Debt, not the fiscal cliff, is what concerns Jason Hamlin, publisher of the Gold Stock Bull newsletter, and if his prediction of a split in the EU comes to pass, it will bolster the case for gold equities. He shares his preference for royalty streamers and prospect generators in the gold space and explains his attraction to graphite in this Gold Report interview.
TGR: Jason, you recently told your Gold Stock Bull readers that you had sold some equities. What were your reasons for selling?
Jason Hamlin: At the time, we were nearly fully allocated and decided to move to a position of roughly 20% cash. Even though this is a high seasonal period for precious metals, we sold a couple of underperformers to take advantage of any potential year-end selloff driven by concerns about the fiscal cliff and its impact on economic growth. There are also year-end opportunities for tax-loss selling and we want to have some dry powder for bargains that may materialize over the next few months in quality resource stocks.
TGR: Do you believe investors should reduce risk and take a more conservative approach until we know what are the repercussions of the fiscal cliff?
JH: I do not. It is sensible to always have some cash available for a selloff, but I do not view the fiscal cliff as some Armageddon-type event like other analysts. I think the politicians will come to a resolution before things become too explosive, but we should never discount their ineptitude.
For me, the true issue here is debt, not the fiscal cliff. Debt is the root cause of nearly all of our economic and social issues.
As it is a mathematic impossibility to ever pay off all of the outstanding debt, neither tax increases nor austerity will solve the debt crisis. As all money is created out of debt and the interest owed back does not exist in the system, the only workable solution is liquidating or forgiving the debt. As controversial as that might sound, one only needs to look up the term “debt jubilee” to see how often it has been used throughout history to clear the slate and allow for a fresh start. So, without getting too detailed, the fiscal cliff in the U.S., debt crisis in Europe, student loan crisis, home mortgage crisis and every other monetary crisis can be tied back to the fact that our monetary system at its root is unsustainable.
TGR: Do you have a calculation that illustrates how difficult that would be?
JH: One way to view that is to look at the percentage of the U.S. budget now being put toward interest on the debt and how it has grown over time. As long as that percentage keeps increasing, it means less and less money is available to spend on legitimate needs and to direct toward growing and driving the economy. This expanding debt burden stifles any type of economic growth that might otherwise be possible. Until our leaders are honest about our debt predicament, balance the budget to stop the bleeding and face the necessity of massive debt forgiveness, my forecast is for continued slow economic growth with the potential for contraction in the near future.
TGR: What are the threats to the average retail investor, especially in the precious metals space?
JH: I believe that another banking crisis could be on the horizon, driven by the large amounts of toxic derivatives and potential revaluation of assets that could render many big banks insolvent. The same kind of threat we saw in the 2008/2009 crisis is still hiding under the surface, as it was only papered over to buy time, rather than addressing the core issues. This could lead to a sell-off in all assets including gold and another rush to the perceived safety of dollars. However, I predict that the deteriorating faith in fiat currencies will translate into a very short dumping of true safe-haven assets such as gold and even quicker rebound that we witnessed following the last financial crisis. Given this outlook, I think it is wise to hold through such corrections and keep cash available to take advantage of the panic selling that will occur if such a crisis materializes.
TGR: While we are talking about the future, do you have any other predictions for 2013?
JH: On a positive note, I think the world will survive the end of the Mayan calendar.
Seriously, I think the euro will fall apart when one or more countries leave. The strong countries will only support the weaker, over-indebted countries for so long before realizing that their sovereignty is more important than the European Union. I think dissolution is absolutely the right course to take, as the concept of the European Union was flawed from the start.
TGR: But the European Central Bank (ECB) has vowed to do everything in its power to stabilize and keep the euro together. Can or should the ECB stave off disintegration at least until the end of 2013?
JH: I think the ECB will try its best, as centralized banking has much to gain from the EU staying together. This attempt will surely involve more bailouts, stimulus and money printing, which will be bullish for precious metals. Ultimately, I think the attempts will fail and we could see a split of the euro as early as next year.
The ECB has constraints that the U.S. Federal Reserve, operating in just one country and with the world reserve currency, does not have. The ECB cannot employ the same bag of tricks as Ben Bernanke and the Fed, so I think it has fewer ways to kick the can down the road. This is why we are seeing the crisis escalate first in Europe, but it will eventually come to the shores of America as we witness a loss of faith in the U.S. dollar as world reserve currency.
TGR: That makes a nice transition into gold. Precious metal investor and Cranberry Capital CEO Paul van Eeden recently said that gold was overvalued. Do you agree?
JH: Mr. van Eeden correctly pointed out that the problem in the U.S. is not inflation, but debt. And I agree with him that the predictions for imminent hyperinflation are overblown. But that is where our agreement ends.
