A long time ago I was studying Russian and my Russian instructor had what I still think is one of the more insightful snippets of political wisdom. He said (as I can remember): “In your country, economics determines politics; in my country politics determines the economy”. And so it goes I guess. Everyone seems to say the current economic trends will determine the fall election. We will see.
Still the world has changed. So much that now you find the best industry and investment analysis coming from the Ukraine? That all just came to mind reading this: Are you ok? сланцевый газ и металлургия США. The source says it is FundMarket: the Stock Market of Ukraine.
or if you prefer read the Google translation of the same: Are you ok? Shale Gas and Metals in the US.
It really does cover it all well. Now ask yourself why there is interest by Ukranian analysts in the state of demand for steel in the US? Might be because of the growing role of Russian investments in US steel production?
One of the most important features of a financial market is liquidity. In a well functioning market, a trader faces low costs of transacting and can confidently expect that at future dates, across many states of nature, the cost of transacting will prove to be
The immediate impact of a low cost of transacting is that it imposes a lower `tax’ upon the speculator, who brings new information
into prices, and the arbitrageur, who removes obvious mistakes in prices. The long-term impacts that are obtained when the trader can confidently expect that transactions will be inexpensive are in two parts. When investors expect to waste money in buying and then selling a certain security, they demand higher rates of return from it: i.e., the cost of capital for the issuer goes up. And, when traders are confident that high liquidity will persist into the future into a diverse array of states of nature, they will more confidently embark upon dynamic trading strategies which are required for producing useful securities such as options.
Measurement of liquidity
In an electronic limit order book market, a static concept of liquidity is eminently visible: you look at the order book and work
out what is the impact cost faced when doing transactions of a desired size. E.g. it is easy to take order book data from NSE and work out the impact cost seen for doing a transaction of Rs.10,000 for all companies.
Impact cost accurately measures the instantaneous cost faced when placing an order of the stated size. It is a observed precisely in a modern exchange setting. There are two weaknesses. No large order is going to be placed as one single market order into the order book. Hence, the analysis of the NSE order books does not guide us in understanding liquidity when doing large sized transactions, e.g. Rs.1,000,000. The moment we think of orders that are spaced over a short time (e.g. I break up an order for Rs.1 million into 100 orders of Rs.10,000 each) or over a long time (e.g. dynamic hedging of an option book) I have to worry about the fluctuations of impact cost, or my liquidity risk.
The biggest problem lies in the fact that in numerous market situations, order book information is not observed. Two key areas are:
the deep past, before order book data existed, and the OTC market, where there is no order book. E.g. the CMIE daily returns data for BSE starts from 1/1/1990. NSE equity trading began in 11/1994. But NSE’s order book snapshots (thrice a day) only exist from 4/1996 onwards. For the period prior to 1996, there is no data on liquidity.
The power of range
The first flush of the financial economics focused on returns. It was amazing, the amount of interesting work that could be done once you had assembled a dataset with daily returns. This was first done at the Centre for Research on Security Prices (CRSP) at the University of Chicago, and it made possible an entire generation of financial economics.
As an example, the ARCH model is a very clever way to utilise pure returns information and construct a time-varying notion of
volatility. Models of the ARCH family assumes that volatility is deterministic, and that it responds to realisations of returns.
A remarkably important fact looks beyond returns to the range between the day’s high and the day’s low price. When volatility is high, the range is higher. Range is a volatility proxy. This has been known for a while — e.g. On the estimation of security price volatilities from historical data, M. B. Garman and M. J. Klass, page 67–78, Journal of Business, 1980.
In the late 1990s, people got back to looking at this in a new way. We understood that range is an enormously informative
volatility proxy. There is much more information in the range of the day than is found in the squared returns of the day.
Another new volatility proxy is `realised volatility’, where you difference intra-day returns to construct a time-series of returns
within the day. As an example, in an 8-hour trading day, there are 480 minutes. So you could difference returns into 5-minute
intervals, and you have 96 readings of returns on each day. The standard deviation of this is a good measure of the volatility of the
day. As an example, the recent paper by Grover and Thomas, Journal of Futures Markets, August 2012, does performance evaluation for a VIX estimator by asking for better predictions of future realised volatility.
In the ARCH world, volatility of the day was not observed, and squared daily returns was a poor proxy for this. Realised volatility is a highly precise estimator of the volatility of the day, and range is also remarkably good.
Constructing a deep history of stock volatility
Using intra-day data, it is possible to construct a realised volatility for every security for every day. This is obviously infeasible for the period when intra-day data is not observed – e.g. in India before electronic trading came along, i.e. before November 1994.
But as long as the day’s high and the day’s low are observed, one can construct a range-based measure, and thus push deeper into
Constructing a deep history of stock liquidity
When trading is electronic, it is possible for the exchange to produce `snapshots’ of the limit order book, as has been done by NSE
from April 1996 onwards. Using these, it is easy to get precise estimates of the spread for all stocks. But what about the period
I just read a fascinating paper: A Simple Way to Estimate Bid-Ask Spreads from Daily High and Low Prices by Shane A. Corwin and Paul Schultz, Journal of Finance, April 2012. Their key insight is that the day’s high is almost always at the ask and the day’s low is almost always at the bid. When the high/low is computed over two days, the variance is doubled but the spread component is intact. This generates a mechanism for extracting a spread estimator using only high-low data.
I liked the paper a lot. At its best, finance is close to data, the data has low measurement error, the work is careful and grounded in a
detailed institutional understanding of reality, and the results open up new lines of inquiry.
Using these new ideas, it becomes possible to dig into history, using the CMIE data for BSE which goes back to 1/1/1990, and construct liquidity measures for that deep period.
The authors do precisely this:
They show a big and dramatic drop in the spread at the time when electronic trading came in. There are three key dates here: NSE
started electronic trading on 3 November 1994, BSE started electronic trading on 14 March 1995 and in November 1995, NSE became the dominant exchange [link]. This is a valuable addition to our understanding of these events. I do
worry about mistakes in measurement of the day’s high and day’s low, however, prior to the onset of electronic trading at NSE in November 1994.
I found it fascinating, how a 2012 paper has produced a better understanding of our history of the mid-1990s.
Understanding the badla episode
What is equally interesting, and what is not mentioned by the authors, is the dog that did not bark prior to the launch of NSE. This
is the event where SEBI forced BSE to stop badla trading.
I had worked on this question at the time (in 1996). I had rigged up a matching scheme where each A group company (where badla
trading used to take place) was matched against a partner from the B group (where there had never been badla trading). This allowed
you to construct a hedged portfolio: long the A group companies and short the B group companies. The performance of this portfolio is:
This hedged portfolio has a most satisfying zero return in the days before SEBI’s decision. This gives us confidence that the matching is done well. The two big dates of SEBI decisions — 12 December 1993 and 12 March 1994 — show big negative returns for A
group companies. And from 4 November 1994, when trading at NSE began, we start seeing a recovery.
At the time, this was interpreted at the time as a liquidity premium. See Short-term traders and liquidity: A test using Bombay Stock Exchange data by Berkman and Eleswarapu, Journal of Financial Economics, 1998, who worked this out nicely.
But the new evidence for the deep history of spreads on the BSE, by Corwin and Schultz, suggests that there was no big change in
liquidity in 1993 or 1994. This raises new questions about why such large price reactions were observed. I used to think this was a
great liquidity premium story; now I’m not so sure. I’m pretty certain that A group companies had sharp negative returns in early 1994, but I am now less sure that we know why.
Time and again, Americans are told to look to Japan as a warning of what the country might become if the right path is not followed, although there is intense disagreement about what that path might be. Here, for instance, is how the CNN analyst David Gergen has described Japan: “It’s now a very demoralized country and it has really been set back.”
But that presentation of Japan is a myth. By many measures, the Japanese economy has done very well during the so-called lost decades, which started with a stock market crash in January 1990. By some of the most important measures, it has done a lot better than the United States.
Japan has succeeded in delivering an increasingly affluent lifestyle to its people despite the financial crash. In the fullness of time, it is likely that this era will be viewed as an outstanding success story.
How can the reality and the image be so different? And can the United States learn from Japan’s experience?
It is true that Japanese housing prices have never returned to the ludicrous highs they briefly touched in the wild final stage of the boom. Neither has the Tokyo stock market.
When the talking heads speak of a decline, what they really mean is a loss of stock portfolio value. Or, more accurately, a decline in the prices of stocks, bonds, real estate, and other forms of capital. The wealthy abhor this potentiality because it would effectively destroy their wealth. While this concern isn’t altogether problematic (why shouldn’t they be self-interested, just like everyone else in the world?), the proposed solutions are.
Preventing “decline” is largely contingent on keeping capital prices afloat, which is itself contingent on leverage (which, it should be noticed, will be subsidized by taxpayers in some way), debt, and/or inflation. This is the only way. Capital asset prices are already significantly overvalued; the only way to keep it this way is to continue the policies that enabled this in the first place.
The only alternative is to let capital asset prices crash and then recover. This is the optimal strategy, in the sense of doing what’s best for the most people, for this strategy only requires non-intervention in the economy, which is unsurprisingly cheaper than intervention and bailouts. The reason why the talking heads never propose this is because the timeline for recovery is fuzzy at best.
