The Energy Report: 2011 was a pretty exciting year with oil prices all over the map, largely fueled by the European debt crisis. What do you expect are going to be the hot topics affecting energy commodities in 2012?

John Stephenson: The spread between Brent and West Texas Intermediate (WTI) prices, which was a big story in 2011, will continue to play a role. I expect a lot of talk about how WTI has once again resumed its place as the global benchmark. Another big topic, as it always is, will be the continuing geopolitics of oil, be it a possible Arab spring in Saudi Arabia or Iran’s nuclear program and how that impacts the world. In terms of possible black swan events, the Environmental Protection Agency (EPA) or other regulators could limit horizontal drilling and fracking. However, that could be very positive in the short run for natural gas prices.

TER: What caused the big spread between the WTI and the Brent prices?

JS: Everyone used to look at WTI as the main global benchmark for crude oil prices, and Brent historically traded at a slight discount. Then, over time, Brent started trading at a premium to WTI. What people have to understand is that these benchmark contracts specify grade and location. The delivery location of the WTI crude contact is Cushing, Oklahoma. Because it’s landlocked, you can’t get crude in from the Gulf region, which actually traded in line with Brent. There also wasn’t enough pipeline capacity to get the large inventories of crude that had built up in Cushing out to other global markets. So it really was an infrastructure issue that caused the price spread. Now, various companies have gotten together and proposed pipeline alternatives that would alleviate this glut of oil at Cushing. Therefore, you’ve seen the spread go from $25 to about $11.40, where it is today.

TER: Your management company, First Asset Investment Management Inc., manages a variety of different commodity-focused funds. What is your 2012 energy outlook?

JS: Our outlook is very supportive and positive for oil. One of the interesting things about oil is that despite the dire headlines, mainly out of Europe, oil has held in as well as it has. In fact, it’s been hitting eight-month highs recently. Why is that? Partly because demand is so strong. We saw record demand globally in August and near-record demand in October and November and continuing strong demand despite the fact that Europe appears to be dipping into recession and growth is potentially slowing a little in Asia. This is why I’m very positive on this and expect to see oil go higher.

Natural gas, on the other hand, is very weak. It’s sub-$3/million cubic feet (MMcf) right now, and I think it will continue to be weak. Historically the period between December and March is when natural gas trades at a premium to its summer prices. This is actually the first winter I can recall seeing it trading at a discount.

TER: Weak natural gas prices are a result of increased shale gas production through fracking, which has created a significant oversupply in the last year or so. Is this going to continue, do you think?

JS: Yes, the U.S. has 200–250 years of reserves of shale gas at current production rates. I don’t see any reason at all for it to change unless, of course, the EPA or someone else were to rule that fracking was detrimental to the environment and there was a moratorium placed on drilling. That could be a black swan event and could change things. If things continue the way they are, there’s no doubt that prices will stay low. Now, clearly, there is some opportunity to export this, but that means building a liquefaction terminal, probably on the Gulf Coast or some other part of the country where people are willing to have a liquefaction facility. That would turn natural gas into a liquid to be transported to Asia or potentially to Europe, where the prices are much higher than they are in North America.

TER: So even though we may have hit peak oil, we certainly haven’t hit peak gas.

JS: No, I don’t think we’ve hit peak gas. Four years ago, the talk was that we were running out. They were going to build terminals on the Gulf Coast to take liquefied natural gas from Trinidad and other places, gasify it and put it in the U.S. pipeline system and supply the northeast in particular with natural gas. Now we’re finding we have so much of this stuff in various shale deposits that we have the potential to become a huge energy exporter. Hopefully that will be the case, but for now we don’t have the infrastructure in place to make that happen.

TER: In some respects it’s a happy turn of events compared to previous supply concerns.

JS: Not if you’re a producer of natural gas, but if you’re a producer of oil, it’s great. If you’re a consumer of electricity, then it’s great.

TER: As far as your portfolio selections and your outlook for this year, you’re clearly leaning much more toward oil and gas liquids. What other factors do you think are going to be affecting prices this year and into the future?

JS: What impacts prices for commodities is supply and demand. I think you’re going to see that demand continues to grow. The reality of why we’ve hit record world demand is not because consumers in the U.S. are doing so much driving. It’s rather because consumers in Asia are doing so much driving. China is now the number-one car market in the world. Who would have thought? If you look at total energy consumption, including coal and other sources, China has overtaken the U.S as the number-one consumer of energy in the world. That trend will continue and put upward pressure on oil prices over time.

The other theme that I think is important for investors to understand is that most of the majors have had real trouble finding replacement reserves to keep producing at the same level. Most of the industry has run from one country to another, where they’ve been kicked out. When Lee Raymond was running Exxon, he ran over to Russia, then to Nigeria, then Venezuela. The settlement that Venezuela was willing to offer Exxon for its assets was a pittance. This is typical of what we’re starting to see around the world. It’s very hard for most of the majors to find new reserves and to continue to produce at the same levels because most of the world that has energy is not open or friendly to the West. This creates a huge problem for these companies.

Given that backdrop, investors need to find companies with reserves in geopolitically stable locations, or where companies are not in the business of generating the reserves; they’re in the business of helping oil companies produce those reserves. That leads you to the service sector, which I think is a lower-risk area. Investors can stay in North America and invest in companies they know and understand without worrying about geopolitics.

TER: What are some of the names that you like in the service sector?

JS: I think if Saudi Aramco, the largest oil company in the world, is going to do a job and it’s going to produce a new field, it will call in Halliburton Co. (HAL:NYSE) or Schlumberger Ltd. (SLB:NYSE). It’s not going to call in Exxon Mobil Corp. (XOM:NYSE). It doesn’t need Exxon’s expertise or capital. But it does need Halliburton’s or Schlumberger’s expertise. These global majors are going to do well on the service side. In the last 25–30 years, the industry has gone from positive bullish cycles to bearish cycles. The people who had the expertise in down-hole seismic techniques, who understood how to operate drill bits at various angles and how to cement and case wells and all of these other things became outsourced to the service industry. The true oil business expertise is in the service industry; that’s why I see it as a sound investment.

TER: So if I may make a mining metaphor, it’s the guys that supply the shovels to the miners that are going to make the money, not necessarily the miners.

JS: Absolutely. It’s the California Gold Rush all over again, except it’s the global energy rush, and you want to be in the picks and shovels business, not necessarily in the prospecting business laying claims. If you’re a Western company and you’re laying claims, chances are you’re laying claims in some part of the world that doesn’t want you there and that may kick you out down the road. Then what do you have?

TER: What are some other companies in your portfolio holdings that you particularly like at this point?

JS: One area to look at is the smaller energy service companies, like Calfrac Well Services Ltd. (CFW:TSX) and Trican Well Service Ltd. (TCW:TSX). Again, there is an increasing amount of drilling that’s happening, even on the gas side. It’s just happening with these new horizontal drilling and fracking techniques. These are the guys who supply this equipment. That’s very strong.

I also think you want to look at the oil companies that don’t have problems with reserves and short reserve life, including some of the Canadian oil sands producers. I would recommend Suncor Energy Inc. (SU:TSX; SU:NYSE) and Canadian Natural Resources (CNQ:NYSE; CNQ:TSX). These stocks are cheap. They’re trading as if oil were $55 or $60/barrel (bbl) when it’s over $100/bbl. These low valuations offer a great opportunity.

TER: Looking at your portfolio in your First Asset Energy and Resource fund back at the end of last quarter, Sept. 30, you were about 78% in cash. Was that a strategic decision? Have you changed that cash into equities at this point?

JS: No. We were very defensive at that time, and I think the reason was pretty simple: Europe was blowing up and when any major economic zone is blowing up, I don’t think you want to be in commodities or commodity producers. Now we’re seeing that the market has stabilized, and you’re going see growth going forward. Valuations certainly never got ahead of themselves in either individual stocks or in any energy sector, so I expect valuations to move higher at this point.

We’re no longer at that same cash level. Our position at that time reflected an overall nervousness about the world. When you have these dominant issues, you need to take your money off the table, which we did. Ultimately, the trade was to the downside, and we preserved value by doing that. I’m very proud that we were able to raise so much cash and be truly defensive at a time when the market was dropping quite substantially.

TER: Are there any of your other attractive portfolio holdings that you’d like to discuss at this point?

JS: I think in terms of other commodity themes that are working well, certainly Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE) would be a great name—that’s on the copper side; it is the largest pure copper producer out there. On a similar vein with a little bit better growth and a little bit more sensitivity to the market—meaning it will move a little more dramatically than the market itself—would be First Quantum Minerals Ltd. (FM:TSX). That’s another name that I think does very well.

We haven’t talked a lot about the agricultural names. If we’re talking about the broad resource base, it’s been a tough time in the agricultural space, particularly for the fertilizer companies. But I continue to think Potash Corp. (POT:TSX; POT:NYSE) looks attractive, especially at this level. Agrium Inc. (AGU:NYSE; AGU:TSX) looks attractive at this level. It’s a little more defensive than Potash. The Mosaic Company (MOS:NYSE) has struggled. I would probably recommend CF Industries Holdings Inc. (CF:NYSE) over Mosaic. Those are the areas that I would look to.