I think his methodology for calculating money supply and gold’s true value is flawed in that he incorporates worldwide gold supply, but compares it only to the U.S. dollar. Demand is strong worldwide and gold has been making new highs in several currencies, not just the dollar.
I also disagree with his notion that the Fed will be able to easily sell assets back into the market to control the inflation that is likely to occur. I’m not sure there would be many buyers of such low yielding bonds in an inflationary environment. The Fed is already forced to buy over 50% of bonds the government auctions during the current environment of relatively low inflation.
Mr. van Eeden has been calling gold overvalued for years now. I think he is a bright analyst and I enjoyed his commentary on gold earlier in this bull market, but he has now joined the ranks of a few other gold bears who have been consistently wrong about the gold price. They will eventually be correct about gold being overvalued, but I suspect it will be a number of years and a few thousand dollars higher before that happens. That being said, I could see some sell-off in gold occurring as a knee-jerk reaction by leveraged investors, but interest rates would have to rise substantially above the true rate of inflation for any serious or lasting impact. Such a move would sink the stock market, which is not something the politicians or central planners would allow. They would prefer to print more money, debase the currency and present the illusion of continued prosperity rather than take their medicine. I do not see interest rates rising any time soon.
The only way to deal with a banking system that is so overleveraged and a government so burdened with debt is to allow the free market to reprice the debt—to reprice housing and equities to their true free market value. However, that would cause the banking system—and possibly the entire world economy—to collapse.
The alternative is to fire up the printing presses, inflate away the debt and hope that the bad loans will once again become solvent. If you study history, you are likely to forecast that the government will choose this option over a deflationary collapse, which will continue to push gold higher in dollar terms.
More broadly speaking, if you take two forms of money valued relative to each other (demand being somewhat constant), the one that increases in quantity faster will lose value against the other. Growth in the gold supply is relatively flat, about 1.5% annual growth. The growth of the supply of almost all fiat currencies ranges from 8–10% on average. To me, that says that gold priced in dollars or any other currency being debased will go up in value relative to that currency.
The other factor to consider is velocity of money, which has been low and has held inflation in check thus far. But in light of quantitative easing (QE) to infinity, which is essentially what QE3 is, recent improvements in housing and the stock market, and some proposed legislative changes to get banks lending, we might see this change in 2013. If velocity picks up, we could see inflationary forces start to take hold. If just a small amount of all of the new money created over the past five years were to begin flowing through the economy, the impact could be significant.
TGR: You rely on technical charts for your advice to your readers. What do your technical charts tell you gold will do in 2013?
JH: I just ran this exercise for my subscribers, and came up with a chart showing the minimum target price of gold at $2,200 an ounce (oz) and over $3,000/oz on the high end by the end of 2013. These prices represent gains in the 35–75% range from the current price. It is a much more aggressive annual return than I would usually forecast—much higher than the average annual rate over the past 10 years.
However, precious metals have been consolidating for well over a year. The chart has an incredible amount of pent-up upside potential for 2013. Plus, the gold price is now bouncing around the bottom line of its trend channel. A failure to push higher and break $2,200/oz by the end of 2013 would mean that gold has fallen out of its long-term trend channel and signal the end of the bull market. I put the likelihood of that outcome at less than 5%. Thus, I think the official, inflation-adjusted high of $2,400/oz will be taken out within the next 12 months.
TGR: Given that prediction, should investors be buying gold, gold equities or both?
JH: I recently published an article on this topic and the answer is: It depends. From 2001 to 2005, gold was up roughly 92% and gold stocks up 648%. In this period you would have seen seven times greater returns investing in gold stocks.
From 2006 to today, the NYSE Arca Gold BUGS Index (HUI) of gold stocks advanced by about 39% while gold itself is up 232%. That equals about a six times greater return for physical gold than mining shares.
However, if you combine both periods and look at the entirety of the current bull market, gold stocks have been the better investment. From 2001 through Nov. 12, 2012, physical gold has appreciated by 537%. However, gold stocks have gone up nearly twice the rate of gold for a gain of 936%. This is the leverage that seasoned investors remember and it drives our decision to allocate a significant portion of our portfolio to mining stocks. That said, I believe it is best to own both bullion and mining shares, because they serve different purposes.
Just from the start of August through mid-November, the gold price advanced 8%. Gold stocks were up 18%. That is leverage of roughly 2.4 times. It is hard to say if that will continue, but it is a positive sign for investors in mining stocks.
TGR: When you look at technical charts for precious metals equities, what do you look for, other than an upward trend?
