(Interviewed by Olivier Garret, CEO, Casey Research)
Editor's Note: Since Casey Research Senior Metals Analyst Louis James manages our metals portfolio – albeit with guidance from Doug and input from the rest of our metals team – and there's an important opportunity forming in metals at present, we thought we'd turn the tables and interview our interviewer.
Olivier: Louis, you, Doug, and the Casey metals team have been saying that the current market weakness in metals presents a great buying opportunity – perhaps the last, best chance to get on the train before it leaves the station for Maniaville. But before we get to that, we should probably start by talking a bit about you. Who is the Mysterious "L," and why should anyone listen to you?
L: Sure. First off, when people follow my investment recommendations, they are not simply following my recommendations, they are getting guidance from the whole metals team. That includes Doug, of course – my teacher and my constant counselor. Just last night, we were discussing via Skype a legal setback that just befell one of our companies. No matter where either of us is in the world, we can compare notes and get each other's ideas for options – usually within minutes or hours – and offer that guidance to readers. But the team also includes David Galland [Casey Research managing director], Bud Conrad [Casey Research chief economist], Jeff Clark [senior precious metals analyst], tireless Andrey Dashkov [research associate], and others.
Olivier: That's very noble of you, to give credit where it is rightly due, but I was hoping you'd toot your own horn a bit…
L: [Chuckles] Okay, okay, but that's not my specialty. I prefer to let my actions and my track record speak for themselves. So, the second reason is that I have spent the last seven-plus years traveling the world, sometimes with Doug, sometimes on my own, "kicking rocks," as we say. Every month I check out two or three – sometimes half a dozen – mineral exploration, development, or production projects. I may not be the brightest bulb in the box, but I have an excellent memory, and I remember the rocks I've seen… lots and lots of rocks, all around the world.
So now, when I see silver-lead mineralization in quartz veins, or gold, or various types of sulfides that can either be pay dirt themselves or important indicators of where to look, I often recognize patterns I've seen before. I know what worked or didn't work, in those other projects I've seen. I know what questions to ask, what details to check on.
I also know a lot of people in the business and can check on the track records of new people I meet. And I know a lot about the local politics in many countries and provinces of countries. I know a lot not just about geology, but mining and processing as well. And… well, I know about a lot more things, but a critical thing I've learned is what the market likes and will respond to and what it won't, under different circumstances.
Between Doug's experience, mine, and the whole team's, our readers have a great deal of seasoned wisdom to draw upon.
Olivier: Fair enough. That wasn't too bad, was it?
L: I'll survive – just don't get any ideas about assigning me to our marketing team.
Oh, and I should also tell any Japanese readers we have – or others who follow Japanese pop culture – that I long ago made my life simpler by signing things just "L." This was long before the super-detective known as "L" appeared in the Japanese manga called Death Note.
Olivier: I had no idea… but you are a sort of detective. We send you out to look for high-leverage, speculative opportunities, and it's your job to go beyond what the companies want you to see to look for what they might not want you to see.
L: Ahem. About those opportunities?
Olivier: Yes, about those opportunities. Why don't you describe the situation? Then we can get into what to do about it.
L: Right. Well, a very interesting situation has developed in the metals markets – especially the precious metals markets. Prices in our sector have been rising for a decade. That rise accelerated greatly after the crash of 2008, until earlier this year. Doug has lamented in past conversations that "nothing is cheap – which seems a metaphysical impossibility." Well, the metals took a much-needed breather after gold topped $1,900 per ounce last summer, but for the most part, they remain quite high, at least in nominal dollar terms –if you adjust for inflation, gold and silver have a long way to go to beat past highs. Metals and mining stocks, on the other hand, have taken a serious beating, and some are now genuinely undervalued, presenting us with great speculative buying opportunities.
"Buy low, sell high" – it's easy enough to say, but how do you actually, reliably, predictably, do it? You buy when others are too afraid or too illiquid to buy – in other words, when the market is like it is today.
Olivier: And why is it that way today?
L: Mr. Market is not a man I can invite to lie on my couch for psychoanalysis. The market is made of many different players, each with his or her own individual and/or institutional agendas. Bulls and bears have very different views of what to do and why at any given time in any given market – and on opposite sides of every single transaction. That said, what we're seeing now is the market "telling" us that on average investors expect prices to keep dropping.
Whether a majority of players think the $1,900 peak we saw in the gold market was the top of this metals cycle or whether they fear that might be so, most people just don't understand what's happening in the world today – or more specifically, what's happening to paper money around the world today, and the implications of that for all commodities… and especially precious metals.
I should pause here and point out that industrial metals are in fact quite different in their market dynamics than precious metals; the two categories of metals have often moved contra-cyclically in the past. In other words, a weak economy was and is bearish for industrial metals but is usually bullish for precious metals, as fear and uncertainty drives people to seek the safe haven of gold and silver.
Olivier: But when a government prints more dollars, euros, or whatever, everything priced in those currencies tends to rise.
