A Random Walk in Pension Accounting

PBT Today: Pittsburgh Pension Loses Out on Millions.

Personally I am going to send each member of the pension board a copy of a book just about everyone who invests in the market should have anyway:

Beyond that… there is a companion story with that: Lamb seeks answers to pension plan delay. Something does not add up to me.  If you were to dig into it, it sure sounded to me like the pension assets were not exactly converted to cash.. which is implied in the ‘delay’ in reinvesting into a more normal portfolio.. but it sure sounded like the intention as to buy some form of option which effectively created the same investment return as cash for precisely the 3 months in the fall the pension board was worried about.   If that is what they did, then once the option ran out, the portfolio would immediately begin to have the investment returns it should.  This option strategy should also give some advantages in not incurring the costs of moving several hundred $million out and then back into the market.  Apparently that isn’t what happened which raises its own questions.

The net result however it happened is really pretty sad.   Pension fund cashes out in fall 2010 which turns out to be quite a big run up in the market.  Delays getting back into the market in first quarter of 2011 which continued to be a great quarter for the market.  Assuming they finally got cash reinvested by April, it was just in time for the horrific returns from the market since then.  There you go.

Economic Events on August 29, 2011

At 8:30 AM EDT, the monthly Personal Income and Outlays report for July will be released. The consensus for Personal Income is an increase of 0.3% over the previous month and the consensus Consumer Spending index change is an increase of 0.5%.

At 10:00 AM EDT, the pending home sales index for July will be announced.  The consensus is that the index decreased 1.0% last month.

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Helen O'Malley: The Manganese Market, a New Economic Growth Barometer?

Helen O'Malley Manganese’s many uses in infrastructure and building materials make its market a strong barometer for gauging the world economy. Soaring growth in countries like China and India has led to high global demand. In this exclusive interview for The Critical Metals Report, Helen O’Malley, a bulk manganese specialist with CRU International in London, discusses how manganese prices are closely tied to the economy and, in contrast to exchange-traded base metals, overwhelmingly determined by supply and demand.

The Critical Metals Report: Economists often use the price of copper as a barometer of global economic health because of its many uses in infrastructure and building materials. Could manganese prices be an even more effective barometer of global economic health? What is your prognosis of global economic health based on what is happening in the manganese market?

Helen O’Malley: Unlike copper and other base metals, manganese is not exchange traded. The price of manganese is overwhelmingly determined by supply and demand. Speculation and confidence levels do not really come into play. Manganese pricing has a lot to do with the general health of the economy. For instance, industrial production and, therefore, levels of demand for steel in the developed world have not recovered to levels seen before the financial crisis. Therefore, a state of overcapacity exists in the manganese ferroalloy sector, so prices have been struggling to reach previous records. This is even though global demand for manganese is at a record high because of soaring growth in countries like China and India.

TCMR: You wrote that for the first time in Q410, China became a net importer of silico-manganese and high-carbon ferromanganese. Will this continue?

HO: That was the first time China became a net importer of manganese alloys, specifically silico-manganese and high-carbon ferromanganese. China has always been self sufficient in manganese alloys and has a great deal of overcapacity itself. To become a net importer is quite surprising.

TCMR: What is the impact?

HO: It is a symptom of the oversupply in the global market. Prices have gotten so low that it is now economical for some mills in China to import manganese alloys. This is not likely to be the start of a meaningful trend nor is China going to suddenly become a major net importer of manganese alloys.

TCMR: China has been stockpiling copper and other base metals. Is it stockpiling and hoarding manganese?

HO: It’s true, stocks of manganese ore at Chinese ports have built up sharply in the last year. In early 2010, stocks were around 2 million tons (Mt.). In May of this year, they peaked to almost 4 Mt., but since then they have eroded back to around 3.5 Mt. The widespread belief is that most of these stocks are held by Chinese traders who bought the material back when the price was higher, in 2010 or even earlier. They will not be releasing this material into market until the price recovers.

The natural level of stocks is bound to be higher now because consumption levels are higher. On a consumption-adjusted basis, stocks are actually around 2008 levels.

TCMR: In July’s CRU Monitor, Bulk Ferroalloys edition, you wrote, “Offsetting the 5% year-on-year drop in Japanese crude steel production, South Korea output was 19% higher than it was in June 2010, while Indian production rose by 7.3%. Output gains have been much smaller in the European Union and the U.S., both in June and for the first half of this year as a whole.” This does not mention China’s percentage gains in steel production, but illustrates the ongoing shift of wealth from the West to the East. Is that permanent?

HO: We can see an extended period of weak and below-trend growth in Europe, the U.S. and Japan. In those countries, the structurally high levels of national debt and the measures taken to address this debt will most likely weigh down on growth for some years. This is a stark contrast to economic growth in China, India and other Asian nations.

TCMR: China now produces approximately 40% of the world’s steel. Would you prefer that steel production be spread over more countries?

HO: Traditionally, steel production facilities are located to serve local or regional demand. China produces so much steel because it consumes so much of it. However, some locations are more cost competitive than others because of factors such as access to raw materials, labor costs and energy costs. Over time, we could see a higher concentration of steel production in lower-cost regions of the world. On the other hand, it is very difficult and costly to permanently close steel facilities, which is perhaps why we are not yet seeing an obvious shift taking place.

TCMR: How is Chinese dominance in steel production influencing the manganese market?

HO: China now accounts for around 40% of global steel production. Five years ago that share was only 30%, and 10 years ago it was 15%. China’s increasing dominance as a steel producer has definitely had an impact on all raw materials markets. It has had an impact particularly on the market for manganese ore because China must import over half of its requirements for manganese ore. It’s a similar situation to what we see in the iron ore market.

TCMR: You said that the manganese ore market has been in a state of oversupply for about a year and that is pushing prices down. When will the market turn? Is the ore market structurally tight or are we on the brink of structural oversupply once a number of development projects in Africa come onstream?

HO: Manganese ore prices have been falling for the better part of a year now, but it seems that prices have been brought low enough to cut out a proportion of the higher-cost supply from the market. Port stocks have been falling for several months now and price stability has returned. This tells me that supply and demand fundamentals are in much closer balance now.

TCMR: When we spoke last May, manganese ore was priced at roughly $8/dry metric ton unit (dmtu). What is a dmtu going for now?

HO: The price of medium-grade ore—say 44% manganese oxide lump—is currently $5.30–$5.40/dmtu, delivered to China.

