https://www.theaureport.com/pub/na/11331
Marshall Auerback: Gold and Silver Opportunities in Turbulent Times
Source: Source: Brian Sylvester of The Gold Report (10/19/11)
Marshall Auerback of Pinetree Capital believes investors get maximumvaluation during periods of turbulence and fear. In this exclusiveinterview with The Gold Report, he explains why the economy is inbetter shape than it seems and shares the names of eight gold companiesand two silver companies poised to take off.
The Gold Report: Many of the resource companies inPinetree Capital's investment portfolio are gold companies. Gold wentfrom above $1,900/ounce (oz.) in early September to around $1,600/oz.currently. Now, European central banks have sold 1.1 million metric tonsof gold into the market to drive the price lower. Pinetree's shareprice has followed gold lower and your exposure to gold remains high.What's Pinetree's pitch to investors right now?
Marshall Auerback: Wehad a very significant run up in the gold price, so some correction isunderstandable. But the conditions that created the run-up to $1,900/oz.have not dissipated. If anything, they've become more pronounced,notably in the Eurozone, where investors must begin to seriouslyconsider the possibility of a break-up of the European monetary unionand the implications that has for gold. And if you look at the monetaryoverhangs in places like China and Japan, it's hard to find stores ofvalue there either. So we have had some significant spec liquidation,some central bank sales—a plus, as central bankers are usually a greatcontrary indicator—and yet the price appears to have stabilized around$1,600/oz. Gold stocks, in contrast, still reflect valuations that aresubstantially lower than the current gold price. It is also important tonote that the capital markets, in contrast to late 2008, have not shutdown. Good quality mining projects can still obtain funding, especiallyfor projects with robust economics, which a number of our holdingspossess.
Pinetree has a unique structure. We raise money from themarkets, which means that our longer-term funding requirements are, tosome degree, shaped by market perceptions and market enthusiasm forresource stocks. But it also means we are not subject to monthly, dailyor quarterly redemption pressures, so we can hold on to some smallernames that now offer the most compelling value they have offered inyears.
TGR: A few years ago, Pinetree went frombeing focused on technology and biotechnology stocks to resource-basedequities. If you were making that decision today, would you still go inthe same direction?
MA: Yes, the fundamental thesis hasnot changed. The developing world is likely to remain the dominantsocial, political and economic theme for at least the next fewgenerations. Commodity prices have soared because the depletion ofreadily available resources is now finally outstripping the ingenuity ofmankind to extract these resources. That is not just our view. JeremyGrantham of GMO believes that this has changed the fundamental trend inreal commodity prices, though the explosive nature of these prices inrecent years has no doubt been amplified by speculation and historicallyunprecedented and ultimately unsustainable fixed investment in China.So you will get periodic corrections, especially during periods ofglobal economic slowdown, but we don't think this changes the long-termthesis. The portfolio composition has changed somewhat to reflect achanged economic environment of less base metals, more precious metals,but that is a tactical, as opposed to strategic, decision.
TGR: Did that one-month, $300-dollar drop in the gold price ruin gold's reputation as a safe-haven investment?
MA:Not really. The price rise was, like other commodities, undoubtedlyamplified by the actions of trend-following speculators. These aregenerally weak holders, and they tend to get shaken out when there aremarket gyrations of the sort that we have experienced over the past fewmonths. But the fundamental reasons for holding gold have, if anything,grown stronger over the past few months.
TGR: Is the fear-trade gone? Is gold now trading strictly on supply and demand fundamentals?
MA:Given the way that markets have traded toward the end of the quarter,where you get maximum incentive to "paint the tape" in an upwarddirection, we think it is way too premature to suggest that the feartrade is over. Ultimately, though, gold is a supply/demand story. Themarket has been in fundamental deficit for decades and only the salesand leasing of gold by the central banks have prevented an even moreacute price explosion.
TGR: The market is always abouttiming, but timing is even more important now given the rampantvolatility in the markets. Fearing an economic collapse, many investorsexited the junior sector once the volatility started in August. Many ofthose same investors remain on the sidelines today and some probablywant to get back in. Is there something they should wait for—like abottoming of the gold price—or is now the time to return?
