The Gold Report: What’s the macroeconomic picture for gold and silver throughout the rest of this year?
Ron Hera: I view gold as a currency, and I don’t think gold is going to lose value on a permanent basis, especially in light of the debt monetization that’s taking place. Real interest rates are negative, and that’s bullish for gold.
TGR: Silver’s been beaten up pretty badly this year. It’s right now around $28/ounce (oz). Where do you believe silver will end up at the end of 2012?
RH: It’s hard to say exactly where it will end up because these are very volatile markets. But the supply-and-demand situation for silver is bullish. The silver investment thesis is an astonishingly simple one. Since the 1970s, there have been considerable aboveground stockpiles of silver, but those stockpiles have dissipated. Smart investors, like Eric Sprott, simply came into the market and bought the remaining silver so that when the supply-and-demand situation tightens, they’ll be able to sell that silver at a profit.
TGR: You’re calling 2012 “the end of cheap everything.” One example is oil. You’re predicting that the spot price for Brent crude will never again go below $100/barrel (bbl). Tell us about oil’s fundamentals and how that’s impacting the junior resource space.
RH: The demand for oil is rising. Year over year, fuel oil consumption in the United States is down, so it certainly isn’t U.S. demand that can account for higher oil prices. It’s demand from developing countries, namely China. That’s why I don’t think that oil prices will stay down. Also, the vast majority of the sweet, light, easy-to-access oil has been discovered and consumed, so we’re looking at more expensive oil. I don’t believe that the world is running out of oil. I just believe that the world is running out of cheap, easy oil. I call it the cheap oil theory, not the peak oil theory. At $200/bbl, we have lots of oil.
This impacts the junior oil companies, like New Zealand Energy Corp. (NZ:TSX.V; NZERF:OTCQX) and Gran Tierra Energy Inc. (GTE:TSX; GTE:NYSE.A), in very interesting ways. It also means that rising production costs for mining companies are here to stay.
That is also why we are repositioning out of mining companies that have lower grades and therefore higher production costs. We are specifically targeting companies that have low production costs. That could be because of the actual basic cost of production or it could be because of byproduct credits, like copper credits. A couple of the operations of New Gold Inc. (NGD:TSX; NGD:NYSE.A), particularly the New Afton mine in southern British Columbia, are really copper mines with gold credits, but as a gold company, it positions as a copper credit. It’ll have a cash cost of -$1,250/ounce (oz) gold produced for 2012. That means it’s producing quite a lot of copper for every ounce of gold.
TGR: In an April 25, 2012, report titled “Gold Stocks: Where Is the Bottom?” you wrote,
“With gold and silver prices at or above current levels, some gold and silver mining stocks are severely undervalued. Exploration companies without substantial defined resources and producers that have relatively high production costs or relatively low grade deposits are less likely to rebound when mining stocks begin to recover. Metals prices stuck in a trading range and higher oil prices, thus, higher energy costs, are crushing the prices of exploration stocks and impairing the share prices of producers with higher production costs or lower grade deposits.”
RH: The situation could be particularly bleak for those companies that do not have economic resources—and that will be the majority of the exploration companies. We’re positioning into companies that have higher-grade deposits and lower production costs.
TGR: You talk about how cash flows are going to decide who’s going to make it and who’s not. In terms of cash flow, what do you like to see?
RH: That really depends on each company’s situation. But we’ve systematically repositioned capital into companies that we believe will rebound most vigorously, and there is a general guide for that. Number one, those companies have strong balance sheets already. Number two, they have positive significant cash flow already. Number three, most important, they have what I call not just a growth story but a monster growth story, meaning that the resources, production and cash flow are going to increase by an absolute minimum of 40–50% in the next year.
TGR: What are the total cash costs that you’re looking at?
RH: We’re looking for gold producers that are producing for less than $500/oz.
TGR: You developed the Hera Research Model Portfolio. Regarding that, you wrote, “If a company is selected for inclusion in the Hera Research Model Portfolio, Hera Research believes that its share price could increase by 100% or more in 18-to-24-months based primarily on tangible value creation or other recognition of value.” How have the last 12 months—when drill results aren’t tangibly moving share prices and equities continue to significantly lag the performance of the underlying commodity—made assessment more difficult?
RH: I would say that it’s always been difficult and that it isn’t materially more difficult now, although it is true that the share prices in the market are more volatile at this time. As I mentioned earlier, I view gold as a currency. So, when we’re talking about gold shares and the global commodity prices, the dollar is an enormous factor. That’s one of the first macro considerations that I’m constantly looking at: What’s going on with the dollar and other global currencies relative to gold in particular but then also to global commodity prices?
TGR: Are there other criteria that have become more important over the last year?
RH: I’m always looking at supply-and-demand fundamentals. The first thing that I try to do is identify natural resources that will rise in value because of supply and demand. Currently, that leads to crude oil, gold, silver, uranium and platinum group metals. Supply-and-demand fundamentals have little to do with inflation. They’re a consideration independent from what’s going on with global currencies.