TCMR: We’re talking about the ore, so that is the straight mined product. What is your near-to-medium term outlook for the manganese alloy market?

HO: In the medium term, looking at the next five years, the drawn-out recovery in steel production in the West will ensure that overcapacity in the manganese sector remains an issue. Ultimately, this means that prices and margins for manganese alloy producers will remain under pressure. One thing to watch is the market for refined ferromanganese. This particular form of alloy is used mostly in the production of high-grade and specialty steel and can also be used as a substitute for electrolytic manganese metal in some steel applications. Intensity of use of refined ferromanganese is rising relatively sharply, so we could see some more upside with demand and pricing of this grade of manganese alloy in the medium term.

TCMR: You had discussed earlier how steel makers in Europe are starting to substitute out the more expensive ferromanganese in favor of the cheaper silico-manganese. What is the impact?

HO: Because ferrosilicon prices have been a lot higher than silico-manganese and high-carbon ferromanganese prices, it is thought that some steel mills in Europe are trying to switch away from the combination of ferrosilicon and ferromanganese by consuming more silico-manganese. Not all steel mills can do this switch for technical reasons and, in the U.S., most mills would not consider switching. We are now slowly starting to see the price gap between ferrosilicon and the manganese alloys close up. But another thing to remember is that ferrosilicon prices are also strongly governed by underlying production costs, which have come under strong upward pressure recently.

TCMR: Is it experimental?

HO: No, the concept of switching between alloys has always been known to the steel industry. It has to do with the economics of using the alloys at their current pricing. However, as I mentioned, technical limitations mean that mills wouldn’t necessarily do this on a short-term basis. Also, some mills are constrained by the type of steel they are producing.

TCMR: Can I get some base prices for a few of the main products you deal with? When you talked to The Gold Report in May 2010, you said they couldn’t manufacture steel without manganese, and manganese ferroalloy prices were 40%–50% lower than the peak levels of 2008. What is the per ton price of ferrosilicon, silico-manganese, silicon metal and high-carbon ferromanganese right now and do those prices compare to 2008 or even a year ago?

HO: Manganese ferroalloy prices have, on average, declined since May 2010. Back then, silico-manganese was priced at around $1,520/metric ton in the U.S. market. Now it is priced at around $1,370/metric ton. We’ve seen a similar decline in the other manganese alloy grades. The reason for this downward trend is the oversupply of manganese alloys. The other important factor is that the manganese ore price has been in decline with manganese ore being the main cost driver of alloy production.

TCMR: What are the main factors behind that fall in the price of ore?

HO: An oversupply. In 2009, rock bottom prices caused the manganese ore sector to aggressively cut its output. When prices recovered over the second half of 2009 and into 2010, production ramped back up to full capacity, ultimately pushing the market back into oversupply. You tend to get this lagged supply response in bulk mined markets because it takes time to ramp up or ramp down production at large scale mine operations and to tune output precisely to the level of demand. In the last year, there’s been a degree of oversupply, but now we are seeing that some of the mines are trimming output again. It is a cyclical effect.

TCMR: Is the sector less exciting to cover when prices are in decline?

HO: No, because you have developments such as production cuts. What becomes interesting is determining who is left in the market and who is going to be forced out of production first.

TCMR: You mentioned earlier that there are a number of development projects coming on in Africa, but we have oversupply now. Is that going to push back the development timetable with those projects or will prices be driven down even further?

HO: South Africa is an interesting example because if you add up all of the potential new supply, it comes to approximately 15 million tons per year (m tpy). This is huge in a market that is around 45 m tpy. In reality, though, in South Africa, restrictions on rail and port capacity will mean that only a portion of this will find its way onto the seaborne market in the next five years. Infrastructure is also a major issue in other African countries where miners are hoping to develop projects. The market for manganese ore could stay tight for some time because these projects will not come online at the advertised dates.

TCMR: Right now we are seeing approximately 95% of all rare earth production being controlled in China. Will we see similar control in the manganese metal side?

HO: Absolutely. Currently, China controls around 95% of the world’s supply of manganese metal and that represents a great deal of risk to consumers of manganese metal in the West, such as in Europe, Japan and the U.S. Not only is there a lot of price volatility, but security of supply is also an issue.

TCMR: Without recommending specific companies, what kinds of manganese or ferromanganese projects are of most interest to the Chinese?

HO: The Chinese and the Indians seem desperate to get their hands on any medium- and high-grade ore deposits. This is to provide them with a greater security of supply of the essential steel-making raw material. You cannot make steel without manganese, so it is a strategic move as well. The challenge is tracking down the remaining high-grade or even medium-grade projects. You want to find one that is not only economical to mine, but also has access to infrastructure.

TCMR: Like a port.

HO: Exactly, a rail or port. South Africa and other African countries have naturally attracted a lot of interest because of the abundant resources of high-grade and medium-grade manganese ore. There are also high-grade deposits elsewhere, such as Indonesia, Australia, Turkey and South America.

TCMR: Have you visited these projects?

HO: I just returned from South Africa where I visited a number of the mines currently in production, as well as a number of the companies in the development stage. It was a very interesting trip.

TCMR: Are there projects in more secure jurisdictions like North America or Australia that are coming onstream in the near-to-medium term?

HO: Australia has a long list of projects, and a number of companies have projects on the table in North America. North America does not have high-grade manganese ore or even medium-grade manganese ore, but there does seem to be, in parts, abundant supplies of low-grade manganese ore.

Some of these companies are looking to upgrade the low-grade manganese ore into a product that can be sold into the market. One of the major products they are looking at is electrolytic manganese metal, which has a variety of end uses, but the main end use is in the steel industry.

TCMR: How far off are those?

HO: Most of these companies are slating project startups toward the end of a five-year horizon. Some of them are making progress with exploration and defining their resource, but there are still several stages in the process to go, including raising finance and bankable feasibility studies.

TCMR: Are there any projects close to putting together a bankable feasibility study that could see greater interest as a result?

HO: Not that I know of, but that is not to say they are not at that stage.

TCMR: Can you provide me with a couple of themes in the manganese space that you expect to play out over the next year or two?

