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James Passin: The Feedback Loop
Source: The Gold Report; interviewed by Karen Roche, Publisher (11/20/09)
Today's extraordinary loose monetary conditions are "benefiting hard assets," according to James Passin, co-founder and manager of Firebird Global Fund and Firebird Global Fund II. Surplus liquidity is flowing into ETFs that buy commodity futures and physical commodities, which James says, is "creating a feedback loop" that is driving up the price of resources. James discusses gold's momentum, as well as its associated near-term risks and shares some hot companies and sectors he's following right now in this exclusive interview with The Gold Report.
James Passin: It was clear to me at the end of 2008 that we were at the beginning of a powerful and lasting recovery in commodity prices and resource stocks. I think that the structural fundamentals are in place to support further increases generally in commodity prices.
TGR: This year we saw, basically, all positions and all sectors increase. What would cause just an increase in the commodity pricing going forward vs. all the other sectors?
JP: We have had a rally in all assets, but hard assets also are benefiting in particular from extraordinary loose monetary conditions. Surplus liquidity is flowing into commodity products like exchange-traded funds (ETFs) that are buying commodity futures and physical commodities, creating a feedback loop, which is driving up the price of resources. But what we thought is that this would be a great year for resource stocks based on our view that capital markets would start to reopen. Resource companies tend to be capital-hungry. So as the cost of capital comes down and as capital becomes available, resource stocks tend to outperform resource prices. At the same time, last year there was a dramatic reduction in issuance of stock by resource companies. This has resulted in a highly bullish environment for resource stocks. But we are concerned about the recent changes in the nature of market sentiment.
TGR: You say you note a changing tone, generally. What's changing?
JP: It's interesting to ask how long these extraordinary loose monetary conditions will continue to exist. At what point will the Fed take the view that the financial system and the economy can withstand tighter monetary conditions? Perhaps it seems unlikely with unemployment at 10%. It also clearly in everyone's interest to allow asset bubbles to develop to enable banks to rebuild their equity through generating profits. But any significant tightening of monetary conditions could undermine the commodity markets in the short-term. There is also a dangerous structural element to the market represented by the ETFs.
The ETF prices increase when the gold price increases and as demand for ETFs increase, then the ETFs actually go out and buy more gold. This is creating a feedback loop. The obvious concern is what happens when it goes the other way, if the gold price actually started to weaken and the ETFs start to sell, creating a negative feedback loop. When I referred to the different tone, I was really referring to the increased level of confidence that I'm observing among gold bugs and to the wave of financings that's coming out of the gold space. A lot of marginal gold companies are getting financed. Gold has shifted into a momentum phase that is generally characteristic of a topping process.
TGR: I think the most interesting thing that's happened in the past week is the government of India buying 200 tons of gold from the IMF. People are saying, is China next? So when governments start buying that volume of gold, is there really an issue of gold being vulnerable?
JP: Looking at the history of Central Bank gold trading habits generally would suggest Central Banks are horrible gold traders. Central Banks were happy to sell gold under $300. The fact that that Central Banker mentality is shifting is arguably a sign of capitulation. There is other evidence of capitulation. For example, Barrick Gold Corp. (NYSE:ABX), the pioneer and big proponent of gold hedging, bought back a significant portion of its outstanding hedge book at a massive loss. Whatever happens to gold in the short term, the gold price will tend to rise over time as long as we have the fiat world currency system.
TGR: You mentioned that gold is hot—it was about $1,145 today—has that overshot the value of the market at this point?
JP: It's hard to say what the fair price of gold is. I think that gold is vulnerable and maybe it will experience a violent correction from a higher level. I'm not an investment advisor and I don't provide investment advice, but personally I think that owning some physical gold makes sense. However, unless you're a very good short-term momentum trader, it's strikes me as a dangerous time to be heavily long gold.
TGR: During 2009 the equities outperformed the commodity, which is the reverse of 2008. So are we at a point now where gold stocks are overvalued relative to the commodity?
JP: A lot of gold stocks seem undervalued, but there's a huge financing pipeline. It depends on your view on the gold price.
TGR: Can you share with us some of those gold stocks you feel are undervalued?
JP: I would mention one special situation that is intriguing: Vangold Resources Ltd. (VAN:TSX.V). I serve as a non-executive director of Vangold, so I am not going to make any statements about the company, but what I will mention is that the company is breaking up into an oil company and a gold company. The gold company has highly interesting exploration properties in Papua New Guinea. PNG is elephant country for gold; it may be worth taking a look at it in the context of the imminent restructuring of the company.
TER: What other commodities or resource areas are you following?
JP: We're very interested in strategic metals and minerals, which would include not only rare earth metals, but other metals and minerals that have critical applications in the energy, military, and industrial sectors.
TER: Can you highlight some of those for our readers?
JP: We've been trading some of the rare earth metal stocks; for example, Avalon Rare Metals (TSX:AVL) and some of the other rare earth metal plays. It's a space we've been following for the last five years. There's been renewed investor interest in rare earth metals, but several commodities with similar fundamentals have been completely ignored by investors.
TER: What are those and why haven't they received the attention? Is the market place too small for it? Are they just not well known enough?
JP: Oddly, there has been tremendous interest towards very small markets, so I do not believe that size is the issue. We anticipate that investor interest will continue to move across the periodic table. One of our key areas of interest is beryllium. Beryllium is needed in certain parts inside nuclear reactors. It's also used in various industrial and military applications.
