Price of Gold Will Continue to Climb, Consolidation Phase is Normal

In today's economic environment, the big money is being made in the natural resource sector.

Certainly, the "easy" money was made by those who invested in the resource stocks before 2000.

But we remain convinced that the big money in the trend is still ahead...especially in the gold market. Since 2000, of course, the price of gold has better than doubled, but the quality gold stocks have gone up much more... 400%, 1,000% or more. Over the last 12 months, however, gold and gold shares have been languishing. But don't let this listless gold price action fool you. The current bull market in gold has the potential to produce an astonishingly powerful and enduring advance from current levels.

The only fundamental reason for the price of gold to go higher is when competing forms of money - usually paper money - lose their purchasing power. For instance, if you lived in Zimbabwe today and were offered an ounce of gold or a brown paper bag of rapidly depreciating Zimbabwean dollars, what would you take? (Hint: take the gold; inflation in Zimbabwe is so bad that a roll of toilet paper now costs over 200,000 Zimbabwe dollars.)

But the world doesn't trade off the back of the Zimbabwean currency unit. That honor belongs to the U.S. dollar which, as you are no doubt aware, has evolved into the de facto reserve asset of virtually every central bank in the world today.

That the unbacked currency of one country is now the core holding of all the countries in the world is unprecedented in the history of the world.

Books have been written about how it happened. The short version of this fascinating story is that it came about as a direct result of the U.S. being the "last man standing" after World War II. In 1944, as the war wound down, delegates from 44 war-battered countries gathered at Bretton Woods, New Hampshire, and, after some arm twisting, agreed to accept the role of the U.S. dollar as the currency of global commerce. The decision to make the greenback the supreme currency was made easier because, as a component of the Bretton Woods agreement, the U.S. agreed to make it forever convertible into gold.

Unfortunately, when dealing with politicians, "forever" has a different meaning than to regular folks. In 1971, when a rush of European dollar-holders began converting their greenbacks into gold, Richard Nixon unilaterally canceled the dollar's gold convertibility. From that moment on, the U.S. dollar became an abstraction, backed by nothing at all... and unrestrained by anything other than political whim.

The growth of dollars outstanding since Nixon ended convertibility has been stunning. There are many implications attached to this global flood of unbacked money. But the primary concept to understand is that the supply of dollars increases rapidly; the supply of gold increases slowly. The debasement of the dollar knows no limits. Over time, therefore, gold's value in dollars should increase substantially.

Since the end of gold convertibility, there have been no limits on what the politicians can promise or what they can spend. A fresh example is provided by the subprime credit crisis, in response to which the government has gone on record stating it would provide "unlimited" credit to banks.

But "credit creation" is just a clever way of saying: "dollar-printing." That's why credit creation is a dangerous game - one that threatens to eliminate the U.S. dollar as a serious competitor to gold.

Any number of the investors who entered the gold trend early look at the price action of the yellow metal over the last year - which has been flat to slightly down - and worry that this is a sign that this gold bull market is over.

What they are doing is letting their emotions run their investment portfolio, a classic reaction during the "Wall of Worry" stage of any bull trend. They have made big money in gold shares, they understand the fundamental arguments, yet declining prices or volatility in the shares (which is especially prevalent in the summer months) gets them to thinking, then worrying, then selling.

Big mistake. Look at the chart below. It is the price of gold during the height of the last major gold bull market. Notice the long, almost two year, decline right in the heart of the trend.

That is what we are looking at now... a very normal, to-be-expected consolidation phase. Understanding that fact opens the door to big profits. Right now you have the unique opportunity to buy the very best junior gold companies at a Wall of Worry discount, in essence taking an extraordinarily profitable, time machine trip back to an earlier point in this long trend.

When buying gold stocks, investors always face two basic choices: Major companies or "juniors." The first, more conservative path, is to choose from among the big gold stocks - the larger producers that will find favor with the big money institutional players and hedge funds. These giant mining concerns will, when things get rolling, provide solid double- and even triple-digit returns. In the last resource share bull market, triggered by a series of major discoveries in the mid-90s, for instance, Kinross went up 197% over a two year period; Barrick went up 57%; and Newmont 74%.Nothing to sneeze at when compared to "traditional" investment sectors.

The second, and most exciting path, however, is to invest in the better-quality junior gold stocks. These are the junior Canadian stocks overseen by seasoned exploration geologists - many of whom used to work for a major - who use their knowledge and investor capital to find prospective new geology. When they find something, they typically joint venture it to a major company, who spends the high-risk money on follow-up drill programs. Alternatively, the junior company will sell its projects, or even itself, to one of the majors.

Returning again to the mid-90s resource stock bull market provides a measure of the potential of the junior exploration companies: Cartaway, up 26,040%; Arequipa Resources, up 5,692%; Francisco Gold, up 3,350%.

Over the last few years, a record amount of money has gone into exploration programs around the globe - money which will start coming back in the form of major discoveries in the next year or two. Pick up your shares now, then plan on holding them as this gold bull trend regains momentum. In other words, buy right and sit tight.

Furthermore, given the financial turmoil gripping the world just now, gold-related investments provide extremely important diversification of risk. In times of crisis, gold shines particularly bright.

But don't delay getting on board this trend. The slow summer months, coupled with Wall of Worry concerns, are depressing the prices of many premier gold companies. So the time seems opportune to build a portfolio that makes the most out of gold's long-term advance.If the price of gold is going to $1,000 an ounce, you'll want to be along for the ride.

David Galland
for The Daily Reckoning Australia

David Galland is the Managing Editor of Doug Casey's International Speculator, now in its 27th year. Today, it is following over 30 high-quality resource stocks on behalf of subscribers, with new buy and sell recommendations monthly.

 

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