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.

– Bob Moriarty, Gold is Getting Frothy

With gold busting through $1100 this month, government deficits/spending/borrowing showing no signs of slowing down anytime soon, the stock market at unsustainable highs, it’s clear to see investors are finding few places to turn.

One of the spots they have found is gold – the ultimate safe haven – as the last bastion of safety and wealth preservation.

The interest in gold is at its highest level in decades. But we’ve discussed the value and importance of precious metals in the past. Now it’s time to maximize the opportunity in gold.

That’s why I’m pleased to tell you that the Prosperity Dispatch was able to track down Bob Moriarty to get his view on the economy, gold, and where the best opportunities in the gold market are.

If you’ve never heard of Bob, I can tell you with great confidence he is one of the most well-respected gold investors and analysts in the world.

For example, convinced gold/silver were at a bottom in 2001, Bob and his wife Barbara started one of the first websites devoted to teaching readers what they need to know about investing in resource stocks. Bob and Barb now operate two resource sites, 321Gold.com and 321Energy.com where up to 100,000 people a day visit.

Knowing what it’s like to start something you know there will be little interest in (our very recent example), I’ve got a lot of respect for Bob.

But the thing is, if you’ve read Bob’s research before, you know he’s not the type of guy to sugar-coat the truth either.

In this exclusive interview, you’ll learn about:

1. The two most important reasons to own gold now (regardless of the price)
2. Why the U.S. is on track to become a third world nation
3. Where Bob is putting his money now
4. An oil technology company that can double its customers oil production
5. How the Dow could hit 20,000
6. One of the most dangerous countries on earth for you and your money!

That’s just to start. There’s a whole lot more.

Read on below for all the details.

Good investing,

Andrew Mickey
Chief Investment Strategist, Q1 Publishing


Andrew Mickey and Bob Moriarty of 321Gold.com


Andrew Mickey: In your view, what’s the top reason to own gold? What would you tell someone who never even considered buying gold before today?

Bob Moriarty: There are two reasons to buy gold.

First, gold is an insurance policy against chaos.

We live in a world where the US Marines are spending $400 a gallon for fuel in Afghanistan and using $320 million dollars in fuel a day. Merrill Lynch executives paid themselves 3.6 billion dollars in bonus money just before the company was taken over after those same executives lose $27 Billion dollars for the firm and had to be taken over. Goldman Sachs looks to be distributing about $23 billion in bonuses for the year.

A year ago they were on the ropes and were only bailed out by US taxpayers. We have privatized profit and socialized losses in the US.

One day soon the unemployed and homeless are going to get very angry. When the riots start and the banks all close, it will be a good time to own gold.

Second, gold is an investment that has no counterparty risk.

There is $600 trillion in derivatives bets, all of which have enormous counterparty risk. The world is a $60 trillion economy. $600 trillion in derivatives is insane.

In 1923 in Germany, a quarter of an ounce of gold would buy a nice home. It’s going to happen again.
 

Andrew Mickey: Over the short-term, the next few months or a year, do you see any short-term catalysts for gold?

Do you see anything like those, or worse?

Bob Moriarty: There is a giant black swan fixing to land on the pond…

Follow this Link to learn what’s going on in the short-term, a breakthrough oil technology company, where Bob’s putting his money, and more…

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 that 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.

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.

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

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 eletter 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.

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. Some time 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

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.

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.

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."

It’s been a dollar vs. gold story ever since the economy ran into trouble last fall, according to Blackmont Metals and Mining Analyst Richard Gray, who sees inevitable inflation down the road. "The trouble is there are no real applicable precedents we can use," he explains, noting the prodigious amount of stimulus money flooding the economy. In this exclusive interview with The Gold Report, Richard discusses major drivers behind gold’s price rise, attributes of successful juniors and why he thinks gold’s upside scenario is "maybe $1,100 or $1,200."

The Gold Report: Gold’s on a roll. What’s your take on what’s driving the gold and precious metals sector right now?

Richard Gray: I believe there are two real drivers behind the gold price: the fear trade vs. the U.S. dollar, and the potential for inflation. I tend to minimize the overall impact of supply and demand. Given what we’ve seen over the course of 2009, investors are looking for an alternative investment to the dollar. If you go back to when the overall economy ran into trouble last fall, ever since then it’s been more of a dollar vs. gold story and that’s still true today.

As the economy recovers and there’s a scenario where inflation is an issue, then there’s a case to be made that gold will do well then, as well. But for the time being, it’s just people worried about where their money is today and using gold as a safe haven vs. where it could go with their other investments. What we’ve seen in the last six weeks is that gold has broken through some historic levels because there’s increased worry that maybe the U.S. dollar isn’t the world currency anymore and the U.S. economy is really not as stable as we’ve been led to believe.

Investment demand, whether from funds or individuals, has been a major, major driver, taking gold from $700/oz through to where we are today. And this investment demand is simply investors just looking for a safe place to put their money.

TGR: Do you think there’s a high probability that once we start to recover we will hit inflation?

RG: The trouble is there are no real applicable precedents we can use. With all the stimulus money that’s been injected into the system, it would seem inevitable that inflation will be an issue down the road.

On the other hand, you could also argue that all the value that was destroyed (particularly in the last 12 months), won’t be regained by all the stimulus money in the world. That’s the argument for people who say inflation’s never going to be an issue because the stimulus money isn’t anywhere near what was lost in the last 12 months.

Personally, what I’ve been telling clients is that gold around $1,000 is probably a reasonable place to be looking long term. I don’t think gold’s going to take off and go to $1,500 or $2,000. I think the upside scenario is maybe $1,100 or $1,200 and then somewhere in a range between $900 and $1,100 is probably where the gold market is healthy and where the economy, as it compares to the gold market, is also reasonably stable. The fear trade is going to be here for a while and inflation might have an impact later on. But in the meantime we are not calling for a dramatic move up or down.

TGR: Gold has gone up about 21% this year. Silver has gone up 61%. Is silver being driven by other elements?

RG: Yes. Silver is somewhat of a unique metal. The simplest way to put it is when the economy is good, it trades closely with the gold price—usually on a 50:1 ratio. During these times it is treated more like a precious metal, a metal you invest in to protect your money. When the economy is weak, like the second half of 2008, it trades more like a base metal, where supply and demand has more of an impact. We saw the ratio rocket up to 80:1 last fall. Right now we’re at 65:1, which is right in the middle of the bull market and bear market scenario here and that probably fits as well.

On the supply-demand aspect of silver; it is consumed (whereas gold is typically not) and it is usually mined in deposits that are primarily lead, zinc and copper. So it’s got a bit of a two-headed look to it. While the increases of 61% this year for silver and 21% on gold are true from January 1st, if you go back to July 31, 2008, that’s when things really just fell off a cliff. From July 31, 2008 to today, gold is up 20% and silver is basically flat. So picking a time horizon, silver has outperformed, but also if you go back to where things were fairly stable and normal, the last time gold-silver traded at around a 50:1 or 55:1 ratio, if we ever get back to that, silver hasn’t really done much since then. For all the same reasons you can say gold could go to $1,500 or $2,000, you could also say silver could go to $30 or $40; but I just don’t see it because silver mines will start popping up all over the world if silver goes through $20, and you’re going to get an increased amount of supply—more so than gold. A lot of silver is going to hit the market, and I don’t think the demand side can really take it all up and keep that price high.

As with the current price of gold, I think the silver market at $17 or $18 an ounce is quite healthy. I just don’t see these kinds of runs because there are a lot of silver deposits out there, whether they’re part gold-silver, part silver-lead-zinc. They get built or they get turned back on, and it becomes more of a supply-demand issue for silver anyway. So, you’re right—silver has outperformed. Is it overbought here? I don’t think so. I think it’s probably right where it should be given the uncertainty of the overall market.

TGR: If we’re looking at a relatively flat market for silver and gold in the same timeframe—and I’m referring to gold stocks here (as the gold equities have, in many cases, doubled, tripled, quadrupled)—did we miss the boat on these or is there more upside to be gained?

RG: On the big cap gold and silver stocks—there are probably 10 to 15 of them in North America—they’ve generally traded on about a 2.5:1 beta to the underlying metal, which is typically where it should be in a good, upward market on gold and silver equities.

Where we haven’t seen that performance and where we’re starting to now is with the smaller cap companies, the more speculative gold and silver companies. I think there’s more money to be made in the smaller caps junior companies right now because we’re seeing a movement of capital from these big, solid companies down to the more speculative names. I think as gold’s gone through $1,000/oz there’s a new level of interest in the smaller cap companies. Having said that, if gold has a correction and goes back below $1,000 even for a week or two, there will be a lot more downside on these junior companies because they’re the ones that will trade on much higher beta to the gold price than the seniors.

A ratio I look at is the HUI Gold Index divided by the gold price. The HUI Gold Index is really one of the best proxies for gold stocks in North America. Right now this ratio is around 0.42 and what does that mean? It got as low as 0.20 last fall. That’s as bad as it got. So since then they have kept pace and outperformed to a certain degree over the last nine months. However, we’re still far below the 0.50 to .55 range we saw in 2007 and early 2008. So that’s a pretty far way to go for the equities to outperform the gold price to get back to that level. I don’t think we’re going to get back there because there’s still that fear element in equities. The 0.42 level is close to the high we’ve seen so far this year of 0.44. I don’t think the equities are fully valued. But they’re close to being fairly valued, and you’re going to get more uptick on the smaller cap companies—but you’re also taking on more risk. The stocks have done very well and I would just say that, on a one-off basis, they can outperform; but general speaking I think they’ll trade in tandem or at least maintain that similar kind of ratio with the gold price.

TGR: Going back to the seniors, are they rebounding because the overall market has rebounded or is there some specific correlation with the price of gold?

RG: Yes. These senior companies are the ones producing gold, and actually have production and cost and revenue and profit. Last year, Q3 of 2008 was really the high watermark for costs. That was the highest costs have ever been and that’s because oil increased significantly and because labor and all the inputs to mining were at all-time highs. At the same time, gold was coming off from its highs. The margins hit their peak, and then started to compress from Q3 ‘08 right through Q1 ‘09.

In addition to all the other risks that come with equities, the companies’ margins were being squeezed enough that they were making less money, so they underperformed the gold price. Since Q1 ‘09, we’ve seen a gradual increase in margins as costs have stabilized and gold has continued to trade higher. Gold was $910 in Q1, $920 in Q2 and it averaged $960 in Q3.

So that’s the general trend of the gold price, and costs on average for the industry have been fairly flat over the last three quarters. So you could see that delta on the gold price is really providing the expanded margins. That’s why people are moving into these equities more so—they’re making more money and they’re healthier companies and, thus, they deserve higher multiples than they did a year ago. It’s not across the board, but generally speaking, the big companies—which constitute a big chunk of the annual global production for gold—their margins are improving every quarter, and that really hasn’t happened for a long time. People are finally realizing that these gold companies are healthy and viable investments. Not just gold investors, but generalists in the stock market are looking at gold companies for the momentum and returns over the last little while.

TGR: What about the juniors? They’ve seen some spectacular gains.

RG: The beauty of it, looking at the juniors, is that most people look at year-to-date performance and it’s off the charts because the junior market was essentially dead last December. The juniors that survived through November-December of 2008 just barely did so, thus the January returns on these things have been spectacular simply because they survived long enough to get financing from the equity markets. The junior market has really just been rejuvenated in the last four to five months.

I think there’s still more upside because now these companies won’t just batten down the hatches and shut down all their drilling. They don’t have to go to the banks for loans. They can go to the equity market, which is traditionally where the money does come from. They can expand their drilling. They can do all the speculative things that they’re supposed to do—discover deposits and build new mines—which is why investors like them, because that’s where you get more of the return. So these companies doing well is really just a function of the overall health of the markets funding them. They have money to do what they’re supposed to do, which is find and develop new deposits.

TGR: When you’re looking at juniors in your role as an analyst, what are the key elements that you’re looking for now?

RG: Whether it’s a good market or bad market, I think the two big things for juniors are location and management. You’ve got to be sure a project is in a place in the world where you’re going to get rewarded for success. Canada, U.S., Mexico, most of the Americas are all pretty good.

Once you get over to Africa, parts of Asia or Eastern Europe, there’s more risk with finding deposits because there’s NGO involvement, there’s nationalization risk from the government and things that just happen in those countries that you don’t usually see in safer parts of the world

The second thing is a capable management team, especially on the operating side of things. If there’s a track record there, all the better. If they have the ability to not only find and develop deposits but also fund them, those are the two most important things. And usually those two things will bring in decent deposits that can get built.

TGR: Do you have some companies you can share with us that have both the location and management you look for?

RG: Yes, one at the top of my list is Jaguar Mining Inc. (TSX:JAG) (NYSE:JAG). I think Brazil is one of the best places in the world to be gold mining. It’s got a very stable framework for finding and developing gold deposits. The tax code is very straightforward; the permitting process is extremely black and white. If they tell you it’s going to take six months to get a permit; you get your permit in six months. It’s somewhat undercapitalized in terms of money being spent in the country if you’re looking for gold deposits. It’s just traditionally been a tricky place to set up shop for whatever reason. So there aren’t a lot of companies down there exploring for gold vs., say, those in Nevada, Northern Ontario or Quebec.

Jaguar’s also good because they have a management team in the U.S. that runs things corporately—but it’s the management team down at the mine sites that is very impressive. They’re guys who have been mining down there for 30 or 40 years and they get it. They know how to do it. Those are the things that attracted me to Jaguar, initially. Since then good things have happened; they now have three producing mines, a fourth on the way and the valuation has followed such that it’s poised to be the next mid-tier producer, in my mind. So that’s a good example of decent management, good country, good assets and it’s worked so far.

First Majestic Silver Corp. (TSX:FR; OTCQX:FRMSF), a silver company in Mexico, is very similar to Jaguar in that they have a specific focus. They have several mines. They built them, they delivered. They’ve been able to build mines and grow them. First Majestic is an attractive silver producer poised to make the jump up to the bigger peer group.

TGR: And they’re currently producing?

RG: Yes, First Majestic has three mines in operation and a couple of other projects that will be brought in to production in the next couple of years. They’re not going to stray away from Mexico because that’s where their expertise lies. And, like Jaguar, they have management that gets them the money—but it’s really the guys in Mexico that build and operate the mines that are key. Once you trust that they’re going to be able to do it, that’s the biggest hurdle you can overcome. Then you know the guys doing the actual work are good.

Also, on the list of ones I cover, New Gold Inc. (TSX:NGD; NYSE Alternext: NGD) is a fairly new company in the mix. New Gold management is really a "who’s who" in the Canadian mining market—the executive chairman is Randall Oliphant, a former CEO of Barrick, and the board includes several of the big names in Canadian mining like Ian Telfer and Pierre Lassonde. These are guys that have had success in the past and they know how to build a company. New Gold has focused on acquiring mines in safe parts of the world such as Canada, the U.S., Mexico, Brazil and Australia.

They started the company by merging three companies a couple of years ago and then they made another acquisition this year. It’s likely they’re going to continue to make more acquisitions because they want to be a million-ounce producer in the safe parts of the world within the next three years. Given what that management team has done already and can do, I think it’s a pretty safe bet that they’re going to be able to deliver on that target. They make you want to buy the company just on what they’ve been able to do and the people behind it. It’s an easy one to feel comfortable about.

TGR: Do you have any that are emerging that we can discuss?

RG: Two that I cover that are small, but could become something bigger. The first one is Apollo Gold Corp. (TSX:APG). Their main focus is the Black Fox mine in Northern Ontario in the Timmins District, which is one of the world’s most prolific gold mining regions over the last 100 years. They’ve built the mine and it’s producing; it’s going to produce over 100,000 ounces next year. And the beauty of Black Fox and Apollo is that it’s not well followed. It doesn’t have a lot of coverage from the investment community. As they show that they can run Black Fox at the rates that they’ve indicated they can, it’s going to be one of the better gold investments out there in terms of return on your money. I think it’s very, very cheap now and as they deliver on what they can do, that’s the upside for investors. So Apollo is one of my favorite juniors. They have some obstacles to overcome, of course. The balance sheet’s fairly weak right now. They had some startup difficulties with the mine, but nothing that’s really that significant. So I think within the next three or four months they’ll be well on their way to showing that they’re an attractive new Canadian junior producer.

TGR: When they get their production ramped up, will that also offset their slightly weak balance sheet?

RG: Absolutely. It all works together. The more gold they get out of their pits, the more money they make, the easier it is to pay off their debt simply is the way it works.

TGR: You mentioned there were two smaller ones that you are following.

RG: The other one is Nevsun (TSX:NSU; NYSE.A: NSU). I’ll be the first to admit it doesn’t really fit with the low political risk criteria, but it’s a name I’ve covered for quite a while. The reason I covered it initially was the world-class discovery —the Bisha Project—they made about six years ago in Eritrea in Africa. They are now building the mine, which has gold, silver, copper, and zinc. The first couple of years of production are gold and there’s three years of primarily copper production and then five years of zinc production. It’s not a pure play gold company, but it’s going to be gold to start. Quite frankly, it’s one of the simplest and most attractive ore deposits in the world.

The risk with Nevsun and the reason the price is probably half of what it should be is Eritrea, which is a very young country with an uncertain risk profile. Over the last five years, Nevsun and the government have established a very good partnership where now the government is essentially a 40% partner in the mine. They have a vested interest to make the mine survive and be a successful operation because they’re going to make money off it, too.

It’s an extremely robust project and I think the country risk is overdone right now. They are building this mine, they have a $235 million project loan from several European and South African banks, and it’s a great time to be buying Nevsun because you can buy it now for something that’ll be a lot higher a year from now when they start producing.

TGR: How interesting. Are there any other companies that you can share with us?

RG: One other junior that I think merits attention right now is a company called B2Gold (TSX:BTO). The management team behind B2Gold is from Bema Gold, which was taken over by Kinross Gold Corp. (K.TO; NYSE:KGC) four years ago. They basically started a new company that has a focus in several parts of the world that aren’t really high profile yet. They have projects in Colombia that are joint ventures with Anglo Gold (NYSE:AU, JSE:ANG, ASX:AGG, LSE:AGD) that are in the exploration development stage. They also have a joint venture in Russia with Kinross that is right beside the high grade Kupol Mine, which is what they found originally and sold to Kinross four years ago. So those are the two large scale exploration focuses. But their production focus, where they’re producing gold right now, is in Latin America, mostly Nicaragua. And they did an acquisition last year of Central Sun Mining. So in Nicaragua they have a small mine that’s producing now and they have a second project that will be producing within the next two months.

B2Gold has been under the radar. They’re at that awkward stage where they’re not able to report on or release any details yet on what they’re doing. They’re still doing the work. So I think B2Gold over the next six months as they get this mine in Nicaragua built and as they have some results out of Colombia and Russia is really one of the most intriguing juniors out there. Management’s done it before and it’s an asset base that could be quite spectacular if things work out the way they could.

IAMGOLD (TSX:IMG) is another one I follow. It’s one of the best performing stocks this year—it’s had a very good run and I’ll be the first to admit I didn’t see it coming. I was fairly neutral to negative on the stock up until a couple of months ago, quite frankly. My concern originally on IAMGOLD was they had assets scattered over West Africa, Suriname, Guyana and Quebec—a mish mash of assets that didn’t look like they were going to grow. Then they bought a company called Orezone right off the scrap heap and with them got this asset called Essakane, which is a large project in Burkina Faso, West Africa. IAMGOLD was able to use cash and its operating team to build Essakane, which will be producing August 2010. It’s going very well for the company and that really kick-started the interest in IAMGOLD in terms of it ended up being quite a good acquisition. In the meantime they’ve also developed and discovered a lot of ounces at Westwood, which is a project in Quebec, which is a great place to be mining or exploring. Interestingly, the other asset that has really emerged as one of their best is a niobium mine. Niobium is a real specialty metal. There’s not many niobium deposits in the world, but they have one. It’s not gold, obviously, but it is a money making operation for them such that it is important to them now because it’s one of their best cash flow producers. And the niobium market has improved over the last year as well. IAMGOLD was a bit of an ugly duckling about a year ago. No one really thought much of it and now it’s one of the better followed, well owned companies in the gold space in that kind of peer group in Canada. Credit the management team.

In terms of the seniors, Goldcorp (TSX:G) (NYSE:GG) and Agnico-Eagle (TSX:AEM) are two of my favorites in that space. Those are just extremely well run companies, with high quality assets in the safest parts of the world—basically, Canada, U.S., Mexico. They’re not cheap, but they are also the highest quality of the senior stocks in North America.

TGR: Are there any additional thoughts you’d like to share with our readers?

RG: It’s easy to get carried away when you’re looking at the gold prices. A rise is ahead. I think it’s definitely a very fun market, but you’ve got to look at where you’ve come from, too. If you’re up 50% or 60% on a good investment, it’s never a bad idea to lock in those profits because it’s been a very unpredictable market the last 12 months. I don’t think you’ll ever get fired for doing that and that’s what I tell clients. You’re never going to get fired for taking money off the table and locking it in on returns.

DISCLOSURE: Richard Gray
I personally and/or my family own the following companies mentioned in this interview: None

Richard became a CFA in 2005 and earned his Bachelor of Applied Science (Geological and Mineral Engineering, 1997) from the University of Toronto.

The dollar’s not going to go straight down, according to Steve Palmer, president and CEO of AlphaNorth Asset Management:"I’m expecting the U.S. dollar to rally in the short term and gold to sell off." Forecasting a bit of a pullback in the next month or so followed by another rally before year’s end, Steve also explains his ‘bigger bang for your buck’ penchant for exploration stories in this exclusive interview with The Gold Report.

The Gold Report: Since the last time we spoke, in February, your performance in your fund year-to-date is up, I believe, 138%. Can you tell us what sectors you focused your fund on during this year to produce that type of return?

Steve Palmer: Well, there’s no particular sector focus. The fund is very diversified. It’s about half resource and half technology, special situations and biotech. But we did have a few big winners that really helped. Bio-Extraction (BXI:TSX.V) is one, and another one I mentioned in our previous interview, Colossus Minerals Inc. (TSX:CSI), was a big winner as well.

TGR: Your fund, as well as the market, has had pretty amazing returns this year. In your August monthly commentary you said you’re getting cautious on equities, given the strong rally. What are you feeling now that we’re in late October? Is there a pullback, or will we continue to move forward?

SP: I don’t think the market can go that much higher in the short term. I think it needs to consolidate and pull back a little bit, so we have added some short positions in anticipation of this.

TGR: Many people have said they’re expecting a pullback in the markets, but it never seems to happen. In what timeframe are you expecting this to occur?

SP: The next month or two. It’s hard to get the timing perfect, but I think maybe a short-term pullback. Not a major correction or anything, but just a breather and then the markets could likely be strong into year end.

TGR: Oh, so it’s going to have a slight pullback, and then rally again before the end of the year?

SP: Yes, that is my prediction. We will see if that pans out.

TGR: So you’re a small cap long biased fund. What are you doing to your fund to maximize this potential pullback and the resulting rally?

SP: We’ve taken some profits in some of our big winners and we’ve purchased some ETFs that have an inverse correlation with the market, like the bear units and the double bear units. We are hedging some of the systematic risk.

TGR: You indicated that you trade gold on the technicals and there’s clearly an inverse correlation with the U.S. dollar. Where do you think the U.S. dollar is going? Have we hit bottom on the dollar, or what do you expect to see in the remainder of ‘09 and through 2010?

SP: The U.S. dollar in the short term, I think, is going to appreciate from here. Almost everybody believes the U.S. dollar is going lower longer term; and I don’t disagree with that, but it’s not going to go straight down. So I’m expecting the U.S. dollar to rally in the short term and gold to sell off.

TGR: Would you see that short-term similar to what you’re looking at in the general market in the next month or two?

SP: Yes. Gold is probably peaking this week if I were to stick my neck out.

TGR: But longer term we’re expecting the U.S. dollar to go lower than where it is today.

SP: Yes. That’s over years—like several years from now.

TGR: So are you anticipating it’s basically going to bump along at the current level it’s at, in a small trading range?

SP: I expect it to rally a little bit then take another leg down, but it’s not going to happen overnight.

TGR: And, as a result, what would you see gold doing for the remainder of this year and into 2010?

SP: Gold will just follow the U.S. dollar. There is currently a lot of speculation in the gold market, as well. There are all these ETFs that have purchased a lot of gold—all the dehedging by the producers that has created a lot of demand that’s not going to be there in future years; so I’m not a super bull on gold. I do have several junior gold investments, but the expectation is that they will do well regardless of whether gold is $1,100 or $850. The share prices of these companies will be driven by company-specific catalysts.

TGR: So you’re looking at the juniors rather than the metals as an investment.

SP: I like to look at the exploration stories, where you get a bigger bang for your buck rather than just buying a producer.

TGR: You mentioned earlier you have a few companies that you’re looking at. Can you share any of those companies with our readers?

SP: Pelangio Exploration Inc. (PX: TSX-V) I like a lot. They recently raised $7 million to drill a property they have in Ghana, which is right beside a large producing mine of AngloGold (NYSE:AU, JSE:ANG, ASX:AGG, LSE:AGD), which has 60 million ounces on the property, and Pelangio is adjacent to that property. On AngloGold’s property the gold is contained in pods of 3–5 million oz each. Pelangio has 15 drill targets, and they’re going to be drilling out over the next few months, and hopefully releasing their results early next year. I like situations like that where it’s in a proven gold district with high odds of success. So I think that could have some significant gains if they can show that there are similar pods containing gold which extend onto their property. If Pelangio can demonstrate this, it should be a multi-dollar stock.

TGR: Any other exploration stories that you’re intrigued with that you can share?

SP: I still like the Colossus Minerals story. I think there’s more upside to come. They just raised money as well, so now they’re fully financed into production and they’ve applied for a mine permit, which they’re hoping to get early next year. That could also be a catalyst for a takeout once they get their permit. They’ve had some fantastic results and they’re continuing to drill on that property.

TGR: They’ve had an incredible increase in their stock price this year. Earlier, you mentioned they were a big winner. How much more upside can they have?

SP: I think that if the drill results keep coming in as they have been and they progress towards producer status by obtaining the permits it will trade over $10.

TGR: Will they be reliant on the price of gold staying above $900?

SP: Not particularly, because it’s more of a building resource type of story; the grade is very high and they don’t just have gold. They have very high grades of platinum, palladium and some other minerals like rhenium as well, so their operation would be highly profitable regardless of whether gold is above $1,000 or not.

It’s still a developing story. Further catalysts could come from proving up other zones on the property that they’re doing some work on, or if they were to acquire additional land in the area.

TGR: Any other companies that you’re following in exploration or near production?

SP: Another company I like that’s not in the gold space is Puget Ventures Inc. (TSXV:PVS).. It has quite a small market cap. The company has a cobalt property that produced in the 1940s, and they still have infrastructure on site. Recently, they’ve raised money to go back and do some further drilling to increase their reserves and mine life. They could be back in production in a relatively short time frame. One of the reasons I like it is that recently investors have been very interested in lithium companies and have bid up share prices of many lithium companies dramatically this year. I think Puget is another play on the same thing, Cobalt will be in increased demand for batteries as a result of the electrification of vehicles. There is actually twice as much cobalt in a lithium battery as there is lithium; and cobalt sells for roughly four times the price of lithium, so it’s a similar play on the whole electric vehicle market.

TGR: Back on to energy, as we also have a sister report called The Energy Report. What trends are you looking at in energy that you feel look like good investment opportunities?

SP: Colombia’s attracted a lot of interest recently; several companies have had a great success in there. The government has moved the army into certain areas to make it safe for foreign companies to operate, so that’s opened up a huge opportunity for many companies. One of the ones I have been buying is a company called Quetzal Energy Ltd. (QEI-TSXV). They recently announced that they acquired a property in Colombia which is highly prospective for oil. They are in the process of raising some money now to fund some work on that. That property is of particular interest because, first of all, a lot of the other companies in Colombia have had great success—but all the properties surrounding this property are producing oil properties, so it’s highly prospective.

TGR: Where do you see oil going compared to some of these alternative energies, which are getting a lot more press?

SP: A lot of the alternative energy initiatives are highly dependent on government programs and grants. Obama and other politicians remain highly supportive of these initiatives so alternative energy companies should do well. Natural gas inventories are very high right now relative to the past several years thus the price of natural gas has been trending lower in North America, while oil has rebounded strongly from the $30s where it bottomed. It is probably unlikely that oil goes much higher in the short term. It’s probably at a reasonable level right now.