There's a company called IBC Advanced Alloys Corp. (TSXV:IB) that is emerging as a leader in beryllium. Firebird and Vangold founded the predecessor company. One of IBC's initiatives is its joint venture with Purdue University. IBC and Purdue are developing beryllium-uranium mix oxide fuel technology, which has a potential to revolutionize nuclear power by creating a safer and more efficient fuel.
Mixed oxide fuel has the potential to solve the two major issues of nuclear fuel, one of which is the tendency of nuclear fuel rods to crack before all of the energy is extracted. The other issue addressed by beryllium is improving safety by eliminating the theoretical risk of overheating. By reducing wasted fuel, IBC could offer nuclear utilities the means of saving billions of dollars on a cumulative basis.
TER: Is there a government regulatory process that this new fuel would need to go through?
JP: Absolutely. In the United States it's governed by the Nuclear Regulatory Commission. IBC is providing the funding required to move the approval process forward. It's going to take several years to test it in a test reactor and to get the licensing and permitting. I don't anticipate that this is going to be a commercial product before four to five years.
TER: I'm going to switch over to uranium here just because you happened to bring it up. In the past you've been very pro uranium. Uranium seems been put on the back burner. What's your feeling about uranium now?
JP: I'm pro uranium in the sense that I believe in its merits economically and politically and we do have some investments in uranium exploration in mining companies. But it is important to acknowledge that the uranium bubble is dead. With that said, there are some interesting companies.
TER: Are there any you can share with us?
JP: I'll mention two. Mega Uranium Ltd. (TSX:MGA) and UEX Corp. (TSX:UEX ). Cameco Corp. (TSX:CCO) owns 21% of the shares of UEX and UEX is partnered with AREVA (ARVCF:OTO), the French nuclear giant, which is the world's second largest uranium producer, on its Shea Creek uranium exploration property. Shea Creek has produced spectacular high grade intersections over startling widths. My view is that UEX will most likely be taken over either by Cameco or by another nuclear industry participant.
I think that Mega Uranium looks interesting right now. The company just did a financing, which has depressed the stock. Mega's strategic partnership with Japan Australia Uranium Resources Development Co. Ltd. and ITOCHU, the Japanese syndicate, is a very promising development for the company.
TGR: I know you recently returned from Mongolia. Can you give an update on what you found over in that section of Asia?
JP: Ivanhoe Mines Ltd. (NYSE:IVN, TSX:IVN) , the Canadian exploration company, finally executed an agreement with the Mongolian government with respect to the development of Oyu Tolgoi, the world's largest undeveloped copper mine. This is a massive mine that will generate $5 billion of revenue per year for over 50 years. While this a positive development of Ivanhoe, a stock that we've been trading from the long side all year, it will be much bigger story for the Mongolian stock market.
Mongolia GDP is only about $5 billion, so Oyu Tolgoi, or OT as the mine is called, will transform the prospects for employment and per capita GDP growth. A great wall of domestic liquidity will support the local stock market, creating a new bull market which will last for decades. The local stock market currently has depressed valuation and almost zero liquidity Mongolia has structural similarities to other emerging markets that started out with very low market capitalizations, such Vietnam or the smaller Gulf states. There's 24mineral projects that have been deemed strategic by the Mongolian government and that represent potential sources of commodity exports.. The Ivanhoe deal marks the beginning of the Mongolian mining boom and I think the most leveraged long-term way to play this mining boom is through the local stock market.
TGR: How does an individual investor play the boom through the Mongolian stock market?
JP: There are no restrictions on foreign ownership of stock and the currency is freely exchangeable. It's easy to open up a and fund brokerage account. The hard part is finding shares to buy because the market is very thinly traded. It's possible to get a small amount of stock from time to time, although the entire market capitalization is only $500 million and the free float is much smaller. I think that it's certainly worth taking time to do a little bit of research and look at some of the larger stocks that are listed on the Mongolian stock exchange.
TGR: You mentioned there are 24 mineral projects and the big one is Ivanhoe with copper. With the recession worldwide, would we expect to see any return from anything in Mongolia for the next five years?
JP: The copper prices had a massive recovery. OT would be profitable at current copper prices. And Mongolia has other commodities, including coal, uranium, and iron ore.
TGR: Thanks so much for your time today, James.
Describing him as "the Indiana Jones of frontier stock markets," the Financial Times praises James Passin for visiting "rough, difficult places…rather than swanning around the more comfortable nightclubs…" A graduate of St. John's College, James majored in philosophy and classical literature. He is a former editor and research director at investment newsletter Taipan. James Passin co-founded and manages Firebird Global Fund and Firebird Global Fund II. James serves on the Board of Directors of National Investment Bank of Mongolia; Vangold Resources, Ltd., a company listed on the Toronto Venture Exchange; Sharyn Gol, a coal producer listed on the Mongolian Stock Exchange; and Maghreb Minerals PLC, a mineral exploration company listed on AIM. He also serves as a director of several private, venture-stage international resource companies.
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: Mega Uranium (TSX:MGA), Vangold Resources Ltd. (VAN:TSX.V)
3) James Passin - I personally and/or my family have direct or indirect exposure to the following companies mentioned in this interview: Vangold Resources Ltd., UEX Corp., Mega Uranium Ltd., IBC Advanced Alloys.
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