Lift Off Approaches Again

By Neil Charnock
www.goldoz.com.au
info@goldoz.com.au



The following statistics and commentary are offered as education on how to play our resource market. Leading producers below the top tier and the larger developers / explorers have had a field day these past few months. I am restricted from talking about individual stocks on these pages but I can talk about sector performance and break it down for readers. In the US many shares are up x10 and the bull market far more mature, in Australia most of the fun is in front of us. Gold only broke AUD$580 in the second half of 2005 and the next rally has begun. Something is brewing, as indicated by this initial run in many gold shares and timing is improving as indicated by the current share pull back, current price of gold here is AUD$857.

I have mentioned the strong sectors over this past few months and performance has generally been good until this recent painful pullback. This is a buying opportunity provided you do your homework and time your entry points. Before this market takes off again it may assist you to look at what worked and what did not.


Performance review ASX


When a gold stock rally commences, the general rule is that the large cap leaders lead the way. I went public back in August to September last year and called a rally. I stated that our leaders had experienced a good rally already so their upside was more limited. The top two diversified giants on the ASX have run + 16% and + 11.4% respectively since their end September low areas.

The other top 5 pure precious metal (PM) plays are up 5%, 7%, 16%, 20% and 90% since this time, some with higher interim peaks. Their run was mostly fair as predicted (except for 1 only) however they paled into insignificance compared to many of the other stocks I was looking at back then. The secondary cap diversified leaders ($1B to $10B) had gains of 0% (peak 28%), 10% (peak 56%), 55%, 70% and 100%, the latter had interim peaks above these gains as well. There is also a new comer to this group with a current P:E ratio of just 7.27 that rose 77%.

Amongst the next group down we have the third tier ($250M to $999M) diversified stocks with performances as follows; -15%, 32%, 33%, 48%, 54%, 80%, 130% and 230%. The results for the pure PM stocks in this range was -13%, flat, 9% (peak 43%), 14% (with take over completed as well), 15%, 18% (peak 36%) and 66%. I did write that the diversified group would do better, and then in a later essay, were… doing better. Clearly we are in a painful correction at present with the PM plays, some off their recent peaks and this represents investor fear and an excellent opportunity in this sector.

The results above all show the value of research as outlined in my work. These were the companies bringing on new production or developing new resources. The “so called” dead commodities boom has presented magnificent returns during this period. Yes some metals have sharply corrected from parabolic price peaks and more sharply due to speculation however the current global demand is still excellent. Look at the current record prices for nickel, lead and tin. Forget the CRB, this index has changed dramatically and no longer represents the metals complex as it did about 18 months ago.

I have stuck my neck out with a handful of writers these last few months, also in the face of some negative broker reports showing the CRB graph. I called for the continuation of the commodities boom. This was not easy to do, however I have to call it according to my research.


Warts and All – the disaster group (for the sake of analysis)


Now onto the smallest cap producers, pure PM and diversified it is a small group. Actually a very weak group with one stand out disaster has been all over the news and is off 75%. A 10M ounce deposit, un-hedged, now with little faith yet the gold field has been one of the richest in Australia. I can’t say if it will go up quickly after that much loss of faith, it has ceased production and may have to base for a time while they get their new act together. It is a national and global treasure in my opinion, given the future of gold… however that future has not arrived just yet; we are still on the journey.

Other problems in this group; next worst at -66% has experienced a military coup and mine invasion plus major production problems at another mine once again in a difficult sovereign state (country). This illustrates the value of minimizing risk using sovereign risk as a major guide, something I have spoken of many times. Australia enjoys the same lack of this risk with Canada even ahead of the USA. Some of our miners have operations in these high risk areas however and I tend to be very light in or avoid these stocks.

Then we had a dual listed stock next down the list at -41% has gone through a merger, cash problems, some sovereign risk issues. These issues create an air of risk and uncertainty for investors. Another production problem stock – 21% (was up 26%), heavy rain, start-up and debt / hedge obligations; once again operating in a ‘difficult’ country. Next best was flat (peak 50%) after going up x6, to be expected. Then we go to a company at the big spend stage expanding production at +8% (peak 26%), then a dual listed big resource new producer +10% (peak 48%), then another at 15%. Lastly a stable smaller profitable producer in this range went up 78% (highly rated on our star system).


Developers and Leading Explorers – performance comment


The leading developers are as good as gold. This group is split into top 6 ($450M +) and next 11 ($175M +) for my personal analysis and performance was as follows; gains only, 21% (peak 41%), 25%, 40%, 50%, 75% and 100% all since end September 06. Second tier -10% (peak 21% gain), 20% (peak 45%), 25% (43%), 26% (42%), 0%, 57% (92%), 72% (100%), 84% (200%) and 110% (140%).

