Consulting Mining Analyst Thomas Schuster looks at the longer term in mining. He is bullish on gold but cautions that we won't see an end to the bear market in precious metals equities until financing again becomes readily available. In this interview with The Gold Report, the publisher of the "Rocks To Riches" research reports presents key factors for investing in gold, silver and niobium that will aid investors in riding out the storm.
The Gold Report: The prices of gold and silver soared after 2008, suggesting a flight to safety by investors. What does the recent volatility in gold from $1,250/ounce [$1,250/oz.] to $1,325/oz. and now down to near $1,300/oz. indicate?
Thomas Schuster: Gold is naturally volatile and reacts constantly to positive and negative market stimuli. I don't believe that the recent uptick in the gold price is comparable to the start of the gold run that occurred after the financial crisis in 2008.
I look at how producers are doing. Average gold grades are lower, costs are higher, and overall production from the majors is declining. Gold reserves need to be replaced with quality ounces. I believe the gold price is finding a new base and will trend upward over the coming years. I'm bullish on gold.
TGR: The tremendous rise in the equities markets, which shows no sign of ending, has not benefited gold and silver stocks. Why not?
TS: People tend to invest in trends. The general market trend has been rising, so investors have been chasing that trend and making money off it. On the flip side, the mining markets have been trending downward for years, so unless you have speculated on the dark side, it has been a difficult time for mining investors. When we start to see a steady uptrend in the mining market, I believe it will come back with a vengeance. Long and deep downturns are usually followed by spectacular upturns.
TGR: The bear market in gold and silver equities goes back to April 2011. When can we expect this sustained upturn?
TS: I think we're currently in a holding pattern. The gold price has been fluctuating around $1,300/oz. and it's now summer. Sell in May and go away, as the saying goes. Brokers are looking forward to the fall and a better investment climate then.
TGR: For 20 years, we've had the Internet, which has ushered in a 24/7/365 news cycle. So isn't it odd that the mining industry continues to operate on the basis that nothing significant can be expected in summer?
TS: Well, a great deal of exploration occurs in the summer. While investors take their holidays, the geologists are out in the field, spending money that was invested in their companies in the winter and spring. Typically mining stocks don't respond to news in the summer unless something significant is released. We tend to get more news flow in fall after the field season, and that's when people see opportunities to invest. That's also when investors tend to be more receptive to additional financings.
TGR: Should investors make decisions based on an assumed future gold price of roughly $1,250/oz. or is it now reasonable to invest based on the assumption of significantly higher prices?
TS: That depends entirely on their investment philosophy. If investors look to exploit volatility and short-term trends, they should examine current gold prices and market sentiment. However, longer-term investors should examine longer-term price forecasts. For instance, if they want to invest in a company with a two- to three-year path to production, they should look to what gold will be worth when that company begins producing.
TGR: What's your investment philosophy?
TS: I'm a longer-term investor, so I consider the longer-term trends. It's much more difficult to predict short-term volatility. I like to identify good companies with a good core asset. As the company advances that asset, it should gain in value.
TGR: In today's market, what are the qualities that distinguish those mining companies that are poised for success?
TS: Good management is always a key factor. These management teams find projects that have the right risk/reward ratio. Whether it means finding projects close to infrastructure in stable, mining-friendly jurisdictions or finding projects with the potential for tremendous discoveries in currently out-of-favor jurisdictions, good management will know what works in different market conditions.
TGR: Must good management always include executives who have hit home runs in the past?
TS: Not necessarily. You just need to identify smart people who can recognize and exploit opportunities. I went to school with a fellow called Patrick Anderson. He and his partner, Keith Barron, positioned themselves in a down market to acquire prime, underexplored ground in Ecuador. They had a pretty much unknown team, but they discovered the 13.7 million ounce [13.7 Moz] Fruta del Norte gold deposit, which was sold for $1 billion [$1B] in 2008.
TGR: How long should investors hold on to underperforming companies if their underlying fundamentals are good?
