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Gold Volatility Breeds Equity Opportunities: Mike Niehuser
Source: Special to The Gold Report (1/11/12)
Volatility in the markets isn't going away any time soon and Mike Niehuser, founder of Beacon Rock Research, expects 2012 to be a year of extreme swings. Niehuser draws parallels to the beginning of 2009, which was a short period of time that produced some very high returns. In this exclusive Gold Report interview, Niehuser shares his market outlook and names a host of companies that are positioned to take off.
Mike Niehuser: Depending on how you want to spin it, we were a little conservative in some respects, but for year-end 2011, we nearly hit it right on the nose. Our forecast for 2011 included the price of gold ranging from $1,300/ounce (oz) to $1,500/oz with the potential with some catalyst to go over $1,600/oz by year-end. In reality, gold traded up to $1,500/oz for the first half of the year making us look smart, then exploded to $1,900/oz and retreated back to where we thought we would end up at year-end at $1,600/oz.
So very close on price, but, more important, we missed the mark on the catalyst, which is the story of the year. We thought the catalyst would be the accelerating deterioration of the U.S. dollar in combination with typical seasonal demand late in the year, but this was blown out by the debt crisis in both the U.S. and Europe, with a wildly different impact on metal and stock prices. Understanding the difference could be very important to making it through 2012.
TGR: What difference are you referring to?
MN: As the U.S. dominates the world's media, those in the U.S. see the world from a closed system. We know closed systems become more unstable over time. The result is that news media can move into hyper drive, which is what happened with the debt ceiling fiasco last summer. This is especially the case where politics are concerned. In reality with the U.S. dollar's role as the world reserve currency, the debt is not an issue so long as foreigners are willing to accept dollars or treasuries on the cheap, and we can continue to kick the can down the road almost indefinitely.
The timing of our new-found austerity came at the wrong time with Europeans dealing with their own austerity issues. It would appear that the combination sparked fears of global currency devaluation sending gold and silver to record levels. As the U.S. economy improved, debt as an issue moved off the front page. The issue did not subside in Europe and the U.S. dollar remained strong relative to the euro, leading to a relative decline in interest rates, gold and, consequently, mining equities. I really thought 2011 had the potential to look like 2010 for mining stocks, but it really started to look like 2008, which led to the best buying opportunity of a lifetime in the first quarter of 2009.
TGR: So what are you seeing for metal prices and mining stocks in the coming year?
MN: The old adage that the only constant was volatility is no longer a cliché. While the U.S. economy is showing strength and the U.S. dollar is strong, there has never been more uncertainty in my lifetime; 2012 could be a very volatile year to the extremes. I was born just prior to the Cuban Missile Crisis, but holding catalysts for volatility constant, which is a bit absurd to even suggest, we would expect gold to trade over a wider range and higher than the prior year, say between $1,400–1,700/oz with the potential for some catalyst for the upside to $1,800/oz or $1,900/oz. Demand destruction by higher gold prices may have upset seasonal factors for good and there may be any number of catalysts that may impact prices almost at any time.
TGR: So what kind of catalyst are you looking for?
MN: Well, it's not any one catalyst, but it is the unperceived impact of any particular catalyst on a potentially unrelated event. Not only the type and relationship of the catalyst but also the timing is important. Working backwards from Dec. 21, 2012, the end of the world by the Mayan calendar, we have a national election in the U.S.; certainly by some timetables Iran is predicted to have a nuclear weapon at some advanced stage of development; and I believe Greece has some event in the month of March. On top of this we are likely to see more political grandstanding early in 2012 on any number of issues including extension of the payroll tax cuts, unemployment benefits and, of course, the federal debt ceiling. Not to be facetious but we will also have the Federal Reserve Chairman Ben Bernanke committing to more frequent press conferences in the name of transparency. Among the international or political challenges of 2012, the Federal Reserve may touch on more of these than you might imagine.
TGR: Are you not giving the Federal Reserve too much credit in world affairs?
MN: Certainly not if the U.S. dollar is the world's reserve currency. Originally the Fed was charged with the mission as an economic stabilizer to provide an elastic currency in times of financial panic and a lender of last resort for failing banks. The Fed has since suffered mission creep and is now charged with maintaining full employment and, most recently, reduction of systematic risk. One can argue that with banks getting bigger since 2008, the potential for moral hazard has, in fact, increased with larger banks still too big to fail. This may be chump change. Bernanke has said he has no exposure to Europe, but it is apparent that through "temporary U.S. dollar liquidity swaps," the Fed now may, in effect, have become a global lender of last resort. Systematic risk domestically and globally may be assured. Once again, put it on the credit card.
TGR: Do you think there is a chance that the Fed may accommodate another stimulus program since this is an election year?
