The Gold Report: Edward, because you're based in Switzerland, it would be interesting to get your perspective on the Eurozone's new rescue fund, the Eurozone Stability Mechanism (ESM). There is talk in the market that it could get a banking license, which would provide it access to European Central Bank (ECB) funds, aiding it in bailing out Spain and other economies. Do you believe that will happen?
Edward Karr: The idea of the ESM actually getting a banking license was floated recently by ECB council member Ewald Nowotny. The question you have to ask is why would it want to give the ESM a banking license? The answer is leverage. The ESM right now has about €500 billion in it, large enough to handle Greece. But now bond yields in Spain have gone above the critical 7% level and banks in Spain and specific regions of Spain, such as Valencia, have asked for their own bailouts, meaning the whole house of cards is starting to tumble. With yields above 7%, Spain has effectively gone over the event horizon of the financial black hole. A deflationary gravity and negative feedback loop is so strong that there is no return once you go over the event horizon.
Next in line are two countries that are going to give the European governments and global central bankers nightmares—Italy and France. The ESM is just not large enough to handle these bailouts in its current configuration, so it has to be increased. The ECB is looking to give the ESM a banking license so it could leverage up to handle some of these larger countries.
TGR: Recently ECB President Mario Draghi said he would do "whatever it takes to support the euro." Your thoughts?
EK: I believe the ECB will do this. I think that it is going to print and print and print. We're talking trillions and trillions of euros to bail out these countries.
TGR: How does the ECB get around European law that prohibits it from undertaking liquidity measures?
EK: First of all, there will be a big ruling coming in September from a German constitutional court about the ESM's legality. Nevertheless, there are a number of ways the Eurocrats can get around European law. The aforementioned banking license for the ESM will leverage it up; they can also change the law to allow the ECB to lend directly to banks. We're going to see creative solutions and we're going to see a lot more liquidity pumped into the system.
TGR: That is what many economists believe the European economies need. What are your thoughts?
EK: It's really a path of no return and it's going to be very difficult to change course. I don't believe that this is what the economies need. Printing money out of thin air is never positive. What is needed, in my opinion, is for a massive cut in government spending so it does not crowd out the free market. The solution is for government to get out of the way and let the private sector flourish, but that is not happening.
TGR: The Bank for International Settlements is discussing the idea of reclassifying gold from a Tier 3 asset to a Tier 1 asset. That would mean that gold is valued at 100%. How do you think that would affect the gold price?
EK: It would be interesting if that does happen. Historically a bank's gold holdings under a Tier 3 classification have to be discounted 50% of the current market value. So a lot of commercial banks have little incentive to hold gold as an asset because they could only lend out half of it. If the Basel Committee does agree to let banks use gold as a Tier 1 capital, I think it could create substantial demand for physical bullion. That would be an important step toward gold's remonetization, having commercial banks and ultimately central banks hold a lot more gold as reserves on their balance sheets. More bank lending may have inflationary effects, too, which would give physical gold bullion a nice double whammy effect if this happens.
"If the Basel Committee does agree to let banks use gold as a Tier 1 capital, I think it could create substantial demand for physical bullion."
TGR: Marshall Auerback, an economist with Toronto-based Pinetree Capital, wrote in a blog that central banks routinely take hedge positions against their underlying reserve assets but never report the derivative overlay. He writes, "if the European national central bank, with 2,000 tons of gold in its vault, sells forward against that position, basically thereby eliminating it, it doesn't report the corresponding forward position. Consequently, it may be that the official institutions do not have the gold they report to hold on their balance sheets." Do you think that's happening and how would that news affect gold equities?
EK: I think this has been happening for a long, long time. Groups like Gold Anti-Trust Action Committee have done an excellent job documenting this fact. The major central banks around the world have entered into forward contracts to try and gain a slightly higher return on their physical holdings. If central banks were caught short and had to cover, it really could have the potential to send the gold price higher. And this would be a big positive for gold equities.
TGR: Where do you see gold finishing this year?
EK: I think that gold will end 2012 a little lower than the current levels today. So, I'll say $1,500/ounce (oz).
TGR: Let's talk about fear. In the fall of 2011 you said, "When people get scared, markets and stock prices get way out of line. That is when you need to have the courage to really step in and accumulate." Lately it's taking even more courage than it used to, to do just that. Did you expect the fall in the junior mining companies to be this steep?
