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Louis James Shares Some of the "Best of the Best"
Source: The Gold Report,
Interviewed by Karen Roche, Publisher (11/17/09)
In this exclusive interview with The Gold Report, Louis James, Senior Editor of Doug Casey's International Speculator, reiterates his conviction that the dollar is on death row with no one prepared to grant a stay of execution. Dismal as it is, this situation gives rise to increasingly positive prospects for gold and other commodities that may ultimately stand in as the world's reserve currency.
The Gold Report: The last time you sat down with The Gold Report, you spoke articulately and persuasively about a U.S. currency crisis of historical proportions. At that time you said, "The dollar is on death row." It's been 14 months since then, and the dollar's position seems even grimmer. Can't the U.S. government find a way to grant the pardon that would prevent the dollar's demise?
Louis James: This is one of those times when you hate being right. The short answer is no. The slightly longer answer is that while some actions might help the dollar, those actions won't prevent pain in the near future and they aren't politically viable anyway. It would mean embracing the pain the market doles out to people who make bad decisions, and those in government won't want to do that. That's not just my supposition or theory. You can see they're doing the exact opposite of what needs to be done; they're creating more debt, more "bubbliness," if you will, which is exactly what got us into this situation in the first place.
TGR: Doesn't "embracing the pain" for bad decisions point to the financial markets as opposed to the government?
LJ: Yes and no. The people in financial institutions caught in the subprime mess, for example, took risks, and one could argue that they deserved what they got. But it was the government that mucked about with interest rates and rules, and made those risks look sensible. Truth be told, I think all of this is a multi-decade long problem, a series of bad decisions, misallocations and distortions by government intervention in the marketplace that has serious consequences. Trying to put the pain of correction off longer only delays and exacerbates the inevitable.
Look at graphs and charts of these deficits. Look at the latest Treasury auctions—another $80 billion this week. The U.S. government is on track for another trillion-dollar deficit year. Not a trillion-dollar budget, a trillion-dollar deficit. These numbers were unimaginable to most people just a couple years ago. But you borrow that much, you create that much new currency, and the consequences are, as the saying goes, "baked in the cake."
TGR: We already have this trillion-dollar bailout, though. What could be done going forward?
LJ: They could stop. They could let the market correct the mistakes. But as I say, it's politically not viable. Because to actually do what needs to be done—to stop borrowing, cut down on debt, start producing more than we consume, put our financial house in order—would mean embracing the pain. It works the same way on a micro level in the family: sometimes you have to embrace the discipline, downgrade your lifestyle, stop dining out so often, stop going to movies all the time. Don't spend more than you make. That's what the overall economy needs. It's really no different just because it's larger.
But that's not politically viable. Nor is defaulting. Imagine the leader of the world's great superpower going on TV and saying, "Oops, sorry; we're not going to pay our debts." So the politicians are stuck doing things that sound good to the mass of voters but make things worse.
TGR: There's a lot of talk these days about being in recovery, we're seeing some good economic news coming out, and Warren Buffet just put a big bet on the U.S. by buying Burlington Northern. What do you see in the economy that they're missing?
LJ: Let's get to basics. None of the fundamental problems in the economy that caused the situation have been fixed. In fact, as we've just been discussing, the government's actions have exacerbated them hugely. So what are the grounds for being optimistic? I think politicians encourage people to forget the fundamental reality that a society, just like a family or an individual, needs to produce more than it consumes in order to get wealthier. (Well, there's war for plunder—or theft, on the personal level—but that causes a net loss of wealth overall.)
Pundits confuse people with talk about confidence. They say that with confidence restored, people will spend again, there will be jobs again, everything will get going again and we'll be fine. All we have to do is restore confidence. But it's not true; you can't buy groceries with confidence.
It's a shell game, a distraction. Confidence comes and goes, ebbs and flows. But in reality, either people can pay for goods and services or they can't. Either their production exceeds consumption or it doesn't. That's the key. If production exceeds consumption, you save, you accumulate wealth that can be used to create new businesses, to build new things, to hire more people. That—capital pooling—is what gets an economy going.
TGR: How can you explain how the market continues to rally?
LJ: Well, as the saying goes: the market can remain irrational longer than you can remain solvent. I should say that we at Casey Research have been on the wrong side of the market the entire year, because we've looked at the fundamentals of the economic situation. We have seen a) no improvement and b) the government doing the opposite of what needs to be done for there to be improvement.