Also, in terms of other oil and gas producers, Canyon Services Group Inc. (FRC:TSX) does well. Transocean Ltd. (RIG:NYSE; RIGN:SIX), a big supplier of offshore platforms, will do well in this environment. Even Baker Hughes Inc. (BHI:NYSE) is transitioning its fleet to more horizontal drilling from straight vertical drilling. Those are all names that we have held and will continue to hold in the future and expect to do well.

TER: To sum things up as far as the energy outlook for 2012, what would you like to tell us?

JS: I would say that energy remains the most important of all the commodities. It will be the most important in 2012 and likely in 2020. Even though we’re over 100 years into the energy era, we are still very much dependent on oil. While it may seem expensive when we’re filling up at the pump or when we look at the futures prices, it’s still cheaper than orange juice on a volumetric basis. There is no substitute for oil, at least no good substitute. There is no technology right now that is commercially viable enough that could change the industry in the way that horizontal drilling and fracking changed the natural gas world. So I think you’re going to see oil prices move considerably higher.

Demand no longer is being driven by America; it’s being driven by Asia and predominantly by China. That trend will continue. In many parts of the world where demand is growing the fastest, namely the Middle East as well as some parts of South America and Asia, fuel prices are subsidized. In an environment where gasoline prices are subsidized, the consumer isn’t feeling the full impact that we feel here in North America. So for those reasons, I think we’ll see oil prices move higher, stay higher and exit 2012 at least $130/bbl. Natural gas prices, on the other hand, will remain range-bound in the $2.50–3, maybe $4, range. It’s very hard to see a successful investment strategy for investors there, other than with the service companies that are going to be the beneficiaries from all of that drilling.

TER: I think that pretty well sums it up. We appreciate your thoughts and input today.

JS: My pleasure.

John Stephenson is a senior vice president and portfolio manager with First Asset Investment Management Inc., where he is responsible for a wide range of equity mandates with a particular focus on energy and resource investing. He has been recognized by Brendan Wood International (BWI) as one of Canada’s 50 best portfolio managers for the past three years. He is the author of The Little Book of Commodity Investing (John Wiley & Sons, 2010), which has been translated into five languages and Shell Shocked: How Canadians Can Invest After the Collapse (John Wiley & Sons, 2009), and writes a free bi-weekly investment newsletter, Money Focus, which reaches a global audience of more than 125,000 (www.reportonmoney.com).

Stephenson is regularly quoted by Bloomberg News, Reuters, The Associated Press, The Wall Street Journal and The Globe and Mail and is a frequent guest on Bloomberg TV, CNBC, CNN, Fox Business and Canada’s Business News Network (BNN), Sun TV and the CBC. He is frequently the keynote speaker at investment conferences throughout North America. Stephenson holds a degree in mechanical engineering from the University of Waterloo, an MBA from INSEAD, as well as the Chartered Financial Analyst (CFA) and Financial Risk Manager (FRM) designations. He lives in Toronto.

The Gold Report: We have seen some incredible volatility in the market over the last three or four months, with many junior resource stocks on the Toronto Venture Exchange beaten down, even if they have proven resources and substantial cash treasuries. We have also seen some volatility in the price of gold and a disconnect between the price of gold and the price of juniors. In this environment, how should investors approach risk in the junior resource space?

Rick Mills: I agree with Baron Nathan Rothschild who became a legend during the financial crisis right after the Franco-Prussian War. As the story goes, a panic-stricken investor came screaming into his office yelling, “You advise me to buy securities now? Now? The streets of Paris run with blood!” Rothschild replied, “My dear friend, if the streets of Paris were not running with blood, do you think you would be able to buy at the present prices? Buy when there’s blood in the streets, even if the blood is your own.”

I’m pretty sure things today are not as bad as they were back then, but this market offers contrarian-minded investors an opportunity to take huge advantage of discount share prices and, as you pointed out, many are trading below cash in the bank. Many, many are way undervalued compared to what they have in the ground and what they will have. The thing to do is to even further derisk.

Everything we do has some level of risk, from flying in a plane to walking across the street. All our lives we identify and quantify risk, so it’s second nature and part of our makeup. Everyone has his own risk profile, of course. For instance, maybe you won’t bungee-jump off a bridge or willingly parachute from an airplane, but you’ll happily get crazy driving around on an ATV or a snowmobile. You have a risk profile. You will do this; you won’t do that.

TGR: So far, so good. So how do you derisk these stocks?

RM: The way to derisk investments into junior resource companies is to know your risk profile. Then wisely deploy capital into the right management team in the right stage, for you, of company development.

TGR: What steps would investors take to identify companies they’re comfortable with? How can they make better-informed choices and thus create less risk?

RM: The most important things are to know yourself and to know that juniors are inherently risky. Understand how much volatility you can handle and how much patience you have to wait while a story plays out. Develop the discipline not to get faked out of your position or chase after hot tips or listen to the cheerleaders. Have a clear and complete understanding of why you’re here in the first place. Know the different development stages of a junior, because risk lessens as a company moves a project through drilling and post-discovery resource definition, then into the various mining studies, and finally into raising money, building the mine, and ultimately, mining. You really have to know who you are invested with and the story. Monitor the progress of your management team with its project and make sure they’re meeting goals and timelines.

TGR: And when you find companies that suit your risk profile and pass muster in terms of development stage and management performance, you jump in?

RM: You don’t want to just walk in and buy all your shares. Develop a plan to buy shares over time . I don’t use stops, because these stocks can make huge moves down in a day and you could get knocked out just before they move back up and go on a tear the next day. I’m here long term so short-term moves don’t bother me; stops in juniors, for non-traders, create more problems than they solve.

TGR: Could you elaborate a bit on evaluating the various development stages?

RM: The most upside and the greatest risk come with the greenfields, the junior resource companies when they are exploring. It takes a lot of patience with them and with the management teams to let stories play out. Some of these stocks are very thinly traded, so it doesn’t take much to make them jump in either direction. Make a discovery, get some good drill assays and they explode in the share price. Get some bad assays and they implode to the downside—make sure they have a back up play, a plan B, already secured and ready to go. They are the riskiest plays by far, but they offer the highest reward.

Next is what I call the post-discovery resource definition stage. A company at this stage already has found something, its share price has exploded and now the company is undertaking a nice drill program. After the price has settled back, decide on an entry point and start to get in. Let the company build an NI 43-101-compliant resource. The risk has been greatly reduced, and of course there’s no longer any waiting for a discovery.

The study stage comes next. After the company has its NI 43-101-compliant resource, it gets into scoping, prefeasibility and feasibility studies. Companies at this stage are so much further down the development path that much of the guesswork about grade, size, cost and metallurgy has been taken out of the equation for investors. These companies have done sufficient work to give investors a certain level of confidence that they’ll successfully move their projects along.

TGR: Haven’t a lot of companies at this stage also been derisked in the sense that their share prices are depressed as well?

RM: Oh, absolutely. A lot of these companies not only have the value, but they continue working and adding to that value every day. It’s a fantastic opportunity to buy some companies not only on the path to production but also on the path to some pretty decent cash flows.

TGR: Could you talk about any companies you like that are enroute to production and positive cash flow?

RM: Not yet. We haven’t finished derisking. Let’s look at gold mining. Even though the price of gold has gone up roughly six times, global gold production has been falling since 2001, which tells us that higher gold prices are not bringing on more gold supply. The money being spent on gold exploration is finally starting to climb, but very few big new deposits are being found, so gold miners are adding to their resources by buying them from smaller-cap miners and explorers—the companies making the new discoveries. The majors need them to replace their reserves and depend on them for their upstream flow of new projects for development. That’s what juniors do; that’s their function in the food chain. So it removes even more risk from the equation for the juniors that are sitting on existing deposits; they are becoming more valuable day by day.

The majors have gone through mergers for much of the last decade, and every round of mergers obviously leaves fewer majors. That said, large Asian miners have been entering the sector. They love not only the gold deposits, but copper-gold porphyries and base metals as well. All of this makes juniors with discernible deposits moving down a path to production all that much more valuable.

TGR: And less risky. So are you ready to tell us about some of those companies, the ones with discernible deposits that are close to production?

RM: Not quite. What is the biggest risk all junior companies face—not investors, but the companies themselves?

TGR: Running out of money?

RM: Move to the head of the class because that is the absolute major risk, the most serious risk all the juniors face—remember most do not have cash flow. So if the markets look a little wonky and you think juniors will have a hard time raising money, you can further derisk by looking at companies with treasuries full enough to keep them working—to get by for a couple of years. And you can derisk even more by narrowing these companies down to those that have cash now and that will actually get some cash flow from production in the next little while.

