Below is a report by Neil Charnock on ***** last night. This is...

Below is a report by Neil Charnock on Kitco last night. This is a must read for investors and shareholders in stocks like FML as it summarises the situation to a "T".

Here is the link if you want to read but I have posted below: http://www.kitco.com/ind/charnock/jul232008.html

When you see viable gold producers selling at infrastructure value and less, with prices sometimes below any level yet seen in this gold bull to date you have to sit up and take a hard look. The gold price in AUD is currently $975 and for your reference I am referring to companies with a cash cost of around $500 per ounce or better. The emerging producers have reached such bazaar “la la land” valuations that you are effectively buying ounces of gold in the ground for as low as $25 with infrastructure thrown in for free in some cases.

The following five year chart illustrates how far these stocks have fallen.



As you see the RSI above is below the 25 level (black circle) for the first time in five years which is proof that this is a deeply over sold sector. Note: the Australian XGD (gold index) is weighted and dominated by the heavy weight gold miners and this tends to hide the true state of the rest of the sector. Thanks to Nick Laird at Sharelynx for this chart series which are available for reference at the Gold Index page in GoldOz and in much greater depth / variety at Nicks site.

Looking back gold was $US 347 back at the beginning of this chart but more importantly the AUD gold price was $533 at that time (at 65c to the USD). This provided little room for profit margin for most companies.

Cost of production at $500 provided a $33 margin which was not exactly robust or safe to invest in. The lending institutions insisted on hedge books and stock prices were poor. Things have changed dramatically and even with a new cost of $600 per ounce there is now a margin of $AUD375 an ounce which is over 11x the $33 margin of 5 years ago in this example. This example of a new indicative profit margin is now wide enough to provide a safe margin for a reasonable variation of price and cost.

There is another significant factor at play on the positive side. These mining operations have been making great strides in terms of understanding their ore bodies and ground positions. They have also made great progress in improving the JORC (Australian reporting standard) status of their resources. Then you have to consider the operational improvements along with key operational stages which are advancing. By this I refer to movement from development ore to stoping (underground mining method) operations with a corresponding increase in volume and grade. It also means a shift from open pit to underground ore in other cases. As production increases for these smaller stocks their own leverage to the gold price escalates as unit costs are lowered and capacity to unlock hidden resources is liberated by the additional cash flow.

I have long stated that the business of mining is quite separate to the trading that occurs in the shares in these stocks. This has not been as obvious for several years as it is right now. Many investors have written to me asking why the price of companies are not reflecting the current price of gold - so the best way to cover this is to put my answer in an article for anybody to read.

Share transactions are essentially a derivative of the business of mining. The ownership shares in these stocks fluctuate on news, sentiment and aggregate perception of future or current earnings. Therefore fundamental analysis is not the only answer – hence the current lack of correlation to the gold price. Technical analysis is not the only answer either and especially for smaller turn over circumstances. For T/A to be more accurate you need large volume in the same manner that predictive statistics used in surveys need population size to get a more accurate picture.

Many of these smaller producers do not have large cash reserves or highly solid balance sheets however they do have cash cover and prudent management with a clear understanding of risk management and how to run on the “smell of an oily rag” – cheaply. They have had to be savvy to survive and grow their businesses. Many have greater potential than most investors can imagine due to two important factors – leverage and organic growth off a low base. Much easier to get a ten bagger out of a perfectly sound stock with a market cap of $40M - $100M that has all these right elements going forward. Links to editorials that link to the web sites of two examples of this type of situation are included at the base of this article however the list is not exhaustive and your own DD is essential.

Sovereign Risk and More on Global Sentiment

You have to be mindful of risk and this is also a lesson learned and repeated over and over by the banking industry over time as they move from over easy credit and greed to restricted credit and fear along with the business cycle. An important aspect of risk is Sovereign Risk which is measured by political stability, business climate and currency / repayment risk. This is not effective as a predictive mechanism however because crisis events manifest quickly even if they do evolve slowly. The Asian and sub prime crisis events are perfect examples of this point.

The mechanism of Sovereign Risk Rating does offer useful comparison on a country to country basis (also across time) and provides an easy to measure quantitative approach to measure safe investing regimes. However such rating systems can also be over simplistic and the weightings of the various factors do not necessarily reflect their individual influence on risk. This is not to invalidate this rating process – merely to recognize its efficacy (or ability to be effective, produce the desired result).

