Hera Research is pleased to present a riveting interview with gold mining industry legend Rob McEwen, Chairman and CEO of US Gold Corporation (NYSE: UXG). In this exclusive interview, Mr. McEwen discusses financial markets, the McEwen Junior Gold Index (MJGI) and the junior mining sector, which he believes offers superior growth opportunities, and where the gold market is headed in 2010 and beyond. Mr. McEwen also offers unique insights into his strategy to create the next Homestake Mining Company.
Rob McEwen formerly founded and served as Chairman and CEO of Goldcorp, Inc. (NYSE:GG), the world's lowest-cost million-ounce gold producer. Mr. McEwen transformed Goldcorp from a group of small companies into a global, tier-1 gold mining giant whose market cap now exceeds $28 billion. Under Mr. McEwen’s leadership, Goldcorp’s share price climbed at a compound annual growth rate of 31%.
Mr. McEwen’s goal for US Gold Corporation, in which he is the largest shareholder, is for it to become Nevada's premier exploration company. Since Mr. McEwen took the helm, US Gold’s share price has increased more than 1000%.
HRM: Thank you for taking the time to speak to me today. Before we get started, I wanted to ask you why you created the MJGI when there are other indexes such as the XAU and HUI?
Rob McEwen: We originally developed the index internally to monitor the performance of our investments relative to other junior mining companies in North America. There have been several articles about it and it’s been cited in research. To be included in the index, companies have to have a minimum market cap of $50 million and a minimum trading volume equal to $50,000. They have to be listed on an exchange and have no commercial production.
HRM: So all the companies are pre-production?
Rob McEwen: Yes. The companies are involved in gold exploration and discovery. This is where the growth is going to be.
HRM: Have you considered creating an Exchange Traded Fund?
Rob McEwen: A number of investors said they wanted to have a product like that. We looked at creating an ETF and determined that the companies within the index are too small. Their shares don’t afford the liquidity necessary to move in and out as frequently as an ETF requires. You’d have to include producers, which tend to have greater market liquidity.
Chart courtesy of McEwen Capital
HRM: Isn’t gold exploration and discovery the highest risk category, compared to junior producers or to more established companies?
Rob McEwen: Shareholders have to approach this cautiously and they shouldn’t put all their money in one stock. An exploration company can promise you one thing. They can’t promise you a discovery, but they can promise they will spend all the money they have on exploration. Once they have a discovery, it has to be large enough to raise more capital, or to sell or joint venture with a larger company.
HRM: Exploration and discovery isn’t for the faint of heart.
Rob McEwen: Anyone who goes into the market thinking it will go up forever should get out now. People have to be thinking about how to grow their capital and individual investors have to diversify their risk. Major producers’ share prices will increase with the price of gold, but they won’t deliver the dramatic growth of a junior with a discovery.
HRM: When the stock market crashed in 2008, the stocks of gold exploration and discovery companies fell more than other types of companies. Couldn’t that happen again?
Rob McEwen: Yes. They’re more thinly traded and they have a smaller number of shares outstanding. A large investor can sell a block of equity and adversely affect the stock price. They can’t absorb aggressive institutional selling. In 2008, the whole market was down. People were selling indiscriminately.
HRM: So pre-production, gold exploration and discovery companies are more vulnerable in a stock market decline?
Rob McEwen: I would say that’s true. In 2008, they had the largest declines. They’ve recovered well but have not returned to former levels. They’re reliant on equity capital. An extended decline in the stock market can limit their access to capital or force them to accept poor terms.
HRM: I would be remiss if I didn’t ask what you look for in gold exploration and discovery companies.
Rob McEwen: I start off looking at where their property is located. I tend to stay away from Africa and the former Soviet Union. I look to see if there is growth potential. I tend to buy distress, meaning companies that are undervalued or underappreciated or depressed because of market timing, and I take large positions so I can influence the company’s strategic direction.
HRM: That’s probably not something the average investor thinks about.
Rob McEwen: I agree. I look for combinations where the sum [of two companies] is greater than two, such as companies operating in established mineralized belts. In US Gold’s case I saw an opportunity to take over three companies. It’s a game of putting different pieces together to create a much stronger entity that can grow its value faster.
