Mexico's Silver Mines Shine: 'Mexico Mike' Kachanovsky

Mike  Kachanovsky Precious metals analyst “Mexico Mike” Kachanovsky, who opines on junior mining and exploration stocks at smartinvestment.ca, is bearish on the world economy, but bullish on mining stocks. Although he has seen a recent rise in narco-violence, in this exclusive interview with The Gold Report, Kachanovsky urges sensible investors to continue to look at firms exploring Mexican metal deposits because the upside is enormous.

The Gold Report: Last September, you predicted gold would rise above $2,000/ounce (oz) by the end of the year. It didn’t quite get there. What do you see as a price limit now?

Mike Kachanovsky: I also suggested that silver would hit $50/oz before the end of last year. I was dead wrong on that prediction as well. But my outlook hasn’t changed. It’s difficult to put a specific timeline on price trends. It’s more important to have confidence that the factors that have contributed to the rise in both gold and silver prices for the last decade are still in effect. What we can accurately predict is how factors driving these prices will play out, while sometimes delays and countertrends and mini bear markets occur along the way.

We are currently trading at a sideways consolidation for gold in the $1,600–1,700/oz range and silver $30–35/oz. I am confident that we are going to see a lot higher than $2,000/oz gold and higher than $50/oz silver. Metal trading is volatile. But I feel very strongly that before the end of 2012, we’ll see both of those levels surpassed.

TGR: You said in your September interview with The Gold Report that we’re likely in a double-dip recession. Is the global economic situation improving now or worsening?

MK: The United States is still in a recession. A lot of people have tempered their bearish sentiment because the official data suggests that things are getting better. A case in point is the way unemployment is calculated. It appears that the unemployment rate is falling because of the way government agencies classify and organize the data. But there are more people looking for work now than there were at this time last year.

There is lasting recession in Europe. There’s less spending. Gross domestic product is generally in decline. Worldwide, more people are unemployed and looking for work. That reality is not necessarily reflected in the data.

TGR: Are we headed into a triple-dip recession?

MK: No matter how you look at it, we are in a secular slump. It’s a real challenge. Decades of malinvestment and debt buildup have to be resolved. It’s going to take years before the economic foundation is reset for another period of growth.

TGR: Will another round of quantitative easing help?

MK: Quantitative easing has been in place all along, although it has not been officially acknowledged. But where’s the money coming from? Interest rates are being held at artificially low levels. The Federal Reserve prints money by buying bonds to keep the interest rates low. That officials have not acknowledged this fact does not mean that it’s not occurring.

TGR: How does quantitative easing affect mining stocks?

MK: In the wake of the first two rounds of quantitative easing, a lot of hot money started chasing natural resource stocks. Printing money contributes to inflation. One of the ways to protect against inflation is to be leveraged in commodities—real stuff, for lack of a better word. But the prices of oil and gas and gold and silver and metals and hard commodities rise in an inflationary environment. Speculators flock to resource stocks to protect against inflation and more inflation ensues.

TGR: What statistical indicators are key when looking at junior mining stocks?

MK: You can’t talk about junior mining stocks as a group. There are three different subsectors. The first subsector is the early stage explorers who don’t have any real assets. They control properties, and they’re spending money on defining a deposit. The second subsector is the emerging producers. These companies have recently commenced mining, and they generate money from operations. The third subsector is the established producers who have been around for a few years. They are far less risky. They are earning lots of money in the current metals price environment. They have strong balance sheets. Investors need to be aware of those distinctions. The early stage companies are attractive only if you’re going to be patient. It may take months or years before those stocks become market leaders.

TGR: Is it still possible to hit a homerun with an early stage company?

MK: Absolutely. History hasn’t changed. But you must be very selective. Look for companies that have management teams in place that can survive difficult times. Look at the property base—is there a legitimate chance of finding a deposit that has the magnitude to allow for a rapid up cycle in value? Be careful, but leverage to that sector, because that’s where the biggest money will come from eventually.

TGR: Your particular area of expertise is Mexico. How do you assess the physical and financial safety of mining ventures in Mexico, considering the drug wars?

MK: That’s the big question about the Mexico stocks. There is a perception that things are spinning out of control there. I travel to Mexico regularly to visit mining projects. For sure, the violence has intensified. In the past, people’s daily lives were not much affected by the gangs. Now rival gangs fight turf wars and the violence spills over into the daily lives of average people and businesses in Mexico. But, overall, it’s still contained.