HO: In the next year or two, we could see some of these manganese ore projects develop. Some of the greenfield projects in Africa should move forward and even come into production. It will be interesting to see how that impacts market fundamentals. And I think it will be interesting to see what happens in the manganese metal space because we have definitely noticed interest for companies to try and reduce their current dependency on Chinese supply. With China currently the world’s main producer of manganese metal, steel producers, aluminum producers and other consumers in Europe and the U.S. are dependent on Chinese exports. People are seeking alternative sources of supply.

The structural dependence on Chinese supply has triggered great interest in investing in manganese metal outside of China. Some of these projects happen to be located in North America, but there are also projects in Russia. At present, there is only one manganese metal producer outside of China, and that’s in South Africa.

TCMR: What is the name of that company?

HO: The Manganese Metal Company of South Africa. A number of potential manganese metal projects are in the pipeline, including in North America, but also in other parts of the world. Certainly, that whole area of the market seems to be quite hot right now because prices are high and we have this structural dependency on China.

TCMR: Thanks very much.

Helen O’Malley is a bulk manganese specialist with CRU International in London, England. She manages research activities in the steel raw materials markets including iron ore, metallurgical coal and coke, and the bulk ferroalloys, including manganese, ferrosilicon and silicon metal. Since joining CRU in 2005, she has built up considerable expertise in the bulk raw materials markets with particular focus on iron ore and ferroalloys but more recently extending her involvement across all of the major raw materials markets.

Rob McEwen: $5,000 Gold and $200 Silver Predicted

Rob McEwen Rob McEwen has become a legend in the gold mining industry by skillfully assembling and building mining companies over the past 20 years. In this exclusive Gold Report interview, he explains his rationale for $5,000/oz. gold and $200/oz. silver and how the factors leading to those price levels will affect the industry and the companies exploring for and producing the metals.

The Gold Report: Rob, you’ve been quite vocal about your belief that gold will reach $5,000/oz. (ounce) and silver $200/oz. for silver. Why and when will that happen?

Rob McEwen: Your readers need to appreciate: Gold is money. It is currency. I think the number of people familiar with gold will grow as people see gold as a currency. China, India, Russia are buying gold to diversify their foreign reserves. To restore the confidence in currencies, I think some central banks, such as the Chinese and possibly the Russian, will increase their gold holdings to the level that the percentage of their total currency will be greater than that of any other currency in the world. At that point, they will assert that their currency should become the reserve currency of the world.

If you look at the last gold run, gold went from $200/oz. in mid-1979 to $800/oz. in early 1980. During the 10-year period of 1970–1980, we saw a 20-fold increase in the price, from $40/oz. to over $800/oz. We also had a 20-year low in 2001 of $250/oz. If you apply that 20-times multiple, you’re up to $5,000/oz.

For silver, if you use the historic ratio of an exchange ratio with gold of 16:1, you get to $312, so $200 is conservative. I think we’ll see these numbers within four years’ time.

TGR: You are talking about a 15-year bull market for gold and silver, starting in 2001 and ending in 2015 or 2016?

RM: Yes. I don’t think prices will necessarily fall dramatically, but gold and silver will reach the zenith of purchasing power relative to other asset classes. When gold peaked in 1980, Volcker was channeling up interest rates. If you had rolled out of bullion into fixed income then, you would have made a tidy gain.

TGR: Are you predicting prices of $5,000/oz. and $200/oz. as spikes, or plateaus that they will reach, stay at and trade around?

RM: I think you’ll have a spike at or above $5,000. Credit will become more expensive, and at some point credit will be denied. There’ll be a need for liquidity, and the metals address that need.

TGR: When prices reach those levels, any project that smells of gold or silver will become a prospect that people will try to put into production. Will we end up with a glut of gold and silver on the market?

RM: No, but the higher prices will spur more exploration. At the same time, it is getting harder to bring a mine into production. It takes longer and costs more. The regulators have put more rules in place. It is not so much that the rules are wrong, but it’s the extended time frames. The risk of putting a property into production has gone up dramatically.

You’re starting to see real limits on the amount of growth that can occur. In the 1990s and 2000s, very few people were going through mining schools because there weren’t many career opportunities. The people who built the physical plants have scaled back. We are seeing the impact of that lack of investment in education, in the productive capacity of the suppliers and huge jumps in the capital expenditures for various projects. Labor wants a larger piece and you see a lot more labor strikes. Finally, governments are looking at the mining industry as a very easy target to extract more money from because the industry doesn’t have a lot of friends.

TGR: There is also a problem finding mining engineers who have track records of putting projects with proven ounces into production. There is a lack of intellectual capital.

RM: You can see that manifesting itself all over the place. Coal mines in Australia are hiring miners from Tennessee. They commute between Tennessee and Australia on a three-week cycle. One headhunter told me he had an assignment to hire 400 people—mining engineers, geologists and related workers—for an iron ore mine. His instructions were to make offers 50% higher than their current salaries.

On top of that, the mines have been mining lower and lower grade, supported by the higher prices. Few high-grade deposits are being found. You have to put more capital in the ground and mine a lower quality or concentration of mineral to stand still.

TGR: Wouldn’t that increase the value of mid caps that have experienced personnel on the production, mine building and engineering side? They know how to put projects with tricky deposits and lower grades into production.

RM: You’re right. There really is a premium on production and on reserves. As the price of gold moves up, those mid caps will become more desirable to the seniors and attractive to investors. Companies doing exploration have proliferated. That creates confusion in the marketplace. Companies will have to go to greater lengths to differentiate themselves to attract capital. Perhaps that is one of the reasons why the exchange-traded fund (ETF) is so popular.

TGR: Could that explain why the juniors have lagged? Companies have projects that sound like they have great potential, yet the prices of most juniors are going nowhere.

RM: A couple of years ago, gold stocks had greater leverage than bullion; it was said that when bullion moves 1%, gold stocks will move 3%. People bought into that and they haven’t seen the performance. Perhaps they were looking initially at the seniors for leadership, but the seniors have been standing still while the price of gold has been running. You can look at someone like Kinross Gold Corp. (TSX:K; NYSE:KGC), which has been trading at a five-year low, or Barrick Gold Corp. (TSX:ABX; NYSE:ABX), and a number of others. They just haven’t delivered the performance. I think investors are asking, “If they are not delivering the performance, why will the intermediates or juniors deliver?”

