The Gold Report: Now that the election is in the rearview mirror and we are well into the new year, what are your thoughts about gold prices and mining stocks for 2013?
Mike Niehuser: In my interviews with The Gold Report over the last couple of years, I have attempted to steer toward moderation but with optimism for higher gold prices, similar to Pierre Lassonde's forecast leading up to the end of the last decade. Early on, Lassonde, the chairman of Franco-Nevada Corp. (FNV:TSX; FNV:NYSE), saw the potential for annual increases of about $100/ounce (oz) in the price of gold through 2010, reaching $1,000/oz. He was surprisingly accurate.
I have taken this a step further, believing that gradual increases seem inevitable given government and central bank policies in the U.S. and globally. Because inflation, as well as the gold price, is a monetary phenomenon, price levels of products and services are managed by central bankers to trick investors and consumers, allowing them to function on a day-to-day basis. This is money illusion. Bankers and policymakers think people are incapable of separating reality from illusion. This is difficult in real time but becomes more obvious looking in the rearview mirror.
"Gradual increases in the gold price seem inevitable given government and central bank policies in the U.S. and globally."
TGR: What was your prediction for gold prices in 2012?
MN: For 2012 I expected gold to trade between $1,400 and $1,700/oz with the potential with some catalyst to trade on the upside to $1,800–1,900/oz. While this is what roughly happened, it didn't happen in a way I expected. I thought gold prices would be more volatile and would follow seasonal demand with highs coming at year-end. Interestingly, prices were pretty flat within my range and came close to $1,800/oz. The range and high for 2012 was about $100 more per ounce than my previous estimate for 2011, which was also close. While my forecasts are a little broad, they are moderate compared to the extremes expected by some experts. I am not a gold trader. My focus is on my level of confidence for gold prices to be generally above costs of exploration and operations for the mining sector to be viable for investment. I then try to assess development risk of projects of which stable gold prices are an important part.
TGR: Do you expect the same $100/oz increase for 2013?
MN: I don't see much changing; higher gold prices appear inevitable. I think that the lower end of the range is fixed, but the potential for higher price levels above my range are more than possible if there is a black swan event. For 2013, let's put down $1,500 to $1,800/oz for the gold price and look for a high of $1,900/oz for the year. It may seem a little wimpy to keep $1,900/oz at the high end of the range, but a lot of things could tamp down gold prices, especially in the near term.
TGR: What are the risks that gold prices may fall or even drop below your lower range?
MN: In the big picture, a novice technical analyst may look at a 10-year gold price chart and say that gold has had its run, is losing momentum and should be ready for a long slide to historic levels. There may be some credibility in this assessment; certainly the government requires taking into account trailing averages for calculating resource models. This may be an argument but it's not realistic. We are not in the world of three years ago much less than 10 years ago. Besides, these nominal price charts are not real prices because they don't take into account inflation.
TGR: What makes gold risky in 2013?
MN: Monetary policy has more impact on moving stock prices than economic data releases—labor data, for example. The recent increase in the price of gold follows quantitative easing (QE) by the Federal Reserve Bank. Gold sputters when the Fed starts talking about stopping its Treasury buying programs. Gold prices have increased among nations that show the linkage of global currencies.
The Fed believes in the Phillips curve and has a full employment mandate, so if the Fed sees inflation increase over 2% or unemployment drop below 6.5%, we can expect it to increase interest rates. Friedrich Hayek said the micromanaging of the economy is the "Fatal Conceit." If the Fed can convince itself that the economy is strengthening, then quantitative easing may end and investor sentiment fade for precious metals. If the Fed starts increasing interest rates, it could crush gold prices in the near term.
TGR: Do you see the U.S. economy growing in 2013 or the Fed increasing interest rates?
MN: It probably depends on how you measure growth. In my opinion, the media and politicians will talk it up. Large politically connected corporations whose lobbyists have helped them secure monopolistic positions will be optimistic. They are set. If you are a riskier biotech company or resource exploration company, you might have a tough time locating financing. If you look at the velocity charts of the Federal Reserve Bank of St. Louis, you can see by any measure that velocity is at the lowest level in decades. This reflects anemic credit, equity markets and business activity.
"Gold is a store of value for central banks, retail investors and everyone in between."
Fed Chairman Ben Bernanke is afraid to death of deflation. Clearly declining velocity has been offset by Treasury purchases, increasing bank reserves that balance with an anemic economy and low inflation. If the economy grows and velocity increases, inflation is going to be a real problem, but great for gold prices. If the economy sputters, the only solution for the central bank is to buy Treasuries. I saw the term "QE Infinity" the other day, great for gold, but a horrifying concept, especially for producers and savers like seniors.
TGR: The Fed doesn't have an easy choice, does it?