TGR: It sounds like you have a similar focus in terms of looking at gold. You’re looking for exploration plays that will have appreciation regardless of the price of the underlying commodity.

SP: Yes. If you can eliminate some of the variables that are not easy to predict like the direction of commodity prices or currencies and just focus on the company specific catalysts, it lowers your risk.

TGR: So Quetzal is an exploration story at this point? Are they producing anything?

SP: They have some small production—very small—in Guatemala. They had some technical issues drilling a well there and I now they’ve acquired an additional avenue for growth in Colombia.

TGR: And is the oil play here more interesting because it’s in Colombia, or do you like the oil sector in general?

SP: I am somewhat indifferent to overweighting the oil sector. I like Colombia because of the recent changes there and the huge drilling success several companies have had there recently. Obviously, areas of the country are highly prospective for oil. Companies I mentioned like Pelangio and Quetzal are ground-floor type situations where there are very good odds of success. And if they have success, the shares would be revalued upwards by multiples. These are the type of situations I like.

TGR: Thank you for your time.

DISCLOSURE: Steve Palmer
I personally and/or my family own shares in the following companies mentioned in this interview: AlphaNorth owns shares of all companies mentioned.

Steve, who is a Chartered Financial Analyst, earned his BA in Economics at the University of Western Ontario. After starting in the investment community as a research associate, he moved to a major financial institution in mid-1998, where he met Joey and built his career. As Vice President of Canadian Equities, he managed assets of approximately $350 million, including a pooled fund that focused on small-cap companies.

S&A Resource Report editor Matt Badiali covers a broad expanse of ideas as well as geography in this exclusive interview with The Energy Report. He discusses the immense potential of Iraqi oil, and the smaller but surer resurrection of old oil fields in Illinois. In addition to sharing views about areas within the oil industry worthy of investors’ attention, he talks about the promise—and problems—associated with major oil finds that have been making the news. These discoveries may postpone peak oil by a decade or two, but they will take a long time to bring to production, too. Matt also points out how data reporting metrics (BOE) manage to hide the extent of dwindling oil production.

The Energy Report: When we interviewed you six months ago, you were talking about some new oil finds in the Tupi field off the coast of Brazil. Since then another big oil field has been identified offshore of Sub-Saharan Africa. Can you speak to these finds and what they will mean to the oil sector?

Matt Badiali: Sure. There have been several big pre-salt or sub-salt discoveries offshore South America, offshore Brazil. The ability to gather much more detailed seismic energy information is driving these new discoveries. They go out and collect seismic information, shooting sound waves through the ocean into the sediment beneath the ocean floor. The further away, the deeper it gets into the earth, the noisier it is. With the advances in computing power, they can actually filter out that noise and see deeper and deeper.

And salt created its own special problem because it attenuates the actual sound you put in; in the past, you couldn’t see underneath it with seismic data. They can do it now with the algorithms they’ve developed and faster, stronger computers.

Having found the oil is one thing. The problem is that the ability to see the oil got ahead of the ability to develop it. This oil is going to require some of the deepest wells ever drilled and the deepest production infrastructure ever placed. Superlatives like that concern me, because the costs go up. Because it’s never been done before, you can probably add a zero to the price tag when you bid out this oil pipeline. Making money on this oil will be a challenge for Petrobras (NYSE:PBR).

And as you mentioned, there is a new discovery in offshore Sub-Saharan Africa, kind of the horn of West Africa. Anadarko Petroleum Corporation (NYSE:APC) and Tullow Oil plc (LSE:TLW.L) have made a couple of really exciting discoveries there. They’re exciting because they’re separated by about 700 miles, stretching from Ghana on the east to Sierra Leone on the west. I think Exxon Mobil Corporation (NYSE:XOM) is competing with one of the Chinese oil companies to get a 25% stake in the Jubilee Field, which is the one south of offshore Ghana.

TER: This might move the peak oil date farther ahead.

MB: I think this is a really, really massive play. And yes, if that’s the case, it pricks the peak oil balloon again for another decade or so. When you start putting the discoveries together on this one, and consider some of the work that Anadarko has put together, you’re looking at 6 billion barrels conservatively.

That’s very similar to the Tupi discovery. So offshore Sub-Saharan Africa could be the next offshore Brazil, in which case we have lots and lots of oil out there. We just have to figure out how to develop it.

TER: And at what price.

MB: David O’Reilly, CEO of Chevron Corporation (NYSE:CVX), came out last week saying there’s going to be a shortage of oil in the next decade and he’s pointing to $100-plus a barrel again. His line of reasoning is rational. For instance, Venezuela basically uses all of its oil revenues to subsidize bizarre projects such as donating heating oil to people in the United States, keeping Chavez in power. Basically, Mexico did the same thing and ran themselves right into the ground. They are on track to becoming net oil importer from one of the biggest oil exporters in the world. And Mexico has the potential of doing the same thing. We’ve already seen it with Indonesia, which was one of the founding members of OPEC but got kicked out because they became a net oil importer a couple of years ago.

Oil fields require sustaining capital. You have to keep drilling. You have to rehabilitate the fields. You have to spend money on them. They’re not a golden goose. A lot of these countries where the sole source of GDP is oil don’t do that. They spread the wealth around and that’s a problem.

The other thing that you see—and you see it reflected in the mix of oil-to-gas reserves in a lot of these big companies—is that the discoveries of oil are declining and they’re replacing oil production with natural gas reserves. It’s very subtle because most oil companies present their data in BOE (barrels of oil equivalent), which is oil and gas combined and published in barrels. It’s kind of a slick way to not tell you that they’re actually finding natural gas and not oil.

So we could see more robust oil prices going forward. We hit $65–$70 a barrel in 2005, 2006, 2007, before things really got crazy, and we’re right back in that same groove. This isn’t out of line. I think $35 a barrel earlier this year was a market over-reaction to the catastrophe. Everybody was looking for the end of the world and when it didn’t happen, things are starting to get back to normal.

TER: Are you talking about a temporary spike due to the oil-producing countries depleting reserves and we don’t yet have the oil from these deepwater finds?

MB: If these countries continue to lose production, it’s going to be very, very difficult to replace it. So even when you bring these massive oil discoveries online, that’s going to take a long time—five, six, eight years down the road to build these pipes and put in the infrastructure they need. These are discovery stage. It takes a long time to go from discovery to 100,000 barrels a day, 300,000 barrels a day.

Part of the equation that’s still in limbo is Iraq. I think they’re shooting for 10 million barrels a day, and that’s oil that’s inexpensive to produce, is land-based, and just needs the infrastructure to be upgraded. That’s going to be the real hinge on what happens to oil prices. If Iraq doesn’t get its act together, we’ll have to rely on offshore oil fields to take up the slack. Then the oil price is going to be very, very cyclical. If there’s a storm, if there’s a riot, it’s going to get bad and oil prices will spike.

I won’t say oil is never going to go below $100 a barrel again, but I certainly am further over in the $100 a barrel camp today than I was April of 2008 when people were saying it was going to go to $200 a barrel and I couldn’t figure out why it was at even $100.

TER: In our last conversation, you were really hot on the oil services sector—partly because you expected the oil price to rise (which it has) and also because you saw the services sector trading for just about book value. You gave us a couple of recommendations, which have doubled or tripled since then. What do those oil service sector companies look like now in terms of investment opportunity?

MB: When you take gains like that, things get too expensive. We were buying those shares at fractions of book value. I think Parker Drilling Company (NYSE:PKD) was trading at 30 cents on the dollar in terms of the value of its rigs. When oil is cheap, the market looks at drill rigs sitting in parking lots and assigns them basically no value at all. I wanted things to get a little better and I knew we would make money that way—and we did. But now they’re trading at multiples of book value again and things could get worse.

The nice thing about the oil and gas industry is it’s very cyclical, so we get these opportunities. Right now I’m less interested in the service companies. There are sectors of it that I probably should be paying more attention to right now. When we talked in April, the number of onshore rigs drilling specifically for oil went from 224 to 204. They were getting clobbered. Today that’s rebounded all the way up to 309 rigs from its bottom in June. So, our timing on the investment was absolutely perfect.

Gas drilling rigs are starting to come back a little bit now, but they didn’t bottom until the middle of July. They went from 800 in April to 675 rigs in July and they’re back up to 721. To me that also speaks to the oil-versus-gas situation I mentioned earlier—300 rigs are out there drilling for oil and 700 are drilling for natural gas. These companies are replacing their reserves with natural gas, so there could be less oil available in the future.

TER: So if not oil services anymore, where do you see the action these days?

MB: I’m very excited about companies that have oil production that’s not the cheapest production in the world, so maybe they’re paying $25 or $30 a barrel to produce it. But as the oil prices go up, their earnings rise faster than lower cost producers. They have leverage to the oil price, so now I think gains will be made in those kinds of companies. These are companies that maybe produce heavy oil or tar sand.

But my favorite group of companies right now does enhanced oil recovery (EOR) or tertiary recovery. They go back into oil fields discovered around the turn of the last century, produced millions or billions of barrels of oil, and then were left for dead in the ’70s or ’80s or ’90s when oil hit $10 or $15 a barrel.

The Lawrence Field in Illinois is a great example. It probably still has 50% or 60% of its original oil in place. They produced maybe half of it, so a little company is back there now and injecting a chemically that acts basically like Dawn liquid dish soap.

TER: Dawn?

MB: Dawn takes the grease out of your way. It’s not really Dawn, but a surfactant. When they put the chemical into the reservoir, it kills the surface tension and the oil mixes with the water. They figure they’re going to get 20% of the original oil out. That’s hundreds of millions of barrels. And they’re going to do it for $25 or $30 a barrel. If oil hits $90, they’ll make a fortune. People are starting to pick up on it, but they haven’t quite gotten there yet.

I like that better than, say, tar sand, because it’s light, sweet crude—the real stuff. A couple of other companies that I really like are injecting CO2 into oil fields to lower the surface tension and loosen up the oil. With today’s society seeing carbon dioxide as a bad actor, an oil company that’s injecting carbon dioxide into its oil field to produce low-carbon oil is going to get a lot of attention. I think they will get a higher multiple for that oil, whether it’s deserved or not.

TER: Who are the companies?

MB: Probably 10 companies are doing this kind of stuff. Marathon Oil Corporation (NYSE:MRO) has done a lot of this, but I haven’t recommended them because it represents only a small fraction of their production. EnCana Corporation (NYSE:ECA) does this too. Marathon and EnCana are the two big guys.

TER: Which one is in Illinois?

MB: The company that’s working in the Lawrence Field is Rex Energy (NASDAQ:REXX). It has absolutely exploded, though, not because of the EOR work, but because they’re based in State College, Pennsylvania, right in the heart of the Marcellus Shale region and they have a partnership in the Marcellus. As soon as natural gas prices turned around, Rex exploded out of the gate.

TER: Do you have a target for Rex?

MB: No. I typically don’t do targets on the upside. I let the market tell me because my experience with a lot of these smaller companies is that I would be way too conservative. I basically told people to buy it up to $8 and it’s closing in on $10.

We don’t know what the oil price will be when the Lawrence Field production comes on and how much money they’re going to make. But at $90 a barrel, the economics of that field look much, much better than they did when I first recommended it, so that’s pretty exciting.

TER: And when do they anticipate production?

MB: The first or second quarter of 2010. I think the Lawrence Field story is fantastic. And bear in mind, this is a region of the United States that’s been hit particularly hard in the downturn and this oil company is putting people to work on an old oil field that was discovered in 1906.

To tie this back to Brazil, Petrobras very quietly put together a $145 million research project to inject CO2 into one of its fading onshore oil fields and it was pretty clear that they will do this to their offshore fields too, because it almost guarantees an additional 20% production. The people at Petrobras are no dummies. They want to get as much oil out of these fields as possible, so I wouldn’t be surprised if they build the infrastructure for their CO2 floods on the front end rather than trying to retrofit things.

TER: You said maybe 10 companies are doing enhanced oil recovery. Can you tell us about any more of them?

MB: BreitBurn Energy Partners L.P. (NASDAQ:BBEP), I believe, is doing some EOR work in California. And Venoco, Inc. (NYSE:VQ), which—believe it or not—has oil wells in downtown Los Angeles, also does this. They have elaborate façades; you wouldn’t even know you were walking by an oil well.

TER: Are you looking at any other oil plays?

MB: This is the perfect time to look at leveraged oil. Suppose a company produces oil for $30 a barrel and sells it for $40. The market says it will value the company at 10 times earnings. If this company then doubles its production or the oil price goes up by $10, it doubles its earnings. On a P/E multiple, that doubles the market cap. It usually doesn’t work quite that nicely, but that’s the way leverage to your commodity works.

With the higher-cost producers—EOR, heavy oil, tar sands—where their production costs are $25 or even $35 a barrel, that’s a very nice increase in share price if oil goes from $80 to $90. So that’s kind of what I’m looking at across the board.

TER: So do both heavy oil and tar sands provide more of that leverage?

MB: They both do. They’re both high-cost production, basically. But you don’t want to buy these high-cost producers in an environment where the price of the commodity could fall. That’s our biggest risk. If the dollar strengthens, the price of oil will come down and these high-cost producers will fall because that leverage also works in reverse. But I think we’re going to hit $90 before we hit $50; that’s what I keep in mind.

TER: Other than these leveraged oil plays, what are you watching?

MB: I’m still really excited about Iraq. I think there’s going to be some enormous discoveries. We recommended a company called Addax Petroleum Corporation in Iraq in May, because they had a discovery we really liked. I was really disappointed because we were only able to be in Addax for six weeks before Sinopec International Petroleum Exploration and Production Corporation (NYSE: SNP.N)bought it. But we made a 55% gain in those six weeks.

There are a couple of other oil companies in Iraq, but they trade mostly on foreign exchanges. Heritage Oil plc (LSE:HOIL; TSX:HOC) is in the process of merging with a privately held Turkish company, Genel Energy International. That’s a spectacular oil company and I think they’re going to make some big discoveries. But they haven’t moved a blip lately because they’re in the middle of a merger and the merger hit a couple of bumps.

Another company I recommended was working on a joint venture with the Iraqi government, the Iraqi State Drilling Company, to bring western drilling techniques into Iraq. Basically, Iraq has had no modern drilling since the ’80s. It is the home of billion-barrel-plus fields with very, very low operating costs. If I were going to start an oil company, Matt Badiali Enterprises, I’d go to Iraq. My operating costs would be less because people still think of Iraq as a war zone, but I’d have a great chance of finding massive oil reserves. To me it’s the best place for a small oil company to go to add a zero to its market cap, if it’s willing to accept the political risk.

When I’m playing oil discovery, I’m looking at places where people are a little afraid to go, political risk over technical risk. That’s the mistake that 90% of analysts are making with those offshore Brazil discoveries. There figure there’s no political risk, that Brazil is as excited as all get-out, but the technical risk is enormous. When you make a mistake on a $4 billion oil pipeline, it’s a problem. And there is political risk in Brazil that people are undervaluing.

TER: How so?

MB: Brazil has proposed to create a brand new company—a quasi state-owned, quasi public company—that will oversee all of these offshore oil fields and will take ownership in part of all fields held by foreign companies. And they’re going to go to production sharing agreements (PSAs), where the foreign companies will get cash per barrel, but won’t be able to book reserves. Knowing what I know about Brazil, I thought, "Man, they just legally added a whole other layer of graft to that system." This is just another way for Brazil to tax that oil discovery and to steal as much as they can.

This is a massive discovery but it’s not going to be the oil industry’s savior. As soon as the size of the deposits became clear, the country changed the rules. If Brazil isn’t careful, it could go the same route as Venezuela and Indonesia.

TER: Could you give us a quick synopsis of your view of the geothermal market as an investment? It’s been attracting a lot of attention of late.

MB: There are two very different investment theses behind some of the companies in this space. Ormat Technologies Inc. (NYSE: ORA) is a play on everybody else getting excited about geothermal. It does produce some geothermal energy, but it is more the general store for the geothermal industry.

And I think if any form of cap-and-trade passes that makes coal-generated electrical power much more expensive, Calpine Corp. (NYSE:CPN) is going to make a lot more money. I’ve actually visited the geysers, which is where Calpine produces a lot of its geothermal energy. They generate hundreds of megawatts and it’s silent, the coolest thing in the world.

TER: It sounds as if geothermal appeals to you.

MB: It does. What really what gets me excited about geothermal is that it works. It’s not solar and wind, which need subsidies; and it’s not tidal energy that works well on some engineer’s drawing board, but doesn’t translate into the real world.

I’ve heard that every megawatt of wind or solar energy needs a megawatt of natural gas or some other consistent power source to back it up, because there’s no way to store this energy. If you produce wind power and suddenly the wind stops blowing at peak hours, you have to be able to turn something else on and generate that electricity.

Geothermal works. It’s an economic, 24-hours-a-day source of power, and it makes a lot of sense. That’s why I’m glad to see these new mid-sized entrants into the geothermal space. I think it will be a race between Ram Power Corp. (TSX: RPG) and Magma Energy Corp. (TSX:MXY) to roll up the junior geothermal industry.

TER: Rick Rule and Ross Beaty. They’re good friends, too.

MB: The fact that Ross (Magma’s founder) got into this is very exciting, and Rick has been pounding the table on geothermal for a long time. So this is good. We’re going to need every source of energy we can get. As China gobbles up more and more energy abroad and our population grows, we will need as much domestic energy production as we can. That’s electricity and fuel.

I look at oil as not so much a source of electricity, but as a source of fuel for trains and boats and planes and cars, trucks. I look at natural gas, like coal, as a source of electricity.

I find it unbelievable how any carbon-producing fuel is suddenly bad. People getting angry about coal, to me, is a complete disconnect. I grew up about 50 miles from Three Mile Island. Remember all the horrors of the 1970s nuclear scares? Now we see green TV commercials with baby birds and bunnies and a nice lawn and an attractive couple who get their electricity from nuclear power. Talk about cyclical. Holy smokes.

Now coal’s the bad guy. But if we’re going to get rid of coal, we need more sources of electricity. That’s where geothermal fits in. It’s also going to spark the renaissance of natural gas, because we need a transitional fuel. If you want to get away from coal, you need something to produce electricity with and natural gas is going to be the source. You can build a natural gas plant far, far faster than you can build a new nuclear plant with far fewer regulations.

TER: That takes us into a whole other discussion. There’s so much to talk about. You’re in an exciting area.

MB: Oh, man, I love it. It’s been spectacular and it’s been fast, with opportunities flying by.

DISCLOSURE: Matt Badiali
I personally and/or my family do not own any of the companies mentioned in this interview.

A member of the Stansberry & Associates Investment Research team of editors, Matt Badiali produces the The S&A Resource Report, a monthly investment advisory that focuses on oil, energy and mining and sectors—from the biggest resource companies in the world to small-cap junior explorers. With "the global economy still in the grip of a long-term bull market for oil, precious metals and other natural resources the likes of which the world has never seen," his company says those are the sectors in which "demand is going through the roof, and one of the best places investors can have their money over the next few years."

Matt, who’s spent the last four years flying all around the world digging up the best resource investments, has more than 15 years of experience as a hydrologist, geologist and a consultant to the oil industry. He holds a master’s degree in geology from Florida Atlantic University and is pursuing his PhD at the University of North Carolina. He’s also a regular contributor to Growth Stock Wire, a free daily pre-market briefing on trading opportunities.

With all the ’strong dollar’ rhetoric coming from the Fed and broken-record Bernanke, it’s a wonder any investors are making money. But one we know and trust is. . .because he’s not listening. "The U.S. will continue to take a laissez faire approach to the dollar," says John Doody, Economics Professor for nearly two decades and current author and publisher of Gold Stock Analyst. In this exclusive interview with The Gold Report, John explains how he measures gold’s price performance, why he believes most investors don’t have enough gold stocks in their portfolios and which companies he’s making money on right now.

The Gold Report: John, why hasn’t the mainstream media caught on to what’s going on with gold?

John Doody: The CNBC types are always talking their own "book," which is mainstream stocks. If no one buys the broad market stocks, there are no jobs for the talking heads, et al., at CNBC. They’re always pooh-poohing gold and love saying that gold at the current price, $1,060, hasn’t really done much from the $850 high in 1980. That’s a false comparison. If you want to use that, then why not point to the S&P high in the 1500s or the Dow high in the 14,000s as a measure, instead of the March 2009 lows?

The gold price was controlled from the 1930s until March 1968 by eight Central Banks (CBs) that were the gold cartel and fixed the price of gold at $35 an ounce. That ended in March 1968 when market forces overwhelmed the CBs. Unable to enforce $35/oz, they let gold’s price float in the free market. Between themselves, they still traded at $35 and then, of course, all of that fell apart when Nixon went off the gold standard entirely in ‘71.

The appropriate measure for me as to how gold has performed is to go back to when the price was set free, March 1968. If you take the $35 gold price and adjust it for 41 years of the U.S. CPI increases, the gold price would be about $220 an ounce, increasing at an average compound rate of about 4.5% a year. But since being set free in 1968, the gold price is now $1,060. So gold has provided great inflation protection, and growth. From $35 to $1,060 — that’s about an 8.5% compounded annual rate per year. That’s the true measure of gold’s value for inflation protection. (See chart.)

TGR: So what’s driving the price of gold? Is it just the devaluation of the U.S. dollar?

JD: Well, that’s part of it; but gold is still about 10% below the all-time high in other currencies, such as the euro or the yen. So part of the growth of gold price is due to all fiat currencies falling, but it’s mostly due to the dollar going down because it’s a dollar-denominated commodity and that’s what people want to escape—the dollar’s declining value. Gold provides appreciation and a safe haven.

TGR: How long do you expect this trend to continue?

JD: It could go forever. I don’t think we’re going to see the hyperinflation of Zimbabwe or the Weimar German Republic. The falling dollar will eventually cure the trade and current account deficits because we’ll stop buying foreign-made goods. They’ll just be too expensive. Currencies go through these ebbs and flows of value. In the ’80s we had high interest rates and the dollar was too strong. Central Banks met at the Plaza Hotel in 1985 to knock down the buck’s value, and they were successful. Now I’m not so sure, because foreign exchange markets and the dollar amounts are so big that the Central Banks can really change the dollar’s direction. Like a tugboat changing the direction of a battleship, they can nudge it a little bit in the short term; but long term, it’s the economic fundamentals that control. The U.S. will continue to take a laissez faire approach to the dollar. They talk a good game, they talk strong dollar, but they don’t do anything to defend it and that’s because they want a weak dollar. A weak dollar stimulates U.S. exports and job growth.

TGR: What’s your long-term target for the gold price?

JD: I really don’t have one because my investing strategy is to find undervalued gold stocks at every gold price. So it’s not necessary for me to say that the stocks I recommend are going to go up because gold’s going to go up. My Top 10 Stocks should go up because they are not properly valued vs. others of comparable stature based on the three metrics I use: 1) market cap per ounce of reserves, 2) market cap per ounce of production, and 3) operating cash flow multiple. My Top 10 so far this year is up 124% and that’s with one stock being flat. So the other nine have, on average, more than doubled. That’s vs. gold at $1,060 up 22%, and the XAU up 45%.

This appreciation is why you should own the stocks more than the metal. Every dollar of price increase gives you a dollar more profit from current production, and it makes all the ounces that you’ve got in the ground that haven’t been mined each worth a dollar more. Typically, a mining company has 10 times the reserves in the ground vs. what it’s currently producing. So that 10 multiple—it’s even higher for some—that’s where you get the leverage from a gold price.

TGR: At a certain point, of course, stocks become overvalued. In your recent newsletter you said that they’re fairly valued at a gold price of $997. We’re now at $1,060. Are we getting close to being overvalued?

JD: Not yet, because the gold price of $1,060 now justifies higher values than at last month’s $997 gold price. What I’m looking for is the market to go to overvalued, as it’s done in the past. I measure overvalued and undervalued based upon past relationships between the market cap per ounce values we calculate every month vs. gold price at that time. Right now we’re at a fairly valued situation. But there’s been four instances, in 2002, 2003, 2006 and 2007, when gold stocks were 20% or more overvalued based on my market cap/oz. metrics. It’s investor enthusiasm that creates these overvalued situations, and as can be seen in the chart, we’re not there yet.

People bid up the prices of the stocks so that the market cap per ounce we calculate goes to overvalued levels vs. where they’ve been in the past. So, even if gold did nothing from here and just stayed around this $1,050–$1,060 area, investor enthusiasm could drive the stock prices higher to make the stocks 20% overvalued.

So I see a lot more upside from here and I think this is evidence that we don’t have a big retail participation in this market yet. People have been thinking there’s a $1,000 an ounce ceiling and they don’t realize that it’s become the floor. Maybe it’s going to take a few months hanging over $1,000 or maybe we’re going to have to get to $1,100. At some point investors are going to realize this gold bull market has much further to go and as they pile into the small gold sector with only a $250 billion market cap, they’ll drive stock prices much higher.

One rationale for more investors coming to gold can be found in studying the S&P500 vs. gold price. As seen in the chart below, from 1973 to 1991, the gold price was higher than the S&P. From 1992 to 2008, the S&P 500 was higher than the gold price. Now we’re back in the area of uncertainty where the gold price and the S&P price are about the same. As you look forward, I can’t make any argument for the S&P going higher. I think that it’s overpriced now and that analysts are building in earnings numbers for the S&P that aren’t going to be earned. The consumer’s tapped out. So the banks have come back some, but they’ve got a lot of bad debt still to write off from credit cards and commercial loans The consumer is 70% of the economy. Without them aggressively participating, I just don’t see any driver for the S&P 500 to even support this level. But I can see lots of drivers to support a higher gold price. Just look at monetary and fiscal policy, printing and borrowing too many dollars The years ahead, in my opinion, have to be good for gold and not so interesting for the S&P 500 and I think as people realize this, we’re going to get more retail investors coming to the gold sector.

TGR: So your Top 10 list that you came out with last January is up 124%. Nine winners and one flat one. Do you come out with another Top 10 list in January 2010?

JD: We do it on an ongoing, not an annual basis. We calculate the results on an annual basis, which is very unique in this industry. Nobody else does this unless they’re a mutual fund. Every other newsletter wants to tell you what their results were based upon when they first recommended the stock, which might be five years ago. But we track the Top 10 the way any private investor would their portfolio and we put a monthly statement in the newsletter. We’ve had one sell in 2009. We took one off that was up 58%. It hit our target price and we didn’t see a reason to raise the target price. We sold it and we had 10% cash for about four months, and we just found a new company, Terrane Metals Corp (TRX: TSX.V), which we put on the Top 10 list in September.

We put Terrane Metals on at 50 cents. It’s 80 cents now and our initial target was $1.50, but we said if a feasibility study update comes through as we expect—and we expect it to see a 30% increase in the reserves — that would make our target price $2.50. Well, yesterday the feasibility results were released and we’ve raised our target price to $2.50. The stock’s still at 80 cents.

Of my Top 10, the flat one is Royal Gold Inc. (TSX:RGL, Nasdaq:RGLD), which started the year around $49 and that’s where it is now. It was the only winner of any note last year in 2008. It was up 60% and I think that 2010 is Royal’s year because it has two big mines coming on line. On Goldcorp’s (TSX:G) (NYSE:GG) Penasquito it gets a 2% royalty that’s worth about 78 cents a share in royalty revenues and another big mine, the Andacollo mine, owned by Pacific Rim Mining Corporation (TSX:PMU, NYSE/AMEX:PMU), will be coming on line towards the end of next year to add almost $1.00 a share. Stocks have cycles, and sometimes we sell and try to buy them back, but sometimes we just stay with them because we know it’s hard to buy some, particularly since Royal’s only got 40 million shares outstanding.

TGR: John, I believe you said to your subscribers, if Royal Gold gets below $40, back up the truck.

JD: I did and it did.

TGR: It did, absolutely, and those subscribers who listened to you have got a nice 30% gain because that did happen.

JD: Well, you know, these all can trade up and down. They’re volatile. Sometimes you get a new fund manager that doesn’t like the story and so he dumps whatever’s in the fund that he doesn’t like. They’re going to get judged on what they buy, so they buy the stories they like. I’m not saying that’s what’s happened to Royal, but it does happen with these stocks, where all of a sudden you can get a 20% or 30% selloff. I tell investors they should keep a mental 20% trailing stop. But then if the stock falls 20%, is that a reason to sell or buy more? And, more often than not, it is a reason to buy more. Sometimes if something basic changes, we’ll take the stock off the Top 10 and tell people to sell. But if nothing basic changes, it becomes a back-up-the-truck opportunity.

