bullion « Citizen Economists

There Is More to Gold than Mere Capital Appreciation: John Hathaway

By The Gold Report, on August 9th, 2012

John Hathaway, senior managing director of Tocqueville Asset Management, does not particularly trust banks to keep stores of physical gold safe and segregated. Indeed, he considers his black lab Jake a better watchdog than the SEC. That is why he favors the SmartMetals program from Hard Assets Alliance, a new service launched in July. Hard Assets Alliance has partnered with Gold Bullion International (GBI) to offer precious metal purchasing and storage solutions to retail investors. With more investors realizing that safety of capital is the real reason to own gold, safe storage is more important than ever. Read more in this exclusive Gold Report interview.

The Gold Report: John, you predicted $2,000/ounce (oz) gold prices. After rising to $1,900/oz last fall, the price has hovered at $1,500–1,600/oz much of 2012. What will cause it to take the next leg up?

John Hathaway: There are several factors that I think will drive gold higher. On the monetary side, central bankers and treasury secretaries are bobbing and weaving, making it up as they go. They lack a comprehensive solution to the sovereign debt crisis in Europe, to the forces that are pulling the Eurozone apart or to the stagnation in the world’s key economies. Ultimately, all of this will further debase the value of paper currency.

More quantitative easing may also be on the table, and I have read a good deal about taking nominal rates to less than zero. That would mean people who have money in savings accounts would be charged a fee for keeping the money, as opposed to earning interest. It would not surprise me to see that evolve as a way to get all of these free reserves in the banking system into the economy.

TGR: How soon might that happen—in the coming months, by the end of 2012, in 2013?

JH: It is hard to say, but we are at a pivotal point. The economic reports are very lackluster. The headlines out of Europe continue to be, at best, dismaying. The upcoming U.S. presidential election complicates things. The Federal Reserve probably does not want to do anything that would be construed as tilting the election one way or the other.

“I would say $2,000/oz gold is very close.”

Gold has been correcting for almost a year now. Last August, it reached $1,900/oz. It has had every opportunity to sink below the low it made at the end of 2011. Basically, the price has been in sideways movement for the last seven months.

I see gold coiling, moving into stronger and stronger hands. There are not many sellers left. People who wanted to sell it have and have gone on to other things. I am more and more encouraged that the downside to gold is limited; it is all about the upside. I would say $2,000/oz gold is very close.

TGR: Could it go higher than $2,000/oz?

JH: Oh, sure, much higher.

TGR: When we spoke at the Casey Conference, you bemoaned the fact that even gold-producing companies were trading at a discount compared to the commodity price itself. What will change that trend?

JH: A higher gold price. You need a change in the perception of what gold is doing. You only buy a gold stock if you are bullish on gold prices. Since there has not been that kind of encouragement from the bullion market, I am not surprised that the stocks are dogging it. You need a lot of patience and tolerance to go through a period like this.

Everything else you hear about—the arguments about political risk, cost pressures and the competition from the exchange-traded funds—goes away pretty quickly once the perception of the gold market turns and gold starts advancing, as I am certain it will.

TGR: You also said that physical precious metals have a place in a diversified portfolio. What percentage do you usually recommend?

JH: In today’s world, I think 5% to 10%. By physical, I do not mean an exchange-traded fund (ETF) or commodity contracts, which are really paper gold, but actual physical gold that you can touch—gold that is outside of the banking system, that you know where it is stored and what your bar numbers are.

TGR: Are more institutional and individual investors including physical metal in their portfolios?

JH: More and more people are thinking strategically about gold. Owning physical gold should not be viewed as a way to make money. Rather, it is way of saving capital that creates optionality for future spending power and investment resources.

The impetus to get into gold is not because someone like me says the next step is $2,000/oz. The real reason is safety of capital.

TGR: Do you also see precious metals as a hedge?

JH: Absolutely. It is optionality. If you look at what is going on in banking regulations, everything banks are now required to ask for regarding personal finances that are nobody’s business, and you couple that with the trend toward negative nominal interest rates, why would you keep all of your money in the banking system?

TGR: Does it matter what form the physical gold is in—coins, bars, bags?

JH: You pay a premium to have coins. Whenever I try to buy coins, I feel moderately ripped off because you pay a premium over the bullion content. However, there is a convenience factor to coins.

“Owning physical gold is way of saving capital that creates optionality for future spending power and investment resources.”

When buying physical metals, you have to consider your needs. If you intend to take personal possession of your holdings, sovereign coins may be a good option for you. Or 1 oz bullion bars. That’s the convenience factor; sovereign coins are more easily verifiable in the retail market.

If your intent is to have a third party store your metals, and you are comfortable with the storage options being offered, it may make more sense to purchase large bars, as your cost per ounce will be lower. It costs less per ounce to cast a 400 oz bar than it does a 1 oz coin.

Either way, you can do better than hoarding coins in your safe deposit box at the bank or in your house.

TGR: If you do not take physical delivery of the coins or bullion, how do investors know that it exists, that it is not being shared or pooled? And does that matter?

JH: If you have your gold in a bank, you cannot be sure it is not being pooled. Banks say it is safe and segregated, but after the LIBOR scandal and JPMorgan’s issues in terms of marking, who can be sure? There is no integrity left in the banking system.

There are other ways to hold gold that would give investors greater peace of mind.

TGR: What are they?

JH: We have invested in a company called Gold Bullion International (GBI), that to date had solely focused on servicing financial institutions and wealth management firms. GBI provides them with trading and logistics platforms to buy, sell and store precious metals in the U.S. and abroad. Noticing that the direct retail market was underserved when it came to institutional-quality platforms for sourcing and storage, GBI decided to partner with the Hard Assets Alliance to introduce the SmartMetals program. Now retail investors can store their metals in secure commercial vaults, outside of the banking system. This is important.

