The Great Resource Bull Markets, Then and Now
By Doug Casey
[ed. note. In the following article, legendary speculator Doug Casey steps back for a historical perspective on current resource markets. You can learn more about Doug's renowned International Speculator newsletter, which each month focuses on providing unbiased recommendations on the world's most profitable junior gold, silver and metals exploration and development companies by clicking here.]
There is an old saying: to look into the future, you must first look to the past. A more Darwinian interpretation of this maxim is that those who don't learn from history are doomed to repeat it. In that context, studying the last great resource bull market may provide useful insights into the current unfolding commodities bull market.
A quick refresher: the period, roughly from late 1971 to early 1980, saw, among other things, gold rise 2,390%, silver 3,487% and crude oil 1153%. Naturally, a number of geopolitical and economic factors contributed to these gains. In an attempt to add some structure to this exercise, I'll use the 7 Ps, my trademark template for sound investments, to compare the resource sector of the 1970s to that of today.
In 1970, "mining" wasn't the dirty word it has become in today's politically correct world. Back then, getting a degree in geology or mining engineering was a perfectly acceptable career move, and such training could be had at any number of prestigious universities. Today, save-the-environment studies are many students' first choice, while geology programs have been partly, or, more frequently, entirely shut down. As a consequence, far more geos are retiring than graduating. You can see this at any mining convention: it's a sea of gray hair, or no hair at all. This may be bad for mining companies, but it can be positive for investors: the dearth of experienced exploration geologists and mining pros limits discoveries of new deposits and keeps supplies tight. It also makes it easier for us to identify promising companies; they're the ones attracting the best talent. These professionals write their own tickets in the current market, and therefore gravitate to the most prospective ventures. (For news on the most successful of these exceptional individuals, see our new Explorers' League.
In August 1971, after years of Johnson's "guns and butter" policy and its consequent inflation, Nixon unleashed the price of gold. Nixon's move had nothing to do with promoting free markets, about which he couldn't have cared less-as demonstrated by his simultaneous implementation of idiotic wage and price controls. De-pegging the gold price was really about defrauding the Europeans, who kept trading increasingly worthless American currency for gold at $35. In a classic case of unintended consequences, the dollar lost ground against gold further and faster than Nixon ever dreamed possible.
The '70s also saw escalating costs of the Vietnam War, the OPEC oil embargo in response to U.S. meddling in the Middle East, generally underpriced commodity markets, and large government deficits. All of these have even more serious counterparts today.
For example, we have a "hedonically adjusted" (which is to say, arbitrarily adjusted or politically corrected) U.S. inflation rate that has officially remained relatively low, but which many observers, myself included, suspect is actually much higher. And of course, we have the Forever War on terror, a wholehearted entanglement in the Middle East and threats to the crude oil supply from Iraq (and, in time, probably from Saudi Arabia and Venezuela as well)-all unintended consequences of the most bellicose U.S. foreign policy since Teddy Roosevelt, and maybe in history.
Given that the same kinds of moronic domestic and foreign policies at large in the 1970s are at work today, we have good reason to think prices will take off like they did three decades ago, starting from a similar low base.
That low base in "property" is important. Many people think commodity prices are higher now, but in inflation-adjusted dollars many key commodities are actually cheaper than they were before the last great commodities bull market peaked. For example, the current "record high" crude oil price of $68 is only $31.63 in 1981 dollars, when oil peaked at C$38.34. Gold, at $440, is only $185.55 in 1980 dollars, when gold peaked at $850. In fact, at $440 in 2005 dollars, gold is actually lower than it has been in 30 years save for the 2000-2003 period when it bottomed. At $1.73, copper today is at about half of the 1980 peak of $1.44. This doesn't mean prices can't temporarily go lower-for the short-term, given my overall pessimism about the U.S. economy, I'm particularly concerned about base metals-but it does paint a bullish picture for commodities for years to come.
Supporting this view is the fact that there have been no giant oil discoveries for 20 years, and discoveries of large mineral deposits are becoming similarly scarce, particularly for precious metals. This begs the question: are we seeing a Peak Oil-type phenomenon developing in minerals?