Quite simply, once the market crashes and capital prices return to their pre-malinvestment valuations, it will be some time before those prices go back up again. This poses a problem to the wealthy employers of the talking heads, for said employers have spent their lifetime accumulating this imaginary wealth and, now that they are beginning to look at retiring, they do not want to see it simply vanish.
Therefore, the mainstream argument against decline—which is prevented only by bailouts and leverage—is entirely founded on the assumption that maintaining capital asset prices is desirable. Given the costs of doing so, and given that the result only benefit wealthy crooks, it seems clear that the best course of action is to welcome decline with open arms. This way, as is seen in Japan, living well will not simply be the privilege of the wealthy.
The other day, my brother emailed me to ask if it was wrong to play the stock market. Since I was going to take the time to write him, I thought I’d share my response on my blog.
In the first place, it’s important to note that the stock market is inherently neutral, morally. By this I mean that the stock market, as a non-human entity, cannot go to heaven or hell and, as such, cannot be inherently moral or immoral by its own state of nature.
In the second place, it’s important to note the sources of immorality within the stock market. Karl Denninger has documented massive amounts of fraud among traders, particularly among firms that engage in automated trades. Furthermore, many companies traded on the stock exchange engage in illegal and immoral business practices. Many trades are based on fraud (think of businesses that lie about their balance sheets and income statements). Also, many people engaging stock trades are highly immoral.
Does this then mean that one can never trade stocks? Of course not. If it were immoral to trade with those who are immoral, then no one could buy groceries or clothes, or engage in any kind of trade. And it is not inherently immoral to be the victim of fraud (though it is foolish). Interacting with those who are immoral does not cause their immorality to transfer to you by the merits of trade.
However, those who are immoral can end up having an influence simply by the virtue of your continued interaction with them. This does not mean that the venue of your interaction is immoral. Rather, your decision to allow those who are immoral to drag you down to their level is immoral, and it is you who will bear the guilt and blame for that decision, not the stock market.
It is worth noting, though, that if playing the stock market troubles your conscience then you should refrain from playing the stock market (cf. Romans 14). And it is also worth noting that there are many major players in the stock market who are simply looking for a sucker of which to take advantage, and that the government has often turned a blind eye to the fraud that usually accompanies this. As such, though it is perfectly moral to play the market, it is at this point in time quite foolish to do so.
One of the stories that caught my attention this week was the Bloomberg piece about how banks in London and New York are starting to jump ship on the old finance hubs due to fear of effects from planned regulatory tightening.
Banks in Europe are exploring ways to cut costs by routing more of their trades and other business through overseas subsidiaries, a plan that may shift tax revenue away from London and loosen European regulators’ influence over the lenders.Nomura Holdings Inc., HSBC Holdings Plc (HSBA) and UBS AG (UBSN) are among lenders preparing plans to book as much business as possible through legal entities in jurisdictions where tax rates are lower and rules on capital and liquidity are less onerous, the banks and lawyers and accountants working with them say.
Banks could record as much as 30 percent of the value of their trades through Hong Kong, Singapore and other jurisdictions instead of hubs such as London and New York without running into trouble with regulators, Matten said. Such a move would hurt traditional hubs such as London because assets are treated for tax and regulatory purposes in the country where they are booked. It would also allow banks to sidestep the U.K. bank levy, introduced last year to raise 2.5 billion pounds ($4.1 billion) from lenders operating in Britain, as well as any financial transaction tax imposed by the European Union.
Perhaps this is a sign of the times in the sense that both banks and market participants seem to be looking increasingly outside the boundaries of the developed world for growth, profit and eventually prosperity. Having just moved to the Big Smoke I would not necessarily lament a downsizing of the finance sector even if it is the pond that I also do my fishing for the daily meal ticket. Perhaps, if fast moving financiers chose to go to Singapore instead of London, the residents of the latter would not have to endure paying 300.000 GBP for a studio flat in Canary Wharf .
Of course, it may all be a red herring but it could also be part of a number of tentative signs that the locus of global activity on a variety of fronts is moving to new epicentres. Let us hope they do not travel entirely in our foot steps.
More generally, we just put out our monthly report and the outlook is very much wishy-washy. Surely, our leading indicators are pointing down, but after the market puke in August it seems to me that the end of the world had almost been priced in as the S&P500 hit the 1100 marker. In this sense, do not be surprised to see it ticking towards 1250 even if the recent job data were abysmal, but beware. The old range has been broken and we are finding a new lower one. Market prices have a tendency to become “normal” after a period and with global economic activity visibly slowing the fundamentals are not really on the bulls’ side even if they point to the merits of chasing a counter trend rally after a 10% drawdown.
More generally as I noted before, the divergence between respectable analysts is widening which always makes me take a few steps back. On the one hand I see both buy side and sell side analysts rather stubbornly sticking to their year-end S&P500 targets of 1300-1400 while other independent analysts put the fair value of the index at 900-1000. Both will obviously have an axe (or maybe even a book) to grind, but part of my job is to synthesize the consensus into a fairly straight road map for our clients, and it is getting difficult.
I tend to side with the pessimists if only because I find it difficult to see how US corporates can continue to operate as efficiently as they have been doing so far. Gerald Minack had some excellent points on this in his latest report;
A big medium-term uncertainty for DM equity investors is the sustainability of earnings. A decade ago, the big uncertainty was whether valuations could be sustained. They weren’t . The de-rating may have further to go, but clearly valuation is less of a headwind now than at the TMT-inspired peak. Earnings, on the other hand, are very high. Profits are now near an all-time high as a share of global GDP, and the real return on equity has followed . What’s not able, however, is not the cycle rebound, but the elevated level of earnings (and real returns) over the past decade. The forward-looking issue is whether those elevated returns can be sustained. At a global level, the answer may be ‘yes’ – for the simple reason it’s now possible to make profits in places where previously it was not. What’s not clear is the sustainability of high earnings in the developed world.
In particular, I would would point to the contradiction between continuing ultra low unit labour costs and the need to now see growth moving from cost cutting to topline growth. Something does not add up.
Real unit labour costs are now at 60-year lows. This matches the decline in wage share of GDP to a 50-year low. Arithmetically, this is the most important support for high profits. As I’ve discussed in prior reports, it’s not clear how long households can support consumer spending at near 70% of GDP with labour income at multi-decade lows. That’s been possible recently due to massive transfers from the public sector, but that support appears unsustainable.
In my opinion, this is big elephant in the room in relation to the US stock market. It will be difficult for earnings (and margins) to stay at current levels going forward. It follows naturally from the fact that if all companies cut costs and this improves margins this will only work for a limited period time as there are decreasing returns if everyone follows this strategy at the same time. Now we need to see topline sales growth for margins to be sustained, but this is obviously difficult with the current macroeconomic backdrop, so something has to give.
Globally, coincident data is already slowing visibly across the globe with headline PMI readings and trade data coming in steadily lower. In that sense we are up against the wall again only so shortly after the shock of 2008/09 and this time, the ability of policy makers to respond is limited.
However, I would be weary about calling this another 2008. One of the effects of experiencing a balance sheet recession with subsequent deleveraging is that trend growth falls and thus that the economy becomes liable to more frequent recessions. This applies to the US in particular but essentially also to the whole of OECD. This means that we will see more frequent but also essentially shallower recessions. The only qualifier here is really that some parts of Europe are now stuck in a depression locked in a vice of dysfunctional institutions and a lack of willingness and political capability to deal with the problems.
As such, within Europe also lies the potential source a Lehman like shock should the crisis prompt a rapid and violent default of one or more sovereigns and/or financial institutions. Certainly, euro area banks are feeling the pinch as USD funding is getting cut off and if anything it seems to me that the EURUSD is looking a bit too strong for its own good given the backdrop of the mess in the euro zone. As cash levels at euro zone banks are drawn down the currency will adjust to fundamentals not to mention of course the fact that the ECB is slowly but steadily being pushed into full blown QE and monetisation of peripheral debt.
The latest G&F provides a good summary;
(…) The risk of a dollar rally against the euro in coming months is growing. This is because, sooner or later, the ECB will have to reverse its recent insane monetary tightening. Trichet made a start in this direction this week in his usual ponderous manner. Thus, he told the Committee on Economic and Monetary Affairs of the European Parliament in Brussels on Monday that “risks to the medium-term outlook for price developments are under study in the context of the ECB staff projections that will be released early September.” The issue here is whether markets will allow Trichet to save face and not performs an abrupt U-turn before his scheduled departure from the scene on 31 October.
More generally, the recent comments from the IMF that euro zone banks need additional capital is once more a case of stating the almost obviously obvious. The transmission mechanism here is very simple. The market is now effectively pricing in a default of Greece and possibly other peripheral economies and this means that the attention must now turn to the losses that creditors will bear or, alternatively, the size of the bailout if we stick to the old mantra of no losses. As a good friend of mine pointed out recently,
All trough last month’s banking shares’ collapse, I have been thinking that perhaps, equity investors are worried that the recapitalization will be different this time, with either the taxpayer (wrong solution) or the bondholder (rightly, through a bond-for-equity swap), massively diluting the shareholder. Politicians obviously do not have the stomach, nor the muscle for new bailouts.