L: Yes, and we've seen that in both industrial and precious metals over the last ten years. But it was gold, not copper, that bounced back from 2008 first and fastest. And when the economy gets really frightening – which is happening now as we exit the eye of the storm that started in earnest in 2008 – people are less likely to want to invest in industrial metals and more likely to want to invest in the safe haven of precious metals. Especially so for the monetary metals – gold and silver – not platinum or other rare metals that have not kept up with gold.
Olivier: So, you are not buying any base metals stocks at all?
L: Well, never say never – we could be wrong. So there are a few "contra-Casey" picks in the portfolio… base metal plays that should do well if the economy rights itself and another global economic boom takes hold. That said, we don't think we're wrong, of course, or we'd change what we think and what we recommend. So almost everything in the portfolio is in precious metals. We've been focusing on emerging production stories in particular.
Olivier: I know the answer, but tell our readers why…
L: Because the heightened level of fear in the marketplace favors the safety of existing production and cash flow over the raw, speculative oomph of early-stage exploration.
If you're truly fearful of what's going on in today's world and are not really concerned with making money but rather want to protect your wealth, you need to focus on buying the metals themselves. As a matter of principle and prudence, we do recommend buying the physical metals to all subscribers.
If you want to make money and understand that gold stocks tend to offer leverage to gold, but are nervous about investing in today's volatile markets, you probably want the biggest, most stable gold producers you can find. If they have good growth potential, so much the better. Jeff focuses on finding the best of the best opportunities in this area in BIG GOLD.
But the biggest companies' shares are so big that it's hard for them to make dramatic moves, like doubling production in a year or quintupling the bottom line. Smaller companies just building their mines can do this, and we've had a great deal of success betting on them in Casey International Speculator.
Olivier: Does that mean that you're not interested in grassroots exploration anymore?
L: No, but that's a kind of speculation that takes a lot of patience. One can hit the occasional home run that way, bagging ten times one's initial investment, or even 50 or 100 times the investment in some extreme cases, it's true. But to get to those great wins, one has to take a lot of losses on all the long shots that don't work out. The average result of stepping up to the high-stakes table, if played intelligently – with patience, discipline, and enough money not to be forced out of the game – is greater yields; but few people have what it takes and many get burned, giving up too soon, realizing losses and no home runs.
In a buoyant – not to say frothy – market, it's easier, because everything is going up. That makes patience easier to maintain. But even in a bear market, resource investors love a discovery, so intelligent and disciplined speculation can pay very handsomely.
Olivier: So, emerging producers offer the best mix of risk and reward?
L: Under current market conditions, that's the sweet spot.
Olivier: What if the naysayers are right, and the $1,900 peak was the top?
L: Then we'll have been thrown an exceptionally unusual curve ball: a bull market without a Mania Phase. But I'm not counting on a mania just because "there's always been one." I'm expecting it because the amount of fiat money creation that has already gone on since 2008 makes it all but inevitable. Moreover, all the world's bigger governments have joined in "the race to the bottom" in paper currencies. In other words, the money creation so far was just an overture. In spite of price destruction in certain asset classes, major inflation is on the way, with hyperinflation in the world's leading economies quite possible. That's going to make the coming mania not just one for the record books, but one that could truly dwarf any mania you could name in all of recorded history.
Olivier: Sounds a little extreme.
L: So is the debasement of the world's reserve currency. The destruction of the US dollar doesn't just affect the US, but the whole world. We are, unfortunately, living through a period that will be a highlight in history books for many, many generations to come.
But suppose I'm wrong and Obama has saved us all from excessive debt and stupid spending by adding more debt and encouraging more stupid spending. Even if this were so, the amount of fear and uncertainty already wracking the global economic system makes it likely that precious metals prices will remain high for years to come, and that means that the profitable producers should continue cranking out profits and attracting market attention.
For industrial metals, that scenario is even better, because demand should increase, even as supply continues being squeezed by higher taxes, royalties, and regulatory burdens – not to mention "not in my back yard" thinking that is chasing mining to ever more distant and inhospitable (for investors) lands.
Silver, it's worth noting, benefits from both scenarios; unlike gold, which has very little industrial use, silver is also an industrial metal and gets used up in all sorts of manufacturing processes. It's also largely a byproduct of big base-metal mines (there's almost no pure silver production in the world), so the supply crunch we see ahead affects it much more than gold. Silver has become the win-win metal.
Olivier: But wouldn't silver get hit harder than gold if we're right about more economic trouble on the way, precisely because it's also an industrial metal?
L: Yes. It sure did in 2008. And if it does, that should be a fantastic buying opportunity, because if gold really takes off, silver will follow at one level or another, regardless of industrial demand.
Olivier: What if metals don't take off into a mania, but just continue in a highly volatile range for some time to come?
L: Again, the producers should do well regardless of the specific scenario. The good ones have gross margins approaching 50-60% – some really low-cost producers have margins over 80% right now. But there's potential joy for the successful explorers, as the producers always need to replace their depleting reserves, and the lowest-risk way to do that is to take over a smaller company that has done all the hard work of making a discovery and proving that it's economic.