MA:We think the time when you get maximum valuation is during theseperiods of turbulence and fear, when the baby gets thrown out with thebathwater. The good stuff is thrown out along with the bad as redemptionpressures mount. Since we are in a comfortable position vis-à-vis ourcash positions, we are in a good position to capitalize. Especially asPinetree, for reasons explained before, doesn't face comparableredemption pressures.
TGR: Our readers are primarilyretail investors who like the high-risk, high-reward nature of theprecious metals juniors. Pinetree is essentially a retail investor withlots of cash and a crack research team. How is Pinetree playing thecurrent market? Have you been adding to your positions on the marketdips? Have you sold off? Have you held tight? Give us the scoop.
MA:We try to "feed the ducks while they're quacking," in the sense that werecognize that many of these holdings are small and illiquid, and wetend to take large, strategic stakes. When our assessments are largelyvalidated by market action, then we find that it is a good time toreduce, particularly because with these smaller, less liquid names, weare almost always going to be a bit early because we have to trim whenthere is good demand. This is especially the case when the company'sdevelopment has largely tracked what our analysts forecasted and withthat comes the growing popularity of the shares with the broader market.Selling in those kinds of situations gives us the flexibility to takeon new deals or, as is the case today, to buy from distressed sellers.
TGR: What are your favorite five gold plays in the Pinetree Capital portfolio?
MA:Gold Canyon Resources Inc. (GCU:TSX.V)is one. We are big believers in this deposit. The initial resourceshould be out by the end of this year and is promising to be severalmillion ounces with grades exceeding most other bulk tonnage deposits inCanada. Looking at the dimensions of the deposit, specifically the newextension to the southeast, the potential here continues to grow farbeyond what the company's initial resource will give it credit for.
Queenston Mining Inc. (QMI:TSX) is the consolidation of key past producing mines in the prolific Kirkland Lake mining camp. There is an Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE)take-out potential. Extensive drilling on the Upper Beaver and theSouth Mine complex joint venture with Kirkland Lake Gold Inc. (KGI:TSX)continues to add ounces.
RoxGold Inc. (ROG: TSX.V)is operating in Burkina Faso and has just raised the money needed toacquire 100% of its flagship asset. High-grade deposits are very hard tocome by and the results it has consistently seen show potential forjust that. With mid-major companies operating in the region, as RoxGoldcontinues to add size, it becomes more and more likely to be anattractive candidate for a take-out.
Continental Gold Ltd. (CNL:TSX)recently reported a very large high-grade resource on its Buriticagold/silver/base metals deposit in Colombia. If you look around rightnow there aren't too many deposits that hold size and grade like thisone and, with 250 kilometers of assays to come since the resource wascalculated, there is still a lot of upside from here.
Mawson Resources Ltd. (MAW:TSX; MWSNF:OTCPK; MRY:Fkft)is exploring at Rompas in Finland, a new discovery with bonanza goldwhere samples up to 22,723 grams per ton (g/t) gold and 43.6% uraniumhave been identified. The weighted average of all channel samples fromthe 2010 program is 0.59m at 203.66 g/t of gold and 0.73% uranium withina sampling footprint of 6.0 km. strike and 200–250m width. More than300 discovery sites have now been identified within the mineralizedfootprint. At this very early stage of exploration, Rompas has to beconsidered as one of the most exciting global gold discoveries (with auranium credit) to emerge into the marketplace, in terms of its highgrades and hundreds of surface showing over a large area.
TGR: What are three gold plays Pinetree has positions in that few have ever heard of?
MA: Redstar Gold Corp. (RGC:TSX.V)is exploring in Alaska where properties have limited historicaldrilling. However, the company has seen very high grades. Currently, itis drilling up there and with the recent addition of the InternationalTower Hill Mines Ltd. CEO to their board, there is reason for interest.The company also has a joint venture with Confederation Minerals Ltd.(CFM:TSX.V) up in Red Lake. Thus far, Redstar has seen very high gradesover 200 g/t over narrow widths stretching over a potentially severalkilometer-long strike length. This kind of project requires lots ofdrilling; however, thus far, there has been some good continuity ofsuccess and with any sort of thicker intervals, this would be a projectwell worth the interest.