EK: Actually, no, I did not. It has been such a difficult last nine months with the junior mining sector; since January it has been straight downhill. And I personally don't believe we have even seen the panic stage yet, when there is a Lehman Brothers-type moment, perhaps when a major international bank goes under. We haven't seen that yet, but we're getting close. When it does happen, that is when investors have to step up and accumulate more.
TGR: Can you connect the dots between the instability in Europe and the different debt crises going on and what's happening in this sector and the lack of risk tolerance?
EK: Not directly, but indirectly. Fear is approaching an all-time high. Clients around the world, both individuals and institutions, want to hold on to cash. They want liquidity at all costs. That is hurting the junior mining sector overall.
The second factor is that a lot of people after the 2008 financial crisis requested redemptions from some of the hedge funds. Some did redeem client shares and closed their doors while others did not, leaving customers anxious to get their funds back. Some of the funds that specialized in junior mining stocks are either out of business or they have redemptions; they're in liquidation and they've been forced to sell.
The final factor is that in this sector liquidity can dry up when the prices start to go down. It's a negative feedback loop. As soon as the prices start to go down due to fund liquidations, investors can see their positions go down 30%, 40%, 50%. It's probably going to stay that way for a while until we get some sort of resolution of the crisis in Europe and then ultimately the United States.
TGR: How does RAMPartners, which is a Swiss-based investment management and investment banking firm, become interested in tiny mining equities operating in North America?
EK: The usual way. We get lots of research reports. We get brokers that call us. We do our own analysis. We're constantly out there looking at different ideas, talking to people within the industry, attending trade shows and presentations, etc. We also go on site visits to see the projects themselves. For instance, I was recently in Nevada visiting several companies and seeing their operations.
TGR: Overall, are you still accumulating in this environment? Are you still buying junior mining and junior mining explorer equities?
EK: 100% yes. Everything out there today really looks very, very attractive. This is a fantastic time to accumulate. This is also why in this industry, with its volatility, you always need a pretty high reserve of cash so you can go in and accumulate. One factor that a lot of people in this industry seem to overlook is the potential for declining energy prices in the future. The United States is currently undergoing an energy revolution. More and more oil and gas production is coming on-line due to the unconventional shales. My view is that energy prices are going to continue to fall and we could see crude back to $50 a barrel (bbl). But, for the reasons we've discussed before, I believe that gold will continue to hold firm at around $1,500/oz or higher and oil will go down to $50/bbl, making gold mining companies a good opportunity.
TGR: Gas and diesel are two of the big input costs of the junior miners.
EK: Yes, they are huge.
TGR: You have management teams from different small-cap resource companies coming into your office and pitching you on investing in their companies. What are some things you look for?
EK: First, everything in life is run by human beings. You've got to understand the management; I like to see people who are positive and passionate about what they do. I also like to see management with experience in the industry and a good track record. Finally, I like to see a management team that has invested its own money into the company. I like to see management have a very big equity stake in the company. These are all junior companies so I don't want to see management that is taking large cash salaries and having very high travel expenses and other things like that. Let them put the money in the ground.
TGR: How has your approach changed since 2007, a period in which we've been in and out of a recessionary economic environment?
EK: We're not doing as many deals as we did in the past. During a big bull market, the rising tide lifts all boats. And with a big commodity super cycle, investors could invest in a lot of different companies and most likely the market would bail them out. That's just not the case anymore. We do a lot of research. We really get to know the management teams. We do onsite visits to most of the deals that we're involved in. We do fewer deals but have bigger positions and know the companies intimately.
TGR: Do you believe this is something you're going to continue once the sector picks up again?
EK: We're very opportunistic; if we see the whole sector picking up, if we really start to see investors deploying capital and we think it is sustainable through an economic recovery, then we might start deploying some more cash. Obviously, we'd be looking at other opportunities at that point. But for now, we're going through a very, very challenging time both in the financial markets and in the junior side of the gold companies and explorers. That means that we have to keep some cash reserves out there in case any of our portfolio companies, for whatever reason, might need some money.
TGR: Are you getting more favorable terms from these junior companies?
