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Why It's a Government-Guaranteed Bull Market in Gold

By Matt Badiali, editor, S&A Resource Report
Thursday, January 31, 2008

You need three things to operate a gold mine: water, roads, and power...

Water to leach the metal out of the ore. Roads to get supplies and workers to and from the site. And finally, electricity to run the equipment. If you're missing any one of those three things, the mine is useless.

Miners are facing overtaxed infrastructure all over the world – water in Mexico, roads in India... and the granddaddy of all problems right now: electricity in South Africa.

In February 2006, blackouts blanketed southwestern South Africa and shut down Johannesburg. The utility blamed faulty transmission lines. Since then, the country has made little progress in improving the grid. Rolling blackouts are now a fact of life in the country.

Millions of people live without electricity for up to five hours at a time – no traffic lights, no refrigeration, and now... no gold mining.

South Africa's power problems won't have much effect on the average American. But from an investor's perspective, it's a huge deal. South Africa is the world's largest gold-producing country. It also produces three-quarters of the world's platinum. Last week, lack of electricity shut down the country's mines.

The price of gold hit $909.75 per ounce on January 15, then headed lower. By January 23, the yellow metal fell $20... a 2% fall in just six trading days. However, South Africa's problems sent the gold price to an all-time high of $923.95 per ounce on Monday

The U.S. Geologic Survey estimates South Africa's mines produced 8.68 million ounces of gold in 2006. That's 23,780 ounces of gold daily. In today's market, that's $22 million worth of gold every day.

The mines in South Africa are some of the deepest in the world. Imagine working a mile and a half below ground... and the lights go out. Losing electricity doesn't just turn out the lights. It cuts off the air supply and the means to escape the mines. That's why the mining companies shut them down.

South Africa has to make huge investments in electrical power infrastructure... new plants, new substations, and new power lines.

That means even more investments... in either coal, nuclear energy, or gas turbines... plus the country needs to contract fuel supplies. In Nevada, Newmont Mining invested several years and millions of dollars to build a 200-megawatt power plant. The company projects a savings of $25 per ounce in production... and it produced 5.9 million ounces of gold in 2006.

Newmont's management understands the value of investing in infrastructure. The question is, will South Africa have the means and the political will to do the same? I think the country will slap a Band-Aid on the problem in the short term – raising prices, forcing conservation, and trying to eke out more supply from its power plants.

We can blame South Africa's power problems on the government. Politicians love to mess with the free market, particularly when it comes to utilities. Gold's rise against paper currencies is also government related. The U.S. government, for instance, has helped push down the value of a dollar by 37% in the past six years.

So... the biggest threat to gold's bull market is the chance that the world's governments will suddenly become thrifty and foreword thinking.

I think you know the likelihood of that happening... which is why it's still a great idea to own gold for the long-term.

Good investing,

Matt Badiali

Market Notes


I apologize if today's chart makes you choke on your coffee...

Below, you'll find the S&P 500 measured in terms of "real money," gold. By measuring stocks in terms of gold, we get a rough idea of how far our stock profits are going when we buy things like milk, hotel rooms, health insurance, gasoline, airplane flights, and homes. All of these things cost much more than they did eight years ago.

You see, stocks in general have gained 69% since the beginning of the bull market in 2003. This return sounds great until we realize gold has increased 165% during the same time. In other words, stocks aren't even keeping pace with inflation.

As you can see from today's chart, the S&P 500 bottomed in real money terms in 2003. It staged a small rally lasting into 2005. Since that rally's peak, stocks have been whipped, losing 50% of their value against gold... By looking at stocks in terms we can eat, drink, and travel on, it's no wonder our relatives are asking how to "get in" on gold.

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