Martin Armstrong:

The metals were one favorite sector where they were constantly bullish – never bearish for 19 years. But hey, the market manipulators always needed cheer-leaders to get people to buy every high so they could sell.

On the Buffett Silver Manipulation, it was PhiBro who had a shill call the Wall Street Journal and tell them I was trying to manipulate silver down because I was short. When the WSJ & I argued and they refused to print the name Buffett they demanded I give them, that forced the CFTC to act calling me to ask where was it taking place. I told them London and they called the Bank of England. When they in turn ordered all silver brokers to show up the next morning, Buffett was forced to come out and admit he bought $1 billion worth of silver but denied he was manipulating the price.

You can ask the guys at GATA. They were well aware of the first 1993 Manipulation by PhiBro (Philips Brothers). They got in bed with Buffett when he stepped in to run Salomon Brothers after they got caught MANIPULATING the US Government bond auctions. They began buying silver and the CFTC stepped in demanding to know who their client was. Now if it had been anyone else, PhiBro’s reply was they refused to tell the name of the client. Forget the law. That does not apply to New York firms. The CFTC responded saying if they could not know who their client was, then PhilBro had to exist the trade. They did and of course made a fortune for the hawkers had all the little guys buy silver just in time for PhilBro to sell it to them.

This is WHY the manipulations began to move to London. Not only did PhiBro try to get me on board, their broker walked across the floor and SHOWED my broker Buffett’s orders at the low!

To create the fundamental, they moved inventory from New York to London. They were manipulating silver as always. Playing games with the inventories. They were moving silver from New York to London where the Buffett orders were being executed. This made the US warehouse inventories drop sharply. Go look at the analysts who talked silver up on that very fundamental. If they said there was a shortage of silver and you better buy it is going to $100, then you may be dealing with a shill or a biased analyst.

Many of the metals analysts with an agenda back then hated my guts. How dare I say there was a manipulation when it was at last silver was going up instead of down. Now I was part of some covert conspiracy hell bent on suppressing the metals because I dared to say “they are back” (manipulators) and the target was $7 by January 1998. To this crowd, a manipulation is always to the downside and never up.

Go check the recommendations of analysts back then. See where they stood. The best one I heard was silver was in demand in London because it was .9999 there instead of .999 in New York.

GATA began to see the same nonsense that I did during the early 1990s. It was just that I saw the manipulations as being UNBIASED. In other words, they did not care what they manipulated as long as there was a guaranteed profit. They manipulated even base metals such as rhodium. They manipulated platinum in league with Russian politicians who strangely recalled all platinum to take an inventory. Hell, Ford Motor Company filed suit over that manipulation.

How do you distinguish a REAL bull market from a bullshit manipulation?

Most manipulations can be seen easily when you look at a market in terms of a Basket of Currencies. Why? Because a REAL bull market must take place ONLY when it rises in terms of ALL currencies. Unless that takes place, investors in some countries will be sellers while others are buyers. Here is a classic example as to why we were bearish on gold for 19 years despite the hate mail and the best attacks of the shills. The manipulators ALWAYS need to get the metals guys worked up into a fever to sell to them to make their profits and big bonuses.

So when analysts only espouse one side, be very careful. For no matter what the market, there is always a time to rally and a time to pause. Nothing is ever straight up or straight down. Anyone who portrays that is either ignorant of the market behavior, or a shill – paid cheer-leader. Putting out bogus research has been the name of the game. Unfortunately, there are just some people who are hardcore.

Markets are the same mix as politics. There are people who simply believe in a given position and no matter what you say or what evidence you present to the contrary, they will never believe it. Thus, I have NEVER been interested in preaching to the choir. I have always preferred the independent thinker – the investor who wants to really learn about market behavior and not read someone who simply supports their never changing view of the world. Nor am I interested in exchange words with those who may not be shills, but are just part of a particular hardcore group. I am cheered only when I agree, and if I disagree, I am despised. But that is expected in the retail world – NEVER in the professional institutional world.

There cannot be a perpetual bull market in anything anymore than you can stand there with your arm straight up in the air. Oh shore, you can do it briefly. But then your arm will feel so heavy you can no longer keep it up. Everything takes a pause for the same reason you sleep at night. Nothing can maintain the same energy output all the time. People come up with all sorts of excuses why they are right yet the market declines. Usually it is some conspiracy of a mythical group so powerful that they just win.

Markets collapse because EVERYONE who ever thought of buying has bought. They are now counting their profits for the next eternity. Something happens and scares the herd. Suddenly, the long try to sell but there is no bid. The market collapses in the blink of an eye. Why, because the majority has already bought and there are no new buyers to keep the momentum going. It is never some mythical short player preventing the upward advance. It is just not time yet.

Philip Tetlock, a professor of organizational behavior at the Haas Business School at the University of California-Berkeley, has been following the so called experts for some 25 years studying primarily the institutional forecasting skill of political experts. He had signed up nearly 300 academics, economists, policymakers and journalists keeping track of more than 82,000 forecasts plotting them against real-world results. He analyzed not just what the experts said but how they reasoned and how quickly they changed their mind in the face of contrary evidence. He also tracked how they reacted when they were wrong, which was of course the majority of the time. Most could not even beat a random forecast generator.

Tetlock’s research did discover that there was one kind of expert turns out consistently more accurate forecasts than others. The most important factor he discovered was not how much education or experience the experts had but how they actually thought. The best forecasters were those who were self-critical, eclectic thinkers who were constantly updating their beliefs when faced with contrary evidence instead of clinging to dogma. He found the best were suspicious of grand schemes and conspiracies and were more practical about their predictive ability. The less successful forecasters clung to the same ideas never wavering pushing the same idea to the breaking point of absurdity. These types of people were more often embraced by the media because they loved to articulate and persuade as to why their idea explained absolutely everything.

Tetlock uncovered widespread forecasting failures. Of course, there is the herd of followers who for some reason want a GURU and unrealistically expect infallibility. This may reinforce the pundits that like to put on a show and claim why they are personally better than everyone else and only their ideas are correct and when wrong, it is the result of some giant conspiracy, not their lack of ability to forecast.

The key to the future lies in the UNBIASED view of whatever it is. You cannot be married to a single position EVER! Tetlock points out that a successful analyst always qualifies their arguments with “however” and “perhaps,” while the dangerous analysts build up momentum with “moreover” and “all the more so” as they try to be more entertaining. The dangerous analyst wants to keep the clients happy and to a large extent preaches to the choir telling them what they want to hear.

The one thing about markets is that the MAJORITY just have to be wrong! Why? They are the fuel that drives the market up and down. Trap the majority either long or short and you create the fuel for the next move in the opposite direction.

So for now, it is far better to let the markets speak. As I stated at just about every conference I have ever given, there is ONLY one analyst that is never wrong – that is the market itself. The key to successful trading & forecasting is to learn how to let the market speak to you and go with the flow. It does so in both TIME as well as PRICE. Turning points are NEVER specific events, but inflection points where highs and lows take place. It would have been nice to have a low first and a more orderly advance afterwards. But markets like to create the worst of all worlds.

So for anyone who thinks he can beat the game as an analyst or trader, must remember one thing. The market is always right. To survive, we have to align ourselves with the market and listen when it speaks. This is not a game for arrogance and prognostications fixed in stone steeped in bias and dogma. History repeats – but also with a slight twist. So how high will gold go? It is a question of CONFIDENCE.

You will ALWAYS be your greatest adversary, for to succeed you must conquer your own biases, fears, and doubts. You cannot do that as Philip Tetlock has keenly demonstrated with fixed ideas. If you are married to a philosophy and will not yield and blame everyone else for conspiring against you and that is the reason something has not yet unfolded, you better see a shrink.

The Energy Report: You last spoke with The Energy Report in June 2011. What has transpired in the fertilizer and potash business since then, both in Canada and in Brazil’s emerging market?

Jaret Anderson: The tail end of 2011 saw a period of weak demand for Canadian potash. Fourth-quarter shipments at Potash Corp. (POT:TSX; POT:NYSE) dropped by about one-third year over year (YOY). General concern over the economy gave dealers an incentive to avoid stocking up their warehouses, resulting in soft shipments, higher unit operating costs and quarterly earnings below expectations. However, Potash Corp. posted a 68% gross margin in its potash segment during the quarter, making it one of the most profitable publicly-traded businesses of this scale.

Meanwhile, Brazil overtook India as the top global importer of potash in 2011, with imports of about 7.5 million tons (Mt) KCl. This figure was up 21% YOY, drawing even more attention to the country’s chronic domestic potash deficit.

TER: What should fertilizer producers expect in the next few years?

JA: We’re going to see bullish prospects for fertilizer producers over the next 12–18 months. Demand for fertilizer products is likely to remain soft in Q112, but as the spring planting season in the northern hemisphere kicks into gear in Q212, we expect markets to tighten.

TER: You put out a report last December showing a fairly large global number of both new and expansion projects in the works. How will these projects affect the supply and demand equation over the next five years?

JA: We actively track 19 different brownfield expansion projects and 26 different greenfield projects around the world, totaling ~67 Mt of planned capacity. If all of those projects were built on the timelines put forward by their respective owners, we would see a massive glut of capacity in the back half of this decade. The reality, though, is that only the best of these projects are going to be built, and those are likely to experience significant delays compared to their projected timelines. Potash demand in 2011 was about 55 Mt. If we assume demand growth of 3%/year for the remainder of the decade, that implies we’ll need an incremental 17 Mt of supply by 2020 in order to maintain operating rates at 2011 levels. That is pretty close to the 20 Mt of brownfield projects currently on the drawing board. Any demand growth beyond this 3% level or further delays of brownfield projects would tighten markets further.

TER: You don’t expect an oversupply or downward price pressure?

JA: In any commodity, things don’t go up forever. At some point, the supply-demand balance is going to shift in favor of the buyers. The next several years however, look very positive for potash producers.

TER: Saskatchewan is the potash capital of North America, and although it’s a major supplier to other parts of the world, the North American market is relatively mature. What North American potash companies are still attractive buys at this time?

JA: In my view, the most attractive greenfield potash project in Saskatchewan is Milestone, which is being developed by a company called Western Potash Corp. (WPX:TSX.V). The company has a very large in situ resource of about 3.5 billion tons (Bt) KCl and has the highest grade of any existing solution-potash mine in Saskatchewan. Milestone looks very similar to the former Legacy project of Potash One Inc., which was purchased by K+S Potash Canada (SDFG:FKFT) in November 2010 for $434 million (M). At a market cap of $200M today, we believe Western Potash represents the lowest-risk greenfield potash company in the world, with a very attractive valuation.

TER: Another Saskatchewan company you’ve discussed in the past is Karnalyte Resources Inc. (KRN:TSX). It is developing a relatively low-cost, solution-mining project. What are your thoughts on the company’s risk-reward ratio?