EK: Without a doubt. Today, if you're an institution that actually has cash and has liquidity and is still writing checks and funding into the junior space, you can almost dictate the terms of your deals these days. That wasn't the case three or four years ago. But, you have to make sure that you use prudence and caution, don't overleverage and keep a lot of cash reserves because the juniors might come back to you for another round of financing.
TGR: What advice would you give to an investor today seeking a private placement in a mining exploration company?
EK: The most important thing is to do your homework. In this sector there could be a lot of lottery tickets but you should not approach this as a lottery. There are thousands of junior mining companies out there and this is not an easy sector in which to invest. Lots of companies are not going to make it. You've got to make sure the company has solid management, a solid project and enough financing to execute. Then you look at the stock and its chart. See if you can get in at a very reasonable valuation. And, continue to know everything about that company.
TGR: Could you tell our readers about some of the small-cap stocks that your company holds and why you bought them?
EK: Last time we spoke I had mentioned Pershing Gold Corp. (PGLC:OTCBB) and I'm still very excited about that company. That's a Nevada exploration company moving into production shortly. I was recently in Nevada and visited its Relief Canyon mine and processing facility. I have to tell you, since leaving Franco-Nevada Corp. (FNV:TSX) and taking the helm at Pershing, Steve Alfers has done a tremendous job of advancing the company. He's done a land deal with Newmont Mining Corp. (NEM:NYSE) and Victoria Gold Corp. (VIT:TSX.V) that dramatically increased Pershing's land position, which is critical. The Pershing geologists can now go out and conduct their exploration programs based upon geology and not worry about prior claim boundaries.
"You've got to make sure the company has solid management, a solid project and enough financing to execute."
Pershing recently closed a private placement with Coeur d'Alene Mines Corp. (CDM:TSX; CDE:NYSE), Pershing's neighbor to the north and the largest silver producer in the United States. The investment by Coeur into Pershing is a real game changer; it shows that Pershing can pass serious institutional due diligence. I would also imagine that we'll be seeing more deals between Pershing and Coeur in the future.
In addition, Pershing recently announced what looks like a new discovery. The company drilled a target at the Pershing Packard project located near its boundary with Coeur. The press release said that the deposit showed alteration and mineralization typically observed with other producing deposits in the area. I'm really looking forward to the assay results when they come out.
The real key with Pershing is its Relief Canyon Processing Facility, which is fully paid for. Add to that the recent Coeur financing and Pershing should be fully funded, in my opinion, to production. I estimate it is going to enter production toward the end of next year. And, I believe Pershing can produce 50,000 oz gold in 2014; the processing facility can easily be expanded to 100,000 oz a year. If we assume a cash cost of $700/oz as energy costs come down, and a $1,500/oz gold price, Pershing can potentially throw off $80 million (M) a year in cash flow and I think it will be able to produce for at least 10 years. If you use a pretty aggressive 10% discount rate, you still come up with about a $500M net present value. I think Pershing is one of the most exciting Nevada exploration and production plays I know.
TGR: But there's no way to hold Pershing without actually holding Pershing.
EK: But there is. Pershing acquired a company called Continental Resources Group Inc. (CRGC:OTCBB), which is basically now a tracking stock for Pershing Gold. The mathematics of the deal is that for every share of Continental Resources, investors will end up getting 0.8 shares of Pershing. So, there's a real arbitrage opportunity here for astute investors because Pershing Gold is trading today at approximately $0.37/share in the open market and Continental Resources is only trading at $0.22/share. It should be trading at $0.30/share. So by buying Continental Resources, you're actually getting Pershing shares at about a discount. That's a great sale. I'll buy that all day long.
TGR: How long is that window going to remain open?
EK: That's a good question. Pershing recently filed a registration statement with the Securities and Exchange Commission. So the window will be just as long as it takes for that registration statement to go effective. Usually registration statements take anywhere from 30 to 60 days to become effective. I'd imagine in the next two months Continental Resources shares will convert into Pershing Gold shares. So, the big opportunity will not last long.
TGR: Can you give us one or two more names?
