By Chris Mayer, editor, Capital & Crisis , Agora Financial

Dear Money Morning reader,

Since I started writing my investment advisory over 10 years ago, the economics of the gold mining business have never looked better to me.

Before we go further, realise mining is a hard business. Gold miners process tons of rock for only a fraction of an ounce of gold. It's complex, costly, and risky. The gold price is also volatile and will have you browning your undies if you're not prepared for it. So just a word of caution here about the inherently speculative nature of gold mining stocks.

Now... if I haven't scared you off, let me show you why gold stocks could shoot much higher in the next few years. Let's look at some rough numbers first...

The price of gold miners as a group is off more than 30% in the last year, even though the price of gold has held firm. Add to that mix falling mining costs in 2009, and you have a recipe for explosive earnings.

As gold analyst John Doody points out, oil accounts for about 25% of the costs of running a mine. Gold miners use a lot of energy to power big shovels and dump trucks and to haul ore. The price of oil, as you need no reminder, has collapsed. It's down more than 70% from its high in July.

For the first three quarters of 2008, gold miners had to contend with an average oil price around $118 a barrel. As I write, oil is around $40 a barrel. Barring a huge rally in oil, gold miners will reap a windfall in lower oil costs.

Not only will gold miners get the benefit of lower oil costs, the currencies of the gold-producing countries have all fallen against the dollar. This means their costs are lower today in dollar terms. Consider, for a moment, where the gold comes from.

In the mid-1990s, four countries made up more than half of global gold production. They were Canada, Australia, South Africa, and the U.S. But by 2006, these four producers made up only about one-third of global production. Today, you see China produce a lot of gold, as well as Peru, Mexico, Chile, and countries in Africa. (This is according to Frank Holmes' book The Goldwatcher – a must-have manual for gold investors.)

Many gold mining stocks today have assets in countries where the currency is falling against the dollar. As Doody says, "All the commodity nation currencies – the Canadian dollar, the Australian dollar, the South African rand, the Brazilian real, the Mexican peso – they're all down 20%-40%. When your mining costs in those countries are translated back into U.S. dollars, they'll be 20%-40% lower."

Lower oil costs and currency effects mean gold profits should be higher in 2009 than in 2008, even if the price of gold goes nowhere.

I'll add one other reason to like gold stocks here: They did pretty well in Great Depression I. And history may repeat. Even at their lowest prices in 1933, the stocks of Alaska Juneau Gold Mining and Homestake Mining were still well above their 1929 highs. At their highest prices, they were 230% and 300% higher, respectively.

Legendary investor Bernard Baruch was a principal stockholder in Alaska Juneau. It was his largest holding in 1931. He knew where the soup would stick to the spoon after Roosevelt's New Deal policies. It would mean a devaluation of the dollar and a rise in the gold price.

Eventually, gold did surge, and so did gold stocks. "Baruch reaped an especially large profit," his biographer James Grant writes, "for he had been buying stock and bullion."

Obama's stimulus plan smells a lot like Roosevelt's New Deal. And if this is the greatest financial test we've faced since the Great Depression – as I believe it will ultimately be – then gold stocks may also be among the few stocks to make new all-time highs in 2009.

Gold trades for around $900 an ounce, and the average cost to produce it is around $450 an ounce or so. And as I pointed out above, the gold price has stayed up and costs should fall in 2009. You don't have to know much about economics to know that's a nice combination. That's why I think right now is a great chance to pick up cheap gold stocks.

Good investing,

Chris Mayer

Turning to the markets

The JSE All Share Index closed down 1.66%. The Gold Mining Index flew up 7.06%. Resources lost 0.9%.

Banks and Financials closed in the red 3.78% and 3.43% respectively. Industrials decreased 1.62% and the Platinum Mining Index gained 1.91%.

London’s FTSE 100 closed negatively 2.43%. The Dow Jones is lower 3.79% and the Nasdaq followed 4.15%. Tokyo’s Nikkei fell 1.56% and Hong Kong’s Hang Seng closed down 2.95%.

Brent crude is currently trading at $40.67 per barrel.

Spot gold’s trading at $973.18 and platinum was last quoted at $1103.50.

And here’s how the rand is performing against the major currencies:

R/$ 10.21
R/£ 14.53
R/€ 12.85

Copyright (c) 2009 Fleet Street Publications Pty (Ltd)

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