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Jack Lifton: Safeguarding Our Future Supply of Rare Earths
Source: The Gold Report; interviewed by Karen Roche, Publisher 12/11/2009

http://www.theaureport.com/pub/na/3394

"Price may not be as important as security of supply," says Jack Lifton, an independent consultant with more than 45 years of experience in sourcing nonferrous strategic metals. In the U.S., our dependence on rare metals is undermined by the simple fact that we're not producing any. Given that China now controls 95% of these 'technology metals' and the world is projected to eat 200,000 tons of rare earth metals near 2015, Jack tells The Gold Report we need to jumpstart our own domestic supply chain and, more importantly, build the refineries to process them—rather than sending them to China for refining, which is our only option currently.

The Gold Report: Jack, we hear you're starting on a documentary, "On the Green Road." Tell us a bit about it, and what you mean by "Green Road."

Jack Lifton: I came up with that title because no matter what the attitude of the individual is towards being "green," there really isn't any other path for us now. My proposed documentary "On the Green Road" will follow the path that a rare earth metal takes from the mine to the market, so that the consumer can see the necessary steps required to make the technological devices upon which our quality of life depends. If the Green Road is the path to the future we need to get on it and stay on it right now.

Six hundred million people in the Western world are enjoying a life increasingly dominated by technology that we don't understand. In particular, we don't understand how it is made. What I see in America is a reluctance to admit that the green road starts in the black earth. We have to mine and refine the minerals and metals into forms which can then be fabricated into forms which can then be made into parts which can then be assembled into the technology devices we use to conserve energy. Everything starts at the mine or at the oil or gas well.

In the West, electronic devices using electricity produced by a huge network of generating devices control our transportation, communication, and our environment. We've got a grid that we talk about as if we understand it, but it's an extremely complicated system. We ignore the fact that we produce and distribute oil and its by-products, metals and their compounds and alloys. Nobody pays attention to that. All we do is say we've got to stop doing this and stop doing that. We have to start educating everyone as to how a metal becomes a radio or how a metal becomes a battery, how a battery propels a car.

TGR: I heard you speak recently at the Hard Assets Conference about supply issues in terms of expanding wind and solar technologies. Can you explain some of those supply constraints?

JL: Yes. In the United States, Canada, and Western Europe we are consuming most of the supplies of the technology metals. Now we're facing six billion people in the rest of the world whose standard of living is growing rapidly and we do not have ten times the amount of materials used to create the good life in the West to create the same standard of living for the entire world.

I don't mean to be a doomsayer, but if the Chinese government wants its own people to have the standard of living that people in Los Angeles have today, it's going to mean that China must use all of its own natural resources to improve its standard of living and its quality of life, which will mean that our standard of living will have to decline. Why? Because there are some materials—for example, the rare earths—that China controls 100% of the supply of today. And as China's economy is growing, China is requiring more and more of these materials for its own domestic economy.

Ten years ago China exported 75% of its production of rare earth metals to the rest of the world. Today it exports less than 25%, even though the production in the last 10 years has more than doubled. So that should tell you what's going on here. This is not a conflict. This is economic reality.

Now I'm using the rare earths as an example of something I think is very much misunderstood in the West. The rare earth metals were originally discovered in Europe and originally produced commercially en masse in California. The largest rare earth deposit in the world of its kind was discovered in California in 1947. It was put into production and by 1984 that site, Mountain Pass, California, near the Nevada border on M-15, was producing 35% of the world's rare earth metals and 100% of the domestic needs of those metals here in the U.S. That was 25 years ago. Today that mine is producing nothing and approximately 95% of the rare earth metals are today produced in the People's Republic of China. The United States imports all its rare earth metals from the People's Republic of China.

Why? Because between 1984 and 2009, Chinese production of those metals ramped up to the point where the Chinese decided to lower the price so that they could sell more metals so they could mine more metal and employ more people. They basically were able to sell these metals into the market, including to the United States, at a price less than the cost of producing it in California. Well, if you believe in a global economy, then you say, that's how capitalism works.

There are now other issues arising besides price, which is what shut down the Mountain Pass mines. Price may not be as important as security of supply. Do we really need rare earth metals to maintain our style of life? We cannot force the Chinese to sell them to us. The Chinese have an internal priority to develop their domestic economy. China's issue is the need of the Chinese economy to grow and to improve the quality and style of life of the Chinese people. We have become so dependent on rare metals in general and rare earth metals in particular in our technological economy and at the same time we've simply ignored the fact that we are not producing them in the West.

TGR: Doesn't the U.S. have plenty of metals? Why aren't we supplying more of what we need?

JL: The United States has the largest distribution of different metals and minerals of any country in the world. The National Mining Association, on their website, nma.org, shows that we have 76 minerals and metals in the United States in sufficient quantity to supply our needs. However, in the last 10 years we have lost our self-sufficiency in between 14 and 25 metals and minerals. Not that we don't have them, but that we don't produce them.

The reason for this is that we have been going global in our economic outlook. For example, Chile produces 25% of the world's copper. Well, the United States was always self-sufficient in copper. Now we're not. Now we're beginning to import copper because it's cheaper to buy Chilean copper than to keep mining more of it in Utah. The U.S. was always self-sufficient in iron. Today we import 30% of our iron ore to make steel here because it's been, up till this moment, cheaper for us to do this than to produce it here. But now something new is happening. The demand in the rest of the world is increasing at such a rate that the United States must, for the first time in its history, compete.

We need to produce wealth here and not just consume it. One way we can produce wealth is by reactivating, for example, the rare earth mines we have and by starting new ones in the United States and North America. If we don't start producing our own critical and strategic metals and minerals, we're going to find that our industry, and anything we want that uses those materials, will be made in other places such as China. We'll be at the mercy of those economies as to whether they have a surplus to ship us. China is a dynamic growing economy, which has four times as many people as we do and maybe 20% of our GDP. So, on average, they're way behind us, but they're growing and they are consuming their own production of energy, minerals, and metals and they do not believe that they must export those things to us, either as raw materials or finished goods if there's a Chinese demand for them and they're trying to increase Chinese demand.

TGR: So North America, the U.S. in particular, has a wealth of these minerals within their own borders. When does the price either get to the point that you get miners who now say, hey, I can make money by mining these rare earths here or the government comes in and decides they're going to subsidize the exploration and the initial development of these mines?

JL: I don't know. I'll tell you what the real problem in the United States is. These industries are too small to return a profit in a short time. In other words, if you look at a rare earth mining opportunity in the U.S. like Molycorp, or a newly named company, U.S. Rare Earths (both privately owned), you have to think, well, it'll cost how much to develop the mine and how much does the product sell for. If you want a return on your investment in one, two, or three years, mining isn't the place for you. So, yes, in order to get mining going, the government has to subsidize it. That's absolutely correct. Or you have to assemble something new in the United States, which is a vertically integrated company.

TGR: At the conference there were companies claiming to be either producing or almost ready to produce these rare earth metals. Will that solve the supply issue?