So we've been cautious. We made money; we bought when we found picks that looked undervalued, and certainly our oft-repeated call to buy gold has worked out very well. So, we're okay; but we'd be a lot more okay if we had ignored all the fundamental evidence of where the economy is headed. It's kind of ironic. Had we jumped on the bandwagon and deployed cash more aggressively—not to say foolishly—we would have made a lot more money. Instead, we've been calling for more correction, and still are.
TGR: Are you looking for another leg down that's as significant as the first or just for a more typical market correction?
LJ: Bearing in mind that it's a good thing to have a daily dose of humble pie, yes, our consensus is that there's a lot worse to come. We see another and bigger leg down. The dollar, in particular, is headed way lower. The government deficits and what's happening with the money creation is all very bearish, more serious than ever, and that's really bullish for gold—at least as long as it's priced in dollars. But other governments are behaving similarly, and that too is bullish for gold.
TGR: Just for gold?
LJ: Our mid- to longer-term view on base metals is actually quite bullish, as well. The growth coming in China and India over the next 10 years is a major factor. But another serious leg down would knock the stuffing out of anything to do with industry, including the base metals, at least for the short term.
TGR: You recently noted a paradox of investing in gold—that is you buy the physical gold for safety and you buy gold stocks for its risk. Can you explain that?
LJ: As we've been discussing, gold has excellent speculative potential right now because of the destruction of the dollar. If dollars lose 25%, 50% or even 75% of their current value in a few years, that's very bullish for gold. But if that happens, we'll have a lot of economic turmoil, which is the real reason to own gold. No matter what happens, gold is still going to be gold. It's the only financial asset that is not simultaneously someone else's liability. It is not a piece of paper; it's not a promise from somebody else. It's a physical thing you can hold in your hand, and if push comes to shove and you have to hop in your car and go down the street and buy food for your family, somebody will give you something for your gold because they recognize it and value it. In extremely volatile times, you want that security.
Gold stocks are almost the polar opposite in terms of security. They are highly, highly speculative. Most gold companies don't have any gold; they are exploring for gold or developing projects that they hope will be economic. Only a few actually produce gold, and even the biggest producers are highly volatile, because the price of their product fluctuates constantly and strongly. So does the price of the electricity they use to produce it. All kinds of things fluctuate so much that these businesses—even the biggest ones, Barrick Gold Corp. (NYSE:ABX) and Newmont Mining Corp. (NYSE:NEM)—are so risky that traditional securities analyses, a la Graham & Dodd, just don't apply. This isn't investing; it's speculating. You want the wild fluctuations of the volatile commodities market to create opportunities for big wins.
TGR: And juniors would be even more speculative. Haven't you compared them to burning matches?
LJ: Most of them are explorers with no substantial assets. All they have is money in the bank (hopefully) and an obligation to spend it trying to discover something. If they do make a discovery, they go from having literally nothing but a geologist's dream to having something of measurable value. The difference in valuation can be huge; this is how it's possible to get 10-baggers or even 50 times your money on one of these stocks.
The odds in any case are quite long. Even when you find a gold prospect, going from having a gold anomaly to a producing mine of any size, even a small one, the odds are something like 1 in 300. If you're knowledgeable and put a lot of effort into it, you may improve those odds, but the odds remain long. This is where the burning match comes in. The company burns through its money in the hope of finding something of value before the fire hits its fingers.
TGR: But the rewards can be commensurate with that risk.
LJ: Absolutely. The juniors' very volatility provides the opportunity to have enormous wins. But you have to understand it's a high-risk proposition. You can apply intelligence to reduce the odds, and you can diversify your risk. Whether it's your overall speculative diversification, or whether it's within an area such as gold stocks, you don't just want to buy one company. It works best if you have a portfolio of companies.
TGR: Any other techniques for improving the odds?
LJ: You tilt the odds more on your favor by betting on trends. If you didn't know anything about markets, if you had no idea whether gold was likely to go up or down, if you just liked gold and wanted to throw darts at the board, that would be pretty much pure gambling. But we have all this evidence we've been talking about regarding the economy to support the idea that gold is going to go up. A rising tide tends to lift most ships. If you pick the most seaworthy vessels with the most experienced management at the helm, assets of value already in hand and so on, you can do better than those 300-to-1 odds.
TGR: How about helping us wade through some of those juniors that have better assets in hand and better management, some that you're telling investors to watch because you feel good about them?