US Gold Corporation engages in the exploration of gold primarily in Nevada and Mexico. In 2007, US Gold completed the acquisition of White Knight Resources Ltd., Nevada Pacific Gold Ltd., and Tone Resources Limited. As a result, US Gold's land position within Nevada's Cortez Trend grew from 36 to 170 square miles. The Cortez Trend is part of the Battle Mountain-Eureka Gold Belt that includes Barrick's (NYSE:ABX) Cortez (35 million ounces of gold) to the north and the Ruby Hill mine (4 million ounces) to the south. US Gold's properties on the Cortez Trend lie 10 miles south of Barrick's recent Cortez discovery. Although the Cortez Trend remains under-developed, recent discoveries indicate that it could rival the famous Carlin Trend which is located approximately 30 miles to the northeast, where reserves and mineralized material are estimated to be 180 million ounces. US Gold’s 3 Nevada projects have resources containing an estimated 2.46 million ounces of gold. As of May 2008, the Tonkin project measured and indicated resource contained an estimated 1,447,000 ounces of gold (.pdf). As of May 2009, the Gold Bar properties’ measured and indicated resource contained an estimated 772,600 ounces of gold (.pdf) and the company announced a 26% increase on March 22, 2010 (.pdf). As of July 2009, the Limo project’s measured and indicated resources contained an estimated 241,080 ounces of gold (.pdf).
I look for companies that have been overlooked or are underappreciated, or whose assets are depressed because of market timing. I am a large shareholder in Minera Andes, Inc. (TSX:MAI), which operates in Argentina, and Rubicon Minerals Corp. (RBY), which has properties at Red Lake, in the Ontario mining district, as well as in the US.
HRM: What are your plans for US Gold’s Nevada projects?
Rob McEwen: We just released an updated gold resource estimate, last week, for our Gold Bar project in Nevada and a preliminary economic assessment will be released later this month that will highlight the initial gold production profile for Gold Bar. Our drilling program slowed down during the winter because the properties are above 6000 feet and we didn’t want to incur additional costs. We will be drilling throughout the summer. The Gold Bar properties are in an area that has been previously mined, so permitting should be easier.
HRM: I understand US Gold has another group of projects in Mexico.
Rob McEwen: US Gold has an exciting high grade, silver discovery at its El Gallo project in Mexico. We are rapidly advancing this project with a large $17 million exploration drilling program this year. In fact, it is probably one of the largest (330,000 feet) exploration programs being conducted in Mexico this year by a junior [mining company]. We’ll have an initial resource estimates out at the end of the second quarter followed by a second updated NI 43-101 by year end along with a preliminary economic assessment for El Gallo. The ore is close to surface and we can use inexpensive mining methods. Targets are shallow, between surface and 500 feet. The topography is gentle and we can do drilling quickly. There is a good chance this will be our first mine.
US Gold holds 530,000 acres of mineral rights in the Magistral District of Sinaloa State, Mexico, which is an underexplored area that has begun to show significant resources. In November 2008, US Gold announced a high-grade silver and gold discovery called El Gallo. US Gold is also expanding the size of its two other discoveries, the Magistral and Palmarito projects. US Gold’s projects in Mexico have resources containing an estimated 500,000 ounces of gold and 8.47 million ounces of silver. As of December 2008, the Palmarito project’s measured and indicated resource contained an estimated 16,484 ounces of gold and 8,472,048 ounces of silver (.pdf) and, as of June 2009, the Magistral project’s measured and indicated resource contained an estimated 502,466 ounces of gold (.pdf).
HRM: Do you see growing investment interest?
Rob McEwen: Gold tends to move up when paper currency and financial products are questioned. From 1981 to 2001, gold was going down and portfolio managers and investment advisers weren’t recommending owning gold or gold stocks and most are still thinking that way. Despite the fact, gold bullion and gold shares have been the best performing asset class over the past 10 years. Performance speaks for itself. There is a growing interest developing and I think we’re going to see substantial funds moving into gold.
HRM: That’s interesting because I understand Goldcorp did very well in the 1990s even though gold was going down. Would you comment on that?
Rob McEwen: Goldcorp originally invested in gold bullion and gold mining shares but, because it was a holding company, it would sell at a discount to its net asset value when the gold market was moving down. At those times, there was pressure from some shareholders to open end the company and distribute the assets. I thought there was an alternative not being considered which was to turn the company into a gold producer and get it valued at a higher multiple. Operating companies were trading at 2.5 times their net asset values. I started merging Goldcorp with other companies to generate cash flows. It took 8 years and three reorganizations during which we merged five companies into one and eliminated the debt, strengthened the balance sheet, improved operational efficiencies and started exploring aggressively. Originally, I was just going to do the financial architecture and leave the running of the company to the mining executives, but in the space of a year I stepped in as CEO and re-made the senior management team.