TGR: You’ve given us a good group of filters for investors to use.

RM: We’re doing some pretty serious research here and we have a very strong plan in place. We have directly targeted risk with the objective to lessen it yet leave potential major share price upside.

With careful due diligence and by thoughtfully choosing the development stage of companies we invest in, I think we can make some money.

TGR: So are we ready to hear about some of those companies?

RM: Yes. And these are in no particular order. Let’s start with Cangold Ltd. (CLD:TSX.V). This is Bob Archer’s gold company, which is working the Ixhuatan gold project in southern Mexico. Archer also has a silver company called Great Panther Silver Ltd. (GPR:TSX; GPL:NYSE.A). The Ixhuatan property encompasses seven or eight different zones, all within a kilometer or two of each other, and all viable targets in their own right that Cangold intends to evaluate. So far, the most drilling has been done on the Campamento deposit, so bringing that into production is the main focus.

Cangold has stepped into something that is already well defined, based on 342 holes and 89,000 meters (m) of drilling, so it won’t have to spend $500,000 a year drilling to try to find something or basically drilling this off. This deposit has a Measured and Compliant resource of 1.041 million ounces (Moz) gold and 4.4 Moz silver, with another 0.7 Moz gold and 2.2 Moz silver in the Inferred category. The deal Cangold made with Brigus Gold Corp. (BRD:TSX; BRD:NYSE.A) calls for Cangold to earn 75% interest by taking this through feasibility.

Campamento is at the scoping study level right now, and Cangold plans to move it as fast as it can through prefeasibility and feasibility. The work needed to advance this project to the mine stage is almost all engineering studies. Optimizing the open-pit shell, looking for the best place to locate a plant and tailing ponds has already started. So this is basically a kit mine that Cangold will develop and put into production.

And Cangold already has done a 5:1 rollback. It didn’t have any problem raising money at $0.50, has a very tightly held share structure and has all that gold and silver in the ground to bring out via an open-pit mine. And it’s trading at $0.30/share.

TGR: Why did Brigus make this partnership with Cangold when it already is a producer, running the Black Fox Mine up in Canada?

RM: I really think it’s because of Bob Archer and his experience with Great Panther. He’s well-established in Mexico, has excellent contacts and knows how to work there. Also, major shareholders such as Sprott back this deal up.

TGR: Certainly Archer has had great success with his mine at Guanajuato.

RM: That’s right. I was buying Great Panther years ago in the high $0.30s and talked with him at the time. He laid out what he wanted to do and has basically delivered on everything. He has built a very strong team that works hard and gets the job done.

TGR: What are some of those other companies?

RM: Okay, the next one is Kootenay Gold Inc. (KTN:TSX.V), which has the 100%-owned Promontorio silver project in Sonora, Mexico. Like Cangold, Kootenay already has a significant resource. AGP Mining Consultants’ resource estimate puts Indicated mineral resource at 5.2 million tons, with 8.9 Moz silver, 99 million pounds (Mlb) lead and 111 Mlb zinc. It grades 52 grams of silver, 0.86% lead and 0.96% zinc.

Since that estimate, Kootenay has drilled 53,000m into Promontorio at an average depth of 300m; the results from two-thirds of that drilling will go into a new resource estimate, which is due out in another month or two. Going back through the results on the website, you see some pretty decent assays, and I expect a very definite resource increase—a doubling or even tripling in the new estimate. Then Kootenay will launch another big and aggressive drill program. It wouldn’t surprise me to see 50 Moz silver and quite likely the equivalent to that in lead and zinc after that drilling.

With all of that, plus a very good share structure with heavy management participation, a very healthy treasury, and more news coming, I refuse to believe that Kootenay won’t be revalued much, much higher over the coming year.

TGR: With the flagship property actually focused more on silver than gold, is it odd that this company is Kootenay Gold rather than Kootenay Silver?

RM: The company took its name from the Kootenay region of British Columbia, where it started, and it has eight or nine serious joint ventures (JVs) with some pretty good junior resource companies on gold properties there and in other parts of B.C.—Copley, Red Lobster, Deer Creek, Jumping Josephine and Rosetta Stone.

Kootenay has the best of both worlds, and operates on the prospector generator business model, taking property dilution instead of share dilution. It uses the money that generates along with money raised to work on its 100%-owned Promontorio. I don’t think most people realize that Promontorio, as a standalone, will be able to potentially produce 3–5 Moz silver a year plus another 3–5 Moz silver equivalent over a 10-year-plus timeframe. In the context of other silver producers in Mexico, that’s a pretty significant asset. It usually takes these producers two or three mines to get up to production numbers like that, and Kootenay will get there with a single asset. That’s pretty uncommon and pretty valuable.

TGR: A lot of great silver producers in Mexico certainly would be interested in this project.

RM: Oh, one project with the potential to produce that much silver and silver equivalent in a year has to be on every radar screen. Don’t get me wrong, Kootenay can take this to production. It absolutely can. It’s just a matter of whether an offer is too good to refuse.

TGR: Well, you’ve named two companies with assets in Mexico. It certainly is a great mining location.

RM: It is, but let’s move up north into Nevada and Idaho with Terraco Gold Corp. (TEN:TSX.V). Terraco has two exciting projects—the Almaden, northwest of Boise, and the Moonlight, northeast of Reno.

The Almaden project could go into production today; it’s very similar to deposits such as the Hollister mine and the Ken Snyder Midas mine in northeast Nevada. It has almost 1 Moz of Measured, Indicated and Inferred NI 43-101-complaint resources, based on almost 900 drill holes. Some of the mineralization outcrops, in fact the bulk of the deposit, lies within 100m of the surface. The exciting thing about this deposit, as with the Hollister and Midas mines, is that the deposit has substantial evidence to suggest higher-grade—maybe bonanza-grade—feeder shoots at depth.

I think Terraco will boost the resource quite a bit just due to the type of drilling program it is using and the fact that it is improving the metallurgy. So even if Terraco does not hit any more gold, I expect a significant increase in the resource. But if the model the drilling is based on proves to be correct and Terraco hits these feeder zones, the impact will be huge.

TGR: Terraco’s chart suggests it has been beaten down quite severely, roughly about 50% in the last nine months.

RM: That’s right. But Ken Snyder and Charlie Sulfrian, who are running the drill program, have discovered several mines. Snyder is one of the foremost geologists and explorationists working today and Sulfrian is a mine finder as well and a very good metallurgist. When he says he might be able to work on the recoveries, you have to anticipate a measure of success. When I asked him if the Almaden could be put into production as it is, he said yes. As I said, with the different drill methods and improved metallurgy, you’re going see the resources at Almaden expand, and when you add in the blue sky of the feeder zones, you’re looking at something pretty exciting. The story gets better and better all the time.

As you indicated, it’s a little beaten up and has been a little worked over—who isn’t—but Terraco has money in the bank and continues to increase shareholder value. Management isn’t turtling up and crawling into a hole and crying themselves to sleep at night. When the market turns around—I fully believe the market’s going to turn around—the companies we’re talking about will be ahead of the herd. They’re out there working and building shareholder value.

TGR: How about the Moonlight project?

RM: Moonlight is a call option on gold discovery. It sits directly north of Spring Valley, a resource of 4.1 Moz. Since that estimate, Terraco has secured the Black Ridge Fault property and incorporated it into Moonlight, hired Tom Chadwick to map it and has now started drilling.

TGR: Terraco also closed a very creative financing in December, with the royalty deal it made on the Spring Valley gold project.

RM: Yes. That deal is a hell of an example of how to create value for shareholders. Spring Valley is a JV between Barrick Gold Corp. (ABS:TSX; ABS:NYSE) and Midway Gold Corp. (MDW:TSX; MDW:NYSE.A), where Barrick has the right to earn 60% interest in the project by completing work expenditures totaling $30 million (M) by the end of 2013. But that sliding royalty from the Barrick/Midway JV is really interesting. I did the math.

TGR: Okay, let’s hear about it.

RM: Terraco receives no royalty on the first 500,000 ounces (oz) of production. After that, Terraco pays $12.5M and gets a 2.5% royalty on 76% of the deposit or, as it stands today, 2.15 Moz. A very conservative 70% recovery means 1.51 Moz gold. Using $500/oz as the cost and a very conservative gold price of $1,100/oz means $600/oz net. On 1.51 Moz gold, that adds up to $22.6M. It will cost $12.5M to get that, of course, which takes Terraco down to $10.1M. Terraco has already received $5M as an initial payment for doing the deal. So with the $10.1M coming from the Barrick/Midway JV net smelter returns royalty and the $5M already in the treasury, Terraco is cashed up today and has a future royalty stream.

It’s a good example of a pretty smart, on-the-ball management team increasing shareholder value. I think investors will find some joy in this one.

TGR: Excellent. Heading further north, do you have any Canadian projects to talk about?