LJ: Okay, but with a caveat emptor. With gold higher than $1,000 for some time now, the market has grown quite heated. In 2007 and 2008, before the jitters, the market was overvaluing a lot of companies, practically anything with "gold" in its name. Some of these companies didn't even have any assay holes drilled into their prospects; all they had were theories and hopes, and they were trading for tens of millions of dollars. Since last fall's crash, there's been quite a separation of wheat from chaff, and many of the companies that had nothing but theories or hopes have not recovered significantly.
But many of the companies with assets of potentially bankable value have had great recognition. Many have not only recovered but have soared to new highs. That's not a bad thing, but it means that the companies with the best potential are not particularly cheap. But as we saw last fall, gold wobbled and came back strongly and quickly, while the gold stocks took a huge hit and took months to come back. That will happen again in another market correction. So maybe these not-particularly-cheap companies are cheap in terms of where they could be a year or two from now, but if you buy heavily now, you're at considerable risk of flubbing the first half of the "Buy Low, Sell High" dictum.
At $1,000 gold, maybe $1,100 gold, people are getting excited and their buying is pushing prices up. I think gold will go much higher, but I don't know that it won't go lower first. Those who are psychologically disposed to follow the herd—nobody wants to think they are, but be honest with yourself—have to ask themselves whether they have the intestinal fortitude to resist selling if your shares drop strongly, for no company-specific reason, before the eventual payday.
Imagine a person who bought, say, in May 2008, when the market was near an interim top. You know how would they feel in October 2008, when it just kept falling and falling and didn't look like it was ever going to stop. Most investors think 5% to 10% is a big fluctuation. To see a stock drop 50% in short order is inconceivable to them; they panic when it keeps falling from there. It's very difficult for people to hold on and say, "This retreat is not justified—I'm not selling." Actually, the thing to do last October, November and December wasn't just to hold, but to buy. People who bought then made so much money it's not even funny.
TGR: So are you saying that smart money right now should stay in physical gold until some of the frothiness subsides?
LJ: If you're psychologically predisposed to being nervous about your investment, and you know you'd have a hard time dealing with a drop of 30%, 40% in a month or two, maybe this is not a good time to be buying speculative gold stocks. That having been said, if you stick to quality companies, buy an initial slice of your ideal position now, and fill out the rest of your position at a lower average price if it fluctuates downward, and you preclude the possibility of missing out on a stock that takes off. But you have to believe in your picks strongly enough to see a sell-off as a buying opportunity.
Our general recommendation right now is to focus on the best of the best. Everything in the International Speculator portfolio has resources drilled off that can be defined by one of the regulation-complaint categories or another. And it's all gold and silver right now.
TGR: Okay, with that big caveat on the table, what are some of the companies that have the resources and management that represent the best of the best?
LJ: Right. Well, we really like AuEx Ventures Inc. (TSX:XAU), which may have Nevada's next low-cost gold mine at their Long Canyon project, joint-ventured with Fronteer Development Group (TSX:FRG) (NYSE.A:FRG). It's got great metallurgy. It's got great mine construction and operation characteristics—there's a nice flat place to put the plant and it's near roads and power. The deposit starts right at the surface so they can mine it in a low-cost open pit. There have been a lot of positive drill results since the last resource estimate, so it's going to get bigger and confidence in the known ounces will increase. How much? Who knows? It could be 50%, or more—or less—but it will be significant.
Long Canyon has a lot of positive characteristics, and it's just their main property. Another AuEx property right nearby Long Canyon is called West Pequop, a gold project being drilled off by Agnico-Eagle Mines (TSX:AEM). There's no official resource estimate there yet, but there's been enough drill success that you know a resource is coming. AuEx has projects in Argentina and Spain where other companies are spending the high-risk money, looking for a discovery, so it looks very good. And in terms of a company that can survive—they've got money, they've got real assets, they've got great management. We're very confident this company will make it.
TGR: Who else might be among the best of the best?
LJ: International Tower Hill Mines Ltd. (NYSE/AMEX: THM; TSX-V:ITH) has a huge gold resource in Alaska they're drilling off. It's not particularly high grade, but it's got good grade for an open pit, and it has a higher-grade core. And it keeps getting bigger and bigger. It's got a lot to prove before the project can be put into production, and it's trading near an all-time high, so you might say, "I don't want to buy now; that would be buying high." You'd be right to think that if there's a correction in December or January, this thing could come off quite significantly. It's huge; it's getting bigger; it has the right characteristics to keep going, but it's early stage. But whatever happens in the short term, if the company is successful, the value they create will be much greater than what the company's trading for now. So you'd have to see it as cheap compared to where it looks headed, not where it's been—and go in confident that if it retreats (barring any specific company bad news, of course), you can average down or hold out for the eventual payday.
