The Gold Report: You have published a recent e-letter for investors called "Fighting Battles to Win the War." Please sum up the major themes of the issue, especially around how small-cap stock investors can combat impatience and deal with the emotional stress associated with temporary market downturns.
Eric Muschinski: Investor psychology is a major passion of mine and I write about it frequently. Stocks go up and down and sometimes moves are cyclical (shorter term) and some secular (long term). The "war" is referencing where we are in the junior mining, gold, and silver markets cycle and where we are heading. The battles referred to several of our recommendations that were experiencing retracements at the time. It's good to remind myself and readers about the bigger picture because the battles are inconsequential if you have your head on straight, are patient and know the ultimate victor of the war.
Gold went up for 12 straight years from 2000–2011; that is simply unheard of in any asset class secular movement. If we take a step back and put that into perspective, it makes sense that gold would take a "breather" and consolidate for two or three years before its imminent "blow-off" phase.
"For big gains in mining stocks, we generally have to wait for the sector to turn in earnest and the tide will lift all boats."
Frankly, the fact that we haven't given up 50% since the 2011 highs is a testament to how strong this bull market is overall. The people who have emotional stress at this juncture likely were buyers when gold was $1,800/ounce ($1,800/oz) and silver in the $40s/oz, whether mining stocks or the physical metals.
However, I am quite confident that the market is going much higher and I am joyful beyond belief because this is gifting me more time to accumulate my favorite assets and mining stocks at substantial discounts. If gold is going to $3,000/oz or silver to $150/oz, do you want to own a little or a lot? This is a secular bull market that I am betting so significantly will change my life forever net worth-wise. I would encourage folks who have emotional distress to hit the reset button and get in the game; now is the time to be a buyer. Once gold is much higher, I'll be selling it to investors who buy based on emotion and excitement; anyone who has a habit of buying/selling on emotion will always lose money over time.
TGR: Are the prices of shares in precious and base metal mining firms directly correlated to the overall market, or do they have some independent movements?
EM: It seems as though share prices of precious and base metal mining companies are now lacking correlation with the overall markets, which is good. Many investors are chasing the indices now for returns/alpha when the contrarian and wise investors are looking at hated assets like junior mining stocks. However, I learned years ago that any given stock tends to trade based on this breakdown, more or less: 50–60% due to overall market, 30–40% the sector it trades in and 10–15% the company's business performance itself. This explains why all gold stocks are in the gutter. People often ask what's up with this company or that and my typical reply is. . .nothing.
For big gains in mining stocks, we generally have to wait for the sector to turn in earnest and the tide will lift all boats. Sometimes, with very special discoveries, a junior can buck the trend, as we saw with our top pick the last year, Zenyatta Ventures Ltd. (ZEN:TSX.V), but large counter moves to a sector are rare. If the general market gets smoked and it's a liquidation race, gold and silver stocks will get hit, but they tend to recover after the initial blast. And once we're in full stride of the phase 3 bull frenzy, we will likely see the market going lower and mining stocks skyrocketing.
TGR: The gold markets have been lingering low for a while now. Why should investors contemplate buying gold stocks? Is bullion preferable to stock? If so, why?
EM: I recommend a mixture of both bullion and stock. First and foremost, investors in the space should initially take a position in physical gold and silver bullion, which is money. Second, mining companies indeed have leverage to the prices, as we're experiencing now on the downside, and will again experience on the upside. The ounce-in-the-ground valuations for mining stocks are the lowest I've ever seen since I've been following the sector.
"The ounce-in-the-ground valuations for mining stocks are the lowest I've ever seen since I've been following the sector."
However, there are a handful of markets where the cyclical bear move was similarly devastating; 1975–1976 was very brutal and many investors capitulated right before we saw a four year, 850% rocket in the price of gold. Thirteen months after a bottom in gold stocks the average weighted return tends to be around 80%. That's a violent bounce because it is a volatile sector, but I suspect the major move in gold stocks will see many multibaggers occur.
