By Sumit Roy
Louis James is chief metals and mining investment strategist for Casey Research. He is senior editor of the International Speculator and Casey Investment Alert. James evaluates dozens of mining companies every month, hoping to uncover those that will provide rapid high returns for investors. HAI Managing Editor Sumit Roy recently caught up with James to discuss the state of the metals and mining sector.
HAI: Why have miners so severely underperformed metal prices over the past several years?
James: There are a lot of reasons we can speculate about, but I think it’s actually not rocket science if you’ve followed the market for a while. It takes a lot of courage to continue an investment strategy based on fundamentals when the fluctuations of the market contradict that. When you have a correction for a month or two, people can take it in stride. But when you have a protracted correction, it’s very difficult for people to hold on.
I don’t claim to know more than anybody else. But if you look at the long-term chart -- look at a 10-year chart for gold -- it is starting to look like it’s crested. In the last couple of years we’ve retreated after peaking in 2011, and people wonder, what if that was the top? That’s what’s really weighing on people’s minds, even if they don’t articulate it.
And once that sentiment gets in place, it has momentum. The truth of the matter is that it was only a few years ago that $1,000 was regarded as a really high price for gold. In our dreams, we hoped that gold would reach $1,000. So when it went over $1,500 -- that was well beyond expectations -- a price that people didn’t believe would be attained, except maybe as a spike.
There are just a lot of people out there who think gold has peaked and that it’s all downhill from here. That adds a lot of momentum to the bearish sentiment.
HAI: Do you think that underperformance in the miners has to do with this notion that people believe gold has peaked and they’re pricing that into the miners? Or are there other factors like taxes, regulation and cost inflation that I’ve heard discussed?
James:All of that is true too, these other factors that you referred to. But my gut is that it’s the former. People who have been in the industry for a long time didn’t think we’d see sustainable $1,500 gold. They’re just waiting for the other shoe to drop. They’re waiting for things to get worse. And when things appear to do so, it becomes a self-fulfilling prophecy.
Many of the people that jumped into gold were not real gold bugs; they were just momentum chasers. And when the momentum reverses itself -- in today’s world of e-trading and the ETFs and the large funds with large amounts of money sloshing in and out of things -- it has a very large impact.
As for this other issue that you’re bringing up, that’s actually not a reason to be bearish on the commodities -- not just gold, but copper and other metals and minerals too. To the degree that mining becomes more and more difficult, that’s actually bullish for the price of things mined. And the harder it is to mine, the more important each mine becomes.
The need for metals isn’t going to go away; without metals, we literally revert to the Stone Age. We’re not going to suddenly wake up one day and say, “You know what, we don’t need any more copper,” or, “Iron’s done.” That’s bullish for metals prices.
For the companies, it’s mixed depending on what jurisdiction they’re operating in. Managing political risk is not easy. There’s no simple formula and it’s constantly changing. That’s a large part of what we do here. We’ve paid a lot of attention to political risk and devoted a lot of resources to keeping ahead of that curve.
HAI: Do the valuations for the miners look very attractive, or is it a case-by-case basis?
James: Definitely case by case. I would say on average the valuations are pretty attractive, because they have been beaten up so much. The metals themselves have retreated. The mining shares have retreated by much wider factors. Fifty percent declines are common.
There are many companies that haven’t done anything wrong and are down by more than that. There are others with really good stories that have strong shareholder bases that have re-rated less than that.
But everything has retreated -- the good, the bad, the ugly, everything. That said, you absolutely have to be careful. You can’t just throw darts to the board, or assume that a rising tide will raise all ships going forward. Because there are a lot of companies that are out of money or very close to out of money -- ships with holes in their hulls.
A difference between what’s happening now and what happened in 2008 is that 2008 was a sharp shock. The 2008 crash put the adrenaline of panic into the market; prices went into free fall. And those of us who believed it was a temporary correction made a lot of money buying that crash.
But now it’s been a dragged-out process. Since the 2011 peak, lots of companies have believed that the metals markets had legs for the future, and they didn’t want to finance at lower prices. For many quarters now, they have been waiting for the market to turn around before financing, because they thought that they’d be able to do so on less dilutive terms. That hasn’t materialized for almost two years, and many of them just don’t have any money.
You certainly can’t just bet on the sector. I would not buy a sector index right now, because there are going to be a lot of train wrecks ahead.
HAI: With the decrease in metals prices recently, will we see production decline?
