:ANG) (ASX:AGG). It has plenty of room to grow. It has great production. It’s exceedingly well managed, with a good reserve position. They know how to build and operate mines. The people who worked in their mines talk about how they work in the Rolls Royce of mines. So it’s a great company going forward. It’s a South African company with operations on four continents, so it’s not specifically a South African play.

TGR: Is South Africa a good place to be doing business?

BK: I think so. South Africa just had elections. They elected Jacob Zuma, which everybody expected. I don’t anticipate any bad political things coming out of South Africa. It’s a very, very difficult country in transition in its post-apartheid years, but it’s not going to turn into Zimbabwe. I’ve been there, and I’ve met African National Congress people. I’ve talked to the business community there. I am very comfortable investing in South Africa—as long as you understand what you’re getting.

Another great company that’s also in Africa but also elsewhere in the world is IAMGOLD Corporation (TSX:IMG) (NYSE:IAG), a very well-managed company with a great future ahead of it. And if you’re just looking for big names, Barrick Gold Corporation (NYSE:ABX) is the world’s biggest gold mining company. They’re well capitalized and have lots of reserves. Every year they mine a bunch of gold and have to go out and get some more. So they mine, they operate, they produce, they make money, and then they go out and buy other operations. A good company going forward.

So there are three ideas if you’re looking for the big guys.

TGR: You mentioned that Anglo is an undervalued play. What about IAM and Barrick?

BK: Barrick is about the right price. You’re not going to get some 40% or 60% appreciation, but it’s a nice safe play that will grow with the gold market. The other thing about big miners, but especially the medium-size and the smaller miners, is that as the price of gold goes up, the profit margins on every ounce of gold that they mine will increase. These guys have a very, very tight control over their cost structures. You talk to any well-managed miner, and they can tell you how many dollars per ounce it costs to do everything—how many dollars for the digging, the hauling, the crushing, the processing. They know exactly how much money they’re spending at every step of the process.

So if somebody says that they can produce at a cost of $400 an ounce and gold is selling at $900 an ounce, there’s $500 right there. But if gold goes up to a $1,000 an ounce, all of a sudden your $500 profit per ounce is now $600. That’s a 20% increase in profit right there. Of course, it’s not that simple; nothing is that simple in this world. But that’s the basic math behind it. And a well-managed gold company that has good reserves and good operators, can control its costs and is in a reasonably good political jurisdiction—whether it’s South Africa or Nevada—is a pretty good choice.

TGR: You mentioned Barrick finding more gold reserves via acquisition. Do you see any interesting plays if you want to invest in a junior miner or an explorer for that potential acquisition opportunity?

BK: One of the most interesting speculations is a smallish gold company called Canplats Resources Corp. (TSX.V:CPQ). It has a gold deposit at Camino Rojo in Mexico. It’s been drilling; working up this prospect, doing all of the geology, all of the engineering, all the estimations—everything they need to come up with a good prospect and can say, “This many ounces of gold are buried in this pile of rock.”

Right next to the Canplats acreage is acreage owned by a Mexican mining giant called Fresnillo PLC (LSE:FRES). The geology of the Canplats property is very similar to an operating gold mine not too far away that Goldcorp (TSX:G) (NYSE:GG) owns, and so Goldcorp also has taken an interest in the Canplats property. And I’ve heard that the good folks at Newmont Mining Corp. (NYSE:NEM), another exceedingly large mining company, have sent engineers to get their boots dirty walking around the Canplats property.

So, here is a company with an established claim in a fairly stable jurisdiction that they’ve done a lot of drilling and a lot of basic estimation on. There’s Fresnillo PLC (LSE:FRES), Newmont and Goldcorp, all of which might get into a bidding contest to see who can make the best deal with Canplats. That’s the kind of thing that could take a dollar stock like Canplats and knock it out of the park—some immense payback on that.

TGR: Are there any other opportunities like Canplats that may have potential multiple bidders on them?

BK: It really isn’t in play, but Gammon Gold Inc. (NYSE:GRS) is a nice producer that might interest a company that just needed to beef up its reserves. Gammon is a well-run company; a producer—unlike Canplats. Gammon is actually a small-to-mid-tier producer at this point, and they’ve got operations; working mineral properties and an exploration pipeline. It’s the kind of thing where if a big company needs reserves in a hurry, it would take them out. Look at the oil industry, they talk about drilling for oil on Wall Street, where it’s cheaper for one oil company to take over another one and improve its reserve position. So, I’d say right now Canplats and Gammon are two companies to watch in terms of takeovers.

TGR: Are these some of the things you’ll be talking about at Agora’s Symposium in Vancouver in July?

BK: I will. I will be talking about these things—gold, trends for gold; energy and other issues related to that. I will be talking about oil and alternative resources, and whatever people want to talk about. It’s always a great conference and this year is no exception. This is the 10th anniversary of the event, and the speaker line up looks outstanding . I always seem to get lots of good comments from attendees, so anyone who is interested should really check in with Agora Financial for the details as last year's event was sold out...

Byron King’s credits include writing for Agora Financial’s Daily Reckoning and its Energy and Scarcity Investor newsletter (editor) as well as Whiskey and Gunpowder (contributing editor for this “independent investor’s daily guide to gold, commodities, profits and freedom”). He serves as co-editor of Outstanding Investments and makes regular appearances in other publications as well as on the lecture circuit. Come July 21-24, for instance, he will be on the agenda and in the audience for the Agora Financial Investment Symposium in Vancouver, BC.

Byron graduated ***** laude from Harvard University with a degree in geology, and earned an advanced degree from the U.S. Naval War College. He received his Juris Doctor from the University of Pittsburgh School of Law, to become a practicing attorney focused on litigation, bankruptcy and other matters involving people and money. After Harvard, Byron worked as a geologist in Gulf Oil’s exploration and production division. He has since followed and commented on developments in the oil and gas industry, and has maintained membership in the Association of Petroleum Geologists for more than three decades.

Serving in both the U.S. Navy and the U.S. Naval Reserve, he logged more than 1,000 hours of flight time in tactical jet aircraft and recorded 128 aircraft carrier landings. Naval service also took him in and around what he calls the "tough neighborhoods" of the Middle East. Byron has explored Alaska's oil pipeline and the oil fields in Prudhoe Bay, too. In addition to oil and gas, his portfolio of expertise includes precious metals and alternative energy sources such as solar, wind and geothermal. He has also provided advice on national energy policy to the U.S. Department of Defense.

To read more articles written by Byron King, click here or go to www.dailyreckoning.com.

Want to read more exclusive Gold Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Expert Insights page.

The GOLD Report is Copyright © 2009 by Streetwise Inc. All rights are reserved. Streetwise Inc. hereby grants an unrestricted license to use or disseminate this copyrighted material only in whole (and always including this disclaimer), but never in part. The GOLD Report does not render investment advice and does not endorse or recommend the business, products, services or securities of any company mentioned in this report. From time to time, Streetwise Inc. directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open mar ket or otherwise.

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