EK: Here's another one in the same family. Pershing Gold recently spun off its exploration portfolio outside of Pershing County and rolled it into a new company called Valor Gold Corp. (VGLD:OTCBB). Pershing Gold is the largest shareholder of Valor Gold but Valor Gold is an independent company with some very interesting properties including Red Rock, which is located in the heart of the Battle Mountain-Eureka Gold Trend. Barrick Gold Corp.'s (ABX:TSX; ABX:NYSE) Pipeline and Cortez Hills deposits lie to the east. The McCoy-Cove mine is just to the west and Newmont's Phoenix mine is to the north. This is big elephant country of world-class deposits. All of the surrounding mines I've just mentioned are at least 5 million ounces (Moz). The geology at Red Rock looks as if it may potentially host a major Carlin-style deposit. The CEO, Art Leger, is a very experienced geologist and has led teams that have discovered millions of ounces of gold in his career. The real exciting thing with Valor Gold is that its 2011 drill program already found gold. It was a small amount, but could be a potential feeder zone that will lead the company to a major deposit. Valor is planning a follow-on drill program this year following lots of geophysical work to pinpoint its targets.
TGR: Anything else in Nevada that you like?
EK: There's a bunch of companies that we like and own. I really like Gold Standard Ventures Corp. (GSV:TSX.V; GDVXF:OTCQX). Its vice president for exploration, Dave Mathewson, is one of the top geologists out there. He really has the tiger by the tail at Railroad. The company recently raised $20M on a financing at $2/share, making it well funded. Gold Standard Ventures is onto a major world-class discovery. The question is how big does this thing get? And, in my opinion, when will it be taken out?
"I really like Nevada as a jurisdiction and I think it has a lot of benefits for investors."
TGR: As far as Nevada goes, is that something that you're specifically looking for? In the U.S., there really isn't another mining district that compares to it but you have a number of companies in a very safe jurisdiction that are exploring for gold resources. Is that a part of your thesis? Would you be less likely, for example, to invest in a deposit in Argentina versus some company coming to you with a gold exploration project in Nevada?
EK: Not necessarily. But there are several great reasons why we want to be in Nevada. Number one, stable political jurisdiction. I don't think the United States is going to nationalize the gold mines in Nevada tomorrow. Number two, there is the rule of law in Nevada, which some other jurisdictions don't have. Number three, the geology. There are very few areas in the world like Nevada that have the geological results to deliver major gold deposits. Number four, the infrastructure. The majors, like Barrick and Newmont, have billions and billions of dollars of infrastructure already invested in the state. That's fantastic for a junior exploration company because if it ends up finding a deposit, the odds are one of the majors is going to come in to take it out. Nevada has modern infrastructure such as roads, etc. It's a lot different when you discover 5 Moz way in the jungle of Brazil or the depths of Siberia or in western China. You'd have to build a tremendous amount of infrastructure. We don't preclude ourselves from looking in any jurisdiction. But I really like Nevada as a jurisdiction and I think it has a lot of benefits for investors.
TGR: Thanks so much for your insights.
Edward Karr is the founder of RAMPartners S.A., an investment management and investment banking firm based in Geneva. Since 2005, RAMPartners has helped raise more than $100 million for small capitalization companies in fields such as natural resources, high technology, health care and clean energy. Prior to founding RAMPartners, Karr worked for a private Swiss asset management, investment banking and trading firm based in Geneva for six years. Prior to moving to Europe, Karr worked for Prudential Securities in the United States and has been in the financial services industry for 20 years. Before his entry into the financial services arena, Karr was affiliated with the United States Antarctic Program and spent 13 consecutive months working in the Antarctic, receiving the Antarctic Service Medal for his contributions of courage, sacrifice and devotion. Karr studied at Embry-Riddle Aeronautical University and Lansdowne College in London, England, and received a Bachelor of Science degree in economics/finance with honors from Southern New Hampshire University. He is the current president of the American International Club of Geneva.
Want to read more exclusive Gold Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Exclusive Interviews page.
1) Brian Sylvester of The Gold Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Pershing Gold Corp., Franco-Nevada Corporation, Continental Resources Group Inc. and Gold Standard Ventures Corp. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) Edward Karr: I personally and/or my family own shares of the following companies mentioned in this interview: Newmont Mining Corp., Barrick Gold Corp., Pershing Gold Corp., Continental Resources Group Inc. and Gold Standard Ventures Corp. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview.