Gold and Energy Advisor Nov 2009

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© 2009 The Silver & Gold Report, LLC. All rights reserved. Gold and Energy Advisor 1

rewepast“peakgold”?Few investors would even understand thisquestion. By thetimeyou finishthis issue,

you’ll not only understand the question, you’llknow the shocking truth about global goldreserves… the shockwavethat’s goingtohit themarkets once this truth gets out… and thestaggeringimplicationsforgoldprices.

Strong words? Absolutely! But I’ll back upeverythingI’vesaid.

Beforewegettotheexcitingpart,though,weneed some background. Sobearwithme whileIcoversomebasics.

PeakOilandGold

“Peakgold”isaconceptthatcomes(indirectly)outoftheoilindustry.ItallstartedwithM.King

Hubbert—amanwhoworkedforShellOilbackinthe1950s.

In1956,Hubbertstoodupatameetingofthe AmericanPetroleumInstituteand predicted thaUS oil production would rise every year foranother 14 or 15 years. At that point, it wouldpeak and start to fall. It would fall inexorablyafterward,andwouldneverrecoveragain.

At thetime, this seemed absurd.The UnitedStateswastheworldleaderinoilproduction,and

had been so for almost a century. Hubbert wasridiculedbyhiscolleagues.Nevertheless, he was dead-on accurate. In

1970, USoilproductionpeaked,andit hasfalleneversince.Sincethen,USannualproductionhasfallen by about 650 million barrels, and it getworseeveryyear.

Hub bert ’s rea soning was simple. Whenexploringforoil,alltheoilthat’seasytofindwillb e found first. Discoveries increase on an

GOLD&ENERGYADVISOR Vol.VI,No.11$19

JamesDiGeorgia,Editor

“Shocking‘Insider’ReportExposestheTruthAbouttheWorld’sGoldSupply.$2,500Gold,HereWeCome!”

“Theminingindustryhasadirtylittlesecret.Despitethebesteffortsof

miningcompanies,goldproductionisplunging!Evenasgoldhasquadrupledinprice,globalproductionhas fallenby19%.

“Insidersarepanicked,butnobodyelseknowsaboutthis—yet.Oncethewordgetsout,we’llseegoldat$2,000…$3,000…even$5,000!”

A



November 2009 — See our website at www.GoldAndEnergyAdvisor.com for our updates, recommendations, and current model portfolio

exponential curve, flattening out as discoveriesbecome more difficult. Since no country has aninfiniteamountof oil, discoveries will eventuallypeak. Afterwards, they fall along a decliningexponentialcurve.Ultimately,discoverywillbea

symmetricalbell-shaped curve,and thepeak wiloccurinthemiddle.

Similarly, production will also follow a bellshaped curve. (It’s delayed when compared todiscoveries,reflectingtheaveragetimebetweenanewdeposit beingfoundand awell beingdrilledto extract it. But the curve—and the peak—are

justasinevitable.)

US production peaked in 1970, but worldproduction continued to rise. However, manyanalysts(includingme)thinkwemightbeattheglobal peak right now. We’ll know for sure inanothercoupleofyears.

Theimportant thing is this. Peak oil doesn’tmeanwe’verunoutofoil.Onthecontrary—we’veonlygonethroughabouthalfourtotalsupply.

ButitdoesmeanthatallthecheapoilisgoneThefirsthalfwastheeasyhalf.Fromhere,everydrop gets harder and more expensiveto extractNot only that, it comes out of the ground more

slowly(forreasonswedon’tneedtodiscusshere). Add itall up, and youhavedeclining supply(remember, it falls every year), while demandcontinues to increase. That means prices wilskyrocket. And that’s why in this issue, we’reasking…

HaveWeReached“Peak”Gold?

“Peak”goldreferstothesamephenomenonasoil,appliedtotheyellowmetal.

Justlikeoil, gold isaphysicalsubstancethatmust be extracted from theearth. Although theprocess is different, the exploration/discoveryproduction cycle is the same. Therefore, a peakwilleventuallyoccur.

Just like oil, gold has only a finite supplyWe’re not going to run out anytime soon—butonce the peak is passed, supply decreases everyyearwhiledemandincreases.

Oncethatpointisreached,pricesgotothemoon.

ThunderInTheDistance

Like the rumblings of a distant oncomingthunderstorm,therehavebeenmanyindicationof a peak in gold production. Here’s a chart ogold’sglobalminingsupply.

THE GOLD AND ENERGY ADVISOR

EDITORIAL STAFF James DiGeorgia Editor

Spiros Psarris Associate Editor

PUBLISHING STAFF

Jon Longo Subscriber Services

Sharol Dell’Amico Marketing Manager

The GOLD AND ENERGY ADVISOR is anewsletter dedicated to educating investors about theinvestment opportunities in precious metals andenergy. Unless otherwise stated, all charts, graphs,forecasts and indices published in the GOLD AND

ENERGY ADVISOR are developed by the employeesand independent consultants employed by The Silver & Gold Report, LLC. The accuracy of the data used isdeemed reliable but is not guaranteed. There’s noassurance that the past performance of these, or anyother forecasts or recommendations in the newsletter,will be repeated in the future. The publisher, editor,and staff of this publication may hold positions in thesecurities, bullion, and rare coins discussed or recommended in this issue. The publisher, editor andstaff are not registered investment advisors and donot purport to offer personalized investment related

advice; the publisher, editor and staff do notdetermine the suitabilit y of the advice andrecommendations contained herein for anysubscriber. Each person must separately determinewhether such advice and recommendations aresuitable and whether they fit within such person’sgoals and portfolio. GOLD AND ENERGY ADVISOR is affiliated with Finest Known, a dealer in rare coinsand bullion. Mining companies, oil & energyexploration and/or oil & energy service companiesmentioned or recommended in GOLD AND ENERGY

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(sourceofsupplycharts:CPMGroup)

Goldminingproductionpeakedin1999.Sincethen,ithasfallenby19percent.

Whatwedon’tyetknowiswhetherthispeakis permanent. It appears that way, though. Onebyone,alloftheworld’stopgoldproducershave

peakedandstartedtofall(seebelow).ThebiggestnewshereisSouthAfrica.Thirty

years ago,thisnationsupplied74 percentoftheworld’sgold allby itself.Todaythat numberhasplunged to 13 percent. In absolute terms, itsproduction is less thanone-third of what itused

tobe.Anditshrinksfurthereveryyear.

TheLargestProducersHaveAllPeaked

Along with South Africa, the world’s largestproducing countries are the US, Canada, and

Australia. Combined, these four nations aloneaccount for 45 percent of global gold miningproduction. As you can see in those charts, allfourpeakedadecadeormoreago.

Ifgoldsupplyistorecover,othernationsmusmultiplytheirproduction.Butthatwon’thappen.

Of all the nations with significant golddeposits, the top four (South Africa, the USCanada, and Australia)arethesafest inpoliticaterms. All the other countries are much riskierplacestomineforgold.

Andthat’soneofthemainreasonswhy…

ProductionElsewhereIsInSeriousTrouble




During the recent boom in commodities,mining companies raked in huge profits fromtheir international operations: not only in gold,butotherpreciousandbasemetalstoo.

Did they deserve these huge windfalls? Absolutely. They took huge risks and investedhuge amounts of capital to find, develop, andextractthese natural resources. (Seethe sidebar

belowformoreonthis.)Nevertheless, the nations where their mineswere located have been outraged by foreigncompanies profiting from “their” gold, silver,copper,andsoon.

Sothesenationsarestartingto“nationalize”these assets. They’re revoking mining contracts,

jacking up license fees,enacting crushing taxes,andevenseizingminesoutright.

Unsurprisingly, this is crippling furtherdevelopment. For example,RioTinto was inthemiddleofa$6billionprojectinGuineatodevelop

the world’s largest iron-ore reserve—until thegovernmentsuddenlystrippedaway50percentofitsminingrights.

In Russia, thegovernment hasthreatened torevoke coal mining licenses for Arcelor-Mittal,whichwasconsideringtrimmingitsworkforces.

In China, the government has arrested RioTintoemployeesfor“espionage,”placingpressureon the company while it was negotiating ironpriceswithChinesesteelcompanies.

InZimbabwe,thegovernmentisreviewingallmining contracts with a strict “use it or lose it”deadlineforinternationalcompanies.

In Zambia, the government is demanding to

double,orinsomecaseseventriple,itsownershippercentageinforeign-runmines.In South Africa, the country’s largest trade

union has demanded thegovernmentnationalizeallmines.