JA: Karnalyte is focused on a different type of project that will seek to extract carnallite mineralization at its Wynyard property. While its carnallite mineralization is only about half the grade of a project like Milestone, Karnalyte’s engineers have designed a plant that can be built in stages, which offers some advantages in terms of capital expenditures. Karnalyte’s shares suffered a significant decline in December after the company pulled a $115M financing. We upgraded the shares from “Hold” to “Buy” during December and believe that below $10/share, the company represents good value. However, it may be difficult to see performance for Karnalyte until it successfully raises capital to begin construction at its Wynyard project in the spring.

TER: Are its prospects reasonable for the company as long as the market holds up?

JA: Its shares now represent good value. That said, I believe Western has a more attractive valuation and project than Karnalyte. But there is a difference between a good project and a good stock. Because Karnalyte has taken a large hit of late, it has some decent upside, especially below $10/share.

TER: You recently visited Brazil to get a little better picture of the country’s fertilizer business. That’s a very large, growing market. Tell us what you learned.

JA: Each time I visit Brazil, I come away with more anecdotes that convince me of the need to find ways to invest in Brazil’s agricultural future. Brazil has over 400 million hectares of arable land, but uses less than 15% of it today for agricultural purposes. It is the largest global exporter of beef, poultry, sugar, coffee and orange juice, and that production should grow for many decades. The problem is that its Cerrado region is generally nutrient-poor and requires significant quantities of fertilizer. Brazil has only one operating potash mine and imports more than 90% of the potash it consumes. In 2011, Brazil was the world’s largest importer of potash, at about 7.5 Mt. The Brazilian government has set a goal of becoming fertilizer independent by the end of this decade and we believe investors should be looking for ways to gain exposure to Brazilian agriculture and fertilizer markets.

To that end, two companies we’ve focused on are Verde Potash (NPK:TSX.V) and Rio Verde Minerals Development Corp. (RVD:TSX). Verde Potash controls the Cerrado Verde project in Minas Gerais state, which contains a large, at-surface deposit of potash-rich verdete slate. The company has developed and patented a process to convert verdete slate into KCl, the same standardized product that’s produced in Saskatchewan and Russia today. This is known as the Cambridge process. It’s very exciting, as it could allow for large-scale potash production in Brazil from an open-pit operation—something that hasn’t been done anywhere in the world.

Verde Potash recently published a Preliminary Economic Analysis that indicated an operating cost of US$274/t during the early years of production, ramping up to $291/t over the 30 year life of mine as the stripping ratio increases. That would give Verde Potash the lowest delivered cash costs to Brazil of any large-scale competitor globally. The potash producers in Canada and Russia have lower operating costs, but face very large transportation costs to deliver product to farmers in Brazil. Capital costs for Verde Potash’s project are estimated at US$800/t, which is about 25% below a typical greenfield solution mining project in Saskatchewan. Based on these attractive economics, we recently increased our 12-month target to $19.00/share. With the stock trading at about $7.00/share today, this is a very interesting story.

Another name we believe offers good exposure to Brazil is Rio Verde Minerals, which controls a land package near Aracaju in Northern Brazil. It is located adjacent to Taquari-Vassouras, the only operating potash mine in Brazil. Rio Verde is still at an early stage of development, having completed drilling on its first drill hole in November. We visited the site a couple of months ago and inspected the core. We await assay results from that hole. Rio Verde plans to drill three holes at its Sergipe potash property and to publish an NI 43-101 resource during Q212. Given the strong outlook for good potash grades on the property and the company’s ideal location in Brazil, with nearby access to a port, roads, power and natural gas, Rio Verde looks to us to offer excellent risk-reward at current levels. Based on our target of $1.30/share, Rio Verde offers more upside to our target than any other company in our coverage universe.

TER: Can you elaborate on the Cambridge process you mentioned?

JA: In December 2010, Verde announced that it had patented a process to convert its verdete slate into KCl. This process was developed by Dr. Derek Fray at Cambridge University in the United Kingdom. This process was tested and optimized by Hazen Research in Denver, CO, and by FLSmidth in Allentown, PA, and SRK Consulting, which resulted in the publication of a Preliminary Economic Assesment in late January. We visited FLSmidth’s facilities in Pennsylvania last week and observed the process in operation. The process is relatively simple and bears many similarities to the cement production process. It employs a rotary kiln, like cement, but uses different inputs, namely Verde Potash’s verdete slate rock, limestone and salt. The Verde Potash KCL production process takes place at lower temperatures than that of cement, about 900C vs. cement at about 1,450C.

TER: Do you expect the Cambridge process to work on a commercial scale?

JA: It’s moved from a bench scale at a university to a pilot plant. To move to a commercial scale is another jump. Staff at FLSmidth and SRK have indicated to us that they typically see fewer problems with commercial scale facilities than they do with pilot plants. Every indication we have points to the commercial scale kiln as being well within the technical ability and experience of the teams at FLSmidth and SRK.

TER: There’s also been some development on the African continent, and a couple of Canadian juniors are working on projects there that are projected to go online in about five years. How are they progressing?

JA: Allana Potash Corp. (AAA:TSX; ALLRF:OTCQX) and Ethiopian Potash Corp (FED:TSX.V; FED.WT:TSX.V) are both working to develop greenfield potash projects in the Danakil depression in Northern Ethiopia. Allana is the much better capitalized of the two companies. It has published a large NI 43-101 resource based on its successful drill program over the last couple of years. The projects in Ethiopia are interesting in that the high year-round temperatures in the Danakil may allow for solar evaporation, thereby materially lowering energy costs in the solution-mining process. Ethiopia is also located relatively close to China and India, two important potash consumers.

Ethiopian projects face a major challenge, however, in that the logistics of moving thousands of tons of potash per day from the project site to the port at Djibouti some 600 kilometers (km) away over roads of varying quality may be a significant hurdle. We believe the transportation costs will end up being materially higher than current estimates.

Both Allana and Ethiopian Potash have seen their share prices languish over recent months and are both near 52-week lows. We believe both stocks have room to move up as the projects are derisked and as Allana moves toward a feasibility study in August of this year. While Ethiopian Potash has more leverage to positive developments given its smaller enterprise value, it is a much riskier investment given its very low cash levels. Allana, on the other hand, has more than $65M in cash on its balance sheet, providing it with a lot of time and resources to derisk its project and make it more attractive to potential suitors.

TER: Will Allana rely on a rail link to be built in order to get its product to market?

JA: There are plans in Ethiopia to build a rail network in the country, and that rail network is planned to approach Allana’s project site. We’ve met with the minister of transportation in Ethiopia on this topic. That project is probably a number of years away from completion, and for at least the first several years of production, Allana is going to need to find a way to transport its product by road via truck. You can’t assume the rail network is going to be ready in the next few years, in our view.

TER: What effect will trucking the material have on the project economics?

JA: Trucking will be much less economic than a rail network. Allana has published its own cost estimates for transporting the product from its project site to the port at Djibouti. We find its estimate of $12/t to be very low. We see a number closer to $50/t, based on the figures we’ve seen at other operations in existence today, such as those in Saskatchewan.

TER: Do you have any other interesting stories that our readers might find useful?

JA: The potash industry today is generating very high cash flow and strong returns on capital for incumbent producers. Potash Corp. generated a gross margin in its potash business last year of 68%. Apple Computer, by comparison, posted a gross margin of 41% in its fiscal 2011. The levels of free cash flow generated by this business and the strong secular trends in agriculture are going to attract capital and will ultimately lead to new greenfield production. With so many companies chasing so few quality projects though, we would caution investors to think carefully about the merits of each individual project. The size and grade of the deposit, the infrastructure in place, the proximity to major potash-consuming countries and the geopolitical risk are all critical drivers of value.

TER: Do you see any further consolidation in this business at this point? Or is it still too early?

JA: We’ve had a lot of consolidation in this business. The successful business strategy that greenfield potash companies have employed in the past has been to identify a good project; then derisk it by defining the resource through engineering and feasibility studies to make it more attractive to well-capitalized companies. A number of greenfield potash companies have had success with that strategy by ultimately selling to large mining companies like BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK), Vale S.A. (VALE:NYSE) and Rio Tinto (RIO:NYSE; RIO:ASX). I think this process makes sense and is going to continue.

TER: What are your top picks at this point?

JA: Our top picks in the sector for 2012 are Verde Potash and Rio Verde Minerals. Both companies offer good leverage to the Brazilian fertilizer market and have the potential to generate meaningful returns to equity investors. By their nature, development-stage resource companies involve much more risk than an operating company. We believe, though, that 2012 is likely to see very strong results for the greenfield companies with the best-quality assets, in the right locations, with attractive valuations. In our view, Verde Potash and Rio Verde check all of those boxes.

TER: Thank you for your time.

JA: Thank you.

Jaret Anderson is a research analyst covering agriculture and fertilizer at Mackie Research Capital. Anderson has 13 years of experience in the investment industry and was rated #1 for earnings estimate accuracy by Starmine in 2006 and #2 for the quality of his reports in 2005. Prior to joining the firm in July 2011 Anderson worked at UBS Securities Canada where he covered Canadian paper and forest companies, as well as chemical and fertilizer industries. Most recently Anderson covered Canadian fertilizer and chemical companies for Salman Partners. He received a Bachelor of Commerce, with honours (Finance) from the University of British Columbia, and was awarded the CFA designation in 2000.

The Gold Report: Recent headlines continue to focus on the debt crisis in Europe as more countries are having their debt downgraded. Greg, you have diagnosed the problem as credit addiction and said that the European Union won’t be able to recover until leaders take painful measures necessary to kick their addiction. What does this mean for commodities and commodity equities?

Greg Weldon: It’s critical for asset prices across the globe. It is a debt addiction, debt refinancing and deficit financing problem, not only in Europe, but also in the U.S. and Japan. Austerity is the real answer to the fact that there is too much debt, and austerity measures in an economic sense are not positive.

My fear is that it’s going to be very difficult to see how economies in Europe, the U.S. and Japan can stand on their own two feet without the assistance of central banks debasing currency through debt monetization. I liken it to filling the sink halfway up with water and pulling the plug out of the drain. Of course, the water level will recede unless you turn the faucet on and start more water pouring into the sink. The level of water represents asset prices, the water flowing out of the faucet represents liquidity provided by global central banks and the drain represents the real macro economy, which has not been fixed.

At the end of the second round of qualitative easing, when the Fed shut off the faucet, the water level (asset prices) started to go down. But now the water is running again—particularly with some of the measures instituted by the European Central Bank, with its three-year loan program, the federal liquidity swaps and the back-ended way that it’s managed to involve the International Monetary Fund.

The problem with all of this is it does nothing to fix the underlying problem, which is too much debt. This is not sustainable. Central banks turning on the water faucet is good for asset prices. The real solutions of fiscal austerity, which are probably not palatable to most politicians in Europe, are the real struggle as we go forward. This problem is not going to go away.

