Oct 31

Tea Leaves & $2000 Gold

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Yes, some people are still forecasting $2000 gold by year’s end…

BOB and BARB Moriarty launched 321gold.com over 10 years ago, adding 321energy.com the better to cover oil, natural gas, gasoline, coal, solar, wind and nuclear energy as well as precious metals.
Previously a US Marine fighter pilot, and holding 14 international aviation records, Bob Moriarty here tells The Gold Report why he’s 100% certain that a market crash is looming… 
The Gold Report: Bob, in our last interview in February, we had currency devaluation in Argentina and Venezuela, interest rate hikes in Turkey and South America, and a cotton and federal bond-buying program. Just eight months later in October, we’ve got Ebola, ISIS and Russia annexing Crimea plus a rising US Dollar Index. We’ve also got pullbacks in gold, silver and pretty much all commodity prices. With all this news, what, in your view, should people really be focusing in on?
Bob Moriarty: There is a flock of black swans overhead, any one of which could be catastrophic. The fundamental problems with the world’s debt crisis and banking crisis have never been solved. The fundamental issues with the Euro have never been solved. The world is a lot closer to the edge of the cliff today than it was back in February.
About ISIS, I think I was six years old when my parents pointed out a hornet’s nest. They said, “Whatever you do, don’t swat the hornets’ nest.” Of course, being six years old, I took stick and went up there and swatted the hornets’ nest, which really pissed off the hornets. I learned my lesson.
We swatted the hornets’ nest when we invaded Iraq and Afghanistan. What we did is we empowered every religious fruitcake in the world. We said, “Okay, here’s your gun, go shoot somebody. We’ll plant flowers.” We are reaping what we sowed. What we need to do is leave them to their own devices and let them figure out what they want to do. It’s our presence in the Middle East that is creating a problem.
TGR: Will stepping back allow the Middle East to heal itself, or will there be continued civil wars that threaten the world?
Bob Moriarty: We are the catalyst in the Middle East. We have been the catalyst under the theory that we are the world’s policemen and that we’re better and smarter than everybody else and rich enough to afford to fight war after war. None of those beliefs are true. The idea that America is exceptional is hogwash. We’re not smarter. We’re not better. We’re certainly not effective policemen.
The Congress of the United States has been bought and paid for by special interest groups: part of it is Wall Street, part of it is the banks and part of it is Israel. We’re just trying to do things that we can’t do. What the US needs to do is mind its own business.
TGR: You’ve commented recently that you’re expecting a stock market crash soon. Can you elaborate on that?
Bob Moriarty: We have two giant elephants in the room fighting it out. One is the inflation elephant and one is the deflation elephant. The deflation elephant is the $710 trillion worth of derivatives, which is $100,000 per man, woman and child on earth. Those derivatives have to blow up and crash. That’s going to be deflationary.
At the same time, we’ve got the world awash in debt, more debt than we’ve ever had in history, and it’s been inflationary in terms of energy and the stock market. When the stock and bond markets implode, as we know they’re going to, we’re going to see some really scary things. We’ll go to quantitative easing infinity, and we’re going to see the price of gold go through the roof. It’s going to go to the moon when everything else crashes.
TGR: How are you looking at the crash – short term, before the end of this year? How imminent are we?
Bob Moriarty: Soon. But I’m in the market. Not in the general market, but I’m in resources. There’s a triangle of value created by a guy named John Exter: Exter’s Pyramid. It’s an inverted pyramid. At the top there are derivatives, and then there are miscellaneous assets going down: securitized debt and stocks, broad currency and physical notes. At the very bottom – the single most valuable asset at the end of time – is gold. When the derivatives, bonds, currencies and stock markets crash, the last man standing is going to be gold.
TGR: So the last man standing is the actual commodity, not the stocks?
Bob Moriarty: Not necessarily. The stocks represent fractional ownership of a real commodity. There are some really wonderful companies out there with wonderful assets that are selling for peanuts.
TGR: In one of your recent articles, “Black Swans and Brown Snakes“, you were tracking the US Dollar Index as it climbed 12 weeks in a row, and you discussed the influence of the Yen, the Euro, the British Pound. Can you explain the US Dollar Index and the impact it has on silver and gold?
Bob Moriarty: First of all, when people talk about the US Dollar Index, they think it has something to do with the Dollar and it does not. It is made up of the Euro, the Yen, the Mexican Peso, the British Pound and some other currencies. When the Euro goes down, the Dollar Index goes up. When the Yen goes down, the Dollar Index goes up. The Dollar, as measured by the Dollar Index, got way too expensive. It was up 12 weeks in a row. On Oct. 3, it was up 1.33% in one day, and that’s a blow-off top. It’s very obvious in hindsight. I took a look at the charts for silver and gold – if you took a mirror to the Dollar Index, you saw the charts for silver and gold inversely. When people talk about gold going down and silver going down, that’s not true. The Euro went down. The Yen went down. The Pound went down and the value of gold and silver didn’t change. It only changed in reference to the US Dollar. In every currency except the Dollar, gold and silver haven’t changed in value at all since July.
The US Dollar Index got irrationally exuberant, and it’s due for a crash. When it crashes, it’s going to take the stock market with it and perhaps the bond market. If you see QE increase, head for your bunker.
TGR: Should I conclude that gold and silver will escalate?
Bob Moriarty: Yes. There was an enormous flow of money from China, Japan, England, Europe in general into the stock and bond markets. What happened from July was the equivalent of the water flowing out before a tsunami hits. It’s not the water coming in that signals a tsunami, it’s the water going out. Nobody paid attention because everybody was looking at it in terms of silver or gold or platinum or oil, and they were not looking at the big picture. You’ve got to look at the big picture. A financial crash is coming. I’m not going to beat around the bush. I’m not saying there’s a 99% chance. There’s a 100% chance.
TGR: Why does it have to crash? Why can’t it just correct?
Bob Moriarty: Because the world’s financial system is in such disequilibrium that it can’t gradually go down. It has to crash. The term for it in physics is called entropy. When you spin a top, at first it is very smooth and regular. As it slows down, it becomes more and more unstable and eventually it simply crashes. The financial system is doing the same thing. It’s becoming more and more unstable every day.
TGR: You spoke at the Cambridge House International 2014 Silver Summit Oct. 23-24. Bo Polny also spoke. He predicts that gold will be the greatest trade in history. He’s calling for $2000 per ounce gold before the end of this year. We’re moving into the third seven-year cycle of a 21-year bull cycle. Do you agree with him?
Bob Moriarty: I’ve seen several interviews with Bo. The only problem with his cycles theory is you can’t logically or factually see his argument. Now if you look at my comments about silver, gold and the stock market, factually we know the US Dollar Index went up 12 weeks in a row. That’s not an opinion; that’s a fact. I’m using both facts and logic to make a point.
When a person walks in and says, okay, my tea leaves say that gold is going to be $2000 by the end of the year, you are forced to either believe or disbelieve him based on voodoo. I don’t predict price; I don’t know anybody who can. If Bo actually can, he’s going to be very popular and very rich.
TGR: Many people have predicted a significant crash for a number of years. How do you even begin to time this thing? A lot of people who have been speculating on this have lost money.
Bob Moriarty: That’s a really good point. People have been betting against the Yen for years. That’s been one of the most expensive things you can bet against. Likewise, people have been betting on gold and silver and they’ve lost a lot of money. I haven’t made the money that I wish I’d made over the last three years, but I’ve taken a fairly conservative approach and I don’t think I’m in bad shape.
TGR: Describe your conservative approach.
Bob Moriarty: The way to make money in any market is to buy when things are cheap and sell when they’re dear. It’s as simple as that. Markets go up and markets go down. There is no magic to anything.
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Oct 23

US Oil & Global Gold

Gold Price Comments Off on US Oil & Global Gold
US oil stocks have soared as shale pushes crude prices down. But gold…?