TGR: How does Hard Assets Alliance differ from SPDR Gold Shares (GLD) ETF, gold coins or bars?

JH: With SPDR Gold Shares, you cannot get your hands on the physical gold; it is segregated gold and it performs the very useful function of allowing investors to hold a security that tracks physical gold in their portfolios. But the gold itself is held at a bank, HSBC. If worse came to worst, all you would have would be a portfolio holding that is still part of the banking system.

“Physical gold is one of the most liquid assets you can think of.”

If you want to take the next step, having physical gold in your possession or outside of the banking system, that is just a further degree of protection of your assets should we go through a difficult period of severe market disruption. This is a better way to ensure your preserved capital, buying power and investment power.

I am also concerned that government intervention into our personal lives and financial assets will become more and more intrusive. Having physical gold may be not perfect, but it is the best way to counteract that. This is why I keep coming back to the idea that people need to think about more than capital appreciation when they buy physical gold. Gold is actually the antidote to what we think of as money, which is just basically scrip that’s issued by governments.

TGR: The other problem often with bullion is its liquidity. How would something like Hard Assets Alliance make it easier for individual investors to buy and sell their gold, silver, platinum or palladium?

JH: Physical gold is one of the most liquid assets you can think of. Hard Assets Alliance facilitates not only the purchase but also the sale. Whether you do it through its website or through its trading desk, liquidity is simply not an issue, in my opinion.

TGR: That does sound easier than going to the guy downtown who offers to buy your jewelry for cash.

JH: If you need cash, you do not want to be carrying a bag of coins to a dealer, especially in a time of stress when he will take advantage of you in terms of valuation. This is a much better system.

TGR: Do you have any other advice for investors looking to diversify their portfolios in a volatile market?

JH: I think you have to be conscious of the risks in the financial system, the risks of paper currency and the assumptions that we make about what it represents in terms of current and, more importantly, future buying power.

I am perfectly fine with owning blue-chip stocks and high-grade corporate bonds, but the world is so different today. I am talking about an additional degree of protection. I wish buying stocks and investing in bonds were enough to protect peoples‘ savings, but I just do not think that’s the case today.

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

Learn more about the Hard Assets Alliance.

John Hathaway, senior managing director of Tocqueville Asset Management, manages all gold equity products and strategies at Tocqueville Asset Management. He holds a bachelor’s degree from Harvard University, a Master of Business Administration from the University of Virginia and is a chartered financial analyst. He began his career in 1970 as an equity analyst with Spencer Trask & Co. In 1976, he joined investment advisory firm David J. Greene & Co., where he became a partner. In 1986, Hathaway founded Hudson Capital Advisors and in 1988, he became chief investment officer of Oak Hall Advisors.

Student of the physical market - demand doesn't drive the gold price

By Bron Suchecki, on April 30th, 2012

Eric Sprott and David Baker has a new article out discussing central bank buying of gold and particularly China. I agree with his conclusion that this is an important demand side shift in the market but then Sprott plays it up way too much with statements like:

“… there isn’t a physical market on earth that can withstand that type of demand increase without higher prices over the long-run, and the gold market is no different. There are no sellers of physical gold that we know of who can satiate that scale of new demand …”

“Who is going to give up their gold purchases to make room for this scale of new demand? Where is the gold going to come from? We ask because we don’t actually know.”

“We have written at length about the disconnect between the paper gold price and the physical gold market. If the demand changes stated above applied to any other market, the investing public would lose their minds.”

“The paper market for gold can continue its charade, but demand in the physical market will soon overpower it through sheer momentum – there’s only so much physical to go around, and it appears that there are some very large buyers that are eager to take it.”

If Sprott and Baker “are students first and foremost of the physical market” then they surely are aware that the one thing which makes gold different from all the other physical markets on earth is its huge above ground stocks relative to new mine supply – 170,000 tonnes versus 2800 tonnes.

This, I suggest, is a quite material fact and one which may be where “the gold is going to come from”. Unlike “any other market”, to which conventional supply/demand analysis can be applied, one cannot understand the gold market by just looking at annual supply/demand numbers when there is such a large overhang of stock.

What drives the gold price I would therefore argue, is not so much demand, but to what extent existing holders of the 170,000t will withhold it from the market. It is actually supply – the withholding of supply – that matters most. If even a small fraction of these holders decide to sell, then that supply “will soon overpower” the physical market, China or no China. This is not a negative statement. The decade long gold bull market is a message that the existing holders are requiring higher and higher gold prices to let go of their gold and that the new holders are more likely to withhold it.

The reason you don’t see this approach to analysing the gold market is because there are only sketchy numbers on the flow of gold from existing holders to new holders – say ETF volumes, futures warehouses and scrap – and therefore its difficult if not impossible to get any handle on total real supply so analysts just avoid it. It doesn’t mean you should.

This unique feature of the gold market, which we can describe as “a stock overhang so large relative to new supply that in any other market would push the price to zero, but for some reason for gold it doesn’t”, is often referred to as monetary demand or gold as a monetary metal. When you see someone refer to gold as a commodity, it tells you they don’t really understand the gold market and you need to exercise some caution with their statements.

Gold is monetary in nature, with only a small commodity component. Further proof of this is the fact that central banks hold it as they generally hold only money as reserves. A lot more can be said on this but it is 8:30 on Sunday night.