MN: This is rather doubtful considering the need has gone away with the stabilization in the U.S. economy. But given the mission of the Fed to pursue full employment, forgetting a moderating unemployment rate, there are still over 10 million unemployed, and millions more under-employed, and they vote. It is interesting that with changes in the voting members at the Fed that there will be fewer stimulus hawks. Sort of like a football team losing their defensive line. Another stimulus program, even talk of one, would be a huge catalyst. Even without a stimulus, the Fed holding short-rate interest rates near zero for the foreseeable future is damaging to a functioning economy in allocating investments. With zero interest rates, basically price controls, funds flow to non-productive assets like gold and other tangibles or consumables rather than fixed assets and equipment for some future return. This also encourages our consumer-driven economy, which is spend now, save later, or better yet pass the buck and kick the can. In any event, we know how well this worked in the last decade.
TGR: It would appear that all that uncertainty should be pretty good for gold?
MN: In the long run, it is without doubt bullish for gold. It is unavoidable but it may take a very long time. Remember that the late Roman Empire was financed through the gradual salting of freshly minted coins with base metals. This is not much different than deficit spending and transfer payments from taxpayers to the entitled or government salaries and pensions. Saving and investment is punished while spending and consuming is encouraged. In the short term, should interest rates increase either by the Fed in the short end or the market requiring higher yields on longer maturities, positive real interest rates could erase gains in metal prices. This seems to be impossible. More likely, as the president has now used a recess appointment for the new head of the Consumer Financial Protection Bureau, the financial markets now have an unvetted regulator in a new bureau accountable only to an independent Federal Reserve. Bankers are risk averse and primarily wish to protect their jobs. I have heard it from bankers' mouths, you won't see lending until they know they have a job. So even with near zero interest rates—negative real rates—a sluggish economy will hold down inflation and with a strong U.S. dollar, gold could have a tough time in the new year.
TGR: So with gold trading over such a wide range are you bullish on mining stocks?
MN: I think it is important to remember that only a few short years ago you would have traded your first born for prices at these levels. Even with higher costs of exploration and production, the cream still rises to the top. We should embrace the idea of higher costs as it rewards the productive who are willing to educate themselves and take risks to meet a need. This is so basic and so important. The most important disclosure I can make is that I am an optimist. Also, I believe that sooner or later the market rewards investors seeking companies with low relative valuations that are building shareholder value.
As I said, this feels a lot like the beginning of 2009, which was a short period of time that produced some very high returns. I can't claim we are at the bottom but getting past seasonal tax loss selling, this is a good time to look for companies with good stories. If companies are better known, I look for production or catalysts for increasing or extending production, important for increasing fundamental value or new discoveries. In this environment, you have a lot to pick from.
TGR: Can you give me some examples?
MN: Two of the best well-known examples that fit this profile include Minefinders Corp. (MFL:TSX; MFN:NYSE) and Alexco Resource Corp. (AXR:TSX; AXU:NYSE.A). Both have operating mines in stable jurisdictions and have profitable operations with good potential for increasing or extending production, as well as significant "blue sky" potential.
Minefinders is currently operating a low-cost heap leach gold-silver Dolores mine near Chihuahua. It is on schedule to meet guidance of about 65–70 thousand ounces (Koz) gold and 3.3–3.5 million ounces (Moz) silver in 2011. It is working on expanding with a mill operation to increase recoveries of higher grade ore from underground. This may add production in 2014; in the meanwhile it could bring its La Bolsa heap-leach gold project into production. This could add another 40 Koz gold starting in 2013. In addition, Minefinders is accelerating exploration of its La Virginia project with potential of generating a resource. Profitable operations should fund these activities, reducing the need to go to the market and risk diluting shareholders.
Also, Alexco just finished its first year of profitable silver production at its Bellekeno mine in the Yukon. We believe it will optimize operations, increasing production of silver as well as lead and zinc as a by-product. It is also working to open two new mines to provide additional feed to the mill. Alexco should also be updating its resource estimate at Bellekeno and may produce new resource estimates at its Bermingham and Flame & Moth targets. Alexco should also be able to fund initiatives from production. It is on course to meet current guidance of 2 Moz silver in 2011 and has the goal to achieve midtier producer status in the next decade by producing 7–10 Moz of silver annually.
We also believe Aurcana Corporation (AUN:TSX.V) fits this profile but is still largely under investors' radars. Aurcana has expanded processing at its La Negra silver and base metal mine in Mexico from 800 to 2,000 tons per day. In addition to production from La Negra, Aurcana is scheduled to commence production at its Shafter silver mine by June 2012 with annual production of about 4 Moz silver in its first year of operations. We visited the project prior to the holidays and were very impressed. Also, Aurcana has hired Dr. Peter McGaw to locate additional mineralization at each project to extend mine life. The potential to increase profitability and identify additional mineralization could lift the investment profile of Aurcana.
TGR: What early stage precious metal exploration companies are you watching?
MN: While clearly at the riskier end of the investment spectrum, most junior explorers are near their 52-week lows, so there is clearly an opportunity for bottom-up stock selection. There are a number of companies that have completed successful drill programs or are drilling historic resources and are close to announcing initial resources. Explorers now at the lower end of their trading range, while continuing to advance their projects, may receive favorable investor attention and experience appreciation by meeting milestones.