TGR: Grant, in your Things That Make You Go Hmmm…. newsletter, you painted a picture of the final implosion of the euro and U.S. municipal bond meltdown. What would this mean for resource stocks?

Grant Williams: That was part of a prediction piece that I wrote at the end of 2011. It was semi-tongue-in-cheek. My contention was that as volatile as 2011 played out, we didn’t actually get any resolution. And it feels like 2012 will be the year those resolutions start to take place. One of the primary ones is the European situation. A Greek deal to solve the crisis seems to constantly be on the horizon, but they can’t seem to come up with an absolute solution to the public sector involvement haircut issue. When they do, I think it’s going to be the start of a whole slew of legal action to try and either trigger credit default swaps or negate any haircut from those who don’t want to sign up. Greece has a big refinancing coming up in March. It has to raise a little over €14 billion (B), and between now and then it somehow has to get a $130B loan package approved from the Troika. It is very hard to see how Europe can just keep pumping money into Greece. It’s very likely we’ll see Greece exit the Eurozone then, and that’s going to focus everyone’s attention on Portugal. I think Italy will be OK. Spain worries me more than Italy because the economy there structurally is in far worse shape. But if a bunch of countries pull out, that leaves the question of how people unwind any obligations they have in the current euro construct.

What this means for commodities is that the money-printing presses are going to be turned up to the max again. Despite adamant claims from politicians to the contrary, money printing—even if by another name—will have to be implemented at a magnitude much, much higher than ever before to meet current demands. Cash is being given to banks basically for free through the long-term refinancing operation on the quid pro quo that the money finds its way back into the government bond market. The problem is that a lot of this money is going to leak out somewhere other than where it is intended and I suspect it’s going to leak into commodities and equities. We are going to see stock markets float higher, not necessarily on particularly good numbers from corporates, but from the simple dynamic of a lot of freshly printed money looking for a home. We have already seen it in gold and silver this year. They both had big corrections in December, but they are two of the best performing assets of the year so far and I suspect the more money they print this year, the faster these things are going to go up.

People are starting to understand that deflation is not an option for the central banks. Once people realize that if we get a brief period of deflation, it will be fought aggressively with inflation, they will start to look past any deflationary period and position themselves for inflation. That is going to mean higher prices in commodities.

TGR: How high could gold and silver go in 2012?

GWilliams: I think gold trades at $2,200 an ounce (oz) this year. I think silver trades at possibly $60/oz this year, but they’re really just stepping stones on the way to higher ground. This 11-year ascent in both precious metals is only going to change when central bank policy surrounding it changes. I just don’t see that happening in the foreseeable future until they get this debt problem under control.

We are going to see periods with crazy spikes. We are going to see corrections. Some will view this as a collapse but the difference between a correction and a collapse is your entry price. If you bought gold at $700/oz a few years ago and you watched it go from $1,900/oz to $1,500/oz in December, that’s a correction. If you bought it at $1,900/oz, it’s a collapse. I think it’s important to try and take a longer view. The rationale for owning gold and silver is still in place. In a world of printing presses and fiat currencies, no one can manufacture gold and silver out of thin air. I think they are both going to go a lot higher.

TGR: Greg, what are your predictions for 2012?

GWeldon: There is a disconnect in the markets. Currencies really aren’t moving much either. The dollar hasn’t appreciated much. This is why gold is stuck in this range, capped just above $1,700/oz, with potential downside toward $1,300/oz. People are liquidating commodities. My sense is that there is more weakness to come in H112. Commodity prices in Q411 have already come down significantly, pumping some relief into margins. There is a little window of opportunity here where equities and some of the commodities markets could have some upside.

Debt could become an issue again in H212 depending on how central banks deal with that and whether we have a big downturn again in the stock and commodity markets. My longer term view is that when push comes to shove and central banks are staring into the abyss of a potential debt deflation, they will choose to reflate at whatever cost. That is bullish for gold long term. If banks can find the political will to do it, there will be significantly higher prices for commodities across the board in the long term.

China, in particular, has a bullish dynamic. Certain commodities, such as copper, have their own supply-demand dynamics that are detached from the dollar and monetary policies. The Chinese imported copper at a record high in December. Copper stocks on the London Metal Exchange have fallen by close to 30% since October. Copper is one of these commodities that has upside potential regardless of what the dollar is doing.

TGR: Grant, you are based in Singapore. There was a lot of talk at the last Cambridge House Conference in Vancouver about whether China is growing, shrinking, landing hard or soft. What impact will China have on commodities and equities around the world?

GWilliams: China faces a lot of problems. A lot of people think it is in for a hard landing. It is always difficult to believe official Chinese statistics, but the message that the Chinese government is sending through those numbers can be useful. For example, the Chinese growth numbers last week showed an 8.9% increase in gross domestic product. In a world of basically zero growth, that’s a pretty good number, but it’s not the double-digit number we’ve been conditioned to expect from China. Whether it was true or not, it shows that the government is saying: things are OK. We are on top of this, we’re in control. We are not going to slow to zero; we’re just going to grow a little bit slower. The big problem China has is inflation. Roaring food inflation in a society in which half the population lives in relative poverty in rural areas would be a big issue. A lot of people talk about property bubbles—and there are definitely bubbles in Chinese property—but as long as the government can keep people fed, it is going to find a way to get through this—at least for now.

China also has vast currency reserves. The Chinese absolutely understand that paper currency is being devalued incredibly quickly. So, until someone puts a sell-by date on copper and iron ore, it will keep stockpiling the stuff because it will need these commodities to continue growing. China will continue to swap paper money for commodities. The Chinese are bringing gold into the country as fast as they possibly can. Gold is in the DNA here in Asia. It doesn’t take an awful lot to persuade the public to own gold.

TGR: Greg, in your book, Gold Trading Boot Camp, you said gold is at the top of the macro-monetary pyramid. Why does it hold such an important position?

GWeldon: It is a rare and unique mineral that has provided a store of value for centuries that is not backed by any government. It is not subject to anyone’s IOU. Gold stands alone in the level of security it creates in people’s minds as a way to store wealth and protect it from governments that are continually debasing the value of paper money.

TGR: You put the dollar second on the pyramid, but said that could change soon. What will be the catalyst for change and what will be the result for investors?

GWeldon: I don’t know what the catalyst for change could potentially be. For me, the dollar stays as No. 2. There’s been an interesting little sequence recently where the dollar has rallied and gold has declined. But gold has not declined to the same degree that the dollar has rallied. Gold is appreciating in a lot of currencies outside of the dollar where it’s actually outperforming dollar-based gold.

Investors have a greater degree of confidence that the Fed will do what it has to do to circumvent a bigger issue. Next to gold, the dollar still is the second place that people feel comfortable.

TGR: Mining equities haven’t been able to keep pace with the price of gold. Do you see that changing?

GWilliams: It continues to surprise me, frankly, that these stocks are on such crazy valuations against the metal. I think once we start to get wider acceptance that inflation is going to be the outcome rather than deflation, people will start to look at these companies in a different way. Mining companies will instantly become some of the most attractive companies in the world.

I think there’s going to be a tremendous wave of consolidation in the mining sector. When it comes is a tough one to call, though. We’re going to see a lot of junior miners get taken out because it’s going to become a battle for ounces in the ground. If you have proven reserves, the majors are going to come looking for you—particularly if you are in a safe political jurisdiction—and they can afford to pay very, very good multiples of where the stocks are trading now.

In the last 10 years, we have seen some tremendous finds. We’ve seen some tremendous small companies that are very, very well run with incredibly experienced geologists. It requires a lot of due diligence to go through the sheer number of gold mining companies and find the very valuable ones, but I think having ounces in the ground and a good, proven management team are the two fundamental criteria that you have to look for in these stocks. Once the consolidation starts to take place and once the scramble for ounces of gold in the ground begins, I think the resulting valuations will be quite spectacular.

TGR: You are both speaking at the Cambridge House California Investment Conference Feb. 11–12. Based on all of these trends that you’ve laid out, how can investors preserve wealth or even profit during volatile times like these?

GWeldon: Investors who are focused on preserving wealth are best served by buying gold on the dip that is currently taking place. The gold price has a chance to reach $1,450/oz—that’s a sizable move downward.

There’s a chance that monetary authorities would take gold coming off that hard as a sign that they need to be more aggressive. It will be interesting to see how that plays out. However, being long gold and silver is clearly the best play in my mind to preserve wealth.

For investors who are looking to appreciate wealth, the commodities markets offer tremendous upcoming opportunities. That is because there is one thing that I can be certain about: Volatility will remain high. We are not going back to a low-volatility environment. It’s treacherous for individual investors trying to do it themselves. We run a long-short commodity program that’s non-leveraged. But there is a lot of talent in the commodities space for individual investors looking to profit from this market environment.

GWilliams: Preserving your wealth is absolutely the right way to look at it at the moment. Trying to make a profit in markets when there is so much uncertainty is a very dangerous thing to do because things change midgame. So I think for the next several years, using gold, silver and the platinum-palladium group metals as a store of wealth fundamentally makes a lot of sense. I suspect you are going to see outsized gains as a byproduct of using that strategy because I think the prices will go materially higher despite low headline inflation numbers. Using gold and precious metals to hedge yourself as a safety trade is the smart thing to do. By doing that, you will not only protect your existing wealth but you can also generate increased wealth through price appreciation in excess of inflation.

TGR: When you say gold and precious metals, how would an individual investor protect wealth using gold? Are you talking about holding the bullion, buying gold exchange-traded funds (ETF) or buying equities?

GWilliams: It depends. I think protecting wealth using highly geared gold mining companies is a dangerous thing to do. Yes, if gold goes crazy, you are going to make some outsize returns, assuming the asset in the ground is good, assuming the management is good and assuming you don’t get any collapsed mines or any other geological anomalies that sometimes are part and parcel of owning gold mining stocks. Holding the bullion itself is absolutely the safest way to do it. You have an asset free and clear with no claims on it. It’s yours. But that’s not necessarily an easy thing to do from a logistical perspective. A lot of people look at the ETFs as a good vehicle, and they are a perfectly good gold proxy. You have a claim on some physical metal there. But for pure safety’s sake, owning the bullion itself or as close to pure bullion as you possibly can is the smartest way to go.

If you’re looking for any kind of leverage or any kind of gearing, then you need to start looking into the mining companies. But outside the major miners, it’s a very dangerous place to be unless you have someone very smart holding your hand, and you need to do an awful lot of work on researching the particular stocks you buy. While the returns can be extremely good, particularly at these low valuations, gold is a very, very tricky thing to dig for and mines are very tricky things to operate and to run. So you have to be aware of that.

