We’re Taking Advantage Through This Low-Cost Producer
Last month, China’s “Fort Knox” got several million ounces bigger…
On February 24, Venezuela announced Citic ? the Chinese state investment company ? would help develop Las Cristinas, the largest undeveloped gold deposit in South America and a classic “trophy” asset.
Las Cristinas contains at least 16.9 million ounces of gold. (And that calculation is based on a $550 per ounce gold price… At today’s $1,700 an ounce price, its reserves should be much greater.) And it will be a simple, giant open-pit mine. The capital cost will be just $356 million. So once the trucks start hauling off its ore, Las Cristinas will be wildly profitable…
It’s exactly the kind of gold deposit China wants to bolster its gold holdings. The deposit used to belong to a Canadian mining company, Crystallex. With the prized Las Cristinas at the center of its portfolio of assets in 2007, the $1.2 billion company looked like a company on the rise…
But then Venezuela’s strongman president, Hugo Chavez, decided he had other plans for the resource. Suddenly, Crystallex’s environmental permit application had mysterious problems. The government blocked the development of Las Cristinas and dragged the process out over years.
Finally, in February 2011, the Venezuelan government canceled Crystallex’s contract. Chavez literally confiscated the gold deposit without explanation. Crystallex’s market value fell to $23 million. It shut its doors for good, delisting from the Toronto Stock Exchange before the year ended.
And look who Chavez brought in to develop the project…
Chavez and the Chinese go way back… China lent Venezuela more than $30 billion in 2007 to develop oil projects. And it became officially involved in Las Cristinas in June 2010, when Crystallex announced a deal with China Railway Resources Group to “help” the company develop the project.
Last month, Chavez handed the Chinese exactly the kind of trophy asset the Chinese are scouring the world to find. What’s happening to Las Cristinas is just another chapter in the big story we introduced last month…
China is engaged in a huge, shadowy program to accumulate as much of the world’s gold supply as it can. This “gold grab” has provided a huge source of buying support for physical gold… and made China the No. 1 gold-producing country in the world, as well as one of the largest shoppers for the world’s best gold deposits. This month, we’ll look into a great value play in this story…
China Picks Up Another Asset in its Gold Binge
China is trading its dollars for gold as fast as it can. (It owns fewer Treasurys now than it did a year ago.) Bullion, individual gold mines, or entire companies… it doesn’t matter. China wants gold in massive volumes…
You see… over the last 30 years, China’s overwhelming success selling its exports to the world has resulted in a massive foreign currency reserve, equal to about $3.2 trillion… Roughly half of that is in U.S. government bonds… But the United States’ policy of printing endless new dollars to pay off its mountainous debts has created a problem for China.
If China hangs on to those bonds… it could see their value “inflated away.” But if it tries to dump those bonds, it would flood the market. And the value of its bonds would collapse… So instead, China is trying to secure the value of its reserves against inflation by buying gold. The country has official gold reserves of 33.9 million ounces. But it plans to get more…
But part of China’s strategy is to comb the globe for world-class gold deposits it can buy for cheap. We saw it in action in November 2011, when the government-owned Chinese gold company Shandong Gold Group bought gold company Jaguar Mining for $1 billion. And we saw it again with Las Cristinas.
China’s concerted effort to acquire valuable gold properties around the world will increase the value of many mining companies… whether or not they are targeted directly by the Chinese. To take advantage of the trend, we want to own world-class, trophy gold deposits now.
Is it worse to be the conman or the dupe?
The United States has racked up more than $15 trillion in debt… Our government’s debt is almost certain to exceed the U.S.’ annual gross domestic product (GDP) in 2012. And in the last 100 years, no government that accumulated debts exceeding 80% of GDP has ever repaid those obligations in sound money.
Add to that the personal debt (credit cards, car loans, etc.), state and local government debt, and corporate debts… and America’s total debt comes to about $56 trillion. The GDP of the entire world is only $64 trillion. So what the U.S. owes represents nearly 90% of the entire world’s GDP.
Surely, no one can imagine the U.S. will pay off its debts honestly and fairly… We can’t. It would take generations to work off those debts, and our political climate has no tolerance for the hopeless economic stagnation that would represent.