MN: In my opinion it doesn't have a choice, but it thinks it does. The Federal Reserve Bank thinkers are largely academics from MIT. These are demand-side Keynesians who believe in the validity of econometric models and their ability to manage the economy as opposed to trusting free markets of individual buyers and sellers or investors. I saw Bill Moyers interview Paul Krugman the other night. To them the problem is so clear: Savers are too greedy or afraid to buy stuff or invest, so demand for goods suffers, which can only be solved by executive action or by the government taxing the rich and engaging in deficit spending. This is the epitome of the Fatal Conceit. The Fed thinkers believe they can manage the economy, and as one of them said, if reality doesn't match their model, reality is wrong. If it were their money, it wouldn't be so scary but Bernanke admits they are experimenting with the economy.
TGR: How does this relate to the Federal Reserve?
MN: In my opinion, the Federal Reserve's job is to maintain price stability but the Fed is now in the economic-health business. The government is in the program-spending business. The Federal Reserve and the federal government are cooperative centers of gravity. It has become apparent since the financial crisis that all the economies are linked. This systematic risk is even greater. All the developed nations are facing the same issue of central banks and spending. Think about Germany's tough role in the euro with the PIGS (Portugal, Italy, Greece, Spain) nations. Even Switzerland has devalued its currency, caving to its exporters at the expense of savers. Japan is devaluing its currency. In a way the world economy is circling the drain, currency is no longer a store of value and wealth is being transferred to consumers at the expense of savers and producers.
TGR: Is gold then the answer as a store of value?
MN: Well, it may be one answer. The truly rich have always gotten richer from inflation. Tangible assets like real estate are tax-deferred hedges against inflation. There seems to be more advertisements for tangibles like art and collectables, but it could be my imagination. Inflation hurts holders of currency and currency-denominated debt. This makes it real hard to get credit; nobody wants to provide it only to be repaid in devalued currency at interest rates that do not compensate for that risk. This is one way the government squeezes out private debt and equity.
"While the potential for higher gold prices is compelling, the decline in the number of discoveries and grades of resources makes stock selection intriguing."
The government is big in mortgage lending and student loans while selectively targeting its priorities with guaranteed debt or tax credits. While this increases demand, it doesn't encourage responsible behavior and leads to bubbles. If the government owns the debt and can forgive or modify the debt, it now is both investor and manager of bubbles. The greatest intervention in the U.S. has been cramming down secured senior creditors at General Motors in favor of union pensions. So, yes, gold is a store of value for central banks, retail investors and everyone in between, as a hedge against the government progressively printing itself out of a problem.
TGR: In a risk-adverse market for equities, does gold provide a hedge against inflation?
MN: That has been the conventional wisdom. While the potential for higher gold prices is compelling, the decline in the number of discoveries and grades of resources makes stock selection intriguing. Corvus Gold Inc. (KOR:TSX) has a very interesting chart in its corporate presentation showing the decline in gold discoveries. It shows reasonably constant gold production over the last couple of decades with discoveries declining. While discoveries may not be related to gold prices, which are a function of production supply not meeting demand, with fewer discoveries where is future production going to come from?
This is also true of copper. Producing mines are mining at lower grades while demand from China is driving prices up. The big surprise in metals in 2013 might be zinc and platinum with mine depletion and closings due to political unrest. In any event, careful company selection for both producers and exploration companies may produce better-than-expected returns.
TGR: You certainly paint a negative picture for raising capital. Are you bullish on mining stocks?
MN: Buying exploration resource companies at a discount to their in-situ value or gold producers makes sense but this is a very risky business. Most discoveries never become a mine and once a mine is built costs may erode profitability; if a windfall is in the air, governments are all too quick to move the goal posts by increasing taxes or royalties or outright nationalization. This is likely to increase as nationalism appears to be on the rise at the expense of international free trade. I am a true believer of free trade benefiting the masses through comparative advantage being superior to national theft. While "let the buyer beware," I am going to be giving a premium for political stability.
TGR: Are you going to be sticking close to home?
MN: About a month ago I presented at the Yukon Mining Summit on the competitiveness of the Yukon. It is amazing that the Yukon is one of the world's most attractive areas for both political stability and geologic potential. If a company can get into production, it may be set. Alexco Resource Corp. (AXR:TSX; AXU:NYSE.MKT) just completed its second full year of production at its 100%-owned Keno Hill silver district. The company has completed improvements to the operations, and capacity is now ahead of ore mined from the Bellekeno mine.
This month Alexco is scheduled to permit the Lucky Queen and Onek mines, which should fill excess capacity at its central mill. As Bellekeno covers fixed costs, the additional throughput should boost profitability. Alexco also just released drill results on the Flame & Moth target adjacent to the mill. Management thinks this could be a real game changer for the company. The Keno Hill silver district previously produced over 200 million ounces (Moz) silver at grades of about 40 ounces per tonne. As most of the production has been within a couple hundred meters from the surface, the area is still highly prospective.
TGR: What other gold producers do you like?
