The Gold Report: . . . → Read More: Gold Juniors Poised to Rebound: Joe Mazumdar]]> Economics and politics. Accretion and repletion. Mergers and acquisitions. Joe Mazumdar, senior mining analyst with Haywood Securities, sees all of these as catalysts for a rebound in the junior gold space in 2012. In this exclusive Gold Report interview, he reveals the names of companies he expects to take off.

The Gold Report: What is the consensus among Haywood analysts on what 2012 will bring for mine commodities, particularly precious metals?

Joe Mazumdar: Last year, risk aversion was a common market theme. In 2012, some of the same global economic concerns, such as the ongoing Eurozone crisis and the future of the euro, will continue to draw attention. But we also believe there is potential for positive economic indicators, primarily from the U.S., where there have been upticks in manufacturing and GDP growth. Also, unemployment in the U.S. is down to 8.5%, generating some consumer confidence. Recently, GDP growth for Q411 came in at 2.8%, which was slower than consensus forecasts—3%—but still the strongest in over a year.

Political factors will play a role in 2012. There could be a change in leadership among four of the five permanent members of the U.N. Security Council. The presidential election will be a key focus of the U.S. and global market. There are also presidential elections in Russia, France and Mexico. There also may be a changing of the guard in China in the latter part of 2012. The potential for changes in leadership in these key nations will generate a bid to market volatility in 2012.

Beyond gold and silver, our preferred commodity sectors include copper, iron ore and coal. Gold continues to be adversely affected by its own volatility, which continues to tarnish its reputation as a safe-haven asset. We note that during 2011, U.S. Treasury securities, the most liquid safe-haven asset, was a preferred recipient of capital investment, providing a ~10% return, its highest annual return since 2008 when it was 14%.

TGR: Will the strengthening American economy have an adverse effect on the gold price?

JM: Yes, the gold price quoted in U.S. dollars will be hindered by any U.S. dollar strength based on economic growth and increasing consumer confidence. In the current environment, gold, quoted in U.S. dollars, is still holding up well at price levels over $1,700/ounce (oz).

We note that the Federal Reserve said recently that it remains concerned about the “vigor” of U.S. economic growth and pledged to maintain low interest rates until at least 2014. The latter is a positive for gold prices.

In the medium to long term, increasing confidence levels in U.S. economic growth we believe will drive higher capital investments domestically and potentially raise inflation expectations, which would be a positive for gold.

TGR: What about silver and copper?

JM: We see copper on the brink of a rebound in 2012. The London Metals Exchange inventories are at low levels and Chinese imports of refined copper accelerated in the latter part of 2011. Copper is covered by Stefan Ioannou/Kerry Smith of Haywood Securities and they highlight a structural tightness in the copper market as supply growth remains constrained while a portion of future production growth resides in higher geopolitical risk jurisdictions. They note that the GFMS has estimated a deficit of 372 Kt copper in 2011 and forecast yet another deficit for 2012, 101 Kt.

Chris Thompson covers the silver sector for Haywood Securities and has commented that despite the growth in investment demand over the past five years, silver is still very much an industrial metal. Volatility, he believes, will be underpinned by potential contradictory moves by those who see silver as an industrial metal and others who seek it as an investment asset.

TGR: Did the junior mining sector hit bottom in 2011?

JM: Within the current cycle, I think it has hit bottom. For me, the question remains: What are the catalysts that will move individual stocks up within the sector?

For a number of the majors, growth has been increasingly difficult to achieve given the higher amounts of reserves they must replete on an annual basis. Companies such as Newmont Mining Corp. (NEM:NYSE) have been offering higher and more levered dividend payout structures to attract investors.

In 2012, we see the potential for more merger and acquisition (M&A) activity, specifically in the junior to intermediate sector, given the plethora of small-cap stories in the gold sector. Producers have performed better with respect to their paper in 2011, compared to development stocks, and boast healthier balance sheets. M&A activity will be driven not only by a desire for growth but also motivated by financing risk to capture any synergistic opportunities such as sharing infrastructure and the potential to merge critical skill sets. There is a paucity of people who can bring projects into production and operate them. Merging structures and management is very important right now in the junior and intermediate sector. Without it, a lot of these companies with development assets may continue to struggle.

TGR: Do you expect the Kinross Gold Corp. (K:TSX; KGC:NYSE, Not Rated) write-down to have an adverse effect on M&A?

JM: Large projects that are required to move the needle in the growth strategy of a large gold producer have a scale and scope that naturally expose them to significant execution risk. So, in a nutshell, escalating capital costs for projects of this magnitude are nothing new.

The M&A opportunities I refer to are at a scale that would be accretive to a junior to intermediate company from a growth perspective and offer opportunities to capture synergistic value. From a valuation perspective, many companies with development stage assets are trading well below their underlying asset valuations. M&A activity allows also for some consolidation in the junior sector given the plethora of small-cap gold plays.

TGR: Did you make any adjustments to your investment thesis following the dip in precious metals equities late in 2011?

JM: In our top picks, which we put out on Jan. 9, we focused on producers generating cash flow and developers with permitted or on a clear path-to-permitted projects in low geopolitical risk jurisdictions.

One pick was Midas Gold Corp. (MAX:TSX, Not Rated), whose flagship asset, the Golden Meadows project, hosts a global resource of 5.8 million ounce (Moz) in the Yellow Pine Stibnite area on a large land package (11,600 hectares) in west-central Idaho, a re-emerging gold district. The company is working toward an updated gold resource estimate before the end of Q112, leading to a preliminary economic assessment (PEA) by Q312.

TGR: Can you give us another name on your list?

JM: Yes, Midway Gold Corp. (MDW:TSX.V; MDW:NYSE.A, Sector Outperform, CA$3.25 Target Price). It has the Spring Valley gold project, an intrusive-hosted gold deposit with a global resource, we estimate at over 5 Moz, in a district close to Lovelock, Nevada, where Barrick Gold Corp. (ABX:TSX; ABX:NYSE, Sector Outperform, CA$61 Target Price), is earning in up to 70% by 2013 by cumulatively spending US$38M.

From a metallurgic perspective, the gold is free, not occluded in pyrite and potentially amenable to be economically extracted via a heap-leach process. Barrick, the joint-venture operator, is currently drilling the edges of the deposit to find out how big it could be. This means the near-term news flow will be linked to drilling results and less about a resource update in 2012.

