Leonard Melman Finds the Fiscal Cliff a Boon for Precious Metals

Leonard Melman Surveying reality from his perch on Vancouver Island, Leonard Melman is a veritable sage in the world of metal mining analysis. In an interview with The Gold Report, the economic philosopher is troubled about the direction of the global economy. However, there are a few bright spots for eagle-eyed junior metal investors, he reports, and names some of his favorite picks.

The Gold Report: Leonard, what are the most pressing issues facing investors today?

Leonard Melman: Let’s start with the fiscal cliff. If America falls into this abyss, the combination of tax increases and spending reductions will slow down economic growth. Interestingly, political leaders in Europe are calling for increasing taxes and decreasing spending in order to solve their problems. I find it amusing that the solution to economic problems being proposed by leaders on the European side of the Atlantic is thought to be the problem on the American side of the Atlantic.

TGR: How do you account for the disconnect?

LM: It is due to a philosophical inconsistency and a lack of economic understanding on the part of the world’s political leaders, most of whom are not well qualified as economic thinkers, nor as philosophers for that matter.

TGR: How important is a philosophical stance to making a cogent economic analysis?

LM: Adhering to a strong underlying philosophy can guide leaders through difficult times. Unfortunately, demands by the public for more and more government services are making politicians even more reluctant to come down on the side of austerity, particularly in America. The results are uncontrollable deficits and a massive national debt. The statutory debt limit of the U.S. government is $16.394 trillion. The national debt of the U.S. as of mid-December was $16.337 trillion. Therefore, a mere $52 billion remained before the ever-rising debt reaches the statutory limit.

TGR: What will happen if no measures are taken to change the debt limit?

LM: According to law, portions of the government must cease operations once the limit is reached. Nobody wants to see that happen, least of all politicians. So I believe they will likely agree to increase the debt limit by another couple trillion dollars.

TGR: What will happen if the two-party system fails to agree on tax and spending cuts? How will the market respond?

LM: The market operates in two different directions. The precious metals market historically has regarded instability as a plus. The financial markets have historically regarded instability or uncertainty as a minus. If the parties fail to resolve either the fiscal cliff or the debt limit problem, I believe the financial markets will react negatively, but the precious metals markets will most probably react positively.

TGR: Then why has the price of gold bullion during the last year been so out of sync with the deflated price of junior gold mining stocks?

LM: In late 2007 and early 2008, the price of gold hovered near $800/ounce (oz). It’s over $1,700/oz now—more than double the earlier price—and yet the three most popular mining share indexes, the Philadelphia Gold and Silver Index (XAU), the NYSE Arca Gold BUGS Index (HUI) and the Market Vectors Gold Miners ETF (GDX), are all below their late 2007 and early 2008 levels. That is rather astonishing. The reason is that the nature of mining—especially for the juniors—has undergone dramatic changes in recent years, none of which are positive. Increasing energy, transportation, geological and licensing costs make it now more expensive to mine for metals, but the most pressing problem is that the time that it takes to put a newly discovered mine into operation has increased at a rapid rate.

“The precious metals market historically has regarded instability as a plus.”

I’ve been in this business for four decades. In the late 1970s, a mine could anticipate rapid progress from the time of discovery. A junior simply raised money, put the money into the ground, proved up the asset, got construction financing and went into production. Now a series of lengthy bureaucratic processes are making it difficult for mining companies to raise new funds in the financial markets because that causes share dilution.

Share dilution tends to knock down share price, which makes it difficult to arrange the next round of financing, which then makes it even more difficult to advance exploration and development and a most difficult spiral ensues that makes it very difficult for miners to generate revenue from production.

TGR: Are environmental regulations the only cause of slowing timelines for new mine development?

LM: There are other obstacles. In Canada, we have an aboriginal problem. The courts have literally given many aboriginal tribes the ability to interfere in the progress of a mining venture. Companies are required to “consult” with them at various stages of progress. Consultation is expensive, it’s time consuming, and it can be interrupted by legal procedures at almost any time.

TGR: Do you see any changes in the near term?

LM: The near term remains very difficult. In the long term, I’m fairly optimistic, because the world needs metals to survive, plain and simple. You can’t cook food, you can’t drive anywhere, you can’t process energy, you can’t run computers, you can’t have medical instruments and you can’t do almost anything that we do in modern life without metals. When genuine metal shortages begin to develop, we will see pressure build for a revision in these policies.

TGR: Are there any North American gold juniors that can weather these difficulties?

LM: There are some. I’ve developed an interest in Balmoral Resources Ltd. (BAR:TSX.V; BAMLF:OTCQX). A while back, I got to know Darin Wagner, and he struck me as a very competent individual. He successfully sold a company called West Timmins Mining Inc. (WTM:TSX), and now he’s the president of Balmoral. He understands the value of obtaining properties with a high likelihood of success. The old adage is that if you want to develop a new mine, acquire property in the vicinity of an old mine. Balmoral is working in the Detour Gold Trend along the Québec-Ontario border, which has four different multimillion-ounce projects. Wagner has a great chance of success there.

“Share dilution tends to knock down share price, which makes it difficult to arrange the next round of financing.”

Another company that I like is DNI Metals Inc. (DNI:TSX.V; DG7:FSE). It is working to develop black shale deposits in northern Alberta fairly close to the shale oil deposits and those black shales contain an enormous variety of metals. DNI has proven up very sizeable ore bodies at two locations on its properties, Buckton and Buckton South, and its current work involves resolving metallurgical problems. It’s obviously a high-risk investment. The shares are about $0.18/share right now, but there could be a very substantial return if the project works out.

TGR: DNI’s shares have fallen from a high of about $0.65 a year ago. Why is that?

LM: The same thing we’ve been talking about: the prolonged period of trying to prove up the resource during which time a firm has to keep raising funds to satisfy all operational and regulatory requirements. And the longer it has to keep looking for new funds, the more shares are outstanding, which tends to dilute the value per share.

TGR: So now would be a good time to buy DNI?

LM: From a risk/reward ratio, I believe it is a good time to acquire the shares—being fully cognizant of the risks and, of course, an investor should always do his own due diligence, but I think the potential gains outweigh the potential risks.

TGR: What about investing in bullion as opposed to investing in gold stocks?

LM: As noted earlier, during the last four years, investing directly in gold bullion would have provided a 112% gain. Investments in a variety of mining shares would have, on balance, stood still. But in the past, the opposite dynamic has applied. Looking forward, if the world monetary situation keeps declining, there could be a truly powerful gold bull market in front of us. That also applies to silver, platinum, palladium and some of the base metals. It is necessary for investors to clearly define their specific goals. If the general motive for investing in gold and silver is safety and preservation of purchasing power in case currencies break down, as they have done before, then one wants physical possession of the metals. But for trading gains, shares can be advantageous. Aside from shares, if a player desires to get in and out of the gold market quickly, exchange-traded funds work well. It depends on the investor’s objective.

TGR: What about silver?

LM: I like silver more than gold as a trading vehicle, because when precious metals are rising, silver tends to rise at twice the rate of gold. Of course, when the prices fall, silver falls farther; but if one anticipates a bull market in metals, then silver has real advantages.

“I like silver more than gold as a trading vehicle, because when precious metals are rising, silver tends to rise at twice the rate of gold.”

There are a couple of silver mines that I truly like in Mexico. Orko Silver Corp. (OK:TSX.V) has a very substantial deposit in Durango State of up to 200 million ounces of Indicated and Inferred reserves. Orko developed the property for about eight years before Pan American Silver Corp. (PAA:TSX; PAAS:NASDAQ) bought into the project. It created a joint venture with Pan American, which provided expertise and at least $18 million (M) of capital for exploration. But then Pan American decided that the project did not fit its needs, so it abandoned it.

The net result is that Orko obtained, at no cost to itself, $18M worth of exploration, which enabled it to publish a resource estimate, and allowed for a substantial increase in holdings. There was a bit of a shock to the share price when Pan American pulled out, but the stock now seems to be moving in an upward trend. The project is huge. Orko can either sell it to a major, or develop it into a very important and productive mine.

NOTE: Immediately following this interview, on December 16 First Majestic Silver Corp. issued a Press Release that announced that it had just concluded a friendly takeover of Orko, which afforded Orko shareholders a 69% gain over the present market value of Orko shares.

SilverCrest Mines Inc. (SVL:TSX.V; SVLC:NYSE.MKT) has a property in production in Sonora State, Mexico, called Santa Elena. It is throwing off a substantial amount of cash flow to further develop the Santa Elena resource, plus another property, La Joya, in Durango State. SilverCrest is expanding resources and increasing production, and doing it thanks to the cash from Santa Elena without suffering from the stock dilution that has been so harmful to other companies. It has managed to create a substantial cash reserve of about $20M.

TGR: Cash flow may be one of the most important things for investors to keep in mind.

LM: Cash flow improves the likelihood of a firm advancing its project by increasing production or discovering new resources without encountering potentially ruinous share dilution.

TGR: The share price of many specialty—or “rare earth”—metal mining corporations has disappointed investors during the past year. What will it take to reverse that trend?

LM: The world of rare earth elements is incredibly complex and potholed with variables. There are an enormous number of elements and each has its own attributes and its own uses. It takes full-time study to get a grip on how to identify demand, and how that demand can be met, given the network of variables. The rare earth miners definitely need to make a better effort to educate the public about the nature of their business.

And there is the same problem, as with all metals, of having to spend money without being on a clear path toward production. Some of the critical metals juniors went up very sharply a few years ago, after the Chinese announced they were suddenly limiting exports. Although the U.S. military establishment requires a stream of rare earth elements and other markets for rare earths are growing, many juniors have made little progress toward achieving production. The reputation of several of these companies has been hurt. The industry must more clearly identify to investors the positive attributes of rare earth elements and step up the pace toward production.

TGR: Are there any names worth watching in the critical metals space?

LM: Commerce Resources Corp. (CCE:TSX.V; D7H:FSE; CMRZF:OTCQX) is unique in that it has two specific projects with preliminary economic assessments. It has the Blue River tantalum-niobium project in British Columbia and a rare earth element project called Eldor in northern Québec. Each project appears to be capable of standing on its own merits; the company is attracting interest from potential end-users and possible joint venture partners. The price of the shares has come down recently, but I believe it’s reached the point where the potential rewards truly outweigh the risks.

TGR: Are there any holding companies in the metal mining space that investors should investigate?

LM: I enjoy Zimtu Capital Corp. (ZC:TSX.V) in Canada. Its game plan is to fund early-stage companies with developable projects. By funding and forming new companies, it is able to offer its own investors a chance to participate in early-stage share offerings at an advantageous price before the initial public offering (IPO). When Zimtu funds a project it normally receives a substantial block of shares. If the general market environment goes up, then the asset values of Zimtu go up, and that should lead to increases in its share price. It is a good game plan and if the market environment for the whole junior mining sector improves, then Zimtu stands to profit substantially.

TGR: Returning to the start of our conversation, how do your political and ideological preferences affect how you identify opportunities in the markets that you cover?

LM: I am a deep believer in limited government. There should be simple and easy to understand regulations only where they’re absolutely necessary. The current government interferences are a profound negative and worsening. If we can somehow turn the long-standing trend toward excessive regulations around, then profit opportunities within the mining industry should improve dramatically.

I’m normally an optimist, but I have serious concerns about the world’s financial stability going forward. Europe in many places is a basket case. Japan is facing enormous problems, particularly demographic problems. Nobody knows for sure what China is doing. America is facing colossal budgetary problems. There’s a mess out there and it’s hard to see a really clear path to valid solutions to the litany of ongoing serious problems.

It’s not that I’m a pessimist. I love life, I love nature and hiking in the woods and mountains, but when it comes to discussing economic matters, I do try to be a realist and look reality straight in the face. Frankly, there have been pleasanter times.

TGR: Thank you, Leonard.

LM: My pleasure, indeed, Peter.

Leonard Melman, publisher of The Melman Report, has been writing about precious and base metals for more than two decades as monthly columnist for California-based ICMJ’s Prospecting and Mining Journal and Vancouver’s Resource World Magazine. He focuses on how political and financial considerations impact the world of mining and the prices of the metals.

Byron King: How to Up Your Investing IQ with Gold

Byron King Have you ever actually held a bar of gold in your hands? Byron King, editor of the Outstanding Investments and Energy & Scarcity Investor newsletters, suggests that you do. But becoming a smart investor shouldn’t just be about physical gold, King says. He also encourages investors to use investments in gold mining juniors to increase their exposure to precious metals. Read on in this Gold Report interview to find out about the handful of companies he’s expecting to shake up the market in 2013.

The Gold Report: Byron, many gold investors spent the early part of December exiting their long positions in gold. Is 2013 the year the gold bull market ends?

Byron King: I don’t think the gold bull market will end any time soon. I believe that much of the recent gold exit has been a reaction to the impending tax changes on Jan. 1, when tax rates will go up unless there is Congressional action. I don’t think very many investors are selling physical gold or silver. I do think people are selling paper and electronic gold to lock in gains and pay capital gains at the lower 2012 tax rate. It is tax-driven selling, not a reflection that the world’s monetary or economic system is getting well.

TGR: How should investors handle the tax-loss selling season?

BK: People have to make their own decisions. If investors own a physical precious metal, the last thing they ought to do is sell out. Really, never sell actual gold or silver if you can avoid it. With the paper gold, or electronic gold, or gold shares? It depends on the investor’s situation. If you have large gains, perhaps you want to lock in the gains, sell and pay a 15% capital gains rate in 2012, versus selling it after Jan. 1 and paying a higher rate. If that’s your case, then sell now and buy it all back next year. Everyone is different, however.

TGR: How should investors position themselves in gold for 2013 and beyond?

BK: Right now, an investor ought to have cash, which is dry gunpowder, as well as physical precious metals in one’s possession. I don’t mean own a certificate, own a call on gold or gold in somebody else’s storage locker. I mean, own the gold!

TGR: What should that portion be approximately?

BK: That’s a matter of individual taste. My view is 10–15% of your portfolio ought to be in precious metals. Some people say 5%. Some people say 25%. The University of Texas at Austin, which has a very large endowment, owns over 663,000 ounces (oz) of physical gold. Kyle Bass, a wealthy Texas resource investor, convinced the board of directors of the endowment to put 5% of the endowment into physical gold, and more importantly, to take delivery.

TGR: You say that the sector is poised for a rebound. Which part of the sector is most likely to rebound first?

BK: Large producers are refocusing and re-emphasizing capital discipline. In the last 10 years, as gold went from $300/oz to $1,700/oz, many gold mining companies—most, really—added new ounces for the sake of adding ounces. They expanded their resource base and added reserves without any real regard to the profitability of each ounce. The culmination of that came with Barrick Gold Corp. (ABX:TSX; ABX:NYSE) this summer. The company has all that gold, and not all that much profit. So Barrick fired its chief executive officer and brought in a different management team. The board of directors and the new management announced a re-emphasis on the profitability of each new ounce that it adds.

“I don’t think the gold bull market will end any time soon.”

The Barrick situation was a reflection of how the price of gold went up six times in the last 10 years. In general, the share price of large gold miners did not have that same bounce.

TGR: Perhaps the biggest issue with gold mining companies right now is steadily creeping costs. Some analysts believe that mining companies aren’t watching their costs as closely as they could be. Do you believe that some companies have better control of that than others?

BK: Yes. For example, take Gold One International Ltd. (GDO:ASX; GDO:JSE; GLDZY:OTCQX), a wonderfully run company in South Africa. It’s had labor issues and strikes. It had to fire workers, just like a lot of other companies. However, its cost control is phenomenal.

I went down into the Modder East mine near Johannesburg in October. It’s one of the newest mines in South Africa. It’s an absolute model of smart design and high-end safety. In terms of cost control, Gold One management measures everything. Down at the rock face, the miners sweep up the last bit of dust off the bottom of the mining panel. Gold One even prints photocopies on both sides of the paper. It is as cost conscious as any company I’ve seen in a long time.

Overall, mining is a tough, expensive environment. Energy costs are going up, in South Africa and everywhere else. Oil costs have gone up. Labor wants a larger slice of the pie. The cost for concrete, steel, machinery, equipment—you name it, everything is more expensive. Cost growth is a big problem.

TGR: Is there a solution?

BK: The solution is really good managers building really good relations with really good miners. At the operational level, you need to keep everybody productive and working as hard as they can. The externalities—oil, cement, steel—are things that companies can’t control and have to design, build or work around.

“Never sell actual gold or silver if you can avoid it.”

The bad news is that we live in an era of money creation and inflation. The good news is that the price of gold will still keep going up. The price of gold may, on occasion, be manipulated downward by the little gnomes of Zurich, to use an old expression from the 1960s, but long-term gold prices are destined to go up. That brings me back to that point I made earlier: Investors who do not own physical gold are truly shortchanging their own future.

TGR: Can you forecast a trading range for gold in 2013?

BK: Gold could hit $2,500/oz during 2013.

TGR: Wow, you’re a bull.

BK: I’m a bull. But I like to think I’m a realistic, informed bull. For example, have you seen reports on how Iran is trading oil with Turkey? Iran has to work around economic sanctions on its banking system. Iran can’t use SWIFT anymore—the Society for Worldwide Interbank Financial Telecommunication. So Iran is out of the system for currency trades. What can Iran do?

Well, there’s massive gold trade between Iran and Turkey for oil. It’s in the range of $15 billion/year. Just that little vignette illustrates the point that, whether the monetarists of the world like it or not, gold retains its usefulness as a means of lubricating transactions.

TGR: You wrote in a recent edition of Energy & Scarcity Investor, “We’ve also followed gold miners like Carlisle Goldfields Ltd. (CGJ:TSX; CGJCF:OTCQX), Mega Precious Metals Inc. (MGP:TSX.V) and others. The gold miners have been drilling core samples, growing their resource base and adding reserves, which is the idea in the junior space. Eventually, with the gold miners, the reserve and resource numbers will be big enough to attract interest from third parties interested in a takeover. Until then, we watch and wait.” Is that your thesis? Is it all about patience?

BK: You named two of my favorite small companies. Carlisle and Mega are very similar. They are both located in Manitoba, Canada, in the classic, old Precambrian greenstone-type regions. Both companies have been working in areas that have been historically picked over. Carlisle is working in an area that was mined for copper-nickel back in the 1960s. Mega is working in an area that has been explored by a multitude of companies during the past 25 years.

“Investors should look at gold on numerous different levels of personal wealth protection, growing wealth over time and diversifying a portfolio.”

Both companies are growing their resource bases very nicely from the 2 million ounce range. Mega and Carlisle are among the cheapest gold miners on the whole stock market by share value per ounce. They actually have gold. I have been to both places and seen the cores. The assay numbers are very respectable 2–4 grams per ton with some spikes into much higher numbers in certain sweet spots and zones.

So with both companies, you’ve got a solid, safe mining jurisdiction, plus great geology. There’s plenty of legacy exploration. Carlisle and Mega are both growing their numbers. One of the larger miners or independents, even a biggie, will absolutely have to take a hard look at them. That is the thesis.