No, our choices are outright default or creating colossal sums of money and inflating the debts away.
That’s the con… By severing the dollar’s tie to gold and borrowing seemingly infinite amount of money over the past 40 years… the U.S. government is now about to leave its creditors around the globe in the lurch.
The predicament will inflict severe consequences on the U.S. and its citizens’ standard of living… but it also leaves our creditors in a Catch-22… They could insist on repayment in some kind of sound money… and essentially force a default. That would leave them with staggering losses to their treasuries. Or they can stand by as we devalue the dollar and repay them in near-worthless dollars.
It’s a bind… But one of our creditors ? the Chinese, who currently hold about $1.5 trillion in U.S. debt ? has other ideas. They don’t intend to be anyone’s patsy…
China’s $3.2 Trillion Crisis
China has a huge, $3.2 trillion problem.
Over the last 30 years, China built a massive economy on its exports. Its companies sell cheap goods to developed economies like the U.S. and Europe. From 1980 to today, China’s foreign currency reserves have swollen from $2.5 billion to $3.2 trillion… Now, China has to figure out what to do with all that cash.
Initially, China bought U.S. government bonds… about $1.5 trillion worth. Now, the U.S. dollar is trying to inflate away those debts. So now, China faces a huge problem. As economist John Maynard Keynes famously said, “If I owe you a pound, I have a problem. If I owe you a million [pounds], the problem is yours.”
If China hangs on to those bonds… it could see their value greatly “inflated away.” But if China tries to dump those bonds, it would flood the market. And the value of its bonds would collapse…
Instead, China plans to “safeguard” the value of those reserves against inflation. That means one thing… buying gold. The country has official gold reserves of 33.9 million ounces. But it plans to get more…
It’s an initiative we’ve dubbed “China’s Fort Knox,” after America’s iconic gold storehouse. For generations, the U.S. backed its dollar with gold. The so-called “gold standard” required the nation to keep immense amounts of gold in reserve. By 1971, when President Nixon ended the dollar’s last tie to gold, America owned the largest government hoard of gold in the world. (And we still do). The bulk of it was kept in Ft. Knox in Kentucky.
Now, China wants to do essentially the same thing… More than simply hedging its reserves against U.S. dollar inflation… It’s clear China has set in motion a plan to accumulate so much gold that it will be able to restore the convertibility of its currency into gold…
An editorial released by China’s official Xinhua said as much. Published in August 2011, in the wake of the credit-ratings agency Standard and Poor’s downgrading the U.S.’ credit, Xinhua stated (emphasis added), “International supervision over the issue of U.S. dollars should be introduced and a new, stable and secured global reserve currency may also be an option to avert a catastrophe caused by any single country.”
Remember… China has spent many of the past 30 centuries as the world’s largest and most powerful economy. But around the time Europe began “stretching its legs out” and building overseas empires in the 17th century, China started a long decline. It suffered humiliating military defeats in the mid-1800s… which resulted in European occupation and the seizure of one of its most prized harbors, Hong Kong. (Imagine how Americans would feel if a foreign country seized Manhattan.)
In the 20th century, China suffered further humiliations and defeats from Japan. It spent the decades after World War II mired in communist hell. Much of the country’s wealth, including its gold, was plundered during these years.
But in the early 1980s, the Chinese government began freeing up the economy. Since then, the resurgence of China is one of the greatest economic growth stories in history. It’s returning to power.
But to join the ranks of the world’s elite powers, China knows it needs a strong currency (its money is called either the “yuan” or the “renminbi”)… one backed by huge amounts of gold. This is why China “fast tracked” its gold industry and became the world’s largest producer. It’s why it has bought massive amounts of physical gold over the past decade. It’s why it’s getting interested in overseas gold deposits.
And the iconic financial historian Richard Russell wrote recently: “China wants the renminbi to be backed with a huge percentage of gold, thereby making the renminbi the world’s best and most trusted currency.”
Keep in mind… China making a play to boast the world’s reserve currency is no “fringe” idea. Just a few months ago, the idea was the cover story of the highly respected financial journal Barron’s.
It’s an amazing turn of events. China has spent much of the past 300 years being brutalized, humiliated, and looted. But the Dragon has risen. And it wants its gold back.