The UNITED STATES is doing better than it has in years, writes Frank Holmes on his Frank Talk blog at US Global Investors.
Jobs growth is up, unemployment is down, our manufacturing sector carries the rest of the world on its shoulders like a wounded soldier and the World Economic Forum named the US the third-most competitive nation, our highest ranking since before the recession.
As heretical as it sounds, there’s a downside to America’s success, and that’s a stronger Dollar. Although our currency has softened recently, it has put pressure on two commodities that we consider our lifeblood at US Global Investors: gold and oil.
It’s worth noting that we’ve been here before. In October 2011, a similar correction occurred in energy, commodities and resources stocks based on European and Chinese growth fears. 
But international economic stimulus measures helped raise market confidence, and many of the companies we now own within these sectors benefited. Between October 2011 and January 2012, Anadarko Petroleum rose 58%; Canadian Natural Resources, 20%; Devon Energy, 15%; Cimarex Energy, 15%; Peyto Exploration & Development, 15%; and Suncor Energy, 10%.
Granted, we face new challenges this year that have caused market jitters – Ebola and ISIS, just to name a couple. But we’re confident that once the Dollar begins to revert back to the mean, a rally in energy and resources stocks might soon follow. Brian Hicks, portfolio manager of our Global Resources Fund (PSPFX), notes that he’s been nibbling on cheap stocks ahead of a potential rally, one that, he hopes, mimics what we saw in late 2011 and early 2012.
A repeat of last year’s abnormally frigid winter, though unpleasant, might help heat up some of the sectors and companies that have underperformed lately.
On the left side of the chart below, you can see 45 years’ worth of data that show fairly subdued fluctuations in gold prices in relation to the Dollar. On the right side, by contrast, you can see that the strong Dollar pushed bullion prices down 6% in September, historically gold’s strongest month. This move is unusual also because gold has had a monthly standard deviation of ±5.5% based on the last 10 years’ worth of data.
Here’s another way of looking at it. On October 3, bullion fell below $1200 to prices we haven’t seen since 2010, but they quickly rebounded to the $1240 range as the Dollar index receded from its peak the same day.
There’s no need to worry just yet. This isn’t 2013, when the metal gave back 28%. And despite the correction, would it surprise you to learn that gold has actually outperformed several of the major stock indices this year?
As for gold stocks, there’s no denying the facts: With few exceptions, they’ve been taken to the woodshed. September was demonstrably cruel. Based on the last five years’ worth of data, the NYSE Arca Gold BUGS Index has had a monthly standard deviation of ±9.4, but last month it plunged 20%. We haven’t seen such a one-month dip since April 2013. This volatility exemplifies why we always advocate for no more than a 10% combined allocation to gold and gold stocks in investor portfolios.
Oil’s slump is a little more complicated to explain.
Since the end of World War II, black gold has been priced in US greenbacks. This means that when our currency fluctuates as dramatically as it has recently, it affects every other nation’s consumption of crude. Oil, then, has become much more expensive lately for the slowing European and Asian markets. Weaker purchasing power equals less overseas oil demand equals even lower prices.
What some people are calling the American energy renaissance has also led to lower oil prices. Spurred by more efficient extraction techniques such as fracking, the US has been producing over 8.5 million barrels a day, the highest domestic production level since 1986. 
We’re awash in the stuff, with supply outpacing demand. Whereas the rest of the world has flat-lined in terms of oil production, the US has zoomed to 30-year highs.
In a way, American shale oil has become a victim of its own success.
At the end of next month, members of the Organization of the Petroleum Exporting Countries (OPEC) are scheduled to meet in Vienna. As Brian speculated during our most recent webcast, it would be surprising if we didn’t see another production cut. With Brent oil for November delivery at $83 a barrel – a four-year low – many oil-rich countries, including Iran, Iraq and Venezuela and Saudi Arabia, will have a hard time balancing their books. Venezuela, in fact, has been clamoring for an emergency meeting ahead of November to make a plea for production cuts. 
Although not an OPEC member, Russia, once the world’s largest producer of crude, is being squeezed by plunging oil prices on the left, international sanctions on the right. This might prompt President Vladimir Putin to scale back the country’s presence in Ukraine and delay a multibillion-Dollar revamp of its armed forces. When the upgrade was approved in 2011, GDP growth was expected to hold at 6%. But now as a result of the sanctions and dropping oil prices, Russia faces a dismally flat 0.5%.
The current all-in sustaining cost to produce one ounce of gold is hovering between $1000 and $1200. With the price of bullion where it is, many miners can barely break even. Production has been down 10% because it’s become costlier to excavate. As I recently told Kitco News’ Daniela Cambone, we will probably start seeing supply shrinkage in North and South America and Africa.
The same could happen to oil production. Extraction of shale oil here in the US costs companies between $50 and $100 a barrel, with producers able to break even at around $80 to $85. If prices slide even further, drillers might be forced to trim their capital budgets or even shelve new projects.
Michael Levi of the Council on Foreign Relations told NPR’s Audie Cornish that a decrease in drilling could hurt certain commodities:
“[I]f prices fall far enough for long enough, you’ll see a pullback in drilling. And shale drilling uses a lot of manufactured goods – 20% of what people spend on a well is steel, 10% is cement, so less drilling means less manufacturing in those sectors.”
At the same time, Levi places oil prices in a long-term context, reminding listeners that we’ve become accustomed to unusually high prices for the last three years.
“People were starting to believe that this was permanent, and they were wrong,” he said. “So the big news is that volatility is back.”
On this note, be sure to visit our interactive and perennially popular Periodic Table of Commodities, which you can modify to view gold and oil’s performance going back ten years.
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Jul 20

What’s the True Rate of Inflation?

Gold Price Comments Off on What’s the True Rate of Inflation?
Watch commodities, and wages, for unmassaged price-level reports…