TGR: Many of your stocks are starting to approach your target price, yet you still sound pretty optimistic that there’s a lot more upside.

JD: Yes, and we have to change the target prices. We’ll probably do that in the November issue. The target prices were basically set when gold was $900. That’s been my working price for the year and for the first six months, the average price was $912, so that was a good enough number. Now we’re getting not only to the end of the year and we’ve got a much higher gold price, but we’re also starting to look forward to what production is going to be next year. One of the things we look for, in addition to the three main metrics, is growth in production. So we’ll start looking at what higher production will do for the stocks next year. We raised the target prices for two stocks in the October mid-month update, and because the November issue updates our reports on four of the Top 10, we’ll probably be raising more targets.

TGR: Are there some other stocks that are in your Top 10, or ones that you’re watching that you can share with our readers?

JD: Sure. Goldcorp (TSX:G) (NYSE:GG) has been a Top 10 stock. It’s up 36% so far this year and, basically, I think the market’s waiting to see that its Penasquito Mine, which is also important to Royal Gold and Silver Wheaton Corp. (NYSE:SLW, TSX:SLW), comes on line as planned. Mines don’t always start up smoothly. They’re not like buying a television and you just turn it on. It’s more like buying a computer that doesn’t work when you start it up. It doesn’t mean they can’t be fixed, but usually there are issues and little glitches and it takes a while to ramp them up.

The Penasquito Mine won’t be fully operational until sometime in 2011. That’s almost a two-year ramp up, but it’s a huge mine. The revenues at these prices are going to be about $1.6 billion a year. It produces a half a million ounces of gold, 31 million ounces of silver, and millions of pounds of lead and zinc a year. It’s going to be the biggest mine by far in Mexico in terms of revenues and in terms of gold production. And I think the market is waiting to see that this is coming on smoothly for Goldcorp to begin to reflect it in its price. And the stock’s 36% increase so far this year is still about double that of gold.

I expect that everything’s going to work fine and that Goldcorp’s big year may be 2010 and that’s the same for Royal Gold, as I said. It’s got a big royalty on the site. At current prices, the revenues of the site are $1.6 billion, Royal Gold’s 2% is $ $32 million a year; close to 78 cents a share.

Silver Wheaton is producing right now about 18 million ounces and it’s really a royalty stream situation, much like Royal Gold . Silver Wheaton’s royalty is 18 million ounces a year times the difference between silver price and the $4 per ounce it pays miners. If silver averages $16 in 2009, that’s $12 net times 18 million ounces for $216 million in royalty income. The silver stream increases by 7 million ounces when Penasquito comes on line fully. So Silver Wheaton is a great way to play silver, though there was a great deal just made today by Pan American Silver Corp. (TSX:PAA; NASDAQ:PAAS), who, in my mind, is the best operating silver miner in the business by far. They’re buying Aquiline Resources Inc. (TSX: AQI) for $600+ million. There’s 700 million ounces of silver, with more expected. This is exactly what Pan American has been missing, in my opinion, as a stock. It’s had a number of smaller mines that add up to about 20 million ounces a year, but the Aquiline deposit is going to give the potential to add another 10 million ounces right on top of that or more and give it the real flagship it lacked.

Another stock that has done well this year is Yamana Gold Inc. (NYSE:AUY), up 63%. And, again, this has been a situation of bringing on line a new mine in Argentina. It’s now operating on a commercial basis and seemingly running fine. If Yamana makes a good jump up in production next year and 2012, the market will soon begin to factor it into the stock price.

Minefinders Corporation (TSX:MFL, NYSE.A:MFN) has doubled this year. It’s up 104%. And, again, it’s not fully up and operational on its new Dolores Mine. It’s not until January of next year that it begins to hit its full recovery for silver. It’s already hit its recovery rate for gold, but silver still is to come. So there’s going to be plenty of basis to raise its target price.

European Goldfields Ltd. (TSX:EGU, AIM:EGU) is up 130% this year. They got a key permit just the other day in Greece and European has 9 million ounces of reserves, almost $200 million cash in the bank. It’s got three mines that it’s building and the one base metal mine that’s currently operating. European has had a $6 stock target, which it hit and I’ve raised the 2010 target. When all of the permits are issued, which should be early 2010, I think the stock could be a long-term triple from here.

My philosophy is you’ve got to buy 10 because if you buy one stock and it’s got a permit or similar issue and it doesn’t get it, you’re going to get killed. But if you’ve got all 10, you can take that risk. But too many investors think that they’ve got gold exposure with one or two stocks. And then when I ask them what the one or two are, they’re exploration plays. That doesn’t give you any gold exposure at all. That’s just exploration exposure.

At the gold shows I speak at, such as the coming one in San Francisco, people show me their portfolios. Most of them suffer from not having enough gold stocks. They have a big enough percentage, the proverbial 10% or 15% of the portfolio. But too often it’s all in a couple of stocks and that’s too much risk. You need to diversify your risk. In the old days when it cost you $200 commission, it was expensive to own 10 stocks. But now with $10 internet commissions it’s no big deal. Or they own too many and the risk of that is that you’re just going to mimic the market at best. The typical gold mutual fund has 40 stocks in it and that’s why they can’t do so well. There aren’t 40 gold stocks worth owning.

TGR: John, you offer a trial subscription, correct?

JD: Yes, you can subscribe for three months, and there’s a free issue on the Gold Stock Analyst website, which you can download. It’s not the current one, but it’s free, and you’ll get an idea of the detail of our work. It takes seven issues to cover all 75 stocks, plus we have the mid-month update of two to six pages. And we often make changes to the Top 10 in the update. The main monthly issue features reports on all the stocks we cover. The updates focus more on what’s going on in the gold market and what’s happening at just the Top 10.

TGR: John, thanks once again for your input. This has been great.

DISCLOSURE: John Doody
I personally and/or my family own shares in all the companies mentioned in this interview.

Success with his method of finding undervalued gold mining stocks led Doody to leave teaching and start the Gold Stock Analyst newsletter late in 1994. The newsletter covers only producers or near-producers that have an independent feasibility study validating their reserves are economical to produce.

Since the bull gold market began in 2001, Gold Drivers Report publisher and Bullion Store proprietor Eric Hommelberg argues that gold has significantly outperformed the Dow in terms of valuations, and as he sees it, the bull run will last at least until the middle of the next decade. The rhythm of this market over the past eight years tells him that $1,000 gold is history, and we can expect the current climb to push the price past the $1,250 mark next spring. In this exclusive Gold Report interview, Eric tells readers why. He also explains that while he prefers the precious metals in physical form, he recommends holding a select set of junior explorers, too—ones with trustworthy, savvy managements and promising drill results.

The Gold Report: The big jumps in the gold price lately have taken a lot of people by surprise. What’s behind these jumps?

Eric Hommelberg: Investors were waiting for a sharp move, anticipating it for weeks, whether up or down. Giant speculative long positions have been taken on versus giant commercial short positions. Something had to give. It was time for a trigger.

Most of the analysts predicted a crash in the gold price due to the extreme commercial short position, arguing that commercial traders know what they are doing and always win. They’re always right so they’ll most probably be right again they say. But as weeks passed, it became clear that some big buyers were waiting just below the $1,000 mark

Again, investors were waiting for a trigger. When the news came out that the Gulf Arabs—along with China, Russia, Japan and France—plan to end dollar dealings for oil, all heck broke loose. The news made it very clear that a new basket of currencies will most likely include gold—as well as the yen, the yuan and the euro. Sure enough, it was very dollar-bearish—and therefore very gold-bullish news. This prompted, of course, a buying spree for gold, which overwhelmed the short players in the short term.

TGR: Not long ago, you aired a fictitious dialog between "GB" (a staunch gold bull and GATA supporter and "MI," a mainstream investor. Through their discussion, you brought up several themes that explained why the price of gold is increasing. One, argued by GATA (the Gold Anti-Trust Action Committee), is the notion that governments have been suppressing the price of gold artificially and that practice has run its course. Another is that a bunch of commercial shorts are coming due. Other themes included the current recession, pending inflation, and the U.S. dollar devaluation. As you look forward, which of these themes do you expect to influence the price of gold the most?

EH: When you look at the big picture, the main driver for gold has always been the U.S. dollar. Look at the long-term charts for both the dollar and gold. You’ll find a major bottom for gold at the same time you’ll find a major top for the dollar around 2001-2002. In 2009, we find ourselves with record high gold prices and a major low for the dollar. So that’s the big picture, dollar down, gold up.

Now the dollar will continue to sink so gold will continue to rise, it’s as simple as that. As we all know, confidence in the U.S. dollar is waning by the day. That’s why countries such as China, India and Russia are demanding a new world reserve currency. There will be a new world reserve currency. Whether it takes five years, 10 years from now, I don’t know. But until something replaces the dollar as a world reserve currency, the dollar will keep going down and gold will keep going up.

TGR: But what about an economic recovery? Wouldn’t that be good for the dollar?

EH: There is a lot of talk about recovery but the simple truth is you can’t have a recovery without people getting back to work. Consumer spending accounts for 75% of GDP, and consumer spending is not going to increase on the back of record high unemployment figures month after month. Housing prices, which are still in decline, aren’t a big help either. The recovery people talk about these days is simply the result of huge stimulus packages thrown at the economy. Sure enough, these stimulus programs are being paid with money the U.S. government doesn’t have. Since they don’t have the money they simply print it. By printing new money the U.S. government is adding more debt to its already exploding debt levels. In fact the U.S. tries to solve its debt problem by issuing even more debt, and this, of course, is not sustainable and drives down confidence. At one point confidence will reach such a critical low that no one wants to own the dollar anymore, the dollar will crash and then we’re not talking about inflation anymore, but about hyperinflation.

TGR: You’ve been among those who say GATA is right about gold prices having been suppressed artificially. In that context, why shouldn’t other governments, in essence, try to bulk up the confidence in the U.S. dollar by keeping a lid on the gold price, at least until the issue of an alternative reserve currency is resolved? It certainly doesn’t help other countries around the world to have hyperinflation in the U.S.

EH: Of course, it’s not in the interest of China or Russia to see the dollar crash because they have so many dollars. On the other hand, they don’t want to go forward with a world reserve currency that no longer has any value. Something needs to be adjusted. They demand that the U.S. do something about its ballooning deficit and the U.S. promises to take care of it. The problem, however, is they can’t. It’s impossible. If you try to run a business with debt growing much faster than income, you know you’re heading into bankruptcy. It’s no different for a nation.

Regarding the manipulation you referenced, the U.S. has been very much involved in suppressing the gold price for more than 30 years. The reason is quite simple—in order to maintain the illusion of a strong dollar they had to keep a lid on the gold price. A sharp rising gold price would set off all kinds of alarm bells which would undermine the dollar’s credibility as a world reserve currency.

Now GATA has done an outstanding job by exposing the gold manipulation scheme by western central banks. After more than 10 years of extensive research, GATA concludes that more than half of all central banks’ gold, which is about 15,000 tons, has been leased/sold into the market. Sure enough, this gold was mobilized in order to stem the rise of gold. Even Alan Greenspan admitted this when he said in his testimony before the U.S. House Banking Committee in 1999 that central banks stand ready to lease gold in increasing quantities should the price rise. Now GATA demonstrates that about 15,000 tons of central bank gold has been mobilized over the years and sold into the market. The problem, however, is that it’s impossible for these central banks to get their leased gold back without catapulting gold prices to new record highs. Are the central banks going to lease their remaining gold reserves in order to stem the rise of gold? Most likely the answer is no, since central banks became net buyers recently for the very first time since 1987. So central bank gold coming to the market is no longer an issue here, something GATA already predicted in 2001—that this would happen in seven to ten years. Without central bank gold hitting the market there’s no way to prevent gold prices to rise in coming years.

TGR: Given the recent run-ups, would you expect a pullback before the price rises again?

EH: I don’t expect a sharp pullback; nothing like the correction last year. That’s not going to happen. Since gold breached the $1,000 mark for the first time in March 2008, the $1,000 area had been a resistance area. It took about five attempts to slash the $1,000 mark. A long-time resistance area becomes a support level once that level has been breached to the upside. That’s exactly what happened a few of weeks ago, when we saw our first weekly close above the $1,000 mark in history. Furthermore we had our highest monthly close ever as well and this marks the beginning of a new up leg. The charts leave no doubt; they point to gold prices of $1250+ within the next six months. When you analyze the long-term charts you’ll notice a pattern of long consolidation phases followed by sharp up moves. The consolidation phases last for about 18 months, the sharp up moves last for about six months, whereby gold can appreciate by 50% or more. We saw it in 2005 when gold just finished an 18-month consolidation period and then it shot up within six months from $430 to $730. That move started with a commercial signal failure, today with record high commercial shorts outstanding we could be on the verge of a commercial signal failure again.

TGR: So, how should investors play this market now?

EH: I wouldn’t try to trade it at all. The risk is to be out of the market, not to be in. I would just sit tight and enjoy the move. When confidence in the dollar is going to collapse, anything can happen to the gold price. It’s no use to predict gold prices of $1,500, $2,000 or $3,000. It’s just a matter of how much the dollar will be devalued. As I pointed out, I think we’re at the beginning of a sharp up move again and going to new record highs.

TGR: You obviously like the safety aspects of physical gold. Can you describe why you prefer that over investing in gold equities?

EH: Physical gold in your hand is the safest investment you could ever think of. Of course, you can go to the stock market and buy ETF gold. For example, you could buy SPDR Gold Trust (ETF) (NYSE:GLD) or other instruments that represent gold. But what happens when a major financial crisis hits, stock markets are closed, banking holidays or whatever? Then what? It will be impossible to withdraw your money. Besides that, there’s a growing distrust against the gold ETFs—do they really own the gold they claim? How could it be that a gold ETF accumulates more than a 1,000 tons of gold without causing a tremendous spike in the gold price? Why is it that no independent audit can be done regarding their supposed gold holdings? Why should we just believe the custodians of the bullion EFTs that are coincidently also the biggest short players in those bullion markets? What happens with the silver ETF ( iShares Silver Trust (ETF) (NYSE:SLV) if JPMorgan goes bust? What happens with GLD if HSBC goes bust? Too many uncertainties here; that’s exactly why more and more investors withdraw their gold ETF holdings and switch to the real metal. A good example, of course, is Greenlight Capital, a $6 billion hedge fund that switched $500 million of investment in GLD to physical gold recently.

TGR: With greater risk, of course, comes higher returns. And aren’t the risks that you outline an extreme? Aren’t there upsides along the way?

EG: Sure. I’m not saying you shouldn’t invest in equities at all. I’m invested in equities myself. The only thing I’m advocating is you should own some physical gold just for the worst case. That’s all.

When you look at gold equities, especially the mining shares, they could provide a good leverage to gold. If gold goes up by 5%, your gold mining shares could go up by 10% or 15%. There’s definitely a leverage there. Especially when it comes to the junior sector, the leverage could be astronomical. So, yes, some of your money should be devoted to equities.

TGR: What percentage of physical gold should be in a portfolio?

EH: That’s very personal. It depends on how much risk you’re willing to take. If you come up to me and you say, "I’m not willing to take any risk at all, nothing. I want to have the safest bet." Then I would say you should invest 100% of your money into physical gold. But if people ask me what I am doing, I’d say half of my money is in the physical metals— about 30% in physical gold, 20% in physical silver. I just split the remaining 50% in half—25% in senior shares and 25% into junior shares. And I spread the juniors’ share among at least 10 different companies.

TGR: So your portfolio is all in precious metals, either physical or equities?

EH: Yes, that’s correct.

TGR: If you’re looking at the juniors—taking more risks but potentially getting greater upside rewards— is this the time to start accumulating juniors?

EH: Let’s go back a bit first. The gold bull market began in 2001; in early 2004, we had a small mania in the junior sector. Juniors that came out with good drilling results back then were rewarded tremendously. Four years later they moved to the exact opposite end of the spectrum to extreme undervaluation. Most of the juniors had been decimated to penny levels, levels not seen since the beginning of the gold bull market. We saw a junior sector so depressed that no one wanted to own junior shares anymore.

Now investing is quite a simple game. You buy equities when stocks are extremely undervalued. You sell when they are extremely overvalued. The pendulum is swinging back and forth all the time. We are now one year further from late 2008, and the junior sector certainly started to recover from its most depressed levels then. Finally the juniors started outperforming gold and we’re seeing most juniors trading at multiples (100% to 500%) of levels seen last year.

So is it a time to get in junior shares? I think, yes, but you have to be careful to pick the high-quality ones because many juniors are not going to survive this dark winter. The problem is money. Most junior business models are simple. They raise money and drill it away, then they raise money again and drill it away again. If they’re lucky, they make a discovery and the stock starts moving up. But generally it takes a lot of money to make a discovery if the junior makes a discovery at all.

TGR: So what do you look for in juniors then? What is important?

EH: First of all, I like to see juniors whose management demonstrates the capability of raising money even during the most difficult periods in our financial history. Furthermore, I would like to see juniors that are producing or on the verge of becoming a producer, because then they can generate their own cash flow and are less dependent on external financings. Last but not least, I would like to see juniors with promising properties, which increases the odds of a significant discovery. If you’re lucky enough to be invested in a junior that makes a big discovery, the reward can be astronomical—which is why I think you should always own a few juniors in your portfolio. But I never have more than 2.5% of my entire portfolio in any one single junior company.

TGR: Could you give us an example of a junior that meets these criteria?

EH: Sure, I think a typical example of what a junior should be concerns Endeavour Silver Corp. (TSX:EDR) (NYSE.A:EXK). What they’ve done over the last five years is really phenomenal; four discoveries in just five years’ time is amazing. In 2004 management turned Endeavour from an exploration company into a producing company overnight. Although they had no money to do it, they did it. They raised the money, became a producer and have reported record high silver production almost every single quarter since then. Besides that, they keep expanding their resource base year after year. Their growth profile is so aggressive that they will most likely become a mid-tier silver producer within the next two years, which will make it an attractive target for the major silver producers. What I like about Endeavour’s management is their transparency. They simply do what they’ve said they would do; that’s what you should demand from management from any junior company.

TGR: Absolutely. Keeping the promises they make. The upside potential would also be limited in companies in that are in politically shaky areas or have managements that aren’t as savvy.

EH: Exactly. If you talk to management of a dozen companies, they will all tell you, "Oh, listen, we’re on the verge of a big discovery." Anyone can tell you anything. They all say that.

And what we have seen in the last couple of years? Only a very few big discoveries. So it’s a matter of faith in management. Even if you’re a geologist yourself, it’s difficult to see the real potential of a company. So in the end, they have to deliver. That’s why I like to see companies go out and start the drilling programs; the results will tell me whether I should buy or not. Drill rigs are the real truth machines.

Many of the juniors that are priced at penny levels are telling shareholders they aren’t going to raise money because they don’t want to dilute their shares. I couldn’t disagree more; an investor wants to see a company go forward. An investor wants to participate in new discoveries. To make new discoveries, you need to drill; in order to drill you need money. But if you aren’t going to raise money to go out for exploration, nothing will happen. I don’t buy into the argument of waiting for better times and higher share prices before raising money. I don’t like it.

TGR: What do you think about new equities that represent a basket of seniors or juniors?

EH: I like the ETF GDX (Market Vectors Gold Miners (NYSE:GDX)), for example, which tracks the HUI (Gold BUGS Index) quite closely; it’s a basket of senior mining companies. Why do I like it? If you’re investing in single companies, you have to follow the company. You worry about management, about their cash position, about trustworthiness, about the political situation where they operate and many other things. But if you invest through an ETF, you’re investing in many companies at the same time and you just know you’re tracking an index. It saves a lot of headaches.

TGR: Any final thoughts you’d like to give our readers?

EH: Yes, most likely you’ll be hearing bearish gold tunes in coming months from the traditional gold institutions, saying that gold’s rise is not justified by its fundamentals and therefore bound to fall. They did so in 2003, they did so in 2005 and now they are at it again. The traditional gold institutions simply don’t appreciate the fact that gold is money and how it has been manipulated over the years. Traditional gold institutions in 2005, with gold prices at $425, were saying that increased gold production would bring down gold prices; that certainly didn’t boost their credibility. Still many analyst quote these very same institutions today for the very same argument— that increased gold production will bring down gold prices in the years ahead. GATA, on the other hand, said in 2001 that gold was going to $850 and that central bank selling wouldn’t be an issue anymore within seven to ten years from then. We find ourselves right in the middle of that projection and gold is trading well above $850 and central bank sales have dried up completely. You are not going to hear these kind of predictions from the traditional gold institutions. No one has been right on the money more than GATA. It’s therefore no wonder that GATA’s credibility is rising fast. To give you an example here, the Chinese sovereign wealth fund ,which manages over $200 billion, has held already three teleconference calls with GATA—they wanted to know what GATA knows. We all know now that China has been accumulating gold for years; we all know now that China wants a new world reserve currency. This, of course, won’t happen overnight, but it’s quite obvious that the U.S. dollar as a world reserve currency is not going to survive. Gold will continue to rise until something new has been put in place on the monetary front and I think we are years away from that. So what I’d say is. "Stick to it and stay the course."

DISCLOSURE: Eric Hommelberg
I personally and/or my family own the following companies mentioned in this interview: Endeavour Silver.

Eric Hommelberg started writing about the gold market in 2002, and is the founder and chief editor of GoldDrivers.com a Caribbean-based gold company. His analyses and commentaries can be found all over the Internet on major gold sites such as The Gold Report (of course) as well as KITCO, Gold-Eagle, Goldseek, 24HGold and LeMetropolecafe. This past June, he signed an exclusive deal with Valcambi Suisse and launched his GoldDrivers Bullion Store—which is the first online retail seller for Valcambi gold that deals with Valcambi Suisse directly.

His passion these days has turned to the geothermal energy arena, where he’s busy putting his Midas Touch on Magma Energy Corp., but mining magnate Ross J. Beaty has not lost his love for silver, copper and gold. An entrepreneur extraordinaire, Ross still serves as chairman of Pan American Silver. In this exclusive Gold Report interview, Ross talks about how Pan American’s business model inspired that of his new enterprise, and what he sees as common ground in the geothermal and mining sectors.

The Gold Report: You come from a mining background, primarily gold, silver and copper now you’ve moved to geothermal. What motivated you to jump into the geothermal arena?

Ross Beaty: After having built a number of public mining companies for 23 years, I retired from my silver company in 2007 and sold my copper companies by early 2008. I was looking around for something else to do and I wanted to build a green company. I’ve always been a closet environmentalist and thought this was a good thing to do with the next part of my life. The more I looked at geothermal, the more I liked it. It’s is very much like mining.

TGR: In what respects?

RB: You’re dealing with a subsurface resource. To develop it successfully, you need to move it through early stage exploration, advanced exploration, feasibility, permitting, financing, construction and then operation. You deal in the same geological environment that you look for gold and silver deposits in and you largely deal in the same countries that I’ve dealt with in most of my career—North and South America, Pacific Rim and so forth.

So it’s an area I am very comfortable with. I understand the science. And as with mining, you need a lot of capital in this business, so public markets are very appropriate. The big difference is that you sell electricity instead of metals.

TGR: One difference between geothermal and metals seems to be that geothermal relies on serving a smaller, somewhat restricted geographical area. But Magma Energy Corp. (TSX:MXY) seems to have an international geographic strategy.

RB: Like mining, geothermal energy is a global business. And as with mining, certain countries are better for geothermal operations than others. When I say better, I mean not only better in terms of resources but more enjoyable places to work—better politically, socially and environmentally. So—again, this is exactly like mining—we screen for all of those things when we look at a potential acquisition.

TGR: How does Magma’s business plan differ from those of your previous companies?

RB: The main difference between geothermal power and the metals business is that geothermal is based on long-term power purchase agreements that are locked in with utilities, whereas with metals you deal with cyclical world markets. So with geothermal you have a long-term sustainable cash flow. Banks love that.

TGR: Another big difference between geothermal and mining—and apparently one of the environmental pluses that drew you to geothermal in the first place—is with mining it’s typically a depleting resource. With the recycling of water into geothermal reservoirs, in contrast, you’d have a sustainable resource that theoretically could go on forever.

RB: That’s a huge difference. All mines ultimately are non-renewable. Geothermal is inherently renewable. This is a form of power that can go on for literally thousands and thousands of years.

TGR: Tell us about a few companies outside the geothermal arena that you’re still keeping an eye on.

RB: Well, 95% of my time is really on building Magma right now. It’s the focus in my life. But I’m still a large investor in the Lumina Group, a tremendous management team that worked with me to successfully acquire and divest our four copper companies in 2006–2008. We’ve put money into Anfield Nickel Corp. (TSX-V:ANF), which has 21 nickel exploration licenses and is developing Mayaniquel, which has 21 nickel exploration licenses and is developing Mayaniquel, a nickel property that surrounds Lake Izabal in Guatemala. It’s done quite well so far. I think it’s got a lot of upside.

We also invested in a Ventana Gold Corp. (TSX:VEN), one of the top performing companies this year in Canada. So that’s doing well, too. Ventana holds rights to 4,573 hectares of exploration property in Colombia’s California-Vetas mining district, northeast of Bogota.

And I’ve personally invested in a number of copper companies because I happen to like the future of copper.

TGR: So you still like copper.

RB: Yes. Actually, copper is an energy metal as much as geothermal is an energy source. And copper has a great future because it’s the second most conductive metal, with incredible applications in energy transmission and generation because, of course, it’s used in motors and generators. What’s mostly driving copper right now is the build-out of China’s energy infrastructure.

TGR: What are some of the copper companies you like?

RB: I’ve invested in a number of them, including Amerigo Resources Ltd. (TSX:ARG), Augusta Resource Corporation (NYSE/AMEX:AZC) , Lumina Copper Corp. (TSX-V:LCC) , and Western Copper Corporation (TSX:WRN).

Amerigo operates a large Chilean copper mine, Augusta is working on a large copper project in Arizona, Lumina—a spin-out of a company I started a few years ago—has a big copper project in Argentina. I’ve just stepped off the board of Western Copper, which owns four Canadian properties, including the Carmacks Copper Project and the Casino Project in the Yukon. But I do remain a shareholder.

So those are some investments I’m taking in the copper space. Of course, Of course, I also love silver and am still chairman of Pan American Silver Corp. (TSX:PAA; NASDAQ:PAAS), as well.

TGR: That’s a terrific story, described earlier this year as one of the best success stories to come out of Vancouver in the past 30 years. You took a buyout offer in 1994 from Hecla Mining Company (NYSE:HL), on your first company, Equinox, and went on to found Pan American that same year. (Equinox Resources Ltd. traded under the symbol EQX on the Toronto Stock Exchange.)

RB: Pan American is now the world’s second-largest primary silver mining company. It’s had a wonderful history, increasing production for 14 consecutive years, and I think has a great future. Before becoming non-executive chairman in mid 2007, I ran Pan American and built it up from an idea to a substantial, world-class silver mining company with a tremendous balance sheet, 8,000 employees and eight operating silver mines in Mexico, Peru, Argentina and Bolivia.

Really, the model for what I’m doing in Magma is Pan American’s. It’s a great model for me to use in Magma’s growth.

TGR: Any parting comments, Ross?

RB: As I said, Magma is the focus of my life, but I love copper. I love silver, I love gold. Gold has wonderful fundamentals. The likely devaluation of the U.S. dollar and the desire of investors to hold gold and silver as money will fuel higher prices for both these metals. The other metals you have to be quite choosy about. And on the whole, I’m very bullish about most commodities. The world is still growing very actively and the consumption of commodities is growing very significantly. We are in a long-term commodity bull market that will stay with us for quite a few years.

TGR: Our readers will appreciate your insights and we look forward to watching another one of your dreams come true.

RB: It’s all about creating shareholder wealth and part of that is making sure people understand what you’re doing and where you’re going. So I sure appreciate your interest, this will help in getting us there.

DISCLOSURE: Ross Beaty
I personally own all of the companies mentioned in this interview.

He is a past president of the Silver Institute in Washington, D.C., a fellow of the Geological Association of Canada and the Canadian Institute of Mining, recipient of the Institute’s Past President’s Memorial Medal, and a founder of the Pacific Mineral Museum in British Columbia. Ross received the Association of Mineral Exploration of B.C.’s Colin Spence Award for excellence in global mineral exploration in 2007 and in 2008 the Mining Person of the Year award from the Mining Association of B.C. and the Ernst & Young, Natural Resources Entrepreneur of the Year award. He served as honorary chairman of the Silver Summit 2009.

