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Louis James: Straight Talk from and About Colombia

Source: Brian Sylvester of The Gold Report  (12/13/10)

Louis James Casey Research Senior Editor Louis "Indiana" James has returned from Colombia with insights into the state of Colombian politics, economics and the inside scoop on a number of unheralded Colombian explorers. In this exclusive interview with The Gold Report, Louis shares his firsthand experiences in the Paramo Highland and discusses the differences between two sides of the same mountain when it comes to gold exploration and environmental protection.

The Gold Report: Louis, an article by Andrey Dashkov in the November issue of Casey's International Speculator discusses a chart that suggests a gold mania is still yet to come. Could you comment on that thesis?

Louis James: Andrey was looking at a couple of things related to volume as an indicator. In a genuine mania phase, it's not just a matter of prices going higher than they were; if there's a mania, a lot of people are piling in, forcing the prices way, way up. In that case, volume doesn't just increase—it starts to go ballistic. You should see a sharp acceleration in volume. So far this year, we have seen increased volumes; but if you look at the curves in the chart, you don't see accelerating volume. Instead, you see a fairly steady rise in volume. So, the chart tells that, as exciting as recent price action has been, we're not going manic yet.

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TGR: Based on that analysis, how close are we to mania?

LJ: It's not like there's a standard curve that allows us to make that kind of projection. Andrey's analysis was really just meant to counter the people saying "Gold's in a bubble." That kind of talk supposes that gold will either pop or go through the roof tomorrow. Our point is that it looks like we're still in the steady building phase.

Another interesting finding—one we were not looking for—in the chart is that that the volumes in the SPDR Gold Trust (ETF) (NYSE:GLD) tend to run counter to the volumes on the TSX Venture Exchange, which, along with the TSX, is where most mining stocks trade.

There's no way to prove this but our thesis is that when people get nervous about the stocks, they move out of stocks and into GLD as a way to stay in the gold market but reduce risk. When Andrey did this analysis in late October, there had been an uptick in volume in GLD. We thought that might mean a retreat in gold stocks and maybe gold, too. As it happens, we saw quite a bit of correction in November. It's interesting how those two pieces of the same market tend to move contra-cyclically.

TGR: In the December issue of the International Speculator, you said share prices have shifted from being based on asset value to what you're calling "relative valuations." You wrote: "A market driven by relative valuation may give a company a price-to-earning value that seemed stretched way beyond reason. In short, things get really weird." What strategies should junior gold-sector investors use in a market like this?

LJ: First, if you're heading into a mania phase, you have to realize that prices are going to seem high. If you turn tail and go home, you miss the big rise in the mania phase. To stay in the market, you have to screw up your courage and recognize that you're going to pay a premium. We're beyond the days when you could buy low and sell high. It's no longer the stealth stage of the market where nobody wants to hear about gold. Everything was dirt cheap and it was easier to get high multiples. Instead, we're going into a phase of buying high and selling higher. You need to understand that and be willing to accept that risk. The price of anything you buy today could go down, and it could go down a lot. But if you're going to play this game, you have to accept that you will pay a premium for the plays that are most likely to go up come mania phase. You have to be able to buy with confidence that good stories will end up higher in the mania even if they go on sale by 50% before then—and look at such corrections as fantastic opportunities to average down, as we did in 2008.

That brings me to the second point—looking for what's most likely to go up. It's like that great philosopher and analyst Wayne Gretzky said: "You don't skate to where the puck is; you skate to where it's going to be."

When you're in the realm of relative valuations, when something is at a high multiple of asset value, your instinct is to not buy. It's overvalued. But, if it's overvalued for a reason—if it's in the sweet spot the market likes—it's going to get a lot more overvalued in the future. It's a speculation, sure; but if you think the market is going into a mania phase, stocks in the sweet spot are the ones worth buying even if you have to pay a higher multiple because it's a market darling. Premium picks will get even more attention in the mania phase.

TGR: You recently made another visit to Colombia. Do you believe Colombia trumps the Yukon as the hottest prospective area for gold exploration plays right now?