China’s Grand Gold Strategy
As part of its strategy for building its own Ft. Knox-like gold hoard… China is buying tremendous amounts of gold. Consider this… In the six years from 2003 to 2009, China increased its official gold holdings by 75% via secret purchases.
These purchases moved China into sixth position on the list of countries with the most gold reserves. Even with these giant purchases, China’s gold holdings represent less than 2% of its currency reserves (compared with the U.S. and Germany, which hold more than 70% of their reserves in gold).
Although China hasn’t disclosed any gold purchases since 2009. It surely has continued its purchasing. Just over a week ago, news outlet Bloomberg reported mainland China bought 3.6 million ounces of gold from Hong Kong over the past few months… that’s 483% more than during the same time the year before. The data come from the Census and Statistics Department of the Hong Kong government. The Chinese government does not make such information public.
So that’s one way China is amassing its hoard of gold… But it’s taking another simultaneously. China is trying to buy gold deposits in the ground. The Chinese government is quietly buying up all ? or several large ? stakes in many of the best gold-mining companies in the world.
And it’s this part of its strategy that we’re most interested in… It’s this part of the strategy that we can invest alongside to protect our wealth and profit as China tries to establish its renminbi as the world’s foremost currency… I believe investing now in the right gold stocks could yield triple-digit gains as China hits the world market to bid up the value of these stocks.
The Script for China’s Gold Buying Spree…
China doesn’t do things half-heartedly. When it wants something done, it goes “all-in.” It throws all of its considerable wealth at accomplishing its goal. Investors who know how to hitch a ride on one of these juggernauts can make a fortune.
This is particularly true in commodities and resources. We’ve seen the incredible influence China can wield when it decides to build its holdings of assets like copper, oil, uranium, coal, or iron ore. And now, China has set its sights on gold.
As China grew richer over the last two decades, it used large chunks of that wealth to acquire resource projects around the world. The reason is simple… China wants to control the flow of resources to the motherland.
Between 1992 and 2000, China’s foreign-exchange reserves rose from $20.6 billion to $165.6 billion. During that period, its investments in foreign resource assets stayed at $900 million per year all through the 1990s. (This represents the funds it spent either acquiring resource companies outright or buying large stakes in them.)
But starting in 2000… China broke out the checkbook. Its investment in global resources rose from $900 million in 2000 to $12.1 billion in 2005. And since 2005, the country has spent $443 billion on resource investments outside its borders, including $94 billion in 2011…
When China decides it needs a lot of a given resource, it follows a familiar script that goes like this…
- Consolidate the domestic industry.
- Dramatically increase imports.
- Go on a foreign-asset spending spree.
We’ve seen it repeated across the resource spectrum. In 1992, China’s oil consumption exceeded its domestic production for the first time. China’s government realized that its future growth would hinge on resources outside its borders.
To satisfy that need, it created some public companies to go out and acquire resources. Over the next nine years, Chinese oil companies crossed the globe… throwing money at valuable assets…
Consider the China National Offshore Oil (CNOOC). In 1999, the Chinese government allowed a 30% share of CNOOC to list on the New York Stock Exchange in 2001. It was worth $7.9 billion at that time.
We have data on its oil reserves back to 1998. At the start of that period, CNOOC had 1.74 billion barrels of oil equivalent (oil and gas together). By the end of 2010 (our most recent data), it had 2.99 billion barrels of oil equivalent.
That 72% reserve growth in 12 years is outstanding. To put it into perspective, ExxonMobil only grew its reserves by 20%. Petrobras, the Brazilian national oil company, made one of the largest offshore oil discoveries in history and only grew its reserves by 53%. CNOOC was exceptionally aggressive. Here’s what it did…
From 2009 to 2011, CNOOC made seven international acquisitions. Among them…
- CNOOC paid $2.1 billion last July for OPTI Canada… a company in Alberta, Canada generating petroleum from the region’s “tar sands.”
- It spent $525 million in June 2010 to acquire Devon Energy’s 25% interest in the Panyu oilfield out in the South China Sea.
