Pierre Lassonde: Moving Sideways Toward the Next Upside
Source: The Gold Report (9/19/08)
Veteran gold analyst and mining executive Pierre Lassonde knows this sector inside and out. He understands the plight of the juniors and the many influences on gold's behavior. In this exclusive interview with The Gold Report, he predicts limited downside given the accelerating demand for natural resources and shares his favorite companies.
The Gold Report: The downward spiral in the markets just doesn't stop. Junior mining stocks have been decimated, and the gold price went lower than any one predicted, although it seems to be recovering a bit. Do you see this as a repeat of the situation we had in the '70s, and what do you see as the outlook for oil and gold?
Pierre Lassonde: Yes, these are the same forces we had in the '70s. Just be prepared to see both oil and gold at much, much higher prices over the next four or five years after another nine to twelve months of so-so prices.
Today there's no let up in sight on the demand side while the supply side is constrained. There’s nowhere to go anymore to find oil. Something like 85% of all the oil reserves is in the hands of national oil companies.
Look at the resurgence of Russia as a Communist country — every week they seem to pass a new law against foreigners. Other countries are doing the same thing. This hurts mineral exploration. There aren't any great places to go anymore, making it difficult for the world resource companies to satisfy demand.
TGR: Gold in the '70s went from $180 down to $90. Where is gold's downside?
PL: I thought that the floor for gold would have been a lot higher than in the '70s. Demand is far more vigorous than it was. In the '70s the whole jewelry market wasn't nearly as mature. The ETF market didn’t exist. The central banks had it all. So I thought that $800 plus or minus $50 would be the bottom over the next 12 months.
TGR: Would you venture a guess as to what the upside could be?
PL: I've been saying that you’re going to see gold with three zeros after the first number. I just don’t know what that first number is going to be. It could be a one, a two, or a five.
It will depend on how much money we'll print to get out of trouble, which is what they did in '70s and they’re going to do again. Because gold is denominated in the U.S. dollar, that’s the currency to watch. The other thing is a panic effect.
In the '70s gold went to $850. But when you look at the last $150, it happened in a month. That was the panic effect because the real price was probably closer to $700. Will it hit $1,500 or $2,000 in the next five years? I don’t know. A panic effect could push it to $4,000 or $5,000. One thing for sure, we’ve seen $1,000. We’ll see it again and higher. I don’t know how big it’s going to be.
TGR: Do you think ultimately gold will detach from oil and the dollar?
PL: The relationship between oil and gold is not a strong one. I would say it’s a causal or an indirect relationship. The higher the oil price, the higher the inflation, the higher the gold price. That’s the kind of relationship you have.
When you look at the correlation over 20, 30, or 40 years, you find is there is none. It’s one of cause and effect, but there’s not a direct relationship. But there is one direct relationship between gold and U.S. dollars. That relationship is very strong.
Interestingly enough, it doesn’t always work one way. When Volcker arrived in 1977, he started hiking interest rates up and the dollar finally bottomed out that year and started to turn around. It even started to gain against the German mark, the yen, and right through 1978 to 1980, at the same time as gold was going up. So the two went up in tandem. It’s not always a one-way street with the dollar going down and gold going up. There are times, years in fact, where they both go up or they both go down. But when you look at the last seven years, six out of the seven years the gold price has gone up when the dollar has gone down.
TGR: Could both the dollar and gold could go up given the increased ETF and jewelry demand?
PL: I think it’s going to happen. Over the next two or three years you’re going to see the Fed liquefy the market as much as it can because there’s more trouble coming down the road with reset mortgages and defaults, and consumer loans. The Fed will keep on printing money and the confidence in the dollar will continue to fall.
However, over the next 12 months I think the dollar is going to firm up. That’s what happened in '75, ’76. You could see a $1.35 to the Euro. That would not be surprising at all. At the same time you may see gold in the $750-$775 range. Then the confidence in the dollar will start to turn around and will hit a new low before both the dollar and gold turn and go up again for the next two to three years. That will be the final leg of this bull market. But you’re looking at three to five years now. Not tomorrow.
TGR: Would define this stage as the "wall of worry?" We’ve had the stealth move in gold. Are we in the wall of worry before the panic, or do you think it’s going to be different this time?
PL: No, I don’t think it’s going to be any different this time. But the fact is that we’ve had very few discoveries. That absolutely amazes me. The gold recovery started in 2001, so we’re seven years into the cycle. When you look at the discovery rate, it’s around one or two per year. Personally, I’ve never seen this; it's extraordinarily low. And that bodes well for much higher prices at the same time. If you look at the '70s and '80s you had a lot of discoveries. But this time around it’s just not happening.
TGR: What explains that?
PL: Two or three things: The world for mining companies is shrinking. They aren't going to go Venezuela anymore, or to any of the "stanzs" in Russia, nor to a lot of African countries. Back in the 1990s the world was opening up. Today it’s shrinking.