RM: VMS Ventures Inc. (VMS:TSX.V) is a solid junior, among the smartest explorers around using all the modern techniques, and it’s a survivor. VMS Ventures has been through the tough times, back in 2000 and again a few years ago in 2008. This company knows how risky it is for a junior to run out of money, and it isn’t going to do it. It has $10M in the treasury to start 2012—enough to keep exploring and going on its own until cash flow starts. Let’s talk about that cash flow.

VMS Ventures has a JV with HudBay Minerals Inc. (HBM:TSX; HBM:NYSE) on its Reed Lake copper deposit that will take the company to production next year. It will get 30% from this operating mine—that’s many, many millions of dollars a year. When you look at the kind of cash flow that this carried-to-production scenario at Reed Lake will give the company, you have to expect an upward revaluation in the share price. Another factor that helps derisk VMS Ventures is HudBay’s Trout Lake Mine is coming offline, its plant in Flin Flon is underutilized, so it needs the feed from production at Reed Lake.

In addition to the JV, HudBay has optioned some of VMS Venture’s properties. One discovery, Reed North, has enormous potential to be an absolute monster of a deposit.

Something like 98% of VMS’s properties are 100% owned. The company did several drill programs last year and will be following up on three discoveries made on three different 100%-owned properties. VMS also owns 45% of North American Nickel Inc. (NAN:TSX.V), which has a possible district-size nickel play in Greenland. With all it has going—its considerable treasury, the cash flow, the exploration upside, the management—VMS Ventures is a poster child for how juniors should manage capital. As we agreed, the most dangerous thing for a junior is to run out of money. This company absolutely doesn’t have that problem. And, as a matter of fact, the closer it moves to production, it’s just going to get better and better.

Fully cashed up with $10M in the bank and financing costs for its 30% of the mine covered, VMS Ventures also focuses on some of the safest areas for investment. It has no geopolitical risk.

TGR: Because VMS is a copper play, you must anticipate somewhat stable demand for copper, too.

RM: We’re never going to see $0.85/pound (lb) copper again. With copper at $3–4/lb, Reed Lake should be wildly profitable. Put $71M into building a ramp down to the deposit and who knows how much more copper it will find? It’s not only that this deposit has 5% copper equivalent over a couple of million tons, but these deposits come in pods. So far, VMS has not drilled off to the side or underneath because it simply doesn’t make economic sense. But once it has the decline into the deposit, it will build side rooms, set up drills and start fan-drilling and see what it gets, right?

TGR: Right. And the idea of diversifying a little bit into base metals makes sense for the typical investor. Any more juniors that you’d like to talk about?

RM: I really like NioGold Mining Corp. (NOX:TSX.V; NOXGF:OTCPK), which is focused in Quebec. These people at NioGold are smart. They can put land packages together, and they have. And look at the deal that they’ve done with Aurizon Mines Ltd. (ARZ:TSX; AZK:NYSE.A). Aurizon right now can earn 65% interest in NioGold’s Marban Block property, an initial 50% by spending $20M over three years, completing an updated NI 43-101-compliant mineral resource estimate, which will be done this March, and then making a resource payment for 50% of the total gold ounces defined by that resource estimate.

So far, Aurizon has completed a first phase, drilling 50,000m, spending $6M and identifying two new gold zones. The second phase will be a $5M, 34,000m diamond drill program, updated resource estimate and basic technical studies this year. If it sees what it needs to see in the resource estimate—and I don’t see why it won’t, because it already has two new discoveries—it just doesn’t make sense for Aurizon to do a third year, buy those ounces and carry NioGold with it to production. Instead, I would think that Aurizon would buy NioGold out as soon as it gets a feel for what’s there.

TGR: Aurizon certainly has the capability to do that. It’s had so much success with building the resource base at the Joanna gold project. So yes, that’s very logical.

RM: And the thing about NioGold is it is fully cashed up. It has lots of money in the treasury. It is also going to have this resource payment. And it has a discovery right beside Osisko Mining Corp.’s (OSK:TSX) Malartic deposit. It also looks as if NioGold has the extension of the Marban deposits, Marbanite and Norbenite, on its 100%-owned block of ground just north of where Aurizon’s drilling. So, NioGold has immense blue-sky potential as well as the deal with Aurizon.

TGR: With the stock trading at around $0.35, NioGold would seem to be a bargain at this point. Any more names in that hat, Rick?

RM: One more. And this might be the cheapest safest gold ounces you’ll find on the Venture Exchange and quite an opportunity. It’s a story that’s been dormant for a long time, but revived itself with acquisition of a hell of a property.

TGR: Tell us more.

RM: On Jan. 3, Altair Ventures Inc. (AVX:TSX.V) put out a news release to announce signing a letter of agreement for an option to acquire from Sultan Minerals Inc. (SUL:TSX.V) up to a 75% interest in the Kena gold project, located close to Nelson in southeastern B.C. At 7,600 hectares, this is a fairly large property in a safe jurisdiction with access to infrastructure. But more important, it covers 8,000m of strike length on a district scale gold and copper-gold system. It has a 1.1 Moz gold resource now, with the potential to double or triple that resource. I have a prospector buddy who’s worked all over the area and on this property. He absolutely loves this property, has been following it for years and always wondered why nothing was ever done with it.

TGR: Do you know why?

RM: Well, Sultan spent about $500,000 tying up this property, which is a lower-grade, bulk-tonnage target, between 2000 and 2003, and had the resource defined by 2004. At that time gold wasn’t as high as it is now, and low-grade bulk-tonnage properties didn’t really come into vogue until later.

TGR: I see Bob Archer is involved with this one as well.

RM: Yes he is. I think at around $0.07/share, with 42M shares outstanding, it has to be some of the cheapest gold on the exchange. The property is severely undervalued, and with the exploration potential to double and possibly even triple the resource, this is pretty exciting stuff. Now it is going to rollback three for one and will have to raise some money. So maybe this isn’t as derisked as others we have mentioned, but this is, in my opinion, incredibly undervalued based on the existing resource and exploration upside as shown from results on other areas of the property.

TGR: You’ve given us a lot of interesting ideas, Rick, and investors certainly will appreciate your explanation of how to lessen their risk as they venture into the junior space. Is there anything you’d like to add before we say goodbye?

RM: Maybe just to emphasize the importance of doing your homework. There’s absolutely no way around it. As an investor, you can rely on other people to do some of it—Ahead of the Herd and Streetwise just did by showcasing, for free, several excellent companies to do further due diligence on—but the ultimate decision and the ultimate responsibility for every decision you make rests with you. That’s why you need to satisfy yourself that what you put your money into is run by a competent management team.

Know your risk profile. Pick your stock. Plan your entrance, and have the patience and discipline to let a quality management team go to work for you and build value. But be sure to have an exit plan as well; pick the stage at which you get out, because you don’t make any money until you sell—stick to your plan.

TGR: Excellent. Thank you, Rick.

RM: Thank you.

Richard (Rick) Mills is the founder, owner and president of Northern Venture Group, which owns aheadoftheherd.com, as well as publisher, editor and host of the website. Focusing on the junior resource sector, Mills has had articles appearing on more than 300 websites, including: The Wall Street Journal, SafeHaven, Market Oracle, USA Today, National Post, Stockhouse, Lewrockwell, Uranium Miner, Casey Research, 24hgold, Vancouver Sun, SilverBearCafe, Infomine, Huffington Post, Mineweb, 321Gold, Kitco, Gold-Eagle, The Gold/Energy Reports, Calgary Herald, Resource Investor, Mining.com, Forbes, FNArena, Uraniumseek, and Financial Sense.

1. They continue to sometimes do tiny blocks of trading on the currency market. In a market of $70 billion a day, a small scale of trading (e.g. $1 billion a month) is irrelevant, so why bother doing it? This has been pointless, but it has done no damage.
2. They have failed to correctly communicate to the market that the exchange rate is now a float. I cannot recall an RBI governor who used the phase “floating exchange rate”. Many economic agents seem to have got the following message: You’re on your own for small fluctuations, but if there are big movements, RBI will block them. This was mis-communication. The people who hedged against small movements but not against large ones, as a consequence of RBI, have now got burned. This is going to further increase the cost of RBI to gain credibility in the years to come, to come to a point where its words are respected.

Economists essentially have a sophisticated lack of understanding of economics, especially macroeconomics. I know it sounds ridiculous. But the reason why I tell people they should study economics is not so they’ll know something at the end—because I don’t think we know much—but because we’re good at thinking. Economics teaches you to think things through. What you see a lot of times in economics is disdain for other’s lack of thinking. You have to think about the ramifications of policies in the short run, the medium run, and the long run. Economists think they’re good at doing that, but they’re good at doing that in the sense that they can write down a model that will help them think about it—not in terms of empirically knowing what the answers are. And we have gotten so enamored of thinking things through that the fact that we don’t know anything needs to bother us more. So, yes, it’s true that the average guy on the street doesn’t understand economics, and it’s also true that we don’t understand economics. We just have a more sophisticated lack of understanding than the guy on the street.