In addition, sovereign debt and other economic factors have the potential to cause some of these commodities to rise much more then the supply-and-demand fundamentals would suggest, and that will be a function of inflation. There potentially is an inflation booster behind some of the natural resource stocks. Then I look at those specific companies within what I consider safe jurisdictions. So, my analysis starts with macroeconomics and monetary economics in particular and then moves into the supply-and-demand fundamentals for the commodities and then ultimately moves to the individual companies.
TGR: What’s your business model? How does Hera Research make money?
RH: First and foremost, I’m an investor in natural resources, and I’m merely publishing what I’m researching and what I’m doing with my own accounts. The newsletter business is simply to have it be subscriber funded. There are no corporate sponsors. You can’t pay us to write a research report. We just produced reports for Fortuna Silver Mines Inc. (FSM:NYSE; FVI:TSX; FVI:BVL; F4S:FSE) and for New Gold Inc. We’re doing one now for Uranium Energy Corp. (UEC:NYSE.A). The company logos on our website are of good companies; they’re examples of companies that we invest in. They’re not there because they paid to be there.
We offer two lists for investors: a Watch List for companies that look promising and the Model Portfolio. We break each list down by resource type and then by life-cycle stage. At every transition point between life-cycle stages, let’s say from preproduction to production, investors can profit. From an asset-allocation standpoint, one of the things we try to do is allocate capital across life-cycle stages. The idea is that as companies develop and mature, we take profits from those later-stage companies and move them back down into earlier-stage companies. It’s a continuous process that creates a snowball effect. That is our investment strategy.
TGR: As of May 15, the Hera Research Model was down about 6.1% for the year, but since then has rebounded to be up about 6.6% as of June 1. Tell us about some of the companies that you believe are going to continue to lift the portfolio’s performance over the remainder of 2012?
RH: I’m very optimistic about New Gold. We added it to the portfolio in April because the price had come off considerably. I believe that, at the $9/share level, it was a good investment. We went ahead and increased our holdings in New Gold. Since that time, the price came down to around $8/share, but it’s now about $10/share.
TGR: What are some other companies that you’re bullish on in your portfolio?
RH: Uranium Energy is a particularly interesting company. It has a tremendous growth story and has delivered beyond our expectations from an execution standpoint. The ability to execute and the track record of the company on execution is one of the key factors that we look at. The timeline to see a significant benefit from a share price perspective is unclear because the Fukushima situation is still an ongoing story. But all of the reactors that had been under construction prior to Fukushima are still under construction today. Uranium Energy is stockpiling uranium. It has multiple producing assets now. It has a very substantial exploration and growth pipeline.
TGR: You have roughly 20 companies in your Model Portfolio. Six are gold companies, and seven are silver companies. What are the gold and silver names?
RH: Both silver and gold are a hedge against inflation. As of May 29, Global Minerals Ltd. (CTG:TSX.V; DPF:FSE) was down roughly 53% from the time that we bought it in early February. The companies that we look for don’t exactly follow the progression of a typical resource stock, because we look for monster growth stories. Companies that don’t just peak once they reach their full value and then decline as they deplete their resource. Companies that continue to expand the resource, expand production and even bring new mines on-line. First Majestic Silver Corp. (FR:TSX; AG:NYSE; FMV:FSE) is a great example of this. Fortuna Silver Mines is potentially the next First Majestic. First Majestic is up about 350% since we first got into it in April 2010.
To be fair, there’ve been various things taken out of the portfolio over time, some with gains and some with losses. We just took out Trelawney Resources Inc. (TRR:TSX.V) with a gain of 205% over 24 months. So, that’s better than 100% per year.
We revalued McEwen Mining Inc. (MUX:NYSE; MUX:TSX) after the merger with Minera Andes. It was north of 100% when we redefined it. We reset what we call the Start of Coverage (SoC) date based on that business combination. That company is a great example of a monster growth story and a really world-class management. Its El Gallo project in Mexico is an absolutely world-class deposit. It’s exactly what we’re looking for as a preproduction situation. That stock is very inexpensive right now because of the company’s exposure in Argentina and an ongoing lawsuit. It’s only $2.50/share or so, which is almost ridiculous.
Everyone, including Pan American Silver Corp. (PAA:TSX; PAAS:NASDAQ), is nervous about Argentina because of the nationalization of Yacimientos Petrolíferos Fiscales (YPF) and trade policy changes. And because Minera Andes was another McEwen play, there’ve been some issues with the mining regulations with respect to foreign sales being forced through to the Argentinean peso. But I don’t believe that Argentina is going to nationalize mining companies anytime soon. Past examples of that in South America have generally been disastrous. Nationalization causes foreign capital, expertise and technology, to evaporate. Argentina knows that. They’re simply trying to leverage foreign companies to stimulate the Argentine economy.
TGR: Are you expecting a large resource boost at Global Minerals’ Strieborná deposit in Slovakia?
RH: I am. We had been investing heavily in preproduction-to-production stories, and this is a classic preproduction-to-production situation with considerable resource expansion potential and very good grades. I believe that it will go back into production and that in three years, easily, it could be $0.30/share to potentially $3/share.
