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When Stock Market Bubble Crashes, Take Refuge in Gold Stocks

Commodities / Gold and Silver Stocks 2014 Apr 15, 2014 - 10:44 AM GMT

By: The_Gold_Report


An overinflated equities market could be good news for metals and mining stocks. In this interview with The Gold Report, Morning Notes Publisher Michael Berry shares two scenarios that could follow an imminent crash and four gold companies that could be perfectly positioned to take advantage of a reset credit market.

The Gold Report: Mike, you've been watching the stock market and, by extension, the precious metals markets very closely for signs of a larger equity market blow-off that could send gold higher. What makes you think the Dow Jones Industrial Average and the NASDAQ are in a bubble? What are the signs that a crash might be imminent?

Michael Berry: I have been watching bubbles since 1987. In September of that year I correctly predicted the 25% crash of October 19. We have been blowing through mini and maxi bubbles for 30 years; this one is nothing new.

The solution to our macroeconomic issues has been to inflate new bubbles, to inflate asset values to soften the blow from the last bubble, all the while creating the conditions for the next one. That is how we ended up with the current equity market bubble. It is driven solely by the Federal Reserve's liquidity. Always remember that liquidity begets liquidity. I also see a debt market that I consider to be a bubble. These markets are just not sustainable. I can't say when, but we have an equity market decline coming, maybe a severe decline.

TGR: The housing bubble and the tech bubble were, by definition, confined to certain niches initially and then the impact reverberated to other sectors. Are you predicting a market-wide crash where everything falls or will it be confined to certain sectors?

MB: The correction will impact everything. As of April 8 I'm measuring the Dow technically, fundamentally and behaviorally, and I see a clear top by all three measurements. The top is not quite as clear for the Standard & Poor's 500, but it's certainly there. A major event could cause this bubble to burst and the markets turn down. I think it's imminent, probably this year. With the Federal Reserve pulling back on its quantitative easing, I can't see the equity market being able to sustain itself.

TGR: Are there any specific indicators that might tell when a crash is about to happen or will we only know after it happens?

MB: The money multiplier, M1, which is a measure of how well the banking system is working, is at its lowest level ever—0.69, according to the St. Louis Federal Reserve. (It usually has been above 1.0). It has continued to decline for the last five and a half years. That is the sign of a disabled banking system, a coming bear market and a severe recession or worse. There's no doubt about that. The velocity of money has been in a decline for quite some time. These indicators mean our banking system is not working properly. These conditions were last this serious during the Great Depression. Even Milton Freidman acknowledged this when he suggested the Fed's problem will be dealing with its own drastically expanded portfolio. Freidman claimed that the Great Depression was the result of a falling multiplier and the failure to increase the money supply. That has not been the case this time but we are still in serious trouble.

Europeans are now concerned about deflation, the slowing of the economy and the falling of prices. The "D" word is actually spoken. The International Monetary Fund is particularly concerned. We've certainly seen falling prices in the metals markets over the last year and a half. China's tightening and slowing along with the U.S. tapering its quantitative easing mean the economic winds are in our face, not at our back. Those are the things I am concerned about.

TGR: So when this bubble does burst, how might the different metals—gold, silver, copper—respond differently to a market crisis?

MB: That is a good question. The answer is it depends. If we don't fix the broken credit cycle and deal with exploding government debt, we will probably begin to see disinflation and deflation. Then prices will fall. Gold, copper, silver, tin, lead and zinc will decline, but probably less than the valuations in the macroeconomic economy. That will be the time to buy metals because we will recover once we see a new credit cycle. However, it could be a three- to five-year hiatus. The Fed and others will have to deleverage. Only then will the economy be able to recover and break out of it torpor. We'll see a new bull market in the commodities then.

On the other hand, if we were to inflate out of the crisis, which the Fed would prefer, we will see gold achieve very high prices. I wish I could give you a very clear answer. Personally I think deflation is much more likely.

TGR: If we experience inflation, and the gold price goes up, will the equity prices follow?

MB: Absolutely. When we have inflation—and we will as soon as a new credit cycle is in place—then we are going to see gold miners take off. A lot of them are really struggling—Barrick Gold Corp. (ABX:TSX; ABX:NYSE), Newmont Mining Corp. (NEM:NYSE), Goldcorp Inc. (G:TSX; GG:NYSE) are all down 50%. They are reacting to a lower gold price. We will see Goldcorp back up to $50/share, but right now there isn't a bottom on the price of these stocks because if gold goes much below $1,250 an ounce ($1,250/oz), then the cost of producing gold is going to be a problem for the big gold producers. These stocks have been punished and are close to their bottoms now. People interested in precious metals and who are patient ought to be buying these on any declines in their current share prices.

TGR: Are some mining stocks going to come back faster than others?

MB: Yes. A lot of the big-cap miners are highly leveraged with debt. They need to deleverage, and that's difficult to do in this environment. I look at a company like Goldcorp and I think it will recover much faster. Its balance sheet looks pretty good. It has a good set of assets. So I think investors want to be buying the big stocks that are not highly leveraged, and Goldcorp is certainly one of them.