The other thing I find interesting about the Sprott piece, and what I react to negatively, is the use of emotive phrases like “on earth”, “lose their minds”, “charade” etc. Never a good thing when we are talking about investing and its a point Kid Dynamite has made, that Screwtape dissects, and which Erik Townsend makes quite forcefully in the Martenson/Harvey interview discussion.

Speaking of that discussion and Sprott, for those interested in Sprott’s silver delivery problem, Jeff Christian has weighed in with some interesting comments at the Martenson/Harvey interview. Warren James has updated Screwtape’s post on the issue with the relevant material and it is a good summary and discussion of the “problem” for those new to it (or who want a refresher).

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Tungsten Fake Gold Bars

By Bron Suchecki, on April 3rd, 2012

Been busy at work and home, hence the lack of posts. I’ve recently posted on Tungsten fake gold bars for those who may not have seen it. I’ve posted before on this issue here and here.

Coincidentaly, the Mint has recently bought a “Panalytical wavelength dispersive X-Ray Fluorescence (XRF) instrument” for $470,000. Before I get comments about how XRF’s don’t detect inside a bar, this unit is used for testing assay samples and those samples undergo a preparation process before being XRFed. Key process is melting the item to get an even distribution of the metal and then taking a dip sample.

Will be looking to post more regularly on the corporate blog and will continue with sharing stuff via my Google+ posts page.

Survivor Bias and TBTF Tyranny

By Bron Suchecki, on January 23rd, 2012

London Banker “has been a central banker and securities markets regulator during a varied and interesting career in global financial markets” and is a very credible commentator IMO. From his latest:

“Perhaps gold is being used as collateral for margin and cash liquidity, sold by counterparties to bring the price lower, leading to margin calls for even more. A crisis arising from a major default (Greece, Portugal, a huge bank) would force the price lower still, when the collateral would be exercised on default. Following on, the price might rocket again to enable the conspirators to seize outsize profits. Just a scenario, mind you! (Although, I note that Lehman’s counterparties reported record profits through much of 2009.)

What is left of the global markets becomes a game of engineered survivor bias. Only those operating outside the law and with unlimited regulatory forbearance can win while the rest of us lose.”

Some may remember my comments on FOFOA blog about how “Bullion banks are like spiders in the center of a web. They can feel the twitching of the flies in the web and determine the mood of the market better than anyone else and often in advance of others.”

London Banker again: “Their top down view of clients’ trading and custody portfolios and cash positions and flows puts them in a position to exercise tyranny. They can game their clients, taking advantage of superior information, credit and liquidity to ramp or crash targeted markets as needed to precipitate a crisis.”

In other words, it is not just about avoiding debt (or its variant, leverage/derivatives) but also avoiding having most of your positions and trading with one bank.

Reading this stuff makes me comfortable that the Perth Mint will be one of the few left standing after all this is over. We don’t engage in speculative trading/risk taking and the AAA rating means we don’t have to beg and put up collateral with banks to be able to do the covering trades and other transactions necessary to keep the business running.

In the coming flight from risk, it won’t just be about moving to cash (and hopefully many moving to precious metals), but it will also be about a flight to riskless/conservative counterparties. The problem for those looking to store precious metals is that at that point the Perth Mint is likely to run out of capacity – both in physical storage and also insurance (as we fully insure – few others do). All that will be left then is personal storage, which won’t be a problem for those with small holdings. But for those with multi-million dollar holdings it will be tough as there aren’t many non-bank fully insured custodians.

The lesson is to prepare now, which I’m sure all my readers have, as it is going to get nasty.

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FOFOA, New Vaults and physical/paper price

By Bron Suchecki, on December 21st, 2011

A couple of weeks ago FOFOA made the following statement:

Do you remember the stories about HSBC clearing out space in their vaults, or JP Morgan building new vaults? What could be the explanation for this if the aggregate gold stock is so stable? Then it occurred to me that unallocated storage is much more space-efficient because the gold sits stacked on pallets. Allocated gold often gets put into cubby holes to assist in recordkeeping. That takes up much more space. So the process of allocation after many decades of non-allocation requires an expansion of vault space. This is how I now interpret these stories.

I left a comment suggesting other reasons for new vaults:

1. Investment’s share of demand vs jewellery/industry is much higher now compared to past, thus more going into vaults rather than around necks.

2. ETFs and others (eg Goldmoney) share of investment demand vs coin/bar is greater compared to past, thus more going into vaults rather than backyards.

3. Industry consolidation during gold bear market meant vault closures and thus increase in utilisation of remaining vaults, leaving less spare capacity to absorb above factors before new vaults were needed.

Just to clarify that last point, say there were 10 vaults with capacity of 100oz but each was only holding 60oz. Total spare capacity is 400oz. Then you have 3 vaults close during gold’s bear market and metal is moved into the remaining 7 vaults. You now have 600oz in 7 vaults, leaving only spare capacity of 100oz.

Another point is that allocated metal is not “often gets put into cubby holes”. Allocated does not rely on physical segregation by client. For example, you can have a pallet of 32 x 400oz bars with 32 owners of each specific bar number on that pallet. My guess is that except for all but the most paranoid client (mostly likely central banks), most allocated at bullion banks is held this way, rather than piles segregated by client.

I also forgot to mention that my guess is that the amount of physical supporting unallocated metal accounts with bullion banks has increased, that is the fractionalisation has declined. This puts further pressure on vault capacity.

Evidence for this is that whereas unallocated accounts were free a number of years ago, there is now a small fee on unallocated. My guess is that the physical turnover/redemptions have increased in line with a more busy gold market and thus bullion banks have needed to hold more physical to back their unallocated to deal with day to day fluctuations.

