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Economic Crisis Crucible for Transforming Trashed Juniors into Treasured Equities?

Commodities / Gold & Silver Stocks Feb 17, 2009 - 06:29 PM GMT

By: The_Gold_Report

Commodities Best Financial Markets Analysis ArticleA gold bug who prefers equities as investments to bullion and bars, Midas Letter publisher James West expects his portfolio picks to shine to the tune of at least 15% appreciation on average. In this exclusive interview with The Gold Report, that sunny outlook stands in stark contrast to other things the well-regarded adviser sees on the horizon. He anticipates no letup in the storm of market volatility and holds out even less hope for the U.S. currency's ability to stay afloat in a multi-trillion-dollar flood of new money.

The Gold Report: You've predicted that the United States' defaulting on its debt is not just likely; it's inevitable and imminent. Given the state of the world economy, can the federal government do anything to avoid this—and the resulting monetary collapse it would trigger?

James West: In pure theoretical terms, absolutely. Stop printing money and put the whole American system on a crash diet in terms of services and infrastructure development. Basically let the excess inventory of just about everything—real estate, automobiles, commodities—be absorbed into the normal, natural processes until no such excess inventories remain. When that's done, we could resume a period of economic growth. But this also means sticking to—or rather committing to—a plan whereby they stop embracing the idea of perpetual economic growth, which is impossible, or perpetual deficit spending, which is also impossible.

TGR: And what's the probability of that happening?

JW: It's about as likely as one of the Muppets being elected president.

TGR: So what should investors be looking out for to protect their portfolios?

JW: The only credible defense against so much inflationary pressure is storing whatever value you might have in gold because storing it in whatever currency you have, assuming you live in a G7 nation, is not advisable. To actually invest money and put capital at risk to make money, I think you should invest in precious metals producers initially and then explore the junior producers for the riskier portions of your portfolio. I really don't see how anything else can make money.

The true reflection of the value of any currency, the only one that's really left, is how much gold it can buy. Whereas in 2001 it took $290 to buy an ounce of gold with U.S. dollars, in 2009 it takes over $900. To some extent that reflects an increase in the value of gold, but it's more a reflection of the decrease in the U.S. dollar's purchasing power relative to gold.

So continuing down that road by printing U.S. dollars? The quantity of gold is not changing in the same sort of relative manner that the quantity of money is changing, so the quantity of money relative to the quantity of gold it can buy is going up. Of course, this means that gold is going up. The role of gold has been to reflect the true purchasing power and value of a currency. Self-delusion remains possible as long as everybody agrees to continue to honor these certain value systems relative to gold and the price of gold does not explode. I imagine that, until gold does explode in price or the derivatives market where a lot of that fudged value is stored collapses, we will continue down the road of self-delusion.

TGR: But you believe the numbers are getting so astronomical that it has to come to an end somehow.

JW: Yes. It's just not a sustainable mathematical equation in any way, shape or form. Technically, the dollar has already been defaulted upon, to some degree, and revalued. Since there's 10 times the money in circulation than in 2002, in real terms a dollar is worth one tenth of what it was then. All the rhetoric coming out of Washington and Wall Street is designed to make us overlook that simple fact. Never mind the economic systems in which this is happening. Such an exponential growth increase in one variable in any equation—be it physics, biology, astronomy—would represent an unsustainable force. Nature automatically seeks equilibrium and, at some point, some force or counter-opposing events to balance it. That hasn't happened yet, and that's what is inevitable. All human systems, including economics, are based on and reflect the laws of nature. We can delude ourselves with our language and our formulas and our currencies and our mathematical interpretations into believing this or perpetuating the imbalance. But at some point, it must give in; it must give way.

TGR: Your formula about the quantity of gold being less than the quantity of dollars being produced is intriguing. If this is true and in essence we see the price of gold go up rapidly because the dollar goes up so rapidly, why not just put all of your gold investment in the physical form? In other words, given the potential inflation because of so many dollars being generated, why invest in the equities?

