Mike Niehuser’s gold investing lessons from banking school

Mike Niehuser: In a former life I was a real estate construction lender; I attended a mid-career banking school and found out there that I am not a banker. I also learned how to analyze banks and in 2000 transitioned to become a bank analyst. In 2004, I found NovaGold Resources Inc. (NG:TSX; NG:NYSE.A) and fell in love with the mining industry. I never forgot the school and was awarded faculty status eight years ago for providing lecture capture for long-distance learning. Staying active in the school has allowed me to see outside the bubble and this I hope has made me a better mining analyst. The skills as a banker—assessing project, credit and market risk—have helped me to compete as an analyst.

TGR: Regarding Bernanke’s comments, how does this impact your forecast on gold prices?

MN: I think Bernanke’s comments, as unclear as they were, demonstrate how polarized the world is in its thinking. The markets are looking for leadership and direction, something investors can trust to plan their investments. This became clear to me at banking school. One direction is to stable money, the other indecisive course will reap the whirlwind. I’m still holding to my original forecast for 2012 of gold ranging from $1,400 to $1,700/ounce (oz) with the potential for some catalyst to push the upside to reach $1,800 to $1,900/oz. While it may appear lame to reiterate what has already occurred, I am quite confident we could see a move to stabilize near the upside of the forecast toward the end of 2012. Due to the election, we may expect significant volatility through the end of the year. It should come as no surprise if silver traces a similar pattern.

TGR: In light of your involvement with the banking industry, how do you think bankers feel about the possibility of more quantitative easing and its impact on interest rates and inflation?

MN: There are individuals who feel strongly one way or another, but strangely indifferent overall. There are hints that all is not well. I am not talking about concerns we might have for deficits, increasing national debt and inflation, but concerns about the public perception of bankers as a class and on their careers with the impact of legislation like the Dodd-Frank Act that has not even been written. Bankers appear to be coming out of a state of denial on Dodd-Frank, but I believe they understand that it will lead to a declining return on equity and being required to hold more capital, receiving lower returns on investment and falling stock prices.

There is also a split between large banks and community banks. This should lead to consolidation and the unforeseen consequence of even larger banks that are “Too Big to Fail,” which, in my opinion, creates even more systematic risk.

Interestingly, some bankers see low interest rates as a new normal that present selling opportunities to their customers. There are people on both sides. On the whole, bankers would rather have the Fed on their side openly, if they want to have access to funds and support for their banks. I fear with Dodd-Frank the banking industry is becoming more of an arm of the government than an investible class of investments. As long as politicians and their regulators, in the name of risk reduction, continue to pick winners and losers, there will be unintended consequences. On the whole, they appear to be in a bubble and to have convinced themselves that they have the ability to shed inflation or interest rate risk on their balance sheets.

TGR: Do most of the bankers you know feel that the general economy is in recovery mode?

MN: Yes, it would seem so. Most of the loans going bad today are small compared with just a few years ago. Not a lot of new loans are being created. It was said by one instructor that, “You have got to be terminally stupid to have a new loan go bad in the first year.” As things are less negative or at least stabilized, bankers’ careers are in less danger and this is how they view the world. This is interesting for a number of reasons. From a microeconomic perspective of demand and supply, artificially low interest rates would actually create a shortage of credit, just as price controls create shortages. Once again, just thinking of additional requirements brought on by Dodd-Frank, the over-regulation will likely lead to unforeseen consequences, distorting markets and misallocating credit. Imagine being a lender with stiff penalties to be assessed by the unaccountable Consumer Financial Protection Bureau or having lawyers regularly sitting in with regulators on bank audits. The culture of banking is to reduce risk, and Dodd-Frank is a healthy dose of reputation, regulatory and political risk. In any event, this will suppress lending and economic growth in the economy, which will lead eventually to more imports or higher prices.

TGR: What is the general sentiment among bankers regarding investing in gold? Does the banking community regard the possibility of making gold a Tier 1 asset a real possibility?

MN: This was strange; in past years some students mentioned gold, but I didn’t hear anyone talk about gold over the session except the economics professor. This was particularly odd because the school was held during the Republican National Convention, with its proposal to complete a study on the gold standard. One would think it would come up in conversation as this would impact the definition of the very lifeblood of the banking industry, money and leverage. I suppose this stems from a misunderstanding or lack of thought on their part of the definition of money. It was interesting that the recent partnership of PayPal and Discover came up. This advancement into mobile payments that skirt the banking system has the attention of both Warren Buffet and banks as technology innovates ahead and outside the banking system, challenging our understanding of money. It was also interesting that gold as a Tier 1 asset never came up. When I prodded some of the knowledgeable instructors on the subject, they said simply that this idea had been around but it never really went anywhere, except maybe in Europe.