Leading explorers have been the same; can anybody see why I have been excited down here Down Under? The Early Birds have had a field day, next step is to ramp up our guidance systems here and this is advancing rapidly. I released a non- advisory sample report on a leading explorer based on existing mill and untapped potential and it has been up as high as 60+% twice now and currently up about 25%, the good news is developing but not there yet.

Uranium stocks have been brilliant and I have sorted a large number of them for investors in a free report (30 pages and will not be free after the end of February).

The sorting I have managed over the last quarter on my broad research list highlights the opportunities down here because I have separated the Leading and Mid Tier Explorers, the Leading and smaller Developers, the Large and smaller producers from the rest. There is even a new section of recent floats with the 4th PDF in the series on Explorers in general. This is available for the very low price of AUD$30 for investors if anybody is interested in increasing their knowledge of these opportunities. Hurry this offer ends at the end of the month. This large volume of work is very cheap because it is designed to be an introductory service.


Fundamental comment – the sneaky effects of inflation over time.


Stepping back about 60 years now, much closer to the beginning of the cause of our current inflationary grief, in Australia the Federal Government introduced personal income tax as a temporary war time measure during World War 2. I have nothing personal against paying taxes; my point is that back then it apparently took a wage of about 30 times the average wage to get into the top taxable wage bracket. The average wage in Australia is approximately $900 per week now so that would take $27,000 per week (30 x $900) to get into this top tax bracket. Now yet I can tell you it only takes about $80,000 per annum or $1,600 per week to get into the top tax bracket now. This nasty erosion of buying power where rising incomes are not balanced against equally moving tax brackets is aptly called “bracket creep”.

This was not such an issue for a long time through the 50’s and 60’s in Australia however it (the water in the pot) started to slowly warm in the early 70’s. A thing called discretionary spending or disposable income had been common across all levels of wage earners during the post war period. Disposable implies money you can spend on pleasure items and little or big luxuries.

After the essentials like accommodation, food and petrol were paid for there was plenty left over to pay off debt or sit by the sea side for 4 weeks every summer. My father in law had been a house painter who came to Australia and worked on the Snowy Mountains Water Scheme in the early 50’s. He earned enough in the mid 50’s in half the year to have the other half of the year off – to spend time on the beach, own a Morgan sports car and go on an ocean cruise. Now that is what I call disposable income. Taxes were low and so were costs, Australia had the second highest living standard on the planet.

Unfortunately people had not generally noticed someone had placed them in a pot of water and turned the heat on low… I have to step back a little to explain for you at this point.

The Bretton Woods Agreement was a system of rules, institutions, and procedures introduced to regulate the international monetary system as agreed in July 1944 by 730 delegates from 44 Allied Nations. Key to the Agreement was an obligation for each country to adopt a monetary policy that maintained the exchange rate of its currency within a fixed value, plus or minus one percent, in terms of gold. Basically speaking the US Dollar was instituted as the global reserve currency in place of gold at this time; however it was still firmly linked to gold.

The global economy boomed post war as things were rebuilt and technologies advanced. The baby boomer generation began to be born in this era of prosperity. As this long 20+ year economic cycle drew to a close things were changing rapidly.

Following all sorts of dramas including the London Gold Pool (Google this for a great story), which attempted to cap the price of gold at the fixed $34 rate, economic conditions had become unbalanced once again. This all fell apart by 1968 as the French Central bank began to buy gold instead of selling. By 1971 the rush of gold leaving the USA had reached an alarming level. This was a critical point in modern history - the President of the USA Mr. Richard Nixon of Watergate fame reneged on the Bretton Woods Agreement and ceased convertibility of USD’s into gold.

The impact was rapid as shown in the graph below where inflation soared once the Bretton Woods Agreement had effectively been abolished. Without the limitation of a fixed gold standard, under which new credit was literally limited by the mining of new gold from the earth, things changed drastically. So with the constraint of dollar production linked to gold all removed completely in 1971 the printing presses were set loose. Money creation constraints were lifted, lending policies were made “more accommodative” in the language of the banking system. It became easier to borrow and build, debt soared.





This caused great hardship and a brief recession by the mid 70’s as the rates had to be raised to slow the borrowing. Australia experienced a property collapse in 1974. Price inflation had raged through the early to mid 70’s as shown above.

Following the sharp contraction of credit creation in the mid 70’s the printing presses went back to work and confidence dropped. A brief economic recovery, mainly in resources Down Under, followed amongst uncertainty and loss of confidence, gold soared throughout the last half of the 70’s.

Jumping forward to the start of the 80’s we had the then head of the US Federal Reserve Mr. Volcker (started his reign in 1975) pushed interest rates to desperation levels to try to regain faith and necessary investment in the USD at that time and curb inflation. The stellar interest rates created demand for US Dollar denoted Treasuries, borrowing dropped as a recession set in during the early 80’s, the banking system rebalanced and confidence returned, gold plummeted in these conditions and with the assistance of other regulatory measures. There was much more to this of course however I am trying to keep this brief so I am over simplifying things.