With gold, whether you buy physical or an ETF, you don’t have any political risk. You don’t have taxation issues or labor strikes. You don’t have senior management making an investment that you don’t agree with. All of those variables conspire to take the enthusiasm out of the buying of the juniors. ETFs are an easy way to get into gold quickly at a lower perceived risk. I prefer to be in the juniors because they have the potential to explode to the upside if they are lucky with a discovery or they are in a right position next to a mine that is growing and the ore body continues onto their property.

TGR: As the chairman, CEO and largest shareholder of Minera Andes Inc. (TSX:MAI; OTCBB:MNEAF) and US Gold (TSX:UXG; NYSE:UXG), tell us what’s going on with the possible merger?

RM: In mid-June, I put a proposal to the board of Minera Andes and US Gold to combine the two companies with an exchange ratio of 0.4 shares of the new company for every share of Minera and one share of the new company for each share of US Gold. The combined company would be a low-cost, mid-tier silver producer with a strong balance sheet, an income stream, a producing silver gold mine, a development pipeline of two silver and gold mines in Mexico and Nevada, and production out of Argentina. In June, if you combined the treasuries, there would be more than $120 million (M) in cash, no debt, and trade liquidity on the NYSE. It would be a low-cost producer based on the production projections from our El Gallo and Gold Bar properties, anticipated to go into production in 2014. We would be producing silver using gold as a byproduct for a negative cost. With the gold credit, our cost of production would be less than $1/oz.

The board has formed independent committees and hired financial and legal advisers to determine the appropriate ratio. The merger has to clear the SEC, which takes 30–45 days. Thirty-five days after the SEC approval, the shareholders will vote. In the case of US Gold, I won’t have a vote, so what the SEC calls the minority shareholders, who are actually the majority, will vote on the merger. Minera shareholders will take two votes on an “evaluation and fairness opinion,” one with me voting and one without me voting.

So far, the market has suggested this is a good combination. Both share prices went up on the day the proposal was announced and have been performing better than the silver price, the gold price or the junior index.

When I announced this deal, on a combined basis, my cost base in US Gold was $50M and $60M in Minera. Combined, based on the market, my investment is worth about $350M. If you were to compare that to the CEO holdings of almost every other gold or silver mining company, it’s right up at the top, about 27 times higher than the average CEO.

TGR: Congratulations. You’ll have cash flow from the Argentinian project, the blue sky of the Mexican silver, and the gold in Nevada with the silver credits. I can see why the shareholders were enthusiastic. Do you have a name for the company?

RM: The name McEwen Mining has been proposed. Given that we will be in copper, silver and gold, that name isn’t aligned with any one metal; it’s more reflective of what we’re doing.

TGR: You are also chairman of Lexam VG Gold Inc. (TSX:LEX; OTCQX:LEXVF; Fkft:VN3A). It sounds like on this deal you’re following in the footsteps of your Lexam merger up in the Timmins Mining Camp. Did you use that as a template?

RM: I started off with five companies and did three corporate restructurings over a period of eight years to create Goldcorp Inc. (TSX:G; NYSE:GG), and then bought Wheaton River Minerals to kick it up to another level.

One of my goals in US Gold was to qualify for inclusion in the S&P 500 in 2015. I think gold is under-represented on the S&P. Newmont Mining Corp. (NYSE:NEM) is the only gold stock listed there.

There is more than $1 trillion invested by index funds in the S&P 500. It’s a market that can add stability to your base and lower your cost to capital. That is an engine for growth, a low-cost capital. We’ve met five criteria for inclusion and have two remaining. We need a market cap in excess of $5 billion and four consecutive quarters of earnings. This combination moves us much closer to that objective.

TGR: Can you expand on Timmins Mining Camp?

RM: Lexam is exploring in the Timmins area in northern Ontario, historically the largest gold-producing area in Canada. Lexam has acquired a number of properties in the shadow of the headframe, the shaft, of some of the largest mines in the area. We have four drills going and released news about some interesting grades we found, extensions of vein structures that had been mined 40 or 50 years ago.

There are about 1.5 million ounces largely in an inferred resource. We are looking to get the remnants and to go deeper than previous mines. There are a couple of sweet spots that we want to explore. The company has no debt and it has about $12M in its treasury, which will allow it to explore for the next two years.

TGR: Is there a small company or two with which you have a particular affinity?

RM: Rubicon Minerals Corp.’s (NYSE.A:RBY; TSX:RMX) development with Agnico-Eagle Mines Ltd. (TSX:AEM; NYSE:AEM) is positive. Agnico just took a position in Rubicon partly because the Rubicon head of operations worked up in the Red Lake district.

TGR: Are there any other topics you’ve been thinking about that might interests our readers?

RM: Right now we are looking at debt: the U.S. debt ceiling debate and the debt of sovereign states in Europe. I think any correction should be used as a time to accumulate.

The quiet summer is a good time to stake out the juniors and intermediates and take positions. We’ve seen periods like this where physical gold and the gold shares separate in terms of performance. In September 1979, which was just before the top in the gold price, gold went from $200 to $400/oz. in the space of a little over four months, but the gold stocks didn’t follow. It was as if the market didn’t believe the price of gold would hold up there. It wasn’t until September 1980 that gold stocks reached their highs. I believe that the market had to see the impact of the higher gold price on the cash flow and earnings before they would buy the stocks.

I think we’re in that period right now. I would argue that we are starting to see the seniors move—Barrick has been moving today with the gold price. These are incredible cash-flow generators right now. They are going to have to do something with their earnings, dividend them out or up their yields.

They also are going to look for growth. Barrick surprised everyone by buying a copper project, with cash. That was a curveball. I think they went into copper believing it was a better cash flow and cheaper than buying a gold property. Barrick is diversifying because they see opportunities. The seniors are doing deals to build the size of their companies, and that’s positive for the intermediates and the juniors. The seniors have been reaching right over the intermediates into the junior–producer/junior–explorer side. The longer this gap exists, the more attractive the juniors and intermediates will become.

TGR: Here at The Gold Report we’ve seen our readership increase along with the exponential increase in investor interest in gold and silver. Most U.S. investors don’t own mining stocks in their portfolios; do you think they will dip their toe into, if not bullion, then an ETF?

RM: Yes. The ETF has given more people exposure to gold. I liken the ETF to a mutual fund. It was often said that buying a mutual fund was the place to start investing in the stock market. Once investors become comfortable with the concept of being in the market, they start thinking about buying individual stocks because they think they understand how the market works.