HRM: So, you acquired gold producers?
Rob McEwen: Yes, we acquired two gold producers and with one came an industrial minerals division which produced lime and sodium sulfate.
HRM: Industrial minerals sound quite different from gold exploration and discovery.
Rob McEwen: Indeed, industrial minerals are usually long life, steady producers. The cash flow from our industrial minerals allowed us to pay down our debt and then fund the exploration at our Red Lake mine.
HRM: That sounds like a long-term plan. How did you achieve such phenomenal growth at Goldcorp?
Rob McEwen: Goldcorp’s success was based on a fantastic gold discovery made a mile below surface in a mine that almost everyone thought was at the end of its life and [that was expected] to close within 3 years. We invested $10 million in exploration and our chief geologist came back 1 1/2 months later with the assay results from 9 drill holes with grades (concentrations of gold) that were 30 times what we were then mining. That was the start.
We grew shareholder value. We increased our resources. We were aggressive in our exploration and innovative in the way we ran the company. We used The Goldcorp Challenge to find new resources. That was the inspiration for Don Tapscott’s best selling book Wikinomics. We also started off paying a dividend out of Red Lake; at first, annually, then semi-annually, then quarterly and then monthly. I saw the dividends as a form of rent to shareholders while they’re waiting for capital gains.
HRM: That’s amazing, because the price of gold continued to go down until the low of 2001.
Rob McEwen: In 2001 when gold was $270/oz,at Goldcorp we started to withhold part of our gold production. The reasons were threefold, one, I believed the gold price was going much higher, two, there were tax advantages to selling it several years later and three, we increased our financial assets by holding back the gold. Several years after we started we had more gold in our bank vaults than half the central banks in the world. When we started withholding the gold I predicted that gold would hit $850 per ounce in 2008. Gold has gone up more than four fold since the low of $250/oz in 2001.
HRM: I’ve heard people say that gold is in a bubble now. Do you think that’s true?
Rob McEwen: Absolutely not, I believe the gold price will climb significantly higher from the current level. Look back 20 years at the price of many asset classes and you will appreciate the enormous price inflation we have experienced. In 1985, in order to get on Forbes’ list of the 1000 richest people in America you needed to have $150 million. At that time, Warren Buffett was one of the 14 billionaires on the list. I saw that list a year ago and there were something like 990 billionaires and, basically, you needed to have $1 billion to be on the list. How was so much wealth created? It was financed by debt. A long period of low interest rates has encouraged very speculative investments financed by high levels of debt. Today we’re seeing the unwinding of financial asset inflation that has happened over the past 10 or 20 years. Areas that are susceptible to further declines are in real estate, so called collectible assets, derivatives, the debt market, and the dollar.
HRM: So, despite inflation, gold is not yet in a bubble in your view?
Rob McEwen: No. We’ve got a long way to go before that happens. If you think about the tech bubble, a few hundred companies became thousands. They all had stories and were looking to make a zillion dollars or be taken over for such an amount. Today, there are a lot of exploration companies [and] as gold goes up there will be more exploration companies and stories and more investor confusion about where to invest. One indicator is the attendance at the annual Prospectors and Developers Association show just held in March in Toronto. It was the largest ever.
HRM: You mentioned that there are many more billionaires. Doesn’t that simply mean that economic activity has expanded and that the wealth of society has increased?
Rob McEwen: Increased economic activity fueled by low interest rates and government monetary expansion, and by record levels of debt, has produced the growth in apparent wealth. It is built on a shaky foundation. In August 2007, when the sub-prime mortgage market blew up, I recall thinking this is like at no time in my career. There appeared to be no safe place to put your money. The global financial/banking system was collapsing. Just prior to British mortgage bank Northern Rock failing there were pictures of people who had deposits there lined up for hours trying to get their money out. That’s where gold comes in; it protects your wealth when the banks can’t. Gold is the ultimate currency that governments can’t create by printing more of it. The collapse of the banking system has been deferred.
HRM: What do you mean by a shaky foundation?
Rob McEwen: OTC derivatives have multiplied wealth like a fractional reserve banking system, but they’re hollow. When someone can no longer provide a guarantee, the system collapses or at least part of it does. Investors and the public have been too cavalier in their approach to risk.
HRM: But the wealth created by OTC derivatives is real?