- In May 2010, it put together a $3.1 billion deal to create a 50-50 joint venture with private South American energy investor Bridas Energy Holdings. The new company, called Bridas Corp., is a private independent energy exploration company focused on Argentina, Bolivia, and Chile.
- In 2010, CNOOC acquired a 33% stake in U.S. natural gas giant Chesapeake Energy’s Eagle Ford shale acreage in Southeast Texas.
Now, look at how China’s influence in a resource market can pay off for investors… In March 2011, copper prices were mired in a bear market. And shares of copper producers were slumping. Australian-listed Equinox Minerals, which owned Africa’s largest copper mine, Lumwana, was no exception. The copper producer closed at a six-month low on March 14 at C$4.84 a share.
However, on April 2, Minmetals Resources, a division of China’s largest metals trading company, offered C$7 per share for the company. That was a 45% premium from the recent low. But it gets better…
Rather than let Equinox get bought uncontested, gold miner Barrick Gold came up with a counteroffer and eventually bought the company for $8.10 per share. That represents a 67% premium to Equinox’s March 14 price in just six weeks.
Over the last five years, there are countless examples of Chinese government-owned companies buying up resources in copper, uranium, and iron ore. And now…
It’s Happening in Gold
On November 16, 2011, shares of a small gold company named Jaguar Mining skyrocketed 45% in a single day.
It was one of the most extraordinary gold stock moves of the year.
The reason for the surge was a “takeover” offer… That’s when another company, usually a larger one, offers to buy another company.
Takeovers, which cause fireworks like Jaguar’s 45% surge, are common in the stock market. But there was something usual about Jaguar’s takeover… something “sinister,” some folks might even say. As I write, this takeover offer is one of the most controversial topics in the gold industry…
You see, Jaguar is a U.S.-based company. It’s headquartered in the beautiful city of Concord, New Hampshire. But while Jaguar is based in the U.S., Jaguar’s mines are in Brazil.
The offer to buy Jaguar’s assets didn’t come from a larger gold company, like Barrick Gold or Newmont Mining. And it didn’t come from a Brazilian billionaire or the government there.
The takeover offer was extremely rich… And it came from the Chinese government.
According to Bloomberg, the $786 million offer (a 74% premium to Jaguar’s market value) is the highest premium ever offered in a cash takeover of a gold miner with more than $500 million in market cap.
As you can see, this story could help usher in a new era of gold stock gains… one I estimate could produce hundreds of percent returns for investors in the right place at the right time.
Jaguar Mining bills itself as the fastest-growing gold company in Brazil. It has three operating gold mines in the “Iron Quadrangle” mining district ? Turmalina, Paciencia, and Caete. These are just north of Rio de Janeiro in southeastern Brazil. The company has its fourth mine, Gurupi, under development.
In my opinion, Jaguar is a crappy little gold miner that struggled to turn a profit in 2011. The company owes $404 million in debt and has just $102 million in cash.
And yet, according Toronto’s Globe and Mail newspaper, the Chinese government-owned Shandong Gold Group has offered $1 billion ? about $9.30 per share in cash ? to take out the company. That represents a 74% premium to its closing price on November 15, the day before the news broke.
Shandong Gold Group is the parent company of China’s second-largest gold producer by market value, Shandong Gold Mining. Its offer for Jaguar represents the largest acquisition by a Chinese gold miner outside China.
Shandong can’t be interested in the company… because the company is terrible. It must be interested in the gold.
At $1 billion, Shandong agreed to pay $6,667 per ounce of gold production. On a reserve basis, it agreed to pay $235 per ounce of gold.
That’s the key to this investment… buying gold cheap. The business side doesn’t matter, because Shandong will change all that. What matters is Jaguar owns three gold mines Shandong can buy cheaply.
The Jaguar deal is like the starter pistol on a huge asset grab for China. The country is about to start scouring the globe for gold assets it can buy. A lot more of these deals are in the offing. And if we position ourselves now… we could enjoy huge returns as China starts bidding up the value of gold deposits around the world…
As we said, China follows a simple, three-step process in resources. First, it consolidates its domestic production.
As I told you in the special report titled, “Government-Backed Gold and Silver: How to Make a Fortune in China,” China lacked a modern mining sector as recently as the 1970s. So in 1979, China opened a tiny region to foreign companies for mineral exploration. It wanted to bring modern Western exploration and production techniques into the country. The program was so successful, China opened up the whole country to foreign companies by 1997.
