Leonard Melman: Put your trust in precious metals, not governments

Leonard Melman: Equities have become somewhat disconnected from economic reality. We’ve heard comments from the European Central Bank, the U.S. Treasury and the Bank of Japan calling for more inflation because dramatic action is needed to improve the world economy. How does that coincide with the bull markets in equities?

TGR: Is there a connection between these bull markets and quantitative easing (QE)?

LM: People now believe that central banks like the Federal Reserve are the only means of stimulating economic activity. Therefore, because QE is likely to continue, investors are buying stocks. I cannot think of any other logical reason for these bull markets. Companies are not rapidly increasing sales. They’re not rapidly developing new markets. They’re not hiring massive numbers of new workers. It’s a stagnant economy, and yet the Dow is up almost 20% this year.

TGR: You said during your presentation at the Cambridge House conference in Spokane that without visible inflation, a strong metals rally might be difficult. John Williams of ShadowStats.com argues that the U.S. is already undergoing highly visible inflation and that the official inflation measurement is so politically perverted as to be practically useless. What’s your view?

LM: I do agree with Williams that there is some underreporting of inflation. If inflation were reported accurately, all the automatic increases in benefit payments that would then ensue, such as higher Medicare payments, higher payments to doctors, and most important, higher Social Security checks, could bankrupt the government.

That said, I don’t think we have anything like the inflation of the late 1970s and early 1980s. Back then, every two weeks you’d walk into a restaurant, and they’d have a new menu with higher prices. Interest rates were horribly high. Gasoline prices have actually been in decline now for quite a few months. There isn’t the scary, visible price inflation we saw 30 years ago. Inflation of maybe 10, 12, 15% or more will generate the psychological background necessary for rampaging gold and silver bull markets.

TGR: You argued at Cambridge House that perceived U.S. political and economic stability is good for gold and silver. To what extent can the U.S. government continue to persuade investors that all is well, and thus keep gold and silver down?

LM: That is the absolute crux of the problem. Most people have tremendous faith in their government to solve problems. But I feel, I hate to say, that a major breakdown is truly beginning to develop. If it does, then we have the potential for massive disillusionment leading to panic. And when people panic, they turn to gold and silver because they begin to lose faith in their currencies.

TGR: A recent New York Times article lauded inflation as good for people. What is your take on it?

LM: Inflation, of course, accompanies virtually every historic gold bull market. There are some who say that more inflation means perhaps just 2 or 3% instead of 1%, but once you open that spigot, it is very hard to turn it off.

We’re seeing that in the budgetary debates. The U.S. is still running a $900 billion ($900B) per year deficit. How on earth is it going to cut out $900B in programs and still keep the government operating? It can’t.

TGR: How long can the debt problem be managed?

LM: For 150 years, the U.S. had a currency of gold. And so the reputations of the U.S. dollar and the U.S. government were unchallenged. If something was good, it was as sound as a dollar. The dollar itself was as good as gold. However, the dollar is no longer backed by gold, and this has resulted in runaway debt.

TGR: What about the role of government in the mining sector?

LM: Government has the capacity not only to do good, but also to do immense amounts of harm. An ocean of overregulation is having a terrible effect on mining. Some of the juniors I know are just in agony, especially now, when metals prices are weak. How in the world can they raise enough money to finance all the regulations, reports, applications and filing fees they have to pay in addition to important exploration work?

I’ll give you some examples of how government regulations affect mining. In Mexico, Congress is seriously considering a 7.5% mining royalty. Grupo México (GMEXICOB:MXN) and Goldcorp Inc. (G:TSX; GG:NYSE) have said that if this tax is enacted, they will pull many of their operations from Mexico and will not invest new money. In Quebec, the leftist Parti Québécois government has made prospecting so difficult that one oil company manager actually said that people are more likely to invest in Africa and Iraq than Quebec.

TGR: Several mining analysts interviewed recently by The Gold Report have argued that it’s time for investors to dump all but the strongest stocks in their portfolios. Do you agree?

LM: I do. There are two kinds of juniors that still retain investment consideration. The first has an adequate treasury to see it through the next year or two without having to raise money, if it takes that long to restore a major bull market.

The second kind, even better, has a producing property and is bringing in cash, which allows it to explore and develop other properties, thus enabling expansion without ruinous share dilution. I have seen a great number of offerings in the last few months on the order of 10 million (10M) shares at $0.03/share just to raise $300,000 ($300K). This keeps the office going for three more months before the company has to go to the market again and maybe offer 15M shares at $0.02/share just to raise another $300K. It’s ludicrous.

TGR: After these companies pay their brokerage fees, they’re not keeping much of this money, are they?

LM: Exactly. Juniors are no longer cutting fat; they’re down to the sinew and bones. Juniors once prospered by finding a project, immediately developing it and releasing a string of news releases. If these were exciting, share prices would rise. Juniors would use that capital to accelerate exploration and development, go quickly through to a preliminary economic assessment (PEA) and a feasibility study and then bring the property into production. That’s how companies like Barrick Gold Corp. (ABX:TSX; ABX:NYSE) and Newmont Mining Corp. (NEM:NYSE) got their starts.