Of course it could just be the banks going for a fee grab if they felt their clients would just accept it.

And while I’m doing posts on my comments on FOFOA’s blog, here is another for those who don’t follow the FOFOA blog comments closely – and I can understand that considering some posts get 400+ comments (link here):

Re 1) [major refiners would start posting their own price for physical gold, having their own auctions, making the trading volume public], that is what the Perth Mint already does. The 5 tonne or so per week we refine is currently auctioned. Settlement can be full cash, but mostly is done in London paper gold plus a cash premium. I just watch this premium, it will tell me when paper gold has really disconnected.

BTW, miners sell their metal to us either for cash or swap for paper gold (which they then on trade).

The system will break when miners find few willing to take their paper gold or the price offered is much lower than what we will pay. And in that situation we will always be after to better the offers they get because we are getting better prices for the real physical at the other end.

Because the Perth Mint stands as intermediary between physical buyer and physical seller, the miner is always informed as to the real price of gold.

We are not reliant on the London market to tell us the price, we make a Perth price every day. However currently London is a convenient settlement mechanism for us the miners and the buyers, but it is just to help the flow.

Negative Gold Lease Rates (again)

By Bron Suchecki, on December 14th, 2011

If Tom from Metal Augmentor keeps on putting out great stuff like this post on negative lease rates, then I’ll be out of a (blogging) job.

It is heavy going but a comprehensive discussion of the issue with a dramatic speculation that “The selective collateral nature of the tri-party format may force bullion banks to eventually declare their unallocated LBMA gold accounts as backed by 100% physical bullion.” Other key points if you don’t have the time to read the 8500 word article:

“leasing is probably done directly by the bullion banks on behalf of commercial banks for a fee. Instead of pledging the assets acquired with the sale proceeds of gold leased pursuant to a carry trade, the borrower of gold now pledges existing collateral that it could not otherwise sell without incurring a loss. The central bank accommodates the gold leasing by accepting a wide range of collateral that would be otherwise prohibited in conventional funding schemes”

“An outright sale of gold could always be hedged by acquiring a gold forward contract. Therefore, even if gold leasing has not experienced a recent resurgence, the increase in the gold forward rate indicates that owners selling gold to generate liquidity still want their gold back once the funding need has abated. The combination of a falling gold price and rising forward rate is quite a bullish feature of the gold market that is lost in the reporting on negative gold lease rates.”

“the persistence of negative lease rates could be accompanied by the emergence of something entirely new: The result could be negative gold “lease rates” as gold price expectations may create an entirely new phenomenon: cash borrowed to buy gold for future delivery (what I call “gold bonds”). In effect, this is the equivalent of gold owners forward selling their gold at higher and higher prices, and receiving cash up front to be used for current liquidity needs. The above scenario may appear a lot like the current futures market because it involves leverage but the difference is that “gold bond” transactions are 100% backed by metal.”

A few of comments:

Tom: “From the perspective of the borrower (typically a bullion bank or its customer, a hedge fund), gold was historically leased as a way to fund a gold carry trade under which excess returns could be earned by using the sales proceeds from leased gold to purchase highly-rated securities meeting the central bank’s collateral requirements.”

Bron: This is by far the major use of leased gold, but gold can also be leased by users/manufacturers of gold products to provide physical funding of their work in progress inventories, which does not involve any sale of the leased gold.

Tom: “As just mentioned, the gold (or silver) lease rate does not represent the actual rate at which lease transactions are being done in the market. The published lease rate is simply an indicated value derived from two related variables, the gold forward rate and LIBOR.”

Bron: In support I would say that the Perth Mint has always paid positive lease rates when borrowing gold, although it does so for inventory funding rather than carry trade etc reasons. Note Perth Mint borrows without posting ANY collateral because of the West Australian Government’s AAA rating.

Tom: “a customer may execute a gold swap with a bullion bank pursuant to which the customer’s physical gold is initially stored in an unallocated account and used as the collateral for dollars loaned to the customer. The bullion bank then sells the gold from the unallocated account to replenish its funds and concurrently enters into a gold forward contract with a gold refinery. The forward contract is then used to back the gold liability to the customer.”

Bron: My emphasis on “physical” in that. This sequence of transactions is what fractional bullion banking is. In this case the customer’s metal is “lent” to the refiner.

Tom: “sane market participants will naturally demand that gold as a financial instrument retain its utility as the ultimate collateral for non-recourse funding. Under these circumstances, the appearance of 100% physical backed LBMA unallocated bullion accounts seems like a very good possibility”

Bron: I note that some years ago balances in LBMA unallocated accounts attracted no fee, whereas now there is a very small account fee as % of value. Indication perhaps that bullion banks have had to increase the percentage of physical backing unallocated (and thus need to recover that cost) due to an increase in physical redemption/turnover on those accounts.

Negative Lease Rates

By Bron Suchecki, on November 1st, 2011

Very good two page analysis of negative lease rates by Pollitt & Co’s John Paul Koning, including central bank activity in this market. Quote:

What sort of “non-banks” might be supplying leased gold to the market-making banks at these extremely negative rates? As we already pointed out, central banks seem willing to lend only at positive rates, which leaves only one other source: the investing public. …

The public effectively lends gold to banks when they deposit their physical gold in unallocated form at a bank. … The negative interest rate received by the borrowing bank is probably in the form of client fees or bid-ask spreads. …

By serving as the cheapest source of lent gold, the investing public has effectively priced central banks out of the gold lending market.

The Perth Mint does a bit of leasing and certainly no one is paying us to borrow metal. However, unallocated accounts at bullion banks do attract an account keeping fee, as Koning notes, and this is effectively paying the bank to use your metal.