TGR: Last time we talked, you told us about Reservoir Minerals Inc. (RMC:TSX.V). What is new with that company?

BK: Reservoir Minerals is a Canadian company, operating in Serbia. It was spun out of Reservoir Capital Corp. (REO:TSX.V). Reservoir Minerals has a play beneath surface deposits, a couple of miles down the road from what was formerly the largest copper deposit in Europe, Bor, in eastern Serbia. Bor is in the Carpathian Alpine mineral district, where people have been mining since the days of the Roman Empire.

Reservoir teamed up with mining giant Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE) and started drilling holes. The first couple of holes were not so great. Then, about a year ago, it pulled out a core that was in the range of 15% copper. Companies are mining copper at fractions of a percent grade, so 15% copper, including a rather scarce mineral called covellite, is really something.

TGR: What’s the size of the resource?

BK: Reservoir Minerals should have a number within a year or so. Until the news of that first big core, Reservoir Minerals was trading the rest of the pack in the junior range, sort of floating along. After the high-grade news, shares went from $0.50/share to about $1.50. Then the follow-up news came out and it went to above $3/share, although it’s trading down with year-end tax-loss selling. A year ago, investors were looking at Reservoir and thinking it was just another copper-mining wannabe. Now it’s up by a factor of six and it’s partnered up with mining giant.

TGR: Is there a gold sweetener in that?

BK: There are quantities of gold at that project. Reservoir Minerals also has other localities in Serbia, and it has expanded its footprint on the Gold Coast of West Africa. Reservoir Minerals is a fabulous copper play, and it’s quite clear that the overall mineralization holds gold and silver.

TGR: We’ve seen some friendly mergers and takeovers in the gold space recently with Osisko Mining Corp. (OSK:TSX) and Queenston Mining Inc. (QMI:TSX); PMI Gold Corp. (PMV:TSX.V; PVM:ASX; PN3N:FSE) and Keegan Resources Inc. (KGN:TSX; KGN:NYSE.A); Andina Minerals Inc. (ADM:TSX.V) and Hochschild Mining Plc (LSE:HOC); and Argonaut Gold Inc. (AR:TSX) and Prodigy Gold Inc. (PDG:TSX.V). Is this a trend?

BK: After the year-long share-price meltdown in the Canadian junior space, a lot of companies have their backs against the wall. A good many gold miners, and other resource companies as well, face depleted cash resources. Plus, it’s virtually impossible to raise new money without massive dilution. So stronger companies can pick up great assets for a song.

TGR: In a lot of these cases, they were neighboring companies.

BK: Consolidating plays, consolidating ideas, regional trends or adjacent mineral claims is part of it. When adjacent companies come together, they can reduce their overhead.

TGR: Is that an investable theme in the gold space? Should investors look for companies that are operating in the vicinity of each other, one with significant cash on hand and access to capital and one that perhaps has a promising deposit but is a little low on cash?

BK: Yes. It goes back to the game of Monopoly, where you want to own all the same properties with the same colors so when somebody lands on it, they have to pay you even more rent for the house or the hotel that you built there.

TGR: What are some other junior gold plays you’re following, Byron?

BK: I’ve kept an eye on NOVAGOLD (NG:TSX; NG:NYSE.MKT) in Alaska. NOVAGOLD spun out the Ambler project into NovaCopper Inc. (NCQ:TSX.V; NCQ:NYSE.MKT). It’s been a longer, harder slog than a lot of people thought to get these two projects going in Alaska. It can be very frustrating, but they are great assets, run by very solid management. NovaGold and NovaCopper are two nice plays.

I’ve kept an eye on Argentex Mining Corporation (ATX:TSX.V; AGXMF:OTCBB) in Argentina. The company has had mixed visibility. It pops up, then goes out of sight, and then pops up again. However, I’ve always liked one main key play, with Argentex: It controls a deposit that’s rich in indium. Indium is an absolutely critical electronic metal. It is almost always associated with zinc deposits. The Argentex deposit at Pinguino is rich in sphalerite with a high concentration of indium. It may be among the highest concentrations in the world. From an electronic metals and technology metals standpoint, Argentex is a company to keep watching.

TGR: The indium is basically a sweetener in that play. It’s mostly a silver-gold project.

BK: That’s the latest viewpoint. As Argentex worked up the base metals, and the associated indium play, it drilled into serious silver and gold assays. How lucky can you get? So yes, I know what you mean about the gold and silver side of Argentex, but then again the world is filled with interesting gold and silver plays. Indium? It’s quite uncommon. Indium distinguishes Argentex. Indium makes the Pinguino play that much more developable.

TGR: Argentex has multiple projects. It’s not all about Pinguino. It’s currently trading at about $0.21/share.

BK: Well, yes, there are several plays with Argentex. But in my view, a small, developing, pre-operational, pre-revenue company, which is burning cash, has to decide how much it wants to confuse investors. What are you? Gold? Silver? Zinc? Indium? Pick something, and be good at it. The “flavor of the month” club is a vanishing business concept in this market. Get with a program, and stick with it. Then, as we’ve seen with other players, a company can double or triple its stock price inside of a couple of days with the right drill hole.

TGR: What’s your advice to precious metals investors as we are heading into 2013?

BK: Investors need to own precious metals on several different levels. Physical metal is wealth protection and wealth preservation over time. Yes, metal prices go up, prices go down. Investors need to understand the concept that gold is money. Metal will hold on to its purchasing power and its value over time. There are historical reasons to own gold as a form of money stretching back over the last 5,000 years at least. Investors have to look at it at that level.

Gold is also part of prudent diversification. When you invest in most financial instruments, you’re investing in somebody else’s liabilities. If you put your cash in the bank, that’s not your cash anymore. It’s ones and zeros down at the bank. You won’t get the same $20 bill back that you put in. So even a bank deposit is a liability, so to speak.

Stocks and bonds are liabilities. Electronic and paper gold are liabilities. However, if you own physical gold, then you control that asset. Obviously, you have to protect the asset. You don’t want to just leave the stuff lying around. But it’s your asset, and it retains value over time.

Investors should look at gold on numerous different levels of personal wealth protection, growing wealth over time and diversifying a portfolio. In a sense, just simply the act of owning gold, improves your IQ as an investor because once you have gold in your hands, you will never touch paper money quite the same way. If you haven’t ever held a gold bar, or gold coins, in your hand? Well, maybe you don’t know what I mean. I suggest you do it. There’s no fever like gold fever.

TGR: Thanks for your insights.

Click here for a free copy of Bryon King’s award-winning Outstanding Investments.

Read Byron King’s ideas for investing in the Critical Metals sector here.

Byron King writes for Agora Financial’s Daily Resource Hunter. He edits two newsletters: Energy & Scarcity Investor and Outstanding Investments. He studied geology and graduated with honors from Harvard University, and holds advanced degrees from the University of Pittsburgh School of Law and the U.S. Naval War College. He has advised the U.S. Department of Defense on national energy policy.

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How to Find Success with Latin American Miners: Heiko Ihle

Heiko Ihle Miners in Latin America are facing both growth and challenges. Heiko Ihle, senior research analyst with Euro Pacific Capital, examines the factors behind these trends. In this Gold Report interview, Ihle urges investors to evaluate mining companies based on three important features rather than on the performance of others in the region.

The Gold Report: Heiko, you cover many companies in Latin America. One silver miner in Mexico is challenging an eviction notice from its property in Chihuahua, Mexico, which is causing a stir in the mining industry. Does that give you cause to reevaluate Mexico as a mining jurisdiction or is this an isolated incident?

Heiko Ihle: Mexico is a more challenging mining jurisdiction than the United States or Canada, but it’s also a much easier place than Bolivia, for example. There are some common challenges with mining there. One of the companies I cover, Fortuna Silver Mines Inc. (FSM:NYSE; FVI:TSX; FVI:BVL; F4S:FSE), has some issues with the community in Oaxaca. This sort of thing happens all the time, and it’s mostly business as usual.

TGR: What sort of gold and silver prices are you using in your models to evaluate these companies?

HI: I’m a stock analyst, as opposed to a macroanalyst, so I use conservative numbers: $1,600/ounce (oz) long-term gold prices and $34/oz long-term silver prices. In the long term, those numbers are likely to be a little too low, but they produce a margin of safety to our net asset value (NAV) and cash-flow models.

“I look at the microeconomic company-specific factors and make my decisions accordingly.”

TGR: The silver companies you cover in Latin America are for the most part outperforming your gold companies. Does this make you more bullish on silver than gold, or are you evaluating specific cases and what those specific equities offer?

HI: I look at specific cases because the best gold company can’t prosper if it can’t get gold out of the ground at a decent cash cost. Similarly, the best silver company won’t flourish if a community demonstration shuts down its plant. Again, I am an individual equity analyst; I look at the microeconomic company-specific factors and make my decisions accordingly.

TGR: What are three must-haves for the companies you cover?

HI: The number one thing is good management. Bad management can run the best company into the ground. I’ve seen it in stocks that I covered and in stocks that I owned.

TGR: How do you quantify good management?

HI: If I speak with a management team and I get the sense that it doesn’t understand what’s going on, then that would put it into the bad management category. If it continuously disappoints, if it continuously over-promises and under-delivers, that would put it into the bad management category. I worry, too, if there is no coherent team—even if the CEO, CFO and chief geologist are great people, there is a chance that they do not work well together. It sounds simplistic, but I always pay close attention.

TGR: What are the other must-haves?

HI: A company must have a good asset. Even if it has great management, if a company doesn’t have a good asset, nothing’s going to be pulled out of the ground. It needs to have a decent land package with room for expansion. The grades need to be right. The type of ore needs to be right. It needs to be permitted or have decent progress toward permitting. The third must-have is a functional mill with potential for expansion. The chain is only as strong as its weakest link, and if one of these factors is broken, the whole system is going to crumble.

“Bad management can run the best company into the ground.”

I do a lot of site visits to evaluate the mills. I look for spare capacity, and I go through all the geological reports for permitting.

TGR: Does that mean you’re looking only at producers?

HI: Not necessarily. I cover Romarco Minerals Inc. (R:TSX). It is still in the permitting phase, but it has made good progress toward a permit; it is so confident that it will get the permit that it already bought the ball mills.

TGR: What is Romarco’s production timeline?

HI: The Army Corps of Engineers should let it know early next year. My gut feeling is that it will be in production in 2015.

TGR: Let’s move into your coverage of precious metals companies in the Americas. Aurizon Mines Ltd.’s (ARZ:TSX; AZK:NYSE.MKT) earnings per share were less than half of what they were in the same period a year prior, Q3/11. The company’s cash costs rose to $759/oz in Q3/12 versus $497/oz in Q3/11. Nonetheless, you have a buy rating on Aurizon.

HI: Yes. Aurizon is going through a transitional year. It is going through a shaft deepening at the Casa Berardi mine. Meanwhile, several other companies that can afford higher wages are poaching its workers. The shaft deepening frequently shuts down production at the site, and the same thing will happen in 2013, which is why my 2013 production numbers are lower. Cash costs are higher and may be even higher next year, when production will dip to 130,000 oz. However, this is temporary and ultimately will serve as an investment in the company’s longer-term growth.

TGR: In a recent research report on Aurizon, you said you believed that, with about $200 million (M) in cash, “the firm will engage in favorable M&A activity.” What sort of projects or targets is it likely to pursue?

HI: Several projects in the area are in the $40–100M market-cap range. Two in the same mining camp are fairly widely known.

TGR: What is your 12–18 month target on Aurizon?

HI: It is $5.20/share.

TGR: Endeavour Silver Corp. (EDR:TSX; EXK:NYSE; EJD:FSE) had a strong Q3/12, with production increasing by about a third. You have a buy rating and a 12-month target price of $11.70 on the company. After such an impressive quarter, will there be room for more growth?

HI: A good part of Endeavour’s Q3/12 growth came from its recently purchased El Cubo mine in Mexico. That is where growth in 2013 and beyond should come from; the mine should produce 1.1 million ounces of silver next year, compared with about 400,000 oz this year. Endeavour also has some growth at Guanacevi and Bolañitos. This growth should lead to more cash flow and potentially more acquisitions for the company.

TGR: Endeavour bough El Cubo from AuRico Gold Inc. (AUQ:TSX; AUQ:NYSE) in July. What were your thoughts when that transaction occurred?

“If investors diversify by going across base metals, gold and silver, they will be doing themselves a favor.”

HI: I liked the acquisition, and I liked it even more after I visited earlier this year, when Endeavour took a number of analysts down for a site visit—it really showed how much of a turnaround it has made. After it took over, Endeavour essentially doubled grades within six weeks because it started following the veins instead of randomly mining into the mountain and processing waste rock. I would expect Endeavour to have a good part of the transmission done next year, and my grades are improving for El Cubo as well.

TGR: Considering its growth, do you think Endeavour will introduce a dividend?

HI: No. It is more focused on growing the enterprise through more acquisitions. Endeavour has a very good track record for acquisitions.

TGR: Yes, Endeavour has made a number of badly performing assets perform.

HI: The day Endeavour closed on El Cubo, the NAV was already substantially above what it paid.

TGR: You also cover Fortuna Silver Mines, which had a great Q3/12 and is poised to exceed its production guidance for 2012. Do you expect similar performance in 2013?

HI: The company has good production numbers at its San Jose mine in Mexico, though there are community protests there. Offsetting that, however, is the Caylloma mine, which is in Peru. I visited it about a year ago. Labor costs are going through the roof at that site, so while production is very good, its cash costs have been rising more than everybody anticipated. The company should have a good 2013, but there will be some cash costs challenges, and it is already working on those.

TGR: In a recent research report, you said Fortuna continues to search for midsized acquisitions in Central and South America. Given the difficulties it has faced at Caylloma and the mine’s higher than anticipated labor costs, which juniors in Peru or nearby might be a good fit for Fortuna?

HI: Fortuna is looking into private enterprise like smaller private mines that it can buy or privately owned land packages that it can attach to its mines. It probably will not buy a public junior company.

TGR: What is it looking for? Is it looking to bring more feet into Caylloma?

HI: Fortuna is looking for a separate project, which is what it should be doing because it diversifies risk. A good example is Aurizon, which has a single asset. Right now, that single asset is going through a tough time and that punishes the entire company. If a company has four assets and one goes through a tough time, it has much less impact.

TGR: What is the next catalyst for Fortuna that will get it to your $6.60/share, 12–18 month target price?

HI: It needs to get cash costs under control, which it should be able to do once labor pressures subside; labor is the biggest factor.

TGR: Is your $6.60/share target price a buy rating?

HI: Yes. That is an upside from here.

TGR: Great Panther Silver Ltd. (GPR:TSX; GPL:NYSE.MKT), on the other hand, had a poor Q3/12. Earnings per share were halved, and total revenues declined 6% year over year. You have a 12 month target of $2.20/share on the company, but it is trading around $1.60/share. What will push it higher?

HI: Great Panther is also experiencing challenges. The droughts in Mexico this year forced it to stockpile ore because the mill wasn’t able to take on the capacity. Meanwhile, some thought Endeavour would take over Great Panther because it was a logical target. However, since it took over El Cubo, there is less of a chance of Endeavour buying Great Panther. Revenues should grow nicely next year. I was disappointed by 2012 results year-to-date, and my price target has gone down as well, but the NAV discount remains. In the longer term, it should hopefully be able to get those assets’ value.

TGR: What is it trading at versus your NAV?

HI: My NAV is at $1.80/share. The 20% premium gets rounded, that is $2.20/share. That consists of $1.44/share for Guanajuato and $0.22/share for Topia, which includes the drought issues. That is $249M for the overall company, including cash and exploratory assets and such.

TGR: Rio Alto Mining Ltd. (RIO:TSX.V; RIO:BVL) operates the La Arena gold-copper mine in Peru, and its share price has trended higher throughout most of 2012. Can investors expect further growth?

HI: Yes. The second part of the company’s project goes on-line in a couple of years, and a lot of copper is being taken from the site. The stock should fare well. Rio Alto is also doing something many others wish they could do, which is growing through internal cash flow, so it doesn’t have to dilute shareholders. It doesn’t have to issue a lot of debt or equity; it is using the free cash flow from its first site and using that to grow.

TGR: Could you give us an overview of Rio Alto? The company has done well this year, but it isn’t widely known.

HI: It owns La Arena, which is about 1,000 hectares, in Peru. It is a gold mine currently and a future gold and copper project. It has an approximately 26,000 hectare land package around there, and it currently produces from the La Arena oxide project, the gold project I just mentioned. That is open-pit mining, and in about 2016, the sulfide project will come on-line. That is where most of its cash is going right now, and at that point it will also produce copper at the site.

TGR: When you met with management from Rio Alto, what stood out?

HI: It has performed so far, and many companies in this space can’t say that. CEO Alex Black is a good guy and the team he leads with CFO Tony Hawkshaw has delivered on everything it said it would, including time tables, grades and proper sales of the metal. It also got lucky this year; the grades from the site were at least temporarily higher than the company and all the analysts had thought they would be.

TGR: You recently downgraded Sandstorm Gold Ltd. (SSL:TSX.V) to neutral. What was your rationale?

HI: That decision was due to valuation. The gold streaming business is still a good business. And I still like the company’s management, which has achieved a lot in a short period. Right now, in a period of high gold prices and a fixed cash cost, many are selling gold for twice what it costs to take it out of the ground. It is a terrific business. Nonetheless, at some point, even the best business becomes fully valued, and I believe Rio Alto reached that point at $13.50/share. That is where it was when I downgraded it. Now the stock is a lot lower; it is trading around $11.50/share.

TGR: The company has royalties on quite a suite of mines. This is a highly profitable business, given the margins and the tax considerations in Canada, but as more people catch on, will more companies enter this space, growing the competition for those royalties and shrinking the margins?

HI: A lot of streaming agreements are like pawn shops: companies go there because they can’t go anywhere else. That is what has held the industry’s margins up. If everybody else were to come out and do the same thing, it could drive the companies’ costs of funding a little lower—but that won’t happen. Also, a streaming company can err and invest in mines that never reach production only so many times until it is broke.

Of course, there are more streaming companies now than there have ever been, and there are more juniors than before, too. All it takes is a project, a dream, an engineer and a geologist.

TGR: The share price for Sandstorm Gold shot up and people made money, and now you say it has come back to earth. Is growth coming from the price of these commodities—or how will a streaming company like Sandstorm grow from here?

HI: The growth will come twofold. The mines it has streaming agreements on are going to enter production or grow production; that is one way to grow. A second way to grow is to issue more capital, which Sandstorm has done this year, and then use that to buy more streams in their infancy.

TGR: Are you bullish on Colossus Minerals Inc.’s (CSI:TSX; COLUF:OTCQX) Serra Pelada mine, in which Sandstorm has a royalty, and when that comes on, will it be a significant contributor to Sandstorm’s revenue?

