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THE
ROCKET SCHOOL OF ECONOMICS


An Unanswered Question.
by Professor von Braun

March 11th, 2006

Currently, given the rising gold price, the gold mining industry does not seem to be enjoying anything that resembles a resurgence as it once did in the early eighties, a period that led to the discovery of several new gold deposits. Instead we are hearing of a shortage of new projects, of declining production, rising costs and of little result-producing activity when it comes to exploration.

Two companies, Barrick and Newmont, now account for 25% of all gold produced in the world today, and Canadian miners account for much of the gold production within Australia, the United States and Canada. It could be said that Canada, not South Africa, is now the largest gold producer in the world.

In turn these 'major' miners have share registers heavily influenced by mutual funds, not the strongest of hands, since they depend upon inflows of investors funds, have little option as to where to put these funds given the 'consolidations' of recent years, and little option as to whom to sell to should there be redemptions.

Takeovers and mergers have reduced the number of players within this industry considerably and I suspect it will get smaller still but not necessarily for the reasons given out by the companies themselves.

After all there is still the unexplained issue of hedge books and what to do with them in a rising gold market. Currently Barrick's mark-to-market liability is estimated by some analysts to be about $5 billion dollars -- a considerable sum. Certainly 18 million ounces, the amount hedged, is a lot of gold to deliver, even more so when rising energy prices are adding to production costs.

Now most industries would like to have bankers that allowed them to reschedule liabilities at will, which is what appears to be taking place when it comes to the apparent lack of margin calls one would expect with an often noted but never resolved increasing mark-to-market liability.

Then there is the unexplained withdrawal by long time player Rothschild and AIG from the London gold market in 2004 with Rothschild's seat going to Barclays and AIG's apparently going to Royal Bank of Canada.

In addition there is the recognition by commentators that there has been a shortfall in supply when it comes to satisfying demand for several years. This shortfall has been met with a supply of gold from somewhere other than official central bank sales. Reported forward sales by mining companies obviously accounts for some of this shortfall but these numbers are not enough to account for all of it.

So who is on the hook? Which central bank(s) have lent/leased their gold to bullion banks who in turn have sold it into a falling market with the intent of buying it back at lower prices only to have to deal with a reversal of prices and an actual increase in the demand for physical metal? Which bullion banks are on the other side of the hedging program Barrick touts as being so successful? Is there a plan by these bullion bankers to get that gold back at or in a different time frame to what Barrick has in mind?

Wouldn't that be something? But what's missing from the equation? Why Newmont of course! Should Barrick bid for Newmont at some stage and succeed the combined entity would account for 25% of all gold produced as well as having control of some of the largest gold reserves in the world. Hey presto -- there is the central bank gold back in the coffers once again.

Would Newmont reject such an offer? I imagine the management would but the offer would be targeted at shareholders and that means mutual funds. A review of the top 20 shareholders of both companies reveals that most of the funds that own Newmont also own Barrick, the notable exception perhaps being Fidelity Fund Management. I am sure that should this event occur, a sales pitch from Barrick and their investment bankers will target the synergies, the cost savings from reduced management, etc. At the end of the day it will be the bottom line shareholder value perception -- in this case fund performance, that likely motivates an acceptance.

Then a year or so out into an ongoing rising gold market enter the bullion bankers and it's goodbye shareholders. Is this an unlikely scenario? Well maybe, maybe not. But if you have 25% of total world gold production under one roof, much of it in 'safe' countries, coupled with an 18 million ounce hedge position and gold goes to $1000 per ounce that's going to dramatically increase the mark-to-market liability and how convenient it would be if there was only one door for the liability issuer to knock on.

Time will tell, but if Barrick ever announces a bid for Newmont it may be prudent to adopt a neutral stance until the issue of mark-to-market liability is clearly resolved.


The Prof can be contacted by email at profvonb2@aol.com

Copyright by Professor von Braun. All Rights Reserved. Reprinted at USAGOLD by permission.

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The Rocket School of Economics -- The Lecture Series Index