In AN AGE when governments of every political leaning and ideological stripe distort economic data to promote their parties’ interests, it is hardly surprising that the nation’s inflation rate is reported in a manner that best suits their political needs, writes Gary Dorsch, editor of the Global Money Trends newsletter.
By the same token, in an age of near universal cynicism on the part of citizens towards their corrupt politicians, it is entirely natural for official inflation data to be wildly at odds with the reality faced by consumers and businesses, and in turn, to be regarded with utter disbelief.
Since the days of the Clinton administration, the US government has tinkered with the methodology of computing the inflation rate, and therefore, the CPI is no longer considered to be an objective gauge of the prices of a fixed basket of goods, that consumers normally buy. Instead, the US government has a vested interest in understating the true rate of inflation, because it enables Washington to lower cost of living allowances for Social Security checks, helps the Fed to keep interest rates artificially low, weakens wage demands, buoys confidence in the US Dollar, and artificially increases the “real” rate of US economic output.
The tens of thousands of government apparatchiks who work for the Bureau of Labor Statistics, Bureau of Economic Analysis, US Treasury, Office of Management and Budget, Economics and Statistics Administration, and countless other agencies, massage their spreadsheets day in and day out, and fudge the numbers. It’s hard not to notice that the inflation rate is reported with distortions caused by seasonal adjustments, hedonic deflators, chain-weighted substitutions, skewed sampling, delayed reporting, and with a twist of political bias. Yet perhaps the simplest advice on how to resolve contradictions between the costs that households face everyday, and the phony CPI, is to watch the Dollars and cents flowing through the global commodity markets, and to map their longer term price trends. Who are you going to believe, the commodity price charts or the skewed data from government apparatchiks? 
According to the Bureau of Labor Statistics, in 2012, US households spent 40% of their total expenditures on commodities, and the remaining 60% was spent on services. Thus, the commodities markets have become less of a leading indicator of future trends of inflation than in the past, when commodities made up 58% of expenditures in 1980 and 64% in 1970.
Still, the alternative to relying on the commodities markets for clues on inflation, is to blindly adopt the Fed’s favorite gauge of inflation, the “personal-consumption-expenditures” price index, (the PCE), which strips out the cost of the basic essentials of life, and is conjured-up by apparatchiks. The PCE was reported to be 1.8% higher in May from a year earlier, or -0.3% less than the CPI. 
On 17 June 2014, the US government reported that consumer prices increased 0.4% in May – the biggest monthly increase in more than a year – saying the cost of food and gasoline showed big gains. Airline fares jumped 5.8%, their largest monthly increase in 15 years. The cost of clothing, prescription drugs and new cars all showed increases. Overall, the consumer price index was 2.1% higher compared with a year earlier. That left prices rising at slightly above the Fed’s so-called 2% inflation target, and traders questioned if the uptick would sound the alarm bells at the Yellen Fed.
The increase in the consumer inflation rate was preceded by a sharp upturn in the market value of the Continuous Commodity Index (CCI), a basket of 17-equally weighted commodities – that started in January ’14. Six months later, the CCI was trading 9% higher than a year earlier. For the first time in 2-½ years, the CCI has emerged from deflation territory (or negative year-over-year returns). However, commodity prices are notoriously volatile, and so, the outlook for inflation can often turn on a dime.
Commodity markets are notoriously volatile from month to month, and from year to year, quite often due to unforeseen acts of nature or military conflict. However, in order to filter out the “noise” of the markets, a simple approach is to take a much longer-term view of price trends. And for a wide array of commodities, their prices have trended significantly higher.
For some of the basic staples of life, the market price of rough rice is up 83% higher, Butter is up 69%, and unleaded gasoline is up 67%, compared with 8.5 years ago. Milk and cattle prices are up 63%, and the cost of wheat is up 61%. So when Americans are driving to the grocery store, they are feeling the pinch of accumulated rates of inflation.
But what about the wages of the US worker, have they kept pace with the increasing cost of living? According to the Labor Dept apparatchiks, the average wage is up 19% compared with 8.5 years ago, for an increase of 2.2% per year, on average. However, for many Americans, their incomes are actually declining and that could put a squeeze on discretionary spending.
For example, in the month of June ’14, the BLS reported that the number of higher paying, full-time jobs plunged by 523,000 to 118.2 million while lesser paying, part-time jobs increased 799,000 to over 28 million. That suggests that many US workers’ are being forced into part-time work, and their income is decreasing. Thus, the hallowing out of the US middle class and the impoverishment of the lower income groups is worsening.
As such, the Fed is already talking about moving the goal posts again, from targeting inflation to targeting wage increases. “Signs of labor-market slack include slow wage growth and low labor-force participation,” Fed chief Yellen said on 15 July. Earlier, on 11 July, Chicago Fed chief Charles Evans said on Bloomberg TV that it would not be a “catastrophe” to allow the inflation rate to overshoot the Fed’s 2% target.
“Even a 2.4% inflation rate, I think that could work out,” he said.
So the message is; the Fed would be tolerant of above target inflation, since lower paying part-time wages are supposed to keep inflationary pressures in check. For the Fed, with the passage of time, many of its sins of the past, in the form of a higher cost of living, are seemingly washed away into obscurity.
When asked about the recent uptick in the consumer inflation rate to 2.1% in the month of May, Fed chief Janet Yellen downplayed the threat saying; “So I think recent readings on, for example, the CPI index, have been a bit on the high side, but I think it’s – the data we are seeing is noisy. It’s important to remember that, broadly speaking, inflation is evolving in line with the Committee’s [ie, politburo’s] expectations. The Fed [ie, a politically appointed Politburo] has expected a gradual return in inflation towards its 2% objective, and I think the recent evidence we have seen…suggests that we are moving back gradually over time to our 2% objective, and I see things roughly in line with where we expected inflation to be,” she said.
However, the reality for the 48 million Americans that are receiving food stamps is their monthly stipend is buying a lot less butter, cheddar cheese, chocolate, and milk, these days. At the Chicago Mercantile Exchange, the nearby futures contract for Milk futures is 23% higher, compared with a year ago, and up 75% compared with 8.5 years ago. However, in the Fed’s view, the soaring cost of dairy products is only transitory. After all, according to the Law of Gravity, what goes up must eventually come down, right? 
From Asia to South America, the demand for US dairy products processed foods containing milk, such as cheddar cheese, is up 19% compared with a year ago, according to the US Dairy Export Council. Exports of cheese jumped 46% in the past year, led by a 38% increase to Mexico, the biggest buyer of US dairy products, and a doubling of sales to China.Exports of dry milk now account for 16% of all dairy sales, compared with 5% a decade ago. As such, dairy farmers’ revenue soared 35% last year to $584 million.
So far this year, rising dairy and meat costs are the biggest sources of inflation. Safeway, the second-largest US supermarket operatorwith a network of more than 2,400-stores and 250,000 employees, said on April 23rd, that it plans to pass along the higher costs for meat, produce and other staples on to shoppers at its US grocery stores in the second quarter.
Hershey (NYSE:HSY) – the No.1 candy maker in the United States – said it would increase prices of its instant consumable, multi-pack, packaged candy and grocery lines by about 8% to tackle rising commodity costs, with Cocoa futures trading at a 3-year high.
However, higher prices for dairy products have widened profits margins for farmers, and in turn, they are already decreasing their dairy cow culling rates, in order to boost the supply of milk. New Zealand, the world’s top dairy exporter, is expanding its output of milk to an all-time high, in order to meet growing demand in China, and is setting the stage for a surplus of milk, in the months ahead.
Increased output in New Zealand has already rattled the milk futures market on the Chicago Mercantile Exchange. The nearby contract has slumped 12% from a record high of $24.32 per hundred pounds in April. Class III milk, used to make cheese, closed at $21.42 per hundred pounds this week. The price of nearby Cheddar Cheese futures have dropped from an all-time of $2.35 per pound to $2.04 today.
In a year when American dairy farmers are enjoying windfall profits, other US farmers can expect to see lower earnings than in 2013. US farmers will suffer a 21% drop in net-cash income, on average, due to sharply lower prices for their biggest cash crops, corn, wheat and soybeans. At the same time, dairy farmers will earn 28% more or roughly $334,100 on average, this year, the USDA predicts.
Two years ago, on the Chicago Board of Trade, Corn futures sold for as high as $8.43 per bushel shortly after the US Dept of Agriculture gave its assessment of the effects of the historic drought plaguing the Farm Belt. The USDA lowered its estimate of the US’s corn production at 10.8 billion bushels, or 13% below 2011, and the lowest since 2006.
However, US farmers figured that drought like conditions would last for a long time, and many decided to profit from record high prices by boosting output. In turn, the collective actions of the farmers created a huge glut of supply in today’s grains markets.
Two years removed from a devastating drought that sent US grain prices soaring, the price of Corn has dropped in half, tumbling to $3.75 per bushel today, and its lowest level in four years. It’s estimated that the average cost of production is around $3.50 for a bushel of corn, which could act as a floor for corn prices. Soybean prices have plunged from a record high of $18 per bushel two years ago, to $11.80 per bushel today, its longest slump in 41 years. The farther dated Nov ’14 contract is priced below $11 per bushel. The USDA says US farmers will harvest 3.8 billion bushels of soybeans this year, compared with last year’s crop of 3.3 billion. Amid a bumper crop that is expected to boost global stockpiles to the highest level in 14 years, corn futures are down 44%, wheat is 24% lower, soybeans 20% lower, and rice is down 18%
Of more than 50,000 edible plant species in the world, only a few hundred contribute significantly to food supplies. Just 15 crop plants provide 90% of the world’s food energy intake, with three rice, maize (corn) and wheat – making up two-thirds of this. 
Whether birthed from Indian soil, or in China or Japan, rice is a staple food for nearly one-half of the world’s population. Today, rice and wheat share equal importance as leading food sources for humankind.rice provides fully 60% of the food intake in Southeast Asia and about 35% in East Asia and South Asia. The highest level of per capita rice consumption is in Bangladesh, Cambodia, Indonesia, Laos, Thailand, and Vietnam.
Yet only 5% of the global rice crop is available for export. Thus, rice commands a higher price than wheat on the international market, because a higher percentage of the wheat crop (16%) is available for export. That leaves small rice-producing countries such as Thailand, Vietnam, and the US as the top exporters of rice. On the basis of yield, rice crops produce more food energy and protein supply per hectare than wheat and maize. Hence, rice can support more people per unit of land than the two other staples.
With its invaluable status as a staple food source in two of the most populous nations on earth and the domination of its export share by relatively small producers, rough rice futures have attracted both hedgers and speculators. In July ’12, China, the world’s top rice producer and consumer, launched the early Indica rice futures contract on the Zhengzhou Commodity Exchange – a world bellwether.
Since the inception of the contract, early Indica rice futures have been gripped by a grizzly bear market, losing 28% to 2,050 Yuan per ton this week. Yet Rough Rice futures traded on the CBoT were remarkably stable over the past few years, gyrating within a narrow range between $14 and $16 per hundred weight (cwt). However, starting in late May ’14, Chicago rice began to tumble, plunging 10% over a two-week period to as low as $14/cwt, before crashing to $12.85/cwt this week. This is certainly good news for citizens residing in the Emerging countries, where households spend as much as 30% of their income on purchases of food.
A pickup in the US’s official consumer inflation rate towards the central bank’s 2% objective has some Fed officials warning about the danger of risking faster inflation in the future by waiting too long to start raising interest rates.
The Fed hawks argue that the central bank must move to tighten its monetary policy sooner, rather than later. The way Philly Fed chief Charles Plosser sees it, the Fed is sitting on a ticking time bomb.
“One thing I worry about is that if we are late, in this environment, with $2.7 trillion of excess reserves, the consequences might be more dramatic than in previous times. If lending begins to surge and those reserves start to pour out of the banking system, that’s going to put pressure on inflation.”
However, Janet Yellen – the money printer in chief – is not swayed by the hawkish view.
“Inflation has moved up in recent months” she acknowledged, “but decisions about the path of the federal funds rate remain dependent on our assessment of incoming information and the implications for the economic outlook,” Yellen told Congress on 15 July.
“The Fed does need to be quite cautious with respect to monetary policy. We have seen false dawns in the past.
“With wages growing slowly and raw material prices generally flat or moving downward, firms are not facing much in the way of cost pressures that they might otherwise try to pass on,” the Fed said in a report accompanying Yellen’s testimony.
It’s true that the most economically sensitive commodities, traded in Shanghai, such as steel, iron ore and rubber, are trading at sharply lower levels than compared with a year ago, and thus, helping to keep a lid on factory-gate inflation. 
Free-falling cotton futures hit fresh two-year-plus lows to close around 68 US cents, amid expectations for a buildup in US stockpiles and growing world inventories outside China. In June, the World Bank cut its projection for global growth to 2.8% this year, from its earlier estimate of 3.2%.
That’s half the growth rate of the pre-financial crisis economy.
The World Bank also downgraded its outlook for the US economy to 2.1% for 2014, down from 2.8% earlier. Commodities such as copper, rubber and iron-ore have meanwhile been commonly used in China for collateral, where traders or investorsborrow against the commodity with the aim of investing Yuan in real estate or sub-prime loans in the shadow banking sector. Some estimates put the portion of inventories of iron-ore that is used as collateral at 40%. Now that Beijing’ is cracking down on shadow lending and weakened the yuan – a deliberate move by authorities – Beijing is trying to push these deals under water. As such, some of these commodities held in storage can find their way back onto the market and weigh on prices. 
China produces as much steel as the rest of the world combined and it’s most actively traded steel futures contract – Shanghai rebar – dropped to a record low of 2,800 Yuan per ton on June 30. That’s down nearly 50% from a record high of 5,450 hit 3 years ago.
Chinese steelmakers suffer from chronic lack of profitability and overcapacity of close to 200 million tons. Despite weak end demand and Beijing’s attempts at consolidation and its crackdown on polluting industries, steel production continues apace because regional authorities are fearful of closing down plants that provide tax revenue and employment. 
In Shanghai, the spot market for iron ore briefly fell below $90 per ton on 16 June, for the first time since September 2012. If sustained below $90 per ton, about one fifth of China’s iron ore miners would be forced to shut down around 80 million tons of output per year.
In contrast, Rio Tinto breaks even at $43 per ton, and BHP stays in the black at $45. Brazil’s Vale’s break even is $75 per ton, due to the greater distance to ship ore from Brazil to China. Iron ore has since rebounded to $97 per ton, but is still trading -23% lower than a year ago. 
The cartel that controls the majority of the world’s rubber production, Thailand, Indonesia and Malaysia has urged its exporters not to sell the commodity below $1.90 or 62.70 Thai Baht per kilo, as the average output cost for growers in Southeast Asia is about 60 Baht. The price of natural rubber is 16% less than a year ago, and at 13,750 Yuan per ton in Shanghai, has lost about two thirds of its value. Stockpiles of rubber at the Shanghai Futures Exchange are at the highest in 10 years, and a global surplus of 241,000 tons is expected in 2014.
Prices for thermal coal are expected to remain weak, with oversupply continuing to plague the market until producers curb output further. Coal prices in Europe and Asia have lost more than half their value since spring 2011, with European physical coal for September delivery was trading at $72.65 per ton, near five-year lows. New-Castle coal prices mined in Australia have also fallen below $70 per ton, bumping along five-year lows, as record output in Q’1 coincided with slowing import needs from China, the world’s biggest coal buyer.
Gold meanwhile is building a base, and eyeing these volatile commodities. History shows that rapid growth of the money supply usually fuels higher rates of inflation. Yet while the Fed increased the size of the MZM Money supply $700 billion in 2013, and $350 billion in the first half of 2014, what has surprised traders is the lethargic behavior of the US’s rate of inflation.
The CPI increased 1.5%, on average, in 2013, and bumped up to 2.1% in May ’14. However, given the -6% slide in the Continuous Commodity Index since the start of July, led by a drop of 20-cents in the price of unleaded gasoline on the Nymex, it’s a good bet that the consumer price index will start to edge lower again, with a lag time of 2-3-months.
Former Fed deputy Alan Blinder explained why the Fed’s QE-scheme didn’t spark an upward spiral in inflation. “The monies the Fed pumped into the banking system didn’t circulate in the US economy. Instead, it all got bottled up in the banks, and essentially, none of it got lent out,” he explained. Because the Fed began to pay 0.25% interest on excess reserves, the banks agreed to park the QE-monies at the Fed itself, instead of lending and creating deposits and increasing the money supply. Therefore, QE didn’t contribute to inflation. And if banks aren’t lending, there’s no boost to the economy. However, there is reason to believe that the $.35 trillion of QE-injections were funneled into the US bond and stock markets.
The meltdown in the yellow metal in 2013 left many gold bugs licking their wounds. However, in hindsight, the collapse in the Continuous Commodity Index (CCI), in the first half of 2013, was probably the biggest contributing factor behind gold’s slide to the $1200 level. And it’s the narrative about low inflation and/or deflation, and weak gold prices that enables the endless printing of money by central banks.
Bubbles in the European and US bond and stock markets can be sustained in the stratosphere, as long as inflation is said to be running near-zero. In fact, the Bank of Japan, the ECB and the Fed all say they must print money to counter the threat of deflation. As for the price of gold, the average break-even point for gold miners worldwide is estimated to be around $1200 per ounce, and it’s this figure, that gold investors believe is the “rock bottom” price for the yellow metal.
Gold bugs have been building a big base of support for the past 12-months, but a sustained rally to $1400/oz and beyond, might require the revival of the “Commodity Super Cycle.”
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Mar 13