It is still safe to walk the streets at night. Well, you do need to have your head on your shoulders. If you’re driving on a major highway at night, you are at risk of being carjacked. If you travel in certain parts of Mexico City, you’re asking for trouble. The senior executives of mining companies could be targets for kidnapping. I’m not aware of that happening yet, but many executives travel with armed security guards. If you are cautious, you can go about your business safely.

TGR: Have the drug wars affected labor pools in the rural areas of Mexico?

MK: Often people who are working in the mines have close relatives who are working with the drug cartels in the hills, growing marijuana. It’s unlikely that the drug gangs have a reason to target the local labor at the mine. People are very pragmatic. I’ve been in towns that are centers of the drug trade. In some ways, they are the safest places in all of Mexico, because the cartels won’t allow anything to get out of line.

TGR: What gold and silver mining production companies do you follow in Mexico?

MK: There is a basket of established midtier level companies that I like: First Majestic Silver Corp. (FR:TSX; AG:NYSE; FMV:FSE), Endeavour Silver Corp. (EDR:TSX; EXK:NYSE; EJD:FSE), Avino Silver & Gold Mines Ltd. (ASM:TSX.V; ASM:NYSE.A; GV6:FSE) and Great Panther Silver Ltd. (GPR:TSX; GPL:NYSE.A).

TGR: What do you like about these companies?

MK: They have recurring production in place. They are profitable. They have fantastic leverage to the upside for future discovery. Their strong balance sheets enable them to look further afield, to make acquisitions of late-stage deposits that have been stalled and can’t move forward without more money. They’ve just been huge winners.

TGR: What’s been the effect on Avino’s prospects after being listed on the various stock exchanges?

MK: Anytime a junior mining stock secures a listing on a major exchange, like the NYSE, it increases that firm’s pool of investors. I mentioned Endeavour and First Majestic and Great Panther. After these companies secured senior listings, their share prices went up substantially. I expect Avino to attract a larger following, causing its share price to increase.

TGR: Are there any other catalysts for Avino this year?

MK: Avino has had limited production. The company needed to reach an agreement with the landowner about dividing up royalties for its main mine. A few days ago, Avino announced it has reached that agreement. It is going to resume production from two separate mining zones, instead of just one. When Avino runs larger tonnage of ore through the processing plant, its unit costs will go down. Profit margins should improve.

TGR: Does Endeavour Silver still have some upside left to it?

MK: Endeavour trades at a higher price than Avino because it has more magnitude. But four years ago, Endeavour was where Avino is today. Avino has a growth path firmly in place, and it can advance to the next level. Five years ago, First Majestic was where Avino is today: it had one major mine that was expanding. First Majestic went on to acquire other assets. It achieved the $1 billion+ valuation that it has today. These companies are all pretty much following the same path.

TGR: And is Great Panther on that same path? Does it still have upside ahead?

MK: Absolutely. We’re waiting for consolidation. A number of the smaller mines are starting to make money, but not as efficiently as they would under the umbrella of a single company. We recently saw a first indication of consolidation, when Minefinders Corp. (MFL:TSX; MFN:NYSE) announced that it had been acquired by Pan American Silver Corp. (PAA:TSX; PAAS:NASDAQ). I suggest that Avino is either going to be a takeover target, or it is going to start acquiring weaker companies to build growth.

TGR: Who could take over Avino?

MK: Any company that has a strong balance sheet that is looking to grow its total production by adding over a million ounces of silver a year. I don’t necessarily think Avino will be a target for Pan American Silver or Goldcorp Inc. (G:TSX; GG:NYSE). But, Avino could partner with other mid-size producers. There’s probably a dozen companies that could see an incremental value by bringing Avino under their umbrellas.

TGR: Galore Resources Inc.’s (GRI:TSX.V) Dos Santos project is next to Goldcorp’s successful Peñasquito mine. Is there a catalyst that would allow the market to value Dos Santos more in line with Peñasquito?

MK: Galore might get a higher speculative premium based on its proximity to large deposits in Mexico. Unfortunately, that hasn’t happened yet. But Galore has drill programs in place that are capable of hitting a big new discovery zone.

A general catalyst would be for gold and silver to break out of its range, reaching a new high. And, again, that could happen very quickly. That could happen when all of the analysts are expecting lower prices and, out of the blue, a strong uptrend kicks off when no one is expecting it.

TGR: Do you see that happening this year?

MK: No. But, again, trying to put a timeline of a specific year on any stock or price target is just inviting yourself to look bad. The present pause in the bull market is long in the tooth. At some point, valuations will snap back in line with a strong bull market. I’m being cautious because there are existential issues on the economic radar screen, like Europe.