One of my favorites is Redstar Gold Corp. (RGC:TSX.V), which recently acquired the Unga gold project in the Aleutian Islands in Alaska. In 2011 it drilled about a dozen holes late in the season in hopes of upgrading a historic resource in the near term. While early in the exploration at Unga, there are possibly 30 kilometers (km) of vein structures. The mineralization is reminiscent of vein swarms seen in Patagonia. Should Redstar complete a compliant resource, investors should have a better idea of the project's potential. The Unga project is in addition to the company's high-grade gold Newman Todd project in the Red Lake Gold Camp in Ontario and about a dozen projects generated in Nevada from the acquisition of AngloGold Ashanti's Nevada database.
Similarly, Argentex Mining Corp. (ATX:TSX.V; AGXM:OTCBB) is scheduled to produce an updated resource in the first quarter of 2012 on its Pinguino project in the Santa Cruz Province of Argentina. The updated resource will focus on silver-gold mineralization near surface. In addition to the potential for a new precious metal resource, Argentex has blue sky potential having encountered mineralization in 16 of 19 veins drilled. This is only about a third of veins identified on the project. As Argentex has about $10 million in the bank, it is not trading much higher than cash per share.
Also, we visited Revolution Resources Corp.'s (RV:TSX; RVRCF:OTCQX) Champion Hills project in North Carolina last year. The company has completed about 15,000 meters (m) of drilling at Jones-Keystone and Loflin prospects and is working to complete an NI 43-101-compliant resource. Gold mineralization is similar to Romarco Minerals Inc.'s (R:TSX) Haile project located in South Carolina. Should it produce a significant resource, this should raise the investment profile of Revolution and demonstrate the potential of its growing land position.
We also visited High Desert Gold Corp.'s (HDG:TSX.V) Gold Springs project a couple months ago. Gold Springs is located on the Nevada-Utah border. The company recently announced a resource with about 233,000 gold equivalent ounces on one of 18 targets. This new deposit is open laterally and at depth with reasonable expansion potential. High Desert owns 60% of the project in partnership with Pilot Gold Inc. (PLG:TSX). High Desert recently completed a ZTEM geophysical survey allowing it to identify a number of blind targets and selectively expand the project to district scale, which is more important than the new resource. Additional drilling should lead to additional resources. We think High Desert has the potential to eventually build a several million ounce gold resource.
Probably our most intriguing idea is Gold Port Resources Ltd. (GPO:TSX.V). The company has a gold project in Guyana. Gold Port is still very early and located in a challenging rainforest setting. It is currently working to upgrade an historic resource of 94 million tonnes grading 0.7 grams/tonne gold and 0.15% copper. This historic resource was established over a decade ago at much lower metal prices by Coeur d'Alene Mines Corp. (CDE:NYSE). In the near term, should Gold Port confirm a fraction of the historic resource, it may move the company's shares out of penny stock status.
TGR: Is your focus solely on precious metals?
MN: Primary gold and silver projects generally command a premium to base metal projects. But there are large copper-gold projects with a bias toward gold that should attract more investor attention if they can grow in size. Two companies that come to mind are Northern Freegold Resources Ltd. (NFR:TSX.V) and Kiska Metals Corp. (KSK:TSX.V).
Northern Freegold has already identified a million-plus gold deposit in the Yukon. The company recently completed a drill program on an adjacent gold-copper porphyry and is scheduled to produce a compliant resource in the coming months. This new target extends only over about 1km of a 6–8km anomaly. We believe the project has the potential to be competitive with Western Copper and Gold Corp.'s (WRN:TSX; WRN:NYSE.A) Casino project in size and grade but with a gold bias and with fewer infrastructure challenges.
Kiska also has a multi-million ounce gold equivalent deposit at its Whistler gold-copper project near Anchorage, Alaska. The company has discovered five additional porphyry targets and has completed 30,000m of drilling in 2011. Kiska is now aggressively exploring the large Island Mountain target. The gold mineralized zone comes to surface. The metallurgy is good and investors may take note of this target, which is still open in three directions. We believe in time the Whistler project has the potential to resemble other large projects in Alaska and British Columbia.
TGR: Thank you for your insights.
Mike Niehuser is the founder of Beacon Rock Research LLC, which produces research for an institutional audience and focuses in part on precious, base and industrial metals, oil and gas and alternative energy. Previously a vice president and senior equity analyst with the Robins Group, he also worked as an equity analyst with The RedChip Review. He holds a bachelor's degree in finance from the University of Oregon.
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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: Minefinders Corp., Revolution Resources Corp., Kiska Metals Corp. Streetwise Reports does not accept stock in exchange for services.
3) Mike Niehuser: I personally and/or my family own shares of the following companies mentioned in this interview: Alexco Resource Corp., Aurcana Corporation, Redstar Gold Corp., Revolution Resources Corp., High Desert Gold Corp., Gold Port Resources Ltd., Northern Freegold Resources Ltd., Kiska Metals Corp. I was not paid by Streetwise for participating in this story.