Investor-Friendly Junior Mining

Gold Price Comments Off on Investor-Friendly Junior Mining
Stop shooting for the stars and deliver some shareholder value…

PAUL ADAMS is a geologist and head of research at Australian brokerage DJ Carmichael.
With 16 years of experience in the mining industry, in Australia and elsewhere, Adams was previously chief geologist and evaluations manager at Placer Dome’s Granny Smith mine. He is a member of the Australian Institute of Mining and Metallurgy and has a Graduate Diploma in Applied Finance and Investment from the Financial Services Institute of Australasia.
Here Adams speaks to The Gold Report‘s sister title, The Mining Report, about how junior miners should focus on more modest projects best suited to maximizing shareholder value, rather than shoot for the stars.
The Mining Report: After over two years of gloom, we’re seeing renewed optimism regarding mining equities in North America. Is there similar optimism in Australia? 
Paul Adams: There is, but the change in sentiment is pretty much in its infancy down here. We recently undertook some analysis of the returns from the various subindices in the market. The small resources index here in Australia is at about +4.3% for 2014 compared to a -8% return for December. The recent surge in the gold price has certainly helped lift the mood. 
The materials sector in Australia is tied closely to sentiment on Chinese growth, and headwinds there tend to have major repercussions. A couple big names have had really strong starts, but they’re pulling back a little now as the price of iron ore landed in China has dropped about $10. But those players have such a heavy weighting on the materials index that it’s really difficult to get a full picture of what’s going on. 
TMR: With regard to China, how much growth do you foresee? 
Paul Adams: Five years ago, China’s GDP growth was around 12%. Obviously, as the size of the Chinese economy increases, they can’t continue growing at that speed. We expect growth in the 6.5-7.5% range for the next year or two.
TMR: What’s your 2014 outlook for precious and industrial metals prices? 
Paul Adams: We think the current gold price is about right, plus/minus $100 per ounce. Wobbles in the emerging markets have prompted gold’s recent move up into the $1300 per ounce range. We’re seeing gold coming back as an alternative investment, a bit of a safe haven.
We’re relatively bullish on platinum and palladium given conditions in Southern Africa.
TMR: What about silver? 
Paul Adams: I don’t see a major diversion from the current gold/silver ratio
TMR: How about industrial and critical metals? 
Paul Adams: The consensus data for the industrial metals generally looks positive for 2014 and into 2015. Obviously, we want to see what effect the Indonesian ban on raw exports will have. That’s very important to nickel prices. 
Zinc and lead should be reasonably well supported. There is very muted mine supply growth. As the global economy improves, there are going to be some increases in industrial demand for those particular metals. There’s softness in the copper market. With the consensus price probably falling below $7,000 per ton, inventories are growing. These data are conflicting, however, and copper has a history of staying up longer than many had anticipated.
TMR: You’ve said that juniors should choose appropriately sized projects in order to have the best chance of generating shareholder wealth. Could you expand on that? 
Paul Adams: In a post-global-financial-crisis and post-metals-boom world, we’re seeing a lot of companies with large projects that can’t get financed. Investors today want to see projects that can weather the complete commodities price cycle. Our view is that we would rather see a good management team take on a Tier 2 or Tier 3 project in a good jurisdiction with a reasonable capex and a reasonable timeframe, rather than a Tier 1 project they ultimately won’t be able to develop without joint ventures. 
TMR: With regard to timeframe, how long is too long? 
Paul Adams: A project that looks like it’s going to take much longer than four to five years to get into production is probably a little bit too far out. 
TMR: What’s the danger zone for capex? 
Paul Adams: It depends on the economics of the individual project, but I think a capex north of about $600-700 million is pretty high. The sweet spot for small companies is somewhere up to $200-250m.
TMR: Is it difficult for mining companies to keep expectations modest? Isn’t there a natural tendency to shoot for the stars? 
Paul Adams: With many mining companies, management has come from majors. They’re used to dealing with big projects and big budgets. There’s a degree of relearning when you’re in a small company; you have to be quick, nimble and you must count the pennies. There is a tendency to shoot for the stars, with the belief that maybe you’ll settle for the moon. But the statistics tell us this isn’t likely to happen. 
We look for teams that have a measured approach to development because smaller projects are easier to develop without overly diluting shareholders in the process. Some management teams forget about that. They’re so intent on making a huge discovery that they forget about the shareholders along the way.
TMR: Which jurisdictions do you like best now? 
Paul Adams: Certain parts of South America offer good opportunities. We particularly like Chile. The other emerging jurisdiction for Australian Stock Exchange (ASX)-listed companies is the United States. Nevada would certainly be front and center, then Arizona, then parts of Utah and Wyoming.
TMR: Chile is politically and socially stable, but concerns have been raised about infrastructure, in particular, deficiencies of water and electricity. What do you think of this? 
Paul Adams: We’ve been to Chile three or four times over the past three years, and water and electricity are major issues. To get water to the high Andes, it must be pumped from the coast. And if you’re not close to existing infrastructure, power costs are a major hurdle. 
TMR: How about another jurisdiction with an interesting infrastructure idea?
Paul Adams: Another example is Fiji, which wants the delta dredged because it will reduce the risk of flooding to the surrounding area. So it’s a win-win, really: increasing employment and government revenue, as well as improving the environment. 
TMR: Fiji is not a name one normally associates with the mining industry. 
Paul Adams: Recent political events in Fiji have raised concern, but don’t forget, Fiji has a very long mining history. Most famous is the Emperor gold mine, which operated for decades.
TMR: How about rare earth elements (REEs)?
Paul Adams: We believe pricing in the light rare earth elements (LREEs) is going to be soft going forward. So we decided that our interest is only in projects dominated by heavy rare earth elements (HREEs). There are only three or four of those on the ASX. 
TMR: Paul, thank you for your time and your insights.
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Feb 12

Due Diligence for Junior Gold Investors

Gold Price Comments Off on Due Diligence for Junior Gold Investors
Only 1 in 1,000 exploration sites turns into an economic mining project…

