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Mike Niehuser: Silver/Gold Ratio Out of Whack

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The silver/gold ratio is "out of whack," says Mike Niehuser, founder of Beacon Rock Research, LLC, who finds silver "particularly interesting" right now. In this exclusive interview with The Gold Report, Mike weighs the historical seasonality of gold and silver against the forces at work in today's market and explains why we could see a significant run up in metals by fall.

The silver/gold ratio is "out of whack," says Mike Niehuser, founder of Beacon Rock Research, LLC, who finds silver "particularly interesting" right now. In this exclusive interview with The Gold Report, Mike weighs the historical seasonality of gold and silver against the forces at work in today's market and explains why we could see a significant run up in metals by fall.

The Gold Report: Mike, what is your feeling about gold and silver prices both in the near and longer term?

Mike Niehuser: Well, gold seasonally runs up late summer to early spring, then up slightly or flat late spring to summer due to seasonal holiday buying for jewelry in Asia. Gold is now about $900 and silver $13 per ounce; both gold and silver are correlated and remain good hedges against inflation.

There are ample concerns of hyperinflation and since the news is out, I am a bit surprised that gold and silver prices appear within bounds of prior years' seasonal price appreciation. Part of this may have to do with the idea that monetary policy takes about 12 to 36 months to influence the economy. As the price of gold today reflects the market's future expectations, it makes one wonder whether more money is truly being poured into the system or we're seeing a reshuffling of spending in the U.S. from the states back up to the federal government.

In addition, you can look up Irving Fisher's “Money Equation” on Wikipedia: MV = PQ. "M", the supply of money, times "V", or velocity, equals "P", the price of money or inflation, times "Q", economic output. So, even if the money supply is increased, without velocity (say bank lending), you are not likely to see increases in inflation or output of goods and services. This is really where I think we are today.

The new administration wants to push for greater control via stimulus, and bankers, whose number-one concern is to protect their careers and not take risks, are not lending. After everyone takes the summer off, lenders may start lending in the fall, increasing velocity. With the addition of seasonal buying of precious metals, we could see metals up significantly in the fall.

Another thing to consider with silver is that silver is a byproduct of base metal mining. With reduced base metal production, the supply of silver is reduced. Also, historically, the silver/gold ratio is currently out of whack, so silver is particularly interesting right now.

TGR: What is your investment thesis for gold and silver equities?

MN: A couple years ago I only focused on big deposits with development potential. My thesis was that major operators needed large deposits to fill their production pipelines, and they were unable to focus on exploration and early development. This created potential upside in junior companies with large deposits.

The two I am most familiar with are NovaGold Resources Inc. (TSX:NG) (NYSE.A:NG) and Seabridge Gold Inc. (TSX:SEA) (NYSE.A:SA). NovaGold is in a 50-50 partnership with Barrick at Donlin Creek, and just produced a feasibility study with reserves of 29.3 million ounces of gold. NovaGold also has a 50-50 interest with Teck Cominco Ltd. (TSX:TCK.A) (TSX:TCK.B) (NYSE:TCK) in the Galore Creek Copper Gold project. I don’t think either of these assets is reflected in the stock price.

Seabridge is also increasing its Mitchell deposit near Barrick Gold Corporation’s (NYSE:ABX) Eskay Creek. Mitchell is big and is getting bigger, still open at depth and along strike. What's interesting to me is it steps out within the pit, encountering mineralization that may convert waste to ore, which improves economics. It also possibly connects with their adjacent Sulphurets deposit, further improving economics.

Seabridge is scheduled to produce an updated economic study and produce drill results. We also expect to hear more from NovaGold on Galore Creek and Rock Creek in 2009. Both companies now have good cash positions, which should take them through 2010. And with their large deposits, they remain leveraged to gold prices on a per-ounce basis.

TGR: How did your 2008 portfolio perform?

MN: Not so good in 2008, which is no surprise. I was expecting some flight to quality, so I focused on companies making the jump from construction to production. While this was a tough year for explorers, developers and producers, any news—bad or good—in general seemed to take stock prices lower.

It was amazing to watch the courage of management teams that worked for years and succeeded in achieving goals, yet were punished for the slightest slippage in production targets.

TGR: Can you give some specific examples?

MN: Well, Minefinders Corporation (NYSE.A:MFN) (MFL.TO) is a good example. They never got the credit for development and are now ramping production at their Dolores project in Chihuahua, Mexico. This is a good example of what I like—good management, low cost production, great underground high-grade potential, open pit expansion to the south, and a large mineralized target parallel to the pit. Most important, they broke even on an operating basis months ago and are not hedged. Minefinders is still cheap.