Most important, try to steer clear of government bonds. In a world of increasing inflation, and a world where central banks have promised to try and generate MORE inflation, to lend money to irresponsible governments at 0.23% for two years in the case of the U.S is just crazy to me. Over the long term, you are absolutely guaranteed to lose money in real terms by doing that.

TGR: Thank you for your advice.

Greg Weldon started his Wall Street career working in the Comex Gold and Silver Pits after graduating Colgate University. He progressed as an institutional sales broker at Lehman and Prudential before joining Moore Capital as a proprietary trader. At Moore, Weldon honed his systematic trading methodology and risk management discipline before joining Commodity Corporation where he became one of its top risk-adjusted money managers. Today, he publishes Weldon’s Money Monitor, The Metal Monitor and The ETF Playbook in addition to operating his Managed Futures Account Program as a CTA. He has a unique ability to define and forecast the market’s direction through his proprietary dissection of fundamental and technical market data. Weldon Financial is now a highly regarded and profitable publishing company, having garnered some of the world’s most respected fund managers as loyal and daily readers.

Weldon published Gold Trading Boot Camp: How to Master the Basics and Become a Successful Commodities Investor, in late 2006 in which he predicted the current global credit crisis and discussed the impact on golf from intensified central bank debt monetization. You are invited to participate in a “one-time” free trial of Weldon’s research @ www.weldononline.com.

Grant Williams is a portfolio and strategy advisor to Vulpes Investment Management in Singapore—a hedge fund running $200 million of largely partners’ capital across multiple strategies. Williams has 26 years of experience in finance on the Asian, Australian, European and U.S. markets and has held senior positions at several international investment houses. Williams also writes the popular investment letter Things That Make You Go Hmmm….., which is available to subscribers.

The Gold Report: Byron, anyone who reads your reports knows two things: you like to tell stories and you like precious metals. The gold price has spent the last 11 years trending higher. Do you see it continuing upward?

Byron King: I anticipate that gold, silver and platinum will all continue to rise in price. There are currency-driven reasons why metal prices are going to keep rising, as well as other issues with overall supply and falling production.

In terms of production, the gold and the platinum production spaces are very precarious. A few very bad things could happen at random and knock global production for a loop and seriously impact supply. Think in terms of a major mine accident in, say, South Africa. Supply could fall off a cliff overnight.

In terms of politics and monetary issues, precious metals create an outside limit on people’s political power. Thus I expect massive amounts of manipulation as we roll along, too. The dollar value of gold, silver or platinum will tend to rise over time, but we could see price spikes up and down due to that manipulation.

TGR: The junior precious metals sector fell hard in 2011. You tend to stick toward the midtier and major precious metals producers with strong cash flow. Those names often have lower risk, but risk can rear its head in that space, too. Major gold producer Kinross Gold Corp. (K:TSX; KGC:NYSE) watched about $3.1 billion (B) of its market cap get buzz sawed off in mid-January after it announced that it would take a $4.6B write-down on its Tasiast gold mine in Mauritania. Kinross spent $7.1B acquiring Tasiast and other assets in the September 2010 takeover of Red Back Mining. Does this serve as a warning to the other majors?

BK: It might be 15 years past the Bre-X scandal, but when it comes to buying and selling gold mines, no amount of due diligence is too much. It gets back to Mark Twain’s comment about how to define the term gold mine. It’s a hole in the ground with a liar standing at the opening of the shaft.

The Kinross writeoff is scary. They’re supposed to be better than that. So when you own physical gold, you can go to bed and close both your eyes. With gold mining shares, you still need to keep one eye open.

TGR: Were you recommending Kinross?

BK: Kinross has been in the Outstanding Investments portfolio for over four years. I’m hanging on to it in the hopes that it will go higher, but it’s been disappointing. It’s not been able to get the share price up and keep it up despite a gold price that has quadrupled.

TGR: Its strategy was to grow through acquiring assets. Apart from buying Red Back Mining, Kinross bought Underworld Resources in the Yukon and Aurelian Resources in Ecuador. Do you believe that was the wrong strategy?

BK: Much of the gold mining investing business is about takeovers. The large companies with, say, 10 million ounces (Moz) a year of output couldn’t discover that much just by sending out their own geologists with rock picks. Gold mining requires an entire process of prospect developers, generators and joint ventures. The better assets get picked up by the larger companies. In fact, Pan American Silver Corp. (PAA:TSX; PAAS:NASDAQ) just announced a takeover of Minefinders Corp. (MFL:TSX; MFN:NYSE). Minefinders is a one-trick pony, but it’s one heck of a pony. It’s the Dolores play in Mexico.

TGR: Sure, acquisitions are key, but many analysts believe that Kinross paid too much for Red Back and it’s now writing down three-quarters of what it paid. Will companies be more loath to spend big dollars in takeovers now?

BK: The acquiring companies have to be smarter and cheaper about takeovers. They have to pay less. Then again, you’re lucky if you get what you pay for, and you never get what you don’t pay for.

The news from Kinross could serve as a wet blanket for the rest of the intermediate and junior mining space. Future takeout plays might see more lowball offers.

It gets back to the idea that an allegedly savvy company like Kinross could make as bad a mistake as it did—at least in retrospect. It’s a wakeup call to the industry. I suppose in the boardrooms of the big mining companies they’re sitting around saying, “We’re much smarter than those guys at Kinross.” All I can say is to be careful of admiring yourself too much in the mirror because I’m sure Kinross thought it was doing the right thing, too.

TGR: In an ironic twist, some analysts are now speculating that Kinross could become a takeover target. Keith Wirtz, chief investment officer at Fifth Third Asset Management, said, “Every dollar lower pushes the stock higher up the list of potential takeovers. That will attract the sharks in the water.” Do you think Kinross will be taken out in 2012?

BK: Kinross has made a big mistake. Now the company has a big bull’s eye pinned on its back. Kinross has some very strong assets. I’m sure other companies are looking at these assets and thinking they could do a much better job at managing them than the guys running the show right now.

TGR: Something else of note in the large-cap gold space is the increase in dividends as gold companies jockey for investor attention with other instruments like real estate investment trusts, exchange-traded funds and even master limited partnerships. One company in particular, Goldcorp Inc. (G:TSX; GG:NYSE), recently raised its dividend again. Do you prefer gold companies with a significant dividend or are other factors more important?

BK: All things considered, I like companies that pay dividends. I like the idea that they bring the shareholders into the equation by sharing some of the wealth. There’s a certain capital discipline in running a company that comes with the knowledge that it has to write a check to the shareholders as well.

TGR: What are some of the major gold producers that are running a dividend that you like?

BK: Newmont Mining Corp. (NEM:NYSE), Barrick Gold Corp. (ABX:TSX; ABX:NYSE), IAMGOLD Corp. (IMG:TSX; IAG:NYSE) and Goldcorp are nice dividend players.

TGR: Which one has the strongest growth profile?

BK: Goldcorp. Five years from now, it could be the best overall return.

TGR: Are you following any midtiers?

BK: I’ve been following Minefinders, but it just got bought. I’m waiting for the development at Donlin Creek, Alaska, to come through for NovaGold Resources Inc. (NG:TSX; NG:NYSE.A). Investors are going to have to be patient with this one. It’s over 30 Moz of gold. It’s partnered up with Barrick, but the development has been slower, longer and more painful than I expected. However, over enough time, NovaGold could be quite rewarding to a patient resource investor.

TGR: What undervalued junior or midtier producers could rebound in 2012?

BK: Carlisle Goldfields Ltd. (CGJ:CNSX) at Lynn Lake, Manitoba. It’s an old copper-nickel producing area, but it has had a very aggressive drilling program. I am waiting for an updated NI 43-101 to come out, which could show an expanded resource base.

Reservoir Minerals Inc. (RMC:TSX.V), a spinout of Reservoir Capital Corp. (REO:TSX.V), is a play on mineralization in Serbia. Reservoir Capital was a hydropower and geothermal company with some mining assets as well. Last fall, it spun out the mining assets into Reservoir Minerals.

It’s now a copper project that is joint ventured with Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE). It has had extremely good drilling results in a historic gold producing area in Serbia that was one of the richest gold mines in Europe in its day. It was sealed up just before World War II and not unsealed until about two years ago.

Reservoir also controls numerous other mineralized areas in Serbia, which is a very well-run, mining-friendly jurisdiction. That is, we’re not dealing with the Serbia of the 1990s. This isn’t the Serbia that NATO bombed in 1999. This is a modern, European country that is looking desperately for investment. Reservoir Minerals is a key part of the future of Serbia.

TGR: Carlisle has the historic MacLellan mine. What stood out when you visited that project?

BK: It’s in Precambrian greenstone in a shear zone, in a known mineralized district. The greenstone and the shearing outcrop at the surface. Carlisle has great land position in terms of following the strike. It has a very aggressive drilling program, and while results aren’t out officially, from what I can gather from my own examination of the cores, there is a very nice consistency of mineralization all along the strike. I think that when Carlisle gets done with its analysis we’re going to see a very nice resource number at very respectable, mineable grades.

TGR: What investment themes do you expect will be prevalent in the gold space this year?

BK: The gold price should continue the 11-year trend of increasing nearly every year with the possibility of a big jump if a one-off type of event, such as a mine accident, chokes off a large amount of the world’s gold supply. I know accidents aren’t ever supposed to happen—nuclear plants in Japan and cruise ships in Italy are failsafe, right? We have to watch that.

TGR: What about increasing tension in the Middle East?

BK: Tension in the Middle East always seems to drive up the price of oil and the price of gold. People move their resources from one jurisdiction to another, from one form of investment to another. I went to one of the gold souks at the grand bazaar in Istanbul about two years ago. I was astonished that people were mobbing the gold souks, throwing money down and grabbing all the gold coins that they could get their hands on. I saw Russians and people from across Europe just peeling out these €500 notes and buying as much gold as they could take. It was fascinating.

TGR: Surreal.

BK: It was surreal to literally watch people scoop up gold, put it in their pockets and walk out of the stores. People were trying to get rid of cash and buy gold. There’s an entire gold-buying culture that a lot of people in the West are not used to seeing.

TGR: What about the protests, violence and economic sanctions being brought to bear on certain Middle Eastern countries? It seems like the tensions there are certainly hotter than they have been since the early ’80s.

BK: War is bad for business, but the rumors of war are sometimes good for business. I think if the Strait of Hormuz closed or if there was a shooting war in the Middle East, it would drive the price of gold upward. As the price of gold goes up, it’s going to lift the share price for the miners that have good fundamentals.

Right now the stock market is barely paying for fundamentals. It really doesn’t respect stories, let alone blue sky. But if the price of gold keeps going up, the companies with decent fundamentals will also rise.

TGR: Thanks for your insight, Byron.