Andthereareotherexamplesbesidesthese. Asaresult,theworld’sminingcompanies are

pullingback fromrisky operations.BHP Billitonis cutting its operations in Russia and Africa

X st ra ta a nd o th er g ol d c om pa ni es h av eabandoned theirplanstopursueprecious metalsin Zimbabwe, Tanzania, Madagascar, and other

placesinAfrica.Andthelistgoeson.Summary: while production in the “safe”countries isplunging, production elsewhere can’tbeboostedtocompensate.

Nevertheless, you might be wondering: asgold’s price rises, production should naturally

Modern mining is verycapital-intensive. Itcantake millions oreven billionsofdollars todevelop a new mine, which ultimately mightnot have the mineral reserves the companyexpects.

In remote locations, the mining companyoften has to construct new roads to the sitebefore development can even begin. This caninvolve logging, grading roadways, evenconstructing bridges across canyons andravines.

Oncethesiteisaccessible,theheavyworkbegins. Remote locations often require on-site

housing for workers. Along with the housingitself, thismeanswellsmustbedrilled,sewagecontainmentmustbe planned and built,powerplants must be constructed, and a variety ofother facilities must be created (hospital, foodstorageandpreparation,andsoon).

And this doesn’t include the infrastructurenecessary to support the mine, includingmaintenance and repair facilities for vehicles

andequipment,ore-processingfacilities,andsoon.

It’s not unusual for an entire town to becreated from scratch when a mine is beingbuilt.

Thenthemineitselfmustbecreated.Foranopen-pit mine,tensorevenhundredsoffeetofearthmustbemovedtoexposetheoredeposits.Forahardrockmine,mineshaftsmustbesunka nd reinforced, ventila tion a nd eleva torsystems must be built, lighting and electricalpowersystemsmustbeinstalled,andusuallyawater-removal system is necessary as well (to

preventgroundwaterfromfloodingthemine).In extreme cases, mining companies mustalsocreateentiretransportationnetworks.Forexample, in Guinea, Rio Tinto had to build anewcross-countryraillineandanewshippingporttobringitsnewlyminedirontomarket.

Note that all of these expenses must bebornebeforethefirstounceofmetalormineralcanbesold.

WhyMiningisSoRisky




increase.Afterall,depositsthatarenon-economicat lowerpricesstart beingworkedoncethepriceriseshighenough.

That’s an excellent question, But before wediscussit,wemustlookatanincrediblepieceofnews…

ShockingReport

RockstheGoldIndustryMetals Economics Group is a research and

data firm that covers the mining and mineralexplorationindustry.

Earlier this year, they quietly released areport ongold that has sent shockwaves acrosstheanalystcommunity.Theytriedtoputahappyface on it, but the numbers portray an industrygoingintofreefall.

Here’sagraphthatsummarizesthedata:

The line shows the money spent on goldexploration. Unsurprisingly, exploration fellsharplyduringthebearmarketofthelate1990sandearly2000s.Ithassincerecoveredtoanall-timehigh,upover$3.1billion.

Fora normal commodity—onethat hasn’tyetp ea ke d— we w ou ld s ee t ha t a ll t hi s n ewe xp lo ra ti on w ou ld r es ul ts i n l ot s o f n ewdiscoveries.Butthat’snotwhatweseehere.

Instead, as shown by the dark bars, newdiscoverieshaveplunged.

Overthelast10years,evenwhileexplorationhasalmosttripled,newgolddiscoverieshaveplummetedby90percent!

Thisistheclassicsignofapeakedcommodity.The large, easy-to-find deposits were all

discovered long ago. Now exploration is gettingmoreandmoredifficultandexpensive,whilethesize and quality of new finds are droppingexponentially.

We’ve seen this process unfold in a differentcommodity: oil. Let’scomparethetwoindustries

togetsomeinsightaboutwhatliesaheadforthegoldmarket.H er e ar e t he i nd ic at or s of a p ea ki ng

commodity, as recentlydemonstrated byboth oiandgold.Supply no longer responds to price

increases.Oil’spricetripledfrom2005to2008—butproductionwent up less than1percent.Overthe last decade, gold’s price quadrupled, butminingsupplyfellby19percent.Production costs rise. Many new oil

discoveries (such as deep-water deposits and

Canadianoil sands) areunprofitable whenoil isbelow$80. So why are oil companies looking insuch expensivelocations? Because all the cheapoilisgone.