Another good example is Coeur d'Alene Mines Corp. (NYSE:CDE) (TSX: CDM). They took the prior owner's big pit idea at Palmarejo, Mexico, reduced the open pit and went directly underground to higher grades. This allowed for more effective blending of ore and stockpiling. They also have a dual processing of ore to increase recoveries and should be hooking up to the grid to get the benefits from low diesel prices or hydropower in Mexico.

Coeur, with Palmarejo and with production from their San Bartoleme project in Bolivia, should have a strong finish to 2009.

Investors should also take a look at Apollo Gold Corporation’s (TSX:APG) Black Fox high-grade gold project near Timmins, Ontario. This company shares many of the same characteristics of Minefinders and Coeur. This project should start processing ore in the next month and see a pop in the stock price. Like Dolores and Palmarejo, there is open pit with high-grade underground potential. We see significant opportunity to increase the resource size at Black Fox through underground drilling of the inferred resource or going deeper. Several mines in the Timmins area go down over a thousand meters and Black Fox has good potential to do the same.

In addition to production, Apollo should be producing drill results on its nearby Grey Fox target, as well as their Huizopa project in Mexico, between Minefinders and Alamos.

TGR: Mike, you mentioned that your track record in 2008 wasn't so great. How's 2009 looking so far?

MN: I like to say I am still learning and, like the professor said, 'if you are not confused, you are not informed.' I picked six developers at the end of 2008 that were up 53% at the end of the quarter. It's interesting that gold and silver were up only 4.2% and 14.2%, respectively, in the same period. This reconfirmed to me that fundamentals still mattered. Many of these stocks were beat up due to liquidity concerns and tax-loss selling.

While this included NovaGold and Seabridge, it included two other great companies, Exeter Resource Corp. (TSX.V:XRC) (NYSE.A:XRA) and South American Silver Corp. (TSX:SAC). Both had ample cash or were selling at near cash. Exeter has about $38 million in cash, and two great projects in Chile and Argentina. They are scheduled to produce additional drill results and metallurgical and economic studies in the near term.

I also just got back from South American Silver’s Malku Khota project in Bolivia. South American had the greatest appreciation of my top picks. Malku Khota has over 144 million indicated ounces of silver and may be the largest low-cost leachable silver sulfide deposit in the world. Geologically, Bolivia may be the Nevada of South America. Though political concerns may be important, many companies have successfully built mines in Bolivia, including Apex Silver Mines Ltd., Coeur d’Alene and Pan American Silver Corp. (TSX:PAA) (Nasdaq:PAAS).

TGR: You mentioned six picks, but have only talked about four. What about the other two?

MN: That would be Etruscan Resources Inc. (TSX:EET) and Alexco Resource Corp. (TSX:AXR) (NYSE.A:AXU). Etruscan has one of the largest land positions in West Africa and is ramping up production at its Youga Gold Project in Burkina Faso.

Etruscan has a new strategic partner, Maxim Finskiy. Finskiy is the owner of a gold mining business in Eastern Siberia Russia. He is also a partner and the Chief Executive Officer in LLC MC Intergeo, the mining and exploration arm of the private Russian investment fund Onexim Group.

I suspect that what Electrum investment did for NovaGold, Maxim Finskiy may do for Etruscan. Good companies with strong financial backers are potentially future mid-tier or majors in the making. These investors don’t put money in unless they expect to get a return.

Also, Alexco is developing the Keno Hill silver district in the Yukon. Keno Hill could have some of the highest silver grades in the world. Silver Wheaton has purchased a silver stream from Alexco even before they have made a construction decision. This demonstrates the potential of Keno Hill. Alexco also has a legacy environmental business with very interesting world or industry-changing patents. Both of these are good investment ideas, as well.

TGR: How are you expecting your picks to perform as we move farther into 2009?

MN: I was surprised that the picks did so well in the first quarter. I think the companies that did well in the first quarter had unnecessary pressure because the market was not sure whether the companies were viable. And as good companies attracted capital, this has not proven to be the case, so they had exceptional returns in the first quarter.

I expect all these companies to have good news flow through the end of the year, and should have greater visibility. And if my thesis is correct about gold and silver prices moving up in the fall, these companies should be attractive for acquisition during the summer months, where potentially flat gold and silver prices are creating opportunities for buying good quality companies with exceptional performance potential.

TGR: Mike, thanks so much for your time.

Mike Niehuser is the founder of Beacon Rock Research, LLC , which produces research for an institutional audience and focuses on precious, base and industrial metals, and substitutes, oil and gas, alternative energy, as well as communications and human resources. Mike is also on the faculty of the Pacific Coast Banking School and was nominated to BrainstormNW magazine's list of the region's top financial professionals in 2007.

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