Interestingly, another catalyst that makes a difference is when a high-profile newsletter writer or analyst recommends a stock. Higher share price generates more money to work on finding metal.

TGR: Is the opposite also true? If newsletter writers frown on a company, does that affect its stock price?

MK: Oh, for sure it does. Analysis is a double-edge sword. Most analysts, including me, are biased toward finding good companies to talk about instead of being quick to pan a stock or to suggest that it doesn’t have the goods. The vast majority of these mining companies are run by sincere, qualified, capable people who are doing their very best to move companies forward in a very difficult market. I think it’s a very rare situation when you have a real problem in any of these stocks that would warrant putting a sell on it.

TGR: Do you have any thoughts about what has given MAG Silver Corp. (MAG:TSX; MVG:NYSE) and Geologix Explorations Inc. (GIX:TSX) recent bumps in the market?

MK: MAG Silver went up after announcing exploration success at the Cinco de Mayo project. It has a molybdenum resource there. It started to find polymetallic resource zones that previously had not been valued in the stock price. It looks like MAG has a second major discovery underway, in addition to its Juanicipio project, which was a company maker.

With Geologix, there’s about 1.5 million ounces gold and significant copper at its Tepal prospect. The company has outlined new target areas. That is contributing to its slightly stronger share price.

The entire exploration sector is trading at almost bear market lows. They’re all representing fantastic opportunities. It’s just a question of waiting it out and letting the sector rotation do its thing. Eventually, the market will rediscover these stories and get excited again about them.

TGR: What about Southern Silver Exploration Corp.’s (SSV:TSX.V; SEG:FSE) partnership with Freeport McMoRan Copper & Gold Inc. (FCX:NYSE)? Is that a positive sign?

MK: It’s a great sign for Southern Silver, because anytime you can close a deal with a senior producer you are getting somebody else’s money to advance a project. Southern Silver has a number of attractive projects in Mexico. Any one of them could yield a major discovery.

TGR: What producers do you like north of the border?

MK: I like companies that have production in place and are making money and showing a strong growth curve. I’m extremely excited about Revett Minerals Inc. (RVM:TSX; RMV:NYSE.A). My optimism is based on the fact that Revett is leveraged to both silver and copper. Both metals are headed for all time highs in the months ahead, in my opinion. The company is debt free and it’s profitable. Plus, its mineral inventory is large enough to sustain it for decades. And it looks like it is getting very close to receiving the green light on its Rock Creek project. That mine, on its own, has the potential to elevate Revett to the stage of a midtier producer.

TGR: Revett’s stock price increased 500% in the last year.

MK: Part of the reason Revett’s stock price went up is because it had a share rollback. The share price roughly doubled, because its risk went down. The firm paid off its debt. It built a cushion of cash in the balance sheet. It operated profitably and efficiently.

TGR: I’ve noticed that Scorpio Gold Corp. (SGN:TSX.V) in Nevada has enjoyed a steady rise in share price over the last year. Any thoughts about what’s backing that?

MK: I visited that project last December. I like Scorpio because it is located in Nevada, which is very friendly to mine development. It’s a very low tech operation. It’s a conventional open-pit mine that has a relatively low strip ratio. It’s low cost to run. Scorpio’s gold recoveries are running at a fairly high level. It is drilling other expansion zones on its current open-pit mine. And, it is developing a second nearby satellite pit with a currently defined deposit. It still has some debt on its books and some of its monthly production is deployed to pay down that loan. But when that loan is paid off, in a year or so, Scorpio is going to be a cash-flow factory.

TGR: What are your current top picks?

MK: I bought more shares in Revett Minerals this week. I bought more Silver Wheaton Corp. (SLW:TSX; SLW:NYSE), which is a royalty play. It’s not even a mining company. But, it has a strong outlook for an even higher share price in the future. Buying the lows makes great sense now. I have not bought any Scorpio Gold, but if it dips in price, I’m going to buy it. I bought more Avino Silver at the end of last year. I bought some Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE), which is a gold miner that has seen its share price cut almost in half over the last six months. But it remains a very high quality company.

TGR: Do you tend to hold junior mining stocks for a while?

MK: Most of these companies I’ve owned for five years or more. I also have an active trading portion of my portfolio. When the market corrects, I can buy low. And I sell holdings during speculative highs. That is the nature our market. It can be volatile. We do not have to like it, but we have to acknowledge it and accept it is what it is: three steps forward and two steps back.