JH: I view technical analysis as just another data point for reference, not as a panacea for forecasting price movements. In markets that are as manipulated as ours, where large firms tilt the level playing field via high-frequency trading and collocation, and banks use their leverage to push prices, I take technical analysis with a large grain of salt.
That being said, I look for the usual trend channels, support and resistance indicators, volume levels, momentum indicators, (Fibonacci) retracements, whether the stock is making lower lows or higher highs. I couple these insights with the timing of fundamental developments for miners: drill results, resource updates, upcoming preliminary economic assessments (PEAs) or feasibility studies to try to time our entry and exit points on trading positions. Our model portfolio also contains long-term holds or core positions that we do not trade.
TGR: What is your investment thesis for precious metals equities?
JH: The equities are undervalued right now relative to bullion. A lot of that has to do with distrust of the stock market and of Wall Street in general, after all of the fraud and failures in the past years. But if the market holds up for a while longer and current trends continue, I think we will see mining stocks continue to outperform gold.
TGR: Which precious metals equities are you telling your readers about?
JH: I have been an early advocate of the streaming royalty model in the mining sector. Silver Wheaton Corp. (SLW:TSX; SLW:NYSE) pioneered it and some of its management broke off to start up a similar company in Sandstorm Gold Ltd. (SSL:TSX.V). I first bought Sandstorm at around $0.50/share; it now trades around $13/share and is up nearly 200% since our last purchase.
Streaming companies make an advance payment to a company with a pre-production stage mineral deposit in exchange for a negotiated percentage of the metal produced for the life of mine.
This model gives companies diversification and risk mitigation because it has agreements with several different miners. There is unlimited upside potential in that the deal is usually for a percentage of the production mine life and limited downside risk if a miner sees its profit margins squeezed as the agreed purchase price is fixed.
Streamers also enjoy an advantageous tax situation, with rates that are usually much lower than tax rates for mining companies.
TGR: You put out a note on Sandstorm after its share price had taken a steep drop, which you attributed to comments made by a pundit in the U.S. Tell us about that.
JH: Two things were at play. First, the stock price got ahead of itself a little bit and was due to pull back. Second, CNBC’s Jim Cramer made some comments that were interpreted negatively on his show, including (referring to Sandstorm Gold): “They’re good, but remember if gold prices go down to a certain price, then those miners won’t be drilling. That is your worry there.”
He did not change from a bullish to a bearish call, but it was enough to ignite a sell-off.
TGR: The streaming royalty space has seen some consolidation in recent years. Is Sandstorm, given its suite of royalties, a favorable target for larger royalty companies?
JH: I do not think so. Nolan Watson heads up Sandstorm and it seems to be his intention to continue running and growing the company for the long term. With all of the buzz around streaming companies at the moment, Sandstorm may be able to command a nice premium, but I don’t believe it will sell.
TGR: The stock is now trading at $12.30/share. If an investor does not have a position in Sandstorm, is this a good time to take one?
JH: I had written that any pullback to $11/share or less would be a good opportunity to establish or add to a position. Funnily enough, it dipped to a $10.99/share low in the U.S. I like Sandstorm as a long-term play and think buying on any dip below $11 will prove a good move a year from now.
TGR: What other companies are you telling your readers about?
JH: Another business model with great merit is the prospect generator model, pioneered by Almaden Minerals Ltd. (AMM:TSX; AAU:NYSE). It has some similarities to the royalty-streaming model that has treated us so well.
Because Almaden owns its own drill rigs, it can drill at a lower cost and has more flexibility with timing. Almaden unlocks value via discovering resources, selling them and usually acquiring a royalty in the process. The company itself is not in the business of production. Its management believes the greatest shareholder value is unlocked when finding the discovery, doing the drilling and passing the project off to a larger company for production.
Almaden has 15 exploration royalties right now, a few of them nearing production. Lately Almaden has focused on the relatively unexplored region of eastern Mexico, where its Ixtaca project is located. Ixtaca has been returning impressive intercepts this year, most recently 134 meters (m) of 4.1 grams per ton (g/t) gold. Almaden expects to issue its NI 43-101 resource on Ixtaca this December. Two years and more than 70,000m of drilling will go into that NI 43-101, including lots of long intercepts over high grade. If the drill results we have already seen are any indication, it could be an absolute game changer for the company.
Producing companies have already shown a lot of interest in Ixtaca, so I think Almaden will be able to sell it rather easily and get an exceptional return on its investment. The best part of this project is that most of the property is still relatively unexplored. There are multiple blind targets and blue-sky potential for Almaden.
TGR: Those recent drill results averaged 4.1 g/t. Is that the sweet spot Almaden has been looking for to make the deposit economic?