The convergence of an assortment of forces—probably the least compelling of which is jewelry demand and the possible role of gold in oil transactions probably the most powerful—promise to keep driving up the price of gold, according to GoldSeek.com founder and president Peter Spina. Still, in this exclusive Gold Report interview, as the gold price climbs toward $2,000, he suggests that investors might wait for another market rally in mining stocks, take some profits and invest the proceeds to add some physical gold to their portfolios. A year from now, says Peter—who also co-founded GoldForecaster.com—we’ll look back on $1,000 gold as a bargain.

The Gold Report: We’ve seen some big bumps for gold several times this month, with the price nudging the $1,050 mark now. What’s behind the spike?

Peter Spina: There’s a lot of confusion out there now, but the bull market in gold is not about jewelry demand; it’s about money. As gold keeps reaching new record highs, it’s becoming more apparent what’s driving it. The true issue at hand is trust (or lack of it) in the value of paper money—specifically the U.S. dollar. What’s really made this country so strong has been the value of its currency.

We’re seeing a shift away from U.S. dollar reserve assets. The value of the dollar had been primarily driven by demand in its global use, including trade in dollars, specifically, the oil trade. There are growing rumors about shifting some of that oil trade away from the dollar, and at the same time, central banks around the world are diversifying away from it. Combine that with other factors we’re experiencing—trade deficits, internal deficits, the incredible amount of printing of dollars to bail out banks and provide stimulus and so on. It can’t go on.

The U.S. internal deficit is nearing $2 trillion a year and growing, especially in the last year. Now they’re talking about projections from the recent financial bailouts total obligations exceeding $20 trillion. That doesn’t take into account future banking and derivative issues, which are upcoming. Already, we do not have the ability to finance our debt. It requires about 80% of the world’s savings to support our debt habits, and we’re just increasing our debt load so quickly—our appetite for a debt is increasing.

How do we continue to finance this kind of system? This has to play itself out at some point and I believe inflation will be the outcome from all this paper printing via growing monetization of U.S. debt. It will cheapen the debt load, but there will be some severe consequences to pay. The price we’ll pay will be reflected in devaluation of the U.S. dollar along with a degree of influence such power provides. Gold will benefit from this process. As people look for sound money and a safe-haven asset, gold will be the obvious choice.

TGR: Aren’t most governments printing more currency to do some form of stimulus in their own countries, and not just the U.S.?

PS: Yes, they are. Gold is actually moving up in foreign currencies as well as U.S. dollar terms, and we could see a widespread devaluation of paper currencies versus gold. A global paper currency problem really brings gold to the forefront.

TGR: Why didn’t gold take off earlier in the year, when a lot of that activity you described was already taking place? This is not news.

PS: It’s a process. In relative terms, gold is such a tiny market that it commands quite limited attention in the financial world. That’s changing, but it’s a process that takes time. Some heavy accumulation behind the scenes helps support the gold price to this point, but some other factors tended to calm down the price appreciation. Primary among these factors has been general stabilization of this turmoil that engulfed us toward the end of last year and early this year. The mass psychology of the markets has shifted and is actually quite good, all things considered. Removal of the fear factor has driven away tension and stabilized things.

I just think there’s not a broad understanding of the process, which is ongoing. I believe the U.S. dollar is going to really start losing its footing but the stock market is going to continue to stay firm and grow. As the dollar begins losing its value and gets to the point where that may happen very quickly, the situation will change and people should realize quickly what’s going on. The squeeze on the dollar will be reflected in the gold price taking off.

TGR: How high can gold go? Won’t people who aren’t invested in it already going to get minimal return because it’s already spiked up so much?

PS: There are definitely short-term risks after spikes. Gold reached $1,000 a couple of times and then pulled back to the $900 for most of this year. Now, after breaking through $1,000 again, it could rally to $1,100 to $1,300 and then pull back somewhat. That said, same time next year I believe we’ll look back and say, "Wow, $1,000 was cheap; it was a bargain." So $1,500 to $2,000 gold in the next 12 to 18 months seems definitely within sight.

TGR: Do you see a situation where we might use gold as actual currency and actually go back to a gold standard?

PS: Direct use of it, while possible, is not likely. But I believe we’ll be using gold in form or other in trade and/or in backing a new currency. We’ll see central banks holding more gold in attempt to stabilize their currencies. They’ve already shifted from disposing gold on a net basis to accumulating gold to their reserves.

TGR: As you look at the gold sector just in the last year, the spot gold price has gone up 20% to 25% up until these recent bumps. But during that period, the gold equities have doubled, tripled, quadrupled. It’s been amazing. Is the play here in gold the physical or the gold equities?

PS: When you invest in mining stocks you take on a greater degree of risk; for that you are entitled to a greater reward. As we saw last year when the markets collapsed, mining equities dropped quite severely. Valuations on many of the stocks went down 70%, 80%, 90%—so these equities are a lot more volatile and sensitive to general market conditions. There are arguments for and against, but I believe a good portfolio should contain both bullion and mining stocks and, within the mining stocks, include more stable mining equities and some high-risk speculative investment opportunities such as exploration plays. But I believe the mining stocks, the gold stocks, will outperform the metal itself.

TGR: You mentioned that an investor should be looking at fairly stable equities along with some more speculative exploration opportunities. Do you define "stable" as the majors?

PS: Yes, the Goldcorps (TSX:G) (NYSE:GG) and Agnico-Eagles (TSX:AEM) of the world, those that would be classified as senior gold companies, with annualized gold production in the multi-millions of ounces. With a basket of those companies, you can march down to the mid-tiers and the smaller-cap gold stocks for more leverage.

TGR: A couple of years ago, when we had a handful of uranium companies, uranium had a run up, and then suddenly hundreds and hundreds of uranium companies flooded the market. Does that happen any time a mania begins? Are we likely to see the same thing in gold, except that hundreds of gold companies may multiply into thousands? If that happens, how do you decide where to invest?

PS: As the gold prices rise, I think we will see some companies coming in that people should be very careful about investing in. They may do well in the bull market, but when all is said and done, if there’s nothing really behind them, they will be the ones that will go away first. As you know, we saw a bit of a washout last year with the market correction. Some good quality companies took a hit and went under or emerged as somewhat different companies. But there were others that I would never have invested in, kind of moose pasture want-to-be gold investments. When those faded away while the good assets remained, that was good for the market.

TGR: So what would a careful investor look for?

PS: When investing in junior exploration gold and/or silver stocks, I first look at the management, look at their history. A company comprised of solely financial backgrounds who have no mining experience should be an obvious red flag. Junior explorers typically have to go to the capital markets to raise equity to explore and develop a project, so company with a bloated share structure to start off with will have a difficult time building a strong share price as it develops these assets. So in the junior exploration stocks, share structure also is very key.

With any of these small capitalization companies, it is typically about raising money in the public markets. So has the company been capable of obtaining a proper value of their assets for their shareholders? So ask yourself some questions: Are they communicating with the public? It’s a publicly traded company; are they telling their story to the public? That’s very important factor to attract investors and to preserve a small capitalization’s primary key advantage which is share structure

And then, of course, the property. You want to look at various criteria in that respect including geography. I prefer locations in Mexico, Canada and Nevada for mining companies. Grades, environmental location, etc. are all very key investment decision makers.

Also look at the business model. Does the company provide any cash flow or is it expecting any near-term cash flow perhaps because it’s close to production? You don’t want to get into another situation like last year where your business model is entirely dependent on raising capital in the equity markets and the capital markets fall apart. However, that seems to be less of a threat if the gold price continues to rally and new capital sources, interest in the gold sector continues to grow. That would keep investment capital flowing into the sector at an accelerated pace

Those are several of the criteria that I look at. All things considered, you have to be very careful. The best thing an investor can do is to just do your research. Call up the company and speak with them and really get a feel for who’s managing the company. Public filings provide excellent insights into the financial condition and management discussions. The resources available online add other easily accessible data and information.

TGR: Can you give us examples of some junior stocks that meet your criteria?

PS: One is Timberline-Resources Corp. (NYSE/AMEX:TLR) which has a terrific share structure, around 35 million shares. They’re about a year away from gold production in Montana, an underground high-grade gold project. They’re in a 50-50 joint venture with Small Mine Development, Llc (SMD), one of the largest underground mining contractors in the United States – serving clients including Newmont Mining Corp. (NYSE:NEM) and Anglo Gold (NYSE:AU, JSE:ANG, ASX:AGG, LSE:AGD). With Small Mines Development carrying the project to production, Timberline does not require to finance to reach production point, which means their share structure should stay intact. At $1,000 gold, they should be bringing in up to $20 million in pre-tax cash. For a company with about $25 million market cap, that’s quite the value.

Additionally, Timberline is looking at other near-term gold production assets and has two drilling divisions, which I believe pull in around $15 million a year. Drilling margins are not very exciting right now because a lot of exploration activity has been slow to come back from last year’s market correction. Still, I believe we’ll see a nice uptake in the next six to 12 months in exploration and thus drilling services. So that company is definitely of interest.

TGR: Who else is on your radar?

PS: Another would be Gold Resource Corp. (OTCBB:GORO, FSE:GIH), which has several properties in Oaxaca in southern Mexico. They have under 50 million shares, no debt. They have several large shareholders, including management. One of the largest investors is Hochschild Mining (HOC: LSE) and the Tocqueville Gold Fund. Gold Resource Corp. is expected to produce 70,000 ounces of gold in the first year at $100 an ounce production cost at its El Aguila property. That’s very high-grading gold. They’re going to increase that to 110,000-plus ounces in years two,177,000 gold equivalent ounces in year three and onwards. As they encounter more base metals, those will be used as credits against production, so their production costs will go to zero or even go to a negative cost.

A lot more exploration work is needed to define the size of this project because of the significant upside their property remains huge. Right now they have several years of production reserves, and we’ll see how that exploration work pans out.

TGR: How close are they to production?

PS: They’re actually mining the open pit ore right now. They have all permits in hand. From what they’ve said in the recent past, the mill should be completed within a matter of days, weeks. I would expect some sort of initial production to begin this month or next.

TGR: So they meet your criteria of being able to essentially live on their own cash flow, not needing to go to the capital markets.

PS: Exactly. They’re going to be producing an incredible amount of cash flow. If you’re looking at 70,000 ounces with a net $100 an ounce margin in the first year alone, that’s up to $1.50 a share right now in free cash flow. Gold Resource also plans to pay out about a third of their cash in the form of a dividend payment, which could be quite the dividend going forward. That’s definitely a company to consider.

TGR: Any others?

PS: Timmins Gold Corp. (TSX.V:TMM) is another one in Northern Mexico. They’re just starting production in an old open pit gold heap leach operation in Sonora. I believe this class of gold producers will soon see additional attention from investors and larger gold miners looking to grow their reserves and production levels therefore providing more upside. With just over 100 million shares, it’s not as attractive of a share structure, but Timmins is now fully financed and soon producing cash flow with their first gold pour expected in January. They’re looking at 80,000 ounces a year, $400 or so an ounce production cost, and they’re trading around 70 cents a share. They have other prospective projects and some strong investor backing. That looks like a pretty good value to me.

TGR: Great. That’s a pretty good list.

PS: Then there’s a new company, Canada Gold (TSX-V:CI; FSE:T9N; OTCBB:CNGZF). They’re just getting going, actually, and I’m not an investor in the company yet. They have a unique business plan, to build a toll mill facility in northern Peru and work with several thousand plus local small and independent gold miners that don’t currently have an ideal place to have their gold ore milled. The Peruvian government estimates that around 3,000 tons per day of high grade gold is currently being extracted. I would expect this number to swell along with the gold price. These miners have been either loading their pickup trucks with ore and driving roughly 1,400 kilometers for processing at a cost of up to $100 per ton, or using mercury for on-site gold recovery, which is health risk to the artesian miners and a potential environmental biohazard. Inevitably these miners only get a fraction of what they could and should.

So within a year, Canada Gold is looking to open its first toll mill and to cater to these small miners, giving them a higher payout and milling the gold for them so they will no longer need to involve themselves in using mercury for extraction. Starting at 300 tons a day with grades pushing ¾ to 1 ounce a ton average, there is significant cash flow potential. Add mill number two, three and more, Canada Gold could grow into a significant gold operation and they can do this without having to deal with the mining and exploration risks.

That’s definitely an interesting and new story. They have a $4 or $5 million dollar market cap and the several million dollars required to get the first mill going has already been financed, so additional capital needs are minimal Definitely, it’s a good win-win situation, which I think will find good backing from some non-traditional sources, including environmental groups and NGOs.

I try to look for stories like that—unique business models and win-win situations.

TGR: It sounds good, but the value of a mill depends on the ounces it can process, so this one will depend on what these small miners can produce. Where’s the guarantee their production will continue in some meaningful fashion through the life of the mill?

PS: With the price of gold where it is and the fact that these miners bring in on average about three-quarters of an ounce a ton of gold with no mill capacity nearby, the payback period could be within a year. Thus, there shouldn’t be much fear that this won’t progress for some years down the road. Because Canada Gold doesn’t have to spend all kinds of money and time trying to find a deposit and mine it, this puts them in a much lower capex situation to get cash flow going. And at the same time these miners who are spending a day mining and two days extracting gold now will be able to focus strictly on mining.

TGR: So the payback period is a year. Why didn’t someone jump on this earlier?

PS: I’ve been asking myself the same thing. I wish I had an answer. I know one or two private firms that do work like this, but no other public company has gone this route that I am aware of. I believe the business model is going to be quite successful, and from everything I’ve looked at initially, it strikes me as a really good story. They want to build this thing up quite aggressively, to the point where they could be producing half a million ounces annually within two, three or so years down the road. The gold’s there. It’s being processed. I believe their advantage will be in making higher payouts to the locals for their gold and being in a strategic location where a lot of this mining is going on along with all the necessary circuits to process various ore types

TGR: Is the Peruvian government likely to facilitate things for Canada Gold, given the ecological question?

PS: They already have government support and see continued support coming in for these environmental reasons as well as general economic ones.

TGR: So there’s another win in this win-win scenario for Canada Gold.

TGR: Are there any other companies that you’re following?

PS: Otis Gold Corp. (TSX:OOO) has five projects in Idaho and one in Nevada. I just visited their flagship, the Kilgore Gold Project in southeastern Idaho. It’s an old gold property with some old production workings on it from the mid-’90s. A few companies such as Placer Dome, Echo Bay and Pegasus have previously worked it. Over 120,000 feet of drilling has been performed on the property to date. The deposit they’re trying to define with the drilling exploration work that’s ongoing as we speak, is to step out on some historic high-grade gold intercepts in an effort to define a high grade deposit that could be mined by underground mining methodologies . In addition, there is an existing bulk tonnage, open-ended 700,000 ounce gold resource that has significant expansion potential. This could turn out to be a multi-million ounce gold deposit. With a market cap of around $12 million dollars right now, Otis is looking pretty cheap. Their per-ounce gold valuation is in the neighborhood of $12 an ounce with their million ounce or so gold resource. The drilling expansion should continue to bump up those numbers. We’re seeing around $40, $50 an ounce valuation now for this kind of deposit reserves, so they’re looking rather inexpensive to me.

TGR: When will they be able to validate the presence of that high-grade intercept?

PS: The high grade exists. They need to continue to drill it out both the high grade and bulk tonnage targets to build the model better to confirm their ideas of this gold deposit. I think they’re doing a 12,500-foot drill program now and the first results should start coming out soon. This first round will help define the deposit and see if indeed this high-grade gold deposit can be expanded. There are a lot of signals that it has the potential.

Once gold really gets at $1,200, $1,300, $1,500 an ounce and these majors need to replenish reserves, deposits that fit certain criteria—and I believe the Kilgore Project that will be one of them—definitely will become quite attractive. So it’s a good opportunity to still get into some of these junior exploration stocks that have very inexpensive per-ounce valuations. Otis also has a terrific share structure, under 20 million shares. With some exercise of warrants coming up, they should have a couple of million dollars in the bank, so they’re cashed up and have quite a few drill holes coming through soon. That could provide some upside pressure on the stock.

TGR: Sounds like another winner.

PS: It could be. If these exploration stocks hit some high-grade gold, you can see things really take a pop. Especially I love these older gold projects that had work done on them. Back in the mid-’90s a lot of these projects had millions and millions of dollars worth of work done on them. But then the gold price drop made them uneconomical and exploration development budgets were extinguished, so they just sat there. With the gold price making them very economical now, I’d say a lot of good gold projects like that are just waiting to be developed.

TGR: It was in the mid-’90s—1995 to be precise—that you founded GoldSeek.com. What did you see then, when everyone else was looking at the high-tech bubble?

PS: At that time, interest in the gold market related to the imbalance of supply and demand. A declining supply was coming from the major gold-producing countries, specifically South Africa, and demand was well above the supply. Investors perceived the imbalance as a market opportunity. But unfortunately it was too early. Central Bank selling closed a big part of the gap along with gold producer forward selling.

The gold market bottomed out in the late ’90s-early 2000. At that time it was about that opportunity to buy low. Today it’s different. It’s the interest in gold market and gold itself as money that led us to the point we are today. Gold is now finally becoming more and more recognized for historical attribute as money.

TGR: GoldSeek.com is still going strong, and more recently, you’ve also co-founded GoldForecaster.com. Could you tell us a bit about major trends you’re recommending there?

PS: GoldForecaster.com follows the gold markets from a global perspective on a weekly basis. We’re watching the record high gold price around $1,035. If we have some consecutive closes above this, we expect another surge, a wave of demand to take the price a lot higher, so we’re in the view that any pullbacks are excellent buying opportunities.

It looks as if the sub-$1,000 gold phase may be coming to a close, so we’re looking for gold to move up to a much higher range and, in the process, take these mining companies to much higher values. So we see a lot of opportunity in all parts of the gold mining stock sector. As the price gets higher and the bullishness and excitement grow, the smaller caps and the juniors will start getting a lot more interest, too.

TGR: Are we in the mania stage yet?

PS: No, not at all. I believe we’re entering the next phase of this global market, which will bring it more into the mainstream. Right now the average investor still doesn’t own gold. They’re starting to know what’s going on. They know gold is getting to a record price but not exactly fully understand why. The big institutions, the big buyers are just starting to get coming in, but it’s still not a mainstream investment yet. That still may take years—not just months—to develop. The mania stage is still quite a way off.

TGR: Thank you, Peter. Any parting thoughts that you want to give to our readers?

PS: I believe the key here in the gold market is what gold represents, what it has been and that’s honest money and as we see this bull market develop, the reason for it is going to be from investment demand. It’s going to from people looking for stable, honest money and with declining trust and confidence in paper currencies and as they continue to devalue, gold will become one of the choices for investors to preserve wealth.

I think we’ll see some extreme volatility continuing on forward. We saw some examples of that last year and mining stocks will just amplify that. So you have to recognize that there will be some extreme wild swings in this market. Taking profits on the way up and diversifying those profits, I think, is always a great idea. Personally I am more overweight in the mining stocks. My strategy at this time would be to wait for the next significant rally and then start monetizing those profits into physical gold and silver.

DISCLOSURE: Peter Spina
I personally and/or my family own the following companies mentioned in this interview: (partial: Timberline Resources, Gold Resource Corporation, Timmins Gold, Otis Gold).

I personally and/or my family am paid by the following companies mentioned in this interview: (partial: Timberline Resources, Gold Resource Corporation, Timmins Gold, Otis Gold)

Peter Spina’s experience with the precious metals markets dates back to the 1990s, and the GoldSeek.com website he debuted in 1995 now ranks among the top three most popular gold websites globally. When a secular bull market in precious metals was taking shape, Peter established the technically focused subscription newsletter, Gold Seeker Report; early in 2005, he merged it into the more comprehensive GoldForecaster.com service. In addition to the newsletter and websites, Peter frequently appears in the media, including Investor’s Business Daily, Wall Street Journal’s MarketWatch, Reuters and TheStreet.com.

Gold is at an all-time high and the XAU index has recently achieved a new recovery high for the year. Is there a basis for this latest gold and silver stock rally in light of the recent 10-year cycle peak? What would be the justification for it based on the cycles? According to savvy market technician, seasoned chart reader and cycle analyst Clif Droke, the answer is that investors are responding to the 10-year cycle peak by running to the precious metals and its related vehicles by treating them as safe havens. The public’s fear of a dollar collapse is no secret and has reached the saturation point

The XAU Gold Silver Index closed 1.38% higher on Thursday, Oct. 8, at 177.22. The Gold Bugs Index (HUI) was 1.43% higher at 449.61. October gold closed 1.14% higher at $1,056. December silver was 1.80% higher at $17.81. Gold is at an all-time high and the XAU index has recently achieved a new recovery high for the year.

Is there a basis for this latest gold and silver stock rally in light of the recent 10-year cycle peak (as discussed in the interview with The Gold Report in September)? What would be the justification for it based on the cycles? My answer is that investors are responding to the 10-year cycle peak by running to the precious metals and its related vehicles by treating them as safe havens. The public’s fear of a dollar collapse is no secret and has reached the saturation point. According to one recent poll, fully 98% of the public is bearish on the dollar’s prospects going forward. This makes for a crowded trade to be sure, but this extreme in sentiment also can create its own momentum and feed on itself for a while. As we’ve seen in the recent past, fear can become self-fulfilling and while a market move based solely on fear never lasts for long, it can be extremely powerful while it lasts.

Gold, meanwhile, has already reached the $1,040 level, which as mentioned last month as a conservative minimum upside target. In my previous commentary I stated my belief that $1,040-$1,050 would be the upside target for the gold price before the 10-year cycle peaked. It looks increasingly likely that gold will exceed this conservative target and possibly hit the nearest round number benchmark of $1,100 before running into some resistance.

Gold stock internal momentum (GOLDMO) is sufficiently buoyant to allow some (though not all) of the actively traded gold shares to rally. The dominant long-term and intermediate-term momentum indicators (circled) are still in an uptrend, a positive factor for the golds. However, the sub-dominant interim momentum indicator (orange line) isn’t to be snuffed at. It’s currently in a downtrend and this is what’s going to create some cross-currents among the mining shares in the coming days.

We saw a similar configuration in the momentum indicators earlier this summer and it caused us to become selective with our stock picking since some stocks obviously stand to benefit from the rising long-term and interim momentum while other stocks are more responsive to the declining momentum indicator shown here. Of course the question is how to determine which stocks to choose and which to avoid. The answer is *relatively* simple: relative strength. Those stocks which remain above their rising 30-day and 60-day moving averages can be held (a select few can even be purchased from here) while those that are lagging behind and struggling below the 30-day MA should mostly be avoided.

Speaking to the heads of several junior and mid-tier mines recently, I still get a sense that producer sentiment has done a complete about-face from the year-ago period. Mining company leaders have, for the most part, embraced a growing conviction that the gold and silver prices, including base metals, can continue its march higher from here.

Neil McMillan, president and CEO of Claude Resources (TSX-CRJ; NYSE Amex-CGR), believes that the gold price can continue its march higher. His company was prepared for the credit crisis before it descended and McMillan has a strong track record of riding out storms and coming out stronger. His view of the yellow metal price is admittedly sanguine:

"I’m very optimistic about the value of gold to purchasers going forward. I put it in perspective this way as others have done: in 1980, adjusted for inflation, gold got to over $2,000 an ounce under a set of financial circumstances that people considered quite extreme. Back then it was inflation. The inflation rate was very high and people were really concerned it was going higher and they sought out gold as an asset where they could preserve their wealth in that environment. So under those circumstances gold got to over $2,000 an ounce."

McMillan acknowledges that a "different set of financial circumstances [exists] today," but adds that these circumstances "provide far greater risk to investors and savers than we saw in 1980 and gold is still at only $1,000 an ounce." He concludes, "There’s no reason in my view why [gold] won’t continue to increase back through $2,000 an ounce over the next two to three years as people realize that these financial concerns are not going away and in fact may be getting worse. So I think this is a long ways from being over and I’m not convinced we’ll see dramatic changes in the price but I think you can expect a steady march through $1,200 and $1,500 and over the next two to three years, possibly through $2,000 an ounce."

The president and CEO of Bard Ventures Ltd. (TSX.V:CBS), Eugene Beukman, sees a stabilizing global economy as the key for the molybdenum and base metals price recovery. Bard Ventures is a junior mining and exploration company with mineral interests in British Columbia and Ontario, focusing on molybdenum, copper, zinc and silver.

"I think that’s the million-dollar question," he said when asked if the global economic recovery would continue. "I do believe that we’ve actually turned the corner and we’re at the stage where there are a lot more plans coming available for venture capital and exploration. We’ve seen only in the last two to three weeks that some of the large financings that have occurred in the sense that $20 to $70 million bought deals have been announced and completed. So we believe that the whole resource market will be turning and we look forward to a great 2010 and who knows what after that but I believe there’s definitely been a turnaround."

Ross Orr, president and CEO of BacTech Mining. (TSX.V:BM), said he would be happy if the price of gold continued at current levels without rising from here. His company uses bacterial oxidation and bioleaching technologies for separating precious metals from sulphide ores and concentrates for gold mining companies.

Said Orr, "If [the gold price] did nothing from here I would be very happy. I don’t need $2,000 gold. This is perfect. I’m looking at projects where I’ve got production and capital costs and everything all in for say $400 [an ounce]. That is a nice margin. If it goes to $2,000 it’s just anarchy out there. It’s hard enough finding projects now with the price of gold where it is because everybody just sort of pulls everything close to their chest."

He added, "As the price of gold goes up people’s expectations change dramatically. It just becomes more of a greed factor I guess is what it really is. One thing about gold is that it definitely has a mind of its own. I see it has hit a new high again this morning [Oct. 8]. But we haven’t seen that frothiness that we’ve seen in the past. And I don’t know if it’s because the ETFs are involved now or whatever because it seems that maybe the retail guys have just been handed their rear end too many times and finally said, "You know what – forget it! I’ll buy the ETFs instead."

DISCLOSURE: Clif Droke: I personally and/or my family own the following companies mentioned in this commentary: None

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

Savvy market technician, seasoned chart reader and cycle analyst Clif Droke is a popular and prolific author. His Gold & Silver Stock Report (published every trading day since 2002) examines daily and weekly technical outlooks on individual stocks and forecasts the near-term outlook for leading indices. In addition to gold and silver, it covers uranium and energy stocks from a short-term technical standpoint. In his Momentum Strategies Report, launched in 1997, Clif shares forecasts and reviews of U.S. equity markets using his proprietary blend of internal momentum indicators, moving averages, various analytical methods and investor sentiment to isolate the best sectors for short- and intermediate-term trading gains. Updated three times a week, Momentum Strategies addresses six major sectors (gold/silver, oil/gas, transportation, financial, REIT and semiconductor/nanotech), in addition to covering real estate, natural resources, money supply and trends in bank credit and the general economy. Also launched in 1997, Clif’s monthly Gold Strategies Review covers gold, U.S. and Canadian precious metals equity markets and mutual funds and other natural resources. He also puts out Silver Strategies Review and Junior Mining Stock Report each month—and more. A frequent contributor to Kitco commentaries and Financial Sense, he has an impressive array of critically acclaimed books to his credit too. They include a variety of how-to volumes (channel busting, parabolic analysis, selling short, chart reading and turnaround trading, to name just a few) and cover topics as diverse as the housing bubble and cattle futures. Visit his website.

Consumption, speculation and growing demand by emerging economies add up to a rather rosy outlook for copper, says Steve Parsons, Senior Research Analyst for Wellington West Capital Markets. In this exclusive Gold Report interview, Steve explains how investors might capitalize on a theme that’s picking up momentum on the copper concentrate side of the industry. He also sheds some light on a great copper story that’s unfolding on the northern shore of Lake Superior in northeastern Minnesota, not far from the Ontario border.

The Gold Report: Steve, it’s often said that copper is a great way to play a period of economic growth. Do you agree with that?

Steve Parsons: I absolutely agree. Copper is an essential metal for developing nations. Generally speaking, an increase in GDP/person coincides with an increase in copper usage. The story here is that China and India are still coming from a low base. If you look at where copper usage is in developed nations, it is upwards of 9 kilograms of consumption per person annually. China’s consumption currently weighs in at approximately 3.5 kilograms per person. So China is still at an early stage of development. The move to urbanization should keep upward pressure on copper usage. By 2025, it is projected that China will have 221 cities with a population of more than one million. At present, Europe only has 35.