JL: The problem is it'll solve the issue of the first step in the supply chain. We'll have the mines in North America producing the concentrates we need. But those materials then need to be refined and purified into the pure metals. Then those metals need to be made into fabricated forms that people who make magnets, electronics, cars, and batteries can use. Then those devices have to be made from them and put into products that ultimately wind up in your driveway, in your drawer, in your purse, in your pocket. The problem is we have yawning gaps in that supply chain in the U.S. The fact is if we were producing rare earth metals in North America today, those ore concentrates would go to China for refining. We do not have any refining capability in the United States today. It's all been shut down.

TGR: So these companies who are mining this will not be able to refine it?

JL: That's right. Those companies, in the tradition of mining, have a plan to dig up the ore, remove everything but the mineral—that's called concentrating—then in the case of rare earths, they'll probably separate those minerals into the constituent forms of the individual metals, the oxides or whatever end form. And then they stop.

Now the next step is to take those individual metal concentrates and make them into metals. Let's say we're talking about neodymium. We take the neodymium. It will come from the mine in the form of an oxide. You make it into neodymium metal. That's usually one company. And then another company will make special alloys of neodymium iron and boron, for example, to make magnets. What that company will do is they'll supply it to a magnet maker. The magnet maker will do their work on it and make it into a magnet. The magnet will then go to a generator producer or a motor producer or a speaker producer or computer hard drive producer and they'll use the magnet as a critical part of some end use product, which will then end up in the shop that you'll buy it from. That includes a car, a computer hard drive, a laser, things like that. What we don't have in America are any of the steps beyond concentrating the ore. That's the problem.

TGR: So, at this point we aren't concentrating the ore because we're not currently producing rare earths?

JL: That is correct. We are not currently in North America producing any rare earth ore at all.

TGR: So having the capabilities to refine if there's no production here is somewhat irrelevant.

JL: We have one refinery running at this point, which is Mountain Pass, California. It's still working off concentrates last produced in 2002 and they restarted the refinery. Mountain Pass is producing two tons of neodymium praseodymium every day, which is a commercial form that needs further work and, also, four tons of lanthanum. Both of those products are produced as oxides and those materials go to their customers, one of which is in Japan and the other one they didn't state. Let's put it this way. Nobody in the United States today has the capability of taking those materials and making the pure metals from them. So that is today almost entirely done in China.

TGR: Would Mountain Pass have the ability to either scale up what they're doing now?

JL: Yes, but it will take years and a lot of money. Mountain Pass—it's Molycorp—has announced that they plan to produce the metals when they resume mining, but they need to build a rare earth metal refinery and get it going. So we're talking about a lot of money and a lot of years because no one in the United States has made those metals for some time. We have people here with the skills, but there's been no demand for it because China now dominates this.

This is why I'm saying you can view success as bringing ore out of the mine, concentrating it and separating it into its individual materials, and the next step is refining that material. One of the biggest problems I have with the mining industry is they don't plan ahead. They don't have a marketing plan.

When I look at a business model for a mining venture, especially in something like rare earths, I look for a mine-to-market venture such as Great Western Minerals Group (GWMG) has. Great Western owns a magnet alloy producer in Great Britain called Less Common Metals Ltd. of Birkenhead, U.K. When I say magnet alloy, they make neodymium iron boron, they make samarium cobalt. Those forms, those base alloys go to people who make magnets. Some of it goes back to China. Some of it goes to the U.S. Some of it goes to Europe. But they're the only vertically integrated rare earth miner that I'm aware of outside of China. So when they start producing, they are planning to build a refinery next to the mine at the same time that they're developing the mine. The goods from that operation will go to a metal producer, which will be theirs, probably in the U.K. Then their U.K. operation will produce magnet alloy, which then goes to magnet makers. Having control of just those steps in the supply chain gives Great Western on paper enough margin, enough profit from producing the metals to show an excellent return on investment. The bankers I've talked to and institutional investors are thrilled with this model.

I am not saying that Great Western can supply the world's needs. I'm saying in my opinion, they'll be the first rare earth producer outside of China to produce heavy rare earths economically. That means that because of what they can do, they hope to be able to produce total rare earth production of 2,500 tons, I think, in three or four years and then maybe 5,000 tons a year after that. In a world that is projected to eat 200,000 tons of rare earth metals by 2015, you can see that's not a lot. But it'll be disproportionally high in the heavy rare earths and they'll be able to sell everything they're mining. They can't produce any more than that. That's what they've got. Because they're going to be the first past the post, they will get a lot of attention and they'll probably get financing. But, more important than that, that's going to make it easier for the other companies that can produce much more to get into the market.

I think the second producer will be Avalon Rare Metals (TSX:AVL), which by sheer volume in size, swamps Great Western. Keep in mind that Great Western's product is not going to be rare earths. It's going to be magnet alloy and Avalon can't compete with that. Avalon is going to produce huge quantities of rare earths ultimately. They have one of the largest if not the largest rare earth ore body on earth in Canada. But they won't be the first to produce. Once Great Western is producing and once the supply chain is reinvigorated in North America, that's going to bring all of these other guys and you're going to have in the next 10 years, in my opinion, four to six producers of rare earths in North America and no more than that. Maybe there's 85 companies, but you're going to have just four to six produce.

TGR: So you say there are four to six producers of rare earth in the next four to five years. You've mentioned Great Western, Avalon. Who else is teeing up to get into that production place?

JL: There's Molycorp. There's Lynas Corporation (LYSCF:US) . I would say there's a good shot for the company U.S. Rare Earths (which I mentioned earlier) in Idaho, Colorado, and Montana. Please note I consult for U.S. Rare Earths. I've been looking at those deposits for several years. They're very nice deposits. It's a junior. It's just now they're trying to raise money to do a pre-feasibility study. So it's very early on. U.S. Rare Earths is a player in the long term because of the accessibility and size of its deposits. But in our immediate time frame, it's Great Western, Avalon, Molycorp, Lynas. That's it. Quite frankly, Molycorp is really a restart. Molycorp's mine holds the record. It was the world's largest producer of rare earths, 20,000 tons a year in, I believe, 1984. No mine today existing or projected has ever approached that output. China's production of 124,000 tons comes from 40 mines, the biggest of which I think is 10,000 tons. Molycorp is a huge deposit. It's 9.5% ore, 30 to 50 million tons.

TGR: How much of that deposit remains after being extracted for so many years?

JL: About 99%. They have just touched the surface of that; it's so huge. Molycorp's distribution of rare earths maximizes cerium, lanthanum, neodymium, the so-called light rare earths. But in order to make modern technology devices that operate at high temperatures, we need the heavy rare earths, dysprosium, terbium, europium. The Canadian deposits are disproportionately rich in the heavy rare earths. I don't mean that they're running over with it; whereas, in Molycorp, basically, dysprosium and terbium are non-existent.

In Avalon and Great Western deposits in Canada you have as much as one or 2% of the total rare earths would be the heavy rare earths, which is very, very high. Great Western has one mine where the heavy rare earths make up 8% of the total. It must be the richest heavy rare earth mine in the world. It's a small ore body, but it can be produced. The point is we need an American producer like a Molycorp or a U.S. Rare Earths and we need a Canadian producer or we need the Australian Lynas, which also is only in the light rare earths and a Canadian producer. We need these kinds of combinations.