JH: It was along the trend, but 50m northeast of the closest drill results that are going into the maiden resource. This shows the potential to significantly expand the current scope of the project. The grade was very convincing.
TGR: What do you expect to happen once the NI 43-101 comes out?
JH: I expect it will attract the attention of investors and that its market cap will increase substantially as a result. This maiden resource may convince larger companies to firm up their offers and move forward. But with the latest round of very strong drill results, it might be better for shareholders if Almaden continues expanding the resource prior to considering any bids.
TGR: Would Almaden issue a dividend to shareholders or keep the money and reinvest it in other projects?
JH: In order to maximize exploration efforts, Almaden does not pay out a dividend and I prefer this. When you can trust management to make deals that are accretive to shareholders, I would rather see the money used for more drilling on prospective projects, of which Almaden has a number in the pipeline.
TGR: You also follow the graphite space. What is the latest news there?
JH: Overall, graphite is attractive due to strong supply/demand fundamentals. Prices have come back down from lofty levels last year, but have stabilized recently and remain elevated. This means that a number of graphite projects that might not have been economic in the past are economic today.
Given that graphite is a key ingredient in so many established industries, from aviation to automotive, steel and plastic, I see prices holding up well. However, future demand growth is likely to come from the high-purity, large-flake graphite that is used in lithium-ion batteries for electric cars and such.
People talk about the big run-up in lithium a while ago, but 10 times more graphite is used inside a lithium-ion battery than lithium. There will be significant demand as we move toward electric vehicles and electric-based power.
The other exciting driver in investment demand for graphite is the potential of graphene, which is reportedly the thinnest and strongest material ever developed. Graphene is 200 times stronger than steel, several times tougher than a diamond and it conducts electricity and heat better than copper. It could even replace silicone in semiconductors. Also, graphene is nearly impossible to break. You could throw a graphene mobile phone display on the ground and it will not shatter like the glass on current phones. Researchers claim graphene is the most important substance to be created since plastic.
Samsung Electronics Co. Ltd. (005930:KSE) plans to launch a cell phone in mid-2013 that will have a bendable display made from graphene. Future versions could be a phone that rolls up on your wrist or that could be folded to fit into your pocket. There is a lot of potential for graphene in the expanding cell phone and green energy markets. The military has an interest as well.
TGR: To date, graphene has been made only in labs using synthetic graphite to control for purity. Is there a graphite deposit in the world that will meet the need for very high-purity, large-flake graphite to manufacture graphene?
JH: Yes, there are a few deposits, and companies are making progress in addressing the technical challenges to reach the purity needed to produce graphene.
Focus Graphite Inc. (FMS:TSX.V) has a high-purity deposit. It just released its PEA in October at 32% pre-tax internal rate of return. It has a 2.8-year payback and is fairly easy to finance with capital costs of just $154 million. Its very low $435/ton cost is driven by the high grades in the deposit. Management believes the company will be one of the highest-grade, lowest-cost producers in the world once it is up and running. This stock has a lot of potential, despite having been beaten down a little bit in the last six months.
TGR: Does that make Focus a good entry point for investors looking for graphite exposure in their portfolios?
JH: Yes, as long as they take a longer-term view and are not looking to trade in and out quickly. It will take Focus time to get closer to production and to prove up the resource. Long-term investors who can buy and hold will find a lot of potential there.
I also like Energizer Resources Inc. (EGZ:TSX.V; ENZR:OTCBB). This company recently completed a drill program of more than 47 holes over 9,000m. It included the largest intersection of graphite ever reported: 421m grading 6.18 carbon, including the valuable jumbo-flake graphite at 93% purity. Plus, the mineralization is exposed at the surface, which means you can build a low-cost open-pit mine.
In addition to possibly sitting on the world’s largest graphite deposit, Energizer also has one of the world’s largest vanadium deposits. Its PEA, expected by year-end, could well be the catalyst to push Energizer’s stock price higher. We are looking to buy on any dip below $0.30/share.
TGR: The biggest concern is that the Green Giant project is in Madagascar. Not only is it a difficult place to permit a mine, there are also a lot of places where it would be hard to mine. Do you know what Energizer’s strategy is for getting a permit and opening a mine?
JH: Given the size and purity of the deposit and the potential revenue for the country, the government may allow some leniency regarding the permit. Energizer will be able to apply some environmental safeguard best practices, which should help with environmental concerns
I think the mine will get built. Thus far, indications are that Green Giant will be a very economic project. I think the company will find ways to work with the local community and the local government.
TGR: When is the new resource estimate on Green Giant due out?
JH: By the end of December 2012, but I would not be surprised if it were delayed by a month or two as is typical in the mining industry.
TGR: Jason, thank you for your time and your insights.