TGR: Some are saying that $2 will be the new copper floor. What’s your thinking on that?

SP: Deposits are getting deeper and they’re getting lower grade. In certain cases in Chile, whether it’s Escondida or Chuquicamata, the deposits are moving into ores with more impurities, such as arsenic. A general deterioration in the quality of deposits will almost certainly push operating costs higher, in turn helping to underpin a higher copper price.

Although $2 is not unreasonable, we use $1.85 long term—with long term starting in 2014. That $1.85 is actually very conservative, and it’s really a function of currencies too. We’re tying the $1.85 figure to an 85-cent Canadian dollar. To the extent we start using a 90-cent or current FX rates, we’d be closer to $2, if not higher.

If you believe in the Chinese story and if you believe there are going to be 221 cities with a population north of a million, $1.85 copper is likely too conservative.

TGR: You mentioned that a lot of this copper is getting deeper and, thus, more expensive to produce. Do you see a scenario where we are at peak production now and that we face a scarcity of copper as we move forward? Or there’s plenty of copper, but it just costs more to produce?

SP: Of course, it takes a long time to discover a new copper deposit, then get it through permitting and regulatory hurdles. A good example of that is the Ivanhoe Mines Ltd. (NYSE:IVN) Oyu Tolgoi in Mongolia. It’s a fantastic copper deposit, but it’s taking a long time to get into production. So there are some very large copper projects out there. The Chinese are developing a couple of very large copper projects in Peru. I think we have the potential to produce more copper than we are today, but many of those opportunities come with higher operating costs. In many of the cases, they are second-tier assets with lower grades than today’s world-class deposits. You might have higher production, but it will come with certainly higher capex costs and higher operating costs.

TGR: Could you review for our readers the differences in terms of investment opportunities between copper concentrate and the actual metal?

SP: Sure. It is important to make the distinction. At the mine level, copper is produced either in concentrate form or as cathode. Concentrates require further upgrading via smelting and refining, whereas copper cathode can be LME grade at the mine gate.

The opportunity we see—and it’s probably one of the most prominent themes in the copper space—is that in the copper concentrate market specifically, there is too much smelting capacity chasing too little concentrate. Smelting and refining capacity expansions in China, Korea and India have bred stiff competition for dwindling sources of Cu concentrate. We believe that China’s mandate to protect employment requires the country to maintain smelter output, thereby exacerbating the situation. Their decision to keep those smelters open has forced treatment and refining charges—levied by the smelters to the miners—to all-time lows. We don’t see this situation changing at least until 2013.

With TC/RC (treatment charges and refining charges)rates falling and the availability of concentrate and scrap copper limited, we believe smelter groups are likely intensifying their efforts to become fully integrated—that is to acquire interest in mines or development projects with copper concentrate production. Such a move not only keeps the smelter fed, but also supplants third-party concentrates that are currently being processed at low treatment and refining charges. Under the current economic environment, the tactic also has the potential to conveniently deliver assets at a discount to NAV while at the same time negating the adverse effect of low TC/RCs on smelter operating margins. This goes back to a model that was more typical of the 1970s and 1980s, when it wasn’t such an adversarial relationship between the smelters and the miners.

TGR: Do you see this trend of foreign smelters buying copper mining companies continuing for the next year or two? Will it result in the whole industry being consolidated under the umbrellas of a few smelters?

SP: We initially saw the smelter integration theme emerge in late 2007/early 2008, with the acquisitions of Northern Peru Copper Corp., Peru Copper, Monterrico Metals plc and Tyler Resources (all of which are expected to produce copper concentrate) by China Minmetals/ Jiangxi Copper Company Limited (OTCBB: JIXAY), Chinalco (Aluminum Corporation of China Limited (NYSE:ACH), Zijin and Jinchuan (all of which have smelting capacity), respectively. The movement seemed to take a hiatus late last year as surplus conditions emerged bringing visibility for higher TC/RCs. Earlier this year the theme re-emerged in no uncertain terms with Japan’s second-largest copper producer Sumitomo Metal Mining Co. Ltd. (STMNF:US) publicly stating plans to take a stake in at least one copper mine in a bid to gain more control over the source of ore feed, with the ultimate goal of increasing the proportion of internally supplied ore to 70% from the current 40%. The opportunity here as it relates to copper concentrate stories is that in an environment where development assets remain at depressed valuations due to a lack of conventional financing, we believe the emergence of smelter groups as motivated buyers should help alleviate these concerns and ultimately enable a re-rating of company shares.

A few recent data points demonstrate that this theme is taking hold, with the most recent one being the deal between Copper Mountain Mining Corp (TSX:CUM) and Mitsubishi. Mitsubishi acquired a 25% stake at the project level and has agreed to arrange a $250 million project loan. This is a good example of how smelters will help finance mine development, all in an effort to secure a steady supply of copper concentrate.

This is a near-term theme and we believe other deals are probably in the offing. In fact, I wouldn’t be surprised to see more deals come out of the LME Metals Conference in mid-October.

TGR: What are some of other potential plays?

SP: One of the most logical plays that could benefit from the same theme is the Augusta Resource Corporation (NYSE/AMEX:AZC) project—Rosemont in Arizona. It’s one of the largest undeveloped copper stories that has no off-take deal in place. Importantly, the concentrate should be of a very high quality, with a high copper grade and few deleterious elements. Of course, the smelters also want stability of supply, which should be very good in Augusta’s case because it’s coming from the U.S. For these reasons, I’d say smelters probably are vying for the Augusta concentrate.

TGR: Do you see other companies with similar potential?

SP: Taseko Mines Limited (NYSE/AMEX:TGB; TSX:TKO) also the potential to deliver substantial amounts of copper concentrate. They’re looking to get a permitting decision on their very large Prosperity Copper-Gold Project in British Columbia probably by the end of 2009. This is the largest undeveloped copper-gold project in Canada, and Taseko quite likely will look to do a deal similar to Copper Mountain’s—where they get a smelter to earn-in on the project, negotiate an off-take agreement, inject cash and help provide the debt financing.

TGR: So these smelters are essentially taking on specific projects rather than ownership positions in the companies themselves?

SP: I think that’s going to be the case in North America if you look at Augusta, Taseko and Copper Mountain. That’s true in Australia, too, where there is also, in effect, more resource nationalism and the Chinese have come to realize that it actually might be hard to acquire such companies outright. They’re better off approaching it at a project level.

However, the situation in South America is a little different. Various Chinese groups were involved in taking over outright some very large strategic copper assets in Peru—Peru Copper, Northern Peru Copper and Monterrico Metals. I think that possibility still exists in Peru and maybe some other South American countries.

TGR: If the trends you’re seeing continue, with Chinese smelters acquiring either projects or entire companies, won’t the smelters end up dictating copper prices?

SP: I don’t think this will have much impact on the copper price. Certainly the mining companies will have less ability to negotiate cheaper refining charges. Right now they have the smelters over the barrel. They can dictate very, very low terms for treatment and refining—to the point where they run the risk of putting the smelters out of business. These integrations will put the ball back in the smelters’ court to a certain extent, and give them a better chance to negotiate on higher TC/RCs.

TGR: How should individual investors take advantage of this trend?

SP: I think you want to get in on copper development plays, particularly ones that produce copper concentrates, as the offtake contract can be a source of financing. Ideally, you want something that will produce a high-quality copper concentrate and have a mine life of 15-plus years. In addition to Augusta and Taseko, you might look at Norsemont Mining, Inc. (TSX:NOM) and even some newcomers such as Nevada Copper Corp. (TSX:NCU).

I just can’t see this thing stopping. The reason I say you want to play copper development stories is, one, because you’ve got the opportunity to get a bid from a smelter and help you finance a project or they take you outright. Larger cashed-up companies such as HudBay Minerals Inc. (TSX: HBM), Quadra Mining Ltd. (QUA.TSX) , Thompson Creek Metals Co Inc (NYSE:TC; TSX:TCM) and KGHM Polish Copper Ltd. (KGHMF) are all talking about rolling up the mid-cap copper space. But the reality is that there’s very little to roll up, so they’re going to have to look at near-term copper development stories. That means they’re competing with the smelters for the same assets.

There is a logical argument to be made that copper development is the place to be.

TGR: One of the data points you mentioned early on involved Copper Mountain and Mitsubishi. That deal was just finalized in late July. What do you see now that this has been finalized?

VSP: Copper Mountain just completed an equity deal, about $50 million, which quite likely provides full financing through to production. The stock trades about 0.5 times our NAV estimate, which is among the cheapest in our coverage universe. We believe the potential for a re-rating is high. As they start building and get close to production, we would expect Copper Mountain shares to re-rate toward 1.0 times our NAV estimate, which is C$3.00/share.

A while ago we were talking about these cashed-up companies looking to roll up the mid-cap producer space. While there aren’t a lot of companies to acquire, this one is logical target. I think the fact that a couple of weeks ago Taseko put together a proposal to merge the two companies—Taseko and Copper Mountain—lends credence to that view.

TGR: Are you looking at any other copper plays?

SP: PolyMet Mining Corp. (NYSE/AMEX:PLM; TSX:POM) is a story that I haven’t mentioned yet. PolyMet differs slightly from the copper concentrate theme. It’s another topical story that I think would interest investors. It has a development story in Minnesota. Minnesota has been an iron mining state for many, many years, but hasn’t had a commercial non-ferrous operation. We believe that is poised to change and PolyMet’s large NorthMet project could be Minnesota’s first.

PolyMet been involved in permitting activities for several years now, and it would appear that they’re finally down to the fine strokes. The Draft Environmental Impact Statement is expected to be filed in the coming weeks. Getting the Draft EIS prepared and filed is arguably the most critical step in the permitting process. There’s a very good opportunity of being issued final permits within six months of the Draft EIS.

So come 2011, we could see Minnesota’s first non-ferrous mine in what is the third-biggest copper-nickel district in the world after Sudbury and Norilsk Nickel (NASDAQ:NILSY, LSE:MNOD).

TER: Wow!

SP: The district has been known by geologists for many years, but it is relatively new to the investment community. I think that is about to change. You ask, "Where is copper going to come from?" If you look at deposits owned by PolyMet, Duluth Metals Ltd. (TSX:DM), Franconia Minerals Corporation (TSX:FRA) and Teck Cominco Ltd. (NYSE:TCK; TSX:TCK.A; TSX:TCK.B) —which are all in the Duluth Complex—this is among the largest copper/nickel districts in the world that is available for development.

TGR: How close are Duluth and Franconia to getting permitting?

SP: They’re years behind PolyMet, but I believe PolyMet has helped pave the way. Any subsequent studies should be completed at a faster rate, and that should only make Duluth’s and Franconia’s lives a little bit easier. If the final permits are received, as we believe they will be, that will send a strong message that Minnesota is open for business, which in turn should help spur merger and acquisition activity.

TGR: That’s just so amazing that no one’s really talking that much about it.

SP: Very surprising, given that the projects are close to railway, close to power. Moreover, PolyMet is a brownfield development. The company purchased a bulk tonnage taconite mill from Cliffs, so the capex intensity is lower than it would have been otherwise. So the stars are aligning for PolyMet and the other companies in the Duluth Complex. And to top it off, this could materially transform Northern Minnesota economically.

TGR: One of the greatest stories never told. Thanks, Steve, for all of your insights.

DISCLOSURE: Steve Parsons
I personally and/or my family own the following companies mentioned in this interview: None.

Steve Parsons, P.Eng., a member of Wellington West Capital Markets’ equity research team since April of 2008, is a Senior Research Analyst focused on the mining sector. Wellington West is an institutional equities firm that specializes primarily in the mining, energy and technology sectors. After earning his bachelor’s of engineering degree in mining at Queen’s University, Steve worked as a metallurgical engineer for Placer Dome, and then moved on to a metallurgical consulting firm. Shifting to the investment side of the business after that, he signed up as a Research Associate with GMP Securities, concentrating on base metals initially and later joined MGI Securities as a Research Analyst.

A highly regarded resource sector expert who discusses his field fervently whenever possible and whose writings include the top-ranking Outstanding Investments, Byron King brings his views direct to The Gold Report audience in this exclusive interview. Unconvinced that the recession is behind us, he is equally sure that the "bottomless pit" mentality of stimulus spending will wreck the dollar. Those are among the reasons he sees $2,000-per-ounce gold on the not-too-distant horizon.

The Gold Report: We’ve seen quite a rebound in the markets since we spoke in May, and governments across the world have begun releasing some positive economic news. Are we out of the recession as Bernanke has told us?

Byron King: I don’t agree with that at all. It’s like at the funeral home where they put really good makeup on the corpse and people walk in and say, "Oh, he looks so good." Then you think to yourself, "Wait a minute. If he looks so good, why is he dead?" That’s where we are now, I think, with our economy. We’re still in the recession, it has been well-masked.

Let me digress and say that yes, the stock market rebounded. The "sell in May, go away" thing didn’t work this year. So if you stayed in the market, you probably benefited very well from the market recovery. But it was a recovery not rooted in fundamentals. Part of it is that we’ve had a banking recovery, too. But that was because of massive infusions of new liquidity out of the Federal Reserve and the Treasury Department into the financial sector. That’s not the prescription for long-term health.

As with someone really sick in the hospital, the problem isn’t putting him on life support; the problem is getting him off the respirator. Now the question is how to stop hemorrhaging public money into the system, and in fact, begin pulling some of it back out.

TGR: Let’s assume for now that the government isn’t prone to taking the patient off the respirator. Do you expect diminishing returns in terms of less recovery seen for every dollar the government puts into the system?

BK: That’s a great point. We’re there, at the point of diminishing returns in terms of what it takes to get another dollar of real GDP. It doesn’t matter how much green ink they use down at the Bureau of Engraving and Printing or how many ones and zeros they create in the Federal Reserve. At the end of the day, how much have we improved? How much have we built our economy? Look at numbers like new business formations, numbers that indicate the health of growing businesses—hiring, recalls, overtime—certain types of gross output figures, job creation. You’re not seeing healthy numbers for those things in the economy.

TGR: And unemployment.

BK: Absolutely. Unemployment may be a lagging indicator, but it’s lagging like an anchor chain on your boat, especially when the numbers get up in the 9% and 10% range nationally. And then look at certain critical states. California, Michigan, Illinois, New York and Pennsylvania are all big, populous, busy states with lots going on and high unemployment rates. Where do you go with your economy when you’ve got that level of unemployment?

And what we’re seeing is the nice numbers. There’s a lot of ugliness behind them. If you look at the shadow statistics, you may as well add 50% or 75%. You know, 10% unemployment could really be 15% or 17% if you looked at who’s really not working. Look at numbers of people applying for early Social Security or disability. They’re up 45% and more this year. These are people at the bow wave of the Baby Boom, exiting the workforce, and entering a life of government dependency.

TGR: In a consumer-based economy, can you really have a jobless recovery?

BK: No, I don’t think you can. And that’s one of our problems. The consumer consumption component of GDP is something like 70% as opposed to what it was historically. In, say, the 1950s, the economy was maybe 55% consumption versus a 45% level of production. At today’s 70%-to-30% ratio of consumption, with high unemployment and income insecurity, you can’t get economic traction.

A report that just came out within last couple of weeks indicates that something like 70% of households are living paycheck to paycheck. And something like 35% or 40% of households that make more than $100,000 a year are living paycheck to paycheck. Think about that. Almost half of the top income demographic is one paycheck away from being broke. Suppose you get laid off, you get sick, you get injured, some problem comes up, a death in the family, a divorce, or some other big hit comes along. If you don’t get paid for a pay period, all of a sudden you’re behind on your bills. You burn through your savings, if you have any savings. You miss two pay periods, you’re really behind. Three pay periods, there goes the house, there goes the car.

TGR: It’s somewhat ironic, but we do hear that people are saving more.

BK: We are seeing big numbers in terms of the savings. The national savings rate has gone from negative to something like 7% since the start of 2009. That’s an excellent savings number in the long term. That’s a good number for the individuals who are doing the savings, good for them. But in a macro-sense, it’s a very asymmetrical type of savings. People at the very high end have cut back on discretionary spending. They’re not buying the new Cadillac, they didn’t take the fancy vacation, they didn’t buy that second house. I think those cuts are what’s driving that savings rate up, and they take big consumption dollars out of the economy.

It’s not the secretaries, the paralegals, medical assistants or cashiers at the shopping malls. Those folks aren’t saving more money than before, not in any gross aggregate kind of way that would move the economy.

TGR: Early on, you said the government’s doing a great job of masking the recession. What happens when people see what’s been so well disguised? What will be the impact on the markets?

BK: I think we are living with a very vulnerable stock market. If large numbers of people were to come to the same opinion that I hold, a lot of them would probably want to take sell out. Would it be a meltdown like last year’s? I don’t think we’d see an overnight crash, but I do think the market would drift down as people take money off the table. I think it’ll vary by sector, though, because some sectors are doing well for the right reasons while other sectors are doing well for the wrong reasons.

TGR: For instance?

BK: Sectors depending on the discretionary income I was talking about—high-end home building, entertainment, travel and leisure—those kinds of things have had what I’d call a false recovery. It’s a recovery based on antibiotics and steroids. On the other hand, the energy sector and certain parts of the mining sector have done well because there’s been an underlying strengthening of demand for the product and a realization that while the dollars in your bank account or your wallet may not hold their value over time, that oil or ore in the ground will protect value. It will hold value over time.

TGR: That’s a pretty smooth segue into gold. Can you give us an overview of what’s in your Gold $2,000 report and your thoughts about of the sector now that gold’s passed that $1,000 trading barrier?

BK: I wrote that report when gold was at about $850, so we’re moving in the right direction. I think that gold could be $2,000 an ounce, and I’m not alone. Rob McEwen, for instance, is making predictions of $1,500 to $1,600 an ounce within about three years. (Rob McEwen founded (NYSE:GFI)(JSE:GFI) Goldcorp (TSX:G) (NYSE:GG), serving as Chairman and CEO until taking the reins at US Gold Corporation (TSX:UXG) (NYSE.A:UXG) and Lexam Explorations Inc. (TSX.V:LEX), serving both companies as Chairman and CEO.)

I think we’re looking at the long-term loss of value in the dollar, what with the tremendous levels of government expenditure—this so-called stimulus. It’s the bottomless pit mentality that Congress has toward the money that the federal government spends. It’s wrecking the dollar. All around the world people are looking for alternatives.

In China, 15 years ago it was illegal for the average citizen to own gold except maybe for a little gold chain. Today, the Chinese government encourages its people to buy gold. Almost every bank or post office in China now sells gold coins.

If the Central Bank of China ever says, "We’re buying gold. We’re going to buy as much as we can and put it in the state coffers," the world gold price would spike through the roof. But if the Chinese government tells a billion of its people, "Okay, take a little bit from your paycheck every week or every month, save it up and then every now and then, go down to the bank or the post office and buy a gold coin," all of a sudden they’ve got a stealth rally going. China will build up its gold reserves, but do it in a distributed way. They’re not putting all that accumulating gold in a Chinese version of Fort Knox. They’re putting it in safe deposit boxes all across the country. Look around the world and you see people accumulating gold. I think that what we see in China is a harbinger of things to come.

TGR: Are they accumulating gold as a hedge against the U.S. dollar, or as a hedge against their own economy? What’s in it for the Chinese government to make that recommendation to the citizens?

BK: It’s a way of getting a lot of gold inside the boundaries of China. I’d say that the government wants its citizens to do the buying so as to keep something of a lid on gold prices. They’re reinventing the U.S. monetary economy of 100 years ago. The United States used to be a gold standard country. We had a lot of gold and gold was in the hands of the people. And then in 1933 Franklin D. Roosevelt issued a presidential directive essentially confiscating all privately held.

TGR: Might the Chinese government do something like that?

BK: They could if they wanted to, but I think part of it is somewhat like the concept of a "fleet in being"—it’s not that you deploy a lot of battleships at once, but if you add individual ships together, you have a rather formidable military force. I would liken the Chinese approach to "Fort Knox in being." They have a Fort Knox in China except that it’s not all in one place. It’s scattered around in millions and millions of households. If the Chinese government ever needed all that gold in one place for some reason, they would cross that bridge once they got to it.

TGR: So if we’re looking at this multi-year, dispersed approach to accumulating gold while keeping a lid of gold prices, why would gold go to $2,000?

BK: Because we’re in a world that appears to have encountered peak gold as well as peak oil. If you look at historical production, worldwide gold output reached a top right around the year 2000–2001. Overall output has declined and we’re not replacing output from the big mines of the past. Despite discoveries here and there, miners have to dig deeper and deeper into the reserves. In a big mining country such as South Africa, for example, some of the deepest mines now are at 4,000 meters. That’s 13,000 feet.

TGR: So your view is that scarcity rather than a weakening U.S. dollar will drive the increase in the gold price?

BK: Well, it’s really both. More and more dollars are chasing less and less gold. You’re piling the monetary inflation coming out of Washington, D.C. on top of the dwindling production coming out of the mines of the whole world. Beyond that, a lot of what kept gold prices down and the dollar strong for years was the impression that the United States had its act together and would pull through over the long term, despite all of its various flaws and faults. In the eyes of the world, we’ve somehow managed to blow off a lot of that impression and I don’t know what it will take to recover it. It took winning World War II the last time.

TGR: How would you characterize prospects for silver?

BK: I think that silver has more opportunities to appreciate percentage wise than gold. If gold goes from $1,000 to $1,500, that’s a 50% gain. If silver’s at $15 and goes to $30, there’s a 100% gain. Silver is a monetary metal, but it also has more industrial-type uses than gold. We’re seeing more and more silver go into the electronics industry, even into biotech. With uses at both the monetary end and the industrial end, there are a lot of good opportunities in silver.

TGR: Since their March lows, stocks in some senior and junior mining stocks—both silver and gold—have doubled or even tripled, while the metals themselves have not climbed nearly so steeply. Does the rapid appreciation in of these mining company shares leave any investment opportunity remaining for the equities?

BK: I think you have to be very careful. You have to pick and choose where you’re going to go with small companies, medium companies, large companies. A lot of gold and silver, for example, are produced as byproducts of copper mining. If you want to see some of the biggest silver producers in the world, you’re also looking at some of the big copper producers. But in terms of smaller companies, one that’s done very well would be like Pan American Silver Corp. (TSX:PAA) (Nasdaq:PAAS), Ross Beaty’s old company. It’s a nice pure silver play. I’ve been watching another smaller one called ECU Silver Mining Inc. (TSX.V:ECU), which has operations down in Mexico. It’s had ups and downs, but it’s done well for the investors.

TGR: Any other interesting equity plays for gold and silver?

BK: Another company that’s done really well is Rob McEwen’s new company, U.S. Gold Corp. It’s just an exploration play at this point, working out of Nevada in the area that’s related to the Carlin Trend. It has an incredibly good land position in some very prospective acreage.

One larger company that has done very well, is very well managed and still well positioned to grow in the future with a rising gold price is Kinross Gold Corporation (K.TO) (NYSE:KGC). Another one with room to go is AngloGold Ashanti Ltd. (NYSE:AU) (LSE:AGD) (JSE:ANG) (ASX:AGG). CEO Mark Cutifani, who’s been there for about a year now, has really taken that company by the horns, changed the whole management style and turned it from the stodgy, sleepy South African gold mining company into a real dynamo. The market has figured it out to some extent, but I don’t think it has yet given AngloGold Ashanti everything it deserves. So in terms of a big mining company, I think AngloGold Ashanti can still have some reward for investors.

TGR: Thank you, Byron. We appreciate your good humor as well as your good advice.

DISCLOSURE: Byron King
I personally and/or my family own the following companies mentioned in this interview: ECU Silver, US Goldcorp
I personally and/or my family am paid by the following companies mentioned in this interview: None.

A self-described "old rock hound," Byron King earned his bachelor’s degree in geology (with honors) at Harvard, and then worked as a geologist in the exploration and production division of a major oil company. He "earned his wings" in the U.S. Navy and the U.S. Naval Reserve, logging more than 1,000 hours of flight time in tactical jet aircraft and recording 128 aircraft carrier landings. Based in Pittsburgh, Pennsylvania—site of the historic G20 Summit last week— Byron practiced law there after earning his Juris Doctor credentials at the University of Pittsburgh School of Law. A prolific author and popular speaker with a gift for wrapping historical context around his observations, Byron contributes to Agora Financial’s Daily Reckoning, Whiskey and Gunpowder and Penny Sleuth. He also edits Energy and Scarcity Investor and Outstanding Investments newsletters.

Post summer doldrums, we’re now beginning to see a nice fall run up in the price of gold—one that marks the beginning of a parabolic move, according to Greg McCoach. The seasoned bullion dealer, investor and newsletter writer sees a number of factors culminating in ever-increasing prices going forward. In this exclusive interview with The Gold Report, Greg reveals current and forthcoming events that will continue driving the yellow metal’s price northward. . .not the least of which involves the commercial real estate market and its "associated derivative sewage."

The Gold Report: Greg, gold has really started to take off. You’ve talked about a parabolic move for gold. Are we in the beginning of that?

Greg McCoach: Yes, I would say so. I’ve been anticipating a nice fall run up. We knew we’d experience the typical summer doldrums, but a couple of things are happening right now.

First, you’ve got the major gold traders coming back from vacation and starting to make some trades. But more importantly, there were two major announcements in the first week of September that could really launch gold. We could see $1,500 gold this fall. No doubt about it.

TGR: What two announcements are those?

GM: First, the Chinese, in layman’s terms, put a stop loss on their derivatives, which they’re taking a bath on. These were sold to them from the likes of Goldman Sachs. This is a huge development. In other words, the Chinese are basically saying it’s a fraudulent transaction—which it was. Goldman Sachs sold these same instruments to Iceland and what took the country down were the derivatives, right? And the people that created these derivative packages and sold them to others like Iceland and China knew full well that they were flawed, that there was no way these people were going to make money on them. So, knowing that, now the Chinese government says we are putting a stop loss on our losses on these instruments and we’re simply not going to pay anymore. So that’s good. Somebody’s standing up against these corrupt jerks who have been taking advantage of other people.

That was a big development and, if you notice, there’s been a lot of discussion. Independent-thinking kinds of newsletters have been talking about this and, so, we’ve seen gold start to rise up.

The second big announcement is that the Hong Kong Monetary Authority has built its own high-tech vault to store its own gold, and they just requested delivery. Up to this point, the Chinese gold had been stored and vaulted in London, England. So now the Chinese are requesting their gold be shipped from London to their new vault in Hong Kong. This has major implications because this is a large amount of physical gold, and I think what it’s going to do is begin to expose the naked shorts who have been playing this game with the gold and silver markets, trying to keep a cap on the prices. So this is a major, major development.

TGR: Why would moving gold from one vault to another vault expose the naked shorts?

GM: Because they won’t have access to that gold. In other words, the shorts, in order to keep a lid on the gold prices, can’t control the gold price. This goes into the manipulation. I don’t talk about this too much just because, to me, it really doesn’t matter. In the end, manipulation never works and free markets eventually overcome any manipulative activity, and gold and silver will go to where they’re going to go. But in this case, the way they’ve been able to play this game over the years—and it’s been going on for a long time—the manipulation crowd could short paper contracts of gold and silver with huge amount of paper contracts. They didn’t have the physical metal to deliver in case the longs decided they wanted delivery. They would get caught if they didn’t have enough physical metal to meet those demands.

So I think it really means that the whole situation of manipulating and playing games with the gold and silver markets just puts even more pressure on it when people start taking delivery of their gold. We all know that the manipulation game will be over at some point when there’s no gold left to play the game. Then the manipulation crowd has no ammunition to play and that’ll all go away.

TGR: Is this what’s really causing the parabolic move for gold or are there other factors?

GM: No, there are other factors. This is just the starting point. What I’m saying is we’re starting to see gold ramp up. The bigger factors are the derivatives associated with the commercial real estate market. I think that’s going to start to blow up this fall and into early next year. And that’s because the commercial real estate market and its associated derivative sewage is much larger than the derivative sewage associated with the residential real estate mortgages that went bad.

We’re going to go through another round of this. This round looks like it’s going to be worse than the last round. And any hogwash about people thinking the economy is back on track and all this stuff from Joe Biden that a million new jobs were created, that’s just nonsense.

TGR: Would you anticipate the market to crash like it did last year as the residential real estate bubble burst?

