John Kaiser: Knocking on the $1,000 Door

Source: The Gold Report  (5/29/09)

Gold investors know all too well the psychological importance of $1,000 gold. The yellow metal's been hovering frustratingly near that level for weeks after briefly surpassing it in February. According to John Kaiser, editor of the Kaiser Bottom-Fishing Report, "we're getting very close." In this exclusive interview with The Gold Report, John shares his "modest" price forecast of $1,300 - $1,400 within the next six months and presents strategies for gold companies looking to create value.


Gold investors know all too well the psychological importance of $1,000 gold. The yellow metal's been hovering frustratingly near that level for weeks after briefly surpassing it in February. According to John Kaiser, editor of the Kaiser Bottom-Fishing Report, "we're getting very close." In this exclusive interview with The Gold Report, John shares his "modest" price forecast of $1,300 - $1,400 within the next six months and presents strategies for gold companies looking to create value.

The Gold Report: John, you have said that you believe gold may go up to $1,300 to $1,400, but probably not higher. Can you give our readers an overview of how you achieved those targets?

John Kaiser: I think we’re ready for a real increase in the price of gold, which is why I am looking at more modest targets, such as $1,300 to $1,400, happening fairly quickly, probably bouncing plus or minus $200 or $300, around that level, but it’s a real price increase without a corresponding catastrophic collapse in the U.S. dollar or hyperinflation descending upon us.

TGR: What time frame are you looking at?

JK: I think we’re getting very close. We’re knocking on the door of $1,000, which is a very important psychological level. I would say in the next six months, as people realize that the banking system is still troubled and will be for a long time because an uptrend in real estate prices is not in the cards for a very long time. And, in order to make the banks solvent, the underlying collateral needs to have liquidity and a stable price.

I’m saying that in the next six months the realization will kick in that the world has changed in a significant way and the United States is losing its role as the overwhelming economic superpower and will continue to do so over the next 20 years as other countries such as China and India come into their own and pick up the slack that’s created by the collapse of consumption right now. If it breaches $1,000, I think it’ll very quickly go to $1,300-$1,500 and establish that as a new base.

What I’m arguing is that the uncertainty about the next 20 years is going to encourage more and more people to put part of their wealth into gold and keep it there. This expansion of investment demand differs from the situation we had in 1980. Back then we had a tenfold increase in the real price of gold from 1972 to 1980 and part of that was because gold’s value had been artificially suppressed through the gold standard and once that was removed, we had a slingshot reaction and gold adjusted to a price ten times higher. There were mines being shut down in the '60s because their costs kept rising while the gold price remained fixed. Then all of a sudden we had new technology in the form of heap leaching and new economies of scale that unleashed an enormous amount of new gold supply. During 1980 the new mine supply of gold was 42 million ounces, which was actually lower than the 48 million produced in 1970. It rose steadily after that, peaking at 82 million ounces in 1999 when gold was also under pressure from official selling by central banks and indirect selling through the gold carry trade made possible by gold leasing. From 1980 through last year gold producers added 1.9 billion ounces to the above ground stock, bringing it to about 5 billion ounces today. But mining costs have kept going up and up and the annual mine supply has been declining since 2004.

TGR: If the gold price continues to rise but costs remain stable, wouldn't one want to invest in the gold production companies?

JK: Yes. In the last four years the gold producers have not actually done very well despite the recovery from $260 to the current level. We’ve had a base metals commodity boom that drove up the costs of producing gold at a much faster rate than the price of gold was increasing. On an inflation-adjusted basis, $400 gold in 1980 today should be about $1,000. The rise since the low of 2001 is not a real price gain, just a catch-up. But in the current deflationary environment another 30% to 50% boost in the price of gold would be a real gain that has a profound impact on the bottom line of gold producers.

For companies that have deposits that are marginal when gold is $600-$700/oz., you wouldn’t dream of putting them into production with gold now at $925-$950/oz. But at $1,300-$1,400/oz., with the cost staying at $600/oz., all of a sudden there’s a huge margin available to be tapped. So we would see a rush of capital going into these deposits and companies and producers to develop these ounces in the ground and turn them into cash flow, which, of course, the market will use its discounted cash flow model to put a value on. And the key thing is, again, to see that this is a real increase in the price of gold and the sense that this is now the new reality, not just a temporary spike that will correct and drive gold back down to, say, $600.