Midway has a portfolio of projects that it is capable of bringing on-line. Its Pan project, a low strip open-pit, heap-leach gold project in Nevada, has submitted a completed bankable feasibility study and a plan of operations. Its Gold Rock project, only 8 kilometers from Pan, is in an earlier stage where we anticipate a resource by Q112 with additional drilling in Q2–Q312, leading to another resource update by Q412 and a PEA by 2013. Additionally, Midway is working a low-sulphidation, high-grade gold project in the Tonopah District.

Midway has a portfolio of projects and is assembling a team to build and operate them. Its COO, Ken Brunk, formerly with Newmont and Romarco, is very familiar with the permitting process and developing/operating projects in Nevada. I believe the company can manage this project pipeline of financeable projects in the low geopolitical risk jurisdiction of Nevada.

TGR: Your target price for Midway is $3.25, up $0.25 from your last report. With that many projects in the development stage, it seems that Midway would be a prime takeover target, especially given its joint venture with Barrick.

JM: Barrick is looking at a number of projects in Nevada, some of which are billion-dollar-plus projects that would add significant ounces to its production profile including Spring Valley, Goldstrike and an expansion at Turquoise Ridge. I believe that Spring Valley may be a target for Barrick going forward as it has potential to contain a +5 Moz global resource and lies in Nevada where Barrick has a significant infrastructure and asset base.

However, the other components of the company’s portfolio, which include smaller open-pit, heap-leach projects, such as Pan and Gold Rock, that could potentially produce between 70–90 thousand ounces (Koz)/year, would not move the needle for most majors. These smaller projects do generate cash flow and are more readily financeable by a company the size of Midway. They could also be attractive to an intermediate operating group looking at accretive transactions with junior developers.

TGR: You cover Orvana Minerals Corp. (ORV:TSX, Sector Outperform, CA$2.25 Target Price), which is in production at its Don Mario mine in Bolivia and its El Valle-Boinás/Carlés (EVBC) mine in Spain. From June to October 2011, gold grades there increased incrementally from 1.4 to 2.17 grams per tonne (g/t). Nevertheless, Orvana’s throughput at EVBC is below your forecast. Results at Don Mario in Bolivia also were below estimates. Is this a make-or-break year for Orvana?

JM: It is a critical year for the company. Bill Williams, formerly Orvana’s vice president of corporate development, is now the CEO. He is an ex-Phelps Dodge vice president and has been instrumental in generating the revised technical reports on both operations, EVBC and Don Mario Upper Mineralized Zone (UMZ), while advancing the Copperwood project. We believe his appointment reflects the company’s focus on getting the operations back on track.

Orvana is currently in the process of re-benchmarking both EVBC and Don Mario UMZ. For Don Mario—an open-pit mine with an upper mineralized zone containing a lot of copper, as well as gold and silver—Orvana has delivered a new life-of-mine forecast that addresses the difficulty of getting copper out using a leach precipitation flotation circuit on a much bigger scale than has been used before. The Don Mario operation also has been troubled by high costs of reagents for the circuit, which has raised the processing costs.

We had originally forecast an annual production profile of 10–15 Koz per year of gold and 10–15 million pounds (Mlb) of copper. We are now looking at a production profile of 9–10 Mlb copper and 8–9 Koz of gold, whereas Orvana is still signaling 13 Mlb of copper and 12 Koz of gold. In Q411, the Don Mario UMZ operation produced 2.5 Mlb of copper and 2.3 Koz of gold, which is a positive. Now, it has to consistently achieve its new benchmarks over the next few quarters so the market can gain confidence in its operational abilities.

At Orvana’s flagship, the EVBC gold-copper project in northwest Spain, the operational issues have been related to head grades. Underground bottlenecks have hindered the company’s ability to blend higher grade feed to the processing plant. We anticipate that a shaft will be in place by April/May 2012, which should alleviate some of the bottlenecks. We had originally forecast that the feed grade, at steady state levels, would be in the area of 5 g/t. However, revised guidance indicated that it would be lower, 3–3.5 g/t gold, which also conspired to lower our target. We anticipate a revised technical report for EVBC prior to March 2012 with updated life-of-mine forecasts.

Orvana’s Copperwood project in upper Michigan is a 50 Mlb/year copper project, now in bankable feasibility study, and Orvana is seeking to permit this year. Even with up to 800 Mlb of copper reserves, we believe that the Copperwood asset is not being valued at its current price levels as Orvana has been heavily discounted in the market due to poor operational performance.

TGR: Given the lower recoveries and production estimates at Don Mario UMZ released in late January, you lowered your target price by $0.15 to $2.25. Yet you still give it a sector outperform rating. Why?

JM: Due to the heavy market discounting related to disappointing results from both operations over the past few quarters, Orvana still provides about a 100% return to our target from where it is trading right now. I continue to believe that management can redeem themselves by achieving the revised benchmarks consistently over the next few quarters. As Orvana meets its goals, I believe the market will appreciate the cash flow being generated, worry less about its working capital position and give the company credit for its advancement of the Copperwood project.

TGR: Prodigy Gold Inc. (PDG:TSX.V, Sector Outperform, CA$1.20 Target Price) recently published an updated PEA on its flagship Magino gold project in northern Ontario. Your model for Prodigy, using the updated PEA, projects a 20,000-ton/day operation, producing 222 Koz of gold per year over 13 years at total cash cost of roughly $775/oz. That would generate annual earnings before interest, taxes, depreciation and amortization margin of more than 50%. Yet, your target price of $1.20 is only about 40% above where Prodigy is trading. Why so conservative?

JM: Given that gold indices provided a negative return in 2011 ranging from 13% to 20%, I think that a positive 40% return to target is probably not conservative in the current market environment. With respect to the valuation, I have adjusted for the technical and execution risk of the study level (PEA) and the fact that I have modeled a larger mineable resource base than that used in the December 2011 PEA. As a company derisks the project from PEA to a feasibility study, I revise the multiples applied to the asset valuation.

Prodigy is planning a significant drill program of 60,000m in 2012 to infill/upgrade and expand the resource base while condemning areas for locating site facilities. We also anticipate an updated resource by Q312 leading to a feasibility study by Q412.

TGR: Do you expect a takeover offer for Prodigy?

