The health of the US economy may not be quite as robust as some government statistics indicate and more stimulus could be on the way, despite what the Fed may be saying. Regardless of which way the economy goes, Chris Marchese, contributor to The Morgan Report, tells us in this interview with The Gold Report that precious metals will go higher as investors seek protection from the effects of monetary policies that don't work. In the process, he expects that greatly undervalued mining shares of silver producers will again shine in the eyes of investors and highlights several of his favorites at current bargain prices.
The Gold Report: This is an election year and everybody is waiting to see what happens with the economy between now and November. The Federal Reserve just signaled that it may be less willing to provide more stimulus. What's your reading on that?
Chris Marchese: The Fed meeting minutes signaled that the members are willing to be very accommodating if gross domestic product (GDP) slows down, if it doesn't maintain a 2% inflation rate and/or unemployment starts to creep back up. Then they tried to play the metals down; they don't like high gold or silver prices because they delegitimize the dollar. I think they are doing that in preparation for the next round of quantitative easing, which in my opinion will just be an extension of Operation Twist that ends in June.
TGR: So you think that's all pretty much in place, regardless of how numbers look, unless there's some drastic change?
CM: Yes, real GDP is supposedly growing, but our deficits are running higher, and 21.5% of that is government spending, which doesn't include any Social Security or the like. If you take that $3 trillion (T) out, our economy is smaller or roughly the same size as it was back in 2006. So there hasn't been a recovery, even though they try to paint it that there is.
I can make the argument that things have gotten worse. There hasn't been any growth, and unemployment has been getting worse if you count discouraged workers, people no longer considered unemployed and people forced to take part-time jobs or jobs that they're overqualified for. John Williams of shadowstats.com calculates these numbers. Last month, it was almost at a record high of 22.5%. Even the US Bureau of Labor Statistics has it at 15%, and it hasn't really budged.
TGR: What happens if the recovery stalls – or if it takes off faster than expected?
CM: I think that Fed Chairman Ben Bernanke and President Barack Obama might do stimulus, tax cuts or something like that to get a short-term hit. It's like heroin, you get a short-term high, then you come down hard again. We've been doing that since we got rid of the gold standard altogether. It's just the boom/bust cycle that eventually runs out when no one trusts our currency anymore. A growing population is already starting not to trust it. Politicians like to talk the talk – "oh, we're going to cut $2.6T over the next decade." Well, it's going to be out of control by that point. Everyone should read the GAO Report, written by the people who audit the government. The phrase "material weakness" is used 50 some-odd times. If that was the case when we filed our taxes, we'd be thrown in jail.
TGR: What do you think the chances are for inflation getting out of hand?
CM: I think it's already a problem. I use what's called True Money Supply, which is basically all currency that's readily available for use and exchange – currency, coins, notes, checkable deposits, savings deposits and the like. That's been growing between 10% and 15% over the last three years.
TGR: What's going to happen with precious metals if the economy stalls, or if inflation really picks up?
CM: I think it's a win-win either way. For one, as opposed to the 1970s, this is an entire-world problem. China has inflation. Argentina has inflation. Europe is going to have inflation. Everyone is running the money spigots non-stop. I think Bernanke is not going to let this economy stall. It's either going to take off through inflation and people will go to the metals, or he'll do another stimulus and if that doesn't get things going, he'll do another and another. At some point, it will be too much. Either way, I don't think the metals will do anything spectacular until the end of the summer. At that point, if the economy is not looking good enough, I think Bernanke will do everything in his power to make Obama look good to get re-elected.
TGR: Do you have any predictions for gold and silver prices?
CM: I think in Q412, we'll break $2,000/ounce (oz.) in gold and $50/oz. in silver. It could run up as far as $60–70/oz. just because of the technical buying and no overhead resistance at $50/oz. Toward the end of 2012, it could be $55/oz. silver and $2,100/oz. gold. That might sound outrageous now, but last April silver ran from $32/oz. to $49/oz. in the blink of an eye.
TGR: When you spoke with us this past September along with Jason Burack, you talked about some 30 companies that were of interest at that time. A lot of those were in silver. Of the more-established producers, whom do you like at this point and what are their prospects now?
CM: I think Silver Wheaton Corp. (SLW:TSX; SLW:NYSE) is a no-brainer for someone who wants something conservative. It's well diversified with the best operators in the world.
I also like what Pan American Silver Corp. (PAA:TSX; PAAS:NASDAQ) has been doing. It acquired Minefinders Corp. (MFL:TSX; MFN:NYSE), which gives it a lot more exposure to Mexico, so it's not so concentrated in Peru and Argentina.
