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James Passin: The Feedback Loop
Source: The Gold Report; interviewed by Karen Roche, Publisher 11/20/2009

http://www.theaureport.com/pub/na/3309

Today's extraordinary loose monetary conditions are "benefiting hard assets," according to James Passin, co-founder and manager of Firebird Global Fund and Firebird Global Fund II. Surplus liquidity is flowing into ETFs that buy commodity futures and physical commodities, which James says, is "creating a feedback loop" that is driving up the price of resources. James discusses gold's momentum, as well as its associated near-term risks and shares some hot companies and sectors he's following right now in this exclusive interview with The Gold Report.

The Gold Report: James, last December, you commented on the low interest rates that the government had on bonds. You said you thought that would spur inflation and an increase in commodity prices. Now that we're in the last quarter of '09, how do you feel about your predictions and what do you see going forward into 2010?

James Passin: It was clear to me at the end of 2008 that we were at the beginning of a powerful and lasting recovery in commodity prices and resource stocks. I think that the structural fundamentals are in place to support further increases generally in commodity prices.

TGR: This year we saw, basically, all positions and all sectors increase. What would cause just an increase in the commodity pricing going forward vs. all the other sectors?

JP: We have had a rally in all assets, but hard assets also are benefiting in particular from extraordinary loose monetary conditions. Surplus liquidity is flowing into commodity products like exchange-traded funds (ETFs) that are buying commodity futures and physical commodities, creating a feedback loop, which is driving up the price of resources. But what we thought is that this would be a great year for resource stocks based on our view that capital markets would start to reopen. Resource companies tend to be capital-hungry. So as the cost of capital comes down and as capital becomes available, resource stocks tend to outperform resource prices. At the same time, last year there was a dramatic reduction in issuance of stock by resource companies. This has resulted in a highly bullish environment for resource stocks. But we are concerned about the recent changes in the nature of market sentiment.

TGR: You say you note a changing tone, generally. What's changing?

JP: It's interesting to ask how long these extraordinary loose monetary conditions will continue to exist. At what point will the Fed take the view that the financial system and the economy can withstand tighter monetary conditions? Perhaps it seems unlikely with unemployment at 10%. It also clearly in everyone's interest to allow asset bubbles to develop to enable banks to rebuild their equity through generating profits. But any significant tightening of monetary conditions could undermine the commodity markets in the short-term. There is also a dangerous structural element to the market represented by the ETFs.

The ETF prices increase when the gold price increases and as demand for ETFs increase, then the ETFs actually go out and buy more gold. This is creating a feedback loop. The obvious concern is what happens when it goes the other way, if the gold price actually started to weaken and the ETFs start to sell, creating a negative feedback loop. When I referred to the different tone, I was really referring to the increased level of confidence that I'm observing among gold bugs and to the wave of financings that's coming out of the gold space. A lot of marginal gold companies are getting financed. Gold has shifted into a momentum phase that is generally characteristic of a topping process.

TGR: I think the most interesting thing that's happened in the past week is the government of India buying 200 tons of gold from the IMF. People are saying, is China next? So when governments start buying that volume of gold, is there really an issue of gold being vulnerable?

JP: Looking at the history of Central Bank gold trading habits generally would suggest Central Banks are horrible gold traders. Central Banks were happy to sell gold under $300. The fact that that Central Banker mentality is shifting is arguably a sign of capitulation. There is other evidence of capitulation. For example, Barrick Gold Corp. (NYSE:ABX), the pioneer and big proponent of gold hedging, bought back a significant portion of its outstanding hedge book at a massive loss. Whatever happens to gold in the short term, the gold price will tend to rise over time as long as we have the fiat world currency system.

TGR: You mentioned that gold is hot—it was about $1,145 today—has that overshot the value of the market at this point?

JP: It's hard to say what the fair price of gold is. I think that gold is vulnerable and maybe it will experience a violent correction from a higher level. I'm not an investment advisor and I don't provide investment advice, but personally I think that owning some physical gold makes sense. However, unless you're a very good short-term momentum trader, it's strikes me as a dangerous time to be heavily long gold.

TGR: During 2009 the equities outperformed the commodity, which is the reverse of 2008. So are we at a point now where gold stocks are overvalued relative to the commodity?

JP: A lot of gold stocks seem undervalued, but there's a huge financing pipeline. It depends on your view on the gold price.

TGR: Can you share with us some of those gold stocks you feel are undervalued?

JP: I would mention one special situation that is intriguing: Vangold Resources Ltd. (VAN:TSX.V). I serve as a non-executive director of Vangold, so I am not going to make any statements about the company, but what I will mention is that the company is breaking up into an oil company and a gold company. The gold company has highly interesting exploration properties in Papua New Guinea. PNG is elephant country for gold; it may be worth taking a look at it in the context of the imminent restructuring of the company.

TER: What other commodities or resource areas are you following?

JP: We're very interested in strategic metals and minerals, which would include not only rare earth metals, but other metals and minerals that have critical applications in the energy, military, and industrial sectors.

TER: Can you highlight some of those for our readers?

JP: We've been trading some of the rare earth metal stocks; for example, Avalon Rare Metals (TSX:AVL) and some of the other rare earth metal plays. It's a space we've been following for the last five years. There's been renewed investor interest in rare earth metals, but several commodities with similar fundamentals have been completely ignored by investors.

TER: What are those and why haven't they received the attention? Is the market place too small for it? Are they just not well known enough?

JP: Oddly, there has been tremendous interest towards very small markets, so I do not believe that size is the issue. We anticipate that investor interest will continue to move across the periodic table. One of our key areas of interest is beryllium. Beryllium is needed in certain parts inside nuclear reactors. It's also used in various industrial and military applications.

There's a company called IBC Advanced Alloys Corp. (TSXV:IB) that is emerging as a leader in beryllium. Firebird and Vangold founded the predecessor company. One of IBC's initiatives is its joint venture with Purdue University. IBC and Purdue are developing beryllium-uranium mix oxide fuel technology, which has a potential to revolutionize nuclear power by creating a safer and more efficient fuel.

Mixed oxide fuel has the potential to solve the two major issues of nuclear fuel, one of which is the tendency of nuclear fuel rods to crack before all of the energy is extracted. The other issue addressed by beryllium is improving safety by eliminating the theoretical risk of overheating. By reducing wasted fuel, IBC could offer nuclear utilities the means of saving billions of dollars on a cumulative basis.

TER: Is there a government regulatory process that this new fuel would need to go through?

JP: Absolutely. In the United States it's governed by the Nuclear Regulatory Commission. IBC is providing the funding required to move the approval process forward. It's going to take several years to test it in a test reactor and to get the licensing and permitting. I don't anticipate that this is going to be a commercial product before four to five years.

TER: I'm going to switch over to uranium here just because you happened to bring it up. In the past you've been very pro uranium. Uranium seems been put on the back burner. What's your feeling about uranium now?

JP: I'm pro uranium in the sense that I believe in its merits economically and politically and we do have some investments in uranium exploration in mining companies. But it is important to acknowledge that the uranium bubble is dead. With that said, there are some interesting companies.

TER: Are there any you can share with us?

JP: I'll mention two. Mega Uranium Ltd. (TSX:MGA) and UEX Corp. (TSX:UEX). Cameco Corp. (TSX:CCO) owns 21% of the shares of UEX and UEX is partnered with AREVA (ARVCF:OTO), the French nuclear giant, which is the world's second largest uranium producer, on its Shea Creek uranium exploration property. Shea Creek has produced spectacular high grade intersections over startling widths. My view is that UEX will most likely be taken over either by Cameco or by another nuclear industry participant.

I think that Mega Uranium looks interesting right now. The company just did a financing, which has depressed the stock. Mega's strategic partnership with Japan Australia Uranium Resources Development Co. Ltd. and ITOCHU, the Japanese syndicate, is a very promising development for the company.

TGR: I know you recently returned from Mongolia. Can you give an update on what you found over in that section of Asia?

JP: Ivanhoe Mines Ltd. (NYSE:IVN, TSX:IVN) , the Canadian exploration company, finally executed an agreement with the Mongolian government with respect to the development of Oyu Tolgoi, the world's largest undeveloped copper mine. This is a massive mine that will generate $5 billion of revenue per year for over 50 years. While this a positive development of Ivanhoe, a stock that we've been trading from the long side all year, it will be much bigger story for the Mongolian stock market.

Mongolia GDP is only about $5 billion, so Oyu Tolgoi, or OT as the mine is called, will transform the prospects for employment and per capita GDP growth. A great wall of domestic liquidity will support the local stock market, creating a new bull market which will last for decades. The local stock market currently has depressed valuation and almost zero liquidity Mongolia has structural similarities to other emerging markets that started out with very low market capitalizations, such Vietnam or the smaller Gulf states. There's 24mineral projects that have been deemed strategic by the Mongolian government and that represent potential sources of commodity exports.. The Ivanhoe deal marks the beginning of the Mongolian mining boom and I think the most leveraged long-term way to play this mining boom is through the local stock market.

TGR: How does an individual investor play the boom through the Mongolian stock market?

JP: There are no restrictions on foreign ownership of stock and the currency is freely exchangeable. It's easy to open up a and fund brokerage account. The hard part is finding shares to buy because the market is very thinly traded. It's possible to get a small amount of stock from time to time, although the entire market capitalization is only $500 million and the free float is much smaller. I think that it's certainly worth taking time to do a little bit of research and look at some of the larger stocks that are listed on the Mongolian stock exchange.

TGR: You mentioned there are 24 mineral projects and the big one is Ivanhoe with copper. With the recession worldwide, would we expect to see any return from anything in Mongolia for the next five years?

JP: The copper prices had a massive recovery. OT would be profitable at current copper prices. And Mongolia has other commodities, including coal, uranium, and iron ore.

TGR: Thanks so much for your time today, James.

Describing him as "the Indiana Jones of frontier stock markets," the Financial Times praises James Passin for visiting "rough, difficult places…rather than swanning around the more comfortable nightclubs…" A graduate of St. John's College, James majored in philosophy and classical literature. He is a former editor and research director at investment newsletter Taipan. James Passin co-founded and manages Firebird Global Fund and Firebird Global Fund II. James serves on the Board of Directors of National Investment Bank of Mongolia; Vangold Resources, Ltd., a company listed on the Toronto Venture Exchange; Sharyn Gol, a coal producer listed on the Mongolian Stock Exchange; and Maghreb Minerals PLC, a mineral exploration company listed on AIM. He also serves as a director of several private, venture-stage international resource companies.

DISCLOSURE:
1) Karen Roche, of The Gold Report, conducted this interview. She personally and/or her family own none of the companies mentioned in this interview.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Mega Uranium (TSX:MGA), Vangold Resources Ltd. (VAN:TSX.V)
3) James Passin - I personally and/or my family have direct or indirect exposure to the following companies mentioned in this interview: Vangold Resources Ltd., UEX Corp., Mega Uranium Ltd., IBC Advanced Alloys.

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Louis James Shares Some of the "Best of the Best"
Source: The Gold Report; Interviewed by Karen Roche, Publisher 11/17/2009

http://www.theaureport.com/pub/na/3289

In this exclusive interview with The Gold Report, Louis James, Senior Editor of Doug Casey's International Speculator, reiterates his conviction that the dollar is on death row with no one prepared to grant a stay of execution. Dismal as it is, this situation gives rise to increasingly positive prospects for gold and other commodities that may ultimately stand in as the world's reserve currency. And there are some pretty hot speculative prospects—Louis' "best of the best" —waiting in the wings for the market's next big leg down he's been forecasting.