The Gold Report: When you last spoke with The Gold Report in August, the gold:silver ratio was about 40:1. Today it’s about 53:1. In August, you were looking for a lower gold:silver ratio that you thought would probably be more reasonable under the circumstances. Yet it seems to have gone the other direction. What do you think has happened here? Was silver drastically overpriced or not able to keep up with the gold?
Chen Lin: In the last interview, I was pretty evenly bidding between gold and silver. I don’t have a particular preference. At that time, there were some major funds buying silver. Historically it has been lower—as low as 10:1 a very long time ago. But, right now, it’s in a reasonable range. So, I’m not saying that one is overvalued and the other is undervalued. Silver has some industrial components to it while gold is mainly monetary. I’m personally looking for the silver:gold ratio to go lower over the long run. Right now, the financial crisis has pushed central banks to actually start buying more gold in the past quarter. So, that’s probably keeping the gold price higher.

TGR: So, what you’re saying is the European debt crisis is the thing that’s really driving the gold price higher.

CL: Two or three of the central banks have put a historical amount of gold on their books, which tells you there’s more focus on gold because of the European crisis.

TGR: What do you think is going to happen with metals prices if this Eurozone situation deteriorates further?

CL: That’s a hard question. I think it’s in the hands of the policymakers. When Greece said we’re going to do the referendum and that Greece could be kicked out of the Eurozone, the Greek people were rushing to their banks to get the euro out. If the euro starts falling apart, I think gold could be one of the hard assets people in Europe will try to get their hands on. That could be very positive for gold. I can see Germany give in to the other euro countries and basically agree to use the European Central Bank to print money. That’s probably the most likely outcome. That would delay the crisis and investors would focus on other countries such as Japan and the United States. Then Europe may quiet down a little bit. But, that would be very positive to gold as well. Gold can potentially have a very explosive move on the announcement.

TGR: You’ve had pretty spectacular performance since you started your portfolio with about $5,000. In August, it was down about 10% for the year. What’s happened here in the last three or four months?

CL: It’s been down between 10% and 15% so far, it has been quite flat this year. Considering that I own a lot of junior stocks, those stocks can be very volatile.

TGR: It’s been a tough year for everybody and not easy to show any spectacular gains in 2011. How about some of the individual stocks in your portfolio; do you have some nice winners that you’d like to talk about?

CL: Prophecy Platinum Corp. (NKL:TSX.V; PNIKD:OTCPK; P94P:Fkft) was a spectacular winner. The rest have been holding on. However, I’m quite optimistic because some of the stocks have some major news coming in the next few months.

TGR: You mentioned platinum, which always used to trade at a pretty substantial premium to gold. It’s obviously a lot rarer than gold. Yet somehow, it’s faded into obscurity in the last few years. Do you have any opinions on why that might be the case?

CL: In fact, I was out telling everybody that I’m loading up on platinum. Platinum is less than 10% of the global production of gold. Some 75% of global production comes from South Africa, which is having problems with electricity, labor disputes and other issues. Right now platinum is trading at a discount to gold. It’s almost unheard of. It used to be platinum was twice as much as gold. There could be hedge funds that may be long platinum and short gold and are having some problems and may be unwinding some positions. Over the long run, I think platinum is probably a very good investment.

TGR: Tell us more about Prophecy Platinum.

CL: This stock has been a spectacular winner for me this year. It’s up from less than $1/share to over $6/share in quite a short time. Now it’s pulled back to about the $3/share range. Prophecy just completed a private placement, of which 25% was participation by the insiders. That’s very strong insider participation. The price right now is at around the private placement price. Prophecy has a huge platinum group metals (PGM) deposit in the Yukon. It’s 12 million ounces in the NI 43-101. Prophecy just had some very nice drill holes. When the next update comes out, it will probably have more PGM and the gold. So, that’s looking very good. It has a sister company called Prophecy Coal Corp. (PCY:TSX; PRPCF:OTCQX; 1P2:Fkft), which owns about 45% of Prophecy Platinum. If you deduct its cash and the value of its Prophecy Platinum holdings, you get the coalmine in Mongolia for free. Plus you have leverage to this platinum play.

TGR: The platinum price situation is just hard to believe—the way it has fallen back. Maybe it has something to do with less industrial demand.

CL: The industrial demand will slow down a little bit. But, it’s not this dramatic. I feel it’s like when silver dropped to $10/ounce in 2008. The price dropped so low that I think it’s an opportunity for investors to buy platinum and platinum stocks on the cheap.

Another platinum producer I like is Stillwater Mining Company (SWC:NYSE). That’s the largest platinum producer in North America.

TGR: Stillwater. That’s the only producer in the U.S. that I’m aware of.

CL: Right. It fell very hard recently and lost two-thirds of its market cap. It now has a little bit of a rebound. I bought it pretty close to the bottom and I’m still holding it.

TGR: You recently returned from a visit to Haiti where you went to take a look at the Majescor Resources Inc. (MJX:TSX.V) gold property. What kind of report do you have on that?

CL: Oh, I was very excited about that. The property has a huge potential and Newmont Mining Corp. (NEM:NYSE) is also in the area. Newmont has been very interested in Majescor’s drilling program and even invited Majescor’s company executives to its office when I was there. That tells you how much focus it has on this drilling program by Majescor. It will have drilling results coming out in December. First, it was targeting copper and copper-gold and then it will drill out the area with some very high gold intercepts. In a previous release, Majescor showed 10 meters of something like 70 grams per ton. It will drill that next year. Basically, it’s a gold and copper or copper and gold project, depending on where you focus on it.

TGR: So, we’re going to wait for results next month and see how that goes, correct?

CL: Exactly. Its market cap is only $15 million and it could have a world-class deposit. Plus all the majors are looking at the drilling results.

TGR: So there may be a good chance that it will get taken out pretty quickly if the stock doesn’t go crazy.

CL: Majescor has been working on this project for two or three years and finally the drilling starts. It’s a pretty exciting time for shareholders.

TGR: Back in August you were also pretty positive on Pretium Resources Inc. (PVG:TSX). The company has a couple of properties that look pretty interesting at Snowfield and Brucejack. What’s been going on with those properties since last August?

CL: I visited its property and it was very, very exciting. The high-grade gold intercept was fantastic. Right now, the market is in a holding mode and we haven’t seen much movement in the past few months. Once people see how good a deposit it is and recognize how undervalued it is, I think we should see some good upside movement on this stock.

TGR: You also visited the Romios Gold Resources Inc. (RG:TSX.V; RMIOF:NASDAQ; D4R:Fkft) and the NovaGold Resources Inc. (NG:TSX; NG:NYSE.A) properties up in Northwestern B.C. last summer. What’s going on there?

CL: Romios started releasing drilling results and you can see it has some pretty good intercepts. It is still looking for the sweet spot and will probably need to take more time to drill out this area to find the center of the deposit.

TGR: When do you expect some significant news?

CL: Depending on the next round of drilling results, it could mean Romios needs to come back next year to do more drilling. It already released a few rounds of results and I think it has maybe one or two rounds of results left.

TGR: Romios is near NovaGold. Do you think there’s some possibility that NovaGold may try to take a run at Romios?

CL: NovaGold has a new CEO and plans to sell this Galore Creek deposit. Last time I think I was hoping it would have fantastic drilling results and then we would have a takeover situation. But, now it looks like it has found a deposit and needs to drill more. So, you probably need a little bit more patience to see how it develops, probably into next year.

TGR: What about NovaCopper?

CL: NovaGold wants to spin copper projects off and potentially the name could be NovaCopper. We’ll have to see what kind of deal it has and what direction that property goes.

TGR: What about other companies in your portfolio? Any developments there that our readers should be aware of?

CL: I’m still holding a lot of OceanaGold Corp. (OGC:TSX; OGC:ASX). The company is a producer in New Zealand and is starting up its new gold mine in the Philippines. It’s probably one of the cheaper gold producers you can find. I also own Coeur d’Alene Mines Corp. (CDM:TSX; CDE:NYSE). That’s a big silver producer and just had a management change. The company has two new silver mines going and half a billion dollar cash flow each year. It’s building up a third mine, which is a gold mine, and a fourth mine, a silver mine. It doesn’t have much in capital requirements coming and I hope will end up paying a dividend. I’ve been holding the stock for a while and expect to keep holding it.

TGR: What are your expectations as far as market performance in the last weeks of the year? Then what happens next year with the precious metals and mining stocks?

CL: A lot depends on the European solution. I think the most likely result would be a massive money printing in the Eurozone. That would be very positive for gold. As far as gold mining, we have seen the general lack of capital in mining stocks. That’s why I try to stay with companies with a strong cash flow. Many exploration companies and emerging producers are trading at very low valuation. Still, the market doesn’t give them recognition. If we have any solutions in the Europe situation, these stocks can have a huge run.

TGR: Are there any other parting thoughts you might want to leave with our readers as far as how they should be playing this market?