Rob McEwen: The obligations are real, at least on one side. What we’ve seen is that when banks fail, governments bail them out. It’s in the interests of banks to create these instruments. Real wealth for the investment banks is generated by their creation and transaction fees generated by selling these derivatives. Huge money has been taken out of investors’ pockets.
HRM: This is fascinating but what do derivatives have to do with gold mining companies?
Rob McEwen: The introduction of the gold ETFs (a derivative) has broadened the market for gold and created an attractive, convenient alternative to buying senior gold producers. I would rather buy bullion than [shares in] a gold ETF. There is greater certainty of ownership when you have a bar of gold.
I would like to comment on a place and time when gold performed and we appear to be on the same path today. After World War I, Germany’s manufacturing base was in ruins, and the victors, the Allied nations, were demanding enormous payments as compensation for the damage Germany caused. Prior to the war Germany had been one to the world’s richest and most powerful nations. Initially, America was providing Germany with the credit to make the payments to the Allies but that soon stopped and Germany, burdened by an enormous debt load and without a manufacturing base to provide employment and tax revenue, turned to printing massive amounts of money to pay its bills. Fast forward to today, where globalization of world trade has opened up Asia for huge capital investments and created the low cost manufacturing center of the world. There’s been an outsourcing of production from the US and the West to Asia. The US went from being the world’s biggest creditor to the biggest debtor. Its largest creditor is China which appears to be growing impatient with Washington’s disregard for maintaining the value of the dollar. Like Germany in the early 1920’s, America is struggling with an enormous debt load [and has] large, expensive, new social programs, in addition to a very expensive war in the Middle East. Those are some of the parallels I see today along with the need to own gold to protect one’s wealth. What happens if China stops buying America’s debt?
HRM: Are you saying that the US is headed for hyperinflation, like Germany?
Rob McEwen: That is a very real possibility. You need to protect your savings, your retirement, [and] your financial independence. Gold can provide part of your solution. From 1929 to 1939, Homestake Mining, which you might think of as a proxy for senior [gold] mining stocks, rose from $80 per share in October 1929 to $495 per share in December 1935, which was 519% and it paid large annual cash dividends while gold was only increased from $20/oz to $35/oz in 1933 by government decree. The Depression of the 1930s started with a severe deflation followed by inflation later in the decade. Senior gold stocks are up perhaps 200% from their lows, and [from the low of] gold in 2001, and still have room to go higher.
Chart courtesy of Homestake Mining Company
HRM: Can gold or gold shares protect wealth in either a deflationary or inflationary environment?
Rob McEwen: People are going to turn to gold as they have repeatedly over the millennia. Whenever a monetary system fails, confidence in the country’s fiat (paper) currency rapidly disappears and gold performs. The monetary expansion of the past 10 or 20 years is going to cause big problems going forward. Gold is money, the ultimate currency, store of value and a very liquid asset. If you sell your gold through a bank it’s 2-day settlement, and you have cash in any other currency in two days. If you take a gold bar into a bullion dealer, it’s immediate. You can go anywhere in the world and sell gold. It’s recognized internationally.
HRM: Where do you see gold going from here?
Rob McEwen: More people are moving into the gold market but it’s still a tiny number compared to the amount invested in the stock, bond and derivative markets. In 1929, something like 10% of the working population owned stocks. Now, with retirement funds and mutual funds, it’s probably closer to 90%. A shift of 1% to 2% of this money into gold would have a profound and positive impact on the price of gold and gold shares. Unlike governments printing massive amounts of paper money with the push of a button the supply of gold increases slowly. Annual mine production increases the supply by approximately 1% per year. When a growing number of investors start adding gold to their portfolio, they will find a limited supply and the gold price will climb. I believe gold will ultimately reach $5,000/oz.
HRM: Thank you for being so generous with your time.
Rob McEwen: My pleasure.
Rob McEwen’s unique perspective offers profound insights as well as a rare glimpse of his deep strategic thinking. By taking control of large swaths of highly prospective mineralized belts based on geological patterns, and by acquiring and merging complementary companies, he has consistently created larger resources in companies with lower production costs, while steadily increasing shareholder value. Mr. McEwen seems to be laying the foundation for a future mining giant that, like Homestake Mining Company, will expand its resources and eventually produce gold for decades to come. Reflecting on Mr. McEwen’s comments on inflation, deflation and OTC derivatives, it’s clear why he anticipates a decline in government currencies and other financial instruments, as well as a persistent rise in the value of gold and gold shares. Mr. McEwen’s strategy can be viewed as one man’s response to this historic shift.
Disclosure: No positions