The Gold Report: The last time you sat down with The Gold Report, you spoke articulately and persuasively about a U.S. currency crisis of historical proportions. At that time you said, "The dollar is on death row." It's been 14 months since then, and the dollar's position seems even grimmer. Can't the U.S. government find a way to grant the pardon that would prevent the dollar's demise?

Louis James: This is one of those times when you hate being right. The short answer is no. The slightly longer answer is that while some actions might help the dollar, those actions won't prevent pain in the near future and they aren't politically viable anyway. It would mean embracing the pain the market doles out to people who make bad decisions, and those in government won't want to do that. That's not just my supposition or theory. You can see they're doing the exact opposite of what needs to be done; they're creating more debt, more "bubbliness," if you will, which is exactly what got us into this situation in the first place.

TGR: Doesn't "embracing the pain" for bad decisions point to the financial markets as opposed to the government?

LJ: Yes and no. The people in financial institutions caught in the subprime mess, for example, took risks, and one could argue that they deserved what they got. But it was the government that mucked about with interest rates and rules, and made those risks look sensible. Truth be told, I think all of this is a multi-decade long problem, a series of bad decisions, misallocations and distortions by government intervention in the marketplace that has serious consequences. Trying to put the pain of correction off longer only delays and exacerbates the inevitable.

Look at graphs and charts of these deficits. Look at the latest Treasury auctions—another $80 billion this week. The U.S. government is on track for another trillion-dollar deficit year. Not a trillion-dollar budget, a trillion-dollar deficit. These numbers were unimaginable to most people just a couple years ago. But you borrow that much, you create that much new currency, and the consequences are, as the saying goes, "baked in the cake."

TGR: We already have this trillion-dollar bailout, though. What could be done going forward?

LJ: They could stop. They could let the market correct the mistakes. But as I say, it's politically not viable. Because to actually do what needs to be done—to stop borrowing, cut down on debt, start producing more than we consume, put our financial house in order—would mean embracing the pain. It works the same way on a micro level in the family: sometimes you have to embrace the discipline, downgrade your lifestyle, stop dining out so often, stop going to movies all the time. Don't spend more than you make. That's what the overall economy needs. It's really no different just because it's larger.

But that's not politically viable. Nor is defaulting. Imagine the leader of the world's great superpower going on TV and saying, "Oops, sorry; we're not going to pay our debts." So the politicians are stuck doing things that sound good to the mass of voters but make things worse.

TGR: There's a lot of talk these days about being in recovery, we're seeing some good economic news coming out, and Warren Buffet just put a big bet on the U.S. by buying Burlington Northern. What do you see in the economy that they're missing?

LJ: Let's get to basics. None of the fundamental problems in the economy that caused the situation have been fixed. In fact, as we've just been discussing, the government's actions have exacerbated them hugely. So what are the grounds for being optimistic? I think politicians encourage people to forget the fundamental reality that a society, just like a family or an individual, needs to produce more than it consumes in order to get wealthier. (Well, there's war for plunder—or theft, on the personal level—but that causes a net loss of wealth overall.)

Pundits confuse people with talk about confidence. They say that with confidence restored, people will spend again, there will be jobs again, everything will get going again and we'll be fine. All we have to do is restore confidence. But it's not true; you can't buy groceries with confidence.

It's a shell game, a distraction. Confidence comes and goes, ebbs and flows. But in reality, either people can pay for goods and services or they can't. Either their production exceeds consumption or it doesn't. That's the key. If production exceeds consumption, you save, you accumulate wealth that can be used to create new businesses, to build new things, to hire more people. That—capital pooling—is what gets an economy going.

TGR: How can you explain how the market continues to rally?

LJ: Well, as the saying goes: the market can remain irrational longer than you can remain solvent. I should say that we at Casey Research have been on the wrong side of the market the entire year, because we've looked at the fundamentals of the economic situation. We have seen a) no improvement and b) the government doing the opposite of what needs to be done for there to be improvement.

So we've been cautious. We made money; we bought when we found picks that looked undervalued, and certainly our oft-repeated call to buy gold has worked out very well. So, we're okay; but we'd be a lot more okay if we had ignored all the fundamental evidence of where the economy is headed. It's kind of ironic. Had we jumped on the bandwagon and deployed cash more aggressively—not to say foolishly—we would have made a lot more money. Instead, we've been calling for more correction, and still are.

TGR: Are you looking for another leg down that's as significant as the first or just for a more typical market correction?

LJ: Bearing in mind that it's a good thing to have a daily dose of humble pie, yes, our consensus is that there's a lot worse to come. We see another and bigger leg down. The dollar, in particular, is headed way lower. The government deficits and what's happening with the money creation is all very bearish, more serious than ever, and that's really bullish for gold—at least as long as it's priced in dollars. But other governments are behaving similarly, and that too is bullish for gold.

TGR: Just for gold?

LJ: Our mid- to longer-term view on base metals is actually quite bullish, as well. The growth coming in China and India over the next 10 years is a major factor. But another serious leg down would knock the stuffing out of anything to do with industry, including the base metals, at least for the short term.

TGR: You recently noted a paradox of investing in gold—that is you buy the physical gold for safety and you buy gold stocks for its risk. Can you explain that?

LJ: As we've been discussing, gold has excellent speculative potential right now because of the destruction of the dollar. If dollars lose 25%, 50% or even 75% of their current value in a few years, that's very bullish for gold. But if that happens, we'll have a lot of economic turmoil, which is the real reason to own gold. No matter what happens, gold is still going to be gold. It's the only financial asset that is not simultaneously someone else's liability. It is not a piece of paper; it's not a promise from somebody else. It's a physical thing you can hold in your hand, and if push comes to shove and you have to hop in your car and go down the street and buy food for your family, somebody will give you something for your gold because they recognize it and value it. In extremely volatile times, you want that security.

Gold stocks are almost the polar opposite in terms of security. They are highly, highly speculative. Most gold companies don't have any gold; they are exploring for gold or developing projects that they hope will be economic. Only a few actually produce gold, and even the biggest producers are highly volatile, because the price of their product fluctuates constantly and strongly. So does the price of the electricity they use to produce it. All kinds of things fluctuate so much that these businesses—even the biggest ones, Barrick Gold Corp. (NYSE:ABX) and Newmont Mining Corp. (NYSE:NEM)—are so risky that traditional securities analyses, a la Graham & Dodd, just don't apply. This isn't investing; it's speculating. You want the wild fluctuations of the volatile commodities market to create opportunities for big wins.

TGR: And juniors would be even more speculative. Haven't you compared them to burning matches?

LJ: Most of them are explorers with no substantial assets. All they have is money in the bank (hopefully) and an obligation to spend it trying to discover something. If they do make a discovery, they go from having literally nothing but a geologist's dream to having something of measurable value. The difference in valuation can be huge; this is how it's possible to get 10-baggers or even 50 times your money on one of these stocks.

The odds in any case are quite long. Even when you find a gold prospect, going from having a gold anomaly to a producing mine of any size, even a small one, the odds are something like 1 in 300. If you're knowledgeable and put a lot of effort into it, you may improve those odds, but the odds remain long. This is where the burning match comes in. The company burns through its money in the hope of finding something of value before the fire hits its fingers.

TGR: But the rewards can be commensurate with that risk.

LJ: Absolutely. The juniors' very volatility provides the opportunity to have enormous wins. But you have to understand it's a high-risk proposition. You can apply intelligence to reduce the odds, and you can diversify your risk. Whether it's your overall speculative diversification, or whether it's within an area such as gold stocks, you don't just want to buy one company. It works best if you have a portfolio of companies.

TGR: Any other techniques for improving the odds?

LJ: You tilt the odds more on your favor by betting on trends. If you didn't know anything about markets, if you had no idea whether gold was likely to go up or down, if you just liked gold and wanted to throw darts at the board, that would be pretty much pure gambling. But we have all this evidence we've been talking about regarding the economy to support the idea that gold is going to go up. A rising tide tends to lift most ships. If you pick the most seaworthy vessels with the most experienced management at the helm, assets of value already in hand and so on, you can do better than those 300-to-1 odds.

TGR: How about helping us wade through some of those juniors that have better assets in hand and better management, some that you're telling investors to watch because you feel good about them?

LJ: Okay, but with a caveat emptor. With gold higher than $1,000 for some time now, the market has grown quite heated. In 2007 and 2008, before the jitters, the market was overvaluing a lot of companies, practically anything with "gold" in its name. Some of these companies didn't even have any assay holes drilled into their prospects; all they had were theories and hopes, and they were trading for tens of millions of dollars. Since last fall's crash, there's been quite a separation of wheat from chaff, and many of the companies that had nothing but theories or hopes have not recovered significantly.

But many of the companies with assets of potentially bankable value have had great recognition. Many have not only recovered but have soared to new highs. That's not a bad thing, but it means that the companies with the best potential are not particularly cheap. But as we saw last fall, gold wobbled and came back strongly and quickly, while the gold stocks took a huge hit and took months to come back. That will happen again in another market correction. So maybe these not-particularly-cheap companies are cheap in terms of where they could be a year or two from now, but if you buy heavily now, you're at considerable risk of flubbing the first half of the "Buy Low, Sell High" dictum.

At $1,000 gold, maybe $1,100 gold, people are getting excited and their buying is pushing prices up. I think gold will go much higher, but I don't know that it won't go lower first. Those who are psychologically disposed to follow the herd—nobody wants to think they are, but be honest with yourself—have to ask themselves whether they have the intestinal fortitude to resist selling if your shares drop strongly, for no company-specific reason, before the eventual payday.

Imagine a person who bought, say, in May 2008, when the market was near an interim top. You know how would they feel in October 2008, when it just kept falling and falling and didn't look like it was ever going to stop. Most investors think 5% to 10% is a big fluctuation. To see a stock drop 50% in short order is inconceivable to them; they panic when it keeps falling from there. It's very difficult for people to hold on and say, "This retreat is not justified—I'm not selling." Actually, the thing to do last October, November and December wasn't just to hold, but to buy. People who bought then made so much money it's not even funny.

TGR: So are you saying that smart money right now should stay in physical gold until some of the frothiness subsides?

LJ: If you're psychologically predisposed to being nervous about your investment, and you know you'd have a hard time dealing with a drop of 30%, 40% in a month or two, maybe this is not a good time to be buying speculative gold stocks. That having been said, if you stick to quality companies, buy an initial slice of your ideal position now, and fill out the rest of your position at a lower average price if it fluctuates downward, and you preclude the possibility of missing out on a stock that takes off. But you have to believe in your picks strongly enough to see a sell-off as a buying opportunity.

Our general recommendation right now is to focus on the best of the best. Everything in the International Speculator portfolio has resources drilled off that can be defined by one of the regulation-complaint categories or another. And it's all gold and silver right now.

TGR: Okay, with that big caveat on the table, what are some of the companies that have the resources and management that represent the best of the best?

LJ: Right. Well, we really like AuEx Ventures Inc. (TSX:XAU), which may have Nevada's next low-cost gold mine at their Long Canyon project, joint-ventured with Fronteer Development Group (TSX:FRG) (NYSE.A:FRG). It's got great metallurgy. It's got great mine construction and operation characteristics—there's a nice flat place to put the plant and it's near roads and power. The deposit starts right at the surface so they can mine it in a low-cost open pit. There have been a lot of positive drill results since the last resource estimate, so it's going to get bigger and confidence in the known ounces will increase. How much? Who knows? It could be 50%, or more—or less—but it will be significant.