I have been doing due diligence consulting for Canadian institutional investors, and I can tell you that they are only waiting for the production of the rare earths to begin at either Great Western or Avalon to support them substantially. I always say to a banker, would you guys please buy Avalon and Great Western and Molycorp and make one company and they say to me, yeah, we will as soon as somebody starts producing. And they're not joking. It's logic.

TGR: Jack, is the supply situation with lithium similar?

JL: It's actually quite different. The world is in over-supply of lithium because the hype on lithium was much more than the demand. So there is no shortage of lithium. The problem is that the six largest producers of lithium today are telling us if we want more lithium, we have to pay. They will not use their capital to massively increase the output of lithium when there's no demand. That's foolish.

TGR: What about tantalum?

JL: The amount of tantalum sold in this world is tiny; there's no market in tantalum. Here's what I'm predicting is going to happen. Those end user companies for which the rare metals are critical are going to create a virtual hedge market. Today you can only hedge materials that are exchange traded with transparent prices, so you have to create a virtual hedge for the rare metals. But if Honeywell were to say to Commerce Resources Corp. (TSX.V:CCE) (PKSHEETS:CMRZF) we'll buy $250 million worth of tantalum from you for delivery from 2015 to 2020 and here's our guarantee of payment, Commerce then goes to Toronto Dominion and says, look, we've got this. Toronto Dominion says we could discount that for you right now. How about if we give you a facility of $225 million and you start building that mine?

I don't know if it's going to happen in the tantalum industry, but it's going to happen in one of these industries sometime in the next 12 months. Some big company is going to say we've decided to take a risk. So if the U.S. government says, for example, we'll cover you—in other words, the Defense Department is going to give you the order for the machines from 2014 to 2020 and it guarantees payment, then you issue your guarantee on the off- take, the bankers are willing to work with that and so is the Congress. I've been involved in these discussions already. We need to get this done. In other words, off-takes are a great way to get buy-ins kick started. It wouldn't surprise me if something like that happened with Commerce Resources, or Molycorp, or Great Western.

TGR: Jack, this has been great. Any closing comments?

JL: We need to safeguard our future. I'm not saying take the future back, beat the Chinese. We can't do that. We need to safeguard our standard of living, not our lifestyle; our standard of living. If we don't stop the outflow of our wealth to overseas, we're going to decline and we can see it already. We now have to adapt and understand the Chinese are doing it right; we're doing it wrong. We have to do long-term thinking, secure our supplies of raw materials, maintain high productivity and efficiency. Otherwise, we're just going to be stop on the world economic train.

Jack Lifton is an independent consultant, focusing on the sourcing of nonferrous strategic metals. (View videos featuring Lifton on strategic metals.) His work includes exploration and mining, and the recovery of metal values by the recycling of not only metals and their alloys but also of metal-based chemicals used as raw materials for component manufacturing. Mr. Lifton has more than 45 years of experience in the global OEM automotive, heavy equipment, electrical and electronic, mining, smelting and refining industries. His background includes the sourcing, manufacturing and sales of platinum group metal products, rare earth compounds and ceramic specialties used to make catalytic converters, oxygen sensors, batteries and fuel cells. He is knowledgeable in locating and analyzing new and recycled supplies of "minor metals," including tellurium, selenium, indium, gallium, silicon, germanium, molybdenum, tungsten, manganese, chromium and the rare earth metals.

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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: Avalon Rare Metals Inc. (TSX:AVL, OTCQX:AVARF) and Commerce Resources Corp. (TSX.V:CCE) (PKSHEETS:CMRZF)
3) Jack Lifton: I personally and/or my family own none of the companies mentioned in this interview. I am a consultant to U.S. Rare Earths.

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Disclosure: 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: Avalon Rare Metals Inc. (TSX:AVL, OTCQX:AVARF) and Commerce Resources Corp. (TSX.V:CCE) (PKSHEETS:CMRZF) 3) Jack Lifton: I personally and/or my family own none of the companies mentioned in this interview. I am a consultant to U.S. Rare Earths.

Sprott's Oliver & Horvat: Hard Assets Should Continue to Appreciate

Source: The Gold Report; interviewed by Karen Roche, Publisher 12/08/2009

http://www.theaureport.com/cs/editors/print/na/3384

The devil will be in the details of the balance sheet when hyperinflation hits. And while lots of companies have been using leverage to drive their ROE (and their stock prices), the structure of their debt may spell the difference between prospering and perishing. Those with low-interest debt that's locked in for a long spell actually will be poised to retire their obligations with cheaper dollars. But woe betide those stuck with floating rates. That's how Sprott Asset Management senior portfolio managers Charles Oliver and Jamie Horvat see what's brewing beyond the horizon, when time comes to pay the price for running the money-printing presses too hot and too long. As Charles and Jamie suggest in this exclusive Gold Report interview, investors who base decisions on the strength and structure of the balance sheet may not do too badly. In fact, they explain how the stock market itself may serve as a hedge against hyperinflation.

The Gold Report: A lot has happened to influence gold prices since the last time we spoke with you in June. India and Russia started buying bullion, which helped increase the prices. Now, the news from Dubai has put some downward pressure on prices. What does all of this mean for the gold sector?

Charles Oliver: In terms of central banks buying, it's very positive. You mentioned India, which just bought a couple hundred tons from the IMF. Sri Lanka also bought 10 tons, and Mauritius bought two tons. We've also seen the Russians buying and there's talk of China buying more—after the 400 tons they added in April.

So we're seeing some very positive fundamentals on the demand side of the equation. The last decade the central banks have been net sellers. It looks as if maybe over the next 12 months central banks will be net buyers, which is a completely turnaround.

I am not going to make too much out of Dubai and its implications for the gold price. We saw a small correction in every asset when the news came out. Everybody sold a bit of everything; I think that was just a knee-jerk reaction. If you look at the chaos in the financial markets, gold is actually a safe-haven area.

Jamie Horvat: The only thing I'll add is that it appears gold is reasserting itself as a currency, instead of being viewed solely as a commodity.

As far as Dubai goes, as Charles said, short-term it looks as if a lot of people got spooked in the market and started taking profits. Gold, obviously, has been pretty profitable year-to-date and we saw a couple of days of selling where people got nervous and wanted to lock in their returns. But that panic selling seems to have ceased.

TGR: Most people expect that all the money printing that's happened is going to lead to inflation—or worse. What's your view on that?

JH: Our view is moving more toward the probability of hyperinflation as governments have actually stepped up their stimulus programs and their deficit spending.

TGR: Let's define hyperinflation. Everyone knows it's big inflation, but what does that mean?

CO: The dictionary gives no fixed definition, but one of the best descriptions I have heard is that hyperinflation is an inflation in which the rate is measured in months or days rather than years. In my mind, if you're running at 50%, you're basically there. But again, there is no absolute number.

JH: One of the other things we've come across and talked about in the past is the aspect of monetary debasement or monetary inflation, where there's a definition for hyperinflation we came across stated as very high or out-of-control inflation due to currencies rapidly losing their value resulting in rapid price increases for all other goods.