MN: I visited Comstock Mining Inc.'s (LODE:NYSE.MKT) project near historic Virginia City, Nevada. I was there when it commenced leaching gold and later for its first pour celebration. I was floored by the progress made since I visited the same project under different management about three years earlier. From a U.S. perspective, the historic Comstock district is the origin of modern mining techniques and technology. When mining met its limits, the area was closed until it was consolidated under the prior owner. The new management team brought in an entirely new approach, establishing credibility among local stakeholders and investors.
In a short period Comstock built a several million ounce gold equivalent resource. Its goal for 2013 is to produce about 20,000 oz gold. This requires only one quarter of the operations capacity. I was most pleased on the visit to see the exploration down the valley and the potential to build a much larger resource and quadruple production in the near future. Nevada is a great place to be, from a political perspective and as a jurisdiction friendly to mining.
TGR: Is Nevada the best place to invest in gold mining companies?
MN: I think so. I am pretty disappointed in federal regulators in the U.S., but everyone has heard of Nevada, and consequently the infrastructure is generally good, and this leads to lower costs overall. One site close to Comstock's at the southern end of the Walker Lane Trend is Corvus Gold's North Bullfrog project near Beatty. I visited this project about a month ago. It's about an hour or so north of Las Vegas. The company has one of the strongest management teams, with a long history in Nevada. The plan at North Bullfrog is to commence production on patented land. There is a low strip ratio and Corvus will soon know if ore may be placed directly on the pad. This should be a very low-cost operation. The company will be applying for a plan of operation with the Bureau of Land Management (BLM) for more extensive exploration drilling. This should increase and upgrade a large portion of the known resource. Corvus will also test new targets and possibly locate higher grades, all of which should improve economics and extend mine life.
TGR: What else do you like in Nevada?
MN: I really think High Desert Gold Corp. (HDG:TSX.V) is set to have a good year. I visited its Gold Springs project late last spring. Gold Springs is on the Nevada-Utah border near Cedar City, Utah. Similar to these other companies, High Desert has a highly prospective district-scale property. South American Silver Corp. (SAC:TSX) made a $2.8 million investment in High Desert. The company has identified and drilled dozens of near-surface gold targets. I suspect that upon the BLM's approval of a plan of operation, High Desert will be in good position to complete a methodical, comprehensive resource drill program, pulling together a much larger resource. Much of the earlier exploration has been near historic underground mines or mineralized rock outcropping, but High Desert seems to have used ZTEM surveying to figure out what is below the overburden. Mineralization and structures are in a caldera setting typical of Nevada gold projects.
TGR: Sounds as if you spend a lot of time in Nevada.
MN: Not as much time as some banking analysts, but I think exploration projects in Nevada will lead us out. I would like to visit NuLegacy Gold Corp.'s (NUG:TSX.V) Red Hill project in the Cortez Trend along strike with the multimillion ounce gold Pipeline and Cortez Hills mines. What makes Red Hills particularly interesting is Barrick Gold Corp.'s (ABX:TSX; ABX:NYSE) 7 Moz Goldrush deposit between Red Hills and these giant operating mines. One key member of the NuLegacy team is Dr. Roger Steininger who discovered Pipeline in 1989. Red Hills looks like the next proverbial pearl on a string. This is clearly an early project, but I like early projects with good management teams in good areas.
TGR: What other areas in Nevada should investors keep an eye on?
MN: I really like the area around Lovelock, Nevada. I have spent a lot of time over the years visiting Midway Gold Corp.'s (MDW:TSX.V; MDW:NYSE.MKT) Spring Valley project. This is a fascinating area, as it once contained Nevada's only gold dredge in the placers around Spring Valley. These placers may sometimes suggest nearby hard rock deposits. In this case, drilling in a joint venture with Barrick, Midway has found targets from the north to the southern boundary adjacent to Coeur d'Alene Mines Corp.'s (CDM:NYSE; CDE:NYSE) Rochester silver and gold mine. Earlier in Midway's history, then President Alan Branham declared the area around Lovelock to be Nevada's next gold trend and I think he deserves the credit for being right.
Interesting to the north is Terraco Gold Corp.'s (TEN:TSX.V) 35-square-kilometer Moonlight project. The company told me the old timers could see the silver in the moonlight; not sure if it is true but it is a great story. Terraco also has royalty interest in Spring Valley. Terraco's main project is in Idaho; although it's not a marquee area like Nevada, Idaho has potential to surprise and I would like to see that project as well.
One more company for investors in the Lovelock area is Orsa Ventures Corp. (ORN:TSX.V), which has sampled a long road cut at its Coal Canyon property, right above the city of Lovelock. While these areas are sometimes very early, with money tight, low-cost operating jurisdictions may provide the next generation of operating mines.
TGR: Sounds good. Thanks for giving us your thoughts about Nevada and 2013.
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) The following companies mentioned in the interview are sponsors of The Gold Report: Franco-Nevada Corp., Comstock Mining Inc., Terraco Gold Corp. and Orsa Ventures Corp. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
2) Mike Niehuser: I personally and/or my family own shares of the following companies mentioned in this interview: Alexco Resource Corp., Comstock Mining Ltd. and High Desert Gold 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.