Long Canyon has a lot of positive characteristics, and it's just their main property. Another AuEx property right nearby Long Canyon is called West Pequop, a gold project being drilled off by Agnico-Eagle Mines (TSX:AEM). There's no official resource estimate there yet, but there's been enough drill success that you know a resource is coming. AuEx has projects in Argentina and Spain where other companies are spending the high-risk money, looking for a discovery, so it looks very good. And in terms of a company that can survive—they've got money, they've got real assets, they've got great management. We're very confident this company will make it.

TGR: Who else might be among the best of the best?

LJ: International Tower Hill Mines Ltd. (NYSE/AMEX: THM; TSX-V:ITH) has a huge gold resource in Alaska they're drilling off. It's not particularly high grade, but it's got good grade for an open pit, and it has a higher-grade core. And it keeps getting bigger and bigger. It's got a lot to prove before the project can be put into production, and it's trading near an all-time high, so you might say, "I don't want to buy now; that would be buying high." You'd be right to think that if there's a correction in December or January, this thing could come off quite significantly. It's huge; it's getting bigger; it has the right characteristics to keep going, but it's early stage. But whatever happens in the short term, if the company is successful, the value they create will be much greater than what the company's trading for now. So you'd have to see it as cheap compared to where it looks headed, not where it's been—and go in confident that if it retreats (barring any specific company bad news, of course), you can average down or hold out for the eventual payday.

TGR: Any others you'd like to tell us about?

LJ: On a slightly more speculative note, Andina Minerals Inc. (TSX-V:ADM) has a very large project in Chile, which is a good mining jurisdiction. It's not particular high grade and the market doesn't seem to understand this deposit very well, and so it's selling quite cheaply right now. We've not been able to find a fatal flaw or any strong reason why these ounces should be selling cheaply. There is a national park nearby, but not significantly nearer than the Refugio Mine, which got permitted. Going there and kicking the rocks ourselves to see if we can figure this out is on our to-do list, but from what we can tell so far, unless we've missed something, this company is undervalued. And not a lot of things are undervalued in today's market.

Inter-Citic Minerals Inc. (TSX:ICI) (ICI.TO) is an interesting one as well. The company has a significant gold resource and terrific exploration success. The company's Dachang project in Qinghai province, China, has yielded a very bullish preliminary economic assessment. The internal rate of return was well in excess of 40% and the net present value was four or five times what the market is giving the entire company. But when they released the study, the market gave them nothing for it, and I have to admit I'm not sure why. They did drop the grade of the deposit when they came out with a more rigorous resource estimate, which could be a contributing factor—but in doing that, they increased confidence in the quality of the model.

One of the things I really like about Inter-Citic is the exceptionally high correlation—something like 90%—between samples from surface soil anomalies and the trenches. In other words, where there's a soil anomaly they've been able to dig through the dirt and find gold in the bedrock. Then they come along with the diamond-bit truth machine, and the drilling also has correlated in excess of 90% with trench results. And there are a lot of gold anomalies not yet tested. So it's a great exploration success story with a lot more potentially to come; there's a lot of gold at Dachang.

TGR: Have you kicked the rocks there?

LJ: I have. It's a very interesting place, near Tibet. It is a refractory deposit, which is more expensive to process, and it's at a significant elevation. It's in a very remote part of China, too, but road building is cheap there and there are no regulatory hurdles. In fact, they have something like a 30-year mining lease already, so there are reasons to be cautious about the economics, but they do have a positive study and seem undervalued.

TGR: Any others you're watching?

LJ: We like Royal Gold Inc. (TSX:RGL, Nasdaq:RGLD). Most companies languished for months after the crash last fall and started coming back in March or so. Royal Gold recovered almost immediately. The reason, I believe, is that it isn't an exploration company. It's not even a producing company. It's a royalty company, with insignificant operating costs. Because its revenue is very much tied to gold, Royal Gold snapped back very quickly last fall when gold snapped back. The company recently reported record revenues and some of its juiciest royalties are yet to come online. It's a leveraged bet on gold. If you're bullish on gold, you buy a stock like Royal Gold, stick it in a drawer, and forget about it until the top of the market.

TGR: Which could be several years away. Let's hope. Any silver companies on your list of favorites?

LJ: We still like Silver Standard Resources Inc. (NASDAQ:SSRI), Silver Wheaton Corp. (NYSE:SLW, TSX:SLW) and Silvercorp Metals Inc. (TSX:SVM). Silver Wheaton is more of a royalty company than a producer, but all three have huge leverage to silver and huge attributable silver resources. Silver companies trade at even more ridiculous multiples than gold companies, and these are all up-and-coming stories. They're relatively expensive, too, but I can easily see them trading at much higher multiples a year from now.

Being a royalty company, Silver Wheaton has no mining risk. It just has revenue from the silver by-product of other companies' mines. Silvercorp has a super high-grade mine that makes money in almost any market. Silver Standard is probably the riskiest of the three because it's only just gone into production. If they fail to produce economically, they'll get whacked. On the other hand, that adds more leverage. They have something like 1.7 billion ounces of silver, and the market is valuing most of those ounces in the same way as an advanced exploration company. If Silver Standard can prove that it can produce profitably, those ounces could be revalued substantially, and this stock could very easily see a higher multiple than the other two. Or not—but that's what speculation is about.

TGR: Silvercorp, which is in production now, still represents some upside. Is that because you're expecting the price of silver to have a higher multiplier than gold? Or is there something unique about Silvercorp?

LJ: Silvercorp has very large resources of a very high grade, resulting in highly profitable operations. It's an extraordinary find they have at the Ying Mine, their flagship operation. The average head grade is still well over a half a kilo of silver per ton—that's after mining dilution and everything that happens getting your ore out of the ground and to your processing facility. That's very good. The fundamentals are there for Silvercorp, limiting the downside risk. Before the crash, the company built a new mill that could triple its production—and then put it immediately on mothballs because it was completed at about the same time the market tanked. They wrote it off, so they took a hit—which was a great buying opportunity—but it creates a special situation now; if they can ramp up again and put it back into use now, it's basically a free mill and thus very bullish for their bottom line.

In addition, because the whole project was so high-grade, Silvercorp was able to finance their mine building out of their exploration by-product. They were exploring by drifting (tunneling) along the mineralization, and were able to take the profit from that to pay for sinking shafts and digging more tunnels. They built their mine without a formal feasibility study or formal proven or probable mining reserves. Very cool, but here's the thing: the project has matured to where Silvercorp can produce formal proven and probable mining reserves. That will change the game, because there are some institutional investors that cannot invest unless a company has P&P mining reserves. According to the U.S. regs, those shady measured and indicated resources Canadians use don't even exist. According to the U.S. SEC, unless you have proven and probable mining reserves, you have nothing. So when Silvercorp can start reporting a very high-grade asset, it will change the dynamics of their market.

On top of that, they're bringing a new mine into production. If silver prices remain high, they can easily triple their output. The average grade may go down, but the overall revenues will go way up. I see a lot of upside here, with many years of mine life left at the super high-grade Ying mine to minimize the downside. If worse comes to worst, they can still keep cranking cash out of Ying.

TGR: What else are you keeping your eyes on?

LJ: We've had a really good lithium play that we made a lot of money on, and also a really good win in a rare earth play. These are more speculative things; but I bring these up because there's a lot of interest in lithium now. It's become quite the flavor of the day, and it seems that all sorts of companies are discovering they have rare earth potential in their property portfolios. Many are changing their business plans to become rare earth or lithium companies. There are good fundamentals there for the longer term for both of these specialty metal areas, but valuations for companies in these sectors just went nuts this year.

My main concern with some of these trendy metals is that you have a really hot sector with really big wins with some of the stocks, but the underlying commodity price hasn't actually changed much yet. There's this idea that all these electric and hybrid cars are going to increase the demand for lithium and rare earths, and that's probably true. It's a reasonable speculation, but it's a multi-year idea, and the price of lithium has not really taken off yet, while some of the rare earths have actually dropped in price recently.

Economic concentrations of it are not an everyday occurrence, but lithium is not a rare metal, either. There's plenty of lithium around, and the current producers have huge resources. I've heard that there were times when SQM (NYSE:SQM) in Chile, a top lithium producer in the world, actually returned lithium to its Salar de Atacama because they were producing more of it than the market needed. So it might be that the existing lithium producers can turn on the spigots faster than we think and wipe out all these new companies.

TGR: Can they go back and mine that back out when the lithium market goes crazy?

LJ: Absolutely. It's not really even mining. A salar is a salt lake. It's got water underneath, so the lithium is still in the water, in solution; they just pump it right back out again. That's what makes these salt brines so cheap as opposed to mining lithium out of hard rock. You pump it out into a big evaporation pan. The sun evaporates the water and concentrates the lithium for you. That does take two years, though; so, if they turn on the spigots now, it will be two years before they get more concentrated lithium.

TGR: So, there might be a short-term bubble between supply and demand.

LJ: There could be. But how much under-utilized capacity do they have now? How much can they ramp up? There's a lot of debate about these are questions. Companies have an incentive to hint that supply might be constrained so they get a better price.

Experience in physics, economics and comprehensible technical writing all contribute to Louis James' popularity as senior editor of the International Speculator and Casey Investment Alert. He is also the interviewer for the weekly free e-letter, 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, checking out highly prospective geological targets and visiting with explorers and producers in the far corners of the globe.

Want to read more exclusive Gold Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Expert Insights page.

DISCLOSURE:
1) Karen Roche, of The Gold Report, conducted this interview. She personally and/or her family own none of the companies mentioned in this interview.
2) The following companies mentioned in the interview are sponsors of The Gold Report: AuEx Ventures Inc. (TSX:XAU), Royal Gold Inc. (TSX:RGL, Nasdaq:RGLD), Inter-Citic Minerals Inc. (TSX:ICI) (ICI.TO)
3) Louis James - I personally and/or my family own the following companies mentioned in this interview: None at this time. (But that's because I took profits and am looking to buy back in at lower prices. I believe in eating my own cooking.) I personally and/or my family am paid by the following companies mentioned in this interview: none.

Eric Sprott: Gold Momentum's Picking Up Dramatically
Source: The Gold Report
Interviewed by Karen Roche, Publisher  11/13/2009

http://www.theaureport.com/pub/na/3280

Although "quantitative easing" (QE) may be propping up the U.S. economy for the time being, it solves nothing. That's how Eric Sprott, Chief Executive Officer & Portfolio Manager of Sprott Asset Management and Chairman of Sprott Money Ltd., sees it. It's not just that QE shoves problems from the private sector into the public sector. It's worse than that, because as Eric tells The Gold Report readers, QE is "just debasing the currency which will eventually lead to hyperinflation." One upside though: "You can just feel the momentum in gold—it's picking up dramatically" and so too are prospects for a plethora of little-known small and mid-cap gold stocks.

The Gold Report: You have written quite a bit about the U.S. government's growing debt and a whole bunch on unfunded liabilities leading to a default on obligations or printing more money.

Eric Sprott: There aren't too many choices when you're in debt to the level that the U.S. government is. As we've outlined in some of our recent articles, one way of calculating it says there's $72 trillion of debt and other way suggests it is $100 trillion. It's almost academic which calculation you use; it's just an overwhelmingly serious problem.

