From Russia With Gold

by RJ Wilcox on November 1, 2013

Enough Already!

As an astute gold market follower, you’ve no doubt been inundated with an abundance of commentary on China and India this year. That’s essentially all we’ve been writing about of late. It’s for good reason!  China and India’s surge to historic levels of physical gold demand are a major driving force behind our bullish gold thesis.

Their story didn’t suddenly become less important this week. On the contrary, several news reports highlighted favorable implications for gold demand. For example, reports from India indicate that gold premiums are now at $150 over the spot price.

This is very bullish news, especially heading into the Indian festival season, while China’s imports of the yellow metal remain at historic levels; reporting 109 tonnes for September.  Annualize that figure and you get a whopping 1,308 tonnes of gold imports.

However, this week we’ve chosen to feature another up and coming player in the gold market game who doesn’t get that much attention, but maybe she should!

A Quick Primer…

Mother Russia is one of the most resource rich countries on the planet, with an enormous endowment of oil, natural gas, diamonds, and of course gold, among many others.

She is the 2nd or 3rd largest oil producer, depending on who you talk to, with the 7th largest reserves, behind only OPEC member states.  The country is neck in neck with Iran for the largest natural gas reserves and is the world’s largest diamond producer.  We’ll get to Mother Russia’s gold profile in a moment, but first a very brief historical review.

Once upon a time there was a cold war era communist world power known as the Soviet Union.  During the 1980s, its large centrally planned economy began to fall woefully behind its counterparts in the West.

Some enlightened souls within the government recognized that without significant reform, their centrally planned experiment would crumble.  In this context began the Mikhail Gorbachev inspired initiatives of Perestroika and Glasnost.

They were intended as a one-two punch to extend an olive branch to the West politically and thereby encourage foreign direct investment and modern technology transfers to provide a much needed jumpstart and upgrade to the Soviet economy.

It was well intentioned but proved to be a little too late.  In 1989 things began to crumble when a certain wall in Germany came crashing down.  You know the one.  Then, in December of 1991 the bottom fell out and the Soviet Union fractured, almost instantaneously, into 15 different countries.

In the midst of the chaos, Boris Yeltsin rose to power with the goal of leading Mother Russia out of the abyss and on to her former glory.  His efforts began with an unforgettable tank assault on Parliament to resolve an intractable constitutional crisis.

This is a man who knew how to get things done.  The shelling proved to be a very persuasive argument as lawmakers gave way, allowing Yeltsin to vest the Presidency with much greater powers.

With vigorous encouragement from the IMF, the U.S., Germany and others, Yeltsin took aggressive steps to dismantle the central planning apparatus, privatize large swaths of the Russian economy, and liberalize markets.  The steps were dubbed “Shock Therapy” at the time, and Yeltsin was assured by the West that this was the answer.

Well intentioned or not, it was a miserable failure and plunged Russia deeper into economic despair and created a colossal kleptocracy in the process.   During this period, GDP and industrial output fell 50% while poverty levels rose from 1.5% to 45%.

Meanwhile, Russia’s oligarchs (many of whom had KGB roots) and bankers took advantage of the privatization process to plunder Russian assets at extremely discounted prices compared to those in the West.  They funneled their billions out of the country in eye-watering amounts making many of them the wealthiest men in the world.

This dark hour in Russia’s history culminated in the 1998 Russian financial crisis when the Russian government and the Central Bank devalued the ruble and defaulted on its debt.  In the wee hours of New Year’s Eve 1999, Yeltsin resigned and surprised many by leaving power in the hands of his somewhat obscure Prime Minister, Vladimir Putin.

With the economic and political slate wiped clean, the stage was set for this former head of the KGB, to shrewdly leverage Russia’s massive natural resources to help launch the economic recovery on display in the chart below.

Russian GDP Since Fall of the Soviet Union to 2013

Russia is the largest country in the world, geographically, by a large margin.  Spread across this vast landscape, she is a major player in uranium, coal, timber and agricultural cereals, in addition to oil, gas, diamonds and gold.

Putin, exploiting Mother Nature’s gifts, grew Russian GDP by 7% annually from 2000 through 2008.  He also dropped the poverty rate to 13.7%, cut unemployment by 50%, and raised the number of middle class by a factor of 7.  He used Russia’s new found wealth and influence to restore the country as a regional superpower, if not a global one.

That is admittedly a very simplistic historical summary, but we wanted to provide some context to set the stage for our favorite topic.

Russia’s Gold Profile

According to the Russian Ministry of Natural Resources, the country has the second largest gold reserves in the world at 12,500 tonnes (over 400 million ounces).