BRENT COOK brings more than 30 years of experience to his role as a geologist, consultant and investment adviser.
Cook’s knowledge spans all areas of the mining business, from the conceptual stage through detailed technical and financial modeling related to mine development and production. His weekly Exploration Insights newsletter focuses on early discovery, high-reward opportunities, primarily among junior mining and exploration companies.
And if now is the time to accumulate deeply discounted companies with strong fundamentals in advance of a hot junior market in 2015, then Brent Cook shines a light here in this interview with The Gold Report on the all-important due diligence process for investors…
The Gold Report: You recently wrote a piece called “A Light at the End of the Tunnel” that outlined the rules of thumb for junior mining speculators and concluded that the fundamentals are pointing to an improving investment climate for junior miners. Why are you so optimistic when people like Harry Dent are predicting deflation and recession?
Brent Cook: I look at the fundamentals behind the mining and exploration industry. We have seen a significant decline in legitimate economic mineral discoveries. At the same time we’ve seen a continuing increase in copper, silver and gold mine production. Those two things are diametrically opposed. With the decline in metal prices, particularly gold, the mining and exploration companies are not putting money into finding the next deposit. That is why although I don’t particularly think this year is going to be a great year for the junior mining sector in general, I think it’s setting up what will be some great returns in 2015 and beyond.
TGR: Is this a classic supply and demand adjustment? If companies are spending less in exploration and development now, is there going to be a lack of supply later?
Brent Cook: There is going to be a dearth of new exploration discoveries coming on to replace the 85 million ounces of gold and 18 million tons of copper we are producing each year.
TGR: What impact does high grading have on future production?
Brent Cook: All-in sustaining cash costs for gold mines are between $1200 per ounce and $1500 per ounce. At current gold prices, producers, on the whole, are not making much money and are therefore being forced to cherry pick the high-grade portions of their deposits, leaving behind the lower-grade material. When they do that, a lot of the resource previously classified as reserves – the lower-grade material – becomes uneconomic. 
By high grading, companies are sterilizing what used to be classified as ore and turning it to waste. The difference between ore and waste is simple: ore makes money, waste loses money. In this coming year, a number of companies are going to announce a decline in their reserve base because of high grading and lowered metal price assumptions.
TGR: What is the impact of mining the best material at a time when it is selling at low prices?
Brent Cook: Companies usually try to maximize their profits by mining the better portions of an ore body when prices are high. With lower prices, many companies will be forced to produce from the better part of their deposits just to stay in business; they don’t have a choice. They have to high grade these deposits to keep the door open. The end result is that quality reserves are being depleted faster than they can replace them.
TGR: You called the inevitable point where there isn’t enough supply based on a lack of investment in exploration and development a “pinch point.” When is this pinch point going to come?
Brent Cook: I hope it will be soon because that is the point when the price of gold, and more important, gold deposits, will go up, but I suspect we won’t see anything until next year. We really don’t know when the companies are going to wake up. By the end of last year, most mining companies were focusing on proving to the investment community that they can actually make money mining. They may temporarily pull it off, but it’s going to put them in a really tough situation one or two years down the road when they’ve got no new ore bodies to replace what they’ve pulled out of the ground.
TGR: You talked in your article about some of the ways that investors who are looking to find some bargains now can tell which companies could really be successful when the market turns. The first thing you suggested was doing a desktop review to screen as many as half of the companies out of contention for investment. What are some of the red flags you look for when you are reading a company website?
Brent Cook: We know the odds of exploration success are extremely low. On average 1 in 1,000 exploration projects turns into an economic deposit. What I spend most of my time doing here at Exploration Insights is screening technical reports for fatal flaws. Some less technical signs are more obvious than others.
  • If a company covers its website with pictures of American flags, stars and stripes and gold bars, that is a warning sign that the company might be flaky.
  • A company website should include drill hole maps, cross-sections and complete assays. If all you are getting are drill highlights, avoid it. Either the company is incompetent or hiding something.
  • Companies only listed on the OTC might be ones to avoid.
  • Companies that focus on their proprietary techniques for mining or processing minerals could be compensating for a lack of resource. In the past some people claiming they could pull otherwise undetectable gold out of volcanic cinder cones were flat out scamming.
  • If the economics of the deposit relies on some oddball mineral credits like cadmium, there may be a problem with the underlying profitability of the deposit.
  • If a project has had its name changed many times or a company has jumped from one hot sector to the next, that is generally a bad sign.
TGR: Another screening tool you mention is management ownership. We interviewed Ted Dixon of INK Research about this last year. How important is it to know what company employees are buying and selling?
Brent Cook: If a person running a company is invested, then it sets up a scenario where if he or she makes money, the investor makes money through share price appreciation. It is also important to know what price the employee actually paid for the shares. A lot of these insiders can buy in at $0.01 or $0.05/share and it looks as if they own a lot, but in fact their cost basis is almost zero. On the other hand, not everyone can own 5% or 10% of a company. A lot of these people just don’t have the financial ability to buy in big at the start. Look at ownership relative to net worth, but having a shared stake with management is critical.
TGR: What if management is selling the stock?
Brent Cook: Generally that’s not a good sign, but there are reasons people have to sell stock. A number of these company presidents don’t make a lot of salary. They may need to buy a house or send a child to school. It is important to understand why someone is selling.
TGR: A lot of stock is bought based on drill reports. Press releases can be confusing. What are the tricks some companies use to make drill results look better than they really are and how do you know what they are really saying?
Brent Cook: One tool that I’ve developed along with Corebox is called the Drill Interval Calculator. Often a few narrow high-grade intervals are smeared across low-grade material to give the impression of a large homogenous mineralization over what is essentially barren rock waste. The Drill Interval Calculator will make that spin apparent.
It is also important to research historic drilling of other holes in the general area. Some companies will re-drill or twin a previous hole that had great results. If the previous company drilled all these holes and walked away because the rest of the holes were no good, then what value is it for the new company to re-drill the one good hole and publish a press release of the fantastic result? I want to see what else has been drilled to get a sense of the size and style of mineralization. Basically, we need to know the history of the prospect: what was drilled, results, interpretations and why the current program is different from previous exploration campaigns.
TGR: A lot of investors go on site tours that to the untrained eye look like sage brush safaris. You are a geologist. What do you look for on a site tour?
Brent Cook: This is really critical. People have to come away from a site tour with an understanding of whether the type of geologic system the company is reporting fits the geology. That determines what size of deposit will be required to make money. That includes estimating capital costs for infrastructure and processing.
When I visit a property, it’s all about turning the rocks into money. To do that you need to mentally build a mine from day one. Assess the likely operating expenses, capital expenditure (capex) costs based on the location, strip ratio, metallurgy and then, how much it will cost the company to address those issues. Then the investor can formulate an investment thesis. That is what sets the successful speculator in this industry apart from the crowd. Even after all this research, 9 times out of 10, subsequent drilling doesn’t confirm the thesis and the investor should sell. That’s key. Once it’s not working, sell. Hope hasn’t proven to be a very good investment thesis for me.
TGR: How do you know if a company still has upside left?
Brent Cook: That goes back to the first day on the ground, looking at the rock and building a conceptual economic mineral deposit in your head. You have to have a sense of what this thing is going to be worth on a net present value (NPV) calculation. I could give you the names of 20 companies whose stocks went up and collapsed. They collapsed because subsequent drilling either limited the deposit or disproved the concept. We made money on some of those because we got out in time. Investors can make money on things that ultimately fail, but they need to have that model built in the back of their minds that tells them whether the geology is working and whether the economics are working.
TGR: How do companies pass the smell test?
Brent Cook: I like prospect generators because the business model is that they develop the ideas and then bring in somebody else to spend the big money testing those concepts. Given that statistically at least 90% of these projects are going to fail, it makes a lot of sense to bring in someone else to spend the exploration Dollars and fail rather than the junior company spending the money. My piece of the company – which is really an intellectual capital company, people generating ideas – is not diluted. 
That’s a smart way to get into this sector, a very high-risk sector, with relatively lower risk.
TGR: You are a geologist. You look a lot at the rocks and you look at the business of whether the project can be brought to completion successfully. Do you spend a lot of time considering the politics? You mentioned a number of companies in South America and Riverside is in Mexico, which recently passed a new royalty tax. How much of an impact on success is the jurisdiction that a company is operating in?
Brent Cook: The jurisdiction is critical. There’s no point finding a deposit in a place that the company is never going to get to mine. That’s just a waste of money. There are a number of places I wouldn’t go. Even within Colombia there are certain areas that an investor doesn’t want to be for social, environmental or political reasons. Once an investor assumes that a country is okay to develop a deposit, then he or she must look at the exact locality. What’s going on there? Is a company drilling out a deposit sitting above a historic church and graveyard? Well, that isn’t going to work no matter where it is. That is what a desktop review screens out.
TGR: Are you still comfortable with Mexico in general?
Brent Cook: I think Mexico is still a good place to be exploring. The government has raised the hurdle as to what makes money, but the tax regime there is still competitive on a global basis, just not as good as it used to be.
TGR: We have covered a lot of ground. Any final words of wisdom for our readers who are looking for that light at the end of the tunnel, but don’t want to get burned on the way?
Brent Cook: Investors have got to do due diligence. Follow the rules of thumb. This is going to be a prime year to accumulate a few companies with deposits that work or exploration companies with competent management and the money to survive. Those are the two things I’m going to be buying this year. This is where investors make money. The Market Vectors Junior Gold Miners ETF (GDXJ) is down more than 70% over the past two years. A lot of the stuff that’s down should be down and will go lower, but there are some companies that have been taken down that are worth buying. I think this is a time to accumulate in anticipation of 2015 and 2016 being much better.
TGR: Thanks, Brent, for your insights.
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Feb 05

"Boring" Gold Price Better for 2014 Miners

Gold Price Comments Off on "Boring" Gold Price Better for 2014 Miners
Simple tips for would-be gold mining investors as price becomes “boring”…

COSMOS CHIU, executive director of precious metals equity research at CIBC World Markets, doesn’t just stick to mining companies in North America.
Consistently ranked in the top 10 in the Brendon Wood International survey for the Precious Metals: Small/Mid Cap sector, Chiu was ranked fifth overall best stock picker by Starmine in 2010. And since joining CIBC in 2006, he now spends much of his time in Africa, where one-third of newly mined gold comes from, as Chiu explains in this interview with The Gold Report
The Gold Report: Cosmos, with US economic data putting pressure on gold and silver prices, Moody’s is forecasting an average of $1100 per ounce) for gold in 2014 with almost identical all-in gold production costs. Bank of America Merrill Lynch is forecasting an average of $1150 per ounce. What’s your view?
Cosmos Chiu: The US economic data is nothing new. Last year certainly wasn’t the best for gold. However, the bad news has already been priced in. We’ve seen some pretty robust US data come out first thing in 2014 and gold prices have held up at the $1200 per ounce level.
CIBC has an average gold price for 2014 of $1350 per ounce, which is predicated on robust Asian demand for physical gold. An all-in gold production cost of $1100 per ounce is pretty realistic from our perspective.
We have wide-ranging coverage at CIBC from gold mining companies to royalty companies. Yes, there will be some companies in trouble. Investors have to be pretty picky about where they invest. They need to focus on the companies that have strong balance sheets and the flexibility to cut costs and focus on the cash cost.
TGR: Most people would say that $1350 per ounce is quite bullish.
Cosmos Chiu: It’s not conservative. Is it overly bullish? I think it’s doable.
TGR: We will soon see Q4/13 earnings reports from gold producers. Will those reports show investors that gold producers can still perform with gold hovering around $1225 per ounce?
Cosmos Chiu: We’ve seen glimpses of what Q4/13 could look like through production reports. It’s becoming a market where there are good producers and there are bad producers. The difference is especially visible right now. For the better producers, some will continue to see cash costs come down. We saw that in Q3 versus Q2. I would expect that to happen again. The better producers will continue to make money even at today’s gold price.
TGR: What are some surprises that companies could provide this year?
Cosmos Chiu: Q4/13 is going to be a lot cleaner than what we saw earlier this year with the write-downs. It might even be a little bit boring which, to be honest, is a good thing. Companies will be able to prove that they can make money. It won’t be one of those noisy, messy quarters that we saw earlier last year.
TGR: Your coverage spans Canada and Mexico, Turkey, Greece, China and South America. This is a still a risk-adverse market where most precious metals analysts are sticking to safe mining jurisdictions like Canada, the US and Mexico.
About 30% of your coverage, however, includes names that primarily or exclusively operate in Africa. Why do you lean heavily on equities with key assets in Africa?
Cosmos Chiu: I try to give broad coverage to the different areas in the world where gold is produced. Looking at the world, about one-quarter to one-third of the gold production is coming from Africa. A lot of Africa’s production is coming from South Africa. I try to pick out the better or more prospective parts for future growth. Mainly, that’s coming from West Africa.
TGR: If you could, please leave our readers with an investable theme or two to chew on.
Cosmos Chiu: Focus on the companies that have a stronger balance sheet, stable operations and growth potential.
TGR: Thanks, Cosmos.
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Nov 28

Stock Market Madness

Gold Price Comments Off on Stock Market Madness
Price is what you pay, value is what you get. Got gold yet…?