TS: I consider a one to three year period when determining whether investors are getting a proper return on investment in the junior market. If a company has met its benchmarks after one year and looks set to achieve its goals, you should hang on to it. And then you should continue to re-evaluate for up to three years, always considering what realistic potential gain can be had from this stock. When you get that, you should take your profit. You never lose money taking a profit.
TGR: You place a great deal of importance on the concept of enterprise value [EV]. Could you explain this term and how it affects your valuation of mining companies?
TS: Because junior exploration companies don't make money, proper financial valuations are pretty much impossible, so we have to look at other ways to value them. EV looks at what the market is willing to pay for a company after its debts are paid and its cash position is taken into account. EV is often divided by the number of ounces or pounds of metal resources in the ground, and this number tells investors how the market values resources by one company as compared to its peers, and whether it is comparatively undervalued or overvalued.
Companies with low EVs are getting little value for their projects, and those on the cusp of making significant discoveries or publishing large resource estimates present good opportunities for investors.
TGR: Now that the Supreme Court of Canada has granted title to Indian groups that can demonstrate continuous use of Crown land, can British Columbia still be considered a mining-friendly jurisdiction?
TS: British Columbia is one of the most highly regulated jurisdictions in Canada, but at the end of the day you can still go to sleep knowing you will own your project in the morning. Successful mining companies know that they must respectfully engage First Nations early on and build good relationships in order to foster mutual understanding and trust that will benefit all parties involved. The Supreme Court ruling re-enforces that reality and hopefully it will provide a road map for negotiating as opposed to litigating.
TGR: Quebec has a new Liberal government, replacing the Parti Québécois. What are the implications for the mining industry?
TS: The Liberal government is on record as being more mining friendly. The proof will be in the pudding.
TGR: Argentina, like Canada, has a federal system. How important is that to mining?
TS: A federal system is important to providing a unified mining code, but as in Canada, some Argentine provinces are more favorable toward mining than others.
Jurisdictions change and when they change favorably they provide great investment opportunities. I can remember when Colombia was a terrible place to work. Now, it is significantly better and subsequently many new discoveries have been made there. Argentina is not regarded very highly at the moment, but there are indications that the political climate could be improving. That sets the stage for opportunity.
TGR: Which specialty metal particularly interests you now?
TS: Niobium, which has a very good outlook. It's used in the form of ferroniobium to produce lighter, stronger steel. For example, $9 worth of niobium in a car reduces its total weight by 100 kilograms, increasing fuel efficiency by 5% and lowering CO2 emissions. The U.S. doesn't produce any. A Roskill Global Commodities Market Report estimates a compound annual ferroniobium growth rate of 3.74-7.32% through 2017.
TGR: Only three mines produce niobium, and 95% comes from Brazil and 5% from Canada. Can these mines meet short-term niobium demand?
TS: They could meet near-term demand, but the issue is diversity of supply. With 90% produced by one company in Brazil, any kind of natural disaster, strike or governmental disruption could cause quite a hiccup in the market. As the U.S. considers niobium a strategic metal, it would prefer some American production.
TGR: What are the reasons for long-term investors to be optimistic about gold and silver stocks?
TS: I've been through a number of cycles, and nasty downturns are always followed by exciting turnarounds. People will always need metals, and metals are not renewable. I read an interesting quote recently, "Mines are value destroyers," referring to the fact that the metals need to be replaced as they are blasted from the ground. New sources must be found to replace what's being mined. The only way to find these new metal sources is through extensive exploration, and that requires risk capital. So we must wait for favorable market conditions to return. In the meantime, there are some great opportunities out there you can invest in now to get yourself in ahead of the rush.
TGR: Thomas, thank you for your time and your insights.
This interview was conducted by Kevin Michael Grace.
Thomas Schuster is a consulting mining analyst in Vancouver. He holds a Bachelor of Science in geological sciences from the University of Toronto and began his career in the Timmins Camp in Ontario. A reporter at the Northern Miner for seven years, he produces an equity research report, "Rocks To Riches," which is distributed to industry brokerage firms.
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