The midtier producers have a real problem because they're really not big enough to go to the next level in this kind of a capital market environment. We are going to see that quite a few of them will be taken out. Goldcorp made a bid and just upped its bid for Osisko Mining Corp. (OSK:TSX). We may see more of that.

The juniors and explorers have been decimated. It's a bloodbath. There's no other word for it right now. These stocks are trading anywhere from $0.07 to $0.40/share. They are worth a lot more, but not in this environment. I have a number that I follow that have good management and good assets, and the ability to sustain themselves over the next year or two until we see a recovery. Sustainability will be very important.

I like Pershing Gold Corp. (PGLC:OTCBB), especially its management. Steve Alfers is CEO and running Pershing. It is a derisked near-term production story. It has about 552,000 oz gold Measured and Indicated and 165 oz gold Inferred, and is building a very nice gold resource.

I like NuLegacy Gold Corporation (NUG:TSX.V; NULGF:OTCPK). Barrick is its partner in the Cortez Trend. It has done a couple of recent financings, which is a significant feat. NuLegacy is going to be drilling based on a fully funded exploration program. I think it has a real chance.

I like Terraco Gold Corp. (TEN:TSX.V). I like its proximity to Midway Gold Corp.'s (MDW:TSX.V; MDW:NYSE.MKT) Spring Valley project and, of course, the Barrick interest in Spring Valley helps. Barrick has invested $53 million ($53M) into Spring Valley.

TGR: Do each of these companies have the capital to stay in business until the price of gold goes up?

MB: I have a 10-point Discovery grid. The factor the market is valuing most right now is sustainability. The No. 2 factor is the quality of the asset and No. 3 is the strength of management.

Pershing scores well on all three. I like its shareholder base. Dr. Phil Frost is a big shareholder in the company. The management team will have access to capital. I also like the asset. The Relief Canyon mine property already has three open pits on the property and a finished processing facility. It has a good chance of being successful.

Over at Terraco Gold, I really like CEO Todd Hilditch's view of the world. He saw this mining economy coming a long time ago. He acquired the royalties on Spring Valley, where Barrick has put more than $50M into development while showing significant gold reserves. That makes the royalty worth a lot more because I think Barrick, which has now earned in, will develop Spring Valley. So by waiting and focusing on the royalty play, Terraco management has been very shrewd.

Nulegacy is on the Cortez Trend. I like it because Roger Steininger is the COO, and he's done a great job of exploration. He's a brilliant guy. Barrick is the partner there and will probably take NuLegacy out eventually for a nice payoff.

TGR: Any other companies you think could benefit when precious metals prices take off?

MB: The final one I want to mention is U.S. Precious Metals Inc. (USPR:OTC). Nobody knows about it. I just visited its property in the state of Michoacán, Mexico, which is on the Pacific Coast roughly parallel to Mexico City. It has a 37,000-acre property. I actually call it my "pregnant virgin" because the gold and copper systems are visible, but it has never been properly explored. The Spanish were there in the 1500s and 1600s and there were adits from the Spanish but no real production records. You can pick up copper float on the ground so it is definitely pregnant. It is a huge mineralized system. We just don't know how big it is yet. It's a $0.12 stock. I don't own it yet, but I will probably take a position in it at some point.

What's really interesting about U.S. Precious Metals is that the management is using satellite-generated, ground-penetrating radar to identify the mineral composition of the anomalies. It also will be using a thermal process based on plasma torch for extracting the ore—eventually.

TGR: Tell us about the processing. How will this new technology make the project more profitable?

MB: Just as hydraulic fracturing revolutionized the oil industry and may make us energy independent in the next 30 years, I think plasma arc processing, developed here in New Jersey at Princeton University by Dr. Edgar Choueiri, could revolutionize mining. Plasma arc will be used to propel satellites. It's the fourth state of matter, a state of ionized gas. This process increases the recovery of the ore significantly and with much less environmental impact. This is the most efficient way to separate minerals from waste. It could well be transformational for the mining industry. My understanding is that at present there is a pilot plant in operation at 29 Palms in California.

TGR: The other three companies that you mentioned were all in Nevada, a fairly safe jurisdiction. What are the risks of being in this part of Mexico?

MB: Whenever you talk about mining in Mexico, you worry about illegal activities. U.S. Precious Metals has decided put together a security force mainly because there's a lot of gold that can just be panned from the dry riverbeds on this property in the Tierra Caliente region. So management has decided to provide its own security. But U.S. Precious Metals and its associates are very close to the Mexican government, so I believe the risks are minimized. When I visited the property I saw a road being built to the property by the Mexican government.

