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Lawrence Roulston: Yesteryear's Castoffs, Tomorrow's Treasures
Source: Interviewed by Karen Roche, Publisher, The Gold Report (2/19/10)
Resource companies that discover and develop deposits come with enormous upside potential, but lucrative finds prove few and far between. In this exclusive Gold Report interview, Resource Opportunities editor and publisher Lawrence Roulston talks about his strategy for finding large gains without taking on discovery risk. He also weighs in on China's importance in the mining and metals space, and talks about some prospective properties in the emerging metals areas of Guyana and the Philippines.
Lawrence Roulston: Largely I agree with the other gold newsletters with regard to comments on the current state of affairs in the United States. Where we differ is in the implications of the situation and what it might look like going forward. Although I think the worst is over, that's not to belittle the challenges. The enormous budget deficit, the incredibly high levels of debt for the government and for consumers, are terrifying. Unemployment is at a very high level, but I think it's stabilized and probably will come down. The economy has shown some pretty significant growth over the last quarter.
Certainly the situation remains very difficult, and it is not sustainable. But that doesn't necessarily imply that the U.S. economy will stop growing or revert back into a recession. There is effectively a mechanism in place that is taking the pressure off and that mechanism is the value of the U.S. dollar. The dollar has lost about half of its value relative to the Euro over the last five years. If your portfolio and assets are valued in dollar terms and are the same as they were five years ago, you've actually lost half the value because the dollar is worth half of what it was.
As that process continues, it takes the pressure off and effectively serves as a self-balancing mechanism that will prevent a cataclysm. Certainly it does not prevent problems. Things measured in dollar terms will become more expensive. I think we'll just see a continuation of inflation—not hyperinflation—and the U.S. economy muddling along.
TGR: Is the decline in the dollar against the Euro somehow a function of the increasing volume of the U.S. money supply, or more just a balancing between the values of the currencies?
LR: It's the net effect of all of the factors. The amount of money put into circulation for bailout programs and stimulus packages and all the rest of it is frightening and will definitely lead to further devaluation in the dollar along the lines of what we've been seeing. In fact, that process probably will accelerate.
TGR: And that's good for gold.
LR: Obviously, when people decide they like gold and want to invest in it, finding signs of inflation is very positive for the gold market. I think we're going to see a long-term continuing uptrend in the gold market and I think we're going to see increasing inflation. But I would disagree with the pace at which that's going to happen. I think it's probably going to look a lot like it has over the last five years, not suddenly going higher.
TGR: You've also discussed China fairly extensively in your newsletter. China's exports have gone down as consumption has declined in the developed countries, but that excess capacity has been filled with internal consumption. There's a lot of speculation on whether that internal consumption is sustainable. Do you think China needs the developed countries to resume strong growth to approach double-digit growth in its own economy?
LR: I think people lose track of the fact that China's exports to the United States or to Western Europe have not stopped. China is still exporting a lot of materials to every part of the world. The United States is buying roughly as much now as a year ago. Even though it hasn't been growing, the U.S. economy didn't stop functioning. True, China's exports dropped considerably and are beginning to recover now, but the internal growth has been astounding.
If you spend some time in the big cities in China—and remember China has 100 cities with more than a million people—you'll see that every one of those cities is going through remarkable expansion: New offices and factories and houses and apartments and schools and every other element.
Last year China became the world's largest market for automobiles and that fact, I think, surprises a lot of people too. It's hard to visualize until you go there. The major cities are crowded with cars. Traffic is becoming a serious problem. Consumption there is very real and it's spreading. Once some people accumulate the kind of wealth that they can display in the form of cars and big houses and so on, everybody else wants it. Right now about 300 million people in China are middle class, with more or less the same purchasing power as people in North America. But another billion people in China are seeing their neighbors becoming wealthy and want to get on board.
China's economy is growing at 10% right now and the government is stepping in already to put in place measures to prevent the growth rate from going higher. So is China's economic growth sustainable? I think the more germane question would be how they restrain growth as the Chinese people become more and more consumer-oriented.
TGR: Louis James, who is with the Casey Research, suggests that China's double-digit growth was based on the government drawing from its reserves to stimulate the economy.