Byron King is the resident energy and natural resource expert at Agora Financial, LLC. A geologist by training, he worked for the former Gulf Oil Co. and has followed oil industry developments for over 30 years. King’s career path also took him into the U.S. Navy, both in active duty and reserve. In the 1990s and 2000s, King engaged in a vigorous private law practice. For the past five years, King has been writing about energy and natural resource issues for an international audience. Currently, King writes and edits Daily Resource Hunter, Outstanding Investments and Energy & Scarcity Investor. He holds degrees from Harvard, the U.S. Naval War College and the University of Pittsburgh.

The Energy Report: With Brent Crude trading at about US$110 per barrel (bbl) and natural gas futures trading at 10-year lows, are you leaning more heavily toward oily names than you did in 2011?

Luc Mageau: Absolutely. In fact, although gas prices have been reduced to around the $2.50 level, it still seems like the picture could get worse before it gets better. Current natural gas storage is at ~3.5 trillion cubic feet (Tcf); that’s a full 0.4 Tcf fuller than an average winter. The reason we have such a glut of gas is the winter has not been co-operating. Basically, we rely on winter to post the bulk of the withdrawals throughout any given year—in the last few years, we have truly been relying on a cold winter to bail us out of the storage glut and we’ve been lucky. On average we normally see ~150-200 billion cubic feet (Bcf) of gas withdrawn per week. With the warm weather we’ve been getting, our average withdrawals from storage have been closer to 80-100 Bcf during the 2011/2012 winter season—that translates to a lot of excess gas. Making matters worse, the weather is not expected to get colder. This means we could be in store for several more weeks of warmer-than-average winter, and given we only have a handful of weeks left in the official “withdrawal season,” we’re running out of time to get back to normal storage.

Historically, when weather fails to bail us out of the glut we have seen production shut-ins to curtail the problem. This time, I think we could be in a slightly different boat—and we can blame the price of oil for that. You see, over the last several years, low natural gas prices have forced gas producers to derive cash flow from other sources. One major source has been incremental extraction of natural gas liquids (NGLs). NGLs are heavier hydrocarbons that are produced in conjunction with natural gas. These products typically trade closer to the oil price. Given the wide discrepancy of oil:gas pricing, NGLs can account for a good chunk of the effective price a gas producer receives. What this means is that even when gas prices are below $2.50, the NGL component now being realized from produced gas is allowing a lot of gas that would have historically been shut in to remain marginally economic, and as such, still on production. So we are seeing less shut-in production than historically, and even if we were to begin shutting in production now we would need nearly 6 Bcf/d to be shut-in for the bulk of 2012 just to get back to normal storage levels—a situation that seems unlikely.

The bottom line is that we continue to expect gas prices will stay depressed and oil prices to continue to thrive and as a result, oil stocks should continue to outperform in general.

TER: Should investors stay away from the gas-heavy names or simply gas-heavy names with liquids-poor content?

LM: Some companies are certainly offering good value today and just because gas prices are low right now doesn’t mean that there are no investable ideas. This being said, dry gas companies (i.e. those with liquids infused plays below 20 bbl/MMcf) are really having their cash flows squeezed right now. Netbacks for companies in this camp have been compressed to mid-single digits and even keeping production levels flat without adding a significant amount of debt is hard. On the other hand, companies with liquids rich gas plays that generate 50 bbl/MMcf or more can boost the realized price of their gas by $4.00/mcf. In fact, given the price of liquids, these companies were already generating in excess of 80% of cash flow from the liquids anyway, so the price of gas does not make that much of an impact on the overall value of the company. So if you are looking for gas exposure, it would probably be safer to look at companies that have exposure to these types of plays. In our coverage universe, Crocotta Energy Inc. (CTA:TSX) is probably the best positioned in this camp.

TER: Let’s talk some more about your coverage universe. Crocotta Energy relies heavily on its liquids-rich assets. Please tell us about how one of those assets, Edson Bluesky, is insulating Crocotta from low gas prices.

LM: Crocotta has been working this asset up for the bulk of 2011 and it has been having very good success. In all it holds ~36,000 acres of land here and the key play so far has been the Bluesky formation. The reason that this play is exciting is because it truly is liquids rich—getting anywhere from 50-100 bbl/MMcf of NGLs. What this means is that even though Crocotta is a gas-weighted producer, at $2.00/mcf gas prices the company can generate netbacks in the mid-$20/barrel oil equivalent (boe) range (compared to low- to mid-single digits for most gas companies). The wells typically cost ~$5.8M, so they are expensive, but considering the amount of wells already drilled on the land base, they are low risk and generate an NPV of over $4M even at $2.00/mcf gas (compared to drier gas wells that would be posting closer to $0-1M NPVs). So the company is still making plenty of money even at these gas prices and it still offers the option on gas prices for the future.

TER: Crocotta exited 2011 with production of about 6,500 boe/day, well ahead of both the company’s exit guidance range and your expectation of about 6,000 boe/day. In fact, those fourth-quarter results brought Crocotta’s 2011 average production up to 3,725 boe/day. What sort of production are you expecting in 2012? And will that be enough to reach your 12-month target of $4.75?

LM: Our numbers have the company exiting 2012 north of 8,000 boe/d—one-third of that production is expected to be oil and liquids. The growth is primarily expected to come from Bluesky liquids rich wells, but we’ve also built in some wells for the company’s Cardium lands at Edson. Late in 2011 the company announced its first Cardium well in the Edson area had an initial production rate of 1,000 boe/d (60% oil). This was previously a formation that we were not anticipating much growth from so there is a significant opportunity for the company to build an oil-weighted portfolio of wells if it can show that this is repeatable—and based on what we’ve seen, we think that’s possible. So our $4.75 target price is premised on the production profile through 2012 and 2013. In fact, for 2013, even at $2.00/mcf gas the company could post cash flow of $0.90/share so it is currently trading at just 3.8x, lower than its gas-weighted peers.

TER: You cover Cequence Energy Ltd. (CQE:TSX), which recently conducted some tests on several new wells at Simonette, Alberta, which is part of the Montney Shale play. One new well tested at 4.8 MMcf/d and 216 bbl/day of condensate over 15 days, which would correspond to a liquids yield of about 45 bbl/MMcf. That means that these wells would be economic even at $2.50 natural gas. What’s your outlook for Cequence given these testing results versus lower than expected oil-equivalent production in 2011?

LM: We believe the recent Montney well results continue to prove that the Simonette area is highly prospective for natural gas production growth. This combined with the additional take-away capacity from the pending Alliance Pipeline connection adds comfort that growth will continue through 2012. You are certainly correct; at 45 bbl/MMcf the company’s Montney wells continue to be economic at $2.50/mcf gas. The unfortunate take-away, however, is that the payout ratios on these wells are expected to be approaching three years. This means that it essentially takes three years for the company to re-coup the money it put into the ground to drill the well, and for a junior company, this makes sustained growth at current prices difficult.

TER: Cequence says that once it connects to the Alliance Pipeline and the Aux Sables liquids extraction facility, which is slated to happen in April 2012, its operating netbacks from Simonette production would reach $30.31/boe. Do those numbers line up with yours and, if so, do you expect that to significantly move the share price?

LM: It all comes down to your view of natural gas prices. We are currently forecasting $3.25/mcf gas for 2012—which sounds more bullish than it actually is. Based on that, we have netbacks in the $18/boe range. If current prices were used instead, i.e. $2.25/mcf gas, netbacks would go to $10/boe.

TER: What’s your 12-month target on Cequence?

LM: We are at $3.50—but again that is premised on $3.25/mcf gas for 2012.

TER: A smaller name that you cover is Renegade Petroleum Ltd. (RPL:TSX.V). Renegade exited 2011 with higher-than-expected average production of 3,625 boe/day, which resulted in year over year growth of 73%. Renegade has set its 2012 production guidance at between 4,000 and 4,200 boe/day and that should result in another year of significant growth. Please tell our readers about why you believe Renegade will reach its production guidance and why you raised your 12-month target to $5.00.

LM: Renegade certainly did have a great year in 2011. After it rolled up its JV partner in the Viking (Petro Uno), it went to work post-breakup and its production growth number definitely reflects that. For 2012 we expect the company is going to put a bit more emphasis on southeast Saskatchewan, though, and we had previously been a bit more conservative on our view of the potential there. We were previously forecasting another break-up season similar to what we saw in 2011—wet and prolonged. But the very unseasonably warm summer, combined with the almost nil snow accumulation in the region is making things look much better than originally expected. Now anything can change—especially the weather—but with a slightly longer drilling season than originally expected, we were able to bring up our production estimate a bit to an average of 4,070 boe/d for 2012, about the midpoint of guidance. With our oil price deck at $100 WTI for 2012, our cash flow estimates and target followed suit.

TER: Things don’t look quite so rosy for Open Range Energy Corp. (ONR:TSX). Most of Open Range’s production base is from natural gas and its production is slated to contract in 2012. Nonetheless, you still have a C$2.00 target on that name. Tell us about that one.

LM: Open Range is coming off of a stellar year in 2011. It successfully launched the spin-out of its Poseidon division, which continues to be a strong performer. However, with that division gone, the bulk of the company’s opportunities are in dry gas, meaning NGLs under 20 bbl/MMcf. The company also has ~$50M of debt on a $75M line and is planning six gross wells for this year. So facing the current commodity price environment, the company is really in cash-conservation mode and as a result has forecasted production to shrink through this year—a stark contrast to the massive growth it was leading investors to believe for most of 2011 (its presentation projected a 2012 exit rate of ~10,000 boe/d). Now the assets that the company has are actually quite good—as far as gas assets go. The company has primarily one consolidated land block in the deep basin, an area that characteristically has large gas reserves and low operating costs, but it also has very low liquids yields so the netbacks are at $2.25/mcf gas. Our $2.00 target is premised on a $3.25/mcf gas price and to be fair, for gas investors looking at options on the commodity, Open Range is certainly a good candidate, however we believe gas markets will remain weak for some time, likely putting more near-term pressure on the name—we’ve had the company rated market perform since the spin-out, which really reflects our neutral-to-negative outlook on natural gas prices.

TER: And, finally, Strategic Oil & Gas Ltd. (SOG:TSX), which completed a $40M equity financing in December to give the junior a total of C$42 million in the bank. How is Strategic planning to use that cash?

LM: Strategic has two core light oil assets; the Maxhamish Chinkeh sand horizontal play in northeast BC, where Legacy is the operator, and its Steen River lands in northern Alberta. At Steen River, the company is the operator and has a 100% working interest in 70,000 net acres, so it has a lot of flexibility to accelerate the program here as well as a significant amount of running room for future drilling. There are at least three different oil-prone zones being targeted at Steen, so this is where we see the company getting the leverage for growing production in 2012. With that in mind, the company has provided a $60M capital program for 2012 that focuses on Steen. It has two rigs running there now, and plans to drill 20 (17 net) wells in 2012. Although the focus is still on the high-impact vertical Keg River wells, which get initial production rates of about 200 bbl/d for $1.5M, the company is also going to continue to advance its more “resource-style” horizontal play in the Sulphur point formation, and test out some new zones and play concepts in the area. Given that this program is pretty front-end weighted (there are nine wells planned for Q112), we think the company could use its balance sheet to expand this program through the back half of the year if it continues to achieve results like it has been.

