James West: Unrestrained Bullishness for Gold and Silver

The Gold Report: James, it seems every time we talk to you, something new is happening. You started off with the Midas Letter in 2008, started the Midas Letter Opportunity Fund this year, and now, you're embarking on the structuring of two additional funds before you've finished raising the money for your first fund. What is your objective in all of this?

James West: Well, first off, let me say that I'm just walking through the doors that seem to be opening for me as a result of the good luck and success of the Midas Letter. When we began circulating the idea of the Opportunity Fund, we envisioned raising no more than 10 million (M) Euros, which is roughly CAD$13.6M, because we only wanted to participate in selected seed and pre-IPO investment rounds of TSX Venture–listed resource deals. We found the participation appetite from our immediate universe was easily double that. Then an investment advisor who represents Chinese groups approached us with the idea of mirroring the Luxembourg fund in China for Chinese high net worth investors. That just wasn't feasible, given the obligation we now have to our unit holders in the Opportunity Fund. Plus, the Chinese investors wanted to put in a starting figure of $200M. We put on our thinking caps, and came up with a fund framework that serves the objectives of all the involved parties. My stated mission for Midas Letter all along has been to use the letter to establish and perpetuate a global platform for the marketing of high performance financial products of any stripe. With the Opportunity Fund, we have the small, high-speed Formula 1 vehicle we need to position our group in the best early stage deals, and provide unit-holders with the first right to finance follow-on financings. For the resource company entrepreneurs, involvement of our fund means non-brokered financings held by much longer time-horizon, European high net worth private family offices. That, in turn, means lower average cost of capital, and at the end of the day, better valuations and retained earnings.

So now, with our Chinese partners and some others, we are developing the Midas Letter Gold Capitalization Fund, which will lend capital for last-mile construction, or pre-feasibility stage, resource projects that are repaid from the commodity stream of the project. For example, we lend company x, which is building a gold mine, $80M to get through bankable feasibility and carry it to the point where it can access conventional debt financing, and we are repaid in a portion of the gold production.

So then we decided to create the Midas Letter Gold Bullion Trust, which will be held in a vault on Guernsey Island, and which will purchase the gold from the Capitalization Fund, refine it ourselves, and hold it in tax-optimized, independent yet British-protected Guernsey Island, in a Bank of England-approved, Lloyds of London-insured vault, with in-and-out fees of 1% and annual management of 0.5% annually. It will be the lowest cost physical bullion trust in the world where owners will be the registered owners of the gold held.

So by participating in the precious metals asset class from exploration to bullion trust, we will be optimally positioned to bring financial products to investors as the global economy moves closer and closer to a gold and silver-linked single currency. That is what we think is the inevitable result of the race to devaluation that is currently underway among all formerly prosperous nations.

TGR: So it sounds like you are quite bullish on gold.

JW: My outlook for gold is best categorized as "Unrestrained Bullishness."

TGR: So just gold, or gold and silver? What about base metals?

JW: For me, the risk of the bloom coming off the copper rose is too high right now, and so our funds have liquidated all copper holdings. Codelco is seeing order cancellations from European customers, and the Chinese demand for copper is not expected to grow, which means the former shortage of copper is quickly going to become a glut of supply and excess of production, no matter how much Goldman and J.P. Morgan and HSBC bury in their warehouses.

Now I caveat that with the recognition that Goldman Sachs has come out very positive for copper, despite global weakness. And now that Helicopter Ben has taken it upon himself to stimulate every other economy in the world with U.S. dollars as his hair-brained solution to solving his own simmering debt crisis, there is likely a strategy being rolled out here that essentially means all that excess U.S. dollars are going to be used to stockpile commodities like copper, because what else is there?

I think copper price weakness is the canary in the coalmine showing that even the Chinese machine is starting to seize up.

TGR: So no to base metals, yes to gold. What about silver and platinum?

JW: Well, first and foremost, I love silver. I agree with Eric Sprott in his assessment that silver is the investment of the next decade. At some point, the daily interference of government-sponsored market manipulation in the futures and options markets of commodities, and most recently stock index futures, must come to an end. As it does, silver will finally be free to reflect the pent-up investment demand that the compromised futures marketplace masks. Silver should explode to the upside, and I have no hesitation in predicting a near term 30:1 price ration in terms of number of ounces of silver it takes to buy an ounce of gold. That implies a silver price of $60/ounce (oz.) if gold is trading at $1,800/oz. And I think we'll see that at some point in 2012.