LR: There's no question that last year the Chinese government stimulus was an important element in kick-starting growth and played an important part in the expansion of the consumer market. However, looking forward it's very important to understand that the stimulus spending in China builds infrastructure—roads, rails, ports, highways all over the country. All of that infrastructure spending is putting the country in a stronger position to further increase its manufacturing and exporting capabilities.
So at the same time that the U.S. economy has received stimulus, it's gone to stop General Motors and Chrysler from going bankrupt and to prop up failing banks, but there was very little, if any, concrete action in terms of adding anything sustainable to the economy that will provide benefits in the future. There is talk about expanding wind generation and other measures that might yield a benefit some day if they ever get implemented. But meanwhile, China worked very quickly to set up and accelerate infrastructure development projects. Those are going to pay off big time.
And putting the stimulus into perspective, China had something in the order of $400 billion of stimulus spending last year; in contrast, the U.S. package was in the multiple trillions.
As stimulus spending tapers off in China, I believe other elements of the economy will continue to expand. Internal consumption is kicking off in a big way and that has a huge multiplier effect. So I'm very confident from first-hand observations and from everything I read and see and hear from other people I talk to that this is a long-term process. As I said, the government is already implementing measures to slow down the pace of growth, so it's not that they're still pushing to make it happen.
TGR: Another interesting observation Louis made was that the Chinese government incurred no debt in its $400 billion infusion, whereas the U.S. government is 100% debt-driven. That leaves long-term implications in terms of paying down that debt.
LR: That's another very important point, absolutely. Speaking of debt, too, another important point to bear in mind is how the residential real estate market works in China. Although there are concerns in Hong Kong, Shanghai and Beijing, for example, about home prices getting so high that a housing bubble forms, they are nowhere near that. The average house purchase in China involves 50% debt and 50% equity, so half of the value of those houses is in the form of equity. As you know, in the United States, many purchases were funded 100%—or nearly 100%—with debt.
TGR: How about India? How do you view developments there?
LR: From all indications, India—which has a billion people—is on the same path as China; several years behind but moving in the direction of catching up. Despite bureaucratic snarls, things are beginning to happen in India and the economy is moving forward. Certainly, there's a lot of wealth there as well.
I was talking to somebody just recently who toured India specifically to explore whether the consumer-oriented society in India was about to take off. His conclusion is an emphatic yes, there are enough wealthy people that others in the country are striving to achieve that same level.
In terms of the metals markets, the implication of all of this in my mind is that, especially when these countries are at the development stage, each unit of GDP is much more intensive in its use of metals than mature economies such as those in the U.S. and Canada. In other words, achieving the same amount of economic activity in North America uses less metal than that amount of activity would in China, in particular, where the focus is on development of infrastructure.
Too many economists, commentators and newsletter writers based in the United States put blinders on, figuring that because the U.S. economy is slow, the rest of the world is slow. That's just simply not the case. With regard to base metals, other parts of the world are far more important drivers in the base metal markets than the United States is. In fact, China is by far the largest consumer of metals of any country in the world. Will China continue to use metals? Absolutely. Will India catch up to that level? Absolutely. That's how I see it.
TGR: In many cases, metals prices have gone up dramatically. Has growth in Asia already been priced in or is there more upside on the horizon?
LR: Let's step back a moment. Over the last year North America and Europe have muddled along at zero growth or very slow growth. During that period, China grew at between 6% and 8% and yet the copper price went from a low of $1.25 to well over $3. I'm not betting on a higher copper price, but you can certainly see the potential when it more than doubled while the Western world was largely stagnant. With China now growing faster than last year and the Western world just beginning to get back onto a road to recovery, the upside potential in copper or any of the base metal markets is tremendous.
TGR: You see tremendous upside potential but won't bet on higher copper prices?
LR: If a company makes sense at $3 copper, it's going to look phenomenal at $4 or $5 or $6 copper. Those prices might come to pass, but they aren't part of my planning or analysis. I feel the same way about gold. I do not use higher metal prices in evaluating companies. Gains will come and the value of the companies will increase as they advance exploration projects toward production. That's always been the basis for our analysis.
