Chen Lin Says Gold Miners Need to Produce at $1,000/oz or Less to Survive

Source: Kevin Michael Grace of The Gold Report  (11/17/14)

How low can gold go? Chen Lin expects a probable near-term low of $1,000/ounce. The author of the What is Chen Buying? What is Chen Selling? newsletter says that at that price we can expect a bloodbath of companies, both large and small. Gold cannot be kept down forever, however, and once the bottom is in, those miners that have survived will be in an enviable position, able to buy lucrative assets at bargain prices. In this interview with The Gold Report, Lin identifies several producers and one near-term project uniquely positioned for the next bull market.

Gold and Money

The Gold Report: You've discussed in your newsletter Goldman Sachs' plan to "push gold [down] to $1,000/ounce" ($1,000/oz). How do you know such a plan exists?

Chen Lin: I am not a big fan of conspiracy theories, but Goldman published a report in early September calling for $1,000/oz gold by the end of 2014. As I saw it, this call was quite aggressive. Goldman will lead and probably has been leading a group shorting gold aggressively.

"Pretium Resources Inc.'s Brucejack deposit in British Columbia is phenomenal—one of the highest grades in the world in a politically safe jurisdiction."

Kitco has published a report arguing that should gold fall to $1,000/oz, this would be catastrophic for most gold miners. The shorts, unfortunately, probably don't care about gold mining companies and the jobs of those who work for them. They just want to make money. If the gold miners go under, they'll be very happy.

TGR: We've heard about these short attacks for at least a year and a half. How long can they keep winning this game?

CL: That's a very good question. There is, however, another reason why gold has declined in price: its reverse correlation with the U.S. dollar. The dollar has recently been strong, so gold has been weak. And the shorts are making money on this.

I see the fall of gold from $1,900/oz to be a healthy correction. This creates buying opportunities for long-term investors. As I told my subscribers, I started to underweight gold and gold miners back in 2011–2012. I hope my subscribers took my advice and have survived this nuclear winter of gold miners. We continue to look for the bottom. This year, in particular, I have increased my efforts to visit gold mines and meet with gold mining company executives, so I can be prepared when the gold market turns.

TGR: The U.S. Federal Reserve is tapering quantitative easing (QE), but just recently the Bank of Japan announced an enormous QE plan. Shouldn't this be very good for gold?

CL: It should have been, but what happened was that Japan's QE lowered the value of the yen and strengthened the dollar. So investors sold gold on the QE news. It's a paper-market game. All these funds don't own gold at all. They're basically borrowing gold to short it. They borrow from some other place, maybe the central government, maybe from exchange-traded funds (ETFs), whatever, I do not know. This game will end, but the question is when.

TGR: What are we hearing about physical gold sales in Asia?

CL: Physical gold buying has been quite strong in China, although not as strong as last year, partly because China's economy has been slowing down. Gold buying in India has been very strong, and the Indian economy is actually picking up. These are the two largest gold-consuming countries. I believe that eventually physical demand will gradually absorb all the shorts' positions. Then the gold market will turn. China bought about 1,000 tons (1 Kt) of gold last year. The U.S. claims to have about 8 Kt gold. It's in Europe where there's a large position. So this turnaround will take a few years.

"Virginia Mines Inc. has a very strong balance sheet."

TGR: On Nov. 7, gold fell to a low of $1,130/oz. Then it rose $47 for the rest of the day to finish at $1,177/oz, a 3.15% increase. Was what happened that day a one-off, or does it perhaps suggest the bottom has been reached?

CL: I wish I could tell gold investors the good news that everyone is waiting for, but I'm not so sure. From the macroeconomic point of view, the U.S. dollar will likely be strong for the next two to three years because the U.S. economy is one of the strongest, if not the strongest, in the world. This year, the shorts may not be able to push gold all the way to $1,000/oz ahead of Christmas and the Chinese New Year, which is a very strong gold consuming season, but they may come back again next year in the summer.

TGR: What do you make of the talk that American sanctions against Russia have pushed Russia into an alliance with China and that this alliance plans to create a new reserve currency to rival the U.S. dollar?

CL: I don't think Russia and China together could create a currency to rival the U.S. dollar. Sanctions and the drop in the oil price have pushed Russia toward China. I don't think they will become allies; their systems are too different, and they are historic rivals. But they will be friendlier.

TGR: Gold heading toward $1,000/oz has resulted already in decreased production, and this decrease will become significantly greater over time. Shouldn't this result in a significantly higher gold price?

CL: Over the long term it will. In the short term, however, there's a large quantity of gold in storage. Annual production is minimal compared to stored gold.

TGR: Do we really have any idea how much gold exists? If the world's gold is endlessly loaned out and rehypothecated, is this a shell game that can run and run?

CL: I don't know how much gold really exists. Many people put money in ETFs, which may not own gold. But most investors don't regard gold as a long-term investment; they regard it as a trading vehicle. This situation won't change until the world recognizes gold as currency.

TGR: You said that investors should look to gold companies that can produce positive cash flow at $1,000/oz. How many companies can actually achieve this?

CL: Not many. Gold at $1,000/oz could potentially bankrupt even companies as well run as Agnico Eagle Mines Ltd. (AEM:TSX; AEM:NYSE).

TGR: Can we expect a revaluation of the few companies able to profit at $1,000/oz gold?

CL: I'm not sure we will get a revaluation upward because it depends on investor perceptions of the gold mining sector, and that depends on the gold price. One thing for sure is that I sleep well at night holding these companies because even at $1,000/oz, they can flourish. And when the bottom happens, these companies with cash will be able to buy out the overleveraged companies.

TGR: Which junior gold producer is your current favorite and why?

CL: I own mostly OceanaGold Corp. (OGC:TSX; OGC:ASX), a company headquartered in Australia. It has mines in New Zealand and the Philippines. In particular, at its Philippines mine, the copper content is such that its gold producing cost is negative. So we are talking about an exceedingly healthy margin. Even at $500/oz gold, OceanaGold would be making a lot of money.

TGR: You are referring to Oceana's Didipio mine?

CL: Exactly. I've been there twice. This is one of the few recent mines that was actually on time and on budget and produced more than its original plan.

TGR: Didipio has just over 2.8 million ounces (2.8 Moz) Measured and Indicated (M&I) gold and 250 Kt copper. What is its copper production price?

CL: It uses copper as a byproduct credit; that's why the gold is free. This is the first mine in the area and it has huge exploration upside. Oceana is accumulating cash to fund exploration of satellite deposits. This can be a district play. In New Zealand, Oceana is a high-cost producer: about $1,000–1,200/oz. But the company has hedged the next two or three years of production to keep this operation cash-flow positive.

There are a lot of rumors. One is that Oceana may buy out Alacer Gold Corp. (ASR:TSX: AQG:ASX). I've been there as well; it's in Turkey. Alacer is finishing its mining of oxide and going to sulphide. So it needs a roaster, and Oceana has one in New Zealand. After it closes its local mine in a few years, its then-free roaster would be a good fit for Alacer.

TGR: Are you invested in any other junior gold producers?

CL: I'll name two. The first is Gold Resource Corp. (GORO:NYSE.MKT; GORO:OTCBB; GIH:FSE), which is a low-cost gold and silver producer in Oaxaca, Mexico. The company is doing quite well. It has no debt on its balance sheet and pays a monthly dividend.

TGR: Gold Resource devotes one-third of its cash flow to dividends. Should it continue to do so?

CL: If the gold price continues to drop, I would argue that management should cut the dividend and buy other assets instead because every other asset is a fire sale. The point is Gold Resource has financial flexibility, and that's a very good thing for a mining company right now. That's why I like it.

TGR: Gold Resource rose 11% Nov. 7. In fact, many gold companies rose substantially that day. Was that a one-off as well?

CL: Yes, and most of these companies have fallen a lot since then. Gold miners are now quite volatile. Probably by the end of 2014 or early 2015, we will see a very good buying opportunity. This could be a tradable bottom. We are going to have tax-loss selling in November and December. Following Dec. 31, the end of the quarter and of the year, there will be the sector rotation of index funds. We will see the rebalancing of index funds. Until then, gold mining stocks are like a casino, and I'd rather gamble in Vegas.

TGR: What's the second company?

CL: Orvana Minerals Corp. (ORV:TSX), which is now debt- and hedge-free. Its cost base in Spain is about $1,000/oz and a little bit less in Bolivia. It is one of the companies that will survive $1,000/oz gold.

TGR: Can you talk about a junior gold miner you follow?

CL: Virginia Mines Inc. (VGQ:TSX). It's a prospect generator and royalty company in Quebec. It owns a production royalty on Goldcorp Inc.'s (G:TSX; GG:NYSE) Éléonore mine: 2.2% now, rising to 3.5%. Commercial production began in October, generating $1 million ($1M) per quarter in cash flow to Virginia. This will increase as Goldcorp ramps up production. So Virginia Mines has a very strong balance sheet.

Virginia Mines is probably going to sell royalties at very high premiums, giving the company the ability to acquire more prospective properties.

TGR: Which near-term gold producer do you like best and why?

CL: I like Pretium Resources Inc. (PVG:TSX; PVG:NYSE) a lot. I've been there twice, as recently as a few months ago. Its Brucejack deposit in British Columbia is phenomenal—one of the highest grades in the world in a politically safe jurisdiction. It is looking to become a very low-cost producer: just over $400/oz. So even if gold drops below $1,000/oz, the mine will be built.

TGR: British Columbia has not been particularly friendly to mining recently, especially considering the recent court decision that gave First Nation groups rights to all the province's Crown lands. Are you confident that Pretium can be permitted in a reasonable amount of time?

CL: I believe so because it will be a relatively small, underground mine in a brownfields location. It was permitted before, and getting a new permit should be relatively easy. The court decision you mentioned was terrible news for a lot of miners. But the lake close to Brucejack has no fish, so the mine will have a small impact on the environment.

TGR: Pretium has been called an "elephant find." Could we see a takeover bid?

CL: Very possibly.

TGR: Pretium has a market cap of about $650M, which would make a takeover about twice as large as recent examples.

CL: Yes, but, again, this is a very low-cost operation. The recent takeovers were producers at about $1,000/oz, as opposed to Pretium's $400/oz. I believe any takeover would be at a significant premium to the current stock price.

TGR: The silver price has been falling. Isn't silver supposed to be insulated somewhat because of its use in industrial applications?

CL: About 50% of silver is used in industrial applications. At the current price, most of the silver miners are not making money. That blows my mind. But silver dropped to a few dollars in late 2008–2009, so I can see that silver could now potentially drop further. Silver will continue to be produced because it is mined mostly as a byproduct of base metals operations. If silver drops to single digits again, it's the buying opportunity of our lifetime.

TGR: Do you like any silver companies?

CL: I own a few pure silver companies, but they're mostly not in very good shape. Gold Resource actually has a lot of silver, so that's probably a better silver bet.

TGR: Pretium has a lot of silver as well.

CL: Yes, but only about 10% of Brucejack's deposit. Gold Resource is almost 50% silver.

TGR: Tell me why you're so keen on platinum group metals (PGMs).

CL: It's a very interesting situation. There is very strong physical demand. China has a huge pollution problem. In China, only Beijing has strict car emission standards comparable with those of the U.S. and the European Union. The surrounding provinces don't. So if China is really serious about reducing pollution, which I believe it is, all Chinese provinces will have to upgrade their emission standards. When and if that happens, I'm not sure we have enough PGMs to upgrade the cars.

TGR: You're talking about catalytic converters here, right?