JM: I try not to work off the takeover model because it is highly uncertain but focus on the underlying valuation. While I do believe that the Magino asset would be a good takeover candidate for an intermediate, I think that there are opportunities for consolidation and capturing some synergies with Richmont Mines Inc. (RIC:TSX; RIC:NYSE.A), which has an underground operation that abuts Prodigy’s land package. Consolidation would probably be a good idea, given that Prodigy could have underground targets within the same host rocks as Richmont, which has a fully permitted and functional process plant.

TGR: In your last interview with The Gold Report, you talked about Revolution Resources Corp. (RV:TSX; RVRCF:OTCQX, Not Rated). You said it was looking for analogs of Romarco Minerals Inc.’s (R:TSX, Not Rated) Haile Deposit in the Carolina Slate Belt. What’s happening with Revolution now?

JM: Revolution still occupies a significant land package of 7,500 acres along a 25-kilometer corridor within the Carolina Slate Belt at its Champion Hills Gold project in North Carolina. It drilled 19,150m in 2011 and is working on a resource estimate in 2012. Currently, gold equity plays exploring in the Carolina Slate Belt are strongly tied to news flow from Romarco’s multimillion-ounce Haile gold development project in South Carolina and its ability to permit it. In an effort to diversify its portfolio, Revolution acquired a significant land package (~400,000 hectares) in two prospective regions in Mexico from Lake Shore Gold (LSG:TSX, Sector Outperform, CA$3.50 Target Price) in 2011. These assets host high-level low-sulphidation epithermal, gold and silver mineralization and we anticipate news flow from drilling results by Q1–Q212. The company wanted to present the market with multiple catalysts from a diversified asset base and this project has allowed it to achieve that goal.

TGR: In late December 2011, Eldorado Gold Corp. (ELD:TSX; EGO:NYSE, Sector Outperform, CA$19.00 Target Price), made a takeover bid for European Goldfields Ltd. (EGU:TSX; EGU:AIM), which has gold exploration and development properties in Greece, Turkey and Romania. Last year, you discussed Carpathian Gold Inc. (CPN:TSX, Sector Outperform, CA$0.90 Target Price) and its Rovina Valley copper-gold-porphyry project, which contains about 10.7 Moz gold equivalent in Romania’s Golden Quadrilateral. Does the proposed European Goldfields takeover make Carpathian Gold more attractive to larger suitors?

JM: Barrick’s private placement in August 2011 into Carpathian to fund additional drilling at Rovina Valley already speaks to the attractiveness of these gold rich porphyry systems to larger suitors. Mining activity in Romania is heavily linked to news flow on the permitting activities at Rosia Montana operated by Gabriel Resources Ltd. (GBU:TSX, Not Rated).

Eldorado Gold’s proposed takeover bid for European Goldfields does put in a bid for assets in Europe, however, the majority of European Goldfields’ assets are located in Greece (Olympias/Skouries) and less so in Romania (Certej). For me, the takeover trigger was related to the receipt of permits to develop its Greek projects in July 2011. Permitting of those projects took an extended period of time. A positive permitting environment in Europe bodes well for Carpathian at Rovina Valley and it will benefit from any positive news flow from Gabriel. The risks include royalty increases and potential free carried interest that the government wants to negotiate.

TGR: Royalties are going from 4% to 8%. That certainly is not positive, but to get those revenues the government has to permit the mines.

JM: Herein lies the rub. On Jan. 3, we lowered our target by $0.10 on Carpathian to $0.90 to accommodate an increase in the gold and copper royalties to 8% at Rovina Valley. However, on the positive side, by defining the mining royalty rates and the tax structure and negotiating a free carried interest, the Romanian government has shown its desire to have these companies invest in these projects and generate the revenue streams within a restructured rent-sharing framework. We note that the local government is also looking to privatize some state-owned mining assets to raise revenue.

TGR: What do analysts, investors and companies need to look out for in terms of geopolitical risk?

JM: I would highlight countries—emerging or developed—that are in economic dire straits with prospective geology whose mining sector is underdeveloped and has untested mining laws and poor infrastructure. Geopolitical risk carries a few facets including outright expropriation to creeping nationalism, which is linked inextricably to a company’s ability to develop/permit the project. These countries will continue to seek foreign direct investment to explore/develop these assets. Outright expropriation is difficult in countries where there is no mining history and a paucity of critical skill sets locally, unless of course it is looking to sell the asset to another bidder. Alternatively, the country may alter its mining laws to increase its share of resource rents derived from the exploitation of these assets. We have observed higher rent sharing globally via increased royalty payments, higher taxes and/or the introduction of windfall tax structures in countries such as Peru, Argentina and Romania, to name a few.

Assets in higher geopolitical risk jurisdictions must provide the investor a high return and quick payback commensurate with the elevated risk profile. Note that assets within higher geopolitical risk jurisdictions may be more difficult to finance and there may be a limit on potential takeover suitors, depending on their risk appetite. To properly risk adjust and quantify these uncertainties remains a challenge.

TGR: Is that because it is not going away?

JM: Let’s not forget that mining is a great way to get an injection of direct investment into an economy and generate employment. For example, high rates of unemployment in developed countries such as the U.S. and European countries are driving mining activity in places where permits have historically been difficult to attain.

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

Joe Mazumdar is a senior mining analyst with Haywood Securities in Vancouver. Previously, he served as director of strategic planning at Newmont Mining and was the senior market analyst for Phelps Dodge. He has held a variety of geologist positions with other mining companies including RTZ, MIM, North and IAMGold working in South America, Australia and Canada, rounding out ~20 years industry experience. He holds a Bachelor of Science in geology from the University of Alberta, Canada, a Master of Science in exploration and mining from James Cook University, Australia, and a Master of Science in mineral economics from the Colorado School of Mines, U.S.

Want to read more exclusive Gold Report interviews like this? Sign up for our free e-newsletter, and you’ll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Exclusive Interviews page.

Sen. Marco Rubio (R) of Florida delivered his party’s weekly address on Saturday morning, and made a provocative claim about President Obama.

“The bottom line is this president inherited a country with serious problems,” Rubio . . . → Read More: Yes Florida, The Economy *IS* On The Mend]]> I happened across this article today and wish I could claim that I wrote it. Here is the opening…

Sen. Marco Rubio (R) of Florida delivered his party’s weekly address on Saturday morning, and made a provocative claim about President Obama.