GM: Here’s the different scenario that I see. Yes, it’s going to affect markets—stock markets will plummet worldwide; but I think it will be different for the precious metal stocks. The mining stocks and precious metals got sucked right down the toilet in the last meltdown. That was unexpected. The reason for that was that all the big hedge and index funds had to liquidate, and they were heavily invested in precious metals and junior mining stocks. So, as that crowd had to sell to raise cash for their clients who were sending in their redemption notices, that’s what hurt us.

This time I think we will get the disconnect. I think precious metal prices will soar to new highs and people with money will flock into the precious metals and the mining stocks as a refuge, as a safe haven. Yes, it’ll affect world markets again, but I think the precious metals will have an insulating protection because people will finally start to realize that precious metals are where you need to be. There will be a new interest and a beginning of a big flow of money into the precious metal sector.

TGR: So if that’s true, won’t all boats float up if precious metals start to take off? Won’t all juniors see appreciation in the stock price?

GM: When the market kicks into gear, the money goes first into the majors, then the quality juniors, and then eventually—you know, even turkeys can fly, right? The more quality-oriented companies will definitely be the bigger recipients of the best funds because people are more selective now than they were before.

Since the last meltdown people have definitely gotten more educated in certain areas where you have to be. You can’t just put your money in a mining stock anywhere in the world. It has to have infrastructure. If it’s in an existing mining camp, that’s better than in an area that has no infrastructure and no mining camp. Why? Because the developmental costs to put something into production are so much higher in those kinds of areas.

So smart money people are looking for new discoveries in existing mining camps, where all the infrastructure exists. So those will be the companies that make the big runs, and that’s what I’m focused on right now. That’s what I’ve been focused on in the newsletter—looking for these opportunities.

TGR: What’s your recommendation about owning physical metal vs. equities? And should the mining stocks be in the major, juniors?

GM: I always recommend owning the physical metals, gold and silver, the bullion bars and coins and the mining stocks. Now for some people, the majors work better for them and their portfolios than the juniors. I personally like the juniors because of the leverage. When someone makes a discovery, as a junior you can make up for a lot of losses very quickly with just one discovery, if you own the right junior mining stock.

So we play the odds; we know we’re not going to win on all of these stocks. But in a good market, where we see a parabolic move, hell, everything’s going to move. We’re hoping to have some of those that do those big moves and everybody’s happy and we’ll take our profits and buy other real assets. At that point it could be undervalued real estate, it could be undervalued ranch land. I’m only willing to give up my precious metals and my precious metal mining stocks for other real assets because I don’t want to hold dollars at this point. I’m not interesting in holding U.S. dollars in quantity.

TGR: Especially if they’re going to be losing value.

GM: Right. A U.S. dollar devaluation at this point is as certain as death and taxes in life. We just don’t know the exact timing; that’s all.

Should You Own Physical Metal or Mining Stocks?

TGR: What are some of your favorite juniors?

GM: Let’s talk about Pediment Gold Corp. (TSX:PEZ; OTCBB:PEZGF; FSE:P5E) because I still list them as number one. Their stock has been a little quiet this year because the company really hasn’t made much in the way of news and it looks like that’s finally going to change.

They got out their new 43-101. It wasn’t spectacular, but it wasn’t bad news. It was a drastic increase in the quality of ounces, from 1.45 million to basically 1.65 million in total ounces, but the quality of ounces went from the inferred category to what we call the measured and indicated. That’s a quality differential and that was a good announcement from that standpoint.

So I think what’s going to happen now—and the company hasn’t made any news yet—but their share price, when it ran up to $3.50, $3.60 a share, was based on the discovery news on their southern Baja property in Mexico, in what we call the San Antonio District. I would guess the company now is going to get back into a major drill program at some point this fall and I’m waiting for that news.

I’ve always said this is going to be a 2 to 3 million-ounce deposit, a sizeable gold deposit. It’s in a good jurisdiction, and we can look forward to a lot of appreciation on our share price. What’s great about it and why I still have it as a strong buy, number one, is you can still buy it so cheap; it’s 80 cents, under a buck. It’s dipped down as low as 70-75 cents. It’s been as high as about $1.20 in the last six months. So it’s at a good range to buy it right now before we make the move.

They also have a production scenario at another project, La Colorado, that’s moving forward very nicely. They’re drilling on this and they’re finding even more ounces that El Dorado Gold left over. El Dorado Gold was the one that started that mine. It’s now been opted to Pediment, who now controls it and is moving it back into production again.

Now as gold prices go up and they keep the drills going and they make further discoveries, which I think is sure to happen down there, that will take that stock right back up again. So there are some good profit opportunities. Again, in the top ten I list the companies with the least amount of risk that have the biggest opportunity for profit.

So if somebody says, Greg, at this point all I have is enough money to buy one stock, you should buy Pediment Exploration because it has the least amount of risk and the biggest upside for a junior mining stock at this point. There’s a nice cash flow for the company that could be in production next year sometime and that stops shareholder dilution and that’s as good as it gets in the junior mining business. A nice big discovery that’s increasing in size and a good jurisdiction with another project also in Mexico that was an existing mine that is now being put back into production for cash flow, so the company doesn’t have to keep raising funds in the private markets that dilute current shareholders. That’s a good story. It doesn’t get much better than that. And don’t be discouraged by the price. That’s just because there’s been little in the way of news and the company’s been protecting their savings. They’ve got about $14 million in the treasury and they’ve got plenty of room to do some things.

TGR: Another company that’s on your strong buy list is Fortuna Silver Mines Inc. (TSX.V:FVI, Lima Exchange:FVI), which happens to be a silver play.

GM: I love silver. I’m not one of these guys who only likes gold. I love Mexico and a company like Fortuna, who’s got not one, but two assets. One is already in production; one will soon be in production. Peru and Mexico are the two countries those assets are located in. They have a very low cost of production. The material is good grade and it’s high profit with higher silver prices. This company will do very, very well. You’ll see a multiple gain in this stock price.

Again, it’s starting to bump up a little bit, but it’s still reasonably priced. I think you can still buy this one and do quite well with it. If you believe silver prices are going higher, Fortuna Silver is a no-brainer.

TGR: Excellon Resources Inc. (TSX:EXN) is also on your list as a strong buy.

GM: Excellon is a very, very fascinating situation. It’s been a long-term recommendation in my newsletter. We originally bought it years and years ago at 15 cents. It ran all the way up to two bucks. We made lots of money on that one. It went right back down again with the meltdown. The company is starting to creep up again.

They recently did a deal and acquired a mine, which they needed to help them on the production side, which was a good move for the company. Unfortunately, they had to give away a lot of shares, so the company has a dilution problem right now and I’m not quite sure how they’re going to handle that. At Platosa, their main project, they keep discovering more ore and the type of geology that this deposit represents is called a carbonate replacement system. These are the biggest silver deposits in Mexico in the most prolific silver mining belt of the world. It’s right smack dab in the middle of this.

You get into the carbonate replacement system and it’s like elephant hunting. Excellon has hit the trunk of the elephant and they’re working their way up the trunk and I believe what is going to happen is they’re going to hit the body of the elephant. When they hit the body of the elephant, all hell is going to break loose because that stock will just go through the roof.

They acquired Silver Eagle Mines, which I thought was a good deal and it gives Excellon a lot of other good exploration properties; but, more importantly, it gave them a production facility where they could process their ore. They’re trying to get their own mill up and running at Platosa and that should be done, hopefully, end of ‘09, early ‘10.They will have the shares outstanding, but once they get the cash flow going, if the share price doesn’t go higher, the company could just start buying back their own shares cheap with the profits they have, reduce the number of shares outstanding. They could do a rollback, which I wouldn’t be in favor of as an existing shareholder. One way or the other, Excellon will continue to move higher as they make further discoveries at Platosa, so it’s still a buy.

TGR: SilverCrest Mines Inc. (TSX.V:SVL) has been on your top ten for quite a while. Can you give us an update?

GM: I like SilverCrest’s story; I like the people running the company. I visited the site in Mexico, a good jurisdiction, and they continue to find more ore down there. It looks like, based on the timeframe, sometime in the first or second quarter of ‘10 their Santa Elena mine will be in production. That’s a sizeable resource and one that’s going to get the attention of the majors, especially when it would be such a low-cost producer.

I think once they put this into production, because of the size of it, this to me looks like at least 100 million ounces of silver equivalent in a good jurisdiction with infrastructure. I think someone will come in and take that company out. That will get a nice price for that.

Even though the stock is below where I recommended, it wouldn’t take much buying to get it right back up to that level. In other words, it’s pretty tightly held; there’s not a lot of buying volume. If some big buyers came into the stock, it would take the stock up rather quickly. I think a buyout would be in the neighborhood of a $3 to $5 a share. If silver prices go much higher, obviously that asset’s going to be worth even more and somebody might be willing to pay even more for it. So that’s what I’m hoping for and that’s why I continue to play it and recommend it as a buy.

TGR: Jinshan Gold Mines (TSX:JIN) has also been on your top ten. Can you give us an update on them?

GM: I like China. There are plenty of great opportunities in China, but you have to be very careful. I’ve been over to China many times looking at a lot of different projects, and the company I like the most is Jinshan. It’s a gold project; it’s in production. They’ve had some bugaboos to work through on the production side. As they were ramping this up, they had some problems with the crushers and they had to get some crushers that could grind the material up a little finer so they’d get better metallurgical recovery on their gold. So they’ve gotten that squared away now, so I anticipate that for 2010 this is a company that’s going to be producing a lot of ounces, upwards to 70, 80, 90, 100,000 ounces next year. So I’m very encouraged by that. It’s at a good price.

This is another stock that I’ve done well on in the past. It’s back at a low price. I like recommending it here again. The Chinese now control Jinshan and it’s in the right jurisdiction in China. When you’re investing in China mining stocks, it’s all about the Chinese partner and province you’re doing business in. Some provinces will work with Western mining companies. In this case, it used to be that a Canadian company controlled Jinshan. Now the Chinese control Jinshan, so there are no problems with that at all. They’ve got some great exploration targets that, once we get the profits going, they can put that money in the ground and make a further discovery. So I really like Jinshan for the longer term, especially if you believe in higher gold prices, which I do. It’s one of the few China plays that I like.

TGR: Moving back over to North America, can you give us an update on Vista Gold Corp. (TSX:VGZ, NYSE.A:VGZ)?

GM: Vista Gold has been a big performer, another long-term recommendation of my newsletter. Vista Gold vended out all their Nevada properties to Allied Nevada Gold Corp. (ANV; TSX:ANV), which has performed wonderfully. Allied Nevada’s share price is up around $10. Early shareholders in Vista Gold who got shares in Allied Nevada because of the breakup of those companies have done just fine. Vista Gold, once the Nevada properties were taken out, has the Mt. Todd project in Australia and a good project down in Paredones Amarillos, Mexico, which is right next to Pediment’s project on the Baja, and they’ve got another big project over in Indonesia.

Their projects are coming around and the big upside for Vista Gold still is once they get the permit situation at Paredones Amarillos rectified, which looks like it’s happened now or soon will happen, it could move forward into production and be a takeover target. What’s good about Vista Gold is they have very few shares outstanding; they have a tight share structure with some great assets. A major player could easily pick up Mt. Todd in Australia from Vista Gold.

Overall I like their stability. It’s got good management, people who are very smart and know the business and have done very well in the past.

TGR: Since you brought up Allied Nevada, how are they doing?

GM: They’re doing great. They continue to move the Hycroft mine forward and everything’s just looking great. They’ve got some other great exploration targets that are getting very exciting; they have money. Now that it’s back into production, they’ve got a lot of cash flow. Here the stock was just a couple of bucks a share not too long ago, it’s almost $10 now. That’s a great success story for us. That’s been a big money maker for our subscribers.

TGR: I just want to mention one more company and that is Argentex Mining Corporation (TSX.V:ATX; OTCBB:AGXM), which you currently have as a buy.

GM: Yes, Argentex is a great mineralized system. This is a company that doesn’t have a lot of money, is trading at a lot lower price than where I bought it and recommended it, but I continue to hold it as a buy because the stock is recovering.

This is a gigantic mineralized system that the company controls. For a junior to try to drill a project of this size, it’s taken some time, but as they get more drill holes in there, the public and the investing market’s going to wake up to the fact that this is a very, very good story and one that could become a mine. These are the kind of stories you want to get in on as an investor because there are other big mines in the area. Big majors own mines near there and, again, this could have a takeout. Once a junior proves up they’ve made a big enough discovery, it’s very likely that a major could swoop this one up as well. So I like that kind of story.

I had another success story down there called Viceroy. We bought the stock at less than a dollar; I think it was 75 cents we recommended it. We sold it a few years later on a buyout for $11. So that’s what you hope for in this business and Argentex reminds me of a Viceroy.

TGR: Can you comment on buying physical gold and the premiums that are being charged? If people have not bought physical gold yet, is it time to get in or have they missed the big run up?

GM: Oh, no. People need to own physical gold for a different reason. Owning the physical metal is your ultimate savings account. I only keep in U.S. dollars what I need to spend on a month-to-month basis. None of my other savings are in U.S. dollars whatsoever. All my other money is either in Canadian dollars, physical gold and silver, or the mining stocks. I also own some Canadian oil and gas stocks. That’s how I diversify my portfolio.

At this point, if you don’t have physical metals, you should consider it very quickly because I think we’re coming up to a very big run and this could be the last time that we ever see gold in our lifetimes below $1,000 an ounce. Silver is ridiculously low. So you still have opportunity, but the longer you wait, the higher this is going to go.

Right now the premiums are not that high. And a typical premium is 5% over spot price. But last fall when things got tight again, hell, we saw things run up 5% to 10%. The premiums can go that high. So right now you still have reasonable premiums even though the spot prices are starting to creep up.

Here’s the other problem. Just like last year, as things got really, really tight, mints stopped making certain bullion coins and bars. We saw the Silver Eagle program stop producing for 10 or 12 weeks. We saw the U.S. Treasury stop minting the gold buffalo coins, which still are not being minted. And fractional eagles are not being minted anymore. All they’re minting is one ounce gold eagles. These scenarios tell me that things are going to get tighter, so why not buy when you can still get the stuff reasonably cheap and it’s got decent premiums?

TGR: Well said. Greg, I appreciate your time and your insights once again.

DISCLOSURE:
Persons interviewed for articles on the site may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise. Streetwise Inc. does not guarantee the accuracy or thoroughness of the information reported.

Greg McCoach is an entrepreneur who has successfully started and run several businesses the past 22 years. For the last eight of these years he has been involved with the precious metals industry as a bullion dealer, investor, and newsletter writer (Mining Speculator). Greg is also the President of AmeriGold, a gold bullion dealer.

Greg’s years of business experience and extensive personal contacts in the mining industry provide unique insights that have generated an impressive track record for The Mining Speculator since its inception in 2001. He also writes a weekly column for Gold World.

A serious student of equity market cycles and stock charts, market technician Clif Droke pulls no punches about the fact that the 120-year Grand Supercycle bodes ill as it approaches its end. Although his analyses of charts and cycles suggest some bright days on the near-term horizon, they also foretell depressing darkness by the middle of the next decade. Clif peppers this exclusive interview with The Gold Report with eye-opening and jaw-dropping insights—cut (thankfully!) with a note of caution that cycles aren’t the only forces in play and some thoughts about how to take advantage of an impending "recoil rally" before we close out the "best recovery year in memory."

The Gold Report: Clif, there’s a lot of talk right now about a market pullback. A recent missive on your website claims it’s because market participants still recall the great unwinding of last September-November. They’re afraid to get into the market. But when you analyze 10-year cycles, you conclude that the market should indeed increase now and through the end of the year. Why are people so fearful?

Clif Droke: There’s an old term most Gold Report readers will know—the wall of worry. As more and more investors and market participants worry about a crash or decline in the stock market, it actually tends to be counterproductive and produces the opposite effect. The market keeps rising on those fears, using fear as a wall to climb higher, as it were. This theory applies only in bull markets, however.

It’s debatable as to whether you want to call this year a bull market. Most people think we are in a long-term bear market and, within the context of the K-wave, maybe we are. Still, there’s no denying this has been one of the best recovery years in memory. The S&P 500’s recovery in percentage terms has been quite impressive. One reason is that the 10-year cycle peaks this year. So I have to define 2009 as a bull market recovery year. For that reason, I say the wall of worry is intact and the more investors worry about a crash or a decline, the more likely the market is to do the opposite and go higher. Certainly, we’ve seen that up until now.

TGR: But if the 10-year cycle is peaking, doesn’t a market pullback await us on the other side of the peak?

CD: That’s a good point, but every major cycle has a half-cycle component. So in that sense, a five-year cycle is coming down at the same time that the 10-year cycle peaks. Every time the 10-year cycle peaks—which is always around September to October of the ninth year of the decade (so that would be 2009, 1999, and so on)—it’s always the ninth year of the decade.

Anyway, the 10-year cycle peaking does tend to produce a sharp pullback. If you look at S&P charts around October of the ninth year of the decade, you will see a sharp pullback almost every time. It usually lasts about one to two weeks. However, when the peak is over, the five-year cycle has bottomed, which usually gives you a recoil rally that lasts about two to three months. So, typically, the S&P closes at or near its highs for the year after the 10-year cycle has peaked. We saw that last in 1999 and should see it again this fall.

TGR: So the 10-year cycle will peak in September-October, and then we may have a one- or two-week pullback followed by a two- or three-month recoil rally.

CD: That’s normally what happens. Typically, the cycle peaks right around the beginning of October, then you see that one- to two-week pullback and then the recoil rally usually into December. I expect that pattern to basically repeat this time around.

TGR: That sounds encouraging.

CD: As I said, I do expect this year to end on a positive note. It’s been positive thus far, and I think the next time we get a pullback, investors who have been on the sidelines all year long—and let’s face it, average retail investors have been on the sidelines; they’ve missed this remarkable rally—will be licking their chops to get in.

TGR: Then what’s on the horizon for 2010?

CD: The fact of the matter is that we are in a deflationary period within the context of the long-term cycles. With the four-year cycle—that’s the dominant cycle in 2010 being down—there will be some headwinds against stock prices next year. When we get past the recoil rally of the 10-year cycle next year, 2010, the 10-year cycle is no longer up. The four-year cycle, which is also known as the business cycle, bottoms next October. So next year could be a down year for equities overall.

TGR: So an individual investor’s best opportunity for gains is toward the end 2009, with cautious investing through the four-year cycle.

CD: Exactly. I see 2010 as being a trading range year. Even though the path of least resistance heading into next October probably will be down, in-and-out trading will provide some opportunities for capturing gains along the way. If you look historically at the zero year, the first year of the new decade, that’s usually what you get. The year 2000 was similar to that. After the 10-year cycle peak in 1999, we had a trading range year in the Dow in 2000 and it afforded a few good in-and-out trades. It was a tough year, though, and if you weren’t a good trader, it was very hard to do any kind of buy-and-hold investing. I think that will be true for 2010, too.

TGR: What about in the longer haul?

CD: The cycles I look at are part of what’s known as the Grand Supercycle. This 120-year cycle is the major dominant long-term cycle, but it also can be split into components. The 10-year cycle is one of them. So is the 60-year cycle; commonly referred to as the K-Wave, it’s actually the half-cycle component of the 120-year cycle. The last time the 120-year cycle bottomed was 1894. Before that it was 1774.

The 120-year cycle is also known as the revolutionary cycle because when it bottoms, not only does it produce a meaningful change in the economy, very often it produces a revolutionary change in the sociopolitical fabric. So we could see, for instance, the American Revolution of the 1770s occurring with the bottom of the 120-year cycle. And then the next time the 120-year cycle bottomed in the 1890s, there was a major depression and U.S. transitioned from an agricultural economy to an industrial economy. That’s another revolution. This time around, the 120-year cycle is bottoming in 2014. I do expect depression-type conditions certainly in the last three years of this cycle—that’s 2012 to 2014.

TGR: Whoa!

CD: And probably when it’s all said and done, America will see another revolution. I think it’s safe to assume the revolution is going to be socialist; the government will wind up with greater control over everything. It may even mean the end of the capitalist economy that we’re living in.

TGR: Aside from the overwhelming social implications that implies, this sounds exceedingly depressing from an investor’s point of view. We have through 2014 until this 120-year cycle bottoms. What do you do?

CD: Two things. The long-term investor has to start thinking in terms of becoming an interim trader in order to realize meaningful gains in equities. As far as buy-and-hold positions, I think the days of expecting long-term gains in stocks are over between now and 2014. However, gold has supplanted equities as a buy-and-hold investment. So long-term investors who are concerned about what’s going to happen in the next few years would certainly have a core position of gold or gold equivalent in their portfolios.

TGR: What do you define as core position?

CD: That depends on the individual investor—age, financial condition. It’s hard to put a definite percentage on it, but at this point I would say at least 15% to 20% on average. With the advent of the exchange traded funds, the gold ETFs, that’s certainly another avenue that can be pursued.

TGR: You’ve indicated that gold prices spike at the end of the 10-year cycle. It’s been trading upwards of $1,000, and earlier this year it was around $950. Do you see $1,000-plus as the peak or will it go exponentially higher?

CD: I have a conservative upside target in gold of about $1,040 to $1,050, based simply on chart measurements between now and whenever the 10-year cycle peaks. Some people are saying we could hit $1,200 based on the chart measurements. If you’re into chart pattern analysis, there’s what’s known as an inverse head-and-shoulders pattern in the long-term gold chart. Even though the 10-year cycle is peaking and that’s usually beneficial for gold, I don’t know that I believe gold can reach $1,200 between now and October.

TGR: Why not?

CD: Simply because gold is becoming exceptionally overbought on a longer-term basis. Certainly, my $1,050 target does not anticipate a big rally such as what we saw in September 1999, the last time the 10-year cycle peaked and gold exploded. Gold also did extremely well in the fall of ‘89 and, of course, ‘79. We’re just in a different economy right now. That’s the best way I can explain it. If we don’t have a magnificent rally in gold between now and October, all I can say is, it’s the economy.

TGR: You said earlier that as the 120-year cycle comes toward its end, long-term buy-and-hold investments typically won’t work except for gold. Where do you expect gold to be when that cycle hits its bottom in 2014?

CD: I would think that, especially during the final hard-down years of the 120-year cycle—between 2012 and 2014—gold will be the ultimate benchmark for safety for the average investor and I would expect it to increase dramatically by then. I don’t have an upside target; I’m really not much into making long term upside targets. I much prefer to follow direction based on internal momentum. But I can tell you that gold should appreciate dramatically heading into the cycle bottom in 2014. Certainly it will be well above anything we’re seeing now.

TGR: Is that because the U.S. dollar will depreciate dramatically or is it just the flight to safety?

CD: It’s the flight to safety. In fact, a disconnect between the dollar and gold during those years wouldn’t surprise me. Inflation is not going to be problematic. The major long-term problem we’re facing is deflation. The final years of the 120-year cycle always bring deflation, usually depression. I know it sounds contradictory to say that gold would outperform in a deflationary environment, but, actually, the two best times to own gold, historically, are during hyperinflation and also hyperdeflation. This is because it is viewed as a safe haven and investors will flock to it when they see major economic instability.

TGR: You note that gold producers’ sentiment has done a complete about face from a year ago, and that now they’re pretty optimistic. Is their optimism justified?

CD: I think they should be in an optimistic position. Longer term, the gold producers have a lot of things going for them, not the least of which is the gold price. A higher gold price certainly bodes well for them longer term. In the intermediate term, now that we are in what I believe to be a measure of economic recovery, it’s going to bode well for them just based on the increase in industrial and other forms of demand for their product. I don’t believe that’s misplaced optimism at all.

TGR: You’re talking about a recovery, and we’re getting some good economic news by the end of this year, but we’re heading towards a depression. The pieces don’t seem to fit together.

CD: Understand that I expect the worst part of the deflationary aspects of the 120-year cycle to begin around the year 2012. The last three years of the 120-year cycle are always the worst. If you look at the last 120-year cycle, I believe the stock market actually peaked out in 1892. That’s pretty analogous to 2012, when I expect everything to just fall apart. You can still have a measure of recovery in the years heading up to this, up to a point. Now we’re at that point.

Obviously, the 10-year cycle has been responsible for a lot of the recovery this year. Next year may not be the best year for stocks, but the Fed and the Treasury and the government have made such a concerted effort to revive and stimulate the economy, I think it’s going to work for a while. I expect the economy to kind of muddle through 2010, possibly 2011. The year 2011 is the last year that any cycle of consequence peaks out; mainly, the six-year cycle. And that’s why I say 2012 to 2014 will be very bad because, during that time, there will be no cycles up; they’re all going to be down.

So until we get to around 2011 or 2012, we could have a measure of economic recovery. It’s not going to be tremendous. Certainly, it won’t be like what we saw in the ’80s and ’90s, coming out of those little recessions, but I think we’re going to have some recovery up until then.

TGR: When we start getting some positive economic news, will that take individual investors off that wall of worry and back into the market?

CD: It will to some degree. I don’t think you can have a major top in equities without people coming off the wall of worry to some extent. People will start to come out of the sidelines, put their cash into the stock market. Even if it turns out to be a misplaced investment, I think we are going to see people coming off these high levels of fear. The stock market typically bottoms six to nine months before economic recovery. If you consider that the S&P bottom was in March of this year, that means between roughly now and December we should start to see the recovery take place. That’s not the only reason I have for saying that. That’s just one of the reasons.

TGR: What are the other reasons?

CD: I look at a basket of stocks, which I find reflect retail consumer demand. I have what’s known as the New Economy Index, which is an average of some key stocks that have been known to precede economic recovery by anywhere from three to six months. Fed Ex is a big one; Monster Worldwide basically reflects the job market; Wal-Mart, of course, the retail economy; and there are some others. Collectively, that index has been making higher highs and higher lows and that’s bullish for the economy. This index has been in recovery for the better part of six months and that’s another reason I expect fourth quarter to show some economic recovery.

TGR: Are you also looking at silver and other precious metals as safe havens?

CD: Gold and silver are the two main ones. I think a long-term investor should concentrate on those two metals above any other natural resource in view of the 120-year cycle bottom.

TGR: What’s your thinking about the rare earths and economic metals?

CD: From a long-term investment standpoint, I’d be very cautious, but tantalum, niobium and some others will do well as long as we’re in economic recovery and global economic demand picks up. We’re just barely starting to see it now. Certainly into 2010 I think the outlook will be fairly good for some of these rare earths and economic metals in the intermediate term.

A good up-and-coming company to look at is Commerce Resources Corp. (TSX-V:CCE, FSE:D7H, PK SHEETS:CMRZF). They’re mining tantalum—from one of the richest tantalum deposits in the world—and niobium in Canada. Tantalum is a major part of the electronics industry and, as the economy recovers in the next couple of years, I think demand for their product will be very good. Also Commerce’s President, Dave Hodge, told me a number of weeks ago and they were somewhat insulated from the credit crisis. That’s a plus going forward, and I do see intermediate-term investment potential there.

TGR: Is that because of the balance sheet or because they’re producing or why?

CD: Part of it is the balance sheet, but also because the demand side didn’t collapse.

TGR: Any other companies you can share with us?

CD: On the silver side, I’ve always been an admirer of the management of Endeavour Silver Corp. (NYSE/AMEX:EXK, DBF:EJD, TSX:EDR). It’s a junior miner in Mexico, but I think someday soon it will become a mid-tier producer. Their mining model is very distinct from most junior producers in that they do less raw exploration. They basically go after companies that have already been fully permitted and have plants already in place and they can skip the time-consuming process of construction and feasibility, permitting, etc. Endeavour has built up quite an operation and I think they’ll move very quickly into the mid-tier status of silver producers that’s been vacant since Hecla Mining Company (NYSE:HL) moved into senior status. Basically, I think one strategic acquisition will put them over the hump.

TGR: Is such a strategic acquisition already in play?

CD: I don’t think it’s in play yet, but they’re getting close. As Endeavour’s Chairman, Bradford Cooke, explained it to me a few weeks ago, they’re actively looking. Another thing worth pointing out about Endeavour is an unbroken five-year track record in terms of annual growth of sales, cash flow and production. Plus, it was the only silver company last year to have four consecutive quarters of falling cash costs, which is another reason I think they will hit that mid-tier status soon.

TGR: Is that because of efficiencies?

CD: Absolutely. Efficiencies and their mining model of not having to spend a lot of time and money being exploration-intensive.