CL: Right. That's where most of the palladium and much of the platinum goes. And the demand will come not just from China. According to the World Health Organization, the world's most polluted city is in India. There is a supply/demand problem looming. Right now, both platinum and palladium are trading at a deficit. With the strike in South Africa, investment will go down. With the troubles in the Russian economy, investment will go down. Production will not keep up with demand for the foreseeable future.

Another source of PGMs is from recycling. Stillwater Mining Co.'s (SWC:NYSE) last conference call reported that recycling has been reduced significantly because of the PGM price decline. The current low prices do not warrant recycling from catalytic converters. Even with 100% recycling, PGM supply couldn't keep up with demand.

PGM prices have been hit very hard, just like gold. But this is due mostly to fund or ETF selloffs. Some 50% of COMEX's platinum position was sold in September. That tells you a lot of funds are really in trouble. Along with energy going down, I believe a lot of funds cannot survive 2014. Even those that do will see a lot of redemption. It won't be a question of investors wanting to get out; they'll be forced out. I see lots of opportunity ahead. Just as with gold, the end of 2014 and the beginning of 2015 could see a bottom in PGMs.

TGR: You recently got into Stillwater, correct?

CL: Yes. This is a very interesting company. It has a very strong balance sheet. It is generating strong cash flow quarterly, about $20–30M per quarter. So it's a very strong company that I like in this market.

Another PGM junior I like is Wellgreen Platinum Ltd. (WG:TSX.V; WGPLF:OTCPK;). I've been there twice. Its Wellgreen property is in southwest Yukon, with good access to infrastructure and transportation. This is a monster project: 5.5 Moz PGM and gold M&I and 13.8 Moz Inferred, 1.9 billion pounds (1.9 Blb) nickel M&I and 4.4 Blb Inferred, and 1 Blb copper M&I and 2.6 Blb Inferred. Today, nobody cares, but if PGMs take off, everybody will care. This company is a sleeper. If the paper metals market breaks, PGMs will break it first because the physical demand is so strong.

TGR: The bear market in gold stocks started in April 2011, 31 months ago. Since then, we've heard many times that the bottom is in, but it never is. With the end of year upon us, could we see one last flurry of panic selling?

CL: I think there's a possibility of final selloff to flush out all the weak hands and all the leveraged positions. But it's hard to say. Sometimes bottoms form that way. Sometimes bottoms form without people paying notice. Sometimes we get round bottoms and sometimes V-shaped bottoms. One thing for certain, as I mentioned earlier, I'm spending a lot more time visiting mines and meeting with mining company executives to be ready when the bottom comes.

TGR: When that finally occurs, how much of a buying opportunity will it present?

CL: It will present a huge buying opportunity. In 2008 it was a V-shaped bottom. I remember I was buying NOVAGOLD (NG:TSX; NG:NYSE.MKT) in December 2008. It then tripled in three or four days. That was a pleasant experience.

TGR: Chen, thank you for your time and your insights.

Chen Lin Chen Lin writes the popular stock newsletter What Is Chen Buying? What Is Chen Selling?, published and distributed by Taylor Hard Money Advisors Inc. While a doctoral candidate in aeronautical engineering at Princeton, Lin found his investment strategies were so profitable that he put his Ph.D. on the back burner. He employs a value-oriented approach and often demonstrates excellent market timing due to his exceptional technical analysis.

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1) Kevin Michael Grace conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
2) Chen Lin: I own, or my family owns, shares of the following companies mentioned in this interview: Alacer Gold Corp., Gold Resource Corp., OceanaGold Corp., Orvana Minerals Corp., Pretium Resources Inc., Stillwater Mining Co. and Wellgreen Platinum Ltd. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
3) The following companies mentioned in the interview are sponsors of Streetwise Reports: Virginia Mines Inc., Pretium Resources Inc. and NOVAGOLD. Goldcorp Inc. is not associated with Streetwise Reports. The companies mentioned in this interview were not involved in any aspect of the interview preparation or post-interview editing so the expert could speak independently about the sector. Streetwise Reports does not accept stock in exchange for its services.
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