“The bottom line is this president inherited a country with serious problems,” Rubio said. “He asked the Congress to give him the stimulus and Obamacare to fix it. The Democrats in Congress gave it to him. And not only did it not work, it made everything worse.”

What a crock!

So have a look at the full article here and see the Rubio claim debunked soundly.

Not only has the U.S. economy grown for the last 10 quarters, but the workforce has ADDED jobs for the last 22 months straight.

Can we do better? Sure. Did Obama policies make things worse?

I don’t think so!

The Energy . . . → Read More: Finding Growth in a Flat Energy Market: Tim Murray]]> Clean balance sheets, cash flow visibility and trading liquidity in oily stocks are the cornerstones of investment success in junior E&Ps, according to Oil and Gas Analyst Tim Murray of Desjardins Securities. In this exclusive interview with The Energy Report, Murray lays out his risk/reward proposition for his very favorite names.

The Energy Report: Tim, what is your investment thesis right now?

Tim Murray: It hasn’t changed since the last time we talked. We are biased towards oil plays. But we will look at selective natural gas players and we prefer the lowest-cost producers as well as the companies with a larger production base.

TER: Are you currently telling investors that they need to be patient?

TM: Yes. Most of the small/micro cap stories have seen a dramatic drop in share price over the last year; however, WTI (West Texas Intermediate) is hovering around $100/barrel (/bbl), and oil companies should be able to generate strong cash flow at these levels. The market has gone quieter on the smaller-cap companies as investors traditionally flock to larger, more liquid names in times of uncertainty. Once we see more general stability in the global market place we expect money to once again flow back into small/micro cap names.

TER: So, how does a micro-cap company get out of a hole like this? If its market cap has been knocked down so dramatically that the stock becomes hard for mutual funds to own, what must happen to get out of that situation?

TM: It usually comes down to market sentiment changing. Money managers will eventually start looking at the small caps again because those companies offer significant potential gains in a portfolio. You don’t buy small caps or micro caps for 20% returns; you buy them for 80% or 90% returns. Small cap names may currently be light in many portfolios, however we believe market participants will return to these names once general global market stability is demonstrated. The other option is to become an active acquirer in order to grow in size, however this can be a challenging goal for many small caps that have depressed valuations, unless you can purchase another small cap in the same situation.

TER: Do institutional E&P investors tend to think in terms of value, or are they looking for growth names?

TM: I think most institutional E&P investors are still looking for growth prospects. However, many of the small cap names are trading cheaply on a cash flow basis, so these growth stories can also be viewed as value plays. Most institutions are choosing companies with better balance sheets that don’t have to go to the market to raise money to move their drill programs forward. Companies that can show good visible organic growth from cash flow for the next two to three years seem to attract more attention. Institutions also seem to be most interested in liquid stocks.

TER: Gasoline prices in some regions have declined to the sub-$3/gal range, and this is right in front of a big holiday. Are we looking at continued weakness now in commodity oil?

TM: I don’t think so. We do like the commodity and prefer it to natural gas right now. As for natural gas, we are bearish in the short/medium term, and I don’t see any meaningful near-term catalyst to change that. We don’t see $50/bbl oil in the near term and we are thinking that anywhere between the $80–100/bbl bandwidth is a realistic range for WTI to trade over the next 12 months.

TER: What catalysts are needed to turn energy stocks around?

TM: Well, some equities have done well this year, and so it’s hard to paint a broad stroke across the board. We believe once general market stability has returned that market participants will return to the small/micro cap space. Looking more to a company-specific level, management teams that continue to deliver results will see stock prices that outperform their peers.

TER: When could we see some upward movement?

TM: There is lots of news flow operationally for the names I cover in January and February, so positive drilling results should help push individual stocks higher. On the commodity front it’s really hard to project what’s going to unfold in the next month and we prefer to look out over the next 12 months and believe a realistic trading level is between $80–100.

TER: What names are you talking to investors about today?

TM: The ones I’m talking about the most have strong management teams, good balance sheets, liquidity and visible cash-flow growth. My favorite name is Whitecap Resources Inc. (WCP:TSX.V), which has all those characteristics. Whitecap is run by Grant Fagerheim, who has led several other successful junior oil and gas companies. We believe Whitecap has a top-tier management team. This is the biggest company that I follow in terms of production and reserves, and it also has the best liquidity. It has a visible light oil growth profile for the next several years, offers a top-tier cash netback and a low relative corporate decline, which we believe positions them very well. We also like that Grant has traditionally been an active M&A player, which we think leads itself well to the current environment as we have mentioned previously many small/micro caps trade fairly cheap.

TER: What’s the story here? Is it about the Pembina Cardium and Valhalla Montney?

TM: Yes, and it is acquiring Compass Petroleum (CPO:TSX.V), which will give the company another core area targeting the Viking in the Dodsland region of Saskatchewan. So, it now has a fourth core oil area.

TER: Your target price was $11. Have you upped that?

TM: Yes, it’s $12.25 now.

TER: That represents 40% upside potential from here.

TM: Yes, and the upside may seem light for a small cap, however it carries considerably less risk than some of the other companies I cover. For instance, I have a target of $1.25 on Torquay Oil Corp. (TOC.A:TSX.V; TOC.B:TSX.V), which would be a much greater return, but there’s a lot more inherent risk in a Torquay then there is with Whitecap. So, on a risk/return basis, Whitecap is currently my top pick.

TER: You took Torquay down from a $2- to a $1.25-target, which is still better than a 200% implied return from current levels. What’s your investment thesis on the company?

TM: A larger portion of my $1.25 target hinges on the company’s key core property at Lake Alma. The company is basically trading at my base net asset value (NAV), which is essentially all the company’s other properties. Torquay has discovered oil at Lake Alma; however, it has not been extracted economically to date. Torquay’s management team believes they do have a viable play and that they can extract the oil economically. However, Torquay is not big enough in size to fund a meaningful drilling program from cash flow, and the company is going to have to go to the market to raise money if they would like to get aggressive again with Lake Alma. The large drop in share price and its marginal success at Lake Alma over the last 18 months could make raising money challenging. That’s why on paper it looks like a no-brainer to invest in because of the huge potential return, but there’s a lot of risk associated with the company from a market perspective (raising capital) and exploration risk at Lake Alma. If Torquay can’t succeed at Lake Alma, then I would have to remove the Lake Alma upside of approximately $0.75/share.