“VALUATION,” writes David Merkel, “is rarely a sufficient reason to be long or short the market,” says Tim Price on his Price of Everything blog.
“Absurdity is like infinity. Twice infinity is still infinity. Twice absurd is still absurd. Absurd valuations, whether high or low, can become even more absurd if the expectations of market participants become momentum-based. Momentum investors do not care about valuation; they buy what is going up, and sell what is going down.”
Merkel went on to warn, “you will know a market top is probably coming” when…
  1. Short sellers are “killed. You don’t hear about them anymore.” Anyone investing in short-only funds suffers “general embarrassment”;
  2. Long-only managers “are getting butchered for conservatism”. Merkel cites early 2000, when Julian Robertson, George Vanderheiden, Robert Sanborn, Gary Brinson and Stanley Druckenmiller all quit “shortly before the market top”;
  3. Value investors start to accumulate cash. “Warren Buffett is an example of this,” says Merkel. “When Buffett said that he ‘didn’t get tech,’ he did not mean that he didn’t understand technology; he just couldn’t understand how technology companies would earn returns on equity justifying the capital employed on a sustainable basis.”;
  4. Growth managers beat value managers. Because, “in short, the future prospects of firms become the dominant means of setting market prices.”;
  5. Momentum strategies “are self-reinforcing due to an abundance of momentum investors…Actual price volatility increases. Trends tend to maintain themselves over longer periods,” and sell-offs are quickly recovered;
  6. Markets start to “favour inexperienced investors,” who simply follow the trend. Merkel’s favourite sign is to check CNBC and “gauge the age, experience and reasoning of the pundits. Near market tops, the pundits tend to be younger, newer and less rigorous.” More experienced investors instead expect reversion to the mean.
Notwithstanding Merkel’s caveat about pricing, valuations still matter.
Assuming that one is investing as opposed to speculating, initial valuation remains the single most important characteristic of whatever one elects to buy. And at the risk of sounding like a broken record, “initial valuation” in the US stock market is at a level consistent with very disappointing subsequent returns, if the history of the last 130 years is any guide. Without fail, every time the US market has traded on a CAPE ratio of 24 or higher over the past 130 years, it has been followed by a roughly 20 year bear market
The evidence for the prosecution is visible below, for the peak years 1901, 1929, 1966 and 2000. And 2013? Of course, this time might be different.
But there is the stock market, and then there are individual stocks. We have no interest in the former, but plenty of interest in the opportunity set of the latter. We’re just not that interested in the US market, given general valuation concerns, and the malign role of Fed policy in distorting the prices of everything. As purists and unashamed value investors, we have plenty of other fish to fry.
Probably the biggest of those fish is that giant part of the world economy known as Asia. The chart below shows the anticipated growth in numbers of the middle class throughout the world over the next two decades.
The solid green circle is the current middle class population (or as at 2009 to be precise); the wider blue-fringed circle represents the forecast size of this population in 20 years’ time. The OECD definition of middle class is those households with daily per capita expenditures of between $10 and $100 in purchasing power parity terms. 
Note that in the US and Europe, the size of the middle class is barely expected to change over the next two decades. Central and South America, and the Middle East and North Africa, are forecast to grow a little. But one area stands out: the emerging middle class in Asia is forecast to explode, from roughly 500 million to some 3 billion people. 
In equity investing, the combination of a compelling secular growth story and compellingly attractive valuations is a very rare thing, the sort of investment opportunity that one might only see once or twice in a generation, if that. But it exists, here in Asia, today. Once again, however, we have to abandon conventional financial thinking in order to exploit it. 
Asian personal consumption between 2007 and 2012 – while the West was suffering from a little localised financial crisis – grew by 5% to 10% per annum. Industries likely to benefit from sustained growth in domestic consumption include food and beverages, clothes, cars and insurance.
But the index composition of Asian equity index benchmarks leaves much to be desired. Of the 10 largest companies in the MSCI Asia ex-Japan index, three are low margin exporters in Korea and Taiwan, one is a low margin Chinese telecoms business, three are state-run Chinese banks, one is an inefficient Chinese oil and gas producer, and one is an expensive Chinese internet business. 
That doesn’t leave much for value investors to go on. Asian equity funds more generally, tending to be index-trackers, are heavy in Chinese stocks of indeterminate value and clunky ‘old Asia’ exporters with far too much research coverage. 
Or one can ignore index composition (‘yesterday’s winners’) entirely and focus instead on ‘best in breed’ businesses throughout the region on an unconstrained basis. Which is exactly what Greg Fisher’s Halley Asian Prosperity Fund does. Stocks that make it into this tightly defined portfolio typically have historic returns on equity of 15% or higher, a history of dividend growth, little or no debt, price / book ratios of 1.5x or less, and price / earnings ratios ideally in single digits (its average p/e stands at around 8x). As Greg puts it, amid a world of worries, “keeping the discipline of holding lowly valued, under-owned and unleveraged companies is likely to continue to protect our capital and earn us both income and capital appreciation over the longer term.”
In terms of macro analysis, this interview with CLSA’s Russell Napier is one of the best we’ve heard this year, concisely addressing many of the major current concerns we really should be worried about, including the rising risk of emerging markets exporting deflation to the West, the next stage of government abuse of markets including the formal rationing of credit, and the growing attraction of gold (as a deflation and inflation hedge) at its current price.
On which topic, David McCreadie of Monument Securities suggests that “if gold is driven down to $1030, and there will be a lot of noise if it does, I think it will offer a very unusual and highly profitable P & L opportunity, both in the physical but especially in the mining shares. Upside of x 5-10 doesn’t come along very often and it’s definitely one for the SIPP and the kids’ education fund. 
Nonetheless if you own it here or above then I think you take the pain in this final phase. Nor do I believe shorting is sensible; the main money has been made on the short side and in these metals, the biggest and most explosive profit potential is always on the upside.” 
Or to put it more plainly, and in the words of Warren Buffett, price is what you pay; value is what you get. US stocks may be expensive, but you can get better economic fundamentals and cheaper valuations selectively throughout Asia. And as insurance against the sort of disorderly currency moves that seem to be almost inevitable courtesy of so many central banks behaving badly, we still maintain you can’t do better over the medium term than gold.
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Nov 28

Junior Gold Miners’ Mistake

Gold Price Comments Off on Junior Gold Miners’ Mistake
Analyst Eric Coffin says the junior gold strategy of the last decade was a big error…

ERIC COFFIN is editor of the Hard Rock Analyst family of publications. Coffin has a degree in corporate and investment finance and has extensive experience in merger and acquisitions and small-company financing and promotion.
For many years, Coffin tracked the financial performance and funding of all exchange-listed Canadian mining companies and has helped with the formation of several successful exploration ventures. Coffin was one of the first analysts to point out the disastrous effects of gold hedging and gold loan-capital financing in 1997. He also predicted the start of the current secular bull market in commodities based on the movement of the US Dollar in 2001 and the acceleration of growth in Asia and India.
Now he says that, as the gold price rose upward over the last decade, junior miners chased ounces at all costs. This was a huge mistake, says Coffin, because it resulted in unexciting projects, low margins and a depressed market. Whereas, he explains here to The Gold Report, the essence of the junior gold miner should be new discoveries with high margins…
The Gold Report: Federal Reserve of Dallas President Richard Fisher gave a speech in Australia declaring that quantitative easing (QE) must end or it would “fuel the kind of reckless market behavior that started the global financial crisis.” If the Fed isn’t going to end QE until employment improves, how will this end?
Eric Coffin: Fisher gets to voice his opinion at Federal Open Market Committee (FOMC) meetings, but he won’t be a voting member until January. He hasn’t been comfortable with QE from the start and has said so repeatedly. There isn’t any news in that quote.
I don’t think you’ll see much change when the FOMC gets four different members next year. Janet Yellen, who will become chairman, is more dovish than Ben Bernanke. I think she was the right choice, not because she loves creating money from nothing but because she’s probably been the most accurate forecaster of the bunch.
TGR: What about the bubble that Fisher fears?
Eric Coffin: If you want to be cynical, you can make the argument that a bubble is exactly what the Fed has been trying to create. It wanted to get equity markets to go up because that increases wealth and raises consumer confidence. About half of the Fed’s QE program is buying mortgage bonds. It is trying to keep mortgage rates down and resuscitate the housing sector.
Fisher is right in a sense, but I don’t think we’re at the point where I’d be terribly concerned about things running out of control. I have to admit, though, that based on the growth of the economy, the US equity markets are probably getting a little bit ahead of themselves. Most consumer inflation measures have been trending down, not up. Personally, I’m more worried about deflation, which is far harder for a central bank to fight than inflation.
TGR: The Q3/13 gross domestic product (GDP) report shows 2.8% growth.
Eric Coffin: Right now, I’m kind of neutral on the economy. The data quality is going to be crappy for a month or two because of the government shutdown. The economy grew 2.8% because there was big growth in inventories, which is not the reason you want. Without that it came in at 2%, which was the expected number. You’re probably going to see production cut a little bit this quarter because more stuff was made than could be sold.
TGR: Karl Denninger pointed out that the gross change in GDP from Q2/13 to Q3/13 was $196.6 billion, but the Fed’s QE program injected $255bn. So the economy actually shrank during Q3/13.
Eric Coffin: I think he’s oversimplifying a little bit. QE is really swapping paper, creating money out of thin air and using that to buy bonds that inject money into the economy. But the velocity of money has been very low since the crash. It’s not as if the banks are taking that $85bn per month and lending it all. That’s where the real multiplier effect is. Right now a lot of the money created through QE has ended up in bank’s excess reserves, not in the wider economy. Karl is a bit of a permabear, but I would agree with him that it wasn’t that great a report.
TGR: Let’s assume that QE continues at its present rate until June 2014. How will that affect gold and silver?
Eric Coffin: When the Fed starts tapering, we have to assume gold and silver prices will get hit. Of course, if it doesn’t actually start tapering until well into next year, we could see gold and silver go up for two or three months before that. That doesn’t preclude later increases in the gold price based on physical demand, but the short term traders are completely fixated on QE (or lack thereof) and will be sellers once the taper starts, and the market will have to get past that before recovering.
TGR: What if it becomes clear we are going to get QE forever?
Eric Coffin: Then I think gold goes to $2000 per ounce.
TGR: At the Subscriber Investment Summit in Vancouver last month, you compared the 10-year chart for gold prices, rising to 2011 and holding above 2010 levels today, to the 10-year chart for junior resources. The first chart looks good, but this second chart of junior gold miner stock prices looks terrible. Why?
Eric Coffin: For all the money thrown at exploration – and, of course, that number has been tumbling dramatically for the past two years – not many good discoveries resulted, especially in the last couple years. That’s one reason. The chart below shows the amount of gold discovered each year since 1990, counting only new gold discoveries above 2 million ounces. You can see how few discoveries there have been in the past couple years. Compared to the 1990s the numbers are tiny.
The other reason is that when the gold price was rising continuously many companies were looking for what I referred to in Vancouver as “crappy ounces”. Their intentions were good. They weren’t trying to hoodwink anybody. They made the reasonable assumption that with gold going up and up, economic cutoff grades would keep dropping. But you can’t produce gold at ever-lower grades with difficult metallurgy and infrastructure and make more money. 
As it turned out, costs rose almost in lockstep with the gold price. A lot of the ounces that were marginal at $500 or $700 or $900 per ounce haven’t been salvaged by the gold price going to $1300 per ounce. Many of those resources are still uneconomic and would require more capital expenditures with longer payback periods than larger producers are willing to accept.
TGR: You said that junior gold miners have a major credibility issue, specifically, that preliminary economic assessments (PEAs) and feasibility studies do not match production realities.
Eric Coffin: There are a couple reasons for that. I’ve already mentioned costs. And when the gold mining sector recovered after 2000, there was a real capacity issue. There weren’t enough geologists or engineers. There weren’t even enough people who make truck tires.
Many NI 43-101s, PEAs and feasibility studies have been written by people who lacked experience. To be fair to the engineering companies, miners can have cost overruns of 20% and still be within the stated margin of error, but people never read the fine print. They just look at the production cost, so when it comes in $100-200 per ounce higher, everybody freaks out.
TGR: Juniors chased lousy projects because gold was soaring, and money flooded into the market. Now that gold has fallen 30%, will this engender the return of old-fashioned values?
Eric Coffin: I think it already has. The large mining companies, having spent huge amounts of money on capital expenses (capexes) that didn’t add to their bottom line, are now saying, “Show me margin.” Large and medium companies will now pick up deposits smaller than what they would have touched 10 years ago because they have the grades, the geometry and the metallurgy to enable low-cost production.
TGR: So is margin now more important than grade?
Eric Coffin: Grade is king, but margin is the key. Majors are focused on margin per ounce produced. You can get high margins with a lower-grade deposit if everything goes right but, by and large, the higher grade the better the margin should be. It comes down to net present value (NPV) and internal rate of return (IRR).
Companies now want gold projects that can be built for $100-150 million, with NPVs of $300m or $400m and all-in cash costs of $600-800 per ounce – assuming they’re big enough. They don’t want to go too small because they can spread themselves only so thin. I don’t see majors picking up 50,000-ounce-per-year deposits, but we might see them picking up 100-150,000 per year projects, when a few years ago few majors would look at a deposit unless it was capable of generating 250,000 ounces per year or more.
In Sonora, Mexico, half a dozen mines that began production in the last five years don’t have grade. They’re 0.8, 0.7 or 0.6 grams per ton, but they have fantastic combinations of logistics, costs, workforces, metallurgy and geometry, and they produce at $500-700 per ounce cash costs.
TGR: Why are new discoveries so important to the junior sector?
Eric Coffin: That’s what the juniors exist for. The market wants something new, with blue-sky potential. The companies with really big runs in the last year or two are, almost without exception, companies that made discoveries. They don’t always work out, but that’s the risk you take.
If you go back to the pretty spectacular bull market in the mid-1990s, it was driven by companies going international for the first time in a long time, juniors going to South America and Africa and finding 3, 5 and 10 million-ounce deposits. Gold prices rose in the mid-1990s, but discoveries drove the bull market.
TGR: Eric, thank you for your time and your insights.
Eric Coffin: You’re welcome. I have a new report available for your readers that is free to download – it is actually an interview with one of the companies I’m tracking, which I think is a very worthwhile read. We also have a special subscription offer included in this report.
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Nov 01