There has been no breakthrough in exploration like we saw back in the '70s and '80s. We saw the advent of heat leaching, pressure autoclaving, and advances in geophysics. We haven’t seen anything now for 10 or 15 years. So we’re still exploring on an exploration model that’s 30 or 40 years old. We need a breakthrough and you can see it by the cost structure of the industry increasing dramatically. Five, six years ago the cash cost in this industry was below $200. Today you’re looking at $450, $500. That’s quite unbelievable, but it’s a reflection of the paucity of discoveries, plus the inflation of oil and everything else.
TGR: When gold moved from $700 up to $1,000, the juniors didn't participate. Is that different from the '70s?
PL: Back in the '70s there were, at most, 1,000 juniors. Today there are 4,000 to 5,000. In this market liquidity has dried up. You can see it in the turnover volume from January to March. Compare that to the turnover from June to August. Liquidity is a quarter of what it was at the start of 2008. Juniors are dying on the vine for this reason. This situation will continue for another year, maybe two.
TGR: So will it shake out juniors that are not well structured—even those with good prospects?
PL: Everyone will feel the pain. It also presents a tremendous opportunity for well-funded smaller companies to acquire decent prospects. The rest will fall by the wayside or merge with cash-rich companies. Juniors are trading for $5 or $10 million and they’ve got more cash in the bank than their market cap. The market doesn't believe there’s going to be any discovery. There have been no discoveries whatsoever in the diamond space over the past couple of years. So it’s a tough, tough market. What really bothers me is that in the 1980s or 1990s, we saw three to five discoveries of 5 to 20 million ounces each, and upwards of 30 to 50 million ounces a year. That is what makes or breaks the industry. There are no discoveries of that magnitude now.
TGR: Because we haven’t found them or they’re literally not there?
PL: I think it's because we don’t have an exploration model conducive to finding them. But look at Canada. It’s got the second largest landmass after Russia. Has it been all explored? Not a chance. But it’s going to take time and money.
TGR: Will the supply issue become a crisis before we have new discoveries?
PL: Gold supply fell by 4% in the first six months of this year. This will be the seventh year in which production has dropped. It’s probably going to fall more in 2008 than it has in prior years. Australia, Indonesia, Canada, and the U.S. are all experiencing declines. Combine this with the drop off in central bank sales. 2008 will have the lowest central bank sales on record because the bankers have all had theirs head handed to them. They all sold gold for $250, $350, and $400—losing tens of billions of dollars. We could soon reach the point where central bank sales will be non-existent. That represents a loss of 500 tons of gold a year in a 3,000-ton market. That’s huge—nearly 20% of supply. Recycling has declined in the last six months too. Even though demand fell when gold hit $900 and $1,000, the supply has been shrinking just as fast. I don't see gold dropping much below $800—plus or minus $50.
TGR: You’re projecting over the next year or two that the dollar will strengthen. Could that push gold back to $500 an ounce?
PL: In the short run, anything is possible. But when I look at the supply-demand picture, at the growth of India and China's economies, and ETF demand, I can't see gold lower than $750. Could it happen? Sure, it could.
TGR: What are you telling investors to do with their money?
PL: I’m looking at some of the longer-term things that I like in my portfolio and adding to them. I see excellent value in the market right now, particularly in the gold sector. I’m talking about my own portfolio. New Gold Inc. (AMEX:NGD, TSX:NGD) traded under $5 two weeks ago. It was $9 in March-April. This company has $500 million in cash, three operating mines, one in construction, and another that will start in about four years time. It's got great management and a good board. The net asset value is probably about $12. At these metal prices, it’s really cheap. It’s also in the U.S. because it was a merger of three companies that I engineered back in the spring—a merger between Peak Gold and Metallica Resources.
TGR: What about the share structure? I remember there were a lot of shares outstanding.
PL: When we did the merger, we consolidated the Peak Gold shares so that New Gold has 220 million shares outstanding. They have $500 million in cash so half their capitalization is in cash. They have a real operating mine that will produce close to 300,000 ounces of gold this year— and up to 600,000 over the next three years. It also produces copper. This is just a real bargain.
TGR: Some other bargains?
PL: I love Franco Nevada Corp. (FNV.TO) because it has the perfect business model for the times. As a royalty company, it doesn’t suffer from cost hikes, but it benefits from gold price increases. So when gold goes up 10% or 20%, our revenue goes up 10% or 20%, but our costs don’t budge. With more than $300 million in cash, we are positioned to make acquisitions. I like cash-flow positive companies trading at less than their net asset value.
TGR: What else do you have in your book?