Prosperity Goldfields Corp.'s (PPG:TSX.V)exploration is headed up by Quinton Hennigh, who is also on the boardof Gold Canyon and is heading up its exploration program. Stock had alarge run-up prior to results, which the market clearly saw asdisappointing. Despite this, we think these results show great promisegiven that Prosperity was the first in the area and the potential sizeof this deposit is very large. This project is in Nunavut; however, awinter camp has been set up and, relative to the region, theinfrastructure is better than most.
Terreno Resources Corp. (TNO:TSX.V)is focused on a few different resources in South America. The companyjust raised $2.8 million and so it is cashed up to move forward on theinitial exploration of both precious/base metal projects in Argentina aswell as their phosphate/potash exploration in Brazil. It has had somesolid trench results thus far down in Argentina, which is promising. Thephosphate/potash market seems to be one of the few places where mostanalysts agree there will be a lift in pricing in the future so we areexcited to see the exploration results.
TGR: Let's switch gears to silver. Does Pinetree believe silver is a better near-term investment than gold?
MA:No, we think gold is likely to be the better performer if a globalrecession becomes the predominant concern, as opposed to systemicissues. That said, there have been some fairly violent moves to thedownside over the last few weeks. The bear talk on China has really beenoverdone. Remember, China has over $2 trillion in foreign exchangereserves, so it has ample firepower to combat the forces of recession.In the very short term, we could get these massively oversold conditionsworked off if it looked like the world was not coming to an end andsilver could have a nice pop. Look at the U.S. data recently:
- Since late August, the U.S. economic data has surprised somewhat to the upside.
- Initial unemployment claims rose less than expected; September chain store sales look stronger than expected; Ford Motor Company's sales for September were up 9%.
- It looks as though GDP growth may come in better than 2% annually in both the third and fourth quarters, surpassing recent pessimistic expectations.
As far as Chinaitself goes, suddenly all the analysts, economists and portfoliomanagers that were all bulled up on China two years ago, a year ago andeven six months ago have become all beared up on China. We are hearingabout an imminent hard landing in China from everyone. So why the suddenbearishness about China?
It is claimed that China's informalcredit market is out of control. Property developers and businesses arestarved for credit; business investment and real estate will fall. Ahard landing is at hand. Let's put this informal credit market intoperspective.
This informal credit market is estimated at 3–4trillion yuan RMB. The Chinese economy is now estimated at somethingnorth of 40 trillion yuan. According to Fitch, the formal credit marketplus the shadow banking system totals about 70 trillion yuan.
When one looks at these numbers one can see that the growth of informallending and the extremely high interest rates on informal lendingrepresent a problem in China. But it does not impact a significant shareof aggregate expenditures.
The real problem lies with the banking system and the shadow banking system.
TGR: Is this important credit market now poised to take Chinese aggregate demand down?
MA:We doubt it. Interest rates in the banking system are negative in realterms. The banking system is still expanding at a double-digit annualrate. Interest rates in the shadow banking system are much higher; theyare no doubt positive in real terms, but it appears they are notusurious. In any case, this credit is still being allowed to expand at avery rapid rate. Will the authorities be able to deal with problems inthe banking system or shadow banking systems, which are the creditmarkets that matter?
The answer is probably yes. The biggestcredit excesses and the biggest white elephant fixed investments in thiscycle lie with the local authorities. The Chinese government in onefell swoop removed half a trillion dollars of such loans off the backsof these local authorities. A half a trillion dollars! That is as largeas the entire alleged informal credit market that everyone is getting sobeared up about.
Longer term, the Chinese economy is anout-of-control Ponzi economy. Labor force growth will go negative.Surplus labor in agriculture is depleting. Fixed investment isimpossibly high relative to a falling warranted rate of growth. Very badthings will eventually happen. However, the Chinese economy is also anextreme command economy. Extraordinary measures will be taken to avertthese very negative outcomes.