HI: I don’t follow Colossus, but I do feel good about that mine. I put out a report on it as well.

TGR: What segment of the precious metals market is going to provide retail investors with the best bang for their buck in 2013?

HI: I suggest people figure out what area they want to invest in, then narrow it down to a couple of companies. Go back to those three must-haves that I mentioned. Look into management, look into the assets and look into the permitting and the operational phase of the firm.

I would also say people should diversify. And if they just go across base metals, gold and silver, they will be doing themselves a favor.

TGR: So your advice is to evaluate individual companies and divide the portfolio up by commodity.

HI: Yes, and commodities shouldn’t be your full portfolio.

TGR: Thank you so much, Heiko.

Heiko Ihle joined Euro Pacific Capital in November 2011 as a senior research analyst covering companies in the mining and engineering and construction (E&C) industries. Prior to joining Euro Pacific, Ihle spent over six years with Gabelli & Company, more than five of which as a research analyst. While at Gabelli, he was awarded second place in the 2010 Financial Times/StarMine Top Analyst Awards for the Engineering & Construction space. A native of Germany, Ihle received his bachelor’s degree in finance and management from the University of Illinois at Chicago in 2004, and his Master of Business Administration from the University of Miami in 2006. He has been a CFA Charterholder since 2010 and is currently a member of the CFA Institute and the Stamford CFA Society.

Porter Stansberry: Gold and Real Estate Are My Hedges for the Fiscal Cliff

goldWith nary a glimmer of hope that economic sense will supplant political expedience, Stansberry & Associates Investment Research Founder Porter Stansberry expects rampant inflation to roar in once the cost of capital rises. How is he preparing himself? Stansberry tells The Gold Report he continues to buy and hold gold and also discusses how real estate can cushion against the fiscal cliff.

The Gold Report: Not a day goes by that we don’t hear or read something about the fiscal cliff. To what extent are you worried about the fiscal cliff? Or do you foresee a resolution?

Porter Stansberry: You can be sure of a couple of things from Washington. One is spending will not slow down. The increase to spending in 2013, 2014, 2015 will be the same kind of increases we have seen in previous years. We will continue to spend 24% of GDP at the federal level.

TGR: And what else can we be sure about?

PS: Some actions will be taken to increase the tax rates on some taxpayers, but they will produce no material change in revenue. The government will continue to take in far less than 20% of GDP in taxes, probably only 16% or 17% of GDP. Further, those changes also will narrow the tax base, which is to say that fewer people will be asked to pay more in taxes.

“People should fear not going over the cliff.”

Those two things—more spending and higher tax rates for some taxpayers—will happen because they’re the only politically expedient things that can happen. That’s been driving politics and the budget since 30, 40 years ago, and will continue to do so because voters demand more from the government and voters demand that they not pay. That will continue until the system completely collapses.

TGR: The fiscal cliff was set up a couple of years ago in theory to force Congress to do something. There’s a lot of fear about it, but at what point will there be enough fear that voters say we can’t proceed in this fashion anymore?

PS: People should fear not going over the cliff. If we go over the cliff, the tax base will greatly expand. The payroll tax cuts will be done away with and the broad middle class—the people who have benefited from the tax cuts—actually will have to pay taxes again in America. There’s no other way to generate the amount of revenue that is required. You cannot finance the federal government on the backs of the top 5% of wage earners because even if you charge them 100%, it wouldn’t come close to being enough money.

Right now the U.S. takes in something on the order of $1.5 trillion (T) a year in income taxes, but we have an annual deficit of $1.6T. Even doubling the amount of income tax collected would leave a deficit. Taxing the rich cannot solve this problem. It can be solved only by freezing spending and broadening the tax base. That will never happen because it’s unacceptable politically.

TGR: Eventually something will happen.

PS: Yes, it will. Our trading partners and the people who finance our debt finally will say, “We’re not doing this anymore.” But look at the Treasury bond market. It’s not happening yet.

TGR: It’s amazing that the U.S. hasn’t been downgraded just on the basis of all the political bickering.

PS: That’s partly because the Federal Reserve keeps buying up all the excess Treasuries. People have no idea how dangerous this is, but they will find out when inflation goes crazy. Another big reason is that there’s not a really viable alternative. What would the Russian Central Bank or the Chinese Central Bank do with their trade surplus? Buy British paper money? Or European paper money? Where’s the hard dollar alternative? There isn’t one. No government-backed money is any more secure than the dollar. Even the Swiss have turned on the printing presses to equalize exchange rates with the Europeans. There’s nowhere to go. That’s why these central banks are buying all the gold they can get. And that’s why gold prices are going to absolutely go higher.

TGR: China particularly has been buying a lot more natural resources such as copper or iron ore.

PS: I have been following the strategic buying of the Chinese and you’re right, it has been buying up lots of resources, especially in Canada. That will continue for sure, but it is also buying lots and lots of gold. I think Russia and China have been neck and neck in gold purchases since the 2008 crisis, spending almost half of their current account surpluses on gold every year.

“I do believe we’re still in a global finance crisis.”

Some folks have been critical of my prediction that the U.S. will lose its world reserve currency status, but I think it has already happened. When two of the world’s largest economies would rather buy gold than Treasury bonds, you’ve got a big problem.

TGR: When do you suppose the gold price will start climbing again?

PS: I don’t have any timetable. I can just tell you that I haven’t sold any of my gold and I won’t until there is a gold-backed, well-financed national currency that offers me a reasonable yield for the risk I take to finance the government. There’s nothing like that in the world and I don’t see any prospects like that.

TGR: The last time we chatted, you discussed the pros and cons of returning to the gold standard. One of your observations was that the U.S. dollar has lost something like 20% of its value since 2008 and you projected it losing another 20% in 12 months. Do you still see the dollar value decreasing at that rate?

PS: I actually think it is but it’s not reflected yet in consumer prices. Manipulating the bond market is so greatly reducing the cost of capital that so far companies have been able to maintain profit margins without raising prices. As a result, we’ve been exchanging capital cost for commodity costs but you can only do that for so long.

Imagine what your purchasing power would be if you’re going to go buy a new home today. If you have $10,000 for a down payment, you could buy a $100,000 home with an FHA mortgage, and you’d only pay something like 3% for the mortgage. But could you afford that if mortgage rates were actually market set? If you had to pay 7.5%? No. Your purchasing power, your standard of living, would be completely destroyed without reasonably priced financing, and that’s absolutely what will happen.

“I’ll continue to buy gold on a regular basis and I’ve never sold a single ounce.”

Look at other markets. General Electric Co. (GE:NYSE), for example, has $600 billion (B) in debt on its balance sheet and its combined annual cost of finance is less than 2%. That makes no sense. Imagine what GE would charge for turbines, light bulbs and appliances if it had to pay a market rate of 9% on that debt. The price of capital is so low that it is retarding the impact of ongoing inflation, but sooner or later all this debt will have to be financed at real prices. When that happens, the impact to the economy will be both a weaker dollar and higher prices for everything.

TGR: But you are making it sound as if the actual financing costs now are artificially low. When interest rates increase, wouldn’t it be more like 4% than 9%?

PS: Look historically what high-yield debt has traded for—9% isn’t even aggressive. Over the last 20 years, I think average yield on a high-yield bond has been 14%. People don’t think of GE as a high-yield credit but they ought to.

TGR: So many of these large companies have a tremendous amount of cash on the balance sheets. They could double their interest payments.

PS: All I am saying is that 9% is a reasonable cost for a GE bond, given its cash flows and given that it owes $600B and still owns all kinds of dicey real estate mortgages. GE is a huge American business. It employs 160,000 people. It is an example of how the Fed’s manipulation of interest rates affects the real cost of things. GE can afford to charge low prices for its goods because it pays so little for its capital. And across our economy, companies have been exchanging capital costs for commodity costs. GE’s commodity costs have gone up, but it has not passed it along to the consumer because it has been able to save so much on financing.

But as I said, that game can’t go on forever, and the minute the game ends it’s going to end badly. The shock to the consumer will be amazing. It’s not just inflation devaluing the purchasing power of wages, which is going on continuously. It’s going to be that suddenly consumers will have this huge price impact. It could reduce the purchasing power of the average consumer by 20% or 30%.

TGR: The way you’re explaining it, it sounds as if it could happen almost overnight.

PS: It will be extremely quick. Nothing particular changed in Greece, Italy or Spain between 2006 and 2009. No significant catalyst caused people to all of a sudden wake up and realize these sovereigns were bankrupt. They’ve been bankrupt for decades. All that changed was the realization that others were unlikely to continue to finance them. There’s no real credit analysis being done with GE. One investor buys the bonds because he’s convinced the next investor will do so, but that’s all based on faith. There’s no real critical thinking going on. All of a sudden, if some investor loses faith, it can happen very quickly.

TGR: Isn’t playing the markets all about faith and what you think the general population is going to do? Markets aren’t always based on fundamental economics. They’re based on fear and greed.

PS: Of course they are, but with the Fed skewing the bond market the way it has, people have become convinced that the yields will always go lower because the Fed will not let them increase. So far that’s been a great trade, but you cannot print your way to prosperity. Sooner or later these policies will destroy the credit of the United States and send interest rates soaring in our domestic economy. That will absolutely happen, no doubt about it.

TGR: Aren’t the Europeans—even the Chinese—in the same game of artificially low interest rates?

PS: China’s not in the same game, nor is Europe to the extent that the U.S. is. Germany has been very reluctant to monetize the European debt. It has certainly increased that greatly this year so maybe there will be runaway printing, but paper money has always been this way. Show me the paper currency that lasted for more than 100 years and was worth anything at the end. Paper money gives human beings the illusion that they can get something for nothing. They believe in it until it falls apart.

TGR: Until we get to a gold standard, we as investors need to be doing something to retain our wealth. You can put a certain amount in gold, which some people are doing, but we also have other types of investments, which for people in the U.S. is based in U.S. dollars. Until it unravels, isn’t the U.S. dollar the best bet?

PS: Yes. I think that’s fair. But it doesn’t mean anything to me because it’s similar to going on death row and asking who is the best guy.

TGR: But we’re looking at an unfortunate situation where individuals need to put their money at risk in equities or the bond market at this point.

PS: I disagree. I don’t believe people have to put their money into bond markets or stock markets. For the last 24 months I’ve been buying real estate almost exclusively. I might have bought a couple of small gold stocks along the way but miniscule positions compared to my net worth. I’ve been buying real estate because it’s an asset I can control, that I could finance extremely cheaply if I chose to. I do not choose to; I buy my real estate in cash. I’m not interested in making money on it. I just want to keep my money safe. I’m happy to make returns of 4% to 6% a year on my real estate portfolio. If inflation comes along I’ll be able to increase rent and have capital appreciation roughly in line with inflation. For me that’s all there is.

Porter Stansberry is intense when it comes to investing and recreation. His Atlas 400 Club brings together intelligent, successful people from all over the world for adventures that last a lifetime. See a video from his travels, including a recent trip that included racing Porsches in Germany.

I do believe we’re still in a global finance crisis. Things are not right with the world. In a situation like this, I think your goal as an investor should be to keep what you’ve got. It’s going to be very difficult to survive this with your wealth intact because so many forces are aligned against you. I just button up and I’m super-conservative.

By buying off the bottom in the real estate markets, I’m doing the best I can to protect myself from any future calamity. Time will tell whether it will work. And if there’s just ongoing inflation instead of a calamity, I’m going to make a lot of money with my real estate.

TGR: Absolutely. Any other insights you’d like to give to our readers of The Gold Report?

PS: I’ll continue to buy gold on a regular basis and I’ve never sold a single ounce. So if you’re buying gold I think you’re going to do very well. And I will continue to be cautious. I don’t believe it is a time to be aggressive, especially in the bond markets around the world.

TGR: Thank you very much, Porter. Have a happy—and I hope prosperous—New Year.

Porter Stansberry founded Stansberry & Associates Investment Research, a private publishing company based in Baltimore, Maryland, in 1999. His monthly newsletter, Stansberry’s Investment Advisory, deals with safe value investments poised to give subscribers years of exceptional returns.

Stansberry oversees a staff of investment analysts whose expertise ranges from value investing to insider trading to short selling. Together, Stansberry and his research team do exhaustive amounts of real-world, independent research. They’ve visited more than 200 companies in order to find the best low-risk investments in the world.

Peter Grandich: What a Turnaround in Junior Gold Mining Stocks Will Look Like

Peter Grandich The fundamentals at many junior mining companies have improved, yet their stock prices continue to languish. In this interview with The Gold Report, market guru Peter Grandich gives his thoughts on when this may end and where gold is headed in 2013, and names some of his picks in unlikely jurisdictions.

The Gold Report: Peter, when we talked in the spring, you were essentially all in on a number of junior resource equities that were trading at what you believed were at or near their lows. Have you changed your course of action or are you still all in?

Peter Grandich: I am still on course. While 2012 may not have been the worst junior resource market by percentage losses, given the prices of metals now versus other markets and other market conditions compared to last year, it was the worst bear market since I entered Wall Street in 1984.

I’ve been in this market since the late 1980s, when it felt that if gold could just get over $400/ounce (oz), all would be well in the junior market. Now gold is at an average price of $1,600-something for the year, yet most companies did not do well. It is befuddling.

TGR: We are not far from exiting 2012. What is your perspective on the junior precious metals sector heading into 2013?

PG: I have believed since midsummer, as much as I would like the market to have a V- or U-shaped recovery, the recovery will look more like an L, at least into the early part of 2013. There are still some excesses in the junior market that have to be worked through.

“I still favor gold over silver.”

I suspect we will see by early 2013 announcements of restructuring, rollbacks, etc., and repricing of options. Then we will have all the classic signs that the worst bear market in some time is behind us. It will take a number of months before the junior market can not only go up, but also stay up.

TGR: Are you more bullish on the higher-beta, high-volatility silver or gold?

PG: I still favor gold over silver. Silver is really a base metal, but because it’s part of the precious metals family, it gets the tagalong and does not get separated.

Retail investors tend to like silver over gold because they tend to like quantity over quality. But at the end of the day, gold is money and will eventually be money again. One of the reasons gold has done what it has in recent years is because some investors want real money and not paper currencies.

TGR: You’re a quality over quantity guy?

PG: Yes, in terms of the metals themselves. When it came to shares this past year, quality was also better. The further you went up the food chain toward emerging producers, producers and significant producers, the damage was less expensive than it was when you went down the food chain to pure explorers or early-stage explorers where that market was creamed.

TGR: That’s owing to the risk-off sentiment on a large scale.

PG: I am not the first to say that juniors are burning matches, producers aren’t. Producers have the luxury of not only borrowing a substantial amount of money, but also doing secondary offerings and getting cash flow out of assets. Juniors continually have to raise money.

TGR: Nonetheless, you are still heavily invested in the junior space.

PG: It is where my expertise lies. Many juniors have just gone too far on the downside. Many of their total market capitalizations don’t come close to their perceived value now. If they are not already off their bottom, they are starting to build substantial bases. That may not thrill people, but share prices have been trading within a fairly tight range now for several months. That is base building. It may not be ready to take off, but it’s far too late to be a seller now.

TGR: How would you characterize your approach? You seem to have great faith in these stocks.

PG: Since I got involved in the junior resource market, there have been probably 10 or 11 bear markets where there has been a decline of 20% or more. At least half of them were 40%, 50% or more. Each time the market rebounds. Each time many investors think that maybe this time it will be different and it won’t rebound. But eventually markets go from one extreme to the other.

“Producers have the luxury of not only borrowing a substantial amount of money, but also doing secondary offerings and getting cash flow out of assets.”

This past year was as extreme as you can get on the negative side. Even the most optimistic bulls were beaten up and have retreated to the safety of hedging their views, if not outright turning bearish. That is just a contrarian investor’s dream come true.

My faith is based on everything in life is like “ferry” investing. People will say the boat is going to sail without you. My response is that there is no such thing as a boat. There are just ferries. When one goes out, eventually another one comes in. It is just a matter of being diligent to stay long enough and be diversified enough. That way even if some stocks don’t rebound, the rest of them should more than make up for it.

It won’t be straight back up, but as bad as this bear market has been, we’ll eventually have a bull market again. It will probably be in the middle part of next year when we really see it take hold.

TGR: That is certainly good news. Are you willing to predict a breakout for either silver or gold?

PG: For gold, it is only a question of when, not if, it gets to a magical number. That will dramatically ramp up interest in metals as well as in the juniors and producers. The magical number is the $2,000/oz gold price.

A $2,000/oz gold price will be the same as when the Dow Jones Industrial Average first crossed 10,000 and what that led to—the average person getting deeply involved in the market at that point. It allowed a speculative fever to take hold.

“As bad as this bear market for juniors has been, we’ll eventually have a bull market again.”

We will see something like that when gold crosses $2,000/oz. That will bring enough players back into the market that we can finally have a speculative run. That is something we have not seen in several years in the junior market.

It is still amazing that something can go up the percentage that gold has over the last decade and still 99% of North American investors have little or no exposure to it. Every time I hear the gold permabears talk about the end of the bull market, I ask how it could be an end when 99% of people are still not in it.

TGR: Do you think there could be a breakout among juniors in H2/13?

PG: Juniors can rebound and stay up but, again, it will not be a V-shaped or a U-shaped recovery. There will continue to be base building into the early part of 2013. The substantial up-move and ability to hold the gains will coincide with gold getting above $2,000/oz.

TGR: Did you read Paul Van Eeden’s comments where he said that gold is overvalued right now and that he doesn’t see the dire inflation that so many goldbugs are predicting?

PG: I have respect for Paul Van Eeden that I don’t have for other gold permabears. He’s just expressing his honest opinion. Unfortunately, he has had that opinion for as long as I can recall, from maybe $500–600/oz gold. So he has not been on the right side of the market, to my knowledge, for over $1,000 of the gold price increase.

TGR: Beyond gold and silver, in what subsectors of the junior mining space do you see some value or some opportunity?

PG: One of the things that always happens in bear markets is the classic saying, “The baby gets thrown out with the bath water.” The iron ore market is one segment that clearly got overdone to the upside, but now is way overdone to the downside.

While we won’t see a rally back to its all-time highs of $180/metric ton (Mt), those who have stated that it won’t be able to ever keep itself above $100/Mt again are likely to be sadly mistaken. I already see the early signs of a rebound. Iron ore should stabilize, and many of the shares that have been very hard hit, especially the emerging market group ones, can rebound.

TGR: What are some iron ore juniors you’re following?

PG: My second largest personal holding is in an iron ore play, Alderon Iron Ore Corp. (ADV:TSX; AXX:NYSE.MKT). As a soon-to-be producer, it’s a bellwether stock of North America.

Management has delivered on everything promised, but was caught in this downdraft. There was a tremendous, overdone reaction to a very slight delay in a crucial report. Management is not delaying it because of a problem, but to actually maximize shareholder value. Alderon Iron Ore is a leading candidate in the sector if you believe that iron ore-related issues have seen their worst days and will rebound.