TGR: So it's not necessarily the Zimbabwe type of hyperinflation, but something that certainly North America hasn't seen.

CO: Just after the Civil War, the U.S. did go through a period of hyperinflation. Everyone on the planet has at some point basically experienced hyperinflation. And that includes the Chinese; I believe it was around 1945 they went through a period of hyperinflation.

TGR: But this time you're looking at this potential hyperinflation as being a worldwide phenomenon—not one country at a time.

CO: It all depends on what the individual governments do. Right now, many of those countries are continuing to expand their monetary base. They're spending money left, right and center. Governments that continue to expand the monetary base at an increasing rate will share in the hyperinflationary phenomenon. Not every country's going to do that, and we ultimately don't know how it will unfold but as Jamie mentioned, we are seeing a lot of signs that governments are continuing to spend vast sums.

Just as an example, the U.S. is spending a huge amount this year. The healthcare program is going to cost them more money. The demographic story that's going on out there, as people retire, Social Security payments will increase while the tax revenues decrease. The Prime Minister of Japan and government bankers there are reportedly having discussions about quantitative easing, which, again, quantitative easing is printing money. The Bank of England has embarked upon a huge program of quantitative easing. Those governments that are going to ultimately pay the price.

TGR: In our last conversation, you mentioned that stock market studies suggest one of the best ways to protect your assets is investing in the market. Can you elaborate on why that works? And whether it would work in a hyperinflationary environment?

CO: If you go through a period of hyperinflation, the worst thing you can own is cash because it becomes worthless. You want to own assets that will protect you against inflation. Gold is one of the simplest things that we all talk about as protecting against inflation. But interestingly enough, if you go back to Weimar Republic, Germany and if you look at the Zimbabwe Stock Exchange a few years ago, the stock exchanges actually acted as an inflation hedge. That's because many of the companies on the exchanges actually pushed through price increases on their end products. Hence, during a hyperinflationary period, these companies were selling their products for much higher year after year after year and their prices went up to reflect that huge increase in earnings. The huge earnings increases were not the result of improvements in productivity or expanding and growing their companies. It was based purely upon the inflated prices they charged for the goods they were selling. So, yes, the stock market can be a very good hedge against hyperinflation as well as inflation.

JH: I'd argue that the stock market is potentially taking on this role already. It may be starting to act as an inflation hedge, as discussions have been coming out of China, Japan, Russia, and even the recent Fed minutes talking about the low interest rate policy in the U.S. and the U.S. dollar as potentially the new carry trade, resulting in this inflation of assets bubble globally. If you can borrow money at prime less 25 or 50 basis points, or essentially for free if you are one of the big U.S. banks that received a bailout, and can put that to work in the market to buy stocks and assets forcing prices up, or you can earn a yield spread, then under these circumstances, I would argue—as many central banks have stated—that this free money is causing the market to act as an inflation hedge.

CO: Just a small counterpoint to my partner in crime. . . . At the beginning of this year, we thought hyperinflation would happen several years out. With the market performing as well as it has, it's a bit of a conundrum with our belief of where we think the market should be valued. Jamie correctly points out that you can explain this by talking about it acting as a hedge against inflation or hyperinflation. But to some extent, my own personal view is that the big movement in stocks will be several years out, and that's contingent upon the governments continuing to expand and spend money at an increasing rate.

People always ask what the risk is to your expected outcome. And the risk is that at some point in time, some of these governments will start to get religion. If you go back to the 1970s, the U.S. was going through a period of huge stagflation. And then one man sort of stood out of the crowd—Paul Volcker. When he got religion and raised interest rates and did the right thing, people absolutely hated him. We look back now and say, "You know what? He stood up; he did the right thing. The U.S. was in a much better place and continued to be a very stable and good environment to invest in, to grow in." So that's the one risk, that there's another Paul Volcker out there who steps up to the plate.

JH: One counterpoint to my earlier argument about the market acting as a carry trade, as Charles said earlier, the thing you have to monitor when you look globally, is the U.K. still has a negative GDP number. The U.S. recently revised the third-quarter number down from 3.5% to 2.8%. Look at Canada. Look at Japan. There's no growth without government stimulus.

So if governments rein in or pull back the stimulus spending or someone gets religion and bumps interest rates 25 basis points, we could easily set up for a double-dip scenario or double-dip recession because the consumer is dead. And without the incentive to spend there is no consumer spending and growth.

TGR: If you're looking at investing in 2010, it sounds like the hyperinflation issues will happen several years out, and in the largest consuming nations we continue to have government expanding the M1 to provide stimulus, which will keep the market growing because the market is going to grow as a hedge. So should we take advantage of the market hedging potential inflation in 2010, and then bail out when we see hyperinflation on the horizon?

CO: We spend a lot of time trying to figure out how next year will unfold. It's a very tough call. Having said that, as long as Ben Bernanke says for the next 12 to18 months the Fed will keep rates low, you could see the stock market show some strength. I think as the market goes higher, the risk of a downturn increases because a lot of the growth in the stock market is people paying higher multiples for earnings.

If you look at the economy, we still have a very weak consumer and very weak earnings growth. A lot of it is a result of cost cutting, and there comes a point where you just can't cut any more costs out. Hence, you may see the stock market continue to go up, but I think the risk is significant that we see a double-dip recession, and as soon as the market catches a whiff that rates are going to start increasing, it probably will take a very big knock.

Again, we don't know exactly how and when that will happen, but we do see the market getting more and more expensive. So I think you'll want to tread very carefully, because there's a significant risk that at some time in 2010 the economy may go back into a double-dip recession.

TGR: Will it be as dramatic as the one that started in 2008?

CO: I don't think so, but it depends on how things play out. If you see the market get really, really expensive and continue upwards, it's going to have to come down further. My personal view is that it won't be as aggressive, but we will continue to monitor that and be ready to be wrong.

In 2008 the whole financial system looked like it was about to implode, and now we've seen if that happens, the government plans to take action. Unfortunately, the action is taking taxpayer dollars and giving them to the banks, but they are ready to act. In that case, the same degree of fear may not exist as it did in 2008 when people were fearful that the whole system would collapse.

JH: I agree with Charles as he hit it on the head. You have to question how forward-looking is the market? When does the market wake up and realize that the growth we had was all predicated on government spending and cost cuts? We can't cost-cut our way to prosperity. At some point the government stimulus and spending have to cease and we have to pay for all of this through future concessions, lowering the benefits that we were going to receive in the future and increases to our taxes.

Also we still need to repair our balance sheet. We haven't really solved the problem of all of those toxic assets and the quadrillion or $800 trillion of derivatives—whatever the number may be; it is still lingering out there.

So it's going to be an ongoing period of lower growth and balance sheet repair. When does the market correct? As Charles said, and I said earlier, that will happen as soon as we get a whiff that interest rates are going to go up.

TGR: Let's talk about some of those companies that have the model balance sheet—debt is low, they'll be able to service debt, and should a downturn happen either in the economy or in the market, they will be able to survive.