A combination of many of these types of analysis however can be combined to form a more useful and accurate picture of Country risk and potential compatibility for your hard earned investment capital. From an institutional risk rating system in 2007 - a score of 1 being the highest ranking down to 100 being the lowest - Australia scored a rank of 18 which was highly credible.

Australia also has asset backing in terms of our mineral wealth which is comforting, like a strong company balance sheet – and an optimum A1 Coface Credit Rating for 2008 which is the top rating. Another index that essentially measures the integration or interface of a Country into the global market place is called the Globalization Index and Australia ranks highly again at 13th in the world.

On a Competitive Scale Index Australia ranked 12th in the world and in terms of doing business here the World Bank rates us at 9th from the top position. An Economic Freedom Index rated Australia at number 4 ahead of the USA, Canada, Chile, Switzerland, the UK and Singapore. The UNDP Human Development Index which essentially measures quality of life and purchasing power parity rated Australia at number 3 in the world only behind Iceland and Norway. Source: MH Bouchet / Ceram – Global Finance.

Australia is a great place to live in and invest capital by all of these standards and this is why I absolutely question the validity of the international investment sentiment in our gold and broader mining industry at present, particularly the mid cap and emerging gold producers.

As corporate activity, technology and resource demand continue to shrink the meaning of sovereign boundaries between nations we will gradually move towards equilibrium of all sorts of things. The financial world moves the fastest (usually) and I refer to international stock markets following the Dow, banking regulations, broad contagion of sentiment particularly, even fashion and diet (and weight problems) as the Corporate machine moves forward towards One World.

Of course resources are internationally priced, varied only by exchange rates and price rises in commodities have outpaced any and all currency strength as a trend and I for one believe this trend will continue. Equities have been out of favor and financial conditions precipitated by the sub prime debacle have forced stocks out of many weak or unfortunate hands. This is going to be regretted as the savvy have accumulated the soon to be coveted Australian precious metals sector.

What to do and how to do it – and when?

I cannot predict the beginning of this event for you at this time although I do currently see signs of absolute bottom for many of these stocks – the rally is getting closer and it will most likely start with mini waves. For the less able, financial and or risk tolerant you may wish to wait and watch for confirmation of the turn over the coming weeks or months. You will miss the powerful leverage gained from being the first on the scene which can only be enjoyed by the liberated true contrarian.

From experience I notice that this current share price behavior is just now beginning to resemble pre-rally traits. Stronger mornings led by pull backs to early morning levels and mixed cross sections of rises sufficient to notice that all is no longer falling. This went on for several weeks at this time of the year in years gone by – years that eventuated in strong rallies. But the question is what do you have to do to find the right investments?

You have to get data and do the research – there are many sources of this type of data and we cover Australia as a specialty. We have been busy preparing a treat for our public visitors and subscribers, both extant and new over the past few weeks and many will not have noticed due to the lack of interest in this sector – a good sign actually.

You have to have a broad knowledge of the sector. We have created a guide to the Australian mining industry by grouping the key producers that specialize in gold, the developers of new mines and the leading explorers into separate pages at the site. A separate page lists many of the more advanced companies involved in PGM and silver activities. This investment research tool also links to stock prices for international investors or those that want a simple Company guide and access to share price data.

You have to understand the currency implications of your investment. We have also added currency conversion facilities to assist offshore investors to evaluate value in terms of their own currency. You have to understand the ground positions of Companies and profitability of the operations so we created a monster mines guide and links to Australian mining authorities for deeper research.

We added links to Australian brokers and other educational sites including the international gold sites that have done so much to inform about and alert investors to this bull market to date. We are all (gold industry writers, miners, analysts) working hard to bring you the message and cover the topics and provide prudent analysis.

We will be locking many of the more specialized pages away for the eyes of subscribers only in the near future as we add greater levels of data but for now it is all accessible and free. Readers at this site are welcome to stop by and search through our resources if they wish. Global financial conditions are still in favor of gold, silver, PGM’s, new cleaner energy solutions and all commodities.

Good trading / investing.

Regards,

Neil Charnock