CL: Gold stocks are extremely undervalued right now versus the gold price. I personally believe that gold will go much higher. How high will gold stocks go? I think this depends on market conditions. Gold stocks have two faces. One is related to gold. The other is related to the capital markets. Mining companies need to raise money to produce gold. It’s a very capital-intensive industry. So, if the capital market doesn’t improve, gold mining stocks may lag behind gold for some time. But, once we have some stabilization, I can see some extremely undervalued gold stocks out there. Another idea to think about is to try to follow what the majors like. A company like Majescor clearly has the interest from majors. Majors are flooded with cash and can afford to pay a reasonable market price for a property. So, I think it’s probably a good time to follow the trades of the majors.

TGR: You’ve given us some good information and food for thought. Thanks for joining us today.

CL: Thanks for having me.

Chen Lin writes the popular stock newsletter What Is Chen Buying? What Is Chen Selling?, published and distributed by Taylor Hard Money Advisors, Inc. While a doctoral candidate in aeronautical engineering at Princeton, Lin found his investment strategies were so profitable that he put his Ph.D. on the back burner. He employs a value-oriented approach and often demonstrates excellent market timing due to his exceptional technical analysis.

The Gold Report: Could you tell us the premise behind your statement at the New Orleans Investment Conference about why so many exploration and mining companies fail?

Brent Cook: Mining is a tough business—a very tough business. So many things can go wrong even if the company did everything right. On the exploration side, probably 95% of the junior companies whose share prices start moving up the discovery curve finish down at the bottom of that chart. Very few actually end up with something of any real economic significance.

The main reason is that exploration is a very inexact science. In geology and exploration, we deal with a limited amount of data at the earth’s surface and then use geologic models to try and understand what is happening at depth. So we are doing a lot of guessing and projecting based on a very limited data set. In fact, exploration geology is as much art as science because so much of what a geologist thinks is subjective and based on experience.

So, in the end, that fuzzy science is being applied to test some sort of geochemical or geophysical anomaly near the earth’s surface. It could be slightly elevated gold or arsenic in the soil or a magnetic body of rock at depth. You have to bear in mind that an anomaly is really little more than a difference in the background values of something like soil or rock or density or magnetism. Whatever it is, the world is full of anomalies and they are not all deposits. Nature has scattered billions of geochemical anomalies all around the world, so chasing anomalies is just the nature of the game; that’s what keeps us all employed in the exploration business. And failure has to be the overwhelming result when you are looking for that rare place in the earth that everything came together to form an economic deposit.

Still, all of that chasing has been very profitable to the Vancouver stock market scene; a lot of money is raised and made chasing anomalies.

TGR: So even for trained geologists like you, geology is an inexact science and you cannot know what you have until you start drilling.

BC: Basically, that’s right. Drilling is a scientific tool. That’s when you test your hypothesis. You hypothesize that a vein of gold, for instance, formed at 200 meters of depth under the right circumstances. More often than not, you test your thesis, get your data back, reassess the data and adjust your thesis to fit the data. That’s another reason it takes so long to actually make a discovery. Putting widely scattered pieces of data together takes time.

TGR: If 95% of what appear to be good geographic anomalies fail the drill test, why does so much money chase the junior mining sector?

BC: Because if you are successful, your stock goes from $0.25 to $2.50, $10, $20. And even without an economic discovery the rewards can be enormous if you know when to get out. As I say, a lot of these stocks start up that price-appreciation curve. At some point, an investor who is well-enough informed and understands the drill results can sell that stock at a profit before the rest of the world realizes that this is a bust. So a lot of money is made on that upcurve.

TGR: That sounds like making money based on hype and not on value.

BC: A lot of hype goes on in this sector for sure, which is facilitated by the inexact nature of the science, but savvy investors really base decisions on interpreting the results as they come in. When the data start indicating that the hypothesis was wrong, they probably decide it is time to start thinking about getting out. To make money, speculators just have to recognize it before the crowd does.

TGR: Few investors really know how to interpret the data and test the thesis, as you say. How can they realistically play in that junior mining game?

BC: My honest answer is to get good advice. Rick Rule, who emceed the mining panel at the conference, runs Global Resource Investments, a brokerage firm that actually employs geologists and mining engineers as brokers. That’s one good place to get advice. A good investment newsletter is another; I like mine.

Of course, a good adviser has to interpret the data correctly and say, “Look, the results from this drilling program from this project up in the Yukon aren’t looking so good right now. The results are telling me we have less chance of finding something, so it’s probably time to sell.” Or it could be the opposite: “This is really looking interesting. Let’s buy some more.”

TGR: In your New Orleans presentation, you advised junior exploration sector investors to know their exit strategy. Can you expand on that in light of what you’ve just explained?

BC: Always buy a junior with some idea of who will buy it from you and why. My exit strategy ultimately is to invest in juniors that find deposits good enough to interest the majors. In other words, my exit strategy is to sell to someone somewhat smarter than I am—a major that knows its stuff, does its due diligence and decides to buy one of these companies. I also like to get in early on a project with the idea that as the company derisks it with drilling, metallurgy or whatever, the project fits the profile of a fund manager or someone looking for less risk and more quantifiable upside. But I think the exit strategy for most people who get into this game is to sell to someone dumber than they are, hoping the fools come in and pay more for a stock than they did. That works in a raging bull market, but not in this market. In essence, with a sound exit strategy you know 1) what the deposit the company is looking for actually looks like, 2) what it is going to take in both money and exploration to realize the deposit goal and 3) what it might be worth if all goes well—and then sell when it gets to that point.

TGR: So 95% of the time you sell to someone not so smart, and 5% of the time you hit it and sell to someone smarter.

BC: Theoretically, yes, but that assumes you buy all the stocks that start up the discovery curve and that you are right and that there is an infinite supply of dopes. It’s such an inexact science, though, that even expert opinions differ. If you get five geologists in this room with me and we start talking about a property, you will hear six different opinions as to what’s going on down at depth or who makes the best beer. I’m certainly not right all the time—no one in this business can be. You have to go with your interpretation of the data at hand and stick with it.

TGR: And the 5% that prove out are fabulous. Does some knowledge base allow a geologist to winnow that 95% down so that geologists have a somewhat lower risk than non-geologists?

BC: I think so, although on the whole geologists are dreamers, so keep that in mind. You can, however, improve the odds quickly by not getting into projects that don’t really have a chance of significant success. I would say half the junior companies in this industry are chasing prospects that are not worth very much even if they’re successful.

TGR: You are also an investor. Do you prefer prospect generators because, in essence, they have multiple projects and thus spread the risk more than explorers? Or does your knowledge as a geologist enable you to pick and choose on a very educated, selective basis?

BC: I think it’s both. The prospect generator model is a very intelligent way to go about investing, and I certainly think that any investors in this sector should have at least some portion of their high-risk investment in some carefully selected prospect generators. With the companies I know that follow this model, the people running them recognize the low odds of success and incorporate that into their business approach. You want intelligent people running the company to begin with—as opposed to those who think they will drill a glory hole, hit it the first time, and strike it rich. That is not a realistic approach to the business.

TGR: What are some of the companies that excite you now in terms of geology and the potential for being in the 5%?

BC: A few prospect generators that I own and are worth others’ considering for their portfolios are Millrock Resources Inc. (MRO:TSX.V), Lara Exploration Ltd. (LRA:TSX.V), Riverside Resources Inc. (RRI:TSX), Eurasian Minerals Inc. (EMX:TSX.V) and Miranda Gold Corp. (MAD:TSX.V).

TGR: What makes these five stand out as prospect generators?

BC: It’s all about management. Management understands the business and they’ve been very successful in implementing a strategy whereby they generate the ideas and bring other people in at the high-cost point to spend the money. If they’re successful, that support carries them.

But again, we know the odds.

TGR: So the managers of these five companies are particularly skilled at finding the right projects with good geologic anomalies that have a higher chance of hitting? Or is it more a function of finding other people to finance the drilling?

BC: It’s both. A company with multiple properties can have one being run by Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE), for instance, and then go out and find partners for the next one and the next one and the next one. It’s a business that’s really a game of odds. With 20 companies working on projects, a prospect generator’s odds of success are much higher than if it is drilling only one or two projects. Of course, if successful it ends up with only a percentage of the deposit rather than the whole thing.

TGR: Could a lay investor infer that a prospect generator’s project has a higher percentage of hitting if it is joint ventured with a major that knows this stuff and has probably done a fair amount of analysis?

BC: That’s a good point. It’s fantastic when a prospect generator is involved with a Freeport or BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK), Kennecott Utah Copper Corporation or whomever. Its in-house experts are doing the due diligence and selecting the properties the company thinks have a chance of making its hurdle and meeting its big company criteria. A prospect generator in those circumstances has access to the big company’s geophysical, geological and engineering experts. There is no way small companies can afford that depth of knowledge on their own.

TGR: Any other companies that you think are worthy of consideration at this time?