CO: Within every sector some companies have healthy balance sheets and surplus cash, and some have debt. Look at base metals, for example. Last year, HudBay Minerals Inc. (TSX:HBM) was trading at a discount to its net cash, and Teck Resources Ltd. (NYSE:TCK), which had an awful lot of debt because it had purchased its coal assets at the top of the market. Our preference is to take the one with the lower risk profile in terms of its potential to continue operating.

The picture also varies from sector to sector. In certain areas, generally speaking, you see a lot of companies with an awful lot of debt. For instance, there's lots of debt in the banking sector. So from a macro point of view, that would be something to avoid. On the other side, a lot of material stocks have very healthy balance sheets. They've been getting high commodity prices for the last several years; so unless they've been on spending sprees, for the most part they have been building up cash balance sheets.

JH: In consumer staples, a lot of the big conglomerates serve as a primary model of how they've been driving ROE through leverage. Their ability to continue to finance going forward is doubtful once rates increase substantially as overall the margins may be pretty slim. So you really have to pick and choose within each segment—the HudBays versus the Tecks, as Charles indicated.

TGR: As you said, material stocks have built up healthy balance sheets due to increase in prices of the underlying commodities. Why haven't gold stocks increased valuations to reflect the 35% increase we've seen in the price of gold?

CO: There has been a disconnect between the gold price and gold stocks certainly over the last year and a half. I think we can all agree that 2008 was really an anomalous year. A gold stock was a stock; the fact that it was in gold did not matter. So gold stocks just went down with the rest of the stock market, and this year we've been playing catch-up. The gold stocks have done very well.

Having said that, one sub-sector of the gold stocks has been the best. We've seen brilliant returns in some mid-cap gold producers, while at the same time some big-cap gold names and some early-stage names whose access to capital has been a bit of an issue have underperformed.

The S&P Global Gold Index is up around 10%, which really isn't a very good return; you would have done better than that if you held gold. But look at an index made up of mid-cap names or look at many of the gold funds in those mid-cap areas. Or look at our own fund—we're up over 100% year-to-date as we speak. There's been some very good performance from many of our peers as well.

TGR: So, is the reason some are outperforming the gold primarily back to that balance sheet issue and the debt?

CO: Except for some of the large caps, I think most gold companies generally have fairly strong balance sheets. A lot of them avoid too much debt because it's a very tough business, and they don't want to get themselves over-leveraged. For the most part, I think the dichotomy between the performance of the large and small caps relative to the mid-caps is just one of those things. Next year I wouldn't be surprised to see—in fact, I expect to see—large caps and small caps outperform the mid caps. They get out of whack sometimes, but eventually they tend to act as a group, so I expect that to become more normalized next year.

TGR: So if we want to look at companies with sound balance sheets in the group, which companies fall into those categories from your analysis—small caps, mid caps and big caps?

CO: The large caps—companies like Goldcorp (TSX:G) (NYSE:GG), Barrick Gold Corp. (NYSE:ABX), Newmont Mining Corp. (NYSE:NEM), AngloGold Ashanti (NYSE:AU, JSE:ANG, ASX:AGG, LSE:AGD), Gold Fields Ltd. (NYSE:GFI)(JSE:GFI), Randgold Resources Ltd. (NASDAQ:GOLD)‎, Kinross Gold Corp. (K.TO; NYSE:KGC)‎, IAMGOLD (TSX:IMG). Silver Wheaton Corp. (NYSE:SLW, TSX:SLW)‎—Silver Wheaton is actually on the verge of becoming a large cap; it probably is a large cap now.

JH: Red Back Mining Inc. (TSX-V:RBI) is probably considered a large cap now too.

CO: Among the mid-cap names, I think of companies such as Osisko Mining Corporation (TSX:OSK), Wesdome Gold Mines Ltd. (TSX:WDO) and San Gold Corporation (TSX-V:SGR).

JH: Also Lake Shore Gold Corp. (TSX:LSG) and Aurizon Mines Ltd. (NYSE/AMEX:AZK; TSX:ARZ) . And Romarco Minerals (TSX.V:R) have strong balance sheets.

CO: Romarco is sort of a small cap breaking into the mid-cap range. Generally speaking, the small caps tend to be more in exploration or development-stage projects. Some of the names may not be familiar. Within every country you can see a lot of small caps. One of our themes is monitoring the jurisdictions these companies operate in because governments sometimes change loyalties. We like stable areas. North America is a pretty good region to operate in. Companies like Rainy River Resources Ltd. (TSX-V:RR). What else do we have in North America, Jamie?

JH: Premier Gold Mines Limited (TSX:PG). Brett Resources Inc. (TSX-V:BBR)—the Hammond Reef project. International Tower Hill Mines Ltd. (NYSE/AMEX: THM; TSX-V:ITH).

CO: Let's pick some small-cap players in Brazil— Verena Minerals Corporation (TSX-V:VML.V). Amarillo Gold Corporation (TSX-V:AGC), Brazauro Resources (TSX-V:BZO), Magellan Minerals Ltd. (TSX.V:MNM). So that's just a smattering of names in the different groups.

TGR: Four companies made it into your top 10 for both the Sprott Gold Precious Metals Fund and the Sprott All Cap Fund— IAMGOLD, Kinross, Osisko and Silver Wheaton. Can you give us some more insight into how and why they achieved that ranking?

CO: I think of those as anchor names within the portfolio. It acts as a core. They're good, sound companies, well-diversified and with a number of different operations. The one that's a bit of an outlier among those you mentioned is Osisko. We've owned it for awhile, but increased our position over a year ago because we thought it was very cheap. Osisko has a very big, very promising deposit in Quebec. We felt that the market was undervaluing it dramatically. Great growth story, very cheap, strong balance sheet, fully cashed up.

JH: Another point about our top 10—many of them grow into those positions. Just over a year or even two years ago, people hated IAMGOLD and wouldn't give CEO Joe Conway any benefit of the doubt. It was a show-me story. Everyone saw a declining growth profile for the company for the next couple of years until a few other projects came on. But Joe was one of the few people out there willing to do something at one of the dour times in the market. He bought the Essakane Project in West Africa and advanced it forward, and now he's ahead of schedule and is showing a really good growth profile. People are willing to pay for that growth now, and you saw significant movement in the stock price.

Another example is Silver Wheaton. A year or so ago, people were dour in the market, silver was down and we had the financial collapse, but with Peñasquito coming on out of Goldcorp and the silver stream there along with a few other assets, investors became positive on the silver and gold price and the profile for the company. You can witness the movement in Silver Wheaton's stock price as a result.

So more often than not, these are companies that have grown into these positions over time.

CO: Jamie was quite right, and I think it's very important to know. We don't generally go in to a portfolio and say, "We're going to make this our largest position." It's usually growth from an initial position that gets larger through the performance of the stock that brings it to that magnitude. Our gold fund's top 10 is usually big, well-diversified producers or stocks that have run an awful lot. In the case of the first three, they are big, well-diversified producers, and as I said, Osisko's been a great performer. It's one of those mid-cap names that I mentioned that has had stunning performance.

