U.S. ELECTIONS IN 2006: LET THE GIVEAWAYS BEGIN!!! WHY GOLD AND FOREIGN CURRENCIES WIN WHEN THE U.S. ELECTION SEASON HEATS UP
The entire House of Representatives and one-third of the Senate is up for re-election in November 2006, and it looks like the incumbents are giving away as much as possible to buy votes. The first phase will be cash giveaways as damage control for the poor Federal response to Hurricane Katrina. Congresspersons and senators are part of the federal bureaucracy. Although they represent individual districts that may be far from the hurricane site, they are afraid of being swept from office by a general national feeling of disappointment that the Federal government was slow and inefficient in responding to the disaster. It would not be the first time that the electorate exhibited disdain for incumbents in general.
The second phase will be the traditional local giveaways to all kinds of voter blocs. The Federal Highway bill that recently passed will go a long way to create jobs, and soon, a major effort will get under way to keep the housing market from imploding before the election. Both of these projects will add massively to the federal budget deficit.
We can expect pressure on the Federal Reserve to not raise interest rates, even though the economy is going to get a boost due to the hurricane rebuilding efforts (enough to counteract much of the economic slowdown caused by high oil prices). We also expect unwise and ineffectual (but politically expedient) verbal attacks on the oil industry, oil pipeline industry and the oil refining industry, blaming them for high gasoline and home heating oil prices. Before it is over, the politicians will have shifted as much blame as possible for their general ineffectual administration to as many others as they can.
In my opinion, the world financial markets are too smart to buy this generalized idiocy. Unfortunately the electorate may not be that smart. The financial market participants know that over spending, expensive waste, and general bad planning have led to the current problems in the U.S. They know that you must measure a country by its financial performance, its trade balance, balance of payments and current account figures. The U.S. has failed in these departments.
The market participants will, like refugees everywhere have done for many centuries, vote with their feet. In this case, voting with their feet means buying less U.S. debt and fewer U.S. dollars. They will shift into other currencies such as gold, the Canadian dollar, Euro, Swiss Franc, British Pound and others.
GOLD SHARES: ANALYSTS, OVER A PERIOD OF TIME, MAY PREFER ROYALTY COMPANIES
Gold shares will benefit more than gold itself because they are, as operating entities, leveraged. Once their cost of goods sold is exceeded, they are able to allocate revenues to cover corporate overhead, interest, debt service and taxes. After adding back certain line items like depreciation, cash flow is available for expansion of their capital budget and thus, expansion of their business enterprise.
The problem is that many gold mining companies, especially the smaller ones, have limited access to capital. If internal cash flow is not sufficient to finance their operations, conventional debt financing may not be available to them due to their newness and small size. These companies often use forward sales and derivatives to finance the expansion of their mines. This can be unwise, as it impacts their ability to profit from the rising price of gold, which will be forthcoming in my opinion. It may also endanger their capital structure and thus, their very existence.
Often, opaque means are used to keep the public from easily understanding what their debt and derivative positions actually are. These means are legal and meet with accounting conventions, but they are hard to decipher.
The presentations differ depending upon the style of operation and the forthrightness of management. One way investors can easily avoid the pitfalls of derivatives is by owning stocks of companies that are recipients of royalty payments. These companies own valuable mineral bearing properties, which are leased to other mining companies. The royalty paying companies have capital and access to financial markets to develop properties. The royalty receiving company is not required to borrow or sell derivatives in order to finance the mines on their property.
The royalty recipient does not have to operate these mines and undergo the immense responsibility for the health and welfare of the mine employees. They do not have to worry about the myriad aspects of running a mining company in a third world country. They only have to make sure that the contract they enter into with the company responsible for building and operating the mine has certain characteristics. It should call for timely and substantial expenditure of resources, an appropriate level of royalty payment, and for clear accountability to the royalty paying company of all plans, the implementation of these plans and the financial results.
As an analyst, it is extremely time consuming to examine the financial statements of many small gold operations. This is because many of the important issues are not obvious from a first level examination of the statements. Discussions with management and the accountants may be necessary to understand the accounting conventions that are employed. This is not the case for royalty companies.
For this reason, as a professional investor, I favor royalty receiving companies for a clear and concise understanding of their outlook. Accordingly, I believe that over time, analysts will evaluate royalty receiving companies more favorably than non-royalty companies that employ the use of derivatives (assuming that both companies are of comparable size and quality of reserves).