TER: Who is currently buying the stock? Is it the hedge fund community?

TM: Since November and December, Torquay has had relatively huge trading volume. Some investors picked it up in the $0.25–0.30 range because they thought it was so cheap that they couldn’t go wrong as it was trading below its base NAV. So they basically got exposure to Lake Alma for free. It’s hard to say who’s playing in this story right now. Some hedge funds may be looking to add this classic high-risk/high-reward play to their portfolios.

TER: What other companies do you like?

TM: It is not my top pick, but one of my other favorite names is Spartan Oil Corp. (STO:TSX). I think of it as a mini lookalike of Whitecap, however smaller in size. Spartan’s core property is located at East Pembina targeting the Cardium formation. Management is very familiar with the Cardium as its predecessor company showed terrific growth drilling the Cardium horizontally. The key asset for Spartan is the Keystone unit #2, which is a legacy oil pool that has been drilled vertically. Spartan believes it can substantially increase the recovery factors through the application of horizontal drilling. The #2 unit has never had a horizontal well drilled into the pool and Spartan has drilled three to date, and we’re waiting on results from these wells. Spartan also has a couple of exploratory plays in Saskatchewan, which is the torque in this story. Further positive drilling results could lead to another core area. We also would like to point out that the balance sheet is very strong and Spartan could announce a very aggressive 2012 capital program.

TER: This is the best-behaved stock in your universe. It’s had its head above water for an entire year.

TM: Right.

TER: Is your target still $4.75?

TM: My target is higher than that. It’s $5.25 now. Whitecap and Spartan are my two favorite names right now. I like both their balance sheets. I believe Whitecap can show organic growth in the 20% neighborhood from cash flow over the next several years, and Spartan should be able to demonstrate similar numbers over the next 12–18 months because its balance sheet is very strong.

TER: Tim, you follow Strategic Oil & Gas Ltd. (SOG:TSX). I saw that it had recently negotiated a $40M bought-equity deal. When a company can avoid the risk of going to the market by selling its equity directly to the investment banks, it sounds like a very positive development.

TM: I definitely agree with that as Strategic will have a very strong balance sheet entering 2012, which will allow it to have an aggressive 2012 drilling program. Strategic has two oil plays that are both very early stage and quite high risk. We can see growth prospects for the next 12–18 months if either one of the oil plays is deemed commercial. On a comparable basis, Strategic’s assets are much higher risk than Whitecap’s or Spartan’s. This stock could perform very well with good drilling results or very poorly with bad drilling results.

TER: I enjoyed speaking with you very much. Thank you.

TM: Cheers. Thank you.

Tim Murray joined Desjardins Securities in July 2011. Prior to this, he was an oil and gas analyst for almost six years at several investment boutiques covering junior and mid-cap companies. He also spent over a year at AltaGas Income Trust performing risk and credit analysis on natural gas and power assets for the company’s midstream business and served as an investment advisor for three years. Tim was awarded the CFA designation in 2003.

The Gold Report: Gold prices reached historic highs during the last quarter. However, in a recent . . . → Read More: John Kaiser: Gold as a Positive Economic Indicator]]> A $3,000/ounce gold spike could boost equity valuation. In this exclusive interview with The Gold Report, John Kaiser, editor of Kaiser Research Online, shares the catalysts that could propel gold and silver stock prices higher in 2012.

The Gold Report: Gold prices reached historic highs during the last quarter. However, in a recent Kaiser Bottom-Fish newsletter, you showed the Toronto Stock Exchange Venture (TSX.V) listings since February have had dramatically more down than up days. Is this a correction or a long-term trend?

John Kaiser: What we have seen is a negative response by ordinary investors to a deteriorating economic outlook for the United States and the world, which we might call a correction of expectations. But what worries me about a long-term trend is the growing prevalence of volatility-based profit harvesting, high-frequency and algorithmic trading paired with the elimination of the downtick rule for short selling, which allows traders to push markets down or up at will and in the process destroy perceptions of value in the market. This has been particularly intense in the junior resource sector, which the TSX.V is dominated by, because these companies, generally, do not have revenues and cash flow, the usual measures by which value is assigned.

It is very difficult to develop a visualization of what a venture project is all about, what it could become and turn that into a market valuation that enables the company to finance its projects at minimal dilution to existing shareholders. It is much easier to pound the order book, fill it with sells and completely undermine the perception of the people who have been investing for value. The bottom line is that we have seen a withdrawal of value-style investors from this market, both at the retail and sophisticated levels. As an example of how significant this has been, during February, the Venture Exchange averaged $310 million (M) worth of trading per day. By October, the average value traded had plunged to $94M per day.

TGR: Are you saying that the difference is not because of the fundamentals of the stocks and the companies behind them that are on the TSX.V, but because the rules have changed and people are playing around the volatility?

JK: It is a combination of the two. We had a surprise recovery in the resource sector in 2009 and 2010, facilitated by U.S. quantitative easing and China’s stimulus program that injected $600 billion into infrastructure development. Coupled with strategic Chinese stockpiling, that helped pull up raw material prices from the end-of-2008 lows. But the Fukushima nuclear disaster with its supply chain interruptions and the emergence of the Tea Party as a major force in the debt ceiling debate conspired to make the world very concerned that the creeping recovery is going to tip back into the garbage can. That has stalled the post-crash recovery in raw material prices, leading investors to price in the possibility of the global economy descending into a 1930s-style depression. Contrary to the beliefs of many goldbugs, a depression would also be negative for gold and silver prices.

TGR: In addition to some of these short-term trends, you have talked about the possibility that the United States is moving away from its power position. Europe and America are descending while China and India are ascending. Do most people see this? And is this impacting the stock market?

JK: The “declinist view” says that the U.S. economy and its military power are in a long-term downtrend. In at least economic terms, this is supported by gross domestic product (GDP) statistics. In 2000, the U.S. GDP was 32% of global GDP while China’s was about 5%. Since then, American GDP has sunk to about 22% while China’s sits at just under 10%. At the same time, we have seen America’s share of total military expenditures rise from about 40% to 43%, where it seems to be going sideways. The U.S. is carrying an unsustainable burden of the cost of keeping the global peace. With America’s share of global GDP in long-term decline, the ability to fund almost single-handedly a global military force is not sustainable.