Another factor as to why investors may be prepared to pay people to borrow their metal is that it can be cheaper than the costs of storing it (ie Allocated). I do also think the derived negative rates are a theoretical interbank no counterparty risk rate. Once you add in a premium for the counterparty risk the actual rate is positive.

Finally, there is a mathematical relationship/arbitrage between the futures markets and GOFO (and thus lease rates) and this could also have an impact (not something I’ve been following too closely).

"Mexico Mike" Kachanovsky: Gold and Silver Producers Due for Big Upside

By The Gold Report, on September 29th, 2011

Mike Kachanovsky, known as “Mexico Mike,” doesn’t follow the so-called smart money. Founder of the website smartinvestment.ca, Mexico Mike believes mainstream commentators are leading investors astray by insisting that it is too late to get into mining stocks and precious metals. In this exclusive interview with The Gold Report, Mexico Mike explains why everyone needs to have some exposure to precious metals and gives his favorite prospects.

The Gold Report: Gold juniors fared worse than most equities in the economic collapse of 2008. Now economic fears are gripping the market once again. The S&P 500 has been trending down since mid-June. Many fear a double-dip recession—if not worse. Why do you still believe in junior precious metal equities given the current market conditions?
Mike Kachanovsky: We are in a double-dip recession. A lot of market commentators still feel that we can avoid that, but I think we’re right in the middle of it. I am still bullish on the junior mining stocks for the reason that, unlike most other business models, mining companies have stronger fundamentals down the road. Most of these juniors that have commenced production are making money now and their outlook is to make even more money going forward. I like the junior resource stocks and I tend to shun the more conventional sectors for investors.

TGR: Investors exited precious metal juniors en masse in early August when U.S. politicians couldn’t reach a deal on the debt ceiling. Gold then spiked, but has since trended lower. Do you believe traders are looking for the gold price to find a bottom before they return to the market?

MK: I think that’s a good statement. The typical investors that I talk to believe that precious metals and gold are too high, that they missed the run, and they’re expecting a lot lower price levels before they consider buying in. That’s very bullish. That’s a contrarian indicator.

Most of the time that sort of analysis has been flawed and the people who were holding off on buying and hoping for lower levels to buy at were left behind. I don’t think it is any different this time around. I think the gold price will go above $2,000/ounce (oz.) and silver will move above $50/oz. before the end of this year.

The fact that so many investors are standing on the sidelines suggests that there is less downside ahead and that a lot of the buying power will start chasing the metals higher once we get some sort of a recovery and a sustained rally.

TGR: Any idea of the timeframe of when that might happen?

MK: The biggest mistake that any amateur analyst can make is to try and pin a time on when a correction is coming or when a new high is coming. It is such a volatile sector. I think the more rational approach is just to buy the dip. It is a volatile commodity. There are triple-digit moves happening on a regular basis in gold. When I see that gold has been hammered for three or four days in a row and it is at a low, I’ll pick up the phone and buy more. In fact, I did just that on Friday and bought more gold and more silver.

TGR: Was that bullion or equities?

MK: I buy and sell equities and I buy bullion and accumulate it. I have actually never sold an ounce of gold or silver, but I’ve been a buyer steadily for the last eight years in both metals.

TGR: The gold price is trading primarily on fear right now. We can see daily swings of $20–$80/oz. When do you think the hyperinflation trade will kick in?

MK: All the major currencies in the world are in a race to the bottom. The events of hyperinflation in the last hundred years usually involved one weak currency, while most other nations were showing strength. In those cases, it was very easy for inflation to manifest itself in places like Germany’s Weimar Republic and Zimbabwe. We are not seeing that because it is affecting almost every nation worldwide. However, because gold, and to a lesser extent silver, are rising so strongly in this environment, that indicates that it is already underway. Gold is the asset of last resort that people are turning to. When you start having a lot of people in a lot of countries around the world all acting at the same time, that is when I think we start having to be concerned that a hyperinflation environment is starting to kick in.

TGR: The London Bullion Market Association (LBMA) said almost 11 billion ounces of gold traded in the first quarter of 2011, which is far more gold than has ever been produced from all mining combined on the planet. Does that make you somewhat wary about some of the gold derivatives being offered out there?

MK: That statistic is probably the most important fact that all investors that are even considering precious metals should consider. The LBMA is just one market. You also have gold trading on the Comex. You have Over the Counter trades between private counterparties. Shanghai just opened a bullion market. Collectively, the amount of gold that trades in any given day is a multiple of the real gold that is out there.

As a trading vehicle, there are all kinds of exchange-traded funds and paper products, but if you want leverage to actual bullion, there is no substitute for buying the real thing and having it in your control and custody. There are all these paper and derivative products that are leveraged to it. I think that is unstable and a lot of people are going to be left holding a toxic asset at the end of the day instead of the security that they thought they were getting leverage to by putting money into bullion.

TGR: You have said that you are buying equities as a way to get some leverage on the price for gold and silver. Are you sticking to precious metal producers or near-term producers with money in the bank as a way to mitigate risk in the current market?

MK: To get full leverage to the sector, you need to have diversity across the spectrum. My current strategy is to lean toward the companies that are currently in production. Both gold and silver have risen substantially. The companies that have the real leverage to that, the producers, are the ones that are going to benefit the most at this stage in the bull market. They are the ones that have the rising earnings and the stronger fundamentals for investors to focus on.

On the other hand, I like emerging stocks. They are trading at a very tight discount range relative to their historic multiples. Companies that have viable deposits that are funded and able to emerge as producing mines in the next year represent a compelling story. I still like exploration because the greatest gains that you can get in this sector come from buying a low-priced exploration story that hits on a big new discovery.