The Chinese economy is highlyindebted. The Chinese central government is not. Before the proverbialyou-know-what hits the fan, the Chinese government will use its balancesheet to keep the white-elephant over-investment juggernaut going. Donot underestimate the fiscal capacity of the Chinese government and itswillingness to use it. We do not think the excesses today in the Chineseinformal credit market are a reason to get very beared up on China all of a sudden. The Chinese bear story will unfold progressively over a long time.
Thereal threat in China is inflation. China's fixed investment has becomeincreasingly credit dependent. To keep the fixed-investment juggernautgoing and avert a hard landing, there must be sustained rapid money andcredit expansion. There is already a large monetary overhang. Thecombination of these flow and stock dynamics threaten a very highinflation down the road. Which again makes the long-term case for goldvery bullish.
TGR: Where is Pinetree getting its exposure to silver?
MA:Apogee Silver Ltd. (APE:TSX.V).The company's primary focus is the Pulacayo-Paca Property located insouthwestern Bolivia. The property includes the historic Pulacayo mine,which was the second largest silver mine in Bolivia's history withhistorical production exceeding 600 million ounces of silver. Althoughthere is obviously some risk with dealing in Bolivia, there are stillmany operating mines and we feel the deposit warrants the risk.
Southern Silver Exploration Corp. (SSV:TSX.V; SEG:Fkft)recently acquired the Cerro Las Minitas property in Durango, Mexico.There is a history of production right in the middle of the property andthus far, the company's initial holes have been promising. This is avery early stage project and there is a lot more definition neededbefore a resource can be laid out; however, Southern Silver is in a goodregion and we feel the property certainly has potential.
TGR: What are some investment themes that you expect to play out in the coming months?
MA:We think that the markets could surprise again to the upside as we haveapparently discounted a double dip recession, whereas a slowdown mightbe more accurate. This period might end up being closer to 1998 than2008.
The trouble with the view that we are heading for another2008 is that all crises are different. But they do share one commonelement: the inability of markets to perceive that when a marketdiscontinuity is fresh in the minds of investors (e.g., 2008); it seldomrepeats until that institutional memory is dissipated. Now, I believethat European banks are insolvent conditional upon the PIIGScollectively being insolvent. Clearly, this is the case for Greece(although the European Central Bank (ECB) could easily forestall this ifit keeps buying Greek debt), but for the others, this is unclear—and,particularly in the case of Spain and Italy, a function of the rates atwhich they can borrow. So while the ECB provides a liquidity backstop,they have the room to adjust. Of course, the missing ingredient isgrowth. Europe already looks as though it has slid into recession. Iwould argue that recession, as opposed to systemic risk and bank runs,is already priced into European stock markets. But nothing is certain.
Whilethe current crisis in Europe is worse than the 1998 crisis with LTCMand Russia, in 1998 it was thought that the entire system wouldcollapse. Remember in 1998 Fed funds were 5%, not zero; 10-year notes,above 4%, not 2%+; 2-year notes were 5%; SPX was 30x earnings, not 15x.We had not gone through a 1974-style liquidation in reverse parabolaterms except for the one day 1987 sell-off, as we did in 2008–2009. Realestate (houses) was not selling for prices yielding 10%–15% onlower-end real estate, but that is where the focus of foreclosures isfelt. The story will be told in the next eight trading days.
TGR: Thank you for your insights.
As Pinetree Capital's corporate spokesperson, Marshall Auerbackis a member of Pinetree's board of directors and has some 28 years ofglobal experience in financial markets worldwide. He plays a key role inthe formulation and articulation of Pinetree's investment strategy.Auerback is a research associate for the Levy Institute and a fellow forthe Economists for Peace and Security.
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DISCLOSURE:
1)Brian Sylvester conducted this interview. He personally and/or hisfamily own shares of the following companies mentioned in thisinterview: None.
2) The following companies mentioned in theinterview are sponsors of The Gold Report: Gold Canyon Resources Inc.,Queenston Mining Inc., Continental Gold Ltd., Mawson Resources Ltd.,Apogee Silver Ltd., Southern Silver Exploration Corp.
3) MarshallAuerback: I personally and/or my family own shares of the followingcompanies mentioned in this interview: None. I personally and/or myfamily am paid by the following companies mentioned in this interview:Pinetree Capital Ltd.