TGR: What are the implications of the Minefinders acquisition?
CM: Minefinders is a lot bigger than people think. Dolores mine is world-class and will produce 7–8 million ounces (Moz.) silver and over 100,000 oz. (100 Koz.) gold, once the mill is optimized. That's going to add between 12–14 Moz. silver equivalent to its growth profile. Its 20 Moz./year Navidad deposit in Argentina is expected to get fully permitted. Also, 12.5% has to be paid to Silver Wheaton because it bought a debenture from Aquiline Resources Inc. (AQI:TSX) from whom Pan American bought the property. Pan American produced about 22 Moz. silver in 2011. With the Minefinders expansion and developing Navidad, it could be a 50–55 Moz. producer and one of the world's largest primary producers after Fresnillo Plc (FRES:LSE). I think the Minefinders properties will give Pan American's stagnant share price a huge boost.
TGR: Any others you'd like to talk about that are more majors?
CM: Another one I like is First Majestic Silver Corp. (FR:TSX; AG:NYSE; FMV:FSE), which is acquiring Silvermex Resources Inc. (SLX:TSX; GGCRF:OTC). This just gives it more growth, especially for how much it is paying for it, $175 million (M). It can get this thing up between 3–5 Moz in a few years plus it already has lots of organic growth through 2015 or so with Del Toro. First Majestic is still looking really good, especially down around $16/share. I consider this one of the safer silver plays now that it has five operating mines and more to come on.
TGR: Let's talk about some of the more junior miners.
CM: One of my favorite junior gold plays right now is a Canadian company with operations in Panama and development projects in Spain and Portugal called Petaquilla Minerals Ltd. (PTQ:TSX, PTQMF:OTCBB, P7Z:FSE). Its main deposit is the Molejon gold mine in Panama, which reached commercial production in 2010 and has been ramping up production via several mill expansions ever since. It has been completely overlooked by the market even though it has one of the best production growth profiles out there, courtesy of its recent acquisition of Iberian Resources Corp. in August 2011.
In 2012, Petaquilla's production is projected to reach 100 Koz. , 120 Koz. in 2013 and nearly 250 Koz in 2015. This is excluding significant copper byproduct credits, which are forecast to reach 100 pounds per annum by 2015. Cash costs net of the company's silver and zinc credits were $557/oz. in 2011 and are projected to remain between $500/oz. and 600/oz. going forward as silver credits will exceed 3 Moz. annually. The company also benefits from Panama's tax policy, giving Petaquilla a projected effective tax rate of 25%. Petaquilla is also a "special situation" at the moment, planning to spin out its wholly-owned infrastructure arm as an independent entity. Shareholders will receive one share for every four it holds prior to the spin-off date. I've modeled a net asset value on a fully diluted basis of over $3/share [using $1,600/oz. Au, $2.50 Cu ~ discounted @ 15%], significantly higher than the current $0.42/share market price.
The composition of a company's largest shareholders often says a lot about the prospects of a company. In this case, management owns more than 12%, followed by significant stakes by Sprott Asset Management, US Global Investors and Libra Advisors. I've always considered having at least 5% management ownership a huge positive due to an obvious alignment of objectives, notably increasing shareholder value.
TGR: Do you have any others?
CM: Up in the Yukon there's Alexco Resource Corp. (AXR:TSX; AXU:NYSE.A), which is one I've liked for a while. We talked about it last time. Since then, the company has identified some much larger targets that are much lower grade silver (on a relative basis), but, given the much wider intercepts, are candidates for significantly higher tonnage operations. That's at the Bermingham and Flame & Moth properties. These potential mines vastly increase the likelihood Alexco will surpass the 10 Moz./year hurdle within five years. Its Lucky Queen project is averaging over 1,200 grams per ton (g/t) coming on-line before the end of the year, along with Onek. So it has a really deep pipeline for continuous growth into the foreseeable future. With those types of mines, you can add a lot of reserves as opposed to most of the mines in the Keno Hill district, which are narrow-vein mines. One hopes that will catch the market's attention a little bit. It's been a good year for it and it's still cheap.
TGR: What about gold miners?
