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Dear Fed: Why Not Buy Gold Miners?


A unique way to spend bailout money.

Have $40 million Bernanke bucks lying around?

Buy Nevsun Resources (NSU) - the entire company. It'll cost you about $40 million at today's price, and you can pocket $20 million of NSU's $60 million cash balance, while at the same time selling its Bisha gold mining project (worth a $267 million NPV at $700 gold and $10 silver) to the Eritrean ENAMCO for the same $25 million that ENAMCO paid NSU earlier this year in order to purchase a 30% interest in the project.

So, if anyone has $40 million lying around for a tender offer, this seems like a pretty easy $20 million profit to bank.

NSU is not the only gold miner being priced for bankruptcy. New Gold (NGD) is currently trading at less than 1/3 of book value and has $350 mln in cash. Northgate Minerals (NXG) is trading at 1/3 of book, 1.32x cash flow, and 2x trailing EPS. I could go on: The entire industry is not only priced for $500 gold, it's priced to "go away" and in many cases it's priced worse than going away.

I guess giveaways like these are what happens when the XAU/Gold ratio makes all-time lows like it is now?

I don't know where the selling stops in these gold miners, but in my opinion somebody is going to make a fortune buying them down here.

If someone told me tomorrow that "I've got $100 billion that I don't know what to do with. What do you recommend?", I'd tell them to just go buy the GDM Index's entire 32 members, which have a $94.57 billion market cap as of yesterday (and is 10% cheaper today), and he'd still have $5 billion left over for a really great party with one heck of an open bar.

In fact, if Treasury Secretary Paulson asked me, I would suggest he spend $95 billion of his $700 billion and really make the US taxpayers some money after the Fed, in my opinion, eventually destroys the dollar with what it's doing.

I believe there are two choices for the US: Default or debase, and both lead to more inflation. Today, the US is a giant debtor nation that relies on the kindness of foreign creditors to finance its gargantuan current account deficit and its enormous debt load. It's for that key reason that the current situation that the US faces is neither Japan of the 1990s, nor the US of the 1930s. Those looking at the bursting of these bubbles in the past and expecting history to repeat today in the U.S. (i.e. - "deflation") are likely to be sorely disappointed with what lies ahead.

If anything, today's situation for the US is more like the US of the 1970s, where the US simply defaulted on its obligation to exchange gold for dollars. Fast forward to today, and the US is going to default on its obligation to not inflate away the world's fiat reserve currency (the US dollar). So, whether we call it "Weimar 2.0" or "stagflation squared," I think this can end only one way: more inflation.

While it may be painful at the moment for gold bulls due to hedge funds continuing to delever and sell anything and everything they own in order to raise cash to meet redemptions (including gold and gold stocks), in my opinion those holding gold and gold stocks today will be sitting pretty a year from now. On the other hand, those holding US government bonds and betting on "deflation" will more than likely be disappointed. As Warren Buffett said last week in The New York Times:

"Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts."

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No positions in stocks mentioned.

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