TGR: Any gold companies on your radar?

CD: Romarco Minerals Inc. (TSX-V:R) is good one—extremely well-managed. Most of the shares, I believe, are institutionally held. If you look at the stock prices, it’s quite phenomenal. I think it’s a testament to the management of Romarco, Diane Garrett, the President and CEO. I think that’s a company, Romarco Minerals, to keep an eye on.

TGR: What attracted you to Romarco?

CD: I live in North Carolina and actually the first mining boom in U.S. history took place in the Carolinas. A trend on the Carolina Slate Belt was heavily mined in the 1800s and early 1900s, but then was kind of been abandoned. Romarco has gone back in there and is reviving, as it were, the Carolina Slate Belt with their Haile Gold Mine. It has 1.62 million ounces of gold (measured and indicated) with 3.26 million total gold resource (including inferred), and is open in three directions.

TGR: If most of the shares are institutionally held and you’re already pretty impressed with their share performance, how much upside is left in this?

CD: Their production can only increase, so I think they do have some meaningful intermediate term upside. Just looking at their pipeline, I think they’ve got one or two years of upside potential. Not necessarily straight up, of course, but excellent management and strong institutional ownership bodes very well for them.

TGR: Why is the 120-year cycle not being discussed by the media?

CD: For one thing, it’s not something you see in a classical economic textbook. Basically we’re taught that government and central banking control the outcome of the economy through money supply and interest rate manipulation. In fact, classical economics and mainstream financial theory do not like to discuss the prevalence of cycles. Nobody wants to think that we’re at the mercy of forces beyond our control. That’s basically is what a cycle is—a cosmic force or a force of nature, if you will.

TGR: Or maybe—in this case—it’s too dark to bring into the light of day.

CD: Don’t equate the end of the Grand Supercycle with Armageddon. No cycle should be viewed as anything more than a rough road map for navigating the markets. Rarely can any cycle be used to consistent success as a standalone trading tool. For best results, investors should combine cycle theory with chart behavior and comprehensive study of rigorous analyses of technicals, fundamentals, market psychology and market liquidity.

DISCLOSURE: Clif Droke: I personally and/or my family own the following companies mentioned in this interview: None

Savvy market technician, seasoned chart reader and cycle analyst Clif Droke is a popular and prolific author. His Gold & Silver Stock Report (published every trading day since 2002) examines daily and weekly technical outlooks on individual stocks and forecasts the near-term outlook for leading indices. In addition to gold and silver, it covers uranium and energy stocks from a short-term technical standpoint. In his Momentum Strategies Report, launched in 1997, Clif shares forecasts and reviews of U.S. equity markets using his proprietary blend of internal momentum indicators, moving averages, various analytical methods and investor sentiment to isolate the best sectors for short- and intermediate-term trading gains. Updated three times a week, Momentum Strategies addresses six major sectors (gold/silver, oil/gas, transportation, financial, REIT and semiconductor/nanotech), in addition to covering real estate, natural resources, money supply and trends in bank credit and the general economy. Also launched in 1997, Clif’s monthly Gold Strategies Review covers gold, U.S. and Canadian precious metals equity markets and mutual funds and other natural resources. He also puts out Silver Strategies Review and Junior Mining Stock Report each month—and more. A frequent contributor to Kitco commentaries and Financial Sense, he has an impressive array of critically acclaimed books to his credit too. They include a variety of how-to volumes (channel busting, parabolic analysis, selling short, chart reading and turnaround trading, to name just a few) and cover topics as diverse as the housing bubble and cattle futures.

The Gold Report: Axel, you’ve been successfully identifying macro trends for decades, and then recommending appropriate investment strategies based on those trends. What macro trends do you see today?

Axel Merk: We have two major forces one inflationary and the other deflationary playing out, and by now many investors are familiar with them. Let me expand on that just a tad. After the credit bubble burst, the market forces wanted a major contraction. Those forces are still firmly in place. Lacking monetary and fiscal subsidies, we would have a very severe recession if not a depression.

On the other hand, of course, we have the government forces, mostly driving in monetary inflation to reflate the system. Depending on the mood of the day in the market, one force or the other is winning out. On days when the market is up, it’s the inflationary-reflationary forces.

When we have the flight to quality and when credit contraction occurs, the dollar often benefits. Each time the pendulum swings in that same direction again, the dollar benefits less than in the previous swing, because the government prints more money and leaves a bigger hole in the balance sheet.

TGR: When the credit bubble first burst, the market wanted a contraction, and then we had a flight to quality. Will market forces ultimately prevail over any government subsidies?

AM: Ben Bernanke doesn’t want to go down in history as the one who oversaw the next Great Depression. I do believe the market forces ultimately will prevail, but only because the government has some tools that will play a major role. The most important of those tools is the printing press. So while we play this back-and-forth game, we’re printing ever more money.

The Federal Reserve wants us to believe that there’s no inflation in the pipeline due to the output gap (or economic slack). That fairy tale is very difficult to believe for anybody who’s serious about macroeconomics, including central bankers. Every central banker knows that the primary drivers of inflation are inflationary expectations not the output gap. The Federal Reserve wants to print money and have very accommodating policies to boost the economy without it being reflected in the higher cost of borrowing. For the time being, they’re getting away with it. But ultimately the Fed is going to have a huge problem which is that it has to combat inflation while at the same time it won’t be in the position to do so.

TGR: If the predictor of inflation is the expectation of inflation, and if the government can convince us that we won’t have inflation, why would the expanded money supply cause inflation?

AM: I doubt that in the long run you can convince the public that having huge deficits and huge money printing won’t cause inflation. There’s a reason the U.S. dollar made it to the status of the world’s reserve currency. Over many decades the Fed has pursued a sounder monetary policy than other central banks. You can’t now turn this upside down and impose unsound, imprudent policies on the rest of the world for too long.

Just because it’s in nobody’s interest for the dollar to fall steeply doesn’t mean you should get away with the sort of policies that have been pursued. You can do that for a while, but ultimately the market will impose a higher cost of borrowing on the U.S. or otherwise force the U.S. to rein in its behavior. And if the government then continues to press the other way, the damage is going to be dramatic.

So I wouldn’t say that the populace will buy the government policies forever. They’re giving the government the benefit of the doubt for now, and in the meantime, of course, investors can position themselves for the risk that things will change. We don’t have a crystal ball, but we know the risks.

TGR: Can you highlight the major risks that should worry investors?

AM: The major risk is that the Fed gets what we believe it wants. Bernanke has said repeatedly that one of the ways we got out of the Great Depression was by getting off the gold standard and allowing inflation allowing prices to rise. Remember, if you have too much debt, inflation helps you; it bails you out.

So many homeowners are under water with their homes, you have a choice of home prices coming down, homeowners downsizing and declaring bankruptcy a scenario politicians don’t want or you induce inflation to allow prices to rise. That’s what the Fed wants, and they might just get more than they bargained for. So inflation is the big risk and its side effect is there is no such thing anymore as safe assets.

Cash is no longer a store of value. We are encouraging investors to take a diversified approach with something as mundane as cash, and the dollar is obviously the focal point. Will the dollar hold up? In the past it has been in the interest of the world to keep the dollar steady, but it just might not be sustainable. So people should be paying the most attention to inflation and the dollar.

TGR: If inflation takes off, the U.S. dollar devalues. What are our alternatives?

AM: Obviously, it’s a complex situation. Some say they’ll have gold and nothing but gold, but I would think that even the staunchest gold bugs probably don’t have all of their money in gold just for practical reasons. So the question is what to do with the part that you don’t have in gold.

Let’s look at a couple of the regions in the world, starting with one of the more controversial ones, the Eurozone. Many people think the Eurozone is doomed just as much as other places because the banking system has major issues. In recent months, we’ve been far more optimistic on the Eurozone than others and it goes back to what Bernanke has said about going off the gold standard.

If you don’t devalue your currency, if you don’t print yourself out of this mess by trying to devalue yourself, you’ll end up with much less economic growth but with a much stronger currency. We believe that’s what the European Central Bank is focusing on. They have been providing unlimited liquidity to the banking system, so they can keep zombie banks alive and keep the economy afloat. But by not pursuing policies as aggressive as the Federal Reserve’s, we believe that they will have a much stronger currency. Also remember that structurally the European Union is far more rigid than the U.S. It’s far more difficult to print money. You can’t just print money and inject it in the bank. The money is coming from the state governments.

Similarly, on the spending side, as a result of that structural rigidity, no centralized body can just ramp up the spending as rapidly as happens in the U.S. So the EU, and the Eurozone in particular, will fare better relative to the U.S.

Of course, there might be more prudent places such as Norway, which we have been advocating, that has the resource income and at the same time is linked to the Euro and other European currencies. The correlation to those currencies is very high. Rounding up the Western European currencies, Switzerland is traditionally considered a safe haven, though the Swiss have worked very hard to try to discredit the Swiss franc. Another reason to move over to Norway if one likes European currencies.

Looking over to another region, especially for gold investors, is the Australian dollar. It has the highest correlation to the price of gold of all the world currencies. Australia tends to benefit from the monetary stimulus that’s pushed everywhere in the world, and the Australians might be among the first to raise rates again. The Australian dollar, in our view, benefits whenever the reflationary trend is invoked. To an extent, the same is true of the Canadian dollar, although its dynamics are far more complex.

In Asia, pressures to allow the currencies to appreciate will only intensify, partially because of the domestic stimuli that these countries have been pursuing. China, in particular, has been very effective with its stimulus because it’s one of the few countries in the world that can afford a stimulus. The most efficient way to prevent inflationary problems down the road, in our view, is by allowing the currency to appreciate particularly because the Chinese have taken all the steps in that direction.

If you look at the weaker Asian countries, they can compete on price alone. These are countries such as the Philippines and Vietnam that deliver goods at the low end of the value chain. Their lives depend on exporting to the U.S. Because we don’t expect a quick consumer recovery in the U.S., some of these countries may even engage in competitive devaluation.

TGR: Do you see any potential for adopting a different reserve currency?

AM: It comes down to what is realistic. In recent months, the heads of state in different countries have been saying, "We have to go away from the dollar." And then their finance ministers come out and say, "Well, we can’t." If you compare the heads of state and the finance ministers to corporate executives, with the CEOs saying one thing and the CFOs saying something else, eventually the CEOs are going to come out ahead. Part of the reason is because there is no easy substitute for the U.S. dollar. The Eurozone is a distant second, and then there’s just about nothing else.

TGR: What does the balance look like in your baskets of currencies?

AM: We have two mutual funds, the Merk Hard Currency Fund and the Merk Asian Currency Fund. In the former, we invest in currencies that we consider backed by sound monetary policy. That’s obviously a relative statement, but we have taken altogether about half of the Western European currencies in the that fund Euros, Norwegian krone and Swiss franc plus about 14% or so in gold and the rest spread out among Australian, Canadian and New Zealand dollars.

TGR: What about the British pound?

AM: We do not have the pound sterling in the Merk Hard Currency Fund. We believe that the Bank of England is the yo-yo central bank of the major central banks, and the U.K. is going to have major issues. Nor do we have the Swedish krona in the basket.

TGR: How about your Asian Currency Fund?

AM: We’ve ramped up our exposure to the Chinese yuan to about 60%, so this fund is really a play on the China appreciation. Asian currencies have very different dynamics. Many of them trade in a very small trading band to the U.S. dollar and it’s mostly in anticipation that some of these currencies may revalue over time.

TGR: Are you looking to store value in your funds or to create wealth, which in this case would be some denomination of cash?

AM: Our objectives state that we seek to profit from a fall in the dollar versus our baskets. Ultimately, the hope would be that you can increase your purchasing power. Having said that, our goal is not to have some gangbuster returns that investors can achieve by investing in very profitable companies. At certain times, it might make sense to diversify to these baskets of currencies just as with a gold investment. Most people don’t buy gold expecting to make a fortune. In fact, many people fear that their gold investment will go through the roof, which would mean that many other assets they hold may be going down the drain. So it’s a balancing act, it’s a diversification act, and it’s in that spirit that we offer these funds.

TGR: As an individual investor looking at baskets of currencies to hedge against the devalued dollar, what percentage of the portfolio would you recommend?

AM: We’re not allowed to give specific allocation advice. Some people put a big percentage of their assets in it. Some people put 5% of their money in it, some put substantially more. And, obviously, some people don’t consider it.

TGR: How should investors look at the opportunity of investing in a basket of currencies as part of their portfolio?

AM: People look at it in different ways. Some think of it as an international bond fund allocation. Others use it for cash holdings that they want to diversify. We caution that we are not a money market fund. We also believe that the markets are going to continue to be unstable, be it the equity markets or the bond markets. Volatility in the currency markets will persist, too, mostly because of the policies being pursued.

In our view, we will not get a sustainable recovery, so we’re providing the international exposure without the added risk of an equity exposure that people would get internationally. That’s attractive for people who don’t like equities, bonds or cash. So where do they put their money, especially if they don’t think real estate has bottomed?

TGR:A lot of gold bugs believe that the devalued dollar will push gold through the roof. So they look at gold as an asset that’s appreciating, not just sustaining wealth. What’s your view on that?

AM: That potential is certainly there, but people underestimate is how small the gold market is. That’s one reason the volatility is so high, but another effect is that if and when there’s a flight into gold, it can really take off much more than many other commodities or equities. In that context, I don’t disagree with that. We have a gold component in our Hard Currency Fund and I personally hold gold in my children’s college savings plans.

TGR: One reason you have a basket of currencies is that you expect the equity markets to be unstable going forward. A number of analysts forecast a major retraction before the end of the year. When you look at your macro trends, do you see that occurring?

AM: That risk is certainly there. Again, I don’t have a crystal ball; but I do assess the world in terms of risk scenarios because while we have seen a lot of money thrown at the economy, much of it has been extremely inefficient. Furthermore, the earnings are not there, the consumer recovery is not there and the cash-for-clunkers program has cut into future sales. So there is risk of a decline in the market even a serious decline.

The only opposing force to that is massive monetary stimulus. The Fed’s programs will be much easier to jumpstart because the tools are in place. While market forces may warrant a significant decline, I would think that policymakers may act with an even more forceful push back if and when a significant decline materializes.

TGR: Even if Bernanke is that savvy and has various tools to deploy rapidly, don’t we need consumer spending to reduce unemployment and increase earnings?

AM: First of all, I would hesitate to call Bernanke savvy. He is determined. Bernanke completely underestimated the political dimension. He has veered away from monetary policy and shifted over to fiscal policies. All these credit-easing programs are fiscal policies that generate political backlash and, as a result, the monetary policy becomes much less effective and ever more expensive. Secondly, increasing the monetary base doesn’t mean the dollars that the Federal Reserve prints will be used in the economy. That’s one of the reasons we have not seen inflation pop up yet.

But we are going to have a big mess on our hands and I don’t think we’re going to get out of it without a significant increase in inflation. It may not appear in the areas where people want it to appear and be a drag on the standard of living.

TGR: So we go into inflation in high single digits, double digits or hyperinflation. How do we eventually get that under control?

AM: I think we’re going to have further erosion of the middle class. The sophisticated investor can deal with inflation. The savers the middle class cannot. We may move toward a more Latin American-style economy, and with that would come a backlash that favors populist politicians. In this age of social networking, where very small groups can mobilize people to come to disrupt healthcare town forums, or in Iran to rally on the streets, I’m just saying that politics will be driven more by populist voices. That will lead to the election of more populist leaders and will make it very difficult to get onto a sustainable path.

It’s a very scary environment and it’s one of the reasons more people get involved. They want to stop that trend. We’re trying to do our part with our public contribution to some of these debates, but it is a very challenging environment. How will it ultimately play out? The only thing I can say in that regard is that throughout this crisis, democracy in general is still in reasonably good shape in the U.S. So, overall, we’ll get through this. It’s just very sad that we have to erode the purchasing power of the masses in the process of doing so, and violate many of the principles we believe in.

TGR: If it does turn around, what timeframe are we looking at a decade, two decades, a generation or two?

AM: For the next decade, I would be most concerned about the inflationary issues. For the time being, we have to take the precaution that things may turn out more inflationary. I’m not a real gold bug, although I do like gold and have for the better part of this decade. But the policymakers just might come to their senses. If things get bad enough, they just might but right now I don’t see that in the cards.

TGR: Let’s all hope we’ll be pleasantly surprised.

Axel Merk is Founder, President and Chief Investment Officer of Merk Investments LLC"the Authority on Currencies" and a pioneer in the currency asset class. His SEC-registered investment advisory firm, which manages mutual funds specializing in international currencies, started out in Switzerland 15 years ago. Axel relocated the business to Palo Alto, California, in 2001. The Merk Hard Currency Fund, established May 10, 2005, with assets of $362 million (as of early September) invests primarily in Euros, the Norwegian Krone, Canadian and Australian dollars and gold. In April 2008, Axel added the Merk Asian Currency Fund, and already it has assets of nearly $64 million (in the currencies of China, Hong Kong, Japan, India, Indonesia, Malaysia, the Philippines, Singapore, South Korea, Taiwan and Thailand). Known for offering understandable advice and an uncanny ability to predict market movements, Axel is a regular guest on CNBC and Fox Business, and is frequently quoted in Barron’s, the Wall Street Journal, Bloomberg News, USA Today and the Financial Times. His book, Sustainable Wealth: Achieving Financial Security in a Volatile World of Debt and Consumption [Sustainable Wealth.org], synthesizes macro trends, explains their effects on individual wealth, and suggests ways to build and preserve financial security in a volatile environment. It will hit the bookstores in October.

That was March though and not too many investors were interested in buying anything. But Embry said to look past the short-term and focus on the big picture.

At the time, Embry predicted:

I think the major development is going to be ongoing issues of currency debasement. The value of paper money against real tangible assets is going to fall considerably. Right now, we are going through this deflationary scare. It won’t last. It will change into a hyperinflationary environment in the not too distant future.

Since then, gold and silver have climbed 9% and 25% respectively. They’ve done well, but the big gains have been in gold and silver stocks, where Embry pointed us to last time. The Philly Gold and Silver Sector Index (XAU) has climbed 51% and many gold and silver stocks have done much better.

The prediction has proved nearly prophetic. So I’ve invited him back to learn what he expects to happen in the short- and long-term and the opportunities he is seeing now.

In our most recent conversation, Embry reveals:

– the catalyst for an “explosion in the price of gold” over the next two months
– assets for which “demand is exploding”
– China’s “interesting problem”
– the sector where short-term sentiment is hiding a huge rally
– hidden impact of 10% official unemployment

That’s just for starters. There’s a lot more on silver, farmland, uranium, and plenty of other high-potential sectors.

Read on below for a full transcript of the exclusive conversation.

Good investing,

Andrew Mickey
Chief Investment Strategist, Q1 Publishing

John Embry and Andrew Mickey

Andrew Mickey: Thanks for joining us today John. A lot has happened since we last talked in February. Basically, it looks like almost everything we looked at last time – gold, silver, agriculture, and other hard assets – continue to be out of favor. There have been “gold shoots,” but nothing really sustainable.

That’s why, today, I want to get into a few more specific topics with you. And one thing that’s really hot right now is what’s going on in China with the real debt explosion. To me, it seems similar to the “Greenspan Solution” – cut interest rates so low they’re actually negative so its cost prohibitive not to borrow money, sit back, and watch an asset bubble form.

Do you see any problems in China? What are your thoughts on this?

John Embry: Actually, I have some fairly strong views on this subject. I don’t think that you can do what they have done and end up without a problem.

To put it simply, they have force fed an enormous amount of credit into their economy through their banking system quickly. And the numbers, for such a short period of time, are quite staggering. But it seems to me that the kinds of loans that are being made are going to be hard to service. I think there are going to be a lot of loans made to people that are going to have to do uneconomic things, and I think we are seeing it also show up in the areas of speculation in stocks and commodities.

I don’t think China is going to have a smooth ride. It just seems to me that people think China has got the magic solution and they are just going to continue to grow at 7% to 10% a year, forever. I believe they will have a huge hiccup at some point, and maybe sooner rather than later.

So yeah, I think that they sort of got a short term bail out with all this money they jammed into the system, but we will see how it works out in the longer term.

Andrew Mickey: The other thing that I wanted to talk to you about is agriculture, which has really fallen out of favor. It’s tough to imagine expectations getting much lower.

I know we’re both big on agriculture over the medium- and long-term, but what do you see happening right now. What’s going on with this year’s crop? What do you see happening in the near term and also more longer term?

John Embry: I think that crops are coming in better than what most expected. For example, if you have a longer term point of view, you are going to go through some bumpy spots for the simple reason that no one can predict what any individual growing season is going to be like. But the fact is, in my opinion, the long term view is still very intact. There are too many people on earth and more of them are becoming better off to the extent that they can eat better.

I suspect the climate is going to be an issue going forward; consequently, there will eventually be food shortages. In the short term, we appear to have gotten bailed out by an exceptional crop. Consequently as the crop actually starts rolling in, prices can be very volatile and perhaps move to the downside.

As I said in the short term, we cannot predict crops on an annual basis up here or anywhere. The industry is very large and a lot depends on unpredictable variables like weather.

However, at Sprott Resources, we are putting together a potential million-acre farm in Western Canada called One Earth Farms. We are putting our money where our mouth is. We think there is a huge opportunity over the full food cycle.

Andrew Mickey: I have heard a little bit about that. Is that going to be part of Sprott Resource Corp?

John Embry: At Sprott Resource Corp we have a joint venture with the First Nations in Western Canada. I think it’s a hell of a concept. We are going to give them a fair shake because they haven’t been given a fair shake, in the past. They have some great land and we think that, if farmed efficiently, it’s going to be a very successful economic venture.

Andrew Mickey: Where is this located?

John Embry: It’s in Alberta and Saskatchewan.

Andrew Mickey: So there has been a mutual agreement over the use of their land reached? I know that can be a problem for a lot of mining and energy companies in those parts.

John Embry: Yes it is. In the past, I think the natives were not treated fairly and in this instance we won their confidence and now things are going pretty well. We are putting it all together and getting it started, but it will take years to play out to its full extent, but things have gone smoothly to date.

Andrew Mickey: That’s an excellent idea. One thing that’s tough to do, from a retail investor’s perspective is to get exposure to farmland. You really may have something there.

What about uranium?

Just a few days ago, I saw that Southern Company (NYSE:SO) announced they are building a nuclear facility in the United States. Is this something that China is still going after? Do you think the cap and trade is beneficiary?

John Embry: My attitude is very simple on energy. We are going to have shortages, and alternative energy isn’t going to come fast enough.

One of the more efficient ways to combat this problem will be, or seems to be, uranium. And again, right now we have been going through a challenging period in the commodity cycle, and clearly uranium has been hit, but I don’t think the longer-term picture is impacted too much.

Andrew Mickey: Let’s get into global infrastructure for a moment. Every country seems to believe building something will be the way out of this situation. The US has a couple of “show” projects. India has some very big aspirations. And infrastructure looks to be China’s continued focus of its efforts. Do you see more opportunity in infrastructure?

John Embry: A lot has gone into that. China has got an interesting problem. It’s clear they grew off the back of the international demand for their manufactured products. This occurred in a sort of bubble-type atmosphere where the entire western world was over stimulating their economies and their consumer sectors. It provided a tremendous stimulus to China.

Now, China has to deal with the collateral damage from getting a significant proportion of their wealth from exports. They are going to have to develop their domestic demand and they as part of this have put a lot of money into their domestic infrastructure.

My concern is in the short run. China may have gotten into a significant overcapacity situation in a number of areas. That’s certainly the case on the manufacturing side. They can build roads and bridges and all sorts of things, including electrical plants because they need these and they have the money to do it. So I think infrastructure spending in China will continue to remain a very significant economic stimulus.

Ironically, in the United States where they are bailing out all the banksters, what the United States really needs is an infrastructure build out.

I don’t know where the money is going to come from but there’s an awful lot of stuff that has been just kind of ignored for the last 20-30 years; roads, bridges and all the real structures. If it were up to me, I would be focusing significantly on that.

Andrew Mickey: Let’s switch our gears for a moment here to gold and silver…right at this point, everyone is focusing on the long, long term, say 10 years, 15 years out.

Read on here for why Embry sees the real gold boom could coming in the next two months.

http://www.q1publishing.com/dispatch/503/Gold-Outlook%3A-Explosion-in-the-Price-of-Gold-Imminent-(Part-II)

Bullish on gold since it carried a $400-per-ounce price tag, Blue Phoenix Chief Investment Strategist John Licata expects the king of metals to ring in the New Year with a $1,200-per-ounce crown. As he told The Gold Report in April, he still considers gold one of the best asset plays in the world. With recovery on the horizon, he’s also high on silver—in part because a pickup in manufacturing will drive up demand. While he says it’s premature to claim economic recovery, he isn’t looking to copper to serve as the traditional harbinger of a return from recession this time. His rationale? Good economic news—while too inconsistent to make recovery imminent—is already baked in to copper’s climb already this year.

The Gold Report: You weren’t too bullish on seeing a recovery in 2009 when we caught up with you in April. We’ve seen some good Q2 reporting from a variety of companies and some encouraging economic data. The government is starting to claim we’re in recovery. What’s your take on this?

John Licata: I do think we’ve seen some better domestic economic data, but it’s premature to think we’re totally out of the woods. In terms of corporate earnings, a lot of company profits might have surprised to the upside, but they’re still down 50% to 70% from quarters before or the prior year.

Many companies have been trying to compare Q1 and Q2. You’re still not seeing dramatic differences to the upside. Quite frankly, some companies are still living within cash flow and I think that’s one of the reasons why we could have a problem with supply and demand imbalances as we come to the end of 2009 and enter 2010.

Unemployment is likely to keep rising. Although the last numbers were much better than anticipated, I don’t think we’ve seen the green light that will cause people to start hiring again. We could hit 10% unemployment by the end of the year, and that’s going to be a precursor to some weaker retail heading into the holiday season. Net-net, you probably could put the word ‘inconsistent’ toward most of the economic data coming out of the U.S.

The industrial numbers that came out of China a couple of weeks ago [August 10] were actually below expectations as well. While everyone wants to be bullish and the data is somewhat better than many expected, it’s still not great. So I think to claim victory right now is definitely premature.

TGR: You mentioned a supply-demand imbalance. What do you see on that front?

JL: Companies are not putting money back into infrastructure. For that reason, once demand actually starts to increase, supply levels will be shockingly different from what people might expect.

TGR: Are you differentiating between the BRIC countries and North America in that regard?

JL: I’m not just looking at the BRIC countries as the barometer for the economic pulse. I don’t even think China is the saving grace for commodities. But I do think what is going to be indicative for a recovery is to see demand pick up, to start seeing jobs pick up again, more consistently; not just one month out of six. We need to see consistent job growth.

TGR: When do you think demand might pick up?

JL: Q3, perhaps Q4, is when we probably can start seeing demand start picking up and I think that’s when we’re going to start to see overall a global economic recovery. I’m skeptical that it can happen before Q4.

TGR: Is that worldwide demand pickup you’re anticipating?

JL: I’m referring to North America.

TGR: Can demand pick up before unemployment abates?

JL: It can happen before, but I think demand and employment will increase in tandem.

TGR: In our previous conversation, you compared the investment opportunities in oil, natural gas and gold to one another. At this point, which of these three sectors do you think offer the greatest return?

JL: Because of the upside that I think could happen over the next 12 months, I would rate natural gas first, gold second and oil third. For right now, I’m conservatively optimistic on oil. Although short term we might have a pullback, I’m still bullish on the price of oil. I think oil will trade north of $80 by year end, and I think we’ll again see triple-digit oil within the next two years. A lot of major wells in the world are not as productive as they once were and when it comes to demand increasing because the overall economic health around the world is picking up, we could be in trouble in terms of supplies. That relates to the metals as well as energy.

TGR: Speaking of metals, your outlook for gold?

JL: I continue to maintain that we could see $1,200 gold prices by year-end. I think gold is very much on the way to hitting that pretty aggressive price target. The miners themselves seem pretty confident on the upside for gold. We’ve been hearing CEOs from various gold companies, including Goldcorp (TSX:G) (NYSE:GG) and Agnico-Eagle Mines (TSX:AEM), saying that we’re probably going to end the year with gold north of $1,000.

TGR: In April, you described gold as one of the best asset plays in the world and your recommendation to investors was to focus initially on physical gold. Have you changed that viewpoint?