Once gold breaches $2,000/oz, the leverage in the junior miners will be incredible. There were gold stocks that went from pennies to hundreds of dollars per share between the mid-1970s and 1981. Even if we don't see anything close to that, sometime in the next couple of years returns from current levels will be quite attractive.
Bottom line, every single soul in the world should have at least 10% of his or her investable assets in gold and silver. Folks with a lower risk tolerance who mainly want to protect their purchasing power should swing heavily in favor of gold. Those who want to take on more risk may want to weight more exposure in silver and mining stocks.
Personally, mining stocks are so cheap I have been putting new money 2-to-1 into the stocks over physical bullion. I also own more silver than gold, which as the poor man's gold will kick in big time toward the end of the cycle because the common man may not be able to afford an ounce of gold at $2,500–$3,000/oz.
I have long-term price targets of $3,200/oz gold and $150/oz silver. The rationale is quite simple: If you take the percentage move that gold had in the 1970s ($35/oz low to $850/oz high) and cut it in half, you get $3,200/oz gold. A typical 16-to-1 ratio on silver at that price is $187.50/oz, which I cut down to $150/oz to leave room for error. Gold and silver may indeed go much higher but these are the price targets I am banking on and will not consider selling any physical metals until they hit these price targets. You can argue all day that the environment today should propel a much more severe percentage gain from the 1970s but I feel the analogy above is reasonable.
The important thing is to know how secular bull/bear markets work—this thing is not over yet. Bull market frenzies don't end with virtually nobody yet owning the asset. Even in 2011, how many of your friends and relatives had 10–20% of their assets in gold? Maybe 1 out of 100 even in my circles, but that ratio will be much higher in the blow-off stage when the public comes in en masse. In contrast, a market bottom typically sees vast investor hatred, frustration, disgust, aversion, avoidance and indifference. Does this sound like the recent sentiment of your favorite gold stock?
TGR: Please define the term "market fundamentals" and explain why investors should pay attention to the much talked about Pareto Principle. Given that it may be a true principle after the fact, how can an investor make predictions using it in real time?
EM: I'll give the exact definition of the Pareto Principle here from Investopedia and then comment: "A principle, named after economist Vilfredo Pareto, that specifies an unequal relationship between inputs and outputs. The principle states that, for many phenomena, 20% of invested input is responsible for 80% of the results obtained. Put another way, 80% of consequences stem from 20% of the causes. Also referred to as the 'Pareto rule' or the '80/20 rule.'"
"We're now in a junior mining market where the fundamentals and assets of many of these companies are being valued at pennies on the dollar."
The Pareto Principle could actually discount the validity of market fundamentals. His theory is translated that 80% of a market's movement will occur in the last 20% of time. This has proven very true in the work I've done looking into secular bull markets. It speaks to the "frenzy or blow-off" stage of markets. Frankly, whether it was Internet stocks in 2000, real estate into 2007 or eventually gold and gold stocks in the future, it makes no difference. The investor psychology component seems to be the driving force of ultimate returns as the masses slowly then quickly get involved in these markets toward the end while smart money is selling. Look at what gold did from 1978–1980 or Internet stocks from 1998–2000 and it would seem this principle holds water. It's also a very exciting theory because, if true, "we ain't seen nothing yet" as it pertains to precious metals and mining stocks.
This speaks to why being on the right side of the emotional curve when investing is critical. Fundamentals are important to me as a back stop and we're now in a junior mining market where the fundamentals and assets of many of these companies are being valued at pennies on the dollar. Fundamentals will improve drastically when gold goes up but I consistently stress the importance of regular accumulation of your favorite assets until the asset exceeds your buy price. For example, I'm a regular buyer (monthly or when I have a cash infusion) of physical gold up to $1,600/oz. I just buy it wherever it is as long as it's below that price. That way, the longer the cyclical bear correction lasts or the lower it goes, I will have more ounces when it eventually goes up, at an average price accumulation.
