by Brent Cook
In this first letter of 2009 we will briefly look at 2008 then cover some macro economic themes that will guide our 2009 investment decisions here at Exploration Insights. As the first quarter progresses we can go into more detail on specific metals, exploration plays and strategies. I have Paul van Eeden lined up for an interview next week, so stay tuned.
I took the photo below at the New York City Halloween parade. It pretty well sums up 2008. Global stocks lost $30 trillion in market valuation; the US alone lost $7.2 trillion. Various metals and minerals commodity price indexes were down 50% to 75%. Physical gold was up marginally for the year yet gold stocks as measured by the HUI index were down about 33% and the TSX-Venture exchange was down a whopping 70%. Our EI portfolio closed out the year down 12%. I recognize our two most recent additions are up substantially and that these illiquid stocks have not had time to settle out. We will do a more honest and thorough review in late February when we can more accurately evaluate our positions and exploration results.
Our most important investment “success” in 2008 was what we didn’t buy. I was very wary throughout the year and refrained from buying many popular stories. In the Exploration Insights portfolio we purchased 13 stocks and held 10 at year-end. The markets will continue to be anything but stable in 2009. New capital for the junior miners will be very scarce and therefore particularly valuable. I intend to remain very cautious with our capital and selective in our investments.
Our 2009 baby caught stumbling to the right in the above photo does not portend well for the Chinese Year of the Ox: things could get weird. The US and global economy is going to get worse, possibly much worse. The massive and growing debts owed by governments, corporations and consumers make growing our way out of this unlikely in the near term at least. The credit markets are tight and a decimated real estate market is still facing commercial property foreclosures plus the significant Alt. A and Option Arm problems (link). Add to this picture falling consumer demand coupled with rising unemployment and we do indeed have a mighty formidable climb back to prosperity.
Never before have we had 10’s of trillions of dollars in hidden derivative time bombs, a proposed rescue plan representing over 9% of US GDP, and a society that increasingly believes the government not only owes it but will make good on its promise of a chicken in every pot. Although Larry Flynt’s request for a $5 billion stimulus package to help the flagging US porn industry may be a hard one for Ben and Hank to swallow (link), Flynt’s irony cuts to the heart of their ad hoc economic rescue where no one knows where the money went or is going. The real irony of the situation is that we are relying on the same folks that blindly drove into this ditch to steer us out. Not a long term bet I am willing to make.
As discussed in the December 21st letter, the Federal Reserve’s statement that it will purchase any and all debt from the Treasury brought about an important investment paradigm shift for us: the Fed’s option of increasing interest rates to attract lenders was taken off the table and an increasing gold price is now virtually assured far into the future as the currency is debased.
You see, the Fed’s ability to create money out of thin air is the easiest and (initially) least painful solution the incoming Obama administration has and, they appear anxious to push it. As this video details better than I ever could (link), we are talking about huge current and future debt obligations that only the Federal Reserve can possibly cover. Bear in mind this video was made before the massive bailout and stimulus packages (see photo below) that we taxpayers are being forced into accepting. Through the imminent monetization of trillions of dollars of debt the US dollar will be debased and monetary inflation will set in. I expect the rest of the world to follow the US monetization lead with gold becoming increasingly seen as the last safe haven and only alternative to the US dollar. Gold is the ultimate beneficiary of this monetization process.
(Did you get yours yet? Here’s the form (link)
Nearly all the hard economic data I see points toward solid gold companies being amongst the best performing stocks of 2009. Junior companies able to produce a real gold discovery will reap the most dramatic share price increases this year. The junior exploration industry overall however is in for some serious devastation with many of companies going under. I do not anticipate a sudden rush into the exploration sector that will raise all boats and certainly won’t base any investments on that premise. Money for mediocre projects and exploration will remain very, very tight. We will therefore continue to focus on what appear to be legitimate, major gold discoveries and under-appreciated gold resources or mines. We own some and are on the lookout for more!
Let’s talk a bit more about the gold and silver space.
World gold production peaked in 2001 and has been steadily declining since then in spite of a nearly US$600 rise in the gold price. There are more or less 32 major gold mining companies and untold minor companies that contribute to the roughly 80 million ounces of annual gold production. Most of the major mining companies show declining production and reserve profiles and have been able to add ounces predominately through acquisitions and by raising the gold price used in reserve calculations. This increased gold price assumption directly translates into a lower average recovered grade, and higher production costs. CIBC World Markets calculates a four-year world recovered gold grade decline from 1.7g/t in 2006 to 1.4g/t in 2008. The declining mined grade problem is further aggravated by the dearth of new gold discoveries. Despite an estimated $US18 billion in exploration expenditure over the past five years (CIBC, Metals Economic Group estimate), both the quality and number of new gold deposits dropped.
Much of the increased gold production and reserves for the majors came by way of the acquisition of base metal deposits and production. When base metal prices were high gold company production costs were lower and earnings strong due to the base metal credits. The collapse in base metal prices at the end of 2008 resulted in a remarkable 31% increase in gold production costs according the World Gold Council figures. Lesson learned: henceforth, gold dominant deposits will command a premium.
There is a concerted effort afoot by the financial movers and shakers to cob a collection of smaller gold (and silver) producers together creating a larger producer. The idea is to tout these newly created mid-tier producers with increased “visibility” to a fresh and better-heeled audience. Although this exercise will undoubtedly make money for the suits, brokers, and some shareholders, usually very little in the way of real shareholder wealth is created in this shell game. Nonetheless, in a rising gold market money can be made; we are actively looking for the deposits that will attract the financial whiz kids. The difficulty we face is that most of these smaller mines or deposits have warts when one bothers to looks hard enough. The question becomes how many warts are we willing to overlook? [I am interested on your thoughts on this subject, please respond through my website: www.explorationinsights.com]
Silver should perform well over the next few years as its value as a precious metal mirrors the gold price. An important and often overlooked aspect of silver production is that nearly 70% of all silver production is associated with base metal deposits. The rapid decrease in base metal production due to mine closures should show up as a positive influence on the silver price. Unfortunately, most silver mines are also base metal mines; the base metal credits are an important (often critical) component of the mine’s profitability. Ditto for “silver companies” with Apex Silver being the most recent casualty.
There are literally 100’s of mediocre silver deposits scattered across Mexico and Peru that an investor could buy into. The majority are one to three meter wide veins averaging 175 to 275 grams per tonne silver with some lead and zinc credits. These have all seen multiple small mining and exploration campaigns, usually by locals, that ended when the easy ore ran out or the silver price sank. These are not deposits or companies I will be buying. We are after deposits like the one discussed in the Stock Talk section below.
For both gold and silver we are looking for the select few deposits or companies that show the potential for high returns and that are big enough to attract an outside bid. These situations are very few and far between as evidenced by a gold price over $800 per ounce and silver price over $10 per ounce. If good gold and silver deposits were common we would be backing currencies with seashells rather than gold.
Looking at base metals.
Base metal exploration on the other hand is dead for many years to come. My review of base metal companies (copper, zinc, lead, molybdenum, aluminum plus PGM’s) shows that production cuts have been announced at 35 mines, current development or expansion plans have either been delayed or suspended at another 36 deposits, and 45 mining operations have been completely stopped or suspended. Major base metal producers Rio Tinto and TeckCominco are facing serious debt issues to the tune of US$38 billion and US$10 billion respectively and are actively selling assets and cutting staff. Exploration is always the first to go and last to return in the mining industry.
When base metal prices do eventually begin to increase there are ample idled, delayed and drilled out reserves and resources on the books that can be brought on line before even considering looking for the next one. Absent another speculative binge in the base metals I do not foresee base metal prices dramatically increasing from current levels, and certainly not on an inflation-adjusted basis. The next bull market cycle’s deposits have already been found and lie dormant. Someone bullish on a base metal price recovery will want to own the producers with minimal debt and production costs in the lowest third of the industry.
From our perspective there are only three base metal stories that very selectively could be of interest. 1) Companies with quality deposits that are of strategic importance to a successful mining company; 2) Companies that are acquiring and inventorying large deposits for pennies on the dollar and that do not plan to build a mine; and 3) World class high-grade discoveries.
Precious metals however will remain our focus for 2009.
This letter/article is not intended to meet your specific individual investment needs and it is not tailored to your personal financial situation. Nothing contained herein constitutes, is intended, or deemed to be — either implied or otherwise — investment advice. This letter/article reflects the personal views and opinions of Brent Cook and that is all it purports to be. While the information herein is believed to be accurate and reliable it is not guaranteed or implied to be so. The information herein may not be complete or correct; it is provided in good faith but without any legal responsibility or obligation to provide future updates. Research that was commissioned and paid for by private, institutional clients are deemed to be outside the scope of the newsletter and certain companies that may be discussed in the newsletter could have been the subject of such private research projects done on behalf of private institutional clients. Neither Brent Cook, nor anyone else, accepts any responsibility, or assumes any liability, whatsoever, for any direct, indirect or consequential loss arising from the use of the information in this letter/article. The information contained herein is subject to change without notice, may become outdated and my not be updated. The opinions are both time and market sensitive. Brent Cook, entities that he controls, family, friends, employees, associates, and others may have positions in securities mentioned, or discussed, in this letter/article. While every attempt is made to avoid conflicts of interest, such conflicts do arise from time to time. Whenever a conflict of interest arises, every attempt is made to resolve such conflict in the best possible interest of all parties, but you should not assume that your interest would be placed ahead of anyone else’s interest in the event of a conflict of interest. No part of this letter/article may be reproduced, copied, emailed, faxed, or distributed (in any form) without the express written permission of Brent Cook. Everything contained herein is subject to international copyright protection.