TGR: Kami is Alderon’s project. It has over 1 billion tons iron ore. There are a number of small iron ore plays out there with significant iron deposits. Why did you choose Alderon over some others?

PG: I have met dozens and dozens of top executives in the junior resource or even the major producer segment of mining in almost 30 years in this business. I can literally count on my hands the number of them that I would entrust my family’s fortune to.

One of those is the executive chairman of Alderon, Mark Morabito. Management is so critical in the junior area as it greatly influences the potential success or failure of a company. When you look at the entire management team at Alderon, it is nothing but a who’s who of success in the industry. It’s a group of people who not only come from the iron ore business but also from major mining. That is one of the reasons I feel I can make a major bet on it and not have it spread out among others.

Within the iron ore group, there are more speculative plays that have been beaten down including Cap-Ex Ventures Ltd. (CEV:TSX.V) and Ridgemont Iron Ore Corp. (RDG:TSX.V). Even the Labrador Trough itself and many of the players there have come to a point where their stocks are very appealing for speculators who envision a stabilization in the iron ore price. That stabilization should come from the ever-increasing demand for steel, not only in China, but also in the inevitable rebound that should come worldwide, maybe not in 2013, but certainly in the foreseeable future.

TGR: Do you have to believe in a global economic recovery to make money in the junior iron ore space?

PG: You have to believe in at least a price of $100/Mt or more for iron ore. I believe we can count on that because of what continues to come out of China.

What I also like about the situation is that most people have discounted any real economic strength anywhere else. People have already built into their minds and their models that economic malaise will still grip most of the world. But if we get a little blip up, if the European economy ends up not being as bad as forecast, then it’s only good news for the iron ore plays. The bad news has been priced into them, but not much potential good news has been priced in and, therefore, they have a lot of upside future potential.

TGR: In a recent post on www.grandich.com, you took issue with a Raymond James report on Geologix Explorations Inc. (GIX:TSX; GIXEF:OTCQX). Why did you feel compelled to challenge the analysis done by Raymond James?

PG: I felt that the report was not as accurate as it could be and misinterpreted a lot of things. Therefore, I felt the need to respond and not just because it’s a client.

I saw a similar story like this with another client of mine, Timmins Gold Corp. (TMM:TSX; TGD:NYSE.MKT), which got impacted negatively in its share price by an analyst with whom I and others, including Timmins, strongly disagreed with. I was scoffed at for responding and was told the only reason I was responding was because it’s a client.

Yet Timmins ended up proving how wrong that analyst was and recently traded at an all-time high. Timmins Gold started its road to riches during the worst financial crisis ever and is near an all-time share price high in a market where most companies have gone the opposite direction. It continues to come out with good news of advancing resources and higher production.

I see similar traits in the Geologix story, and that’s why I took the time to respond to the analyst report.

TGR: Geologix has meandered around sub-$0.40/share for a while. What’s going to bring Geologix back and allow shareholders to make money on this stock?

PG: Geologix is not much different from a lot of other companies that continue to have success on the corporate side but have seen their share prices languish and/or deteriorate.

The company has made great progress with advancing its resource projects. The analyst’s report ignored a very large deposit and when the company releases an economic report soon, that can demonstrate it is a very viable project.

That’s one of the things that can eventually lift the juniors market; majors are in great need of replenishing resources. Many deposits like the ones that Geologix has, which are well advanced, are likely to be taken over. They may not be taken over at prices that people paid a year or two ago, but they should be at a decent premium to where they are now. That’s a reason why I continue to hold my position in Geologix.

TGR: What did you make of the recent drill results from prospect drilling at Tepal?

PG: The results weren’t barn burners, but I’ve never owned it for just those drill results, but for the many more to come. What was lost in the news is how its results have moved from raw to Measured and Indicated and how much closer to viable the deposit has come.

TGR: Mike Bandrowski at Clarus Securities said, “Geologix could see a rerating once it publishes its prefeasibility study.” Do you share that opinion?

PG: That’s more of a realistic view by an analyst. I would hope that if such a report demonstrates the true viability of this project, people will pay up for the stock. But one of the things we’ll see next year is the Geologixes of the world, and a lot of these mid-development-moving-into-production type companies, merge and be acquired. They’ve moved so far along in achieving their corporate goals, but their share prices have gone in the other direction.

TGR: The companies have derisked, but their share prices haven’t really shown that. You now have a lower risk at a great price.

PG: Right. That stinks for those who are already all in, but for anybody who isn’t, Geologix is a classic example of where the share price hasn’t represented the advancement that the company has seen in the last year.

TGR: In another post on www.grandich.com, you talk about your accumulation of shares of Oromin Explorations Ltd. (OLE:TSX; OLEPF:OTCBB). You pull up a technical chart to help make your case. You strongly believe it will receive a takeover offer. Why is that a reasonable thesis?

PG: It’s my single largest holding ever in any company, period. Oromin has the footprint of a company that’s heading in that direction. To begin with, the company has made it known multiple times for almost a year now that it has engaged an investment banker to explore all sorts of strategic potential factors, including being taken over.

Second, the country in which it operates, Senegal, has been actively promoting that district as the next up-and-coming gold district in Africa and the world.

Third, for another public company that has a substantial position already in Oromin, that has built a mill near Oromin’s projects and that will be forced sooner or later to look for resources elsewhere, it makes a lot of sense for it to look at Oromin as an acquisition. The combination of both of them coming together could then pose a very attractive takeover and another bump up by someone even larger in the area.

It’s a combination of all of these factors, plus Oromin has been around a long time. It’s been a story that’s been in development for years. Managements of these types of companies like to get to this point and be taken out because they would like to start over somewhere else.

TGR: What are some other compelling stories in the junior mining space?

PG: As I said earlier, we are at the point where a lot of companies that greatly advanced their projects and their share prices may have not gone in that same direction. Sunridge Gold Corp. (SGC:TSX.V) is one that fits that mold as is Spanish Mountain Gold Ltd. (SPA:TSX.V). Donner Metals Ltd. (DON:TSX.V) is another classic example.

My surprise pick for 2013, something I have not spoken about publicly before, is South Africa. It may be wise for speculators to look at South Africa again for gold plays for a lot of reasons. One reason is the rand, South Africa’s currency, is finally going down in value, which is a critical point. Second, the necessary changes that needed to happen politically, economically and on the labor front are ongoing and advanced.

In South Africa, a particular company that I happen to represent is Wits Gold Ltd. (WGR:TSX; WGR:JSE). But really, South African mining in general could be a very interesting speculative play for 2013.

TGR: What are some equities based in South Africa?

PG: At the moment, I would look for a fund, an exchange-traded fund or a company that has several plays under its belt in South Africa. That’s what I hope to do in the next month. This is certainly not something that needs to be rushed into overnight. But everything I know about it and people whom I’ve trusted for almost 30 years have, in the last few weeks, started to feel that South Africa has gotten to the point where it needs to be back on the map when we look for gold plays. I am certainly going to target that in the early days of 2013.

TGR: You mentioned Sunridge Gold, which we have talked about it in previous interviews with The Gold Report. Sunridge recently announced that it’s going to publish its full feasibility study for its Asmara project in Q2/13. It plans to lower its capital expenditures and mine direct-shipping ore first to generate more cash flow off the top. What were your initial impressions from that news release?

PG: If Sunridge Gold were suddenly lifted up by a gust of wind and fell anywhere on the map in North America, its stock price would be 5 to 10 times higher than where it is, everything else remaining the same. It has been punished for being in a perceived not-great place, Eritrea. But in fact management attests, and we can see also from the results of Nevsun Resources Ltd. (NSU:TSX; NSU:NYSE.MKT), that it’s been a good place to work in. But the world’s perception of Eritrea still remains, and people tremendously discount values of companies operating there.

I believe that both Sunridge and Nevsun can be acquired, most likely by a Chinese-led company. The Chinese have been building their position in Africa. To me, it’s only a question of which one receives the bid first, Nevsun or Sunridge.

There is still the chance that Nevsun—which has much in common with Sunridge—may buy it, concluding that based on where Sunridge’s price is, it can only enhance Nevsun’s value.

TGR: Any copper projects you want to talk about?

PG: Excelsior Mining Corp. (MIN:TSX.V) has a copper project in Arizona that is very viable. But it’s another company that many have perceived as being further down the road than it was and had hiccups early this year, which seemingly have regressed, that impacted Excelsior. If that ends and people look back to that area positively again, Excelsior can turn around. Mark Morabito is chairman of the board. In the past, he has managed to bring major investment parties into his projects. That’s something we can hope can happen with Excelsior.

TGR: Since year-end is approaching, how should retail investors handle tax loss selling season?

PG: My No. 1 advice on juniors is to realize failure is the norm in the junior resource business. Not realizing that leads to a whole host of difficulties. If we understand that, we won’t get as mentally and financially distressed as we do when we overindulge.

One of the things that I see corporations battle so much is this need on the part of speculators to have constant news, almost on a daily basis, from these companies. Even IBM and Microsoft cannot put out news every day, and people expect far too much and far too soon developments from juniors. They set themselves up for disappointment that should never be there in the first place. So failure is the norm in this business, and it takes a lot longer for the ones that work out to get to where they have to get to. Patience is clearly a virtue. Have a plan for when things don’t work out because a lot of them, even some that I’ve spoken to you about today, may not reach all the goals that we originally thought they could.

TGR: That sounds great, Peter.

Financial adviser and market analyst Peter Grandich started publishing The Grandich Letter—now a blog—without a high school diploma or even a day of formal training. His ability to interpret and forecast financial happenings, which once earned him the moniker “Wall Street Whiz Kid,” has led to hundreds of media interviews. He is regarded as one of the world’s foremost market strategists.

Pent-Up Potential for Precious Metals in 2013: Jason Hamlin

Jason Hamlin Debt, not the fiscal cliff, is what concerns Jason Hamlin, publisher of the Gold Stock Bull newsletter, and if his prediction of a split in the EU comes to pass, it will bolster the case for gold equities. In this Gold Report interview Hamlin shares his preference for royalty streamers and prospect generators in the gold space and explains his attraction to graphite.

TGR: Jason, you recently told your Gold Stock Bull readers that you had sold some equities. What were your reasons for selling?

Jason Hamlin: At the time, we were nearly fully allocated and decided to move to a position of roughly 20% cash. Even though this is a high seasonal period for precious metals, we sold a couple of underperformers to take advantage of any potential year-end selloff driven by concerns about the fiscal cliff and its impact on economic growth. There are also year-end opportunities for tax-loss selling and we want to have some dry powder for bargains that may materialize over the next few months in quality resource stocks.

TGR: Do you believe investors should reduce risk and take a more conservative approach until we know what are the repercussions of the fiscal cliff?

JH: I do not. It is sensible to always have some cash available for a selloff, but I do not view the fiscal cliff as some Armageddon-type event like other analysts. I think the politicians will come to a resolution before things become too explosive, but we should never discount their ineptitude.

For me, the true issue here is debt, not the fiscal cliff. Debt is the root cause of nearly all of our economic and social issues.

“I think the official, inflation-adjusted high for gold of $2,400/oz will be taken out within the next 12 months.”

As it is a mathematic impossibility to ever pay off all of the outstanding debt, neither tax increases nor austerity will solve the debt crisis. As all money is created out of debt and the interest owed back does not exist in the system, the only workable solution is liquidating or forgiving the debt. As controversial as that might sound, one only needs to look up the term “debt jubilee” to see how often it has been used throughout history to clear the slate and allow for a fresh start. So, without getting too detailed, the fiscal cliff in the U.S., debt crisis in Europe, student loan crisis, home mortgage crisis and every other monetary crisis can be tied back to the fact that our monetary system at its root is unsustainable.

TGR: Do you have a calculation that illustrates how difficult that would be?

JH: One way to view that is to look at the percentage of the U.S. budget now being put toward interest on the debt and how it has grown over time. As long as that percentage keeps increasing, it means less and less money is available to spend on legitimate needs and to direct toward growing and driving the economy. This expanding debt burden stifles any type of economic growth that might otherwise be possible. Until our leaders are honest about our debt predicament, balance the budget to stop the bleeding and face the necessity of massive debt forgiveness, my forecast is for continued slow economic growth with the potential for contraction in the near future.

TGR: What are the threats to the average retail investor, especially in the precious metals space?

JH: I believe that another banking crisis could be on the horizon, driven by the large amounts of toxic derivatives and potential revaluation of assets that could render many big banks insolvent. The same kind of threat we saw in the 2008/2009 crisis is still hiding under the surface, as it was only papered over to buy time, rather than addressing the core issues. This could lead to a sell-off in all assets including gold and another rush to the perceived safety of dollars. However, I predict that the deteriorating faith in fiat currencies will translate into a very short dumping of true safe-haven assets such as gold and even quicker rebound that we witnessed following the last financial crisis. Given this outlook, I think it is wise to hold through such corrections and keep cash available to take advantage of the panic selling that will occur if such a crisis materializes.

TGR: While we are talking about the future, do you have any other predictions for 2013?

JH: On a positive note, I think the world will survive the end of the Mayan calendar.

Seriously, I think the euro will fall apart when one or more countries leave. The strong countries will only support the weaker, over-indebted countries for so long before realizing that their sovereignty is more important than the European Union. I think dissolution is absolutely the right course to take, as the concept of the European Union was flawed from the start.

TGR: But the European Central Bank (ECB) has vowed to do everything in its power to stabilize and keep the euro together. Can or should the ECB stave off disintegration at least until the end of 2013?

JH: I think the ECB will try its best, as centralized banking has much to gain from the EU staying together. This attempt will surely involve more bailouts, stimulus and money printing, which will be bullish for precious metals. Ultimately, I think the attempts will fail and we could see a split of the euro as early as next year.

The ECB has constraints that the U.S. Federal Reserve, operating in just one country and with the world reserve currency, does not have. The ECB cannot employ the same bag of tricks as Ben Bernanke and the Fed, so I think it has fewer ways to kick the can down the road. This is why we are seeing the crisis escalate first in Europe, but it will eventually come to the shores of America as we witness a loss of faith in the U.S. dollar as world reserve currency.

TGR: That makes a nice transition into gold. Precious metal investor and Cranberry Capital CEO Paul van Eeden recently said that gold was overvalued. Do you agree?

JH: Mr. van Eeden correctly pointed out that the problem in the U.S. is not inflation, but debt. And I agree with him that the predictions for imminent hyperinflation are overblown. But that is where our agreement ends.

“Precious metals equities are undervalued right now relative to bullion.”

I think his methodology for calculating money supply and gold’s true value is flawed in that he incorporates worldwide gold supply, but compares it only to the U.S. dollar. Demand is strong worldwide and gold has been making new highs in several currencies, not just the dollar.

I also disagree with his notion that the Fed will be able to easily sell assets back into the market to control the inflation that is likely to occur. I’m not sure there would be many buyers of such low yielding bonds in an inflationary environment. The Fed is already forced to buy over 50% of bonds the government auctions during the current environment of relatively low inflation.

Mr. van Eeden has been calling gold overvalued for years now. I think he is a bright analyst and I enjoyed his commentary on gold earlier in this bull market, but he has now joined the ranks of a few other gold bears who have been consistently wrong about the gold price. They will eventually be correct about gold being overvalued, but I suspect it will be a number of years and a few thousand dollars higher before that happens. That being said, I could see some sell-off in gold occurring as a knee-jerk reaction by leveraged investors, but interest rates would have to rise substantially above the true rate of inflation for any serious or lasting impact. Such a move would sink the stock market, which is not something the politicians or central planners would allow. They would prefer to print more money, debase the currency and present the illusion of continued prosperity rather than take their medicine. I do not see interest rates rising any time soon.

The only way to deal with a banking system that is so overleveraged and a government so burdened with debt is to allow the free market to reprice the debt—to reprice housing and equities to their true free market value. However, that would cause the banking system—and possibly the entire world economy—to collapse.

The alternative is to fire up the printing presses, inflate away the debt and hope that the bad loans will once again become solvent. If you study history, you are likely to forecast that the government will choose this option over a deflationary collapse, which will continue to push gold higher in dollar terms.

More broadly speaking, if you take two forms of money valued relative to each other (demand being somewhat constant), the one that increases in quantity faster will lose value against the other. Growth in the gold supply is relatively flat, about 1.5% annual growth. The growth of the supply of almost all fiat currencies ranges from 8–10% on average. To me, that says that gold priced in dollars or any other currency being debased will go up in value relative to that currency.

The other factor to consider is velocity of money, which has been low and has held inflation in check thus far. But in light of quantitative easing (QE) to infinity, which is essentially what QE3 is, recent improvements in housing and the stock market, and some proposed legislative changes to get banks lending, we might see this change in 2013. If velocity picks up, we could see inflationary forces start to take hold. If just a small amount of all of the new money created over the past five years were to begin flowing through the economy, the impact could be significant.

TGR: You rely on technical charts for your advice to your readers. What do your technical charts tell you gold will do in 2013?

JH: I just ran this exercise for my subscribers, and came up with a chart showing the minimum target price of gold at $2,200 an ounce (oz) and over $3,000/oz on the high end by the end of 2013. These prices represent gains in the 35–75% range from the current price. It is a much more aggressive annual return than I would usually forecast—much higher than the average annual rate over the past 10 years.

Gold chart

However, precious metals have been consolidating for well over a year. The chart has an incredible amount of pent-up upside potential for 2013. Plus, the gold price is now bouncing around the bottom line of its trend channel. A failure to push higher and break $2,200/oz by the end of 2013 would mean that gold has fallen out of its long-term trend channel and signal the end of the bull market. I put the likelihood of that outcome at less than 5%. Thus, I think the official, inflation-adjusted high of $2,400/oz will be taken out within the next 12 months.

TGR: Given that prediction, should investors be buying gold, gold equities or both?

JH: I recently published an article on this topic and the answer is: It depends. From 2001 to 2005, gold was up roughly 92% and gold stocks up 648%. In this period you would have seen seven times greater returns investing in gold stocks.

“I view technical analysis as just another data point for reference, not as a panacea for forecasting price movements.”

From 2006 to today, the NYSE Arca Gold BUGS Index (HUI) of gold stocks advanced by about 39% while gold itself is up 232%. That equals about a six times greater return for physical gold than mining shares.

However, if you combine both periods and look at the entirety of the current bull market, gold stocks have been the better investment. From 2001 through Nov. 12, 2012, physical gold has appreciated by 537%. However, gold stocks have gone up nearly twice the rate of gold for a gain of 936%. This is the leverage that seasoned investors remember and it drives our decision to allocate a significant portion of our portfolio to mining stocks. That said, I believe it is best to own both bullion and mining shares, because they serve different purposes.

Just from the start of August through mid-November, the gold price advanced 8%. Gold stocks were up 18%. That is leverage of roughly 2.4 times. It is hard to say if that will continue, but it is a positive sign for investors in mining stocks.

TGR: When you look at technical charts for precious metals equities, what do you look for, other than an upward trend?