I think the same principle applies to the ETF. Once investors are in there, they are going to start looking around and saying, “Well, this gold price is going to do very positive things to these mining stocks at some point. Maybe I’ll rotate some of my money out of the ETF or I’ll put in some additional money and it will go into individual stocks where I think I can see much larger gains down the road.”

TGR: Rob, thank you for your time and insights.

Rob McEwen, whose association with the resource industry spans nearly three decades, serves as CEO of US Gold Corp. and chairman of its board of directors. Five years ago he also became the company’s largest shareholder. Rob joined the Minera Andes board of directors in August 2008 and took over as president and CEO a year ago. Rob is also chairman of Lexam VG. He started building his reputation as the founder of Goldcorp, which has what is still considered the richest gold mine in the world in its Red Lake Mine in Ontario. He took Goldcorp from an investment company with $50 million market capitalization to one of the largest gold-mining companies in the world with an $8 billion market capitalization by the time he retired from the company. Rob has been recognized with awards such as Canadian Business’ Most Innovative CEO, Northern Miner’s Mining Man of the Year, Ernst & Young’s Ontario Entrepreneur of the Year (2002) and Prospectors and Developers Association of Canada (PDAC) Developer of the Year. A 1969 graduate of St. Andrews College—where the McEwen Leadership Program was modeled on Rob’s vision—Rob went on to obtain a bachelor’s degree from the University of Western Ontario. He earned his MBA from York University’s Schulich School of Business, where he serves on the Dean’s Advisory Board, holds the Alumni Recognition Award for Outstanding Executive Leadership (2007) and provides generous financial support. He also holds an honorary Doctor of Laws Degree from York University. With community-oriented efforts focused on encouraging excellence and innovation in healthcare and education, Rob’s generosity helped establish the McEwen Centre for Regenerative Medicine at the Toronto General Hospital and support the Red Lake (Ontario) Margaret Cochenour Memorial Hospital.

Current Home Loan Trends

With economic uncertainty continuing to hamper economic growth, inflation has been non-existent, and mortgage rates have remained low.  Current rates for conforming loans have dropped below the lows seen late last year to set new record lows for fixed rate mortgages, 5 year ARMs, and 1 year ARMs.

However, many new home buyers looking for a new mortgage and existing home buyers that would like to refinance their current mortgage have struggled to take advantage of these record low rates because of stricter lending standards put in place by most banks or a lack of equity in the home.

Fortunately for people looking for a mortgage that have been unable to obtain one, there have been rumors of another attempt by the federal government to assist existing homeowners swirling around Washington, and most of the plans under discussion are more focused on benefits for existing homeowners that are expected to end the decline in home prices, rather than improving bank balance sheets or handing out credits to new home buyers.  These programs are expected to help existing home owners immediately and new home owners in the long term by increasing home values, making a home a safer investment and a quality asset again.

One assistance program that has already been put into place is a refinancing program for existing home owners with little to no equity in their home.  The program is for mortgages owned by Fannie Mae that were originated before June 1, 2009 without any mortgage insurance, and it will allow qualified applicants to refinance their mortgage debt (including a second mortgage) up to 105% of your current home value at current market interest rates.   These stipulations do limit the pool of eligible home owners, but for people that qualify, it is a great opportunity.  You can begin by determining if your home loan is owned by Fannie Mae here.

If you believe that you qualify for the Fannie Mae program described above or are looking for any other type of mortgage assistance, you should contact a lender like Aurora Loans to start the process of obtaining a new mortgage or refinancing an existing one.

Economic Events on August 26, 2011

At 8:30 AM EDT, the preliminary GDP report for the second quarter of 2011 will be announced.  The consensus is an increase of 1.1% in real GDP and an increase of 2.3% in the GDP price index.  The real GDP estimate is 0.2% lower than the advance value for the second quarter of 2011, and the GDP price index is the same.

Also at 8:30 AM EDT, the monthly Corporate Profits report from the Bureau of Economic Analysis will be released.

At 9:55 AM EDT, Consumer Sentiment for the second half of August will be announced.  The consensus is that the index will be at 56.0, which is 1.1 points higher than the value reported in the first half of the month.

At 10:00 AM EDT, Federal Reserve Chairman Ben Bernanke will speak at the Kansas City Fed conference in Jackson Hole, Wyoming on the state of the economy.

Carlos Andres: Discovering Bargain Basement Gold Stocks

Carlos Andres If gold equities are on sale, the stocks Carlos Andres follows as publisher of the Frontier Research Report are on clearance. Andres seeks out stocks that have been unfairly pummeled, offering extra upside for investors. In this exclusive interview with The Gold Report, Andres identifies some of his best stock picks trading at insanely low prices that belie their quality management and mining projects.

The Gold Report: How did you launch the Frontier Research Report?
Carlos Andres: I grew up in an entrepreneurial household that gave me an early foundation in business and finance. My career developed on that foundation. I’ve been a founding partner of a couple of boutique consulting firms over the last 20 years that provided a variety of services that included financial analysis, business valuation, forensic accounting, business turnaround and M&A work across a wide range of industries. I also have an educational background in international or macro-economics and geopolitics. In the mid-1990s, I took notice of global supply/demand imbalances in the natural resource space with the emergence of the Chinese, Indian and other Asian economies and, as a result, became a committed natural resource investor in the late 1990s.

Like many, I began to read a lot of newsletters and ultimately entrusted my investments to selections made by newsletter writers that I had come to respect. With some exceptions, I had a good deal of success this way. But it always bothered me that I wasn’t applying my own experience, expertise and education to company due diligence and industry and market research with the idea that I could remove some of the risk from my investing activities. Eventually I took my own advice and began looking at companies very closely, applying my expertise and developing ideas about targeting companies where there is a significant gap between perceived risk and actual risk. The newsletter was born out of a desire to share my journey with a wider audience.

TGR: How did you end up in Uruguay?

CA: I have always had a desire to travel extensively and live abroad since I spent a year in France in my college days. On another track, as I followed the global natural resource story with great interest over the last decade or more, I also developed a desire to place myself geographically in the midst of this emerging trend. As a result, I began to look for places that satisfied both desires. For me, Uruguay represents just such a place. It is an excellent base from which to explore the resource rich countries of South America.

TGR: What is your definition of an overlooked opportunity, and what approach do you use to unearth these opportunities?