  • 22 May 2009 -- An Often Overlooked Issue!
  • 28 Mar 2009 -- Problematic Banking Systems!
  • 14 Nov 2008 -- What Exactly is an Asset?
  • 23 Aug 2008 -- Through the Looking Glass?
  • 02 Aug 2008 -- Compounding to the Downside!
  • 26 May 2008 -- Back to Basics Again!
  • 31 Mar 2008 -- The Broken Watch -- Part 2.
  • 27 Mar 2008 -- The Broken Watch -- Part 1.
  • 06 Feb 2008 -- The Financial Equivalent of Faulty Towers.
  • 10 Dec 2007 -- Monetary Systems & Productive Assets.
  • 14 Feb 2007 -- Divorced from Reality
  • 06 Sep 2006 -- Gold, Bankers, the Trade Deficit and Unsettled Transactions
  • 19 Jun 2006 -- When is a Reserve Not a Reserve?
  • 31 May 2006 -- The significance of August 15, 1971.
  • 08 Apr 2006 -- Keep Your Eye on the Ball!
  • 30 Mar 2006 -- What came first?
  • 11 Mar 2006 -- An Unanswered Question.
  • 08 Jan 2006 -- Where have all the projects gone!
  • 11 Dec 2005 -- Gorillas, Rising Gold Prices and Depreciating Paper Currencies!
  • 23 Oct 2005 -- Custodial Risk.
  • 16 Sep 2005 -- An Inherent Flaw.
  • 08 Aug 2005 -- Central Banks and 'Reserves'.
  • 31 Jul 2005 -- Central Bankers, Actors and 'We'.
  • 17 Jul 2005 -- Unintended Consequences! -- Part 3.
  • 07 Jul 2005 -- Unintended Consequences! -- Part 2.
  • 25 Jun 2005 -- Unintended Consequences! -- Part 1.
  • 14 Jun 2005 -- The Two Greater Fools Theory.
  • 03 Jun 2005 -- Real Money, Funny Money and YOU -- Part 4.
  • 30 May 2005 -- Real Money, Funny Money and YOU -- Part 3.
  • 26 May 2005 -- Real Money, Funny Money and YOU -- Part 2.
  • 21 May 2005 -- Real Money, Funny Money and YOU -- Part 1.
  • 09 Nov 2002 -- Carrying a Big Stick.
  • 17 Sep 2002 -- Wishful Thinking!
  • 27 Jul 2002 -- Gold Bugs Beware -- part 2.
  • 10 Jun 2002 -- Gold Bugs Beware!
  • 06 Apr 2002 -- Currencies versus Gold.
  • 26 Jan 2002 -- Bear Market Strategies.
  • 01 Jan 2002 -- 2002 -- A Perspective.
  • 20 Oct 2001 -- The Storm Clouds are Gathering.
  • 30 Sep 2001 -- What to Say?
  • 01 Jul 2001 -- ...Said the Fly to the Spider.
  • 14 Jun 2001 -- Upward and Downward!
  • 28 May 2001 -- Volatility Time, Again!
  • 14 May 2001 -- The Coming Bull Market in Gold Stocks?
  • 24 Feb 2001 -- High Hopes, Wishful Thinking & The Absurd
  • 20 Feb 2001 -- Who Put the Holes in the Swiss Cheese?
  • 22 Jan 2001 -- US Dollar Admits Identity Crisis!
  • 16 Jan 2001 -- Dear George W.
  • 24 Nov 2000 -- The Bubble Has Burst
  • 11 Nov 2000 -- The Media, Bull Markets & the Gold Price
  • 02 Nov 2000 -- Gold Stocks
  • 29 Oct 2000 -- Oh The Tangled Web We Weave ...When We Set Out to Deceive
  • 24 Oct 2000 -- A Mystery!
  • 16 Oct 2000 -- A Peso Here ...and a Few Thousand Pesos There
  • 10 Oct 2000 -- The Unfolding
  • 30 Sep 2000 -- What's Wrong with THIS Picture?
  • 25 Sep 2000 -- Buy Gold Now!!
  • 23 Sep 2000 -- The Times, They Are a' Changing
  • 15 Sep 2000 -- Time WILL Tell!
  • 27 Aug 2000 -- SS "Paper Assets" Begins to Take on Water
  • 06 Aug 2000 -- The Indian Summer
  • 26 Jun 2000 -- A Yellow Brick Wall
  • 22 May 2000 -- The King IS Naked
  • 30 Apr 2000 -- Goodbye Yellow Brick Road
  • 18 Apr 2000 -- Beware the Ides of March, April and May
  • 08 Apr 2000 -- Really, Sir Aldot!
  • 25 Mar 2000 -- Where To From Here?
  • 18 Mar 2000 -- The Gnomes of Zurich
  • 12 Mar 2000 -- The "New" Economy??
  • 06 Mar 2000 -- Two Questions
  • 04 Mar 2000 -- Iceberg Dead Ahead!
  • 28 Feb 2000 -- The Wizard of Oz
  • 06 Feb 2000 -- Here We Go Again!!
  • 15 Jan 2000 -- Comments on the Gold Market
  • 29 Dec 1999 -- No Raw Ingredients Required
  • 28 Dec 1999 -- No Way Out
  • 14 Dec 1999 -- Ho, Ho, Ho!
  • 07 Dec 1999 -- Greenspan's Bubble
  • 03 Dec 1999 -- Early Warning Signs


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