Or to put it differently, there are no easy solutions left. One solution is the Brady Bond plan which is currently being floated in the case of Greece. The problem as I see is that it is fudged precisely when it comes to the current valuation of the bonds. Basically, there has to be pain today for the creditors, otherwise we are just kicking the proverbial can down the road as recapitalisation is avoided today but made worse for tomorrow. A solution for recapitalising banks today would naturally be for their creditors to accept a swap for equity and thus being moved into the frontline to absorb any losses that the banks would bear on sovereign debt, but that is not popular. Essentially, being degraded to equity holder in a bank with known sovereign assets in the European periphery is equal to taking a haircut on your initial investment, but all this then leaves the inevitable question of who and when someone will step up to take the lead in the debt restructuring.
Of course, the idea of substituting debt for equity is the same principle applied in the case of Greece posting domestic assets (islands, utility companies etc) as collateral for credit. We can then think about this collateral as Greek sovereign equity and as with creditors of banks, it is all good in theory but in practice, not so well.
Elsewhere, the game of Old Maid in global currency markets continue with the SNB still in the spotlight despite already having taken desperate measures to stop the appreciation of the CHF;
While the Swiss National Bank has so far avoided currency purchases in its latest bid to keep a lid on the franc, it may soon have no alternative but to follow through on its threat to intervene, economists and strategists said.
But what really caught my attention was comments by Brazilian Finance Minister Guido Mantega that lowering interest rates represents an effective antidote against an appreciating currency.
For “the next two or three years, the conditions will be there for rates to keep falling,” Mantega told reporters in Sao Paulo today. “Falling rates are a good antidote for the gains in the real.”
Allow me to quote myself from the post linked above;
Old Maid is a card game where the simple task is to avoid holding a given card (often the queen of spades) at the end of the game. Even in the company of good friends however, holding Old Maid at the end is not fun. Often, you have to buy the drinks, drop a piece of clothes, or endure other travails. And as it turns out, the global FX market is not unlike this good old game of cards where the Old Maid is proxied by having a strong currency on whose shoulders the correction of global macroeconomic imbalances must invariably fall. In this way, and although one sometimes get the feeling that everyone believes that everybody may actually export their way out of their current misery, buying one country’s currency means selling another and thus, someone (be it an individual economy or a group/basket of economies) must end up holding Old Maid.
The easy investment advice here is naturally to buy the Old Maid which means that just as the global financial punditry searching for clues as to what lies ahead for the global economy and the looming slowdown the SNB et al may have to skint yet awhile for light at the end of the tunnel.
 – No my dear reader, I am renting and I would never touch these things but they are there and they are being sold.
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The week of August 15 was one of the most volatile stock market performances in years. Negative news about the global economy, gloomy forecasts and mixed signals on the jobs front battered stocks and sent gold repeatedly above $1,800/ounce. The Gold Report asked an analyst, two newsletter writers and an economist the following: What should be a precious metals investor’s next move?
The Gold Report: John Williams, government economist and editor of ShadowStats, put it this way: “The financial markets remain unstable and the U.S. dollar is viewed increasingly as the investment currency of last choice. . .Any cosmetic actions taken pre-2012 election likely only will add to the long-term inflation and dollar-debasement problems.” Considering these market conditions, is this a buying opportunity for equities or a good time to take refuge in gold and silver bullion as they continue their climb north? How are you adjusting your investing positions in light of global geopolitical and financial unrest?
Nana Sangmuah, Clarus Securities analyst: All indicators point to weakening global macro-economic framework that has stoked the safe haven demand for the bullion. Despite the good run so far, I expect to see some volatility going forward and there will be some pullbacks in the near term. To stay a winner depends on when you jumped on the bullion band wagon. A better way to reap this upside is to move into gold equities with production and immediate leverage to rising gold prices. Most of these have not re-rated to the $1,500/oz. gold price environment so pose little risk to the downside, but a lot of upside, as they continue to report record quarterly results.
John Kaiser, producer of Kaiser Research Online: The valuation lag for gold and silver equities relative to the prices of gold and silver bullion reflects an embedded pessimism about the medium- to long-term global economic outlook, which has been exacerbated by the recent debt ceiling debacle. Private sector deleveraging has been underway since 2008, and it now appears that political pressures are forcing a cycle of public sector deleveraging called “austerity.” China’s fiscal stimulus response to the 2008 curtailment of consumption demand depended on the American economy regaining traction by 2011, but it is now clear that American fiscal stimulus efforts have been ineffectual and China’s slowing economy will not receive a boost from a recovery in American demand. This crimps expectations that China’s growing economy will continue to incur a rising cost structure as domestic consumption assumes a greater share of Chinese GDP and boosts the competitiveness of American-produced goods and expands the Chinese market for them. A slowing Chinese economy, in turn, reduces the willingness of the private sector to invest in American production capacity and boost employment through manufacturing jobs. That will further encourage private sector deleveraging and result in scaled-back consumption, in effect putting in place an economic death spiral accelerated by ongoing job losses at the state and local government levels as the tax revenue base shrinks.
While the prospect of a dysfunctional global financial system boosts demand for gold and silver prices, the arrival of a double-dip recession possibly deteriorating into a full-blown depression has deflationary implications that will “pop” the so called bubble in gold and silver prices. Equities are not tracking the short-term rise in gold and silver, which could exceed $2,000/oz. and $50/oz. respectively, because markets are anticipating a serious medium-term retreat in gold and silver prices. We could see gold and silver head higher while gold and silver equity prices head lower. The buying window would emerge after gold and silver have spiked in the midst of “panic” conditions, with the speculation being that current prices plus or minus 20% are the new long-term reality for gold and silver prices. However, for that to happen there must be signs that the American economy is on a growth track, and that the Eurozone will avoid disintegration. The sharp sell-off in gold and silver prices in the medium term, which current equity prices are discounting, would not happen if the American economy continues its current trend of relative decline within a growing global economy. The latter requires the United States to adopt a fiscal stimulus program that produces assets that flow value to future generations expected to pay off the associated debt.
The negative scenario for gold would be one where the United States, in an effort to postpone or suspend its relative economic decline, engineers a downturn that inflicts considerable suffering on its citizens, but utterly demolishes emerging economies such as China, which represents the biggest displacement threat to the United States. The political discourse seems to suggest that the best way for America to save itself is to submerge itself and drown dependent economies before they are advanced enough to swim on their own.
Ian Gordon, economic forecaster and chair of the Longwave Group: The majority of gold investors are there because they can see the impending collapse of paper money, but some investors, including many hedge funds, are in the gold market simply because they are trend-followers. In ugly markets, such as the one now unfolding, these trend-followers sell their gold. During the stock bear market, which commenced in October 2007, the price of gold continued to rise into March 2008, even though the Dow had lost about 17.5% from October 2007 to March 2008. But after March, gold sold off into October 2008, losing about 35% of its value. We feel that something similar could happen to gold, this time, in the wake of falling stock prices. As for silver, prices fell by 60% between March 2008 and October 2008. A 35% drop from current prices would see the price of gold fall to something like $1,200/oz. As for the stock market, we are extremely bearish and believe that in the Elliott Wave market cycles, we are entering the third downswing, which should take the Dow Jones Industrial Average well below the March 2009 low of 6,470; perhaps 4,500 will be the target by September 2012.
Jason Hamlin, president of Gold Stock Bull: I am going to continue holding precious metals and buying the dips. The Gold Stock Bull portfolio has been short general equities and long precious metals for the past few months, which has paid off handsomely from both angles. Having already hit my 2011 target of $1,800, I now think gold could end the year above $2,000 rather easily. I have not closed my short positions against emerging markets and the Nasdaq, despite the current correction. I do not anticipate a healthy rebound anytime soon, only dead cat bounces unless and until a much larger QE3 program is announced. But even with the massive liquidity injections, we are seeing the law of diminishing return take hold. Eventually, the house of cards must tumble. I have been allocating more towards physical metals and towards funds that hold the physical metal such as Central Fund of Canada (AMEX:CEF). I have also increased my allocation of gold versus silver, as I think gold will outperform under weak economic conditions.
The frontiers of Nifty.
Next steps on the SEBI story: An interview with U. K. Sinha, by Puja Mehra and Rajiv Bhuva, in Business Today. Mobis Philipose in the Mint. Uproar over I-T raids on SEBI members, in Business Today. In probing SEBI board members, go by CVC rule: Abraham,
by Sunny Verma, in the Financial Express. Sebi may stick to its guns in MCX-SX case by N. Sundaresha Subramanian in the Business Standard. Sebi’s Abraham emerges front-runner for FMC top job by Ashish Rukhaiyar & Sanjeeb Mukherjee in the Business
Standard. An editorial in the Business Standard. Sunil Jain on the problem of recruiting a UTI Chairman, in the Financial Express. SEBI looks to amend law to protect officials from investigative agencies by Reena Zachariah, in the Economic Times. SEBI seems to have not backed away in the high court on MCX-SX.
Static on the FM channel by Puja Mehra, in Business Today.
That seventies feeling by Pratap Bhanu Mehta, in the Indian Express.
Shubhashis Gangopadhyay in the Business Standard on land acquisition.
We should be learning from these Afghans!
A difficult patch in the Indian IPO market.
Saurabh Kumar in the Mint on the extent to which IPOs from certain investment bankers are more exciting for investors than
Demystifying Swiss banking by Priti Patnaik, in the Financial Express.
Imagine there’s no central bank.
Steven Levy has a great story of how Google built Plus, in Wired magazine. And, PC World magazine on where and why Google
Plus is better.