TER: Despite the equity dilution in December, over the course of 2012 you expect Strategic’s share price to almost double to C$1.50. How is that going to happen?

LM: Strategic spent a lot of time on its Steen River assets in 2011. A lot of this was laying the technical foundation on which to build a strong portfolio of oil drill prospects. It successfully tested the horizontal Sulphur Point oil play, and it built out and de-risked its Keg River locations. With its balance sheet now all cashed up, we see 2012 really as a year where it focuses on aggressive drilling at Steen River. Since these wells can get IP rates of 100—200 bbl/d of oil and the capital costs of drilling them are low, it is able to really step on the accelerator pedal quickly. So we think that both cash flow and production will grow substantially through the year and into 2013. Right now we have it spending its guidance of $60M in 2012 and exiting the year with production of ~3,000 boe/d, a pretty strong growth profile when you compare it to 2011 exit production of 1,880 boe/d.

TER: Do you have some parting wisdom to impart to investors looking to enter this space for the first time in 2012?

LM: We are still constructive on oil prices, and with our view on NGL pricing and yields, we remain very cautious on the outlook for gas prices, so obviously we would overweight oil-focused names. That said, there are gas-weighted names that have currently good liquids yields with the ability to weather low gas prices and reallocate capital away from dry gas. Crocotta Energy is an exceptional example of this—the company is getting a liquids yield of 50-80 bbl/MMcf, which means that not only can it weather low natural gas prices, the bulk of cash flow is already coming from the liquids so the wells are very economic even at gas prices with a $1-handle. Second, we would certainly look to invest in companies that have the financial resources (balance sheet and cash flow) to fund an oil- or liquids-focused drilling program in order to take advantage of current oil prices. To put this in perspective—a typical oil well will pay-out in ~1.5 years, which means that all the money a producer puts in the ground they get back in 1.5 years—everything else after that is profit. Gas wells on the flip side can have pay-outs longer than three years. For a junior company, the ability to recycle cash by putting it in the ground, getting it out and repeating the process is paramount—particularly given that the amount they have is very limited. So to that end, junior companies with high oil weightings that we especially like include companies like Renegade Petroleum, Strategic, and Twin Butte Energy for their growth profiles and valuation. However, the top pick in our space right now is Twin Butte Energy, which recently closed the acquisition of Emerge. It pays a healthy dividend of 7%, has the potential to outperform its guidance, and has a very conservative payout ratio for 2012 if light-heavy differentials and oil prices remain within reason of current levels.

TER: Thanks for sharing your insights with us.

LM: My pleasure.

Luc Mageau joined Raymond James in March 2006. He is responsible for covering junior and intermediate oil and gas producers. Prior to joining the firm, Luc was employed as a commercial lender at a major bank and as a research analyst at a U.S.-based equity research firm. He has a bachelor of commerce degree from the University of Alberta (2001) and holds the CFA designation.

The Gold Report: Given the volatile 2011 market and the fact that gold trades at seasonally lower prices in the summer, James, what led you to say you believe we’ve already hit the low for the gold price in 2012?

James Turk: We started this year in an unusual position. Normally, we see seasonal strength in the last quarter. We didn’t get it. We’d been in a correction since the high in silver back in April 2011. The high in gold came during the summer, which was very unusual, but basically both metals have been moving sideways. Starting from the end of a correction, value is more important than seasonality. Clearly, gold and silver both represent good, undervalued assets at the moment.

The other factor is continuing problems in the financial system. The European banks are still on the brink and many American banks are in a similar situation. Questions about the currency—whether the euro will survive—and the ongoing sovereign debt issue will cause people to look at the precious metals. I’ve said we saw the low in the gold price the first week of January, and the further into the year we get without going lower, the greater the probability that it was, in fact, the low for the year.

TGR: Considering all the issues you mentioned that existed last summer as well, why didn’t that seasonal strength return late in 2011?

JT: An interesting thing about markets is that nothing works all of the time. You just have to respond accordingly in looking at how things are going to unfold. That’s why I think the low has been made already.

TGR: You also mentioned in a recent interview that you thought gold could get above $2,000/ounce (oz) in the next three months. With all the monetary issues on the table, not to mention a few new wrinkles, what will make the gold price pop up so much in such a short period of time? What’s the catalyst?

JT: I can’t tell you what the event will be, but I look at charts and things of that nature to give me an indication as to when something’s ready to move. The fact that we’ve been in a correction for several months is one indication that something will happen. Whether it’s a bank failure or a problem with the euro or some European bank, you can’t really tell. But whatever is coming, the markets reflect it. It’s like following footprints in the sand on the beach, leading a certain way. The charts and the circumstances are telling me to expect a big pop in the gold price this year.

TGR: And would it correct immediately afterward?

JT: Not necessarily, because at some point, the currencies will collapse. When they do, gold won’t correct. It will just keep going up.

TGR: So are you projecting currency collapses within the next few months?

JT: No, I’m not, but they will at some point. It could happen in the next several months; it could happen in the next several years. We are in a bubble, not a gold bubble but a fiat currency bubble. The belief that fiat currencies have value will be tested. I think fiat currencies, which are backed by nothing but government promises, will collapse, and gold will return to center stage in global commerce. When it does, expect a straight shot up. It may be three months or three years. Take it month by month and see how it goes. Don’t try to trade the gold market. Continue to build your gold and/or silver holdings, and when all is said and done, you’ll be very, very happy.

TGR: You’ve also indicated that you expect the U.S. to get into hyperinflation, citing examples of currencies in the Weimar Republic, Argentina and Zimbabwe. None of those currencies was world reserve currencies as the U.S. dollar is. Would the world allow the U.S. dollar to go into hyperinflation?

JT: The world can’t do anything to stop it. President Nixon’s Treasury secretary, John Connally, captured it perfectly when he told one of his European counterparts, “The dollar is our currency but your problem.” That’s still true 40 years later.

The dollar continues to be the world’s problem, and the U.S. government isn’t doing anything to make the dollar worthy of the esteemed position of being the world’s reserve currency. There is no pressure that can be brought to bear on the dollar that would cause the U.S. government to reverse course and go in the right direction.

We are seeing countries around the world accumulating more gold in case the dollar collapses, which is what individuals should be doing as well. Countries around the world are also taking other steps to protect themselves. For instance, they’re entering bilateral trade agreements that don’t involve U.S. dollars. China has been doing a lot of bilateral trade agreements that completely exclude the dollar. India and Iran, of all places, just recently announced an agreement whereby they’re going to use gold for transacting.

TGR: In King World News in October you wowed the world with the Gold Money Index discussion and how it shows that the fair price of gold is really $11,000/oz. You based your calculation on the combined total of central banks’ foreign exchange reserves divided by their gold holdings. Why do you use only foreign-exchange reserves in that calculation and not total reserves?

JT: Because gold is international money, and I’m trying to focus solely on the monetary component. Instead of moving gold around as they did under the classical gold standard, the central banks have been using foreign currencies as a money substitute. If you’re using a money substitute, the money itself should be equivalent to gold. The real factor underlying all of this is that gold is way too cheap, and accepting paper currencies instead of gold is the wrong thing to do, which is what the Gold Money Index shows.

So it’s basically reestablishing gold’s role in the international monetary system and what its value would be based on historical evidence, particularly from the 1960s and 1970s, when the index was working much more clearly. Over the last 20 years, the gap between the fair value of gold and its actual price has become huge.

TGR: Have you gone back to 1900 with that calculation?

JT: It’s hard to get all the data, but the logic is basically there. I’ve gone back prior to 1900, not with the Gold Money Index, but with my Fear Index, looking at domestic money supplies. The Fear Index is at about 3% now, so gold today backs about 3% of the domestic money supply. When Sir Isaac Newton devised the classical gold standard, an average of 40% of the monetary system’s value was based on gold and 60% on paper. That we’re so far below the guideline he established is an indication to how undervalued gold is relative to all the paper money systems out there.

TGR: You mentioned using foreign-exchange reserves because they mimic the way gold was transferred under the gold standard. But wasn’t it part of being on the gold standard that each currency unit reflected a gold component?

JT: Yes. But, the Fear Index and the Gold Money Index distinguish between domestic and international money supplies. That’s why I was saying this 40% on the Fear Index is the historical norm.

TGR: Your Gold Money Index is interesting, and the $11,000/oz number grabs a lot of attention, but maybe the real underlying question is whether this ratio is really relevant.

JT: What makes the ratio relevant is that it had relevance up until the last 20 years. The fair price and the actual price have separated so far due to government intervention—attempts to cap the price of gold. Governments intervene in the gold market for the same reason they intervene in any market. When they don’t like the outcome, they try to change things around. This index gives people an opportunity to understand how undervalued gold is.

The index is relevant, too, in that it makes it very clear that we’re living in a bubble. How can something work for so many years and then all of a sudden not work? It’s because we’re in a bubble.

TGR: Didn’t it work for so many years because we were on a gold standard?

JT: Exactly, but we went off the gold standard in 1971, and even in the 1970s, that ratio worked. It continued to work in the early 1980s. Then it stopped working.

TGR: So it wasn’t until they started printing money, and expanding the M1—increasing the money supply—that the imbalance grew.

JT: Yes. The attributes that gave gold value and made it money in the first place did not disappear, but they were ignored or forgotten. Gold was marginalized. Then in recent years, people started to rediscover those attributes and realized that gold is very, very useful.

At some point the price of gold will just keep rising and not stop. That’s when the currency collapses. And while we can’t predict when it will happen, people have to reach one of two conclusions. Either 1) monetary history is not relevant and the fiat currency system will survive, or 2) monetary history is relevant, this is a bubble, the fiat currency system will collapse and gold is much undervalued.

TGR: There’s no doubt about which conclusion you’ve reached. You’ve also made it clear that while you can’t predict when the fiat currency will collapse or when hyperinflation will kick in, you recognize where the path we’re going down leads. Still, as an astute historian of the currencies, could you tell us how long it took from the tipping point to all-out hyperinflation in the countries that experienced it?

JT: Once you hit the tipping point, it’s usually six months before the currency is finished. To give you an example, I went to Argentina in 1991 to study what was happening there. Hyperinflation appeared to be brewing. The currency, the austral, was linked to the U.S. dollar at 14:1 in January, and the link was broken. During the first week of May, when I arrived, the austral had already devalued to 64:1 against the dollar. When I left at the end of the week, it was 96:1 and by December, it was 10,000:1. So I was right there at the tipping point.