JL: No. I’ve been bullish on gold since it was below $400. But now I am starting to see some opportunities in the equity side of the gold market that are becoming very appealing and I didn’t see that when we last spoke. For example, Gold Fields Ltd. (NYSE:GFI)(JSE:GFI) is paying a dividend of 1.77%; that might start to draw some attention. Outside of the dividend plan, their costs have been improved relating to Eskom in South Africa. If they can keep those costs balanced, that’s another reason investors should take a look at GFI.

Agnico-Eagle actually might raise the dividend in 2010 or buy assets either in the Arctic and Mexico. That’s pretty interesting, too, considering the move they’re expecting in gold prices.

TGR: Any others that appeal to you?

JL: I’ve been high on NovaGold Resources Inc. (TSX:NG) (NYSE.A:NG) for a long time. They have partners, including Barrick Gold Corporation (NYSE:ABX) and Teck Cominco Ltd. (TSX:TCK.A) (TSX:TCK.B) (NYSE:TCK) and I do think that they could gain the external financing they need develop their properties and get them up and running. Their assets are very rich. I also love Golden Star Resources Ltd. (TSX:GSC). So those are names I’m looking at right now in the gold space that I think would be quite attractive for investors.

TGR: How about Fronteer Development Group (TSX:FRG) (NYSE.A:FRG)? Anything new with them?

JL: I’m still very much a fan of Fronteer, but at the moment more for their uranium assets than their gold assets. A third-party surveyor is supposed to announce uranium results for Fronteer before October. That should go a long way toward showing Wall Street some economics around the company’s uranium business and that Fronteer has a robust profitable project in Michelin. Fronteer has about 100 million pounds of uranium in that project in Labrador.

TGR: Are you still bullish on platinum and palladium, too?

JL: I am still enthusiastic, but not as bullish on either of them just because we have seen a bit of a run since April. I’d rather be in silver. I think silver gets forgotten when we start talking about precious metals. As opposed to platinum or palladium, I would rather be in the silver space and possibly look at a company like Hecla Mining Company (NYSE:HL).

TGR: What’s about Hecla captures your attention versus the hundreds of other silver equities?

JL: They’re the largest U.S. silver producer. They’ve been doing a really good job of paying down their debt. The company has cut down its costs and is on track to meet their full-year production guidance between 10 million and 11 million ounces of silver. In addition, Hecla recently announced a 24% increase in quarterly silver production. The fact that they have record silver production—thanks to, I guess, more stringent management and better mill optimization—speaks volumes for this company. And they said on their last conference call that they could have a record-breaking Q4.

TGR: Given the rally we’ve seen in the last four months or so, hasn’t the market already priced that in?

JL: I don’t see it. I think there’s more upside to come.

TGR: Is there anything in particular in silver that you’re finding appealing?

JL: I just think if we’re talking about an economic recovery in the back half of this year into 2010 and silver is mostly used for industrial purposes, I honestly think that silver prices are just forgotten. When people start talking about the inflation hedge, they jump into gold. If they start talking about the economy improving, they jump into copper. They tend to forget that silver is actually used for much manufacturing. So I think that is the forgotten metal and I do think that silver prices can move a lot higher, especially as gold prices march through $1,000.

TGR: As you say, people look to copper as the leading metal to point to in terms of a recovery. What’s your feeling about copper?

JL: You hit the nail on the head. Everyone starts to talk about copper, but nothing has jumped out at me to say that copper prices have much more upside. Copper prices are up nearly 100% year-to-date, so I think a lot of the recovery that many people are talking about has been priced in already. In addition, Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX)—the world’s largest publicly traded copper company—is up north of 150% year-to-date. It seems to me that a lot of the good news is baked in already. So I think the upside in both the futures and in the bellwether—Freeport—is definitely limited.

Beyond that, the Baltic Dry Index, an index that just had the biggest monthly drop since October (down 28% in August), has been down because people fear that China might cut back on buying iron ore and coal. If that happens, copper prices won’t be immune. Copper supplies have been tight for the last couple of quarters. If anything, we’re trading about 35 cents or 40 cents above the recent 50-day moving average. I think copper is over-extended right now.

TGR: Any last comments before we meet again?

JL: Only that while it’s a difficult marketplace and I do expect tight markets around the world to continue, some of the plays we’ve talked about have the makings of a pretty successful portfolio.

DISCLOSURE: John Licata
I personally and/or my family own the following companies mentioned in this interview: None
I personally and/or my family am paid by the following companies mentioned in this interview: None

After studying economics and graduating from Saint Peter’s College in New Jersey (where he received the Wall Street Journal Award for economic excellence), John J. Licata set his sights on Wall Street. During his career, John has held both trading and research positions on the NYMEX, Dow Jones, Smith Barney and Brokerage America. Early in 2006, he founded Blue Phoenix, Inc., an independent energy/metals research and consulting firm based in New York City. John, the company’s Chief Investment Strategist, has appeared regularly in the media (CNBC, Bloomberg TV/Radio, Business News Network (BNN), Barron’s, The Wall Street Journal, Chicago Sun, Los Angeles Times, etc.) over the years for his insights/forecasts in the commodity spectrum.

The stock market’s still on tap for a ferocious fall after Labor Day, claims TraderTracks editor Roger Wiegand—as he told The Gold Report a few months back. The veteran prognosticator doesn’t see much to be encouraged about on the global economic front, either, with the engines of growth "melting like snow in July." However, he does see the makings of some "pretty exciting" action in precious metals.

The Gold Report: When we chatted in May, you predicted a major selling event this fall. Is the move that started in mid-August the beginning of that?

Roger Wiegand: No, we’re not quite there yet but we see the first glimmerings of an attempted top during this last week of August. I think we have a little more time for the final shares’ thrust to the top. There may be room for one more wave up. And, then after Labor Day and moving on into September, we’ll hit the spot where we’re predicting the big sell. The date we think when markets are going to drop is September 15.

TGR: You also projected that the Dow could rally up to nearly 10,400. Do you still see that happening before September 15?

RW: There’s a chance, but I now think 9,800 is more probable. Months ago we said 10,400-10,800, but I give it a 1-in-3 chance for it to rise to 10,400 now. TGR: When it drops, how low will it go? RW: In a longer drop, technically on Elliott Wave theory, instead of doing an ABC sideways channel-type correction or going into a continuation triangle; prices can begin selling down in steps and stairs in a full five waves, first on the dailies and then into the weekly. It depends on how severe certain things get—we can’t measure that—but technically we could go back to 6,600-7,250 on the Dow this fall. TGR: What would that mean for worldwide markets? RW: Well, it’s going to be pretty bad. The last time we went through this, the big stock market went down and gold and silver and some of the other markets still had some remaining power and, still earned quite a bit of money. The thing that really irritates me is the fact that people who owned both precious metals and related stocks had to get out of the precious metals. They had to raise cash to cover their other problems. Many have learned from the lesson and this time I don’t think they are so far out or so long in a lot of the shares.

The major difference—and this is very important—is the juniors. A handful of juniors are so good that we’re almost ready to say, "Just hang on, despite knowing you’re going to get hit on the head probably in September-October. You’re not going to be able to put your money exactly where you want to, so it may be better to hang on or sell half and keep half and then buy in again after the end of October."

TGR: So you’d be inclined to hold on? RW: I see three options. You can hold and grit your teeth knowing you might get cut in half. That’s pretty typical and I think it could happen. Or you can sell half and keep half, knowing that the half you keep might get cut in half. Or you could sell it all, deal with your tax event if you’ve had some good gains, and then be careful about when you get back in. TGR: Either way, you’re still expecting a pretty frightful fall? RW: Yes, traditionally, the stock market has its worst month in September. That’s just by the numbers over the years. Now it’s a little worse because of what happened last year and fundamental market conditions right now, but those calendar days and cycles still work to some extent. So I think we have a good chance for precious metals shares to take-off and get going again after October 31.

Keep in mind another key date in the fall. The December gold and silver futures for traders usually expire between November 15 and November 25. People sitting with big gains as we approach those dates are probably going to take them, which will knock down both cash prices and December future prices.

TGR: That’s pretty dicey timing. RW: It is a little convoluted going through that period. Probably the safer way to play it is if you’re in the shares trading seniors, get out of the way. Especially if you have a lot of premium senior stock; you can exit before the market goes down and park your money in an ETF or cash such as the Canadian dollar—which I like as a longer trade. Then when the stock market comes back, investors and traders can re-enter with the seniors and juniors again. But this September thing looks pretty scary. TGR: What exactly is making September so scary? And why now after having an incredible rally during summer, which is typically slow? RW: You know the phrase, "Sell in May, Go Away." Now this year the "Sell in May" thing was tardy. It happened four to six weeks later, which pushed calendar cycles forward. TGR: How will you know when it’s relatively safe to get back into the stock market? RW: As far as shares are concerned, I would be very guarded about going into anything after Labor Day. The first thing I would work on is an exit strategy. Let’s say somebody owned a really top-notch senior stock, made a lot of money and wanted to preserve those gains, but stay in the market—they didn’t want to sell. They could either sell half and keep half or keep it all and jam a stop under it really tight, because if a senior stock with big volume starts to go down and hits your stop, at least you’ll preserve most of what you’ve earned. Exit liquidity is strong on the seniors.

The problem lies with the good junior stocks. Their tradability in the middle of a downer is not good. Let’s say you pay $1 for a stock and it’s now $3. You’ve made a lot of money. Suppose you put in a stop at $2.80. Come this fall you’re liable to get a fill way down lower than what you wanted simply because no one is available to buy those shares. Nobody wants to get in front of a falling knife.

It’s difficult, it really is, because we like the juniors for the upside and potential for big gains, so you’ve got the three choices I mentioned. Quite frankly, if somebody owns a lot of shares in a junior company and has made a lot of money, if I were in those shoes, I’d take the money and be looking immediately to find the re-entry spot for a comeback. Some very, very interesting things are on the table this fall—in the fundamentals, in foreign relations, in government, in credit, in the dollar, in bonds and in international markets. It could get pretty exciting, it really could.

TGR: Many very smart analysts are looking to the BRIC economies to pull the rest of the world out of recession, that these countries’ economies will turn first and grow first. Do you share that belief? RW: I did before, but not now. Things are deteriorating all over the world. The engines of growth are melting like snow in July. Argentina and Brazil have been pretty hot for a time, but they’re starting to have problems. Russia is in much worse condition than a lot of people think. Eastern Europe has been very bad during the last four to six months. Many loans they received from Western European banks denominated in Swiss francs are expiring to be recycled and they don’t have the credit to recycle them. Most important of all are those massive bubbles we see in Chinese debts, real estate, their shares markets, and severely falling exports to the West.

So if you look around at all these places, where is the engine of growth? Nobody can explain where there’s some big power to hold things together. On the other hand, there is some power that can make things move-trade—in the hedge funds and the billions being printed-originated in bonds and dollars in the U.S. Foreigners are getting more skittish but some foreign countries are still investing and trading in New York markets and perhaps the Asian markets. So there’s a major divergence between the economy and the stock markets. The stock markets can levitate beyond where the economies are and the economies are sinking.

There are always the exceptions, and the exceptions confuse people. In Brazil, for instance, Ford has a state-of-the-art auto plant that’s almost fully automated and running 24/7. It’s their finest, most up-to-date factory, but that’s an exception as to what’s going on in most places. Another exception is that General Motors, despite all their problems and troubles, is selling 150,000 to 180,000 Buicks in China. Since the 1920s, Chinese auto buyers have preferred the American Buick. It’s really kind of an anomaly. GM wisely got over there with a factory and built some good Buicks in the ’20s. Everybody in China lusted after a Buick. They like the Buicks even better than the Cadillacs. That little paradigm continues today and they’re selling Buicks like crazy. I think that’s another reason why GM kept the Buick brand. They didn’t want to kill that line because they’re doing so well with it in China.

TGR: So all of these economies are going to spiral down? RW: I think they will. It’s just degrees and how far they fall. One thing China has in its favor is some organic growth because the economy has grown so quickly. Their standard of living has come up. However, compared to where it was before or compared to the United States, China isn’t strong enough to offset all the exported U.S. sales they have lost. The Chinese economy is 25% the size of the U.S. economy. Consider the population of the U.S. at 330 million and China at about 1.4 billion, and that tells you there are still a lot of poor people and unemployed people. Just to stay even, the Chinese have to produce 24 million new jobs a year. It’s just impossible. It’s just not there.

Bubbles are bubbles; they have a stock market bubble and a real estate bubble, a lot of commercial real estate that’s vacant and a lot of overly leveraged projects that aren’t going to produce the kind of income stream they expected perhaps three to five years ago.

TGR: On a bit brighter note, let’s go back to the precious metals camp. When will gold go above $1,000? And when it does, will it stay? RW: I think it’s important we all watch key numbers for gold. There’s pressure at $1,007; that’s a hard resistance number. We have to get through there. The next technical number that’s very important is $1,032.50. If we can rally past it, it appears we’ll start a run-away to the upside. If I see some closes in gold past $1,050, I’m going to be a happy camper. I think at that price we’re going to be off and running toward my $1,250–$1,260 forecast for December.

My high call for gold on the December futures has been $1,250–$1,260 for months. I want to stick with that, although some have said it could go into the $1,300s. The pressure is definitely on the upside. You could see it in silver in the last few weeks. Is it selling? Is it correcting? Sure. But we’re getting higher lows; we’re seeing more pressure toward the buy side in a bias, despite what the calendar is telling us.

TGR: How low would you expect gold to go when we have this market pullback? RW: Still this month we may see it go as low as $915 to $907. After Labor Day, brokers will come back from the beach and will want to get busy and start buying shares, so things should move up a bit. But I think after a couple of weeks back in the trading saddle, prices are going to hit the wall. When they do, that’s the question mark. If the bullion banks don’t really crush gold and sell 10,000 or 20,000 short futures contracts when it’s at its weak point in the first two weeks of September, chances are it could go into a runaway. TGR: What do you suppose the bullion banks will do? RW: If they see gold going to the point where they’re going to lose control and they can’t stop it, they’re going to enter buy positions in front of the rally train because they want to make money. That’s when you’d see a quick take-off beyond $1,050. Then somewhere up at around $1,300, $1,400, people are going to say, "We’ve made enough money." Then price will probably come back to a profit-taking higher low, something like $1,150 or maybe $1,200. TGR: For those who have cash, how would you play the physical metal versus equities? You mentioned that there are lots of good equities that you’d be inclined to keep and hold. RW: You want to hold physical, of course. Never mind the prices; just sit and hang on. For this fall event, I have three or four senior companies I like very much, and would hold them to the extent that I could try to get the last nickel out of them, then jam the stops up really tight and then either sell just before they fall down or let the stops take me out. Either way—but that’s only on senior stocks. With the junior ones, you’ve got a different problem, as we discussed. TGR: What are some of the juniors you like? RW: We like Bravo Venture Group (TSX.V:BVG), Timmins Gold Corp. (TSX.V:TMM), Eastmain Resources Inc. (TSX:ER), Endeavour Silver Corp. (TSX:EDR) (NYSE.A:EXK), Miranda Gold Corp. (TSX.V:MAD) and then San Gold Corporation (TSX.V:SGR).

We like Hecla Mining Company (NYSE:HL), too. Hecla is a senior, but their price got whacked down so far, it’s almost trading like a junior now. I don’t know of another similar senior in that kind of a price frame. But Hecla is a big, strong company with a lot of money and they’re going to be coming back. That’s should be a terrific stock.

TGR: So would you hold Hecla like one of the seniors you like or sell it like a junior that will come back? RW: I would buy Hecla, hang on, watch it go up some more, push the stop up pretty tight and then see what happens. If you get knocked out, so what? Just wait, let it drop and come back and buy it again. If we see gold up to $1,200 or $1,300, it would not surprise me for Hecla stock to break out beyond $12—to $18, $20, $25. They have an absolutely wonderful gold mine in Mexico in an area where three seniors—Goldcorp (TSX:G) (NYSE:GG), Barrick Gold Corporation (NYSE:ABX) and Newmont Mining Corp. (NYSE:NEM)—and one junior, Canplats Resources Corp. (TSX.V:CPQ), all have strong operations within 50 miles of each other.

And what we like about Canplats is that they located northeast, just beyond these bigger operators, and nailed down some 300 square miles of property adjacent to the region where the big boys are. That’s why I think they’re going to get picked up. They’ve got some good things coming.

TGR: Can you summarize your thoughts about Bravo, which you featured in your newsletter a week or so ago? RW: The company is run by a top-notch smart operator, number one. But, number two, for some reason or other, the stock is very tradable. If you get into a gold rally, Bravo seems to have a trading impetus that goes beyond a lot of the other juniors. Five good juniors may go up a quarter, but then Bravo will rise 50 or 60 cents. They’ve had some really good rallies, and there’s good money to be made in that stock. No question about it. TGR: You’ve also featured Miranda quite a few times. RW: Yes. Miranda is run by a top geologist. They’ve got small overhead, and they’ve got money; they’re in the right spot. It’s one of the real good ones like Eastmain, but it’s going to take a bit of time for it to get a little further down the road. Gold prices are probably going to have to rally beyond $1,050 to really make the stock take off.

But I’ll tell you what: If we get a rally in gold and silver beyond these recent highs—say beyond $19 in silver and beyond $1,050 in gold—all these juniors are going to fly. Even some that don’t deserve to fly are going to move. Of course, we want to be picky. We want to own three or four senior companies and maybe five to eight juniors, selecting the best and trying to maximize gains.

TGR: You compared Miranda with Eastmain. What makes them "good ones"? RW: Miranda is in the right spot in Nevada where they should be. Because you can’t be everywhere; you might as well try to be in the best places. Canada, Alaska, Northern Mexico and Northeast Nevada are pretty much where we recommend. If you want to be a gold miner, look for the best locations for proven gold mines. Northeast Nevada has had so much gold pulled out of it over the years. So Miranda has the money, the staying power and the geology. The thing that they don’t have right now is more partnerships with seniors and a higher price in gold, but we think that’s coming.

Eastmain, on the other hand, is a little further along the track in that they have some partnerships with big companies and plenty of cash. They’ve been very careful with their money, and they’re in the really hot spots in Canada. Eastmain will come to a head perhaps even faster than some of the other juniors. It’s just really a good company.

TGR: You mentioned Endeavour as well. They are also in silver, too, right? RW: Yes. We like them. They’re somewhat like Eastmain, but they’ve got different places where they’re operating. They’ve got some good production and are just going to keep adding to what they have.

The key thing we look at with these junior shares is management. If you don’t have good management, you don’t have anything. They’ve got to have capital staying power. We prefer a junior that doesn’t have to go out and raise a lot of money in this environment to continue operations, and we also like the idea of somebody that’s already got a partnership with a big company like Goldcorp.

TGR: Another example? RW: One of the ones we like is Timmins Gold. That’s run by one of the smartest operators I’ve ever seen. He took an old mine, built it back up, and found secondary and third choice sites that they’re expanding into. They rebuilt the whole flagship property for immediate mining operations. That is a junior that’s going to turn into a bigger operator. They don’t need a partner; they don’t need money. They don’t need anything from anybody. They’re going to pour gold this year. That’s going to be a good one, one of the really top-notch companies in the junior field that we think can become an intermediate or larger. TGR: As far as timing is concerned, what would you suggest if an investor isn’t holding these juniors you like now? RW: If someone came to me with a lot of cash, I would recommend sitting tight for a little while and wait until after September and maybe a few weeks more, then look to buy in and get onto the best part of the forthcoming rally. But historically, the last time this happened, 25 or 30 years ago, if somebody threw darts and picked 20 juniors, as the story goes, they made a 395% gain. Some were complete losers, some made a little bit, and a handful made a bunch—anywhere from 1,000% to 2,000%.

Some people keep screaming diversification and recommend buying several companies. I think it’s better to have a small nest and watch the nest. Most of us know who the top two, three or four seniors are. With the juniors, of course, everybody has an opinion, but I’ve gone through a sifting period for the last five years and think I’ve got my selection pretty much weeded out.

TGR: Any parting words, Roger? RW: One more point I might make. I think 80% of this whole rally in precious metals is ahead of us. It could come this winter, it could be a year from this winter, but we’re getting closer and it’s going to be very interesting. Everything we have done since 2001 is just opening the door. We haven’t seen anything yet.

DISCLOSURE: Roger Wiegand —I personally and/or my family own the following companies mentioned in this interview:I do not own shares in any companies and deliberately trade futures and commodities only to avoid ethical questions.

I personally and/or my family am paid by the following companies mentioned in this interview: None of these companies pay me any fees for recommendations. Some of them do, however, pay a modest one-time fee for reprint rights for using my professional journalist’s writings and work.

Roger Wiegand produces the popular Trader Tracks online newsletter, offering investors short-term buy-and-sell recommendations and insights into political and economic factors that drive markets. He has devoted intensive research time to the precious metals, currency, energy and financial markets for more than 17 years. His varied background—a blend of graphics and commercial printing, writing and editing, sales and marketing, consulting and real estate development (from sand and gravel mines to landfills to residential/commercial projects)…and trading—also shapes the views he shares. "TraderRog" also digests various domestic and international publications for economic, political, monetary and market news and commentary that inform his opinions and analyses. Roger is a regular essay contributor to popular websites addressing the commodities markets and is frequently interviewed on radio in the United States and Canada. Roger is a regular speaker at major precious metals and resource conventions in North America.

Not many investors anticipated the devastation 2008 would visit upon the markets. Nonetheless, shrewd advisors sought, as always, to limit risk by investing in a wide array of sectors. Looking to do just that, Malcolm Gissen and Marshall Berol started a no-load mutual fund—the Encompass Fund—in June 2006. Like others, the fund suffered a steep decline in Q408, but has since witnessed a pretty dramatic recovery. In this exclusive interview with The Gold Report, Malcolm and Marshall share why they believe "we’re still in the early innings" of the resource investment game and foresee a bright future for the all-star junior miners.

The Gold Report: Malcolm and Marshall, you started the Encompass Fund in June of ‘06 with the intent of investing in a wide array of sectors, "to minimize or avoid sharp declines in the market," as it says on your site. However, according to your stock chart, you had a fairly dramatic decline in Q4 ‘08 with a pretty dramatic recovery since then. Tell us a bit about what happened there.

Malcolm Gissen: What happened was that prior to and in 2008 we emphasized resource companies in our portfolio, and we believed that these companies were performing well. We had confidence in management. In the case of the resource companies, many of them continued to expand their resources, in some cases, very substantially. So we felt we were pretty comfortable with holding these positions in our portfolio.

In the second half of 2008, a number of these companies experienced very sharp declines in their stock prices. We were alarmed, so we called the companies and asked if they knew what was going on. Their only explanation was that somebody was dumping a lot of their shares, which we, of course, could see in the market.

But it wasn’t until very late in the year, when these companies spoke to and visited hedge funds, that the hedge funds would tell them that they had experienced a lot of liquidations and, as a result, were selling all of their resource company positions—and selling them as quickly as they could. In some cases, it was program trading. In other cases, they just dumped the stock. In the case of the junior mining companies, where the stock was generally thinly traded, it had a profound impact on stock prices when hundreds of thousands of shares or, in some cases, millions of shares, were unloaded in the marketplace, driving down the price of a number of these companies anywhere between 50% and 95%. When we saw that happen late in the year and realized the cause, as managers of the Encompass Fund, we decided we would buy more shares of some of the companies. We did that and that is one of the reasons the Encompass Fund has gained about 80% this year.

Marshall Berol: There were several things we did, but when we saw what was happening with the markets in the fourth quarter of 2008 and what was happening with the companies that the Fund was invested in, we went back and reviewed each of the companies for how well we thought they could survive (i.e., a good investment going forward), and sold several of the companies we felt were weaker because of finances or the projects, or the time involved in getting the projects moved along, and factors of that nature. So those companies we sold at that time, and as Malcolm said. We increased the positions in some of the companies that we did own and felt were strong companies with good management, finances and projects that we felt would be worth owning going forward. Fortunately, that has worked out this year.

MG: I would say I have not been surprised at how well many of the companies in the Encompass Fund have performed this year. Marshall may not agree with this—and we don’t agree on some issues—but I expected that good companies that performed well from an operations standpoint would outperform. I felt that the resources companies that were continuing to expand their resources would excel since I didn’t think the prices of the resources were going to decline much. I felt there would continue to be demand for the resources and so I’ve not been surprised by the performance and, in fact, think that there’s more to come. I don’t think the story is over yet.

MB: Yes, we’re definitely of the view that the resource investment story is not over. We’re still in the early innings. There are a lot of reasons we believe that the demand for resources will continue to expand. It’s supply-demand in the case of gold and, to a lesser extent, silver. It’s the storehouse of value. There’s the inflation aspect. A lot of aspects come into the various resources—whether it’s the metals or energy—that we feel has a very bright future going forward.

We’re not of the camp that thinks deflation is here to stay, or that there’s not going to be some decent growth globally. We’re in a global economy. There’s just no two ways about it. While the U.S. or Europe may be slower, at this time and going forward over the next few quarters, there’s a lot of growth that’s occurring in Asia and Latin America, and they need resources. And, to the extent that the populations are improving their quality of life, they’re consumers and they want things that use resources of base metals, and they want gold. They want silver from a jewelry standpoint and a storehouse of value standpoint for gold. We just don’t see where that doesn’t continue, certainly with some volatility, with some ups and downs. But we just believe that it will continue and that there’s a very bright future for resource companies.

TGR: Marshall, in an interview you did with Al Korelin you brought up the demand creation by the BRIC countries, particularly China and India. With the demand and also the time it takes to put new mines into production, you said there’s going to be a shortfall for quite a while. Am I correct in thinking that those mines were taken offline during the recession? And, if so, wouldn’t bringing these mines back up in the next couple of years soften the gap between the demand-supply?

MB: There have been some mines that were taken out of production. However, I don’t think it’s all that significant in the overall scheme of things. What has been more significant is the reduction in the expansion of existing mines that some of the majors have done, such as BHP, with various commodities. Some of the small producers have slowed down their expansion and, certainly, the juniors have slowed down getting into production. So it’s more a factor that the expansions that were planned for ‘08, ‘09, ‘10 and ‘11 have been delayed or slowed down or maybe, in some cases, eliminated, rather than that existing production has been taken offline.

TGR: Do you see a possibility that the lack of base metals—copper, iron ore, etc.—could actually slow the growth of the emerging countries in China and India?

MB: Yes, I think to some degree that could happen. It should also be said that in the case of a good number of these metals, it’s become more and more difficult to find major resources. As you know, the large gold companies have a demand that needs to be met for a certain number of ounces a year just to maintain their current levels. And over the last few years, we’ve seen them be increasingly aggressive in buying these smaller companies. The smaller companies are faster on their feet, they’re more flexible, they move much more easily, and a number of them control very substantial resources.

One of the companies in our portfolio, Seabridge Gold (NYSE.A: SA), is a very good example of controlling substantial gold in the ground. So, we believe that at some point, one of the major gold mining companies is likely to acquire Seabridge, as well as a number of the other smaller gold and silver mining companies. We see that trend continuing as companies are being forced to spend more money, to be doing their exploration in more difficult environments, in some cases, hostile jurisdictions.

TGR: How do you decide where you’re going to invest for your fund?

MB: The Encompass Fund is set up as a no-load general mutual fund. It’s not a hedge fund. We’re an SEC-registered no-load mutual fund. It was set up to invest in companies regardless of market cap size because we don’t think a fund should be limited to investing in large or small companies, or any type of company. It was also set up to invest in any areas we believe offer good, long-term appreciation.

In the Encompass Fund we can invest in any sectors that we think look attractive. For the last several years and even before we started the Fund, with our private accounts, we’ve believed in resource companies—gold, silver, other commodities—so we were invested there. When we established the Fund, we invested in a number of resource companies. We do have other areas we like—healthcare, particularly, and some special situations that we invest in. From the standpoint of the Fund, we don’t want to be necessarily a resource fund or a gold fund. We want to invest where we believe there are opportunities for long-term appreciation and that leads us to a variety of the resource sectors currently.

TGR: Can you clarify for me in terms of long-term appreciation are you looking at that as a sector play long-term appreciation or actually buying individual companies and holding them for long-term appreciation?

MG: I would say both. When Marshall and I got into this business, ‘long term’ meant 5 to 10 to 15 years. Nowadays, long term seems to mean two to four years. The definition of ‘long term’ has clearly changed as investors have gotten less and less patient. We want to have exposure to metals and we believe that once we make that decision and decide which metals may look more attractive now than