Thank goodness we have a zero interest rate policy. Otherwise, the cost of those obligations would be unbearable. As we analyze where we are and look at all the things that the administration is doing, it certainly seems that they're going to try to spend their way out of it. Last week's announcement regarding the extension of the homeowner credit, in addition to giving corporations loss carry-backs while paying unemployment benefits for an additional 20 weeks—these are all signs of trying to spend their way out of it. It is looking more and more like it will be an inflationary scenario. It could even be hyperinflationary.

I find it instructive that the U.K. has announced another quantitative easing program. I really think that once the Fed has spent the $1.25 trillion buying the GSE paper that we might yet see another level of quantitative easing in the States.

TGR: Since there clearly isn't enough tax revenue to support spending their way out of this, are you looking at a situation in which the U.S. government is just going to be printing more money?

ES: That's what I would presume. I knew that net government revenues from taxes for '09 versus '08 were pretty brutal, but I recently looked back to '07. In October'07 the U.S. government received net $150 billion in taxes. In '08 it was something like $133 billion and in '09 they got $110 billion. That's at least three years in a row of contraction in tax revenues.

TGR: Do you see any scenario in which the government will begin to contract itself—meaning cut costs?

ES: I don't think they are going to restrict anything. They have no choice. We are in such a weak economy that any suggestion of tax increases or spending cuts would just tip people over, so I do not see that happening. I think we will continue to have a quantitative easing policy. It's funny. It's not a policy; it was an absolute necessity because no one was going to buy the bonds. I do not know why anyone would buy a U.S. government bond for 10 years, paying 3% or so when the currency fluctuates as much as it does, the financial position being what it is and the alternatives being what they are. You could buy stocks, you could buy commodities, and you could buy foreign markets. Every one of those has done better than the bond. Because I do not see who would likely buy those bonds, I consider the government purchasing its own securities a necessity, not a policy.

TGR: Given enough quantitative easing, the dollar may no longer be the reserve currency. If that happens, what's in store for the economy and for investors?

ES: As an investor I am pretty sure what areas of the market will do well, but I truly cannot tell you how things will function when the current fiat currency system fails. To be brutally honest, I have no idea. It is hard to imagine what happens when people turn their backs on currencies, but I would suggest that we are already seeing it happen as we speak. You can feel in the market; people do not want to own currencies today. Particularly U.S. currency.

I am not saying that this is anything imminent, but people are questioning many global currencies now, not just the U.S. dollar. I would question the U.K. pound today; I would question the Japanese yen today. Many governments have completely overdone it.

When the Indian government purchased 200 tons of IMF gold, the finance minister said that Europe and the U.S. had "collapsed." Those were his words. They wanted to get those dollars out of their treasury; they would obviously much rather own something physical.

TGR: Do you see the potential of any currency becoming the new reserve currency?

ES: The only one would be the Chinese yuan. However, I think collectively the world would probably say, "Having one reserve currency was a mistake the last time. We should probably use a basket to determine values."

TGR: So what are the options?

ES: Various members of the G-20 talk about commodity backing and so on. You could create a computer system where you could actually use commodities as currencies. It's pretty easy to quantify all these units, so maybe we will go there. Hardly any hard currency physically trades hands now, you could literally have everything just trade in gold and silver on computers. Maybe it goes to that. We will see.

TGR: If it had to be gold and silver, could you expand it into oil?

ES: Yes. You could include any number of commodities. As long as the units are backed by something. You would have to be able to get the unit on demand.

TGR: You said earlier that as an investor, you know which areas will do well. What are they?

ES: We have been seriously involved in precious metals for 10 years now. With some obvious ups and downs, it has been 10 great years. I had purchased gold and silver because I knew there would be more demand than supply, and I am sure that is the case today. I could not have predicted quantitative easing in 2009, nor could I have predicted that the financial world might actually buy into it. I still almost pinch myself when I think about it.

I always knew there would be a bonus thrown in by fiat currencies being damaged, and with quantitative easing you know that the values of currencies are going down. That makes the precious metals story just that much more compelling and I am sure that is why India bought 200 tons of IMF gold and others will follow suit. We are also seeing many hedge funds and pension funds moving into gold. Whereas central banks used to sell gold, now they are buying it. Then there are the ETFs. You can just feel the momentum in gold—it's picking up dramatically.

TGR: With no interest in buying bonds given such low returns, and with so many currencies declining, is there really any upside in the market beyond precious metals?

ES: There is, but as one who runs hedge funds and has a short side in my portfolio, my biggest fear today is that we actually go into a hyperinflationary situation where all asset prices go up. Of course some will go up way more than others. Hard assets, including precious metals, would probably go up the most. Softer things such as bank shares probably would not perform as well. However, everything would go up in a hyperinflationary environment.

TGR: Do you see that happening in the short term?

ES: You cannot rule it out. It is shocking to think the Fed bought almost $2 trillion of securities. If they have to announce another quantitative easing, it will not take too many people too long to figure out what the net result of that has to be. Looking at the price of gold makes me think a lot of people are catching on.

Although I think it is a distinct possibility, I have no idea when it would happen because it's a function of whether they continue quantitative easing. That is just debasing the currency which will eventually lead to hyperinflation.

TGR: Some people are predicting a fairly substantial market correction. From your viewpoint, would that just be a blip in light of the inflationary spiral you foresee?

ES: I think in many ways the rally off the bottom has been a little phony and it is interesting how it has coincided with quantitative easing. I am not so sure that we have really solved any problems. We have just moved them from private company statements onto public statements. We own GM, Fannie, Freddie, AIG, GMAC, whatever. We just moved the problem, but the problem has not disappeared. It may yet happen that the weakness continues to beget weakness. As people lose jobs, their homes are foreclosed upon, they declare bankruptcy, it's a permeating negativism that has to stop. You are never going to stop it until jobs are created and we still have not created any jobs. I am shocked that with all the stimulus and all the job creation that supposedly went with it, there has been nothing, net. There have been no new jobs.

TGR: But they say there's a delay between the market appreciating and when the jobs start, that the market is the leading indicator. And then you get someone like Warren Buffet, who just bought Burlington Northern. He's betting on America. What do you see that Warren doesn't?

ES: I would never criticize Warren Buffet. I am not criticizing him, but I do not think he saw the extent of the financial problems that we encountered and he is not perfectly right all the time. Yes, I think Warren has to bet on America. He is a big part of it and he may yet be right because Burlington Northern is a business that moves real things and real things will still have value in the situation that we all imagine us maybe going to. So he can be right and I can be right at the same time.

TGR: Your funds are heavily invested in precious metals, basically as a hedge against devaluing dollars. To what extent are you looking at physical metals versus equities in these funds?

ES: Early this year I began to move out of some of our physical gold and into mining stocks. There have been a plethora of mining stocks that had incredible value if you could buy into the companies' production forecasts and buy into the price of the metal at the time. When gold was $850, we could buy stocks that in two years' time would have been trading at two times cash flow. When we were buying them at $950, we could still do that. There were some phenomenal values and most in an agglomeration of names no one's ever heard of. Many of them are new with things just starting up. Of course, they had financing problems because of the decline in the market. But the opportunities were overwhelming. So we bought a lot of stocks of that nature.

TGR: Can you share with us some of the juniors that were relatively unknown that have given you some good returns?

ES: Sure. Some of the smaller producers are CGA Mining Limited (TSX:CGA; ASX:CGX), Medusa Mining Limited (ASX:MML) , Norton Gold Fields Limited (ASX:NGF), Norseman Gold Plc (LSE:NOGO.L), and Yukon-Nevada Gold Corp. (TSX:YNG). These are all very small market cap companies, but they can make significant amounts of money. You know, 100,000 ounces is $100 million in sales. It is a very simple thing to put the three zeros on the end, right? If your costs are half the price of gold (i.e., $500), you have $50 million of cash flow. With $50 million of cash flow in a stock trading at $100 million, you have a cheap investment. There are lots of those names around.

TGR: How about in the exploration space?

ES: There have been lots of interesting exploration plays, some of which are in the States. We own a little company called Romarco Minerals (TSX.V:R). We own San Gold Corporation (TSX-V:SGR), which has had some tremendous exploration. There is one in Indonesia called East Asia Minerals Corporation (TSX-V:EAS) that could be very exciting on the exploration front. Galway Resources Ltd. (TSX-V:GWY); Galway picked up the gold property south of Ventana Gold Corp. (TSX:VEN). Ventana's been one of the hottest gold stocks around and that's brought a lot of attention to Galway.

TGR: Right now it seems that the metal is outperforming the producers and the junior companies. Do you see that changing?

ES: I would not agree with that. I go back to 2000 when I started buying gold and gold shares and the HUI Gold Index was 35 then. It is about 660 today, so it has gone up about 1200% while the price of gold has gone up some 300%. Since the bottom in October, the HUI has risen maybe 190% from the bottom. I do not know what the bottom of gold was, but maybe it got as low as $650, but the HUI Index has probably appreciated twice that.

A couple of months ago I saw a list of the top 100 performing junior gold stocks since the bottom. I don't have that list in front of me right now and cannot even tell you who did it, but to make the list, a company had to be up 400%. The average was 700%. It was shocking how much some of these stocks went up. You would have to be deep into small mining stocks to recognize the names.

TGR: Does gold have to increase for such stocks to see any more appreciable value or is there more upside for them?

ES: I probably own 25 or more names on that list, and really have not sold many of them. When this list was done, the price of gold might have been $900. Now we are $1,100. I am finding lots of upside opportunities in these small to mid-size gold companies. I have a tough time stomaching the incredible valuations in some of the bigger ones, but I still think there is pretty good value in the smaller names.

TGR: At The Gold Report we don't get a sense that the average investor is buying gold. Is that your sense as well?

ES: Yes, I agree that very few people have gone there. In fact, one of the funny things about the physical gold market and even mining stocks, for that matter, is that there is not a lot of room for everybody. Almost everything is spoken for. It's not as if gold is not owned by someone already. There is very little produced each year.

When I first got into gold, it was suggested there was a shortage of physical gold, and the only reason the price did not go up substantially then was because the central banks kept selling it. Now the central banks do not sell and you have all these new buyers. I have no idea where this gold is physically coming from. Even the array of gold stocks available to the world is not that large. We are very lucky to be based in Toronto, sort of the gold mining financing capital of the world. Everybody in the world of gold tends to come through here. There is not a big sense of gold mining in the United States for sure, but it's quite a topic in Toronto.

TGR: How likely are we to get into a gold mania if indeed people in some countries aren't even talking about it yet?

ES: You just have to watch the gold price. We are probably at a very significant level right now. Finance people looking at it have to be wondering what is going on. I do not think it is a secret now. You can hardly pick up a financial newspaper where they are not talking about the potential weakness of the U.S. dollar.

TGR: As you say here, we're trading around $1,100 as of this interview. What catalyst is going to come up? I clearly think that India stepping up to the plate, making that buy—frankly, I expected China to do it before India.

ES: If the Chinese come in now, we all have a story. I am sure they will, and/or somebody else will. It is not a lot of money—$6 billion or $7 billion is a drop in the bucket for the Chinese. That could happen. I have always believed there could end up being some problems in the physical market some day, regarding the settlement of contracts. We have these huge concentrated short positions in both the silver and gold on the Comex. There was a day when the price of gold went up $25; those shorts lost $1 billion dollars that day—serious dough now. So there could be things happening in the physical markets.