TGR: At a recent conference you highlighted strategies or approaches that gold companies should pursue to create value. Can you give us an overview of those strategies and some examples of companies who are doing that well?

JK: You’ve got to look at it as producer and non-producer categories. The big producers have been creating value by putting existing deposits that they have in their inventory into production and they have been growing themselves bigger by doing mergers of equals—such as what we saw Glamis and Goldcorp (TSX:G) (NYSE:GG) do a couple of years ago and Barrick Gold Corporation (NYSE:ABX) and Placer—so that the big mining companies just get bigger and bigger by consolidation.

But the more popular route is for a bigger company to take over near-development assets such as Kinross Gold Corporation (K.TO) (NYSE:KGC) did with Aurelian Resources and its 14 million ounce Fruta del Norte deposit in Ecuador or IAMGOLD Corporation (TSX:IMG) (NYSE:IAG), which took over Orezone Gold Corporation (TSX:GMI), which was dead in the water last year when funding was cut off for the construction of the Essakane deposit in Burkina Faso.

So the stronger company comes in and buys out the distressed company because it has the internal capital to develop those assets. With the non-producers, the idea is to look at the projects that have the ounces in the ground where it may not be so great right now, but if we are expecting a significant increase in the price of gold, value will end up being created, courtesy of the gold price increase.

So in anticipation of this type of takeover bid what these non-producer companies are doing now is raising the risk capital to push these projects along the exploration cycle. They’re doing their in-fill drilling, metallurgical studies, and pre-feasibility studies. And even if the pre-feasibility says, well, this is kind of so-so at the $700-$775 three year trailing average the engineers are plugging into their cash flow models—if we do get this move, everybody will say, well, that pre-feasibility study established the cost side of the equation. And now we’re seeing the revenue side expand massively thanks to a higher real gold price, now there is value being created, and the stocks will adjust upwards five, ten times in price to reflect the new reality of a significantly higher gold price.

TGR: So this relies on gold settling in at something higher than today. So let’s say gold settles in at $1,200, then these near-term or non-producers should see a five to tenfold increase in price based on a much improved margin.

JK: Let’s take Riverside Resources Inc. (TSX:RRI) as an example. They have picked up a deposit in Arizona called Sugarloaf Peak, which has a million-plus ounces. It’s a very large system, but it’s low grade. The average grade is too low to be minable at the current gold price. However, if you increase the gold price 30% to 50%, all of a sudden the open pit mining scenario starts becoming very interesting for this project.

The market is assigning a very low valuation to Sugarloaf Peak at this point, only $14 million. Yet it has an in-ground resource of a million ounces and the kind of geological footprint where you could conceivably say, well, this is a multi-million ounce system, a science project for the last 30 years, but in the new reality of a higher real price in gold, this thing could be enormously valuable. And even if it’s only, say, worth $100 to $200 million on a discounted cash flow basis, that’s still 10 to 20 times how much the market is pricing the project right now. So it’s this kind of leverage that you see in these marginal gold deposits where the companies are now revisiting them, doing the confirmation drilling, testing new models to see if deeper down there is a giant feeder system or something else that shows that this is not just a 1 or 2 million ounce deposit, but perhaps a 5 to 10 million ounce system of interest to majors, who are looking for something they can operate for 20 or 30 years as opposed to being just a ten-year blast of cash flow. These are the types of non-producer companies one should be looking at now.

TGR: Are there any other non-producers or near-term producers that our investors should be aware of?

JK: Another junior that I follow is Hawthorne Gold Corp. (TSX.V:HGC). A couple of years ago they started looking at this low-grade system in British Columbia called Frasergold, trying to establish that it is a multi-million ounce low grade system that could be developed as an open pit mine.

But along the way they came upon this opportunity to acquire a distressed company called Cusac Gold, which had been trying to mine a high-grade gold vein on the Table Mountain Project in Northwestern British Columbia and they were able to acquire the company and its assets at fairly cheap prices. What they are doing now is revisiting the old Table Mountain deposit, which is a complex high-grade vein system. They’ve done the digitization of all the data, they’ve put the mine engineers and geologists to work to revisualize how this system works. And they’re now doing the work to demonstrate, yes, here are the lenses where we can get this fairly small-scale mill being fed ore again very profitably. And in the process what they’re hoping to establish is their credibility as a miner, as a small producer. There are not a lot of competent small producers out there.