Sebastian Mallaby in Foreign Affairs on how emerging markets should play the appointment problem of the IMF MD.
Economic cycles, like weather, run in seasons. Longwave Group Founder Ian Gordon explains why he believes the world economy is in the “winter” portion of an approximate 80-year cycle and how the financial excesses of the past 60 years are now being wrung out of the system. Ian also explains how investors can prepare to profit from the coming financial storm by positioning themselves in gold and junior gold stocks in this exclusive interview with The Gold Report.
The Gold Report: Good morning Ian. Thanks for taking the time to bring us up to date with your current thoughts about the economic situation and on specific companies you think our readers might be interested in learning about today. When you spoke with The Gold Report in January, you expressed your thoughts on where things were headed. Can you give us an idea of what you think people should do with their financial investments now in order to protect their assets? What changes do you see, and what do you think now in light of what’s happened since January?
Ian Gordon: I think things are actually getting worse. Basically, the currencies of the world are under fire right now. I’m not sure that the euro will even survive this year. All it will take will be one country, like Greece, to leave it, and then the whole thing will probably collapse like a house of cards. Of course, the U.S. dollar, as the reserve currency, has been under fire, as well. So, I think things are coming to a head here, which is something we anticipated in our own work because it’s based on the Long (Kondratiev) Wave Theory.
In 2011, we see parallels to 1931 because we’re 80 years beyond that time. We believe 20-year cycles are important anniversaries, and this is just four twenties. In 1931, the whole world monetary system effectively collapsed. We’ve been long anticipating a collapse in the current world monetary system based on the collapse of 1931. However, we see that the current collapse is going to have far more significant and devastating implications than the collapse between 1931 and 1933 simply because it’s the collapse of the paper-money system now. Essentially, paper money is credit money. When paper money fails, credit fails. Effectively, the economy will fail on credit.
TGR: So, given what could be a major upheaval in the way the global economic cycle works, if this all comes to pass, what sort of system will we end up with? Are we going back to the gold standard or something similar to it? How is this going to happen, how long is it going to take and what are the implications for investors?
IG: I’m pretty sure that we will go back to a gold standard system. Paper-money systems have never survived throughout history. Generally, they’ve been set around a one-country experiment. And when those have failed, as in France after John Law’s paper-money scheme failed in 1720 or the Assignat failed in about 1798, there was tremendous upheaval. And, following these failures, the country resumed gold as the backing for its currency. So, I think we have to go back to something like that because, in essence, gold enforces discipline on governments. We’ve seen a complete lack of discipline in the paper-money system that’s been ongoing since the 1931 collapse of the world monetary system. Paper-money printing has just gotten out of control; and now, parallel to the paper-money printing is the debt. They go hand in hand.
We’ve built massive debt worldwide, which, in total, is probably well in excess of $100 trillion. In the U.S. alone, the total debt is something like $57 trillion. So, that debt is starting to be wrung out of the world’s economies and everybody is facing a pretty frightening depression.
As investors, we have to protect ourselves as best we can. We’ve long been advocating positions in gold and gold stocks. In fact, we’ve been 100% positioned in both of those—physical and gold stocks—since 2000 because our cycle told us that that’s where we should put our assets. So, that’s what we’ve done. I think investors have to do that and they have to be out of the general stock market because, eventually, the stock market has to reflect the realities of the economy. The current U.S. stock market has been propped up by quantitative easing (QE) with massive amounts of money injected into the banking system. That banking system is not putting that money back into the economy because consumers are completely tapped out; they can’t borrow any more money. So, much of the money the Federal Reserve is putting into the banks is being used for speculation.
TGR: Can we pursue the mechanics of this a bit further before we get into more-specific investing ideas? Given the internationalization of the world economy and money being just electronic numbers on computer systems, how does the world get back on some sort of a hard-money standard without years of turmoil?
IG: When the global monetary system started to collapse in 1931, it began with the failure of the Austrian Creditanstalt Bank in Europe. Everyone was trying to bail out this large bank. The Fed was trying to bail it out, the Bank of England was trying to bail it out and JP Morgan also was in there trying to bail it out. They all knew the implications of the failure of this one bank would cause the bankruptcy of Austria and the failure of many other banks plagued with rotten paper money on their books. So, when this bank collapsed in May 1931, it was the beginning of the end of the world monetary system. A bankrupted Austria was forced out of the gold exchange standard system and was soon followed by Germany. Great Britain was forced out of the monetary system in September 1931, which effectively brought down the entire world monetary system. A new monetary system didn’t evolve until 1944 when the Bretton Woods system was signed into law. It was a long hiatus. The parallels with the current evolving monetary system collapse are pretty plain to see.
After 1931, America was pretty self-sufficient, had all the oil and food it needed and became very isolationist. Great Britain traded within its then-empire. World trade collapsed following 1931 and 2011 may well be a repeat of that tragic year, with the collapse of the euro and the unraveling of the entire global monetary system. It could be a long hiatus before a new system is developed. It goes back to that 20-year anniversary cycle I mentioned. The pure gold standard system that had evolved initially in Great Britain in 1821 collapsed in 1914 because the combatants in World War I couldn’t remain on a gold standard system and print the money they needed to fight the war. So, I would say that we will likely return to a gold standard in 2014—100 years after the gold standard collapsed in 1914.
TGR: So, you’re saying investors have a two- to three-year window to position themselves and their investments to profit from what’s going to happen when this is all turns around.
TGR: We’ve had all this volatility in the metals prices over the past year and some substantial gains. How is this affecting companies in the mining business?
IG: For the main part, I’ve positioned myself in either new producing companies or companies that have gold assets in the ground. I’m principally more disposed to investing in gold than I am in silver. I think these assets are going to be extremely valuable. I met with one of my website subscribers just yesterday and said it’s quite possible that there won’t be enough physical gold available on the market to supply the demand. We produce only 80 million ounces (Moz.) of gold a year from existing mines. I think, eventually, the demand for gold will become so extreme that the producers won’t want to be paid in paper money because the paper system is collapsing. So, gold may well be taken out of the market, that’s why it is important to get the physical bullion now rather than later. Of course, gold company stocks that produce physical gold are going to be extremely valuable, as well.
TGR: Obviously, you’re quite selective about which companies you decide to invest your own money in and suggest that other people do the same with their money. What criteria do you use in selecting companies for your portfolios?
IG: First, I have to meet with management before I ever put my money into a company. I realize that a lot of investors can’t do that, but they can certainly talk to management. On the junior side, management is usually very disposed to talking with perspective shareholders. It’s just a matter of picking up the phone and asking the president of a company why it is a good investment, and then listening to the answers. I have to feel confident that a company’s management will be able to produce what they say they’re going to produce on behalf of the shareholders.
Another criterion that I use is geopolitical risk. I want to invest only in companies that I am confident are in politically secure jurisdictions. I have been bitten in the past by investing in companies in countries that I thought were politically secure, which became insecure. In Ecuador, the rules changed and mining almost ceased to function in that country. So, I particularly like companies that have assets in Canada, which I think is a very safe jurisdiction. Many of the companies that I’ve selected for my own portfolio have assets in Canada. I also like Mexico.
I think the U.S. is ok, but I’m a bit worried about what might happen when the whole system starts to collapse. After 9/11, I remember when an unnamed Federal Reserve spokesman said in an interview that it looked at many ways to avert a panic. One of the things he mentioned was buying gold mines. If the U.S. doesn’t have the gold it purports to have, it could well be that the country could nationalize gold companies. I do have investments in companies that are exploring for gold in the U.S., but not a lot. I particularly like companies in Canada.
TGR: There was a little fear recently about the possibility that the New Democratic Party (NDP) may be coming back into power in British Columbia. Its administration had a devastating effect a generation ago, when it caused the whole BC mining industry to retrench. I guess that’s probably not going to happen at this point; but if something like that was to happen, would that possibly have a negative effect at least on BC?
IG: Well, it might. If the NDP does win in British Columbia, I think it probably learned from past experience. Under recent governments, there’s been a tremendous amount of exploration and a lot of companies going into production in the Province. It’s going to be very hard to shut those down because they’re all permitted under present mining laws. So, if the NDP was to win in BC, it’s not something that I would be in favor of because I live in the Province and know what negative effect it had on the region’s mining not long ago. I think most of the companies in BC now are sufficiently advanced in terms of their exploration, and some have gone into production like Barkerville Gold Mines Ltd. (TSX.V:BGM). So, all the permitting is in place and it’s going to be very difficult to rescind it.
TGR: Can you bring us up to date on some of the companies you’ve talked about with us previously and give us some ideas on others you’re looking at?
IG: I own shares of Fire River Gold Corp. (TSX.V:FAU; OTCQX:FVGCF). I think the company’s put together an extremely strong management team in order to put the Nixon Fork gold mine back into production, and I’m confident that Fire River is going to succeed. Right now, on the basis of the reserves the company’s put together through exploration, it probably has only a three-year mine life. The company is going to continue drilling to expand that resource and will be able to produce 50,000 ounces (Koz.) gold per year.
Barkerville Gold Mines is probably my favorite gold-company investment at this time; I think it’s very undervalued. The company currently produces about 50 Koz./year and will probably more than double that when it brings the second mill onstream. It’s a very large property, which I’ve been on, and I think it has the potential to host a 5 Moz. gold resource. So, I’m very excited about Barkerville, and I think it’s going to do extremely well. I have about 15% of my portfolio invested in BGM.