In gold, production costs aresoaring as wellTheMetals Economics Groupreported this aboutthelargest gold companies: “Thegroup’saverageannual cost of producing and replacing gold—incorporatingoperatingcosts,capitalcostsofnewmines, sustaining capital costs at existingoperations,andreservesreplacementcosts—morethan doubled over the past decade… Only a

triplingof gold prices from the lows oftheearly2000s to an average of $872/oz in 2008 haspreventedafinancialmeltdown likethatseeninthebasemetalssector.”Exploration produces diminishing

returns.Thankstothepeak,mostoilexplorationefforts losemoney today. Energy companies stillfindnewdeposits,butmostoftheonestheyfindareworthlessthanthemoneyspenttofindthemThat’s why companies like Exxon Mobil arebuyingbackstockand issuinghugedividendstoinvestorsinstead ofusingthe moneytofindnew

deposits. They’re admitting that their coremission(producingandsellingenergy)isfailing.

This isalsotruefor gold. Theprevious chartshowed hownewdiscoverieshaveplummeted.Asit turns out, thetruepictureis evenworsethanthechartshows.

The chart shows discoveries as a three-yearaverage. This covers up the fact that the mostrecent years have been a disaster. In fact, the




report(whichwasreleased inmid-2009)containsafootnotethatadmits…

“Atthetimeofwriting,nosignificantgolddiscoveriescouldbeattributedto2008.”

This collapse in new discoveries has twofurtherimplications,whichwe’vealsoseenbeforeinoil.Companies are not replacing their

reserves. I’ve documented extensively in GEAhow most of the major oil companies are notreplacingalltheoil theypump outoftheground.They’re able to find some, but not 100 percent.(They obscure this by announcing natural gasdiscoveriesas“barrelsofoilequivalent.”)

Goldcompaniesarehavingthesameproblem.

Q uo ti ng M et al s E co no mi cs G ro up a ga in :“Globally, 62 significant discoveries (eachcontaining at least 2 million oz of gold in totalreservesandresources)havebeenreportedsofarin the 1997-2007 period. These discoveriescontain a potential 377 million oz of gold inanticipated recoverable reserves—less than halfof the estimated world gold mine productionduringthesameperiod”(emphasisadded).Compani es mask t hi s f ai lu re by

acquiring other companies. In the energyindustry, when a large company acquires a

smallerone,thelargeone’sreserves“grow”bytheamountthatthesmalleroneusedtoown.

Investors who aren’t paying close attentionarereassured.It looks likethe large companyisreplacingitsreservesandevengrowingthemovertime.

But this is an illusion. In reality, the totalenergyavailable to themarket continued to fallas old reserves were produced and not replaced.To create these “new” reserves, no new energyw as f ou nd . E xi st in g e ne rg y j us t c ha ng edownership.

Thesame thing is happening in gold. Here’stheMetalsEconomicsGroupreportonelasttime:“Although, as a group, the major producerssuccessfully replaced almost twice their totalproduction over thepast ten years, almost all ofthese reserves additions were achieved throughacquisitionsorbyupgradingresourcesatexistingprojectsandmines,andnot throughfindingnewsignificantdiscoveries”(emphasisadded).

Indeed, as we saw earlier, “no significantdiscoveries”occurredalllastyear.

Weseethatjustasoilhaspeaked,goldlooksthesame.Butthere’sonelastfactortoconsider…

TheKeyDifferenceBetweenPeakOilandPeakGold

Goldhasasecondarysourceofsupplythatoildoes not. Recyclingof scrap goldand old jewelryprovides an additional source of supply beyondminingproduction.

Indeed,thisistheonlythingthathaskeptthgoldmarketstableasminingproductionhasplunged.

Weseethatsecondarysupplyhasrisentofiltheshortfall created by sliding mineproduction

Ifithadn’t,we’dprobablybeat$2,500goldalready.Buthowlongcansecondarysupplykeepgold’s

price down? There areseveral reasons to expectthatitcan’tdosoformuchlonger.Secondary supply must keep growing

Scrapsupplyis alreadyat sky-highlevels, butithas to keep growing to compensate for fallingmining production. Otherwise, gold’s net supplywill fallandthe full impactof“peakgold”willhitthemarkets.The required growth rate is unsus

tainable.Scrapsupplyhasdoubledinthelast10

years. (And even at this high growth rate, goldprices still quadrupled.) But scrap supply can’tgrow forever. It’s alreadyhalf of overall supply

Atthecurrentrate,itwouldbe100percentofthemarketin9-10years—whichisridiculous.There’s only so much scrap left to

recycle.Inthisdecadealone,292millionounceshavealreadybeenmelteddownandrecycledintothemarket.




