Inflation Drives Price of Gold

"Inflation is Here... Time to Buy Gold is Now

There’s no doubt that the Treasury is printing more money to battle today’s economic crisis. The question is, why isn’t gold shooting to the moon?

Gold should be at $2,000 an ounce by now. It’s not, but it has climbed 21% since the markets started falling apart. As I write this people are selling gold to buy dollars or to free up cash. But this can’t last; it’s just a knee-jerk reaction to the latest equity sell-off. The most likely scenario is that once the weak hands are out, inflation will kick in and gold will rally strong.

In fact, there is evidence that central governments are starting to hoard it. In the second week of October, the cost of borrowing gold jumped by a factor of 3 to 2.68%, the highest since May of 2001. Historically, a jump in the lease rate registers before a boost in price of the metal itself. This is a bullish sign. Gold is heading back above $1,000.

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With governments around the world sweating out failing banks, they’ve stashed 30,000 metric tons, or 25%, of all aboveground gold in existence.

The funny thing is that, even with gold going up in dollar terms and soaring in euro terms, gold stocks haven’t gone up at all. In fact, they’ve been slaughtered. Our old friend, Barrick Gold Corp (ABX:NYSE), is down 13%, and it’s at nearly half its 52-week high at $30.

It’s Inflation, Stupid!

Here’s the deal: Inflation is here and more is coming. It will be the story in six months.

Take out a Post-it note and write “It’s inflation, stupid!” Stick it on your monitor. Don’t let anyone tell you different. And when inflation is running in the double digits, and people are complaining about the high price of everything, you can smile inwardly knowing that at the very least you bought gold.

But don’t just buy gold… buy gold companies.

You see, when gold goes from $800 per ounce to $1,000 per ounce (a 25% jump), cash flow in major gold companies like Barrick goes up between 43-51%, which is a 2-to-1 leverage factor.

I like Barrick going forward. It spent a lot of money last year undoing most of its gold hedges so that it could profit from the higher prices. It also went on a buying bender investing in more than six mines. Barrick now owns 27 mines around the world, and produces more than 8 million tons of gold a year. It is the world’s largest producer. In the current credit crunch, the competition will find it difficult to start new mines.

Global Mine Production Is in Decline

They aren’t making any more of it. Global gold production is in decline. In 2005, global mine production was 2,550 metric tons. In 2006 it was 2,481 metric tons, and in 2007 it was 2,447 metric tons — a drop of 1%. Old gold scrap and inventory also declined by 3%.

On the demand side, jewelry, industrial, bar and coin, and ETFs increased by a total of 4%.

Barrick Is Making Money Like It’s Lying in the Ground

According to second-quarter SEC documents, Barrick increased net income by 22% to 56 cents a share. Cash margins increased by 68% to $477 per ounce.

Second-quarter gold production was 1.86 million ounces at a total cash cost of $417 an ounce, and copper production was at 87 million pounds at a total cash cost of $1.08 per pound.

Barrick continues to be in line with its gold production guidance for 2008 of 7.6-8.1 million ounces, but with full-year production tending towards the low end of the range. That said, with the price of oil (a large cost) dropping, Barrick should benefit on the cost side.

You could almost buy any gold company at this point. I’d suggest you buy Barrick Gold Corp (ABX:NYSE) at market.

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