TGR: Speaking of physical markets, where are premiums on coins these days?

ES: On gold coins it's about 6.5% and around 20% above intrinsic on silver. Wafers and bars are obviously less. If all of a sudden there is a run in coins, those premiums can change pretty quickly. It does vary a lot. There have been times when the U.S. mint is on-again, off-again in terms of output. Regardless we have had significant interest in large quantities and we are lucky that we have always had a substantial inventory of particularly gold Maple Leafs. We probably have $50 million of them in inventory at all times, so we're not likely to run out. Besides, we have great supply sources, and we are constantly replenishing our inventory as we sell—regardless of how high the gold price is.

TGR: And considering your Sprott Money Ltd. enterprise, you're clearly a believer in holding the physical metal.

ES: I am. People should want to have their own physical gold and silver. A lot of them take certificates, but I certainly would never advise doing that.

Eric Sprott has accumulated 35 years of experience in the investment industry. After earning his designation as a chartered accountant, he entered the investment industry as a research analyst at Merrill Lynch. In 1981, he founded Sprott Securities. After establishing Sprott Asset Management Inc. in December 2001 as a separate entity, Eric divested his entire ownership of Sprott Securities to its employees. In December 2004, the Sprott Hedge Fund L.P. won the Opportunistic Strategy Hedge Fund Award at the Canadian Investment Awards. The Sprott Offshore Fund, Ltd. won the 2006 Mar Hedge Annual Performance Award under the Canada-Based Manager category. Eric received the two Ernst & Young awards in 2006—Entrepreneur of the Year (Financial Services) and the Entrepreneur of the Year for Ontario. In December 2007, Investment Executive named Eric Fund Manager of the Year. Last year, the Sprott Offshore Fund Ltd. won the HFM Week's Best Long/Short Hedge Fund award globally. Sprott Money Ltd. is one of Eric's newest ventures. As one of Canada's largest owners of gold and silver bullion, the company's goal is to facilitate ownership of precious metals to the general public.

Want to read more exclusive Gold Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Expert Insights page.

DISCLOSURE:
1) Karen Roche, of The Gold Report, conducted this interview. She personally and/or her family own none of the companies mentioned in this interview.
2) The following company mentioned in the interview is a sponsor of The Gold Report: San Gold Corporation (TSX-V:SGR)
3) Eric Sprott has advanced a gold loan to Yukon-Nevada Gold Corp. This article does not constitute an offer to sell or solicitation to purchase securities of any issuer or any portfolio managed by Sprott Asset Management LP (SAM), including any of the Sprott Funds. Views expressed regarding a particular company, security, industry or market sector should not be considered an indication of trading intent of any investment funds managed by SAM. These views are not to be considered as investment advice nor should they be considered a recommendation to buy or sell.

Andrew Mickey: Are We Headed for a 25% Market Drop?
Source: The Gold Report 11/10/2009

http://www.theaureport.com/pub/na/3261

With anticipated GDP growth insufficient to sustain current market levels, Q1 Publishing's Founder and Chief Investment Strategist Andrew Mickey asserts that great expectations tend to lead to great disappointments. Although he's not foretelling a big crash, he tells Gold Report readers why it makes sense to expect the market to fall back to a fair-value level over the next six months to a year and there will still be plenty of opportunities for those in the right spot.

The Gold Report: In one of your recent articles, you suggest that even if good economic news continues coming out next year, the market is likely to drop 20% to 25%. Would you go through the logic that leads you to that conclusion?

Andrew Mickey: If we look back to the way the stock market has moved over the past 20 to 30 years, it has always been valued relative to earnings. The most common valuation for the market has 15 to 20 times the 10-year average annual earnings. That smoothes out the up-and-down years and brings you to a fair valuation—with the S&P 500 between 800 and 1000.

Granted the stock market goes much higher and much lower than that—and can stay at an extreme for longer than most investors expect—but it always returns to its fair value.

Now that so many stocks have had a great run, the S&P is up to around 1050, which means it is overvalued. The market basically has a lot of positive expectations built in. Earnings estimates are starting to rise, although all CEOs are still trying to keep expectations low. Economic expectations are rising. Expectations for everything are rising and we've learned consistently throughout the years—great expectations usually lead to great disappointments.

So as long as GDP growth is low the market will fall right back to fair value. That's why, even with the big picture news getting better, the very real risk is that it's still insufficient to hold the S&P up at 1050, 1100, or wherever it does eventually top out at.

We may not have an outright crash because everyone is still on watch, but probably a slow, steady fall over maybe six months to a year.

TGR: Are all sectors currently overpriced, or will some continue to appreciate?

AM: There will be some that will appreciate. But it won't be a case of great and greater returns like we've had. There is some great historical research done on the way stocks move. One important factor is the factors of market, sector, and stock. If you break it down, basically 50% of a stock's movement is usually tied the overall market. There's nothing you can do about that; it depends on the market. Another 30% of that stock's move depends on the sector. And the remaining 20% can be attributed to the individual company.

In other words, you can expect the initial impact across all sectors. We see it all the time when the markets go down. Just look at what happened last fall. Everything is very closely tied together. Over time though, there will be the divergence between the quality and value and all the speculative stuff.

TGR: How much focus should individual investors put on international investments versus North American-based investments in this environment?

AM: A lot of it depends on your time horizon. If you have five years or more, you can build a reasonable case for focusing 30% to 50% of your money in international stocks.

That's a very high concentration for any portfolio in any particular sector. If you're looking out that far, you definitely want to be in the emerging markets. In the short term, the falling dollar has been very helpful to some of the really large, high-quality U.S. companies.

But if we look at the massive U.S. dollar carry trade right now, we can see that is going to be driving everything. We watched the Yen carry trade last for about four years and then the credit crunch forcing the sudden unwinding of it. With the U.S. dollar carry trade, it is going be even bigger, could last even longer, and the when it is unwound, the volatility and fear even bigger.

TGR: In another of your recent articles, you said that junior gold stocks offer exceptional value because they're still in the relatively early stages of recovery. With gold up 30%, major gold stocks down 15%, and junior gold stocks down 60%, you asked, "Which one would you like to buy now?"

But with the greatest opportunities for appreciation, don't those juniors also present a correspondingly greater risk? If so, how do you minimize the risks of investing in juniors?

AM: There are two ways. The first is timing and picking the bottom, which is a very tough thing to do. The other is diversification; I'd recommend owning at least five to 10 across the board. In addition, you'd want to buy consistently. The way we see it, we'll be buying gold juniors for the next two years.

We don't want to exhaust all of our capital right away. It's a lot less stressful and you don't have to be exactly right to make a fortune.

Also, when they're still deeply undervalued on a relative basis, you don't have to risk nearly as much capital. So you could make 20% in big gold stocks, but you may have missed 50% to 100% in juniors. The juniors are riskier, but the amount of capital required to earn the equivalent nominal gains is less. Risk is always relative to a lot more factors than simple percentage moves, positions sizes are as equally important.

TGR: When you're looking at juniors, do you differentiate between current producers and near-term producers? Or JV models versus royalty companies?

AM: Most of our valuations are based on traditional metrics such as net present value of future cash flows for producers. Of course, once a company is producing and we know much gold it is producing, there's a clear way to value it through the cash flow model. That's how the big money values things, so that's how you have to do it.

If you really want to swing for something with just a little bit more upside potential, maybe you select a near-term producer. There's a lot more room to value them differently because as the big money managers continue to look at gold, they're going to have to come up with ways to value those stocks.

Think of it like the dot-com days. If a company had earnings, there was a way to value it traditionally. But if a company didn't even have a chance of being profitable, traders and investors would come up with all kinds of ridiculous ways to justify lofty prices and bid them up even more. That's why the worse a company was fundamentally, the better it actually did.

That happens in all euphoric bubbles. And when it does, it will feel great, but that's also the time to start taking money off the table.

TGR: Are any of those on your radar?

AM: One junior gold company I really like right now is in that larger junior tier, and that's Nevsun (TSX:NSU; NYSE.A: NSU). The first two years it produces it will produce mostly gold, and then it becomes basically a copper-zinc mine in the out years. It's fully financed now with debt from European and South African lenders, and Nevsun is comfortable with building a mine in Eritrea, Africa.

So, that one really makes sense to me, and it's really doing well. The stock is $3 now, and the biggest risk I see to it, aside from commodity price risk, is that it gets taken out at around $5 or $6 before it realizes its full potential. In a market like this, that's a risk worth taking.

TGR: Most of those you follow are really exploration companies. Would you share some of those with us?

AM: One that has me really interested is Otis Gold Corp. (TSX:OOO). It has a unique kind of deposit at its Kilgore Gold Project in Idaho. The early exploration results have been good mixed in with the occasional high-grade greatness, but I don't think the market completely understands what it may have at this point.

It's similar to past discoveries in Nevada in that it has small pockets of high-grade gold. Otis has discovered just one of those pockets so far, but that pocket has maybe 500,000 to 750,000 ounces of gold—and that justifies the current market cap of around $15 million excluding everything else.

It's fairly valued at that point if the company stopped all exploration right now and did nothing else. But if this is like the Round Mountain mine in Nevada, which also has pockets of very high grade gold in a large low-grade deposit, has already produced 10 million ounces and with almost 2 million ounces of reserves left.

You never know, of course, but at this point, the company is really cheap based on what is known and there's all kinds of potential. Since we start looking at things with a risk-first approach, we like the low downside mixed with the truly unlimited upside. The company's drilling. The results will be coming out over the next few months. And we'll soon have a better picture, which, at this point, can only add value to the company. It just seems like the right time.

TGR: So the market's basically only valuing the current pocket and there may be several more?

AM: That's what it seems like. There's no premium at all built into the exploration upside at this point.

TGR: You mentioned copper a bit earlier. We always hear about copper as the leading indicator of the market expansion, because building, construction, housing, electricity and durable goods are all very copper-intensive. Timber is apparently emerging as another such indicator, and not long ago, you referred to timber as "the next silver" in terms of its appreciation potential. Do you see timber's prospects greater than copper's?

AM: Copper demand and timber demand are both driven fundamentally by population growth, plain and simple. Where there are more people, they want more things—more copper demand. More people need more houses—more timber demand.

Over the long run, it really is that basic. During the housing bubble, timber shot up to $450 per 1000 board feet, and when the bubble burst, it fell two-thirds to about $150 just like almost every other commodity.

Now it's back up to the $180-$190 level now and still I can't find too many people remotely interested in timber.

It's not that I expect a housing bubble to return. I don't. But 660,000 houses are currently under construction in the United States. But just to keep up with average population growth, housing growth is pegged at 1.2% per year over the next 40 years. That means we need about 1.3 million more houses per year just to meet basic demand for new houses and replacement of old ones. That rebound would justify a lumber price of $250 to $300 per 1000 board feet. That's kind of the long-run average for timber and it'll rebound there over time.

But what timber has over copper is a supply problem that's potentially much more severe. This is caused in large part by the pine beetle infestation in North America. Over the last decade, the pine beetle has decimated the forests in British Columbia, and is now hitting the U.S., as far down as Colorado. Basically, the pine beetle has taken 20% of the future world timber supply off the market. Think about that in terms of other commodities such as copper or oil. If one-fifth of the supply went away, you know we'd see a big surge of demand. Once people start to figure that out, timber assets will really be worth something again.

TGR: Any other areas that interest you at the moment?