Russia has a handful of major gold producing regions in the east; Krasnoyarsk, Irkutsk, Magadan, Amur, and Chelyabinsk.  Krasnoyarsk in particular is one of the more prolific gold mining regions in the world.  As you can see, many of these areas are remote in the extreme sense of the word.

Map of Russia's Gold Producing Regions

Interestingly, since 2008, Russian gold production has risen dramatically.  In 2009, 2010, and 2011 production figures were 185, 202, 211 metric tonnes respectively.  In 2012, gold production jumped to 226 tonnes and is estimated to reach 237 tonnes in 2013, based on production figures through September.

There are three major Russian domiciled gold miners, Polyus Gold, Polymetal, and Petropavlovsk.  Polyus is the largest, in terms of output, producing 1.6 Moz of gold in 2012.  Polymetal and Petropavlovsk produced 1Moz and 700Koz respectively last year.

The only major foreign gold miner in Russia is Kinross. They operate the Kupol Mine in far eastern Siberia, which produced an impressive 578Koz all by itself in 2012.

Russia is 4th in terms of world gold production since it overtook South Africa in 2012. They now have their sights set to surpass the U.S., who currently sits in 3rd place, and whose major producing state, Nevada, has recently reported lower production numbers.

Supporting the Russian push for 3rd place is the Russian Ministry of Natural Resources who is working to relax regulations that limit the amount of gold reserves that can be produced without federal government approval.

Currently, if a gold deposit has over 50 tonnes, the amount over this limit is considered federal property.  The Ministry is looking to increase that threshold to 250 tonnes to stimulate mining project development.

Another contributing factor is Polyus’ Natalka project located in the Magadan region. Considered one of the largest gold deposits in the world, it has 32 million ounces of proven and probable reserves and a total resource of 60Moz+.  The mine is expected to begin production in mid-2014 and could reach up to1.5 Moz per year.

Aside from production, the Russian Federation’s Central Bank has been a steady buyer of gold since 2007. They currently sit 8th in official gold holdings, however, their rate of accumulation has been significant, as you can see in the chart below.

Chart of Russian Official Government Gold Reserves 2006 to 2013

Russia, the U.S, China, Gold, and the Implications

In his excellent book, Currency Wars, Jim Rickards retells the story of Pentagon sponsored economic war games, in which he was invited to participate a few years ago.

In order to give them (the Pentagon) their money’s worth Jim and his teammates decided to coordinate a scenario where Russia, who is tired of the U.S.’s dominant currency position, would move its gold to Switzerland, start a new bank in London, and issue a new form of currency that was backed by gold.

Initially Russia would own all of the new currency but others would be able to deposit gold and receive the currency. However, the key feature was that any Russian exports of oil or natural gas would have to be paid for in the new currency.

The eventual take away from the war game was that a potential disruption to the dollar’s hegemony is possible.

Putin is on record saying, at the World Economic Forum in 2009, that “the one reserve currency has become a danger to the world economy: that is now obvious to everybody.” Putin believes that the world should have multiple dominant currencies and Russia’s aggressive activity in the gold sector supports his sentiment.

The picture below does a much better job communicating the state of U.S. Russian relations than I could.

Obama and Putin

In contrast, the Russian Federation reached an agreement, in June of 2011, with the People’s Bank of China, entering into a swap agreement that allows economic entities from both countries to settle trade in either Yuan or Rubles.

Once again, a picture is worth a thousand words.

Putin and Chinese Premier

Considering Putin’s declaration that the dollar’s days at the top of the monetary pecking order are numbered, their currency swap agreement and close trade relationship with China, and both country’s rapid accumulation of gold, it seems a strategic initiative is underway in the monetary realm.

As we pointed out in last week’s piece, “China’s Tentacles Grip World”, in the modern era, reserve currency status shifts to the dominant economic and monetary power of the day. It seems as though a transition is taking place and gold will play a part in the change.

Since both Russia and China think it’s a good idea to accumulate gold.

Shouldn’t you to?

As we never tire of pointing out, a great way to take advantage of a rising gold price is by accumulating the shares of promising and deeply undervalued gold miners, like those in our Model Portfolio.  Their gains significantly outpace the yellow metal itself, as shown in gold’s must recent rise between June 27th and its short-term peak on August, 28th.

For this reason, you should check out our Comparative Analysis Table below.

It provides many critical metrics to use in evaluating and comparing gold mining companies. Its purpose is to help discerning investors separate the wheat from the chaff.

(Click the image to enlarge)

Gold Miners Comparative Analysis Table


RJ Wilcox

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