This also speaks to "stress free" investing as it does not put pressure on me to buy the low all at once, which is highly unlikely even for the best of us. This is a psychological defect that cripples many investors. They tell themselves it's all or nothing and zero or hero—no middle ground. However, I'll gladly buy a stock at $2 then $1.75 then $1.50 then $2 if it is eventually going to $5. If I didn't buy at $2 initially, chances are that I would not have pulled the trigger at the low of $1.50. Investing is a process for me and operating this way also allows for the fun in it to flourish, versus much undo pressure people put on themselves when they allow no flexibility for volatility, which is normal.
TGR: How does a wise investor hedge gold investments? How do inverse funds work?
EM: There are plenty of simple hedges these days that can be bought just like a stock. PowerShares DB Gold Double Short ETN (DZZ), VelocityShares 3X Inverse Silver ETN (DSLV) and Direxion Daily Gold Miners Bear 3X Shares (DUST) are all examples of leveraged shorts on gold, silver and mining stocks. These can come in handy when investors are jittery about their holdings or when gold or silver breaches a key technical support level. Instead of rushing to the dealer with a 42-pound monster box of silver American Eagles, you can simply buy DSLV as a hedge on your holdings. I only use these vehicles for trades, not against long-term holdings.
TGR: Are dividends worth the trouble of keeping investments in the gold companies when share prices are stuck low? What about royalty companies?
EM: Dividends definitely help! There are some awesome companies in the gold mining sector that pay handsome dividends currently. I like IAMGOLD Corp. (IMG:TSX; IAG:NYSE), which is paying 5.4%, and Market Vectors Junior Gold Miners ETF (GDXJ), the junior mining index, is actually paying out a hefty 7.3% annually right now. Not only is there big upside in these companies long term, but we can also get paid for our time holding with juicy distributions. One other one worth mentioning is Gabelli Global Gold, Natural Resources & Income Trust (GGN), which is paying $0.12 cents per month and you can buy it under $11/share. This trust has paid a very consistent dividend around this level for a decade and I like it for a yield play right here.
TGR: What do you think of royalty companies?
EM: Royalty companies are the cream of the crop due to the way they structure their deals with producers. They do not suffer from cost problems because their take is on gross revenues/production so the income streams are much more predictable and the overhead for the companies is usually very low. Silver Wheaton Corp. (SLW:TSX; SLW:NYSE) has a $7 billion market cap and only 28 employees. There's a similar situation at Royal Gold Inc. (RGLD:NASDAQ; RGL:TSX). Those two are the blue chips in the gold and silver royalty space and are worth having a piece of in one's portfolio.
TGR: You have been championing Zenyatta Ventures for a while. But its stock slipped from $5 to $2/share. That is bad news for those who bought in at the high, is it not? Is it good news for investors looking to buy in at a low? What does Zenyatta have going for it in the graphite mining, copper and platinum space?
EM: I scoured the earth looking for stocks that could give us good returns last year when I thought the gold junior market had further to fall. I coined Zenyatta as my top pick in August 2012 when the stock was near $0.20/share. It utterly skyrocketed to $5 in less than a year.
Similar to what I mentioned with gold going up 12 years in a row and needing a breather, Zenyatta's pullback is healthy. There were too many Johnny-come-latelys piling into Zenyatta who heard about it from a friend and didn't understand its business. Now those investors are puking out in the $2s/share and I think it's a perfect time for investors to take a very serious look at it. I decided to write a thorough report just a few weeks back that readers can review here.
I've learned that a stock can go up 25-fold and people can still lose money! Seriously, it's a shame when investors write me that did see me recommending Zenyatta well under $1/share only to finally buy at $4 and then sell at $2.50 because they got freaked out. I was actually taking profits there but some people really do trade mainly on emotion and Zenyatta was rocking this past summer.
Zenyatta is just a couple of weeks away from releasing a maiden NI 43-101 on its very special Albany graphite deposit. This is the real deal. Zenyatta's graphite is a freak of nature and the company has a LOT of it. My report link above takes time to walk through some economics but I think a couple of impactful things will happen soon:
1. The NI 43-101 will allow some serious institutional money to buy shares; they have been on the sidelines until Zenyatta proved it has what it has said it has drilled. The stock is too heavily retail focused and institutions, not retail, take stocks from $2 to $10/share.
