Why Aren't the Producers Moving Up With Gold?

|
Includes: ATADF, GLD, KMKGF
by: Equedia Network Corporation

Before we get started this week, I want to share something that will shock you.

The US now ranks 190th in the World in account balance.

The account balance is a country's net trade in goods and services, plus net earnings from rents, interest, profits, and dividends, and net transfer payments (such as pension funds and worker remittances) to and from the rest of the world during the period specified.

China ranks number one with a positive balance of $272,500,000,000. The US? Ranked number 190th in the world with a negative balance of $ -561,000,000,000.

Countries such as Haiti, Kosovo, Uganda, Rwanda, Zimbabwe, and Vietnam all have better balances than the US.

Take a look at the rankings here:

Click Here for Account Balance (1 - 95)

Click Here for Account Balance (96 - 190)

With US debt continuing to climb and interest rates at all time lows, you can see why I continue to be bullish on gold and bearish on the Dollar. Which leads us to a question I get asked a lot: Gold is up big, so why aren't the producers up higher?

The Difference Between Gold and Gold Producers

It seems logical that as gold prices move up, the big gold producers should make more money. But that isn't always the case.

Especially now.

Often times, gold moves with the price of oil - especially in a situation where there is risk and tension involved. I hate using the word "war" but the unrest in the Middle East has only gotten worse, leading to a further drain in the worldwide supply of oil.

I've always liked oil and gas. It's a cash flow business and much simpler to value than precious metals or other commodities. It gets used up and once it's gone, it's gone. We are far, far away from any real "green" alternatives. This makes oil the most preciously traded resource.

I have been predicting that oil will hit $100 over the last few months. The growing unrest in the Middle East only adds more fuel to that theory. While there are many that say these oil prices won't last, I am not so sure...yet. As long as there is tension in the Middle East, there will be room for oil's advances. Unless you believe the situation will just disappear, oil prices will remain high.

We know the demand for oil hasn't changed much. As a matter of fact, given the high price of oil, demand should diminish in an economy that's trying to pick itself back up - which would lead to lower oil prices. But the fear factor is once again in play. Oil is rising because of fear and risk, and not macro-economic growth.

And that's what we're seeing. The overall stock market dropping, as oil rises.

Barclays has estimated that one million barrels of oil per day has been shut down from the world as a result Libya. But is that enough to justify the climb in prices? Just as the Greek crisis took oil down, the unrest in the Middle East is forcing it up. So it doesn't matter if it's justified - the market plays on perception, not reality.

I expect prices to climb even higher in the short term, and would not be surprised to see $120/barrel. Whether oil remains consistently at those levels in another question, but the fact that oil could hit $120 could have negative consequences. We'll likely see $105 by the end of next week which should give us another great opportunity to profit from oil's run like it did in 2008.

But we all remember what happened after the run in 2008, when oil hit $147. How can we forget?

While we can make a lot of money from knowing that oil could reach $120, it wouldn't be good for the overall economy. It would be downright brutal.

$120 oil is the level that oil as a share of global GDP starts to move above 5.5 per cent of GDP, which has historically been an environment where global growth has come under pressure. We've seen this over and over again, with our most current reminder in 2008.

We have seen a major increase in the price of oil in the last two years, and every time we have seen oil prices rise 120 per cent over a two-year period there has been a recession, with the exception of 2006 when the housing boom counteracted the price movement. This time around there won't be a housing boom to mitigate the effects. And the world knows this.

Saudi Arabia and other OPEC nations have already talked about replacing any lost Libyan oil. But that may actually lead to higher prices in the long term.

Right now, the price of oil is kept in check because there is around 5 - 6 million barrels a day of excess capacity on a global basis, with the majority of this in Saudi Arabia. But if they start to make up for short falls elsewhere, such as Libya, that spare capacity still never drops. That means that oil has to be made up from the overall supply, leading to higher overall prices in the long term.

Although I prefer to say otherwise, the unrest in the Middle East has just gotten started. That means continued high prices for commodities and continued high prices for oil and gas. It's not rocket science. Whenever there is war, tension, unrest, or whatever word you choose to use, energy, food, and resource prices go up - including gold.

So now we go back to the question. Gold is up big, so why aren't the producers?

Why have we seen Barrick (NYSE:ABX), Goldcorp (NYSE:GG), Kinross (NYSE:KGC), Newmont Mining (NYSE:NEM), Agnico-Eagle Mines Ltd. (NYSE:AEM), and Yamana Gold Inc. (NYSE:AUY) all drop 2-7%, as oil climbs 2%.

Gold producers require a lot of energy to pull the gold out of the ground and energy costs a lot of money. As a matter of fact, the majority of the costs associated with producing gold is energy.

With the tension in the Middle East and the media outlets screaming $200 oil, this puts a very dramatic constraint in the profits for the big producers.

Commodity prices, labor costs, and energy prices are rising around the world. When you have high oil prices and high labor costs, the bottom line for the gold producers drops significantly - even if gold climbs.

Furthermore, big producers are forced to mine for lower grades, as the higher grade ore deposits are running out of steam. That means for every tonne of processed rock, producers are yielding less gold, which leads to less money.

If oil continues its climb or remains at these levels over the coming months, you can be sure that these big producers will have some disappointing quarterlies. For these producers to satisfy shareholders, they'll need to produce more gold to continue revenue growth. They no longer have the luxury of high gold prices combined with $40-$60 oil, like they did last year. Ultimately, this means exhausting more resources.

So does that mean we should stay away from gold stocks? Nope. In fact, it's quite the opposite.

The SPDR Gold Trust (NYSE: GLD) and other Gold ETFs continue to climb forward and companies that aren't producers are still making a very strong run.

Last week we talked about Kaminak Gold Corporation (OTCPK:KMKGF), ATAC Resources (OTCPK:ATADF), and Northern Dynasty (NSK). Two of them made advances this week while one remained steady, despite oil climbing higher. Why? Why are they climbing when the major producers are falling?

In order for the majors to keep up, they need to produce more - especially with higher oil prices. The market forces these majors to increasingly exhaust resources because every investor wants to see increased revenue.

There are only a few ways a major can increase its value besides having gold prices climb, when energy costs stay consistent. They can either increase production, or acquire other gold properties and add to their reserves.

The majors do not explore. They let the juniors do the work. While they may invest in the exploration programs of the juniors, they rarely get their hands dirty. Their job is to produce as much gold as they can, in the shortest time possible. Because of that, they need to replace their dwindling supply, which means they are always eyeing takeover targets. That's why there's a lot of money being poured into the sector.

Many of the juniors I have spoken with have had little problem financing their projects. The speculative investments from the funds and banks are rising quicker than ever, signalling a junior market that is becoming more bullish every day.

Disclosure: I own no positions in the stocks mentioned.