Lawrence Roulston: As Demand Exceeds Supply, Prices Will Trend Higher
Source: The Gold Report (7/11/08)
The Gold Report caught up with newsletter writer and analyst Lawrence Roulston of Resource Opportunities. In this wide-ranging interview, Roulston gives us his thoughts on the outlook on the economy and what factors impact the gold market and all the other metals. He says, "the pattern I see continuing is gold trending higher with spikes and pullbacks."
TGR: Gold has made a pretty substantial move, but yet the juniors haven’t; in fact, some of them have gone backwards. Why do you think the juniors have not done as well as, say, a producer or the price of gold?
LR: Earlier this year when Bear Stearns was on the brink, and then collapsed, there was a lot of concern throughout the financial community around the world that perhaps a number of other banks were going to fail, and perhaps the whole banking sector was going to come crashing down. Because of that fear, a lot of investors started buying up gold as a hard asset, a long-term store of wealth.
Gold has always had this role as a sort of safe-haven investment. So there was a huge amount of investment in gold because of that fear about the banking sector and concern over paper investments of all sorts; a huge concern over subprime mortgages. People were just plain scared, so there was a huge move into the gold market.
When the government bailed out Bear Stearns and when it became apparent that the U.S. government was going to do whatever was required to prop up the economy and the banking sector, a lot of those investors who had gone into gold realized they didn’t need their gold. At that point, gold came back on the market and the price has come back down.
That move into gold was based on fear. A junior mining company is considered pretty risky, and they didn’t participate in that rally. The ironic thing is that as the government props up Bear Stearns and the economy, it is very positive for gold in the long term. Gold came on the market in the short term, but long term it was just one more indication that the U.S. dollar will continue to trend lower, and that the gold price is going to trend higher.
So it’s just a matter of time. I think we’re seeing it in the market today, with the gold price coming back up again. People recognize that the gold price is going to trend higher, and when they get more comfortable with the long-term trend, I think we’re going to see that movement come back into the juniors.
TGR: One of your articles mentioned that part of the reason metals haven’t appreciated is because they’re all tied to the U.S. dollar. If the dollar continues to depreciate, would you still expect gold to trend higher or just a lag before anyone realizes it?
LR: A number of factors have an impact on the gold market and all the other metals. In the Western world, we use the U.S. dollar as a measure for most commodities, and as the value of the U.S. dollar declines, the apparent value of the metals increases as measured in U.S. dollar terms. So that is one contributor to the nominal rise in metal prices.
But superimposed on that – whether we’re talking gold, silver, copper, cobalt, zinc or any of other metals – over the last few years there’s been a very significant increase in real terms as the demand for the metal increases at a faster pace than the mining industry has been able to deliver metals.
TGR: So give us your overview on precious metals and base metals.
LR: My view on the gold market is that the value will trend higher because of the continuing debasement of the U.S. dollar and debasement of other currencies over time, as has been the case since the beginning of time. On top of that, we have an increase in real demand for gold and precious metals because of growing concern around the world over stability of the U.S. economy, the U.S. banking sector and paper currencies – and just a growing awareness that holding some hard asset like gold provides some stability to an investment portfolio.
So we’re seeing a huge increase in gold demand and it’s reflected in the ETFs and the other means that have made it easier for investors to own gold over the last few years.
TGR: Where do you put silver?
LR: Silver largely mirrors the movement of the gold price, but in reality, the silver market and the gold market are very, very different. The primary use for gold is as an investment or as an ornament. The markets for silver are different in that the primary uses for silver are industrial. So in the gold market, virtually every ounce of gold that has been produced by mankind is available at the surface and could be brought back onto the market. In silver, it’s very different.
Over the past two decades we have seen the enormous stock of silver that was built up over thousands of years being used up in industrial applications, so it is no longer available.
TGR: Isn’t there a fair amount of silver recycling going on?
LR: The biggest component in silver recycling is in photography, and to a large extent, photography is a closed loop. The chemicals used are recovered in the developing process and go back into making new film and new other components as well. But a lot of products – mirrors, for example, and thousands of electronic products– employ very small amounts of silver in each application. And that silver is lost to the world forever.
TGR: Could it be argued that silver would appreciate more because there’s a bigger gap between supply and demand?
LR: The demand for silver is increasing steadily as more and more applications are coming about, and a lot of these applications are in high-tech situations and high-value products where the value of the silver is insignificant compared to the value of the finished product. The flip side of it, though, is that there’s a lot more silver to be mined and silver coming out of mines is increasing. It’s coming out at a pace that moderates the upward movement in the silver price. I believe that will continue.