AM: As you may know, about 80% of manganese is used in steel production, but there's a new demand for it now in hybrid car batteries. If you like lithium and rare earths, you should look into manganese could be a big opportunity in manganese as well.

In that space, your readers may be interested in a company called Wildcat Silver Corporation (TSX-V: WS). Some of the same people are behind one of our top-performing picks we found February, Ventana Gold Corp. (TSX:VEN). Ventana was actually spun out of Wildcat, which owns 80% of what is basically a silver/manganese deposit in Arizona.

There's plenty of exploration upside there, and Wildcat's net present value is about four to five times higher than its market cap. It's something with the right mix to do well, but it's not going to be one the biggest gold discoveries of the decade, so it will take a little bit of time.

DISCLOSURE: Andrew Mickey
I personally and/or my family own the following companies mentioned in this interview: Nevsun Resources, Otis Gold, and Wildcat Silver. I personally own shares in all of the mentioned companies. You've got to eat your own cooking.

I personally and/or my family am paid by the following companies mentioned in this interview: None.

Andrew Mickey is Q1 Publishing's Chief Investment Strategist. Q1 Publishing provides investors with "well-researched, level-headed, no-nonsense" business analysis and advice that claims to filter out 99.9% of the noise in the financial world to help investors "secure enduring wealth and independence in today's turbulent financial markets." Its products include subscription-only communications such as Andrew Mickey's Prudent Investing and the President's List as well as a free e-letter called Prosperity Dispatch.

Andrew's investment philosophy is based on being prudent (limiting risk without surrendering upside potential), paying close attention to risk-reward relationships and evaluating a variety of asset classes. He searches relentlessly for explosive assets and businesses off the beaten track, traveling often to unearth hidden gems. Over the past few years he has visited Indonesia, the Ukraine, Papua New Guinea, Russia, Mexico, Australia, China, Thailand, Albania, Croatia, Norway and many other places. His research has been featured on CNBC, BNN, BusinessWeek and other media outlets.

Want to read more exclusive Gold Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Expert Insights page.

Victor Gonçalves Favors Juniors to Win the 2009 Gold Series
Source: The Gold Report 11/06/2009

http://www.theaureport.com/pub/na/3240

An avowed Keynesian, Equities and Economics Report writer Victor Gonçalves braces against the economic gale-force headwinds that threaten to whip gold's stellar run into seasonal weakness. But, before the new year, the yellow metal will generally see more strength than weakness, according to Victor, after which "things really get sour." In this exclusive interview with The Gold Report, Victor says he's rooting for the juniors in the homestretch, affirming: "This is the best part about juniors—we're in results season."

The Gold Report: Victor, you and many others were expecting a major pullback in the market and we had some pullback in late October. Is that what you anticipated?

Victor Gonçalves: It's roughly what I expected. It could have gone one of two ways, but technical indicators have been showing that we have one of those triple-top occurrences that cascade on the way down. Preceding that pullback was a broad based rally but it gave a false sense of hope, if you will, in the sense that it wasn't going to go any higher. The TSX, for example, which is mostly what I follow, hit about 11,700 several times and then went down. That's telling me is that we're looking at an interim market top, at least. Whether we're going to have another major crash again now is still in the air. I don't think we're going to have a major, let's say, 50% correction on this dip. I think we might have another shot at a rally before a major correction. And although I do think one is imminent and investors are taking some profits off the table, I haven't seen all the signs a full-up crash this time, and fall-to-winter typically sees seasonal strength. The economic gale-force headwind will be bit of a problem when we get into the seasonal weakness.

TGR: When does the typical seasonal weakness begin?

VG: We see some tax loss selling toward the end of December, and then the Santa Claus rally coming out of that. It's a bit of a whipsaw, but generally more strength than weakness until the early new year, when it won't be so nice. That's when I expect things to really get sour. But I want to emphasize this could happen now.

TGR: When we get to the major downturn, will we retest the 2009 March lows?

VG: The short answer is yes. Based on my model, I don't think we'll break through them. If we do, it won't be by much. This is healthy. It tends to happen. With every major crash we've had, we've had a nice euphoric run after the first major cascading, which happened at the end of last year and the beginning of this year. It depends on which exchange you're looking at, but up until the top of the market we've had, effectively, between a 70% and 90% run. We could see the market correct now in a major way or just a 10%–15% pullback, which we're in the middle of right now.

TGR: How are you playing this market?

VG: I've been really aggressive this year. Right now I'm taking some profits, but I'm not selling everything. I'm keeping strong companies because they will still rally. A lot of companies have stopped or are winding down this year's drilling, and more results will be coming. The strong companies are likely to have better results and are likely to be able to capitalize on them, especially with the capital markets as strong as they have been. I've certainly kept a large enough position on a lot of these strong companies to feel the appreciation of these potential good results coming down the pipe.

TGR: You're a big believer in gold. It's had a pretty good rally this year, starting at about $850 and now about $1,030. Do you still see that going close to $1,200 or $1,300 by year end?

VG: I generally don't want to put an exact timeline because these things never work out as you plan them. Gold is going to have to get comfortable at $1,000. That's what it's been doing. We're going to have to get this comfort level really established and some more economic data before gold can really start taking off.

The price of gold has rallied strongly this year, but really not until the latter half of the year and not until the China effect kicked in. The Chinese government now wants the Chinese people to own physical gold. They're flat-out promoting it. If any one society acts as a collective, it's the Chinese—and when the world's largest population is acting as a collective, even if a small fraction buys gold, that can make a huge difference. This fresh demand is the reason why we have sustainably higher gold prices now. Once that buying really kicks in and has filtered into the full supply-demand equation, we'll get to that $1,200 or $1,300 price point or more.

TGR: Considering the great appreciation we've seen in the junior equities, do you think there's much more upside potential?

VG: Every commodity has a base of equity that trades around it. You've got the copper, silver and zinc stocks that tend to trade reasonably 1:1 with the commodities, depending on whether it's a junior, a mid-tier or a senior company. With gold it acts a little different. The majors trade about 1:1 with gold in terms of price increases and decreases. That makes sense because when you're buying a major, you're basically buying a produced ounce.

However, when you're buying a mid-tier, you're buying a near-term produced ounce, so mid-tiers normally trade at about 0.7:1. Over the past couple of years, the juniors have been moving only about 0.2:1 at best. So, really, zero correlation. Junior equities wouldn't really respond to the gold price, up or down, because junior gold companies don't represent gold, they represent management, land, cash and so on. In other words, they represent a venture that is trying to find economic gold and therefore will trade like a stock and not like gold. So when gold prices are consistently rising, stocks generally don't do well and gold juniors, because they don't represent gold, are no exception unless they actually made a discovery. Now people want to get in on the action of gold, and the best way to is not in the majors; you might as well buy physical gold. The mid-tiers and juniors will see the true appreciation because we have had the equity markets and the gold markets going up at the same time, which doesn't normally happen.

With gold where it is, juniors are more likely to retain equity prices when investors are taking profits. So while the market is treading water or getting these initial stages of a downturn, funds are going to flow somewhere. People are going into something that still has some sizzle and that's the junior golds and some other categories as well. So I still think there's appreciation in the gold juniors as a basket. That said, if the market corrects 50%–70%, everything goes down. When the tide goes out, all the boats come down.

TGR: If an investor's money is in the juniors, isn't it at greater risk in the event of a major market pullback, because these equities aren't as liquid as in the seniors?

VG: Absolutely. Once the market really starts pulling back, the best thing to do is just to go flat out in cash. That's what I will be recommending once I see that market really, truly turning south. There's no point in being in equities when people are selling them. At the moment, there's still money on the sidelines, there's still some money out there for juniors particularly because of the discovery factor that's going on. So as it stands now, juniors are still good to be in.

TGR: And when the market turns up again, investors can be ready and knowledgeable about which juniors are likely to bounce back first. So what are some of the companies that should be coming out with some good news and perhaps some stock appreciation?

VG: My poster boy is Richfield Ventures Corp. (TSX-V: RVC). Anyone who took my recommendation certainly did well because the company not only put out some stellar results, but went from 12 cents to $1.88 in a matter of maybe two-and-a-half months. When I first recommended the company, I think the market cap wasn't even $1 million, so they were certainly a junior at the time. Not every company's going to behave this way, but out of the 15 holes Richfield Ventures drilled, 14 holes had mineralization. That's a success rate of 97%. Very, very good. And half to two-thirds of those were slamming out-of-the-ballpark type results—huge results. Their footprint could host easily 2 million ounces of gold. That is fantastic for a company with all of 14 million shares out. That's a company that still has a lot of legs to it. Next year they're thinking about definition drilling and doing some more exploratory work to the south because they haven't really touched the south part of the property yet. The beauty about this project is that it's road accessible; you can get on there in your car.

TGR: Who else are you watching?

VG: A company we talked about in August was Kent Exploration Inc. (TSX.V:KEX). At that time, I think it was at 7 or 8 cents, and now it's pushing close to 25 cents. It's done quite well, and for good reasons. They've acquired some New Zealand and Australian properties with almost 700,000 ounces of gold on them. They have near-term cash flow of barite, anywhere from $1.2 million to $1.5 million a year. They've drilled their Flagstaff property in Washington State, where they have very high-grade holes that they're trying to prove because these are historical holes drilled in the early '80s. And it's in a safe jurisdiction and all those good things we need in a company. It's well run. Graeme O'Neill (the CEO) is one to spend money where it's required and not do it frivolously, so that's one thing I like about him. His management team is the type to make sure things get done from A to Z. That's what they're doing now. Based on the fact that the company has approximately 28 million shares, it's only a $7 million company with some very nice results coming out. They've done well so far, and still have room to grow. I'm quite eager to see what happens.

TGR: Any others you could share with us?

VG: There are a few other companies that I've looked at that are, again, in positions to do well. We can look at a company called NioGold Mining Corporation (TSX-V: NOX) (OTC: NOXGF.pk) and that's one that I've been following for quite some time. NioGold already has a resource of around 600,000 ounces. They've drilled off a bunch more holes to increase that resource. At that point they've got the ability and the network, if you will, to go to a mining decision if they want to, or there are enough others in the area, such as Osisko Mining Corporation (TSX:OSK) that could very well just buy it out. NioGold is in a good position here at about 24 cents, because they're due to have a resource calculation reasonably soon—sometime in November, I would hope—and that should appreciate the stock notably if they come out between 1 million and 1.5 million ounces.

What else do we have? I was on Otis Gold Corp.’s (TSX:OOO) property in August down in Idaho and that's a company that has 706,000 ounces of gold already at 1.15 grams per ton. This is a historic resource, so it's not 43-101 compliant, but it was drilled off by some very reputable companies so I'm pretty confident in the data. And I've talked to the people at Otis, Craig Lindsay and so on. They're looking to build out a high-grade core, a nice sweet spot and then see if there's more to the low-grade halo. As with NioGold, Otis has a lot of risk that has been removed because they have a resource already and they know where they're going. The geologists who are working on this property are the ones who originally discovered it 20 years ago now they're back on the project as managers. This is a fairly new company, very low float. They've got a lot of their market sizzle still because no one's heard much about it; Otis has that ability to really appreciate in value if and when good results come out.

This has to go back to the thesis that we still have some more time for these juniors to appreciate before the market truly does crash. This is the best part about juniors—we're in results season. A lot of these companies are going to have results coming out over the next month, month and a half and that's really going to make sure that the juniors in the gold space do well as opposed to juniors in spaces where the commodity may not be as much in favor.