We just don’t see much of that anymore. The Australian Stock Exchange and the TSX Venture Exchange have a whole host of companies that are dead in the water, and these exchanges may be at risk themselves because they need income (registration and filing fees) from active companies to remain in business.

TGR: You said at the Cambridge House conference that present stock price levels offer major opportunity and upside breakouts.

LM: Let me explain that comment. When you consider the worth of all other investments versus precious metals, it’s on the order of 99.4% to 0.6%. If even 3% of that 99.4% switched to precious metals, the leverage could be absolutely enormous: Multiples of 5, 10 or even 15 times present quotes could occur quite rapidly. That, I think, is the kind of potential that could exist at the early stages of a major bullish turn in the metals.

TGR: Which silver companies could benefit from that kind of turn?

LM: Silver Bull Resources Inc. (SVB:TSX; SVBL:NYSE.MKT) has a very interesting project. Great Panther Silver Ltd. (GPR:TSX; GPL:NYSE.MKT) has a good combination of production and developing projects. El Tigre Silver Corp. (ELS:TSX.V; EGRTF:OTCQX; 5RT:FSE) has a very nice potential tailings reclamation project.

Canasil Resources Inc. (CLZ:TSX.V) is developing its Salamandra silver-copper-zinc-lead project via a joint venture with MAG Silver Corp. (MAG:TSX; MVG:NYSE). This allows Canasil to stay in the game without having to dilute its shares. I recently talked to Canasil’s president, Bahman Yamini, and he thinks Salamandra could become a true company builder.

TGR: Silver Bull, on Oct. 1, released a PEA for its Sierra Mojada project.

LM: I had the pleasure of visiting that project earlier this year. It’s an amazing silver and zinc project, two completely distinct ore bodies, in many places one lying right on top of the other. I think there is excellent potential there. The company could definitely use a little assistance from higher metals prices, but it’s the kind of project I like. It has adequate financing. The upward potential appears to be sizable.

TGR: Sierra Mojada’s preproduction capital expense (capex) is $297.2M. Is that manageable?

LM: Without being a mining engineer, I think the figure, given the size of the deposit, is probably quite reasonable. I think Silver Bull is one of those companies that may have trouble raising sufficient capital in today’s troubled market to go into production, but it’s the kind of deposit that will be very attractive down the road when capital markets loosen, and the mining field becomes exciting once again.

TGR: Great Panther released its Q3/13 production figures last month, which showed really significant increases.

LM: Guanajuato is another project I’ve had the opportunity to visit. I was quite impressed with the management and with the geologists, both for current production and for exploration of expanding reserves. At least Great Panther is getting money in. It is financing its own exploration. The potential to increase production, I believe, is very real.

Guanajuato is one of the most fascinating cities in all of Mexico. It sits at 6,600 feet above sea level. There are ancient roads that run under the downtown area. Great Panther’s mine and Endeavour Silver Corp.’s (EDR:TSX; EXK: NYSE; EJD:FSE) mine are right in the metropolitan area of Guanajuato. They get enormous kudos from the community for the economic wealth they are bringing to the region.

TGR: Canasil has nine properties in Mexico. That’s quite a few.

LM: Yamini stressed that to me. His hope is that if Salamandra can bring in sufficient revenue, the company can use that to develop some of the others. I’ve visited Durango several times. There are almost continuous ore discoveries along the silver belt that runs right through the center of Mexico, the Sierra Madre.

TGR: What do you make of El Tigre’s business plan of first generating cash flow by building a processing facility to recover silver and gold from the tailings pile at the original mine?

LM: I think it’s terrific. The only problem El Tigre has had, like everybody else, is raising capital, but it recently finalized an offering of $700K. Stuart Ross, the company president, anticipates that unless there are some unforeseen difficulties, it will be in production within about a year. From roughly 1900 to about 1935, El Tigre mined silver ore that averaged about 40 ounces (40 oz) per ton and previous operators apparently regarded anything under 15 oz/ton as just waste. So those wastes, frequently used as production backfills, may actually contain an average of 7 or 8 oz/ton.

More to the point, if El Tigre can explore the area thoroughly, is it illogical to believe there’s a possibility that it could uncover more 40 oz/ton resources? You can just imagine the boon that would be, even at $20/oz silver.

TGR: All the companies we’ve discussed so far are in Mexico. According to the Oct. 31 Financial Post, “Shares in several Canadian miners with Mexican operations are swooning after Mexico’s Senate on Tuesday gave its general approval of tax reforms hard sought by President Enrique Peña Nieto.”