Olivier: Some of those high-margin producers might become takeover targets as well.
L: Sure. Substantial and profitable production is always attractive to bigger fish, but they can be picky. Generally, annual production needs to be about 100,000 ounces of gold or equivalent per year, and there needs to be more than five years of mine life left in current reserves, hopefully with brownfield exploration upside visibly imminent. Such a company, operating in a stable, pro-mining jurisdiction is a good candidate for consolidation, which usually comes in the form of a takeover offer at a premium for existing shareholders.
Olivier: And the explorers? What makes for a good takeover candidate among them?
L: Size matters there. Basically, when I look at an earlier-stage company, I ask myself: "Would a major mining company want to buy this?" For the answer to be "yes," they have to be working on something big enough – or potentially big enough – to interest a major. Generally, that means multimillion ounces: a good five million ounces or more definitely puts a project on the majors' radar screens. They might reach down for something smaller, if the grade is unusually high, or if the project is located near their existing production and they can see it as something of a satellite operation.
Olivier: But it's more than size, of course…
L: Of course. They are not in the business of cool science projects. The thing needs to have clear economic potential – or better yet, a bankable feasibility study showing high Net Present Value and Internal Rate of Return. Political risk is a big factor as well. The majors are highly risk averse, and will usually opt for easy over gutsy.
But there are aggressive mid-tiers and even cashed-up juniors that can add value by buying up smaller companies to consolidate ownership of key projects or expand production.
Olivier: Can you give us an example?
L: Yes. One of the better happy endings we've had recently was the Long Canyon project, formerly held by a small junior called AuEx Ventures. AuEx was run by the serially successful mine-finder Ron Parrat, one of our Explorers' League honorees. He came at a known gold showing in a little-explored corner of Nevada – one of the best mining jurisdictions in the world – with a new geological theory, drilled a fence of holes, and, bang, bang, bang, hit high-grade, near-surface, oxide gold (which tends to be lower-cost to process) in almost every hole. We put out an alert and bought shares based on that success in October of 2005, at 55 cents.
Next came a legal challenge – not because AuEx made any mistakes, but because the government land claims office did. The result was a joint venture to explore Long Canyon with the company that had the conflicting land claims. Then along comes Fronteer Development Company, which made a lot of money spinning out a large uranium project and wanted to re-focus on gold. Fronteer bought AuEx's partner, changed its name to Fronteer Gold, and after a couple of years of great exploration success, ended up buying AuEx, with a final price of C$6.47. That was a great win.
But that's not the end of the story. Fronteer was already in our portfolio for other reasons, and now we liked it even more – we thought Long Canyon and Fronteer's other Nevada assets made it a natural takeover target, especially for nearby mining giant Newmont. Fronteer was trading at C$4.96 when we bought it in April of 2006. It went to C$15 a year later, and we took profits. Good thing too, because it retreated to about C$2.00 in 2008, when we put an emphatic buy recommendation on it. It was back up to about C$10 when it took over AuEx. Then, sure enough, Newmont took out Fronteer, which ended up at C$14.78.
A tale of two takeovers.
Olivier: A double win.
L: Triple, if you count the profits we took on Fronteer during its first brush with C$15.
Olivier: And you think you have more picks with this sort of potential in the portfolio now?
L: At the risk of turning this into an infomercial, yes; I believe I do have several with excellent takeover potential.
Olivier: Well, quite a few of these conversations have been pure public service announcements. Prices are down, and this is a great opportunity for people late to the party, so I think our readers can forgive us for wanting to point it out to them.
L: I hope so. I really hope so! Did you hear about the UK vetoing the plan France and Germany had put together to save the Eurozone? The wheels could easily fall off the global economy at any time. The precious metals are the obvious and immediate beneficiaries. And for the first time in years, the stocks that offer the most leverage to that eventuality are on sale relatively cheap compared to the underlying commodities.
I remember well all the really great buys we had in 2008, but that most investors were too paralyzed or too illiquid to take advantage of them. We may see an opportunity just like that, or even more extreme, in 2012. I hope people are listening to what we're saying, because playing that right could make a life-changing difference.
Olivier: Exactly. We certainly hope some of the readers of this conversation who don't get your newsletter will subscribe, but even if they don't, they can still take what you've told them and apply it themselves.
L: True enough.
Olivier: Anything else to add?
L: I would stress again that people should buy gold for prudence. The stocks are for speculation. Also, I agree with Doug that the greatest threat to anyone's financial security is his or her own government. Internationalizing one's assets has never been more urgent.
Olivier: Very good. Thank you for your thoughts.
L: My pleasure.
[There's no better time than now to get into the severely undervalued precious metals juniors that Louis has identified as screaming "Buys." Due to overall market weakness, they have been dragged down with the rest of the market, but they're sure to come back with a vengeance – providing Casey International Speculator subscribers with exceptional gains.
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