The metals began a bear market that lasted 20 years and manifested as a slow demise, there were dead cat bounces (“dead cat bounce” – term for a rebound rally after a very sharp rise and sharp drop in a price of a stock or commodity) and counter rallies but the trend was down. Inflation continued it’s erosion of living standards as the previous large gap between the cost of necessities and net income decreased. Inflation stayed high during the first 10 years of this period and interest rates reached record levels in Australia by the end of the 80’s. Real return on capital above the real rate of inflation makes other investments more attractive than gold.


Moving towards current times


Moving quickly now, as bracket creep and inflation erode disposable income, the struggle of the middle class gets underway. It has taken several decades and it is now quite severe if you earn a “normal” wage under $50,000 PA here. The property boom has transpired and is nothing more that property inflation if you don’t own a house you get left behind. Then the rental returns are lousy so you get less investment in property, wages are artificially low due to global competition for manufacturing jobs which is why the wages are not keeping up. We have to stay competitive they say and “they” are right, the world has changed. SO we get terrible competition for rental accommodation due to the lack of available accommodation. This is reaching crisis point now.

Here is another twist that is set to break the camels back and wake a large volume of frogs up. Rents have to rise even more to provide a fair return on investment (ROI) for property developers to bother risking capital in a rising interest rate climate. Wages will not accommodate this at current levels and this, with all the other inflation in the system (petrol, food and other necessities) places undue and unacceptable stress on wages and so the underclass gets bigger. Middle class living standards are crashing alarmingly ringing load alarm bells in the “pot”.

The garbage inflation figures quoted to us are just not washing anymore. The figures are rubbish because they to not represent the correct spending ratios of the average citizens. Who buys a new car every week or a new computer? Thing is this; food and a dwelling and petrol to get to work will soon (maybe do for many already) cost more than these former middle class working Australians earn. Many are experiencing this unpalatable reality now. I am not saying Australia will crumble, do not get me wrong we are in a fantastic position and have stable Government, I am just pointing out some of the inflationary pressures right in front of us, happening now. These are challenges we must face as investors and the Australian experience is common throughout the first world.

Inflation and bracket creep have gone too far and something is snapping, is that the sound of our way of life crumbling around us?? Take $600 per week rent and $300 for food out of an over taxed wage earners pocket and you have serious trouble. So wages will have to ratchet up behind this inflation. We are back to a point, now an imminent stage similar to the 70’s where wages were forced to go higher. And this is more inflation so guess what, this means higher interest rates to attempt to control this monster. This is a critical point in the destructive spiral we saw in the 70’s only then we had no where near the debt levels we do now. Or Globalization either! Oh yes… no wonder the resource shares are looking good. Gold and silver in particular have to flourish in this economic climate.

The strength of the global economy due to globalization is adding pressure to all commodities, this is a resource war as more of the vast populations of Asia scrambles to catch up to the Western Way of life. Conditions for precious metals have changed back from the 1980 – 2000 era and this is covered elsewhere in great depth by myself and other writers.

To top this off we have the need to change our ways with power generation, transportation and now address all sorts of air and water quality issues which are another topic of conversation. This too will exert a force, further demands on resources… we live in interesting times. I ran out of room a page and a half back and will go over the 80’s and 90’s and 00’s in greater depth plus some of these other issues in the near future, this is crucial to the reading of current conditions. It is important to read the social change in the so called “first world” as well as Asia if we are to understand the current investment climate.

Good trading / investing.
Regards,
Neil Charnock


PS We provide information services that cover this kind of invaluable data for busy investors; a new version of our key producer spreadsheet containing an innovative rating system on our market leaders as researched by our expert panel is now available. Special offer to end February; We also cover ASX developers, explorers and producers in a time saving, convenient and comprehensive product which is under constant development. As a special offer we will offer this for immediate delivery with a follow up delivery of an upgraded version with bonus uranium report available now, all for AUD$30. We have a site under construction at www.goldoz.com.au and our panel now includes a highly experienced international trader with high profile. Products can be found on the Gold Oz store page.

Neil Charnock is not a registered investment advisor. He is a private investor who, in addition to his essay publication offerings, has now assembled a highly experienced panel to assist in the presentation of various research information services. The opinions and statements made in the above publication are the result of extensive research and are believed to be accurate and from reliable sources. The contents are my current opinion only, further more conditions may cause my opinions to change without notice. The insights herein published are made solely for international and educational purposes. The contents in this publication are not to be construed as solicitation or recommendation to be used for formulation of investment decisions in any type of market whatsoever. WARNING share market investment or speculation is a high risk activity. Investors enter such activity at their own risk and must conduct their own due diligence to research and verify all aspects of any investment decision, if necessary seeking competent professional assistance.