An 80-page report released by JP Morgan on January 24, 2005 projects falling gold production in South Africa and North America this year and states: "We believe that the larger driver for gold prices is the coming decline in gold production." This growing supply crunch, coupled with increased demand from both institutional and individual investors, could be the catalyst that takes gold over $500 this year. Of course, the companies we are following in the International Speculator that actually have resources in the ground-or are good at finding them-will rise by multiples of any gains made by these commodities themselves.
On the other hand, the collapse of the Soviet Empire and the opening of the Third World have made vast areas of the world available to new exploration. We also have new exploration and production technologies that simply didn't exist back in 1970 (to name two: using satellites to spot mineralization and using heap leaching to extract it inexpensively). Then there's China-communists in name, but capitalists in practice. I don't doubt that China has great geological potential, and we are currently following one particularly undervalued Canadian junior with a large gold deposit in that country, but I won't get overly excited about China as a home for my mineral investments until a fairly steady flow of Chinese projects begin making it through the minefield of local regulation.
At the right commodity prices, there is literally an infinite amount of mineral wealth out there. But mines are not like a McDonald's that you can knock together in a few weeks on any given street corner. A typical exploration cycle-the time it takes to find and evaluate a mineral deposit-is about two years. If a property appears economic, then the company has to engage in a lengthy and bureaucratic permitting process (ensuring there are no semi-rare salamanders in the area, for example). They also have to do the extensive and expensive drilling and mine plan analysis required to complete a bankable feasibility study, as well as raise the small mountain of cash necessary to keep the process moving along.
The bottom line is that it takes a long time to bring a mine into production, which means that for many metals, supply is relatively, if not absolutely, inelastic.
The Demand Picture
Of course, for prices to rise in real terms, demand has to outstrip supply. On the supply side, the situation looks extremely bullish for silver, copper, nickel and gold-significant new mine production of these metals is unlikely to be realized in the near term. But will demand continue to rise? As long-time readers know, I believe commodities are ultimately trending toward zero (once nanotechnology and other major new technologies live up to their potential), but we're a long way from there.
At this stage of the super-cycle, more people have access to markets than ever before, increasing their standards of living and therefore increasing their demand for resources. Starvation was a common phenomenon in the '70s; now former basket cases such as China and India are emerging as world economic powerhouses. Such developments never go smoothly, of course, and I'm concerned by the possibility of a cooling in the global economy affecting many things-base metals in particular. Long-term, however, the question is not "if" demand for commodities will grow, but, "How fast?"
Phinancing and Paper
A way to focus on the "paper" dimension of market conditions then and now is to look at how U.S. paper-Federal Reserve Notes-has fared. While inflationary policies and wasteful government programs dissipate wealth, they also tend to increase returns on commodities. While the U.S. government is busily manipulating the money supply, my guess is that inflation is not as far below the levels seen in the '70s-the highest inflation figures of the last half-century and a trigger for the commodities spikes of 1980-as the Bureau of Labors statistics would have us believe.
Remember: cycles do repeat, but never exactly. The relatively low levels of inflation up to this point in the current cycle could mean we are in for a longer, less volatile run. Or they could mean that inflation is being masked by the U.S., not just through hedonic adjustments and other statistical sleights of hand, but also through the recent devaluation of the dollar. This, in essence, exports U.S. inflation to other countries. That could change-with a vengeance-if the foreigners holding trillions in expat dollars ever come to doubt the value of that paper (or, more accurately, to recognize its true value, which is zero).
Devaluation of the U.S. dollar followed inflationary policies in the U.S. in the '70s. But this time around the dollar's collapse has brought very little inflation, as measured by the CPI. If U.S. inflation is actually higher than reported and/or kicks in at higher rates due to dollars held overseas flooding home, the leverage to investments in precious metals companies working in the U.S. is likely to be spectacular. That's because, as the dollar weakens and gold prices go up, companies with U.S. production will see their costs go down (in real terms) while their revenue improves. This is why I'm currently speculating on a several very prospective gold exploration juniors operating in Nevada-one of the world's most pro-mining jurisdictions.