TGR: Any others you'd like to tell us about?
LJ: On a slightly more speculative note, Andina Minerals Inc. (TSX-V:ADM) has a very large project in Chile, which is a good mining jurisdiction. It's not particular high grade and the market doesn't seem to understand this deposit very well, and so it's selling quite cheaply right now. We've not been able to find a fatal flaw or any strong reason why these ounces should be selling cheaply. There is a national park nearby, but not significantly nearer than the Refugio Mine, which got permitted. Going there and kicking the rocks ourselves to see if we can figure this out is on our to-do list, but from what we can tell so far, unless we've missed something, this company is undervalued. And not a lot of things are undervalued in today's market.
Inter-Citic Minerals Inc. (TSX:ICI) (ICI.TO) is an interesting one as well. The company has a significant gold resource and terrific exploration success. The company's Dachang project in Qinghai province, China, has yielded a very bullish preliminary economic assessment. The internal rate of return was well in excess of 40% and the net present value was four or five times what the market is giving the entire company. But when they released the study, the market gave them nothing for it, and I have to admit I'm not sure why. They did drop the grade of the deposit when they came out with a more rigorous resource estimate, which could be a contributing factor—but in doing that, they increased confidence in the quality of the model.
One of the things I really like about Inter-Citic is the exceptionally high correlation—something like 90%—between samples from surface soil anomalies and the trenches. In other words, where there's a soil anomaly they've been able to dig through the dirt and find gold in the bedrock. Then they come along with the diamond-bit truth machine, and the drilling also has correlated in excess of 90% with trench results. And there are a lot of gold anomalies not yet tested. So it's a great exploration success story with a lot more potentially to come; there's a lot of gold at Dachang.
TGR: Have you kicked the rocks there?
LJ: I have. It's a very interesting place, near Tibet. It is a refractory deposit, which is more expensive to process, and it's at a significant elevation. It's in a very remote part of China, too, but road building is cheap there and there are no regulatory hurdles. In fact, they have something like a 30-year mining lease already, so there are reasons to be cautious about the economics, but they do have a positive study and seem undervalued.
TGR: Any others you're watching?
LJ: We like Royal Gold Inc. (TSX:RGL, Nasdaq:RGLD). Most companies languished for months after the crash last fall and started coming back in March or so. Royal Gold recovered almost immediately. The reason, I believe, is that it isn't an exploration company. It's not even a producing company. It's a royalty company, with insignificant operating costs. Because its revenue is very much tied to gold, Royal Gold snapped back very quickly last fall when gold snapped back. The company recently reported record revenues and some of its juiciest royalties are yet to come online. It's a leveraged bet on gold. If you're bullish on gold, you buy a stock like Royal Gold, stick it in a drawer, and forget about it until the top of the market.
TGR: Which could be several years away. Let's hope. Any silver companies on your list of favorites?
LJ: We still like Silver Standard Resources Inc. (NASDAQ:SSRI), Silver Wheaton Corp. (NYSE:SLW, TSX:SLW) and Silvercorp Metals Inc. (TSX:SVM). Silver Wheaton is more of a royalty company than a producer, but all three have huge leverage to silver and huge attributable silver resources. Silver companies trade at even more ridiculous multiples than gold companies, and these are all up-and-coming stories. They're relatively expensive, too, but I can easily see them trading at much higher multiples a year from now.
Being a royalty company, Silver Wheaton has no mining risk. It just has revenue from the silver by-product of other companies' mines. Silvercorp has a super high-grade mine that makes money in almost any market. Silver Standard is probably the riskiest of the three because it's only just gone into production. If they fail to produce economically, they'll get whacked. On the other hand, that adds more leverage. They have something like 1.7 billion ounces of silver, and the market is valuing most of those ounces in the same way as an advanced exploration company. If Silver Standard can prove that it can produce profitably, those ounces could be revalued substantially, and this stock could very easily see a higher multiple than the other two. Or not—but that's what speculation is about.
TGR: Silvercorp, which is in production now, still represents some upside. Is that because you're expecting the price of silver to have a higher multiplier than gold? Or is there something unique about Silvercorp?