But that is also the riskiest part of the market. Investors need to be very selective and careful in choosing good projects, good management and companies with the money to continue with their exploration work.

The fear that we are seeing in the market right now is very short term and cyclical. An exploration story may take years to develop. I don’t think investors should stay away from the explorers. They just need to be selective because during those bearish times it is difficult for companies to raise money and their stocks are probably going to be out of favor. Investors should find the companies that they can be comfortable holding and wait until they find new mineral discoveries and get rewarded with a higher share price.

TGR: What are some producers that fit that bill?

MK: I just returned from a trip to Montana to see Revett Minerals Inc. (RVM:TSX; RVM:NYSE.A). I was floored. I was impressed at every stage of this operation. The company is a silver and copper producer, so it has leverage to base and precious metals. Its balance sheet is strong. Its mine is absolutely superb. Its mineral inventory is growing. Environmentally, Revett is a textbook operation in how to run a clean, efficient mine. The stock price is trading at a value range right now. I started accumulating the stock just in the last couple of weeks. I think it has a bright future.

This is exactly the kind of company that I am looking for to provide safety in my current investment, provide upside for the future, and have full leverage to what I believe is a long-term bull market for the metals.

TGR: The company also has another more robust project called Rock Creek. However, Revett’s involved with litigation regarding that project in a district court. A ruling is not far away. If Revett were to get a favorable ruling on Rock Creek, it could materially change the stock price in a hurry.

MK: I agree. I think Revett has done everything right. It is starting to win over some of the environmental groups because of the attention to environmental stewardship that the company demonstrated in its current operation. It has proven that it can run a mine that has very minimal disruption to the surrounding wilderness and community.

At the same time, Revett brings in great benefits to a part of the world that doesn’t have a lot of economic opportunity or high paying jobs. My feeling is that the company will be successful in getting permitting for Rock Creek. However, I minimize the impact on the actual operating results of the company because even if it had approval today and it was able to commence development, it is a very large project and it is probably at least two years down the road before it would see any operating return. Whereas the current Troy Mine has a world-class resource that could still be producing in 20 or 30 years.

It is nice to have an even better prospect to look forward to, but I think it is compelling just on its current upside potential.

TGR: Let’s talk about some near-term producers.

MK: There’s a stock that I like in the rare earth segment called Pacific Wildcat Resources Corp. (PAW:TSX.V), which has two projects active in Africa. The company’s tantalum mine, which is an exotic metal, is in production. It also has a rare earth and niobium project. If Pacific Wildcat can get one of these rare earth element mines into production, it has the potential to generate near-term cash flow from just niobium and tantalum.

Pacific Wildcat is a very risky stock. A lot of moving parts could create delays. But, on the other hand, it is priced at a very reasonable level. It has strong upside if the management team is able to advance these projects to a point where it achieves full production and has leverage to the high metal prices in those resources. Don’t bet the farm and put granny’s retirement money on the line, but a small investment in a company like this could easily turn into a very large winner.

TGR: Any other near-termers?

MK: One that I like is Avino Silver & Gold Mines Ltd. (ASM:TSX.V; SGMF:OTCBB) in Mexico. The company has been active on this project for 20 years. It was in production in the 1990s. The company just got this thing going again in the last year and it is making money. It plans to expand capacity and continue with production.

Avino has strong management, a very strong balance sheet, a good resource, current infrastructure in place, it’s profitable, and it provides investors with full leverage to gold, silver and base metals. It’s a good near-term emerging producer that I can put into my portfolio, hold for a year or two, and probably see the stock rise substantially. But there may be ups and downs and swings of sentiment that are going to be a test of commitment along the way.

One other emerging producer that is worth a look is Scorpio Gold Corp. (SGN:TSX.V) I think Nevada is a great place to build a mining company and Mineral Ridge Mine looks like it can generate strong cash flow with gold above $1,500/oz. I expect to see a nice growth curve as the company expands production and improves the overall operating efficiency of the project; plus I think there is a good chance that further exploration will expand the resource and extend the mine life. The stock has plenty of upside potential if the company can achieve its production targets for next year.

TGR: What about exploration plays?

MK: I am following quite a few good explorers right now. And when I say a “good” explorer, I mean they have the potential to find a world-class discovery. But a lot of these companies are early stage.

One explorer that I like is Galore Resources Inc. (GRI:TSX.V), which has a large-scale project in Mexico. It has been working on this project very patiently for about two years doing field work, defining structure and identifying the areas that could produce a world-class deposit.

Galore trades at a very tiny market cap. It has a chance to be one of those winners that can make a portfolio. It has got very competent management and a solid track record in advancing the early-stage exploration on its prospect. It has all the upside ingredients and you can still buy it very cheaply today, and sit and wait. It is like the prototypical lottery ticket junior explorer.

TGR: Galore also has a copper project in British Columbia. Where’s the company at with that?

MK: I believe that Galore’s real focus is in Mexico and it’s just going to do enough work to maintain the copper story and hold it in good standing. It’s not necessarily what the company is most excited about at this point in the cycle.

TGR: Galore just released some results on the property at El Alamo, which is part of the Dos Santos project. The best result was 12 meters of 0.96 grams gold. That’s a very modest result, but it points to the fact that there is certainly gold in the area. What were your thoughts after hearing about those results?

MK: Typically, I’m not motivated by the grades that come from the early-stage field work. I want to see that the company is finding gold or whatever metals it has leveraged at surface and that the geology and the interpretation of the structure suggests that there could be a large volume of rock that has those types of grades. Most large deposits have zoning, so what is going on in one part of the story may be completely different from what is found as you go deeper.