LJ: No, no. Colombia is a different play. In a way, it's more interesting—more prospective. It has been underexplored for decades due to guerilla warfare and other problems. Because of that, I believe there is a lot more opportunity there.

However, compared to Colombia, the political risk associated with the Yukon is much lower. That is a great comforting factor. When you can speculate with greater comfort, it makes a huge difference. A specific project might run into First Nations issues if not handled well, but I rate the chances of the Yukon doing a U-turn and becoming anti-mining to be very low. People in the Yukon can see what mining brings to their province. The Yukon is a small province without a huge GDP. Mining adds significantly to the bottom line and it's going to do even more, with new mines coming online even as we speak. I think people in the Yukon can see which side of the bread is buttered and that's a very good thing.

TGR: Those are good points, but I want to come back to Colombia. Apart from being an underexplored open frontier, what else makes Columbia hot?

LJ: There's been a lot of success in Colombia; it's underexplored—but not unexplored. There have been a lot of finds and/or dusting off of finds. Some of the known plays there include Medoro Resources Ltd. (TSX.V:MRS). It is drilling off the Marmato area, which has long been known as an area for informal activity (i.e., a nice way to say disastrous illegal mining). The company drilled off almost 10 million ounces (Moz.) there in short order. That sort of thing certainly gets the market's attention.

Greystar Resources Ltd.'s (TSX:GSL) success in making a monster deposit out of its Angostura find is another example. Ventana Gold Corp. (TSX:VEN) is drilling on the same ridge down the valley from Angostura. I think that, at 3.5 Moz., its first resource estimate was smaller than people were expecting, but it's high grade and still open with all kinds of high-grade gold there. Galway Resources Ltd. (TSX.V:GWY) has also succeeded in finding more gold farther down the ridge from Greystar and Ventana.

Of course, one of the big signs of success is when somebody buys your find. Ventana has a takeout offer by Brazilian gazillionaire, Eike Batista, who made a great offer at a premium for Ventana. That somebody was willing to step up to the plate and pay almost US$1.3 billion for what started as a penny stock is a great win. For those in early, it was a tenbagger—even for those who got in after the discovery was made. It was evident Ventana was going somewhere when it was in the US$5–US$6 range—it's still a double. And there are a lot of opportunities to do similar things.

TGR: But hasn't Ventana adopted a poison pill?

LJ: The company did make that move, but later put out a press release saying it was reconsidering. On the one hand, you can imagine that management doesn't want to lose the offer in hand. On the other hand, maybe it can shoot for more if they don't make things too easy. Who knows?

I heard a lot of rumors about Batista when I was in Colombia. This wasn't a secret deal known only to insiders; it was pretty much the talk on the street. Batista was already a significant shareholder and had increased his shareholdings. I called Ross Beaty, who also had become a significant insider with Ventana and is a friend of ours at Casey Research, and asked him if he could comment. He just laughed and said no. I respect that integrity.

TGR: Colombia has legislation that bans mining above 2,800 meters of elevation. There's some talk that Greystar's Angostura project, which is higher than 2,800 meters, could be grandfathered in. But there are significant environmentalist factions that could ensure that Angostura never reaches production. Could you give us an overview of what's going on there and maybe even handicap the outcome?

LJ: It's worth emphasizing that this is not a new law. Colombia didn't change the rules on anybody after the discovery, so it's not a confiscation or a taking with an environmental excuse. That said, the law had never been enforced before. What's changed is that the government and the entire country is pulling itself together and getting more serious about enforcing its own rules. If Greystar gets shut down or its assets are rendered invaluable by the law, it would definitely be a black eye for Colombia. But I think most of the people at the top in Colombia are aware of this; and I think they want the project to proceed.

If you go see the place Greystar wants to mine, as I have, you'll see it's a bloody environmental disaster zone. The best thing that could happen would be for a modern international company to go in there and make a big, clean open-pit mine out of it. That may sound ghastly, but this mountain has been defiled by informal mining for a long time. The river valley is discolored by cyanide and other chemical spills. It's a trash heap, an environmental nightmare. Responsible mining in that area would be the best thing that could happen to it. That may not matter to the environmentalists, but it should matter and may matter to the people at the top in Colombia. The former president, Álvaro Uribe, was certainly known to be positive about the project when he was in office. It's reasonable to think that his handpicked successor would also be pretty positive about it.

