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Which Gold Miners Will Do Best?

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Base metal co-production can hurt profits.

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I've had a bit of an epiphany.

Perhaps I've been slow to understand this but, in essence, this seems to be where we are: The Federal Reserve is willing to print money to buy Treasurys that will be issued, and it's willing to exchange Treasurys for potentially any piece of trashy paper.

Think of it this way: Suppose there's a couple trillion dollars of bad paper out there that the government is willing to let you exchange for Treasurys. If there aren't enough buyers desperate to own Treasurys, the Fed will print money with which to buy them.

To me, that's analogous to 17th-century alchemists attempting to turn lead into gold. While the plan may arrest the decline in certain classes of paper, in the end it can only put downward pressure on the value of Treasury paper (i.e., it will cause rates to rise). Perhaps yields won't rise just yet as we work through the credit crisis, but I believe that somewhere not too far down the road, the law of unintended consequences will rear its head and interest rates in the US will rise substantially.

In any case, the euro's problems -- and our scheme to print money to buy Treasurys and exchange them for even more bogus paper -- can only be very bullish for precious metals over time.

On that subject, I would like to share a thought about gold-mining companies. The ones that will do the best prospectively will be those with the least base-metal co-production.

To elaborate: Often, copper is produced as a byproduct of gold. (In silver mining, it's lead and zinc that are the major byproducts.) Mining companies use the profits from byproducts to reduce their cost of production for specific precious metals. That's the accounting rule, not something the companies make up.

In my opinion, going forward, the lower the base-metal exposure, the better. In any case, I think that is a screen folks will want to use if they have an interest in precious-metal mining companies.

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No positions in stocks mentioned.

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