JW: A couple of reasons. For one thing, as physical bullion's safe-haven value increases, it's going to be subject to a herd mentality and to overpricing somewhere along the way. The only way to get through this entire crisis is for one of two things to happen. At some point either the system enforces its rebalancing nature on us or somebody in the whole human resource equation says, “Okay, that's enough; we're in deep trouble, we need to change everything, and we either do it ourselves or it's going to be forced on us.” The longer we wait, the tougher it's going to be.

In addition, there's no real return on investment in physical gold. You can protect yourself from inflationary forces of currency expansion by putting your money in gold, and sure, as the price of gold rises, you can trade it in for an increased number of dollars. Either way, gold's relative value remains stable because its purchasing power doesn't really change. So gold is a store of the value of the purchasing power that is being eroded in currencies, but not an appreciation of value. It's not leveraging the price of gold so that there's a return on investment that would be provided, on the most minimalized basis, through senior producers on the maximum end of the scale with the coincident level of risk, the junior explorers.

TGR: So given all that's happening around the world, and particularly in the U.S., you say that gold equities represent both the best defensive and ROI investments we can make in the next year or two.

JW: The only defense.

TGR: Some people we've been chatting with recently say that because the senior producers' stock prices have been so beaten down and thus represent a great upside value, it's not even worth taking the risk in the junior explorers. Why take that risk when you can capture an Agnico-Eagle Mines (TSX:AEM) and a Barrick Gold Corporation (NYSE:ABX) at these prices?

JW: I don't necessarily agree. Certainly the prices have come down. But Agnico-Eagle, Barrick, Newmont Mining Corp. (NYSE:NEM) , Goldcorp (TSX:G) (NYSE:GG) are all approaching pre-meltdown levels at this point, so I don't really agree that they're still in a state of being really beat up. In fact, the most significant funds—JPMorgan, HSBC, etc.—have increased their positions in major gold producers by an average of 10% to 12% of their portfolios in the last year. That's the source of the increased values. So the big funds have been buying the majors, and the price of gold has gone up and the price of the producers has gone up.

But the price of the juniors has risen on average in the last three months, too. In fact, near-term producers and the ones with major deposits in 43-101-compliant categories, have risen on average by 20% in value; whereas a lot of the seniors have gone back up 15% to 50% toward their previous levels. In my opinion, in terms of maximizing leverage for an acceptable amount or risk, the place to be is in the juniors, especially those with 43-101-compliant reserves and resources in politically stable jurisdictions.

TGR: Could you share anything about some of these 43-101-compliant junior gold explorers that represent the best opportunities from your perspective?

JW: For sure. Top of the list would have to be Greystar Resources Ltd. (TSX:GSL) . Greystar has what's approaching 14 million ounces in Colombia, which is one of the most stable jurisdictions according to the World Bank, even though it is South America. Another one is Osisko Mining Corp. (TSX:OSK) in Quebec, 7 million ounces. Both 43-101 compliant. Other big resource juniors that aren't in production and are 43-101-compliant are Midway Gold Corp. (TSX.V:MDW) (NYSE.A:MDW) , for sure, and Anatolia Minerals (TSX:ANO) , operating in Turkey, which is difficult but politically stable. And then a few junior producers— New Gold Inc. (TSX:NGD) (NYSE.A:NGD) , Kirkland Lake Gold Inc. (TSX:KGI) , Alamos Gold Inc. (TSX:AGI) .

Those, I guess, would be a good representation of the safer ones in which you really haven't yet seen the leverage to the price of gold be realized in the value of the share price.

TGR: So these are all pre-producers?

JW: New Gold is producing; it produced 272,000 ounces last year. Kirkland Lake is producing, not nearly so much. Alamos is producing.

Greystar; Osisko, Midway and Anatolia are not in production yet.

TGR: Speaking of near-term producers, do you know the ATW Gold Corp. (TSX.V:ATW) story?