TGR: Obviously, you’re voting with your money.
IG: What I tend to do, and also advise for my subscribers, is to take large positions in companies that I think are going to do very well and smaller positions in companies where I’m not as confident. But, if those companies really do well, they’ll boost the value of my portfolio. If they don’t, they won’t hurt it that badly either. So, by taking a large investment position in Barkerville, I am confident that the share price will perform very well.
Premier Gold Mines Ltd. (TSX:PG) is another great company building an expanding resource. I like the company very much. But I don’t own it because I think it’s expensive and that’s due to CEO Ewan Downey’s past record and reputation. He’s the CEO, president and director of the company and is a real mine finder. I think he’s repeating his past success with Premier.
I like Millrock Resources Inc. (TSX.V:MRO) because I have the utmost respect for Greg Beischer, its CEO and president. He’s put some great properties in Alaska and Arizona into the company, most of which he’s been able to joint venture (JVs) with major companies. Big companies just don’t do JVs on properties that don’t have big potential. So, I think Millrock is a company that, at these prices, is probably undervalued. But it’s a little more grassroots than my other investments.
Timmins Gold Corp. (TSX.V:TMM) is in production at its San Francisco Gold Mine in northern Mexico. I think it will meet the objectives the management team set out for the company, which was producing about 100 Koz. gold/year. Drilling results near the mine show an expanding resource. This company has always been an absolute standout in achieving the objectives its management sets. I still own TMM shares and have done very well.
Another little company I particularly like right now, and own almost 10% of, is called Colibri Resource Corp. (TSX.V:CBI), which has all of its properties in northern Mexico. The company just completed a JV deal with Agnico-Eagle Mines Ltd. (TSX:AEM; NYSE:AEM) on a big gold property where the geology is fairly complex and very similar to La Herradura, which is a Newmont Mining Corp. (NYSE:NEM)/Fresnillo PLC (LSE:FRES) JV property. The La Herradura property hosts roughly 12 Moz. gold and is only about 12 km. away. Colibri also has a silver property that looks extremely attractive. The company did some percussion drilling in 2006 and got great results, so it’s drilling it again. I’ve got just under 10% of the company. Sprott has just under 20% and Agnico-Eagle has just under 20%. With Sprott and Agnico, Colibri has some very important shareholders.
Another company I really like and own a lot of, and whose share price doesn’t reflect what I think it’s worth, is called Temex Resources Corp. (TSX.V:TME; FSE:TQ1). All of the company’s assets are in Ontario, Canada. It has about 1.2 Moz. gold at surface on its Shining Tree property averaging about 1.5 grams per ton (g/t), so it’s certainly mineable. You’re really only paying maybe $40 per ounce of gold in the ground for this company. So, I think Temex is extremely undervalued. I own a lot of the stock and think it will do very well for shareholders.
Another one I like and have been buying lately is a company called PC Gold Inc. (TSX:PKL). Between my wife and me, we’ve probably accumulated about 1 million shares. PC’s main asset is a past-producing, very high-grade mine on Pickle Lake in Northwestern Ontario. The company has been drilling and producing exceptionally good drill results and probably now has a resource of more than 1 Moz. I think it’s extremely undervalued. I’ve been buying it in the open market and believe it can do very well for investors. So, there are a few more ideas.
TGR: Thank you for those great ideas. Did you have any last thoughts about the future of the economy you’d like to share?
IG: Unfortunately, I’m very pessimistic about the economy. If paper money, which is credit money, collapses, then, essentially, credit collapses and the economy grinds to a halt. Quite a scary scenario could evolve from a collapse in the paper-money system. We almost had a major credit failure in 2008. What happens if credit does that again? Everything stops—trucking stops, the movement of goods stops and it becomes a very difficult time for everyone. I think people have to prepare for the worst.
TGR: We’ve certainly gotten used to a system that is automated and electronic. People press buttons and expect results. If things start falling apart as you predict, we could see some real turmoil—financial and possibly even physical.
IG: Investors need to keep those possibilities in mind and protect their assets as best as they can. I’m a little reluctant to admit it, but one of the things I keep on hand is a one-year supply of food. It’s a relatively inexpensive way of protecting your food source. If the system falls apart, as it could, you won’t be able to run down to the store and get what you want when you need it.
TGR: Thank you very much, Ian, for your valuable insights and recommendations.
IG: Thank you very much.
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, Ian assists select precious metal companies in financings. Educated in England, Ian graduated from the Royal Military Academy, Sandhurst. After a few years serving as a platoon commander in a Scottish regiment, Ian 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. Ian has been publishing his Long Wave Analyst website since 1998. Eric Sprott, chairman, CEO and portfolio manager at Sprott Asset Management, describes Ian as “a rare breed in the investment-advisor arena.” He notes that Ian’s forecasts “have taken on a life force of their own and if you care to listen, Ian will tell you how it will all end.”
There is more to the periodic table—and to investing opportunities—than gold, silver and copper. Siddharth Rajeev, vice president and head of research at Fundamental Research Corp., sums up the market prospects for rare earth elements (REE) and a host of metals. He unearths some new names and some historical finds in this exclusive interview with The Gold Report.
The Gold Report: Sid, today we’re going to talk about a number of different metals: gold, silver, vanadium, copper and rare earths. Could you handicap each of those metals for us, starting with gold, copper and silver?
Siddharth Rajeev: Let’s look first at the factors that have been driving up commodity prices. We think two key factors are responsible. Number one is increasing global demand; the second is the continued weakness in the U.S. dollar.
Let’s look at increasing global demand. We believe in the Brazil, Russia, India and China (BRIC) story and we expect continued growth from those countries. We believe that the U.S. economy will continue to see a gradual recovery. So, we expect increasing demand from the U.S. and continued demand growth from the BRIC countries to keep the demand side strong. Thus, the first factor looks good for the commodities market.
However, we expect the second factor, which is the U.S. dollar, to gradually improve with respect to other currencies as the U.S. economy improves. That should have a negative impact on the commodities market.
So, we expect to see some sort of correction this year. For example, copper is at $4.45/lb. We do not think these prices are sustainable in the long term and therefore we expect to see some kind of correction.
In terms of gold, we believe that as the U.S. economy recovers and the U.S. dollar strengthens, investors would move away from safe-haven assets such as gold and put their money where it could achieve higher returns. So, over the long term we expect the gold price to soften. But, in the near term, uncertainty regarding the U.S. and European economies and inflationary scares should give us high gold prices.
As to copper, we don’t think it’s sustainable at such prices over the long term. Even though demand looks very strong, we expect prices to drop with the gradual recovery in the U.S dollar.
Silver is unique as it behaves like a capital preservation asset, such as gold, as well as like a commodity due to its industrial applications. The uncertainty in the U.S. and Europe and inflationary pressures, combined with continued demand growth from Asia and the BRIC countries, are some of the reasons we think silver has been one of the best movers recently.
Although we think silver should soften in the long term, we think that silver should stay strong in the near term due to the same reasons as gold. In our valuation models, we use a long-term (2014+) price of US$18.35/oz.
TGR: What price are you using for gold price?
SR: We use a long-term gold price of US$1,000/oz.
TGR: What can you tell us about vanadium and rare earths?
SR: Unlike other commodities, vanadium prices have not been as volatile in the last 18 months. They’ve stayed around $7/lb. for over a year. Over the long term we have a good outlook on the commodity. We believe strong growth in steel consumption, especially from China and India, will be the key demand drivers. Steel accounts for 90% of vanadium demand; so vanadium demand is highly correlated to the steel segment.
The use of vanadium in battery and renewable energy storage devices is expected to drive the demand up. Vanadium supply is expected to remain quite stable from the three major producing countries—China, Russia and South Africa. We think the demand side should keep prices high.
The main factor driving up rare earth prices is the supply side. China accounts for 97% of all production, and has been cutting down significantly on its rare earth exports. China also has been increasing the demand for rare earths. The U.S. currently imports nearly 100% of its rare earths consumption. We are bullish on REE prices primarily because of the concentrated supply conditions.
TGR: So, the more obscure you get, the better the outlook. There seems to be a bit of a contradiction in that you see softening prices for copper, but strengthening prices for vanadium. Both of those metals have the same sort of investment thesis. Why are you bullish on one and not so bullish on the other?
SR: That’s because copper has moved up by 40%–50% in the last 12 months, while vanadium has stayed pretty constant. For the last 12 months vanadium has been around $7/lb. It has not really moved up, while copper has moved up significantly. So we think copper will have a higher price correction.
TGR: What would have to happen in the Middle East before you would be willing to be bullish on the gold price?
SR: Obviously the turmoil in the Middle East is positive to commodities such as gold and oil. But, we think those factors are short-term catalysts. Over the long term, we do not think these incidents should play a role. Historically, all of these geopolitical tensions around the world cause sudden and short-term spikes in prices. They’ve not really had an impact over the long term.
TGR: In the 1970s there was an oil crisis that lasted about five years that paralleled a run in the gold price. Five years is pretty long term.
SR: High oil prices typically result in high inflation and high gold price. So if the problems in the Middle East somehow impact long-term oil supply, we will see high gold prices for a prolonged duration. We have not seen anything so far in the Middle East that brings up concerns over the long-term supply of oil.