A lot of companies will get investors excited because they’ll do trenching and find really high-grade gold at the surface, but then they’ll find out it doesn’t go very far down and they can’t replicate the same kind of intervals to depth. There has to be a lot more of that type of metal the further down you go. That’s when you start getting excited.

Canplats is a great example of that with their Camino Rojo discovery in Mexico. Canplats was bought by Goldcorp Inc. (G:TSX; GG:NYSE) and so Camino Rojo is now a Goldcorp property that is very close to Galore’s property. About three years prior to the big discovery, its stock wasn’t going very far. It was very quiet and sedate. It was coming up with reasonable grades, but nothing exciting for a long time. Then, all of a sudden, it started to hit these broad intervals and the project accelerated.

TGR: What are some other interesting explorers?

MK: One that I really like in Québec is Eastmain Resources Inc. (ER:TSX), which has been active for more than 10 years. The company has been finding high-grade gold just about everywhere it goes, but it just recently announced a new discovery in a part of its deposit that had not been investigated.

Eastmain is finding high-grade gold across fairly wide intervals. It has evolved to become an open-pit gold mine prospect, whereas previously it was drilling deeper and finding more narrow vein high-grade gold. Now it has revaluated the entire prospect and figures that it can have an economic shot with a lower average grade, but in a large deposit that can be open-pit mined near surface.

That is why I’m starting to get excited about this story. A lot of other juniors have taken that same model in recent years and started looking at much lower grades that can be mined more cheaply in a window of $1,500–$2,000/oz. gold.

I like Eastmain because it has a strong track record of success. The company is located in a favorable mining jurisdiction. It is spending over $10 million this year alone in exploration. It’s very well funded, so it can continue to carry a project forward. Plus, its market cap and share price are still very low relative to its peer group. Despite all these strong factors, Eastmain is still a cheap stock to buy with a big upside if it is successful.

TGR: Is there another out-of-favor name that you like?

MK: Commerce Resources Corp. (CCE:TSX.V; D7H:Fkft; CMRZF:OTCQX) is another rare element story. The rare element subsector tends to go through boom/bust cycles. Right now, we’re on the bust side of it. Investors seem to get very excited every year or so about these stocks and then it fizzles and the stocks sell off again. It doesn’t really reflect the fundamental strength of some of the companies within that subsector.

Commerce is a very strong company. It has been active in rare metals for more than a decade. It’s not just a “flavor of the month” pick. It has two excellent projects in play, both of which are emerging as very large tonnage, relatively high-grade discovery areas. Commerce is actively advancing both projects to be able to support a development decision.

A project that I’m excited about is known as the Eldor property. It has several showings on that property for rare elements. I’m excited because it has enrichment zones in both the heavy rare earth elements and the light rare earth elements. That’s very rare. Very few companies anywhere in the world have deposits that are enriched in both the heavy and the light.

Eldor is still fairly early stage, but having that higher grade and a high value is a huge advantage that can help even if some of the other development parameters come in marginal. Commerce fits my model of finding quality companies that are well financed with strong discovery potential, but trade well below the peer group for the sector.

TGR: Any final bits of investing wisdom for our readers?

MK: There are a lot of big changes going on in the world. I think “buy and hold” no longer works. The torch for economic leadership is in the process of passing from the developed Western nations to emerging countries and the Asian nations. It’s a period of turmoil and change.

Based on the major stock indexes, investors haven’t made any money in the past 10 years—in fact, they probably lost money. Many of the different asset classes are losing money. The one exception is bonds and fixed income, but I believe that’s a bubble that’s subject to popping. It’s too late to buy those. The one exception to this is precious metals. They have outperformed every other asset class and it is the only legitimate candidate to be a buy-and-hold investor in.

I find it very ironic that the majority of the commentary in the mainstream is steering people away from the metals and suggesting perhaps that it’s a bubble or that it’s the wrong time to be a buyer. I have always approached the market as a contrarian. I feel most comfortable putting my money at risk where most other investors are not feeling bullish. I think there is a really good trend there and I am going to continue buying the mining stocks that have strong fundamentals with full leverage to the metals and ignoring what the majority of the so-called smart money has to say.

The mainstream commentary that has had anything to say about the precious metals sector over the last 10 years has been largely discredited. I would be very leery as in investor right now in participating in fixed income or bonds or buying the broader markets. But I do think everyone needs to have some exposure to precious metals and to be a long-term passive investor in these sectors. That’s probably the way to have some sort of stability in this macro environment of dramatic change and volatility.

TGR: Thanks, Mike.

Mike Kachanovsky, known as “Mexico Mike,” 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. Kachanovsky is a founder of the website www.smartinvestment.ca, which serves as an online community for the discussion of all topics relating to junior mining stocks.

Physical v Paper & PAGE discussion on FOFOA

By Bron Suchecki, on September 15th, 2011

Below is a cut and paste of some of my comments on this issue at FOFOA’s latest post. Also see here for some comments on the GBI system which was the focus of the FOFOA post, in particular the “fully insured” claim, which many operators imply they have.

mortymer: “You will maybe find this one interesting”

I had seen the SNA papers and tend to agree with Paul I’s “egghead” analysis- in the end there is no forced requirement to split out physical gold from unallocated from leased out, so they can continue to play their games.

Kid Dynamite: “How do you have true allocated storage of any bullion less than a full bar? Ie, yes: bars have numbers that you can put on the statement. Coins do not.”