JW: Sure do. They have two near-term or past-producing mines. They're going into production March 1 on their Burnakura project, which I think is expected to produce 25,000 ounces this year, going up to 45,000 next year. That's about as good as it gets and it's in Australia, so also meets the political stability criteria. And ATW's Gullewa project, also in Australia, is supposed to go back into production next year and start off at 100,000 ounces.

TGR: So ATW is a producer that also falls in the category of a junior that is a relatively safe investment but represents a good upside potential?

JW: Absolutely, absolutely. 43-101-compliant reserves, permitted near-term facilities, all essentially turnkey mining operations.

TGR: Are you aware of the Hawthorne Gold Corp. (TSX.V:HGC) story, as well?

JW: Actually, I just had a meeting with Hawthorne Gold recently. It has three properties; one has over a million ounces in 43-101-compliant resources. They also have Table Mountain, which has a small resource of 23,000 ounces but a permitted 300-ton–per-day mill on the property. They're going to be going into production this year on that. And they're starting a 10,000-meter drill program this year to add to the resources in 43-101.

TGR: So Hawthorne Gold fits nicely in that group that you were just mentioning. The safer ones that have not seen the appreciation in their share price.

JW: Absolutely. Actually, Hawthorne represents one of the greatest bargains. The reason I was meeting with them was to discuss an investment in their company by myself and some of my partners.

TGR: Are you also following Colossus Minerals Inc. (TSX:CSI) ?

JW: Yeah, Colossus, too, actually, a good one. Past producers have taken at least 4 to 5 million ounces out of the old Serra Pelada pit. At one point, 80,000 garimperos were climbing in that pit and carrying burlap sacks full of raw material.

TGR: That's quite an image.

JW: It is. There's a great photo on Colossus's website; it's something else. They're in an exploration phase. They've had some great drill results with high-grade gold, silver, and platinum group metals.

TGR: All in the same mine?

JW: All in the same pit, yeah, and they're stepping out from there and having the same result. It's extremely high-grade PGMs; some of the drill core intercepts would be worth $80,000 per ton, if not more. It's a great story. It's taking a while to unfold. I haven't really seen a lot of news flow out of them. I doubt they're exploring right now because it's the rainy season in Brazil, but I assume they're going to start another phase of drilling as soon as the rainy season ends.

TGR: What do you think about Riverside Resources Inc. (TSX:RRI) ?

JW: Riverside has huge district-size property in Durango, Mexico—El Capitan, with five targets on it, a hot springs replacement mineralized system. Most of their holes are hitting gold. Again, it's not 43-101 compliant, but they're going to continue drilling it this year. Kinross Gold Corporation (K.TO) (NYSE:KGC) has just done an exploration partnership with them that came with a $1.2 million investment with no warrants and no shares—just a cash investment. Riverside also has the Sugarloaf property in Arizona, which has a 1.4 million-ounce resource that is 43-101 compliant, and they're going to drill some more there to try to upgrade that resource.

TGR: So they're also in that group of being still undervalued relative to what they might be able to produce?

JW: Yes. Definitely. Last I saw, Riverside was trading at 35 cents. The real story with Riverside is John-Mark Staude, a PhD geologist and hot springs replacement specialist who worked with Teck Cominco Ltd. (TSX:TCK.A) (TSX:TCK.B) (NYSE:TCK) and actually worked on some of the biggest copper and gold deposits in the world. He's basically considered a rising star in the whole framework of the mining industry and so has attracted investments from the Lucas Lundin Family Trust, the Rick Rule Family Trust, Kinross. That's testament to the premium that he commands just based on expectations placed on him as an explorer and as a geologist. But that's being borne out in the fact that he states the company's goals clearly for the upcoming year, and then he executes on them reliably. He under-promises and over-delivers, so Riverside is considered a safe investment. Even though they haven't really found anything that spectacular, Sugarloaf is a great accomplishment. Everybody thinks it's just a matter of time until John-Mark finds something that's really economically viable and probably quite major in size.