Clearly we've benefited from higher prices, and to the extent that the metal prices rise in the future, we'll see that same benefit. But just to keep things in perspective, over the last nine years the gold price has tripled while returns on companies in our newsletter have averaged 50% to 100% a year. Clearly the metal prices contributed, but a much larger component of the gains came through advancements by the companies themselves.
TGR: If we have another substantial leg down in the markets, or if capital markets seize up again, to what extent would some of the junior companies that you focus on end up on the short end of the stick because they won't be able to get the money they need to develop their projects?
LR: I really don't believe that's going to happen. A more realistic scenario is for the American economy to just muddle along—slow growth, but slightly positive. As we discussed, at the same time the rest of the world, especially Asia, is taking on a life of its own. We didn't talk about the mining industry in China, though. It has become very, very significant and a lot of the takeovers of juniors over the last couple of years have actually been by mid-sized Chinese companies. As long as there's growth in China, these companies will want to expand and provide supplies for China. So, even if there are problems in the Western world, including credit problems, the Chinese mining companies will be looking to acquire new deposits and junior companies will become a more and more important element of that over time.
TGR: Are you describing a scenario in which China becomes the financial market for metals juniors?
LR: It's very important to differentiate between the government and the hundreds of publicly traded companies based in China. In some cases they're partly owned by the government, but in every way, they act as private enterprises. Those companies are definitely on the prowl. I see evidence of them in every part of the world—Africa, Canada, South America. They will become more and more active and a bigger factor in terms of junior takeovers.
TGR: So the strategy you're pursuing could be really wonderful if the metals markets continue up. These Chinese miners competing with other capital should make stocks respond more positively.
LR: Absolutely. And getting new supplies of metals is critical. Going back to gold as an example, the gold mining industry pulls 80 million ounces of gold out of the ground every year. If they don't replace it with 80 million ounces of reserves, the industry shrinks. In fact, over the last few years the rate of production has exceeded the rate of new reserves, so the gold mining industry overall has shrunk. Barrick Gold Corp. (NYSE:ABX) and Newmont Mining Corp. (NYSE:NEM) alone each need about 8 million ounces a year of new reserves just to stay level, and the same applies throughout the industry.
And to a somewhat lesser extent, it applies to base metals as well as precious metals. If the typical life of a mine is roughly 20 years, every decade 50% of all the metal mining capacity in the world has to be replaced just to stay level. Factoring in 2% to 3% average growth annually over the last few years, you can see an incredible need for new metals deposits to be discovered, developed and brought into production. That's where my focus has been.
TGR: And it's been quite successful. Do you have some examples of companies that you'll share with us that fit your focus—companies that advance early-stage deposits from exploration through development?
LR: Most of our companies are looking at deposits that are further along, but a good example of the process in action is Underworld Resources Ltd. (TSX.V:UW). A year ago was trading at about 50 cents a share. They made the discovery in the Yukon—they've only just announced their initial resource estimate—and are now up to $1.65 a share. So we've had a triple on that one.
Kaminak Gold Corporation (TSX.V:KAM) will be drilling this spring on a project that looks very much like Underworld's. So there's another discovery potential. If you pick a company that makes a discovery, you get enormous upside potential, but it's really challenging finding that one out of hundreds and hundreds that actually will make a discovery.
The much better model, in my opinion, is with development-stage companies, such as Sandspring Resources Ltd. (TSX.V:SSP), which only recently started trading. Sandspring has a deposit where a lot of historic work has been done, but the potential for the value added is tremendous. They're going to drill it over the course of a year and, hopefully, increase the confidence level in the deposit and increase the size of their deposit. That's one that I'm counting on for substantial returns as they advance that deposit through the development process.
TGR: Where is Sandspring's project located?
LR: It's in Guyana. Until Sandspring came along, the mining investment business paid very little attention to Guyana, but I think we're going to see a lot more companies with interesting projects there. A lot of work had been done in Guyana a couple of decades ago and then it sort of fell out of favor. Now we're going to start to see a lot of activity in Guyana, with Sandspring just being the first example of that.
LR: Silvermex Resources Ltd. (TSX.V:SMR) is using the same model, beginning work on a project that's had previous work done on it, looking at it from a new geological perspective and bringing new ideas. Silvermex actually took it one step further. In addition to a deposit that's interesting geologically, close by they bought a processing plant that another company had shut down. Silvermex put these two pieces together—a deposit that had some historic work and a nearby mill—which should give them a fast track to production.