Gold Price Outlook for Miners

Gold Price Comments Off on Gold Price Outlook for Miners
How near-term gold prices could affect the mining industry…

ENCOMPASS fund managers Malcolm Gissen and Marshall Berol don’t agree on the timeline for gold’s recovery, they have faith that it will come.
In the meantime, as they explain in this interview with The Gold Report, their focus is on gold mining players already in production, generating cash flow with top-notch management teams.
The Gold Report: It’s almost Halloween and we remain in the clutches of a tricky market for junior resource equities. What are your perspectives on how long it’s going to take before investors see another treat-filled year like 2010?
Malcolm Gissen: The last couple of years have been frightening for investors, in both gold commodities and gold stocks. Gold prices have been rising the last few weeks, allowing some people hope, but I don’t expect an appreciable change in the gold price and the appeal of gold mining companies until 2015.
Marshall Berol: I’m more optimistic than Malcolm. I think the market will change, possibly in as little as five months. The underlying fundamentals that have driven gold up over the last dozen years are still in place: the money printing presses, supply and demand for bullion, bars and coins. Costs are going up, so is the need for higher prices.
I would like to see the market refocus on fundamentals and get away from tracking the hour-to-hour and day-to-day activities of the financial players. What they are doing in the futures markets is driving the price of gold and other commodities up and down incessantly. The Dollar is up; the Dollar is down. Oil is up, oil is down. Stock prices react to whatever news is coming out of Washington, Europe or Japan. At some point, investors will realize that gold’s underlying fundamentals have not changed and that there are reasons to buy it.
Malcolm Gissen: We started investing heavily in gold in the accounts of clients of our RIA firm, Malcolm H. Gissen & Associates, in 2002, when the gold price was under $300 per ounce . We built allocations to precious metals of 15-18% by 2004. When Marshall and I launched the Encompass Fund in mid-2006, gold companies was the largest asset class. We believed that gold was deeply undervalued and with India and China, cultures that value gold and use it as a currency substitute, developing a middle and upper class, demand for gold would increase exponentially. We also knew that many investors would come to realize that the gold price would go up because of inflation and currency devaluation – the historical reasons people buy gold.
That attitude has changed over the last two-and-a-half years. Fundamentals no longer seem to play a role in attracting investors to buy gold or gold stocks. Marshall thinks it would be nice for people to go back to looking at fundamentals; I’m not sure that will happen. The information explosion – gossip, rumors and trying to guess what hedge funds and private equity investors are doing – plays an increasingly larger role in decision-making.
One factor that would cause gold to rise would be the realization that the US government is printing money to deal with its tremendous debt. This is not sound policy. This should scare people, but it doesn’t seem to at this time.
The Federal Reserve is doing everything it can to keep interest rates low, which is good for corporations and good for the economy, but it is doing that by buying bonds and mortgages. Eventually, we will have to pay the piper. At that point, hard assets like gold and silver will look a lot more attractive. Until we get to that point, I’m concerned that gold will not break out of the range it has been trading in for the last couple of years.
TGR: Change will require the onset of fear.
Malcolm Gissen: Fear is definitely one strong motivator. Unlike Halloween, where children (and many adults!) love going to haunted houses to be frightened, people do not seek fear in their investments. Rather, they avoid fear, often at all costs. If fear returns in the markets, Marshall and I think that gold is likely to be a place where investors will move their money.
Another new development affecting gold and silver prices in the long run could be supply constraints. The world’s largest mining companies have realized that they must be more sensitive to escalating costs of building and operating mines, especially with gold and silver at present prices. They can’t rely on $1600-1900 per ounce gold prices to pay for $3-7 billion expansion and construction projects and remain profitable. With gold in the $1000-1300 range, some companies are not profitable.
I just attended an excellent presentation by Juan Carlos Artigas, head of investment research at the World Gold Council. While arguing that all investors should have a 3-10% allocation to gold because it is an asset with low correlation to almost all other assets, he pointed out that all-in costs for some gold producers were in the $1200 range. As a result, CEOs are less willing to build large projects. We also have seen much less merger and acquisition activity among the majors. I believe that will, over the next few years, threaten the gold and silver supply.
If gold supplies are threatened, it could raise gold prices. I can’t say whether that will happen in six months or three years, but I believe that we’re headed in that direction.
TGR: Do you expect the trend of up-and-down gold prices with no real pattern and with little consensus to continue until there is a decided move upward?
Marshall Berol: Although we disagree on timing, we agree that gold will continue trading in the $1200-1450 range until it breaks out to the upside.
Malcolm Gissen: I think there’s a floor in the $1100-1200 range. When gold goes below a certain level, companies will stop producing, there will not be enough gold to meet demand and we’ll see higher prices.
Industry executives tell us that if gold should ever get to $1000 or $900 per ounce they expect many of their colleagues to go on care and maintenance, because they can’t make any money at that price. They’ll go to a skeletal crew and cut back on production.
TGR: Let’s look at silver. New York’s CPM Group expects silver prices to consolidate for another three years, at an average of $18 per ounce. Do you support that forecast?
Malcolm Gissen: I don’t, for a couple of reasons. First, it’s very difficult to make forecasts for a specific timeframe. I cannot predict what will happen in three years. It is difficult enough trying to forecast where prices will be in three or six months! Second, because silver has so many more industrial uses than gold, I don’t see silver prices declining by an additional 15% after the sharp decline of the past year. I also do not believe that silver prices will break out until factors – similar to what I mentioned for gold – change.
Marshall Berol: Silver’s current price is $21-22, so CPM’s forecast implies that the price will decline over the next three years. I don’t agree. About half of silver usage is industrial – electronics and medical, for example – all of which are increasing.
Silver tracks the price of gold investment-wise, but I think it could do better than gold percentage-wise over three years. Historically, silver has been more volatile than gold. It goes up or down to a greater percentage than gold.
TGR: Malcolm, we’re just a couple of weeks beyond the federal government shutdown in the US. What are your thoughts on the long-term health of the American economy and the American political system?
Malcolm Gissen: I’m going to stay away from the politics, because my politics and Marshall’s politics are almost diametrically opposite.
I believe the US economy is much healthier than a lot of Americans realize. Our entrepreneurial spirit is extraordinary; the number of young people starting companies has never been greater.
Sometimes government can get in the way. We need more reasonable, workable regulation than we have now. If we do that, the sky is the limit for the US economy. I don’t think that will change for many years; I’m very bullish on our economy.
TGR: In 25 years, will the US greenback still be the world’s reserve currency?
Malcolm Gissen: I think it will. Twenty-five years would be too soon for the American Dollar to lose its position as the world’s basic currency, just as English is the dominant language used around the world.
Marshall Berol: You also have to ask yourself what the reserve currency would change to. The Euro isn’t in any position to become a reserve currency. Nor will it be the Yen, the Ruble or the Peso. It may one day be the Chinese currency, but not that soon.
That brings us back to gold. It would not replace the Dollar, but central banks are adding gold to their reserves to lessen the impact of the Dollar on the percentages held in their reserves.
TGR: Did you make changes to your Encompass Fund due to the government shutdown?
Malcolm Gissen: We made no changes in either client accounts or in the Encompass Fund. However, we did debate whether to move more to cash in the eventuality of a default on the US debt and the negative impact that would have on the market. We concluded Congress would likely go right to the wire, when the more moderate Republicans would prevail and strike a deal.
Marshall Berol: The client accounts are managed to each client’s individual goals and objectives. The objective of the Encompass Fund is long-term capital appreciation. We are not a trading fund. The turnover rate for the Encompass Fund runs around 25%. We don’t focus on day-to-day, week-to-week or even month-to-month news developments. We look for industries and companies that will do well over time.
TGR: What are your clients telling you these days?
Malcolm Gissen: I think clients like less risk and less volatility, and we have moved in that direction over the last 12-15 months. We have invested client accounts in more large-cap, domestic stocks. We like the energy, healthcare and technology sectors. We also have added Real Estate Investment Trusts.
We’ve done the same thing in the Encompass Fund. It was more heavily invested in resource companies, particularly metals. Over the last six months, we’ve kept the best of the resource companies, but energy is now the largest component represented in the Encompass Fund.
TGR: Your website describes the Encompass Fund as a “go anywhere fund”. Geographically, where has the fund gone in the last year that it had not gone previously?
Marshall Berol: It’s more a factor of where we’ve pulled back than where we’ve gone for the first time. The fund has a number of resource sector investments in Canada, the US, Mexico, South America, Africa and a couple of companies in Europe. We are more wary of jurisdictions that have experienced geopolitical problems, such as Argentina, Bolivia, Ecuador, areas where the governments appear less friendly toward resource operations.
TGR: Marshall, you’ve invested in resource companies based, in part, on your relationships with company management. How has the downturn in the junior resource space changed those relationships?
Marshall Berol: It hasn’t changed the relationships as much as it has focused us even more on company management.
At the end of 2008, we assessed where all of the companies in the Encompass Fund were relative to their projects, finances and management. We reduced or eliminated a number of the companies that were not making the progress we had hoped for and added to those we thought were stronger. That worked out extremely well for the following couple of years, as the markets improved and some of the companies did likewise.
We did the same thing earlier this year, focusing even more on the management teams. In this very difficult environment, strong, knowledgeable managements with successful track records for bringing projects along and raising money are extremely important.
TGR: But you must have to say no to people when they come to you for more financing.
Marshall Berol: Yes, almost every day. This year in particular, companies have needed to raise funds just to keep the lights on, much less advance their projects.
We are being far more selective in what we believe justifies funding. Primarily, that translates to companies that are in production and need funding to increase production, or are very, very near production.
TGR: Do the relationships just dry up when you have to turn down funding requests?
Marshall Berol: I hope not. It’s a business decision. Companies are in a position where they need to ask. We’re in a position where we can and will say no if it doesn’t fit our portfolio objectives. I would hope that the management teams understand our position and our responsibility to our investors.
TGR: What is your current investment thesis for junior mining companies? What do companies you invest in today have to have?
Marshall Berol: It’s very good if they’re in production or very near production. That means they’re generating revenue and cash flow of some kind and are advancing their projects.
Management and the state of the balance sheet are also factors. Companies with significant cash on their balance sheets are a lot more attractive.
With rare exceptions, it is difficult for us to justify investing in very early-stage companies in this environment.
TGR: Regarding other jurisdictions, you’ve talked about avoiding places like Argentina, Bolivia and Ecuador, but not Brazil. Why are you comfortable investing in Brazil?
Marshall Berol: The Brazilian government seems to be more reasonable, and it is a far larger and broader based economy than elsewhere in South America. Argentina, for example, nationalized a Spanish oil company and changed the tax laws, and the monetary situation is challenging.
TGR: What tricks should investors avoid in today’s economic environment?
Marshall Berol: Unfortunately, tricks are most noticeable with hindsight. I think the trick to success is to avoid assuming that when gold or silver prices rise that it will raise all the boats. While we remain optimistic on the price of gold and silver, just having an inexpensive stock doesn’t mean it will go up if the price of gold goes up. You have to dig deeper and look at the management, the projects, the location and the finances.
TGR: Indeed. That trick is a real treat. Thanks for your time and insights.
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Oct 23