CA: An overlooked opportunity, from my perspective, is one that goes unnoticed or is simply ignored by the investment herd and most analysts. Natural resource investing, although growing in popularity, is still virtually ignored by the mainstream investment community. There are several reasons for this, but an important one is simply a lack of familiarity in connection with ever-increasing global supply and demand imbalances and the complex business of mineral exploration and production. Therefore, we specifically target companies in the natural resource space because this is where we tend to find bargain basement prices, meaning this is where we will find prices that are substantially below the company’s intrinsic value. In this context, we ask the question: Which companies represent the highest risk and thus present the highest potential reward? The answer is pretty straightforward: Junior exploration companies easily represent the highest risk in mining and junior explorers located in emerging and frontier markets drive the risk factor right off the charts. The investment herd and most analysts typically fear to tread in foreign markets that are shrouded in uncertainty. In targeting this segment, we vigorously apply our long experience and considerable expertise to separate the wheat from the chaff. In short, we choose countries and companies where perceived risk is substantially higher than actual risk, with the idea of profiting on the difference. When we get it right, we will make many multiples of our original investment.

To spice things up and increase the high-risk, high-reward factor even further, we will also target distressed junior explorers in emerging and frontier markets. We are sometimes able to identify companies that are on the verge of emerging from distress. The shares of such companies can typically be purchased at steep discounts. Perhaps our tag line should be “unearthing overlooked and undervalued opportunities.”

As an example, we identified Sulliden Gold Corp. (TSX:SUE; OTCQX:SDDDF) as just such a distressed opportunity. Sulliden was a junior exploration company with its flagship project located in Peru. The company was involved in a four-year lawsuit that put its title into question. As a result, the market completely discounted the company. When Sulliden settled the lawsuit and emerged with an established gold deposit, a new management team and a revamped business plan, few people took notice. We recommended the company to our subscribers just as it was emerging from the lawsuit with impressive results.

TGR: What are the drivers that you are focusing on now with rising prices, unsettled world economic conditions and the possibility of another recession?

CA: In the developed world, say North America and Europe, we have this notion that the global economy is driven by the Western world that consumes things that are manufactured in Asia. In order to manufacture these things, Asia imports natural resources from the rest of the world to use along with its own domestic supply. From this perspective, it is typically argued that if there is an economic slowdown in North America and/or Europe, then, by extension, this will cause manufacturing in Asia to slow down, which will cause demand for natural resources to slow and hence cause a worldwide recession. Although elements of this storyline are certainly true, it overshadows a more important driver—fundamental domestic demand changes taking place in Asia with respect to the size of its population, rapid urbanization, a growing middle class, rising incomes and a rising standard of living.

In short, internal demand is rising rapidly in Asia, which is creating an economic dynamic that is being ignored in the West due to inaccurate assumptions about emerging trends and what drives the global demand and supply of natural resources. Asia is an emerging story all on its own with growing domestic demand for natural resources. Asia’s internal demand and internal economy represent a huge global driver and Western investors ignore it at the peril of their portfolios.

TGR: The gold price has made some spectacular moves in the last couple of weeks. This should lead to some greater interest in mining stocks, which have been underperforming the physical metal.

CA: It has been perplexing to a lot of people as to why the producers should be undervalued when the gold price is rising. The HUI/Gold ratio chart is a good place to see this borne out graphically as it is falling to lows not seen since the onset of the global financial crisis in 2008. As one might expect, this trend is even more pronounced among the gold junior explorers. But the fundamentals that are driving the gold price higher remain powerfully intact. Therefore, we expect the producers and juniors to eventually play catch-up. Until then, current valuations represent a buying opportunity and we are buyers at these levels. The disparity between the rising price of the metal and the shares of the companies that find and produce the metal will not likely go unnoticed forever. Demand for gold, oil, uranium, potash and other mineral resources is rising at a much faster rate than supply can or will be able to match over the short to medium term, if ever. In addition, production is depleting reserves much faster than new reserves are being found. This situation argues that commodity prices will continue their upward climb.

TGR: Is Sulliden Gold, which you mentioned earlier, still undervalued? It has a 1 million ounce (Moz.) resource that it has developed in Peru, which is surrounded by some of the largest gold producers in that country.

CA: Sulliden’s Shahuindo gold project is located in what may be the lowest production cost gold mining neighborhood on the planet. The region includes Yanacocha, which is by far the biggest open-pit mine in South America and is considered the second largest in the world. It is owned by major gold miners Newmont and Peru’s Buenaventura. Among the many other gold mines in the area, Buenaventura has two new projects to the north that are similar to Shahuindo. Barrick’s massive Laguna Norte mine is just to the south. Overall, Peru is the fourth or fifth largest gold producer on the planet.

In this setting, Sulliden updated its resource estimate in June. It has been doing a lot of exploration drilling over the past year or more, which has resulted in a dramatically increased estimate from 1.4 Moz. to 3.4 Moz. today. Hence, the dramatic rise in the company’s stock price. Sulliden is a great little company with a great story.

After the four-year lawsuit we mentioned earlier, it was taken over by a group of experienced and serially successful gold miners, from a mining investment house known as Forbes & Manhattan. F&M is run by Stan Bharti, who is an exceptional mining personality. The firm put Peter Tagliamonte, who is also a very accomplished gold mine developer, in charge of Sulliden and together they placed Sulliden on an aggressive exploration and development footing as it emerged from the shadow of litigation.

For investors who were able to purchase the stock earlier last year as it emerged from the lawsuit, it has provided a return that is many multiples of their initial investment. The company has delivered on its business plan and has now progressed beyond being an early-stage explorer to being a company on the path to developing and operating a mine. Nevertheless it still has extraordinary exploration upside as well.

The intriguing thing about the deposit is that the company continues to extend the strike length and lateral extensions of the deposit. In other words, it continues to find gold further and further away from the main deposit in all directions. In addition, a vast majority of its previous drilling has only explored down to about 110 meters (m). The current resource of 3.4 Moz. is found at very shallow depths. The company has punched a few holes beneath this depth to about 400m and discovered that the deposit is open to that depth as well. The bottom line is this planned open-pit gold mine is going to get a lot bigger—in length, width and depth.

It also looks as though the grade is getting better as the company better understands the geology and continues to drill. Sulliden is in the midst of preparing a definitive feasibility study and the results are due to be released any time now. This will be a significant milestone in the company’s development that will set the stage for a decision to start construction and to obtain mine financing. We would also expect a positive study to provide the basis for a revaluation of the share prices in the upward direction.