There is going to be an explosion in demand for monetary metals, and many people forget that platinum is a monetary metal as much as gold is, and, at its current price, is seriously lagging its decade-long trend of out-pricing gold by a large margin. Platinum has averaged around $400-$420/oz. higher than gold in the last 10 years, but while gold has risen by 32% this year, platinum has increased in value by only 5%. And let's not forget that the political situation in South Africa is becoming increasingly hostile to foreign mine ownership, so you can expect investment in mine-dependent infrastructure to go wanting where it is already in a decrepit condition. That will negatively impact global supply, and thus put upward pressure on platinum prices, in the long term. If the demand for gold is based on value preservation, then platinum serves that function just as well.

But for gold, the demand is steady and relentless. Large capital positions are realizing that the very best wealth preservation strategy lies in holding physical bullion. People who say gold doesn't return an investment profit are incredibly myopic. Its just rubbish to say something like that about a commodity that, if invested in 2001, will have returned 500% over the last decade.

TGR: Okay, what about the stocks? It seems the producers have been underperforming gold, and the explorers and near-term producers have been losing value steadily.

JW: Yes. . .in terms of the producers, we're starting to see the advent of a phenomenon that essentially demonstrates the idea that, after a certain point, a gold company like Barrick Gold Corp. (ABX:TSX; ABX:NYSE) or Newmont Mining Corp. (NEM:NYSE) or AngloGold Ashanti Ltd. (AU:NYSE; ANG:JSE; AGG:ASX; AGD:LSE) can't really deliver a lot of shareholder value on the speculative side, because they've got to constantly trade in their equity to replace the ounces they produce, which creates a perpetual wall of paper that tends to limit price beta to gold. So if you're trying to look for less risk by exposing yourself to producers, look to the smaller, up-and-coming producers for better bang for the buck.

TGR: Such as. . .?

JW: Well, like Kinross Gold Corp. (K:TSX; KGC:NYSE), for example. Kinross' management largely has the approach of an exploration company, in that the company is willing to come a lot further down the value chain and, subsequently, the risk ladder, to obtain earlier-stage deposits based on what it perceives, I think, as a future pay-off based on geological theory. Kinross looks to acquire projects that have the potential to become big—really big—like White Gold in the Yukon, or Tasiast in Mauritania, or even in politically challenging jurisdictions like Kupol in Russia or Fruta del Norte in Ecuador.

Kinross is willing to take chances and gamble on their internal strengths, and to me, that makes them the most interesting producer to keep an eye on. I could see Kinross becoming one the bigger producers down the road.

TGR: And the juniors?

JW: Well it is true that the TSX Venture index has been drifting downward steadily since the May highs. And, yes, the senior producers have been underperforming gold. But this past week's sell-off in gold precipitated primarily by Bernanke's "Choke the East with Dollars" campaign is exactly the kind of price action in gold that delays movements into senior miners. Holding the metal is one thing when the price dives—producers seem to react with a greater beta to gold when the price tumbles—so investors are wary.

But in the juniors, despite the general decline of the TSX Venture index, there are some shining examples of incremental price appreciation, and last month's market plunge has inadvertently taken some very high quality companies with it. So there is going to be a pile of money made in the juniors, I think, in the next 12 months, but investors need to be extremely selective.

TGR: So who do you like in the sector?

JW: One of my favorite companies right now is Prophecy Platinum Corp. (NKL:TSX.V; PNIKD:OTCPink; P94P:Fkft), and that's because I think it is going to turn out to be much bigger than the current resource of 10–12 million ounces (Moz.) of combined platinum and gold. Drilling is going to be continuous up there come spring, and that current resource comes from 2.3 kilometers (km.) within a 17 km. land position with multiple surface expressions of the same geochemistry and geology as that which hosts the known resource. So never mind 10 Moz.—I've been to the property several times now and I get the sense that there is great potential for a doubling of that resource.

Another excellent company is Sunward Resources Ltd. (SWD:TSX.V), which just came out with a very large resource in an NI 43-101 report that had indicated resource of 2.2 Moz. of gold, or 3.5 Moz. of gold equivalent when factoring in the copper, and 6.08 Moz. of gold in the inferred resource category, or 7.9 Moz. of gold equivalent. There are nine drills turning on the property, so if the company can bump the inferred resource to indicated, you're looking at 11.4 Moz. of gold equivalent. Sunward is very tightly held by insiders by over 50%, so that means its interests are acutely aligned with those of the retail investor, making it a great investment for risk-tolerant portfolios.