TGR: Other companies in your portfolio that are really underperforming so far this year are Colossus Minerals Inc. (CSI:TSX; COLUF:OTCQX), down just about 41% as of the end of May, and Golden Predator Corp. (GPD:TSX), down 11.5% for the end of May. What are you looking for from those stories?
RH: Colossus has the fantastic Serra Pelada deposit in Brazil. It has phenomenal grades of gold, platinum and palladium. Everywhere the company sinks a drill bit, it has significant results. It’s moving directly to production without even an NI 43-101. It is going to have one at some point, but it hasn’t bothered yet because there is a history of artisan mining in that area, and it knows it has high grades.
TGR: But Colossus owns only 75% of Serra Pelada. Is that what’s suppressing the stock price?
RH: That’s a factor. But the main issues are the platinum, palladium and gold prices. I just put North American Palladium Ltd. (PDL:TSX; PAL:NYSE) back into the portfolio because I felt it was so undervalued. Its 52-week high was something like $7/share, and it was down to $2 and change. Will the share price double in the next 24 months? That’s an easy question to answer, assuming the world doesn’t sink into a new global recession.
Back to Colossus, this is going to be a cash cow. It has significant grades of both of platinum group metals and gold. If there is a strong world economy, then the demand for platinum group metals is going to make Colossus a very profitable business. If there is a weak world economy, the gold production will hold the company up. And the company is well financed.
TGR: In terms of Golden Predator, it’s looking to have some production early on, and it already has some more on the leach pad there. What else about that situation is unique?
RH: We have a few companies in the portfolio that I would describe as speculative in terms of exploration and Golden Predator is one. We’re basically betting that Brewery Creek is a world-class deposit. And, it’s looking pretty good so far.
TGR: Let’s move to your Watch List. It’s heavily leveraged toward gold plays. Why?
RH: Gold and silver exploration offers the most potential upside in the near-term. We are watching that for what I call a value entry point into the stocks. Tahoe Resources Inc. (THO:TSX; TAHO:NYSE) is at one of those.
TGR: Its high-grade Escobal silver project in Guatemala would have significant byproduct credits.
RH: If you’re a silver investor, it’s almost like a Silver Wheaton Corp. (SLW:TSX; SLW:NYSE). I mean you almost have to own it as a core position. The question is what’s the right entry point? I don’t own Tahoe at this time because we haven’t found it to be significantly undervalued. Right now, it’s about $18/share. That may be a fair price, but as value investors we’re not looking to pay a fair price.
TGR: You own shares of some of the companies on the Watch List; they are asterisked.
RH: They are on the Watch List and not on the Model Portfolio because when we formulated the portfolio, we did not believe the share prices were significantly undervalued. If you were to come to this Watch List today, I would suggest you take note of where the asterisks are, companies like Esperanza Resources (EPZ:TSX.V) and Ethos Gold Corp. (ECC:TSX.V; ETHOF:OTCQX).
We recently added Olivut Resources Ltd. (OLV:TSX.V) to our Watch List; it is a unique company that’s led by Leni Keough. She’s a geologist, and she’s proven her thesis about finding kimberlite deposits. It’s a promising situation but also an exploration play. I would categorize it as speculative.
TGR: Prophecy Platinum Corp. (NKL:TSX.V; PNIKD:OTCPK; P94P:FSE) is another company on your Watch List. Some interesting results recently came back from its Wellgreen deposit in Alaska.
RH: I was a little cautious about Prophecy Platinum. That happens from time to time: There’s a company that everybody loves, that everybody is writing about, and I’ll tend to ignore it. That may be at my peril, or it may actually be a good idea because I’m looking for the next company that everybody is going to love. Prophecy Platinum is not a very expensive stock right now. I think it’s a good story. But if you weren’t in it before these latest drill results, I’m not sure that you’d want to chase up market. In a volatile market, opportunities come and go and sometimes come back again.
TGR: What else is on your Watch List?
RH: Rackla Metals Inc. (RAK:TSX.V) was originally part of Radius Gold Inc. (RDU:TSX.V), which is in our Model Portfolio. This property is a very promising potential silver deposit with high-grade silver mineralization. It doesn’t have a resource yet. Radius CEO Simon Ridgway discovered a million-ounce-plus gold deposit on the property that now also contains Tahoe’s Escobal silver deposit. As I see it, Ridgway is back in Central America looking for the next Escobal. This is a great example of betting alongside the people who have the exploration and discovery track record. Building successful resource companies is all about the people.
TGR: Thanks for your insights.
Ron Hera, founder of Hera Research LLC, and the principal author of the Hera Research Monthly newsletter, holds a master’s degree from Stanford University. A native Californian, Hera is a self-described “escapee” from Silicon Valley. Originally a serial entrepreneur and private investor in communications software and mobile technology, Hera turned his attention to investing in hard assets after the dot-com bubble and stock market crash of 2000. When he is not consulting for investors and resource companies, Hera writes articles and focuses on special research projects. Hera’s articles have appeared on GoldSeek.com, 321gold.com, King World News, Seeking Alpha, the Ludwig von Mises Institute and in other professional economics and investment publication venues.