BC: Lydian International Ltd. (LYD:TSX) has a deposit on the order of 2.5 million ounces (Moz) that I visited in Armenia. It’s low grade, but it will be a very high-margin deposit because the metallurgy is simple, the mining is simple and it’s in a good region of the world. I like Lydian, and I think it will be a takeover target for a midsize gold producer.

Another one is Almaden Minerals Ltd. (AMM:TSX; AAU:NYSE), which has a discovery in Mexico that looks very, very prospective. As yet, I don’t see an economic resource, but the geologic system is large enough that it has the potential to do something meaningful.

TGR: Any others?

BC: Midas Gold Corp. (MAX:TSX) is a major company run by very, very competent people. It has a good-grade 5.6 Moz deposit in Idaho that is going to get much larger. It’s not going to be easy to permit, but nowhere in the world is anymore.

TGR: When Rick Rule asked about stealth plays, you said you particularly like western U.S. projects because you think that area will really come into its own.

BC: These aren’t really stealth plays, but I do think the western U.S. has a lot of potential left to cover—places such as Oregon, Idaho, Arizona, Utah, Wyoming and even parts of California. A lot of work is being done there, but because it has been neglected to some degree I think companies working there will turn up some new ideas, new targets, new discoveries.

For instance, Barrick Gold Corp. (ABX:TSX; ABX:NYSE) has just announced a major discovery in Nevada on the Cortez Trend. The Long Canyon discovered by Fronteer Gold Inc. (FRG:TSX; FRG:NYSE.A) and AuEx Ventures Inc. (XAU:TSX) was a great new discovery in eastern Nevada that Newmont Mining Corp. (NEM:NYSE) bought. So things are happening in the U.S. And porphyry coppers, too. People are re-looking at porphyry coppers, and I expect to see some success there.

TGR: Where do you think the next really big precious metals discovery will be?

BC: If I could go anywhere in the world regardless of politics, I’d be in Iran, second is probably Afghanistan. After that it’s a tough call.

TGR: Would you like to add anything else, Brent?

BC: I’d like people reading this to come to my website and click on the Discovery Process video link to a property tour I did in the Yukon; it’s also on youtube. I think it’s worth seeing the reality of a property visit and the sorts of things you can’t get reading a press release.

TGR: And you’re also doing a special workshop in that vein?

BC: I’ll be doing that in San Francisco, at the Hard Assets Investment Conference (November 27–28). We will talk with investors about understanding what a company is saying, or not saying, in a news release. We will investigate bogus and misleading statements. We also will look in detail at something we talked about today—how to interpret drill hole results—as well as sample methods and geologic models. And of course, we’ll field questions from workshop participants.

TGR: Thanks for fielding our questions today, Brent. And for the link. Another one our readers may want to check out is an article you wrote as an online preview of the upcoming conference.

Brent Cook brings more than 30 years of experience in more than 60 countries to bear on his reputation as a world-renowned exploration analyst, geologist, consultant and investment adviser. His knowledge spans all areas of the mining business, from the conceptual stage through detailed technical and financial modeling related to mine development and production. His credentials include service as principal mining and exploration analyst to Global Resource Investments, where he provided analysis to retail brokers and two in-house funds. His weekly Exploration Insights newsletter (www.explorationinsights.com) selectively covers junior mining and exploration investment opportunities.

The Gold Report: You founded this firm based on your long wave theory that is based on the Kondratieff Cycle. How is this same or different from Kondratieff?
Ian Gordon: We have gone significantly beyond Kondratieff’s original thesis published in 1925. I am very proud that we have made the cycle far more encompassing than Kondratieff would have ever envisioned. For instance, one of the key things we have done is identify an investment cycle within the long cycle. This is an extremely valuable tool for investors, which allows them to make appropriate investment decisions in each quarter of the cycle.

TGR: Do you feel that you have legitimized the Kondratieff Cycle beyond theory and as a general principle?

IG: Well, I think we have. The proof is in the pudding. We have been able to recognize exactly where we are in the cycle and envision what the implications are likely to be. I think we have been able to pinpoint that with a great deal of accuracy the critical aspects of the cycle and how these relate to the economy and to investing.

TGR: You obviously can’t expect investors to wait through an 80-year super cycle. You’ve managed to isolate the bull and bear markets. Is that what you are saying?

IG: Yes, we have not only been able to isolate the bull and bear markets, but also we have been able to identify the best and most appropriate investments for each quarter of the cycle, and they generally work throughout that quarter. We have broken the cycle into the four seasons. We call it a lifetime cycle because it is 60–80 years, and each of its seasons is approximately 15–20 years, a quarter of the cycle. By the way, this is the fourth cycle, and it has always repeated pretty well the same in every cycle. Certainly essential investment decisions have been the same for each of the seasons in the cycle.

TGR: Take it from the beginning.

IG: Spring essentially renews economic growth. It is the rebirth of the economy following the winter of the cycle, which is the time when the economy dies and when debt is wrung out of the system. Because spring is the rebirth, stocks and real estate make appropriate investments and do very well for investors. We can show from our current cycle, which we maintain began in 1949, that the Dow Jones Industrial Average rises from 161 points at the beginning of spring and ends at 995 points at the end of spring. Of course, real estate also does exceptionally well during this period.

Then, following spring we move to the summer, which began in 1966 in our current cycle. We have always had inflation in summer because there has always been a war in this part of the cycle, and that war has always been financed through a huge expansion of the money supply. In the first cycle, it was the War of 1812. In the second cycle, it was the U.S. Civil War. In the third cycle, it was the First World War from 1914 to 1918. And, in the fourth cycle, it was the Vietnam War. With that inflation, stocks do not do that well and essentially make no gains. If anything, stocks end summer about 30% below the point from where they began. Conversely, gold performs exceptionally well, as do all commodities. Gold goes from $35/ounce (oz.) in 1966 to $850/oz. in 1980, and the Dow goes from 995 at the end of spring and ends the summer at 777 points. Real estate continues to do well in the summer of the cycle.

Four things always anticipate the onset of autumn in every cycle: These are the peak in interest rates; the peak in the consumer price index; the bear market in stocks such as the one that occurred between 1981 and 1982; and a recession. Now, autumn is always the point from which stocks, bonds and real estate perform the best in the cycle. It is the most speculative period in the cycle, and it is when debt really starts to build exponentially, and so gold performs very poorly in this portion of the cycle. In fact, gold prices go from that $850/oz. peak at the end of summer to $250/oz. at the end of autumn, and the Dow goes from 777 to 11,750 and real estate continues to perform very, very well. So, real estate has a three-season growth period and stocks have a two-season growth period, to the end of autumn, while gold has a one-season growth period.

The winter of the cycle, which we call the payback period, is when the economy dies. It goes into a deflationary depression overcome by the overwhelming debt in the system that has built-up principally through autumn. When we get into winter, we get very defensive and we move into gold, which performs exceptionally well, as do gold stocks. The general stock market performs abysmally. Between 1929 and 1932, the Dow lost 90% of its value. And, real estate also performs very, very poorly on account of the economic depression and the fact that homeowners have assumed huge mortgage debt to purchase their homes. During this time many people lose their homes because they are unable to make the mortgage payments. House prices decline to very low levels and in many cases mortgage debt is significantly higher than the value of the home.

TGR: Where are we in the cycle now?

IG: We are in the winter. The signal of the onset of winter was the peak in stock prices in January 2000 for the Dow and March 2000 for the NASDAQ. That was the end of autumn. And, yes, the Dow was higher than that in October 2007, but, again, that was really an abnormality created by paper money systems. The Federal Reserve was able to print copious amounts of money, pump it into the economy and revive the stock market after 2000 and into 2007. That money printing also contributed to the greatest real estate bubble in history and we know what the outcome of that bubble is.

TGR: I’m looking at your dire wintery target prediction that the Dow Jones Industrial Average will descend by more than 90% to 1,000 from current levels that are around 11,000. It sounds like a global economic meltdown of unseen proportions.

IG: Politicians are desperately trying to revive the economy by printing even more money. So, this bear market that started in 2000 continues in 2011. Normally bear markets last about one-third the time of the preceding bull market; obviously that has not been the case this time. So, we think when the end does come, it is going to be very traumatic. Eventually the Federal Reserve will lose control and will not be able to get the stock market reignited because it will reflect the reality in the economy. We think the Dow at 1,000 is probably a little optimistic. We think it could go below that to something like 500 if we were to emulate the 1929–1932 experience.

TGR: That translates into massive unemployment, does it not?

IG: It translates into an economy that’s basically a disaster: massive unemployment, huge bankruptcies, breadlines and a government that, in fact, can’t raise the cash to support the depression. Remember, going into the last depression the U.S. government was extremely wealthy, and America was the world’s largest creditor nation by a huge margin. The U.S. government debt had been paid down all the way through the 1920s, and it went into the last depression with government debt of only $16 billion. When the depression hit, the government had oodles of cash to throw at it to get the economy going. Yet it was never effectively able to do that. The Second World War brought us out of the depression.