TGR: And how about Bravo Venture Group (TSX.V:BVG) ?

JW: Had a bite to eat with some Bravo people a week or so ago. They have this fantastic Homestake property up in Northern British Columbia. There's some incredible intercepts, very high-grade intercepts of gold and silver in high-grade lenses disseminated through low-grade bulk-mineable material. It's extremely high grade. They've had some intercepts hitting as much as 60 ounces per ton silver up there.

TGR: Are they mostly silver?

JW: Silver and gold.

TGR: Are they mining?

JW: No, they're in exploration mode. They're raising some more money for exploration now and will continue to drill probably starting in April or May. They don't have a resource calculation on that at this time.

TGR: But it's looking as if they're going down that path?

JW: Yeah, they probably will have a 43-101 resource calculation done after this year's drilling.

TGR: Your Midas Letter lists your top 10 junior stocks for 2009. Aren't you also coming out with a small portfolio of recommendations?

JW: My mini portfolio for February includes the near-term 43-101-compliant companies such as we've been talking about, or companies with major exploration indicators based on either fantastic drill results or very high-caliber talent.

An example of the latter is Magellan Minerals Ltd. (TSX.V:MNM) , which is at the top of my list in February's mini-portfolio. It's run by Dr. Alan Carter. A PhD geologist, he's worked with BHP Billiton Ltd. (NYSE:BHP) (ASX:BHP) (PK SHEETS:BHPLF) . He's worked with the biggest and the best. He's very well connected. He's the one who discovered the Tocantinzinho project that is currently in Brazauro Resources Corp. (TSX.V:BZO) . Brazauro just did a deal with El Dorado Gold Corporation (ELD.TO) (AMEX:EGO) , whereby Eldorado Gold is going to earn into as much as 70% of the project in exchange for spending $123 million on it over the next six years. He discovered that project; he and his partner, Dennis Moore, are both principals in Magellan now. They retain an NSR (Net Smelter Royalty) on that property from Brazauro, but they've got this Ciúi Ciúi project, with a drill result there last summer of 220 meters of 2.01 grams per ton gold. That's just spectacular.

TGR: Where is this project?

JW: It's in the Tapajós region of Brazil on the same trend as the Tocantinzinho project, and that's in Northern Brazil. So at Ciúi Ciúi, which is another district-sized play—something like 450 square kilometers—they've drilled into five targets that all have yielded substantial results, either long intercepts of low grade or smaller intercepts of high grade. Some of them have 3, 4, 5, 6 ounces of gold per ton. So that's across five different deposits in a massive land package that has historically produced 20 to 30 million ounces from alluvial workings for the last 100 years.

So these guys just acquired the property in February last year. They started drilling it and got exceptional grades across all five targets. They have a massive bauxite showing; I think 42% is considered an economic commercial level of bauxite, and theirs ranges from 42% to 48%. That same area is home to one of the largest bauxite mines in the world, so they've got good diversity and super-high quality projects. They don't have a 43-101-compliant resource yet, so this year 10,000 meters of drilling will put them in the position to make a determination as to a 43-101 resource. That's the project.

Magellan Minerals has a total of some 30 million shares outstanding. Newmont Mining invested in 8% of those in the IPO at a dollar a share, and that was Magellan Minerals' only financing. So it's a great deal because you can basically bet along with Newmont at a 30% discount to what Newmont paid—just a fantastic opportunity.

TGR: Remarkable story.

JW: That's the sort of case where the value is not reflected in the stock price because the market really doesn't know about Dr. Alan Carter yet. But if they come out with a few more drill intercepts such as the ones they've had and you look at the size of the district, the quality of the intercepts, plus the fact that 80% of them are in mineralization, you can easily see the scenario of 4 or 5 million ounces—or even 10 million ounces—per deposit across the district.

TGR: Does this mini portfolio include others that you haven't mentioned already?