TGR: Thanks for sharing your insights.

“Mexico Mike” Kachanovsky is a consultant providing analysis of junior mining and exploration stocks. His work is published on a freelance basis in a variety of publications, including the Mexico Mike column in Investor’s Digest of Canada. He is a founder of www.smartinvestment.ca, which serves as an online community for the discussion of all topics relating to junior mining stocks.

Positive Signs

From the Grey Lady:

LAST week, Attorney General Eric H. Holder Jr. proclaimed in a speech that when it comes to fighting financial fraud, the Obama administration’s “record of success has been nothing less than historic.” Such self-congratulation is not only premature, but it also reveals a troubling lack of understanding about what is required to win the war against financial wrongdoing.

Four years after the disintegration of the financial system, Americans have, rightfully, a gnawing feeling that justice has not been served. Claims of financial fraud against companies like Citigroup and Bank of America have been settled for pennies on the dollar, with no admission of wrongdoing. Executives who ran companies that made, packaged and sold trillions of dollars in toxic mortgages and mortgage-backed securities remain largely unscathed.

As I’ve observed numerous times before on this blog, I am not at all a fan of regulation. I don’t like how the government imposes limits on inter-account transfers, nor am I fond of anti-trust regulation that makes buyouts more difficult. However, I am very much opposed to people being able to get away with taking someone else’s property under false pretenses, otherwise known as fraud. Quite simply, these thieves need to go to jail as punishment for their crime. There is no excuse for their behavior, and the American people should demand that those who committed fraud, in whatever way, be put on trial for their crimes. That there are some in the MSM calling for this very thing suggests that there may be hope yet.

Other Alpha Sources

1. Variant Perception’s blog is up and running and while I realise there has been little or no macroeconomic analysis here for a while, there is plenty of top notch analysis over at VP’s blog. The three latest entries take a look at inflation in the UK, the divergence between Spain and Italy in sticking to the path of austerity and how money keeps trickling out of the eurozone periphery. If you think I have been running lean on analysis and commentary here, the VP blog is a good way to get a take on what me and my colleagues are looking at.

2. The debate on macroeconomics and microfoundations keeps in chugging along and there has been a lot of interesting contributions lately beyond the ones I pointed to in my latest discussion of the subject. Simon Wren-Lewis has posted two additional pieces after the first one. PhD student Jérémie Cohen-Setton has a very nice summary of the flurry up on the Bruegel Blog and I would also emphasize Noah Smith’s comment. I realise that all this is terribly wonkish, but it is at the heart of developing modern macroeconomics into something that can tackle the important problems and issues ahead. As such, it won’t be work wasted to take a dive into the deep end here and have a look.

3. Morgan Stanley’s global central bank team takes a look at the outlook for QE3 in the US.

We see a three-out-of-four chance that the Fed acts as the data on growth soften and the rally in the equity market fades.  If the Fed is in a hurry or feels no need to push up inflation expectations, the action likely takes the form of sterilized asset purchases, i.e., the one-in-four chance of Operation Twist 2.  Recent public comments by Fed officials, along with press comments, make it more likely we are underestimating, not overestimating, their willingness to execute OT2.  If the Fed needs to see some slowing in the economic expansion either to get internal agreement or external insurance, the policy initiative waits until the April or May meeting and more likely entails asset purchases that are funded with reserve creation.  This policy, Quantitative Easing 3, which we peg at a one-in-two chance, would also be favored if the Fed desired more significant currency depreciation.

The view above squares well in my view of a slight change in the consensus expectation of the Fed’s next move. As the US data has improved and as it has continued to come in with upside surprises in key areas such as the labour market and auto sales the expectations of outright QE3 have been paired. Instead, the consensus has moved towards the expectation of an extension of Operation Twist. Such a move would however has its limits. It OT II were to happen in an environment of an improving economy yield curve flattening could move into inversion if short term yields became unhinged. This would obviously be unacceptable and therefore an outright expansion of the balance sheet specifically aimed at MBS would probably be the least risky alternative for the Fed.

4. Elsewhere in CB land it was absolutely amazing to hear the ECB actually worry about inflation just days after having completed the largest balance sheet expansion in the ECB’s history.

European Central Bank President Mario Draghi signaled he’s done enough to battle the sovereign debt crisis, laying the groundwork for an eventual exit from record-low interest rates and emergency lending measures.Declaring that the environment “has improved enormously” and there are “many signs of returning confidence in the euro,” Draghi yesterday turned the spotlight on “upside risks” to inflation, which is now forecast to remain above the ECB’s 2 percent limit this year. That suggests policy makers don’t plan to cut rates further or add to their 1 trillion euros ($1.32 trillion) of long-term loans to banks, economists said.