TGR: Ian, I know you said gold will perform quite well in this kind of environment, and so I assume you believe there is much more upside yet for gold.

IG: Well, I do. One of the ways that we’ve always been able to measure where we think gold is going to go is simply using the Dow/Gold ratio, the value of the Dow Jones Industrial Average divided by the price for an ounce of gold. When this ratio reaches extreme highs, stocks have performed exceptionally well. So, we would anticipate that it would reach an extreme high at the end of spring of our current cycle, and so it did when it was about 28:1. In other words, it took 28 ounces of gold to buy the Dow Jones. And at the end of summer, gold performs well, and stocks don’t. It went down to a 1:1 relationship that was the lowest low, which we have seen twice. But, we are envisioning that we are going to go below 1:1 simply because we made an all time high at the end of autumn of 44:1. The decline must be in proportion to the advance. So, we think the decline is going to take us to something like a quarter to one (0.25:1), which is $4,000/oz. gold and a Dow of 1,000. We’re currently at about 6:1 on the ratio.

TGR: What about gold equities versus physical gold? Will gold equities climb this wall of fear into this winter cycle?

IG: Well, we know that between 1929 and 1936 gold equities performed exceptionally well. I think that the reason that they haven’t performed that well recently, particularly in the junior sector, is that [non-gold] stocks have generally performed pretty well aided and abetted by the Federal Reserve. If the bear market had followed its normal course, it should have ended in 2006, but it did not follow that normal course. So, once that bear market begins in earnest and once the Federal Reserve loses control of the stock market, we believe that the gold stocks will begin to mirror the actual price of gold, for which our forecast is $4,000/oz. And, that may be conservative because we believe that when the whole debt bubble continues to unravel that you won’t be able to obtain gold at any price. But at $4,000/oz., the gold stocks will perform exceptionally well.

TGR: This would be a dramatic divergence between gold equities and non-gold equities. What are your recommendations for investors?

IG: Well, we have always believed that you should definitely own the physical metal as well as the equities. And we have always had a big belief in the performance of the juniors because of the leverage that they provide to the price of gold.

TGR: Where do investors go? Which equities?

IG: Well, one that we like very, very much is Barkerville Gold Mines Ltd. (BGM:TSX.V). The reason we like the company is that it is in production. It’s producing 25 thousand ounces (Koz.)/year of gold from its QR deposit in central British Columbia, Once it receive its permits to mine the Bonanza Ledge deposit, and that should be very soon, production will increase to 50 Koz. per annum. This makes the company very positive on a cash-flow basis. Barkerville is also finding and adding quite dramatically to its ounces in the ground position. It is going to bring in a second mill, and once that is permitted, production will rise to about 150 Koz./year. It is targeting 2013 for the second mill to be up and running.

TGR: Over the past 12 weeks, Barkerville is down 30%, and yet it still has a market cap of $100 million. It looks like shares have sufficient liquidity.

IG: I own a lot of it; it could be 30% of my stock portfolio.

TGR: So Barkerville would be your favorite?

IG: It’s my favorite, but there are also others that I like an awful lot. I love PC Gold Inc. (PKL:TSX) which I own. The company is in Pickle Lake, Ontario. I sort of trust Canadian mining, not because I’m a Canadian, but just because I feel it has been our heritage for so long. The Canadian government is always going to be a party to it. PC Gold has a very, very rich underground mine at Pickle Lake, and it has outlined about 1.2 million ounces (Moz.). PC Gold has also discovered a surface zone. It’s going to be a lower grade, but this gold in the ground has got to be worth something.

PC Gold hit $1.80 in April 2010, and I think it’s trading at around $0.47 right now. The other thing about PC Gold is that it has about $7.5 million in cash in the bank. So, even if we are in a major credit crunch, and I suspect we are, PC Gold has money to outlive a credit crunch and then get back on track and eventually be able to put its mine back into production.

TGR: The $7.5 million on its balance sheet represents about a third of its market cap.

IG: Right. We’re very keen on it and we own a lot of shares, all of which I bought in the market. I’m very happy to own this company.

Another one that we think a lot of is Colibri Resource Corp. (CBI:TSX.V). All of the Colibri properties are in Sonora, Mexico. One of its properties is very near La Herradura, which is owned by Newmont Mining Corp. (NEM: NYSE) and Fresnillo PLC (FRES:LSE). It’s a 12 Moz. deposit that consistently seems to stay at 12 Moz. In other words, as fast as the joint-venture partners mine the deposit, they replace it with new found gold. The Colibri property is about 12 km. from La Herradura and it has almost the identical geology to La Herradura. Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE) is doing a joint venture earn-in on that property. So, you’ve got a major producer earning into that property and, if successful as Newmont and Fresnillo have been at La Herradura, it will take Colibri into production and hopefully find the 12 Moz. plus that they’ve found at La Herradura. I think it is very, very cheap. Agnico owns just under 20% of the company and Sprott Asset Management owns just under 20% and my wife and I own just under 10%. So, effectively, that’s half of the company’s shares. Colibri has about $2 million cash, and it has an excellent board.

TGR: I’m looking at Colibri’s market cap of about $7.2 million. I’m thinking that would scare a lot of people off.

IG: Well, I’m not scared off because Agnico is not going to allow this company to flounder. I’m sure it’s going to support it. And I don’t think Sprott is going to allow this company to flounder given the fantastic assets that it has.

Another company that has just gone on our website is Terraco Gold Corp. (TEN:TSX.V). I own shares in the company and I really like Terraco. It owns 100% of a property in Idaho called the Almaden Project, which it bought from a company in financial distress. The property has just under 1 Moz. already defined in an NI 43-101. Again, this company has a very, very strong board. Terraco has another property in Nevada, the Moonlight Project, which adjoins the north side of Barrick Gold Corporation (ABX:TSX; ABX:NYSE) and Midway Gold Corp.’s (MDW:TSX.V; MDW:NYSE.A) Spring Valley Project. We think that this company will do exceptionally well for shareholders.

TGR: Was there one more you wanted to mention?

IG: Actually there are several other companies that I like, but let me mention a couple more and give you the names of some other companies that I own. I am particularly fond of Temex Resources Corp. (TME:TSX.V; TQ1:FSE), which has all its properties in Ontario. One of the properties has outlined an NI 43-101 resource of about 1.2 Moz. of gold. It is also now drilling and being very successful on a property that it has in the Timmins gold camp, of which it owns about 60%. Goldcorp Inc. (G:TSX; GG:NYSE) owns 40%. So, that particular mine was the richest mine in the Timmins camp. I own a lot of shares, and I have just purchased more shares in a private placement that the company is now doing.

Another company that I have long owned and think will ultimately perform very well for shareholders is Golden Goliath Resources Ltd. (GNG:TSX.V; GGTHF:OTCPK). The properties are all in Mexico and several have had significant past producing gold and silver mines on them. Agnico-Eagle owns about 8% of the company’s shares and Sprott Asset management owns a little less than 20%. The company is working toward a joint venture agreement with Agnico-Eagle on its Las Bolas property.

Other companies that I own and like are African Queen Mines (AQ:TSX.V), Fire River Gold Corp. (FAU:TSX.V; FVGCF:OTCQX), Freegold Ventures Limited (FVL:TSX), and Northern Freegold Resources (NFR:TSX.V). All these companies have significant gold in the ground assets. Fire River Gold is in production. I would encourage prospective investors to visit the companys’ websites and read through the corporate presentations and even to phone the presidents of companies before they make a decision to purchase shares.

TGR: My final question is, how long will winter last?

IG: It will last until the debt has been eradicated from the economies of the world. So, to give it a date is difficult. If the whole world monetary system collapses under the massive mountain of debt that has accumulated worldwide, then it will happen reasonably fast, and a new world monetary system will evolve. I think that new system will be based on gold.

TGR: Ian, this has been very valuable. Thank you.

IG: Thank you very much for having me.

A globally renowned economic forecaster, author and speaker, Ian Gordon is founder and chairman of the Longwave Group, comprising two companies—Longwave Analytics and Longwave Strategies. The former specializes in Ian’s ongoing study and analysis of the Longwave Principle originally expounded by Nikolai Kondratiev. With Longwave Strategies, Gordon assists select precious metal companies in financings. Educated in England, Gordon graduated from the Royal Military Academy, Sandhurst. After a few years serving as a platoon commander in a Scottish regiment, he moved to Canada in 1967 and entered the University of Manitoba’s History Department. Taking that step has had a profound impact because, during this period, he began to study the historical trends that ultimately provided the foundation for his Long Wave theory. Gordon has been publishing his Long Wave Analyst website since 1998. Eric Sprott, chairman, CEO and portfolio manager at Sprott Asset Management, describes Gordon as “a rare breed in the investment-advisor arena.” He notes that Gordon’s forecasts “have taken on a life force of their own and if you care to listen, Gordon will tell you how it will all end.”