One of things I can tell you is somewhere below that top 10 list there's another Osisko, which next year will probably break into the top 10. Again, it will be through the outperformance of the company and growing recognition by the investment community of the value of that company's projects and assets.

TGR: If investors are already well into their gold positions in their portfolio, what other sectors should they be looking at?

CO: Gold is our favorite sector. On a long-term basis, we're believers in peak oil, too, so we believe that energy should be part of an investor's outlook. In terms of mid-term themes, we think over the next decade there are some areas in which to have some exposure that maybe over the last two decades weren't so important. Agriculture is one example. A decade ago nobody talked about agriculture. I think now it's very important, and the macro themes are very compelling for why investors would want to get into agriculture.

TGR: Okay. Agriculture is one. Where else?

CO: We think infrastructure will be a good area. With all the government spending that's going on, there's going to be a lot of spending in infrastructure. We've gone through a year of talking about it. So far, the infrastructure companies haven't really benefited that much because it's been a time for signing contracts and getting everything put in place. The real spending comes on later down the line.

JH: We're looking at areas of the healthcare sector as well, but it's more on the productivity, technology and medical equipment side and not so much in biotech and pharmaceuticals. So the bread-and-butter supply types of companies look pretty good.

There's some appeal in the technology space as well, with developments that enhance productivity and make companies a little more efficient.

TGR: Anything else you'd like to tell our readers?

JH: Keep the faith. As long as governments continue to print money and debase fiat currencies, hard assets should continue to appreciate and do well as a store of value.

Bringing more than 21 years of experience in the investment industry, Charles Oliver joined Sprott Asset Management (SAM) in January 2008 as an Investment Strategist with focus on the Sprott Gold and Precious Minerals Fund. Prior to joining SAM, Charles was at AGF Management Limited, where he led the team that was awarded the Canadian Investment Awards Best Precious Metals Fund in 2004, 2006, 2007, and was a finalist for the best Canadian Small Cap fund in 2007. At the 2007 Canadian Lipper Fund awards, the AGF Precious Metals Fund was awarded the best 5-year return in the Precious Metals category, and the AGF Canadian Resources Fund was awarded the best 10-year return in the Natural Resources category.

Jamie Horvat joined SAM in January 2008. Jamie is co-manager of the Sprott All Cap Fund, the Sprott Gold and Precious Minerals Fund, the Sprott Opportunities Fund LP and the Sprott Global Equity Fund. Jamie has over 10 years of investment experience. Prior to joining SAM, he was co-manager of the Canadian Small Cap, Global Resources, Canadian Resources and Precious Metals funds at AGF Management Limited. He was also the Associate Portfolio Manager of the AGF Canadian Growth Equity Fund, as well as an instrumental contributor to a number of structured products and institutional mandates while at AGF. He joined AGF in 2004 as a Canadian Equity Analyst with a special focus on Canadian and Global resources, as well as Canadian small-cap companies. Prior to joining AGF he spent 5 years at another large Canadian mutual fund company as an Investment Analyst.

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: Romarco Minerals Inc., Aurizon Mines Ltd., San Gold, IAMGOLD, Goldcorp, Gold Fields
3) Charles Oliver: I personally and/or my family own none of the companies mentioned in this interview. I personally and/or my family am paid by none of the companies mentioned in this interview.
4) Jamie Horvat: I personally and/or my family own the following companies mentioned in this interview: Aurizon Mines I personally and/or my family am paid by the following companies mentioned in this interview: None.

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Disclosure: 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: Romarco Minerals Inc., Aurizon Mines Ltd., San Gold, IAMGOLD, Goldcorp, Gold Fields 3) Charles Oliver: I personally and/or my family own none of the companies mentioned in this interview. I personally and/or my family am paid by none of the companies mentioned in this interview. 4) Jamie Horvat: I personally and/or my family own the following companies mentioned in this interview: Aurizon Mines I personally and/or my family am paid by the following companies mentioned in this interview: None.

Barry Allan: Stage Is Set for Stellar Silver Performance
Source: The Gold Report; interviewed by Karen Roche, Publisher 12/04/2009

http://www.theaureport.com/pub/na/3365

Gold's recorded a powerful upward sprint this year. The first quarter—historically a tough period for gold—is around the corner. Research Capital's equity team lead and senior mining analyst Barry Allan remains absolutely optimistic about the king of metals' long-term outlook for a variety of reasons, and in this exclusive Gold Report interview talks about some of the emerging companies whose deposits portend the next generation of gold mines. But in the meantime, he says silver will slip into the limelight for what's likely to prove a stellar performance. In a rising gold price environment, Barry tells us, the second-string metal's price lags gold. Then, when it gains momentum in the drive to come more into line with the historical gold-silver ratio, silver tends to overshoot. He foresees a short-term breather for gold and a strong surge by silver—meaning that we're approaching silver's season to sparkle.

The Gold Report: When we interviewed you last March, you were very bullish on gold and silver, partly because demand for gold is being driven by investors rather than jewelry and also by worldwide currency crises, particularly problems with the U.S. dollar. Gold is now approaching $1,200 an ounce, and central banks have shifted from selling to buying gold. What's your impression of where we are in this precious metals bull market now?

Barry Allan: It's fair to say that all the ingredients we talked about in March have really come to fruition and quite dramatically so. I recently saw statistics in our financial Globe and Mail about fundamental purchasing of gold by the average person. We are seeing unprecedented hoarding rates, as far as people putting gold in safety deposit boxes is concerned, but also a continuing evolution in the amount of gold going into exchange traded funds, ETFs. And as you pointed out, we have seen this material shift by central bankers. It's now fashionable to actually to own gold as part of their foreign holdings.

I am a bit concerned that gold is becoming too fashionable, that it is now not only mainstream thinking that you need some gold, but it's actually approaching a point where gold is occupying the forefront of a lot of people's attention. Short term, that worries me a little. Nevertheless, while we might have some short-term weakness, prospects for the U.S. dollar and interest rates still suggest that in certainly U.S. dollar terms, my expectations for gold a year from now are higher than where we are now.

TGR: What do you mean by the short-term weakness?

BA: In the near term we are always cautious about the seasonality element, which basically says that gold gets into a tough environment toward the end of January or February. It certainly has been the case for the last number of years; and I have no reason to suspect that will change. We typically go into the doldrums before the beginning of spring. But with that caveat, we continue to be optimistic on both gold and silver. We don't really see the dynamic of the market changing all that much over the long-term.

TGR: A lot of people who see this current market rally as a bear market rally are calling for a correction; in fact some are even calling for a crash. If the market does crash, will gold and silver decouple or pull back with the general market?

BA: My expectation is to see a certain amount of correction in gold. I do not expect a decoupling. Gold has become fairly tied to investment opportunities and prospects in the sense that if we get into a tough equity market, you're going to see some profits taken in gold as well. The more you say gold is an investment vehicle, the more it will behave like other investment vehicles. If we're having a general contraction in equity markets, I find it hard to believe that we wouldn't have some correction in gold—certainly gold equities, but also in the price of gold itself.

TGR: But aren't the metals often viewed as a hedge against downturns?