So, let me get this straight. The ECB has just effectively backstopped the entire European banking system for 3 years effectively becoming a clearing house for the reshuffling of lending risk onto the ECB’s balance sheet in exchange of 3y loans over to now worrying about the inflationary effects of its policies?

What planet are they on?

Obviously, the single interest rate policy does not work and perhaps such statements are exactly a reflection of this, but if the market was looking for transparency and foresight from the ECB they are going to look a bit harder it seems. The sovereign debt crisis is merely a few 100 basis points short of reflaring and Portugal and Spain are about to re-enter the limelight. Not a time it seems to me to assure markets that everything is about to move back to normal.

5. Portugal seems to be the next in line as yields stay in double digit territory, but who can really claim to be surprised? Edward certainly isn’t.

So why would people think that Portugal might be the next to need a second bailout? Well, what the Greek historian Thucydides would have called the efficient cause would be the fact that it has a 9.3 billion euro bond redemption due in September next year and the despite initial Troika hopes, the markets remain closed tighter than the lips of Angela Merkel were to the supposedly amorous advances of Silvio Berlusconi. But the final (or underlying) cause which will send Portugal into a second bailout is the fact that the country has a high level of debt (both public and private) and a chronic growth problem which won’t simply be turned around by a bit of good will and a few “magic wand” structural reforms. So essentially the numbers just don’t add up.

6. It was a beautiful weekend in London this week and on Sunday I picked up the Independent and while I was not surprised, I thought their piece on cheating at UK universities disturbing.

Over the past three years, more than 45,000 students at 80 institutions have been hauled before college authorities and found guilty of “academic misconduct” ranging from bringing crib-sheets or mobile phones into exams to paying private firms to write essays for them.Some 16,000 cases were recorded in the past year alone, as university chiefs spent millions on software to identify work reproduced from published material, or simply cut and pasted from the internet. But officials last night warned they were fighting a losing battle against hi-tech advances – which means it is becoming increasingly difficult to detect the cheats.

Cheating in academia is as old as academic itself and even tenured professors have been known to fudge their results or even plagiarise their colleagues’ work. But what does it tell us when the problem is particularly severe among entry level students? Surely, the article’s rationale based on university leaders’ comments that higher tuition fees and pressure to do well mean that more students are pushed into wrongdoing is sound. However, there is an underlying problem, or an elephant in the room if you will, that is not being mentioned in particular detail. Specifically, I am talking about the chasm between the level of academic standards applied by UK (and European universities) and the academic standards brought into universities by the foreign students largely financing the UK education industry.

I have seen this with own eyes and I have been amazed. Yet, the way Western universities produce (and set standards for) knowledge is simply so foreign for many who come from abroad that they are compelled to cross corners. When these students are then exposed they often do not realise why they are being summoned to a disciplinary body.

Another and more disturbing trend however is the implied argument that some students cheat because they can. Take for example the industry which has emerged to furnish students in a tight spot with a tailor made essay on any topic they might wish for a fee. This seems to be absolutely mad to me and any student resorting to this must either be desperate or stupid (or both) since anyone would be able to tell you that the quality of such essays is likely to be poor, at best.

Economic Events on March 13, 2012

At 7:30 AM Eastern time, the NFIB Small Business Optimism Index for February will be released, providing information regarding the health and confidence of small businesses in the United States.  The consensus is that the index is at a level of 95.0, which is 1.1 points higher than the previous month’s value.

At 7:45 AM Eastern time, the weekly ICSC-Goldman Store Sales report will be released, giving an update on the health of the consumer through this analysis of retail sales.

At 8:30 AM Eastern time, the Retail Sales report for February will be released.  The consensus is that retail sales were 1.2% higher last month, after an increase of 0.4% in the previous month.

At 8:55 AM Eastern time, the weekly Redbook report will be released, giving us more information about consumer spending.

At 10:00 AM Eastern time, the Business Inventories report for January will be released.  The consensus is that inventories increased 0.5% from the previous month.

At 2:15 PM Eastern time, the FOMC Meeting Announcement will be made, which will provide insight into how long the Federal Reserve plans to keep their rates target at 0% to 0.25%.  It is assumed that there will be no immediate change in the Fed funds target rate, but any hint that rates could rise in the future could have an impact on the bond market and stock market.