TGR: The other thing to consider is that if a company looks good at $1,000/oz., it will look very good at any price above that.
TGR: Quite a few of the small cap companies in your coverage universe are exploring for gold. Many of them have never appeared in The Gold Report. Could you give us a few under-the-radar names that our readers should know about?
SR: I will name three companies today that we really like. I’ll start with Rio Alto Mining Limited (TSX.V:RIO; BVL:RIO; OTCQX:RIOAF). It has an advanced-stage project. We picked them up for coverage in January 2010, when they were at $0.46. Today, its price is over $2.40. The main deposit is the La Arena Deposit, which has over a million ounces of gold in oxide. The company also has a copper gold sulphide resource (adjacent to the oxides), which has close to 2.9 billion pounds of copper and over 3 million ounces (3 Moz.) of gold. The company plans to put the oxide into production in Q211. Construction commenced in August 2010. The sulphide should go into production in the next three to four years. The company has an extremely strong management team. They recently raised close to $58 million in equity financing.
TGR: One noteworthy thing about La Arena is that it’s not too far from Barrick Gold Corporation’s (TSX:ABX; NYSE:ABX) Lagunas Norte project. Do you see Rio Alto as a possible takeover target?
SR: Yes, especially these days when investors and majors are more interested in higher quality assets because of the volatility in commodity prices. Investors and majors are looking for more advanced, quality projects. We believe Rio Alto fits into that category. We cover about 150 small- to mid-cap companies, and we think Rio has one of the best deposits in our coverage.
TGR: And your second gold name?
SR: Evolving Gold Corp. (TSX.V:EVG; Fkft:EV7) has made a huge discovery at its Rattlesnake Hills Gold Project in Wyoming. The company also has the Carlin project in Nevada. They have done aggressive drilling in the last couple of years and the results have been extremely impressive. Evolving Gold doesn’t have an NI 43-101 resource estimate, but we came up with an internal resource estimate. We think the project should have at least 1.5 Moz. gold. This company also has a strong management team and a strong cash position. In July 2010, Goldcorp Inc. (TSX:G; NYSE:GG) invested $15 million in Evolving Gold, which is a huge vote of confidence for investors.
TGR: What’s the next stage for Evolving? Could we see a preliminary economic assessment (PEA) in the near term?
SR: I think the next step is a NI 43-101- compliant resource estimate.
TGR: When can we expect that?
SR: We would like to see it sometime this year.
TGR: And your guesstimate was 1.5 Moz. But, you tend to be on the conservative side.
SR: Right. For valuation purposes we’re slightly on the conservative side. Our fair value on Evolving is $1.40 per share. We have a BUY (Risk 5: Speculative) rating.
TGR: And your third gold name?
SR: This is a slightly different company from the previous two I mentioned. The company is called 49 North Resources Inc. (TSX.V:FNR). It’s a resource investment company based out of Saskatchewan. It is Saskatchewan’s first publicly traded resource investment company, with close to $65 million in assets under management. It invests in early stage resource projects, including minerals, oil and gas. Right now, the majority of the investments are in oil and gas and precious metals.
We think this company offers investors a very good opportunity to hold a diverse portfolio of assets in different sectors, different regions. Investors also get the opportunity to participate in the upside potential of private company investments. FNR shares are currently trading at a 30% discount to the NAV (net asset value). We will be initiating coverage on this company shortly.
TGR: It’s quite a diverse group of assets that 49 holds: coal, diamonds, uranium, base metals, a little bit of gold. What are your thoughts on that business model? It is a bit unusual.
SR: Yes. For example, the company owns 150 to 200 stocks in its portfolio, but the top 15 of its holdings account for over 60% of its NAV. We think it’s a very good business model, especially because the CEO and President Tom MacNeill has a lot of experience and is well known in the industry.
One of its best success stories so far include its investment in Athabasca Potash, which was later acquired by BHP Billiton Ltd. (NYSE:BHP; OTCPK:BHPLF). FNR made a 611% gain in that investment.
Basically, this model offers investors an opportunity to get exposure to the upside of the junior resource market with lower risk due to the fact that the company holds a diverse portfolio. We think the return/risk ratio is higher for this kind of model.
TGR: Let’s move on to silver. Silver outperformed gold in 2010 on a percentage basis and is off to a very good start in 2011. Although you see some softness in silver, what are some silver names that our readers might be interested in?
SR: We cover two very good silver stories right now. One is an advanced stage company called SilverCrest Mines Inc. (TSX.V:SVL). In September, the company announced the first gold and silver pour at the Santa Elena Project in Mexico. We expect commercial production to be announced this quarter. SVL expects annual production of 35,000 oz of gold and 0.6 Moz. of silver. This is an open-pit, heap-leach operation. The company plans to expand operations to over 100,000 ozs. in the next couple of years. Again, this company has a strong management team; something which is important for any junior. Our fair value for SilverCrest is $2.84 per share.
TGR: What’s the second silver name?
SR: It is a relatively under-followed, under-explored company called Thunder Mountain Gold Inc. (TSX.V:THM, OTCBB:THMG). Its key property is the South Mountain Project in Idaho. It’s a past-producing mine. It currently has a resource of 3.4 million tons (Mts.) of indicated and inferred resource. It’s a polymetallic deposit, in which the primary metal is silver. The deposit is open at depth and along strike. The company is also developing a new gold target close to the historic mine which we think should add more resources. It’s working on a PEA and an updated resource estimate.
Our fair value on the stock is $0.70 and it’s trading at $0.25 per share. To value the stock we looked at the average enterprise value to resource ratio of its peers. Thunder Mountain is trading at $0.47/silver oz., while the peer average ratio is $1.34. We think that it’s undervalued at this price.
TGR: That’s precisely the kind of name we’re looking for. Now let’s move on to rare earths. Their price appreciation was dramatic in 2010. What are some companies with REE projects that could show some promise in 2011?
SR: We cover a lot of companies in the rare earth segment. I will talk about three of our top companies, starting with Commerce Resources Corp. (TSX.V:CCE; Fkft:D7H; OTCQX:CMRZF). It’s focusing on its Blue River Project in British Columbia, which is an advanced stage project. Then it has an early-stage exploration project in Eldor, Quebec, where it’s done some aggressive drilling and is getting very impressive results. Based on the results at Eldor we believe that the continuity, depth and thickness of the mineralization are positive signs for a near-surface REE deposit. The company announced an updated resource estimate at Blue River in February, with significant increases in tonnage and tantalum oxide and niobium oxide content.
REE prices have gone up significantly. Let’s look at tantalum. Its price moved up by 42% in the last four months, from $120/lb. to $171/lb. We continue to believe that demand for tantalum, which is used in electronic products, will increase. The supply side is very concentrated. For example, Australia and Brazil alone account for 50% of the production. The concentrated supply and increasing demand, and lack of production in the U.S. shows the importance of advanced stage tantalum explorers like Commerce.
Our fair value on Commerce Resources’ stock is $1.51 per share. Right now, I think it’s trading at around $1.00. To get that valuation, we used long-term tantalum price of $120/lb.; the current price is $171/lb. For niobium, which is used in making steel, we used $15/lb.; the current price is $23/lb. Even based on our conservative price forecast, we think it has an economic deposit at Blue River.
TGR: Any other REE names?
SR: Another name is Quantum Rare Earth Developments Corp. (TSX.V:QRE; FSE:BR3; OTCQX:QREDF). It’s developing the Elk Creek carbonatite complex in the U.S. It has had historic exploration. The historical resource is 39 Mts. of 0.82% niobium oxide. According to the U.S. Geological Survey, this property may hold one of the world’s largest resources of niobium and REE. A few months ago, the company raised close to $6.5 million. Our valuation on the stock is $0.85 per share, and it is trading at $0.53.
TGR: What do you think of Quantum’s CEO Peter Dickie?
SR: We’ve been following Peter Dickie and his associates for several years. They’ve been involved in some good projects in the past. We believe Quantum has a good management team.
TGR: Can you give us one more name?
SR: In the rare earth segment is a lithium company called Rock Tech Lithium (TSX.V:RCK; Fkft:RJIA). It’s exploring for lithium and rare metals in Ontario and Quebec. The main project is its 100%-owned Georgia Lake Project, which has historic resources of 9.8 Mts. with grades of 1.18% lithium oxide (Li2O). The company is conducting a 4,000-meter drilling program that should be completed in the first week of March. The company expects a NI 43-101 resource by mid-2011.
TGR: It’s hit high-grade spodumene there. And you can get lithium out of spodumene, correct?
SR: Yes, that’s right.
TGR: In terms of other similar deposits around the world, is the Georgia Lake project similar grade, higher grade, lower grade?
SR: I would say the grades are good..
TGR: What’s your fair value on Rock Tech?
SR: We are currently updating our valuation on the company.
TGR: Do you cover any vanadium plays?
SR: There’s a company called Apella Resources Inc. (TSX.V:APA; Fkft:NWN), based out of Vancouver. It’s exploring for vanadium and titanium in central Quebec. Its Iron-T property has a resource of 11.6 Mts. inferred and 0.73% vanadium oxide equivalent.