Nobodyknowshowmuchisleft,but it seemsclear that the amount of scrap coming back tomarketcan’tkeepgrowingeveryyear.

‘Do-Loops’ are absorbing scrap supplyCPMGrouprecentlyreportedonasharpincrease

continued on page 10

I n U pd at e # 75 8 , we i ss ued a n ew

recommendation for Hess Corporation (symbolHES), for the GEA 2 Portfolio. We sold shorttheNov.$50put(symbolIGGWJ).

In Update #760, we issued instructionsforsubscribers who sold calls on Pioneer NaturalResources (PXD),Occidental Petroleum (OXY),Devon Energy (DVN), and Forest Oil Corp.(FST).OnPXD,werolleduptheOct.$25calls(PXDJE)totheNov.$30calls(PXDKF),sellingtwocontractsforGEA2.OnOXY,werolled upthe Oct. $65 calls (OXYJM) to the Nov. $70calls(OXYKN).OnDVN,werolledupourOct.

$60 calls (DVNJL) to the Nov. $60 calls(DVNKL).OnFST,werolledupourOct.$17.50calls(FAHJW)totheNov.$17.50calls(FAHKW).

In Update #761, we issued instructionsfors ub sc ri be rs w ho s ol d c al ls o n E ne rg yExploration and Production ETF (XOP), XTOEnergy (XT O), Apa che Corp. (AP A), a ndTalismanEnergy(TLM).OnXOP,werolleduptheOct.$35calls(XOAJI)totheNov.$37calls(XOAKK). OnXTO,werolled up theOct.$41calls (XJVJO) to the Nov. $41 calls (XJVKO).On APA, we rolled up the Oct. $100 calls

(APAJT) to the Nov. $105 calls (APAKA). OnTLM, we rolled up the Oct. $12.50 calls(TLMJV)totheNov.$15calls(TLMKC).

In Update #762, we issued instructionsforsubscriberswhosoldcallsonNobleCorp.(NE),Suncor Energy (SU), Sandridge Energy (SD),and ATP Oil &Gas (ATPG). OnNE, werolledup the Oct.$36 calls (NEJD)to the Nov. $36calls(NEKD).OnSU,werolleduptheOct.$32calls(SXHJK) tothe Nov. $33 calls (SXHKR).On SD, we rolled up the Oct $12.50 calls

(SDJV) to the Nov. $12.50 calls (SDKV). On ATPG, we rolled up the Oct. $12.50 calls(HKUJV)totheNov.$15.00calls(HKUKC).

In Update #764, we issued instructionsforsubscribers who sold these options: XOAVG,KWKVG, PVXVA, PXDVE, DNRVC, FAHVC,EACVG, SXHVK, AZWVK, OXYVN, DVNVL,andGQIJD.Welettheoptionsexpire,andkeptthepremiumsofapproximately$1,655.

I n U p d a t e # 7 6 5 , w e i s s u e d a

recommendation for the GEA 2 portfolio. Wesold short the $43 November puts on XTOEnergy(putsymbolXJVWQ).

InUpdate#766,wenotedthatouroptiononQuicksilver Resources (the October $12.50,KWKJV)wasexercised.Ourreturnwas79.6%.

In Update#769,wecoveredour hedges onDevon Energy (DVN) and Apache Corp (APA).OnDVN,weboughttoclosetheNov.$60calls(DVNKL).We had sold for$10.30, and boughtfor$6.80.OnAPA,weboughttoclosetheNov.$105calls(APAKL).Wehadsoldfor$3.10,and

boughtfor$.40.In Update #770, we sold short puts on

Devon Energy (DVN), Encore Acquisition(EAC), Suncor Energy (SU), and AnadarkoPetroleum (APC). On DVN, we sold the Nov.$65puts(DVNWM).OnEAC,wesoldtheDec.$40 puts (EACXH). On SU, we sold the Nov.$32 puts (SXHWK).OnAPC, wesoldtheNov.$60puts(AZWWL).

In Update #771, we issued a recom-mendation on EOG Resources (EOG). Weboughtshares,andalsosoldshorttheNov.$80

put(EOGWP).In Update#772,wecoveredour hedges on

XOP, Talisman Energy (TLM), OccidentalPetroleum(OXY), and SuncorEnergy (SU).On

XOP,weboughttoclosetheNov.$37(XOAKK).We sold for $5.80, and bought at $2.45. OnTLM, we bought to clo se t he Nov. $15(TLMKC). We sold for $4.20, and bought for$2.05.OnOXY,weboughttoclosetheNov.$70(XOAKK). We sold for $12.00, and bought for$6.50.OnSU,weboughttoclosetheNov.$33

(SXHKR).Wesoldfor$5.80,andboughtfor$1.40.InUpdate#773,weaddedtoourpositiononDenbury Resources (DNR). We sold short theDec.$12.50puts(DNRXV).