LM: I saw that. Some politicians still believe mining is nothing but a bird to be plucked, but mining production is often a goose that lays golden eggs, and such taxation measures could kill it. These politicians don’t understand mining, which, to my mind, is the greatest creator of genuine wealth that exists on this earth. Take a place in Mexico like La Preciosa in Durango state. It once was a flat piece of territory that generated nothing. Then mining companies came, spent a great deal of capital and generated huge numbers of jobs and growing prosperity.

You would think governments would love that. Instead, they just try to milk every penny of taxation they can. It’s short-sighted and destructive. I’ve seen it in other countries: Chile, Bolivia, Guyana.

TGR: Would Mexico’s new mining regime threaten Silver Bull, Great Panther, El Tigre and Canasil?

LM: I don’t think it will have a very strong effect on them because most of the burden will fall on companies making very sizable profits. The companies we have talked about are not in that category and won’t be for several years at least. It’s the long range that I don’t like. Short term, I don’t think there’s a real negative impact.

TGR: Which companies do you like in gold?

LM: I visited Balmoral Resources Ltd. (BAR:TSX.V; BAMLF:OTCQX), on the Ontario-Quebec border. Balmoral is on the Quebec side of the same Detour trend that, on the Ontario side, has Detour Gold Corp.’s (DGC:TSX) huge mine. Balmoral is run by the same people who succeeded so well with West Timmins Mining, which was bought out in 2009 by Lake Shore Gold Corp. (LSG:TSX). The management team is experienced, competent and thorough. I think that is another company of interest for investors looking just down the road.

TGR: Balmoral just raised $6M, correct?

LM: Yes, and the three or four east-west trends that follow along Ontario-Quebec border have seen enormous metals production through the decades. It’s an area of elephants.

TGR: What other companies are you following in Canada?

LM: There is Commerce Resources Corp. (CCE:TSX.V; D7H:FSE; CMRZF:OTCQX) and its parent company Zimtu Capital Corp. (ZC:TSX.V). Commerce’s big rare earth project, Ashram, is in northern Quebec. This is an area without too much infrastructure. Virtually everything has to be flown in, and because of the resulting high expenses, the company has begun to feel the pinch financially. Ashram itself appears to have real merit, just like Commerce’s Blue River tantalum-niobium project in British Columbia.

I like Commerce, and I think the world of the people who run it. This is a company that could use a real break in the junior sector, so that it can to get its shares back up to where it can raise money efficiently.

TGR: Not that long ago, rare earths and other critical metals were all the rage among investors. How do you rate them now?

LM: There is a great deal of uncertainty. After the Chinese announced they were going to start withholding supply to the West, rare earth stocks shot to the moon, and investors made a great deal of money. Then many of those shares came back down, virtually as fast as they went up. I’m a little leery of the group because three problems exist. The first is that refining rare earths is a very difficult process. Second, there is some difficulty in developing identifiable markets. The third problem is nanotechnology. As the size of end products keeps shrinking, so the quantity of metal needed for each electronic device is also shrinking.

TGR: Of the six companies we’ve discussed, is there one that strikes you as a particularly good bargain given its present stock price?

LM: I believe El Tigre is in a unique position. It has substantial assets of potentially exceptionally high quality, but because of the general market environment, its shares have been beaten down to $0.18. I believe if we get any kind of boost in the market, this is the kind of company that could see an enormous leveraged run develop quite quickly. I’m not giving any direct buy recommendation, but I do believe this could be a company of particular interest to investors.

TGR: When can we expect a resurgence in precious metals?

LM: I remember very clearly one of the worst bear markets in stock market history. It was from 1971 to 1974. The Dow dropped from about 1,070 to 570 by June 1974, when it then hit bottom. It bounced back to about 700 during the fall and then fell again to about 600 in very late 1974. The key point is that the second selloff terminated above the first. Then the bull market began. This is a technical pattern called a spread double-bottom.

Picture gold now. It fell from a high of $1,935/oz in August 2011 to $1,175/oz in June 2013. It then rallied to more than $1,400/oz and now it has fallen again. The low of the second decline so far has been $1,260/oz. So we have a technical pattern that’s identical in basic form to that giant reversal in the Dow I mentioned above. I believe if we can exceed $1,400/oz, technically we will have completed a major spread-double-bottom pattern that could be the prelude to a major precious metals bull move.

There is also one other technical point. A lot of important market move retracements are about 50%. The present golden bull market started in 2001 with gold at about $260/oz. It ran up to $1,935/oz before this retracement. That’s a gain of $1,675/oz. Half of that would be about $840. If you subtract $840 from $1,935, you get about $1,100, which also indicates we could be in a zone where there would be a natural rebound. There are no guarantees in technical analysis—I should note I’m a member of the Canadian Society of Technical Analysts—but we do have indications that are well worth watching.

TGR: Leonard, thank you for your time and your insights.

Leonard Melman, publisher of The Melman Report, has been writing about precious and base metals for more than two decades as monthly columnist for California-based ICMJ’s Prospecting and Mining Journal and Vancouver’s Resource World Magazine. He focuses on how political and financial considerations impact the world of mining and the prices of the metals.

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