TGR: Based on that, what is your prediction for the final quarter of 2011?

JK: What I have described is a long-term trend that is underway. Right now, we are in the throes of sorting out what is going on with the Eurozone. Europe is in danger of imploding upon itself. It needs to stabilize its financial situation. At the same time, we need to see some signs that the American economy is rebounding. Employment statistics are going to be important. After losing nearly 6 million manufacturing jobs between 2001 and the end of 2009, some 303,000 manufacturing jobs have been created since 2010. This trend stalled earlier this year because of the Japanese supply chain disruption and concern that the political quagmire will result in consumer demand destruction. We need manufacturing capacity to come back to the U.S. in order to support the growing service job economy. The uncertainty about the growth of real jobs could result in a very volatile market during the last couple months of this year.

Wall Street sees down as easier than up, so the tendency is to lean on the market and pressure it down. A big tax loss selling window is going to emerge soon. We may even see a bottom-fishing window open up. My concern is that shareholders who understand why they own quality stocks will be reluctant to sell at the bottom after enduring what amounted to a nearly yearlong slow motion crash. On the other hand, low quality stocks will probably be sold ruthlessly. That means poor liquidity in the better stocks, but very high liquidity at very cheap prices in the stocks that do not have staying power. We may, in fact, see an icicle-type formation where prices dip down because there has been lots of selling into the bids without significant replacement by new bids. Too many investors remember how unwise it was to catch half-price bargains in the fall of 2008 that turned out be falling knives and anvils. When people finally go looking for quality stocks at depressed prices this December, they will find little available. As they start to reach for stocks, prices will spike upward and kick off Q112 with a strong uptrend.

TGR: In an environment like this, what is the best way for an investor to protect wealth or maybe even profit?

JK: My area of specialty is the resource sector, both the mining companies and the resource exploration and development companies. If you accept my belief that the strength in gold and silver prices reflect anxiety about the relative decline of the United States as both an economic and military power, which I see manifested in the fact that the value of all the aboveground gold and silver has risen to 12% and 3% of global GDP, respectively, from the 4% and 0.5% levels that prevailed a decade ago when America was indisputably triumphant, we will see prices head modestly higher from current levels over the next five years.

That is very significant for the gold and resource producers and juniors because they are pricing a bubble-type perception, namely that gold is going to go back to $1,000/ounce (oz) and that silver is going to go back below $15/oz, prices that could make many of these companies unprofitable. That is the reason we are seeing very low cash-flow multiples similar to what we often see in industrial mineral-type companies. So the big bet here is that we will witness an inflection when people start to accept that the current gold and silver prices are the new reality, which will result in an upward repricing of anywhere from 100–300% for gold and silver companies.

One strategy is to look at the solid, cash flow-positive silver and gold producers right now, and take a position in them. A secondary strategy would be to look at the gold and silver ounce-in-the-ground development companies, which are trading at valuations considerably lower than what you get by plugging current metal prices into the discounted cash-flow valuation model.

TGR: What would be some examples of companies that fit either the cash-flow positive or the development company trading at a lower-valuation model?

JK: Fortuna Silver Mines Inc. (FVI:TSX; FSM:NYSE; FVI:Lima Exchange) has a mix of silver and base metal production. It would benefit considerably if people expect the current cash flow to be sustainable over the next few years.

TGR: It looks like it is trading at $6.58 right now. It has been as high as $7.22.

JK: Right now, Fortuna is being priced at roughly a very conservative six-times multiple of 2012 cash flow based on forecast production and the current $34/oz silver price. The reason it is so low is that people do not think the cash flow is sustainable. That can be either because they think a mine will encounter a problem and cease production or because they expect the commodity price to go down substantially.

So far, Fortuna has not disappointed us with production from Caylloma, but we do need to see production ramp up for San Jose to proceed next year as expected. But a lowish 5–7 multiple for next year’s forecast production at current silver prices seems to be the norm for primary silver producers. To help my readers better understand the situation, I have created a couple of graphics based on our production and cash-flow forecast for Fortuna. The annual production and price target chart shows the impact San Jose coming on stream will have on silver production over the next four years. In 2012, San Jose will add 1.7–1.9 million ounces (Moz) from Caylloma, growing overall silver production to 5 Moz annually by 2015. The chart shows the stock price that would result at a 10 times cash-flow multiple at different average silver prices for 2012.

As you can see, the current $6.58 stock price is not far from the $7.01 price target that corresponds with a $20/oz silver price and a 10 times cash-flow multiple. But if we apply the current $34.64/oz silver price, the stock price jumps to $11.20 at a 10 times multiple. At $50/oz silver, the price target jumps to $15.59. You can also see what happens at more optimistic silver prices such as $75 and $100. A five times cash-flow multiple is too conservative for a precious metals producer such as Fortuna whose silver production at $20/oz silver is 60% of revenue.

Once there is acceptance that silver prices are not going back to the bad old days, you could see a 15:1-type multiple emerge. It is hard to predict what sort of cash-flow multiple the market will eventually settle on during these volatile times, but the second Fortuna chart helps me see the price target for Fortuna during 2012 at various average silver prices and cash-flow multiples.

For example, suppose you think, like I do, that silver could average $50/oz in 2012 and silver producers attract a 15 times multiple. Slide that vertical silver bar reflecting the current silver price over to $50/oz, and move up to the green line corresponding with a 15 multiple and you get a price target just short of $25/share for Fortuna. It should be obvious that the market is biased toward a pessimistic scenario where silver crashes back to $20/oz. Keep in mind that this cash-flow-based valuation metric assumes that higher silver prices are not due to substantial cost inflation or U.S. dollar exchange rate declines, which would gobble up any gains in silver revenues caused by price increases.

The primary silver producers are companies that did all the heavy lifting in the past few years, putting their silver deposits into production. They are now getting an enormous amount of cash flow, but are not being priced as if this cash flow will be sustainable over the life of the mine. So, the big bet is whether current silver prices are sustainable over the next five years. I am arguing that they are sustainable and we will see a valuation paradigm shift where these low cash-flow multiples of 5:1 will jump up to a 10:1 or 15:1 ratio. What will follow is an aggressive development of more silver production absent the concern that capital expenditures will end up being lost because silver prices collapse.

TGR: Could a shift to 10:1 pricing boost all silver producers?