JH: I view technical analysis as just another data point for reference, not as a panacea for forecasting price movements. In markets that are as manipulated as ours, where large firms tilt the level playing field via high-frequency trading and collocation, and banks use their leverage to push prices, I take technical analysis with a large grain of salt.

That being said, I look for the usual trend channels, support and resistance indicators, volume levels, momentum indicators, (Fibonacci) retracements, whether the stock is making lower lows or higher highs. I couple these insights with the timing of fundamental developments for miners: drill results, resource updates, upcoming preliminary economic assessments (PEAs) or feasibility studies to try to time our entry and exit points on trading positions. Our model portfolio also contains long-term holds or core positions that we do not trade.

TGR: What is your investment thesis for precious metals equities?

JH: The equities are undervalued right now relative to bullion. A lot of that has to do with distrust of the stock market and of Wall Street in general, after all of the fraud and failures in the past years. But if the market holds up for a while longer and current trends continue, I think we will see mining stocks continue to outperform gold.

TGR: Which precious metals equities are you telling your readers about?

JH: I have been an early advocate of the streaming royalty model in the mining sector. Silver Wheaton Corp. (SLW:TSX; SLW:NYSE) pioneered it and some of its management broke off to start up a similar company in Sandstorm Gold Ltd. (SSL:TSX.V). I first bought Sandstorm at around $0.50/share; it now trades around $13/share and is up nearly 200% since our last purchase.

Streaming companies make an advance payment to a company with a pre-production stage mineral deposit in exchange for a negotiated percentage of the metal produced for the life of mine.

This model gives companies diversification and risk mitigation because it has agreements with several different miners. There is unlimited upside potential in that the deal is usually for a percentage of the production mine life and limited downside risk if a miner sees its profit margins squeezed as the agreed purchase price is fixed.

Streamers also enjoy an advantageous tax situation, with rates that are usually much lower than tax rates for mining companies.

TGR: You put out a note on Sandstorm after its share price had taken a steep drop, which you attributed to comments made by a pundit in the U.S. Tell us about that.

JH: Two things were at play. First, the stock price got ahead of itself a little bit and was due to pull back. Second, CNBC’s Jim Cramer made some comments that were interpreted negatively on his show, including (referring to Sandstorm Gold): “They’re good, but remember if gold prices go down to a certain price, then those miners won’t be drilling. That is your worry there.”

He did not change from a bullish to a bearish call, but it was enough to ignite a sell-off.

TGR: The streaming royalty space has seen some consolidation in recent years. Is Sandstorm, given its suite of royalties, a favorable target for larger royalty companies?

JH: I do not think so. Nolan Watson heads up Sandstorm and it seems to be his intention to continue running and growing the company for the long term. With all of the buzz around streaming companies at the moment, Sandstorm may be able to command a nice premium, but I don’t believe it will sell.

TGR: The stock is now trading at $12.30/share. If an investor does not have a position in Sandstorm, is this a good time to take one?

JH: I had written that any pullback to $11/share or less would be a good opportunity to establish or add to a position. Funnily enough, it dipped to a $10.99/share low in the U.S. I like Sandstorm as a long-term play and think buying on any dip below $11 will prove a good move a year from now.

TGR: What other companies are you telling your readers about?

JH: Another business model with great merit is the prospect generator model, pioneered by Almaden Minerals Ltd. (AMM:TSX; AAU:NYSE). It has some similarities to the royalty-streaming model that has treated us so well.

Because Almaden owns its own drill rigs, it can drill at a lower cost and has more flexibility with timing. Almaden unlocks value via discovering resources, selling them and usually acquiring a royalty in the process. The company itself is not in the business of production. Its management believes the greatest shareholder value is unlocked when finding the discovery, doing the drilling and passing the project off to a larger company for production.

Almaden has 15 exploration royalties right now, a few of them nearing production. Lately Almaden has focused on the relatively unexplored region of eastern Mexico, where its Ixtaca project is located. Ixtaca has been returning impressive intercepts this year, most recently 134 meters (m) of 4.1 grams per ton (g/t) gold. Almaden expects to issue its NI 43-101 resource on Ixtaca this December. Two years and more than 70,000m of drilling will go into that NI 43-101, including lots of long intercepts over high grade. If the drill results we have already seen are any indication, it could be an absolute game changer for the company.

Producing companies have already shown a lot of interest in Ixtaca, so I think Almaden will be able to sell it rather easily and get an exceptional return on its investment. The best part of this project is that most of the property is still relatively unexplored. There are multiple blind targets and blue-sky potential for Almaden.

TGR: Those recent drill results averaged 4.1 g/t. Is that the sweet spot Almaden has been looking for to make the deposit economic?

JH: It was along the trend, but 50m northeast of the closest drill results that are going into the maiden resource. This shows the potential to significantly expand the current scope of the project. The grade was very convincing.

TGR: What do you expect to happen once the NI 43-101 comes out?

JH: I expect it will attract the attention of investors and that its market cap will increase substantially as a result. This maiden resource may convince larger companies to firm up their offers and move forward. But with the latest round of very strong drill results, it might be better for shareholders if Almaden continues expanding the resource prior to considering any bids.

TGR: Would Almaden issue a dividend to shareholders or keep the money and reinvest it in other projects?

JH: In order to maximize exploration efforts, Almaden does not pay out a dividend and I prefer this. When you can trust management to make deals that are accretive to shareholders, I would rather see the money used for more drilling on prospective projects, of which Almaden has a number in the pipeline.

TGR: You also follow the graphite space. What is the latest news there?

JH: Overall, graphite is attractive due to strong supply/demand fundamentals. Prices have come back down from lofty levels last year, but have stabilized recently and remain elevated. This means that a number of graphite projects that might not have been economic in the past are economic today.

Given that graphite is a key ingredient in so many established industries, from aviation to automotive, steel and plastic, I see prices holding up well. However, future demand growth is likely to come from the high-purity, large-flake graphite that is used in lithium-ion batteries for electric cars and such.

People talk about the big run-up in lithium a while ago, but 10 times more graphite is used inside a lithium-ion battery than lithium. There will be significant demand as we move toward electric vehicles and electric-based power.

The other exciting driver in investment demand for graphite is the potential of graphene, which is reportedly the thinnest and strongest material ever developed. Graphene is 200 times stronger than steel, several times tougher than a diamond and it conducts electricity and heat better than copper. It could even replace silicone in semiconductors. Also, graphene is nearly impossible to break. You could throw a graphene mobile phone display on the ground and it will not shatter like the glass on current phones. Researchers claim graphene is the most important substance to be created since plastic.

Samsung Electronics Co. Ltd. (005930:KSE) plans to launch a cell phone in mid-2013 that will have a bendable display made from graphene. Future versions could be a phone that rolls up on your wrist or that could be folded to fit into your pocket. There is a lot of potential for graphene in the expanding cell phone and green energy markets. The military has an interest as well.

TGR: To date, graphene has been made only in labs using synthetic graphite to control for purity. Is there a graphite deposit in the world that will meet the need for very high-purity, large-flake graphite to manufacture graphene?

JH: Yes, there are a few deposits, and companies are making progress in addressing the technical challenges to reach the purity needed to produce graphene.

Focus Graphite Inc. (FMS:TSX.V) has a high-purity deposit. It just released its PEA in October at 32% pre-tax internal rate of return. It has a 2.8-year payback and is fairly easy to finance with capital costs of just $154 million. Its very low $435/ton cost is driven by the high grades in the deposit. Management believes the company will be one of the highest-grade, lowest-cost producers in the world once it is up and running. This stock has a lot of potential, despite having been beaten down a little bit in the last six months.

TGR: Does that make Focus a good entry point for investors looking for graphite exposure in their portfolios?

JH: Yes, as long as they take a longer-term view and are not looking to trade in and out quickly. It will take Focus time to get closer to production and to prove up the resource. Long-term investors who can buy and hold will find a lot of potential there.

I also like Energizer Resources Inc. (EGZ:TSX.V; ENZR:OTCBB). This company recently completed a drill program of more than 47 holes over 9,000m. It included the largest intersection of graphite ever reported: 421m grading 6.18 carbon, including the valuable jumbo-flake graphite at 93% purity. Plus, the mineralization is exposed at the surface, which means you can build a low-cost open-pit mine.

In addition to possibly sitting on the world’s largest graphite deposit, Energizer also has one of the world’s largest vanadium deposits. Its PEA, expected by year-end, could well be the catalyst to push Energizer’s stock price higher. We are looking to buy on any dip below $0.30/share.

TGR: The biggest concern is that the Green Giant project is in Madagascar. Not only is it a difficult place to permit a mine, there are also a lot of places where it would be hard to mine. Do you know what Energizer’s strategy is for getting a permit and opening a mine?

JH: Given the size and purity of the deposit and the potential revenue for the country, the government may allow some leniency regarding the permit. Energizer will be able to apply some environmental safeguard best practices, which should help with environmental concerns.

I think the mine will get built. Thus far, indications are that Green Giant will be a very economic project. I think the company will find ways to work with the local community and the local government.

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

Jason Hamlin is the founder of Gold Stock Bull and publishes one of the most highly rated investment newsletters available, focused on strategies for profiting on the bull markets in gold, silver, energy, critical metals and agriculture. Hamlin has a background analyzing charts and trends for the world’s largest market research company, is versed in fundamental and technical analysis and has consulted to Fortune 500 companies around the globe.

Rick Mills: Low-Cost Producers Trump Larger Mines in Costly Market

Richard Mills Rick Mills isn’t looking for huge producers with so much overhead that they can’t profitably mine an ounce of gold. Instead, Mills, the publisher, editor and president of Aheadoftheherd.com, seeks out the smaller mines with low capital costs. That’s where the money will be made in the next two years, he tells The Gold Report.

The Gold Report: Rick, is this a good time to be buying gold?

Rick Mills: There are three key reasons to have exposure to gold bullion. The traditional reason is to protect against inflation. We’re printing money. More quantitative easing has taken place and inflation looks to be coming down the pike. I buy groceries. I pay for gas. I can see inflation. I firmly believe it’s going to get higher over the coming months and years. Buying gold as a protection against inflation is realistic.

The second reason investors have traditionally bought gold is as a safe-haven investment. There’s a lot going on in the world—from secession talk in the U.S. to turmoil in Israel, Iran, Syria, the South China Sea region and Turkey.

One of the things that most investors don’t know about gold is that adding a gold allocation to your portfolio, especially over the last decade or so, has provided substantial enhancements to the portfolio’s return.

Gold helps minimize the downside deviations in an overall portfolio. In 2002, the S&P 500 was down 23%. Emerging market equities were down 6%. International equities were down 16%. Yet gold was up 25%.

TGR: That was early in the bull run in gold.

RM: Even in 2008, the S&P 500 was down 37%, international equities were down 43% and emerging market equities were down 53%. However, gold was up 8%.

TGR: It felt like the end of the world in 2008. Gold has saved the portfolios of a lot of investors who were smart enough to start collecting it in 2001 and onward. However, there are investors who don’t believe that gold has the multiples now.

RM: It’s true. I believe gold producers have shot themselves in the foot because of their reporting methods. They use cash cost for reporting. In 2001 and 2002, miners were producing gold for below $180/ounce (oz). By 2005, cash costs had risen 45% to $250/oz. Data from research consultancy Thompson Reuters GFMS shows that world gold production costs for the first half of 2009 averaged $457/oz. In 2011, they were $657/oz. GFMS’ Gold Survey 2012 says it’s now $727/oz.

“Buying gold as a protection against inflation is realistic.”

But if investors have been looking at that, they’ve been misled because that’s not really the cost of producing gold. These average cash-cost figures include only the costs directly associated with the production of gold, such as wages, energy and raw materials. The problem is that gold cash costs are not the only costs associated with mines. Investment bank CIBC just produced a complete breakdown of costs. Yes, operating costs are $700/oz, but there is also sustaining capital, construction capital, discovery costs and overhead. CIBC pegs those at an average of $600/oz. Add in $200/oz for taxes on average, and you’re looking at $1,500 to produce an ounce of gold.

TGR: In that environment, many of the gold mining producers would be out of business.

RM: The gold price is $1,700/oz. Companies are not making a lot of money here. The funny thing is that the sustainable costs for gold—the sustainable number gold miners need—according to CIBC, is $1,700/oz. You can see why investors are leery to jump into the space with numbers so tight.

TGR: But you’re a gold bull. You believe that people should be investing in bullion. The bullion has to come from somewhere. What’s an investor to do when he believes in the fundamental reasons for owning gold, but doesn’t understand how the equities can perform?

RM: Historically, the precious metals equities have given investors the most leverage to a rise in gold and silver prices. We need to have a rise in gold and silver price. We need to get into that environment again, like it was from 2001 to 2006 when gold equities went up 900%.

Let’s look at why companies aren’t making a profit. One of the biggest reasons is capital expenditures (capex), which is the basic cost of building a mine and its supporting infrastructure. There are lower grades being mined—down 23% over the last five years and expected to drop another 4% this year—and more complex metallurgy. Companies are increasingly going into more remote areas that lack infrastructure. Environmental regulations are increasing. We are seeing more money-grabbing governments and resource nationalization. There’s a serious shortage of skilled personnel and labor unrest is pretty much everywhere: strikes, protests and unions demanding higher wages. Everything you can imagine is working in a perfect storm to increase costs and risks on mining companies.

Costs are going through the roof, yet gold is stuck in a holding pattern at $1,700/oz. Then, when people want exposure to the sector, they buy an exchange-traded fund (ETF). In the past, a lot of that money would have gone into mining equities.

“Gold helps minimize the downside deviations in an overall portfolio.”

There’s a huge increase in exploration spending—more than $8 billion ($8B) in 2011—but a serious lack of new discovery. There have been very few large, high-grade deposits discovered during the past few years. Barrick Gold Corp. (ABX:TSX; ABX:NYSE) said at the Precious Metals Conference 2012 that of the “super giant” discoveries, those that are more than 20 million ounces (Moz), 18 were discovered in the 1900s. Fast-forward to the 1980s when 14 were discovered. In the 1990s, 11 were discovered. In the 2000s, only five were uncovered.

The number of annual gold discoveries of more than 5 Moz since 2007 is six in 2007, one in 2008, one in 2009, three in 2010 and one in 2011. None is producing yet. A lot of people who think that they’re going to produce are in for a disappointment because of resource nationalism, permitting problems, environmental problems, lack of water, labor unrest and protests.

TGR: Assuming gold demand will continue to escalate due to macroeconomic pressures, will the price of gold continue to increase?

RM: Gold demand is still rising. Five-year average quarterly demand is rising, so that’s correct.

TGR: What do you forecast for the 2013 gold price?

RM: That’s a mug’s game, trying to predict gold prices, but it’ll be higher.

TGR: You believe the price of gold can only go up.

RM: That’s right. Inflation, world events, diversification—gold does offer leverage. So do equities, or at least they will again. I’m not looking at huge mines with billions and billions of dollars in capex. I’m much more comfortable with the smaller mines with lower capex and under-control operating expenditures. I like the lowest-cost producers. That’s where the money is going to be made over the next two years.

TGR: Canada, the U.S. and some places in Latin America are the preferred jurisdictions for risk reduction, infrastructure, rule of law and reliability of government.

RM: Absolutely. Look at the Muslim Brotherhood in Egypt canceling a nearly 20-year-old license for a mining company. In Madagascar, a DJ gets elected president and the first thing he wants to do is cancel permits and do a review. That’s not happening in Canada, the U.S. or politically stable places like Greenland. There is enough risk in this business as it is without intentionally inviting more.

TGR: Given that backdrop, what are some companies you find interesting right now?

RM: Let’s stick with soon-to-be producers or companies that are going to be very low-cost producers. They’re all in geopolitically acceptable countries with superior management teams.

According to a July 2012 research report by Natural Resource Holdings, there are only 164 undeveloped gold deposits globally, with more than 1 Moz of gold in all categories, that are owned by non-major mining companies. The average grade of all these deposits is 0.66 grams per ton (g/t). Since we’re mining +80 Moz a year, that makes these non-major-owned deposits quite valuable.

The total current gold resource on Altair Gold Inc.’s (AVX:TSX.V) Kena property sits at 1.06 Moz. In the Kena Gold Zone, Measured and Indicated (M&I) resources are 300,000 oz (300 Koz) at 0.64 g/t Au, and Inferred are 85 Koz at 0.70 g/t Au. In the Gold Mountain Zone, M&I resources are 249 Koz at 0.71 g/t Au, and Inferred are 428 Koz at 0.60 g/t Au.

“Everything you can imagine is working in a perfect storm to increase costs and risks on mining companies.”

I like Altair Gold because the company has an amazing technical team and they are putting some serious money into their project. Altair put $1.75 million ($175M) into the Kena property in British Columbia this year. The company drilled 7,400 meters (m) and got some results back, but is going to put a comprehensive plan together based on the complete results. That will be exciting. Altair has proven it can raise money. It can run a technical drill program. It can get the word out to investors. With the right results, this management team can take this project all the way to being one of those low-cost producers. Altair could have something spectacular.

TGR: Bob Archer, who has had great success with Great Panther Silver Ltd. (GPR:TSX; GPL:NYSE.MKT), is behind this company, as well as Fayyaz Alimohamed.

Do you foresee a problem with Altair getting permitting due to the rise of the green movement and First Nations issues?

RM: Most of the companies in British Columbia that have had problems with the First Nations created their own problems by not getting the First Nations involved in the projects early. They show disrespect to the traditional ways. A company that engages the First Nations, is willing to work with them and is willing to provide jobs and help them, isn’t likely to be road-blocked by them. The First Nations are not against resource development. They want jobs. Engage them early in a project and you won’t have a problem.

As for the greens, Altair is a historic mining district. There is not really much you can say when you’re in an area of past-producing mines.

TGR: It sounds as if it won’t be an issue.

RM: The next one we’ll talk about is NioGold Mining Corp. (NOX:TSX.V; NOXGF:OTCPK). I like this project, which is a joint venture with Aurizon Mines Ltd. (ARZ:TSX; AZK:NYSE.MKT). There has been some uncertainty surrounding it. Aurizon was supposed to have made a decision to invest in the third phase, but it is going to wait and see the next NI 43-101.

The first NI 43-101 didn’t have phase two results and was very conservative. The phase one report has delineated 2.1 Moz, most of that in the Marban deposit. The goal of the phase one drilling on the Marban deposit was to bring as many surface ounces as possible into a pit shell. The stripping ratio looks pretty high, but the grade is good and that should compensate for the high strip. Now, NioGold is going to look at the open pit, the high grade and strip ratio.

TGR: When does NioGold expect to publish the updated NI 43-101, and how good was the grade in the first NI 43-101?

RM: Next March. Phase two included $5M of drilling, and that is being added to the NI 43-101 report now. The NI 43-101 shows 1.58 g/t and that compares with 1.07 g/t across the road at Osisko Mining Corp.’s Canadian Malartic mine. And the 43-101 report was quite conservative, using a punitive grade capping that discounts the contained metal by as much as 30%. The phase two report will be more detailed, using tighter intervals and high- and low-grade envelopes to more accurately detail the deposit, and this should capture more of the ounces.