BA: Yes, but on a practical basis people will take profits. Gold is certainly a hedge against currencies, but if the market is correcting, why would I sell my equities and go straight to currencies? Wouldn't I go to gold? It's that kind of logic. The practical part of it, though which I have seen over the years, is that any time we've had an equity market correction, we've always had a correction in the commodity price as well. I do not expect that to decouple. It may be less of a phenomenon, but I don't expect a surge in bullion price if equity markets roll over.

TGR: Silver prices have done very well this year, along with gold, but they're still a lot of "silver bugs" who expect it to start to increase relative to gold due to the gold-silver ratio. What do you think will happen with silver?

BA: That's a fair comment. Certainly what we've been tracking and saying is that silver has lagged gold. History has shown us that silver often does catch up and tends to overreact, so we fully anticipate that gold and silver will come back into line. We haven't changed our thesis; we've always argued that the best predictor for silver price is the price of gold. We look at gold as our benchmark. The R-squared value of the correlation between gold and silver is the best predictor for silver prices, with the caveat that it tends to lag and then it tends to overshoot. For that reason, particularly now, we'd be more apt to be in silver than gold.

TGR: Because you're expecting silver to catch up.

BA: That's correct. Yes. And that's based on a little more concern about gold and a little more correction in the ratio.

TGR: Are you looking for silver to have that increase before the seasonality downturn? Or is that more likely to occur throughout 2010?

BA: Probably more in the seasonality period. I would expect the ratio to correct itself with silver holding up a bit better than gold. We'll certainly see silver trying to catch up while we're in this bullish environment for gold, but I really think it's going to be a matter of gold coming more into line with silver, at least for that period. After that, they'll march together again. But again, in a rising gold price environment, silver almost always lags.

TGR: So, even though you're expecting a really nice run up in silver, both silver and gold had a very nice run 2009. With this tremendous increase in metals prices, why aren't most of the mining companies generating a corresponding increase in profits?

BA: That is a really good question, and there is no really good answer. Gold companies have not distinguished themselves in capitalizing on this gold price environment to get earnings to the bottom line. Quite often, we've had disappointments, start-up issues, grade problems, and on and on we go—to the extent that the rise in bullion prices is not translating into bottom-line performance. We have had an immoderate amount of disappointments by our senior gold companies, whereby mines haven't started up as planned or on schedule. There's a long list of woes we could go through—but in short, they just haven't delivered the goods. That's one reason why gold equities have lagged gold commodity prices.

TGR: That's not a bad answer. But are there other reasons?

BA: Another factor is the evolution of ETFs. If you want gold price exposure, you now have a much more liquid way of getting that exposure. An ETF gives you that exposure without exploration exposure or operating cost exposure and other things that go along with owning part of a mining company—and, by the way, these companies have not gotten earnings to the bottom line anyway. The two phenomena together have been the primary reasons that gold equities have underperformed the commodity.

TGR: Why aren't the mining companies successful at getting earnings to the bottom line?

BA: This gets back to the fundamental logic of gold mining. When gold prices rise, gold miners will go to a more marginal ore grade. By virtue of extracting lower cut-off grades, they cannot achieve the same percentage increase in bottom-line performance that they would if they were taking higher-quality stuff. It's a little bit a self-defeating kind of process, but they're looking to get the maximum level of cash flow. Their margin with a poorer-quality ore grades is not quite as large as it would have been, but total cash flow generated is better because they're producing more ounces.

Some of this is going on as we speak. You've seen the evolution of large low-grade deposits, which are classic examples of what I've described. In Canada—it's been more common in other parts of the world—we are now rather uniformly getting one-gram–ore-grade deposits in hard rock, or even less, and that's a direct result of these high gold prices. So high gold prices do have consequences on the bottom-line performance of gold companies.

TGR: Let's continue down that line of thought about the effect of increasing gold prices on ore quality for a moment. Suppose we have a settling out of the gold price or a correction that takes it back to $1,000. In that case, these lower-grade deposits might no longer be attractive from a cash flow standpoint. And if that happens, won't we run into a supply issue?

BA: No, because a good portion of the mines will have been built already. For example, Osisko Mining Corporation (TSX:OSK) is building a very large, low-grade mine with economics based on gold in the $850 area. They've raised all the capital to build this mine, so I expect them to complete construction and operate it. Even if gold were to go as far down as $850, they wouldn't care because the economics are based on the capital required to build the mine plus an acceptable rate of return on that capital. So even at $850 gold, they could say, "We are going to produce. We may not get the return on capital we wanted, but we'll still make positive cash flow."

TGR: At what point would supply become an issue?

BA: You'd see a contraction in gold supply only if you start getting into the marginal cost of production, which probably sits in the high $400s now.

TGR: So as some of these new mines come on board, like Osisko's, we actually might begin to see a rapidly increasing margin in the next year or so.

BA: Absolutely.

TGR: As the higher grade ore starts to come up top?

BA: In Osisko's case, a higher grade ore is a bit difficult. Osisko's economics works by economies-of-scale. It's low margin, high volume. That's where they make money. With the gold prices we're looking at now, they'll be rolling in cash. They'll be producing 600,000 ounces of gold annually. They're going to be a very significant gold producer in Canada, and considering their original return on capital was based on $850 gold, they're going to have a wonderful margin if these gold prices hold up and will become a very significant cash flow generator.

TGR: Any other stories like that?

BA: Detour Gold Corporation (TSX:DGC) is a very, very similar kind of proposition. Detour has not raised the funding required for building the mine and has not started construction, but the economics and value proposition are almost identical to that of Osisko. Both of them will be close to being the largest gold producers we have in this part of the world.

TGR: When we spoke in March, you talked about the balance between low and high-beta stocks, with the relative weight in your portfolio depending on whether you were bullish or bearish on the sector. To what extent is your portfolio weighted toward more high-beta stocks now?

BA: In the summer months we'd gone to a high-beta strategy in the sense that we wanted exposure to gold. We continue to be there at this point and—unless something catastrophic happens here in the short term, which I am not anticipating—we'll probably stay there right on into early 2010. We have a technical analyst and I watch charts fairly closely. If we see some rapid outbreak in gold price, even more than we've already had, I might go to a defensive mode a little bit more quickly. By that I mean go to a low-beta strategy in gold stocks—go to low-cost operators; low-debt kinds of companies; away from the smaller market cap companies and into the bigger cap companies—and maybe straight to ETFs as well. If there's an outbreak in gold price, I am going to say, "You know what, I'm going to take profits here, thank you very much."

TGR: More of a profit-taking thing.

BA: Absolutely. Going to a defensive strategy comes back to an overall phenomenon I've observed in analyzing some 29 years' worth of quarterly data. The end of the first quarter is an extremely high-risk period for gold. Better than 45% of the time, we get into a problem at the end of the first quarter. About 30% of the time it will be in the second quarter. It's rarely a fourth-quarter problem; only 5% of the time have we been in an ugly gold price environment in the fourth quarter.

Because of this pattern, I'd need something—something like a very dramatic move up by gold—to really shake my fundamental seasonality strategy and go to a more defensive posture now. Some people are saying we've had it already, but I'm not there. . . yet.