There are a lot of situations around like that, where companies in years gone by did a lot of work and now a new generation of companies goes in to start from that basis, rather than just putting a drill hole where they hope a deposit might be.
TGR: What's making these historic properties attractive again? Is it better technology that enables miners to extract more volume, or lower operating costs, or higher metals prices?
LR: In many of these situations where deposits were looked at in the past, it was an era of lower metal prices. At that time—a lot of this was in the '60s, '70s and the early part of the '80s—picture a company that goes looking for a copper deposit, finds one and starts developing it. Meanwhile, the company's geologists are finding other copper deposits all over the place, and as soon as they find something better, they drop everything and put the focus on developing the better one they found later. Fast-forward 20 or 30 years, and those better deposits are all mined out.
The properties that were cast off in decades gone by are now the best available in the world. The low hanging fruit has been picked. The mining industry has spent 50 years now going over every square inch of the surface of the earth, and the big deposits that were sticking out of the ground have been found, developed and mined out. Now we're going back to what were effectively second-tier deposits in the first pass.
TGR: So instead of being cheaper thanks to technology or whatever, these deposits actually cost more to develop and more to mine than they did in the good old days.
LR: And that's why we'll never see metal prices back at the levels of previous decades.
TGR: Are there any other parts of the world making a name for themselves on the metals maps?
LR: Colombia has long been recognized as having a lot of geological potential. As the situation regarding personal safety—guerillas, kidnappings, etc—has improved, there's been a real rush into Colombia. The Philippines has also become attractive. A change in government policy that was fairly recently implemented has resulted in a real pick-up in activity in the last few months. I think that's going to really accelerate.
TGR: What kinds of deposits are you looking at in the Philippines?
LR: The most popular geological type is copper-gold porphyries, so huge deposits with a fairly low grade of copper and a low grade of gold, but together the grades are very attractive.
TGR: Do you have any companies there to tell us about?
LR: One striking example is Indophil Resources NL (ASE:IRN), which trades in Australia. I haven't followed it specifically, but Indophil has a 37% interest in a project that's just about to begin a feasibility study. A Chinese company has bid $500 million cash to take over Indophil to gain access to that 37% interest. Normally takeovers happen toward the end of the feasibility stage, so it's really unusual to see a deal like this on the table when the study isn't even under way. That gives an indication of the valuations that the mining industry will place on these types of deposits in an area like the Philippines.
TGR: Very interesting. And there's China again. You talked a bit about gold and its role as a hedge against dollar devaluation and inflation. How do you feel about silver as an investment metal?
LR: Silver is very different than gold. Most of the silver that's mined is used up in products of all kinds. There's only a very small investor component in the silver market and the silver market is very small. Because it's such a small market, as investors get excited about silver, the price can move up very sharply and very quickly, but it can fall just as fast.
I imagine silver will continue to spike up and down, but it won't go back to the levels it saw briefly in 1979-1980. Those were unique circumstances and unlikely to be repeated. That's not to say that I don't like silver. I do. And I invest in silver companies, but not because I expect a sudden, large gain in the metal price.
TGR: You offer such interesting information and good insights. Thank you, Lawrence.
Lawrence Roulston, a geologist with engineering and business training and more than 20 years of hands-on experience as an analyst and manager in the resource industry, founded the 100% subscriber supported Resource Opportunities newsletter—which provides objective commentary on the resource industry and emerging resource companies—in 1998. Having established an impressive track record, with a particular knack for picking emerging companies that delivered 10-fold or better returns, he launched GreenTech Opportunities in February 2009.
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1) Karen Roche of The Gold Report conducted this interview. She personally and/or her family own none of the companies mentioned in this interview.
2) The following companies mentioned in the interview are sponsors of The Energy Report or The Gold Report: Sandspring and Silvermex.
3) Lawrence Roulston —I personally and/or my family own shares of the following companies mentioned in this interview: Underworld, Kaminak, Silvermex and Sandspring.
Neither I personally nor my family nor any business associates are paid by any companies.