JK: If the silver price proves to be sustainable, we could see the stocks all undergo significant gains as they adjust to this new paradigm, as is evident in the Upside Potential chart for the 15 primary silver producers we track. The one apparent exception is Aurcana Corporation (AUN:TSX.V), which looks weak because in 2012 its Shafter mine will add only 900,000 silver ounces to the existing 1 Moz production from La Negra. But Shafter is forecast to hit 3 Moz in 2013, bringing total production to 4.8 Moz in 2015. So Aurcana might be the laggard to watch for those speculators who prefer to react to the inflection rather than anticipate it.

TGR: On the gold side, you pointed out in a recent article that the inflation-adjusted equivalent of the post-1980s bubble of $400/oz would be $1,032/oz and that $1,800/oz gold represents a 74% real gain. What are you predicting is going to be the new normal for gold?

JK: Much of the discussion about gold treats it as an inflation hedge. We can argue that the big move during the 1980s was a slingshot effect that allowed gold to catch up for decades of inflation while its dollar price was artificially fixed. Goldbugs today will argue that the “real price gain” I am observing is just an anticipation of the inflation that will come once the world’s debt problems are monetized. If they are correct, then it explains why there is such muted interest in gold equities despite record gold prices. Whatever profits are present today will vanish tomorrow when costs undergo an inflation big bang. But I think there is a different reason for this “real price gain” to be present, and it is not bad for gold equities, at least not in the medium-term future.

Rather than relate the value of the existing gold stock to measures such as the money supply, I look at gold’s value as a function of global GDP. Given that GDP represents the total value of exchanged goods and services whose turnover one can assume created wealth while gold just sits there growing incrementally while accomplishing very little, you might wonder what the connection would be between wealth creation and the value of the gold stock. This chart graphs the annual value of the aboveground gold stock based on the average annual gold price as a percentage of nominal global GDP expressed in U.S. dollars at the average currency exchange rates prevailing each year.

That description is a mouthful, but I find the graph fascinating because it shows a massive spike to an $850/oz gold peak of 26% in 1980 when it looked very much like America was losing it on the global stage, plunging to a low of 4% in 2001 when it looked like the world was America’s oyster. Since then, we see a gradual increase to a peak of 15% in 2011, but still well short of the 1980 peak of 26%. We see a similar pattern with the aboveground silver stock.

Note that during the past 30 years miners added 2.2 billion ounces (Boz) gold to the 3.2 Boz that existed in 1980, and 17 Boz silver to the 30 Boz that existed then. This graph includes the value of that additional gold and silver.

The possible meaning of this trend begins to take shape when we look at another chart that plots the American and Chinese GDP as a percentage of global GDP, along with plots of each nation’s military expenditures as percentages of global military expenditures. America’s GDP percentage has declined from 32% in 2000 to its current level of 22%, while China’s has grown from 4% to nearly 10%. At the same time we see America’s military spending stuck at about 43% of global spending, while China’s share has nearly doubled to just over 7%, a trend that closely tracks the growth of its GDP. Given political efforts to contain government spending, and the fact that military spending is the single biggest item in the spending budget, an obvious question is what exactly does this overwhelmingly high percentage of global military spending accomplish, and do American taxpayers proportionately benefit? Regardless of the answer, what happens if these inversely related American and Chinese GDP percentage trends continue along their trajectories?

In my view, the expansion of the value of the aboveground gold and silver as percentages of global GDP reflect growing international uneasiness about the next two decades during which America and China respectively become relatively weaker and stronger on the global stage. The real price increases we have seen in gold and silver reflect this growing structural uncertainty rather than fear about hyper-inflation and fiat currency collapse. And short of a catastrophic global economic collapse that causes China to implode worse than the United States, I do not see anything on the horizon to make this anxiety diminish.

So let’s assume that, rather than an escalation of anxiety such as we saw in 1980, we are stuck with persistent medium-level anxiety that, for argument’s sake, stabilizes at a level where the value of the gold stock is 10% of GDP and in the case of silver 3%. These are levels less than half the peak percentages of 26% and 14% achieved for gold at $850/oz and silver at $50/oz in 1980. If we accept the global economic growth projected by the International Monetary Fund and gold production increases over the next five years along the lines projected by CMP or GFMS, then at a 10% “anxiety” percentage of GDP I can see the gold price trading in a range of $1,400–1,700/oz during the next five years. In the case of silver at 3% of GDP I see a range of $45–60 which is even better than the current $34 price.

I am confident that these new levels are the new reality, which means that this 50–70% real gain that we see in the price of gold represents a lot of potential profit to be harvested by putting into production deposits that three years ago would not have been economic. This is good news for producers and ounce-in-the-ground projects that have a significant profit margin to be captured if they are put into production and can sell their gold at prices of $1,500–2,000/oz over the next five years.

TGR: So if we assume $1,500–2,000/oz gold prices, what are some of the juniors that could profit in the next year or so?

JK: One that has been an ongoing recommendation is Spanish Mountain Gold Ltd. (SPA:TSX.V), which was formerly Skygold Ventures. It trades at about $0.80 right now. At a gold price of about $1,750/oz, it has a potential value of just under $2/share when I run the parameters published in the junior’s 2010 preliminary economic assessment through a discounted cash-flow model at a 10% discount rate. At a gold price of $1,100/oz, Spanish Mountain is worthless. So this is an example of a large-tonnage, low-grade deposit, which at the prices from a few years ago is basically dead in the water.

But at the $1,750 level, it’s potentially a $1.50–2 stock. If gold ends up at $2,500/oz, I could see Spanish Mountain being worth $4, but only if such a gold price rise is not accompanied by capital and operating cost escalation. I certainly do not rule out a spike toward $3,000/oz over the next few years—$3,300/oz right now would be the equivalent to $850/oz in 1980 if we take gold’s value as 26% of GDP as the bubble limit. Although unsustainable, such a move would create a tidal wave of interest in the sector. It would trigger a gold price valuation paradigm switch for gold equities similar to what I am predicting for silver. People would start taking the current prices seriously and plug them into their cash-flow models instead of using $1,100/oz 3-year trailing averages for gold projects.