TGR: But these environmental non-governmental organizations (NGOs) are well funded.

LJ: I don't think the fact that there is well-funded, active environmentalism in Colombia makes it a foregone conclusion that it'll be able to stop Angostura. The greens don't have control of the government or parliament. It's an active, local, well-funded lobby but it's not the controlling factor yet.

Actually, this Paramo Highland ecosystem the NGOs are trying to protect is a unique environment; but it's not small and it's not in danger. It covers mountains in several South American countries. It's not like losing this one mountain Greystar wants to mine would destroy this ecosystem. And you have to remember this was a war zone 10 years ago. Colombia is still recovering, and the people want economic growth. When you talk to the people in those areas, they care about their land but they would like to see responsible mining and jobs—what's important to the people there will be important to the politicians.

Having said all that, Angostura could be stopped. In that case, it would be all the more important this Ventana sale go through and that Batista be able to put Ventana's project into production. That would show the world that, yes, big mining can still be done and that Colombia still is open for business.

TGR: So, you're saying even if there's a negative ruling on Greystar, it won't inhibit direct foreign investment in Colombia in any significant way.

LJ: I'm saying that if it does, it would be a buying opportunity. If Greystar becomes a black eye and everything in Columbia goes on sale, I think it will be an incorrect perception of political risk in Colombia. That will make Columbia plays better buys.

TGR: Can you tell us about some of the Colombian projects you visited?

LJ: One that I'd seen previously and saw again this time was Colombian Mines Corporation's (TSX.V:CMJ) Yarumalito property. You might ask, "why go to the same project you've seen already?" Well, we have more data now and more drill holes; so, we can stand there with the drill hole data in hand and try to visualize the distribution of the mineralization in the ground.

In this case, looking at the drill holes and reading the press releases, you might assume that the mineralization the company has hit is relatively narrow—up to 100 meters of potentially economic-grade material—for its type. But that's a misperception. The drill holes don't go into blank rock after the reported intervals; they go into mineralization that's below "cutoff threshold" for reporting. So, beyond the 100 meters reported, there are still 100m–200m more; it's just lower grade, and that's very significant. There were even high-grade hits in the mineralization below the reported intervals, but it was too far away to count. Say, for example, a 1-meter section had one-third of an ounce. It would be irresponsible to report that stretched out over 100 meters of nothing or very low-grade material, so the company doesn't report it. This makes the reported mineralized intervals look thinner than the mineralization actually is, which has important implications for the potential size of the gold system at Yarumalito. Does that make sense?

TGR: Basically, you're saying there is more gold than one might think.

LJ: Yes. This is important because the target is the gold-porphyry target, and porphyries tend to be very large deposits. What I'm saying is that it hasn't petered off; Colombian Mines needs to angle in on the location of the better grades—if they're there.

A high-grade component is also starting to come together at Yarumalito. Whereas, before, it was a hit here or there, now there are good a number of hits lining up. These hits aren't close enough to string together into a high-grade mineralized area, but they do suggest a high-grade corridor or a feeder zone. More drilling could sweeten the whole thing considerably.

TGR: Would that have to be mined in a small open pit, and then underground, if those holes continue to hit higher-grade mineralization?

LJ: Those hits are at depth; we don't yet know whether they come near to surface. If it does, it could make for a starter pit that would sweeten the average grade of the whole thing. A second possibility would be to look at just the higher-grade part, as an underground mining scenario.

The bottom line is that the results really haven't been fantastic enough to put Yarumalito in the market's spotlight; however, they certainly haven't disqualified that from the project's future.

TGR: Plus, Colombian Mines is a small company. You're talking about 23-million share float, trading at about US$1.01. There seems to be more room for financing and a lot of area it has yet to test.

LJ: That's the beauty of something like this. If you know the market cap is US$20M or so, it's so cheap that if the company hit anything it could not just double but easily be a fivebagger or better. Of course, there is substantial risk—they don't actually have a deposit yet.