LJ: Silvercorp has very large resources of a very high grade, resulting in highly profitable operations. It's an extraordinary find they have at the Ying Mine, their flagship operation. The average head grade is still well over a half a kilo of silver per ton—that's after mining dilution and everything that happens getting your ore out of the ground and to your processing facility. That's very good. The fundamentals are there for Silvercorp, limiting the downside risk. Before the crash, the company built a new mill that could triple its production—and then put it immediately on mothballs because it was completed at about the same time the market tanked. They wrote it off, so they took a hit—which was a great buying opportunity—but it creates a special situation now; if they can ramp up again and put it back into use now, it's basically a free mill and thus very bullish for their bottom line.
In addition, because the whole project was so high-grade, Silvercorp was able to finance their mine building out of their exploration by-product. They were exploring by drifting (tunneling) along the mineralization, and were able to take the profit from that to pay for sinking shafts and digging more tunnels. They built their mine without a formal feasibility study or formal proven or probable mining reserves. Very cool, but here's the thing: the project has matured to where Silvercorp can produce formal proven and probable mining reserves. That will change the game, because there are some institutional investors that cannot invest unless a company has P&P mining reserves. According to the U.S. regs, those shady measured and indicated resources Canadians use don't even exist. According to the U.S. SEC, unless you have proven and probable mining reserves, you have nothing. So when Silvercorp can start reporting a very high-grade asset, it will change the dynamics of their market.
On top of that, they're bringing a new mine into production. If silver prices remain high, they can easily triple their output. The average grade may go down, but the overall revenues will go way up. I see a lot of upside here, with many years of mine life left at the super high-grade Ying mine to minimize the downside. If worse comes to worst, they can still keep cranking cash out of Ying.
TGR: What else are you keeping your eyes on?
LJ: We've had a really good lithium play that we made a lot of money on, and also a really good win in a rare earth play. These are more speculative things; but I bring these up because there's a lot of interest in lithium now. It's become quite the flavor of the day, and it seems that all sorts of companies are discovering they have rare earth potential in their property portfolios. Many are changing their business plans to become rare earth or lithium companies. There are good fundamentals there for the longer term for both of these specialty metal areas, but valuations for companies in these sectors just went nuts this year.
My main concern with some of these trendy metals is that you have a really hot sector with really big wins with some of the stocks, but the underlying commodity price hasn't actually changed much yet. There's this idea that all these electric and hybrid cars are going to increase the demand for lithium and rare earths, and that's probably true. It's a reasonable speculation, but it's a multi-year idea, and the price of lithium has not really taken off yet, while some of the rare earths have actually dropped in price recently.
Economic concentrations of it are not an everyday occurrence, but lithium is not a rare metal, either. There's plenty of lithium around, and the current producers have huge resources. I've heard that there were times when SQM (NYSE:SQM) in Chile, a top lithium producer in the world, actually returned lithium to its Salar de Atacama because they were producing more of it than the market needed. So it might be that the existing lithium producers can turn on the spigots faster than we think and wipe out all these new companies.
TGR: Can they go back and mine that back out when the lithium market goes crazy?
LJ: Absolutely. It's not really even mining. A salar is a salt lake. It's got water underneath, so the lithium is still in the water, in solution; they just pump it right back out again. That's what makes these salt brines so cheap as opposed to mining lithium out of hard rock. You pump it out into a big evaporation pan. The sun evaporates the water and concentrates the lithium for you. That does take two years, though; so, if they turn on the spigots now, it will be two years before they get more concentrated lithium.
TGR: So, there might be a short-term bubble between supply and demand.
LJ: There could be. But how much under-utilized capacity do they have now? How much can they ramp up? There's a lot of debate about these are questions. Companies have an incentive to hint that supply might be constrained so they get a better price.
Experience in physics, economics and comprehensible technical writing all contribute to Louis James' popularity as senior editor of the International Speculator and Casey Investment Alert. He is also the interviewer for the weekly free e-letter, Conversations with Casey. Fluent in English, Spanish and French—and conversant in German and Russian to boot—Louis regularly takes his skills on the road, checking out highly prospective geological targets and visiting with explorers and producers in the far corners of the globe.
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1) Karen Roche, of The Gold Report, conducted this interview. She personally and/or her family own none of the companies mentioned in this interview.
2) The following companies mentioned in the interview are sponsors of The Gold Report: AuEx Ventures Inc. (TSX:XAU), Royal Gold Inc. (TSX:RGL, Nasdaq:RGLD), Inter-Citic Minerals Inc. (TSX:ICI) (ICI.TO)
3) Louis James - I personally and/or my family own the following companies mentioned in this interview: None at this time. (But that's because I took profits and am looking to buy back in at lower prices. I believe in eating my own cooking.) I personally and/or my family am paid by the following companies mentioned in this interview: none.