But here’s the interesting thing. Hyperinflation is first recognized outside the country before it’s recognized within, because foreigners own another country’s currency by choice. If they don’t like what’s going on, they sell that currency and move into something else. Where we are with the U.S. dollar, so many indications suggest that internationally we’ve hit the tipping point, but not yet within the U.S., where people are still getting paid in dollars and still spending dollars. Once the domestic tipping point is reached, it’s six months before the currency collapses.

TGR: Considering that you’re based in London now and presumably have greater insight into what’s happening with the euro and in the European Union than most of us, how do you see the situation in Europe vis-à-vis the U.S.?

JT: Last year, the euro was in the doghouse and the dollar was relatively strong. A couple of years ago, the dollar was in the doghouse and the euro was relatively strong. As a famous hedge fund manager in New York said, trying to pick between the currencies today is like trying to choose the best-looking horse in the glue factory. You really can’t say that the dollar is a good choice just because the euro is weak this year. It’s not. All fiat currencies have serious problems.

The problems differ to a certain extent, and at any moment in time—depending upon what different central banks are doing or how investor sentiment is moving—you could have relative strength in one or the other. But they’re all sinking relative to gold, so when deciding how to hold your liquidity, you have to consider gold bullion as one of the best choices simply because it’s done so well against all of the world’s major currencies for the past decade.

TGR: You’ve said many times that anyone who gets into precious metals needs to know why. You’ve suggested it’s either exposure to the silver and gold prices—in which case people can opt for instruments such as exchange-traded funds—or elimination of counterparty risk, which means they need tangible assets. Most of the rationale for people getting into precious metals these days is the insurance factor. Does protection against currency devaluation fall into either of those two categories?

JT: It falls into the tangible asset category. If you’re holding gold or silver for insurance, you’re holding bedrock assets with thousands of years of history. Come what may, they’re going to have value in the future.

TGR: The typical advice for people holding gold as insurance is to have 10% of your assets in gold. Maybe now that things are so volatile, 20% would be a better idea. But you’re even more aggressive on that.

JT: I am, but everybody has unique circumstances, so it’s hard to make sweeping generalizations. My basic view, though, is the older you are the more conservative you should be and, therefore, the more gold you should own. As a rule of thumb, use your age as a guide. If you’re 20, you may want 20% of your portfolio in gold and the rest in higher risk assets because you still have time to generate wealth as you get older. But once you’re older, you want to be conservative, and the way to be conservative in this environment is to own physical bullion. If you’re 60, you should have 60% of your portfolio in gold.

TGR: People look at gold now and see the wonderful returns—17% annually on average, in the U.S. alone. What about an investor who says, “Hey, I’m just going to invest in gold because it will give me a better return than equities”? Is that a bad way to look at it?

JT: No, but understand that gold doesn’t create wealth. It doesn’t have cash flow, it doesn’t have a management team and it doesn’t have a price/earnings ratio. It’s just a sterile, tangible asset. Gold doesn’t even really generate a return. When you talk about returns in gold, you’re actually talking about the lost purchasing power of the dollar. An ounce of gold today buys the same amount of crude oil it did 60 years ago. It didn’t increase your wealth. It basically just preserved your purchasing power over that period of time.

Even when the gold price rises, even at 17.7%/year on average over the last 11 years against the U.S. dollar, it’s not creating wealth. It’s taking wealth that already exists and is being held by people who own fiat currencies. That wealth is being moved from them to people who own gold. But gold is not a wealth-generating asset. It doesn’t grow anything.

TGR: A lot of vehicles that people put in their portfolios mimic stock indices, which also don’t create wealth, but they do create returns.

JT: If they mimic stock indices, they create wealth. Ultimately, if the shares themselves go up, what mimics those shares goes up. If the stock in these indices goes up, the wealth in the world expands because it generates cash flow. A company generates some goods or services that benefit people, and people are willing to use their hard-earned cash to buy those goods or services. Ultimately, the firm grows and, as a consequence, creates wealth.

TGR: Now that we’re talking about stocks, what’s the role of gold equities? You said that people should use their age when they think about what percentage of their portfolio should be in gold. Let’s say someone is 50. Would that 50% be in physical gold, or could it also include gold equities?

JT: Gold equities are different than gold. Gold equities are investments. Gold bullion is money. A portfolio has two components. The investment component focuses on risk versus return. The monetary component provides liquidity. When you sell an investment, you have liquidity, whether gold, a national currency or some mix. You hold that liquidity until you’re ready to use some of it to make your next investment or to buy goods or services.

But, mining stocks are fundamentally different than gold. A company you invest in has a balance sheet. It has a management team. Acts of God can destroy a mine. There are political risks and other considerations involved in owning mining stocks. Of course, that’s also how you actually create wealth—if you choose the right stock, you get a return. It’s also true that these stocks have exposure to the gold price in the sense that if the gold price goes up, the mining stocks probably will go up also. But even then, there’s no guarantee that the mining stocks will go up.

And remember, gold mining stocks are investments. Gold is money. Do you want liquidity or do you want an investment?

TGR: For those who want an investment, how do you feel about the gold equities? They do carry the additional risks you outlined but not so much the counterparty risk.

JT: I happen to be bullish on mining stocks because I think their bear market ended a few years ago. We’re just now retesting lows that had been made previously, and with the rise in gold and silver I expect this year, I think we’ll see the mining stocks go up as well.

In fact, if you choose the right mining stock and the gold price increases, the mining stock should rise by a higher percentage than gold itself. This has to do with the fact that a rising gold price improves the bottom line, increases the profit margin and ultimately results in a higher price/earnings ratio because the market senses that this is a major bull market, and the earnings and cash flow generated will lead the company to possibly increase dividends or something like that down the road.

As I indicated at the start of our conversation, though, an interesting thing about markets is that nothing works all the time. So while generally speaking, mining stocks rise by a higher percentage in a rising gold price environment, it doesn’t always work that way. For the last 10 years, gold has done very well, but the mining stocks have basically gone nowhere.

TGR: One of the themes of the Vancouver Resource Investment Conference seemed to be that gold stocks are a really good deal for that very reason, and that they’re on sale at bargain prices right now.

JT: I agree completely.

TGR: You’re also bullish on silver and apparently expect the silver/gold ratio to return to historic levels.

JT: I am very bullish on silver, but not because of that ratio. The ratio is basically just the outward measure used to show how silver is undervalued relative to gold. The underlying fundamentals suggest to me that the silver price is very cheap relative to how I sense the supply and demand characteristics.

TGR: We have minimal economic growth in Europe and the U.S., if any, and everyone seems to agree that China’s growth is slowing. With the world economy in slow motion, and silver being an industrial metal, what makes you so bullish on this commodity? What underlying fundamentals will drive the silver price up?

JT: It’s a good substitute for gold. Fifty-one ounces of silver do the same thing as one ounce of gold. Silver is a monetary asset that preserves and protects purchasing power. It’s the combination of the monetary and industrial demands that creates so much volatility in silver relative to gold. With gold, you have only the monetary demand. Economists call that demand inelastic, because people want to own gold regardless of the price. With silver, the demand is very elastic, meaning it’s very sensitive to changes in price.

TGR: If people want both metals in their portfolio, what kind of balance do you recommend?

JT: Two-thirds gold and one-third silver.

TGR: You’ve suggested that silver prices are going to rise faster than gold. Should that carry over to silver equities? Do you expect them to outperform gold equities?

JT: Yes, I do. Again, it’s difficult to make a sweeping generalization, but the odds are that silver stocks will do better than gold stocks in the foreseeable future.

TGR: You’ve covered some of the same points here that you made in your presentation at the Vancouver Resource Investment Conference. What would you consider the key takeaways from that presentation?

JT: First of all, I hope people understand more clearly that gold is money, and that they view it from that perspective in order to properly assess whether it makes sense in their portfolios. Secondly, I hope people realize that despite the fact that the gold price has risen, it’s important to distinguish between price and value—they’re different things. The gold price has risen because the dollar is being debased, but gold remains very undervalued and it’s well worth it for you to continue to accumulate it. Work it into your family budget, and every month or two, buy more gold—and silver, if you’re so inclined. That leads to the third point. Don’t try to trade gold; save it. When you’re doing that, you’re saving sound money, and that’s a good thing.

TGR: When you started GoldMoney, you talked about a vision that at some point people would use GoldMoney units as currency to trade for services—a bit like using PayPal or an online bank but using your digital gold currency (DGC) instead. Do you still see that coming?

JT: Yes, it seems inevitable to me. In fact we’ve used the DGC payment feature, but recently stopped for a variety of reasons. It had not been used very actively anyway because of Gresham’s law—that bad money drives out good. In today’s world, people would rather spend fiat currency as a form of payment and save their gold and silver. That’s a good thing, for now, but that will change as fiat currency itself becomes less trusted and ultimately collapses.

James Turk, a renowned authority on gold and the precious metals markets, is founder and chairman of GoldMoney®, patented gold-based electronic money—digital gold currency (DGC)—that’s transferred over the Internet. In vaults in London, Zurich and Hong Kong, GoldMoney.com stores more than $2 billion worth of precious metals bullion, including platinum and palladium as well as gold and silver, for customers located in more than 100 countries. In August 2009, Turk’s Freemarket Gold & Money Report, which began in 1987 as a subscription-based investment newsletter, completed a transformation to become a free, web-based commentary. Accordingly, its name changed to the Free Gold Money Report (FGMR).

Turk is also a director of the GoldMoney Foundation, a nonprofit educational organization dedicated to providing information on the role of gold and silver as money and currency and their importance to society. Co-author of The Collapse of the Dollar, Turk has specialized in international banking, finance and investments since his 1969 graduation from George Washington University with a Bachelor of Arts degree in international economics. He began his business career with The Chase Manhattan Bank (now JPMorgan Chase), which included assignments in Thailand, the Philippines and Hong Kong, followed by several years with a prominent precious metals trader’s private investment and trading company, and, based in the United Arab Emirates, several more years managing the Abu Dhabi Investment Authority’s Commodity Department.

The Gold Report: When you last spoke with The Gold Report in early March of last year, gold was trading around $1,420/ounce (oz) and silver was around $36/oz. Silver peaked about $49/oz in late April and then gold hit around $1,900/oz in September. Now we’re back up above $1,700/oz on gold and about $33/oz on silver. Where do you see these prices going this year, after it appears that they have likely bottomed out?

Matthew Zylstra: We’re long-term bulls on both metals. Gold has been correcting since September and it looks like it bottomed out around $1,500/oz. We believe the recent decline is a normal pullback in a longer-term uptrend where nothing has really changed to the outlook. We see a perfect environment for the metal—concerns over our currency debasement, negative real interest rates, geopolitical friction, etc. I expect gold will reclaim the 2011 highs and could reach $2,000/oz.

