The Gold Report recently caught up with newsletter writer and analyst Lawrence Roulston of Resource Opportunities, who's been travelling to learn more about the state of mining worldwide. In this exclusive interview, Roulston provides his thoughts on the outlook for the economy and what factors impact gold and other metal markets. "As the Western world gets back on track," says Roulston, "commodity prices will continue higher."
The Gold Report: Lawrence, you have just returned from trips to Dubai, Hong Kong and Europe. What does the rest of the world think of the health of the U.S. and European economies?
Lawrence Roulston: It is striking how different the outlooks are in different parts of the world. In North America, most people are totally focused on the U.S. economy, which is not looking that promising in the near term. Therefore, investors are quite gloomy. Europe is also not very upbeat. But, in Europe, they are more pragmatic and they tend to look a little further into the future. As a result, many European investors see this down period as a buying opportunity. Parts of Asia were hit hard by the slowdown, but there is still a lot of growth in China and India. China reacted quickly with an effective stimulus plan that is focused on building infrastructure. Growth there is forecast at 8% for this year. With enhancements to rail, roads, ports and the like, China will become an even greater economic force.
TGR: What is the Asian perspective on the importance of emerging markets to global economic turnaround?
LR: There is a myth that Asian growth depends mainly on exports to the West. Much of the economic activity in Asia is related to trade within the region. After the credit crisis, there was a severe shortage of export financing, which meant that exports plummeted. Now that financing is available again, activity is recovering throughout the region. Asians are far less concerned about the global situation than they are with what is happening in the region. With China, which is the third-biggest economy in the world, growing at 8%, it doesn’t really matter what happens in other regions. Once upon a time, Asian growth depended on exports to the West. Now, the West will benefit from growth in Asia.
TGR: What do investors in other regions think about precious metals and the U.S. dollar?
LR: Investors are very nervous about the outlook for the dollar, but it remains the global currency. With uncertainty remaining about the U.S. financial system, gold has become more important as a currency hedge, as an inflation hedge. People can see the long-term downtrend in the dollar. As a result, the dollar is seen more as a medium of exchange. It’s held for the short term, by most investors. Of course, the Chinese government holds most of its $2 trillion dollars worth of foreign currency reserves in dollars. There is growing nervousness about that huge exposure and moves away. In part, the government is buying commodities.
TGR: It's been said that the Chinese government is buying commodities and stockpiling these commodities as a way to get out of the U.S. dollar. If this is true, should we expect commodity prices to fall when China has built up a significant stockpile and, if so, in what timeframe?
LR: The Chinese government is taking advantage of low metal prices to build strategic stockpiles. They are smart enough that they are not going to push the price up with their buying. Recovery in the West should dovetail with the Chinese buying so that the prices will not drop. The amount of actual commodities being bought for the stockpiles is small in relation to the total value of their reserves.
Much of the Chinese buying of commodities that we read about in the popular press is about Chinese companies in the private sector acquiring interests in metal deposits with the intent of developing mines. The Chinese mining industry is becoming quite large and it is only natural that they acquire resources.
TGR: What will be the impact on the U.S. dollar if/when commodity prices fall?
LR: I don’t believe commodity prices will fall. What we are seeing now are commodity prices that reflect weak demand as a result of the recession in the West. As the Western world gets back on track, commodity prices will continue higher.
TGR: What will be the impact on gold of a weakening dollar?
LR: Gold is denominated in dollar terms, so as the value of the dollar falls, the nominal value of gold rises in dollar terms. In addition, gold will appreciate in real terms as a growing number of investors turn to gold as a secure store of wealth.
TGR: Given your viewpoints, how should investors view gold/silver as part of an investment portfolio?
LR: Gold, silver and other commodities provide stability to a portfolio. But, owning bullion is not the most effective way to gain exposure to precious metals. A much more effective way to gain the currency hedge and the inflation hedge of precious metals is to own companies involved in the metals. Of course, that approach carries risk. It also means that one must do some hard work to identify suitable companies. If you own the right companies, you stand to profit from developments within the companies. In addition, you can actually get a far more effective exposure to precious metals by owning a company. What I mean is that if precious metals go up by some percent, then companies will increase in value by a greater percent.
TGR: There is a common thought that when an investment idea becomes part of cocktail conversation, that investment has hit the top and it’s time to sell. There is significant buzz around gold now. Has gold reached the top?
LR: North American investors have a very short outlook—often days or weeks. Gold and silver go through short-term swings. If you buy gold today at $930 expecting to profit when it hits $950 next week, you may be disappointed. My belief is that gold will continue to notch higher, exactly as it has for the past eight years, spiking up and then giving back part of its gain before the next up leg. Looking longer term, there is every reason in the world to believe the gold price will be higher. But, the gains may not come quickly enough to justify holding bullion. Back to my earlier comment: Gain the exposure to precious metals through owning companies that are adding value. The longer-term gains in bullion will come on top of what should be attractive returns from companies carrying out business plans.
TGR: Will there be any impact of Dubai shifting gold from London to Dubai?
LR: Not really. It’s part of the growing importance of gold to Middle East investors. It also shows the maturing of Dubai as a regional financial center and the growing wealth in that region.
TGR: Should we expect any impact with the authorization from the U.S. Congress for the IMF to sell gold?
LR: Central bank selling of gold has been an important part of the gold market for the past decade. Investor and consumer demand for gold exceeds the amount of gold mined each year. Central banks have made up the difference. The European banks have sold less than their quotas in each of the last three years. If handled properly, the IMF sales should not affect an orderly market. With the central banks selling, and now the IMF, it will continue to put a damper on the market. Those commentators calling for $2,000 or $3,000 gold in the near term seem to forget that there is a lot of gold that can enter the market. Gold will certainly go higher, but not necessarily at the pace that some would hope for.
TGR: Earlier you stated that a more effective way to gain the currency and inflation hedge of precious metals is to own companies involved in the metals. I assume you are referring to mining companies. The senior producers have had a significant increase in stock valuations from their recent lows. Given this recovery, is there still room for gains?
LR: The seniors have outpaced the recovery in bullion from the lows earlier this year. Senior producers tend to trade at a premium to bullion, presently about two times net asset value. To explain that: If you valued a gold producer on an objective basis using the current gold price you would get some net asset value. The present share prices reflect a market value about twice that net asset value. Investors pay that premium in order to get the optionality of owning a gold company compared to bullion—the gold company will increase in value faster than bullion. The seniors will continue to track the gold price. But, you are paying a premium. There is far greater value in the smaller companies. There is also greater risk, but potential for much larger gains.
TGR: Is the risk/reward for near term-producers now tilted in favor of investment in the smaller companies compared to seniors?
LR: Each investor has to assess his or her own tolerance for risk. In my opinion, the smaller companies—that is near-term producers, small producers and companies with defined gold deposits—clearly represent a very favorable risk/reward profile. But, you have to assess these companies carefully. There are big differences among the companies.
TGR: Given the potential upside of the recent producers/near-term producers, should individual investors look at exploration companies?
LR: Exploration covers a huge range—from companies that hope to one day find something of value to companies that have made important discoveries and are now quantifying the size and grade of their deposits. At this time, I would tend to stay closer to the latter type of companies. There is still huge upside potential. Consider some numbers: a company that has the earliest stage of metal deposit, what we call an inferred resource, is valued in the order of $10 to $20 per ounce of gold in the ground. Once that deposit reaches production, it is valued in excess of $200 per ounce of gold in the ground. So, you can see the potential for ten-fold returns without taking on the discovery risk.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.
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