It is entirely possible that we could see a very substantial short-term spike in the silver market, but there is enough silver in mines that it will moderate the upward movement of the silver market in the longer-term context.
TGR: So is the larger influence of silver based on gold? When gold went over $1,000, didn’t silver get to $21 or something like that?
LR: That’s right. And in the short term, the silver price is mirroring the gold price. But it’s not a perfect match. There are variances.
TGR: Do you see something that would cause decoupling at some point?
LR: It’s entirely possible at some point – whether it’s a week from now, next month, or a number of years. But at some point the above-ground stocks of silver are likely to run out. For most of the last two decades, in fact fully two decades, the amount of silver consumed in industrial applications plus investment demand have exceeded the mine supply. So above-ground silver has been run down steadily over the last two decades.
There’s a lot of debate about how much silver might still remain at surface. We don’t know, but at some point we’re going to hit the wall on the amount of silver available on surface. There’s going to be a short-term spike, but there’s also a lot of activity within the mining sector, especially the junior sector, toward an increase in production. As the silver price moves up, there will be more and more activity to bring old silver mines back into production and develop new silver mines.
TGR: What should our readers be thinking about in terms of the base metals, particularly copper?
LR: Copper is the biggest of the base metals, but in my mind is like all the other base metals, and I will make some general comments. As the developing world has developed, demand for base metals, oil, food and every commodity on the planet has been escalating at a pace that nobody thought possible. So when you look at the base metal prices, most of them are up several times, 10 times in some cases, from where they were at the start of the decade. This reflects the fact that demand for the metals has been increasing much faster than the industry has been able to increase its production capacity.
There’s a perception that the base metal prices are going to come back down in the near term because of concerns about the slowing U.S. economy. In many investors’ minds, and even in many analysts’ minds – which is surprising – there’s a perception that a slowdown in the U.S. economy will slow down the rest of the world, and that in turn will slow the demand for metals and the prices will come back down. The reality is that this idea of the U.S. economy slowing has been out there a long time, and the base metal prices are still holding at very high levels.
China is by far the largest consumer of every metal. There’s still a perception that the Chinese economy is dependent on exports to the United States, but the reality is that exports to the U.S. represented only 2.1% of the Chinese economy last year. So if the U.S. economy slows by a couple of percentage points from where it was last year, it will have no noticeable impact on the Chinese economy or on other parts of the world.
Chinese exports to the oil-exporting nations grew by 45% last year, and exports to the other BRIC nations – Brazil, Russia and India – grew by 60% last year over the year before, and in fact are still growing at that pace. So the developing world has taken on a life of its own, independent of what is happening to the U.S. economy.
Now, if the U.S. economy were to disappear from the face of the planet, of course, it would have an impact on the rest of the world. But nobody is suggesting that. We’re talking about growing at a couple of percentage points, and now perhaps shrinking by a couple. That kind of change in the economic activity in the U.S. will not impact what’s happening in the rest of the world.
So in my mind there’s an enormous investment opportunity because of the perception that the U.S. economy will slow and bring down metal prices, and the reality being an incredible demand for new metal deposits. I wouldn’t advocate anybody go out and speculate on what the copper price is going to do tomorrow – or the cobalt price or the nickel price – because too many variables affect those. I am not convinced that they’re going to go higher in the near term.
But having said that, the real play in the commodities market or the metals market is not betting on what’s going to happen next week to the metal price. The real play is to recognize the fundamental shortage of supply and to invest in the companies that are going to fill the supply gap. That means these little companies that are finding and developing metal deposits that will become mines in the coming years. In our newsletter we have had enormous success identifying companies that hold deposits, and seeing those deposits evolve and develop and in many, many cases being bought by larger companies and developed into new mines.
I am continuing to see that as being the greatest investment opportunity of the decade – identifying companies with tangible metal deposits that are being enhanced in value and being advanced through the development stage to the point where they are sold off to other companies or being developed in their own right.
TGR: On that note, we'd like to hear about some specific stocks you’re currently following and recommending in your newsletter, but we realize that out of fairness to your subscribers, you don’t wish to talk about specific company recommendations.
LR: That's right. We would be happy to send anybody a sample copy of the newsletter, and you can request one on the website.