Instead of suspiciously viewing today’s gold prices as a trend that will end terribly, people need to look back at a long-term gold chart from the early 1970s when the price went from $35/oz to $850/oz. Yes, that was a hyperbolic chart and it still stalled out. But gold stalled out at $400/oz and stabilized there. And that was a huge, 500% real increase. So we had 30 years of gold production where all this fruit that had previously been very high in the trees was suddenly turned into low-hanging fruit that the mining industry systematically harvested and added 2 Boz to the 3.2 Boz that existed in 1980. What we are witnessing now is on a somewhat smaller scale, but if you use this measure of the gold value as a percentage of global GDP, then the current percentage of about 12% is still halfway from a bubble limit where it starts becoming too much of a self-fulfilling phenomenon that has to burn out and crash back.

TGR: So what about a hybrid company? You have written about Geologix Explorations Inc. (GIX:TSX). It is trading at $0.28 now. Is that factoring in higher metals prices? Where could that go?

JK: Geologix is copper and gold. An important message I am trying to send to my audience is that gold is not inversely related to economic strength anymore. It is not a hedge against the world economy collapsing, which normally means what is good for copper is bad for gold, a reason miners who understand the meaning of “hedge” like copper-gold mines. The real price strength of both copper and gold is now twinned.

Because Geologix is still perceived as more of a potential copper producer than a gold producer, when copper prices retreated earlier this year, the stock followed. While we can argue into the wee hours whether or not my analysis of the factors driving the gold price is correct, few will dispute that strength in copper is a function of expectations that the global economy will continue to undergo growth rather than go back into a major recession.

If you are inclined to believe that the global economy is more resilient than most people think, but still lean toward the notion that what is good for people in general is bad for the gold price, then a copper-gold project such as Geologix’s Tepal project in Mexico merits attention. I have run discounted cash-flow models of Tepal based on the preliminary economic assessment parameters presented by Geologix in April 2011 in which I assume a pessimistic scenario of $2/pound (lb) copper and the optimistic scenario of the current $3.50 price. At the current $1,750/oz gold price, the model shows a price target of only $0.67 using a 10% discount rate, but at $3.50/lb copper the target jumps to $2.03. At $1,400/oz gold and $2/lb copper, Tepal is dead, an outcome the market already seems to be pricing into the stock at $0.29. But if copper stays at $3.50/lb and gold soars to $2,500/oz, the Geologix price target blossoms to $3.50. Geologix is thus a good example of a leveraged play on my theory that gold’s strength is linked to a growing economy rather than a faltering one.

TGR: Any other good examples of how the rerating of gold prices into stock prices could impact companies you are following?

JK: One of my newer picks is a company called Probe Mines Ltd. (PRB:TSX.V). A year and a half ago, it was pretty much just limping along on the basis of a small claim it had in the McFauld’s Lake area of Ontario where it covered a fraction of a chromium deposit. But since then it has made a brand-new gold discovery in the Borden Lake area of Ontario, and it just published an Inferred resource of over 4 Moz at a fairly low grade of about 0.7 grams/ton. At current prices, this represents about $40/ton. It is one of these large, disseminated gold systems that will be amenable to open-pit mining, a similar concept to Spanish Mountain. Probe has not yet done the economic scoping studies needed to identify operating and capital costs, the key to evaluating the impact of the current gold price on undeveloped gold deposits. Here is an opportunity to benefit from comparing similar deposits such as, say, Brett Resources Inc. (BBR:TSX.V) and its Hammond Reef deposit that Osisko Mining Corp. (OSK:TSX) bought for about $500M while gold had a lower price than today. Probe’s total valuation is only about $187M based on 80M shares fully diluted. With expansion drilling underway there is potential to get a stock price boost from the discovery of additional ounces, not just growing confidence in the current gold price and optimism about mining costs at Borden Lake.

TGR: How high do you think it can go?

JK: In the short term, I would expect $3–4 if it delivers its preliminary economic assessment by the end of Q112 and the numbers are similar to Brett’s Hammond Reef, if not better, but if the exploration drilling establishes similar mineralization along the fold of this belt where no real work has ever been done in the past, it could end up boosting this resource to a 5–10 Moz system. At that level, it starts becoming interesting to a major. Then we could see this stock flirt with a $5–10 range. Plus, it was financed earlier this year to the tune of $25M, and again a week ago for $15M, so there is no need to worry about financing dilution risk in the near term. And the Black Creek chromium asset could be a target for Cliffs Natural Resources Inc. (CLF:NYSE), which is developing its Big Daddy chromite project in Ontario. That could give this company another injection of capital without having to undergo equity dilution.

TGR: You mentioned that you now see gold as positive toward economic development, not inverse to economic health. Do you think that higher gold prices are driven by goldbugs or by investors who are looking to profit?

JK: It is my view that goldbugs are a minority. I believe the buying is by investors who are simply hedging some of the wealth, higher net worth people who are putting a portion, maybe 5%, of their wealth into gold. They have the most to lose if the world becomes unstable, and currencies fall apart relative to each other. They don’t need that 5% of their wealth that they are stashing in gold. A similar thing is happening with silver, except it is driven by people in emerging nations where they cannot really afford a 1 oz gold coin and they don’t trust their governments, so they are using silver to store accumulated wealth. Therefore, a lot of silver, which primarily was fabricated into industrial applications, is now being pulled out of those applications by the high price and being redistributed as a very dispersed asset class. It is not going to come back into the system quickly, just as I don’t think the gold overhang is going to come back because investors decide to grab a profit and run. Frankly, I think gold and silver ownership will be quite boring in profit or loss terms during the next year, which is very good for gold and silver equities.

TGR: Thank you, John, for your insights.

John Kaiser, a mining analyst with over 25 years of experience, is editor of Kaiser Research Online. He specializes in high-risk speculative Canadian securities and the resource sector is the primary focus for an investment approach he developed that combines his “bottom-fishing strategy” with his “rational speculation model.” Kaiser began work in January 1983 as a research assistant with Continental Carlisle Douglas, a Vancouver brokerage firm that specialized in Vancouver Stock Exchange listed securities. In 1989 he moved to Pacific International Securities Inc., where he was research director until April 1994 when he moved to the United States with his family. He launched the Kaiser Bottom-Fishing Report (now Kaiser Research Online) as an independent publication in October 1994 and developed it into an online commentary and information portal. He has written extensively about the junior resource sector, is frequently quoted by the media, and is a regular speaker at investment conferences. Since 2008 he has developed a focus on security of supply issues and how they relate to critical metals such as rare earths.