TGR: You also mentioned Midland Exploration Inc. (TSX.V:MD) in our last conversation. What's going on with them?

VG: Midland's president and CEO, Gino Roger, is a very good guy. I've run into him a number of times and have had a lot of good conversations with him. That is a company that ought to be on the Discovery Channel, How Did They Do That? This company has very few shares outstanding—23 million fully diluted—is three or four years old and still has $3.2 million in the bank. That, in my mind, is very impressive. By that stage of the game, a lot of companies would have up to 60 million shares out and probably a little bit less money. So Midland's done a very good job of managing their float, managing their money, and it shows in the stock.

It also impressed me in the sense that Midland lost less than 50% of its stock value in the market crash and downturn last year and early this year, when most of their peers lost 80 to 90%. Most of their shares are in hands that they know, too, so the stock doesn't normally have a lot of downside risk, which is kind of built into their share structure. So that's the first thing I think was brilliantly done. Secondly, as a project generator they rarely spend the big money. They spend enough to get the project drill-ready or drill a couple of holes themselves and pass it on to a company with deeper pockets and a mandate to drill off a resource or develop the project. They carry an interest and their shareholders benefit from that.

This isn't a new concept. Quite a few companies do this. Midland just manages to do it well. In addition, they recently made a strategic, very well-placed acquisition of a rare earth element property not far from the Strange Lake area. It's very good because it's right beside Quest Uranium Corporation (TSX-V:QUC), which has a resource on one of their projects. This will be attractive to somebody and that's what joint venturing is all about. I suspect they'll do some work on it, get it ready to drill, pass it off to somebody who will do bigger things with it and the shareholders of Midland will benefit. We can see this in the share price; it's a very beautiful chart.

It is constantly moving up slowly. It's not one of those companies that does a 10- or 15-bagger in a year. But it is a company that's a little more consistent. You can sleep a little easier at night.

All these juniors have risk and to think otherwise is deluding yourself. But this company has a lot of risk taken out just by virtue of their model, by virtue of the way their shares are positioned and the size of their float.

So they've done pretty well since the last time we talked. They made a rare earth acquisition, their gold projects are moving along quite nicely, and this is a company I think everybody should look at.

TGR: Any other juniors that pique your interest?

VG: Sure. Eastmain Resources Inc. (TSX:ER). All I really tell anybody who asks me about Eastmain is, "Buy it and put it away." I talk about very few companies that way, and rarely would that apply to a company that is not a major. Eastmain is nowhere near a major, but they're in great shape. They have a beautiful deposit, over a million ounces of high-grade material at Clearwater. They've had results as high as 75 ounces per ton gold, but the lower grade 1 ounce per ton material is consistent throughout the property. The beauty is it's not just some little core area with these nice newsworthy grades. It's everywhere.

This is very attractive to a major, and Goldcorp (TSX:G) (NYSE:GG) just so happens to be very nearby. So as far as I know, Eastmain will continue to develop their project until it's time for Goldcorp to buy them out. Goldcorp already owns 9.9%. But Eastmain is in a perfectly good position. They've got all weather roads, they've got power lines going to the property, James Bay is right there. So they have all the ingredients and if they wanted to go after this on their own, they could. But they've also got the luxury of being right beside a very interested major. On top of all of this, Eastmain has $17 million in the bank, which is really like having $25 million because for every dollar you put in the ground, you get 50 cents back from the government in Quebec. Very few jurisdictions do that.

TGR: You can't beat that.

VG: Another one worth looking at Mexoro (OTCBB:MXOM). I went to visit their property just an hour outside of Chihuahua Mexico in mid October and was very impressed. This project is really nice, and from what I understand, they've applied to trade on the TSX, which would give it a fair bit more liquidity, a lot more transparency, and a lot more access by the major funds. The company right now has about 1.2 million ounces of gold on the property, grading around 3 grams a ton. That's based on 50 drill holes. They drilled 103, so they're going to update their resource calculation with the balance of the holes plus some more drilling, so we can expect that the resource is going to increase reasonably significantly, I would say, just by adding the rest of the holes they've drilled already. Sometime in early November the mill should be completed and they should be getting into production. Once it's up in full production and ramped up, this company should be producing about 30,000 ounces of gold at a cash cost of around $300. That's very cheap gold, and cash flow is good. I personally like to see a company with a) cash flow and b) exploration upside—and Mexoro has both. The exploration team is one of the best I've seen.

The company is trading at about 40 cents with 50 million shares out. So, really, it's a $20 million company with a mill that is basically complete, a resource of 1.2 million ounces of gold as it stands now, and production once it's ramped up at roughly 30,000 ounces per year. That's all worth more than $20 million, which is why I'm intrigued with this company.

TGR: Any parting thoughts today, Victor?

VG: I'll reiterate that the junior space is a very good place to be because it certainly has the most upside potential. This is particularly the case with the right companies and some of the risk mitigated (i.e., a resource with some production or an acquisition that was done or something else where you don't have to do everything from the ground up). Mind you, if you do get something from the ground up, such as Richfield, you get a big, big return. I would also repeat a caution: We hope we'll see only a small pullback here, and then a continued rally. But it is quite possible that this pullback will be protracted, or will lead into a bit of a crash. It's important to really be on top of the markets to see what they do.

TGR: With those words of caution and optimism, we thank you once again.

DISCLOSURE: Victor Gonçalves
I personally and/or my family own the following companies mentioned in this interview: Kent, Richfield Ventures, NioGold, Mexoro and Midland.

My family has been paid by the following companies mentioned in this interview: Kent.

A proud and avowed Keynesian, Victor Gonçalves developed a strong background in economics at the University of Winnipeg, where he served as a Professor's Assistant as well as earning his degree. His Equities and Economics Report has been accurately picking winners and calling market direction. In 2007, for instance, he correctly predicted the Dow Jones topping 14,000 points and pegged uranium reaching $136 per pound and many more. In addition to EER, Victor also produces the Green Dollar Report , as well as writes for a number of print and electronic publications including CIM Magazine (Canadian Institute of Mining), Western Standard, Barron's and Kitco. He also has been featured on BNN, Mining Industry TV and at numerous industry events and conferences.

Want to read more exclusive Gold Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Expert Insights page.

Jay Taylor Envisions Scary Specter of '30s-Style Depression
Source: The Gold Report 11/03/2009

http://www.theaureport.com/pub/na/3233

Jay Taylor, who publishes Gold, Energy & Technology Stocks and hosts his "Turning Hard Times into Good Times" radio program each week, is hoping and praying for deflation to help the U.S. heal its wounds and find its way back to prosperity. He has reasons to think the dollar might bounce back, too. Nevertheless, Jay reminds The Gold Report readers about frightening parallels to the 1930s and doesn't dismiss the possibility of a hyperinflation that renders the U.S. dollar about as valuable as toilet paper. Although bulls have been charging around Wall Street the past few months, he expects fearsome bears to reemerge soon and feast on equities almost like they did last year. If he's right, he also foresees a "grand buying opportunity" and the potential for "huge upside gains" for savvy investors in some gold mining stocks.

The Gold Report: The last time we spoke, in July, you expected a market downturn this fall. Is that correction yet to come?

JT: I think we're on the verge of that correction, but I'm not so sure it's so much a correction as a resumption of the secular bear market that started with the Lehman Brothers collapse last fall. We saw the first leg down in the market, a bottoming out in equities, in March; then a very strong rally with the Dow going back up past 10,000. And now we're most likely to see a major decline in equity prices. We can only hope and pray that the March lows hold because if they don't, we could be looking at something very, very frightening on the downside.

TGR: So are you thinking we are not out of our recession?

JT: I don't believe we're out of the recession at all. Not if you use numbers that I think are more valid—and those would be numbers from the likes of the independent economist, John Williams, who's been on my radio show. According to his ShadowStats, inflation is grossly understated and hence our GDP is overstated, that, in fact, we've never come out of recession. If you just look around and see what's going on in the U.S. economy—except for Wall Street, which is really more of a gaming industry than anything else—it's hard to make the case that we're back on a growth track.

We've been in trouble for a long time. I would argue that we've been in trouble since 2000 or even before. Greenspan kept the illusion of prosperity going by digging us into debt and creating the housing bubble. Before that we had the dot-com bubble, the telecom bubble. Every time there was a crisis of one kind or another—the Asian crisis, the Mexican crisis, the Russian crisis the perceived Y2K crisis—huge amounts of money were pumped into the system. That all fueled a stock market bubble and malinvestment in companies that had no commercial viability.

If the banks were not borrowing money through the Fed, their reserves would be hugely negative. Their net worth would be negative; they would be broke. They stopped reporting on a mark-to-market basis, so we're not seeing all of the junk in these banks' portfolios now. That doesn't mean it's gone away. So sooner or later, Pinocchio's nose gets longer and longer and you can't hide it anymore. I don't see how you can make a strong case for growth and a continuation of an equity market boom.

There's just no rational reason to be optimistic about the U.S. economy and I think that holds true to a certain extent with the European economy too. I just came back from Singapore and I can tell you, there's a different attitude in Hong Kong and Singapore, where there's lots of action, lots of economic growth and activity.

TGR: How can we be in recession and have inflation at the same time?

JT: We certainly experienced that in the 1970s. In fact, John Williams suggests we're going to have a hyperinflationary depression. In other words, prices will rise like mad, but unemployment will be extremely high. How could that be? Because the United States doesn't produce anything and we have to import everything. Now if you buy the idea of a continued weak dollar, you could see prices going up, up and up. Most people say a good part of the oil story, for example—oil's rise from $35 or so to $80—is the weak dollar. It's counter intuitive, because in the past we've always thought prices should fall in an economic downturn. Normally that's the case. But we have some major shifts going on in the global economy right now because the dollar is losing its value, and that's inflationary.

Another side of me says I'm not sure that that's going to continue and that the dollar could bounce back, but that's another story.

TGR: If the dollar continues to lose value and prices rise because we're importing, wouldn't the law of free markets say we'll start producing things in the U.S. and begin to export?

JT: In time that would happen, but we're seeing more government intervention all of the time and in some ways capital controls are already secretly being employed. We could well see more and more trade controls put into place. But you're right. If prices go up in terms of our currency, assuming that the cost doesn't go up faster, we could start producing things.

By the way, that's what I think we've seen in the last year with the gold mining industry. The price of the metal has risen more than the costs since the Lehman Brothers collapse. That said, it's a lot easier to mine—a lot less regulation, a lot less political interference—in some parts of the world than in the United States. So it's harder to provide that supply to our industry in the U.S. and it's harder for companies to produce those metals in the U.S. than it might be in other jurisdictions. There are all kinds of nuances in different economies that don't allow free markets to work.

TGR: You mentioned that part of you believes the dollar might bounce back. What's your reasoning there?

JT: Just from a contrarian point of view, when up to 94% of everybody in the market thinks it's heading one way, usually you're getting a little heavy in that direction. Robert Prechter talked about that on my radio show. By the way, he is very bullish on the dollar and I think for some of the same reasons that I am. For one thing, as I said at the outset, I think we're going to see another equity market decline. People are getting rid of dollars, trading their dollars for stuff again, and investing more recklessly again.