PL: Canadian Oil Sands (COSWF.PK) is absolutely the best in the oil space. At today’s production level— about 300,000 barrels a day—they have 50 to 65 years of reserves without drilling another well. The current dividend is $5 a share, so you’re getting a ten yield. The SEC does not currently classify oil sands reserves. If Shell or Exxon were to buy Canadian Oil Sands, the SEC cannot classify them. We think the SEC will change its definition of oil reserves by the end of this year. Then this company is very likely to become a hot takeover target. If you’re a big oil company that needs to replace reserves, you want a peaceful, law-abiding country. Canada is the best place in the world to be. That stock is going to disappear at much, much higher prices.
TGR: How do you factor in the energy costs to release the oil from the tar sands?
PL: Production costs about $24 to $25 a barrel using natural gas.
TGR: And they’ve got a ready supply of that?
PL: They've got tons of it in Alberta. They’ve got a pretty decent profit margin here.
TGR: A lot of people are talking about the U.S. entering a depression. You are convinced the Fed will keep printing money—and inflation will continue.
PL: Bernanke's mission is to keep the liquidity flowing. That’s why he rescued Bear Stearns, and will save Fannie Mae and Sallie. Ultimately, his actions will turn the economy around. Once the French and the German economies hit the skids, their interest rates are going to fall and they’re going to do the same darn thing. At that point you are going to see the world reflate. But we won't see the 12% to 15 % interest rates and inflation that we had in the '70s.
TGR: Why not?
PL: Back then we had structural inflation. The labor unions had more control then; now they have no power. Asia wasn't producing goods at cheaper and cheaper prices. When we talk about the 5.1% inflation we’ve had in the last 12 months, that's the peak for this half of the cycle. The second half will be the same or lower.
TGR: So we’re not going to see runaway inflation?
PL: No. I just don’t see it.
TGR: What are your thoughts on uranium? Do you think the world will turn to nuclear power?
PL: I do, but uranium producers have never been able to withstand prosperity. There is no shortage of uranium. You've seen peak uranium prices. New mines will open in Russia and Kazakhstan and all over the world. You’re not going to see that high price again. The long-term contract price will probably settle in the $40 range.
TGR: So that's it?
PL: Yes, but at $40, there’s enough resource worldwide to make money.
TGR: What about base metals?
PL: I like copper a lot because it's essential for building a nation's infrastructure. You need it in transformers, electrical substations, power distribution—everything. When you’ve got 2.5 billion people moving up the economic curve, the demand is just unbelievable. Every two years, China builds an electrical grid the equivalent of the UK and they’re going to continue to do that for decades. The coal China uses is terrible for the environment. They’re going to have to turn to nuclear power as will India. It takes 10 years to build a nuclear power plant and they’re finding the uranium a lot faster than they’re going to need it. But where is the big production of copper going to come from? When have you heard of a big new discovery with grades like Escondida, 2% for the first 500 million tons? They're not there.
TGR: So the price of copper will go up?
PL: Copper will still come down a bit more. But over the next five to ten years, it will have a better price profile than any of the commodities except for gold and oil.
TGR: So that would be your third basket if you will.
PL: Yes. I like New Gold Inc. (TSX:NGD, AMEX:NGD) because it’s a copper gold story and I like Franco Nevada because it’s oil, gold, and 10% of a basket of commodities.
TGR: Would you recommend bullion?
PL: Absolutely. If you don't want to take time to analyze companies and follow stocks but you want to play the commodity, it's a good way to go. We came out with the gold ETF (GLD) at the World Gold Council in November 2005. It's grown from zero to 750 tons in three years. It continues to be very popular. We launched the ETF as an alternative investment to the dollar. Now you can literally trade the ETF 24 hours a day, 7 days a week.
TGR: You haven't mentioned silver at all?
PL: It’s not a metal that I follow all that much. Of all of my mining companies and investments, silver represents only a very small portion of the revenue.
TGR: Do you have one more idea for our readers?
PL: How about a diamond stock? Olivut Resources Ltd. (OLV:TSX.V) has a real good shot at the moon for very little money. The company has $8 million in the bank and 30 million shares outstanding. So that's about $.25 a share in cash. Stock trades around $.80. They have 2 million acres of land in the Mackenzie River Delta in the Northwest Territories. In their first drilling season they found seven pipes, three of them had micro diamonds. They’re drilling another 20 to 25 anomalies this year, as well as redrilling others. This is a whole new diamond province—a completely new discovery.
TGR: Where is it located exactly?
PL: It’s to the west of the Mackenzie River. This new diamond province is far more accessible because the Alaska Highway runs through it. So it makes a very interesting play. Olivutt is well funded and has very tight management. I own about 13% of the company. I’ve been buying the stock at $.80 for the past four months.
TGR: Back in May 2007 it was trading around $2.50.
PL: It peaked at $2.50. They were smart and did a big financing around $1.75, and they've been saving their money.
TGR: So, to recap, you see this market as a repeat of the '70s; gold could be trading sideways—maybe dropping to $750; and the juniors trading sideways too?
PL: The juniors have been decimated. From here on it’s a matter of surviving for the next two years. The juniors that will get the attention will be those with discoveries or takeovers.