But this resource estimate covers only a small portion of the known mineral-bearing complex. We feel that the company can significantly increase the resource outside of the current resource area. We valued the stock by looking at similar stage vanadium projects. The average ratio of enterprise value to vanadium resource is around $0.06/lb. We used that multiple to value Apella’s projects. Our fair value on APA is $0.65. The shares are currently trading at $0.21.
TGR: To close, what do you see happening, on a macro level, over the next year or so?
SR: Overall, we expect to see some sort of correction in the commodities market with the gradual recovery in the U.S. dollar. Precious metals should stay relatively strong in the near term due to the continued uncertainties in the U.S. and Europe and inflationary pressures.
For investors at this point, because of the uncertainty in the markets and the volatility in commodity prices, the main strategy should be to look for companies with quality advanced stage assets.
TGR: Sid, thanks for your time.
Siddharth Rajeev joined Fundamental Research Corp. in April 2006. At FRC, he oversees the research department, and also covers a broad array of companies, primarily in the energy, mining, and technology sectors. Prior to FRC, he has had a mix of engineering and finance experience including corporate finance experience at a leading Investment Bank in Kuwait. Sid has ranked as a four-star analyst in the energy and mining sectors by Deutsche Asset Management, a division of Deutsche Bank.
Sid holds a bachelor of technology degree in electronics engineering from Cochin University of Science & Technology, and an MBA in finance from The University of British Columbia. He is a CFA Charterholder, and has completed studies in exploration and prospecting at the British Columbia Institute of Technology. Sid is sought by the media for commentary on the valuation of small cap stocks and industries he covers, and is a speaker at various investment conferences.
Sprott Asset Management Senior Portfolio Manager Charles Oliver says the social unrest in the Middle East could lead to a premium for junior companies operating in North and South America. He’s even betting on it, saying, “I believe juniors will give you the best long-term outperformance and alpha.” He’s taken profits on companies with exposure to Africa and moved that cash into others with primary assets in the Americas, where, he says, there is much lower risk. Charles discusses a basket full of those names in this exclusive interview with The Gold Report.
The Gold Report: Charles, the Sprott Gold and Precious Minerals Fund (TSX:SPR300) had an impressive 74.7% gain in 2010. That same fund was up 114% in 2009. Congratulations!
Charles Oliver: Thank you very much.
TGR: Most of those gains came from dramatic rises in gold and silver juniors but more recently you trimmed back a lot of those positions in exchange for positions in large-cap gold producers. Why the change in philosophy after having such success with the juniors?
CO: It’s not actually a change in philosophy. I love the juniors. I believe juniors will give you the best long-term outperformance and alpha. I’m continually upgrading the portfolio and improving it. Generally speaking, I like to have about one-third large caps, one-third mid caps and one-third small caps. The large caps give you liquidity and act as an anchor. In 2009, we saw great performance from the mid caps, but in 2010 they slowed down and a lot of the small caps took off.
In 2003, I did something very similar. I took some of my stocks, which were getting a little expensive on a relative basis, trimmed those positions and redeployed them into the best opportunities out there. Right now, I’m finding the large caps are the cheapest segment out there. I am still buying some mid and some small caps, but I’m looking for those companies that are significantly underpriced. It’s a continuing philosophy; there is no change.
TGR: But what’s going to make those large caps move? We haven’t seen a dramatic movement in large-cap share prices despite having a gold price above $1,300/oz. for some time.
CO: You’re absolutely correct. The large caps have performed terribly over the last four or five years for a couple of reasons. When the gold exchange traded funds (ETFs) came out, a lot of money that had been in large caps migrated to the ETFs. That’s been going on for several years. When people migrate out of the large caps they help depress the price. So when I look at the large caps today I’m seeing valuations that are cheaper than I’ve seen this decade. If you look at companies like Goldcorp Inc. (TSX:G; NYSE:GG) and Barrick Gold Corporation (TSX:ABX; NYSE:ABX)—the big boys out there—these companies are trading very close to where they were in 2006 and 2007 when gold was at $600–$700/oz. Today, we’ve got nearly double that gold price.
These companies are making huge profits and generating a lot of cash flow. I think there’s going to be a day when people suddenly wake up and say, “Wow, look at the value!” I think part of the driver will be new investment from dividend-seeking individuals, dividend funds and value funds. If you look at dividend funds, they never held a gold stock because, during the 20-year bear market in gold, most gold companies weren’t paying a dividend and those that were certainly weren’t increasing it. Today, companies like Barrick are actually increasing their dividends and have the potential to do even more. I’m looking for that tipping point and I believe it will come.
TGR: In a June 2010 interview with The Gold Report, you said gold would go above $2,000/oz. based largely on further paper currency debasement. But, supply/demand fundamentals don’t seem to support a higher gold price. A recent World Gold Council report said total investment demand for gold fell about 14.3% in 2010 and scrap supply continues to pour in at record levels, reaching about 1,650 tons that year. Obviously, social unrest in countries like Libya and Bahrain continue to push gold higher based on the safe-haven bid but does it concern you that total gold demand is, in fact, retreating?
CO: It doesn’t, actually. If I thought that was a long-term theme, it would be a big concern. But, having said that, I think you have to look at the numbers and make sure you put them in proper perspective. Investment demand is often a plug for all the other numbers that go into the supply/demand numbers. Consequently, many numbers actually don’t get included in that final demand number.
Let’s look at it in a slightly different way. Gold mine supply today is roughly 2,650 tons. We use the numbers from Gold Field Minerals Services and if you look at investment demand over most of the last decade, basically it’s been flat. You didn’t really get significant investment demand until 2009 when, by GFMS’ calculations, it was around 1,400 tons. Now going from practically nothing to 1,400 tons when mine supply is only 2,500 is a huge difference.
If you look at 2010, GFMS has an investment demand number of 967 tons. Is it a significant decrease? On first blush it seems quite significant, but it’s the second-highest level of investment demand in the last decade. The trend is clearly up. I’ve been reading reports that Chinese and Indian citizens are increasing their gold purchases at record levels. When I look at the other things around me, they suggest that we are more likely to see higher demand in the future. When you look at sales from the U.S., Canadian, Australian or any other Mint, you’ll find most of them are running at record production levels due to individuals buying coins.
TGR: And central banks have stopped selling their gold, too.
CO: Yes, that’s another good example. If you go back to 2005, the central banks, as a group, were selling about 600 tons of gold annually. When you have mine supply at 2,600 tons, and then you get another 600 tons on top of it, there’s a fair amount of gold out there. Today, those 600 tons are no longer being sold into the market. And we are seeing central banks actually buying gold.
In 2010, we saw India announce that it added 200 tons. We’ve seen some of the smaller banks buying, too, like Mauritius, Sri Lanka. We’ve seen China indicate that it’s been buying over the last several years, though, the country doesn’t officially report that on a regular basis. And a Russian minister said the country was looking at adding about 100 tons of gold on average each year to its reserves. So, a lot of the anecdotal evidence suggests that investment demand is actually increasing.
TGR: Let’s go back to the Middle East for a moment. The unrest there has pushed gold up about $100 over the past couple of weeks. Have the ongoing issues there or in northern Africa caused you to change your investment strategy in the near term?
CO: One slight difference is that I’ve become a little more cautious on Africa in general. Many gold companies have exposure to Africa. The speed at which some of these countries are destabilizing has caused me concern. I think that most of the countries where mines operate will be fine; but having said that, I am cognizant there could be some nervous investors who decide they want to reduce their ownership in those areas. I’ve taken some profits from those areas and redeployed them back into what I deem are safer jurisdictions like North and South America.
TGR: Do you believe what’s happening in northern Africa and the Middle East is the “mania” catalyst the gold bugs have been seeking?
CO: Generally speaking, most crises pass and get resolved. Frequently, you see the gold price run up only to fall back down the next day. I try to block out these events because often they don’t really change the long-term value of gold. The concern, however, would be if this becomes more systemic and global in nature. In that case, I certainly think it would have a larger, more-lasting impact. But, again, I think you want to look at how destabilizing this is on Europe and the U.S. If it spreads to Saudi Arabia, that would cause me great concern.
TGR: Well, King Abdullah recently announced $37 billion in appeasement money over the next few years in an attempt to stave off any unrest.
CO: That’s a nice way to put it. The fact that they’re actually doing that leads one to believe that these guys must be getting a little bit nervous about the situation.
TGR: You mentioned safe jurisdictions like North and South America. Is there a price premium on companies with gold projects in those jurisdictions due to the unrest elsewhere?
CO: Over the last decade, there’ve been periods when I would say there was a price premium on North American projects and some of the other countries have versus those in other less-desirable or more-risky areas. I think we may be embarking upon that situation once again, but we haven’t seen a huge movement occur yet. As I said, I’ve started trimming and moving more money out of my African countries. Again, that’s commensurate with the discount rate that should be used for different countries and their associated risks.
TGR: Are you still finding value in companies with projects in North and South America?
CO: When I look at the basket of opportunities in North America, some companies are expensive and some are dirt cheap. I’m finding lots of opportunities to add in the North American space.
TGR: What are some juniors with projects in North America that you believe can be had at good value?
CO: There are companies like San Gold Corporation (TSX.V:SGR); we’re big shareholders of San Gold. We’re also big shareholders of Kirkland Lake Gold Inc. (TSX:KGI). The company is producing 100,000 ounces (100 Koz.), has the potential to triple that production and is trading at dirt-cheap valuations relative to most of the other companies out there.