TGR: So going back a bit. . . We talked about China and how if the U.S. goes into a recession or a prolonged slowdown. What if it’s worse? What if there is a confidence crisis? I can’t remember exactly what Doug Casey calls it – the re-depression or the depression. What does that do to the rest of the world? We talked a little about China, but what about the other BRIC economies? How do they fit in?
LR: That’s a long, complex question. I feel very strongly that the U.S. economy is not going to suddenly collapse and be reduced to a pile of smoldering ashes. We have heard such forecasts in the 12 years I’ve been following this sector from this perspective, and I’ve been hearing some of the same people making the same forecasts for that entire period.
The U.S. economy is extremely strong, extremely resilient, and it is facing a very difficult time. There is a transition going on right now, and many people in the United States don’t have a clue. In fact, I would say very few people in the U.S. have a clue as to what’s going on in the rest of the world. They view the entire world through this myopic perspective of what is happening in the U.S. Now, that’s fine; the United States’ economy, in my opinion, will muddle along. It will be a long time before we see the kind of growth in the economy that most people would like to see – you know, 3% to 4% annual growth in GDP. It might be years before we get to that level.
We debate whether the economy is growing by 1% or shrinking by 1%. Are we officially in a recession are we not? Is it a period of slow growth or is it a recession? In terms of the rest of the world, who cares?
But your question was, will something more serious happen? I seriously doubt it. The government has made it clear that they will do what it takes to prop up the economy. They will keep printing money; they will prop up the consumers; they will keep lowering interest rates and bailing out banks that have made stupid investments. Plus the fact that there’s enormous strength in most of the companies in the economy.
If you look over the S&P 500, some are up and some are down. I think you will find that some of those companies are doing extremely well – growing their earnings and growing their revenues, and those are the ones that are looking outside the U.S. Companies like Boeing that are selling airplanes to places like the United Arab Emirates are doing very well; other companies that are too myopic to look outside the U.S. are hurting. General Motors had no clue, it would appear, that the oil price was going to go up and that gas price was going to go up and they would have to start introducing more fuel-efficient cars; they seem to have been caught by surprise on that.
So it’s company by company, but there are enough forward-looking, visionary companies within the U.S. economy that it’s hard to imagine that it’s going to collapse and drop into a hole in the ground. Certainly, banks like Bears Stearns made absolutely ludicrous investments in subprime mortgages, and as it turns out, some people within the organization knew that some of those investments were stupid. We’re seeing criminal prosecutions beginning in that regard.
But there’s strength in other economies and overall the U.S. economy is going to muddle along because there are enough companies that take a global perspective. If my pension depended on the success of companies like General Motors and the U.S. banks, I would be worried. But, remember, we’re talking about commodities, and metals in particular. So, the question is, what impact will further slowing, or a prolonged slowdown have on the metal prices.
Credit Suisse addressed that issue earlier this year and looking at the copper market in particular, they said, if the U.S. economy continues at the current pace and the rest of the world continues to grow, even if somewhat slower than they’re going, the copper price would rise from the current level near $4 to $6. Their downside scenario was that the U.S. would go into a serious recession and other economies around the world would slow significantly to the point where overall growth in the world would be severely curtailed. In that worst-case scenario, they predicted that the copper price would come down to $2.60 a pound.
I am not holding my breath on seeing copper anywhere near $6 in the near term and certainly not factoring that into any analysis. But a lot of thought went into the Credit Suisse analysis, and I think that’s a pretty good indication of how to see it. They’re saying the worst-case scenario is $2.60; long-term projections on the copper price now being used to value junior companies are on the order of $1.50 a pound. So anything over a $1.50 a pound represents investment potential on any of these juniors.
TGR: It’s fascinating how all this fits together. There may be a gap in my understanding that you can fill in. You said earlier that the world economies are generally doing fine, and even if the U.S. goes into a slight recession, the BRIC countries will be fine. Also that we have this potential of above-ground gold reemerging in the marketplace as the investors become more relieved that the world is not going belly up. If all of that is true, should we see any increase in gold over the next five to 10 years?
LR: Some commentators out there are talking multi-thousand dollars for a gold price, and I am not holding my breath on that; I am not even dreaming about that. But looking at what the gold market has done going back to 2001, when there were some fundamental changes, and bringing it up to the current level, I would say that six years of actual real-world experience is the best proxy for what’s likely to happen over the next one or two or even four years. That is – more investment demand for gold and continuing demand for gold in the ornaments market.