JW: It does. Some of them are not necessarily trying to put a mine in production, but most of them don't like to be painted as exploration specialists either. The exception there might be Northern Freegold Resources (TSX.V:NFR) , which was actually in my January portfolio. Bill Harris, the President and CEO, is exploring the Freegold Mountain property in the Yukon, which was originally prospected by his father in the early 1900s. He and Sue Craig, who are the principals of that company, are dedicated explorers and make no bones about it. The property has seven zones, all of which have the potential for a million-ounce-plus deposit. They have a 43-101 compliant resource, but they're probably going to add to it.

TGR: So each of your two mini portfolios so far—January's and February's—has 10 junior gold stocks. Are you planning to bring out a new mini portfolio every month? At some point, won't you max out in terms of upside stars with real potential?

JW: Of the entire mining matrix of companies on the TSX Venture I'm essentially exposed to, I'm trying to do it so that I started the year off with the very best of the best. So in January I had some producers and some explorers. The February portfolio has no producers; it's sort of the second tier. In the third portfolio in March, I'll coming out with junior explorers, strictly explorers, which will include New Gold, Kirkland Lake Gold, Red Back Mining Inc. (TSX:RBI) , Alamos and others.

Of course at some point I will have exhausted the ones I think are real contenders, and who knows what the market will be like then? Maybe base metals will be back if the stimulus illusion continues. Maybe Barack Obama will put $900 trillion into evolving a green infrastructure for fuels and transportation. I can't tell you what I'm going to be doing because I don't know what the market will be doing.

TGR: Would investors reading the Midas Letter be looking at these three portfolios on a scale of most to least secure, with those in January having the best upside potential and those in March, the junior explorers, being somewhat riskier?

JW: No, it doesn't really work that way. I hadn't recommended any stocks to my subscribers from about June onward of last year. So I took the time to just start watching the stocks and figured it was going to be a gold market when things started to turn around and that's all that's emerged is the gold market. So the January portfolio includes those I'd been watching the longest. Some of my more recent discoveries are in the second group—such as Magellan. Had I known about it in January, it would have been on January's list instead. I was quite surprised to find it and very surprised to find out that I'd never heard of it because I was very close to Brazauro and that whole situation. Every once in a while you think you know everything and you find out you don't know anything. That was one of those epiphanies.

Essentially, my goal is that each of the companies I recommend has a very good chance of doubling within the next year, given the upcoming gold market. That's my criterion right now. I'm not looking for 10% or 15%; I'm looking for 100% return within a year. So, obviously, I'm not going to be right on every single one, but if the majority return 100%, I'm sure that's going to average out to somewhere above 15% return over the year, which I think will be pretty rare across the investing landscape.

Of course, that's assuming that gold does become stronger and that attention shifts from bullion and seniors down to juniors. There's a lot of assumptions in there, but I'm basing my predictions on patterns in past gold bull markets and so that's essentially the scenario I'm looking for. So at some point in the year, I think I'll say that's it for the mini portfolios. With each month's subscription I'll update what's happening in each of the portfolios, why the ones that have risen have risen and what might explain why the others didn't. And then I may suggest selling some of them.

For example, I recommended one company based on the fact that it was in a takeover move on another company, but they subsequently got shut out by a better offer from a bigger company. That one really hasn't declined in value, but it hasn't gone anywhere and I haven't got a clear sense of direction. So if they don't get off their duffs soon and do something with their treasury, I'm going to say people should probably get rid of that one and get into something a little more dynamic.

I think market volatility is going to be with us for years to come, so it's really a trading market as opposed to a long-term investment one. You want to find the companies that have things going on that will move the share price up in the short term, and then get out of them when you've made some money. Or take out some money and let the rest ride with stop losses to avoid a bath should they suddenly go the other way.

Publisher of the Midas Letter , James West has devoted 20 years to helping small companies in the resource sector—helping them raise money, further their projects, build their identities and get their stories in front of investors on the lookout for quality investments with excellent returns.

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