In Update #775, we made new recom-mendations for Bill Barrett Corp. (BBG) andQuicksilverResources(KWK).OnBBG,wesoldshorttheNov.$30puts(BBGWF).OnKWK,wesoldshorttheJan.$12.50puts(KHPMV).

PortfolioUpdate



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recious metals are going berserk. Gold hasshattered its price records and set a series of

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I’ve managed to obtain just 12 sets of someremarkable ancient silver coins. e inherent value of this ve-coin set is increased evenfurther by their fascinating role in history—issued by the men who ruled Rome as it

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e rst coin was issued by Diocletian. isinfamous Emperor attained the throne inAD 284, when theRoman Empire wass p l i n t e r e d a n da n a r c h i c . B y sheer force of will and an iron-

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A 21st Century Bull Market Meets an

Ancient Roman Emper or by Ja mes DiGeorgia

P

Diocletian, Emperor of Rome

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rule, and established a Tetrarchy (“leadership of four”). Today hispolitical achievements areovershadow ed by his murder-ous persecution of Christians.

e second coin was issuedby Maximian, the ferociousgeneral whom Diocletian

appointed as his Augustus (co-emperor). While Diocletianattended to political matters,Maximian crushed multiplerevolts within the Empire andfought multiple armies of foreigners as well. Known forhis cruelty, he often destroyedthe homelands of his enemiesin scorched-earth campaigns,leaving entire populations todie from starvation and disease.

e third coin depictsGalerius, who ruled as Caesar ( jun ior emperor ) underDiocletian and Maximian. While Maximian was cruel tohis enemies, Galerius wreakedmurderous havoc on his owncitizens. Galerius was thep r i m a r y a r c h i t e c t o f Diocletian’s savage GreatPersecution against Christians.A f t e r h i s e l e v a t i o n t oAugustus, he died of a horribly gruesome disease, which was viewed by many as the vengeance of the Christian God.

e fourth coin depicts thefourth ruler of the Tetrarchy,Constantius. An accomplishedsoldier, he rst ruled as Caesar,

then as Augustus. e fth and nal coin inthe set came from Constantine

the Great (shown to the right). When his fatherConstantius died in 306, Constantine replacedhim as Augustus, beginning a twenty-year periodof civil wars and assassination attempts. Whileleading his army into battle in 312,

Constantine saw a vision of across with this message: “Inthis sign you will conquer.” His victory that day and infollowing battles convincedhim that he had been aided by the Christian God, whom hebegan to worship. He then

moved his capitol from Rometo Byzantium, founding theByzantine Empire—the greatChristian civilization which would last another 1,000 years.

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in “do-loops.” This describes a growing practicewhere jewelers buygold from refinersand makelow-end jewelry. They then sell it back to therefiners,whomelt itdown intobullion, which isthenresoldtothejewelerstomakemorejewelry.

This procedure seems crazy, but there’s areason for it. By doing this, the refiners andmanufacturers are able to reap a windfall in

s ub si di es a nd t ax b en ef it s f ro m v ar io usgovernments. (Do-loops are currently prevalentbetween MumbaiandDubai.There’sanother bigloop from China to Hong Kong to Taiwan, andbackagain.)

As this practice grows, it absorbs gold andcurtailsscrap supply. Themetal is taken offthemarket,asitcirculatesinanendlessloop.

Asgoldpricesrise,won’tminingsupplyrisetoo?

After all, for most mined commodities(copper,zinc,nickel,andsoon),astheirpricesrise, most mines increase production. Theirmarginal deposits become profitable at thehigherprices,sotheminecanproducemore.

However, gold is not a typical commodity.

Even as it rises to $2,500 or even $5,000,miningproductionwon’triseasstronglyasyoumightexpect.Here’swhy.

High-concentration gold deposits are raretoday. After 4,000 years of miners digging forgold,thehighest-gradedepositswereexhaustedlongago.

Today, gold mines usually work depositswherethegold is inthe partspermillion.Themetal exists onlyas invisible particles. To theeye,theoreslooklikeordinary,worthlessrocks.