TGR: So if the phase 2 report shows improved ounces and grade, what happens next?

RM: This is the best part of the story. Aurizon has already spent $11M and at this stage the company has not earned anything. If it doesn’t continue with phase three, the entire deposit reverts to NioGold and it will have 100% ownership of a 2.1 Moz deposit. Assuming Aurizon continues with the earn-in, then another $9M is spent over 9–12 months. Then a final 43-101 is delivered to Aurizon and it has to make a resource payment to NioGold for half of the gold in the deposit at a rate of $40/oz for Measured and Indicated, and $30/oz for Inferred. This payment is already estimated at $39M, just including the gold outlined with phase one. The payment could easily grow to $50–60M by the end of the program. And that is only for half of the deposit. NioGold gets to keep the other half. Aurizon would then be the operator and it can go to 60% by delivering a feasibility report, and up to 65% by arranging project financing. But that last 5% is at NioGold’s option.

Don’t forget that this deal with Aurizon is for only part of NioGold’s property—about 8% of its land package. The company has several other gold discoveries and showings to follow up on its own.

The stock is trading in the low $0.30s, and with just a little over 100M shares that’s a cap of about $32M. The payment from Aurizon is already going to be bigger than the entire market cap right now.

TGR: What is your third pick?

RM: Terraco Gold Corp. (TEN:TSX.V) has several irons in the fire. Nutmeg Mountain, the Almaden project, is putting out an updated NI 43-101. It has 887 holes that were inherited. They were rotary air blast (RAB) drilling and reverse circulation (RC), but those types of drilling wouldn’t give you the best representation. The company has done 52 core holes and four 4-inch metallurgical holes that it is going to include in the new NI 43-101.

Institutional interest in large-scale gold and copper discoveries has dropped off mainly because every time it puts some money into them, its interest just gets totally destroyed. It gets delay after delay. It gets cost increase after cost increase. These smaller ones, which have low costs to put into production along with low-cost producers, are going to be the way that we’re looking at things as retail investors.

“I like the lowest-cost producers. That’s where the money is going to be made over the next two years.”

Almaden seems to be a perfect example of a low-cost deposit. We’re looking at a new NI 43-101 with better recovery in the cores, and the holes support that. The diamond-drill holes were 20–40% better grade than the RAB and the RC. We’re waiting on metallurgical results that should be out shortly. The biggest knock on this deposit is that it has only been able to recover 63% of the gold. It doesn’t absolutely kill you economically, but it’s not a huge incentive either. However, there are reasons for the lower recoveries, namely that the column tests weren’t leached for a full 90 days. It never separated the sulfide, oxides and the mix into separate columns.

Terraco should have a preliminary economic assessment (PEA) early in 2013. It could come up with some superior numbers that show Almaden as a serious low-cost producer. It’s heap leach. The company has $1.8M in the treasury. Terraco is going to do its PEA and see if it can produce out there.

TGR: Terraco has the benefit of its primary asset being in northern Idaho, where mining is well accepted, and in Nevada, which is a fantastic jurisdiction. What CEO Todd Hilditch has done with his career is impressive.

RM: I was lucky to get in on his company Salares Lithium Inc., which merged with Talison Lithium Ltd. (TLH:TSX). The buyout by Talison was 400% of what I originally bought it. Of course, now we have the bidding war for those who got Talison shares.

TGR: That’s been a wonderful thing for the shareholders of Salares.

RM: Then Hilditch turned around and did something that is almost as impressive—buying the royalty on the Barrick deposit.

TGR: That’s part of the assets in Terraco, right?

RM: Yes, it’s on a project in Nevada, the Spring Valley joint venture (JV) project of Barrick and Midway Gold Corp. (MDW:TSX.V; MDW:NYSE.A). Midway’s Spring Valley deposit is at 3.5 Moz. That’s $40M net present value (NPV to Terraco. After $13M to exercise its option, that’s a $27M NPV, which is $2M more than its current market cap.

TGR: Just on the royalty.

RM: Yes. If it does expand that deposit to, say, 6 Moz, which is certainly not out of the realm of possibility, that’s a NPV of $64M. After exercising its options, it’s a NPV of $51M. That’s double the market cap—just on the royalty.

There is also a lot of blue-sky potential. The Barrick/Midway JV’s best hole is on the north end of Spring Valley. They have in hand a permit to drill toward the north, which is the south end of Terraco’s Moonlight project. If the JV hits Moonlight is in play.

TGR: What’s up next?

RM: My next one for your readers is Northern Vertex Mining Corp. (NEE:TSX.V; NHVCF:OTCQX). This is a company that is fast-tracking its Moss project in Arizona.

In the last six weeks, Northern Vertex has drilled 200 percussion holes and raised $9.1M. Ken Berry just stepped aside as CEO to bring on Dick Whittington, a mining engineer. Whittington took Farallon Mining Ltd.’s (FAN:TSX) project in Mexico to production in four years. He’s also put a voice behind mining interests in Mexico. He gathered together miners and explorers worth $50B in assets and they speak to the Mexican government as a single voice. Whittington is well respected and is very good at what he does. The mission is to fast-track Moss into production. When this happens, Northern Vertex is definitely going to be one of the lower-cost producers out there.

TGR: Tell me about the asset.

RM: Moss is a gold and silver project in northwestern Arizona with all the necessary infrastructure nearby. It has a gold-equivalent (eq) NI 43-101 resource of 950 Koz Measured and Indicated and 266 Koz Inferred gold eq, and it’s growable. It’s got a low strip ratio and is amenable to low-cost, heap-leach open pit mining. It’s a major stockwork vein system that outcrops at the surface for 5,500 feet. It has a unique three-phase plan. The third phase will be paid for by production. It’s a smart plan run by some very smart people. I have no doubt that this one is going to be successful.

TGR: The fact that it was able to raise $9.1M in this environment is pretty impressive. That’s been within the last 30 days.

RM: Exactly. Its management team is extremely popular with investors and institutions for several good reasons. When they say they’re going to do something, they go out and they do it. They’re a no-nonsense team.

TGR: This has been an interesting list. Thanks, Rick.

Richard (Rick) Mills is the founder, owner and president of Northern Venture Group, which owns Aheadoftheherd.com, as well as publisher, editor and host of the website. Focusing on the junior resource sector, Mills has had articles appearing in more than 400 different publications, including the Wall Street Journal, Safe Haven, the Market Oracle, USA Today, National Post, Stockhouse, LewRockwell, Pinnacle Digest, Uranium Miner, Beforeitsnews, Seeking Alpha, Montreal Gazette, Casey Research, 24hgold, Vancouver Sun, CBS News, Silver Bear Cafe, Infomine, Huffington Post, Mineweb, 321Gold, Kitco, Gold-Eagle, The Gold/Energy Reports, Calgary Herald, Resource Investor, Mining.com, Forbes, FN Arena, UraniumSeek, Financial Sense, GoldSeek, Dallas News, VantageWire, Indiatimes, ninemsn, IBTimes, jsmineset, the Association of Mining Analysts and Resource Clips.

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Paul van Eeden on Why Gold is Overvalued

Paul van Eeden Many goldbugs like gold as a hedge against Federal Reserve policies and high inflation. Paul van Eeden, president of Cranberry Capital, says he does not fear high inflation due to Fed policies. Van Eeden is a different kind of goldbug and in this interview with The Gold Report, he explains how his proprietary monetary measure, “The Actual Money Supply,” is the reason why.

The Gold Report: Paul, your speech at the Hard Assets Conference in San Francisco was titled “Rational Expectations.” You spoke about monitoring the real rate of monetary inflation based on the total money supply.

You take into account everything in your indicator that acts as money, creating a money aggregate that links the value of gold and the dollar. You conclude that quantitative easing (QE) is not resulting in hyperinflation and is not acting as a driver for the continuing rise in the gold price. What then is pushing gold to $1,700/ounce (oz)?

Paul van Eeden: Expectations and fear. It’s very hard to know what gold is worth in dollars if you don’t also know what the dollar is doing. When we analyze the gold price in U.S. dollars, we’re analyzing two things simultaneously—gold and dollars. You cannot do one without the other. The problem with analyzing the dollar is that the market doesn’t have a good measure by which to recognize the effects of quantitative easing.

Since approximately the 1950s, economists have used monetary aggregates called M1, M2 and M3 (no longer being published) to describe the U.S. money supply. But M1, M2 and M3 are fatally flawed as monetary aggregates for very simple reasons. M1 only counts cash and demand deposits such as checking accounts. M1 assumes that any money that you have, say, in a savings account isn’t money. Well, that’s a bit absurd.

TGR: What comprises M2?

PvE: M2 does include deposit accounts, such as savings accounts, but only up to $100,000. That implies that if you had $1 million in a savings account, $900,000 of it doesn’t exist. That’s equally absurd.

“If gold is money, we should be able to look at gold and compare gold as one form of money against dollars, another form of money.”

M3 describes money as all of these—cash, plus demand deposits plus time deposits, but to an unlimited size. One may think then that M3 is the right monetary indicator. But the problem with both M2 and M3 is that they also include money market mutual funds, a fund consisting of short-term money market instruments.

That’s double-counting money because if I buy a money market mutual fund, the money I use to pay for that mutual fund is used by the mutual fund to buy a money market instrument from a corporation. The corporation takes the money it received from the sale of the instrument and deposits it into its bank account, where it is counted in the money supply. I cannot then count the money market mutual fund certificate as money, as it would be counting the same money twice.

TGR: So there is no accurate indicator.

PvE: M2 and M3 double-count money; M1 and M2 don’t count all the money. All are imperfect measurements. That is why I created a monetary aggregate called “The Actual Money Supply,” which is on my website at www.paulvaneeden.com.

TGR: How is your measurement more accurate?

PvE: It counts notes and coins, plus all bank deposit accounts, whether they’re time deposits or demand deposits. This is equal to all the money that circulates in the economy and can be used for commerce—nothing more and nothing less.

TGR: How does that separate out gold from the dollar in value terms?

PvE: I’m a goldbug. I believe gold is a store of wealth and gold is money. If gold is money, we should be able to look at gold and compare gold as one form of money against dollars, another form of money.

Changes in the relative value of gold and dollars will be dictated by their relative inflation rates. If I create more dollars, I decrease the value of all the dollars. If I create more gold, I decrease the value of all the gold.

TGR: The relationship is determined by both quantitative easing and mining?

PvE: Correct. Essentially most of the gold that has been mined is above ground in the form of bars and coins and jewelry. We can calculate how much that is. That’s the gold supply. That supply increases every year by an amount equal to mine production less an amount used up during industrial fabrication. That’s gold’s inflation rate.

“If the Federal Reserve starts to see an increase in price inflation or a rapid increase in loan creation—monetary inflation—it can sell assets back into the market.”

We can also look at the money supply and see how it increases every year. That’s the dollar’s inflation rate. The value of gold vis-a-vis via the dollar will be dictated by these relative inflation rates.

I have data on both gold and the U.S. dollar going back to 1900 and thus can compare the two. By doing that, I can calculate how the value of gold changes relative to the U.S. dollar and what gold is theoretically worth in terms of dollars.

Keep in mind that the market price is not the same as the value. In the market, price is seldom equal to value. Price often both exceeds and is below value. But it will always oscillate around value.

For example, in 1980, gold was trading much higher than value. By 1995, the gold price had sufficiently declined and U.S. dollar inflation had sufficiently increased to bring the gold price back to value, vis-a-vis the dollar. By 1999, gold was substantially undervalued. By 2007, it was again reasonably valued. But in 2012, it is again substantially overvalued.

van Eeden chart

Gold price and U.S. dollar inflation (blue) 1970–present

TGR: The value of gold is not $1,700/oz?

PvE: No. The value of gold is about $900/oz. Expectations of monetary inflation are keeping gold prices high.

In 2008, after the financial crisis, the Federal Reserve Bank announced the first round of quantitative easing. The gold price started to rally because there was an expectation, with the Fed openly engaging in quantitative easing, that we would see massive U.S. dollar inflation. But that didn’t happen.

“Whether annual mine production goes up or down, it makes no difference to the price of gold.”

When the Fed engages in quantitative easing, it does so by buying assets in the open market, such as Treasury notes or bonds. When the Fed buys a government bond in the open market it creates the money to pay for it out of thin air. The payment is credited against a commercial bank’s account at the Federal Reserve Bank and is not available for commerce in the economy. It’s part of the monetary base, but not the money supply, as the money supply only counts money that can be used for commerce.

Thus, the money that the Fed creates is not in circulation. It’s not part of the money supply because it cannot be spent. The commercial bank in whose name it is credited cannot withdraw it. The only thing it can do is to create new loans against that reserve asset. But the bank can only create new loans equal to the demand for such new loans.

Right now, as a result of QE1 and QE2, there is an enormous amount of excess reserves on account at the Federal Reserve on behalf of these commercial banks. These excess reserves in theory could be used to create new loans. The reality is that new loan creation by commercial banks have proceeded at a very normal pace, and not at all at a rate that should cause fear of hyperinflation.

TGR: Is it that there isn’t a demand or that the banks don’t see creditworthy people to loan to?

PvE: It doesn’t matter; the result is the same. The point is that the marketplace is not creating those loans.

Money that is counted in the money supply is created when consumers and corporations borrow money from commercial banks. When a loan is created by a commercial bank, the banking system creates that money out of thin air just as the Federal Reserve created its money out of thin air.

When a loan is repaid, that money is destroyed. The natural increase of the money supply is the balance between loan creation and loan repayment from consumers and corporations to commercial banks. Their ability to create those loans is dependent, to some extent, on their reserve assets in the monetary base that they have on account at the Federal Reserve. Right now, those reserve assets are much, much larger than what is necessary to account for existing loans of banks. So banks have enormous capacity to create loans, but capacity to create is not the same as having created. We are not seeing runaway inflation in the market. The U.S. money supply is increasing at an annual rate of around 7%, which is high, but not high enough to cause the type of hysteria that the gold price is exhibiting.

TGR: The expectation that banks will eventually loan up to their lending capacity is what is causing the fears of hyperinflation and the gold price to go up.

PvE: That is correct.

TGR: When will banks start lending?

PvE: They are lending, which is why the U.S. money supply is increasing. But they are not lending at a torrid pace—the U.S. money supply is increasing only very slightly faster than the average annual rate since 1900, and slower than it was in the period from 2000 to 2009 before quantitative easing started. It is highly improbable that we will see the kind of monetary inflation the market is afraid of—the fear is misplaced.

The Federal Reserve alone controls the level of money in the monetary base. If the Federal Reserve starts to see an increase in price inflation or a rapid increase in loan creation—monetary inflation—it can sell assets back into the market. When those assets are sold back into the market the money that the Federal Reserve receives for the asset is destroyed. It evaporates.

Just as the Federal Reserve created money, it can destroy money. The Fed can absolutely prevent runaway inflation by selling assets back into the market, therefore constricting the ability of commercial banks to make loans.

TGR: If the Fed-created money isn’t loaned out, will the inflationary expectation in the market eventually disappear? Will the price of gold go to $800–900/oz?

PvE: That’s a possibility. The gold price rallied in response to QE1 and QE2 and when QE2 ended, the gold price started falling.

Prior to the announcement of QE3, the gold price rallied again in anticipation, but since QE3 has been announced, the gold price has been falling.

When the Federal Reserve announced QE1, there was a massive increase in the monetary base. When it announced QE2, there was another substantial increase in the monetary base, but much less than with QE1. But there hasn’t been an increase in the monetary base since the QE3 announcement. The Fed is “sterilizing” QE3 by offsetting sales of assets at the same time it is purchasing assets.

TGR: So the key is how the Fed implements quantitative easing?

PvE: Correct. The question is whether the gold market is rational in expecting hyperinflation or massive runaway inflation. That expectation is not being supported by the money supply, or by price inflation, or any other data. The only place the expectation is being manifest is in the prices of gold and silver.

TGR: If you look at the supply and demand expectations for gold versus the inflated valuation for gold, do you see more gold producers bringing gold out of the ground? If so, is that going to have an effect on the price?

PvE: If the gold price is high relative to production costs then yes, it does bring marginal mines into production, which increases the supply of gold. Incidentally, the increase in production from marginal mines then causes production costs to increase as well.

Does that have an impact on the price of gold? No. The reason is very simple. Approximately 1,000–2,000 tons of gold is traded each day. Annual production of gold is roughly 2,000 tons. If annual gold production increases by 5%, which is a lot, it’s 100 tons. We trade that in a couple of hours.

Whether annual mine production goes up or down, it makes no difference to the price of gold. The gold that’s trading globally is not just the gold that’s being mined; it’s all the gold that’s ever been mined, that’s sitting above ground in vaults and in storage. That’s where the price is set. Not on the margin of incremental production.

TGR: As you’re looking at the gold companies that are out there, are you seeing that we have some good prospects or are you seeing that the producers aren’t able to replace what they’re using and the juniors aren’t able to get the funding to find new sources?

PvE: I agree with your last statement. Producers are not able to replace their reserves. New exploration is not keeping up with reserve depletion and the juniors are not getting the funding to do the exploration.

The reason juniors aren’t getting funding is because the market has become quite risk averse. Junior exploration companies are among the most risky investments you can imagine. When risk aversion increases in the market, the ability of juniors to fund exploration evaporates.

It’s also true that the miners, particularly gold and copper, are having a tough time replacing reserves. Is that something that’s going to cause a calamity in the next 12 or 24 months? No. But, it is a reason why, over the long term, investing in mineral exploration is an interesting business. Without mineral exploration, there can be no mining industry and without a mining industry, our society does not function.

TGR: The last time we spoke to you, you said that you were very scared and that it was a healthy thing for investors to be scared because it keeps them from making mistakes. Are you still scared?

PvE: I’m definitely concerned that the market is going to look worse in 2013 than it looked in 2012. I think risk aversion is not yet ready to be replaced by risk appetite. The big concern I have for next year is further deterioration of the Chinese economy. In particular, a tipping point is being reached in China where its banking system can no longer sustain the bad loans it has created.

If economic growth in China takes a really big hit at the same time the financial problems in Europe have not yet been resolved, I see more risk aversion creeping into the market. That’s not good for junior exploration companies.

What makes me optimistic is that I think the worst is behind us in the United States. I think that slowly but surely the U.S. economy is going to get better and better. With time the improvement in the U.S. economy will bring risk appetite back into the market, but I don’t see that happening in 2013. We’ll have to see this time next year what the prognosis is for 2014.

TGR: In 2008, you told your investors to sell everything. Is that still your position?

PvE: The end of 2007 and the beginning of 2008 was the top of the market for most metals and certainly for mineral exploration stocks. That was the time to sell everything. Now we’re very close to the bottom of the market. It could be a long and drawn-out bottom but, nonetheless, I think that we’re close to a bottom.