Gold production has been flat during that period; a lot of old gold mines have been falling off. South Africa is still the largest producer, but gold production in South Africa has been declining steadily for years. China has now emerged as the second-largest gold producing nation, and its gold production is now coming from 15,000 tiny little mines. All of these factors are happening in the real world, and they’re all going to continue to unfold.
The net result is that the gold price is trending higher, not only in U.S. terms, but also in real terms. There’s been any number of times that the gold price has spiked up, as it did earlier this year to over $1,000, and dropped back down. So the pattern I would see continuing is gold trending higher with spikes and pullbacks. Investors using the short-term swings to advantage probably will do quite well in the long-term context. But unfortunately what happens so often is the majority of people buy at the top of the market and sell at the bottom of the market.
TGR: If you’re expecting the U.S. dollar to continue to devalue against other currencies, and maybe many other currencies devalue as well, would actual gold be a hedge against the value of the dollar?
LR: In the long term, all paper currencies have declined in value. That’s just a given. The U.S. dollar has declined more quickly than other currencies over the past four or five years – in a significant way declining more rapidly. Whether it’s going to continue to debase at that level, over time it’s likely to continue to devalue. Therefore, certainly gold provides some stability in that regard.
But I would not own gold. I have never owned bullion; I probably never would own bullion just because you don’t get the leverage you get by investing in a gold equity. Companies that are involved in the gold sector, whether they’re exploring or developing or producing, provide a great deal more exposure to the gold market than you would have by merely buying ounces of gold.
TGR: You were talking earlier about the base metals and the developing countries, and the infrastructure being developed in different countries. Are there some base metals that have less likelihood of supply meeting demand? You said there was a lot of silver that probably would eventually even out. Do you look more opportunistically at some base metals because the supply is not there?
LR: I think the market has already beat us to it, in effect. A year ago I would have said cobalt. The cobalt price was $50 a pound recently, up from a few dollars not too many years ago. I think we’re seeing other people – speculators, analysts – who have kind of looked through and already pushed up the prices. So if we’re looking for a metal where there might be a short-term speculative spike because suddenly investors become aware of it, I can’t see anything directly. I don’t mean to sidestep your question. If I had one, I would love to pile onto it.
But just to reiterate my fundamental investment philosophy, if you’re looking for a metal that might spike in the short term or even the longer term, you’re just speculating on a commodity price. And there are so many variables that really it’s speculation. Whereas if you look at a particular company, you’ve got a much greater opportunity for identifying situations where there’s a greater likelihood of the value increasing as the companies execute their business plans.
TGR: I was listening to National Public Radio program where they were talking about a precious metal being used as a fuel additive for jet planes. They sell it in very, very small amounts, and it’s more precious than gold.
LR: Platinum has been used. It is used as a catalyst in the catalytic converter in every automobile in the western world. Palladium and rhodium are used also. You can achieve that catalytic effect and get better combustion if you take nanoparticles of platinum and mix them in with the fuel. It increases the burning, and it’s better to get that in the combustion chamber than in the catalytic converter. The only trouble is that it’s enormously expensive. It makes no sense economically.
TGR: Even for a jet plane?
TGR: This other metal – they were looking into it and using it and potentially it could make a difference. I think they were talking about the way the engine is made. It burns much hotter, which causes fuel consumption to be more efficient.
LR: Well, I imagine if you line the cylinder with platinum, you would get more combustion, but can you afford to do that? Another metal that is even more useful – and again in incredibly small amounts in catalytic converters – is rhodium. Rhodium sells for just under $10,000 an ounce right now. Maybe some extreme examples would need that kind of extraordinary performance, but it’s hard to imagine these things being used on an ongoing basis.
TGR: Are you familiar with beryllium?
LR: Yes, it’s a fairly common element.
TGR: Isn’t it good for heat and used in rockets and satellites?
LR: I am not aware specifically, but there are a lot of specialty metals. Indium is another one that is valued at nearly $1 million per tonne, or $1 per gram, and it’s found as a byproduct in a lot of zinc mines.
TGR: This has been terrific. I appreciate your giving us the opportunity.
Resource Opportunities, which Roulston has published since 1998, provides objective commentary on the resource industry and emerging resource companies. Lawrence is a geologist, with engineering and business training, and more than 20 years of hands-on experience in the resource industry. Lawrence conducts frequent property visits as part of his due diligence and has toured mining and exploration projects in many parts of the world. He has worked in various roles for mineral exploration companies. Since 1997 he has been a resource industry consultant and independent mining analyst.