This means that tons of rock must beblastedfromtheearth,movedtoamill,crushedandgroundup,andtreatedwithacidsolutions,

just to extract tiny quantities of the preciousmetal.

Milling and treating are complicated,expensiveoperations.(Thishasgottenworseasenvironmental regulations have restricted theuseofcyanideand otherdangerouschemicals.)Therefore, gold mines tend to have smallermills that run at full capacity, rather thanpayingforexpensivecapacitythatcan’talways

beused.Now consider that typical gold mining

executiveswantto extract everypossibleouncefromtheirmines.Most minersaren’tdrivenbyshort-termprofits; they love the yellow metal,are bullish on its prospects, and want toproperly steward the rare golden resourcesthey’vemanagedtodiscoverinsidetheearth.

Asgoldpricesriseandfall,variousdepositsinaminebecomeeconomicornon-economictoextract.Tokeep his mineoperatingas long aspossible,atypicalexecutivewill trytosavethehighest-grade ores for the future, for tworeasons.

First, churning through a mine to get itshighest-gradeoresoftenmakesthelower-grade

material non-economic. So the mine getsabandoned with a lot of gold left in it. (Formanyminers,thisthoughtistoopainfultoevencontemplate.)

Second, the high-grade deposits will beprofitable at a wide range of gold prices. Butdeposits that are modestly profitable todaymightnotbe profitabletomorrowifgold pricesfall.

Therefore, miners tend to extract thelowest-gradedepositspossibleatcurrentprices.Tokeepshareholdershappy,alittlehigh-grade

mightbeaddedtothemixtoboostprofits.Butoverall,mostexecutiveswanttoextractandsellevery ounce they can from the deposits theycontrol. And thebest waytodothatistoshiftproductionto lower-gradeoresas they becomeprofitablewhengoldrises.

WhyHighPricesCanSometimes

DepressGoldProduction

By definition, low-grade ore contains more gangue (waste rock) per ounce of gold thanhigh-gradeore.

But as wesaw earlier, gold mines tend tohavefixedcapacities.Theycanonlyextractand

Won’tRisingPricesLiftMiningProduction?

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Scraprecyclersarealreadyoperatingatfull capacity. Gold recycling is a specializedbusiness.Youcan’tjustbuildasmelterandstartpumpingoutgold bars—nobodywould buythem.Theriskistoogreat.Withoutthesealofatrustedrefiner, a bar of yellow metal would have noguaranteeofpurityandwouldnotbeacceptedonworldexchanges.

Therefore,scraprecyclingcanonlybedonebya trusted, established refiner. But these are aloperating at full capacity. For example, ArgorHeraeus in Switzerland is cranking out 400metrictons ofgold peryear. They’reoperating 3shifts,24hoursperday.Oneofitsexecutivestoldan industry journal, "I have been in the goldbu si nes s f or 30 y ear s an d I ha ve n ev er

experienced anything like this…We cannot copewithdemand."H ow t he n c an s cr ap s up pl y i nc re as e

significantly from here? It would seem that itcan’t.

OneLastChance

Without a continual growth in secondarysupply,there’sonlyonemorepotentialsourceforg ol d s up pl y: s al es o f g ol d b y i nv es to rs

governments,and centralbanks.But thissourcehasallbutdriedup.

In fact, it’s sharply reversing itself into asource of demand! For example, there’s thisbreakingnewsitem…

IndiaBuys200MetricTonsofGold

The Reserve Bank of India (the country’s

central bank)hasbought 200metric tons ofgoldfrom the International Monetary Fund. That’shalf of the 403.5 metric tons that the IMF wasplanningtosell.

This gold is gone, vacuumed off the marketNote that India didn’t buy this gold to resell itagain later. It bought it to keep it as foreignreserves.

(Rumorsarenowswirlingabouttheotherhalof theIMF sale. An analyst with Commerzbank

AGisexpectingChinatotakeit.)Therearefar-reachingimplicationshere.This

isn’tjust avoteofconfidencefor gold. It’salsoa vote of no-confidence in the dollar. As theWall StreetJournalnoted,“Centralbanksinemergingmarkets are diversifying their foreign reservesinto hard assets, as the US dollar continues todepreciate.”

This also provides ‘official’ endorsement ohighgoldprices.Indiaboughtatabout$1,045perounce.

(more importantly) mill and treat so muchoreatatime.

Therefore, asa mineprocessesmorelow-gradeore,itsoutputofgolddecreases.Onceamine is operating at maximum capacity, itcan’t process a higher volume of ore tocompensate for the lower amount of gold itcontains.