2. I think there's better than a 50/50 chance someone tries to buy Zenyatta before it releases the preliminary economic assessment (PEA) in Q1/14. What price? Who knows, but I've stated I would not entertain anything under $500 million ($500M) and that takes the stock to nearly $10/share. If I'm right, there's still a lot of room to get involved here. So, yes, I believe the recent retracement in the share price, which is very volatile, is a blessing for new people learning about the story here.
TGR: How about rare earths? Do you have any picks in that space?
EM: I only like Medallion Resources Ltd. (MDL:TSX.V; MLLOF:OTCQX; MRD:FSE) in the rare earth sector. The company is shortcutting the entire exploration/production cycles that every other public rare earth company has to do. Many times rare earth projects have severe metallurgical challenges that companies gloss over to their investors. It ends up that the projects cost much more than initially planned, take way longer to get into production and fall short on actual producing of materials.
Medallion doubled after we picked up coverage from $0.20 to $0.43/share over the summer but is now back in the low-mid $0.20s. I think it's an excellent buying opportunity. I wrote a detailed report on Medallion fairly recently on my blog as well.
The report walks through Medallion's financial partners in the Middle East and other key factors to consider when assessing the company for a potential investment. It is still fairly early in Medallion's development but the company is knocking out huge barriers to entry with recent alliances in Oman. Its financial partners on this project are huge and eager to create jobs in the Middle East and enter the rare earth sector, diversifying out of oil money.
Medallion will likely structure a deal that carries the company to production (or most of its costs to production) while maintaining control and majority ownership in the project. I expect a lynchpin monazite supply agreement and coverage by a reputable brokerage firm by year-end. Early next year I see many possible catalysts, including initial results from an environmental study, securing financial terms with partners and accelerated plans to get to production in 2015–2016. This is eventually a cash flow play; Medallion could earn $50M to $70M in its first year of production, but it's a tiny $15M market-cap stock, so the upside is enormous if it pulls this off.
TGR: Now for gold: I hear you like Timberline Resources Corp. (TLR:NYSE.MKT). Why? Its share price has been falling off a cliff of late.
EM: Timberline is now a part of our very select "$0.20 to $2 within 2 years" focus list. Details about the company from a vantage point of a new investor taking a look at it can be read here.
All the juniors have fallen off a cliff. There's nothing specific to Timberline's story that caused it to get walloped except a financing the company did at $0.20/share in September. It cooled Timberline off quicker than the other juniors that rallied big in late summer. Timberline basically doubled this summer before coming back under $0.20.
TGR: Timberline has been selling off properties and seems to be betting on finding new gold in the Butte Highlands project. What are the chances of that? Does it have partners with deep pockets?
EM: Butte Highlands is a key piece to Timberline's story. In addition to the details in the report linked above, I will say the company was carried to production by a very strong financial partner. Timberline owns 50% of the mine and will have circumvented nearly $40M in development costs to take the mine into production. It is VERY close after years of work in Montana in getting the final operating permit. I still think we see final approval around the end of the year and Timberline could be pouring gold 30–60 days thereafter, maybe 90 days. The company should produce 40,000 oz per year at around a $900/oz cash cost. Initially, Timberline takes 20% of revenues until the backer is paid from carrying development, then it flips to 50/50.
I estimate numbers in my report but, essentially, after Timberline pays this thing off, it could be cash flowing more than $10M per year at Butte. That may take three years but its market cap is nothing. Butte isn't even Timberline's flagship project; that is South Eureka/Lookout Mountain in Nevada. I just went to visit a few weeks ago and it's a huge property that has multimillion-ounce potential. Timberline's share of the Butte development cost OR Nevada is getting zero value in the marketplace, and they are both valuable assets. With Timberline, you get exploration upside and revenues/cash flow in the very near term.