For silver, the picture is less clear. Silver is, in part, an industrial metal accounting for around 50% of demand and less of a currency. Silver peaked at almost $50/oz in April 2011 and the price has been very volatile. We think the move is a correction, again, in a longer uptrend going back to 2003. I expect silver will trade around the mid-$30/oz range this year.

We actually feel platinum has a lot of potential. South Africa, Zimbabwe and Russia account for about 90% of platinum production and there’s a scarcity of good platinum metals group (PMG) projects outside those countries. We expect increased investment demand and believe that supply disruptions, as well as resource nationalization concerns, will drive the price higher. We note that Sprott Asset Management has formed a physical platinum and palladium trust, which could boost investment demand.

TGR: So, what really happened to the platinum market? Historically, platinum traded at a 30–40% premium over gold. Does it have to do with industrial demand or what happened to cause it to trade below gold?

MZ: The main industrial use for platinum/palladium is automotive catalysts. With fears of a global slowdown, their prices came off. But our view is that supply is not going to be able to meet the demand going forward. And, as you mentioned, platinum has historically traded at a significant premium to gold but the value is now only about 95% of the price of gold.

TGR: Getting to the actual equities, the gold and silver stocks certainly didn’t track the metals prices very well the last year. What’s been the problem?

MZ: Gold stocks have performed poorly compared to the metals. We believe this has to do with investors being leery about another period similar to what occurred in 2008 when credit markets froze. Exploration and development companies, in particular, are sensitive to what’s going on in the capital markets since they require capital to continue exploration. Take, for example, Trade Winds Ventures Inc., which was acquired last year by Detour Gold Corp. (DGC:TSX). Shares of Trade Winds traded down to $0.03 in the 2008 crisis. Trade Wind shares were later bought for cash and stock, which at the time amounted to about $0.45 a share. My point is that people are nervous but that creates opportunity especially with what I believe will be a catch-up in equity prices.

TGR: I hope with metals prices staying up, the credit markets will be a little more optimistic and will loosen up a bit.

MZ: We certainly don’t expect another period like 2008. I think that was an aberration.

TGR: So, I hope the stocks start picking up here and not continue acting like gold is $800/oz and silver is $15/oz.

MZ: That is what we expect and the precious metals stocks could really get a boost on QE3 or other stimulus programs.

TGR: So, what do you think is going to be some sort of catalyst to get people more excited faster? Or is this just going to have to be a gradual progression and we are going to have to wait for $2,000/oz gold and $50/oz silver for people to really get into this market?

MZ: The disconnect between gold/silver prices and mining company equities has grown considerably. The sector is cheap by historical standards when you consider the price of gold miners’ shares relative to the price of gold. The Philadelphia Gold and Silver Index (XAU), which is an index of 16 precious metals and mining companies, is close to the lowest level it has been since the 2008 crisis relative to gold. We expect this ratio to gradually work its way back to the average. If we see gold mining stocks move up to even the low end of their historical range versus gold, it will mean a significant gain for many of these companies.

Increased merger and acquisition (M&A) activity in the sector will get people interested in a lot of these companies. As the price of gold and silver continues to rise, the economics become very compelling, especially for large- and mid-cap companies to acquire smaller players.

More interest in precious metals will help too. With what I see as a developing currency war—a race to devalue—I think more investors are going to turn to precious metals and related equities.

TGR: It certainly seems like there are a lot of smaller companies out there with some interesting looking projects that may be sitting ducks for being taken over. If they have to keep going back to the market to raise more money and create more dilution, that could be a problem. What’s your thinking on that?

MZ: Small exploration companies are going to continue to need funds to advance their projects, and costs have been increasing. That’s a major problem. The need to raise capital isn’t going to change but we are seeing alternative ways of financing such as gold and silver streams, alternative debt arrangements and joint ventures, which mean less dilution.

TGR: A lot of companies that were able to load up with plenty of cash at reasonable prices are obviously happy in this market. Do you think they’re going to get pushed to go out and do acquisitions?

MZ: I think what we’re seeing now are mining companies with the ability to acquire languishing juniors taking advantage of the environment. The seniors and intermediates, which have filled up their treasuries with robust gold and silver prices, certainly have the ability to do the same. At the end of the year we saw companies like Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE) acquiring Grayd Resource Corp, AuRico Gold Inc. (AUQ:TSX; AUQ:NYSE) acquiring Northgate Minerals, and New Gold Inc. (NGD:TSX; NGD:NYSE.A) acquiring Richfield Ventures Corp. and Silver Quest Resources Ltd. We see this trend intensifying, especially if mining company valuations don’t keep pace with rising metals prices.

TGR: That brings us to a little follow-up on some of the companies that you talked about last time. A couple of the junior producers you talked about were Barkerville Gold Mines Ltd. (BGM:TSX.V) and Orvana Minerals Corp. (ORV:TSX). Can you tell us what’s going on with them?

MZ: The market has been disappointed with production from both companies. Barkerville recently got a boost after receiving a permit for its Bonanza Ledge property, which is a high-grade open-pittable gold resource. The delay in getting that permit meant that production was not what we had originally expected. Updated resource calculations for the company’s Bonanza Ledge, Cariboo Quartz and B.C. vein zone in the first half of 2012 could be a positive there.

Orvana has two properties that were both put into production in 2011. In Spain, the company’s El Valle-Boinás/Carlés is an operating gold mine, which is not seeing the head grade we had expected. Grades are slowly increasing from around 2 grams per tonne (g/t) to an expected 3.5 g/t. Its other project in Bolivia, the Don Mario mine, has a different problem. It’s an open-pit, copper-gold mine where recoveries have been less than expected—around 50% versus 70–80% for copper. We look for recoveries to improve and think a lot of the bad news has been priced into the shares. We’re also encouraged by the fact that Bill Williams has now taken the helm of the company. Bill has exceptional operational technical expertise.

TGR: So you feel both of those are reasonable values at this point?

MZ: On Barkerville we’re taking a wait-and-see approach and have the stock rated as a hold. On Orvana we believe the negative news has been priced into the shares and valuation looks compelling.

TGR: So, how about some of the near-term producers that you follow, such as Canadian Zinc Corporation (CZN:TSX; CZICF:OTCBB)?

MZ: Canadian Zinc is a situation where the valuation has not kept up with the project. The company recently passed the major hurdle for environmental approval of its Prairie Creek mine. It’s a really interesting story—an old Hunt Brothers mine that could be in production in 2014 or maybe even as early as 2013. For readers who don’t know the history of the Prairie Creek mine, it is in the Northwest Territories and was just a few months away from going into production when silver prices collapsed in the early 1980s and the Hunt Brothers went bankrupt. It’s a high-grade silver-lead-zinc mine with much of the infrastructure in place that we think has a lot of potential. We actually believe this is an ideal time to own shares of the company since fundamentals have improved and the share price has drifted lower with the sector.

TGR: So that’s another one to watch closely and this may be a good time to be picking some up. What about some of the other junior explorers that you like and have talked about in the past?

MZ: For very near-term production I have followed but do not cover Armistice Resources Corp. (AZ:TSX). The company expects to produce 25,000 oz gold in 2012. At around $0.22/share, which is about 50% less than last year, valuation looks interesting. Two that I cover, which are exploration stories, are NioGold Mining Corp. (NOX:TSX.V; NOXGF:OTCPK) and Prophecy Platinum Corp. (NKL:TSX.V; PNIKD:OTCPK; P94P:FSE). NioGold continues to drill at its Marban project in Val-d’Or, Québec. This is a joint venture with Aurizon Mines Ltd. (ARZ:TSX; AZK:NYSE.A) where Aurizon is funding $20 million for exploration. We think the resource could grow fairly significantly from the current 960,000 oz to 1.4–1.5 million ounces (Moz). We actually think Marban could give Aurizon’s other project, Joanna, some competition. I think the valuation looks fairly attractive here, trading at about 60% lower than our calculated net asset value.

We’re also excited about the potential of Prophecy Platinum. Prophecy has the Wellgreen deposit in the Yukon, which contains 12 Moz of combined PGMs and gold plus 2.4 billion pounds (Blb) of nickel and 2.2 Blb of copper. The in-situ value is around $50 billion and we think a preliminary economic assessment due out in Q112 will show some strong economics for an optimized open-pit. The company is carrying out other work to derisk the project, including metallurgical studies and additional infill drilling for which we’ll start seeing results early this year.

TGR: So, that one is well priced at this point and a buy as far as you’re concerned.

MZ: Absolutely. The price drifted down after the excitement over the updated resource estimate, but it’s come down to a level where we think it offers very good value. We have a $6.40 target price.

TGR: So then, let’s look at some silver juniors. One that you follow is Cream Minerals Ltd. (CMA:TSX.V; CRMXF:OTCBB; DFL:FSE). What’s going on with that one?

MZ: Cream is a company I cover and which I visited late last year. It’s an exploration company with a 41 Moz silver deposit called Nuevo Milenio. It also has about 300,000 oz gold. We believe the company has the potential to really expand the current resource. Cream completed about 20,000 meters (m) of drilling in 2011 and we expect an updated resource out late Q112. This should actually upgrade a fair amount of the Inferred resource to Indicated and could add about 30% to that resource. We also see it doing another round of drilling of 20,000–30,000m in 2012, which we think has the potential to more than double the current resource.

TGR: That sounds promising.

MZ: Another one I don’t cover but I think is very interesting is Oremex Silver Inc. (OAG:TSX.V; OARGF:OTCBB; OSI:FSE). This is a small-cap silver exploration company with assets in Mexico. The company recently moved up on good initial results on its Chalchihuites project. The project is in the same area as First Majestic Silver Corp.’s (FR:TSX; AG:NYSE; FMV:FSE) Del Toro project, and we understand First Majestic is aggressively acquiring property in the area. The company’s flagship property, Tejamen, has a defined 51 Moz silver deposit. We think the president and CEO is also a real asset for a company with a market cap of around $20M. He’s been manager of exploration and development for Barrick Gold Corp. (ABX:TSX; ABX:NYSE) in South America.

TGR: So, are you expecting that 2012 is going to be the year that mining stock investors finally wake up and smell the gold and realize it’s time to get into this market?

MZ: I think this is the year! Investors have been cautious and focusing just on the downside, holding their money in cash. I think investors should be opportunistic and look for well-run companies with strong management and great assets.

TGR: Well, we’re certainly hoping for that also. We appreciate your joining us today and look forward to talking with you again.

MZ: Thank you and I appreciate the opportunity.

Analyst Matthew Zylstra joined Northern Securities in 2010 after having worked at Sprott Resource Corp. and investment counsel firm Foyston, Gordon and Payne Inc., a unit of Affiliated Managers Group Inc. He is focused primarily on junior precious metals producers and also follows some base metals miners. Zylstra has worked in the finance sector since 1999.