TGR: What do you think the chances are of it being taken over by one of its larger neighbors?

CA: We think the chances are very high. I have no doubt that the company is on the short list of several of the majors.

TGR: What other companies appear undervalued to you?

CA: As the market has sold-off, gold shares have not been spared. As one might expect, the sell-off does not discriminate and takes both good and bad companies with it. This creates a great opportunity to buy good companies at a steep discount. The current environment is no exception.

In this context, one company in particular that is extremely undervalued, in our view, and represents extraordinary value is Gran Colombia Gold Corp. (TSX.V:GCM), with multiple projects in Colombia. This is a story that has flown significantly under the radar.

It represents the recently completed merger of two companies, Medoro Resources and Gran Colombia. Both are run by the legendary Serafino Iacono and his longtime business partner, Miguel de la Campa. Together they are responsible for the development of Bolivar Gold Corp., which identified the mammoth Choco 10 deposit on the Venezuelan segment of the resource-rich geological setting known as the Guiana Shield. They sold the company to major Gold Fields Ltd. (NYSE:GFI), making fortunes for the shareholders in the process, before Hugo Chavez began nationalizing the gold industry. Gold Fields eventually sold the mine to Rusoro Mining Ltd. (TSX.V:RML). Rusoro owns some of the most prolific gold mines and deposits in the world but is currently receiving the Hugo Chavez discount.

Serafino Iacono and Miguel de la Campa are also the personalities behind Pacific Rubiales Energy Corp. (TSX:PRE; BVC:PREC). For those unfamiliar with the story, Pacific Rubiales is a relatively new company that is also the result of a merger that created the basis for what is now the second largest oil and gas producer in Colombia. The company went from roughly CAD$1.50 a share to a price of over CAD$30 in just two short years. The point here is that these guys know what they are doing. They know the region and they only know one speed: Go big or go home.

Gran Colombia has assembled a group of historic gold projects within Colombia’s prolific and historic gold producing districts. Few realize that Colombia was once the largest gold producer in the world and its gold deposits are what prompted the Spanish to make it the headquarters for colonial expansion. As a result of strategically targeting the area, the company already has the largest deposit in Colombia and is the largest gold producer. Its Marmato project has close to 10 Moz. and an operating underground gold mine. This is a world class deposit no matter how you slice it. In addition, its Gran Colombia project is currently mining just 4 of 29 known high-grade gold veins. These are all historic gold mining areas that have been in production for over 100 years, and in some cases much longer. However, they have not been subject to modern exploration or bulk mining techniques. The company has tremendous upside with a world-class existing deposit, underdeveloped production at 100 thousand ounces (Koz.) per year, underexplored properties, superior management and $80M in the bank. It also owns a 60% interest in a gold refiner, which is a definite value-added feature that you rarely see in any gold mining company. Surprisingly, the company is currently being valued as if it were an early stage junior explorer. We don’t think this perception or its low value will last for long.

TGR: Are there any other discounted stocks you’re watching?

CA: One of the cheapest companies in our portfolio at the moment is Crocodile Gold Corp. (TSX:CRK; OTCQX:CROCF) in Australia, which has an extensive inventory of gold and other mineral deposits. It is a producing gold miner with over 5 Moz. of resources, but, like Gran Colombia, is being valued as though it’s an early-stage, high-risk junior explorer. It is unbelievable how cheap it is. This is another Stan Bharti and Forbes & Manhattan project. Peter Tagliamonte from Sulliden is also actively involved in exploration and mine development at the board level.

The value of the company on an enterprise value per ounce basis as a percentage of the actual gold price is somewhere in the neighborhood of 1.5%. It is just incredibly cheap for a company that is producing gold and has 5 Moz. in the ground. In addition, it recently hired the former CEO of DeBeers Canada to oversee the strategic development of what amounts to a gold district around Darwin in northern Australia.

TGR: Usually they’re worth at least 5%–10% in the ground.

CA: Exactly. Gran Colombia is currently 1.7% and Crocodile is 1.5%. Ironically, these two companies actually represent the companies in our portfolio that have the largest gold deposits, with Gran Colombia at 10 Moz. and Crocodile at 5 Moz. Both have plans to increase production from 100 Koz. to somewhere around 600–700 Koz. per year. Both are world-class operations run by top management with plenty of cash. Their low valuations are just an anomaly and in our estimation investors would be well advised to take advantage.

TGR: Anything else you would like to mention?

CA: The entire gold mining industry from producers on up the risk curve to explorers is undervalued. I think it is definitely shopping season in the gold sector. Do your homework, pick your favorites, buy some now and nibble all the way down on price weakness. Then just have a little patience.

TGR: Do you have any closing thoughts?

CA: Times are definitely tough. The world seems to be undergoing some sort of convulsion where the underlying theme is change, whether it is political, economic, social, peaceful or violent. How things will settle out is anybody’s guess. This is very unsettling for people in general, and this includes investors. It is at times like these that it is important for people to replace their anxiety with a quest for knowledge, insight and understanding. I encourage investors to get involved and do their homework rather than allowing themselves to become overwhelmed by confusion resulting in deer-in-the-headlights–type inaction. Investigate the trends and then put your investments in the way of these trends. It’s the equivalent of setting your sails to harmonize with the direction the wind is blowing. Get out there ahead of it all and run before the wind. Seize historic change as historic opportunity. The road to wealth lies through such times as these.

TGR: I greatly appreciate your input. I think our readers now realize that there are opportunities everywhere and they aren’t just in North America or Africa.

Carlos Andres is the managing editor and chief analyst of the Frontier Research Report, a natural resource–oriented monthly investment newsletter focused on high-risk, high-reward junior exploration companies in emerging and frontier markets. Mr. Andres applies a potent mix of world-class expertise and lengthy experience in identifying countries and companies where “perceived” risk is much higher than “actual” risk, providing opportunities to profit significantly on the difference. Mr. Andres has been a natural resource analyst and investor for over 15 years.

Pop Quiz

Q: Who said this:

Second, the idea that U.S. economic difficulties hinge crucially on our failures in international economic competition somewhat paradoxically makes those difficulties seem easier to solve. The productivity of the average American worker is determined by a complex array of factors, most of them unreachable by any likely government policy. So if you accept the reality that our “competitive” problem is really a domestic productivity problem pure and simple, you are unlikely to be optimistic about any dramatic turnaround. But if you can convince yourself that the problem is really one of failures in international competition—that imports are pushing workers out of high-wage jobs, or subsidized foreign competition is driving the United States out of the high value-added sectors—then the answers to economic malaise may seem to you to involve simple things like subsidizing high technology and being tough on Japan. [Emphasis added.]