In my view, if you're going to take on more risk, the payoff has to be commensurate with that risk. This play has not yet demonstrated it has the tiger by the tail. It could come up empty-handed. The reason it's worth looking at is because, if it does show that it's got the tiger by the tail, the upside is quite substantial. Colombian Mines is in our portfolio; so, if anybody thinks I'm just "talking my book" he or she should feel free to ignore this play; it won't hurt my feelings.

TGR: You've talked about Mercer Gold Corp. (OTCBB:MRGP) in the past.

LJ: That one is not yet a company we recommend. This is a new company, which I looked at for the first time on this trip. It's quite interesting; this play is on the other side of the mountain from Medoro.

The Medoro folks have drilled off almost 10 Moz. on their Marmato project. There's no discovery risk there, but there are social issues. That side of the mountain is covered with informal workings (and some formal workings). There's a big, official mine at the bottom of the mountain but the whole top is like a Swiss cheese, it's so full of holes. It's a social nightmare. The company's got to get all these people to stop digging holes and move. It's difficult. Medoro is making progress, but it's not easy.

On the other side of the same mountain, however, there's almost nothing—just five little mines that have formed a collective. Mercer Gold, which owns the mineral rights on this other side of the mountain, has a deal with these five outfits, so things look much simpler for them.

I visited some of these small workings on the Mercer side of the mountain. You can see quartz veins where these guys are mining narrow but high-grade gold within the context of a very large alteration area. There is a road cutting a couple of kilometers long, and much of it shows this alteration. There's a stretch over 1-km long that runs low-grade gold throughout. Obviously, the little guys are working it on a small scale but I believe there is potential for a large, bulk-scale deposit. What we don't have yet, and the reason I haven't recommended it yet, are drill results that confirm this hypothesis.

Mercer has just started its first drilling campaign. Its reported results on the first two holes show that it has hit pay dirt. However, while those results are encouraging, technically, they are not yet evidence of something really big—something that would really get the market's attention. They're not terribly high-grade and they're not terribly great thicknesses, but they do confirm that the mineralization continues through the mountain. I'd like to see more and better drill results that I could really sink my teeth into before I recommend it, but it's certainly something your readers can put on their watch lists. And if they feel like taking a chance, Mercer is a company that has a modest market cap compared to its neighbor—Medoro—on the other side of the mountain.

TGR: Can you share some thoughts on the market, perhaps some sage advice to leave with our readers?

LJ: All of us at the Casey Brain Trust are confident gold is going much higher. Has it gone too far too fast? Might it correct more? It might, but it doesn't really matter. If gold and our favorite shares correct, we would be unequivocally delighted to buy more with the profits we've realized over the last few years. It'd be like going into the store and seeing our favorite wine on sale at a deep discount. Why wouldn't we like that? Given where we think gold is going, we have no problem with corrections in the short term. We happily view those as opportunities to add to our positions.

But beware—unprepared speculators who buy something on the buy-high-sell-higher strategy are likely to panic if it goes on sale. That pushes you into the buy-high-sell-low paradigm, and that's not what the game is about. When you buy something and it goes on sale, it can be very difficult to hold on or be enthusiastic about seeing it as an opportunity to back up the truck for more. So, perhaps it will help to remember what happened in 2008—there was blood in the streets and people were convinced it was the end. But the truth is that was a fantastic buying opportunity—the best since 2001. That's what you have to keep in mind now.

TGR: Great insights Louis, thank you.

Always on the lookout for the next double-your-money winner, Louis James is the master of metals at Casey Research where he's the widely read and well-respected senior editor of the International Speculator, Casey Investment Alert and Conversations with Casey. Fluent in English, Spanish and French—and conversant in German and Russian, to boot—Louis regularly takes his skills on the road, evaluating highly prospective geological targets, visiting explorers and producers at the far corners of the globe and getting to know their management teams. In addition to subject matter expertise, he's built a following on the basis of a dynamic combination of investment savvy, practical advice, experience in physics and economics and a gift for comprehensible technical writing.

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DISCLOSURE:
1) Brian Sylvester of The Gold Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Colombian Mines.
3) Louis James: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None.



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