I’ve posted on this issue here. In my view “true” allocated can only be for full bars and coins. Bar numbers help in trusting the custodian, but can still achieve the same with unnumbered bars and coins by marking them (eg texta). One way to really test if allocated is being offered is toask if you can view your metal and if there will be any problem if you mark your coins and bars.

Blondie: “The interview with Ned Naylor-Leyland describing PAGE is a must watch IMO, as I agree that this has the potential to be a real game-changer.”

I’m underwhelemed by PAGE. So there maybe a “fully allocated spot gold contract”. Guess what, we sell the 300t of physical gold we refine each year at spot in the OTC market – the buyers can be totally private. I don’t think we will see much trading moving to PAGE beyond what bullion banks will feed it to meet local demand as other buyers aren’t going to want their activities out in the public and visible to the benevolent Chinese Govt.

The Giants are going to continue to deal with the bullion banks in the OTC market where they can wade about without anyone knowing.

Blondie: “The significance I see in PAGE is as a physical gold price discovery market. If it is fully allocated contracts that create the spot fix, then I see an arb developing between the existing (paper-based) exchanges and PAGE where the contracts are backed by physical.”

Just to be clear, in the wholesale markets the price of paper unallocated gold with a bullion bank in London and physical gold are the same. Tonnes and tonnes of physical deals (as well as paper) are priced off the London Fixes. The Giants don’t need PAGE as a “physical gold price discovery market”- it already exists in the OTC market. There already are arbitragers between paper futures exchange and “contracts backed by physical” ie allocated and spot physical deals.

This is not to say it will always be like this, but right now paper price = physical price. Through all the ups and downs of the past five years and all the rumors of imminent market failure I have not seen paper and physical diverge.

As to PAGE being a way to get renminbi exposure, well that will be interesting to watch but note what Victor said “long the allocated contract at the PAGE and short gold in US$” – the end result is no impact on the gold price because the long cancels the short.

Paul I: “Right now, the gold spot market is like a big, stupid, compliant Labrador, Perth Mint included. It doesn’t

mind having it’s tale wagged by the paper market. PAGE will turn out to be a snarling Rottveiler.”

I’d say that is debatable. Everyone assumes paper is in charge, when the only data we have is COMEX and other visible exchanges but nothing on what goes on in the OTC market, save for some opaque “transfer” numbers from LBMA.

Paul I: “Quite frankly, as an Australian, it makes me sick to see our national gold wealth sold off for pennies on the dollar. I may be naive, but I have to ask why an organization like the Perth mint hasn’t long ago tried to maximize value for Australia and Australian gold mines by proposing something along the lines of PAGE.”

I don’t think you are getting what I’m saying. Perth Mint doesn’t need to start an Australian PAGE – every week we offer 5t or so of physical gold to the OTC market and the bullion banks and other bid for it. You may consider the current gold price undervalued, but that does not mean that we aren’t maximising Australia’s gold – if the demand is there then those banks bid for it. If anything changing the current private OTC approach to a public PAGE would likely hamper the process.

Paul I: “Instead, we see them pushing massively over-priced “collectable coins” to Grandmas in Post Offices, more demand divertion, very little education.”

Our marketing guys push those fancy coins because they are our highest margin product – that makes business sense, we aren’t going to waste prime “shopfront”pushing low margin kilo bars. But that stuff is small by volume compared to kilo bars where ultimately the big dollars are.

mortymer: “To separate physical gold in unallocated from leased would be at this stage too much, they got so far to clear definitions and on what is allocated what is not and that is a progress.”

Agreed. What that document does is makeit clear what unallocated is. No professional player is unaware of that, they just believe in the system and thus believe in the “value”of their unallocated, because they are of the system. I do not believe there is any big move from unallocated to allocated at themoment, nothwithstanding the antics of Chavez. If that was the case we would be seeing a lot more bidding for our weekly 5t.

costata: “According to Bron the Perth Mint relies on mine supply of silver for its refinery as very little scrap silver finds its way to them. I see your point about the price of copper and silver. I would be interested to hear Bron’s thoughts on this. Is it merely a question of price?”

Those comments about “silver scrap is mainly sold and refined locally because it is not high enough in value to justify shipping it around the world” were primarily focused on Australia, which is more geographically remote, and does not have much silver refining capacity. In other markets silver maybe far more mobile.

whiteelefant: “Concerning PAGE: my impression is that any offer which is closer to physical than what the LBMA & Co offers might be taken up and will push the price of Au up. But, I am only a small shrimp and not into finance”

Again, this is an assumption that the LBMA banks are all paper and ignores the huge physical market that exists side by side with paper.

costata: “Recently I came to the opinion that leverage on the currency side was irrelevant. The key point is that the gold itself is not fractionalized. If PAGE said no margin that doesn’t prevent someone from borrowing outside the exchange and trading a 100% cash account with PAGE.”

Ha, now we are peeling the onion, or should I say seeing more of the spider’s web.

costata: “We should also not underestimate how much the Chinese love to gamble. The paper gold market appears to be going gangbusters right alongside the development of the physical gold market according to this article.”

Very good point, I noted that comment as well. We should not blindly think that Asia is a physical only market and cannot be tempted by the leverage paper offers.

The Mint is humming

By Bron Suchecki, on August 24th, 2011

Nigel Moffatt, Treasurer of the Perth Mint, breaks from his leash with some really bullish statements in an interview with The Australian newspaper:

He said he could see no end to the gold boom.

“If you’re in the US or Europe, what on earth are you going to put your money into?” he said. “You wouldn’t touch the equity market at this stage. Interest rates are low, and frankly precious metals are a hell of a good way to go. I can’t see anything around to stop it. Bit it won’t go northwards in a straight line because people will always be taking profits.”