CM: Basically, gold stocks are trading cheaper than they were in 2008 relative to the underlying gold and silver price. There are only so many silver companies, but gold companies are a much bigger universe. One I like is Metanor Resources Inc. (MTO:TSX.V), located in Quebec. Its main property is the Bachelor Lake mine, which will be in commercial production this quarter. It will ramp up to feasibility levels by Q312 just because it's only running the mill at 65% capacity at this point. It has a $60M market cap but will be producing 60–75 Koz/year gold, although it does have a streaming agreement with Sandstorm Gold Ltd. (SSL:TSX.V) whereby it has to sell 20% at $500/oz. This shouldn't hurt it too much because it produces under $500/oz. Its average grade is about 7 g/t on that property. When it wants to access its Hewfran zone, it can increase production by about 25% or 70–80 Koz/year. That's a good smaller play.
It also has other properties. One is the Barry mine, which is also in Quebec and relatively close. It has a lot of the same features and structure as Canadian Malartic and Detour Lake. It's a high-tonnage, low-grade gold mine. Management will probably look for a joint venture partner on that one. This is another company that's gone under the radar.
TGR: Bachelor Lake used to be a separate company, or at least the mine was in a company called Bachelor Lake back in the 1980s and 1990s, as I recall.
CM: Yes, it's a past-producing shaft mine. I hate to harp on these really small caps, but they shouldn't be this small.
TGR: Any others that are interesting?
CM: There's an exploration company, Kimber Resources Inc. (KBR:TSX; KBX:NYSE.A). It has the Monterde project in Mexico, which could be on-line in two years if it had the money. It's not expensive to bring on-line for what's projected to be production of 60 Koz./year gold and 2 Moz. silver for 15.5 years. The initial capital expenditure is just $100M. This looks like a likely buyout target unless it can sell a stream or something to that effect to Sandstorm Gold or someone else. In this market, these miners can't economically raise money through equity because of low prices and dilution.
This company, along with most others, were trading at two to three times what they are now. This one is also a $75M market-cap company. I think it will get bought out within the next 12–18 months.
TGR: What else is happening in Central America?
CM: Tahoe Resources Inc. (THO:TSX) has a huge project called Escobal in Guatemala and is fully financed. It is looking at expanding the mill capacity so that it can produce between 26–28 Moz. silver with very low cash costs—around $3–4/oz. net of all the byproducts. The only problem is it's in Guatemala.
TGR: Anything else you like?
CM: There's also Aurcana Corporation (AUN:TSX.V; AUNFF:OTCQX). It's a Mexican and soon-to-be American silver producer. It has the Shafter mine in Texas, which is two months ahead of schedule and should be coming on-line relatively soon. That will produce about 4 Moz./year, plus byproducts, and increase total U.S. silver production by 10%. It has the La Negra mine that produces about 1 Moz. silver and 500 Koz silver equivalent, with zinc, lead, etc. It's going to have a huge growth spurt—a company that produces 1.5 Moz. is going up to 5 Moz. in a year and a half. People can buy it under $1/share and should be able to catch a double.
TGR: What would you like to leave as a final takeaway for our readers on how to best play this nervous market?
CM: Try to buy quality. Buy on dips. Always keep some cash in reserve because, as we know, things can go lower. You don't feel as bad when you have money left to deploy if a stock you like drops by 50%. Remember that negative sentiment in the market is a good thing. That's usually the sign of a bottom or a bottoming process. The average investor gets scared out of the market and sometimes liquidates his or her position at the very bottom. Understand the fundamentals of silver and gold. They are money and have been for thousands of years. Above all else, own the physical asset, then dabble in some mining companies.
TGR: Thanks for joining us today.
CM: Thanks a lot.
Chris Marchese is an equity analyst and contributor at The Morgan Report. He has served as a research analyst at Morgan Stanley, founded and co-managed a private equity fund and was an adviser to Vishni Capital. Marchese has published over 150 articles on various financial sites such as Financial Sense, Goldseek, Kitco and Seeking Alpha and is co-author of the e-book Treasure Hunting for Precious Metal Stocks.
Disclosure: 1) Zig Lambo of The Gold Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None. 2) The following companies mentioned in the interview are sponsors of The Gold Report: Minefinders Corp., Silvermex Resources Inc., Kimber Resources Inc., Tahoe Resources Inc. and Aurcana Corp. Streetwise Reports does not accept stock in exchange for services. 3) Chris Marchese: I personally and/or my family own shares of the following companies mentioned in this interview: Petaquilla Minerals Ltd., Alexco Resource Corp., First Majestic Silver Corp., Silver Wheaton Corp., Metanor Resources Inc., Sandstorm Gold Ltd., Pan American Silver Corp., Bear Creek Mining Corp. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this story.
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