TGR: You've indicated that you're looking for the "next generation" of Canadian gold mines. Why not stick with the ones that are already up and have cash flow and profit margins?

BA: When gold stocks move, you have tiering of companies. The big tier moves first, then the intermediates, then the juniors. Then you see the last tier, the very high-risk stocks—the people who are in exploration mode or in development mode. That's where we've gone to try and engineer our performance. So, for example, in a company like Rubicon Minerals Corp. (TSX:RMX) (NYSE.A:RBY), we see its resource continue to grow. We don't have any idea yet of how big this resource is in terms of a 43-101, but they just continue to intersect gold with more drilling. As they drill more, they intersect more gold. If you take all the intersections and as you get more data, the averages of the intersections become more soundly based. It shows that they have something of significant proportions. It really has nothing to do with gold price, per se, but as I said, it has everything to do with successfully adding to the ounce count. We're looking for value, creation of value, and that's where we see our next generation of emerging gold producers.

TGR: Any examples you could share?

BA: I mentioned Detour. Osisko is the closest and is under construction. San Gold Corporation (TSX-V:SGR) fits that mold as well. This is about exploration, about good-quality exploration, adding good-quality exploration ounces to the ounce count. And in the case of San Gold, they'll be getting some of that to the production curve more quickly than what you'd normally expect because it's all within kilometers of an established infrastructure.

Lake Shore Gold Corp. (TSX:LSG) is another company that is just about to come into production, and there's one in the high north, Comaplex Minerals Corp. (TSX:CMF). Not a lot of people have heard about Comaplex. Their deposit is in Nunavut, near Rankin Inlet. It's a very high-quality reserve. Last year they went underground and took a 25,000-ton bulk sample to test the mining continuity and actual ore grade, and were pleasantly surprised. Underground the deposit is averaging about 21-gram material before dilution. Comaplex is progressing through to feasibility and ultimately production, and it is another one of this generation of companies I've been talking about.

So we do have a number of these companies that are at various stages of exploration, advanced exploration and development, and over the next three or four years they will come into production. The emergence of these very high-quality underground mines and large, lower-grade open pits portends our next generation of gold mines.

TGR: When do you expect some of these companies to start coming out with 43-101s?

BA: In the case of Rubicon, which is probably the one that most people are focused on, the nature of the deposit is such that it is very difficult to prove by just drilling it. Red Lake (Ontario) history has shown the only way operators can prove up deposits and develop acceptable 43-101s is to get underground and take bulk samples.

That's vastly different from open-pit deposits, which you can drill off of with a greater degree of certainty because they are generally uniform and near-surface deposits. The continuities of open-pit deposits are generally in terms of tens of meters, whereas in underground circumstances you're talking to two or three meters. So Rubicon needs to get underground to explore actually continuity of the ore - and they have a plan to do so by the second half of next year. It would only be after that program that they would be in a position to be able to speak with authority about the nature of the resource.

Both San Gold and Lake Shore are also in the high-grade, underground mine camps. Lake Shore has a resource statement already. San Gold has been underground for five months on their new ore zones; so we're expecting its 43-101 by the end of the year. Rubicon is by far the earliest-stage company we've talked about.

TGR: Who are some of other very early-stage, near-production juniors in the next-generation camp?

BA: Osisko is in that category. Generally, when I say "junior," I'm talking about an emerging company or a producing company with a market cap of under a billion dollars or so. A whole bunch of other junior-type companies that are producing gold are not included in my next generation of gold mines because they have been around a while, have less than 100,000 ounces and typically don't generate operating profit. We have a number companies in Canada like that, such as Claude Resources Inc. (NYSE/AMEX:CGR), Richmont Mines Inc. (NYSE/AMEX:RIC), Kirkland Lake Gold Inc. (TSX/AIM:KGI). They're producing gold, but they're very small and have limited prospects for a major expansion.

TGR: One of the ways some investors tend to play in any commodity is with associated services companies. Do drilling company equities, for instance, complement holdings in a metals portfolio?

BA: Historically yes, although the drilling companies are very levered to the exploration cycle, and over the past 12 months the different strategies employed by the drilling companies have dramatically affected their top- and bottom-line performance. The big driller in Canada, Major Drilling Group International Inc. (TSX:MDI), has been the hardest hit, with valuation off fairly dramatically. That said, they are looking at a better position now. In fact, I would say that the drilling industry for 2010 is going to improve overall. We are currently in the budgetary cycle for 2010; in other words, 2010 budgets are being put to boards now and being approved. Early indications we've seen—and it's pretty uniform—is that the next year's exploration expenditures will be much better than what we saw for 2009.

Drilling programs will be heavily influenced by gold price, but generally speaking, metal prices across the board have held up a lot better than what anyone would have anticipated. So there is confidence that we've seen the worst. So I'm fully anticipating that 2010 will be a much better exploration year.

Some of our smaller drillers, though, such like Foraco International (TSX:FAR) and Orbit Garant Drilling (TSX:OGD), continued to do well throughout the cycle. They specialize in a niche, have very good business strategies and focus on a unique type of drilling. For them, it's as if there's been no change in the exploration cycle at all. They continue to generate good levels of operating results and cash flow. They've really had no decline in top or bottom-line performance over the last 12 months. It's been the big guys like Major Drilling and Boart Longyear (ASX: BLY) that have felt the contraction of the worldwide exploration the most. In any event, as I've said, I believe 2010 will change for the better for the drillers.

TGR: Are these smaller companies in a position to ramp up and capitalize on some of this increased budget for exploration?

BA: The reason the smaller drillers have done well and have not experienced decline with exploration expenditures off very dramatically is that they very, very carefully pick their clients and pick what they do well. They're very niche-focused, and one-fifth the size of a Major Drilling in number of drill rigs, market cap and so on. So they're quite cautious about going out and trying to take advantage of this environment. They will tell you point blank that they don't want to get involved with companies that don't match their strategy. That stance has held them in good stead to this point in time, and I don't see that changing all that much. They have nice little businesses, and they're going to continue to grow them organically, but it's not going to be major acquisitions on their horizons.

Consistently ranked as one of Canada's top 10 gold and precious metals mining analysts, Research Capital's Barry Allan has more than 15 years' experience in the mining sector that brings together geological fieldwork, equity research and finance. Before joining Research Capital in 1997, he was a Gold and Precious Metals Mining Analyst with Gordon Capital, BZW and Prudential Bache. Prior to equity research, Barry was a member of the specialist finance group at CIBC, one of Canada's largest financiers of mining projects. Barry earned his B.Sc. (Geology) and MBA degrees from Dalhousie University.

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: San Gold Corporation, Rubicon Minerals
3) Barry Allan—I personally and/or my family do not own the following companies mentioned in this interview. Research Capital Corporation has been involved in corporate transactions with Rubicon Minerals, Comaplex, and Foraco International.

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Disclosure: 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: San Gold Corporation, Rubicon Minerals. 3) Barry Allan—I personally and/or my family do not own the following companies mentioned in this interview. Research Capital Corporation has been involved in corporate transactions with Rubicon Minerals, Comaplex, and Foraco International.