This makes it a very good time to be accumulating mineral exploration assets or junior exploration companies. It assumes an investor has the patience and financial ability to wait for the next bull market and stay with the trades. Remember that junior exploration companies don’t generate revenue. If the bear market is protracted, these companies will need several rounds of financings in order to stay alive.

TGR: You also invest in silver, base metals and energy. Are some of these sectors doing better than others?

PvE: Copper, like gold, is very expensive. So is silver. The other base metals, such as aluminum, zinc, lead and nickel, are much more reasonably priced. Oil is also very reasonably priced at $85/barrel. I see less systemic risk in those sectors than I see in gold, silver or copper.

TGR: What specific companies do you like in those sectors?

PvE: I have recently acquired additional shares of both Miranda Gold Corp. (MAD:TSX.V) and Evrim Resources Corp. (EVM:TSX.V). I’m on the board of both of those companies and so I am not at all independent, or impartial.

I also recently acquired shares of a company called Millrock Resources Inc. (MRO:TSX.V). And I continue to scour the market for more opportunities. I intend to be a buyer of mineral exploration companies for the foreseeable future.

TGR: Why do you like those three?

PvE: All three of those companies share one element that is critically important. All have competent, experienced management and they have management that I trust: trust that they’re not going to squander the money that we give them and trust that they will use their best efforts to create shareholder value. It is my confidence in management teams that causes me to invest in mineral exploration. Mineral exploration is a business about ideas. It’s not about assets. And when you’re dealing with ideas, the asset that you’re de facto buying is people—it’s management.

TGR: You say that you’re doing this for the long term. How long do you think that you’ll have to wait?

PvE: Who knows? 5, 10 years? Maybe we get lucky sooner. Maybe we don’t.

TGR: Thanks for your insights.

Paul van Eeden is president of Cranberry Capital Inc., a private Canadian holding company. He began his career in the financial and resources sector in 1996 as a stockbroker with Rick Rule’s Global Resources Investments Ltd. He has actively financed mineral exploration companies and analyzed markets ever since. Van Eeden is well known for his work on the interrelationship between the gold price, inflation and the currency markets.

Fund Managers Face Off in the Quest for Mining Profits

Adrian Day Brian Ostroff Buy and hold or go for the tenbagger? Two successful money managers, Adrian Day and Brian Ostroff, sat down with The Gold Report at the Hard Assets Conference to share their forecasts for 2013. Although the two have very different investing approaches, they came to some of the same conclusions about the future of gold and the companies that could make it through the next cycle.

The Gold Report: Adrian, you are a long-term, value investor. That makes company selection critical. How do you evaluate what companies would fit your needs?

Adrian Day: We manage money in all areas, not just gold and resources. I try to find good quality companies, buy them when they’re selling for less than their value and hold on to them for a long time. I tend to be a very patient holder so long as the company itself doesn’t change course or make disastrous decisions. I’m much less concerned about the outside environment so long as the company is doing what it said it was doing and continuing to grow, or earn cash flow. We have some very, very long-term holdings. In fact I just sold HSBC Holdings Plc (HSBA:LSE), which was the first stock we bought in 1991. That is an extraordinarily long holding period.

TGR: What made you decide to sell?

AD: I have been concerned about HSBC for a little while. I think the culture has changed. It made some disastrous mistakes in the U.S. sub-prime market. The potential criminal investigations in the U.S. on money laundering and in the UK on mis-selling mortgages made me think that maybe it was just time to get out. And the overall environment, frankly, for banking stocks is not positive. So we decided to move out.

We apply the same philosophy to gold and gold stocks. I’m not a geologist; I can’t look at a particular property and say, “Wow, that’s a great property about to be drilled; let’s buy it.” I tend to buy companies that have good business plans, good management and good balance sheets, which I think can grow over time.

TGR: Brian, you describe yourself as more of a prudent speculator. How do you pick companies?

Brian Ostroff: Unlike Adrian, we are not generalists. We operate two funds. One is natural resources as a whole and one is specific to mining. Where our funds really differ is that most of our partners are technical. They are geologists, mining engineers, metallurgists and the like. That allows us to look at situations a lot earlier than more traditional investors. I have always said that if we are going to take a big position in a select company, we need to understand why it has the potential to be a tenbagger. We also like lesser-known or lesser-appreciated commodities. That allows us to be the first movers in a particular commodity, hopefully in the best companies in the space because we can do our homework before the rest of the investing public starts to turn on to the theme and we enjoy the quick lift.

TGR: When we last interviewed each of you, you were both pretty optimistic—or at least not negative—about the timing for buying select junior companies. After all the volatility of late are you still feeling that way?

BO: I’m still very positively inclined toward some of the juniors. The key to the juniors is that we need to see the seniors perform better. We got really bullish in the summer about the seniors, which is not usually our space, except as a catalyst for money to come back to the juniors. The seniors had a wonderful lift of 20–30% off of their lows. A lot of that came from generalist funds as opposed to resource-specific funds. Unfortunately, what happened about three weeks ago was that just about every one of these major companies missed their numbers by a wide margin. A lot of the gains that came about from the summer have evaporated and I think a lot of the generalists’ funds have exited the sector. That has probably pushed back the timeline for some of these juniors to wake up.

“I tend to buy companies that have good business plans, good management and good balance sheets, which I think can grow over time.”
–Adrian Day

One thing, however, that is very encouraging is seeing some of the M&A activity, not so much the seniors buying the juniors, but mid caps buying into the juniors. I think that this will ultimately prove out the thesis that there is value in select juniors.

TGR: Is that one of the things you look for when evaluating whether the company could be a tenbagger or whether it is an acquisition target?

BO: Certainly, we try to understand what the drivers could be when we make an investment. One of our larger holdings, d’Arianne Resources Inc. (DAN:TSX.V; DRRSF:OTCBB; JE9N:FSE), which is actually a phosphate play, is an example of a company we believe could be taken out.

One of our largest holdings in the gold exploration space, Adventure Gold Inc. (AGE:TSX.V), is held for other reasons. Although the company could be acquired, for us it’s more a matter of the parts being worth a lot more than the whole. The company has done a very good job cutting some deals on some assets while focusing on other assets that have been cheaper to move forward, thereby getting a lot of value from a little bit of money in the ground.

TGR: Adrian, in addition to juniors, you look at producers and royalty companies as well. What are you most excited about right now?

AD: Like Brian, I’m overall positively inclined to the sector, but Brian mentioned a very important word: “selective.” It is so critical to be selective right now, particularly in the junior space as so many simply don’t have enough money to last. Canadian companies can always raise the money. The question is on what terms. That is not good for the sector if they are issuing highly diluted shares. It increases the supply of stock without increasing the demand.

“If we are going to take a big position in a select company, we need to understand why it has the potential to be a tenbagger.”
–Brian Ostroff

The senior gold stocks have been selling at pretty much the lowest valuations on many metrics, ever. In June, the Philadelphia Gold and Silver Index (XAU) was cheaper on cash flow, earnings, book value and dividend than the S&P. I don’t remember the last time that happened. Even after the recent rally, the senior producers are still selling pretty much at their low point relative to bullion. In June and July, we loaded up on seniors, including Barrick Gold Corp. (ABX:TSX; ABX:NYSE) and Newmont Mining Corp. (NEM:NYSE), because they were just so ridiculously inexpensive. By the first week of October we sold virtually all the shares we bought. That is not my normal style, but it’s difficult for me to be fundamentally positive on the senior producers as companies because they have let us down time after time. Barrick had an original cost estimate on Pascua Lama a little over $2 billion (B) and year after year it’s gone up. Now it’s at $8.5B. If you look at the senior mining companies on a 50-year basis, they have a negative return on equity. They are horrible companies. I see selected juniors as long-term core holdings.

I am also a big fan of royalty companies. The business model obviates a lot of the negatives in mining. And let’s be honest, mining is a very difficult business. They say Murphy works overtime; things can and do go wrong. But royalty companies tend to obviate all of that because for the royalty company, the first dollar in is normally the last dollar in. In other words, when the royalty company decides a royalty is worth $200 million (M), it pays $200M. It may never get a penny out of that royalty, but that’s the worst that can happen. It is not obligated to put more money up. It is not obligated to talk to the government to try to negotiate tax rates. And if tax rates go up, it doesn’t really matter because most royalties are net smelter returns, on net profits. It is a return on what is produced and it doesn’t matter if the tax rate goes up or the company has to move a village; it’s all irrelevant to the royalty company. I like the royalty model a lot. Nobody would confuse royalty companies with Graham & Dodd value investments. Royalties are expensive. Franco-Nevada Corp. (FNV:TSX; FNV:NYSE) is now trading at about 45 times earnings. It is my favorite. It has $1.2B in cash on the balance sheet. It generates over $300M of free cash flow each year. Earnings should double in the next three years absent any new acquisition, and absent any increase in the price of gold. Earnings will double in three years just from the new royalties coming onstream. So I’m a big fan of the royalties as core holdings.

TGR: How does the current political environment, including the pending fiscal cliff, impact your positive view?

AD: I think the results of the election were positive for gold. Obama’s reelection removed the threat that Federal Reserve Chairman Ben Bernanke would be leaving anytime soon and the monetary policy would change. That’s a terrible thing for the economy, but it’s very positive for gold.

We also have the same make up of Congress that we had before the election and six weeks to come up with a comprehensive solution to the U.S. deficit. One would like to think the politicians have learned their lesson. But they are just going to put it off for another few months so they can study it more. I do think the headlines won’t be so outrageous because politicians remember what happened in 2011 when we had those last minute negotiations over the debt ceiling and the gold price went up dramatically.

TGR: Because the dollar crashed?

BO: Actually, the dollar did not crash. You know it’s one of those ironies because what happened was that as a result of the U.S. losing its top-tier credit rating, everyone freaked out and in a rush for safety went out and they bought the U.S. long bond. In order to buy the U.S. long bond, they had to buy dollars. But gold did go up at the same time. Many believe gold acts inversely to the U.S. dollar. But that’s not really the case. Gold is a currency and, in a free market, currency buyers have a choice: they can buy dollars, euro, yen, sterling or gold. They are not inversely related; preferences just shift. I think that it’s possible to be bullish on both gold and the U.S. dollar.

“The beautiful thing about contrarian bets is you can put in a little bit of money and get a pretty big payoff.”
–Brian Ostroff

What I worry about is that the fiscal cliff will probably, as Adrian says, get pushed down the road. People need clarity. Even if you don’t necessarily like the solution, companies can at least know what the playing field looks like and start to do what they have to do. That will solve the money problem. There is more than enough money out there; what is important is the velocity of money. Trillions of dollars are sitting on corporate balance sheets. That money is not going anywhere until people figure out the ground rules.

AD: One thing we do know with some certainty is that investment taxes are likely to go up. After the election, people started selling stocks that paid high dividends and had long-term capital gains along with oil companies that probably won’t do well under a Democratic administration.

BO: As a Canadian, I’m amazed at how ugly and polarized politics in America are. People are going to have to learn to get along with each other.

TGR: Are people getting along better in Europe and are there any signs from Europe you are looking for that could support or hurt gold prices or gold equities in 2013?

BO: That backdrop is actually very bullish for gold. Gold prices should continue to appreciate if only due to scarcity. I don’t know how the euro ultimately ends, if it ends, if you have a Northern euro and a Southern euro, but people don’t like uncertainty and the Euro is a very uncertain currency. That is bullish for gold. Maybe the answer is gold-linked debt. Let the investor choose between Spanish paper bonds at 5.50% or a bond at 0.50% backed by gold and interest paid in gold.

Europe’s problems are not a huge drag on the U.S. economy because those countries are not big trading partners, but it is negative for China because it is reliant upon European consumers to buy products.

TGR: Adrian, you talked earlier about companies having to dilute their stock in order to get money. Are juniors going to have any better of a time in 2013 getting capital for projects?

AD: A lot of companies will come to market in 2013. In the last couple of weeks, a half dozen companies that didn’t actually need the money went to market for funding, which is smart. If you don’t need the money, you can demand better terms than when you are desperate. But a lot of companies are very, very low on cash.

BO: Things are a lot worse for the juniors today than they were in 2008. In 2008, most of these stocks lost 90% but they didn’t stay down long and the window opened up for financing pretty quickly. Today, these stocks are down 70% (on average) but the window for financing has by and large been shut for 18 months and doesn’t look too encouraging for the immediate future.

AD: And many of them had raised money in 2007, so there weren’t that many companies that were desperate.

BO: Right. A lot of these companies are hard up for funding right now. More advanced companies with an asset are getting creative. We just provided a credit facility for one of our portfolio companies, d’Arianne. We like the asset. We believed that the share price didn’t reflect the value of the company and didn’t want to see the company issue more stock. This should take the company through a couple more milestones at which point we think they’ll be in a better position to raise money. You will see more creative debt deals like that.

AD: Another type of deal we are seeing more of is royalty companies that for relatively little money at the pre-development stage, get a royalty on future production. That gives the company the financing it needs when it needs it. We are seeing more and more of that.

BO: The reality is that there is a limited capital pool for juniors. And it’s a shame when some of these companies that are really not deserving get money because that leaves less capital for companies that are deserving. It would be very cathartic if a lot of these companies went away, leaving capital for the ones that have a legitimate chance of success.

TGR: So how do you determine which ones are deserving?

BO: It really takes four pieces: the rocks, management, financing and good investor relations. If you do not have all four of those, you are not going to tenbag. Sadly, some companies have just the investor relations piece and they get the money.

TGR: Based on all of the factors we have discussed, how are you adjusting your portfolio? What are you doing for 2013 to be better positioned?

BO: As I mentioned, we focus on lesser-known commodities. Our largest holding, the phosphate company d’Arianne, plays on the theme of security of supply. No one really understands the dynamics of the phosphate market. It is one of the three components for fertilizer—potash and nitrogen being the others—and the only one that North America is not self sufficient in. I can probably do without my iPad if there is a problem with getting the rare earths, but I’m probably not going to be able to do without eating. Morocco is the prime player in phosphate. Other players were Tunisia, Egypt, Syria and those stories didn’t end particularly well. To be fully vertically integrated, North Americans have to mine their own phosphate rock. d’Arianne has a world-class deposit in Quebec and makes a very pure form of the concentrate. It has put out a prefeasibility study that shows a $1B net present value (NPV). If you were to plug in the price of the type of phosphate that it produces, you are closer to a $3B NPV. It has top-notch management and a sub-$100M market cap. We got in lower, but even from this level I think that you could get a multifold move. With the money it has now, it shouldn’t have to raise money through the end of 2013. That takes the company through a full bankable feasibility study and quite a ways through permitting.

The real kicker is the possibility of an acquisition and the math on this is simple. To us, anyone who is not fully vertically integrated and has a decent balance sheet is a logical buyer. For example, Agrium Inc.’s (AGU:NYSE; AGU:TSX) Kapuskasing mine is closing within the next six to nine months due to depletion, which will add to the company’s deficit by 1 million tons a year. The Mosaic Co. (MOS:NYSE) has publicly said it is looking to buy phosphate rock property because it is reliant on imports to make up its shortfall. Third party producers (such as the Moroccans) charge roughly $200/ton while d’Arianne will produce at roughly $90/ton. At 3 million tons a year and a $110/ton savings, this would result in $330M margin growth if one owned d’Arianne. That is real money and that is not even considering the security of supply issue. Even if one of those companies bought d’Arianne for $350M, which would be about $4/share, and put $700M into production, which for those companies wouldn’t be a problem, it has a three year payback with 20, 30, 40 years of production and no worries that one day you are going to wake up and those pictures you see on TV are not Benghazi, but Rabat or Casablanca.

TGR: What other lesser-known sectors are you shifting to?

BO: Although it doesn’t qualify as a lesser-known commodity, gold certainly qualifies as a lesser-appreciated commodity and that is amazing to me. People are talking about how poor gold is acting at $1,720/ounce (oz). We are $200/oz off of our all-time high and everyone hates gold. So I think that if we can click through $1,800/oz we will get a pretty good run.

Our favorite name there is Adventure Gold. That is one where the parts are worth a lot more than the whole. The company only has a $20M market cap. In the next week or two it will put out its initial resource calculation on its flagship property, the Pascalis. I think that is going to show that just that one property is probably worth two to three times the company’s entire market cap. In addition, the company does a very good job of assessing properties. It has done deals with Lake Shore Gold Corp. (LSG:TSX) and Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE) to move forward projects that would be expensive to do on its own. Adventure Gold also has a great portfolio of properties including a land package up in Detour just to the eastern side of Detour Gold Corp. (DGC:TSX). It is intertwined with Balmoral Resources Ltd. (BAR:TSX.V; BAMLF:OTCQX), which has done very well. It is probably the best property finder we have come across and has top class management. At some point it will get some attention, which should result in a considerably higher stock price.

TGR: What is your distribution of physical gold vs. junior and producer?

BO: We really don’t own any physical. We have some iShares Silver Trust (ETF SLV:NYSE), which is the silver exchange-traded fund (ETF), but our focus really is in the juniors.

TGR: Adrian, how are you adjusting your portfolio?

AD: We own about 10—11% physical gold and ETFs and we are increasing our holdings of physical gold, which to us is a sort of bedrock of the portfolio. Over the last several years, we have moved away from the senior producers toward exploration companies. We are about 27% in seniors right now and that includes the royalty companies. In fact half of our seniors are royalty companies. Most of our money is in exploration companies. But, again, I am not a geologist so I tend to look at companies that have a business plan that I like that enables the company to stay around. One of the big problems in this business is that when things go wrong you don’t get just a 10% or 20% haircut; you get 70%, 80%, 90% price declines. One of the keys to being successful is to try as much as possible to avoid huge declines.

One company we like a lot is Virginia Mines Inc. (VGQ:TSX). It started as a prospect generator, but it has gone way beyond that now. It has about 27 different projects. About 11 of those projects are active with joint venture partners. But it also is doing a lot of work itself now. It has a strong balance sheet, over $40M in cash and it gets money from its joint venture partners for managing the projects. The cash balance tends to increase year over year even though it is not actually producing anything yet. It also enjoys a royalty on the Éléonore deposit it sold to Goldcorp Inc. (G:TSX; GG:NYSE). After the second full year of production, if gold stays above $1,500/oz, Virginia will earn $30–35M a year in free cash flow for 17 years. The company’s market cap is only around $300M. A net present value on the future cash flow will show that the royalty is actually worth more than the market cap of the entire company. That royalty could be sold tomorrow in a heartbeat. It means the company never has to raise money again if it doesn’t want to. It also has a nickel deposit ready to sell to somebody when prices get better. The gold resources, joint ventures, exploration, everything else is free. I like that one a lot and continue to like it. It’s about $9.80/share right now so it has gone up quite a bit, but is still cheap compared to the value. And of course the closer we get to the last quarter of 2014, when Goldcorp commences production at Éléonore, the more valuable that royalty becomes. The discounted value of the future cash flow gets higher as it gets closer to actually earning the money. So it is logical that this stock is moving up.