TGR: How do you account for the indifference of a group of financial professionals toward gold, considering the higher prices over the last decade?

MN: I think the greatest pearl of wisdom I took away from being a student at the school in the 1990s was that people are different. They may look alike but they are different, not just because of their education or background, but how they process information and make decisions. People are individuals and they can be counted on to act one way or another in their own self-interest, and particularly in how they see the world. This is what makes markets so difficult to predict and makes it impossible to craft policies that micromanage business, investment decisions or personal behavior. On the other hand, groups of people bind themselves into special interests that in a silo or bubble become increasingly unstable over time. This is more than armchair philosophy. Demographics and an expanding culture of entitlement have hurt Europe beyond repair and are driving politics and economic trends in the U.S., perverting the role of money in an efficient economy, which is clearly the best case for higher gold prices in the near to long term.

TGR: Why does this make you so sure that this will lead to higher gold prices?

MN: It’s just my opinion, but the world appears to be polarizing. I am in the minority where I come from, sort of a combination of a Classic Liberal, Austrian School, Friedmanite, Supply-Sider. I think, like Frédéric Bastiat, that the Law is to protect the individual’s life, liberty and property. This requires free will, choice and belief in the virtues of mutually agreed upon free exchange, an economy regulated to eliminate deception and reinforce trust. Stable money is essential here and gold is the very essence of trust that all people desire. The other side is driving the boat in Europe and the United States. They work their own book and believe that they are smarter and can organize society. They believe demonizing the 1% and co-opting the bottom 50%, thereby destroying capitalism—moral capitalism—is actually going to benefit them. After they get done taxing the rich and destroying the economy, the only option left is to enforce redistribution of wealth through inflating the currency. It may be too late to turn back. I think this is why the U.S. Presidential election is so important and historic for the global and national economies.

TGR: That’s a pretty negative perspective.

MN: Yes, I know, and I’m an optimist. At the current birth replacement rate the world population will voluntarily decrease without wars and pestilence for the first time in human history. The population of the world is expected to start declining around 2050. This is a big deal for Europe, India and China, and less so for the U.S. An aging population is likely to politically guarantee distribution and easy money, which is good for gold.

On the other hand, in the United States, the baby boom each day is declining in importance compared to an equal size group, right around 75 million, born between 1982 and 2000. This group plus immigrants pursuing the American brand of moral capitalism is seeking a better future than the one I just portrayed. This group will outgrow the hang-ups of the aging and increasingly irrelevant baby boomers. Keynesianism has periodically relied on tricking people with easy money and counting on “money illusion.” Then they count on wage and price controls, which always have and will always fail. Young people will figure this out—if only the hard way. This is my children’s generation, but despite my negative prognosis, for them I am intensely positive. Until they move into leadership, gold is the best hedge for the market distortions caused by social justice.

TGR: You’re from Portland, Oregon, and are an advocate of the business development in the northwestern U.S. Don’t most of the locals feel negatively about expansion of mining in that general region?

MN: The funny thing about the Occupy Movement is that Portland has been occupied for decades. Private sector jobs here have declined for over 10 years. Decades ago environmentalists worked their book and succeeded in destroying the lumber industry. They had no concern for the communities, schools and lives they upset. As an optimist, my money is on entrepreneurs, including those in the mining industry, that continue to contest monopolies and special interests. Most people who feel negatively live in the cities. My son calls these the “haves” in the “moneyburbs.” These folks just are not educated to understand that they could not exist without mining. Until the population of the planet begins to shrink, mining will become increasingly more important and so will the need to educate both investors and the uninformed. I built my business on this idea and I love my job.

TGR: Is there a significant core group of resource investors in that part of the U.S.?

MN: Yes, primarily adults in eastern Washington, Idaho and Montana. They may be outnumbered by Californians, but the legacy of mining has not totally disappeared. In these areas even politicians recognize the importance of wealth-creating, good-paying jobs that fund schools and communities.

TGR: With lackluster economic growth throughout the West, do you see mining projects in Oregon, Montana, Idaho and Utah progressing through the permitting process more quickly now?