Mexico is still a country that has to be mined in spite of the new 7.5% tax. A lot of good players are there: Coeur Mining Inc. (CDM:TSX; CDE:NYSE), Hecla Mining Co. (HL:NYSE), Endeavour Silver Corp. (EDR:TSX; EXK:NYSE; EJD:FSE). U.S. Precious Metals is likely to become a big copper-gold play with a silver byproduct. I think management has really done a good job of minimizing the risk with respect to the cartels and the exploration risk.

TGR: Is this a long-term investment? When might the thesis for the processing and the thesis for the asset be proven?

MB: The plasma arc technology is proven. U.S. Precious Metals is the first to license it for processing the ore. The company is not yet in mining operations. Its property contains 37,000 acres in one land position and only several hundred acres have been explored.

So it is early days at U.S.Precious Metals, but a good investment for those people who like early exploration plays on potentially world class assets. Let's face it, you do not find properties like this easily.

TGR: The silver market is more volatile than gold. What companies are worth looking at in that space?

MB: I love silver. I'm on the board of a couple of companies that have big silver plays. But the silver market is volatile; it's a much smaller market and an industrial, as well as a precious metals, market. Gold is down 27%, but silver is down almost 45% from its October 2012 top. We produce about 800 million ounces (800 Moz)/year silver globally, and we basically use it all for everything from electronics to medical technology. The price can't stay at $20/oz for very long because new silver mines are going to be required. Tahoe Resources Inc. (THO:TSX; TAHO:NYSE) has a new mine down in Guatemala, which I think will be a very good producer. But you don't find new silver mines every day. So I'm very bullish on silver.

Right now, I think you have to look at Coeur and Hecla as two companies that are self-sustainable, generating cash, and are going to be around. I should point out Goldcorp itself produces a lot of silver from Peñasquito. So, it, too, has a significant upside as silver goes from its current $20/oz level to where it should be, $50/oz, which would not surprise me in 2014 or 2015.

Then there are companies that are midtier, and I think they are probably takeout candidates eventually. First Majestic Silver Corp. (FR:TSX; AG:NYSE; FMV:FSE) would be one. It produced 11 Moz silver last year. It has five mines, and is an $11 stock. It will likely produce 12 Moz this year.

Then there is Endeavour Silver. It produced about 6.8 Moz silver last year, and it has three operating mines.

Silver investors must be believers today. They must live with the volatility of the market and believe the price of silver will appreciate eventually. If you believe in silver and you believe in the ultimate limited supply/excess demand dynamic, then I think you ought to own a portfolio of these companies, put them away and let silver do its thing, because it will over time.

TGR: Would that same advice go for the other metals?

MB: Not exactly. Copper is a totally different market. I like copper a lot. I'm on the board of a company that has a big copper play. It is becoming increasingly difficult for companies to bring big mines on line. The Indonesians have done some things that hurt both Newmont and Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE) by disallowing them to ship ore overseas. Freeport actually declared force majeure in Indonesia. The Chileans and other South Americans have had some problems. There are problems in Mongolia with BHP Billiton Ltd.'s (BHP:NYSE; BHPLF:OTCPK) big copper facility there. That makes North American copper plays in Arizona, Nevada, Canada and, to a lesser degree, Mexico, a great place to be right now. Copper could go below $3/pound, but with the rest of the world growing a new middle class of consumers, we're going to need more copper and that means more copper mines. It takes a long time to bring a copper mine into production, so I think copper is also very cheap today and should be considered selectively.

TGR: So these are long-term investments?

MB: Certainly. We are seeing a lot of private equity players now that are picking up properties for cents on the dollar. The private equity players can afford to sit with a property for two or three years until the commodity prices improve. Most junior mining management teams cannot do the same thing. Juniors are going to have to be able to survive over the next couple of years, so look for companies that can conserve resources. Some developers have stopped drilling. A few marginal producers have stopped producing. Everyone is, or should be, reining in costs, cutting costs. The Vancouver model of financing is broken right now. The capital market is telling us that nobody cares. If nobody cares, then it's time to tread carefully in the exploration space.

TGR: Thank you for your insights.

Michael Berry served as a professor of investments at the Colgate Darden Graduate School of Business Administration at the University of Virginia from 1982 to 1990, during which time he published a book, Managing Investments: A Case Approach. He was the Wheat First Professor of Investments at James Madison University. He has managed small- and mid-cap value portfolios for Heartland Advisors and Kemper Scudder. His publication, Morning Notes, analyzes emerging geopolitical, technological and economic trends. He travels the world with his son, Chris, looking for discovery opportunities for his readers.

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

1) JT Long conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an employee. She owns, or her family owns, shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of Streetwise Reports: Pershing Gold Corp., Terraco Gold Corp., NuLegacy Gold Corporation and Tahoe Resources Inc. Goldcorp Inc. is not affiliated with Streetwise Reports. Streetwise Reports does not accept stock in exchange for its services.
3) Michael Berry: I own, or my family owns, shares of the following companies mentioned in this interview: Pershing Gold Corp., Terraco Gold Corp. and Goldcorp Inc. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: Terraco Gold Corp. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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