TGR: And Kirkland Lake’s conducting more underground drilling so it could further increase its resource, too.
CO: Yes, I visited the property last summer and looked at some of the new underground drill platforms. I remember asking about how much drilling the company would be doing from this one particular platform. Kirkland said, “Well, we’ve got this new area that’s never been drilled before. It’s right beside our existing underground mine. We’re going to drill it for two or three years.”
Just this past month, the company announced some of the first drill results from that campaign. It’s very early stages but it looks like Kirkland Lake will be adding more resources to an already very significant resource, which would increase its ability to expand production.
TGR: What are its cash costs there?
CO: The cash costs are a little high, about $700/oz. right now. The company’s trying to bring it down to a more reasonable level. The precise cash costs for the Macassa mine are $709 in Q111 and $809 in Q211.
TGR: What are some other names that offer value?
CO: Another company I quite like is Osisko Mining Corp. (TSX:OSK). Osisko has had a great run up recently as it’s moved toward production. My understanding is it’s just about to start running the mill and producing gold.
TGR: Did it alarm you when Goldcorp sold off its 10% interest in advance of production?
CO: No, I think Goldcorp has lots of opportunities. I think it would’ve liked to have gotten Osisko at a dirt-cheap price because Osisko has done a great job of building up the company—not just with the new Malartic mine in Quebec, but the company also bought Brett Resources Inc. and its Hammond Reef project, which it’s drilling extensively. Osisko also got the Duparquet joint venture (JV) with Clifton Star Resources Inc. (TSX.V:CFO).
TGR: And you still have a position in Clifton Star, right?
CO: Yes, I do hold some Clifton Star, as well. We trimmed our position in Osisko earlier this year. It had done very well but we’ve seen the company consolidate over the last number of months. As it’s done further drilling and gotten closer to production, I think the story has improved. You’re looking at a company that’s trading in the low double digits. I think this company has the potential to be one of the premier emerging gold companies, and it’s Canadian.
TGR: You also have a position in Fire River Gold Corp. (TSX.V:FAU; OTCQX:FVGCF). Why do you own shares in Harry Barr’s company?
CO: We invested in Fire River Gold almost two years ago. I remember when Harry came in to talk to me in 2009, talking about an asset he bought from a company that was in financial distress. Many companies were caught off guard by the magnitude of the 2008 correction.
TGR: Was he talking about St Andrews Goldfields Ltd. (TSX:SAS)?
CO: Yes. He managed to come up with $5 million to buy the Nixon Fork Gold Project and plant. Harry bought those assets for a song. It’s going to be small scale, but Fire River will be starting production in the next several months. It’s got cash on the balance sheet, no debt and some of the highest-grade ore out there—it’s nearly 1 oz./ton. And it’s planned further drilling programs.
TGR: Some of that is to better understand the geology of the deposit because St Andrews didn’t really understand the deposit, so it got into some issues with the recovery circuit and dilution.
CO: Yes, mining is a very tough business. You’ve got to find the gold, and then extract it economically—that’s often quite a challenge. But Fire River has all the parts. It really comes down to execution now.
TGR: Harry certainly has the financing connections and the experience to lure the kind of expertise needed to bring Nixon Fork to production. Another project in Alaska that you have a position in is Kiska Metals Corp.’s (TSX.V:KSK) Whistler project.
CO: Yes, I took a position in Kiska last year. I always liked the management team; I’ve known them for quite some time. It was probably around the Prospectors & Developers Association of Canada (PDAC) conference last year where I met up with them again and looked at the Whistler Project and thought that looks like a very interesting project. One of the issues I had at the time was that Rio Tinto (NYSE:RIO; ASX:RIO) had a back-in right to the project.
TGR: Not anymore.
CO: Not anymore. I talked to management several months later to schedule a follow-up meeting. This was around the time that Rio Tinto looked like it was about to walk away. As soon as I recognized that it would no longer be involved in the play, I basically decided it was time to become a shareholder.
Kiska has been drilling up the Whistler Property. I think it’s got just over 5 million ounces of gold equivalent (Moz. Au Eq.) there now. It’s moving on to drilling some of the other peripheral targets where it has some discoveries. That drilling will ultimately decide whether or not Whistler is economical. One thing to remember is that a lot of these plays in Alaska are very remote, so infrastructure is always something you have to consider. Barrick has been looking at using a natural gas pipeline as part of the development model for the Donlin Creek copper-gold project in Alaska.
TGR: That’s a 50/50 JV with NovaGold Resources Inc. (TSX:NG; NYSE.A:NG), right?
CO: That’s correct. If Barrick builds that nat gas pipeline, basically, it would go right by Kiska’s Whistler property. If that happens, Kiska would get some pretty good infrastructure put into place, which would really be a big win for the company—one of those things that’s outside of Kiska’s hands—but, I’m keeping a close eye on what Barrick does.
TGR: Do you see Kiska as a takeover target, Charles?
CO: At this point, I don’t expect it to be taken over. Should the natural gas pipeline get the go-ahead, then I think it would definitely be a takeover target.
TGR: Could you give us one more name before we let you go?
CO: I hate to give you one. Can I give you a whole bunch? We haven’t really talked about South America. I always like to give a basket of names because they all have different risks. The companies in which we have significant positions are, alphabetically, Belo Sun Mining Corp. (TSX.V:BSX), Guyana Goldfields, Inc. (TSX:GUY), Magellan Minerals Ltd. (TSX.V:MNM), Minera Andes Inc. (TSX:MAI; OTCBB:MNEAF) and Torex Gold Resources Inc. (TSX:TXG).
TGR: Let’s start with Belo Sun with a Brazilian gold project where it’s been busy proving up ounces.
CO: Yes, it’s got north of 2 Moz. One of the things that’s been a really nice surprise this year is that as Belo’s done some infill drilling it’s actually been able to increase the grade of the resource. What you often see with a rising gold price is that companies use a lower-grade resource. It’s nice to see that going the other way.
TGR: You mentioned Guyana Goldfields. Do you see an opportunity for Sandspring Resources Ltd. (TSX.V:SSP), which also has a gold project in Guyana, to join forces with GUY?
CO: I don’t think the two will join forces. You’ve got two very different management teams. Guyana Goldfields looked at Sandspring’s properties before Sandspring had even acquired some of them. It would probably make sense to have all these properties under one umbrella, but I doubt it will happen. At some point, I expect somebody will take out Guyana Goldfields. One of the logical buyers would be a company like IAMGOLD Corporation (TSX:IMG; NYSE:IAG), which already has a presence there. But if Sandspring continues to build ounces, and it’s had some great drilling success to the north where it added quite a few ounces, then maybe it, too, could get acquired at some future point.
TGR: You mentioned Minera Andes, too. Tell us about that one.
CO: Minera Andes is Rob McEwen’s company that has the JV with Hochschild Mining (LSE:HOC).
TGR: And Mr. McEwen is Minera’s largest shareholder.
CO: Yes, McEwen’s the largest shareholder at 33%. Rob has done very well for those people who’ve gone along with his investments. I think he’s done a great job. Minera Andes has a couple other assets besides the silver play. It also has the Los Azules copper-porphyry deposit, which probably should be spun out. The other thing that gets me excited is that Goldcorp recently bought Andean Resources for about $3.5 billion. Rob McEwen has all the properties surrounding that area.
TGR: Yes, he’s hoping some of Andean’s high-grade mineralized structures run onto his claims. And there is some evidence of that.
CO: The company will certainly get some. The question always is: Will it be economic? Will the company find enough? And you can’t do that without putting in the proper legwork.
TGR: But Goldcorp’s never going to take out a Rob McEwen majority-owned company.
CO: I’m going to bite my tongue on a comment right now.
TGR: Right. Well, what should we expect in terms of the near-term gold price?
CO: I’m still extremely bullish on the gold price. As I said, I expect gold to be at $2,000/oz. in the not-too-distant future. Otherwise, I will have to shave all the hair off my head.
TGR: Back in April 2008, you made a statement that gold would reach $2,000/oz. in four years and if it didn’t you would shave your head. Are you still standing by your statement and is the deadline April 16, 2012?
CO: Yes. My view is really based on the fact that anywhere I look, I see governments continuing to print money left, right and center. I see deficits continuing to spiral out of control. I think governments are helpless to do the right thing, which is cut spending, because if they cut spending they get voted out of power. Without any other answers, they ultimately decide to print some money. That’s easy enough. Nobody complains about that.
TGR: Could gold eclipse $1,500/oz. in the near term?
CO: I wouldn’t be at all surprised to see gold break out, make a new high and take out $1,500 in a very short period of time.
TGR: We’ll look forward to that. Thank you for talking with us today, Charles.
Bringing more than 21 years of experience in the investment industry, Charles Oliver joined Sprott Asset Management (SAM) in January 2008 as an investment strategist with a focus on the Sprott Gold and Precious Minerals Fund. Prior to joining SAM, Charles was at AGF Management Limited, where he led the team that was awarded the Canadian Investment Awards Best Precious Metals Fund in 2004, 2006 and 2007 and was a finalist for the best Canadian Small-Cap Fund in 2007. At the 2007 Canadian Lipper Fund awards, the AGF Precious Metals Fund was awarded the best 5-year return in the precious metals category, and the AGF Canadian Resources Fund was awarded the best 10-year return in the natural resources category.
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