And, again, if we get this significant move in the price of gold that unleashes a gold mania and money comes flooding into this market, it’s going to be looking for management groups who have a demonstrated ability to take these small deposits and figure out where the ore is and how to mine them profitably. And they’ll say we’re going to give you more money to acquire other projects and repeat the process, hopefully, even bigger projects.

And in the case of Hawthorne, as part of that big land package they acquired something similar to the Riverside situation, a large low-grade gold deposit on which they are also doing work while they’re waiting for the gold price to go up. They are sorting out what the metallurgy is for this deposit and what it would take to develop this as a bulk minable situation. They can’t, of course, make the price of gold go up, but the strategy they’re pursuing is, we can figure out where the high grade gold is on this vein system on this same property, mine it and get cash flow going from the small-scale operation. And if gold does go up, then we get a double positive whammy, both from the little cash cow that we have going with the small scale mine and with this larger resource that we have also within this property.

TGR: Are there any other juniors that are positioning themselves similarly?

JK: You asked earlier what strategies companies can use to create shareholder value and I neglected to mention the one that is not very popular in the market right now and that is old fashioned exploration aimed at making a major new discovery. I have a certain fondness for these companies because that’s where you can get the 5,000% to 10,000% type gains from a company that’s raising risk capital, putting geological creativity and ingenuity to work, establishing targets, drilling them, and coming up with, say, a 5, 10, 20 million ounce deposit. And one of the companies that’s on my list is Miranda Gold Corp. (TSX.V:MAD).

They have focused on Nevada and they’ve got their in-house team of people who are out there doing grunt work on the geological side to identify potential properties where buried gold deposits may exist based on their interpretation of fault structures and their intersection and their relative location to known deposits like Cortez Hills and so on. They also have a policy of making their nickel last a long time because they do the early stage work, they dress up the target, and then they farm it out to other companies which may be more promotionally minded. A company like Miranda—we call them a prospect generator type of company—keeps generating prospects, and they farm them out to others to spend the higher risk capital. The tradeoff is they don’t control the project while it’s under option to the other company and they end up with a lower net interest, but they keep repeating the cycle over and over again.

The market’s not very interested in this, but if we do get a significant move in the price of gold, the number of ounces-in-the-ground type projects is quite limited. Those will all go up substantially and then the market will wander down the food chain and start throwing money at those companies which can generate drill targets. Even if gold doesn’t go up, they may make a discovery tomorrow where suddenly this company goes up and delivers huge gains to the speculator.

Miranda Gold has about six to ten projects that they’ve got in their portfolio. Half of them are farmed out. Some of them have recently been dropped by companies that cannot raise the money. But each one of them right now, depending on whether they net 50% or 40%, is carrying a valuation of, say, $18 to $40 million. The failure of one does not make the stock go down. It’s a statistics game. A company can toil doing this forever and never come up with anything. But then it could finally get lucky and one of its farmed out projects could deliver that huge hole, and then it doesn’t matter if you have a 40% or 30% net interest. Your $40 million valuation will go to $4 billion, which would be a 100 times price increase.

TGR: Thanks, John. This has been very informative.


DISCLOSURE: John Kaiser and/or his family owns shares of Miranda Gold, mentioned in this interview. He and/or his family are not paid by any of the companies mentioned.

John Kaiser, a mining analyst with over 25 years experience, is editor of the Kaiser Bottom-Fishing Report . He specializes in high-risk speculative Canadian securities and the resource sector is the primary focus for an investment approach he developed that combines his "bottom-fishing strategy" with his "rational speculation model." Kaiser began work in January 1983 as a research assistant with Continental Carlisle Douglas, a Vancouver brokerage firm that specialized in Vancouver Stock Exchange listed securities. In 1989 he moved to Pacific International Securities Inc where he was research director until April 1994 when he moved to the United States with his family. From 1989 until 1994 he was also a registered investment advisor. He worked six months as a researcher for Bob Bishop's Gold Mining Stock Report before branching out on his own with the publication of the first issue of the Kaiser Bottom-Fishing Report in October 1994. He has written extensively about speculative Canadian issues, is frequently quoted by the media, and is a regular speaker at investment conferences.


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