James: With any decrease in metal prices right now, you will see impact on supply. The supply is already constrained because of the rising royalties and rising regulations. There was just news out today [April 11, 2013] that Chile suspended the Pascua-Lama project on the Chilean side of the border. That’s a really big deal -- an $8 billion project, with a huge impact in a mine-friendly jurisdiction. That that can happen in Chile sends tremors through the whole industry.
And lower prices don’t help. There are a lot of marginal producers out there. There are companies that have taken advantage of high prices to get mines in operation that only work at high prices. Those will be impacted if prices continue to decline.
That said, most of the big projects, and most of the major companies -- they’re modeling much lower prices. There are a lot of economic studies of mining projects out there that use different prices. But the people with big money, Asians who want to invest in a copper play, for example, are looking at maybe $2 copper, and that’s far lower than current prices.
If you look at an economic study by a responsible gold company, they don’t use the current spot price, but a historical average. Now here’s an interesting thing, though: They typically have used a three-year trailing average. While the market was going up, and while gold was going up, that three-year trailing average was conservative. But now that the price of gold has gone sideways for two years, and now down, the three-year trailing average is actually pretty close to current spot. And that’s a scary price to model.
I’ve seen recent studies with $1,400 gold, which is below spot. Maybe that’s pretty close to the three-year trailing average now, but it’s not a very conservative number.
HAI: In which of the metals do you see the most opportunities right now?
James: There’s not a simple answer to that. Gold can be binary. Any number of things can happen with all these black swans circling the global economy. Europe is on the verge of disintegration. There’s heat in the Middle East. China -- nobody knows what to believe about the numbers out of China.
There are any number of factors that could send gold screaming north tomorrow, or that may not happen. There’s the appearance of economic recovery, which is bearish for gold, but all the printing of money that governments are doing is eventually bullish for gold. However, in the near term, it bolsters the stock market. Gold could go either way in the near term, and I can’t tell you which way. You really should run away from anyone that pretends to have that crystal ball.
That said, this year, I like silver even more than gold. It has the advantage of being an industrial metal, as well as a precious metal. It can hold on to value as a safe-haven metal, but to the degree that the governments of the world are successful in reflating the economies, the industrial demand for it can go up too. Eventually, the economic bubble all this money they’re creating is inflating will pop, but I don’t expect that in the very near term.
I also like platinum and palladium more than I have in recent years for the same reason. They are precious metals and there’s safe-haven value in them, but they’re also industrial metals that get used up. And the sad but powerful truth here is that most of the supply -- for platinum in particular -- comes from South Africa, which is facing serious trouble. And it’s not just general economic and political trouble, but trouble specifically in the mining sector. Meanwhile, the Chinese have just mandated catalytic converters in their cars, which are mostly gas-powered. That means they’ll use more palladium. India won’t be far behind, depending on how seriously they take their pollution problems.
So there’s a strong argument to be made for very significant near-term supply constraints in the platinum and palladium marketplace at the same time that demand may increase greatly. It’s a pretty interesting dynamic right now in the near term; I like them a lot.
HAI: You just mentioned that you find silver very attractive this year. What’s your favorite way to get exposure to that metal right now?
James: As Doug Casey likes to say, you buy the metals themselves -- physical bullion -- for prudence. You don’t buy them to speculate on whether price is going to go up or down. You buy them because they are what they are. And come hell or high water, they remain what they are. And someone will exchange those metals for some other value in the future no matter what. That’s protection.
Speculation is different; as a speculator, I’m looking for whatever is going to give me the most oomph. As long as governments are apparently successfully reflating their economies, creating this appearance of recovery, that’s not particularly bullish for gold. But it is bullish for silver. If I want to speculate on that, rather than buying the silver itself, I’d rather buy a good silver stock.
The no-brainer of the silver market is Silver Wheaton (SLW), of course. They get to be a producer without actually having to run mines and deal with all the difficulties and problems of being a miner -- and they basically get guaranteed profits. Their contracts are written in such a way that they get to buy well below spot. It’s just a money-making machine.
But I also like some of the emerging silver producers, the ones that have new mines that are coming on line. They have growth on tap. They’re already building it, or have just built it and so on.
HAI: Do you tend to shy away from the ETFs and stick with the individual names?
James: Yes. If I’m going to buy something that’s paper and not the physical thing, then I want the speculative upside. I want the upside of an undervalued producer that’s just about to double its production, or significantly increase its production. If I want to just have the security of the metal, then I don’t want a paper substitute. I don’t want to have counterparty risk there. I want the bars in my vault.