There are quite a few projects in the Red Lake camp in Ontario that are shaping up to be home runs. Gold Canyon Resources Inc. (GCU:TSX.V), Confederation Minerals Ltd. (CFM:TSX.V) and Prodigy Gold Inc. (PDG:TSX.V) are home runs in the making, as far as we're concerned. Gold Canyon is expecting to publish a resource estimate before the end of the year, and since the announcement on Sept. 15 of a 308 meter (m) intercept grading 1.29 grams per tonne (g/t), I think its pretty clear that we're going to see somewhere in the neighborhood of 5-10 Moz. by the time all is said and done on its Springpole project. Gold Canyon has four drills underway there, and it expects to complete 10,000m of drilling before the November freeze-up.

Confederation's Newman Todd is reporting excellent grades from drilling, and recently hit a half meter of 7 oz./tonne, which, though a short intercept, is indicative of the kind of bonanza grade pods that make the Red Lake Mine so profitable. Zero in on the source of those, which in the Red Lake area, tend to increase at depth, and there's going to be a king's ransom paid for that project by somebody big. So far, there's at least 1.2 km. of strike, and remains open to depth, which bodes very well. Also, Confederation has encountered numerous instances of extremely high grade, suggesting that these are not isolated occurrences, but may in fact be representative of a high-grade, structurally controlled system.

Prodigy is not getting quite the amount of attention I think it deserves, considering continued long intercepts at its Magino deposit, like the 161m intercept announced at the end of August that assayed 1.35 g/t, including a 36m chunk that popped up at 2.64 g/t. And that's all infill drilling which will add to the existing resource of 1.57 Moz. The market seems to forget that this is a company with an NI 43-101 Preliminary Economic Assessment that indicates a net present value of $351M and an internal rate of return of 49% with a 1.8-year payback. That's before the current 40,000m program now underway gets factored in. And that's at $1,300/oz. gold price. Plus, the company has a whole raft of exploration targets that have yet to see the business end of a diamond drill. So Prodigy has got it all going on, making it one of the more exciting speculative investments for us.

And I really don't want to miss the chance to talk about Newstrike Capital Inc. (NES:TSX.V). It's shaping up to be a monster, and we have yet to see a new resource calculation from that deposit since Richard Hall and his team started announcing drill intercepts that dreams are made of. Since the company acquired the project in June 2010, it has done nothing but announce stellar intercepts from an area that comprises roughly 10% of the whole strike length. This year alone, Newstrike has announced 120m of 4.6 g/t gold on August 3, 190m grading 3.52 g/t gold on June 27, 112.9m grading 2.51 g/t gold on June 6, and 230m grading 7.51 g/t gold back in April. A classic Mexican gold mine in the making.

Some of the more beat up stocks out there also represent exceptional value at these levels, in my opinion. For instance, Orbite Exploration VSPA Inc. (ORT:TSX.V), which is getting ready to deliver its first commercial shipment of aluminum to Aluminerie Alouette Inc. very soon, has taken the first step in completely game-changing the way aluminum is manufactured, reducing costs by up to 30% by using its patented process to produce five nines purity aluminum from aluminal clays, rather than from the much more expensive bauxite.

And Southern Arc Minerals Inc. (SA:TSX.V), with seven rigs turning in Indonesia, is a real steal at these prices, considering that the company is definitely onto to some very large porphyry action there. It suffered a bit of a hit when its rigs got torched by an unruly mob, which may portend some political difficulties, but looking at the results from the work so far, I think we're going to see some big numbers from Southern Arc.

And I also like Mineral Mountain Resources Ltd. (MMV:TSX.V) which has three potentially company-making projects on the go—two in Ontario, and one in British Columbia—and I think Nelson Baker is going to essentially duplicate, if not exceed, his success at Rainy River with another home run.

I've got a lot more I could discuss with you but I'm out of breath and out of time.

TGR: Thanks James. Your newsletter is still available to subscribers?

JW: You bet, but the price is going up at the end of October!

Midas Letter is the Journal of Investment Strategy of the Midas Letter Opportunity Fund, a Luxembourg-based Special Investment Fund that specializes in Canadian-listed emerging companies in the resource sector with a focus on precious metals explorers and miners. James West is the portfolio and investment advisor to the fund.

Every month, James West's Midas Letter Premium Edition deconstructs the economic and political events of the past and upcoming week, and identifies risks and opportunities to investors seeking to profit while the majority of investors are losing money.

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DISCLOSURE:
1) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Sunward Resources Ltd., Gold Canyon Resources Inc., Prodigy Gold Inc., Newstrike Capital Inc.