A:  Paul Krugman (Pop Internationalism p. 16 [1996], The MIT Press, Cambridge).

In spite of his remarkable daily stupidity, Krugman actually correctly recognizes the problem of American competitiveness in international trade.  What hampers America is not foreign trade, but domestic productivity.  And one of the biggest hindrances to domestic productivity is government, both at the state and municipal level, and particularly at the federal level.  Thus, if one wants to know why Americans are losing manufacturing jobs, one need only look at domestic policy.  The federal government has increasingly hamstrung manufacturing jobs over the past several decades.

Furthermore, instead of allowing consumers to feel the pain that domestic production policy would naturally incur, the federal government instead decided to promote increased foreign trade (under, it should be noted, the auspices of so-called “free” trade).  This policy has then had the effect of subsidizing foreign production at the expense of domestic production because foreign manufacturers do not have to face the massive regulatory costs that domestic manufacturers face, giving foreign manufacturers a leg up on their competition.

As I have undoubtedly noted before, there are only two correct positions for a domestic government that presumably claims to represent the people over which it governs.  Either the government can highly regulate domestic business and place tariffs on imports that approximate the costs faced by domestic producers or the government can reduce the burden of regulation on domestic business in conjunction with the decreased cost of importing.  It is, however, quite foolish to do what the U.S. government is doing now:  highly regulate domestic business while decreasing the cost of importing.  Either a high degree of regulation is desirable or it is not.  If it is, whatever regulations that exist should be applied to every person and corporation that wishes to do business in America.  If it is not, the domestic market should be deregulated posthaste.  There is no excuse for the current state of affairs.

Economic Events on August 25, 2011

At 8:30 AM EDT, the U.S. government will release its weekly Jobless Claims report. The consensus is that there were 405,000 new jobless claims last week, which would would be 3,000 less than the previous week.

At 9:45 AM EDT, the weekly Bloomberg Consumer Comfort Index will be released, providing an update on Americans’ views of the U.S. economy, their personal finances and the buying climate.

At 10:30 AM EDT, the weekly Energy Information Administration Natural Gas Report will be released, giving an update on natural gas inventories in the United States.

At 4:30 PM EDT, the Federal Reserve will release its Money Supply report, showing the amount of liquidity available in the U.S. economy.

Also at 4:30 PM EDT, the Federal Reserve will release its Balance Sheet report, showing the amount of liquidity the Fed has injected into the economy by adding or removing reserves.

Tex-Pats out there somewhere

There is a new report via Penn State and some partners on the economic impact of Marcellus Shale development.  According to the news coverage the report has some new data on the great Marcellus worker mystery.  From Somerset County’s Daily American:

The study also suggests that a large majority of industry employees are coming from out of state. While overall employment increased in about half of the municipalities, only 28 percent experienced lower unemployment rates in 2010.”

This all gets to just a small debate over whether the development of shale gas in Pennsylvania is generating jobs for folks residing in the state already, or for folks coming into the state from elsewhere.  My version of that is that it makes a difference whether you are talking about folks who are flying in temporarily in stints, versus people moving into the state from elsewhere.  If folks are actually moving into the state it clearly will have positive impacts on state-wide population trends as well as economic growth.  If folks just fly in and fly out,  but continue to make their permanent residences elsewhere, it makes the Pennsylvania T akin to a large North Sea oil platform. Or to use a US analogy.. maybe places like Altoona, or even Pittsburgh are the Port Fourhon’s of Midatlantic?  If folks are not living here permanently, they will be buying their homes elsewhere.  Making all of those home related purchases elsewhere and raising their families elsewhere and so forth and so on.

Clearly there are new jobs in Pennsylvania resulting from shale gas development.  The scale of employment projections I have seen make it impossible that all the new jobs are being filled by folks in the parts of Pennsylvania where most of the drilling has been happening.  The fundamental question is whether the folks are itinerant or permanent migrants into Pennsylvania.

So is this migration happening?  It was brought up specifically recently by Brian O. in the PG.  Brian isn’t the only one who has brought up this issue of Marcellus Shale induced migration…  for some rather colorfully named “Tex-Pats” I learn.  I thought I might try to find the migrants in the data.  Has there been some shift in migration flows that correlates with the beginning of shale gas development in Pennsylvania is the question.  Seemed the best place to start was to look specifically at migration flows between Texas and Pennsylvania. That is obviously just one particular migration flow, but since Texas is the place with the shale gas expertise, it is the place you would expect to see some of the specific shale gas talent diaspora.  Here is what I get from the IRS migration data which will capture those who are telling the IRS they have moved in or out of Pennsylvania.. probably correlates pretty clsoely to where they are paying most of their taxes overall:

So maybe there are a few net new migrants resulting from shale gas development, but I don’t think you will find much evidence of a change in trend in the data state-wide as shown there.   At least from this data the answer to whether the the shale workers are moving to Pennsylvania is no.. but it may be it is too soon to measure the full migration flow that shale development may be inspiring.  This data reflects moves that have happened in 2009 at the latest. So the better answer is at least through 2009 is ‘not yet’.

Still, look at the scale and for state-wide migration flows those are not the biggest of numbers. It will not take much new migration to really show some shift in the trend.. or any shift in trend.  Seems to me that the argument that folks are moving into Pennsylvania because of shale development has been floating out there for a couple years now at least so you would see something by now in the IRS data.  So we will keep watching.  I would be surprised if you do not see some movement in this trend in subsequent years.   Just an exogenous extra 1,000 migrants a year (roughly a total of 15 people per county in Pennsylvania…  in other words just a few households) from Texas to anywhere in Pennsylvania would cut that net migration time series in half from where it has been recently.  Given the scale of employment impacts that are floating out there, seems like it would be hard to hide any meaningful impact on migration flows.

For those who want more detail, this is the table that I made the graph from.

TX to PA
PA to TX
Net
2004-2005 5,204 6,488 -1,284
2005-2006 5,236 7,405 -2,169
2006-2007 5,220 7,452 -2,232
2007-2008 5,372 7,834 -2,462
2008-2009 5,488 7,637 -2,149