MN: No, but there is a real effort in Montana to boost jobs in the energy sector. They probably see how neighboring states are benefiting. I suspect this is having some spillover to Montana, but it is a start. Idaho is pretty consistent. We are even starting to see some very real activity in Oregon after decades of inactivity. This is primarily a function of metal prices drawing entrepreneurial mining companies with willing allies in county government who have not given up on their communities. State governments are starting to look more favorably on mining but this may require a change at the top. Once again, a change in national leadership would be immensely positive for the mining and energy sectors, and we could have Friedman-like policies and expect a burst of economic activity as we saw under Ronald Reagan in the 1980s.

TGR: What are some of the most interesting mining projects/companies in the Northwest?

MN: Seabridge Gold Inc. (SEA:TSX; SA:NYSE.A) sold its Oregon project, Grassy Mountain, to Calico Resources Corp. (CKB:TSX.V; CVXHF:OTCQX) and its Quartz Mountain property to Orsa Ventures Corp. (ORN:TSX.V). We were quite interested to visit Quartz Mountain about a month ago. The project has an Inferred gold resource of about 2.8 million ounces of which over a million of the ounces are in oxides. Orsa has put together a strong management team in a short period. The company maintains a modest share count. It has done an exceptional job pulling together historic studies. About 270,000 feet have already been drilled on the Quartz Mountain project.

The property is located near state highways and is accessed by numerous well-maintained roads. It is situated near Lakeview, Oregon, and as the area welcomes development, management has jumped on establishing good relationships with local officials. We see Orsa as a deep value idea with good potential to locate more ounces, growing the resource or advancing the project and upgrading the classification of the identified resource.

TGR: Do you have other American mining projects that you are excited about?

MN: We visited High Desert Gold Corp.’s (HDG:TSX.V) Gold Springs project on the Nevada-Utah border about a year ago. High Desert has a district-size land position and has completed comprehensive geophysical surveys complementing already successful preliminary drill and sampling programs. There were several historic producers on the property and management appears to be pulling all this together to understand the project. This has led recently to bonanza-grade gold results. The company is waiting for assays on other promising targets. We believe High Desert is also well managed and maintains a competitive capital structure. While High Desert has established a modest initial resource, we anticipate this is just the first of numerous resources at the project. We also see the market taking note and responding to potential high-grade drill intercepts.

Prior to our visit to Orsa’s Quartz Mountain project, we toured the Yukon. Although Alexco Resource Corp.’s (AXR:TSX; AXU:NYSE.A) Keno Hill silver project is in the Yukon, it is populated by American management. This remains one of my favorite companies based on the quality of management, its high-grade silver resource in the politically stable Yukon, and its potential production and exploration profile.

With lower metal prices and a statistically challenging production quarter, disappointed investors took the stock price down to a two-year low. We believe it is nearly impossible to repeat the same performance as in the second quarter, and with metal prices showing upward potential, we anticipate a much stronger finish to 2012 and Alexco meeting its guidance for silver production positively surprising investors. We also took the opportunity following the release of second quarter results to increase our position.

TGR: Any companies in the U.S. that are ready to surprise?

MN: After the Independence Day holiday we visited North Bay Resources Inc.’s (NBRI:OTCBB) Ruby gold mine in the Sierra Nevada northeast of Sacramento, in the northern extension of the California Mother Lode. This is a fully permitted, past-producing underground placer and lode gold mine. The Ruby was in production until World War II. The mine at that time was enjoying the greatest operating results. The mine and equipment have been maintained in exceptional condition and, pending completion of financing and completing rehabilitation of underground workings, should move back into production.

While modest in appearance for its early production potential, management is preparing to reopen the mine and begin gold production while initiating an exploration program to further expand and delineate the resource. We see long-term potential with Ruby, but more important for our purposes, the potential to surprise investors with a new producing gold mine in California is compelling.

TGR: That’s a great note to end on. Thanks for your time.

Mike Niehuser is the founder of Beacon Rock Research LLC, which produces research for an institutional audience and focuses in part on precious, base and industrial metals, and alternative energy. Previously a vice president and senior equity analyst with the Robins Group, he also worked as an equity analyst with The RedChip Review. He currently holds faculty status with the Pacific Coast Banking School and is on the board of the Oregon International Airshow. Niehuser holds a bachelor’s degree in finance from the University of Oregon.

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