I suspect Timberline will need to do another financing fairly soon. The stock is so cheap I would begin buying now, then after any financing, load the boat. I don't think the company will have to raise a lot of money and I also believe it could cut a similar deal in Nevada to what it did at Butte. If so, Timberline essentially just needs to pay its bills and can make huge progress. Once cash flow pours in from Montana and/or market conditions improve, it can drill out Nevada into a very attractive resource.
TGR: Any other juniors that tickle your fancy?
EM: I'll give you two new juicy picks, both outside of the gold box. The first is Cardero Resources Corp. (CDU:TSX; CDY:NYSE.MKT; CR5:FSE), trading at $0.14. This is a coal play and it is terribly cheap. An insider has stepped up to finance the company after a previous partner tried to steal its world-class Carbon Creek resource in Canada for pennies. This insider is in it for the long term so money is not an issue for the company. I believe Cardero will sell in the future for a significant premium to current prices. It was a $5/share stock in 2006 and $1 not long ago. Tax-loss selling is in effect and I have my catcher's mitt on, gobbling up a large position here in the teens.
Coal stocks are in the gutter just as gold and silver stocks are, but the market will turn around just as the sun rises in the east and sets in the west. When it does (and there are early signs that it is now), it will be fierce as coal is a very volatile commodity. I haven't written a public report on this one so your readers have to do their own homework. But I don't think the company would sell for less than $1/share and if you look at comps from other deposits bought by majors in the area (there are only two left owned by juniors and Cardero is much further along and is higher quality), we could justify closer to $3/share as the ultimate price tag. This one won't happen overnight but for patient investors, the price here is a total steal.
The next pick is Poly Shield Technologies Inc. (SHPR:OTCBB). This is an incredible story and it seems no one knows about it yet. I haven't written a report on it yet but I will. For now, here's a good intro interview with the company's chairman and founder, Rasmus Norling.
The float is very tight on Poly Shield and I believe the company plans on cancelling a big chunk of its shares outstanding by the end of the year, essentially cutting the market cap in half overnight. The upside potential here is just massive. In fact, I think it may be one of the fastest companies ever to go from zero to more than $1 billion in revenues in history. Poly Shield has the only solution in a new market being created in the huge shipping/maritime industry due to government regulations to reduce sulfur output. The company's solution is one-tenth the cost of competitors and has massive size and operational benefits as well. The maritime industry has a gun to its head to do something and Poly Shield will get a huge chunk of this business.
Poly Shield has contracted more than 40 ships already but it is really just the beginning. I believe we'll see an accelerated pace of big contracts going forward and an even greater pace once we break into 2014 and shippers are forced to act or are left out in the cold. If Poly Shield signs on 500 ships between now and next fall, it's a $10 stock, and with 1,000 ships, it could be a $20 stock. Again, the upside is massive here; I've never seen anything like it where I got involved this early and all the stars were lining up.
Most of the companies I've mentioned have big upside but I always remind people that with that potential typically involves correlated risk. So, I'd remind everyone to do their own homework and be prepared for volatility if buying any of the names mentioned in this interview.
TGR: Thank you for your insights.
Readers can receive Eric Muschinski's Gold Investment E-Letter for free here.
Eric Muschinski, the editor of Gold Investment Letter, is founder and CEO of Phenom Ventures LLC, president and co-founder of Investor Media Inc. and co-founder and managing member of Diadem Media Group. Muschinski has been recommending gold and silver accumulation since 2003 to his clients and has over 15 years of diverse experience in the capital markets. Initially as a general securities broker, and later becoming recognized as a specialist assisting the needs of high-net-worth investors, Muschinski focused his practice on alternative investments, including venture capital, private equity and alternative investment management, exclusively for accredited investors and institutions. Prior to Waveland Capital Partners where he worked from 2006–2011, Muschinski was vice president and co-founder of GunnAllen Venture Partners and has also served in the Private Client Group with McDonald Investments Inc. Muschinski studied business economics and psychology at the University of Wisconsin-Whitewater while interning at both Piper Jaffray and Merrill Lynch.
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