Looking Beyond Flashy Drill Results

Gold Price Comments Off on Looking Beyond Flashy Drill Results
Trained metallurgist and mining analyst on spotting value in junior miners…

DEREK MACPHERSON is a mining analyst at investment bank M Partners in Toronto, Canada. Before joining, he worked in mining research for a bank-owned investment dealer. And prior to entering capital markets, MacPherson spent six years working as a metallurgist. 
Now studying underappreciated companies, Derek Macpherson says they can be opportunities to buy, not sell. Don’t be dazzled by flashy drill results, he advises in this interview with The Gold Report. Investors are better looking for junior explorers with long-term vision, high grades and simple operations in good jurisdictions.
The Gold Report: Derek, when it comes to junior mining equities you’re something like a shark cruising for prey, seeking an opportunity to strike. What common buying opportunities do you look for that other investors might overlook?
Derek Macpherson: We seek out assets that have been underappreciated or unjustly tossed aside, companies whose stories are starting to change. That change might be an operations turnaround, a turnover in the management team or a revision to the capital structure.
TGR: One of your recent research flashes reported on the Mexican government’s consideration of imposing a royalty on Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA) on companies that mine commodities in Mexico. Tell us about that.
Derek Macpherson: Whenever that topic comes up, it puts pressure on Mexican producers and developers. We are seeing the potential of a royalty getting priced in to those companies, and priced in as a worst case scenario.
Initial discussions centered on a 5% EBITDA royalty, which could affect company valuations significantly. However, Mexican mining companies are working with the government to find a more reasonable solution. If the proposal gets ratcheted down to a 2.5% EBITDA royalty or perhaps a 2% net smelter return, then company valuations could recover.
In Mexico, you want to look for companies that have low all-in cash costs. They will be somewhat insulated from the royalty because their margins won’t be as compressed as higher cost operations.
TGR: What common events lead you to undervalued equities?
Derek Macpherson: One of the most obvious is when management teams disappoint; the mining space is littered with those.
In those instances, we look at the underlying value and whether the management team can turn the operation around. We ask ourselves if the selloff was excessive, potentially creating a buying opportunity if the damage is recoverable.
TGR: Do you think management teams are being punished too harshly for performance shortcomings?
Derek Macpherson: I think it’s partly a function of the commodity price environment. In a rising gold price environment, there was more room for error and setback didn’t have as large an impact on project economics.
In a volatile price environment, investors have shown very little patience. If production results or a resource update aren’t in line with projections or better, the market pushes the stock down.
TGR: Do you watch for seasonal opportunities, or has seasonality become less predictable?
Derek Macpherson: Seasonality has been a bit less predictable. It has been dampened, first, by gold being driven by macro events and, second, by it being technically traded.
This year, in particular, investors should be looking at the season for tax-loss selling. I expect to see an accelerated selloff near the end of 2013, as investors try to capitalize on their tax losses. This should create a buying opportunity for a lot of good stocks. This is the time for investors to do their homework and find the stocks they want to pick up as they sell off later in the year.
TGR: What types of stocks do you think will sell off more than others?
Derek Macpherson: I think it will be a function of the company’s year-to-date performance. Companies that had a tough time from January to October will be the most affected. That doesn’t speak to the quality of their projects, which could create buying opportunities.
TGR: News flow used to dry up in the summer and start to flow again in September with the publication of summer drill results. Does news flow still matter?
Derek Macpherson: To a certain extent, yes. Drill results became a bit of a selling opportunity or a liquidity event this summer. However, we are seeing that abate, particularly in September.
TGR: Haywood Securities produces a quarterly report on the junior exploration companies that looks out three months to forecast how the companies listed will perform quarter to quarter. Do you look for quarter-to-quarter performance or do you look more long term?
Derek Macpherson: In the junior exploration space, you have to look a little bit longer term. It often takes time and money to determine the value of a deposit. We try to look through flashy drill results that might move the stock over the short term but don’t necessarily indicate anything about a company’s long-term economic viability.
We try to hitch our wagon to companies that take a long-term approach to how they do their work and a long-term approach to driving value.
TGR: Speaking to those of our readers who are new to the junior mining space, what are some effective approaches for novice investors?
Derek Macpherson: You certainly need to account for commodity volatility. Pick companies that have lower risk and can withstand volatility.
When it comes to projects, we look for one of two things: a project needs to have very high grade or it needs to be technically simple. Having one of those two features can reduce the risk of your investment.
The next thing to be aware of is jurisdiction. In the current market, there is an increased discount for political or permitting risk, and for the additional capital expense (capex) needed to put infrastructure in a remote location. Consequently, we tend to focus on North America, Mexico and some South American jurisdictions. In South America we look for jurisdictions with an existing mining culture, which can mean focusing on a specific region or even town in a given country. Peru is a good example; mining is welcome in some areas and is more challenging in others.
TGR: What about playing the volatility itself in metals prices?
Derek Macpherson: That’s very difficult to do because investors have to guess right on which way metal prices go that day. If investors want to play that volatility through equities, they have to get into more leveraged names, which tend to have a higher risk balance sheet. Playing the volatility can be very difficult and very expensive if you guess wrong.
TGR: Your thesis seems to prefer companies with cash and those that can raise cash with low-cash projects. Is that accurate?
Derek Macpherson: Yes. That is, in part, a function of the current market environment.
TGR: Do you have any parting thought for our readers?
Derek Macpherson: Even though markets are challenging for mining equities, some high-quality names have sold off, creating an opportunity for investors to get involved at a reasonable price. Despite the overhang that equity markets have put on the space, it will get better; it’s just a matter of when.
TGR: Derek, thanks for your time and insights.
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