This freedom accounted for a massive surge in gold production. By 2006, its gold production rose 15% compared to a decline of 3% in the rest of the world. By 2007, China eclipsed South Africa, to become the world’s largest gold producer.
In 2011, China produced 11.4 million ounces of gold… That almost doubled China’s 2002 production of 6.2 million ounces.
The domestic consolidation began in full force in 2005. China National Gold Group (CG), a private government-owned company, spent more than $476 million on five gold mining companies in the past four years.
The acquired companies range in size from junior exploration companies to interest in $1.2 billion major integrated mining companies.
- On August 27, 2007, CG spent $4.1 million to acquire 61.9 million shares (5%) of the $116 billion Zhongjin Gold Corp. (This Shanghai-listed company is the largest public gold miner in China.)
- Also in 2007, CG paid $5.3 million for 65% of the Geophysical Exploration Institute of Hei Long Jiang Province. (This is a small gold-mining company focused in Hebei province.)
- In May 2008, CG bought a large minority stake in then-Canadian-listed junior gold miner Jinshan Gold Mines for its mine in Inner Mongolia, China. CG later took over the entire company and renamed Jinshan Gold as China Gold International Resources (TSX: CGG). China Gold International remains a Canadian-listed company that produces almost 125,000 ounces of gold per year.
- In August 2008, CG spent $293.2 million on a partnership with Gansu Jinchuan Group. This company operates base-metal (nickel, copper, and cobalt) mines.
- In 2009, CG spent $154.4 million for two additional gold mining companies, including Zhen’an Gold Mining Co.
- In 2010, CG purchased an additional 149 million shares of Zhongjin Gold Corp., which it first invested in 2007. This time, CG spent $422.5 million to increase its interest in Zhongjin to 49.6%.
- In 2011, CG purchased its second Canadian-listed junior mining company, Mundoro Mining. It paid $14.7 million to acquire the company for its Maoling Gold Project in China. The Maoling mine is under construction and is expected to produce 328,000 ounces of gold per year.
This domestic consolidation is part of what we focused on in our initial 2009 China gold report… Longtime S&A Resource Report readers will recognize Jinshan’s name…
We bought shares in July 2009 not long after CG’s initial investment. We booked a 339% gain nine months later when the Chinese government announced its intention to turn Jinshan into China Gold International. I’m proud to note my Jinshan call is among the most profitable trades ever produced by my publisher, Stansberry & Associates Investment Research…
And it’s the kind of gain we want to make again on China’s burgeoning gold sector.
So Step 1 is done. What about Step 2, China’s gold imports?
It was illegal to own gold in China prior to 2007. When that law was changed, it opened the floodgates.
China imported a record 56.9 metric tons of gold in September 2011. That’s six times as much as it imported in September 2010. It imported 140 metric tons from July 2011 to September 2011. While the data is incomplete, the estimate for China’s total gold imports for 2011 is 350 metric tons. That’s a lot of gold.
Consider that the world’s miners outside China only produced 2,155 metric tons in 2010. China bought the equivalent of 16% of the world’s 2010 gold production last year.
It’s more gold than Canada, Chile, Ghana, and Brazil combined produced in 2010. It was more gold than any single country produced in 2010… even the world’s largest producer ? China ? which produced 345 metric tons.
In 2011, it passed India to become the world’s largest consumer of gold. For many people in the gold market, this was a big shock ? India has always been the world’s leading gold buyer. In India, people traditionally save and display their wealth in gold. Their entire financial culture is based on gold. Historically, silver has played the same role in China… but not anymore.
The demand hasn’t slowed at all. The Shanghai Gold Exchange (SGE) had its busiest month ever in January 2012. It averaged 392,239 ounces per day for the month.
The World Gold Council developed a program with the Industrial and Commercial Bank of China where citizens can convert their savings to gold. Approximately 2.3 million Chinese citizens are participating.
So we’ve seen consolidation in China’s domestic gold sector and an explosion in its gold imports… That means China should be gearing up for the third step… a big spending spree.