It's also useful to look at U.S. equities during the last resource bull market. Many people believe the Dow, the S&P 500, and equities in general "traded sideways" during the period, but they forget to take inflation into account; the DJIA actually dropped during the '70s, in real terms, as steeply as it rose during the '80s and '90s. Given the amount of money tied up in U.S. equities, even a modest flight of capital out of those markets and into resource stocks today would be like trying to squeeze Niagara Falls through a garden hose. It's coming.
The equivalent here would be the market's mass psychology or zeitgeist. This is not something I can quantify in numbers, but it is clear that we have not yet reached the mania stage we had at the end of the 1970s, when barbers and bartenders were telling their patrons about the gold coins they'd just bought. Or, when people lined up around the block to sell their grandmother's silver. My sense is that we are beyond the early, contrarian phase when speculators can get in on the best opportunities for next to nothing. More and more people are waking up to the coming boom in commodities, and people like Jim Rogers are writing books about it for mainstream consumption. With good promotion like that, I think it won't be long before this market heats up to the mania stage and the high caliber gold and silver exploration and development companies we are following in the International Speculator turn into moonshots.
How high could gold and other commodities go in this cycle? Some people think I'm trying to be controversial when I talk about $1,000 gold, but to my mind, that's a conservative estimate. Reversing the then and now price comparisons shown earlier, gold's peak at $850 in January of 1980 would correspond to $2,015.66 today. $50 silver then would be $118.57 silver today. $42 uranium then would be $99.60 now. $1.44 copper would be $3.41. And $38 crude would be $90.11. Recent price increases are, at most, only the beginning. Silver, in particular, is still near a long-term historic low.
At the beginning of the '70s bull market, we had just come through a long period of underinvestment in resources, post-depression, post-WWII. This was particularly true for gold, due to price controls. Today, the situation is eerily similar. The analogy includes, among other factors, a "guns and butter" mentality within the U.S. government that has the printing presses-weapons of mass devaluation-going flat-out around the clock, and the fact that we are coming out of a long period of under-investment in resources. Again, this is particularly so in gold, which hit near 25-year inflation-adjusted lows in 2001-a trend perhaps exacerbated by the misallocation of investment in the tech bubble.
When considering the recent correction in precious metals, it's worth remembering that there was a massive slump in the middle of the '70s, not just for the resource sector, but for all commodities and for the U.S. economy as a whole, including equities. This led to the highly inflationary "economic stimulus" policies of the late 1970s. One could certainly argue that these developments are similar to the low metals prices and bear market suffered by U.S. equities in 2001-2002 and the extremely loose Fed policies that followed.
Having said that, while it is interesting to compare the cycles then and now, it is important not to try too hard to find a perfect match. This time around, we aren't coming out of a long period where the price of gold was officially fixed (though, according to GATA.org, the price may still be suppressed by government policy). And today, we have massive creation of wealth in countries such as China and India.
While only a guess, I suspect we are currently in about the 4th inning of the new resource bull market, a cycle that will surprise most investors with its strength and duration. However, the savvy investor should always remember that the market never runs out of surprises; there is no "sure thing". As prices rise, the masses will tend to cut back and consume less, potentially just as operators are cranking up production (at least in those markets where they can). The market will go up, but it will also go down. Overall, though, I expect we'll be looking at higher lows and higher highs for years to come.
The best way to play this cycle is to buy good companies on the dips, recover your initial investments on bounces that give you a double, and then sit tight and be right. In time, when commodities take off to the moon and Business Week starts running front-page stories about the great resource boom, we at Casey Research will be looking to make an orderly exit and move on to what's next.
Doug Casey, legendary natural resource speculator and author of "Crisis Investing", one of the best-selling investment books of all times, has helped tens of thousands of investors become a great deal richer. His monthly newsletter, the International Speculator, which is now in its 26th year, recommends almost solely companies that can be expected to generate a double- or triple-digit return within a year. For a limited time only, you can receive his latest subscriber-only report 10 Best Values in Resources Stocks -- risk-free! Click to read.