We also like stocks that look as though they have the potential to be really big in the long run. I think back to Diamond Fields Resources Inc. in Voisey’s Bay in Newfoundland. We were buying all the way up. We were buying at $2, at $4, and $8/share. We were even buying at $30/share because the higher the stock price went, the closer to the actual deal the asset was worth. At $30/share it was probably a better buy than it was at $2/share, frankly, on a risk-reward basis. One that we view similarly, even if it doesn’t have the exact same performance, is Reservoir Minerals Inc. (RMC:TSX.V), which has a spectacular copper discovery in Serbia. Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE) is a joint venture partner. Freeport’s doing all the work and has released the assays from two absolutely spectacular drill holes. One of the geologists said to me that he had never seen a drill hole that looked better in his life.

TGR: One last prediction for 2013?

BO: I’m going to go with a contrarian view. I wouldn’t put 100% of my money on this bet, but the beautiful thing about contrarian bets is you can put in a little bit of money and get a pretty big payoff. Everyone is having the discussion about whether China will have a hard landing or soft landing. We are getting more comfortable with the thought of no landing. Therefore, we are in the process of looking at some very cheap assets because everyone thinks China is about to hit the wall. If China doesn’t hit the wall, that’s how you get a tenbagger. You probably get a three- or fourbagger just on the relief.

AD: I agree. I like to quote Mark Mobius: “I think China is still flying.” We buy very few Chinese companies. We are concerned about the books and local government interference with businesses. One we have bought recently is Sino Agro Foods Inc. (SIAF:OTCBB), a dairy company. It trades on the OTC and it’s extraordinarily cheap.

We are also buying some European companies outside the Eurozone, but frankly are not really considering the strength of the euro. We are looking at holding companies trading at big discounts, companies like Pargesa Holding S.A. (PARG:SW), a Swiss company that owns shares in Total S.A. and Suez S.A. and GDF Power, Imerys S.A. and Pernod, the spirits company. It has cash on the balance sheet, yields over 4%, is actually selling at a 28% discount to the value of the publicly traded shares it owns. That is a margin of safety. A similar situation is Investor AB Series B (SE:INVEB:STO), a Swedish company run by the Wallenberg family. It is a good, long-term value investor focused on Scandinavian companies and trading about a 25% discount to the value of the shares it owns. And again a pretty good margin of safety.

TGR: We will have to check back in on both of those next year to see if you are right. Thank you for taking the time to talk to me.

Adrian Day, London born and a graduate of the London School of Economics, heads the eponymous money management firm Adrian Day’s Asset Management (adriandayassetmanagement.com; 410-224-2037), where he manages discretionary accounts in both global and resource areas. His latest book is “Investing in Resources: How to Profit from the Outsized Potential and Avoid the Risks.”

Brian Ostroff is a managing director at Windermere Capital, where he focuses on the junior and mid-tier mining sectors. He brings over 25 years of small-cap mining expertise to the table, having served at RBC Dominion Securities and as a managing partner at Goodrich Capital, an M&A advisory firm. Prior to joining Windermere Capital in 2009, Ostroff spent four years as an independent proprietary trader.

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Rick Rule: Be a Risk Manager, Not a Reward Chaser

Rick Rule The Gold Report met up with Rick Rule, founder and chairman of Sprott Global Resource Investments Ltd, at the Hard Assets Conference in San Francisco. In this interview with The Gold Report, he shares his belief in the power of gold as both “catastrophe insurance” and an investment vehicle. As to equities, he sees a new discovery cycle lifting the prospects of majors and juniors alike, as long as they act like “rational” businesses.

The Gold Report: Rick, you believe the natural resources sector is experiencing a cyclical decline in a secular bull market similar to the 1970s. Is that true for other sectors as well?

Rick Rule: I learned the hard way not to assume that my success in the natural resource business was transferable to other sectors, so I am going to stick with resources.

However, there are parallels with the gold market. In the 1970s, we had a spectacular resource market, in particular for gold. Its price soared from $35/ounce (oz) to $850/oz. By 1975, in the middle of that secular bull market, gold had fallen to $100/oz. Those who sold at the bottom missed an 800% move in six years.

“I own gold the way that I own life, auto or homeowner insurance. I regard it as catastrophe insurance.”

It is important to understand that in cyclical markets like resources, declines in secular markets are to be expected. From my point of view, you need to understand cyclical declines for what they are—sales.

TGR: Is it fair to think that the prices of natural resources will bounce back as they did in 1970s, when the recession was much shorter and not as global?

RR: That depends on the resource. For gold, the answer is yes because the parallels between the 1970s and today are striking.

The U.S. dollar has stayed fairly strong, not because of the strength of the economy but as a function of the dollar’s liquidity. As the U.S. dollar appreciates relative to frontier and emerging market currencies, we are causing very real inflation in places like India, Vietnam and South Africa.

In the U.S. however, we are seeing inflation in two places: in the liabilities that we are leaving for our heirs and in a tremendous bond bubble. The prices of U.S. Treasury securities, the inverse function of the yields, suggest that we are in the biggest economic bubble in history.

When the U.S. went through the economic turmoil of the 1970s, we went into it with a much stronger national balance sheet than we have today. Then, we had the ability to capitalize our reconstruction while we serviced our debts. I am not sure we have that ability anymore. Our federal on-balance sheet and off-balance sheet liabilities, relative to our ability to service those obligations, are much lower. The alternative is to inflate our obligations away, which would be good for bullion.

Finally, in a demographic sense, our needs will continue to outpace our means. In the 1970s, you and I were coming into our productive years. Today, you and I are at the opposite end of our productive years, no matter how much we want to forestall it. The demographic implications of that are profound. If a country cannot produce its way out of its deficit, it has to default.

TGR: Or quantitative ease.

RR: That is a form of default. There are two ways to default. You can renounce your obligations or you can lie. Quantitative easing (QE) is the lying part. You depreciate the currency that your obligation is in.

TGR: But with the entire world in that situation, are we in a cyclical decline or is the bull market over, specifically for gold?

RR: The West is in for a period of muted demand for commodities. As the advanced economies become less free and poorer, and frontier markets become more free and richer, it will lead to volatile demand characteristics for many industrial commodities.

“Increasingly, investors are telling management teams to be rational.”

Overall, I am afraid that the circumstances ahead of us will be very good for all precious metals. Traditionally, gold has been a great way to avoid the impact of chaos. When other exchange mechanisms—yen, renminbi, euros, dollars—are engaged in competitive devaluation while managing a staged default, people will look for a medium of exchange that is also a store of value: gold. It is not a promise to pay; it is payment.

TGR: Does more QE portend that gold or equities will be a better return?

RR: They are very different asset classes.

Rationally, I might not be well advised to own any gold at all because I have so much of my net worth tied up in my business, which reacts to the gold market. Nonetheless, I own a lot of gold, silver and platinum bullion. I own it the way that I own life, auto or homeowner insurance. I regard it as catastrophe insurance.

I would suggest that your readers establish a core or insurance position in bullion and hope to God that later on they can regard that investment as a waste of time and money.

TGR: Over the last several years, if you bought gold for its investment return, you would have done better in bullion than in equities. Why do we keep telling people not to look at physical gold for investment return when it has outperformed equities?

RR: I would not discourage that either. It is implied at the Hard Assets Conference that rising gold prices will affect the share prices of the exhibitors, most of whom have no gold; they are looking for gold. If the price of something you do not have goes up, it should not have any impact on your share price.

As for the companies that do have gold, their performance over the last 10 or 12 years has been pathetic relative to the increase in the price of the commodity that they produce. That said, I believe we are through the worst of that. We should see the senior and intermediate gold companies begin to perform surprisingly well at the corporate level.

TGR: Why?

RR: The companies have learned lessons. Investors asked mining companies to exhibit, as an investment characteristic, leverage to the commodity price. In other words, we asked them to be marginal. Marginal producers enjoy the most outsized gains in an escalating commodity price environment. The industry gave us exactly what we asked. They became extraordinarily marginal and inefficient.

Four years ago, an irrational metric appeared that sticks in investors’ minds: ounces of gold in the ground per dollar of enterprise value. You divide the enterprise value into the number of ounces, without taking into account the capital cost of bringing the ounces into production, the cost of extracting the gold or the time value of money. Ounces were valued irrespective of whether or when they would be recovered.

“The first point of attraction for juniors is that the major mining companies, in order to stay steady—much less grow—will have to acquire deposits. “

Increasingly, investors are telling management teams to be rational. They are telling managements, “In addition to giving us some leverage to the gold price, it would be nice if you made money. We do not want to see you buy 20 million ounces at 5,000 meters (m) in the Andes, only to have to spend $7 billion to bring the deposit on and generate an 8% internal rate of return (IRR) with a 7-year payback. We would rather see you do something that generated a 30% IRR with reasonable amounts of capital where you pay back the capital in three years.

Investors are asking the gold mining business to become a business. That is not too much to ask.

TGR: But in your opening remarks at the Geo Tips seminar, you noted how many of the publicly held mining companies have no gold. That seems contradictory.

RR: There is no contradiction. We want the producing companies to be rational. With regard to the juniors, 80% of them have no net present value (NPV).

The attractiveness of the juniors is twofold. The junior share prices have all been taken down, the good companies along with the bad. There are probably 20 developmental-stage juniors selling at substantial discounts to the NPV of their existing deposits, even though those deposits will grow through exploration. The major mining companies know it will be easier to buy that resource than to discover it. So the first point of attraction for juniors is that the major mining companies, in order to stay steady—much less grow—will have to acquire deposits.

The second thing, and it is somewhat hidden, is that we are coming into a discovery cycle. In the next 12 to 24 months, we are going to see reasonable, maybe spectacular, discoveries with increasing frequency. This is a market that rewards tangible results, for example, GoldQuest Mining Corp. (GQC:TSX.V) going from $0.06/share to $2/share; Reservoir Minerals Inc. (RMC:TSX.V), $0.30/share to $3/share; Africa Oil Corp. (AOI:TSX.V), $0.80/share to $10/share. There is nothing like discoveries to add hope and liquidity in the junior market.

TGR: How does an investor know when to jump into a junior exploration market?

RR: That is a big topic. In brief, the dynamic changes from market to market. You need to figure out which parts of the market are unloved and, hence, available. You have to pay attention to where the values are and set your strategies not by what you wish would happen but by the facts represented by pricing in the market.

The most common mistake I see speculators make is regarding the market as a source of information. It is not. It is a mechanism for buying and selling fractional ownership of businesses. Getting your information from the market is the same as getting your information from the expectations of 10,000 people who probably know less about the topic than you do.

TGR: But can an investor use catalyst events like a preliminary economic assessment (PEA) or a drill result to minimize the risk?

RR: The beauty of a bear market is that people’s expectations are so low that many companies sell off on news, even news that is not truly spectacular. For the first time in my career, I see developmental-stage juniors with PEAs selling at substantial discounts to the admittedly speculative values established in the PEA.

We look for three things in a company: One, the sum of the enterprise value of the issuer and the front-end capital costs are lower than the NPV at today’s gold prices. Two, IRRs above 25% but preferably about 30%. Three, capital payback within three years. I have not seen these three things come together very often in my career, but they are occurring right now.

With a good deposit, a couple of things will happen between the PEA and the bankable feasibility study. In the two years it takes to get from PEA to bankable feasibility study, the deposit is likely to be bigger and higher grade. More important, the bankable feasibility study gives legal cover to the outside directors of an acquirer. It takes courage to take over a company based on a PEA; with a bankable feasibility study in hand, you are covered.

Canplats Resources Corp. (CPQ:TSX.V) is a recent example. For a long time, it traded at a substantial discount to the indicated value of the deposit established by the PEA. In the two years between its PEA and bankable feasibility study, the stock chart looked like the electrocardiogram of a corpse. Within eight or nine weeks of the bankable feasibility study, Canplats had three takeover offers. The professional risk to the acquirer’s board of directors was effectively eliminated. That was the catalyst.

TGR: You mentioned earlier that the majors have to acquire. How much does proximity to a major increase the likelihood of a junior being acquired?

RR: Being next door to an existing operation lowers the total cost associated with the acquisition. Because the infrastructure costs have already been paid, the major can afford to pay more for you.

TGR: But there also is no bidding.

RR: That is the bad news. It is tough to have an auction with one bidder.

There are two positives in this market. First, compared to 2010 at least, it is cheap. And cheap is good. Second, some of those cheap companies are also good companies. Granted, investors may not get huge premiums in a takeover, but a probable 40% or a 50% premium today is better than a mere possibility 12 to 24 months out.

The wild card that few people are focusing on is this discovery cycle. Having a low-cost entry point in 2012 is preferable to a high-cost entry point in 2010, in particular because we are two years further into the exploration cycle and the payoff is closer. People are going to make tenbaggers or fifteenbaggers.

TGR: Rick, I know you like the prospect-generator model. Would you advise investors just coming into this market to start by investing in prospect generators?

RR: Because prospect generation is such a rational approach, most people cannot do it. Most people come into the exploration sector for emotional reasons. They want to believe the newsletter propaganda, “I made 603% in seven trading days.”

If you want to take emotion out of the exploration business and focus on cash and cash returns over time, you can pursue a portfolio strategy that will give you three standard deviations of superior performance over a decade. You have to manage your hope and be willing to watch your portfolio decline 30% or 35% in a bad year.

TGR: It really comes down to a risk-appetite decision.

RR: You just put your finger on the most important part of the equation. If you are engaging in a high-risk, high-return activity, returns take care of themselves. You have to manage risk.

The expectation of exploration has to be failure. When most of your investment decisions are unsuccessful, your winners have to amortize your losers. Every step that you take in building a speculative portfolio has to be a step taken with the view to minimizing portfolio risk in an extremely risky activity.

Most speculators are reward chasers not risk managers, which is why most people who come into the sector fail.

TGR: You have long been involved in debt financing. Is that on the increase?

RR: Yes, for a couple of reasons. First, we have had 10 years of extraordinary equity investment in resources. That builds up collateral for a lender. Today’s collateral values in the mining business are orders of magnitude better than they were 10 or 15 years ago.

Second, equity costs companies money now. In 2009 and 2010, underwriters and speculators were throwing equity at companies. Now, equity issuers believe, rightly or wrongly, that they are selling at 30 or 40% of net asset value, which makes issuing equity very expensive. Companies realize that coming to us as bridge or mezzanine lenders is substantially cheaper than equity financing.

Oddly enough, the market often sees that these companies need capital and prices the equity down in anticipation of an offering. If the company borrows $30–35 million from us, the pressure comes off and its market increases by 25% or 30%. The company can then raise what it needs to pay us back in the equity markets.

Now is the best set of circumstances to be a bridge or mezzanine lender that I have seen in 30 years in the natural resource markets.

TGR: Do bridge and mezzanine financing carry less risk with slightly less yield?

RR: Yes. In effect, it is junk debt, but not the kind that Wall Street offers up. As lenders, we will not make a tenfold return, but we have a probability rather than a possibility of 15% compounded annual returns with much less risk.

TGR: How does one get involved in debt financing?

RR: You can own shares in us or participate with us in private lending syndicates. You can also buy shares in Dundee Bank Corp. or Macquarie, the Australian bank. There are also public markets for high-yield or junk debt, primarily in Canada. There are some very nice bond issuances in the mining and the oil and gas sectors with returns in the 7.75–8% range.

TGR: At the conference, you are talking about The 9 Nosy Questions to Ask Mining Experts. What is the one fatal question investors do not ask?

RR: Can I have two?

First, you must ask a management team to describe its track record of success. For example, a promoter might tell you he operated a gold mine in Precambrian rocks in French-speaking Québec but his new project is exploring for gold in tertiary volcanics in Spanish-speaking Peru. It is important to understand management’s track record of success in an endeavor that is relevant to the current situation. Investors are not discerning enough with regard to the specific expertise needed in every task.

The second thing that’s critical is to ask management how funding will be obtained. Reward chasers will sit at a booth and the promoter will say we have 800,000 oz (800 Koz), we’re going to drill 50,000m, there’s going to be this new flow, we’re going to do this and we’re going to do that. What the investor has to say is, hmm, interesting, so how much money is this going to take over 18 months? How much general and administrative (G&A) expense do you have? What’s the relationship between G&A expense and exploration expense? If you don’t have the money, why am I listening to you? Many times I’ll be on the exhibit floor and somebody will have a $10M exploration budget and a $3M G&A budget, so there’s $13M to answer my unanswered question. And they have $2M in the bank. I say to them that I don’t really have to listen to you anymore because you’re $11M away from giving me the answer that’s going to get me an increased share price.

TGR: But isn’t that what you do in your private financings?

RR: Sure. If I can answer the question as to where the capital is coming from, then I’ve removed the risk. But if I can’t, I won’t.

TGR: So absent the ability to go into private financings, you need to have the money to answer the questions.

RR: Yes, absolutely. I’m not suggesting this is a recommendation. If you talk to a prospect generator, Altius Minerals Corp. (ALS:TSX.V) might be an example, its exploration budget this year may be $20M, and joint venture partners are going to spend $17M of that. So its net exploration expenditure is $3M. Its G&A budget is $2M. So it needs to find $5M and it has $180M in cash and securities. The question is answered. You have a yes. You see another company, however, that is operating on its own nickel, whose budget is five or six times the cash it has, and if it can’t give you a very, very, very good answer as to where it is going to get the money, you get to walk away.

About 20 years ago probably, I gave a speech at one of the predecessors of this conference, the Boston Gold Show. After I got offstage and changed into casual clothes, I was wandering around the exhibit hall. A particularly aggressive salesman tackled me, brought me in the booth and went on and on about all the stuff he was going to do. I said that’s very interesting. It’s going to cost a lot of money. How much money do you have? He said, well, that doesn’t really matter; I said tell me more. I didn’t have my nametag on. He said that there’s a really, really hot California stockbroker named Rick Rule. I said that I have heard of that guy, he spoke here. He said that he’s going to finance us. I said, is that so? He said the opportunity really is that Rick doesn’t like to finance things below $2/share, and our stock is at $0.60/share. When we get it up to $2/share, he’ll finance us and, in effect, you can leverage off his money. I asked why would he do that? He said that’s just the way he is. So at that point, I got out my driver’s license and I said I know this Rick Rule guy really well.

TGR: Rick, any final words of wisdom for our readers?

RR: It’s important to understand that part of this business involves painting dreams on a piece of paper and marking up the paper based on the dream. With 4,000 companies out there, the game is not finding something to invest in. The game is throwing away stuff quickly so that you are not wasting time on the dross.

TGR: Rick, thank you for painting a rational approach to gold investing for us today.

Rick Rule, founder and chairman of Sprott Global Resource Investments Ltd., began his career in the securities business in 1974. He is a leading American retail broker specializing in mining, energy, water utilities, forest products and agriculture. His company has built a national reputation on taking advantage of global opportunities in the oil and gas, mining, alternative energy, agriculture, forestry and water industries.