But I don't see the justification for the price-earnings ratios we're seeing in equities. I think we're going to see another decline in the equity market and in the commodities market as a result, much the same as we saw last fall. If you think back what happened then, the dollar got stronger as the price of commodities weakened, as the equities market weakened. When you borrow dollars and spend them on a stock or a house or a business overseas or what-have-you, you're basically taking a short position on the currency. When you unwind that trade and go back in the other direction, you're covering your short position. You're buying dollars off the market to repay your loans. That's what happened last fall and it could happen again.

TGR: That's not a very pretty picture.

JT: No. That's a very scary reason for the dollar to rise. A better reason would be vibrant growth in the U.S. economy and producing things efficiently. But I think it's this unwinding of the dollar short trade that could really cause the dollar to get stronger.

TGR: Wouldn't we see a corresponding decrease in the price of gold and oil if the dollar gets stronger?

JT: I don't know about a corresponding decrease. If you go back to last fall again, the price of gold did come down in nominal terms, meaning that the value of the dollar went up versus gold. However, the value of the dollar went up an awful lot more versus oil and everything else.

If you look at the relationship between gold and oil from the Lehman Brothers collapse until oil hit its bottom, at one point an ounce of gold would have bought six times more oil than it bought right before the collapse. The point I'm making is that these things don't necessarily go down in the same proportion.

So I believe that this kind of event would be extremely bullish for gold mining companies and for gold itself in terms of its purchasing power. The question is whether paper gains even more than gold. Again, harkening back to my discussion with Robert Prechter, he thinks that paper will be a better investment than gold. But he is also quick to say that gold will buy more than almost everything else.

TGR: What do you foresee in terms of inflation and its effect on gold mining costs?

JT: If we get this pullback in the equity markets, we'll also possibly see a decline in the price of gold in nominal terms. But I think we're going to see a bigger decline in the cost of the inputs of producing gold. Energy can be a very, very big cost factor in certain mining projects. Materials costs went down dramatically last year, as well as energy costs. And labor became much more plentiful when the base metal mines shut down after the copper and zinc and other base metal prices went down; so gold mining costs have come down. They've come up some since the bottom, but of course the price of gold has come up a lot more too since then.

So if the inflationists are right, if we're going to see hyperinflation as John Williams thinks and some of the other people on my radio show have suggested, then gold mining is not the greatest place to be, honestly. But throughout history, the best place to be in a serious deflationary depression is in gold mining. That was true in the 1930s. Bob Hoy, an analyst out of Vancouver who's also been on my show in the past, has provided great insights into this. He's looked into the last six major credit expansion/contraction events, going back 300 years. The first four of those were UK-centric. This one is U.S.-centric and, of course, the 1930s was, too, because the United States has had the world's reserve currency since then.

In each of those environments we've seen the real price of gold surge—the real price meaning the price of gold relative to other commodities, relative to other costs. I've done some number-crunching and if you had only 15% of your portfolio on Homestake Mining in the 1930s, you could have had the rest of it in the Dow (which at one point lost nearly 90% of its value) and basically avoided losing money in the stock market. Homestake was one of the premier gold mining companies from the 19th century until its 2002 merger with Barrick Gold Corp. (NYSE:ABX). So I'm extremely bullish about gold mining given my still deflationary views.

So the good news is that if the economics improve for gold mining, as I suggest they will in a deflationary environment, we will start to produce real wealth again. We'll have real money that has real, intrinsic value. When we do that, those gold miners will make lots of profits. Assuming the government doesn't tax all those profits away, we can rebuild this country on the basis of real money again. That's an optimistic tone from someone who believes deflation is a possibility. But people who think we can keep going along as we have been with fiat money, living beyond our means and thinking we can get rich by printing money and not working hard, must be smoking something funny. Wouldn't it be nice if we could just put on our rose-colored glasses and see the world that way?

But there are lots of good mining companies out there—good companies that are starting to produce gold in many cases, others that are developing viable projects. We've had a bull market in gold for a number of years now, a long enough period of time to allow a lot of money to be put into the ground in exploration and proving out deposits. So I think we're on the verge of seeing a lot of new companies emerge as producers. They will be household names in this bull market in gold—which I think will continue for quite a few years yet.

TGR: Can you share with us some of the companies that you think are particularly good?

JT: One of my favorites is Apollo Gold Corp. (TSX:APG), operating in Ontario. It has a project and is producing at the rate of around 125,000 ounces of gold a year now. The costs are below $400. What's really exciting is that Apollo has staked out a lot more ground in that same area, which suggests they can increase their resource and reserves by many, many fold over the years. That's a stock that's selling at 50 cents or thereabouts. I think it has huge upside potential.

TGR: Any other favorites?

JT: There are quite a few of these emerging companies. Another gold producer I like an awful lot is Hawthorne Gold Corp. (TSX.V:HGC). Always, you know, you go with the people. Hawthorne's management team is headed up by two individuals who were involved with the development of Eldorado Gold Corporation (NYSE:EGO; TSX-ELD) and Bema Gold Corporation, two well-known and successful gold mining companies. (Kinross Gold Corp. [K.TO; NYSE:KGC] acquired Bema in 2007.) I think they're going to have their third success story in Hawthorne.

They should be producing gold on a small scale at Table Mountain in British Columbia, where they have a fully permitted mine and mill. They also are finding some lower grade open pit gold, with pockets of very high grade, which they probably can combine with very high grade underground material from Table Mountain along with the resource from the Taurus deposit, which is next door, to feed the mill. So Hawthorne is another favorite, another penny stock that could evolve into a big growth story.

TGR: Any others?

JT: San Gold Corporation (TSX-V:SGR) is another favorite of mine. Stock's come off its highs here. We could see some more weakness in all gold shares in the near term, but that's going to pave a fantastic buying opportunity. San Gold is producing in Manitoba from the Rice Lake property. Right next to it they've got the Hinge deposit and assays from parallel zones there are looking like extremely high grade material. They should be feeding in this higher grade material, blending it with the lower grade deposit from Rice Lake. Underground in the Rice Lake Mine they've recently come up with some very high grades, too, so that's the story I think is going to be very, very much in the market. People are going to start paying more and more attention to San Gold.

Another one I like enormously is Allied Nevada Gold Corp. (TSX:ANV) (ANV). It has a large scale open pit resource, but huge underground potential. Many, many millions of ounces of gold and huge exploration potential. There's a metallurgical issue in terms of how much silver is in that property, but if they're able to extract more than 10% or 20% silver recoveries, their costs go way down and this becomes hugely profitable. But enormously prospective, huge exploration potential. Another company that should be producing north of 100,000 ounces a year. So those are some ideas.

TGR: Great list. Any more?

JT: Romarco Minerals (TSX.V:R), which is based in South Carolina, has just come out with a new resource. I think they're above 4 million ounces among the various categories of resources. Romarco's open pit deposit in the Haile Gold Mine is probably at least a couple of years away from production, but it's a world-class deposit. The company's stock has risen very dramatically, and I think it has a long way to go on the upside.

If we see a general equity market pullback, I think you're going to have a grand buying opportunity with these companies. I'm watching them very carefully, watching the fundamentals. Companies like this—developing viable deposits in the ground—are in a position to provide huge upside gains for savvy investors.

TGR: Terrific.

JT: AuEx Ventures Inc. (TSX:XAU) in Nevada is another one I like a lot. AuEx is what you call a prospect or a project generator. It has some really smart geologists, has staked some highly prospective claims, did some initial work on those claims, and now has other companies spending their money to drill in and gain a percentage of the deposits and of the joint venture projects. AuEx is on to at least one, possibly two, very major discoveries in Nevada and also has a host of other properties, mostly in Nevada, with good longer-term prospects.

In a way, AuEx is sort of the lowest-risk way for individuals to play the gold shares. The risks are lower because AuEx is not spending huge amounts to explore and develop, so they don't have to dilute shareholders' interests by going out to raise huge amounts of capital. I like the management, too. It's an extremely strong management team there, headed by Ron Parratt.

TGR: Are you scoping any silver plays in particular?

JT: I'm not as bullish on silver, generally speaking. I just think it's harder for silver companies to make money, in part because silver has not kept up with gold. If we go into an inflationary environment and this deflationary notion is wrong, then you could see silver outperforming gold. In that case, there is one company on my list that I like quite a bit. It's Great Panther Resources (TSX:GPR) and it's in production in an old historical mine in Mexico—the Guanajuato Mine—which has huge amounts of silver left to be mined. I visited the property, was in the mine, saw the community a couple of years back. Bob Archer, who heads up Great Panther, is doing a remarkable job of cutting costs and lowering the cost of production. If you're going to buy a silver stock, that one is worth a serious look.

TGR: Any last thoughts you'd like to share with our readers?

JT: Just that I think we're approaching some very difficult times in the equity markets now. I could be wrong, but I just sense that we could have a severe pullback. The bear market for stocks began last fall and it is not over. Maybe you can make a case using government numbers that we're technically out of the recession, but I don't buy it. In reality, unfortunately. I wish that weren't the case.

I really look back at the 1930s—the first leg down in 1929, when the equity market was the one getting all the media attention. After a big wave up, everybody thought it was all over, the worst was past. People got suckered back into the stock market and there was lots of optimism, just as we're seeing now in this equity market. Then the big one came. Why did it come? Because there was no growth in the economy. There was nothing to support the equity prices and there was lots and lots of debt that could not be repaid. I see a replay of that in many ways.

There is increasing tension among trading partners now, but a lot of it is more subtle through this beggar-thy-neighbor currency devaluation. Countries cheapen their currency, hoping to be able to export more and get an advantage over their trading partners. When everybody starts playing that game, you have a real problem and prices keep falling.

I think today's parallels with the 1930s are much closer than people recognize and that's partly by design. Policymakers don't want people to think in those terms because if they do, it becomes a self-fulfilling prophecy. If people think we're heading into a deflationary depression, why would they buy anything today? They want people buying things. But consumers can't buy because they're broke. The government can buy because it can print money, but how long can that continue if the rest of the world doesn't want your money anymore?

These are questions that are in my mind. But I do think we have some very turbulent times in store and this debt is really strangling the American economy. I remain tipped toward the deflationary side, but I want to be nimble and ready to change my thinking. For that reason, I put out my Inflation/Deflation Watch (IDW) and look at it every day to try to get a sense of it. We shall see.

DISCLOSURE: Jay Taylor
I personally and/or my family own the following companies mentioned in this interview: Apollo Gold Corporation, Hawthorne Gold Corp., San Gold Corporation, Allied Nevada Gold Corp, Romarco Minerals Inc, and AuEx Ventures.

I personally and/or my family am paid by the following companies mentioned in this interview: None of the companies mentioned herein pay either myself or my family. However, the following companies are sponsors on my radio show, Turning Hard Times Into Good Times: Apollo Gold, Hawthorne Gold, and San Gold. As such they pay a sponsorship fee to Taylor Hard Money Advisors, Inc. of Turning Hard Times Into Good Times.

As he followed the demolition of the U.S. gold standard and the rapid rise in the national debt, Jay Taylor's interest in U.S. monetary and fiscal policy grew, particularly as it related to gold. He began publishing North American Gold Mining Stocks in 1981. To better understand the potential of the mining stocks he researched, Jay added a BA in geology to his CV in 1988. He already had a master's in finance. A native of Ohio, he migrated to Wall Street in 1973, working first at Barclay's Bank International. He was with the ING Barings mining and metals group when, in 1997, he decided to pursue his avocation as a new full-time career—including publication of his weekly Gold, Energy & Technology Stocks newsletter. This year, he debuted a new radio program, "Turning Hard Times Into Good Times."

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