This doesn’t mean its profits decrease.

Remember, the smaller volume of metal isbeing sold at higher prices. But as miningcompanies shift production to lower-gradeores, less gold is being supplied to themarket.

Thustheparadox: highergold pricescanmeanlowergoldproduction.

Of course, not all miningexecutives runtheir operations this way. Many are short-sighted and chase short-term profits, event ho ug h t hi s d am ag es t he ir l on g- t er mprospects. That’s why rising prices tend to

push production up (at least they used to,beforegoldpeaked).

Nevertheless, it’s not as strong of aneffect as you might expect. And for thoseanalystswhosayrisinggoldpriceswillresultin a ballooning of mining supply, considerthis:

Asgold’spricequadrupledinthelastdecade,

itsminingsupplyfellby19percent.

That’salltheproofweneed toshowthata rising price will not necessarily increasesupply.Ithasn’tdonesoforthelastdecade,sowhywoulditsuddenlystartnow?

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Thisis thebiggestcentral bankpurchase forat least 30 years. To find anything comparable,we’d need to look back to the US government’spurchasesinthe1930sand1940s.

AsJamesMoore(theLondonanalyst

forTheBullionDesk.com)commented,“Centralbanks,ratherthanbeingnetsellers,arenowlookingatbecoming

netbuyers.”

Whenasourceofsupplyswitchestobecominga source of demand, that’s a huge shift in themarket.

Analystsnowexpect other countries tofollowIndia’s lead. Forexample, since2003, China hasexpanded its reserves by 76 percent, and hastalkedaboutbuyingmore.

Russia and Brazil are also rumored to be inthemarketforlargeamountsofbullion.

AnalystsPredictGoldat$5,800

Investment analysts MaryAnneand Pamela Aden recently published a fascinating report.Theycomparedtheongoinggoldbulltodaytothegoldbullofthe1970s.

According to their analysis, if today’s bullfollows the same path as gold did from 1976 to1980,goldwouldhit$4,100perouncesoon.

And if gold today repeated its performanceovertheentiredecadeofthe1970s,thenitwouldhit$5,800.

Sound outrageous? Not at all. As the Adenscommented, “With today’s bull market being farmore global in scope compared to the1970s, wecouldeventuallyseethesemuchhighergoldpricetargetsrealized.”

If gold continues to spike up sharply, thiscouldverywellattractbroadmarketinterest.Forexample, only about 0.4 percent of managedglobalassetsareinvestedingold.

In fact, the CEO of the World Gold Councilrecently predicted this could “easily” rise to 1-2percent.

AShrinkingWindowofOpportunity

As I write this, gold is blasting up to newhighs, up above $1,100. I think it won’t be toolong before gold that’s ‘only’ $1,100 will be adistantmemory.

How long before the “peak gold” scenarioignites thegold market? There aretwoways tolook atit:from physical reality,or from investorsentiment.

Physically,wecanlookattheongoingcollapseofnewgolddiscoveries,whichstartedin2000and2001. This is terrible news for future gold

production.

However, there’s roughly a 10-year delaybetweenanewgolddiscoveryandthefirst ouncecomingtomarket.Therefore,thefullimpactof‘nonew discoveries’ hasn’t been felt yet. We’re stilc oa st in g o n t he m om en tu m o f p re vi ou sdiscoveries.

Whenwill it hit themarkets?About10yearsafteritstarted.Inotherwords,2010and2011.

Yes, that’s starting next year. Twelve totwenty-fourmonthsatthemost.

Of course, themarket won’t necessarily waitfor the physical reality to manifest. Like anyothermarket,gold’spricecanbedrivenuppurelybyinvestor sentiment. And oncethetruthaboutpeak gold gets out, investors might “buy therumor” and stampede into gold even before theactualphysicalimpacthits.

Just think of peak oil. In a short period otime, it went from being considered a wackonutjob idea to a serious model for explainingmarketbehavior.Andoilwent upbyalmost 500

percentinjustfouryears!

Ofcourse,peakoil is old newsnow. But peakgoldisonlyunderstoodbyindustryinsiders—sofar.

Oncethisstorybreakstothebroadermarket,I thinkitwill light arocketundergold’s price. Iexpectthistobeoneofthebiggeststoriesingoldoverthenext12-18months.

Youhearditherefirst!

Gold and Energy Advisor Nov 2009

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